10-Q 1 cys10q2012q3.htm FORM 10-Q CYS 10Q 2012 Q3
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 __________________________________
FORM 10-Q
 __________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             .
Commission file number 001-33740
__________________________________
 CYS Investments, Inc.
(Exact name of registrant as specified in its charter)
__________________________________
Maryland
20-4072657
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
 
 
890 Winter Street, Suite 200
Waltham, Massachusetts
02451
(Address of principal executive offices)
(Zip Code)
(617) 639-0440
(Registrant’s telephone number, including area code)
__________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Check one:
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
Outstanding at October 17, 2012
Common Stock ($0.01 par value)
174,950,026
 



__________________________________
Table of Contents
 



PART I. Financial Information
Item 1.         Financial Statements
CYS INVESTMENTS, INC.
CONDENSED STATEMENTS OF ASSETS AND LIABILITIES (UNAUDITED)
(In thousands, except per share numbers)
September 30, 2012
 
December 31, 2011*
ASSETS:
 
 
 
Investments in securities, at fair value (including pledged assets of $14,752,504 and $8,412,295, respectively)
$
22,646,305

 
$
9,466,128

Interest rate cap contracts, at fair value
125,331

 
5,966

Cash and cash equivalents
20,496

 
11,508

Receivable for securities sold and principal repayments
20,423

 
5,550

Interest receivable
50,433

 
27,815

Other assets
1,129

 
1,090

Total assets
22,864,117

 
9,518,057

LIABILITIES:
 
 
 
Repurchase agreements
13,911,977

 
7,880,814

Interest rate swap contracts, at fair value
111,725

 
79,476

Payable for securities purchased
6,084,047

 
463,302

Payable for cash received as collateral
47,960

 

Distribution payable
79,677

 

Accrued interest payable (including accrued interest on repurchase agreements of $5,086 and $3,747, respectively)
19,389

 
15,617

Accrued expenses and other liabilities
4,606

 
1,390

Total liabilities
20,259,381

 
8,440,599

Commitments and contingencies (note 6)

 

NET ASSETS
$
2,604,736

 
$
1,077,458

Net assets consist of:
 
 
 
Series A Cumulative Redeemable Preferred Stock, $0.01 par value, 50,000 shares authorized (3,000 and 0 shares issued and outstanding, respectively, liquidation preference of $25.00 per share or $75,000 and $0 in aggregate, respectively)
$
72,488

 
$

Common Stock, $0.01 par value, 500,000 shares authorized (174,942 and 82,753 shares issued and outstanding, respectively)
1,749

 
828

Additional paid in capital
2,236,234

 
997,884

Retained earnings
294,265

 
78,746

NET ASSETS
$
2,604,736

 
$
1,077,458

NET ASSET VALUE PER COMMON SHARE
$
14.46

 
$
13.02

__________________
*    Derived from audited financial statements.

See notes to condensed financial statements.



1


CYS INVESTMENTS, INC.
CONDENSED SCHEDULES OF INVESTMENTS
SEPTEMBER 30, 2012 (UNAUDITED)
INVESTMENTS IN SECURITIES – UNITED STATES OF AMERICA
 
(In thousands)
Face Amount
 
Fair Value
Fixed Income Securities - 869.4%(c)
 
 
 
Mortgage Pass-Through Agency RMBS - 867.5%(c)
 
 
 
Fannie Mae Pools - 829.0%(c)
 
 
 
2.290%, due 11/1/2042(b)
$
100,000

 
$
104,438

2.350%, due 12/1/2042(b)
100,000

 
104,438

2.399%, due 9/1/2042(a)(b)
39,731

 
41,576

2.416%, due 7/1/2042(a)(b)
49,772

 
52,059

2.438%, due 10/1/2042(b)
201,410

 
211,042

2.443%, due 7/1/2042(a)(b)
50,121

 
52,500

2.448%, due 10/1/2042(a)(b)
55,392

 
58,025

2.455%, due 6/1/2042(a)(b)
58,484

 
61,237

2.510%, due 10/1/2042(b)
52,000

 
54,730

2.516%, due 10/1/2042(a)(b)
99,646

 
104,529

2.564%, due 7/1/2042(a)(b)
53,369

 
56,079

2.584%, due 8/1/2042(a)(b)
34,823

 
36,577

2.618%, due 7/1/2042(a)(b)
49,168

 
51,679

2.641%, due 4/1/2042(a)(b)
36,977

 
38,937

2.707%, due 6/1/2042(a)(b)
70,311

 
74,028

2.789%, due 1/1/2042(a)(b)
43,772

 
46,176

2.792%, due 3/1/2042(a)(b)
45,622

 
48,130

2.795%, due 4/1/2042(a)(b)
186,713

 
197,142

2.804%, due 2/1/2042(a)(b)
26,924

 
28,419

2.808%, due 2/1/2042(a)(b)
50,760

 
53,546

2.811%, due 2/1/2042(a)(b)
60,944

 
64,271

2.819%, due 4/1/2042(a)(b)
54,944

 
58,035

2.837%, due 2/1/2042(a)(b)
35,708

 
37,713

2.857%, due 12/1/2041(a)(b)
56,874

 
60,082

2.867%, due 1/1/2042(a)(b)
62,266

 
66,113

2.904%, due 2/1/2042(a)(b)
43,257

 
45,637

2.995%, due 1/1/2041(a)(b)
32,811

 
34,327

3.000%, due 9/1/2026 - 12/1/2032(a)
7,757,362

 
8,236,480

3.022%, due 12/1/2040(a)(b)
111,353

 
116,493

3.054%, due 9/1/2041(a)(b)
41,862

 
44,085

3.056%, due 9/1/2041(a)(b)
38,752

 
40,939

3.164%, due 9/1/2041(a)(b)
34,151

 
36,252

3.170%, due 11/1/2041(a)(b)
30,140

 
31,990

3.176%, due 10/1/2041(a)(b)
41,800

 
44,371

3.216%, due 9/1/2041(a)(b)
93,117

 
98,647

3.237%, due 3/1/2041(a)(b)
16,366

 
17,298

3.242%, due 10/1/2041(b)
78,850

 
83,688

3.246%, due 4/1/2041(a)(b)
42,976

 
45,322

3.292%, due 9/1/2041(a)(b)
72,379

 
76,731

3.300%, due 5/1/2041(a)(b)
34,624

 
36,505

3.302%, due 6/1/2041(a)(b)
93,557

 
98,639


2

CYS INVESTMENTS, INC.
CONDENSED SCHEDULES OF INVESTMENTS - (Continued)
SEPTEMBER 30, 2012 (UNAUDITED)

 
Face Amount
 
Fair Value
3.305%, due 10/1/2041(a)(b)
$
117,613

 
$
124,637

3.366%, due 8/1/2041(a)(b)
28,702

 
30,875

3.369%, due 5/1/2041(a)(b)
18,800

 
19,813

3.372%, due 6/1/2041(a)(b)
88,645

 
93,826

3.376%, due 4/1/2041(a)(b)
41,233

 
43,634

3.500%, due 7/1/2021(a)
224,154

 
238,674

3.500%, due 12/1/2025 - 5/1/2027(a)
2,516,746

 
2,680,835

3.500%, due 8/1/2042 - 12/1/2042(a)
4,105,608

 
4,392,654

3.514%, due 8/1/2040(a)(b)
29,486

 
31,228

3.621%, due 6/1/2041(a)(b)
52,201

 
55,497

3.651%, due 7/1/2040(a)(b)
31,181

 
32,953

3.665%, due 8/1/2040(a)(b)
28,671

 
30,413

3.710%, due 5/1/2040(a)(b)
26,062

 
27,726

3.789%, due 7/1/2040(a)(b)
25,580

 
27,191

3.937%, due 10/1/2039(a)(b)
24,479

 
25,896

3.990%, due 9/1/2039(a)(b)
11,947

 
12,642

4.000%, due 10/1/2024 - 6/1/2026(a)
1,288,581

 
1,378,755

4.000%, due 8/1/2042
118,750

 
128,994

4.500%, due 10/1/2024 - 6/1/2025(a)
56,508

 
61,060

4.500%, due 4/1/2030 - 11/1/2030(a)
130,880

 
142,333

4.500%, due 11/1/2041(a)
268,801

 
291,875

5.000%, due 11/1/2042
800,000

 
872,250

Total Fannie Mae Pools
20,273,716

 
21,592,666

Freddie Mac Pools - 33.5%(c)
 
