News Column

WESTERN ASSET MORTGAGE CAPITAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

August 11, 2014

FORWARD-LOOKING INFORMATION

The Company makes forward-looking statements herein and will make forward-looking statements in future filings with the Securities and Exchange Commission (the "SEC"), press releases or other written or oral communications within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). For these statements, the Company claims the protections of the safe harbor for forward-looking statements contained in such sections. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond the Company's control. These forward-looking statements include information about possible or assumed future results of the Company's business, financial condition, liquidity, results of operations, plans and objectives. When the Company uses the words "believe," "expect," "anticipate," "estimate," "plan," "continue," "intend," "should," "may" or similar expressions, the Company intends to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking: market trends in the Company's industry, interest rates, real estate values, the debt securities markets, the U.S. housing and the U.S. and foreign commercial real estate markets or the general economy or the demand for residential and/or commercial mortgage loans; the Company's business and investment strategy; the Company's projected operating results; actions and initiatives of the U.S. Government and changes to U.S. Government policies and the execution and impact of these actions, initiatives and policies; the state of the U.S. and, to a lesser extent, international economy generally or in specific geographic regions; economic trends and economic recoveries; the Company's ability to obtain and maintain financing arrangements, including securitizations; the current potential return dynamics available in residential mortgage-backed securities ("RMBS") and commercial mortgage-backed securities ("CMBS" and collectively with RMBS, "MBS"); the level of government involvement in the U.S. mortgage market; the anticipated default rates on Agency and Non-Agency MBS (as defined herein); the loss severity on Non-Agency MBS; the return of the Non-Agency RMBS CMBS and asset-backed securities ("ABS") securitization markets; the general volatility of the securities markets in which the Company participates; changes in the value of the Company's assets; the Company's expected portfolio of assets; the Company's expected investment and underwriting process; interest rate mismatches between the Company's target assets and any borrowings used to fund such assets; changes in interest rates and the market value of the Company's target assets; changes in prepayment rates on the Company's target assets; effects of hedging instruments on the Company's target assets; rates of default or decreased recovery rates on the Company's target assets; the degree to which the Company's hedging strategies may or may not protect the Company from interest rate volatility; the impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters; the Company's ability to maintain the Company's qualification as a real estate investment trust for U.S. federal income tax purposes; the Company's ability to maintain its exemption from registration under the Investment Company Act of 1940, as amended (the "1940 Act"); the availability of opportunities to acquire Agency RMBS, Non-Agency RMBS, CMBS, residential and/or commercial mortgage loans and other mortgage assets; the availability of opportunities to acquire ABS (as defined herein); the availability of qualified personnel; estimates relating to the Company's ability to make distributions to its stockholders in the future; and the Company's understanding of its competition. The forward-looking statements are based on the Company's beliefs, assumptions and expectations of its future performance, taking into account all information currently available to it. Forward-looking statements are not predictions of future events. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to the Company. Some of these factors are described in Item "1A - Risk Factors" in the Company's annual report on Form 10-K for the year ended December 31, 2013, as filed on March 17, 2014 with the SEC. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that the Company files with the SEC, could cause its actual results to differ materially from those included in any forward-looking statements the Company makes. All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect the Company. Except as required by law, the Company is not obligated to, and does not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following discussion should be read in conjunction with the Company's financial statements and the accompanying notes to the Company's financial statements, which are included in Item 1 of this Quarterly Report on Form 10-Q, as well as the information contained in the Company's annual report on Form 10-K for the year ended December 31, 2013, as filed on March 17, 2014 with the SEC. 40

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Table of Contents Overview Western Asset Mortgage Capital Corporation (the "Company" unless otherwise indicated or except where the context otherwise requires "we", "us" or "our") upon commencing operations in May 2012, had an initial investment strategy which was primarily focused on investing in, financing and managing Agency RMBS (including TBA contracts as defined herein). Over time, we have expanded our investment strategy to include both Non-Agency RMBS and subsequently Agency and Non-Agency CMBS, In addition, and to a significantly lesser extent, we have invested in other securities including certain Agency obligations that are not technically MBS and are currently evaluating investments in ABS. Our Manager (as defined herein) is also actively pursuing investing in whole loans or whole securities as set forth in more detail below. These changes in our investment strategy, including future changes, are based on our Manager's perspective of which mix of portfolio assets it believes provide us with the best risk-reward opportunities at any given time. We have and expect to continue to finance our investment portfolio primarily through the use of repurchase agreements. We operate and elected to be taxed as a real estate investment trust ("REIT"), commencing with our taxable year ended December 31, 2012. We generally will not be subject to U.S. federal income taxes on our taxable income to the extent that we annually distribute, in accordance with the REIT regulations, all of our net taxable income to stockholders and maintain our intended qualification as a REIT. We also intend to operate our business in a manner that will permit us to maintain our exemption from registration under the 1940 Act.



We are externally managed and advised by Western Asset Management Company ("WAM", or the "Manager"), an SEC-registered investment advisor and a wholly-owned subsidiary of Legg Mason, Inc. Our Manager is responsible for administering our business activities and our day-to-day operations, subject to the supervision of our board of directors.

In light of the aforementioned developments and given our Manager's current market outlook and investment view, while we expect that Agency RMBS will continue to be a significant part of our portfolio, Agency RMBS will not necessarily be our primary investment in the future. Going forward, our Manager may vary the allocation among various asset classes subject to maintaining our qualification as a REIT under the federal tax law and maintaining our exemption from the 1940 Act. These restrictions limit our ability to invest in non-real estate assets and/or assets which are not secured by real estate. Accordingly, our portfolio will continue to be principally invested in MBS. On April 3, 2014, we entered into a binding agreement with a group of underwriters to sell an incremental 13.0 million shares of our common stock, which closed on April 9, 2014. The agreement provided the underwriters with the right to purchase an additional 1.95 million shares (15% of 13.0 million) during the succeeding thirty (30) days. The shares were offered to the market at a price of $14.85 per share and the underwriters exercised a portion of their option and purchased an incremental 1.0 million shares on May 2, 2014, which closed on May 7, 2014. We received net proceeds of approximately $205.4 million after subtracting underwriting commissions and offering expenses of approximately $2.9 million. On April 3, 2014, we also entered into an agreement to sell 650,000 shares of our common stock, for $14.85 per share, to our Manager in a private placement for an aggregate offering price of approximately $9.7 million, which closed on April 9, 2014. We have invested the proceeds of our IPO, concurrent private placements and follow-on public offerings primarily in Agency RMBS, including Mortgage pass-through certificates, Agency derivatives, Agency Interest-Only Strips, and Agency CMOs, Non-Agency RMBS as well as Agency and Non-Agency CMBS and Non U.S. CMBS. We have also used "to-be-announced" forward contracts, or TBAs, in order to invest in Agency RMBS. Pursuant to these TBAs, we agree to purchase, for future delivery, Agency RMBS with certain principal and interest terms. At June 30, 2014, our portfolio was comprised of approximately $3.5 billion of Agency RMBS, approximately $757.2 million of Non-Agency RMBS, approximately $39.2 million of Agency CMBS, approximately $392.1 million of Non-Agency CMBS and approximately $33.8 million of other securities, exclusive of linked transactions. In addition, at June 30, 2014, our linked transactions included approximately $15.2 million of Non-Agency MBS and approximately $25.3 million of Non U.S. CMBS. We use leverage, currently comprised of borrowings under repurchase agreements, as part of our business strategy in order to increase potential returns to stockholders. We accomplish this by borrowing against existing MBS and other securities through repurchase agreements. There are no limits on the maximum amount of leverage that we may use, and we are not required to maintain any particular debt-to-equity leverage ratio under our charter. We may also change our financing strategy and leverage without the consent of stockholders. 41 --------------------------------------------------------------------------------



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As of June 30, 2014, we had entered into master repurchase agreements with 22 counterparties. As of June 30, 2014, we had approximately $4.1 billion of borrowings, including borrowing on linked transactions, outstanding under our repurchase agreements collateralized by approximately $4.7 billion of MBS and other securities. The balance outstanding at June 30, 2014 includes approximately $27.5 million related to linked transactions collateralized by approximately $40.6 million of MBS. We have entered into swaps to effectively fix the interest rate of our borrowings (for the life of the swap); net of variable-rate payment swaps, of approximately $2.9 billion of borrowings under our repurchase agreements, excluding forward starting swaps of $1.3 billion. In addition, as of June 30, 2014, we also owned swaptions on approximately an incremental $305.0 million of borrowings. As of June 30, 2014, our aggregate debt-to-equity ratio was approximately 6.5 to 1, including repurchase agreements on linked transactions and 6.4 to 1, excluding repurchase agreements on linked transactions.



Recent Market Conditions and Strategy

Our business is affected by general U.S. residential real estate fundamentals, domestic and foreign commercial real estate fundamentals and the overall U.S. and, to a lesser extent, international economic environment. In particular, our strategy is influenced by the specific characteristics of these markets, including but not limited to, prepayment rates and interest rate levels. We expect the results of our operations to be affected by various factors, many of which are beyond our control. Our results of operations will primarily depend on, among other things, the level of our net interest income, the market value of our investment portfolio and the supply of and demand for mortgage-related securities. Our net interest income, which includes the amortization of purchase premiums and accretion of discounts, will vary primarily as a result of changes in interest rates, borrowing costs, and prepayment speeds on our MBS investments. Similarly, the overall value of our MBS investment portfolio will be impacted by these factors as well as changes in the value of residential and commercial real estate and continuing regulatory changes. The current economic and market outlook are shaped in a significant manner by the unprecedented level of fiscal and monetary stimulus that the U.S. Government and U.S. Federal Reserve Board provided in the aftermath of the 2007-2010 financial crisis. The current rate environment is characterized by a steep yield curve with the spread between two-year U.S. Treasury Notes and ten-year U.S. Treasury Notes well above the average spread over the last three decades. The U.S. Federal Reserve Board has maintained a near-zero target for the federal funds rate, and has reiterated its commitment to fulfilling its mandate to promote higher growth and lower unemployment and to maintain price stability in the U.S. economy. On July 30, 2014, the U.S. Federal Reserve Board reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. Notwithstanding economic data which suggests continued improvement in the U.S. economy and the Federal Reserve's indication in the minutes to its June 17-18 Open Market Committee Meeting that it anticipates completing its reduction in open market security purchases following its October 2014 meeting, it is our Manager's view that the significant mortgage debt burden, run-off of fiscal stimulus and budget discipline at both the U.S. federal and state level will serve as an impediment to real GDP and employment growth throughout the remainder of 2014 and well into 2015. Real gross domestic product ("GDP") is estimated to have declined sharply in the first quarter of 2014, but rebounded in the second quarter of 2014. Nevertheless, the housing sector continues to struggle and recent headline inflation data remains relatively benign. In this slow growth environment it is the Manager's prospective that credit related securities provide us with attractive risk adjusted opportunities. Accordingly, we believe core rates will be range bound with slow inflation. For these reasons, and considering its dual mandate to manage both inflation and unemployment, we believe that the U.S. Federal Reserve Board will continue its accommodative monetary policy now in effect. U.S. Federal Reserve Chair Yellen affirmed this position during her Semi-annual Monetary Policy Report to Congress in July 2014, stating that she expected that highly accommodative monetary policy would remain appropriate for a considerable time after the asset purchases end, especially if projected inflation continues below the Federal Reserve's stated long run goal of 2%. Despite the recent decline in the unemployment rate to 6.1%, Ms. Yellen expressed continuing concern regarding the overall health of the labor market. She pointed out that the unemployment rate remains above the Federal Reserve's expected longer-run normal level and stated, "Labor force participation appears weaker than one would expect based on the aging of the population and the level of unemployment. These and other indications that significant slack remains in labor markets are corroborated by the continued slow pace of growth in most measures of hourly compensation". While the yield curve did flatten during the second quarter of 2014, we expect that, on a historical basis, the yield curve will remain relatively steep and interest rates will remain range bound due to the continuing muted recovery. Barring any system shocks to the capital markets, this should provide for continued strong demand for mortgage securities. 42 --------------------------------------------------------------------------------



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As the capital markets have recovered, commercial banks have re-entered the secured lending market, which has quickened the pace of asset recovery, and the return to more normalized credit spreads. Financing of Agency and Non-Agency RMBS as well as Agency and Non-Agency CMBS is currently widely available through, among other vehicles, repurchase agreements. Haircuts, or the discount attributed to the value of securities sold under repurchase agreements, range from a low of 3.0% to a high of 5.0% for Agency RMBS, depending on the specific security used as collateral for such repurchase agreements, while haircuts for IOs and IIOs can be as high as 25.0% and haircuts for Non-Agency RMBS and Agency and Non-Agency CMBS range from a low of 10.0% to a high of 45.0%. Even during last year's market volatility, such financing remained readily available. Notwithstanding the foregoing, such financing may not be as readily available in the future as a result of the increased regulatory capital requirements under the Dodd-Frank Act and Basel III. In response to the financial crisis, the U.S. government, through the FHA, the Federal Deposit Insurance Corporation, or FDIC, and the U.S. Treasury, has commenced or proposed implementation of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. These loan modification and refinance programs, future U.S. federal, state and/or local legislative or regulatory actions that result in the modification of outstanding mortgage loans, as well as changes in the requirements necessary to qualify for refinancing mortgage loans with FNMA, FHLMC or GNMA, may adversely affect the value of, and the returns on, residential mortgage loans, RMBS, real estate-related securities and various other asset classes in which we may invest. In addition to the foregoing, the U.S. Congress and/or various states and local legislators may enact additional legislation or regulatory action, such as the recently enacted qualifying mortgage requirements under the Dodd-Frank Act, to address the current economic crisis or for other purposes that could have a material adverse effect on our ability to execute our business strategies. In particular, we believe that while the recently enacted qualifying mortgage requirements under the Dodd-Frank Act may present an opportunity to acquire and securitized certain "non-qualifying" or Non-QM mortgages, it is likely to reduce the overall production of new mortgages, thereby negatively impacting the general supply of MBS. On January 4, 2012, the U.S. Federal Reserve Board released a report titled "The U.S. Housing Market: Current Conditions and Policy Considerations" to Congress providing a framework for thinking about certain issues and tradeoffs that policy makers might consider. In March 2014, Senate Banking Committee Chairman Tim Johnson and Ranking Member Mike Crapo announced an agreement on their own version of GSE reform which would eventually replace FNMA and FHLMC with a new system. It is unclear how future legislation may impact the housing finance market and the investing environment for agency securities as the method of reform is undecided and has not yet been defined by the regulators. Our Investment Strategy Our Manager's investment philosophy, which developed from a singular focus in fixed-income asset management over a variety of credit cycles and conditions, is to provide clients with diversified, tightly controlled, long-term value-oriented portfolios. Through rigorous analysis of all sectors of the fixed-income market, our Manager seeks to identify assets with the greatest risk-adjusted total value potential. In making investment decisions on our behalf, our Manager incorporates its views on the economic environment and the outlook for the mortgage markets, including relative valuation, supply and demand trends, the level of interest rates, the shape of the yield curve, prepayment rates, financing and liquidity, commercial and residential real estate prices, delinquencies, default rates, recovery of various segments of the economy and vintage of collateral, subject to maintaining our REIT qualification and our exemption from registration under the 1940 Act. We benefit from the breadth and depth of our Manager's overall investment philosophy, which focuses on a macroeconomic analysis as well as an in-depth analysis of individual assets and their relative value. We rely on our Manager's expertise in asset allocation and identifying attractive assets within our investment strategy. At the time of our IPO, our core investment strategy was focused primarily on Agency RMBS. Our Manager's expertise in related investment disciplines such as Non-Agency RMBS, CMBS, and ABS has provided us with the ability to expand our investment portfolio to include Non-Agency RMBS, Agency and Non-Agency CMBS, Non U.S. CMBS and other structured securities, as well as, providing valuable investment insights to our Agency RMBS investment selection and strategy. We currently purchase and sell Agency (including TBAs) and Non-Agency RMBS, Agency and Non-Agency CMBS, Non U.S. CMBS as well as other structured securities. Currently, our Manager expects to expand our purchase of Non-Agency RMBS, Agency and Non-Agency CMBS and Non U.S. CMBS as well as commence investing in whole loans or whole loan securities and ABS. We do not have specific investment guidelines providing for precise minimum or maximum allocations to any sector other than those necessary for our qualification as a REIT and exemption from the 1940 Act. Our Manager has not and does not expect to purchase securities on our behalf with a view to selling them shortly after purchase. However, in order to maximize returns and manage portfolio risk while remaining opportunistic, we may dispose of securities earlier than anticipated or hold securities longer than anticipated depending upon prevailing market conditions, credit performance, availability of leverage or other factors regarding a particular security or our capital position. 43 --------------------------------------------------------------------------------

Table of Contents Our Target Assets



We have invested the proceeds of our IPO, concurrent private placements and follow-on public offerings and expect to continue to focus on investing in the following types of securities:

