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, 2017

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
(State or other jurisdiction of
 incorporation or organization)
22-3479661
(IRS Employer Identification No.)
   
   
1211 AVENUE OF THE AMERICAS
NEW YORK, NY 10036
(Address of principal executive offices)
10036
(Zip Code)


(212) 696-0100
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes ☑ No ☐
 

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

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

Large accelerated filer ☑ Accelerated filer ☐
Non-accelerated filer ☐ Smaller reporting company ☐
Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐

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

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 31, 2017
Common Stock, $.01 par value
1,159,543,027
 
 
ANNALY CAPITAL MANAGEMENT, INC. 
FORM 10-Q
TABLE OF CONTENTS
   
 
Page
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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,
  
   
2017 (1)
    
2016 (2)
  
   
(Unaudited)
        
ASSETS
            
             
Cash and cash equivalents (including cash pledged as collateral of $689,290 and $1,428,475, respectively) (3)
  
$
867,840
    
$
1,539,746
  
Investments, at fair value:
                
Agency mortgage-backed securities (including pledged assets of $74,711,243 and $70,796,872, respectively)
    
85,889,131
      
75,589,873
  
Credit risk transfer securities (including pledged assets of $251,077 and $608,707, respectively)
    
582,938
      
724,722
  
Non-Agency mortgage-backed securities (including pledged assets of $670,425 and $1,064,603, respectively) (4)
    
1,227,235
      
1,401,307
  
Residential mortgage loans (including pledged assets of $723,705 and $314,746, respectively) (5)
    
895,919
      
342,289
  
Mortgage servicing rights (including pledged assets of $2,693 and $5,464, respectively)
    
570,218
      
652,216
  
Commercial real estate debt investments (including pledged assets of $3,866,629 and $4,321,739, respectively) (6)
    
3,869,110
      
4,321,739
  
Commercial real estate debt and preferred equity, held for investment (including pledged assets of $482,822 and $506,997, respectively)
    
981,748
      
970,505
  
Commercial loans held for sale, net
    
-
      
114,425
  
Investments in commercial real estate
    
470,928
      
474,567
  
Corporate debt (including pledged assets of $432,460 and $592,871, respectively)
    
856,110
      
773,274
  
Interest rate swaps, at fair value
    
12,250
      
68,194
  
Other derivatives, at fair value
    
266,249
      
171,266
  
Receivable for investments sold
    
340,033
      
51,461
  
Accrued interest and dividends receivable
    
293,207
      
270,400
  
Other assets
    
353,708
      
333,063
  
Goodwill
    
71,815
      
71,815
  
Intangible assets, net
    
25,742
      
34,184
  
Total assets
  
$
97,574,181
    
$
87,905,046
  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                
Liabilities:
                
Repurchase agreements
  
$
69,430,268
    
$
65,215,810
  
Other secured financing
    
3,713,256
      
3,884,708
  
Securitized debt of consolidated VIEs (7)
    
3,357,929
      
3,655,802
  
Participation sold
    
-
      
12,869
  
Mortgages payable
    
311,886
      
311,636
  
Interest rate swaps, at fair value
    
606,960
      
1,443,765
  
Other derivatives, at fair value
    
75,529
      
86,437
  
Dividends payable
    
326,425
      
305,674
  
Payable for investments purchased
    
5,243,868
      
65,041
  
Accrued interest payable
    
231,611
      
163,013
  
Accounts payable and other liabilities
    
121,231
      
184,319
  
Total liabilities
    
83,418,963
      
75,329,074
  
Stockholders’ Equity:
                
7.875% Series A Cumulative Redeemable Preferred Stock: 7,412,500 authorized, 0 and 7,412,500 issued and outstanding, respectively
    
-
      
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
  
7.625% Series E Cumulative Redeemable Preferred Stock: 11,500,000 authorized, issued and outstanding
    
287,500
      
287,500
  
6.95% Series F Cumulative Redeemable Preferred Stock: 32,200,000 and 0 authorized, 28,800,000 and 0 issued and outstanding, respectively
    
696,910
      
-
  
Common stock, par value $0.01 per share, 1,917,837,500 and 1,945,437,500 authorized, 1,088,083,794 and 1,018,913,249 issued and outstanding, respectively
    
10,881
      
10,189
  
Additional paid-in capital
    
16,377,805
      
15,579,342
  
Accumulated other comprehensive income (loss)
    
(640,149
)
    
(1,085,893
)
Accumulated deficit
    
(3,320,160
)
    
(3,136,017
)
Total stockholders’ equity
    
14,148,758
      
12,568,180
  
Noncontrolling interest
    
6,460
      
7,792
  
Total equity
    
14,155,218
      
12,575,972
  
Total liabilities and equity
  
$
97,574,181
    
$
87,905,046
  
 

(1)  As a result of a change to a clearing organization’s rulebook effective January 3, 2017, beginning with the first quarter 2017 and in subsequent periods the Company is presenting the fair value of centrally cleared interest rate swaps net of variation margin pledged under such transactions. The variation margin was previously reported under cash and cash equivalents and is currently reported as a reduction to interest rate swaps, at fair value. Balances reported prior to the effective date will not be adjusted. 
(2)
 Derived from the audited consolidated financial statements at December 31, 2016. 
(3)
Includes cash of consolidated Variable Interest Entities (“VIEs”) of $40.0 million and $23.2 million at September 30, 2017 and December 31, 2016, respectively.  
(4)
Includes $72.1 million and $88.6 million at September 30, 2017 and December 31, 2016, respectively, of non-Agency mortgage-backed securities in a consolidated VIE pledged as collateral and eliminated from the Company’s Consolidated Statements of Financial Condition.  
(5) Includes securitized residential mortgage loans of a consolidated VIE carried at fair value of $139.8 million and $165.9 million at September 30, 2017 and December 31, 2016, respectively.  
(6) Includes senior securitized commercial mortgage loans of consolidated VIEs carried at fair value of $3.6 billion and $3.9 billion at September 30, 2017 and December 31, 2016, respectively.  
(7) Includes securitized debt of consolidated VIEs carried at fair value of $3.4 billion and $3.7 billion at September 30, 2017 and December 31, 2016, 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)
  
                         
   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
   
2017
    
2016
    
2017
    
2016
  
Net interest income:
                        
Interest income
  
$
622,550
    
$
558,668
    
$
1,747,703
    
$
1,403,929
  
Interest expense
    
268,937
      
174,154
      
689,643
      
474,356
  
Net interest income
    
353,613
      
384,514
      
1,058,060
      
929,573
  
                                 
Realized and unrealized gains (losses):
                                
Realized gains (losses) on interest rate swaps(1)
    
(88,211
)
    
(124,572
)
    
(288,837
)
    
(402,809
)
Realized gains (losses) on termination of interest rate swaps
    
-
      
1,337
      
(58
)
    
(58,727
)
Unrealized gains (losses) on interest rate swaps
    
56,854
      
256,462
      
28,471
      
(1,148,478
)
Subtotal
    
(31,357
)
    
133,227
      
(260,424
)
    
(1,610,014
)
Net gains (losses) on disposal of investments
    
(11,552
)
    
14,447
      
(11,833
)
    
25,307
  
Net gains (losses) on trading assets
    
154,208
      
162,981
      
140,104
      
370,050
  
Net unrealized gains (losses) on investments measured at fair value through earnings
    
(67,492
)
    
29,675
      
(27,569
)
    
