Close

Form 10-Q CYS Investments, Inc. For: Sep 30

FREE Breaking News Alerts from StreetInsider.com!

E-mail Address

StreetInsider.com Top Tickers, 4/23/2024

1. TSLA
2. SPY
3. SPOT
4. GM
5. AMZN
6. SHW
7. AAPL
8. IBM
9. MINN
10. NVDA


October 23, 2014 1:51 PM EDT

�
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
�__________________________________
FORM 10-Q
�__________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September�30, 2014
OR
�
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ������������ to ������������.
Commission file number 001-33740
__________________________________
�CYS Investments, Inc.
(Exact name of registrant as specified in its charter)
__________________________________
Maryland
20-4072657
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
�
�
890 Winter Street, Suite 200
Waltham, Massachusetts
02451
(Address of principal executive offices)
(Zip Code)
(617) 639-0440
(Registrants telephone number, including area code)
__________________________________
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:
Large�accelerated�filer
x
Accelerated�filer
�
Non-accelerated filer
���(Do not check if a smaller reporting company)
Smaller�reporting�company
�
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 issuers classes of common stock, as of the latest practicable date.
Class
October�23, 2014
Common Stock ($0.01 par value)
162,013,913
�


__________________________________
Table of Contents
�


PART I. Financial Information
Item 1. ��������Financial Statements
CYS INVESTMENTS, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except per share numbers)
September�30, 2014
�
December�31, 2013*(a)
Assets:
�
�
�
Investments in securities, at fair value (including pledged assets of $10,953,155 and $11,835,975, respectively)
$
14,481,002

�
$
13,865,793

Derivative assets, at fair value
203,657

�
295,707

Cash
10,370

�
4,992

Receivable for securities sold and principal repayments
214,578

�
429,233

Interest receivable
36,158

�
36,731

Other assets
688

�
608

Total assets
$
14,946,453

�
$
14,633,064

Liabilities and stockholders' equity:
�
�
�
Liabilities:
�
�
�
Repurchase agreements
$
10,403,088

�
$
11,206,950

Derivative liabilities, at fair value
3,434

�
29,458

Payable for securities purchased
2,519,002

�
1,556,821

Payable for cash received as collateral
16,212

�
37,938

Distribution payable
53,008

�
4,410

Accrued interest payable (including accrued interest on repurchase agreements of $2,919 and $7,204, respectively)
28,874

�
24,613

Accrued expenses and other liabilities
5,109

�
4,218

Total liabilities
$
13,028,727

�
$
12,864,408

Stockholders' equity:
�
�
�
Preferred Stock, $25.00 par value, 50,000 shares authorized:
�
�
�
7.75% Series A Cumulative Redeemable Preferred Stock, (3,000 shares issued and outstanding, respectively, $75,000 in aggregate liquidation preference)
$
72,369

�
$
72,369

7.50% Series B Cumulative Redeemable Preferred Stock, (8,000 shares issued and outstanding, respectively, $200,000 in aggregate liquidation preference)
193,531

�
193,531

Common Stock, $0.01 par value, 500,000 shares authorized (161,995 and 161,650 shares issued and outstanding, respectively)
1,620

�
1,616

Additional paid in capital
2,049,507

�
2,046,530

Accumulated deficit
(399,301
)
�
(545,390
)
Total stockholders' equity
$
1,917,726

�
$
1,768,656

Total liabilities and stockholders' equity
$
14,946,453

�
$
14,633,064

__________________
*����Derived from audited financial statements.
(a)
Previously reported under specialized accounting, ASC 946  Financial Services  Investment Companies.� See Note 2 to interim consolidated financial statements.

See Notes to interim consolidated financial statements.



1

CYS INVESTMENTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
�
Three Months Ended September 30,
�
Nine�Months�Ended�September 30,
(In thousands, except per share numbers)
2014
�
2013(a)
�
2014
�
2013(a)
Interest income:
�
�
�
�
�
�
�
Interest income from Agency RMBS
$
74,052

�
$
85,599

�
$
219,658

�
$
238,691

Other interest income
3,080

�


�
13,819

�
1,477

Total interest income
77,132

�
85,599

�
233,477

�
240,168

Interest expense:
�
�
�
�
�
�
�
Repurchase agreement interest expense
7,657

�
11,969

�
24,669

�
41,047

Swap and cap interest expense
25,789

�
23,744

�
64,162

�
72,399

Total interest expense
33,446

�
35,713

�
88,831

�
113,446

Net interest income
43,686

�
49,886

�
144,646

�
126,722

Other income (loss):
�
�
�
�
�
�
�
Net realized gain (loss) on investments
40,470

�
(407,728
)
�
90,258

�
(572,466
)
Net unrealized gain (loss) on investments
(112,085
)
�
423,509

�
134,628

�
(146,859
)
Net realized gain (loss) on termination of swap and cap contracts


�
25,707

�
(15,327
)
�
41,666

Net unrealized gain (loss) on swap and cap contracts
58,909

�
(55,243
)
�
(22,512
)
�
183,720

Other income
50

�
37

�
219

�
120

Total other income (loss)
(12,656
)
�
(13,718
)
�
187,266

�
(493,819
)
Expenses:
�
�
�
�
�
�
�
Compensation and benefits
3,767

�
3,453

�
11,108

�
10,198

General, administrative and other
2,278

�
2,144

�
6,751

�
6,623

Total expenses
6,045

�
5,597

�
17,859

�
16,821

Net income (loss)
$
24,985

�
$
30,571

�
$
314,053

�
$
(383,918
)
Dividends on preferred stock
(5,203
)
�
(5,203
)
�
(15,609
)
�
(10,651
)
Net income (loss) available to common shareholders
$
19,782

�
$
25,368

�
$
298,444

�
$
(394,569
)
Net income (loss) per common share basic�& diluted
$
0.12

�
$
0.14

�
$
1.84

�
$
(2.29
)
Dividends declared per common share
$
0.30

�
$
0.34

�
$
0.94

�
$
1.00

____________
(a)
Previously reported under specialized accounting, ASC 946  Financial Services  Investment Companies.� See Note 2 to interim consolidated financial statements.
See Notes to interim consolidated financial statements.

2

CYS INVESTMENTS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
�
�
Cumulative Redeemable Preferred Stock
�
�
�
�
�
�
�
�
(in thousands)
�
Series A
�
Series B
�
Common Stock Par Value
�
Additional Paid-in Capital
�
Accumulated Deficit
�
Total
Balance, December 31, 2013
�
$
72,369

�
$
193,531

�
$
1,616

�
$
2,046,530

�
$
(545,390
)
�
$
1,768,656

Net income (loss)
�


�


�


�


�
314,053

�
314,053

Issuance of common stock
�


�


�
4

�
(4
)
�


�


Issuance of preferred stock
�


�


�


�


�


�


Amortization of share based compensation
�


�


�


�
3,405

�


�
3,405

Return of capital distributions
�


�


�


�
62

�
(62
)
�


Repurchase and cancellation of common stock
�


�


�


�
(486
)
�


�
(486
)
Preferred dividends
�


�


�


�


�
(15,609
)
�
(15,609
)
Common dividends
�


�


�


�


�
(152,293
)
�
(152,293
)
Balance, September 30, 2014
�
$
72,369

�
$
193,531

�
$
1,620

�
$
2,049,507

�
$
(399,301
)
�
$
1,917,726


See Notes to interim consolidated financial statements.

3

CYS INVESTMENTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
�
Nine�Months�Ended�September 30,
(In thousands)
2014
�
2013(a)
Cash flows from operating activities:
�
�
�
Net income (loss)
$
314,053

�
$
(383,918
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
�
�
�
Amortization of share based compensation
3,405

�
2,573

Amortization of premiums and discounts on investment securities
36,084

�
104,137

Amortization of premiums on interest rate cap contracts
15,853

�
17,985

Net realized (gain) loss on investments
(90,258
)
�
572,466

Net realized (gain) loss on termination of cap contracts
(6,563
)
�
(37,958
)
Net unrealized (gain) loss on investments
(134,628
)
�
146,859

Net unrealized (gain) loss on swap and cap contracts
22,512

�
(183,720
)
Change in assets and liabilities:
�
�
�
Interest receivable
573

�
7,785

Other assets
(80
)
�
(66
)
Accrued interest payable
4,260

�
(13,724
)
Accrued expenses and other liabilities
891

�
4,784

Net cash provided by (used in) operating activities
166,102

�
237,203

Cash flows from investing activities:
�
�
�
Purchase of investment securities
(25,140,605
)
�
(39,821,249
)
Premium paid on interest rate caps


�
(91,860
)
Proceeds from disposition of investment securities
23,765,066

�
43,280,830

Proceeds from termination of interest rate cap contracts
34,225

�
103,275

Proceeds from paydowns of investment securities
949,132

�
2,122,423

Change in assets and liabilities:
�
�
�
Receivable for securities sold and principal repayments
214,655

�
(734,148
)
Payable for securities purchased
962,181

�
(2,858,777
)
Payable for cash received as collateral
(21,726
)
�
6,578

Net cash provided by (used in) investing activities
762,928

�
2,007,072

Cash flows from financing activities:
�
�
�
Proceeds from repurchase agreements
61,394,222

�
99,827,406

Repayments of repurchase agreements
(62,198,084
)
�
(102,073,642
)
Net proceeds (payments) from issuance and repurchase of common stock
(486
)
�
(72,772
)
Net proceeds from issuance of preferred stock


�
193,550

Distributions paid
(119,304
)
�
(122,102
)
Net cash used in financing activities
(923,652
)
�
(2,247,560
)
Net increase (decrease) in cash
5,378

�
(3,285
)
Cash - Beginning of period
4,992

�
13,882

Cash - End of period
$
10,370

�
$
10,597

Supplemental disclosures of cash flow information:
�
�
�
Interest paid
$
68,719

�
$
116,079

Supplemental disclosures of non-cash flow information:
�
�
�
Distributions declared, not yet paid
$
53,008

�
$
61,149


4

___________
(a)
Previously reported under specialized accounting, ASC 946  Financial Services  Investment Companies.� See Note 2 to interim consolidated financial statements.

See Notes to interim consolidated financial statements.

5

CYS INVESTMENTS, INC.
NOTES TO CONDOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September�30, 2014
1. ORGANIZATION
CYS Investments, Inc. (the Company) was formed as a Maryland corporation on January�3, 2006, and commenced operations on February�10, 2006. The Company has elected to be taxed and intends to continue to qualify as a real estate investment trust (REIT) and is required to comply with the provisions of the Internal Revenue Code of 1986, as amended (the Code), with respect thereto. The Company has primarily purchased residential mortgage-backed securities that are issued and the principal and interest of which are guaranteed by a federally chartered corporation (Agency RMBS), such as the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac), or an agency of the U.S. government such as the Government National Mortgage Association (Ginnie Mae), and debt securities issued by the United States Department of Treasury ("U.S. Treasuries"). The Company may also purchase collateralized mortgage obligations issued by a government agency or government-sponsored entity that are collateralized by Agency RMBS ("CMOs"), or securities issued by a government sponsored entity that are not backed by collateral but, in the case of government agencies, are backed by the full faith and credit of the U.S. government, and, in the case of government sponsored entities, are backed by the integrity and creditworthiness of the issuer (U.S. Agency Debentures).
The Companys common stock, Series A Cumulative Redeemable Preferred Stock, $25.00 liquidation preference (the "Series A Preferred Stock"), and Series B Cumulative Redeemable Preferred Stock, $25.00 liquidation preference (the "Series B Preferred Stock"), trade on the New York Stock Exchange under the symbols CYS, "CYS PrA" and "CYS PrB," respectively.

2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) and the instructions to Securities and Exchange Commission ("SEC") Form 10-Q and Article 10, Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. 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. The interim consolidated financial statements should be read in conjunction with the Companys audited financial statements as of and for the year ended December�31, 2013, included in its Annual Report on SEC Form 10-K. The results for interim periods are not necessarily indicative of the results to be expected for the fiscal year.
The interim consolidated financial statements include the accounts of the Company and all of its subsidiaries. All intercompany balances and transactions have been eliminated. The interim consolidated financial statements of the Company have been prepared on the accrual basis of accounting in accordance with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires management to make a number of estimates and assumptions that affect the amounts reported in the interim consolidated financial statements and accompanying footnotes. Actual results could differ from these estimates and the differences may be material.
The Company adopted Financial Accounting Standards Board (FASB) Statement of Position (SOP) 07-1, Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for investments in Investment Companies, prior to its deferral in February 2008. Under SOP 07-1, the Company used financial reporting for investment companies, in accordance with FASB Accounting Standards Codification (ASC) 946, Investment Companies. Accounting Standards Update No. 2013-08, which was effective for the Company on January 1, 2014 required, among other things, that entities that adopted SOP 07-1 before the FASBs indefinite deferral assess whether they continue to be within the scope of ASC 946. The Company determined that REITs are excluded from the scope of ASC 946, and effective January 1, 2014, the Company discontinued use of investment company accounting on a prospective basis.
Reclassification and Presentation
Effective January 1, 2014, the Company discontinued its use of investment company accounting under ASC 946. Upon transition, the following changes and elections were made:
(i)
Investments are now presented as available-for-sale securities in accordance with ASC 320 Investments -- Debt and Equity Securities,

6

(ii)
Management elected the Fair Value Option (FVO) under ASC 825 -- Financial Instruments for all investments held. As a result of the FVO election, all changes in the fair value of investments held on January 1, 2014 will continue to be recorded in the Companys consolidated statements of operations, and
(iii)
The Company elected not to designate its derivatives as hedging instruments in accordance with ASC 815  Derivatives and Hedging. As a result, all changes in the fair value of derivative instruments held on January 1, 2014 will also continue to be recorded in the Companys consolidated statements of operations.
The discontinuation of investment company accounting under ASC 946 did not change the Companys accounting for any financial statement item, but rather changed the presentation of the Company's consolidated financial statements prospectively, the most significant of which are as follows:
(i)
the schedule of investments has been replaced with the available-for-sale tables in the footnotes,
(ii)
reformatted the statement of assets and liabilities to a consolidated balance sheet presentation,
(iii)
reformatted the consolidated statements of operations to include the statement of comprehensive income (loss), as applicable,
(iv)
removed the statement of changes in net assets and included the consolidated statement of changes in stockholders equity,
(v)
reformatted the statement of cash flows and included an investing section,
(vi)
changed certain footnotes to reflect conformity with applicable U.S. GAAP for non-investment companies,
(vii)
included summary information on the amortization/accretion of bond premium/discounts, and
(viii)
removed the financial highlights, as it is no longer required.

Beginning January 1, 2014, the Company reclassified its prior period consolidated financial statements to conform to the non-investment company financial statement presentation. This reclassification had no impact on the previously reported income, total assets and liabilities, net cash flows, or stockholders equity. On the statement of cash flows, cash from investing activities, which were previously included in cash flows from operating activities, have been separately classified as cash flows from investing activities.
Investments in Securities
The Company's investment securities are accounted for in accordance with ASC 320. The Company has chosen to make a fair value election pursuant to ASC 825 for its securities and, therefore, our investment securities are recorded at fair market value on the consolidated balance sheets. The periodic changes in fair market value are recorded in current period earnings on the consolidated statements of operations as a component of net unrealized gain (loss) on investments. These investments generally meet the requirements to be classified as available-for-sale under ASC 320, which requires the securities to be carried at fair value on the balance sheet. Electing the fair value option permits the Company to record changes in fair value of our investments in the consolidated statements of operations, which in managements view, more appropriately reflects the results of operations for a particular reporting period as all securities activities will be recorded in a similar manner.
The Company records its transactions in securities on a trade date basis. We record realized gains and losses on securities transactions on an identified cost basis.
Agency RMBS
The Companys investments in Agency RMBS consist of pass-through certificates backed by fixed-rate, monthly-reset adjustable-rate loans (ARMs) and hybrid ARMs, the principal and interest of which are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. Hybrid ARMs have interest rates that have an initial fixed period (typically three, five, seven or ten years) and thereafter reset at regular intervals in a manner similar to ARMs.
Forward Settling Transactions
The Company engages in forward settling transactions to purchase certain securities. The Company records forward settling transactions on the trade date, and maintains security positions such that sufficient liquid assets will be available to make payment on the settlement date for the securities purchased. The Agency RMBS purchased at the forward settlement date are typically priced at a discount to securities for settlement in the current month. Securities purchased on a forward settling basis are carried at fair value and begin earning interest on the settlement date. Gains or losses may occur on these transactions due to changes in market conditions or the failure of counterparties to perform under the contract. Along with other forward settling transactions, the Company transacts in to-be-announced (TBA) securities. As with other forward settling transactions, a seller agrees to issue TBAs at a future date; however, the seller does not specify the particular securities to be delivered. Instead, the Company agrees to accept any security that meets specified terms such as issuer, interest rate and terms of underlying mortgages. The Company records TBAs on the trade date utilizing information associated with the specified

7

terms of the transaction as opposed to the specific mortgages. TBAs are carried at fair value and begin earning interest on the settlement date. Gains or losses may occur due to the fact that the actual underlying mortgages received may be more or less favorable than those anticipated by the Company.

At times, the Company may enter into TBA contracts as a means of investing in and financing Agency RMBS via 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 Company records such pair offs on a gross basis such that there is a sale of the original TBA and a subsequent purchase of a new TBA.�
Investment Valuation
The Company has a pricing committee responsible for establishing valuation policies and procedures, and reviewing and approving valuations at a monthly pricing meeting. The pricing committee is composed of individuals from the accounting team, the investment team and senior management.
Agency RMBS, Agency Debentures and U.S. Treasuries are generally valued based on prices provided by third party services, as derived from such services pricing models. Inputs to the models may include, but are not limited to, reported trades, executable bid and asked prices, broker quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. The pricing services may also use a matrix approach, which considers information regarding securities with similar characteristics to determine the valuation for a security.
We generally value interest rate swaps and caps using prices provided by broker quotations. Such broker quotations are based on the present value of fixed and projected floating rate cash flows over the term of the swap contract. Future cash flows are discounted to their present value using swap rates provided by electronic data services or by brokers. No credit valuation adjustments were made in determining the fair value of the Company's interest rate swaps and caps.
Fair values of long-lived assets, including real estate, are primarily derived internally, and are based on inputs observed from sales transactions of similar assets. For real estate, fair values are also based on discounted cash flow estimates which reflect current and projected lease profiles and available industry information about capitalization rates and expected trends in rents and occupancy.��
All valuations we receive from third party pricing services or broker quotes are non-binding. We review all prices. To date, the Company has not adjusted any of the prices received from third party pricing services or brokers. Our pricing review includes comparisons of similar market transactions, alternative third party pricing services and broker quotes, or comparisons to a pricing model. To ensure the proper fair value hierarchy, the Company reviews the third party pricing services methodology periodically to understand whether observable or unobservable inputs are being used. See Note 8, Fair Value Measurements, for a discussion of how the Company values its assets.
Interest Income
We record interest income and expense on an accrual basis. We accrue interest income based on outstanding principal amount of the securities and their contractual terms. We amortize premium and discount using the effective interest method, and this net amortization is either accretive to or a reduction of interest income from Agency RMBS in the Company's consolidated statements of operations. The Company does not estimate prepayments when calculating the yield to maturity on Agency RMBS. We record the amount of premium or discount associated with a prepayment through interest income from Agency RMBS on our consolidated statements of operations as it occurs.
Repurchase Agreements
Repurchase agreements are borrowings collateralized by the Companys Agency RMBS and U.S. Treasuries and carried at their amortized cost, which approximates their fair value due to their short-term nature (generally 30-90 days). The Companys repurchase agreement counterparties are institutional dealers in fixed income securities. Collateral under repurchase agreements is valued daily and counterparties may require additional collateral when the fair value of the collateral declines. Counterparties have the right to sell or repledge collateral pledged under repurchase agreements. See Note 5, Repurchase Agreements.