 
 
2.435%, due 6/1/2042(b)
39,657

 
41,570

2.451%, due 7/1/2042(a)(b)
49,813

 
52,158

2.518%, due 9/1/2042(a)(b)
129,907

 
136,378

2.539%, due 7/1/2042(a)(b)
42,137

 
44,231

2.605%, due 3/1/2042(a)(b)
37,454

 
39,546

2.796%, due 12/1/2041(a)(b)
45,655

 
48,163

3.237%, due 2/1/2041(a)(b)
32,655

 
34,612

3.270%, due 6/1/2041(a)(b)
35,001

 
36,904

3.287%, due 1/1/2041(a)(b)
37,191

 
39,473

3.407%, due 9/1/2041(a)(b)
38,644

 
40,967

3.500%, due 4/1/2026 - 2/1/2027(a)
205,171

 
217,276

3.630%, due 6/1/2041(a)(b)
34,960

 
36,897

4.000%, due 10/1/2025(a)
40,748

 
43,368

4.500%, due 12/1/2024 - 5/1/2025(a)
57,325

 
61,502

Total Freddie Mac Pools
826,318

 
873,045

Ginnie Mae Pools - 5.0%(c)
 
 
 
3.500%, due 7/20/2040(a)(b)
108,238

 
115,472

4.000%, due 1/20/2040(a)(b)
14,712

 
15,756

Total Ginnie Mae Pools
122,950

 
131,228

Total Mortgage Pass-Through Agency RMBS (Cost - $22,146,485)
21,222,984

 
22,596,939

U.S. Treasury Bills - 1.2%(c)
 
 
 
0.060%, due 2/7/2013(a)(d)
30,000

 
29,989


3

CYS INVESTMENTS, INC.
CONDENSED SCHEDULES OF INVESTMENTS - (Continued)
SEPTEMBER 30, 2012 (UNAUDITED)

Total U.S. Treasury Bills (Cost - $29,985)
$
30,000

 
$
29,989

Other investments (Cost - $13,221)(e) - 0.7%(c)
20,473

 
19,377

Total Investments in Securities (Cost - $22,189,691)
$
21,273,457

 
$
22,646,305

 
Interest Rate Cap Contracts - 4.8%(c)
 
 
 
 
 
Expiration
Cap Rate
 
Notional Amount
 
Fair Value
12/30/2014
2.073
%
 
$
200,000

 
$
64

10/15/2015
1.428
%
 
300,000

 
489

11/8/2015
1.360
%
 
200,000

 
374

5/23/2019
2.000
%
 
300,000

 
7,007

6/1/2019
1.750
%
 
300,000

 
7,998

6/29/2019
1.500
%
 
300,000

 
9,057

7/2/2019
1.500
%
 
300,000

 
9,389

7/16/2019
1.250
%
 
500,000

 
17,770

7/16/2022
1.750
%
 
500,000

 
36,610

7/25/2022
1.750
%
 
500,000

 
36,573

Total Interest Rate Cap Contracts (Cost, $139,793)
 
$
3,400,000

 
$
125,331

 
Interest Rate Swap Contracts - (4.3%)(c)(f)
 
 
 
 
 
Expiration
Pay Rate
 
Notional Amount
 
Fair Value
5/26/2013
1.600
%
 
$
100,000

 
$
(822
)
6/30/2013
1.378
%
 
300,000

 
(2,315
)
7/15/2013
1.365
%
 
300,000

 
(2,425
)
12/15/2013
1.309
%
 
400,000

 
(4,670
)
12/16/2013
1.264
%
 
400,000

 
(4,452
)
12/16/2013
1.281
%
 
500,000

 
(5,625
)
12/17/2013
1.323
%
 
400,000

 
(4,717
)
7/1/2014
1.720
%
 
100,000

 
(2,377
)
7/16/2014
1.733
%
 
250,000

 
(6,137
)
8/16/2014
1.353
%
 
200,000

 
(3,711
)
9/23/2014
1.312
%
 
500,000

 
(9,342
)
10/6/2014
1.173
%
 
240,000

 
(3,875
)
2/14/2015
2.145
%
 
500,000

 
(20,823
)
6/2/2016
1.940
%
 
300,000

 
(15,471
)
(g)12/19/2016
1.426
%
 
250,000

 
(7,961
)
(h)4/24/2017
1.310
%
 
500,000

 
(11,536
)
7/13/2017
0.860
%
 
750,000

 
(4,835
)
9/6/2017
0.768
%
 
250,000

 
(124
)
9/6/2017
0.775
%
 
500,000

 
(443
)
9/6/2017
0.765
%
 
250,000

 
(64
)
Interest Rate Swap Contracts (Cost, $0)
 
 
$
6,990,000

 
$
(111,725
)
__________________
LEGEND

(a)
Securities or a portion of the securities are pledged as collateral for repurchase agreements or interest rate swap contracts.
(b)
The coupon rate shown on floating or adjustable rate securities represents the rate at September 30, 2012.

4

CYS INVESTMENTS, INC.
CONDENSED SCHEDULES OF INVESTMENTS - (Continued)
SEPTEMBER 30, 2012 (UNAUDITED)

(c)
Percentage of net assets.
(d)
Zero coupon bond, rate shown represents purchase yield.
(e)
Comprised of investments that were individually less than 1% of net assets.
(f)
The Company’s interest rate swap contracts receive a floating rate set quarterly to three month LIBOR.
(g)
The interest rate swap effective date is December 19, 2012 and does not accrue any income or expense until that date.
(h)
The interest rate swap effective date is April 24, 2013 and does not accrue any income or expense until that date.

See notes to condensed financial statements.




5

CYS INVESTMENTS, INC.
CONDENSED SCHEDULES OF INVESTMENTS - (Continued)
DECEMBER 31, 2011 (UNAUDITED)*

INVESTMENTS IN SECURITIES – UNITED STATES OF AMERICA

(In thousands)
Face Amount
 
Fair Value
Fixed Income Securities - 878.6% (c)
 
 
 
Mortgage Pass-Through Agency RMBS - 869.9% (c)
 
 
 
Fannie Mae Pools - 785.0% (c)
 
 
 
