a51216304.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 

 
FORM 10-Q

[X]             QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED:  SEPTEMBER 30, 2015

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  
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 October 30, 2015
  Common Stock, $.01 par value 947,835,514
 
 
 
 
 
ANNALY CAPITAL MANAGEMENT, INC.
  
FORM 10-Q
  
TABLE OF CONTENTS
  
   
   
PART I  -  FINANCIAL INFORMATION
  
   
Item 1.  Financial Statements
Page
Consolidated Statements of Financial Condition at September 30, 2015 (Unaudited) and December 31, 2014 (Derived from the audited consolidated financial statements at December 31, 2014)
1
Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the quarters and nine months ended September 30, 2015 and 2014
2
Consolidated Statements of Stockholders’ Equity (Unaudited) for the nine months ended September 30, 2015 and 2014
3
Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2015 and 2014
4
Notes to Consolidated Financial Statements (Unaudited)
  
Note 1. Description of Business
6
Note 2. Basis of Presentation
6
Note 3. Significant Accounting Policies
6
Note 4. Agency Mortgage-Backed Securities
16
Note 5. Commercial Real Estate Investments
18
Note 6. Fair Value Measurements
25
Note 7. Secured Financing
28
Note 8. Derivative Instruments
29
Note 9. Convertible Senior Notes
32
Note 10. Common Stock and Preferred Stock
32
Note 11. Interest Income and Interest Expense
34
Note 12. Goodwill
34
Note 13. Net Income (Loss) per Common Share
34
Note 14. Long-Term Stock Incentive Plan
35
Note 15. Income Taxes
35
Note 16. Lease Commitments and Contingencies
36
Note 17. Risk Management
36
Note 18. RCap Regulatory Requirements
37
Note 19. Related Party Transactions
37
Note 20. Subsequent Events
38
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
  
Special Note Regarding Forward-Looking Statements
39
Overview
41
Business Environment
41
Results of Operations
43
Financial Condition
51
Capital Management
54
Risk Management
57
Critical Accounting Policies and Estimates
65
Glossary of Terms
67
   
Item 3. Quantitative and Qualitative Disclosures about Market Risk
75
   
Item 4. Controls and Procedures
75
   
PART II  -  OTHER INFORMATION
  
   
Item 1. Legal Proceedings
76
   
Item 1A. Risk Factors
76
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 76
   
Item 6. Exhibits
77
   
SIGNATURES
80
 
 
 
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1.  Financial Statements
 
PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
  
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
  
(dollars in thousands, except per share data)
  
             
   
September 30,
    
December 31,
  
   
2015
    
2014(1)
  
   
(Unaudited)
        
ASSETS
            
             
Cash and cash equivalents (including cash pledged as collateral of $2,098,919 and $1,584,701, respectively)
   $ 2,237,423     $ 1,741,244  
Reverse repurchase agreements
     -       100,000  
Investments, at fair value:
                
Agency mortgage-backed securities (including pledged assets of $59,721,331 and $74,006,480, respectively)
     65,806,640       81,565,256  
Agency debentures (including pledged assets of $97,463 and $1,368,350, respectively)
     413,115       1,368,350  
Credit risk transfer securities (including pledged assets of $101,908 and $0, respectively)
     330,727       -  
Non-Agency mortgage-backed securities (including pledged assets of $332,034 and $0, respectively)
     490,037       -  
Commercial real estate debt investments (including pledged assets of $2,881,659 and $0, respectively) (2)
     2,881,659       -  
Investment in affiliate
     -       143,045  
Commercial real estate debt and preferred equity, held for investment (including pledged assets of $220,390 and $0, respectively) (3)
     1,316,595       1,518,165  
Loans held for sale
     476,550       -  
Investments in commercial real estate
     301,447       210,032  
Corporate debt
     424,974       166,464  
Receivable for investments sold
     127,571       1,010,094  
Accrued interest and dividends receivable
     228,169       278,489  
Receivable for investment advisory income (including from affiliate of $3,992 and $10,402, respectively)
     3,992       10,402  
Goodwill
     71,815       94,781  
Interest rate swaps, at fair value
     39,295       75,225  
Other derivatives, at fair value
     87,516       5,499  
Other assets
     101,162       68,321  
Total assets
   $ 75,338,687     $ 88,355,367  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                
                 
Liabilities:
                
Repurchase agreements
     56,449,364       71,361,926  
Other secured financing
     359,970       -  
Convertible Senior Notes
     -       845,295  
Securitized debt of consolidated VIEs (4)
     2,553,398       260,700  
Mortgages payable
     166,697       146,553  
Participation sold
     13,389       13,693  
Payable for investments purchased
     744,378       264,984  
Accrued interest payable
     145,554       180,501  
Dividends payable
     284,348       284,293  
Interest rate swaps, at fair value
     2,160,350       1,608,286  
Other derivatives, at fair value
     113,626       8,027  
Accounts payable and other liabilities
     63,280       47,328  
Total liabilities
     63,054,354       75,021,586  
                 
Stockholders’ Equity:
                
7.875% Series A Cumulative Redeemable Preferred Stock:
7,412,500 authorized, issued and outstanding
     177,088       177,088  
7.625% Series C Cumulative Redeemable Preferred Stock:
12,650,000 authorized, 12,000,000 issued and outstanding
     290,514       290,514  
7.50% Series D Cumulative Redeemable Preferred Stock:
18,400,000 authorized, issued and outstanding
     445,457       445,457  
Common stock, par value $0.01 per share, 1,956,937,500 authorized,
947,826,176 and 947,643,079 issued and outstanding, respectively
     9,478       9,476  
Additional paid-in capital
     14,789,320       14,786,509  
Accumulated other comprehensive income (loss)
     262,855       204,883  
Accumulated deficit
     (3,695,884 )     (2,585,436 )
Total stockholders’ equity
     12,278,828       13,328,491  
Noncontrolling interest
     5,505       5,290  
Total equity
     12,284,333       13,333,781  
Total liabilities and equity
   $ 75,338,687     $ 88,355,367  
 
(1)
Derived from the audited consolidated financial statements at December 31, 2014.
(2)
Includes senior securitized commercial mortgage loans of consolidated VIEs carried at fair value of $2.6 billion and $0 at September 30, 2015 and December 31, 2014, respectively. 
(3)
Includes senior securitized commercial mortgage loans of a consolidated VIE with a carrying value of $314.9 million and $398.6 million carried at amortized cost, net of an allowance for losses of $0, at September 30, 2015 and December 31, 2014. 
(4)
Includes securitized debt of consolidated VIEs carried at fair value of $2.4 billion and $0 at September 30, 2015 and December 31, 2014, respectively. 

