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: MARCH 31, 2014
OR
[ ] 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 | 10036 |
| (Address of principal executive offices) | (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 þ No o
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
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 April 30, 2014 |
| Common Stock, $.01 par value | 947,503,334 |
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ANNALY CAPITAL MANAGEMENT, INC.
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FORM 10-Q
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TABLE OF CONTENTS
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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
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CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
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(dollars in thousands, except per share data)
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March 31,
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December 31,
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|||||||
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2014
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2013(1)
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(Unaudited)
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ASSETS
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Cash and cash equivalents
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$ | 924,197 | $ | 552,436 | ||||
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Reverse repurchase agreements
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444,375 | 100,000 | ||||||
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Securities borrowed
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513,500 | 2,582,893 | ||||||
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Investments, at fair value:
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||||||||
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U.S. Treasury securities (including pledged assets of $0 and $1,113,027, respectively)
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- | 1,117,915 | ||||||
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Agency mortgage-backed securities (including pledged assets of $66,110,869 and $63,897,873, respectively)
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75,350,388 | 70,388,949 | ||||||
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Agency debentures (including pledged assets of $2,368,493 and $2,931,261, respectively)
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2,408,259 | 2,969,885 | ||||||
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Investment in affiliates
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137,647 | 139,447 | ||||||
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Commercial real estate debt and preferred equity(2)
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1,640,206 | 1,583,969 | ||||||
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Investments in commercial real estate
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40,313 | 60,132 | ||||||
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Corporate debt, held for investment
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145,394 | 117,687 | ||||||
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Receivable for investments sold
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19,116 | 1,193,730 | ||||||
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Accrued interest and dividends receivable
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276,007 | 273,079 | ||||||
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Receivable for investment advisory income (including from affiliates of $6,498 and $6,839, respectively)
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6,498 | 6,839 | ||||||
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Goodwill
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94,781 | 94,781 | ||||||
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Interest rate swaps, at fair value
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340,890 | 559,044 | ||||||
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Other derivatives, at fair value
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40,105 | 146,725 | ||||||
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Other assets
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33,101 | 34,949 | ||||||
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Total assets
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$ | 82,414,777 | $ | 81,922,460 | ||||
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LIABILITIES AND STOCKHOLDERS’ EQUITY
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Liabilities:
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||||||||
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U.S. Treasury securities sold, not yet purchased, at fair value
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$ | - | $ | 1,918,394 | ||||
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Repurchase agreements
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64,543,949 | 61,781,001 | ||||||
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Securities loaned
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513,510 | 2,527,668 | ||||||
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Payable for investments purchased
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1,898,507 | 764,131 | ||||||
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Convertible Senior Notes
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827,486 | 825,262 | ||||||
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Securitized debt of consolidated VIE
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260,700 | - | ||||||
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Mortgages payable
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19,317 | 19,332 | ||||||
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Participation sold
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13,963 | 14,065 | ||||||
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Accrued interest payable
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170,644 | 160,921 | ||||||
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Dividends payable
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284,247 | 284,230 | ||||||
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Interest rate swaps, at fair value
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1,272,616 | 1,141,828 | ||||||
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Other derivatives, at fair value
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6,045 | 55,518 | ||||||
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Accounts payable and other liabilities
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39,081 | 25,055 | ||||||
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Total liabilities
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69,850,065 | 69,517,405 | ||||||
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Stockholders’ Equity:
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7.875% Series A Cumulative Redeemable Preferred Stock:
7,412,500 authorized, issued and outstanding
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177,088 | 177,088 | ||||||
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7.625% Series C Cumulative Redeemable Preferred Stock:
12,650,000 authorized, 12,000,000 issued and outstanding
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290,514 | 290,514 | ||||||
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7.50% Series D Cumulative Redeemable Preferred Stock:
18,400,000 authorized, issued and outstanding
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445,457 | 445,457 | ||||||
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Common stock, par value $0.01 per share, 1,956,937,500 authorized,
947,488,945 and 947,432,862 issued and outstanding, respectively
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9,475 | 9,474 | ||||||
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Additional paid-in capital
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14,770,553 | 14,765,761 | ||||||
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Accumulated other comprehensive income (loss)
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(2,088,479 | ) | (2,748,933 | ) | ||||
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Accumulated deficit
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(1,039,896 | ) | (534,306 | ) | ||||
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Total stockholders’ equity
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12,564,712 | 12,405,055 | ||||||
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Total liabilities and stockholders’ equity
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$ | 82,414,777 | $ | 81,922,460 | ||||
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(1)
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Derived from the audited consolidated financial statements at December 31, 2013.
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(2)
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Includes senior securitized mortgages of consolidated VIE with a carrying value of $398.1 million at March 31, 2014.
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See notes to consolidated financial statements.
1
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
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(dollars in thousands, except per share data)
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(Unaudited)
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For the Quarter Ended
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March 31,
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March 31,
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|||||||
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2014
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2013
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Net interest income:
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Interest income
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$ | 655,901 | $ | 737,217 | ||||
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Interest expense
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124,971 | 177,590 | ||||||
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Net interest income
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530,930 | 559,627 | ||||||
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Other income (loss):
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Realized gains (losses) on interest rate swaps(1)
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(260,435 | ) | (225,476 | ) | ||||
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Realized gains (losses) on termination of interest rate swaps
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(6,842 | ) | (16,378 | ) | ||||
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Unrealized gains (losses) on interest rate swaps
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(348,942 | ) | 325,734 | |||||
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Subtotal
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(616,219 | ) | 83,880 | |||||
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Investment advisory income
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6,123 | 13,408 | ||||||
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Net gains (losses) on disposal of investments
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79,710 | 182,843 | ||||||
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Dividend income from affiliates
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13,045 | 6,431 | ||||||
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Net gains (losses) on trading assets
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(146,228 | ) | 1,549 | |||||
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Net unrealized gains (losses) on interest-only Agency mortgage-backed securities
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(20,793 | ) | 80,127 | |||||
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Other income (loss)
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1,460 | 132 | ||||||
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Subtotal
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(66,683 | ) | 284,490 | |||||
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Total other income (loss)
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(682,902 | ) | 368,370 | |||||
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General and administrative expenses:
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Compensation and management fee
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38,521 | 38,443 | ||||||
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Other general and administrative expenses
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8,857 | 13,469 | ||||||
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Total general and administrative expenses
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47,378 | 51,912 | ||||||
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Income (loss) before income taxes
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(199,350 | ) | 876,085 | |||||
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Income taxes
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4,001 | 5,807 | ||||||
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Net income (loss)
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(203,351 | ) | 870,278 | |||||
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Dividends on preferred stock
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17,992 | 17,992 | ||||||
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Net income (loss) available (related) to common stockholders
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$ | (221,343 | ) | $ | 852,286 | |||
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Net income (loss) per share available (related) to common stockholders:
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Basic
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$ | (0.23 | ) | $ | 0.90 | |||
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Diluted
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$ | (0.23 | ) | $ | 0.87 | |||
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Weighted average number of common shares outstanding:
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Basic
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947,458,813 | 947,249,901 | ||||||
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Diluted
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947,458,813 | 994,815,169 | ||||||
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Dividends Declared Per Share of Common Stock
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$ | 0.30 | $ | 0.45 | ||||
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Net income (loss)
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$ | (203,351 | ) | $ | 870,278 | |||
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Other comprehensive income (loss):
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Unrealized gains (losses) on available-for-sale securities
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741,172 | (867,151 | ) | |||||
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Reclassification adjustment for net (gains) losses included in net income (loss)
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(80,718 | ) | (182,843 | ) | ||||
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Other comprehensive income (loss)
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660,454 | (1,049,994 | ) | |||||
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Comprehensive income (loss)
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$ | 457,103 | $ | (179,716 | ) | |||
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(1)
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Interest expense related to the Company’s interest rate swaps is recorded in Realized gains (losses) on interest rate swaps.
