News Column

JAVELIN MORTGAGE INVESTMENT CORP. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 4, 2014

The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this report.

References to "we," "us," "our," "JAVELIN" or the "Company" are to JAVELIN Mortgage Investment Corp. References to "ARRM" are to ARMOUR Residential Management LLC, a Delaware limited liability company. Refer to the Glossary of Terms for definitions of capitalized terms and abbreviations used in this report.

Dollar amounts are presented in thousands, except per share amounts or as otherwise noted.

Overview

We are a Maryland corporation formed to invest in and manage a leveraged portfolio of RMBS and mortgage loans. Some of these securities are issued or guaranteed by a U.S. GSE, such as Fannie Mae, Freddie Mac, or guaranteed by Ginnie Mae (collectively, Agency Securities), while other securities are backed by residential and/or commercial mortgages, for which the payment of principal and interest is not guaranteed by a GSE or government agency (collectively, Non-Agency Securities and, together with Agency Securities, MBS). We also may invest in collateralized CMBS and other mortgage related investments, including mortgage loans, mortgage related derivatives and mortgage servicing rights. From time to time, a portion of our assets may be invested in unsecured notes and bonds issued by GSEs, U.S. Treasuries and money market instruments, subject to certain income tests we must satisfy for our qualification as a REIT. Our charter permits us to invest in Agency Securities and Non-Agency Securities. At June 30, 2014, investments in Agency Securities accounted for 88.5% of our MBS portfolio and 80.9% of our total MBS portfolio inclusive of the Non-Agency Securities underlying our Linked Transactions. At June 30, 2014, investments in Non-Agency Securities accounted for 11.5% of our MBS portfolio and 19.1% of our total MBS portfolio inclusive of the Non-Agency Securities underlying our Linked Transactions (see Note 8 to the condensed consolidated financial statements). As of December 31, 2013, investments in Agency Securities accounted for 84.8% of our MBS portfolio and 73.8% of our total MBS portfolio inclusive of the Non-Agency Securities underlying our Linked Transactions. As of December 31, 2013, investments in Non-Agency Securities accounted for 15.2% of our MBS portfolio and 26.2% of our total MBS portfolio inclusive of the Non-Agency Securities underlying our Linked Transactions (see Note 8 to the condensed consolidated financial statements). We are externally managed by ARRM, pursuant to the Management Agreement, which was most recently amended on March 5, 2014. ARRM is an investment advisor registered with the SEC. ARRM is also the external manager of ARMOUR, a publicly traded REIT, which invests in and manages a leveraged portfolio of Agency Securities. Our executive officers also serve as the executive officers of ARMOUR. We seek attractive long-term investment returns by investing our equity capital and borrowed funds in our targeted asset classes. We earn returns on the spread between the yield on our assets and our costs, including the cost of the funds we borrow, after giving effect to our hedges. We identify and acquire our target assets, finance our acquisitions with borrowings under a series of short-term repurchase agreements at the most competitive interest rates available to us and then cost-effectively hedge our interest rate and other risks based on our entire portfolio of assets, liabilities and derivatives and our management's view of the market. Successful implementation of this approach requires us to address interest rate risk, maintain adequate liquidity and effectively hedge interest rate risks. We believe that the residential mortgage market will undergo significant changes in the coming years as the role of GSEs, such as Fannie Mae and Freddie Mac, is diminished, which we expect will create attractive investment opportunities for us. We execute our business plan in a manner consistent with our intention of qualifying as a REIT under the Code and avoiding regulation as an investment company under the 1940 Act. We have elected to be taxed as a REIT under the Code. We will generally not be subject to federal income tax to the extent that we distribute our taxable income to our stockholders and as long as we satisfy the ongoing REIT requirements under the Code, including meeting certain asset, income and stock ownership tests.



Factors that Affect our Results of Operations and Financial Condition

Our results of operations and financial condition are affected by various factors, many of which are beyond our control, including, among other things, our net interest spread, the market value of our target assets and the supply of and demand for such assets. We invest in financial assets and markets. Recent events, such as those discussed below, may affect our business in ways that are difficult to predict. Our net interest income varies primarily as a result of changes in interest rates, borrowing costs and prepayment speeds, the behavior of which involves various risks and uncertainties. We invest across the spectrum of mortgage investments, from Agency Securities, for which the principal and interest payments are guaranteed by a GSE, to Non-Agency Securities, non-prime mortgage loans and unrated equity tranches of CMBS. As such, we expect our investments to be subject to 29 -------------------------------------------------------------------------------- risks arising from delinquencies and foreclosures, thereby exposing our investment portfolio to potential losses. We are exposed to changing credit spreads, which could result in declines in the fair value of our investments. We believe ARRM's in-depth investment expertise across multiple sectors of the mortgage market, prudent asset selection and our hedging strategy enable us to minimize our credit losses, our market value losses and financing costs. Prepayment rates, as reflected by the rate of principal pay downs, and interest rates vary according to the type of investment, conditions in financial markets, government actions, competition and other factors, none of which can be predicted with any certainty. In general, as prepayment rates on our target assets purchased at a premium increase, related purchase premium amortization will increase, thereby reducing the net yield on such assets. Because changes in interest rates may significantly affect our activities, our operating results depend, in large part, upon our ability to manage interest rate risks and prepayment risks effectively while maintaining our status as a REIT. For any period during which changes in the interest rates earned on our target assets do not coincide with interest rate changes on our borrowings, such assets will tend to reprice more slowly than the corresponding liabilities. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net interest income. Interest rate increases tend to decrease our net interest income and the market value of our target assets and therefore, our book value. Such rate increases could possibly result in operating losses or adversely affect our ability to make distributions to our stockholders. Prepayments on our target assets are influenced by changes in market interest rates and a variety of economic and geographic factors, policy decisions by regulators, as well as other factors beyond our control. Consequently, prepayment rates cannot be predicted with certainty. To the extent we hold assets acquired at a premium or discount to par, or face value, changes in prepayment rates may impact our anticipated yield. In periods of declining interest rates, prepayments on our target assets increase. If we are unable to reinvest the proceeds of such prepayments at comparable yields, our net interest income may decline. The recent climate of government intervention in the housing finance markets significantly increases the risk associated with prepayments. While we use strategies to economically hedge some of our interest rate risk, we do not hedge all of our exposure to changes in interest rates and prepayment rates, as there are practical limitations on our ability to insulate our MBS portfolio from all potential negative consequences associated with changes in short-term interest rates in a manner that allows us to seek attractive net spreads on our MBS portfolio. Also, since we have not elected to use cash flow hedge accounting, earnings reported in accordance with GAAP will fluctuate even in situations where our derivatives are operating as intended. As a result of this mark-to-market accounting treatment, our results of operations are likely to fluctuate far more than if we were to designate our derivative activities as cash flow hedges. Comparisons with companies that use cash flow hedge accounting for all or part of their derivative activities may not be meaningful. For these and other reasons more fully described under the section captioned "Derivative Instruments" below, no assurance can be given that our derivatives will have the desired beneficial impact on our results of operations or financial condition. In addition to the use of derivatives to hedge interest rate risk, a variety of other factors relating to our business may also impact our financial condition and operating performance; these factors include,



our degree of leverage;

our access to funding and borrowing capacity;

the REIT requirements under the Code; and

the requirements to qualify for an exclusion under the 1940 Act and other regulatory and accounting policies related to our business.



Our Manager

We are externally managed by ARRM, pursuant to the Management Agreement. All of our executive officers are also employees of ARRM (see Note 15 to the condensed consolidated financial statements). ARRM manages our day-to-day operations, subject to the direction and oversight of the Board. The Management Agreement expires after an initial term of five years on October 5, 2017 and is thereafter automatically renewed for additional one-year terms unless terminated under certain circumstances. Either party must provide 180 days prior written notice of any such termination. ARRM is further entitled to receive a termination fee from us under certain circumstances. Pursuant to the Management Agreement, ARRM is entitled to receive a management fee payable monthly in arrears in an amount equal to 1/12th of (a) 1.5% of gross equity raised (including equity from our initial public offering and concurrent private placement) up to $1.0 billion, plus (b) 1.0% of gross equity raised in excess of $1.0 billion. The cost of repurchased stock and any dividend representing a return of capital for tax purposes will reduce the amount of gross equity raised used to calculate the monthly management fee. ARRM is entitled to receive a monthly management fee regardless of the performance of our MBS portfolio. Accordingly, the payment of our monthly management fee may not decline in the event of a decline in our earnings and 30 -------------------------------------------------------------------------------- may cause us to incur losses. For the quarter and six months ended June 30, 2014 we incurred $915 and $1,828, respectively, in management fees to ARRM. For the quarter and six months ended June 30, 2013, we incurred $790 and $1,352, respectively, in management fees. We are required to take actions as may be reasonably required to permit and enable ARRM to carry out its duties and obligations. We are responsible for any costs and expenses that ARRM incurs solely on our behalf other than various overhead expenses specified in the terms of the Management Agreement. For the quarter and six months ended June 30, 2014, we reimbursed ARRM $95 and $179, respectively, for other expenses incurred on our behalf. For the quarter and six months ended June 30, 2013, we reimbursed ARRM $27 and $37, respectively, for other expenses incurred on our behalf. Also, JAVELIN and ARRM entered into a Sub-Management Agreement with SBBC, an entity jointly owned by Daniel C. Staton and Marc H. Bell, each of whom is a member of our board of directors. Pursuant to the Sub-Management Agreement, ARRM is responsible for paying a sub-management fee to SBBC in an amount equal to a monthly retainer of $115 and a sub-management fee of 25% of the net management fee earned by ARRM under the Management Agreement. The Sub-Management Agreement continues in effect until it is terminated in accordance with its terms.