8

Interest Rate Swap and Cap Contracts
The Company uses interest rate swaps and interest rate caps to hedge a portion of its exposure to market risks, including interest rate risk, credit risk and extension risk. The objective of our risk management strategy is to reduce fluctuations in stockholders equity over a range of interest rate scenarios. In particular, we attempt to mitigate the risk of the cost of our variable rate liabilities increasing during a period of rising interest rates.
During the term of an interest rate swap or cap, the Company makes or receives periodic payments and records unrealized gains or losses as a result of marking the swap and cap to their fair value. When the Company terminates a swap or cap, we record a realized gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Companys cost basis in the contract, if any. We report the periodic payments and amortization of premiums on cap contracts under interest expense in the consolidated statements of operations. Swaps involve a risk that interest rates will move contrary to the Companys expectations, thereby increasing the Companys payment obligation.
The Company's interest rate swap and cap contracts are subject to master netting arrangements. The Company is exposed to credit loss in the event of non-performance by the counterparty to the swap or cap limited to the fair value of collateral posted in excess of the fair value of the contract in a net liability position and the shortage of the fair value of collateral posted for the contract in a net asset position. As of September�30, 2014 and December�31, 2013, the Company did not anticipate non-performance by any counterparty. Should interest rates move unexpectedly, the Company may not achieve the anticipated benefits of the interest rate swap or cap and may realize a loss.

While the Companys derivative agreements generally permit for netting or setting off derivative assets and liabilities with the counterparty, the Company reports related assets and liabilities on a gross basis in our consolidated balance sheets. Derivative instruments in a gain position are reported as derivative assets at fair value and derivative instruments in a loss position are reported as derivative liabilities at fair value in our consolidated balance sheets. We record changes in fair value of our derivative instruments in net unrealized gain (loss) on swap and cap contracts in our consolidated statements of operations. Cash receipts and payments related to derivative instruments are classified in our consolidated statements of cash flows in accordance with U.S. GAAP in both the operating and investing activities sections in the Companys consolidated statement of cash flows. See Note 4, Investments in Interest Rate Swap and Cap Contracts.
Income Taxes
The Company has elected to be treated as a REIT under the Code.��The Company will generally not be subject to federal income tax to the extent that it distributes 90% 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.
Earnings Per Share (EPS)
We compute basic EPS using the two-class method by dividing net income (loss), after adjusting for the impact of unvested stock awards deemed to be participating securities, by the weighted-average number of common shares outstanding calculated excluding unvested stock awards. We compute diluted EPS by dividing net income (loss), after adjusting for the impact of unvested stock awards deemed to be participating securities, by the weighted-average number of common shares outstanding calculated excluding unvested stock awards, giving effect to common stock options and warrants, if they are not anti-dilutive. See Note 10, Earnings Per Share for EPS computations.


9

3. INVESTMENTS IN SECURITIES
In accordance with the discontinuation of investment company accounting under ASC 946, the Company was required to add the available-for-sale disclosures into this note. Those disclosures include (i) the table disclosing the amortized cost, gross unrealized gains, gross unrealized losses and fair value of available-for-sale investments, (ii) the table showing the gross gains and gross losses upon the sale of available-for-sale securities, and (iii) the table disclosing the unamortized premium and unamortized discount on available-for-sale securities. See Note 2, Significant Accounting Policies for more information on the impacts of the discontinuation of ASC 946.
The available-for-sale portfolio consisted of the following as of September�30, 2014 and December�31, 2013 (in thousands):����
September�30, 2014
�

�
�
�
�
�

Asset Type
�
Amortized Cost
�
Gross Unrealized Loss
�
Gross Unrealized Gain
�
Fair Value
Fannie Mae Certificates
�
�
�
�
�
�
�
�
Fixed Rate
�
$
10,894,736

�
$
(15,558
)
�
$
89,255

�
$
10,968,433

ARMs
�
1,345,757

�
(17,801
)
�
3,765

�
1,331,721

Total Fannie Mae
�
12,240,493

�
(33,359
)
�
93,020

�
12,300,154

Freddie Mac Certificates
�
�
�
�
�
�
�
�
Fixed Rate
�
1,030,950

�
(216
)
�
17,210

�
1,047,944

ARMs
�
502,735

�
(9,837
)
�
1,160

�
494,058

Total Freddie Mac
�
1,533,685

�
(10,053
)
�
18,370

�
1,542,002

Ginnie Mae Certificates - ARMs
�
73,398

�


�
2,353

�
75,751

U.S. Treasuries
�
556,274

�
(124
)
�


�
556,150

Other Investments
�
6,945

�


�


�
6,945

Total
�
$
14,410,795

�
$
(43,536
)
�
$
113,743

�
$
14,481,002

�
�
�
�
�
�
�
�
�
December�31, 2013
�
�
�
�
�
�
�
�
Fannie Mae Certificates
�
�
�
�
�
�
�
�
Fixed Rate
�
$
10,629,503

�
$
(72,295
)
�
$
45,660

�
$
10,602,868

ARMs
�
1,439,379

�
(27,277
)
�
2,796

�
1,414,898

Total Fannie Mae
�
12,068,882

�
(99,572
)
�
48,456

�
12,017,766

Freddie Mac Certificates
�


�
�
�
�
�


Fixed Rate
�
1,055,991

�
(7,083
)
�
6,231

�
1,055,139

ARMs
�
554,395

�
(15,701
)
�
1,334

�
540,028

Total Freddie Mac
�
1,610,386

�
(22,784
)
�
7,565

�
1,595,167

Ginnie Mae Certificates
�
�
�
�
�
�
�
�
Fixed Rate
�
158,792

�
(500
)
�


�
158,292

ARMs
�
85,211

�


�
2,412

�
87,623

Total Ginnie Mae
�
244,003

�
(500
)
�
2,412

�
245,915

Other Investments
�
6,945

�


�


�
6,945

Total
�
$
13,930,216

�
$
(122,856
)
�
$
58,433

�
$
13,865,793


10

The following table presents the gross unrealized loss and fair values of our available-for-sale Agency RMBS by length of time that such securities have been in a continuous unrealized loss position as of September�30, 2014 and December�31, 2013 (in thousands):
�
�
Unrealized loss positions for
�
�
Less than 12 Months
�
Greater than 12 months
�
Total
As of
�
Fair value
�
Unrealized loss
�
Fair value
�
Unrealized loss
�
Fair value
�
Unrealized loss
September�30, 2014
�
$
5,345,936

�
$
(9,363
)
�
$
1,718,373

�
$
(34,173
)
�
$
7,064,309

�
$
(43,536
)
December�31, 2013
�
$
8,415,016

�
(107,019
)
�
408,348

�
(15,837
)
�
8,823,364

�
(122,856
)
The following table is a summary of our net gain (loss) from the sale of available-for-sale investments for the three and nine months ended September�30, 2014 and 2013 (in thousands):
�
Three Months Ended September 30,
�
Nine�Months�Ended�September 30,
�
2014
�
2013
�
2014
�
2013
Available-for-sale investments, at cost
$
9,523,312

�
$
15,079,756

�
$
23,674,808

�
$
43,853,296

Proceeds from available-for-sale investments sold
9,563,782

�
14,672,028

�
23,765,066

�
43,280,830

Net gain on sale of available-for-sale investments
40,470

�
(407,728
)
�
90,258

�
(572,466
)
�
�
�
�
�
�
�
�
Gross gain on sale of available-for-sale investments
48,439

�
16,162

�
140,076

�
152,555

Gross loss on sale of available-for-sale investments
(7,969
)
�
(423,890
)
�
(49,818
)
�
(725,021
)
Net gain on sale of available-for-sale investments
$
40,470

�
$
(407,728
)
�
$
90,258

�
$
(572,466
)
The components of the carrying value of available-for-sale securities at September�30, 2014 and December�31, 2013 are presented below. The premium purchase price is due to the average coupon interest rates on these investments being higher than prevailing market rates, and conversely, the discount purchase price is due to the average coupon interest rates on these investments being lower than prevailing market rates.
(in thousands)
�
September�30, 2014
�
December�31, 2013
Principal balance
�
$
13,906,540

�
$
13,581,742

Unamortized premium
�
508,151

�
351,476

Unamortized discount
�
(3,896
)
�
(3,002
)
Gross unrealized gains
�
113,743

�
58,433

Gross unrealized losses
�
(43,536
)
�
(122,856
)
Fair value
�
$
14,481,002

�
$
13,865,793

As of September�30, 2014, the weighted-average coupon interest rate on the Company's Agency RMBS and U.S. Treasuries was 3.41% and 1.63%, respectively. As of December�31, 2013, the weighted-average coupon interest rate on the Company's Agency RMBS was 3.30%. Actual maturities of Agency RMBS are generally shorter than stated contractual maturities (which range up to 30 years), as they are affected by the contractual lives of the underlying mortgages, periodic payments and prepayments of principal. As of September�30, 2014, the range of final contractual maturity of the Companys Agency RMBS portfolio is between 2024 and 2044. As of September�30, 2014, the final maturity of the Company's U.S. Treasuries was 2019.
Credit Risk
CYS has minimal exposure to credit losses on its investment securities assets at September�30, 2014 and December�31, 2013 because it owns principally Agency RMBS and U.S. Treasuries. Principal and interest payments on Agency RMBS are guaranteed by Freddie Mac and Fannie Mae, while principal and interest payments on Ginnie Mae RMBS and U.S. Treasuries are backed by the full faith and credit of the U.S. government. In September 2008, both Freddie Mac and Fannie Mae were placed in the conservatorship of the U.S. government. On August�5, 2011, Standard�& Poors downgraded the U.S. governments credit rating for the first time to AA+. Fitch Ratings Inc. ("Fitch") announced on October 15, 2013 that it had

11

placed the U.S. government's credit rating on "negative watch"; this negative watch was changed to "stable" on March 21, 2014.
As of September 30, 2014, S&P has maintained its AA+ rating, while Fitch and Moody's rated the U.S. government AAA and Aaa, respectively. Because Fannie Mae and Freddie Mac are in U.S. government conservatorship, the implied credit ratings of Agency RMBS were similarly rated. While the conservatorship, ratings downgrade and ratings watch appear not to have had a significant impact on the fair value of the Agency RMBS or U.S. Treasuries in the Companys portfolio, these developments increased the uncertainty regarding the credit risk of Agency RMBS and U.S. Treasuries.

4. INVESTMENTS IN INTEREST RATE SWAP AND CAP CONTRACTS
In order to mitigate our interest rate exposure, the Company enters into interest rate swap and cap contracts. The Company had the following activity in interest rate swap and cap transactions during the three and nine months ended September�30, 2014 and 2013 (in thousands):
Three and Nine Months Ended September 30, 2014
�
Three and Nine Months Ended September 30, 2013
Trade�Date
�
Transaction
�
Notional
�
Trade�Date
�
Transaction
�
Notional
February 2014
�
Terminated
�
$
(500,000
)
�
February 2013
�
Opened
�
$
1,500,000

April 2014
�
Terminated
�
$
(1,100,000
)
�
March 2013
�
Terminated
�
$
(500,000
)
April 2014
�
Opened
�
$
500,000

�
March 2013
�
Opened
�
$
1,200,000

May 2014
�
Terminated
�
$
(300,000
)
�
April 2013
�
Opened
�
$
500,000

May 2014
�
Opened
�
$
300,000

�
May 2013
�
Opened
�
$
500,000

June 2014
�
Terminated
�
$
(550,000
)
�
May 2013
�
Matured
�
$
(100,000
)
June 2014
�
Opened
�
$
1,200,000

�
June 2013
�
Terminated
�
$
(700,000
)
July 2014
�
Opened
�
$
400,000

�
June 2013
�
Matured
�
$
(300,000
)
Net�Decrease
�
�
�
$
(50,000
)
�
July 2013
�
Matured
�
$
(300,000
)
�
�
�
�
�
�
August 2013
�
Terminated
�
$
(2,200,000
)
�
�
�
�
�
�
August 2013
�
Opened
�
$
500,000

�
�
�
�

�
Net Increase
�
�
�
$
100,000

As of September�30, 2014 and December�31, 2013, the Company had pledged Agency RMBS and U.S. Treasuries with a fair value of $61.5 million and $63.0 million, respectively, as collateral on interest rate swap and cap contracts. As of September�30, 2014, the Company had Agency RMBS and U.S. Treasuries of $149.9 million and cash of $16.0 million pledged to it as collateral for its interest rate swap and cap contracts. As of December�31, 2013, the Company had Agency RMBS and U.S. Treasuries of $211.4 million and cash of $37.9 million pledged to it as collateral for its interest rate cap contracts. Below is a summary of our interest rate swap and cap contracts open as of September�30, 2014 and December�31, 2013 (in thousands):
Derivatives not designated as hedging instruments under ASC 815
Interest Rate Swap Contracts
�
Notional�Amount
�
Fair�Value
�
Consolidated Balance Sheets
September�30, 2014
�
$
1,500,000

�
$
(3,434
)
�
Derivative liabilities, at fair value
September�30, 2014
�
6,150,000

�
65,595

�
Derivative assets, at fair value
December�31, 2013
�
2,050,000

�
(29,458
)
�
Derivative liabilities, at fair value
December�31, 2013
�
4,250,000

�
61,004

�
Derivative assets, at fair value
�
�
�
�
�
�
�
Interest Rate Cap Contracts
�
Notional Amount
�
Fair Value
�
Consolidated Balance Sheets
September�30, 2014
�
$
2,500,000

�
$
138,062

�
Derivative assets, at fair value
December�31, 2013
�
3,900,000

�
234,703

�
Derivative assets, at fair value

12

The following table presents information about the net realized and unrealized gain and loss on swap and cap contracts for the three and nine months ended September 30, 2014 and 2013 on the Company's interest rate swap and cap contracts not designated as hedging instruments under ASC 815 (in thousands):
�
�
�
�
Amount Recognized in Income on Derivatives
�
�
�
�
Three Months Ended September 30,
�
Nine�Months�Ended�September 30,
Derivative Type
�
Location�of�Gain or (Loss) Recognized in Income on Derivative
�
2014
�
2013
�
2014
�
2013
Interest rate swaps and caps
�
Net realized gain (loss) on termination of swap and cap contracts
�
$


�
$
25,707

�
$
(15,327
)
�
$
41,666

Interest rate swaps and caps
�
Net unrealized gain (loss) on swap and cap contracts
�
58,909

�
(55,243
)
�
(22,512
)
�
183,720

Interest rate swaps and caps
�
Total recognized in income on derivatives
�
$
58,909

�
$
(29,536
)
�
$
(37,839
)
�
$
225,386


5. REPURCHASE AGREEMENTS
The Company leverages its portfolio through repurchase agreement borrowings. Each of the Company's repurchase agreement borrowings bear interest at a floating rate based on a spread above or below LIBOR. The fair value of borrowings under repurchase agreements approximates their carrying amount due to the short-term nature of these financial instruments.
Certain information with respect to the Companys repurchase agreement borrowings outstanding at the balance sheet date is summarized in the table below. Each of the borrowings is contractually due in one year or less.
(in thousands)
September�30, 2014

�
December�31, 2013

Outstanding repurchase agreements
$
10,403,088

�
$
11,206,950

Interest accrued thereon
$
2,919

�
$
7,204

Weighted-average borrowing rate(1)
0.20
%
�
0.41
%
Weighted-average remaining maturity (in days)
42

�
40

Fair value of the collateral(2)
$
10,876,739

�
$
11,760,720

�__________________

(1)
The weighted-average borrowing rate as of September 30, 2014 was determined as set forth in the table below.
Collateral
Amount
�
Rate
Agency RMBS
$
9,849,569

�
0.33
�%
U.S. Treasuries
553,519

�
(2.20
)%
Total / weighted-average borrowing rate
10,403,088

�
0.20
�%

(2)
Collateral for repurchase agreements consisted of Agency RMBS and U.S. Treasuries.
Our weighted-average borrowing rate of 0.20% at September 30, 2014 was the result of a unique short-term borrowings environment at the end of September 2014. Due to excessive demand for U.S. Treasuries as repurchase agreement collateral at the end of the quarter, we experienced extremely attractive repurchase agreement funding by being paid 220 basis points to lend U.S. Treasuries overnight. Our weighted-average rate during the entire quarter was 0.30%.
At September�30, 2014 and December�31, 2013, the Company had no borrowings under repurchase agreements where the amount at risk with an individual counterparty exceeded 2% of stockholders' equity. In addition, we had no borrowings with any counterparty that exceeded 6% of our total borrowings.

6. COMMITMENTS AND CONTINGENCIES
The Company enters into certain contracts that contain a variety of indemnifications, principally with broker dealers. As of September�30, 2014 and December�31, 2013, no claims have been asserted under these indemnification agreements. Accordingly, the Company has no liabilities recorded for these agreements as of September�30, 2014 and December�31, 2013.