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See notes to consolidated financial statements.
2
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
| ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES | ||||||||||||||||||||||||||||||||
| CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY | ||||||||||||||||||||||||||||||||
| (dollars in thousands, except per share data) | ||||||||||||||||||||||||||||||||
| (Unaudited) | ||||||||||||||||||||||||||||||||
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7.875% Series A Cumulative Redeemable Preferred Stock
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7.625% Series C Cumulative Redeemable Preferred Stock
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7.50% Series D Cumulative Redeemable Preferred Stock
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Common
Stock
Par
Value
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Additional
Paid-In
Capital
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Accumulated Other Comprehensive Income (Loss)
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Accumulated Deficit
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Total
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BALANCE, December 31, 2012
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$ | 177,088 | $ | 290,514 | $ | 445,457 | $ | 9,472 | $ | 14,740,774 | $ | 3,053,242 | $ | (2,792,103 | ) | $ | 15,924,444 | |||||||||||||||
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Net income (loss)
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- | - | - | - | - | - | 870,278 | 870,278 | ||||||||||||||||||||||||
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Unrealized gains (losses) on available-for-sale securities
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- | - | - | - | - | (867,151 | ) | - | (867,151 | ) | ||||||||||||||||||||||
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Reclassification adjustment for net (gains) losses
included in net income (loss)
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- | - | - | - | - | (182,843 | ) | - | (182,843 | ) | ||||||||||||||||||||||
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Exercise of stock options
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- | - | - | - | 265 | - | - | 265 | ||||||||||||||||||||||||
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Stock compensation expense
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- | - | - | - | 817 | - | - | 817 | ||||||||||||||||||||||||
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Net proceeds from direct purchase and dividend
reinvestment
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- | - | - | 1 | 760 | - | - | 761 | ||||||||||||||||||||||||
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Contingent beneficial conversion feature on 4%
Convertible Senior Notes
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- | - | - | - | 3,963 | - | - | 3,963 | ||||||||||||||||||||||||
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Preferred Series A dividends, declared $0.492 per share
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- | - | - | - | - | - | (3,648 | ) | (3,648 | ) | ||||||||||||||||||||||
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Preferred Series C dividends, declared $0.477 per share
|
- | - | - | - | - | - | (5,719 | ) | (5,719 | ) | ||||||||||||||||||||||
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Preferred Series D dividends, declared $0.469 per share
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- | - | - | - | - | - | (8,625 | ) | (8,625 | ) | ||||||||||||||||||||||
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Common dividends declared, $0.45 per share
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- | - | - | - | - | - | (426,173 | ) | (426,173 | ) | ||||||||||||||||||||||
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BALANCE, March 31, 2013
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$ | 177,088 | $ | 290,514 | $ | 445,457 | $ | 9,473 | $ | 14,746,579 | $ | 2,003,248 | $ | (2,365,990 | ) | $ | 15,306,369 | |||||||||||||||
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BALANCE, December 31, 2013
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$ | 177,088 | $ | 290,514 | $ | 445,457 | $ | 9,474 | $ | 14,765,761 | $ | (2,748,933 | ) | $ | (534,306 | ) | $ | 12,405,055 | ||||||||||||||
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Net income (loss)
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- | - | - | - | - | - | (203,351 | ) | (203,351 | ) | ||||||||||||||||||||||
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Unrealized gains (losses) on available-for-sale securities
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- | - | - | - | - | 741,172 | - | 741,172 | ||||||||||||||||||||||||
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Reclassification adjustment for net (gains) losses included
in net income (loss)
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- | - | - | - | - | (80,718 | ) | - | (80,718 | ) | ||||||||||||||||||||||
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Net proceeds from direct purchase and dividend
reinvestment
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- | - | - | 1 | 606 | - | - | 607 | ||||||||||||||||||||||||
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Contingent beneficial conversion feature on 4%
Convertible Senior Notes
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- | - | - | - | 4,186 | - | - | 4,186 | ||||||||||||||||||||||||
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Preferred Series A dividends, declared $0.492 per share
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- | - | - | - | - | - | (3,648 | ) | (3,648 | ) | ||||||||||||||||||||||
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Preferred Series C dividends, declared $0.477 per share
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- | - | - | - | - | - | (5,719 | ) | (5,719 | ) | ||||||||||||||||||||||
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Preferred Series D dividends, declared $0.469 per share
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- | - | - | - | - | - | (8,625 | ) | (8,625 | ) | ||||||||||||||||||||||
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Common dividends declared, $0.30 per share
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- | - | - | - | - | - | (284,247 | ) | (284,247 | ) | ||||||||||||||||||||||
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BALANCE, March 31, 2014
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$ | 177,088 | $ | 290,514 | $ | 445,457 | $ | 9,475 | $ | 14,770,553 | $ | (2,088,479 | ) | $ | (1,039,896 | ) | $ | 12,564,712 | ||||||||||||||
See notes to consolidated financial statements.
3
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
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CONSOLIDATED STATEMENTS OF CASH FLOWS
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(dollars in thousands)
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(Unaudited)
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For the Quarter Ended March 31,
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2014
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2013
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Cash flows from operating activities:
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Net income (loss)
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$ | (203,351 | ) | $ | 870,278 | |||
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Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
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Amortization of Investment Securities premiums and discounts, net
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118,988 | 421,057 | ||||||
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Amortization of commercial real estate investment premiums and discounts, net
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792 | - | ||||||
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Amortization of intangibles
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99 | 323 | ||||||
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Amortization of deferred financing costs
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2,813 | 2,038 | ||||||
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Amortization of net origination fees and costs, net
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(973 | ) | - | |||||
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Amortization of contingent beneficial conversion feature and equity component of Convertible Senior Notes
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6,410 | 3,324 | ||||||
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Depreciation expense
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292 | - | ||||||
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Net gain on sale of commercial real estate
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(1,213 | ) | - | |||||
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Net (gains) losses on sales of Agency mortgage-backed securities and debentures
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(80,718 | ) | (182,843 | ) | ||||
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Stock compensation expense
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- | 817 | ||||||
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Unrealized (gains) losses on interest rate swaps
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348,942 | (325,734 | ) | |||||
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Net unrealized (gains) losses on interest-only Agency mortgage-backed securities
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20,793 | (80,127 | ) | |||||
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Net (gains) losses on trading assets
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146,228 | 14,829 | ||||||
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Proceeds from repurchase agreements of RCap
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329,649,937 | 237,569,485 | ||||||
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Payments on repurchase agreements of RCap
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(324,602,992 | ) | (238,600,415 | ) | ||||
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Proceeds from reverse repurchase agreements
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35,181,890 | 105,335,861 | ||||||
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Payments on reverse repurchase agreements
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(35,526,265 | ) | (108,458,231 | ) | ||||
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Proceeds from securities borrowed
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19,993,580 | 53,799,157 | ||||||
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Payments on securities borrowed
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(17,924,187 | ) | (54,326,700 | ) | ||||
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Proceeds from securities loaned
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37,178,735 | 110,725,140 | ||||||
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Payments on securities loaned
|
(39,192,893 | ) | (110,203,395 | ) | ||||
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Proceeds from U.S. Treasury securities
|
3,159,253 | 21,683,636 | ||||||
|
Payments on U.S. Treasury securities
|
(3,920,425 | ) | (22,157,117 | ) | ||||
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Net payments on derivatives
|
(90,440 | ) | (1,490 | ) | ||||
|
Net change in:
|
||||||||
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Due to / from brokers
|
8,596 | - | ||||||
|
Other assets
|
3,439 | (14,779 | ) | |||||
|
Accrued interest and dividends receivable
|
(16,035 | ) | 22,616 | |||||
|
Receivable for investment advisory income
|
341 | 4,913 | ||||||
|
Accrued interest payable
|
25,032 | (11,147 | ) | |||||
|
Accounts payable and other liabilities
|
13,801 | 26,250 | ||||||
|
Net cash provided by (used in) operating activities
|
4,300,469 | (3,882,254 | ) | |||||
|
Cash flows from investing activities:
|
||||||||
|
Payments on purchases of Agency mortgage-backed securities and debentures
|
(9,367,034 | ) | (17,699,472 | ) | ||||
|
Proceeds from sales of Agency mortgage-backed securities and debentures
|
6,155,091 | 15,484,409 | ||||||
|
Principal payments on Agency mortgage-backed securities
|
1,675,575 | 8,514,074 | ||||||
|
Proceeds from Agency debentures called
|
- | 847,205 | ||||||
|
Payments on purchases of corporate debt
|
(28,705 | ) | (3,483 | ) | ||||
|
Principal payments on corporate debt
|
1,051 | 911 | ||||||
|
Origination of commercial real estate investments, net
|
(125,949 | ) | - | |||||
|
Proceeds from sales of commercial real estate held for sale
|
20,740 | - | ||||||
|
Principal payments on commercial real estate investments
|
69,795 | - | ||||||
|
Proceeds from derivatives
|
- | 7,465 | ||||||
|
Net cash provided by (used in) investing activities
|
(1,599,436 | ) | 7,151,109 | |||||
Statements continued on following page.
