Edgar Filing: ANNALY CAPITAL MANAGEMENT INC

a50686541.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED: JUNE 30, 2013

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _______________ TO _________________

COMMISSION FILE NUMBER: 1-13447

ANNALY CAPITAL MANAGEMENT, INC.

(Exact name of Registrant as specified in its Charter)

MARYLAND	22-3479661
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

1211 AVENUE OF THE AMERICAS, SUITE 2902

NEW YORK, NEW YORK

(Address of principal executive offices)

10036

(Zip Code)

(212) 696-0100

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

Yes X No___

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:

Class	Outstanding at August 8, 2013
Common Stock, $.01 par value	947,278,992

ANNALY CAPITAL MANAGEMENT, INC.

FORM 10-Q

TABLE OF CONTENTS

PART I

	PAGE
Part I. FINANCIAL INFORMATION

Item 1. Financial Statements:

Consolidated Statements of Financial Condition at June 30, 2013 (Unaudited) and December 31, 2012 (Derived from the audited Consolidated Statement of Financial Condition at December 31, 2012)	1

Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited) for the quarters and six months ended June 30, 2013 and 2012	2

Consolidated Statements of Stockholders’ Equity (Unaudited) for the six months ended June 30, 2013 and 2012	3

Consolidated Statements of Cash Flows (Unaudited) for the quarters and six months ended June 30, 2013 and 2012	4

Notes to Consolidated Financial Statements (Unaudited)	6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	30

Item 3. Quantitative and Qualitative Disclosures about Market Risk	50

Item 4. Controls and Procedures	52

Part II. OTHER INFORMATION

Item 1. Legal Proceedings	52

Item 1A. Risk Factors	52

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	53

Item 5. Other Information	53

Item 6. Exhibits	53

SIGNATURES	56

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share amounts)

ASSETS	June 30, 2013 (Unaudited)			December 31, 2012(1)
Cash and cash equivalents	$	725,537		$	615,789
Reverse repurchase agreements		171,234			1,811,095
Investments, at fair value:
U.S. Treasury securities (including pledged assets of $0 and $752,076, respectively)		-			752,076
Securities borrowed		2,425,024			2,160,942
Agency mortgage-backed securities (including pledged assets of $86,747,090 and $107,466,084, respectively)		92,487,318			123,963,207
Agency debentures (including pledged assets of $2,550,646 and $981,727, respectively)		3,306,473			3,009,568
Investments in affiliates		134,948			234,120
Commercial real estate investments		1,005,560			-
Corporate debt, held for investment		61,682			63,944
Receivable for investments sold		1,499,140			290,722
Accrued interest and dividends receivable		340,671			419,259
Receivable for investment advisory income (including from affiliates of $6,521 and $14,077, respectively)		10,374			17,730
Intangible for customer relationships (net of accumulated amortization of $6,294 and $5,779, respectively)		6,474			6,989
Goodwill		102,783			55,417
Interest rate swaps, at fair value		38,950			-
Other derivative contracts, at fair value		91,270			9,830
Other assets		61,146			41,607
Total Assets	$	102,468,584		$	133,452,295

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
U.S. Treasury securities sold, not yet purchased, at fair value	$	-		$	495,437
Repurchase agreements		81,397,335			102,785,697
Securities loaned, at fair value		2,284,245			1,808,315
Payable for investments purchased		2,833,214			8,256,957
Payable for share buyback program		-			141,149
Convertible Senior Notes		824,229			825,541
Mortgages payable		19,361			-
Participation sold		14,324			-
Accrued interest payable		164,190			186,896
Dividends payable		396,888			432,154
Interest rate swaps, at fair value		1,189,178			2,584,907
Accounts payable and other liabilities		82,316			10,798
Total Liabilities		89,205,280			117,527,851

Stockholders’ Equity:
7.875% Series A Cumulative Redeemable Preferred Stock: 7,412,500 authorized, issued and outstanding		177,088			177,088
7.625% Series C Cumulative Redeemable Preferred Stock: 12,650,000 authorized, 12,000,000 issued and outstanding		290,514			290,514
7.50% Series D Cumulative Redeemable Preferred Stock: 18,400,000 authorized, issued and outstanding, respectively		445,457			445,457
Common stock, par value $0.01 per share, 1,956,937,500 authorized, 947,483,487 and 947,213,204, issued and outstanding, respectively		9,475			9,472
Additional paid-in capital		14,754,681			14,740,774
Accumulated other comprehensive income (loss)		(1,289,246	)		3,053,242
Accumulated deficit		(1,124,665	)		(2,792,103	)
Total Stockholders’ Equity		13,263,304			15,924,444
Total Liabilities and Stockholders’ Equity	$	102,468,584		$	133,452,295

(1) Derived from the audited consolidated financial statements at December 31, 2012.


