Anworth Mortgage Asset Corporation
Annual Report 2014

Plain-text annual report

Anworth Mortgage Asset Corporation Annual Report 2014 SELECTED FINANCIAL DATA The selected financial data as of December 31, 2014 and 2013 and for the years ended December 31, 2014, 2013 and 2012 are derived from our audited consolidated financial statements included in this Annual Report on Form 10-K. The selected financial data as of December 31, 2012, 2011 and 2010 and for the years ended December 31, 2011 and 2010 are derived from audited consolidated financial statements not included in this Annual Report on Form 10-K. You should read these selected financial data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and notes thereto that are included in this Annual Report on Form 10-K beginning on page F-1. Statements of Income Data Days in period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income net of amortization of premium and For the Years Ended December 31, 2014 2013 2012 2011 2010 (amounts in thousands, except per share data and days) 365 365 366 365 365 discount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $157,156 (79,907) $174,784 (92,970) $195,853 (86,073) $224,180 (89,265) $219,803 (95,830) Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 77,249 (30,876) (17,754) $ 81,814 9,634 (15,728) $109,780 5,860 (15,422) $134,915 2,225 (14,264) $123,973 270 (13,744) Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 28,619 $ 75,720 $100,218 $122,876 $110,499 Dividends on preferred stock . . . . . . . . . . . . . . . . . . . . (5,716) (5,736) (5,773) (5,885) (5,764) Net income available to common stockholders . . . . . . $ 22,903 $ 69,984 $ 94,445 $116,991 $104,735 Basic earnings per common share . . . . . . . . . . . . . . . . Diluted earnings per common share . . . . . . . . . . . . . . . Average number of shares outstanding . . . . . . . . . . . . Average number of diluted shares outstanding . . . . . . $ $ 0.18 0.18 123,949 128,057 $ $ 0.49 0.49 142,455 146,400 $ $ 0.68 0.67 138,382 142,485 $ $ 0.91 0.90 128,601 132,759 $ $ 0.89 0.87 118,164 121,919 As of December 31, 2014 2013 2012 2011 2010 (amounts in thousands, except per share data ) Balance Sheets Data MBS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . Repurchase agreements . . . . . . . . . . . . . . . . . Junior subordinated notes . . . . . . . . . . . . . . . Total liabilities . . . . . . . . . . . . . . . . . . . . . . . Series B Preferred Stock . . . . . . . . . . . . . . . . Stockholders’ equity (common and Series A Preferred) . . . . . . . . . . . . . . . . . . . . . . . . . . Number of common shares outstanding . . . . Book value per common share . . . . . . . . . . . $7,223,073 $7,298,335 $6,370,740 37,380 $ $6,516,894 23,924 $ $8,556,446 $8,619,491 $7,580,000 37,380 $ $7,717,305 23,924 $ $9,244,693 $9,285,105 $8,020,000 37,380 $ $8,197,388 25,222 $ $8,763,479 $8,813,769 $7,595,000 37,380 $ $7,804,243 27,239 $ $7,739,052 $7,790,215 $6,375,000 37,380 $ $6,896,304 25,630 $ $ 757,517 109,234 6.48 $ $ 878,262 138,717 5.98 $ $1,062,495 142,013 7.14 $ $ 982,287 134,115 6.96 $ $ 868,281 120,901 6.78 $ Anworth Mortgage Asset Corporation 2014 Annual Report Dear Fellow Stockholders, During our fiscal year ended December 31, 2014: • Net income available to our common stockholders, using GAAP as reported on page F-4 in the attached Form 10-K, was $22.9 million, or $0.18 per common share; • The increase in our book value, plus dividends declared, resulted in a 17.7% increase in value per share, which for mortgage REITs during 2014 is amongst the highest; • Dividends declared during 2014 were $0.56 per common share; and • The return on shareholder investment, which reflects the change in our stock price plus dividends reinvested, was 39.0%. Our Business At December 31, 2014, our portfolio of residential mortgage-backed securities (“MBS”) was allocated as follows (in thousands of dollars): Agency Residential MBS Adjustable-rate MBS . . . . . . . . . . . . . . . . . . . . . . . . . . Fixed-rate MBS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-Agency Residential MBS . . . . . . . . . . . . . . . . . . . . . . $5,750,406 1,272,957 199,710 $7,223,073 Our $7.2 billion portfolio of MBS was acquired using our equity capital and $6.37 billion of repurchase agreement financing. The principal and interest payments of our agency residential mortgage pass-through securities are guaranteed by a government-sponsored enterprise (“GSE”) such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”). Based on our belief that residential properties will appreciate in value over the next several years, we have acquired $199.7 million of Non-Agency residential MBS. We expect to continue to increase our allocation of Non-Agency MBS, which are backed primarily by the value of mortgage loans secured by residential properties and are not GSE guaranteed. We have also allocated $12.9 million of our equity capital to residential properties acquired primarily through foreclosure sales and from which we earn rental income after renovation. Interest Rate Hedging To lessen our portfolio’s exposure to increases in our financing costs, we use interest rate swap agreements (“Swaps”) where, for stated periods such as one, two or more years, we agree to pay a fixed-rate of interest on a specified amount of money to a counterparty who agrees to regularly pay us a LIBOR-based floating-rate on the same specified amount of money. At December 31, 2014, the notional balance of our Swaps was $3.3 billion, which represented 52% of the amount of our repurchase agreement financing. Our Swaps had an average term to maturity of approximately 4.0 years. 1 Since we tend to finance our MBS using shorter-term repurchase agreements whose terms are one, three or more months, the effect of the Swaps is to provide financing with a fixed-rate of interest over the term of the Swaps. Economic and Interest Rate Outlook As we have reported here for several years, we believe that the health of the U.S. housing market during this economic cycle is a major leading indicator of the return to health of the overall U.S. economy. The appreciation of single-family houses during the past two years has resulted in home prices now being only 10% less than the pre-crisis peak in 2006 and indicates to us that increasing numbers of homebuyers will be more comfortable in making their decision to own a home which, for many, will be their largest ever purchase. While significant headwinds that can impact the U.S. economy continue, this uptick in housing prices bodes well for a lower likelihood of a return to the recessionary environment and the accompanying lesser demand for credit. In spite of this outlook for reduced recessionary pressures, there remain questions about how well the U.S. economy can operate if the Federal Reserve raises short-term interest rates during 2015 as they have indicated they will do. Many of the recent measures of economic activity have been at levels considerably lower than where many economists think they should be at this stage of the economic recovery process. It appears that the likely answer is that the economic recovery will remain weak but will be a recovery nonetheless. Significantly for the U.S. and other developed countries, a prolonged period of tepid U.S. growth per capita, when compared with the strong growth and productivity increases in the developing world, points toward a more influential role for the developing world in the management of global economic policies. In this environment, a material concern for the U.S. is its workforce’s ability to compete globally for many of the available jobs. If the developing world captures increasing percentages of these jobs, it does not bode well for increased home ownership in the U.S. At its peak in 2005, the percentage of home ownership was 69% and now, in the aftermath of the financial crisis, is 64%. As noted earlier, our belief is that owner-occupied and rental residential properties will appreciate over the long-term. Our outlook for interest rates during the remainder of 2015 is for modest if any increases. Our Stock’s Long-Term Return Anworth’s 2014 year-end common stock price on the New York Stock Exchange was $5.25 and at the beginning of 2014 was $4.21. This change in our common stock price, along with the dividends paid, resulted in a rate of return of 39.0% during 2014. During this same period, the S&P 500 Index provided a rate of return of 13.7% for the year and the FTSE NAREIT Mortgage REIT index provided a rate of return of 17.9%. Since our initial public offering in March 1998 at $9.00 per share, our common shares, along with dividends reinvested, have provided investors with a cumulative return of 292%, which is also a compounded rate of return of 8.5% per year between March 1998 and December 2014, while the S&P 500 Index provided a return of 5.8% per year during this same period. Also, the FTSE NAREIT Mortgage REIT Index produced a return of 3.3% per year during this same period. Other Investment Opportunities Anworth Properties, Inc., our wholly-owned Qualified REIT Subsidiary (“QRS”), began operating in mid- 2014 and is the entity through which we own residential rental properties and may own other REIT-qualified real estate assets. 2 Although currently not operational, we incorporated a Taxable REIT Subsidiary (“TRS”) which is the entity through which we may participate in various taxable real estate-related activities such as the securitization of mortgage loans; mortgage origination; leasing and managing rental properties; and property renovation or owning properties acquired through the foreclosure process. Book Value Per Share You will observe on page 53 in the attached Form 10-K that our book value per share at December 31, 2014 increased to $6.48 per common share from $5.98 per common share on December 31, 2013. The increase in our book value, plus dividends declared, resulted in a 17.7% increase in value per share, which for mortgage REITs during 2014 is amongst the highest. Share Repurchase Program During the year ended December 31, 2014, we repurchased an aggregate of 29.8 million common shares at a weighted average price of $5.16 per share. This amount represents 21% of our shares outstanding at December 31, 2013. Dividend Reinvestment and Stock Purchase Plan We believe that our Dividend Reinvestment and Stock Purchase Plan (the “Plan”) is an attractive benefit of common stock ownership. Common stockholders can, without brokerage commissions, reinvest their dividends into additional shares of Anworth’s common stock and make monthly purchases of up to $10,000 in Anworth’s common stock without brokerage commissions. Please call or e-mail us to receive a prospectus that describes the details of the Plan so you can join and invest with us. Our Series A Cumulative Preferred Stock Our 8.625% Series A Cumulative Preferred Stock (the “Series A Preferred Stock”) also trades on the New York Stock Exchange. The issue price and liquidation preference are $25.00 per share and the annual dividend rate is $2.15625 per share. At December 31, 2014, there were 1,919,378 shares of Series A Preferred Stock issued and outstanding. The dividend is scheduled to be paid on the 15th of the first month in each calendar quarter. A copy of the prospectus is available on the www.sec.gov website or from the Company. Our Series A Preferred Stock is currently callable on one month’s notice at $25.00 per share. On December 31, 2014, the closing price of our Series A Preferred Stock was $25.27. Our Series B Cumulative Convertible Preferred Stock Our 6.25% Series B Cumulative Convertible Preferred Stock (the “Series B Preferred Stock”) also trades on the New York Stock Exchange. The issue price and liquidation preference are $25.00 per share and the annual dividend rate is $1.5625 per share. At December 31, 2014, there were 1,009,640 shares of Series B Preferred Stock issued and outstanding. Effective December 31, 2014, the conversion rate increased to 4.2029 shares of our common stock for each Series B Preferred share from a conversion rate of 3.9881 at December 31, 2013. Also, if our common stock dividend yield exceeds 6.25%, this conversion rate will increase as it did throughout 2014. A copy of the prospectus is available on the www.sec.gov website or from the Company. At December 31, 2014, the closing price of our Series B Preferred Stock on was $22.85, which provided a cash dividend yield of approximately 6.84%. 3 Our Series C Cumulative Preferred Stock In January 2015, we completed an offering of our new 7.625% Series C Cumulative Preferred Stock (the “Series C Preferred Stock”) which also trades on the New York Stock Exchange. The issue price and liquidation preference are $25.00 per share and the annual dividend rate is $1.90625 per share. At March 31, 2015, there were 300,000 shares of Series C Preferred Stock issued and outstanding. The dividend is scheduled to be paid on the 15th of the first month in each calendar quarter. A copy of the prospectus is available on the www.sec.gov website or from the Company. Our Series C Preferred Stock is not callable until January 27, 2020 at $25.00 per share. Anworth.com The size of our investor e-mail list continues to grow and we are always pleased to add interested investors to the distribution list to receive notifications of news releases and other items of interest. You can register for e-mail notifications at our website, http://www.anworth.com, where you may also obtain information about our corporate governance procedures, listen to webcasts of earnings calls and presentations that the Company has made to investor groups, and to obtain other statistical information. Our web site has been optimized for viewing on your iPhone and other mobile devices. Our Philosophy We continue to believe that our Company is well suited to continue to be a long-term participant in the mortgage finance industry and to provide a valuable service to residential homeowners. Many financial institutions that originate mortgage loans for homeowners no longer keep these loans in their investment portfolios. Therefore, these originators often promptly securitize their residential mortgage loans either privately or through Fannie Mae and Freddie Mac so that more permanent owners like us can acquire them. As the long-term beneficial owner of approximately $7.2 billion of residential mortgage assets, Anworth continues to be a significant financial participant in the U.S. mortgage industry. We believe that many large institutional investors tend to speculate in mortgage rates, thereby adding to the volatility of residential mortgage rates. We also believe that our long-term commitment to owning residential mortgages in a very capital-efficient and tax-efficient manner can improve the stability of mortgage interest rates. Annual Meeting of Stockholders We invite you to attend our 2015 Annual Meeting of Stockholders in Santa Monica. I am confident that those of you who have attended in the past will agree that we provide good weather and an interesting and informative experience. If you need information regarding directions, hotels, or nearby restaurants, etc., please give us a call. As always, I thank you for your continued support. Lloyd McAdams, CFA Chairman and Chief Executive Officer 4 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 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 001-13709 ANWORTH MORTGAGE ASSET CORPORATION (Exact Name of Registrant as Specified in Its Charter) MARYLAND (State or Other Jurisdiction of incorporation or organization) 1299 OCEAN AVENUE, SECOND FLOOR SANTA MONICA, CALIFORNIA (Address of Principal Executive Offices) 52-2059785 (I.R.S. Employer Identification No.) 90401 (Zip Code) Registrant’s telephone number, including area code: (310) 255-4493 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Series A Cumulative Preferred Stock, $0.01 Par Value Series B Cumulative Convertible Preferred Stock, $0.01 Par Value Series C Cumulative Redeemable Preferred Stock, $0.01 Per Value Common Stock, $0.01 Par Value Name of Each Exchange on Which Registered New York Stock Exchange New York Stock Exchange New York Stock Exchange New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  No  Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  No  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  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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  No  Indicate by check mark that disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  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  Non-Accelerated Filer  Accelerated Filer  Smaller Reporting Company  Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  No  The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant, computed by reference to the closing price of such stock on the New York Stock Exchange, as of June 30, 2014 was approximately $629,892,084. As of February 20, 2015, the registrant had 106,446,276 shares of common stock issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Part III of this Form 10-K incorporates by reference certain portions of the registrant’s proxy statement for its 2015 annual meeting of stockholders to be filed with the Commission not later than 120 days after the end of the fiscal year covered by this report. ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES FORM 10-K ANNUAL REPORT FISCAL YEAR ENDED DECEMBER 31, 2014 TABLE OF CONTENTS Item PART I 1. 1A. 1B. 2. 3. 4. 5. 6. 7. 7A. 8. 9. 9A. 9B. 10. 11. 12. 13. 14. Business .............................................................................................................................................................................. Risk Factors ......................................................................................................................................................................... Unresolved Staff Comments ............................................................................................................................................... Properties ............................................................................................................................................................................ Legal Proceedings ............................................................................................................................................................... Mine Safety Disclosures ..................................................................................................................................................... PART II Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities .......... Selected Financial Data ....................................................................................................................................................... Management’s Discussion and Analysis of Financial Condition and Results of Operations .............................................. Quantitative and Qualitative Disclosures About Market Risk ............................................................................................ Financial Statements and Supplementary Data ................................................................................................................... Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .............................................. Controls and Procedures ..................................................................................................................................................... Other Information................................................................................................................................................................ PART III Directors, Executive Officers and Corporate Governance .................................................................................................. Executive Compensation ..................................................................................................................................................... Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ............................ Certain Relationships and Related Transactions, and Director Independence .................................................................... Principal Accountant Fees and Services ............................................................................................................................. Page 3 28 50 50 50 50 51 53 54 69 73 73 73 75 76 76 76 76 76 Exhibits and Financial Statement Schedules ....................................................................................................................... 15. Signatures .......................................................................................................................................................................................... Financial Statements ......................................................................................................................................................................... 77 78 F-1 PART IV Item 1. BUSINESS Overview Our Company PART I We were incorporated in Maryland on October 20, 1997 and we commenced operations on March 17, 1998. Our principal business is to invest in, finance and manage a leveraged portfolio of residential mortgage-backed securities which presently are primarily agency mortgage-backed securities, or Agency MBS. Agency MBS include residential mortgage pass-through certificates and collateralized mortgage obligations, or CMOs, which are securities representing interests in pools of mortgage loans secured by residential property in which the principal and interest payments are guaranteed by a government-sponsored enterprise, or GSE, such as the Federal National Mortgage Association, or Fannie Mae, or the Federal Home Loan Mortgage Corporation, or Freddie Mac. We also own non-agency mortgage-backed securities, or Non-Agency MBS, which are securities issued by companies that are not guaranteed by federally sponsored enterprises and that are secured primarily by first-lien residential mortgage loans. Our principal business objective is to generate net income for distribution to our stockholders primarily based upon the spread between the interest income on our mortgage assets and our borrowing costs to finance our acquisition of those assets. We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code. As long as we retain our REIT status, we generally will not be subject to federal or state income taxes to the extent that we distribute our income to our stockholders and we routinely distribute to our stockholders substantially all of the income generated from our operations. In order to qualify as a REIT, we must meet various ongoing requirements under the tax law, including requirements relating to the composition of our assets, the nature of our gross income, minimum distribution requirements and requirements relating to the ownership of our stock. We believe that we have met all of these requirements and that we will continue to qualify as a REIT. In February 2014, we incorporated our wholly-owned Qualified REIT Subsidiary, or QRS, Anworth Properties, Inc., which commenced operations in March 2014. Our QRS presently has also acquired REIT-qualified residential real estate assets from which we receive rental income and that have the potential for price appreciation. In addition, our QRS may also own other types of mortgage assets, from which we would receive interest income, and other real estate assets. We also incorporated Anworth Property Services, Inc., which we intend will elect to be treated as a Taxable REIT Subsidiary, or TRS, that is wholly-owned by us and currently has no operations. Our TRS will provide the entity through which we may participate in various activities that might otherwise have adverse tax consequences if conducted directly by a REIT or a QRS. Unlike a REIT, a TRS pays standard corporate taxes on its income earned from these activities in the mortgage and real estate markets. These other activities include almost everything other than receiving rent on properties owned and collecting interest on real estate mortgages or related investments. Examples of other possible activities in which our TRS might engage in include the securitization of mortgage loans; mortgage origination; leasing and managing of rental property owned by third parties; and owning properties acquired through the foreclosure process. Our Manager We are externally managed and advised by Anworth Management, LLC, or our Manager. Effective as of December 31, 2011, we entered into a Management Agreement (which we refer to as the “Management Agreement”) with our Manager, which effected the externalization of our management function, or the Externalization. Since the effective date, our day-to-day operations are being conducted by our Manager through the authority delegated to it under the Management Agreement and pursuant to the policies established by our board of directors. Our Manager is supervised and directed by our board of directors and is responsible for administering our day-to-day operations. In addition, our Manager is responsible for (i) the selection, purchase and sale of our investment portfolio; (ii) our financing and hedging activities; and (iii) providing us with management services. Our Manager will also perform such other services and activities relating to our assets and operations as may be appropriate. In exchange for these services, our Manager receives a management fee paid monthly in arrears in an amount equal to one-twelfth of 1.20% of our Equity (as defined in the Management Agreement). 3 Special Note Regarding Forward-Looking Statement This Annual Report on Form 10-K contains, or incorporates by reference, not only historical information, but also forward- looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act, and that are subject to the safe harbors created by such sections. Forward-looking statements involve numerous risks and uncertainties. Our actual results may differ from our beliefs, expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as “anticipate,” “estimate,” “will,” “should,” “expect,” “target,” “believe,” “intend,” “seek,” “plan,” “goals,” “future,” “likely,” “may,” and similar expressions or their negative forms, or by references to strategy, plans, or intentions. These forward-looking statements are subject to risks and uncertainties including, among other things, those described in this Annual Report on Form 10-K under the caption “Risk Factors.” Other risks, uncertainties and factors that could cause actual results to differ materially from those projected are described below and may be described from time to time in reports we file with the United States Securities and Exchange Commission, or the SEC, including our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. Forward-looking statements speak only as of the date they are made and we undertake no obligation to update or revise any such forward-looking statements, whether as a result of new information, future events, or otherwise. Statements regarding the following subjects, among others, that may affect our actual results may be forward-looking:                       risks associated with investing in mortgage-backed securities, or MBS, and related assets; changes in interest rates and the market value of our target investments; changes in prepayment rates of the mortgage loans securing our MBS; changes in the yield curve; the credit performance of our Non-Agency MBS; the concentration of the credit risks we are exposed to; the state of the credit markets and other general economic conditions, particularly as they affect the price of earning assets and the credit status of borrowers; the availability of our target investments for purchase at attractive prices; the availability of financing for our target investments, including the availability of repurchase agreement financing; declines in home prices; increases in payment delinquencies and defaults on the mortgages comprising and underlying our target investments; changes in liquidity in the market for MBS, the re-pricing of credit risk in the capital markets, inaccurate ratings of securities by rating agencies, rating agency downgrades of securities, and increases in the supply of MBS available-for- sale; changes in the values of the MBS in our portfolio and the impact of adjustments reflecting those changes on our income statement and balance sheet, including our stockholders’ equity; our ability to generate the amount of cash flow we expect from our target investments; changes in our investment and financing strategies and the new risks that those changes may expose us to; changes in the competitive environment within our industry, including changes that may affect our Manager’s ability to attract and retain personnel; our ability to successfully diversify our business into new investments and manage the new risks they may expose us to; our ability to manage various operational and regulatory risks associated with our business; our ability to establish, adjust and maintain appropriate hedges for the risks to our portfolio; legislative and regulatory actions affecting the mortgage and derivative industries or our business; implementation of or changes in government regulations or programs affecting our business; changes due to the consequences of actions by the U.S. government and other foreign governments to address the global financial crisis;  our ability to maintain our qualification as a real estate investment trust, or REIT, for federal income tax purposes; 4   our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended; limitations imposed on our business due to our REIT status and our status as exempt from registration under the Investment Company Act of 1940, as amended; and  our ability to manage our growth. 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 do not intend to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. As used in this Annual Report on Form 10-K, “Company,” “we,” “us,” “our” and “Anworth” refer to Anworth Mortgage Asset Corporation. Our Investment Strategy Our investment objective is to provide attractive risk-adjusted total returns to our stockholders over the long-term primarily through dividends and secondarily through capital appreciation. Our strategy is to invest primarily in MBS. While we currently have the majority of our assets in Agency MBS, a portion of our portfolio consists of Non-Agency MBS. We also have a small portfolio of residential real estate properties which we lease to tenants. We seek to acquire assets that will produce competitive returns after considering the amount and nature of the investment’s anticipated returns, our ability to pledge the investment to secure collateralized borrowings and the costs associated with financing, managing and reserving for these investments. We do not currently originate mortgage loans or provide other types of financing to the owners of real estate. Financing Strategy Our primary financing source for our Agency MBS portfolio is repurchase agreements which we may use to deploy, on a debt- to-allocated-equity basis, up to twelve times leverage on our Agency MBS assets. We are not required to maintain any particular minimum leverage ratio. We employ short-term borrowing to attempt to increase potential returns to our stockholders. Pursuant to our Capital and Leverage Policy, we seek to strike a balance between the under-utilization of leverage, which reduces potential returns to stockholders, and the over-utilization of leverage, which could reduce our ability to meet our obligations during adverse market conditions. The amount of leverage we deploy for particular investments in our target investments depends upon an assessment of a variety of factors, which may include:         the anticipated liquidity and price volatility of our assets; the gap between the duration of our assets and liabilities, including hedges; the availability and cost of financing our assets; our opinion of the credit worthiness of financing counterparties; the health of the U.S. economy and residential mortgage and housing markets; our outlook for the level, slope and volatility of interest rates; the credit quality of the loans underlying our Agency MBS and Non-Agency MBS; and our outlook for asset spreads relative to the London Interbank Offered Rate, or LIBOR, curve. Repurchase agreements are financings pursuant to which one party, the seller or borrower, sells assets to the repurchase agreement counterparty, the buyer or lender, for an agreed price with the obligation to repurchase the assets from the buyer at a future date and at a price higher than the original purchase price. The amount of financing available under a repurchase agreement is limited to a specified percentage of the estimated market value of the assets. The difference between the sale price and repurchase price is the interest expense of financing under a repurchase agreement. Under repurchase agreement financing arrangements, if the value of the collateral decreases, the buyer could require the seller to provide additional cash collateral to re-establish the ratio of value of the collateral to the amount of borrowing. In the current financing climate, lenders using repurchase agreements generally advance approximately 94% to 97% of the market value of the Agency MBS financed (meaning a 3% to 6% discount from market value, also 5 known as a haircut) and 65% to 80% of the market value of the Non-Agency MBS financed (meaning a 20% to 35% haircut). A significant decrease in advance rate or an increase in the haircut could result in our having to sell securities in order to meet additional margin requirements by the lender. We expect to mitigate our risk of margin calls under repurchase agreements by deploying a prudent amount of leverage that is below the amount that could be used under current advance rates. In order to reduce our exposure to counterparty-related risk, we generally seek to diversify our exposure by entering into repurchase agreements with multiple counterparties. At December 31, 2014, we had approximately $6.37 billion of outstanding balances under repurchase agreements with 25 different counterparties, with a maximum net exposure (the difference between the amount loaned to us and the value of the assets pledged by us as collateral) to any single lender of approximately $44 million, or approximately 6% of our equity. Growth Strategy It is our long-term objective to grow our earnings and our dividends per common share by increasing our paid-in capital and book value per share. Our Target Investments Our investment portfolio is focused on two different strategies that embody our hybrid investment approach. The target investments that fall under these strategies are: Agency MBS This strategy includes investing in Agency MBS and the related derivative transactions. The performance of this strategy is most affected by changes interest rates, prepayments and mortgage spreads relative to U.S. Treasury securities. These assets have minimal exposure to the underlying credit of the investments. Agency MBS are collateralized by fixed-rate mortgage loans, adjustable-rate mortgage loans or hybrid mortgage loans, or derivatives thereof, including:  mortgage pass-through certificates issued by a government-sponsored enterprise, or GSE, such as Fannie Mae and Freddie Mac; collateralized mortgage obligations (CMOs); and “to-be-announced” forward contracts, or TBAs, which are pools of mortgages with specific investment terms to be issued by government-sponsored enterprises at a future date.   Mortgage Credit Investments These assets include investing in Non-Agency MBS, residential mortgage loans and related derivative transactions. Examples of Non-Agency MBS include MBS collateralized by prime mortgage loans, Alt-A mortgage loans and subprime mortgage loans, which may have fixed-rate, adjustable-rate or hybrid-rate terms. Non-Agency MBS includes both senior and mezzanine MBS. Senior MBS refers to Non-Agency MBS that represent the senior-most tranches – that is, tranches which have the highest priority claim to cash flows from the related collateral pool within the MBS structure. Mezzanine MBS refers to subordinated tranches within the collateral pool. The Non-Agency MBS we purchase may include investment-grade and non-investment grade classes including non-rated securities. Hybrid mortgage loans have terms with interest rates that are fixed for a specified period of time and, thereafter, generally adjust annually to an increment over a specified interest rate index. ARMs refer to hybrid and adjustable-rate mortgage loans which typically have interest rates that adjust annually to an increment over a specified interest rate index. The performance of this strategy is most affected by changes in credit performance of the underlying collateral. These assets have interest rate and mortgage spread exposure, but the exposure is not viewed to be the main driver of performance. Residential Real Estate These assets consist primarily of single-family residential properties acquired through bids at foreclosure sales which, after renovation, we lease to tenants. Our focus is on acquiring properties located in in-migration geographical areas that can produce high occupancy and attractive rental rates and generate long-term property appreciation. 6 While we presently have not acquired any single-family residential mortgage loans, it is expected that we will do so in the future. After that time, it is expected that any properties acquired through foreclosure of mortgage loans that we own will be allocated to our rental properties portfolio. Our Operating Policies and Programs We have established the following four primary operating policies to implement our business strategies:     our Asset Acquisition Policy; our Capital and Leverage Policy; our Credit Risk Management Policy; and our Asset/Liability Management Policy. Asset Acquisition Policy Our Asset Acquisition Policy provides guidelines for acquiring investments and contemplates that we will acquire a portfolio of investments that can be grouped into specific categories. Each category and our respective investment guidelines are as follows:  Category I — At least 60% of our total assets will generally be adjustable- or fixed-rate MBS and short-term investments. Assets in this category will be rated within one of the two highest rating categories by at least one nationally recognized statistical rating organization or, if not rated, will be obligations guaranteed by a GSE, such as Fannie Mae or Freddie Mac. Also included in Category I are the portion of real estate mortgage loans that have been deposited into a trust and have received a rating within one of the two highest rating categories by at least one nationally recognized statistical rating organization.  Category II — At least 90% of our total assets will generally consist of Category I investments plus unsecuritized mortgage loans, mortgage securities rated at least “investment grade” by at least one nationally recognized statistical rating organization, or shares of other REITs or mortgage-related companies and the portion of real estate mortgage loans that have been deposited into a trust and have received an investment grade rating by at least one nationally recognized statistical rating organization.  Category III — No more than 10% of our total assets may be of a type not meeting any of the above criteria. Among the types of assets generally assigned to this category are mortgage securities rated below investment grade and leveraged mortgage derivative securities. Under our Category III investment criteria, we may acquire other types of mortgage derivative securities including, but not limited to, interest-only, principal-only or other types of MBS that receive a disproportionate share of interest income or principal. Capital and Leverage Policy We employ a leverage strategy to increase our investment assets by borrowing against existing mortgage-related assets and using the proceeds to acquire additional mortgage-related assets. Our borrowings may vary from time to time depending on market conditions and other factors deemed relevant by our management and our board of directors. We believe that this will leave an adequate capital base to protect against interest rate environments in which our borrowing costs might exceed our interest income from mortgage-related assets. At December 31, 2014, our leverage on capital (including common stockholders’ equity, all preferred stock and junior subordinated notes) was 7.78x. Depending on the different costs of borrowing funds at different maturities, we may vary the maturities of our borrowed funds. Our borrowings are short-term and we manage actively, on an aggregate basis, both the interest rate indices and interest rate adjustment periods of our borrowings against the interest rate indices and interest rate adjustment periods on our mortgage-related assets. Our mortgage-related assets are financed primarily at short-term borrowing rates through repurchase agreements. In the future, we may also employ borrowings under lines of credit and other collateralized financings that we may establish with approved institutional lenders. 7 Credit Risk Management Policy Subject to the constraints of our Asset Acquisition Policy, we are allowed to own both investment grade and non-investment grade Non-Agency MBS and other mortgage-related assets. Prior to purchase, we review credit risk and other risks of loss associated with each of our potential investments. To lessen our overall credit risk, we may diversify our portfolio of mortgage-related assets relative to geographic, insurer, industry and certain other types of concentrations. If there is a decline in the credit quality of any of our Non-Agency MBS holdings, we may, after evaluation, maintain or increase our holdings or liquidate all or a portion of the position. We are not required to sell a security when it is moved to a lower Category in our Asset Acquisition Policy. Asset/Liability Management Policy Interest Rate Risk Management. To the extent consistent with our election to qualify as a REIT, we follow an interest rate risk management program intended to protect our portfolio of mortgage-related assets and related debt against the effects of major interest rate changes. Specifically, our interest rate management program is formulated with the intent to offset, to some extent, the potential adverse effects resulting from rate adjustment limitations on our mortgage-related assets and the differences between interest rate adjustment indices and interest rate adjustment periods of our adjustable-rate mortgage-related assets and related borrowings. Our interest rate risk management program encompasses a number of procedures including the following:  monitoring and adjusting, if necessary, the interest rate sensitivity of our mortgage-related assets compared with the interest rate sensitivities of our borrowings;   attempting to structure our borrowing agreements relating to adjustable-rate mortgage-related assets to have a range of different maturities and interest rate adjustment periods (although substantially all will be less than one year); and actively managing, on an aggregate basis, the interest rate indices and interest rate adjustment periods of our mortgage- related assets compared to the interest rate indices and adjustment periods of our borrowings. We expect to be able to adjust the average maturity/adjustment period of our borrowings on an ongoing basis by changing the mix of maturities and interest rate adjustment periods as borrowings come due or are renewed. Through the use of these procedures, we attempt to reduce the risk of differences between interest rate adjustment periods of our adjustable-rate mortgage-related assets and our related borrowings. Depending on market conditions and the cost of the transactions, we may conduct certain hedging activities in connection with the management of our portfolio. To the extent consistent with our election to qualify as a REIT, we may adopt a hedging strategy intended to lessen the effects of interest rate changes and to enable us to earn net interest income in periods of generally rising, as well as declining or static, interest rates. Specifically, hedging programs are formulated with the intent to offset some of the potential adverse effects of changes in interest rate levels relative to the interest rates on the mortgage-related assets held in our investment portfolio and differences between the interest rate adjustment indices and periods of our mortgage-related assets and our borrowings. We monitor carefully, and may have to limit, our hedging activity to assure that we do not realize excessive hedging income or hold hedges having excess value in relation to our mortgage-related assets, which could result in our disqualification as a REIT or, in the case of excess hedging income, if the excess is due to reasonable cause and not willful neglect, the payment of a penalty tax for failure to satisfy certain REIT income tests under the Code. In addition, hedging activity involves transaction costs that increase dramatically as the period covered by hedging protection increases and that may increase during periods of fluctuating interest rates. Prepayment Risk Management. We also seek to lessen the effects of prepayment of mortgage loans underlying our securities at a faster or slower rate than anticipated. We accomplish this by structuring a diversified portfolio with a variety of prepayment characteristics, investing in mortgage-related assets with prepayment prohibitions and penalties, investing in certain mortgage security structures that have prepayment protections and purchasing mortgage-related assets at a premium or at a discount. Under normal market conditions, we generally seek to maintain the aggregate capitalized purchase premium of the portfolio at 3.5% or less. In addition, we can purchase principal-only derivatives to a limited extent as a hedge against prepayment risks. We monitor prepayment risk through periodic review of the impact of a variety of prepayment scenarios on our revenues, net earnings, dividends, cash flow and net balance sheets market value. We believe that we have developed cost-effective asset/liability management policies to mitigate prepayment risks. However, no strategy can completely insulate us from prepayment risks. Further, as noted above, certain of the federal income tax requirements that we must satisfy to qualify as a REIT limit our ability to fully hedge our prepayment risks. Therefore, we could be prevented from effectively hedging our prepayment risks. 8 Our Investment Portfolio Agency MBS Residential Mortgage Pass-Through Certificates. We principally invest in pass-through certificates, which are securities representing interests in “pools” of mortgage loans secured by residential real property in which payments of both interest and principal on the securities are generally made monthly to holders of the security, in effect “passing through” monthly payments made by the individual borrowers on the mortgage loans that underlie the securities, net of fees paid to the issuer/guarantor and servicers of the securities. In general, mortgage pass-through certificates distribute cash flows from underlying collateral on a pro rata basis among certificate holders. The payment of principal and interest on these securities is guaranteed by Ginnie Mae or a GSE such as Fannie Mae or Freddie Mac. Early repayment of principal on some MBS, arising from prepayments of principal due to sale of the underlying property, refinancing or foreclosure, net of fees and costs which may be incurred, may expose us to a lower rate of return upon reinvestment of principal. This is generally referred to as “prepayment risk.” Additionally, if a security subject to prepayment has been purchased at a premium, the unamortized value of the premium would be lost in the event of prepayment. Like other fixed-income securities, when interest rates rise, the value of a mortgage-backed security generally will decline. When interest rates are declining, however, the value of MBS with prepayment features may not increase as much as other fixed- income securities. The rate of prepayments on underlying mortgages will affect the price and volatility of MBS and may have the effect of shortening or extending the effective maturity of the security beyond what was anticipated at the time of purchase. When interest rates rise, our holdings of MBS may experience reduced returns if the owners of the underlying mortgages pay off their mortgages later than anticipated. This is generally referred to as “extension risk.” Payment of principal and interest on some mortgage pass-through securities, though not the market value of the securities themselves, may be guaranteed by the full faith and credit of the federal government, including securities backed by Ginnie Mae, or by agencies or instrumentalities of the federal government, including Fannie Mae and Freddie Mac. MBS created by non-governmental issuers, including commercial banks, savings and loan institutions, private mortgage insurance companies, mortgage bankers and other secondary market issuers, may be supported by various forms of insurance or guarantees including individual loan, title, pool and hazard insurance and letters of credit which may be issued by governmental entities, private insurers or the mortgage poolers. Collateralized Mortgage Obligations (CMOs). CMOs are securities that are structured instruments representing interests in agency residential pass-through certificates. CMOs consist of multiple classes of securities, with each class having specified characteristics, including stated maturity dates, weighted average lives and rules governing principal and interest distribution. Monthly payments of interest and principal, including prepayments, are typically returned to different classes based on rules described in the trust documents. Principal and interest payments may also be divided between holders of different securities in the CMO and some securities may only receive interest payments while others receive only principal payments. General Information About Agency MBS The Agency MBS that we acquire provide funds for mortgage loans made to residential homeowners. These securities generally represent interests in pools of mortgage loans made by mortgage bankers, commercial banks, savings and loan institutions and other mortgage lenders. These pools of mortgage loans are assembled for sale to investors, such as us, by various government- related or private organizations. Agency MBS differ from other forms of traditional debt securities, which normally provide for periodic payments of interest in fixed amounts with principal payments at maturity or on specified call dates. Instead, Agency MBS provide for a monthly payment, which may consist of both interest and principal. In effect, these payments are a “pass-through” of the monthly interest and scheduled and unscheduled principal payments (referred to as “prepayments”) made by the individual borrower on the mortgage loans, net of any fees paid to the issuer, servicer or guarantor of the securities. The investment characteristics of Agency MBS differ from those of traditional fixed-income securities. Major differences include the payment of interest and principal on the securities on a more frequent schedule, as described above, and the possibility that principal may be prepaid, without penalty, at par at any time due to prepayments on the underlying mortgage loans. These differences can result in significantly greater price and yield volatility than is the case with traditional fixed-income securities. Various factors affect the rate at which mortgage prepayments occur, including changes in the level of and directional trends in housing prices, interest rates, general economic conditions, defaults on the underlying mortgages, the age of the mortgage loan, the size of the loan, the loan-to-value ratio of the mortgage, the location of the property and social and demographic conditions. Additionally, changes to GSE underwriting practices or other governmental programs could also significantly impact prepayment rates or expectations. Also, the pace at which the loans underlying our securities become seriously delinquent or are modified and the 9 timing of GSE repurchases of loans from our securities can materially impact the rate of prepayments. Generally, prepayments on Agency MBS increase during periods of falling mortgage interest rates and decrease during periods of rising mortgage interest rates; however, this may not always be the case. We may reinvest principal repayments at a yield that is higher or lower than the yield on the repaid investment, thus affecting our net interest income by altering the average yield on our assets. When interest rates are declining, the value of Agency MBS with prepayment options may not increase as much as other fixed income securities or could even decrease. The rate of prepayments on underlying mortgages affect the price and volatility of Agency MBS and may have the effect of shortening or extending the duration of the security beyond what was anticipated at the time of purchase. When interest rates rise, our portfolio of Agency MBS may experience reduced returns if the owners of the underlying mortgages pay-off their mortgages slower than anticipated. This could cause the prices of our mortgage assets to fall more than we anticipated and for our hedge portfolio to underperform relative to the decline in the value of our mortgage assets, thus reducing our net book value. This is generally referred to as “extension risk.” Payments of principal and interest on Agency MBS, although not the market value of the securities themselves, are guaranteed either by the full faith and credit of the United States, such as those issued by Ginnie Mae, or by a GSE, such as those issued by Fannie Mae or Freddie Mac. Agency MBS are collateralized by pools of fixed-rate mortgage loans, or FRMs, adjustable-rate mortgage loans, or ARMs and hybrid ARMs. Hybrid ARMs are mortgage loans that have interest rates that are fixed for an initial period (typically three, five, seven or 10 years) and, thereafter, reset at regular intervals subject to interest rate caps. Our allocation of investments among securities collateralized by FRMs, ARMs or hybrid ARMs depends upon our Manager’s assessment of the relative value of the securities, which is based upon numerous factors including, but not limited to, expected future prepayment trends, supply and demand, costs of financing, costs of hedging, expected future interest rate volatility and the overall shape of the U.S. Treasury and interest rate swap yield curves. The types of residential pass-through certificates in which we invest, or which may comprise the CMOs in which we may invest, are described below. Freddie Mac and Fannie Mae We invest in Agency MBS issued by Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are stockholder-owned corporations chartered by Congress with a public mission to provide liquidity, stability and affordability to the U.S. housing market. Fannie Mae and Freddie Mac are currently regulated by the Federal Housing Finance Agency, or FHFA, the U.S. Department of Housing and Urban Development, or HUD, the U.S. Securities and Exchange Commission, or the SEC, and the U.S. Department of the Treasury, or the U.S. Treasury, and are currently operating under the conservatorship of FHFA. The U.S. Treasury has agreed to support the continuing operations of Fannie Mae and Freddie Mac with any necessary capital contributions while in conservatorship. However, the U.S. Government does not guarantee the securities, or other obligations, of Fannie Mae or Freddie Mac. Fannie Mae and Freddie Mac operate in the secondary mortgage market. They purchase residential mortgage loans and mortgage-related securities from primary mortgage market institutions, such as commercial banks, savings and loan associations, mortgage banking companies, seller/servicers, securities dealers and other investors. Through the mortgage securitization process, they package the purchased mortgage loans into guaranteed MBS for sale to investors, such as us, in the form of pass-through certificates and guarantee the payment of principal and interest on the securities or, on the underlying loans held within the securitization trust, in exchange for guarantee fees. The underlying loans must meet certain underwriting standards established by Fannie Mae and Freddie Mac (referred to as “conforming loans”) and may be fixed or adjustable-rate loans with original terms to maturity of up to 40 years. Non-Agency Mortgage Investments Non-Agency MBS are securities backed by residential mortgages for which the payment of principal and interest is not guaranteed by a GSE or government agency. Instead, a private institution such as a commercial bank will package residential mortgage loans and securitize them through the issuance of MBS. Non-Agency MBS are often referred to as “private label MBS.” Non-Agency MBS may benefit from credit enhancement derived from structural elements, such as subordination, overcollateralization or insurance and they may also be bought at significant discounts. As such, Non-Agency MBS can carry a significantly higher level of credit exposure relative to the credit exposure of Agency MBS. We may also purchase highly-rated instruments that benefit from credit enhancement or non-investment grade instruments that absorb credit risk. We focus primarily on Non-Agency MBS where the underlying mortgages are secured by residential properties within the United States. Non-Agency MBS also include securitized non- performing loans where a resolution of the loans may come from loan modifications, short sales or foreclosures. While there is a high expectation of losses on these loans, the bonds benefit from credit enhancement and over-collateralization. 10 Non-Agency MBS are backed by residential mortgages that can be comprised of prime mortgage or non-prime mortgage loans which are described below: Prime mortgage loans. Prime mortgage loans are residential mortgage loans that generally conform to the underwriting guidelines of a U.S. Government agency or a GSE but that do not carry any credit guarantee from either a U.S. Government agency or a GSE. Jumbo prime mortgage loans are prime mortgage loans that conform to such underwriting guidelines except as to loan size. Non-prime mortgage loans. Non-prime mortgage loans are residential mortgage loans that do not meet all of the underwriting guidelines of a U.S. Government agency or a GSE. Consequently, these loans may carry higher credit risk than prime mortgage loans. Non-prime mortgage loans may allow borrowers to qualify for a mortgage loan with reduced or alternative forms of documentation. This category includes loans commonly referred to as alternative A- paper, or Alt-A, or as subprime. Alt-A mortgage loans are considered riskier than prime mortgage loans but less risky than subprime mortgage loans. They are typically characterized by borrowers with less than full documentation, lower credit scores and higher loan-to-value ratios and include a higher percentage of investment properties. Subprime mortgage loans are considered to be of the lowest credit quality. These loans may also include option-ARM loans, which contain a feature providing the borrower the option, within certain constraints, to make lesser payments than otherwise required by the stated interest rate for a number of years, leading to negative amortization and increased loan balances. Other Mortgage-Related Investments Mortgage Derivative Securities. We may acquire mortgage derivative securities in an amount not to exceed 10% of our total assets. Mortgage derivative securities provide for the holder to receive interest-only, principal-only or interest and principal in amounts that are disproportionate to those payable on the underlying mortgage loans. Payments on mortgage derivative securities are highly sensitive to the rate of prepayments on the underlying mortgage loans. In the event of faster or slower than anticipated prepayments on these mortgage loans, the rates of return on interests in mortgage derivative securities, representing the right to receive interest-only or a disproportionately large amount of interest or interest-only derivatives, would be likely to decline or increase, respectively. Conversely, the rates of return on mortgage derivative securities, representing the right to receive principal-only or a disproportionate amount of principal or principal-only derivatives, would be likely to increase or decrease in the event of faster or slower prepayments, respectively. We may invest in inverse floaters, a class of CMOs with a coupon rate that resets in the opposite direction from the market rate of interest to which it is indexed, including LIBOR or the 11th District Cost of Funds Index. Any rise in the index rate, which can be caused by an increase in interest rates, causes a drop in the coupon rate of an inverse floater, while any drop in the index rate causes an increase in the coupon of an inverse floater. An inverse floater may behave like a leveraged security since its interest rate usually varies by a magnitude much greater than the magnitude of the index rate of interest. The leverage-like characteristics inherent in inverse floaters result in a greater volatility of their market prices. We may invest in other mortgage derivative securities that may be developed in the future. Mortgage Warehouse Participations. We may occasionally acquire mortgage warehouse participations as an additional means of diversifying our sources of income. We anticipate that these investments, together with our investments in other Category III assets, will not, in the aggregate, exceed 10% of our total mortgage-related assets. These investments are participations in lines of credit to mortgage loan originators secured by recently originated mortgage loans that are in the process of being sold to investors. Our investments in mortgage warehouse participations are limited because they are not qualified REIT assets under the Code. Subordinated Interests. We may acquire subordinated interests, which are classes of MBS that are junior to other classes of the same series of MBS in the right to receive payments from the underlying mortgage loans. The subordination may be for all payment failures on the mortgage loans securing or underlying such series of mortgage securities. The subordination will not be limited to those resulting from particular types of risks, including those resulting from war, earthquake or flood, or the bankruptcy of a borrower. The subordination may be for the entire amount of the series of mortgage-related securities or may be limited in amount. Other Mortgage-Related Assets Mortgage Loans. We may also acquire and accumulate mortgage loans as part of our investment strategy until a sufficient quantity has been accumulated for securitization into high-quality MBS in order to enhance their value and liquidity. We anticipate that any mortgage loans that we would acquire and do not immediately securitize, will not constitute more than 40% of our total mortgage-related assets at any time. Mortgage loans would be acquired with the intent of securitizing them into high-credit quality mortgage securities. Despite our intentions, however, we may not be successful in securitizing these mortgage loans. To meet our investment criteria, mortgage loans acquired by us would generally conform to the underwriting guidelines established by Fannie Mae, Freddie Mac or to secondary market standards for high quality mortgage loans. Applicable banking laws generally require that an appraisal be obtained in connection with the original issuance of mortgage loans by the lending institution and we do not intend to obtain additional appraisals at the time of acquiring mortgage loans. 