See notes to consolidated financial statements.
 
 
1
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
  
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
  
(dollars in thousands, except per share data)
  
(Unaudited)
  
                         
   
Quarter Ended September 30,
    
Nine Months Ended September 30,
  
   
2015
    
2014
    
2015
    
2014
  
                         
Net interest income:
                        
Interest income
   $ 450,792     $ 644,640     $ 1,594,310     $ 1,984,503  
Interest expense
     110,297       127,069       352,789       378,147  
Net interest income
     340,495       517,571       1,241,521       1,606,356  
                                 
Realized and unrealized gains (losses):
                                
Realized gains (losses) on interest rate swaps(1)
     (162,304 )     (169,083 )     (465,008 )     (650,452 )
Realized gains (losses) on termination of interest rate swaps
     -       -       (226,462 )     (779,333 )
Unrealized gains (losses) on interest rate swaps
     (822,585 )     98,593       (587,995 )     (75,287 )
Subtotal
     (984,889 )     (70,490 )     (1,279,465 )     (1,505,072 )
Net gains (losses) on disposal of investments
     (7,943 )     4,693       58,246       90,296  
Net gains (losses) on trading assets
     108,175       4,676       (12,961 )     (188,041 )
Net unrealized gains (losses) on financial instruments measured at fair value through earnings
     (24,501 )     (37,944 )     (40,466 )     (56,652 )
Impairment of goodwill
     -       -       (22,966 )     -  
Subtotal
     75,731       (28,575 )     (18,147 )     (154,397 )
Total realized and unrealized gains (losses)
     (909,158 )     (99,065 )     (1,297,612 )     (1,659,469 )
                                 
Other income (loss):
                                
Investment advisory income
     3,780       8,253       24,848       20,485  
Dividend income from affiliate
     -       4,048       8,636       21,141  
Other income (loss)
     (13,521 )     (22,249 )     (36,947 )     (16,102 )
Total other income (loss)
     (9,741 )     (9,948 )     (3,463 )     25,524  
                                 
General and administrative expenses:
                                
Compensation and management fee
     37,450       39,028       113,093       116,826  
Other general and administrative expenses
     12,007       12,289       39,311       34,058  
Total general and administrative expenses
     49,457       51,317       152,404       150,884  
                                 
Income (loss) before income taxes
     (627,861 )     357,241       (211,958 )     (178,473 )
Income taxes
     (370 )     2,385       (8,039 )     5,534  
Net income (loss)
     (627,491 )     354,856       (203,919 )     (184,007 )
Net income (loss) attributable to noncontrolling interest
     (197 )     -       (436 )     -  
Net income (loss) attributable to Annaly
     (627,294 )     354,856       (203,483 )     (184,007 )
Dividends on preferred stock
     17,992       17,992       53,976       53,976  
Net income (loss) available (related) to common stockholders
   $ (645,286 )   $ 336,864     $ (257,459 )   $ (237,983 )
Net income (loss) per share available (related) to common stockholders:
                                
Basic
   $ (0.68 )   $ 0.36     $ (0.27 )   $ (0.25 )
Diluted
   $ (0.68 )   $ 0.35     $ (0.27 )   $ (0.25 )
Weighted average number of common shares outstanding:
                                
Basic
     947,795,500       947,565,432       947,732,735       947,513,514  
Diluted
     947,795,500       987,315,527       947,732,735       947,513,514  
Dividends declared per share of common stock
   $ 0.30     $ 0.30     $ 0.90     $ 0.90  
Net income (loss)
   $ (627,491 )   $ 354,856     $ (203,919 )   $ (184,007 )
Other comprehensive income (loss):
                                
Unrealized gains (losses) on available-for-sale securities
     609,725       (390,871 )     116,154       1,872,427  
Reclassification adjustment for net (gains) losses included in net income (loss)
     8,095       (4,693 )     (58,182 )     (91,314 )
Other comprehensive income (loss)
     617,820       (395,564 )     57,972       1,781,113  
Comprehensive income (loss)
   $ (9,671 )   $ (40,708 )   $ (145,947 )   $ 1,597,106  
Comprehensive income (loss) attributable to noncontrolling interest
     (197 )     -       (436 )     -  
Comprehensive income (loss) attributable to Annaly
     (9,474 )     (40,708 )     (145,511 )     1,597,106  
Dividends on preferred stock
     17,992       17,992       53,976       53,976  
Comprehensive income (loss) attibutable to common stockholders
   $ (27,466 )   $ (58,700 )   $ (199,487 )   $ 1,543,130  
 
(1)  
Consists of interest expense on interest rate swaps. 
 