4
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
|
Cash flows from financing activities:
|
||||||||
|
Proceeds from repurchase agreements
|
49,726,537 | 101,631,583 | ||||||
|
Principal payments on repurchase agreements
|
(52,010,534 | ) | (103,063,408 | ) | ||||
|
Proceeds from issuance of securitized debt
|
260,700 | - | ||||||
|
Payment of deferred financing cost
|
(4,288 | ) | - | |||||
|
Proceeds from exercise of stock options
|
- | 265 | ||||||
|
Net proceeds from direct purchases and dividend reinvestments
|
607 | 761 | ||||||
|
Payments on participation sold
|
(72 | ) | - | |||||
|
Net payment on share repurchase
|
- | (141,149 | ) | |||||
|
Dividends paid
|
(302,222 | ) | (450,146 | ) | ||||
|
Net cash provided by (used in) financing activities
|
(2,329,272 | ) | (2,022,094 | ) | ||||
|
Net (decrease) increase in cash and cash equivalents
|
371,761 | 1,246,761 | ||||||
|
Cash and cash equivalents, beginning of period
|
552,436 | 615,789 | ||||||
|
Cash and cash equivalents, end of period
|
$ | 924,197 | $ | 1,862,550 | ||||
| - | - | |||||||
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Supplemental disclosure of cash flow information:
|
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Interest received
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$ | 769,627 | $ | 1,188,202 | ||||
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Dividends received
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$ | 13,045 | $ | 7,097 | ||||
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Investment advisory income received
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$ | 6,464 | $ | 18,321 | ||||
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Interest paid (excluding interest paid on interest rate swaps)
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$ | 118,131 | $ | 184,426 | ||||
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Net interest paid on interest rate swaps
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$ | 250,571 | $ | 226,463 | ||||
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Taxes paid
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$ | 2,137 | $ | 2,382 | ||||
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Noncash investing activities:
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Receivable for investments sold
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$ | 19,116 | $ | 1,292,478 | ||||
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Payable for investments purchased
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$ | 1,898,507 | $ | 3,203,461 | ||||
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Net change in unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment
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$ | 660,454 | $ | (1,049,994 | ) | |||
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Noncash financing activities:
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Dividends declared, not yet paid
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$ | 284,247 | $ | 426,173 | ||||
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Contingent beneficial conversion feature on 4% Convertible Senior Notes
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$ | 4,186 | $ | 3,963 |
See notes to consolidated financial statements.
5
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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Annaly Capital Management, Inc. (the “Company” or “Annaly”) is a Maryland corporation that commenced operations on February 18, 1997. The Company owns a portfolio of real estate related investments, including mortgage pass-through certificates, collateralized mortgage obligations, agency callable debentures, other securities representing interests in or obligations backed by pools of mortgage loans, commercial real estate assets and corporate loans. The Company’s principal business objective is to generate net income for distribution to its stockholders from its investments.
The Company’s business operations are primarily comprised of the following:
- Annaly, the parent company, which invests primarily in various types of Agency mortgage-backed securities and related derivatives to hedge these investments.
- Annaly Commercial Real Estate Group, Inc. (“ACREG,” formerly known as CreXus Investment Corp. (“CreXus”)), a wholly-owned subsidiary that was acquired during the second quarter of 2013 which specializes in acquiring, financing and managing commercial mortgage loans and other commercial real estate debt, commercial mortgage-backed securities and other commercial real estate-related assets.
- RCap Securities, Inc. (“RCap”), a wholly-owned subsidiary which operates as a broker-dealer, and is a member of the Financial Industry Regulatory Authority (“FINRA”).
- Fixed Income Discount Advisory Company (“FIDAC”), a wholly-owned subsidiary which manages an affiliated real estate investment trust (“REIT”) for which it earns fee income.
- Annaly Middle Market Lending LLC (formerly known as Charlesfort Capital Management LLC), a wholly-owned subsidiary which engages in corporate middle market lending transactions.
- Shannon Funding LLC (“Shannon”), a wholly-owned subsidiary which acquires residential mortgage loans and provides warehouse financing to residential mortgage originators in the United States.
The Company has elected to be taxed as a REIT as defined under the Internal Revenue Code of 1986, as amended, and regulations promulgated thereunder (the “Code”). The Company is externally managed by Annaly Management Company LLC (the “Manager”).
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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 ("GAAP").
The accompanying consolidated financial statements and related notes are unaudited and should be read in conjunction with the audited consolidated financial statements included in the Company’s most recent annual report on Form 10-K. The consolidated financial information as of December 31, 2013 has been derived from audited consolidated financial statements not included herein.
In the opinion of management, all normal, recurring adjustments have been included for a fair statement of this interim financial information. Interim period operating results may not be indicative of the operating results for a full year.
Principles of Consolidation – The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
The Company has evaluated all of its investments in legal entities in order to determine if they are variable interests in Variable Interest Entities ("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 subordinated 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.
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6
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
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To assess whether the Company has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, the Company considers all facts and circumstances, including the Company’s role in establishing the VIE and the Company’s ongoing rights and responsibilities. This assessment includes first, identifying the activities that most significantly impact the VIE’s economic performance; and second, identifying which party, if any, has power over those activities. In general, the parties that make the most significant decisions affecting the VIE or have the right to unilaterally remove those decision makers are deemed to have the power to direct the activities of a VIE.
To assess whether the Company has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE, the Company considers all of the Company’s economic interests, including debt and equity investments and other arrangements deemed to be variable interests in the VIE. This assessment requires that the Company applies judgment in determining whether these interests, in the aggregate, are considered potentially significant to the VIE. Factors considered in assessing significance include: the design of the VIE, including its capitalization structure; subordination of interests; payment priority; relative share of interests held across various classes within the VIE’s capital structure; and the reasons why the interests are held by the Company.
The Company performs ongoing reassessments of whether changes in the facts and circumstances regarding the Company’s involvement with a VIE causes the Company’s consolidation conclusion regarding the VIE to change.
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 and other derivatives. Cash and securities deposited with clearing organizations and collateral held in the form of cash on margin with counterparties to its interest rate swaps and other derivatives totaled $755.5 million and $371.8 million at March 31, 2014 and December 31, 2013, respectively.
