hts-10q_20160331.htm

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Check one:

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

(Dollars in thousands, except share related amounts)
	(Unaudited)
	March 31, 2016			December 31, 2015
Assets
Mortgage-backed securities, at fair value
(including pledged assets of $11,540,366 and $13,932,415)	$	12,045,571		$	14,302,230
Agency CRT securities, at fair value		111,021			109,387
Mortgage loans held for investment, at fair value
(including pledged assets of $47,176 and $50,143)		152,197			116,857
Mortgage loans held for investment in securitization trusts, at fair value		209,418			226,908
Mortgage loans held for sale, at fair value
(including pledged assets of $25,919 and $17,542)		25,919			17,542
Mortgage servicing rights, at fair value		316,176			269,926
Cash and cash equivalents (including pledged cash of $469,690 and $376,081)		705,920			816,715
Unsettled purchased mortgage-backed securities, at fair value		5,536			12,582
Receivable for securities sold		274,127			-
Accrued interest receivable		38,826			45,008
Principal payments receivable		91,476			108,201
Other investments		51,464			51,930
Derivative assets, at fair value		20,207			2,914
Other assets		46,647			57,326
Total assets ⁽¹⁾	$	14,094,505		$	16,137,526

Liabilities and shareholders’ equity
Borrowings:
Repurchase agreements	$	11,419,354		$	13,443,883
Warehouse lines of credit		63,615			60,096
Federal Home Loan Bank advances		-			14,132
Collateralized borrowings in securitization trusts, at fair value		60,550			57,611
Total borrowings		11,543,519			13,575,722
Payable for unsettled securities		5,483			12,582
Accrued interest payable		3,052			4,938
Derivative liabilities, at fair value		419,282			325,233
Dividends payable		47,166			47,824
Other liabilities		30,632			27,870
Total liabilities ⁽¹⁾		12,049,134			13,994,169

Shareholders’ equity:
7.625% Series A Cumulative Redeemable Preferred stock, $.001 par value, 25,000,000 shares authorized, 11,500,000 shares issued and outstanding ($287,500 aggregate liquidation preference)		278,252			278,252
Common stock, $.001 par value, 200,000,000 shares authorized, 94,529,206 and 95,773,767 shares issued and outstanding		95			96
Additional paid-in capital		2,424,741			2,438,223
Accumulated deficit		(791,055	)		(671,872	)
Accumulated other comprehensive income		133,338			98,658
Total shareholders’ equity		2,045,371			2,143,357
Total liabilities and shareholders’ equity	$	14,094,505		$	16,137,526

(Dollars in thousands, except share related amounts)

	Three Months Ended March 31
	2016			2015
Interest income:
Securities	$	67,705		$	86,362
Mortgage loans		1,149			467
Mortgage loans in securitization trusts		1,819			-
Short-term cash investments		464			288
Total interest income		71,137			87,117

Interest expense:
Repurchase agreements		22,088			27,314
Warehouse lines		252			-
Collateralized borrowings in securitization trusts		406			-
Total interest expense		22,746			27,314

Net interest margin		48,391			59,803

Other income (loss):
Servicing income		18,882			-
Management fee income		1,400			-
Net realized gain on sale of securities		4,287			16,453
Net gain on mortgage loans		2,607			244
Net loss on mortgage servicing rights		(38,111	)		-
Net loss on derivative instruments		(92,494	)		(102,785	)
Net miscellaneous gains and losses		1,315			-
Total other loss		(102,114	)		(86,088	)

Expenses:
Management fee		3,982			4,095
Share-based compensation		1,293			1,045
Servicing expenses		2,665			-
General and administrative		9,430			3,110
Securitization deal costs		72			-
Total expenses		17,442			8,250

Net loss		(71,165	)		(34,535	)
Dividends on preferred stock		5,480			5,481
Net loss available to common shareholders	$	(76,645	)	$	(40,016	)

Loss per share - common stock, basic	$	(0.81	)	$	(0.41	)
Loss per share - common stock, diluted	$	(0.81	)	$	(0.41	)

Dividends per share of common stock	$	0.45		$	0.50

Weighted average common shares outstanding, basic		94,850,791			96,783,199
Weighted average common shares outstanding, diluted		94,850,791			96,783,199

(Dollars in thousands)

	Three Months Ended March 31
	2016			2015

Net loss	$	(71,165	)	$	(34,535	)

Other comprehensive income (loss):

Net unrealized gains on securities
available for sale		31,887			74,546
Net unrealized gains on derivative instruments		2,793			14,167
Other comprehensive income		34,680			88,713

Comprehensive income (loss)		(36,485	)		54,178

Dividends on preferred stock		5,480			5,481

Comprehensive income (loss) available to
common shareholders	$	(41,965	)	$	48,697


See accompanying notes.

(Dollars in thousands)
	7.625% Series A Cumulative Redeemable Preferred Stock		Common Stock			Additional Paid-in Capital			Accumulated Deficit			Accumulated Other Comprehensive Income		Total

Balance at December 31, 2015	$	278,252	$	96		$	2,438,223		$	(671,872	)	$	98,658	$	2,143,357
Repurchase of common stock		-		(1	)		(14,775	)		-			-		(14,776	)
Share-based compensation expense		-		-			1,293			-			-		1,293
Dividends declared on preferred stock		-		-			-			(5,480	)		-		(5,480	)
Dividends declared on common stock		-		-			-			(42,538	)		-		(42,538	)
Net loss		-		-			-			(71,165	)		-		(71,165	)
Other comprehensive income		-		-			-			-			34,680		34,680
Balance at March 31, 2016	$	278,252	$	95		$	2,424,741		$	(791,055	)	$	133,338	$	2,045,371

(Dollars in thousands)
	Three Months Ended March 31
Operating activities	2016			2015
Net loss	$	(71,165	)	$	(34,535	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Net amortization of premium related to mortgage-backed securities		18,943			27,116
Reclassification of deferred swap net loss		1,376			13,438
Share-based compensation expense		1,293			1,045
Net realized gain on sale of securities		(4,287	)		(16,453	)
Net unrealized loss on MSR		38,111			-
Net unrealized gain on mortgage loans		(2,007	)		(244	)
Purchase of mortgage loans held for sale		(112,617	)		-
Sale of mortgage loans held for sale		104,962			-
Net loss on derivative instruments		92,494			102,785
Other		(1,895	)		29
Changes in operating assets and liabilities:
Decrease in accrued interest receivable		6,182			2,654
(Increase) decrease in other assets		11,241			(669	)
Decrease in accrued interest payable		(1,886	)		(3,956	)
Increase in other liabilities		3,843			8,976
Net cash provided by operating activities		84,588			100,186

Investing activities
Purchases of securities		(217,728	)		(783,566	)
Principal repayments on securities		693,381			877,143
Sales of securities		1,540,791			628,123
Purchases of mortgage loans held for investment		(40,855	)		(95,769	)
Principal repayments on mortgage loans held for investment		24,870			4,172
Purchases of mortgage servicing rights		(84,361	)		-
Net payments on derivative instruments		(15,402	)		(25,050	)
Net cash provided by investing activities		1,900,696			605,053

Financing activities
Repurchase of common stock		(14,776	)		-
Cash dividends paid		(48,676	)		(53,868	)
Proceeds from borrowings		37,257,993			42,920,560
Principal repayments on borrowings		(39,293,135	)		(43,571,853	)
Proceeds from collateralized trust borrowing		6,240			-
Repayments on collateralized trust borrowing		(3,725	)		-
Net cash used in financing activities		(2,096,079	)		(705,161	)

Net increase (decrease) in cash and cash equivalents		(110,795	)		78
Cash and cash equivalents, beginning of period		816,715			627,595
Cash and cash equivalents, end of period	$	705,920		$	627,673

Supplemental disclosure of cash flow information
Cash paid for interest	$	28,667		$	39,226

Supplemental schedule of non-cash investing and financing activities
Obligation to brokers for unsettled purchases of securities	$	5,483		$	103,995
Receivable for securities sold	$	274,127		$	13,423
Dividends accrued on preferred stock, not yet paid	$	4,628		$	4,628
Dividends accrued on common stock, not yet paid	$	42,538		$	48,396

Hatteras Financial Corp. (the “Company”) was incorporated in Maryland on September 19, 2007. The Company invests in single-family residential mortgage assets, such as mortgage-backed securities (“MBS”), and other financial assets. To date, the Company has primarily invested in MBS issued or guaranteed by a U.S. Government agency, such as Ginnie Mae, or by a U.S. Government-sponsored entity, such as Fannie Mae and Freddie Mac (“agency securities”).

The Company is externally managed and advised by its manager, Atlantic Capital Advisors LLC (“ACA”).

The Company has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). As a result, the Company does not pay federal income taxes on taxable income distributed to shareholders if certain REIT qualification tests are met. It is the Company’s policy to distribute 100% of its taxable income, after application of available tax attributes, within the time limits prescribed by the Code, which may extend into the subsequent taxable year. However, the Company may conduct certain activities that cause it to earn income which will not be qualifying income for REIT purposes. The Company has designated certain of its subsidiaries as taxable REIT subsidiaries (“TRSs”) as defined in the Code to engage in such activities, and the Company may in the future form additional TRSs.

See Note 15 for information regarding the planned merger of the Company with Annaly Capital Management, Inc., a Maryland corporation (“Annaly”), which is expected to close by the end of the third quarter of 2016. The closing is subject to various conditions and regulatory approvals, including two-thirds of the outstanding shares of the Company’s common stock being validly tendered into the exchange offer, and therefore, the Company cannot provide any assurance that the merger will close in a timely manner or at all.

On August 31, 2015, the Company closed on its acquisition of the voting interests of Pingora Asset Management, LLC (“PAM”) and Pingora Loan Servicing, LLC (“PLS,” and together, “Pingora”), a specialized asset manager focused on investing in new-production performing mortgage servicing rights (“MSR”) and master-servicing residential mortgage loans sourced primarily from direct, ongoing relationships with loan originators. PAM is a registered investment advisor and PLS is an approved servicer with Fannie Mae, Freddie Mac and Ginnie Mae that is managed by PAM. The acquisition provides the Company with MSR portfolio management and master-servicing oversight capabilities to the Company, accelerating the Company’s entry into investing in MSR. In addition to being an income-producing investment, the Company expects that MSR will serve as a natural hedge against the impact of changes in interest rates on the fair value of the Company’s interest-earning portfolio. The Company acquired 100% of the voting interests of Pingora for cash consideration of approximately $23.5 million. In conjunction with the transaction, the Company also issued approximately $4.4 million of equity interests to Pingora management, a significant portion of which is subject to future vesting. The Company has accounted for the transaction as a business combination in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations. The acquired operations generated other income of $21.8 million and a net loss of $8.2 million during the three months ended March 31, 2016.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2016. These unaudited consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2015.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates affecting the accompanying consolidated financial statements include the valuation of investments and derivative instruments.

Certain prior period amounts have been reclassified to conform to the current period classification.

The consolidated financial statements include the accounts of the Company and all of its subsidiaries. The Company also considers the provisions of FASB ASC Topic 810, Consolidation, in determining whether consolidation is appropriate for any interests held in variable interest entities. All significant intercompany balances and transactions have been eliminated.

The Company consolidates a securitization trust, also known as a collateralized financing entity (“CFE”) that purchased individual whole mortgage loans from one of the Company’s subsidiaries and issued MBS that are backed by the loans. This securitization occurred in December 2015. An owner of a variable interest in a variable interest entity (“VIE”) must consolidate the VIE if that owner has: (i) the power to direct the activities that most significantly impact the VIE’s economic performance (“power”), and (ii) the obligation to absorb losses of, or to receive benefits from, the VIE that could potentially be significant to the VIE. Because the Company purchased the majority of the MBS that were issued by the CFE, including all the subordinate tranches, and because a subsidiary of the Company continues to be the named servicer of the loans in the trust, the criteria for consolidation of the CFE are met. See Note 3 for further information related to the CFE.

PLS, which meets the definition of a business pursuant to GAAP, has also been determined to be a VIE. Further, PLS has structured its operations, and the funding and capitalization thereof, into three pools of assets and liabilities referred to as “silos.” Owners of variable interests in a given PLS silo are entitled to all of the returns and risk of loss on the investments and operations in that silo and have no substantive recourse to assets contained in any other silo. While the Company has power over all PLS silos because it owns 100% of the voting interests of PLS, it only has variable interests in two of the three silos. In the two silos in which it has a variable interest, the Company holds 100% of the variable interests, making it the primary beneficiary thereof. These silos have been included in the Company’s consolidated financial statements. The Company’s consolidated financial statements exclude the PLS silo in which the Company has no variable interest.

The Company is required to reassess the consolidation of VIEs quarterly, and changes in facts and circumstances may change the Company’s determination. This could result in a material impact to the Company’s consolidated financial statements during subsequent reporting periods.

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The carrying amounts of cash equivalents approximate their fair value. Cash and cash equivalents includes cash pledged to derivative counterparties, which is held in margin accounts at various counterparties as collateral related to interest rate swaps, Eurodollar Futures Contracts (“Futures Contracts”) and forward commitments to purchase to-be-announced (“TBA”) securities.

The Company considers its cash and cash equivalents, MBS and agency credit risk transfer (“CRT”) securities (settled and unsettled), mortgage loans, forward purchase commitments, debt security held-to-maturity, receivable for securities sold, accrued interest receivable, principal payments receivable, payable for unsettled securities, derivative instruments, borrowings and accrued interest payable to meet the definition of financial instruments. The carrying amount of cash and cash equivalents, receivable for securities sold, accrued interest receivable and payable for unsettled securities approximate their fair value due to the short maturities of these instruments and would be valued using Level 1 inputs. The carrying amount of repurchase agreements is deemed to approximate fair value given their short-term duration and would be valued using Level 2 inputs. See Note 5 for discussion of the fair value of MBS and agency CRT securities. See Note 6 for discussion of the fair value of mortgage loans. See Note 8 for discussion of the fair value of the held-to-maturity debt security. See Note 10 for discussion of the fair value of derivative instruments, including forward purchase commitments.

The Company limits its exposure to credit losses on its portfolio of securities by purchasing predominantly agency securities. In addition, the Company’s portfolio is diversified to avoid undue exposure to loan originator, geographic and other types of concentration. The Company manages the risk of prepayments of the underlying mortgages by creating a diversified portfolio with a variety of expected prepayment characteristics. See Note 5 for additional information on MBS.

The Company is engaged in various trading and brokerage activities including repurchase agreements, dollar roll transactions, interest rate swap agreements, interest rate swaptions and Futures Contracts in which counterparties primarily include broker-dealers, banks, and other financial institutions. In the event counterparties do not fulfill their obligations, the Company may be exposed to risk of loss. The risk of default depends on the creditworthiness of the counterparty and/or issuer of the instrument. It is the Company’s policy to review, as necessary, the credit standing for each counterparty and retain collateral when appropriate. See Note 9 for additional information on repurchase agreements and Note 10 for additional information on dollar roll transactions, interest rate swap agreements, interest rate swaptions and Futures Contracts.

The Company invests primarily in MBS representing interests in or obligations backed by pools of single-family residential mortgage loans. GAAP requires the Company to classify its 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. The Company currently classifies all of its MBS as available-for-sale. All assets that are classified as available-for-sale are carried at fair value and unrealized gains and losses are included in other comprehensive income (loss). Agency CRT securities are credit risk transfer securities issued by government sponsored entities, which are designed to synthetically transfer mortgage credit risk from Fannie Mae and Freddie Mac to private investors. The Company has elected to account for agency CRT securities under the fair value option, which simplifies accounting for these particular securities due to the potential for embedded derivatives therein. The estimated fair values of MBS and agency CRT securities are determined by management utilizing valuations obtained from independent sources. Security purchase and sale transactions 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.

Forward purchase commitments to acquire “when issued” or TBA securities are recorded at fair value in accordance with FASB ASC Topic 815, Derivatives and Hedging (“ASC 815”). The fair value of these forward purchase commitments is included in derivative assets or derivative liabilities in the accompanying consolidated balance sheets. If the Company intends to take physical delivery of the securities, as is the case for forward purchase commitments to acquire TBA securities from mortgage originators, the commitment is designated as an all-in-one cash flow hedge and its unrealized gains and losses are recorded in other comprehensive income. If the Company does not intend to take physical delivery of the securities, as is the case with most TBA dollar roll transactions, the commitment is not designated as an accounting hedge and unrealized gains and losses are recorded in “Gain (loss) on derivative instruments, net.” See Note 10 for additional information on forward purchase commitments.

The Company assesses its available-for-sale securities for other-than-temporary impairment on at least a quarterly basis. When the fair value of an investment is less than its amortized cost at the balance sheet date the impairment is designated as either “temporary” or “other-than-temporary.” In deciding on whether or not a security is other-than-temporarily impaired, the Company uses a two-step evaluation process. First, the Company determines whether it has made any decision to sell a security that is in an unrealized loss position, or, if not, the Company determines whether it is more likely than not that the Company will be required to sell the security prior to recovering its amortized cost basis. If the answer to either of these questions is “yes” then the security is considered other-than-temporarily impaired.

The Company does not originate any loans, but purchases individual prime jumbo adjustable-rate whole mortgage loans with the intention of holding them as investments. In order to finance its investment in the loans, the Company may securitize the loans into MBS not issued or guaranteed by a U.S. Government agency or U.S. Government-sponsored entity. The Company would then purchase the majority of the MBS that the securitization trusts would issue, and would expect to consolidate the trusts pursuant to GAAP. The Company completed such a securitization transaction during 2015.

The Company has elected to account for these loans under the fair value option, pursuant to FASB ASC Topic 825, Financial Instruments (“ASC 825’). As a result of electing the fair value option, the mortgage loans are carried at fair value with changes therein reflected in consolidated net income (loss), consistent with the accounting for the related hedging instruments, thereby enhancing the usefulness of the Company’s financial statements. See “Interest Income” below for discussion of the recognition of the interest income on mortgage loans. Other changes in fair value are reported in “Net gain (loss) on mortgage loans” in the consolidated statements of income. Given the Company’s intent to hold the mortgage loans as investments, purchases and sales or paydowns of mortgage loans held for investment are classified as investing cash flows in the consolidated statements of cash flows.

As discussed under “Principles of Consolidation,” the Company consolidates a CFE that securitized individual prime jumbo adjustable-rate whole mortgage loans it had purchased from a subsidiary of the Company. These securitized mortgage loans are legally isolated from the Company, are beyond the reach of the Company’s creditors, and may only be used to settle obligations of the CFE. The Company has elected to account for the assets and liabilities of the CFE under the fair value option, pursuant to ASC 825. As a result, mortgage loans held for investment in securitization trusts are carried at fair value. See “Interest Income” below for discussion of the recognition of the interest income on mortgage loans. Paydowns on these mortgage loans are classified as investing cash flows in the consolidated statements of cash flows. See Note 3 for further information regarding the CFE.

The Company purchases certain individual whole loans with the intention of selling them to Ginnie Mae for inclusion in securitizations. The Company has elected to account for these loans under the fair value option, pursuant to ASC 825, because it better reflects the short-term nature of the Company’s holdings in these loans. As a result of electing the fair value option, the mortgage loans are carried at fair value with changes therein reflected in consolidated net income (loss). Changes in fair value are

reported in “Net gain (loss) on mortgage loans” in the consolidated statements of income. Cash flows related to mortgage loans held for sale are classified as operating cash flows in the consolidated statements of cash flows.