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)
  
                                                             
   
7.875% Series A Cumulative Redeemable Preferred Stock
    
7.625% Series C Cumulative Redeemable Preferred Stock
    
7.50% Series D Cumulative Redeemable Preferred Stock
    
Common stock par value
    
Additional paid-in capital
    
Accumulated other comprehensive income (loss)
    
Accumulated deficit
    
Total stockholders’ equity
    
Noncontrolling interest
    
Total
  
BALANCE, December 31, 2013
   $ 177,088     $ 290,514     $ 445,457     $ 9,474     $ 14,765,761     $ (2,748,933 )   $ (534,306 )   $ 12,405,055     $ -     $ 12,405,055  
Net income (loss) attributable to Annaly
     -       -       -       -       -       -       (184,007 )     (184,007 )     -       (184,007 )
Unrealized gains (losses) on available-for-sale securities
     -       -       -       -       -       1,872,427       -       1,872,427       -       1,872,427  
Reclassification adjustment for net (gains) losses included in net income (loss)
     -       -       -       -       -       (91,314 )     -       (91,314 )     -       (91,314 )
Stock compensation expense
     -       -       -       -       998       -       -       998       -       998  
Net proceeds from direct purchase and dividend reinvestment
     -       -       -       2       1,784       -       -       1,786       -       1,786  
Contingent beneficial conversion feature on 4% Convertible Senior Notes
     -       -       -       -       12,765       -       -       12,765       -       12,765  
Preferred Series A dividends, declared $1.477 per share
     -       -       -       -       -       -       (10,944 )     (10,944 )     -       (10,944 )
Preferred Series C dividends, declared $1.430 per share
     -       -       -       -       -       -       (17,157 )     (17,157 )     -       (17,157 )
Preferred Series D dividends, declared $1.406 per share
     -       -       -       -       -       -       (25,875 )     (25,875 )     -       (25,875 )
Common dividends declared, $0.90 per share
     -       -       -       -       -       -       (852,786 )     (852,786 )     -       (852,786 )
BALANCE, September 30, 2014
   $ 177,088     $ 290,514     $ 445,457     $ 9,476     $ 14,781,308     $ (967,820 )   $ (1,625,075 )   $ 13,110,948     $ -     $ 13,110,948  
BALANCE, December 31, 2014
   $ 177,088     $ 290,514     $ 445,457     $ 9,476     $ 14,786,509     $ 204,883     $ (2,585,436 )   $ 13,328,491     $ 5,290     $ 13,333,781  
Net income (loss) attributable to Annaly
     -       -       -       -       -       -       (203,483 )     (203,483 )     -       (203,483 )
Net income (loss) attributable to noncontrolling interest
     -       -       -       -       -       -       -       -       (436 )     (436 )
Unrealized gains (losses) on available-for-sale securities
     -       -       -       -       -       116,154       -       116,154       -       116,154  
Reclassification adjustment for net (gains) losses included in net income (loss)
     -       -       -       -       -       (58,182 )     -       (58,182 )     -       (58,182 )
Stock compensation expense
     -       -       -       -       1,089       -       -       1,089       -       1,089  
Net proceeds from direct purchase and dividend reinvestment
     -       -       -       2       1,722       -       -       1,724       -       1,724  
Equity contributions from (distributions to) noncontrolling interest
     -       -       -       -       -       -       -       -       651       651  
Preferred Series A dividends, declared $1.477 per share
     -       -       -       -       -       -       (10,944 )     (10,944 )     -       (10,944 )
Preferred Series C dividends, declared $1.430 per share
     -       -       -       -       -       -       (17,157 )     (17,157 )     -       (17,157 )
Preferred Series D dividends, declared $1.406 per share
     -       -       -       -       -       -       (25,875 )     (25,875 )     -       (25,875 )
Common dividends declared, $0.90 per share
     -       -       -       -       -       -       (852,989 )     (852,989 )     -       (852,989 )
BALANCE, September 30, 2015
   $ 177,088     $ 290,514     $ 445,457     $ 9,478     $ 14,789,320     $ 262,855     $ (3,695,884 )   $ 12,278,828     $ 5,505     $ 12,284,333  
 
See notes to consolidated financial statements.
 
 
3
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
  
CONSOLIDATED STATEMENTS OF CASH FLOWS
  
(dollars in thousands)
  
(Unaudited)
  
             
   
Nine Months Ended September 30,
  
   
2015
    
2014
  
Cash flows from operating activities:
            
Net income (loss)
   $ (203,919 )   $ (184,007 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating  activities:
                
Amortization of Investment Securities premiums and discounts, net
     633,937       466,338  
Amortization of commercial real estate investment premiums and discounts, net
     (1,080 )     607  
Amortization of intangibles
     5,095       445  
Amortization of deferred financing costs
     5,192       8,023  
Amortization of net origination fees and costs, net
     (3,350 )     (3,337 )
Amortization of contingent beneficial conversion feature and equity component of Convertible Senior Notes
     12,246       24,128  
Depreciation expense
     8,773       1,264  
Net gain on sale of commercial real estate
     -       (2,748 )
Net loss on sale of commercial real estate debt held for investment
     100       -  
Net (gains) losses on sales of Investment Securities
     (70,796 )     (91,314 )
Net (gain) loss on sale of investment in affiliate
     12,450       -  
Stock compensation expense
     1,089       998  
Impairment of goodwill
     22,966       -  
Unrealized (gains) losses on interest rate swaps
     587,995       75,287  
Net unrealized (gains) losses on financial instruments measured at fair value through earnings
     40,466       56,652  
Equity in net income from unconsolidated joint venture     414       -  
Net (gains) losses on trading assets
     12,961       188,041  
Proceeds from repurchase agreements of RCap
     1,447,650,000       747,790,774  
Payments on repurchase agreements of RCap
     (1,452,000,000 )     (742,842,907 )
Proceeds from reverse repurchase agreements
     39,875,000       60,698,578  
Payments on reverse repurchase agreements
     (39,775,000 )     (60,598,578 )
Proceeds from securities borrowed
     -       23,888,955  
Payments on securities borrowed
     -       (21,306,062 )
Proceeds from securities loaned
     -       41,939,298  
Payments on securities loaned
     -       (44,466,959 )
Proceeds from U.S. Treasury securities
     -       3,159,253  
Payments on U.S. Treasury securities
     -       (3,920,425 )
Net payments on derivatives
     7,288       (98,704 )
Net change in:
                
