ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
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Special Note Regarding Forward-Looking Statements
Certain statements contained in this quarterly report, and certain statements contained in our future filings with the Securities and Exchange Commission (the SEC or the Commission), in our press releases or in our other public or stockholder communications contain or incorporate by reference certain forward-looking statements which are based on various assumptions (some of which are beyond our control) and may be identified by reference to a future period or periods or by the use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “anticipate,” “continue,” or similar terms or variations on those terms or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, changes in interest rates; changes in the yield curve; changes in prepayment rates; the availability of mortgage-backed securities and other securities for purchase; the availability of financing and, if available, the terms of any financing; changes in the market value of our assets; changes in business conditions and the general economy; our ability to grow our commercial business; our ability to grow our residential mortgage credit business; our ability to grow our middle market lending business, credit risks related to our investments in credit risk transfer securities, residential mortgage-backed securities and related residential mortgage credit assets, commercial real estate assets and corporate debt; risks related to investments in mortgage servicing rights (or MSRs); our ability to consummate any
contemplated investment opportunities; changes in government regulations or policy affecting our business; our ability to maintain our qualification as a real estate investment trust (or REIT) for U.S. federal income tax purposes; and our ability to maintain our exemption from registration under the Investment Company Act. For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in our most recent Annual Report on Form 10-K and Item 1A “Risk Factors” in this quarterly report on Form 10-Q. We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our most recent annual report on Form 10-K. All references to “Annaly,” “we,” “us,” or “our” mean Annaly Capital Management, Inc. and all entities owned by us, except where it is made clear that the term means only the parent company. Refer to the section titled “Glossary of Terms” located at the end of this Item 2 for definitions of commonly used terms in this quarterly report on Form 10-Q.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
| INDEX TO ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
| | | Page |
| Overview | 50 |
| Acquisition of Hatteras | 50 |
| Business Environment | 50 |
| Economic Environment | 50 |
| Financial Regulatory Reform | 52 |
| 52 |
| Results of Operations | 52 |
| Net Income (Loss) Summary | 52 |
| Non-GAAP Financial Measures | 55 |
| Amortization | 55 |
| Core earnings and core earnings (excluding PAA), core earnings and core earnings | |
| (excluding PAA) per average common share and annualized core return on average equity | |
| (excluding PAA) | 56 |
| Interest income (excluding PAA), economic interest expense and economic net interest | |
| income (excluding PAA) | 57 |
| Experienced and Projected Long-term CPR | 58 |
| Average yield on Interest Earning Assets (excluding PAA), net interest spread (excluding PAA), | |
| and net interest margin (excluding PAA) | 58 |
| Economic Interest Expense and the Average Cost of Interest Bearing Liabilities | 59 |
| Realized and Unrealized Gains (Losses) | 60 |
| Other Income (Loss) | 61 |
| General and Administrative Expenses | 61 |
| Unrealized Gains and Losses | 62 |
| Return on Average Equity | 63 |
| Financial Condition | 64 |
| Residential Investment Securities | 64 |
| Contractual Obligations | 67 |
| Off-Balance Sheet Arrangements | 67 |
| Capital Management | 67 |
| Stockholders’ Equity | 68 |
| Common and Preferred Stock | 68 |
| Leverage and Capital | 69 |
| Risk Management | 69 |
| Risk Appetite | 69 |
| Governance | 70 |
| Description of Risks | 70 |
| Liquidity Risk Management | 71 |
| Funding | 71 |
| Excess Liquidity | 73 |
| Maturity Profile | 75 |
| Stress Testing | 76 |
| Liquidity Management Policies | 76 |
| Investment/Market Risk Management | 77 |
| Credit Risk Management | 78 |
| Counterparty Risk Management | 78 |
| Operational Risk Management | 79 |
| Compliance, Regulatory and Legal Risk Management | 79 |
| Critical Accounting Policies and Estimates | 80 |
| Valuation of Financial Instruments | 80 |
| Residential Investment Securities | 80 |
| Residential Mortgage Loans | 80 |
| Commercial Real Estate Investments | 81 |
| Interest Rate Swaps | 81 |
| Revenue Recognition | 81 |
| Consolidation of Variable Interest Entities | 81 |
| Use of Estimates | 81 |
| Glossary of Terms | 82 |
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
We are a leading diversified capital manager that invests in and finances residential and commercial assets. Our principal business objective is to generate net income for distribution to our stockholders through capital preservation, prudent selection of investments, and continuous management of our portfolio. We are a Maryland corporation that has elected to be taxed as a REIT. We are externally managed by Annaly Management Company LLC (or Manager). Our common stock is listed on the New York Stock Exchange under the symbol “NLY.”
We use our capital coupled with borrowed funds to invest primarily in real estate related investments, earning the spread between the yield on our assets and the cost of our borrowings and hedging activities.
Our investment groups are comprised of the following:
| Investment Groups | Description |
| Annaly Agency Group | Invests in Agency mortgage-backed securities (or MBS) collateralized by residential mortgages which are guaranteed by Fannie Mae. Freddie Mac or Ginnie Mae. |
| Annaly Residential Credit Group | Invests in non-Agency residential mortgage assets within securitized products and residential mortgage loan markets. |
| Annaly Commercial Real Estate Group | Originates and invests in commercial mortgage loans, securities, and other commercial real estate debt and equity investments. |
| Annaly Middle Market Lending Group | Provides financing to private equity backed middle market businesses across the capital structure. |
For a full discussion of our business, refer to the section titled “Business Overview” in our most recent Annual Report on Form 10-K.
As previously disclosed in our filings with the SEC, the acquisition of Hatteras Financial Corp. (or Hatteras and such acquisition, the Hatteras Acquisition), an externally managed mortgage REIT that invested primarily in single-family residential mortgage real estate assets, closed on July 12, 2016 for an aggregate consideration to Hatteras common shareholders of $1.5 billion, consisting of $1.0 billion in equity consideration and $521.1 million in cash.
Refer to the note titled “Acquisition of Hatteras” located in Item 1. “Financial Statements” for additional details.
Our portfolio activity during the three months ended September 30, 2017 focused on deploying the capital from our common and preferred equity raises. Given that Agency option-adjusted spreads had reached their widest levels since 2013 in the early part of the summer and were attractive relative to credit, much of the capital deployed went into Agency MBS. In turn, Agency MBS performed strongly during the quarter, helping to achieve a robust economic return over the period. Meanwhile, we continue in our disciplined approach to grow our credit businesses. We have avoided investment opportunities where we are uncomfortable with credit fundamentals or credit protection
and chose to compete in areas where we have a distinctive advantage, for example through our business partnerships in the whole loan area, where we remain comfortable with current residential housing fundamentals. We expect interest rate markets to remain largely range bound going forward as the gradual monetary policy tightening currently undertaken by the Federal Reserve (or Fed) is partially offset by a continued low inflation environment and monetary policy accommodation from other central banks around the globe.
Economic Environment
Economic growth picked up slightly in the three months ended September 30, 2017, though remained roughly in line with post-crisis averages. Economic growth, as measured by real gross domestic product (or GDP), increased to 3.0% in the three months ended September 30, 2017, to make year-to-date growth an annualized 2.4% according to the Bureau of Economic Analysis. This growth pace compares favorably to 2016 of 1.8% and is slightly above the seven year average of 2.1%. Consumption growth remains moderate, contributing 1.6% to GDP in the three months ended September 30, 2017, driven by auto replacement in the wake of the devastating hurricane. Meanwhile, non-residential investment continued its strong year in the three months ended September 30, 2017 to contribute 0.5% to growth in spite of hurricanes, which temporarily disrupted company investment in non-residential structures. The breadth of equipment investment, contributing 0.5% to GDP for consecutive quarters for the first time since late 2014, is a positive sign for future productivity growth. Residential investment declined again in the three months ended September 30, 2017, subtracting 0.2% after providing a 0.3% reduction in the second quarter of 2017.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
The Fed currently conducts monetary policy with a dual mandate: full employment and price stability. Employment continued to improve in the three months ended September 30, 2017, most notably with the unemployment rate falling to the Fed’s revised-lower year-end projection of 4.2% in September 2017 from 4.4% in June 2017, according to the Bureau of Labor Services. The economy added 91,000 jobs per month in the three months ended September 30, 2017, compared to 187,000 per month in the second quarter of 2017. The primary reason for this slowdown was the loss of food services jobs in September 2017 due to the impact of Hurricane Irma on Florida. This trend is expected to reverse in the October report, with the underlying trend remaining intact, with business confidence high and signaling strong labor demand. Wage growth, as measured by the year-over-year change in Average Hourly Earnings, improved in the three months ended September 30, 2017 to 2.9% as of September 2017 compared to 2.5% in June 2017, returning to the recent peak seen in December 2016. At the Fed meeting on September 19-20, 2017 the Fed forecasted that the unemployment rate would decline to 4.3% by year-end, then slightly lower to 4.1% in 2018 and 2019, a forecast already undershot this year with potential for an improved forecast at the Fed’s December 12-13, 2017 meeting.
Inflation remained below the Fed’s 2.0% target through August 2017, as measured by the year-over-year changes in the Personal Consumer Expenditure Chain Price Index (or PCE), as inflation weakness appeared broad-based. The headline PCE measure remained at 1.4% year-over-year in August 2017, down significantly from 2.2% as recently as February 2017. The more stable core PCE measure, which excludes volatile food and energy prices, dropped over the quarter, at 1.3% year-over-year in August 2017, compared to 1.5% in June 2017 and a recent peak of 1.9% in January 2017. The Fed expects a moderate rise in inflation in both the PCE and core PCE measures to 1.6% and 1.5% year-over-year, respectively, by the fourth quarter of 2017, before rising to its target of 1.9% in the fourth quarter of 2018, then to its target of 2.0% by the end of 2019.
Throughout the three months ended September 30, 2017, the Federal Open Market Committee (or FOMC) aimed to support its dual mandate by keeping its target for the federal funds rate at accommodative levels, while taking the historic step to gradually reduce the size of its portfolio of U.S. Treasury and Agency mortgage-backed securities holdings. In assessing realized and expected progress towards its objectives, the FOMC decided to keep the target rate at 1.00-1.25% at its July and September 2017 meetings as the Committee analyzed incoming data which appeared to show a weaker inflation trend in spite of generally healthy labor markets. The FOMC’s Summary of Economic Projections, wherein members reveal their economic and policy projections, showed few changes, with the median forecast continuing to expect one additional interest rate hike in 2017 and three in 2018, though the FOMC downgraded their expectation for 2019 interest rate hikes from 3-4 to 2-3 and lowered the longer-run target rate forecast to 2.8% from 3.0%. At the September 19-20, 2017 meeting, the FOMC officially announced the initiation of their plan to gradually cease reinvestments to begin in October 2017. The program will involve caps on runoff amounts, to begin at $6.0 billion per month for U.S. Treasury securities and $4.0 billion per month for Agency mortgage-backed securities, to be increased by the same amounts every three months until reaching a max monthly runoff level of $30.0 billion and $20.0 billion, respectively.
During the three months ended September 30, 2017, the 10-year U.S. Treasury was largely range-bound at similar yields to the second quarter of 2017, as markets remained in a low volatility environment with no major risk events. Yields remained between 2.04% and 2.39% throughout the quarter as investors were well-prepared for the Fed’s balance sheet runoff announcement and noted economic progress in spite of low inflation readings. The market’s pricing of future inflation, as measured by trading in the Treasury Inflation-Protected Securities market, rebounded as core inflation readings stabilized, with the longer-dated 5-year, 5-year forward breakeven rising from 1.86% to 1.95% by quarter-end. The mortgage basis, or the spread between the 30-year Agency mortgage-backed security coupon and 10-year U.S. Treasury, declined significantly in the three months ended September 30, 2017, according to Bloomberg, reflecting strong supply-demand dynamics and a market prepared for the Fed’s balance sheet runoff.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
The following table presents interest rates at each date presented:
| | | September 30, 2017 | | December 31, 2016 | | September 30, 2016 |
| 30-Year mortgage current coupon | | 2.97% | | 3.13% | | 2.36% |
| Mortgage basis | | 63 bps | | 68 bps | | 77 bps |
| 10-Year U.S. Treasury rate | | 2.33% | | 2.44% | | 1.59% |
| LIBOR: | | | | | | |
| 1-Month | | 1.23% | | 0.77% | | 0.53% |
| 6-Month | | 1.51% | | 1.32% | | 1.24% |
Financial Regulatory Reform
Uncertainty remains surrounding financial regulatory reform and its impact on the markets and the broader economy. It is difficult to predict the ultimate outcomes of legislative and other regulatory efforts. We continue to monitor these developments and to evaluate the potential impact on our businesses.
Income Tax Reform
The U.S. House of Representatives Committee on Ways and Means released draft legislation under the Tax Cuts and Jobs Act on November 2, 2017 in an effort to reform the U.S. federal income tax regime. It is difficult to ascertain what points would be included in a final legislative package or whether the legislation will pass at all. We continue to monitor the legislative process and what effect it may have on our businesses, our competitors and the economic environment.
The results of our operations are affected by various factors, many of which are beyond our control. Certain of such risks and uncertainties are described herein (see “Special Note Regarding Forward-Looking Statements” above) and in Part I, Item 1A. “Risk factors” of our most recent annual report on Form 10-K.
This Management’s Discussion and Analysis section contains analysis and discussion of both U.S. generally accepted accounting principles (or GAAP) and non-GAAP measurements. To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide non-GAAP financial measures to enhance investor understanding of our period-over-period operating performance and business trends, as well as for assessing our performance versus that of industry peers.
Please refer to the “Non-GAAP Financial Measures” section for additional information.
Net Income (Loss) Summary
The following table presents summarized financial information related to our results of operations as of and for the three and nine months ended September 30, 2017 and 2016.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
| | For the Three Months Ended | | For the Nine Months Ended |
| | September 30, 2017 | | September 30, 2016 | | September 30, 2017 | | September 30, 2016 |
| | (dollars in thousands, except per share data) |
| Interest income | $ | 622,550 | | | $ | 558,668 | | | $ | 1,747,703 | | | $ | 1,403,929 | |
| Interest expense | 268,937 | | | 174,154 | | | 689,643 | | | 474,356 | |
| Net interest income | 353,613 | | | 384,514 | | | 1,058,060 | | | 929,573 | |
| Realized and unrealized gains (losses) | 43,807 | | | 412,906 | | | (159,722 | ) | | (1,166,432 | ) |
| Other income (loss) | 28,282 | | | 29,271 | | | 90,793 | | | 13,226 | |
| Less: General and administrative expenses | 57,016 | | | 97,737 | | | 164,867 | | | 194,903 | |
| Income (loss) before income taxes | 368,686 | | | 728,954 | | | 824,264 | | | (418,536 | ) |
| Income taxes | 1,371 | | | (1,926 | ) | | 2,019 | | | (2,839 | ) |
| Net income (loss) | 367,315 | | | 730,880 | | | 822,245 | | | (415,697 | ) |
| Net income (loss) attributable to noncontrolling interest | (232 | ) | | (336 | ) | | (437 | ) | | (883 | ) |
| Net income (loss) attributable to Annaly | 367,547 | | | 731,216 | | | 822,682 | | | (414,814 | ) |
Dividends on preferred stock (1) | 30,355 | | | 22,803 | | | 77,301 | | | 58,787 | |
| Net income (loss) available (related) to common stockholders | $ | 337,192 | | | $ | 708,413 | | | $ | 745,381 | | | $ | (473,601 | ) |
| Net income (loss) per share available (related) to common stockholders: | | | | | | | |
| Basic | $ | 0.31 | | | $ | 0.70 | | | $ | 0.72 | | | $ | (0.50 | ) |
| Diluted | $ | 0.31 | | | $ | 0.70 | | | $ | 0.72 | | | $ | (0.50 | ) |
| Weighted average number of common shares outstanding: | | | | | | | |
| Basic | 1,072,566,395 | | | 1,007,607,893 | | | 1,037,033,076 | | | 953,301,855 | |
| Diluted | 1,073,040,637 | | | 1,007,963,406 | | | 1,037,445,177 | | | 953,301,855 | |
| Other information: | | | | | | | |
| Asset portfolio at period-end | $ | 95,343,337 | | | $ | 83,158,385 | | | $ | 95,343,337 | | | $ | 83,158,385 | |
| Average total assets | $ | 91,275,380 | | | $ | 82,312,889 | | | $ | 88,778,691 | | | $ | 79,315,159 | |
| Average equity | $ | 13,382,322 | | | $ | 12,411,838 | | | $ | 12,996,991 | | | $ | 12,096,902 | |
Leverage at period-end (2) | 5.4:1 | | 5.3:1 | | 5.4:1 | | 5.3:1 |
Economic leverage at period-end (3) | 6.9:1 | | 6.1:1 | | 6.9:1 | | 6.1:1 |
Capital ratio (4) | 12.3 | % | | 13.3 | % | | 12.3 | % | | 13.3 | % |
| Annualized return on average total assets | 1.61 | % | | 3.55 | % | | 1.23 | % | | (0.70 | )% |
| Annualized return (loss) on average equity | 10.98 | % | | 23.55 | % | | 8.44 | % | | (4.58 | )% |
Annualized core return on average equity (excluding PAA) (5) | 10.57 | % | | 10.09 | % | | 10.49 | % | | 9.73 | % |
Net interest margin (6) | 1.33 | % | | 1.40 | % | | 1.34 | % | | 1.12 | % |
Net interest margin (excluding PAA) (5) | 1.47 | % | | 1.42 | % | | 1.51 | % | | 1.50 | % |
| Average yield on Interest Earning Assets | 2.79 | % | | 2.70 | % | | 2.71 | % | | 2.44 | % |
Average yield on Interest Earning Assets (excluding PAA) (5) | 2.97 | % | | 2.72 | % | | 2.91 | % | | 2.88 | % |
| Average cost of Interest Bearing Liabilities | 1.82 | % | | 1.57 | % | | 1.72 | % | | 1.66 | % |
| Net interest spread | 0.97 | % | | 1.13 | % | | 0.99 | % | | 0.78 | % |
Net interest spread (excluding PAA) (5) | 1.15 | % | | 1.15 | % | | 1.19 | % | | 1.22 | % |
Constant prepayment rate (7) | 10.3 | % | | 15.9 | % | | 10.9 | % | | 12.5 | % |
Long-term constant prepayment rate (7) | 10.4 | % | | 14.4 | % | | 10.4 | % | | 14.4 | % |
| Common stock book value per share | $ | 11.42 | | | $ | 11.83 | | | $ | 11.42 | | | $ | 11.83 | |
Interest income (excluding PAA) (5) | $ | 662,449 | | | $ | 562,559 | | | $ | 1,878,172 | | | $ | 1,661,811 | |
Economic interest expense (5) | $ | 347,501 | | | $ | 277,254 | | | $ | 941,425 | | | $ | 808,881 | |
Economic net interest income (excluding PAA) (5) | $ | 314,948 | | | $ | 285,305 | | | $ | 936,747 | | | $ | 852,930 | |
Core earnings (5) | $ | 313,647 | | | $ | 309,002 | | | $ | 891,576 | | | $ | 628,944 | |
| Premium amortization adjustment cost (benefit) | $ | 39,899 | | | $ | 3,891 | | | $ | 130,469 | | | $ | 257,882 | |
Core earnings (excluding PAA) (5) | $ | 353,546 | | | $ | 312,893 | | | $ | 1,022,045 | | | $ | 886,826 | |
Core earnings per common share (5) | $ | 0.26 | | | $ | 0.29 | | | $ | 0.79 | | | $ | 0.60 | |
PAA cost (benefit) per common share (5) | $ | 0.04 | | | $ | — | | | $ | 0.12 | | | $ | 0.27 | |
Core earnings (excluding PAA) per common share (5) | $ | 0.30 | | | $ | 0.29 | | | $ | 0.91 | | | $ | 0.87 | |
| (1) | Includes cumulative and undeclared dividends on our Series F Preferred Stock of $8.3 million for the three and nine months ended September 30, 2017. |
| (2) | Debt consists of repurchase agreements, other secured financing, securitized debt, participation sold and mortgages payable. Securitized debt, participation sold and mortgages payable are non-recourse to us. |
| (3) | Computed as the sum of recourse debt, TBA derivative notional outstanding and net forward purchases of investments divided by total equity. |
| (4) | Represents the ratio of stockholders’ equity to total assets (inclusive of total market value of TBA derivatives and exclusive of consolidated VIEs associated with B-Piece commercial mortgage-backed securities). |
| (5) | Represents a non-GAAP financial measure. Refer to the “Non-GAAP Financial Measures” section for additional information. |
| (6) | Represents the sum of annualized economic net interest income, inclusive of interest expense on interest rate swaps used to hedge costs of funds, plus TBA dollar roll income less interest expense on interest rate swaps used to hedge TBA dollar roll transactions, divided by the sum of average Interest Earning Assets plus average outstanding TBA contract balances. |
| (7) | In addition to market factors, the change in CPR compared to the prior period also reflects the change in portfolio mix due to the acquisition of Hatteras. |
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
GAAP
Net income (loss) was $367.3 million, which includes ($0.2) million attributable to a noncontrolling interest, or $0.31 per average basic common share, for the three months ended September 30, 2017 compared to $730.9 million, which includes ($0.3) million attributable to a noncontrolling interest, or $0.70 per average basic common share, for the same period in 2016. We attribute the majority of the change in net income (loss) to a decrease in unrealized gains on interest rate swaps, the change in net unrealized gains (losses) on investments measured at fair value through earnings and the $72.6 million bargain purchase gain related to the Hatteras Acquisition that was recognized during the three months ended September 30, 2016. Unrealized gains on interest rate swaps were $56.9 million for the three months ended September 30, 2017 compared to $256.5 million for the same period in 2016, reflecting a sharper rise in forward interest rates during the three months ended September 30, 2016 compared to the same period in 2017. Net unrealized gains (losses) on investments measured at fair value through earnings were ($67.5) million for the three months ended September 30, 2017 compared to $29.7 million for the same period in 2016, primarily due to unfavorable changes in unrealized gains (losses) on Agency interest-only investments and MSRs.
