• Financial Condition

• Results of Operations

• Liquidity and Capital Resources

• Forward-Looking Statements

EXECUTIVE OVERVIEW
We were incorporated in Maryland on March 15, 2011 and commenced operations on August 9, 2011 following the completion of our IPO. We invest in, finance and manage a leveraged portfolio of mortgage-related investments, which we define to include agency mortgage investments, non-agency mortgage investments and other mortgage-related investments. Agency mortgage investments include residential mortgage pass-through certificates and CMOs structured from residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by a GSE, such as Fannie Mae and Freddie Mac, or by a U.S. Government agency, such as Ginnie Mae. Non-agency mortgage investments include RMBS backed by residential mortgages that are not guaranteed by a GSE or U.S. Government agency. Non-agency mortgage investments may also include prime and non-prime residential mortgage loans. Other mortgage-related investments may include CMBS, commercial mortgage loans, mortgage-related derivatives and other mortgage-related investments.
We operate so as to qualify to be taxed as a REIT under the Internal Revenue Code. As such, we are required to, among other things, distribute annually at least 90% of our taxable net income. As long as we qualify as a REIT, we will generally not be subject to U.S. federal corporate taxes on our taxable net income to the extent that we distribute all of our annual taxable net income to our stockholders.
We are externally managed by an affiliate of American Capital and we do not have any employees.
Our Investment Strategy
Our objective is to provide attractive risk-adjusted returns to our stockholders over the long-term through a combination of dividends and net book value appreciation. In pursuing this objective, we rely on our Manager's expertise to construct and manage a diversified mortgage investment portfolio by identifying asset classes that, when properly financed and hedged, are selected to produce attractive returns across a variety of market conditions and economic cycles, considering the risks associated with owning such investments. Specifically, our investment strategy is designed to:

•         manage a leveraged portfolio of mortgage-related investments to
          generate attractive risk-adjusted returns;


•         capitalize on discrepancies in the relative valuations in the
          mortgage-related investments market;

• manage financing, interest, prepayment rate and credit risks;

• preserve our net asset value within reasonable bands;

• provide regular quarterly distributions to our stockholders;

• qualify as a REIT; and

• remain exempt from the requirements of the Investment Company Act.

The size and composition of our investment portfolio depends on investment strategies implemented by our Manager, the availability of investment capital and overall market conditions, including the availability of attractively priced investments and suitable financing to appropriately leverage our investment portfolio. Market conditions are influenced by, among other things, current levels of and expectations for future levels of, interest rates, mortgage prepayments, market liquidity, housing prices, unemployment rates, general economic conditions, government participation in the mortgage market, evolving regulations or legal settlements that impact servicing practices or other mortgage related activities.

Trends and Recent Market Impacts
On September 13, 2012, the Federal Reserve announced their third quantitative easing program, commonly known as QE3, and extended their guidance to keep the federal funds rate at "exceptional low levels" through at least mid-2015. QE3 entails large-scale purchases of agency mortgage-backed securities ("MBS") at the pace of $40 billion per month in addition to the Federal Reserve's existing policy of reinvesting principal payments from its holdings of agency MBS into new agency MBS purchases. The program is open-ended in nature, and is intended to put downward pressure on longer-term interest rates, support mortgage markets, and help make the broader financial conditions more accommodative. The Federal Reserve plans to continue their purchases of agency MBS and employ other policy tools, as appropriate, until they foresee substantial improvement in the outlook for the U.S. labor market.
The Federal Reserve's purchases have been concentrated in newly-issued, fixed-rate agency MBS (i.e., the part of the mortgage market with the greatest impact on mortgage rates offered to borrowers). The combined total purchases of agency MBS by the Federal Reserve have been approximately $70 billion per month during the fourth quarter of 2012, representing approximately half of the average monthly gross issuance of fixed-rate agency MBS over the quarter. Prices across the agency MBS spectrum initially increased following the Federal Reserve's QE3 announcement, with the lowest coupon 30-year and 15-year fixed-rate agency MBS outperforming higher coupon agency MBS. Although fixed-rate agency MBS prices have decreased during the fourth quarter of 2012, the prices as of December 31, 2012 generally remain above those seen prior to the announcement of QE3. During these periods, the lower coupon, fixed-rate agency MBS outperformed those with higher coupon securities. The table below summarizes interest rates and prices of generic fixed-rate agency MBS as of the end of each respective quarter.

