Document
CONFIDENTIAL DRAFT V4


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, 2018

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
 
nlyfinallogo10417a08.jpg
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 þ No ☐
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes þ No ☐






CONFIDENTIAL DRAFT V4


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 þ 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 þ

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:
Class  
Outstanding at October 31, 2018
Common Stock, $.01 par value 
1,313,722,699




ANNALY CAPITAL MANAGEMENT, INC.
FORM 10-Q
TABLE OF CONTENTS
 
 
Page
 




PART I - FINANCIALINFORMATION

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,
 
 
2018
 
2017 (1)
 
 
(Unaudited)
 
 
ASSETS
 
 
 
 
Cash and cash equivalents (includes pledged assets $924,891 and $579,213, respectively) (2)
 
$
1,082,747

 
$
706,589

Securities (includes pledged assets of $84,613,575 and $84,752,790, respectively) (3)

 
91,338,611

 
92,563,572

Loans (includes pledged assets of $2,519,340 and $1,811,062, respectively)
 
4,224,203

 
2,999,148

Mortgage servicing rights (includes pledged assets of $2,958 and $5,224, respectively)
 
588,833

 
580,860

Assets transferred or pledged to securitization vehicles
 
4,287,821

 
3,306,133

Real estate, net
 
753,014

 
485,953

Derivative assets

 
404,841

 
313,885

Reverse repurchase agreements

 
1,234,704

 
—

Receivable for unsettled trades
 
1,266,840

 
1,232

Interest receivable
 
347,278

 
323,526

Goodwill and intangible assets, net

 
103,043

 
95,035

Other assets
 
329,868

 
384,117

Total assets
 
$
105,961,803

 
$
101,760,050

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 

 
 

Liabilities:
 
 

 
 

Repurchase agreements
 
$
79,073,026

 
$
77,696,343

Other secured financing
 
4,108,547

 
3,837,528

Debt issued by securitization vehicles
 
3,799,542

 
2,971,771

Mortgages payable
 
511,588

 
309,686

Derivative liabilities

 
379,794

 
607,854

Payable for unsettled trades
 
2,505,428

 
656,581

Interest payable
 
399,605

 
253,068

Dividends payable
 
102,811

 
347,876

Other liabilities

 
125,606

 
207,770

Total liabilities
 
91,005,947

 
86,888,477

Stockholders’ Equity:
 
 

 
 

Preferred stock, par value $0.01 per share, 75,950,000 and 70,700,000 authorized, 73,400,000 and 70,700,000 issued and outstanding, respectively
 
1,778,168

 
1,720,381

Common stock, par value $0.01 per share, 1,924,050,000 and 1,929,300,000 authorized, 1,303,079,555 and 1,159,585,078 issued and outstanding, respectively
 
13,031

 
11,596

Additional paid-in capital
 
18,793,706

 
17,221,265

Accumulated other comprehensive income (loss)
 
(3,822,956
)
 
(1,126,020
)
Accumulated deficit
 
(1,811,955
)
 
(2,961,749
)
Total stockholders’ equity
 
14,949,994

 
14,865,473

Noncontrolling interests
 
5,862

 
6,100

Total equity
 
14,955,856

 
14,871,573

Total liabilities and equity
 
$
105,961,803

 
$
101,760,050

(1) 
Derived from the audited consolidated financial statements at December 31, 2017. 
(2) 
Includes cash of consolidated Variable Interest Entities (“VIEs”) of $28.4 million and $42.3 million at September 30, 2018 and December 31, 2017, respectively. 
(3) 
Excludes $129.8 million and $66.3 million at September 30, 2018 and December 31, 2017, respectively, of non-Agency mortgage-backed securities and $275.8 million and $0 at September 30, 2018 and December 31, 2017, respectively, of commercial mortgage-backed securities in consolidated VIEs pledged as collateral and eliminated from the Company’s Consolidated Statements of Financial Condition. 


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,
 
 
2018
 
2017
 
2018
 
2017
Net interest income:
 
 
 
 
 
 
 
 
Interest income
 
$
816,596

 
$
622,550

 
$
2,472,889

 
$
1,747,703

Interest expense
 
500,973

 
268,937

 
1,311,086

 
689,643

Net interest income
 
315,623

 
353,613

 
1,161,803

 
1,058,060

Realized and unrealized gains (losses):
 
 

 
 

 
 
 
 
Net interest component of interest rate swaps
 
51,349

 
(88,211
)
 
34,664

 
(288,837
)
Realized gains (losses) on termination or maturity of interest rate swaps
 
575

 
—

 
1,409

 
(58
)
Unrealized gains (losses) on interest rate swaps
 
417,203

 
56,854

 
1,737,963

 
28,471

Subtotal
 
469,127

 
(31,357
)
 
1,774,036

 
(260,424
)
Net gains (losses) on disposal of investments
 
(324,294
)
 
(11,552
)
 
(376,943
)
 
(11,833
)
Net gains (losses) on other derivatives
 
94,827

 
154,208

 
81,871

 
140,104

Net unrealized gains (losses) on instruments measured at fair value through earnings
 
(39,944
)
 
(67,492
)
 
(139,913
)
 
(27,569
)
Subtotal
 
(269,411
)
 
75,164

 
(434,985
)
 
100,702

Total realized and unrealized gains (losses)
 
199,716

 
43,807

 
1,339,051

 
(159,722
)
Other income (loss)
 
(10,643
)
 
28,282

 
57,550

 
90,793

General and administrative expenses:
 
 

 
 

 
 
 
 
Compensation and management fee
 
45,983

 
41,993

 
136,091

 
120,193

Other general and administrative expenses
 
80,526

 
15,023

 
116,709

 
44,674

Total general and administrative expenses
 
126,509

 
57,016

 
252,800

 
164,867

Income (loss) before income taxes
 
378,187

 
368,686

 
2,305,604

 
824,264

Income taxes
 
(7,242
)
 
1,371

 
(3,416
)
 
2,019

Net income (loss)
 
385,429

 
367,315

 
2,309,020

 
822,245

Net income (loss) attributable to noncontrolling interests
 
(149
)
 
(232
)
 
(277
)
 
(437
)
Net income (loss) attributable to Annaly
 
385,578

 
367,547

 
2,309,297

 
822,682

Dividends on preferred stock (1)
 
31,675

 
30,355

 
96,818

 
77,301

Net income (loss) available (related) to common stockholders
 
$
353,903

 
$
337,192

 
$
2,212,479

 
$
745,381

Net income (loss) per share available (related) to common stockholders:
 
 

 
 

 
 
 
 
Basic
 
$
0.29

 
$
0.31

 
$
1.88

 
$
0.72

Diluted
 
$
0.29

 
$
0.31

 
$
1.88

 
$
0.72

Weighted average number of common shares outstanding:
 
 

 
 

 
 
 
 
Basic
 
1,202,353,851

 
1,072,566,395

 
1,174,292,701

 
1,037,033,076

Diluted
 
1,202,353,851

 
1,073,040,637

 
1,174,292,701

 
1,037,445,177

Dividends declared per share of common stock
 
$
0.30

 
$
0.30

 
$
0.90

 
$
0.90

Net income (loss)
 
$
385,429

 
$
367,315

 
$
2,309,020

 
$
822,245

Other comprehensive income (loss):
 
 

 
 

 
 
 
 
Unrealized gains (losses) on available-for-sale securities
 
(719,609
)
 
195,251

 
(3,104,218
)
 
397,600

Reclassification adjustment for net (gains) losses included in net income (loss)
 
331,100

 
15,367

 
407,282

 
48,144

Other comprehensive income (loss)
 
(388,509
)
 
210,618

 
(2,696,936
)
 
445,744

Comprehensive income (loss)
 
(3,080
)
 
577,933

 
(387,916
)
 
1,267,989

Comprehensive income (loss) attributable to noncontrolling interests
 
(149
)
 
(232
)
 
(277
)
 
(437
)
Comprehensive income (loss) attributable to Annaly
 
(2,931
)
 
578,165

 
(387,639
)
 
1,268,426

Dividends on preferred stock (1)
 
31,675

 
30,355

 
96,818

 
77,301

Comprehensive income (loss) attributable to common stockholders
 
$
(34,606
)
 
$
547,810

 
$
(484,457
)
 
$
1,191,125

(1) 
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
(dollars in thousands)
(Unaudited)
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
Preferred Stock
 
 
 
 
Beginning of period
 
$
1,720,381

 
$
1,200,559

Issuance
 
411,335

 
696,910

Acquisition of subsidiary
 
55,000

 
—

Redemption
 
(408,548
)
 
(177,088
)
End of period
 
$
1,778,168

 
$
1,720,381

Common Stock
 
 
 
 
Beginning of period
 
$
11,596

 
$
10,189

Issuance
 
1,103

 
690

Acquisition of subsidiary
 
330

 
—

Direct purchase and dividend reinvestment
 
2

 
2

End of period
 
$
13,031

 
$
10,881

Additional paid-in capital
 
 
 
 
Beginning of period
 
$
17,221,265

 
$
15,579,342

Stock compensation expense
 
1,789

 
1,276

Issuance
 
1,116,409

 
803,464

Acquisition of subsidiary
 
455,613

 
—

Redemption of preferred stock
 
(3,952
)
 
(8,224
)
Direct purchase and dividend reinvestment
 
2,582

 
1,947

End of period
 
$
18,793,706

 
$
16,377,805

Accumulated other comprehensive income (loss)
 
 
 
 
Beginning of period
 
$
(1,126,020
)
 
$
(1,085,893
)
Unrealized gains (losses) on available-for-sale securities
 
(3,104,218
)
 
397,600

Reclassification adjustment for net gains (losses) included in net income (loss)
 
407,282

 
48,144

End of period
 
$
(3,822,956
)
 
$
(640,149
)
Accumulated deficit
 
 
 
 
Beginning of period
 
$
(2,961,749
)
 
$
(3,136,017
)
Net income (loss) attributable to Annaly
 
2,309,297

 
822,682

Dividends declared on preferred stock

 
(96,818
)
 
(69,000
)
Dividends and dividend equivalents declared on common stock and share-based awards
 
(1,062,685
)
 
(937,825
)
End of period
 
$
(1,811,955
)
 
$
(3,320,160
)
 
 
 
 
 
Total stockholder’s equity
 
$
14,949,994

 
$
14,148,758

Noncontrolling interests
 
 
 
 
Beginning of period
 
$
6,100

 
$
7,792

Net income (loss) attributable to noncontrolling interests
 
(277
)
 
(437
)
Equity contributions from (distributions to) noncontrolling interests
 
39

 
(895
)
End of period
 
$
5,862

 
$
6,460

 
 
 
 
 
Total
 
$
14,955,856

 
$
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,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income (loss)
 
$
2,309,020

 
$
822,245

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
 
Amortization of premiums and discounts of investments, net
 
474,449

 
668,195

Amortization of securitized debt premiums and discounts and deferred financing costs
 
991

 
618

Depreciation, amortization and other noncash expenses
 
63,839

 
21,686

Net (gains) losses on disposals of investments
 
376,943

 
11,833

Net (gains) losses on investments and derivatives
 
(1,679,921
)
 
(141,006
)
Income from unconsolidated joint ventures
 
6,441

 
2,223

Payments on purchases of loans held for sale
 
(191,641
)
 
(230,503
)
Proceeds from sales and repayments of loans held for sale
 
64,460

 
330,285

Net receipts (payments) on derivatives
 
1,519,228

 
(732,998
)
Net change in:
 
 
 
 
Other assets
 
100,010

 
(30,387
)
Interest receivable
 
(8,468
)
 
(17,322
)
Interest payable
 
124,316

 
68,598

Other liabilities
 
(136,510
)
 
(43,936
)
Net cash provided by (used in) operating activities
 
3,023,157

 
729,531

Cash flows from investing activities:
 
 
 
 
Payments on purchases of Residential Securities
 
(17,053,068
)
 
(25,852,497
)
Proceeds from sales of Residential Securities
 
9,558,735

 
11,598,472

Principal payments on Residential Securities
 
8,696,239

 
8,971,444

Payments on purchases of MSRs
 
(381
)
 
(11,081
)
Payments on purchases of corporate debt
 
(744,071
)
 
(374,358
)
Principal payments on corporate debt
 
235,423

 
295,380

Originations and purchases of commercial real estate related assets
 
(697,753
)
 
(388,951
)
Proceeds from sales of commercial real estate related assets
 
134,538

 
11,960

Principal repayments on commercial real estate related assets
 
478,726

 
852,381

Proceeds from reverse repurchase agreements
 
70,016,988

 
50,280,000

Payments on reverse repurchase agreements
 
(70,313,441
)
 
(50,280,000
)
Distributions in excess of cumulative earnings from unconsolidated joint ventures
 
5,434

 
6,160

Payments on purchases of residential mortgage loans held for investment
 
(729,917
)
 
(668,977
)
Proceeds from repayments of residential mortgage loans held for investment
 
251,407

 
131,052

Payments on purchases of equity securities
 
—

 
(2,104
)
Cash paid related to asset acquisition, net of cash acquired
 
(258,334
)
 
—

Net payment from disposal of subsidiary
 
—

 
5,337

Net cash provided by (used in) investing activities
 
(419,475
)
 
(5,425,782
)
Cash flows from financing activities:
 
 
 
 
Proceeds from repurchase agreements and other secured financing
 
3,866,183,872

 
2,505,995,751

Principal payments on repurchase agreements and other secured financing
 
(3,868,097,943
)
 
(2,501,952,817
)
Proceeds from issuance of securitized debt
 
588,111

 
—

Principal repayments on securitized debt
 
(614,536
)
 
(334,386
)
Payment of deferred financing cost
 
—

 
(2,054
)
Net proceeds from stock offerings, direct purchases and dividend reinvestments
 
1,531,690

 
1,503,013

Redemption of preferred stock
 
(412,500
)
 
(185,312
)
Principal payments on participation sold
 
—

 
(12,827
)
Principal payments on mortgages payable
 
(49
)
 
(54
)
Net contributions (distributions) from (to) noncontrolling interests
 
(780
)
 
(895
)
Dividends paid
 
(1,405,389
)
 
(986,074
)
Net cash provided by (used in) financing activities
 
(2,227,524
)
 
4,024,345

Net (decrease) increase in cash and cash equivalents
 
376,158

 
(671,906
)
Cash and cash equivalents including cash pledged as collateral, beginning of period
 
706,589

 
1,539,746

Cash and cash equivalents including cash pledged as collateral, end of period
 
$
1,082,747

 
$
867,840

Supplemental disclosure of cash flow information:
 
 
 
 
Interest received
 
$
2,846,535

 
$
2,460,097

Dividends received
 
$
5,448

 
$
3,774

Interest paid (excluding interest paid on interest rate swaps)
 
$
1,159,384

 
$
693,983

Net interest paid (received) on interest rate swaps
 
$
(243,946
)
 
$
264,965

Taxes paid
 
$
86

 
$
2,612

Noncash investing activities:
 
 
 
 
Receivable for unsettled trades
 
$
1,266,840

 
$
340,033

Payable for unsettled trades
 
$
2,505,428

 
$
5,243,868

Net change in unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment
 
$
(2,696,936
)
 
$
445,744

Noncash financing activities:
 
 
 
 
Dividends declared, not yet paid
 
$
102,811

 
$
326,425

See notes to consolidated financial statements.

4
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 and to preserve capital through 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 four investment groups are primarily comprised of the following:
Investment Groups
Description
Annaly Agency Group
Invests in Agency mortgage-backed securities (“MBS”) collateralized by residential mortgages which are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae.
Annaly Residential Credit Group
Invests primarily in non-Agency residential mortgage assets within securitized products and residential mortgage loan markets.
Annaly Commercial Real Estate Group
Originates and invests in commercial mortgage loans, securities, and other commercial real estate debt and equity investments.
Annaly Middle Market Lending Group
Provides financing to private equity-backed middle market businesses across the capital structure.
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 for the fiscal year ended December 31, 2017 (the “2017 Form 10-K”). The consolidated financial information as of December 31, 2017 has been derived from audited consolidated financial statements included in the Company’s 2017 Form 10-K. The Company reclassified previously presented financial information to conform to the current presentation.

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported balance sheet amounts and/or disclosures 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.
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.

5
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1.  Financial Statements



3. SIGNIFICANT ACCOUNTING POLICIES
The Company’s significant accounting policies are described below or are included in the following notes:

Notes
Note 1. Description of Business
Note 9. Real Estate
Note 17. Income Taxes
Note 2. Basis of Presentation
Note 10. Derivative Instruments
Note 18. Risk Management
Note 3. Significant Accounting Policies
Note 11. Fair Value Measurements
Note 19. Related Party Transactions
Note 4. Financial Instruments
Note 12. Goodwill and Intangible Assets, Net
Note 20. Lease Commitments and Contingencies
Note 5. Securities
Note 13. Secured Financing
Note 21. Arcola Regulatory Requirements
Note 6. Loans
Note 14. Capital Stock
Note 22. Acquisition of MTGE Investment Corp.
Note 7. Mortgage Servicing Rights
Note 15. Interest Income and Interest Expense
Note 23. Subsequent Events
Note 8. Variable Interest Entities
Note 16. Net Income (Loss) Per Common Share
 

Principles of Consolidation – The consolidated financial statements include the accounts of the entities where the Company has a controlling financial interest. In order to determine whether the Company has a controlling financial interest, it first evaluates whether an entity is a voting interest entity (“VOE”) or a variable interest entity (“VIE”). All intercompany balances and transactions have been eliminated in consolidation.

Voting Interest Entities – A VOE is an entity that has sufficient equity and in which equity investors have a controlling financial interest. The Company consolidates VOEs where it has a majority of the voting equity of such VOE.

Variable Interest Entities – 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 VIE is required to be consolidated by its primary beneficiary, which is defined as the party that has both (i) the power to control the activities that most significantly impact the VIE’s economic performance and (ii) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE.

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 to change. Refer to the “Variable Interest Entities” Note for further information.

Equity Method Investments - For entities that are not consolidated, but where the Company has significant influence over the operating or financial decisions of the entity, the Company accounts for the investment under the equity method of accounting. In accordance with 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. These investments are included in Real estate, net and Other assets with income or loss included in Other income (loss).

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. 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 $924.9 million and $579.2 million at September 30, 2018 and December 31, 2017, respectively.
 
Equity Securities – The Company may invest in equity securities that are not accounted for under the equity method or do not result in consolidation. These equity securities are required to be reported at fair value with unrealized gains and losses reported in the Consolidated Statements of Comprehensive Income (Loss) as Net unrealized gains (losses) on instruments measured at fair value through earnings, unless the securities do not have readily determinable fair values.  For such equity securities without readily determinable fair values, the Company has elected to carry the securities at cost less impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer. For equity securities carried at fair value through earnings, dividends are recorded in earnings on the declaration date. Dividends from equity securities without readily determinable fair values are recognized as income when received to the extent they are distributed from net accumulated earnings.

Fair Value Measurements and the Fair Value Option – The Company reports various investments at fair value, including certain eligible financial instruments elected to be accounted for under the fair value option (“FVO”). The Company chooses to elect the fair value option in order to simplify the accounting treatment for certain financial instruments. If an item is accounted for at fair

6
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1.  Financial Statements



value, including financial instruments elected under the FVO, it is presented at fair value in the Consolidated Statements of Financial Condition and any change in fair value is recorded in Net unrealized gains (losses) on instruments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss). The Company made elections to account for the investments at fair value as these elections simplify the accounting. For additional information regarding financial instruments for which the Company has elected the fair value option see the table in the “Financial Instruments” Note.

Refer to the “Fair Value Measurement” Note for a complete discussion on the methodology utilized by the Company to estimate the fair value of certain financial instruments.

Offsetting Assets and Liabilities - The Company elected to present all derivative instruments on a gross basis as discussed in the “Derivative Instruments” Note. Reverse repurchase and repurchase agreements are presented net in the Consolidated Statements of Financial Condition if they are subject to netting agreements and they meet the offsetting criteria. Please see below and refer to the “Financing” Note for further discussion on reverse repurchase and repurchase agreements.

Derivative Instruments – 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). The changes in the estimated fair value are presented within Net gains (losses) on other derivatives with the exception of interest rate swaps which are separately presented. None of the Company’s derivative transactions have been designated as hedging instruments for accounting purposes. Refer to the “Derivative Instruments” Note for further discussion.

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.

Interest Income - Premiums and discounts associated with the purchase of residential mortgage loans and with those transferred or pledged to securitization trusts 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). Refer to the “Interest Income and Interest Expense” Note for further discussion on interest income.
 
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. As a REIT, the Company will not incur federal income tax to the extent that it distributes its taxable income to its stockholders. The Company and certain of its direct and indirect subsidiaries 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 its taxable income. Refer to the “Income Taxes” Note for further discussion on income taxes.
Recent Accounting Pronouncements
The Company considers the applicability and impact of all Accounting Standards Updates (“ASUs”).  ASUs not listed below were not applicable, not expected to have a significant impact on the Company’s consolidated financial statements when adopted, or did not have a significant impact on the Company’s consolidated financial statements upon adoption.



7
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 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. 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. The Company needs to complete the development of an appropriate allowance methodology, assess the impact on the consolidated financial statements and determine appropriate internal controls and financial statement disclosures. 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.
 
 
 
 
Standard
Description
Effective Date
Effect on the Financial Statements or Other Significant Matters
Standards that were adopted
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
The amendments are expected to result in fewer transactions being accounted for as business combinations.
ASU 2016-15 Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments

This update provides specific guidance on certain cash flow classification issues, including classification of cash receipts and payments that have aspects of more than one class of cash flows. If cash flows cannot be separated by source or use, the appropriate classification should depend on the activity that is likely to be the predominant source or use of cash flows.

January 1, 2018
As a result of adopting this standard, the Company reclassified its cash flows on reverse repurchase and repurchase agreements entered into by Arcola Securities, Inc. from operating activities to investing and financing activities, respectively, in the Consolidated Statements of Cash Flows. The Company applied the retrospective transition method, which resulted in reclassification of comparative periods.


8
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1.  Financial Statements



4. FINANCIAL INSTRUMENTS                         
The following table presents characteristics for certain of the Company’s financial instruments at September 30, 2018 and December 31, 2017.
Financial Instruments (1)
Balance Sheet Line Item
Type / Form
Measurement Basis
September 30, 2018
 
December 31, 2017
 
Assets
(dollars in thousands)
 
 
 
Securities
Agency mortgage-backed securities (2)
Fair value, with unrealized gains (losses) through other comprehensive income
$
88,363,876

 
$
89,426,437

Securities
Agency mortgage-backed securities (3)

Fair value, with unrealized gains (losses) through earnings
926,252

 
1,125,326

Securities
Credit risk transfer securities
Fair value, with unrealized gains (losses) through earnings
688,521

 
651,764

Securities
Non-agency mortgage-backed securities
Fair value, with unrealized gains (losses) through earnings
1,173,467

 
1,097,294

Securities
Commercial real estate debt investments - CMBS
Fair value, with unrealized gains (losses) through other comprehensive income
162,678

 
244,636

Securities
Commercial real estate debt investments - Conduit CMBS
Fair value, with unrealized gains (losses) through earnings
23,817

 
18,115

Total securities

 
91,338,611

 
92,563,572

Loans
Residential mortgage loans
Fair value, with unrealized gains (losses) through earnings
1,217,139

 
958,546

Loans
Commercial real estate debt and preferred equity, held for investment
Amortized cost
1,435,865

 
1,029,327

Loans
Loans held for sale, net
Lower of amortized cost or fair value
42,325

 
—

Loans
Corporate debt
Amortized cost
1,528,874

 
1,011,275

Total loans
 
 
4,224,203

 
2,999,148

Assets transferred or pledged to securitization vehicles

Residential mortgage loans
Fair value, with unrealized gains (losses) through earnings
765,876

 
479,776

Assets transferred or pledged to securitization vehicles
Commercial mortgage loans
Fair value, with unrealized gains (losses) through earnings
3,521,945

 
2,826,357

Total assets transferred or pledged to securitization vehicles
 
4,287,821

 
3,306,133

Reverse repurchase agreements
Reverse repurchase agreements
Amortized cost
1,234,704

 
—

 
Liabilities
 
 
 
 
Repurchase agreements
Repurchase agreements
Amortized cost
79,073,026

 
77,696,343

Other secured financing
Loans
Amortized cost
4,108,547

 
3,837,528

Debt issued by securitization vehicles
Securities
Fair value, with unrealized gains (losses) through earnings
3,799,542

 
2,971,771

Mortgages payable
Loans
Amortized cost
511,588

 
309,686

(1)
Receivable for unsettled trades, Interest receivable, Dividends payable, Payable for unsettled trades and Interest payable are accounted for at cost.
(2)
Includes Agency pass-through, CMO and multifamily securities.
(3)
Includes interest-only securities and reverse mortgages.


5. SECURITIES                                      
The Company’s investments in securities include agency, credit risk transfer, non-agency and commercial mortgage-backed securities. All of the debt are classified as available-for-sale. Available-for-sale securities are carried at fair value with changes in fair value recognized in other comprehensive income unless the fair value option is elected. Transactions for securities are recorded on trade date, including TBA securities that meet the regular-way securities scope exception from derivative accounting. Gains and losses on disposals of securities are recorded on trade date based on the specific identification method.

The Company accounts for equity securities at fair value unless it is accounted for under the equity method of accounting or the measurement alternative for equity securities without readily determinable fair values.

Other-Than-Temporary Impairment - Management evaluates available-for-sale securities for other-than-temporary impairment at least quarterly, and more frequently when economic or market conditions warrant such evaluation.


9
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). There was no other-than-temporary impairment recognized for the three or nine months ended September 30, 2018 and 2017.

Agency Mortgage-Backed 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. Many of the underlying loans and certificates are 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”). 

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”). TBA securities without intent to accept delivery (“TBA derivatives”),
are accounted for as derivatives as discussed in the “Derivative Instruments” Note.

Credit Risk Transfer 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.

Non-Agency Mortgage-Backed Securities- The Company invests in non-Agency mortgage-backed securities such as those issued in non-performing loan (“NPL”) and re-performing loan (“RPL”) securitizations.

Commercial Mortgage-Backed Securities (“Commercial Securities”) - Certain commercial mortgage-backed securities are classified as available-for-sale and reported at fair value with unrealized gains and losses reported as a component of Other comprehensive income (loss). Management evaluates such Commercial Securities for other-than-temporary impairment at least quarterly. The Company elected the fair value option on certain Commercial Securities, including conduit commercial mortgage-backed securities, to simplify the accounting where the unrealized gains and losses on these financial instruments are recorded through earnings.

Agency mortgage-backed securities, non-agency mortgage-backed securities and CRT securities are referred to herein as “Residential Securities.” Although the Company generally intends to hold most of its Residential Securities until maturity, it may, from time to time, sell any of its Residential Securities as part of the overall management of its portfolio.
The following represents a rollforward of the activity for the Company’s securities:

 
September 30, 2018
 
Residential Securities
 
Commercial Securities
 
Total
 
(dollars in thousands)
Beginning Balance January 1
$
92,300,821

 
$
262,751

 
$
92,563,572

Purchases
25,395,018

 
62,402

 
25,457,420

Sales
(14,532,225
)
 
(40,900
)
 
(14,573,125
)
Principal paydowns
(8,695,247
)
 
(96,397
)
 
(8,791,644
)
Amortization / accretion
(485,804
)
 
501

 
(485,303
)
Fair value adjustment
(2,830,447
)
 
(1,862
)
 
(2,832,309
)
Ending Balance September 30
$
91,152,116

 
$
186,495

 
$
91,338,611




10
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1.  Financial Statements



The following tables present the Company’s securities that were carried at fair value at September 30, 2018 and December 31, 2017:
 
September 30, 2018
 
Principal / Notional
 
Remaining Premium
 
Remaining Discount
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Agency
(dollars in thousands)
Fixed-rate pass-through
$
80,917,596

 
$
4,376,927

 
$
(7,643
)
 
$
85,286,880

 
$
28,156

 
$
(3,664,420
)
 
$
81,650,616

Adjustable-rate pass-through
5,415,559

 
268,852

 
(1,568
)
 
5,682,843

 
9,098

 
(164,520
)
 
5,527,421

CMO
11,610

 
55

 
—

 
11,665

 
—

 
(124
)
 
11,541

Interest-only
6,248,885

 
1,226,033

 
—

 
1,226,033

 
2,500

 
(340,766
)
 
887,767

Multifamily
1,204,773

 
8,596

 
(8,242
)
 
1,205,127

 
306

 
(31,135
)
 
1,174,298

Reverse mortgages
34,552

 
4,272

 
—

 
38,824

 
—

 
(339
)
 
38,485

Total Agency Securities
$
93,832,975

 
$
5,884,735

 
$
(17,453
)
 
$
93,451,372

 
$
40,060

 
$
(4,201,304
)
 
$
89,290,128

Residential Credit
 

 
 

 
 

 
 

 
 

 
 

 
 

CRT
$
651,360

 
$
33,670

 
$
(14,996
)
 
$
670,034

 
$
18,537

 
$
(50
)
 
$
688,521

Alt-A
239,990

 
385

 
(36,910
)
 
203,465

 
12,730

 
(131
)
 
216,064

Prime
386,193

 
2,111

 
(25,419
)
 
362,885

 
15,341

 
(596
)
 
377,630

Subprime
449,425

 
1,973

 
(67,841
)
 
383,557

 
45,238

 
(109
)
 
428,686

NPL/RPL
3,431

 
—

 
(37
)
 
3,394

 
45

 
—

 
3,439

Prime Jumbo (>= 2010 Vintage)
137,953

 
587

 
(4,644
)
 
133,896

 
49

 
(3,977
)
 
129,968

Prime Jumbo (>= 2010 Vintage) Interest-Only
884,325

 
13,265

 
—

 
13,265

 
4,415

 
—

 
17,680

Total Residential Credit Securities
$
2,752,677

 
$
51,991

 
$
(149,847
)
 
$
1,770,496

 
$
96,355

 
$
(4,863
)
 
$
1,861,988

Total Residential Securities
$
96,585,652

 
$
5,936,726

 
$
(167,300
)
 
$
95,221,868

 
$
136,415

 
$
(4,206,167
)
 
$
91,152,116

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial Securities
196,407

 
339

 
(9,903
)
 
186,843

 
575

 
(923
)
 
186,495

Total Securities
$
96,782,059

 
$
5,937,065

 
$
(177,203
)
 
$
95,408,711

 
$
136,990

 
$
(4,207,090
)
 
$
91,338,611

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
Principal / Notional
 
Remaining Premium
 
Remaining Discount
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Agency
(dollars in thousands)
Fixed-rate pass-through
$
78,509,335

 
$
4,514,815

 
$
(1,750
)
 
$
83,022,400

 
$
140,115

 
$
(1,178,673
)
 
$
81,983,842

Adjustable-rate pass-through
6,760,991

 
277,212

 
(1,952
)
 
7,036,251

 
15,776

 
(103,121
)
 
6,948,906

Interest-only
6,804,715

 
1,326,761

 
—

 
1,326,761

 
1,863

 
(242,862
)
 
1,085,762

Multifamily
490,753

 
5,038

 
(341
)
 
495,450

 
84

 
(1,845
)
 
493,689

Reverse mortgages
35,000

 
4,527

 
—

 
39,527

 
37

 
—

 
39,564

Total Agency Securities
$
92,600,794

 
$
6,128,353

 
$
(4,043
)
 
$
91,920,389

 
$
157,875

 
$
(1,526,501
)
 
$
90,551,763

Residential Credit
 

 
 

 
 

 
 

 
 

 
 

 
 

CRT
$
593,027

 
$
25,463

 
$
(3,456
)
 
$
615,034

 
$
36,730

 
$
—

 
$
651,764

Alt-A
204,213

 
499

 
(34,000
)
 
170,712

 
13,976

 
(802
)
 
183,886

Prime
197,756

 
358

 
(24,158
)
 
173,956

 
18,804

 
—

 
192,760

Subprime
554,470

 
2,037

 
(78,561
)
 
477,946

 
56,024

 
(90
)
 
533,880

NPL/RPL
42,585

 
14

 
(117
)
 
42,482

 
506

 
—

 
42,988

Prime Jumbo (>= 2010 Vintage)
130,025

 
627

 
(3,956
)
 
126,696

 
1,038

 
(1,112
)
 
126,622

Prime Jumbo (>= 2010 Vintage) Interest-Only
989,052

 
15,287

 
—

 
15,287

 
1,871

 
—

 
17,158

Total Residential Credit Securities
2,711,128

 
44,285

 
(144,248
)
 
1,622,113

 
128,949

 
(2,004
)
 
1,749,058

Total Residential Securities
$
95,311,922

 
$
6,172,638

 
$
(148,291
)
 
$
93,542,502

 
$
286,824

 
$
(1,528,505
)
 
$
92,300,821

Commercial
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial Securities
$
270,288

 
$
680

 
$
(9,731
)
 
$
261,237

 
$
1,843

 
$
(329
)
 
$
262,751

Total Securities
$
95,582,210

 
$
6,173,318

 
$
(158,022
)
 
$
93,803,739

 
$
288,667

 
$
(1,528,834
)
 
$
92,563,572



11
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1.  Financial Statements



The following table presents the Company’s Agency mortgage-backed securities portfolio concentration by issuing Agency at September 30, 2018 and December 31, 2017:
 
 
September 30, 2018
 
December 31, 2017
Investment Type
 
(dollars in thousands)
Fannie Mae
 
$
59,568,293

 
$
63,361,415

Freddie Mac
 
29,636,443

 
27,091,978

Ginnie Mae
 
85,392

 
98,370

Total
 
$
89,290,128

 
$
90,551,763

 
Actual maturities of the Company’s Residential 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.

The following table summarizes the Company’s available-for-sale Residential Securities at September 30, 2018 and December 31, 2017, according to their estimated weighted average life classifications:
 
 
September 30, 2018
 
December 31, 2017
 
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
Weighted Average Life
 
(dollars in thousands)
Less than one year
 
$
19,335

 
$
19,339

 
$
471,977

 
$
476,538

Greater than one year through five years
 
10,442,022

 
10,737,675

 
13,838,890

 
13,925,749

Greater than five years through ten years
 
79,260,878

 
83,003,720

 
77,273,833

 
78,431,852

Greater than ten years
 
1,429,881

 
1,461,134

 
716,121

 
708,363

Total
 
$
91,152,116

 
$
95,221,868

 
$
92,300,821

 
$
93,542,502

 
The weighted average lives of the Residential Securities at September 30, 2018 and December 31, 2017 in the table above are based upon projected principal prepayment rates. The actual weighted average lives of the Residential 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 where the fair value option has not been elected, by length of time that such securities have been in a continuous unrealized loss position at September 30, 2018 and December 31, 2017.
 
 
September 30, 2018
 
December 31, 2017
 
 
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
 
$
46,457,384

 
$
(1,401,491
)
 
2,213

 
$
39,878,158

 
$
(272,234
)
 
1,114

12 Months or More
 
40,098,674

 
(2,458,708
)
 
1,233

 
39,491,238

 
(1,011,405
)
 
911

Total
 
$
86,556,058

 
$
(3,860,199
)
 
3,446

 
$
79,369,396

 
$
(1,283,639
)
 
2,025

(1) 
Excludes interest-only mortgage-backed securities and reverse mortgages.

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. 

During the three and nine months ended September 30, 2018, the Company disposed of $9.1 billion and $14.5 billion of Residential Securities, resulting in net realized (losses) of ($322.4) million and ($372.5) million, respectively. During the three and nine months ended September 30, 2017, the Company disposed of $6.8 billion and $11.4 billion of Residential Securities, resulting in net realized losses of ($10.2) million and ($14.3) million, respectively.

12
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1.  Financial Statements



6. LOANS                                              
The Company invests in residential, commercial and corporate loans. Loans are classified as either held for investment or held for sale. Loans are also eligible to be accounted for under the fair value option. As of September 30, 2018, the Company reported $1.2 billion of loans elected under the fair value option. If loans are held for investment and the fair value option has not been elected, they are accounted for at amortized cost less impairment. If loans are held for sale and the fair value option has not been elected, they are accounted for at the lower of cost or fair value.
 
Loans can be classified as held for investment if the Company has the intent and ability to hold the loan for the foreseeable future or to maturity or payoff. If the Company has the intent and ability to sell loans, they are classified as held for sale.

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 or loans in default as all of the loans were performing at September 30, 2018 and December 31, 2017. There were no allowances for loan losses at September 30, 2018 or December 31, 2017.

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 at origination or acquisition of a new investment and if events occur that trigger re-evaluation by management.

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.

The Company’s internal loan risk ratings are based on the guidance provided by the Office of the Comptroller of the Currency for commercial real estate lending. The Company’s 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 meet all present contractual obligations, but exhibit potential weakness that deserves management’s close attention and, if uncorrected, may result in deterioration of repayment

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



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. The Company did not have any impaired loans, nonaccrual loans, or loans in default in the commercial loan portfolio as all of the loans were performing at September 30, 2018 and December 31, 2017. As such, no provision for loan losses was deemed necessary at September 30, 2018 or December 31, 2017.

The following table presents the activity of the Company’s loan investments for the nine months ended September 30, 2018:

 
Residential
 
Commercial
 
Corporate
 
Total
 
(dollars in thousands)
Beginning balance January 1, 2018
$
958,546

 
$
1,029,327

 
$
1,011,275

 
$
2,999,148

Purchases
430,854

 
528,835

 
788,213

 
1,747,902

Syndications
—

 
—

 
(44,125
)
 
(44,125
)
Principal Payments
(156,198
)
 
(124,559
)
 
(235,423
)
 
(516,180
)
Change in fair value
(13,812
)
 
—

 
—

 
(13,812
)
Amortization
(2,251
)
 
2,262

 
8,934

 
8,945

Ending balance September 30, 2018
$
1,217,139

 
$
1,435,865

 
$
1,528,874

 
$
4,181,878


The carrying value of the Company’s loans held for sale was $42.3 million and $0 at September 30, 2018 and December 31, 2017, respectively.

Residential

The Company’s residential mortgage loans are primarily comprised of performing adjustable-rate and fixed-rate whole loans. Additionally, the Company consolidates a collateralized financing entity that securitized prime adjustable-rate jumbo residential mortgage loans. The Company also consolidates securitization trusts in which it had purchased subordinated securities because it also has certain powers and rights to direct the activities of such trusts. Please refer to the “Variable Interest Entities” Note for further information related to the Company’s consolidated Residential Mortgage Loan Trusts.

The following table presents the fair value and the unpaid principal balances of the residential mortgage loan portfolio, including loans transferred or pledged to securitization vehicles, at September 30, 2018 and December 31, 2017:

 
 
September 30, 2018
 
December 31, 2017
 
 
(dollars in thousands)
Fair value
 
$
1,983,015

 
$
1,438,322

Unpaid principal balance
 
$
1,976,077

 
$
1,419,807

 
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, 2018 and 2017 for these investments: 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
September 30, 2017
 
September 30, 2018
 
September 30, 2017
 
 
(dollars in thousands)
Net interest income
 
$
16,423

 
$
8,226

 
$
45,702

 
$
18,935

Net gains (losses) on disposal of investments (1)
 
(2,975
)
 
(2,093
)
 
(7,924
)
 
(3,407
)
Net unrealized gains (losses) on instruments measured at fair value through earnings
 
(3,633
)
 
(725
)
 
(14,802
)
 
5,400

Total included in net income (loss)
 
$
9,815

 
$
5,408

 
$
22,976

 
$
20,928

(1) Includes loan premium write offs.

The following table provides the geographic concentrations based on the unpaid principal balances at September 30, 2018 and December 31, 2017, for the residential mortgage loans, including loans transferred or pledged to securitization trusts:


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



Geographic Concentrations of Residential Mortgage Loans
September 30, 2018
 
December 31, 2017
Property Location
% of Balance
 
Property Location
% of Balance
California
54.5
%
 
California
49.8
%
New York
8.1
%
 
Florida
9.3
%
Florida
6.6
%
 
New York
7.1
%
All other (none individually greater than 5%)
30.8
%
 
All other (none individually greater than 5%)
33.8
%
Total
100.0
%
 
Total
100.0
%
 
The following table provides additional data on the Company’s residential mortgage loans, including loans transferred or pledged to securitization trusts, at September 30, 2018 and December 31, 2017:
 
 
September 30, 2018
 
December 31, 2017
 
 
Portfolio
Range
Portfolio Weighted Average
Portfolio
Range
Portfolio Weighted Average
 
 
(dollars in thousands)
Unpaid principal balance
 
$1 - $3,500
 
$494
 
$1 - $3,663
 
$514
Interest rate
 
2.00% - 7.50%
 
4.74%
 
1.63% - 7.50%
 
4.25%
Maturity
 
1/1/2028 - 9/1/2058
 
1/5/2045
 
1/1/2028 - 5/1/2057
 
2/1/2043
FICO score at loan origination
 
510 - 823
 
754
 
468 - 823
 
748
Loan-to-value ratio at loan origination
 
11% - 100%
 
67%
 
11% - 100%
 
68%
 

At September 30, 2018 and December 31, 2017, approximately 54% and 78%, respectively, of the carrying value of the Company’s residential mortgage loans, including loans transferred or pledged to securitization trusts, were adjustable-rate.

Commercial

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 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 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. 
At September 30, 2018 and December 31, 2017, approximately 87% and 85%, respectively, of the carrying value of the Company’s CRE Debt and Preferred Equity Investments, excluding loans held for sale, was comprised of floating-rate debt investments.

On December 11, 2015, the Company originated a $335.0 million recapitalization financing with respect to eight class A/B office properties in Orange County, California.  The Company previously classified the senior mortgage loan as held for sale. During the nine months ended September 30, 2017, the Company sold the remaining balance of $115.0 million ($114.4 million, net of origination fees) of the senior loan to unrelated third parties at carrying value. Accordingly, no gain or loss was recorded in connection with the sale.

At September 30, 2018 and December 31, 2017, commercial real estate investments held for investment were comprised of the following:

15
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 1.  Financial Statements



 
 
September 30, 2018
 
December 31, 2017
 
 
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
 
$
1,090,849

 
$
1,084,167

 
75.6
%
 
$
629,143

 
$
625,900

 
60.9
%
Mezzanine loans
 
343,354

 
342,700

 
23.8
%
 
395,015

 
394,442

 
38.2
%
Preferred equity
 
9,000

 
8,998

 
0.6
%
 
9,000

 
8,985

 
0.9
%
Total
 
$
1,443,203

 
$
1,435,865

 
100.0
%
 
$
1,033,158

 
$
1,029,327

 
100.0
%
(1) 
Carrying value includes unamortized origination fees of $5.7 million and $3.8 million at September 30, 2018 and December 31, 2017, respectively.
(2) 
Based on outstanding principal.

The following tables represent a rollforward of the activity for the Company’s commercial real estate investments held for investment at September 30, 2018 and December 31, 2017:

 
 
September 30, 2018
 
 
Senior
Mortgages
 
Mezzanine
Loans
 
Preferred
Equity
 
Total
 
 
(dollars in thousands)
Beginning balance (January 1, 2018)
 
$
625,900

 
$
394,442

 
$
8,985

 
$
1,029,327

Originations & advances (principal)
 
489,271

 
45,334

 
—