Fair Value Measurements – The Company carries various financial instruments at fair value. A complete discussion of the methodology utilized by the Company to estimate the fair value of certain financial instruments is included in the notes to these consolidated financial statements.
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Revenue Recognition – The revenue recognition policy by asset class is discussed below.
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 the Government National Mortgage Association (“Ginnie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”) or the Federal National Mortgage Association (“Fannie Mae”) (collectively, “Agency mortgage-backed securities”). These Agency mortgage-backed securities may include forward contracts for Agency mortgage-backed securities purchases or sales of a generic pool, on a to-be-announced basis (“TBA securities”). The Company also invests in Agency debentures issued by the Federal Home Loan Banks, Freddie Mac and Fannie Mae.
Agency mortgage-backed securities and Agency debentures 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 are classified as available-for-sale and 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 other comprehensive income (loss). Investment Securities transactions are recorded on trade date, including TBA securities that meet the regular-way securities scope exception from derivative accounting. Realized gains and losses on sales of Investment Securities are determined using the average cost method.
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 with changes in fair value recorded as Net unrealized gains (losses) on interest-only Agency mortgage-backed securities in the Company’s Consolidated Statements of 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.
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7
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
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Interest income from coupon payments is accrued based on the outstanding principal amounts 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.
Corporate Debt – 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 March 31, 2014 and December 31, 2013.
Equity Securities – The Company may invest 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 Comprehensive Income (Loss) as Net gains (losses) on trading assets. Dividends are recorded in earnings based on the declaration date.
Derivative Instruments – The Company may use a variety of derivative instruments to economically hedge some of its exposure to market risks, including interest rate and prepayment risk. These instruments include, but are not limited to, interest rate swaps, options to enter into interest rate swaps (“swaptions”), TBA securities with the intent to net settle (“TBA derivatives”), options on TBA securities (“MBS options”) and U.S. Treasury futures contracts. The Company may also invest in other types of mortgage derivatives such as interest-only securities and synthetic total return swaps, such as the Markit IOS Synthetic Total Return Swap Index. Derivatives are accounted for in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging, which requires recognition of all derivatives as either assets or liabilities at fair value in the Consolidated Statements of Financial Condition with changes in fair value recognized in the Consolidated Statements of Comprehensive Income (Loss).
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Some derivative agreements contain provisions that allow for netting or setting off by counterparty; however, beginning on September 30, 2013, the Company elected to present related assets and liabilities on a gross basis in the Consolidated Statements of Financial Condition. Prior to September 30, 2013, the Company presented in the Consolidated Statements of Financial Condition the fair value of interest rate swap contracts net, by counterparty, if the derivative agreements included netting provisions.
Interest rate swap agreements - Interest rate swaps are the primary instrument used to mitigate interest rate risk. In particular, the Company uses interest rate swaps to manage its exposure to changing interest rates on its repurchase agreements by economically hedging cash flows associated with these borrowings. Swap agreements may be over-the-counter (“OTC”) agreements which are negotiated directly with a counterparty, or centrally cleared through a registered commodities exchange. OTC swaps are fair valued using internal pricing models and compared to the counterparty market values. Centrally cleared swaps are fair valued using internal pricing models and compared to the exchange market values.
Interest rate swaptions - Interest rate swaptions are purchased to mitigate the potential impact of increases or decreases in interest rates. Interest rate swaptions provide the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay and receive interest rates in the future. They are not centrally cleared. The premium paid for interest rate swaptions is reported as an asset in the Consolidated Statement of Financial Position. The difference between the premium and the fair value of the swaption is reported in Net gain (loss) on trading assets in the Consolidated Statements of Comprehensive Income (Loss). If a swaption expires unexercised, the realized gain (loss) on the swaption would be equal to the premium paid. If the Company sells or exercises a swaption, the realized gain or loss on the swaption would be equal to the difference between the cash received or the fair value of the underlying interest rate swap received and the premium paid.
The fair value of interest rate swaptions is estimated using internal pricing models and compared to the counterparty market value.
TBA Dollar Rolls - TBA dollar roll transactions are accounted for as a series of derivative transactions. The fair value of TBA derivatives is based on similar methods used to value Agency mortgage-backed securities with gains and losses recorded in Net gains (losses) on trading assets in the Consolidated Statements of Comprehensive Income (Loss).
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8
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
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MBS Options – MBS options are generally options on TBA contracts, which help manage mortgage market risks and volatility while providing the potential to enhance returns. MBS options are over-the-counter traded instruments and those written on current-coupon mortgage-backed securities are typically the most liquid. MBS options are fair valued using internal pricing models and compared to the counterparty market value at the valuation date with gains and losses recorded in Net gains (losses) on trading assets in the Consolidated Statements of Comprehensive Income (Loss).
U.S. Treasury Futures - U.S. Treasury futures contracts are derivatives that track the prices of specific U.S. Treasury securities. Short sales of U.S. Treasury futures contracts help mitigate the potential impact of changes in interest rates on the portfolio performance. The Company maintains a margin account which is settled daily with Futures Commission Merchants (“FCMs”). The margin requirement varies based on the market value of the open positions and the equity retained in the account. Futures contracts are fair valued based on exchange pricing with gains and losses recorded in Net gains (losses) on trading assets in the Consolidated Statements of Comprehensive Income (Loss).
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 conditions warrant such evaluation. When the fair value of an 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 security, (2) is more likely than not that it will be required to sell the security before recovery of its amortized cost basis, or (3) does not expect to recover the entire amortized cost basis of the security. 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 Comprehensive Income (Loss), while the balance of losses related to other factors will be recognized as a component of other comprehensive income (loss). There was no other-than-temporary impairment recognized for the quarters ended March 31, 2014 and December 31, 2013.
Loan Loss Reserves – To determine if loan loss allowances are required on investments in corporate debt, the Company reviews the monthly and/or quarterly financial statements of the borrowers to verify they meet the covenants of the loan documents. If based on the financial review it is deemed probable that the Company will be unable to collect contractual principal and interest amounts (e.g. financial performance and delinquencies), a loan loss provision would be recorded. No allowance for loan losses was deemed necessary as of March 31, 2014 and December 31, 2013.
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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 reverse repurchase and repurchase agreements entered into by RCap and Shannon as operating activities in the Consolidated Statements of Cash Flows.
Goodwill and Intangible Assets – The Company’s acquisitions of FIDAC, Merganser Capital Management, Inc. (“Merganser”) and CreXus were accounted for using the acquisition method. In October 2013, the Company sold the operations of Merganser. 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 may make it more likely than not that an impairment has occurred. If a qualitative analysis indicates that there may be an impairment, a quantitative analysis is performed. The quantitative 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.
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9
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
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Intangible assets with an estimated useful life are amortized over the expected life.
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. A Conversion Feature may be recognized as a result of adjustments to the conversion price for dividends declared to common stockholders.
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.
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 stockholders 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, RCap and certain subsidiaries of ACREG, have made separate joint elections to treat these subsidiaries as taxable REIT subsidiaries (“TRS”). As such, each of these TRSs is taxable as a domestic C corporation and subject to federal, state and local income taxes based upon their taxable income.
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 uncertain 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 March 31, 2014 and December 31, 2013.
Use of Estimates – The preparation of the consolidated financial statements in conformity with 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 from those estimates.
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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, net of unamortized origination fees and costs, premiums or discounts, less a reserve for estimated losses if necessary. Origination fees and costs, premiums and discounts are amortized or accreted into interest income over the estimated life of the loan. 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, net of unamortized origination fees and costs, premiums or discounts, less a reserve for estimated losses if necessary. Origination fees and costs, premiums and discounts are amortized or accreted into interest income over the estimated life of the investment.