Agency RMBS - Agency RMBS, which are RMBS for which the principal and interest payments are guaranteed by a U.S. Government agency, such as Government National Mortgage Association ("GNMA"), or a U.S. Government-sponsored entity, such as Federal National Mortgage Association ("FNMA") or Federal Home Loan Mortgage Corporation ("FHLMC"). The Agency RMBS we acquire can be secured by fixed-rate mortgages, adjustable-rate mortgages or hybrid adjustable-rate mortgages. Fixed-rate mortgages have interest rates that are fixed for the term of the loan and do not adjust. The interest rates on adjustable-rate mortgages generally adjust annually (although some may adjust more frequently) to an increment over a specified interest rate index. Hybrid adjustable-rate mortgages have interest rates that are fixed for a specified period of time (typically three, five, seven or ten years) and, thereafter, adjust to an increment over a specified interest rate index. Adjustable-rate mortgages and hybrid adjustable-rate mortgages generally have periodic and lifetime constraints on the amount by which the loan interest rate can change on any predetermined interest rate reset date. As of June 30, 2014, all of our Agency RMBS are secured by fixed-rate mortgages. Mortgage pass-through certificates. - Mortgage pass-through certificates are securities representing interests in "pools" of mortgage loans secured by residential real property where payments of both interest and scheduled principal, plus pre-paid principal, on the securities are made monthly to holders of the securities, in effect "passing through" monthly payments made by the individual borrowers on the mortgage loans that underlie the securities, net of fees paid to the issuer/guarantor of the securities and servicers of the underlying mortgages. Interest-Only Strips or IOs. - This type of security only entitles the holder to interest payments. The yield to maturity of Interest-Only Strips is extremely sensitive to the rate of principal payments (particularly prepayments) on the underlying pool of mortgages. We invest in these types of securities primarily to take advantage of particularly attractive prepayment-related or structural opportunities in the MBS markets, as well as to help manage the duration of our overall portfolio. Inverse Interest-Only Strips or IIOs. - This type of security has a coupon with an inverse relationship to its index and is subject to caps and floors. Inverse Interest-Only MBS entitles the holder to interest only payments based on a notional principal balance, which is typically equal to a fixed rate of interest on the notional principal balance less a floating rate of interest on the notional principal balance that adjusts according to an index subject to set minimum and maximum rates. The current yield of Inverse Interest-Only MBS will generally decrease when its related index rate increases and increase when its related index rate decreases. Principal-Only Strips. - This type of security generally only entitles the holder to receive cash flows that are derived from principal repayments of an underlying loan pool, but in the case of Non-Agency Principal-Only Strips will also include cash flows from default recoveries and excess interest. The yield to maturity of Principal-Only Strips is extremely sensitive to the rate of principal payments (particularly prepayments) on the underlying pool of mortgages. We invest in these types of securities primarily to take advantage of structural opportunities in the MBS markets. TBAs. - We may utilize TBAs, in order to invest in Agency RMBS. Pursuant to these TBAs, we would agree to purchase (or deliver), for future settlement, Agency RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular Agency RMBS to be delivered would not be identified until shortly before the TBA settlement date. Our ability to purchase Agency RMBS through TBAs may be limited by the 75% income and asset tests applicable to REITs. Collateralized Mortgage Obligations or CMOs. - CMOs are securities that are structured from residential and/or commercial pass-through certificates, which receive monthly payments of principal and interest. CMOs divide the cash flows which come from the underlying mortgage pass-through certificates into different classes of securities that may have different maturities and different weighted average lives than the underlying pass-through certificates. 44 --------------------------------------------------------------------------------



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Non-Agency RMBS. - RMBS that are not guaranteed by a U.S. Government agency or U.S. Government-sponsored entity, with an emphasis on securities that when originally issued were rated in the highest rating category by one or more of the nationally recognized statistical rating organizations. The mortgage loan collateral for Non-Agency RMBS consists of residential mortgage loans that do not generally conform to underwriting guidelines issued by a U.S. Government agency or U.S. Government-sponsored entity due to certain factors, including mortgage balances in excess of agency underwriting guidelines, borrower characteristics, loan characteristics and level of documentation, and therefore are not issued or guaranteed by a U.S. Government agency or U.S. Government-sponsored entity. The mortgage loan collateral may be classified as subprime, Alternative-A or prime depending on the borrower's credit rating and the underlying level of documentation. Non-Agency RMBS may be secured by fixed-rate mortgages, adjustable-rate mortgages or hybrid adjustable-rate mortgages. Agency CMBS. - We may also invest in fixed and floating rate commercial mortgage-backed securities, or CMBS, for which the principal and interest payments are guaranteed by a U.S. Government agency or U.S. Government-sponsored entity, but for which the underlying mortgage loans are secured by real property other than single family residences. These may include, but are not limited to Fannie Mae DUS (Delegated Underwriting and Servicing) MBS, Freddie Mac Multifamily Mortgage Participation Certificates and Ginnie Mae project loan pools, and/or CMOs structured from such collateral. Non-Agency CMBS. - Fixed and floating rate CMBS for which the principal and interest payments are not guaranteed by a U.S. Government agency or U.S. Government-sponsored entity. To date, our primary emphasis has been on legacy securities that when originally issued were rated in the highest rating category by one or more of the nationally recognized statistical rating organizations but we have also invested in subordinated classes for which the property securing the underlying mortgage collateral is located within the U.S. We do not have an established a minimum current rating requirement for such investments. Non U.S. CMBS. - As of June 30, 2014, we have made an investment in a security secured by commercial real estate outside of the U.S. and may make additional such investments in the future. Although our Manager believes that these investments can provide attractive risk-reward opportunities and offer additional asset diversification, investing in international real estate has a number of additional risks, including but not limited to currency risk, political risk and the legal risk of investing in jurisdiction(s) with varying laws and regulations and potential tax implications. See Item 3: Quantitative and Qualitative Disclosures about Market Risk - Foreign Investment Risk and Currency Risk herein. Agency and Non-Agency CMBS IO and IIO Securities. - Interest-Only and Inverse Interest-Only securities for which the underlying collateral is commercial mortgages the principal and interest on which may or may not be guaranteed by a U.S Government agency or U.S. Government-sponsored entity. Unlike single family residential mortgages in which the borrower, generally, can prepay at any time, commercial mortgages frequently limit the ability of the borrower to prepay, thereby providing a certain level of prepayment protection. Common restrictions include yield maintenance and prepayment penalties, the proceeds of which are generally at least partially allocable to these securities, as well as defeasance. Risk Sharing Securities Issued by Fannie Mae and Freddie Mac. - From time to time we have and may in the future continue to invest in risk sharing securities issued by Fannie Mae and Freddie Mac. Principal and interest payments on these securities are based on the performance of a specified pool of Agency residential mortgages but the securities are not secured by the referenced mortgages, but by the full faith and credit of Fannie Mae or Freddie Mac, respectively. Accordingly, our ability to invest these securities will be limited by the 75% income and asset tests applicable to REITs as such securities are not considered real assets and therefore the income generated by these securities is not real estate income. Historically, our primary investment strategy focused on Agency RMBS. As discussed above, we continue to increase the portion of our portfolio allocated to Non-Agency RMBS and Agency and Non-Agency CMBS and in the future are likely to expand our investments in these securities as well as residential and commercial whole-loans which are described below. In addition, we may also invest in asset-backed securities or "ABS" which are also described below. The allocation to Non-Agency RMBS, Agency and Non-Agency CMBS, residential and commercial whole-loans and ABS may vary from time to time based on market conditions. 45

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Residential and commercial whole-loans. - We may in the future invest in or seek to gain exposure to "whole loan" mortgages, secured by both single family residential and/or commercial properties. In this regard, our Manager is actively working on a number of potential whole loan programs involving RMBS. As currently contemplated, this program would involve investing in structured Non-Agency RMBS programs crafted specifically for us, although it is possible that we could hold mortgage loans directly at some point. In addition to holding these instruments for investment, our Manager is also working to provide us with the ability to invest in or acquire whole-loans directly or gain exposure to whole-loans through investments in structured programs with the intention of securitizing the whole-loans in the future, selling the investment grade portion of the securitized structure and retaining the residual portion Although our expectation is that we will begin to make at least a limited amount of these investments in the near future, adding these instruments to our target assets involves complex investment, structural, regulatory and accounting issues and there can be no assurance that we will in fact expand our target assets to include whole loans or, if we do, in what form and to what extent we will do so. ABS. - Debt and/or equity tranches of securitizations backed by various asset classes including, but not limited to, aircrafts, automobiles, credit cards, equipment, franchises, recreational vehicles and student loans. Investments in ABS generally are not qualifying assets for purposes of the 75% asset test applicable to REITs and generally do not generate qualifying income for purposes of the 75% income test applicable to REITs. As a result, we may be limited in our ability to invest in such assets. Other investments. - In addition to MBS, our principal investment, and ABS from time to time, we may also make other investments in securities which our Manager believes will assist us in meeting our investment objective and are consistent with our overall investment policies. Consistent with our ABS investments, these investments will normally be limited by the REIT requirements that 75% our assets be real estate assets and that 75% of our income be generated from real estate, thereby limiting our ability to invest in such assets. As of June 30, 2014, the fair value of our investment portfolio was comprised of 73.9% of Agency RMBS, 16.2% of Non-Agency RMBS, 0.8% of Agency CMBS, 8.4% of Non-Agency CMBS and 0.7% of other securities, excluding linked transactions. As of June 30, 2014, the fair value of our investment portfolio was comprised of 73.2% of Agency RMBS, 16.4% of Non-Agency RMBS, 0.8% of Agency CMBS, 8.9% of Non-Agency CMBS and 0.7% of other securities, including linked transactions which includes $25.3 million (or less than 1% of the fair value of our investment portfolio) of Non-Agency CMBS the underlying mortgage collateral of which is secured by real property located outside of the United States. Our Financing Strategy The leverage that we employ is specific to each asset class and is determined based on several factors, including potential asset price volatility, margin requirements, the current cycle for interest rates, the shape of the yield curve, the outlook for interest rates and our ability to use and the effectiveness of interest rate hedges. We analyze both historical volatility and market-driven implied volatility for each asset class in order to determine potential asset price volatility. Our leverage targets attempt to risk-adjust asset classes based on each asset class's potential price volatility. The goal of our leverage strategy is to ensure that, at all times, our investment portfolio's overall leverage ratio is appropriate for the level of risk inherent in the investment portfolio. We may fund the acquisition of our assets through the use of leverage from a number of financing sources, subject to maintaining our qualification as a REIT. We finance purchases of MBS and our other securities primarily through the use of repurchase agreements. Our operating results depend in large part on differences between the income earned on our assets and our cost of borrowing and hedging activities. We use leverage to increase potential returns to our stockholders. We currently accomplish this by borrowing against existing assets through repurchase agreements. Our investment policies place no limits on the maximum amount of leverage that we may use, and we are not required to maintain any particular debt-to-equity leverage ratio under our charter. We may also change our financing strategy and leverage without the consent of our stockholders. The costs associated with our borrowings are generally based on prevailing market interest rates. During a period of rising interest rates, our borrowing costs generally will increase while the yields earned on our existing portfolio of leveraged fixed-rate MBS will remain static. This could result in a decline in our net interest spread and net interest margin. The severity of any such decline would depend on our asset/liability composition at the time, as well as the magnitude and duration of the interest rate increase. Further, an increase in short-term interest rates could also have a negative impact on the market value of our assets. If either of these events happens, we could experience a decrease in net income or incur a net loss during these periods, which could adversely affect our liquidity and results of operations. 46 --------------------------------------------------------------------------------



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We expect to maintain a debt to equity ratio of six to ten times the amount of our stockholders' equity, although there is no minimum or maximum leverage that our investment policies explicitly require. To the extent the Agency percentage of our portfolio decreases, our overall leverage is likely to decrease. Depending on the different cost of borrowing funds at different maturities, we will vary the maturities of our borrowed funds to attempt to produce lower borrowing costs and reduce interest rate risk. We enter into collateralized borrowings only with institutions that are rated investment grade by at least one nationally-recognized statistical rating organization. We rely on financing to acquire, on a leveraged basis, assets in which we invest. If market conditions deteriorate, our lenders may exit the repurchase market, and tighten lending standards, or increase the amount of equity capital required to obtain financing making it more difficult and costly for us to obtain financing. For the three and six months ended June 30, 2014, we financed our MBS with repurchase agreements, on a debt-to-equity basis, ranging from approximately six to eight times leverage calculated at each month-end. In the future, we may, however, be limited or restricted in the amount of leverage we may employ by the terms and provisions of any financing or other agreements, and may be subject to margin calls as a result of our financing activity. We had an aggregate debt-to-equity ratio, related to our repurchase agreements of approximately 6.5 to 1, including repurchase agreements on linked transactions, and 6.4 to 1, excluding repurchase agreements on linked transactions at June 30, 2014. Our debt-to-equity ratio is computed by dividing repurchase borrowings by total stockholders' equity. We finance MBS with repurchase agreement financing with maturities ranging from one to three months, but in some cases longer. At June 30, 2014, we had entered into master repurchase agreements with 22 counterparties. We had approximately $4.1 billion outstanding under our repurchase agreements, including repurchase agreements accounted for as part of linked transactions at June 30, 2014. The balance outstanding at June 30, 2014 includes approximately $27.5 million related to linked transactions. Our Hedging Strategy Subject to maintaining our qualification as a REIT for U.S. federal income purposes, we pursue various economic hedging strategies to seek to reduce our exposure to adverse changes in interest rates and, to a much more limited extent, foreign currency. The U.S. federal income tax rules applicable to REITs may require us to implement certain of these techniques through a domestic taxable REIT subsidiary ("TRS") that is fully subject to federal corporate income taxation. As of June 30, 2014 we do not utilize a domestic TRS, although we may consider doing so in future. Our hedging activity varies in scope based on the level and volatility of interest rates, the type of assets held, including currency denomination, and other changing market conditions. As of June 30, 2014, the vast majority of swaps we entered into are designed to mitigate the effects of increases in interest rates under a portion of our repurchase agreements. These swaps generally provide for fixed interest rates indexed off of the London interbank offered rate or LIBOR and effectively fix the floating interest rates. Notwithstanding the foregoing, in order to manage our hedge position with regard to our liabilities, we on occasion will enter into interest rate swaps which involve the receipt of fixed-rate amounts from a counterparty in exchange for us making variable-rate payments over the life of the interest rate swap without exchange of the underlying notional amount. As of June 30, 2014, we effectively fixed the floating interest rates on approximately $2.9 billion of borrowings under our repurchase agreements, net of variable-rate payment swaps. We also entered into forward starting swaps of $1.3 billion. We utilize forward starting swaps and swaptions for several reasons including replacing expiring swaps, in anticipation of increasing our overall financing and reducing our exposure to future interest rate increases. Interest rate swaptions provide us the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay and receive interest rates in the future. As of June 30, 2014, we owned swaptions on approximately an incremental $305.0 million of borrowings. As of June 30, 2014, we also entered into a foreign currency swap, agreeing to pay a fixed amount of euros in exchange a fixed amount of U.S. dollars as well as 90 day currency forward. We entered into the currency swap and currency forward in order to hedge our exposure to foreign currency with respect to a $25.3 million (18.5 million) CMBS investment and the corresponding repurchase financing utilized to make such investment. To date, we have not elected to apply hedge accounting for our derivatives and, as a result, we record the change in fair value of our derivatives and the associated interest and currency exchange in earnings. 47 --------------------------------------------------------------------------------



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Our interest rate hedging techniques are partly based on assumed levels of prepayments of our target assets. If prepayments are slower or faster than assumed, the life of the investment will be longer or shorter, which would reduce the effectiveness of any of the interest rate hedging strategies we may use and may cause losses on such transactions. Hedging strategies both interest rate and foreign currency, involve the use of derivative securities which are highly complex and may produce volatile returns.



Critical Accounting Policies

Our financial statements are prepared in accordance with GAAP, which requires the use of estimates and assumptions that involve the exercise of judgment and use of assumptions as to future uncertainties. In accordance with SEC guidance, the following discussion addresses the accounting policies that we currently apply. Our most critical accounting policies will involve decisions and assessments that could affect our reported assets and liabilities, as well as our reported revenues and expenses. We believe that all of the decisions and assessments upon which our financial statements have been based were reasonable at the time made and based upon information available to us at that time. We have identified what we believe will be our most critical accounting policies to be the following: Investments We elected the fair value option for all of our MBS and other securities at the date of purchase, which permits us to measure these securities at fair value with the change in fair value included as a component of earnings. Although we have elected the fair value option for our MBS and other securities, we separately compute interest income on our MBS and other securities under the prescribed method based on the nature of the security. As such, premiums and discounts are amortized or accreted into interest income and are included in Interest income in the Statement of Operations.



Valuation of financial instruments

We disclose the fair value of our financial instruments according to a fair value hierarchy (Levels I, II, and III, as defined below). In accordance with GAAP, we are required to provide enhanced disclosures regarding instruments in the Level III category (which require significant management judgment), including a separate reconciliation of the beginning and ending balances for each major category of assets and liabilities. GAAP establishes a framework for measuring fair value in accordance with GAAP and expands financial statement disclosure requirements for fair value measurements. GAAP further specifies a hierarchy of valuation techniques, which is based on whether the inputs into the valuation technique are observable or unobservable. The hierarchy is as follows:



Level I - Quoted prices in active markets for identical assets or liabilities.

Level II - Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level III - Prices are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period), unobservable inputs may be used.

The level in the fair value hierarchy within which a fair measurement in its entirety falls is based on the lowest level input that is significant to the fair value measurement in its entirety. When available, we use quoted market prices to determine the fair value of an asset or liability. If quoted market prices are not available, we consult with independent pricing services or obtain third party broker quotes. If independent pricing service, or third party broker quotes are not available, we determine the fair value of the securities using valuation techniques that use, when possible, current market-based or independently-sourced market parameters, such as interest rates. While linked transactions are treated as derivatives for GAAP, the securities underlying the Company's linked transactions are valued using similar techniques to those used for our securities portfolio. The value of the underlying security is then netted against the carrying amount (which approximates fair value) of the repurchase agreement at the valuation date. Additionally, TBA instruments are similar in substance to our Agency RMBS portfolio, and the Company therefore estimates fair value based on similar methods. 48 --------------------------------------------------------------------------------



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We determine the fair value of derivative financial instruments by obtaining quotes from a third party pricing service, whose pricing is subject to review by our Manager's pricing committee. In valuing our interest rate derivatives, such as swaps and swaptions, we consider the creditworthiness of our counterparties, along with collateral provisions contained in each derivative agreement, from the perspective of both us and our counterparties. All of our interest rate swaps are either cleared through a central clearing house and subject to the clearing house margin requirements or subject to bilateral collateral arrangements with the vast majority of interest rate swaps entered into beginning in September 2013 being cleared through a central clearing house. We also have netting arrangements in place with all derivative counterparties pursuant to standard documentation developed by the International Swap and Derivatives Association. Consequently, no credit valuation adjustment was made in determining the fair value of interest rate derivatives. Valuation techniques for MBS and other structured securities may be based upon models that consider the estimated cash flows of the security. The primary inputs to the model include yields for to-be-announced (also known as TBAs) Agency RMBS, the U.S. Treasury market and floating rate indices such as LIBOR, the Constant Maturity Treasury rate and the prime rate as a benchmark yield. In addition, the model may incorporate the current weighted average maturity and additional pool level information such as prepayment speeds, default frequencies and default severities, if applicable. To the extent, the inputs are observable and timely, the securities are categorized in Level II of the fair value hierarchy; otherwise, unless alternative pricing information as described is available, they are categorized as Level III. Fair value under GAAP represents an exit price in the normal course of business, not a forced liquidation price. If we are forced to sell assets in a short period to meet liquidity needs, the prices we receive could be substantially less than the recorded fair values of our assets. Furthermore, the analysis of whether it is more likely than not that we will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities will be sold is also subject to significant judgment, particularly in times of market illiquidity.



We determine the fair value of derivative financial instruments and obtain quotations from a third party to facilitate the process of determining these fair values.

We will review any changes to the valuation methodology to ensure the changes are appropriate. The methods used may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods will be appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments can result in a different estimate of fair value at the reporting date. We use inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced.