   Interest                                                                                                December 31, 2012     December 31, 2012
Rate/Security                           September                                          December 31,    Versus September     Versus December 31,
     (1)          December 31, 2012      30, 2012      June 30, 2012     March 31, 2012        2011            30, 2012                2011
LIBOR:
1-Month                       0.21 %         0.21 %            0.25 %             0.24 %         0.30 %                  -  %              (0.09 )%
3-Month                       0.31 %         0.36 %            0.46 %             0.47 %         0.58 %              (0.05 )%              (0.27 )%
U.S. Treasury
Securities:
2-Year U.S.
Treasury                      0.25 %         0.23 %            0.30 %             0.33 %         0.24 %               0.02  %               0.01  %
5-Year U.S.
Treasury                      0.72 %         0.63 %            0.72 %             1.04 %         0.83 %               0.09  %              (0.11 )%
10-Year U.S.
Treasury                      1.76 %         1.63 %            1.65 %             2.21 %         1.88 %               0.13  %              (0.12 )%
Interest Rate
Swap Rates:
2-Year Swap
Rate                          0.39 %         0.37 %            0.55 %             0.58 %         0.73 %               0.02  %              (0.34 )%
5-Year Swap
Rate                          0.86 %         0.76 %            0.97 %             1.27 %         1.22 %               0.10  %              (0.36 )%
10-Year Swap
Rate                          1.84 %         1.70 %            1.78 %             2.29 %         2.03 %               0.14  %              (0.19 )%
30-Year Fixed
Rate MBS
Price:
3.5%             $          106.66     $   107.25     $      105.11     $       102.72     $   102.88     $          (0.59 )    $           3.78
4.0%             $          107.22     $   107.75     $      106.44     $       104.86     $   105.03     $          (0.53 )    $           2.19
4.5%             $          108.03     $   108.25     $      107.28     $       106.38     $   106.42     $          (0.22 )    $           1.61
15-Year Fixed
Rate MBS
Price:
2.5%             $          104.61     $   105.13     $      103.09     $       101.42     $   101.34     $          (0.52 )    $           3.27
3.0%             $          105.61     $   106.00     $      104.77     $       103.56     $   103.28     $          (0.39 )    $           2.33
3.5%             $          106.14     $   106.41     $      105.66     $       104.92     $   104.58     $          (0.27 )    $           1.56


 ________________________

We expect during periods in which the Federal Reserve purchases significant volumes of mortgages, yields on agency MBS securities will be lower than yields would have been absent QE3 and refinancing volumes will be higher than volumes would have been absent QE3. Since returns on agency MBS are highly sensitive to prepayment speeds, we have positioned our investment portfolio towards agency MBS that we believe have favorable prepayment attributes. As of December 31, 2012, 83% of our agency investment portfolio was comprised of agency securities backed by lower loan balance mortgages (pools backed by original loan balances of up to $150,000) and loans originated under HARP (pools backed by 100% refinance loans with original loan-to-value ratios greater than or equal to 80%), which we believe have a lower risk of prepayment relative to

generic agency securities. The remainder of our agency portfolio as of December 31, 2012 was primarily comprised of lower coupon, newer issuance, fixed-rate agency securities. (See Financial Condition below for further details of our portfolio composition as of December 31, 2012).

The following table summarizes recent prepayment trends for our portfolio and, for comparison, Fannie Mae 2011 30-
year 4.0% fixed-rate generic mortgage-backed securities for the year ended December 31, 2012.

                                                                    Fannie Mae 2011
                                                                      30-year 4.0%
                                                 Agency Portfolio      Fixed Rate
2012                                              Actual CPR (1)      Universe (2)
January                                                 4%                11%
February                                                6%                13%
March                                                   7%                19%
April                                                   5%                21%
May                                                     5%                14%
June                                                    5%                15%
July                                                    7%                21%
August                                                  8%                29%
September                                               7%                35%
October                                                 7%                32%
November                                                6%                34%
December                                                6%                35%


_______________________

(2) Source: JP Morgan

The non-agency market environment showed significant signs of improvement with broad market participation during the year ended December 31, 2012 as compared to the end of 2011. While market sentiment concerning the general housing market has improved, we believe that any housing recovery will be uneven across the country and are cognizant that other events, such as additional U.S. regulatory actions or further economic weakness in Europe, could have a material negative impact on the market for non-agency securities. As such, we will continue our selective approach to increasing our non-agency portfolio. Additionally, the majority of recent non-agency transactions are limited to the population of legacy securities issued prior to 2009, as agency securitizations continue to provide funding for the large majority of recent residential lending. As such, our future growth in non-agency investments will depend on our ability to access non-agency investments other than legacy non-agency securities. Summary of Critical Accounting Estimates

Our critical accounting estimates relate to the fair value of our investments and derivatives and the recognition of interest income. Certain of these items involve estimates that require management to make judgments that are subjective in nature. We rely on our Manager's experience and analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. Under different conditions, we could report materially different amounts based on such estimates. Our significant accounting policies are described in Note 2 to the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K.