See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(dollars in thousands, except per share amounts)
(Unaudited)

	For the Quarter Ended						For the Six Months Ended
	June 30, 2013			June 30, 2012			June 30, 2013			June 30, 2012
Interest income:
Investment Securities	$	686,577		$	874,984		$	1,411,397		$	1,725,408
U.S. Treasury securities		7,242			7,397			13,238			8,815
Securities loaned		2,302			2,698			4,914			5,216
Commercial real estate investments		13,906			-			13,906			-
Reverse repurchase agreements		2,775			1,122			6,411			1,544
Other		134			123			287			236
Total interest income		712,936			886,324			1,450,153			1,741,219

Interest expense:
Repurchase agreements		141,945			139,579			299,009			253,493
Convertible Senior Notes		16,364			18,965			32,177			33,692
U.S. Treasury securities sold, not yet purchased		4,075			5,801			6,863			8,445
Securities borrowed		1,737			2,098			3,662			4,158
Participation sold		134			-			134			-
Total interest expense		164,255			166,443			341,845			299,788

Net interest income		548,681			719,881			1,108,308			1,441,431

Other income (loss):
Investment advisory income		12,187			21,810			25,595			42,450
Net gains (losses) on disposal of investments		147,998			94,837			330,841			175,136
Dividend income from affiliates		4,048			6,621			10,479			14,142
Net gains (losses) on trading assets		54,046			1,105			55,595			6,361
Net unrealized gains (losses) on interest-only Agency mortgage-backed securities		111,521			(26,103	)		191,648			4,774
Impairment of goodwill		(23,987	)		-			(23,987	)		-
Loss on previously held equity interest in CreXus		(18,896	)		-			(18,896	)		-
Other income (loss)		7,192			119			7,324			245
Subtotal		294,109			98,389			578,599			243,108
Realized gains (losses) on interest rate swaps(1)		(212,727	)		(222,002	)		(438,203	)		(441,342	)
Realized gains (losses) on termination of interest rate swaps		(35,649	)		-			(52,027	)		(2,385	)
Unrealized gains (losses) on interest rate swaps		1,109,022			(611,215	)		1,434,756			(269,576	)
Subtotal		860,646			(833,217	)		944,526			(713,303	)
Total other income (loss)		1,154,755			(734,828	)		1,523,125			(470,195	)

General and administrative expenses:
Compensation and management fee		43,764			53,536			82,207			112,550
Other general and administrative expenses		21,367			11,020			34,836			19,921
Total general and administrative expenses		65,131			64,556			117,043			132,471

Income (loss) before income taxes		1,638,305			(79,503	)		2,514,390			838,765
Income taxes		92			11,656			5,899			28,118

Net income (loss)		1,638,213			(91,159	)		2,508,491			810,647

Dividends on preferred stock		17,992			6,508			35,984			10,446

Net income (loss) available (related) to common shareholders	$	1,620,221		$	(97,667	)	$	2,472,507		$	800,201

Net income (loss) per share available (related) to common shareholders:
Basic	$	1.71		$	(0.10	)	$	2.61		$	0.82
Diluted	$	1.64		$	(0.10	)	$	2.51		$	0.78

Weighted average number of common shares outstanding:
Basic		947,411,380			974,555,392			947,331,087			973,141,546
Diluted		995,229,637			974,555,392			995,151,942			1,052,888,301

Dividends Declared Per Share of Common Stock	$	0.40		$	0.55		$	0.85		$	1.10

Net income (loss)	$	1,638,213		$	(91,159	)	$	2,508,491		$	810,647
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities		(3,144,496	)		741,727			(4,011,647	)		579,468
Reclassification adjustment for net (gains) losses included in net income (loss)		(147,998	)		(94,837	)		(330,841	)		(175,136	)
Other comprehensive income (loss)		(3,292,494	)		646,890			(4,342,488	)		404,332
Comprehensive income (loss)	$	(1,654,281	)	$	555,731		$	(1,833,997	)	$	1,214,979

(1)	Interest expense related to the Company’s interest rate swaps is recorded in Realized gains (losses) on interest rate swaps on the Consolidated Statements of Operations and Comprehensive Income (Loss).

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(dollars in thousands, except per share amounts)
(Unaudited)

	7.875% Series A Cumulative Redeemable Preferred Stock		7.625% Series C Cumulative Redeemable Preferred Stock		7.50% Series D Cumulative Redeemable Preferred Stock		Common Stock Par Value		Additional Paid-In Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total
BALANCE, DECEMBER 31, 2011	$	177,088		-		-	$	9,702	$	15,068,870		$	3,008,988		$	(2,504,006	)	$	15,760,642
Net income (loss)		-		-		-		-		-			-			810,647			810,647
Unrealized gains (losses) on available-for- sale securities		-		-		-		-		-			579,468			-			579,468
Reclassification adjustment for net (gains) losses included in net income (loss)		-		-		-		-		-			(175,136	)		-			(175,136	)
Exercise of stock options		-		-		-		4		5,387			-			-			5,391
Stock compensation expense		-		-		-		-		2,860			-			-			2,860
Conversion of Series B cumulative preferred stock		-		-		-		40		32,232			-			-			32,272
Net proceeds from direct purchase and dividend reinvestment		-		-		-		1		844			-			-			845
Contingent beneficial conversion feature on 4% Convertible Senior Notes		-		-		-		-		46,341			-			-			46,341
Equity component on 5% Convertible Senior Notes		-		-		-		-		11,717			-			-			11,717
Offering expenses		-		-		-		-		(231	)		-			-			(231	)
Net proceeds from 7.625% Series C Cumulative Redeemable Preferred Stock offering		-		290,514		-		-		-			-			-			290,514
Preferred Series A dividends declared $0.984 per share		-		-		-		-		-			-			(7,298	)		(7,298	)
Preferred Series B dividends declared $0.375 per share		-		-		-		-		-			-			(289	)		(289	)
Preferred Series C dividends declared $0.238 per share																(2,859	)		(2,859	)
Common dividends declared, $1.10 per share		-		-		-		-		-			-			(1,070,298	)		(1,070,298	)
BALANCE, JUNE 30, 2012	$	177,088	$	290,514		-	$	9,747	$	15,168,020		$	3,413,320		$	(2,774,103	)	$	16,284,586
BALANCE, DECEMBER 31, 2012	$	177,088	$	290,514	$	445,457	$	9,472	$	14,740,774		$	3,053,242		$	(2,792,103	)	$	15,924,444
Net income (loss)		-		-		-		-		-			-			2,508,491			2,508,491
Unrealized gains (losses) on available-for- sale securities		-		-		-		-		-			(4,011,647	)		-			(4,011,647	)
Reclassification adjustment for net (gains) losses included in net income (loss)		-		-		-		-		-			(330,841	)		-			(330,841	)
Exercise of stock options		-		-		-		2		2,202			-			-			2,204
Stock compensation expense		-		-		-		-		1,762			-			-			1,762
Net proceeds from direct purchase and dividend reinvestment		-		-		-		1		1,430			-			-			1,431
Contingent beneficial conversion feature on 4% Convertible Senior Notes		-		-		-		-		8,513			-			-			8,513
Preferred Series A dividends declared $0.984 per share		-		-		-		-		-			-			(7,296	)		(7,296	)
Preferred Series C dividends declared $0.953 per share		-		-		-		-		-			-			(11,438	)		(11,438	)
Preferred Series D dividends declared $0.938 per share		-		-		-		-		-			-			(17,250	)		(17,250	)
Common dividends declared, $0.85 per share		-		-		-		-		-			-			(805,069	)		(805,069	)
BALANCE, JUNE 30, 2013	$	177,088	$	290,514	$	445,457	$	9,475	$	14,754,681		$	(1,289,246	)	$	(1,124,665	)	$	13,263,304