All valuations received from independent pricing services are non-binding. We primarily utilize an independent third party pricing service as the primary source for valuing the Company's assets.

We generally receive one independent pricing service price for each investment in our portfolio. Our Manager has established a process to review and validate the pricing received from the independent pricing service and has a process for challenging prices received from the independent pricing service when necessary. The Company utilizes our Manager's policies in this regard. Our and our Manager's review of the independent third party pricing data may consist of a review of the daily change in the prices provided by the independent pricing vendor which exceed established tolerances or comparisons to executed transaction prices. Our Manager's pricing group, which functions independently from its portfolio management personnel, corroborates the price differences or changes in price by comparing the vendor price to alternate sources including other independent pricing services or broker quotations. If the price change or difference cannot be corroborated, the Manager's pricing group consults with the portfolio management team for market color in reviewing such pricing data as warranted. To the extent that our Manager has information, typically in the form of broker quotations that would indicate that a price received from the independent pricing service is outside of a tolerance range, our Manager generally challenges the independent pricing service price. To ensure proper fair value hierarchy, we and our Manager review the methodology used by the third party pricing service to understand whether observable market data is being utilized in the vendor's pricing methodology. Generally, this review is conducted annually, however ad-hoc reviews of the pricing methodology and the data do occur. The review of the assumptive data received from the vendor includes comparing key inputs. In addition, as part of our regular review of pricing, our Manager's pricing group may have informal discussions with the independent pricing vendor regarding their evaluation methodology or the market data utilized in their determination. The conclusion that a price should be overridden in accordance with our Manager's pricing methodology may impact the fair value hierarchy of the security for which such price has been adjusted. 49

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Table of Contents Linked transactions In instances where we finance the acquisition of securities through repurchase agreements with the same counterparty from which the securities were purchased, we evaluate such transactions in accordance with GAAP. This guidance requires the initial transfer of a financial asset and repurchase financing that are entered into contemporaneously with, or in contemplation of, one another to be considered linked unless all of the criteria found in the guidance are met at the inception of the transaction. If the transaction meets all of the conditions, the initial transfer shall be accounted for separately from the repurchase financing, and we will record the securities and the related financing on a gross basis on our Balance Sheet with the corresponding interest income and interest expense in our Statements of Operations. If the transaction is determined to be linked, we will record the initial transfer and repurchase financing on a net basis and record a forward commitment to purchase securities as a derivative instrument with changes in market value being recorded on our Statement of Operations. Such forward commitments are recorded at fair value with subsequent changes in fair value recognized in Gain (loss) on linked transactions, net on our Statement of Operations. We refer to these transactions as Linked Transactions. When or if a transaction is no longer considered to be linked, the security and related repurchase financing will be reported on a gross basis. The unlinking of a transaction causes a realized event in which the fair value of the security as of the date of unlinking will become the cost basis of the security. The difference between the fair value on the unlinking date and the existing cost basis of the security will be the realized gain or loss. Recognition of effective yield for such security will be calculated prospectively using the new cost basis. For linked transactions, we reflect purchases and sales of securities within the investing section of our Statement of Cash Flows. Proceeds from repurchase agreements borrowings and repayments of repurchase agreement borrowings are reflected in the financing section of our Statement of Cash Flows.



The securities underlying our linked transactions are valued using similar techniques to those used for our securities portfolio.

Interest income recognition and Impairment

Agency MBS and Non-Agency MBS excluding Interest-Only Strips, and other securities rated AA and higher at the time of purchase

Interest income on mortgage-backed securities and other securities is accrued based on the respective outstanding principal balances and their corresponding contractual terms. Premiums and discounts associated with Agency MBS and Non-Agency MBS, excluding Interest-Only Strips, and other securities rated AA and higher at the time of purchase are amortized into interest income over the estimated life of such securities using the effective yield method. Adjustments to premium and discount amortization are made for actual prepayment activity. On at least a quarterly basis, we estimate prepayments for our securities and, as a result, if prepayments increase (or are expected to increase), we will accelerate the rate of amortization on premiums or discounts and make a retrospective adjustment to historical amortization. Alternatively, if prepayments decrease (or are expected to decrease) we will reduce the rate of amortization on the premiums or discounts and make a retrospective adjustment to historical amortization. A change in the calculation used to determine the amortization of bond premium as of April 1, 2014, resulted in a change in estimate of approximately $1.2 million, or an accretive $0.03 core earnings per share (a non-GAAP measure). The impact of the change in estimate was limited to an increase of approximately $1.2 million to Interest Income and an offsetting reduction to Unrealized gain (loss) on Mortgage-backed securities and other securities, net on the Statement of Operations. We do not believe the aforementioned change in estimate will have a material impact to subsequent periods. A decline in the fair market value of our assets may require us to recognize an "other-than-temporary" impairment against such assets under GAAP unless we were to determine that, with respect to any assets in unrealized loss positions, we do not have the intent to sell these investments, it is more likely than not that we will not be required to sell the investment before recovery of a security's amortized cost basis and we will not be required to sell the security for regulatory or other reasons. In addition, an other-than-temporary impairment is deemed to have occurred when there is an adverse change in the expected cash flows (principal or interest) to be received and the fair value of the security is less than its carrying amount. In determining whether an adverse change in cash flows occurred, the present value of the remaining cash flows, as estimated at the initial transaction date (or the last date previously revised), is compared to the present value of the expected cash flows at the current reporting date. The estimated cash flows reflect those a "market participant" would use and are discounted at a rate equal to the current yield used to accrete interest income. If such a determination is made, we would recognize unrealized losses through earnings and write down the amortized cost of such assets to a new cost basis, based on the fair value of such assets on the date they are considered to be other-than-temporarily impaired. Other than for "plain-vanilla" variable rate Non-Agency MBS we do not bifurcate the loss between credit loss and loss attributed to change in interest rates, therefore, the entire loss is recorded as other-than-temporary. Such impairment charges reflect non-cash losses at the time of recognition; subsequent disposition or sale of such assets can further affect our future losses or gains, as they are based on the difference between the sales price received and adjusted amortized cost of such assets at the time of sale. 50 --------------------------------------------------------------------------------



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The determination of whether an other-than-temporary impairment exists is subject to management's estimates based on consideration of both factual information available at the time of assessment as well as our estimates of the future performance and projected amount and timing of cash flows expected to be collected on the security. As a result, the timing and amount of an other-than-temporary impairment constitutes an accounting estimate that may change materially over time.



Non-Agency MBS and other securities that are rated below AA at the time of purchase and Interest-Only Strips that are not classified as derivatives

Interest income on Non-Agency MBS and other securities that are rated below AA at the time of purchase and Interest-Only Strips that are not classified as derivatives are recognized based on the effective yield method. The effective yield on these securities is based on the projected cash flows from each security, which is estimated based on our observation of the then current market information and events and will include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses. On at least a quarterly basis, we review and, if appropriate, make adjustments to our cash flow projections based on input and analysis received from external sources, internal models, and our judgment about interest rates, prepayment rates, the timing and amount of credit losses (if applicable), and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, or mortgages, periodic payments of scheduled principal, and prepayments of principal. Therefore, actual maturities of the securities will generally be shorter than stated contractual maturities. Based on the projected cash flows from any Non-Agency MBS or other structured security, which we may purchase at a discount to par value, a portion of the purchase discount may be designated as credit protection against future credit losses and, therefore, not accreted into interest income. The amount designated as credit discount may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a security with a credit discount is more favorable than forecasted, a portion of the amount designated as credit discount may be accreted into interest income prospectively. In addition, an other-than-temporary impairment is deemed to have occurred when there is an adverse change in the expected cash flows (principal or interest) to be received and the fair value of the beneficial interest is less than its carrying amount. In determining whether an adverse change in cash flows occurred, the present value of the remaining cash flows, as estimated at the initial transaction date (or the last date previously revised), is compared to the present value of the expected cash flows at the current reporting date.



The

estimated cash flows reflect those a "market participant" would use and are discounted at a rate equal to the current yield used to accrete interest income. The Company does not bifurcate the loss between credit loss and loss attributed to change in interest rates, therefore, the entire loss is recorded as other-than-temporary. These adjustments are reflected in our Statement of Operations as Other loss on Mortgage-backed securities and other securities. Following the recognition of an other-than-temporary impairment, a new amortized cost basis is established for the security. However, to the extent that there are subsequent increases in cash flows expected to be collected, the other-than-temporary impairment previously recorded may be accreted back through interest income via increased yield. The determination of whether an other-than-temporary impairment exists is subject to management's estimates based on consideration of both factual information available at the time of assessment as well as our estimates of the future performance and projected amount and timing of cash flows expected to be collected on the security. As a result, the timing and amount of an other-than-temporary impairment constitutes an accounting estimate that may change materially over time. 51

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Table of Contents Foreign currency transactions We expect to enter into transactions denominated in foreign currency from time to time. At the date the transaction is recognized, the asset and/or liability will be measured and recorded using the exchange rate in effect at the date of the transaction. At each balance sheet date, such foreign currency assets and liabilities are re-measured using the exchange rate in effect at the date of the balance sheet, resulting in unrealized foreign currency gains or losses. Unrealized foreign currency gains or losses on MBS and other securities are recorded in Unrealized gain (loss) on Mortgage-backed securities and other securities, net on the Statement of Operations. Unrealized and realized foreign currency gains or losses on borrowings under repurchase agreements are recorded in Interest income on cash balances and other income (loss), net on the Statement of Operations. Interest income from investments denominated in a foreign currency and interest expense on borrowings denominated in a foreign currency are recorded at the average rate of exchange during the period.



Derivatives and hedging activities

Subject to maintaining our qualification as a REIT for U.S. federal income tax purposes, we utilize derivative financial instruments to hedge the interest rate risk associated with our borrowings and the currency risk associated with our non U.S. dollar denominated investments. Derivatives are used for hedging purposes rather than speculation. We determine their fair value and obtain quotations from a third party to facilitate the process of determining these fair values. If our hedging activities do not achieve the desired results, reported earnings may be adversely affected.



GAAP requires an entity to recognize all derivatives as either assets or liabilities on the Balance Sheet and to measure those instruments at fair value. Fair value adjustments are recorded in earnings immediately, if the reporting entity does not elect hedge accounting for a derivative instrument.

We elected not to apply hedge accounting for these derivative instruments and record the change in fair value and net interest rate swap payments (including accrued amounts) related to interest rate swaps in Gain (loss) on derivative instruments, net in our Statement of Operations. Similarly, the change in fair value and net currency payment (including accrued amounts) related to our currency hedges will also be included in Gain (loss) on derivative instruments net in our Statement of Operations. We also invest in Agency and Non-Agency Interest-Only Strips, swaptions, futures contracts and TBAs. We evaluate the terms and conditions of our holdings of Agency and Non-Agency Interest-Only Strips, swaptions, futures contracts and TBAs to determine if these instruments have the characteristics of an investment or should be considered a derivative under GAAP. In determining the classification of our holdings of Interest-Only Strips, we evaluate the securities to determine if the nature of the cash flows has been altered from that of the underlying mortgage collateral. Generally, Interest-Only Strips for which the security represents a strip off of a mortgage pass through security will be considered a hybrid instrument classified as a MBS investment on our Balance Sheet utilizing the fair value option. Alternatively, those Interest-Only Strips, for which the underlying mortgage collateral has been included into a structured security that alters the cash flows from the underlying mortgage collateral, are accounted for as derivatives at fair value. Accordingly, Agency and Non-Agency Interest-Only Strips, swaptions, futures contracts and TBAs having the characteristics of derivatives are accounted for at fair value with such changes recognized in Gain (loss) on derivative instruments, net in our Statement of Operations, along with any interest earned (including accrued amounts). The carrying value of the Agency and Non-Agency Interest-Only Strips, accounted for as derivatives, is included in Mortgage-backed securities on the Balance Sheet. The carrying value of interest rate swaptions, currency forwards, futures contracts and TBAs is included in Derivative assets or Derivative liabilities on the Balance Sheet. We evaluate all of our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. An embedded derivative is separated from the host contact and accounted for separately when all of the guidance criteria are met. Hybrid instruments that are remeasured at fair value through earnings, including the fair value option are not bifurcated. Our derivative instruments also include linked transactions, which reflect a forward commitment to purchase assets. Derivative instruments are recorded at fair value and are re-valued at each reporting date, with changes in the fair value together with interest earned (including accrued amounts) reported in Gain (loss) on derivative instruments, net in our Statement of Operations. 52

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Table of Contents Repurchase agreements Mortgage-backed securities and other securities sold under repurchase agreements are treated as collateralized financing transactions, unless they meet sales treatment. Securities financed through a repurchase agreement remain on our Balance Sheet as an asset and the amount of cash received from the lender is recorded in our Balance Sheet as a liability. Interest paid in accordance with repurchase agreements is recorded as interest expense. In instances where we acquire securities through repurchase agreements with the same counterparty from which the securities were purchased, we will account for the purchase commitment and repurchase agreement on a net basis and record a forward commitment to purchase securities as a derivative instrument if the transaction does not comply with the criteria for gross presentation. Such forward commitments will be recorded at fair value with subsequent changes in fair value recognized in income. Additionally, we will record the cash portion of our investment in securities as a mortgage-related receivable from the counterparty on our balance sheet. If the transaction complies with the criteria for gross presentation, we will record the assets and the related financing on a gross basis in our Balance Sheet and the corresponding interest income and interest expense in our Statements of Operations. Share-based compensation We account for share-based compensation to our independent directors, to our officers and employees, to our Manager and to employees of our Manager and its affiliates using the fair value based methodology prescribed by GAAP. Compensation cost related to restricted common stock issued to our independent directors and employees is measured at its fair value at the grant date, and amortized into expense over the service period on a straight-line basis. Compensation cost related to restricted common stock issued to our Manager and to employees of our Manager and its affiliates is initially measured at fair value at the grant date, and re-measured at fair value on subsequent dates to the extent the awards are unvested and the change in fair value is reported in the Statement of Operations as non-cash stock based compensation. Warrants We account for the warrants comprising a part of the units issued in the private placement to certain institutional accredited investors concurrent with our IPO in accordance with Accounting Standards Codification 815, Accounting for Derivative Instruments and Hedging Activities, which provides guidance on the specific accounting treatment of a multitude of derivative instruments. We have evaluated the warrants issued by us and have recorded the warrants at their relative fair value as a component of equity, using a variation of the adjusted Black-Scholes option valuation model at their time of issuance. Income taxes We operate and have elected to be taxed as a REIT commencing with our taxable year ended December 31, 2012. Accordingly, we will generally not be subject to corporate U.S. federal or state income tax to the extent that we make qualifying distributions to our stockholders, and provided that we satisfy on a continuing basis, through actual investment and operating results, the REIT requirements including certain asset, income, distribution and stock ownership tests. If we fail to qualify as a REIT, and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal, state and local income taxes and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year in which we lost our REIT qualification. Accordingly, our failure to qualify as a REIT could have a material adverse impact on our results of operations and amounts available for distribution to our stockholders. Our dividends paid deduction for qualifying dividends paid to our stockholders is computed using our taxable income as opposed to net income reported on the financial statements. Taxable income, generally, will differ from net income reported on the financial statements because the determination of taxable income is based on tax provisions and not financial accounting principles. We may elect to treat certain of our subsidiaries as TRSs. In general, a TRS of ours may hold assets and engage in activities that we cannot hold or engage in directly and generally may engage in any real estate or non-real estate-related business. A TRS is subject to U.S. federal, state and local corporate income taxes. While a TRS will generate net income, a TRS can declare dividends to us, which will be included in our taxable income and necessitate a distribution to our stockholders. Conversely, if we retain earnings at the TRS level, no distribution is required and we can increase book equity of the consolidated entity. As of June 30, 2014, we did not have a TRS, or any other subsidiary. 53

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We evaluate uncertain tax positions, if any, and classify interest and penalties, if any, related to unrecognized tax benefits as a component of the provision for income taxes.

Accounting standards applicable to emerging growth companies

The JOBS Act contains provisions that relax certain requirements for "emerging growth companies" for which we qualify. For as long as we are an emerging growth company, which may be up to five full fiscal years, unlike other public companies, we will not be required to: (i) comply with any new or revised financial accounting standards applicable to public companies until such standards are also applicable to private companies under Section 102(b)(1) of the JOBS Act; (ii) provide an auditor's attestation report on management's assessment of the effectiveness of our system of internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act; (iii) comply with any new requirements adopted by the PCAOB requiring mandatory audit firm rotation or a supplement to the auditor's report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer; or (iv) comply with any new audit rules adopted by the PCAOB after April 5, 2012 unless the SEC determines otherwise. We may take advantage of any or all of such exemptions, but have not yet made a decision on whether to do so. As noted above, under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards that have different effective dates for public and private companies until such time as those standards apply to private companies. We currently intend to take advantage of such extended transition period. Since we are not required to comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies, our financial statements may not be comparable to the financial statements of companies that comply with public company effective dates. If we were to elect to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act.



