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ANNALY CAPITAL MANAGEMENT INC - Quarter Report: 2019 September (Form 10-Q)

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


FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED:  September 30, 2019
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

nlya04.jpg

ANNALY CAPITAL MANAGEMENT INC
(Exact Name of Registrant as Specified in its Charter)
Maryland
22-3479661
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
 
 
 
1211 Avenue of the Americas
 
New York,
New York
10036
(Address of principal executive offices)
(Zip Code)
(212) 696-0100
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on Which Registered
Common Stock, par value $0.01 per share
NLY
New York Stock Exchange
7.50% Series D Cumulative Redeemable Preferred Stock
NLY.D
New York Stock Exchange
6.95% Series F Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock
NLY.F
New York Stock Exchange
6.50% Series G Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock
NLY.G
New York Stock Exchange
6.75% Series I Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock
NLY.I
New York Stock Exchange








Indicate by check mark whether the registrant (1) has filed all 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 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 ☑    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 the definitions 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 Act).  Yes     No 

The number of shares of the registrant’s Common Stock outstanding on October 25, 2019 was 1,430,106,199.




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



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

PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
 
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share data)
 
September 30,
 
December 31,
 
2019
 
2018 (1)
 
(Unaudited)
 
 
Assets
 
 
 
Cash and cash equivalents (includes pledged assets of $1,625,999 and $1,581,775, respectively) (2)
$
1,793,921

 
$
1,735,749

Securities (includes pledged assets of $111,087,358 and $87,193,316, respectively) (3)
116,094,061

 
92,623,788

Loans, net (includes pledged assets of $2,837,690 and $2,997,051, respectively) (4)
3,946,614

 
4,585,975

Mortgage servicing rights (includes pledged assets of $2,788 and $3,616, respectively)
386,051

 
557,813

Assets transferred or pledged to securitization vehicles
4,688,144

 
3,833,200

Real estate, net
725,508

 
739,473

Derivative assets
168,755

 
200,503

Reverse repurchase agreements

 
650,040

Receivable for unsettled trades
193,229

 
68,779

Principal and interest receivable
483,744

 
357,365

Goodwill and intangible assets, net
94,904

 
100,854

Other assets
381,189

 
333,988

Total assets
$
128,956,120

 
$
105,787,527

Liabilities and stockholders’ equity
 

 
 

Liabilities
 

 
 

Repurchase agreements
$
102,682,104

 
$
81,115,874

Other secured financing
4,466,030

 
4,183,311

Debt issued by securitization vehicles
3,856,082

 
3,347,062

Mortgages payable
485,657

 
511,056

Derivative liabilities
972,415

 
889,750

Payable for unsettled trades
245,626

 
583,036

Interest payable
565,797

 
570,928

Dividends payable
359,491

 
394,129

Other liabilities
99,214

 
74,580

Total liabilities
113,732,416

 
91,669,726

Stockholders’ equity
 

 
 

Preferred stock, par value $0.01 per share, 85,150,000 and 75,950,000 authorized, 81,900,000 and 73,400,000 issued and outstanding, respectively
1,982,026

 
1,778,168

Common stock, par value $0.01 per share, 2,914,850,000 and 1,924,050,000 authorized, 1,437,964,466 and 1,313,763,450 issued and outstanding, respectively
14,380

 
13,138

Additional paid-in capital
20,034,970

 
18,794,331

Accumulated other comprehensive income (loss)
2,313,815

 
(1,979,865
)
Accumulated deficit
(9,125,895
)
 
(4,493,660
)
Total stockholders’ equity
15,219,296

 
14,112,112

Noncontrolling interests
4,408

 
5,689

Total equity
15,223,704

 
14,117,801

Total liabilities and equity
$
128,956,120

 
$
105,787,527

 
(1) 
Derived from the audited consolidated financial statements at December 31, 2018.
(2) 
Includes cash of consolidated Variable Interest Entities (“VIEs”) of $49.6 million and $30.4 million at September 30, 2019 and December 31, 2018, respectively.
(3) 
Excludes $429.1 million and $83.6 million at September 30, 2019 and December 31, 2018, respectively, of non-Agency mortgage-backed securities and $182.3 million and $224.3 million at September 30, 2019 and December 31, 2018, respectively, of commercial mortgage-backed securities in consolidated VIEs pledged as collateral and eliminated from the Company’s Consolidated Statements of Financial Condition. 
(4) 
Includes $76.3 million and $97.5 million of residential mortgage loans held for sale and $0 and $42.2 million of commercial mortgage loans held for sale at September 30, 2019 and December 31, 2018, 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)
 
For The Three Months Ended September 30,
 
For The Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Net interest income
 
 
 
 
 
 
 
Interest income
$
919,299

 
$
816,596

 
$
2,713,083

 
$
2,472,889

Interest expense
766,905

 
500,973

 
2,164,817

 
1,311,086

Net interest income
152,394

 
315,623

 
548,266

 
1,161,803

Realized and unrealized gains (losses)
 
 
 
 
 
 
 
Net interest component of interest rate swaps
88,466

 
51,349

 
306,154

 
34,664

Realized gains (losses) on termination or maturity of interest rate swaps
(682,602
)
 
575

 
(1,438,349
)
 
1,409

Unrealized gains (losses) on interest rate swaps
(326,309
)
 
417,203

 
(1,992,884
)
 
1,737,963

Subtotal
(920,445
)
 
469,127

 
(3,125,079
)
 
1,774,036

Net gains (losses) on disposal of investments
66,522

 
(324,294
)
 
(65,727
)
 
(376,943
)
Net gains (losses) on other derivatives
(16,888
)
 
94,827

 
(638,458
)
 
81,871

Net unrealized gains (losses) on instruments measured at fair value through earnings
(1,091
)
 
(39,944
)
 
41,657

 
(139,913
)
Loan loss provision
(3,504
)
 

 
(9,207
)
 

Subtotal
45,039

 
(269,411
)
 
(671,735
)
 
(434,985
)
Total realized and unrealized gains (losses)
(875,406
)
 
199,716

 
(3,796,814
)
 
1,339,051

Other income (loss)
35,074

 
(10,643
)
 
93,757

 
57,550

General and administrative expenses
 
 
 
 
 
 
 
Compensation and management fee
41,161

 
45,983

 
130,225

 
136,091

Other general and administrative expenses
24,977

 
80,526

 
98,058

 
116,709

Total general and administrative expenses
66,138

 
126,509

 
228,283

 
252,800

Income (loss) before income taxes
(754,076
)
 
378,187

 
(3,383,074
)
 
2,305,604

Income taxes
(6,907
)
 
(7,242
)
 
(10,241
)
 
(3,416
)
Net income (loss)
(747,169
)
 
385,429

 
(3,372,833
)
 
2,309,020

Net income (loss) attributable to noncontrolling interests
(110
)
 
(149
)
 
(294
)
 
(277
)
Net income (loss) attributable to Annaly
(747,059
)
 