Market and Interest Rate Trends and the Effect on our MBS Portfolio

Developments at Fannie Mae and Freddie Mac

Payments of principal and interest on the Agency Securities in which we invest are guaranteed by Fannie Mae and Freddie Mac. Because of the guarantee and the underwriting standards associated with mortgages underlying Agency Securities, Agency Securities historically have had high stability in value and been considered to present low credit risk. In February 2011, the U.S. Treasury along with the U.S. Department of Housing and Urban Development released a report titled, "Reforming America's Housing Finance Market" to the U.S. Congress outlining recommendations for reforming the U.S. housing system, specifically Fannie Mae and Freddie Mac, and transforming the U.S. Government's involvement in the housing market. 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. Without U.S. Government support for residential mortgages, we may not be able to execute our current business model in an efficient manner. In March 2011, the U.S. Treasury announced that it would begin the orderly wind down of Agency Securities it had purchased from Fannie Mae, Freddie Mac and Ginnie Mae to stabilize the housing market, with sales up to $10.0 billion per month, subject to market conditions. We are unable to predict the timing or manner in which the U.S. Treasury or the Fed will liquidate their holdings or make further interventions in the Agency Securities markets, or what impact, if any, such action could have on the Agency Securities market, the Agency Securities we hold, our business, results of operations and financial condition. On June 25, 2013, a bipartisan group of U.S. senators introduced a draft bill titled, "Housing Finance Reform and Taxpayer Protection Act of 2013" to the U.S. Senate, which would wind down Fannie Mae and Freddie Mac over a period of five years and replace the public securitization market used by the GSEs with a public-private alternative market. On July 11, 2013, members of the U.S. House Committee on Financial Services introduced a similar draft bill titled, "Protecting American Taxpayers and Homeowners Act" to the U.S. House of Representatives. While distinguishable in some respects from the Senate version, the House bill would also eliminate Fannie Mae and Freddie Mac and seek to increase the opportunities for private capital to participate in, and consequently bear the risk of loss in connection with, government-guaranteed MBS. In March 2014, a bipartisan group of U.S. senators led by members of the U.S. Senate Banking Committee announced that they had agreed on a bill to overhaul the nation's housing finance system and eliminate Fannie Mae and Freddie Mac. The bill would replace Fannie Mae and Freddie Mac with a new federal regulator, called the Federal Mortgage Insurance Corporation, to provide guarantees for government mortgages and regulate the system. As the insurer of last resort, the Federal Mortgage Insurance Corporation would require 10% in private capital reserves. The guarantee, provided for a fee equivalent to 0.1% interest, would not kick in until the private reserves were exhausted. The bill would also set a minimum down payment of 5% for home buyers, except for first-time home buyers, who would instead be required to put down 3.5% for the mortgage to qualify for the guarantee. In May 2014, the U.S. Senate Banking Committee approved the bill. While it is unlikely the bill will be brought to the Senate floor this year, we are unable to predict the effect the passage of this bill could have on our business, results of operations and financial condition. The passage of any new legislation affecting Fannie Mae and Freddie Mac may create market uncertainty and reduce the actual or perceived credit quality of securities issued or guaranteed by the U.S. Government through a new or existing successor entity to Fannie Mae and Freddie Mac. If Fannie Mae and Freddie Mac were reformed or wound down, it is unclear what effect, 31 -------------------------------------------------------------------------------- if any, this would have on the value of the existing Fannie Mae and Freddie Mac Agency Securities. It is also possible that the above-referenced proposed legislation, if made law, could adversely impact the market for securities issued or guaranteed by the U.S. Government and the spreads at which they trade. The foregoing could materially adversely affect the pricing, supply, liquidity and value of the Agency Securities in which we invest and otherwise materially adversely affect our business, operations and financial condition. We cannot predict whether or when new actions may occur, the timing and pace of current actions already implemented, or what impact if any, such actions, or future actions, could have on our business, results of operations and financial condition.



U.S. Government Mortgage Related Securities Market Intervention

In September 2012, the Fed announced QE3 to purchase an additional $40.0 billion of Agency Securities per month until the unemployment rate and other economic indicators improved. QE3 plus its existing investment programs grew the Fed's U.S. Treasury Securities and Agency Securities holdings by approximately $85.0 billion per month at least through the end of 2013. At its January 29, 2014 and March 19, 2014 meetings, the Fed decided to trim its monthly Agency Securities purchases to $30.0 billion for February and March 2014, and $25.0 billion for April 2014, respectively, down from $40.0 billion in 2013. Longer term U.S. Treasury Securities purchases were trimmed at a pace of $35.0 billion for February and March 2014, and $30.0 billion for April 2014, respectively, down from $45.0 billion in 2013. At its most recent meeting on July 30, 2014, the Fed decided to further trim its monthly Agency Securities purchases to $10.0 billion for August 2014, down from $15.0 billion in July 2014 and $20.0 billion in May and June 2014. Longer term U.S. Treasury Securities monthly purchases were also trimmed again to $15.0 billion for August 2014, down from $20.0 billion in July 2014 and $25.0 billion in May and June 2014. These actions were to keep in place the Fed's highly accommodative stance of monetary policy. As part of that policy, the Fed announced at its July 30, 2014 meeting that it would keep the target range for the Federal Funds Rate between 0.0% and 0.25% toward its objectives of achieving maximum employment and curbing inflation to 2%. Reduced purchase levels by the Fed may result in lower overall demand and therefore lower prices for Agency Securities. Lower Agency Securities prices will reduce our book value and the amounts that we can borrow under repurchase agreements.



Financial Regulatory Reform Bill and Other Government Activity

We believe that we conduct our business in a manner that allows us to avoid being regulated as an investment company pursuant to the exclusion provided by Section 3(c)(5)(C) of the 1940 Act for entities that are primarily engaged in the business of purchasing or otherwise acquiring "mortgages and other liens on and interests in real estate." On August 31, 2011, the SEC issued a concept release (No. IC-29778; File No. SW7-34-11, Companies Engaged in the Business of Acquiring Mortgages and Mortgage Related Instruments) pursuant to which it is reviewing whether certain companies that invest in MBS and rely on the exclusion from registration under Section 3(c)(5)(C) of the 1940 Act (such as us) should continue to be allowed to rely on such exclusion from registration. If we fail to continue to qualify for this exclusion from registration as an investment company, or the SEC determines that companies that invest in MBS are no longer able to rely on this exclusion, our ability to use leverage would be substantially reduced and we would be unable to conduct our business as planned, or we may be required to register as an investment company under the 1940 Act, either of which could negatively affect the value of shares of our stock and our ability to make distributions to our stockholders. Certain programs initiated by the U.S. Government, through the FHFA and FDIC, to provide homeowners with assistance in avoiding residential mortgage loan foreclosures are currently in effect. The programs may involve, among other things, the modification of mortgage loans to reduce the principal amount of the loans or the rate of interest payable on the loans, or to extend the payment terms of the loans. While the effect of these programs has not been as extensive as originally expected, the effect of such programs for holders of Agency Securities could be that such holders would experience changes in the anticipated yields of their Agency Securities due to (i) increased prepayment rates and/or (ii) lower interest and principal payments. In March 2009, the HAMP was introduced to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. HAMP is designed to help at risk homeowners, both those who are in default and those who are at imminent risk of default, by providing the borrower with affordable and sustainable monthly payments. On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act is extensive, complicated and comprehensive legislation that impacts practically all aspects of banking, and a significant overhaul of many aspects of the regulation of the financial services industry. Although many provisions remain subject to further rulemaking, the Dodd-Frank Act implements numerous and far-reaching changes that affect financial companies, including our company, and other banks and institutions which are important to our business model. Certain notable rules are, among other things: 32 --------------------------------------------------------------------------------



requiring regulation and oversight of large, systemically important

financial institutions by establishing an interagency council on

systemic risk and implementation of heightened prudential standards and

regulation by the Board of Governors of the Fed for systemically important financial institutions (including nonbank financial companies), as well as the implementation of the FDIC resolution procedures for liquidation of large financial companies to avoid market disruption; applying the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies, savings and loan holding companies and systemically important nonbank financial companies; limiting the Fed's emergency authority to lend to nondepository institutions to facilities with broad-based eligibility, and



authorizing the FDIC to establish an emergency financial stabilization

fund for solvent depository institutions and their holding companies,

subject to the approval of Congress, the Secretary of the U.S. Treasury

and the Fed; creating regimes for regulation of over-the-counter derivatives and non-admitted property and casualty insurers and reinsurers;



implementing regulation of hedge fund and private equity advisers by

requiring such advisers to register with the SEC;

providing for the implementation of corporate governance provisions for

all public companies concerning proxy access and executive

compensation; and

reforming regulation of credit rating agencies.