Recent accounting pronouncements

Accounting Standards to be Adopted in Future Periods

In April 2014, the Financial Accounting Standards Board issued updated guidance that changes the requirements for reporting discontinued operations. Under the new guidance, a discontinued operation is defined as a disposal of a component of an entity or group of components of an entity that is disposed of or is classified as held for sale and represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results. The guidance is effective prospectively as of the first quarter of 2015, with early adoption permitted for new disposals or new classifications as held-for-sale. The guidance is effective for annual periods beginning on or after December 15, 2014 and interim periods within annual periods beginning on or after December 15, 2015. Early adoption is permitted but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issue. The new guidance is not expected to have a material impact on our financial statements. In June 2014, the Financial Accounting Standards Board issued guidance that changes the accounting for repurchase-to-maturity transactions and repurchase financing arrangements. The new guidance aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. These transactions would all be accounted for as secured borrowings. The guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement, which has resulted in outcomes referred to as off-balance-sheet accounting. In addition, the guidance requires additional disclosures. The guidance is effective for the first interim or annual period beginning after December 15, 2014. Earlier application for a public company is prohibited. We currently account for certain transfers as forward agreements under the existing guidance, which are currently classified as linked transactions. The new guidance will require us to record these transfers as secured borrowings however, it is not expected to have a material impact on our financial statements. 54

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Table of Contents Results of Operations The following discussion of our results of operations highlights our performance for the three and six months ended June 30, 2014 and 2013. For the three and six months ended June 30, 2014, we had a net income of $67.6 million and $59.1 million or $1.68 and $1.76 per basic and diluted weighted average common share, respectively. For the three and six months ended June 30, 2013, we had net loss of $27.7 million and $56.2 million or $1.16 and $2.34 per basic and diluted weighted average common share, respectively. During the later portion of 2013, and continuing through the six months ended June 30, 2014, we expanded our investment in Non-Agency MBS and commenced investing in CMBS and other structured securities and adjusted our overall leverage and hedging strategy pursuant to our current business plan. Investments The following table presents certain information about our investment portfolio at June 30, 2014 which is a Non-GAAP measure due to the inclusion of our Linked Transactions, in order to present a complete economic presentation of our portfolio, which is reconciled to GAAP below, as follows (dollars in thousands): Net Discount Weighted Unamortized Designated as Average Principal Premium Credit Reserve Unrealized Estimated Coupon Balance (Discount) and OTTI Amortized Cost Gain (Loss) Fair Value (1) 20-Year Mortgage Coupon Rate: 3.00% $ 333,885$ 16,119 $ - $ 350,004$ (9,263 )$ 340,741 3.0 % 3.50% 95,026 6,015 - 101,041 (1,539 ) 99,502 3.5 % 4.00% 640,972 38,115 - 679,087 8,125 687,212 4.0 % 1,069,883 60,249 - 1,130,132 (2,677 ) 1,127,455 3.6 % 30-Year Mortgage Coupon Rate: 3.50% 600,453 42,268 - 642,721 (25,198 ) 617,523 3.5 % 4.00% 536,822 45,794 - 582,616 (12,016 ) 570,600 4.0 % 4.50% 688,473 52,660 - 741,133 12,965 754,098 4.5 % 5.50% 76,233 9,780 - 86,013 1,008 87,021 5.5 % 6.00% 8,550 986 - 9,536 149 9,685 6.0 % 1,910,531 151,488 - 2,062,019 (23,092 ) 2,038,927 4.1 % Agency RMBS IOs and IIOs(2) N/A N/A - 208,738 5,483 214,221 4.2 % Agency and Non-Agency IOs and IIOs accounted for as derivatives (2)(3) N/A N/A N/A N/A N/A 95,562 2.9 % N/A N/A - 208,738 5,483 309,783 3.7 % Non-Agency RMBS 888,473 (1,835 ) (183,441 ) 703,197 10,006 713,203 3.6 % Non-Agency RMBS IOs and IIOs N/A N/A N/A 52,584 2,264 54,848 6.1 % 888,473 (1,835 ) (183,441 ) 755,781 12,270 768,051 4.2 % Agency and Non-Agency CMBS, including Non U.S. 455,580 1,733 (26,483 ) 430,830 5,794 436,624 5.5 % Other securities 25,560 4,580 - 30,140 3,706 33,846 7.3 % Total: Non GAAP Basis-Including Linked Transaction 4,350,027 216,215 (209,924 ) 4,617,640 1,484 4,714,686 4.0 % Linked Transactions, including Non U.S. 34,674 8,585 (3,550 ) 39,709 846 40,555 13.8 % Total: GAAP Basis $ 4,315,353$ 207,630$ (206,374 )$ 4,577,931 $ 638 $ 4,674,131 4.0 %



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(1) Net weighted average coupon as of June 30, 2014 is presented net of servicing and other fees.

(2) Agency RMBS IOs and IIOs, Non-Agency RMBS IOs and IIOs, Agency and Non-Agency IOs and IIOs, accounted for as derivatives, and Agency and Non-Agency CMBS IOs and IIOs have no principal balances and bear interest based on a notional balance. The notional balance is used solely to determine interest distributions on interest-only class of securities. At June 30, 2014, the notional balance for Agency RMBS IOs and IIOs, Non-Agency IOs and IIOs, and for Agency and Non-Agency IOs and IIOs, accounted for as derivatives, was $1,249,977, $290,719 and $809,721, respectively.



(3) Interest on these securities is reported as a component of Gain (loss) on derivative instruments, net.

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As of June 30, 2014 and 2013, the fixed-rate Agency RMBS we held consisted primarily of securities which our Manager believes exhibit prepayment mitigation attributes, including Agency RMBS collateralized by low loan balances, loans where the underlying borrower is unable to access the Making Home Affordable Program, including the Home Affordable Refinance Program or HARP or loans which were not originated by third party originators or brokers. The following table details the constant prepayment rates for our Agency portfolio as of June 30, 2014, based on our Manager's estimates which are based on third party models, as adjusted by our Manager, and are updated quarterly on a prospective basis: Constant Prepayment Rates Low High Agency RMBS 20-Year Mortgage 3.91 % 26.72 % 30-Year Mortgage 4.57 % 33.98 % Agency RMBS IOs and IIOs 5.21 % 32.00 %



Agency RMBS IOs and IIOs accounted for as derivatives 4.33 % 25.67 % Agency CMBS IOs accounted for as derivatives(1) N/A N/A

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(1) CMBS generally include prepayment restrictions; therefore, there are no Constant Prepayment Rates available.

The following table details information for our Non-Agency portfolio as of June 30, 2014, based on our Manager's estimates which are based on third party models, as adjusted by our Manager, and is updated quarterly on a prospective basis: Cumulative Default Cumulative Severity



Cumulative 5-Year CRR

Low High Low High Low High Non-Agency RMBS 5.52 % 61.06 % 4.26 % 88.60 % 1.68 % 12.58 % Non-Agency IOs and IIOs 25.28 % 44.05 % 11.39 % 74.22 % 4.68 % 8.16 % Non-Agency IOs and IIOs accounted for as derivatives 14.57 % 21.89 % 4.26 % 59.40 % 1.81 % 1.81 % Non-Agency CMBS 14.04 % 14.04 % 31.96 % 31.96 % 3.17 % 3.17 % Other securities 0.97 % 0.97 % 0.00 % 0.00 % 0.13 % 0.13 % Linked transactions, net, at fair value 0.00 % 33.59 % 0.00 % 54.11 % 0.00 % 5.75 % Investment Activity



Agency and Non-Agency RMBS, Agency and Non-Agency CMBS, IO and IIO Securities and Other Securities.

The following tables present our MBS and other securities activity, including linked transactions (Non-GAAP) for the three and six months ended June 30, 2014 and 2013 (dollars in thousands): For the three months ended June 30, 2014 Principal Payments Proceeds from Purchases and Basis Recovery Sales Agency RMBS and Agency RMBS IOs and IIOs $ 1,987,402 $ 66,892 $ 1,323,065 Non-Agency RMBS 499,958 15,109 136,913 Agency CMBS and Agency CMBS IOs and IIOs 19,196 414 - Non-Agency CMBS 435,616 - 73,059 Other securities 78,174 - 78,932 Total MBS and other securities: Excluding Linked Transactions (GAAP) $ 3,020,346 $ 82,415 $ 1,611,969 Non-Agency RMBS Linked Transactions - 759 - Non-Agency CMBS Linked Transactions, including Non U.S. 25,141 - - Total MBS: Including Linked Transactions (Non-GAAP) $ 3,045,487 $ 83,174 $ 1,611,969 For the six months ended June 30, 2014 Principal Payments Proceeds from Purchases and Basis Recovery Sales Agency RMBS and Agency RMBS IOs and IIOs $ 2,344,350 $ 114,075 $ 1,336,352 Non-Agency RMBS 604,015 22,762 240,089 Agency CMBS and Agency CMBS IOs and IIOs 19,196 834 - Non-Agency CMBS, including Non U.S. 450,315 - 73,059 Other securities 78,174 - 78,932 Total MBS: Excluding Linked Transactions (GAAP) $ 3,496,050 $ 137,671 $ 1,728,432 Non-Agency RMBS Linked Transactions - 3,777 - Non-Agency CMBS Linked Transactions, including Non U.S. 25,141 - - Total MBS: Including Linked Transactions (Non-GAAP) $ 3,521,191 $ 141,448 $ 1,728,432 56

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Table of Contents For the three months ended June 30, 2013 Principal Payments Proceeds from Purchases and Basis Recovery Sales Agency RMBS and Agency RMBS IOs and IIOs $ 548,253 $ 74,043 $ 317,165 Non-Agency RMBS 48,506 3,435 67,184 Total MBS: Excluding Linked Transactions (GAAP) $ 596,759 $ 77,478 $ 384,349 Agency RMBS Linked Transactions 9,705 58 - Non-Agency RMBS Linked Transactions - 415 21,734 Total MBS: Including Linked Transactions (Non-GAAP) $ 606,464 $ 77,951 $ 406,083 For the six months ended June 30, 2013 Principal Payments Proceeds from Purchases and Basis Recovery Sales Agency RMBS and Agency RMBS IOs and IIOs $ 1,571,400 $ 151,763 $ 2,145,887 Non-Agency RMBS 176,071 5,207 67,184 Total MBS: Excluding Linked Transactions (GAAP) $ 1,747,471 $ 156,970 $ 2,213,071 Agency RMBS Linked Transactions 9,705 58 - Non-Agency RMBS Linked Transactions 66,703 985 21,734 Total MBS: Including Linked Transactions (Non-GAAP) $ 1,823,879 $ 158,013 $ 2,234,805 For the three and six months ended June 30, 2014, we realized a net gain of approximately $0 million and $1.3 million, respectively, from the unlinking of securities previously accounted for as derivatives through linked transactions. We reclassify, from mark-to-market, adjustments on linked transactions to realized gain (loss) on linked transactions during the period the security becomes unlinked. For the three and six months ended June 30, 2013, we realized a net gain of approximately $2.4 million and $2.4 million, respectively, from the unlinking of securities previously accounted for as derivatives through linked transactions.



The following table presents the vintage of our MBS investment portfolio, including linked transactions at June 30, 2014:

1998 2001 2002 2003 2004 2005 2006 2007



2008 2009 2010 2011 2012 2013 2014 Total Agency RMBS 20-Year Mortgage - - - - - - - -

- - - - 6.1 % 12.9 % 4.8 % 23.8 % 30-Year Mortgage - - - - - - 0.2 % -

- 0.3 % 1.5 % 0.1 % 14.6 % 12.6 % 14.0 % 43.3 % Agency Interest Only- Strips

- - - 0.1 % 0.1 % 0.2 % 0.1 % 0.1 % - 0.2 % 0.7 % 0.5 % 2.4 % 0.2 % - 4.6 % Agency and Non-Agency Interest-Only Strips, accounted for as derivatives - - - - - 0.1 % - - 0.1 % - 0.2 % 0.1 % 1.0 % 0.5 % - 2.0 % Non-Agency RMBS 0.3 % 0.2 % 0.3 % 0.3 % 0.5 % 4.0 % 6.8 % 3.3 % 0.3 % - - - - - - 16.0 % Non-Agency Linked Transactions, including Non U.S. - - - - - - 0.1 % 0.2 % - - - - - - 0.5 % 0.8 % Agency and Non-Agency CMBS - - - - 0.2 % 0.6 % 2.4 % 4.0 % - - 0.6 % - - 0.6 % 0.4 % 8.8 % Other securities - - - - - - - - - - - - 0.7 % - 0.7 % Total MBS (Non-GAAP) 0.3 % 0.2 % 0.3 % 0.4 % 0.8 % 4.9 % 9.6 % 7.6 % 0.4 % 0.5 % 3.0 % 0.7 % 24.8 % 26.8 % 19.7 % 100 % 57

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As of June 30, 2014 the weighted average expected remaining term to the expected maturity of our investment portfolio, including linked transactions is 7.9 years.

Financing and Other Liabilities. We have entered into repurchase agreements to finance a substantial majority of our MBS and other securities. These agreements are secured by substantially all of our MBS and other securities and bear interest at rates that have historically moved in close relationship to LIBOR. The following table summarizes the fair value of MBS and other collateral pledged as of June 30, 2014 and December 31, 2013. June 30, 2014 December 31, 2013 Repurchase Fair Value of Repurchase Agreement MBS Agreement Fair Value of (dollars in thousands) Borrowings Collateral Borrowings MBS Collateral Collateral Outstanding Pledged Outstanding Pledged Agency RMBS $ 3,264,316$ 3,447,802$ 2,331,276$ 2,463,347 Non-Agency RMBS 504,733 721,260 208,923 305,318 Agency and Non-Agency CMBS 315,214 420,356 17,544 23,597 Other securities 26,985 33,846 21,324 26,685 Total: Excluding Linked Transactions $ 4,111,248$ 4,623,264$ 2,579,067$ 2,818,947 Non-Agency RMBS Linked Transactions 12,282 15,226 61,187 79,746 Non-Agency CMBS Linked Transactions, including Non U.S. 15,198 25,329 - - Total: Including Linked Transactions (Non-GAAP) $ 4,138,728$ 4,663,819$ 2,640,254$ 2,898,693



The following tables present our borrowing activity, by type of collateral pledged, for the three and six months ended June 30, 2014 and 2013:

For the three months ended June For the six months ended June (dollars in thousands) 30, 2014 30, 2014 Collateral Proceeds Repayments Proceeds Repayments Agency RMBS $ 5,928,825$ 5,194,034$ 9,819,517$ 8,886,476 Non-Agency RMBS 896,241 649,327 1,321,850 1,026,040 Agency and Non-Agency CMBS 420,374 119,453 434,666 136,997 Other securities 224,185 218,524 224,185 218,524 Total: Excluding Linked Transactions $ 7,469,625$ 6,181,338$ 11,800,218$ 10,268,037 Agency RMBS Linked Transactions - - - - Non-Agency RMBS Linked Transactions 37,238 37,670 75,809 124,714 Non-Agency CMBS Linked Transactions, including Non U.S. 15,198 - 15,198 - Total $ 7,522,061$ 6,219,008$ 11,891,225$ 10,392,751 For the three months ended June For the six months ended June (dollars in thousands) 30, 2013 30, 2013 Collateral Proceeds Repayments Proceeds Repayments Agency RMBS $ 8,757,240$ 8,866,512$ 19,816,748$ 20,746,488 Non-Agency RMBS 113,115 97,144 257,356 160,717 Total: Excluding Linked Transactions $ 8,870,355$ 8,963,656$ 20,074,104$ 20,907,205 Agency RMBS Linked Transactions 18,618 18,618 18,618 18,618 Non-Agency RMBS Linked Transactions 19,732 60,317 67,627 64,342 Total $ 8,908,705$ 9,042,591 $

20,160,349 $ 20,990,165 58

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At June 30, 2014, we had outstanding repurchase agreement borrowings with the following 19 counterparties totaling approximately $4.1 billion, which is a Non-GAAP measure due to our Linked Transactions, which is reconciled to GAAP below as follows: Fair Value of Percent of Total Company (dollars in thousands) Amount Amount Securities Counterparty Repurchase Agreement Counterparties Outstanding Outstanding Held as Collateral Rating(2) Barclays Capital Inc. (1) $ 616,326 14.9 % $ 700,154 A Merrill Lynch Pierce Fenner & Smith Inc. (1) 586,625 14.2 % 608,781 A JP Morgan Securities LLC (1) 467,758 11.3 % 548,775 A+ Deutsche Bank Securities LLC (1) 467,688 11.3 % 490,768 A BNP Paribas Securities Corporation (1) 356,353 8.6 % 383,822 A+ Credit Suisse Securities (USA) LLC (1) 301,543 7.3 % 388,229 A Goldman Sachs Bank USA (1) 245,519 5.9 % 258,580 A Mizuho Securities USA Inc. (1) 218,261 5.3 % 246,567 (P)A2 UBS Securities LLC (1) 211,761 5.1 % 250,424 A Morgan Stanley & Co. LLC (1) 167,238 4.0 % 174,388 A Royal Bank of Canada (1) 162,043 3.9 % 225,704 AA- RBC Capital Markets LLC (1) 97,851 2.4 % 106,289 AA- Jefferies & Company Inc. (1) 79,546 1.9 % 83,655 BBB Wells Fargo Bank NA (1) 65,553 1.6 % 69,529 AA- Citigroup Global Markets Inc. (1) 36,290 0.9 % 46,895 A The Royal Bank of Scotland plc (1) 27,109 0.7 % 36,448 BBB+ Deutsche Bank AG 15,198 0.4 % 25,329 A Nomura Securities International, Inc. 10,096 0.2 % 11,459 Unrated(3) Wells Fargo Securities LLC 5,970 0.1 % 8,022 AA- Total: Non-GAAP Basis - Including Linked Transactions, including Non U.S. $ 4,138,728 100.0 % $ 4,663,818 Linked Transactions 27,480 - 40,554 Total: GAAP Basis - Excluding Linked Transactions $ 4,111,248 - $ 4,623,264



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(1) Counterparty holds collateral valued in excess of 5% of our stockholders' equity as security for our obligations under the applicable repurchase agreements as of June 30, 2014.

(2) The counterparty rating presented above is the long-term issuer credit rating as rated at June 30, 2014 by S&P, except for Mizuho Securities USA Inc. which is the long-term issuer credit rating by Moody's at June 30, 2014.



(3) Nomura Holdings, Inc., the parent company of Nomura Securities International, Inc., is rated BBB+ by S&P at June 30, 2014.

At December 31, 2013, we had outstanding repurchase agreement borrowings with the following 16 counterparties totaling approximately $2.6 billion, which is a Non-GAAP measure, due to our Linked Transactions, which is reconciled to GAAP below as follows: Fair Value of Percent of Total Company (dollars in thousands) Amount Amount Securities Counterparty Repurchase Agreement Counterparties Outstanding Outstanding Held as Collateral Rating(2) Barclays Capital Inc. (1) $ 362,476 13.7 % $ 414,344 A Deutsche Bank Securities LLC (1) 356,372 13.5 % 381,319 A Goldman Sachs Bank USA (1) 306,708 11.6 % 328,504 A JP Morgan Securities LLC (1) 271,887 10.3 % 313,967 A+ Citigroup Global Markets Inc. (1) 205,856 7.8 % 213,358 A Credit Suisse Securities (USA) LLC (1) 178,896 6.8 % 235,680 A Mizuho Securities USA Inc. (1) 173,030 6.6 % 178,101 (P)A2 BNP Paribas Securities Corporation. (1) 152,084 5.8 % 164,025 A+ Merrill Lynch Pierce Fenner & Smith Inc. (1) 142,665 5.4 % 148,351 A UBS Securities LLC (1) 130,833 5.0 % 133,938 A South Street Securities LLC (1) 100,818 3.8 % 105,020 AA+ Jefferies & Company Inc. (1) 100,762 3.8 % 104,302 BBB RBC Capital Markets LLC (1) 56,222 2.1 % 61,898 AA- RBS Securities Inc. (1) 51,138 1.9 % 52,625 A- The Royal Bank of Scotland plc(1) 37,993 1.4 % 50,834 BBB+ Morgan Stanley & Co. LLC 12,514 0.5 % 12,427 A Total: Non-GAAP Basis - Including Linked Transactions $ 2,640,254 100.0 % $ 2,898,693 Linked Transactions 61,187 - 79,746 Total: GAAP Basis - Excluding Linked Transactions $ 2,579,067 - $ 2,818,947



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(1) Counterparty holds collateral valued in excess of 5% of our stockholders' equity as security for our obligations under the applicable repurchase agreements as of December 31, 2013.