11 Mortgage loans and other mortgage-related assets may be purchased from various suppliers of mortgage-related assets throughout the United States including savings and loans associations, banks, mortgage bankers and other mortgage lenders. Other Investments. We may acquire other investments that include equity and debt securities issued by other primarily mortgage-related finance companies, interests in mortgage-related collateralized bond obligations, other subordinated interests in pools of mortgage-related assets, commercial mortgage loans and securities and residential mortgage loans other than high-credit quality mortgage loans. Although we expect that our other investments will be limited to less than 10% of total assets, we have no limit on how much of our stockholders’ equity will be allocated to other investments. There may be periods in which other investments represent a large portion of our stockholders’ equity. We may acquire other investments that include equity and debt securities issued by other primarily mortgage-related finance companies, interests in mortgage-related collateralized bond obligations, other subordinated interests in pools of mortgage-related assets, commercial mortgage loans and securities and residential mortgage loans other than high-credit quality mortgage loans. We expect that our other investments in Category III assets under our Asset Acquisition Policy will be less than 10% of total assets. However, there is no stated limit as to how much these investments will be allocated related to our stockholders’ equity. There may be periods in which other investments represent a large portion of our stockholders’ equity. Residential Real Estate These assets consist of residential properties which we lease to tenants. Our focus is on acquiring properties in those areas within in-migration states that will produce high occupancy and rental rates and generate long-term property appreciation. Corporate Governance We strive to maintain an ethical workplace in which the highest standards of professional conduct are practiced.  Our board of directors is composed of a majority of independent directors. Our Audit, Compensation, Nominating and Corporate Governance and Strategic Review Committees are composed exclusively of independent directors.  In order to foster the highest standards of ethics and conduct in all of our business relationships, we have adopted a Code of Ethics and Business Conduct and Corporate Governance Guidelines, which cover a wide range of business practices and procedures that apply to all of our directors and officers and the officers and employees of our Manager. In addition, we have implemented a Whistle-Blower Hotline and procedures by which any officer or employee may raise, on a confidential basis, concerns regarding any questionable or unethical accounting, internal accounting controls or auditing matters with our Audit Committee.  We have an Insider Trading Policy, which is incorporated into our Code of Ethics and Business Conduct, which prohibits any of our directors and officers and the officers and employees of our Manager from buying or selling our securities on the basis of material non-public information and prohibits communicating material non-public information about our Company to others.  We have a formal internal audit function, through the current use of an outsourced firm, to further the effective functioning of our internal controls and procedures. Our internal auditors report directly to our Audit Committee and the internal audit function is intended to provide management and our Audit Committee with an effective tool to identify and address areas of financial or operational concerns and to ensure that appropriate controls and procedures are in place. We have implemented Section 404 of the Sarbanes-Oxley Act of 2002, as amended, which requires an evaluation of internal control over financial reporting in association with our consolidated financial statements as of December 31, 2014 (see Item 9A, “Controls and Procedures,” included in this Annual Report on Form 10-K). Competition When we invest in MBS, we compete with a variety of institutional investors including other REITs, insurance companies, mutual funds, pension funds, investment banking firms, banks and other financial institutions that invest in the same or similar types of assets. Many of these investors have greater financial resources and access to lower costs of capital than we do. Employees Effective December 31, 2011, in accordance with the Management Agreement, all of our employees at the Company were terminated and were employed by our Manager. 12 Company Information We were incorporated in Maryland on October 20, 1997 and commenced our operations on March 17, 1998. Our principal executive offices are located at 1299 Ocean Avenue, Second Floor, Santa Monica, California, 90401. Our telephone number is (310) 255-4493 and our fax number is (310) 434-0070. Information on our Company Website The Company maintains a website, http://www.anworth.com. We make our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, available, free of charge, on our website as soon as reasonably practicable after we file or furnish these reports with the SEC. In addition, we post the following information on our website (we do not intend to and does not hereby incorporate by reference the information on our website as a part of this Annual Report on Form 10-K):    our corporate code of conduct, which qualifies as a “code of ethics” as defined by Item 406 of Regulation S-K of the Exchange Act; our corporate governance guidelines; and charters for our Audit Committee, Nominating and Corporate Governance Committee and Compensation Committee. All of the above information is also available in print upon request to our secretary at the address listed under the heading “Company Information” above. CERTAIN FEDERAL INCOME TAX CONSIDERATIONS The following discussion summarizes particular U.S. federal income tax considerations regarding our qualification and taxation as a REIT and particular U.S. federal income tax consequences resulting from the acquisition, ownership and disposition of our capital stock. This discussion is based on current law and assumes that we have qualified at all times throughout our existence, and will continue to qualify, as a REIT for U.S. federal income tax purposes. The tax law upon which this discussion is based could be changed and any such change could have a retroactive effect. The following discussion is not exhaustive of all possible tax considerations. This summary neither gives a detailed discussion of any state, local or foreign tax considerations nor discusses all of the aspects of U.S. federal income taxation that may be relevant to an investor in light of its particular circumstances or to particular types of stockholders which are subject to special tax rules, such as insurance companies, tax-exempt entities, financial institutions or broker-dealers, foreign corporations or partnerships and persons who are not citizens or residents of the U.S., stockholders that hold our stock as a hedge, part of a straddle, conversion transaction or other arrangement involving more than one position, or stockholders whose functional currency is not the U.S. dollar. This discussion assumes that our capital stock is held by an investor as a “capital asset” under the Code, which his general is property held for investment. General Our qualification and taxation as a REIT depends upon our ability to continue to meet the various qualification tests, imposed under the Code and discussed below, relating to our actual annual operating results, asset diversification, distribution levels and diversity of stock ownership. Accordingly, the actual results of our operations for any particular taxable year may not satisfy these requirements. We have made an election to be taxed as a REIT under the Code commencing with our taxable year ended December 31, 1998. We currently expect to continue operating in a manner that will permit us to maintain our qualification as a REIT. All qualification requirements for maintaining our REIT status, however, may not have been, or might not continue to be, met. So long as we qualify for taxation as a REIT, we generally will be permitted a deduction for dividends that we pay to our stockholders. As a result, we generally will not be required to pay federal corporate income taxes on our net income that is currently distributed to our stockholders. This treatment substantially eliminates the “double taxation” that ordinarily results from investment in a corporation. Double taxation means taxation once at the corporate level when income is earned and once again at the stockholder level when this income is distributed. We will be required to pay federal income tax, however, as follows:  we will be required to pay tax at regular corporate rates on any undistributed “real estate investment trust taxable income,” including undistributed net capital gains;  we may be required to pay the “alternative minimum tax” on our items of tax preference; and 13  if we have (a) net income from the sale or other disposition of “foreclosure property” which is held primarily for sale to customers in the ordinary course of business, or (b) other non-qualifying income from foreclosure property, we will be required to pay tax at the highest corporate rate on this income. Foreclosure property is generally defined as property acquired through foreclosure or after a default on a loan secured by the property or on a lease of the property. To the extent that distributions exceed current and accumulated earnings and profits, they will constitute a return of capital, rather than dividend or capital gain income, and will reduce the basis for the stockholder’s stock with respect to which the distributions are paid or, to the extent that they exceed such basis, will be taxed in the same manner as gain from the sale of that stock. For purposes of determining whether distributions are out of current or accumulated earnings and profits, our earnings and profits will be allocated first to our preferred stock (as compared to distributions with respect to our common stock) so that distributions with respect to our preferred stock are more likely to be treated as dividends than as return of capital or a distribution in excess of basis. Calculations of corporate earnings and profits are complex and it is possible that distributions expected to be a return of capital may subsequently be determined to be taxable distributions of earnings and profits. Currently, dividends paid by regular C corporations to stockholders other than corporations are generally taxed at the rate applicable to long-term capital gains, which is currently a maximum of 20%, subject to certain limitations. Because we are a REIT, however, our dividends, including dividends paid on our stock, including shares of our preferred stock, generally will continue to be taxed at regular ordinary income tax rates, except in limited circumstances. We will be required to pay a 100% tax on any net income from prohibited transactions. Prohibited transactions are, in general, sales or other taxable dispositions of property other than foreclosure property held primarily for sale to customers in the ordinary course of business. While the Code contains certain safe harbors provisions to avoid the application of this 100% tax, outside of the safe harbor, the determination of whether property is held as inventory or primarily for sale to customers in the ordinary course of a trade or business depends on all the facts and circumstances surrounding the particular transaction. No assurance can be given that any particular property in which we hold a direct or indirect interest will not be treated as property held for sale to customers, or that we can comply with certain safe harbor provisions of the Code that would prevent such treatment. The 100% tax will not apply to gains from the sale of property that is held through a taxable REIT subsidiary or other taxable corporation, although such income will be taxed to the corporation at regular corporate tax rates. If we fail to satisfy the 75% gross income test or the 95% gross income test discussed below but nonetheless maintain our qualification as a REIT because certain other requirements are met, we will be subject to a tax equal to the greater of (i) the amount by which 75% of our gross income exceeds the amount qualifying under the 75% gross income test described below, and (ii) the amount by which 95% of our gross income exceeds the amount qualifying under the 95% gross income test described below, multiplied by a fraction intended to reflect our profitability. In the event of more than de minimis failure of any of the asset tests occurs in a taxable year, as long as the failure was due to reasonable cause and not willful neglect and we dispose of the assets or otherwise comply with the asset tests within six months after the last day of the quarter in which we identify such failure, we may pay a tax equal to the greater of $50 thousand or 35% of the net income from the non-qualifying assets during the period in which we failed to satisfy any of the asset tests in lieu of having our qualification as a REIT terminated. In the event of a failure to satisfy one or more requirements for REIT qualification occurring in a taxable year, other than the gross income tests and the asset tests, as long as such failure was due to reasonable cause and not to willful neglect, we will be required to pay a penalty of $50 thousand for each such failure in order to maintain our REIT qualification. We will be required to pay a nondeductible 4% excise tax on the excess of the required distribution over the amounts actually distributed if we fail to distribute during each calendar year at least the sum of:    85% of our real estate investment trust ordinary income for the year; 95% of our real estate investment trust capital gain net income for the year; and any undistributed taxable income from prior periods. This distribution requirement is in addition to, and different from, the distribution requirements discussed below in the section entitled “Annual Distribution Requirements.” We may elect to retain and pay income tax on our net long-term capital gain. In that case, a U.S. stockholder would be taxed on its proportionate share of our undistributed long-term capital gain (to the extent that we make a timely designation of such gain to the stockholder) and would receive a credit or refund of its proportionate share of the tax we paid. The basis of the stockholder’s shares is 14 increased by the amount of the undistributed long-term capital gain (less the amount of capital gains tax paid by the REIT) included in the stockholder’s long-term capital gains. If we own a residual interest in a real estate mortgage investment conduit, or REMIC, we will be taxable at the highest corporate rate on the portion of any excess inclusion income that we derive from the REMIC residual interests equal to the percentage of our stock that is held by “disqualified” organizations. Although the law is unclear, similar rules may apply if we own an equity interest in a taxable mortgage pool. To the extent that we own a REMIC residual interest in a taxable mortgage pool through a taxable REIT subsidiary, we will not be subject to tax. A “disqualified organization” includes:       the United States of America; any state or political subdivision of the United States of America; any foreign government; any international organization; any agency or instrumentality of any of the foregoing; any other tax-exempt organization other than a farmers’ cooperative described in Section 521 of the Code that is exempt both from income taxation and from taxation under the unrelated business taxable income provisions of the Code; and  any rural electrical or telephone cooperative. If we acquire any asset from a corporation which is or has been taxed as a C corporation under the Code in a transaction in which the basis of the asset in our hands is determined by reference to the basis of the asset in the hands of the C corporation and we subsequently recognize gain on the disposition of the asset during the ten-year period beginning on the date on which we acquired the asset, then we will be required to pay tax at the highest regular corporate tax rate on this gain to the extent of the excess of:    the fair market value of the asset, over our adjusted basis in the asset, in each case determined as of the date on which we acquired the asset. We may be subject to a 100% excise tax to the extent that the terms of our dealings with any taxable REIT subsidiaries (defined below) are not consistent with arm’s length terms. In addition, notwithstanding our REIT status, we may also have to pay certain state and local income taxes, because not all states and localities treat REITs in the same manner as they are treated for federal income tax purposes. Requirements for Qualification as a REIT The Code defines a REIT as a corporation, trust or association: 1. 2. 3. 4. 5. that is managed by one or more trustees or directors; that issues transferable shares or transferable certificates to evidence beneficial ownership; that would be taxable as a domestic corporation but for Code Sections 856 through 859; that is not a financial institution or an insurance company within the meaning of the Code; that is beneficially owned by 100 or more persons; 6. not more than 50% in value of the outstanding stock of which is owned, actually or constructively, by five or fewer individuals, including specified entities, at all times during the last half of each taxable year; 7. 8. that meets other tests, described below, regarding the nature of its income and assets and the amount of its distributions; and that elects to be a REIT or has made such election for a previous taxable year and satisfies all relevant filing and other administrative requirements established by the IRS that must be met in order to elect and retain REIT status. The Code provides that all of the first four conditions stated above must be met during the entire taxable year and that the fifth condition must be met during at least 335 days of a taxable year of twelve months, or during a proportionate part of a taxable year of less than twelve months. The fifth and sixth conditions do not apply until after the first taxable year for which an election is made to be taxed as a REIT. 15 For purposes of the sixth condition, certain specified types of trusts and tax-exempt entities are treated as individuals, except that a “look-through” exception generally applies with respect to pension funds. Stock Ownership Tests As noted above, our stock must be beneficially held by at least 100 persons, or the “100 Stockholder Rule,” and no more than 50% of the value of our stock may be owned, directly or indirectly, by five or fewer individuals at any time during the last half of the taxable year, or the “5/50 Rule.” We are required to solicit information from certain of our record stockholders to verify actual stock ownership levels and our charter provides for restrictions regarding the transfer of our stock in order to aid in meeting the stock ownership requirements. If we were to fail either of the stock ownership tests, we would generally be disqualified from our REIT status. However, if we comply with regulatory rules pursuant to which we are required to send annual letters to holders of our stock requesting information regarding the actual ownership of our stock, and we do not know, or exercising reasonable diligence would not have known, whether we failed to meet the 5/50 Rule, then we will be treated as having met the 5/50 Rule. Income Tests We must satisfy two gross income requirements annually to maintain our qualification as a REIT:  We must derive, directly or indirectly, at least 75% of our gross income, excluding gross income from prohibited transactions, from specified real estate sources, including rental income, interest on obligations (including certain MBS) that are secured by mortgages on real property or on interests in real property, gain from the disposition of “qualified real estate assets,” i.e., interests in real property, mortgages secured by real property or interests in real property, and some other assets, income from certain types of temporary investments, amounts, such as commitment fees, received in consideration for entering into an agreement to make a loan secured by real property, unless such amounts are determined by income and profits, and income derived from a REMIC in proportion to the real estate assets held by the REMIC, unless at least 95% of the REMIC’s assets are real estate assets (in which case, all of the income derived from the REMIC), or the “75% gross income test;” and  We must derive at least 95% of our gross income, excluding gross income from prohibited transactions, from (a) the sources of income that satisfy the 75% gross income test, (b) dividends, interest and gain from the sale or disposition of stock or securities, or (c) any combination of the foregoing, or the “95% gross income test.” Gross income from servicing loans for third parties is not qualifying income for purposes of either gross income test. Any gross income from our sale of property held primarily for sale to customers in the ordinary course of business is excluded from both the numerator and the denominator in both income tests (but is subject to a 100% tax as a prohibited transaction unless certain safe harbor provisions are satisfied). Income and gain from certain transactions that we enter into to hedge indebtedness incurred or to be incurred to acquire or carry real estate assets, and that are clearly and timely identified as such, are excluded from both the numerator and denominator for purposes of both gross income tests. For purposes of the 75% and 95% gross income tests, a REIT is deemed to have earned a proportionate share of the income earned by any partnership, or any limited liability company treated as a partnership for federal income tax purposes, in which it owns an interest, which share is determined by reference to the REIT’s capital interest in such entity, and is deemed to have earned all of the income earned by any qualified REIT subsidiary (in general, a 100%-owned corporate subsidiary of a REIT) or any other entity that is disregarded as separated from the parent REIT for U.S. federal income tax purposes. Interest earned by a REIT ordinarily does not qualify as income meeting the 75% or 95% gross income tests if the determination of all or some of the amount of interest depends on the income or profits of any person. Interest will not be disqualified from meeting such tests, however, solely by reason of being based on a fixed percentage or percentages of receipts or sales. The following paragraphs discuss in more detail the specific application of the gross income tests to us. Interest. The term “interest,” as defined for purposes of both gross income tests, generally excludes any amount that is based in whole or in part on the income or profits of any person. However, interest generally includes the following:   an amount that is based on a fixed percentage or percentages of receipts or sales; and an amount that is based on the income or profits of a debtor as long as the debtor derives substantially all of its income from the real property securing the debt from leasing substantially all of its interest in the property and only to the extent that the amounts received by the debtor would be qualifying “rents from real property” if received directly by a REIT. If a loan contains a provision that entitles a REIT to a percentage of the borrower’s gain upon the sale of the real property securing the loan or a percentage of the appreciation in the property’s value as of a specific date, income attributable to that loan 16 provision will generally be treated as gain from the sale of the property securing the loan, which normally constitutes qualifying income for purposes of both gross income tests. Interest on debt secured by a mortgage on real property or on interests in real property, including, for this purpose, discount points, prepayment penalties, loan assumption fees and late payment charges that are not compensation for services, generally is qualifying income for purposes of the 75% gross income test. However, if the highest principal amount of a loan outstanding during a taxable year exceeds the fair market value of the real property securing the loan as of the date the REIT agreed to originate or acquire the loan, a portion of the interest income from such loan will not be qualifying income for purposes of the 75% gross income test but will be qualifying income for purposes of the 95% gross income test. The portion of the interest income that will not be qualifying income for purposes of the 75% gross income test will be equal to the portion of the principal amount of the loan that is not secured by real property—that is, the amount by which the loan exceeds the value of the real estate that is security for the loan. The interest, original issue discount and market discount income that we receive from our mortgage loans and certain MBS (including Agency MBS and interests in REMICs) generally will be qualifying income for purposes of both gross income tests. However, as discussed above, if the fair market value of the real estate securing any of our loans is less than the principal amount of the loan, a portion of the income from that loan will be qualifying income for purposes of the 95% gross income test but not the 75% gross income test. Fee Income. We may receive various fees in connection with originating mortgage loans. The fees will be qualifying income for purposes of both the 75% and 95% income tests if they are received in consideration for entering into an agreement to make a loan secured by real property and the fees are not determined based on the borrower’s income or profits. Therefore, commitment fees will generally be qualifying income for purposes of the income tests. Other fees, such as fees received for servicing loans for third parties, are not qualifying income for purposes of either income test. Dividends. Our share of any dividends received from any corporation (including any of our taxable REIT subsidiaries, but excluding any REIT) in which we own an equity interest will qualify for purposes of the 95% gross income test but not for purposes of the 75% gross income test. Our share of any dividends received from any other REIT in which we own an equity interest will be qualifying income for purposes of both gross income tests. Rents from Real Property. To the extent that we acquire real property or an interest therein, rents that we receive will qualify as “rents from real property” in satisfying the gross income requirements for a REIT described above only if the following conditions are met:  First, the amount of rent must not be based, in whole or in part, on the income or profits of any person. However, an amount received or accrued generally will not be excluded from rents from real property solely by reason of being based on fixed percentages of receipts or sales.  Second, rents we receive from a “related party tenant” will not qualify as rents from real property in satisfying the gross income tests unless the tenant is a taxable REIT subsidiary, at least 90% of the property is leased to unrelated tenants and the rent paid by the taxable REIT subsidiary is substantially comparable to the rent paid by the unrelated tenants for comparable space. A tenant is a related party tenant if the REIT, or an actual or constructive owner of 10% or more of the REIT, actually or constructively owns 10% or more of the tenant.  Third, if rent attributable to personal property leased in connection with a lease of real property is greater than 15% of the total rent received under the lease, then the portion of rent attributable to the personal property will not qualify as rents from real property.  Fourth, we generally must not operate or manage our real property or furnish or render services to our tenants, other than through an “independent contractor” who is adequately compensated and from whom we do not derive revenue. However, we may provide services directly to tenants if the services are “usually or customarily rendered” in connection with the rental of space for occupancy only and are not considered to be provided for the tenants’ convenience. In addition, we may provide a minimal amount of “non-customary” services to the tenants of a property, other than through an independent contractor, as long as our income from the services does not exceed 1% of our income from the related property. Furthermore, we may own up to 100% of the stock of a taxable REIT subsidiary, which may provide customary and non- customary services to tenants without tainting our rental income from the related properties. Hedging Transactions. From time to time, we may enter into hedging transactions with respect to one or more of our assets or liabilities. Our hedging activities may include entering into interest rate swaps, caps and floors, options to purchase these items and futures and forward contracts. Income and gain from certain “hedging transactions” will be excluded from gross income for purposes of both the 95% gross income test and the 75% gross income test. A “hedging transaction” includes any transaction entered into in the normal course of our trade or business primarily to manage the risk of interest rate, price changes or currency fluctuations with respect to borrowings made or to be made, or ordinary obligations incurred or to be incurred, to acquire or carry real estate assets. We will be 17 required to clearly identify any such hedging transaction before the close of the day on which it was acquired, originated or entered into. To the extent that we hedge for other purposes, or to the extent that a portion of our mortgage loans is not secured by “real estate assets” (as described below under “Asset Tests”), or in other situations, the income from those transactions could be treated as income that does not qualify for purposes of one or both of the gross income tests. We intend to structure any hedging transactions in a manner that does not jeopardize our status as a REIT. Prohibited Transactions. As discussed above, a REIT will incur a 100% tax on the net income derived from any sale or other disposition of property other than foreclosure property that the REIT holds primarily for sale to customers in the ordinary course of a trade or business. We believe that none of our assets will be held primarily for sale to customers and that a sale of any of our assets will not be in the ordinary course of our business. Whether a REIT holds an asset “primarily for sale to customers in the ordinary course of a trade or business” depends, however, on the facts and circumstances in effect from time to time, including those related to a particular asset. Nevertheless, we will attempt to comply with the terms of safe-harbor provisions in the federal income tax laws prescribing when an asset sale will not be characterized as a prohibited transaction. Foreclosure Property. We will be subject to tax at the maximum corporate rate on any income from foreclosure property other than income that otherwise would be qualifying income for purposes of the 75% gross income test, less expenses directly connected with the production of that income. However, gross income from foreclosure property will qualify under the 75% and 95% gross income tests. Foreclosure property is any real property, including interests in real property, and any personal property incident to such real property:   that is acquired by a REIT as the result of the REIT having bid on such property at foreclosure, or having otherwise reduced such property to ownership or possession by agreement or process of law, after there was a default or default was imminent on a lease of such property or on indebtedness that such property secured; for which the related loan or lease was acquired by the REIT at a time when the default was not imminent or anticipated; and  for which the REIT makes a proper election to treat the property as foreclosure property. Permitted foreclosure property income also includes foreign currency gain that is attributable to otherwise permitted income from foreclosure property. Such foreign currency gain also is included as foreclosure property income for purposes of any tax on such income. However, a REIT will not be considered to have foreclosed on a property where the REIT takes control of the property as a mortgagee-in-possession and cannot receive any profit or sustain any loss except as a creditor of the mortgagor. Property generally ceases to be foreclosure property at the end of the third taxable year following the taxable year in which the REIT acquired the property or longer if an extension is granted by the Secretary of the Treasury. This grace period terminates and foreclosure property ceases to be foreclosure property on the first day:   on which a lease is entered into for the property that, by its terms, will give rise to income that does not qualify for purposes of the 75% gross income test or any amount is received or accrued, directly or indirectly, pursuant to a lease entered into on or after such day that will give rise to income that does not qualify for purposes of the 75% gross income test; on which any construction takes place on the property, other than completion of a building or any other improvement, where more than 10% of the construction was completed before default became imminent; or  which is more than 90 days after the day on which the REIT acquired the property and the property is used in a trade or business which is conducted by the REIT other than through an independent contractor from whom the REIT itself does not derive or receive any income. Failure to Satisfy Gross Income Tests. If we fail to satisfy one or both of the gross income tests for any taxable year, we nevertheless may qualify as a REIT for that year if we qualify for relief under certain provisions of the federal income tax laws. Those relief provisions will be available if:   our failure to meet those tests is due to reasonable cause and not to willful neglect, and following such failure for any taxable year, a schedule of the sources of our income is filed in accordance with regulations prescribed by the Secretary of the Treasury. We cannot predict, however, whether in all circumstances we would qualify for the relief provisions. In addition, as discussed above, even if the relief provisions apply, we would incur a 100% tax on the gross income attributable to the greater of (i) the amount by which we fail the 75% gross income test or (ii) the amount by which 95% of our gross income exceeds the amount of our income qualifying under the 95% gross income test, multiplied, in either case, by a fraction intended to reflect our profitability. 18 Foreign Investment and Exchange Gains A REIT must be a U.S. domestic entity, but it is permitted to hold foreign real estate or other foreign-based assets, provided that the 75% and 95% income tests and other requirements for REIT qualification are met. A REIT that holds foreign real estate or other foreign-based assets may have foreign currency exchange gain under the foreign currency transaction tax rules. Foreign currency exchange gain originally was not explicitly included in the statutory definitions of qualifying income for purposes of the 75% and 95% income tests until a statutory change, although the IRS issued guidance that allowed foreign currency gain to be treated as qualified income in certain circumstances. The statutory change excludes certain foreign currency gain from the computation of qualifying income for purposes of the 75% income test or the 95% income test, respectively. The exclusion is solely for purposes of the computations under these tests. The statutory change defines two new categories of income for purposes of the exclusion rules: “real estate foreign exchange gain” and “passive foreign exchange gain.” Real estate foreign exchange gain is excluded from gross income for purposes of both the 75% and the 95% income tests. Passive foreign exchange gain is excluded for purposes of the 95% income test but is included in gross income and treated as non-qualifying income, to the extent that it is not real estate foreign exchange gain, for purposes of the 75% income test. Real estate foreign exchange gain is foreign currency gain which is attributable to: (i) any item of income qualifying for the numerator for the 75% income test; (ii) the acquisition or ownership of obligations secured by mortgages on real property or interests in real property; or (iii) becoming or being the obligor under obligations secured by mortgages on real property or interests in real property. Real estate foreign exchange gain also includes certain foreign currency gains attributable to certain “qualified business units” of the REIT. Passive foreign exchange gain includes all real estate foreign exchange and, in addition, includes foreign currency gain which is attributable to: (i) any item of income or gain included in the numerator for the 95% income test, (ii) acquisition or ownership of obligations other than described in the preceding paragraph; (iii) becoming the obligor under obligations other than described in the preceding paragraph; and (iv) any other foreign currency gain to be determined by the IRS. Notwithstanding the foregoing rules, except in the case of certain income excluded under the hedging rules, foreign currency exchange gain derived from engaging in dealing, or substantial and regular trading, in certain securities constitutes gross income that does not qualify under either the 75% or 95% income test. Asset Tests To qualify as a REIT, we also must satisfy the following asset tests at the end of each quarter of each taxable year: First, at least 75% of the value of our total assets must consist of:        cash or cash items, including certain receivables; government securities; interests in real property, including leaseholds and options to acquire real property and leaseholds; interests in mortgage loans secured by real property (including, in general, Agency MBS); stock in other REITs; investments in stock or debt instruments during the one-year period following our receipt of new capital that we raise through equity offerings or public offerings of debt with at least a five-year term; and regular or residual interests in a REMIC. However, if less than 95% of the assets of a REMIC consist of assets that are qualifying real estate-related assets under the federal income tax laws, determined as if we held such assets, we will be treated as holding directly our proportionate share of the assets of such REMIC. The term “cash” for purposes of the REIT asset qualification rules is defined to include foreign currency if the REIT or its “qualified business unit” uses such foreign currency as its functional currency, but only to the extent such foreign currency is held for use in the normal course of the activities of the REIT or the “qualified business unit” giving rise to income in the numerator for the 75% or 95% income tests, or directly related to acquiring or holding assets qualifying for the numerator in the 75% assets test, and is not held in connection with a trade or business of trading or dealing in certain securities. Second, not more than 25% of the value of our total assets may be represented by securities (other than those included in the preceding category). 19 Third, not more than 25% of the value of our total assets may be represented by securities of one or more taxable REIT subsidiaries. Fourth, except with respect to a taxable REIT subsidiary and securities that qualify for purposes of the 75% test described above, (a) not more than 5% of the value of our total assets may be represented by securities of any one issuer, (b) we may not hold securities possessing more than 10% of the total voting power of the outstanding securities of any one issuer and (c) we may not hold securities having a value of more than 10% of the total value of the outstanding securities of any one issuer. For purposes of the second and third asset tests, the term “securities” does not include stock in another REIT, equity or debt securities of a qualified REIT subsidiary or taxable REIT subsidiary, mortgage loans that constitute real estate assets, or equity interests in a partnership. For purposes of the 10% value test, the term “securities” does not include:  “Straight debt” securities, which is defined as a written unconditional promise to pay on demand or on a specified date a sum certain in money if (i) the debt is not convertible, directly or indirectly, into stock, and (ii) the interest rate and interest payment dates are not contingent on profits, the borrower’s discretion, or similar factors. “Straight debt” securities do not include any securities issued by a partnership or a corporation in which we or any controlled taxable REIT subsidiary (i.e., a taxable REIT subsidiary in which we own directly or indirectly more than 50% of the voting power or value of the stock) hold non-“straight debt” securities that have aggregate value of more than 1% of the issuer’s outstanding securities. However, “straight debt” securities include debt subject to the following contingencies:   a contingency relating to the time of payment of interest or principal, as long as either (i) there is no change to the effective yield of the debt obligation other than a change to the annual yield that does not exceed the greater of 0.25% or 5% of the annual yield, or (ii) neither the aggregate issue price nor the aggregate face amount of the issuer’s debt obligations held by us exceeds $1 million and no more than 12 months of unaccrued interest on the debt obligations can be required to be prepaid; and a contingency relating to the time or amount of payment upon a default or prepayment of a debt obligation, as long as the contingency is consistent with customary commercial practice.  Any loan to an individual or an estate.  Any “section 467 rental agreement” other than an agreement with a related party tenant.  Any obligation to pay “rents from real property.”  Certain securities issued by governmental entities.  Any security issued by a REIT.  Any debt instrument of an entity treated as a partnership for federal income tax purposes to the extent of our interest as a partner in the partnership.  Any debt instrument of an entity treated as a partnership for federal income tax purposes not described in the preceding bullet points if at least 75% of the partnership’s gross income, excluding income from prohibited transaction, is qualifying income for purposes of the 75% gross income test described above in “Income Tests.” The asset tests described above are based on our gross assets. For federal income tax purposes, we will be treated as owning both the loans we hold directly and the loans that we would securitize through non-REMIC debt securitizations. Although we will have a partially offsetting obligation with respect to the securities issued pursuant to securitizations, these offsetting obligations will not reduce the gross assets we are considered to own for purposes of the asset tests. We believe that all or substantially all of the mortgage loans and MBS that we will own will be qualifying assets for purposes of the 75% asset test. At December 31, 2014, we owned approximately $62 million of investments in non-REMIC debt securitizations that did not qualify for purposes of the 75% asset test. These assets did not present any issues regarding any of the other asset tests. For purposes of these rules, however, if the outstanding principal balance of a mortgage loan exceeds the fair market value of the real property securing the loan, a portion of such loan likely will not be a qualifying real estate asset under the federal income tax laws. Although the law on the matter is not entirely clear, it appears that the non-qualifying portion of that mortgage loan will be equal to the portion of the loan amount that exceeds the value of the associated real property that is security for that loan. To the extent that we own debt securities issued by other REITs or C corporations that are not secured by a mortgage on real property, those debt securities will not be qualifying assets for purposes of the 75% asset test. Instead, we would be subject to the second, third and fourth asset tests with respect to those debt securities. 20 Revenue Procedures 2011-16 and 2014-51 discuss the modification of a mortgage loan (or an interest therein) that is held by a REIT in which the modification was occasioned by either a default on the loan or a modification that satisfies both of the following conditions: (a) based on all the facts and circumstances, the REIT or servicer of the loan (the “pre-modified loan”) reasonably believes that there is a significant risk of default of the pre-modified loan upon maturity of the loan or at an earlier date, and (b) based on all the facts and circumstances, the REIT or servicer reasonably believes that the modified loan presents a substantially reduced risk of default, as compared with the pre-modified loan. Revenue Procedures 2011-16 and 2014-51 provide that a REIT may treat a modification of a mortgage loan described therein as not being a new commitment to make or purchase a loan for purposes of apportioning interest on that loan between interest with respect to real property or other interest. The modification will also not be treated as a prohibited transaction. Further, with respect to the REIT asset test, the IRS will not challenge the REIT’s treatment of a loan as being in part a “real estate asset” if the REIT treats the loan as being a real estate asset in an amount equal to the lesser of (a) the value of the loan as determined under Treasury Regulations Section 1.856-3(a), or (b) the loan value of the real property securing the loan as determined under Treasury Regulations Section 1.856-5(c) and Revenue Procedures 2011-16 and 2014-51. We will monitor the status of our assets for purposes of the various asset tests and will seek to manage our investment portfolio to comply at all times with such tests. There can be no assurance, however, that we will be successful in this effort. In this regard, to determine our compliance with these requirements, we will need to estimate the value of the real estate securing our mortgage loans at various times. Although we will seek to be prudent in making these estimates, there can be no assurances that the IRS might not disagree with these determinations and assert that a lower value is applicable. If we fail to satisfy the asset tests at the end of a calendar quarter, we will not lose our REIT status if:  we satisfied the asset tests at the end of the preceding calendar quarter; and  the discrepancy between the value of our assets and the asset test requirements arose from changes in the market values of our assets and was not wholly or partly caused by the acquisition of one or more non-qualifying assets, or solely by a change in the foreign currency exchange rate used to value a foreign asset. If we did not satisfy the condition described in the second item, above, we still could avoid disqualification by eliminating any discrepancy within 30 days after the close of the calendar quarter in which it arose. In the event that, at the end of any calendar quarter, we violate the asset tests described above, we will not lose our REIT status if (i) the failure is de minimis (up to the lesser of 1% of our assets or $10 million) and (ii) we dispose of assets or otherwise comply with the asset tests within six months after the last day of the quarter in which we identify such failure. In the event of a more than de minimis failure of any of the asset tests, as long as the failure was due to reasonable cause and not to willful neglect, we will not lose our REIT status if (i) we dispose of assets or otherwise comply with the asset tests within six months after the last day of the quarter in which we identify such failure and (ii) pay a tax equal to the greater of $50 thousand or 35% of the net income from the non- qualifying assets during the period in which we failed to satisfy the asset tests. We currently believe that the securities and other assets that we expect to hold will satisfy the foregoing asset test requirements. However, no independent appraisals will be obtained to support our conclusions as to the value of our assets and securities, or in many cases, the real estate collateral for the mortgage loans that we hold. Moreover, the values of some assets may not be susceptible to a precise determination. As a result, there can be no assurance that the IRS will not contend that our ownership of securities and other assets violates one or more of the asset tests applicable to REITs. Annual Distribution Requirements Each taxable year, we must distribute dividends, other than capital gain dividends and deemed distributions of retained capital gain, to our stockholders in an aggregate amount at least equal to:  the sum of:    90% of our “REIT taxable income,” computed without regard to the dividends paid deduction and our net capital gain or loss, and 90% of our after-tax net income, if any, from foreclosure property, minus the sum of certain items of excess non-cash income. We must pay such distributions in the taxable year to which they relate or in the following taxable year if we declare the distribution before we timely file our federal income tax return for the year and pay the distribution on or before the first regular dividend payment date after such declaration. In addition, dividends declared in October, November or December payable to stockholders of record in such month are deemed received by stockholders on December 31 and to have been paid on December 31 if actually paid in January of the following year. See below under “Distributions Generally.” 21 We will pay the federal income tax on taxable income, including net capital gain, which we do not distribute to stockholders. Furthermore, if we fail to distribute during a calendar year, or by the end of January following the calendar year in the case of distributions with declaration and record dates falling in the last three months of the calendar year, at least the sum of:    85% of our REIT ordinary income for such year, 95% of our REIT capital gain income for such year, and any undistributed taxable income from prior periods, we will incur a 4% nondeductible excise tax on the excess of such required distribution over the amounts we actually distribute. We may elect to retain and pay income tax on the net long-term capital gain we receive in a taxable year. See “Taxation of Taxable U.S. Stockholders.” If we so elect, we will be treated as having distributed any such retained amount for purposes of the 4% nondeductible excise tax described above. We intend to make timely distributions sufficient to satisfy the annual distribution requirements and to not incur corporate income tax and the 4% nondeductible excise tax. It is possible that, from time to time, we may experience timing differences between the actual receipt of income and actual payment of deductible expenses and the inclusion of that income and deduction of such expenses in arriving at our REIT taxable income. Possible examples of those timing differences include the following:  Because we may deduct capital losses only to the extent of our capital gains, we may have taxable income that exceeds our economic income.  We will recognize taxable income in advance of the related cash flow if any of our mortgage loans or MBS are deemed to have original issue discount. We generally must accrue original issue discount based on a constant yield method that takes into account projected prepayments but that defers taking into account credit losses until they are actually incurred.  We may recognize taxable market discount income when we receive the proceeds from the disposition of, or principal payments on, loans that have a stated redemption price at maturity that is greater than our tax basis in those loans, although such proceeds often will be used to make non-deductible principal payments on related borrowings.  We may recognize taxable income without receiving a corresponding cash distribution if we foreclose on or make a significant modification to a loan to the extent that the fair market value of the underlying property or the principal amount of the modified loan, as applicable, exceeds our basis in the original loan.  We may recognize phantom taxable income from any residual interests in REMICs or retained ownership interests in mortgage loans subject to collateralized mortgage obligation debt. Although several types of non-cash income are excluded in determining the annual distribution requirement, we will incur corporate income tax and the 4% nondeductible excise tax with respect to those non-cash income items if we do not distribute those items on a current basis. As a result of the foregoing, we may have less cash than is necessary to distribute all of our taxable income and thereby avoid corporate income tax and the excise tax imposed on certain undistributed income. In such a situation, we may need to borrow funds or issue additional common stock or preferred stock. Under certain circumstances, we may be able to correct a failure to meet the distribution requirement for a year by paying “deficiency dividends” to our stockholders in a later year. We may include such deficiency dividends in our deduction for dividends paid for the earlier year. Although we may be able to avoid income tax on amounts distributed as deficiency dividends, we will be required to pay interest to the IRS based upon the amount of any deduction we take for deficiency dividends. Recordkeeping Requirements We must maintain certain records in order to qualify as a REIT. In addition, to avoid a monetary penalty, we must request, on an annual basis, information from our stockholders designed to disclose the actual ownership of our outstanding stock. We intend to comply with these requirements. Failure to Qualify If we fail to satisfy one or more requirements for REIT qualification, other than the gross income tests and the asset tests, we could avoid disqualification if our failure is due to reasonable cause and not to willful neglect and we pay a penalty of $50 thousand for each such failure. In addition, there are relief provisions for a failure of the gross income tests and asset tests as described in “Income Tests” and “Asset Tests.” 22 If we fail to qualify as a REIT in any taxable year and no relief provision applies, we would be subject to federal income tax and any applicable alternative minimum tax on our taxable income at regular corporate rates. In calculating our taxable income in a year in which we fail to qualify as a REIT, we would not be able to deduct amounts paid out to stockholders. In fact, we would not be required to distribute any amounts to stockholders in that year. In such event, to the extent of our current and accumulated earnings and profits, all distributions to stockholders would be taxable as ordinary income. Subject to certain limitations of the federal income tax laws, corporate stockholders might be eligible for the dividends received deduction and domestic non-corporate stockholders may be eligible for the reduced federal income tax rate of 20% on qualified dividends. Unless we qualified for relief under specific statutory provisions, we also would be disqualified from taxation as a REIT for the four taxable years following the year during which we ceased to qualify as a REIT. We cannot predict whether, in all circumstances, we would qualify for such statutory relief. Qualified REIT Subsidiaries A Qualified REIT Subsidiary, or QRS, is any corporation in which we own 100% of such corporation’s outstanding stock and for which no election has been made to classify it as a taxable REIT subsidiary. As such, their assets, liabilities and income would generally be treated as our assets, liabilities and income for purposes of each of the above REIT qualification tests. In February 2014, we incorporated our wholly-owned QRS, Anworth Properties, Inc., which commenced operations in March 2014. Our QRS will provide the entity through which we may own REIT-qualified real estate assets such as: (1) other types of mortgage assets, from which we would receive interest income; and (2) real estate assets, from which we would receive rental income and potential price appreciation. Taxable REIT Subsidiaries A Taxable REIT Subsidiary, or TRS, is any corporation in which we own stock (directly or indirectly) and which we and such corporation elect to classify as a taxable REIT subsidiary. A taxable REIT subsidiary is not subject to the REIT asset, income and distribution requirements, nor are its assets, liabilities or income treated as our assets, liabilities or income for purposes of each of the above REIT qualification tests. We have incorporated Anworth Property Services, Inc., a wholly-owned subsidiary which we intend will be treated as a TRS, although it has not yet commenced operations. Our TRS will provide an entity through which we may participate in various activities that might otherwise have adverse tax consequences if conducted directly by a REIT or through a QRS. Unlike a REIT, a TRS pays standard corporate taxes on its income earned from these activities in the mortgage and real estate markets. These other activities include almost everything other than receiving rent on properties owned and collecting interest on real estate mortgages owned. Examples of these other activities include: the securitization of mortgage loans; mortgage origination; leasing and managing rental properties; and owning properties acquired through the foreclosure process. We generally intend to make a taxable REIT subsidiary election with respect to any other corporation in which we acquire securities constituting more than 10% by vote or value of such corporation and that is not a qualified REIT subsidiary. However, the aggregate value of all of our taxable REIT subsidiaries must be limited to 25% of the total value of our assets. We will be subject to a 100% penalty tax on any rent, interest or other charges that we impose on any taxable REIT subsidiary in excess of an arm’s length price for comparable services. We expect that any rents, interest or other charges imposed on any taxable REIT subsidiary will be at arm’s length prices. We generally expect to derive income from our taxable REIT subsidiaries by way of dividends in the event that we establish any taxable REIT subsidiaries. Such dividends are not real estate source income for purposes of the 75% income test, although they are included for purposes of the 95% test. Therefore, when aggregated with our non-real estate source income, such dividends must be limited to 25% of our gross income each year. We will monitor the value of our investment in, and the distributions from, our taxable REIT subsidiaries to ensure compliance with all applicable REIT income and asset tests in the event that we establish any taxable REIT subsidiaries. Taxable REIT subsidiaries are generally subject to corporate level tax on their net income and will generally be able to distribute only net after-tax earnings to their stockholders, including us, as dividend distributions. Any dividends that we pay which are attributable to dividends received by us from taxable REIT subsidiaries can qualify for the 20% tax rate on qualified dividends in the hands of our stockholders that are not corporations. Taxation of Taxable U.S. Stockholders For purposes of the discussion in this Annual Report on Form 10-K, the term “U.S. stockholder” means a holder of our stock that is, for U.S. federal income tax purposes:   a citizen or resident of the U.S.; a corporation (including an entity treated as a corporation for federal income tax purposes), partnership or other entity created or organized in or under the laws of the U.S. or of any state thereof or in the District of Columbia, unless Treasury regulations provide otherwise; 23   an estate the income of which is subject to U.S. federal income taxation regardless of its source; or a trust (i) whose administration is subject to the primary supervision of a U.S. court and which has one or more U.S. persons who have the authority to control all substantial decisions of the trust or (ii) that has a valid election in place to be treated as a U.S. person. Distributions Generally Distributions out of our current or accumulated earnings and profits, other than capital gain dividends, will generally be taxable to U.S. stockholders as ordinary income. Provided that we continue to qualify as a REIT, dividends paid by us will not be eligible for the dividends received deduction generally available to U.S. stockholders that are corporations. To the extent that we make distributions in excess of current and accumulated earnings and profits, the distributions will be treated as a tax-free return of capital to each U.S. stockholder and will reduce the adjusted tax basis which each U.S. stockholder has in our stock by the amount of the distribution, but not below zero. Distributions in excess of a U.S. stockholder’s adjusted tax basis in its stock will be taxable as capital gain and will be taxable as long-term capital gain if the stock has been held for more than one year. If we declare a dividend in October, November, or December of any calendar year which is payable to stockholders of record on a specified date in such a month and actually pay the dividend during January of the following calendar year, the dividend is deemed to be paid by us and received by the stockholder on December 31st of the previous year, but only to the extent we have any remaining undistributed earnings and profits (as computed under the Code) as of December 31st. Any portion of this distribution in excess of our previously undistributed earnings and profits as of December 31st should be treated as a distribution to our stockholders in the following calendar year for U.S. federal income tax purposes. Stockholders may not include in their own income tax returns any of our net operating losses or capital losses. Ordinary dividends to a U.S. stockholder generally will not qualify for the 20% tax rate for “qualified dividend income.” However, the 20% tax rate for “qualified dividend income” will apply to our ordinary REIT dividends (i) attributable to dividends received by us from non-REIT corporations such as a taxable REIT subsidiary, and (ii) any income on which we have paid a corporate income tax. Cost Basis Reporting New federal income tax information reporting rules may apply to certain transactions in our shares acquired through the Dividend Reinvestment and Stock Purchase Plan. Where such rules apply, the “cost basis” calculated for the shares involved will be reported to the IRS and to you. Generally these rules apply to all shares purchased after December 31, 2010 including those purchased through the Dividend Reinvestment and Stock Purchase Plan. For “cost basis” reporting purposes, you may identify by lot the shares that you transfer or that are redeemed, but if you do not timely notify us of your election, we will identify the shares that are transferred or redeemed on a “first in/first out” basis. The shares in the Dividend Reinvestment and Stock Purchase Plan are also eligible for the “average cost” basis method, should you so elect. Information reporting (transfer statements) on other transactions may also be required under these new tax rules. Generally, these reports are made for certain transactions other than purchases in shares acquired before January 1, 2011. Transfer statements are issued between “brokers” and are not issued to the IRS or to you. Brokers that are required to report the gross proceeds from a sale of shares on Form 1099-B will also be required to report the customer’s adjusted basis in the shares and whether any gain or loss with respect to the shares is long-term or short-term. In some cases, there may be alternative methods of determining the basis in shares that are disposed of, in which case a broker will apply a default method of its choosing if the investors does not indicate which method it chooses to have applied. Capital Gain Distributions Distributions designated by us as capital gain dividends will be taxable to U.S. stockholders as capital gain income. We can designate distributions as capital gain dividends to the extent of our net capital gain for the taxable year of the distribution. This capital gain income will generally be taxable to non-corporate U.S. stockholders at a 20% or 25% rate based on the characteristics of the asset we sold that produced the gain. U.S. stockholders that are corporations may be required to treat up to 20% of certain capital gain dividends as ordinary income. Retention of Net Capital Gains We may elect to retain, rather than distribute as a capital gain dividend, our net capital gains. If we were to make this election, we would pay tax on such retained capital gains. In such a case, our stockholders would generally:    include their proportionate share of our undistributed net capital gains in their taxable income; receive a credit for their proportionate share of the tax paid by us in respect of such net capital gain; and increase the adjusted basis of their stock by the difference between the amount of their share of our undistributed net capital gain and their share of the tax paid by us. 24 Passive Activity Losses, Investment Interest Limitations and Other Considerations of Holding Our Stock Distributions we make and gains arising from the sale or exchange of our stock by a U.S. stockholder will not be treated as passive activity income. As a result, U.S. stockholders will not be able to apply any “passive losses” against income or gains relating to our stock. Distributions by us, to the extent they do not constitute a return of capital, generally will be treated as investment income for purposes of computing the investment interest limitation under the Code. Further, if we, or a portion of our assets, were to be treated as a taxable mortgage pool, any excess inclusion income that is allocated to you could not be offset by any losses or other deductions you may have. Dispositions of Stock and Warrants A U.S. stockholder or U.S. warrant holder that sells or disposes of our stock or warrants will recognize gain or loss for federal income tax purposes in an amount equal to the difference between the amount of cash or the fair market value of any property the stockholder or warrant holder receives on the sale or other disposition and the stockholder’s or warrant holder’s adjusted tax basis in the stock or warrants, as applicable. This gain or loss will be capital gain or loss and will be long-term capital gain or loss if the stockholder or warrant holder has held the stock or warrants for more than one year. In general, any loss recognized by a U.S. stockholder or warrant holder upon the sale or other disposition of our stock or warrants that the stockholder or warrant holder has held for six months or less will be treated as long-term capital loss to the extent the stockholder or warrant holder received distributions from us which were required to be treated as long-term capital gains. All or a portion of any loss that a U.S. stockholder or warrant holder realizes upon a taxable disposition of our stock or warrants may be disallowed if the stockholder purchases other stock within 30 days before or after the disposition. Information Reporting and Backup Withholding We report to our U.S. stockholders and the IRS the amount of dividends paid during each calendar year and the amount of any tax withheld. Under the backup withholding rules, a stockholder may be subject to backup withholding with respect to dividends paid and redemption proceeds unless the holder is a corporation or comes within other exempt categories and, when required, demonstrates this fact or provides a taxpayer identification number or social security number certifying as to no loss of exemption from backup withholding and otherwise complies with applicable requirements of the backup withholding rules. A U.S. stockholder that does not provide us with its correct taxpayer identification number or social security number may also be subject to penalties imposed by the IRS. A U.S. stockholder can meet this requirement by providing us with a correct, properly completed and executed copy of IRS Form W-9 or a substantially similar form. Backup withholding is not an additional tax. Any amount paid as backup withholding will be creditable against the stockholder’s income tax liability, if any, and otherwise be refundable. In addition, we may be required to withhold a portion of capital gain distributions made to any stockholders who fail to certify their non-foreign status. Medicare Tax Certain U.S. stockholders who are individuals, estates or trusts and whose income exceeds certain thresholds will be required to pay a 3.8% Medicare tax on dividends, interest and certain other investment income, including capital gains from the sale or disposition of our stock. Taxation of Tax-Exempt Stockholders The IRS has ruled that amounts distributed as a dividend by a REIT will be treated as a dividend by the recipient and excluded from the calculation of unrelated business taxable income, or UBTI, when received by a tax-exempt entity. Based on that ruling, provided that a tax-exempt stockholder has not held our stock as “debt financed property” within the meaning of the Code, i.e., property, the acquisition, or holding of which is financed through a borrowing by the tax-exempt U.S. stockholder, the stock is not otherwise used in an unrelated trade or business, and we do not hold a residual interest in a REMIC that gives rise to “excess inclusion” income, as defined in Section 860E of the Code, dividend income on our stock and income from the sale of our stock should not be unrelated business taxable income to a tax-exempt stockholder. However, if we or a pool of our assets were to be treated as a “taxable mortgage pool,” a portion of the dividends paid to a tax-exempt stockholder may be subject to tax as unrelated business taxable income. Although we do not believe that we, or any portion of our assets, will be treated as a taxable mortgage pool, no assurance can be given that the IRS might not successfully maintain that such a taxable mortgage pool exists. For tax-exempt stockholders that are social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts, and qualified group legal services plans exempt from federal income taxation under Sections 501(c)(7), (c)(9), (c)(17) and (c)(20) of the Code, respectively, income from an investment in our stock will constitute unrelated business taxable income unless the organization is able to properly claim a deduction for amounts set aside or placed in reserve for certain purposes so as to offset the income generated by its investment in our stock. Any prospective and current investors should consult their tax advisors concerning these “set aside” and reserve requirements. 