In this quarterly report on Form 10-Q, we refer to Hatteras Financial Corp. as "we," "us," "our company," or "our," unless we specifically state otherwise or the context indicates otherwise. The following defines certain of the commonly used terms in this quarterly report on Form 10-Q: RMBS refers to residential mortgage-backed securities; agency RMBS and agency securities refer to our RMBS that are issued or guaranteed by a U.S. Government sponsored entity, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae; hybrids and hybrid ARMs refer to hybrid mortgage loans that have interest rates that are fixed for a specified period of time and, thereafter, generally adjust annually to an increment over a specified interest rate index; and ARMs refers to hybrids after the fixed rate period expires and adjustable-rate mortgage loans which typically at all times have interest rates that adjust annually to an increment over a specified interest rate index.

The following discussion should be read in conjunction with our financial statements and accompanying notes included in Item 1 of this quarterly report on Form 10-Q as well as our Annual Report on Form 10-K for the year ended December 31, 2008 filed February 19, 2009.

Forward-Looking Statements

When used in this quarterly report on Form 10-Q, in future filings with the Securities and Exchange Commission ("SEC") or in press releases or other written or oral communications, statements which are not historical in nature, including those containing words such as "believe," "expect," "anticipate," "estimate," "plan," "continue," "intend," "should," "may" or similar expressions, are intended to identify "forward-looking statements" 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"), and, as such, may involve known and unknown risks, uncertainties and assumptions.

Forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. The following factors could cause actual results to vary from our forward-looking statements:
changes in interest rates and the market value of our agency securities; changes in the prepayment rates on the mortgage loans securing our agency securities; our ability to borrow to finance our assets; changes in government regulations affecting our business; our ability to maintain our qualification as a REIT for federal income tax purposes; our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended ( the "Investment Company

Act"); and risks associated with investing in real estate assets, including changes in business conditions and the general economy. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that we file with the SEC, could cause our actual results to differ materially from those projected in any forward-looking statements we make. All forward-looking statements speak only as of the date on which they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

We are a mortgage REIT that invests in adjustable-rate and hybrid adjustable-rate single-family residential mortgage pass-through securities guaranteed or issued by a U.S. Government agency (such as the Government National Mortgage Association, or Ginnie Mae), or by a U.S. Government-sponsored entity (such as the Federal National Mortgage Association, or Fannie Mae, and the Federal Home Loan Mortgage Corporation, or Freddie Mac). We were incorporated in Maryland in September 2007 and commenced operations in November 2007. We completed our initial public offering in April 2008, and listed our common stock on the New York Stock Exchange "NYSE" under the symbol "HTS". We are managed and advised by our manager, Atlantic Capital Advisors LLC.

Our principal goal is to generate net income for distribution to our shareholders, through regular quarterly dividends, from the difference between the interest income on our investment portfolio and the interest costs of our borrowings and hedging activities, which we refer to as our net interest income, and other expenses. In general, our strategy is to manage interest rate risk while trying to eliminate exposure to credit risk. We believe that the best approach to generating a positive net interest income is to manage our liabilities in relation to the interest rate risks of our investments. To help achieve this result, we employ repurchase financing, generally short-term, and combine our financings with hedging instruments, relying primarily on interest rate swaps. We may, subject to maintaining our REIT qualification, also employ other hedging techniques from time to time, including interest rate caps, floors and swaptions to mitigate the effects of adverse interest rate movements.

We focus on agency securities consisting of hybrid adjustable-rate residential mortgage loans with short effective durations, which we believe reduces the impact of changes in interest rates on the market value of our portfolio and on our net interest income. However, because our investments vary in interest rate, prepayment speed and maturity, the leverage or borrowings that we employ to fund our asset purchases will never exactly match the terms or performance of our assets, even after we have employed our hedging techniques. Based on our manager's experience, the interest rates of our assets will change more slowly than the corresponding short-term borrowings used to finance our assets. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income and shareholders' equity.

Since our formation, virtually all of our invested assets have been in agency securities. These agency securities principally consist of whole-pool, pass-through certificates that are backed by adjustable-rate mortgages, or ARMs, and hybrid ARMs that have principal and interest payments guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac. ARMs have interest rates that reset monthly, quarterly and annually, based on the 12-month moving average of the one-year constant maturity U.S. Treasury rate or LIBOR. Hybrid ARMs have interest rates that are fixed for a longer initial period (typically three, five, seven or 10 years) and, thereafter, generally adjust annually to an increment over a pre-determined interest rate index. As of September 30, 2009, our portfolio consisted of approximately $6.7 billion in market value of agency RMBS with a weighted average initial fixed-interest rate period of 47 months.