Many of the provisions of the Dodd-Frank Act, including certain provisions described above are subject to further study, rulemaking, and the discretion of regulatory bodies. As the hundreds of regulations called for by the Dodd-Frank Act are promulgated, we will continue to evaluate the impact of any such regulations. It is unclear how this legislation may impact the borrowing environment, investing environment for Agency Securities and interest rate swap contracts as much of the bill's implementation has not yet been defined by the regulators. In addition, in 2010, the Group of Governors and Heads of Supervisors of the Basel Committee on Banking Supervision, the oversight body of the Basel Committee, published Basel III. Under these standards, when fully phased in on January 1, 2019, banking institutions will be required to maintain heightened Tier 1 common equity, Tier 1 capital and total capital ratios, as well as maintaining a "capital conservation buffer." Beginning with the Tier 1 common equity and Tier 1 capital ratio requirements, Basel III will be phased in incrementally between January 1, 2013 and January 1, 2019. The final package of Basel III reforms were approved by the Group of Twenty Finance Ministers and Central Bank Governors in November 2010 and are subject to individual adoption by member nations, including the U.S. In October 2011, the Federal Housing Finance Agency announced changes to HARP to expand access to refinancing for qualified individuals and families whose homes have lost value, including increasing the HARP loan to value ratio above 125%. However, this would only apply to mortgages guaranteed by the GSEs. There are many challenging issues to this proposal, notably the question as to whether a loan with a loan to value ratio of 125% qualifies as a mortgage or an unsecured consumer loan. The chances of this initiative's success have created additional uncertainty in the Agency Securities market, particularly with respect to possible increases in prepayment rates. On January 4, 2012, the Fed issued a white paper outlining additional ideas with regard to refinancings and loan modifications. It is likely that loan modifications would result in increased prepayments on some Agency Securities. These loan modification programs, as well as future legislative or regulatory actions, including amendments to the bankruptcy laws, that result in the modification of outstanding mortgage loans may adversely affect the value of, and the returns on, the Agency Securities in which we invest.



In an effort to continue to provide meaningful solutions to the housing crisis, effective June 1, 2012, the Obama administration expanded the population of homeowners that may be eligible for HAMP.

On September 28, 2012, the FSA released the Wheatley Review. Some of our derivative positions use various maturities of U.S. dollar LIBOR. Our borrowings in the repurchase market have also historically tracked these LIBOR rates. The Wheatley Review found, among other things, that potential conflicts of interests coupled with insufficient oversight and accountability resulted in some reported LIBOR rates that did not reflect the true cost of inter-bank borrowings they were meant to represent.



The Wheatley Review also proposes a number of remedial actions, including;

New statutory authority for the FSA to supervise and regulate the LIBOR

setting process; Establishing a new independent oversight body to administer the LIBOR setting process; 33

--------------------------------------------------------------------------------

Eliminating LIBOR rates for certain currencies and maturities where markets are not sufficiently deep and liquid; Ceasing immediate reporting of rates submitted by individual participating banks; and Establishing controls to ensure that submitted rates represent actual transactions. In April 2013, all the recommendations of the Wheatley Review came into force through the Financial Services Act of 2012. In this new regulatory framework, the FCA and the PRA have replaced the FSA, the Bank of England has overall responsibility for financial stability, and a new FPC was created to assist the Bank in achieving its financial stability objective. Additionally, in September 2013, the European Commission proposed draft legislation that will enhance the robustness and reliability of benchmarks like LIBOR, facilitate the prevention and detection of their manipulation and clarify responsibility for and the supervision of benchmarks.



Our derivative and repurchase borrowings are conducted in U.S. dollars for maturities with historically deep and liquid markets. To date, implementation of the Wheatley Review recommendations have not had a material impact on the reported levels of LIBOR rates relevant to our derivative or repurchase borrowings.

On July 2, 2013, the Fed, in coordination with the FDIC and the OCC, approved a final rule that enhances bank regulatory capital requirements and implements certain elements of the Basel III capital reforms in the U.S. On July 9, 2013, the OCC approved the final rule and the FDIC approved the final rule as an interim rule. The final rule includes a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that will apply to all supervised U.S. financial institutions. The final rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all U.S. banking organizations. The final rule will continue to apply existing risk-based capital standards with respect to residential loans, including a 50% risk weight for safely underwritten first-lien mortgages that are not past due. "Advanced approaches banking organizations," those with $250 billion or more in total consolidated assets or $10.0 billion or more in foreign exposures, were required to comply with the final rule starting on January 1, 2014. Other banking organizations will be required to comply with the final rule starting January 1, 2015. On July 9, 2013, the Fed, the FDIC, and the OCC proposed a rule to change the leverage ratio standards for the largest U.S. banking organizations. Under the proposed rule, bank-holding companies with more than $700 billion in consolidated total assets or $10 trillion in assets under custody would be required to maintain a Tier 1 capital leverage buffer of at least 5%, which is 2% above the minimum supplementary leverage ratio requirement of 3% adopted by these three agencies in their Basel III capital reform rules on July 2, 2013. In addition to the leverage buffer, the proposed rule would require insured depository institutions of such large bank-holding companies to meet a 6% supplementary leverage ratio to be considered "well capitalized." The proposed rule would apply starting January 1, 2018. Adoption of these rules may increase cost and reduce availability of repurchase funding provided by institutions subject to the rules.



Credit Market Disruption and Current Conditions

The residential housing and mortgage markets in the U.S. have experienced a variety of difficulties and changed economic conditions including loan defaults, credit losses and decreased liquidity. These conditions have resulted in volatility in the value of the MBS we purchase and an increase in the average collateral requirements under our repurchase agreements we have obtained. While these markets have recovered significantly, further increased volatility and deterioration in the broader residential mortgage and RMBS markets may adversely affect the performance and market value of the Agency Securities and other high quality RMBS.



Short-term Interest Rates and Funding Costs

In December 2008, the Fed stated that it was adopting a policy of "quantitative easing" and would target keeping the Federal Funds Rate between 0.00% and 0.25%. To date, the Fed has maintained that target range. Our funding costs, which traditionally have tracked the 30-day LIBOR have generally benefited by this easing of monetary policy, although to a somewhat lesser extent. Because of continued uncertainty in the credit markets and U.S. economic conditions, we expect that interest rates are likely to experience continued volatility, which will likely affect our financial results since our cost of funds is largely dependent on short-term rates. Historically, 30-day LIBOR has closely tracked movements in the Federal Funds Rate and the Effective Federal Funds Rate. The Effective Federal Funds Rate can differ from the Federal Funds Rate in that the Effective index represents the volume weighted average of interest rates at which depository institutions lend balances at the Fed to other depository institutions overnight (actual transactions, rather than target rate). 34 -------------------------------------------------------------------------------- Our borrowings in the repurchase market have also historically closely tracked the Federal Funds Rate and LIBOR. Traditionally, a lower Federal Funds rate has indicated a time of increased net interest margin and higher asset values. However, for the past several years, LIBOR and repurchase market rates have varied greatly, and often have been significantly higher than the target Federal Funds Rate. The difference between 30-day LIBOR and the Federal Funds rate has also been quite volatile, with the spread alternately returning to more normal levels and then widening out again. The continued volatility in these rates and divergence from the historical relationship among these rates could negatively impact our ability to manage our MBS portfolio. If this were to occur, our net interest margin and the value of our MBS portfolio might suffer as a result.



The following graph shows 30-day LIBOR as compared to the Effective Federal Funds Rate on a monthly basis from December 2012 to June 2014.