(2) The counterparty rating presented above is the long-term issuer credit rating as rated at March 12, 2014 by S&P, except for Mizuho Securities USA Inc. which is the long-term issuer credit rating by Moody's at March 12, 2014. 59 --------------------------------------------------------------------------------



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We record the liability for MBS and other securities purchased, for which settlement has not taken place as an investment related payable. As of June 30, 2014, we had investment related payables of $57.0 million.

The following tables present our borrowings by type of collateral pledged as of June 30, 2014 and 2013, and the respective Effective Cost of Funds for the three and six months then ended (dollars in thousands): Weighted Average Cost Weighted of Funds for Average Cost the three months of Funds for Balance (GAAP) ended June 30, the six months ended Collateral June 30, 2014 2014 June 30, 2014 Agency RMBS $ 3,264,316 0.38 % 0.39 % Non-Agency RMBS 504,733 1.64 1.66 Agency and Non-Agency CMBS 315,214 1.55 1.53 Other securities 26,985 1.60 1.62 Total $ 4,111,248 0.58 % 0.56 % Weighted Average Cost Weighted of Funds for Average Cost the three months of Funds for Balance (GAAP) ended June 30, the six months ended Collateral June 30, 2013 2013 June 30, 2013 Agency RMBS $ 3,864,990 0.42 % 0.43 % Non-Agency RMBS 96,639 1.85 1.85 Total $ 3,961,629 0.45 % 0.45 %



The following tables present our borrowings by type of collateral pledged as of June, 2014 and 2013, and the respective Effective Cost of Funds (Non-GAAP financial measure) for the three and six months then ended (dollars in thousands) See "Non-GAAP financial measures":

Weighted Average Effective Cost Weighted of Funds for Average Effective Cost Balance (Non- the three months of Funds for GAAP) ended June 30, the six months ended Collateral June 30, 2014 2014 (1) June 30, 2014 (1) Agency RMBS $ 3,264,316 1.05 % 1.33 % Non-Agency RMBS 504,733 1.75 1.78 Agency and Non-Agency CMBS 315,214 1.98 1.99 Other securities 26,985 1.60 1.62 Total: Excluding Linked Transactions $ 4,111,248 1.17 % 1.40 % Non-Agency RMBS Linked Transactions 12,282 1.57 1.71 Non-Agency CMBS Linked Transactions, including Non U.S. 15,198 1.71 1.71 Total $ 4,138,728 1.17 % 1.40 %

-------------------------------------------------------------------------------- (1) The effective cost of funds for the three and six months ended June 30, 2014 are calculated on an annualized basis and include interest expense for the periods and net payments on interest rate swaps of approximately $6.1 million and $13.9 million, respectively and interest payments on Non-Agency and other securities linked transactions of approximately $50 thousand and $275 thousand, respectively. While swaps are not accounted for using hedge accounting, such instruments are viewed by us as an economic hedge against increases in interest rates on our liabilities and are classified as hedges for purposes of satisfying the REIT tax requirements. In addition, although certain securities and their respective repurchase borrowings are classified as derivatives, we view the interest expense attributed to these borrowings as additional cost of funds. See "Non-GAAP Financial Measures." 60 --------------------------------------------------------------------------------

Table of Contents Weighted Average Effective Cost Weighted of Funds for Average Effective Cost Balance (Non- the three months of Funds for GAAP) ended June 30, the six months ended Collateral June 30, 2013 2013 (1) June 30, 2013 (1) Agency RMBS $ 3,864,990 0.94 % 0.90 % Non-Agency RMBS 96,639 1.85 1.85 Total: Excluding Linked Transactions $ 3,961,629 0.96 % 0.91 % Agency RMBS Linked Transactions - 0.38 0.38 Non-Agency RMBS Linked Transactions 3,286 1.78 1.80 Total $ 3,964,915 0.96 % 0.91 %

-------------------------------------------------------------------------------- (1) The effective cost of funds for the three and six months ended June 30, 2013, are calculated on an annualized basis and include interest expense for the periods and net payments on interest rate swaps of approximately $5.2 million and $9.7 million, respectively, interest payments on Agency linked transactions of approximately $6 thousand and $6 thousand, respectively and interest payments on Non-Agency linked transactions of approximately $99 thousand and $188 thousand, respectively. While swaps are not accounted for using hedge accounting, such instruments are viewed by us as an economic hedge against increases in interest rates and are classified as hedges for purposes of satisfying the REIT tax requirements. In addition, although certain securities and their respective repurchase borrowings are classified as derivatives, we view the interest expense attributed to these borrowings as additional cost of funds. See "Non GAAP Financial Measures".



The following table presents our average borrowings, by type of collateral pledged, on a GAAP and Non-GAAP basis for the three and six months ended June 30, 2014 and 2013 (in thousands):

For For For For the three months the three months the six months the six months ended Collateral ended June 30, 2014 ended June 30,



2013 ended June 30, 2014June 30, 2013 Agency RMBS

$ 3,438,511 $ 3,959,424 $ 2,896,627 $ 4,243,261 Non-Agency RMBS 412,897 80,375 309,530 65,543 Agency and Non-Agency CMBS 207,596 - 112,459 - Other securities 62,812 - 42,472 - Total: Excluding Linked Transactions (GAAP) $ 4,121,816 $ 4,039,799 $ 3,361,088 $ 4,308,804 Agency RMBS Linked Transactions (Non-GAAP) - 6,301 - 3,200 Non-Agency RMBS Linked Transactions (Non-GAAP) 12,501 22,370 32,227 21,050 Non-Agency CMBS Linked Transactions (Non-GAAP), including Non U.S. 234 - 119 - Total (Non-GAAP) $ 4,134,551 $ 4,068,470 $ 3,393,434 $ 4,333,054 Maximum borrowings during the period (Non-GAAP)(1) 4,254,145 4,231,087 4,254,145 4,808,778



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(1) Amount represents the maximum borrowings at month-end during each of the respective periods.

Derivative Instruments. As of June 30, 2014, we had entered into swaps designed to mitigate the effects of increases in interest rates under a portion of our repurchase agreements as such repurchase agreements are renewed and/or extended. The swaps generally provide for fixed interest rates that are indexed off of LIBOR and are viewed by us to effectively fix the floating interest rates, net of variable-rate payment swaps, on approximately $2.9 billion of borrowings under our repurchase agreements, excluding forward starting swaps of $1.3 billion as of June 30, 2014. 61 --------------------------------------------------------------------------------



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The following table presents information about our fixed pay rate interest rate swaps as of June 30, 2014 and December 31, 2013 (dollars in thousands):

June 30, 2014 Average Fixed Average Pay Maturity Remaining Interest Rate interest rate swap Term Notional Amount Rate (Years) Forward Starting 1 year or less $ 215,900 0.4 % 0.3 - % Greater than 1 year and less than 3 years 1,129,100 0.8 2.1 35.4 Greater than 3 years and less than 5 years 2,297,800 1.7 4.6 - Greater than 5 years 3,206,050 2.7 10.3 31.6 Total $ 6,848,850 2.0 % 6.7 20.6 % December 31, 2013 Average Fixed Average Pay Maturity Remaining Interest Rate interest rate swap Term Notional Amount Rate (Years) Forward Starting 1 year or less $ 215,900 0.4 % 0.8 - % Greater than 1 year and less than 3 years 179,100 0.5 1.9 - Greater than 3 years and less than 5 years 574,200 1.3 4.4 - Greater than 5 years 1,718,650 2.4 10.8 28.6 Total $ 2,687,850 1.9 % 8.0 18.3 % The following table presents information about our variable pay rate interest rate swaps as of June 30, 2014 and December 31, 2013 (dollars in thousands): June 30, 2014 Average Variable Average Pay Maturity Remaining Interest Rate interest rate swap Term Notional Amount Rate (Years) Forward Starting Greater than 3 years and less than 5 years $ 1,520,000 0.2 % 4.9 - % Greater than 5 years 1,132,100 0.2 10.4 9.7 Total $ 2,652,100 0.2 % 7.2 4.1 % December 31, 2013 Average Variable Average Pay Maturity Remaining Interest Rate interest rate swap Term Notional Amount Rate (Years) Forward Starting Greater than 3 years and less than 5 years $ 81,000 0.2 % 4.8 - % Greater than 5 years 46,000 0.2 24.1 - Total $ 127,000 0.2 % 11.8 - %



The following tables present information about our interest rate swaptions as of June 30, 2014 and December 31, 2013 (dollars in thousands):

June 30, 2014 Option Underlying Swap Weighted Average Months Until Weighted Option Notional Average Swap Fixed-Pay Rate for Underlying Swap Fair Value Expiration Amount Term (Years) 2.26 - 2.50% $ 276 23.8 $ 105,000 1.0 3.51 - 3.75% 61 3.6 200,000 10.0 $ 337 10.6 $ 305,000 6.9 62

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Table of Contents December 31, 2013 Option Underlying Swap Weighted Average Months Until Weighted Option Notional Average Swap Fixed-Pay Rate for Underlying Swap Fair Value Expiration Amount Term (Years) 2.51- 2.75% $ 1,889 4.4 $ 150,000 7.0 2.76 - 3.00% 2,762 4.3 250,000 7.0 3.01 - 3.25% 1,192 4.6 1,500,000 10.0 3.26 - 3.50% 971 4.0 100,000 10.0 3.51 - 3.75% 4,363 9.6 200,000 10.0 $ 11,177 5.0 $ 2,200,000 9.5 December 31, 2013 Option Underlying Swap Weighted Average Months Weighted Until Option Notional Average Swap Fixed-Receive Rate for Underlying Swap Fair Value Expiration Amount Term (Years) 3.76 - 4.00% $ (264 ) 4.0 $ 100,000 10 $ (264 ) 4.0 $ 100,000 10 We also purchased or sold TBAs. As of June 30, 2014 and December 31, 2013, we had contracts to purchase ("long position") and sell ("short position") TBAs on a forward basis. Following is a summary of our long and short TBA positions reported in Derivative assets, at fair value on the Balance Sheet as of June 30, 2014 and December 31, 2013 (dollars in thousands): June 30, 2014 December 31, 2013 Notional Fair Notional Fair Amount Value Amount Value Purchase contracts, asset $ 2,173,400$ 8,036$ 13,600$ 35 Sale contracts, asset - - - - TBA securities, asset 2,173,400 8,036 13,600 35 Purchase contracts, liability 200,000 (863 ) 176,400 (1,207 ) Sale contracts, liability (1,693,000 ) (5,713 ) - - TBA securities, liability (1,493,000 ) (6,576 ) 176,400 (1,207 ) TBA securities, net $ 680,400$ 1,460$ 190,000$ (1,172 )



The following table presents additional information about our contracts to purchase and sell TBAs for the six months ended June 30, 2014 (dollars in thousands):

Notional Amount Settlement, Notional as of December Termination,



Expiration Amount as of

31, 2013 Additions or Exercise June 30, 2014 Purchase of TBAs $ 190,000 11,811,896 $ (9,628,496 ) $ 2,373,400 Sale of TBAs $ - 11,321,496 $ (9,628,496 ) $ 1,693,000 We also entered into Eurodollar futures during the six months ended June 30, 2014. As of June 30, 2014, we had purchase contracts ("long position"), representing a notional amount of $592.0 million with a fair value of $437 thousand and an expiration date of June 2016. In addition, as of June 30, 2014, we had contracts to sell ("short position"), representing a notional amount of $592.0 million with a fair value in a liability position of $548 thousand and an expiration date of June 2018.



The following is a summary of our foreign currency forwards with a fair value in a liability position of $138 thousand at June 30, 2014:

Notional Notional Derivative Type Amount (USD Equivalent) Maturity Sell EUR/Buy USD Currency forward 11,100 $ 15,199 July 2014 Buy EUR/Sell USD Currency forward 11,100 $ 15,205 September 2014 63

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The following is a summary of our foreign currency swaps with a fair value of $15 thousand at June 30, 2014:

Date entered Maturity Fixed Rate Denomination Notional Amount June 2014 July 2024 7.25 % EUR 18,500 June 2014 July 2024 9.005 % USD 25,160 Net Interest Income We earned interest income, net of premium amortization and amortization/recovery of basis, and inclusive of discount accretion of approximately $44.6 million and $68.0 million for the three and six months ended June 30, 2014, respectively, and approximately $32.8 million and $66.5 million for the three and six months ended June 30, 2013, respectively, which represents interest earned on our assets. We incurred interest expense of approximately $6.0 million and $9.4 million for the three and six months ended June 30, 2014, respectively, and approximately $4.5 million and $9.7 million for the three and six months ended June 30, 2013, respectively, which was related to borrowings from repurchase agreements. Yields on Agency RMBS decreased in 2014 corresponding to the decrease on the yield on the ten-year U.S. Treasury. Yields on Non-Agency RMBS generally decreased as result of continuing home price appreciation and market demand for such securities, however, the yield on our Non-Agency RMBS portfolio increased due higher expected recoveries and changes in the composition of such portfolio. Yields on our Agency and Non-Agency CMBS portfolio generally decreased due to the tightening of credit spreads in that sector. Cost of repurchase financing remained relatively constant as the Federal Reserve continues to maintain its accommodative monetary policy. Our effective gross yield, a non-GAAP measure, increased for the quarter due to the change in composition of our portfolio. Our effective cost of funds, a non-GAAP measure, for the quarter was 1.17%, a 0.60% decrease from the prior quarter ended March 31, 2014. The reduction in our effective cost of funds for the quarter ended June 30, 2014, primarily resulted from lower net interest expense associated with our hedging costs as the amount of interest rate swaps for which we incurred a current payment obligation was lower relative to our outstanding borrowings than in the prior quarter ended March 31, 2014. For the three months ended June 30, 2014 Agency and (dollars in Non-Agency Non-Agency Other thousands) Agency RMBS RMBS CMBS securities Total Average amortized cost of securities $ 3,751,050$ 596,871$ 286,678$ 79,960$ 4,714,559 Total interest income (1) $ 30,749$ 8,809$ 3,985$ 1,061$ 44,604 Yield on average securities 3.29 % 5.92 % 5.58 % 5.32 % 3.79 % Average balance of repurchase agreements $ 3,438,511$ 412,897$ 207,596$ 62,812$ 4,121,816 Total interest expense $ 3,230$ 1,688$ 802$ 251$ 5,971 Average cost of funds (2) 0.38 % 1.64 % 1.55 % 1.60 % 0.58 % Net interest income $ 27,519$ 7,121$ 3,183$ 810$ 38,633 Net interest rate spread 2.91 % 4.28 % 4.03 % 3.72 % 3.21 %

-------------------------------------------------------------------------------- (1)Amount includes net (amortization of premiums), accretion of discounts and (amortization/recovery of basis) of approximately $(13.9) million for Agency RMBS, approximately $(516) thousand for Non-Agency RMBS, approximately $291 thousand for Agency and Non-Agency CMBS, and approximately $114 thousand for other securities for three months ended June 30, 2014. In accordance with GAAP, interest income does not include $251 thousand for linked transactions for the three and months ended June 30, 2014; instead such amounts are included in gain (loss) on linked transactions. (2) For the three months ended June 30, 2014, cost of funds does not include accrual and settlement of interest associated with derivative instruments and linked transactions of approximately $6.1 million and $50 thousand, respectively. In accordance with GAAP, such costs are included in gain (loss) on derivative instruments and gain (loss) on linked transactions, respectively, in the Statement of Operations. 64

-------------------------------------------------------------------------------- Table of Contents For the six months ended June 30, 2014 Agency and Non-Agency Non-Agency Other (dollars in thousands) Agency RMBS RMBS CMBS securities Total Average amortized cost of securities $ 3,161,100$ 452,857$ 149,945$ 53,169$ 3,817,071 Total interest income (1) $ 48,458$ 13,812$ 4,210$ 1,554$ 68,034 Yield on average securities 3.09 % 6.15 % 5.66 % 5.89 % 3.59 % Average balance of repurchase agreements $ 2,896,627$ 309,530$ 112,459$ 42,472$ 3,361,088 Total interest expense $ 5,621$ 2,544$ 854$ 342$ 9,361 Average cost of funds (2) 0.39 % 1.66 % 1.53 % 1.62 % 0.56 % Net interest income $ 42,837$ 11,268$ 3,356$ 1,212$ 58,673 Net interest rate spread 2.70 % 4.49 % 4.13 % 4.27 % 3.03 %

-------------------------------------------------------------------------------- (1)Amount includes net (amortization of premiums), accretion of discounts and (amortization/recovery of basis) of approximately $(26.0) million for Agency RMBS, approximately $121 thousand for Non-Agency RMBS, approximately $468 thousand for Agency and Non-Agency CMBS and approximately $215 thousand for other securities for the six months ended June 30, 2014. In accordance with GAAP, interest income does not include approximately $1.2 million for linked transactions for the six months ended June 30, 2014; instead such amounts are included in gain (loss) on linked transactions. (2) For the six months ended June 30, 2014, cost of funds does not include accrual and settlement of interest of approximately $13.9 million and $275 thousand associated with derivative instruments and linked transactions, respectively. In accordance with GAAP, such costs are included in gain (loss) on derivative instruments and gain (loss) on linked transactions, respectively, in the Statement of Operations. For the three months ended June 30, 2013 For the six months ended June 30, 2013 (dollars in thousands) Agency Non-agency Total



Agency Non-agency Total

Average amortized cost of RMBS $ 4,274,504$ 157,025$ 4,431,529$ 4,415,030$ 133,107$ 4,548,137 Total interest income (1) $ 30,409$ 2,333$ 32,742$ 62,578$ 3,914$ 66,492 Yield on average RMBS 2.85 % 5.96 % 2.96 % 2.86 % 5.93 % 2.95 % Average balance of repurchase agreements $ 3,959,424$ 80,375$ 4,039,799$ 4,243,261$ 65,543$ 4,308,804 Total interest expense $ 4,151 $ 371 $ 4,522 $ 9,102 $ 601$ 9,703 Average cost of funds (2) 0.42 % 1.85 % 0.45 % 0.43 % 1.85 % 0.45 % Net interest income $ 26,258$ 1,962$ 28,220$ 53,476$ 3,313$ 56,789 Net interest rate spread 2.43 % 4.11 % 2.51 % 2.43 % 4.08 % 2.50 %