We are organized and conduct our operations to qualify as a REIT under the Code, and generally are not subject to federal taxes on our income to the extent we currently distribute our income to our shareholders and maintain our qualification as a REIT.

The following table represents key data regarding our company since the beginning of operations on November 5, 2007:

(in thousands except per share amounts)

                                                                                                               Quarterly Diluted
                                                       Repurchase                  Shares       Book Value         Earnings
As of                             Agency Securities    Agreements     Equity     Outstanding    Per Share          Per Share
September 30, 2009               $         7,303,441   $ 6,007,909   $ 943,597        36,200   $      26.07   $              1.26
June 30, 2009                    $         6,699,512   $ 5,496,854   $ 865,204        36,200   $      23.90   $              1.20
March 31, 2009                   $         6,329,731   $ 5,250,382   $ 803,575        36,192   $      22.20   $              1.07
December 31, 2008                $         5,211,730   $ 4,519,435   $ 736,287        36,186   $      20.35   $              0.73
September 30, 2008               $         4,974,648   $ 4,569,262   $ 527,220        26,777   $      19.69   $              1.11
June 30, 2008                    $         5,097,189   $ 4,387,739   $ 561,176        26,777   $      20.96   $              0.88
March 31, 2008                   $         3,036,826   $ 2,739,631   $ 329,400        15,268   $      21.57   $              0.71
December 31, 2007                $         1,619,290   $ 1,475,512   $ 165,356         8,368   $      19.76   $              0.15

Factors that Affect our Results of Operations and Financial Condition

Our results of operations and financial condition are affected by various factors, many of which are beyond our control, including, among other things, our net interest income, the market value of our assets and the supply of and demand for such assets. We invest in financial assets and markets, and recent events, such as those discussed below, can affect our business in ways that are difficult to predict, and produce results outside of typical operating variances. Our net interest income varies primarily as a result of changes in interest rates, borrowing costs and prepayment speeds, the behavior of which involves various risks and uncertainties. Prepayment rates, as reflected by the rate of principal paydown, and interest rates vary according to the type of investment, conditions in financial markets, competition and other factors, none of which can be predicted with any certainty. In general, as prepayment rates on our agency securities purchased at a premium increase, related purchase premium amortization increases, thereby reducing the net yield on such assets. Because changes in interest rates may significantly affect our activities, our operating results depend, in large part, upon our ability to manage interest rate risks and prepayment risks effectively while maintaining our status as a REIT.

We anticipate that, for any period during which changes in the interest rates earned on our assets do not coincide with interest rate changes on our borrowings, such assets will reprice more slowly than the corresponding liabilities. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net interest income. With the maturities of our assets generally of longer term than those of our liabilities, interest rate increases will tend to decrease our net interest income and the market value of our assets (and therefore our book value). Such rate increases could possibly result in operating losses or adversely affect our ability to make distributions to our shareholders.

Prepayments on agency securities and the underlying mortgage loans may be influenced by changes in market interest rates and a variety of economic, geographic and other factors beyond our control; and consequently, such prepayment rates cannot be predicted with certainty. To the extent we have acquired agency securities at a premium or discount to par, or face value, changes in prepayment rates may impact our anticipated yield. In periods of declining interest rates, prepayments on our agency securities will likely increase. If we are unable to reinvest the proceeds of such prepayments at comparable yields, our net interest income may suffer.

While we intend to use hedging to mitigate some of our interest rate risk, we do not intend to hedge all of our exposure to changes in interest rates and prepayment rates, as there are practical limitations on our ability to insulate our portfolio from all potential negative consequences associated with changes in short-term interest rates in a manner that will allow us to seek attractive net spreads on our portfolio.

In addition, a variety of other factors relating to our business may also impact our financial condition and operating performance. These factors include:

• our degree of leverage;

• our hedging activities; and

• the REIT requirements, the requirements to qualify for an exemption under the Investment Company Act and other regulatory and accounting policies related to our business.

Our manager is entitled to receive a management fee that is based on our equity (as defined in our management agreement), regardless of the performance of our portfolio. Accordingly, the payment of our management fee may not decline in the event of a decline in our profitability and may cause us to incur losses.

For a discussion of additional risks relating to our business see "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2008.