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(Unaudited)

	For the Quarter Ended						For the Six Months Ended
	June 30, 2013			June 30, 2012			June 30, 2013			June 30, 2012
Cash flows from operating activities:
Net income (loss)	$	1,638,213		$	(91,159	)	$	2,508,491		$	810,647
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Amortization of Investment Securities premiums and discounts, net		320,125			302,769			741,182			583,105
Amortization of commercial real estate investment premiums and discounts, net		492			-			492			-
Amortization of intangibles		323			633			646			1,224
Amortization of deferred expenses		2,038			1,838			4,076			2,738
Amortization of contingent beneficial conversion feature on convertible senior notes		3,876			6,232			7,200			14,060
Net (gains) losses on sales of Agency mortgage-backed securities and debentures		(147,998	)		(94,837	)		(330,841	)		(175,136	)
Stock compensation expense		945			1,011			1,762			2,860
Impairment of goodwill		23,987			-			23,987			-
Loss on previously held equity interest in CreXus		18,896			-			18,896			-
Unrealized (gains) losses on interest rate swaps		(1,109,022	)		611,215			(1,434,756	)		269,576
Net unrealized (gains) losses on interest-only Agency mortgage-backed securities		(111,521	)		26,103			(191,648	)		(4,774	)
Net (gains) losses on trading assets		(70,424	)		(1,105	)		(55,595	)		(3,976	)
Proceeds from repurchase agreements of RCap		302,192,952			213,985,974			539,762,437			341,038,916
Payments on repurchase agreements of RCap		(312,346,171	)		(214,067,318	)		(550,946,586	)		(336,809,273	)
Proceeds from reverse repurchase agreements of RCap		84,402,455			130,785,187			189,362,118			185,681,953
Payments on reverse repurchase agreements of RCap		(79,653,078	)		(130,254,085	)		(187,758,014	)		(186,831,887	)
Proceeds from reverse repurchase agreements of Shannon		267,896			129,848			644,094			223,740
Payments on reverse repurchase agreements of Shannon		(255,042	)		(145,820	)		(608,337	)		(238,411	)
Proceeds from securities borrowed		76,474,674			12,741,368			130,273,831			19,424,651
Payments on securities borrowed		(76,211,213	)		(13,084,242	)		(130,537,913	)		(19,961,246	)
Proceeds from securities loaned		105,005,660			33,856,914			215,730,800			65,859,868
Payments on securities loaned		(105,051,475	)		(33,620,656	)		(215,254,870	)		(65,551,662	)
Proceeds from U.S. Treasury securities		39,150,789			15,289,185			60,834,425			31,097,679
Payments on U.S. Treasury securities		(38,397,508	)		(17,754,440	)		(60,554,625	)		(31,840,754	)
Net payments on derivatives		(42,958	)		(18,309	)		(44,448	)		(17,460	)
Net change in:
Due to / from brokers		659			-			659			-
Other assets		(3,350	)		8,072			(18,128	)		2,154
Accrued interest and dividends receivable		51,340			(1,562	)		73,956			(12,130	)
Receivable for investment advisory income		2,443			(1,135	)		7,356			(1,193	)
Accrued interest payable		(11,495	)		45,711			(22,642	)		35,854
Accounts payable and other liabilities		32,636			36,926			58,885			87,630
Net cash provided by (used in) operating activities		(3,820,856	)		(1,305,682	)		(7,703,110	)		3,688,753
Cash flows from investing activities:
Payments on purchases of Agency mortgage-backed securities and debentures		(8,499,751	)		(18,020,975	)		(26,199,223	)		(38,120,124	)
Proceeds from sales of Agency mortgage-backed securities and debentures		13,459,639			5,145,156			28,944,048			9,915,497
Principal payments on Agency mortgage-backed securities		6,548,595			7,877,543			15,062,669			15,254,031
Proceeds from Agency debentures called		1,300,000			698,523			2,147,205			850,163
Payments on purchase of corporate debt		(19,899	)		(9,900	)		(23,382	)		(9,900	)
Proceeds from corporate debt called		24,252			-			24,252			-
Principal payments on corporate debt		610			125			1,521			1,460
Acquisition of CreXus		(724,424	)		-			(724,424	)		-
Purchases of commercial real estate investments		(230,000	)		-			(230,000	)		-
Principal payments on commercial real estate investments		20,840			-			20,840			-
Earn out payment		-			-			-			(13,387	)
Proceeds from derivatives		-			-			7,465			-
Proceeds from sales of equity securities		-			4,048			-			4,048
Net cash provided by (used in) investing activities		11,879,862			(4,305,480	)		19,030,971			(12,118,212	)
Cash flows from financing activities:
Proceeds from repurchase agreements		123,341,832			84,206,888			224,973,415			167,136,997
Principal payments on repurchase agreements		(132,114,220	)		(79,085,612	)		(235,177,628	)		(158,703,728	)
Proceeds from exercise of stock options		1,939			3,549			2,204			5,391

