Hatteras Financial Corp. Announces First Quarter 2014 Financial Results

Hatteras Financial Corp. (NYSE: HTS) (“Hatteras” or the “Company”) today announced financial results for the quarter ended March 31, 2014.

First Quarter 2014 Highlights

• GAAP net income of $0.12 per weighted average share
• Core earnings of $0.64 per weighted average share
• Dividend of $0.50 per common share
• Quarter end book value of $21.81 per common share
• GAAP leverage of 6.3 to 1
• Leverage of 7.7 to 1, including TBA dollar rolls
• Weighted average constant prepayment rate (“CPR”) of 13.0 for the quarter

First Quarter 2014 Results

During the quarter ended March 31, 2014, the Company had GAAP net income available to common shareholders of $11.3 million, or $0.12 per diluted common share, compared to net loss of ($15.4) million, or ($0.16) per diluted common share during the quarter ended December 31, 2013. The increase in net income was primarily due to an increase in gains on sales of the Company’s agency securities which were partially offset by losses on its derivative instruments. The Company realized a net gain on sale of mortgage-backed securities (MBS) of $7.4 million during the quarter compared to a loss of ($68.7) million for the previous quarter. For the quarter ended March 31, 2014, the Company had core earnings of $0.64 per common share compared to $0.51 per common share during the quarter ended December 31, 2013. “Core earnings" represents a non-GAAP measure and is calculated as net interest margin, as adjusted for certain derivative impacts, and after deducting operating expenses and dividends on preferred stock. Management believes core earnings is additional useful information of the Company’s performance in light of, among other things, the discontinuation of hedge accounting for its interest rates swaps effective at the beginning of the fourth quarter of 2013.

Net interest margin for the quarter ended March 31, 2014 was $58.1 million, compared to $64.0 million for the quarter ended December 31, 2013. The Company’s net interest spread was essentially unchanged at 1.25% for the first quarter of 2014 compared to 1.26% in the fourth quarter of 2013. The yield on the Company’s agency securities was 2.22% in the first quarter compared to 2.16% in the fourth quarter as a rise in mortgage rates in the second half of 2013 caused a slowdown in prepayments and less amortization expense.

The Company’s cost of funds increased 0.07% to 0.97% for the quarter ended March 31, 2014 compared to the previous quarter. The Company’s average short term financing rate decreased to 0.35% in the first quarter of 2014 from 0.36% in the fourth quarter of 2013. The Company’s effective cost of funds, which includes certain interest rate swap adjustments, was 1.09% as compared to 1.05% in the prior quarter. Operating expenses decreased to $7.2 million from $7.5 million in the previous quarter. The total annualized expense ratio for the quarter was 1.18% of average shareholders’ equity for the quarter ended March 31, 2014 as compared to 1.25% for the fourth quarter, reflecting higher equity in the first quarter along with decreased expenses.

“The first quarter was one of few surprises and relative market stability,” said Michael Hough the Company’s Chief Executive Officer. “Hatteras’ portfolio has been positioned well for the recent trading range volatility and we remain biased from a risk perspective toward the possibility of higher interest rates. We will continue to closely watch economic conditions and Fed policy to be best prepared for future rate volatility. In the meantime, current mortgage rates suggest that prepayments should remain benign although perhaps a little higher than in the first quarter. We expect this to bode well for earnings and stability this year absent unexpected news or volatility.”

Dividend

The Company declared a dividend of $0.50 per share of common stock with respect to the quarter ended March 31, 2014, consistent with the quarter ended December 31, 2013. Based on the closing share price of $18.85 on March 31, 2014, the first quarter dividend equates to an annualized yield of 10.6%.

Portfolio

The Company’s weighted average earning assets, consisting of residential mortgage securities issued primarily by Fannie Mae and Freddie Mac, was $20.5 billion (on a book value basis) for the quarter ended March 31, 2014, compared to $20.1 billion for the previous quarter. The fair value of our earning assets as of March 31, 2014 and December 31, 2013 is summarized below.

The annualized yield on our average ARMs and 15-year fixed securities was 2.22% for the first quarter of 2014, compared to 2.16% for the fourth quarter of 2013, due to the increase in average coupon and due to lower premium amortization.

At March 31, 2014, the Company also owned 15-year TBA dollar rolls with a fair value of $3,551.8 million, as shown in the table above. The Company accounts for TBA dollar roll positions as derivative instruments and recognizes dollar roll income/(loss) in other income (loss), net on the Company's financial statements. As of March 31, 2014, the Company's net TBA dollar roll position had a cost basis of approximately $3,565.4 million and a net carrying value of ($13.6) million reported in other liabilities on the Company's balance sheet. The Company uses dollar rolls as an alternative financing for its 15-year fixed rate positions.

During the first quarter of 2014, the expense of amortizing the premium on the Company’s securities was $22.1 million, compared to $26.7 million during the fourth quarter of 2013. The weighted-average principal repayment rate (scheduled and unscheduled principal payments as a percentage of the weighted-average portfolio, on an annualized basis) during the first quarter of 2014 was 17.7%, compared to 19.6% during the fourth quarter of 2013, indicating the extent of the slowdown in mortgage refinancing. The Company’s weighted-average one-month CPR for the quarter ended March 31, 2014 was 13.0, as compared to 14.2 for the quarter ended December 31, 2013. CPR measures unscheduled repayment rate as a percentage of principal on an annualized basis.

Portfolio Financing and Leverage

At March 31, 2014, the Company financed its portfolio with approximately $15.2 billion of borrowings under repurchase agreements. The Company’s debt-to-shareholders’ equity ratio at March 31, 2014, was 6.3 to 1 compared to 7.0 to 1 as December 31, 2013. The Company’s effective leverage, which includes the effects of TBA dollar roll financing, was 7.7 to 1 at March 31, 2014 compared with 7.3 to 1 at December 31, 2013. At March 31, 2014, the Company’s repurchase agreements had a weighted-average remaining term of approximately 25 days.

The Company uses interest rate swap agreements and Eurodollar futures contracts to synthetically extend the fixed interest period of these liabilities and hedge against the interest rate risk associated with financing the Company’s portfolio. As of March 31, 2014, the Company had entered into interest rate swaps and Eurodollar futures contracts with effective notional amounts and rates as shown in the following table.

Book Value

The Company’s book value (shareholders’ equity less preferred stock liquidation preference) per share on March 31, 2014 was $21.81, up 1.4%, from the per share book value of $21.50 on December 31, 2013. On a per share basis, the book value at March 31, 2014 consisted of $25.31 of common equity, ($4.11) of retained losses, $1.50 of unrealized gains on agency securities, and ($0.89) of unrealized losses on interest rate swaps.

Conference Call

The Company will host a conference call at 10:00 a.m. ET on Wednesday, April 23, 2014, to discuss financial results for the quarter ended March 31, 2014. To participate in the event by telephone, please dial (888) 317-6016 five to 10 minutes prior to the start time (to allow time for registration) and ask to join the “Hatteras Financial” conference call. International callers should dial (412) 317-6016. Canada callers should dial (855) 669-9657. A digital replay of the call will be available on Wednesday, April 23, 2014 at approximately 12:00 noon ET through Thursday, May 1, 2014 at 9:00 a.m. ET. Dial (877) 344-7529 and enter the conference ID number 10044543. International callers should dial (412) 317-0088 and enter the same conference ID number. Canada callers should dial (855) 669-9658. The conference call will also be webcast live over the Internet and can be accessed at Hatteras' web site at www.hatfin.com. To monitor the live webcast, please visit the web site at least 15 minutes prior to the start of the call to register, download, and install any necessary audio software. An audio replay of the event will be archived on Hatteras' web site.

About Hatteras Financial Corp.

Hatteras Financial is a real estate investment trust formed in 2007 to invest in single-family residential mortgage real estate assets, such as pass-through securities guaranteed or issued by U.S. Government agencies or U.S. Government-sponsored entities, such as Fannie Mae, Freddie Mac or Ginnie Mae. Based in Winston-Salem, N.C., Hatteras is managed and advised by Atlantic Capital Advisors LLC. Hatteras is a component of the Russell 1000® index.

Non-GAAP Measures

In addition to the Company’s results presented in accordance with GAAP, this press release includes certain non-GAAP financial information. Management’s decision to present these supplemental non-GAAP measures arose largely from two developments during 2013: 1) the Company’s cessation of hedge accounting for its interest rates swaps effective September 30, 2013, 2) increased use of Futures Contracts as interest rate hedges, and 3) the Company’s use of TBA dollar rolls, which generate non-traditional investment income and embody off-balance sheet financing. These changes result in the recognition of material fair value adjustments in net income, as well as line item classifications that make it difficult to clearly explain the economics of the Company’s results and strategies without supplemental disclosures. The non-GAAP measures the Company employs include effective interest expense, effective net interest margin, core earnings, and certain financial metrics derived from non-GAAP information, such as effective cost of funds and effective leverage. The Company uses these measures internally to assess its results and financial condition. Therefore, the Company believes that providing these measures gives users of financial information additional clarity regarding its performance and financial condition, and better enables them to see “through the eyes of management.”

These measures involve differences from results computed in accordance with GAAP, and should be considered supplementary to, and not as a substitute for, the Company’s results computed in accordance with GAAP. Further, the Company’s definition of these non-GAAP measures may not be comparable to other similarly-titled measures of other companies. Reconciliations of each non-GAAP measure to its nearest directly comparable measure calculated in accordance with GAAP are included below.

Forward-Looking Statements

This press release, together with other statements and information publicly disseminated by the Company, contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and includes this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe the Company's future plans, strategies and expectations, are generally identifiable by use of the words "believe," ”will,” "expect," "intend," "anticipate," "estimate," ”should,” "project" or similar expressions.You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond the Company's control and which could materially affect actual results, performances or achievements. Forward-looking statements in this press release include, among others, statements about the Company’s MBS portfolio and repurchase agreements, future volatility in the domestic and global economies and interest rates, prepayment rates, future earnings, risks in the portfolio and the Company’s return profile. Factors that may cause actual results to differ materially from current expectations include the risk factors discussed in the Company’s most recent Annual Report on Form 10-K and Quarterly Reports on Form 10-Q. Accordingly, there is no assurance that the Company's expectations will be realized. Except as otherwise required by the federal securities laws, the Company disclaims any obligation or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in the Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

(1) This table includes non-GAAP financial measures. See the earlier section on non-GAAP Measures for important disclosures, as well as Tables 10 and 11 which contain reconciliations to the most comparable U.S. GAAP measures.

(2) The averages presented herein are computed from the Company’s books and records, using daily weighted values. Percentages are annualized, as appropriate.

(3) Average debt includes borrowings under repurchase agreements and dollar roll liability as presented on the balance sheet. It does not include off-balance sheet financing related to the Company’s TBA dollar roll position.

(4) Effective interest expense includes certain interest rate swap adjustments. Effective cost of funds is effective interest expense for the period on an annualized basis divided by average repurchase agreements and dollar roll liability for the period. See Table 10.

(5) Effective net interest margin includes certain interest rate swap adjustments and TBA dollar roll income. See Table 11.

(6) Effective interest rate spread is the difference between average portfolio yield including TBA dollar roll income and effective cost of funds for the period.

(7) Core earnings consists of effective interest margin reduced by operating expenses and dividends on preferred stock for the period. See Table 11.

Fixed