385,578

 
(3,372,539
)
 
2,309,297

Dividends on preferred stock (1)
36,151

 
31,675

 
101,067

 
96,818

Net income (loss) available (related) to common stockholders
$
(783,210
)
 
$
353,903

 
$
(3,473,606
)
 
$
2,212,479

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

 
 
 
 
Basic
$
(0.54
)
 
$
0.29

 
$
(2.42
)
 
$
1.88

Diluted
$
(0.54
)
 
$
0.29

 
$
(2.42
)
 
$
1.88

Weighted average number of common shares outstanding
 
 
 
 
 
 
 
Basic
1,453,359,211

 
1,202,353,851

 
1,436,204,582

 
1,174,292,701

Diluted
1,453,359,211

 
1,202,353,851

 
1,436,204,582

 
1,174,292,701

Other comprehensive income (loss)
 
 
 
 
 
 
 
Net income (loss)
$
(747,169
)
 
$
385,429

 
$
(3,372,833
)
 
$
2,309,020

Unrealized gains (losses) on available-for-sale securities
1,034,873

 
(719,609
)
 
4,289,054

 
(3,104,218
)
Reclassification adjustment for net (gains) losses included in net income (loss)
(86,061
)
 
331,100

 
4,626

 
407,282

Other comprehensive income (loss)
948,812

 
(388,509
)
 
4,293,680

 
(2,696,936
)
Comprehensive income (loss)
201,643

 
(3,080
)
 
920,847

 
(387,916
)
Comprehensive income (loss) attributable to noncontrolling interests
(110
)
 
(149
)
 
(294
)
 
(277
)
Comprehensive income (loss) attributable to Annaly
201,753

 
(2,931
)
 
921,141

 
(387,639
)
Dividends on preferred stock (1)
36,151

 
31,675

 
101,067

 
96,818

Comprehensive income (loss) attributable to common stockholders
$
165,602

 
$
(34,606
)
 
$
820,074

 
$
(484,457
)
 
 
 
 
 
 
 
 

(1) 
The three months ended September 30, 2019 exclude cumulative and undeclared dividends of $0.3 million on the Company's Series I Preferred Stock as of June 30, 2019.


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)
 
 
For The Three Months Ended September 30,
 
For The Nine Months Ended September 30,
 
 
2019
 
2018
 
2019
 
2018
Preferred stock
 
 
 
 
 
 
 
 
Beginning of period
 
$
2,110,346

 
$
1,723,168

 
$
1,778,168

 
$
1,720,381

Issuance
 
41,146

 

 
428,324

 
411,335

Acquisition of subsidiary
 

 
55,000

 

 
55,000

Redemption
 
(169,466
)
 

 
(224,466
)
 
(408,548
)
End of period
 
$
1,982,026

 
$
1,778,168

 
$
1,982,026

 
$
1,778,168

Common stock
 
 
 
 
 
 
 
 
Beginning of period
 
$
14,562

 
$
11,643

 
$
13,138

 
$
11,596

Issuance
 

 
1,057

 
1,422

 
1,103

Buyback of common stock
 
(182
)
 

 
(182
)
 

Acquisition of subsidiary
 

 
330

 

 
330

Direct purchase and dividend reinvestment
 

 
1

 
2

 
2

End of period
 
$
14,380

 
$
13,031

 
$
14,380

 
$
13,031

Additional paid-in capital
 
 
 
 
 
 
 
 
Beginning of period
 
$
20,195,419

 
$
17,268,596

 
$
18,794,331

 
$
17,221,265

Stock compensation expense
 
207

 
168

 
2,018

 
1,789

Issuance
 

 
1,068,292

 
1,397,484

 
1,116,409

Buyback of common stock
 
(155,122
)
 

 
(155,122
)
 

Acquisition of subsidiary
 

 
455,613

 

 
455,613

Redemption of preferred stock
 
(5,534
)
 

 
(5,534
)
 
(3,952
)
Direct purchase and dividend reinvestment
 

 
1,037

 
1,793

 
2,582

End of period
 
$
20,034,970

 
$
18,793,706

 
$
20,034,970

 
$
18,793,706

Accumulated other comprehensive income (loss)
 
 
 
 
 
 
 
 
Beginning of period
 
$
1,365,003

 
$
(3,434,447
)
 
$
(1,979,865
)
 
$
(1,126,020
)
Unrealized gains (losses) on available-for-sale securities
 
1,034,873

 
(719,609
)
 
4,289,054

 
(3,104,218
)
Reclassification adjustment for net gains (losses) included in net income (loss)
 
(86,061
)
 
331,100

 
4,626

 
407,282

End of period
 
$
2,313,815

 
$
(3,822,956
)
 
$
2,313,815

 
$
(3,822,956
)
Accumulated deficit
 
 
 
 
 
 
 
 
Beginning of period
 
$
(7,982,649
)
 
$
(1,800,370
)
 
$
(4,493,660
)
 
$
(2,961,749
)
Net income (loss) attributable to Annaly
 
(747,059
)
 
385,578

 
(3,372,539
)
 
2,309,297

Dividends declared on preferred stock (1)
 
(36,451
)
 
(31,675
)
 
(101,067
)
 
(96,818
)
Dividends and dividend equivalents declared on common stock and share-based awards (1)
 
(359,736
)
 
(365,488
)
 
(1,158,629
)
 
(1,062,685
)
End of period
 
$
(9,125,895
)
 
$
(1,811,955
)
 
$
(9,125,895
)
 
$
(1,811,955
)
Total stockholder’s equity
 
$
15,219,296

 
$
14,949,994

 
$
15,219,296

 
$
14,949,994

Noncontrolling interests
 
 
 
 
 
 
 
 
Beginning of period
 
$
4,726

 
$
5,266

 
$
5,689

 
$
6,100

Net income (loss) attributable to noncontrolling interests
 
(110
)
 
(149
)
 
(294
)
 
(277
)
Equity contributions from (distributions to) noncontrolling interests
 
(208
)
 
745

 
(987
)
 
39

End of period
 
$
4,408

 
$
5,862

 
$
4,408

 
$
5,862

Total equity
 
$
15,223,704

 
$
14,955,856

 
$
15,223,704

 
$
14,955,856

 
 
 
 
 
 
 
 
 
(1)    See Note titled “Capital Stock” for dividends per share for each class of shares.