-------------------------------------------------------------------------------- (1)Amount includes net amortization of premiums, accretion of discounts and amortization of basis of approximately $(15.4) million for Agency, and approximately $1.7 million for Non-Agency for the three months ended June 30, 2013. For the six months ended June 30, 2013, amount includes net amortization of premiums, accretion of discounts and amortization of basis of approximately $(33.7) million for Agency and approximately $2.8 million for Non-Agency. In accordance with GAAP, interest income does not include $562 thousand and $997 thousand for linked transactions for the three and six months ended June 30, 2013, respectively; instead they are included in gain on linked transactions. (2) For the three months ended June 30, 2013, cost of funds does not include accrual and settlement of interest associated with derivative instruments and linked transactions of approximately $5.2 million and $105 thousand, respectively. For the six months ended June 30, 2013, cost of funds does not include interest of approximately $9.7 million associated with derivative instruments and $194 thousand associated with linked transactions. In accordance with GAAP, those costs are included in gain (loss) on derivative instruments and gain on linked transactions, respectively, in the statement of operations. 65 --------------------------------------------------------------------------------



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The following tables set forth certain information regarding our net investment income for the three and six months ended June 30, 2014 and 2013, See "Non-GAAP Financial Measures":



For the three months ended June 30, 2014:

Non-GAAP Financial Measures: Agency and Non-Agency Non-Agency Other (dollars in thousands) Agency RMBS RMBS CMBS securities Total Average amortized cost of securities held including Agency and Non-Agency Interest-Only Strips accounted for as derivatives and linked transactions $ 3,826,090$ 616,532$ 307,869$ 79,960$ 4,830,451 Total interest income including interest income on Agency and Non-Agency Interest-Only Strips accounted for as derivatives and linked transactions(1) $ 32,060$ 9,115$ 4,252$ 1,061$ 46,488 Yield on average amortized cost of securities including adjustments related to cost of Agency and Non-Agency Interest-Only Strips accounted for as derivatives and linked transactions 3.36 % 5.93 % 5.52 % 5.32 % 3.86 % Average balance of repurchase agreements, including repurchase agreements on linked transactions $ 3,438,511$ 425,398$ 207,830$ 62,812$ 4,134,551 Total interest expense including interest income (expense), net incurred on interest rate swaps and interest expense incurred on linked transactions(2) $ 8,980$ 1,846$ 1,027$ 251$ 12,104 Average cost of funds including interest income (expense) on Agency and Non-Agency Interest-Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions 1.05 % 1.74 % 1.98 % 1.60 % 1.17 % Net interest income including interest income (expense) on Agency and Non-Agency Interest-Only Strips, accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions $ 23,080$ 7,269$ 3,225$ 810$ 34,384 Net interest rate spread including interest income (expense) on Agency and Non-Agency Interest-Only Strips accounted as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions 2.31 % 4.19 % 3.54 % 3.72 % 2.69 %

-------------------------------------------------------------------------------- (1) For the three months ended June 30, 2014 includes net (amortization of premiums), accretion of discounts and (amortization/recovery of basis) of approximately $(19.0) million. This amount is composed of approximately $(13.9) million for Agency RMBS included in interest income, approximately $(516) thousand for Non-Agency RMBS included in interest income, approximately $291 thousand for Agency and Non-Agency CMBS included in interest income, approximately $114 thousand for Other securities included in interest income, approximately $(509) thousand for Non-Agency linked transactions (Non-GAAP measure) and approximately $(4.5) million of amortization/recovery of basis on Agency and Non-Agency Interest-Only Strips accounted for as derivatives (Non-GAAP measure), not reported in interest income for GAAP (included in Loss on derivative instruments). (2) Represents the net amount paid, including accrued amounts, for interest rate swaps during the period, included in loss on derivative instruments for GAAP and interest expense on linked transactions. 66 --------------------------------------------------------------------------------



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For the six months ended June 30, 2014:

Non-GAAP Financial Measures:

Agency and Non-Agency Non-Agency Other (dollars in thousands) Agency RMBS RMBS CMBS securities Total Average amortized cost of securities held including Agency and Non-Agency Interest-Only Strips accounted for as derivatives and linked transactions $ 3,249,998$ 498,429$ 170,671$ 53,169$ 3,972,267 Total interest income including interest income on Agency and Non-Agency Interest-Only Strips accounted for as derivatives and linked transactions(1) $ 52,292$ 15,086$ 4,748$ 1,554$ 73,680 Yield on average amortized cost of securities including adjustments related to cost of Agency and Non-Agency Interest-Only Strips accounted for as derivatives and linked transactions 3.24 % 6.10 % 5.60 %



5.89 % 3.74 %

Average balance of repurchase agreements, including repurchase agreements on linked transactions $ 2,896,627$ 341,757$ 112,578



$ 42,472$ 3,393,434

Total interest expense including interest income (expense), net incurred on interest rate swaps and interest expense incurred on linked transactions(2) $ 19,104$ 3,013$ 1,113$ 342$ 23,572 Average cost of funds including interest income (expense) on Agency and Non-Agency Interest-Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions 1.33 % 1.78 % 1.99 %



1.62 % 1.40 %

Net interest income including interest income (expense) on Agency and Non-Agency Interest-Only Strips, accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions $ 33,188$ 12,073$ 3,635



$ 1,212$ 50,108

Net interest rate spread including interest income (expense) on Agency and Non-Agency Interest-Only Strips accounted as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions 1.91 % 4.32 % 3.61 % 4.27 % 2.34 %

-------------------------------------------------------------------------------- (1) For the six months ended June 30, 2014 includes net (amortization of premiums), accretion of discounts and (amortization/recovery of basis) of approximately $(38.0) million. This amount is composed of approximately $(26.0) million for Agency RMBS included in interest income, approximately $121 thousand for Non-Agency RMBS included in interest income, approximately $468 thousand for Agency and Non-Agency CMBS included in interest income, approximately $215 thousand for Other securities, included in interest income, approximately $(2.7) million for Non-Agency linked transactions (Non-GAAP measure) and approximately $(10.1) million of amortization/recovery of basis on Agency and Non-Agency Interest-Only Strips accounted for as derivatives (Non-GAAP measure), not reported in interest income for GAAP (included in Loss on derivative instruments). (2) Represents the net amount paid, including accrued amounts, for interest rate swaps during the period, included in loss on derivative instruments for GAAP and interest expense on linked transactions. 67 --------------------------------------------------------------------------------



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For the three months ended June 30, 2013:

Non-GAAP Financial Measures: (dollars in thousands) Agency Non-agency Total Average amortized cost of RMBS held including Agency Interest-Only Strips, Agency Inverse Interest-Only Strips accounted for as derivatives and linked transactions $ 4,381,145$ 191,571



$ 4,572,716

Total interest income including interest income on Agency Interest-Only Strips, Agency Inverse Interest- Only Strips accounted for as derivatives and linked transactions(1) $ 32,853$ 2,851



$ 35,704

Yield on average amortized cost of RMBS including adjustments related to cost of Agency Interest-Only Strips, Agency Inverse Interest-Only Strips accounted for as derivatives and linked transactions 3.01 % 5.97 %



3.14 %

Average balance of repurchase agreements, including repurchase agreements on linked transactions $ 3,965,725$ 102,745



$ 4,068,470

Total interest expense including interest income (expense), net incurred on interest rate swaps and interest expense incurred on linked transactions(2) $ 9,313$ 470



$ 9,783

Average cost of funds including interest income (expense) on Agency Interest-Only Strips, Agency Inverse Interest-Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions 0.94 % 1.83 %



0.96 %

Net interest income including interest income (expense) on Agency Interest-Only Strips, Agency Inverse Interest-Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions $ 23,540$ 2,381



$ 25,921

Net interest rate spread including interest income (expense) on Agency Interest-Only Strips and Agency Inverse Interest-Only Strips accounted as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions 2.07 % 4.14 % 2.18 %

-------------------------------------------------------------------------------- (1) For the three months ended June 30, 2013 includes net amortization of premiums, accretion of discounts and amortization of basis of approximately $(17.9) million. This amount is composed of approximately $(15.4) million for Agency RMBS included in interest income, approximately $1.7 million for Non-Agency included in interest income, $(9) thousand for Agency linked transactions (Non-GAAP measure), $0.4 million for Non-Agency linked transactions (Non-GAAP measure) and $(4.6) million of amortization of basis on Agency Interest-Only Strips and Agency Inverse Interest Only Strips accounted for as derivatives (Non-GAAP measure), not reported in interest income for GAAP (included in Loss on derivative instruments). (2) Represents the net amount paid, including accrued amounts, for interest rate swaps during the period, included in loss on derivative instruments for GAAP and interest expense on linked transactions. 68 --------------------------------------------------------------------------------



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For the six months ended June 30, 2013:

Non-GAAP Financial Measures:

(dollars in thousands) Agency Non-agency Total Average amortized cost of RMBS held including Agency Interest-Only Strips, Agency Inverse Interest-Only Strips accounted for as derivatives and linked transactions $ 4,513,039$ 167,291



$ 4,680,330

Total interest income including interest income on Agency Interest-Only Strips, Agency Inverse Interest- Only Strips accounted for as derivatives and linked transactions(1) $ 66,782$ 4,867



$ 71,649

Yield on average amortized cost of RMBS including adjustments related to cost of Agency Interest-Only Strips, Agency Inverse Interest-Only Strips accounted for as derivatives and linked transactions 2.98 % 5.87 %



3.09 %

Average balance of repurchase agreements, including repurchase agreements on linked transactions $ 4,246,461$ 86,593



$ 4,333,054

Total interest expense including interest income (expense), net incurred on interest rate swaps and interest expense incurred on linked transactions(2) $ 18,846$ 789



$ 19,635

Average cost of funds including interest income (expense) on Agency Interest-Only Strips, Agency Inverse Interest-Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions 0.89 % 1.84 %



0.91 %

Net interest income including interest income (expense) on Agency Interest-Only Strips, Agency Inverse Interest-Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions $ 47,936$ 4,078



$ 52,014

Net interest rate spread including interest income (expense) on Agency Interest-Only Strips and Agency Inverse Interest-Only Strips accounted as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions 2.09 % 4.03 % 2.18 %

-------------------------------------------------------------------------------- (1) For the six months ended June 30, 2013 includes net amortization of premiums, accretion of discounts and amortization of basis of approximately $(38.9) million. This amount is composed of approximately $(33.7) million for Agency RMBS included in interest income, approximately $2.8 million for Non-Agency included in interest income, $(9) thousand for Agency linked transactions (Non-GAAP measure), $0.8 million for Non-Agency linked transactions (Non-GAAP measure) and $(8.8) million of amortization of basis on Agency Interest-Only Strips and Agency Inverse Interest Only Strips accounted for as derivatives (Non-GAAP measure), not reported in interest income for GAAP (included in Loss on derivative instruments). (2) Represents the net amount paid, including accrued amounts, for interest rate swaps during the period, included in loss on derivative instruments for GAAP and interest expense on linked transactions. 69 --------------------------------------------------------------------------------

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Interest income is subject to interest rate risk. Refer to Item 7A, "Quantitative and Qualitative Disclosures about Market Risk," for more information relating to interest rate risk and its impact on our operating results.

Other Income (Loss) The following tables present the sales of our MBS and other securities (dollars in thousands): For the three months ended June 30, 2014 Proceeds Gross Gains Gross Losses Net Gain (Loss) Agency RMBS (1) $ 1,323,065$ 8,997$ (35,201 ) $ (26,204 ) Non-Agency RMBS 136,913 9,267 (45 ) 9,222 Agency and Non-Agency CMBS 73,059 367 (2 ) 365 Other securities 78,932 5,064 - 5,064 Total $ 1,611,969$ 23,695$ (35,248 ) $ (11,553 )



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(2) Includes proceeds for Agency Interest-Only Strips, accounted for as derivatives, of approximately $20.2 million, gross realized gains of $437 thousand and gross realized losses of $712 thousand.

For the six months ended June 30, 2014 Proceeds Gross Gains Gross Losses Net Gain (Loss) Agency RMBS (1) $ 1,336,352$ 9,013$ (36,070 ) $ (27,057 ) Non-Agency RMBS 240,089 13,502 (580 ) 12,922 Agency and Non-Agency CMBS 73,059 367 (2 ) 365 Other securities 78,932 5,064 - 5,064 Total $ 1,728,432$ 27,946$ (36,652 ) $ (8,706 )



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(2) Includes proceeds for Agency Interest-Only Strips, accounted for as derivatives, of approximately $31.4 million, gross realized gains of $437 thousand and gross realized losses of approximately $1.6 million.

For the three months ended June 30, 2013 Proceeds Gross Gains Gross Losses Net Gain (Loss) Agency RMBS $ 317,170 $ - $ (10,462 ) $ (10,462 ) Non-Agency RMBS 67,184 4,379 - 4,379 Total $ 384,354$ 4,379$ (10,462 ) $ (6,083 ) For the six months ended June 30, 2013 Proceeds Gross Gains Gross Losses Net Gain (Loss) Agency RMBS (1) $ 2,145,888$ 8,646$ (30,867 ) $ (22,221 ) Non-Agency RMBS 67,184 4,379 - 4,379 Total $ 2,213,072$ 13,025$ (30,867 ) $ (17,842 )



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(2) Includes proceeds for Agency Interest-Only Strips, accounted for as derivatives, of approximately $8.4 million and gross realized losses of $99 thousand.

The MBS and structured securities markets remain dynamic and, at times, volatile markets. Our Manager regularly reviews the characteristics of our portfolio and may make changes to our portfolio in order to adjust such portfolio characteristics in response to and/or anticipation of changing market conditions. Accordingly, due to changes in market conditions or expected changes in market conditions, we sold these MBS and other securities in order to adjust the overall characteristics of our portfolio including, but not limited to, prepayment expectations and duration. 70 --------------------------------------------------------------------------------



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With respect to our MBS and other securities, we elected the fair value option and, as a result, we record the change in fair value related to MBS and other securities in earnings. The following tables present amounts related to realized gains and losses as well as changes in fair value of our securities portfolio and derivative instruments that are included in our statement of operations for three and six months ended June 30, 2014 and 2013:



For the three months ended June 30, 2014:

Contractual Other interest loss on Unrealized Realized income Mortgage Gain Mark-to- Gain (expense), -backed (Loss), Basis market Description (Loss), net net(1) securities net Recovery adjustments Total MBS and Other Securities $ (11,278 ) $ - $ (2,999 )$ 114,117 $ - $ - $ 99,840 Cash and cash equivalents - 24 - - - - 24 Derivative Instruments: Interest rate swaps 15,996 (6,083 ) - - - (84,619 ) (74,706 ) Interest rate swaptions (5,908 ) - - - - 4,333 (1,575 ) Agency and Non-Agency Interest-Only Strips accounted for as derivatives (275 ) 6,139 - - (4,507 ) 1,803 3,160 Futures contracts (16,495 ) - - - - (229 ) (16,724 ) Foreign currency forwards - - - - - (138 ) (138 ) Foreign currency swaps - 1 - - - 15 16 TBAs 20,191 - - - - 3,099 23,290 Linked Transactions - 710 - - (509 ) 487 688 Total $ 2,231 $ 791 $ (2,999 )$ 114,117$ (5,016 )$ (75,249 )$ 33,875



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(1) Contractual interest income (expense), net on derivative instruments includes interest settlement paid or received.

For the six months ended June 30, 2014:

Contractual Other interest loss on Unrealized Realized income Mortgage Gain Mark-to- Gain (expense), -backed (Loss), Basis market Description (Loss), net net(1) securities



net Recovery adjustments Total

MBS and Other Securities $ (7,562 ) $ $ (4,708 )$ 145,208 $ - $ - $ 132,938 Cash and cash equivalents - 12 - - - - 12 Derivative Instruments: Interest rate swaps 15,998 (13,936 ) - - - (130,115 ) (128,053 ) Interest rate swaptions (5,908 ) - - - - (4,991 ) (10,899 ) Agency and Non-Agency Interest-Only Strips accounted for as derivatives (1,144 ) 14,565 - - (10,099 ) 583 3,905 Futures contracts (16,495 ) - - - - (111 ) (16,606 ) Foreign currency forwards - - - - - (138 ) (138 ) Foreign currency swaps - 1 - - - 15 16 TBAs 22,561 - - - - 2,631 25,192 Linked Transactions 1,290 3,463 - - (2,559 ) 713 2,907 Total $ 8,740$ 4,105$ (4,708 )$ 145,208$ (12,658 )$ (131,413 )$ 9,274



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(1) Contractual interest income (expense), net on derivative instruments includes interest settlement paid or received. In addition, contractual interest income (expense), net on linked transactions includes amortization of approximately $122 thousand for Non-Agency RMBS.

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For the three months ended June 30, 2013:

Contractual Other interest loss on Unrealized Realized income Mortgage Gain Mark-to- Gain (expense), -backed (Loss), Basis market Description (Loss), net net(1) securities net Recovery adjustments Total

RMBS and Other Securities $ (6,083 ) $ - $ (3,533 )$ (156,286 ) $ - $ - $ (165,902 ) Cash and cash equivalents - 12 - - - - 12 Derivative Instruments: Interest rate swaps 23,881 (5,156 ) - - - 71,202 89,927 Interest rate swaptions 1,038 - - - - 20,751 21,789 Agency and Non-Agency Interest-Only Strips accounted for as derivatives - 7,031 - - (4,631 ) 3,633 6,033 Options (925 ) - - - - 324 (601 ) TBAs (3,163 ) - - - - (4,511 ) (7,674 ) Linked Transactions 3,748 457 - - - (296 ) 3,909 Total $ 18,496$ 2,344$ (3,533 )$ (156,286 )$ (4,631 )$ 91,103$ (52,507 )

-------------------------------------------------------------------------------- (1) Contractual interest income (expense), net on derivative instruments includes interest settlement paid or received. In addition, contractual interest income (expense), net on linked transactions includes amortization of premium of $9 thousand for Agency RMBS and accretion of discount of $437 thousand for Non-Agency RMBS.