2.820%, due 3/1/2042(b)
$
20,000

 
$
20,627

2.840%, due 1/1/2042(b)
36,000

 
37,288

2.850%, due 1/1/2042(b)
16,000

 
16,575

2.880%, due 12/1/2041(b)
63,081

 
65,342

2.900%, due 2/1/2042(b)
50,000

 
51,750

2.940%, due 1/1/2042(b)
15,000

 
15,572

2.979%, due 10/1/2040(a)(b)
43,981

 
45,730

3.005%, due 1/1/2041(a)(b)
40,986

 
42,804

3.028%, due 12/1/2040(a)(b)
150,737

 
157,242

3.050%, due 9/1/2041(a)(b)
48,486

 
50,252

3.054%, due 9/1/2041(a)(b)
48,199

 
50,255

3.120%, due 1/1/2042(b)
50,000

 
52,016

3.168%, due 9/1/2041(a)(b)
39,736

 
41,366

3.176%, due 1/1/2042(b)
36,000

 
37,530

3.178%, due 10/1/2041(a)(b)
50,099

 
52,153

3.179%, due 7/1/2041(a)(b)
36,737

 
38,265

3.200%, due 6/1/2041(a)(b)
180,296

 
187,753

3.214%, due 11/1/2040(a)(b)
37,557

 
39,183

3.224%, due 7/1/2040(a)(b)
41,581

 
43,485

3.238%, due 9/1/2041(a)(b)
110,829

 
115,419

3.239%, due 3/1/2041(a)(b)
17,931

 
18,644

3.246%, due 4/1/2041(a)(b)
59,124

 
61,544

3.251%, due 10/1/2041(a)(b)
101,419

 
105,830

3.255%, due 11/1/2040(a)(b)
42,699

 
44,561

3.258%, due 12/1/2040(a)(b)
62,487

 
65,219

3.263%, due 6/1/2041(a)(b)
51,090

 
53,186

3.282%, due 5/1/2041(a)(b)
41,835

 
43,569

3.284%, due 9/1/2041(a)(b)
89,046

 
92,760

3.287%, due 6/1/2041(a)(b)
115,948

 
120,770

3.308%, due 6/1/2041(a)(b)
33,112

 
34,480

3.308%, due 10/1/2041(a)(b)
145,746

 
151,824

3.356%, due 8/1/2041(a)(b)
31,291

 
32,620

3.366%, due 5/1/2041(a)(b)
22,685

 
23,661

3.387%, due 4/1/2041(a)(b)
52,425

 
54,583

3.391%, due 4/1/2041(a)(b)
46,394

 
48,322

3.396%, due 6/1/2041(a)(b)
109,987

 
114,549

3.500%, due 7/1/2021 (a)
272,115

 
284,948

3.500%, due 12/1/2025 - 1/1/2027(a)
2,337,971

 
2,446,851

3.546%, due 8/1/2040(a)(b)
37,780

 
39,569

3.564%, due 7/1/2040(a)(b)
13,746

 
14,405

3.574%, due 7/1/2040(a)(b)
16,592

 
17,388

3.577%, due 8/1/2040(a)(b)
37,002

 
38,791




6

CYS INVESTMENTS, INC.
CONDENSED SCHEDULES OF INVESTMENTS - (Continued)
DECEMBER 31, 2011 (UNAUDITED)*

 
Face Amount
 
Fair Value
3.599%, due 6/1/2041(a)(b)
$
64,248

 
$
67,400

3.616%, due 6/1/2041(a)(b)
62,636

 
65,703

3.677%, due 7/1/2040(a)(b)
39,283

 
41,115

3.682%, due 8/1/2040(a)(b)
37,852

 
39,770

3.699%, due 5/1/2040(a)(b)
31,975

 
33,665

3.701%, due 8/1/2040(a)(b)
9,420

 
9,902

3.734%, due 9/1/2039(a)(b)
25,442

 
26,734

3.811%, due 7/1/2040(a)(b)
33,941

 
35,739

3.951%, due 9/1/2039(a)(b)
14,578

 
15,410

3.965%, due 10/1/2039(a)(b)
30,165

 
31,831

4.000%, due 10/1/2024 - 6/1/2026(a)
1,689,232

 
1,783,467

4.000%, due 9/1/2030 - 12/1/2030(a)
392,940

 
415,235

4.500%, due 5/1/2023 - 3/1/2026(a)
369,311

 
393,873

4.500%, due 4/1/2030 - 11/1/2030(a)
158,827

 
169,867

5.000%, due 4/1/2041 - 5/1/2041(a)
239,747

 
259,123

Total Fannie Mae Pools
8,053,327

 
8,457,515

Freddie Mac Pools - 71.2% (c)
 
 
 
2.983%, due 9/1/2041(a)(b)
48,696

 
50,838

3.025%, due 9/1/2041(a)(b)
49,029

 
51,159

3.236%, due 12/1/2040(a)(b)
42,661

 
44,466

3.240%, due 2/1/2041(a)(b)
39,068

 
40,779

3.246%, due 1/1/2041(a)(b)
46,017

 
48,037

3.272%, due 6/1/2041(a)(b)
45,131

 
46,984

3.423%, due 9/1/2041(a)(b)
48,337

 
50,535

3.500%, due 4/1/2026(a)
180,607

 
188,414

3.645%, due 6/1/2041(a)(b)
46,075

 
48,390

4.000%, due 10/1/2025(a)
57,327

 
60,183

4.500%, due 7/1/2024 - 5/1/2025(a)
129,517

 
137,334

Total Freddie Mac Pools
732,465

 
767,119

Ginnie Mae Pools - 13.7% (c)
 
 
 
3.500%, due 7/20/2040(a)(b)
78,468

 
82,891

3.500%, due 7/20/2040(a)(b)
44,331

 
46,830

4.000%, due 1/20/2040(a)(b)
17,026

 
18,099

Total Ginnie Mae Pools
139,825

 
147,820

Total Mortgage Pass-Through Agency RMBS (Cost - $9,148,730)
8,925,617

 
9,372,454

U.S. Treasury Bills - 7.0% (c)
 
 
 
0.060%, due 2/9/2012(d)
75,000

 
74,999

Total U.S. Treasury Bills (Cost - $74,995)
75,000

 
74,999

Other investments (Cost - $15,318)(e) - 1.7%(c)
27,944

 
18,675

Total Investments in Securities (Cost - $9,239,043)
$
9,028,561

 
$
9,466,128

 


 



7

CYS INVESTMENTS, INC.
CONDENSED SCHEDULES OF INVESTMENTS - (Continued)
DECEMBER 31, 2011 (UNAUDITED)*

Interest Rate Cap Contracts - 0.6%(c)
 
 
 
 
 
Expiration
Cap Rate
 
Notional Amount
 
Fair Value
12/30/2014
2.073
%
 
$
200,000

 
$
656

10/15/2015
1.428
%
 
300,000

 
3,062

11/8/2015
1.360
%
 
200,000

 
2,248

Total Interest Rate Cap Contracts (Cost, $13,722)
 
$
700,000

 
$
5,966

 
Interest Rate Swap Contracts - (7.4%)(c)(f)
 
 
 
 
 
Expiration
Pay Rate
 
Notional Amount
 
Fair Value
5/26/2013
1.600
%
 
$
100,000

 
$
(1,266
)
6/30/2013
1.378
%
 
300,000

 
(3,000
)
7/15/2013
1.365
%
 
300,000

 
(3,034
)
12/15/2013
1.309
%
 
400,000

 
(4,587
)
12/16/2013
1.264
%
 
400,000

 
(4,230
)
12/16/2013
1.281
%
 
500,000

 
(5,421
)
12/17/2013
1.323
%
 
400,000

 
(4,695
)
7/1/2014
1.720
%
 
100,000

 
(2,375
)
7/16/2014
1.733
%
 
250,000

 
(6,149
)
8/16/2014
1.353
%
 
200,000

 
(3,059
)
9/23/2014
1.312
%
 
500,000

 
(7,115
)
10/6/2014
1.173
%
 
240,000

 
(2,520
)
2/14/2015
2.145
%
 
500,000

 
(20,274
)
6/2/2016
1.940
%
 
300,000

 
(11,027
)
(g)12/19/2016
1.426
%
 
250,000

 
(724
)
Interest Rate Swap Contracts (Cost, $0)
 
$
4,740,000

 
$
(79,476
)
 __________________
LEGEND
 
*    Derived from audited financial statements.
(a)
Securities or a portion of the securities are pledged as collateral for repurchase agreements or interest rate swap contracts.
(b)
The coupon rate shown on floating or adjustable rate securities represents the rate at December 31, 2011.
(c)
Percentage of net assets.
(d)
Zero coupon bond, rate shown represents purchase yield.
(e)
Comprised of investments that were individually less than 1% of net assets.
(f)
The Company’s interest rate swap contracts receive a floating rate set quarterly to three month LIBOR.
(g)
The interest rate swap effective date is December 19, 2012 and does not accrue any income or expense until that date.