[[Image Removed]] Results of Operations Net Income (Loss) Summary Our primary source of income is the interest income we earn on our MBS portfolio. Our net income (loss) for the quarter and six months ended June 30, 2014 was $(8,776) and $(10,639), respectively. Our net income (loss) for the quarter and six months ended June 30, 2013 was $38,237 and $49,213, respectively. The main factors for the difference between the quarter and six months ended 2013 to the corresponding period in 2014, were the changes in value from our derivatives and increased management fees, which were partially offset by gains on the sale of Agency Securities (which gains represent partial recovery of write-downs recorded in the fourth quarter of 2013). At June 30, 2014 and December 31, 2013, our Agency Securities were carried at a net premium to par value with a weighted average amortized cost of 104.22% and 100.01%, respectively, because the average interest rates on these securities are higher than prevailing market rates. At June 30, 2014 and December 31, 2013, our Non-Agency Securities were carried at a net discount to par value with a weighted average amortized cost of 86.65% and 86.71%, respectively, because the average interest rates on these securities are lower than prevailing market rates. 35 -------------------------------------------------------------------------------- The following table presents the components of the yield earned on our MBS portfolio and Linked Transactions for the quarterly periods presented. See Note 8 to the condensed consolidated financial statements for additional discussion of Linked Transactions. Interest Net Expense on Cost of Interest Repurchase MBS Asset Yield Funds Margin Agreements Agency Securities: June 30, 2014 2.85 % 1.33 % 1.52 % 0.36 % March 31, 2014 3.36 % 1.56 % 1.80 % 0.39 % December 31, 2013 3.02 % 1.39 % 1.63 % 0.42 % September 30, 2013 2.79 % 1.11 % 1.68 % 0.41 % June 30, 2013 2.76 % 0.99 % 1.77 % 0.42 % Non-Agency Securities (including Linked Transactions): June 30, 2014 4.37 % 2.43 % 1.94 % 1.69 % March 31, 2014 4.79 % 2.10 % 2.69 % 1.56 % December 31, 2013 4.48 % 2.38 % 2.10 % 1.61 % September 30, 2013 4.40 % 2.07 % 2.33 % 1.59 % June 30, 2013 4.50 % 2.39 % 2.11 % 2.06 % Total portfolio: June 30, 2014 3.20 % 1.50 % 1.70 % 0.58 % March 31, 2014 3.71 % 1.67 % 2.04 % 0.62 % December 31, 2013 3.33 % 1.55 % 1.78 % 0.62 % September 30, 2013 3.04 % 1.21 % 1.83 % 0.54 % June 30, 2013 2.95 % 1.09 % 1.86 % 0.53 % 36

-------------------------------------------------------------------------------- The yield on our assets is most significantly affected by the rate of repayments on our Agency Securities. The following graph shows the annualized CPR for the quarterly periods presented. [[Image Removed]] During the quarter and six months ended June 30, 2014 , we realized losses of $(3,097) and $(6,203), respectively, related to our derivatives. During the quarter and six months ended June 30, 2013, we realized losses of $(1,989) and $(2,939), respectively, related to our derivatives. Our total interest rate swap contracts aggregate notional balance remained $801,250 at June 30, 2014 and December 31, 2013. At June 30, 2014 and December 31, 2013, our interest rate swap contracts had a weighted average swap rate of 1.67% and 1.70%, respectively, and a weighted average term of 97 months and 103 months, respectively. Our total interest rate swaptions aggregate notional balance remained $750,000 at June 30, 2014 and December 31, 2013. Our swaptions had an underlying weighted average swap rate of 2.73% and 2.70%, respectively, and a weighted average term of 3 months and 9 months, respectively, at June 30, 2014 and December 31, 2013. Unrealized losses on derivatives totaled $(15,703) and $(35,732), respectively, for the quarter and six months ended June 30, 2014. Unrealized gains on derivatives totaled $43,181 and $46,626 for the quarter and six months ended June 30, 2013. The losses during the quarter and six months ended June 30, 2014 were primarily the result of the decline in the reference interest rates. Net Interest Income Our net interest income for the quarter and six months ended June 30, 2014 was $8,672 and $17,888, respectively. Our net interest income for the quarter and six months ended June 30, 2013 was $9,244 and $16,521, respectively. Net interest income reflects any increase to the portfolio during the quarter. At June 30, 2014, our MBS portfolio consisted of $1,196,872 current face amount of Agency Securities and $155,783 current face amount of Non-Agency Securities compared to $801,777 current face amount of Agency Securities and $143,399 current face amount of Non-Agency Securities as of December 31, 2013. 37 --------------------------------------------------------------------------------



Gains and Losses on Sale of MBS

During the six months ended June 30, 2014, we sold $743,647 of Agency Securities, to reposition our portfolio, which resulted in realized gains of $8.8 million. We did not have any sales of Agency Securities for the quarter ended June 30, 2014, however we realized a loss of $(34) due to a settlement adjustment on the Agency Securities sales in the first quarter. During the quarter and six months ended June 30, 2013, we did not sell any Agency Securities.



Gains and Losses on U.S. Treasury Securities

During the quarter and six months ended June 30, 2014, we did not purchase or sell any U.S. Treasury Securities. During the quarter and six months ended June 30, 2013, we sold short $301,903 of U.S. Treasury Securities and purchased $70,126, resulting in a realized loss of $(390). The outstanding balance resulted in an unrealized loss of $(2,716).



Other Than Temporary Impairment of Agency Securities

We evaluated our Agency Securities with unrealized losses at June 30, 2014, June 30, 2013 and December 31, 2013, to determine whether there was an other than temporary impairment. The decline in value of our Agency Securities in 2013 was solely due to market conditions and not the credit quality of the assets. All of our Agency Securities are issued and guaranteed by GSEs. The GSEs have a long term credit rating of AA+. As of those dates, we also considered whether we intended to sell Agency Securities and whether it was more likely than not that we could meet our liquidity requirements and contractual obligations without selling Agency Securities. There was no other than temporary impairment for the quarter and six months ended June 30, 2014 and June 30, 2013. In December 31, 2013, anticipating portfolio repositioning sales in the first quarter of 2014, we concluded that the December 31, 2013 unrealized losses on our 25-year and 30-year fixed rate Agency Securities represented an other than temporary impairment. Accordingly, at December 31, 2013, we recognized losses totaling $(44,300) in our 2013 statements of operations, thereby establishing a new cost basis for Agency Securities with aggregate fair value of $744,600 as of December 31, 2013. We also determined that at December 31, 2013, there was no other than temporary impairment of our other Agency Securities, which are primarily 20-year and 15-year fixed rate securities.



Expenses

Our total expenses for the quarter and six months ended June 30, 2014, were $1,852 and $3,949, respectively. Our total expenses for the quarter and six months ended June 30, 2013 were $1,170 and $2,173, respectively. Our total management fee expense for the quarter and six months ended June 30, 2014 was $915 and $1,828, respectively, compared to $790 and $1,352 for the quarter and six months ended June 30, 2013. Management fees are determined based on gross equity raised. Therefore, our management fee increases when we raise capital and declines when we repurchase previously issued stock. Professional fees were $422 and $1,164, respectively, for the quarter and six months ended June 30, 2014, compared to $138 and $333 for the quarter and six months ended June 30, 2013. The increase in professional fees represents legal and advisory expenses associated with potential new financing and investment opportunities and shareholder value activities.



Taxable Income

We have elected to be taxed as a REIT under the Code. We will generally not be subject to federal income tax to the extent that we distribute our taxable income to our stockholders and as long as we satisfy the ongoing REIT requirements under the Code including meeting certain asset, income and stock ownership tests. 38

-------------------------------------------------------------------------------- The following table reconciles our GAAP net income (loss) to estimated REIT taxable income for the quarter and six months ended June 30, 2014 and June 30, 2013. For the Quarter Ended For the Six Months Ended June 30, 2014 June 30, 2013 June 30, 2014 June 30, 2013 GAAP net income (loss) $ (8,776 )$ 38,237$ (10,639 )$ 49,213 Book to tax differences: Net book to tax differences on Non-Agency Securities and Linked Transactions (2,003 ) 8,359 (5,699 ) 6,634 Unrealized loss on U.S. Treasury Securities sold short - 2,716 - 2,716 Realized capital loss on short sale of U.S. Treasury Securities - 390 - 390 (Gain) loss on sale of Agency Securities 34 - (8,776 ) - Amortization of deferred hedging gains 146 - 291 - Net premium amortization differences (181 ) - (809 ) - Changes in interest rate contracts 15,703 (43,181 ) 35,732 (46,626 ) Other (6 ) - (5 ) 2



Estimated taxable income $ 4,917$ 6,521 $

10,095 $ 12,329

The aggregate tax basis of our assets and liabilities was less than our total Stockholders' Equity at June 30, 2014 by approximately $(33,730), or approximately $(2.81) per share (based on the 11,999 shares then outstanding).

We are required and intend to timely distribute substantially all of our taxable REIT income in order to maintain our REIT status under the Code. Total dividend payments to stockholders were $5,398 and $10,795 for the quarter and six months ended June 30, 2014. Our estimated taxable REIT income available to pay dividends was $4,917 and $10,095 for the quarter and six months ended June 30, 2014. Our taxable REIT income and dividend requirements to maintain our REIT status are determined on an annual basis. Dividends in excess of taxable REIT income for the year (including amounts carried forward from prior years) will generally not be taxable to common stockholders.



Net capital losses realized in 2013 and 2014 will be available to offset future capital gains realized through 2018 and 2019, respectively.

Our management is responsible for determining whether tax positions taken by us are more likely than not to be sustained on their merits. We have no material unrecognized tax benefits or material uncertain tax positions.



Comprehensive Income (Loss)

Comprehensive Income (Loss) includes all changes in equity during a period, except those resulting from investments by owners and distributions to owners. During the quarter and six months ended June 30, 2014, other comprehensive income totaled $14,331 and $10,819, respectively. During the quarter and six months ended June 30, 2013, other comprehensive loss totaled $(77,461) and $(93,301), respectively. Comprehensive income (loss) reflects net unrealized gains or losses on available for sale Agency Securities net of amounts reclassified upon sale. The 2013 other comprehensive loss resulted from significant price declines in our Agency Securities. The gains in 2014 resulted primarily from the reclassification adjustment for the unrealized gains on the sale of Agency Securities. Financial Condition Agency Securities We typically purchase Agency Securities at premium prices. The premium price paid over par value on those assets is expensed as the underlying mortgages experience repayment or prepayment. The lower the constant prepayment rate, the lower the amount of amortization expense for a particular period. Accordingly, the yield on an asset and earnings are higher. If prepayment rates increase, the amount of amortization expense for a particular period will go up. These increased prepayment rates would act to decrease the yield on an asset and would decrease earnings. 39 --------------------------------------------------------------------------------



The tables below summarize certain characteristics of our Agency Securities at June 30, 2014 and December 31, 2013.