The Company purchases MSR with the intention of holding them as investments. The Company and its subsidiaries do not originate or directly service mortgage loans. Rather, it utilizes duly licensed subservicers to perform substantially all servicing functions for the loans underlying the MSR. The Company has elected to account for its investments in MSR at fair value pursuant to FASB ASC Topic 860, Transfers and Servicing. As a result, MSR are carried at fair value with changes therein reported in “Net gain (loss) on mortgage servicing rights” in the consolidated statements of income. Servicing income and expenses are reported on a gross basis in the consolidated statements of income.

The Company manages economic risks, including interest rate, liquidity and credit risks, primarily by managing the amount, sources, cost and duration of its debt funding. The objectives of the Company’s risk management strategy are 1) to attempt to mitigate the risk of the cost of its variable rate liabilities increasing during a period of rising interest rates, and 2) to reduce fluctuations in net book value over a range of interest rate scenarios. The principal instruments that the Company uses to achieve these objectives are interest rate swaps and Eurodollar Futures Contracts (“Futures Contracts”). The Company uses Futures Contracts to approximate the economic hedging results achieved with interest rate swaps. The Company does not enter into any of these transactions for speculative purposes.

The Company accounts for derivative instruments in accordance with ASC 815, which requires an entity to recognize all derivatives as either assets or liabilities and to measure those instruments at fair value. The accounting for changes in the fair value of derivative instruments depends on whether the instruments are designated and qualify as part of a hedging relationship pursuant to ASC 815. Changes in fair value related to derivatives not in hedge designated relationships are recorded in “Gain (loss) on derivative instruments, net” in the Company’s consolidated statements of income, whereas changes in fair value related to derivatives in hedge designated relationships are initially recorded in other comprehensive income (loss) and later reclassified to income at the time that the hedged transactions affect earnings. Any portion of the changes in fair value due to hedge ineffectiveness is immediately recognized in the income statement.

Derivative instruments in a gain position are reported as derivative assets and derivative instruments in a loss position are reported as derivative liabilities in the Company’s consolidated balance sheets. In the Company’s consolidated statements of cash flows, cash receipts and payments related to derivative instruments are classified according to the underlying nature or purpose of the derivative transaction, generally in the operating section if the derivatives are designated as accounting hedges and in the investing section otherwise. The use of derivatives creates exposure to credit risk relating to potential losses that could be recognized in the event that the counterparties to these instruments in an asset position fail to perform their obligations under the contracts. The Company attempts to minimize this risk by limiting its counterparties to major financial institutions with acceptable credit ratings, monitoring positions with individual counterparties and adjusting posted collateral as required.

The Company may also enter into forward purchase commitments as a means of investing in and financing agency securities via TBA dollar roll transactions. TBA dollar roll transactions involve moving the settlement of a TBA contract out to a later date by entering into an offsetting short position (referred to as a "pair off"), net settling the paired-off positions for cash, and simultaneously purchasing a similar TBA contract for a later settlement date. The agency securities purchased at the later settlement date are typically priced at a discount to securities for settlement in the current month. This difference is referred to as the “price drop.” The price drop represents compensation to the Company for foregoing net interest margin (interest income less repurchase agreement financing cost) and is referred to as “dollar roll income,” which the Company classifies in “Gain (loss) on derivative instruments, net.” Realized and unrealized gains and losses related to TBA dollar roll transactions are also recognized in “Gain (loss) on derivative instruments, net.” TBA dollar roll transactions represent off-balance sheet financing.

The Company finances the acquisition of its MBS through the use of repurchase agreements. Under these repurchase agreements, the Company sells securities to a lender and agrees to repurchase the same securities in the future for a price that is higher than the original sales price. The difference between the sale price that the Company receives and the repurchase price that the Company pays represents interest paid to the lender. Although structured as a sale and repurchase obligation, a repurchase agreement operates as a financing under which the Company pledges its securities as collateral to secure a loan which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. The Company records repurchase agreements on the consolidated balance sheets at the amount of cash received (or contract value), with accrued interest recorded separately. The Company retains beneficial ownership of the pledged collateral. At the maturity of a repurchase agreement, the Company is required to repay the loan and concurrently receives back its pledged collateral from the lender or, with the consent of the lender, the Company may renew such agreement at the then-prevailing financing rate. These repurchase agreements may require the Company to pledge additional assets to the lender in the event the estimated fair value of the existing pledged collateral declines.

Warehouse lines of credit include borrowings under mortgage loan warehouse facilities with various counterparties that expire within one year. These borrowings are collateralized by mortgage loans. If the value of the underlying collateral (as determined by the counterparty) securing these borrowings decreases, the Company may be subject to margin calls during the period the borrowing is outstanding. To satisfy these margin calls, the Company may have to pledge additional collateral or repay portions of the borrowings.

During the third quarter of 2015, a wholly-owned subsidiary of the Company became a member of the Federal Home Loan Bank of Atlanta (the “FHLB”). The FHLB offers a variety of products and services, including short-term and long-term secured advances. FHLB advances are carried at their contractual amounts. Based on the current status of recent rulemaking by the Federal Housing Finance Agency (“FHFA”), the Company will need to surrender its membership in the FHLB in 2016.

As discussed under “Principles of Consolidation,” the Company consolidates a CFE that securitized individual prime jumbo adjustable-rate whole mortgage loans it had purchased from a subsidiary of the Company. Investors in the collateralized borrowings issued by the CFE have recourse against the assets within the CFE, but have no recourse against the Company itself. The Company has elected to account for the assets and liabilities of the CFE under the fair value option, pursuant to ASC 825. As a result, collateralized borrowings in securitization trusts are carried at fair value. The debt certificates issued by the CFE are tradeable MBS, and the fair value of the debt is determined by management by obtaining valuations from independent sources, consistent with how the Company values its investment portfolio. Paydowns on this debt are classified as financing cash flows in the consolidated statements of cash flows. See Note 3 for further information regarding the CFE.

The Company’s derivative agreements and repurchase agreements generally contain provisions that allow for netting or the offsetting of receivables and payables with each counterparty. The Company reports amounts in its consolidated balance sheets on a gross basis without regard for such rights of offset or master netting arrangements.

Interest income on MBS and agency CRT securities is earned and recognized based on the outstanding principal amount of the investment securities and their contractual terms. Premiums and discounts associated with the purchase of MBS are amortized or accreted into interest income over the actual lives of the securities using the effective interest method. Interest income on agency CRT securities, which are accounted for under the fair-value option, is recognized based on their stated coupon rates.

The Company recognizes interest income on mortgage loans held for investment and mortgage loans held for investment in securitization trusts based on their stated coupon rates. If a loan becomes 90 days past due, it is considered non-performing and is placed in non-accrual status. Accrual of interest income ceases and any existing interest receivables are reversed. Any cash received while a loan is in non-accrual status is first applied to unpaid principal and then to unpaid interest. In general, non-performing loans are only restored to accrual status when no principal or interest remains due and unpaid.

The Company has elected to be taxed as a REIT under the Code. The Company will generally not be subject to federal income tax to the extent that it distributes 100% of its taxable income, after application of available tax attributes, within the time limits prescribed by the Code and as long as it satisfies the ongoing REIT requirements including meeting certain asset, income and stock ownership tests. The Company has made an election to treat certain of its subsidiaries as TRSs. These TRSs are taxable as domestic C corporations and are subject to federal, state and local income taxes based upon their taxable income.

Share-based compensation is accounted for under the guidance included in FASB ASC Topic 718, Stock Compensation. For share and share-based awards issued to employees, a compensation charge is recorded in earnings based on the fair value of the award. For transactions with non-employees in which services are performed in exchange for the Company’s common stock or other equity instruments, the transactions are recorded on the basis of the fair value of the service received or the fair value of the equity instruments issued, whichever is more readily measurable at the date of issuance. The Company’s share-based compensation transactions resulted in compensation expense of $1,293 and $1,045 for the three months ended March 31, 2016 and 2015, respectively.

Basic EPS is computed by dividing net income less preferred stock dividends to arrive at net income available to holders of common stock by the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed using the

two class method, as described in FASB ASC Topic 260, Earnings Per Share, which takes into account certain adjustments related to participating securities. Participating securities are unvested share-based awards that contain rights to receive nonforfeitable dividends, such as those awarded under the Company’s equity incentive plans. Net income available to holders of common stock after deducting dividends on unvested participating securities if antidilutive, is divided by the weighted average shares of common stock and common equivalent shares outstanding during the period. For the diluted EPS calculation, common equivalent shares outstanding includes the weighted average number of shares of common stock outstanding adjusted for the effect of dilutive unexercised stock options, if any.

Other comprehensive income refers to revenue, expenses, gains, and losses that are recorded directly as an adjustment to shareholders’ equity. Other comprehensive income for the Company generally arises from unrealized gains or losses generated from changes in market values of the securities held as available-for-sale and derivative instruments that have been designated as accounting hedges.

In January 2016, the FASB issued ASU 2016-1, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-1”). Among other things, ASU 2016-1 modifies accounting and impairment assessments for equity investments, eliminates certain disclosures related to financial instruments carried at amortized cost, and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset. ASU 2016-1 is effective January 1, 2018 for calendar year companies and early adoption is permitted. The Company is still assessing the potential impacts of ASU 2016-1, but it is not expected to have a material impact on the Company’s consolidated financial statements.

As discussed under “Principles of Consolidation” above, the Company consolidates a CFE that purchased individual whole mortgage loans from one of the Company’s subsidiaries and issued MBS that are backed by the loans. The Company purchased most of the MBS issued by the CFE. The Company has elected the fair value option for the financial assets and liabilities of the CFE in order to avoid an accounting mismatch and more accurately present the economics of the securitization. The underlying loans are classified as “Mortgage loans held for investment in securitization trusts, at fair value” and the portion of the related debt that is not eliminated in consolidation is classified as “Collateralized borrowings in securitization trusts, at fair value” in the consolidated balance sheets. The securitized mortgage loans are legally isolated from the Company, are beyond the reach of the Company’s creditors, and may only be used to settle obligations of the CFE. Similarly, investors in the collateralized borrowings issued by the CFE have recourse against the assets within the CFE, but have no recourse against the Company itself. The Company is not contractually required to provide and has not provided any form of financial support to the CFE.

The following table presents the carrying amounts and classifications of the CFE’s assets and liabilities as reflected in the Company’s consolidated balance sheets, prior to certain consolidation adjustments:

The following table presents the statement of income of the CFE as reflected in the Company’s consolidated statements of income:

The Company’s valuation techniques for financial instruments are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions. FASB Topic 820, Fair Value Measurements, classifies these inputs into the following hierarchy:

Level 2 Inputs– Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

The Company’s Futures Contracts were valued using Level 1 inputs. The Company’s MBS, mortgage loans held for sale and derivatives other than Futures Contracts were valued using Level 2 inputs. Mortgage loans held for investment along with related purchase commitments and MSR were valued using Level 3 inputs. See Notes 5, 6, 7 and 10, respectively, for a discussion of the valuation of MBS, mortgage loans, MSR and derivatives.

The carrying values and fair values of assets and liabilities that are required to be reported or disclosed at fair value as of March 31, 2016 and December 31, 2015 were as follows.

	March 31, 2016				December 31, 2015
	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets
MBS	$	12,045,571	$	12,045,571	$	14,302,230	$	14,302,230
Agency CRT securities		111,021		111,021		109,387		109,387
Mortgage loans held for investment		152,197		152,197		116,857		116,857
Mortgage loans held for investment in securitization trusts		209,418		209,418		226,908		226,908
Mortgage loans held for sale		25,919		25,919		17,542		17,542
MSR		316,176		316,176		269,926		269,926
Cash and cash equivalents		705,920		705,920		816,715		816,715
Unsettled purchased MBS		5,536		5,536		12,582		12,582
Receivable for securities sold		274,127		274,127		-		-
Accrued interest receivable		38,826		38,826		45,008		45,008
Principal payments receivable		91,476		91,476		108,201		108,201
Debt security, held-to-maturity ⁽¹⁾		15,000		14,477		15,000		14,871
Short-term investments ⁽¹⁾		30,447		30,447		30,327		30,327
Interest rate swaps and swaptions ⁽²⁾		6		6		2,031		2,031
Futures Contracts asset ⁽²⁾		-		-		693		693
Forward purchase commitments ⁽²⁾		20,201		20,201		190		190
Liabilities
Repurchase agreements	$	11,419,354		11,419,354	$	13,443,883	$	13,443,883
Warehouse lines of credit		63,615		63,615		60,096		60,096
FHLB advances		-		-		14,132		14,132
Collateralized borrowings in securitization trusts		60,550		60,550		57,611		57,611
Payable for unsettled securities		5,483		5,483		12,582		12,582
Accrued interest payable		3,052		3,052		4,938		4,938
Interest rate swap liability ⁽³⁾		11,440		11,440		6,802		6,802
Futures Contracts liability ⁽³⁾		407,842		407,842		286,058		286,058
Forward purchase commitments ⁽³⁾		-		-		32,373		32,373

All of the Company’s securities, other than its agency CRT securities, are classified as available-for-sale and are reported at their estimated fair value. The agency CRT securities are accounted for under the fair value option as discussed in Note 2. The MBS market is primarily an over-the-counter market. As such, there are no standard, public market quotations for individual MBS. The Company estimates the fair value of its securities based on a market approach by obtaining values for its securities from third-party pricing services. The third-party pricing services gather trade data and use pricing models that incorporate such factors as coupons, primary mortgage rates, prepayment speeds, spread to the U.S. Treasury and interest rate swap curves, periodic and life caps and other similar factors. The third party pricing services also receive data from traders at broker-dealers that participate in the active markets for these securities and directly observe numerous trades of securities similar to the securities owned by the Company.

The Company regularly reviews the prices obtained and the methods used to derive those prices. As part of this evaluation, the Company considers security-specific factors such as coupon, prepayment experience, fixed/adjustable rate, annual and life caps, coupon index, time to next reset and issuing agency, among other factors to ensure that estimated fair values are appropriate. The Company’s analysis of pricing information obtained also includes comparing the data received to other available information, such as other independent pricing services, repurchase agreement pricing, discounted cash flow analysis, matrix pricing, option adjusted spread models and other fundamental analysis of observable market factors.

In addition to agency securities, the Company at times invests in MBS not issued or guaranteed by a U.S. Government agency or a U.S. Government-sponsored entity (“non-agency” securities). The following table presents the composition of the Company’s MBS and agency CRT securities portfolio at March 31, 2016.

	Amortized Cost		Gross Unrealized Loss			Gross Unrealized Gain		Estimated Fair Value
Agency MBS
Fannie Mae Certificates
ARMs	$	6,680,662	$	(4,469	)	$	94,897	$	6,771,090
Fixed-Rate		-		-			-		-
Total Fannie Mae		6,680,662		(4,469	)		94,897		6,771,090

Freddie Mac Certificates
ARMs		5,234,739		(7,041	)		46,783		5,274,481
Fixed-Rate		-		-			-		-
Total Freddie Mac		5,234,739		(7,041	)		46,783		5,274,481

Total Agency MBS	$	11,915,401	$	(11,510	)	$	141,680	$	12,045,571

Agency CRT Securities	$	111,217	$	(659	)	$	463	$	111,021

The following table presents the composition of the Company’s MBS and agency CRT securities portfolio at December 31, 2015.

	Amortized Cost		Gross Unrealized Loss			Gross Unrealized Gain		Estimated Fair Value
Agency MBS
Fannie Mae Certificates
ARMs	$	7,392,021	$	(14,465	)	$	102,247	$	7,479,803
Fixed-Rate		1,005,458		(8,148	)		-		997,310
Total Fannie Mae		8,397,479		(22,613	)		102,247		8,477,113

Freddie Mac Certificates
ARMs		5,806,425		(22,551	)		41,243		5,825,117
Fixed-Rate		-		-			-		-
Total Freddie Mac		5,806,425		(22,551	)		41,243		5,825,117

Total Agency MBS	$	14,203,904	$	(45,164	)	$	143,490	$	14,302,230

Agency CRT Securities	$	111,217	$	(1,830	)	$	-	$	109,387

The components of the combined carrying value the Company’s MBS and agency CRT securities at March 31, 2016 and December 31, 2015 are presented below:

The following table presents components of interest income on the Company’s MBS and agency CRT securities for the three months ended March 31, 2016 and 2015.

Gross gains and losses from sales of available-for-sale MBS and agency CRT securities for the three months ended March 31, 2016 and 2015 were as follows:

The Company monitors the performance and market value of its available-for-sale MBS portfolio on an ongoing basis, and on a quarterly basis reviews its MBS for impairment. At March 31, 2016 and December 31, 2015, the Company had the following MBS in a loss position as presented in the following two tables:

	As of March 31, 2016
	Less than 12 Months					Greater than 12 Months					Total
	Fair Market		Unrealized			Fair Market		Unrealized			Fair Market		Unrealized
	Value		Loss			Value		Loss			Value		Loss
Fannie Mae Certificates
ARMs		775,829	$	(2,022	)	$	503,197	$	(2,447	)	$	1,279,026	$	(4,469	)
Fixed-Rate		-		-			-		-			-		-
Freddie Mac Certificates
ARMs		620,483		(1,830	)		889,689		(5,211	)		1,510,172		(7,041	)
Fixed-Rate		-		-			-		-			-		-
Total temporarily impaired securities	$	1,396,312	$	(3,852	)	$	1,392,886	$	(7,658	)	$	2,789,198	$	(11,510	)
Number of securities in an unrealized loss position				84					57					141

	As of December 31, 2015
	Less than 12 Months					Greater than 12 Months					Total
	Fair Market		Unrealized			Fair Market		Unrealized			Fair Market		Unrealized
	Value		Loss			Value		Loss			Value		Loss
Fannie Mae Certificates
ARMs		1,712,043	$	(7,922	)	$	511,884	$	(6,542	)	$	2,223,927	$	(14,464	)
Fixed-Rate		997,310		(8,148	)		-		-			997,310		(8,148	)
Freddie Mac Certificates
ARMs		1,814,773		(9,246	)		861,198		(13,306	)		2,675,971		(22,552	)
Fixed-Rate		-		-			-		-			-		-
Total temporarily impaired securities	$	4,524,126	$	(25,316	)	$	1,373,082	$	(19,848	)	$	5,897,208	$	(45,164	)
Number of securities in an unrealized loss position				223					52					275

The Company did not make the decision to sell the above MBS as of March 31, 2016 and December 31, 2015, nor was it deemed more likely than not the Company would be required to sell these securities before recovery of their amortized cost basis. The unrealized losses on the above securities are the result of market interest rates and are not considered to be credit related. No impairment losses were recognized during the periods presented herein.

The contractual maturity of the Company’s MBS ranges from 15 to 30 years. Because of prepayments on the underlying mortgage loans, the actual weighted-average life is expected to be significantly less than the stated maturity.