Net income (loss) was $822.2 million, which includes ($0.4) million attributable to a noncontrolling interest, or $0.72 per average basic common share, for the nine months ended September 30, 2017 compared to ($415.7) million, which includes ($0.9) million attributable to a noncontrolling interest, or ($0.50) per average basic common share, for the same period in 2016. We attribute the majority of the change in net income (loss) to the change in unrealized (gains) losses on interest rate swaps and higher net interest income, partially offset by lower gains on trading assets. Unrealized gains (losses) on interest rate swaps were $28.5 million for the nine months ended September 30, 2017 compared to a loss of ($1.1) billion for the same period in 2016, reflecting periods of rising forward interest rates during the nine months ended September 30, 2017 compared to a sharp decline in forward
interest rates for the same period in 2016. Net interest income increased $128.5 million to $1.1 billion for the nine months ended September 30, 2017 compared to the same period in 2016, primarily due to higher coupon income resulting from an increase in average Interest Earning Assets and lower amortization expense, partially offset by an increase in interest expense resulting from average Interest Bearing Liabilities. Net gains (losses) on trading assets were $140.1 million for the nine months ended September 30, 2017 compared to $370.1 million for the same period in 2016, reflecting a $303.3 million decline in net gains on TBA derivatives partially offset by lower net losses of $96.2 million on futures contracts during the nine months ended September 30, 2017 compared to the same period in 2016.
Non-GAAP
Core earnings (excluding premium amortization adjustment (or “PAA”)) were $353.5 million, or $0.30 per average common share, for the three months ended September 30, 2017 compared to $312.9 million, or $0.29 per average common share, for the same period in 2016. Core earnings (excluding PAA) increased during the three months ended September 30, 2017 compared to the same period in 2016 primarily due to higher coupon income earned resulting from an increase in average Interest Earning Assets and lower interest expense on interest rate swaps, partially offset by an increase in interest expense from higher rates and an increase in average Interest Bearing Liabilities.
Core earnings (excluding PAA) were $1.0 billion, or $0.91 per average common share, for the nine months ended September 30, 2017 compared to $886.8 million, or $0.87 per average common share, for the same period in 2016. Core earnings (excluding PAA) increased during the nine months ended September 30, 2017 compared to the same period in 2016 primarily due to an increase in interest income earned on higher average Residential Investment Securities balances, a decrease in interest expense on interest rate swaps and lower amortization expense, partially offset by higher interest expense due to an increase in average Interest Bearing Liabilities and higher rates on repurchase agreements and FHLB advances.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Non-GAAP Financial Measures
To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide the following non-GAAP financial measures.
| • | core earnings and core earnings (excluding PAA); |
| • | core earnings and core earnings (excluding PAA) per average common share; |
| • | annualized core return on average equity (excluding PAA); |
| • | interest income (excluding PAA); |
| • | economic interest expense; |
| • | economic net interest income (excluding PAA); |
| • | average yield on Interest Earning Assets (excluding PAA); |
| • | net interest margin (excluding PAA); and |
| • | net interest spread (excluding PAA). |
These measures should not be considered a substitute for, or superior to, financial measures computed in accordance with GAAP. While intended to offer a fuller understanding of our results and operations, non-GAAP financial measures also have limitations. For example, our non-GAAP metrics may be defined differently than those of industry peers. Additionally, in the case of non-GAAP measures that exclude the PAA, the amount of amortization expense excluding the PAA is not necessarily representative of the amount of future periodic amortization nor is it indicative of the term over which we will amortize the remaining unamortized premium. Changes to actual and estimated prepayments will impact the timing and amount of premium amortization and, as such, both GAAP and non-GAAP results.
These non-GAAP measures provide additional detail to enhance investor understanding of our period-over-period operating performance and business trends, as well as for assessing our performance versus that of industry peers. Additional information pertaining to our use of these non-GAAP financial measures, including discussion of how each such measure is useful to investors, and reconciliations to their most directly comparable GAAP results are provided below.
Amortization
In accordance with GAAP, we amortize or accrete premiums or discounts into interest income for Agency mortgage-backed securities (other than interest-only securities), taking into account estimates of future principal prepayments in the calculation of the effective yield. We recalculate the effective yield as differences between anticipated and actual prepayments occur. Using third-party model and market information to project future cash flows and expected remaining lives of securities, the effective interest rate determined for each security is applied as if it had been in place from the date of the security’s acquisition. The amortized cost of the security is then adjusted to the amount that would have existed had the new effective yield been applied since the acquisition date, which results in a cumulative PAA in each period. The adjustment to amortized cost is offset with a charge or credit to interest income. Changes in interest rates and other market factors will impact prepayment speed projections and the amount of premium amortization recognized in any given period.
Our GAAP metrics include the unadjusted impact of amortization and accretion associated with this method. Certain of our non-GAAP metrics exclude the effect of the PAA, which quantifies the component of premium amortization representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term CPR.
The following table illustrates the impact of the PAA on premium amortization expense for our Residential Investment Securities portfolio for the periods presented:
| | For the Three Months Ended | | For the Nine Months Ended |
| | September 30, 2017 | | September 30, 2016 | | September 30, 2017 | | September 30, 2016 |
| | (dollars in thousands) |
| Premium amortization expense (accretion) | $ | 220,636 | | | $ | 213,241 | | | $ | 675,354 | | | $ | 834,387 | |
| Less: PAA Cost (Benefit) | 39,899 | | | 3,891 | | | 130,469 | | | 257,882 | |
| Premium amortization expense exclusive of PAA | $ | 180,737 | | | $ | 209,350 | | | $ | 544,885 | | | $ | 576,505 | |
| | For the Three Months Ended | | For the Nine Months Ended |
| | September 30, 2017 | | September 30, 2016 | | September 30, 2017 | | September 30, 2016 |
| | (per average common share) |
| Premium amortization expense (accretion) | $ | 0.21 | | | $ | 0.21 | | | $ | 0.65 | | | $ | 0.88 | |
| Less: PAA Cost (Benefit) | 0.04 | | | — | | | 0.12 | | | 0.27 | |
| Premium amortization expense exclusive of PAA | $ | 0.17 | | | $ | 0.21 | | | $ | 0.53 | | | $ | 0.61 | |
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Core earnings and core earnings (excluding PAA), core earnings and core earnings (excluding PAA) per average common share and annualized core return on average equity (excluding PAA)
One of our principal business objectives is to generate net income by earning a net interest spread on our investment portfolio, which is a function of our interest income from our investment portfolio less financing, hedging and operating costs. Core earnings, which is comprised of interest income plus TBA dollar roll income, less financing and hedging costs and general and administrative expenses, and core earnings (excluding PAA), are used by management, and we believe, used by our analysts and investors, to measure its progress in achieving this objective. We define core earnings, a non-GAAP measure, as net income (loss) excluding gains or losses on disposals of investments and termination of interest rate swaps, unrealized gains or losses on interest rate swaps and investments measured at fair value through earnings, net gains and losses on trading assets, impairment losses, net income (loss) attributable to noncontrolling interest, corporate acquisition related expenses and certain other non-recurring gains or losses, and inclusive of TBA dollar roll income (a component of Net gains (losses) on trading assets) and realized amortization of MSRs (a component of net unrealized gains (losses) on investments measured at fair value through earnings). Core earnings (excluding PAA) excludes the component of premium amortization expense representing the cumulative effect of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities (other than interest-only securities), which can obscure underlying trends in the performance of the portfolio.
We believe these measures provide management and investors with additional details regarding our underlying operating results and investment portfolio trends by (i) making adjustments to account for the disparate reporting of changes in fair value where certain instruments are reflected in GAAP net income (loss) while others are reflected in Other comprehensive income (loss), and (ii) by excluding certain unrealized, non-cash or episodic components of GAAP net income (loss) in order to provide additional transparency into the operating performance of our portfolio. Annualized core return on average equity (excluding PAA), which is calculated by dividing core earnings (excluding PAA) over average stockholders’ equity, provides investors with additional detail on the core earnings generated by our invested equity capital.
The following table presents a reconciliation of GAAP financial results to non-GAAP core earnings for the periods presented:
| | For the Three Months Ended | | For the Nine Months Ended |
| | September 30, 2017 | | September 30, 2016 | | September 30, 2017 | | September 30, 2016 |
| | (dollars in thousands, except per share data) |
| GAAP net income (loss) | $ | 367,315 | | | $ | 730,880 | | | $ | 822,245 | | | $ | (415,697 | ) |
| Less: | | | | | | | |
| Realized (gains) losses on termination of interest rate swaps | — | | | (1,337 | ) | | 58 | | | 58,727 | |
| Unrealized (gains) losses on interest rate swaps | (56,854 | ) | | (256,462 | ) | | (28,471 | ) | | 1,148,478 | |
| Net (gains) losses on disposal of investments | 11,552 | | | (14,447 | ) | | 11,833 | | | (25,307 | ) |
| Net (gains) losses on trading assets | (154,208 | ) | | (162,981 | ) | | (140,104 | ) | | (370,050 | ) |
| Net unrealized (gains) losses on financial instruments measured at fair value through earnings | 67,492 | | | (29,675 | ) | | 27,569 | | | 24,351 | |
| Bargain purchase gain | — | | | (72,576 | ) | | — | | | (72,576 | ) |
Corporate acquisition related expenses (1) | — | | | 46,724 | | | — | | | 48,887 | |
| Net (income) loss attributable to noncontrolling interest | 232 | | | 336 | | | 437 | | | 883 | |
| Plus: | | | | | | | |
TBA dollar roll income (loss) (2) | 94,326 | | | 90,174 | | | 245,345 | | | 252,882 | |
MSR amortization (3) | (16,208 | ) | | (21,634 | ) | | (47,336 | ) | | (21,634 | ) |
Core earnings (4) | $ | 313,647 | | | $ | 309,002 | | | $ | 891,576 | | | $ | 628,944 | |
| Less: | | | | | | | |
| Premium amortization adjustment cost (benefit) | 39,899 | | | 3,891 | | | 130,469 | | | 257,882 | |
Core earnings (excluding PAA) (4) | $ | 353,546 | | | $ | 312,893 | | | $ | 1,022,045 | | | $ | 886,826 | |
GAAP net income (loss) per common share (5) | $ | 0.31 | | | $ | 0.70 | | | $ | 0.72 | | | $ | (0.50 | ) |
Core earnings per common share (4)(5) | $ | 0.26 | | | $ | 0.29 | | | $ | 0.79 | | | $ | 0.60 | |
Core earnings (excluding PAA) per common share (4)(5) | $ | 0.30 | | | $ | 0.29 | | | $ | 0.91 | | | $ | 0.87 | |
| Annualized GAAP return (loss) on average equity | 10.98 | % | | 23.55 | % | | 8.44 | % | | (4.58 | )% |
Annualized core return on average equity (excluding PAA) (4) | 10.57 | % | | 10.09 | % | | 10.49 | % | | 9.73 | % |
(1) | Represents transaction costs incurred in connection with the Hatteras Acquisition. |
(2) | Represents a component of Net gains (losses) on trading assets in the Consolidated Statements of Comprehensive Income (Loss). |
(3) | Represents the portion of changes in fair value that is attributable to the realization of estimated cash flows on our MSR portfolio and is reported as a component of Net unrealized (gains) losses on investments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss). |
(4) | Represents a non-GAAP financial measure. Refer to the “Non-GAAP Financial Measures” section for additional information. |
(5) | Net of dividends on preferred stock, including cumulative and undeclared dividends on the Company’s Series F Preferred Stock of $8.3 million for the three and nine months ended September 30, 2017. |
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
From time to time, we enter into TBAs as an alternate means of investing in and financing Agency mortgage-backed securities. A TBA contract is an agreement to purchase or sell, for future delivery, an Agency mortgage-backed security with a specified issuer, term and coupon. A TBA dollar roll represents a transaction where TBA contracts with the same terms but different settlement dates are simultaneously bought and sold. The TBA contract settling in the later month typically prices at a discount to the earlier month contract with the difference in price commonly referred to as the “drop”. The drop is a reflection of the expected net interest income from an investment in similar Agency mortgage-backed securities, net of an implied financing cost, that would be foregone as a result of settling the contract in the later month rather than in the earlier month. The drop between the current settlement month price and the forward settlement month price occurs because in the TBA dollar roll market, the party providing the financing is the party that would retain all principal and interest payments accrued during the financing period. Accordingly, TBA dollar roll income generally represents the economic equivalent of the net interest income earned on the underlying Agency mortgage-backed security less an implied financing cost.
TBA dollar roll transactions are accounted for under GAAP as a series of derivatives transactions. The fair value of TBA derivatives is based on methods similar to those used to value Agency mortgage-backed securities. We record TBA derivatives at fair value on the Consolidated Statements of Financial Condition and recognize periodic changes in fair value as Net gains (losses) on trading assets in the Consolidated Statements of Comprehensive Income (Loss), which includes both unrealized and realized gains and losses on derivatives (excluding interest rate swaps).
TBA dollar roll income is calculated as the difference in price between two TBA contracts with the same terms but different settlement dates multiplied by the notional amount of the TBA contract. Although accounted for as derivatives, TBA dollar rolls capture the economic equivalent of net interest income, or carry, on the underlying Agency mortgage-backed security (interest income less an implied cost of financing). TBA dollar roll income is reported as a component of Net gains (losses) on trading assets in the Consolidated Statements of Comprehensive Income (Loss).
Interest income (excluding PAA), economic interest expense and economic net interest income (excluding PAA)
Interest income (excluding PAA) represents interest income excluding the effect of the premium amortization adjustment, and serves as the basis for deriving average yield on Interest Earning Assets (excluding PAA), net interest spread (excluding PAA) and net interest margin (excluding PAA), which are discussed below. We believe this measure provides management and investors with additional detail to enhance their understanding of our operating results and trends by excluding the component of premium amortization expense representing the cumulative effect of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities (other than interest-only securities), which can obscure underlying trends in the performance of the portfolio.