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)
 
For The Nine Months Ended September 30,
 
2019
 
2018
Cash flows from operating activities
 
 
 
Net income (loss)
$
(3,372,833
)
 
$
2,309,020

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
Amortization of premiums and discounts of investments, net
943,277

 
474,449

Amortization of securitized debt premiums and discounts and deferred financing costs
(11,457
)
 
991

Depreciation, amortization and other noncash expenses
24,107

 
63,839

Net (gains) losses on disposals of investments
65,727

 
376,943

Net (gains) losses on investments and derivatives
2,589,685

 
(1,679,921
)
Income from unconsolidated joint ventures
3,350

 
6,441

Loan loss provision
9,207

 

Payments on purchases of loans held for sale
(196,252
)
 
(191,641
)
Proceeds from sales and repayments of loans held for sale
220,409

 
64,460

Net receipts (payments) on derivatives
(2,561,170
)
 
1,519,228

Net change in
 
 
 
Other assets
(45,547
)
 
100,010

Interest receivable
(92,959
)
 
(8,468
)
Interest payable
(5,131
)
 
124,316

Other liabilities
34,194

 
(136,510
)
Net cash provided by (used in) operating activities
(2,395,393
)
 
3,023,157

Cash flows from investing activities
 
 
 
Payments on purchases of Residential Securities
(51,291,188
)
 
(17,053,068
)
Proceeds from sales of Residential Securities
19,619,907

 
9,558,735

Principal payments on Residential Securities
11,163,622

 
8,696,239

Payments on purchases of MSRs

 
(381
)
Payments on purchases of corporate debt
(631,275
)
 
(744,071
)
Proceeds from sales of corporate debt
265,218

 

Principal payments on corporate debt
143,284

 
235,423

Originations and purchases of commercial real estate investments
(618,348
)
 
(697,753
)
Proceeds from sales of commercial real estate investments
193,846

 
134,538

Principal repayments on commercial real estate investments
1,852,854

 
478,726

Proceeds from sales of real estate
6,661

 

Proceeds from reverse repurchase agreements
78,439,755

 
70,016,988

Payments on reverse repurchase agreements
(77,789,715
)
 
(70,313,441
)
Distributions in excess of cumulative earnings from unconsolidated joint ventures
1,975

 
5,434

Payments on purchases of residential mortgage loans held for investment
(1,692,648
)
 
(729,917
)
Proceeds from repayments of residential mortgage loans held for investment
570,503

 
251,407

Cash paid related to asset acquisition, net of cash acquired

 
(258,334
)
Net cash provided by (used in) investing activities
(19,765,549
)
 
(419,475
)
Cash flows from financing activities
 
 
 
Proceeds from repurchase agreements and other secured financing
4,275,937,246

 
3,866,183,872

Principal payments on repurchase agreements and other secured financing
(4,254,088,297
)
 
(3,868,097,943
)
Proceeds from issuances of securitized debt
2,030,356

 
588,111

Principal repayments on securitized debt
(1,778,314
)
 
(614,536
)
Payment of deferred financing cost
(5,222
)
 

Net proceeds from stock offerings, direct purchases and dividend reinvestments
1,829,025

 
1,531,690

Redemptions of preferred stock
(230,000
)
 
(412,500
)
Principal payments on mortgages payable
(25,398
)
 
(49
)
Net contributions (distributions) from (to) noncontrolling interests
(987
)
 
(780
)
Net payment on share repurchase
(155,304
)
 

Dividends paid
(1,293,991
)
 
(1,405,389
)
Net cash provided by (used in) financing activities
22,219,114

 
(2,227,524
)
Net (decrease) increase in cash and cash equivalents
$
58,172

 
$
376,158

Cash and cash equivalents including cash pledged as collateral, beginning of period
1,735,749

 
706,589

Cash and cash equivalents including cash pledged as collateral, end of period
$
1,793,921

 
$
1,082,747

Supplemental disclosure of cash flow information
 

 
 

Interest received
$
3,583,189

 
$
2,846,535

Dividends received
$
6,279

 
$
5,448

Interest paid (excluding interest paid on interest rate swaps)
$
2,041,539

 
$
1,159,384

Net interest paid on interest rate swaps
$
(96,169
)
 
$
(243,946
)
Taxes received (paid)
$
274

 
$
86

Noncash investing activities
 

 
 

Receivable for unsettled trades
$
193,229

 
$
1,266,840

Payable for unsettled trades
$
245,626

 
$
2,505,428

Net change in unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment
$
4,293,680

 
$
(2,696,936
)
Noncash financing activities
 

 
 

Dividends declared, not yet paid
$
359,491

 
$
102,811

 
 
 
 
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 optimize its returns through prudent management of its diversified investment strategies. 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, 2018 (the “2018 Form 10-K”). The consolidated financial information as of December 31, 2018 has been derived from audited consolidated financial statements included in the Company’s 2018 Form 10-K.
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.

3. SIGNIFICANT ACCOUNTING POLICIES
 
The Company’s significant accounting policies are described below or are included elsewhere in these notes to the Consolidated Financial Statements.
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.

5


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

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 $1.6 billion at September 30, 2019 and December 31, 2018.
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. Items for which the fair value option has been elected are 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). 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 Measurements” 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 “Secured 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 ratably over the requisite service period for the entire award.

6


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

Interest Income - The Company recognizes coupon income, which is a component of interest income, based upon the outstanding principal amounts of the financial instruments 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 multifamily 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, reverse mortgages 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.
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 of 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 certain 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 plans to adopt the new standard on January 1, 2020. 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 has decided to apply a probability of default methodology to loans and loan commitments that will be impacted by the adoption and is determining appropriate internal controls and financial statement disclosures. Key implementation efforts have included initiating a parallel process including model testing and validation and development of internal controls. The Company expects an increase in the allowance as a result of adoption of the new guidance, but does not expect that the increase will be significant. The ultimate impact will depend on the Company’s portfolio, the macroeconomic conditions and forecast, and other management assumptions as of the date of adoption. Further, based on the amended guidance for available-for-sale debt securities, the Company does not expect a significant impact to its securities portfolio.
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. (“Arcola”) 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, 2019 and December 31, 2018.
Financial Instruments (1)
Balance Sheet Line Item
Type / Form
Measurement Basis
September 30, 2019
 
December 31, 2018
 
Assets
(dollars in thousands)
 
 
 
Securities
Agency mortgage-backed securities (2)
Fair value, with unrealized gains (losses) through other comprehensive income
$
113,670,254

 
$
89,840,322

Securities
Agency mortgage-backed securities (3)
Fair value, with unrealized gains (losses) through earnings
792,270

 
912,673

Securities
Credit risk transfer securities
Fair value, with unrealized gains (losses) through earnings
474,765

 
552,097

Securities
Non-agency mortgage-backed securities
Fair value, with unrealized gains (losses) through earnings
1,015,921

 
1,161,938

Securities
Commercial real estate debt investments - CMBS
Fair value, with unrealized gains (losses) through other comprehensive income
65,215

 
138,242

Securities
Commercial real estate debt investments - CMBS (4)
Fair value, with unrealized gains (losses) through earnings
75,636

 
18,516

Total securities
 
 
116,094,061

 
92,623,788

Loans, net
Residential mortgage loans
Fair value, with unrealized gains (losses) through earnings
1,219,402

 
1,359,806

Loans, net
Commercial real estate debt and preferred equity, held for investment
Amortized cost
611,429

 
1,296,803

Loans, net
Commercial loans held for sale, net
Lower of amortized cost or fair value