See notes to condensed financial statements.




8


CYS INVESTMENTS, INC.
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands, except per share numbers)
2012
 
2011
 
2012
 
2011
INVESTMENT INCOME:
 
 
 
 
 
 
 
Interest income from Agency RMBS
$
75,609

 
$
63,548

 
$
210,108

 
$
168,263

Other income
1,022

 
1,018

 
3,639

 
3,003

Total investment income
76,631

 
64,566

 
213,747

 
171,266

EXPENSES:
 
 
 
 
 
 
 
Interest
11,893

 
4,778

 
27,739

 
12,352

Management fees

 
2,291

 

 
8,442

Compensation and benefits
3,068

 
4,338

 
9,578

 
5,472

General, administrative and other
2,272

 
3,203

 
6,160

 
5,202

Total expenses
17,233

 
14,610

 
43,477

 
31,468

Net investment income
59,398

 
49,956

 
170,270

 
139,798

GAINS AND (LOSSES) FROM INVESTMENTS:
 
 
 
 
 
 
 
Net realized gain (loss) on investments
27,049

 
13,267

 
93,335

 
28,613

Net unrealized appreciation (depreciation) on investments
194,078

 
107,692

 
229,528

 
241,390

Net gain (loss) from investments
221,127

 
120,959

 
322,863

 
270,003

GAINS AND (LOSSES) FROM SWAP AND CAP CONTRACTS:
 
 
 
 
 
 
 
Net swap and cap interest income (expense)
(17,255
)
 
(15,469
)
 
(41,448
)
 
(42,202
)
Net gain (loss) on termination of swap contracts

 

 

 
(3,492
)
Net unrealized appreciation (depreciation) on swap and cap contracts
(21,363
)
 
(59,125
)
 
(38,955
)
 
(116,267
)
Net gain (loss) from swap and cap contracts
(38,618
)
 
(74,594
)
 
(80,403
)
 
(161,961
)
NET INCOME
$
241,907

 
$
96,321

 
$
412,730

 
$
247,840

DIVIDEND ON PREFERRED STOCK
(953
)
 

 
(953
)
 

NET INCOME AVAILABLE TO COMMON SHARES
$
240,954

 
$
96,321

 
$
411,777

 
$
247,840

NET INCOME PER COMMON SHARE BASIC & DILUTED
$
1.46

 
$
1.16

 
$
3.19

 
$
3.15

See notes to condensed financial statements.

9


CYS INVESTMENTS, INC.
CONDENSED STATEMENT OF CHANGES IN NET ASSETS (UNAUDITED)
(In thousands)
Three Months Ended September 30, 2012
 
Nine Months Ended September 30, 2012
Net income:
 
 
 
Net investment income
$
59,398

 
$
170,270

Net realized gain (loss) on investments
27,049

 
93,335

Net unrealized appreciation (depreciation) on investments
194,078

 
229,528

Net gain (loss) on swap and cap contracts
(38,618
)
 
(80,403
)
Net income
241,907

 
412,730

Dividend on preferred stock
(953
)
 
(953
)
Net income available to common shares
240,954

 
411,777

Capital transactions:
 
 
 
Net proceeds from issuance of common shares
739,443

 
1,237,152

Net proceeds from issuance of preferred shares
72,488

 
72,488

Distributions to common stockholders
(78,724
)
 
(196,258
)
Amortization of share based compensation
721

 
2,119

Increase in net assets from capital transactions
733,928

 
1,115,501

Total increase in net assets
974,882

 
1,527,278

Net assets:
 
 
 
Beginning of period
1,629,854

 
1,077,458

End of period
$
2,604,736

 
$
2,604,736

See notes to condensed financial statements.

10


CYS INVESTMENTS, INC.
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
Nine Months Ended September 30,
(In thousands)
2012
 
2011
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
412,730

 
$
247,840

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Purchase of investment securities
(26,295,320
)
 
(6,104,138
)
Premium paid on interest rate caps
(133,483
)
 

Proceeds from disposition of investment securities
11,428,649

 
2,355,791

Proceeds from paydowns of investment securities
1,940,265

 
828,994

Amortization of share based compensation
2,119

 
4,691

Amortization of premiums and discounts on investment securities
69,092

 
27,289

Amortization of premiums on interest rate cap contracts
7,412

 
2,879

Net realized (gain) loss on investments
(93,335
)
 
(28,613
)
Net unrealized (appreciation) depreciation on investments
(229,528
)
 
(241,390
)
Net unrealized (appreciation) depreciation on swap and cap contracts
38,955

 
116,267

Change in assets and liabilities:
 
 
 
Receivable for securities sold and principal repayments
(14,873
)
 
(3,486
)
Interest receivable
(22,618
)
 
(11,410
)
Other assets
(39
)
 
(950
)
Payable for securities purchased
5,620,745

 
(1,472,279
)
Accrued interest payable
3,772

 
8,782

Related party management fee payable

 
(800
)
Accrued expenses and other liabilities
3,216

 
2,532

Payable for cash received as collateral
47,960

 

Net cash used in operating activities
(7,214,281
)
 
(4,268,001
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from repurchase agreements
59,689,598

 
31,273,293

Repayments of repurchase agreements
(53,658,435
)
 
(27,176,468
)
Net proceeds from issuance of common shares
1,235,842

 
275,936

Net proceeds from issuance of preferred shares
72,488

 

Distributions paid
(116,224
)
 
(99,090
)
Net cash provided by financing activities
7,223,269

 
4,273,671

Net increase (decrease) in cash and cash equivalents
8,988

 
5,670

CASH AND CASH EQUIVALENTS - Beginning of period
11,508

 
1,510

CASH AND CASH EQUIVALENTS - End of period
$
20,496

 
$
7,180

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Interest paid
$
67,128

 
$
47,975

SUPPLEMENTAL DISCLOSURES OF NONCASH FLOW INFORMATION:
 
 
 
Distributions declared, not yet paid
$
79,677

 
$
45,509

Reinvestment of common share distributions
$
1,310

 
$

See notes to condensed financial statements.

11


CYS INVESTMENTS, INC.
CONDENSED NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. ORGANIZATION
CYS Investments, Inc. (the “Company”) was formed as a Maryland corporation on January 3, 2006, and commenced operations on February 10, 2006. The Company has elected to be taxed and intends to continue to qualify as a real estate investment trust (“REIT”) and is required to comply with the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), with respect thereto. Since March 2008, the Company has exclusively purchased residential mortgage-backed securities that are issued and the principal and interest of which are guaranteed by a federally chartered corporation (“Agency RMBS”), such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”), or an agency of the U.S. government such as the Government National Mortgage Association (“Ginnie Mae”), or U.S. Treasuries securities. The Company’s common stock and Series A Cumulative Redeemable Preferred Stock, $25.00 liquidation preference (the "Series A Preferred Stock") trade on the New York Stock Exchange under the symbols “CYS” and "CYS PrA," respectively.
On September 1, 2011, the Company acquired certain assets and entered into agreements to internalize the Company’s management (the “Internalization”). The Company previously had been managed by Cypress Sharpridge Advisors LLC (the “Manager”) pursuant to a management agreement (the “Management Agreement”). The Manager had entered into sub-advisory agreements with Sharpridge Capital Management, L.P. (“Sharpridge”) and an affiliate of The Cypress Group, pursuant to which the Manager was provided with all of the resources and assets (the “Assets”) used to operate the Company’s business and manage the Company’s assets. In connection with the completion of the Internalization, the Management Agreement, sub-advisory agreements and other ancillary agreements related thereto were terminated. No termination fee was incurred or paid as a result of terminating those agreements.