Economic interest expense is comprised of interest expense, as computed in accordance with GAAP, plus interest expense on interest rate swaps used to hedge the cost of funds, which is a component of Realized gains (losses) on interest rate swaps in the Consolidated Statements of Comprehensive Income (Loss). We use interest rate swaps to manage our exposure to changing interest rates on repurchase agreements by economically hedging cash flows associated with these borrowings. Accordingly, adding the contractual interest payments on interest rate swaps to interest expense, as computed in accordance with GAAP, reflects the total contractual interest expense and thus, provides investors with additional information about the cost of our financing strategy.
Similarly, economic net interest income (excluding PAA), as computed below, provides investors with additional information to enhance their understanding of the net economics of our primary business operations.
The following tables provide GAAP measures of interest expense and net interest income and details with respect to reconciling the aforementioned line items on a non-GAAP basis for each respective period:
Interest Income (excluding PAA)
| | GAAP Interest Income | | PAA cost (benefit) | | Interest income (excluding PAA) |
| Three Months Ended: | (dollars in thousands) |
| September 30, 2017 | $ | 622,550 | | | $ | 39,899 | | | $ | 662,449 | |
| September 30, 2016 | $ | 558,668 | | | $ | 3,891 | | | $ | 562,559 | |
| Nine Months Ended: | | | | | |
| September 30, 2017 | $ | 1,747,703 | | | $ | 130,469 | | | $ | 1,878,172 | |
| September 30, 2016 | $ | 1,403,929 | | | $ | 257,882 | | | $ | 1,661,811 | |
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Economic Interest Expense and Economic Net Interest Income (excluding PAA)
| | GAAP Interest Expense | | Add: Interest Expense on Interest Rate Swaps Used to Hedge Cost of Funds (1) | | Economic Interest Expense | | GAAP Net Interest Income | | Less: Interest Expense on Interest Rate Swaps Used to Hedge Cost of Funds (1) | | Economic Net Interest Income | | Add: PAA Cost (Benefit) | | Economic Net Interest Income (excluding PAA) |
| Three Months Ended: | (dollars in thousands) |
| September 30, 2017 | $ | 268,937 | | | $ | 78,564 | | | $ | 347,501 | | | $ | 353,613 | | | $ | 78,564 | | | $ | 275,049 | | | $ | 39,899 | | | $ | 314,948 | |
| September 30, 2016 | $ | 174,154 | | | $ | 103,100 | | | $ | 277,254 | | | $ | 384,514 | | | $ | 103,100 | | | $ | 281,414 | | | $ | 3,891 | | | $ | 285,305 | |
| Nine Months Ended: | | | | | | | | | | | | | | | |
| September 30, 2017 | $ | 689,643 | | | $ | 251,782 | | | $ | 941,425 | | | $ | 1,058,060 | | | $ | 251,782 | | | $ | 806,278 | | | $ | 130,469 | | | $ | 936,747 | |
| September 30, 2016 | $ | 474,356 | | | $ | 334,525 | | | $ | 808,881 | | | $ | 929,573 | | | $ | 334,525 | | | $ | 595,048 | | | $ | 257,882 | | | $ | 852,930 | |
(1) A component of realized gains (losses) on interest rate swaps on the Consolidated Statements of Comprehensive Income Loss.
Experienced and Projected Long-term CPR
Prepayment speeds, as reflected by the Constant Prepayment Rate (or CPR) 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 speeds and expectations of
prepayment speeds on our Agency mortgage-backed securities portfolio increase, related purchase premium amortization increases, thereby reducing the yield on such assets. The following table presents the weighted average experienced CPR and weighted average projected long-term CPR on our Agency mortgage-backed securities portfolio as of or for the periods presented.
| Three Months Ended | | Experienced CPR (1) | | Projected Long- term CPR (2) |
| September 30, 2017 | | 10.3% | | 10.4% |
| September 30, 2016 | | 15.9% | | 14.4% |
| Nine Months Ended | | Experienced CPR (1) | | Projected Long- term CPR (2) |
| September 30, 2017 | | 10.9% | | 10.4% |
| September 30, 2016 | | 12.5% | | 14.4% |
(1) For the three and nine months ended September 30, 2017 and 2016, respectively.
(2) At September 30, 2017 and 2016, respectively.
The change in CPR measures for the current periods compared with the prior periods also reflect the change in portfolio mix due to the acquisition of Hatteras.
Average yield on Interest Earning Assets (excluding PAA), net interest spread (excluding PAA) and net interest margin (excluding PAA)
Net interest spread (excluding PAA), which is the difference between the average yield on Interest Earning Assets (excluding PAA) and the average cost of Interest Bearing Liabilities,
and net interest margin (excluding PAA), which is calculated by dividing the economic net interest income (excluding PAA) by the sum of average Interest Earning Assets and average TBA balances, provide management with additional measures of our profitability that management relies upon in monitoring the performance of the business.
Disclosure of these measures for which reconciliation to GAAP is presented below provides investors with additional detail regarding how management evaluates our performance.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Economic Net Interest Income (excluding PAA)
| | Average Interest Earning Assets (1) | | Interest income (excluding PAA) (2) | | Average Yield on Interest Earning Assets (excluding PAA) (2) | | Average Interest Bearing Liabilities | | Economic Interest Expense (2)(3) | | Average Cost of Interest Bearing Liabilities | | Economic Net Interest Income (excluding PAA) (2)(3) | | Net Interest Spread (excluding PAA) (2) | | Net Interest Margin (excluding PAA) (2)(4) |
| Three Months Ended: | (dollars in thousands) |
| September 30, 2017 | $ | 89,253,094 | | | $ | 662,449 | | | 2.97 | % | | $ | 76,382,315 | | | $ | 347,501 | | | 1.82 | % | | $ | 314,948 | | | 1.15 | % | | 1.47 | % |
| September 30, 2016 | $ | 82,695,270 | | | $ | 562,559 | | | 2.72 | % | | $ | 70,809,712 | | | $ | 277,254 | | | 1.57 | % | | $ | 285,305 | | | 1.15 | % | | 1.42 | % |
| Nine Months Ended: | | | | | | | | | | | | | | | | |
| September 30, 2017 | $ | 86,114,838 | | | $ | 1,878,172 | | | 2.91 | % | | $ | 73,097,354 | | | $ | 941,425 | | | 1.72 | % | | $ | 936,747 | | | 1.19 | % | | 1.51 | % |
| September 30, 2016 | $ | 76,818,322 | | | $ | 1,661,811 | | | 2.88 | % | | $ | 65,079,627 | | | $ | 808,881 | | | 1.66 | % | | $ | 852,930 | | | 1.22 | % | | 1.50 | % |
| (1) | Does not reflect unrealized gains/(losses). |
| (2) | Represents a non-GAAP financial measure. Refer to the “Non-GAAP Financial Measures” section for additional information. |
| (3) | Net of interest expense on interest rate swaps used to hedge cost of funds. |
| (4) | Represents the sum of annualized economic net interest income (excluding PAA), inclusive of interest expense on interest rate swaps used to hedge costs of funds, plus TBA dollar roll income less interest expense on interest rate swaps used to hedge dollar roll transactions divided by the sum of average Interest Earning Assets plus average outstanding TBA contract balances. |
Economic Interest Expense and the Average Cost of Interest Bearing Liabilities
Typically, our largest expense is the cost of Interest Bearing Liabilities and interest expense on interest rate swaps, which is recorded in realized gains (losses) on interest rate swaps on the Consolidated Statements of
Comprehensive Income (Loss). The table below shows our average Interest Bearing Liabilities and average cost of Interest Bearing Liabilities as compared to average one-month and average six-month LIBOR for the periods presented.
Cost of Funds on Average Interest Bearing Liabilities
| | Average Interest Bearing Liabilities | | Interest Bearing Liabilities at Period End | | Economic Interest Expense (1) | | Average Cost of Interest Bearing Liabilities | | Average One- Month LIBOR | | Average Six- Month LIBOR | | Average One- Month LIBOR Relative to Average Six-Month LIBOR | | Average Cost of Interest Bearing Liabilities Relative to Average One- Month LIBOR | | Average Cost of Interest Bearing Liabilities Relative to Average Six- Month LIBOR |
| Three Months Ended: | (dollars in thousands) |
| September 30, 2017 | $ | 76,382,315 | | | $ | 76,501,453 | | | $ | 347,501 | | | 1.82 | % | | 1.23 | % | | 1.46 | % | | (0.23 | )% | | 0.59 | % | | 0.36 | % |
| September 30, 2016 | $ | 70,809,712 | | | $ | 69,314,660 | | | $ | 277,254 | | | 1.57 | % | | 0.51 | % | | 1.15 | % | | (0.64 | )% | | 1.06 | % | | 0.42 | % |
| Nine Months Ended: | | | | | | | | | | | | | | | | |
| September 30, 2017 | $ | 73,097,354 | | | $ | 76,501,453 | | | $ | 941,425 | | | 1.72 | % | | 1.04 | % | | 1.42 | % | | (0.38 | )% | | 0.68 | % | | 0.30 | % |
| September 30, 2016 | $ | 65,079,627 | | | $ | 69,314,660 | | | $ | 808,881 | | | 1.66 | % | | 0.46 | % | | 0.99 | % | | (0.53 | )% | | 1.20 | % | | 0.67 | % |
(1) Economic interest expense includes interest expense on interest rate swaps used to hedge cost of funds.
Economic interest expense increased by $70.2 million to $347.5 million for the three months ended September 30, 2017 compared to the same period in 2016. Economic interest expense increased by $132.5 million to $941.4 million for the nine months ended September 30, 2017 compared to the same period in 2016. The change in each period was primarily due to an increase in average Interest Bearing Liabilities and higher rates on repurchase agreements, partially offset by lower interest expense on interest rate swaps used to hedge cost of funds.
We do not manage our portfolio to have a pre-designated amount of borrowings at quarter or year end. Our borrowings at period end are a snapshot of our borrowings as of a date, and this number should be expected to differ from average borrowings over the period for a number of reasons.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
The mortgage-backed securities we own pay principal and interest towards the end of each month and the mortgage-backed securities we purchase are typically settled during the beginning of the month. As a result, depending on the amount of mortgage-backed securities we have committed to purchase, we may retain the principal and interest we receive in the prior month, or we may use it to pay down our borrowings. Moreover, we generally use interest rate swaps, swaptions and other derivative instruments to hedge our portfolio, and as we pledge or receive collateral under these agreements, our borrowings on any given day may be increased or decreased. Our average borrowings during a quarter will differ from period end borrowings as we implement our portfolio management strategies and risk management strategies over changing market conditions by increasing or decreasing leverage. Additionally, these numbers will differ during periods when we conduct capital raises, as in certain instances we may purchase additional assets and increase leverage with the expectation of a successful capital raise. Since our average borrowings and period end borrowings can be expected to differ, we believe our average borrowings during a period provide a more accurate representation of our exposure to the risks associated with leverage than our period end borrowings.
At September 30, 2017 and December 31, 2016, the majority of our debt represented repurchase agreements and other secured financing arrangements collateralized by a pledge of our Residential Investment Securities, residential mortgage loans, commercial real estate investments and corporate loans. All of our Residential Investment Securities are currently accepted as collateral for these borrowings. However, we limit our borrowings, and thus our potential asset growth, in order to maintain unused borrowing capacity and thus increase the liquidity and strength of our balance sheet.
Realized and Unrealized Gains (Losses)
Realized and unrealized gains (losses) is comprised of net gains (losses) on interest rate swaps, net gains (losses) on disposal of investments, net gains (losses) on trading assets and net unrealized gains (losses) on investments measured at fair value through earnings. These components of realized and unrealized gains (losses) for the three and nine months ended September 30, 2017 and 2016 were as follows:
| | For the Three Months Ended, | | For the Nine Months Ended, |
| | September 30, 2017 | | September 30, 2016 | | September 30, 2017 | | September 30, 2016 |
| | (dollars in thousands) | |
Net gains (losses) on interest rate swaps (1) | $ | (31,357 | ) | | $ | 133,227 | | | $ | (260,424 | ) | | $ | (1,610,014 | ) |
| Net gains (losses) on disposal of investments | (11,552 | ) | | 14,447 | | | (11,833 | ) | | 25,307 | |
| Net gains (losses) on trading assets | 154,208 | | | 162,981 | | | 140,104 | | | 370,050 | |
| Net unrealized gains (losses) on investments measured at fair value through earnings | (67,492 | ) | | 29,675 | | | (27,569 | ) | | (24,351 | ) |
| Bargain purchase gain | — | | | 72,576 | | | — | | | 72,576 | |
| Total | $ | 43,807 | | | $ | 412,906 | | | $ | (159,722 | ) | | $ | (1,166,432 | ) |
(1) Includes realized gains (losses) on interest rate swaps and unrealized gains (losses) on interest rate swaps.
For the Three Months Ended September 30, 2017 and 2016
Net gains (losses) on interest rate swaps for the three months ended September 30, 2017 was ($31.4) million compared to $133.2 million for the same period in 2016. The change was primarily attributable to a $199.6 million decrease in unrealized gains on interest rate swaps which was $56.9 million for the three months ended September 30, 2017 compared to $256.5 million for the same period in 2016, reflecting a sharper rise in forward interest rates during the three months ended September 30, 2016 compared with the same period in 2017.
Net gains (losses) on disposal of investments was ($11.6) million for the three months ended September 30, 2017 compared with $14.4 million for the same period in 2016. During the three months ended September 30, 2017, we disposed of Residential Investment Securities with a carrying value of $6.8 billion for an aggregate net loss of ($10.2) million. For the same period in 2016, we disposed of Residential Investment Securities with a carrying value of $3.8 billion for an aggregate net gain of $14.7 million.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Net gains (losses) on trading assets was $154.2 million for the three months ended September 30, 2017 compared to $163.0 million for the same period in 2016. The change was primarily due to a $40.5 million decrease in net gains on futures contracts for three months ended September 30, 2017 compared to the same period in 2016 and the change in net gains/(losses) on interest rate swaptions which was ($9.1) million for the three months ended September 30, 2017 compared to $4.3 million for the same period in 2016, partially offset by a $44.4 million increase in net gains on TBA derivatives for the three months ended September 30, 2017 compared to the same period in 2016.
Net unrealized gains (losses) on investments measured at fair value through earnings was ($67.5) million for the three months ended September 30, 2017 compared to $29.7 million for the same period in 2016. The change was primarily attributable to unfavorable marks on Agency interest-only investments and MSRs for the three months ended September 30, 2017 compared to the same period in 2016.
For the Nine Months Ended September 30, 2017 and 2016
Net losses on interest rate swaps for the nine months ended September 30, 2017 was ($260.4) million compared to ($1.6) billion for the same period in 2016. Unrealized gains (losses) on interest rate swaps for the nine months ended September 30, 2017 was $28.5 million compared to ($1.1) billion for the same period in 2016, reflecting periods of rising forward interest rates during the nine months ended September 30, 2017 compared to lower forward interest rates for the same period in 2016.
Net gains (losses) on disposal of investments was ($11.8) million for the nine months ended September 30, 2017 compared with $25.3 million for the same period in 2016. During the nine months ended September 30, 2017, we disposed of Residential Investment Securities with a carrying value of $11.4 billion for an aggregate net loss of ($14.3) million and residential mortgage loans for a net loss of ($3.4) million partially offset by a disposal of a wholly-owned triple net leased property for a gain of $5.1 million. For the same period in 2016, we disposed of Residential Investment Securities with a carrying value of $9.1 billion for an aggregate net gain of $24.9 million.
Net gains (losses) on trading assets was $140.1 million for the nine months ended September 30, 2017 compared to $370.1 million for the same period in 2016. The change was primarily due to a $303.3 million decrease in net gains on TBA derivatives, partially offset by a $96.2 million decrease in net losses on futures contracts for nine months ended September 30, 2017 compared to the same period in 2016.
Net unrealized gains (losses) on investments measured at fair value through earnings was ($27.6) million for the nine months ended September 30, 2017 compared to ($24.4) million for the same period in 2016. The change was primarily attributable to lower valuations on MSRs, partially offset by favorable valuations on interest-only mortgage-backed securities for nine months ended September 30, 2017 compared to the same period in 2016.
Other Income (Loss)
Other income (loss) includes certain revenues and costs associated with our investments in commercial real estate, including rental income and recoveries, net servicing income on MSRs, operating and transaction costs as well as depreciation and amortization expense. We report in Other income (loss) items whose amounts, either individually or in the aggregate, would not, in the opinion of management, be meaningful to readers of the financial statements. Given the nature of certain components of this line item, balances may fluctuate from period to period.
General and Administrative Expenses
General and administrative (or G&A) expenses consist of compensation expense, the management fee and other expenses. The following table shows our total G&A expenses as compared to average total assets and average equity for the periods presented.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
G&A Expenses and Operating Expense Ratios
| | | Total G&A Expenses (1) | | | Total G&A Expenses/Average Assets (1) | | | Total G&A Expenses/Average Equity (1) | |
| For the Three Months Ended: | | (dollars in thousands) | |
| September 30, 2017 | | $ | 57,016 | | | | 0.25% | | | | 1.70% | |
| September 30, 2016 | | $ | 97,737 | | | | 0.47% | | | | 3.15% | |
| For the Nine Months Ended: | | | | | | | | | | | | |
| September 30, 2017 | | $ | 164,867 | | | | 0.25% | | | | 1.69% | |
| September 30, 2016 | | $ | 194,903 | | | | 0.33% | | | | 2.15% | |
(1) Includes $46.7 million and $48.9 million of acquisition costs attributable for the Hatteras Acquisition for the three and nine months ended September 30, 2016, respectively.
G&A expenses were $57.0 million for the three months ended September 30, 2017, a decrease of $40.7 million compared to the same period in 2016. G&A expenses decreased $30.0 million to $164.9 million for the nine months ended September 30, 2017 compared to $194.9 million for the same period in 2016. The change in each period was attributable to transaction costs recognized in connection with the Hatteras Acquisition of $46.7 million and $48.9 million for the quarter and nine months ended September 30, 2016, respectively, partially offset by higher compensation and management fees reflecting an increase in adjusted stockholders’ equity primarily resulting from the Hatteras Acquisition for the three and nine months ended September 30, 2017 compared to the same periods in 2016.