Statement continued on following page.

Statement continued from previous page.

Net proceeds from Series C Preferred offering		-			290,514			-			290,514
Net proceeds from issuance of 5% Convertible Senior Notes offering		-			727,500			-			727,500
Net proceeds from direct purchases and dividend reinvestments		670			845			1,431			845
Net (payments) proceeds from follow-on offerings		-			-			-			(231	)
Payments on participation sold		(67	)		-			(67	)		-
Net payment on share repurchase		-			-			(141,149	)		-
Dividends paid		(426,173	)		(540,909	)		(876,319	)		(1,097,653	)
Net cash provided by (used in) financing activities		(9,196,019	)		5,602,775			(11,218,113	)		8,359,635
Net (decrease) increase in cash and cash equivalents		(1,137,013	)		(8,387	)		109,748			(69,824	)
Cash and cash equivalents, beginning of period		1,862,550			932,761			615,789			994,198
Cash and cash equivalents, end of period	$	725,537		$	924,374		$	725,537		$	924,374

Supplemental disclosure of cash flow information:
Interest received	$	1,078,672		$	1,186,292		$	2,266,874		$	2,311,295
Dividends received	$	6,431		$	7,521		$	13,528		$	15,804
Fees received	$	14,630		$	20,794		$	33,083		$	41,502
Interest paid (excluding interest paid on interest rate swaps)	$	168,898		$	115,764		$	353,324		$	249,863
Net interest paid on interest rate swaps	$	215,768		$	220,738		$	442,231		$	441,353
Taxes paid	$	4,057		$	7,766		$	6,439		$	29,167

Noncash investing activities:
Receivable for investments sold	$	1,499,140		$	1,320,996		$	1,499,140		$	1,320,996
Payable for investments purchased	$	2,833,214		$	7,387,410		$	2,833,214		$	7,387,410
Net change in unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment	$	(3,292,494	)	$	646,890		$	(4,342,488	)	$	404,332

Noncash financing activities:
Dividends declared, not yet paid	$	396,888		$	535,898		$	396,888		$	535,898
Conversion of Series B cumulative preferred stock		-			-			-		$	32,272
Contingent beneficial conversion feature on 4% Convertible Senior Notes	$	4,550		$	23,020		$	8,513		$	46,341
Equity component of 5% Convertible Senior Notes		-		$	11,717			-		$	11,717

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Annaly Capital Management, Inc. (“Annaly” or the “Company”) was incorporated in Maryland on November 25, 1996. The Company commenced its operations of purchasing and managing an investment portfolio of mortgage-backed securities on February 18, 1997, upon receipt of the net proceeds from the private placement of equity capital, and completed its initial public offering on October 14, 1997. The Company is a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). On June 4, 2004, the Company acquired Fixed Income Discount Advisory Company (“FIDAC”). FIDAC is a registered investment advisor and is a wholly-owned taxable REIT subsidiary of the Company. On June 27, 2006, the Company made a majority equity investment in an affiliated investment fund (the “Fund”), which is now wholly-owned by the Company. During the third quarter of 2008, the Company formed RCap Securities, Inc. (“RCap”). RCap was granted membership in the Financial Industry Regulatory Authority (“FINRA”) on January 26, 2009, and operates as a broker-dealer. RCap is a wholly-owned taxable REIT subsidiary of the Company. On October 31, 2008, the Company acquired Merganser Capital Management, Inc. (“Merganser”). Merganser is a registered investment advisor and is a wholly-owned taxable REIT subsidiary of the Company. In 2010, the Company established Shannon Funding LLC (“Shannon”), which provides warehouse financing to residential mortgage originators in the United States. In 2010, the Company also established Charlesfort Capital Management LLC (“Charlesfort”), which engages in corporate middle market lending transactions. In 2011, FIDAC established FIDAC Europe Limited (“FIDAC Europe”), which the Company sold in December 2012. In 2011, the Company established FIDAC FSI LLC (“FIDAC FSI”), which invested in trading securities. FIDAC FSI was liquidated in August 2012. During the second quarter of 2013, the Company, through its wholly-owned subsidiary CXS Acquisition Corporation (“CXS Acquisition”) which was formed in January 2013, acquired CreXus Investment Corp. (“CreXus”), a specialty finance company that specialized in acquiring, managing and financing commercial mortgage loans and other commercial real estate debt, commercial mortgage-backed securities and other commercial real estate-related assets. Following the acquisition, CXS Acquisition was renamed Annaly Commercial Real Estate Group, Inc. (“Annaly Commercial”). Annaly Commercial is a wholly-owned qualified REIT subsidiary of the Company.