Due to / from brokers
     -       8,596  
Other assets
     (29,324 )     (2,011 )
Accrued interest and dividends receivable
     52,057       (27,362 )
Receivable for investment advisory income
     6,410       (1,530 )
Accrued interest payable
     (34,947 )     34,733  
Accounts payable and other liabilities
     17,417       2,958  
Net cash provided by (used in) operating activities
     (3,166,560 )     4,798,984  
                 
Cash flows from investing activities:
                
Payments on purchases of Investment Securities
     (13,172,943 )     (27,898,595 )
Proceeds from sales of Investment Securities
     22,081,011       15,529,556  
Principal payments on Agency mortgage-backed securities
     7,811,368       5,945,647  
Proceeds from sale of investment in affiliate
     126,402       -  
Payments on purchases of corporate debt
     (301,739 )     (114,183 )
Principal payments on corporate debt
     43,846       88,078  
Purchases of commercial real estate debt investments
     (368,511 )     -  
Sales of commercial real estate debt investments
     41,016       -  
Purchase of securitized loans at fair value
     (2,574,353 )     -  
Origination of commercial real estate investments, net
     (826,877 )     (206,849 )
Proceeds from sale of commercial real estate investments
     227,450       -  
Principal payments on commercial real estate debt investments
     10,170       -  
Proceeds from sales of commercial real estate held for sale
     -       26,019  
Principal payments on commercial real estate investments
     327,936       237,796  
Purchase of investments in real estate
     (29,900 )     (36,743 )
Investment in unconsolidated joint venture
     (70,602 )     -  
Purchase of equity securities
     (27,519 )     -  
Proceeds from sale of equity securities     13,119       -  
Net cash provided by (used in) investing activities
     13,309,874       (6,429,274 )
                 
 
 
4
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
Cash flows from financing activities:
                
Proceeds from repurchase agreements
     156,196,644       147,564,412  
Principal payments on repurchase agreements
     (166,759,206 )     (144,682,558 )
Payments on maturity of convertible senior notes
     (857,541 )     -  
Proceeds from other secured financing
     687,935       -  
Payments on other secured financing
     (327,965 )     -  
Proceeds from issuance of securitized debt
     2,382,810       260,700  
Principal repayments on securitized debt
     (84,560 )     -  
Principal repayments on securitized loans
     201       -  
Payment of deferred financing cost
     (886 )     (4,288 )
Net proceeds from direct purchases and dividend reinvestments
     1,724       1,785  
Proceeds from mortgages payable
     20,450       23,375  
Principal payments on participation sold
     (220 )     (207 )
Principal payments on mortgages payable
     (262 )     (30 )
Contributions from noncontrolling interests     1,107       -  
Distributions to noncontrolling interests
     (456 )     -  
Dividends paid
     (906,910 )     (906,714 )
Net cash provided by (used in) financing activities
     (9,647,135 )     2,256,475  
                 
Net (decrease) increase in cash and cash equivalents
     496,179       626,185  
Cash and cash equivalents, beginning of period
     1,741,244       552,436  
Cash and cash equivalents, end of period
   $ 2,237,423     $ 1,178,621  
Supplemental disclosure of cash flow information:
                
Interest received
   $ 2,241,301     $ 2,454,211  
Dividends received
   $ 12,684     $ 21,141  
Investment advisory income received
   $ 31,258     $ 18,955  
Interest paid (excluding interest paid on interest rate swaps)
   $ 314,568     $ 370,784  
Net interest paid on interest rate swaps
   $ 450,750     $ 640,316  
Taxes paid
   $ 1,926     $ 6,925  
                 
Noncash investing activities:
                
Receivable for investments sold
   $ 127,571     $ 855,161  
Payable for investments purchased
   $ 744,378     $ 2,153,789  
Net change in unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment
   $ 57,972     $ 1,781,113  
                 
Noncash financing activities:
                
Dividends declared, not yet paid
   $ 284,348     $ 284,278  
Contingent beneficial conversion feature on 4% Convertible Senior Notes
   $ -     $ 12,765  
 
See notes to consolidated financial statements.
 
 
5
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1.  Financial Statements
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
1.           DESCRIPTION OF BUSINESS
 
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 debentures, credit risk transfer (“CRT”) securities, 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 is externally managed by Annaly Management Company LLC (the “Manager”).
 
The Company’s business operations are primarily comprised of the following:
 
-  Annaly, the parent company, which invests primarily in both Agency and non-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 real estate loans and other commercial real estate debt, commercial mortgage-backed securities and other commercial real estate-related assets.
-  Annaly Middle Market Lending LLC (“MML,” formerly known as Charlesfort Capital Management LLC), a wholly-owned subsidiary which engages in corporate middle market lending transactions.
-  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 managed an affiliated real estate investment trust (“REIT”) for which it earned fee income.
 
The Company has elected to be taxed as a Real Estate Investment Trust (“REIT”) as defined under the Internal Revenue Code of 1986, as amended, and regulations promulgated thereunder (the “Code”).
  
2.           BASIS OF PRESENTATION
 
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, 2014 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 presentation of this interim financial information. Interim period operating results may not be indicative of the operating results for a full year.

3.           SIGNIFICANT ACCOUNTING POLICIES
 
Principles of Consolidation – The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and consolidated variable interest entities. All intercompany balances and transactions have been eliminated in consolidation.  The Company reclassified previously presented financial information so that amounts previously presented conform to the current presentation.
 
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.
 
 
6
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
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 applies significant judgment and considers all of its economic interests, including debt and equity investments and other arrangements deemed to be variable interests, both explicit and implicit, 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, cash held in money market funds on an overnight basis and cash pledged as collateral with counterparties. Cash 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. RCap is a member of various clearing organizations with which it maintains cash required to conduct its day-to-day clearance activities. Cash and securities deposited with clearing organizations and collateral held in the form of cash on margin with counterparties to the Company’s interest rate swaps and other derivatives totaled approximately $2.1 billion and $1.6 billion at September 30, 2015 and December 31, 2014, respectively.
  