Unrealized Gains and Losses
With our available-for-sale accounting treatment on our Agency mortgage-backed securities which represent the largest portion of assets on balance sheet, unrealized fluctuations in market values of assets do not impact our GAAP or taxable income but rather are reflected on
our balance sheet by changing the carrying value of the asset and stockholders’ equity under accumulated other comprehensive income (loss). As a result of this fair value accounting treatment, our book value and book value per share are likely to fluctuate far more than if we used amortized cost accounting. As a result, comparisons with companies that use amortized cost accounting for some or all of their balance sheet may not be meaningful.
The table below shows cumulative unrealized gains and losses on our available-for-sale investments reflected in the Consolidated Statements of Financial Condition.
| | | September 30, 2017 | | | December 31, 2016 | |
| | | (dollars in thousands) | |
| Unrealized gain | | $ | 290,845 | | | $ | 275,680 | |
| Unrealized loss | | | (930,994 | ) | | | (1,361,573 | ) |
| Net unrealized gain (loss) | | $ | (640,149 | ) | | $ | (1,085,893 | ) |
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Unrealized changes in the estimated fair value of available-for-sale investments may have a direct effect on our potential earnings and dividends: positive changes will increase our equity base and allow us to increase our borrowing capacity while negative changes tend to reduce borrowing capacity under our investment policy. A very large negative change in the net fair value of our available-for-sale Residential Investment Securities might impair our liquidity position, requiring us to sell assets with the likely result of realized losses upon sale.
The fair value of these securities being less than amortized cost at September 30, 2017 is solely due to market conditions and not the quality of the assets. Substantially all of the Agency mortgage-backed securities are “AAA” rated or carry an implied “AAA” rating. The investments are not considered to be other-than-temporarily impaired because we currently have the ability and intent to hold the investments to maturity or for a period of time sufficient for a forecasted market price recovery up to or beyond the cost of the
investments, and it is not more likely than not that we will be required to sell the investments before recovery of the amortized cost bases, which may be maturity. Also, we are guaranteed payment of the principal amount of the securities by the respective issuing Agency.
Return on Average Equity
Our annualized return (loss) on average equity was 10.98% and 23.55% for the three months ended September 30, 2017 and 2016, respectively. Our annualized return (loss) on average equity was 8.44% and (4.58)% for the nine months ended September 30, 2017 and 2016, respectively. The following table shows the components of our annualized return on average equity for the periods presented.
Components of Annualized Return on Average Equity
| | Economic Net Interest Income/ Average Equity (1) | Realized and Unrealized Gains and Losses/Average Equity (2) | Other Income (Loss)/Average Equity (3) | G&A Expenses/ Average Equity | Income Taxes/ Average Equity | Return on Average Equity |
| For the Three Months Ended: | | | | | |
| September 30, 2017 | 8.21% | 3.66% | 0.85% | (1.70)% | (0.04)% | 10.98% |
| September 30, 2016 | 9.07% | 16.63% | 0.94% | (3.15)% | 0.06% | 23.55% |
| For the Nine Months Ended: | | | | | |
| September 30, 2017 | 8.27% | 0.94% | 0.93% | (1.69)% | (0.01)% | 8.44% |
| September 30, 2016 | 6.56% | (9.17)% | 0.15% | (2.15)% | 0.03% | (4.58)% |
(1) Economic net interest income includes interest expense on interest rate swaps used to hedge cost of funds.
(2) Realized and unrealized gains and losses excludes interest expense on interest rate swaps used to hedge cost of funds.
(3) Other income (loss) includes investment advisory income, dividend income from affiliate, and other income (loss).
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Total assets were $97.6 billion and $87.9 billion at September 30, 2017 and December 31, 2016, respectively. The change was primarily due to a $10.0 billion increase in Residential Investment Securities partially offset by a $0.6 million decrease in our
commercial real estate assets. Our portfolio composition, net equity allocation and debt-to-net equity ratio by asset class was as follows at September 30, 2017:
| | | Residential | | | Commercial | | | | | |
| | | Agency MBS (1) | | | TBAs (2) | | | CRTs | | | Non-Agency MBS (3) | | | CRE Debt & Preferred Equity Investments | | | Investments in CRE | | | Corporate Debt | | | Total (4) | | |
| | | (dollars in thousands) | | |
| Assets: | | | | | | | | | | | | | | | | | | | | | | | | | |
Fair Value/Carrying Value | | $ | 86,459,349 | | | $ | 20,826,145 | | | $ | 582,938 | | | $ | 2,123,154 | | | $ | 4,850,858 | | | $ | 470,928 | | | $ | 856,110 | | | $ | 95,343,337 | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Debt: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Repurchase agreements | | | 68,431,702 | | | | 19,960,000 | | | | 193,347 | | | | 422,190 | | | | 383,029 | | | | — | | | | — | | | | 69,430,268 | | |
Other secured financing | | | 2,764,298 | | | | — | | | | — | | | | 618,837 | | | | 213,963 | | | | — | | | | 116,158 | | | | 3,713,256 | | |
Securitized debt | | | — | | | | — | | | | — | | | | 38,548 | | | | 3,319,381 | | | | — | | | | — | | | | 3,357,929 | | |
Net forward purchases | | | 4,875,750 | | | | — | | | | — | | | | 28,085 | | | | — | | | | — | | | | — | | | | 4,903,835 | | |
Mortgages payable | | | — | | | | — | | | | — | | | | — | | | | — | | | | 311,886 | | | | — | | | | 311,886 | | |
Net Equity Allocated | | $ | 10,387,599 | | | $ | 866,145 | | | $ | 389,591 | | | $ | 1,015,494 | | | $ | 934,485 | | | $ | 159,042 | | | $ | 739,952 | | | | 13,626,163 | | (5) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net Equity Allocated (%) | | | 77 | % | | | 6 | % | | | 3 | % | | | 7 | % | | | 7 | % | | | 1 | % | | | 5 | % | | | 100 | % | (6) |
Debt/Net Equity Ratio | | 7.3:1 | | | 23.0:1 | | | 0.5:1 | | | 1.1:1 | | | 4.2:1 | | | 2.0:1 | | | 0.2:1 | | | 5.4:1 | | |
(1) Includes MSRs.
(2) Fair value/carrying value represents implied market value and repurchase agreements represent the notional value.
(3) Includes residential mortgage loans.
(4) Excludes the TBA asset, debt and equity balances.
(5) Net Equity Allocated, as disclosed in the above table, excludes non-portfolio related activity and may differ from stockholders’ equity per the Consolidated Statements of Financial Condition.
(6) Represents the debt/net equity ratio as determined using amounts on the Consolidated Statements of Financial Condition.
Residential Investment Securities
Substantially all of our Agency mortgage-backed securities at September 30, 2017 and December 31, 2016 were backed by single-family residential mortgage loans and were secured with a first lien position on the underlying single-family properties. Our mortgage-backed securities were largely Freddie Mac, Fannie Mae or Ginnie Mae pass through certificates or CMOs, which carry an actual or implied “AAA” rating. We carry all of our Agency mortgage-backed securities at fair value on the Consolidated Statements of Financial Condition.
We accrete discount balances as an increase to interest income over the expected life of the related Interest Earning Assets and we amortize premium balances as a decrease to interest income over the expected life of the related Interest Earning Assets. At September 30, 2017
and December 31, 2016 we had on our Consolidated Statements of Financial Condition a total of $158.4 million and $171.9 million, respectively, of unamortized discount (which is the difference between the remaining principal value and current amortized cost of our Residential Investment Securities acquired at a price below principal value) and a total $5.9 billion and $5.5 billion, respectively, of unamortized premium (which is the difference between the remaining principal value and the current amortized cost of our Residential Investment Securities acquired at a price above principal value).
The weighted average experienced prepayment speed on our Agency mortgage-backed securities portfolio for the three months ended September 30, 2017 and 2016 was 10.3% and 15.9%, respectively. The weighted average projected long-term prepayment speed on our Agency mortgage-backed securities portfolio for the three months ended September 30, 2017 and 2016 was 10.4% and 14.4%, respectively.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Given our current portfolio composition, if mortgage principal prepayment rates were to increase over the life of our mortgage-backed securities, all other factors being equal, our net interest income would decrease during the life of these mortgage-backed securities as we would be required to amortize our net premium balance into income over a shorter time period. Similarly, if mortgage principal prepayment rates
were to decrease over the life of our mortgage-backed securities, all other factors being equal, our net interest income would increase during the life of these mortgage-backed securities as we would amortize our net premium balance over a longer time period.
The following table summarizes certain characteristics of our Residential Investment Securities (excluding interest-only mortgage-backed securities) and interest-only mortgage-backed securities at the dates presented.
| | | September 30, 2017 | | | December 31, 2016 | |
| | | (dollars in thousands) | |
Residential Investment Securities: (1) | | | | | | |
| Principal Amount | | $ | 82,683,648 | | | $ | 73,621,439 | |
| Net Premium | | | 4,405,197 | | | | 3,867,055 | |
| Amortized Cost | | | 87,088,845 | | | | 77,488,494 | |
| Amortized Cost/Principal Amount | | | 105.33 | % | | | 105.25 | % |
| Carrying Value | | | 86,557,897 | | | | 76,458,517 | |
| Carrying Value / Principal Amount | | | 104.69 | % | | | 103.85 | % |
| Weighted Average Coupon Rate | | | 3.66 | % | | | 3.54 | % |
| Weighted Average Yield | | | 2.79 | % | | | 2.69 | % |
Adjustable-Rate Residential Investment Securities: (1) | | | | | |
| Principal Amount | | $ | 8,541,745 | | | $ | 12,179,455 | |
| Weighted Average Coupon Rate | | | 3.00 | % | | | 2.84 | % |
| Weighted Average Yield | | | 2.43 | % | | | 2.30 | % |
| Weighted Average Term to Next Adjustment | | 26 Months | | | 31 Months | |
Weighted Average Lifetime Cap (2) | | | 8.13 | % | | | 8.09 | % |
| Principal Amount at Period End as % of Total Residential Investment Securities | | | 10.33 | % | | | 16.54 | % |
Fixed-Rate Residential Investment Securities: (1) | | | | | | | | |
| Principal Amount | | $ | 74,141,903 | | | $ | 61,441,984 | |
| Weighted Average Coupon Rate | | | 3.74 | % | | | 3.68 | % |
| Weighted Average Yield | | | 2.83 | % | | | 2.76 | % |
| Principal Amount at Period End as % of Total Residential Investment Securities | | | 89.67 | % | | | 83.46 | % |
| Interest-Only Residential Investment Securities: | | | | | | | | |
| Notional Amount | | $ | 8,193,820 | | | $ | 8,997,175 | |
| Net Premium | | | 1,339,825 | | | | 1,451,321 | |
| Amortized Cost | | | 1,339,825 | | | | 1,451,321 | |
| Amortized Cost/Notional Amount | | | 16.35 | % | | | 16.13 | % |
| Carrying Value | | | 1,141,407 | | | | 1,257,385 | |
| Carrying Value/Notional Amount | | | 13.93 | % | | | 13.98 | % |
| Weighted Average Coupon Rate | | | 3.56 | % | | | 3.82 | % |
| Weighted Average Yield | | | 5.29 | % | | | 5.40 | % |
(1) Excludes interest-only mortgage-backed securities.
(2) Excludes non-Agency mortgage-backed securities and CRT securities as this attribute is not applicable to these asset classes.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
The tables below summarize certain characteristics of our Residential Credit portfolio at September 30, 2017.
| By Sector Product | |
| Product | | Market Value | | | Coupon | | | Credit Enhancement | | | 60+ Delinquencies | | | 3M VPR (1) | |
| (dollars in thousands) | |
| Alt-A | | $ | 179,725 | | | | 4.43 | % | | | 11.39 | % | | | 12.29 | % | | | 12.32 | % |
| Prime | | | 220,641 | | | | 4.43 | % | | | 1.15 | % | | | 9.42 | % | | | 16.33 | % |
| Prime Interest-Only | | | 912 | | | | 0.10 | % | | | — | | | | 3.91 | % | | | 19.96 | % |
| Subprime | | | 567,890 | | | | 2.57 | % | | | 20.30 | % | | | 19.36 | % | | | 7.44 | % |
| Prime Jumbo (>=2010 Vintage) | | | 134,171 | | | | 3.59 | % | | | 14.11 | % | | | 0.05 | % | | | 10.03 | % |
| Prime Jumbo (>=2010 Vintage) Interest-Only | | | 18,623 | | | | 0.46 | % | | | — | | | | — | | | | 8.73 | % |
| Re-Performing Loan Securitizations | | | 50,289 | | | | 3.99 | % | | | 47.97 | % | | | 27.75 | % | | | 6.27 | % |
| Agency Credit Risk Transfer | | | 544,105 | | | | 5.18 | % | | | 1.25 | % | | | 0.18 | % | | | 11.46 | % |
| Private Label Credit Risk Transfer | | | 38,833 | | | | 7.19 | % | | | 6.44 | % | | | 2.30 | % | | | 14.61 | % |
| Non-Performing Loan Securitizations | | | 54,984 | | | | 4.39 | % | | | 52.83 | % | | | 70.06 | % | | | 2.93 | % |
| Total/Weighted Average | | $ | 1,810,173 | | | | 2.44 | % | | | 7.15 | % | | | 7.23 | % | | | 10.87 | % |
(1) Represents the 3 month voluntary prepayment rate (or VPR).
| Market Value By Sector and Payment Structure | |
| Product | | Senior | | | Subordinate | | | Total | |
| (dollars in thousands) | |
| Alt-A | | $ | 101,654 | | | $ | 78,071 | | | $ | 179,725 | |
| Prime | | | 26,759 | | | | 193,882 | | | | 220,641 | |
| Prime Interest-Only | | | 912 | | | | — | | | | 912 | |
| Subprime | | | 250,955 | | | | 316,935 | | | | 567,890 | |
| Prime Jumbo (>=2010 Vintage) | | | 107,539 | | | | 26,632 | | | | 134,171 | |
| Prime Jumbo (>=2010 Vintage) Interest-Only | | | 18,623 | | | | — | | | | 18,623 | |
| Re-Performing Loan Securitizations | | | 50,289 | | | | — | | | | 50,289 | |
| Agency Credit Risk Transfer | | | — | | | | 544,105 | | | | 544,105 | |
| Private Label Credit Risk Transfer | | | — | | | | 38,833 | | | | 38,833 | |
| Non-Performing Loan Securitizations | | | 47,147 | | | | 7,837 | | | | 54,984 | |
| Total/Weighted Average | | $ | 603,878 | | | $ | 1,206,295 | | | $ | 1,810,173 | |
| Market Value By Sector and Bond Coupon | |
| Product | | ARM | | | Fixed | | | Floater | | | Interest-Only | | | Total | |
| (dollars in thousands) | |
| Alt-A | | $ | 52,029 | | | $ | 99,846 | | | $ | 27,850 | | | $ | — | | | $ | 179,725 | |
| Prime | | | 114,435 | | | | 106,206 | | | | — | | | | — | | | | 220,641 | |
| Prime Interest-Only | | | — | | | | — | | | | — | | | | 912 | | | | 912 | |
| Subprime | | | — | | | | 86,179 | | | | 481,711 | | | | — | | | | 567,890 | |
| Prime Jumbo (>=2010 Vintage) | | | — | | | | 134,171 | | | | — | | | | — | | | | 134,171 | |
| Prime Jumbo (>=2010 Vintage) Interest-Only | | | — | | | | — | | | | — | | | | 18,623 | | | | 18,623 | |
| Re-Performing Loan Securitizations | | | — | | | | 50,289 | | | | — | | | | — | | | | 50,289 | |
| Agency Credit Risk Transfer | | | — | | | | — | | | | 544,105 | | | | — | | | | 544,105 | |
| Private Label Credit Risk Transfer | | | — | | | | — | | | | 38,833 | | | | — | | | | 38,833 | |
| Non-Performing Loan Securitizations | | | — | | | | 54,984 | | | | — | | | | — | | | | 54,984 | |
| Total | | $ | 166,464 | | | $ | 531,675 | | | $ | 1,092,499 | | | $ | 19,535 | | | $ | 1,810,173 | |
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Contractual Obligations
The following table summarizes the effect on our liquidity and cash flows from contractual obligations at September 30, 2017. The table does not include the effect of net interest rate payments on our interest rate
swap agreements. The net swap payments will fluctuate based on monthly changes in the receive rate. At September 30, 2017, the interest rate swaps had a net fair value of ($594.7) million.
| | | Within One Year | | | One to Three Years | | | Three to Five Years | | | More than Five Years | | | Total | |
| | | (dollars in thousands) | |
| Repurchase agreements | | $ | 67,473,026 | | | $ | 1,957,242 | | | $ | — | | | $ | — | | | $ | 69,430,268 | |
Interest expense on repurchase agreements (1) | | | 178,084 | | | | 11,945 | | | | — | | | | — | | | | 190,029 | |
| Other secured financing | | | 6,886 | | | | 91,885 | | | | 3,614,485 | | | | — | | | | 3,713,256 | |
Interest expense on other secured financing (1) | | | 51,461 | | | | 102,248 | | | | 13,575 | | | | — | | | | 167,284 | |
| Securitized debt of consolidated VIEs (principal) | | | — | | | | — | | | | — | | | | 3,287,374 | | | | 3,287,374 | |
| Interest expense on securitized debt of consolidated VIEs | | | 61,366 | | | | 122,732 | | | | 122,732 | | | | 67,376 | | | | 374,206 | |
| Mortgages payable (principal) | | | 2,311 | | | | 23,375 | | | | — | | | | 289,125 | | | | 314,811 | |
| Interest expense on mortgages payable | | | 13,282 | | | | 37,874 | | | | 37,119 | | | | 11,352 | | | | 99,627 | |
| Long-term operating lease obligations | | | 3,267 | | | | 7,129 | | | | 7,712 | | | | 11,907 | | | | 30,015 | |
| Total | | $ | 67,789,683 | | | $ | 2,354,430 | | | $ | 3,795,623 | | | $ | 3,667,134 | | | $ | 77,606,870 | |
(1) Interest expense on repurchase agreements and other secured financing calculated based on rates at September 30, 2017.