A summary of the Company’s significant accounting policies follows:

Basis of Accounting – The accompanying consolidated financial statements and related notes of the Company have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). In the opinion of management, the consolidated financial statements reflect all adjustments considered necessary for a fair presentation of the Company's financial position, results of operations and cash flows.

Principles of Consolidation – The consolidated financial statements include the accounts of the Company, FIDAC, FIDAC FSI, FIDAC Europe, Merganser, RCap, Shannon, Charlesfort, the Fund and Annaly Commercial. All intercompany balances and transactions have been eliminated in consolidation. Beginning with the Company’s consolidated financial statements for the quarter and six month periods ended June 30, 2013, the Company reclassified previously presented financial information so that amounts previously presented in the Consolidated Statements of Operations and Comprehensive Income (Loss) as interest income from Investments are presented as interest income in Reverse repurchase agreements and Other. Consolidated financial statements for periods prior to June 30, 2013 have been conformed to the current presentation.

The Company has evaluated all of its investments in order to determine if they qualify as Variable Interest Entities ("VIEs") or as variable interests in VIEs. A VIE is defined as 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 financial support from other parties. A variable interest is an investment or other interest that will absorb portions of a VIE's expected losses or receive portions of the entity’s expected residual returns. A VIE is required to be consolidated by its primary beneficiary, which is defined as the party that (i) has the power to control the activities that most significantly impact the VIE’s economic performance and (ii) has the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.

Cash and Cash Equivalents – Cash and cash equivalents include cash on hand and cash held in money market funds on an overnight basis. RCap is a member of various clearing organizations with which it maintains cash required for the conduct of its day-to-day clearance activities. Cash and securities deposited with clearing organizations are carried at cost, which approximates fair value. The Company also maintains collateral in the form of cash on margin with counterparties to its interest rate swaps. Cash and securities deposited with clearing organizations and collateral held in the form of cash on margin with counterparties to its interest rate swaps totaled $561.6 million and $527.5 million at June 30, 2013 and December 31, 2012, respectively.

Reverse Repurchase Agreements – RCap enters into reverse repurchase agreements as part of its matched book trading activity. Reverse repurchase agreements are recorded on trade date at the contract amount and are collateralized by mortgage-backed or other securities. Margin calls are made by RCap as necessary based on the daily valuation of the underlying collateral as compared to the contract price. RCap generates income from the spread between what is earned on the reverse repurchase agreements and what is paid on the matched repurchase agreements. RCap’s policy is to obtain possession of collateral with a market value in excess of the principal amount loaned under reverse repurchase agreements. To ensure that the market value of the underlying collateral remains sufficient, collateral is valued daily, and RCap will require counterparties to deposit additional collateral, when necessary. All reverse repurchase activities are transacted under master repurchase agreements that give RCap the right, in the event of default, to liquidate collateral held and to offset receivables and payables with the same counterparty.

Securities Borrowed and Loaned Transactions – RCap records securities borrowed and loaned transactions as collateralized financings. Securities borrowed transactions require RCap to provide the counterparty with collateral in the form of cash, or other securities. RCap receives collateral in the form of cash or other securities for securities loaned transactions in an amount generally in excess of the fair value of the securities loaned. RCap monitors the fair value of the securities borrowed and loaned on a daily basis, with additional collateral obtained or refunded as necessary. Securities borrowed and securities loaned transactions are recorded at contract value. For these transactions, the rebates accrued by RCap are recorded as interest income or expense.

U.S. Treasury Securities – RCap trades in U.S. Treasury securities for its proprietary portfolio, which consists of long and short positions on U.S Treasury notes and bonds. U.S. Treasury securities are classified as trading investments and are recorded on the trade date at cost. Changes in fair value are reflected in the Company’s Consolidated Statement of Operations and Comprehensive Income (Loss). Generally, RCap does not hold the U.S. Treasury notes and bonds to maturity and realizes gains and losses from trading those positions. Interest income or expense on U.S. Treasury notes and bonds is accrued based on the outstanding principal amount of those investments and their stated terms.

Agency Mortgage-Backed Securities and Agency Debentures – The Company invests primarily in mortgage pass-through certificates, collateralized mortgage obligations and other mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans, and certificates guaranteed by Ginnie Mae, Freddie Mac or Fannie Mae (collectively, “Agency mortgage-backed securities”). The Company also invests in Agency debentures issued by Federal Home Loan Bank (“FHLB”), Freddie Mac, and Fannie Mae.

Investment Securities – Agency mortgage-backed securities, Agency debentures, and corporate debt are referred to herein as “Investment Securities.” Although the Company generally intends to hold most of its Investment Securities until maturity, it may, from time to time, sell any of its Investment Securities as part of its overall management of its portfolio. Investment Securities classified as available-for-sale are reported at fair values estimated by management that are compared to independent sources for reasonableness, with unrealized gains and losses reported as a component of stockholders’ equity. Investment Securities transactions are recorded on the trade date. Realized gains and losses on sales of Investment Securities are determined using the average cost method. The Company’s investments in corporate debt are designated as held for investment, and are carried at their principal balance outstanding plus any premiums or discounts less allowances for loan losses. No allowance for loan losses was deemed necessary as of June 30, 2013 and December 31, 2012.

On April 1, 2011, the Company elected the fair value option for Agency interest-only mortgage-backed securities acquired on or after such date. Interest-only securities and inverse interest-only securities are collectively referred to as “interest-only securities.” These Agency interest-only mortgage-backed securities represent the Company’s right to receive a specified proportion of the contractual interest flows of specific Agency mortgage-backed securities. Agency interest-only mortgage-backed securities acquired on or after April 1, 2011 are measured at fair value through earnings in the Company’s Consolidated Statements of Operations and Comprehensive Income (Loss). The interest-only securities are included in Agency mortgage-backed securities at fair value on the accompanying Consolidated Statements of Financial Condition.