13

7. PLEDGED ASSETS
Our repurchase agreements and derivative contracts require us to fully collateralize our obligations under the agreements based upon our counterparties' collateral requirements and their determination of the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, credit quality and liquidity conditions within the investment banking, mortgage finance and real estate industries. In addition, obligations under our derivative agreements will typically vary over time based on similar factors as well as the remaining term of the derivative contract. We are also typically required to post initial margin ("IM") upon execution of derivative transactions, such as interest rate swaps and caps. If we breach any of these provisions, we will be required to fully settle our obligations under the agreements, which could include a forced liquidation of our pledged collateral.
Our repurchase agreement and derivative counterparties also apply a "haircut" to our pledged collateral, which means our collateral is valued at slightly less than market value and limits the amount we can borrow against our securities. This haircut reflects the underlying risk of the specific collateral and protects the counterparty against a change in its value. Our agreements do not specify the haircut; rather haircuts are determined on an individual transaction basis.
Consequently, the use of repurchase agreements and derivative instruments exposes us to credit risk relating to potential losses that could be recognized in the event that our counterparties fail to perform their obligations under such agreements. We minimize this risk by limiting our repurchase agreement and derivative counterparties to major financial institutions with acceptable credit ratings, or to a registered clearinghouse, and we closely monitor our positions with individual counterparties. In the event of a default by a counterparty, we may have difficulty obtaining our assets pledged as collateral to such counterparty and may not receive payments provided for under the terms of our derivative agreements. In the case of centrally cleared instruments, we could be exposed to credit risk if the central clearing agency or a clearing member defaults on its respective obligation to perform under the contract. However, we believe that this risk is minimal due to clearing exchange initial and daily mark-to-market margin requirements, clearinghouse guarantee funds, and other resources that are available in the event of a clearing member default.
Further, each of our International Standard Derivative Association (ISDA) agreements contains a cross default provision under which a default under certain of our other indebtedness in excess of a certain threshold causes an event of default under the agreement. Threshold amounts vary by lender. Following an event of default, we could be required to settle our obligations under the agreements. Additionally, under certain of our ISDA master agreements, we could be required to settle our obligations under the agreements if we fail to maintain certain minimum stockholders' equity thresholds or our REIT status or if we fail to comply with limits on our leverage above certain specified levels. As of September�30, 2014, the fair value of additional collateral that could be required to be posted as a result of the credit-risk-related contingent features being triggered was not material to our consolidated financial statements.
As of September�30, 2014, our amount at risk with any counterparty related to our repurchase agreements was less than 2% of our stockholders' equity, and our amount at risk with any counterparty related to our interest rate swap and cap agreements, excluding centrally cleared swaps, was less than 2% of our stockholders' equity.
Our collateral is generally valued on the basis of prices provided by recognized bond market sources agreed to by the parties. Inputs to the models used by pricing sources may include, but are not necessarily limited to, reported trades, executable bid and asked prices, broker quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. Our master agreements for repurchase transactions contain mostly standard provisions for the valuation of collateral. These agreements typically provide that both the repurchase seller (the borrower) and the repurchase buyer (the lender) value the collateral on a daily basis. Each party uses prices that it obtains from generally recognized pricing sources, or the most recent closing bid quotation from such a source. If the buyer, or the seller, as the case may be, determines that additional collateral is required, it may call for the delivery of such collateral. Under certain of our repurchase agreements, in limited circumstances, such as when a pricing source is not available, our lenders have the right to determine the value of the collateral we have provided to secure our repurchase borrowings. In instances where we have agreed to permit our lenders to make a determination of the value of such collateral, such lenders are expected to act reasonably and in good faith in making such valuation determinations.
Assets Pledged to Counterparties
The following tables summarize our assets pledged as collateral under our repurchase agreements and derivative agreements by type, including securities pledged related to securities purchased or sold but not yet settled, as of September�30, 2014 and December�31, 2013 (in thousands):

14

September�30, 2014
�
�
Assets Pledged to Counterparties
�
Repurchase Agreements
�
Derivative Instruments
�
Forward Settling Trades (TBAs)
�
Total
Agency RMBS - fair value
�
$
10,327,686

�
$
42,722

�
$
7,826

�
$
10,378,234

U.S. Treasuries - fair value
�
556,150

�
18,771

�


�
574,921

Accrued interest on pledged securities
�
28,298

�
289

�
19

�
28,606

Total
�
$
10,912,134

�
$
61,782

�
$
7,845

�
$
10,981,761

December�31, 2013
�
�
Assets Pledged to Counterparties
�
Repurchase Agreements
�
Derivative Instruments
�
Forward Settling Trades (TBAs)
�
Total
Agency RMBS - fair value
�
$
11,760,720

�
$
30,988

�
$
12,252

�
$
11,803,960

U.S. Treasuries - fair value
�


�
32,015

�


�
32,015

Accrued interest on pledged securities
�
31,539

�
93

�
30

�
31,662

Total
�
$
11,792,259

�
$
63,096

�
$
12,282

�
$
11,867,637

Assets Pledged from Counterparties
As the estimated fair value of our investment securities pledged as collateral increases due to changes in interest rates or other factors, we may require counterparties to release collateral back to us, which may be in the form of identical securities, similar securities, or cash. As of September�30, 2014 and December�31, 2013, we also had assets pledged to us as collateral under our repurchase and derivative agreements summarized in the tables below (in thousands):
September�30, 2014
�
�
Assets Pledged to CYS
�
Repurchase Agreements
�
Derivative Instruments
�
Forward Settling Trades (TBAs)
�
Total
Agency RMBS - fair value
�
$
3,557

�
$
113,176

�
$
424

�
$
117,157

U.S. Treasuries - fair value
�
3,540

�
36,695

�


�
40,235

Accrued interest on pledged securities
�
19

�
628

�
1

�
648

Cash
�


�
16,048

�
164

�
16,212

Total
�
$
7,116

�
$
166,547

�
$
589

�
$
174,252

December�31, 2013
�
�
Assets Pledged to CYS
�
Repurchase Agreements
�
Derivative Instruments
�
Forward Settling Trades (TBAs)
�
Total
Agency RMBS - fair value
�
$


�
$
163,386

�
$


�
$
163,386

U.S. Treasuries - fair value
�


�
48,036

�


�
48,036

Accrued interest on pledged securities
�


�
542

�


�
542

Cash
�


�
37,938

�


�
37,938

Total
�
$


�
$
249,902

�
$


�
$
249,902

Cash collateral received is recognized in "Cash" with a corresponding amount recognized in "Payable for cash received as collateral" on the accompanying interim consolidated balance sheets. Securities collateral received from counterparties is disclosed as a component of our liquidity amount in Note 4, "Investment in Interest Rate Swap and Cap Contracts".
Cash and Agency RMBS and U.S. Treasuries we pledge as collateral under our derivatives agreements is included in "Cash" and "Investment in securities, at fair value" on our consolidated balance sheets.
Offsetting Assets and Liabilities
Certain of our repurchase agreements and derivative transactions are governed by underlying agreements that generally provide for a right of set-off under master netting arrangements (or similar agreements), including in the event of default or in the event of bankruptcy of either party to the transactions. Under U.S. GAAP, if the Company has a valid right of

15

set-off, it may offset the related asset and liability and report the net amount. However, the Company reports amounts subject to its Master Repurchase Agreements (MRA) and ISDA agreements in the consolidated balance sheets on a gross basis without regard to such rights of offset.
At September�30, 2014 and December�31, 2013, the Company's derivative assets and liabilities (by type) are as follows (in thousands):
September�30, 2014
�
Assets
�
Liabilities
Interest rate swap contracts
�
$
65,595

�
$
3,434

Interest rate cap contracts
�
138,062

�


Total derivative assets and liabilities in the interim consolidated balance sheet
�
203,657

�
3,434

Derivatives not subject to a master netting agreement or similar agreement ("MNA")
�
15,250

�
150

Total assets and liabilities subject to a MNA
�
$
188,407

�
$
3,284

�
�
�
�
�
December�31, 2013
�
Assets
�
Liabilities
Interest rate swap contracts
�
$
61,004

�
$
29,458

Interest rate cap contracts
�
234,703

�


Total derivative assets and liabilities in the interim consolidated balance sheet
�
295,707

�
29,458

Derivatives not subject to a MNA
�
11,188

�
440

Total assets and liabilities subject to a MNA
�
$
284,519

�
$
29,018

Below is a summary of the Company's assets subject to offsetting provisions (in thousands):
�
�
�
�
�
�
Gross Amounts Not Offset in the Consolidated Balance Sheet
�
�
As of
�
Description
�
Amounts of Assets Presented in the Consolidated Balance Sheet
�
Instruments Available for Offset
�
Collateral Received(1)
�
Net Amount(2)
September�30, 2014
�
Derivative assets
�
$
188,407

�
$
2,616

�
$
160,889

�
$
24,902

December 31, 2013
�
Derivative assets
�
284,519

�
9,237

�
244,721

�
30,561

�_________________
(1)
Collateral consists of Agency RMBS, U.S. Treasuries and cash. Excess collateral received is not shown for financial reporting purposes.
(2)
Net amount represents the net amount receivable from the counterparty in the event of the counterparty's default.
Below is a summary of the Company's liabilities subject to offsetting provisions (in thousands):
�
�
�
�
�
�
Gross Amounts Not Offset in the Consolidated Balance Sheet
�
�
As of
�
Description
�
Amounts of Liabilities Presented in the Consolidated Balance Sheet
�
Instruments Available for Offset
�
Collateral Pledged(1)
�
Net Amount(2)
September�30, 2014
�
Derivative liabilities
�
$
3,284

�
$
2,616

�
$
668

�
$


September�30, 2014
�
Repurchase agreements
�
10,403,088

�


�
10,403,088

�


December 31, 2013
�
Derivative liabilities
�
29,018

�
9,237

�
19,781

�


December 31, 2013
�
Repurchase agreements
�
11,206,950

�


�
11,206,950

�


�_________________
(1)
Collateral consists of Agency RMBS, U.S. Treasuries and cash. Further detail of collateral pledged on repurchase agreements is disclosed in Note 5. Excess collateral pledged is not shown for financial reporting purposes.
(2)
Net amount represents the net amount payable to the counterparty in the event of the counterparty's default.


16

8. FAIR VALUE MEASUREMENTS

The Companys valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Companys market assumptions. ASC 820 -- Fair Value Measurements, classifies these inputs into the following hierarchy:
Level 1 InputsQuoted prices for identical instruments in active markets.
Level 2 InputsQuoted 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.
Level 3 InputsInstruments with primarily unobservable value drivers.
Excluded from the tables below are financial instruments carried in the consolidated financial statements at cost basis, which is deemed to approximate fair value, primarily due to the short duration of these instruments, including cash, receivables, payables and borrowings under repurchase arrangements with initial terms of 1 year or less. The fair value of these instruments is determined using level two inputs. The following tables provide a summary of the Companys assets and liabilities that are measured at fair value on a recurring basis as of September�30, 2014 and December�31, 2013 (in thousands):
September�30, 2014
Fair Value Measurements Using
�
Level�1
�
Level�2
�
Level�3
�
Total
Assets
�
�
�
�
�
�
�
Agency RMBS
$


�
$
13,917,907

�
$


�
$
13,917,907

U.S. Treasuries
556,150

�


�


�
556,150

Other Investments


�


�
6,945

�
6,945

Derivative assets


�
203,657

�


�
203,657

Total
$
556,150

�
$
14,121,564

�
$
6,945

�
$
14,684,659

Liabilities
�
�
�
�
�
�
�
Derivative liabilities
$


�
$
3,434

�
$


�
$
3,434

December�31, 2013
Fair Value Measurements Using
�
Level�1
�
Level�2
�
Level�3
�
Total
Assets
�
�
�
�
�
�
�
Agency RMBS
$


�
$
13,858,848

�
$


�
$
13,858,848

Other investments


�


�
6,945

�
6,945

Derivative assets


�
295,707

�


�
295,707

Total
$


�
$
14,154,555

�
$
6,945

�
$
14,161,500

Liabilities
�
�
�
�
�
�
�
Derivative liabilities
$


�
$
29,458

�
$


�
$
29,458

Other investments is comprised of real estate assets. The table below presents a reconciliation of changes in other investments classified as Level 3 in the Companys interim consolidated financial statements for the three and nine months ended September�30, 2014 and 2013.
Fair values of real estate assets are valued based on discounted cash flow models. A discussion of the method of fair valuing these assets is included above in Note 2, Significant Accounting Policies -- Investments in Securities -- Investment Valuation. The significant unobservable input used in the fair value measurement is capitalization rates, which the Company estimated to be between 4% and 5% at September�30, 2014 and December�31, 2013.��

17

Level 3 Fair Value Reconciliation
(In thousands)
Nine�Months�Ended�September 30,
Other investments
2014
�
2013
Beginning balance Level 3 assets
$
6,945

�
$
19,576

Cash payments recorded as a reduction of cost basis


�
(324
)
Change in net unrealized gain (loss)


�
(6,721
)
Net sales


�
(12,005
)
Net gain (loss) on sales


�
6,419

Transfers into (out of) Level 3


�


Ending balance Level 3 assets
$
6,945

�
$
6,945


9. SHARE CAPITAL
The Company has authorized 500,000,000 shares of common stock having par value of $0.01 per share. As of September�30, 2014 and December�31, 2013, the Company had issued and outstanding 161,994,611 and 161,650,114 shares of common stock, respectively.
The Company has authorized 50,000,000 shares of preferred stock having a par value of $0.01 per share. As of September�30, 2014 and December�31, 2013, 3,000,000 shares of 7.75% Series A Preferred Stock ($25.00 liquidation preference) were issued and outstanding. As of September�30, 2014 and December�31, 2013, 8,000,000 shares of 7.50% Series B Preferred Stock ($25.00 liquidation preference) were issued and outstanding. The Series A Preferred Stock and Series B Preferred Stock will not be redeemable before August 3, 2017 and April 30, 2018, respectively, except under circumstances where it is necessary to preserve the Company's qualification as a REIT, for federal income tax purposes or the occurrence of a change of control. On or after August 3, 2017 and April 30, 2018, the Company may, at its option, redeem any or all of the shares of the Series A Preferred Stock and Series B Preferred Stock, respectively, at $25.00 per share plus any accumulated and unpaid dividends to, but not including, the respective redemption date. The Series A Preferred Stock and Series B Preferred Stock have no stated maturity and are not subject to any sinking fund or mandatory redemption.
Equity Offerings
On April 30, 2013, the Company closed a public offering of 8.0 million shares of its Series B Preferred Stock, liquidation preference of $25.00 per share, for total net proceeds of approximately $193.5 million, after the underwriting discount and commissions and expenses.
����
On May 23, 2014, the Company filed an automatically effective shelf registration statement on SEC Form S-3 with the SEC. The Company may offer and sell, from time to time, shares of common stock, preferred stock and debt securities in one or more offerings pursuant to the prospectus that is a part of the registration statement. As of September�30, 2014, the Company had not issued any shares of common stock, preferred stock or debt securities under the prospectus.
Equity Placement Program (EPP)
Effective May 15, 2014, the Company terminated that certain Equity Distribution Agreement by and between the Company and JMP Securities LLC (JMP), dated as of June 7, 2011 (the JMP Agreement), in connection with the expiration of the Companys prior shelf registration statement on Form S-3. Under the JMP Agreement, the Company could offer and sell, from time to time, up to 15.0 million shares of the Companys common stock through an at the market offering program with JMP. For the nine months ended September�30, 2014 and 2013, the Company did not sell any shares of common stock under the JMP Agreement.
Dividend Reinvestment and Direct Stock Purchase Plan (DSPP)
The Company sponsors a dividend reinvestment and direct stock purchase plan through which stockholders may purchase additional shares of common stock by reinvesting some or all of the cash dividends received on shares of common stock. Stockholders may also make optional cash purchases of shares of common stock subject to certain limitations detailed in the plan prospectus. For the nine months ended September�30, 2014 and 2013 the Company did not issue any shares under the plan. As of September�30, 2014 and December�31, 2013, there were approximately 4.1 million shares available for issuance under the plan.


18

Share Repurchase Program
On November�15, 2012, the Company announced that its Board of Directors authorized the repurchase of shares of the Companys common stock having an aggregate value of up to $250 million. Pursuant to this program, the Company repurchased approximately $115.7 million in aggregate value of its shares of common stock on the open market. On July 21, 2014, the Company announced that its Board of Directors authorized the repurchase of shares of the Company's common stock having an aggregate value of up to $250 million, which included the approximately $134.3 million still available for repurchase under the November 2012 authorization. In July 2014, pursuant to the program, the Company repurchased 39,800 shares of its common stock in open market transactions with a weighted-average purchase price of $8.86 per share for $353,584. Accordingly, the Company still had approximately $249.6 million available to repurchase shares of its common stock as of September 30, 2014.
Restricted Stock Awards
For the nine months ended September�30, 2014 and 2013, the Company granted 0.4 million and 0.4 million shares of restricted stock, respectively, to certain of its directors, officers and employees.

10. EARNINGS PER SHARE
Components of the computation of basic and diluted EPS were as follows (in thousands except per share amounts):�
�
Three Months Ended September 30,
�
Nine�Months�Ended�September 30,
�
2014
�
2013
�
2014
�
2013
Net income (loss)
$
24,985

�
$
30,571

�
$
314,053

�
$
(383,918
)
Less preferred stock dividends
(5,203
)
�
(5,203
)
�
(15,609
)
�
(10,651
)
Net income (loss) available to common shareholders
19,782

�
25,368

�
298,444

�
(394,569
)
Less dividends paid:
�
�
�
�
�
�
�
Common shares
(48,307
)
�
(56,444
)
�
(151,344
)
�
(170,473
)
Unvested shares
(291
)
�
(295
)
�
(948
)
�
(884
)
Undistributed earnings (loss)
(28,816
)
�
(31,371
)
�
146,152

�
(565,926
)
Basic weighted-average shares outstanding:
�
�
�
�
�
�
�
Common shares
161,016

�
169,465

�
160,986

�
172,284

Basic earnings (loss) per common share:
�
�
�
�
�
�
�
Distributed earnings
$
0.30

�
$
0.33

�
$
0.94

�
$
0.99

Undistributed earnings (loss)
(0.18
)
�
(0.19
)
�
0.90

�
(3.28
)
Basic earnings (loss) per common share
$
0.12

�
$
0.14

�
$
1.84

�
$
(2.29
)
Diluted weighted-average shares outstanding:
�
�
�
�
�
�
�
Common shares
161,016

�
169,465

�
160,986

�
172,284

Net effect of dilutive stock options (1)


�


�


�


�
161,016

�
169,465

�
160,986

�
172,284

Diluted earnings (loss) per common share:
�
�
�
�
�
�
�
Distributed earnings
$
0.30

�
$
0.33

�
$
0.94

�
$
0.99

Undistributed earnings (loss)
(0.18
)
�
(0.19
)
�
0.90

�
(3.28
)
Diluted earnings (loss) per common share
$
0.12

�
$
0.14

�
$
1.84

�
$
(2.29
)
__________________
(1)
For the three and nine months ended September�30, 2014 and 2013, the Company had an aggregate of 131,088 stock options outstanding with a weighted-average exercise price of $30.00 that were not included in the calculation of EPS, as their inclusion would have been anti-dilutive. These instruments may have a dilutive impact on future EPS.




19

11. INVESTMENT COMPANY ACCOUNTING DISCLOSURES
The information in the tables below was required under investment company accounting for which the Company ceased to meet the criteria on January 1, 2014. However, as of December 31, 2013, the Company used investment company financial statement presentation under ASC 946 and the following schedules have been included to comply with ASC 946. See Note 2, Significant Accounting Policies for more information.