The Company classifies its mortgage loans held for investment and mortgage loans held for investment in securitization trusts as Level 3 in the fair value hierarchy. Prices for these instruments are obtained from third party pricing providers which use significant unobservable inputs in their valuations. These valuations are prepared on an instrument-by-instrument basis and primarily use discounted cash flow models that include unobservable market data inputs including prepayment speeds, delinquency levels, and credit losses. Model valuations are then compared to external indicators such as market price quotations from market makers for similar instruments and recent transactions in the same or similar instruments. These valuations may also be discounted to reflect illiquidity and/or non-transferability, with the amount of such discount estimated by the third-party pricing provider in the absence of market information. The valuation of these mortgage loans requires significant judgment by the third-party pricing provider and management. Assumptions used by the third-party pricing provider due to lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s financial statements. Management reviews the valuations received from the third-party pricing provider. As part of this review, prices are compared against other pricing along with internal valuation expertise to ensure assumptions and pricing is reasonable.

The Company purchases individual jumbo whole mortgage loans with the intention of securitizing them. These loans are considered held for investment because the Company expects to consolidate the securitization trusts and are accounted for under the fair value option. See Note 2 for further discussion. As of March 31, 2016, the unpaid principal balance and the fair value of the Company’s mortgage loans held for investment were $148,691 and $152,197, respectively. As of December 31, 2015, the unpaid principal balance and the fair value of the Company’s mortgage loans held for investment were $114,997 and $116,857, respectively. The following table provides the geographic distribution of mortgage loans held for investment at March 31, 2016 and December 31, 2015, based on the unpaid principal balance.

The following table provides additional data on the Company’s mortgage loan portfolio at March 31, 2016 and December 31, 2015.

No loans were 90 days or more past due and none were on nonaccrual status at March 31, 2016 or December 31, 2015.

The following table presents the rollforward of mortgage loans held for investment for the periods presented.

None of the change in the fair value of the mortgage loans was attributable to changes in credit risk. The portion of the change in fair value included in the Company’s consolidated statements of income that were attributable to mortgage loan held for investment that were held at March 31, 2016 and December 31, 2015 was $1,034 and $261, respectively.

The following table provides information about the significant unobservable inputs used in the Level 3 valuation of the Company’s mortgage loans held for investment at March 31, 2016 and December 31, 2015.

A significant increase or decrease in any of the above unobservable inputs, in isolation, would likely result in a significantly lower or higher fair value measurement.

As discussed in Notes 2 and 3, the Company consolidates a CFE that owns whole mortgage loans it purchased from a subsidiary of the Company. These securitized mortgage loans are legally isolated from the Company, are beyond the reach of the Company’s creditors, and may only be used to settle obligations of the CFE. These loans are carried at fair value as a result of a fair value option election. As of March 31, 2016, the unpaid principal balance and the fair value of the Company’s mortgage loans held for investment in securitization trusts was $204,766 and $209,418, respectively. As of December 31, 2015, the unpaid principal balance and the fair value of the Company’s mortgage loans held for investment in securitization trusts was $223,205 and $226,908, respectively. The following table provides the geographic distribution of mortgage loans held for investment in securitization trusts at March 31, 2016 and December 31, 2015 based on the unpaid principal balance.

The following table provides additional data on mortgage loans held for investment in in securitization trusts at March 31, 2016 and December 31, 2015.

No loans were 90 days or more past due and none were on nonaccrual status at March 31, 2016 or December 31, 2015.

The following table presents the rollforward of mortgage loans held for investment in securitization trusts for the period presented.

None of the change in the fair value of these mortgage loans was attributable to changes in credit risk. The portion of the change in fair value included in the Company’s consolidated statements of income that were attributable to mortgage loan held for investment in securitization trusts that were held at March 31, 2016 and December 31, 2015 was $1,238 and $0, respectively, adjusted for the effects of the transfer of these loans into the CFE.

The following table provides information about the significant unobservable inputs used in the Level 3 valuation of the Company’s mortgage loans held for investment in securitization trusts at March 31, 2016 and December 31, 2015.

A significant increase or decrease in any of the above unobservable inputs, in isolation, would likely result in a significantly lower or higher fair value measurement.

The Company purchases individual whole mortgage loans with the intention of selling them to Ginnie Mae for inclusion in securitizations. As of March 31, 2016, the unpaid principal balance and the fair value of the Company’s mortgage loans held for sale were $25,676 and $25,919, respectively. As of December 31, 2015, the unpaid principal balance and the fair value of the Company’s mortgage loans held for sale were $16,629 and $17,542, respectively. The Company did not invest in mortgage loans held for sale prior to the acquisition of Pingora on August 31, 2015.

The Company classifies its mortgage loans held for sale as Level 2 in the fair value hierarchy. Prices for these instruments are obtained from third-party pricing providers and other applicable market data. If observable market prices are not available or insufficient to determine fair value due principally to illiquidity in the marketplace, then fair value is based upon cash flow models that are primarily based on observable market-based inputs but may also include unobservable market data inputs, including prepayment speeds, delinquency levels, and credit losses. No unobservable inputs were significant to the valuation of these loans as of March 31, 2016 or December 31, 2015.

In connection with its acquisition of Pingora, as discussed in Note 1, the Company entered agreements with PLS to begin investing in MSR during the third quarter of 2015. As discussed in Note 2, MSR are carried at fair value. The following table presents the rollforward of MSR for the three months ended March 31, 2016.

The Company classifies its MSR as Level 3 in the fair value hierarchy. Prices for these instruments are obtained from internal models and third-party pricing providers, both of which use significant unobservable inputs in their valuations. These valuations are prepared on an instrument-by-instrument basis and primarily use discounted cash flow models that include unobservable market data inputs including prepayment rates, delinquency levels, and discount rates. Model valuations are then compared to external indicators such as market price quotations from market makers for similar instruments and recent transactions in the same or similar instruments. These valuations may also be discounted to reflect illiquidity and/or non-transferability, with the amount of such discount estimated by the third-party pricing provider in the absence of market information. The valuation of MSR requires significant judgment by management and the third-party pricing provider. Assumptions used for which there is a lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s financial statements. Management reviews the valuations received from the third-party pricing provider and uses them as a point of comparison to its internally modeled values. As part of this review, prices are compared against other pricing indicators to ensure assumptions and pricing are reasonable.

The following table provides information about the significant unobservable inputs used in the Level 3 valuation of the Company’s MSR at March 31, 2016 and December 31, 2015.

The Company’s mortgage servicing income consisted of the following for the three months ended March 31, 2016:

A decline in interest rates could lead to higher-than-expected prepayments of mortgages underlying the Company’s MSR, which would result in a decline in the value of the MSR. The Company’s investment in MBS mitigates the impact of such a decline on the Company’s total portfolio as a decline in interest rates generally leads to an increase in the value of the Company’s MBS.

Other investments consisted of the following items as of March 31, 2016 and December 31, 2015:

The Company owns both a $15,000 debt security and a $6,000 equity investment in a non-public repurchase lending counterparty. The debt security matures on March 24, 2019. The Company has designated this debt security as a held-to-maturity investment, and as such it is carried at its cost basis. The debt security pays interest quarterly at the rate of 4.0% above the three-month London Interbank Offered Rate (“LIBOR”). The Company estimates the fair value of this debt security to be approximately $14,477 and $14,871 at March 31, 2016 and December 31, 2015, respectively, which was determined by calculating the present value of the projected future cash flows using a discount rate from a similar issuer and security (which represent Level 2 inputs). The Company accounts for the equity investment in the non-public repurchase lending counterparty under the cost method and concluded there have been no identified events or circumstance that would have a significant adverse effect on the fair value of the investment since the purchase date. As a member of the FHLB, the Company also has an equity investment of $17 in FHLB. The amount of investment required is partially dependent on the level of advances taken. This investment is accounted for under the cost method, because the stock can only be sold at its par value, and only to the FHLB.

The Company uses repurchase agreements to finance purchases of securities. These repurchase agreements are collateralized by the Company’s securities and typically bear interest at rates that are closely related to LIBOR. At March 31, 2016 and December 31, 2015, the Company had repurchase indebtedness outstanding with 26 and 25 counterparties with a weighted average remaining contractual maturity of 0.8 and 0.9 months, respectively.

The following table presents contractual maturity information regarding the Company’s repurchase agreements:

The fair value of securities and accrued interest the Company had pledged under repurchase agreements at March 31, 2016 and December 31, 2015 was $11,676,938 and $14,072,647, respectively.

Beginning in 2015, the Company has access to warehouse lines of credit with three financial institutions to finance purchases of whole mortgage loans. Borrowings under these facilities are charged interest at a specified margin over the one-month LIBOR interest rate. At March 31, 2016, the Company has outstanding borrowings with two counterparties totaling $63,615 with maturity dates between June 2016 and December 2016. The Company has pledged mortgage loans with a fair value of $67,685 as collateral pursuant to these lines of credit. The borrowing limit under these lines of credit is $300 million. As of December 31, 2015, the Company had outstanding borrowings of $60,096 under these lines of credit.

As discussed in Note 2, during 2015, a subsidiary of the Company became a member of the FHLB. As of March 31, 2016 and December 31, 2015, the Company had advances outstanding of $0 and $14,132, respectively. The advances as of December 31, 2015 were secured by the pledge of agency MBS with a fair value of $15,714. The Company’s aggregate borrowing capacity with the FHLB is $1 billion. Unused capacity may be adjusted at the sole discretion of the FHLB. The ability to borrow from the FHLB is subject to the Company’s continued creditworthiness, pledging of sufficient eligible collateral to secure advances, and compliance with certain covenants. Each advance requires approval by the FHLB and is secured by collateral in accordance with the FHLB’s credit and collateral guidelines, which the FHLB may revise from time to time. Based on the current status of recent FHFA rulemaking, the Company will need to surrender its membership in the FHLB in 2016.

As discussed in Notes 2 and 3, the Company consolidates a CFE that has issued MBS backed by mortgage loans. The portion of the CFE’s collateralized borrowings that is not eliminated in consolidation is carried at fair value as a result of a fair value option election. Investors in the collateralized borrowings issued by the CFE have recourse against the assets within the CFE, but have no recourse against the Company itself. As of March 31, 2016, the collateralized borrowings has an outstanding principal amount of $60,567 and a weighted-average interest rate of 2.75%. As of December 31, 2015, the collateralized borrowings has an outstanding principal amount of $58,052 and a weighted-average interest rate of 2.75%. The final scheduled distribution date thereof is November 2045. The actual maturity of the collateralized borrowing is based on the principal repayments of the underlying mortgage loans. As a result, the actual maturity of the borrowing may be substantially sooner than the final scheduled distribution date.

In connection with the Company’s risk management strategy, the Company hedges a portion of its interest rate risk by entering into derivative contracts. The Company may enter into agreements for interest rate swaps, interest rate swaptions, interest rate cap or floor contracts and futures or forward contracts. The Company’s risk management strategy attempts to manage the overall risk of the portfolio, reduce fluctuations in book value and generate additional income distributable to shareholders. For additional information regarding the Company’s derivative instruments and its overall risk management strategy, please refer to the discussion of derivative instruments in Note 2.

The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The fair values of interest rate swaptions are based on the fair value of the underlying interest rate swaps that the Company has the option to enter, and are based on inputs from the counterparty and pricing models. The fair value of Futures Contracts is based on quoted prices from the exchange on which they trade. The fair value of MBS forward purchase commitments was determined using the same methodology as MBS as described in Note 5. The fair value of forward purchase commitments for whole loans was determined using the same methodologies as mortgage loans as described in Note 6. The Company applies fallout assumptions to the third-party pricing of forward purchase commitments regarding loans that the counterparties may not successfully issue. The table below presents the fair value of the Company’s derivative instruments as well as their classification on the consolidated balance sheets as of March 31, 2016 and December 31, 2015, respectively.

Derivative Instruments	Balance Sheet Location	March 31, 2016		December 31, 2015

Interest rate swaps and swaptions	Derivative assets	$	6	$	2,031
Futures Contracts	Derivative assets		-		693
Forward purchase commitments - MBS	Derivative assets		20,150		165
Forward purchase commitments - mortgage loans	Derivative assets		51		25
		$	20,207	$	2,914


Interest rate swaps	Derivative liabilities	$	11,440	$	6,802
Futures Contracts	Derivative liabilities		407,842		286,058
Forward purchase commitments - MBS	Derivative liabilities		-		32,373
		$	419,282	$	325,233

The Company finances its activities primarily through repurchase agreements, which are generally settled on a short-term basis, usually from one to three months. At each settlement date, the Company refinances each repurchase agreement at the market interest rate at that time. Since the Company is exposed to interest rates on its borrowings that change on a short-term basis, it enters into hedging agreements to mitigate the effect of these changes. Interest rate swaps involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. The effect of these hedges is to synthetically lockup interest rates on a portion of the Company’s repurchase agreements for the terms of the interest rate swaps. Although the Company’s objective is to hedge the risk associated with changing repurchase agreement rates, the Company’s interest rate swaps are benchmark interest rate swaps which perform with reference to LIBOR. Therefore, the Company remains at risk to the variability of the spread between repurchase agreement rates and LIBOR interest rates.

Changes in the fair value of the Company’s interest rate swaps are recorded in “Net gain (loss) on derivative instruments” in the consolidated statements of income. Monthly net cash settlements under the interest rate swaps are also recorded in “Net gain (loss) on derivative instruments.”

The volume of activity for the Company’s interest rate swap instruments is shown in the table below.

Information regarding the Company’s interest rate swaps as of March 31, 2016 and December 31, 2015 follows.

	March 31, 2016						December 31, 2015
			Wtd. Avg.						Wtd. Avg.
			Remaining		Wtd. Avg.				Remaining		Wtd. Avg.
	Notional		Term		Fixed Interest		Notional		Term		Fixed Interest
Maturity	Amount		in Months		Rate		Amount		in Months		Rate

12 months or less	$	2,400,000		6		0.95%	$	2,400,000		6		0.92%
Over 12 months to 24 months		1,600,000		17		0.87%		1,800,000		17		0.89%
Over 24 months to 36 months		-		-		-		400,000		26		0.96%

Total	$	4,000,000		11		0.92%	$	4,600,000		12		0.91%

A swaption is a derivative instrument that gives the holder the option to enter into a pay-fixed interest rate swap in the future, if it so desires. As of March 31, 2016, the Company had four interest rate swaptions outstanding, which were entered into during 2015:

As of December 31, 2015, the Company had six interest rate swaptions outstanding:

During the first quarter of 2015, the Company terminated swaptions held as of December 31, 2014 and received proceeds of $2,049.

The Company uses Futures Contracts to 1) synthetically replicate an interest rate swap, or 2) offset the changes in value of its forward purchases of certain MBS and mortgage loans. The following table presents the composition of the Company’s Futures Contracts as of March 31, 2016 and December 31, 2015, respectively.

The volume of activity for the Company’s Futures Contracts is shown in the table below.

Each Futures Contract embodies $1 million of notional value and corresponds to a Eurodollar contract for a specific three month timeframe. The effective dates of the Eurodollar contracts underlying the Company’s Futures Contracts range from 2016 through 2021.

The Company has not designated its Futures Contracts as hedges for accounting purposes. As a result, realized and unrealized changes in fair value thereon are recognized in net income in the period in which the changes occur. See “Financial Statement Presentation” below for quantification of gains and losses on Futures Contracts for the three months ended March 31, 2016 and 2015.

The Company purchases certain of its investment securities in the forward market. The Company purchases ARM TBA contracts and fixed-rate TBA contracts from dealers. ARM TBA contracts are not a frequently-traded security and are generally used to acquire MBS for the portfolio. Fixed-rate TBA contracts are a highly liquid security, and may be physically settled, net settled or traded as an investment. The Company also has commitments with various mortgage origination companies to purchase their production as it becomes securitized. Forward purchases do not qualify for trade date accounting and are considered derivatives for financial statement purposes, as described in Note 2. The net fair value of the forward commitment is reported on the balance sheet as an asset or liability. Whether the unrealized gain (or loss) is recognized in net income or other comprehensive income depends on whether or not the commitment has been designated as an accounting hedge, as discussed in Note 2. Forward purchase commitments on ARMs are designated as all-in-one cash flow hedges and the related unrealized gain or loss is recorded in other comprehensive income. Unrealized gains and losses on forward purchase commitments on mortgage loans and fixed-rate TBA dollar roll securities are recorded in net income.

The following table summarizes the Company’s forward purchase commitments as of March 31, 2016.

The following table summarizes the Company’s forward purchase commitments as of December 31, 2015.

The Company does not use either offsetting or netting to present any of its derivative assets or liabilities. The following table shows the gross amounts associated with the Company’s derivative financial instruments and the impact if netting were used as of March 31, 2016.

	Assets/(Liabilities)			Cash Collateral Posted (Held)			Net Asset/(Liability)
Interest rate swaps	$	-		$	-		$	-
Interest rate swaptions		6			(25	)		(19	)
Futures contracts		-			-			-
Forward purchase commitments		20,201			-			20,201

Interest rate swaps	$	(11,440	)	$	16,518		$	5,078
Futures contracts		(407,842	)		447,624			39,782
Forward purchase commitments		-			5,148			5,148

The following table shows the gross amounts associated with the Company’s derivative financial instruments and the impact if netting were used as of December 31, 2015.

	Assets/(Liabilities)			Cash Collateral Posted (Held)			Net Asset/(Liability)
Interest rate swaps		1,304			-			1,304
Interest rate swaptions		727			(1,106	)		(379	)
Futures contracts		693			-			693
Forward purchase commitments		190			-			190

Interest rate swaps		(6,802	)		14,626			7,824
Futures contracts		(286,058	)		335,084			49,026
Forward purchase commitments		(32,373	)		25,687			(6,686	)

The following table shows the components of “Loss on derivative instruments, net” for the three months ended March 31, 2016 and 2015.

	Three Months Ended March 31
	2016			2015
Interest rate swaps – net realized and unrealized gains	$	(5,942	)	$	1,116
Interest rate swaptions – net realized and unrealized losses		(721	)		(3,027	)
Interest rate swaps – monthly net settlements		(5,411	)		(21,423	)
Futures Contracts – fair value adjustments		(122,477	)		(94,016	)
Futures Contracts – losses from maturities		(18,630	)		(7,493	)
Futures Contracts – other realized losses		(9,884	)		(22,374	)
Mortgage loan purchase commitments - fair value adjustments		(20	)		331
TBA dollar roll income		17,602			23,155
TBA dollar rolls – net realized and unrealized gains (losses)		52,989			20,946
Net gain (loss) on derivative instruments	$	(92,494	)	$	(102,785	)

See Note 2 for discussion of TBA dollar roll transactions and TBA dollar roll income.

The table below presents the effect of the interest rate swaps that were previously designated as cash flow hedges on the Company’s AOCI for the three months ended March 31, 2016 and 2015.

During the next 12 months, the Company estimates that $109 of net deferred gains will be reclassified out of AOCI as a decrease to interest expense.

The Company has agreements with its interest rate swap and swaption counterparties that contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.

The Company has agreements with certain of its derivative counterparties that contain a provision where if the Company’s GAAP shareholders’ equity declines by a specified percentage over a specified time period, or if the Company fails to maintain a minimum shareholders’ equity threshold, then the Company could be declared in default on its derivative obligations. The Company also has

agreements with several of those counterparties that contain provisions regarding maximum leverage ratios. At March 31, 2016, the Company was in compliance with these requirements.

As of March 31, 2016, the fair value of derivatives in a net liability position related to these agreements was $11,440. The Company has collateral posting requirements with each of its counterparties and all interest rate swap agreements were fully collateralized as of March 31, 2016.