 
42,184

Loans, net
Corporate debt, held for investment
Amortized cost
2,115,783

 
1,887,182

Total loans, net
 
 
3,946,614

 
4,585,975

Assets transferred or pledged to securitization vehicles
Residential mortgage loans
Fair value, with unrealized gains (losses) through earnings
2,376,731

 
1,094,831

Assets transferred or pledged to securitization vehicles
Commercial mortgage loans
Fair value, with unrealized gains (losses) through earnings
1,501,408

 
2,738,369

Assets transferred or pledged to securitization vehicles
Commercial mortgage loans
Amortized cost
810,005

 

Total assets transferred or pledged to securitization vehicles
 
4,688,144

 
3,833,200

Reverse repurchase agreements
Reverse repurchase agreements
Amortized cost

 
650,040

 
Liabilities
 
 
 
 
Repurchase agreements
Repurchase agreements
Amortized cost
102,682,104

 
81,115,874

Other secured financing
Loans
Amortized cost
4,466,030

 
4,183,311

Debt issued by securitization vehicles
Securities
Fair value, with unrealized gains (losses) through earnings
3,856,082

 
3,347,062

Mortgages payable
Loans
Amortized cost
485,657

 
511,056

(1)     Receivable for unsettled trades, Principal and interest receivable, Payable for unsettled trades, Interest payable and Dividends payable are accounted for at cost.
(2)     Includes Agency pass-through, collateralized mortgage obligation (“CMO”) and multifamily securities.
(3)     Includes interest-only securities and reverse mortgages.
(4)     Includes conduit CMBS.


5. SECURITIES
 
The Company’s investments in securities include agency, credit risk transfer, non-agency and commercial mortgage-backed securities. All of the debt securities 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 in which case changes in fair value are recognized in Net unrealized gains (losses) on instruments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss). 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.
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. 

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).  When the fair value of a held-to-maturity security is less than the cost, 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 or nine months ended September 30, 2019 and 2018.
Agency Mortgage-Backed Securities - The Company invests in mortgage pass-through certificates, collateralized mortgage obligations and other MBS 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.
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.
Non-Agency Mortgage-Backed Securities - The Company invests in non-Agency mortgage-backed securities such as those issued in prime loan, Alt-A loan, subprime loan, non-performing loan (“NPL”) and re-performing loan (“RPL”) securitizations.
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.
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.
The following represents a rollforward of the activity for the Company’s securities for the nine months ended September 30, 2019:
 
Residential Securities
 
Commercial Securities
 
Total
 
(dollars in thousands)
Beginning balance January 1, 2019
$
92,467,030

 
$
156,758

 
$
92,623,788

Purchases
50,982,244

 
111,582

 
51,093,826

Sales
(19,793,722
)
 
(92,366
)
 
(19,886,088
)
Principal paydowns
(11,215,154
)
 
(43,170
)
 
(11,258,324
)
(Amortization) / accretion
(942,429
)
 
548

 
(941,881
)
Fair value adjustment
4,455,241

 
7,499

 
4,462,740

Ending balance September 30, 2019
$
115,953,210

 
$
140,851

 
$
116,094,061

 
 
 
 
 
 


10


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

The following tables present the Company’s securities portfolio that was carried at their fair value at September 30, 2019 and December 31, 2018:
 
September 30, 2019
 
Principal /
Notional
 
Remaining Premium
 
Remaining Discount
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated Fair Value
Agency
(dollars in thousands)
Fixed-rate pass-through
$
102,020,108

 
$
4,321,803

 
$
(37,466
)
 
$
106,304,445

 
$
2,216,560

 
$
(102,943
)
 
$
108,418,062

Adjustable-rate pass-through
2,338,560

 
123,228

 
(1,440
)
 
2,460,348

 
11,265

 
(56,122
)
 
2,415,491

CMO
9,623

 
45

 

 
9,668

 
298

 

 
9,966

Interest-only
4,657,039

 
899,601

 

 
899,601

 
4,311

 
(173,304
)
 
730,608

Multifamily
2,562,366

 
28,314

 
(2,446
)
 
2,588,234

 
239,213

 
(712
)
 
2,826,735

Reverse mortgages
56,464

 
5,354

 

 
61,818

 
62

 
(218
)
 
61,662

Total agency securities
$
111,644,160

 
$
5,378,345

 
$
(41,352
)
 
$
112,324,114

 
$
2,471,709

 
$
(333,299
)
 
$
114,462,524

Residential credit
 

 
 

 
 

 
 

 
 

 
 

 
 

CRT (1)
$
463,982

 
$
16,785

 
$
(2,258
)
 
$
463,584

 
$
13,492

 
$
(2,311
)
 
$
474,765

Alt-A
153,891

 
255

 
(22,816
)
 
131,330

 
14,307

 

 
145,637

Prime
267,196

 
2,223

 
(18,176
)
 
251,243

 
18,506

 
(29
)
 
269,720

Prime interest-only
459,718

 
4,195

 

 
4,195

 

 
(538
)
 
3,657

Subprime
380,293

 
1,394

 
(62,355
)
 
319,332

 
40,883

 
(116
)
 
360,099

NPL/RPL
28,669

 

 
(74
)
 
28,595

 

 
(41
)
 
28,554

Prime jumbo (>=2010 vintage)
197,879

 
1,052

 
(4,374
)
 
194,557

 
6,967

 

 
201,524

Prime jumbo (>=2010 vintage) Interest-only
591,980

 
9,472

 

 
9,472

 

 
(2,742
)
 
6,730

Total residential credit securities
$
2,543,608

 
$
35,376

 
$
(110,053
)
 
$
1,402,308

 
$
94,155

 
$
(5,777
)
 
$
1,490,686

Total Residential Securities
$
114,187,768

 
$
5,413,721

 
$
(151,405
)
 
$
113,726,422

 
$
2,565,864

 
$
(339,076
)
 
$
115,953,210

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial Securities
$
140,600

 
$
343

 
$
(8,391
)
 
$
132,552

 
$
8,299

 
$

 
$
140,851

Total securities
$
114,328,368

 
$
5,414,064

 
$
(159,796
)
 
$
113,858,974

 
$
2,574,163

 
$
(339,076
)
 
$
116,094,061

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
Principal /
Notional
 
Remaining Premium
 
Remaining Discount
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated Fair Value
Agency
(dollars in thousands)
Fixed-rate pass-through
$
81,144,650

 
$
3,810,808

 
$
(36,987
)
 
$
84,918,471

 
$
264,443

 
$
(2,130,362
)
 
$
83,052,552

Adjustable-rate pass-through
4,835,983

 
247,981

 
(1,337
)
 
5,082,627

 
7,127

 
(151,770
)
 
4,937,984

CMO
11,113

 
53

 

 
11,166

 
55

 

 
11,221

Interest-only
6,007,008

 
1,179,855

 

 
1,179,855

 
1,446

 
(307,412
)
 
