recordkeeping requirements are fulfilled. Even if we maintain our qualification as a REIT, we may be subject to some federal, state and local taxes on our income.
Factors that Affect our Results of Operations and Financial Condition A variety of industry and economic factors may impact our results of operations and financial condition. These factors include:
• interest rate trends;

• prepayment rates on mortgages underlying our Agency RMBS, and credit trends insofar as they affect prepayment rates;

• competition for investments in Agency RMBS;

• actions taken by the U.S. Government, including the Federal Reserve and the U.S. Treasury;

• credit rating downgrades of the United States' and certain European countries' sovereign debt; and

• other market developments.

In addition, a variety of factors relating to our business may also impact our results of operations and financial condition. These factors include:
• our degree of leverage;

• our access to funding and borrowing capacity;

• our borrowing costs;

• our hedging activities;

• the market value of our investments; and

• the REIT requirements and the requirements to qualify for a registration exemption under the Investment Company Act.

We anticipate that, for any period during which changes in the interest rates earned on our assets do not coincide with interest rate changes on the corresponding liabilities, such assets will likely change in value more slowly than the corresponding liabilities. Consequently, changes in interest rates, particularly short term interest rates, may significantly influence our net investment income.
Our net investment income may be affected by a difference between actual prepayment rates and our projections. Prepayments on loans and securities may be influenced by changes in market interest rates and homeowners' ability and desire to refinance their mortgages. To the extent we have acquired assets at a premium or discount to par value, changes in prepayment rates may impact our anticipated yield.

The Federal Reserve expects these measures to maintain downward pressure on long-term interest rates producing an advantageous refinancing environment to homeowners. In the short term, these actions have driven Agency RMBS prices to all-time highs, which has further compressed interest spreads. It has also distorted the correlation between mortgage rates and U.S. Treasury or interest rate swaps. These factors have contributed to a challenging interest rate hedging environment.
The U.S. unemployment rate declined in 2012 from 8.5% in December 2011 to 7.8% in December 2012. This is good news, but must be tempered in part by the decrease in the participation rate, which went from 64.0% in December 2011 to 63.6% in December 2012. Uncertainty in the marketplace surrounding the longer-term pace of job creation, fiscal and tax policy continues to be a concern for the U.S. economy and likely will remain a primary focus of policy makers. The U.S. housing market is in the midst of a recovery. Select regions are showing an increase in average home prices. Existing home sales have increased recently, building on the momentum in late 2011. According to the U.S. Department of Commerce, privately-owned housing units authorized by building permits in November 2012 were at a seasonally adjusted annual rate of 899,000. To put this figure in perspective, the December 2002 annual rate was 1,896,000. Therefore, this housing recovery can be described as improving moderately, but at a slower pace then prior recoveries.
In addition, the European debt crisis, the fiscal cliff and the 2012 downgrading of a significant number of U.S. banks by Moody's also added pressure to the U.S. economy and consumer confidence.
The following trends and recent market impacts may also affect our business:
Interest Rates
As described above, the actions by the Federal Reserve have decoupled U.S. Treasury rates from mortgage rates. During the year ended December 31, 2012, the 10 Year U.S. Treasury rate decreased 12 basis points to 1.76%. This compares with a decrease of 65 and 35 basis points in the yields on par-priced Fannie Mae Agency RMBS backed by 30 year and 15 year fixed rate mortgage loans, respectively, bringing the yields to 2.23% and 1.73%, respectively, at December 31, 2012. The decrease in yields on Agency RMBS has been caused by an increase in demand, primarily from the Federal Reserve. During the three months ended December 31, 2012 the average yield on the Company's purchases of Agency RMBS was 1.65%.
Another way to demonstrate this decoupling is to look at the spread between the yield on par-priced Fannie Mae Agency RMBS backed by 15 year fixed rate mortgage loans (currently 56% of our Agency RMBS portfolio) and the three year interest rate swap rate (the current weighted average maturity of our interest rate swaps is 2.7 years).