On June 18, 2013, the Company’s board of directors authorized a stock repurchase program (the “Repurchase Program”) to acquire up to 10,000,000 shares of the Company’s common stock. For the three months ended March 31, 2016, the Company repurchased 1,273,625 shares of common stock under the Repurchase Program in at-the-market transactions at a total cost of $14,776. The Company did not repurchase any shares during the three months ended March 31, 2015. As of March 31, 2016, there are 4,697,645 shares of repurchase capacity available under the Repurchase Program.

The following table details the Company’s calculation of earnings per share for the three months ended March 31, 2016 and 2015.

	Three Months Ended March 31
	2016			2015
Basic earnings (loss) per share:
Net income (loss)	$	(71,165	)	$	(34,535	)
Less preferred stock dividends		(5,480	)		(5,481	)
Net income (loss) available to common shareholders	$	(76,645	)	$	(40,016	)

Weighted average shares		94,850,791			96,783,199

Basic earnings (loss) per share	$	(0.81	)	$	(0.41	)

Diluted earnings (loss) per share:
Net income (loss)	$	(71,165	)	$	(34,535	)
Less preferred stock dividends for antidilutive shares		(5,480	)		(5,481	)
Net income (loss) available to common shareholders	$	(76,645	)	$	(40,016	)

Weighted average shares		94,850,791			96,783,199
Potential dilutive shares from exercise of stock options		-			-
Diluted weighted average shares		94,850,791			96,783,199

Diluted earnings (loss) per share	$	(0.81	)	$	(0.41	)

The Company is externally managed by ACA pursuant to a management agreement (the “Management Agreement”). All of the Company’s executive officers are also employees of ACA. ACA manages the Company’s day-to-day operations, subject to the direction and oversight of the Company’s board of directors which includes six independent directors. The Management Agreement expires on February 23, 2017 and is thereafter automatically renewed for an additional one-year term unless terminated under certain circumstances. ACA must be provided 180 days prior notice of any such termination and will be paid a termination fee equal to four times the average annual management fee earned by ACA during the two year period immediately preceding termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination. See Note 15 for information regarding a subsequent related to the Management Agreement.

Under the terms of the Management Agreement, the Company reimburses ACA for certain operating expenses of the Company that are borne by ACA. ACA is entitled to receive a management fee payable monthly in arrears in an amount equal to 1/12th of an amount determined as follows:

For purposes of calculating the management fee, equity is defined as the value, computed in accordance with GAAP, of shareholders’ equity, adjusted to exclude the effects of unrealized gains or losses. The following table presents amounts incurred for management fee, reimbursable expenses and share-based compensation expense related to the restricted common shares granted to management.

None of the reimbursement payments were specifically attributable to the compensation of the Company’s executive officers. Reimbursable expenses above includes rent paid by ACA for the Company’s office space. As of October 2014, the Company’s office space is rented from a real estate partnership in which some of the Company’s executive officers have a financial interest, at an annual rate of approximately $300. At March 31, 2016 and December 31, 2015, the Company owed ACA $3,806 and $3,063, respectively, for the management fee and reimbursable expenses, which is included in other liabilities.

The Company records unrealized gains and losses on its MBS and its forward purchase commitments securities as described in Note 5 and Note 10. The Company ceased hedge accounting for its interest rate swaps effective September 30, 2013. Beginning October 1, 2013, changes in the fair value of interest rate swaps are recorded directly to net income. The cumulative net unrealized gains and losses on interest rate swaps in AOCI as of September 30, 2013 are being amortized to net income as the hedged forecasted transactions occur. The following table rolls forward the components of AOCI, including reclassification adjustments, for the three months ended March 31, 2016.

	Unrealized gain/(loss) on available for sale MBS			Unrealized gain/(loss) on unsettled MBS			Unrealized gain/(loss) on other investments			Unrealized gain/(loss) on derivative instruments			Total

Accumulated other comprehensive income (loss) at January 1, 2016	$	98,368		$	(1	)	$	(547	)	$	838		$	98,658

Other comprehensive income (loss) before reclassification		36,025			54			94			1,582			37,755

Balance Sheet Reclassification:
Amount reclassified to MBS available for sale		-			1			-			(165	)		(164	)

Income Statement Reclassification:
Amounts reclassified to net gain on the sale of MBS		(4,287	)		-			-			-			(4,287	)
Amounts reclassified to interest expense		-			-			-			1,376			1,376

Net current period other comprehensive income (loss)		31,738			55			94			2,793			34,680

Accumulated other comprehensive income (loss) at March 31, 2016	$	130,106		$	54		$	(453	)	$	3,631		$	133,338

The following table rolls forward the components of AOCI, including reclassification adjustments, for the three months ended March 31, 2015.

	Unrealized gain/(loss) on available for sale MBS			Unrealized gain/(loss) on unsettled MBS			Unrealized gain/(loss) on other investments			Unrealized gain/(loss) on derivative instruments			Total

Accumulated other comprehensive income (loss) at January 1, 2015	$	232,240		$	42		$	(595	)	$	(25,922	)	$	205,765

Other comprehensive income before reclassification		90,119			794			129			4,848			95,890

Balance Sheet Reclassification:
Amount reclassified to MBS available for sale		-			(42	)		-			(4,120	)		(4,162	)

Income Statement Reclassification:
Amounts reclassified to net gain on the sale of MBS		(16,453	)		-			-			-			(16,453	)
Amounts reclassified to interest expense		-			-			-			13,438			13,438

Net current period other comprehensive income		73,666			752			129			14,166			88,713

Accumulated other comprehensive income (loss) at March 31, 2015	$	305,906		$	794		$	(466	)	$	(11,756	)	$	294,478

On April 10, 2016, the Company, Annaly and Ridgeback Merger Sub Corporation, a Maryland corporation and a wholly owned subsidiary of Annaly (“Purchaser”), entered into an Agreement and Plan of Merger (the “Merger Agreement”).

Pursuant to the Merger Agreement, and upon the terms and conditions thereof, Purchaser will commence an exchange offer (the “Offer”) to purchase all of the Company’s issued and outstanding shares of the Company’s common stock. In the Offer, holders of the Company’s common stock will have the option to elect from among three forms of consideration for each share (subject to proration as described below):

Holders of the Company’s common stock who do not make a valid election will receive the Mixed Consideration Option for their shares. Holders who elect to receive the Cash Consideration Option or Stock Consideration Option will be subject to proration to ensure that approximately 65% of the aggregate consideration paid to holders of the Company’s common stock in the Offer will be paid in the form of Annaly common stock and approximately 35% of the aggregate consideration paid to holders of the Company’s common stock in the Offer will be paid in cash.

It is a condition to the closing of the Offer that one share more than two-thirds of the outstanding shares of the Company’s common stock, when added to any shares of the Company’s common stock owned by Annaly and Purchaser, are validly tendered and not validly withdrawn. In addition to the minimum tender condition, completion of the Offer is subject to the satisfaction or waiver of a number of other customary closing conditions as set forth in the Merger Agreement, including the effectiveness of a registration

statement on Form S-4 registering the shares of Annaly common stock to be issued in connection with the Offer and the Merger (as defined below) and the receipt of certain regulatory approvals.

Immediately following the closing of the Offer, subject to the terms and conditions set forth in the Merger Agreement, the Company will be merged with and into Purchaser (the “Merger”), with Purchaser surviving the Merger. The Merger Agreement contemplates that, if the Offer is completed, the Merger will be effected pursuant to Section 3-106.1 of the Maryland General Corporation Law, which permits completion of the Merger without a vote of the holders of the Company’s common stock upon the acquisition by Purchaser of at least two-thirds of shares of the Company’s common stock that are then issued and outstanding. In the Merger, holders of the Company’s common stock will be entitled to the same election options as described above for the Offer and subject to the same proration rules.

Each share of the Company’s 7.625% Series A Cumulative Redeemable Preferred Stock, par value $0.001 per share (“Series A Preferred Stock”), that is outstanding as of immediately prior to the Merger will be converted into one share of a newly-designated series of Annaly preferred stock, par value $0.01 per share, which Annaly expects will be classified and designated as 7.625% Series E Cumulative Redeemable Preferred Stock, and which will have rights, preferences, privileges and voting powers substantially the same as a Series A Preferred Stock immediately prior to the Merger.

In general, each award of restricted shares of the Company’s common stock outstanding at the effective time of the Merger will vest and be cancelled in exchange for the right of the holder thereof to receive the Mixed Consideration Option in respect of each share subject to such award, less applicable tax withholding, except that certain awards of restricted shares of the Company’s common stock shall instead be converted at the effective time of the Merger into restricted stock awards with respect to Annaly common stock on the terms set forth in the Merger Agreement.

Prior to closing the transactions contemplated by the Merger Agreement, each of the Company and Annaly will declare a prorated dividend to their respective shareholders with a record and payment date on the last business day prior to the completion of the Offer. Each of the dividends will be prorated based on the number of days that elapsed since the record date for the most recent quarterly dividend paid to the Company and Annaly shareholders, respectively, and the amount of such prior quarterly dividend, as applicable.

The Merger Agreement also contains customary representations, warranties and covenants, including, among others, covenants by the Company to conduct its business in all material respects in the ordinary course of business consistent with past practice, subject to certain exceptions, during the period between the execution of the Merger Agreement and the consummation of the Merger.

The Company’s board of directors has unanimously agreed, based on the unanimous recommendation of the special committee of the board of directors (composed entirely of independent directors), to recommend that holders of the Company’s common stock tender their shares into the Offer, and has agreed not to solicit alternative transactions, subject to customary exceptions.

The Merger Agreement contains certain termination rights by the Company and Annaly. If the Merger Agreement is terminated under specified circumstances, including with respect to a change of the recommendation of the Company’s board of directors, the Company will pay Annaly a termination fee equal to $44,949.

In connection with the execution of the Merger Agreement, the Company and ACA entered into an amendment (the “Management Agreement Amendment”) to the Management Agreement. The Management Agreement Amendment provides that upon the completion of the transactions contemplated by the Merger Agreement, the Management Agreement will terminate, and as a result of such termination, the Company will pay to ACA a termination fee of $45,411.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

In this Quarterly Report on Form 10-Q, we refer to Hatteras Financial Corp. as “we,” “us,” “our company,” or “our,” unless we specifically state otherwise or the context indicates otherwise. The following defines certain of the commonly used terms in this quarterly report on Form 10-Q: “MBS” refers to mortgage-backed securities; “agency securities” refer to our residential MBS that are issued or guaranteed by a U.S. Government agency, such as Ginnie Mae, or by a U.S. Government-sponsored entity, such as Fannie Mae or Freddie Mac; “non-agency securities” refer to our residential MBS that are not issued or guaranteed by a U.S. Government agency or a U.S. Government-sponsored entity; “GSE CRT bonds” refer to credit risk transfer bonds issued by Fannie Mae and Freddie Mac; “MSR” refer to mortgage servicing rights; and “ARMs” refer to adjustable-rate mortgage loans which typically either 1) at all times have interest rates that adjust periodically to an increment over a specified interest rate index; or 2) have interest rates that are fixed for a specified period of time and, thereafter, generally adjust annually to an increment over a specified interest rate index.

The following discussion should be read in conjunction with our financial statements and accompanying notes included in Part 1, Item 1 of this Quarterly Report on Form 10-Q as well as our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the Securities and Exchange Commission (“SEC”) on February 24, 2016.

Amounts other than share-related amounts are presented in thousands, unless otherwise noted.

This report contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such statements include, in particular, statements about our plans, intentions, expectations, beliefs, and strategies as they relate to our business as described herein. 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.

Although we believe that our plans, intentions, expectations and beliefs reflected in or suggested by such forward-looking statements are reasonable, we cannot assure you that our plans, intentions, expectations or beliefs will be achieved. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. The following factors could cause actual results to vary from our forward-looking statements:

These and other risks, uncertainties and factors, including those set forth under the sections captioned “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein and in our annual report on Form 10-K for the year ended December 31, 2015, as updated by our quarterly and current reports that we file with the Securities and Exchange Commission (“SEC”), could cause our actual results to differ materially from those projected in any forward-looking statements we make.

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.

On April 10, 2016, our company, Annaly Capital Management, Inc., a Maryland corporation (“Annaly”), and Ridgeback Merger Sub Corporation, a Maryland corporation and a wholly owned subsidiary of Annaly (“Purchaser”), entered into an Agreement and Plan of Merger (the “Merger Agreement”). See Note 15 of the Notes to Consolidated Financial Statements included elsewhere in this report for a discussion of the Merger Agreement. The merger is expected to close by the end of the third quarter of 2016, although closing is subject to various conditions and regulatory approvals, including two-thirds of the outstanding shares of our common stock being validly tendered in the exchange offer, and therefore, we cannot provide any assurance that the merger will close in a timely manner or at all.

Our ability to execute on our business plan could be adversely impacted by operating restrictions included in the Merger Agreement, including restrictions on investing in new assets and raising additional capital. We have incurred and will incur a variety of merger-related expenses, which, while not recurring in nature, will not be recoverable if the merger is not consummated.

We are an externally-managed mortgage real estate investment trust (“REIT”) that invests primarily in single-family residential mortgage real estate assets, such as mortgage-backed securities (“MBS”), MSR, residential mortgage loans and other financial assets. MBS are pass-through securities consisting of a pool of mortgage loans. To date, the majority of our investments have been MBS issued or guaranteed by a U.S. Government agency, such as Ginnie Mae, or by a U.S. Government-sponsored enterprise, such as Fannie Mae or Freddie Mac. We refer to these securities as “agency securities.” We were incorporated in Maryland in September 2007. We listed our common stock on the New York Stock Exchange (“NYSE”) in April 2008 and trade under the symbol “HTS.”

We are organized and conduct our operations to qualify as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”), and generally are not subject to federal taxes on our income to the extent we timely distribute our income to our shareholders and maintain our qualification as a REIT.

Our principal goal is to provide an attractive risk-adjusted total return to our shareholders over the long term, primarily through dividends and secondarily through capital appreciation. We selectively acquire and manage an investment portfolio of real estate financial assets, with the aim of generating attractive returns throughout interest rate cycles. We focus on asset selection and implement a relative value investment approach across various sectors within the residential mortgage market. Our primary investment assets include the following:

In general, our strategy focuses on managing the interest rate risk related to our mortgage assets along with our exposure to credit risk. Our primary business since inception has been owning and managing agency securities, with a primary focus on adjustable-rate mortgage (“ARM”) securities. We currently intend for agency securities to continue to be the majority of our investment assets. As part of this strategy we employ financing, or leverage, to increase our returns. Much of this financing is short-term, which exposes us to interest rate risk. To reduce this risk to levels we believe are acceptable, we use various hedges, such as interest rate swaps, swaptions and futures contracts. We may, subject to maintaining our REIT qualification, also employ other hedging instruments from time to time, including interest rate caps, collars, and “to-be-announced” (“TBA”) securities to protect against adverse interest rate movements.

We own non-agency investments both in the form of whole loans and, at times, MBS. We invest in prime non-conforming residential whole mortgage loans through our wholly owned subsidiary, Onslow Bay Financial LLC (“Onslow”). Onslow acquires such loans from select mortgage loan originators and secondary market institutions with the intent to securitize the loans through the issuance of non-agency MBS. Our intention is to generally retain the related subordinated securities, representing the credit risk tranche associated with these securitization transactions, as well as portions of the AAA tranches. While we purchase loans with the intent of securitization, depending on our view of the securitization market, we may decide to retain some amount of the whole loans as a direct investment. We do not originate loans or provide direct financing to lenders; rather, through our mortgage loan conduit we contract with originators to acquire loans they originate that meet our purchase criteria. We completed our first securitization during the fourth quarter of 2015 and we may complete additional securitizations in the coming year, subject to market conditions.

In August of 2015, Wind River TRS LLC, our wholly owned subsidiary, acquired PAM and PLS (together, “Pingora”). Pingora owns and manages our MSR portfolio as well as MSR portfolios for third parties. As an investor in MSR, we purchase the right to control the servicing of mortgage loans from high-quality originators. We do not directly service the mortgage loans we acquire, nor the mortgage loans underlying the MSR we acquire; rather, we contract with licensed third-party subservicers to handle substantially all servicing functions. In addition to allowing us to own and manage MSR as an additional asset class, we believe Pingora provides attractive synergies with our other lines of business.

We view MSR income as a complimentary asset to our overall investment portfolio. As an asset that is generally inverse in nature to interest rate changes when compared to our agency securities, we believe that the inclusion of MSR in our strategic mix is beneficial not only in providing earnings stability, but also as an offset to value changes in our interest-earning portfolio. The MSR we own are all on agency loans, and almost all of these loans are fixed-rate in nature.

Prior to 2015, essentially all of our capital was allocated to investing in agency securities. We believe our efforts to diversify our investments provide us with a more efficient portfolio and additional flexibility to allocate capital opportunistically based on our expectation of market conditions.

Due to our significant exposure to interest rate risk from our investments, we focus on constructing a portfolio with a short effective duration, which we believe limits the impact of changes in interest rates on the market value of our portfolio and on our net interest margin (interest income less financing costs). However, because our investments vary in interest rate, prepayment speed and maturity, the leverage or borrowings that we employ to fund our asset purchases will never exactly match the terms or performance of our assets, even after we have employed our hedging techniques. Based on our manager’s experience, the interest rates of our assets will change more slowly than the corresponding short-term rates on the borrowings used to finance our assets. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income and shareholders’ equity.

Our manager’s approach to managing our investment portfolio is to take a longer term view of assets and liabilities; accordingly, our periodic earnings and mark-to-market valuations at the end of a period will not significantly influence our strategy of providing cash distributions to shareholders over the long term. Our manager has invested and seeks to invest in mortgage assets that it believes are likely to generate attractive risk-adjusted returns on capital invested, after considering (1) the amount and nature of anticipated cash flows from the asset, (2) our ability to borrow against the asset, (3) the capital requirements resulting from the purchase and financing of the asset, and (4) the costs of financing, hedging, and managing the asset.

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 margin, the market value of our assets and the supply of and demand for such assets. We invest in financial assets and markets, and recent events, including those discussed below, can affect our business in ways that are difficult to predict, and produce results outside of typical operating variances. Our net interest margin varies primarily as a result of changes in interest rates, borrowing costs and prepayment speeds, the behavior of which involves various risks and uncertainties. Prepayment rates, as reflected by the rate of principal paydown, 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 MBS purchased at a premium increase, related purchase premium amortization increases, 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.

We anticipate that, for any period during which changes in the interest rates earned on our assets do not coincide with interest rate changes on our borrowings, such asset coupon rates will reprice more slowly than the corresponding borrowing rates for the liabilities used to finance those assets. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net interest margin. With the maturities of our assets generally being longer term than those of our liabilities, interest rate increases will tend to decrease our net interest margin and the market value of our 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 shareholders.

Prepayments on MBS and the underlying mortgage loans may be influenced by changes in market interest rates and a variety of economic, geographic and other factors beyond our control; and consequently such prepayment rates cannot be predicted with certainty. To the extent we have acquired MBS 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 MBS will likely increase. If we are unable to reinvest the proceeds of these prepayments at comparable yields, our net interest margin may suffer. The current climate of government intervention in the mortgage market significantly increases the risk associated with prepayments.