SCHEDULE OF INVESTMENTS
DECEMBER�31, 2013
INVESTMENTS IN SECURITIES  UNITED STATES OF AMERICA
�
�
�
�
(in thousands)
Face�Amount
�
Fair Value
Fixed Income Securities - 784.0% (c)
�
�
�
Mortgage Pass-Through Agency RMBS - 783.6% (c)
�
�
�
Fannie Mae Pools - 679.5% (c)
�
�
�
2.14%, due 2/1/2043�(a)(b)
$
87,600

�
$
87,892

2.15%, due 10/1/2042 (a)(b)
40,103

�
40,356

2.18%, due 11/1/2042 (a)(b)
29,015

�
29,160

2.25%, due 10/1/2042 - 11/1/2042 (a)(b)
84,755

�
85,399

2.33%, due 11/1/2042�(a)(b)
63,251

�
64,029

2.36%, due 1/1/2043 (a)(b)
83,235

�
84,181

2.40%, due 9/1/2042 - 10/1/2042 (a)(b)
51,272

�
51,974

2.41%, due 11/1/2042 (a)(b)
62,378

�
63,235

2.42%, due 9/1/2042 (a)(b)
19,388

�
19,677

2.43%, due 7/1/2042 - 1/1/2043�(a)(b)
215,819

�
219,176

2.44%, due 6/1/2042 (a)(b)
45,301

�
46,050

2.50%, due 10/1/2042 (a)(b)
76,110

�
77,442

2.52%, due 10/1/2042 (a)(b)
45,306

�
46,099

2.57%, due 8/1/2042 (a)(b)
29,496

�
30,079

2.60%, due 4/1/2042�(a)(b)
31,018

�
31,707

2.70%, due 6/1/2042 (a)(b)
55,666

�
57,043

2.78%, due 4/1/2042 (a)(b)
133,381

�
137,323

2.80%, due 2/1/2042 - 4/1/2042�(a)(b)
84,553

�
87,096

2.81%, due 2/1/2042 (a)(b)
25,550

�
26,361

2.84%, due 12/1/2041 (a)(b)
43,963

�
45,398

3.00%, due 2/1/2027 - 2/1/2029�(a)
4,839,617

�
4,943,083

3.00%, due 12/1/2037 (a)
51,087

�
48,558

3.00%, due 10/1/2042 (a)
42,107

�
39,556

3.05%, due 9/1/2041 (a)(b)
28,001

�
28,987

3.24%, due 3/1/2041 (a)(b)
11,485

�
11,969

3.37%, due 5/1/2041 - 8/1/2041 (a)(b)
34,796

�
36,423

3.50%, due 12/1/2025 - 1/1/2029 (a)
948,463

�
992,515

3.50%, due 6/1/2042 - 9/1/2043 (a)
1,872,351

�
1,862,400

3.97%, due 9/1/2039 (a)(b)
7,363

�
7,842

4.00%, due 1/1/2026 - 4/1/2026�(a)
229,778

�
243,561

4.00%, due 7/1/2043 - 2/1/2044 (a)
2,106,542

�
2,169,411

4.50%, due 4/1/2030 - 11/1/2030�(a)
84,730

�
90,796

4.50%, due 11/1/2041�(a)
200,955

�
212,988

Total Fannie Mae Pools
11,764,435

�
12,017,766

Freddie Mac Pools - 90.2% (c)
�
�
�

20

SCHEDULE OF INVESTMENTS
DECEMBER�31, 2013
INVESTMENTS IN SECURITIES  UNITED STATES OF AMERICA
�
�
�
�
(in thousands)
Face�Amount
�
Fair Value
2.20%, due 2/1/2043 (a)(b)
$
28,154

�
$
28,175

2.22%, due 12/1/2042 (a)(b)
42,719

�
42,887

2.30%, due 11/1/2042�(a)(b)
88,989

�
89,526

2.43%, due 6/1/2042�(a)(b)
$
34,581

�
$
35,224

2.44%, due 4/1/2043 (a)(b)
29,699

�
29,220

2.46%, due 7/1/2042 (a)(b)
39,112

�
39,771

2.52%, due 11/1/2042�(a)(b)
36,896

�
37,560

2.54%, due 7/1/2042�(a)(b)
33,904

�
34,563

2.55%, due 2/1/2043�(a)(b)
111,565

�
110,650

2.59%, due 3/1/2042�(a)(b)
29,871

�
30,638

2.79%, due 12/1/2041�(a)(b)
32,352

�
33,276

3.31%, due 1/1/2041 (a)(b)
27,151

�
28,537

3.50%, due 4/1/2026 - 2/1/2027 (a)
130,144

�
135,772

3.50%, due 5/1/2043 - 7/1/2043�(a)
428,429

�
425,633

4.00%, due 8/1/2043 - 2/1/2044 (a)
443,680

�
455,999

4.50%, due 12/1/2024 - 5/1/2025�(a)
35,497

�
37,736

Total Freddie Mac Pools
1,572,743

�
1,595,167

Ginnie Mae Pools - 13.9% (c)
�
�
�
3.00%, due 10/20/2028�(a)
154,038

�
158,293

3.50%, due 7/20/2040 (a)(b)
74,931

�
78,517

4.00%, due 1/20/2040 (a)(b)
8,650

�
9,105

Total Ginnie Mae Pools
237,619

�
245,915

Total Mortgage Pass-Through Agency RMBS (Cost - $13,923,271)
13,574,797

�
13,858,848

Other Investments - (Cost - $6,945) (d)�0.4% (c)
6,945

�
6,945

Total Investments in Securities (Cost - $13,930,216)
$
13,581,742

�
$
13,865,793

�
�
Interest Rate Cap Contracts - 13.3%(c)(e)
�
�
�
�
�
Expiration
Cap�Rate
�
Notional�Amount
�
Fair�Value
10/15/2015
1.43
%
�
$
300,000

�
$
164

11/8/2015
1.36
%
�
200,000

�
145

5/23/2019
2.00
%
�
300,000

�
12,853

6/1/2019
1.75
%
�
300,000

�
14,679

6/29/2019
1.50
%
�
300,000

�
16,539

7/2/2019
1.50
%
�
300,000

�
16,970

7/16/2019
1.25
%
�
500,000

�
31,335

3/26/2020
1.25
%
�
500,000

�
41,322

3/30/2020
1.25
%
�
700,000

�
57,785

5/20/2020
1.25
%
�
500,000

�
42,911

Total Interest Rate Cap Contracts (Cost, $137,117)
�
$
3,900,000

�
$
234,703

�





21


SCHEDULE OF INVESTMENTS
DECEMBER�31, 2013
INVESTMENTS IN SECURITIES  UNITED STATES OF AMERICA
(in thousands)
�
�
�
�
�
Interest Rate Swap Contracts - 1.8%(c)(e)
�
�
�
�
�
Expiration
Pay�Rate
�
Notional�Amount
�
Fair�Value
2/14/2015
2.15
%
�
$
500,000

�
$
(10,255
)
6/2/2016
1.94
%
�
300,000

�
(9,526
)
12/19/2016
1.43
%
�
250,000

�
(4,255
)
4/24/2017
1.31
%
�
500,000

�
(4,982
)
7/13/2017
0.86
%
�
750,000

�
6,583

9/6/2017
0.77
%
�
250,000

�
3,755

9/6/2017
0.77
%
�
500,000

�
7,407

9/6/2017
0.77
%
�
250,000

�
3,804

11/7/2017
1.11
%
�
500,000

�
3,240

11/29/2017
0.87
%
�
500,000

�
8,136

2/21/2018
1.02
%
�
500,000

�
7,948

2/27/2018
0.96
%
�
500,000

�
9,226

4/25/2018(f)
1.01
%
�
500,000

�
10,905

8/15/2018
1.65
%
�
500,000

�
(440
)
Interest Rate Swap Contracts (Cost, $0)
�
$
6,300,000

�
$
31,546

�__________________
�
(a)
Securities or a portion of the securities are pledged as collateral for repurchase agreements or interest rate swap contracts or forward settling transactions.
(b)
The coupon rate shown on floating or adjustable rate securities represents the rate at December�31, 2013.
(c)
Percentage of stockholders' equity.
(d)
Comprised of investments that were individually less than 1% of stockholders' equity.
(e)
The Companys interest rate swap contracts receive a floating rate set quarterly to three month LIBOR. Interest rate caps receive a floating rate quarterly in the amount of three month LIBOR that is in excess of the cap rate.
(f)
The interest rate swap effective date is April 25, 2014, and it does not accrue any income or expense until that date.


22

FINANCIAL HIGHLIGHTS
In accordance with financial reporting requirements applicable to investment companies, the Company has included below certain financial highlight information for the three and nine months ended September�30, 2013:
�
Per Common Share
�
Three Months Ended September 30, 2013
�
Nine Months Ended September 30, 2013
Net asset value, beginning of period
$
10.20

��
�
$
13.31

��
Net income (loss):
�
�
�
�
�
Net investment income
0.40

(a)��
�
1.05

(a)��
Net gain (loss) from investments and swap and cap contracts
(0.22
)
(a)��
�
(3.27
)
(a)��
Net income (loss)
0.18

���
�
(2.22
)
���
Dividends on preferred stock
(0.03
)
(a)��
�
(0.06
)
(a)��
Net income (loss) available to common shareholders
0.15

�
�
(2.28
)
�
Capital transactions:
�
�
�
�
�
Distributions to common stockholders
(0.34
)
�
�
(1.00
)
�
Issuance/Repurchase of common and preferred shares and amortization of share based compensation
0.09

(a)��
�
0.07

(a)��
Net decrease in net asset value from capital transactions
(0.25
)
�
�
(0.93
)
�
Net asset value, end of period
$
10.10

��
�
$
10.10

��
Net asset value total return (%)(d)
2.35
�%
(b)��
�
(16.60
)%
(b)��
Market value total return (%)
(8.02
)%
(b)��
�
(23.53
)%
(b)��
Ratios to Average Net Assets
�
�
�
�
�
Expenses before interest expense
1.13
�%
(c)��
�
1.01
�%
(c)��
Total expenses
3.55
�%
(c)��
�
3.47
�%
(c)��
Net investment income
13.77
�%
(c)��
�
10.92
�%
(c)��
�__________________
(a)
Calculated based on average shares outstanding during the period. Average shares outstanding include vested and unvested restricted shares and differs from weighted-average shares outstanding used in calculating EPS (see Note 3, Investments in Securities).
(b)
Not computed on an annualized basis.
(c)
Computed on an annualized basis.
(d)
May also be referred to as common book value total return.

12. SUBSEQUENT EVENTS
On October�1, 2014, an aggregate of 17,255 shares of restricted common stock were granted to certain directors as a portion of their compensation for serving on the Companys Board of Directors.
On October 16, 2014, the Company's Board of Directors elected Karen Hammond to serve as a Director and granted her 2,047 shares as compensation for serving on the Board.



23

Item 2. ��������Managements Discussion and Analysis of Financial Condition and Results of Operations

CYS Investments, Inc. (the "Company", "we", "us", and "our,") is a specialty finance company created with the objective of achieving consistent risk-adjusted investment income. Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to provide the reader of the Companys consolidated financial statements and accompanying notes with a narrative from management to provide its perspective on the business underlying those financial statements and its financial condition and results of operations during the periods presented. The Companys MD&A is comprised of five sections:

"
Executive Overview
"
Financial Condition
"
Results of Operations
"
Liquidity and Capital Resources and
"
Forward-Looking Statements
The following discussion should be read in conjunction with our unaudited consolidated financial statements and accompanying notes included in Item�1 of this Quarterly Report on SEC Form 10-Q, as well as our Annual Report on SEC Form 10-K for the fiscal year ended December�31, 2013, filed on February�14, 2014.

Executive Overview
We seek to achieve our objective of consistent risk-adjusted investment income by investing on a leveraged basis primarily in agency residential mortgage backed securities (Agency RMBS). These investments consist of residential mortgage pass-through securities for which the principal and interest payments are guaranteed by a government-sponsored enterprise, such as the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"), or by a U.S. government agency, such as the Government National Mortgage Association ("Ginnie Mae") (collectively referred to as "GSEs"). We may also invest in debt securities issued by the United States Department of Treasury (U.S. Treasuries) and, in addition, our investment guidelines permit investments in collateralized mortgage obligations issued by a government agency or GSE that are collateralized by Agency RMBS (CMOs), or securities issued by a GSE that are not backed by collateral but, in the case of government agencies, are backed by the full faith and credit of the U.S. government, and, in the case of GSEs, are backed by the integrity and creditworthiness of the issuer (U.S. Agency Debentures).
We commenced operations in February 2006, and completed our initial public offering in June 2009. Our common stock, our 7.75% Series A Cumulative Redeemable Preferred Stock, $25.00 liquidation preference (the "Series A Preferred Stock"), and our 7.50% Series B Cumulative Redeemable Preferred Stock, $25.00 liquidation preference (the "Series B Preferred Stock"), trade on the New York Stock Exchange under the symbols CYS, "CYS PrA" and "CYS PrB," respectively.
We earn income from our investment portfolio currently comprised principally of Agency RMBS and U.S. Treasuries. We currently fund our investments primarily through borrowings under repurchase agreements. We use leverage to seek to enhance our returns. Our net interest income is generated primarily from the net spread, or difference, between the interest income we earn on our investment portfolio and the cost of our borrowings and hedging activities. The amount of net interest income we earn on our investments depends in part on our ability to control our financing costs, which comprise a significant portion of our operating expenses. Although we leverage our portfolio investments in Agency RMBS and U.S. Treasuries to seek to enhance our potential returns, leverage also may exacerbate losses.
While we use hedging to attempt to mitigate some of our interest rate risk, we do not hedge all of our exposure to changes in interest rates. Our investments vary in interest rate and maturity compared with the rates and duration of the hedges we employ. As a result, it is not possible to insulate our portfolio from all potential negative consequences associated with changes in interest rates in a manner that will allow us to achieve attractive spreads on our portfolio. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income.
In addition to investing in issued pools of Agency RMBS, we regularly utilize forward settling transactions, including forward settling purchases of Agency RMBS where the pool is to-be-announced (TBA). Pursuant to a TBA, we agree to purchase, for future delivery, Agency RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular Agency RMBS to be delivered is not identified until shortly before the TBA settlement date. For our other forward settling transactions, we agree to purchase, for future delivery, Agency RMBS. However, unlike our TBAs, these forward settling transactions reference an identified Agency RMBS. Given the favorable terms available thus far in 2014 in the TBA dollar roll market and relative lower benefit of holding specific mortgage pools, we generally have continued to roll the purchases forward to a later settlement date.

24

We have elected to be treated as a real estate investment trust ("REIT") for U.S. federal income tax purposes, and have complied with, and intend to continue to comply with, the provisions of the Internal Revenue Code of 1986, as amended (the Internal Revenue Code), with respect thereto. Accordingly, we generally do not expect to be subject to federal income tax on our REIT taxable income that we currently distribute to our stockholders if certain asset, income and ownership tests and recordkeeping requirements are fulfilled. Even if we maintain our qualification as a REIT, we may be subject to some federal, state and local taxes on our income.
Investing Strategy
Our investment strategy is designed to:
"
build an investment portfolio consisting primarily of Agency RMBS that generates risk-adjusted investment income;
"
manage financing, interest and prepayment rate risks;
"
capitalize on discrepancies in the relative valuations in the Agency RMBS market;
"
manage cash flow so as to provide for regular quarterly distributions to stockholders;
"
limit credit risk;
"
minimize the impact that changing interest rates have on our net investment income and net asset value;
"
opportunistically invest in other assets within our investment guidelines;
"
cause us to maintain our qualification as a REIT; and
"
cause us to remain exempt from the registration requirements of the Investment Company Act of 1940, as amended (the "Investment Company Act").
Because our investments vary in interest rate, prepayment speed and maturity, the leverage or borrowings that we employ to fund our asset purchases are not exactly matched to the terms or performance of our assets. Based on our experience, because our assets are not match funded, such assets market prices may change more slowly than the corresponding liabilities. Decreases in these short-term rates will tend to increase our net income and the market value of our assets, while increases in these rates will tend to decrease our net income and the market value of our assets and could possibly result in operating losses. Our approach to managing our investment portfolio is to take a longer term view of assets and liabilities, such that our net income and mark-to-market valuations at the end of a financial reporting period will not significantly influence our strategy of maximizing cash distributions to stockholders and achieving capital appreciation over the long-term.
Financing Strategy
We use leverage to finance a portion of our Agency RMBS portfolio and to seek to increase potential returns to our stockholders. Our use of leverage may, however, also have the effect of increasing losses when securities in our portfolio decline in value. Generally, we expect our leverage to be between five and ten times. Given recent actions and guidance provided by the U.S. Federal Reserve (the "Fed") about the future path of the Federal Funds Target Rate ("Fed Funds Rate"), their goal of reducing asset purchases, the heightened interest-rate volatility that these policy changes have created, and may likely continue to create, and current market conditions, we currently expect our leverage to remain in the lower end of this range. Our leverage varies from time to time depending on many factors and conditions, including the short-term changes in the market value of our assets and net asset value and other factors management assesses, analyzes and deems relevant. At September�30, 2014, our portfolio leverage ratio was approximately 6.63 to 1, up from 6.35 to 1 at June 30, 2014.
We currently finance our investments using borrowings under repurchase agreements with a diversified group of commercial and investment banks and broker/dealers. Under these repurchase agreements, we are able to borrow against the value of our assets. Under these agreements, we sell our assets to a counterparty and agree to repurchase the same assets from the counterparty at a price equal to the original sales price plus an interest factor. If the market value of the securities sold by us to a counterparty declines below the "haircut" level, which may occur due to prepayments of the mortgages causing the face value of the mortgage pool provided as collateral to the counterparty to decline or when the value of the mortgage pool provided as collateral declines as a result of interest rate movements or spread widening, we may be required by the counterparty to provide additional collateral, which is commonly referred to as a margin call. Our borrowings under repurchase agreements are accounted for as debt for purposes of U.S. generally accepted accounting principles (U.S. GAAP) and secured by the underlying assets. During the period of a borrowing transaction under a repurchase agreement, we are entitled to and receive the principal and interest payments on the related assets. In the future, we may utilize other financing techniques, which may include, but not necessarily be limited to, the issuance of common stock, secured or unsecured debt, or preferred stock.

25

Hedging Strategy
We engage in interest rate hedging activities intended to mitigate changes in interest rates that we expect would impair our ability to continue to finance assets we own at favorable rates. Our hedging techniques are also used in an attempt to protect us against declines in the market value of our assets that result from general trends in debt markets. Our interest rate hedging methods have historically consisted of interest rate swaps (a contract exchanging a variable rate for a fixed rate, or vice versa), including cancelable interest rate swaps (swaps that may be canceled at one partys option before the swap expires), and interest rate caps (a contract protecting against a rise in interest rates above a fixed level). In the future, our interest rate hedging methods are likely to continue to consist of interest rate swaps, including cancelable interest rate swaps, and interest rate caps, but may also include interest rate floors (a contract protecting against a decline in interest rates below a fixed level), interest rate collars (a combination of caps and floors), Eurodollar and U.S. Treasury futures and other interest rate and non-interest rate derivative instruments or contracts.

We enter into interest rate swap agreements to offset the potential adverse effects of rising interest rates on certain short-term repurchase agreements. Our borrowings under repurchase agreements generally carry interest rates that correspond to the London Interbank Offered Rate (LIBOR) for the borrowing periods. Historically, we have sought to enter into interest rate swap agreements structured such that we receive payments based on a variable interest rate and make payments based on a fixed interest rate. The variable interest rate on which payments are received is calculated based on various reset mechanisms for LIBOR. Additionally, we have entered into interest rate cap agreements structured such that we receive payments based on a variable interest rate being above a fixed cap interest rate. The variable interest rate on which payments are received on interest rate caps is also calculated based on various reset mechanisms for LIBOR. Our interest rate swap and cap agreements effectively fix or cap our borrowing cost and are not held for speculative or trading purposes
Recent Activity
During the three months ended September 30, 2014, the Company has taken several steps to attempt to better position the portfolio in the changing Agency RMBS market environment, one of which is to generally maintain lower leverage during the year and to lengthen our hedging position by adding one new 7-year swap cancelable in July 2015. Our investment portfolio is comprised of Hybrid ARMs, 15-Yr. Agency RMBS, 20-Yr. Agency RMBS, 30-Yr. Agency RMBS, and U.S.Treasuries. Our investment portfolio is hedged using 5- and 7-Year interest rate swaps and caps intended to keep the duration gap low. The relative percentage of 15-Yr. versus 20-Yr. versus 30-Yr. maturity Agency RMBS in the overall portfolio will vary depending on prevailing market conditions and investment opportunities. In the third quarter of 2014, we reduced the percentage of U.S. Treasuries in the portfolio, and increased our 30-Yr. Agency RMBS position, benefiting from the relative outperformance of 30-Yr. mortgages during the period. The Company continues to invest in TBAs as the supply dynamics in the market provide for favorable returns.
Trends and Recent Market Activity -- Interest Rate and Other Macroeconomic Trends
During the first three quarters of 2014, interest rates and the fixed income markets returned to relative stability after an extremely volatile period in 2013. Guidance provided by the Federal Reserve Bank (the "Fed) about the future path of monetary policy had a significant impact on interest rates in 2013, and created a steepening in the yield curve. Interest rates became very volatile, as markets anticipated the end of asset purchases by the Fed. During 2014, the Fed has followed its announced policy, reducing purchases of Agency RMBS and US Treasuries by $5 billion of each security per month, and is on track to end its asset purchasing program in October 2014. The markets focus has now turned to the timing of when the Fed might begin to raise short-term rates. Current indications are for a first rate rise in mid-2015; however, the U.S. economy in 2014 has absorbed slack in the labor market at a sluggish pace and inflation is still below the Feds target of 2 percent, so there is no certainty as to when the Fed might take action.
The U.S. economys performance in 2014 has been mixed. After a decline in first quarter 2014 gross domestic product ("GDP") of 2.1% attributed to the severe winter, second quarter 2014 GDP growth was 4.6%, and consensus for the third quarter is trending around 3.3%. While U.S. unemployment has fallen from 6.7% in December 2013 to 5.9% in September 2014, the current labor force participation rate of 62.7% is at lows not seen since September 1994, and the jobs created have generally been part-time, lower paying and with limited benefits. Inflation, the other part of the Feds dual mandate, hovered around 2% for the second quarter of 2014, but fell back to 1.7% in August 2014.
The U.S. economy continues to outperform Europe, and U.S. government bond yields are high relative to government bond yields of other industrialized countries. For example, at September 30, 2014, 10-Year Federal Republic of Germany bonds yielded 0.95%, fully 155 basis points ("bps") lower than 10-Year U.S. Treasuries. The low yields available around the world have pushed global investors into U.S. bond markets. Foreign investors are also attracted by the recent significant rise in the value of the U.S. dollar. These pressures are unlikely to subside any time soon as global economic performance remains below potential and inflation risks continue to appear low. In some industrialized countries, deflation continues to be a bigger threat than inflation, and this has caused some foreign central banks to be highly accommodative.