In the coming periods, we expect to continue to finance our Residential Investment Securities in a manner that is largely consistent with our current operations via repurchase agreements. We may use FHLB Des Moines advances, securitization structures, mortgages payable or other term financing structures to finance certain of our assets. During the nine months ended September 30, 2017, we received $9.0 billion from principal repayments and $11.6 billion in cash from disposal of Residential Investment Securities, respectively. During the nine months ended September 30, 2016, we received $8.6 billion from principal repayments and $8.7 billion in cash from disposal of Residential Investment Securities.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships which would have been established for the sole purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
We have limited future funding commitments related to certain of our unconsolidated joint ventures. In addition, we have provided customary non-recourse carve-out and environmental guarantees (or underlying indemnities with respect thereto) with respect to mortgage loans held by subsidiaries of these unconsolidated joint ventures. We believe that the likelihood of making any payments under these guarantees is remote, and have not accrued a related liability at September 30, 2017.
Capital Management
Maintaining a strong balance sheet that can support the business even in times of economic stress and market volatility is of critical importance to our business strategy. A strong and robust capital position is essential to executing our investment strategy. Our capital strategy is predicated on a strong capital position, which enables us to execute our investment strategy regardless of the market environment.
Our Internal Capital Adequacy Assessment Program (or ICAAP) framework supports capital measurement, and is integrated within the overall risk governance framework. The ICAAP framework is designed to align capital measurement with our risk appetite.
Our capital policy defines the parameters and principles supporting a comprehensive capital management practice, including processes that effectively identify, measure and monitor risks impacting capital adequacy. Our capital assessment process considers the precision in risk measures as well as the volatility of exposures and the relative activities producing risk. Parameters used in modeling economic capital must align with our risk appetite.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
The major risks impacting capital are liquidity, investment/market, credit, counterparty, operational and compliance, regulatory and legal risks. For further discussion of the risks we are subject to, please see Part I, Item 1A. “Risk Factors” in our most recent Annual Report on Form 10-K and Item 1A. “Risk Factors” in quarterly reports on Form 10-Q.
Capital requirements are based on maintaining levels above approved limits, ensuring the quality of our capital appropriately reflects our asset mix, market and funding structure. As such we use a complement of capital metrics and related threshold levels to measure and analyze our capital from a magnitude and composition perspective. Our policy is to maintain an appropriate amount of available financial resources over the aggregate economic capital requirements.
Available Financial Resources is the actual capital held to protect against the unexpected losses measured in our capital management process and may include:
| ▪ | Common and preferred equity |
| ▪ | Other forms of equity-like capital |
| ▪ | Surplus credit reserves over expected losses |
| ▪ | Other loss absorption instruments |
In the event we fall short of our internal limits, we will consider appropriate actions which may include asset sales, changes in asset mix, reductions in asset purchases or originations, issuance of capital or other capital enhancing or risk reduction strategies.
Stockholders’ Equity
The following table provides a summary of total stockholders’ equity at September 30, 2017 and December 31, 2016:
| | | September 30, 2017 | | | December 31, 2016 | |
| Stockholders’ Equity: | | (dollars in thousands) | |
| 7.875% Series A Cumulative Redeemable Preferred Stock | | $ | — | | | $ | 177,088 | |
| 7.625% Series C Cumulative Redeemable Preferred Stock | | | 290,514 | | | | 290,514 | |
| 7.50% Series D Cumulative Redeemable Preferred Stock | | | 445,457 | | | | 445,457 | |
| 7.625% Series E Cumulative Redeemable Preferred Stock | | | 287,500 | | | | 287,500 | |
| 6.95% Series F Cumulative Redeemable Preferred Stock | | | 696,910 | | | | — | |
| Common stock | | | 10,881 | | | | 10,189 | |
| Additional paid-in capital | | | 16,377,805 | | | | 15,579,342 | |
| Accumulated other comprehensive income (loss) | | | (640,149 | ) | | | (1,085,893 | ) |
| Accumulated deficit | | | (3,320,160 | ) | | | (3,136,017 | ) |
| Total stockholders’ equity | | $ | 14,148,758 | | | $ | 12,568,180 | |
Common and Preferred Stock
The following table provides a summary of option and direct purchase activity for the periods presented:
| | | Options Exercised | | | Aggregate Exercise Price | | | Shares Issued Through Direct Purchase | | | Amount Raised from Direct Purchase and Dividend Reinvestment Program | |
| For the Nine Months Ended: | | (dollars in thousands) | |
| September 30, 2017 | | | — | | | $ | — | | | | 169,000 | | | $ | 1,949 | |
| September 30, 2016 | | | — | | | $ | — | | | | 172,000 | | | $ | 1,795 | |
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
During the three months ended September 30, 2017, we closed a public offering of an original issuance of 60,000,000 shares of common stock for gross proceeds of approximately $709.8 million before deducting estimated offering expenses. In connection with the offering, we granted the underwriters a thirty-day option to purchase up to an additional 9,000,000 shares of common stock, which the underwriters exercised in full resulting in an additional $106.5 million in gross proceeds before deducting estimated offering expenses.
During the three months ended September 30, 2017, we issued 28,800,000 shares of our 6.95% Series F Preferred Stock, liquidation preference of $25.00 per share, for gross proceeds of $720.0 million before deducting the underwriting discount and other estimated offering expenses. The Series F Preferred Stock is redeemable at $25.00 per share plus accrued and unpaid dividends (whether or not declared) exclusively at our option commencing from and including the original issue date to, but excluding September 30, 2022, at a fixed rate equal to 6.95% per annum of the $25.00 liquidation preference, and from and including September 30, 2022, at a floating rate equal to three-month LIBOR plus a spread of 4.993% per annum.
In August 2015, our Board authorized the repurchase of up to $1.0 billion of our outstanding common shares through December 31, 2016. During the nine months ended September 30, 2016, we repurchased 11,132,226 shares of our common stock under this repurchase program for an aggregate amount of $102.7 million.
In March 2012, we entered into six separate Distribution Agency Agreements (or Distribution Agency Agreements) with each of Merrill Lynch; Pierce, Fenner & Smith Incorporated; Credit Suisse Securities (USA) LLC; Goldman, Sachs & Co.; J.P. Morgan Securities LLC; Morgan Stanley & Co. LLC; and RCap Securities, Inc. (or RCap) (together, the Agents). Pursuant to the terms of the Distribution Agency Agreements, we may sell from time to time through the Agents, as our sales agents, up to 125,000,000 shares of our common stock. We did not make any sales under the Distribution Agency Agreements during the nine months ended September 30, 2017 or 2016.
Leverage and Capital
We believe that it is prudent to maintain conservative debt-to-equity and economic leverage ratios as there continues to be volatility in the mortgage and credit markets. Our capital policy governs our capital and leverage position including setting limits. Based on the guidelines, we generally expect to maintain an economic leverage ratio of less than 10:1. Our actual economic leverage ratio varies from time to time based upon various factors, including our management’s opinion of the level of risk of our assets and liabilities, our liquidity position, our level of unused borrowing capacity, the availability of credit, over-collateralization levels required by lenders when we pledge assets to secure borrowings and our assessment of domestic and international market conditions.
Our debt-to-equity ratio at September 30, 2017 and December 31, 2016 was 5.4:1 and 5.8:1, respectively. Our economic leverage ratio, which is computed as the sum of recourse debt, TBA derivative notional outstanding and net forward purchases of investments divided by total equity, at September 30, 2017 and December 31, 2016 was 6.9:1 and 6.4:1, respectively. Our capital ratio, which represents our ratio of stockholders’ equity to total assets (inclusive of total market value of TBA derivatives), was 12.3% and 13.1% at September 30, 2017 and December 31, 2016, respectively.
Risk Management
We are subject to a variety of risks in the ordinary conduct of our business. The effective management of these risks is of critical importance to the overall success of Annaly. The objective of our risk management framework is to measure, monitor and manage these risks. Our risk management framework is intended to facilitate a holistic, enterprise wide view of risk.
We have built a strong and collaborative risk management culture throughout Annaly focused on awareness which ensures the key risks are understood and managed appropriately. Each employee of our Manager is accountable for monitoring and managing risk within their area of responsibility.
Risk Appetite
We maintain a firm-wide risk appetite statement which defines the types and levels of risk we are willing to take in order to achieve our business objectives, and reflects our risk management philosophy. We only engage in risk activities based on our core expertise that aim to enhance value for our stockholders. Our activities focus on capital preservation and income generation through proactive portfolio management, supported by a conservative liquidity and leverage posture. The risk appetite statement provides key parameters to guide our risk management activities:
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
| Portfolio Composition | | We will maintain a portfolio comprised of target assets approved by our Board and in accordance with our capital allocation policy. |
| Leverage | | We will operate at an economic leverage ratio no greater than 10:1. |
| Liquidity Risk | | We will seek to maintain an unencumbered asset portfolio sufficient to meet our liquidity needs under adverse market conditions. |
| Interest Rate Risk | | We will seek to manage interest rate risk to protect the portfolio from adverse rate movements utilizing derivative instruments targeting both income and capital preservation. |
| Credit Risk | | We will seek to manage credit risk by making investments which conform within our specific investment policy parameters and optimize risk-adjusted returns. |
| Capital Preservation | | We will seek to protect our capital base through disciplined risk management practices. |
| Compliance | | We will comply with regulatory requirements needed to maintain our REIT status and our exemption from registration under the Investment Company Act. |
Governance
Risk management begins with our Board, through the review and oversight of the risk management framework, and executive management, through the ongoing formulation of risk management practices and related execution in managing risk. The Board exercises its oversight of risk management primarily through the Board Risk Committee (or BRC) and Board Audit Committee (or BAC). The BRC is responsible for oversight of our risk governance structure, risk management and risk assessment guidelines and policies, our risk appetite and our capital, liquidity and funding practices. The BAC is responsible for oversight of the quality and integrity of our accounting, internal controls and financial reporting practices, including independent auditor selection, evaluation and review, and oversight of the internal audit function.
Risk assessment and risk management are the responsibility of our management. A series of management committees have oversight or decision-making responsibilities for risk management activities. Membership of these committees is reviewed regularly to ensure the appropriate personnel are engaged in the risk management process. Four primary management committees have been established to provide a comprehensive framework for risk management. The management committees responsible for our risk management include the Enterprise Risk Committee (or ERC), Asset and Liability Committee (or ALCO), Investment Committee and the Financial Reporting and
Disclosure Committee (or FRDC). Each of these committees reports to our management Operating Committee which is responsible for oversight and management of our operations including oversight and approval authority over all aspects of our enterprise risk management.
Description of Risks
We are subject to a variety of risks due to the business we operate. Risk categories are an important component of a robust enterprise wide risk management framework.
We have identified the following primary categories that we utilize to identify, assess, measure and monitor risk.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
| Risk | | Description |
| Liquidity Risk | | Risk to earnings, capital or business arising from our inability to meet our obligations when they come due without incurring unacceptable losses because of inability to liquidate assets or obtain adequate funding. |
| Investment/Market Risk | | Risk to earnings, capital or business resulting in the decline in value of our assets or an increase in the costs of financing caused by changes in market variables, such as interest rates, which affect the values of investment securities and other investment instruments. |
| Credit Risk | | Risk to earnings, capital or business resulting from an obligor’s failure to meet the terms of any contract or otherwise failure to perform as agreed. This risk is present in lending, and investing activities. |
| Counterparty Risk | | Risk to earnings, capital or business resulting from a counterparty’s failure to meet the terms of any contract or otherwise failure to perform as agreed. This risk is present in funding and hedging activities. |
| Operational Risk | | Risk to earnings, capital, reputation or business arising from inadequate or failed internal processes or systems, human factors or external events. Model risk is included in operational risk. |
| Compliance, Regulatory and Legal Risk | | Risk to earnings, capital, reputation or conduct of business arising from violations of, or nonconformance with internal and external applicable rules and regulations, losses resulting from lawsuits or adverse judgments, or from changes in the regulatory environment that may impact our business model. |
Liquidity Risk Management
Our liquidity risk management strategy is designed to ensure the availability of sufficient resources to support our business and meet our financial obligations under
both normal and adverse market and business environments. Our liquidity risk management practices consist of the following primary elements:
| Element | | Description |
| Funding | | Availability of diverse and stable sources of funds. |
| Excess Liquidity | | Excess liquidity primarily in the form of unencumbered assets. |
| Maturity Profile | | Diversity and tenor of liabilities and modest use of leverage. |
| Stress Testing | | Scenario modeling to measure the resiliency of our liquidity position. |
| Liquidity Management Policies | | Comprehensive policies including monitoring, risk limits and an escalation protocol. |
Funding
Our primary financing sources are repurchase agreements provided through counterparty arrangements and through RCap, other secured financing including funding from the Federal Home Loan Bank (or FHLB), securitized debt, mortgages, credit facilities, note sales and various forms of equity. We maintain excess liquidity through high quality assets.
We conservatively manage our repurchase agreement funding position through a variety of methods including diversity, breadth and depth of counterparties and maintaining a staggered and longer-term maturity profile.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Additionally, RCap provides direct access to third party funding as a FINRA member broker-dealer. RCap borrows funds through the General Collateral Finance Repo service offered by the Fixed Income Clearing Corporation (or FICC), with FICC acting as the central counterparty. RCap may also borrow funds through other repurchase arrangements.
To reduce our liquidity risk we maintain a laddered approach to our repurchase agreements. At September 30, 2017, the weighted average days to maturity was 65 days.
Our repurchase agreements generally provide that in the event of a margin call we must provide additional securities or cash on the same business day that a margin call is made. Should prepayment speeds on the mortgages underlying our Agency and Residential mortgage-backed securities and/or market interest rates or other factors move suddenly and cause declines in the market value of assets posted as collateral, resulting margin calls may cause an adverse change in our liquidity position.
We maintain access to FHLB funding through our captive insurance subsidiary Truman. We finance eligible Agency, residential credit and commercial investments through the FHLB. A rule from the Federal Housing Finance Agency (or FHFA) requires captive insurance companies to terminate their FHLB membership, however, given the length of its membership, Truman has been granted a five year sunset provision whereby its membership will expire in February 2021.
We utilize diverse funding sources to finance our commercial investments. Aside from FHLB funding, we may utilize credit facilities, securitization funding and, in the case of investments in commercial real estate, mortgage financing and note sales.
At September 30, 2017, we had total financial instruments and cash pledged as collateral for secured financing arrangements and interest rate swaps of $78.0 billion. The weighted average haircut was approximately 4% on repurchase agreements. The quality and character of the Residential Investment Securities and commercial real estate investments that we pledge as collateral under the repurchase agreements and interest rate swaps did not materially change at September 30, 2017 compared to December 31, 2016, and our counterparties did not materially alter any requirements, including required haircuts, related to the collateral we pledge under repurchase agreements and interest rate swaps during the three months ended September 30, 2017.
The following table presents our quarterly average and quarter-end repurchase agreement and reverse repurchase agreement balances outstanding for the periods presented:
| | Repurchase Agreements | | Reverse Repurchase Agreements |
| | Average Daily Amount Outstanding | | Ending Amount Outstanding | | Average Daily Amount Outstanding | | Ending Amount Outstanding |
| Three Months Ended: | (dollars in thousands) |
| September 30, 2017 | $ | 69,314,576 | | | $ | 69,430,268 | | | $ | 994,565 | | | $ | — | |
| June 30, 2017 | 63,191,827 | | | 62,497,400 | | | 474,176 | | | — | |
| March 31, 2017 | 64,961,511 | | | 62,719,087 | | | 1,738,333 | | | — | |
| December 31, 2016 | 64,484,326 | | | 65,215,810 | | | 1,064,130 | | | — | |
| September 30, 2016 | 63,231,246 | | | 61,784,121 | | | 1,494,022 | | | — | |
| June 30, 2016 | 54,647,175 | | | 53,868,385 | | | 1,159,341 | | | — | |
| March 31, 2016 | 55,753,041 | | | 54,448,141 | | | 1,294,505 | | | — | |
| December 31, 2015 | 57,483,870 | | | 56,230,860 | | | 214,674 | | | — | |
| September 30, 2015 | 57,102,712 | | | 56,449,364 | | | 931,522 | | | — | |
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
At September 30, 2017, the repurchase agreements and other secured financing outstanding had weighted average remaining maturities of 122 days and the following remaining maturities and weighted average rates:
| | | September 30, 2017 | |
| | | Principal Balance | | | Weighted Average Rate | | | % of Total | |
| | | (dollars in thousands) | |
| 1 day | | $ | — | | | | — | | | | — | |
| 2 to 29 days | | | 33,176,429 | | | | 1.34 | % | | | 45.4 | % |
| 30 to 59 days | | | 6,588,239 | | | | 1.34 | % | | | 9.0 | % |
| 60 to 89 days | | | 15,873,458 | | | | 1.39 | % | | | 21.7 | % |
| 90 to 119 days | | | 3,306,328 | | | | 1.40 | % | | | 4.5 | % |
Over 120 days (1) | | | 14,199,070 | | | | 1.48 | % | | | 19.4 | % |
| Total | | $ | 73,143,524 | | | | 1.38 | % | | | 100.0 | % |
(1) Approximately 8% of the total repurchase agreements and other secured financing had a remaining maturity over 1 year.
The table below presents our outstanding debt balances and associated weighted average rates and days to maturity at September 30, 2017:
| | | | | | Weighted Average Rate | | | | |
| | | Principal Balance | | | At Period End | | | For the Quarter (3) | | | Weighted Average Days to Maturity | |
| | | (dollars in thousands) | |
| Repurchase agreements | | $ | 69,430,268 | | | | 1.38 | % | | | 1.34 | % | | | 65 | |
Other secured financing (1) | | | 3,713,256 | | | | 1.49 | % | | | 1.63 | % | | | 1,190 | |
Securitized debt of consolidated VIEs (2) | | | 3,287,374 | | | | 1.87 | % | | | 1.92 | % | | | 2,150 | |
Mortgages payable (2) | | | 314,811 | | | | 4.24 | % | | | 4.34 | % | | | 2,661 | |
| Total indebtedness | | $ | 76,745,709 | | | | | | | | | | | | | |
(1) Includes advances from the Federal Home Loan Bank of Des Moines of $3.6 billion and financing under credit facilities.
(2) Non-recourse to Annaly.
(3) Determined based on estimated weighted-average lives of the underlying debt instruments.