June 30, 2014 Weighted Average Weighted Month to % of Total Average Reset or Agency Asset Type Principal Amount Fair Value Coupon CPR (1) Maturity Securities

Multi-Family MBS $ 53,277 $ 55,845 3.50 % 0.00 % 117 4.70 % 15 Year Fixed 1,042,003 1,093,257 3.21 % 4.98 % 170 91.30 % 20 Year Fixed 45,795 47,770 3.45 % 10.75 % 207 4.00 % Total or Weighted Average $ 1,141,075$ 1,196,872 3.23 % 5.04 % 169 100.00 % (1) Weighted average for all prepayments during the quarter ended June 30, 2014 including prepayments related to Agency Securities purchased or sold during the quarter. December 31, 2013 Weighted Average Weighted Month to % of Total Average Reset or Agency Asset Type Principal Amount Fair Value Coupon CPR (1) Maturity Securities 15 Year Fixed $ 27,676 $ 28,279 3.00 % 7.48 % 159 3.44 % 20 Year Fixed 29,177 28,888 3.08 % 0.76 % 224 3.63 % 25 Year Fixed 53,877 52,944 3.37 % 9.62 % 277 6.69 % 30 Year Fixed 694,135 691,666 3.53 % 3.58 % 349 86.24 % Total or Weighted Average $ 804,865 $ 801,777 3.48 % 4.01 % 333 100.00 %



(1) Weighted average for all prepayments during the quarter ended December 31, 2013, including prepayments related to Agency Securities purchased or sold during the quarter.

Our net interest income is primarily a function of the difference between the yield on our assets and the financing cost of owning those assets. Since we tend to purchase Agency Securities at a premium to par, the main item that can affect the yield on our Agency Securities after they are purchased is the rate at which the mortgage borrowers repay the loan. While the scheduled repayments, which are the principal portion of the homeowners' regular monthly payments, are fairly predictable, the unscheduled repayments, which are generally refinancing of the mortgage but can also result from repurchases of delinquent, defaulted, or modified loans, are less so. Being able to accurately estimate and manage these repayment rates is a critical portion of the management of our MBS portfolio, not only for estimating current yield but also for considering the rate of reinvestment of those proceeds into new securities, the yields which those new securities may add to our MBS portfolio and our hedging strategy.



Non-Agency Securities and Linked Transactions

We purchase Non-Agency Securities at prices which incorporate our expectations for prepayment speeds, defaults, delinquencies and severities. These expectations determine the yields we receive on our assets. If actual prepayment speeds, defaults, delinquencies and severities are different from our expectations, our actual yields could be higher or lower.



The tables below summarize certain characteristics of our Non-Agency Securities (including those underlying Linked Transactions) at June 30, 2014 and December 31, 2013.

40 --------------------------------------------------------------------------------

June 30, 2014 Weighted Average % of Total Weighted Month to Agency Asset Type Principal Amount Market Value

Average Coupon Maturity Securities Prime Fixed $ 174,994 $ 164,607 3.73 % 329 55.34 % Prime Hybrid 19,840 16,202 3.02 % 270 6.27 % Prime Floater 3,250 3,840 5.12 % 343 1.03 % Alt-A Fixed 107,660 88,589 5.90 % 278 34.05 % Alt-A Hybrid 10,473 8,795 2.48 % 259 3.31 %



Total or Weighted Average $ 316,217 $ 282,033 4.35 %

308 100.00 % At June 30, 2014, our overall investment in Non-Agency Securities (including those underlying Linked Transactions) represents 19.1% of our total investment in MBS. During the quarter ended June 30, 2014, we completed the purchase of Non-Agency Securities with a fair value of $16,735 that were previously treated as Linked Transactions with repayment at maturity of related repurchase agreement borrowings of $10,770. December 31, 2013 Weighted Average % of Total Weighted Month to Agency Asset Type Principal Amount Market Value Average Coupon Maturity Securities Prime Fixed $ 179,566 $ 164,471 3.77 % 335 54.80 % Prime Hybrid 21,253 17,066 3.36 % 276 6.50 % Prime Floater 2,000 2,117 5.41 % 348 0.61 % Alt-A Fixed 113,744 91,572 5.90 % 283 34.71 % Alt-A Hybrid 11,090 9,118 2.59 % 265 3.38 % Total/Weighted Average $ 327,653 $ 284,344 4.41 % 313 100.00 %



As of December 31, 2013, our overall investment in Non-Agency Securities (including those underlying Linked Transactions) represents 26.2% of our total investment in MBS.

Liabilities We have entered into repurchase agreements to finance most of our MBS. Our repurchase agreements are secured by our MBS and bear interest at rates that have historically moved in close relationship to the Federal Funds Rate and LIBOR. We have established borrowing relationships with several investment banking firms and other lenders, 23 of which we had done repurchase trades with at June 30, 2014 and 20 of which we had done repurchase trades with as of December 31, 2013. We had outstanding balances under our repurchase agreements of $1,233,195 at June 30, 2014. Our outstanding repurchase agreements balance at December 31, 2013 was $839,405. The increase in our repurchase agreement borrowings is consistent with the increase in our MBS in our securities portfolio. 41 --------------------------------------------------------------------------------



Derivative Instruments

We generally hedge our interest rate risk as we deem prudent in light of market conditions and the associated costs with counterparties that have a high quality credit rating and with futures exchanges. We generally pay a fixed rate and receive a floating rate with the objective of fixing a portion of our borrowing costs and hedging the change in our book value to some degree. The floating rate we receive is generally the Federal Funds Rate or LIBOR. While our policies do not contain specific requirements as to the percentages or amount of interest rate risk that we are required to hedge, we maintain an overall target of hedging at least 40% of our non-adjustable rate mortgages. At June 30, 2014, the notional value of our derivatives was 104.89% of the fair market value of our non-adjustable rate mortgages (including those underlying Linked Transaction). For interest rate risk mitigation purposes, we consider Agency Securities to be ARMs if their interest rate is either currently subject to adjustment according to prevailing rates or if they are within 18 months of the period where such adjustments will occur. No assurance can be given that our derivatives will have the desired beneficial impact on our results of operations or financial condition. We have not elected cash flow hedge accounting treatment as allowed by GAAP. Since we do not designate our derivative activities as cash flow hedges, realized as well as unrealized gains/losses from these transactions will impact our earnings.



Use of derivative instruments may fail to protect or could adversely affect us because, among other things:

available derivatives may not correspond directly with the interest

rate risk for which protection is sought (e.g., the difference in

interest rate movements for long term U.S. Treasury Securities compared

to Agency Securities); the duration of the derivatives may not match the duration of the related liability; the counterparty to a derivative agreement with us may default on its obligation to pay or not perform under the terms of the agreement and the collateral posted may not be sufficient to protect against any consequent loss;



we may lose collateral we have pledged to secure our obligations under

a derivative agreement if the associated counterparty becomes insolvent

or files for bankruptcy; we may experience a termination event under one or more of our derivative agreements related to our REIT status, equity levels and performance, which could result in a payout to the associated counterparty and a taxable loss to us; the credit-quality of the party owing money on the derivatives may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and the value of derivatives may be adjusted from time to time in accordance with GAAP to reflect changes in fair value; downward



adjustments, or "mark-to-market losses," would reduce our net income or

increase any net loss.

At June 30, 2014 and December 31, 2013, we had interest rate swap contracts with an aggregate notional balance of $801,250. At June 30, 2014 and December 31, 2013, we had interest rate swaptions with an aggregate notional balance of $750,000. These derivative transactions are designed to lock in some funding costs for financing activities associated with our assets in such a way as to help assure the realization of attractive net interest margins and to vary inversely in value with our Agency Securities. Such contracts are based on assumptions about prepayments which, if not realized, will cause results to differ from expectations. Although we attempt to structure our derivatives to offset the changes in asset prices, they are not perfectly correlated and depend on the corresponding durations and sections of the yield curve that moves to offset each other. For the quarter and six months ended June 30, 2014, we recognized a net loss of $(18,800) and $(41,935), respectively, related to our derivatives. For the quarter and six months ended June 30, 2013, we recognized a net gain of $41,192 and $43,687, respectively, related to our derivatives. The net unrealized gain on Agency Securities for the quarter and six months ended June 30, 2014 was $14,297 and $19,595, respectively. The net unrealized (loss) on Agency Securities for the quarter and six months ended June 30, 2013 was $(77,461) and $(93,301), respectively. As required by the Dodd-Frank Act, the Commodity Futures Trading Commission has adopted rules requiring certain interest rate swap contracts to be cleared through a derivatives clearing organization. We are required to clear certain new interest rate swap contracts. Cleared interest rate swaps may have higher margin requirements than un-cleared interest rate swaps we previously had. We have established an account with a futures commission merchant for this purpose. To date, we have not entered into any cleared interest rate swap contracts.