The following table illustrates this market environment by comparing market levels for three benchmark securities or rates, the yield on five year U.S. Treasury Notes, the three year interest rate swap rate and the yield of par-priced Fannie Mae Agency RMBS backed by 15 year fixed rate mortgage loans:

                       Five Year U.S.        Three Year Interest Rate      Par-priced Fannie Mae 15
Date                   Treasury Note                Swap Rates                 year RMBS Yield
December 31, 2012             0.723 %                      0.501 %                           1.726 %
September 30, 2012            0.625 %                      0.439 %                           1.562 %
June 30, 2012                 0.718 %                      0.624 %                           2.146 %
March 31, 2012                1.039 %                      0.758 %                           2.126 %
December 31, 2011             0.832 %                      0.820 %                           2.074 %
September 30, 2011            0.952 %                      0.736 %                           2.097 %
June 30, 2011                 1.761 %                      1.147 %                           3.137 %
March 31, 2011                2.277 %                      1.571 %                           3.454 %
December 31, 2010             2.006 %                      1.279 %                           3.401 %

Source: Bloomberg & The Yield Book® Software Short-term rates have remained low, the table below presents 30-Day LIBOR, 3-Month LIBOR and the U.S. Federal Funds Target Rate at the end of each respective fiscal quarter. The availability of repurchase agreement financing is stable with interest rates between 0.43% and 0.55% for 30-90 day repurchase agreements at December 31, 2012. Several of our repurchase agreement counterparties were downgraded by Moody's in the second quarter of 2012. We believe that these downgrades resulted in slightly higher financing costs, and this modestly-incremental cost is likely to remain in place for the foreseeable future.

Date               30-Day LIBOR     3-Month LIBOR    Federal Funds Target Rate
December 31, 2012       0.209 %          0.306 %                     0.25 %
September 30, 2012      0.214 %          0.359 %                     0.25 %
June 30, 2012           0.246 %          0.461 %                     0.25 %
March 31, 2012          0.241 %          0.468 %                     0.25 %
December 31, 2011       0.295 %          0.581 %                     0.25 %
September 30, 2011      0.239 %          0.374 %                     0.25 %
June 30, 2011           0.186 %          0.246 %                     0.25 %
March 31, 2011          0.243 %          0.303 %                     0.25 %
December 31, 2010       0.261 %          0.303 %                     0.25 %

Source: Bloomberg

In 2012, the three year to 10 year portion of the yield curve flattened slightly. This has primarily been the result of various Federal Reserve actions since September 2011 designed to maintain the recent low level of the U.S. Federal Funds Target Rate and lower yields on longer term U.S. Treasury securities, which the Federal Reserve expects to consequently lower interest rates that are tied to such yields, such as mortgage rates and interest rates on commercial loans. Such programs are described in more detail below under the heading "-Government Activity." Below is a graph of the yield curve at December 31, 2012 and 2011.

        Jan-11    Feb-11    Mar-11    Apr-11    May-11    Jun-11    Jul-11    Aug-11    Sep-11    Oct-11    Nov-11    Dec-11
15 Year  17.8 %    13.6 %    13.7 %    12.2 %    12.2 %    14.7 %    15.6 %    18.4 %    23.0 %    25.2 %    23.2 %    20.8 %
30 Year  19.5 %    15.5 %    15.4 %    13.4 %    13.0 %    14.9 %    14.9 %    16.8 %    21.4 %    24.4 %    25.2 %    23.6 %


        Jan-12    Feb-12    Mar-12    Apr-12    May-12    Jun-12    Jul-12    Aug-12    Sep-12    Oct-12    Nov-12    Dec-12
15 Year  18.8 %    20.9 %    21.6 %    18.7 %    18.5 %    19.2 %    21.0 %    23.6 %    21.0 %    23.5 %    22.6 %    23.1 %
30 Year  21.6 %    25.0 %    25.8 %    23.7 %    24.8 %    25.8 %    28.0 %    31.2 %    28.0 %    31.4 %    29.6 %    30.7 %

On October 4, 2012, the Federal Housing Finance Authority (the "FHFA") released its white paper entitled "Building a New Infrastructure for the Secondary Mortgage Market" (the "FHFA White Paper"). This release follows up on the FHFA's February 21, 2012 Strategic Plan for Enterprise Conservatorships, which set forth three goals for the next phase of the Fannie Mae and Freddie Mac conservatorships. These three goals are to (i) build a new infrastructure for the secondary mortgage market, (ii) gradually contract Fannie Mae and Freddie Mac's presence in the marketplace while simplifying and shrinking their operations, and (iii) maintain foreclosure prevention activities and credit availability for new and refinanced mortgages.