873,889

Multifamily
1,802,292

 
12,329

 
(5,332
)
 
1,809,289

 
32,753

 
(3,477
)
 
1,838,565

Reverse mortgages
34,650

 
4,175

 

 
38,825

 
69

 
(110
)
 
38,784

Total agency investments
$
93,835,696

 
$
5,255,201

 
$
(43,656
)
 
$
93,040,233

 
$
305,893

 
$
(2,593,131
)
 
$
90,752,995

Residential credit
 

 
 

 
 

 
 

 
 

 
 

 
 

CRT
$
542,374

 
$
28,444

 
$
(15,466
)
 
$
555,352

 
$
7,879

 
$
(11,134
)
 
$
552,097

Alt-A
202,889

 
349

 
(31,238
)
 
172,000

 
10,559

 
(198
)
 
182,361

Prime
353,108

 
2,040

 
(23,153
)
 
331,995

 
12,821

 
(830
)
 
343,986

Subprime
423,166

 
1,776

 
(65,005
)
 
359,937

 
35,278

 
(594
)
 
394,621

NPL/RPL
3,431

 

 
(30
)
 
3,401

 
37

 

 
3,438

Prime jumbo (>=2010 vintage)
225,567

 
1,087

 
(4,691
)
 
221,963

 
1,439

 
(2,744
)
 
220,658

Prime jumbo (>=2010 vintage) Interest-only
860,085

 
12,820

 

 
12,820

 
4,054

 

 
16,874

Total residential credit securities
$
2,610,620

 
$
46,516

 
$
(139,583
)
 
$
1,657,468

 
$
72,067

 
$
(15,500
)
 
$
1,714,035

Total Residential Securities
$
96,446,316

 
$
5,301,717

 
$
(183,239
)
 
$
94,697,701

 
$
377,960

 
$
(2,608,631
)
 
$
92,467,030

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial Securities
$
155,921

 
$
9,778

 
$
(9,740
)
 
$
155,959

 
$
1,659

 
$
(860
)
 
$
156,758

Total securities
$
96,602,237

 
$
5,311,495

 
$
(192,979
)
 
$
94,853,660

 
$
379,619

 
$
(2,609,491
)
 
$
92,623,788

 

(1)
Principal/Notional amount includes $14.9 million of a CRT interest-only security as of September 30, 2019.



11


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

The following table presents the Company’s Agency mortgage-backed securities portfolio by issuing Agency concentration at September 30, 2019 and December 31, 2018:
 
 
September 30, 2019
 
December 31, 2018
Investment Type
(dollars in thousands)
Fannie Mae
$
73,707,294

 
$
60,270,432

Freddie Mac
40,592,878

 
30,397,556

Ginnie Mae
162,352

 
85,007

Total
$
114,462,524

 
$
90,752,995

 
 
 
 

Actual maturities of the Company’s Residential Securities are generally shorter than stated contractual maturities because actual maturities of the portfolio are generally affected by periodic payments and prepayments of principal on the underlying mortgages.
The following table summarizes the Company’s Residential Securities at September 30, 2019 and December 31, 2018, according to their estimated weighted average life classifications:
 
September 30, 2019
 
December 31, 2018
 
Estimated Fair Value
 
Amortized
Cost
 
Estimated Fair Value
 
Amortized
Cost
Estimated weighted average life
(dollars in thousands)
Less than one year
$
5,508

 
$
6,454

 
$
13,447

 
$
13,670

Greater than one year through five years
58,857,860

 
57,504,374

 
11,710,172

 
11,928,973

Greater than five years through ten years
57,032,062

 
56,163,913

 
80,202,479

 
82,218,464

Greater than ten years
57,780

 
51,681

 
540,932

 
536,594

Total
$
115,953,210

 
$
113,726,422

 
$
92,467,030

 
$
94,697,701

 
The estimated weighted average lives of the Residential Securities at September 30, 2019 and December 31, 2018 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, 2019 and December 31, 2018.
 
September 30, 2019
 
December 31, 2018
 
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
$
3,524,012

 
$
(17,042
)
 
45

 
$
22,418,036

 
$
(432,352
)
 
713

12 Months or more
13,989,400

 
(142,735
)
 
506

 
43,134,843

 
(1,853,257
)
 
1,476

Total
$
17,513,412

 
$
(159,777
)
 
551

 
$
65,552,879

 
$
(2,285,609
)
 
2,189

 
(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, 2019, the Company disposed of $11.1 billion and $30.7 billion of Residential Securities, resulting in net realized gains (losses) of $76.3 million and ($50.6) million, respectively. 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 gains (losses) of ($322.4) million and ($372.5) 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. Excluding loans transferred or pledged to securitization vehicles, as of September 30, 2019, the Company reported $1.2 billion of loans for which the fair value option was elected. 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 the Company intends to sell or securitize the loans and the securitization vehicle is not expected to be consolidated, the loans are classified as held for sale. If loans are held for sale and the fair value option was not elected, they are accounted for at the lower of cost or fair value. Any origination fees and costs or purchase premiums or discounts are deferred and recognized upon sale. The Company determines the fair value of loans held for sale on an individual loan basis.
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.
Allowance for Losses – The Company evaluates the need for a loss reserve on its loans. A provision for loan losses 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 loans 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 commercial real estate loans and preferred equity interests (“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 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 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.
For the three and nine months ended September 30, 2019, the Company recorded a loan loss provision of $3.5 million and $9.2 million, respectively.

13


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

As of September 30, 2019 and December 31, 2018, the Company’s loan loss provision was $12.7 million and $3.5 million, respectively. There was no provision for loan loss recorded as of and for the nine months ended September 30, 2018.
The following table presents the activity of the Company’s loan investments, including loans held for sale and excluding loans transferred or pledged to securitization vehicles, for the nine months ended September 30, 2019:
 
Residential
 
Commercial
 
Corporate
 
Total
 
(dollars in thousands)
Beginning balance January 1, 2019
$
1,359,806

 
$
1,338,987

 
$
1,887,182

 
$
4,585,975

Purchases
1,894,303

 
395,058

 
631,065

 
2,920,426

Sales and transfers (1)
(1,878,218
)
 
(958,912
)
 
(268,403
)
 
(3,105,533
)
Principal payments
(156,579
)
 
(156,437
)
 
(143,284
)
 
(456,300
)
Gains / (losses)
1,671

 
(9,207
)
 
5,260

 
(2,276
)
(Amortization) / accretion
(1,581
)
 
1,940

 
3,963

 
4,322

Ending balance September 30, 2019
$
1,219,402

 
$
611,429

 
$
2,115,783

 
$
3,946,614

 
 
 
 
 
 
 
 
(1)     Includes securitizations, syndications and transfers to securitization vehicles.