For the six months ended June 30, 2013:

Contractual Other interest loss on Unrealized Realized income Mortgage Gain Mark-to- Gain (expense), -backed (Loss), Basis market Description (Loss), net net(1) securities net Recovery adjustments Total

RMBS and Other Securities $ (17,743 ) $ - $ (5,801 )$ (211,045 ) $ - $ - $ (234,589 ) Cash and cash equivalents - 45 - - - - 45 Derivative Instruments: Interest rate swaps 42,139 (9,738 ) - - - 73,060 105,461 Interest rate swaptions 1,038 - - - - 19,245 20,283 Agency and Non-Agency Interest-Only Strips accounted for as derivatives (99 ) 12,976 - - (8,816 ) 1,284 5,345 Options (925 ) - - - - - (925 ) TBAs (2,563 ) - - - - (3,287 ) (5,850 ) Linked Transactions 3,748 803 - - - (46 ) 4,505 Total $ 25,595$ 4,086$ (5,801 )$ (211,045 )$ (8,816 )$ 90,256$ (105,725 )

-------------------------------------------------------------------------------- (1) Contractual interest income (expense), net on derivative instruments includes interest settlement paid or received. In addition, contractual interest income (expense), net on linked transactions includes amortization of premium of $9 thousand for Agency RMBS and accretion of discount of $766 thousand for Non-Agency RMBS. In order to mitigate interest rate risk resulting from our future repurchase agreement borrowings, we entered into interest rate swaps with an aggregate notional amount of approximately $9.5 billion, of which $1.5 billion are forward starting. Our effective swaps are comprised of approximately $5.4 billion fixed pay rate swaps and $2.5 billion are variable pay swaps, which effectively fix (for the life of the swap) the floating interest rate of approximately $2.9 billion and interest rate swaptions with an aggregate notional amount of approximately $305.0 million at June 30, 2014. Similarly, we have entered into a currency swap for approximately $25.2 million (18.5 million) and currency forward for approximately $15.2 million (11.1 million) in order to mitigate our foreign currency risk on our euro denominated assets and liabilities. While not designated as a hedge for accounting purposes, our current and future interest rate swaps, interest rate swaptions, foreign currency swaps and foreign currency forwards are, respectively, viewed as an economic hedge on a portion of our floating-rate borrowings and foreign rate exposure, respectively. Since we do not apply hedge accounting for these instruments, we record the change in fair value related to such agreements in earnings as unrealized gain (loss) on derivative instruments. Included in realized gain or loss on derivative instruments are the net interest rate swap payments and currency payments (including accrued amounts) associated with these instruments. Expenses



General and Administrative Expenses

We incurred general and administrative expenses of approximately $2.4 million and $4.5 million for the three and six months ended June 30, 2014, respectively, and approximately $1.5 million and $3.3 million for the three and six months ended June 30, 2013, respectively, which represents professional fees, insurance, non-cash stock based compensation and overhead costs of the Company. The increase in general and administrative expenses from 2014 over 2013 is primarily due to an increase in audit and insurance fees and compensation expense for our chief financial officer and controller. 72 --------------------------------------------------------------------------------

Table of Contents Management Fee Expense We incurred management fee expense of approximately $2.6 million and $4.4 million for the three and six months ended June 30, 2014, respectively, and approximately $1.8 million and $3.9 million for the three and six months ended June 30, 2013, respectively, of which approximately $2.6 million was payable at June 30, 2014 to our Manager under the Management Agreement. Pursuant to the terms of the Management Agreement, our Manager is paid a management fee equal to 1.5% per annum of our stockholders' equity (as defined in the Management Agreement), calculated and payable (in cash) quarterly in arrears. Management fees primarily increased from 2014 over 2013 due to an increase in our stockholder's equity resulting from the successful completion of our follow-on offering in April 2014. The management fees, expense reimbursements and the relationship between our Manager and us are discussed further in Note 9, "Related Party Transactions," to the financial statements contained in this Quarterly Report on Form 10-Q. Dividends



The following table presents cash dividends declared and paid by us on our common stock:

Declaration Date Record Date Payment Date Amount per Share Tax Characterization

2014

June 19, 2014 June 30, 2014 July 29, 2014 $



0.67 Not yet determined

March 20, 2014 March 31, 2014 April 29, 2014 $



0.67 Not yet determined

2013

April 1, 2013 April 12, 2013 April 30, 2013 $



0.95 Ordinary income

June 20, 2013 July 1, 2013 July 29, 2013 $ 0.90 Ordinary income September 19, 2013 September 30, 2013 October 29, 2013 $ 0.90 Ordinary income December 19, 2013 December 30, 2013 January 28, 2014 $ 2.35 (1) Ordinary income

-------------------------------------------------------------------------------- (1) Consisting of cash and stock. For stockholders who elected to receive the entire $2.35 per share dividend in stock, each stockholder received 0.1590 shares in newly issued shares of our common stock for each common share that they held as of the dividend record date. For stockholders who elected to receive the dividend in cash, or did not make an election, each stockholder received $0.9159 per share in cash and 0.0970 shares in newly issued shares of our common stock for each common share that they held as of the dividend record date. Subsequent Events On July 29, 2014, we formed a wholly owned subsidiary Western Asset Mortgage TRS, LLC, a taxable REIT subsidiary which was formed under Delaware law. We intend to utilize this entity to make certain investments which we otherwise would be prohibited from doing so. On July 31, 2014, Board of Directors has authorized the repurchase of up to 2,050,000 shares of our common stock through December 31, 2015. Purchases made pursuant to the program will be made in the open market, in privately negotiated transactions, or pursuant to any trading plan that may be adopted in accordance with Rules 10b5-1 and 10b-18 of the Securities and Exchange Commission. The authorization does not obligate us to acquire any particular amount of common shares and the program may be suspended or discontinued at our discretion without prior notice. The timing, manner, price and amount of any repurchases will be determined by us in our discretion and will be subject to economic and market conditions, stock price, applicable legal requirements and other factors. We have not yet entered into definitive agreements to utilize the authorization and, accordingly, have not repurchased any shares of common stock pursuant to the authorization as of the date hereof. 73 --------------------------------------------------------------------------------

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Liquidity and Capital Resources

General Our liquidity and capital resources are managed on a daily basis to ensure that we have sufficient liquidity to absorb market events that could negatively impact collateral valuations and result in margin calls and to ensure that we have the flexibility to manage our investment portfolio to take advantage of market opportunities. Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations make distributions to our stockholders, and other general business needs. We use cash to purchase our target assets, repay principal and interest on our borrowings, make distributions to our stockholders and fund our operations. Under our repurchase agreements and derivative contracts, lenders and counterparties retain the right to determine the fair value of the collateral pledged, or in the case of cleared swaps the required collateral may be determined by clearinghouse rules. A reduction in the value of the collateral pledged will require us to provide additional collateral or fund cash margin calls. Alternatively, since margins calls for our interest rate swaps and swaptions generally are inversely correlated to those of our repurchase agreements, our interest rate swap and swaptions counterparties would likely be required to post collateral with us during a period in which we were required to post collateral with our repurchase agreement counterparties. During 2013, the fixed income markets experienced volatility and, in particular, the sell-off in Agency RMBS that occurred between the beginning of July 2013 and the Federal Reserve postponing its decision to taper in September 2013, resulted in demands for additional collateral from our repurchase agreement counterparties. Similarly, we received incremental collateral from our interest rate swap and swaption counterparties during this time. We were able to satisfy our additional collateral requirements with unpledged securities in our portfolio, cash on hand and incremental cash from portfolio sales as well as cash received as and with respect to incremental collateral received on our interest rate swaps and swaptions. We were not forced to involuntarily sell any of our assets, nor did any of counterparties sell any of assets held by them as collateral. During the six months ended June 30, 2014, we were able to satisfy our additional collateral requirements pertaining to our repurchase agreements and our swaps and swaptions with cash on hand and proceeds of our repurchase agreements borrowings, and therefore, we did not rehypothecate any securities during this period. During the second and third quarters of 2013, we rehypothecated some of the securities we received as incremental collateral on our swaps and swaptions, effectively entering into repurchase agreements with such securities, in order to increase our cash position. At June 30, 2014, and December 31, 2013, no securities were rehypothecated. In an instance of severe volatility, or where the additional stress on liquidity resulting from volatility is sustained over an extended period of time, we could be required to sell securities, possibly even at a loss to generate sufficient liquidity to satisfy collateral and margin requirements which could have a material adverse effect on our financial position, results of operations and cash flows.



As part of our risk management process, our Manager closely monitors our liquidity position. This includes the development and evaluation of various alternative processes and procedures, which continue to be updated with regard to scenario testing for purposes of assessing our liquidity in the face of different economic and market developments. We believe we have sufficient current liquidity and access to additional liquidity to meet financial obligations for at least the next 12 months.

Our primary sources of liquidity are as follows:

Borrowing under Various Financing Arrangements

As of June 30, 2014, we had master repurchase agreements with 22 counterparties. We had borrowings under repurchase agreements with 19 counterparties of approximately $4.1 billion at June 30, 2014. The following tables present our borrowings by type of collateral pledged as of June 30, 2014 and 2013, and the respective effective cost of funds (Non-GAAP financial measure) for the three and six months ended June 30, 2014 and 2013. See "Non-GAAP Financial Measures" (dollars in thousands): Weighted Weighted Weighted Average Weighted Average Average Cost Effective Cost of Average Cost Effective Cost of Repurchase of Funds Funds (Non- of Funds Funds (Non- Agreement Weighted for the three GAAP) for the for the six GAAP) for the Borrowings Fair Value of Average months ended for the three months ended for the six Outstanding Collateral Interest Rate June 30, months ended June June 30, months ended Collateral June 30, 2014 Pledged (1) end of period 2014 30, 2014 (2) 2014 June 30, 2014 (2) Agency RMBS $ 3,264,316$ 3,447,802 0.37 % 0.38 % 1.05 % 0.39 % 1.33 % Non-Agency RMBS 504,733 721,260 1.63 1.64 1.75 1.66 1.78 Agency and Non-Agency CMBS 315,214 420,356 1.53 1.55 1.98 1.53 1.99 Other securities 26,985 33,846 1.55 1.60 1.60 1.62 1.62 Total: Excluding Linked Transactions $ 4,111,248$ 4,623,264 0.62 % 0.58 % 1.17 % 0.56 % 1.40 % Non-Agency RMBS Linked Transactions 12,282 15,226 1.55 n/a 1.57 n/a 1.71 Non-Agency CMBS Linked Transactions (3) 15,198 25,329 2.11 n/a 1.71 n/a 1.71 Total (Non-GAAP) $ 4,138,728$ 4,663,819 0.63 % 0.58 % 1.17 % 0.56 % 1.40 %



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(1) Excludes approximately $18.1 million of cash collateral posted.

(2) The effective cost of funds for the periods presented is calculated on an annualized basis and includes interest expense for the periods and net payments on interest rate swaps of approximately $6.1 million and $13.9 million and interest expense on linked transactions of approximately $50 thousand and $275 thousand for the three and six months ended June 30, 2014, respectively. While interest rate swaps are not accounted for using hedge accounting, such instruments are viewed by us as an economic hedge against increases in interest rates on our liabilities and are treated as hedges for purposes of satisfying the REIT tax requirements. See "Non-GAAP Financial Measures".



(3) Including Non U.S. CMBS pledged as collateral and Non U.S. repurchase agreement borrowings.

74 -------------------------------------------------------------------------------- Table of Contents Weighted Weighted Average Weighted Weighted Average Cost Effective Cost of Average Cost Average Repurchase of Funds Funds for the of Funds Effective Cost of Agreement Weighted for the three for the three for the six Funds for the Borrowings Fair Value of Average months ended months ended months ended for the six months Outstanding Collateral Interest Rate June 30, June 30, June 30, ended June 30, Collateral June 30, 2013 Pledged (1) end of period 2013 2013 (2) 2013 2013 (2) Agency RMBS $ 3,864,990$ 4,001,774 0.40 % 0.42 % 0.94 % 0.43 % 0.90 % Non-Agency RMBS 96,639 144,872 1.79 1.85 1.85 1.85 1.85 Total: Excluding Linked Transactions $ 3,961,629$ 4,146,646 0.44 % 0.45 % 0.96 % 0.45 % 0.91 % Agency RMBS Linked Transactions - - n/a n/a 0.38 n/a 0.38 Non-Agency RMBS Linked Transactions 3,286 4,933 1.70 n/a 1.78 n/a 1.80 Total $ 3,964,915$ 4,151,579 0.44 % 0.45 % 0.96 % 0.45 % 0.91 %



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(1) Excludes approximately $123.2 million of cash collateral posted.

(2) The effective cost of funds for the period presented is calculated on an annualized basis and includes interest expense for the periods and net payments on interest rate swaps of approximately $5.2 million and approximately $9.7 million and interest expense on linked transactions of approximately $105 thousand and approximately $195 thousand for the three and six months ended June 30, 2013, respectively. While interest rate swaps are not accounted for using hedge accounting, such instruments are viewed by us as an economic hedge against increases in interest rates and are treated as hedges for purposes of satisfying the REIT tax requirements. See "Non-GAAP Financial Measures". As of June 30, 2014, our repurchase agreements with 22 counterparties, require collateral in excess of the loan amount, or haircuts, ranging from a low of 3.0% to a high of 5.0% for Agency RMBS, exclusive of IOs and IIOs for which the haircuts are as high as 25.0% and for Non-Agency RMBS and Agency and Non-Agency CMBS and other securities for which the haircuts range from a low of 10.0% to a high of 45.0%. Declines in the value of our portfolio can trigger margin calls by our lenders under our repurchase agreements. Margin calls could adversely affect our liquidity. Our inability to post adequate collateral for a margin call by the counterparty could result in a condition of default under our repurchase agreements. An event of default or termination event would give some of our counterparties the option to terminate all existing repurchase transactions with us and require any amount due to the counterparties by us to be payable immediately. In which case, we may be forced to sell assets under adverse market conditions or through foreclosure which may have a material adverse consequence on our business, financial position, our results of operations and cash flows. During the three and six months ended June 30, 2014, we were able to satisfy margin calls using cash on hand, unlevered or underleveraged securities, and cash from our repurchase agreement borrowings. No event of default occurred. Under the repurchase agreements and derivative contracts, the respective lenders and counterparties, subject to the terms of the individual agreements and in the case of cleared swaps, the clearinghouse rules, retain the right to determine the fair value of the underlying collateral. A reduction in the value of pledged assets requires us to provide additional collateral or fund margin calls. In addition, certain of the repurchase agreements may be terminated by our counterparties if we do not maintain certain equity and leverage metrics. We are compliant with these tests at June 30, 2014. At June 30, 2014, MBS and other securities held by counterparties as security for repurchase agreements totaled approximately $4.7 billion, inclusive of MBS and other securities posted of $40.1 million for repurchase agreements accounted for as linked transactions. At December 31, 2013, MBS held by counterparties as security for repurchase agreements totaled approximately $2.9 billion, inclusive of MBS posted of $79.7 million for repurchase agreements accounted for as linked transactions. 75

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We are also required to pledge cash or securities as collateral as part of a margin arrangement, calculated daily, in connection with the swaps and swaptions. The amount of margin that we are required to post will vary and generally reflects collateral posted with respect to swaps that are in an unrealized loss position to us and a percentage of the aggregate notional amount of swaps per counterparty as well as margin posted with our clearing broker, pursuant to clearinghouse rules and practices, for cleared swaps. Conversely, if our bilateral swaps and swaptions are in an unrealized gain position, our counterparties are required to post collateral with us, under the same terms that we post collateral with them. Cash collateral held by counterparties at June 30, 2014 was approximately $135.3 million, which is included in Due from counterparties on our Balance Sheet, comprised of approximately $18.1 million held in connection with repurchase agreement borrowings, approximately $419 thousand held in connection with our futures contracts and approximately $116.8 million held by our interest rate swap counterparties. At June 30, 2014, Due to counterparties on our Balance Sheet was comprised of approximately $8.6 million posted with us by our repurchase agreement counterparties and approximately $10.9 million posted by our interest rate swap and swaption counterparties. Cash collateral held by counterparties at December 31, 2013 was approximately $55.4 million, which is included in Due from counterparties on our Balance Sheet, comprised of approximately $32.6 million held in connection with repurchase borrowings and approximately $22.8 million held by our interest rate swap counterparties. At December 31, 2013, Due to counterparties on our Balance Sheet was comprised of approximately $3.2 million posted with us by our repurchase agreement counterparties and approximately $62.7 million posted by our interest rate swap and swaption counterparties. We had approximately $5.1 million and $0, respectively of unsettled purchased securities as of June 30, 2014 and December 31, 2013, included in Investment related payables on our Balance Sheet. In addition, we had approximately $35.6 million and $0, respectively of unsettled sold securities as of June 30, 2014 and December 31, 2013, included in Investment related receivables on our Balance Sheet.



Cash Generated from Operations

For the six months ended June 30, 2014, operating activities increased our cash balance by approximately $59.2 million. This was primarily attributable to the net interest income we earned on our investments for the six months net of adjustments pertaining to the amortization/accretion of premiums and discounts, which are non-cash items. For the six months ended June 30, 2013, operating activities increased our cash balance by approximately $93.6 million. This was primarily attributable to the net interest income we earned on our investments net of adjustments pertaining to the amortization/accretion of premiums and discounts, which are non-cash items, and cash received on termination of interest rate swaps.



Cash Provided by and Used in Investing Activities

For the six months ended June 30, 2014, our investing activities decreased our cash balance by approximately $1.7 billion. This was primarily attributable to our cash expenditures to acquire MBS and other securities, partially offset by proceeds from sales of MBS and other securities. For the six months ended June 30, 2013, investing activities increased our cash balance by approximately $785.8 million. This was primarily attributable to our receipt of principal payments on MBS and to proceeds from sale of MBS, offset by capital expenditures to acquire MBS.



Cash Provided by and Used in Financing Activities

For the six months ended June 30, 2014, our financing activities increased our cash balance by approximately $1.5 billion. This was primarily attributable to an increase in our net borrowings under repurchase agreements and the proceeds of a stock offering. For the six months ended June 30, 2013, financing activities reduced our cash balance by approximately $926.9 million. This was primarily attributable to a decrease in our net borrowings under repurchase agreements. 76

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Other Potential Sources of Financing

We held cash of approximately $1.0 million and $48.5 million at June 30, 2014 and December 31, 2013, respectively. Our primary sources of cash currently consist of repurchase facility borrowings, investment income and the proceeds of any future securities offering, to the extent available in the capital market. In the future, we expect our primary sources of liquidity to consist of payments of principal and interest we receive on our portfolio of assets, unused borrowing capacity under our financing sources and future issuances of equity and debt securities. To maintain our qualification as a REIT under the Code, we must distribute annually at least 90% of our taxable income. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital for operations. We believe that our significant capital resources and access to financing will provide us with financial flexibility at levels sufficient to meet current and anticipated capital requirements, including funding new investment opportunities, paying distributions to our stockholders and servicing our debt obligations.