Allowance for Losses – The Company evaluates the need for a loss reserve on its commercial real estate mortgages, loans and preferred equity interests held for investment (collectively referred to as “CRE Debt and Preferred Equity Investments”). A provision for losses related to CRE Debt and Preferred Equity Investments, including those accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, may be established when it is probable the Company will not collect amounts contractually due or all amounts previously estimated to be collectable. 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 CRE Debt and Preferred Equity Investments 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 conducts 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.
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10
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
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The Company may be exposed to various levels of credit risk depending on the nature of its investments and the nature and level of the assets underlying the investments and credit enhancements, if any, supporting its assets. The Company’s core investment process includes procedures related to the initial approval of and periodic monitoring of credit risk and other risks associated with each investment. The Company’s investment underwriting procedures include an evaluation of the borrower’s ability to manage and operate the properties. Management reviews loan to value metrics upon either the origination or the acquisition of a new investment but generally does not update the loan to value metrics in the course of quarterly surveillance. Management generally reviews the most recent financial information produced by the borrower, which may include, but is not limited to net operating income (“NOI’), debt service coverage ratios, property debt yields (net cash flow or NOI divided by the amount of outstanding indebtedness), loan per unit and rent rolls relating to each of the Company’s CRE Debt and Preferred Equity Investments, and may consider other factors management deems important. Management also reviews market pricing to determine the borrower’s ability to refinance the asset at the maturity of the loan. Management also reviews economic trends, both macro as well as those directly affecting the property, and the supply and demand of competing projects in the sub-market in which the subject property is located.
In connection with the quarterly surveillance review process, loans are assigned an internal rating of Performing Loans, Watch List Loans or Workout Loans. Loans that are deemed Performing Loans meet all present contractual obligations. Watch List Loans are defined as performing or nonperforming loans for which the timing of cost recovery is under review. Workout Loans are defined as loans for which there is likelihood that we may not recover our cost basis.
Investments in Commercial Real Estate – Investments in commercial 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.
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Investments in real estate are depreciated using the straight-line method over the estimated useful lives of the assets, summarized as follows:
Category Term
Building 35-40 years
Site improvements 2-7 years
The Company follows the acquisition method of accounting for acquisitions of operating real estate held for investment, where the purchase price of operating real estate is allocated to tangible assets such as land, building, site improvements and other identified intangibles such as above/below market and in-place leases.
The Company evaluates whether real estate acquired in connection with a foreclosure ("REO") or UCC/deed in lieu of foreclosure (herein collectively referred to as a foreclosure) constitutes a business and whether business combination accounting is applicable. Upon foreclosure of a property, the excess of the carrying value of a loan, if any, over the estimated fair value of the property, less estimated costs to sell, is charged to provision for loan losses.
Investments in commercial real estate, including REO, which do not meet the criteria to be classified as held for sale, are separately presented in the consolidated statements of financial condition as held for investment. Real estate held for sale is reported at the lower of its carrying value or its estimated fair value less estimated costs to sell. Once a property is determined to be held for sale, depreciation is no longer recorded. In addition, if considered material to the overall consolidated financial statements, the results of operations are reclassified to income (loss) from discontinued operations in the consolidated statements of comprehensive income (loss).
The Company's real estate portfolio (REO and real estate held for investment) is reviewed on a quarterly basis, or more frequently as necessary, to assess whether there are any indicators that the value of its operating real estate may be impaired or that its carrying value may not be recoverable. A property's value is considered impaired if the Company's estimate of the aggregate future undiscounted cash flows to be generated by the property is less than the carrying value of the property. In conducting this review, the Company considers U.S. macroeconomic factors, including real estate sector conditions, together with asset specific and other factors. To the extent impairment has occurred and is considered to be other than temporary, the loss will be measured as the excess of the carrying amount of the property over the calculated fair value of the property.
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11
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
| Revenue Recognition – Commercial Real Estate Investments - Interest income is accrued based on the outstanding principal amount of the CRE Debt and Preferred Equity Investments and their contractual terms. Premiums and discounts associated with the purchase of the CRE Debt and Preferred Equity Investments are amortized or accreted into interest income over the projected lives of the CRE Debt and Preferred Equity Investments using the interest method based on the estimated recovery value.
Broker Dealer Activities
In January 2014, RCap ceased its trading activity in U.S. Treasury securities, derivatives and certain securities borrowed and loaned transactions.
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 in some instances, 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. 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.
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U.S. Treasury Securities – RCap traded in U.S. Treasury securities for its proprietary portfolio, which consisted of long and short positions on U.S Treasury notes and bonds. U.S. Treasury securities were classified as trading investments and were recorded on the trade date at cost. Changes in fair value are reflected in Net gains (losses) on trading assets in the Company’s Consolidated Statement of Comprehensive Income (Loss). Interest income or expense on U.S. Treasury notes and bonds was accrued based on the outstanding principal amount of those investments and their stated terms.
Derivatives - RCap entered primarily into U.S. Treasury, Eurodollar, federal funds, German government and U.S. equity index and currency futures and options contracts. RCap maintained a margin account which was settled daily with FCMs. 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 Net gains (losses) on trading assets in the Company’s Consolidated Statements of 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.
A Summary of Recent Accounting Pronouncements Follows:
Presentation
Presentation of Financial Statements (ASC 205)/Property, Plant and Equipment (ASC 360)
On April 10, 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360) Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which raises the threshold for a disposal to be treated as discontinued operations. Under this update, the Company is required to report disposals that represent a strategic shift that has (or will have) a major effect on the Company’s operations and financial results if the component of the Company or group of components meets the criteria to be accounted for as held for sale or the component of the Company or group of components is disposed of by sale. The ASU removes requirements that operations and cash flows have been (or will be eliminated) from the ongoing operations and that the Company will not have any significant continuing involvement with the component in order to be reported as discontinued operations. Additionally, ASU 2014-08 also eliminates a number of scope exceptions and requires additional disclosures for transactions that meet the definition of a discontinued operations and significant items that are disposed of or held for sale that do not meet the discontinued operations criteria. The ASU is effective for reporting periods beginning after December 15, 2014 with early adoption permitted. Adoption is not expected to have a significant impact on the consolidated financial statements.
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12
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
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Balance Sheet (ASC 210)
On December 23, 2011, the 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 Company’s Consolidated Statements of Financial Condition 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, the 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 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 other comprehensive income. 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 other comprehensive income on the components of net income and other comprehensive income. No other requirements under ASU 2011-05 are affected by ASU 2011-12. The 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 other comprehensive income 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 other comprehensive income by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, a cross-reference must be provided to other disclosures required under 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.
Assets
Receivables – Troubled Debt Restructurings by Creditors (ASC 310-40)
In January 2014, the FASB issued ASU 2014-04, Receivables–Troubled Debt Restructurings by Creditors, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, which clarifies that an in substance repossession or foreclosure has occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, when the creditor obtains legal title to the property upon completion of a foreclosure or the borrower conveys all interest in the property to the creditor through a deed in lieu of foreclosure or similar arrangement. ASU 2014-04 also requires disclosure of the amount of foreclosed residential real estate held by the creditor and the recorded investment in mortgage loans collateralized by residential real estate property in the process of foreclosure. The update is effective for reporting periods beginning after December 15, 2014. Adoption is not expected to have a significant impact on the consolidated financial statements.
|
13
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to 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. In January 2014, the FASB has officially removed the Investment Companies: Real
|
Estate Property Investments and the Investment Properties projects from its agenda. As stated in ASC 946-10-15-3, the guidance in Topic 946 does not apply to REITs, and thus has no effect on the Company’s consolidated financial statements.