Excess Liquidity
Our primary source of liquidity is the availability of unencumbered assets which may be provided as collateral to support additional funding needs. We target minimum thresholds of available, unencumbered assets to maintain excess liquidity. The following table illustrates our asset portfolio available to support potential collateral obligations and funding needs.
Assets are considered encumbered if pledged as collateral against an existing liability, and therefore no longer available to support additional funding. An asset is considered unencumbered if it has not been pledged or securitized. The following table also provides the carrying amount of our encumbered and unencumbered financial assets at September 30, 2017:
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
| | | Encumbered Assets | | | Unencumbered Assets | | | Total | |
| | | (dollars in thousands) | |
| Financial Assets: | | | | | | | | | |
| Cash and cash equivalents | | $ | 689,290 | | | $ | 178,550 | | | $ | 867,840 | |
Investments, at carrying value: (1) | | | | | | | | | | | | |
| Agency mortgage-backed securities | | | 74,711,243 | | | | 6,942,159 | | | | 81,653,402 | |
| Credit risk transfer securities | | | 251,077 | | | | 313,314 | | | | 564,391 | |
| Non-Agency mortgage-backed securities | | | 670,425 | | | | 555,237 | | | | 1,225,662 | |
| Residential mortgage loans | | | 723,705 | | | | 172,214 | | | | 895,919 | |
| MSRs | | | 2,693 | | | | 567,525 | | | | 570,218 | |
| Commercial real estate debt investments | | | 3,866,629 | | | | 2,481 | | | | 3,869,110 | |
| Commercial real estate debt and preferred equity, held for investment | | | 482,822 | | | | 498,926 | | | | 981,748 | |
| Corporate debt | | | 432,460 | | | | 423,650 | | | | 856,110 | |
| Total financial assets | | $ | 81,830,344 | | | $ | 9,654,056 | | | $ | 91,484,400 | |
(1) The amounts reflected in the table above are on a settlement date basis and may differ from the total positions reported on the Consolidated Statements of Financial Condition.
We maintain liquid assets in order to satisfy our current and future obligations in normal and stressed operating environments. These are held as the primary means of liquidity risk mitigation. The composition of our liquid assets is considered as well and is subject to certain parameters. The composition is monitored for concentration risk and asset type. We believe the assets we consider liquid can be readily converted into cash, through liquidation or by being used as collateral in
financing arrangements (including as additional collateral to support existing financial arrangements). Our balance sheet also generates liquidity on an on-going basis through mortgage principal and interest repayments and net earnings held prior to payment of dividends. The following table presents our liquid assets as a percentage of total assets at September 30, 2017.
| Liquid Assets | | Carrying Value (1) | |
| | | (dollars in thousands) | |
| Cash and cash equivalents | | $ | 867,840 | |
Residential Investment Securities (2) | | | 83,443,455 | |
| Residential mortgage loans | | | 895,919 | |
Commercial real estate debt investments (3) | | | 290,479 | |
| Commercial real estate debt and preferred equity, held for investment | | | 612,860 | |
| Corporate debt | | | 657,612 | |
| Total liquid assets | | $ | 86,768,165 | |
Percentage of liquid assets to carrying amount of encumbered and unencumbered financial assets (3) | | | 98.71 | % |
(1) Carrying value approximates the market value of assets. The assets listed in this table include $78.2 billion of assets that have been pledged as collateral against existing liabilities at September 30, 2017. Please refer to the Encumbered and Unencumbered Assets table for related information.
(2) The amounts reflected in the table above are on a settlement date basis and may differ from the total positions reported on the Consolidated Statements of Financial Condition.
(3) Excludes senior securitized commercial mortgage loans of consolidated VIEs carried at fair value of $3.6 billion.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Maturity Profile
We consider the profile of our assets, liabilities and derivatives when managing both liquidity risk as well as investment/market risk employing a measurement of both the maturity gap and interest rate gap.
We determine the amount of liquid assets that are required to be held by monitoring several liquidity metrics. We utilize several modeling techniques to analyze our current and potential obligations including the expected cash flows from our assets, liabilities and derivatives. The following table illustrates the expected final maturities and cash flows of our assets, liabilities and derivatives. The table is based on a static portfolio and assumes no reinvestment of asset cash flows and no future liabilities are entered into. In assessing the maturity of our assets, liabilities and off balance sheet obligations, we use the stated maturities, or our prepayment expectations for assets that exhibit prepayment characteristics. Cash and cash equivalents are included in the ‘Less than 3 Months’ maturity bucket, as they are typically held for a short period of time.
With respect to each maturity bucket, our maturity gap is considered negative when the amount of maturing liabilities exceeds the amount of maturing assets. A negative gap increases our liquidity risk as we must enter into future liabilities.
Our interest rate sensitivity gap is the difference between Interest Earning Assets and Interest Bearing Liabilities maturing or re-pricing within a given time period. Unlike the calculation of maturity gap, interest rate sensitivity gap includes the effect of our interest rate swaps. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities. A gap is considered negative when the amount of interest-rate sensitive liabilities exceeds interest-rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if assets and liabilities were perfectly matched in each maturity category. The amount of assets and liabilities utilized to compute our interest rate sensitivity gap was determined in accordance with the contractual terms of the assets and liabilities, except that adjustable-rate loans and securities are included in the period in which their interest rates are first scheduled to adjust and not in the period in which they mature. The effects of interest rate swaps, which effectively lock in our financing costs for a longer term, are also reflected in our interest rate sensitivity gap. The interest rate sensitivity of our assets and liabilities in the following table at September 30, 2017 could vary substantially based on actual prepayment experience.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
| | | Less than 3 Months | | | 3-12 Months | | | More than 1 Year to 3 Years | | | 3 Years and Over | | | Total | |
| Financial Assets: | | (dollars in thousands) | |
| Cash and cash equivalents | | $ | 867,840 | | | $ | — | | | $ | — | | | $ | — | | | $ | 867,840 | |
| Agency mortgage-backed securities (principal) | | | 1,193,505 | | | | — | | | | 874,164 | | | | 78,806,500 | | | | 80,874,169 | |
| Credit risk transfer securities (principal) | | | — | | | | — | | | | — | | | | 534,608 | | | | 534,608 | |
| Non-Agency mortgage-backed securities (principal) | | | 14,841 | | | | 60,199 | | | | 220,965 | | | | 978,866 | | | | 1,274,871 | |
| Residential mortgage loans (principal) | | | — | | | | — | | | | — | | | | 878,574 | | | | 878,574 | |
| Commercial real estate debt investments (principal) | | | — | | | | — | | | | — | | | | 3,808,225 | | | | 3,808,225 | |
| Corporate debt (principal) | | | — | | | | — | | | | 23,132 | | | | 844,979 | | | | 868,111 | |
| Commercial real estate debt and preferred equity (principal) | | | 157,384 | | | | 249,389 | | | | 464,613 | | | | 114,232 | | | | 985,618 | |
| Total financial assets - maturity | | | 2,233,570 | | | | 309,588 | | | | 1,582,874 | | | | 85,965,984 | | | | 90,092,016 | |
Effect of utilizing reset dates (1) | | | 6,807,440 | | | | 2,052,723 | | | | 2,095,171 | | | | (10,955,334 | ) | | | | |
| Total financial assets - interest rate sensitive | | $ | 9,041,010 | | | $ | 2,362,311 | | | $ | 3,678,045 | | | $ | 75,010,650 | | | $ | 90,092,016 | |
| | | | | | | | | | | | | | | | | | | | | |
| Financial Liabilities: | | | | | | | | | | | | | | | | | | | | |
| Repurchase agreements | | $ | 55,638,126 | | | $ | 11,834,900 | | | $ | 1,957,242 | | | $ | — | | | $ | 69,430,268 | |
| Other secured financing | | | 6,886 | | | | — | | | | 91,885 | | | | 3,614,485 | | | | 3,713,256 | |
| Securitized debt of consolidated VIE (principal) | | | — | | | | — | | | | — | | | | 3,287,374 | | | | 3,287,374 | |
| Total financial liabilities - maturity | | | 55,645,012 | | | | 11,834,900 | | | | 2,049,127 | | | | 6,901,859 | | | | 76,430,898 | |
Effect of utilizing reset dates (1)(2) | | | (19,626,228 | ) | | | (4,300,192 | ) | | | 6,600,208 | | | | 17,326,212 | | | | | |
| Total financial liabilities - interest rate sensitive | | $ | 36,018,784 | | | $ | 7,534,708 | | | $ | 8,649,335 | | | $ | 24,228,071 | | | $ | 76,430,898 | |
| | | | | | | | | | | | | | | | | | | | | |
| Maturity gap | | $ | (53,411,442 | ) | | $ | (11,525,312 | ) | | $ | (466,253 | ) | | $ | 79,064,125 | | | $ | 13,661,118 | |
| | | | | | | | | | | | | | | | | | | | | |
| Cumulative maturity gap | | $ | (53,411,442 | ) | | $ | (64,936,754 | ) | | $ | (65,403,007 | ) | | $ | 13,661,118 | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Interest rate sensitivity gap | | $ | (26,977,774 | ) | | $ | (5,172,397 | ) | | $ | (4,971,290 | ) | | $ | 50,782,579 | | | $ | 13,661,118 | |
| | | | | | | | | | | | | | | | | | | | | |
| Cumulative rate sensitivity gap | | $ | (26,977,774 | ) | | $ | (32,150,171 | ) | | $ | (37,121,461 | ) | | $ | 13,661,118 | | | | | |
(1) Maturity gap utilizes stated maturities, or prepayment expectations for assets that exhibit prepayment characteristics, while interest rate sensitivity gap utilizes reset dates, if applicable.
(2) Includes effect of interest rate swaps.
The methodologies we employ for evaluating interest rate risk include an analysis of our interest rate “gap,” measurement of the duration and convexity of our portfolio and sensitivities to interest rates and spreads.
Stress Testing
We utilize liquidity stress testing to ensure we have sufficient liquidity under a variety of scenarios and stresses. These stress tests assist with the management of our pool of liquid assets and influence our current and future funding plans. Our stress tests are modeled over both short term and longer time horizons. The stresses applied include market-wide and firm-specific stresses.
Liquidity Management Policies
We utilize a comprehensive liquidity policy structure to inform our liquidity risk management practices including monitoring and measurement, along with well-defined key limits. Both quantitative and qualitative targets are utilized to measure the ongoing stability and condition of the liquidity position, and include the level and composition of unencumbered assets, as well as both short-term and long-term sustainability of the funding composition under stress conditions.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
We also monitor early warning metrics designed to measure the quality and depth of liquidity sources based upon both company-specific and macro environmental conditions. The metrics assess liquidity conditions and are integrated into our escalation protocol, with various liquidity ratings influencing management actions with respect to contingency planning and potential related actions.
Investment/Market Risk Management
One of the primary risks we are subject to is investment/market risk. Changes in the level of interest rates can affect our net interest income, which is the difference between the income we earn on our Interest Earning Assets and the interest expense incurred from Interest Bearing Liabilities and derivatives. Changes in the level of interest rates and spreads can also affect the value of our securities and potential realization of gains or losses from the sale of these assets. We may utilize a variety of financial instruments, including interest rate swaps, swaptions, options, futures and other hedges, in order to limit the adverse effects of interest rates on our results. Our portfolio and the value of our portfolio, including derivatives, may be adversely affected as a result of changing interest rates and spreads.
We simulate a wide variety of interest rate scenarios in evaluating our risk. Scenarios are run to capture our sensitivity to changes in interest rates, spreads and the shape of the yield curve. We also consider the assumptions affecting our analysis such as those related to prepayments. In addition to predefined interest rate scenarios, we utilize Value-at-Risk measures to estimate potential losses in the portfolio over various time horizons utilizing various confidence levels. The following tables estimate the potential changes in economic net interest income over a twelve month period and the immediate effect on our portfolio market value (inclusive of derivative instruments), should interest rates instantaneously increase or decrease by 25, 50 or 75 basis points, and the effect of portfolio market value if mortgage option-adjusted spreads instantaneously increase or decrease by 5, 15 or 25 basis points (assuming shocks are parallel and instantaneous). All changes to income and portfolio market value are measured as percentage changes from the projected net interest income and portfolio value at the base interest rate scenario. The base interest rate scenario assumes interest rates at September 30, 2017. The net interest income simulations incorporate the interest expense effect of rate resets on liabilities and derivatives as well as the amortization expense and reinvestment of principal based on the prepayments on our securities, which varies based on the level of rates. The results assume no management actions in response to the rate or spread changes. Actual results could differ significantly from these estimates in the table below at September 30, 2017.
Change in Interest Rate (1) | | Projected Percentage Change in Economic Net Interest Income (2) | | Estimated Percentage Change in Portfolio Value (3) | | Estimated Change as a % on NAV (3)(4) |
| -75 Basis Points | | (10.8)% | | 0.4% | | 2.8% |
| -50 Basis Points | | (6.2)% | | 0.4% | | 2.9% |
| -25 Basis Points | | (2.1)% | | 0.3% | | 2.1% |
| Base Interest Rate | | — | | — | | — |
| +25 Basis Points | | 0.6% | | (0.4)% | | (3.1)% |
| +50 Basis Points | | (0.7)% | | (1.0)% | | (6.9)% |
| +75 Basis Points | | (3.0)% | | (1.6)% | | (11.4)% |
| | | | | | | |
MBS Spread Shock (1) | | Estimated Change in Portfolio Market Value | | Estimated Change as a % on NAV (3)(4) | | |
| -25 Basis Points | | 1.6% | | 11.7% | | |
| -15 Basis Points | | 1.0% | | 7.0% | | |
| -5 Basis Points | | 0.3% | | 2.3% | | |
| Base Interest Rate | | — | | — | | |
| +5 Basis Points | | (0.3)% | | (2.3)% | | |
| +15 Basis Points | | (1.0)% | | (6.9)% | | |
| +25 Basis Points | | (1.6)% | | (11.4)% | | |
| (1) | Interest rate and MBS spread sensitivity are based on results from third party models in conjunction with inputs from our internal investment professionals. Actual results could differ materially from these estimates. |
| (2) | Scenarios include Residential Investment Securities, commercial real estate investments, corporate debt, repurchase agreements, other secured financing and interest rate swaps. Economic net interest income includes interest expense on interest rate swaps. |
| (3) | Scenarios include Residential Investment Securities, residential mortgage loans, MSRs and derivative instruments. |
| (4) | NAV represents book value of equity. |
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Credit Risk Management
Key risk parameters have been established to specify our credit risk appetite. We will seek to manage credit risk by making investments which conform within the firm’s specific investment policy parameters and optimize risk-return attributes.
While we do not expect to encounter credit risk in our Agency investments, we face credit risk on the non-Agency mortgage-backed securities and CRT securities in our portfolio. In addition, we are also exposed to credit risk on residential mortgage loans, commercial real estate investments and corporate debt. MSR values may also be impacted if overall costs to service the underlying mortgage loans increase due to borrower performance. We are subject to risk of loss if an issuer
or borrower fails to perform its contractual obligations. We have established policies and procedures for mitigating credit risk, including establishing and reviewing limits for credit exposure. We will originate or purchase commercial investments that meet our comprehensive underwriting process and credit standards and are approved by the appropriate committee. Once a commercial investment is made, our ongoing surveillance process includes regular reviews, analysis and oversight of investments by our investment personnel and appropriate committee. We review credit and other risks of loss associated with each investment. Our management monitors the overall portfolio risk and determines estimates of provision for loss. Our portfolio composition at September 30, 2017 and December 31, 2016 was as follows:
| Asset Portfolio (using balance sheet values) | |
| Category | | September 30, 2017 | | | December 31, 2016 | |
| Agency mortgage-backed securities | | | 90.1 | % | | | 88.5 | % |
| Credit risk transfer securities | | | 0.6 | % | | | 0.8 | % |
| Residential mortgage loans | | | 0.9 | % | | | 0.4 | % |
| Mortgage servicing rights | | | 0.6 | % | | | 0.8 | % |
| Non-Agency mortgage-backed securities | | | 1.3 | % | | | 1.7 | % |
Commercial real estate (1)(2) | | | 5.6 | % | | | 6.9 | % |
| Corporate debt | | | 0.9 | % | | | 0.9 | % |
(1) Net of unamortized origination fees.
(2) Including commercial loans held for sale, net.
Counterparty Risk Management
Our use of repurchase and derivative agreements and trading activities create exposure to counterparty risk relating to potential losses that could be recognized if the counterparties to these agreements fail to perform their obligations under the contracts. In the event of default by a counterparty, we could have difficulty obtaining our assets pledged as collateral. A significant portion of our investments are financed with repurchase agreements by pledging our Residential Investment Securities and certain commercial real estate investments as collateral to the lender. The collateral we pledge generally exceeds the amount of the borrowings under each agreement. If the counterparty to the repurchase agreement defaults on its obligations and we are not able to recover our pledged asset, we are
at risk of losing the over-collateralization or haircut. The amount of this exposure is the difference between the amount loaned to us plus interest due to the counterparty and the fair value of the collateral pledged by us to the lender including accrued interest receivable on such collateral.
We also use interest rate swaps and other derivatives to manage interest rate risk. Under these agreements, we pledge securities and cash as collateral or settle variation margin payment as part of a margin arrangement.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
If a counterparty were to default on its obligations, we would be exposed to a loss to a derivative counterparty to the extent that the amount of our securities or cash pledged exceeded the unrealized loss on the associated derivative and we were not able to recover the excess collateral. Additionally, we would be exposed to a loss to a derivative counterparty to the extent that our unrealized gains on derivative instruments exceeded the amount of the counterparty’s securities or cash pledged to us.
We monitor our exposure to counterparties across several dimensions including by type of arrangement, collateral type, counterparty type, ratings and geography.