26

While the short- and intermediate-end of the yield curve in the 2- to 5- year range has steepened, the longer-end of the curve has flattened considerably in the nine months ended September 30, 2014. When the 10-Yr. Treasury rate reached 3.03% at December 31, 2013, market consensus was that longer-term rates would remain higher in 2014. However, rates have fallen in 2014, with the 10-Yr. Treasury rate at 2.49% on September 30, 2014, after having hit a low of 2.34% in the third quarter of 2014. We believe that these interest rate movements indicate that the market is pricing in an interest rate increase by the Fed, but the market continues to manifest uncertainty about sustainable growth in the longer term.
Set forth below is the yield curve at December 31, 2013, March 30, 2014, June 30, 2014 and September 30, 2014:
����In addition, the spread between Agency RMBS and interest rate swaps tightened during the quarter, with the spread between Fannie Mae 30-Yr. par priced securities and 7- year interest rate swaps tightening 10 bps, and Fannie Mae 15-Yr. and 5- year interest rate swaps tightening 9 bps. In general, this will lower our asset values because the majority of our Agency RMBS cash flows are in the 3- to 6-year part of the curve, where the curve steepened during the third quarter of 2014.


27

While some short-term interest rates increased slightly in the third quarter of 2014, short-term rates generally remain low. The table below presents 30-Day LIBOR, 3-Month LIBOR and the Fed Funds Rate at the end of each respective fiscal quarter. As the chart illustrates, we have been able to benefit from a favorable financing environment. The availability of repurchase agreement financing was generally stable with interest rates between 0.22% and 0.40% for 30-90 day repurchase agreements at September 30, 2014. Our weighted-average cost of funds was 0.30% for both the third and second quarter of 2014.
Date
�
30-Day�LIBOR
�
3-Month�LIBOR
�
Fed�Funds�Rate
September 30, 2014
�
0.157
%
�
0.235
%
�
0.25
%
June 30, 2014
�
0.155
%
�
0.231
%
�
0.25
%
March 31, 2014
�
0.152
%
�
0.231
%
�
0.25
%
December 31, 2013
�
0.168
%
�
0.246
%
�
0.25
%
September 30, 2013
�
0.179
%
�
0.249
%
�
0.25
%
June 30, 2013
�
0.195
%
�
0.273
%
�
0.25
%
March�31, 2013
�
0.204
%
�
0.283
%
�
0.25
%
December 31, 2012
�
0.209
%
�
0.306
%
�
0.25
%

The U.S. dollar gained strength in the third quarter of 2014, rising significantly against most major currencies, including the Euro. The rising dollar and market consensus that the Fed will raise rates have served as tailwinds for U.S. Treasuries. The U.S. economy generally continues to improve and geopolitical tensions outside of the U.S. have pushed investors looking for some yield to the U.S., with its highly liquid and secure bonds in a growing economy and where domestic currency values also are rising. The dollar is being spurred by positive U.S. economic data, but also by the European Central Bank ("ECB"), which�recently decided to push its deposit rate further into negative territory and we believe the ECB will begin some form of quantitative easing in the near term. On a relative basis, the ECB action has made the carry offered by the U.S. dollar more attractive. In addition, there are signs of stagnation and even the threat of deflation in Western Europe and Japan. This severe and chronic economic weakness could spill over to the U.S. through rising imported and declining exported goods and services, and subsequently contribute to rises in unemployment and a decline in GDP.

As we entered the fourth quarter of 2014, U.S. interest rates fell across the U.S. Treasury yield curve upon the reporting of the minutes from the September FOMC meeting, indicating that the timing and velocity of increasing the Fed

28

Funds Rate and tighter monetary policy remain data dependent amid strong concerns about the sluggish world economy and strength of the dollar. In addition, while U.S. unemployment claims are dropping, FOMC members judged that there remained significant underutilization of domestic labor resources, and expressed concerns about potential deflationary pressures in Europe and Japan as well as a stronger U.S. dollar.� This news brought on declines in interest rates and sent Agency RMBS prices higher.� Although the Fed has indicated that it will end Agency RMBS purchases in October 2014, because the Fed will continue to purchase Agency RMBS with the principal and interest payments it receives from the Agency RMBS it holds in its portfolio, we expect strong demand for Agency RMBS to continue. In the beginning of the fourth quarter of 2014, rates on U.S. Treasuries have declined while mortgage rates have lagged this drop.

-- Investing and Reinvestment Environment

Home sales and new single-family home construction remain slow due to tight mortgage lending rules coming from the Wall Street Reform and Consumer Protection Act ("Dodd-Frank") legislation and bank conservatism in efforts to prevent future mortgage "put-backs". These factors have created a shortage of mortgage origination, and new Agency RMBS issuance is low. The Feds asset purchase programs have continued to dominate the Agency RMBS markets and have contributed to our limited new investment opportunities to date in 2014.

The strength in the Agency RMBS market is illustrated below by the movement in prices of two securities commonly held in our portfolio. In the third quarter, we saw some reversal of the increases in value during the first six months of 2014; however, we believe that we remain positioned to take advantage of opportunities as they arise. If interest rate spreads continue to narrow, this will have the effect of limiting our investment and reinvestment opportunities in the short-term. Also, as the long-end of the curve flattens, we expect that this will have the effect of reducing our yield on reinvestments.

The table below shows potential Agency RMBS investments and their respective net interest margins as of September�30, 2014:



29

Net Interest Margin
30 Yr. 4.0%
�
15 Yr. 3.0%
Asset Yield
3.28
%
�
2.41
%
Financing Rate
0.30
%
�
0.30
%
Hedge Cost (1)
1.19
%
�
0.85
%
Net interest margin
1.79
%
�
1.26
%
_______________________________________�
(1) Assumed 7 Year and 5 Year Swap Hedge Ratio of 70% for the 30-YR 4.0% and 50% for the 15-YR. 3.0%.
During the three months ended September�30, 2014, the weighted-average yield on the Company's purchases of Agency RMBS and U.S. Treasuries was 2.73% and 1.75%, respectively.

-- Agency RMBS Supply Trends

The supply of Agency RMBS continues to be low in 2014 compared to 2012 and 2013, and this shortage of Agency RMBS has been a factor in the attractive TBA market, as low financing rates and the inability of the GSEs to settle forward transactions has led to the strong dollar roll market. Even as the Fed's large scale asset purchase program draws to a close, mortgage rates are lower. New Agency RMBS issuance declined steadily throughout 2013 and the first quarter of 2014, and increased slightly in the second and third quarters of 2014, as the chart below demonstrates:
��

One of the principal reasons for the Agency RMBS supply shortage is that single-family home mortgage applications and single-family home sales as of September 30, 2014 were down from the same period last year. Buyers are being held back by a number of dynamics. Homeowners who refinanced when interest rates were very low now have little incentive to sell, as they would likely have to borrow at higher rates. Potential new buyers among adults 25 to 34 are burdened by large student debt, and the employment rate for that group is about 75%. Each of these factors have inhibited residential home purchases and new household formation. From the lenders' perspective, the tight requirements of the Dodd-Frank "Ability to Repay" ("ATR") and Qualified Mortgage ("QM ") rules make it difficult for lenders to originate new mortgages to all but very high quality consumer credits. Affordability products such as ARMs are very limited, and first-time home buyers have difficulty qualifying under the QM rules.




30


-- Agency RMBS Market Volatility Trends

During 2014, there has been relatively low volatility in the Agency RMBS market. This lack of volatility has occurred principally due to low RMBS supply, Fed Agency RMBS purchases, higher yields, and relatively low prepayment rates. The charts below illustrate both the steep drop in refinancing activity since February 2013, the relative refinancing stability and the steep decline of constant prepayment rate ("CPR") rates (for both 15- and 30-year mortgages) since the beginning of 2014.

31


This lack of volatility has enabled the Company to maintain a diversified portfolio with stable cash flows. There is no way to predict whether this low volatility environment will persist in the remainder of 2014 or 2015, or the effect this will have on the Companys financial condition and results of operations.

-- Government Activity
GSE reform lost momentum in the second quarter of 2014 when a proposed GSE reform bill introduced by Senators Tim Johnson (D-SD) and Mike Crapo (R-ID), the two most senior members of the Senate Banking Committee, failed to secure enough support for the bill to be considered by Congress.� The House Republican leadership continues to favor a very different approach, which is generally based on earlier legislation proposed by Senators Bob Corker (R-TN) and Mark Warner (D-VA). As the Federal Housing Finance Agency and both houses of Congress are each working on separate measures intended to restructure the U.S. housing finance system and the operations of Fannie Mae and Freddie Mac, we expect debate and discussion on the topic to continue throughout the remainder of 2014. �It is unclear which, if any, of these measures will be enacted and, if any are enacted, what the effects would be.
The words and actions of federal regulators overseeing the residential mortgage market has created numerous conflicts. For example, numerous rules and regulations under Dodd-Frank such as ATR and QM, as well as costly put-backs to banks, have resulted in stricter, more difficult credit availability for residential consumers directly conflict with the Federal Home Financing Authority ("FHFA") and U.S. Department of Housing and Urban Development ("HUD") rules to permit easier lending standards.� There also are historically low mortgage interest rates coupled with high household leverage, underemployment, and low wages. These are all factors that impact our investment opportunities.
In August 2014, the FHFA issued a request for comment on its proposal to establish a "Single Security" for Agency RMBS, with conformed structures, terms, disclosures and settlement date. Under the plan, the proposed Single Security would leverage the GSEs' existing security structures and would encompass many of the pooling features of the current Fannie Mae MBS and more of the disclosure framework of the current Freddie Mac Participation Certificate ("PC"). The FHFA indicated that the ultimate goal for the new structure is for the legacy MBS and PC securities to be fungible or transferable�with the new security. Such a plan would benefit investors in Agency RMBS by simplifying the structures, terms, disclosures and settlement rules for Agency RMBS, and making these securities more comparable for purposes of pricing and transacting.��������
Financial Condition
As of September�30, 2014 and December�31, 2013, the Agency RMBS in our portfolio were purchased at a net premium to their face value due to the average interest rates on these investments being higher than the prevailing market rates at the time of purchase. As of September�30, 2014 and December�31, 2013, we had approximately $508.2 million and $351.5 million, respectively, of unamortized premium included in the cost basis of our investments.

32

Our Agency RMBS, U.S. Treasuries and Agency Debenture portfolio ("Debt Securities") consisted of the following assets:
(In thousands)
�
�
�
�
�
�
�
Weighted-Average
Coupon
�
Face Value
�
Fair Value
�
Amortized Cost Basis per Face Value
�
Loan Balance(1)
�
Loan Age (in months)(1)
�
3 Month CPR(1)(2)
�
Duration(3)
September�30, 2014
�
�
�
�
�
�
�
�
�
�
�
�
�
�
15 Year Agency Mortgage Securities
�
�
�
�
�
�
�
�
�
�
�
�
���3.0%
�
$
4,033,599

�
$
4,162,732

�
$
102.63

�
$
268

�
14
�
7.2
%
�
4.30
��TBA 3.0%
�
482,000

�
496,460

�
103.03

�
�n/a

�
�n/a
�
�n/a

�
4.45
3.5%
�
1,481,398

�
1,559,939

�
103.45

�
232

�
25
�
10.4

�
3.65
��TBA 3.5%
�
205,000

�
215,490

�
105.18

�
�n/a

�
�n/a
�
�n/a

�
3.58
4.0%
�
192,407

�
205,345

�
101.24

�
175

�
43
�
17.3

�
2.81
4.5%
�
28,581

�
30,613

�
102.78

�
248

�
56
�
21.4

�
2.08
Subtotal
�
6,422,985

�
6,670,579

�
102.89

�
253

�
17
�
8.5

�
4.08
20 Year Agency Mortgage Securities
�
�
�
�
�
�
�
�
�
�
�
�
4.5%
�
71,568

�
78,005

�
102.98

�
221

�
50
�
15.4

�
2.25
30 Year Agency Mortgage Securities
�
�
�
�
�
�
�
�
�
�
�
�
4.0%
�
3,467,839

�
3,661,551

�
104.91

�
294

�
6
�
5.2

�
5.61
TBA 4.0%
�
1,339,000

�
1,410,512

�
105.44

�
�n/a

�
�n/a
�
�n/a

�
5.23
4.5%
�
180,949

�
195,730

�
106.96

�
287

�
41
�
14.9

�
3.05
Subtotal
�
4,987,788

�
5,267,793

�
105.13

�
294

�
8
�
5.9

�
5.42
Agency Hybrid ARMs
�
�
�
�
�
�
�
�
�
�
�
�
�
�
2.6%(4)
�
1,857,254

�
1,901,530

�
103.48

�
336

�
27
�
15.5

�
3.44
U.S. Treasuries
�
�
�
�
�
�
�
�
�
�
�
�
�
�
1.6%
�
560,000

�
556,150

�
99.31

�
�n/a

�
�n/a
�
�n/a

�
4.73
Total
�
$
13,899,595

�
$
14,474,057

�
$
103.63

�
$
281

�
16
�
9.2
%
�
4.49
�
�
�
�
�
�
�
�
�
�
�
�
�
�
�
December�31, 2013
�
�
�
�
�
�
�
�
�
�
�
�
�
�
15 Year Agency Mortgage Securities
�
�
�
�
�
�
�
�
�
�
�
�
3.0%
�
$
4,261,654

�
$
4,354,365

�
$
102.64

�
$
265

�
7
�
3.2
%
�
4.60
TBA 3.0%
�
732,000

�
747,012

�
102.69

�
n/a

�
n/a
�
n/a

�
4.48
3.5%
�
1,078,606

�
1,128,285

�
102.50

�
269

�
27
�
9.7

�
3.35
4.0%
�
229,779

�
243,560

�
101.31

�
175

�
34
�
16.9

�
2.82
4.5%
�
35,497

�
37,736

�
102.99

�
249

�
47
�
17.8

�
1.99
Subtotal
�
6,337,536

�
6,510,958

�
102.58

�
262

�
12
�
5.3

�
4.30
20 Year Agency Mortgage Securities
�
�
�
�
�
�
�
�
�
�
�
�
4.5%
�
84,730

�
90,795

�
103.07

�
223

�
41
�
16.0

�
2.68
30 Year Agency Mortgage Securities
�
�
�
�
�
�
�
�
�
�
�
�
3.0%
�
93,193

�
88,114

�
103.90

�
421

�
14
�
3.9

�
6.72
3.5%
�
2,300,782

�
2,288,035

�
100.58

�
217

�
8
�
3.0

�
6.98
4.0%
�
1,775,221

�
1,827,827

�
102.91

�
326

�
5
�
3.4

�
6.39
TBA 4.0%
�
775,000

�
797,584

�
103.64

�
n/a

�
n/a
�
n/a

�
6.41
4.5%
�
200,955

�
212,988

�
107.07

�
287

�
32
�
11.7

�
4.33
Subtotal
�
5,145,151

�
5,214,548

�
102.15

�
269

�
8
�
3.6

�
6.58
Agency Hybrid ARMs
�
�
�
�
�
�
�
�
�
�
�
�
�
�
2.6%(4)
�
2,007,380

�
2,042,547

�
103.57

�
337

�
19
�
12.6

�
3.91
Total
�
$
13,574,797

�
$
13,858,848

�
$
102.57

�
$
277

�
12
�
6.0
%
�
5.10

33

__________________
(1)
TBAs are excluded from this calculation as they do not have a defined weighted-average loan balance or age until mortgages have been assigned to the pool.
(2)
The CPR represents the 3-month CPR of the Companys Agency RMBS held at September�30, 2014 and December 31, 2013. The CPR experienced by the Company during the period may differ. Securities with no prepayment history are excluded from this calculation.
(3)
Duration essentially measures the market price volatility of financial instruments as interest rates change, using DV01 methodology. We generally calculate duration using various third-party financial models and empirical data. Different models and methodologies can produce different duration numbers for the same securities. Source: The Yield Book�.
(4)
Coupon represents the weighted-average coupon of Agency Hybrid ARMs.
�

Hedging Instruments
We engage in interest rate swaps and caps as a means of mitigating our interest rate risk on forecasted interest expense associated with repurchase agreements for the term of the swap and cap contracts. Below is a summary of our interest rate swaps and caps as of September�30, 2014 and December�31, 2013:
�
�
�
�
�
�
Weighted-Average
�
�
September�30, 2014
�
Number of Contracts
�
Notional (000's)
�
Rate
�
Maturity
�
Duration
�
Fair Value (000's)
Interest Rate Swaps
�
18

�
$
7,650,000

�
1.39
%
�
October 2018
�
(3.48
)
�
$
62,160

Interest Rate Caps
�
5

�
2,500,000

�
1.28
%
�
January 2020
�
(3.18
)
�
138,063

�
�
�
�
�
�
�
�
�
�
�
�
�
December�31, 2013
�
�
�
�
�
�
�
�
�
�
�
�
Interest Rate Swaps
�
14

�
$
6,300,000

�
1.17
%
�
July 2017
�
(3.33
)
�
$
31,546

Interest Rate Caps
�
10

�
3,900,000

�
1.40
%
�
May 2019
�
(2.50
)
�
234,703

The fair value of interest rate swaps and caps is heavily dependent on the current market fixed rate, the corresponding term structure of floating rates (known as the yield curve) as well as the expectation of changes in future floating rates.

We continued to reposition our hedges, and in July 2014 entered into a 7-year $400 million notional amount swap cancelable in July 2015.