We have not designated any derivatives as hedging instruments and therefore all changes in fair value are reflected in income during the period in which they occur. We also have elected the option to account for all of our financial assets, including all mortgage-related investments, at fair value, with changes in fair value reflected in income during the period in which they occur. In management's view, this election more appropriately reflects the results of our operations for a particular reporting period, as financial asset fair value changes are presented in a manner consistent with the presentation and timing of the fair value changes of economic hedging instruments.

Fair Value of Investments in Mortgage-Backed Securities We estimate the fair value of our mortgage-backed securities based on inputs from multiple third-party pricing services and dealer quotes. The third-party pricing services use pricing models which incorporate such factors as coupons, primary and secondary mortgage rates, prepayment speeds, spread to the Treasury and interest rate swap curves, convexity, duration, periodic and life caps, default and severity rates and credit enhancements. The dealer quotes incorporate common market pricing methods, including a spread measurement to the Treasury or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, rate reset period, issuer, additional credit support and expected life of the security. Our Manager observes market information relevant to our specific investment portfolio by trading in the market for mortgage related investments. Our Manager uses this observable market information in reviewing the inputs to and the estimates derived from the valuation process for reasonableness. Changes in the market environment and other events that may occur over the life of our investments may cause the gains or losses ultimately realized on these investments to be different than the valuations currently estimated. See Note 7 to the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K.

Interest Income
Interest income is accrued based on the outstanding principal amount of the securities and their contractual terms. Premiums and discounts associated with the purchase of agency securities and non-agency securities of high credit quality are amortized or accreted into interest income over the projected lives of the securities, including contractual payments and estimated prepayments, using the effective interest method. We estimate long-term prepayment speeds using a third-party service and market data.

The third-party service estimates prepayment speeds using models that incorporate the forward yield curve, current mortgage rates, current mortgage rates of the outstanding loans, loan age, volatility and other factors. We review the prepayment speeds estimated by the third-party service and compare the results to market consensus prepayment speeds, if available. We also consider historical prepayment speeds and current market conditions to validate the reasonableness of the prepayment speeds estimated by the third-party service, and based on our Manager's judgment, we may make adjustments to their estimates. Actual and anticipated prepayment experience is reviewed at least quarterly and effective yields are recalculated when differences arise between the previously estimated future prepayments and the amounts actually received plus current anticipated future prepayments. If the actual and anticipated future prepayment experience differs from our prior estimate of prepayments, we are required to record an adjustment in the current period to the amortization or accretion of premiums and discounts for the cumulative difference in the effective yield through the reporting date.

At the time we purchase non-agency securities and loans that are not of high credit quality, we determine an effective interest rate based on our estimate of the timing and amount of cash flows and our cost basis. On at least a quarterly basis, we review the estimated cash flows and make appropriate adjustments, based on input and analysis received from external sources, internal models, and our judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Any resulting changes in effective yield are recognized prospectively based on the current amortized cost of the investment as adjusted for credit impairment, if any. Our cash flow estimates for these investments are based on our Manager's judgment and observations of current information and events. These estimates include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses. Furthermore, other market participants could use materially different assumptions with respect to default rates, severities, loss timing, or prepayments. Our assumptions are subject to future events that may impact our estimates and interest income, and as a result, actual results may differ significantly from these estimates.

Derivatives
We maintain a risk management strategy, under which we may use a variety of derivative instruments to economically hedge some of our exposure to market risks, including interest rate risk, prepayment risk and credit risk. Our risk management objective is to reduce fluctuations in net book value over a range of market conditions. The principal instruments that we currently use are interest rate swaps, TBAs, U.S. Treasury securities, and options to enter into interest rate swaps ("interest rate swaptions"). In the future, we may also use forward contracts for specified agency securities, U.S. Treasury futures contracts and put or call options on TBA securities. We may also invest in other types of mortgage derivatives, such as interest-only securities, credit default swaps and synthetic total return swaps.

We recognize all derivatives as either assets or liabilities on the balance sheet, measured at fair value. As we have not designated any derivatives as hedging instruments, all changes in fair value are reported in earnings in our consolidated statement of operations in unrealized gain (loss) on other derivatives and securities, net during the period in which they occur. Derivatives in a gain position are reported as derivative assets at fair value and derivatives in a loss position are reported as

derivative liabilities at fair value in our consolidated balance sheet. In our consolidated statement of cash flows, cash receipts and payments related to derivative instruments are reported in the investing section.

The use of derivatives creates exposure to credit risk relating to potential losses that could be recognized in the event that the counterparties to these instruments fail to perform their obligations under the contracts. We attempt to minimize this risk by limiting our counterparties to major financial institutions with acceptable credit ratings, monitoring positions with individual counterparties and adjusting posted collateral as required. See Notes 2 and 6 to the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K.