2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying interim unaudited condensed financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and the instructions to Form 10-Q and Article 10, Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The interim unaudited condensed financial statements should be read in conjunction with the Company’s audited financial statements as of and for the year ended December 31, 2011, included in the annual report on Form 10-K. The results for interim periods are not necessarily indicative of the results to be expected for the fiscal year.
The Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 946, Clarification of the Scope of Audit and Accounting Guide Investment Companies (“ASC 946”), prior to its deferral in February 2008. Under ASC 946, the Company uses financial reporting for investment companies.
Segment Reporting
The Company operates as a single segment reporting to the Chief Executive Officer, who manages the entire investment portfolio.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those management estimates.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, cash held in banks and highly liquid investments with original maturities of three months or less. Interest income earned on cash and cash equivalents is recorded in other income.
Interest Rate Swap and Cap Contracts
The Company utilizes interest rate swaps and caps to hedge the interest rate risk associated with the financing of its portfolio. Specifically, the Company seeks to hedge the exposure to potential interest rate mismatches between the interest earned on investments and the borrowing costs caused by fluctuations in short term interest rates. In a simple interest rate swap, one investor pays a floating rate of interest on a notional principal amount and receives a fixed rate of interest on the same

12


notional principal amount for a specified period of time. Alternatively, an investor may pay a fixed rate and receive a floating rate. In a simple interest rate cap, one investor pays a premium for a notional principal amount based on a capped interest rate (the “cap rate”). If the floating interest rate (the “floating rate”) exceeds the cap rate, the investor receives a payment from the cap counterparty equal to the difference between the floating rate and the cap rate on the same notional principal amount for a specified period of time. Alternatively, an investor may receive a premium and pay the difference in cap rate and floating rate.
During the term of the interest rate swap or cap, the Company makes or receives periodic payments and unrealized gains or losses are recorded as a result of marking the swap and cap to their fair value. When the swap or cap is terminated, the Company records a realized gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Company’s cost basis in the contract, if any. The periodic payments, amortization of premiums on cap contracts and any realized or unrealized gains or losses are reported under gains and losses from swap and cap contracts in the statements of operations. Swaps involve a risk that interest rates will move contrary to the Company’s expectations, thereby increasing the Company’s payment obligation.
Because the Company uses financial reporting for investment companies, its investments, including its interest rate swap and cap contracts, are carried at fair value with changes in fair value included in earnings. Consequently, there would be no impact to designating interest rate swaps and caps as cash flow or fair value hedges under GAAP.
The Company is exposed to credit loss in the event of nonperformance by the counterparty to the swap or cap limited to the amount of collateral posted that exceeds the fair value of the contract. However, as of September 30, 2012 and December 31, 2011, the Company did not anticipate nonperformance by any counterparty. Should interest rates move unexpectedly, the Company may not achieve the anticipated benefits of the interest rate swap or cap and may realize a loss.
Investment Valuation
The Company has established a pricing committee responsible for establishing valuation policies and procedures as well as approving valuations on a monthly basis at a pricing meeting. The pricing committee is made up of individuals from the accounting team, the investment team and senior management.
Agency RMBS and U.S. Treasury securities are generally valued on the basis of valuations provided by third party pricing services, as derived from such services’ pricing models. Inputs to the models may include, but are not limited to, reported trades, executable bid and asked prices, broker quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. The pricing services may use a matrix approach, which considers information regarding securities with similar characteristics to determine the valuation for a security.
Interest rate swaps and caps are generally valued using valuations provided by broker quotations. Such broker quotations are based on the present value of fixed and projected floating rate cash flows over the term of the swap contract. Future cash flows are discounted to their present value using swap rates provided by electronic data services or by broker.
Collateralized loan obligations ("CLOs") are generally valued using valuations provided by broker quotations, as derived from such brokers’ pricing models. Inputs to the models may include, but are not limited to, reported trades, executable bid and asked prices, prices or yields of securities with similar characteristics, default rates, recovery rates, prepayment rates, reinvestment rates, and information pertaining to the issuer, as well as industry and economic events.
Fair values of long-lived assets, including real estate, are primarily derived internally and are based on observed sales transactions for similar assets. For real estate, fair values are based on discounted cash flow estimates which reflect current and projected lease profiles and available industry information about capitalization rates and expected trends in rents and occupancy.  
All valuations received from third party pricing services or broker quotes are non-binding. The Company does not adjust any of the prices received from third party pricing services or brokers, and all prices are reviewed by the Company. This review includes comparisons of similar market transactions, alternative third party pricing services and broker quotes, or comparisons to a pricing model. To ensure the proper fair value hierarchy, the Company reviews the third party pricing service’s methodology to understand whether observable or unobservable inputs are being used.
Agency RMBS
The Company’s investments in Agency RMBS consist of whole-pool pass-through certificates backed by fixed rate, monthly reset adjustable-rate loans (“ARMs”) and hybrid ARMs, the principal and interest of which are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. Hybrid ARMs have interest rates that have an initial fixed period (typically three, five, seven or ten years) and thereafter reset at regular intervals in a manner similar to ARMs.
Forward Settling Transactions
The Company may engage in forward settling transactions. The Company records forward settling transactions on the

13


trade date and maintains security positions such that sufficient liquid assets will be available to make payment on the settlement date for the securities purchased. Securities purchased on a forward settling basis are carried at fair value and begin earning interest on the settlement date. Losses may occur on these transactions due to changes in market conditions or the failure of counterparties to perform under the contract. Among other forward settling transactions, the Company may transact in to-be-announced securities (“TBAs”). As with other forward settling transactions, a seller agrees to issue TBAs at a future date. However, the seller does not specify the particular securities to be delivered. Instead, the Company agrees to accept any security that meets specified terms such as issuer, interest rate and terms of underlying mortgages. The Company records TBAs on the trade date utilizing information associated with the specified terms of the transaction as opposed to the specific mortgages. TBAs are carried at fair value and begin earning interest on the settlement date. Losses may occur due to the fact that the actual underlying mortgages received may be less favorable than those anticipated by the Company.
As of September 30, 2012, the Company had pledged Agency RMBS with a fair value of $6.5 million on its open forward settling transactions. In addition, as of September 30, 2012 the Company had $10.0 million in cash pledged to it under its forward settling sales transactions. The Company did not have any pledged Agency RMBS on its open forward settling transactions as of December 31, 2011.
Repurchase Agreements
Repurchase agreements are borrowings that are collateralized by the Company’s Agency RMBS and are carried at their amortized cost, which approximates their fair value due to their short term nature, generally 30-90 days. The Company’s repurchase agreement counterparties are large institutional dealers in fixed income securities. Collateral is valued daily and counterparties may require additional collateral when appropriate. Counterparties have the right to sell or repledge collateral pledged for repurchase agreements.
Investment Transactions and Income
The Company records its transactions in securities on a trade date basis. Realized gains and losses on securities transactions are recorded on an identified cost basis. Interest income and expense are recorded on the accrual basis. Interest income on Agency RMBS is accrued based on outstanding principal amount of the securities and their contractual terms. Interest on CLOs is accrued at a rate determined based on estimated future cash flows and adjusted prospectively as future cash flow amounts are recast. For CLOs placed on nonaccrual status or when the Company cannot reliably estimate cash flows, the cost recovery method is used. Amortization of premium and accretion of discount are recorded using the yield to maturity method, and are included in investment income in the statements of operations. The Company does not estimate prepayments when calculating the yield to maturity. The amount of premium or discount associated with a prepayment is recorded through investment income on the statements of operations as they occur.
Reclassification and Presentation
The condensed statements of operations for the three and nine months ended September 30, 2011 had previously provided combined disclosure of investment income - interest income which was expanded as interest income from Agency RMBS and other income in the presentation herein.
Compensation and Benefits
Included in the Company’s compensation and benefits are salaries, incentive compensation, benefits, share based compensation and the expense relating to restricted stock granted to non-employees (prior to the Internalization). The Company accounts for share based compensation using the fair value based methodology prescribed by ASC 718, Share-Based Payment (“ASC 718”). Compensation cost related to restricted common stock issued is measured at its estimated fair value at the grant date and recognized as expense over the vesting period. Prior to the Internalization, which became effective on September 1, 2011, compensation cost related to restricted common stock and common stock options issued to the Company’s executive officers, certain employees of its Manager and its sub-advisors and other individuals who provide services to the Company was initially measured at estimated fair value at the grant date and was remeasured on subsequent dates to the extent the awards were unvested.
Income Taxes
The Company has elected to be taxed as a REIT and intends to continue to comply with provisions of the Code with respect thereto. As a REIT, the Company generally will not be subject to federal or state income tax on income that it currently distributes to its stockholders. To maintain its qualification as a REIT, the Company must distribute at least 90% of its REIT taxable income to its stockholders and meet certain other tests relating to assets and income.
Earnings Per Share (“EPS”)
Basic EPS is computed using the two class method by dividing net income (loss), after adjusting for the impact of unvested stock awards deemed to be participating securities, by the weighted average number of common shares outstanding