25 Notwithstanding the above, however, a substantial portion of the dividends a tax-exempt stockholder receives may constitute UBTI if we are treated as a “pension-held REIT” and the stockholder is a pension trust which:   is described in Section 401(a) of the Code; and holds more than 10%, by value, of the interests in the REIT. Tax-exempt pension funds that are described in Section 401(a) of the Code and exempt from tax under Section 501(a) of the Code are referred to below as “qualified trusts.” A REIT is a “pension-held REIT” if:   it would not have qualified as a REIT but for the fact that Section 856(h)(3) of the Code provides that stock owned by a qualified trust shall be treated, for purposes of the 5/50 Rule, described above, as owned by the beneficiaries of the trust, rather than by the trust itself; and either at least one qualified trust holds more than 25%, by value, of the interests in the REIT, or one or more qualified trusts, each of which owns more than 10%, by value, of the interests in the REIT, holds in the aggregate more than 50%, by value, of the interests in the REIT. The percentage of any REIT dividend treated as unrelated business taxable income is equal to the ratio of:  the unrelated business taxable income earned by the REIT, less directly related expenses, treating the REIT as if it were a qualified trust and therefore subject to tax on unrelated business taxable income, to  the total gross income, less directly related expenses, of the REIT. A de minimis exception applies where the percentage is less than 5% for any year. As a result of the limitations on the transfer and ownership of stock contained in our charter, we do not expect to be classified as a “pension-held REIT.” Taxation of Non-U.S. Stockholders The rules governing federal income taxation of “non-U.S. stockholders” are complex and no attempt will be made herein to provide more than a summary of these rules. “Non-U.S. stockholders” means beneficial owners of shares of our stock that are not U.S. stockholders (as such term is defined in the discussion above under the heading entitled “Taxation of Taxable U.S. Stockholders”). Distributions to non-U.S. stockholders that are not attributable to gain from our sale or exchange of U.S. real property interests, and that are not designated by us as capital gain dividends or retained capital gains, will be treated as dividends of ordinary income to the extent that they are made out of our current or accumulated earnings and profits. These distributions will generally be subject to a withholding tax equal to 30% of the distribution unless an applicable tax treaty reduces or eliminates that tax. However, if income from an investment in our stock is treated as effectively connected with the non-U.S. stockholder’s conduct of a U.S. trade or business, the non-U.S. stockholder generally will be subject to federal income tax at graduated rates on a net basis in the same manner as U.S. stockholders are taxed with respect to those distributions and also may be subject to the 30% branch profits tax in the case of a non- U.S. stockholder that is a corporation. We expect to withhold tax at the rate of 30% on the gross amount of any distributions made to a non-U.S. stockholder unless:   a lower treaty rate applies and any required form, for example IRS Form W-8BEN, evidencing eligibility for that reduced rate is filed by the non-U.S. stockholder with us; or the non-U.S. stockholder files an IRS Form W-8ECI with us claiming that the distribution is effectively connected income. Any portion of the dividends paid to non-U.S. stockholders that is treated as excess inclusion income will not be eligible for exemption from the 30% withholding tax or a reduced treaty rate. Distributions in excess of our current and accumulated earnings and profits will not be taxable to non-U.S. stockholders to the extent that these distributions do not exceed the adjusted basis of the stockholder’s stock, but rather will reduce the adjusted basis of that stock. To the extent that distributions in excess of current and accumulated earnings and profits exceed the adjusted basis of a non-U.S. stockholder’s stock, these distributions will give rise to tax liability if the non-U.S. stockholder would otherwise be subject to tax on any gain from the sale or disposition of its stock, as described below. Because it generally cannot be determined at the time a distribution is made whether or not such distribution may be in excess of current and accumulated earnings and profits, the entire amount of any distribution normally will be subject to withholding at the same rate as a dividend. However, amounts so withheld are creditable against U.S. tax liability, if any, or refundable by the IRS to the extent the distribution is subsequently determined to be in excess of our current and accumulated earnings and profits. We are also required to withhold 10% of any distribution in excess of our current and accumulated earnings and profits if our stock is a U.S. real property interest and if we are not a domestically controlled 26 REIT, as discussed below. Consequently, although we intend to withhold at a rate of 30% on the entire amount of any distribution, to the extent that we do not do so, any portion of a distribution not subject to withholding at a rate of 30% may be subject to withholding at a rate of 10%. Distributions attributable to our capital gains which are not attributable to gain from the sale or exchange of a U.S. real property interest generally will not be subject to income taxation unless (1) investment in our stock is effectively connected with the non-U.S. stockholder’s U.S. trade or business (or, if an income tax treaty applies, is attributable to a U.S. permanent establishment of the non- U.S. stockholder), in which case the non-U.S. stockholder will be subject to the same treatment as U.S. stockholders with respect to such gain (except that a corporate non-U.S. stockholder may also be subject to the 30% branch profits tax), or (2) the non-U.S. stockholder is a non-resident alien individual who is present in the U.S. for 183 days or more during the taxable year and certain other conditions are satisfied, in which case the non-resident alien individual will be subject to a 30% tax on the individual’s capital gains. For any year in which we qualify as a REIT, distributions that are attributable to gain from the sale or exchange of a U.S. real property interest, which includes some interests in real property, but generally does not include an interest solely as a creditor in mortgage loans or MBS, will be taxed to a non-U.S. stockholder under the provisions of the Foreign Investment in Real Property Tax Act of 1980, or FIRPTA. Under FIRPTA, distributions attributable to gain from sales of U.S. real property interests are taxed to a non- U.S. stockholder as if that gain were effectively connected with the stockholder’s conduct of a U.S. trade or business. Non-U.S. stockholders thus would be taxed at the normal capital gain rates applicable to stockholders, subject to applicable alternative minimum tax and a special alternative minimum tax in the case of nonresident alien individuals. Distributions subject to FIRPTA also may be subject to the 30% branch profits tax in the hands of a non-U.S. corporate stockholder. We are required to withhold 35% of any distribution that we designate (or, if greater, the amount that we could designate) as a capital gains dividend. The amount withheld is creditable against the non-U.S. stockholder’s FIRPTA tax liability. A capital gain distribution from a REIT to a foreign investor has been removed from the category of effectively connected income, provided that (i) the distribution is received with respect to a class of stock that is regularly traded on an established securities market located in the U.S. (our stock currently is so traded) and (ii) the foreign investor does not own more than 5% of the class of stock at any time during the taxable year within which the distribution is received. In that case, the foreign investor is not required to file a U.S. federal income tax return by reason of receiving such a distribution. The distribution is to be treated as a REIT dividend to that investor, taxed as a REIT dividend that is not a capital gain. Also, the branch profits tax does not apply to such a distribution. Gains recognized by a non-U.S. stockholder upon a sale of our stock generally will not be taxed under FIRPTA if we are a domestically-controlled REIT, which is a REIT in which at all times during a specified testing period less than 50% in value of the stock was held directly or indirectly by non-U.S. stockholders. Because our stock is publicly traded, we cannot assure our investors that we are or will remain a domestically-controlled REIT. Even if we are not a domestically-controlled REIT, however, a non-U.S. stockholder that owns, actually or constructively, 5% or less of our stock throughout a specified testing period will not recognize taxable gain on the sale of our stock under FIRPTA if the shares are traded on an established securities market. If gain from the sale of the stock were subject to taxation under FIRPTA, the non-U.S. stockholder would be subject to the same treatment as U.S. stockholders with respect to that gain, subject to applicable alternative minimum tax, a special alternative minimum tax in the case of nonresident alien individuals, and the possible application of the 30% branch profits tax in the case of non- U.S. corporations. In addition, the purchaser of the stock could be required to withhold 10% of the purchase price and remit such amount to the IRS. Gains not subject to FIRPTA will be taxable to a non-U.S. stockholder if:   the non-U.S. stockholder’s investment in the stock is effectively connected with a trade or business in the U.S., in which case the non-U.S. stockholder will be subject to the same treatment as U.S. stockholders with respect to that gain; or the non-U.S. stockholder is a nonresident alien individual who was present in the U.S. for 183 days or more during the taxable year and other conditions are met, in which case the nonresident alien individual will be subject to a 30% tax on the individual’s capital gains. Information Reporting and Backup Withholding If the proceeds of a disposition of our stock are paid by or through a U.S. office of a broker-dealer, the payment is generally subject to information reporting and to backup withholding (currently at a rate of 28%) unless the disposing non-U.S. stockholder certifies as to his name, address and non-U.S. status or otherwise establishes an exemption. Generally, U.S. information reporting and backup withholding will not apply to a payment of disposition proceeds if the payment is made outside the U.S. through a foreign office of a foreign broker-dealer. If the proceeds from a disposition of our stock are paid to or through a foreign office of a U.S. broker-dealer or a non-U.S. office of a foreign broker-dealer that is (i) a “controlled foreign corporation” for federal income tax purposes, (ii) a foreign person 50% or more of whose gross income from all sources for a three-year period was effectively connected 27 with a U.S. trade or business, (iii) a foreign partnership with one or more partners who are U.S. persons and who in the aggregate hold more than 50% of the income or capital interest in the partnership, or (iv) a foreign partnership engaged in the conduct of a trade or business in the U.S., then (i) backup withholding will not apply unless the broker-dealer has actual knowledge that the owner is not a foreign stockholder, and (ii) information reporting will not apply if the non-U.S. stockholder satisfies certification requirements regarding its status as a foreign stockholder. Foreign Accounts Shareholders that acquire our stock through an account maintained at a non-U.S. financial institution should be aware that the Foreign Account Tax Compliance Act, or FATCA, enacted in 2010 provides that a 30% withholding tax will be imposed on certain payments made to a foreign entity if such entity fails to satisfy certain new disclosure and reporting rules. FATCA generally requires that (i) in the case of shareholder that is foreign financial institution (defined broadly to include a hedge fund, a private equity fund, a mutual fund, a securitization vehicle or other investment vehicle), the entity identify and provide information with respect to financial accounts with such entity held (directly or indirectly) by U.S. persons and U.S.-owned foreign entities and (ii) in the case of a shareholder that is a non-financial foreign entity, the entity identify and provide information with respect to substantial U.S. owners of such entity. The IRS has released final regulations generally providing that FATCA withholding will not apply with respect to payments made prior to January 1, 2014 and that FATCA withholding tax on gross proceeds from the disposition of stock will not be imposed with respect to payments made prior to January 1, 2017. The U.S. Treasury is also in the process of signing Intergovernmental Agreements with other countries to implement the exchange of information required under FATCA. Shareholders that invest in the Company through an account maintained at a non-U.S. financial institution are strongly encouraged to consult with their own tax advisors regarding the potential application and impact of FATCA and any Intergovernmental Agreement between the United States and their home jurisdiction in connection with FATCA compliance. State, Local and Foreign Taxation We may be required to pay state, local and foreign taxes in various state, local and foreign jurisdictions, including those in which we transact business or make investments, and our stockholders may be required to pay state, local and foreign taxes in various state, local and foreign jurisdictions, including those in which they reside. Our state, local and foreign tax treatment may not conform to the federal income tax consequences summarized above. In addition, a stockholder’s state, local and foreign tax treatment may not conform to the federal income tax consequences summarized above. Consequently, prospective investors should consult their tax advisors regarding the effect of state, local and foreign tax laws on an investment in our stock. Possible Legislative or Other Actions Affecting Tax Considerations Prospective investors and stockholders should recognize that the present U.S. federal income tax treatment of an investment in our stock may be modified by legislative, judicial or administrative action at any time and that any such action may affect investments and commitments previously made. The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Treasury Department, resulting in revisions of regulations and revised interpretations of established concepts as well as statutory changes. Revisions in U.S. federal tax laws and interpretations thereof could adversely affect the tax consequences of an investment in our stock. Item 1A. RISK FACTORS Our business routinely encounters and attempts to address risks, some of which will cause our future results to differ, sometimes materially, from those originally anticipated. Below, we have described our present view of the most significant risks facing the Company. The risk factors set forth below are not the only risks that we may face or that could adversely affect us. If any of the circumstances described in the risk factors discussed in this Annual Report on Form 10-K actually occur, our business, financial condition and results of operations could be materially adversely affected. If this were to occur, the trading price of our securities could decline significantly and shareholders may lose all or part of their investment. The following discussion of risk factors contains “forward-looking statements,” which may be important to understanding any statement in this Annual Report on Form 10-K or in our other filings and public disclosures. In particular, the following information should be read in conjunction with Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8 – Financial Statements and Supplementary Data of this Annual Report on Form 10-K. 28 Risks Related to Our Business Adverse developments in the global capital markets, including defaults, credit losses and liquidity concerns, as well as recent mergers, acquisitions and bankruptcies of potential repurchase agreement counterparties, could make it difficult for us to borrow money to acquire MBS on a leveraged basis, on favorable terms or at all, which could adversely affect our profitability. We rely on the availability of financing to acquire MBS on a leveraged basis. Institutions from which we obtain financing may have owned or financed MBS and other assets, which have declined in value and caused them to suffer losses as a result of the downturn in the residential mortgage market. As these conditions persist, institutions may be forced to exit the repurchase agreement market, become insolvent or further tighten their lending standards or increase the amount of equity capital or haircut required to obtain financing and, in such event, could make it more difficult for us to obtain financing on favorable terms or at all. During the past few years, there have been several proposed or completed mergers, acquisitions and bankruptcies of investment banks and commercial banks that have historically acted as repurchase agreement counterparties. This has resulted in a fewer number of potential repurchase agreement counterparties operating in the market. Fewer potential counterparties may reduce our ability to diversify and thereby attempt to minimize risk of counterparty default. In addition, many commercial banks, investment banks and insurance companies have announced extensive losses from exposure to the residential mortgage market. These losses have reduced financial industry capital, leading to reduced liquidity for some institutions. As a result of these difficulties, there has been an increased focus by U.S. and international regulators and banking groups (such as from the Dodd-Frank legislation and Basel III accord) on increasing capital requirements for financial institutions and on greater restrictions on lending. This may have an adverse impact on the supply of MBS and could also make it more difficult for us as well as others in the marketplace to obtain financing on favorable terms or at all. Our profitability may be adversely affected if we are unable to obtain cost-effective financing for our investments. Failure to procure funding on favorable terms, or at all, would adversely affect our results and may, in turn, negatively affect the market price of shares of our common stock, Series A Preferred Stock, Series B Preferred Stock or the newly-issued Series C Preferred Stock. The current weakness in the mortgage market could cause one or more of our lenders to be unwilling or unable to provide us with financing. This could potentially increase our financing costs and reduce liquidity. Furthermore, if many of our lenders are unwilling or unable to provide us with additional financing, we could be forced to sell our assets at an inopportune time when prices are depressed. If one or more major market participants fail, it could negatively impact the marketability of all fixed income securities, including MBS, and this could negatively impact the value of the securities in our portfolio, thus reducing our net book value. If we are unable to negotiate favorable terms and conditions on future repurchase arrangements with one or more of our lenders, our financial condition and earnings could be negatively impacted. The terms and conditions of each repurchase arrangement with our lenders are negotiated on a transaction-by-transaction basis. Key terms and conditions of each transaction include interest rates, maturity dates, asset pricing procedures and margin requirements. We cannot assure you that we will be able to continue to negotiate favorable terms and conditions on our future repurchase arrangements. Also, during periods of market illiquidity or due to perceived credit quality deterioration of the collateral pledged, a lender may require that less favorable asset pricing procedures be employed or the margin requirements be increased. Possible market developments, including a sharp rise in interest rates, a change in prepayment rates or increasing market concern about the value or liquidity of MBS, may reduce the market value of our portfolio, which may cause our lenders to require additional collateral. Under these conditions, we may determine it is prudent to sell assets to improve our ability to pledge sufficient collateral to support our remaining borrowings. Such sales may be at disadvantageous times, which may harm our operating results and net profitability. Adverse developments in the residential mortgage market may adversely affect the value of the MBS in which we invest. During the past several years, the residential mortgage market in the U.S. has experienced a variety of difficulties and changing economic conditions including defaults, credit losses and liquidity concerns. News of actual and potential security liquidations has increased the volatility of many financial assets including MBS. Further increased volatility and deterioration in the broader residential mortgage and MBS markets may adversely affect the performance and market value of the MBS in which we invest. Our investments serve as collateral for our financings. Any decline in their value, or perceived market uncertainty about their value, would likely make it difficult for us to obtain financing on favorable terms or at all, or maintain our compliance with terms of any financing arrangements already in place. If market conditions result in a decline in the value of our MBS, our financial position and results of operations could be adversely affected. 29 New laws may be passed affecting the relationship between Fannie Mae and Freddie Mac, on the one hand, and the federal government, on the other, which could adversely affect the price of Agency MBS. The interest and principal payments we expect to receive on the Agency MBS in which we invest will be guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. Unlike the Ginnie Mae certificates in which we invest, the principal and interest on securities issued by Fannie Mae and Freddie Mac are not guaranteed by the U.S. government. All the Agency MBS in which we invest depend on a steady stream of payments on the mortgages underlying the securities. Since September 2008, there have been increased market concerns about Fannie Mae’s and Freddie Mac’s ability to withstand future credit losses associated with securities held in their investment portfolios, and on which they provide guarantees, without the direct support of the federal government. Fannie Mae and Freddie Mac were placed into the conservatorship of the FHFA, their federal regulator, pursuant to its powers under The Federal Housing Finance Regulatory Reform Act of 2008, a part of the Housing and Economic Recovery Act of 2008. In addition to FHFA becoming the conservator of Fannie Mae and Freddie Mac, the U.S. Department of the Treasury has taken various actions intended to provide Fannie Mae and Freddie Mac with additional liquidity and ensure their financial stability. The U.S. Treasury can hold its portfolio of Agency MBS to maturity and, based on mortgage market conditions, may make adjustments to the portfolio. This flexibility may adversely affect the pricing and availability for our target investments. It is also possible that if and when the U.S. Treasury commits to purchase Agency MBS in the future, it could create additional demand that would increase the pricing of Agency MBS that we seek to acquire. Shortly after Fannie Mae and Freddie Mac were placed in federal conservatorship, the Secretary of the U.S. Treasury suggested that the guarantee payment structure of Fannie Mae and Freddie Mac should be re-examined. The future roles of Fannie Mae and Freddie Mac could be significantly reduced and the nature of their guarantees could be eliminated or considerably limited relative to historical measurements. The U.S. Treasury could also stop providing credit support to Fannie Mae and Freddie Mac in the future. Any changes to the nature of the guarantees provided by Fannie Mae and Freddie Mac could redefine what constitutes an Agency MBS and could have broad adverse market implications. In addition, if Fannie Mae or Freddie Mac were eliminated, or their structures were to change radically, we would not be able to acquire Agency MBS from these companies, which would eliminate the major component of our business model. Our income could be negatively affected in a number of ways depending on the manner in which related events unfold. For example, the current credit support provided by the U.S. Treasury to Fannie Mae and Freddie Mac, and any additional credit support it may provide in the future, could have the effect of lowering the interest rate we expect to receive from Agency MBS that we seek to acquire, thereby tightening the spread between the interest we earn on our portfolio of targeted assets and our cost of financing that portfolio. A reduction in the supply of Agency MBS could also negatively affect the pricing of Agency MBS we seek to acquire by reducing the spread between the interest we earn on our portfolio of targeted assets and our cost of financing that portfolio. Any law affecting these government-sponsored enterprises may create market uncertainty and have the effect of reducing the actual or perceived credit quality of securities issued or guaranteed by Fannie Mae or Freddie Mac. As a result, such laws could increase the risk of loss on investments in Fannie Mae and/or Freddie Mac Agency MBS. It also is possible that such laws could adversely impact the market for such securities and spreads at which they trade. All of the foregoing could materially adversely affect our business, operations and financial condition. Separate legislation has been introduced in both houses of the U.S. Congress, which would, among other things, wind down Fannie Mae and Freddie Mac, and we could be materially adversely affected if these proposed laws were enacted. On June 25, 2013, a bipartisan group of U.S. Senators introduced a draft bill to the U.S. Senate titled, “Housing Finance Reform and Taxpayer Protection Act of 2013,” which may serve as a catalyst for congressional discussion on the reform of Fannie Mae and Freddie Mac. Also, on July 11, 2013, members of the House Committee on Financial Services introduced a draft bill to the U.S. House of Representatives titled, “Protecting American Taxpayers and Homeowners Act.” During the first quarter of 2014, another bipartisan bill was introduced that builds on these earlier bills. All of these bills call for the winding down of Fannie Mae and Freddie Mac and seek to increase the opportunities for private capital to participate in, and consequently bear the risk of loss in connection with, government-guaranteed MBS. While these bills have support in their respective houses of Congress, they have failed to garner enough support for a vote; however, these bills do suggest that efforts are being made to reform and possibly eliminate Fannie Mae and Freddie Mac. The passage of any new legislation affecting Fannie Mae and Freddie Mac may create market uncertainty and reduce the actual or perceived credit quality of securities issued or guaranteed by the U.S. government through a new or existing successor entity to Fannie Mae and Freddie Mac. If Fannie Mae and Freddie Mac were reformed or wound down, it is unclear what effect, if any, this would have on the value of the existing securities guaranteed by Fannie Mae or Freddie Mac. It is also possible that the above- referenced proposed legislation, if enacted into law, could adversely impact the market for securities guaranteed by the U.S. 30 government and the spreads at which they trade. The foregoing could materially adversely affect the pricing, supply, liquidity and value of the MBS in which we invest and otherwise materially adversely affect our business operations and financial condition. Certain actions taken or that may be taken in the future by the U.S. government to address the financial crisis could negatively affect the availability of financing, the quantity and quality of available products, cause changes in interest rates and the yield curve, any and each of which could materially adversely affect our business, results of operations and financial condition. In September 2012, the Fed Open Market Committee of the Federal Reserve, or FOMC, announced an open-ended program to purchase an additional $40 billion of Agency MBS per month until economic conditions (primarily the unemployment rate) improved. This program, combined with the then-existing Fed bond-buying program of Treasury securities, was to increase the Federal Reserve’s holdings by $85 billion per month. The Federal Reserve also announced its projection that the federal funds rate would likely remain at exceptionally low levels until at least mid-2015. In May and June 2013, then Federal Reserve Chairman Ben Bernanke commented that if there was continued improvement in the U.S. economy, the pace of purchases could be slowed down or tapered. These comments had a great effect on the bond market, as longer-term interest rates rose while short-term interest rates remained constant. The resulting steepened yield curve caused a decline in the value of MBS. At the FOMC meeting on December 18, 2013, the Federal Reserve announced that it would begin the tapering of its bond-buying program down from the $85 billion per month and would continue to re-evaluate this at subsequent FOMC meetings. At its meeting in October 2014, the Federal Reserve ended its monthly purchases of Agency MBS and Treasury securities. Most Federal Reserve officials previously announced in the June 2014 meeting that they expected the first hike in interest rates to come sometime in 2015. At its December 17, 2014 meeting, the FOMC maintained the Fed Funds rate at its current level and stated that it would continue to review the appropriate target rate based on the goals of maximizing employment and as long as the inflation rate was under 2%. We cannot predict whether or when such other actions may occur or what impact, if any, such actions could have on our business, results of operations and financial condition. While such programs are intended to aid economic activity, there are no assurances that this will occur. In fact, these actions could negatively affect the availability of financing and the quantity and quality of available products and/or cause changes in interest rates and the yield curve, any and each of which could materially adversely affect our business, results of operations and financial condition, as well as those of the entire mortgage sector in general. A failure by the U.S. government to meet the conditions of the Budget Control Act of 2011 or to reduce its budget deficit or a further downgrade of U.S. sovereign debt and government-sponsored agency debt could have a material adverse impact on our borrowings and the valuations of our securities and may have a material adverse impact on our financial condition and results of operations. As widely reported, there continues to be concerns over the ability of the U.S. government to reduce its budget deficit and resolve its debt crisis. The U.S. sovereign debt and government-sponsored agency debt credit ratings continue to be monitored to account for the risk that U.S. lawmakers fail to meet the conditions of the Budget Control Act of 2011 and/or reduce its overall debt. Such failures could have a material adverse effect both on the U.S. economy and on the global economy. In particular, this could cause disruption in the capital markets and impact the stability of future U.S. treasury auctions and the trading market for U.S. government securities, resulting in increased interest rates and impaired access to credit. These factors could negatively impact our borrowing costs, our liquidity and the valuation of the securities we currently own in our portfolio, which could have a material adverse impact on our financial condition and our results of operations. The consequences of the American Taxpayer Relief Act of 2012 or a failure or delay by the U.S. government to resolve the 2013 debt ceiling could materially adversely affect our stock price, our business, results of operations and financial condition. On January 2, 2013, the U.S. Congress passed the American Taxpayer Relief Act of 2012, or the Taxpayer Relief Act, which extended, for most Americans, tax cuts implemented under President George W. Bush’s administration. However, the Taxpayer Relief Act also delayed the implementation of the budget sequestration provisions of the Budget Control Act of 2011, which provided for automatic spending cuts, which went into effect on March 1, 2013. During 2013 and 2014, Congress passed several interim measures of providing temporary funding to the U.S. government and temporarily increasing the debt ceiling. On February 12, 2014, Congress passed a bill, which was signed into law by President Obama, suspending the debt ceiling until March 2015. On December 16, 2014, President Obama signed a $1.1 trillion appropriations bill that will fund most government operations through September 2015. A failure by the U.S. government to reach agreement on future budgets and debt ceilings, or reduce its budget deficit, or a future downgrade of U.S. sovereign debt and government-sponsored agencies debt could have a material adverse effect on the U.S. economy and the global economy. These events could have a material adverse effect on our borrowing costs, the availability of financing, the liquidity and valuation of securities in general and the securities in our portfolio. The consequences of the Taxpayer Relief Act in increasing income tax rates, payroll tax rates, and dividend and capital gains rates may materially affect our stock price. Also, delays in implementing the budget sequestration, substantially addressing spending cuts, or resolving the impending debt ceiling, could have unintended consequences on the U.S. economy and could materially affect not only our stock price but our business, results of operations and financial condition. 31 Mortgage loan modification programs and future legislative action may adversely affect the value of, and the returns on, the Agency MBS in which we invest. The U.S. government, through the Federal Housing Authority and the Federal Deposit Insurance Corporation, has commenced implementation of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. The programs may involve, among other things, the modification of mortgage loans to reduce the principal amount of the loans or the rate of interest payable on the loans, or extending the payment terms of the loans. In addition, members of the U.S. Congress have indicated support for additional legislative relief for homeowners. These loan modification programs, as well as future legislative or regulatory actions that result in the modification of outstanding mortgage loans, may adversely affect the value of, and the returns on, the MBS in which we invest. We are subject to the risk that the global credit crisis, despite efforts by global governments to halt that crisis, may affect interest rates and the availability of financing in general, which could adversely affect our financing and our operating results. During the past several years, several large European banks experienced financial difficulty and were either rescued by government assistance or by other large European banks. Several European governments have coordinated plans to attempt to shore up their financial sectors through loans, credit guarantees, capital infusions, promises of continued liquidity funding and interest rate cuts. Additionally, other governments of the world’s largest economic countries also implemented interest rate cuts. There is no assurance that these and other plans and programs will be successful in halting the global credit crisis or in preventing other banks from failing. If unsuccessful, this could adversely affect our financing and operations as well as those of the entire mortgage sector in general. As the European credit crisis continues, with the bailout of Greece, and problems in other countries such as Italy and Spain, there is a growing risk to the financial condition and stability of major European banks. Many of the European banks have U.S. banking subsidiaries, which have provided financing to us, particularly repurchase agreement financing for the acquisition of various investments, including MBS investments. During 2011, the U.S. government placed many of the U.S. banking subsidiaries of these major European banks on credit watch. In June 2012, Moody’s downgraded the credit ratings of 15 global banks. If the European credit crisis continues to impact these major European banks, there is the possibility that it will also impact the operations of their U.S. banking subsidiaries. This could adversely affect our financing and operations as well as those of the entire mortgage sector in general. Our leveraging strategy increases the risks of our operations. Relative to our MBS, we have generally borrowed, on a short-term basis, between seven to twelve times the amount of our equity, although our borrowings may at times be above or below this amount. During the past several years, we have reduced our borrowings to a range of five to nine times the amount of our equity due to the uncertainty in the marketplace and the broader problems in the economy. We incur this leverage by borrowing against a substantial portion of the market value of our mortgage- related assets. Use of leverage can enhance our investment returns (and at times when we reduce our leverage, our profitability may be reduced as a result). Leverage, however, also increases risks. In the following ways, the use of leverage increases our risk of loss and may reduce our net income by increasing the risks associated with other risk factors including a decline in the market value of our MBS or a default of a mortgage-related asset:  The use of leverage increases our risk of loss resulting from various factors including rising interest rates, increased interest rate volatility, downturns in the economy and reductions in the availability of financing or deterioration in the conditions of any of our mortgage-related assets.  Substantially all of our borrowings are secured by our MBS, generally under repurchase agreements. A decline in the market value of the MBS used to secure these debt obligations could limit our ability to borrow or result in lenders requiring us to pledge additional collateral to secure our borrowings. In that situation, we could be required to sell MBS under adverse market conditions in order to obtain the additional collateral required by the lender. If these sales are made at prices lower than the carrying value of the MBS, we would experience losses.  A default of a mortgage-related asset that constitutes collateral for a repurchase agreement could also result in an involuntary liquidation of the mortgage-related asset. This would result in a loss to us of the difference between the value of the mortgage-related asset upon liquidation and the amount borrowed against the mortgage-related asset.  To the extent we are compelled to liquidate qualified REIT assets to repay debts, our compliance with the REIT rules regarding our assets and our sources of income could be affected, which could jeopardize our status as a REIT. Losing our REIT status would cause us to lose tax advantages applicable to REITs and may decrease our overall profitability and distributions to our stockholders. 32 We may incur increased borrowing costs related to repurchase agreements and that would adversely affect our profitability. Substantially all of our borrowings are collateralized borrowings in the form of repurchase agreements. If the interest rates on these agreements increase, that would harm our profitability. Our borrowing costs under repurchase agreements generally correspond to short-term interest rates such as LIBOR or a short- term Treasury index, plus or minus a margin. The margins on these borrowings over or under short-term interest rates may vary depending upon:    the movement of interest rates; the availability of financing in the market; and the value and liquidity of our mortgage-related assets. An increase in interest rates may harm our book value, which could adversely affect the cash available for distribution to you and could cause the price of our securities to decline. Increases in interest rates may harm the market value of our mortgage-related assets. Our hybrid adjustable-rate mortgage- related assets (during the fixed-rate component of the mortgages underlying such assets) and our fixed-rate securities are generally more harmed by these increases. In accordance with generally accepted accounting principles utilized in the United States of America, or GAAP, we reduce our book value by the amount of any decrease in the market value of our mortgage-related assets. Losses on securities classified as available-for-sale, which are determined by management to be other-than-temporary in nature, are reclassified from “accumulated other comprehensive income,” or AOCI, to current operations. An increase in interest rates may cause a decrease in the volume of newly issued, or investor demand for, MBS and other mortgage-related assets, which could adversely affect our ability to acquire MBS and other mortgage-related assets that satisfy our investment objectives and to generate income and pay dividends. Rising interest rates generally reduce the demand for consumer credit, including mortgage loans, due to the higher cost of borrowing. A reduction in the volume of mortgage loans originated may affect the volume of MBS and other mortgage-related assets available to us, which could affect our ability to acquire MBS and other mortgage-related assets that satisfy our investment objectives. Rising interest rates may also cause MBS and other mortgage-related assets that were issued prior to an interest rate increase to provide yields that exceed prevailing market interest rates. If rising interest rates cause us to be unable to acquire a sufficient volume of MBS or mortgage-related assets or MBS or mortgage-related assets with a yield that exceeds the borrowing cost we will incur to purchase MBS or mortgage-related assets, our ability to satisfy our investment objectives and to generate income and pay dividends in the amount expected, or at all, may be materially and adversely affected. A change in the LIBOR setting process could affect the interest rates that repurchase agreement counterparties charge on borrowings in general. Any such change could affect our borrowing agreements and could have an adverse impact on our net interest income. LIBOR is an unregulated rate based on estimates that lenders submit to the British Bankers’ Association, a trade group that compiles this information and publishes daily the LIBOR rate. During 2012 and 2013, U.S. and British banking authorities assessed fines on several major financial institutions for LIBOR manipulation. In September 2013, oversight of LIBOR was transferred over to United Kingdom regulators, the Financial Conduct Authority. The administration of LIBOR was to be transferred to the NYSE Euronext Rate Administration Limited, but this group was renamed as the ICE Benchmark Administration Limited, or the IBA, upon the successful completion of the acquisition of NYSE Euronext by the Intercontinental Exchange in November 2013. On February 1, 2014, the administration of LIBOR was transferred from the BBA to the IBA following authorization by the Financial Conduct Authority. In October 2014, the IBA proposed a package of measures designed to make LIBOR more accurate and less susceptible to manipulation, including defining which trades can be used to calculate bank borrowing costs to ensure the calculation of LIBOR is based on actual trades as opposed to estimates. The proposal was sent out for comments to be submitted back to the IBA by December 19, 2014. The calculation of LIBOR under the IBA is the average of the interest rates that some of the world’s leading banks charge each other for short-term loans. It is unclear at this time how this change will affect the interest rates that repurchase agreement counterparties charge on borrowings in general and how they could specifically affect our borrowing agreements. If there are other settlements with other financial institutions over the LIBOR setting process, the process may become subject to even greater regulation and review by British and U.S. banking authorities, and the method of calculating LIBOR may change. A change in the LIBOR setting process could affect the interest rates that repurchase agreement counterparties charge on borrowings in general and could affect our borrowing agreements, which could have an adverse impact on our net interest income. 33 A flat or inverted yield curve may negatively affect our operations, book value and profitability due to its potential impact on investment yields and the supply of adjustable-rate mortgage products. A flat yield curve occurs when there is little difference between short-term and long-term interest rates. An inverted yield curve occurs when short-term interest rates are higher than long-term interest rates. A flat or inverted yield curve may be an adverse environment for adjustable-rate mortgage, or ARM, product volume, as there may be little incentive for borrowers to choose an ARM product over a longer-term fixed-rate loan. If the supply of ARM product decreases, yields may decline due to market forces. Our borrowing costs under repurchase agreements generally correspond to short-term interest rates such as LIBOR. A flat or inverted yield curve will likely result in lower profits. Additionally, a flat or inverted yield curve may negatively impact the pricing of our securities. According to GAAP, if the values of our securities decrease, we reduce our book value by the amount of any decrease in the market value of our mortgage-related assets. We depend on short-term borrowings to purchase mortgage-related assets and reach our desired amount of leverage. If we fail to obtain or renew sufficient funding on favorable terms, we will be limited in our ability to acquire mortgage-related assets and our earnings and profitability would decline. We depend on short-term borrowings to fund acquisitions of mortgage-related assets and reach our desired amount of leverage. Accordingly, our ability to achieve our investment and leverage objectives depends on our ability to borrow money in sufficient amounts and on favorable terms. In addition, we must be able to renew or replace our maturing short-term borrowings on a continuous basis. Moreover, we depend on a limited number of lenders to provide the primary credit facilities for our purchases of mortgage- related assets. If we cannot renew or replace maturing borrowings, we may have to sell our mortgage-related assets under adverse market conditions and may incur permanent capital losses as a result. Any number of these factors in combination may cause difficulties for us, including a possible liquidation of a major portion of our portfolio at disadvantageous prices with consequent losses, which may render us insolvent. Any repurchase agreements that we use to finance our assets may require us to provide additional collateral or pay down debt, and if these requirements are not met, our financial condition and prospects could deteriorate rapidly. Our repurchase agreements involve the risk that the market value of the securities pledged or sold by us to the repurchase agreement counterparty may decline in value, in which case the counterparty may require us to provide additional collateral or to repay all or a portion of the funds advanced. We may not have additional collateral or the funds available to repay our debt at that time, which would likely result in defaults unless we are able to raise the funds from alternative sources, which we may not be able to achieve on favorable terms or at all. Posting additional collateral would reduce our liquidity and limit our ability to leverage our assets. If we cannot meet these requirements, the counterparty could accelerate its indebtedness, increase the interest rate on advanced funds and terminate our ability to borrow funds from them, which could materially and adversely affect our financial condition and ability to implement our investment strategy. In addition, in the event that the counterparty files for bankruptcy or becomes insolvent, our securities may become subject to bankruptcy or insolvency proceedings, thus depriving us of the benefit of these assets. In the event that we are unable to meet these collateral obligations, our financial condition and prospects could deteriorate rapidly. Our use of repurchase agreements to borrow funds may give our lenders greater rights in the event that either we or a lender files for bankruptcy. Our borrowings under repurchase agreements may qualify for special treatment under the bankruptcy code, giving our lenders the ability to avoid the automatic stay provisions of the bankruptcy code and to take possession of and liquidate our collateral under the repurchase agreements without delay in the event that we file for bankruptcy. Furthermore, the special treatment of repurchase agreements under the bankruptcy code may make it difficult for us to recover our pledged assets in the event that a lender files for bankruptcy. Thus, the use of repurchase agreements exposes our pledged assets to risk in the event of a bankruptcy filing by either a lender or us. Because assets we acquire may experience periods of illiquidity, we may lose profits or be prevented from earning gains if we cannot sell mortgage-related assets at an opportune time. We bear the risk of being unable to dispose of our mortgage-related assets at advantageous times or in a timely manner because mortgage-related assets generally experience periods of illiquidity. The lack of liquidity may result from the absence of a willing buyer or an established market for these assets, as well as legal or contractual restrictions on resale. As a result, the illiquidity of mortgage-related assets may cause us to lose profits and lose the ability to earn gains. 34 A decrease or lack of liquidity in our investments may adversely affect our business, including our ability to value and sell our assets. We invest in certain MBS or other investment securities that are not publicly traded in liquid markets. Moreover, turbulent market conditions, such as those currently in effect, could significantly and negatively impact the liquidity of our assets. In some cases, it may be difficult to obtain third-party pricing on certain of our investment securities. Illiquid investments typically experience greater price volatility, as a ready market does not exist, and can be more difficult to value. In addition, third-party pricing for illiquid investments may be more subjective than for more liquid investments. The illiquidity of certain investment securities may make it difficult for us to sell such investments if the need or desire arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded certain of our investment securities. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited, which could adversely affect our results of operations and financial condition. We may not have the benefit of repurchase rights or indemnification upon the breach of broad representations and warranties for all of the assets we acquire, which could increase the risk that we suffer losses on such assets. We may acquire assets from counterparties that are not able or willing to provide broad representations and warranties on such assets. Even if such counterparties provide representations and warranties on the assets, they may not be contractually required to repurchase the assets or indemnify us if there are defaults with respect to the representations and warranties on the assets. To the extent that our counterparties are not contractually obligated to repurchase the assets or are unable to fulfill their indemnification obligations, we will bear the same risks with respect to such assets as if such representations and warranties were not made. If we do not have the benefit of repurchase rights or indemnification upon the breach of broad representations and warranties on our assets, we may lose money on our investments in such assets that we otherwise would not lose had such repurchase rights or indemnification been available. Our hedging strategies may not be successful in mitigating our risks associated with interest rates. We engage in hedging activity from time to time. As such, we use various derivative financial instruments to provide a level of protection against interest rate risks, but no hedging strategy can protect us completely. When interest rates change, we expect to record a gain or loss on derivatives, which would be offset by an inverse change in the value of loans or residual interests. Additionally, from time to time, we may enter into hedging transactions in connection with our holdings of MBS and government securities with respect to one or more of our assets or liabilities. Our hedging activities may include entering into interest rate swaps, caps and floors, options to purchase these items and futures and forward contracts. Our actual hedging decisions will be determined in light of the facts and circumstances existing at the time and may differ from our currently anticipated hedging strategy. We cannot assure you that our use of derivatives will offset the risks related to changes in interest rates. It is likely that there will be periods in the future during which we will incur losses after accounting for our derivative financial instruments. The derivative financial instruments we select may not have the effect of reducing our interest rate risk. In addition, the nature and timing of hedging transactions may influence the effectiveness of these strategies. Poorly designed strategies or improperly executed transactions could actually increase our risk and losses. In addition, hedging strategies involve transaction and other costs. We cannot assure you that our hedging strategy and the derivatives that we use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses. The characteristics of hedging instruments present various concerns, including illiquidity, enforceability, and counterparty risks, which could adversely affect our business and results of operations. From time to time, we enter into interest rate swap agreements to hedge risks associated with movements in interest rates. Entities entering into interest rate swap agreements are exposed to credit losses in the event of non-performance by counterparties to these transactions. Effective October 12, 2012, the Commodities Futures Trading Commission, or CFTC, issued new rules regarding swaps under the authority granted to it pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd- Frank Act. Although the new rules do not directly affect the negotiations and terms of individual swap transactions between counterparties, they do require that after September 9, 2013, the clearing of all swap transactions occur through registered derivatives clearing organizations, or swap execution facilities, through standardized documents under which each swap counterparty transfers its position to another entity whereby the centralized clearinghouse effectively becomes the counterparty to each side of the swap. It is the intent of the Dodd-Frank Act that the clearing of swaps in this manner is designed to avoid concentration of swap risk in any single entity by spreading and centralizing the risk in the clearinghouse and its members. In addition to greater initial and periodic margin (collateral) requirements and additional transaction fees both by the swap execution facility and the clearinghouse, the swap transactions are now subjected to greater regulation by both the CFTC and the SEC. These additional fees, costs, margin requirements, documentation, and regulation could adversely affect our business and results of operations. Additionally, for all swaps we entered into prior to September 9, 2013, we are not required to clear them through the central clearinghouse and these swaps are still subject to the risks of nonperformance by any of the individual counterparties with whom we entered into these transactions. If the swap counterparty cannot perform under the terms of an interest rate swap, we would not receive payments due under that agreement, we 35 may lose any unrealized gain associated with the interest rate swap, and the hedged liability would cease to be hedged by the interest rate swap. We may also be at risk for any collateral we have pledged to secure our obligation under the interest rate swap if the counterparty becomes insolvent or files for bankruptcy. Default by a party with whom we enter into a hedging transaction may result in a loss and force us to cover our commitments, if any, at the then-current market price. Although generally we will seek to reserve the right to terminate our hedging positions, it may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty and we may not be able to enter into an offsetting contract in order to cover our risk. There may not always be a liquid secondary market that will exist for hedging instruments purchased or sold and we may be required to maintain a position until exercise or expiration, which could result in losses. Competition may prevent us from acquiring mortgage-related assets at favorable yields and that would negatively impact our profitability. Our net income largely depends on our ability to acquire mortgage-related assets at favorable spreads over our borrowing costs. In acquiring mortgage-related assets, we compete with other REITs, investment banking firms, savings and loan associations, banks, insurance companies, mutual funds, other lenders and other entities that purchase mortgage-related assets, many of which have greater financial resources than us. As a result, we may not in the future be able to acquire sufficient mortgage-related assets at favorable spreads over our borrowing costs. If that occurs, our profitability will be harmed. Interest rate mismatches between our adjustable-rate MBS and our borrowings used to fund our purchases of these assets may reduce our income during periods of changing interest rates. We fund most of our acquisitions of adjustable-rate MBS (including hybrid adjustable-rate MBS) with borrowings that have interest rates based on indices and repricing terms similar to, but of shorter maturities than, the interest rate indices and repricing terms of our MBS. Accordingly, if short-term interest rates increase, this may harm our profitability. Most of the MBS we acquire are adjustable-rate securities. This means that their interest rates may vary over time based upon changes in a short-term interest rate index. Therefore, in most cases, the interest rate indices and repricing terms of the MBS that we acquire and their funding sources will not be identical, thereby creating an interest rate mismatch between our assets and liabilities. While the historical spread between relevant short-term interest rate indices has been relatively stable, there have been periods when the spread between these indices was volatile. During periods of changing interest rates, these mismatches could reduce our net income, dividend yield and the market price of our stock. The interest rates on our borrowings generally adjust more frequently than the interest rates on our adjustable-rate MBS. For example, at December 31, 2014, our Agency MBS and Non-Agency adjustable-rate MBS had a weighted average term to next rate adjustment of approximately 36 months, while our borrowings had a weighted average term to next rate adjustment of 37 days. After adjusting for interest rate swap transactions, the weighted average term to next rate adjustment was 767 days. Accordingly, in a period of rising interest rates, we could experience a decrease in net income or a net loss because the interest rates on our borrowings adjust faster than the interest rates on our adjustable-rate MBS. Increased levels of prepayments from Agency MBS may decrease our net interest income. Pools of mortgage loans underlie the MBS that we acquire. We generally receive payments from principal payments that are made on these underlying mortgage loans. When borrowers prepay their mortgage loans faster than expected, this results in prepayments that are faster than expected on the MBS. Faster than expected prepayments could harm our profitability as follows:  We primarily purchase Agency MBS that have a higher interest rate than the market interest rate at the time. In exchange for this higher interest rate, we pay a premium over the par value to acquire the security. In accordance with accounting rules, we amortize this premium over the term of the mortgage-backed security. If the mortgage-backed security is prepaid in whole or in part prior to its maturity date, however, we expense the premium that was prepaid at the time of the prepayment. At December 31, 2014, substantially all of our Agency MBS had been acquired at a premium.  We anticipate that a substantial portion of our adjustable-rate Agency MBS may bear interest rates that are lower than their fully indexed rates, which are equivalent to the applicable index rate plus a margin. If an adjustable-rate mortgage-backed security is prepaid prior to or soon after the time of adjustment to a fully indexed rate, we will have held that mortgage- backed security while it was less profitable and lost the opportunity to receive interest at the fully indexed rate over the remainder of its expected life.  If we are unable to acquire new Agency MBS similar to the prepaid MBS, our financial condition, results of operation and cash flow would suffer. 36 Prepayment rates generally increase when interest rates fall and decrease when interest rates rise, but changes in prepayment rates are difficult to predict. Prepayment rates also may be affected by conditions in the housing and financial markets, general economic conditions, actions by the federal government and the relative interest rates on fixed-rate and adjustable-rate mortgage loans. While we seek to minimize prepayment risk to the extent practical, in selecting investments, we must balance prepayment risk against other risks and the potential returns of each investment. No strategy can completely insulate us from prepayment risk. The timing and amount of prepayments could adversely affect our liquidity and our profitability. Prepayments may be difficult to predict and can vary significantly over time. As a holder of MBS, on a monthly basis, we receive a payment equal to a portion of our investment principal as the underlying mortgages are prepaid. With respect to our Agency MBS, we typically receive notice of monthly principal prepayments on the fifth business day of each month (more commonly referred to as “factor day”) and receive the related scheduled payment on a specified later date, which for (a) Agency MBS guaranteed by Fannie Mae is the 25th day of that month (or the next business day thereafter); (b) Agency MBS guaranteed by Freddie Mac is the 15th day of the following month (or the next business day thereafter); and (c) Agency MBS guaranteed by Ginnie Mae is the 20th day of that month (or the next business day thereafter). This delay between factor day and receipt of payment creates a short-term receivable for us in the amount of any such principal prepayments. In general, on the date each month that the principal prepayments are announced (factor day), the value of our MBS pledged as collateral is reduced by the amount of the prepaid principal and, as a result, our repurchase agreement counterparties will typically initiate a margin call requiring the pledge of additional collateral or cash, in an amount equal to such prepaid principal, in order to re-establish the required ratio of borrowing to collateral value under such repurchase agreements. As the posting of such additional collateral or payment of cash to our counterparties is on or about factor day and is prior to the receipt of the payment to us by the agencies, this would reduce and, depending on the magnitude of such principal prepayments, could be material to, our liquidity. As a result, in order to meet such margin calls, we could be forced to sell assets or take other actions in order to maintain liquidity. If we were required to sell Agency MBS under adverse market conditions, we may receive sale prices lower than we might have received if we sold those securities under normal market conditions and, if these prices were lower than the amortized cost of the Agency MBS, we would incur losses. An increase in prepayment rates could have a material adverse effect on our business, financial condition and results of operations. We may experience reduced net interest income from holding fixed-rate investments during periods of rising interest rates. We generally fund our acquisition of fixed-rate MBS with short-term borrowings. During periods of rising interest rates, our costs associated with borrowings used to fund acquisition of fixed-rate assets are subject to increases while the income we earn from these assets remains substantially fixed. This reduces or could eliminate the net interest spread between the fixed-rate MBS that we purchase and our borrowings used to purchase them, which could lower our net interest income or cause us to suffer a loss. At December 31, 2014, 14% of our MBS were 15-year fixed-rate Agency MBS, 3% of our MBS were 20-year and 30-year fixed-rate Agency MBS and approximately 2% of our MBS were fixed-rate Non-Agency MBS. Interest rate caps on our adjustable-rate MBS may reduce our income or cause us to suffer a loss during periods of rising interest rates. Our adjustable-rate MBS (including hybrid adjustable-rate MBS) are subject to periodic and lifetime interest rate caps. Periodic interest rate caps limit the amount an interest rate can increase during any given period. Lifetime interest rate caps limit the amount an interest rate can increase through maturity of a mortgage-backed security. Our borrowings are not subject to similar restrictions. Accordingly, in a period of rapidly increasing interest rates, the interest rates paid on our borrowings could increase without limitation while interest rate caps would limit the interest rates on our adjustable-rate MBS. This problem is magnified for our adjustable-rate MBS that are not fully indexed. Further, some adjustable-rate MBS may be subject to periodic payment caps that result in a portion of the interest being deferred and added to the principal outstanding. As a result, we could receive less cash income on adjustable-rate MBS than we need to pay interest on our related borrowings. These factors could lower our net interest income or cause us to suffer a loss during periods of rising interest rates. At December 31, 2014, approximately 83% of our MBS were adjustable-rate securities. A decline in the fair market value of our Non-Agency MBS could result in us recording impairments on these investments, which may have an adverse effect on our results of operations and financial condition. A majority of our Non-Agency MBS are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Credit Deterioration (ASC 310-30). A debt security accounted for under ASC 310-30 is initially recorded at its purchase price (fair value). The amount of expected cash flows that exceed the initial investment represents accretable yield, which is recognized as interest income on a level yield basis over the life of the security. The excess of total contractual cash flows over the cash flows expected at its origination is considered to be non-accretable yield. The Company must periodically reassess the expected cash flows of loans accounted for under ASC 310-30 along with the cash flows received. A significant increase in expected cash flows must be accounted 37 for as an increase in the rate of accretion over the remaining life of the security. Conversely, if expected cash flows decrease, an other- than-temporary impairment must be recognized as a charge to earnings. Adjustments to the fair value of Non-Agency MBS, accounted for as available-for-sale securities, are recorded in “accumulated other comprehensive income,” or AOCI. The determination as to whether impairment and accretable yield exists is based on cash flow projections related to the securities. As a result, the timing and amount of impairment and accretable yield constitutes a material estimate that is susceptible to significant change. Our investments in Non-Agency MBS involve credit risk, which could materially adversely affect our results of operations. Investments in MBS carry a risk that the borrower on the underlying mortgage may default on their obligations to make full and timely payments of principal and interest. Pursuant to our investment policy, we have the ability to acquire Non-Agency MBS and other investment assets of lower credit quality (less than investment grade). In general, Non-Agency MBS carry greater investment risk than Agency MBS because they are not guaranteed as to principal and/or interest by the U.S. Government, any federal agency or any federally chartered corporation. Unexpectedly high rates of default (i.e., in excess of the default rates forecasted) and/or higher than expected loss severities on the mortgages collateralizing our Non-Agency MBS may adversely affect the values of such assets. Accordingly, Non-Agency MBS and other investment assets of less-than-high credit quality could cause us to incur losses of income from, and/or losses in market value relating to, these assets if there are defaults of principal and/or interest on these assets. We may have significant credit risk, especially on Non-Agency MBS, in certain geographic areas and may be disproportionately affected by economic or housing downturns, natural disasters, terrorist events, adverse climate changes or other adverse events specific to those markets. A significant number of the mortgages collateralizing our MBS may be concentrated in certain geographic areas. Any event that adversely affects the economy or real estate market in these areas could have a disproportionately adverse effect on our Non-Agency MBS portfolio. In general, any material decline in the economy or significant difficulties in the real estate markets would be likely to cause a decline in the value of residential properties securing the mortgages in the relevant geographic area. This, in turn, would increase the risk of delinquency, default and foreclosure on real estate collateralizing our Non-Agency MBS in this area. This may then materially adversely affect our credit loss experience on our Non-Agency MBS in such area if unexpectedly high rates of default (i.e., in excess of the default rates forecasted) and/or higher than expected loss severities on the mortgages collateralizing such securities were to occur. The occurrence of a natural disaster (such as an earthquake, tornado, hurricane, wildfires, or a flood) or a significant adverse climate change may cause a sudden decrease in the value of real estate and would likely reduce the value of the properties securing the mortgages collateralizing or Non-Agency MBS. Since certain natural disasters may not typically be covered by the standard hazard insurance policies maintained by borrowers, the borrowers may not be able to repair the properties or may stop paying their mortgages if the property is damaged. This would likely cause defaults and credit loss severities to increase on the pool of mortgages securing our Non-Agency MBS which may materially adversely affect our results of operations and financial condition. We may invest in Non-Agency MBS that are collateralized by loans of lower credit quality, such as Alt-A loans or securitized non- performing loans, which, due to lower underwriting standards, are subject to increased risk of losses. We may invest in Non-Agency MBS backed by collateral pools containing mortgage loans that have been originated using underwriting standards that are less strict than those used in underwriting “prime mortgage loans” (mortgage loans that generally conform to the underwriting standards of Fannie Mae or Freddie Mac). These loans may experience delinquency, foreclosure, bankruptcy and loss rates that are higher than “prime mortgage loans,” which could cause the performance of Non-Agency MBS backed by such lower credit quality loans to be adversely affected, which could materially adversely impact our results of operations and financial condition. We may generate taxable income that differs from our GAAP income on Non-Agency MBS purchased at a discount to par value, which may result in significant timing differences in the recognition of income and losses. We may acquire Non-Agency MBS at prices that reflect significant market discounts on their unpaid principal balances. For financial statement reporting purposes, we would generally establish, on such securities, a portion of the discount as a non-accretable discount. This non-accretable discount is generally not accreted into income for financial statement purposes. For tax purposes, however, we would not be permitted to establish a reserve for credit losses prior to their actual occurrence. Such differences between tax accounting and GAAP accounting can lead to significant timing differences in the recognition of income and losses. Taxable income on Non-Agency MBS purchased at a discount to par value may be higher than GAAP income in early periods (before losses are actually incurred) and lower than GAAP income in subsequent periods when the realized credit losses are incurred. As a REIT must distribute at least 90% of its annual taxable income (subject to certain adjustments) to our stockholders, such timing differences could affect the amount of the dividend distribution. However, dividends are declared and paid at the discretion of our board of 38 directors and depend not only on REIT taxable income but also on our financial results, our overall financial condition, maintenance of our REIT qualification and such other factors as our board may deem relevant from time to time. Generally, Non-Agency MBS have greater price sensitivity than Agency MBS which could cause fluctuations in our book value. Such price fluctuations could cause repurchase agreement lenders to require greater amounts of collateral and higher margin requirements which could affect our results of operations and could cause us to sell our Non-Agency MBS at potentially distressed prices in periods of significant price fluctuation. It could also cause repurchase agreement lenders to withdraw their financing from such investments. Non-Agency MBS historically have been more price sensitive than Agency MBS which may limit the number of lenders willing to provide repurchase agreement financing for these securities. In periods of price volatility, we may be subject to higher margin requirements or may be required to pledge additional collateral which could affect our results of operations. Also, during periods of significant price fluctuation, lenders may cut back the amounts they are willing to finance on such investments or withdraw from lending on such securities. If we could not find replacement financing, this could cause us to sell our Non-Agency MBS at potentially distressed prices, which would adversely affect our results of operations and financial condition. Our investments may include subordinated tranches of non-agency MBS, which are subordinate in right of payment to more senior tranches, subjecting us to greater risk of losses. We may invest in subordinated tranches of non-agency MBS, which are subordinated classes of securities in a structure of securities collateralized by a pool of mortgage loans and, accordingly, are among the first to bear the losses from non-payment and default of the underlying collateral. Additionally, estimated fair values of these subordinated interests tend to be more sensitive to changes in economic conditions than more senior securities. A projection of an economic downturn could cause a decline in the value of lower credit quality securities because the ability of obligors or mortgages underlying non-agency MBS to make principal and interest payments may be impaired. In such event, existing credit support in the securitization structure may be insufficient to protect us against loss of our principal on these securities. Government use of eminent domain to seize underwater mortgages could materially and adversely affect the value of, and the returns on, our Non-Agency MBS. The mortgages securing our Non-Agency MBS are located in different geographic regions across the United States, with significantly higher exposure in California, New York and Florida. Several county and municipal governments have discussed using eminent domain to seize from mortgage holders the mortgages of borrowers who are underwater but not in default. In August 2013, the FHFA released a statement expressing serious concerns on the use of eminent domain to restructure mortgages based on a review it conducted since requesting public input on the proposal in August 2012 and indicated that it may take action in response to such use. However, if definitive action is taken by any local governments and such actions withstand Constitutional and other legal challenges resulting in mortgages securing our Non-Agency MBS being seized using eminent domain, the consideration received from the seizing authorities for such mortgages may be substantially less than the outstanding principal balance, which would result in a realized loss and a corresponding write-down of the principal balance of those mortgages. The result of these seizures would be that the amount we receive on our Non-Agency MBS would be less than we would have otherwise received if the mortgage loans had not been seized, which may result in a decline in the market value and an other-than-temporary impairment of these securities. If governments adopt such plans and mortgages securing our Non-Agency MBS are seized on a widespread scale, it could have a material adverse effect on the value of and/or returns on our Non-Agency MBS and our results of operations. Mortgage loan modification and refinancing programs and future legislative action may materially adversely affect the value of, and the returns on, our Non-Agency MBS. The U.S. Government, through the Federal Reserve, the FHFA and the Federal Deposit Insurance Corporation, has implemented a number of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures, including the Home Affordable Modification Program, which seeks to provide relief to homeowners whose mortgages are in foreclosure, and the Home Affordable Refinance Program, which allows certain borrowers who are underwater in their mortgage but current on their mortgage payments to refinance their loans. These programs and other loss mitigation programs may involve, among other things, the modification or refinancing of mortgage loans to reduce the principal amount of the loans, reduction in the rate of interest payable on the loans and extend the payment terms of the loans. Loan modification may lead to fewer foreclosures and reduce the losses on non-Agency MBS arising from foreclosures. However, loan modifications and refinancing may also result in significant reductions in cash flows to the holders of these securities, which may adversely affect the value of, and the returns on, these assets. 39 The servicing of the mortgage loans that are the underlying collateral of our Non-Agency MBS is outside of our control and if this servicing is not successful in limiting future delinquencies, defaults and losses, this could adversely affect our results of operations. Third party services provide for the servicing of the mortgage loans that are the underlying collateral of our Non-Agency MBS. These service providers control all aspects of loan collection, loss mitigation, default management and ultimate resolution of a defaulted loan. We have no contractual rights with respect to these service providers and their efforts may not be successful in limiting future delinquencies, defaults and losses, which could adversely affect our results of operations. The Non-Agency MBS in which we invest and the mortgage loans underlying the Non-Agency MBS in which we invest are subject to delinquency, foreclosure and loss, which could result in losses to us. Residential mortgage loans are secured by single-family residential property and are subject to risks of loss, delinquency and foreclosure. The ability of a borrower to repay a loan secured by a residential property is dependent upon the income or assets of the borrower. A number of factors, including a general economic downturn, acts of God, terrorism, social unrest and civil disturbances, may impair borrowers’ abilities to repay their loans. Residential MBS evidence interests in or are secured by pools of residential mortgage loans and collateralized MBS evidence interests in or are secured by a single commercial mortgage loan or a pool of commercial mortgage loans. Accordingly, the Non- Agency MBS we invest in are subject to all of the risks of the underlying mortgage loans. In the event of defaults with respect to the mortgage loans that underlie our Non-Agency MBS investments and the exhaustion of any underlying or additional credit support, we may not realize our anticipated return on these investments and we may incur a loss on these investments. We may invest in leveraged mortgage derivative securities that generally experience greater volatility in market prices, thus exposing us to greater risk with respect to their rate of return. We may acquire leveraged mortgage derivative securities that may expose us to a high level of interest rate risk. The characteristics of leveraged mortgage derivative securities result in greater volatility in their market prices. Thus, acquisition of leveraged mortgage derivative securities would expose us to the risk of greater price volatility in our portfolio and that could harm our net income and overall profitability. New assets we acquire may not generate yields as attractive or be as accretive to book value as have been experienced historically. We may acquire new assets as we receive principal and interest payments and prepayments from our existing assets. We also sell assets from time to time as part of our portfolio and asset/liability management programs. We may invest these proceeds into new earning assets. New assets may not generate yields as attractive as we have experienced historically. Business conditions, including credit results, prepayment patterns and interest rate trends in the future, may not be as favorable as they have been during the periods we held the replaced assets. New assets may not be as accretive to book value as existing assets. The market value of our assets is sensitive to interest rate fluctuations. In the past as short-term interest rates increased, the market value of our existing assets has declined. As we classify our Agency MBS and Non-Agency MBS as available-for-sale, accounting regulations require that any unrealized losses from the decline in market value that are not considered to be an other-than-temporary impairment be carried as “accumulated other comprehensive loss” in the “Stockholders’ equity” section of the balance sheets. When short-term interest rates stop increasing, or start declining, or when the interest rates on these securities reset, the market value of these assets may increase. This may be more accretive to book value than the new assets that we acquire to replace existing assets. If we are unable to find suitable investments, we may not be able to achieve our investment objectives or pay dividends. The availability of mortgage-related assets meeting our criteria depends upon, among other things, the level of activity and quality of and demand for securities in the mortgage securitization and secondary markets. The market for agency securities depends upon various factors including the level of activity in the residential real estate market, the level of and difference between short-term and long-term interest rates, incentives for issuers to securitize mortgage loans and demand for agency securities by institutional investors. The size and level of activity in the residential real estate lending market depends upon various factors, including the level of interest rates, regional and national economic conditions and real estate values. To the extent we are unable to acquire a sufficient volume of mortgage-related assets meeting our criteria, our results of operations would be adversely affected. Furthermore, we cannot assure you that we will be able to acquire sufficient mortgage-related assets at spreads above our costs of funds. 40 We are dependent on information and communications systems and such systems’ failures could significantly disrupt our business. Our business is highly dependent on our information and communications systems. Any failure or interruption of our systems, such as caused by earthquake, fire, flood or terrorist act or by issues such as power outages, telephone or internet disconnections (not withstanding any of our back-up systems, which could also be subject to failure), could cause delays or other problems in our securities trading activities or in our repurchase agreement transactions, which would materially adversely affect our operations and performance. Risks Related to Our Management We have no employees and our Manager is responsible for making all of our investment decisions. The employees of our Manager are not required to devote any specific amount of time to our business. Effective December 31, 2011, in accordance with the Management Agreement, we have no employees and all our prior employees became employees of our Manager. Our Manager is responsible for conducting our day-to-day operations and is responsible for the selection, purchase and sale of our investment portfolio; our financing and hedging activities; providing us with management services; and such other services and activities relating to our assets and operations as may be appropriate. Messrs. Lloyd McAdams, Joseph E. McAdams, Thad M. Brown, Ms. Bistra Pashamova and others are officers and employees of our Manager and are also officers and employees of Pacific Income Advisers, or PIA, where they devote a portion of their time. These officers and employees are under no contractual obligations mandating minimum amounts of time to be devoted to our Company. In addition, a trust controlled by Mr. Lloyd McAdams is the principal stockholder of PIA. These officers and employees are involved in investing both our assets and approximately $3.2 billion in MBS and other fixed income assets for institutional clients and individual investors through PIA. These multiple responsibilities and ownerships may create conflicts of interest if these officers and employees of our Company are presented with opportunities that may benefit both us and the clients of PIA. These officers allocate investments among our portfolio and the clients of PIA by determining the entity or account for which the investment is most suitable. In making this determination, these officers consider the investment strategy and guidelines of each entity or account with respect to acquisition of assets, leverage, liquidity and other factors that our officers determine appropriate. These officers, however, have no obligation to make any specific investment opportunities available to us and the above-mentioned conflicts of interest may result in decisions or allocations of securities that are not in our best interests. Additionally, there is nothing in the Management Agreement that prevents our Manager or any of its Affiliates, officers, directors or employees from engaging in other businesses or from rendering services of any kind to any other Person or entity, whether or not the investment objectives or policies of any such other Person or entity are similar to those of the Company or in any way binds or restricts our Manager or any of its Affiliates, officers, directors or employees from buying, selling or trading any securities or commodities for their own accounts or for the accounts of others for whom our Manager or any of its Affiliates, officers, directors or employees may be acting. Mr. Lloyd McAdams is also an owner and Chairman of Syndicated Capital, Inc., a registered broker-dealer. Syndicated Capital, Inc. has been authorized by our board of directors to act as an authorized broker on any buyback of the Company’s common stock. The service to PIA and Syndicated Capital, Inc. by the officers and employees of our Manager allow them to spend only part of their time and effort managing our Company, as they are required to devote a portion of their time and effort to the management of other companies, and this may harm our overall management and operating results. Messrs. Lloyd McAdams, Joseph E. McAdams, Charles J. Siegel and John T. Hillman, and Ms. Heather U. Baines and others, are officers and employees of PIA Farmland, Inc. and its external manager, PIA, where they devote a portion of their time. PIA Farmland, Inc., a privately-held real estate investment trust investing in U.S. farmland properties leased to independent farm operators, was incorporated in February 2013 and acquired its first farm property in October 2013. These officers and employees are under no contractual obligations to PIA Farmland, Inc., its external manager, PIA, or to Anworth or its external manager, Anworth Management, LLC, as to their time commitment. To the extent that significant time is devoted to PIA Farmland, Inc. and its external manager, this could harm our overall management and operating results. Mr. Steven Koomar, the Chief Executive Officer of PIA Farmland, Inc., has no involvement with either our Company or our Manager. We are completely dependent upon our Manager, who provides services to us through the Management Agreement, and we may not find suitable replacements for our Manager if the Management Agreement is terminated or such key personnel are no longer available to us. The loss of any key personnel of our Manager could harm our operations. We no longer have any employees and are completely dependent on our Manager to conduct our operations pursuant to the Management Agreement. Our Manager has its own employees, which conduct its day-to-day operations. The Management Agreement does not require our Manager to dedicate specific personnel to our operations. 41 If we terminate the Management Agreement without cause, we may not, without the consent of our Manager, employ any employee of our Manager or any of its Affiliates, or any Person who has been employed by our Manager or any of its Affiliates at any time within the two year period immediately preceding the date on which the Person commences employment with us for two years after such termination of the Management Agreement. We will not have retention agreements with any of our officers. We believe that the successful implementation of our investment and financing strategies will depend upon the experience of certain of our Manager’s officers and employees. None of these individuals’ continued service is guaranteed. If the Management Agreement is terminated or these individuals leave our Manager, our Manager may be unable to replace them with persons with appropriate experience, or at all, and we may not be able to execute our business plan. We depend on the diligence, experience and skill of the officers and employees of our Manager for the selection, structuring and monitoring of our mortgage-related assets and associated borrowings. The key officers of our Manager include Mr. Lloyd McAdams, President and Chief Executive Officer; Mr. Joseph E. McAdams, Chief Investment Officer and Executive Vice President; Mr. Thad M. Brown, Chief Financial Officer, Treasurer and Secretary; Mr. Charles J. Siegel, Senior Vice President-Finance and Assistant Secretary; Ms. Bistra Pashamova, Senior Vice President; Mr. Brett Roth, Senior Vice President; and Mr. Evangelos Karagiannis, Vice President. Our dependence on our Manager is heightened by the fact that they have a relatively small number of employees and the loss of any key person could harm our entire business, financial condition, cash flow and results of operations. In particular, the loss of the services of Messrs. Lloyd McAdams or Joseph E. McAdams could seriously harm our business. The Management Agreement was not negotiated on an arm’s-length basis and the terms, including fees payable, may not be as favorable to us as if it were negotiated with an unaffiliated third party. Effective as of December 31, 2011, we entered into the Management Agreement, which effected the externalization of our management function. The Management Agreement was negotiated between related parties, and we did not have the benefit of arm’s- length negotiations of the type normally conducted with an unaffiliated third party. The terms of the Management Agreement, including fees payable, may not reflect the terms we may have received if it was negotiated with an unrelated third party. In addition, as a result of this relationship, we may choose not to enforce, or to enforce less vigorously, our rights under the Management Agreement because of our desire to maintain our ongoing relationship with our Manager. If we elect to not renew the Management Agreement without cause, we would be required to pay our Manager a substantial termination fee. It will be costly for us if we elect not to renew the Management Agreement without cause. With the consent of the majority of our independent directors, and with at least 180-days’ prior written notice before the end of the calendar year, we may elect to not renew the Management Agreement at the end of the calendar year. If we elect not to renew the Management Agreement without cause, we will be required to pay our Manager a termination fee equal to three times the average annual management fee earned by the our Manager during the 24-month period immediately preceding the most recently completed quarter prior to the year-end termination of the Management Agreement. After giving notice of our intent to not renew the Management Agreement without cause, we will continue to be required to pay our Manager the management fees stated in the Management Agreement until the end of the calendar year that the Management Agreement is not renewed. If such notice is given less than 180 days prior to the end of the calendar year, the management fees will be paid until termination of the Management Agreement at the end of the following calendar year. At December 31, 2014, if this termination event had occurred, the termination fee, based on the average annual management fee earned by our Manager during the 24-month period immediately preceding the most recently completed quarter prior to the effective date of termination, would be approximately $34.1 million. If we do not renew the Management Agreement for any reason, we would continue to be obligated to pay the sublease on our office premises in California. Our obligation to pay the sublease on our office premises does not end with termination of the Management Agreement. There can be no assurance that we can sublease our office space to another tenant at a rate which eliminates this obligation and is satisfactory to the sublessor and the building owner. 42 If we elect to not renew the Management Agreement without cause, for two years thereafter, we may not retain any of our Manager’s employees to assist us in managing the Company on a full-time or interim basis. The Management Agreement provides that, without the consent of our Manager, the Company may not, for two years after termination of the Management Agreement, employ any employee of our Manager or any of its Affiliates or any person who has been employed by our Manager or any of its Affiliates at any time within the two-year period immediately preceding the date on which the person commences employment with the Company. This provision would make it unlikely that the Company would be able to immediately rely on the experience and knowledge of the employees of the former Manager to assist in any changes made by the board of directors, including assisting with the sale, or the sale or liquidation of a substantial portion of the assets of the Company. Various corporate actions require the approval of the majority of all shareholders. There are corporate actions which can be implemented only if a majority of all shareholders approves at a convened meeting of shareholders. There can be no assurance that a majority of all shareholders will vote to approve any measure that only a majority of the voting shareholders had previously approved. Examples of actions which require the approval of a majority of all shareholders to pass are: an agreement of consolidation, merger, share exchange or transfer of assets; for dissolution of the Corporation; or for a business combination between the Corporation and an interested stockholder. In the event of a change of control, we will owe certain of the officers and employees of our Manager a payment as specified in their Change of Control and Arbitration Agreements between these officers/employees and the Company. In the event of a change of control of the Company, we would incur the costs of paying lump sum payments and other employee benefits to certain of the officers and employees of our Manager as specified in their Change of Control and Arbitration Agreement between these officers/employees and the Company. The management fee is payable regardless of our performance. Our Manager is entitled to receive a management fee from us that is based on 1.20% of our Equity (as defined in our Management Agreement), regardless of the performance of our investment portfolio. For example, we would pay our Manager a management fee for a specific period even if we experienced a net loss during the same period. Our Manager’s entitlement to substantial nonperformance-based compensation may reduce its incentive to devote sufficient time and effort to seeking investments that provide attractive risk-adjusted returns for our investment portfolio. This in turn could harm our ability to make distributions to our stockholders and the market price of our common stock. The fee structure of the Management Agreement may limit our Manager’s ability to retain access to its key personnel. Under the terms of the Management Agreement, we are required to pay our Manager a base management fee payable monthly in arrears in an amount equal to one twelfth of 1.20% of our Equity. Our Equity is defined as our month-end stockholders’ equity, adjusted to exclude the effect of any unrealized gains or losses included in either retained earnings or other comprehensive income, each as computed in accordance with GAAP. The Management Agreement does not provide our Manager with an incentive management fee that would pay our Manager additional compensation as a result of meeting performance targets. Some of our externally-managed competitors pay their managers an incentive management fee, which enables them to provide additional compensation to their key personnel. Thus, the lack of an incentive fee in the Management Agreement may limit the ability of our Manager to provide key personnel with additional compensation for strong performance, which could adversely affect our Manager’s ability to retain these key personnel. If our Manager were not able to retain any of the key personnel providing services to our Manager, it would have to find replacement personnel to provide those services. Those replacement key personnel may not be able to produce the same operating results as the current key personnel. Some investors may not view our external management in a positive light, which may affect the market price of our common stock and may make it more difficult for future offerings of our stock. Although there are currently other mortgage REITs that are externally-managed, there may be times in the future when some investors may have a preference for internally-managed companies. There may also be times, if there are low returns from our portfolio, when our external management is not viewed in a positive light. In either of these cases, there may be a negative effect on the market price of our common stock and this may make it difficult for future offerings of our common stock. 43 Potential conflicts of interest could arise if our Manager were to take greater risk for the purpose of increasing our equity in order to earn a greater management fee. The Management Agreement does not contain an incentive fee. Our Manager is paid a base management fee payable monthly in arrears in an amount equal to one twelfth of 1.20% of our Equity, as defined in the Management Agreement. As the Management Agreement does not contain an incentive fee, our Manager may take greater risk in our investment portfolio to increase our equity in order to earn a greater management fee. Our Manager’s liability is limited under the Management Agreement, and we have agreed to indemnify our Manager against certain liabilities. Pursuant to the Management Agreement, our Manager does not assume any responsibility other than to render the services called for thereunder and is not responsible for any action of our board of directors in following or declining to follow any advice or recommendation of our Manager. Our Manager and its Affiliates, and the directors, officers, employees and stockholders of our Manager and its Affiliates, are not liable to us, any subsidiary of ours, our board of directors or our stockholders for any acts or omissions by our Manager, its officers, employees or its Affiliates, performed in accordance with and pursuant to the Management Agreement, except by reason of acts constituting bad faith, willful misconduct, gross negligence or reckless disregard of their respective duties under this Management Agreement. We have agreed to indemnify our Manager and its Affiliates, its directors, officers, employees and stockholders of our Manager and its Affiliates (each a “Manager Indemnified Party”) of and from any and all expenses, losses, damages, liabilities, demands, charges and claims of any nature whatsoever (including reasonable attorneys’ fees) in respect of or arising from any acts or omissions of such Manager Indemnified Party, not constituting bad faith, willful misconduct, gross negligence or reckless disregard of duties of such Manager Indemnified Party under this Management Agreement. Our Manager has limited resources and may not be able to defend itself in litigation. The only fee that our Manager receives from us is the base management fee, as previously described. It is anticipated that most, if not all, of this fee will be used by our Manager for compensation to its employees and to pay for its other administrative expenses. Our Manager has limited resources. If our Manager were to be involved in litigation not related to our operations, it may not be able to defend itself and it may be forced to declare bankruptcy or go out of business and we would have to find another Manager. This could have a material adverse impact on our business and our operations. Failure of our Manager to comply with SEC rules and regulations could cause various disciplinary actions which could cause a disruption in services provided to us and may impact our business operations and our profitability. Under recent rules promulgated under Dodd-Frank, our Manager is considered an investment adviser. In reliance upon the no- action letter issued by the SEC to the American Bar Association on January 18, 2012, we consider Anworth Management, LLC to be a “relying adviser,” which means that its registration as an investment adviser is integrated into the existing registration of PIA, its “filing adviser.” Anworth Management, LLC and PIA are both subject to the Investment Advisers Act of 1940 and the rules and regulations of the SEC and also are subject to examination by the SEC. Any failure by Anworth Management, LLC, PIA, or any of their respective employees to comply with such rules and regulations could cause various disciplinary actions, up to and including loss of registration status as investment advisers. Such disciplinary actions could lead to disruptions in the services provided to us which may impact our business operations and our profitability. Our board of directors may change our operating policies and strategies without prior notice or stockholder approval and such changes could harm our business, results of operation and stock price. Our board of directors can modify or waive our current operating policies and our strategies without prior notice and without stockholder approval. We cannot predict the effect any changes to our current operating policies and strategies may have on our business, operating results and stock price, however, the effects may be adverse. Risks Related to Our Residential Properties Business We are in a relatively new industry that has significant competition, and we have limited operating history in this sector, which makes this business difficult to evaluate and may affect our ability to operate this business in a profitable manner. Until very recently, the single-family residential rental business consisted primarily of private individual investors in local markets and was managed individually or by small local property managers. Within the past few years, several institutional companies and REITs have entered this market and have attempted to acquire and operate single-family properties on a large-scale basis and to achieve attractive yields employing technology through a disciplined approach to acquisitions and leasing, marketing and management. Many of our competitors may be larger and have greater financial, technical, leasing, marketing and other resources than we do, which may affect our ability to acquire our target properties at attractive prices and attract quality tenants. 44 In addition, although we have several employees who have previously personally engaged in this business on a small scale, we have limited operating history as a company in this business and contract with various third-party professionals to assist us in acquiring and managing our properties and providing services to tenants. If these professionals do a poor job or don’t perform to our expectations, it could affect the prices we pay to acquire properties, our relationships with our tenants, the operation of our properties, and our reputation in this business. These factors make this business difficult to evaluate, and may affect our ability to operate this business in a profitable manner. Many factors affect the single-family residential rental market and the profitability of this business will be affected both by our assumptions about this market and this market’s conditions in our target areas. The success of our business model will depend upon many factors including, but not limited to: the availability of properties that meet our investment criteria and our ability to acquire such properties at favorable prices; real estate appreciation or depreciation in our target markets; the condition of our properties; our ability to contain renovation, maintenance, marketing and other operating costs for our properties; our ability to maintain high occupancy rates and target rent levels; general economic conditions in our target markets, such as changes in employment and household earnings and expenses; the effects of rent controls, stabilization laws and other laws or regulations regarding rental rates and tenant rights; and changes in, and changes in enforcement of, laws, regulations and government policies including health, safety, environmental, property, zoning and tax laws. We will have no control over many of these factors, which could adversely affect the profitability of this business. Our success will also depend, in part, on our assumptions about our target properties, our target renters, our renovation, maintenance and other operating costs, and our rental rates and occupancy levels and, if our assumptions prove to be inaccurate, this may adversely affect the profitability of this business. Initially, our portfolio of properties has been geographically concentrated and any adverse developments in local economic conditions, or the demand for single-family rental homes in these markets, or the occurrence of natural disasters may adversely affect the operating results of this business. Initially, our target markets are in the east coast of Florida and we are exposed to any adverse developments in local economic conditions or natural disasters in that area. Due to this geographic concentration, any such developments could affect our business to a greater extent than if our properties were less geographically concentrated. Poor resident selection and defaults by renters may adversely affect the financial performance of this business and harm our reputation. Our success depends, in large part, upon our ability to attract and retain qualified tenants. This will depend, in turn, upon our ability to screen applicants, identify good residents, avoid tenants who may default, and the willingness of our tenants to renew their leases. When properties are vacant, we are not earning rental income and incur maintenance costs as well as turnover costs associated with re-leasing the properties, such as marketing and leasing commissions. Additionally, if we have to evict tenants, we will incur legal costs and may have renovation costs if the tenants don’t properly maintain the properties or cause damage to the properties. Our reputation in the communities where our properties are located may be harmed if our tenants are not good neighbors or do damage to our properties or to the local communities. Declining real estate values and impairment charges could adversely affect the earnings and financial condition of this business. Our success depends upon our ability to acquire rental properties at attractive values, such that we can earn a satisfactory return on our investment primarily through rental income and secondarily through increases in property values. If we overpay for properties, or if their values subsequently decline or fail to rise because of market factors, we may not achieve our financial objectives. Additionally, U.S. GAAP requires companies to take an impairment charge if there is a permanent decline in the value of a property based upon a review of various market factors. An impairment charge would reduce the net income in the period in which it was taken. Even if we concluded that an impairment charge was not needed, a decline in the value of a property may become manifest over time through reduced rental income from the property, which would affect the earnings and financial condition of this business. Risks Related to REIT Compliance and Other Tax Matters If we are disqualified as a REIT, we will be subject to tax as a regular corporation and face substantial tax liability. We believe that, since our initial public offering in 1998, we have operated so as to qualify as a REIT under the Code and we intend to continue to meet the requirements for taxation as a REIT. Nevertheless, we may not remain qualified as a REIT in the future. Qualification as a REIT involves the application of highly technical and complex Code provisions for which only a limited number of judicial or administrative interpretations exist. Even a technical or inadvertent mistake could require us to pay a penalty or jeopardize our REIT status. Furthermore, Congress or the IRS might change tax laws or regulations and the courts might issue new rulings, in 45 each case potentially having retroactive effects that could make it more difficult or impossible for us to qualify as a REIT. If we fail to qualify as a REIT in any tax year, then:  we would be taxed as a regular domestic corporation, which, among other things, means being unable to deduct distributions to stockholders in computing taxable income and being subject to federal income tax on our taxable income at regular corporate rates;  any resulting tax liability could be substantial and would reduce the amount of cash available for distribution to stockholders;  we would no longer be required to make distributions to our stockholders; and  unless we were entitled to relief under applicable statutory provisions, we could be disqualified from treatment as a REIT for the subsequent four taxable years following the year during which we lost our qualification and thus our cash available for distribution to stockholders would be reduced for each of the years during which we do not qualify as a REIT. Complying with REIT requirements may cause us to forego otherwise attractive opportunities. In order to qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, our sources of income, the nature and diversification of our MBS and other assets, the amounts we distribute to our stockholders and the ownership of our stock. We may also be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with REIT requirements may hinder our ability to operate solely on the basis of maximizing profits. Complying with REIT requirements may limit our ability to hedge effectively. Compliance with the REIT provisions of the Code may limit our ability to hedge our assets and operations. Under these provisions, any income that is generated from transactions intended to hedge our interest rate, inflation and/or currency risks will be excluded from gross income for purposes of the REIT 75% and 95% gross income tests if the instrument hedges (1) interest rate risk on liabilities incurred to carry or acquire real estate or (2) risk of currency fluctuations with respect to any item of income or gain that would be qualifying income under the REIT 75% or 95% gross income tests, and such instrument is properly identified under applicable Treasury Regulations. Income from hedging transactions that does not meet these requirements will generally constitute non-qualifying income for purposes of both the REIT 75% and 95% gross income tests. As a result of these rules, we may have to limit use of hedging techniques that might otherwise be advantageous, which could result in greater risks associated with interest rate or other changes than we would otherwise incur. Complying with REIT requirements may force us to liquidate otherwise attractive investments or to make investments inconsistent with our business plan. In order to qualify as a REIT, we must also determine that at the end of each calendar quarter at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets. The remainder of our investment in securities generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets can consist of the securities of any one issuer. No more than 25% of the total value of our assets can be stock in taxable REIT subsidiaries. If we fail to comply with these requirements, we must dispose of a portion of our assets within 30 days after the end of the calendar quarter in order to avoid losing our REIT status and suffering adverse tax consequences. The need to comply with these gross income and asset tests may cause us to acquire other assets that are qualifying real estate assets for purposes of the REIT requirements that are not part of our overall business strategy and might not otherwise be the best investment alternative for us. Complying with REIT requirements may force us to borrow to make distributions to stockholders. As a REIT, we must distribute at least 90% of our annual taxable income (subject to certain adjustments) to our stockholders. At the time when we are required to make previously declared dividend distributions, declines in the value of our portfolio holdings and the resulting subsequent margins calls may have depleted most or all of our cash and cash equivalents. If this were to occur and if market conditions allowed us to do so, we would sell some of our portfolio holdings to generate sufficient funds to make the dividend payments. If market conditions did not allow us to sell portfolio holdings, we would be required to borrow funds on an unsecured basis to make the previously declared dividend payments. Dividends payable by REITs do not qualify for the reduced tax rates. Tax legislation enacted in 2003 and extended in 2010 to be effective through December 31, 2012, temporarily reduced the maximum U.S. federal tax rate on certain corporate dividends paid to individuals and other non-corporate taxpayers to 15%. In 46 January 2013, the Taxpayer Relief Act permanently extended these rates except for individuals with taxable income over $400,000 and married couples with taxable income over $450,000. For those taxpayers, the long-term capital gains rate was increased to 20%. Dividends paid by REITs to these stockholders are generally not eligible for these reduced rates. Although this legislation does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to non-REIT corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock. The tax imposed on REITs engaging in “prohibited transactions” will limit our ability to engage in transactions, including certain methods of securitizing loans, which would be treated as sales for federal income tax purposes. A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property but including any mortgage loans, held in inventory primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were to sell a loan or securitize loans in a manner that was treated as a sale of such inventory for federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans other than through a taxable REIT subsidiary and may limit the structures we utilize for our securitization transactions even though such sales or structures might otherwise be beneficial for us. In addition, this prohibition may limit our ability to restructure our investment portfolio of mortgage loans from time to time, even if we believe that it would be in our best interest to do so. We may incur excess inclusion income that would increase the tax liability of our stockholders. In general, dividend income that a tax-exempt entity receives from us should not constitute unrelated business taxable income as defined in Section 512 of the Code. If we realize excess inclusion income and allocate it to stockholders, however, then this income would be fully taxable as unrelated business taxable income under Section 512 of the Code. If the stockholder is foreign, it would generally be subject to U.S. federal income tax withholding on this income without reduction pursuant to any otherwise applicable income tax treaty. U.S. stockholders would not be able to offset such income with their operating losses. We generally structure our borrowing arrangements in a manner designed to avoid generating significant amounts of excess inclusion income. However, excess inclusion income could result if we held a residual interest in a REMIC. Excess inclusion income also may be generated if we were to issue debt obligations with two or more maturities and the terms of the payments on these obligations bore a relationship to the payments that we received on our mortgage loans or MBS securing those debt obligations. For example, we may engage in non-REMIC CMO securitizations. We also enter into various repurchase agreements that have differing maturity dates and afford the lender the right to sell any pledged mortgage securities if we default on our obligations. The IRS may determine that these transactions give rise to excess inclusion income that should be allocated among our stockholders. We may invest in equity securities of other REITs and it is possible that we might receive excess inclusion income from those investments. Some types of entities, including, without limitation, voluntarily employee benefit associations and entities that have borrowed funds to acquire their shares of our stock, may be required to treat a portion of or all of the dividends they receive from us as unrelated business taxable income. Misplaced reliance on legal opinions or statements by issuers of MBS and government securities could result in a failure to comply with REIT gross income or asset tests. When purchasing MBS and government securities, we may rely on opinions of counsel for the issuer or sponsor of such securities, or statements made in related offering documents, for purposes of determining whether and to what extent those securities constitute “real estate assets” for purposes of the REIT asset tests and produce income that qualifies under the REIT income tests. The inaccuracy of any such opinions or statements may harm our REIT qualification and result in significant corporate level tax. Additional Risk Factors Failure to maintain an exemption from the Investment Company Act would materially harm our results of operations. We believe that we conduct our business in a manner that results in our not being regulated as an investment company under the Investment Company Act of 1940, as amended, or the Investment Company Act. If we fail to continue to qualify for an exemption from registration as an investment company, our ability to use leverage would be substantially reduced and we would be unable to conduct our business as we presently do. The Investment Company Act has an exemption for entities that are primarily engaged in the business of purchasing or otherwise acquiring “mortgages and other liens on and interests in real estate.” Under the SEC’s current interpretation, we qualify for this exemption if we maintain at least 55% of our assets directly in qualifying real estate interests. In meeting the 55% requirement under the Investment Company Act, we treat MBS issued with respect to an underlying pool for which we hold all issued certificates as qualifying interests. If the SEC or its staff adopts a contrary interpretation, we could be required to 47 sell a substantial amount of our MBS under potentially adverse market conditions. Further, in order to maintain our exemption from registration as an investment company by acquiring “mortgages and other liens on and interests in real estate”, we may be precluded from acquiring MBS whose yield is somewhat higher than the yield on “mortgages and other liens on and interests in real estate” that could be purchased in a manner consistent with the exemption. On August 31, 2011, the SEC issued a release soliciting comments on the mortgage REIT exemption under the Investment Company Act. The SEC indicated in its release that it is concerned that some mortgage companies may be subject to the kinds of abuses that the Investment Company Act was intended to address, such as misvaluations of a company’s investment portfolio and excessive leveraging. The release asked for comments on or before November 7, 2011 on whether the exclusion should be narrowed or changed in such a way that these potential abuses can be curtailed. The SEC also asked whether there are existing safeguards in the structure and operations of REITs and other mortgage companies that would address these or similar concerns. Although we believe that we have conducted our operations in a manner that would not be of the types of concerns addressed in the SEC’s release, we could be subject to any rules or regulations that the SEC could propose in changing or narrowing the current exclusion that mortgage REITs rely on to maintain an exemption from the Investment Company Act. If the SEC or its staff changes or narrows this exemption, we could be required to sell a substantial amount of our MBS under potentially adverse market conditions. Although, at the present time, it is unknown whether the SEC or its staff will make any changes to this exclusion or the nature of any such changes, it is possible that any such changes could impact our Asset Acquisition Policy, our leverage, our liquidity, the size of our investment portfolio, our ability to use interest rate swap agreements, our ability to borrow, and could have a material adverse effect on our business and results of operations. We presently are not, nor do we intend to be, regulated as an investment company. Fluctuations in our net income and in our book value will likely be greater than those of investment companies. This may affect investors or potential investors as to the appropriateness of our stock as compared to that of an investment company. While presently our assets are similar to those owned by some investment companies, we are not regulated as an investment company. Regulation as an investment company entails that all investment companies maintain significantly lower levels of financial leverage than we have employed since our organization began operations in 1998. Because of the differences in our leverage from that of investment companies, this results in the fluctuation in net income and in book value by us to likely be greater than that experienced by investment companies. Therefore, investors and potential investors in our company should, on an ongoing basis, carefully determine if this greater level of income fluctuation and book value fluctuation is appropriate for them as compared to whether the less volatile results of investment companies are more appropriate for them. The market price of our common stock may fluctuate significantly. The market price and marketability of shares of our securities may, from time to time, be significantly affected by numerous factors, including many over which we have no control and that may not be directly related to us. These factors including the following:         price and volume fluctuations in the stock market from time to time, which are often unrelated to the operating performance of particular companies; significant volatility in the market price and trading volume of securities of REITs or other companies in our sector, which is not necessarily related to the operating performance of these securities; changes in regulatory policies, tax guidelines and financial accounting and reporting standards, particularly with respect to REITs; changes in business conditions and the general economy, including the consequences of actions by the U.S. government and other foreign governments to address the global financial crisis; changes in our dividend policy and earnings or variations in operating results; any shortfall in revenue or net income or any increase in losses from levels expected by securities analysts; general economic trends and other external factors; and loss of major repurchase agreement providers. Fluctuations in the trading price of our common stock may adversely affect the liquidity of the trading market for our common stock and, in the event that we seek to raise capital through future equity financings, our ability to raise such equity capital. 