The FHFA White Paper proposes a new infrastructure for Fannie Mae and Freddie Mac that has two basic goals. The first goal is to replace the current, outdated infrastructures of Fannie Mae and Freddie Mac with a common, more efficient infrastructure that aligns the standards and practices of the two entities, beginning with core functions performed by both entities such as issuance, master servicing, bond administration, collateral management and data integration. The second goal is to establish an operating framework for Fannie Mae and Freddie Mac that is consistent with the progress of housing finance reform and encourages and accommodates the increased participation of private capital in assuming credit risk associated with the secondary mortgage market. The FHFA recognizes that there are a number of impediments to their goals which may or may not be surmountable, such as the absence of any significant secondary mortgage market mechanisms beyond Fannie Mae, Freddie Mac and Ginnie Mae, and that their proposals are in the formative stages. As a result, it is unclear if the proposals will be enacted. If such proposals are enacted, it is unclear how closely what is enacted will resemble the proposals from the FHFA White Paper or what the effects of the enactment will be.

On September 13, 2012, the U.S. Federal Reserve (the "Federal Reserve"), announced a third round of quantitative easing ("QE3"), which is an open-ended program designed to expand the Federal Reserve's holdings of long-term securities by purchasing an additional $40 billion of Agency RMBS per month until key economic indicators, such as the unemployment rate, show signs of improvement. When combined with programs to extend the average maturity of the Federal Reserve's holdings of securities, which was known as "Operation Twist" and described below, and reinvest principal and interest

payments from the Federal Reserve's holdings of agency debt and Agency RMBS into Agency RMBS, QE3 was expected to increase the Federal Reserve's holdings of long-term securities by $85 billion each month through the end of 2012. The Federal Reserve also announced that it would keep the target range for the Federal Funds Rate between zero and 0.25% through at least mid-2015, which was six months longer than previously expected.

The Federal Reserve provided further guidance to the market in December 2012 by stating that it intended to keep the Federal Funds Rate close to zero while the unemployment rate is above 6.5% and as long as inflation does not rise above 2.5%. In December 2012, the Federal Reserve also announced that it would initially begin buying $45 billion of long-term Treasury bonds each month and noted that such amount may increase in the future. This bond purchase program replaced the program known as "Operation Twist," in which the Federal Reserve repurchased approximately $45 billion of long-term Treasury bonds each month and sold approximately the same amount of short-term Treasury bonds.