Fair Value Measurements – The Company reports 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 these Notes to Consolidated Financial Statements.

Revenue Recognition – The revenue recognition policy by asset class is discussed below.

Agency Mortgage-Backed Securities, Agency Debentures, Non-Agency Mortgage-Backed Securities and CRT Securities – 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, as well as CRT securities. CRT securities are risk sharing instruments issued by Fannie Mae and Freddie Mac, and similarly structured transactions arranged by third party market participants. CRT securities are designed to synthetically transfer mortgage credit risk from Fannie Mae and Freddie Mac to private investors. The Company also invests in non-Agency mortgage-backed securities such as those issued in non-performing loan and re-performing loan securitizations.

Agency mortgage-backed securities, Agency debentures, non-Agency mortgage-backed securities and CRT securities 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 the overall management of its portfolio. Investment Securities classified as available-for-sale are reported at fair value with unrealized gains and losses reported as a component of other comprehensive income (loss). The fair value of Investment Securities classified as available-for-sale are estimated by management and are compared to independent sources for reasonableness.  Investment Securities transactions are recorded on trade date, including TBA securities that meet the regular-way securities scope exception from derivative accounting.
 
 
7
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
The Company previously changed its accounting policy for determining the realized gains and losses on sales of Investment Securities from the average cost method to the specific identification method.  The Company determined that the specific identification method was preferable because it more accurately matches gains or losses with costs and is the methodology predominantly used by its industry peers, among other considerations.  The impact of the change was immaterial to the consolidated financial statements and prior periods.

The Company elected the fair value option for interest-only mortgage-backed securities, non-Agency mortgage-backed securities and certain CRT securities. Interest-only securities and inverse interest-only securities are collectively referred to as “interest-only securities.” These interest-only mortgage-backed securities represent the Company’s right to receive a specified proportion of the contractual interest flows of specific mortgage-backed securities. Interest-only mortgage-backed securities, non-Agency mortgage-backed securities and certain CRT securities are measured at fair value with changes in fair value recorded as Net unrealized gains (losses) on financial instruments measured at fair value through earnings 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.

Interest income from coupon payments is accrued based on the outstanding principal amounts of the Investment Securities and their contractual terms. In addition, the Company recognizes income under the retrospective method on substantially all of its Investment Securities classified as available-for-sale. Premiums and discounts associated with the purchase of Investment Securities are amortized or accreted into income over the remaining projected lives of the securities. Using a third-party supplied model and market information to project future cash flows and expected remaining lives of securities, the effective interest rate determined for each security is applied as if it had been in place from the security’s acquisition.  The amortized cost of the investment is then adjusted to the amount that would have existed had the new effective yield been applied since the acquisition.  The adjustment to amortized cost is offset with a charge or credit to interest income.  Changes in interest rates and other market factors will impact prepayment speed projections.

Corporate Debt   – The Company’s investments in corporate debt that are loans are designated as held for investment, and those that are debt securities are designated as held to maturity when the Company has the intent and ability to hold the investment until maturity or payoff.  These investments are carried at their principal balance outstanding plus any premiums or discounts less allowances for loan losses (or other-than-temporary impairment). No allowance for loan losses or other-than temporary impairment was recognized as of September 30, 2015 and December 31, 2014. Interest income from coupon payments is accrued based upon the outstanding principal amounts of the debt and its contractual terms. Premiums and discounts are amortized or accreted into interest income using the interest method.
  
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 without intent to accept delivery (“TBA derivatives”), options on TBA securities (“MBS options”) and U.S. Treasury and Eurodollar 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). None of the Company’s derivative transactions have been designated as hedging instruments for accounting purposes. 

Some derivative agreements contain provisions that allow for netting or setting off by counterparty; however, the Company elected to present related assets and liabilities on a gross basis in the Consolidated Statements of Financial Condition.
 
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 or may not be cleared through a derivatives clearing organization (“DCO”).  Uncleared 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 DCO’s market values.
 
 
8
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
Interest rate swaptions - Interest rate swaptions are purchased/sold 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/received for interest rate swaptions is reported as an asset/liability in the Consolidated Statement of Financial Condition. The difference between the premium and the fair value of the swaption is reported in Net gains (losses) 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 received/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).

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).
  
Futures Contracts - Futures contracts are derivatives that track the prices of specific assets. Short sales of futures contracts help mitigate the potential impact of changes in interest rates on the portfolio performance. The Company maintains margin accounts that are 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 and nine months ended September 30, 2015 and 2014.
 
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 September 30, 2015 and December 31, 2014.
 
 
9
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
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.
 
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 meet the criteria to 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 as operating activities in the Consolidated Statements of Cash Flows.

Goodwill and Intangible Assets – The Company’s acquisitions are accounted for using the acquisition method. Under the acquisition method, net assets and results of operations of acquired companies are included in the consolidated financial statements from the date of acquisition. The purchase prices are 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.  An impairment of the goodwill associated with the Company’s acquisition of FIDAC was recorded in the nine months ended September 30, 2015.

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

Convertible Senior Notes – The Company recorded 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. The 4% and 5% Convertible Senior Notes matured in February 2015 and May 2015, respectively.

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 subject 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 (“TRSs”).  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 September 30, 2015 and December 31, 2014.

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.

Commercial Real Estate Investments
 
Commercial Real Estate Debt Investments - The Company’s commercial real estate debt investments are comprised of commercial mortgage backed securities and loans held by consolidated collateralized financing entities.  Commercial mortgage backed securities are classified as available-for-sale and reported at fair value with unrealized gains and losses reported as a component of other comprehensive income (loss). Management evaluates commercial mortgage backed securities for other-than-temporary impairment at least quarterly.  See the Commercial Real Estate Investment footnote for additional information regarding the consolidated collateralized financing entities.
 