While we intend to use hedging to mitigate some of our interest rate risk, we do not intend to hedge all of our exposure to changes in interest rates and prepayment rates, as there are practical limitations on our ability to insulate our portfolio from all potential negative consequences associated with changes in short-term interest rates in a manner that will allow us to seek attractive net spreads on our portfolio.

In addition, a variety of other factors relating to our business may also impact our financial condition and operating performance. These factors include:

Our manager is entitled to receive a management fee that is based on our equity (as defined in our management agreement), regardless of the performance of our portfolio. Accordingly, the payment of our management fee may not decline in the event of a decline in our profitability and may cause us to incur losses.

For a discussion of additional risks relating to our business see Item 1A - “Risk Factors”.

Mortgage markets in general, and our strategy in particular, are interest rate sensitive. The relationship between several interest rates is generally determinant of the performance of our company. In the United States, interest rates are highly determined by the U.S. Federal Reserve actions and outlooks for setting their benchmark rate. Current speculation about when, and with what frequency, the U.S. Federal Reserve will change short-term interest rates has increased volatility in asset pricing and nervousness among interest rate investors. The lack of certainty about the rate environment tends to decrease the value of our assets.

Our borrowings in the repurchase market have historically closely tracked LIBOR and the U.S. Federal Funds Effective Rate. Significant volatility in these rates or a divergence from the historical relationship among these rates could negatively impact our

ability to manage our portfolio. The investments we buy are affected by the shape of the yield curve, particularly along the area between two-year Treasury rates and 10-year Treasury rates. The values of the hedges we employ are affected by the interest rate spread over the corresponding Treasury rates of two-year, three-year and five-year swaps, with the two-year currently being most representative of our portfolio composition.

The following table shows the 30-day LIBOR as compared to these rates at each period end:

	30- day LIBOR	Fed Funds Effective Rate	Two-Year Treasury	10-Year Treasury	Two-Year Swap Spread
March 31, 2016	0.44%	0.25%	0.73%	1.78%	0.12%
December 31, 2015	0.43%	0.20%	1.06%	2.27%	0.12%
September 30, 2015	0.19%	0.07%	0.64%	2.06%	0.12%
June 30, 2015	0.19%	0.08%	0.64%	2.35%	0.26%
March 31, 2015	0.18%	0.06%	0.56%	1.94%	0.25%
December 31, 2014	0.17%	0.06%	0.67%	2.17%	0.23%
September 30, 2014	0.16%	0.07%	0.58%	2.52%	0.25%
June 30, 2014	0.16%	0.09%	0.47%	2.53%	0.13%
March 31, 2014	0.15%	0.06%	0.44%	2.73%	0.13%
December 31, 2013	0.17%	0.07%	0.38%	3.04%	0.11%
September 30, 2013	0.18%	0.06%	0.33%	2.64%	0.14%
June 30, 2013	0.19%	0.07%	0.36%	2.49%	0.16%

While short-term rates have been relatively stable over this period, long-term rates have been less so. This primarily affects the values of our investments and hedges, and prepayment rates on our investments. Swap spreads have been more volatile in recent years, with three-year and five-year swap spreads entering the single digits (in terms of basis points) and even turning negative at times. In periods where swap spreads tighten or widen, our hedges will be less effective in their ability to mitigate changes in the values of our investments.

Our net interest margin is primarily a function of the difference between the yield on our interest-earning assets and the financing cost of owning those assets. Since we tend to purchase securities at a premium to par, the main item that can affect the yield on our 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, are less so. Estimates of repayment rates are critical to the management of our portfolio, not only for estimating current yield but also to consider the rate of reinvestment of those proceeds into new securities, the yields which those new securities may add to our portfolio, as well as the extent to which we extend the duration of our liabilities in connection with hedging activities.

The following table shows the weighted average principal repayment rate and the one-month constant prepayment rate (“CPR”) for our securities portfolio for the periods presented:

	Weighted-Average Principal Repayment Rate ⁽¹⁾		Weighted-Average Principal Repayment Rate Annualized ⁽²⁾		Weighted-Average One Month CPR ⁽³⁾
March 31, 2016		5.21%		20.84%		15.2
December 31, 2015		5.85%		23.40%		17.2
September 30, 2015		7.24%		28.96%		21.1
June 30, 2015		6.65%		26.60%		19.5
March 31, 2015		5.26%		21.04%		15.4
December 31, 2014		5.16%		20.63%		15.4
September 30, 2014		6.33%		25.31%		19.0
June 30, 2014		5.09%		20.36%		15.4
March 31, 2014		4.42%		17.66%		13.0
December 31, 2013		4.89%		19.55%		14.2
September 30, 2013		6.93%		27.72%		19.7
June 30, 2013		7.03%		28.10%		20.8

Our investments in mortgage loans are also subject to prepayment risk. However, we account for our mortgage loans under the fair value option and recognize interest income thereon based on the contractual rate of the loans. Thus, the reported yield on our mortgage loan portfolio is not impacted by prepayments, other than to the extent they impact the weighted-average contractual rate of the portfolio. Instead, prepayments (and forward-looking prepayment assumptions) impact our earnings through changes in the fair value of our mortgage loans.

Our investments in MSR are also subject to prepayment risk. Revenue on MSR consists primarily of a servicing fee expressed in a number of basis points on the unpaid principal balance (“UPB”) of the underlying mortgage loans. Prepayments in the underlying loans decrease future servicing revenue by reducing the UPB upon which servicing revenue is calculated. Because MSR essentially represent interest-only strips on the underlying loans, there is no early return of principal when prepayments occur, unlike investments in MBS and mortgage loans. This makes prepayment risk particularly important for MSR. Since we account for our MSR under the fair value option, prepayments primarily affect our fair value changes on MSR.

As of March 31, 2016, our book value per share of common stock (total shareholders’ equity less the aggregate liquidation preference for our preferred stock divided by shares of common stock outstanding) was $18.60, a decrease of $0.78, from $19.38 at December 31, 2015. The decrease in our book value was the result of our net loss, dividends declared on common and preferred stock and share buybacks partially offset by unrealized gains on our MBS portfolio. See “Results of Operations” for further discussion. The following table shows our book value on a per share basis at each period end:

We invest in both adjustable and fixed-rate agency securities, non-agency securities. which are not issued or guaranteed by a U.S. Government agency or a U.S. Government entity, and agency CRT securities issued by Fannie Mae and Freddie Mac (collectively, “securities”). While agency CRT securities are debt obligations of Fannie Mae and Freddie Mac, the payment of principal on these securities is not guaranteed and we may incur a loss if the loans in the associated reference pools experience delinquencies exceeding specified thresholds. We assess the credit risk associated with our investment in agency CRT securities by assessing the current performance of the loans in the associated reference pool. Over time, our investments in non-agency securities and agency CRT securities may increase further, depending on our view of the relative risk-return attributes of these instruments.

At March 31, 2016 and December 31, 2015, we owned $12.2 billion and $14.4 billion of securities, respectively. While our strategy focuses on ARM securities, we also own fixed-rate securities with estimated durations that we believe are beneficial to the overall mix of our assets. As of March 31, 2016 and December 31, 2015, our securities portfolio was purchased at a net premium to par, or face value, with a weighted-average amortized cost of 102.64 and 102.72, respectively, of face value. As of March 31, 2016 and December 31, 2015, we had approximately $309.0 million and $379.6 million, respectively, of unamortized premium included in the cost basis of our securities.

During the three months ended March 31, 2016, we purchased approximately $0.2 billion of securities (at face amount) with a weighted average coupon of 2.70%. We also sold approximately $1.8 billion of securities (at face amount) with a weighted average coupon of 3.14%. During the three months ended March 31, 2015, we purchased approximately $0.9 billion of securities with a weighted average coupon of 2.48%. We also sold approximately $0.6 billion of securities with a weighted average coupon of 3.11%. These actions were taken to better position the portfolio for the expected risk environment by reducing our leverage ratio and the duration of our assets.

We typically want to own a higher percentage of Fannie Mae ARMs, than Freddie Mac ARMs as Fannie Mae has better cash flow to the security holder because Fannie Mae pays principal and interest sooner after accrual (54 days) as compared to Freddie Mac (75 days).

	Amortized Cost		Gross Unrealized Loss			Gross Unrealized Gain		Estimated Fair Value		% of Total
Agency MBS
Fannie Mae Certificates
ARMs	$	6,680,662	$	(4,469	)	$	94,897	$	6,771,090		56.2	%
Fixed-Rate		-		-			-		-		0.0	%
Total Fannie Mae		6,680,662		(4,469	)		94,897		6,771,090

Freddie Mac Certificates
ARMs		5,234,739		(7,041	)		46,783		5,274,481		43.8	%
Fixed-Rate		-		-			-		-		0.0	%
Total Freddie Mac		5,234,739		(7,041	)		46,783		5,274,481

Total Agency MBS		11,915,401		(11,510	)		141,680		12,045,571		100.0	%
Total Non-Agency MBS (ARMs)		-		-			-		-		0.0	%

Total Agency MBS	$	11,915,401	$	(11,510	)	$	141,680	$	12,045,571		100.0	%

Agency CRT Securities	$	111,217	$	(659	)	$	463	$	111,021

	Amortized Cost		Gross Unrealized Loss			Gross Unrealized Gain		Estimated Fair Value		% of Total
Agency MBS
Fannie Mae Certificates
ARMs	$	7,392,021	$	(14,465	)	$	102,247	$	7,479,803		52.3	%
Fixed-Rate		1,005,458		(8,148	)		-		997,310		7.0	%
Total Fannie Mae		8,397,479		(22,613	)		102,247		8,477,113

Freddie Mac Certificates
ARMs		5,806,425		(22,551	)		41,243		5,825,117		40.7	%
Fixed-Rate		-		-			-		-		0.0	%
Total Freddie Mac		5,806,425		(22,551	)		41,243		5,825,117

Total Agency MBS	$	14,203,904	$	(45,164	)	$	143,490	$	14,302,230		100.0	%

Agency CRT Securities	$	111,217	$	(1,830	)	$	-	$	109,387

As of March 31, 2016 our investment portfolio included adjustable-rate MBS and agency CRT securities as follows:

Months to Reset	% of ARM Portfolio			Current Face Value ⁽¹⁾		Weighted Avg. Coupon ⁽²⁾			Wtd. Avg. Amortized Purchase Price ⁽³⁾		Amortized Cost ⁽⁴⁾		Weighted Avg. Market Price ⁽⁵⁾		Market Value ⁽⁶⁾
0-12		21.0	%	$	2,441,051		2.80	%	$	102.05	$	2,491,175	$	104.73	$	2,556,436
13-24		12.1	%		1,416,396		2.88	%	$	102.75		1,455,363	$	104.09		1,474,265
25-36		18.6	%		2,178,021		2.70	%	$	102.83		2,239,713	$	103.73		2,259,330
37-48		31.1	%		3,670,357		2.45	%	$	102.99		3,779,949	$	103.14		3,785,525
49-60		7.8	%		924,273		2.52	%	$	102.40		946,424	$	103.07		952,691
61-72		8.5	%		989,371		2.89	%	$	102.44		1,013,532	$	103.81		1,027,066
73-84		0.8	%		95,024		2.67	%	$	102.36		97,267	$	103.15		98,022
109-120		0.1	%		3,143		3.04	%	$	101.65		3,195	$	103.63		3,257
Total ARMS and Agency CRTs		100.0	%	$	11,717,636		2.67	%	$	102.64	$	12,026,618	$	103.75	$	12,156,592

As of December 31, 2015, our investment portfolio included adjustable-rate MBS and agency CRT securities as follows:

Months to Reset	% of ARM Portfolio			Current Face Value ⁽¹⁾		Weighted Avg. Coupon ⁽²⁾			Wtd. Avg. Amortized Purchase Price ⁽³⁾		Amortized Cost ⁽⁴⁾		Weighted Avg. Market Price ⁽⁵⁾		Market Value ⁽⁶⁾
0-12		17.7	%	$	2,257,422		2.84	%	$	101.95	$	2,301,436	$	105.30	$	2,377,014
13-24		10.9	%		1,405,584		2.69	%	$	102.75		1,444,298	$	104.41		1,467,597
25-36		12.6	%		1,626,999		2.87	%	$	102.67		1,670,489	$	104.03		1,692,591
37-48		35.8	%		4,679,280		2.50	%	$	103.03		4,821,273	$	102.70		4,805,462
49-60		10.0	%		1,311,237		2.43	%	$	102.47		1,343,689	$	102.10		1,338,716
61-72		7.6	%		986,205		2.95	%	$	102.39		1,009,803	$	102.96		1,015,398
73-84		5.1	%		670,062		2.73	%	$	102.28		685,338	$	102.11		684,191
109-120		0.3	%		32,772		2.85	%	$	101.72		33,337	$	101.73		33,338
Total ARMS and Agency CRTS		100.0	%	$	12,969,561		2.67	%	$	102.62	$	13,309,663	$	103.43	$	13,414,307

As of March 31, 2016, excluding any fixed-rate securities, the ARMs underlying our adjustable rate MBS had fixed interest rates for an average period of approximately 33 months after which time the interest rates reset and become adjustable annually. At March 31, 2016, 90.0% of our ARMs were still in their initial fixed-rate period and 10.0% of our ARMs have already reached their initial reset period and will reset annually for the life of the security. At March 31, 2016, an additional 11.3% of our ARMs will reach the end of their initial fixed-rate period in the next 12 months.

After the reset date, interest rates on our ARMs float based on spreads over various indices, usually LIBOR or the one-year CMT. These interest rate adjustments are subject to caps that limit the amount the applicable interest rate can increase during any year, known as an annual cap, and through the maturity of the security, known as a lifetime cap. Our ARMs typically have a maximum initial one-time adjustment of 2% or 5%, and the average annual interest rate increase (or decrease) to the interest rates on our MBS is 2% per year. The average lifetime cap on increases (or decreases) to the interest rates on our MBS is 5% from the initial stated rate.

In addition to adjustable-rate securities, we also invest in fixed-rate securities. Until late 2015, all of our fixed-rate MBS purchased to date had been 10-year and 15-year amortizing fixed rate securities. However, at March 31, 2016, we did not own any fixed-rate MBS. The expected life of a 30-year fixed-rate MBS typically ranges from 4.5 to 7 years depending on market conditions. The following table details our fixed rate portfolio at December 31, 2015.

While most of our purchases of MBS are accounted for using trade date accounting, some forward purchases, such as certain TBA contracts, do not qualify for trade date accounting and are considered derivatives for financial statement purposes. Our accounting for these forward purchases depends on whether or not we intend to take physical delivery of the securities. In either case, the net fair value of the forward commitment is reported on the balance sheet as a derivative asset or liability. If we intend to take physical delivery of the securities, as is the case for forward purchase commitments to acquire TBA securities from mortgage originators, the commitment is designated as an all-in-one cash flow hedge and its unrealized gains and losses are recorded in other comprehensive income. If we do not intend to take physical delivery of the securities, as is the case with most of our TBA dollar roll transactions, the commitment is not designated as an accounting hedge and the unrealized gains and losses are recorded in “Loss on derivative instruments, net.”

We invest in individual jumbo adjustable-rate whole mortgage loans with the intention of holding them as investments. Dependent on market conditions, our intent is to securitize the loans through the issuance of non-agency MBS. Our intention is to generally retain the related subordinated securities, representing the credit risk piece associated with these deals as well as a portion of the AAA tranches. Depending on our view of the securitization and secondary markets, we may decide to retain a portion of the whole loans as a direct investment, or to sell loans in the secondary market. During 2015, we completed our first securitization transaction. We consolidate the related securitization trust, because we are deemed to be its primary beneficiary.

As of March 31, 2016, we own mortgage loans held for investment with a fair value of $361,615, of which $209,418 are held in the securitization trust. See Note 6 of our consolidated financial statements included in this report for further information, including activity rollforwards and portfolio characteristics.

In the third quarter of 2015, and in conjunction with our acquisition of Pingora, we began investing in MSR. To date, all of our MSR relate to agency mortgage loans. As of March 31, 2016, we own MSR with a fair value of $316,176. The following table provides further information regarding our MSR portfolio:

We have entered into repurchase agreements to finance most of our securities. Our repurchase agreements are secured by our securities and bear interest at rates that have historically moved in close relationship to LIBOR. As of March 31, 2016, we had established 36 borrowing relationships with various investment banking firms and other lenders. We had an outstanding balance under our repurchase agreements at March 31, 2016 of $11.4 billion with 26 counterparties. We had an outstanding balance of $13.4 billion at December 31, 2015 with 25 different counterparties.

During the third quarter of 2015, we began funding a portion of our securities with Federal Home Loan Bank of Atlanta (the “FHLB”) advances and a portion of our mortgage loans with warehouse lines of credit, as discussed further under “Liquidity Sources—Borrowings.” At March 31, 2016, we had $63,615 of borrowings outstanding under warehouse lines of credit, which are collateralized by the mortgage loans financed thereon. The $14,132 of borrowings outstanding with the FHLB as of December 31, 2015 was repaid in January 2016. Based on the current status of Federal Housing Finance Agency(“FHFA”) rulemaking, we will be

required to surrender our membership in the FHLB in 2016. We do not expect the new regulations to materially adversely affect our core business and operations.

We generally intend to hedge, on an economic basis, as much of our interest rate risk as our manager deems prudent in light of market conditions. No assurance can be given that our hedging activities will have the desired beneficial impact on our results of operations or financial condition. Our policies do not contain specific requirements as to the percentages or amount of interest rate risk that our manager is required to hedge.

Interest rate hedging may fail to protect or could adversely affect us because, among other things:

As of March 31, 2016, we had 21 interest rate swap agreements with 8 counterparties to hedge (on an economic basis) a benchmark interest rate – LIBOR. This portfolio of hedges is designed to lock in funding costs for specific funding activities associated with specific assets as a way to realize attractive net interest margins. This hedging strategy incorporates an assumed prepayment schedule, which, if not realized, will cause our results to differ from expectations. These swap agreements provide for fixed interest rates indexed off of one-month LIBOR and effectively fix the floating interest rates on $4.0 billion of borrowings under our repurchase agreements. We also use Eurodollar Futures Contracts (“Futures Contracts”), which are based on three month LIBOR, as part of our strategy to mitigate interest rate risk. The effective notional amounts and rates of our interest rate swaps and Futures Contracts as of March 31, 2016 were as follows:

Effective Dates	Wtd.-Avg. Futures Contract Notional		Wtd.-Avg. Futures Contracts Rate			Wtd.-Avg. Swap Notional		Wtd.-Avg. Swap Rate			Total		Wtd.-Avg. Rate
2Q 2016		9,147,000		1.69	%		3,800,000		0.92	%		12,947,000		1.46	%
3Q 2016		8,146,000		1.92	%		3,200,000		0.91	%		11,346,000		1.64	%
4Q 2016		8,020,000		2.17	%		2,600,000		0.90	%		10,620,000		1.86	%
2017		7,256,750		2.76	%		1,125,000		0.90	%		8,381,750		2.51	%
2018		5,771,000		3.28	%		50,000		0.96	%		5,821,000		3.26	%
2019		2,317,250		3.33	%		-		-			2,317,250		3.33	%
2020		1,257,250		4.02	%		-		-			1,257,250		4.02	%
2021		292,000		3.98	%		-		-			292,000		3.98	%

If the rates on our repurchase agreements do not move in tandem with LIBOR, we will be less effective at fixing this cost and our results will differ from expectations.