The Federal Reserve expects these measures to put downward pressure on long-term interest rates. In the short term, these actions have driven Agency RMBS prices to new highs, which has further compressed interest spreads, and caused the historical correlation between mortgage rates and U.S. Treasury or interest rate swaps to no longer exist.
On January 4, 2012, the Federal Reserve released a report titled "The U.S. Housing Market: Current Conditions and Policy Considerations" to Congress, which provided a framework for thinking about certain issues and tradeoffs that policy makers might consider. It is unclear how future legislation may impact the housing finance market and the investing environment for Agency RMBS as the method of reform is undecided and has not yet been defined by the regulators. In September 2011, the White House announced it is working on a major plan to allow some of the 11 million homeowners who owe more on their mortgages than their homes are worth to refinance. Consequently, in October 2011 the FHFA announced changes to the Home Affordable Refinance Program ("HARP") to expand access to refinancing for qualified individuals and families whose homes have lost value. One such change is to increase the HARP loan-to-value ceiling above 125%. However, this would only apply to mortgages guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. There are many challenging issues to this proposal, notably the question as to whether a loan with a 125% or greater loan-to-value ratio qualifies as a mortgage or an unsecured consumer loan. The chances of this initiative's success and other ideas proposed by the Federal Reserve's white paper, have created additional uncertainty in the RMBS market, particularly with respect to possible increases in prepayment rates. According to information published by the U.S. Department of Housing and Urban Development, 709,000 distressed homeowners were refinanced in the period from January through September of 2012.
In February 2011, the U.S. Department of the Treasury along with the U.S. Department of Housing and Urban Development released a report titled "Reforming America's Housing Finance Market" to Congress outlining recommendations for reforming the U.S. housing system, specifically Fannie Mae and Freddie Mac, and transforming government involvement in the housing market. It is unclear how future legislation may impact the housing finance market and the investing environment for Agency RMBS as the method of reform is undecided and has not yet been defined by the regulators.
Certain programs initiated by the U.S. Government, through the Federal Housing Administration ("FHA") and the FDIC, to provide homeowners with assistance in avoiding residential mortgage loan foreclosures are currently in effect. The programs may involve, among other things, the modification of mortgage loans to reduce the principal amount of the loans or the rate of interest payable on the loans, or to extend the payment terms of the loans. While the effect of these programs has not been as extensive as originally expected, the effect of such programs for holders of Agency RMBS could be that such holders would experience changes in the anticipated yields of their Agency RMBS due to (i) increased prepayment rates on their Agency RMBS and (ii) lower interest and principal payments on their Agency RMBS.
Dodd-Frank Act
On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act is extensive, complicated and comprehensive legislation that impacts practically all aspects of banking and represents a significant overhaul of many aspects of the regulation of the financial services industry. Although many provisions remain subject to further rulemaking, the Dodd-Frank Act implements numerous and far-reaching regulatory changes that affect financial companies, including our Company, and other banks and institutions which are important to our business model. Certain notable rules are, among other things:
• Requiring regulation and oversight of large, systemically important financial institutions ("SIFI") by establishing an interagency council on systemic risk and implementation of heightened prudential standards and regulation by the Board of Governors of the Federal Reserve for SIFI (including nonbank financial companies), as well as the implementation of the Federal Deposit Insurance Corporation ("FDIC") resolution procedures for liquidation of large financial companies to avoid market disruption;

• applying the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies, savings and loan holding companies and systemically important nonbank financial companies;

• limiting the Federal Reserve's emergency authority to lend to nondepository institutions to facilities with broad-based eligibility, and authorizing the FDIC to establish an emergency financial stabilization fund for solvent depository institutions and their holding companies, subject to the approval of Congress, the Secretary of the U.S.

• creating regimes for regulation of over-the-counter derivatives (which has included requiring some over-the-counter derivatives to be cleared on an exchange) and non-admitted property and casualty insurers and reinsurers;

• implementing regulation of hedge fund and private equity advisers by requiring such advisers to register with the SEC;

• providing for the implementation of corporate governance provisions for all public companies concerning proxy access and executive compensation; and

• reforming regulation of credit rating agencies.

Qualified Mortgages

The Dodd-Frank Act requires that lenders make a good faith effort to ensure consumers have an ability to repay new mortgage loans based on verified and documented information. To accomplish this, the Dodd-Frank Act created the Consumer Financial Protection Bureau (CFPB), which was assigned the responsibility of defining Qualified Mortgage ("QM"). The key factor for lenders and originators is that loans which meet the QM standard give lenders "safe harbor" against future claims that the loans violated "ability to repay" requirements. In January 2013, the CFPB published the definition of a QM. An important part of the QM definition is the cap on how much income can go toward debt: along with the other tests, mortgages made to people who have debt-to-income ratios less than or equal to 43 percent will be considered QM. This requirement helps ensure consumers are borrowing only what they can likely afford and it creates one level of protection for lenders. Before the crisis, many consumers took on mortgages they could not afford based on their incomes and the QM rules are intended to protect consumers going forward. For a temporary, transitional period, loans that do not have a 43 percent debt-to-income ratio but meet government affordability or other standards, such as eligibility for purchase by Fannie Mae or Freddie Mac, will be considered QMs. Agency RMBS will continue to be a large portion of the overall mortgage market, and we believe that, as a result of this rule-making, it is unlikely that lenders will be willing to make loans without the safe harbor protections of QM. Lenders will be more deliberate and the resulting mortgages will be more consistent and will result in more predictable prepayments. We do not expect this to impact the current supply of Agency RMBS.
Many of the provisions of the Dodd-Frank Act, including certain provisions described above are subject to further study, rulemaking and the discretion of regulatory bodies. As the hundreds of regulations called for by the Dodd-Frank Act are promulgated, we will continue to evaluate their impact. It is unclear . . .