Market and Interest Rate Trends and the Effect on our Portfolio

Credit Market Disruption

During the past two years, the residential housing and mortgage markets in the United States have experienced a variety of difficulties and changed economic conditions including loan defaults, credit losses and decreased liquidity. These conditions have resulted in volatility in the value of the agency securities in our portfolio and an increase in the average collateral requirements under our repurchase agreements. Liquidating sales by several large institutions increased the volatility of many financial assets, including agency securities and other high-quality RMBS. As a result, values for RMBS, including some agency securities, were negatively impacted. Further increased volatility and deterioration in the broader residential mortgage and RMBS markets may adversely affect the performance and market value of the agency securities in which we invest. In addition, we rely on the availability of financing to acquire agency securities on a leveraged basis. As values for certain types of agency securities declined many lenders in the agency securities market tightened their lending standards, and in some cases, withdrew financing of residential mortgage assets and agency securities. Our lenders may have owned or financed RMBS that have declined in value and caused them to incur losses. Although market conditions have returned to more normal conditions, if they were to worsen again, our lenders may be forced to exit the repurchase market, or further tighten lending standards or increase the amount of equity capital or "haircut" required to obtain financing, any of which could make it more difficult or costly for us to obtain financing. Furthermore, certain lenders also could become insolvent which could cause us to incur losses.

Developments at Fannie Mae and Freddie Mac

Payments on the agency securities in which we invest are guaranteed by Fannie Mae and Freddie Mac. Because of the guarantee and the underwriting standards associated with mortgages underlying agency securities, agency securities historically have had high stability in value and been considered to present low credit risk. In 2008, Fannie Mae and Freddie Mac were placed under the conservatorship of the U.S. government due to the significant weakness of their financial condition. The turmoil in the residential mortgage sector and concern over the future role of Fannie Mae and Freddie Mac have generally increased credit spreads and decreased price stability of agency securities.

In response to the credit market disruption and the deteriorating financial condition of Fannie Mae and Freddie Mac, Congress and the U.S. Treasury undertook a series of actions in 2008 aimed at stabilizing the financial markets in general, and the mortgage market in particular. These actions include the large-scale buying of mortgage-backed securities, significant equity infusions into banks and aggressive monetary policy. We cannot predict whether or when new actions may occur, the timing and pace of current actions already implemented, or what impact if any, such actions, or future actions, could have on our business, results of operations and financial condition.

Interest Rates

The overall credit market deterioration since 2007 has also affected prevailing interest rates, which have been unusually volatile since the third quarter of 2007. Since September 18, 2007, the U.S. Federal Reserve lowered the target for the Federal Funds Rate nine times from 5.25% to 1.0% in October 2008. In December 2008, the Federal Reserve stated that it was adopting a policy of "quantitative easing" and would target keeping the Federal Funds Rate between 0 and 0.25%. Our funding costs, which traditionally have tracked the 30-day London Interbank Offered Rate, or LIBOR, have generally benefited by this easing of monetary policy, although to a somewhat lesser extent. Because of continued uncertainty in the credit markets and U.S. economic conditions, we expect that interest rates are likely to experience continued volatility, which will likely affect our financial results since our cost of funds is largely dependent on short-term rates.

Historically, the 30-day LIBOR, has closely tracked movements in the Federal Funds Rate. Our borrowings in the repurchase market have also historically closely tracked LIBOR. So traditionally, a lower Federal Funds rate has indicated a time of increased net interest margin and higher asset values. However, since July 2007 (prior to our commencement of operations) LIBOR and repurchase market rates have been significantly higher than the target Federal Funds Rate. The difference between 30-day LIBOR and the Federal Funds rate has been quite volatile, with the spread alternately returning to more normal levels and then widening out again. Towards the end of the third quarter of 2008 this difference increased to historically high levels. Although this difference has returned to more normal levels, the volatility in these rates and divergence from the historical relationship among these rates could negatively impact our ability to manage our portfolio. If this were to occur, our net interest margin and the value of our portfolio might suffer as a result. The following table shows the 30-day LIBOR as compared to the Federal Funds rate at each period end:

                                          30-Day      Federal
                                          LIBOR        Funds

                     September 30, 2009     0.25 %       0.25 %

                     June 30, 2009          0.31 %       0.25 %

                     March 31, 2009         0.50 %       0.25 %

                     December 31, 2008      0.44 %       0.25 %

                     September 30, 2008     3.93 %       2.00 %

                     June 30, 2008          2.46 %       2.00 %

                     March 31, 2008         2.70 %       2.25 %

                     December 31, 2007      4.60 %       4.25 %

Principal Repayment Rate

Our net income is primarily a function of the difference between the yield on our assets and the financing cost of owning those assets. Since we tend to purchase assets at a premium to par, the main item that can affect the yield on our assets after they are purchased is the rate at which the mortgage borrowers repay the loan. While the scheduled repayments, which are the principal portion of the homeowners' regular monthly payments, are fairly predictable, the unscheduled repayments, which are generally refinancing of the mortgage, are less so. Being able to accurately estimate and manage these repayment rates is a critical portion of the management of our portfolio, not only for estimating current yield but also to consider the rate of reinvestment of those proceeds into new securities and the yields which those new securities may add to our portfolio. The following table shows the average principal repayment rate for each quarter since our commencement of operations:

                                       Average
                                 Quarterly Principal      Average Rate
            Quarter ended          Repayment Rate          Annualized

            September 30, 2009                  5.56 %           22.26 %

            June 30, 2009                       5.23 %           20.93 %

            March 31, 2009                      3.09 %           12.36 %

            December 31, 2008                   1.96 %            7.84 %

            September 30, 2008                  2.12 %            8.46 %

            June 30, 2008                       3.14 %           12.57 %

            March 31, 2008                      3.90 %           15.61 %

Investing the Proceeds of our Offerings

We began operations following the closing of our initial private offering on
November 5, 2007. We raised additional equity capital three times in 2008. The
following is a summary of these transactions:



(Dollars in thousands except per
share amounts)
                                        Number of Shares         Offering Price            Net
Date of Offering                      of Common Stock Sold         Per Share           Proceeds (1)

November 5, 2007                                 8,203,937      $          20.00      $      157,054

February 5, 2008                                 6,900,000      $          24.00      $      158,743

April 30, 2008 (IPO)                            11,500,000      $          24.00      $      255,440

December 15, 2008                                9,409,090      $          22.00      $      196,463

(1) After deducting underwriting discounts, and other fees and costs associates with issuance.

While our operations are affected in many ways by the issuance of additional shares, the most significant immediate earnings impact is that we generally do not invest all of the proceeds immediately. Depending on market conditions, and the fact that normal trade settlement on agency securities is not based on the trade date, we have averaged around two months to invest the proceeds from these offerings. Since each capital raise was individually significant to the size of our portfolio, our results from operations, and some statistics regarding such results, may not be meaningful or portray the underlying fundamentals of our investment portfolio.

Counter-Party Default

During 2008, one of our lenders, Lehman Brothers Inc. ("LBI"), became insolvent and defaulted under the terms of our repurchase agreement with them. We filed a claim with the trustee handling the estate and have reserved the entire amount of our exposure, $6.1 million, in the quarter ended December 31, 2008. We continue to seek repayment from the estate. On May 29, 2009, the trustee for the estate filed its first interim report which discussed the complexity of the estate and that considerable time may be needed to adequately resolve all claims. The final deadline for claims was July 1, 2009. During the nine months ended September 30, 2009, we received no payments or additional information regarding the status of our claim.

Book Value per Share

As of September 30, 2009, our book value per share of common stock (total shareholders' equity divided by shares of common stock outstanding) was $26.07, an increase of $2.17, or 9.08%, from $23.90 at June 30, 2009 and an increase of $5.72, or 28.11%, from $20.35 at December 31, 2008. Declining U.S. Treasury securities rates, U.S. government actions, particularly the large-scale purchasing of agency securities, and decreasing turmoil in the financial markets increased values on our securities to historically high levels. Our interest rate swaps, which fix the borrowing cost on a portion of our financing, generally help mitigate changes in our book value. Generally, the

value of our interest rate swaps moves in the opposite direction of the value of our agency securities. However, for much of the first nine months of 2009, our swap values remained fairly level, or strengthened along with the value of our agency securities. The following table shows the components of our book value at each period end:

                                                                                     Unrealized              Unrealized
                                    Common Shareholders'       Undistributed         Gain/(Loss)           Gain/(Loss) on             Book Value
As of                                      Equity                Earnings              on MBS            Interest Rate Swaps          Per Share

September 30, 2009                 $                21.27               0.16                5.96                       (1.32 )       $      26.07

June 30, 2009                      $                21.26               0.05                3.69                       (1.10 )       $      23.90

March 31, 2009                     $                21.26              (0.05 )              2.75                       (1.76 )       $      22.20

December 31, 2008                  $                21.26              (0.08 )              0.90                       (1.73 )       $      20.35

September 30, 2008                 $                21.37               0.12               (1.88 )                      0.08         $      19.69

June 30, 2008                      $                21.37               0.06               (0.75 )                      0.28         $      20.96

March 31, 2008                     $                20.72               0.44                0.55                       (0.14 )       $      21.57

December 31, 2007                  $                18.79               0.15                0.82                          -          $      19.76


Investments

Agency Securities

As of September 30, 2009 and December 31, 2008, our agency securities portfolio was purchased at a net premium to par, or face value, with a weighted-average amortized cost of 101.45 and 101.23, respectively, of face value, due to the average interest rates on these securities being higher than prevailing market rates. As of September 30, 2009 and December 31, 2008, we had approximately $93.4 million and $61.7 million, respectively, of unamortized premium included in the cost basis of our investments.

As of September 30, 2009, our investment portfolio consisted of agency securities as follows:

                                                                                                 Weighted Avg.
. . .