Liabilities
We have entered into repurchase agreements to finance a portion of our assets. Borrowings under these agreements are secured by our assets and bear interest at rates that have historically moved in close relationship to LIBOR. At September�30, 2014 and December�31, 2013, we had liabilities pursuant to repurchase agreements with 32 and 24 counterparties, respectively, which are summarized below:
September�30, 2014
�
�
�
�
�
Weighted-Average
Original Days to Maturity
�
Repurchase Agreements Outstanding (000's)
�
Percentage of Total
�
Interest Rate
�
Remaining Days to Maturity
�
Original Days to Maturity
Agency RMBS
�
�
�
�
�
�
�
�
�
�
d 30 Days
�
$
926,016

�
9%
�
0.30%
�
15
�
30
> 30 to d 60 Days
�
3,047,068

�
29%
�
0.31%
�
15
�
33
> 60 Days
�
5,876,485

�
57%
�
0.35%
�
64
�
103
Subtotal
�
$
9,849,569

�
95%
�
0.33%
�
44
�
74
�
�
�
�
�
�
�
�
�
�
�
U.S. Treasuries
�
�
�
�
�
�
�
�
�
�
Overnight
�
$
553,519

�
5%
�
(2.20)%
�
1
�
1
�
�
�
�
�
�
�
�
�
�
�
Total
�
$
10,403,088

�
100%
�
0.20%
�
42
�
70


34

December�31, 2013
�
�
�
�
�
Weighted-Average
Original Days to Maturity
�
Repurchase Agreements Outstanding (000's)
�
Percentage of Total
�
Interest Rate
�
Remaining Days to Maturity
�
Original Days to Maturity
d 30 Days
�
$
83,917

�
1%
�
0.39%
�
11
�
22
>30 to d 60 Days
�
801,587

�
7%
�
0.39%
�
13
�
37
> 60 Days
�
10,321,446

�
92%
�
0.42%
�
42
�
99
Total
�
$
11,206,950

�
100%
�
0.41%
�
40
�
94

In addition, as of September�30, 2014, we had payable for securities purchased, a portion of which will be or, in the case of December�31, 2013, was financed through repurchase agreements summarized below (in thousands).
September�30, 2014
�
�
�
�
Settle Date
�
Face Value
�
Payable
October 2014
�
$
2,250,425

�
$
2,361,715

November 2014
�
150,000

�
157,287

�
�
$
2,400,425

�
$
2,519,002

December�31, 2013
�
�
�
�
Settle Date
�
Face Value
�
Payable
January 2014
�
$
1,507,000

�
$
1,566,821


Summary Financial Data
�
Three Months Ended September 30,
�
Nine�Months�Ended�September 30,
(In thousands, except per share numbers)
2014
�
2013
�
2014
�
2013
Interest income:
�
�
�
�
�
�
�
Interest income from Agency RMBS
$
74,052

�
$
85,599

�
$
219,658

�
$
238,691

Other interest income
3,080

�


�
13,819

�
1,477

Total interest income
77,132

�
85,599

�
233,477

�
240,168

Interest expense:
�
�
�
�
�
�
�
Repurchase agreement interest expense
7,657

�
11,969

�
24,669

�
41,047

Swap and cap interest expense
25,789

�
23,744

�
64,162

�
72,399

Total interest expense
33,446

�
35,713

�
88,831

�
113,446

Net interest income
43,686

�
49,886

�
144,646

�
126,722

Other income (loss):
�
�
�
�


�


Net realized gain (loss) on investments
40,470

�
(407,728
)
�
90,258

�
(572,466
)
Net unrealized gain (loss) on investments
(112,085
)
�
423,509

�
134,628

�
(146,859
)
Net realized gain (loss) on termination of swap and cap contracts


�
25,707

�
(15,327
)
�
41,666

Net unrealized gain (loss) on swap and cap contracts
58,909

�
(55,243
)
�
(22,512
)
�
183,720

Other income
50

�
37

�
219

�
120

Total other income (loss)
(12,656
)
�
(13,718
)
�
187,266

�
(493,819
)
Expenses:
�
�
�
�
�
�
�
Compensation and benefits
3,767

�
3,453

�
11,108

�
10,198

General, administrative and other
2,278

�
2,144

�
6,751

�
6,623

Total expenses
6,045

�
5,597

�
17,859

�
16,821

Net income (loss)
$
24,985

�
$
30,571

�
$
314,053

�
$
(383,918
)
Dividend on preferred stock
(5,203
)
�
(5,203
)
�
(15,609
)
�
(10,651
)

35

Net income (loss) available to common shareholders
$
19,782

�
$
25,368

�
$
298,444

�
$
(394,569
)
Net income (loss) per common share basic & diluted
$
0.12

�
$
0.14

�
$
1.84

�
$
(2.29
)
Distributions per common share
$
0.30

�
$
0.34

�
$
0.94

�
$
1.00

�
�
�
�
�
�
�
�
Key Balance Sheet Metrics
�
�
�
�
�
�
�
Average settled Debt Securities (1)
$
11,837,201

�
$
14,143,340

�
$
12,047,213

�
$
15,390,880

Average total Debt Securities (2)
$
14,138,849

�
$
16,135,672

�
$
13,792,448

�
$
18,865,463

Average repurchase agreements (3)
$
10,189,360

�
$
12,180,713

�
$
10,426,426

�
$
13,306,964

Average Debt Securities liabilities (4)
$
12,491,008

�
$
14,173,045

�
$
12,171,661

�
$
16,781,547

Average stockholders' equity (5)
$
1,937,700

�
$
1,977,424

�
$
1,907,260

�
$
2,226,481

Average common shares outstanding (6)
162,008

�
170,351

�
161,957

�
173,120

Leverage ratio (at period end) (7)
6.63:1

�
6.45:1

�
6.63:1

�
6.45:1

�
�
�
�
�
�
�
�
Key Performance Metrics*
�
�
�
�
�
�
�
Average yield on settled Debt Securities (8)
2.61
%
�
2.42
%
�
2.58
%
�
2.08
�%
Average yield on total Debt Securities including drop income (9)
2.67
%
�
2.67
%
�
2.72
%
�
2.27
�%
Average cost of funds(10)
0.30
%
�
0.39
%
�
0.32
%
�
0.41
�%
Average cost of funds and hedge (11)
1.31
%
�
1.17
%
�
1.14
%
�
1.14
�%
Adjusted average cost of funds and hedge (12)
1.07
%
�
1.01
%
�
0.97
%
�
0.90
�%
Interest rate spread net of hedge (13)
1.30
%
�
1.25
%
�
1.44
%
�
0.94
�%
Interest rate spread net of hedge including drop income(14)
1.60
%
�
1.66
%
�
1.75
%
�
1.37
�%
Operating expense ratio (5)
1.25
%
�
1.13
%
�
1.25
%
�
1.01
�%
Common book value total return (%)(16)
1.26
%
�
2.35
%
�
19.91
%
�
(16.60
)%
___________
(1)
The average settled Debt Securities is calculated by averaging the month end cost basis of settled Debt Securities during the period.
(2)
The average total Debt Securities is calculated by averaging the month end cost basis of total Debt Securities during the period.����
(3)
The average repurchase agreements are calculated by averaging the month end repurchase agreements balance during the period.����
(4)
The average Debt Securities liabilities are calculated by adding the average month end repurchase agreements balance plus average unsettled Debt Securities during the period.������������
(5)
The average stockholders' equity is calculated by averaging the month end stockholders' equity during the period.������������
(6)
The average common shares outstanding are calculated by averaging the daily common shares outstanding during the period.
(7)
The leverage ratio is calculated by dividing (i) the Company's repurchase agreements balance plus payable for securities purchased minus receivable for securities sold by (ii) stockholders' equity.��������
(8)
The average yield on Debt Securities for the period is calculated by dividing total interest income by average settled Debt Securities.����
(9)
The average yield on total Debt Securities including drop income for the period is calculated by dividing total interest income plus drop income by average total Debt Securities. Drop income was $17.2 million and $22.1 million for the three months ended September�30, 2014 and 2013, respectively. Drop income was $48.2 million and $81.7 million for the nine months ended September�30, 2014 and 2013, respectively. Drop income is a component of our net realized and unrealized gain (loss) on investments on our consolidated statements of operations. Drop income is the difference between the spot price and the forward settlement price for the same security on trade date. This difference is also the economic equivalent of the assumed net interest margin (yield minus financing costs) of the bond from trade date to settlement date. We derive drop income through utilization of forward settling transactions.
(10)
The average cost of funds for the period is calculated by dividing repurchase agreement interest expense by average repurchase agreements for the period.
(11)
The average cost of funds and hedge for the period is calculated by dividing interest expense by average repurchase agreements.
(12)
The adjusted average cost of funds and hedge for the period is calculated by dividing interest expense by average Debt Securities liabilities.������������
(13)
The interest rate spread net of hedge for the period is calculated by subtracting average cost of funds and hedge from average yield on settled Debt Securities.
(14)
The interest rate spread net of hedge including drop income for the period is calculated by subtracting adjusted average cost of funds and hedge from average yield on total Debt Securities including drop income.������������
(15)
The operating expense ratio for the period is calculated by dividing operating expenses by average stockholders' equity.

36

(16)
Not computed on annualized basis. ������������
*
All percentages are annualized.

Core Earnings
"Core earnings" represents a non-U.S. GAAP financial measure and is defined as net income (loss) available to common shareholders excluding net realized and unrealized gain (loss) on investments, net realized gain (loss) on termination of swap and cap contracts and net unrealized gain (loss) on swap and cap contracts. Management uses core earnings to evaluate the effective yield of the portfolio after operating expenses. In addition, management utilizes core earnings as a key metric in conjunction with other portfolio and market factors to determine the appropriate leverage and hedging ratios, as well as the overall structure of the portfolio.
The primary limitation associated with core earnings as a measure of our financial performance over any period is that it excludes the effects of net realized and unrealized gain (loss) on investments. In addition, our presentation of core earnings may not be comparable to similarly-titled measures of other companies, which may use different calculations. As a result, core earnings should not be considered as a substitute for our U.S. GAAP net income (loss) as a measure of our financial performance or any measure of our liquidity under U.S. GAAP.
(In thousands)
Three Months Ended September 30,
�
Nine�Months�Ended�September 30,
Non-U.S. GAAP Reconciliation:
2014
�
2013
�
2014
�
2013
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS
$
19,782

�
$
25,368

�
$
298,444

�
$
(394,569
)
Net realized (gain) loss on investments
(40,470
)
�
407,728

�
(90,258
)
�
572,466

Net unrealized (gain) loss on investments
112,085

�
(423,509
)
�
(134,628
)
�
146,859

Net realized (gain) loss on termination of swap and cap contracts


�
(25,707
)
�
15,327

�
(41,666
)
Net unrealized (gain) loss on swap and cap contracts
(58,909
)
�
55,243

�
22,512

�
(183,720
)
Core earnings
$
32,488

�
$
39,123

�
$
111,397

�
$
99,370


Results of Operations
Three Months Ended September�30, 2014 Compared to the Three Months Ended September�30, 2013
Net Income
Net income available to common shareholders decreased $5.6 million to net income of $19.8 million for the three months ended September�30, 2014, compared to net income of $25.4 million for the three months ended September�30, 2013, partially due to the losses on our investments in the third quarter of 2014. The major components of this decrease are detailed below.
Interest Income, Coupon and Asset Yield
Our principal source of income is interest income that we earn on our investment securities portfolio. Interest income, which consists primarily of interest income on Agency RMBS and U.S. Treasuries, decreased by $8.5 million to $77.1 million for the three months ended September�30, 2014, as compared to $85.6 million for the three months ended September�30, 2013. One of the most significant factors in this decrease are changes both in the size of our portfolio and yield on investments, as shown below (in thousands):
Change in Size
�
Change in Yield
�
Change in Size & Yield
Change in average settled
$
(2,306,139
)
�
Change in average yield
0.186
%
�
Change in average settled
$
(2,306,139
)
2013 average yield
2.42
%
�
2013 average settled
14,143,340

�
Change in average yield
0.186
%
Change
$
(13,957
)
�
Change
$
6,560

�
Change
$
(1,070
)
�
�
�
�
�
�
Total change
$
(8,467
)
Our average settled Debt Securities for the three months ended September�30, 2014 was $11.8 billion, compared to $14.1 billion for the three months ended September�30, 2013. Our annualized yield on average settled Debt Securities for the three months ended September�30, 2014 was 2.61%, as compared to 2.42% for the three months ended September�30, 2013. The yield on our assets is most directly affected by the stated coupon rate, and the rate of repayments on our Agency RMBS due to its impact on the amortization of premium on Agency RMBS. Our yield increase was primarily a function of higher weighted-average coupon in the third quarter of 2014 compared to the third quarter of 2013, coupled with the portfolio premium amortizing at a lower rate than the comparable period. Our weighted-average coupon as of September�30, 2014 was 3.34%,

37

compared to 3.30% as of September�30, 2013. Our amortization expense was $3.1 million for the three months ended September�30, 2014, and $4.1 million for the three months ended September�30, 2013.
Interest Expense and Cost of Funds
Our interest expense for the three months ended September�30, 2014, which primarily consists of interest expense from repurchase agreements and interest rate swap and cap contracts, decreased $2.3 million to $33.4 million, as compared to $35.7 million for the three months ended September�30, 2013. A decline in interest expense from repurchase agreements made up $4.3 million of the $2.3 million change in interest expense for the three months ended September�30, 2014. This decline was partially offset by a $2.1 million increase in swap and cap interest expense. Our average borrowings decreased from $12.2 billion for the three months ended September�30, 2013 to $10.2 billion for the three months ended September�30, 2014, consistent with the smaller portfolio that existed in 2014 as compared to 2013 described above. As shown below, the change in interest expense from repurchase agreements was primarily the result of changes to the amount outstanding and rates on repurchase agreements during the three months ended September�30, 2014 and 2013 (in thousands):
Change in Size
�
Change in Rate
�
Change in Size & Yield
Change in average outstanding
$
(1,991,353
)
�
Change in average rate
(0.09
)%
�
Change in average outstanding
$
(1,991,353
)
2013 average rate
0.39
%
�
2013 average outstanding
12,180,713

�
Change in average rate
(0.09
)%
Change
$
(1,957
)
�
Change
$
(2,816
)
�
Change
$
461

�
�
�
�
�
�
Total change
$
(4,312
)
Our annualized weighted-average cost of funds, including hedges, was 1.31% for the three months ended September�30, 2014, as compared to 1.17% for the three months ended September�30, 2013. The components of our cost of funds are 1) rates on our repurchase agreements, 2) rates on our interest rate swaps and caps, 3) the size of our borrowings, and 4) the total notional amount of the interest rate swaps and caps.
Net Interest Income and Drop Income
Our net interest income for the three months ended September�30, 2014 was $43.7 million, and our interest rate spread net of hedge, was 1.30%. For the three months ended September�30, 2013, our net interest income was $49.9 million and our interest rate spread net of hedge was 1.25%. This increase in our interest rate spread net of hedge was due to our increased portfolio yield due to increased coupon rates and lower amortization rates. While the dollar figure of our net interest income is influenced significantly by the size of our portfolio and overall interest rate levels, we believe our interest rate spread net of hedge is an important indicator of our performance.
During the three months ended September�30, 2014 and 2013, we generated drop income of approximately $17.2 million and $22.1 million, respectively. The continued high level of drop income was primarily due to continuing large volumes of forward settling transactions from which we derive drop income. Drop income is a component of our net realized and unrealized gain (loss) on investments on our consolidated statements of operations and therefore excluded from core earnings. Drop income is the difference between the spot price and the forward settlement price for the same security on the trade date. This difference is also the economic equivalent of the assumed interest rate spread net of hedge (yield minus financing costs) of the bond from trade date to settlement date.
Gain (Loss) on Investments
During the three months ended September�30, 2014, our net realized and unrealized gain (loss) on investments decreased by $87.4 million to a $(71.6) million net loss, compared to a gain of $15.8 million for the three months ended September�30, 2013. This change was driven in part by a decline in prices of Agency RMBS for the three months ended September�30, 2014, compared with increases in prices of Agency RMBS for the three months ended September�30, 2013. For example, during the three months ended September�30, 2014 the price of a 30-Yr. 4.0% Agency RMBS decreased $0.56, and during the three months ended September�30, 2013 it increased $0.75.
Gain (Loss) on Derivatives
Our net realized and unrealized gain (loss) on swap and cap contracts increased by $88.4 million to a gain of $58.9 million for the three months ended September�30, 2014, compared to a loss of $(29.5) million for the three months ended September�30, 2013. The realized and unrealized gain in the three months ended September�30, 2014 was due principally to an environment of rising interest rates in which swap and cap prices rose, offsetting to some extent the losses on the Agency RMBS. During the three months ended September�30, 2014 and 2013, our average interest rate swap and cap notional amount was $10,050.0 million and $11,915.0 million, respectively. During the three months ended September�30, 2014 and 2013, 5-year swap rates increased by 23 bps and decreased by 3 bps, respectively.


38

Operating Expenses
Operating expenses remained generally consistent at $6.0 million and $5.6 million for the three months ended September�30, 2014 and 2013, respectively.

Nine Months Ended September�30, 2014 Compared to the Nine Months Ended September�30, 2013
Net Income
Net income available to common shareholders increased $693.0 million to net income of $298.4 million for the nine months ended September 30, 2014, compared to net loss of $(394.6) million for the nine months ended September�30, 2013. This result followed from the $(719.3) million loss on investments for the nine months ended September 30, 2013 compared to an investments gain of $224.9 million for the nine months ended September 30, 2014. The major components of this increase are detailed below.
Interest Income and Asset Yield
Interest income decreased by $6.7 million to $233.5 million for the nine months ended September 30, 2014, as compared to $240.2 million for the nine months ended September�30, 2013. The decrease in our interest income is due to the change in both the size of our portfolio and yield on investments as shown below (in thousands):
Change in Size
�
Change in Yield
�
Change in Size & Yield
�
Change in average settled
$
(3,343,667
)
�
Change in average yield
0.503
%
�
Change in average settled
$
(3,343,667
)
�
2013 average yield
2.08
%
�
2013 average settled
15,390,880

�
Change in average yield
0.503
%
�
Change
$
(52,176
)
�
Change
$
58,110

�
Change
$
(12,625
)
�
�
�
�
�
�
�
Total change
$
(6,691
)
�
Our average settled Debt Securities for the nine months ended September 30, 2014 was $12.0 billion, compared to $15.4 billion for the nine months ended September�30, 2013. Our weighted-average coupon as of September�30, 2014 was 3.34% compared to 3.30% as of September�30, 2013. The decrease in average coupon for the first nine months of 2014 was more than offset by an increase in yield for the nine months ended September 30, 2014.
Our annualized yield on average settled Debt Securities for the nine months ended September 30, 2014 was 2.58%, as compared to 2.08% for the nine months ended September�30, 2013. Our yield increase was both a function of a higher average coupon rate and the portfolio premium amortized at a lower rate than the comparable period. Our annualized rate of portfolio prepayment for the nine months ended September 30, 2014 was 7.4%, which was lower than the rate of 13.4% for the nine months ended September�30, 2013. Our amortization expense was $8.3 million for the nine months ended September 30, 2014 and $18.7 million for the nine months ended September�30, 2013. The decrease in prepayments was largely brought on by the effects of lower mortgage rates.
Interest Expense and Cost of Funds
Interest expense, which primarily consists of interest expense from repurchase agreements and interest rate swap and cap contracts, decreased $24.6 million to $88.8 million for the nine months ended September�30, 2014, as compared to $113.4 million for the nine months ended September�30, 2013. Lower interest expense from repurchase agreements made up $16.3 million of the $24.6 million change in interest expense for the nine months ended September 30, 2014. As shown below, the change in interest expense from repurchase agreements was primarily the result of changes to the amount outstanding and rates on repurchase agreements during the nine months ended September 30, 2014 and 2013 (in thousands):
Change in Size
�
Change in Rate
�
Change in Size & Yield
�
Change in average outstanding
$
(2,880,538
)
�
Change in average rate
(0.096
)%
�
Change in average outstanding
$
(2,880,538
)
�
2013 average rate
0.41
%
�
2013 average outstanding
13,306,964

�
Change in average rate
(0.096
)%
�
Change
$
(8,885
)
�
Change
$
(9,563
)
�
Change
$
2,070

�
�
�
�
�
�
�
Total change
$
(16,378
)
�
Our average borrowings decreased from $13.3 billion for the nine months ended September�30, 2013 to $10.4 billion for the nine months ended September 30, 2014, similar to the portfolio decline described above. Our annualized weighted-average cost of funds, including hedges, was unchanged at 1.14% for the nine months ended September 30, 2014 and 2013.