|
The following tables present the Company’s available-for-sale Agency mortgage-backed securities portfolio as of March 31, 2014 and December 31, 2013 which were carried at their fair value:
|
March 31, 2014
|
Freddie Mac
|
Fannie Mae
|
Ginnie Mae
|
Total
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Principal outstanding
|
$ | 24,875,914 | $ | 47,149,481 | $ | 113,744 | $ | 72,139,139 | ||||||||
|
Unamortized premium
|
1,697,704 | 3,367,828 | 22,465 | 5,087,997 | ||||||||||||
|
Unamortized discount
|
(9,446 | ) | (11,341 | ) | (380 | ) | (21,167 | ) | ||||||||
|
Amortized cost
|
26,564,172 | 50,505,968 | 135,829 | 77,205,969 | ||||||||||||
|
Gross unrealized gains
|
205,409 | 381,265 | 8,650 | 595,324 | ||||||||||||
|
Gross unrealized losses
|
(1,013,503 | ) | (1,433,916 | ) | (3,486 | ) | (2,450,905 | ) | ||||||||
|
Estimated fair value
|
$ | 25,756,078 | $ | 49,453,317 | $ | 140,993 | $ | 75,350,388 | ||||||||
|
Fixed Rate
|
Adjustable Rate
|
Total
|
||||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Amortized cost
|
$ | 73,655,761 | $ | 3,550,208 | $ | 77,205,969 | ||||||||||
|
Gross unrealized gains
|
455,048 | 140,276 | 595,324 | |||||||||||||
|
Gross unrealized losses
|
(2,435,557 | ) | (15,348 | ) | (2,450,905 | ) | ||||||||||
|
Estimated fair value
|
$ | 71,675,252 | $ | 3,675,136 | $ | 75,350,388 | ||||||||||
|
December 31, 2013
|
Freddie Mac
|
Fannie Mae
|
Ginnie Mae
|
Total
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Principal outstanding
|
$ | 24,458,925 | $ | 43,564,657 | $ | 120,739 | $ | 68,144,321 | ||||||||
|
Unamortized premium
|
1,627,966 | 2,970,813 | 27,085 | 4,625,864 | ||||||||||||
|
Unamortized discount
|
(9,533 | ) | (11,568 | ) | (383 | ) | (21,484 | ) | ||||||||
|
Amortized cost
|
26,077,358 | 46,523,902 | 147,441 | 72,748,701 | ||||||||||||
|
Gross unrealized gains
|
227,423 | 456,057 | 9,845 | 693,325 | ||||||||||||
|
Gross unrealized losses
|
(1,267,106 | ) | (1,781,683 | ) | (4,288 | ) | (3,053,077 | ) | ||||||||
|
Estimated fair value
|
$ | 25,037,675 | $ | 45,198,276 | $ | 152,998 | $ | 70,388,949 | ||||||||
|
Fixed Rate
|
Adjustable Rate
|
Total
|
||||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Amortized cost
|
$ | 68,784,424 | $ | 3,964,277 | $ | 72,748,701 | ||||||||||
|
Gross unrealized gains
|
538,556 | 154,769 | 693,325 | |||||||||||||
|
Gross unrealized losses
|
(3,040,153 | ) | (12,924 | ) | (3,053,077 | ) | ||||||||||
|
Estimated fair value
|
$ | 66,282,827 | $ | 4,106,122 | $ | 70,388,949 | ||||||||||
| Actual maturities of Agency mortgage-backed securities are generally shorter than stated contractual maturities because actual maturities of Agency mortgage-backed securities are affected by periodic payments and prepayments of principal on the underlying mortgages. The following table summarizes the Company’s Agency |
mortgage-backed securities as of March 31, 2014 and December 31, 2013, according to their estimated weighted average life classifications:
|
14
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
|
March 31, 2014
|
December 31, 2013
|
|||||||||||||||
|
Weighted Average Life
|
Estimated
Fair Value
|
Amortized
Cost
|
Estimated
Fair Value
|
Amortized
Cost
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Less than one year
|
$ | 66,051 | $ | 65,248 | $ | 65,584 | $ | 64,561 | ||||||||
|
Greater than one year through five years
|
46,192,942 | 47,553,922 | 50,046,013 | 51,710,059 | ||||||||||||
|
Greater than five years through ten years
|
22,833,176 | 23,099,356 | 14,915,716 | 15,292,973 | ||||||||||||
|
Greater than ten years
|
6,258,219 | 6,487,443 | 5,361,636 | 5,681,108 | ||||||||||||
|
Total
|
$ | 75,350,388 | $ | 77,205,969 | $ | 70,388,949 | $ | 72,748,701 | ||||||||
|
The weighted average lives of the Agency mortgage-backed securities at March 31, 2014 and December 31, 2013 in the table above are based upon principal prepayment rates for each security provided through subscription-based financial information services. The prepayment model considers current yield, forward yield, steepness of the yield curve, current mortgage rates, mortgage rate of the outstanding loans, loan age, margin, volatility and other factors. The actual weighted average lives of the Agency mortgage-backed securities could be longer or shorter than estimated.
|
The following table presents the gross unrealized losses and estimated fair value of the Company’s Agency mortgage-backed securities by length of time that such securities have been in a continuous unrealized loss position at March 31, 2014 and December 31, 2013.
|
|
March 31, 2014
|
December 31, 2013
|
|||||||||||||||||||||||
|
Estimated
Fair Value
|
Gross
Unrealized
Losses
|
Number of
Securities
|
Estimated
Fair Value
|
Gross
Unrealized
Losses
|
Number of
Securities
|
|||||||||||||||||||
|
(dollars in thousands)
|
||||||||||||||||||||||||
|
Less than 12 Months
|
$ | 50,079,785 | $ | (2,046,126 | ) | 642 | $ | 47,677,197 | $ | (2,569,474 | ) | 583 | ||||||||||||
|
12 Months or More
|
6,055,285 | (404,779 | ) | 50 | 6,102,283 | (483,603 | ) | 55 | ||||||||||||||||
|
Total
|
$ | 56,135,070 | $ | (2,450,905 | ) | 692 | $ | 53,779,480 | $ | (3,053,077 | ) | 638 | ||||||||||||
|
The decline in value of these securities 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 the Company currently has 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 the Company will be required to sell the investments before recovery of the amortized cost bases, which may be maturity. Also, the Company is guaranteed payment of the principal amount of the securities by the respective issuing government agency.
During the quarter ended March 31, 2014, the Company disposed of $4.3 billion of Agency mortgage-backed securities, resulting in a net realized gain of $129.5 million. During the quarter ended March 31, 2013, the Company sold $16.3 billion of Agency mortgage-backed securities, resulting in a net realized gain of $182.8 million. Average cost is used as the basis on which the realized gain or loss on sale is determined.
|
Agency interest-only mortgage-backed securities represent the right to receive a specified portion of the contractual interest flows of the underlying outstanding principal balance of specific Agency mortgage-backed securities. Agency interest-only mortgage-backed securities in the Company’s portfolio as of March 31, 2014 and December 31, 2013 had net unrealized gains of $57.3 million and $78.1 million and an amortized cost of $1.1 billion and $1.0 billion, respectively.