We also enter into swaptions as a method to offset a portion of the volatility in the value of our interest-earning portfolio. As of March 31, 2016, we had four interest rate swaptions outstanding:

Two of the swaps held as of December 31, 2015 expired during the first quarter of 2016.

The following table includes non-GAAP financial measures. See the section on non-GAAP measures under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” for important information about these non-GAAP measures and reconciliations to the most comparable GAAP measures.

	(Unaudited)
	Three Months Ended March 31
	2016			2015
Statement of Income Data
Total interest income	$	71,137		$	87,117
Total interest expense		(22,746	)		(27,314	)
Net interest margin		48,391			59,803

Other income (loss):
Servicing income		18,882			-
Management fee income		1,400			-
Net realized gain (loss) on sale of securities		4,287			16,453
Net gain (loss) on mortgage loans, MSR and other		(34,189	)		244
Net gain (loss) on derivative instruments		(92,494	)		(102,785	)
Total other loss		(102,114	)		(86,088	)

Expenses:
Servicing expenses		(2,665	)		-
Securitization deal costs		(72	)		-
Other operating expenses		(14,705	)		(8,250	)
Total expenses		(17,442	)		(8,250	)

Net income (loss)		(71,165	)		(34,535	)
Dividends on preferred stock		(5,480	)		(5,481	)
Net income (loss) available to common shareholders	$	(76,645	)	$	(40,016	)

Comprehensive income (loss) available to common shareholders	$	(41,965	)	$	48,697

Earnings (loss) per share of common stock, basic and diluted	$	(0.81	)	$	(0.41	)

Comprehensive income (loss) per share available to common shareholders, basic and diluted	$	(0.44	)	$	0.50

Weighted average shares outstanding, basic and diluted		94,850,791			96,783,199

Dividends per common share	$	0.45		$	0.50

Selected Balance Sheet Data
Interest-earning portfolio	$	12,518,207		$	17,048,305
Total assets	$	14,094,505		$	18,036,268
Borrowings	$	11,543,519		$	15,108,538
Shareholders' equity	$	2,045,371		$	2,422,142

Key Statistics ⁽¹⁾
Average interest-earning portfolio	$	13,708,102		$	17,049,114
Average borrowings	$	12,588,970		$	15,482,427
Average equity	$	2,099,287		$	2,442,640
Average interest-earning portfolio yield ⁽²⁾		2.06	%		2.03	%
Average cost of funds ⁽³⁾		0.72	%		0.71	%
Interest rate spread ⁽⁴⁾		1.34	%		1.32	%
TBA dollar roll income	$	17,602		$	23,155
Average TBA dollar roll position	$	3,294,832		$	4,027,774
Average interest-earning yield, including TBA dollar roll income ⁽⁵⁾		2.08	%		2.08	%
Effective interest expense ⁽⁶⁾	$	45,411		$	42,792
Effective cost of funds ⁽⁶⁾		1.44	%		1.11	%
Effective net interest margin ⁽⁷⁾	$	43,328		$	67,480
Effective interest rate spread ⁽⁸⁾		0.64	%		0.97	%
Core earnings ⁽⁹⁾	$	35,894		$	53,749
Core earnings per share, basic and diluted⁽⁹⁾	$	0.38		$	0.56
Average annual securities portfolio repayment rate ⁽¹⁰⁾		20.84	%		21.04	%
Debt to equity (at period end) ⁽¹¹⁾	5.6:1			6.2:1
Debt to paid-in capital (at period end) ⁽¹²⁾	4.2:1			5.5:1
Effective debt to equity (at period end) ⁽¹³⁾	7.4:1			8.1:1

In addition to our results presented in accordance with GAAP, the discussions of our results of operations and liquidity and capital resources include certain non-GAAP financial information. The non-GAAP measures we employ are 1) effective interest expense, 2) effective net interest margin, 3) core earnings and core earnings per share, and financial metrics derived from these non-GAAP measures, such as effective cost of funds and effective leverage. We use these measures internally to assess our results and financial condition. Therefore, we believe that providing these measures gives users of financial information additional clarity regarding our performance and financial condition and better enables them to see “through the eyes of management.”

We define effective interest expense as our interest expense determined in accordance with GAAP, adjusted to exclude reclassification of deferred swap losses included in interest expense subsequent to our termination of hedge accounting, to include interest rate swap monthly net settlements subsequent to our termination of hedge accounting, and to include swap equivalent gains and losses related to our Futures Contracts.

We similarly define effective net interest margin as our net interest margin determined in accordance with GAAP, adjusted to exclude reclassification of deferred swap losses included in interest expense subsequent to our termination of hedge accounting, to include interest rate swap monthly net settlements subsequent to our termination of hedge accounting, to include swap equivalent gains and losses related to our Futures Contracts, and to include TBA dollar roll income.

We define core earnings as our effective net interest margin (as defined above) plus MSR income net of amortization, management fee income and gain from mortgage loans held for sale, less adjusted operating expenses (which exclude transaction costs, amortization of intangible assets and change in representation and warranty reserve) and dividends on preferred stock.

Amortization on MSR represents the portion of the change in MSR fair value that is attributable to the realization of cash flows, and is a non-GAAP measure because we account for MSR at fair value, not at amortized cost.

We believe that our presentation of effective interest expense, effective net interest margin and core earnings provide a better basis for understanding our results of operations.

We define our average cost of funds as our total net interest expense (including hedges) determined in accordance with GAAP divided by our average balance outstanding under our repurchase agreements and dollar roll liability computed from our books and records, using daily weighted values. Similarly, we define effective cost of funds as our total effective interest expense divided by our average balance outstanding under our repurchase agreements and dollar roll liability computed from our books and records, using daily weighted values.

These measures involve differences from results computed in accordance with GAAP, and should be considered supplementary to, and not as a substitute for, our results computed in accordance with GAAP. None of the non-GAAP measures we present represents cash provided by operating activities determined in accordance with GAAP, and none is a measure of liquidity or an indicator of our ability to pay cash dividends. Further, our definitions of these non-GAAP measures may not be comparable to similarly-titled measures of other companies, and therefor comparative analysis may be difficult. Reconciliations of each non-GAAP measure to its nearest directly comparable measure calculated in accordance with GAAP are included below.

Please see “Summary Financial Data” for definitions of other metrics we use below, including average portfolio yield and average portfolio repayment rate.

The performance of our investments are significantly affected by the actions of large central banks, primarily the U.S. Federal Reserve. Due to economic conditions in the United States and abroad, the U.S. Federal reserve has taken actions to keep U.S. interest rates at extraordinarily low levels for a significant amount of time. Uncertainty around the timing and amount of increases has influenced our decisions regarding our strategy in two primary ways. First, we have focused on diversifying into new asset classes that are either less sensitive to interest rates in general or will perform well in times of rising rates. Second, we have been decreasing our leverage so that increases in rates will have less impact on our results.

During 2015, we made substantial progress in our efforts to diversify our investment portfolio to include jumbo ARM whole mortgage loans and MSR. As of March 31, 2016, the UPB and the fair value of our mortgage loans held for investment were $353.5 million and $361.6, respectively, inclusive of mortgage loans held by a consolidated financing entity (“CFE”). In December 2015, we completed our first securitization of jumbo whole loans. We retained approximately 75% of the beneficial interests issued by the securitization trust, thereby retaining the credit exposure therein within our portfolio. See Note 6 of our consolidated financial statements, contained in this report, for further information regarding whole mortgage loans owned as of March 31, 2016 and December 31, 2015.

In August 2015, our wholly owned subsidiary, Wind River TRS LLC, purchased Pingora, a specialized asset manager focused on investing in new-production performing MSR and master-servicing residential mortgage loans sourced primarily from direct, ongoing relationships with loan originators. PAM is a registered investment advisor and PLS is an approved servicer with Fannie Mae, Freddie Mac and Ginnie Mae that is managed by PAM. Pingora currently manages an MSR portfolio of approximately $78 billion UPB including approximately $47 billion UPB managed for unrelated third-party investors.

In conjunction with our acquisition of Pingora, we began investing in MSR. As of March 31, 2016 we have investments in MSR with a fair value of $316.2 million. Over time, we expect that incorporating MSR into our investment portfolio will benefit us in several ways, including further improvement to the risk profile of our balance sheet by providing an income generating asset with a fair value that is inversely correlated to interest rates and our interest-earning portfolio. See Note 7 of our consolidated financial statements, contained in this report, for further information.

Even with the diversification activities described above, the primary drivers of our comprehensive income for the near term continue to be 1) our net investment income, and 2) the net impact of changes in the fair value of our earning assets and of our hedging instruments, both of which are driven primarily by changes in interest rates. However, we anticipate growth within our residential whole mortgage loan and MSR initiatives in the coming years, with servicing income, in particular, expected to become a larger percentage of our earnings.

Our summarized results of operations for the three month periods ended March 31, 2016 and 2015, along with related key metrics, were as follows:

	Three Months Ended
	March 31
	2016			2015			Change

Total interest income	$	71,137		$	87,117			-18	%
Interest expense		(22,746	)		(27,314	)		17	%
Net interest margin		48,391			59,803			-19	%

Other income (loss):
Servicing income		18,882			-		NM
Management fee income		1,400			-		NM
Net realized gain on sale of securities		4,287			16,453			-74	%
Net gain (loss) on mortgage loans, MSR and other		(34,189	)		244		NM
Net loss on derivative instruments		(92,494	)		(102,785	)		10	%
Total other loss		(102,114	)		(86,088	)		-19	%

Expenses:
Servicing expenses		(2,665	)		-		NM
Securitization deal costs		(72	)		-		NM
Operating expenses		(14,705	)		(8,250	)		-78	%
Total expenses		(17,442	)		(8,250	)		-111	%

Net loss		(71,165	)		(34,535	)		-106	%
Dividends on preferred stock		(5,480	)		(5,481	)		0	%
Net loss available to common shareholders	$	(76,645	)	$	(40,016	)		-92	%

Loss per share of common stock, basic and diluted	$	(0.81	)	$	(0.41	)		-95	%

Other comprehensive income	$	34,680		$	88,713			-61	%

Comprehensive income (loss) available to common shareholders	$	(41,965	)	$	48,697			-186	%

Comprehensive income (loss) per share available to common shareholders, basic and diluted	$	(0.44	)	$	0.50			-188	%

Core earnings	$	35,894		$	53,749			-33	%

Core earnings per share, basic and diluted	$	0.38		$	0.56			-32	%

Weighted average shares outstanding		94,850,791			96,783,199			-2	%

	Three Months Ended
	March 31
	2016			2015			Change
Gross interest income	$	90,080		$	114,233			-21	%
Net premium amortization on MBS		(18,943	)		(27,116	)		-30	%
Total interest income	$	71,137		$	87,117			-18	%

Average interest-earning portfolio	$	13,708,102		$	17,049,114			-20	%
Weighted-average coupon on securities		2.67	%		2.74	%		-3	%
Average interest-earning portfolio yield		2.06	%		2.03	%		2	%
Average annual securities portfolio repayment rate		20.84	%		21.04	%		27	%

The major drivers of our interest income are the coupons on our interest-earning investments, the size of our interest-earning portfolio, and the rate of principal repayments. The following are key components of the change between periods:

	Three Months Ended
	March 31
	2016			2015			Change
Borrowings	$	21,370		$	13,847			54	%
Swaps settlements and amortization		-			29			-100	%
Reclassification of deferred hedge loss		1,376			13,438			-90	%
Interest expense	$	22,746		$	27,314			-17	%

Effective interest expense	$	45,411		$	42,792			6	%

Average borrowings	$	12,588,970		$	15,482,427			-19	%
Average rate on borrowings		0.68	%		0.36	%		90	%
Average cost of funds		0.72	%		0.71	%		1	%
Effective cost of funds		1.44	%		1.11	%		30	%

The costs of financing we incur are primarily affected by the amount of our borrowings, the interest rates on those borrowings and the degree to which we hedge those rates. See “Reconciliations of Non-GAAP Measures” below for a reconciliation of interest expense to effective interest expense. The following are key components of the change between periods:

	Three Months Ended
	March 31
	2016			2015			Change
Net interest margin	$	48,391		$	59,803			-19	%
Effective net interest margin	$	43,328		$	67,480			-36	%

Average interest-earning portfolio yield		2.06	%		2.03	%		2	%
Average cost of funds		0.72	%		0.71	%		1	%
Average interest rate spread		1.34	%		1.32	%		2	%

Average interest-earning portfolio yield, including TBA dollar roll income		2.08	%		2.08	%		0	%
Effective cost of funds		1.44	%		1.11	%		30	%
Effective interest rate spread		0.64	%		0.97	%		-34	%

The most important metric of our earnings power is our net interest margin, or our “spread” when referred to in percentage form. Our spread, combined with our leverage, largely indicate our ability to earn distributable income. Our interest rate spread increased versus the prior year. See the discussions of total interest income and interest expense above for the key drivers of these changes. Effective net interest margin and effective interest rate spread include earnings from our TBA dollar roll securities, which are discussed under “Other Income (Loss)” below.

	Three Months Ended
	March 31
	2016			2015			Change
Other income (loss):
Servicing income	$	18,882		$	-		NM
Management fee income		1,400			-		NM
Net realized gain on sale of securities		4,287			16,453			-74	%
Net gain on mortgage loans		2,607			244			968	%
Net loss on mortgage servicing rights		(38,111	)		-		NM
Net loss on derivative instruments		(92,494	)		(102,785	)		-10	%
Net miscellaneous gains and losses		1,315			-		NM
Total other loss	$	(102,114	)	$	(86,088	)		19	%

Our other income (loss) has historically consisted of realized gains and losses on our securities and realized and unrealized gains and losses on derivative instruments. Beginning in the third quarter of 2015, other income also includes our earnings from MSR investments and other revenues from Pingora. With our election of the fair value option of accounting for mortgage loans in late 2014, and this same election for MSR and certain securities in 2015, fair value adjustments on these investments have become meaningful components of other income as well. Realized gains and losses on sale of securities and fair value adjustments on investments and derivatives tend to be uneven, varying with interest rates and other market movements and/or management actions to re-position our portfolio. The values of MSR and our derivative instruments are positively correlated with movements in interest rates, such that changes therein should serve to partially hedge changes in the value of our interest-earning portfolio. See Note 10 of our consolidated financial statements for further detail of the net loss on derivative instruments. The following are key components of the change in other income loss between periods:

We attempt to efficiently manage our expenses as they directly affect our return on investment. Our total expenses have grown in recent years due to initiatives to diversify our investment portfolio, as illustrated by the following:

	Three Months Ended
	March 31
	2016			2015			Change
Management fee	$	3,982		$	4,095			-3	%
Share-based compensation		1,293			1,045			24	%
Servicing expenses		2,665			-		NM
General and administrative		9,430			3,110			203	%
Securitization deal costs		72			-		NM
Total	$	17,442		$	8,250			111	%

Average equity	$	2,099,287		$	2,442,640			-14	%
Expenses as a percentage of average equity, annualized		3.32	%		1.35	%		146	%

Expenses by Asset Class:
Agency	$	8,841		$	7,585			17	%
Non-Agency		841			665			26	%
MSR		7,760			-		NM
Total	$	17,442		$	8,250			111	%

The reconciliation of core earnings and effective net interest margin to their nearest comparable GAAP measure, net interest margin, is as follows for the three months ended March 31, 2016 and 2015:

	Three Months Ended
	March 31
	2016			2015
Net interest margin	$	48,391		$	59,803
Reclassification of deferred swap losses included in interest expense		1,376			13,438
Interest rate swaps – monthly net settlements		(5,411	)		(21,423	)
Losses on maturing Futures Contracts		(18,630	)		(7,493	)
TBA dollar roll income		17,602			23,155
Effective net interest margin		43,328			67,480
Servicing income, net of amortization ⁽¹⁾		11,770			-
Management fee income		1,400			-
Net gain on mortgage loans held for sale ⁽²⁾		742			-
Net operating revenue		57,240			67,480
Total expenses ⁽³⁾		(15,866	)		(8,250	)
Dividends on preferred stock		(5,480	)		(5,481	)
Core earnings	$	35,894		$	53,749

⁽¹⁾ Reduced by $(7,112) of MSR fair value change that represents estimated amortization of the MSR asset for the three months ended March 31, 2016.

⁽²⁾ Excludes gain on mortgage loans held for investment of $1,865 for the three months ended March 31, 2016.

⁽³⁾ Excludes ($1,009) of transaction expenses and ($567) of amortization of intangible assets for the three months ended March 31, 2016.

The reconciliation of effective interest expense to its nearest comparable GAAP measure, interest expense, along with their respective cost of funds measures, is as follows for the three months ended March 31, 2016 and 2015:

	Three Months Ended March 31
	2016						2015
	Amount			% ⁽¹⁾			Amount			% ⁽¹⁾
Interest expense and cost of funds	$	22,746			0.72	%	$	27,314			0.71	%
Reclassification of deferred swap losses included in interest expense		(1,376	)		-0.04	%		(13,438	)		-0.35	%
Interest rate swaps – monthly net settlements		5,411			0.17	%		21,423			0.56	%
Losses on maturing Futures Contracts		18,630			0.59	%		7,493			0.19	%
Effective interest expense and effective cost of funds	$	45,411			1.44	%	$	42,792			1.11	%

Average borrowings	$	12,588,970					$	15,482,427

⁽¹⁾ Dollar amount on an annualized basis as a percentage of average borrowings.

We had the following contractual obligations under repurchase agreements as of March 31, 2016:

In addition, we had contractual commitments under interest rate swap agreements as of March 31, 2016. These agreements were for a total notional amount of $4.0 billion, had a weighted-average rate of 0.92% and a weighted average term of 11 months.

From time to time we may make forward commitments to purchase agency securities. The commitments generally require physical settlement with the sellers on settlement date, usually between 30 and 90 days from the date of trade. We purchase ARM TBA contracts and fixed-rate TBA contracts from dealers. ARM TBA contracts are not a frequently-traded security and are generally used to acquire MBS for the portfolio. Fifteen-year fixed TBA securities are a highly liquid security, and may be physically settled, net settled or traded as an investment. Fifteen-year TBA contracts may also be financed in the dollar roll market. We also purchase ARM agency securities and mortgage loans directly from loan originators. Such purchase commitments are entered into on a “best-efforts” basis, which allows for the fact that such originators cannot guarantee that the loans in their pipelines (or the resulting agency securities such loans will be packaged into, if applicable) will actually come to fruition. As of March 31, 2016, we had the following contractual obligations related to such forward purchases of investments:

As of March 31, 2016 and December 31, 2015, we did not maintain any relationships with unconsolidated entities or financial partnerships, such as structured finance, special purpose or variable interest entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, as of March 31, 2016 and December 31, 2015, we had not guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities.

As described in Note 2 of the Notes to Consolidated Financial Statements included elsewhere in this report, PLS has been determined to be a variable interest entity (“VIE”) and is structured into silos (separate pools of assets and liabilities). Owners of variable interests in a given PLS silo are entitled to all of the returns and risk of loss on the investments and operations in that silo and have no substantive recourse to assets contained in any other silo. Our consolidated financial statements exclude a PLS silo in which we have no variable interest.