The following table summarizes our exposure to counterparties by geography at September 30, 2017:
| Country | | Number of Counterparties | | | Repurchase Agreement Financing | | | Interest Rate Swaps at Fair Value | | | Exposure (1) | |
| | | (dollars in thousands) | |
| North America | | | 26 | | | $ | 53,466,643 | | | $ | (220,248 | ) | | $ | 2,683,427 | |
| Europe | | | 11 | | | | 11,504,955 | | | | (374,462 | ) | | | 768,677 | |
| Asia (non-Japan) | | | 1 | | | | 254,189 | | | | — | | | | 15,738 | |
| Japan | | | 4 | | | | 4,204,481 | | | | — | | | | 243,892 | |
| Total | | | 42 | | | $ | 69,430,268 | | | $ | (594,710 | ) | | $ | 3,711,734 | |
| (1) | Represents the amount of cash and/or securities pledged as collateral to each counterparty less the aggregate of repurchase agreement financing and unrealized loss on swaps for each counterparty. |
Operational Risk Management
We are subject to operational risk in each of our business and support functions. Operational risk may arise from internal or external sources including human error, fraud, systems issues, process change, vendors, business interruptions and other external events. Model risk considers potential errors with a model’s results due to uncertainty in model parameters and inappropriate methodologies used. The result of these risks may include financial loss and reputational damage. We manage operational risk through a variety of tools including policies and procedures which cover topics such as business continuity, personal conduct and vendor management. Other tools include training on topics such as cybersecurity awareness; testing, including disaster recovery testing; systems controls, including access controls; and monitoring, which includes the use of key risk indicators. Employee level lines of defense against operational risk include proper segregation of incompatible duties, activity-level internal controls over financial reporting, the empowerment of business units to identify and mitigate operational risk sources, testing by our internal audit staff, and our overall governance framework.
Compliance, Regulatory and Legal Risk Management
Our business is organized as a REIT, and we plan to continue to meet the requirements for taxation as a REIT. The determination that we are a REIT requires an analysis of various factual matters and circumstances. Accordingly, we closely monitor our REIT status within our risk management program.
The financial services industry is highly regulated and continues to receive increasing attention from regulators, which may impact both our company as well as our business strategy. We proactively monitor the potential impact regulation may have both directly and indirectly on us. We maintain a process to actively monitor both actual and potential legal action that may affect us. Our risk management framework is designed to identify, monitor and manage these risks under the oversight of the ERC.
We currently rely on the exemption from registration provided by Section 3(c)(5)(C) of the Investment Company Act, and we plan to continue to meet the requirements for this exemption from registration. The determination that we qualify for this exemption from registration depends on various factual matters and circumstances. Accordingly, in conjunction with our legal department, we closely monitor our compliance with Section 3(c)(5)(C) within our risk management program. The monitoring of this risk is also under the oversight of the ERC.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the U.S. Commodity Futures Trading Commission (or CFTC) gained jurisdiction over the regulation of interest rate swaps. The CFTC has asserted that this causes the operators of mortgage real estate investment trusts that use swaps as part of their business model to fall within the statutory definition of Commodity Pool Operator (or CPO), and, absent relief from the Division of Swap Dealer and Intermediary Oversight or the CFTC, to register as CPOs. On December 7, 2012, as a result of numerous requests for no-action relief from the CPO registration requirement for operators of mortgage real estate investment trusts, the Division of Swap Dealer and Intermediary Oversight of the CFTC issued no-action relief entitled “No-Action Relief from the Commodity Pool Operator Registration Requirement for Commodity Pool Operators of Certain Pooled Investment Vehicles Organized as Mortgage Real Estate Investment Trusts” that permits a CPO to receive relief by filing a claim to perfect the use of the relief. A claim submitted by a CPO will be effective upon filing, so long as the claim is materially complete.
The conditions that must be met relate to initial margin and premiums requirements, net income derived annually from commodity interest positions that are not qualifying hedging transactions, marketing of interests in the mortgage real estate investment trust to the public, and identification of the entity as a mortgage real estate investment trust in its federal tax filings with the Internal Revenue Service. While we disagree with the CFTC’s position that mortgage real estate investment trusts that use swaps as part of their business model fall within the statutory definition of a CPO, we have submitted a claim for the relief set forth in the no-action relief entitled “No-Action Relief from the Commodity Pool Operator Registration Requirement for Commodity Pool Operators of Certain Pooled Investment Vehicles Organized as Mortgage Real Estate Investment Trusts” and believe we meet the criteria for such relief set forth therein.
Critical Accounting Policies and Estimates
Our critical accounting policies that require us to make significant judgments or estimates are described below. For more information on these critical accounting policies and other significant accounting policies, see “Significant Accounting Policies” in the Notes to the Consolidated Financial Statements.
Valuation of Financial Instruments
Residential Investment Securities
There is an active market for our Agency mortgage-backed securities, Agency debentures, CRT securities and non-Agency mortgage-backed securities. Since we primarily invest in securities that can be valued using actively quoted prices for actively traded assets, there is a high degree of observable inputs and less subjectivity in measuring fair value. Internal fair values are determined using quoted prices from the TBA securities market, the Treasury curve and the underlying characteristics of the individual securities, which may include coupon, periodic and life caps, reset dates and the expected life of the security. Prepayment rates are difficult to predict and are a significant estimate requiring judgment in the valuation of Agency mortgage-backed securities. All internal fair values are compared to external pricing sources and/or dealer quotes to determine reasonableness. Additionally, securities used as collateral for repurchase agreements are priced daily by counterparties to ensure sufficient collateralization, providing additional verification of our internal pricing.
Residential Mortgage Loans
There is an active market for the residential whole loans in which we invest. Since we primarily invest in residential loans that can be valued using actively quoted prices for similar assets, there is a high degree of observable inputs and minimal subjectivity in measuring fair value. Internal fair values are determined using quoted prices for similar market transactions, the Treasury curve and the underlying characteristics of the individual loans, which may include loan term, coupon, and reset dates. Prepayment rates are difficult to predict and are a significant estimate requiring judgment in the valuation of residential whole loans. All internal fair values are compared to external pricing sources to determine reasonableness.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Commercial Real Estate Investments
The fair value of commercial mortgage-backed securities classified as available-for-sale is determined based upon quoted prices of similar assets in recent market transactions and requires the application of judgment due to differences in the underlying collateral. These securities must also be evaluated for other-than-temporary impairment if the fair value of the security is lower than its amortized cost. Determining whether there is an other-than-temporary impairment may require us to exercise significant judgment and make estimates to determine expected cash flows incorporating assumptions such as changes in interest rates and loss expectations.
For commercial real estate loans and preferred equity investments classified as held for investment, we apply significant judgment in evaluating the need for a loss reserve. Estimated net recoverable value of the commercial real estate loans and preferred equity investments and other factors such as the fair value of any collateral, the amount and status of senior debt, the prospects of the borrower and the competitive landscape where the borrower conducts business must be considered in determining the allowance for loan losses. For commercial real estate loans held for sale, significant judgment may need to be applied in determining fair value of the loans and whether a valuation allowance is necessary. Factors that may need to be considered to determine fair value of a loan held for sale include the borrower’s credit quality, liquidity and other market factors and the fair value of the underlying collateral.
Interest Rate Swaps
We use the overnight indexed swap (or OIS) curve as an input to value substantially all of our uncleared interest rate swaps. We believe using the OIS curve, which reflects the interest rate typically paid on cash collateral, enables us to most accurately determine the fair value of uncleared interest rate swaps. Consistent with market practice, we exchange collateral (also called margin) or settle variation margin payments based on the fair values of our interest rate swaps. Through this margining process, we may be able to compare our recorded fair value with the fair value calculated by the counterparty or derivatives clearing organization, providing additional verification of our recorded fair value of the uncleared interest rate swaps. We value our cleared interest rate swaps using the prices provided by the derivatives clearing organization.
Revenue Recognition
Interest income from coupon payments is accrued based on the outstanding principal amounts of the Residential Investment Securities and their contractual terms. Premiums and discounts associated with the purchase of the Residential Investment Securities are amortized or accreted into interest income over the projected lives of the securities using the interest method. We use third-party model and market information to project prepayment speeds. Our prepayment speed projections incorporate underlying loan characteristics (i.e., coupon, term, original loan size, original loan-to-value ratio, etc.) and market data, including interest rate and home price index forecasts and expert judgment. Prepayment speeds vary according to the type of investment, conditions in the financial markets and other factors, and cannot be predicted with any certainty. Changes to model assumptions, including interest rates and other market data, as well as periodic revisions to the model will cause changes in the results. Adjustments are made for actual prepayment activity as it relates to calculating the effective yield. Gains or losses on sales of Residential Investment Securities are recorded on trade date based on the specific identification method.
Consolidation of Variable Interest Entities
Determining whether an entity has a controlling financial interest in a VIE requires significant judgment related to assessing the purpose and design of the VIE and determination of the activities that most significantly impact its economic performance. We must also identify explicit and implicit variable interests in the entity and consider our involvement in both the design of the VIE and its ongoing activities. To determine whether consolidation of the VIE is required, we must apply judgment to assess whether we have the power to direct the most significant activities of the VIE and whether we have either the rights to receive benefits or the obligation to absorb losses that could be potentially significant to the VIE.
Use of Estimates
The use of 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
A
Adjustable-Rate Loan / Security
A loan / security on which interest rates are adjusted at regular intervals according to predetermined criteria. The adjustable interest rate is tied to an objective, published interest rate index.
Agency
Refers to a federally chartered corporation, such as the Federal National Mortgage Association, or the Federal Home Loan Mortgage Corporation, or an agency of the U.S. Government, such as the Government National Mortgage Association.
Agency Debentures
Debt issued by a federal agency or a government-sponsored enterprise (GSE) for financing purposes. These types of debentures are not backed by collateral, but by the integrity and credit-worthiness of the issuer. Agency debentures issued by a GSE are backed only by that GSE’s ability to pay. The callable feature allows the Agency to repay the bond prior to maturity.
Agency Mortgage-Backed Securities
Refers to residential mortgage-backed securities that are issued or guaranteed by an Agency.
Amortization
Liquidation of a debt through installment payments. Amortization also refers to the process of systematically reducing a recognized asset or liability (e.g., a purchase premium or discount for a debt security) with an offset to earnings.
Average Life
On a mortgage-backed security, the average time to receipt of each dollar of principal, weighted by the amount of each principal prepayment, based on prepayment assumptions.
B
Basis Point (BP)
One hundredth of one percent, used in expressing differences in interest rates. One basis point is 0.01% of yield. For example, a bond’s yield that changed from 3.00% to 3.50% would be said to have moved 50 basis points.
Benchmark
A bond or an index referencing a basket of bonds whose terms are used for comparison with other bonds of similar maturity. The global financial market typically looks to U.S. Treasury securities as benchmarks.
Beneficial Owner
One who benefits from owning a security, even if the security’s title of ownership is in the name of a broker or bank.
B-Note
Subordinate mortgage notes and/or subordinate mortgage loan participations.
B-Piece
The most subordinate commercial mortgage-backed security bond class.
Board
Refers to the board of directors of Annaly.
Bond
The written evidence of debt, bearing a stated rate or stated rates of interest, or stating a formula for determining that rate, and maturing on a date certain, on which date and upon presentation a fixed sum of money plus interest (usually represented by interest coupons attached to the bond) is payable to the holder or owner. Bonds are long-term securities with an original maturity of greater than one year. For purposes of computations tied in to “per bond,” a $1,000 increment of an issue is used (no matter what the actual denominations are).
Book Value Per Share
Calculated by summing common stock, additional paid-in capital, accumulated other comprehensive income (loss) and accumulated deficit and dividing that number by the total common shares outstanding.
Broker
Generic name for a securities firm engaged in both buying and selling securities on behalf of customers or its own account.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
C
Capital BufferIncludes unencumbered financial assets which can be either sold or utilized as collateral to meet liquidity needs.
Capital Ratio
Calculated as total stockholders’ equity divided by total assets inclusive of outstanding market value of TBA positions and exclusive of consolidated VIEs associated with B-Piece commercial mortgage-backed securities.
Carry
The amount an asset earns over its hedging and financing costs. A positive carry happens when the rate on the securities being financed is greater than the rate on the funds borrowed. A negative carry is when the rate on the funds borrowed is greater than the rate on the securities that are being financed.
Collateral
Securities, cash or property pledged by a borrower or party to a derivative contract to secure payment of a loan or derivative. If the borrower fails to repay the loan or defaults under the derivative contract, the secured party may take ownership of the collateral.
Collateralized Mortgage Obligation (CMO)
A multiclass bond backed by a pool of mortgage pass-through securities or mortgage loans.
Commodity Futures Trading Commission (CFTC)
An independent U.S. federal agency established by the Commodity Futures Trading Commission Act of 1974. The CFTC regulates the swaps, commodity futures and options markets. Its goals include the promotion of competitive and efficient futures markets and the protection of investors against manipulation, abusive trade practices and fraud.
Commercial Mortgage-Backed Security (CMBS)
Securities collateralized by a pool of mortgages on commercial real estate in which all principal and interest from the mortgages flow to certificate holders in a defined sequence or manner.
Constant Prepayment Rate (CPR)
The percentage of outstanding mortgage loan principal that prepays in one year, based on the annualization of the Single Monthly Mortality, which reflects the outstanding mortgage loan principal that prepays in one month.
Convertible Securities
Securities which may be converted into shares of another security under stated terms, often into the issuing company’s common stock.
Convexity
A measure of the change in a security’s duration with respect to changes in interest rates. The more convex a security is, the more its duration will change with interest rate changes.
Core Earnings and Core Earnings Per Average Common Share
Non-GAAP measure that is defined as net income (loss) excluding gains or losses on disposals of investments
and termination of interest rate swaps, unrealized gains or losses on interest rate swaps and investments measured at fair value through earnings, net gains (losses) on trading assets, impairment losses, net income (loss) attributable to noncontrolling interest, corporate acquisition related expenses and certain other non-recurring gains or losses, and inclusive of TBA dollar roll income (a component of Net gains (losses) on trading assets) and realized amortization of MSRs. Core earnings per average common share is calculated by dividing core earnings by average basic common shares for the period.
Corporate Debt
Non-government debt instruments issued by corporations. Long-term corporate debt can be issued as bonds or loans.
Counterparty
One of two entities in a transaction. For example, in the bond market a counterparty can be a state or local government, a broker-dealer or a corporation.
Coupon
The interest rate on a bond that is used to compute the amount of interest due on a periodic basis.
Credit and Counterparty Risk
Risk to earnings, capital or business, resulting from an obligor’s or counterparty’s failure to meet the terms of any contract or otherwise failure to perform as agreed. Credit and counterparty risk is present in lending, investing, funding and hedging activities.
Credit Derivatives
Derivative instruments that have one or more underlyings related to the credit risk of a specified entity (or group of entities) or an index that exposes the seller to potential loss from specified credit-risk related events. An example is credit derivatives referencing the commercial mortgage-backed securities index.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Credit Risk Transfer (CRT) Securities
Credit Risk Transfer securities are risk sharing transactions issued by Fannie Mae and Freddie Mac and similarly structured transactions arranged by third party market participants. The securities issued in the CRT sector are designed to synthetically transfer mortgage credit risk from Fannie Mae, Freddie Mac and/or third parties to private investors.
Current Face
The current remaining monthly principal on a mortgage security. Current face is computed by multiplying the original face value of the security by the current principal balance factor.
D
DealerPerson or organization that underwrites, trades and sells securities, e.g., a principal market-maker in securities.
Default Risk
Possibility that a bond issuer will fail to pay principal or interest when due.
Derivative
A financial product that derives its value from the price, price fluctuations and price expectations of an underlying instrument, index or reference pool (e.g. futures contracts, options, interest rate swaps, interest rate swaptions and certain to-be-announced securities).
Discount Price
When the dollar price is below face value, it is said to be selling at a discount.
Duration
The weighted maturity of a fixed-income investment’s cash flows, used in the estimation of the price sensitivity of fixed-income securities for a given change in interest rates.
E
Economic CapitalA measure of the risk a firm is subject to. It is the amount of capital a firm needs as a buffer to protect against risk. It is a probabilistic measure of potential future losses at a given confidence level over a given time horizon.
Economic Interest Expense
Non-GAAP financial measure that is composed of GAAP interest expense adjusted for realized gains or losses on interest rate swaps used to hedge cost of funds.
Economic Leverage Ratio (Economic Debt-to-Equity Ratio)
Calculated as the sum of recourse debt, TBA derivative notional outstanding and net forward purchases of investments divided by total equity.
Economic Net Interest Income
Non-GAAP financial measure that is composed of GAAP net interest income adjusted for realized gains or losses on interest rate swaps used to hedge cost of funds.
Encumbered Assets
Assets on the company’s balance sheet which have been pledged as collateral against a liability.
Eurodollar
A U.S. dollar deposit held in Europe or elsewhere outside the United States.
F
Face AmountThe par value (i.e., principal or maturity value) of a security appearing on the face of the instrument.
Factor
A decimal value reflecting the proportion of the outstanding principal balance of a mortgage security, which changes over time, in relation to its original principal value.
Fannie Mae
Federal National Mortgage Association.
Federal Deposit Insurance Corporation (FDIC)
An independent agency created by the U.S. Congress to maintain stability and public confidence in the nation’s financial system by insuring deposits, examining and supervising financial institutions for safety and soundness and consumer protection, and managing receiverships.
Federal Funds Rate
The interest rate charged by banks on overnight loans of their excess reserve funds to other banks.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Federal Home Loan Banks (FHLB)
U.S. Government-sponsored banks that provide reliable liquidity to member financial institutions to support housing finance and community investment.
Federal Housing Financing Agency (FHFA)
The FHFA is an independent regulatory agency that oversees vital components of the secondary mortgage market including Fannie Mae, Freddie Mac and the Federal Home Loan Banks.
Financial Industry Regulatory Authority (FINRA)
FINRA is a non-governmental organization tasked with regulating all business dealings conducted between dealers, brokers and all public investors.
Fixed-Rate Mortgage
A mortgage featuring level monthly payments, determined at the outset, which remain constant over the life of the mortgage.
Fixed Income Clearing Corporation (FICC)
The FICC is an agency that deals with the confirmation, settlement and delivery of fixed-income assets in the U.S. The agency ensures the systematic and efficient settlement of U.S. Government securities and mortgage-backed security transactions in the market.
Floating Rate Bond
A bond for which the interest rate is adjusted periodically according to a predetermined formula, usually linked to an index.