The carrying value of the Company’s residential loans held for sale was $76.3 million and $97.5 million at September 30, 2019 and December 31, 2018, respectively. The carrying value of the Company’s commercial loans held for sale was $0 and $42.2 million at September 30, 2019 and December 31, 2018, 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. 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, 2019 and December 31, 2018:
 
September 30, 2019
December 31, 2018
 
(dollars in thousands)
Fair value
$
3,596,133

$
2,454,637

Unpaid principal balance
$
3,475,799

$
2,425,657


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, 2019 and 2018 for these investments:
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30, 2019
 
September 30, 2018
 
September 30, 2019
 
September 30, 2018
 
(dollars in thousands)
Interest income
$
37,673

 
$
16,423

 
$
102,689

 
$
45,702

Net gains (losses) on disposal of investments
(9,671
)
 
(2,975
)
 
(19,499
)
 
(7,924
)
Net unrealized gains (losses) on instruments measured at fair value through earnings
18,093

 
(3,633
)
 
61,805

 
(14,802
)
Total included in net income (loss)
$
46,095

 
$
9,815

 
$
144,995

 
$
22,976

 



14


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

The following table provides the geographic concentrations based on the unpaid principal balances at September 30, 2019 and December 31, 2018 for the residential mortgage loans, including loans transferred or pledged to securitization vehicles:
 
Geographic Concentrations of Residential Mortgage Loans
September 30, 2019
 
December 31, 2018
Property location
% of Balance
 
Property location
% of Balance
California
51.9%
 
California
53.7%
New York
10.4%
 
Florida
7.1%
Florida
5.7%
 
New York
6.6%
All other (none individually greater than 5%)
32.0%
 
All other (none individually greater than 5%)
32.6%
Total
100.0%
 
 
100.0%
 
The following table provides additional data on the Company’s residential mortgage loans, including loans transferred or pledged to securitization vehicles, at September 30, 2019 and December 31, 2018:
 
September 30, 2019
 
December 31, 2018
 
Portfolio
Range
Portfolio Weighted
Average
 
Portfolio
Range
Portfolio Weighted Average
 
(dollars in thousands)
Unpaid principal balance
$1 - $3,448
 
$463
 
$0 - $3,500
 
$457
Interest rate
2.00% - 9.25%
 
5.03%
 
2.00% - 7.75%
 
4.72%
Maturity
1/1/2028 - 9/1/2059
 
5/29/2047
 
1/1/2028 - 11/1/2058
 
1/11/2046
FICO score at loan origination
 505 - 825
 
756
 
505 - 823
 
752
Loan-to-value ratio at loan origination
8% - 111%
 
67%
 
8% - 111%
 
68%
At September 30, 2019 and December 31, 2018, approximately 38% and 47%, respectively, of the carrying value of the Company’s residential mortgage loans, including loans transferred or pledged to securitization vehicles, were adjustable-rate.

Commercial
The Company’s commercial real estate loans are comprised of adjustable-rate and fixed-rate loans. 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.
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, 2019 and December 31, 2018, approximately 91% and 88%, respectively, of the carrying value of the Company’s CRE Debt and Preferred Equity Investments, including loans transferred or pledged to securitization vehicles and excluding commercial loans held for sale, were adjustable-rate.
At September 30, 2019 and December 31, 2018, commercial real estate investments held for investment were comprised of the following:
 
September 30, 2019
 
December 31, 2018
 
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
$
434,949

 
$
432,460

 
30.2
%
 
$
988,248

 
$
981,202

 
75.6
%
Senior securitized mortgages (3)
814,423

 
810,005

 
56.5
%
 

 

 
%
Mezzanine loans
192,065

 
178,969

 
13.3
%
 
319,663

 
315,601

 
24.4
%
Total
$
1,441,437

 
$
1,421,434

 
100.0
%
 
$
1,307,911

 
$
1,296,803

 
100.0
%
 
(1) 
Carrying value includes unamortized origination fees of $7.3 million and $7.6 million at September 30, 2019 and December 31, 2018, respectively.
(2) 
Based on outstanding principal.
(3) 
Assets of a consolidated VIE.

15


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

The following tables represent a rollforward of the activity for the Company’s commercial real estate investments held for investment at September 30, 2019 and December 31, 2018:
September 30, 2019
 
Senior
Mortgages
 
Senior
Securitized Mortgages
(1)
 
Mezzanine
Loans
 
Total
 
(dollars in thousands)
Net carrying value (January 1, 2019)
$
981,202

 
$

 
$
315,601

 
$
1,296,803

Originations & advances (principal)
376,651

 
964,473

 
21,032

 
1,362,156

Principal payments
(16,099
)
 
(150,050
)
 
(139,955
)
 
(306,104
)
Transfers
(913,849
)
 

 
(8,675
)
 
(922,524
)
Net (increase) decrease in origination fees
2,972

 
(6,999
)
 
(184
)
 
(4,211
)
Amortization of net origination fees
1,583

 
2,581

 
357

 
4,521

Allowance for loan losses

 

 
(9,207
)
 
(9,207
)
Net carrying value (September 30, 2019)
$
432,460

 
$
810,005

 
$
178,969

 
$
1,421,434

 
December 31, 2018
 
Senior
Mortgages
 
Mezzanine
Loans
 
Preferred
Equity
 
Total
 
(dollars in thousands)
Net carrying value (January 1, 2018)
$
625,900

 
$
394,442

 
$
8,985

 
$
1,029,327

Originations & advances (principal)
575,953

 
52,224

 

 
628,177

Principal payments
(216,849
)
 
(127,575
)
 
(9,000
)
 
(353,424
)
Net (increase) decrease in origination fees
(6,624
)
 
(370
)
 

 
(6,994
)
Amortization of net origination fees
2,822

 
376

 
15

 
3,213

Allowance for loan losses

 
(3,496
)
 

 
(3,496
)
Net carrying value (December 31, 2018)
$
981,202

 
$
315,601

 
$

 
$
1,296,803

 
(1)    Assets of a consolidated VIE.


The following table provides the internal loan risk ratings of commercial real estate investments held for investment as of September 30, 2019 and December 31, 2018.
September 30, 2019
 
 

 
 
 
Internal Ratings
Investment Type
Outstanding Principal
 
Percentage of CRE Debt and Preferred Equity Portfolio
 
Performing
 
Performing - Closely Monitored
 
Performing - Special Mention
 
Substandard (1)
 
Doubtful (2)
 
Loss (3)
 
Total
(dollars in thousands)
Senior mortgages
$
434,949

 
30.2
%
 
$
141,505

 
$
185,954

 
$
64,390

 
$
43,100

 
$

 
$

 
$
434,949

Senior securitized mortgages (4)
814,423

 
56.5
%
 
322,193

 
316,710

 
125,520

 
50,000

 

 

 
814,423

Mezzanine loans
192,065

 
13.3
%
 
61,063

 
70,299

 

 
17,100

 
36,603

 
7,000

 
192,065

Total
$
1,441,437

 
100.0
%
 
$
524,761

 
$
572,963

 
$
189,910

 
$
110,200

 
$
36,603

 
7,000

 
$
1,441,437

 
December 31, 2018
 
 