As of March 31, 2016 and December 31, 2015, we had TBA dollar roll transactions outstanding with cost bases of $3,739,203 and $2,736,748, respectively. Forward purchase commitments and TBA dollar roll transactions represent off-balance sheet financing. Pursuant to ASC 815, Derivatives and Hedging, we account for these positions as derivative transactions and, consequently, they are not reflected in our on-balance sheet debt and leverage ratios.

Our primary sources of funds are borrowings under repurchase arrangements, warehouse lines, dollar roll transactions, and monthly principal and interest payments on our investments. Subject to restrictions under the Merger Agreement, other sources of funds may include proceeds from debt and equity offerings and asset sales. Since borrowings under most of our debt facilities are uncommitted, we maintain a large diverse set of counterparties in order to help increase our financial flexibility and ability to withstand periods of contracting liquidity in the credit markets. At March 31, 2016, we had uncommitted repurchase facilities with 36 lending counterparties to finance our portfolio, subject to certain conditions, and have borrowings outstanding with 26 of these counterparties. We also have three warehouse lines supporting our whole loan investment activities, as discussed further under “—Liquidity Sources—Borrowings—Warehouse Lines of Credit.”

We generally maintain liquidity to pay down our borrowings thereby reducing borrowing costs and otherwise efficiently managing our long-term investment capital. Because the level of these borrowings can be adjusted on a daily basis, the level of cash and cash equivalents carried on the 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 borrowings and the payment of cash dividends as required for continued qualification as a REIT.

As discussed in Note 15 of the Notes to Consolidated Financial Statements included elsewhere in this report, the Merger Agreement contains customary representations, warranties and covenants, including, among others, covenants to conduct our business in all material respects in the ordinary course of business consistent with past practice, subject to certain exceptions, during the period between the execution of the Merger Agreement and the consummation of the merger. Until the pending merger closes, or the Merger Agreement is terminated, we will be subject to various restrictions under the Merger Agreement on raising additional capital, issuing additional equity or debt, repurchasing equity or debt, and entering into certain acquisitions and dispositions, among other restrictions.

Our securities have values that fluctuate according to market conditions and, as discussed above, the market value of our securities will decrease as prevailing interest rates or credit spreads increase. When the value of the securities pledged to secure a loan decreases to the point where the positive difference between the collateral value and the loan amount fails to exceed a negotiated threshold (often referred to as 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 borrowing facilities, our lenders have full discretion to determine the value of the collateral we pledge to them. Lenders also issue margin calls each month when the new factors (amount of principal remaining on the securities pledged as collateral) and scheduled and unscheduled paydowns are published by the issuing agency.

Similar to the valuation margin calls that we receive on our borrowing agreements, we also receive margin calls on our derivative instruments when their value declines. This typically occurs when prevailing market rates change adversely, with the severity of the change also dependent on the term of the derivatives involved. The amount of any margin call will generally be dollar for dollar, on a daily basis. Our posting of collateral with our counterparties can be done in cash or securities, and is generally bilateral, which means that if the value of our interest rate hedges increases, our counterparty will post collateral with us.

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 securities, we may experience margin calls daily. In seeking to manage effectively 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 investments. If interest rates increase as a result of a yield curve shift or for another reason, such as if credit spreads widen, the prices of our collateral (and our unpledged assets that constitute our liquidity) will decline, we will likely experience margin calls, and we will use our liquidity to meet the 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. In addition, if we increase our borrowings, our liquidity will decrease by the amount of additional haircut on the increased level of indebtedness.

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 remain substantially invested. 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 could force us to liquidate assets into unfavorable market conditions and harm our results of operations and financial condition.

We have utilized repurchase facilities, lines of credit with financial institutions and advances from the FHLB as part of our financing strategy with the most significant being repurchase agreements.

The table below sets forth the average amount of borrowings outstanding during each quarter and the amount of borrowings outstanding as of the end of each quarter for the last three years. The amounts at a period end can be either above or below the average amounts for the quarter. We do not manage our portfolio to have a pre-designated amount of borrowings at quarter end. These numbers will differ as we implement our portfolio management strategies and risk management strategies over changing market conditions.

	Average Daily Borrowings		Borrowings at Period End		Highest Daily Borrowing Balance During Quarter		Lowest Daily Borrowing Balance During Quarter
March 31, 2016	$	12,604,504	$	11,543,519	$	13,575,629	$	11,519,114
December 31, 2015		13,963,798		13,575,722		14,982,707		13,520,444
September 30, 2015		14,807,631		14,288,113		15,098,710		14,266,407
June 30, 2015		15,071,081		14,993,065		15,273,283		14,961,293
March 31, 2015		15,482,427		15,108,538		15,873,532		14,982,204
December 31, 2014		15,235,739		15,759,831		15,817,877		14,920,959
September 30, 2014		14,806,602		14,920,959		15,034,614		14,607,060
June 30, 2014		15,349,322		15,019,880		15,641,652		15,019,880
March 31, 2014		15,685,392		15,183,457		16,129,683		15,085,150
December 31, 2013		17,464,981		16,129,683		18,832,650		16,119,555
September 30, 2013		21,989,907		18,829,771		23,495,767		18,829,771
June 30, 2013		22,701,463		23,077,252		23,429,222		22,383,758

With repurchase facilities being an integral part of our financing strategy, and thus our financial condition, full understanding of the repurchase market is necessary to understand the risks and drivers of our business. For example, we anticipate that, upon repayment of each borrowing under a repurchase agreement, we will use the collateral immediately for borrowing under a new repurchase agreement. While we have borrowing capacity under our repurchase facilities well in excess of what is required for our operations, these borrowing lines are uncommitted and generally do not provide long-term excess liquidity. Currently, we have not entered into any committed facilities under which the lender would be required to enter into new repurchase agreements during a specified period of time. As of March 31, 2016 and December 31, 2015, we had repurchase agreement borrowings outstanding of $11,419,354 and $13,443,883, respectively. As of March 31, 2016 and December 31, 2015, the weighted-average margin requirement, or the percentage amount by which the collateral value must exceed the loan amount (the haircut), under all our repurchase agreements, was approximately 4.3% and 4.4%, respectively (weighted by borrowing amount). This rate has remained fairly constant as lending conditions have been relatively stable.

We commonly receive margin calls from our lenders. We may receive margin calls daily, although we typically receive them once or twice per month. We receive margin calls under our repurchase agreements for two reasons. One of these is what is known as a “factor call” which occurs each month when the new factors (amount of principal remaining on the security) are published by the issuing agency, such as Fannie Mae. The second type of margin call we may receive is a valuation margin call. Both factor and valuation margin calls occur whenever the total value of our pledged assets drops beyond a threshold amount, which is usually between $100 and $250. This threshold amount is generally set by each counterparty and does not vary based on the notional amount of the repurchase agreements outstanding with that counterparty. Both of these margin calls require a dollar for dollar restoration of the margin shortfall. The total amount of our unpledged cash and cash equivalents, plus any unpledged securities, is available to

satisfy margin calls, if necessary. As of March 31, 2016 and December 31, 2015, we had approximately $0.9 billion and $1.1 billion, respectively in securities, short-term investments, cash and cash equivalents available to satisfy future margin calls. To date, we have maintained sufficient liquidity to meet margin calls, and we have never been unable to satisfy a margin call, although no assurance can be given that we will be able to satisfy requests from our lenders to post additional collateral in the future.

One risk to our liquidity is the collateral, or haircut, held by our lenders. In the event of insolvency by a repurchase agreement lender, our claim to our haircut becomes that of a general unsecured creditor. Because of this risk, we monitor the credit quality of our lenders and diversify our lenders to mitigate risk. Due to the varying stability of some sovereigns, part of our risk management includes regional monitoring. We have no direct exposure to any non-U.S. credit, but some of our lenders are subsidiaries of foreign-owned parents.

The following table shows our repurchase agreement counterparty exposure by region as of March 31, 2016:

⁽¹⁾ Exposure represent our total assets pledged as collateral in excess of our obligations, including any accrued interest receivable on the pledged asses.

We also have interest rate hedging relationships with subsidiaries of foreign-owned banks. We make cash payments or pledge securities as collateral as part of a margin arrangement in connection with these hedges that are in a loss position. In the event that a counterparty were to default on its obligation, we would be exposed to a loss to the extent that the amount of cash or securities pledged exceeded the unrealized loss on the associated swaps and we were not able to recover the excess collateral.

Management monitors our exposure to our repurchase agreement and interest rate swap counterparties on a regular basis, using various methods, including review of recent rating agency actions or other developments and by monitoring the amount of cash and securities collateral pledged and the associated loan amount under repurchase agreements and/or the fair value of the swaps with our counterparties. We intend to make reverse margin calls on our counterparties to recover excess collateral as permitted by the agreements governing our financing arrangements, or take other necessary actions to reduce the amount of our exposure to a counterparty when such actions are considered necessary.

An event of default or termination event under the standard master repurchase agreement would give our counterparty the option to terminate all repurchase transactions existing with us and require any amount due by us to the counterparty to be payable immediately. Our agreements for our repurchase facilities generally conform to the terms in the standard master repurchase agreement as published by the Securities Industry and Financial Markets Association (SIFMA) as to repayment, margin requirements and the segregation of all purchased securities covered by the repurchase agreement. In addition, each lender may require that we include supplemental terms and conditions to the standard master repurchase agreement that are generally required by the lender. Some of the typical terms which are included in such supplements and which supplement and amend terms contained in the standard agreement include changes to the margin maintenance requirements, purchase price maintenance requirements, the addition of a requirement that all controversies related to the repurchase agreement be litigated in a particular jurisdiction and cross default provisions. These provisions differ for each of our lenders.

We maintain three warehouse lines of credit in support of our whole loan investment activities: one related to mortgage loans held for investment and two related to mortgage loans held for sale. These lines of credit are with three different counterparties. They expire within one year and are collateralized by mortgage loans that we own. These borrowings are charged interest at a specified margin over the one-month LIBOR interest rate. At March 31, 2016, we had $63,615 of borrowings outstanding under our warehouse lines of credit, and $236,385 of unused borrowing capacity under these lines.

If the value of the underlying collateral (as determined by the counterparty) securing these borrowings decreases, we may be subject to margin calls during the period the borrowing is outstanding. To satisfy these margin calls, we may have to pledge additional collateral or repay portions of the borrowings.

During the third quarter of 2015, one of our wholly-owned subsidiaries became a member of the FHLB. FHLB offers a variety of products and services, including secured advances, which charge interest and a specified margin over the one-month LIBOR interest rate. At March 31, 2016, we had no borrowings outstanding with the FHLB, and $1 billion of unused borrowing capacity

under this facility. Based on the current status of FHFA rulemaking, we will be required to surrender our membership in the FHLB in 2016. We have no plans to utilize our FHLB membership beyond January 2016.

We also enter into dollar roll transactions as a source of financing for our investments. Dollar roll transactions represent a form of financing that may be on or off-balance sheet, depending on whether the financed security is a specified pool or a TBA contract. TBA contracts that are financed using dollar rolls transactions are accounted for as derivatives and shown on our balance sheet at net fair market value. Under certain market conditions it may be uneconomical for us to roll our TBA contracts and we may need to settle our obligations and take physical delivery of the underlying securities. If we were required to take physical delivery to settle a TBA contract, we would have to fund our total purchase commitment with cash or other financing sources and our liquidity position could be negatively impacted. Our TBA dollar roll transactions are also subject to margin requirements governed by our prime brokerage agreements. In the event of a margin call, we must generally provide additional collateral on the same business day. The table below sets forth information regarding the volume of dollar roll transactions (both specified pools and TBA contracts) during the quarters in which we have engaged in dollar roll transactions.

	Average Daily Dollar Roll Liability		Gross Dollar Roll Liability at Period End		Highest Daily Dollar Roll Balance During Quarter		Lowest Daily Dollar Balance During Quarter
March 31, 2016	$	3,294,832	$	3,849,083	$	3,849,083	$	2,714,754
December 31, 2015		2,732,180		2,730,705		2,737,774		2,723,165
September 30, 2015		3,559,674		2,723,165		3,846,630		2,723,165
June 30, 2015		4,307,588		3,846,630		4,455,020		3,846,630
March 31, 2015		4,027,774		4,455,020		4,681,289		3,518,289
December 31, 2014		3,687,748		3,518,289		3,741,918		3,518,289
September 30, 2014		3,257,935		3,718,924		3,718,924		2,961,749
June 30, 2014		3,393,046		2,961,749		3,549,363		2,961,749
March 31, 2014		2,935,689		3,159,801		3,699,859		1,037,879
December 31, 2013		1,275,595		1,037,879		2,134,370		-

The above table shows all dollar rolls at gross amounts, including dollar roll liabilities for both specified pools and TBAs. As discussed above, TBA dollar rolls represent off-balance sheet financing.

In addition to our repurchase facilities and dollar roll transactions, we also rely on follow-on securities offerings as a source of both short-term and long-term liquidity.

Subject to restrictions under the Merger Agreement, from time to time, we may sell shares of our common stock, preferred stock, debt securities, depositary shares or warrants under our Registration Statement on Form S-3 (No. 333-204935), which became effective upon filing with the SEC on June 12, 2015, including sales of common stock made in “at the market” offerings. In an “at the market” offering, sales of the shares of common stock, if any, may be made in private transactions, negotiated transactions or any method permitted by law deemed to be an “at the market” offering as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or to or through a market maker other than on an exchange.

No shares of common or preferred stock have been issued since 2012 other than shares issued under our equity incentive plans and in connection with our acquisition of Pingora.

On June 18, 2013, our board of directors authorized a stock repurchase program (the “Repurchase Program”) to acquire up to 10,000,000 shares of our common stock. During the first quarter of 2016, we repurchased 1,273,625 shares in at-the-market transactions at a total cost of $14,776. As of March 31, 2016, there is repurchase capacity available under the Repurchase Program of 4,697,645 shares. Subject to restrictions under the Merger Agreement, we are authorized by our board of directors to repurchase or offer to repurchase shares of common stock under the Repurchase Program and may repurchase additional shares from time to time as liquidity and market conditions permit.

Based on our current portfolio, leverage rate and available borrowing arrangements, we believe that our cash flow from operations and available borrowing capacity will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity

requirements such as to fund our investment activities, to pay fees under our management agreement, to fund our distributions to shareholders and for general corporate expenses.

Our ability to meet our long-term (greater than one year) liquidity and capital resource requirements will be subject to obtaining additional debt financing and equity capital. We may increase our capital resources by obtaining long-term credit facilities or making public or private offerings of equity or debt securities, possibly including classes of preferred stock, common stock, and senior or subordinated notes. Such financing will depend on market conditions for capital raises and for the investment of any proceeds. If we are unable to renew, replace or expand our sources of financing on substantially similar terms, it may have an adverse effect on our business and results of operations.

We generally seek to borrow (on a recourse basis) between six and 12 times the amount of our shareholders’ equity. Some of our agreements with our derivative counterparties contain restrictive financial covenants, including covenants limiting our leverage levels, the most restrictive of which provide that if we exceed a leverage ratio of 10 to 1, then we could be declared in default on the applicable derivative obligations. At March 31, 2016 and December 31, 2015, our total on-balance sheet borrowings were approximately $11.5 billion and $13.6 billion (excluding accrued interest), respectively, which represented a leverage ratio of approximately 5.6:1 and 6.3:1, respectively. Our effective leverage ratio (defined as our debt-to-shareholders equity ratio, including the effects of off-balance sheet TBA dollar roll liability) was approximately 7.4:1 and 7.6:1 as of March 31, 2016 and December 31, 2015, respectively.

Virtually all of our assets and liabilities are interest rate sensitive in nature. Although changes in expected inflation are an important determinant of changes in interest rates, the two are not perfectly correlated. Therefore, the impact of inflation on our balance sheet and operating results may be imperfect or lagging. As a result, interest rates and other factors directly influence our performance far more than inflation. Our financial statements are prepared in accordance with GAAP and any distributions we may make will be determined by our board of directors based in part on our REIT taxable income as calculated under the Code. In each case, our activities and balance sheet are measured with reference to fair value without considering inflation.

We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while providing an opportunity to shareholders to realize attractive risk-adjusted returns through ownership of our capital stock. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and we seek to actively manage that risk in order to earn sufficient compensation to justify taking the risks we undertake and to maintain capital levels consistent with taking such risks.

Interest rate risk is the primary component of our market risk. Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. We are subject to interest rate risk in connection with our investments and our related financing obligations.

Our operating results depend in large part on differences between the yields earned on our investments and the cost of our borrowing and hedging activities. The cost of our borrowings will generally be based on prevailing market interest rates. During periods of rising interest rates, our borrowing costs tend to increase while the income earned on our interest-earning portfolio may remain substantially unchanged until the interest rates reset. This results in a narrowing of the net interest spread between the assets and related borrowings and may even result in losses. The severity of any such decline would depend on our asset/liability composition at the time as well as the magnitude and duration of the interest rate increase. Further, an increase in short-term interest rates could also have a negative impact on the market value of our investments. If any of these events happen, we could experience a decrease in net income or incur a net loss during these periods, which could adversely affect our liquidity and results of operations.

We seek to mitigate interest rate risk through utilization of longer term repurchase agreements and hedging instruments, primarily interest rate swaps and Futures Contracts. These instruments are intended to serve as a hedge against future interest rate increases on our variable rate borrowings. Hedging techniques are partly based on assumed levels of prepayments of our interest-earning investments. If prepayments are slower or faster than assumed, the life of the investments will be longer or shorter, which would reduce the effectiveness of any hedging strategies we may use and may cause losses on such transactions. Hedging strategies involving the use of derivative securities are highly complex and may produce volatile returns. Hedging techniques are also limited by the rules relating to REIT qualification. In order to preserve our REIT status, we may be forced to terminate a hedging transaction at a time when the transaction is most needed.

The ARMs that underlie our adjustable-rate MBS and the mortgage loans we invest in directly are typically subject to periodic and lifetime interest rate caps and floors, which limit the amount by which the security’s interest rate may change during any given period. However, our borrowing costs pursuant to our financing agreements will not be subject to similar restrictions. Therefore, in a period of increasing interest rates, interest rate costs on our borrowings could increase without limitation, while the interest-rate increases on our adjustable-rate and hybrid MBS and mortgage loans could effectively be limited by caps. MBS backed by ARMs may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This could result in our receipt of less cash from such investments than we would need to pay the interest cost on our related borrowings. These factors could lower our net interest margin or cause a net loss during periods of rising interest rates, which would harm our financial condition, cash flows and results of operations.

We fund and hedge a substantial portion of our acquisition of interest-earnings investments with borrowings that are based on, or move similarly to, LIBOR. The interest rates on our adjustable-rate MBS and mortgage loans are generally indexed to LIBOR or another index rate, such as the one-year CMT rate. However, our borrowing rate may increase relative to LIBOR or one-year CMT rates thus resulting in an increase in our borrowing costs that is not matched by a corresponding increase in the interest earnings on these investments. Any such interest rate index mismatch could adversely affect our profitability, which may negatively impact distributions to our shareholders. To seek to mitigate interest rate mismatches, we may utilize the hedging strategies discussed above.

Our analysis of risks is based on our manager’s experience, estimates and assumptions, including estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of investment decisions by our manager may produce results that differ significantly from our manager’s estimates and assumptions.