Floating Rate CMO
A CMO tranche which pays an adjustable rate of interest tied to a representative interest rate index such as the LIBOR, the Constant Maturity Treasury or the Cost of Funds Index.
Freddie Mac
Federal Home Loan Mortgage Corporation.
Futures Contract
A legally binding agreement to buy or sell a commodity or financial instrument in a designated future month at a price agreed upon at the initiation of the contract by the buyer and seller. Futures contracts are standardized according to the quality, quantity, and delivery time and location for each commodity. A futures contract differs from an option in that an option gives one of the counterparties a right and the other an obligation to buy or sell, while a futures contract represents an obligation of both counterparties, one to deliver and the other to accept delivery. A futures contract is part of a class of financial instruments called derivatives.
G
GAAPU.S. generally accepted accounting principles.
Ginnie Mae
Government National Mortgage Association.
H
Hedge
An investment made with the intention of minimizing the impact of adverse movements in interest rates or securities prices.
I
In-the-Money
Description for an option that has intrinsic value and can be sold or exercised for a profit; a call option is in-the-money when the strike price (execution price) is below the market price of the underlying security.
Interest Bearing Liabilities
Refers to repurchase agreements, securitized debt of consolidated VIEs, participation sold, FHLB Des Moines advances, credit facilities, U.S. Treasury securities sold, not yet purchased and securities loaned. Average Interest Bearing Liabilities is based on daily balances.
Interest Earning Assets
Refers to Residential Investment Securities, securities borrowed, U.S. Treasury securities, reverse repurchase agreements, commercial real estate debt investments, commercial real estate debt and preferred equity interests and corporate debt. Average Interest Earning Assets is based on daily balances.
Interest-Only (IO) Bond
The interest portion of mortgage, Treasury or bond payments, which is separated and sold individually from the principal portion of those same payments.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Interest Rate Risk
The risk that an investment’s value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship. As market interest rates rise, the value of current fixed income investment holdings declines. Diversifying, deleveraging and hedging techniques are utilized to mitigate this risk. Interest rate risk is a form of market risk.
Interest Rate Swap
A binding agreement between counterparties to exchange periodic interest payments on some predetermined dollar principal, which is called the notional principal amount. For example, one party will pay fixed and receive a variable rate .
Interest Rate Swaption
Options on interest rate swaps. The buyer of a swaption has the right to enter into an interest rate swap agreement at some specified date in the future. The swaption agreement will specify whether the buyer of the swaption will be a fixed-rate receiver or a fixed-rate payer.
Internal Capital Adequacy Assessment Program (ICAAP)
The ongoing assessment and measurement of risks, and the amount of capital which is necessary to hold against those risks. The objective is to ensure that a firm is appropriately capitalized relative to the risks in its business.
International Swaps and Derivatives Association (ISDA) Master Agreement
Standardized contract developed by ISDA used as an umbrella under which bilateral derivatives contracts are entered into.
Inverse IO Bond
An interest-only bond whose coupon is determined by a formula expressing an inverse relationship to a benchmark rate, such as LIBOR. As the benchmark rate changes, the IO coupon adjusts in the opposite direction. When the benchmark rate is relatively low, the IO pays a relatively high coupon payment, and vice versa.
Investment/Market Risk
Risk to earnings, capital or business resulting in the decline in value of our assets caused from changes in market variables, such as interest rates, which affect the values of Residential Investment Securities and other investment instruments.
Investment Company Act
Refers to the Investment Company Act of 1940 as amended.
L
Leverage
The use of borrowed money to increase investing power and economic returns.
Leverage Ratio (Debt-to-Equity Ratio)
Calculated as total debt to total stockholders’ equity. For purposes of calculating this ratio total debt includes repurchase agreements, other secured financing, securitized debt of consolidated VIEs, loan participation sold and mortgages payable which are non-recourse to us, subject to customary carveouts.
LIBOR (London Interbank Offered Rate)
The rate banks charge each other for short-term Eurodollar loans. LIBOR is frequently used as the base for resetting rates on floating-rate securities and the floating-rate legs of interest rate swaps.
Liquidity Risk
Risk to earnings, capital or business arising from our inability to meet our obligations when they come due without incurring unacceptable losses because of inability to liquidate assets or obtain adequate funding.
Long-Term CPR
The Company’s projected prepayment speeds for certain Agency mortgage-backed securities using third-party model and market information. The Company’s prepayment speed projections incorporate underlying loan characteristics (e.g., coupon, term, original loan size, original loan-to-value ratio, etc.) and market data, including interest rate and home price index forecasts. Changes to model assumptions, including interest rates and other market data, as well as periodic revisions to the model will cause changes in the results.
Long-Term Debt
Debt which matures in more than one year.
M
Monetary Policy
Action taken by the Board of Governors of the Federal Reserve System to influence the money supply or interest rates.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Mortgage-Backed Security (MBS)
A security representing a direct interest in a pool of mortgage loans. The pass-through issuer or servicer collects the payments on the loans in the pool and “passes through” the principal and interest to the security holders on a pro rata basis.
Mortgage Loan
A mortgage loan granted by a bank, thrift or other financial institution that is based solely on real estate as security and is not insured or guaranteed by a government agency.
Mortgage Servicing Rights (MSRs)
Contractual agreements constituting the right to service an existing mortgage where the holder receives the benefits and bears the costs and risks of servicing the mortgage.
N
NAV
Net asset value.
Net Equity Yield
Calculated using GAAP net income, excluding depreciation and amortization expense, divided by average net equity.
Net Interest Income
Represents interest income earned on our portfolio investments, less interest expense paid for borrowings.
Net Interest Margin
Represents annualized economic net interest income, inclusive of interest expense on interest rate swaps used to hedge cost of funds, plus TBA dollar roll income less interest expense on interest rate swaps used to hedge TBA dollar roll transactions divided by the sum of its average Interest Earning Assets plus average outstanding TBA derivative balances.
Net Interest Spread
Calculated by taking the average yield on Interest Earning Assets minus the average cost of Interest Bearing Liabilities, including the net interest payments on interest rate swaps used to hedge cost of funds.
Non-Performing Loan (NPL)
A loan that is close to defaulting or is in default.
Notional Amount
A stated principal amount in a derivative contract on which the contract is based.
O
Operational Risk
Risk to earnings, capital, reputation or business arising from inadequate or failed internal processes or systems, human factors or external events.
Option Contract
A contract in which the buyer has the right, but not the obligation, to buy or sell an asset at a set price on or before a given date. Buyers of call options bet that a security will be worth more than the price set by the option (the strike price), plus the price they pay for the option itself. Buyers of put options bet that the security’s price will drop below the price set by the option. An option is part of a class of financial instruments called derivatives, which means these financial instruments derive their value from the worth of an underlying investment.
Original Face
The face value or original principal amount of a security on its issue date.
Out-of-the-Money
Description for an option that has no intrinsic value and would be worthless if it expired today; for a call option, this situation occurs when the strike price is higher than the market price of the underlying security; for a put option, this situation occurs when the strike price is less than the market price of the underlying security.
Over-The-Counter (OTC) Market
A securities market that is conducted by dealers throughout the country through negotiation of price rather than through the use of an auction system as represented by a stock exchange.
P
Par
Price equal to the face amount of a security; 100%.
Par Amount
The principal amount of a bond or note due at maturity. Also known as par value.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Pass-Through Security
A securitization structure where a GSE or other entity “passes” the amount collected from the borrowers every month to the investor, after deducting fees and expenses.
Pool
A collection of mortgage loans assembled by an originator or master servicer as the basis for a security. In the case of Ginnie Mae, Fannie Mae, or Freddie Mac mortgage pass-through securities, pools are identified by a number assigned by the issuing agency.
Premium
The amount by which the price of a security exceeds its principal amount. When the dollar price of a bond is above its face value, it is said to be selling at a premium.
Premium Amortization Adjustment (PAA)
The component of premium amortization representing the quarter-over-quarter change in estimated long-term CPR.
Prepayment
The unscheduled partial or complete payment of the principal amount outstanding on a mortgage loan or other debt before it is due.
Prepayment Risk
The risk that falling interest rates will lead to increased prepayments of mortgage or other loans, forcing the investor to reinvest at lower prevailing rates.
Prime Rate
The indicative interest rate on loans that banks quote to their best commercial customers.
Principal and Interest
The term used to refer to regularly scheduled payments or prepayments of principal and payments of interest on a mortgage or other security.
R
Rate Reset
The adjustment of the interest rate on a floating-rate security according to a prescribed formula.
Real Estate Investment Trust (REIT)
A special purpose investment vehicle that provides investors with the ability to participate directly in the ownership or financing of real-estate related assets by pooling their capital to purchase and manage mortgage loans and/or income property.
Recourse Debt
Debt on which the economic borrower is obligated to repay the entire balance regardless of the value of the pledged collateral. By contrast, the economic borrower’s obligation to repay non-recourse debt is limited to the value of the pledged collateral. Recourse debt consists of repurchase agreements, and other secured financing.
Reinvestment Risk
The risk that interest income or principal repayments will have to be reinvested at lower rates in a declining rate environment.
Re-Performing Loan (RPL)
A type of loan in which payments were previously delinquent by at least 90 days but have resumed.
Repurchase Agreement
The sale of securities to investors with the agreement to buy them back at a higher price after a specified time period; a form of short-term borrowing. For the party on the other end of the transaction (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement.
Residential Investment Securities
Refers to Agency mortgage-backed securities, Agency debentures, CRT securities and non-Agency mortgage-backed securities.
Residual
In a CMO, the residual is the tranche that collects any cash flow from the collateral that remains after obligations to the other tranches have been met.
Return on Average Equity
Calculated by taking earnings divided by average stockholders’ equity.
Reverse Repurchase Agreement
Refer to Repurchase Agreement. The buyer of securities effectively provides a collateralized loan to the seller.
Risk Appetite Statement
Defines the types and levels of risk we are willing to take in order to achieve our business objectives, and reflects our risk management philosophy.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
S
Secondary Market
Ongoing market for bonds previously offered or sold in the primary market.
Settlement Date
The date securities must be delivered and paid for to complete a transaction.
Short-Term Debt
Generally, debt which matures in one year or less. However, certain securities that mature in up to three years may be considered short-term debt.
Spread
When buying or selling a bond through a brokerage firm, an individual investor will be charged a commission or spread, which is the difference between the market price and cost of purchase, and sometimes a service fee. Spreads differ based on several factors including liquidity.
T
Target Assets
Includes Agency mortgage-backed securities, to-be-announced forward contracts, Agency debentures, CRT securities, MSRs, non-Agency mortgage-backed securities, residential mortgage loans, commercial real estate investments, and corporate debt.
To-Be-Announced Securities (TBAs)
A contract for the purchase or sale of a mortgage-backed security to be delivered at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date but does not include a specified pool number and number of pools.
TBA Dollar Roll Income
TBA dollar roll income is defined as the difference in price between two TBA contracts with the same terms but different settlement dates. The TBA contract settling in the later month typically prices at a discount to the earlier month contract with the difference in price commonly referred to as the “drop.” TBA dollar roll income represents the equivalent of interest income on the underlying security less an implied cost of financing.
Total Return
Investment performance measure over a stated time period which includes coupon interest, interest on interest, and any realized and unrealized gains or losses.
Total Return Swap
A derivative instrument where one party makes payments at a predetermined rate (either fixed or variable) while receiving a return on a specific asset (generally an equity index, loan or bond) held by the counterparty.
U
Unencumbered AssetsAssets on our balance sheet which have not been pledged as collateral against an existing liability.
U.S. Government-Sponsored Enterprise (GSE) Obligations
Obligations of Agencies originally established or chartered by the U.S. government to serve public purposes as specified by the U.S. Congress, such as Fannie Mae and Freddie Mac; these obligations are not explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the U.S. government.
V
Value-at-Risk (VaR)
A statistical technique which measures the potential loss in value of an asset or portfolio over a defined period for a given confidence interval.
Variable Interest Entity (VIE)
An entity in which equity investors (i) do not have the characteristics of a controlling financial interest, and/or (ii) do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.
Variation Margin
Cash or securities provided by a party to collateralize its obligations under a transaction as a result of a change in value of such transaction since the trade was executed or the last time collateral was provided.
Volatility
A statistical measure of the variance of price or yield over time. Volatility is low if the price does not change very much over a short period of time, and high if there is a greater change.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
W
Warehouse Lending
A line of credit extended to a loan originator to fund mortgages extended by the loan originators to property purchasers. The loan typically lasts from the time the mortgage is originated to when the mortgage is sold into the secondary market, whether directly or through a securitization. Warehouse lending can provide liquidity to the loan origination market.
Weighted Average Coupon
The weighted average interest rate of the underlying mortgage loans or pools that serve as collateral for a security, weighted by the size of the principal loan balances.
Weighted Average Life (WAL)
The assumed weighted average amount of time that will elapse from the date of a security’s issuance until each dollar of principal is repaid to the investor. The WAL will change as the security ages and depending on the actual realized rate at which principal, scheduled and unscheduled, is paid on the loans underlying the MBS.
Y
Yield-to-Maturity
The expected rate of return of a bond if it is held to its maturity date; calculated by taking into account the current market price, stated redemption value, coupon payments and time to maturity and assuming all coupons are reinvested at the same rate; equivalent to the internal rate of return.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and qualitative disclosures about market risk are contained within the section titled “Risk Management” of Item 2. “Management’s Discussion
and Analysis of Financial Condition and Results of Operations.”
ITEM 4. CONTROLS AND PROCEDURES
Our management, including our Chief Executive Officer (the CEO) and Chief Financial Officer (the CFO), reviewed and evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act) as of the end of the period covered by this report. Based on that review and evaluation, the CEO and CFO have concluded that our current disclosure controls and procedures, as designed, (1) were effective in ensuring that information required to be disclosed by the Company in reports it files or submits under the Securities Exchange Act is accumulated and communicated to our management,
including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure and (2) were effective in ensuring that information required to be disclosed by the Company in reports it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms.
There have been no changes in our internal controls over financial reporting that occurred during the three months ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we are involved in various claims and legal actions arising in the ordinary course of business.
At September 30, 2017, we were not party to any pending material legal proceedings.
There have been no material changes to the risk factors disclosed in Item 1A. “Risk Factors” of our most recent annual report on Form 10-K. The materialization of any risks and uncertainties identified in our Special Note Regarding Forward-Looking Statements contained in this report together with those previously disclosed in our most recent annual report on Form 10-K or those
that are presently unforeseen could result in significant adverse effects on our financial condition, results of operations and cash flows. See Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Special Note Regarding Forward-Looking Statements” in this quarterly report or our most recent annual report on Form 10-K.
ITEM 5. OTHER INFORMATION
On October 31, 2017, we filed Articles Supplementary (the “Articles Supplementary”) to the Charter of the Company (the “Charter”) with the State Department of Assessments and Taxation of Maryland, which Articles Supplementary were accepted for record. The Articles Supplementary reclassified and designated (1) 7,412,500 authorized but unissued shares of the our preferred stock, $0.01 par value per share, without designation as to series or class, as shares of our undesignated common stock, $0.01 par value per share (the “Common Stock”); (2) 650,000 authorized but unissued shares of the Company’s 7.625% Series C Cumulative Redeemable Preferred Stock, $0.01 par value per share (the “Series C Preferred Stock”), as shares of undesignated Common Stock; and (3) 3,400,000 authorized but unissued shares of the
Company’s 6.95% Series F Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, $0.01 par value per share (the “Series F Preferred Stock”), as shares of undesignated Common Stock.
Following the filing of the Articles Supplementary, the total number of shares of capital stock which we have authority to issue is 2,000,000,000, consisting of 1,929,300,000 shares of Common Stock; 12,000,000 shares Series C Preferred Stock; 18,400,000 shares of 7.50% Series D Cumulative Redeemable Preferred Stock, $0.01 par value per share; 11,500,000 shares of 7.625% Series E Cumulative Redeemable Preferred Stock, $0.01 par value per share; and 28,800,000 shares of Series F Preferred Stock.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 6. ExhibitsExhibits:
The exhibits required by this item are set forth on the Exhibit Index attached hereto.
Exhibit Number | | Exhibit Description |
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| | Articles Supplementary reclassifying and designating (1) 7,412,500 authorized but unissued shares of the Registrant’s preferred stock, $0.01 par value per share, without designation as to series or class, as shares of undesignated Common Stock; (2) 650,000 authorized but unissued shares of the Registrant’s 7.625% Series C Cumulative Redeemable Preferred Stock, $0.01 par value per share, as shares of undesignated Common Stock; and (3) 3,400,000 authorized but unissued shares of the Registrant’s 6.95% Series F Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, $0.01 par value per share, as shares of undesignated Common Stock.† |
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| Exhibit 101.INS XBRL | | Instance Document † |
| Exhibit 101.SCH XBRL | | Taxonomy Extension Schema Document † |
| Exhibit 101.CAL XBRL | | Taxonomy Extension Calculation Linkbase Document † |
| Exhibit 101.DEF XBRL | | Additional Taxonomy Extension Definition Linkbase Document Created† |
| Exhibit 101.LAB XBRL | | Taxonomy Extension Label Linkbase Document † |
| Exhibit 101.PRE XBRL | | Taxonomy Extension Presentation Linkbase Document † |
† Submitted electronically herewith. Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition at September 30, 2017 (Unaudited) and December 31, 2016 (Derived from the audited Consolidated Statement of Financial Condition at December 31, 2016); (ii) Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the three and nine months ended September 30, 2017 and 2016; (iii) Consolidated Statements of Stockholders’ Equity (Unaudited) for the nine months ended September 30, 2017 and 2016; (iv) Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2017 and 2016; and (v) Notes to Consolidated Financial Statements (Unaudited).
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the city of New York, State of New York.
| | | | ANNALY CAPITAL MANAGEMENT, INC. |
| | | | |
| Dated: | November 2, 2017 | | By: /s/ Kevin G. Keyes |
| | | | Kevin G. Keyes |
| | | | Chief Executive Officer, President and Director (Principal Executive Officer) |
| | | | |
| Dated: | November 2, 2017 | | By: /s/ Glenn A. Votek |
| | | | Glenn A. Votek |
| | | | Chief Financial Officer (Principal Financial Officer) |