14


calculated excluding unvested stock awards. Diluted EPS is computed by dividing net income (loss), after adjusting for the impact of unvested stock awards deemed to be participating securities, by the weighted average number of common shares outstanding calculated excluding unvested stock awards, giving effect to common stock options and warrants, if they are not anti-dilutive. See note 3 for EPS computations.
Recent Accounting Pronouncements
In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities (Topic 210), Balance Sheet. The update requires new disclosures about balance sheet offsetting and related arrangements. For derivatives and financial assets and liabilities, the amendments require disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The guidance is effective December 1, 2013 and is to be applied retrospectively. This guidance does not amend the existing guidance on when it is appropriate to offset. As a result, we do not expect this guidance to have a material effect on the Company’s financial statements.
3. EARNINGS PER SHARE
Components of the computation of basic and diluted EPS were as follows (in thousands, except per share numbers): 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
241,907

 
$
96,321

 
$
412,730

 
$
247,840

Less preferred stock dividends
(953
)
 

 
(953
)
 

Net income available to common shares
240,954

 
96,321

 
411,777

 
247,840

Less dividends paid:
 
 
 
 
 
 
 
Common shares
(78,397
)
 
(45,138
)
 
(195,175
)
 
(143,293
)
Unvested shares
(327
)
 
(371
)
 
(1,083
)
 
(1,306
)
Undistributed earnings
162,230

 
50,812

 
215,519

 
103,241

Basic weighted average shares outstanding:
 
 
 
 
 
 
 
Common shares
164,269

 
81,898

 
128,116

 
77,950

Basic earnings per common share:
 
 
 
 
 
 
 
Distributed earnings
$
0.48

 
$
0.55

 
$
1.52

 
$
1.84

Undistributed earnings
0.98

 
0.61

 
1.67

 
1.31

Basic earnings per common share
$
1.46

 
$
1.16

 
$
3.19

 
$
3.15

Diluted weighted average shares outstanding:
 
 
 
 
 
 
 
Common shares
164,269

 
81,898

 
128,116

 
77,950

Net effect of dilutive warrants (1)

 

 

 
1

 
164,269

 
81,898

 
128,116

 
77,951

Diluted earnings per common share:
 
 
 
 
 
 
 
Distributed earnings
$
0.48

 
$
0.55

 
$
1.52

 
$
1.84

Undistributed earnings
0.98

 
0.61

 
1.67

 
1.31

Diluted earnings per common share
$
1.46

 
$
1.16

 
$
3.19

 
$
3.15

 
(1)
The impact of equity instruments is not included in the computation of EPS for periods in which their inclusion would be anti-dilutive. For the three and nine months ended September 30, 2012 and 2011, the Company had an aggregate of 131,088 stock options outstanding with a weighted average exercise price of $30.00 that were not included in the calculation of EPS, as their inclusion would have been anti-dilutive. These equity instruments may have a dilutive impact on future EPS.
4. INVESTMENTS IN SECURITIES AND INTEREST RATE SWAP AND CAP CONTRACTS AND OTHER ASSETS
The Company’s valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions. ASC 820, Fair Value Measurements, classifies these inputs into the following hierarchy:
Level 1 Inputs—Quoted prices for identical instruments in active markets.
Level 2 Inputs—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant

15


value drivers are observable.
Level 3 Inputs—Instruments with primarily unobservable value drivers.
Excluded from the tables below are financial instruments carried on the accompanying financial statements at cost basis, which is deemed to approximate fair value, primarily due to the short duration of these instruments, including cash and cash equivalents, receivables, payables and borrowings under repurchase arrangements with initial terms of 120 days or less. The fair value of these instruments is determined using level two inputs. The following tables provide a summary of the Company’s assets and liabilities that are measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011:
September 30, 2012
Fair Value Measurements Using
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Assets
 
 
 
 
 
 
 
Agency RMBS
$

 
$
22,596,939

 
$

 
$
22,596,939

U.S. Treasury Bills
29,989

 

 

 
29,989

CLOs

 

 
12,449

 
12,449

Real estate assets

 

 
6,928

 
6,928

Interest rate cap contracts

 
125,331

 

 
125,331

Total
$
29,989

 
$
22,722,270

 
$
19,377

 
$
22,771,636

Liabilities
 
 
 
 
 
 
 
Interest rate swap contracts
$

 
$
111,725

 
$

 
$
111,725

December 31, 2011
Fair Value Measurements Using
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Assets
 
 
 
 
 
 
 
Agency RMBS
$

 
$
9,372,454

 
$

 
$
9,372,454

U.S. Treasury Bills
74,999

 

 

 
74,999

CLOs

 

 
18,675

 
18,675

Interest rate cap contracts

 
5,966

 

 
5,966

Total
$
74,999

 
$
9,378,420

 
$
18,675

 
$
9,472,094

Liabilities
 
 
 
 
 
 
 
Interest rate swap contracts
$

 
$
79,476

 
$

 
$
79,476


The table below presents a reconciliation of changes in assets classified as Level 3 in the Company’s financial statements for the three and nine months ended September 30, 2012 and 2011. A discussion of the method of fair valuing these assets is included above in “Investment Valuation.” CLOs are generally valued using valuations provided by broker quotations. The Company validates the broker quotations using internal discounted cash flow models. The significant unobservable inputs used in the fair value measurement of the Company’s CLOs are prepayment rates, probability of default, and recovery rate in the event of default. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates. The weighted average inputs to the models were:
 
Constant 
Prepayment Rate
 
Default Rate
 
Recovery Rate
 
Recovery Lag
Weighted Average
20
%
 
2
%
 
60
%
 
6 Months
Fair Value Reconciliation, Level 3
(in thousands)

16


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
CLOs
 
 
 
 
 
 
 
Beginning balance Level 3 assets
$
17,874

 
$
24,141

 
$
18,675

 
$
20,478

Cash payments recorded as a reduction of cost basis
(964
)
 