The majority of our assets are subject to prepayment risk. As we receive repayments of principal on our interest-bearing assets (MBS and mortgage loans) from prepayments and scheduled payments, premiums paid on such securities are amortized against interest income and discounts are accreted to interest income. Premiums arise when we acquire assets at prices in excess of the principal balance of these interest-bearing asset. Conversely, discounts arise when we acquire assets at prices below the principal balance of the asset. To date, most of our interest-bearing assets have been purchased at a premium.

For financial accounting purposes, interest income is accrued based on the outstanding principal balance of the investment securities and their contractual terms. In general, purchase premiums on investment securities are amortized against interest income over the lives of the securities using the effective yield method, adjusted for actual prepayment and cash flow activity. An increase in the principal repayment rate will typically accelerate the amortization of purchase premiums and a decrease in the repayment rate will typically slow the accretion of purchase discounts, thereby reducing the yield/interest income earned on such assets.

Our MSR assets are also subject to prepayment risk. The amount of servicing revenue that we receive is determined by multiplying the underlying UPB of the mortgage loans times the contractual servicing fee. When the mortgages underlying the MSR repay faster than our estimates, we will earn less than we expected when we purchased the MSR, and may even lose money. Conversely, when the underlying mortgage loans repay slower than our estimates, our rate of return on the MSR increases.

We invest in MBS that are either fixed-rate or backed by hybrid ARMs and in mortgage loans which have interest rates that are fixed for the early years of the loan (typically three, five, seven or 10 years) and thereafter reset periodically. We compute the projected weighted-average life of our portfolio based on assumptions regarding the rate at which the borrowers will prepay the underlying mortgage loans. In general, when investments are acquired with borrowings, we may, but are not required to, enter into an interest rate swap agreement or other hedging instrument that effectively fixes our borrowing costs for a period close to the anticipated weighted-average life of the fixed-rate portion of the related investments. This strategy is designed to protect us from rising interest rates by fixing a portion of our borrowing costs for the duration of the fixed-rate period of the investment.

We may structure our interest rate hedges to expire in conjunction with the estimated weighted average life of the fixed period of the mortgage loans underlying our MBS. However, in a rising interest rate environment, the weighted average life of the mortgage loans underlying our MBS could extend beyond the term of the interest rate swap or other hedging instrument. This is sometimes referred to as “tail risk.” This could have a negative impact on our results from operations, as borrowing costs would no longer be fixed after the term of the hedging instrument while the income earned on the remaining MBS would remain fixed for a period of time. This situation may also cause the market value of our investments to decline, with little or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.

Another component of interest rate risk is the effect changes in interest rates will have on the market value of our investments. We face the risk that the market value of our investments will increase or decrease at different rates than that of our liabilities, including our hedging instruments.

We primarily assess our market value interest rate risk by estimating the effective duration of our assets relative to the effective duration of our liabilities. Effective duration essentially measures the market price volatility of financial instruments as interest rates change. We generally estimate effective duration using various financial models and empirical data. Different models and methodologies can produce different effective duration estimates for the same securities.

The sensitivity analysis tables presented below show the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments (“portfolio value”) and net annual interest margin, at March 31, 2016 and December 31, 2015, assuming a static portfolio. When evaluating the impact of changes in interest rates on net interest margin, prepayment assumptions and principal reinvestment rates are adjusted based on our manager’s expectations. The analysis presented utilized assumptions, models and estimates of the manager based on the manager’s judgment and experience.

While the charts above reflect the estimated immediate impact of interest rate increases and decreases on a static portfolio, we rebalance our portfolio from time to time either to seek to take advantage of or reduce the impact of changes in interest rates. It is important to note that the impact of changing interest rates on portfolio value and net interest margin can change significantly when interest rates change beyond 100 basis points from current levels. Therefore, the volatility in the market value of our assets could increase significantly when interest rates change beyond amounts shown in the table above. In addition, other factors impact the portfolio value of and net interest margin from our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, portfolio value and net interest margin would likely differ from that shown above, and such difference might be material and adverse to our shareholders.

The above table quantifies the potential changes in net interest margin and portfolio value, which includes the value of interest rate swaps, interest rate swaptions, and Eurodollars Futures Contracts should interest rates immediately change. Given the low level of short-term interest rates at March 31, 2016 and December 31, 2015, we applied a floor of 0%, for all anticipated interest rates included in our assumptions. Due to presence of this floor, it is anticipated that any hypothetical interest rate decrease would have a limited positive impact on our funding costs beyond a certain level; however, because prepayments speeds are unaffected by this floor, it is expected that any increase in our prepayment speeds (occurring as a result of any interest rate decrease or otherwise) could result in an acceleration of our premium amortization and the reinvestment of such prepaid principal in lower yielding assets. As a result, the presence of this floor limits the positive impact of any interest rate decrease on our funding costs.

To the extent consistent with maintaining our REIT status, we seek to manage our interest rate risk exposure to protect our portfolio and related debt against the effects of major interest rate changes. We generally seek to manage our interest rate risk by:

Although we do not believe that we are exposed to credit risk in our agency MBS portfolio, we are exposed to credit risk through our credit-sensitive residential mortgage investments, in particular non-agency MBS and residential whole loans, and to a lesser extent our investments in MSR and CRT securities. Our exposure to credit risk from our credit sensitive investments is discussed in more detail as follows:

Non-agency MBS and Residential Whole Loans – We are also exposed to credit risk from our investments in residential whole loans. We believe that our investment strategy will generally keep our risk of credit losses low to moderate. However, we intend to retain the risk of potential credit losses on all of the loans underlying the non-agency securities we originate and on our mortgage loans. With respect to our non-agency securities, credit support contained in MBS deal structures provide a level of protection from losses. We seek to manage the remaining credit risk through our pre-acquisition due diligence process, and by factoring assumed credit losses into the purchase prices we pay for non-agency securities and mortgage loans. In addition, with respect to any particular target asset, we evaluate relative valuation, supply and demand trends, the shape of yield curves, prepayment rates, delinquency and default rates, recovery of various sectors and vintage of collateral. We further mitigate credit risk in our mortgage loan portfolio through (1) selecting servicers whose specialties are well matched against the underlying attributes of the mortgage borrowers contained in the loan pools, and (2) an actively managed internal servicer oversight and surveillance program. At times, we may enter into credit default swaps or other derivative instruments in an attempt to manage our credit risk. Nevertheless, unanticipated credit losses could adversely affect our operating results.

CRT Securities – We are exposed to potential credit losses from our investments in CRT securities issued by Fannie Mae and Freddie Mac. While CRT securities are debt obligations of these GSEs, payment of principal on these securities is not guaranteed. As an investor in a CRT security, we may incur a loss if the loans in the associated reference pool experience delinquencies exceeding specified thresholds or other specified credit events occur. We assess the credit risk associated with our investment in CRT securities by assessing the current performance of the loans in the associated reference pool.

MSR – We are exposed to potential credit losses on our MSR. While the underlying loans are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae, when we take ownership of the MSR we inherit potential liabilities regarding the representation and warranties of the original loans. While we generally have recourse to the originator for these defects, there is no assurance that we can collect any amounts we are due. Further, if the borrower were to default during this process, we may be forced to purchase and service the loan pending our recovery from the originator. We manage these risks by maintaining a strong approval process for our originators, and by doing extensive oversight of their processes and our sub-servicers performance.

We maintain disclosure controls and procedures to ensure that material information relating to us is made known to the officers who certify our financial reports and to the members of senior management and the board of directors.

Based on management’s evaluation as of March 31, 2016, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act) are effective to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

There was no change to our internal control over financial reporting during the quarter ended March 31, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Our company and our manager are not currently subject to any material legal proceedings.

Other than as set forth below, there have been no material changes from the risk factors disclosed in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the SEC on February 24, 2016.

The risk factors previously disclosed in our annual report on Form 10-K for the year ended December 31, 2015 are updated by adding the risk factors below which we are including in this report as a result of our entering into the Merger Agreement on April 10, 2016, as further described above:

There may be unexpected delays in the completion of the merger, or the merger may not be completed at all.

The merger is currently expected to close by the end of the third quarter of 2016, assuming that all of the conditions in the Merger Agreement are satisfied or waived. The Merger Agreement provides that either we or Annaly, may terminate the Merger Agreement if the merger has not occurred by January 10, 2017. Certain events may delay the completion of the merger or result in a termination of the Merger Agreement. Some of these events are outside the control of either party. In particular, completion of the merger requires the satisfaction of the conditions precedent to consummation of the proposed transaction, including two-thirds of the outstanding shares of our common stock being validly tendered in the exchange offer. We may incur significant additional costs in connection with any delay in completing the merger or termination of the Merger Agreement, in addition to significant transaction costs, including legal, financial advisory, accounting, and other costs we have already incurred. We can neither assure you that the conditions to the completion of the merger will be satisfied or waived or that any adverse change, effect, event, circumstance, occurrence or state of facts that could give rise to the termination of the Merger Agreement will not occur, and we cannot provide any assurances as to whether or when the merger will be completed.

Failure to complete the merger in a timely manner or at all could negatively affect our stock price and future business and financial results.

Delays in completing the merger or the failure to complete the merger at all could negatively affect our future business and financial results, and, in that event, the market price of our common stock may decline significantly, particularly to the extent that the current market price reflects a market assumption that the merger will be completed. If the merger is not completed for any reason, we will not achieve the expected benefits thereof and will be subject to several risks, including the diversion of management focus and resources from operational matters and other strategic opportunities while working to implement the merger, any of which could materially adversely affect our business, financial condition, results of operations and the value of our stock price.

Under the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to completing the merger. These restrictions may prevent us from pursuing certain strategic transactions, acquiring and selling assets, undertaking certain financing transactions and otherwise pursuing other actions that are not in the ordinary course of business, even if such actions could prove beneficial and may cause us to forego certain opportunities we might otherwise pursue absent the Merger Agreement. These restrictions may impede our growth which could negatively impact our revenue, earnings and cash flows. Additionally, the pendency of the merger may make it more difficult for us to effectively recruit, retain and incentivize key personnel and may cause distractions from our strategy and day-to-day operations for management.

Our shareholders electing to receive either the all-cash consideration or the all-stock consideration in the offer will be subject to proration to ensure that approximately 65.0% of the aggregate consideration in the offer will be paid in shares of Annaly common stock, and approximately 35.0% of the aggregate consideration in the offer will be paid in cash. Similarly, our shareholders electing to receive either the all-cash consideration or the all-stock consideration in the merger will be subject to proration to ensure that approximately 65.0% of the aggregate consideration in the merger will be paid in shares of Annaly common stock, and approximately 35.0% of the aggregate consideration in the merger will be paid in cash. Accordingly, some of the consideration a shareholder receives in the offer or the merger may differ from the type of consideration selected and such difference may be significant. This may result in, among other things, tax consequences that differ from those that would have resulted if a shareholder had received solely the form of consideration elected.

Our shareholders who receive Annaly common stock in the offer will become Annaly shareholders. Annaly common stock may be affected by different factors and Annaly shareholders will have different rights than our shareholders.

Upon consummation of the merger, our shareholders receiving shares of Annaly common stock will become shareholders of Annaly. Annaly’s business differs from that of our company, and Annaly’s results of operations and the trading price of Annaly common stock may be adversely affected by factors different from those that would affect our results of operations and stock price. In addition, holders of shares of Annaly common stock will have rights as Annaly shareholders that differ from the rights they had as our shareholders before the merger.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Maryland		26-1141886
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)
751 W. Fourth Street, Suite 400 Winston-Salem, North Carolina		27101
(Address of principal executive offices)		(Zip Code)

Large accelerated filer	x	Accelerated filer	¨

Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	¨

		Page
PART I	Financial Information
Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	32
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	57
Item 4.	Controls and Procedures	60
PART II	Other Information
Item 1.	Legal Proceedings	61
Item 1A.	Risk Factors	61
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	62
Item 3.	Defaults Upon Senior Securities	62
Item 4.	Mine Safety Disclosures	62
Item 5.	Other Information	62
Item 6.	Exhibits	63
	Signatures	64

	March 31,			December 31,
	2016			2015
Principal balance	$	11,717,636		$	13,935,533
Unamortized premium		311,245			381,851
Unamortized discount		(2,263	)		(2,263	)
Gross unrealized gains		142,143			143,490
Gross unrealized losses		(12,169	)		(46,994	)
Carrying value/estimated fair value	$	12,156,592		$	14,411,617

	March 31, 2016			December 31, 2015
		Portfolio			Portfolio
	Portfolio Range	Weighted Average		Portfolio Range	Weighted Average
Unpaid principal balance	$110 to $1,980	$	778	$116 to $1,987	$	804
Interest rate	2.63% to 4.00%		3.50%	2.63% to 4.00%		3.48%
Maturity	11/2044 to 4/2046	11/2045		11/2044 to 2/2046	10/2045
FICO score at loan origination	700 to 811	762		701 to 811	763
Loan-to-value ratio at loan origination	20% to 80%		71%	20% to 80%		71%

Class		Outstanding at May 3, 2016
Common Stock ($0.001 par value)		94,529,206

	March 31, 2016		December 31, 2015
Mortgage loans held-for-investment in securitization trusts	$	208,047	$	225,285
Accrued interest receivable and other assets		8,176		2,955
Total assets	$	216,223	$	228,240
Collateralized borrowings in securitization trusts	$	60,550	$	57,611
Accrued interest payable		125		133
Other liabilities		37		40
Total liabilities	$	60,712	$	57,784


	Three Months Ended
	March 31, 2016
Interest income	$	1,819
Interest expense		(406	)
Net interest margin		1,413
Gain on mortgage loans		1,201
Loss on collateralized borrowings		(358	)
Operating expenses		(26	)
Net income	$	2,230

	March 31, 2016			December 31, 2015
California		66	%		68	%
Washington		7	%		6	%
Texas		5	%		5	%
Illinois		3	%		3	%
All other		19	%		18	%
Total		100	%		100	%

	March 31, 2016				December 31, 2015
		Weighted-				Weighted-
Unobservable Input	Range	Average			Range	Average
Discount rate	2.8% - 3.1%		3.0	%	3.0% - 3.5%		3.3	%
Conditional refinance rate	14.6% - 21.5%		17.4	%	13.6% - 21.7%		16.4	%
Default rate	0% - 1.9%		0.4	%	0% - 2.1%		0.7	%
Loss severity	10.0% - 21.4%		13.3	%	10.5% - 22.2%		14.9	%

	March 31, 2016		December 31, 2015
Short-term investments	$	30,447	$	30,327
Debt security, held-to-maturity		15,000		15,000
Equity investments		6,017		6,603
Total other investments	$	51,464	$	51,930

	Notional Value
	Three Months Ended March 31
	2016			2015
Beginning of period	$	4,600,000		$	8,300,000
Expirations and terminations		(600,000	)		(1,000,000	)
End of period	$	4,000,000		$	7,300,000

	Options						Underlying Swaps
Swaptions	Original Cost		Fair Value		Wtd. Avg. Months to Expiration		Notional		Wtd. Avg. Fixed Pay Rate		Receive Rate	Wtd. Avg. Term (Years)
Fixed payer	$	6,813	$	6		4	$	2,000,000		3.35%	3 month LIBOR		6

	Number of Contracts
	Three Months Ended March 31
	2016			2015
Beginning of period		108,824			130,074
New positions opened		1,773			20,518
Early settlements		(5,427	)		(13,268	)
Settlements at maturity		(9,712	)		(8,611	)
End of period		95,458			128,713

	Face / UPB		Cost		Fair Market Value		Net Asset (Liability)
ARMs - originators	$	173,605	$	177,117	$	178,699	$	1,582
Fixed-rate TBA dollar roll securities		3,617,000		3,739,204		3,757,772		18,568
Whole mortgage loans		14,010		14,003		14,054		51
Total purchase commitments	$	3,804,615	$	3,930,324	$	3,950,525	$	20,201


Hatteras Financial Corp., the parent company	Invests primarily in various types of residential mortgage assets with a focus on agency securities.
Onslow Bay Financial LLC	Wholly owned subsidiary formed to acquire, invest in, securitize and manage non-agency mortgage loans.
First Winston Securities, Inc.	Wholly owned subsidiary that operates as a broker-dealer, and is a member of the Financial Industry Regulatory Authority.
Wind River TRS LLC	Wholly owned subsidiary which invests in and manages MSR, both for us and for third parties, via its acquisition of Pingora Asset Management LLC (“PAM”) and Pingora Loan Servicing LLC (“PLS”).

As of	Book Value Per Share
March 31, 2016	$	18.60
December 31, 2015		19.38
September 30, 2015		19.69
June 30, 2015		21.06
March 31, 2015		22.05
December 31, 2014		22.05
September 30, 2014		22.30
June 30, 2014		22.23
March 31, 2014		21.81
December 31, 2013		21.50
September 30, 2013		21.31
June 30, 2013		22.18

	Face		Cost		Fair Market Value		Net Asset (Liability)
ARMs - originators	$	173,605	$	177,117	$	178,699	$	1,582
Fixed-rate TBA dollar roll securities		3,617,000		3,739,204		3,757,772		18,568
Total MBS purchase commitments	$	3,790,605	$	3,916,321	$	3,936,471	$	20,150


Underlying Loan Balances by Investor		UPB
	Fannie Mae	$	14,509,592
	Freddie Mac		5,495,212
	Ginnie Mae		11,033,653
	Other		5,691
		$	31,044,148

Average Loan Size		$	243

Weighted Average Coupon			3.99%
	<=3.5		11%
	3.5-4.0		45%
	4.0-4.5		38%
	>4.5%		6%

Average Loan-to-Value Ratio			82%

Average FICO Score			734

	March 31, 2016
	Balance		Weighted Average Contractual Rate			Contractual Interest Payments		Total Contractual Obligation
Within 30 days	$	10,669,354		0.66	%	$	3,982	$	10,673,336
31 days to 3 months		500,000		0.90	%		1,007		501,007
91 days to 6 months		250,000		0.79	%		645		250,645
	$	11,419,354		0.67	%	$	5,633	$	11,424,987

	Number of Counterparties		Exposure ⁽¹⁾		Exposure as a Percentage of Equity
Asia		5	$	94,865		4.6	%
Europe		7	$	100,566		4.9	%
North America		14	$	369,946		18.1	%
		26	$	565,377		27.6	%

Change in Interest rates	Percentage Change in Projected Net Interest Margin	Percentage Change in Projected Portfolio Value
+ 1.00%	18.17%	0.05%
+ 0.50%	10.13%	0.14%
- 0.50%	(4.15%)	(0.38%)
- 1.00%	(8.27%)	(0.92%)


Period	Total Number of Shares Purchased ⁽¹⁾	Average Price Paid per Share ⁽²⁾	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs ⁽³⁾
January 1, 2016 – January 31, 2016	1,273,625	$ 11.58	1,273,625	4,697,645
February 1, 2016 – February 29, 2016	-	$ -	-	4,697,645
March 1, 2016 – March 31, 2016	-	$ -	-	4,697,645
Total	1,273,625	$ 11.58	1,273,625	4,697,645

	HATTERAS FINANCIAL CORP.
Dated: May 3, 2016	BY:	/s/ KENNETH A. STEELE
		Kenneth A. Steele
		Chief Financial Officer, Treasurer and Secretary
		(Principal Financial Officer and Principal Accounting Officer)