48 We may not be able to use the money we raise from time to time to acquire investments at favorable prices. We intend to seek to raise additional capital from time to time if we determine that it is in our best interests and the best interests of our stockholders, including through public offerings of our stock. The net proceeds of any offering could represent a significant increase in our equity. Depending on the amount of leverage that we use, the full investment of the net proceeds of any offering might result in a substantial increase in our total assets. There can be no assurance that we will be able to invest all of such additional funds in mortgage-related assets at favorable prices. We may not be able to acquire enough mortgage-related assets to become fully invested after an offering, or we may have to pay more for MBS than we have historically. In either case, the return that we earn on stockholders’ equity may be reduced. We have not established a minimum dividend payment level for our common stockholders and there are no assurances of our ability to pay dividends to them in the future. We intend to pay quarterly dividends and to make distributions to our common stockholders in amounts such that all or substantially all of our taxable income in each year, subject to certain adjustments, is distributed. This, along with other factors, should enable us to qualify for the tax benefits accorded to a REIT under the Code. We have not established a minimum dividend payment level for our common stockholders and our ability to pay dividends may be harmed by the risk factors described in this Annual Report on Form 10-K. All distributions to our common stockholders will be made at the discretion of our board of directors and will depend on our earnings, our financial condition, maintenance of our REIT status and such other factors as our board of directors may deem relevant from time to time. There are no assurances of our ability to pay dividends in the future. If we raise additional capital, our earnings per share and dividends per share may decline since we may not be able to invest all of the new capital during the quarter in which additional shares are sold and possibly the entire following calendar quarter. Our charter does not permit ownership of over 9.8% of our common or preferred stock and attempts to acquire our common or preferred stock in excess of the 9.8% limit are void without prior approval from our board of directors. For the purpose of preserving our REIT qualification and for other reasons, our charter prohibits direct or constructive ownership by any person of more than 9.8% of the lesser of the total number or value of the outstanding shares of our common stock or more than 9.8% of the outstanding shares of our preferred stock. Our charter’s constructive ownership rules are complex and may cause the outstanding stock owned by a group of related individuals or entities to be deemed to be constructively owned by one individual or entity. As a result, the acquisition of less than 9.8% of the outstanding stock by an individual or entity could cause that individual or entity to own constructively in excess of 9.8% of the outstanding stock and thus be subject to our charter’s ownership limit. Any attempt to own or transfer shares of our common or preferred stock in excess of the ownership limit without the consent of the board of directors shall be void and will result in the shares being transferred by operation of law to a charitable trust. Our board of directors has granted one third party institutional investor an exemption from the 9.8% ownership limitation as set forth in our charter documents. This exemption permitted the third party institutional investor to hold up to 20.0% of our Series A Preferred Stock. Because provisions contained in Maryland law, our charter and our bylaws may have an anti-takeover effect, investors may be prevented from receiving a “control premium” for their shares. Provisions contained in our charter and bylaws, as well as Maryland corporate law, may have anti-takeover effects that delay, defer or prevent a takeover attempt, which may prevent stockholders from receiving a “control premium” for their shares. For example, these provisions may defer or prevent tender offers for our common stock or purchases of large blocks of our common stock, thereby limiting the opportunities for our stockholders to receive a premium for their common stock over then-prevailing market prices. These provisions include the following:  Ownership limit. The ownership limit in our charter limits related investors including, among other things, any voting group, from acquiring over 9.8% of our common stock or more than 9.8% of our preferred stock without our permission.  Preferred Stock. Our charter authorizes our board of directors to issue preferred stock in one or more classes and to establish the preferences and rights of any class of preferred stock issued. These actions can be taken without soliciting stockholder approval.  Maryland business combination statute. Maryland law restricts the ability of holders of more than 10% of the voting power of a corporation’s shares to engage in a business combination with the corporation.  Maryland control share acquisition statute. Maryland law limits the voting rights of “control shares” of a corporation in the event of a “control share acquisition.” 49 Future offerings of debt securities, which would be senior to our common stock, Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock upon liquidation, or other equity securities, which would dilute our existing stockholders and may be senior to our common stock, Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock for the purposes of dividend distributions, may harm the market price of our common stock, Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock. In the future, we may attempt to increase our capital resources by making additional offerings of debt or equity securities, including commercial paper, medium-term notes, senior or subordinated notes and classes of preferred stock or common stock. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock. Our preferred stock may have a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our common stockholders bear the risk of our future offerings reducing the market price of our common stock. Our charter provides that we may issue up to 20 million shares of preferred stock in one or more series. The issuance of additional preferred stock on parity with or senior to the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock could have the effect of diluting the amounts we may have available for distribution to holders of the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock. The Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock will be subordinated to all our existing and future debt. Thus, our Series A Preferred Stockholders, our Series B Preferred Stockholders and our Series C Preferred Stockholders bear the risk of our future offerings reducing the market price of our Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock. We may issue additional shares of common stock or shares of preferred stock that are convertible into common stock. If we issue a significant number of shares of common stock or convertible preferred stock in a short period of time, there could be a dilution of the existing common stock and a decrease in the market price of the common stock. Item 1B. UNRESOLVED STAFF COMMENTS None. Item 2. PROPERTIES In February 2012, we signed a new sublease agreement with PIA that expires on June 30, 2022 for approximately 7,300 square feet of office space at our existing location in Santa Monica, California. We believe this facility is adequate for our intended level of operations. Item 3. LEGAL PROCEEDINGS We are not a party to any material pending legal proceedings. Item 4. MINE SAFETY DISCLOSURES Not applicable. 50 PART II Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Market Information Our common stock began trading under the symbol ANH on the New York Stock Exchange on May 9, 2003. Our common stock previously traded under the symbol ANH on the American Stock Exchange. Prior to March 17, 1998, there had been no public market for our common stock. The high and low sale prices for our common stock, as reported by the New York Stock Exchange, for the periods indicated are as follows: First Quarter ......................................................................... $ Second Quarter ..................................................................... $ Third Quarter ........................................................................ $ Fourth Quarter ...................................................................... $ 5.32 5.50 5.23 5.45 $ $ $ $ 4.25 5.04 4.79 4.82 $ $ $ $ 6.38 $ 6.33 $ 5.65 $ 5.11 $ 5.90 5.45 4.35 4.14 2014 2013 High Low High Low Holders As of February 20, 2015, there were approximately 806 record holders of our common stock. On February 20, 2015, the last reported sale price of our common stock on the New York Stock Exchange was $5.19 per share. Dividends We pay cash dividends on a quarterly basis. The following table lists the cash dividends declared on each share of our common stock for our most recent two fiscal years. The dividends listed below were based primarily on the board of directors’ evaluation of earnings and consideration of actions necessary to maintain our REIT status for each listed quarter and were declared on the date indicated: 2014 First quarter ended March 31, 2014 ......................................................... $ Second quarter ended June 30, 2014 ........................................................ $ Third quarter ended September 30, 2014 ................................................. $ Fourth quarter ended December 31, 2014 ................................................ $ 2013 First quarter ended March 31, 2013 ......................................................... $ Second quarter ended June 30, 2013 ........................................................ $ Third quarter ended September 30, 2013 ................................................. $ Fourth quarter ended December 31, 2013 ................................................ $ Cash Dividends Per Common Share Date Dividends Declared March 20, 2014 June 19, 2014 September 18, 2014 December 18, 2014 March 28, 2013 June 28, 2013 September 30, 2013 December 13, 2013 0.14 0.14 0.14 0.14 0.15 0.15 0.12 0.08 51 Issuer Purchase of Equity Securities Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs(1) Shares purchased previously under this program: Month #1 (October 1-31) ......................................................... Month #2 (November 1-30) ..................................................... Month #3 (December 1-31) ...................................................... Total shares purchased this quarter: ...................................... Total shares available to replace shares issued under the 2012 Dividend Reinvestment and Stock Purchase Plan .................... Additional shares authorized for repurchase on October 17, 2004 ......................................................................................... Total shares available for repurchase at December 31, 2014 ... 5,374,500 $ 595,435 $ 1,832,472 $ 7,802,407 81,494 10,000,000 31,191,399 5.09 36,565,899 5.27 37,161,334 5.32 38,993,806 9,213,439 3,838,939 3,243,504 1,411,032 1,411,032 1,492,526 11,492,526 11,492,526 (1) On October 3, 2011, we announced that our board of directors had authorized a share repurchase program which permits us to acquire up to 2,000,000 shares of our common stock. The shares are expected to be acquired at prevailing prices through open market transactions. Our board of directors also authorized the Company to purchase an amount of our common stock up to the amount of common stock sold through our 2012 Dividend Reinvestment and Stock Purchase Plan. On December 13, 2013, our board of directors authorized us to acquire up to an additional 5,000,000 shares of our common stock; on March 13, 2014, our board of directors authorized us to acquire up to an additional 10,000,000 shares of our common stock; on May 22, 2014, we announced that our board of directors had authorized the Company to acquire up to an additional 10,000,000 shares of our common stock; and on October 17, 2014, our board of directors authorized us to acquire up to an additional 10,000,000 shares of our common stock, in each case through our share repurchase program. Total Return Comparison The following graph presents a cumulative total shareholder return comparison of our common stock with the Standard & Poor’s 500 Index and the National Association of Real Estate Investment Trusts, Inc. Mortgage REIT Index: 52 Index Anworth Mortgage Asset Corporation ............ S&P 500 Index ................................................ NAREIT Mortgage REIT Index ..................... 12/31/09 100.00 100.00 100.00 12/31/10 114.60 115.06 122.60 12/31/11 117.64 117.49 119.63 12/31/12 120.55 136.30 143.43 12/31/13 96.77 180.44 140.62 12/31/14 134.58 205.14 165.76 Period Ending The cumulative total shareholder return reflects stock price appreciation, if any, and the value of dividends for our common stock and for each of the comparative indices. The graph assumes that $100 was invested on December 31, 2009 in our common stock, that $100 was invested in each of the indices on December 31, 2009 and that all dividends were reinvested into additional shares of common stock at the frequency with which dividends are paid on the common stock during the applicable fiscal year. The total return performance shown in this graph is not necessarily indicative of and is not intended to suggest future total return performance. Measurement points are at the last trading day of the fiscal years represented above. Item 6. SELECTED FINANCIAL DATA The selected financial data as of December 31, 2014 and 2013 and for the years ended December 31, 2014, 2013 and 2012 are derived from our audited consolidated financial statements included in this Annual Report on Form 10-K. The selected financial data as of December 31, 2012, 2011 and 2010 and for the years ended December 31, 2011 and 2010 are derived from audited consolidated financial statements not included in this Annual Report on Form 10-K. You should read these selected financial data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and notes thereto that are included in this Annual Report on Form 10-K beginning on page F-1. 2014 For the Years Ended December 31, 2012 (amounts in thousands, except per share data and days) 2011 2013 Statements of Income Data Days in period ................................................................................... Interest income net of amortization of premium and discount .......... $ Interest expense ................................................................................ Net interest income ........................................................................... $ Other (loss) income ........................................................................... Expenses ........................................................................................... Net income ........................................................................................ $ Dividends on preferred stock ............................................................ Net income available to common stockholders ................................. $ Basic earnings per common share ..................................................... $ Diluted earnings per common share .................................................. $ Average number of shares outstanding ............................................. Average number of diluted shares outstanding ................................. 365 157,156 $ (79,907) 77,249 $ (30,876) (17,754) 28,619 $ (5,716) 22,903 $ 0.18 $ 0.18 $ 123,949 128,057 2014 365 174,784 $ (92,970) 81,814 $ 9,634 (15,728) 75,720 $ (5,736) 69,984 $ 0.49 $ 0.49 $ 142,455 146,400 366 195,853 $ (86,073 ) 109,780 $ 5,860 (15,422 ) 100,218 $ (5,773 ) 94,445 $ 0.68 $ 0.67 $ 138,382 142,485 365 224,180 $ (89,265) 134,915 $ 2,225 (14,264) 122,876 $ (5,885) 116,991 $ 0.91 $ 0.90 $ 128,601 132,759 As of December 31, 2012 (amounts in thousands, except per share data) 2011 2013 2010 365 219,803 (95,830) 123,973 270 (13,744) 110,499 (5,764) 104,735 0.89 0.87 118,164 121,919 2010 Balance Sheets Data MBS .................................................................................................. $ 7,223,073 $ 8,556,446 $ 9,244,693 $ 8,763,479 $ 7,739,052 Total assets ....................................................................................... $ 7,298,335 $ 8,619,491 $ 9,285,105 $ 8,813,769 $ 7,790,215 Repurchase agreements ..................................................................... $ 6,370,740 $ 7,580,000 $ 8,020,000 $ 7,595,000 $ 6,375,000 Junior subordinated notes ................................................................. $ 37,380 Total liabilities .................................................................................. $ 6,516,894 $ 7,717,305 $ 8,197,388 $ 7,804,243 $ 6,896,304 25,630 Series B Preferred Stock ................................................................... $ 868,281 Stockholders' equity (common and Series A Preferred) ................... $ 120,901 Number of common shares outstanding ............................................ 6.78 Book value per common share .......................................................... $ 23,924 $ 25,222 $ 878,262 $ 1,062,495 $ 142,013 138,717 7.14 $ 5.98 $ 27,239 $ 982,287 $ 134,115 6.96 $ 23,924 $ 757,517 $ 109,234 6.48 $ 37,380 $ 37,380 $ 37,380 $ 37,380 $ 53 Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General We are a Maryland corporation focused on investing in, financing and managing a leveraged portfolio of residential mortgage- backed securities and other financial assets which we collectively refer to as our target investments. We operate as a REIT as defined under the Code. We are externally managed and advised by Anworth Management, LLC, or our Manager. Our day-to-day operations are being conducted by our Manager through the authority delegated to it under the Management Agreement and pursuant to the policies established by our board of directors. Our objective is to provide attractive risk-adjusted total returns to our stockholders over the long-term, primarily through dividends and secondarily through capital appreciation. We selectively acquire and manage an investment portfolio of our target investments. We focus on asset selection and implement a relative value investment approach across various sectors within the residential mortgage market. Our target investments include the following:  Agency MBS (meaning MBS whose principal and interest payments are guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac);  Non-Agency MBS (meaning MBS that are not issued or guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac); and  Residential real estate and other financial assets comprising up to 10% of our total portfolio. We generally view our target investments as being influenced primarily by either interest rate risks or credit risks. Our Agency MBS are sensitive to changes in interest rates and prepayment speeds. Our Non-Agency MBS are sensitive to changes in credit risk. The assets which we allocate to Agency MBS are also allocated to one of two subcategories: Agency MBS which have a fixed interest rate during the life of the mortgages and Agency MBS whose interest rates will change or adjust to current market levels at varying times. We believe our hybrid investment model allows us to allocate assets across various sectors within the residential mortgage market with a focus on security selection and implementation of a relative value investment approach. Our asset allocation process takes into account the opportunities in the marketplace, cost of financing and cost of hedging interest rate, prepayment credit and other portfolio risks. As a result, MBS asset allocation reflects management’s opportunistic approach to investing in the marketplace. During the fourth quarter of 2014, we reintroduced Non-Agency MBS into our asset allocation. The table below provides the MBS asset allocation and asset allocation between our Agency MBS and Non-Agency MBS at December 31, 2014 and 2013 (dollar amounts in thousands): December 31, 2014 December 31, 2013 Dollar Amount Percentage Dollar Amount Percentage Agency MBS ........................ $ Non-Agency MBS ................ Total MBS: ........................ $ 7,023,363 199,710 7,223,073 97.24% $ 2.76 100.00% $ 8,556,367 79 8,556,446 100.00% - 100.00% As we develop more of our hybrid investment model, these percentages may change. As our MBS asset allocation shifts, our annualized yields and cost of financing shift. As previously discussed, our investment decisions are not driven solely by annualized yields but also by taking into account the uncertainty of faster or slower prepayments, extension risk and credit-related events. 54 Our Portfolio At December 31, 2014 and December 31, 2013, our total assets, the fair value of our MBS portfolio (which consists primarily of Agency MBS and Non-Agency MBS) and its allocation were approximately as follows: Total assets ........................................................................................................ $ Fair value of MBS ............................................................................................. $ Adjustable-rate Agency MBS (less than 1 year reset) ....................................... Adjustable-rate Agency MBS (1-2 year reset) .................................................. Adjustable-rate Agency MBS (2-3 year reset) .................................................. Adjustable-rate Agency MBS (3-4 year reset) .................................................. Adjustable-rate Agency MBS (4-5 year reset) .................................................. Adjustable-rate Agency MBS (5-7 year reset) .................................................. Adjustable-rate Agency MBS (>7 year reset) ................................................... 15-year fixed-rate Agency MBS ....................................................................... 20-year and 30-year fixed-rate Agency MBS ................................................... Non-Agency MBS ............................................................................................. Total MBS: .................................................................................................. December 31, 2014 December 31, 2013 (dollar amounts in thousands) 7,298,335 $ 7,223,073 $ 25 % 13 11 4 7 11 9 14 3 3 100 % 8,619,491 8,556,446 19% 9 15 10 3 15 8 20 1 - 100% Stockholders’ equity available to common stockholders at December 31, 2014 was approximately $708.2 million, or $6.48 per share. The $708.2 million equals total stockholders’ equity of $757.5 million less the Series A Preferred Stock liquidating value of approximately $48 million and less the difference between the Series B Preferred Stock liquidating value of $25.2 million and the proceeds from its sale of $23.9 million. Government Activity Developments Concerning Fannie Mae and Freddie Mac Payments on the Agency MBS in which we invest are guaranteed by Fannie Mae and Freddie Mac. Since 2008, these agencies have been under the conservatorship of the U.S. government. Separate legislation has been introduced in both houses of the U.S. Congress to wind-down both of these agencies. On June 25, 2013, a bipartisan group of U.S. Senators introduced a draft bill (better known as the Corker-Warner bill) to the U.S. Senate titled, “Housing Finance Reform and Taxpayer Act of 2013,” which may serve as a catalyst for congressional discussion on the reform of Fannie Mae and Freddie Mac. On July 11, 2013, members of the House Committee on Financial Services introduced a draft bill to the U.S. House of Representatives titled, “Protecting American Taxpayers and Homeowners Act.” The Corker-Warner bill failed to garner enough support to make it to the Senate floor for a vote. The House bill did not have enough support to make it out of the House Committee on Financial Services. During the first quarter 2014, Senate Banking Committee Chairman Tim Johnson (D-South Dakota) and ranking member Mike Crapo (R-Idaho) introduced a bipartisan housing finance reform bill that builds on the earlier Corker-Warner bill. This new Senate bill would also wind-down and eliminate Fannie Mae and Freddie Mac, as well as establish a Federal Mortgage Insurance Corporation (FMIC) in their place that would guarantee qualified mortgages. In May 2014, this bill received the approval of the Senate Banking Committee but it was not brought to the full Senate for this year. Lenders would be required to bear any losses on the first 10% of capital. The bill also calls for the creation of a “member-only securitization platform that would issue a single, standardized FMIC- wrapped security, and permit private label securities to be issued in a manner that encourages standardization and improved market liquidity.” It is currently unknown if, and when, any of these bills would become law and, if they did, what impact that would have on housing finance in general and what the impact would be on the existing securities guaranteed by Fannie Mae and Freddie Mac, as well as the impact on the pricing, supply, liquidity and value of the MBS in which we invest. Actions of the Federal Reserve In September 2012, the Fed Open Market Committee of the Federal Reserve, or FOMC, announced an open-ended program to purchase an additional $40 billion of Agency MBS per month until economic conditions (primarily the unemployment rate) improved. This program, combined with the then-existing Fed bond-buying program of Treasury securities, was to increase the Federal Reserve’s holdings by $85 billion per month. The Federal Reserve also announced its projection that the federal funds rate would likely remain at exceptionally low levels until at least mid-2015. In May and June 2013, then Federal Reserve Chairman Ben Bernanke commented that if there was continued improvement in the U.S. economy, the pace of purchases could be slowed down or tapered. These comments had a great effect on the bond market, as longer-term interest rates rose while short-term interest rates 55 remained constant. The resulting steepened yield curve caused a decline in the value of MBS. At the FOMC meeting on December 18, 2013, the Federal Reserve announced that it would begin the tapering of its bond-buying program down from the $85 billion per month and would continue to re-evaluate this at subsequent FOMC meetings. At its meeting in October 2014, the Federal Reserve ended its monthly purchases of Agency MBS and Treasury securities. Most Federal Reserve officials previously announced in the June 2014 meeting that they expected the first hike in interest rates to come sometime in 2015. At its December 17, 2014 meeting, the FOMC maintained the Fed Funds rate at its current level and stated that it would continue to review the appropriate target rate based on the goals of maximizing employment and as long as the inflation rate was under 2%. Other Recent Activity On January 2, 2013, the U.S. Congress passed the American Taxpayer Relief Act of 2012, or the Taxpayer Relief Act, which extended, for most Americans, tax cuts implemented under President George W. Bush’s administration. However, the Taxpayer Relief Act also delayed the implementation of the budget sequestration provisions of the Budget Control Act of 2011, which provided for automatic spending cuts, which went into effect on March 1, 2013. During 2013 and 2014, Congress passed several interim measures of providing temporary funding to the U.S. government and temporarily increasing the debt ceiling. On February 12, 2014, Congress passed a bill, which was signed into law by President Obama, suspending the debt ceiling until March 2015. On December 16, 2014, President Obama signed a $1.1 trillion appropriations bill that will fund most government operations through September 2015. A failure by the U.S. government to reach agreement on future budgets and debt ceilings, reduce its budget deficit or a future downgrade of U.S. sovereign debt and government-sponsored agencies debt could have a material adverse effect on the U.S. economy and the global economy. These events could have a material adverse effect on our borrowing costs, the availability of financing and the liquidity and valuation of securities in general and also on the securities in our portfolio. In 2010, the Group of Governors and Heads of Supervisors of the Basel Committee on Banking Supervision, the oversight body of the Basel Committee, published its capital standards for major banking institutions (Basel III). Under these standards, when fully phased-in on January 1, 2019, banking institutions will be required to maintain heightened capital ratio requirements. As of September 2013, the majority of participating nations had formally adopted most provisions of Basel III, with implementations generally beginning on January 1, 2014. It is unclear how the adoption of Basel III will affect our business at this time; however, increased capital requirements for banks could adversely affect our borrowing costs, availability of financing and the lending capacity of banks which, in turn, would affect the availability of MBS that we could acquire. During 2012 and 2013, U.S. and British banking authorities assessed fines on several major financial institutions for LIBOR manipulation. LIBOR is an unregulated rate based on estimates that lenders submitted to the British Bankers’ Association, a trade group that compiled the information and published daily the LIBOR rate. In September 2013, oversight of LIBOR was transferred over to United Kingdom regulators, the Financial Conduct Authority. The administration of LIBOR was to be transferred to the NYSE Euronext Rate Administration Limited but this group was renamed as the ICE Benchmark Administration Limited, or the IBA, upon the successful completion of the acquisition of NYSE Euronext by the Intercontinental Exchange in November 2013. On February 1, 2014, the administration of LIBOR was transferred from the BBA to the IBA following authorization by the Financial Conduct Authority. In October 2014, the IBA proposed a package of measures designed to make LIBOR more accurate and less susceptible to manipulation, including defining which trades can be used to calculate bank borrowing costs and to ensure the calculation of LIBOR is based on actual trades as opposed to estimates. The proposal was sent out for comments to be submitted back to the IBA by December 19, 2014. At this time, we do not know what changes, if any, will be made by the IBA. The calculation of LIBOR under the IBA is the average of the interest rates that some of the world’s leading banks charge each other for short-term loans. It is unclear at this time how this change will affect the interest rates that repurchase agreement counterparties charge on borrowings in general and how they could specifically affect our borrowing agreements. Although the U.S. government and other foreign governments have taken various actions intended to protect their respective economies, their respective housing and mortgage markets, their banking systems and financial institutions, we continue to operate under very difficult market conditions. There can be no assurance that these various actions will have a beneficial impact on the global financial markets and, more specifically, the market for the securities we currently own in our portfolio. We cannot predict what, if any, impact these actions or future actions by either the U.S. government or foreign governments could have on our business, results of operations and financial conditions. These events may impact the availability of financing, borrowing costs and the liquidity and valuation of securities in general and also on the securities in our portfolio. 56 Results of Operations Years Ended December 31, 2014 and 2013 For the year ended December 31, 2014, our net income available to common stockholders was approximately $22.9 million, or $0.18 per diluted share, based on a weighted average of 128.1 million fully diluted shares outstanding. This includes net income of $28.6 million minus the payment of preferred dividends of $5.7 million. For the year ended December 31, 2013, our net income available to common stockholders was approximately $70 million, or $0.49 per diluted share, based on a weighted average of 146.4 million fully diluted shares outstanding. This included net income of $75.7 million minus the payment of preferred dividends of $5.7 million. Net interest income for the year ended December 31, 2014 totaled $77.2 million, or 38% of gross income, compared to $81.8 million, or 34.5% of gross income, for the year ended December 31, 2013. Net interest income is comprised of the interest income earned on mortgage investments (net of premium amortization expense) and other income less interest expense from borrowings. Interest and other income net of premium amortization expense for the year ended December 31, 2014 was $157.2 million, compared to $174.8 million for the year ended December 31, 2013, a decrease of 10.1%, due primarily to a decrease in the weighted average coupons on MBS (from 2.67% in 2013 to 2.56% in 2014) and a decrease in the weighted average portfolio outstanding, from approximately $8.86 billion in 2013 to approximately $7.89 billion in 2014, partially offset by a decrease in premium amortization expense of $16.3 million. Interest expense for the year ended December 31, 2014 was $79.9 million, compared to $93 million for the year ended December 31, 2013, a decrease of approximately 14.1%, which resulted primarily from a decrease in the weighted average interest rates, after giving effect to the swap agreements, from 1.15% in 2013 to 1.11% in 2014, and a decrease in the average borrowings outstanding, from $8.01 billion in 2013 to $7.09 billion in 2014. Recoveries on Non-Agency MBS were approximately $120 thousand for the year ended December 31, 2014 compared to $397 thousand for the year ended December 31, 2013. The results of our operations are affected by a number of factors, many of which are beyond our control, and primarily depend on, among other things, the level of our net interest income, the market value of our MBS, the supply of, and demand for, MBS in the marketplace, and the terms and availability of financing. Our net interest income varies primarily as a result from changes in interest rates, the slope of the yield curve (the differential between long-term and short-term interest rates), borrowing costs (our interest expense) and prepayment speeds on our MBS portfolios, the behavior of which involves various risks and uncertainties. Interest rates and prepayment speeds, as measured by the constant prepayment rate, vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. With respect to our business operations, increases in interest rates, in general, may, over time, cause: (i) the interest expense associated with our borrowings, which are primarily comprised of repurchase agreements, to increase; (ii) the value of our MBS portfolios and, correspondingly, our stockholders’ equity to decline; (iii) coupons on our MBS to reset, although on a delayed basis, to higher interest rates; (iv) prepayments on our MBS portfolios to slow, thereby slowing the amortization of our MBS purchase premiums; and (v) the value of our interest rate swap agreements and, correspondingly, our stockholders’ equity to increase. Conversely, decreases in interest rates, in general, may, over time, cause: (i) prepayments on our MBS portfolios to increase, thereby accelerating the amortization of our MBS purchase premiums; (ii) the interest expense associated with our borrowings to decrease; (iii) the value of our MBS portfolios and, correspondingly, our stockholders’ equity to increase; (iv) the value of our interest rate swap agreements and, correspondingly, our stockholders’ equity to decrease; and (v) coupons on our MBS to reset, although on a delayed basis, to lower interest rates. In addition, our borrowing costs and credit lines are further affected by the type of collateral pledged and general conditions in the credit markets. During the year ended December 31, 2014, premium amortization expense decreased $16.3 million, or 26.3%, to $45.7 million from $62 million during the year ended December 31, 2013 due primarily to a decrease in the balance of unamortized purchase premium as well as a decrease in both actual prepayments and future prepayment assumptions, on average, for the year. The decrease in the balance of unamortized purchase premium was due primarily to a decrease in Agency MBS assets. Based on the amount of Agency MBS assets held at December 31, 2014, we expect this trend of decreasing unamortized purchase premium and its effect on premium amortization expense to continue. Realized prepayments decreased from 2013 to 2014. The primary driver of realized prepayments is the relative difference between the new mortgage rate and borrowers’ current mortgage rates or expected future mortgage rates, as is the case with adjustable-rate mortgages. The decrease in realized prepayments during 2014 was due primarily to mortgage rates being higher, on average, during the year as compared 2013. The prepayment rate assumptions used in our projection of long-term CPR percentages are based primarily on historical prepayment rates on our MBS assets as well as assumptions about future mortgage rates and their expected impact on future prepayments. Based upon current actual prepayments and expected future mortgage rates and their impact on future prepayments, we do not expect the trend of decreasing actual prepayments and future prepayment assumptions seen from 2013 to 2014 to continue significantly. 57 The table below shows the approximate constant prepayment rate of our Agency MBS and Non-Agency MBS: Portfolio Agency MBS and Non-Agency MBS ... First Quarter Year Ended December 31, 2014 Year Ended December 31, 2013 Second Quarter Third Quarter Fourth Quarter First Quarter Second Quarter Third Quarter 12 % 14% 18% 15% 24% 24 % 23% Fourth Quarter 15% We review our MBS portfolios relative to current market conditions, trading prices of individual MBS, the general level of mortgage interest rates, prepayment activity, other investment opportunities and the duration of our portfolio versus the duration of our liabilities. Although there is no set pattern or expectation of a trend to sales of Agency MBS, we may sell some of the securities in our portfolio based upon these factors. During the year ended December 31, 2014, we received proceeds of approximately $562 million from the sales of Agency MBS and recognized a net loss of approximately $2.85 million. We had no set plan to sell these securities nor were we required to do so. During the year ended December 31, 2013, we received proceeds of approximately $637 million from the sales of Agency MBS and recognized gross realized gains on sales of approximately $14.89 million and gross realized losses on sales of approximately $5.65 million. Asset sales during 2014 were primarily a factor of shifting more of our portfolio to TBA dollar roll funded assets, which do not require repurchase agreement financing. In 2013, we sold assets for repositioning our investment portfolio for asset/liability management purposes. During the year ended December 31, 2014, we sold approximately $4 billion in notional amounts of TBA Agency MBS, net of derivative income, and recognized a gain of approximately $10.2 million. During the year ended December 31, 2013, we did not enter into any TBA Agency MBS contracts. During the year ended December 31, 2014, we also had a loss on interest rate swaps recognized in our income statement of approximately $36.7 million, consisting primarily of $31.6 million in net cash settlements, approximately $7.7 million in AOCI amortization and the difference of approximately $2.6 million in the change in fair value (see the section entitled “Accounting for Derivative and Hedging Activities” in Note 1 for additional information). During the year ended December 31, 2013, we had a gain on interest rate swaps of approximately $62.7 million due primarily to the change in fair value of the swaps, which was recognized not through earnings but in AOCI. Also during the year ended December 31, 2014, we had a loss of approximately $1.7 million on Eurodollar Futures Contracts. During the year ended December 31, 2013, we did not have any Eurodollar Futures Contracts. Total expenses were approximately $17.8 million for the year ended December 31, 2014, compared to approximately $15.7 million for the year ended December 31, 2013. For the year ended December 31, 2014, we incurred management fees of approximately $10.75 million, which is based on a percentage of our equity (see Note 11 to the accompanying audited consolidated financial statements) compared to management fees of approximately $12 million for the year ended December 31, 2013. “Other expenses” (as detailed in Note 15 to the accompanying audited consolidated financial statements) increased by $3.2 million due primarily to the increase in legal and professional fees of approximately $2.1 million and the increase in printing and stockholder communications of approximately $0.4 million, both of which were related to the Company’s proxy solicitation contest during 2014 and also to the increase in expenses related to our rental properties business of approximately $0.7 million. We did not own any rental properties during 2013. Years Ended December 31, 2013 and 2012 For the year ended December 31, 2013, our net income available to common stockholders was approximately $70 million, or $0.49 per diluted share, based on a weighted average of 146.4 million fully diluted shares outstanding. This includes net income of $75.7 million minus the payment of preferred dividends of $5.7 million. For the year ended December 31, 2012, our net income available to common stockholders was approximately $94.4 million, or $0.67 per diluted share, based on a weighted average of 142.5 million fully diluted shares outstanding. This included net income of $100.2 million minus the payment of preferred dividends of $5.8 million. Net interest income for the year ended December 31, 2013 totaled $81.8 million, or 34.5% of gross income, compared to $109.8 million, or 40.9% of gross income, for the year ended December 31, 2012. Net interest income is comprised of the interest income earned on mortgage investments (net of premium amortization expense) less interest expense from borrowings. Interest income net of premium amortization expense for the year ended December 31, 2013 was $174.8 million, compared to $195.9 million for the year ended December 31, 2012, a decrease of 10.8%, due primarily to a decrease in the weighted average coupons on Agency MBS (from 3.10% in 2012 to 2.67% in 2013), partially offset by an increase in the weighted average portfolio outstanding, from approximately $8.7 billion in 2012 to approximately $8.86 billion in 2013, and a decrease in premium amortization expense of $10.7 million. Interest expense for the year ended December 31, 2013 was $93 million, compared to $86.1 million for the year ended December 31, 2012, an increase of approximately 8%, which resulted primarily from an increase in the weighted average interest rates, after giving effect to the swap agreements, from 1.08% in 2012 to 1.15% in 2013, and an increase in the average borrowings outstanding, from $7.88 billion in 2012 to $8.01 billion in 2013. Recoveries on Non-Agency MBS were approximately $397 thousand for the year ended December 31, 2013 compared to $1.4 million for the year ended December 31, 2012. 58 The results of our operations are affected by a number of factors, many of which are beyond our control, and primarily depend on, among other things, the level of our net interest income, the market value of our MBS, the supply of, and demand for, MBS in the marketplace, and the terms and availability of financing. Our net interest income varies primarily as a result from changes in interest rates, the slope of the yield curve (the differential between long-term and short-term interest rates), borrowing costs (our interest expense) and prepayment speeds on our MBS portfolios, the behavior of which involves various risks and uncertainties. Interest rates and prepayment speeds, as measured by the constant prepayment rate, vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. With respect to our business operations, increases in interest rates, in general, may, over time, cause: (i) the interest expense associated with our borrowings, which are primarily comprised of repurchase agreements, to increase; (ii) the value of our MBS portfolios and, correspondingly, our stockholders’ equity to decline; (iii) coupons on our MBS to reset, although on a delayed basis, to higher interest rates; (iv) prepayments on our MBS portfolios to slow, thereby slowing the amortization of our MBS purchase premiums; and (v) the value of our interest rate swap agreements and, correspondingly, our stockholders’ equity to increase. Conversely, decreases in interest rates, in general, may, over time, cause: (i) prepayments on our MBS portfolios to increase, thereby accelerating the amortization of our MBS purchase premiums; (ii) the interest expense associated with our borrowings to decrease; (iii) the value of our MBS portfolios and, correspondingly, our stockholders’ equity to increase; (iv) the value of our interest rate swap agreements and, correspondingly, our stockholders’ equity to decrease; and (v) coupons on our MBS to reset, although on a delayed basis, to lower interest rates. In addition, our borrowing costs and credit lines are further affected by the type of collateral pledged and general conditions in the credit markets. During the year ended December 31, 2013, premium amortization expense decreased $10.7 million, or 14.8%, to $62 million from $72.8 million during the year ended December 31, 2012, due primarily to a decrease in lower future CPR projections, partially offset by an increase in the amortization of unearned premium on securities acquired in 2013 and 2012 at higher premiums. The table below shows the approximate constant prepayment rate of our Agency MBS and Non-Agency MBS: Year Ended December 31, 2013 Year Ended December 31, 2012 Portfolio Agency MBS and Non-Agency MBS ..... First Quarter Second Quarter Third Quarter Fourth Quarter First Quarter Second Quarter Third Quarter 24% 24% 23% 15% 22% 24% 26% Fourth Quarter 26% During the years ended December 31, 2013 and December 31, 2012, there was no gain or loss recognized in earnings due to hedge ineffectiveness. We have determined that our hedges are still considered “highly effective.” There were no components of the derivative instruments’ gain or loss excluded from the assessment of hedge effectiveness. During the year ended December 31, 2013, we received proceeds of approximately $637 million from the sales of Agency MBS and recognized a net gain of approximately $9.2 million. During the year ended December 31, 2012, we received proceeds of approximately $141 million from the sales of Agency MBS and recognized a net gain on sales of approximately $4.4 million. Total expenses were approximately $15.7 million for the year ended December 31, 2013, compared to approximately $15.4 million for the year ended December 31, 2012. For the year ended December 31, 2013, we incurred management fees of approximately $12 million, which is based on a percentage of our equity (see Note 11 to the accompanying audited consolidated financial statements) compared to management fees of approximately $11.6 million for the year ended December 31, 2012. “Other expenses” (as detailed in Note 15 to the accompanying audited consolidated financial statements) decreased by $70 thousand. Financial Condition MBS Portfolio At December 31, 2014, we held Agency MBS which had an amortized cost of approximately $6.96 billion, consisting primarily of approximately $5.7 billion of adjustable-rate MBS and approximately $1.3 billion of fixed-rate MBS. This amount represents an approximate 18.9% decrease from the $8.58 billion held at December 31, 2013. Of the adjustable-rate Agency MBS owned by us, 31% were adjustable-rate pass-through certificates whose coupons reset within one year. The remaining 69% consisted of hybrid adjustable-rate Agency MBS that have an initial interest rate that is fixed for a certain period, usually one to ten years, and thereafter adjust annually for the remainder of the term of the loan. At December 31, 2014, the Non-Agency MBS had an amortized cost of approximately $199.7 million, a fair value of approximately $199.7 million and a contractually required principal of approximately $236.4 million. 59 The following table presents a schedule of our MBS at fair value owned at December 31, 2014 and December 31, 2013, classified by type of issuer (dollar amounts in thousands): Agency December 31, 2014 December 31, 2013 Fair Value Portfolio Percentage Fair Value Portfolio Percentage Fannie Mae (FNM) .......................................... $ Freddie Mac (FHLMC) .................................... Ginnie Mae (GNMA) ....................................... Non-Agency MBS ............................................ Total MBS: .................................................... $ 4,103,073 2,908,590 11,700 199,710 7,223,073 56.8% $ 40.3 0.1 2.8 100.0% $ 4,962,273 3,580,834 13,260 79 8,556,446 58.0% 41.8 0.2 - 100.0% The following table classifies our portfolio of MBS owned at December 31, 2014 and December 31, 2013 by type of interest rate index (dollar amounts in thousands): Index December 31, 2014 December 31, 2013 Fair Value Portfolio Percentage Fair Value Portfolio Percentage One-month LIBOR .......................................... $ Six-month LIBOR ............................................ One-year LIBOR .............................................. Six-month certificate of deposit ....................... Six-month constant maturity treasury .............. One-year constant maturity treasury ................ Cost of Funds Index ......................................... 15-year fixed-rate ............................................. 20-year and 30-year fixed-rate ......................... Total Agency MBS: ...................................... $ Non-Agency MBS ............................................ Total MBS: ................................................... $ 1,098 42,994 5,495,253 888 170 196,752 13,251 1,042,820 230,137 7,023,363 199,710 7,223,073 -% $ 0.6 76.1 - - 2.7 0.2 14.4 3.2 97.2% $ 2.8 100.0% $ 1,532 51,301 6,488,980 992 227 227,805 16,223 1,658,348 111,038 8,556,446 - 8,556,446 -% 0.6 75.8 - - 2.7 0.2 19.4 1.3 100.0% - 100.00% The fair values indicated do not include interest earned but not yet paid. With respect to our hybrid adjustable-rate Agency MBS, the fair value of these securities appears on the line associated with the index based on which the security will eventually reset once the initial fixed interest rate period has expired. The fair value of our MBS is reported to us independently from dealers who are major financial institutions and are considered to be market makers for these types of instruments. For more detail on the fair value of our MBS, see Note 7 to the accompanying audited consolidated financial statements. 60 The weighted average coupon and average amortized cost of our Agency MBS at December 31, 2014, September 30, 2014, June 30, 2014, March 31, 2014, and December 31, 2013 were as follows: December 31, 2014 September 30, 2014 June 30, 2014 March 31, 2014 December 31, 2013 Agency MBS Portfolio Weighted Average Coupon: Adjustable-rate Agency MBS ........................ Hybrid adjustable-rate Agency MBS ............. 15-year fixed-rate Agency MBS .................... 20-year and 30-year fixed-rate Agency MBS .............................................................. Total Agency MBS: .............................. 2.53% 2.53 2.65 4.37 2.61% 2.58% 2.55 2.69 4.40 2.64% 2.60 % 2.57 2.65 5.01 2.63 % 2.57% 2.59 2.68 5.04 2.65% Average Amortized Cost: Adjustable-rate Agency MBS ........................... Hybrid adjustable-rate Agency MBS ................ 15-year fixed-rate Agency MBS ....................... 20-year and 30-year fixed-rate Agency MBS ... Total Agency MBS: .................................... 102.88% 103.57 103.05 103.13 103.30% 102.81% 103.60 103.14 103.17 103.32% 102.65 % 103.58 103.16 102.86 103.28 % 102.56% 103.55 103.10 102.91 103.24% 2.52% 2.62 2.66 5.71 2.65% 102.46% 103.45 103.39 101.31 103.23% Current yield on Agency MBS (weighted average coupon divided by average amortized cost) .......... 2.53% 2.56% 2.55 % 2.57% 2.57% Non-Agency MBS yields are based on our estimate of the timing and amount of future cash flows and our cost basis. Our cash flow estimates for these investments are based on our observations of current information and events and include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses and other factors. The following table summarizes our Non-Agency MBS portfolio at December 31, 2014 (dollar amounts in thousands): Loan Type Fair Value Amortized Cost Contractual Principal Amortized Cost Coupon Yield Weighted Average Prime .......................................... $ Alt-A .......................................... Subprime .................................... Non-performing ......................... Total Non-Agency MBS: ...... $ 21,798 $ 79,584 35,987 62,341 199,710 $ 21,787 $ 79,625 35,987 62,306 199,705 $ 28,371 106,482 37,834 63,674 236,361 76.83 % 74.97 % 95.12 % 97.85 % 84.59 % 1.73% 2.00% 3.40% 4.83% 2.95% 6.39% 5.65% 5.63% 5.72% 5.75% 61 The information in the table below pertains to our repurchase agreement borrowings at December 31, 2014, September 30, 2014, June 30, 2014, March 31, 2014, December 31, 2013 and December 31, 2012: December 31, 2014 September 30, 2014 June 30, 2014 March 31, 2014 December 31, 2013 December 31, 2012 (dollar amounts in thousands) Repurchase agreements outstanding ................... $ 6,370,740 $ 6,550,000 $7,118,500 $7,510,000 $ 7,580,000 $8,020,000 Average repurchase agreements outstanding during the quarter ................................................ $ 6,469,942 $ 6,901,889 $7,434,984 $7,565,029 $ 7,644,822 $8,069,889 Average quarterly repurchase agreements outstanding during the year ................................. $ 7,092,961 N/A $ 8,011,694 $7,860,703 Maximum monthly amount during the quarter ...... $ 6,467,509 $ 7,041,000 $7,551,000 $7,563,000 $ 7,635,000 $8,051,000 Maximum monthly amount during the year ........ $ 7,563,000 N/A $ 8,485,000 $8,051,000 Average interest rate on outstanding repurchase agreements during the quarter ............................. Average days to maturity .................................... Average interest rate after adjusting for interest rate swaps ............................................................ Weighted average maturity after adjusting for interest rate swaps ............................................... 