(1,236
)
 
(3,081
)
 
(3,664
)
Change in net unrealized appreciation (depreciation)
1,483

 
(1,816
)
 
2,799

 
4,275

Sales, at cost
(5,944
)
 
(995
)
 
(5,944
)
 
(995
)
Transfers into (out of) Level 3

 

 

 

Ending balance Level 3 assets
$
12,449

 
$
20,094

 
$
12,449

 
$
20,094


Fair values of real estate assets are valued based on discounted cash flow models. The significant unobservable input used in the fair value measurement is capitalization rates, which the Company estimated to be between 4% and 5% at September 30, 2012.  
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Real Estate Assets
2012
 
2011
 
2012
 
2011
Beginning balance Level 3 assets
$
6,928

 
$

 
$

 
$

Purchase of real estate assets

 

 
6,928

 

Change in net unrealized appreciation (depreciation)

 

 

 

Transfers into (out of) Level 3

 

 

 

Ending balance Level 3 assets
$
6,928

 
$

 
$
6,928

 
$


The Agency RMBS portfolio consisted of Agency RMBS as follows:
September 30, 2012
 
Par Value
 
Fair Value
 
Weighted Average
Asset Type
 
(in thousands)
 
Cost/Par
 
Fair
Value/Par
 
MTR(1)
 
Coupon
 
CPR(2)
10 Year Fixed Rate
 
$
224,154

 
$
238,674

 
$
103.69

 
$
106.48

 
N/A

  
3.50
%
 
16.0
%
15 Year Fixed Rate
 
11,142,835

 
11,854,179

 
104.04

 
106.38

 
N/A

  
3.26
%
 
16.1
%
20 Year Fixed Rate
 
910,489

 
967,434

 
104.87

 
106.25

 
N/A

  
3.22
%
 
11.2
%
30 Year Fixed Rate
 
5,293,159

 
5,685,772

 
105.83

 
107.42

 
 N/A

  
3.79
%
 
16.5
%
Hybrid ARMs
 
3,652,347

 
3,850,880

 
103.07

 
105.44

 
69.3

  
2.92
%
 
21.8
%
Total/Weighted Average
 
$
21,222,984

 
$
22,596,939

 
$
104.35

 
$
106.47

 
69.3

(3) 
3.33
%
 
17.4
%
 
December 31, 2011
 
Par Value
 
Fair Value
 
Weighted Average
Asset Type
 
(in thousands)
 
Cost/Par
 
Fair
Value/Par
 
MTR(1)
 
Coupon
 
CPR(2)
10 Year Fixed Rate
 
$
272,115

 
$
284,948

 
$
103.96

 
$
104.72

 
N/A

  
3.50
%
 
13.6
%
15 Year Fixed Rate
 
4,763,965

 
5,010,121

 
102.53

 
105.17

 
N/A

  
3.79
%
 
17.8
%
20 Year Fixed Rate
 
551,766

 
585,103

 
102.32

 
106.04

 
N/A

  
4.14
%
 
28.1
%
30 Year Fixed Rate
 
239,747

 
259,123

 
103.09

 
108.08

 
N/A

  
5.00
%
 
26.3
%
Hybrid ARMs
 
3,098,024

 
3,233,159

 
102.31

 
104.36

 
64.0

  
3.29
%
 
20.3
%
Total/Weighted Average
 
$
8,925,617

 
$
9,372,454

 
$
102.50

 
$
105.01

 
64.0

(3) 
3.66
%
 
19.5
%
__________________
(1) 
MTR, or “Months to Reset” is the number of months remaining before the fixed rate on a hybrid ARM becomes a variable rate. At the end of the fixed period, the variable rate will be determined by the margin and the pre-specified caps of the ARM. After the fixed period, 100% of the hybrid ARMS in the portfolio reset annually.
(2) 
CPR, or “Constant Prepayment Rate,” is a method of expressing the prepayment rate for a mortgage pool that assumes that a constant fraction of the remaining principal is prepaid each month or year. Specifically, the constant prepayment rate is an annualized version of the prior three month prepayment rate. Securities with no prepayment history are

17


excluded from this calculation.
(3) 
Weighted average months to reset of our Hybrid ARM portfolio.
As of September 30, 2012 and December 31, 2011, the Company’s Agency RMBS were purchased at a net premium to their par value with approximately $923.8 million and $223.5 million, respectively, of unamortized premium included in their cost basis. This is due to the average interest rates on these investments being higher than prevailing market rates.
Actual maturities of Agency RMBS are generally shorter than stated contractual maturities (which range up to 30 years), as they are affected by the contractual lives of the underlying mortgages, periodic payments and prepayments of principal. As of September 30, 2012 and December 31, 2011, the average final contractual maturity of the Company’s Agency RMBS portfolio is in year 2033 and 2031, respectively.
In order to mitigate its interest rate exposure, the Company enters into interest rate swap and cap contracts. The Company had the following activity in interest rate swap and cap transactions during the three and nine months ended September 30, 2012 and 2011 (in thousands):
Three and Nine Months Ended September 30, 2012
 
Three and Nine Months Ended September 30, 2011
Trade Date
Transaction
 
Notional
 
Trade Date
Transaction
 
Notional
April 2012
Opened
 
$
500,000

 
February 2011
Opened
 
$
500,000

May 2012
Opened
 
600,000

 
March 2011
Opened
 
250,000

June 2012
Opened
 
600,000

 
May 2011
Terminated
 
(300,000
)
July 2012
Opened
 
2,250,000

 
May 2011
Opened
 
300,000

September 2012
Opened
 
1,000,000

 
June 2011
Opened
 
300,000

Net Increase
 
 
$
4,950,000

 
Net Increase
 
 
$
1,050,000

As of September 30, 2012 and December 31, 2011, the Company had pledged Agency RMBS and U.S Treasury securities with a fair value of $131.5 million and $127.9 million, respectively, as collateral on interest rate swap and cap contracts. In addition, the Company had Agency RMBS and U.S. Treasuries of $21.4 million and cash of $38.0 million pledged to it as collateral for its interest rate cap contracts as of September 30, 2012. The Company did not have any collateral pledged to it as of December 31, 2011. Below is a summary of our interest rate swap and cap contracts open as of September 30, 2012 and December 31, 2011 and for the three and nine months ended September 30, 2012 and 2011 (in thousands):
Derivatives not designated as hedging instruments under ASC 815(a)
Interest Rate Swap Contracts
Notional Amount
 
Fair Value
 
Statement of Assets and Liabilities Location
September 30, 2012
$
6,990,000

 
$
(111,725
)
 
Liabilities
December 31, 2011
4,740,000

 
(79,476
)
 
Liabilities
 
 
 
 
 
 
Interest Rate Cap Contracts
Notional Amount
 
Fair Value
 
Statement of Assets and Liabilities Location
September 30, 2012
$
3,400,000

 
$
125,331

 
Assets
December 31, 2011
700,000

 
5,966

 
Assets
 
 
Amount of Gain or (Loss)
Recognized in Income on Derivative
Derivatives Not Designated as Hedging Instruments Under ASC 815(a)
Location of Gain or (Loss) Recognized in Income on Derivative
Three Months Ended September 30,
 
Nine Months Ended September 30,
2012
 
2011
 
2012
 
2011
Interest rate swap and cap contracts
Net gain (loss) from swap and cap contracts
$
(38,618
)
 
$
(74,594
)
 
$
(80,403
)
 
$
(161,961
)
__________________
(a)
See note 2 for additional information on the Company’s purpose for entering into interest rate swaps and caps and the decision not to designate them as hedging instruments.
Credit Risk
At September 30, 2012 and December 31, 2011, the Company continued to have minimal exposure to credit losses on its mortgage assets by owning principally Agency RMBS. The payment of principal and interest on Agency RMBS is guaranteed by Freddie Mac, Fannie Mae or Ginnie Mae. In September 2008, both Freddie Mac and Fannie Mae were placed in the