(24,351
)
Bargain purchase gain
    
-
      
72,576
      
-
      
72,576
  
Subtotal
    
75,164
      
279,679
      
100,702
      
443,582
  
Total realized and unrealized gains (losses)
    
43,807
      
412,906
      
(159,722
)
    
(1,166,432
)
                                 
Other income (loss):
                                
Other income (loss)
    
28,282
      
29,271
      
90,793
      
13,226
  
Total other income (loss)
    
28,282
      
29,271
      
90,793
      
13,226
  
                                 
General and administrative expenses:
                                
Compensation and management fee
    
41,993
      
38,709
      
120,193
      
111,754
  
Other general and administrative expenses
    
15,023
      
59,028
      
44,674
      
83,149
  
Total general and administrative expenses
    
57,016
      
97,737
      
164,867
      
194,903
  
Income (loss) before income taxes
    
368,686
      
728,954
      
824,264
      
(418,536
)
Income taxes
    
1,371
      
(1,926
)
    
2,019
      
(2,839
)
Net income (loss)
    
367,315
      
730,880
      
822,245
      
(415,697
)
Net income (loss) attributable to noncontrolling interest
    
(232
)
    
(336
)
    
(437
)
    
(883
)
Net income (loss) attributable to Annaly
    
367,547
      
731,216
      
822,682
      
(414,814
)
Dividends on preferred stock (2)
    
30,355
      
22,803
      
77,301
      
58,787
  
Net income (loss) available (related) to common stockholders
  
$
337,192
    
$
708,413
    
$
745,381
    
$
(473,601
)
Net income (loss) per share available (related) to common stockholders:
                                
Basic
  
$
0.31
    
$
0.70
    
$
0.72
    
$
(0.50
)
Diluted
  
$
0.31
    
$
0.70
    
$
0.72
    
$
(0.50
)
Weighted average number of common shares outstanding:
                                
Basic
    
1,072,566,395
      
1,007,607,893
      
1,037,033,076
      
953,301,855
  
Diluted
    
1,073,040,637
      
1,007,963,406
      
1,037,445,177
      
953,301,855
  
Dividends declared per share of common stock
  
$
0.30
    
$
0.30
    
$
0.90
    
$
0.90
  
Net income (loss)
  
$
367,315
    
$
730,880
    
$
822,245
    
$
(415,697
)
Other comprehensive income (loss):
                                
Unrealized gains (losses) on available-for-sale securities
    
195,251
      
18,237
      
397,600
      
1,519,874
  
Reclassification adjustment for net (gains) losses included in net income (loss)
    
15,367
      
(15,606
)
    
48,144
      
(22,601
)
Other comprehensive income (loss)
    
210,618
      
2,631
      
445,744
      
1,497,273
  
Comprehensive income (loss)
  
$
577,933
    
$
733,511
    
$
1,267,989
    
$
1,081,576
  
Comprehensive income (loss) attributable to noncontrolling interest
    
(232
)
    
(336
)
    
(437
)
    
(883
)
Comprehensive income (loss) attributable to Annaly
    
578,165
      
733,847
      
1,268,426
      
1,082,459
  
Dividends on preferred stock (2)
    
30,355
      
22,803
      
77,301
      
58,787
  
Comprehensive income (loss) attributable to common stockholders
  
$
547,810
    
$
711,044
    
$
1,191,125
    
$
1,023,672
  
 
(1)
Consists of interest expense on interest rate swaps.
(2)
Includes cumulative and undeclared dividends on the Company’s Series F Preferred Stock of $8.3 million for the three and nine months ended September 30, 2017.
 
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
  
Nine Months Ended September 30, 2017 and 2016
  
(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
    
7.625%
Series E Cumulative Redeemable Preferred
Stock
    
6.95%
Series F
Fixed-to-
Floating Rate
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, 2015
  
$
177,088
    
$
290,514
    
$
445,457
    
$
-
    
$
-
    
$
9,359
    
$
14,675,768
    
$
(377,596
)
  
$
(3,324,616
)
  
$
11,895,974
    
$
9,948
    
$
11,905,922
  
Net income (loss) attributable to Annaly
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(414,814
)
    
(414,814
)
    
-
      
(414,814
)
Net income (loss) attributable to
noncontrolling interest
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(883
)
    
(883
)
Unrealized gains (losses) on available-for-sale
securities
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
1,519,874
      
-
      
1,519,874
      
-
      
1,519,874
  
Reclassification adjustment for net (gains)
losses included in net income (loss)
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(22,601
)
    
-
      
(22,601
)
    
-
      
(22,601
)
Stock compensation expense
    
-
      
-
      
-
      
-
      
-
      
-
      
6,949
      
-
      
-
      
6,949
      
-
      
6,949
  
Net proceeds from direct purchase and dividend
reinvestment
    
-
      
-
      
-
      
-
      
-
      
2
      
1,793
      
-
      
-
      
1,795
      
-
      
1,795
  
Buyback of common stock
    
-
      
-
      
-
      
-
      
-
      
(111
)
    
(102,601
)
    
-
      
-
      
(102,712
)
    
-
      
(102,712
)
Acquisition of subsidiary
    
-
      
-
      
-
      
287,500
      
-
      
939
      
996,768
      
-
      
-
      
1,285,207
      
-
      
1,285,207
  
Equity contributions from (distributions to)
noncontrolling interest
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(924
)
    
(924
)
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
)
Preferred Series E dividends, declared $0.477
per share
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(4,811
)
    
(4,811
)
    
-
      
(4,811
)
Common dividends declared, $0.90 per share
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(857,223
)
    
(857,223
)
    
-
      
(857,223
)
BALANCE, September 30, 2016
  
$
177,088
    
$
290,514
    
$
445,457
    
$
287,500
    
$
-
    
$
10,189
    
$
15,578,677
    
$
1,119,677
    
$
(4,655,440
)
  
$
13,253,662
    
$
8,141
    
$
13,261,803
  
BALANCE, December 31, 2016
  
$
177,088
    
$
290,514
    
$
445,457
    
$
287,500
    
$
-
    
$
10,189
    
$
15,579,342
    
$
(1,085,893
)
  
$
(3,136,017
)
  
$
12,568,180
    
$
7,792
    
$
12,575,972
  
Net income (loss) attributable to Annaly
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
822,682
      
822,682
      
-
      
822,682
  
Net income (loss) attributable to
noncontrolling interest
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(437
)
    
(437
)
Unrealized gains (losses) on available-for-sale
securities
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
397,600
      
-
      
397,600
      
-
      
397,600
  
Reclassification adjustment for net (gains)
losses included
in net income (loss)
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
48,144
      
-
      
48,144
      
-
      
48,144
  
Stock compensation expense
    
-
      
-
      
-
      
-
      
-
      
-
      
1,276
      
-
      
-
      
1,276
      
-
      
1,276
  
Redemption of preferred stock
    
(177,088
)
    
-
      
-
      
-
      
-
      
-
      
(8,224
)
    
-
      
-
      
(185,312
)
    
-
      
(185,312
)
Net proceeds from direct purchase and dividend
reinvestment
    
-
      
-
      
-
      
-
      
-
      
2
      
1,947
      
-
      
-
      
1,949
      
-
      
1,949
  
Net proceeds from issuance of common stock
    
-
      
-
      
-
      
-
      
-
      
690
      
803,464
      
-
      
-
      
804,154
      
-
      
804,154
  
Net proceeds from issuance of preferred stock
    
-
      
-
      
-
      
-
      
696,910
      
-
      
-
      
-
      
-
      
696,910
      
-
      
696,910
  
Equity contributions from (distributions to)
noncontrolling interest
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(895
)
    