Contractual Obligations and Commitments

Our contractual obligations as of June 30, 2014 are as follows (dollars in thousands): Less than 1 1 to 3 3 to 5 More than year years years 5 years Total Borrowings under repurchase agreements (including linked transactions) $ 4,138,728 - - - $ 4,138,728 Investment related payables 56,977 56,977 TBA - long positions 2,519,573 - - - 2,519,573 Total: Non-GAAP Basis -Including Linked Transactions 6,715,278 - - - 6,715,278 Linked Transactions 27,480 - - - 27,480 TBA - long positions 2,519,573 - - - 2,519,573 Total: GAAP Basis -Excluding Linked Transactions and TBA-long positions $ 4,168,225 - - - $ 4,168,225 We enter into a linked transaction when the initial transfer of a financial asset and repurchase financing are entered into contemporaneously with, or in contemplation of, one another. In this situation, we then record the initial transfer and repurchase financing on a net basis. The fair value of linked transactions reflects the value of the underlying real estate securities and linked repurchase agreement borrowings; resulting in an embedded repurchase agreement. As of June 30, 2104, we had three linked transactions resulting in approximately $27.5 million of embedded repurchase agreements with a weighted average rate of 1.86%. The weighted average contractual maturity of the repurchase agreements for linked transactions was 58 days. As of June 30, 2014, we have an obligation for approximately $5.6 million in contractual interest payments related to our repurchase agreements, including linked transactions of approximately $99 thousand through the respective maturity date of each repurchase agreement. In addition, at June 30, 2014, we had entered into repurchase agreement borrowings of approximately $50.2 million, which settled on July 1, 2014, with a weighted average interest rate of 1.64%, a weighted average contractual maturity of 64 days and secured by collateral of approximately $72.4 million. The table above does not include amounts due under the Management Agreement (as defined herein) with our Manager, as those obligations do not have fixed and determinable payments. For a description of the Management Agreement, see "Our Manager and the Management Agreement-the Management Agreement." On May 9, 2012, we entered into a management agreement (the "Management Agreement") with our Manager which describes the services to be provided by our Manager and compensation for such services. Our Manager is responsible for managing our operations, including: (i) performing all of our day-to-day functions; (ii) determining investment criteria in conjunction with our board of directors; (iii) sourcing, analyzing and executing investments, asset sales and financings; (iv) performing asset management duties; and (v) performing financial and accounting management, subject to the direction and oversight of our board of directors. Pursuant to the terms of the Management Agreement, our Manager is paid a management fee equal to 1.50% per annum of our stockholders' equity, (as defined in the Management Agreement), calculated and payable (in cash) quarterly in arrears. For purposes of calculating the management fee, "stockholders' equity" means the sum of the net proceeds from any issuances of our equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus retained earnings, calculated in accordance with GAAP, at the end of the most recently completed fiscal quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less any amount paid for repurchases of our shares of common stock, excluding any unrealized gains, losses or other non-cash items, including OTTI charges included in other loss on MBS and other securities, unrealized gain (loss) on MBS and other securities and the non-cash portion of gain (loss) on derivative instruments, that have impacted stockholders' equity as reported in our financial statements prepared in accordance with GAAP, regardless of whether such items are included in other comprehensive income or loss, or in net income, and excluding one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between our Manager and our independent directors and after approval by a majority of our independent directors. However, if our stockholders' equity for any given quarter is negative based on the calculation described above, our Manager will not be entitled to receive any management fee for that quarter. 77

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In addition, under the Management Agreement, we are required to reimburse our Manager for the expenses described below. Expense reimbursements to the Manager are made in cash on a monthly basis following the end of each month. Our reimbursement obligation is not subject to any dollar limitation. Because our Manager's personnel perform certain legal, accounting, due diligence tasks and other services that outside professionals or outside consultants otherwise would perform, our Manager may be paid or reimbursed for the documented cost of performing such tasks, provided that such costs and reimbursements are in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm's-length basis. Commencing January 1, 2014, our chief financial officer is now an employee of the Manager. Accordingly, we will reimburse our Manager for his compensation and benefits as well as the compensation and benefits provided to our controller. For the three and six months ended June, 2014, we recorded expenses, paid by the Manager on our behalf, totaling approximately $199 thousand and $409 thousand, respectively, related to employee costs and benefits associated with our chief financial officer and controller, and approximately $45 thousand and $54 thousand for the three and six months ended June 30, 2013, respectively. The Management Agreement may be amended, supplemented or modified by agreement between our Manager and us. The initial term of the Management Agreement expires on May 15, 2015 and it is automatically renewed for one-year terms on each anniversary thereafter unless previously terminated as described below. Our independent directors will review the Manager's performance and any fees payable to the Manager annually and, following the initial term, the Management Agreement may be terminated annually upon the affirmative vote of at least two-thirds (2/3) of our independent directors, based upon: (i) our Manager's unsatisfactory performance that is materially detrimental to us; or (ii) our determination that any fees payable to our Manager are not fair, subject to our Manager's right to prevent such termination due to unfair fees by accepting a reduction of management fees agreed to by at least two-thirds (2/3) of our independent directors. We will provide our Manager 180 days prior notice of any such termination. Unless terminated for cause, we will pay the Manager a termination fee equal to three times the average annual management fee earned by the Manager during the prior 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination. We may also terminate the Management Agreement at any time, including during the initial term, without the payment of any termination fee, with 30 days prior written notice from our board of directors for cause, which will be determined by a majority of our independent directors, which is defined as: (i) our Manager's continued material breach of any provision of the Management Agreement (including our Manager's failure to comply with our investment guidelines); (ii) our Manager's fraud, misappropriation of funds, or embezzlement against us; (iii) the Manager's gross negligence in the performance of its duties under the Management Agreement; (iv) the occurrence of certain events with respect to the bankruptcy or insolvency of our Manager, including an order for relief in an involuntary bankruptcy case or our Manager authorizing or filing a voluntary bankruptcy petition; (v) our Manager is convicted (including a plea of nolo contendere) of a felony; or (vi) the dissolution of our Manager.



Off-Balance Sheet Arrangements

Our linked transactions are comprised of securities and associated repurchase agreements. The extent to which these transactions become unlinked in the future, the underlying securities and the borrowings under repurchase agreements and associated interest income and expense will be presented on a gross basis on our balance sheet and statement of operations, prospectively. As of June 30, 2014, our maximum exposure to loss on linked transactions was approximately $13.1 million. 78

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As of June 30, 2014, we held contracts to purchase ("long position") and sell ("short position") TBAs on a forward basis. If a counterparty to one of the TBAs that we enter into defaults on its obligations, we may not receive payments or securities due under the TBA agreement, and thus, we may lose any unrealized gain associated with that TBA transaction. We do not have any relationships with any entities or financial partnerships, such as entities often referred to as structured investment vehicles, or special purpose or variable interest entities, established to facilitate off-balance sheet arrangements or other contractually narrow or limited purposes.



Further, we have not guaranteed any obligations of any entities or entered into any commitment to provide additional funding to any such entities.

See "Warrants" above for a description of our outstanding warrants.

Dividends We intend to make regular quarterly dividend distributions to holders of our common stock. U.S. federal income tax law generally requires that a REIT distribute annually, in accordance with the REIT regulations, at least 90% of its REIT taxable income for the taxable year, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually, in accordance with the REIT regulations, distributes less than 100% of its net taxable income. We intend to pay regular quarterly dividends to our stockholders based on our net taxable income, if and to the extent authorized by our board of directors. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on our repurchase agreements and other debts payable. If our cash available for distribution is less than our net taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities. On June 19, 2014, we declared a regular quarterly dividend of $0.67 per common share for the quarter ended June 30, 2014. The dividend was paid on July 29, 2014 to shareholders of record as of June 30, 2014. Non-GAAP Financial Measures



Total Interest Income and Net Interest Income, including Interest Income on Agency and Non-Agency Interest-Only strips accounted for as derivatives and Effective Cost of Funds

Total interest income including interest income on Agency and Non-Agency Interest-Only Strips classified as derivatives and Effective Cost of Funds for the three and six months ended June 30, 2014 and 2013, constitutes a Non-GAAP financial measure within the meaning of Regulation G promulgated by the SEC. We believe that the measures presented in this quarterly report on Form 10-Q, when considered together with U.S. GAAP financial measures, provide information that is useful to investors in understanding our borrowing costs and net interest income, as viewed by us. An analysis of any Non-GAAP financial measure should be made in conjunction with results presented in accordance with GAAP. For purposes of evaluating operating results, we believe it useful to present investors with additional information pertaining to the net interest margin generated by our portfolio. Net interest margin is gross interest, adjusted for amortization/accretion of bond premium/discount, less interest expense or financing cost. GAAP requires that certain of our Agency and Non-Agency Interest Only Strips be treated as derivatives and, accordingly, the interest income associated with these securities be included with Gain (loss) on derivative instruments, net in our Statement of Operations. Similarly, GAAP requires that interest income on linked transactions be included in Gain (loss) on linked transactions, net in our Statement of Operations. Accordingly, in order to determine the gross interest income generated by our IO and IIO securities which are classified as derivatives and our MBS and other securities which are classified as linked transactions, we calculate the interest income on these securities as if they were not derivatives or linked transactions. 79 --------------------------------------------------------------------------------

Table of Contents The following table reconciles total interest income to interest income including interest income on Agency and Non-Agency Interest-Only Strips classified as derivatives and interest income on linked transactions (Non-GAAP financial measure) for the three and six months ended June 30, 2014 and 2013: For the three For the three For the six For the six months months ended June months ended June months ended ended June 30, (in thousands) 30, 2014 30, 2013 June 30, 2014 2013 Coupon Interest $ 58,652 $ 46,411 $ 93,230 $ 97,412 Premium amortization, discount accretion and amortization of basis, net (14,048 ) (13,669 ) (25,196 ) (30,920 ) Interest Income $ 44,604 $ 37,742 $ 68,034 $ 66,492 Contractual Interest income, net of amortization of basis on Agency and Non-Agency Interest-Only and Interest Strips, classified as derivatives(1): Coupon Interest $ 6,139 $ 7,031 $ 14,565 $ 12,976 Amortization of basis (Non-GAAP Financial Measure) (4,507 ) (4,631 ) (10,099 ) (8,816 ) Contractual Interest Income, net on Foreign currency swaps(1) 1 - 1 - Contractual Interest income, net of premium amortization, discount accretion and amortization of basis on Linked Transactions (2): Coupon Interest 760 134 3,860 240 Premium amortization, discount accretion and amortization of basis, net (509 ) 428 (2,681 ) 757 Subtotal 1,884 2,962 5,646 5,157 Total interest income, including interest income on Agency and Non-Agency Interest-Only Strips, classified as derivatives - Non-GAAP Financial Measure $ 46,488 $ 35,704 $ 73,680 $ 71,649



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(1) Reported in gain (loss) on derivative instruments in the Statement of Operations.

(2) Reported in gain (loss) on linked transactions in the Statement of Operations.

Effective Cost of Funds includes the net interest component related to our interest rate swaps and borrowings under linked transactions as well as the impact of our foreign currency swaps and forwards. While we have not elected hedge accounting for these instruments, such derivative instruments are viewed by us as an economic hedge against increases in future market interest rates on our liabilities and changes in foreign currency exchange rates on our assets and liabilities and are characterized as hedges for purposes of satisfying the REIT tax requirements and therefore the Effective Cost of Funds reflects interest expense adjusted to include the realized loss (i.e., the interest expense component) for all of our interest rate swaps and the impact of our foreign currency swaps and forwards. In addition, our linked transactions are comprised of real estate securities and other structured securities, associated with repurchase agreements. We view the cost of the associated repurchase agreements (interest expense) as a component of our Effective Cost of Funds. The following tables reconcile the Effective Cost of Funds (Non-GAAP financial measure) with interest expense for the three and six months ended June 30, 2014 and 2013: For the three months ended June 30, 2014 For the six months ended June 30, 2014 Cost of Cost of Funds/Effective Funds/Effective (dollars in thousands) Reconciliation Borrowing Costs Reconciliation Borrowing Costs Interest expense $ 5,971 0.58 % $ 9,361 0.56 % Interest expense on linked transactions 50 1.57 % 275 1.71 % Net interest paid - interest rate swaps 6,083 0.59 % 13,936 0.83 % Effective Borrowing Costs $ 12,104 1.17 % $ 23,572 1.40 % Weighted average repurchase borrowings (1) 4,134,551 3,393,434



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(1) Includes average repurchase borrowings under linked transactions. For the three months ended June 30, 2013 For the six months ended June 30, 2013 Cost of Cost of Funds/Effective Funds/Effective (dollars in thousands) Reconciliation Borrowing Costs Reconciliation Borrowing Costs Interest expense $ 4,522 0.45 % $ 9,703 0.45 % Interest expense on linked transactions 105 1.47 % 194 1.61 % Net interest paid - interest rate swaps 5,156 0.51 % 9,738 0.46 % Effective Borrowing Costs - Non-GAAP Financial Measure $ 9,783 0.96 % $ 19,635 0.91 % Weighted average repurchase borrowings(1) 4,068,470 4,333,054



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(1) Includes average repurchase borrowings under linked transactions. 80

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Table of Contents Core Earnings Our Core Earnings were approximately $30.0 million and $42.4 million for the three and six months ended June 30, 2014, respectively, and approximately $22.8 million and $45.4 million for the three and six months ended June 30, 2013, respectively. Core Earnings is a Non-GAAP financial measure that is used by us to approximate cash yield or income associated with our portfolio and is defined as GAAP net income (loss) as adjusted, excluding: (i) net realized gain (loss) on investments and derivative contracts; (ii) net unrealized gain (loss) on investments; (iii) net gain (loss) resulting from mark-to-market adjustments on derivative contracts; (iv) other loss on MBS and other securities; (v) non-cash stock-based compensation expense; and (vi) one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between the us, the Manager and our independent directors and after approval by a majority of the our independent directors. In order to evaluate the effective yield of the portfolio, we use Core Earnings to reflect the net investment income of our portfolio as adjusted to reflect the net interest rate swap interest income (expense). Core Earnings allows us to isolate the interest income (expense) associated with our interest rate swaps in order to monitor and project our borrowing costs and interest rate spread. In addition, we utilize Core Earnings as a key metric in conjunction with other portfolio and market factors to determine the appropriate leverage and hedge ratios, as well as the overall structure of the portfolio. We also believe that our investors use Core Earnings or a comparable supplemental performance measure to evaluate and compare our performance and our peers, and as such, we believe that the disclosure of Core Earnings is useful to our investors. Our presentation of Core Earnings may not be comparable to similarly-titled measures of other companies, who may use different calculations. As a result, Core Earnings should not be considered as a substitute for our GAAP net income as a measure of our financial performance or any measure of our liquidity under GAAP. 81

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The table below reconciles Net Income (Loss) to Core Earnings for the three and six months ended June 30, 2014 and 2013:

For the three For the six For the six months For the three months months ended June months ended ended June 30, (dollars in thousands) ended June 30, 2014 30, 2013 June 30, 2014 2013 Net Income (loss) - GAAP $ 67,574 $ (27,654 ) $ 59,133 $ (56,153 ) Adjustments: MBS and other securities: Unrealized (gain) loss on MBS and other securities (114,117 ) 156,286 (145,208 ) 211,045 Other loss on mortgage-backed and other securities 2,999 3,533 4,708 5,801 Realized loss on sale of MBS and other securities 11,278 6,083 7,562 17,743 Derivative Instruments: Realized gain on termination of interest rate swaps (15,996 ) (23,881 ) (15,998 ) (42,139 ) Realized (gain) loss on settlement of TBAs (20,191 ) 3,163 (22,561 ) 2,563 Realized loss on expiration of option derivatives - 925 - 925 Realized loss on termination of futures 16,495 - 16,495 - Realized (gain) loss on sale of swaptions 5,908 (1,038 ) 5,908 (1,038 ) Realized gain on sale/unlinking of securities underlying linked transactions - (3,748 ) (1,290 ) (3,748 ) Realized loss on Agency Interest-Only Strips - accounted for as derivatives 275 - 1,144 99 Mark-to-market adjustments on interest rate swaps 84,619 (71,202 ) 130,115 (73,060 ) Mark-to-market adjustments on interest rate swaptions (4,333 ) (20,751 ) 4,991 (19,245 ) Mark-to-market adjustments on options - (324 ) - - Mark-to-market adjustments on futures contracts 229 - 111 - Mark-to-market adjustments on TBAs (3,099 ) 4,511 (2,631 ) 3,287 Mark-to-market adjustments on linked transactions (487 ) 296 (713 ) 46 Mark-to-market adjustments on derivative instruments (1,803 ) (3,633 ) (583 ) (1,284 ) Mark-to-market adjustments on foreign currency swaps (15 ) - (15 ) - Mark-to-market adjustments on foreign currency forwards 138 - 138 - Non-cash stock-based compensation expense 479 251 1,067 537 Total adjustments (37,621 ) 50,471 (16,760 ) 101,532 Core Earnings - Non-GAAP Financial Measure $ 29,953 $ 22,817 $ 42,373 $ 45,379 Basic Core Earnings per Share of Common Stock and Participating Securities - Non-GAAP Financial Measure $ 0.75 $ 0.94 $ 1.26 $ 1.87 Diluted Core Earnings per Share of Common Stock and Participating Securities - Non-GAAP Financial Measure $ 0.75 $ 0.94 $ 1.26 $ 1.86 Basic weighted average common shares and participating securities 40,130,814 24,305,631 33,555,650 24,256,175 Diluted weighted average common shares and participating securities 40,130,814 24,374,608 33,555,650 24,357,358 Alternatively, our Core Earnings can also be derived as presented in the table below by starting with Net interest income including interest income on Interest-Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps (a Non-GAAP financial measure) subtracting Operating Expenses, net of Non-cash stock based compensation, and adding Interest income on cash balances and other income (loss), net: For the three For the three For the six For the six months ended months ended months ended months ended (dollars in thousands) June 30, 2014 June 30, 2013 June 30, 2014 June 30, 2013 Net interest income including interest income on Interest-Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and foreign currency swaps (a Non-GAAP financial measure) $ 34,384$ 25,921$ 50,108$ 52,014 Total Operating Expenses (4,934 ) (3,367 ) (8,814 ) (7,217 ) Non-cash stock based compensation 479 251 1,067 537 Interest income on cash balances and other income (loss), net 24 12 12 45 Core Earnings (a Non-GAAP) financial measure $ 29,953$ 22,817$ 42,373$ 45,379 82

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