 
 
 
Internal Ratings
Investment Type
Outstanding Principal
 
Percentage of CRE Debt and Preferred Equity Portfolio
 
Performing
 
Performing - Closely Monitored
 
Performing - Special Mention
 
Substandard (1)
 
Doubtful (2)
 
Loss
 
Total
(dollars in thousands)
Senior mortgages
$
988,248

 
75.6
%
 
$
653,066

 
$
215,792

 
$
55,000

 
$
64,390

 
$

 
$

 
$
988,248

Mezzanine loans
319,663

 
24.4
%
 
140,776

 
38,884

 
96,400

 
36,603

 
7,000

 

 
319,663

Total
$
1,307,911

 
100.0
%
 
$
793,842

 
$
254,676

 
$
151,400

 
$
100,993

 
$
7,000

 
$

 
$
1,307,911

 

16


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

(1) 
The Company rated three loans as of September 30, 2019 and two loans as of December 31, 2018 as Substandard. The Company evaluated whether an impairment exists and determined in each case that, based on quantitative and qualitative factors, the Company expects repayment of contractual amounts due.
(2) 
The Company rated one loan as Doubtful and evaluated for impairment as of September 30, 2019. The Company rated one loan as Doubtful and evaluated for impairment as of December 31, 2018. The allowance for loan losses for Doubtful loans was $5.7 million and $3.5 million as of September 30, 2019 and December 31, 2018, respectively.
(3) The Company transferred a loan from Doubtful to Loss during the three months ended September 30, 2019.
(4) 
Assets of a consolidated VIE.

Corporate Debt  
The Company’s investments in corporate loans 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 five to seven years. In connection with these senior secured loans the Company receives a security interest in certain 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. 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 effective interest method.
The Company invests in corporate loans through its Annaly Middle Market Lending Group. The industry and rate attributes of the portfolio at September 30, 2019 and December 31, 2018 are as follows:
 
Industry Dispersion
 
September 30, 2019
 
December 31, 2018
 
Fixed Rate
 
Floating Rate
 
Total
 
Fixed Rate
 
Floating Rate
 
Total
 
(dollars in thousands)
Aircraft and Parts
$

 
$
41,064

 
$
41,064

 
$

 
$
41,342

 
$
41,342

Arrangement of Transportation of Freight & Cargo

 

 

 

 
21,632

 
21,632

Coating, Engraving & Allied Services

 
49,767

 
49,767

 

 
57,223

 
57,223

Commercial Fishing

 

 

 

 
242,185

 
242,185

Computer Programming, Data Processing & Other Computer Related Services

 
347,287

 
347,287

 

 

 

Drugs

 
35,918

 
35,918

 

 
35,882

 
35,882

Electrical Work

 
42,372

 
42,372

 

 
41,760

 
41,760

Electronic Components & Accessories

 
24,000

 
24,000

 

 
24,059

 
24,059

Engineering, Architectural, and Surveying

 
77,284

 
77,284

 

 
80,748

 
80,748

Grocery Stores

 
23,292

 
23,292

 

 
23,431

 
23,431

Home Health Care Services

 
29,391

 
29,391

 

 

 

Insurance Agents, Brokers and Service

 
76,444

 
76,444

 

 
48,942

 
48,942

Mailing, Reproduction, Commercial Art and Photography, and Stenographic

 
14,770

 
14,770

 

 
14,843

 
14,843

Management & Public Relations Services

 
339,319

 
339,319

 

 
487,046

 
487,046

Medical & Dental Laboratories

 
41,467

 
41,467

 

 
26,858

 
26,858

Metal Cans & Shipping Containers

 
118,420

 
118,420

 

 
118,248

 
118,248

Miscellaneous Business Services

 
215,709

 
215,709

 

 
19,622

 
19,622

Miscellaneous Equipment Rental & Leasing

 
49,732

 
49,732

 

 
49,552

 
49,552

Miscellaneous Health & Allied Services, not elsewhere classified

 
77,551

 
77,551

 

 
56,003

 
56,003

Miscellaneous Plastic Products

 
10,000

 
10,000

 

 
9,953

 
9,953

Motor Vehicles and Motor Vehicle Equipment

 

 

 

 
16,563

 
16,563

Motor Vehicles and Motor Vehicle Parts & Supplies

 
28,877

 
28,877

 

 
29,046

 
29,046

Nonferrous Foundries (Castings)

 
12,918

 
12,918

 

 
12,948

 
12,948

Offices & Clinics of Doctors of Medicine

 
107,066

 
107,066

 

 
97,877

 
97,877

Offices & Clinics of other Health Practitioners

 
10,123

 
10,123

 

 
21,100

 
21,100

Petroleum and Petroleum Products

 
24,957

 
24,957

 

 

 

Public Warehousing & Storage

 
94,877

 
94,877

 

 
84,278

 
84,278

Research, Development & Testing Services

 
45,610

 
45,610

 

 
33,381

 
33,381

Schools & Educational Services, not elsewhere classified

 
19,635

 
19,635

 

 
19,805

 
19,805

Services Allied with the Exchange of Securities

 

 

 

 
14,877

 
14,877

Surgical, Medical & Dental Instruments & Supplies

 
96,702

 
96,702

 

 
96,607

 
96,607

Telephone Communications

 
61,231

 
61,231

 

 
61,371

 
61,371

Total
$

 
$
2,115,783

 
$
2,115,783

 
$

 
$
1,887,182

 
$
1,887,182

 


17


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

The table below reflects the Company’s aggregate positions by their respective place in the capital structure of the borrowers at September 30, 2019 and December 31, 2018.
 
 
September 30, 2019
 
December 31, 2018
 
(dollars in thousands)
First lien loans
$
1,305,810

 
$
1,346,356

Second lien loans
809,973

 
540,826

Total
$
2,115,783

 
$
1,887,182

 

7. MORTGAGE SERVICING RIGHTS
 
The Company owns variable interests in an entity that invests in MSRs. Refer to the “Variable Interest Entities” Note for a detailed discussion on this topic.
MSRs represent the rights associated with servicing pools of residential mortgage loans. The Company and its subsidiaries do not originate or directly service residential mortgage loans. Rather, these activities are carried out by duly licensed subservicers who perform substantially all servicing functions for the loans underlying the MSRs. The Company intends to hold the MSRs as investments and 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 instruments 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).
The following table presents activity related to MSRs for the three and nine months ended September 30, 2019 and 2018:
 
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2019
 
September 30, 2018
 
September 30, 2019
 
September 30, 2018
 
(dollars in thousands)
Fair value, beginning of period
$
425,328

 
$
599,014

 
$
557,813

 
$
580,860

Change in fair value due to:
 
 
 
 
 
 
 
Changes in valuation inputs or assumptions (1)
(17,312
)
 
(19,913
)
 
(116,150
)
 