(895
)
Preferred Series A dividends, declared $1.477
per share
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(9,527
)
    
(9,527
)
    
-
      
(9,527
)
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
)
Preferred Series E dividends, declared $1.430
per share
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(16,441
)
    
(16,441
)
    
-
      
(16,441
)
Common dividends declared, $0.90 per share
    
-
      
-
      
-
      
-
      
-
      
-
      
-
      
-
      
(937,825
)
    
(937,825
)
    
-
      
(937,825
)
BALANCE, September 30, 2017
  
$
-
    
$
290,514
    
$
445,457
    
$
287,500
    
$
696,910
    
$
10,881
    
$
16,377,805
    
$
(640,149
)
  
$
(3,320,160
)
  
$
14,148,758
    
$
6,460
    
$
14,155,218
  
 
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,
  
   
2017
    
2016
  
Cash flows from operating activities:
            
Net income (loss)
  
$
822,245
    
$
(415,697
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating  activities:
                
Amortization of Residential Investment Securities premiums and discounts, net
    
675,354
      
834,257
  
Amortization of Residential Mortgage Loans premiums and discounts, net
    
1,036
      
-
  
Amortization of securitized debt premiums and discounts, net
    
(813
)
    
-
  
Amortization of commercial real estate investment premiums and discounts, net
    
(4,404
)
    
(2,393
)
Amortization of intangibles
    
6,965
      
10,446
  
Amortization of deferred financing costs
    
1,431
      
1,315
  
Amortization of net origination fees and costs, net
    
(3,791
)
    
(3,925
)
Depreciation expense
    
13,445
      
16,511
  
Bargain purchase gain
    
-
      
(72,576
)
Net (gains) losses on sales of commercial real estate
    
(5,050
)
    
(821
)
Net (gains) losses on sales of commercial loans held for sale
    
3
      
72
  
Net (gains) losses on sales of Residential Investment Securities
    
14,263
      
(24,941
)
Net (gains) losses on sales of residential mortgage loans
    
3,407
      
383
  
Net (gain) on sale of subsidiary
    
(790
)
    
-
  
Stock compensation expense
    
1,276
      
6,949
  
Unrealized (gains) losses on interest rate swaps
    
(28,471
)
    
1,148,478
  
Net unrealized (gains) losses on investments measured at fair value through earnings
    
27,569
      
24,351
  
Equity in net income from unconsolidated joint ventures
    
1,355
      
5,344
  
Distributions of cumulative earnings from unconsolidated joint venture
    
868
      
-
  
Net (gains) losses on trading assets
    
(140,104
)
    
(370,050
)
Proceeds from sale of commercial loans held for sale
    
114,422
      
134,253
  
Payments on purchase of residential mortgage loans
    
(211,009
)
    
(73,370
)
Proceeds from repayments from residential mortgage loans
    
196,258
      
107,648
  
Payment on purchase of corporate debt held for sale
    
(19,494
)
    
-
  
Proceeds from sale of corporate debt held for sale
    
19,605
      
-
  
Proceeds from repurchase agreements of RCap
    
2,354,907,385
      
1,661,650,000
  
Payments on repurchase agreements of RCap
    
(2,350,682,385
)
    
(1,662,100,000
)
Proceeds from reverse repurchase agreements of RCap
    
50,280,000
      
48,390,000
  
Payments on reverse repurchase agreements of RCap
    
(50,280,000
)
    
(48,390,000
)
Net payments on derivatives
    
(732,998
)
    
23,168
  
Net change in:
                
Due to / from brokers
    
(16
)
    
-
  
Other assets
    
(30,371
)
    
(72,800
)
Accrued interest and dividends receivable
    
(17,322
)
    
13,970
  
Accrued interest payable
    
68,598
      
15,729
  
Accounts payable and other liabilities
    
(43,936
)
    
(23,162
)
Net cash provided by (used in) operating activities
  
$
4,954,531
    
$
833,139
  
                 
Cash flows from investing activities:
                
Payments on purchases of Residential Investment Securities
    
(25,852,497
)
    
(13,628,516
)
Proceeds from sales of Residential Investment Securities
    
11,598,472
      
8,729,912
  
Principal payments on Residential Investment Securities
    
8,971,444
      
8,580,353
  
Purchase of MSRs
    
(11,081
)
    
(127,489
)
Payments on purchases of corporate debt
    
(374,358
)
    
(324,863
)
Principal payments on corporate debt
    
295,380
      
98,542
  
Purchases of commercial real estate debt investments
    
(40,904
)
    
(76,862
)
Purchase of securitized loans at fair value
    
-
      
(1,489,268
)
Origination of commercial real estate investments, net
    
(324,581
)
    
(204,184
)
Proceeds from sale of commercial real estate investments
    
11,960
      
12,750
  
Principal payments on commercial real estate debt investments
    
182,792
      
71,116
  
Principal payments on securitized loans at fair value
    
352,475
      
106,786
  
Principal payments on commercial real estate investments
    
317,114
      
486,435
  
Purchase of investments in real estate
    
(947
)
    
(2,043
)
Investment in unconsolidated joint venture
    
(22,519
)
    
(3,109
)
Distributions in excess of cumulative earnings from unconsolidated joint ventures
    
6,160
      
4,155
  
Payments on purchase of residential mortgage loans held for investment
    
(668,977
)
    
(8,022
)
Proceeds from repayments from residential mortgage loans held for investment
    
131,052
      
11,771
  
Purchase of equity securities
    
(2,104
)
    
(88,062
)
Proceeds from sales of equity securities
    
-
      
16,112
  
Cash acquired in business combination
    
-
      
41,697
  
Net payment from disposal of subsidiary
    
5,337
      
-
  
Net cash provided by (used in) investing activities
  
$
(5,425,782
)
  
$
2,207,211
  
 
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
    
151,081,565
      
128,601,867
  
Principal payments on repurchase agreements
    
(151,092,107
)
    
(133,021,365
)
Proceeds from other secured financing
    
6,801
      
2,358,314
  
Payments on other secured financing
    
(178,325
)
    
(434,458
)
Proceeds from issuance of securitized debt
    
-
      
1,381,640
  
Principal repayments on securitized debt
    
(334,386
)
    
(273,091
)
Payment of deferred financing cost
    
(2,054
)
    
(3,076
)
Net proceeds from issuance of preferred stock
    
696,910
      
-
  
Redemption of preferred stock
    
(185,312
)
    
-
  
Net proceeds from direct purchases and dividend reinvestments
    
1,949
      
1,795
  
Net proceeds from issuance of common stock
    
804,154
      
-
  
Principal payments on participation sold
    
(12,827
)
    
(230
)
Principal payments on mortgages payable
    
(54
)
    
(7,500
)
Contributions from noncontrolling interests
    
19
      
-
  
Distributions to noncontrolling interests
    
(914
)
    
(926
)
Net payment on share repurchase
    
-
      
(102,712
)
Dividends paid
    
(986,074
)
    
(927,678
)
Net cash provided by (used in) financing activities
  
$
(200,655
)
  
$
(2,427,420
)
Net (decrease) increase in cash and cash equivalents
  
$
(671,906
)
  
$
612,930
  
Cash and cash equivalents, beginning of period
    
1,539,746
      
1,769,258
  
Cash and cash equivalents, end of period
  
$
867,840
    
$
2,382,188
  
Supplemental disclosure of cash flow information:
                