18


conservatorship of the United States government. While it is hoped 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 or Fannie Mae will be able to satisfy their guarantees of Agency RMBS.
On August 5, 2011, Standard & Poor’s downgraded the U.S.’s credit rating to AA+ for the first time. Because Fannie Mae and Freddie Mac are in conservatorship of the U.S. Government, the implied credit ratings of Agency RMBS guaranteed by Freddie Mac, Fannie Mae or Ginnie Mae were also downgraded to AA+. While this downgrade did not have a significant impact on the fair value of the Agency RMBS in the Company’s portfolio, it has increased the uncertainty regarding the credit risk of Agency RMBS.
The Company’s CLOs and real estate assets do not have the backing of Fannie Mae, Freddie Mac or Ginnie Mae. Payment of principal and interest is dependent on the performance of the underlying loans, which are subject to borrower default and possible losses.
5. BORROWINGS
The Company leverages its Agency RMBS portfolio through the use of repurchase agreements. Each of the borrowing vehicles used by the Company bears interest at floating rates based on a spread above or below the LIBOR. The fair value of borrowings under repurchase agreements approximates their carrying amount due to the short term nature of these financial instruments.
Certain information with respect to the Company’s borrowings is summarized in the following tables. Each of the borrowings listed is contractually due in one year or less (dollars in thousands).
September 30, 2012
Outstanding repurchase agreements
$
13,911,977

Interest accrued thereon
$
5,086

Weighted average borrowing rate
0.42
%
Weighted average remaining maturity (in days)
29.2

Fair value of the collateral(1)
$
14,614,440

December 31, 2011
Outstanding repurchase agreements
$
7,880,814

Interest accrued thereon
$
3,747

Weighted average borrowing rate
0.36
%
Weighted average remaining maturity (in days)
27.6

Fair value of the collateral(1)
$
8,284,423

 __________________
(1)
Collateral for repurchase agreements consists of Agency RMBS.
At September 30, 2012 and December 31, 2011, the Company did not have any borrowings under repurchase agreements where the amount at risk exceeded 10% of net assets.
6. COMMITMENTS AND CONTINGENCIES
The Company enters into certain contracts that contain a variety of indemnifications, principally with brokers. The maximum potential amount of future payment the Company could be required to make under these indemnification provisions is unknown. The Company has not had any asserted claims nor incurred any costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of September 30, 2012 and December 31, 2011.
7. SHARE CAPITAL
The Company has authorized 500,000,000 shares of common stock having par value of $0.01 per share. As of September 30, 2012 and December 31, 2011, the Company had issued and outstanding 174,942,130 and 82,753,036 shares of common stock, respectively. The Company’s common stock transactions during the nine months ended September 30, 2012 and 2011 are as follows (in thousands):

19


 
Nine Months Ended September 30, 2012
 
Nine Months Ended September 30, 2011
 
Shares
 
Amount
 
Shares
 
Amount
Shares sold in public offerings or issued as restricted stock
92,104

 
$
1,238,141

 
23,192

 
$
280,614

Shares issued in reinvestment of distributions
98

 
1,310

 
1

 
13

Shares canceled
(13
)
 
(180
)
 

 

Net increase
92,189

 
$
1,239,271


23,193


$
280,627

The Company has authorized 50,000,000 shares of preferred stock having a par value of $0.01 per share. As of September 30, 2012, 3,000,000 shares of 7.75% Series A Preferred Stock ($25.00 liquidation preference) were issued and outstanding. The Series A Preferred Stock will not be redeemable before August 3, 2017, except under circumstances where it is necessary to preserve our qualification as a REIT, for federal income tax purposes and the occurrence of certain change of control. On or after August 3, 2017, the Company may, at its option, redeem any or all of the shares of the Series A Preferred Stock at $25.00 per share plus any accumulated and unpaid dividends to, but not including, the redemption date. The Series A Preferred Stock has no stated maturity, is not subject to any sinking fund or mandatory redemption. As of December 31, 2011, no such shares were issued or outstanding.
Equity Offerings
On February 1, 2012, the Company closed a public offering of 28,750,000 shares of its common stock at a public offering price of $13.28 per share for total net proceeds of approximately $377.3 million, after the underwriting discount and commissions and expenses.
On July 16, 2012, the Company closed a public offering of 46,000,000 shares of its common stock at a public offering price of $13.70 per share for total net proceeds of approximately $622.2 million, after the underwriting discount and commissions and expenses.
On August 3, 2012, the Company closed a public offering of 3,000,000 shares of its Series A Preferred Stock, liquidation preference of $25.00 per share, for total net proceeds of approximately $72.5 million, after the underwriting discount and commissions and expenses.
Dividend Reinvestment and Direct Stock Purchase Plan (“DSPP”)
The Company sponsors a dividend reinvestment and direct stock purchase plan through which stockholders may purchase additional shares of common stock by reinvesting some or all of the cash dividends received on shares of common stock.
Stockholders may also make optional cash purchases of shares of common stock subject to certain limitations detailed in the plan prospectus. For the nine months ended September 30, 2012 and 2011, the Company issued 5,327,661 and 9,192 shares under the plan, respectively, raising approximately $74.0 million and $116,064 of net proceeds, respectively. As of September 30, 2012 and December 31, 2011, there were approximately 4.1 million and 9.4 million shares, respectively, available for issuance under this plan.
Restricted Stock Awards
For the nine months ended September 30, 2012 and 2011, the Company granted 205,390 and 171,132 shares of restricted stock, respectively, to certain of its directors, officers and employees.
Equity Placement Program (“EPP”)
On June 7, 2011, the Company entered into a sales agreement with JMP Securities LLC whereby the Company may, from time to time, publicly offer and sell up to 15.0 million shares of the Company’s common stock through at-the-market transactions and/or privately negotiated transactions. For the nine months ended September 30, 2012, the Company issued 11,918,553 shares under the plan raising approximately $164.3 million. As of September 30, 2012 and December 31, 2011, approximately 3.1 million and 15.0 million shares of common stock, respectively, remained available for issuance and sale under the sales agreement.
8. FINANCIAL HIGHLIGHTS
In accordance with financial reporting requirements applicable to investment companies, the Company has included below certain financial highlight information for the three and nine months ended September 30, 2012 and 2011:

20


 
Per Common Share
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
 
Net asset value, beginning of period
$
13.52

  
$
12.35

  
$
13.02

  
$
11.59

  
Net income:
 
 
 
 
 
 
 
 
Net investment income
0.36

(a)  
0.60

(a)  
1.32

(a)  
1.78

(a)  
Net gain from investments and swap and cap contracts
1.11

(a)  
0.56

(a)  
1.88

(a)  
1.37

(a)  
Net income
1.47

   
1.16

   
3.20

   
3.15

   
Dividend on preferred stock
(0.01
)
(a)  

(a)  
(0.01
)
(a)  

(a)  
Net income available to common shares
1.46

 
1.16

 
3.19

 
3.15

 
Capital transactions:
 
 
 
 
 
 
 
 
Distributions to common stockholders
(0.45
)
 
(0.55
)
 
(1.45
)
 
(1.75
)
 
Issuance of common and preferred shares and amortization of share based compensation
(0.07
)
(a)  
0.02

(a)  
(0.30
)
(a)  
(0.01
)
(a)  
Net decrease in net asset value from capital transactions
(0.52
)
 
(0.53
)
 
(1.75
)
 
(1.76
)
 
Net asset value, end of period
$
14.46