Liquidity and Capital Resources

At June 30, 2014, we financed our MBS portfolio with $1,233,195 of borrowings under repurchase agreements, plus an additional $111,739 of repurchase agreements underlying linked transactions. Our leverage ratio was 7.67 to 1 at June 30, 2014 (or 8.37 to 1 on an unlinked basis). At June 30, 2014, our liquidity totaled $46,402, consisting of $22,397 of cash plus $24,005 of unpledged securities (including securities received as collateral). Our primary sources of funds are borrowings under repurchase arrangements, monthly principal and interest payments on our investments and cash generated from our operating results. Other 42 -------------------------------------------------------------------------------- sources of funds may include proceeds from equity and debt offerings and asset sales. We generally maintain liquidity to pay down borrowings under repurchase arrangements to reduce borrowing costs and otherwise efficiently manage our long-term investment capital. Because the level of our borrowings can be adjusted on a daily basis, the level of cash carried on our balance sheet is significantly less important than our potential liquidity available under our borrowing arrangements. We currently believe that we have sufficient liquidity and capital resources available for the acquisition of additional investments, repayments on repurchase borrowings, reacquisition of securities to be returned to borrowers and the payment of cash dividends as required for continued qualification as a REIT. In addition to the repurchase agreement financing discussed above, from time to time we have entered into reverse repurchase agreements with certain of our repurchase agreement counterparties. Under a typical reverse repurchase agreement, we purchase U.S. Treasury Securities from a borrower in exchange for cash and agree to sell the same securities back in the future. We then sell such U.S. Treasury Securities to third parties and recognize a liability to return the securities to the original borrower. Reverse repurchase agreement receivables and repurchase agreement liabilities are presented net when they meet certain criteria, including being with the same counterparty, being governed by the same MRA, settlement through the same brokerage or clearing account and maturing on the same day. The practical effect of these transactions is to replace a portion of our repurchase agreement financing of our MBS portfolio with short positions in U.S. Treasury Securities. We believe that this helps to reduce interest rate risk, and therefore counterparty credit and liquidity risk. Both parties to the repurchase and reverse repurchase transactions have the right to make daily margin calls based on changes in the value of the collateral obtained and/or pledged. Our primary uses of cash are to purchase MBS, pay interest and principal on our borrowings, fund our operations and pay dividends. During the six months ended June 30, 2014, we purchased $1,179,446 of MBS using proceeds from our repurchase agreements, principal repayments and certain Linked Transactions. During the six months ended June 30, 2014, we received cash of $50,707 from prepayments and scheduled principal payments on our MBS. Our total repurchase indebtedness was approximately $1,233,195 at June 30, 2014, and we made cash interest payments of approximately $8,969 on our liabilities for the six months ended June 30, 2014. Part of funding our operations includes providing margin cash to offset liability balances on our derivatives. The amount of cash collateral posted to counterparties decreased by $186 and we decreased our liability by $29,548 for cash collateral posted by counterparties to us at June 30, 2014. In response to the growth of our MBS portfolio and to the relatively weak financing market, we have continued to pursue additional lending counterparties in order to help increase our financial flexibility and ability to withstand periods of contracting liquidity in the credit markets.



Repurchase and Related Facilities

At June 30, 2014, we had MRAs with 29 counterparties and had $1,233,195 in outstanding borrowings with 23 of those counterparties. As of December 31, 2013, we had MRAs with 27 counterparties and had $839,405 in outstanding borrowings with 20 of those counterparties. The following tables represent the contractual repricing and other information regarding our repurchase agreements and Linked Transactions at June 30, 2014 and December 31, 2013 (see Note 8 to the condensed consolidated financial statements for additional discussion of Linked Transactions and Note 9 to the condensed consolidated financial statements for additional discussion of repurchase agreements). Weighted Weighted Average Average Haircut for Repurchase Contractual Maturity Repurchase June 30, 2014 Agreements Rate in days Agreements (1) Agency Securities $ 1,126,421 0.34 % 39 4.79 % Non-Agency Securities and Linked Transactions (2) 218,513 1.51 % 154 18.48 % Total $ 1,344,934 0.53 % 58 7.35 %



(1) The Haircut represents the weighted average margin requirement, or the percentage amount by which the collateral value must exceed the loan amount. (2) Includes $111,739 of repurchase agreements on Linked Transactions.

43 --------------------------------------------------------------------------------

Weighted Weighted Average Haircut for Repurchase Average Maturity Repurchase December 31, 2013 Agreements Contractual Rate in days Agreements (1) Agency Securities $ 731,782 0.42 % 33 4.90 % Non-Agency Securities and Linked Transactions (2) 232,163 1.55 % 57 19.92 % Total $ 963,945 0.69 % 39 8.51 %



(1) The Haircut represents the weighted average margin requirement, or the percentage amount by which the collateral value must exceed the loan amount. (2) Includes $124,540 of repurchase agreements on Linked Transactions.

June 30, 2014 December 31, 2013 Weighted Weighted Repurchase Average Repurchase Average Maturing or Repricing Agreements Contractual Rate Agreements Contractual Rate Within 30 days $ 662,430 0.48 % $ 388,921 0.67 % 31 days to 60 days 324,892 0.46 % 453,028 0.49 % 61 days to 90 days 229,181 0.61 % 111,751 1.00 % Greater than 90 days 128,431 0.87 % 10,245 2.10 % Total $ 1,344,934 0.53 % $ 963,945 0.62 %



The tables above include $111,739 of repurchase agreements on Linked Transactions at June 30, 2014, and $124,540 of repurchase agreements on Linked Transactions at December 31, 2013.

We have 10 repurchase agreement counterparties that individually account for between 5% and 10% of our aggregate borrowings. In total, these counterparties account for approximately 68.50% of our repurchase agreement borrowings outstanding at June 30, 2014. In April 2014, we entered in to a long term collateral exchange agreement whereby we will receive approximately $50.0 million of U.S. Treasury Securities or cash for two years (declining to $30.0 million for a third year) in exchange for certain of our Non-Agency Securities. At June 30, 2014, the $155,783 of Non-Agency Securities on our condensed consolidated balance sheet includes $47,721 fair value of securities pledged under this agreement. At June 30, 2014, collateral received under this agreement consisted of $22,483 of cash, which is treated as repurchase agreement borrowings on our condensed consolidated balance sheet and $12,153 of U.S. Treasury Securities, which are not reflected on our condensed consolidated balance sheet. Declines in the value of our MBS portfolio can trigger margin calls by our lenders under our repurchase agreements. An event of default or termination event under the standard MRA would give our counterparty the option to terminate all repurchase transactions existing with us and require any amount due to be payable immediately.



The residential mortgage market in the U.S. continues to experience difficult economic conditions including:

increased volatility of many financial assets, including Agency Securities and other high-quality RMBS assets;



increased volatility and deterioration in the broader residential

mortgage and RMBS markets; and

statements and actions by the Fed and other regulators impacting

financing of RMBS. While conditions have improved, should there be a reoccurrence of difficulties in the residential mortgage market, our lenders may be forced to exit the repurchase market, become insolvent or further tighten lending standards, or increase the amount of required equity capital or haircut, any of which could make it more difficult or costly for us to obtain financing.



Financial sector volatility can also lead to increased demand and prices for high quality debt securities, including Agency Securities. While increased prices may increase the value of our MBS, higher values may also reduce the return on reinvestment of capital, thereby lowering our future profitability.

44 -------------------------------------------------------------------------------- The following graph represents the month-end outstanding balances of our repurchase agreements (before the effect of netting reverse repurchase agreements and Linked Transactions), which finance most of our MBS. The balance of repurchase agreements outstanding will fluctuate within any given month based on changes in the market value of the particular MBS pledged as collateral (including the effects of principal pay downs) and the level and timing of investment and reinvestment activity. [[Image Removed]]