Interest received
  
$
2,460,097
    
$
2,197,880
  
Dividends received
  
$
3,774
    
$
1,253
  
Interest paid (excluding interest paid on interest rate swaps)
  
$
693,983
    
$
441,121
  
Net interest paid on interest rate swaps
  
$
264,965
    
$
415,223
  
Taxes paid
  
$
2,612
    
$
858
  
Noncash investing activities:
                
Receivable for investments sold
  
$
340,033
    
$
493,839
  
Payable for investments purchased
  
$
5,243,868
    
$
454,237
  
Net change in unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment
  
$
445,744
    
$
1,497,273
  
Noncash financing activities:
                
Dividends declared, not yet paid
  
$
326,425
    
$
269,111
  
 
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 is a leading diversified capital manager that invests in and finances residential and commercial assets. The Company owns a portfolio of real estate related investments, including mortgage pass-through certificates, collateralized mortgage obligations,  credit risk transfer (“CRT”) securities, other securities representing interests in or obligations backed by pools of mortgage loans, residential mortgage loans, mortgage servicing rights (“MSRs”), commercial real estate assets and corporate debt. The Company’s principal business objective is to generate net income for distribution to its stockholders through capital preservation, prudent selection of investments, and continuous management of its portfolio. The Company is externally managed by Annaly Management Company LLC (the “Manager”).
The Company’s investment groups are comprised of the following:
•
The Annaly Agency Group invests in Agency mortgage-backed securities collateralized by residential mortgages which are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae.
•
The Annaly Residential Credit Group invests in non-Agency residential mortgage assets within securitized product and whole loan markets.
•
The Annaly Commercial Real Estate Group (“ACREG”) originates and invests in commercial mortgage loans, securities, and other commercial real estate debt and equity investments.
•
The Annaly Middle Market Lending Group (“AMML”) provides financing to private equity backed middle market businesses across the capital structure.

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 U.S. generally accepted accounting principles (“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, 2016 has been derived from audited consolidated financial statements included in the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2016.
 
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.

Variable Interest Entities - The Company has evaluated all of its investments in legal entities in order to determine if they are variable interests in VIEs. A VIE is defined as an entity in which equity investors (i) do not have the characteristics of a controlling financial interest, and/or (ii) do not have sufficient equity at risk for the entity to finance its activities without additional 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.
 
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.
 
6
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
 
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 apply 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 is 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. As a result of a change to a clearing organization’s rulebook effective January 3, 2017, beginning with the first quarter 2017 and in subsequent periods the Company is presenting the fair value of centrally cleared interest rate swaps net of variation margin pledged under such transactions. The variation margin was previously reported under cash and cash equivalents. At September 30, 2017, $752.4 million of variation margin was reported as a reduction to interest rate swaps, at fair value. RCap Securities, Inc., the Company’s wholly-owned broker-dealer (“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 $689.3 million and $1.4 billion at September 30, 2017 and December 31, 2016, 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 Credit Risk Transfer Securities – The Company invests in mortgage pass-through certificates, collateralized mortgage obligations and other mortgage-backed securities representing interests in or obligations backed by pools of residential or multifamily 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 (“NPL”) and re-performing loan (“RPL”) securitizations.

Agency mortgage-backed securities, Agency debentures, non-Agency mortgage-backed securities and CRT securities are referred to herein as “Residential Investment Securities.” Although the Company generally intends to hold most of its Residential Investment Securities until maturity, it may, from time to time, sell any of its Residential Investment Securities as part of the overall management of its portfolio. Residential 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) unless the Company has elected the fair value option, where the unrealized gains and losses on these financial instruments are recorded through earnings (e.g., interest-only securities). The fair value of Residential Investment Securities classified as available-for-sale are estimated by management and are compared to independent sources for reasonableness. Residential Investment Securities transactions are recorded on trade date, including TBA securities that meet the regular-way securities scope exception from derivative accounting. Gains and losses on sales of Residential Investment Securities are recorded on trade date based on the specific identification method.
 
7
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
 
The Company elected the fair value option for interest-only mortgage-backed securities, non-Agency mortgage-backed securities and certain CRT securities as this election simplifies the accounting. 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 investments 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.
The Company recognizes coupon income, which is a component of interest income, based upon the outstanding principal amounts of the Residential Investment Securities and their contractual terms. In addition, the Company amortizes or accretes premiums or discounts into interest income for its Agency mortgage-backed securities (other than interest-only securities), taking into account estimates of future principal prepayments in the calculation of the effective yield. The Company recalculates the effective yield as differences between anticipated and actual prepayments occur. Using third-party model and market information to project future cash flows and expected remaining lives of securities, the effective interest rate determined for each security is applied as if it had been in place from the date of the security’s acquisition. The amortized cost of the security is then adjusted to the amount that would have existed had the new effective yield been applied since the acquisition date, which results in a cumulative premium amortization adjustment in each period. The adjustment to amortized cost is offset with a charge or credit to interest income. Changes in interest rates and other market factors will impact prepayment speed projections and the amount of premium amortization recognized in any given period.
Premiums or discounts associated with the purchase of Agency interest-only securities and residential credit securities are amortized or accreted into interest income based upon current expected future cash flows with any adjustment to yield made on a prospective basis.

Interest income for Agency debentures is recognized by applying the interest method using contractual cash flows without estimating prepayments.
The table below summarizes the interest income recognition methodology for Residential Investment Securities:
 
Interest Income
Methodology
Agency
    
Fixed-rate pass-through (1)
Effective yield(3)
Adjustable-rate pass-through (1)
Effective yield(3)
Multifamily (1)
Contractual Cash Flows
Collateralized Mortgage Obligation (“CMO”) (1)
Effective yield(3)
Debentures (1)
Contractual Cash Flows
Interest-only (2)
Prospective
Residential Credit
    
CRT (2)
Prospective
Legacy (2)
Prospective
NPL/RPL (2)
Prospective
New issue (2)
Prospective
New issue interest-only (2)
Prospective

(1) Changes in fair value are recognized in Other comprehensive income (loss) on the accompanying Consolidated Statements of Comprehensive Income (Loss).
(2) Changes in fair value are recognized in Net unrealized gains (losses) on investments measured at fair value through earnings on the accompanying Consolidated Statements of Comprehensive Income (Loss).
(3) Effective yield is recalculated for differences between estimated and actual prepayments and the amortized cost is adjusted as if the new effective yield had been applied since inception.
Residential Mortgage Loans   – The Company’s residential mortgage loans are primarily comprised of new origination, performing adjustable-rate and fixed-rate whole loans acquired in connection with the Company’s acquisition of Hatteras Financial Corp. (“Hatteras” and such acquisition, the “Hatteras Acquisition”) and through subsequent purchases. Additionally, in connection with the Hatteras Acquisition, the Company consolidates a collateralized financing entity that securitized prime adjustable-rate jumbo residential mortgage loans. The Company made elections to account for the investments in residential mortgage loans held in its portfolio and in the securitization trust at fair value as these elections simplify the accounting. Residential mortgage loans are recognized at fair value on the accompanying Consolidated Statements of Financial Condition. Changes in the estimated fair value are presented in Net unrealized gains (losses) on investments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss).
 
8
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
 
Premiums and discounts associated with the purchase of residential mortgage loans and with those held in the securitization trust are primarily amortized or accreted into interest income over their estimated remaining lives using the effective interest rates inherent in the estimated cash flows from the mortgage loans. Amortization of premiums and accretion of discounts are presented in Interest income in the Consolidated Statements of Comprehensive Income (Loss).