Interest income from coupon payments is accrued based on the outstanding principal amount of the Investment Securities and their contractual terms. Premiums and discounts associated with the purchase of the Investment Securities are amortized or accreted into interest income over the projected lives of the securities using the interest method. The Company’s policy for estimating prepayment speeds for calculating the effective yield is to evaluate historical performance, consensus prepayment speeds, and current market conditions. Adjustments are made for actual prepayment activity.

Other-Than-Temporary Impairment – Management evaluates available-for-sale securities for other-than-temporary impairment at least quarterly, and more frequently when economic or market concerns warrant such evaluation. When the fair value of available-for-sale security is less than its amortized cost the security is considered impaired. For securities that are impaired, the Company determines if it (1) has the intent to sell the securities, (2) is more likely than not that it will be required to sell the securities before recovery, or (3) does not expect to recover the entire amortized cost basis of the securities. Further, the security is analyzed for credit loss (the difference between the present value of cash flows expected to be collected and the amortized cost basis). The credit loss, if any, will then be recognized in the Consolidated Statements of Operations and Comprehensive Income (Loss), while the balance of losses related to other factors will be recognized as a component of stockholders’ equity. There was no other-than-temporary impairment for the quarters and six months ended June 30, 2013 and 2012.

Commercial Real Estate Investments

Commercial Real Estate Loans – The Company's commercial real estate mortgages and loans are comprised of fixed-rate and adjustable-rate loans. Commercial real estate mortgages and loans are designated as held for investment and are carried at their outstanding principal balance, plus any premiums or discounts, less allowances for loan losses. The difference between the principal amount of a loan and proceeds at acquisition is recorded as either a discount or premium.

Preferred Equity Interests Held for Investment – Preferred equity interests are designated as held for investment and are carried at their outstanding principal balance, plus premiums or discounts, less allowances for losses.

Investments in Real Estate – Investments in real estate are carried at historical cost less accumulated depreciation. Costs directly related to acquisitions deemed to be business combinations are expensed. Ordinary repairs and maintenance which are not reimbursed by the tenants are expensed as incurred. Major replacements and improvements that extend the useful life of the asset are capitalized and depreciated over their useful life.

Allowance for Loan Losses – The Company evaluates the need for a loan loss reserve on its commercial real estate loans and preferred equity interests. A provision is established when the Company believes a loan is impaired, which is when it is deemed probable that the Company will be unable to collect contractual principal and interest amounts. A provision for credit losses related to loans, including those accounted for under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”), may be established when it is probable the Company will not collect amounts contractually due or all amounts previously estimated to be collected. Management assesses the credit quality of the portfolio and adequacy of loan loss reserves on a quarterly basis, or more frequently as necessary. Significant judgment is required in this analysis. Depending on the expected recovery of its investment, the Company considers the estimated net recoverable value of the loan as well as other factors, including but not limited to the fair value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the competitive landscape where the borrower does business. Because this determination is based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized may differ materially from the carrying value as of the reporting date.

Revenue Recognition – Commercial Real Estate Investments - Interest income is accrued based on the outstanding principal amount of the loans or preferred equity investments and their contractual terms. Premiums and discounts associated with the purchase of the loans or preferred equity investments are amortized or accreted into interest income over the projected lives of the loans or preferred equity investments using the interest method based on the estimated recovery value.

Equity Securities – The Company invests in equity securities that are classified as available-for-sale or trading. Equity securities classified as available-for-sale are reported at fair value, based on market quotes, with unrealized gains and losses reported as a component of other comprehensive income (loss). Equity securities classified as trading are reported at fair value, based on market quotes, with unrealized gains and losses reported in the Consolidated Statements of Operations and Comprehensive Income (Loss) as Net gains (losses) on trading assets. Dividends are recorded in earnings based on the declaration date.

Derivative Instruments – The Company accounts for interest rate swaps at fair value as either assets or liabilities on the Consolidated Statements of Financial Condition. Changes in the fair value of interest rate swaps are recognized in earnings. The Company uses interest rate swaps to manage its exposure to changing interest rates on its repurchase agreements. Net payments on interest rate swaps are included in the Consolidated Statements of Cash Flows as a component of operating activities.

The Company elected to net, by counterparty, the fair value of interest rate swap contracts. These contracts contain legally enforceable provisions that allow for netting or setting off swap receivables and payables with each counterparty and, therefore, the fair value of those swap contracts are netted by counterparty. The credit support annex provisions of the Company’s interest rate swap contracts allow the parties to mitigate their credit risk by requiring the party which is out of the money to post collateral. As the Company elects to net by counterparty the fair value of interest rate swap contracts, it also nets by counterparty any collateral exchanged as part of the interest rate swap contracts. In addition, the Company’s agreements with certain of its counterparties with whom it has both interest rate swap contracts and master repurchase agreements contain legally enforceable provisions that allow for netting or setting off on an aggregate basis all receivables, payables and collateral postings required under both the interest rate swap contract and the master repurchase agreement with respect to such counterparty.

The Company may from time to time also use a variety of derivative instruments to economically hedge some of its exposure to market risks, including interest rate and prepayment risk. Any such hedging transactions could take a variety of forms, including the use of derivative instruments such as interest rate swap agreements, interest rate swaptions or forward contracts. The Company may also purchase or sell To-Be-Announced (“TBA”) securities, purchase or write put or call options on TBA securities or invest in other types of mortgage derivative securities. The Company maintains a margin account which is settled daily with futures and options commission merchants. The Company accounts for derivatives at fair value as either assets or liabilities on the Consolidated Statements of Financial Condition. Changes in the fair value of these derivatives are included in net gains (losses) on trading assets on the Consolidated Statements of Operations and Comprehensive Income (Loss).