On April 17, 2013, the Company, through its wholly-owned subsidiary CXS Acquisition Corporation, obtained control of CreXus pursuant to the merger agreement dated January 30, 2013. CreXus owned a portfolio of commercial real estate assets which are now owned by the Company. Following the acquisition, CXS Acquisition Corporation was renamed Annaly Commercial Real Estate Group, Inc.
|
15
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
| The business combination was accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations, (“ASC 805”). Accordingly, goodwill was measured as the excess of the aggregate of the acquisition-date fair value of the consideration transferred and the acquisition-date fair value of the Company’s previously held equity interest in CreXus over the fair value, at acquisition date, of the |
identifiable assets acquired net of assumed liabilities. The following table summarizes the aggregate consideration and preliminary fair value of the assets acquired and liabilities assumed at the acquisition date:
|
|
April 17, 2013
|
||||
|
(dollars in thousands)
|
||||
|
Cash consideration transferred
|
$ | 876,267 | ||
|
Fair value of equity interest in CreXus held before the business combination
|
106,521 | |||
|
|
$ | 982,788 | ||
|
Recognized amounts of identifiable assets acquired and liabilities assumed
|
||||
|
Cash and cash equivalents
|
$ | 151,843 | ||
|
Commercial real estate investments
|
796,950 | |||
|
Accrued interest receivable
|
3,485 | |||
|
Other assets
|
5,617 | |||
|
Mortgages payable
|
(19,376 | ) | ||
|
Participation sold
|
(14,352 | ) | ||
|
Accounts payable and accrued expenses
|
(12,729 | ) | ||
|
Total identifiable net assets
|
911,438 | |||
|
Goodwill
|
71,350 | |||
|
|
$ | 982,788 | ||
|
The Company recorded $71.4 million of goodwill during the second quarter of 2013 associated with the acquisition of CreXus in the Consolidated Statements of Financial Condition. The Company recorded a $0.4 million adjustment to goodwill during the second half of 2013. The final goodwill recorded on the Consolidated Statements of Financial Condition may differ from that reflected herein as a result of future measurement period adjustments. In management’s opinion, the goodwill represents the synergies that will result from integrating CreXus’ commercial real estate platform into the Company, which the Company believes is complementary to its existing business and return profile.
The acquisition-date fair value of the previously held equity interest in CreXus excluded the estimated fair
|
value of the control premium that resulted from the merger transaction. The Company recognized a loss of $18.9 million during the second quarter of 2013 as a result of remeasuring the fair value of its equity interest in CreXus held before the business combination.
Under ASC 805, merger-related transactions costs (such as advisory, legal, valuation and other professional fees) are not included as components of consideration transferred but are expensed in the periods in which the costs are incurred. Transaction costs of $7.3 million were incurred during 2013 and were included in other general and administrative expenses in the Consolidated Statements of Comprehensive Income (Loss).
|
16
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
At March 31, 2014 and December 31, 2013, commercial real estate investments were composed of the following:
CRE Debt and Preferred Equity Investments
|
March 31, 2014
|
December 31, 2013
|
|||||||||||||||||||||||
|
Outstanding
Principal
|
Carrying
Value(1)
|
Percentage
of Loan
Portfolio(2)
|
Outstanding
Principal
|
Carrying
Value(1)
|
Percentage
of Loan
Portfolio(2)
|
|||||||||||||||||||
|
(dollars in thousands)
|
(dollars in thousands)
|
|||||||||||||||||||||||
|
Senior mortgages
|
$ | 337,845 | $ | 336,845 | 20.5 | % | $ | 669,512 | $ | 667,299 | 42.2 | % | ||||||||||||
|
Senior securitized mortgages(3)
|
399,541 | 398,113 | 24.3 | % | - | - | 0.0 | % | ||||||||||||||||
|
Subordinate notes
|
15,965 | 16,049 | 1.0 | % | 41,059 | 41,408 | 2.6 | % | ||||||||||||||||
|
Mezzanine loans
|
641,253 | 641,887 | 39.0 | % | 626,883 | 628,102 | 39.5 | % | ||||||||||||||||
|
Preferred equity
|
249,769 | 247,312 | 15.2 | % | 249,769 | 247,160 | 15.7 | % | ||||||||||||||||
|
Total
|
$ | 1,644,373 | $ | 1,640,206 | 100 | % | $ | 1,587,223 | $ | 1,583,969 | 100 | % | ||||||||||||
|
(1) Net carrying value includes unamortized origination fees of $4.9 million.
|
|
(2) Based on outstanding principal.
|
|
(3) Assets of consolidated VIE.
|
|
March 31, 2014
|
||||||||||||||||||||||||
|
Senior
Mortgages
|
Senior Securitized
Mortgages(1)
|
Subordinate
Notes
|
Mezzanine
Loans
|
Preferred
Equity
|
Total
|
|||||||||||||||||||
|
(dollars in thousands)
|
||||||||||||||||||||||||
|
Beginning balance
|
$ | 667,299 | $ | - | $ | 41,408 | $ | 628,102 | $ | 247,160 | $ | 1,583,969 | ||||||||||||
|
Originations & advances (principal)
|
67,946 | - | - | 59,000 | - | 126,946 | ||||||||||||||||||
|
Principal payments
|
(72 | ) | - | (25,094 | ) | (44,630 | ) | - | (69,796 | ) | ||||||||||||||
|
Sales (principal)
|
- | - | - | - | - | - | ||||||||||||||||||
|
Amortization & accretion of (premium) discounts
|
(36 | ) | - | (265 | ) | (617 | ) | 28 | (890 | ) | ||||||||||||||
|
Net (increase) decrease in origination fees
|
(1,012 | ) | - | - | 15 | 1 | (996 | ) | ||||||||||||||||
|
Amortization of net origination fees
|
698 | 135 | - | 17 | 123 | 973 | ||||||||||||||||||
|
Transfers
|
(397,978 | ) | 397,978 | - | - | - | - | |||||||||||||||||
|
Allowance for loan losses
|
- | - | - | - | - | - | ||||||||||||||||||
|
Net carrying value
|
$ | 336,845 | $ | 398,113 | $ | 16,049 | $ | 641,887 | $ | 247,312 | $ | 1,640,206 | ||||||||||||
|
(1) Assets of consolidated VIE.
|
||||||||||||||||||||||||
|
December 31, 2013
|
||||||||||||||||||||||||
|
Senior
Mortgages
|
Senior Securitized
Mortgages(1)
|
Subordinate
Notes
|
Mezzanine
Loans
|
Preferred
Equity
|
Total
|
|||||||||||||||||||
|
(dollars in thousands)
|
||||||||||||||||||||||||
|
Beginning balance
|
$ | 429,229 | $ | - | $ | 41,571 | $ | 568,759 | $ | 187,623 | $ | 1,227,182 | ||||||||||||
|
Originations & advances (principal)
|
240,150 | - | - | 136,040 | 60,000 | 436,190 | ||||||||||||||||||
|
Principal payments
|
(388 | ) | - | (90 | ) | (64,035 | ) | - | (64,513 | ) | ||||||||||||||
|
Sales (principal)
|
(13,750 | ) | - | - | - | - | (13,750 | ) | ||||||||||||||||
|
Amortization & accretion of (premium) discounts
|
(37 | ) | - | (73 | ) | (192 | ) | 31 | (271 | ) | ||||||||||||||
|
Net (increase) decrease in origination fees
|
(1,106 | ) | - | - | 14 | (601 | ) | (1,693 | ) | |||||||||||||||
|
Amortization of net origination fees
|
701 | - | - | 16 | 107 | 824 | ||||||||||||||||||
|
Transfers
|
12,500 | - | - | (12,500 | ) | - | - | |||||||||||||||||
|
Allowance for loan losses
|
- | - | - | - | - | - | ||||||||||||||||||
|
Net carrying value
|
$ | 667,299 | $ | - | $ | 41,408 | $ | 628,102 | $ | 247,160 | $ | 1,583,969 | ||||||||||||
|
(1) Assets of consolidated VIE.