There was no real estate acquired in settlement of residential mortgage loans at September 30, 2017 or December 31, 2016. The Company would be considered to have received physical possession of residential real estate property collateralizing a residential mortgage loan, so that the loan is derecognized and the real estate property would be recognized, if either (i) the Company obtains legal title to the residential real estate property upon completion of a foreclosure or (ii) the borrower conveys all interest in the residential real estate property to the Company to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement.

MSRs – MSRs represent the rights associated with servicing contracts obtained in connection with the Hatteras Acquisition or through the subsequent purchase of such rights from third parties with the intention of holding them as investments. The Company and its subsidiaries do not originate or directly service mortgage loans. Rather, the Company utilizes duly licensed subservicers to perform substantially all of the servicing functions for the loans underlying the MSRs. The Company elected to account for all of its investments in MSRs at fair value. As such, they are recognized at fair value on the accompanying Consolidated Statements of Financial Condition with changes in the estimated fair value presented as a component of Net unrealized gains (losses) on investments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss). Servicing income, net of servicing expenses, is reported in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

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. Equity securities that do not have readily determinable fair values, do not result in consolidation of the investee and are not required to be accounted for under the equity method are carried at cost. Dividends from cost method equity securities are recognized as income when received to the extent they are distributed from net accumulated earnings.
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”), U.S. Treasury and Eurodollar futures contracts and certain forward purchase commitments. The Company may also enter into other types of mortgage derivatives such as interest-only securities, credit derivatives referencing the commercial mortgage-backed securities index and synthetic total return swaps. 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 swap agreements are the primary instrument used to mitigate interest rate risk. In particular, the Company uses interest rate swap agreements to manage its exposure to changing interest rates on its repurchase agreements by economically hedging cash flows associated with these borrowings. Interest rate swap agreements may or may not be cleared through a derivatives clearing organization (“DCO”). Uncleared interest rate swaps are fair valued using internal pricing models and compared to the counterparty market values. Centrally cleared interest rate swaps are fair valued using internal pricing models and compared to the DCO’s market values.

Swaptions – Swaptions are purchased or 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 or received for swaptions is reported as an asset or 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 or 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.
 

 
9
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements

 
The fair value of 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 methods similar to those 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 measured at fair value 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 or benchmark rates. Short sales of futures contracts help mitigate the potential impact of changes in interest rates on the portfolio performance. The Company maintains margin accounts which 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).
 
Forward purchase commitments – The Company may enter into forward purchase commitments with counterparties whereby the Company commits to purchasing residential mortgage loans at a particular price, provided the residential mortgage loans close with the counterparties. Gains and losses are recorded in Net gains (losses) on trading assets in the Consolidated Statements of Comprehensive Income (Loss).
 
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 is recognized as goodwill. Conversely, any excess of the fair value of the net assets acquired over the purchase price is recognized as a bargain purchase gain.
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.
 
Finite life intangible assets are amortized over their expected useful lives.

Repurchase Agreements – The Company finances the acquisition of a significant portion of its assets with repurchase agreements. At the inception of each transaction, the Company assesses each of the specified criteria in ASC 860, Transfers and Servicing, and has determined that each of the financings agreements 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.

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.
 

10
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
 
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 RCap and certain subsidiaries of ACREG and Hatteras, 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 at September 30, 2017 and December 31, 2016.

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 materially 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), except for conduit commercial mortgage-backed securities for which the Company has elected to fair value through earnings to simplify the accounting. Management evaluates commercial mortgage-backed securities, excluding conduit commercial mortgage-backed securities, for other-than-temporary impairment at least quarterly. See the “Commercial Real Estate Investments” Note for additional information regarding the consolidated collateralized financing entities.
Commercial Real Estate Loans and Preferred Equity Interests (collectively referred to as “CRE Debt and Preferred Equity Investments”) – 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. The difference between the principal amount of a loan and proceeds at acquisition is recorded as either a discount or premium. 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 an allowance for loan losses if necessary. Origination fees and costs, premiums or discounts are amortized into interest income over the life of the loan.
 
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 sale are carried at the lower of amortized cost or fair value and recorded as Commercial loans held for sale, net in the accompanying Consolidated Statements of Financial Condition. Any origination fees and costs or purchase premiums or discounts are deferred and recognized upon sale. The Company determines the fair value of commercial real estate loans held for sale on an individual loan basis.
 
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. See the “Commercial Real Estate Investments” Note for additional information.
 
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:
 

11
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
 
Category
Term
Building
30 - 40 years
Site improvements
1 - 28 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, or deed in lieu of foreclosure, herein collectively referred to as a foreclosure, (“REO”) 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 CRE Debt and Preferred Equity Investments and their contractual terms. Origination fees and costs, premiums or discounts associated with the purchase of CRE Debt and Preferred Equity Investments are amortized or accreted into interest income over the lives of the CRE Debt and Preferred Equity Investments using the interest method.

Corporate Debt
 
Corporate Loans – The Company’s investments in corporate loans are designated as held for investment 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. 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. These investments typically take the form of senior secured loans primarily in first or second lien positions. The Company’s senior secured loans generally have stated maturities of three to eight years. In connection with these senior secured loans the Company receives a security interest in certain of the assets of the borrower and such assets support repayment of such loans. Senior secured loans are generally exposed to less credit risk than more junior loans given their seniority to scheduled principal and interest and priority of security in the assets of the borrower. To date, the significant majority of the Company’s investments in corporate debt have been funded term loans versus bonds.
 
Corporate Debt Securities – The Company’s investments in corporate debt that are debt securities are designated as held-to-maturity when the Company has the intent and ability to hold the investment until maturity. These investments are carried at their principal balance outstanding plus any premiums or discounts less other-than-temporary impairment. 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.
 
Impairment of Securities and Loans
 
Other-Than-Temporary Impairment – Management evaluates available-for-sale securities and held-to-maturity debt securities for other-than-temporary impairment at least quarterly, and more frequently when economic or market conditions warrant such evaluation.
 
12
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements

 
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). If the fair value is less than the cost of a held-to-maturity security, the Company performs an analysis to determine whether it expects to recover the entire cost basis of the security. There was no other-than-temporary impairment recognized for the three months ended September 30, 2017 and 2016.
 
Allowance for Losses – The Company evaluates the need for a loss reserve on its CRE Debt and Preferred Equity Investments and its corporate loans. A provision for losses related to CRE Debt and Preferred Equity Investments and corporate loans, 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 collectible. 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. 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, verifies loan compliance packages, if applicable, and analyzes current results relative to budgets and sensitivities performed at inception of the investment. Because these determinations are 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 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 or companies. 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, economic trends, both macro and those affecting the property specifically, and the supply and demand of competing projects in the sub-market in which each subject property is located. Management monitors the financial condition and operating results of its corporate borrowers and continually assesses the future outlook of the borrower’s financial performance in light of industry developments, management changes and company-specific considerations.