 
10
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
Commercial Real Estate Loans – The Company's commercial real estate loans are comprised of fixed-rate and adjustable-rate loans. The Company designates loans as held for investment if it has the intent and ability to hold the loans until maturity or payoff.  If the Company intends to sell or securitize the loans and the securitization vehicle is not expected to be consolidated, they are classified as held for sale. Commercial real estate loans that are designated as held for investment and are originated or purchased by the Company 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. Commercial real estate loans that are designated as held for sale are carried at the lower of amortized cost or fair value and recorded as Loans held for sale in the accompanying Consolidated Statements of Financial Condition. The Company determines the fair value of commercial real estate loans held for sale on an individual loan basis. The difference between the principal amount of a loan and proceeds at acquisition is recorded as either a discount or premium. Origination fees and costs, premiums and discounts are amortized or accreted into interest income, where required by US GAAP, over the estimated life of the loan.  The Company has elected the fair value option for multi-family mortgage loans held in securitization trusts that it was required to consolidate.  Interest income is recognized as earned determined by the stated coupon and outstanding principal balance.  See “Commercial Real Estate Investments” footnote for additional information.

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 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.

The Company may be exposed to various levels of credit risk depending on the nature of its investments and the nature 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 and periodic monitoring of credit risk and other risks associated with each investment.  The Company’s investment underwriting procedures include evaluation of the underlying borrowers’ ability to manage and operate their respective 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 each borrower’s ability to refinance their respective assets at the maturity of each 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 each subject property is located.
 
 
11
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
In connection with the quarterly surveillance review process, loans are assigned an internal rating of “Performing”, “Watch List”, “Defaulted-Recovery” or “Impaired”. Loans that are deemed to be Performing meet all present contractual obligations and do not qualify for Watch List designation.  Watch List loans are defined as Performing loans that are significantly lagging expectations and/or for which there is an increased potential for default. Defaulted–Recovery loans are currently in default; however full recovery of contractual principal and interest is expected. Impaired loans may or may not be in default, impairment is anticipated, and a loan loss provision has been recognized to reflect expected losses.

Investments in Commercial Real Estate – Investments in commercial real estate are carried at historical cost less accumulated depreciation. Historical cost includes all costs necessary to bring the asset to the condition and location necessary for its intended use, including financing during the construction period.  Costs directly related to acquisitions deemed to be business combinations are expensed. Ordinary repairs and maintenance which are not reimbursed by 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.

Investments in commercial real estate are depreciated using the straight-line method over the estimated useful lives of the assets, summarized as follows:
 
Category                            Term
 
Building                               31 - 40 years
Site improvements              1 - 10 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 applies the equity method of accounting for its investments in joint ventures where it is not considered to have a controlling financial interest.    Under the equity method of accounting, the Company will recognize its share of earnings or losses of the investee in the period in which they are reported by the investee.  The Company also considers whether there are any indicators of other-than-temporary impairment of joint ventures accounted for under the equity method.

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, that 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.

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.

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 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.

Broker Dealer Activities

In January 2014, RCap ceased its trading activity in U.S. Treasury securities, derivatives and 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 settlement 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
 
 
12
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
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.
  
Recent Accounting Pronouncements

The following table provides a brief description of recent accounting pronouncements that could potentially impact the Company’s consolidated financial statements:
 
 
13
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
Standard
  
Description
Date of Adoption
Effect on the financial statements or other significant matters
Standards that are not yet adopted
        
ASU 2015-16 Business Combinations (Topic 805) Simplifying the Accounting Measurement-Period Adjustments
 
  
This amendment removes the requirement to present adjustments to provisional amounts retrospectively.  The update requires that an acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to provisional amounts.
January 1, 2016 (early adoption permitted)
Not expected to have a significant impact on the consolidated financial statements.
ASU 2015-10, Technical Corrections and Improvements
  
This perpetual project updates the Codification for technical corrections and improvements.
January 1, 2016 (early adoption permitted), for amendments subject to transition guidance
Not expected to have a significant impact on the consolidated financial statements.
ASU 2015-07, Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)
  
This update removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient and also removes certain disclosure requirements for these investments.
January 1, 2016 (early adoption permitted)
Not expected to have an impact on the consolidated financial statements.
ASU 2015-05, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement
  
This update clarifies that customers should determine whether a cloud computing arrangement includes the license of software by applying the same guidance cloud service providers use.  The guidance also eliminates the current requirement that customers analogize to the leasing standard when determining the asset acquired in a software licensing arrangement.
January 1, 2016 (early adoption permitted)
Not expected to have a significant impact on the consolidated financial statements.
ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs
  
This ASU requires that debt issue costs are presented in the balance sheet as a direct deduction from the carrying amount of that debt liability.  The recognition and measurement of debt issue costs are not affected.
January 1, 2016 (early adoption permitted)
Impacts presentation only and will not have a significant impact on the consolidated financial statements.
ASU 2015-02, Consolidation (Topic 810) Amendments to the Consolidation Analysis
  
This update affects the following areas of the consolidation analysis:  limited partnerships and similar entities, evaluation of fees paid to a decision maker or service provider as a variable interest and in determination of the primary beneficiary, effect of related parties on the primary beneficiary determination and for certain investment funds.
January 1, 2016 (early adoption permitted)
Not expected to have a significant impact on the consolidated financial statements.
ASU 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20)
  
This update eliminates from GAAP the concept of extraordinary items.
January 1, 2016 (early adoption permitted)
Not expected to have an impact on the consolidated financial statements.
ASU 2014-16, Derivatives and Hedging (Topic 815) Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is More Akin to Debt or Equity
  
This ASU provides additional guidance for evaluating whether conversion rights, redemption rights, voting rights, liquidation rights and dividend payment preferences and other features embedded in a share, including preferred stock, contain embedded derivatives requiring bifurcation.  The update requires that an entity determine the nature of the host contract by considering all stated and implied terms and features in a hybrid instrument.
January 1, 2016 (early adoption permitted)
Not expected to have an impact on the consolidated financial statements.
ASU 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-04) Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
  
This ASU requires management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date the financial statements are issued.
January 1, 2017 (early adoption permitted)
Not expected to have an impact on the consolidated financial statements.
ASU 2014-09, Revenue from Contracts with Customers
  
This guidance applies to contracts with customers to transfer goods or services and contracts to transfer nonfinancial assets unless those contracts are within the scope of other standards (for example, lease transactions).
 January 1, 2018
Not expected to have a significant impact on the consolidated financial statements.
 