RCap enters primarily into U.S. Treasury, Eurodollar, federal funds, U.S. equity index and currency futures and options contracts. RCap maintains a margin account which is settled daily with futures and options commission merchants. Changes in the unrealized gains or losses on the futures and options contracts as well as any foreign exchange gains and losses are reflected in the Company’s Consolidated Statements of Operations and Comprehensive Income (Loss). Unrealized gains (losses) are excluded from net income (loss) in arriving at cash flows from operating activities in the Consolidated Statements of Cash Flows.

Credit Risk – The Company has limited its exposure to credit losses on its portfolio of Agency mortgage-backed securities by only purchasing securities issued by Freddie Mac, Fannie Mae or Ginnie Mae and Agency debentures issued by the FHLB, Freddie Mac and Fannie Mae. The payment of principal and interest on the Freddie Mac and Fannie Mae Agency mortgage-backed securities are guaranteed by those respective agencies, and the payment of principal and interest on Ginnie Mae Agency mortgage-backed securities are backed by the full faith and credit of the U.S. government. Principal and interest on Agency debentures are guaranteed by the agency issuing the debenture. Substantially all of the Company’s Investment Securities have an actual or implied “AAA” rating. The Company faces credit risk on the portions of its portfolio which are not Agency mortgage-backed securities and Agency debentures. The Company is exposed to credit risk on commercial real estate loans, preferred equity interests and corporate debt.

Market Risk – Weakness in the mortgage market may adversely affect the performance and market value of the Company’s investments. This could negatively impact the Company’s net book value. Furthermore, if many of the Company’s lenders are unwilling or unable to provide additional financing, the Company could be forced to sell its Investment Securities at an inopportune time when prices are depressed. The Company does not anticipate having difficulty converting its assets to cash or extending financing terms due to the fact that its Agency mortgage-backed securities and Agency debentures have an actual or implied “AAA” rating and principal payment is guaranteed by Freddie Mac, Fannie Mae, or Ginnie Mae.

The Company has established policies and procedures for mitigating market risk, including conducting scenario analysis and utilizing a range of hedging strategies.

Counterparty Credit Risk – The Company is exposed to risk of loss if an issuer or a counterparty fails to perform its obligations under contractual terms.

The Company has established policies and procedures for mitigating credit risk, including reviewing and establishing limits for credit exposure, limiting transactions with specific counterparties, maintaining qualifying collateral and continually assessing the creditworthiness of counterparties.

Repurchase Agreements – The Company finances the acquisition of a significant portion of its Agency mortgage-backed securities with repurchase agreements. The Company examines each of the specified criteria in ASC 860, Transfers and Servicing, at the inception of each transaction and has determined that each of the financings meet the specified criteria in this guidance. None of the Company’s repurchase agreements are accounted for as components of linked transactions. As a result, the Company separately accounts for the financial assets and related repurchase financings in the accompanying consolidated financial statements.

Reverse repurchase agreements and repurchase agreements with the same counterparty and the same maturity are presented net in the Consolidated Statements of Financial Condition when the terms of the agreements permit netting. The Company reports cash flows on repurchase agreements as financing activities in the Consolidated Statements of Cash Flows. The Company reports cash flows on repurchase agreements entered into by RCap as operating activities in the Consolidated Statements of Cash Flows.

Convertible Senior Notes – The Company records the 4% Convertible Senior Notes and 5% Convertible Senior Notes (collectively, the “Convertible Senior Notes”) at their contractual amounts, adjusted by the effects of a beneficial conversion feature and a contingent beneficial conversion feature (collectively, the “Conversion Features”). The Conversion Features’ intrinsic value is included in “Additional paid-in capital” on the Company’s Consolidated Statements of Financial Condition and reduces the recorded liability amount associated with the Convertible Senior Notes.

The Convertible Senior Notes have a conversion price adjustment feature that is evaluated at the time of the conversion price adjustment. A contingent beneficial conversion feature may be recognized as a result of adjustments to the conversion price for dividends declared. The Company determined the intrinsic value of a contingent beneficial conversion feature on its 4% Convertible Senior Notes.

Income Taxes – The Company has elected to be taxed as a REIT and intends to comply with the provisions of the Code, with respect thereto. Accordingly, the Company will not be subjected to federal income tax to the extent of its distributions to shareholders and as long as certain asset, income and stock ownership tests are met. The Company and certain of its direct and indirect subsidiaries, including FIDAC, Merganser, RCap and a subsidiary of Annaly Commercial, have made separate joint elections to treat these subsidiaries as taxable REIT subsidiaries. As such, each of these taxable REIT subsidiaries are taxable as a domestic C corporation and subject to federal, state and local income taxes based upon their taxable income. FIDAC Europe was located in Europe and was not required to pay United States income taxes. FIDAC Europe was sold by the Company in December 2012.

The provisions of ASC 740, Income Taxes, (“ASC 740”) clarify the accounting for uncertainty in income taxes recognized in financial statements and prescribe a recognition threshold and measurement attribute for tax positions taken or expected to be taken on a tax return. ASC 740 also requires that interest and penalties related to unrecognized tax benefits be recognized in the financial statements. The Company does not have any unrecognized tax benefits that would affect its financial position. Thus, no accruals for penalties and interest were necessary as of June 30, 2013 or December 31, 2012.