In connection with the quarterly surveillance review process, the Company’s CRE Debt and Preferred Equity Investments are assigned an internal risk rating. The loan risk ratings reflect guidance provided by the Office of the Comptroller of the Currency for commercial real estate lending. The initial internal risk ratings (“Initial Ratings”) are based on loan-to-values and the net operating income debt yields of the underlying collateral of the Company’s CRE Debt and Preferred Equity Investments and based upon leverage and cash flow coverages of the borrowers’ debt and operating obligations. The final internal risk ratings are influenced by other quantitative and qualitative factors that can result in an adjustment to the Initial Ratings, subject to review and approval by the respective committee. The internal risk rating categories include “Performing”, “Performing - Closely Monitored”, “Performing - Special Mention”, “Substandard”, “Doubtful” or “Loss”. Performing loans meet all present contractual obligations. Performing - Closely Monitored loans meet all present contractual obligations, but are transitional or could be exhibiting some weakness in both leverage and liquidity. Performing - Special Mention loans exhibit potential weakness that deserves management’s close attention and if uncorrected, may result in deterioration of repayment prospects. Substandard loans are inadequately protected by sound worth and paying capacity of the obligor or of the collateral pledged with a distinct possibility that loss will be sustained if some of the deficiencies are not corrected. Doubtful loans are Substandard loans whereby collection of all contractual principal and interest is highly questionable or improbable. Loss loans are considered uncollectible.

 
13
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements

 
Nonaccrual Status – If collection of a loan’s principal or interest is in doubt or the loan is 90 days or more past due, interest income is not accrued. For nonaccrual status loans carried at fair value or held for sale, interest is not accrued, but is recognized on a cash basis. For nonaccrual status loans carried at amortized cost, if collection of principal is not in doubt, but collection of interest is in doubt, interest income is recognized on a cash basis. If collection of principal is in doubt, any interest received is applied against principal until collectability of the remaining balance is no longer in doubt; at that point, any interest income is recognized on a cash basis. Generally, a loan is returned to accrual status when the borrower has resumed paying the full amount of the scheduled contractual obligation, if all principal and interest amounts contractually due are reasonably assured of repayment within a reasonable period of time and there is a sustained period of repayment performance by the borrower.

The Company did not have any impaired loans, nonaccrual loans, or loans in default as all of the loans were performing at September 30, 2017 and December 31, 2016. There were no allowances for loan losses at September 30, 2017 and December 31, 2016.
Broker Dealer Activities

Reverse Repurchase Agreements – RCap enters into reverse repurchase agreements and repurchase agreements as part of its matched book trading activity. Reverse repurchase agreements are recorded on settlement date at the contractual 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. Substantially all of RCap’s reverse repurchase activity is with affiliated entities.

Recent Accounting Pronouncements

The Company considers the applicability and impact of all Accounting Standards Updates (“ASUs”). ASUs not listed below were determined to be either not applicable, are not expected to have a significant impact on our consolidated financial statements when adopted, or did not have a significant impact on our consolidated financial statements upon adoption.


14
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 

Standard
  
Description
  
Effective Date
  
Effect on the financial statements or other significant matters
Standards that are not yet adopted
            
ASU 2017-05 Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets
  
This update clarifies that a financial asset is within the scope of Subtopic 610-20 if it meets the definition of an in-substance nonfinancial asset, including nonfinancial assets transferred within a legal entity to a counterparty.  The ASU requires the Company to derecognize a distinct nonfinancial asset or in-substance nonfinancial asset in a partial sale transaction when it ceases to have a controlling financial interest in a legal entity that holds the asset or transfers control of the asset, with any noncontrolling interest retained recognized at fair value.  Transfers of ownership interest in a consolidated subsidiary with controlling financial interest retained are accounted for as equity transactions.
  
January 1, 2018 (early adoption permitted).
  
The Company is evaluating the expected impact of this ASU.
ASU 2017-01 Business Combinations (Topic 805) Clarifying the Definition of a Business
  
This update provides a screen to determine and a framework to evaluate when a set of assets and activities is a business.
  
January 1, 2018 (early adoption permitted)
  
The amendments are expected to result in fewer transactions being accounted for as business combinations.
ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
  
This ASU updates the existing incurred loss model to a current expected credit loss (“CECL”) model for financial assets and net investments in leases that are not accounted for at fair value through earnings.  The amendments affect loans, held-to-maturity debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures and any other financial assets not excluded from the scope.  There are also limited amendments to the impairment model for available-for-sale debt securities.
  
January 1, 2020 (early adoption permitted)
  
The Company currently plans to adopt the new standard on its effective date and has developed an implementation plan, which it has begun executing. While the Company is continuing to assess the impact the ASU will have on the consolidated financial statements, the measurement of expected credit losses under the CECL model will be based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts of the financial assets in scope of the model. Further, based on the amended guidance for available-for-sale debt securities, the Company:
• will be required to use an allowance approach to recognize credit impairment, with the allowance to be limited to the amount by which the security’s fair value is less than its amortized cost basis;
• may not consider the length of time fair value has been below amortized cost, and
• may not consider recoveries of fair value after the balance sheet date when assessing whether a credit loss exists.
 

15
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
 
4.   ACQUISITION OF HATTERAS

As previously disclosed in the Company’s filings with the Securities and Exchange Commission (“SEC”), on July 12, 2016 the Company completed its acquisition of Hatteras, an externally managed mortgage REIT that invested primarily in single-family residential mortgage real estate assets, for aggregate consideration to Hatteras common stockholders of $1.5 billion, consisting of $1.0 billion in equity consideration and $521.1 million in cash consideration. The Company issued 93.9 million shares of common stock as part of the consideration for the Hatteras Acquisition, which includes replacement share-based payment awards.
In addition, as part of the Hatteras Acquisition, each share of Hatteras’ 7.625% Series A Cumulative Redeemable Preferred Stock, par value $0.001 per share (the “Hatteras Preferred Stock”), that was outstanding immediately prior to the completion of the Hatteras Acquisition was converted into one share of a newly-designated series of the Company’s preferred stock, par value $0.01 per share, which the Company classified and designated as 7.625% Series E Cumulative Redeemable Preferred Stock, and which has rights, preferences, privileges and voting powers substantially the same as the Hatteras Preferred Stock.

The following table summarizes the aggregate consideration and fair value of the assets acquired and liabilities assumed recognized at the acquisition date.

 
 
 
 
 
 
 
 
   
July 12, 2016
  
Consideration Transferred:
  
(dollars in thousands)
  
Cash
  
$
521,082
  
Common equity
    
997,707
  
         
Preferred shares:
        
Exchange of Hatteras preferred stock for Annaly preferred stock
    
278,252
  
Preferred stock fair value adjustment
    
9,248
  
Preferred shares
    
287,500
  
Total consideration
  
$
1,806,289
  
         
Net Assets:
        
Cash
  
$
562,780
  
Agency mortgage-backed securities, at fair value
    
10,863,070
  
Credit risk transfer securities, at fair value
    
116,770
  
Residential mortgage loans
    
360,447
  
Mortgage servicing rights
    
355,820
  
Other derivatives, at fair value
    
8,677
  
Principal receivable
    
438,005
  
Accrued interest and dividend receivable
    
83,814
  
Other assets
    
57,250
  
Total assets acquired
  
$
12,846,633
  
         
Repurchase agreements
  
$
10,422,757
  
Other secured financing
    
35,769
  
Securitized debt of consolidated VIEs
    
54,135
  
Other derivatives, at fair value
    
349,922
  
Dividends payable
    
670
  
Payable for investments purchased
    
2,643
  
Accrued interest payable
    
4,833
  
Accounts payable and other liabilities
    
97,039
  
Total liabilities assumed
    
10,967,768
  
Net assets acquired
  
$
1,878,865
  
Bargain purchase gain
  
$
72,576
  
 

For additional details regarding the terms and conditions of the Hatteras Acquisition and related matters, please refer to the Company’s other filings with the SEC that were made in connection with the Hatteras
Acquisition, including the Prospectus/Offer to Exchange filed with the SEC pursuant to Rule 424(b)(3) on July 8, 2016 and the Current Report on Form 8-K filed with the SEC on July 12, 2016.