39

Net Interest Income and Drop Income
Our net interest income for the nine months ended September 30, 2014 was $144.6 million, and our interest rate spread net of hedge was 1.44%. For the nine months ended September�30, 2013, our net interest income was $126.7 million and our interest rate spread net of hedge was 0.94%. The increase in net interest income was primarily due to the increase in our interest rate spread net of hedge, a function of our increased portfolio yield due to increased coupon rates and lower amortization rates.
During the nine months ended September�30, 2014 and 2013, we generated drop income of approximately $48.2 million and $81.7 million, respectively. The decrease in drop income was primarily due to fewer forward settling transactions.
Gain (Loss) on Investments
Net realized and unrealized gain (loss) on investments increased by $944.2 million to a gain of $224.9 million for the nine months ended September 30, 2014, compared to a loss of $(719.3) million for the nine months ended September�30, 2013. This was due in part to a positive change in prices of Agency RMBS in the first nine months of 2014 as compared to the first nine months of 2013. For example, during the nine months ended September�30, 2014 the price of a 30-YR. 4.0% Agency RMBS increased $2.44, and during the nine months ended September�30, 2013 the price for the same security decreased $2.28. In addition, our average settled Debt Securities was approximately $15.4 billion, or $3.4 billion (22% ) larger for the nine months ended September 30, 2013 compared to $12.0 billion for the nine months ended September 30, 2014, which would have the effect of magnifying the impact of the Agency RMBS price declines on our overall losses in 2013, as compared to the impact of Agency RMBS price increases on the smaller investment portfolio in 2014.
Gain (Loss) on Derivatives
Net realized and unrealized loss on swap and cap contracts was $(37.8) million for the nine months ended September�30, 2014, compared to a gain of $225.4 million for the nine months ended September�30, 2013. In the nine months ended September�30, 2014, with Agency RMBS prices rising in response to lower interest rates, the swaps generally lost value and we incurred losses on our swaps (the proportionality of the losses in the first nine months of 2014 was lessened somewhat by the significantly smaller size of our hedge book in 2014 as compared to 2013). The unrealized and realized gain on swap and cap contracts in the nine months ended September�30, 2013 was due principally to an environment of rising interest rates and falling Agency RMBS prices. During the nine months ended September�30, 2014 and 2013, our average interest rate swap and cap notional amount was $9,820.0 million and $12,250.0 million, respectively. During the nine months ended September 30, 2014 and 2013, 7-year swap rates decreased by 18 bps and increased by 85 bps, respectively.
Operating Expenses
Operating expenses were $17.9 million and $16.8 million for the nine months ended September 30, 2014 and 2013, respectively.

40

Contractual Obligations and Commitments
The following table summarizes our contractual obligations for repurchase agreements, interest expense on repurchase agreements and the office lease at September�30, 2014 and December�31, 2013 (in thousands):
September�30, 2014
Within One Year
�
One�to�Three Years
�
Three�to Five�Years
�
Total
Repurchase agreements
$
10,403,088

�
$


�
$


�
$
10,403,088

Interest expense on repurchase agreements, based on rates at September 30, 2014
7,078

�


�


�
7,078

Long-term operating lease obligation
262

�
197

�


�
459

Total
$
10,410,428

�
$
197

�
$


�
$
10,410,625

December�31, 2013
Within One Year
�
One�to�Three Years
�
Three�to Five�Years
�
Total
Repurchase agreements
$
11,206,950

�
$


�
$


�
$
11,206,950

Interest expense on repurchase agreements, based on rates at December�31, 2013
12,202

�


�


�
12,202

Long-term operating lease obligation
293

�
393

�


�
686

Total
$
11,219,445

�
$
393

�
$


�
$
11,219,838

At September�30, 2014 and December�31, 2013, we had the following interest rate swap and cap contracts (in thousands):
As of September�30, 2014
Interest Rate Swaps
�
Weighted-Average
�
Notional
�
Fair
Expiration Year
�
Fixed Pay�Rate
�
Amount
�
Value
2017
�
0.94
%
�
$
3,250,000

�
$
31,031

2018
�
1.16
%
�
2,000,000

�
25,311

2019
�
1.75
%
�
800,000

�
3,792

2021
�
2.43
%
�
1,600,000

�
2,026

Total
�
1.39
%
�
$
7,650,000

�
$
62,160

�
�
�
�
�
�
�
Interest Rate Caps
�
Weighted-Average
�
Notional
�
Fair
Expiration Year
�
Cap�Rate
�
Amount
�
Value
2019
�
1.34
%
�
800,000

�
34,987

2020
�
1.25
%
�
1,700,000

�
103,076

Total
�
1.28
%
�
$
2,500,000

�
$
138,063



41

As of December�31, 2013
Interest Rate Swaps
�
Weighted-Average
�
Notional
�
Fair
Expiration Year
�
Fixed Pay�Rate
�
Amount
�
Value
2015
�
2.15
%
�
$
500,000

�
$
(10,255
)
2016
�
1.71
%
�
550,000

�
(13,780
)
2017
�
0.94
%
�
3,250,000

�
27,942

2018
�
1.16
%
�
2,000,000

�
27,639

Total
�
1.17
%
�
$
6,300,000

�
$
31,546

�
�
�
�
�
�
�
Interest Rate Caps
�
Weighted-Average
�
Notional
�
Fair
Expiration Year
�
Cap�Rate
�
Amount
�
Value
2015
�
1.40
%
�
$
500,000

�
$
309

2019
�
1.56
%
�
1,700,000

�
92,376

2020
�
1.25
%
�
1,700,000

�
142,018

Total
�
1.40
%
�
$
3,900,000

�
$
234,703


We enter into certain contracts that contain a variety of indemnification obligations, principally with our brokers and counterparties to interest rate swap contracts and repurchase agreements. The maximum potential future payment amount we could be required to pay under these indemnification obligations is unlimited. We have not incurred any costs to defend lawsuits or settle claims related to these indemnification obligations. As a result, the estimated fair value of these agreements is minimal. Accordingly, we recorded no liabilities for these agreements as of September�30, 2014 and December�31, 2013. In addition, as of September�30, 2014 and December�31, 2013, we had $2,519.0 million and $1,556.8 million of payable for securities purchased, respectively, a portion of which either will be or was financed through repurchase agreements. A summary of our payable for securities purchased as of September�30, 2014 and December�31, 2013 is included in the Financial ConditionLiabilities section.

Off-Balance Sheet Arrangements
As of September�30, 2014 and December�31, 2013, we did not maintain any relationships with unconsolidated entities or financial partnerships, such as entities often referred to 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 September�30, 2014 and December�31, 2013, we had not guaranteed any obligations of unconsolidated entities or entered into any commitment or had any intent to provide funding to any such entities.
Liquidity and Capital Resources
Our primary sources of funds are borrowings under master repurchase agreements, equity offerings, asset sales and monthly principal and interest payments on our investment portfolio. Because the level of our borrowings can be adjusted on a daily basis, the level of cash carried on our balance sheet is significantly less important than the 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, maintenance of any margin requirements and the payment of cash dividends as required for our continued qualification as a REIT. To qualify as a REIT, we must distribute annually at least 90% of our net taxable income. To the extent that we annually distribute all of our net taxable income in a timely manner, we will generally not be subject to federal and state income taxes. We currently expect to distribute all of our taxable income in a timely manner so that we are not subject to federal and state income taxes. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital from operations.
As of September�30, 2014 and December�31, 2013, we had approximately $1,382.3 million and $1,115.8 million, respectively, in Agency RMBS, U.S. Treasuries and cash 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. During the nine months ended September�30, 2014, we maintained an average liquidity level of 66% and never less than 55% of stockholders' equity.
During the third quarters of 2014 and 2013, we had average repurchase agreements outstanding of $10,189.4 million and $12,180.7 million, respectively, with a weighted-average borrowing rate of 0.30% and 0.39%. The availability of repurchase agreement financing was generally stable with interest rates between 0.22% and 0.40% for 30-90 day repurchase agreements at September 30, 2014.

42

To limit our exposure to counterparty credit risk, we diversify our funding across multiple counterparties and by counterparty region. As of September�30, 2014 and December�31, 2013, we had master repurchase agreements with 45 and 37 financial institutions, respectively, subject to certain conditions, located throughout North America, Europe and Asia. In the third quarter of 2014, we added two new counterparties and entered into borrowings with one of these counterparties. The table below includes a summary of our repurchase agreement funding by number of repurchase counterparties and counterparty region as of September�30, 2014 and December�31, 2013:
�
�
September�30, 2014
Counterparty Region
�
Number of Counterparties
�
Percent of Repurchase Agreement Funding
North America
�
16

�
47.4
%
Europe
�
11

�
33.2
%
Asia
�
5

�
19.4
%
�
�
32

�
100.0
%
�
�
December�31, 2013
Counterparty Region
�
Number of Counterparties
�
Percent of Repurchase Agreement Funding
North America
�
12

�
49.7
%
Europe
�
7

�
29.4
%
Asia
�
5

�
20.9
%
�
�
24

�
100.0
%
Our repurchase agreements contain typical provisions and covenants as set forth in the standard master repurchase agreement published by the Securities Industry and Financial Markets Association. Our repurchase agreements generally require us to transfer additional securities to the counterparty in the event the value of the securities then held by the counterparty in the margin account falls below specified levels and contain events of default in cases where we or the counterparty breaches our respective obligations under the agreement.
We receive margin calls from our repurchase agreement counterparties from time to time in the ordinary course of business similar to other entities in the specialty finance business. We receive two types of margin calls under our repurchase agreements. The first type, which are known as factor calls, are margin calls that occur each month and relate to the timing difference between the reduction of principal balances of our Agency RMBS, due to monthly principal payments on the underlying mortgages, and the receipt of the corresponding cash. The second type of margin call we may receive is a valuation call, which occurs due to market and interest rate movements. Both factor and valuation margin calls occur if the total value of our assets pledged as collateral to our counterparty drops beyond a threshold level, typically between $100,000 and $500,000. Both types of margin calls require a dollar for dollar restoration of the margin shortfall. Conversely, we may initiate margin calls to our counterparties when the value of our assets pledged as collateral with a counterparty increases above the threshold level, thereby increasing our liquidity. All unrestricted cash plus any unpledged securities, are available to satisfy margin calls.
Our collateral is generally valued on the basis of prices provided by recognized bond market sources agreed to by the parties. Inputs to the models used by pricing sources may include, but are not necessarily limited to, reported trades, executable bid and asked prices, broker quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. Our master agreements for repurchase transactions contain mostly standard provisions for the valuation of collateral. These agreements typically provide that both the repurchase seller (the borrower) and the repurchase buyer (the lender) value the collateral on a daily basis. Each party uses prices that it obtains from generally recognized pricing sources, or the most recent closing bid quotation from such a source. If the buyer, or the seller, as the case may be, determines that additional collateral is required, it may call for the delivery of such collateral. Under certain of our repurchase agreements, in limited circumstances, such as when a pricing source is not available, our lenders have the right to determine the value of the collateral we have provided to secure our repurchase borrowings. In instances where we have agreed to permit our lenders to make a determination of the value of such collateral, such lenders are expected to act reasonably and in good faith in making such valuation determinations.
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 make any amount due by us to the counterparty immediately payable.
For our short-term (one year or less) and long-term liquidity and capital resource requirements, we also rely on the cash flow from operations, primarily monthly principal and interest payments to be received on our Agency RMBS, as well as any securities offerings authorized by our board of directors.

43

During the nine months ended September 30, 2014 and 2013, we received $949.1 million and $2,122.4 million of principal repayments, respectively, and $234.1 million and $248.0 million of interest payments, respectively. We held cash of $10.4 million and $5.0 million at September�30, 2014 and December�31, 2013, respectively. For the nine months ended September�30, 2014 and 2013, net cash provided by operating activities was $166.1 million and $237.2 million, respectively.
Based on our current portfolio, leverage rate and available borrowing arrangements, we believe that our cash flow from operations and the utilization of borrowings will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity requirements such as funding our investment activities, funding our distributions to stockholders and for general corporate expenses. However, an increase in prepayment rates substantially above our expectations could cause a temporary liquidity shortfall due to the timing of the necessary margin calls on the financing arrangements and the actual receipt of the cash related to principal paydowns. If our cash resources are at any time insufficient to satisfy our liquidity requirements, we may have to issue debt or additional equity securities or sell Agency RMBS in our portfolio. If required, the sale of Agency RMBS at prices lower than their amortized cost would result in realized losses. We believe that we have additional capacity through repurchase agreements to leverage our equity further should the need for additional short-term (one year or less) liquidity arise.
Our investment portfolio is comprised principally of highly liquid Agency RMBS guaranteed by Freddie Mac or Fannie Mae, and Ginnie Mae RMBS and U.S. Treasuries backed by the full faith and credit of the U.S. government. We regularly monitor the creditworthiness of the U.S. government. While the U.S. government has had its credit rating downgraded in recent years by on e of the credit rating agencies, it remains one of the most secure creditors in the world as of September 30, 2014. See Note 2, Investments in Securities.
We may increase our capital resources by obtaining long-term credit facilities or making public or private offerings of equity or debt securities. 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.
From time to time we raise capital through sale and issuance of our capital stock. On May 23, 2014, we filed an automatically effective shelf registration statement on Form S-3 with the Securities and Exchange Commission. We may offer and sell, from time to time, shares of common stock, preferred stock and debt securities in one or more offerings pursuant to the prospectus that is a part of the registration statement. As of September�30, 2014, we had not issued any shares of common stock, preferred stock or debt securities under the prospectus.
Another vehicle for this is our Direct Share Purchase Program ("DSPP"), through which stockholders may purchase additional shares of common stock by reinvesting some or all of the cash dividends received on shares of common stock. Stockholders may also make optional cash purchases of shares of common stock subject to certain limitations detailed in the plan prospectus. We did not issue any shares under the plan during the nine months ended September�30, 2014 and 2013. As of September�30, 2014 and December�31, 2013, there were approximately 4.1 million shares available for issuance under the DSPP.
Effective May 15, 2014, the Company terminated that certain Equity Distribution Agreement by and between the Company and JMP Securities LLC (JMP), dated as of June 7, 2011 (the JMP Agreement), in connection with the expiration of the Companys prior shelf registration statement on Form S-3. Under the JMP Agreement, the Company could offer and sell, from time to time, up to 15.0 million shares of the Companys common stock through an at the market offering program with JMP. The Company sold 11.9 million shares of common stock under the JMP Agreement. For the nine months ended September�30, 2014 and 2013, the Company did not sell any shares of common stock under the JMP Agreement.
On November�15, 2012, the Company announced that its Board of Directors authorized the repurchase of shares of the Companys common stock having an aggregate value of up to $250 million. Pursuant to this program, the Company repurchased approximately $115.7 million in aggregate value of its shares of common stock on the open market. On July 21, 2014, the Company announced that its Board of Directors authorized the repurchase of shares of the Company's common stock having an aggregate value of up to $250 million, which included the approximately $134.3 million available for repurchase under the November 2012 authorization. In July 2014, pursuant to the program, the Company repurchased 39,800 shares of its common stock in open market transactions with a weighted-average purchase price of $8.86 per share for $353,584. Accordingly, the Company still had approximately $249.6 million available to repurchase shares of its common stock as of September 30, 2014.
We have made and intend to continue to make regular quarterly distributions of all or substantially all of our REIT taxable income to holders of our common stock. In order to qualify as a REIT and to avoid federal corporate income tax on the income that we distribute to our stockholders, we are required to distribute at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain, on an annual basis. This requirement can impact our liquidity and capital resources.

44


Qualitative and Quantitative Disclosures about Short-Term Borrowings
The following table discloses quantitative data about our short-term borrowings under repurchase agreements during the three and nine months ended September 30, 2014:
�
Three Months Ended September 30,
�
Nine�Months�Ended�September 30,
(In millions)
2014
�
2013
�
2014
�
2013
Outstanding at period end
$
10,403

�
$
11,735

�
$
10,403

�
$
11,735

Weighted-average rate at period end
0.20
%
�
0.39
%
�
0.20
%
�
0.39
%
Average outstanding during period (1)
$
10,189

�
$
12,181

�
$
10,426

�
$
13,307

Weighted-average rate during period
0.30
%
�
0.39
%
�
0.32
%
�
0.41
%
Largest month end balance during period
$
10,403

�
$
13,809

�
$
11,771

�
$
14,544

�
_______________
(1)
Calculated based on the average month end balance during the period.
The Company's borrowing rates were stable during each of the three months ended September�30, 2014 and 2013. The Company's borrowing rates were lower for the three and nine months ended September�30, 2014 compared to the three and nine months ended September�30, 2013 due to generally lower interest rate environment and using more U.S. Treasuries as collateral for repurchase agreements at September�30, 2014, which attract lower borrowing rates.
At September�30, 2014 and December�31, 2013, the Company had no repurchase agreement borrowings where the amount at risk with an individual counterparty exceeded 2% of stockholders' equity. In addition, we had no borrowings with any counterparty that exceeded 6% of our total borrowings.

Inflation
Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence our performance more than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with U.S. GAAP and our distributions are determined by our board of directors based in part on our REIT taxable income as calculated according to the requirements of the Internal Revenue Code. In each case, our activities and balance sheet are measured with reference to fair value without considering inflation.