 
14
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
Standard
  
Description
Date of Adoption
Effect on the financial statements or other significant matters
Standards that were adopted
        
ASU 2015-15, Interest - Imputation of Interest (Subtopic 835-30) Simplifying the Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements - Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting (SEC Update)
  
This amendment provides SEC guidance that it would not object to filers presenting debt issue costs related to line-of-credit arrangements as an asset and ratably amortizing the costs over the term of the arrangement.
 
June 18, 2015 (early adoption permitted)
Did not have an impact on the consolidated financial statements.
ASU 2015-08, Business Combinations  Topic 805 Pushdown Accounting Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115
  
This update amends the codification for SEC Staff Bulletin No. 115
November 18, 2014
Did not have an impact on the consolidated financial statements.
ASU 2014-17, Business Combinations (Topic 805): Pushdown Accounting
  
This amendment provides an acquired entity with the option to apply push down accounting in its separate financial statements upon occurrence of an event in which an acquirer obtains control of the acquired entity.
November 18, 2014
Did not have a significant impact on the consolidated financial statements.
ASU 2014-13, Consolidation (Topic 810) Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity
  
This Update provides a practical expedient to measure the fair value of the financial assets and financial liabilities of a consolidated collateralized financing entity, which the reporting entity has elected to or is required to measure on a fair value basis.
January 1, 2015 (early adoption permitted)
The Company early adopted this ASU and applied the guidance to commercial mortgage backed securitization transactions.  See "Commercial Real Estate Investments" footnote for further disclosure.
ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosure
  
This update makes limited amendments to the guidance in ASC 860 on accounting for certain repurchase agreements.
 January 1, 2015
Impacts disclosures only and does not have a significant impact on the consolidated financial statements.
ASU 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
  
This ASU raises the threshold for a disposal to be treated as discontinued operations.
April 1, 2015
Did not have a significant impact on the consolidated financial statements.
ASU 2014-04  Receivables–Troubled Debt Restructurings by Creditors, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure
  
This update 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.
January 1, 2015
Did not have a significant impact on the consolidated financial statements.
ASU 2013-02, Comprehensive Income: Reporting of Amounts Reclassified  Out of Accumulated Other Comprehensive Income
  
This update requires the provision of information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, it requires presentation of 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.
January 1, 2014
Did not have a significant impact on the consolidated financial statements.
ASU 2011-11, Balance Sheet: Disclosures about Offsetting Assets and Liabilities
  
Under this update, the Company is required to disclose both gross 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.
January 1, 2014
Did not have a significant impact on the consolidated financial statements.
 
 
15
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
4.           AGENCY MORTGAGE-BACKED SECURITIES
 
The following tables present the Company’s available-for-sale Agency mortgage-backed securities portfolio as of September 30, 2015 and December 31, 2014, which were carried at their fair value:
 
September 30, 2015
  
Freddie Mac
    
Fannie Mae
    
Ginnie Mae
    
Total
  
   
(dollars in thousands)
  
                         
Principal outstanding
   $ 21,598,845     $ 39,061,904     $ 72,826     $ 60,733,575  
Unamortized premium
     1,913,855       2,909,606       31,899       4,855,360  
Unamortized discount
     (6,039 )     (6,201 )     (11 )     (12,251 )
Amortized cost
     23,506,661       41,965,309       104,714       65,576,684  
Gross unrealized gains
     244,683       547,434       6,467       798,584  
Gross unrealized losses
     (249,094 )     (316,455 )     (3,079 )     (568,628 )
Estimated fair value
   $ 23,502,250     $ 42,196,288     $ 108,102     $ 65,806,640  
 
   
Fixed Rate
    
Adjustable Rate
    
Total
  
   
(dollars in thousands)
  
Amortized cost
   $ 61,727,096     $ 3,849,588     $ 65,576,684  
Gross unrealized gains
     668,600       129,984       798,584  
Gross unrealized losses
     (551,434 )     (17,194 )     (568,628 )
Estimated fair value
   $ 61,844,262     $ 3,962,378     $ 65,806,640  
 
December 31, 2014
  
Freddie Mac
    
Fannie Mae
    
Ginnie Mae
    
Total
  
   
(dollars in thousands)
  
                         
Principal outstanding
   $ 27,906,221     $ 47,979,778     $ 97,000     $ 75,982,999  
Unamortized premium
     1,951,798       3,396,368       20,560       5,368,726  
Unamortized discount
     (8,985 )     (8,857 )     (358 )     (18,200 )
Amortized cost
     29,849,034       51,367,289       117,202       81,333,525  
Gross unrealized gains
     313,761       660,230       8,010       982,001  
Gross unrealized losses
     (322,094 )     (424,800 )     (3,376 )     (750,270 )
Estimated fair value
   $ 29,840,701     $ 51,602,719     $ 121,836     $ 81,565,256  
 
   
Fixed Rate
    
Adjustable Rate
    
Total
  
   
(dollars in thousands)
  
Amortized cost
   $ 78,250,313     $ 3,083,212     $ 81,333,525  
Gross unrealized gains
     847,615       134,386       982,001  
Gross unrealized losses
     (732,533 )     (17,737 )     (750,270 )
Estimated fair value
   $ 78,365,395     $ 3,199,861     $ 81,565,256  
 
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 September 30, 2015 and December 31, 2014, according to their estimated weighted average life classifications:
 
   
September 30, 2015
    
December 31, 2014
  
Weighted Average Life
  
Estimated Fair Value
    
Amortized Cost
    
Estimated Fair Value
    
Amortized Cost
  
   
(dollars in thousands)
  
Less than one year
   $ 26,908     $ 27,387     $ 43,248     $ 42,831  
Greater than one year through five years
     24,579,949       24,237,266       42,222,114       41,908,586  
Greater than five years through ten years
     40,978,447       41,081,291       39,018,833       39,098,352  
Greater than ten years
     221,336       230,740       281,061       283,756  
Total
   $ 65,806,640     $ 65,576,684     $ 81,565,256     $ 81,333,525  
 
 
16
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
The weighted average lives of the Agency mortgage-backed securities at September 30, 2015 and December 31, 2014 in the table above are based upon projected principal prepayment rates. The actual weighted average lives of the Agency mortgage-backed securities could be longer or shorter than projected
  
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 September 30, 2015 and December 31, 2014.
 