Effects of Margin Requirements, Leverage and Credit Spreads

Our MBS have values that fluctuate according to market conditions and, as discussed above, the market value of our MBS will decrease as prevailing interest rates or credit spreads increase. When the value of the securities pledged to secure a repurchase loan decreases to the point where the positive difference between the collateral value and the loan amount is less than the haircut, our lenders may issue a margin call, which means that the lender will require us to pay the margin call in cash or pledge additional collateral to meet that margin call. Under our repurchase facilities, our lenders have full discretion to determine the value of the MBS we pledge to them. Most of our lenders will value securities based on recent trades in the market. Lenders also issue margin calls as the published current principal balance factors change on the pool of mortgages underlying the securities pledged as collateral when scheduled and unscheduled principal repayments are announced monthly. We experience margin calls in the ordinary course of our business and under certain conditions, such as during a period of declining market value for MBS and we may experience margin calls monthly or as frequently as daily. In seeking to effectively manage the margin requirements established by our lenders, we maintain a position of cash and unpledged securities. We refer to this position as our liquidity. The level of liquidity we have available to meet margin calls is directly affected by our leverage levels, our haircuts and the price changes on our securities. If interest rates increase as a result of a yield curve shift or for another reason or if credit spreads widen, the prices of our collateral (and our unpledged assets that constitute our liquidity) will decline and we may experience margin calls. We will use our liquidity to meet such margin calls. There can be no assurance that we will maintain sufficient levels of liquidity to meet any margin calls. If our haircuts increase, our liquidity will proportionately decrease. If we increase our borrowings, our liquidity will decrease by the amount of additional haircut on the increased level of indebtedness. In addition, certain of our MRAs contain a restriction that prohibits our leverage from exceeding twelve times our stockholders' equity as well as termination events in the case of significant reductions in equity capital. We intend to maintain a level of liquidity in relation to our assets that enables us to meet reasonably anticipated margin calls but that also allows us to be substantially invested in MBS. We may misjudge the appropriate amount of our liquidity by maintaining excessive liquidity, which would lower our investment returns, or by maintaining insufficient liquidity, which would force us to involuntarily liquidate assets into unfavorable market conditions and harm our results of operations and financial condition. 45 -------------------------------------------------------------------------------- We generally seek to borrow (on a recourse basis) between six and ten times the amount of our total stockholders' equity to finance the Agency Securities in which we invest and between one and three times the amount of our stockholders' equity to finance the Non-Agency Securities in which we invest, but we are not limited to those ranges. At June 30, 2014 and December 31, 2013, our total borrowings were approximately $1,233,195 and $839,405 (excluding accrued interest), respectively. At June 30, 2014 and December 31, 2013, we had a leverage ratio of approximately 7.67:1 and 4.90:1, respectively.



Forward-Looking Statements Regarding Liquidity

Based on our current portfolio, leverage rate and available borrowing arrangements, we believe that our cash flow from operations and our ability to make timely portfolio adjustments, will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity requirements such as to fund our investment activities, meet our financing obligations, pay fees under the Management Agreement, fund our distributions to stockholders and pay general corporate expenses. We may increase our capital resources by obtaining long-term credit facilities or making public or private offerings of equity or debt securities, including classes of preferred stock, common stock and senior or subordinated notes to meet our long-term (greater than one year) liquidity. Such financing will depend on market conditions for capital raises and for the investment of any proceeds and there can be no assurances that we will successfully obtain any such financing. Stockholders' Equity Dividends The following table presents our common stock dividend transactions for the six months ended June 30, 2014. Aggregate Rate per amount paid to Record Date Payment Date common share holders of record January 15, 2014 January 30, 2014 $ 0.15 $ 1,799 February 14, 2014 February 27, 2014 $ 0.15 $ 1,799 March 17, 2014 March 28, 2014 $ 0.15 $ 1,799 April 15, 2014 April 29, 2014 $ 0.15 $ 1,799 May 15, 2014 May 29, 2014 $ 0.15 $ 1,799 June 16, 2014 June 27, 2014 $ 0.15 $ 1,800 Total dividends paid $ 10,795



Off-Balance Sheet Arrangements

At June 30, 2014 and December 31, 2013, we had not maintained any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, or special purpose or variable interest entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Furthermore, at June 30, 2014 and December 31, 2013, we had not guaranteed any obligations of any unconsolidated entities or entered into any commitment or intent to provide funding to any such entities.



Critical Accounting Policies

Our condensed consolidated financial statements are prepared in conformity with GAAP. In preparing the financial statements, management is required to make various judgments, estimates and assumptions that affect the reported amounts. Changes in these estimates and assumptions could have a material effect on our financial statements. The following is a summary of our policies most affected by management's judgments, estimates and assumptions.



Revenue Recognition

Agency Securities. Interest income is accrued based on the unpaid principal amount of the target assets we purchase and their contractual terms. Premiums and discounts associated with the purchase of Agency Securities are amortized or accreted into interest income over the actual lives of the securities. 46 -------------------------------------------------------------------------------- Non-Agency Securities. Non-Agency Securities are carried at their estimated fair value and changes in those fair values are recognized in earnings in the periods in which they occur. The portion of those changes in fair value recognized as interest income are determined on an effective yield method based on estimates of future cash flows revised quarterly. Other than temporary impairments, which establish a new cost basis in the security for purposes of calculating effective yields, are recognized when the fair value of a security is less than its cost basis and there has been an adverse change in the future cash flows expected to be received. Other changes in future cash flows expected to be received are recognized prospectively over the remaining life of the security.



Fair Value of MBS

We invest in MBS representing interests in or obligations backed by pools of adjustable rate, hybrid adjustable rate and fixed rate mortgage loans. The authoritative literature requires us to classify our investments as either trading, available for sale or held to maturity securities. Management determines the appropriate classifications of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet date. We classify all of our Agency Securities as available for sale securities. All assets that are classified as available for sale securities are carried at fair value with unrealized gains and losses excluded from earnings and reported in net unrealized loss on available for sale securities in the statement of comprehensive income (loss). We classify all of our Non-Agency Securities as trading assets. All assets that are classified as available for trading will be carried at fair value and unrealized gains and losses are included in other income (loss) as a component of the statements of operations. The fair values for the securities in our MBS portfolio are based on obtaining a valuation for each MBS from third party pricing services, dealer quotes and our estimates as described below. The third party pricing services use common market pricing methods that may include pricing models that may incorporate such factors as coupons, prepayment speeds, spread to the Treasury curves and interest rate swap curves, duration, periodic and life caps and credit enhancement, as applicable. The dealer quotes and our estimates incorporate common market pricing methods, including a spread measurement to the Treasury curve or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, collateral type, rate reset period and seasoning or age of the security, as applicable. Below is a description of the processes we use to value our MBS portfolio. Agency Securities: We obtain pricing data from a third party pricing service for each Agency Security and validate such data by obtaining pricing data from a second third party pricing service. If the difference between pricing data obtained for an Agency Security from the two third party pricing services exceeds a certain threshold, or pricing data is unavailable from the third party pricing services, we obtain valuations from dealers who make markets in similar financial instruments. Non-Agency Securities: The fair value for the Non-Agency Securities in our MBS portfolio is based on estimates prepared by our Portfolio Management group, which organizationally reports to our Chief Investment Officer. In preparing the estimates, the Portfolio Management group uses commercially available and proprietary models and data as well as market intelligence gained from discussions with and transactions by other market participants. We also periodically compare our estimates of fair value with those of our financing counterparties. We estimate the fair value of our Non-Agency Securities by estimating the future cash flows for each Non-Agency Security and then discounting those cash flows based on our estimates of current market yield for each individual security. Our estimates for future cash flows and current market yields incorporate such factors as collateral type, bond structure and priority of payments, coupons, prepayment speeds, defaults, delinquencies and severities. We review all pricing of our MBS used to ensure that current market conditions are properly reflected. This review includes, but is not limited to, comparisons of similar market transactions or alternative third party pricing services, dealer quotes and comparisons to a pricing model. We classify values obtained from the third party pricing service for similar instruments as Level 2 securities if the pricing methods used are consistent with the Level 2 definition. If quoted prices for a security are not reasonably available from the pricing service, but dealer quotes are, we classify the security as a Level 2 security. If neither is available, we determine the fair value based on characteristics of the security that we receive from the issuer and based on available market information received from dealers and classify it as a Level 3 security. Security purchase and sale transactions, including purchase of when issued securities, are recorded on the trade date. Gains or losses realized from the sale of securities are included in income and are determined using the specific identification method. Impairment of Assets: We evaluate MBS for other than temporary impairment at least on a quarterly basis and more frequently when economic or market concerns warrant such evaluation. We consider an impairment to be other than temporary if we (1) have the intent to sell the Agency Securities, (2) believe it is more likely than not that we will be required to sell the securities before recovery (for example, because of liquidity requirements or contractual obligations) or (3) a credit loss exists. In the case 47 --------------------------------------------------------------------------------



of Non-Agency Securities, we also consider whether there have been adverse changes in the estimates of future cash flows. Impairment losses recognized establish a new cost basis for the related Agency Securities.