FINANCIAL CONDITION
The table below presents our condensed consolidated balance sheets as of
December 31, 2012 and 2011 (dollars in thousands, except per share amounts):
                                     December 31, 2012      December 31, 2011
Balance Sheet Data:
Total investments                  $         7,048,445    $         1,779,323
Total assets                       $         7,696,140    $         2,170,322
Repurchase agreements              $         6,245,791    $         1,706,281
Total liabilities                  $         6,770,578    $         1,961,521
Total stockholders' equity         $           925,562    $           208,801
Net asset value per common share   $             25.74    $             20.87

We grew our total investment portfolio to $7.0 billion as of December 31, 2012, compared to $1.8 billion as of December 31, 2011 after the completion of two follow-on public offerings of shares of our common stock for net proceeds of $579.7 million. We also increased the percentage of our investment portfolio allocated to non-agency securities to 10% as of December 31, 2012 from 4% as of December 31, 2011. The following tables summarize certain characteristics of our investment portfolio by issuer and investment category as of December 31, 2012 and 2011(dollars in thousands):

                                                              As of December 31, 2012
                                                      Amortized Cost                      Weighted Average
                                       Fair Value         Basis          Par Value      Coupon      Yield (1)
Fannie Mae                            $ 5,325,187     $  5,211,321     $ 4,939,592       3.40 %         2.42 %
Freddie Mac                             1,041,855        1,018,449         965,074       3.57 %         2.65 %
Agency total                            6,367,042        6,229,770       5,904,666       3.43 %         2.46 %
Non-agency securities (2)                 681,403          616,707       1,045,891       1.70 %         7.47 %
Total                                 $ 7,048,445     $  6,846,477     $ 6,950,557       3.17 %         2.91 %

                                                              As of December 31, 2011
                                                      Amortized Cost                      Weighted Average
                                       Fair Value         Basis          Par Value      Coupon      Yield (1)
Fannie Mae                            $ 1,316,275     $  1,305,135     $ 1,240,435       3.95%        2.85%
Freddie Mac                               423,816          421,139         396,625       4.19%        2.91%
Agency total                            1,740,091        1,726,274       1,637,060       4.01%        2.87%
Non-agency securities                      25,561           25,994          47,151       2.63%        8.10%
Total                                   1,765,652        1,752,268       1,684,211       3.97%        2.94%
Non-agency securities underlying
Linked Transactions                        50,193           52,050          88,671       1.94%        7.08%
Adjusted total                        $ 1,815,845     $  1,804,318     $ 1,772,882       3.87%        3.06%

(2) As of December 31, 2012, there are no non-agency securities accounted for as Linked Transactions.

Agency Investments
As detailed in the tables below, the weighted average agency security portfolio coupon, yield and projected CPR decreased from December 31, 2011 to December 31, 2012. These decreases resulted mainly from the combination of the market impact of QE3, which generally increased prices and lowered yields on agency securities, and our agency security portfolio shift towards lower coupon securities that have more favorable prepayment attributes.

The following tables summarize certain characteristics of our agency securities portfolio by term and coupon as of December 31, 2012 and 2011 (dollars in thousands):

                                         As of December 31, 2012
                                                                 Weighted Average
           Fair Value     Amortized Cost Basis     Par Value        Yield        Projected CPR
15-Year
2.5%      $ 1,172,193    $           1,165,844    $ 1,119,368        1.59 %              10 %
3.0%          341,883                  333,689        320,239        2.04 %              10 %
3.5%          348,478                  338,364        324,261        2.36 %              13 %
4.0%          324,555                  319,339        299,077        2.14 %              14 %
4.5%           21,860                   21,404         20,004        2.63 %              13 %
Total     $ 2,208,969    $           2,178,640    $ 2,082,949        1.87 %              11 %
20-Year
3.0%      $    64,642    $              64,667    $    61,355        2.20 %               7 %
3.5%           85,218                   82,404         79,112        2.63 %              11 %
4.0%            8,840                    8,619          8,230        2.68 %              17 %
5.0%            3,530                    3,648          3,282        2.30 %              15 %
Total     $   162,230    $             159,338    $   151,979        2.40 %              10 %
30-Year
3.0%      $   279,669    $             279,470    $   265,647        2.36 %               6 %
3.5%        2,113,307                2,063,030      1,956,547        2.74 %               8 %
4.0%        1,429,633                1,381,735      1,291,383        2.90 %               9 %
4.5%          122,856                  118,314        110,574        3.29 %              10 %
5.0%           50,378                   49,243         45,587        3.27 %              14 %
Total     $ 3,995,843    $           3,891,792    $ 3,669,738        2.79 %               8 %

                                         As of December 31, 2011
                                                                  Weighted Average
           Fair Value      Amortized Cost Basis      Par Value       Yield        Projected CPR
15-Year
3.0%      $     53,265    $               53,082    $   51,448        2.35 %               8 %
3.5%           345,563                   342,475       327,883        2.50 %              10 %
. . .