 
 
16
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
 
5.              RESIDENTIAL INVESTMENT SECURITIES

The following tables present the Company’s Residential Investment Securities portfolio that was carried at fair value at September 30, 2017 and December 31, 2016:
 
 
September 30, 2017
 
Principal / Notional
Remaining Premium
Remaining Discount
Amortized Cost
Unrealized Gains (1)
Unrealized Losses (1)
Estimated Fair Value
Agency
(dollars in thousands)
Fixed-rate pass-through
$
73,190,164
  
$
4,249,983
  
$
(1,236
)
$
77,438,911
  
$
267,534
  
$
(854,518
)
$
76,851,927
  
Adjustable-rate pass-through
7,274,214
  
285,022
  
(2,608
)
7,556,628
  
21,917
  
(74,739
)
7,503,806
  
Interest-only
6,821,975
  
1,322,697
  
—
  
1,322,697
  
2,257
  
(203,082
)
1,121,872
  
Multifamily
409,791
  
3,828
  
(424
)
413,195
  
68
  
(1,737
)
411,526
  
Total Agency investments
$
87,696,144
  
$
5,861,530
  
$
(4,268
)
$
86,731,431
  
$
291,776
  
$
(1,134,076
)
$
85,889,131
  
Residential Credit
              
CRT
$
534,608
  
$
21,083
  
$
(4,062
)
$
551,629
  
$
31,954
  
$
(645
)
$
582,938
  
Alt-A
200,757
  
667
  
(33,716
)
167,708
  
12,143
  
(126
)
179,725
  
Prime
235,851
  
371
  
(33,821
)
202,401
  
18,257
  
(17
)
220,641
  
Prime Interest-only
334,298
  
954
  
—
  
954
  
—
  
(42
)
912
  
Subprime
597,658
  
1,885
  
(78,375
)
521,168
  
46,750
  
(28
)
567,890
  
NPL/RPL
104,936
  
86
  
(142
)
104,880
  
420
  
(27
)
105,273
  
Prime Jumbo (>= 2010 Vintage)
135,669
  
636
  
(3,980
)
132,325
  
1,846
  
—
  
134,171
  
Prime Jumbo (>= 2010 Vintage) Interest-Only
1,037,547
  
16,174
  
—
  
16,174
  
2,449
  
—
  
18,623
  
Total residential credit investments
$
3,181,324
  
$
41,856
  
$
(154,096
)
$
1,697,239
  
$
113,819
  
$
(885
)
$
1,810,173
  
Total Residential Investment Securities
$
90,877,468
  
$
5,903,386
  
$
(158,364
)
$
88,428,670
  
$
405,595
  
$
(1,134,961
)
$
87,699,304
  
               
 
December 31, 2016
 
Principal / Notional
Remaining Premium
Remaining Discount
Amortized Cost
Unrealized Gains (1)
Unrealized Losses (1)
Estimated Fair Value
Agency
(dollars in thousands)
Fixed-rate pass-through
$
60,759,317
  
$
3,633,354
  
$
(1,956
)
$
64,390,715
  
$
228,430
  
$
(1,307,771
)
$
63,311,373
  
Adjustable-rate pass-through
10,653,109
  
391,267
  
(4,081
)
11,040,295
  
47,250
  
(53,795
)
11,033,751
  
Interest-only
8,133,805
  
1,436,192
  
—
  
1,436,192
  
4,225
  
(195,668
)
1,244,749
  
Total Agency investments
$
79,546,231
  
$
5,460,813
  
$
(6,037
)
$
76,867,202
  
$
279,905
  
$
(1,557,234
)
$
75,589,873
  
Residential Credit
              
CRT
$
690,491
  
$
11,113
  
$
(10,907
)
$
690,697
  
$
34,046
  
$
(21
)
$
724,722
  
Alt-A
173,108
  
1,068
  
(23,039
)
151,137
  
3,721
  
(685
)
154,173
  
Prime
248,176
  
287
  
(35,068
)
213,395
  
7,050
  
(253
)
220,192
  
Subprime
697,983
  
380
  
(96,331
)
602,032
  
12,578
  
(1,061
)
613,549
  
NPL/RPL
269,802
  
670
  
(209
)
270,263
  
1,004
  
(429
)
270,838
  
Prime Jumbo (>= 2010 Vintage)
129,453
  
852
  
(345
)
129,960
  
267
  
(308
)
129,919
  
Prime Jumbo (>= 2010 Vintage) Interest-Only
863,370
  
15,129
  
—
  
15,129
  
—
  
(2,493
)
12,636
  
Total residential credit investments
$
3,072,383
  
$
29,499
  
$
(165,899
)
$
2,072,613
  
$
58,666
  
$
(5,250
)
$
2,126,029
  
Total Residential Investment Securities
$
82,618,614
  
$
5,490,312
  
$
(171,936
)
$
78,939,815
  
$
338,571
  
$
(1,562,484
)
$
77,715,902
  

(1)
Unrealized gains and losses on Agency investments, excluding interest-only investments, are reported as a component of Other comprehensive income (loss). Unrealized gains and losses on residential credit securities and Agency interest-only investments are reported in Net unrealized gains (losses) on investments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss).
 
The following table presents the Company’s Agency mortgage-backed securities portfolio concentration by issuing Agency at September 30, 2017 and December 31, 2016:
 
Investment Type
  
September 30, 2017
  
December 31, 2016
   
(dollars in thousands)
Fannie Mae
  
$
59,635,438
    
$
51,658,391
  
Freddie Mac
  
26,189,947
    
23,858,110
  
Ginnie Mae
  
63,746
    
73,372
  
Total
  
$
85,889,131
    
$
75,589,873
  
 

Actual maturities of the Company’s Residential Investment Securities portfolio are generally shorter than stated contractual maturities because actual maturities
of the portfolio are generally affected by periodic payments and prepayments of principal on underlying mortgages.
 
 
17
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
 
The following table summarizes the Company’s available-for-sale Residential Investment Securities at September 30, 2017 and December 31, 2016, according to their estimated weighted average life classifications:
 
   
September 30, 2017
  
December 31, 2016
Weighted Average Life
  
Estimated Fair Value
  
Amortized Cost
  
Estimated Fair Value
  
Amortized Cost
   
(dollars in thousands)
        
Less than one year
  
$
1,330,463
    
$
1,344,966
    
$
63,510
    
$
61,775
  
Greater than one year through five years
  
16,173,212
    
16,164,913
    
12,626,932
    
12,666,394
  
Greater than five years through ten years
  
69,944,328
    
70,675,577
    
56,785,601
    
57,738,588
  
Greater than ten years
  
251,301
    
243,214
    
8,239,859
    
8,473,058
  
Total
  
$
87,699,304
    
$
88,428,670
    
$
77,715,902
    
$
78,939,815
  
 

The weighted average lives of the Agency mortgage-backed securities at September 30, 2017 and December 31, 2016 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, accounted for as available-for-sale, by length of time that such securities have been in a continuous unrealized loss position at September 30, 2017 and December 31, 2016.
 
   
September 30, 2017
  
December 31, 2016
   
Estimated Fair
Value (1)
  
Gross Unrealized
Losses (1)
  
Number of
Securities (1)
  
Estimated Fair
Value (1)
  
Gross Unrealized
Losses (1)
  
Number of
Securities (1)
   
(dollars in thousands)
Less than 12 Months
  
$
49,631,846
    
$
(644,526
)
  
1,230
    
$
52,465,045
    
$
(1,094,957
)
  
1,368
  
12 Months or More
  
8,987,810
    
(286,468
)
  
175
    
6,277,814
    
(266,609
)
  
54
  
Total
  
$
58,619,656
    
$
(930,994
)
  
1,405
    
$
58,742,859
    
$
(1,361,566
)
  
1,422
  
(1)
Excludes interest-only mortgage-backed securities.

 
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 three and nine months ended September 30, 2017, the Company disposed of $6.8 billion and $11.4 billion of Residential Investment Securities, resulting in a net realized loss of $10.2 million and $14.3 million, respectively.
 
During the three and nine months ended September 30, 2016, the Company disposed of $3.8 billion and $9.1 billion of Residential Investment Securities, resulting in a net realized gain of $14.7 million and $24.9 million, respectively.
 
18
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
 
6.              RESIDENTIAL MORTGAGE LOANS
 
The table below presents the fair value and the unpaid principal balance of the residential mortgage loan portfolio at September 30, 2017 and December 31, 2016:
 
   
September 30, 2017
  
December 31, 2016
   
(dollars in thousands)
Fair value
  
$
895,919
    
$
342,289
  
Unpaid principal balance
  
$
878,574
    
$
338,323
  
 
The following table provides information regarding the line items and amounts recognized in the Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2017 for these investments: 
 
   
Three Months Ended
  
Nine Months Ended
   
September 30, 2017
  
September 30, 2016
  
September 30, 2017
  
September 30, 2016
   
(dollars in thousands)
Net gains (losses) on disposal of investments
  
$
(2,093
)
  
$
(383
)
  
$
(3,407
)
  
$
(383
)
Net unrealized gains (losses) on investments measured at fair value through earnings
  
(725
)
  
(493
)
  
5,400
    
(493
)
Net interest income
  
8,226
    
1,203
    
18,935
    
1,203
  
Total included in net income (loss)
  
$
5,408
    
$
327
    
$
20,928
    
$
327
  
 
The change in the fair value of the residential mortgage loans can be primarily attributed to changes in interest rates.

The following table provides the geographic concentrations based on the unpaid principal balances at September 30, 2017 and December 31, 2016, for the residential mortgage loans, including loans held in a securitization trust:
 
Geographic Concentrations of Residential Mortgage Loans
September 30, 2017
December 31, 2016
Property Location
% of Balance
Property Location
% of Balance
California
52.8
%
California
46.3
%
Florida
10.3
%
Texas
9.6
%
New York
8.1
%
Illinois
5.7
%
All other (none individually greater than 5%)
28.8
%
Florida
5.2
%
   
Washington
5.1
%
   
All other (none individually greater than 5%)
28.1
%
Total
100.0
%
Total
100.0
%
 
The following table provides additional data on the Company’s residential mortgage loans, including loans held in a securitization trust, at September 30, 2017 and December 31, 2016:
 
   
September 30, 2017
  
December 31, 2016
   
Portfolio
Range
  
Portfolio Weighted Average
  
Portfolio
Range
  
Portfolio Weighted Average
   
(dollars in thousands)
  
(dollars in thousands)
Unpaid principal balance
  
$2 - $3,677
  
$616
  
$22 - $1,905
  
$691
Interest rate
  
2.38% - 7.25%
  
4.37%
  
2.50% - 6.75%
  
3.72%
Maturity
  
8/1/2029 - 9/1/2047
  
10/9/2045
  
4/8/2044 - 11/1/2046
  
8/20/2045
FICO score at loan origination
  
620 - 828
  
754
  
665 - 814
  
761
Loan-to-value ratio at loan origination
  
14% - 105%
  
67%
  
24% - 90%
  
71%
 
At September 30, 2017 and December 31, 2016, approximately 78% and 85%, respectively, of the carrying value of the Company’s residential mortgage loans, including loans held in a securitization trust, were adjustable-rate.
 
19
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
 
7.              MORTGAGE SERVICING RIGHTS
 
The Company invests in MSRs and elected to carry them at fair value. The following table presents activity related to MSRs for the three and nine months ended September 30, 2017:
 
 
Three Months Ended
  
Nine Months Ended
 
September 30, 2017
  
September 30, 2016
  
September 30, 2017
  
September 30, 2016
 
(dollars in thousands)
Fair value, beginning of period
$
605,653
    
$
—
    
$
652,216
    
$
—
  
Obtained through Hatteras Acquisition
—
    
355,820
    
—
    
355,820
  
Purchases (1)
(30
)
  
131,729
    
(27
)
  
131,729
  
Other
10
    
—
    
10
    
—
  
Change in fair value due to:
              
Changes in valuation inputs or assumptions (2)
(19,207
)
  
26,254
    
(34,645
)
  
26,254
  
Other changes, including realization of expected cash flows
(16,208
)
  
(21,634
)
  
(47,336
)
  
(21,634
)
Fair value, end of period
$
570,218
    
$
492,169
    
$
570,218
    
$
492,169
  
 
(1)
Includes adjustments to original purchase price from early payoffs, defaults, or loans that were delivered but were deemed to not be acceptable.
(2)
Principally represents changes in discount rates and prepayment speed inputs used in valuation model, primarily due to changes in interest rates.

 
For the three and nine months ended September 30, 2017, the Company recognized $31.9 million and $99.7 million, respectively, of net servicing income from MSRs in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss). For the three and nine months ended September 30, 2016, the Company recognized $26.2 million of net servicing income from MSRs in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).
8.   COMMERCIAL REAL ESTATE INVESTMENTS


At September 30, 2017 and December 31, 2016, commercial real estate debt investments held for investment were comprised of the following:
 
20
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1. Financial Statements
 
 
CRE Debt and Preferred Equity Investments
 
   
September 30, 2017
  
December 31, 2016
   
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
  
$
583,630
    
$
580,609
    
59.2
%
  
$
512,322
    
$
510,071
    
52.6
%
Mezzanine loans
  
392,988
    
392,159
    
39.9
%
  
453,693
    
451,467
    
46.5
%
Preferred equity
  
9,000
    
8,980
    
0.9
%
  
9,000
    
8,967
    
0.9
%
Total (3)
  
$
985,618
    
$
981,748
    
100.0
%
  
$
975,015
    
$
970,505
    
100.0
%
 
(1)
Carrying value includes unamortized origination fees of $3.9 million and $4.5 million at September 30, 2017 and December 31, 2016, respectively.
(2)
Based on outstanding principal.
(3)
Excludes loans held for sale, net.
 
   
Nine months ended September 30, 2017
   
Senior
Mortgages
  
Mezzanine
Loans
  
Preferred
Equity
  
Total
   
(dollars in thousands)
Beginning balance
  
$
510,071
    
$
451,467
    
$
8,967
    
$
970,505
  
Originations & advances (principal)
  
263,916
    
63,801
    
—
    
327,717
  
Principal payments
  
(192,608
)
  
(124,506
)
  
—
    
(317,114
)
Amortization & accretion of (premium) discounts
  
(43
)
  
28
    
—
    
(15
)
Net (increase) decrease in origination fees
  
(2,531
)
  
(605
)