767 days 992 days 1,008 days 1,010 days 0.35 % 37 days 845 days 420 days 38 days 37 days 37 days 38 days 0.47% 34 days 1.48 % 0.39% 1.50% 0.37% 0.32% 1.47% 1.06% 1.08% 0.32% 1.12% N/A N/A N/A N/A N/A = Not applicable. At December 31, 2014 and December 31, 2013, the unamortized net premium paid for our Agency MBS was approximately $222.4 million and $268.1 million, respectively. At December 31, 2014, the unamortized net discount on our Non-Agency MBS was approximately $36.6 million. At December 31, 2013, the Non-Agency MBS were acquired at par. At December 31, 2014, the current yield on our Agency MBS declined to 2.53% at December 31, 2014 from 2.57% at December 31, 2013. This was due primarily to the decline in the weighted average coupon. As portions of our portfolio reset, and as older assets mature or payoff and are replaced with newer lower-yielding assets, the weighted average coupon will continue to decline. As noted in the trend above, the weighted average coupon has declined by an average of approximately 1 basis point per quarter. For the three months ended December 31, 2014, the weighted average coupon for our total Agency MBS declined by 3 basis points. One of the factors that also impact the reported yield on our MBS portfolio is the actual prepayment rate on the underlying mortgages. We analyze our MBS and the extent to which prepayments impact the yield. When the rate of prepayments exceeds expectations, we amortize the premiums paid on mortgage assets over a shorter time period, resulting in a reduced yield to maturity on our mortgage assets. Conversely, if actual prepayments are less than the assumed constant prepayment rate, the premium would be amortized over a longer time period, resulting in a higher yield to maturity. The balance of the amounts of repurchase agreements outstanding and the balances for the averages on the repurchase agreements outstanding have been declining due to the Company’s repurchases of its common stock, which is the basis for the leveraging of the repurchase agreements. The average interest rate on outstanding repurchase agreements after adjusting for interest rate swap transactions decreased from 1.50% at December 31, 2013 to 1.06% at December 31, 2014. The decrease was due primarily to a decrease in the amount of outstanding swap agreements, from $5.375 billion at December 31, 2013 to $3.33 billion at December 31, 2014. The weighted average term to next rate adjustment after adjusting for interest rate swap transactions decreased from 1010 days at December 31, 2013 to 767 days at December, 31, 2014. This was due primarily to the decrease in the amount of outstanding swap agreements and because very few swaps were added during the year. Please see the discussion on this in the section entitled “Derivatives” which follows below. At December 31, 2014, the balance of our Non-Agency MBS was $199.7 million. The balance of our Non-Agency MBS at December 31, 2013 was approximately $79 thousand. Residential Properties Portfolio At December 31, 2014, we owned 79 single-family residential properties which are all located in Southeastern Florida and are carried at a total cost, net of accumulated depreciation, of approximately $12.9 million. As we did not start this operation until March 2014, we did not own any single-family residential properties at December 31, 2013. 62 Derivatives We periodically enter into derivative transactions, in the form of interest rate swaps, which are intended to hedge our exposure to rising rates on funds borrowed to finance our investments in securities. We designate interest rate swap transactions as cash flow hedges for tax purposes. To the extent that we enter into hedging transactions to reduce our interest rate risk on indebtedness incurred to acquire or carry real estate assets, any income or gain from the disposition of hedging transactions should be qualifying income under the REIT rules for purposes of the 95% gross income test. The hedging rules that exclude certain hedging income from the computation of the 95% income test have been extended to exclusion under the 75% income test as well. To qualify for this exclusion, the hedging transaction must be clearly identified as such before the close of the day on which it was acquired, originated or entered into. The transaction must hedge indebtedness incurred or to be incurred by us to acquire or carry real estate assets. As part of our asset/liability management policy, we may enter into hedging agreements such as interest rate caps, floors or swaps. These agreements are entered into to try to reduce interest rate risk and are designed to provide us with income and capital appreciation in the event of certain changes in interest rates. We review the need for hedging agreements on a regular basis consistent with our capital investment policy. Swaps are derivative instruments as defined by ASC 815-10. We do not anticipate entering into derivative transactions for speculative or trading purposes. In accordance with the swap agreements, we pay a fixed rate of interest during the term of the swaps we receive a payment that varies with the three-month LIBOR rate. The information in the following table pertains to all of our swaps at December 31, 2014, September 30, 2014, June 30, 2014, March 31, 2014, and December 31, 2013: December 31, 2014 September 30, 2014 June 30, 2014 March 31, 2014 December 31, 2013 Aggregate notional amount of swap agreements ...................... $3.330 billion $3.805 billion $5.265 billion $5.44 billion $5.375 billion Average maturity of swap agreements ............................... 4.0 years 4.0 years 3.7 years 3.8 years 3.9 years Weighted average fixed rate paid on swap agreements ................. 1.56% 1.54% 1.78% 1.79 % 1.81% Aggregate notional amount of Eurodollars Futures Contracts ... $5.50 billion $5.50 billion $ 0 $ 0 $ 0 Swap agreements are used to provide protection from increases in interest rates having a negative impact on the market value of our portfolio that could result in our lenders requiring additional collateral for our repurchase agreement borrowings. An increase or decrease in the notional value of our swap agreements usually provides an increase or decrease in protection to our portfolio’s change in value due to interest rate changes. However, there are other methods that can also lessen our portfolio’s change in value due to interest rate increases. Among them are: acquiring mortgages that are inherently less sensitive to interest rate changes and borrowings using long-term agreements. On March 17, 2014, we decided to discontinue hedge accounting on certain swaps with notional balances of approximately $1.685 billion. On August 22, 2014, we decided to discontinue hedge accounting on the remainder of our swaps. During 2014, the aggregate amount of swaps that we either terminated or that had matured was $2.61 billion. Most of the swaps that were terminated had a remaining term of less than two years and had higher interest rates, which is the primary reason for the decline in the average fixed pay swap rate, from 1.81% at December 31, 2013 to 1.56% at December 31, 2014. While these were still effective under GAAP, they were becoming less viable economically and for asset/liability management. They were replaced with the Eurodollar Futures Contracts, which require no payments of interest during their term. For both the terminated swaps and the de-designated swaps, as long as there is the probability that the forecasted transactions that were being hedged (i.e., rollovers of our repurchase agreement borrowings) are still expected to occur, the amount of the gain or loss in AOCI remains in AOCI and is amortized over the remaining term of the swaps. During the year ended December 31, 2014, the net unrealized loss in AOCI on the interest rate swaps was approximately $47 million (consisting primarily of approximately $34.4 on de-designated swaps, approximately $0.4 million on new swaps and approximately $11.8 million on terminated de-designated swaps) as compared to unrealized losses in AOCI of approximately $33 million on our swap agreements at December 31, 2013. Each Eurodollar Futures Contract embodies $1 million of notional value. We do not designate these contracts as hedges for accounting purposes. As a result, realized and unrealized changes in fair value are recognized in earnings in the period in which the changes occur. At December 31, 2014, we had 5,500 Eurodollar Futures Contracts representing $5.5 billion in notional amount. The effective term of these contracts is three months. The cash held by the broker on the Eurodollar Futures Contracts was approximately $2.96 million, which is included in “other assets,” and there was a derivative liability of approximately $1.7 million. For the year 63 ended December 31, 2014, we had losses on Eurodollar Futures Contracts of approximately $1.7 million. We did not enter into these types of contracts during the year ended 2013. At December 31, 2014, we had approximately $690 million in notional amount of TBA Agency MBS. During 2014, we recognized approximately $10.2 million in gains on the TBA Agency MBS, net of derivative income. For more information on the amounts, policies, objectives and other qualitative data on our derivatives, see Notes 1, 7 and 13 to the accompanying audited consolidated financial statements. Liquidity and Capital Resources Agency MBS and Non-Agency MBS Portfolios Our primary source of funds consists of repurchase agreements which totaled $6.37 billion at December 31, 2014. As collateral for the repurchase agreements and swaps, we had pledged approximately $6.65 billion in Agency MBS and approximately $155 million in Non-Agency MBS. Our other significant source of funds for the year ended December 31, 2014 consisted of payments of principal from our Agency MBS portfolio in the amount of $1.44 billion. For the year ended December 31, 2014, there was a net increase in cash and cash equivalents of approximately $7.6 million. This consisted of the following components:  Net cash provided by operating activities for the year ended December 31, 2014 was approximately $85.2 million. This is comprised primarily of net income of $28.6 million and adding back the following non-cash items: the amortization of premium and discounts of approximately $45.7 million; depreciation on rental properties of $235 thousand; loss on sales of Agency MBS of approximately $2.85 million; loss on interest rate swaps of approximately $36.7 million; the amortization of restricted stock of $97 thousand; and loss on Eurodollar Futures Contracts of approximately $1.7 million, partially offset by periodic net settlements on interest rate swaps of approximately $17.5 million; gain on derivatives net of derivative income on TBA Agency MBS of approximately $10.2 million; accretion of discount on Non-Agency MBS of approximately $429 thousand and recovery on Non-Agency MBS of $120 thousand. Net cash provided by operating activities also included an increase in accrued expenses of approximately $3.1 million; a decrease in accrued interest payable of approximately $1 million; a decrease in interest receivable of approximately $4.2 million and an increase in prepaid expense of approximately $8.7 million;  Net cash provided by investing activities for the year ended December 31, 2014 was approximately $1.39 billion, which consisted of $1.44 billion from principal payments on Agency MBS; proceeds from sales of Agency MBS of approximately $562 million and principal payments on Non-Agency MBS of approximately $1.5 million, partially offset by purchases of Agency MBS of $431 million; purchases of Non-Agency MBS of approximately $176 million and purchases of residential properties of approximately $13.1 million; and  Net cash used in financing activities for the year ended December 31, 2014 was approximately $1.46 billion. This consisted of borrowings on repurchase agreements of approximately $33.862 billion, offset by repayments on repurchase agreements of approximately $35.071 billion; common stock repurchased of approximately $153 million, net of proceeds from common stock issued; dividends paid of $63.7 million on common stock; dividends paid of approximately $5.7 million on preferred stock and settlements on terminated interest rate swaps of approximately $42.4 million, less net settlements on TBA Agency MBS of approximately $9.2 million. Relative to our MBS portfolio at December 31, 2014, all of our repurchase agreements were fixed-rate term repurchase agreements with original maturities ranging from 29 days to 3.75 months. At December 31, 2014, we had borrowed funds under repurchase agreements with 25 different financial institutions. As the repurchase agreements mature, we enter into new repurchase agreements to take their place. Because we borrow money based on the fair value of our MBS and because increases in short-term interest rates or increasing market concern about the liquidity or value of our MBS can negatively impact the valuation of MBS, our borrowing ability could be reduced and lenders may initiate margin calls in the event short-term interest rates increase or the value of our MBS declines for other reasons. We had adequate cash flow, liquid assets and unpledged collateral with which to meet our margin requirements during the year ended December 31, 2014 but there can be no assurance we will have adequate cash flow, liquid assets and unpledged collateral with which to meet our margin requirements in the future. Our leverage on capital (including all preferred stock and junior subordinated notes) decreased from 8.1x at December 31, 2013 to 7.78x at December 31, 2014. The decrease in leverage was due primarily to a decrease in repurchase agreements outstanding, from $7.58 billion at December 31, 2013 to $6.37 billion at December 31, 2014. 64 In the future, we expect that our primary sources of funds will continue to consist of borrowed funds under repurchase agreement transactions and of monthly payments of principal and interest on our MBS portfolios. Our liquid assets generally consist of unpledged MBS, cash and cash equivalents. A large negative change in the market value of our MBS might reduce our liquidity, requiring us to sell assets with the likely result of realized losses upon sale. During the year ended December 31, 2014, we raised approximately $1.4 million in capital under our 2012 Dividend Reinvestment and Stock Purchase Plan. At December 31, 2014, our authorized capital included 20 million shares of $0.01 par value preferred stock, which we have classified as Series A Cumulative Preferred Stock, or Series A Preferred Stock, and Series B Cumulative Convertible Preferred Stock, or Series B Preferred Stock. On May 27, 2011, we entered into a Controlled Equity Offering Sales Agreement, or the 2011 Sales Agreement, with Cantor to sell up to 20,000,000 shares of our common stock, 1,000,000 shares of our Series A Preferred Stock and 1,000,000 shares of our Series B Preferred Stock. During the year ended December 31, 2014, we did not issue any shares of our Series A Preferred Stock, our Series B Preferred Stock or our common stock under the 2011 Sales Agreement. At December 31, 2014, there were 19,409,400 shares of common stock, 956,122 shares of Series A Preferred Stock and 894,518 shares of Series B Preferred Stock, respectively, available for sale under the 2011 Sales Agreement. On October 3, 2011, we announced that our board of directors had authorized a share repurchase program which permits us to acquire up to 2,000,000 shares of our common stock. The shares are expected to be acquired at prevailing prices through open market transactions. The manner, price, number and timing of share repurchases will be subject to market conditions and applicable SEC rules. Our board of directors also authorized the Company to purchase an amount of our common stock up to the amount of common stock sold through our 2012 Dividend Reinvestment and Stock Purchase Plan. On December 13, 2013, our board of directors authorized us to acquire up to an additional 5,000,000 shares of our common stock; on March 13, 2014, our board of directors authorized us to acquire up to an additional 10,000,000 shares of our common stock; on May 22, 2014, our board of directors authorized us to acquire up to an additional 10,000,000 shares of our common stock; and on October 17, 2014, our board of directors authorized us to acquire up to ab additional 10,000,000 share of our common stock, in each case through our share repurchase program. During the year ended December 31, 2014, we repurchased an aggregate of 29,778,634 shares at a weighted average price of $5.16 per share under our share repurchase program. Disclosure of Contractual Obligations The following table represents our contractual obligations at December 31, 2014 (in thousands): Total Less Than 1 Year 1-3 Years 3-5 Years More Than 5 Years Repurchase agreements(1) .................. $ Junior subordinated notes(2) ............... Lease commitment ............................ Total: ............................................ $ 6,370,740 $ 37,380 3,779 6,411,899 $ 6,370,740 $ 0 457 6,371,197 $ 0 $ 0 956 956 $ 0 $ 0 1,014 1,014 $ 0 37,380 1,352 38,732 (1) These represent amounts due by maturity. (2) These represent amounts due by contractual maturity. However, we do have the option to redeem these as more fully described in Note 6 to the accompanying audited consolidated financial statements. Stockholders’ Equity We use available-for-sale treatment for our Agency MBS and Non-Agency MBS, which are carried on our balance sheets at fair value rather than historical cost. Based upon this treatment, our total equity base at December 31, 2014 was $757.5 million. Common stockholders’ equity was approximately $708.2 million, or a book value of $6.48 per share. “Common stockholders’ equity” serves as the basis for how book value per common share is calculated. Under our available-for-sale accounting treatment, unrealized fluctuations in fair values of assets are assessed to determine whether they are other-than-temporary. To the extent we determine that these unrealized fluctuations are not other-than-temporary, they do not impact GAAP income or taxable income but rather are reflected on the balance sheets by changing the carrying value of the assets and reflecting the change in stockholders’ equity under “accumulated other comprehensive income, unrealized gain (loss) on available-for-sale securities.” 65 As a result of this mark-to-market accounting treatment, our book value and book value per share are likely to fluctuate far more than if we used historical amortized cost accounting on all of our assets. As a result, comparisons with some companies that use historical cost accounting for all of their balance sheets may not be meaningful. Unrealized changes in the fair value of MBS have one significant and direct effect on our potential earnings and dividends: positive fair value changes will increase our equity base and allow us to increase our borrowing capacity, while negative changes will tend to reduce borrowing capacity under our capital investment policy. A very large negative change in the net market value of our MBS might reduce our liquidity, requiring us to sell assets with the likely result of realized losses upon sale. “Accumulated other comprehensive income, unrealized income” on available-for-sale Agency MBS was approximately $31.6 million, or 0.45% of the amortized cost of our Agency MBS, at December 31, 2014. This, along with “accumulated other comprehensive loss, derivatives” of approximately $46.6 million and “accumulated other comprehensive income” on available-for-sale Non-Agency MBS of approximately $5 thousand, constitutes the total “accumulated other comprehensive loss” of approximately $15 million. Non-GAAP Measure The following table represents our common stockholders’ equity with and without accumulated other comprehensive income, or AOCI, which are non-GAAP financial measures, at December 31, 2014 and December 31, 2013, respectively, which are reconciled to the nearest comparable GAAP financial measure, which is “total stockholders’ equity.”. The Company’s management believes that these financial measures, when considered together with our GAAP financial measures, provide information that is useful to investors in understanding the differences between our common stockholders’ equity including AOCI and our common stockholders’ equity without AOCI and the effect of each on our book value per share. We believe that common stockholders’ equity without AOCI is a relevant measure to provide to investors because AOCI fluctuates on a quarterly and yearly basis based upon changes in fair market values on our securities and swap agreements. Showing common stockholders’ equity without AOCI allows investors to evaluate how our common stockholders’ equity has changed exclusive of the changes in AOCI. These financial measures should not be used as a substitute in assessing the Company’s financial condition at December 31, 2014 and December 31, 2013, respectively. An analysis of any non-GAAP financial measure should be used in conjunction with results presented in accordance with GAAP. Common stockholders’ equity without AOCI ...................................................... $ AOCI – unrealized (loss) income ......................................................................... Common stockholders’ equity ............................................................................. $ Series A Preferred Stock liquidation value .......................................................... Series B Preferred Stock liquidation value........................................................... Less: Series B Preferred Stock proceeds from issuance ....................................... Total stockholders’ equity per balance sheets ...................................................... $ Common shares outstanding ................................................................................ Per Share Amounts: Common stockholders’ equity without AOCI ................................................... $ AOCI ................................................................................................................. Common stockholders’ equity ........................................................................... $ December 31, 2014 December 31, 2013 (in thousands) 723,197 $ (14,981 ) 708,216 $ 47,984 25,241 (23,924 ) 757,517 $ 109,234 6.62 $ (0.14 ) 6.48 $ 920,969 (92,008) 828,961 47,984 25,241 (23,924) 878,262 138,717 6.64 (0.66) 5.98 The primary reason for the decrease in common stockholder’s equity without AOCI, from approximately $921 million at December 31, 2013 to approximately $723 million at December 31, 2014, was due to our repurchases of our common stock. Critical Accounting Policies and Estimates Management has the obligation to ensure that its policies and methodologies are in accordance with GAAP. Management has reviewed and evaluated its critical accounting policies and believes them to be appropriate. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying audited consolidated financial statements. In preparing these audited consolidated financial statements, management has made its best estimates and judgments on the basis of information then readily available to it of certain amounts included in the audited consolidated financial statements, giving due consideration to materiality. Application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ materially and adversely from these estimates. 66 Our accounting policies are described in Note 1 to the accompanying audited consolidated financial statements. Management believes the more significant of our accounting policies are the following: Revenue Recognition The most significant source of our revenue is derived from our investments in MBS. We reflect income using the effective yield method which, through amortization of premiums and accretion of discounts at an effective yield, recognizes periodic income over the estimated life of the investment on a constant yield basis, as adjusted for actual prepayment activity and estimated prepayments. Management believes our revenue recognition policies are appropriate to reflect the substance of the underlying transactions. Interest income on our Agency MBS is accrued based on the actual coupon rate and the outstanding principal amounts of the underlying mortgages. Premiums and discounts are amortized or accreted into interest income over the expected lives of the securities using the effective interest yield method, adjusted for the effects of actual prepayments and estimated prepayments based on ASC 320- 10. Our policy for estimating prepayment speeds for calculating the effective yield is to evaluate historical performance, street consensus prepayment speeds and current market conditions. If our estimate of prepayments is incorrect, we may be required to make an adjustment to the amortization or accretion of premiums and discounts that would have an impact on future income, which could be material and adverse. For Non-Agency MBS purchased at a discount, these are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Credit Deterioration (ASC 310-30). A debt security accounted for under ASC 310-30 is initially recorded at its purchase price (fair value). The amount of expected cash flows that exceed the initial investment represents accretable yield, which is recognized as interest income on a level yield basis over the life of the security. The excess of total contractual cash flows over the cash flows expected at its origination is considered to be non-accretable yield. The Company must periodically reassess the expected cash flows of loans accounted for under ASC 310-30 along with the cash flows received. A significant increase in expected cash flows must be accounted for as an increase in the rate of accretion over the remaining life of the security. Conversely, if expected cash flows decrease, an other-than-temporary impairment must be recognized as a charge to earnings. Adjustments to the fair value of Non- Agency MBS, accounted for as available-for-sale securities, are recorded in “accumulated other comprehensive income,” or AOCI. The determination as to whether impairment and accretable yield exists is based on cash flow projections related to the securities. As a result, the timing and amount of impairment and accretable yield constitutes a material estimate that is susceptible to significant change. Valuation and Classification of Investment Securities We carry our investment securities on our balance sheet at fair value. The fair values of our Agency MBS are generally based on third party bid price indications provided by certain dealers who make markets in such securities. If, in the opinion of management, one or more securities prices reported to us are not reliable or unavailable, management reviews the fair value based on characteristics of the security it receives from the issuer and available market information. The fair values reported reflect estimates and may not necessarily be indicative of the amounts we could realize in a current market exchange. We review various factors (i.e., expected cash flows, changes in interest rates, credit protection, etc.) in determining whether and to what extent an other-than-temporary impairment exists. To the extent that unrealized losses on our Agency MBS are attributable to changes in interest rates and not credit quality, and because we did not have the intent at December 31, 2014 to sell these investments, nor is it not more likely than not that we will be required to sell these investments before recovery of their amortized cost bases, which may be at maturity, we do not consider these investments to be other-than-temporarily impaired. Losses (that are related to credit quality) on securities classified as available-for- sale, which are determined by management to be other-than-temporary in nature, are reclassified from “accumulated other comprehensive income (loss)” to current-period income (loss). For more detail on the fair value of our securities, see Note 7 to the accompanying audited consolidated financial statements. In determining the fair value of our Non-Agency MBS, management considers a number of observable market data points, including prices obtained from well-known major financial brokers that make markets in these instruments, pricing from independent pricing services, and timely trading activity in the marketplace. Management reviews these inputs in the valuation of our Non-Agency MBS. We understand that in order to determine the fair market value of a security, market participants not only consider the characteristics of the type of bond and its underlying collateral but also take into consideration the historical performance data of the underlying collateral of that security including loan delinquency, loan losses and credit enhancement. In addition, we also collect and consider current market intelligence on all major markets, including benchmark security evaluations and bid list results from various sources. Our MBS are valued using various market data points as described above, which management considers to be directly or indirectly observable parameters. Accordingly, our MBS are classified as Level 2 in the fair value hierarchy. 67 Accounting for Derivatives and Hedging Activities In accordance with ASC 815, we recognize all derivatives as either assets or liabilities and we measure these investments at fair value. Changes in fair value for derivatives not designated as hedges are recorded in our consolidated statements of income as “gain (loss) on derivatives.” In accordance with ASC 815-10, a derivative that is designated as a hedge is recognized as an asset/liability and measured at estimated fair value. In order for our interest rate swap agreements to qualify for hedge accounting, upon entering into the swap agreement, we must anticipate that the hedge will be highly “effective,” as defined by ASC 815-10. Prior to March 18, 2014 and August 22, 2014, when we de-designated our swaps from hedge accounting, on the date we entered into a derivative contract, we designated the derivative as a hedge of the variability of cash flows that are to be received or paid in connection with a recognized asset or liability (a “cash flow” hedge). Changes in the fair value of a derivative that were highly effective and that are designated and qualify as a cash flow hedge, to the extent that the hedge is effective, were recorded in “other comprehensive income” and reclassified to income when the forecasted transaction affected income (e.g., when periodic settlement interest payments were due on repurchase agreements). The swap agreements were carried on our balance sheets at their fair value based on values obtained from large financial institutions who were market makers for these types of instruments. Hedge ineffectiveness, if any, was recorded in current-period income. We formally assessed, both at the hedge’s inception and on an ongoing basis, whether the derivatives that were used in hedging transactions were highly effective in offsetting changes in the cash flows of hedged items and whether those derivatives were expected to remain highly effective in future periods. If it was determined that a derivative was not (or ceased to be) highly effective as a hedge, we discontinued hedge accounting. When we discontinued hedge accounting, the gain or loss on the derivative remains in “accumulated other comprehensive income (loss)” and is reclassified into income when the forecasted transaction affects income. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, we carry the derivative at its fair value on our balance sheets, recognizing changes in the fair value in current-period income. At December 31, 2014, none of our derivative instruments were designated as hedges. At December 31, 2013, all of our derivative instruments were classified as hedges. For purposes of the cash flow statement, cash flows from derivative instruments were classified with the cash flows from the hedged item. Cash flows from derivatives that are not hedges are classified according to the underlying nature or purpose of the derivative. For more detail on our derivative instruments, see Notes 1, 7 and 13 to the accompanying audited consolidated financial statements. Income Taxes Our financial results do not reflect provisions for current or deferred income taxes. Management believes that we have and intend to continue to operate in a manner that will allow us to be taxed as a REIT and, as a result, management does not expect to pay substantial, if any, corporate level taxes. Many of these requirements, however, are highly technical and complex. If we were to fail to meet these requirements, we would be subject to federal income tax. Recent Accounting Pronouncements A description of recent accounting pronouncements, the date adoption is required and the impact on our audited consolidated financial statements is contained in Note 1 to the accompanying audited consolidated financial statements. Subsequent Events On January 15, 2015, we declared a Series A Preferred Stock dividend of $0.539063 per share and a Series B Preferred Stock dividend of $0.390625 per share, each of which is payable on April 15, 2015 to our holders of record of Series A Preferred Stock and Series B Preferred Stock, respectively, as of the close of business on March 31, 2015. On January 27, 2015, we completed a public offering of 300,000 shares of our 7.625% Series C Cumulative Redeemable Preferred Stock and received net proceeds of approximately $7.0 million. The shares were sold pursuant to our shelf registration statement on Form S-3. From January 1, 2015 through February 20, 2015, we issued an aggregate of 74,656 shares of our common stock at a weighted average price of $5.22 per share under our 2012 Dividend Reinvestment and Stock Purchase Plan, resulting in net proceeds to us of approximately $389 thousand. 68 From January 1, 2015 through February 20, 2015, we repurchased an aggregate of 3,056,139 shares of our common stock at a weighted average price of $5.16 per share under our share repurchase program. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We seek to manage the interest rate, market value, liquidity, prepayment and credit risks inherent in all financial instruments in a prudent manner designed to insure our longevity while, at the same time, seeking to provide an opportunity for stockholders to realize attractive total rates of return through ownership of our common stock. While we do not seek to avoid risk completely, we do seek, to the best of our ability, to assume risk that can be quantified from historical experience, to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake. Interest Rate Risk We primarily invest in adjustable-rate, hybrid and fixed-rate mortgage-related assets. Hybrid mortgages are ARMs that have a fixed interest rate for an initial period of time (typically three years or greater) and then convert to an adjustable-rate for the remaining loan term. Our debt obligations are generally repurchase agreements of limited duration that are periodically refinanced at current market rates. ARM-related assets are typically subject to periodic and lifetime interest rate caps that limit the amount an ARM-related asset’s interest rate can change during any given period. ARM securities are also typically subject to a minimum interest rate payable. Our borrowings are not subject to similar restrictions. Hence, in a period of increasing interest rates, interest rates on our borrowings could increase without limitation, while the interest rates on our mortgage-related assets could be limited. This problem would be magnified to the extent we acquire mortgage-related assets that are not fully indexed. Further, some ARM-related assets may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. These factors could lower our net interest income or cause a net loss during periods of rising interest rates, which would negatively impact our liquidity, net income and our ability to make distributions to stockholders. We fund the purchase of a substantial portion of our ARM-related assets with borrowings that have interest rates based on indices and repricing terms similar to, but of shorter maturities than, the interest rate indices and repricing terms of our mortgage assets. Thus, we anticipate that in most cases the interest rate indices and repricing terms of our mortgage assets and our funding sources will not be identical, thereby creating an interest rate mismatch between assets and liabilities. During periods of changing interest rates, such interest rate mismatches could negatively impact our net interest income, dividend yield and the market price of our common stock. Most of our adjustable-rate assets are based on the one-year constant maturity treasury rate and the one-year LIBOR rate and our debt obligations are generally based on LIBOR. These indices generally move in the same direction, but there can be no assurance that this will continue to occur. Our ARM-related assets and borrowings reset at various different dates for the specific asset or obligation. In general, the repricing of our debt obligations occurs more quickly than on our assets. Therefore, on average, our cost of funds may rise or fall more quickly than does our earnings rate on the assets. Further, our net income may vary somewhat as the spread between one-month interest rates and six- and twelve-month interest rates varies. 69 At December 31, 2014, our MBS and related borrowings will prospectively reprice based on the following time frames (dollar amounts in thousands): Investments(1)(2) Borrowings Amount Percentage of Total Investments Amount Percentage of Total Borrowings Agency MBS Portfolio: Investment Type/Rate Reset Dates: 15-year fixed-rate investments ......................... $ 20-year and 30-year fixed-rate investments ..... 1,042,820 230,137 Adjustable-Rate Investments/Obligations: Less than 3 months ........................................... Greater than 3 months and less than 1 year ...... Greater than 1 year and less than 2 years ......... Greater than 2 years and less than 3 years ........ Greater than 3 years and less than 4 years ........ Greater than 4 years and less than 5 years ........ Greater than 5 years and less than 7 years ........ Greater than 7 years ......................................... Non-Agency MBS Portfolio: Floating-rate MBS(3) .............................................. Hybrid MBS .......................................................... Fixed-rate MBS ..................................................... Total MBS Portfolio: ..................................... $ 570,045 1,258,553 951,325 791,649 254,491 496,154 810,394 617,795 35,796 40,589 123,325 7,223,073 14.4% $ 3.2 7.9 17.4 13.2 11.0 3.5 6.9 11.2 8.5 0.5 0.6 1.7 100.0% $ - - 6,370,740 - - - - - - - - - - 6,370,740 -% - 100.0 - - - - - - - - - - 100.0% (1) Based on when they contractually reprice and do not reflect the effect of any prepayments. (2) We assume that if the repricing of the investment is just beyond 3 months but less than 4 months, it is included in the “3 months or less” category. (3) Floating-rate Non-Agency MBS are based on 1-month LIBOR. At December 31, 2013, our MBS and related borrowings will prospectively reprice based on the following time frames (dollar amounts in thousands): Investments(1)(2) Borrowings Amount Percentage of Total Investments Amount Percentage of Total Borrowings Investment Type/Rate Reset Dates: 15-year fixed-rate investments ............................. $ 30-year fixed-rate investments ............................. 1,658,348 111,038 Adjustable-Rate Investments/Obligations: Less than 3 months ............................................... Greater than 3 months and less than 1 year .......... Greater than 1 year and less than 2 years ............. Greater than 2 years and less than 3 years ............ Greater than 3 years and less than 4 years ............ Greater than 4 years and less than 5 years ............ Greater than 5 years and less than 7 years ............ Greater than 7 years .............................................. Total: ................................................................. $ 528,776 1,113,514 730,340 1,273,775 873,407 293,402 1,305,608 668,238 8,556,446 19.4% $ 1.3 6.2 13.0 8.5 14.9 10.2 3.4 15.3 7.8 - - 7,580,000 - - - - - - -% - 100.0 - - - - - - 100.0% $ 7,580,000 100.00% (1) Based on when they contractually reprice and do not reflect the effect of any prepayments. (2) We assume that if the repricing of the investment is just beyond 3 months but less than 4 months, it is included in the “3 months or less” category. 70 Market Risk Market Value Risk All of our MBS are classified as available-for-sale assets. As such, they are reflected at fair value (i.e., market value) with the periodic adjustment to fair value (that is not considered to be an other-than-temporary impairment) reflected as part of “accumulated other comprehensive income” that is included in the equity section of our balance sheet. The market value of our assets can fluctuate due to changes in interest rates and other factors. At December 31, 2014, the fair value adjustment of our MBS reflected in AOCI increased to a positive adjustment (other comprehensive income) of approximately $31.6 million from a negative adjustment (other comprehensive loss) at December 31, 2013 of approximately $58.6 million. Real Estate Risk Non-Agency MBS and residential property values are subject to volatility and may be affected adversely by a number of factors including national, regional and local economic conditions; local real estate conditions (such as an oversupply of housing); changes or continued weakness in specific industry segments; construction quality; age and design; demographic factors; and retroactive changes to building or similar codes. Decreases in property values reduce the value of the collateral for mortgage loans and the potential proceeds available to borrowers to repay the loans, which could cause us to suffer losses on our Non-Agency MBS investments. Liquidity Risk Our primary liquidity risk arises from financing long-maturity MBS with short-term debt. The interest rates on our borrowings generally adjust more frequently than the interest rates on our adjustable-rate MBS. For example, at December 31, 2014, our Agency MBS had a weighted average term to next rate adjustment of approximately 36 months while our borrowings had a weighted average term to next rate adjustment of 37 days. After adjusting for interest rate swap transactions, the weighted average term to next rate adjustment was 767 days. Accordingly, in a period of rising interest rates, our borrowing costs will usually increase faster than our interest earnings from MBS. As a result, we could experience a decrease in net income or a net loss during these periods. Our assets that are pledged to secure short-term borrowings are high-quality liquid assets. As a result, we have been able to roll over our short- term borrowings as they mature. There can be no assurance that we will always be able to roll over our short-term debt. During the past few years, there have been continuing liquidity and credit concerns surrounding the mortgage markets and the general global economy. While the U.S. government and other foreign governments have taken various actions to address these concerns, there are also concerns about the ability of the U.S. government to meet the obligations of the Budget Control Act of 2011 and to reduce its budget deficit and about possible future rating downgrades of U.S. sovereign debt and government-sponsored agency debt. During 2013 and 2014, Congress passed several interim measures of providing temporary funding to the U.S. government and temporarily increasing the debt ceiling. On February 12, 2014, Congress passed a bill, which was signed into law by President Obama, suspending the debt ceiling until March 2015. On December 16, 2014, President Obama signed a $1.1 trillion appropriations bill that will fund most government operations through September 2015. A failure by the U.S. government to reach agreement on future budgets and debt ceilings, reduce its budget deficit or a future downgrade of U.S. sovereign debt and government-sponsored agencies debt could have a material adverse effect on the U.S. economy and the global economy. These events could have a material adverse effect on our borrowing costs, the availability of financing and the liquidity and valuation of securities in general and the securities in our portfolio. As a result, there continues to be concerns about the potential impact on product availability, liquidity, interest rates and changes in the yield curve. While we have been able to meet all of our liquidity needs to date, there are still concerns in the mortgage sector about the availability of financing generally. At December 31, 2014, we had unrestricted cash of approximately $15 million and $344 million in unpledged Agency MBS available to meet margin calls on short-term borrowings that could be caused by asset value declines or changes in lender collateralization requirements. Prepayment Risk Prepayments are the full or partial repayment of principal prior to the original term to maturity of a mortgage loan and typically occur due to refinancing of mortgage loans. Prepayment rates on mortgage-related securities and mortgage loans vary from time to time and may cause changes in the amount of our net interest income. Prepayments of ARM loans usually can be expected to increase when mortgage interest rates fall below the then-current interest rates on such loans and decrease when mortgage interest rates exceed the then-current interest rate on such loans, although such effects are not entirely predictable. Prepayment rates may also be affected by the conditions in the housing and financial markets, general economic conditions and the relative interest rates on fixed-rate loans and ARM loans underlying MBS. The purchase prices of MBS are generally based upon assumptions regarding the expected amounts and rates of prepayments. Where slow prepayment assumptions are made, we may pay a premium for MBS. To the extent such assumptions differ from the actual amounts of prepayments, we could experience reduced earnings or losses. The total prepayment of any MBS purchased at a premium by us would result in the immediate write-off of any remaining capitalized premium amount and a 71 reduction of our net interest income by such amount. In addition, in the event that we are unable to acquire new MBS to replace the prepaid MBS, our financial condition, cash flows and results of operations could be harmed. We often purchase mortgage-related assets that have a higher interest rate than the market interest rate at the time. In exchange for this higher interest rate, we must pay a premium over par value to acquire these assets. In accordance with accounting rules, we amortize this premium over the term of the MBS. As we receive repayments of mortgage principal, we amortize the premium balances as a reduction to our income. If the mortgage loans underlying MBS were prepaid at a faster rate than we anticipate, we would amortize the premium at a faster rate. This would reduce our income. Credit Risk We review credit risk and other risks of loss associated with each of our potential investments. In addition, we may diversify our portfolio of mortgage-related assets to avoid undue geographic, insurer, industry and certain other types of concentrations. We believe that our investment strategy will generally keep our risk of credit losses low to moderate. However, we retain the risk of potential credit losses on all of the loans underlying our Non-Agency MBS. On investments in Non-Agency MBS that are collateralized by non-performing loans, there is a high expectation of losses on these loans. Resolution of the loans typically comes from loan modifications, short sales and foreclosures. With respect to these Non-Agency MBS, our investments are senior in the credit structure and credit support contained in these MBS deal structures provides a level of protection from losses. We seek to manage the remaining credit risk through our pre-acquisition due diligence process and by factoring assumed credit losses into the purchase prices we pay for Non-Agency MBS. In addition, with respect to any particular target investment, we evaluate relative valuation, supply and demand trends, the shape of yield curves, prepayment rates, delinquency and default rates, recovery of various sectors and vintage of collateral. Nevertheless, unanticipated credit losses could adversely affect our operating results. General Many assumptions are made to present the information in the tables below and, as such, there can be no assurance that assumed events will occur, or that other events that could affect the outcomes will not occur; therefore, the tables below and all related disclosures constitute forward-looking statements. The analyses presented utilize assumptions and estimates based on management’s judgment and experience. Furthermore, future sales, acquisitions and restructuring could materially change the interest rate risk profile for us. The tables quantify the potential changes in net income and portfolio value should interest rates immediately change (are “shocked”) and remain at the new level for the next twelve months. The results of interest rate shocks of plus and minus 100 and 200 basis points are presented. The cash flows from our portfolio of mortgage-related assets for each rate shock scenario are projected, based on a variety of assumptions including prepayment speeds, time until coupon reset, yield on future acquisitions, slope of the yield curve and size of the portfolio. Assumptions made on the interest rate-sensitive liabilities, which are repurchase agreements, include anticipated interest rates (no negative rates are utilized), collateral requirements as a percent of the repurchase agreement and amount of borrowing. Assumptions made in calculating the impact on net asset value of interest rate shocks include projected changes in U.S. Treasury interest rates, prepayment rates and the yield spread of mortgage-related assets relative to prevailing U.S. Treasury interest rates. Tabular Presentation The information presented in the table below projects the impact of instantaneous parallel shifts in interest rates on Anworth’s annual projected net income (relative to the unchanged interest rate scenario), and the impact of the same instantaneous parallel shifts on Anworth’s projected portfolio value (the value of our assets, including the value of any derivative instruments or hedges, such as interest rate swap agreements). These projections are based on investments in place at December 31, 2014 and include all of our interest rate sensitive assets, liabilities and hedges, such as interest rate swap agreements. This analysis utilized assumptions, models and estimates of our Manager based upon our Manager’s judgment, experience and expectations. Change in Interest Rates –2% –1% 0% 1% 2% Percentage Change in Projected Net Interest Income –55% –18% 0% –24% –47% Percentage Change In Projected Portfolio Value –2.4% –0.2% 0% –0.9% –2.2% 72 The information presented in the table below projects the impact of the same sudden changes in interest rates on Anworth’s annual projected net income and projected portfolio value compared to the base case used in the table above, and the only difference is that it excludes the effect of our interest rate swap agreements and Eurodollar Futures Contracts on both net interest income and portfolio value. As of December 31, 2014, the aggregate notional amount of the interest rate swap agreements was $3.33 billion and the weighted average maturity was approximately 4 years. Change in Interest Rates –2% –1% 0% 1% 2% Percentage Change in Projected Net Interest Income 15% 52% 0% –7% –77% Percentage Change In Projected Portfolio Value 1.3% 1.6% 0% –2.7% –5.9% Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and related financial information required to be filed hereunder are indexed under Item 15 of this Annual Report on Form 10-K and are incorporated herein by reference. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. Item 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls We maintain disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported on a timely basis. Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective. Management Report on Internal Control Over Financial Reporting The management of Anworth is responsible for establishing and maintaining adequate internal control over financial reporting. Anworth’s internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of prepared financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Our management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework from 2013. Based on our assessment, we believe that, as of December 31, 2014, Anworth’s internal control over financial reporting is effective based on the criteria set forth in the 2013 COSO Framework. The Company’s independent auditors, McGladrey LLP, have issued an attestation report on the effectiveness of the Company’s internal control over financial reporting. This report appears on the following page of this Annual Report on Form 10-K. 73 Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders Anworth Mortgage Asset Corporation We have audited Anworth Mortgage Asset Corporation’s (the Company) internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Item 9A, “Management Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed 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. A company’s internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Anworth Mortgage Asset Corporation as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2014, and our report dated February 26, 2015 expressed an unqualified opinion. McGladrey LLP Los Angeles, California February 26, 2015 74 Item 9B. OTHER INFORMATION None. 75 PART III Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE The information required by this Item is incorporated herein by reference from the information under the captions entitled “Election of Directors—Information Regarding Nominees for Director,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement to be filed with the SEC no later than April 30, 2015. Item 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference from the information under the caption entitled “Executive Compensation” in our definitive proxy statement to be filed with the SEC no later than April 30, 2015. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Certain of the information required by this Item is incorporated by reference from the information under the caption entitled “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” in our definitive proxy statement to be filed with the SEC no later than April 30, 2015. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE The information required by this Item is incorporated by reference from the information under the caption entitled “Certain Relationships and Related Transactions, and Director Independence” in our definitive proxy statement to be filed with the SEC no later than April 30, 2015. Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this Item is incorporated by reference from the information under the caption entitled “Principal Accountant Fees and Services” in our definitive proxy statement to be filed with the SEC no later than April 30, 2015. 76 Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Documents filed as part of this report: PART IV (1) The following financial statements of the Company are included in Part II, Item 8 of this Annual Report on Form 10-K:  Report of Independent Registered Public Accounting Firm, McGladrey LLP;  Consolidated Balance Sheets as of December 31, 2014 and December 31, 2013;  Consolidated Statements of Income: For the Years Ended December 31, 2014, December 31, 2013 and December 31, 2012;  Consolidated Statements of Comprehensive Income: For the Years Ended December 31, 2014, December 31, 2013 and December 31, 2012;  Consolidated Statements of Stockholders’ Equity: For the Years Ended December 31, 2014, December 31, 2013 and December 31, 2012; and  Consolidated Statements of Cash Flows: For the Years Ended December 31, 2014, December 31, 2013 and December 31, 2012;  Notes to Consolidated Financial Statements. (2) Schedules to financial statements: All financial statement schedules have been omitted because they are either inapplicable or the information required is provided in the Company’s Consolidated Financial Statements and Notes thereto, included in Part II, Item 8 of this Annual Report on Form 10-K. (3) The exhibits listed on the accompanying Exhibit Index are filed as part of this Annual Report on Form 10-K. 77 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. DATED: February 26, 2015 ANWORTH MORTGAGE ASSET CORPORATION /S/ JOSEPH LLOYD MCADAMS Joseph Lloyd McAdams Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date /S/ JOSEPH LLOYD MCADAMS Joseph Lloyd McAdams /s/ THAD M. BROWN Thad M. Brown /s/ JOSEPH E. MCADAMS Joseph E. McAdams /s/ LEE A. AULT, III Lee A. Ault, III /s/ JOE E. DAVIS Joe E. Davis /s/ ROBERT C. DAVIS Robert C. Davis /s/ MARK S. MARON Mark S. Maron Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer) February 26, 2015 Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) February 26, 2015 Executive Vice President, Chief Investment Officer and Director Director Director Director Director February 26, 2015 February 26, 2015 February 26, 2015 February 26, 2015 February 26, 2015 78 ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm McGladrey LLP ................................................................................... F-2 Consolidated Balance Sheets as of December 31, 2014 and 2013 ..................................................................................................... F-3 Consolidated Statements of Income for the Years Ended December 31, 2014, 2013 and 2012 ........................................................ F-4 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 and 2012 .............................. F-5 Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2014, 2013 and 2012 .................................. F-6 Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012.................................................. F-7 Notes to Consolidated Financial Statements ...................................................................................................................................... F-8 F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders Anworth Mortgage Asset Corporation We have audited the accompanying consolidated balance sheets of Anworth Mortgage Asset Corporation and subsidiaries (the Company) as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Anworth Mortgage Asset Corporation and subsidiaries as of December 31, 2014 and 2013, and their results of operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Anworth Mortgage Asset Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated February 26, 2015 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. McGladrey LLP Los Angeles, California February 26, 2015 F-2 ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts) Agency MBS: ASSETS Agency MBS pledged to counterparties at fair value ........................................................... Agency MBS at fair value .................................................................................................... Paydowns receivable ............................................................................................................ Non-Agency MBS at fair value (including $155,311 pledged to counterparties) ...................... Residential real estate ................................................................................................................. Cash and cash equivalents .......................................................................................................... Interest and dividends receivable ............................................................................................... Derivative instruments at fair value ........................................................................................... Prepaid expenses and other ........................................................................................................ Total Assets: ............................................................................................................................ LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Accrued interest payable ....................................................................................................... Repurchase agreements ........................................................................................................ Junior subordinated notes ..................................................................................................... Derivative instruments at fair value ...................................................................................... Dividends payable on Series A Preferred Stock ................................................................... Dividends payable on Series B Preferred Stock ................................................................... Dividends payable on common stock ................................................................................... Accrued expenses and other ................................................................................................. Total Liabilities: ................................................................................................................. Series B Cumulative Convertible Preferred Stock: par value $0.01 per share; liquidating preference $25.00 per share ($25,241 and $25,241, respectively); 1,010 and 1,010 shares issued and outstanding at December 31, 2014 and December 31, 2013, respectively ............................................................................................................................ Stockholders' Equity: Series A Cumulative Preferred Stock: par value $0.01 per share; liquidating preference $25.00 per share ($47,984 and $47,984, respectively); 1,919 and 1,919 shares issued and outstanding at December 31, 2014 and December 31, 2013, respectively .................................................................................................................. Common Stock: par value $0.01 per share; authorized 200,000 shares, 109,972 issued and 109,234 outstanding at December 31, 2014 and 138,717 issued and outstanding at December 31, 2013, respectively ......................................................... Additional paid-in capital ..................................................................................................... Accumulated other comprehensive (loss) consisting of unrealized gains and losses ........... Accumulated deficit .............................................................................................................. Total Stockholders' Equity: ................................................................................................ Total Liabilities and Stockholders' Equity: ..................................................................... December 31, 2014 December 31, 2013 $ $ $ $ $ $ 6,650,143 $ 343,734 29,486 7,023,363 $ 199,710 12,871 14,989 19,115 9,792 18,495 7,298,335 $ 17,606 $ 6,370,740 37,380 45,259 1,035 394 15,396 29,084 6,516,894 $ 8,060,567 462,399 33,401 8,556,367 79 - 7,368 23,310 22,551 9,816 8,619,491 30,117 7,580,000 37,380 55,914 1,035 394 11,097 1,368 7,717,305 23,924 $ 23,924 $ 46,537 $ 46,537 1,100 1,033,015 (14,981) (308,154) 757,517 $ 7,298,335 $ 1,387 1,185,369 (92,008) (263,023) 878,262 8,619,491 $ $ See accompanying notes to audited consolidated financial statements. F-3 ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share amounts) For the Years Ended December 31, 2013 2012 2014 Interest and other income: Interest on Agency MBS ............................................................................. $ Interest on Non-Agency MBS ..................................................................... Income on rental properties ......................................................................... Other income ............................................................................................... Interest expense: Interest expense on repurchase agreements ................................................. Interest expense on junior subordinated notes ............................................. Net interest income ........................................................................................... Other Income: (Loss) gain on sales of Agency MBS ................................................................ Loss on interest rate swaps, net ......................................................................... Gain on derivatives-TBA Agency MBS, net ..................................................... Loss on derivatives-Eurodollar Futures Contracts ............................................ Recovery on Non-Agency MBS ....................................................................... Total other (loss) income ............................................................................. 155,486 $ 1,039 589 42 157,156 174,713 $ 15 - 56 174,784 78,643 1,264 79,907 77,249 (2,854) (36,676) 10,228 (1,694) 120 (30,876) 91,690 1,280 92,970 81,814 9,237 - - - 397 9,634 Operating Expenses: Management fee to related party ................................................................. General and administrative expenses ........................................................... Total operating expenses ........................................................................ Net income ........................................................................................................ $ Dividend on Series A Cumulative Preferred Stock ........................................... Dividend on Series B Cumulative Convertible Preferred Stock ....................... Net income to common stockholders ................................................................ $ (10,746) (7,008) (17,754) 28,619 $ (4,139) (1,577) 22,903 $ (11,961) (3,767) (15,728) 75,720 $ (4,142) (1,594) 69,984 $ Basic earnings per common share ..................................................................... $ Diluted earnings per common share .................................................................. $ Basic weighted average number of shares outstanding ..................................... Diluted weighted average number of shares outstanding .................................. 0.18 $ 0.18 $ 123,949 128,057 0.49 $ 0.49 $ 142,455 146,400 See accompanying notes to audited consolidated financial statements. 195,705 58 - 90 195,853 84,720 1,353 86,073 109,780 4,434 - - - 1,426 5,860 (11,585) (3,837) (15,422) 100,218 (4,045) (1,728) 94,445 0.68 0.67 138,382 142,485 F-4 ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (in thousands) For the Years Ended December 31, 2014 2013 2012 Net income ..................................................................................................................... $ Available-for-sale Agency MBS, fair value adjustment ........................................... Reclassification adjustment for loss (gain) on sales of Agency MBS included in net income ................................................................................................................ Available-for-sale Non-Agency MBS, fair value adjustment ................................... Unrealized gains (losses) on derivatives ................................................................... Reclassification adjustment for interest expense on swap agreements included in net income .............................................................................................. Other comprehensive income (loss) ............................................................................... Comprehensive income (loss) ........................................................................................ $ 28,619 $ 87,467 75,720 $ (224,927) 100,218 34,210 2,854 (74 ) (67,407 ) (9,237) (281) 3,411 54,187 77,027 105,646 $ 59,250 (171,784) (96,064) $ (4,434) (1,225) (52,691) 53,693 29,553 129,771 See accompanying notes to audited consolidated financial statements. F-5 S E I R A I D I S B U S D N A N O I T A R O P R O C T E S S A E G A G T R O M H T R O W N A Y T I U Q E ’ S R E D L O H K C O T S F O S T N E M E T A T S D E T A D I L O S N O C 2 1 0 2 d n a 3 1 0 2 , 4 1 0 2 , 1 3 r e b m e c e D d e d n E s r a e Y e h t r o F ) s t n u o m a e r a h s r e p t p e c x e , s d n a s u o h t n i ( ) 2 4 1 , 4 ( ) 2 4 1 , 4 ( ) 4 9 5 , 1 ( ) 6 6 0 , 1 7 ( ) 4 9 5 , 1 ( ) 6 6 0 , 1 7 ( 0 5 ) 1 5 2 , 4 ( 8 8 1 , 6 5 2 0 2 3 5 5 , 9 2 8 1 2 , 0 0 1 8 1 2 , 0 0 1 2 0 0 , 1 ) 5 2 2 , 1 ( 6 7 7 , 9 2 2 0 2 ) 4 4 2 , 4 ( 2 0 1 , 6 5 ) 7 ( 6 8 0 5 ) 4 3 7 ( 2 3 6 , 8 7 8 2 , 2 8 9 $ ) 7 0 4 , 0 6 2 ( $ ) 5 2 0 , 7 9 ( $ 5 8 5 , 1 3 6 6 , 5 4 1 $ 3 3 7 , 5 4 1 , 1 $ 1 4 3 , 1 $ 7 9 3 , 5 4 $ 5 1 1 , 4 3 1 l a t o T ) t i c i f e D ( . m u c c A r e h t O . m u c c A ) s s o L ( . p m o C s e v i t a v i r e D r e h t O . m u c c A . p m o C ) s s o L ( e m o c n I S B M y c n e g A - n o N r e h t O . m u c c A . p m o C ) s s o L ( e m o c n I S B M y c n e g A l a n o i t i d d A n I - d i a P l a t i p a C k c o t S n o m m o C e u l a V r a P A s e i r e S d e r r e f e r P k c o t S e u l a V r a P k c o t S n o m m o C s e r a h S g n i d n a t s t u O 1 6 7 8 , 1 A s e i r e S d e r r e f e r P s e r a h S k c o t S g n i d n a t s t u O ) 4 4 0 , 4 ( ) 4 4 0 , 4 ( ) 6 2 7 , 1 ( ) 2 8 9 , 5 9 ( ) 6 2 7 , 1 ( ) 2 8 9 , 5 9 ( 0 9 0 , 1 2 7 3 , 5 2 ) 1 3 0 , 8 3 ( ) 4 8 7 , 1 7 1 ( 2 0 2 0 2 7 , 5 7 0 2 7 , 5 7 1 6 6 , 2 6 ) 1 8 2 ( ) 4 6 1 , 4 3 2 ( 2 0 2 8 2 3 , 5 2 ) 4 5 9 , 7 3 ( 4 4 ) 7 7 ( 5 9 4 , 2 6 0 , 1 $ ) 1 4 9 , 1 6 2 ( $ ) 3 2 0 , 6 9 ( $ 0 6 3 9 3 4 , 5 7 1 $ 3 9 7 , 7 9 1 , 1 $ 0 2 4 , 1 $ 7 4 4 , 5 4 0 9 0 , 1 $ 3 1 0 , 2 4 1 0 5 3 , 4 ) 6 4 6 , 7 ( 2 4 7 7 8 , 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1 0 2 , 1 3 r e b m e c e D , e c n a l a B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . k c o t S d e r r e f e r P A s e i r e S f o e c n a u s s I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . k c o t s n o m m o c f o e c n a u s s I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . k c o t s n o m m o c f o n o i t p m e d e R . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . s n o i t a c i f i s s a l c e r d n a s t n e m t s u j d a . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . e m o c n i t e N . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . k c o t s d e t c i r t s e r f o n o i t a z i t r o m A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . e r a h s d e r r e f e r p A s e i r e S r e p 2 5 2 6 5 1 . 2 $ - 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d e r a l c e d d n e d i v i D F-6 e u l a v r i a f , e m o c n i e v i s n e h e r p m o c r e h t O . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . e r a h s d e r r e f e r p . . . . . . . . . . . . . . . . . . . e r a h s n o m m o c r e p 0 5 . 0 $ - d e r a l c e d d n e d i v i D B s e i r e S r e p 5 2 6 5 . 1 $ - d e r a l c e d d n e d i v i D 2 6 2 , 8 7 8 $ ) 3 2 0 , 3 6 2 ( $ ) 2 6 3 , 3 3 ( $ 9 7 ) 5 2 7 , 8 5 ( $ 9 6 3 , 5 8 1 , 1 $ 7 8 3 , 1 $ 7 3 5 , 6 4 $ 7 1 7 , 8 3 1 9 1 9 , 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1 0 2 , 1 3 r e b m e c e D , e c n a l a B ) 9 3 1 , 4 ( ) 9 3 1 , 4 ( ) 7 7 5 , 1 ( ) 4 3 0 , 8 6 ( ) 7 7 5 , 1 ( ) 4 3 0 , 8 6 ( 2 7 3 , 1 ) 4 7 1 , 0 5 1 ( 7 9 7 2 0 , 7 7 9 1 6 , 8 2 ) 6 3 9 , 3 ( 9 1 6 , 8 2 ) 0 2 2 , 3 1 ( ) 4 7 ( 1 2 3 , 0 9 7 9 ) 6 3 9 , 3 ( 9 6 3 , 1 ) 4 8 8 , 9 4 1 ( 3 ) 0 9 2 ( 5 9 2 ) 0 4 0 , 9 2 ( ) 8 3 7 ( . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . k c o t s n o m m o c f o e c n a u s s I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . k c o t s n o m m o c f o n o i t p m e d e R . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . s n o i t a c i f i s s a l c e r d n a s t n e m t s u j d a . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . e m o c n i t e N . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . t n e m e r i t e r g n i d n e p d e s a h c r u p e r s e r a h S . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . k c o t s d e t c i r t s e r f o n o i t a z i t r o m A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . e r a h s d e r r e f e r p A s e i r e S r e p 2 5 2 6 5 1 . 2 $ - d e r a l c e d d n e d i v i D . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . e r a h s d e r r e f e r p . . . . . . . . . . . . . . . . . . . e r a h s n o m m o c r e p 6 5 . 0 $ - d e r a l c e d d n e d i v i D B s e i r e S r e p 5 2 6 5 . 1 $ - d e r a l c e d d n e d i v i D e u l a v r i a f , e m o c n i e v i s n e h e r p m o c r e h t O 7 1 5 , 7 5 7 $ ) 4 5 1 , 8 0 3 ( $ ) 2 8 5 , 6 4 ( $ 5 6 9 5 , 1 3 $ 5 1 0 , 3 3 0 , 1 $ 0 0 1 , 1 $ 7 3 5 , 6 4 $ 4 3 2 , 9 0 1 9 1 9 , 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 1 0 2 , 1 3 r e b m e c e D , e c n a l a B . s t n e m e t a t s l a i c n a n i f d e t a d i l o s n o c d e t i d u a o t s e t o n g n i y n a p m o c c a e e S ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) For the Years Ended December 31, 2014 2013 2012 28,619 $ 75,720 $ 100,218 72,774 - - (4,434) 202 (1,426) - - - - 2,246 1,775 (3,186) (282) 167,887 Operating Activities: Net income ..................................................................................................................... $ Adjustments to reconcile net income to net cash provided by operating activities: Amortization of premium (Agency MBS) ............................................................... Accretion of purchase discounts (Non-Agency MBS) ............................................. Depreciation on rental properties ............................................................................. Loss (gain) on sales of Agency MBS ....................................................................... Amortization of restricted stock ............................................................................... Recovery on Non-Agency MBS .............................................................................. Periodic net settlements on interest rate swaps, net of amortization ........................ Loss on interest rate swaps, net ................................................................................ (Gain) on derivatives, net of derivative income-TBA Agency MBS ....................... Loss on derivatives-Eurodollar Futures Contracts ................................................... Changes in assets and liabilities: 45,690 (429) 235 2,854 97 (120) (17,509) 36,676 (10,228) 1,694 62,033 - - (9,237 ) 202 (397 ) - - - - Decrease in interest receivable ................................................................................. (Increase) decrease in prepaid expenses and other ................................................... (Decrease) increase in accrued interest payable ....................................................... Increase (decrease) in accrued expenses .................................................................. Net cash provided by operating activities .......................................................... $ 4,195 (8,679) (995) 3,092 85,192 $ 2,529 1,737 9,732 607 142,926 $ Investing Activities: Available-for-sale Agency MBS: Proceeds from sale ................................................................................................... $ Purchases ................................................................................................................. Principal payments ................................................................................................... 561,689 $ (430,779) 1,443,874 636,807 $ (2,591,994 ) 2,356,590 141,438 (3,231,919) 2,550,225 Available-for-sale Non-Agency MBS: Purchases ................................................................................................................. Principal payments ................................................................................................... Residential properties purchases .................................................................................... Net cash provided by (used in) investing activities ............................................ $ (176,062) 1,527 (13,106) 1,387,143 $ - - - 401,403 $ Financing Activities: Borrowings from repurchase agreements ....................................................................... $ Repayments on repurchase agreements ......................................................................... Settlements on terminated interest rate swaps ................................................................ Net settlements on TBA Agency MBS commitments .................................................... Common stock repurchased net of proceeds from common stock issued ...................... Proceeds on Series B Preferred Stock issued ................................................................. Proceeds on Series A Preferred Stock issued ................................................................. Series A Preferred stock dividends paid ........................................................................ Series B Preferred stock dividends paid ......................................................................... Common stock dividends paid ....................................................................................... Net cash (used in) provided by financing activities ................................................. $ Net increase (decrease) in cash and cash equivalents .......................................................... Cash and cash equivalents at beginning of period ............................................................... Cash and cash equivalents at end of period.......................................................................... $ Supplemental Disclosure of Cash Flow Information: 33,862,233 $ 42,833,039 $ (35,071,493) (43,273,039 ) - (42,438) 9,173 (152,739) - - (4,139) (1,577) (63,734) (1,464,714) $ 7,621 7,368 14,989 $ (15,293 ) 1,335 1,090 (4,117 ) (1,615 ) (81,271 ) (539,871 ) $ 4,458 2,910 7,368 $ Cash paid for interest ..................................................................................................... $ Conversions of Series B Preferred Stock into common stock ........................................ $ Common stock repurchased ........................................................................................... $ Change in payable for MBS purchased .......................................................................... $ 109,925 $ - $ 154,110 $ 24,624 $ 83,237 $ 2,633 $ 38,031 $ - $ See accompanying notes to audited consolidated financial statements. F-7 - - - (540,256) 43,857,077 (43,432,077) - 49,655 265 50 (4,044) (1,761) (102,763) 366,402 (5,967) 8,877 2,910 89,258 2,283 4,251 (20,679) ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Our Company We were incorporated in Maryland on October 20, 1997 and we commenced operations on March 17, 1998. Our principal business is investing in and managing a leveraged portfolio of residential mortgage-backed securities which presently are primarily agency mortgage-backed securities, or Agency MBS. Agency MBS include residential mortgage pass-through certificates and collateralized mortgage obligations, or CMOs, which are securities representing interests in pools of mortgage loans secured by residential property in which the principal and interest payments are guaranteed by a government-sponsored enterprise, or GSE, such as the Federal National Mortgage Association, or Fannie Mae, or the Federal Home Loan Mortgage Corporation, or Freddie Mac. We also own non-agency mortgage-backed securities, or Non-Agency MBS, which are securities issued by companies that are not guaranteed by federally sponsored enterprises and that are secured primarily by first-lien residential mortgage loans. Our principal business objective is to generate net income for distribution to our stockholders primarily based upon the spread between the interest income on our mortgage assets and our borrowing costs to finance our acquisition of those assets. In February 2014, we incorporated our wholly-owned Qualified REIT Subsidiary, or QRS, Anworth Properties, Inc., which commenced operations in March 2014. Our QRS presently has primarily through the foreclosure process acquired REIT-qualified residential real estate assets from which we receive rental income and have the potential for price appreciation. In addition, our QRS may also own other types of mortgage assets, from which we would receive interest income, and other real estate assets. We also incorporated Anworth Property Services, Inc., which we intend will elect to be treated as a Taxable REIT Subsidiary, or TRS. Our TRS is wholly-owned by us and currently not in operation. Our TRS may participate in various real estate-related activities that could earn profits that the Internal Revenue Service, or IRS, considers to be taxable income. Examples of these other activities include: the securitization of mortgage loans; mortgage origination; leasing and managing rental properties; and owning properties acquired through the foreclosure process. We operate so as to qualify to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code. As a REIT, we routinely distribute substantially all of the taxable income generated from our operations to our stockholders. As long as we retain our REIT status, we generally will not be subject to federal or state taxes on our income to the extent that we distribute our taxable net income to our stockholders. At December 31, 2014, our qualified REIT assets (real estate assets, as defined under the Code, cash and cash items and government securities) were greater than 95% of our total assets, as compared to the Code requirement that at least 75% of our total assets must be qualified REIT assets. Greater than 90% of our 2014 revenue qualified for the 75% source of income test and greater than 99% of our revenue qualified for the 95% source of income test under the REIT rules. At December 31, 2014, we believe we met all REIT requirements regarding the ownership of our common stock and the distributions of our taxable net income. Therefore, we believe that we continue to qualify as a REIT under the provisions of the Code. Our Manager We are externally managed and advised by Anworth Management, LLC, or our Manager. Effective as of December 31, 2011, we entered into a Management Agreement, or the Management Agreement, with our Manager, which effected the externalization of our management function, or the Externalization. Since the effective date, our day-to-day operations are being conducted by our Manager through the authority delegated to it under the Management Agreement and pursuant to the policies established by our board of directors. Our Manager is supervised and directed by our board of directors and is responsible for administering our day-to-day operations. In addition, our Manager is responsible for (i) the selection, purchase and sale of our investment portfolio; (ii) our financing and hedging activities; and (iii) providing us with management services. Our Manager will also perform such other services and activities relating to our assets and operations as may be appropriate. In exchange for these services, our Manager receives a management fee paid monthly in arrears in an amount equal to one-twelfth of 1.20% of our Equity (as defined in the Management Agreement). F-8 BASIS OF PRESENTATION AND CONSOLIDATION The accompanying audited consolidated financial statements are prepared on the accrual basis of accounting in accordance with generally accepted accounting principles utilized in the United States of America, or GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Material estimates that are susceptible to change relate to the determination of the fair value of investments and derivatives, cash flow projections for Non-Agency MBS, amortization of security premiums, accretion of security discounts and accounting for derivatives and hedging activities. Actual results could materially differ from these estimates. In the opinion of management, all material adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Our consolidated financial statements include the accounts of all subsidiaries. Significant intercompany accounts and transactions have been eliminated. The following is a summary of our significant accounting policies: Cash and Cash Equivalents Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. The carrying amount of cash equivalents approximates their fair value. Mortgage-Backed Securities (MBS) Agency MBS are securities that are obligations (including principal and interest) guaranteed by the U.S. government, such as Ginnie Mae, or guaranteed by federally sponsored enterprises, such as Fannie Mae or Freddie Mac. Our investment-grade Agency MBS portfolio is invested primarily in fixed-rate and adjustable-rate mortgage-backed pass-through certificates and hybrid adjustable- rate MBS. Hybrid adjustable-rate MBS have an initial interest rate that is fixed for a certain period, usually three to ten years, and then adjusts annually for the remainder of the term of the asset. We structure our investment portfolio to be diversified with a variety of prepayment characteristics, investing in mortgage assets with prepayment penalties, investing in certain mortgage security structures that have prepayment protections and purchasing mortgage assets at a premium and at a discount. A portion of our portfolio consists of Non-Agency MBS. Our principal business objective is to generate net income for distribution to our stockholders primarily based upon the spread between the interest income on our mortgage assets and our borrowing costs to finance our acquisition of those assets. We classify our MBS as either trading investments, available-for-sale investments or held-to-maturity investments. Our management determines the appropriate classification of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet date. We currently classify all of our MBS as available-for-sale. All assets that are classified as available-for-sale are carried at fair value and unrealized gains or losses are generally included in “Other comprehensive income (loss)” as a component of stockholders’ equity. Losses that are credit-related on securities classified as available-for-sale, which are determined by management to be other-than-temporary in nature, are reclassified from “Other comprehensive income” to income (loss). The most significant source of our revenue is derived from our investments in MBS. Interest income on Agency MBS is accrued based on the actual coupon rate and the outstanding principal amount of the underlying mortgages. Premiums and discounts are amortized or accreted into interest income over the estimated lives of the securities using the effective interest yield method, adjusted for the effects of actual and estimated prepayments based on the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, 320-10. Our policy for estimating prepayment speeds for calculating the effective yield is to evaluate historical performance, street consensus prepayment speeds and current market conditions. If our estimate of prepayments is materially incorrect, as compared to the aforementioned references, we may be required to make an adjustment to the amortization or accretion of premiums and discounts that would have an impact on future income, which could be material and adverse. A majority of our Non-Agency MBS are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Credit Deterioration, or ASC 310-30. A debt security accounted for under ASC 310-30 is initially recorded at its purchase price (fair value). The amount of expected cash flows that exceed the initial investment represents accretable yield, which is recognized as interest income on a level yield basis over the life of the security. The excess of total contractual cash flows over the cash flows expected at its origination is considered to be non-accretable yield. The Company must periodically reassess the expected cash flows of loans accounted for under ASC 310-30 along with the cash flows received. A significant increase in expected cash flows must be accounted for as an increase in the rate of accretion over the remaining life of the security. Conversely, if expected cash flows decrease, an other- than-temporary impairment must be recognized as a charge to earnings. Adjustments to the fair value of Non-Agency MBS, accounted F-9 for as available-for-sale securities, are recorded in “Accumulated other comprehensive income,” or AOCI. The determination as to whether impairment and accretable yield exists is based on cash flow projections related to the securities. As a result, the timing and amount of impairment and accretable yield constitutes a material estimate that is susceptible to significant change. Interest income on the Non-Agency MBS that were purchased at a discount to par value and were rated below AA at the time of purchase is recognized based on the security’s effective interest rate. The effective interest rate on these securities is based on the projected cash flows from each security, which are estimated based on the Company’s observation of current information and events and include assumptions related to interest rates, prepayment rates, and the timing and amount of credit losses. On at least a quarterly basis, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on input and analysis received from external sources, internal models, and its judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the available-for-sale securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, and prepayments of principal. Therefore actual maturities of available-for-sale securities are generally shorter than stated contractual maturities. Stated contractual maturities are generally greater than ten years. There can be no assurance that the Company’s assumptions used to estimate future cash flows or the current period’s yield for each asset would not change in the near term, and the change could be material. Based on the projected cash flows from the Company’s Non-Agency MBS purchased at a discount to par value, a portion of the purchase discount may be designated as a non-accretable discount and, therefore, not accreted into interest income. The amount designated as a non-accretable discount may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions, and other factors. If the performance of a security with a non-accretable discount is more favorable than forecasted, a portion of the amount designated as a non-accretable discount may be accreted into interest income prospectively. Conversely, if the performance of a security with a non-accretable discount is less favorable than forecasted, an impairment charge and write-down of such security to a new cost basis results. Securities are recorded on the date the securities are purchased or sold. Realized gains or losses from securities transactions are determined based on the specific identified cost of the securities. The following table shows the gross unrealized losses and fair value of those individual securities in our MBS portfolio that have been in a continuous unrealized loss position at December 31, 2014 and December 31, 2013, aggregated by investment category and length of time (dollar amounts in thousands): December 31, 2014 Description of Securities Agency MBS ............ Non-Agency MBS ............ Less Than 12 Months 12 Months or More Number of Securities Fair Value Unrealized Losses Number of Securities Fair Value Unrealized Losses Number of Securities Total Fair Value Unrealized Losses 91 $ 348,783 $ (1,792 ) 361 $ 3,032,057 $ (53,820) 452 $ 3,380,840 $ (55,612) 7 $ 45,988 $ (63 ) 0 0 0 7 $ 45,988 $ (63 ) December 31, 2013 Less Than 12 Months 12 Months or More Description of Securities Number of Securities Fair Value Unrealized Losses Number of Securities Fair Value Unrealized Losses Number of Securities Total Fair Value Unrealized Losses Agency MBS ............ 202 $ 4,262,712 $ (122,890 ) 230 $ 763,911 $ (23,089) 432 $ 5,026,623 $ (145,979) We do not consider those Agency MBS that have been in a continuous loss position for 12 months or more to be other-than- temporarily impaired. The unrealized losses on our investments in Agency MBS were caused by fluctuations in interest rates. We purchased the Agency MBS primarily at a premium relative to their face value and the contractual cash flows of those investments are guaranteed by the U.S. government or government-sponsored agencies. Since September 2008, the government-sponsored agencies have been in the conservatorship of the U.S. government. We currently do not have the intent to sell the Agency MBS at a price less than the amortized cost basis of our investments. Because the decline in market value of the Agency MBS is attributable to changes in interest rates and not the credit quality of the Agency MBS in our portfolio, and because we do not have the intent to sell these investments nor is it more likely than not that we will be required to sell these investments before recovery of their amortized cost basis, which may be at maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2014. F-10 Residential Properties Residential properties are stated at cost and consist of land, buildings and improvements, including other costs incurred during their acquisition, possession and renovation. Residential properties purchased that are not subject to an existing lease are treated as asset acquisitions and, as such, are recorded at their purchase price, including acquisition and renovation costs, all of which are allocated to land and building based upon their relative fair values at the date of acquisition. Residential properties acquired either subject to an existing lease or as part of a portfolio level transaction are treated as a business combination under ASC 805, “Business Combinations,” and, as such, are recorded at fair value, allocated to land, building and the existing lease, if applicable, based upon their relative fair values at the date of acquisition, with acquisition fees and other costs expensed as incurred. Building depreciation is computed on a straight-line basis over the estimated useful lives of the assets. We will generally use a 27.5 year estimated life with no salvage value. We will incur costs to prepare our acquired properties to be leased. These costs will be capitalized and allocated to building costs. Costs related to the restoration, renovation, or improvement of our properties that improve and extend their useful lives are capitalized and depreciated over their estimated useful lives. Expenditures for ordinary repairs and maintenance are expensed as incurred. Costs incurred by us to lease the properties will be capitalized and amortized over the life of the lease. Escrow deposits include refundable and non-refundable cash and earnest money on deposit with independent third parties for property purchases. Repurchase Agreements We finance the acquisition of MBS primarily through the use of repurchase agreements. Under these repurchase agreements, we sell securities to a lender and agree to repurchase the same securities in the future for a price that is higher than the original sales price. The difference between the sale price that we receive and the repurchase price that we pay represents interest paid to the lender. Although structured as a sale and repurchase obligation, a repurchase agreement operates as a financing under which we pledge our securities and accrued interest as collateral to secure a loan which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. We retain beneficial ownership of the pledged collateral. Upon the maturity of a repurchase agreement, we are required to repay the loan and concurrently receive back our pledged collateral from the lender or, with the consent of the lender, we may renew such agreement at the then-prevailing financing rate. These repurchase agreements may require us to pledge additional assets to the lender in the event the estimated fair value of the existing pledged collateral declines. Derivative Financial Instruments Risk Management We primarily use short-term (less than or equal to 12 months) repurchase agreements to finance the purchase of MBS. These obligations expose us to variability in interest payments due to changes in interest rates. We continuously monitor changes in interest rate exposures and evaluate various opportunities to mitigate this risk. Our objective is to limit the impact of interest rate changes on earnings and cash flows. The principal instruments we use to achieve this are interest rate swaps and Eurodollar Futures Contracts. Interest rate swaps effectively convert a percentage of our repurchase agreements to fixed-rate obligations over a period of up to ten years. Under interest rate swaps, we agree to pay an amount equal to a specified fixed rate of interest times a notional principal amount and to receive in return an amount equal to a specified variable-rate of interest times a notional amount, generally based on the London Interbank Offered Rate, or LIBOR. The notional amounts are not exchanged. We do not issue or hold the interest rate swaps and the Eurodollar Futures Contracts for speculative purposes. See Note 13 for more information on the Eurodollar Futures Contracts. We may also enter into To-Be-Announced, or TBA, Agency MBS as a means of investing in and financing agency MBS or as a means of disposing of or reducing our exposure to agency securities. Pursuant to TBA contracts, we agree to purchase or sell, for future delivery, agency MBS with certain principal and interest terms and certain types of collateral, but the particular agency MBS to be delivered are not identified until shortly before the TBA settlement date. We also may choose, prior to settlement, to move the settlement of these MBS out to a later date by entering into an offsetting short or long 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. This transaction is commonly referred to as a “dollar roll.” The agency MBS purchased or sold for a forward settlement date are typically priced at a discount to agency securities for settlement in the current month. This difference (or discount) is referred to as the “price drop.” The price drop represents compensation to us for foregoing net interest margin (interest income less repurchase agreement financing cost). TBA Agency MBS are accounted for as derivative instruments since they do not meet the exemption allowed for a “regular way” security trade under ASC 815, as either the TBA contracts do not settle in the shortest period of time possible or we cannot assess that it is probable at inception that we will take physical delivery of the security or that we will not settle on a net basis. Accounting for Derivative and Hedging Activities We account for derivative instruments in accordance with ASC 815, which requires recognition of all derivatives as either assets or liabilities and measurement of those instruments at fair value, which is typically based on values obtained from large F-11 financial institutions who are market makers for these types of instruments. The accounting for changes in the fair value on derivative instruments depends on whether the instruments are designated and qualify as hedges in accordance with ASC 815. Changes in fair value related to derivatives not designated as hedges are recorded in our consolidated statements of income as “Gain (loss) on derivatives” and specifically identified as either relating to interest rate swaps, Eurodollar Futures Contracts or TBA Agency MBS. For a derivative to qualify for hedge accounting, we must anticipate that the hedge will be highly “effective” as defined by ASC 815- 10. A hedge of the variability of cash flows that are to be received or paid in connection with a recognized asset or liability is known as a ”cash flow” hedge. Changes in the fair value of a derivative that is highly effective and that is designated as a cash flow hedge, to the extent the hedge is effective, are recorded in AOCI and reclassified to income when the forecasted transaction affects income (e.g. when periodic settlement interest payments are due on repurchase agreements). Hedge ineffectiveness, if any, is recorded in current period income. When we discontinue hedge accounting, the gain or loss on the derivative remains in AOCI and is reclassified into income when the forecasted transaction affects income. In all situations where hedge accounting is discontinued and the derivative remains outstanding, we carry the derivative at its fair value on our balance sheet, recognizing changes in fair value in current period income. All of our swaps had historically been accounted for as cash flow hedges under ASC 815. However, on March 17, 2014, we discontinued hedge accounting on approximately $1.685 billion in notional amounts by de-designating these swaps as cash flow hedges. On August 22, 2014, we decided to discontinue hedge accounting on the remainder of our swaps. During 2014, the aggregate amount of swaps that we either terminated or that had matured was $2.61 billion. As a result of discontinuing hedge accounting for our swaps, beginning March 18, 2014 and August 23, 2014, changes in the fair value of these swaps are recorded in “Gain (loss) on interest rate swaps, net” in our consolidated statements of income rather than in AOCI. Also, net interest paid or received on these swaps which, through March 17, 2014 and August 22, 2014, was recognized in interest expense, is instead recognized in “Gain (loss) on interest rate swaps, net.” These continue to be reported as assets or liabilities on our consolidated balance sheets at their fair value. As long as the forecasted transactions that were being hedged (i.e. rollovers of our repurchase agreement borrowings) are still expected to occur, the balance in AOCI from the activity in these swaps through March 17, 2014 and August 22, 2014 will remain in AOCI and be recognized in our consolidated statements of income as “interest expense” over the remaining term of these swaps. For purposes of the consolidated statements of cash flows, cash flows hedges were classified with the cash flows from the hedged item. Cash flows from derivatives that are not hedges are classified according to the underlying nature or purpose of the derivative transaction. For more details on the amounts and other qualitative information on all our derivative transactions, see Note 13. For more information on the fair value of our derivative instruments, see Note 7. Credit Risk At December 31, 2014, we have attempted to limit our exposure to credit losses on our Agency MBS by purchasing securities primarily through Freddie Mac and Fannie Mae. The payment of principal and interest on the Freddie Mac and Fannie Mae MBS are guaranteed by those respective enterprises. In September 2008, both Freddie Mac and Fannie Mae were placed in the conservatorship of the U.S. government. While it is the intent that the conservatorship will help stabilize Freddie Mac’s and Fannie Mae’s losses and overall financial position, there can be no assurance that it will succeed or that, if necessary, Freddie Mac and Fannie Mae will be able to satisfy its guarantees of Agency MBS. There have also been concerns as to what the U.S. government will do regarding winding down the operations of Freddie Mac and Fannie Mae. There have also been concerns over the past few years regarding the credit standing of Freddie Mac, Fannie Mae, and U.S. sovereign debt. We do not know what effect any future ratings of Freddie Mac, Fannie Mae and U.S. sovereign debt may ultimately have on the U.S. economy, the value of our securities, or the ability of Freddie Mac and Fannie Mae to satisfy its guarantees of Agency MBS, if necessary. Our adjustable-rate MBS are subject to periodic and lifetime interest rate caps. Periodic caps can limit the amount an interest rate can increase during any given period. Some adjustable-rate MBS subject to periodic payment caps may result in a portion of the interest being deferred and added to the principal outstanding. We also invest in Non-Agency MBS, which are securities that are secured by pools of residential mortgages which are not issued by government-sponsored enterprises and are not guaranteed by any agency of the U.S. government or any federally chartered corporation. Such investments carry a risk that the borrower on the underlying mortgage may default on their obligation to make full and timely payments of principal and interest. Other-than-temporary losses on our available-for-sale MBS, as measured by the amount of decline in estimated fair value attributable to credit losses that are considered to be other-than-temporary, are charged against income, resulting in an adjustment of the cost basis of such securities. Based on the criteria in ASC 320-10, the determination of whether a security is other-than- temporarily impaired, or OTTI, involves judgments and assumptions based on both subjective and objective factors. When a security F-12 is impaired, an OTTI is considered to have occurred if (i) we intend to sell the security, (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis or (iii) we do not expect to recover its amortized cost basis (i.e., there is a credit-related loss). The following are among, but not all of, the factors considered in determining whether and to what extent an OTTI exists and the portion that is related to credit loss: (i) the expected cash flow from the investment; (ii) whether there has been an other-than-temporary deterioration of the credit quality of the underlying mortgages; (iii) the credit protection available to the related mortgage pool for MBS; (iv) any other market information available, including analysts’ assessments and statements, public statements and filings made by the debtor or counterparty; (v) management’s internal analysis of the security, considering all known relevant information at the time of assessment; and (vi) the magnitude and duration of historical decline in market prices. Because management’s assessments are based on factual information as well as subjective information available at the time of assessment, the determination as to whether an other-than-temporary decline exists and, if so, the amount considered impaired, is also subjective and therefore constitutes material estimates that are susceptible to significant change. For all interest rate swaps entered into on or before September 9, 2013, we are exposed to credit losses in the event of non- performance by counterparties to interest rate swap agreements. In order to limit this risk, our practice was to only enter into swaps with large financial institution counterparties who were market makers for these types of instruments, limit our exposure on each swap to a single counterparty under our defined guidelines and either pay or receive collateral to or from each counterparty on a periodic basis to cover the net fair market position of the swaps held with that counterparty. For all swaps entered into on or after September 9, 2013, all swap participants are required by rules of the Commodities Futures Trading Commission, or CFTC, under authority granted to it pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, to clear swaps through a registered derivatives clearing organization, or “swap execution facility,” through standardized documents under which each swap counterparty transfers its position to another entity whereby a central clearinghouse effectively becomes the counterparty on each side of the swap. Both the swap execution facility and the central clearinghouse could require greater initial and periodic margin (collateral) requirements and additional transaction fees. It is the intent of the Dodd-Frank Act that the clearing of swaps in this manner is designed to avoid concentration of risk in any single entity by spreading and centralizing the risk in the clearinghouse and its members. Income Taxes We have elected to be taxed as a REIT and to comply with the provisions of the Code with respect thereto. Accordingly, we will not be subject to federal income tax to the extent that our distributions to our stockholders satisfy the REIT requirements and that certain asset, income and stock ownership tests are met. We have no unrecognized tax benefits and do not anticipate any increase in unrecognized benefits during 2014 relative to any tax positions taken prior to January 1, 2014. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is our policy to record such accruals in our income taxes accounts; and no such accruals existed at December 31, 2014. We file REIT U.S. federal and California income tax returns. These returns are generally open to examination by the IRS and the California Franchise Tax Board for all years after 2010 and 2009, respectively. Cumulative Convertible Preferred Stock We classify our Series B Cumulative Convertible Preferred Stock, or Series B Preferred Stock, on our balance sheets using the guidance in ASC 480-10-S99. Our Series B Preferred Stock contains certain fundamental change provisions that allow the holder to redeem the preferred stock for cash only if certain events occur, such as a change in control. As redemption under these circumstances is not solely within our control, we have classified our Series B Preferred Stock as temporary equity. We have analyzed whether the conversion features in our Series B Preferred Stock should be bifurcated under the guidance in ASC 815-10 and have determined that bifurcation is not necessary. Stock-Based Expense In accordance with ASC 718-10, any expense relating to share-based payment transactions is recognized in the audited consolidated financial statements. Restricted stock is expensed over the vesting period (see Note 12). Earnings Per Share Basic earnings per share, or EPS, is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS assumes the conversion, exercise or issuance of all potential common stock equivalents (which includes stock options and convertible preferred stock) and the adding back of the Series B Preferred Stock dividends unless the effect is to reduce a loss or increase the income per share. F-13 The computation of EPS for the years ended December 31, 2014, 2013 and 2012 is as follows (amounts in thousands, except per share data): For the year ended December 31, 2014 ............................. Basic EPS .................................................................... $ Effect of dilutive securities .......................................... Diluted EPS ................................................................. $ For the year ended December 31, 2013 ............................. Basic EPS .................................................................... $ Effect of dilutive securities .......................................... Diluted EPS ................................................................. $ For the year ended December 31, 2012 ............................. Basic EPS .................................................................... $ Effect of dilutive securities .......................................... Diluted EPS ................................................................. $ Net Income Available to Common Stockholders Average Shares Earnings per Share 22,903 1,577 24,480 69,984 1,594 71,578 94,445 1,728 96,173 123,949 $ 4,108 128,057 $ 142,455 $ 3,945 146,400 $ 138,382 $ 4,103 142,485 $ 0.18 - 0.18 0.49 - 0.49 0.68 (0.01) 0.67 For the years ended December 31, 2014, 2013 and 2012, options to purchase 5,000, 5,000 and 320,700 shares of our common stock, respectively, were outstanding and not included in the computation of diluted EPS as their exercise price and option expense exceeded the average stock price for those respective periods. Accumulated Other Comprehensive Income In accordance with ASC 220-10-55-2, total comprehensive income is divided into net income and other comprehensive income, which includes unrealized gains and losses on marketable securities classified as available-for-sale, and unrealized gains and losses on derivative financial instruments. In accordance with ASU 2013-02, we have identified, in our Statements of Comprehensive Income, items that are reclassified and included in our statements of income. USE OF ESTIMATES The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates. RECENT ACCOUNTING PRONOUNCEMENTS In the first quarter of 2013, the FASB issued ASU 2013-04, “Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date.” This ASU requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this ASU is fixed at the reporting date, as the sum of the following: (a) the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors; and (b) any additional amount the reporting entity expects to pay on behalf of its co-obligors. This ASU also requires an entity to disclose the nature and amount of the obligation as well as other information about the obligations including the terms and conditions of the arrangement. Examples of obligations within the scope of this ASU include debt arrangements, other contractual obligations, and settled litigation and judicial rulings. This ASU was effective for our financial statements beginning with the quarter ended March 31, 2014. We have adopted this ASU and it did not have a material impact on our financial statements. In May 2014, the FASB issued a new standard on revenue recognition, ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” This new standard will replace more than 200 ad hoc pronouncements on revenue recognition. This ASU requires companies to recognize revenue in a way that shows the transfer of goods or services to customers in amounts that reflect the payment that a company expects to be entitled to in exchange for those goods or services. To do that, companies will now have to go through a five-step process: (1) tie the contract to a customer; (2) identify the contract’s performance obligations; (3) determine the transaction price; (4) connect the transaction price to the performance obligations in the contract; and (5) recognize revenue when (or as) a company satisfies the performance obligation. This ASU only affects an entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within other F-14 standards (for example, insurance contracts or lease contracts). This ASU is effective for a public entity for the financial statements beginning with the quarter ending March 31, 2017. We do not believe that this ASU will have a material impact on our financial statements. In June 2014, the FASB issued a new standard on repurchase agreements, ASU No. 2014-11, “Transfers and Servicing: Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures (Topic 860).” This new standard introduces two major changes to the existing accounting guidance: (1) it requires transferors and transferees to account for repurchase-to-maturity transactions as secured borrowings, where the transferor maintains control over the transferred asset instead of accounting for these as a sale; and (2) it requires separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, causing the repurchase agreement to be accounted for as a secured borrowing. For these types of transactions, there is additional disclosure about the nature of the transaction. This ASU also requires the following disclosures for all repurchase agreements, securities lending transactions and repurchase-to-maturity transactions that are accounted for as secured borrowings: (i) a disaggregation of the gross obligation by the class of collateral pledged; (ii) the remaining contractual tenor of the agreements; and (iii) a discussion of the potential risks associated with the agreements and the related collateral pledged, including obligations arising from a decline in the fair value of the collateral pledged and how those risks are managed. This ASU is effective for a public entity for the financial statements beginning with the quarter ending March 31, 2015. We do not believe that this ASU will have a material impact on our financial statements. In November 2014, the FASB issued ASU 2014-16, “Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is More Akin to Debt or Equity – a consensus of the FASB Emerging Issues Task Force.” U.S. GAAP defines a “hybrid” financial instrument as consisting of a host contract and an embedded derivative (for example, convertible, redeemable preferred stock). An entity must bifurcate (account for separately as a derivative) an embedded derivative from a hybrid financial instrument if the embedded derivative (1) is not clearly and closely related to the host contract and (2) meets the definition of a derivative as a freestanding instrument. To determine whether an embedded derivative is clearly and closely related to the host contract, an entity must first determine whether the terms and features in a hybrid financial instrument are debt-like versus equity-like, and then weigh the terms and features based on relevant facts and circumstances to ultimately determine the nature of the host contract. This ASU will become effective for our financial statements beginning with the quarter ended March 31, 2016. We do not believe this ASU will have a material impact on our financial statements. In January 2015, the FASB issued ASU 2015-01, “Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” Currently, an event or transaction that is unusual and occurs infrequently must be separately classified and presented as an extraordinary item net of tax after income from continuing operations. Entities are also required to disclose income taxes and earnings per share data for each extraordinary item if the amounts are not already disclosed on the face of the income statements. By removing the concept of extraordinary items from U.S. GAAP, this ASU removes the uncertainty and disparity in practice involved in identifying, presenting and disclosing extraordinary items. This ASU is effective for our financial statements beginning with the quarter ending March 31, 2016. We do not believe that this ASU will have a material impact on our financial statements. NOTE 2. REVERSE REPURCHASE AGREEMENTS At December 31, 2014, we did not have any reverse repurchase agreements outstanding. During the year ended December 31, 2014, the maximum amount of reverse repurchase agreements outstanding was $46 million and the average amount of reverse repurchase agreements outstanding was approximately $1.24 million. These investments are used as a means of investing excess cash. The collateral for these loans would be U.S. Treasury securities or Agency MBS with an aggregate fair value equal to the amount of the loans. At December 31, 2013, there were no reverse repurchase agreements outstanding. F-15 NOTE 3. MORTGAGE-BACKED SECURITIES (MBS) The following tables summarize our MBS, classified as available-for-sale, at December 31, 2014 and December 31, 2013, which are carried at their fair value (amounts in thousands): December 31, 2014 By Agency Ginnie Mae Freddie Mac Fannie Mae Total Agency MBS Non-Agency MBS Total MBS Amortized cost ................. $ Paydowns receivable(1) ..... Unrealized gains ............... Unrealized losses.............. Fair value .................... $ 11,823 $ - 32 (155 ) 11,700 $ 2,889,128 $ 29,486 21,534 (31,558) 2,908,590 $ 4,061,330 $ - 65,642 (23,899) 4,103,073 $ 6,962,281 $ 29,486 87,208 (55,612) 7,023,363 $ 199,705 $ - 68 (63) 199,710 $ 7,161,986 29,486 87,276 (55,675) 7,223,073 By Security Type ARMs Hybrids 15-Year Fixed-Rate 20-Year and 30-Year Fixed-Rate Total Agency MBS Non-Agency MBS Total MBS Amortized cost ............. $ 1,779,031 $ 3,914,431 $ 1,048,991 $ Paydowns receivable(1) .. 2,769 - 3,782 51,827 Unrealized gains ........... (9,953) (5,027 ) Unrealized losses.......... Fair value ................ $ 1,828,600 $ 3,921,806 $ 1,042,820 $ 26,717 21,290 (40,632) 219,828 $ - 10,309 - 230,137 $ 6,962,281 $ 199,705 $ 7,161,986 29,486 87,276 (55,675) 7,023,363 $ 199,710 $ 7,223,073 29,486 87,208 (55,612 ) - 68 (63) (1) Paydowns receivable are generated when the Company receives notice from Freddie Mac of prepayments but does not receive the actual cash with respect to such prepayments until the 15th day of the following month. During the year ended December 31, 2014, we received proceeds of approximately $562 million from the sales of Agency MBS and recognized gross gains on sales of approximately $2.76 million and gross realized losses on sales of approximately $5.6 million. During the year ended December 31, 2013, we received proceeds of approximately $637 million from the sales of Agency MBS and recognized gross realized gains on sales of approximately $14.89 million and gross realized losses on sales of approximately $5.65 million. During the year ended December 31, 2014, we acquired approximately $200 million of Non-Agency MBS. December 31, 2013 By Agency Ginnie Mae Freddie Mac Fannie Mae Non-Agency MBS Total MBS Amortized cost ................ Paydowns receivable(1) .... Unrealized gains .............. Unrealized losses............. Fair value ................... $ $ 13,374 $ - 10 (124) 13,260 $ 3,618,312 $ 33,401 18,384 (89,263) 3,580,834 $ 4,950,005 $ - 68,860 (56,592) 4,962,273 $ - $ - 79 - 79 $ 8,581,691 33,401 87,333 (145,979) 8,556,446 By Security Type ARMs Hybrids 15-Year Fixed-Rate 30-Year Fixed-Rate Floating-Rate CMOs(2) Total MBS Amortized cost ............... $ 1,594,183 $ Paydowns receivable(1) ... 2,843 46,294 Unrealized gains ............. (2,560 ) Unrealized losses............ Fair value .................. $ 1,640,760 $ 5,168,156 $ 30,558 31,668 (85,614) 5,144,768 $ 1,714,427 $ - 1,695 (57,774) 1,658,348 $ 103,476 $ - 7,591 (29) 111,038 $ 1,449 $ - 85 (2) 1,532 $ 8,581,691 33,401 87,333 (145,979) 8,556,446 F-16 (1) Paydowns receivable are generated when the Company receives notice from Freddie Mac of prepayments but does not receive the actual cash with respect to such prepayments until the 15th day of the following month. (2) At December 31, 2013, Non-Agency MBS were included in the Floating-Rate CMOs category. The following table presents information regarding the estimates of the contractually required payments, the cash flows expected to be collected and the estimated fair value of the Non-Agency MBS held at carrying value acquired by the Company for the year ended December 31, 2014: (in thousands) For the Year Ended December 31, 2014 Contractually required principal............................................................................................................. $ Contractual cash flows not expected to be collected (non-accretable yield) .......................................... Expected cash flows to be collected ....................................................................................................... Interest component of expected cash flows (accretable yield) ............................................................... Fair value ............................................................................................................................................... $ 236,361 (18,123) 218,238 (18,528) 199,710 The following table presents the change for the year ended December 31, 2014 of the components of the Company’s purchase discount on its Non-Agency MBS between the amount designated as the accretable discount and the non-accretable difference: For the Year Ended December 31, 2014 Accretable Discount Non- Accretable Balance, beginning of period .................................................................................................. $ Accretion of discount .............................................................................................................. Purchases ................................................................................................................................. Sales ........................................................................................................................................ Reclass adjustments for other-than-temporary impairments ................................................... Transfer from (to).................................................................................................................... Balance, end of period ............................................................................................................ $ - $ (429 ) 18,957 - - - 18,528 $ - - 18,123 - - - 18,123 At December 31, 2013, all of our Non-Agency MBS had been acquired at par. NOTE 4. RESIDENTIAL PROPERTIES At December 31, 2014, we owned 79 single-family residential properties which are all located in Southeastern Florida and are carried at a total cost, net of accumulated depreciation, of approximately $12.9 million. As we did not start this operation until March 2014, we did not own any single-family residential properties as of December 31, 2013. The income from these properties is included in our statements of income as “Income on rental properties.” The expenses on these properties are included in our statements of income in “Other expenses” and the details are included in Note 15. NOTE 5. REPURCHASE AGREEMENTS We have entered into repurchase agreements with large financial institutions to finance most of our MBS. The repurchase agreements are short-term borrowings that are secured by the market value of our MBS and bear fixed interest rates that have historically been based upon LIBOR. F-17 At December 31, 2014 and December 31, 2013, the repurchase agreements had the following balances (dollar amounts in thousands), weighted average interest rates and remaining weighted average maturities: December 31, 2014 December 31, 2013 Weighted Average Interest Rate Balance Balance Weighted Average Interest Rate Overnight ................................................................................................ $ Less than 30 days .................................................................................... 30 days to 90 days ................................................................................... Over 90 days to less than 1 year .............................................................. 1 year to 2 years ...................................................................................... Demand ................................................................................................... - 2,510,740 3,860,000 - - - $ 6,370,740 - % $ - 0.39 3,105,000 0.35 4,475,000 - - - 0.37 % $ 7,580,000 - - - -% 0.39 0.39 - - - 0.39% Weighted average maturity ..................................................................... Weighted average interest rate after adjusting for interest rate swaps ............................................................................................. Weighted average maturity after adjusting for interest rate swaps ............................................................................................. Agency MBS pledged as collateral under the repurchase agreements and swap agreements ........................................................ $ 6,650,143 Non-Agency MBS pledged as collateral under the repurchase agreements ........................................................................................... $ 767 days 155,311 37 days 1.06% 38 days 1.50% 1,010 days $ 8,060,567 $ - The following tables present information about certain assets and liabilities that are subject to master netting arrangements (or similar agreements) only in the event of default on a contract. See Notes 1, 7 and 13 for more information on the Company’s interest rate swaps (both items that were hedges and also for de-designated swaps) and other derivative instruments. December 31, 2014 (in thousands) Gross Amounts of Recognized Assets or Liabilities Gross Amounts Offset in the Balance Sheets or Liabilities Presented in the Balance Sheets Net Amounts of Assets Gross Amounts Not Offset in the Balance Sheets(1) Financial Instruments Cash Collateral Received Net Amounts Derivative assets at fair value(2) .................................... $ Total .................................... $ Repurchase Agreements(3) ...... $ Derivative liabilities at fair value(2) .................................... Total .................................... $ 9,792 $ 9,792 $ 6,370,740 $ 45,259 6,415,999 $ - $ - $ - $ - - $ 9,792 $ 9,792 $ 6,370,740 $ (9,792 ) $ (9,792 ) $ (6,370,740 ) $ 45,259 6,415,999 $ (45,259 ) (6,415,999 ) $ December 31, 2013 (in thousands) Gross Amounts of Recognized Assets or Liabilities Gross Amounts Offset in the Balance Sheets or Liabilities Presented in the Balance Sheets Net Amounts of Assets Gross Amounts Not Offset in the Balance Sheets(1) Financial Instruments Cash Collateral Received Derivative assets at fair value(2) .................................... $ Total .................................... $ Repurchase Agreements(3) ...... $ Derivative liabilities at fair value(2) .................................... Total .................................... $ 22,551 $ 22,551 $ 7,580,000 $ 55,914 7,635,914 $ 22,551 $ 22,551 $ 7,580,000 $ (22,551 ) $ (22,551 ) $ (7,580,000 ) $ 55,914 7,635,914 $ (55,914 ) (7,635,914 ) $ - $ - $ - $ - - $ F-18 - $ - $ - $ - - $ - $ - $ - $ - - $ - - - - - - - - - - Net Amounts (1) Amounts presented are limited to collateral pledged sufficient to reduce the related net amount to zero in accordance with ASU No. 2011-11, as amended by ASU No. 2013-01. (2) At December 31, 2014, we had pledged approximately $54 million in Agency MBS as collateral and paid another approximately $13 million on swap margin calls on our swap derivatives, which were approximately $8.7 million in derivative assets and approximately $43.6 million in derivative liabilities at December 31, 2014. At December 31, 2013, we had pledged approximately $84.2 million in Agency MBS as collateral and paid another approximately $7.1 million on our swap margin calls on our swap derivatives. At December 31, 2014, we had a derivative liability on the Eurodollar Futures Contracts of approximately $1.7 million and we had cash held with the broker against this liability of approximately $2.96 million. (3) At December 31, 2014, we had pledged approximately $6.65 billion in Agency MBS and approximately $155 million of Non- Agency MBS as collateral on our repurchase agreements. At December 31, 2013, we had pledged approximately $7.98 billion in Agency MBS as collateral on our repurchase agreements. NOTE 6. JUNIOR SUBORDINATED NOTES On March 15, 2005, we issued $37,380,000 of junior subordinated notes to a newly-formed statutory trust, Anworth Capital Trust I, organized by us under Delaware law. The trust issued $36,250,000 in trust preferred securities to unrelated third party investors. Both the notes and the trust preferred securities require quarterly payments and bear interest at the prevailing three-month LIBOR rate plus 3.10%, reset quarterly. The first interest payments were made on June 30, 2005. Both the notes and the trust preferred securities will mature in 2035 and are currently redeemable, at our option, in whole or in part, without penalty. We used the net proceeds of this private placement to invest in Agency MBS. We have reviewed the structure of the transaction under ASC 810-10 and concluded that Anworth Capital Trust I does not meet the requirements for consolidation. As of the date of this filing, we have not redeemed any of the notes or trust preferred securities. NOTE 7. FAIR VALUES OF FINANCIAL INSTRUMENTS As defined in ASC 820-10, fair value is the price that would be received from the sale of an asset or paid to transfer or settle a liability in an orderly transaction between market participants in the principal (or most advantageous) market for the asset or liability. ASC 820-10 establishes a fair value hierarchy that ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value are classified and disclosed in one of the three following categories: Level 1: Quoted market prices in active markets for identical assets or liabilities. Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data. This includes those financial instruments that are valued using models or other valuation methodologies where substantially all of the assumptions are observable in the marketplace, can be derived from observable market data or are supported by observable levels at which transactions are executed in the marketplace. We consider the inputs utilized to fair value our Agency MBS to be Level 2. Management bases the fair value for these investments primarily on third party bid price indications provided by dealers who make markets in these instruments. The Agency MBS market is primarily an over-the-counter market. As such, there are no standard, public market quotations or published trading data for individual MBS securities. As our portfolio consists of hundreds of similar, but distinct, securities that have each been traded with only one broker counterparty, we generally seek to have each Agency MBS security priced by one broker. The prices received are non-binding offers to trade, but are indicative quotations of the market value of our securities as of the market close on the last day of each quarter. The brokers receive trading data from several traders that participate in the active markets for these securities and directly observe numerous trades of securities similar to the securities owned by us. Given the volume of market activity for Agency MBS, it is our belief that the broker pricing accurately reflects market information for actual, contemporaneous transactions. We do not adjust quotes or prices we obtain from brokers and pricing services. In the limited instances where valuations are received on a security from multiple brokers, we use the median value of the prices received to determine fair value. To validate the prices we obtain, to ensure our fair value determinations are consistent with ASC 820, and to ensure that we properly classify these securities in the fair value hierarchy, we evaluate the pricing information we receive taking into account factors such as coupon, prepayment experience, fixed/adjustable rate, coupon index, time to reset and issuing agency, among other factors. Based on these factors, broker prices are compared to prices of similar securities provided by other brokers. If we determine (based on such a comparison and our market knowledge and expertise) that a security is priced significantly differently than similar securities, the broker is contacted and requested to revisit their valuation of the security. If a broker refuses to reconsider its valuation, we will request pricing from another broker and use the median value of the prices received to determine fair value. If we are unable to receive a valuation from another broker, the price received from an independent third party pricing service will be used, if it is determined (based on our market knowledge and expertise) to be more reliable than the broker pricing. However, the fair value reported may not be indicative of the amounts that could be realized in an actual market exchange. Our derivative assets and derivative liabilities include interest rate swaps (in which we pay a fixed-rate of interest and receive a variable-rate of interest that is based on LIBOR), TBA Agency MBS and Eurodollar Futures Contracts. The fair value of both the derivatives and the swaps are reported to us independently from dealers who are large financial institutions and are market makers for F-19 these types of instruments. The LIBOR swap rate is observable at commonly quoted intervals over the full term of the swaps and therefore is considered a Level 2 item. The fair value of the derivative instruments’ assets and liabilities are the estimated amounts the Company would either receive or pay to terminate these agreements at the reporting date, taking into account current interest rates and the Company’s credit worthiness. For more information on all our swaps (both hedged swaps and de-designated swaps) and other derivative instruments, see Note 1 and Note 13. In determining the fair value of our Non-Agency MBS, management considers a number of observable market data points, including prices obtained from well-known major financial brokers that make markets in these instruments, pricing from independent pricing services, and timely trading activity in the marketplace. Management reviews these inputs in the valuation of our Non-Agency MBS. We understand that in order to determine the fair market value of a security, market participants not only consider the characteristics of the type of bond and its underlying collateral but also take into consideration the historical performance data of the underlying collateral of that security including loan delinquency, loan losses and credit enhancement. In addition, we also collect and consider current market intelligence on all major markets, including benchmark security evaluations and bid list results from various sources. Our MBS are valued using various market data points as described above, which management considers to be directly or indirectly observable parameters. Accordingly, our MBS are classified as Level 2 in the fair value hierarchy. Level 3: Unobservable inputs that are not corroborated by market data. This is comprised of financial instruments whose fair value is estimated based on internally developed models or methodologies utilizing significant inputs that are generally less readily observable from objective sources. In determining the appropriate levels, we perform a detailed analysis of the assets and liabilities that are subject to ASC 820-10. At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as Level 3. At December 31, 2014, fair value measurements on a recurring basis were as follows (in thousands): Assets: Agency MBS(1) ........................................................... $ Non-Agency MBS(1) ................................................... $ Derivative instruments(2) ............................................ $ Liabilities: Derivative instruments(2) ............................................ $ Level 1 Level 2 Level 3 Total - $ - $ - $ - $ 7,023,363 $ 199,710 $ 9,792 $ 45,259 $ - $ - $ - $ - $ 7,023,363 199,710 9,792 45,259 (1) For more detail about the fair value of our MBS by agency and type of security, see Note 3. (2) Derivative instruments include discontinued hedges under ASC 815-10. For more detail about our derivative instruments, see Notes 1 and 13. At December 31, 2013, fair value measurements on a recurring basis were as follows (in thousands): Assets: MBS(1) ........................................................................ $ Derivative instruments(2) ............................................ $ Liabilities: Derivative instruments(2) ............................................ $ Level 1 Level 2 Level 3 Total - $ - $ - $ 8,556,446 $ 22,551 $ 55,914 $ - $ - $ - $ 8,556,446 22,551 55,914 (1) For more detail about the fair value of our MBS, including by agency and type of security, see Note 3. (2) Derivative instruments are hedging instruments under ASC 815-10. For more detail about our derivative instruments, see Notes 1 and 13. At December 31, 2014 and December 31, 2013, cash and cash equivalents, restricted cash, escrow deposits, interest receivable, repurchase agreements and interest payable are reflected in our consolidated financial statements at cost, which approximate fair value because of the nature and short term of these instruments. Junior subordinated notes are variable-rate debt and, as we believe the spread would be consistent with the expectations of market participants as of December 31, 2014 and December 31, 2013, the carrying value approximates fair value. F-20 NOTE 8. INCOME TAXES We have elected to be taxed as a REIT and to comply with the provisions of the Code with respect thereto. Accordingly, we will not be subject to federal or state income taxes to the extent that our distributions to stockholders satisfy the REIT requirements and certain asset, income and stock ownership tests are met. We believe we currently meet all REIT requirements regarding the ownership of our common stock and the distribution of our taxable net income. Therefore, we believe that we continue to qualify as a REIT under the provisions of the Code. Income tax expense (benefit) for the years ended December 31, 2014, 2013 and 2012 was zero. None of the components of income tax expense are significant on a separately stated basis. At December 31, 2014 and December 31, 2013, there were no significant deferred tax assets and deferred tax liabilities. The tables below present tax information regarding Anworth’s dividend distributions for the fiscal year ended December 31, 2014: Series A Cumulative Preferred Stock (CUSIP 03747 20 0) Declaration Date Record Date 10/03/13 01/27/14 04/17/14 07/17/14 10/17/14 12/31/13 03/31/14 06/30/14 09/30/14 12/31/14 Payable Date 01/15/14 04/15/14 07/15/14 10/15/14 01/15/15 Total: 2014 Total Distribution Per Share 2014 Ordinary Income 2014 Return of Capital Short-Term Capital Gains Carry-Over to 2015 $ $ $ $ $ $ 0.539063 $ 0.539063 $ 0.539063 $ 0.539063 $ 0.539063 $ 2.695315 $ 0.539063 $ 0.539063 $ 0.335024 $ - $ - $ 1.413150 $ - $ - $ - $ 0.539063 $ - $ 0.539063 $ - $ - $ 0.204039 $ - $ - $ 0.204039 $ - - - - 0.539063 0.539063 Series B Cumulative Convertible Preferred Stock (CUSIP 03747 30 9) Declaration Date Record Date 10/03/13 01/27/14 04/17/14 07/17/14 10/17/14 12/31/13 03/31/14 06/30/14 09/30/14 12/31/14 Payable Date 01/15/14 04/15/14 07/15/14 10/15/14 01/15/15 Total: Common Stock (CUSIP 03747 10 1) Declaration Date Record Date Payable Date 2014 Total Distribution Per Share 2014 Ordinary Income 2014 Return of Capital Short-Term Capital Gains Carry-Over to 2015 $ $ $ $ $ $ 0.390625 $ 0.390625 $ 0.390625 $ 0.390625 $ 0.390625 $ 1.953125 $ 0.390625 $ 0.390625 $ 0.242770 $ - $ - $ 1.024020 $ - $ - $ - $ 0.390625 $ - $ 0.390625 $ - $ - $ 0.147855 $ - $ - $ 0.147855 $ - - - - 0.390625 0.390625 2014 Total Distribution Per Share 2014 Ordinary Income 2014 Return of Capital Short-Term Capital Gains Carry-Over to 2015 12/13/13 03/20/14 06/19/14 09/18/14 12/18/14 12/23/13 03/31/14 06/30/14 09/30/14 12/30/14 01/29/14 04/29/14 07/29/14 10/29/14 01/29/15 Total: $ $ $ $ $ $ 0.08 $ 0.14 $ 0.14 $ 0.14 $ 0.14 $ 0.64 $ 0.080000 $ 0.140000 $ 0.082669 $ - $ - $ 0.302669 $ - $ - $ 0.010656 $ 0.140000 $ - $ 0.150656 $ - $ - $ 0.046675 $ - $ - $ 0.046675 $ - - - - 0.140000 0.140000 NOTE 9. SERIES B CUMULATIVE CONVERTIBLE PREFERRED STOCK Our Series B Preferred Stock has a par value of $0.01 per share and a liquidation preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared). The holders of our Series B Preferred Stock receive dividends at a rate of 6.25% per year on the $25.00 liquidation preference before holders of our common stock are entitled to receive any dividends. Our Series B F-21 Preferred Stock is senior to our common stock and on parity with our 8.625% Series A Cumulative Preferred Stock, or Series A Preferred Stock, with respect to the payment of distributions and amounts, upon liquidation, dissolution or winding up. So long as any shares of our Series B Preferred Stock remain outstanding, we will not, without the affirmative vote or consent of the holders of at least two-thirds of the shares of our Series B Preferred Stock outstanding at the time, authorize or create, or increase the authorized or issued amount of, any class or series of capital stock ranking senior to our Series B Preferred Stock with respect to payment of dividends or the distribution of assets upon liquidation, dissolution or winding up. Our Series B Preferred Stock has no maturity date, is not redeemable and is convertible at the then-current conversion rate into shares of our common stock per $25.00 liquidation preference. The conversion rate is adjusted in any fiscal quarter in which the cash dividends paid to common stockholders results in an annualized common stock dividend yield that is greater than 6.25%. The conversion ratio is also subject to adjustment upon the occurrence of certain specific events such as a change in control. Our Series B Preferred Stock is convertible into shares of our common stock at the option of the holder(s) of Series B Preferred Stock at any time at the then-prevailing conversion rate. At December 31, 2014, the conversion rate was 4.2029. On or after January 25, 2012, we may, at our option, under certain circumstances, convert each share of Series B Preferred Stock into a number of shares of our common stock at the then-prevailing conversion rate. We may exercise this conversion option only if our common stock price equals or exceeds 130% of the then-prevailing conversion price of our Series B Preferred Stock for at least twenty (20) trading days in a period of thirty (30) consecutive trading days (including the last trading day of such period) ending on the trading day immediately prior to our issuance of a press release announcing the exercise of the conversion option. During the year ended December 31, 2014, we did not, at our option, convert any shares of Series B Preferred Stock. Our Series B Preferred Stock contains certain fundamental change provisions that allow the holder to redeem our Series B Preferred Stock for cash if certain events occur, such as a change in control. Our Series B Preferred Stock generally does not have voting rights, except if dividends on the Series B Preferred Stock are in arrears for six or more quarterly periods (whether or not consecutive). Under such circumstances, the holders of Series B Preferred Stock, together with the holders of Series A Preferred Stock, would be entitled to elect two additional directors to our board of directors to serve until all unpaid dividends have been paid or declared and set aside for payment. In addition, certain material and adverse changes to the terms of our Series B Preferred Stock may not be taken without the affirmative vote of at least two-thirds of the outstanding shares of Series B Preferred Stock and Series A Preferred Stock voting together as a single class. Through December 31, 2014, we have declared and set aside for payment the required dividends for our Series B Preferred Stock. NOTE 10. PUBLIC OFFERINGS AND CAPITAL STOCK At December 31, 2014, our authorized capital included 200,000,000 shares of common stock, of which 109,972,144 shares were issued and 109,234,112 shares were outstanding. At December 31, 2014, our authorized capital included 20,000,000 shares of $0.01 par value preferred stock, of which 5,150,000 shares had been designated 8.625% Series A Cumulative Preferred Stock (liquidation preference $25.00 per share) and 3,150,000 shares had been designated 6.25% Series B Cumulative Convertible Preferred Stock (liquidation preference $25.00 per share). The undesignated shares of preferred stock may be issued in one or more classes or series, with such distinctive designations, rights and preferences as determined by our board of directors. At December 31, 2014, there were 1,919,378 shares of Series A Preferred Stock issued and outstanding and 1,009,640 shares of Series B Preferred Stock issued and outstanding. On October 3, 2011, we announced that our board of directors authorized a share repurchase program which permits us to acquire up to 2,000,000 shares of our common stock. The shares are expected to be acquired at prevailing prices through open market transactions. The manner, price, number and timing of share repurchases will be subject to market conditions and applicable SEC rules. On December 13, 2013, our board of directors authorized us to acquire up to an additional 5,000,000 shares of our common stock; on March 13, 2014, our board of directors authorized us to acquire up to an additional 10,000,000 shares of our common stock; on May 22, 2014, our board of directors authorized us to acquire up to an additional 10,000,000 shares of our common stock; and on October 17, 2014, our board of directors authorized us to acquire up to an additional 10,000,000 shares of our common stock, in each case through our share repurchase program. During the year ended December 31, 2014, we repurchased an aggregate of 29,778,634 shares at a weighted average price of $5.16 per share under our share repurchase program. Our Dividend Reinvestment and Stock Purchase Plan allows stockholders and non-stockholders to purchase shares of our common stock and to reinvest dividends therefrom to acquire additional shares of our common stock. On March 14, 2012, we filed a shelf registration statement on Form S-3 with the SEC, registering up to 27,000,000 shares of our common stock for our 2012 Dividend Reinvestment and Stock Purchase Plan, or the 2012 Plan. During the year ended December 31, 2014, we issued an aggregate of 285,327 shares of our common stock at a weighted average price of $5.13 per share under the 2012 Plan, resulting in proceeds to us of approximately $1.462 million. At December 31, 2014, there were approximately 16.478 million shares remaining under the 2012 Plan. On March 20, 2013, we filed a shelf registration statement on Form S-3 with the SEC and on April 5, 2013 we filed a pre- effective amendment thereto with the SEC, offering up to $544,727,778 of our capital stock. The registration statement was declared F-22 effective on April 8, 2013. At December 31, 2014, approximately $544.7 million of our capital stock was available for future issuance under the registration statement. On August 5, 2014, we filed a registration statement on Form S-8 with the SEC to register an aggregate of up to 2,000,000 shares of our common stock to be issued pursuant to the Anworth Mortgage Asset Corporation 2014 Equity Compensation Plan, or the 2014 Equity Plan. During 2014, we issued 10,000 restricted stock units (phantom shares) under the 2014 Equity Plan. NOTE 11. TRANSACTIONS WITH AFFILIATES Management Agreement and Externalization Effective as of December 31, 2011, we entered into the Management Agreement with our Manager, pursuant to which our day- to-day operations are being conducted by our Manager. Our Manager is supervised and directed by our board of directors and is responsible for (i) the selection, purchase and sale of our investment portfolio; (ii) our financing and hedging activities; and (iii) providing us with management services. Our Manager will also perform such other services and activities relating to our assets and operations as may be appropriate. In exchange for these services, our Manager receives a management fee paid monthly in arrears in an amount equal to one-twelfth of 1.20% of our Equity (as defined in the Management Agreement). On the effective date of the Management Agreement, the employment agreements with our executives were terminated, our employees became employees of our Manager, and we took such other actions as we believed were reasonably necessary to implement the Management Agreement and externalize our management function. A trust controlled by Mr. Lloyd McAdams, our Chairman, Chief Executive Officer and President, and Ms. Heather U. Baines, an Executive Vice President of our Manager, beneficially owns 50% of the outstanding membership interests of our Manager; Mr. Joseph E. McAdams, the Chief Investment Officer of our Manager, beneficially owns 45% of the outstanding membership interests of our Manager; and Mr. Thad M. Brown, our Chief Financial Officer, beneficially owns 5% of the outstanding membership interests of our Manager. The Management Agreement may only be terminated without cause, as defined in the agreement, after the expiration of any annual renewal term. We are required to provide 180-days prior notice of non-renewal of the Management Agreement and must pay a termination fee on the last day of any automatic renewal term equal to three times the average annual management fee earned by our Manager during the prior 24-month period immediately preceding the most recently completed month prior to the effective date of termination. We may only not renew the Management Agreement with or without cause with the consent of the majority of our independent directors. These provisions make it difficult to terminate the Management Agreement and increase the effective cost to us of not renewing the Management Agreement. Certain of our former officers were previously granted restricted stock and other equity awards (see Note 12), including dividend equivalent rights, in connection with their service to us, and certain of our former officers had agreements under which they would receive payments if the Company is subject to a change in control (discussed later in this Note 11). In connection with the Externalization, certain of the agreements under which our officers were granted equity awards and would be paid payments in the event of a change in control were modified so that such agreements will continue with respect to our former officers and employees after they became officers and employees of our Manager. In addition, as officers and employees of our Manager, they will continue to be eligible to receive equity awards under equity compensation plans in effect now or in the future. Messrs. Lloyd McAdams, Joseph E. McAdams, Charles J. Siegel, John T. Hillman and Ms. Heather U. Baines and others are officers and employees of PIA Farmland, Inc. and its external manager, PIA, where they devote a portion of their time. PIA Farmland, Inc., a privately-held real estate investment trust investing in U.S. farmland properties to lease to independent farm operators, was incorporated in February 2013 and acquired its first farm property in October 2013. These officers and employees are under no contractual obligations to PIA Farmland, Inc., its external manager, PIA, or to Anworth or its external manager, Anworth Management, LLC, as to their time commitment. Mr. Steven Koomar, the Chief Executive Officer of PIA Farmland, Inc., has no involvement with either Anworth or its external manager, Anworth Management, LLC. Change in Control and Arbitration Agreements On June 27, 2006, we entered into Change in Control and Arbitration Agreements with each of Mr. Thad M. Brown, our Chief Financial Officer, Mr. Charles J. Siegel, our then Senior Vice President-Finance, Ms. Bistra Pashamova, our then Senior Vice President and Portfolio Manager, and Mr. Evangelos Karagiannis, our then Vice President and Portfolio Manager, as well as certain of our other officers. In connection with the Externalization, we amended these agreements to provide that should a change in control (as defined in the amended agreements) occur, each of these officers will receive certain severance and other benefits valued as of December 31, 2011. Under the amended agreements, in the event that a change in control occurs, each of these officers will receive a F-23 lump sum payment equal to (i) 12 months annual base salary in effect on December 31, 2011, plus (ii) the average annual incentive compensation received for the two complete fiscal years prior December 31, 2011, plus (iii) the average annual bonus received for the two complete fiscal years prior to December 31, 2011, as well as other benefits. The amended Change in Control and Arbitration Agreements also provide for accelerated vesting of equity awards granted to these officers upon a change in control. Agreements with Pacific Income Advisers, Inc. On January 26, 2012, we entered into a sublease agreement that became effective on July 1, 2012 with PIA. Under the sublease agreement, we lease, on a pass-through basis, 7,300 square feet of office space from PIA at the same location and pay rent at an annual rate equal to PIA’s obligation, which is currently $61.67 per square foot. The base monthly rental for us is $37,518.40, which will be increased by 3% per annum on July 1, 2015. The sublease agreement runs through June 30, 2022 unless earlier terminated pursuant to the master lease. During the years ended December 31, 2014, 2013 and 2012, we expensed $502 thousand, $489 thousand and $396 thousand, respectively, in rent and related expenses to PIA under this sublease agreement, which is included in “other expenses” on our statements of income. At December 31, 2014, the future minimum lease commitment is as follows (in whole dollars): Year Commitment . $ 2015 456,987 $ 2016 470,720 $ 2017 484,852 $ 2018 499,398 $ 2019 514,374 $ Thereafter Total Commitment 1,352,380 $ 3,778,711 On July 25, 2008, we entered into an administrative services agreement with PIA, which was amended and restated on August 20, 2010. Under this agreement, PIA provides administrative services and equipment to us including human resources, operational support and information technology, and we pay an annual fee of 5 basis points on the first $225 million of stockholders’ equity and 1.00 basis points thereafter (paid quarterly in arrears) for those services. The administrative services agreement had an initial term of one year and renews for successive one-year terms thereafter unless either party gives notice of termination no less than 30 days before the expiration of the then-current annual term. We may also terminate the administrative services agreement upon 30 days prior written notice for any reason and immediately if there is a material breach by PIA. During the years ended December 31, 2014, 2013 and 2012, we paid fees of $191 thousand, $211 thousand and $207 thousand, respectively, to PIA in connection with this agreement. NOTE 12. EQUITY COMPENSATION PLAN 2014 Equity Compensation Plan At our 2014 annual meeting of stockholders held on May 22, 2014, our stockholders approved the adoption of the 2014 Equity Compensation Plan, or the 2014 Equity Plan, which replaced the Anworth Mortgage Asset Corporation 2004 Equity Compensation Plan, or the 2004 Plan, due to its expiration. We filed a registration statement on Form S-8 on August 5, 2014 to register up to an aggregate of 2,000,000 shares of our common stock to be issued pursuant to the 2014 Equity Plan. The 2014 Equity Plan decreases the aggregate share reserve from 3,500,000 shares that were available under the 2004 Equity Plan to 2,000,000 shares of our registered common stock available under the 2014 Equity Plan. The 2014 Equity Plan authorizes our board of directors, or a committee of our board of directors, to grant DERs or phantom shares, which qualify as performance-based awards under Section 162(m) of the Code. Unlike the 2004 Equity Plan, however, the 2014 Equity Plan does not provide for automatic increases in the aggregate share reserve or the number of shares remaining available for grant and only provides for the granting of DERs or phantom shares. During the year ended December 31, 2014, we issued 10,000 restricted stock units (phantom shares) under the 2014 Equity Plan. Certain of our former officers have previously been granted restricted stock and other equity incentive awards, including dividend equivalent rights, in connection with their service to us. In connection with the Externalization, certain of the agreements under which our former officers have been granted equity awards were modified so that such agreements will continue with respect to our former officers after they became officers and employees of our Manager. As a result, these awards and any future grants will be accounted for as non-employee awards. In addition, as officers and employees of our Manager, they will continue to be eligible to receive equity incentive awards under equity incentive plans in effect now or in the future. In accordance with the Externalization effective as of December 31, 2011, the DERs previously granted to all of our officers, with the exception of our Chief Executive Officer and Chief Financial Officer, were terminated under the 2007 Dividend Equivalent Rights Plan and were reissued under the 2004 Equity Plan with the same amounts, terms and conditions. The 2004 Equity Plan was subsequently replaced by the 2014 Equity Plan. F-24 A summary of stock option transactions that were previously issued under the 2004 Equity Compensation Plan and are outstanding under the 2014 Plan are as follows: 2014 2013 2012 Weighted Average Exercise Price Weighted Average Exercise Price Weighted Average Exercise Price Shares Shares Shares Outstanding, beginning of year ............. Granted .................................................. Exercised ............................................... Expired .................................................. Outstanding, end of year ....................... Weighted average fair value of options expired during the year ......................... Options exercisable at year-end ............ 5,000 $ - - - 5,000 $ $ 5,000 9.720 - - - 9.720 320,700 $ - - (315,700) 5,000 $ 13.736 - - 13.800 9.720 592,480 $ - - (271,780) 320,700 $ 12.535 - - 10.570 13.736 - $ 13.800 $ 10.570 5,000 320,700 The following table summarizes information about stock options outstanding at December 31, 2014: Exercise Price $ 9.72 Options Outstanding and Exercisable Remaining Contractual Life (Years) 5,000 0.6 The following table summarizes information about restricted stock transactions during the year ended December 31, 2014: Grant Date Fair Value $ $ 4.24 5.93 Unvested Shares at December 31, 2013 Restricted Shares Granted Shares Vested in 2014 Shares Forfeited Unvested Shares at December 31, 2014 Weighted Average Remaining Contractual Life (Years) 31,107 197,362 228,469 - - - 15,542 - 15,542 - 5,482 5,482 15,565 191,880 207,445 0.8 1.8 1.7 In October 2005, our board of directors approved the grant of an aggregate of 200,780 shares of restricted stock to various officers under the 2004 Equity Compensation Plan. The stock price on the grant date was $7.72. The restricted stock vests 10% per year on each anniversary date for a ten-year period and shall also vest immediately upon the death of the grantee or upon the grantee reaching age 65. Each grantee shall have the right to sell 40% of the restricted stock any time after such shares have vested. The remaining 60% of such vested restricted stock may not be sold until after termination of employment with us. We amortize the restricted stock over the vesting period, which is the lesser of ten years or the remaining number of years to age 65. Upon the expiration of the 2004 Equity Compensation Plan, this grant is now being accounted for under the 2014 Plan. In October 2006, our board of directors approved a grant of an aggregate of 197,362 shares of performance-based restricted stock to various officers under the 2004 Equity Compensation Plan. Such grant was made effective on October 18, 2006. The closing stock price on the effective date of the grant was $9.12. The shares vest in equal annual installments over a three-year period provided that the annually compounded rate of return on our common stock, including dividends, exceeds 12% measured on an annual basis as of the anniversary date of the grant. If the annually compounded rate of return does not exceed 12%, then the shares will vest on the anniversary date thereafter when the annually compounded rate of return exceeds 12%. If the annually compounded rate of return does not exceed 12% within ten years after the effective date of the grant, then the shares will be forfeited. The shares will fully vest within the ten-year period upon the death of a grantee. Upon vesting, each grantee shall have the right to sell 40% of the restricted stock any time after such shares have vested. The remaining 60% of such vested restricted stock may not be sold, transferred or pledged until after termination of employment with us or upon the tenth anniversary of the effective date. Upon the expiration of the 2004 Equity Compensation Plan, this grant is now being accounted for under the 2014 Plan. F-25 The fair value of the aforementioned stock-based awards was estimated using the Black-Scholes model with the following weighted-average assumptions: Assumptions: Dividend yield ............................................................................ Expected volatility ...................................................................... Risk-free interest rate .................................................................. Expected lives ............................................................................. 2005 Grant 2006 Grant 6.00 % 29.00 % 4.29 % 10 years 4.00% 28.00% 4.80% 10 years We recognize the expense related to restricted stock over the ten-year vesting period. During the years ended December 31, 2014, 2013 and 2012, we expensed approximately $97 thousand, $202 thousand and 202 thousand, respectively, related to these restricted stock grants. At our May 24, 2007 annual meeting of stockholders, our stockholders adopted the Anworth Mortgage Asset Corporation 2007 Dividend Equivalent Rights Plan, or the 2007 DER Plan. A dividend equivalent right, or DER, is a right to receive amounts equal in value to the dividend distributions paid on a share of our common stock. DERs are paid in either cash or shares of our common stock, whichever is specified by our Compensation Committee at the time of grant, at such times as dividends are paid on shares of our common stock during the period between the date a DER is issued and the date the DER expires or earlier terminates. The Compensation Committee may impose such other conditions to the grant of DERs as it may deem appropriate. The maximum term for DERs under the 2007 DER Plan is ten years from the date of grant. Prior to January 1, 2012, an aggregate of 582,000 DERs were issued to our officers under the 2007 DER Plan. These DERs are not attached to any stock and only have the right to receive the same cash distribution per common share distributed to our common stockholders during the term of the grant. All of these grants have a five-year term from the date of the grant. During the years ended December 31, 2014, 2013 and 2012, we paid or accrued $323 thousand, $291 thousand and $402 thousand, respectively, related to DERs granted. NOTE 13. DERIVATIVE INSTRUMENTS The table below presents the fair value of our derivative instruments as well as their classification in our consolidated balance sheets as of December 31, 2014 and December 31, 2013: Derivative Instruments Balance Sheet Location December 31, 2014 December 31, 2013 Hedged interest rate swaps ............................... Derivative Assets De-designated interest rate swaps .................... Derivative Assets TBA Agency MBS ........................................... Derivative Assets Hedged interest rate swaps ............................... Derivative Liabilities De-designated interest rate swaps .................... Derivative Liabilities Eurodollar Futures Contracts ........................... Derivative Liabilities $ $ $ $ (in thousands) - $ 8,738 1,054 9,792 $ - $ 43,565 1,694 45,259 $ 22,551 - - 22,551 55,914 - - 55,914 Interest Rate Swap Agreements At December 31, 2014, we were a counterparty to interest rate swaps, which are derivative instruments as defined by ASC 815- 10, with an aggregate notional amount of $3.33 billion and a weighted average maturity of approximately 4 years. During the year ended December 31, 2014, the aggregate amount of swaps that we either terminated or that had matured was $2.61 billion. During the year ended December 31, 2014, we entered into 11 new swap agreements with an aggregate notional amount of $565 million and terms of up to seven years. We utilize interest rate swaps to manage interest rate risk relating to our repurchase agreements and do not anticipate entering into derivative transactions for speculative or trading purposes. In accordance with the swap agreements, we will pay a fixed-rate of interest during the term of the swap agreements (ranging from 0.578% to 3.06%) and receive a payment that varies with the three-month LIBOR rate. F-26 The estimated net amount of the existing losses that were reported in AOCI at December 31, 2014 that is expected to be reclassified into earnings within the next twelve months is approximately $22 million. The amount of gains and (losses) on derivative instruments designated as cash flow hedges that was recognized in other comprehensive income during the years ended December 31, 2014, 2013 and 2012 was $(35.1) million, $62.7 million and $1 million, respectively. At December 31, 2014 and 2013, our swaps had the following notional amounts (dollar amounts in thousands), weighted average fixed rates and remaining terms (in months): Maturity Notional Amount December 31, 2014 Weighted Average Fixed Rate Remaining Term in Months Notional Amount December 31, 2013 Weighted Average Fixed Rate Remaining Term in Months Less than 12 months ............. $ 1 year to 2 years ................... 2 years to 3 years .................. 3 years to 5 years .................. 5 years to 7 years .................. 7 years to 10 years ................ $ - 550,000 795,000 1,080,000 555,000 350,000 3,330,000 -% 0.80 1.03 1.48 2.35 2.93 1.56% - $ 20 31 46 72 100 48 $ 410,000 680,000 1,145,000 1,715,000 925,000 500,000 5,375,000 2.07% 2.07 1.82 1.18 2.11 2.84 1.81% 4 18 29 48 76 107 47 Swap Agreements by Counterparty Chicago Mercantile Exchange(1) ............................................. Deutsche Bank Securities ......................................................... ING Financial Markets LLC .................................................... JPMorgan Securities ................................................................ RBS Greenwich Capital ........................................................... Nomura Securities International .............................................. Bank of New York ................................................................... Credit Suisse ............................................................................ Morgan Stanley ........................................................................ LBBW Securities, LLC ............................................................ $ $ December 31, 2014 December 31, 2013 (in thousands) 780,000 665,000 650,000 625,000 215,000 200,000 120,000 75,000 - - 3,330,000 $ $ 400,000 1,165,000 650,000 1,175,000 800,000 650,000 260,000 75,000 150,000 50,000 5,375,000 (1) For all swap agreements entered into after September 9, 2013, the counterparty is the Chicago Mercantile Exchange regardless of who the trading party is. See the section entitled “Derivative Financial Instruments – Interest Rate Risk Management” in Note 1 for additional details. Eurodollar Futures Contracts Each Eurodollar Futures Contract embodies $1 million of notional value and is effective for a term of approximately three months. We do not designate these contracts as hedges for accounting purposes. As a result, realized and unrealized changes in fair value are recognized in earnings in the period in which the changes occur. At December 31, 2014, we had 5,500 Eurodollar Futures Contracts representing $5.5 billion in notional amount. All of these contracts were entered into during 2014. The cash held by the broker on the Eurodollar Futures Contracts was approximately $2.96 million, which is included in “other assets,” and there was a derivative liability of approximately $1.7 million. For the year ended December 31, 2014, we had losses on Eurodollar Futures Contracts of approximately $1.7 million. We did not enter into these types of contracts during 2013. F-27 TBA Agency MBS We also enter into TBA contracts and will recognize a gain or loss on the sale of the contracts or dollar roll income. See the section in Note 1 on “Derivative Financial Instruments – TBA Agency MBS” for more information on TBA Agency MBS. During the year ended December 31, 2014, we recognized a gain on derivatives-TBA Agency MBS, net of derivative income, of approximately $10.2 million. During the year ended December 31, 2013, we did not enter into any TBA contracts. The types of securities involved in these TBA contracts are Fannie Mae 15-year fixed-rate securities with coupons ranging from 2.5% to 3.5%. At December 31, 2014, the notional amount of the TBA Agency MBS was approximately $690 million. For more information on our accounting policies, the objectives and risk exposures relating to derivatives and hedging agreements, see the section on “Derivative Financial Instruments” in Note 1. For more information on the fair value of our derivative instruments, see Note 7. NOTE 14. COMMITMENTS AND CONTINGENCIES Lease Commitment and Administrative Services Commitment — We sublease office space and use administrative services from PIA, as more fully described in Note 11. NOTE 15. OTHER EXPENSES For the Years Ended December 31, 2014 2013 2012 (in thousands) $ Legal and professional fees(1) .................................................................... $ Printing and stockholder communications(1) ............................................. Directors and Officers insurance ............................................................... DERs expense ........................................................................................... Amortization of restricted stock ................................................................ Software implementation and maintenance .............................................. Administrative service fees ....................................................................... Rent ........................................................................................................... Stock exchange and filing fees .................................................................. Custodian fees ........................................................................................... Sarbanes-Oxley consulting fees ................................................................ Board of directors fees and expenses ........................................................ Securities data services ............................................................................. Leasing commissions on residential properties ......................................... Other expenses on residential properties ................................................... Depreciation expense on residential properties ......................................... Property taxes on residential properties .................................................... Other ......................................................................................................... Total of other expenses: ....................................................................... $ 2,561 596 509 323 97 315 191 502 180 284 107 350 176 73 274 235 98 137 7,008 $ 503 211 469 291 202 295 211 489 215 136 107 324 131 - - - - 183 3,767 $ $ 520 205 436 402 202 287 207 396 238 136 119 327 124 - - - - 238 3,837 (1) The increase during 2014 was primarily related to the Company’s proxy solicitation contest during 2014. F-28 NOTE 16. SUMMARIZED QUARTERLY RESULTS (UNAUDITED) The following tables summarize quarterly results for the years ended December 31, 2014 and December 31, 2013. Earnings per share amounts for each quarter and the full years have been calculated separately. Accordingly, quarterly amounts may not add to the annual amounts because of substantial differences in the average shares outstanding during each period and, with regard to diluted earnings per share amounts, they may also differ because of the inclusion of the effect of potentially dilutive securities only in the periods in which such effect would have been dilutive. Dilutive EPS assumes the conversion, exercise or issuance of all potential common stock equivalents (which includes stock options and convertible preferred stock) and adding back the Series B Preferred Stock dividends, unless the effect is to reduce a loss or increase the income per share. For the year ended December 31, 2014 (in thousands, except per share amounts): First Quarter Second Quarter Third Quarter Fourth Quarter Interest and other income: Interest on Agency MBS ............................................................................ $ Interest on Non-Agency MBS .................................................................... Income on rental properties ........................................................................ Other income .............................................................................................. $ 44,394 1 - 11 44,406 41,399 $ 37,057 - 197 10 37,264 1 70 10 41,480 $ Interest expense: 19,024 318 19,342 17,922 (5,617) 10,947 Interest expense on repurchase agreements ................................................ Interest expense on junior subordinated notes ............................................ 25,807 315 26,122 15,358 Net interest income .......................................................................................... 1,594 Gain (loss) on sale of Agency MBS ................................................................. (2,006 ) Gain (loss) on interest rate swaps, net .............................................................. (779) 1,578 Gain (loss) on derivatives-TBA Agency MBS ................................................. 366 - Derivative income-TBA Agency MBS ............................................................ 111 - Gain (loss) on derivatives-Eurodollar Futures Contracts ................................. 37 33 Recovery on Non-Agency MBS ...................................................................... (3,497) (6,510 ) Expenses .......................................................................................................... 19,490 10,047 Net income (loss) ............................................................................................. (1,035) (1,035 ) Dividend on Series A Cumulative Preferred Stock .......................................... (394 ) (394) Dividend on Series B Cumulative Convertible Preferred Stock ...................... 8,618 $ 18,061 $ Net income (loss) to common stockholders ..................................................... $ 0.15 $ 0.07 $ Basic earnings (loss) per common share .......................................................... $ Diluted earnings (loss) per common share ....................................................... $ 0.15 $ 0.07 $ Basic weighted average number of shares outstanding .................................... 136,848 126,787 121,061 Diluted weighted average number of shares outstanding ................................. 140,875 130,867 125,192 27,406 314 27,720 16,686 - 628 - - - 37 (3,980) 13,371 (1,035) (394) 11,942 $ 0.09 $ 0.09 $ 32,636 1,037 322 11 34,006 6,405 317 6,722 27,284 1,169 (46,244) 8,374 688 (1,806) 12 (3,767) (14,290) (1,035) (394) (15,719) (0.14) (0.13) 111,536 115,727 F-29 For the year ended December 31, 2013 (in thousands, except per share amounts): Interest and other income: Interest on Agency MBS ............................................................................... $ Interest on Non-Agency MBS ....................................................................... Other income ................................................................................................. Interest expense: First Quarter Second Quarter Third Quarter Fourth Quarter $ 43,444 6 17 43,467 45,226 $ 42,643 3 11 42,657 5 13 45,244 $ 43,401 2 13 43,416 Interest expense on repurchase agreements ................................................... Interest expense on junior subordinated notes ............................................... 28,258 318 28,576 14,840 Net interest income ............................................................................................. - Gain on sale of Agency MBS .............................................................................. 64 Recovery on Non-Agency MBS ......................................................................... (3,814) Expenses ............................................................................................................. 11,090 Net income .......................................................................................................... (1,035) Dividend on Series A Cumulative Preferred Stock ............................................. (394) Dividend on Series B Cumulative Convertible Preferred Stock ......................... 9,661 Net income to common stockholders .................................................................. $ 0.07 Basic earnings per common share ....................................................................... $ 0.07 Diluted earnings per common share .................................................................... $ Basic weighted average number of shares outstanding ....................................... 142,903 144,252 142,380 140,314 Diluted weighted average number of shares outstanding .................................... 146,945 148,126 146,287 144,272 22,484 321 22,805 19,852 1,991 100 (3,935) 18,008 (1,035) (394) 21,569 $ 16,579 $ 0.12 $ 0.12 $ 20,902 320 21,222 22,245 5,170 129 (3,920) 23,624 (1,034) (412) 22,178 $ 0.16 $ 0.15 $ 20,046 320 20,366 24,878 2,076 103 (4,059 ) 22,998 (1,035 ) (394 ) 0.15 $ 0.15 $ NOTE 17. SUBSEQUENT EVENTS On January 15, 2015, we declared a Series A Preferred Stock dividend of $0.539063 per share and a Series B Preferred Stock dividend of $0.390625 per share, each of which is payable on April 15, 2015 to our holders of record of Series A Preferred Stock and Series B Preferred Stock, respectively, as of the close of business on March 31, 2015. On January 27, 2015, we completed a public offering of 300,000 shares of our 7.625% Series C Cumulative Redeemable Preferred Stock and received net proceeds of approximately $7.0 million. The shares were sold pursuant to our shelf registration statement on Form S-3. From January 1, 2015 through February 20, 2015, we issued an aggregate of 74,565 shares of common stock at a weighted average price of $5.22 per share under the 2012 Dividend Reinvestment and Stock Purchase Plan, resulting in proceeds to us of approximately $389 thousand. From January 1, 2015 through February 20, 2015, we had repurchased an aggregate of 3,056,139 shares of our common stock at a weighted average price of $5.16 per share under our share repurchase program. F-30 EXHIBIT INDEX Description Amended Articles of Incorporation of Anworth (incorporated by reference from our Registration Statement on Form S-11, Registration No. 333-38641, which became effective under the Securities Act of 1933 on March 12, 1998) Articles of Amendment to Amended Articles of Incorporation (incorporated by reference from our Definitive Proxy Statement filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, as filed with the SEC on May 14, 2003) Articles of Amendment to Amended Articles of Incorporation (incorporated by reference from our Current Report on Form 8-K filed with the SEC on May 28, 2008) Amended Bylaws of the Company (incorporated by reference from our Current Report on Form 8-K filed with the SEC on March 13, 2009) Amendment of Bylaws to Amended Bylaws of the Company (incorporated by reference from our Current Report on Form 8- K filed with the SEC on April 1, 2014) Articles Supplementary for Series A Cumulative Preferred Stock (incorporated by reference from our Current Report on Form 8-K filed with the SEC on November 3, 2004) Articles Supplementary for Series A Cumulative Preferred Stock (incorporated by reference from our Current Report on Form 8-K filed with the SEC on January 21, 2005) Articles Supplementary for Series B Cumulative Convertible Preferred Stock (incorporated by reference from our Current Report on Form 8-K filed with the SEC on January 30, 2007) Articles Supplementary for Series B Cumulative Convertible Preferred Stock (incorporated by reference from our Current Report on Form 8-K filed with the SEC on May 21, 2007) Exhibit Number 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10 Articles Supplementary for Series C Cumulative Redeemable Preferred Stock (incorporated by reference from our Current Report on Form 8-K filed with the SEC on January 26, 2015) 4.1 4.2 4.3 4.4 4.5 4.6 4.7 10.1* 10.2* 10.3* 10.4 Specimen Common Stock Certificate (incorporated by reference from our Registration Statement on Form S-11, Registration No. 333-38641, which became effective under the Securities Act of 1933 on March 12, 1998) Specimen Series A Cumulative Preferred Stock Certificate (incorporated by reference from our Current Report on Form 8-K filed with the SEC on November 3, 2004) Specimen Series B Cumulative Convertible Preferred Stock Certificate (incorporated by reference from our Current Report on Form 8-K filed with the SEC on January 30, 2007) Specimen Anworth Capital Trust I Floating Rate Preferred Stock Certificate (liquidation amount $1,000 per Preferred Security) (incorporated by reference from our Current Report on Form 8-K filed with the SEC on March 16, 2005) Specimen Anworth Capital Trust I Floating Rate Common Stock Certificate (liquidation amount $1,000 per Common Security) (incorporated by reference from our Current Report on Form 8-K filed with the SEC on March 16, 2005) Specimen Anworth Floating Rate Junior Subordinated Note Due 2035 (incorporated by reference from our Current Report on Form 8-K filed with the SEC on March 16, 2005) Junior Subordinated Indenture dated as of March 15, 2005, between Anworth and JPMorgan Chase Bank (incorporated by reference from our Current Report on Form 8-K filed with the SEC on March 16, 2005) 2014 Equity Compensation Plan (incorporated by reference from our Registration Statement on Form S-8 filed with the SEC on August 5, 2014) 2007 Dividend Equivalent Rights Plan (incorporated by reference from our Definitive Proxy Statement filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, as filed with the SEC on April 26, 2007) 2012 Dividend Reinvestment and Stock Purchase Plan (incorporated by reference from our Registration Statement on Form S-3, Registration No. 333-180093, which became effective under the Securities Act of 1933 on March 14, 2012) Termination Agreement, dated as of December 31, 2011, between Anworth and Lloyd McAdams, with respect to the Employment Agreement, dated as of January 1, 2002, between Anworth and Lloyd McAdams, as amended (incorporated by reference from our Current Report on Form 8-K filed with the SEC on January 3, 2012) Exhibit Number 10.5 10.6 10.7 10.8 Description Termination Agreement, dated as of December 31, 2011, between Anworth and Heather U. Baines, with respect to the Employment Agreement, dated as of January 1, 2002, between Anworth and Heather U. Baines, as amended (incorporated by reference from our Current Report on Form 8-K filed with the SEC on January 3, 2012) Termination Agreement, dated as of December 31, 2011, between Anworth and Joseph E. McAdams, with respect to the Employment Agreement, dated as of January 1, 2002, between Anworth and Joseph E. McAdams, as amended (incorporated by reference from our Current Report on Form 8-K filed with the SEC on January 3, 2012) Purchase Agreement dated as of March 15, 2005, by and among Anworth, Anworth Capital Trust I, TABERNA Preferred Funding I, Ltd., and Merrill Lynch International (incorporated by reference from our Current Report on Form 8-K filed with the SEC on March 16, 2005) Second Amended and Restated Trust Agreement dated as of September 26, 2005 by and among Anworth, JPMorgan Chase Bank, National Association, Chase Bank USA, National Association, Lloyd McAdams, Joseph McAdams, Thad Brown and the several Holders, as defined therein (incorporated by reference from our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, as filed with the SEC on March 16, 2006) 10.9* Change in Control and Arbitration Agreement, dated June 27, 2006, between Anworth and Thad M. Brown (incorporated by reference from our Current Report on Form 8-K filed with the SEC on June 28, 2006), as amended by Amendment to Anworth Mortgage Asset Corporation Change in Control and Arbitration Agreement, effective December 31, 2011, between Anworth and Thad M. Brown (incorporated by reference from our Current Report on Form 8-K filed with the SEC on January 3, 2012) 10.10 Amended and Restated Administrative Services Agreement dated August 20, 2010, between Anworth and PIA (incorporated by reference from our Current Report on Form 8-K filed with the SEC on August 20, 2010) 10.11 Management Agreement dated as of December 31, 2011 by and between Anworth Mortgage Asset Corporation and Anworth Management, LLC (incorporated by reference from our Current Report on Form 8-K filed with the SEC on January 3, 2012) 10.12 Sublease dated as of January 26, 2012, between Anworth and PIA (incorporated by reference from our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, as filed with the SEC on August 6, 2012) 12.1 Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends 23.1 Consent of Independent Registered Public Accounting Firm 31.1 Certification of the Principal Executive Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934 31.2 Certification of the Principal Financial Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934 32.1 32.2 101 101 101 101 101 101 Certifications of the Principal Executive Officer provided pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Certifications of the Principal Financial Officer provided pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 XBRL Instance Document XBRL Taxonomy Extension Schema Document XBRL Taxonomy Extension Calculation Linkbase Document XBRL Taxonomy Definition Linkbase Document XBRL Taxonomy Extension Labels Linkbase Document XBRL Taxonomy Extension Presentation Linkbase Document * Represents a management contract or compensatory plan, contract or arrangement in which any director or any of the named executives participates. [THIS PAGE INTENTIONALLY LEFT BLANK] [THIS PAGE INTENTIONALLY LEFT BLANK] Anworth Mortgage Asset Corporation 2014 Annual Report Corporate Information DIRECTORS Transfer Agent and Registrar Lloyd McAdams Chairman of the Board of Directors, President and Chief Executive Officer Joseph E. McAdams Director, Chief Investment Officer and Executive Vice President Lee A. Ault, III Director Joe E. Davis Director Robert C. Davis Director Mark S. Maron Director EXECUTIVE OFFICERS Thad M. Brown Chief Financial Officer, Secretary and Treasurer Heather U. Baines Executive Vice President Charles J. Siegel Senior Vice President—Finance and Assistant Secretary Brett Roth Senior Vice President Bistra Pashamova Senior Vice President Evangelos Karagiannis Vice President EXECUTIVE OFFICES Anworth Mortgage Asset Corporation 1299 Ocean Avenue, Second Floor Santa Monica, CA 90401 (310) 255-4493 | Fax (310) 434-0070 Corporate Website www.anworth.com American Stock Transfer & Trust Company, LLC 59 Maiden Lane, Plaza Level New York, NY 10038 Tel. (212) 936-5100 Independent Registered Public Accounting Firm McGladrey LLP 515 S. Flower Street, 41st Floor Los Angeles, CA 90071 Legal Counsel Greenberg Traurig, LLP 1840 Century Park East, Suite 1900 Los Angeles, CA 90067 Investor Relations Any stockholder wishing a copy of the Company’s Annual Report on Form 10-K or the Quarterly Report on Form 10-Q, as filed with the Securities and Exchange Commission, may obtain such report, without charge, upon written request to the Company, Attn: Investor Relations. Stock Listings The Company’s securities are traded on the New York Stock Exchange as follows: Series A Cumulative Preferred Stock (Symbol: ANHPrA); Series B Cumulative Convertible Preferred Stock (Symbol: ANHPrB); Series C Cumulative Redeemable Preferred Stock (Symbol: ANHPrC); and Common Stock (Symbol: ANH). Annual Meeting of Stockholders Our Annual Meeting of Stockholders will be held at 10:00 a.m. on Wednesday, May 20, 2015 at the offices of the Company (address above). Corporate Governance The Company filed (1) an annual certification of its Chief Executive Officer in 2014 with the NYSE regarding the Company’s compliance with the NYSE’s corporate governance listing standards and (2) the certifications of its Chief Executive Officer and Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002 as exhibits to its 2014 Annual Report on Form 10-K. Anworth Mortgage Asset Corporation 1299 Ocean Avenue, Second Floor Santa Monica, CA 90401 (310) 255-4493 Fax: (310) 434-0070 www.anworth.com 

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