|
||||||||||||||||||||||||
17
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
Internal CRE Debt and Preferred Equity Investment Ratings
|
March 31, 2014
|
||||||||||||||||||||
|
Percentage of CRE Debt and
|
Internal Ratings
|
|||||||||||||||||||
|
Investment Type
|
Outstanding Principal
|
Preferred Equity Portfolio |
Performing
|
Watch List Loans
|
Workout Loans
|
|||||||||||||||
|
(dollars in thousands)
|
||||||||||||||||||||
|
Senior mortgages
|
$ | 337,845 | 20.5 | % | $ | 312,372 | $ | 25,473 | (2) | $ | - | |||||||||
|
Senior securitized mortgages(1)
|
399,541 | 24.3 | % | 399,541 | - | - | ||||||||||||||
|
Subordinate notes
|
15,965 | 1.0 | % | 15,965 | - | - | ||||||||||||||
|
Mezzanine loans
|
641,253 | 39.0 | % | 635,253 | 6,000 | - | ||||||||||||||
|
Preferred equity
|
249,769 | 15.2 | % | 249,769 | - | - | ||||||||||||||
| $ | 1,644,373 | 100 | % | $ | 1,612,900 | $ | 31,473 | $ | - | |||||||||||
|
(1) Assets of consolidated VIE.
|
|
(2) Includes approximately $13 million related to one loan on non accrual status.
|
|
December 31, 2013
|
||||||||||||||||||||
|
Percentage of CRE Debt and
|
Internal Ratings
|
|||||||||||||||||||
|
Investment Type
|
Outstanding Principal
|
Preferred Equity Portfolio |
Performing
|
Watch List Loans
|
Workout Loans
|
|||||||||||||||
|
(dollars in thousands)
|
||||||||||||||||||||
|
Senior mortgages
|
$ | 669,512 | 42.2 | % | $ | 644,039 | $ | 25,473 | (1) | $ | - | |||||||||
|
Subordinate notes
|
41,059 | 2.6 | % | 41,059 | - | - | ||||||||||||||
|
Mezzanine loans
|
626,883 | 39.5 | % | 620,883 | 6,000 | - | ||||||||||||||
|
Preferred equity
|
249,769 | 15.7 | % | 249,769 | - | - | ||||||||||||||
| $ | 1,587,223 | 100 | % | $ | 1,555,750 | $ | 31,473 | $ | - | |||||||||||
|
(1) Includes approximately $13 million related to one loan on non accrual status.
|
||||||||||||||||||||
Total Commercial Real Estate Investment
|
March 31, 2014
|
December 31, 2013
|
|||||||
|
(dollars in thousands)
|
(dollars in thousands)
|
|||||||
|
Real estate held for investment, at amortized cost
|
||||||||
|
Land
|
$ | 6,639 | $ | 6,639 | ||||
|
Buildings and improvements
|
31,100 | 31,100 | ||||||
|
Subtotal
|
37,739 | 37,739 | ||||||
|
Less: accumulated depreciation
|
(1,170 | ) | (877 | ) | ||||
|
Total real estate held for investment at amortized cost, net
|
36,569 | 36,862 | ||||||
|
Real estate held for sale at fair value
|
3,744 | 23,270 | ||||||
|
Total investment in commercial real estate, net
|
40,313 | 60,132 | ||||||
|
Net carrying value of CRE Debt and Preferred Equity Investments
|
1,640,206 | 1,583,969 | ||||||
|
Total commercial real estate investments
|
$ | 1,680,519 | $ | 1,644,101 | ||||
|
Securitizations and VIEs
In January 2014, the Company closed NLY Commercial Mortgage Trust 2014-FL1 (the “Trust”), a $399.5 million securitization financing transaction which provides permanent, non-recourse financing collateralized by floating-rate first mortgage debt investments originated or purchased by the Company and is not subject to margin calls. A total of $260.7 million of investment grade bonds were issued by the
|
Trust, representing an advance rate of 65.3% at a weighted average coupon of LIBOR plus 1.74%. The Company is using the proceeds to originate commercial real estate investments. The Company retained bonds rated below investment grade and the only interest-only bond issued by the Trust, which are referred to as the subordinate bonds.
The Company incurred approximately $4.3 million of costs in connection with the securitization that have been capitalized and are being amortized to interest expense. Deferred financing costs are included in Other assets in the accompanying consolidated statements of financial condition.
|
18
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
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The Trust is structured as a pass through entity that receives principal and interest on the underlying collateral and distributes those payments to the certificate holders. The Trust is a VIE and the Company is the primary beneficiary as a result of its ability to replace the special servicer without cause through its ownership interest in the subordinate bonds. The Company’s exposure to the obligations of the VIE is generally limited to the Company’s investment in the Trust. Assets of the Trust may only be used to settle obligations of the Trust. Creditors of the Trust have no recourse to the general credit of the Company. The Company is not contractually required to provide and has not provided any form of financial support to the Trust. No gain or loss was recognized upon initial consolidation of the Trust.
As of March 31, 2014 the carrying value of the Trust’s assets was $398.1 million, net of $1.4 million of unamortized origination fees, which are included in Commercial real estate debt and preferred equity investments in the accompanying Consolidated Statements of Financial Condition. As of March 31, 2014, the carrying value of the Trust’s liabilities was $260.7 million, classified as Securitized debt in the accompanying Consolidated Statements of Financial Condition.
The Company follows fair value guidance in accordance with GAAP to account for its financial instruments. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
GAAP requires classification of the instruments into a three-level hierarchy based on the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Financial assets and liabilities recorded at fair value on the Consolidated Statements of Financial Condition or disclosed in the related notes are categorized based on the inputs to the valuation techniques as follows:
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Level 1– inputs to the valuation methodology are quoted prices (unadjusted) for identical assets and liabilities in active markets.
Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 – inputs to the valuation methodology are unobservable and significant to overall fair value.
The Company designates its financial instruments as available for sale or trading depending upon the type of instrument and the Company’s intent and ability to hold such instrument to maturity. Instruments classified as available for sale and trading are reported at fair value on a recurring basis.
The following is a description of the valuation methodologies used for instruments carried at fair value. These methodologies are applied to assets and liabilities across the three level fair value hierarchy, with the observability of inputs determining the appropriate level.
U.S. Treasury securities and investment in affiliates are valued using quoted prices for identical instruments in active markets. Agency mortgage-backed securities, Agency debentures, interest rate swaps, swaptions and other derivatives are valued using quoted prices, including dealer quotes, or internally estimated prices for similar assets using internal models. The Company incorporates common market pricing methods, including a spread measurement to the Treasury curve as well as underlying characteristics of the particular security including coupon, prepayment speeds, periodic and life caps, rate reset period and expected life of the security in its estimates of fair value. Management reviews the fair values generated by the internal models to determine whether prices are reflective of the current market. Management indirectly corroborates its estimates of the fair value derived using internal models by comparing its results to independent prices provided by dealers in the securities and/or third party pricing services. Certain liquid asset classes, such as Agency fixed-rate pass-throughs, may be priced using independent sources such as quoted prices for TBA securities.
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19
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements
| The Agency mortgage-backed securities, interest rate swap and swaption markets are considered to be active markets such that participants transact with sufficient frequency and volume to provide transparent pricing information on an ongoing basis. The liquidity of the Agency mortgage-backed securities, interest rate swaps and swaptions markets and the similarity of the Company’s securities to those actively traded enable the Company to observe quoted prices in the market and utilize those prices as a basis for formulating fair | value measurements. Consequently, the Company has classified Agency mortgage-backed securities, interest rate swaps, swaptions, TBA derivatives and MBS options as Level 2 inputs in the fair value hierarchy.
The following table presents the estimated fair values of financial instruments measured at fair value on a recurring basis.
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Level 1
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Level 2
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Level 3
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Total
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March 31, 2014
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(dollars in thousands)
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Assets:
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Agency mortgage-backed securities
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$ | - | $ | 75,350,388 | $ | - | $ | 75,350,388 | ||||||||
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Agency debentures
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- | 2,408,259 | - | 2,408,259 | ||||||||||||
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Investment in affiliates
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137,647 | - | - | 137,647 | ||||||||||||
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Interest rate swaps
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- | 340,890 | - | 340,890 | ||||||||||||
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Other derivatives
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- | |||||||||||||||