Forward Looking Statements
When used in this Quarterly Report on SEC Form 10-Q, in future filings with the SEC or in press releases or other written or oral communications, statements which are not historical in nature, including those containing words such as believe, expect, may, will, anticipate, estimate, plan, continue, intend, should, or the negative of these words and similar expressions, are intended to identify 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), and, as such, may involve known and unknown risks, uncertainties and assumptions.��
The forward-looking statements in this report are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us.��These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us.��If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements.��The following factors could cause actual results to vary from our forward-looking statements: changes in our investment, financing and hedging strategies; the adequacy of our cash flow from operations and borrowings to meet our short-term liquidity requirements; the liquidity of our portfolio; unanticipated changes in our industry, actions taken by the Fed or other U.S. government regulator; the credit markets, the general economy or the real estate market; changes in interest rates and the market value of our investments; changes in the prepayment rates on the mortgage loans securing our Agency RMBS; our ability to borrow to finance our assets; changes in government regulations affecting our business; our ability to maintain our qualification as a REIT for federal income tax purposes; our ability to maintain our exemption from registration under the Investment Company Act; and risks associated with investing in real estate assets, including changes in business conditions and the general economy.��These and other risks, uncertainties and factors, including those set forth under the section captioned Risk Factors Managements Discussion and Analysis of Financial Condition and Results of Operations herein and in our Annual Report on

45

SEC Form 10-K for the year ended December�31, 2013, and Quarterly Report on SEC Form 10-Q for the quarter ended June�30, 2014, as updated by our quarterly and current reports that we file with the SEC, could cause our actual results to differ materially from those projected in any forward-looking statements we make.��All forward-looking statements speak only as of the date on which they are made.��New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us.��Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.�
����
Item�3. Quantitative and Qualitative Disclosures about Market Risk
As of September�30, 2014 and December�31, 2013, the primary component of our market risk was interest rate risk, as described below. While we do not seek to avoid risk completely, we do believe that risk can be quantified from historical experience, and actively managed, to earn sufficient compensation to justify taking risks and to maintain capital levels consistent with the risks we undertake. Our board of directors exercises oversight of risk management in many ways, including overseeing our senior managements risk-related responsibilities and reviewing management and investment policies and performance against these policies and related benchmarks. See BusinessRisk Management in our Annual Report on SEC Form 10-K for the fiscal year ended December�31, 2013 for a further discussion of our risk mitigation practices.
Interest Rate Risk
We are subject to interest rate risk in connection with our investments in Agency RMBS collateralized by ARMs, hybrid ARMs and fixed rate mortgage loans and our related debt obligations, which are generally repurchase agreements of limited duration that are periodically refinanced at current market rates. We seek to mitigate this risk through utilization of derivative contracts, primarily interest rate swap and cap contracts.
Effect on Net Interest Income.� We fund our investments in long-term Agency RMBS collateralized by ARMs, hybrid ARMs and fixed rate mortgage loans with short-term borrowings under repurchase agreements. During periods of rising interest rates, the borrowing costs associated with those Agency RMBS tend to increase while the income earned on such Agency RMBS (during the fixed rate component of such securities) may remain substantially unchanged. This results in a narrowing of the net interest spread between the related assets and borrowings and may even result in losses.
We are a party to the interest rate swap and cap contracts as of September�30, 2014 and December�31, 2013 described in detail under Item�2. Managements Discussion and Analysis of Financial Condition and Results of OperationsContractual Obligations and Commitments in this Quarterly Report on SEC Form 10-Q.
Hedging techniques are partly based on assumed levels of prepayments of our Agency RMBS. If prepayments are slower or faster than assumed, the life of the Agency RMBS will be longer or shorter, which would reduce the effectiveness of any hedging strategies we may use and may cause losses on such transactions.
Effect on Fair Value.�Another component of interest rate risk is the effect changes in interest rates will have on the fair value of our assets. We face the risk that the fair value of our assets will increase or decrease at different rates than that of our liabilities, including our hedging instruments.
We primarily assess our interest rate risk by estimating the duration of our assets and the duration of our liabilities. Duration essentially measures the market price volatility of financial instruments as interest rates change. We generally calculate duration using various third-party financial models and empirical data. Different models and methodologies can produce different duration numbers for the same securities.
Extension Risk.�We invest in Agency RMBS collateralized by hybrid ARMs, which have interest rates that are fixed for the first few years of the loan (typically three, five, seven or ten years) and thereafter reset periodically on the same basis as Agency RMBS collateralized by ARMs. We compute the projected weighted-average life of our Agency RMBS collateralized by hybrid ARMs based on assumptions regarding the rate at which the borrowers will prepay the underlying mortgages. In general, when Agency RMBS collateralized by fixed rate or hybrid ARMs is acquired with borrowings, we may, but are not required to, enter into an interest rate swap contract 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 Agency RMBS. This strategy is designed to protect us from rising interest rates by fixing our borrowing costs for the duration of the fixed rate period of the collateral underlying the related Agency RMBS.
We have structured our swaps to expire in conjunction with the estimated weighted-average life of the fixed period of the mortgages underlying our Agency RMBS portfolio. However, in a rising interest rate environment, the weighted-average life of the fixed rate mortgages underlying our Agency RMBS could extend beyond the term of the swap agreement or other hedging instrument. 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 Agency RMBS would remain fixed for a period of time. This situation may also cause the market value of our Agency RMBS to decline with little or no offsetting

46

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.
Interest Rate Cap Risk.�Both the ARMs and hybrid ARMs that collateralize our Agency RMBS are typically subject to periodic and lifetime interest rate caps and floors, which limit the amount by which the securitys interest yield may change during any given period. However, our borrowing costs will not be subject to similar restrictions. Therefore, in a period of increasing interest rates, the interest costs on our borrowings could increase without limitation by caps while the interest rate yields on our Agency RMBS would effectively be limited by caps. This problem will be magnified to the extent that we acquire Agency RMBS that are collateralized by hybrid ARMs that are not fully indexed. In addition, the underlying mortgages 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 income on our Agency RMBS than we need in order to pay the interest cost on our related borrowings. These factors could lower our net interest income or cause a net loss during periods of rising interest rates, which would harm our financial condition, cash flows and results of operations.
Interest Rate Mismatch Risk.� We intend to fund a substantial portion of our acquisitions of Agency RMBS with borrowings that, after the effect of hedging, have interest rates based on indices and repricing terms similar to, but of somewhat shorter maturities than, the interest rate indices and repricing terms of the Agency RMBS. Thus, we anticipate that in most cases the interest rate indices and repricing terms of our Agency RMBS and our funding sources will not be identical, thereby creating an interest rate mismatch between assets and liabilities. Therefore, our cost of funds would likely rise or fall more quickly than would our earnings rate on assets. During periods of changing interest rates, such interest rate mismatches could negatively impact our financial condition, cash flows and results of operations. To mitigate interest rate mismatches, we may utilize the hedging strategies discussed above.
Our analysis of risks is based on managements experience, estimates, models and assumptions. These analyses rely on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of investment decisions by our management may produce results that differ significantly from the estimates and assumptions used in our models and the projected results reflected herein.
Prepayment Risk
Prepayments are the full or partial repayment of principal prior to the original contractual maturity of a mortgage loan, and typically occur due to refinancing of mortgage loans. Prepayment rates for existing Agency RMBS generally increase when prevailing mortgage interest rates fall, and vice-versa. In addition, prepayment rates on Agency RMBS collateralized by ARMs and hybrid ARMs generally increase when the difference between long-term and short-term interest rates declines or becomes negative, and vice-versa. Additionally, we own Agency RMBS that were purchased at a premium. The prepayment of such Agency RMBS at a rate faster than anticipated would result in a write-off of any remaining capitalized premium amount.
Durations for 30-year and 15-year Agency RMBS have already extended over a year from the early part of 2013 and have subsequently remained stable over the last few quarters. More importantly, at the current time Agency RMBS also appears to be much less negatively convex than early 2013. Therefore, even if we do have a significant increase in rates, we do not believe that durations on our Agency RMBS are likely to extend in the second half of 2014 nearly as much as they did in the first half of 2014.
We seek to mitigate our prepayment risk by investing in Agency RMBS with (i)�a variety of prepayment characteristics, (ii)�prepayment prohibitions and penalties and (iii)�prepayment protections, as well as by balancing Agency RMBS purchased at a premium with Agency RMBS purchased at a discount.
Effect on Fair Value and Net Income
Another component of interest rate risk is the effect changes in interest rates will have on the fair value of our assets and our net income exclusive of the effect on fair value. We face the risk that the fair value of our assets and net interest income will increase or decrease at different rates than that of our liabilities, including our hedging instruments.
We primarily assess our interest rate risk by estimating the duration of our assets and the duration of our liabilities. Duration essentially measures the market price volatility of financial instruments as interest rates change. We generally calculate duration using various financial models and empirical data. Different models and methodologies can produce different duration numbers for the same securities.

47

The following sensitivity analysis table shows the estimated impact of our interest rate-sensitive investments and repurchase agreement liabilities on the fair value of our assets and our net income, exclusive of the effect of changes in fair value on our net income, at September�30, 2014 and December�31, 2013, assuming a static portfolio and that rates instantaneously fall 25, 50 and 75 bps and rise 25, 50 and 75 bps:
September�30, 2014
�
�
�
�
Change in Interest Rates
�
Projected�Change�in Our Net Income
�
Projected Change in the Fair Value of Our Assets
- 75 basis points
�
6.7
�%
(a)
0.6
�%
- 50 basis points
�
4.9
�%
(a)
0.6
�%
- 25 basis points
�
2.4
�%
(a)
0.4
�%
No Change
�

�%
�

�%
+ 25 basis points
�
(6.1
)%
�
(0.5
)%
+ 50 basis points
�
(12.2
)%
�
(1.1
)%
+ 75 basis points
�
(18.3
)%
�
(1.7
)%
�
�
�
�
�
December�31, 2013
�
�
�
�
- 75 basis points
�
8.6
�%
(a)
1.4
�%
- 50 basis points
�
6.6
�%
(a)
1.2
�%
- 25 basis points
�
3.3
�%
(a)
0.7
�%
No Change
�

�%
�

�%
+ 25 basis points
�
(8.3
)%
�
(0.8
)%
+ 50 basis points
�
(16.6
)%
�
(1.5
)%
+ 75 basis points
�
(24.9
)%
�
(2.3
)%
_____________
*
Analytics provided by The Yield Book� Software.
(a)
Given the low level of interest rates at September�30, 2014 and December�31, 2013, we reduced 3-month LIBOR by 10, 20 and 25 bps and our repurchase agreement rates by 10, 20 and 25 bps for the down 25, 50 and 75 bps net income scenarios, respectively. All other interest rate sensitive instruments were calculated in accordance with the table.
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 take advantage or minimize the impact of changes in interest rates. Generally, our interest rate swaps reset in the quarter following changes in interest rates. It is important to note that the impact of changing interest rates on fair value and net income can change significantly when interest rates change beyond 75 bps from current levels. Therefore, the volatility in the fair value of our assets could increase significantly when interest rates change beyond 75 bps. In addition, other factors impact the fair value of and net income 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, in the event of changes in actual interest rates, the change in the fair value of our assets and our net income would likely differ from that shown above, and such difference might be material and adverse to our stockholders.
Risk Management
Our board of directors exercises its oversight of risk management in many ways, including overseeing our senior managements risk-related responsibilities, including reviewing management policies and performance against these policies and related benchmarks.
As part of our risk management process, we actively manage the interest rate, liquidity, prepayment and counterparty risks associated with our Agency RMBS portfolio. We seek to manage our interest rate risk exposure by entering into various hedging instruments in order to minimize our exposure to potential interest rate mismatches between the interest we earn on our investments and our borrowing costs.
We seek to manage our liquidity risks by monitoring our liquidity position on a daily basis and maintaining a prudent level of leverage, which we currently consider to be between five and ten times the amount of shareholders' equity in our overall portfolio, based on current market conditions and various other factors, including the health of the financial institutions that lend to us under our repurchase agreements and the presence of special liquidity programs provided by domestic and foreign central banks.

48

We seek to manage our prepayment risk by investing in Agency RMBS with a variety of prepayment characteristics as well as by balancing Agency RMBS purchased at a premium with Agency RMBS purchased at a discount.
We seek to manage our counterparty risk by (i)�diversifying our exposure across a broad number of counterparties, (ii)�limiting our exposure to any one counterparty and (iii)� monitoring the financial stability of our counterparties.

Item�4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September�30, 2014. The term disclosure controls and procedures, as defined in Rules�13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the companys management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September�30, 2014, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective.
There have been no changes in our internal controls over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II. Other Information
Item�1. Legal Proceedings
The Company is not currently subject to any material legal proceedings.
Item�1A. Risk Factors
There have been no material changes from the risk factors disclosed in the Risk Factors section of our Annual Report on SEC Form 10-K for the year ended December 31, 2013, filed with the SEC on February 14, 2014.
Item�2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item�3. Defaults Upon Senior Securities
None.
Item�4. Mine Safety Disclosures
None.
Item�5. Other Information
None.
Item�6. Exhibits
(a)
Exhibits.

49

Exhibit
Number
�
Description of Exhibit
�
�
3.1(1)
�
Articles of Amendment and Restatement of CYS Investments, Inc.
�
�
�
3.2(2)
�
Articles of Amendment to the Articles of Amendment and Restatement
�
�
�
3.3(2)
�
Articles of Amendment to the Articles of Amendment and Restatement
�
�
�
3.4(3)
�
Articles of Amendment to the Articles of Amendment and Restatement
�
�
�
3.5(4)
�
Articles Supplementary of 7.75% Series A Cumulative Redeemable Preferred Stock
�
�
�
3.6(5)
�
Articles Supplementary of 7.50% Series B Cumulative Redeemable Preferred Stock
�
�
�
3.7(6)
�
Amended and Restated Bylaws of CYS Investments, Inc.
�
�
�
31.1*
�
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes  Oxley Act of 2002
�
�
31.2*
�
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes  Oxley Act of 2002
�
�
32.1**
�
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes  Oxley Act of 2002
�
�
32.2**
�
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes  Oxley Act of 2002
�
�
Exhibit�101.INS�XBRL
�
Instance Document (7)
�
�
Exhibit�101.SCH�XBRL
�
Taxonomy Extension Schema Document (7)
�
�
Exhibit 101.CAL�XBRL
�
Taxonomy Extension Calculation Linkbase Document (7)
�
�
Exhibit 101.DEF XBRL
�
Additional Taxonomy Extension Definition Linkbase Document Created (7)
�
�
Exhibit�101.LAB�XBRL
�
Taxonomy Extension Label Linkbase Document (7)
�
�
Exhibit 101.PRE XBRL
�
Taxonomy Extension Presentation Linkbase Document (7)
_________________
*����Filed herewith.
**����Furnished herewith.

(1)
Incorporated by reference to the Registrants Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File No. 333-142236).
(2)
Incorporated by reference from the Registrants Form 10-K filed with the Securities and Exchange Commission on February 10, 2010.
(3)
Incorporated by reference from the Registrants Current Report on Form 8-K filed with the Securities and Exchange Commission on September 1, 2011.
(4)
Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the Securities and Exchange Commission on August 12, 2012.
(5)
Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the Securities and Exchange Commission on April 29, 2013.
(6)
Incorporated by reference from the Registrants Form 10-K filed with the Securities and Exchange Commission on February 10, 2012.
(7)
Submitted electronically herewith. Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i)�Consolidated Balance Sheets at September�30, 2014 (Unaudited) and December�31, 2013 (Derived from the audited balance sheet at December�31, 2013); (ii)�Consolidated Statements of Operations (Unaudited) for the three and nine months ended September 30, 2014 and 2013; (iii)�Consolidated Statement of Changes in Shareholders' Equity (Unaudited) for the nine months ended September�30, 2014; (iv)�Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September�30, 2014 and 2013; and (v)�Consolidated Notes to Financial Statements (Unaudited) for the three and nine months ended September 30, 2014 and 2013.

50

SIGNATURES
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.


CYS INVESTMENTS, INC.
Dated: October�23, 2014
BY:����/s/ FRANCES R. SPARK
Frances R. Spark
Chief Financial Officer and Treasurer
(Principal Financial Officer and Principal Accounting Officer)


51

EXHIBIT INDEX
�
Exhibit
Number
�
Description
�
�
3.1(1)
�
Articles of Amendment and Restatement of CYS Investments, Inc.
�
�
�
3.2(2)
�
Articles of Amendment to the Articles of Amendment and Restatement
�
�
�
3.3(2)
�
Articles of Amendment to the Articles of Amendment and Restatement
�
�
�
3.4(3)
�
Articles of Amendment to the Articles of Amendment and Restatement
�
�
�
3.5(4)
�
Articles Supplementary of 7.75% Series A Cumulative Redeemable Preferred Stock
�
�
�
3.6(5)
�
Articles Supplementary of 7.50% Series B Cumulative Redeemable Preferred Stock
�
�
�
3.7(6)
�
Amended and Restated Bylaws of CYS Investments, Inc.
�
�
�
31.1*
�
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes  Oxley Act of 2002
�
�
31.2*
�
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes  Oxley Act of 2002
�
�
32.1**
�
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes  Oxley Act of 2002
�
�
32.2**
�
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes  Oxley Act of 2002
�
�
Exhibit�101.INS�XBRL
�
Instance Document (7)
�
�
Exhibit�101.SCH�XBRL
�
Taxonomy Extension Schema Document (7)
�
�
Exhibit�101.CAL�XBRL
�
Taxonomy Extension Calculation Linkbase Document (7)
�
�
Exhibit�101.DEF�XBRL
�
Additional Taxonomy Extension Definition Linkbase Document Created (7)
�
�
Exhibit�101.LAB�XBRL
�
Taxonomy Extension Label Linkbase Document (7)
�
�
Exhibit�101.PRE�XBRL
�
Taxonomy Extension Presentation Linkbase Document (7)
__________________
�* ����Filed herewith.
**����Furnished herewith.

(1)
Incorporated by reference to the Registrants Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File No. 333-142236).
(2)
Incorporated by reference from the Registrants Form 10-K filed with the Securities and Exchange Commission on February 10, 2010.
(3)
Incorporated by reference from the Registrants Current Report on Form 8-K filed with the Securities and Exchange Commission on September 1, 2011.
(4)
Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the Securities and Exchange Commission on August 12, 2012.
(5)
Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the Securities and Exchange Commission on April 29, 2013.
(6)
Incorporated by reference from the Registrants Form 10-K filed with the Securities and Exchange Commission on February 10, 2012.
(7)
Submitted electronically herewith. Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i)�Consolidated Balance Sheets at September�30, 2014 (Unaudited) and December�31, 2013 (derived from the audited balance sheet at December�31, 2013); (ii)�Consolidated Statements of Operations (Unaudited) for the three and nine months ended September 30, 2014 and 2013; (iii)�Consolidated Statement of Changes in Shareholders' Equity (Unaudited) for the nine months ended September�30, 2014; (iv)�Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September�30, 2014 and

52

2013; and (v)�Consolidated Notes to Financial Statements (Unaudited) for the three and nine months ended September 30, 2014 and 2013.

53


Exhibit 31.1
Certification of Chief Executive Officer Pursuant to Section�302 of the Sarbanes-Oxley Act of 2002
I, Kevin E. Grant, certify that:
1.
I have reviewed this Quarterly Report on Form 10-Q of CYS Investments, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrants other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and
5.
The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting.
Dated: October�23, 2014
�
/s/����KEVIN E. GRANT��������
�
Kevin E. Grant
�
Chairman of the Board
and Chief Executive Officer




Exhibit 31.2
Certification of Chief Financial Officer Pursuant to Section�302 of the Sarbanes-Oxley Act of 2002
I, Frances R. Spark, certify that:
1.
I have reviewed this Quarterly Report on Form 10-Q of CYS Investments, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrants other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and
5.
The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting.
Dated: October�23, 2014
�
�
�
�
/s/����FRANCES R. SPARK��������
�
Frances R. Spark
�
Chief Financial Officer and Treasurer




Exhibit 32.1
Certification Pursuant To
18 U.S.C. Section�1350,
as Adopted Pursuant to
Section�906 of The Sarbanes-Oxley Act of 2002
In connection with the Quarterly Report of CYS Investments, Inc. (the Company) on Form 10-Q for the period ended September�30, 2014 as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Kevin E. Grant, Chairman of the Board and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section�1350, as adopted pursuant to Section�906 of the Sarbanes-Oxley Act of 2002, that:
(1)
the Report fully complies with the requirements of Section�13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2)
the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: October�23, 2014
�
/s/����KEVIN E. GRANT��������
�
Kevin E. Grant
�
Chairman of the Board
and Chief Executive Officer




Exhibit 32.2
Certification Pursuant To
18 U.S.C. Section�1350,
as Adopted Pursuant to
Section�906 of The Sarbanes-Oxley Act of 2002
In connection with the Quarterly Report of CYS Investments, Inc. (the Company) on Form 10-Q for the period ended September�30, 2014 as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Frances R. Spark, Chief Financial Officer and Treasurer of the Company, certify, pursuant to 18 U.S.C. Section�1350, as adopted pursuant to Section�906 of the Sarbanes-Oxley Act of 2002, that:
(1)
the Report fully complies with the requirements of Section�13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2)
the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: October�23, 2014
�
/s/����FRANCES R. SPARK��������
�
Frances R. Spark
�
Chief Financial Officer and Treasurer



Serious News for Serious Traders! Try StreetInsider.com Premium Free!

You May Also Be Interested In





Related Categories

SEC Filings