   
September 30, 2015
    
December 31, 2014
  
   
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
     6,574,181       (61,722 )     283       4,613,599       (36,959 )     205  
12 Months or More
     22,917,561       (506,906 )     286       35,175,194       (713,311 )     302  
Total
     29,491,742       (568,628 )     569       39,788,793       (750,270 )     507  
 
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 Agency.

During the quarter and nine months ended September 30, 2015, the Company disposed of $3.6 billion and $20.1 billion of Agency mortgage-backed securities, respectively, resulting in a net realized gain of $6.3 million and $77.9, respectively.
  
During the quarter and nine months ended September 30, 2014, the Company disposed of $4.1 billion and $13.3 billion of Agency mortgage-backed securities, respectively, resulting in a net realized gain of $5.5 million and $176.5 million, respectively.

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. Interest-only mortgage-backed securities in the Company’s portfolio as of September 30, 2015 and December 31, 2014 had net unrealized gains (losses) of $(42.7) million and $(8.0) million and an amortized cost of $1.6 billion and $1.2 billion, respectively.
 
 
17
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
5.           COMMERCIAL REAL ESTATE INVESTMENTS
 
In September 2015, the Company originated a $592.0 million acquisition financing with respect to a 24-building New York City multifamily apartment portfolio. As of September 30, 2015, such financing is comprised of a $480.0 million senior mortgage loan ($476.6 million, net of origination fees), and mezzanine debt with an initial principal balance of $72.0 million and a future funding component of $20.0 million. The senior mortgage loan is held for sale on the accompanying Consolidated Statements of Financial Condition as of September 30, 2015.
  
At September 30, 2015 and December 31, 2014, commercial real estate investments held for investment were composed of the following:
 
CRE Debt and Preferred Equity Investments
 
   
September 30, 2015
    
December 31, 2014
  
   
Outstanding Principal
    
Carrying
Value(1)
    
Percentage
of Loan
Portfolio(2)
    
Outstanding Principal
    
Carrying
Value(1)
    
Percentage
of Loan
Portfolio(2)
  
   
(dollars in thousands)
  
Senior mortgages
     322,564       321,350       24.4 %     384,304       383,895       25.2 %
Senior securitized mortgages (3)
     315,172       314,921       23.9 %     399,541       398,634       26.3 %
Mezzanine loans
     560,800       558,613       42.4 %     522,474       522,731       34.4 %
Preferred equity
     122,444       121,711       9.3 %     214,653       212,905       14.1 %
Total (4)
   $ 1,320,980     $ 1,316,595       100.0 %   $ 1,520,972     $ 1,518,165       100.0 %
                                                 
(1) Carrying value includes unamortized origination fees of $4.8 million and $3.0 million as of September 30, 2015 and December 31, 2014, respectively.
  
(2) Based on outstanding principal.
  
(3) Assets of consolidated VIEs.
  
(4) Excludes Loans held for sale.
  
 
 
   
September 30, 2015
  
   
Senior Mortgages
    
Senior Securitized Mortgages(1)
    
Mezzanine
Loans
    
Preferred
Equity
    
Total
  
   
(dollars in thousands)
  
Beginning balance
   $ 383,895     $ 398,634     $ 522,731     $ 212,905     $ 1,518,165  
Originations & advances (principal)
     216,125       -       140,106       -       356,231  
Principal payments
     (230,220 )     (84,369 )     (101,781 )     (92,210 )     (508,580 )
Sales (principal)
     (46,945 )     -       -       -       (46,945 )
Amortization & accretion of (premium) discounts
     (107 )     -       (164 )     516       245  
Net (increase) decrease in origination fees
     (3,200 )     -       (2,556 )     -       (5,756 )
Amortization of net origination fees
     1,802       656       277       500       3,235  
Transfers
     -       -       -       -       -  
Allowance for loan losses
     -       -       -       -       -  
Net carrying value (2)
   $ 321,350     $ 314,921     $ 558,613     $ 121,711     $ 1,316,595  
                                         
(1) Assets of consolidated VIE.
  
(2) Excludes Loans held for sale.
  
 
 
18
 
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
   
December 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)
     127,112       -       -       122,742       -       249,854  
Principal payments
     (12,756 )     -       (41,059 )     (227,151 )     (35,116 )     (316,082 )
Sales (principal)
     -       -       -       -       -       -  
Amortization & accretion of (premium) discounts
     (138 )     -       (349 )     (1,093 )     108       (1,472 )
Net (increase) decrease in origination fees
     (2,427 )     (116 )     -       (478 )     -       (3,021 )
Amortization of net origination fees
     2,783       772       -       609       753       4,917  
Transfers
     (397,978 )     397,978       -       -       -       -  
Allowance for loan losses
     -       -       -       -       -       -  
Net carrying value
   $ 383,895     $ 398,634     $ -     $ 522,731     $ 212,905     $ 1,518,165  
                                                 
(1) Assets of consolidated VIE.
  
 
Internal CRE Debt and Preferred Equity Investment Ratings
 
   
September 30, 2015
  
         
 
    
Internal Ratings