Goodwill and Intangible Assets – The Company’s acquisitions of FIDAC, Merganser and CreXus were accounted for using the acquisition method. Under the acquisition method, net assets and results of operations of acquired companies are included in the consolidated financial statements from the date of acquisition. The costs of FIDAC, Merganser and CreXus were allocated to the assets acquired, including identifiable intangible assets and the liabilities assumed based on their estimated fair values at the date of acquisition. The excess of purchase price over the fair value of the net assets acquired was recognized as goodwill.

The Company tests goodwill for impairment on an annual basis and at interim periods when events or circumstances make it more likely than not that an impairment may have occurred. The impairment test for goodwill utilizes a two-step approach, whereby the Company compares the carrying value of each identified reporting unit to its fair value. If the carrying value of the reporting unit is greater than its fair value, the second step is performed, where the implied fair value of goodwill is compared to its carrying value. The Company recognizes an impairment charge for the amount by which the carrying amount of goodwill exceeds its fair value.

Intangible assets with an estimated useful life are amortized over the expected life.

Stock Based Compensation – The Company is required to measure and recognize in the consolidated financial statements the compensation cost relating to share-based payment transactions. The Company recognizes compensation expense on a straight-line basis over the requisite service period for the entire award.

Use of Estimates – The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. All assets classified as trading or available-for-sale and interest rate swaps are reported at their estimated fair value, based on market prices. The Company’s policy is to obtain fair values from one or more independent sources to compare to internal prices for reasonableness. Actual results could differ from those estimates.

A Summary of Recent Accounting Pronouncements Follows:

Presentation

Balance Sheet (ASC 210)

On December 23, 2011, FASB released ASU 2011-11 Balance Sheet: Disclosures about Offsetting Assets and Liabilities. Under this update, the Company is required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and transactions subject to an agreement similar to a master netting arrangement. The scope includes derivatives, sale and repurchase agreements and reverse sale and repurchase agreements and securities borrowing and securities lending arrangements. This disclosure is intended to enable financial statement users to understand the effect of such arrangements on the Company’s financial position. In January 2013, FASB released ASU 2013-01 Balance Sheet: Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which served solely to clarify the scope of financial instruments included in ASU 2011-11 as there was concern about diversity in practice. The objective of these updates is to support further convergence of US GAAP and IFRS requirements. The updates are effective for annual reporting periods beginning on or after January 1, 2013 and did not have a significant impact on the consolidated financial statements.

Comprehensive Income (ASC 220)

On December 23, 2011, the FASB issued ASU 2011-12, Comprehensive Income: Deferral of Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income In ASU No. 2011-05, which defers those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated OCI. This was done to allow the FASB time to re-deliberate the presentation on the face of the financial statements the effects of reclassifications out of accumulated OCI on the components of net income and OCI. No other requirements under ASU 2011-05 are affected by ASU 2011-12. FASB tentatively decided not to require presentation of reclassification adjustments out of accumulated other comprehensive income on the face of the financial statements and to propose new disclosures instead.

In February 2013, the FASB issued ASU 2013-02 Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This update addresses the disclosure issue left open at the deferral under ASU 2011-12. This update requires the provision of information about the amounts reclassified out of accumulated OCI by component. In addition, it requires presentation, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated OCI by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, a cross-reference must be provided to other disclosures required under U.S. GAAP that provide additional detail about those amounts. This update is effective for reporting periods beginning after December 15, 2012. Adoption of ASU 2013-02 did not have a significant impact on the consolidated financial statements.

Broad Transactions

Financial Services – Investment Companies (ASC 946)

In June 2013, the FASB finalized ASU 2013-08 amending the scope, measurement and disclosure requirements under Topic 946 – Financial Services-Investment Companies. The FASB decided not to address issues related to the applicability of investment company accounting for real estate entities and the measurement of real estate investments at this time. Further, as stated in ASC 946-10-15-3, the guidance in Topic 946 does not apply to real estate investment trusts, and thus has no effect on the Company’s consolidated financial statements.

2. AGENCY MORTGAGE-BACKED SECURITIES

The following tables present the Company’s available-for-sale Agency mortgage-backed securities portfolio as of June 30, 2013 and December 31, 2012 which were carried at their fair value:

June 30, 2013	Freddie Mac			Fannie Mae			Ginnie Mae			Total Mortgage- Backed Securities
	(dollars in thousands)

Agency mortgage-backed securities, par value	$	32,331,213		$	55,685,938		$	204,526		$	88,221,677
Unamortized discount		(12,845	)		(13,134	)		(382	)		(26,361	)
Unamortized premium		1,871,508			3,473,288			33,788			5,378,584
Amortized cost		34,189,876			59,146,092			237,932			93,573,900

Gross unrealized gains		427,974			893,025			11,893			1,332,892
Gross unrealized losses		(939,614	)		(1,477,347	)		(2,513	)		(2,419,474	)

Estimated fair value	$	33,678,236		$	58,561,770		$	247,312		$	92,487,318

	Amortized Cost			Gross Unrealized Gain			Gross Unrealized Loss			Estimated Fair Value
	(dollars in thousands)

Adjustable rate	$	4,562,693		$	240,181		$	(10,059	)	$	4,792,815
Fixed rate		89,011,207			1,092,711			(2,409,415	)		87,694,503

Total	$	93,573,900		$	1,332,892		$	(2,419,474	)	$	92,487,318

December 31, 2012

Freddie Mac

Fannie Mae

Ginnie Mae

Total Mortgage
Backed Securities