Linked Transactions: The initial purchase of Non-Agency Securities and the related contemporaneous repurchase financing of such MBS with the same counterparty are considered part of the same arrangement, or a "Linked Transaction," when certain criteria are met. The components of a Linked Transaction are evaluated on a combined basis and in totality, accounted for as a forward contract and reported as Linked Transactions on our balance sheets. Changes in the fair value of the assets and liabilities underlying Linked Transactions and associated interest income and expense are reported as "unrealized net gains/(losses) and net interest income from Linked Transactions" on our statements of operations and are not included in other comprehensive income (loss). When certain criteria are met, the initial transfer (i.e., the purchase of a security) and repurchase financing will no longer be treated as a Linked Transaction and will be evaluated and reported separately, as a MBS purchase and repurchase financing. Repurchase Agreements: We finance the acquisition of our MBS through the use of repurchase agreements. Our repurchase agreements are secured by our MBS and bear interest rates that have historically moved in close relationship to the Federal Funds Rate and the LIBOR. Under these repurchase agreements, we sell MBS to a lender and agree to repurchase the same MBS in the future for a price that is higher than the original sales price. The difference between the sales price that we receive and the repurchase price that we pay represents interest paid to the lender. A repurchase agreement operates as a financing arrangement under which we pledge our MBS as collateral to secure a loan which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. We retain beneficial ownership of the pledged collateral. At the maturity of a repurchase agreement, we are required to repay the loan and concurrently receive back our pledged collateral from the lender or, with the consent of the lender, we may renew such agreement at the then prevailing interest rate. The repurchase agreements may require us to pledge additional assets to the lender in the event the estimated fair value of the existing pledged collateral declines. In addition to the repurchase agreement financing discussed above, from time to time we have entered into reverse repurchase agreements with certain of our repurchase agreement counterparties. Under a typical reverse repurchase agreement, we purchase U.S. Treasury Securities from a borrower in exchange for cash and agree to sell the same securities in the future in exchange for a price that is higher than the original purchase price. The difference between the purchase price originally paid and the sale price represents interest received from the borrower. Reverse repurchase agreement receivables and repurchase agreement liabilities are presented net when they meet certain criteria, including being with the same counterparty, being governed by the same MRA, settlement through the same brokerage or clearing account and maturing on the same day. We did not have any reverse repurchase agreements outstanding at June 30, 2014 or December 31, 2013. Obligations to Return Securities Received as Collateral at Fair Value: At certain times, we also sell to third parties the U.S. Treasury Securities received as collateral for reverse repurchase agreements and recognize the resulting obligation to return said U.S. Treasury Securities as a liability on our balance sheet. Interest is recorded on the repurchase agreements, reverse repurchase agreements and U.S. Treasury Securities on an accrual basis and presented as net interest expense. Both parties to the transaction have the right to make daily margin calls based on changes in the fair value of the collateral received and/or pledged. We did not have any obligations to return securities received as collateral at June 30, 2014 or December 31, 2013. Derivative Instruments: We account for derivative instruments in accordance with GAAP, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for derivative activities. The guidance requires that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value and that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. We do not designate our derivative activities as cash flow hedges for GAAP purposes, which, among other factors, would require us to match the pricing dates of both derivative transactions and repurchase agreements. Operational issues and credit market volatility make such matching impractical for us. Since we have not elected cash flow hedge accounting treatment, our operating results may suffer because losses on the derivative instruments may not be offset by a changes in the fair value or cash flows of the related hedged transaction. Consequently, any declines in the hedged interest rates would result in a charge to earnings. We will continue to designate derivative transactions as hedges for tax purposes and any unrealized gains or losses should not affect our distributable net taxable income. 48 --------------------------------------------------------------------------------



Inflation

Virtually all of our assets and liabilities are interest rate-sensitive in nature. As a result, interest rates and other factors influence our performance far more than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our condensed consolidated financial statements are prepared in accordance with GAAP and any distributions we may make will be determined by our Board based in part on our taxable REIT income as calculated according to the requirements of the Code. In each case, our activities and balance sheet are measured with reference to fair value without considering inflation.



Subsequent Events

See Note 17 to the condensed consolidated financial statements.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS This report contains various "forward-looking statements." Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by the use of forward-looking terminology such as "believes," "expects," "may," "will," "would," "could," "should," "seeks," "approximately," "intends," "plans," "projects," "estimates" or "anticipates" or the negative of these words and phrases or similar words or phrases. All forward-looking statements may be impacted by a number of risks and uncertainties, including statements regarding the following subjects:



our business and investment strategy;

our anticipated results of operations;

statements about future dividends;

our ability to obtain financing arrangements;

our understanding of our competition and ability to compete effectively;

market, industry and economic trends; and

interest rates. The forward-looking statements in this report are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. You should carefully consider these risks before you make an investment decision with respect to our stock, along with the following factors that could cause actual results to vary from our forward-looking statements:



our limited operating history;

ARRM's limited experience in acquiring or financing Non-Agency Securities;

mortgage loan modification programs and future legislative action;

actions by the Fed which could cause a flattening of the yield curve, which could materially adversely affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders;



the impact of the continued delay or failure of the U.S. Government in

reaching an agreement on the national debt ceiling;

availability, terms and deployment of capital;

changes in economic conditions generally;

changes in interest rates, interest rate spreads, the yield curve or prepayment rates;



general volatility of the financial markets, including markets for MBS;

the downgrade of the U.S. Government's or certain European countries'

credit ratings and future downgrades of the U.S. Government's or

certain European countries' credit ratings may materially adversely

affect our business, financial condition and results of operations;

inflation or deflation;



the impact of the federal conservatorship of Fannie Mae and Freddie Mac

and related efforts, along with any changes in laws and regulations

affecting the relationship between Fannie Mae and Freddie Mac and the U.S. Government and the Fed System; the possible material adverse effect on our business if the U.S. Congress passed legislation reforming or winding down Fannie Mae or Freddie Mac;



availability of suitable investment opportunities;

the degree and nature of the competition for investments in our target assets;

49 --------------------------------------------------------------------------------



changes in our business and investment strategy;

our failure to maintain an exemption from being regulated as a commodity pool operator;



our dependence on ARRM and ability to find a suitable replacement if

ARRM were to terminate its management relationship with us; the existence of conflicts of interest in our relationship with ARRM, ARMOUR, certain of our directors and our officers, which could result



in decisions that are not in the best interest of our stockholders;

our management's competing duties to other affiliated entities, which could result in decisions that are not in the best interests of our stockholders.



changes in personnel at ARRM or the availability of qualified personnel

at ARRM;

limitations imposed on our business by our status as a REIT under the Code;

the potential burdens on our business of maintaining our exclusion from

the 1940 Act and possible consequences of losing that exemption;

changes in GAAP, including interpretations thereof; and

changes in applicable laws and regulations.

We cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on forward-looking statements, which apply only as of the date of this report. We do not intend and disclaim any duty or obligation to update or revise any industry information or forward-looking statements set forth in this report to reflect new information, future events or otherwise, except as required under the U.S. Federal securities laws. 50

-------------------------------------------------------------------------------- GLOSSARY OF TERMS "Agency Securities" means securities issued or guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae; interests in or obligations backed by pools of adjustable rate, hybrid adjustable rate and fixed rate mortgage loans.



"ARMs" means Adjustable Rate Mortgage backed securities

"Basel III" means "calibrated" capital standards for major banking institutions

"Board" means JAVELIN's Board of Directors

"CMBS" means commercial mortgage backed securities

"Code" means the Internal Revenue Code

"CPR" means constant prepayment rate

"Fannie Mae" means the Federal National Mortgage Association

"FCA" means the Financial Conduct Authority

"FDIC" means the Federal Deposit Insurance Corporation

"Fed" means the U.S. Federal Reserve

"FHFA" means the Federal Housing Finance Agency

"FPC" means the Financial Policy Committee

"Freddie Mac" means the Federal Home Loan Mortgage Corporation

"FSA" means the United Kingdom Financial Services Authority

"GAAP" means accounting principles generally accepted in the United States of America

"Ginnie Mae" means the Government National Mortgage Administration

"GSE" means U.S. Government Sponsored Entity. Obligations of agencies originally established or chartered by the U.S. government to serve public purposes as specified by the U.S. Congress; these obligations are not explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the U.S. government.



"HAMP" means the Home Affordable Modification Program

"HARP" means the Home Affordable Refinance Program

"ARMOUR" means ARMOUR Residential REIT, Inc.

"LIBOR" means the London Interbank Offered Rate

"Management Agreement" means the management agreement between JMI and ARRM whereby ARRM performs certain services for JMI in exchange for a specified fee

"MBS" means mortgage backed securities, a security representing a direct interest in a pool of mortgage loans. The pass-through issuer or servicer collects the payments on the loans in the pool and "passes through" the principal and interest to the security holders on a pro rata basis.

"MRA" means master repurchase agreement. A document that outlines standard terms between the Company and counterparties for repurchase agreement transactions.

51 --------------------------------------------------------------------------------



"Non-Agency Securities" means securities backed by residential mortgages in which we invest, for which the payment of principal and interest is not guaranteed by a GSE or government agency

"OCC" means the Office of the Comptroller of the Currency

"PRA" means the Prudential Regulation Authority

"QE3" means the Fed's third quantitative easing program

"REIT" means Real Estate Investment Trust. A special purpose investment vehicle that provides investors with the ability to participate directly in the ownership or financing of real-estate related assets by pooling their capital to purchase and manage mortgage loans and/or income property.



"Repurchase Program" means the Company's common stock repurchase program

"RMBS" means residential mortgage backed securities

"SEC" means the Securities and Exchange Commission

"SBBC" means Staton Bell Blank Check Company

"Sub-Management Agreement" means a Sub-Management Agreement between JAVELIN, ARRM and SBBC. ARRM is responsible for the payment of a monthly sub-management fee.



"1940 Act" means the Investment Company Act of 1940

"U.S." means United States

"Wheatley Review" means the results of FSA's review of the process for setting LIBOR interest rate for various currencies and maturities

52



--------------------------------------------------------------------------------


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters