Ready Capital Corp - FORM 10-Q

Attached files

file	filename
EXCEL - IDEA: XBRL DOCUMENT - Ready Capital Corp	Financial_Report.xls
EX-32.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER, PURSUANT TO SECTION 906 - Ready Capital Corp	exhibit32-2.htm
EX-10.3 - AMENDMENT NUMBER ONE, DATED MAY 23, 2014, TO THE MASTER LOAN REPURCHASE - Ready Capital Corp	exhibit10-3.htm
EX-32.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER, PURSUANT TO SECTION 906 - Ready Capital Corp	exhibit32-1.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - Ready Capital Corp	exhibit31-1.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - Ready Capital Corp	exhibit31-2.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014
Commission File Number: 001-35808

ZAIS FINANCIAL CORP.
(Exact Name of Registrant as Specified in its Charter)

Maryland
(State or Other Jurisdiction of Incorporation or Organization)

90-0729143
(IRS Employer Identification No.)

Two Bridge Avenue, Suite 322, Red Bank, New Jersey 07701-1106
(Address of Principal Executive Offices, Including Zip Code)

(732) 978-7518
(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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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 o	Accelerated filer o	Non-accelerated filer x	Smaller reporting company o
		(Do not check if a 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 o No x

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date:

The Company has 7,970,886 shares of common stock, par value $0.0001 per share, outstanding as of August 11, 2014.

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ZAIS FINANCIAL CORP.
FORM 10-Q TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION		1
Item 1. Financial Statements		1
Item 1A. Forward-Looking Statements		31
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		33
Item 3. Quantitative and Qualitative Disclosures About Market Risk		47
Item 4. Controls and Procedures		50
PART II. OTHER INFORMATION		51
Item 1. Legal Proceedings		51
Item 1A. Risk Factors		51
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		51
Item 3. Defaults Upon Senior Securities		51
Item 4. Mine Safety Disclosures		51
Item 5. Other Information		51
Item 6. Exhibits		51
SIGNATURES		S-1

EXHIBITS

Exhibit 10.3	Amendment Number One, dated May 23, 2014, to the Master Loan Repurchase Agreement dated as of May 30, 2013 among ZFC Trust and Citibank, N.A.	Exh. 10.3-1
Exhibit 31.1 Certifications		Exh. 31.1-1
Exhibit 31.2 Certifications		Exh. 31.2-1
Exhibit 32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 10 U.S.C. Section 1350		Exh. 32.1-1
Exhibit 32.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 10 U.S.C. Section 1350		Exh. 32.2-1

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ZAIS Financial Corp. and Subsidiaries
Consolidated Balance Sheets

	June 30, 2014
	(unaudited)		December 31, 2013
	(Expressed in United States Dollars)
Assets
Cash	$	27,619,043	$	57,060,806
Restricted cash		8,144,052		2,128,236
Mortgage loans, at fair value - $433,299,627 and $331,522,165 pledged as collateral,
respectively		433,553,720		331,785,542
Real estate securities, at fair value - $197,404,343 and $183,722,511 pledged as collateral,
respectively		227,293,536		226,155,221
Other investment securities, at fair value, $12,034,003 and $0 pledged as collateral,
respectively		12,034,003		—
Derivative assets, at fair value		368,136		284,454
Other assets		4,148,627		2,666,799
Total assets	$	713,161,117	$	620,081,058
Liabilities
Loan repurchase facility	$	293,609,481	$	236,058,976
Securities repurchase agreements		156,343,944		138,591,678
Exchangeable Senior Notes		54,995,215		54,539,051
Derivative liabilities, at fair value		1,550,129		1,471,607
Dividends and distributions payable		3,559,120		8,452,910
Accounts payable and other liabilities		2,547,654		1,828,947
Accrued interest payable		1,550,258		1,369,327
Total liabilities		514,155,801		442,312,496
Commitments and Contingencies (Note 14)
Stockholders' equity
12.5% Series A cumulative non-voting preferred stock, $0.0001 par value; 50,000,000 shares
authorized; zero shares issued and outstanding		—		—
Common stock, $0.0001 par value; 500,000,000 shares authorized; 7,970,886 shares issued
and outstanding		798		798
Additional paid-in capital		164,207,617		164,207,617
Retained earnings (accumulated deficit)		14,062,821		(4,958,607	)
Total ZAIS Financial Corp. stockholders' equity		178,271,236		159,249,808
Non-controlling interests in operating partnership		20,734,080		18,518,754
Total stockholders' equity		199,005,316		177,768,562
Total liabilities and stockholders' equity	$	713,161,117	$	620,081,058

The accompanying notes are an integral part of these consolidated financial statements.

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ZAIS Financial Corp. and Subsidiaries
Consolidated Statements of Operations (unaudited)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2014			2013			2014			2013
	(Expressed in United States Dollars)
Interest income
Mortgage loans	$	6,819,954		$	903,953		$	12,469,507		$	932,859
Real estate securities		3,832,576			5,031,558			7,573,191			8,438,685
Other investment securities		178,690			—			281,555			—
Total interest income		10,831,220			5,935,511			20,324,253			9,371,544
Interest expense
Loan repurchase facility		2,260,080			289,296			4,090,987			289,296
Securities repurchase agreements		737,290			867,484			1,397,692			1,381,519
Exchangeable senior notes		1,419,015			—			2,831,658			—
Total interest expense		4,416,385			1,156,780			8,320,337			1,670,815
Net interest income		6,414,835			4,778,731			12,003,916			7,700,729
Other gains/(losses)
Change in unrealized gain or loss on mortgage loans		21,960,921			1,596,197			22,650,525			1,567,291
Change in unrealized gain or loss on real estate securities		1,548,195			(15,642,642	)		4,284,253			(14,739,365	)
Change in unrealized gain or loss on other investment securities		905,862			—			1,276,626			—
Realized gain on mortgage loans		176,667			66,244			407,404			66,244
Realized gain/(loss) on real estate securities		—			(246,055	)		73,619			(246,055	)
(Loss)/gain on derivative instruments		(1,902,949	)		3,698,381			(5,011,630	)		3,979,525
Total other gains/(losses)		22,688,696			(10,527,875	)		23,680,797			(9,372,360	)
Expenses
Professional fees		939,744			231,389			2,751,595			1,492,573
Advisory fee - related party		710,563			704,687			1,413,318			1,193,072
Loan servicing fees		600,747			114,534			972,879			114,534
General and administrative expenses		980,342			769,123			2,191,927			1,123,372
Total expenses		3,231,396			1,819,733			7,329,719			3,923,551
Net income/(loss)		25,872,135			(7,568,877	)		28,354,994			(5,595,182	)
Net income/(loss) allocated to non-controlling interests		2,698,204			(788,476	)		2,956,858			(489,382	)
Preferred dividends		—			—			—			15,379
Net income/(loss) attributable to ZAIS Financial Corp
common stockholders	$	23,173,931		$	(6,780,401	)	$	25,398,136		$	(5,121,179	)
Net income/(loss) per share applicable to common stockholders:
Basic	$	2.91		$	(0.85	)	$	3.19		$	(0.78	)
Diluted	$	2.47		$	(0.85	)	$	2.79		$	(0.78	)
Weighted average number of shares of common stock:
Basic		7,970,886			7,970,886			7,970,886			6,564,284
Diluted		10,677,360			8,897,800			10,677,360			7,491,198

The accompanying notes are an integral part of these consolidated financial statements.

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ZAIS Financial Corp. and Subsidiaries
Consolidated Statements of Stockholders' Equity

											Retained			Total ZAIS			Non-Controlling
	Preferred Stock				Common Stock						Earnings /			Financial Corp.			Interests in			Total
	Shares of		Preferred Stock		Shares of	Common Stock		Additional			(Accumulated			Stockholders'			Operating			Stockholders'
	Preferred Stock		at Par		Common Stock	at Par		Paid-in Capital			Deficit)			Equity			Partnership			Equity
							(Expressed in United States Dollars)
Balance at December 31, 2012	133		$	—	2,071,096	$	207	$	39,759,770		$	5,281,941		$	45,041,918		$	20,098,877		$	65,140,795
Reversal of common stock repurchase liability	—			—	249,790		25		5,440,150			—			5,440,175			—			5,440,175
Repurchase of preferred shares	(133	)		—	—		—		(133,000	)		—			(133,000	)		—			(133,000	)
Net proceeds from initial public offering	—			—	5,650,000		566		118,861,934			—			118,862,500			—			118,862,500
Equity raise payments	—			—	—		—		(216,658	)		—			(216,658	)		—			(216,658	)
Distributions on OP units	—			—	—		—		—			—			—			(1,965,060	)		(1,965,060	)
Dividends on common stock	—			—	—		—		—			(16,898,276	)		(16,898,276	)		—			(16,898,276	)
Rebalancing of ownership percentage between the
Company and operating partnership	—			—	—		—		495,421			—			495,421			(495,421	)		—
Net income	—			—	—		—		—			6,657,728			6,657,728			880,358			7,538,086
Balance at December 31, 2013	—			—	7,970,886		798		164,207,617			(4,958,607	)		159,249,808			18,518,754			177,768,562
Distributions on OP units	—			—	—		—		—			—			—			(741,532	)		(741,532	)
Dividends on common stock	—			—	—		—		—			(6,376,708	)		(6,376,708	)		—			(6,376,708	)
Net income	—			—	—		—		—			25,398,136			25,398,136			2,956,858			28,354,994
Balance at June 30, 2014 (unaudited)	—		$	—	7,970,886	$	798	$	164,207,617		$	14,062,821		$	178,271,236		$	20,734,080		$	199,005,316

The accompanying notes are an integral part of these consolidated financial statements.

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ZAIS Financial Corp. and Subsidiaries
Consolidated Statements of Cash Flows (unaudited)

	Six Months Ended June 30,
	2014			2013
	(Expressed in United States Dollars)
Cash flows from operating activities
Net income / (loss)	$	28,354,994		$	(5,595,182	)
Adjustments to reconcile net income / (loss) to net cash (used in) / provided by operating
activities
Net (accretion)/amortization of (discounts)/premiums related to mortgage loans		(3,423,653	)		(259,435	)
Net (accretion)/amortization of (discounts)/premiums related to real estate securities		(2,603,804	)		(1,566,256	)
Net (accretion)/amortization of (discounts)/premiums related to other investment securities		(80,424	)		—
Change in unrealized gain or loss on mortgage loans		(22,650,525	)		(1,567,291	)
Change in unrealized gain or loss on real estate securities		(4,284,253	)		14,739,365
Change in unrealized gain or loss on other investment securities		(1,276,626	)		—
Realized gain on mortgage loans		(407,404	)		(66,244	)
Realized (gains) / loss on real estate securities		(73,619	)		246,055
Change in unrealized gain or loss on derivative instruments		4,798,590			(3,244,803	)
Amortization of Exchangeable Senior Notes discount		456,164			—
Changes in operating assets and liabilities
Increase in other assets		(1,481,828	)		(302,375	)
Increase in accounts payable and other liabilities		718,707			788,610
Increase in accrued interest payable		180,931			361,927
Net cash (used in) / provided by operating activities		(1,772,750	)		3,534,371
Cash flows from investing activities
Acquisitions of mortgage loans		(84,795,975	)		(119,758,049	)
Proceeds from principal repayments on mortgage loans		9,509,379			867,594
Acquisitions of real estate securities, net of change in payable for real estate
securities purchased		(11,830,958	)		(344,623,655	)
Proceeds from principal repayments on real estate securities		15,582,121			24,639,160
Proceeds from sales of real estate securities, net of changes in receivable for real
estate securities sold		2,072,198			53,913,098
Acquisitions of other investment securities		(10,676,953	)		—
Premium paid for interest rate swaption		(4,803,750	)		—
Restricted cash used in investment activities		(6,015,816	)		(8,777,793	)
Net cash used in investing activities		(90,959,754	)		(393,739,645	)
Cash flows from financing activities
Proceeds from issuance of common stock, net		—			118,862,500
Payment of common stock repurchase liability		—			(5,750,512	)
Net borrowings from loan repurchase facility		57,550,505			89,112,325
Borrowings from securities repurchase agreements		71,542,192			287,941,369
Repayments of securities repurchase agreements		(53,789,926	)		(95,524,421	)
Dividends on common stock and distributions on OP Units (net of change in
dividends and distributions payable)		(12,012,030	)		(1,957,516	)
Repurchase of preferred stock including dividend		—			(148,379	)
Equity raise payments		—			(216,658	)
Net cash provided by financing activities		63,290,741			392,318,708
Net (decrease)/increase in cash		(29,441,763	)		2,113,434
Cash
Beginning of period		57,060,806			19,061,110
End of period	$	27,619,043		$	21,174,544
Supplemental disclosure of cash flow information
Interest paid on loan repurchase facility, securities repurchase agreements and Exchangeable
Senior Notes	$	7,607,762		$	1,308,888
Taxes paid	$	—		$	—
Supplemental disclosure of noncash investing and financing activities
Increase in dividends and distributions payable	$	3,559,120		$	—

The accompanying notes are an integral part of these consolidated financial statements.

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ZAIS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Formation and Organization

ZAIS Financial Corp. (the "Company") was incorporated in Maryland on May 24, 2011, and has elected to be taxed and to qualify as a real estate investment trust ("REIT") beginning with the taxable year ended December 31, 2011. The Company completed its formation transaction and commenced operations on July 29, 2011. On February 13, 2013, the Company completed its initial public offering ("IPO"), pursuant to which the Company sold 5,650,000 shares of its common stock at a price of $21.25 per share for gross proceeds of $120.1 million. Net proceeds after the payment of offering costs of $1.2 million were $118.9 million.

The Company primarily invests in, finances and manages performing and re-performing residential mortgage loans, which may be seasoned or recently originated. The Company also invests in, finances and manages residential mortgage-backed securities ("RMBS") that are not issued or guaranteed by a federally chartered corporation, 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") ("non-Agency RMBS") with an emphasis on securities that, when originally issued, were rated in the highest rating category by one or more of the nationally recognized statistical rating organizations. The Company also has the discretion to invest in mortgage servicing rights ("MSRs"), RMBS that are issued or guaranteed by a federally chartered corporation or a U.S. Government agency ("Agency RMBS"), including through To-Be-Announced ("TBA") contracts, and in other real estate-related and financial assets, such as interest only strips created from RMBS ("IOs"), commercial mortgage-backed securities ("CMBS") and asset-backed securities ("ABS"). The Company refers collectively to the assets it targets for acquisition as its target assets.

The Company is externally managed by ZAIS REIT Management, LLC (the "Advisor"), a subsidiary of ZAIS Group, LLC ("ZAIS"), and has no employees. The Company is the sole general partner of, and conducts substantially all of its business through, ZAIS Financial Partners, L.P., the Company's consolidated operating partnership subsidiary (the "Operating Partnership").

The Company's charter authorizes the issuance of up to 500,000,000 shares of common stock with a par value of $0.0001 per share, and 50,000,000 shares of preferred stock, with a par value of $0.0001 per share. The Company's board of directors is authorized to amend its charter, without the approval of stockholders, to increase the aggregate number of authorized shares of capital stock or the number of shares of any class or series of capital stock or to classify and reclassify any unissued shares of its capital stock into other classes or series of stock that the Company has authority to issue.

2. Summary of Significant Accounting Policies

Basis of Quarterly Presentation

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") as contained within the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") and the rules and regulations of the U.S. Securities and Exchange Commission ("SEC") for interim financial reporting. In the opinion of management, all adjustments considered necessary for a fair statement of the Company's financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for the interim period are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. Certain prior period amounts have been reclassified to conform to the current period’s presentation.

The Company currently operates as one business segment.

Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may ultimately differ from those estimates.

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Principles of Consolidation

The consolidated financial statements include the accounts of the Company and all of the wholly owned subsidiaries of the Operating Partnership. The Company, which serves as the sole general partner of and conducts substantially all of its business through the Operating Partnership, holds approximately 89.6% of the operating partnership units ("OP units") in the Operating Partnership at June 30, 2014 and December 31, 2013. The Operating Partnership in turn holds directly or indirectly all of the equity interests in its subsidiaries. All intercompany balances have been eliminated in consolidation.

Changes in the Company's ownership interest (and transactions with non-controlling interest unit holders in the Operating Partnership) while the Company retains its controlling interest in its subsidiary, are accounted for as equity transactions. The carrying amount of the non-controlling interest is adjusted to reflect the change in its ownership interest in the subsidiary, with the offset to equity attributable to the Company.

Variable Interest Entities

A variable interest entity ("VIE") is an entity that lacks one or more of the characteristics of a voting interest entity. The Company evaluates each of its investments to determine whether it is a VIE based on: (1) the sufficiency of the entity's equity investment at risk to finance its activities without additional subordinated financial support provided by any parties, including the equity holders; (2) whether as a group the holders of the equity investment at risk have (a) the power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impacts the entity's economic performance, (b) the obligation to absorb the expected losses of the legal entity and (c) the right to receive the expected residual returns of the legal entity; and (3) whether the voting rights of these investors are proportional to their obligations to absorb the expected losses of the entity, their rights to receive the expected returns of their equity, or both, and whether substantially all of the entity's activities involve or are conducted on behalf of an investor that has disproportionately fewer voting rights. An investment that lacks one or more of the above three characteristics is considered to be a VIE. The Company reassesses its initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events.

A VIE is subject to consolidation if the equity investors either do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support, are unable to direct the entity's activities, or are not exposed to the entity's losses or entitled to its residual returns. VIEs are required to be consolidated by their primary beneficiary. The primary beneficiary of a VIE is determined to be the party that has both the power to direct the activities of a VIE that most significantly impact the VIE's economic performance and the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. This determination can sometimes involve complex and subjective analyses.

The Company has evaluated its real estate securities investments to determine if each represents a variable interest in a VIE. The Company monitors these investments and analyzes them for potential consolidation. The Company's real estate securities investments represent variable interests in VIEs. At June 30, 2014 and December 31, 2013, no VIEs required consolidation as the Company was not the primary beneficiary of any of these VIEs. At June 30, 2014 and December 31, 2013, the maximum exposure of the Company to VIEs is limited to the fair value of its investments in real estate securities as disclosed in the consolidated balance sheets.

Cash and Cash Equivalents

The Company considers highly liquid short-term interest bearing instruments with original maturities of three months or less and other instruments readily convertible into cash to be cash equivalents. The Company's deposits with financial institutions may exceed federally insurable limits of $250,000 per institution. The Company mitigates this risk by depositing funds with major financial institutions. At June 30, 2014, the Company's cash was held with two custodians.

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Restricted Cash

Restricted cash represents the Company's cash held by counterparties as collateral against the Company's derivatives and/or securities repurchase agreements. Cash held by counterparties as collateral is not available to the Company for general corporate purposes, but may be applied against amounts due to derivative or securities repurchase agreement counterparties or returned to the Company when the collateral requirements are exceeded or at the maturity of the derivatives or securities repurchase agreements.

Other Investment Securities

Other investment securities are comprised of investments in Fannie Mae's Risk Transfer Notes ("FMRT Notes" or "Other Investment Securities"). The FMRT Notes represent unsecured general obligations of Fannie Mae and are structured to be subject to the performance of a certain pool of residential mortgage loans.

Mortgage Loans, Real Estate Securities and Other Investment Securities—Fair Value Election

U.S. GAAP permits entities to choose to measure certain eligible financial instruments at fair value. The Company has elected the fair value option for each of its mortgage loans, real estate securities and Other Investment Securities at the date of purchase. The fair value option election is irrevocable and requires the Company to measure these mortgage loans, real estate securities and Other Investment Securities at estimated fair value with the change in estimated fair value recognized in earnings. The Company has established a policy for these assets to separate interest income from the full change in fair value in the consolidated statements of operations. The interest income component is presented as interest income on mortgage loans, real estate securities and Other Investment Securities and the remainder of the change in fair value is presented separately as change in unrealized gain or loss in the Company's consolidated statements of operations.

Determination of Fair Value Measurement

The "Fair Value Measurements and Disclosures" Topic of the FASB ASC defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements under U.S. GAAP. Specifically, this guidance defines fair value based on exit price, or the price that would be received upon the sale of an asset or the transfer of a liability in an orderly transaction between market participants at the measurement date.

Fair value under U.S. GAAP represents an exit price in the normal course of business, not a forced liquidation price. If the Company was forced to sell assets in a short period to meet liquidity needs, the prices it receives could be substantially less than their recorded fair values. Furthermore, the analysis of whether it is more likely than not that the Company will be required to sell securities in an unrealized loss position prior to an expected recovery in fair value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold is also subject to significant judgment.

Any proposed changes to the valuation methodology will be reviewed by the Advisor to ensure changes are consistent with the applicable accounting guidance and approved as appropriate. The fair value methodology may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company anticipates that the Advisor's valuation methods will be appropriate and consistent with other market participants, the use of different methodologies, or assumptions by other market participants, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

The Company categorizes its financial instruments in accordance with U.S. GAAP, based on the priority of the inputs to the valuation, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

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Financial assets and liabilities recorded in the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:

Level 1	Quoted prices for identical assets or liabilities in an active market.

Level 2	Financial assets and liabilities whose values are based on the following:

	Quoted prices for similar assets or liabilities in active markets Quoted prices for identical or similar assets or liabilities in nonactive markets. Pricing models whose inputs are observable for substantially the full term of the asset or liability. Pricing models whose inputs are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability.

Level 3	Prices or valuation techniques based on inputs that are both unobservable and significant to the overall fair value measurement.

The Company may use valuation techniques consistent with the market and income approaches to measure the fair value of its assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future projected cash flows to a single discounted present value amount. When applying either approach, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires significant judgment and considers factors specific to the investment. The Company utilizes proprietary modeling analysis to support the independent third party broker quotes selected to determine the fair value of its real estate securities, Other Investment Securities and derivative instruments.

The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.

Mortgage Loans

The fair value of the Company's mortgage loans considers data such as loan origination information and additional updated borrower and loan servicing data, as available, forward interest rates, general economic conditions, home price index forecasts and valuations of the underlying properties. The variables considered most significant to the determination of the fair value of the Company's mortgage loans include market-implied discount rates, projections of default rates, delinquency rates, loss severity (considering mortgage insurance) and prepayment rates. The Company uses loan level data, macro-economic inputs and forward interest rates to generate loss adjusted cash flows and other information in determining the fair value of its mortgage loans. Because of the inherent uncertainty of such valuation, the fair values established for mortgage loans held by the Company may differ from the fair values that would have been established if a ready market existed for these mortgage loans. Accordingly, mortgage loans are classified as Level 3 in the fair value hierarchy.

At June 30, 2014, approximately 10.7% in unpaid principal balance of the Company's mortgage loans carries mortgage insurance.

Real Estate Securities and Other Investment Securities

The fair value of the Company's real estate securities and Other Investment Securities considers the underlying characteristics of each security including coupon, maturity date and collateral. The Company estimates the fair value of its RMBS and Other Investment Securities based upon a combination of observable prices in active markets, multiple indicative quotes from brokers and executable bids. In evaluating broker quotes the Company also considers additional observable market data points including recent observed trading activity for identical and similar securities, back-testing, broker challenges and other interactions with market participants, as well as yield levels generated by model-based valuation techniques. In the absence of observable quotes, the Company utilizes model-based valuation techniques that may contain unobservable valuation inputs.

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When available, the fair value of real estate securities is based on quoted prices in active markets. If quoted prices are not available, fair values are obtained from either broker quotes, observed traded levels or model-based valuation techniques using observable inputs such as benchmark yields or issuer spreads.

While the Company's non-Agency RMBS and Other Investment Securities are valued using the same process with similar inputs as the Agency RMBS as described below, a significant amount of inputs are unobservable due to relatively low levels of market activity. The fair value of these securities is typically based on broker quotes or the Company's model-based valuation. Accordingly, the Company's non-Agency RMBS and Other Investment Securities are classified as Level 3 in the fair value hierarchy. Model-based valuation consists primarily of discounted cash flow and yield analyses. Significant model inputs and assumptions include constant voluntary prepayment rates, constant default rates, delinquency rates, loss severity, market-implied discount rates, default rates, expected loss severity, weighted average life, collateral composition, borrower characteristics and prepayment rates, and may also include general economic conditions, including home price index forecasts, servicing data and other relevant information. Where possible, collateral-related assumptions are determined on an individual loan level basis.

The Company's Agency RMBS, if any, are valued using the market data described above, which includes inputs determined to be observable or whose significant fair value drivers are observable. Accordingly, Agency RMBS securities are classified as Level 2 in the fair value hierarchy.

Derivative Instruments

Interest Rate Swaption Agreements

An interest rate swaption agreement represents an option that gives the Company the right, but not the obligation, to enter into a previously agreed upon interest rate swap agreement on a future date. If exercised the Company will enter into an interest rate swap agreement and is obligated to pay a fixed rate of interest and receive a floating rate of interest. The Company utilizes proprietary modeling analysis or industry standard third party analytics to support the counterparty valuations received for interest rate swaption agreements. These counterparty valuations are generally based on models with observable market inputs such as interest rates and contractual cash flows, and, as such, are classified as Level 2 on the fair value hierarchy. The Company's interest rate swaption agreements are governed by International Swap and Derivative Association trading agreements, which are separately negotiated agreements with dealer counterparties. At June 30, 2014, no credit valuation adjustment was made in determining the fair value of the derivative.

Interest Rate Swap Agreements

An interest rate swap is an agreement between the Company and a counterparty to exchange periodic interest payments where one party to the contract makes a fixed rate payment in exchange for a floating rate payment from the other party. The Company utilizes proprietary modeling analysis or industry standard third party analytics to support the counterparty valuations received for interest rate swap agreements. These counterparty valuations are generally based on models with observable market inputs such as interest rates and contractual cash flows, and, as such, are classified as Level 2 on the fair value hierarchy. The Company's interest rate swap agreements are governed by International Swap and Derivative Association trading agreements, which are separately negotiated agreements with dealer counterparties. At June 30, 2014 and December 31, 2013, no credit valuation adjustment was made in determining the fair value of the derivative.

TBA Securities

A TBA security is a forward contract for the purchase of Agency RMBS at a predetermined price with a stated face amount, coupon and stated maturity at an agreed upon future date. The specific Agency RMBS delivered into the contract upon the settlement date, published each month by the Securities Industry and Financial Markets Association ("SIFMA"), are not known at the time of the transaction. The Company estimates the fair value of TBA securities based on independent third party closing levels. Accordingly, TBAs are classified as Level 2 in the fair value hierarchy.

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Interest Income Recognition and Impairment—Mortgage Loans

Pursuant to the Company's policy for separately presenting interest income on mortgage loans, the Company follows acceptable methods under U.S. GAAP for allocating a portion of the change in fair value of mortgage loans to interest income.

When the Company purchases mortgage loans that have shown evidence of credit deterioration since origination and management determines that it is probable the Company will not collect all contractual cash flows on those assets, the Company will apply the guidance that addresses accounting for differences between contractual cash flows and cash flows expected to be collected if those differences are attributable to, at least in part, credit quality.

Interest income is recognized on a level-yield basis over the life of the loan as long as cash flows can be reasonably estimated. The level-yield is determined by the excess of the Company's initial estimate of undiscounted expected principal, interest, and other cash flows (cash flows expected at acquisition to be collected) over the Company's initial investment in the mortgage loan (accretable yield). The amount of interest income to be recognized cannot result in a carrying amount that exceeds the payoff amount of the loan. The excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) will not be recognized as an adjustment of yield.

On a quarterly basis, the Company updates its estimate of the cash flows expected to be collected. For purposes of interest income recognition, any subsequent increases in cash flows expected to be collected are generally recognized as prospective yield adjustments (which establishes a new level yield) and any subsequent decreases in cash flows expected to be collected are recognized as an impairment to be recorded through change in unrealized gain or loss in the consolidated statements of operations.

Income recognition is suspended for a loan when cash flows cannot be reasonably estimated.

Interest Income Recognition and Impairment—Real Estate Securities and Other Investment Securities

Pursuant to the Company's policy for separately presenting interest income on real estate securities and Other Investment Securities, the Company follows acceptable methods under U.S. GAAP for allocating a portion of the change in fair value of real estate securities and Other Investment Securities to interest income.

Interest income on Agency RMBS, if any, is accrued based on the effective yield method on the outstanding principal balance and their contractual terms. Premiums and discounts associated with Agency RMBS at the time of purchase are amortized into interest income over the life of such securities using the effective yield method and adjusted for actual prepayments.

Interest income on the non-Agency RMBS and Other Investment Securities, which were purchased at a discount to par value and/or were rated below AA at the time of purchase, is recognized based on the effective yield method. The effective yield on these securities is based on the projected cash flows from each security, which are estimated based on the Company's observation of current information and events and include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses. On a monthly basis, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on input and analysis received from external sources, internal models and its judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, prepayments of principal and credit losses. Therefore, actual maturities of the securities are generally shorter than stated contractual maturities.

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Based on the projected cash flows from the Company's non-Agency RMBS purchased at a discount to par value, a portion of the purchase discount may be designated as credit protection against future credit losses and, therefore, not accreted into interest income. The amount designated as credit discount is determined, and may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a security with a credit discount is more favorable than forecasted, a portion of the amount designated as credit discount may be accreted into interest income prospectively.

RMBS and Other Investment Securities are evaluated for other-than-temporary impairment ("OTTI") each quarter. A security with a fair value that is less than amortized cost is considered impaired. Impairment of a security is considered to be other-than-temporary when: (i) the holder has the intent to sell the impaired security; (ii) it is more likely than not the holder will be required to sell the security; or (iii) the holder does not expect to recover the entire amortized cost of the security. When a security has been deemed to be other-than-temporarily impaired, the amount of OTTI is bifurcated into: (i) the amount related to expected credit losses; and (ii) the amount related to fair value adjustments in excess of expected credit losses. The portion of OTTI related to expected credit losses is recognized in the consolidated statements of operations as a realized loss on real estate securities and realized loss on Other Investment Securities. The remaining OTTI related to the valuation adjustment is recognized as a component of change in unrealized gain or loss in the consolidated statements of operations. Realized gains and losses on sale of real estate securities and Other Investment Securities are determined using the specific identification method. Real estate securities and Other Investment Securities transactions are recorded on the trade date.

Expense Recognition

Expenses are recognized when incurred. Expenses include, but are not limited to, loan servicing fees, advisory fees, professional fees for legal, accounting and consulting services, and general and administrative expenses such as insurance, custodial and miscellaneous fees.

Offering Costs

Offering costs are accounted for as a reduction of additional paid-in capital. Offering costs in connection with the Company's IPO were paid out of the proceeds of the IPO. Costs incurred to organize the Company were expensed as incurred. The Company's obligation to pay for organization and offering expenses directly related to the IPO was capped at $1.2 million and the Advisor paid for such expenses incurred above the cap.

Loan Repurchase Facility

The Company finances a portion of its mortgage loan portfolio through the use of repurchase agreements entered into under a master repurchase agreement with Citibank, N.A. ("Citi"), pursuant to which the Company may sell, and later repurchase trust certificates representing interests in residential mortgage loans (the "Trust Certificates") in an aggregate principal amount of up to $325.0 million (the "Loan Repurchase Facility"). The borrowings under the Loan Repurchase Facility are treated as collateralized financing transactions and are carried at their contractual amounts, including accrued interest, as specified in the respective agreement. The borrowings under the Loan Repurchase Facility are recorded on the trade date at the contract amount.

The Company pledges cash and certain of its Trust Certificates as collateral under the Loan Repurchase Facility. The amounts available to be borrowed are dependent upon the fair value of the Trust Certificates pledged as collateral, which fluctuates with changes in interest rates, type of underlying mortgage loans and liquidity conditions within the banking, mortgage finance and real estate industries. In response to declines in the fair value of pledged Trust Certificates, the lender may require the Company to post additional collateral or pay down borrowings to re-establish agreed upon collateral requirements, referred to as margin calls. At June 30, 2014 and December 31, 2013, the Company has met all margin call requirements.

Securities Repurchase Agreements—Real Estate Securities and Other Investment Securities

The Company finances a portion of its RMBS portfolio and Other Investment Securities through the use of securities repurchase agreements entered into under master repurchase agreements with four financial institutions at June 30, 2014. Repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, including accrued interest, as specified in the respective agreements. Repurchase agreements are recorded on trade date at the contract amount.

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The Company pledges cash and certain of its RMBS and Other Investment Securities as collateral under these securities repurchase agreements. The amounts available to be borrowed are dependent upon the fair value of the RMBS and Other Investment Securities pledged as collateral, which fluctuates with changes in interest rates, type of securities and liquidity conditions within the banking, mortgage finance and real estate industries. In response to declines in the fair value of pledged RMBS and Other Investment Securities, the lenders may require the Company to post additional collateral or pay down borrowings to re-establish agreed upon collateral requirements, referred to as margin calls. At June 30, 2014 and December 31, 2013, the Company has met all margin call requirements.

Derivatives and Hedging Activities

The Company accounts for its derivative financial instruments in accordance with derivative accounting guidance, which requires an entity to recognize all derivatives as either assets or liabilities in the consolidated balance sheets and to measure those instruments at fair value. The Company has not designated any of its derivative agreements as hedging instruments for accounting purposes. As a result, changes in the fair value of derivatives are recorded through current period earnings.

Interest Rate Swaption Agreements

The credit support annex provisions of the Company's interest rate swaption agreement allows the parties to mitigate their credit risk by requiring the party which is out of the money to post collateral. At June 30, 2014, all collateral provided under this agreement consisted of cash collateral.

Interest Rate Swap Agreements

The Company's interest rate swap agreements contain legally enforceable provisions that allow for netting or setting off of all individual interest rate swap receivables and payables with each respective counterparty and, therefore, the fair value of those interest rate swap agreements are netted. The credit support annex provisions of the Company's interest rate swap agreements allow the parties to mitigate their credit risk by requiring the party which is out of the money to post collateral. At June 30, 2014 and December 31, 2013, all collateral provided under these agreements consisted of cash collateral.

TBA Securities

8% Exchangeable Senior Notes Due 2016

On November 25, 2013, the Operating Partnership issued $57.5 million aggregate principal amount of unsecured 8.00% Exchangeable Senior Notes due 2016 (the "Exchangeable Senior Notes"). The Exchangeable Senior Notes are carried at amortized cost. Interest expense on the Exchangeable Senior Notes is computed using the effective interest method. The conversion features of the Exchangeable Senior Notes are deemed to be an embedded derivative. Accordingly, the Company is required to bifurcate the embedded derivative related to the conversion features of the Exchangeable Senior Notes. The Company recognized the embedded derivative as a liability in its consolidated balance sheets at June 30, 2014 and December 31, 2013, measures it at its estimated fair value and recognizes changes in its estimated fair value in gain/(loss) on derivative instruments in the Company's consolidated statements of operations.

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Net Income (Loss) Per Share

The Company's basic earnings per share ("EPS") is computed by dividing net income or loss attributable to common stockholders by the weighted average number of shares of common stock outstanding. Diluted EPS reflects the potential dilution that could occur if outstanding OP units and Exchangeable Senior Notes were converted to common stock, where such exercise or conversion would result in a lower EPS. The dilutive effect of OP units is computed assuming all units are converted to common stock. The dilutive effect of the Exchangeable Senior Notes is computed assuming shares converted are limited to 1,779,560 pursuant to New York Stock Exchange ("NYSE") restrictions. The 1,779,560 shares of common stock were included in the calculation of diluted EPS as such inclusion was dilutive for the three and six months ended June 30, 2014.

Income Taxes

The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"), commencing with its taxable year ended December 31, 2011. The Company was organized and has operated and intends to continue to operate in a manner that will enable it to qualify to be taxed as a REIT. To qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of the Company's annual REIT taxable income to its stockholders (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with U.S. GAAP). As a REIT, the Company will not be subject to federal income tax on its taxable income that it distributes to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially adversely affect the Company's net income and net cash available for distribution to stockholders. However, the Company intends to continue to operate in a manner that will enable it to qualify for treatment as a REIT.

The Company evaluates uncertain income tax positions when applicable. Based upon its analysis of income tax positions, the Company concluded that it does not have any uncertain tax positions that meet the recognition or measurement criteria at either June 30, 2014 or December 31, 2013.

The Company has elected to treat two of its subsidiaries, ZAIS Funding, Inc. and ZFC Trust TRS I, LLC, as taxable REIT subsidiaries (the "TRS entities"). The Company may perform certain activities through these TRS entities that could adversely impact the Company's REIT qualification if performed other than through a TRS. Earnings from activities conducted through the TRS entities are subject to federal and state income taxes irrespective of the dividends-paid deduction available to REITs for federal income tax purposes. In addition, for the Company to continue to qualify to be taxed as a REIT, the Company's total investment in all TRS entities may not exceed 25% of the value of the total assets of the Company determined for federal income tax purposes.

For the three months ended June 30, 2014 and June 30, 2013, and the six months ended June 30, 2014 and June 30, 2013, the Company did not have any significant activity in the TRS entities. No provision for federal income taxes has been made in the accompanying consolidated financial statements, as the TRS entities did not generate taxable income for the periods presented.

Recent Accounting Pronouncements

In January 2014, the FASB issued ASU 2014-04: Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure ("ASU 2014-04"), to reduce diversity in practice by clarifying when an in substance repossession or foreclosure has occurred and when a creditor should derecognize the associated loan receivable and recognize the real estate property. ASU 2014-04 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. Adoption of ASU 2014-04 is not expected to have a material effect on the Company's consolidated financial statements.

In June 2014, the FASB issued Accounting Standards Update No. 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures ("ASU 2014-11") which amends the accounting guidance for repo-to-maturity ("RTM") transactions and repurchase agreements executed as repurchase financings. Under this new accounting guidance, RTMs will be accounted for as secured borrowings rather than sales of an asset, and transfers of financial assets with a contemporaneous repurchase agreement will no longer be evaluated to determine whether they should be accounted for on a combined basis as forward contracts. The new guidance also prescribes additional disclosures particularly on the nature of collateral pledged in repurchase agreements accounted for as secured borrowings. ASU 2014-11 is effective for the first interim or annual reporting periods beginning after December 15, 2014. Adoption of ASU 2014-11 is not expected to have a material effect on the Company's consolidated financial statements.

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3. Fair Value

Fair Value Measurement

Financial assets and liabilities recorded at fair value on a recurring basis are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

The following table sets forth the Company's financial instruments that were accounted for at fair value on a recurring basis at June 30, 2014, by level within the fair value hierarchy:

	Assets and Liabilities at Fair Value
	Level 1		Level 2		Level 3		Total
Assets
Mortgage loans	$	—	$	—	$	433,553,720	$	433,553,720
Non-Agency RMBS		—		—		227,293,536		227,293,536
Other Investment Securities		—		—		12,034,003		12,034,003
Derivative assets		—		368,136		—		368,136
Total	$	—	$	368,136	$	672,881,259	$	673,249,395
Liabilities
Derivative liabilities	$	—	$	1,550,129	$	—	$	1,550,129
Total	$	—	$	1,550,129	$	—	$	1,550,129

The following table sets forth the Company's financial instruments that were accounted for at fair value on a recurring basis at December 31, 2013, by level within the fair value hierarchy:

	Assets and Liabilities at Fair Value
	Level 1		Level 2		Level 3		Total
Assets
Mortgage loans	$	—	$	—	$	331,785,542	$	331,785,542
Non-Agency RMBS		—		—		226,155,221		226,155,221
Derivative assets		—		284,454		—		284,454
Total	$	—	$	284,454	$	557,940,763	$	558,225,217
Liabilities
Derivative liabilities	$	—	$	1,471,607	$	—	$	1,471,607
Total	$	—	$	1,471,607	$	—	$	1,471,607

The following table presents additional information about the Company's financial instruments which are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:

	Six Months Ended June 30, 2014								Year Ended December 31, 2013
							Other
	Mortgage						Investment		Mortgage
	Loans			RMBS			Securities		Loans			RMBS
Beginning balance	$	331,785,542		$	226,155,221		$	—	$	—		$	100,911,651
Total net transfers into/out of Level 3		—			—			—		—			—
Acquisitions		84,795,975			11,830,958			10,676,953		334,162,044			234,397,506
Proceeds from sales		—			(2,072,198	)		—		—			(68,190,593	)
Net accretion of discounts		3,423,653			2,603,804			80,424		3,059,231			3,727,702
Proceeds from principal repayments		(9,509,379	)		(15,582,121	)		—		(13,871,059	)		(39,338,730	)
Total losses (realized/unrealized) included in
earnings		(4,302,177	)		(468,061	)		—		(6,344,877	)		(9,138,009	)
Total gains (realized/unrealized) included in
earnings		27,360,106			4,825,933			1,276,626		14,780,203			3,785,694
Ending balance	$	433,553,720		$	227,293,536		$	12,034,003	$	331,785,542		$	226,155,221

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	Six Months Ended June 30, 2014						Year Ended December 31, 2013
					Other
	Mortgage				Investment		Mortgage
	Loans		RMBS		Securities		Loans		RMBS
The amount of total gains or (losses) for the
period included in earnings attributable to
the change in unrealized gains or losses
relating to assets or liabilities still held at
the reporting date	$	22,695,371	$	4,316,518	$	1,276,626	$	7,136,482	$	(2,822,969	)

There were no financial assets or liabilities that were accounted for at fair value on a nonrecurring basis at June 30, 2014 and December 31, 2013. There were no transfers into or out of Level 1, Level 2 or Level 3 during the three and six months ended June 30, 2014.

The following table presents quantitative information about the Company's mortgage loans which are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:

Quantitative Information about Level 3 Fair Value Measurements

	Fair Value at		Valuation						Weighted
	June 30, 2014		Technique(s)	Unobservable Input	Min/Max				Average
Mortgage Loans	$	433,553,720	Model	Constant voluntary prepayment	1.3	%	8.4	%	3.8	%
				Constant default rate	0.3	%	4.3	%	2.9	%
				Loss severity	6.8	%	46.0	%	26.0	%
				Delinquency	3.2	%	12.8	%	10.4	%

The following table presents quantitative information about the Company's real estate securities which are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:

Quantitative Information about Level 3 Fair Value Measurements

	Fair Value at		Valuation						Weighted
	June 30, 2014		Technique(s)	Unobservable Input	Min/Max				Average
Non-Agency RMBS⁽¹⁾
Alternative – A	$	87,957,373	Broker quotes/	Constant voluntary prepayment	1.2	%	27.1	%	12.2	%
			comparable trades	Constant default rate	0.1	%	15.6	%	3.1	%
				Loss severity	0.0	%	93.6	%	26.1	%
				Delinquency	1.2	%	28.0	%	10.3	%
Pay option adjustable rate		27,446,408	Broker quotes/	Constant voluntary prepayment	1.4	%	19.7	%	9.1	%
			comparable trades	Constant default rate	2.0	%	9.2	%	4.6	%
				Loss severity	0.1	%	63.1	%	42.0	%
				Delinquency	7.4	%	32.6	%	15.9	%
Prime		93,817,617	Broker quotes/	Constant voluntary prepayment	2.1	%	17.6	%	9.4	%
			comparable trades	Constant default rate	0.1	%	8.3	%	4.0	%
				Loss severity	0.1	%	78.4	%	30.6	%
				Delinquency	2.4	%	25.3	%	12.4	%
Subprime		18,072,138	Broker quotes/	Constant voluntary prepayment	1.7	%	13.0	%	6.6	%
			comparable trades	Constant default rate	3.1	%	13.2	%	4.4	%
				Loss severity	7.5	%	93.1	%	46.9	%
				Delinquency	12.5	%	24.0	%	16.2	%
Total Non-Agency RMBS	$	227,293,536

____________________

(1)

The Company uses third-party dealer quotes to estimate fair value of some of its financial assets. The Company verifies selected prices by using a variety of methods, including comparing prices to internally estimated prices and corroborating the prices by reference to other independent market data, such as relevant benchmark indices and prices of similar instruments. Where the Company has disclosed unobservable inputs for broker quotes or comparable trades, those inputs are based on the Company's validations performed at the security level.

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The following table presents quantitative information about the Company's Other Investment Securities which are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:

Quantitative Information about Level 3 Fair Value Measurements

	Fair Value at				Weighted
	June 30, 2014		Valuation Technique(s)	Unobservable Input	Average
			Broker quotes/
Other Investment Securities⁽¹⁾	$	12,034,003	comparable trades	Constant voluntary prepayment	10.0	%

____________________

(1)

The fair value measurements of these assets are sensitive to changes in assumptions regarding prepayment, probability of default, loss severity in the event of default, forecasts of home prices, and significant activity or developments in the real estate market. Significant changes in any of those inputs in isolation may result in significantly higher or lower fair value measurements. A change in the assumption used for forecasts of home price changes is accompanied by directionally opposite changes in the assumptions used for probability of default and loss severity. Significant increases (decreases) in any of these inputs in isolation would result in significantly lower (higher) fair value measurements.

Fair Value Option

Changes in fair value for assets and liabilities for which the fair value option was elected are recognized in earnings as they occur. The fair value option may be elected on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.

The following table presents the difference between the fair value and the aggregate unpaid principal amount and/or notional balance of assets for which the fair value option was elected at June 30, 2014 and December 31, 2013:

	June 30, 2014							December 31, 2013
			Unpaid							Unpaid
			Principal							Principal
			and/or							and/or
			Notional							Notional
	Fair Value		Balance⁽¹⁾		Difference			Fair Value		Balance⁽¹⁾		Difference
Financial instruments, at fair value
Assets
Mortgage loans	$	433,553,720	$	489,964,409	$	(56,410,689	)	$	331,785,542	$	398,828,497	$	(67,042,955	)
Non-Agency RMBS		227,293,536		310,577,527		(83,283,991	)		226,155,221		324,241,597		(98,086,376	)
Other Investment Securities		12,034,003		10,000,000		2,034,003			—		—		—
Total financial instruments, at fair value	$	672,881,259	$	810,541,936	$	(137,660,677	)	$	557,940,763	$	723,070,094	$	(165,129,331	)

____________________

(1)

Non-Agency RMBS includes an IO with a notional balance of $55.8 million and $64.3 million at June 30, 2014 and December 31, 2013, respectively.

Fair Value of Other Financial Instruments

In addition to the above disclosures regarding assets or liabilities which are recorded at fair value, U.S. GAAP requires disclosure about the fair value of all other financial instruments. Estimated fair value of financial instruments was determined by the Company using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. The use of different market assumptions and/or estimation methodologies may have a material effect on estimated fair values.

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The following table summarizes the estimated fair value for all other financial instruments at June 30, 2014 and December 31, 2013:

	June 30, 2014		December 31, 2013
Other financial instruments
Assets
Cash	$	27,619,043	$	57,060,806
Restricted cash		8,144,052		2,128,236
Liabilities
Loan Repurchase Facility	$	293,609,481	$	236,727,512
Securities repurchase agreements		156,520,762		138,790,158
Exchangeable Senior Notes		56,438,289		54,737,573

Cash includes cash on hand for which fair value equals carrying value (a Level 1 measurement). Restricted cash represents the Company's cash held by counterparties as collateral against the Company's derivatives, Loan Repurchase Facility and securities repurchase agreements. Due to the short-term nature of the restrictions, fair value approximates carrying value (a Level 1 measurement). The fair value of securities repurchase agreements and of the Loan Repurchase Facility is based on an expected present value technique using observable market interest rates. As such, the Company considers the estimated fair value to be a Level 2 measurement. This method discounts future estimated cash flows using rates the Company determined best reflect current market interest rates that would be offered for loans with similar characteristics and credit quality. The fair value of the Exchangeable Senior Notes is based on observable market prices (a Level 2 measurement).

4. Mortgage Loans

During the six months ended June 30, 2014 and year ended December 31, 2013, the Company's acquisition of mortgage loans were as follows:

	Aggregate Unpaid		Loan Repurchase
	Principal Balance		Facility Used
Acquisition Date	(in millions)		(in millions)
Year ended December 31, 2013:
March 22, 2013	$	17.7	$	—
May 30, 2013		—		—	⁽¹⁾
May 31, 2013		134.5		78.5
July 25, 2013		162.4		98.7
August 28, 2013		98.2		54.8
Six months ended June 30, 2014:
March 27, 2014		100.4		60.6

____________________

(1)

On May 30, 2013, the Company entered into the Loan Repurchase Facility and utilized $10.6 million of the Loan Repurchase Facility to finance its then existing residential mortgage loan portfolio.

The following table sets forth certain information regarding the Company's mortgage loan portfolio at June 30, 2014:

	Unpaid
	Principal		Premium					Gross Unrealized⁽¹⁾							Weighted Average
	Balance		(Discount)			Amortized Cost		Gains		Losses			Fair Value		Coupon		Yield⁽²⁾
Mortgage Loans
Performing
Fixed	$	282,361,337	$	(54,730,082	)	$	227,631,255	$	24,102,606	$	(1,640,726	)	$	250,093,135	4.51	%	7.03	%
ARM		176,654,287		(23,903,555	)		152,750,732		10,012,628		(830,771	)		161,932,589	3.68		6.94
Total performing		459,015,624		(78,633,637	)		380,381,987		34,115,234		(2,471,497	)		412,025,724	4.19		7.00
Non-performing⁽³⁾		30,948,785		(7,564,059	)		23,384,726		1,013,933		(2,870,663	)		21,527,996	5.09		7.65
Total Mortgage Loans	$	489,964,409	$	(86,197,696	)	$	403,766,713	$	35,129,167	$	(5,342,160	)	$	433,553,720	4.25	%	7.03	%

____________________

(1)		The Company has elected the fair value option pursuant to ASC 825 for its mortgage loans. The Company recorded a gain of $22.0 million and a gain of $1.6 million for the three months ended June 30, 2014 and June 30, 2013, respectively, and $22.7 million and $1.6 million for the six months ended June 30, 2014 and June 30, 2013, respectively, as change in unrealized gain or loss on mortgage loans in the consolidated statements of operations.
(2)		Unleveraged yield.
(3)		Loans that are delinquent for 60 days or more are considered non-performing.

- 17 -

The following table sets forth certain information regarding the Company's mortgage loan portfolio at December 31, 2013:

	Unpaid
	Principal		Premium					Gross Unrealized⁽¹⁾							Weighted Average
	Balance		(Discount)			Amortized Cost		Gains		Losses			Fair Value		Coupon		Yield⁽²⁾
Mortgage Loans
Performing
Fixed	$	212,701,494	$	(43,530,581	)	$	169,170,913	$	7,842,598	$	(3,558,171	)	$	173,455,340	4.56	%	7.05	%
ARM		170,178,466		(25,617,563	)		144,560,903		5,088,302		(1,556,430	)		148,092,775	3.76		6.67
Total performing		382,879,960		(69,148,144	)		313,731,816		12,930,900		(5,114,601	)		321,548,115	4.20		6.88
Non-performing⁽³⁾		15,948,537		(5,031,293	)		10,917,244		456,024		(1,135,841	)		10,237,427	5.06		8.03
Total Mortgage Loans	$	398,828,497	$	(74,179,437	)	$	324,649,060	$	13,386,924	$	(6,250,442	)	$	331,785,542	4.24	%	6.91	%

____________________

(1)		The Company has elected the fair value option pursuant to ASC 825 for its mortgage loans.
(2)		Unleveraged yield.
(3)		Loans that are delinquent for 60 days or more are considered non-performing.

The following table presents the difference between the fair value and the aggregate unpaid principal balance of the Company's mortgage loan portfolio at June 30, 2014 and December 31, 2013:

	June 30, 2014							December 31, 2013
			Unpaid							Unpaid
			Principal							Principal
	Fair Value		Balance		Difference			Fair Value		Balance		Difference
Loan Type
Performing loans:
Fixed	$	250,093,135	$	282,361,337	$	(32,268,202	)	$	173,455,340	$	212,701,494	$	(39,246,154	)
ARM		161,932,589		176,654,287		(14,721,698	)		148,092,775		170,178,466		(22,085,691	)
Total performing loans		412,025,724		459,015,624		(46,989,900	)		321,548,115		382,879,960		(61,331,845	)
Non-performing loans		21,527,996		30,948,785		(9,420,789	)		10,237,427		15,948,537		(5,711,110	)
Total	$	433,553,720	$	489,964,409	$	(56,410,689	)	$	331,785,542	$	398,828,497	$	(67,042,955	)

At June 30, 2014 and December 31, 2013, the Company's mortgage loan portfolio consisted of mortgage loans on residential real estate located throughout the United States. The following is a summary of certain concentrations of credit risk in the mortgage loan portfolio at June 30, 2014 and December 31, 2013:

	June 30, 2014		December 31, 2013
Concentration
Percentage of fair value of mortgage loans with unpaid principal balance to current property value
in excess of 100%	65.5	%	73.6	%
Percentage of fair value of mortgage loans secured by properties in the following states:
Each representing 10% or more of fair value:
California	25.4	%	25.6	%
Florida	16.5	%	17.8	%
Additional state representing more than 5% of fair value:
Georgia	6.4	%	6.8	%

At June 30, 2014, the interest rates on the Company's mortgage loan portfolio ranged from 1.75% - 12.20% and the contractual maturities ranged from 1 - 46 years.

The following table presents the change in accretable yield for the six months ended June 30, 2014:

Accretable yield, January 1, 2014	$	223,401,697
Acquisitions		55,532,098
Accretion		(12,469,507	)
Reclassifications from nonaccretable difference		9,851,517
Accretable yield, June 30, 2014	$	276,315,805

5. Real Estate Securities and Other Investment Securities

The Company's non-Agency RMBS portfolio is not issued or guaranteed by Fannie Mae, Freddie Mac or any other U.S. Government agency or a federally chartered corporation and is therefore subject to additional credit risks.

- 18 -

The following table sets forth certain information regarding the Company's RMBS and Other Investment Securities at June 30, 2014:

	Principal or
	Notional		Premium					Gross Unrealized⁽¹⁾							Weighted Average
	Balance		(Discount)			Amortized Cost		Gains		Losses			Fair Value		Coupon		Yield⁽²⁾
Real estate securities
Non-Agency RMBS
Alternative – A⁽³⁾	$	156,601,029	$	(72,068,376	)	$	84,532,653	$	3,650,686	$	(225,966	)	$	87,957,373	4.13	%	7.41	%
Pay option adjustable rate		33,037,784		(6,243,093	)		26,794,691		771,606		(119,889	)		27,446,408	0.73		6.92
Prime		101,800,879		(12,419,696	)		89,381,183		4,482,363		(45,929	)		93,817,617	4.68		6.73
Subprime		19,137,835		(1,499,380	)		17,638,455		563,759		(130,076	)		18,072,138	1.07		6.08
Total RMBS	$	310,577,527	$	(92,230,545	)	$	218,346,982	$	9,468,414	$	(521,860	)	$	227,293,536	3.70	%	6.96	%
Other investment securities	$	10,000,000	$	757,377		$	10,757,377	$	1,276,626	$	—		$	12,034,003	5.40	%	6.66	%

____________________

(1)		The Company has elected the fair value option pursuant to ASC 825 for its real estate securities and Other Investment Securities. The Company recorded a gain of $1.5 million and a loss of $15.6 million for the three months ended June 30, 2014 and June 30, 2013, respectively, and a gain of $4.3 million and a loss of $14.7 for the six months ended June 30, 2014 and June 30, 2013, respectively, as change in unrealized gain or loss on real estate securities in the consolidated statements of operations. The Company also recorded a gain of $0.9 million for the three months ended June 30, 2014 and a gain of $1.3 million for the six months ended June 30, 2014 as change in unrealized gain or loss on other investment securities in the consolidated statements of operations.
(2)		Unleveraged yield.
(3)		Alternative – A RMBS includes an IO with a notional balance of $55.8 million.

The following table sets forth certain information regarding the Company's RMBS at December 31, 2013:

	Principal or
	Notional			Premium				Gross Unrealized⁽¹⁾							Weighted Average
	Balance			(Discount)		Amortized Cost		Gains		Losses			Fair Value		Coupon		Yield⁽²⁾
Real estate securities
Non-Agency RMBS
Alternative – A⁽³⁾	$	160,590,487	$	(80,206,745	)	$	80,383,742	$	2,414,864	$	(1,112,077	)	$	81,686,529	4.26	%	6.77	%
Pay option adjustable rate		34,374,028		(7,057,026	)		27,317,002		464,756		(345,915	)		27,435,843	0.76		6.80
Prime		109,136,108		(13,590,489	)		95,545,619		3,751,248		(767,825	)		98,529,042	4.77		6.45
Subprime		20,140,974		(1,894,417	)		18,246,557		536,407		(279,157	)		18,503,807	1.07		5.97
Total RMBS	$	324,241,597	$	(102,748,677	)	$	221,492,920	$	7,167,275	$	(2,504,974	)	$	226,155,221	3.80	%	6.57	%

____________________

(1)		The Company has elected the fair value option pursuant to ASC 825 for its real estate securities.
(2)		Unleveraged yield.
(3)		Alternative – A RMBS includes an IO with a notional balance of $64.3 million.

The following table presents certain information regarding the Company's non-Agency RMBS at June 30, 2014 by weighted average life:

	Non-Agency RMBS
					Weighted Average
	Fair Value		Amortized Cost		Yield
Weighted average life⁽¹⁾
Greater than 5 years	$	227,293,536	$	218,346,982	6.96%
	$	227,293,536	$	218,346,982	6.96%

____________________

(1)

Actual maturities of real estate securities are generally shorter than stated contractual maturities. Maturities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, prepayments of principal and credit losses.

At June 30, 2014, the contractual maturities of the real estate securities ranged from 7.1 to 32.6 years, with a weighted average maturity of 23.7 years. All real estate securities held by the Company at June 30, 2014 were issued by issuers based in the United States.

The following table presents certain information regarding the Company's Other Investment Securities at June 30, 2014 by weighted average life:

	Other Investment Securities
					Weighted Average
	Fair Value		Amortized Cost		Yield
Weighted average life⁽¹⁾
Greater than 5 years	$	12,034,003	$	10,757,377	6.66	%
	$	12,034,003	$	10,757,377	6.66	%

____________________

(1)

Actual maturities of other investment securities are generally shorter than stated contractual maturities. Maturities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, prepayments of principal and credit losses.

- 19 -

At June 30, 2014, the contractual maturity of the Other Investment Securities was 9.3 years. All Other Investment Securities held by the Company at June 30, 2014 were issued by issuers based in the United States.

The following table presents certain information regarding the Company's non-Agency RMBS at December 31, 2013 by weighted average life:

	Non-Agency RMBS
					Weighted Average
	Fair Value		Amortized Cost		Yield
Weighted average life⁽¹⁾
Greater than 5 years	$	226,155,221	$	221,492,920	6.57	%
	$	226,155,221	$	221,492,920	6.57	%

____________________

(1)

At December 31, 2013, the contractual maturities of the real estate securities ranged from 7.7 to 33.0 years, with a weighted average maturity of 24.0 years. All real estate securities held by the Company at December 31, 2013 were issued by issuers based in the United States.

The following table presents certain additional information regarding the Company's RMBS:

	Three Months Ended					Six Months Ended
	June 30, 2014		June 30, 2013			June 30, 2014		June 30, 2013
Proceeds from the sale of real estate securities	$	—	$	47,111,700		$	2,072,198	$	53,913,098
Realized gain (loss) on the sale of real estate securities		—		(206,876	)		73,619		(206,876	)
Realized loss on OTTI		—		(39,179	)		—		(39,179	)

There were no sales or realized losses for OTTI on Other Investment Securities for the three and six months ended June 30, 2014.

6. Loan Repurchase Facility

The Loan Repurchase Facility is used to fund purchases of the Company's mortgage loans. The Loan Repurchase Facility closed on May 30, 2013 with a borrowing capacity of $250.0 million, and was committed for a period of 364 days from inception. On March 27, 2014, the Company entered into an amendment of the Loan Repurchase Facility providing it with an additional $75.0 million of uncommitted borrowing capacity. On May 23, 2014 the Company entered into an amendment with Citi extending the termination date of the facility to May 22, 2015. The obligations are fully guaranteed by the Company.

The principal amount paid by Citi under the Loan Repurchase Facility for the Trust Certificate, which represent interests in residential mortgage loans, is based on a percentage of the lesser of the market value or the unpaid principal balance of such mortgage loans backing the Trust Certificate. Upon the Company's repurchase of a Trust Certificate sold to Citi under the Loan Repurchase Facility, the Company is required to repay Citi a repurchase amount based on the purchase price plus accrued interest. The Company is also required to pay Citi a commitment fee for the Loan Repurchase Facility, as well as certain other administrative costs and expenses in connection with Citi's structuring, management and ongoing administration of the Loan Repurchase Facility. The commitment fee is included in interest expense in the consolidated statements of operations.

The Loan Repurchase Facility contains margin call provisions that provide Citi with certain rights in the event of a decline in the market value of the mortgage loans backing the purchased Trust Certificate, subject to a floor amount. Under these provisions, Citi may require the Company to transfer cash sufficient to eliminate any margin deficit resulting from such a decline.

- 20 -

The following table presents certain information regarding the Company's Loan Repurchase Facility at June 30, 2014 and December 31, 2013, by remaining maturity:

	June 30, 2014				December 31, 2013
			Weighted Average				Weighted Average
	Balance		Rate		Balance		Rate
Loan Repurchase Facility borrowings maturing within
91-180 days	$	—	—	%	$	236,058,976	2.92	%
Greater than 180 days to 1 year		293,609,481	2.90			—	—
Total/weighted average	$	293,609,481	2.90	%	$	236,058,976	2.92	%

The following table presents information with respect to the Company's posting of mortgage loan collateral for the Loan Repurchase Facility at June 30, 2014 and December 31, 2013:

	June 30, 2014		December 31, 2013
Loan Repurchase Facility secured by mortgage loans	$	293,609,481	$	236,058,976
Fair value of Trust Certificates pledged as collateral under Loan Repurchase Facility		433,299,627		331,522,165
Fair value of mortgage loans not pledged as collateral under Loan Repurchase Facility		254,093		263,377
Cash pledged as collateral under Loan Repurchase Facility		—		—
Unused Amount⁽¹⁾		31,390,519		13,941,024

____________________

(1)

The amount the Company is able to borrow under the Loan Repurchase Facility is tied to the fair value of unencumbered Trust Certificates eligible to secure those agreements and the Company's ability to fund the agreements' margin requirements relating to the collateral sold.

The following table presents additional information with respect to the Loan Repurchase Facility:

	Three Months Ended						Six Months Ended
	June 30, 2014			June 30, 2013			June 30, 2014			June 30, 2013
Weighted average interest rate		2.93	%		2.94	%		2.92	%		2.94	%
Average balance of loans sold under
agreements to repurchase	$	—		$	266,499		$	192,380		$	266,499
Maximum daily amount outstanding	$	297,401,891		$	89,112,325		$	297,401,891		$	89,112,325
Total interest expense	$	2,260,080		$	289,296		$	4,090,987		$	289,296

7. Securities Repurchase Agreements

Repurchase agreements related to real estate securities and Other Investment Securities involve the sale and a simultaneous agreement to repurchase the transferred assets or similar assets at a future date. The amount borrowed generally is equal to the fair value of the assets pledged less an agreed-upon discount, referred to as a "haircut." Repurchase agreements related to real estate securities and Other Investment Securities entered into by the Company are accounted for as financings and require the repurchase of the transferred securities at the end of each arrangement's term, typically 30 to 90 days. The Company maintains the beneficial interest in the specific securities pledged during the term of the repurchase arrangement and receives the related principal and interest payments. Interest rates on these borrowings are fixed based on prevailing rates corresponding to the terms of the borrowings, and interest is paid at the termination of the repurchase arrangement at which time the Company may enter into a new repurchase arrangement at prevailing market rates with the same counterparty or repay that counterparty and negotiate financing with a different counterparty. In response to declines in fair value of pledged securities due to changes in market conditions or the publishing of monthly security paydown factors, the lender requires the Company to post additional securities as collateral, pay down borrowings or establish cash margin accounts with the counterparty in order to re-establish the agreed-upon collateral requirements, referred to as margin calls. Under the terms of the Company's master repurchase agreements related to real estate securities and Other Investment Securities, the counterparty may sell or re-hypothecate the pledged collateral.

- 21 -

The following table presents certain information regarding the Company's securities repurchase agreements at June 30, 2014 and December 31, 2013 by remaining maturity and collateral type:

	June 30, 2014								December 31, 2013
	Non-Agency RMBS				Other Investment Securities				Non-Agency RMBS
			Weighted				Weighted				Weighted
	Balance		Average Rate		Balance		Average Rate		Balance		Average Rate
Securities repurchase
agreements maturing
within
30 days or less	$	81,648,945	1.79	%	$	8,360,999	1.75	%	$	121,913,678	1.90	%
31-60 days		5,858,000	1.77			—	—			6,415,000	1.84
61-90 days		19,862,000	1.83			—	—			10,263,000	1.85
Greater than 90 days		40,614,000	1.73			—	—			—	—
Total/weighted average	$	147,982,945	1.78	%	$	8,360,999	1.75	%	$	138,591,678	1.89	%

Although securities repurchase agreements are committed borrowings until maturity, the lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets would require the Company to provide additional collateral or cash to fund margin calls.

The following table presents information with respect to the Company's posting of collateral under its securities repurchase agreements at June 30, 2014 and December 31, 2013:

	June 30, 2014		December 31, 2013
Securities repurchase agreements secured by non-Agency RMBS	$	147,982,945	$	138,591,678
Securities repurchase agreements secured by Other Investment Securities		8,360,999		—
Fair value of non-Agency RMBS pledged as collateral		197,404,343		183,722,511
Fair value of Other Investment Securities pledged as collateral		12,034,003		—
Fair value of non-Agency RMBS not pledged as collateral		29,889,193		42,432,710
Cash pledged as collateral		2,531,630		1,360,528

8. 8.0% Exchangeable Senior Notes due 2016

On November 25, 2013, the Operating Partnership issued the Exchangeable Senior Notes with an aggregate principal amount of $57.5 million. The Exchangeable Senior Notes were issued pursuant to an Indenture, dated November 25, 2013, between the Company, as guarantor, the Operating Partnership and U.S. Bank National Association, as trustee. The sale of the Exchangeable Senior Notes generated net proceeds of approximately $55.3 million. Aggregate estimated offering expenses in connection with the transaction, including the initial purchasers' discount of approximately $1.7 million, were approximately $2.2 million. At June 30, 2014 and December 31, 2013, the carrying value of the Exchangeable Senior Notes was $55.0 million and $54.5 million, respectively.

The Exchangeable Senior Notes bear interest at a rate of 8.0% per year, payable semiannually in arrears on May 15 and November 15 of each year, beginning on May 15, 2014. The effective interest rate of the Exchangeable Senior Notes, which is equal to the stated rate of 8.0% plus the amortization of the original issue discount and associated costs, is 10.2%. For the three and six months ended June 30, 2014, the interest incurred on this indebtedness was $1.4 million and $2.8 million, respectively. The Exchangeable Senior Notes will mature on November 15, 2016 (the "Maturity Date"), unless previously exchanged or repurchased in accordance with their terms. The Exchangeable Senior Notes are the Company's senior unsecured obligations and rank senior in right of payment to the Company's existing and future indebtedness that is expressly subordinated in right of payment to the Exchangeable Senior Notes; equal in right of payment to the Company's existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of the Company's secured indebtedness (including existing unsecured indebtedness that the Company later secures) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by the Company's subsidiaries, financing vehicles or similar facilities.

The Exchangeable Senior Notes are exchangeable for shares of the Company's common stock or, to the extent necessary to satisfy NYSE listing requirements, cash, at the applicable exchange rate at any time prior to the close of business on the scheduled trading day prior to the Maturity Date. The Company may not elect to issue shares of common stock upon exchange of the Exchangeable Senior Notes to the extent such election would result in the issuance of 20% or more of the common stock outstanding immediately prior to the issuance of the Exchangeable Senior Notes (or more than 1,779,560 shares of common stock) unless the Company receives stockholder approval for issuances above this threshold.

- 22 -

As a result of the NYSE related limitation on the use of share-settlement for the full conversion option, the embedded conversion option does not qualify for equity classification and instead is separately valued and accounted for as a derivative liability. The initial value allocated to the derivative liability was $1.3 million, which represents a discount to the debt to be amortized through interest expense using the effective interest method through the Maturity Date. During each reporting period, the derivative liability is marked to fair value through earnings. At June 30, 2014 and December 31, 2013, the derivative liability had a fair value of $1.1 million and $1.5 million, respectively.

The exchange rate was initially 52.5417 shares of common stock per $1,000 principal amount of Exchangeable Senior Notes (equivalent to an initial exchange price of approximately $19.03 per share of common stock). The exchange rate will be subject to adjustment for certain events, including for regular quarterly dividends in excess of $0.50 per share, but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the Maturity Date, the exchange rate will be increased but will in no event exceed 60.4229 shares of common stock per $1,000 principal amount of Exchangeable Senior Notes. The exchange rate was adjusted on December 27, 2013 to 54.3103 shares of common stock per $1,000 principal amount of Exchangeable Senior Notes pursuant to the Company's special dividend of $0.55 per share of common stock and OP unit declared on December 19, 2013.

The Company does not have the right to redeem the Exchangeable Senior Notes prior to the Maturity Date, except to the extent necessary to preserve its qualification as a REIT for U.S. federal income tax purposes. No sinking fund is provided for the Exchangeable Senior Notes. In addition, if the Company undergoes certain corporate events that constitute a "fundamental change," the holders of the Exchangeable Senior Notes may require the Company to repurchase for cash all or part of their Exchangeable Senior Notes at a repurchase price equal to 100% of the principal amount of the Exchangeable Senior Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date.

9. Derivative Instruments

Interest Rate Swap and Swaption Agreements

To help mitigate exposure to higher short-term interest rates, the Company uses currently-paying and forward-starting, three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements. Additionally, the Company enters into interest rate swaption agreements which gives the Company the right, but not the obligation, to enter into a previously agreed upon swap contract on a future date. If exercised the Company will enter into an interest rate swap agreement and is obligated to pay a fixed rate of interest and receive a floating rate of interest. These swap agreements establish an economic fixed rate on related borrowings because the variable-rate payments received on the interest rate swap agreements largely offset interest accruing on the related borrowings, leaving the fixed-rate payments to be paid on the interest rate swap agreements as the Company's effective borrowing rate, subject to certain adjustments including changes in spreads between variable rates on the interest rate swap agreements and actual borrowing rates.

The Company's interest rate swap agreements and interest rate swaption agreement have not been designated as hedging instruments.

TBA Securities

The Company may, and has in the past, entered into TBA contracts as a means of acquiring exposure to Agency RMBS and may, from time to time, utilize TBA dollar roll transactions to finance Agency RMBS purchases. The Company may also enter into TBA contracts as a means of hedging against short-term changes in interest rates. The Company accounts for its TBA contracts as derivative instruments due to the fact that it does not intend to take physical delivery of the securities. The Company had no exposure to TBA contracts at any time during the three and six months ended June 30, 2014. During the three months ended June 30, 2013, the Company paired off purchases of TBA securities with a combined notional amount of $388.0 million by entering into simultaneous sales of TBA securities and as a result, realized gains of $0.9 million and recognized unrealized losses of $4.1 million. During the six months ended June 30, 2013, the Company paired off purchases of TBA securities with a combined notional amount of $473.0 million by entering into simultaneous sales of TBA securities and as a result, realized gains of $0.8 million and recognized unrealized losses of $3.7 million. For the three and six months ended June 30, 2013, the Company recognized unrealized losses of $1.4 million and $1.4 million, respectively on TBA securities that had not been paired off at June 30, 2013.

- 23 -

Conversion Option – 8% Exchangeable Senior Notes Due 2016

Changes in the fair value of the conversion option derivative related to the Exchangeable Senior Notes are recorded through earnings.

Derivative Instruments

The following table summarizes information related to derivative instruments at June 30, 2014 and December 31, 2013:

Non-hedge derivatives	June 30, 2014		December 31, 2013
Notional amount of interest rate swaption	$	225,000,000	$	—
Notional amount of interest rate swaps		17,200,000		17,200,000
Total notional amount	$	242,200,000	$	17,200,000

The following table presents the fair value of the Company's derivative instruments and their balance sheet location at June 30, 2014 and December 31, 2013:

Derivative instruments	Designation	Balance Sheet Location	June 30, 2014			December 31, 2013
Interest rate swaption	Non-hedge	Derivative assets, at fair value	$	368,136		$	—
Interest rate swaps	Non-hedge	Derivative (liabilities)/assets, at fair value	$	(442,585	)	$	284,454
Exchangeable Senior Notes
conversion option	Non-hedge	Derivative liabilities, at fair value	$	(1,107,544	)	$	(1,471,607	)

The following table summarizes gains and losses related to derivatives:

		Three Months Ended						Six Months Ended
	Income Statement
Non-hedge derivatives	Location	June 30, 2014			June 30, 2013			June 30, 2014			June 30, 2013
	Gain/(loss) on derivative
Interest rate swaption	instruments	$	(1,893,322	)	$	—		$	(4,435,614	)	$	—
	Gain/(loss) on derivative
Interest rate swaps	instruments	$	(482,794	)	$	8,272,229		$	(940,079	)	$	8,216,927
Exchangeable Senior Notes	Gain/(loss) on derivative
conversion option	instruments	$	473,167		$	—		$	364,063		$	—
	Gain/(loss) on derivative
TBAs⁽¹⁾	instruments	$	—		$	(4,573,848	)	$	—		$	(4,237,402	)

____________________

(1)

Gains and losses from purchases and sales of TBAs consist of $0.8 million of net TBA dollar roll net interest income and a net loss of $5.4 million due to price reductions.

The following table presents information about the Company's interest rate swaption agreement at June 30, 2014:

	Notional
Swaption Expiration	Amount		Strike Rate	Swap Maturity
2015	$	225,000,000	3.64%	2025

Restricted cash at June 30, 2014 included $4.4 million of cash pledged as collateral against an interest rate swaption agreement.

- 24 -

The following table presents information about the Company's interest rate swap agreements at June 30, 2014:

			Weighted	Weighted	Weighted
	Notional		Average Pay	Average	Average Years
Maturity	Amount		Rate	Receive Rate	to Maturity
2023	$	17,200,000	2.72%	0.23%	9.1
Total/Weighted average	$	17,200,000	2.72%	0.23%	9.1

Restricted cash at June 30, 2014 included $1.2 million of cash pledged as collateral against interest rate swap agreements.

The following table presents information about the Company's interest rate swap agreements at December 31, 2013:

			Weighted	Weighted	Weighted
	Notional		Average Pay	Average	Average Years
Maturity	Amount		Rate	Receive Rate	to Maturity
2023	$	17,200,000	2.72%	0.24%	9.6
Total/Weighted average	$	17,200,000	2.72%	0.24%	9.6

Restricted cash at December 31, 2013 included $0.8 million of cash pledged as collateral against interest rate swaps.

10. Earnings Per Share

The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted earnings per share:

	Three Months Ended						Six Months Ended
	June 30, 2014			June 30, 2013			June 30, 2014			June 30, 2013
Numerator:
Net income (loss) attributable to ZAIS Financial Corp. common
stockholders	$	23,173,931		$	(6,780,401	)	$	25,398,136		$	(5,121,179	)
Effect of dilutive securities:
Net income allocated to non-controlling interests		2,698,204			(788,476	)		2,956,858			(489,382	)
Exchangeable Senior Notes
Interest expense		808,629			—			1,613,628			—
Gain on derivative instruments		(269,635	)		—			(207,462	)		—
Total – Exchangeable Senior Notes		538,994			—			1,406,166			—
Dilutive net income available to stockholders	$	26,411,129		$	(7,568,877	)	$	29,761,160		$	(5,610,561	)
Denominator:
Weighted average number of shares of common stock		7,970,886			7,970,886			7,970,886			6,564,284
Effect of dilutive securities:
Weighted average number of OP units		926,914			926,914			926,914			926,914
Weighted average number of shares convertible under
Exchangeable Senior Notes		1,779,560			—			1,779,560			—
Weighted average dilutive shares		10,677,360			8,897,800			10,677,360			7,491,198
Net income per share applicable to ZAIS Financial Corp.
common stockholders - Basic	$	2.91		$	(0.85	)	$	3.19		$	(0.78	)
Net income per share applicable to ZAIS Financial Corp.
common stockholders - Diluted	$	2.47		$	(0.85	)	$	2.79		$	(0.78	)

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11. Related Party Transactions

ZAIS REIT Management, LLC

The Company is externally managed and advised by the Advisor, a subsidiary of ZAIS. Subject to certain restrictions and limitations, the Advisor is responsible for managing the Company's affairs on a day-to-day basis including, among other responsibilities, (i) the selection, purchase and sale of the Company's portfolio of assets, (ii) the Company's financing activities and (iii) providing the Company with advisory services.

The Company pays to its Advisor an advisory fee, calculated and payable quarterly in arrears, equal to 1.5% per annum of the Company's stockholders' equity, as defined in the amended and restated investment advisory agreement between the Company and the Advisor, as amended from time to time (the "Investment Advisory Agreement"). Prior to the Company's IPO, the advisory fee paid to the Advisor was calculated based on the Company's net asset value, as set forth in the Investment Advisory Agreement.

The Advisor may be paid or reimbursed for the documented cost of its performing certain services for the Company, which may include legal, accounting, due diligence tasks and other services, that outside professionals or outside consultants otherwise would perform, provided that such costs and reimbursements are in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm's-length basis. In addition, the Company may be required to pay its portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of the Advisor and its affiliates required for the Company's operations. To date, the Advisor has not sought reimbursement for the services and expenses described in the two preceding sentences. The Company is also required to pay directly, or reimburse the Advisor for, products and services, including hardware and software, provided by third parties, other than those operating expenses required to be borne by the Advisor under the Investment Advisory Agreement. The Advisor has in the past also declined full reimbursement for the costs of such products and services. In the future, however, the Advisor may seek reimbursement for all of the services, cost and expenses described in this paragraph, as a result of which the total expenses and the expense ratio of the Company may increase.

After an initial three-year term, the Advisor may be terminated annually upon the affirmative vote of at least two-thirds of the Company's independent directors or by a vote of the holders of at least two-thirds of the outstanding shares of the Company's common stock based upon (i) unsatisfactory performance by the Advisor that is materially detrimental to the Company or (ii) a determination that the advisory fees payable to the Advisor are not fair, subject to the Advisor's right to prevent such termination due to unfair fees by accepting a reduction of advisory fees agreed to by at least two-thirds of the Company's independent directors. Additionally, upon such a termination without cause, the Investment Advisory Agreement provides that the Company will pay the Advisor a termination fee equal to three times the average annual advisory fee earned by the Advisor during the prior 24-month period immediately preceding such termination, calculated as of the end of the most recently completed fiscal year before the date of termination.

For the three months ended June 30, 2014 and June 30, 2013, the Company incurred $0.7 million and $0.7 million in advisory fee expense, respectively. For the six months ended June 30, 2014 and June 30, 2013, the Company incurred $1.4 million and $1.2 million in advisory fee expense, respectively. At June 30, 2014, $0.7 million in advisory fee expense was included in accounts payable and other liabilities in the consolidated balance sheet. The advisory fee was calculated and payable as set forth above.

12. Stockholders' Equity

Common Stock

The holders of shares of the Company's common stock are entitled to one vote per share on all matters voted on by common stockholders, including election of the Company's directors. The Company's charter does not provide for cumulative voting in the election of directors. Therefore, the holders of a majority of the outstanding shares of the Company's common stock can elect its entire board of directors. Subject to any preferential rights of any outstanding series of preferred stock, the holders of shares of the Company's common stock are entitled to such distributions as may be authorized from time to time by the Company's board of directors out of legally available funds and declared by the Company and, upon liquidation, are entitled to receive all assets available for distribution to stockholders. Holders of shares of the Company's common stock do not have preemptive rights. This means that stockholders do not have an automatic option to purchase any new shares of common stock that the Company issues. In addition, stockholders only have appraisal rights under circumstances specified by the Company's board of directors or where mandated by law.

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Initial Public Offering

On February 13, 2013, the Company completed its IPO, pursuant to which the Company sold 5,650,000 shares of its common stock to the public at a price of $21.25 per share for gross proceeds of $120.1 million. Net proceeds after the payment of offering costs of approximately $1.2 million were $118.9 million. In connection with the IPO, the Advisor paid $6.3 million in underwriting fees. The Company did not pay any underwriting fees, discounts or commissions in connection with the IPO above those paid by the Advisor.

Common Stock Repurchase

In January 2013, the Company's agreement with one of its stockholders to repurchase 515,035 shares of common stock was amended to require the Company to repurchase only 265,245 shares of the Company's common stock. The amended repurchase amount was approximately $5.8 million which was predominantly paid to such stockholder during the three months ended March 31, 2013 with the remaining amount paid during the three months ended June 30, 2013.

Private Placements

In October 2012, the Company completed a private placement in which it sold 195,458 shares of common stock and the Operating Partnership sold 22,492 OP units. In December 2012, the Company completed a private placement in which it sold 36,581 shares of common stock and the Operating Partnership sold 904,422 OP units. Net proceeds from the two private placements were $25,151,174, net of approximately $763,000 in offering costs.

Dividends and Distributions

During the six months ended June 30, 2014 and year ended December 31, 2013, the Company declared the following dividends:

			Amount
Declaration Date	Record Date	Payment Date	per Share
Year ended December 31, 2013:
May 14, 2013	May 24, 2013	May 31, 2013	$	0.22
June 25, 2013	July 9, 2013	July 23, 2013	$	0.45
September 18, 2013	September 30, 2013	October 11, 2013	$	0.50
December 19, 2013⁽¹⁾	December 31, 2013	January 15, 2014	$	0.95
Six months ended June 30, 2014:
March 20, 2014	March 31, 2014	April 14, 2014	$	0.40
June 18, 2014	June 30, 2014	July 15, 2014	$	0.40

____________________

(1)

Regular cash dividend of $0.40 per share of common stock and OP unit for the quarter ending December 31, 2013, and an additional special cash dividend of $0.55 per share of its common stock and OP unit. The Company declared the special cash dividend to distribute taxable income from 2013 attributable to the termination of interest rate swap contracts.

Preferred Shares

The Company's charter authorizes its board of directors to classify and reclassify any unissued shares of its common stock and preferred stock into other classes or series of stock. Prior to issuance of shares of each class or series, the board of directors is required by the Company's charter to set, subject to the charter restrictions on transfer of its stock, the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the board of directors could authorize the issuance of shares of common stock or preferred stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or change in control that might involve a premium price for holders of the Company's common stock or otherwise be in their best interest.

On January 18, 2012 the Company completed a private placement of 133 shares of its 12.5% Series A Cumulative Non-Voting Preferred Stock (the "Series A Preferred Stock") raising net proceeds of $115,499, net of $17,501 in offering fees.

- 27 -

On February 15, 2013, the Company redeemed all 133 shares of its 12.5% Series A Preferred Stock outstanding for an aggregate redemption price, including preferred dividend, of $148,379.

13. Non-controlling Interests in Operating Partnership

Non-controlling interests in the Operating Partnership in the accompanying consolidated financial statements relate to OP units in the Operating Partnership held by parties other than the Company.

Certain entities own OP units in the Operating Partnership. An OP unit and a share of common stock of the Company have substantially the same economic characteristics in as much as they effectively share equally in the net income or loss of the Operating Partnership. OP unit holders have the right to redeem their OP units, subject to certain restrictions. The redemption is required to be satisfied in shares of common stock or cash at the Company's option, calculated as follows: one share of the Company's common stock, or cash equal to the fair value of a share of the Company's common stock at the time of redemption, for each OP unit. When an OP unit holder redeems an OP unit, non-controlling interest in the Operating Partnership is reduced and the Company's equity is increased. At June 30, 2014 and December 31, 2013, the non-controlling interest OP unit holders owned 926,914 OP units, or 10.4% of the OP Units issued by the Operating Partnership.

14. Commitments and Contingencies

Advisor Services

The Company is dependent on the Advisor for certain services that are essential to the Company, including the identification, evaluation, negotiation, origination, acquisition and disposition of investments; management of the daily operations of the Company's investment portfolio including determination of fair value; and other general and administrative responsibilities. In the event that the Advisor is unable to provide the respective services, the Company will be required to obtain such services from an alternative source.

Litigation

From time to time, the Company may become involved in various claims and legal actions arising in the ordinary course of business. Management is not aware of any contingencies that would require accrual or disclosure in the consolidated financial statements at June 30, 2014 or December 31, 2013.

15. Counterparty Risk and Concentration

Counterparty risk is the risk that counterparties may fail to fulfill their obligations, including their inability to post additional collateral in circumstances where their pledged collateral value becomes inadequate. The Company attempts to manage its exposure to counterparty risk through diversification, use of financial instruments and monitoring the creditworthiness of counterparties.

The Company finances the acquisition of a significant portion of its residential mortgage loans, RMBS and Other Investment Securities with repurchase agreements. In connection with these financing arrangements, the Company pledges its residential mortgage loans and securities as collateral to secure the borrowings. The amount of collateral pledged will typically exceed the amount of the borrowings (i.e., the haircut) such that the borrowings will be over-collateralized. As a result, the Company is exposed to the counterparty if, during the term of the repurchase agreement financing, a lender should default on its obligation and the Company is not able to recover its pledged assets. The amount of this exposure is the difference between the amount loaned to the Company plus interest due to the counterparty and the fair value of the collateral pledged by the Company to the lender including accrued interest receivable on such collateral.

As explained in the notes above, while the Company engages in repurchase financing activities with several financial institutions, the Company maintains custody accounts with two custodians at June 30, 2014. There is no guarantee that these custodians will not become insolvent. While there are certain regulations that seek to protect customer property in the event of a failure, insolvency or liquidation of a custodian, there is no certainty that the Company would not incur losses due to its assets being unavailable for a period of time in the event of a failure of a custodian that has custody of the Company's assets. Although management monitors the credit worthiness of its custodians, such losses could be significant and could materially impair the ability of the Company to achieve its investment objective.

- 28 -

16. Offsetting Assets and Liabilities

The following tables present information about certain assets and liabilities that are subject to master netting arrangements (or similar agreements) and can potentially be offset in the Company's consolidated balance sheets at June 30, 2014 and December 31, 2013:

Offsetting of Assets

						Net Amounts of
			Gross Amounts			Assets Presented		Gross Amounts Not Offset in the
	Gross Amounts		Offset in the			in the		Consolidated Balance Sheets
	of Recognized		Consolidated			Consolidated		Financial		Cash Collateral
	Assets		Balance Sheets			Balance Sheets		Instruments		Received⁽¹⁾		Net Amount
June 30, 2014
Interest rate swaption	$	368,136	$	—		$	368,136	$	—	$	—	$	368,136
Total	$	368,136	$	—		$	368,136	$	—	$	—	$	368,136

December 31, 2013
Interest rate swap agreements	$	396,068	$	(111,614	)	$	284,454	$	—	$	—	$	284,454
Total	$	396,068	$	(111,614	)	$	284,454	$	—	$	—	$	284,454

____________________

(1)

At June 30, 2014, the Company pledged $4,401,503 of cash collateral in relation to its interest rate swaption; with the total net counterparty exposure for this position totaling $4,769,639. At December 31, 2013, the Company pledged $767,708 of cash collateral in relation to its interest rate swap agreements; with the total net counterparty exposure for this position totaling $1,052,162.

Offsetting of Liabilities

						Net Amounts of
			Gross Amounts			Liabilities Presented		Gross Amounts Not Offset in the
	Gross Amounts		Offset in the			in the		Consolidated Balance Sheets
	of Recognized		Consolidated			Consolidated		Financial			Cash Collateral
	Liabilities		Balance Sheets			Balance Sheets		Instruments			Received			Net Amount
June 30, 2014
Loan Repurchase Facility	$	293,609,481	$	—		$	293,609,481	$	(293,609,481	)	$	—		$	—
Securities repurchase agreements		156,343,944		—			156,343,944		(153,812,314	)		(2,531,630	)		—
Interest rate swap agreements		547,268		(104,683	)		442,585		—			(442,585	)		—
Total	$	450,500,693	$	(104,683	)	$	450,396,010	$	(447,421,795	)	$	(2,974,215	)	$	—

December 31, 2013
Loan Repurchase Facility	$	236,058,976	$	—		$	236,058,976	$	(236,058,976	)	$	—		$	—
Securities repurchase agreements		138,591,678		—			138,591,678		(137,231,150	)		(1,360,528	)		—
	$	374,650,654	$	—		$	374,650,654	$	(373,290,126	)	$	(1,360,528	)	$	—

17. Subsequent Events

GMFS Transaction

On August 5, 2014, the Company, in its capacity as guarantor, entered into an agreement and plan of merger (the "Merger Agreement") among ZFC Honeybee TRS, LLC ("Honeybee TRS"), an indirect subsidiary of the Company, ZFC Honeybee Acquisitions, LLC ("Honeybee Acquisitions"), a wholly owned subsidiary of Honeybee TRS, GMFS, LLC ("GMFS"), and Honeyrep, LLC, solely in its capacity as the Securityholder Representative (as defined in the Merger Agreement). Subject to the terms and conditions of the Merger Agreement, Honeybee Acquisitions will merge with and into GMFS (the “Merger”), with GMFS surviving the Merger as an indirect subsidiary of the Company.

GMFS is an approved Fannie Mae Seller-Servicer, Freddie Mac Seller-Servicer, Ginnie Mae issuer, Department of Housing and Urban Development (“HUD”) / Federal Housing Administration (“FHA”) Mortgagee, U.S. Department of Agriculture (“USDA”) approved originator and U.S. Department of Veterans Affairs (“VA”) Lender. GMFS currently originates loans that are eligible to be purchased, guaranteed or insured by Fannie Mae, Freddie Mac, FHA, VA and USDA through retail, correspondent and broker channels. GMFS also originates and sells reverse mortgage loans as part of its existing operations.

- 29 -

Under the terms of the Merger Agreement, the purchase price will consist of cash payable at closing, estimated at approximately $61 million, two contingent $1 million deferred premium payments payable in cash over two years, plus potential additional consideration based on future loan production and profits which will be payable over a four-year period if certain conditions are met. The cash payable at closing will include the actual market value of GMFS’s MSR portfolio, which was $30.1 million at June 30, 2014. In addition to the value of the MSR portfolio, the purchase price will reflect the actual value of GMFS's net tangible assets as of the closing date. The $2 million of deferred premium payments is contingent on GMFS remaining profitable and retaining certain key employees. The additional contingent consideration is dependent on GMFS achieving certain profitability and loan production goals and is capped at $20 million. Up to 50% of the additional contingent consideration may be paid in common stock of the Company, at the Company’s option. The Company intends to fund the closing payment from existing cash and the sale of non-Agency RMBS holdings.

The obligation of each party to the Merger Agreement to consummate the Merger is subject to a number of conditions, including the receipt of regulatory and seller/servicer related approvals relating to the transfer of GMFS’s licenses, the delivery of certain documents and consents, the representations and warranties of the parties being true and correct, subject to the materiality standards contained in the Merger Agreement, and the absence of a material adverse effect on GMFS.

The Company anticipates that the closing of the Merger will occur in the fourth quarter of 2014. Upon closing, the Company expects GMFS to continue to operate under its existing name, and under the leadership of the current management team. The Merger Agreement contains customary representations and warranties by the parties, as well as customary covenants, including non-competition and non-solicitation covenants by GMFS's key managers, a covenant by GMFS to conduct its business and operations in the ordinary course between the date of the Merger Agreement and the closing of the Merger and indemnification covenants by both parties, subject to stated thresholds and limitations.

Amendment to Investment Advisory Agreement

On August 11, 2014, the Company amended its Investment Advisory Agreement to provide that the Company shall pay its Advisor a loan sourcing fee quarterly in arrears in lieu of any payments or reimbursements that would otherwise be due to the Advisor or its affiliates pursuant to Investment Advisory Agreement for loan sourcing services provided. The loan sourcing fee is equal to 0.50% of the principal balance of newly originated residential mortgage loans sourced by the Advisor or its affiliates through its conduit program and acquired by the Company's subsidiaries.

- 30 -

Item 1A. Forward-Looking Statements

The Company makes forward-looking statements in this quarterly report on Form 10-Q within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). For these statements, the Company claims the protections of the safe harbor for forward-looking statements contained in such Sections. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond the Company's control. These forward-looking statements include information about possible or assumed future results of the Company's business, financial condition, liquidity, results of operations, plans and objectives. When the Company uses the words "believe," "expect," "anticipate," "estimate," "plan," "continue," "intend," "should," "could," "would," "may," "potential" or the negative of these terms or other comparable terminology, the Company intends to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking:

the Company's investment objectives and business strategy;
the Company's ability to obtain future financing arrangements;
the Company's expected leverage;
the Company's expected investments;
the GMFS, LLC ("GMFS") transaction;
estimates or statements relating to, and the Company's ability to make, future distributions;
the Company's ability to compete in the marketplace;
the Company's ability to originate or acquire the assets it targets and achieve risk-adjusted returns;
the Company's ability to borrow funds at favorable rates;
market, industry and economic trends;
recent market developments and actions taken and to be taken by the U.S. Government, the U.S. Department of the Treasury and the Board of Governors of the Federal Reserve System, the Federal Depositary Insurance Corporation, the Federal National Mortgage Association ("Fannie Mae"), the Federal Home Loan Mortgage Corporation ("Freddie Mac"), the Government National Mortgage Association ("Ginnie Mae") and the U.S. Securities and Exchange Commission ("SEC");
mortgage loan modification programs and future legislative actions;
the Company's ability to maintain its qualification as a real estate investment trust ("REIT");
the Company's ability to maintain its exemption from qualification under the Investment Company Act of 1940, as amended (the "1940 Act");
projected capital and operating expenditures;
availability of qualified personnel;
prepayment rates; and
projected default rates.

- 31 -

The Company's beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to the Company or are within its control, including:

the factors referenced in the Company's annual report on Form 10-K, including those set forth under Item 1, "Business" and Item 1A, "Risk Factors" therein and the factors described herein under this heading, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and under the heading "Quantitative and Qualitative Disclosures about Market Risk";
general volatility of the capital markets;
changes in the Company's investment objectives and business strategy;
the availability, terms and deployment of capital;
the availability of suitable investment opportunities;
a delay in the closing of the GMFS transaction;
changes in future loan production;
the Company's ability to retain certain key managers of GMFS;
the Company's ability to integrate GMFS's operations;
the Company's dependence on its external advisor, ZAIS REIT Management, LLC (the "Advisor"), and the Company's ability to find a suitable replacement if the Company or the Advisor were to terminate the investment advisory agreement the Company has entered into with the Advisor;
changes in the Company's assets, interest rates or the general economy;
increased rates of default and/or decreased recovery rates on the Company's investments;
changes in interest rates, interest rate spreads, the yield curve or prepayment rates; changes in prepayments of the Company's assets;
limitations on the Company's business as a result of its qualification as a REIT; and
the degree and nature of the Company's competition, including competition for residential mortgage-backed securities ("RMBS"), loans or its other target assets.

Upon the occurrence of these or other factors, the Company's business, financial condition, liquidity and consolidated results of operations may vary materially from those expressed in, or implied by, any such forward-looking statements.

Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, levels of activity, performance or achievements. These forward-looking statements apply only as of the date of this quarterly report on Form 10-Q. The Company is not obligated, and does not intend, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. See Item 1A, "Risk Factors," of the Company's annual report on Form 10-K.

- 32 -

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Company's consolidated financial statements and accompanying Notes included in Item 1, "Financial Statements," of this quarterly report on Form 10-Q.

Overview

The Company primarily invests in, finances and manages performing and re-performing residential mortgage loans, which may be seasoned or recently originated. The Company also invests in, finances and manages non-Agency RMBS with an emphasis on securities that, when originally issued, were rated in the highest rating category by one or more of the nationally recognized statistical rating organizations. The Company also has the discretion to invest in MSRs, Agency RMBS, including through TBA contracts, and in other real estate-related and financial assets, such as IOs, CMBS and ABS.

The Company plans over time to evolve its whole loan strategy to include newly originated residential mortgage loans, which the Company expects to become a core component of its strategy. The Company has taken steps to enable the funding and financing of such mortgage loans in its portfolio and expects to begin such activities in the second half of 2014. The Company believes that this business will benefit from the Advisor's existing expertise in mortgage product development, loan pricing, hedging and analytics, due diligence, risk management and servicing oversight. In addition, the Advisor has recently devoted significant resources to the development of systems, documentation and other intellectual property specific to the acquisition of newly originated loans. The Company expects to pursue opportunities for the origination and purchase of newly originated mortgage loans through both the GMFS platform, as well as an independent loan seller network which is currently being established. This loan seller network is expected to be complementary to the GMFS platform and enable the Company to purchase loans in a broader geographic footprint.

On August 5, 2014, the Company entered into a merger agreement (the “Merger Agreement”) pursuant to which a subsidiary of the Company will merge with and into GMFS (the “Merger”), with GMFS to survive the Merger as an indirect subsidiary of the Company. GMFS is a Fannie Mae, Freddie Mac, Ginnie Mae and U.S. Department of Agriculture ("USDA") approved originator, and a Fannie Mae, Freddie Mac and U.S. Department of Housing and Urban Development approved servicer. Under the terms of the Merger Agreement, the purchase price will consist of cash payable at closing, estimated at approximately $61 million, two contingent $1 million deferred premium payments payable in cash over two years, plus potential additional consideration based on future loan production and profits which will be payable over a four-year period if certain conditions are met. The Company intends to fund the closing payment from existing cash and the sale of non-Agency RMBS holdings. The Company anticipates that the closing of the Merger will occur in the fourth quarter of 2014. See Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations—Subsequent Events," of this quarterly report on Form 10-Q, for more information related to the Merger Agreement.

The Company's income is generated primarily by the net spread between the income it earns on its assets and the cost of its financing and hedging activities. The Company's objective is to provide attractive risk-adjusted returns to its stockholders, primarily through quarterly distributions and secondarily through capital appreciation.

The Company completed its formation transaction and commenced operations on July 29, 2011. On February 13, 2013, the Company successfully completed its IPO, pursuant to which the Company sold 5,650,000 shares of its common stock to the public at a price of $21.25 per share for gross proceeds of $120.1 million. Net proceeds after the payment of offering costs of approximately $1.2 million were $118.9 million. In connection with the IPO, the Advisor paid $6.3 million in underwriting fees. The Company did not pay any underwriting fees, discounts or commissions in connection with the IPO. The Operating Partnership issued and sold the 8% Exchangeable Senior Notes (the "Exchangeable Senior Notes") in a private transaction on November 25, 2013.

At June 30, 2014, the Company held a diversified portfolio of fixed rate mortgage loans and adjustable rate mortgage loans ("ARMs") with a fair value of $433.6 million. At June 30, 2014, the Company also held RMBS assets with a fair value of $227.3 million, consisting primarily of senior tranches of non-Agency RMBS that were originally highly rated but subsequently downgraded and other investment securities ("FMRT Notes" or "Other Investment Securities") with a fair value of $12.0 million. The borrowings the Company used to fund the purchase of its portfolio totaled $506.1 million at June 30, 2014 under the loan repurchase facility used to finance the Company's residential mortgage loan portfolio (the "Loan Repurchase Facility"), master securities repurchase agreements with four counterparties and the Exchangeable Senior Notes. The Exchangeable Senior Notes were issued and sold by the Operating Partnership in a private transaction on November 25, 2013. See Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources," of this quarterly report on Form 10-Q, for a discussion of the terms of the Exchangeable Senior Notes.

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The Company has elected to be taxed as a REIT for U.S. federal income tax purposes commencing with its taxable year ended December 31, 2011. The Company is organized in a format pursuant to which it serves as the general partner of, and conducts substantially all of its business through, its Operating Partnership subsidiary, ZAIS Financial Partners, L.P., a Delaware limited partnership. The Company also expects to operate its business so that it is not required to register as an investment company under the 1940 Act.

Results of Operations

The following discussion of the Company's consolidated results of operations highlights the Company's performance for the three and six months ended June 30, 2014.

Financial Overview

A summary of the Company's second quarter 2014 results is below, followed by an overview of the market conditions that impacted our results during the quarter:

GAAP net income for the three months ended June 30, 2014 was $25.9 million, or $2.47 per diluted weighted average share outstanding compared with a net loss of $7.6 million, or $0.85 per diluted weighted average share outstanding for the three months ended June 30, 2013;
Core Earnings (which excludes changes in unrealized gains or losses on mortgage loans, real estate securities and other investment securities, realized gains or losses on mortgage loans and real estate securities, gains or losses on derivative instruments and certain non-recurring adjustments) was $3.2 million, or $0.36 per diluted weighted average share outstanding for the three months ended June 30, 2014 compared with Core Earnings of $3.0 million, or $0.33 per diluted weighted average share outstanding for the three months ended June 30, 2013. Core Earnings is a non-GAAP financial measure;
At June 30, 2014 the Company's book value was $22.37 per share of common stock and OP unit, compared with book value per share of common stock and OP unit of $19.86 at March 31, 2014; and
2.54x leverage ratio at June 30, 2014.

The Company's results of operations for the three months ended June 30, 2014, were impacted by a number of factors. In the second quarter of 2014 the U.S. economy experienced a strong rebound in economic activity, following the economic contraction of the first quarter. Despite this rebound, interest rates remained relatively low, given concerns related to second half 2014 economic growth, as well as increased geopolitical tensions. Central Banks policy remained accommodative and as a result market volatility across asset classes remained low. Mortgage credit investments benefited from this lack of volatility as spreads tightened. At the same time, continued home price appreciation, albeit at a lower rate, and general strengthening of consumer credit led to improved mortgage fundamental performance. Higher risk, seasoned residential mortgage loans, in particular, benefited from these improved fundamentals as well as increased sponsorship by investors.

Investments

The following table sets forth certain information regarding the Company's mortgage loan portfolio at June 30, 2014:

	Unpaid
	Principal		Premium			Amortized		Gross Unrealized⁽¹⁾							Weighted Average
	Balance		(Discount)			Cost		Gains		Losses			Fair Value		Coupon		Yield⁽²⁾
Mortgage Loans
Performing
Fixed	$	282,361,337	$	(54,730,082	)	$	227,631,255	$	24,102,606	$	(1,640,726	)	$	250,093,135	4.51	%	7.03	%
ARM		176,654,287		(23,903,555	)		152,750,732		10,012,628		(830,771	)		161,932,589	3.68		6.94
Total performing		459,015,624		(78,633,637	)		380,381,987		34,115,234		(2,471,497	)		412,025,724	4.19		7.00
Non-performing⁽³⁾		30,948,785		(7,564,059	)		23,384,726		1,013,933		(2,870,663	)		21,527,996	5.09		7.65
Total Mortgage Loans	$	489,964,409	$	(86,197,696	)	$	403,766,713	$	35,129,167	$	(5,342,160	)	$	433,553,720	4.25	%	7.03	%

____________________

(1)		The Company has elected the fair value option pursuant to ASC 825 for its mortgage loans. The Company recorded a gain of $22.0 million and a gain of $1.6 million for the three months ended June 30, 2014 and June 30, 2013, respectively, and $22.7 million and $1.6 million for the six months ended June 30, 2014 and June 30, 2013, respectively, as change in unrealized gain or loss on mortgage loans in the consolidated statements of operations.
(2)		Unleveraged yield.
(3)		Loans that are delinquent for 60 days or more are considered non-performing.

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The following table sets forth certain information regarding the Company's RMBS and Other Investment Securities at June 30, 2014:

	Principal or
	Notional		Premium			Amortized		Gross Unrealized⁽¹⁾							Weighted Average
	Balance		(Discount)			Cost		Gains		Losses			Fair Value		Coupon		Yield⁽²⁾
Real estate securities
Non-Agency RMBS
Alternative – A⁽³⁾	$	156,601,029	$	(72,068,376	)	$	84,532,653	$	3,650,686	$	(225,966	)	$	87,957,373	4.13	%	7.41	%
Pay option adjustable rate		33,037,784		(6,243,093	)		26,794,691		771,606		(119,889	)		27,446,408	0.73		6.92
Prime		101,800,879		(12,419,696	)		89,381,183		4,482,363		(45,929	)		93,817,617	4.68		6.73
Subprime		19,137,835		(1,499,380	)		17,638,455		563,759		(130,076	)		18,072,138	1.07		6.08
Total RMBS	$	310,577,527	$	(92,230,545	)	$	218,346,982	$	9,468,414	$	(521,860	)	$	227,293,536	3.70	%	6.96	%

Other investment securities	$	10,000,000	$	757,377		$	10,757,377	$	1,276,626	$	—		$	12,034,003	5.40	%	6.66	%

____________________

(1)		The Company has elected the fair value option pursuant to ASC 825 for its real estate securities and Other Investment Securities. The Company recorded a gain of $1.5 million and a loss of $15.6 million for the three months ended June 30, 2014 and June 30, 2013, respectively, and a gain of $4.3 million and a loss of $14.7 for the six months ended June 30, 2014 and June 30, 2013, respectively, as change in unrealized gain or loss on real estate securities in the consolidated statements of operations. The Company also recorded a gain of $0.9 million for the three months ended June 30, 2014 and a gain of $1.3 million for the six months ended June 30, 2014 as change in unrealized gain or loss on other investment securities in the consolidated statements of operations.
(2)		Unleveraged yield.
(3)		Alternative – A RMBS includes an IO with a notional balance of $55.8 million.

Investment Activity

Mortgage Loans. During the three months ended June 30, 2014, the Company did not acquire any fixed rate mortgage loans or ARMs. During the six months ended June 30, 2014, the Company acquired fixed rate mortgage loans and ARMs with an unpaid principal balance of $100.4 million. During the three and six months ended June 30, 2014, the Company did not sell any mortgage loans. The fair value of the Company's mortgage loans at June 30, 2014 was $433.6 million.

RMBS. During the three months ended June 30, 2014, the Company acquired non-Agency RMBS with a principal balance of $0.1 million. During the same period, the Company did not sell any non-Agency RMBS or acquire any Agency RMBS. During the six months ended June 30, 2014, the Company acquired non-Agency RMBS with a principal balance of $24.7 million and also sold non-Agency RMBS with a principal balance of $2.7 million. During the same period, the Company did not acquire any Agency RMBS. The fair value of the Company's non-Agency RMBS at June 30, 2014 was $227.3 million. The Company did not own any Agency RMBS at June 30, 2014.

Other Investment Securities. During the three months ended June 30, 2014, the Company did not acquire any Other Investment Securities. During the six months ended June 30, 2014, the Company acquired the FMRT Notes with a principal balance of $10.0 million. The fair value of the Company's Other Investment Securities at June 30, 2014 was $12.0 million.

TBA Securities. During the three and six months ended June 30, 2014, the Company did not have any exposure to TBA contracts to purchase or sell Agency RMBS.

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Financing and Other Liabilities. At June 30, 2014, the Company had the Loan Repurchase Facility outstanding totaling $293.6 million, which was used to finance mortgage loans. The Loan Repurchase Facility is secured by a portion of the Company's mortgage loan portfolio and bears interest at a rate that has historically moved in close relationship to LIBOR. At June 30, 2014, the Company's total borrowing capacity is $325.0 million. At June 30, 2014 the Company also had 49 securities repurchase agreements outstanding with four counterparties totaling $156.3 million, which was used to finance investments in non-Agency RMBS and Other Investment Securities. These agreements are secured by cash collateral and a portion of the Company's non-Agency RMBS and Other Investment Securities and bear interest at rates that have historically moved in close relationship to LIBOR. At June 30, 2014, the Company had Exchangeable Senior Notes outstanding totaling $57.5 million of aggregate principal balance.

The following table presents certain information regarding the Company's Loan Repurchase Facility at June 30, 2014, by remaining maturity and collateral type:

	Mortgage loans
			Weighted
	Balance		Average Rate
Loan Repurchase Facility borrowings maturing within
Greater than 180 days to 1 year	$	293,609,481	2.90	%
Total/weighted average	$	293,609,481	2.90	%

The following table presents certain information regarding the Company's securities repurchase agreements at June 30, 2014 by remaining maturity:

	Non-Agency RMBS				Other Investment Securities
			Weighted				Weighted
	Balance		Average Rate		Balance		Average Rate
Repurchase agreements maturing within
30 days or less	$	81,648,945	1.79	%	$	8,360,999	1.75	%
31-60 days		5,858,000	1.77			—	—
61-90 days		19,862,000	1.83			—	—
Greater than 90 days		40,614,000	1.73			—	—
Total/weighted average	$	147,982,945	1.78	%	$	8,360,999	1.75	%

Derivative Instruments

At June 30, 2014, the Company had outstanding interest rate swap agreements designed to mitigate the effects of increases in interest rates under a portion of its repurchase agreements. These interest rate swap agreements provide for the Company to pay fixed interest rates and receive floating interest rates indexed to LIBOR. The swap agreements effectively fixed the floating interest rates on $17.2 million of borrowings under the Company's repurchase agreements at June 30, 2014. At June 30, 2014, the Company also had an interest rate swaption agreement outstanding which gives the Company the right, but not the obligation, to enter into a previously agreed upon swap contract on a future date. If exercised the Company will enter into an interest rate swap agreement and is obligated to pay a fixed rate of interest and receive a floating rate of interest.

The following table presents information about the Company's interest rate swaption agreement at June 30, 2014:

	Notional
Swaption Expiration	Amount		Strike Rate		Swap Maturity
2015	$	225,000,000	3.64	%	2025

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The following table presents information about the Company's interest rate swap agreements at June 30, 2014:

			Weighted		Weighted		Weighted
	Notional		Average Pay		Average		Average Years
Maturity	Amount		Rate		Receive Rate		to Maturity
2023	$	17,200,000	2.72	%	0.23	%	9.1
Total/Weighted average	$	17,200,000	2.72	%	0.23	%	9.1

The following analysis focuses on the results generated during the three months ended June 30, 2014 and June 30, 2013 and the six months ended June 30, 2014 and June 30, 2013.

Net Interest Income

The Company's net interest income for the three months ended June 30, 2014 and June 30, 2013 was as follows (in millions):

	Three Months Ended
	June 30, 2014		June 30, 2013
Interest income	$	10.8	$	5.9
Interest expense		4.4		1.2
Net interest income		6.4		4.7

The increase in interest income was mainly due to the deployment of capital raised in the Company's February 2013 IPO and November 2013 issuance of the Exchangeable Senior Notes, which is now primarily allocated to whole loans. This allocation to whole loans increased interest income by $5.9 million. This increase was partially offset by a decrease in interest income from the RMBS portfolio due to the reallocation of the portfolio to whole loans consistent with the Company's investment strategy.

The increase in interest expense was due to an increase in borrowings from the Loan Repurchase Facility and the issuance of the Exchangeable Senior Notes.

The Company's net interest income for the six months ended June 30, 2014 and June 30, 2013 was as follows (in millions):

	Six Months Ended
	June 30, 2014		June 30, 2013
Interest income	$	20.3	$	9.4
Interest expense		8.3		1.7
Net interest income		12.0		7.7

The increase in interest income was mainly due to the deployment of capital raised in the Company's February 2013 IPO and November 2013 issuance of the Exchangeable Senior Notes, which is now primarily allocated to whole loans. This allocation to whole loans increased interest income by $11.5 million. This increase was partially offset by a decrease in interest income from the RMBS portfolio due to the reallocation of the portfolio to whole loans consistent with the Company's investment strategy.

The increase in interest expense was due to an increase in borrowings from the Loan Repurchase Facility and securities repurchase agreements used to finance the Company's RMBS portfolio and the issuance of the Exchangeable Senior Notes.

The weighted average net interest spread between the yield on the Company's assets and the cost of funds, including the impact of interest rate hedging, for the Company's mortgage loans, non-Agency RMBS and Other Investment Securities and Agency RMBS at June 30, 2014 and June 30, 2013 were as follows:

	June 30, 2014	June 30, 2013
Mortgage loans	4.06%	3.84%
Non-Agency RMBS and Other Investment Securities	5.11%	4.46%
Agency RMBS	—	1.21%

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The Company's net interest income is also impacted by prepayment speeds, as measured by the weighted average Constant Prepayment Rate ("CPR")⁽¹⁾ on its assets. The three-month average and the six-month average CPR for the period ended June 30, 2014 for the Company's mortgage loans, non-Agency RMBS and Other Investment Securities were as follows:

	Three-Month Average	Six-Month Average
Mortgage loans	2.73%	2.22%
Non-Agency RMBS	14.82%	13.86%
Other Investment Securities	4.74%	4.63%

____________________

(1)

CPR includes both voluntary and involuntary amounts.

Expenses

Professional Fees. For the three months ended June 30, 2014, the Company incurred professional fees of $0.9 million as compared to $0.2 million for the three months ended June 30, 2013 (primarily related to legal fees, audit fees and consulting fees). The increase in professional fees was due to interim procedures performed by the independent auditors for the 2014 financial statement audit, quarterly tax procedures, additional legal and accounting expenses related to the Company’s registration statement filings on Form S-3 and legal expenses related to funding and financing structures for newly originated whole loans. For the six months ended June 30, 2014, the Company incurred professional fees of $2.8 million as compared to $1.5 million for the six months ended June 30, 2013 (primarily related to legal fees, audit fees and consulting fees). The increase in professional fees was primarily due to interim procedures performed by the independent auditors for the 2014 financial statement audit, quarterly tax procedures, additional legal and accounting expenses related to the Company's registration statement filings on Form S-3 and legal expenses related to funding and financing structures for newly originated whole loans.

Advisory Fee Expense (Related Party). Pursuant to the terms of the Investment Advisory Agreement, the Company incurred advisory fee expense of $0.7 million for the three months ended June 30, 2014 and June 30, 2013 and $1.4 million for the six months ended June 30, 2014, as compared to $1.2 million for the six months ended June 30, 2013. The increase in advisory fee expense over these periods was due to an increase in stockholders' equity resulting from the Company's February 2013 IPO.

General and Administrative Expenses. For the three months ended June 30, 2014, general and administrative expenses were $1.0 million as compared to $0.8 million for the three months ended June 30, 2013. The increase in general and administrative expenses was largely attributable to due diligence costs and professional fees of $0.5 million related to the Company's evaluation of the GMFS acquisition, which were partially offset by a decrease in whole loan transaction costs. For the six months ended June 30, 2014, general and administrative expenses were $2.2 million as compared to $1.1 million for the six months ended June 30, 2013. The increase in general and administrative expenses was largely attributable to due diligence costs and professional fees of $1.3 million related to the Company's evaluation of the GMFS acquisition, which were partially offset by a decrease in whole loan transaction costs.

Loan Servicing Fees. For the three months ended June 30, 2014, loan servicing fees were $0.6 million, as compared to $0.1 million for the three months ended June 30, 2013. For the six months ended June 30, 2014, loan servicing fees were $1.0 million, as compared to $0.1 million for the six months ended June 30, 2013. The increase in loan servicing fees was due to the acquisition of whole loans as the Company executed on its investment strategy.

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Realized and Change in Unrealized Gain or Loss

The following amounts related to realized gains and losses, as well as changes in estimated fair value of the Company's mortgage loan portfolio, RMBS portfolio, Other Investment Securities and derivative instruments are included in the Company's unaudited consolidated statements of operations.

	Three Months Ended						Six Months Ended
	June 30, 2014			June 30, 2013			June 30, 2014			June 30, 2013
Change in unrealized gain or loss on mortgage loans	$	21,960,921		$	1,596,197		$	22,650,525		$	1,567,291
Change in unrealized gain or loss on real estate securities		1,548,195			(15,642,642	)		4,284,253			(14,739,365	)
Change in unrealized gain or loss on other investment securities		905,862			—			1,276,626			—
Realized gain on mortgage loans		176,667			66,244			407,404			66,244
Realized gain on real estate securities		—			(246,055	)		73,619			(246,055	)
Loss/(gain) on derivative instruments		(1,902,949	)		3,698,381			(5,011,630	)		3,979,525
Total other gains/(losses)	$	22,688,696		$	(10,527,875	)	$	23,680,797		$	(9,372,360	)

The Company's interest rate swap agreements and interest rate swaption agreement have not been designated as hedging instruments.

The Company recorded the change in estimated fair value related to (i) an interest rate swaption agreement held during the three and six months ended June 30, 2014, (ii) interest rate swaps held during the three months ended June 30, 2014 and June 30, 2013 and the six months ended June 30, 2014 and June 30, 2013 and (iii) TBAs held during the three and six months ended June 30, 2013 in earnings as (loss)/gain on derivative instruments. Included in (loss)/gain on derivative instruments are the net interest rate swap payments and net TBA payments for the derivative instruments.

The Company has elected to record the change in estimated fair value related to its mortgage loans, RMBS and Other Investment Securities in earnings by electing the fair value option.

Factors Impacting Operating Results

The Company held a diversified portfolio of mortgage loans with a fair value of $433.6 million, RMBS assets with a fair value of $227.3 million and Other Investment Securities with a fair value of $12.0 at June 30, 2014, and mortgage loans with a fair value of $331.8 million and RMBS assets with a fair value of $226.2 million at December 31, 2013. In addition, the Company is in negotiations with counterparties and anticipates having additional available borrowing capacity from which it expects to be able to acquire additional assets. The Company's operating results will be impacted by the Company's actual available borrowing capacity.

The Company expects that the results of its operations will also be affected by a number of other factors, including the level of its net interest income, the fair value of its assets and the supply of, and demand for, the target assets in which it may invest. The Company's net interest income, which includes the amortization of purchase premiums and accretion of purchase discounts, varies, primarily as a result of changes in market interest rates and prepayment speeds, as measured by CPR on the Company's target assets. Interest rates and prepayment speeds vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. The Company's operating results may also be impacted by credit losses in excess of initial anticipations or unanticipated credit events experienced by borrowers whose mortgage loans are held directly by the Company or included in its non-Agency RMBS or Other Investment Securities or in other assets it may originate or acquire in the future.

Changes in Fair Value of the Company's Assets

The Company's mortgage loans, RMBS and Other Investment Securities are carried at fair value and future mortgage-related assets may also be carried at fair value. Accordingly, changes in the fair value of the Company's assets may impact the results of its operations for the period in which such change in value occurs. The expectation of changes in real estate prices is a major determinant of the value of mortgage loans and, therefore, of RMBS and Other Investment Securities. This factor is beyond the Company's control.

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Changes in Market Interest Rates

With respect to the Company's business operations, increases in interest rates, in general, may, over time, cause: (i) the interest expense associated with the Company's borrowings to increase; (ii) the value of its fixed-rate portfolio to decline; (iii) coupons on its ARMs and hybrid ARMs (including RMBS secured by such collateral) and on its residential mortgage loans and other floating rate securities to reset, although on a delayed basis, to higher interest rates; (iv) prepayments on its residential mortgage loans and RMBS to slow, thereby slowing the amortization of the Company's purchase premiums and the accretion of its purchase discounts; and (v) the value of its interest rate swap agreements to increase.

Conversely, decreases in interest rates, in general, may, over time, cause: (i) prepayments on the Company's residential mortgage loans and RMBS to increase, thereby accelerating the amortization of its purchase premiums and the accretion of its purchase discounts; (ii) the interest expense associated with its borrowings to decrease; (iii) the value of its fixed-rate portfolio to increase; (iv) the value of its interest rate swap agreements to decrease; and (v) coupons on its ARMs and hybrid ARMs (including RMBS secured by such collateral) and on its residential mortgage loans and other floating rate securities to reset, although on a delayed basis, to lower interest rates. At June 30, 2014 and December 31, 2013, 39.3% and 46.1% of the Company's performing mortgage loan portfolio, respectively, as measured by fair value consisted of mortgage loans with a variable interest rate component, including ARMs and hybrid ARMs. At June 30, 2014 and December 31, 2013, 22.9% and 23.3% of the Company's RMBS assets, respectively, as measured by fair value, consisted of RMBS assets with a variable interest rate component, including ARMs and hybrid ARMs. Additionally, at June 30, 2014, 100% of the Company's Other Investment Securities, as measured by fair value, consisted of FMRT Notes with a variable interest rate component.

Prepayment Speeds

Prepayment speeds on residential mortgage loans, and therefore, RMBS vary according to interest rates, the type of investment, conditions in the financial markets, competition, defaults, foreclosures and other factors that cannot be predicted with any certainty. In general, when interest rates rise, it is relatively less attractive for borrowers to refinance their mortgage loans and, as a result, prepayment speeds tend to decrease. This can extend the period over which the Company earns interest income. When interest rates fall, prepayment speeds on residential mortgage loans, and therefore, RMBS tend to increase, thereby decreasing the period over which the Company earns interest income. Additionally, other factors such as the credit rating of the borrower, the rate of home price appreciation or depreciation, financial market conditions, foreclosures and lender competition, none of which can be predicted with any certainty, may affect prepayment speeds on residential mortgage loans and RMBS. In particular, despite the historically low interest rates, recent severe dislocations in the housing market, including home price depreciation resulting in many borrowers owing more on their mortgage loans than the values of their homes, have prevented many such borrowers from refinancing their mortgage loans, which has impacted prepayment rates and the value of RMBS assets. However, mortgage loan modification and refinance programs or future legislative action may make refinancing mortgage loans more accessible or attractive to such borrowers, which could cause the rate of prepayments on residential mortgage loans and RMBS assets to accelerate. For RMBS assets, higher prepayment rates would adversely affect the value of such assets or cause the holder to incur losses with respect to such assets.

Spreads on Non-Guaranteed Mortgage Loans and Securities

Since the financial crisis that began in 2007, the spreads between swap rates and residential mortgage loans and non-Agency RMBS have been volatile. Spreads on these assets initially moved wider due to the difficult credit conditions and have only recovered a portion of that widening. As the prices of securitized assets declined, a number of investors and a number of structured investment vehicles faced margin calls from dealers and were forced to sell assets in order to reduce leverage. The price volatility of these assets also impacted lending terms in the repurchase market, as counterparties raised margin requirements to reflect the more difficult environment. The spread between the yield on the Company's assets and its funding costs is an important factor in the performance of this aspect of the Company's business. Wider spreads imply greater income on new asset purchases but may have a negative impact on the Company's stated book value. Wider spreads generally negatively impact asset prices. In an environment where spreads are widening, counterparties may require additional collateral to secure borrowings, which may require the Company to reduce leverage by selling assets. Conversely, tighter spreads imply lower income on new asset purchases, but may have a positive impact on the Company's stated book value. Tighter spreads generally have a positive impact on asset prices. In this case, the Company may be able to reduce the amount of collateral required to secure borrowings.

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Mortgage Extension Risk

The Advisor computes the projected weighted-average life of the Company's investments based on assumptions regarding the rate at which the borrowers will prepay the underlying mortgages and the rate at which defaults, foreclosures and recoveries will occur. In general, when the Company originates or acquires a fixed-rate mortgage or hybrid ARM asset, the Company may, but is not required to, enter into an interest rate swap agreement or other hedging instrument that effectively fixes the Company's borrowing costs for a period close to the anticipated average life of the fixed-rate portion of the related assets. This strategy is designed to protect the Company from rising interest rates, because the borrowing costs are effectively fixed for the duration of the fixed-rate portion of the related RMBS.

However, if prepayment rates decrease in a rising interest rate environment, the life of the fixed-rate portion of the related assets could extend beyond the term of the swap agreement or other hedging instrument. This could have a negative impact on the Company's consolidated results of operations, as borrowing costs would no longer be fixed after the maturity or termination of hedging instruments while the income earned on the assets would remain fixed. This situation may also cause the fair value of the Company's assets to decline, with little or no offsetting gain from the related hedging transactions. In extreme situations, the Company may be forced to sell assets to maintain adequate liquidity, which could cause the Company to incur losses.

In addition, the use of this swap hedging strategy effectively limits increases in the Company's book value in a declining rate environment, due to the effectively fixed nature of the Company's hedged borrowing costs. In an extreme rate decline, prepayment rates on the Company's assets might actually result in certain of its assets being fully paid off while the corresponding swap or other hedge instrument remains outstanding. In such a situation, the Company may be forced to liquidate the swap or other hedge instrument at a level that causes it to incur a loss.

Credit Risk

The Company is subject to credit risk in connection with its investments. Although the Company does not expect to encounter credit risk in its Agency RMBS, if any, it does expect to encounter credit risk related to its non-Agency RMBS, mortgage loans and other target assets, including assets it may originate or acquire in the future. Increases in defaults and delinquencies will adversely impact the Company's operating results, while declines in rates of default and delinquencies may improve the Company's operating results from this aspect of its business. The Company is subject to counterparty risk under the FMRT Notes if Fannie Mae is unable to perform its obligations under the FMRT Notes.

A large portion of the mortgage loans that the Company acquired were current in their payment status at the time of acquisition. The Company calculates delinquency roll rates for its mortgage loan portfolio which represent the percentage of loans, as measured by unpaid principal balance, that were in current payment status in the prior month but became delinquent in the measured month. The Company's delinquency roll rates have generally outperformed its model projections from late 2013 when the whole loan portfolio achieved scale through June 30, 2014.

Size of Investment Portfolio

The size of the Company's investment portfolio, as measured by the aggregate principal balance of its mortgage-related securities and the other assets the Company owns, is a key revenue driver. Generally, as the size of the Company's investment portfolio grows, the amount of interest income the Company receives increases. A larger investment portfolio, however, drives increased expenses, as the Company incurs additional interest expense to finance the purchase of its assets.

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Critical Accounting Policies and Use of Estimates

See "Notes to Consolidated Financial Statements, Note 2 – Summary of Significant Accounting Policies" included in Item 1, "Financial Statements," included in this quarterly report on Form 10-Q for the Company's Critical Accounting Policies and Use of Estimates.

Liquidity and Capital Resources

Liquidity is a measure of the Company's ability to turn non-cash assets into cash and to meet potential cash requirements. The Company uses significant cash to purchase assets, pay dividends, repay principal and interest on its borrowings, fund its operations and meet other general business needs. The Company's primary sources of liquidity are its existing cash balances, borrowings under the Loan Repurchase Facility and under its securities repurchase agreements, the net proceeds from offerings of equity and debt securities and notes issued by the Operating Partnership and net cash provided by operating activities, private funding sources, including other borrowings structured as repurchase agreements, securitizations, term financings and derivative agreements, and future issuances of common equity, preferred equity, convertible securities, exchangeable notes, trust preferred and/or debt securities. The Company does not currently have any committed borrowing capacity, other than pursuant to the Loan Repurchase Facility and securities repurchase agreements discussed below.

The borrowings the Company used to fund the purchase of its portfolio totaled $506.1 million, at June 30, 2014 under the Loan Repurchase Facility, master securities repurchase agreements with four counterparties and the Exchangeable Senior Notes. The Company is also in discussions with other financial institutions to provide it with additional borrowing capacity under various agreements including repurchase agreements and other types of financing arrangements.

At June 30, 2014, the Company had a total of $433.3 million in fair value of trust certificates representing interests in residential mortgage loans (the "Trust Certificates") pledged against its borrowings under the Loan Repurchase Facility and $197.4 million in fair value of RMBS and $12.0 million of Other Investment Securities pledged against its securities repurchase agreement borrowings.

Under the Loan Repurchase Facility and securities repurchase agreements, the Company may be required to pledge additional assets to its counterparties (lenders) in the event that the estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral, which may take the form of additional securities or cash. Generally, the Company's Loan Repurchase Facility and securities repurchase agreements contain a LIBOR-based financing rate, term and haircuts depending on the types of collateral and the counterparties involved. Further, at June 30, 2014, the range of haircut provisions associated with the Company's repurchase agreements was between 27% and 29% for pledged Trust Certificates and was between 15% and 40% for pledged non-Agency RMBS and Other Investment Securities.

If the estimated fair value of the assets increases due to changes in market interest rates or market factors, lenders may release collateral back to the Company. Specifically, margin calls may result from a decline in the value of the investments securing the Company's Loan Repurchase Facility and securities repurchase agreements, prepayments on the mortgages securing such investments and from changes in the estimated fair value of such investments generally due to principal reduction of such investments from scheduled amortization and resulting from changes in market interest rates and other market factors. Counterparties also may choose to increase haircuts based on credit evaluations of the Company and/or the performance of the assets in question. Historically disruptions in the financial and credit markets have resulted in increased volatility in these levels, and this volatility could persist as market conditions continue to change rapidly. Should prepayment speeds on the mortgages underlying the Company's investments or market interest rates suddenly increase, margin calls on the Company's Loan Repurchase Facility and securities repurchase agreements could result, causing an adverse change in its liquidity position. To date, the Company has satisfied all of its margin calls and has never sold assets in response to any margin call under these borrowings.

- 42 -

The Company's borrowings under repurchase agreements are renewable at the discretion of its lenders and, as such, the Company's ability to roll-over such borrowings is not guaranteed. The terms of the repurchase transaction borrowings under the Company's repurchase agreements generally conform to the terms in the standard master repurchase agreement as published by SIFMA, as to repayment, margin requirements and the segregation of all assets the Company has initially sold under the repurchase transaction. In addition, each lender typically requires that the Company include supplemental terms and conditions to the standard master repurchase agreement. Typical supplemental terms and conditions, which differ by lender, may include changes to the margin maintenance requirements, required haircuts and purchase price maintenance requirements, requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction, and cross default and setoff provisions.

At June 30, 2014, the Company had a leverage ratio of 2.54x.

The Company maintains certain assets, which, from time to time, may include cash, unpledged mortgage loans, non-Agency RMBS and Other Investment Securities (which may be subject to various haircuts if pledged as collateral to meet margin requirements) and collateral in excess of margin requirements held by the Company's counterparties (collectively, the "Cushion") to meet routine margin calls and protect against unforeseen reductions in the Company's borrowing capabilities. The Company's ability to meet future margin calls will be impacted by the Cushion, which varies based on the fair value of its securities, its cash position and margin requirements. The Company's cash position fluctuates based on the timing of its operating, investing and financing activities and is managed based on the Company's anticipated cash needs. At June 30, 2014, the Company had a Cushion of $51.6 million in addition to certain reserves held with respect to the Loan Repurchase Facility.

At June 30, 2014, the Company had a total of $8.1 million of restricted cash pledged against its interest rate swaps, swaption and repurchase agreements.

On November 25, 2013, the Operating Partnership issued the Exchangeable Senior Notes, which may be exchanged for shares of the Company's common stock or, to the extent necessary to satisfy NYSE listing requirements, cash, at the applicable exchange rate at any time prior to the close of business on the scheduled trading day prior to the maturity date. The Company may not elect to issue shares of common stock upon exchange of the Exchangeable Senior Notes to the extent such election would result in the issuance of 20% or more of the common stock outstanding immediately prior to the issuance of the Exchangeable Senior Notes (or more than 1,779,560 shares of common stock) until the Company receives stockholder approval for issuances above this threshold. The initial exchange rate for each $1,000 aggregate principal amount of the Exchangeable Senior Notes was 52.5417 shares of common stock, equivalent to an exchange price of approximately $19.03 per share, representing an approximately 15% premium to the last reported sale price of the common stock on November 19, 2013 (the date of the initial sale of the Exchangeable Senior Notes), which was $16.55 per share. The exchange rate will be subject to adjustment for certain events, including for regular quarterly dividends in excess of $0.50 per share, but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the maturity date, the exchange rate will be increased but will in no event exceed 60.4229 shares of common stock per $1,000 principal amount of 2016 Exchangeable Notes. The exchange rate was adjusted on December 27, 2013 to 54.3103 shares of common stock per $1,000 principal amount of Exchangeable Senior Notes pursuant to the Company's special dividend of $0.55 per common share and OP unit declared on December 19, 2013. Pursuant to a registration rights agreement, the Company agreed to file with the SEC within 120 days from the issue date, and to use its commercially reasonable efforts to cause to become effective within 180 days, a shelf registration statement with respect to the resales of the Company's common stock that may be issued upon exchange of the Exchangeable Senior Notes. The Company filed this shelf registration statement with the SEC on March 14, 2014, and the SEC declared it effective on May 23, 2014. If the Company fails to comply with certain of its obligations under the registration rights agreement, the Company will be required to pay liquidated damages to holders of the Exchangeable Senior Notes. The Company will increase the exchange rate by 3% for holders that exchange the Exchangeable Senior Notes when there exists a registration default with respect to shares of the Company's common stock. For additional information related to the Exchangeable Senior Notes, see "Notes to Consolidated Financial Statements—8.0% Exchangeable Senior Notes due 2016."

- 43 -

On August 5, 2014, the Company entered into the Merger Agreement pursuant to which a subsidiary of the Company will merge with and into GMFS, with GMFS to survive the Merger as an indirect subsidiary of the Company. Under the terms of the Merger Agreement, the purchase price will consist of cash payable at closing, estimated at approximately $61 million, two contingent $1 million deferred premium payments payable in cash over two years, plus potential additional consideration based on future loan production and profits which will be payable over a four-year period if certain conditions are met. The Company intends to fund the closing payment from existing cash and the sale of non-Agency RMBS holdings. The Company anticipates that the closing of the Merger will occur in the fourth quarter of 2014. See Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations—Subsequent Events," of this quarterly report on Form 10-Q, for more information related to the Merger Agreement.

The Company believes these identified sources of liquidity will be adequate for purposes of meeting its short-term (within one year) liquidity and long-term liquidity needs. However, the Company's ability to meet its long-term liquidity and capital resource requirements may require additional financing. The Company's short-term and long-term liquidity needs include funding future investments and operating costs. In addition, to qualify as a REIT, the Company must distribute annually at least 90% of its net taxable income, excluding net capital gains. These distribution requirements limit the Company's ability to retain earnings and thereby replenish or increase capital for operations.

The Company's current policy is to pay quarterly distributions which will allow it to qualify as a REIT and generally not be subject to U.S. federal income tax on its undistributed income. Taxable and GAAP earnings will typically differ due to differences in premium amortization and discount accretion, certain non-taxable unrealized and realized gains and losses, and non-deductible general and administrative expenses.

Cash Provided by Operating Activities

The Company's operating activities used net cash of $1.8 million and provided net cash of $3.5 million for the six months ended June 30, 2014 and June 30, 2013, respectively. The cash used in and provided by operating activities is primarily a result of income earned on the Company's assets, partially offset by interest expense on the Company's borrowings and operating expenses.

Cash Used in Investing Activities

The Company's investing activities used net cash of $90.9 million for the six months ended June 30, 2014 by purchasing $84.8 million of mortgage loans, $11.8 million of RMBS and $10.7 million of Other Investment Securities paying a premium of $4.8 million for an interest rate swaption and increasing restricted cash by $6.0 million in connection with interest rate swaps, swaption and securities repurchase agreements, which was offset by $9.5 million of principal repayments on mortgage loans, $15.6 million of principal repayments on real estate securities and $2.1 million of proceeds from the sale of real estate securities.

The Company's investing activities used net cash of $393.7 million for the six months ended June 30, 2013. During the six months ended June 30, 2013, the Company utilized cash to purchase $119.8 million in mortgage loans and $344.6 million in RMBS (net of changes in amounts payable for real estate securities purchased) and increased restricted cash by $8.7 million in connection with swap, TBAs and repurchase agreements, which was offset by principal repayments principal repayments on mortgage loans of $0.9 million and on real estate securities of $24.6 million, and proceeds from the sale of real estate securities of $53.9 million (net of changes in amounts receivable for real estate securities sold).

Cash Provided by Financing Activities

The Company's financing activities provided cash of $63.3 million for the six months ended June 30, 2014, which was a result of net borrowings from the Loan Repurchase Facility of $57.6 million, borrowings from securities repurchase agreements of $71.5 million, offset by repayments of securities repurchase agreements of $53.8 million and the payment of dividends and distributions on common stock and OP units of $12.0 million.

The Company's financing activities provided cash of $392.3 million for the six months ended June 30, 2013, which was a result of net proceeds and borrowings from the Loan Repurchase Facility of $89.1 million, net proceeds from the issuance of common stock of $118.9 million and borrowings from securities repurchase agreements of $287.9 million, partially offset by repayments of securities repurchase agreements of $95.5 million, repurchases of common stock of $5.8 million, the payment of dividends and distributions on common stock and OP units of $2.0 million, and other items.

- 44 -

Contractual Obligations

The Company has entered into an Investment Advisory Agreement with the Advisor. The Advisor is entitled to receive a quarterly advisory fee, loan sourcing fee and the reimbursement of certain expenses; however, these obligations do not have fixed and determinable payments.

The following table presents contractual obligations and commitments at June 30, 2014, as discussed above under "Liquidity and Capital Resources":

			Less than						More than
Contractual Obligations	Total		1 year		1-3 years		3-5 years		5 years
	(dollars in thousands)
Loan repurchase facility	$	293,609	$	293,609	$	—	$	—	$	—
Interest on loan repurchase facility⁽¹⁾		8,497		8,497		—		—		—
Repurchase agreements		156,344		156,344		—		—		—
Interest on securities repurchase agreements⁽¹⁾		532		532		—		—		—
Exchangeable Senior Notes		57,500		—		57,500		—		—
Interest on Exchangeable Senior Notes		11,500		5,188		6,312		—		—
Total	$	527,982	$	464,170	$	63,812	$	—	$	—

____________________

(1)

Interest is calculated based on the interest rate in effect at June 30, 2014 and includes all interest expense incurred and expected to be incurred in the future through the contractual maturity of the associated repurchase agreement.

Off-Balance Sheet Arrangements

As of the date of this quarterly report on Form 10-Q, the Company had no off-balance sheet arrangements.

Inflation

Virtually all of the Company's assets and liabilities are and will be interest rate sensitive in nature. As a result, interest rates and other factors influence the Company's performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. The Company's financial statements are prepared in accordance with U.S. GAAP and the Company's activities and balance sheet shall be measured with reference to historical cost and/or fair value without considering inflation.

Non-GAAP Financial Measures

Core Earnings is a non-GAAP measure that the Company defines as GAAP net income, excluding changes in unrealized gains or losses on mortgage loans, real estate securities and other investment securities, realized gains or losses on mortgage loans, and real estate securities, gains or losses on derivative instruments, and certain non-recurring adjustments.

The Company believes that providing investors with this non-GAAP financial information, in addition to the related GAAP measures, gives investors greater transparency to the information used by management in its financial and operational decision-making. However, because Core Earnings is an incomplete measure of the Company's financial performance and involves differences from net income computed in accordance with GAAP, it should be considered along with, but not as an alternative to, the Company's net income computed in accordance with GAAP as a measure of the Company's financial performance. In addition, because not all companies use identical calculations, the Company's presentation of Core Earnings may not be comparable to other similarly-titled measures of other companies.

- 45 -

The following table reconciles net income computed in accordance with GAAP to Core Earnings:

	Three Months Ended						Six Months Ended
	June 30, 2014			June 30, 2013			June 30, 2014			June 30, 2013
Net income – GAAP	$	25,872,135		$	(7,568,877	)	$	28,354,994		$	(5,595,182	)
Recurring adjustments for non-core earnings:
Change in unrealized gain or loss on mortgage loans		(21,960,921	)		(1,596,197	)		(22,650,525	)		(1,567,291	)
Change in unrealized gain or loss on real estate securities		(1,548,195	)		15,642,642			(4,284,253	)		14,739,365
Change in unrealized gain or loss on other investment securities		(905,862	)		—			(1,276,626	)		—
Realized (gain) on mortgage loans		(176,667	)		(66,244	)		(407,404	)		(66,244	)
Realized (gain) on real estate securities		—			246,055			(73,619	)		246,055
Loss/(gain) on derivative instruments		1,902,949			(3,698,381	)		5,011,630			(3,979,525	)
Core Earnings – non-GAAP	$	3,183,439		$	2,958,998		$	4,674,197		$	3,777,178
Core Earnings – per diluted weighted average share
outstanding – non-GAAP	$	0.36		$	0.33		$	0.53		$	0.50

Subsequent Events

GMFS Transaction

- 46 -

Amendment to Investment Advisory Agreement

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The primary components of the Company's market risk are related to interest rate risk, prepayment risk, credit risk and fair value risk. While the Company does not seek to avoid risk completely, the Company believes that risk can be quantified from historical experience and the Company will seek to actively manage that risk, to earn sufficient compensation to justify taking risk and to maintain capital levels consistent with the risks the Company undertakes.

Interest Rate Risk

Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the Company's control.

The Company is subject to interest rate risk in connection with any floating or inverse floating rate investments and its repurchase agreements. The Company's repurchase agreements may be of limited duration and are periodically refinanced at current market rates. The Company intends to manage this risk using interest rate derivative agreements. These instruments are intended to serve as a hedge against future interest rate increases on the Company's borrowings. The Company primarily assesses its interest rate risk by estimating and managing the duration of its assets relative to the duration of its liabilities. Duration measures the change in the fair value of an asset based on a change in an interest rate. The Company generally calculates duration using various financial models and empirical data. Different models and methodologies can produce different duration numbers for the same securities.

The borrowings the Company used to fund the purchase of its portfolio included $450.0 million at June 30, 2014 under master securities repurchase agreements with four counterparties and under the Loan Repurchase Facility. The Company is also in discussions with other financial institutions to provide it with additional borrowing capacity under various agreements including repurchase agreements and other types of financing arrangements. At June 30, 2014, the Company also had interest rate swaps with an outstanding notional amount of $17.2 million, resulting in variable rate debt of $432.8 million. A 50 basis point increase in LIBOR would increase the quarterly interest expense related to the $432.8 million in variable rate debt by $0.5 million. Such hypothetical impact of interest rates on the Company's variable rate debt does not consider the effect of any change in overall economic activity that could occur in a rising interest rate environment. Further, in the event of such a change in interest rates, the Company may take actions to further mitigate its exposure to such a change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, this analysis assumes no changes in the Company's financial structure.

Net Interest Income

The Company's operating results will depend in large part on differences between the income from its investments and its borrowing costs. Most of the Company's securities repurchase agreements and its Loan Repurchase Facility provide financing based on a floating rate of interest calculated on a fixed spread over LIBOR. During periods of rising interest rates, the borrowing costs associated with the Company's investments tend to increase while the income earned on the Company's fixed interest rate investments may remain substantially unchanged. This will result in a narrowing of the net interest spread between the related assets and borrowings and may result in losses.

- 47 -

Hedging techniques are partly based on assumed levels of prepayments of the Company's RMBS and residential mortgage loans. If prepayments are slower or faster than assumed, the effectiveness of any hedging strategies the Company uses will be reduced and may cause losses on such transactions. Hedging strategies involving the use of derivative securities are complex and may produce volatile returns.

Fair Value

Changes in interest rates may also have an impact on the fair value of the assets the Company originates or acquires.

Prepayment Risk

As the Company receives prepayments of principal on its investments, premiums paid on such investments will be amortized against interest income. In general, an increase in prepayment rates will accelerate the amortization of purchase premiums, thereby reducing the interest income earned on the investments. Conversely, discounts on such investments are accreted into interest income. In general, an increase in prepayment rates will accelerate the accretion of purchase discounts, thereby increasing the interest income earned on the investments.

Credit Risk

The Company expects to encounter credit risk related to its non-Agency RMBS, mortgage loans and other target assets, including assets it may originate or acquire in the future. A portion of the Company's assets are comprised of residential mortgage loans that are unrated. The credit risk related to these investments pertains to the ability and willingness of borrowers to pay the mortgage loan payments, the ability of which is assessed before credit is granted or renewed and periodically reviewed throughout the loan or security term. The Company believes that residual loan credit quality is primarily determined by the borrowers' credit profiles and loan characteristics.

Extension Risk

If prepayment rates decrease in a rising interest rate environment, the life of the fixed-rate portion of the related assets could extend beyond the term of the swap agreement or other hedging instrument. This could have a negative impact on the Company's results from operations, as borrowing costs would no longer be fixed after the end of the hedging instrument, while the income earned on the hybrid adjustable-rate assets would remain fixed. This situation may also cause the fair market value of the Company's hybrid adjustable-rate assets to decline, with little or no offsetting gain from the related hedging transactions. In extreme situations, the Company may be forced to sell assets to maintain adequate liquidity, which could cause it to incur losses.

Fair Value Risk

The Company intends to elect the fair value option of accounting on most of its securities investments and residential mortgage loans and account for them at their estimated fair value with unrealized gains and losses included in earnings pursuant to accounting guidance. The estimated fair value of these securities and residential mortgage loans fluctuates primarily due to changes in interest rates and other factors. Generally, in a rising interest rate environment, the estimated fair value of these securities and residential mortgage loans would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of these securities and residential mortgage loans would be expected to increase.

Counterparty Risk

- 48 -

Certain of the Company's subsidiaries have entered into over-the-counter interest rate swap agreements to hedge risks associated with movements in interest rates. Because interest rate swaps were not cleared through a central counterparty, the Company remains exposed to the counterparty's ability to perform its obligations under each such swap and cannot look to the creditworthiness of a central counterparty for performance. As a result, if an over-the-counter swap counterparty cannot perform under the terms of an interest rate swap, the Company's subsidiary would not receive payments due under that agreement, the Company may lose any unrealized gain associated with the interest rate swap and the hedged liability would cease to be hedged by the interest rate swap. While the Company would seek to terminate the relevant over-the-counter swap transaction and may have a claim against the defaulting counterparty for any losses, including unrealized gains, there is no assurance that the Company would be able to recover such amounts or to replace the relevant swap on economically viable terms or at all. In such case, the Company could be forced to cover its unhedged liabilities at the then current market price. The Company may also be at risk for any collateral the Company has pledged to secure the Company's obligations under the over-the-counter interest rate swap if the counterparty becomes insolvent or files for bankruptcy. Therefore, upon a default by an interest rate swap agreement counterparty, the interest rate swap would no longer mitigate the impact of changes in interest rates as intended.

During the past several years, certain repurchase agreement and interest rate swap counterparties in the United States and Europe have experienced financial difficulty and have been either rescued by government assistance or otherwise benefited from accommodative monetary policy of their respective central banks.

The following table summarizes the Company's exposure to its repurchase agreements and derivative counterparties at June 30, 2014:

		Repurchase		Swaps &					Exposure as a
	Number of	Agreement		Swaption at Fair					Percentage of Total
	Counterparties	Borrowings⁽¹⁾		Value			Exposure⁽²⁾		Assets
	(dollars in thousands)
North America:
U.S.	1	$	92,602	$	—		$	30,420	4.3	%
Canada⁽³⁾	1		300,458		—			141,488	19.8
	2		393,060		—			171,908	24.1	%
Europe:⁽³⁾
United Kingdom	1		12,054		—			4,530	0.6	%
Switzerland	1		45,802		(74	)		23,453	3.3
	2		57,856		(74	)		27,983	3.9	%
Total Counterparty Exposure	4	$	450,916	$	(74	)	$	199,891	28.0	%

____________________

(1)		Includes accrued interest payable.
(2)		The exposure reflects the difference between (a) the amount loaned to us through repurchase agreements, including interest payable, plus the derivative liability and (b) the cash and the fair value of the securities pledged by us as collateral, including accrued interest receivable on such securities, plus derivative assets.
(3)		Includes foreign based counterparties as well as U.S. domiciled subsidiaries of such counterparties, as such transactions are generally entered into with a U.S. domiciled subsidiary of such counterparties.

- 49 -

The following table presents information with respect to any counterparty for repurchase agreements for which the Company had greater than 5% of stockholders' equity at risk in the aggregate at June 30, 2014:

					Weighted
					Average Months
					to Maturity for	Percentage of
		Counterparty			Repurchase	Stockholders'
Counterparty		Rating⁽¹⁾	Amount of Risk⁽²⁾		Agreements	Equity
	(dollars in thousands)
Citigroup Inc.⁽³⁾		A/A2	$	141,488	11	71.1	%
Barclays PLC⁽⁴⁾		A/NR	$	23,453	<1	11.8	%
RBC Capital Markets, LLC		AA-/A2	$	30,420	2	15.3	%

____________________

(1)		The counterparty rating presented is the long-term issuer credit rating as rated at June 30, 2014 by S&P and Moody's, respectively.
(2)		The amount at risk reflects the difference between (a) the amount loaned to us through repurchase agreements, including interest payable, plus the net unrealized gain on swaps including collateral pledged and (b) the cash and the fair value of the securities pledged by us as collateral, including accrued interest receivable on such securities.
(3)		Includes amounts at risk with Citibank, N.A. and Citigroup Global Markets Inc. Counterparty rating is for Citibank, N.A. which represents $138.9 million of the total exposure. The remaining exposure is to Citigroup Global Markets Inc. which was rated A/Baa2 by S&P and Moody's, respectively at June 30, 2014.
(4)		Includes amounts at risk with Barclays Capital Inc. and Barclays Bank PLC. Counterparty rating is for Barclays Capital Inc. which represents $18.4 million of the total exposure. The remaining exposure is to Barclays Bank PLC which was rated A/A2 by S&P and Moody's, respectively at June 30, 2014.

Item 4. Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of "disclosure controls and procedures" as promulgated under the Exchange Act and the rules and regulations thereunder. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

The Company, including its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of June 30, 2014. Based on the foregoing, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective.

Changes in Internal Controls over Financial Reporting

There have been no changes in the Company's "internal control over financial reporting" (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the three month period ended June 30, 2014 that have materially affected, or was reasonably likely to materially affect, the Company's internal control over financial reporting.

- 50 -

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, the Company may be involved in various claims and legal actions in the ordinary course of business. As of June 30, 2014, the Company was not involved in any legal proceedings.

Item 1A. Risk Factors

There have been no material changes from the risk factors disclosed in the "Risk Factors" section of the Company's combined Annual Report on Form 10-K for the year ended December 31, 2013.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

(a) Exhibits Files

Exhibit No.		Description
3.1*		Articles of Amendment and Restatement of ZAIS Financial Corp., incorporated by reference to Exhibit 3.1 of the Registrant's Form S-11, as amended (Registration No. 333-185938).

3.2*		Articles Supplementary of ZAIS Financial Corp., incorporated by reference to Exhibit 3.2 of the Registrant's Form S-11, as amended (Registration No. 333-185938).

3.3*		Bylaws of ZAIS Financial Corp., incorporated by reference to Exhibit 3.3 of the Registrant's Form S-11, as amended (Registration No. 333-185938).

4.1*		Specimen Common Stock Certificate of ZAIS Financial Corp., incorporated by reference to Exhibit 4.1 of the Registrant's Form S-11, as amended (Registration No. 333-185938).

10.1*		Agreement of Limited Partnership, dated as of July 29, 2011, of ZAIS Financial Partners, L.P., as amended on August 3, 2011, October 11, 2012, and December 13, 2012, incorporated by reference to Exhibit 10.2 of the Registrant's Form S 11, as amended (Registration No. 333 185938).

10.2*		Amendment to Agreement of Limited Partnership, dated as of February 13, 2013, of ZAIS Financial Partners, L.P., incorporated by reference to Exhibit 10.3 of the Registrant's Form 10 K, filed March 28, 2013.

10.3		Amendment Number One, dated May 23, 2014, to the Master Loan Repurchase Agreement dated as of May 30, 2013 among ZFC Trust and Citibank, N.A.

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

- 51 -

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of the Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of the Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS^**		XBRL Instance Document

101.SCH^**		XBRL Taxonomy Extension Schema Document

101.CAL^**		XBRL Taxonomy Calculation Linkbase Document

101.DEF^**		XBRL Extension Definition Linkbase Document

101.LAB^**		XBRL Taxonomy Extension Linkbase Document

101.PRE^**		XBRL Taxonomy Presentation Linkbase Document

____________________

*		Previously filed
**		This exhibit is being furnished rather than filed, and shall not be deemed incorporated by reference into any filing, in accordance with Item 601 of Regulation S-K

- 52 -

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	ZAIS FINANCIAL CORP.

Date: August 12, 2014

	By:	/s/ Michael Szymanski
		Michael Szymanski
		Chief Executive Officer and President

	By:	/s/ Paul McDade
		Paul McDade
		Chief Financial Officer and Treasurer

S-1

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