(61,011
)
Other changes, including realization of expected cash flows
(21,965
)
 
9,732

 
(55,612
)
 
68,984

Fair value, end of period
$
386,051

 
$
588,833

 
$
386,051

 
$
588,833

 
(1)     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, 2019, the Company recognized $27.7 million and $82.9 million, respectively, and for the three and nine months ended September 30, 2018, the Company recognized $27.7 million and $83.8 million, respectively, of net servicing income from MSRs in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

8. VARIABLE INTEREST ENTITIES
 
Commercial Trusts
The Company has investments in Freddie Mac securitizations (“FREMF Trusts”) which are structured as pass-through entities that receive principal and interest on the underlying collateral and distribute those payments to the certificate holders. The FREMF Trusts are VIEs and the Company is considered to be the primary beneficiary as a result of its ability to replace the special servicer without cause through its ownership of the Class C Certificates and its current designation as the directing certificate holder. The FREMF Trusts are included in the “Commercial Trusts” in the tables below.
The Company purchased approximately $94 million of a subordinated tranche in a securitization trust in 2018. As the directing holder, the Company can remove the special servicer with or without cause as well as direct the activities that are considered to be most significant to the economic performance of the trust. As such, the Company was determined to be the primary beneficiary and consolidates the trust. The trust is included in “Commercial Trusts” in the tables below.

18


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

In August 2019, the Company purchased approximately $20.3 million of a subordinated tranche in a securitization trust. As the controlling class representative, the Company can remove the special servicer with or without cause as well as direct activities that are considered to be most significant to the economic performance of the trust. The trust is included in “Commercial Trusts” in the tables below.
Upon consolidation, the Company elected the fair value option for the financial assets and liabilities of the Commercial Trusts in order to avoid an accounting mismatch, and to represent more faithfully the economics of its interest in the entities. The fair value option requires that changes in fair value be reflected in the Company’s Consolidated Statements of Comprehensive Income (Loss). The Company applied the practical expedient under ASU 2014-07, whereby the Company determines whether the fair value of the financial assets or financial liabilities is more observable as a basis for measuring the less observable financial instruments. The Company has determined that the fair value of the financial liabilities of the Commercial Trusts are more observable, since the prices for these liabilities are primarily available from third-party pricing services utilized for multifamily mortgage-backed securities, while the individual assets of the trusts are inherently less capable of precise measurement given their illiquid nature and the limitations on available information related to these assets. Given that the Company’s methodology for valuing the financial assets of the Commercial Trusts are an aggregate fair value derived from the fair value of the financial liabilities, the Company has determined that the fair value of each of the financial assets in their entirety should be classified in Level 2 of the fair value measurement hierarchy.
The Commercial Trusts mortgage loans had an aggregate unpaid principal balance of $1.5 billion at September 30, 2019.  At September 30, 2019, there were no loans 90 days or more past due or on nonaccrual status. There is no gain or loss attributable to instrument-specific credit risk of the underlying loans or securitized debt securities at September 30, 2019 based upon the Company’s process of monitoring events of default on the underlying mortgage loans.
Collateralized Loan Obligation
In February 2019, the Company closed NLY 2019-FL2 a managed commercial real estate collateralized loan obligation (“CLO”) securitization with a face value of $857.3 million, which provides non-recourse financing to the Company collateralized by certain commercial real estate mortgage loans originated by the Company. As of September 30, 2019 a total of $635.9 million of notes were held by third parties and the Company retained or purchased $223.9 million of subordinated notes and preferred shares, which eliminate upon consolidation. The Company has determined that it is the primary beneficiary because it has the right to direct the servicer as well as remove the special servicer without cause and it holds variable interests that could be potentially significant to the CLO. The transfers of loans to the CLO did not qualify for sale accounting because the Company maintains effective control over the loans. The Company elected the fair value option for the financial liabilities issued by the CLO in order to simplify the accounting; however, the commercial loans continue to be carried at amortized cost as they were not eligible for the fair value option as it was not elected at origination of the loans. The Company incurred $8.3 million of costs in connection with the CLO that were expensed as incurred during the nine months ended September 30, 2019. The aggregate unpaid principal balance of loans in the CLO was $814.4 million at September 30, 2019 and there were no loans 90 days or more past due or on nonaccrual status. There is no gain or loss attributable to instrument-specific credit risk of the debt securities at September 30, 2019 based upon the Company’s process of monitoring events of default on the underlying mortgage loans. The contractual principal amount of the CLO debt held by third parties was $633.9 million at September 30, 2019.
Residential Trusts
The Company consolidates a securitization trust, which is included in “Residential Trusts” in the tables below, that issued residential mortgage-backed securities that are collateralized by residential mortgage loans that had been transferred to the trust by one of the Company’s subsidiaries. The Company owns the subordinate securities, and a subsidiary of the Company continues to be the master servicer. As such, the Company is deemed to be the primary beneficiary of the residential mortgage trust and consolidates the entity. The Company has elected the fair value option for the financial assets and liabilities of this VIE, but has not elected to apply the practical expedient under ASU 2014-13 as prices of both the financial assets and financial liabilities of the residential mortgage trust are available from third-party pricing services. The contractual principal amount of the residential mortgage trust’s debt held by third parties was $66.2 million at September 30, 2019.
OBX Trusts
The entities in the table below are referred to collectively as the “OBX Trusts.” These securitizations represent financing transactions which provide non-recourse financing to the Company that are collateralized by residential mortgage loans purchased by the Company.

19


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

Securitization
Date of Closing
Face Value at Closing
 
 
(dollars in thousands)
OBX 2018-1
March 2018
$
327,162

OBX 2018-EXP1
August 2018
$
383,451

OBX 2018-EXP2
October 2018
$
384,027

OBX 2019-INV1
January 2019
$
393,961

OBX 2019-EXP1
April 2019
$
388,156

OBX 2019-INV2
June 2019
$
383,760

OBX 2019-EXP2
July 2019
$
463,405



As of September 30, 2019, a total of $1.8 billion of bonds were held by third parties and the Company retained $512.6 million of mortgage-backed securities, which were eliminated in consolidation. The Company is deemed to be the primary beneficiary and consolidates the OBX Trusts because it has power to direct the activities that most significantly impact the OBX Trusts’ performance and holds a variable interest that could be potentially significant to these VIEs. The Company has elected the fair value option for the financial assets and liabilities of these VIEs, but has not elected the practical expedient under ASU 2014-13 as prices of both the financial assets and financial liabilities of the residential mortgage trusts are available from third-party pricing services. The Company incurred $2.6 million and $1.8 million of costs during the three months ended September 30, 2019 and 2018, respectively, and $7.3 million and $3.3 million of costs during the nine months ended September 30, 2019 and 2018, respectively, in connection with these securitizations that were expensed as incurred. The contractual principal amount of the OBX Trusts’ debt held by third parties was $1.8 billion at September 30, 2019.
Although the residential mortgage loans have been sold for bankruptcy and state law purposes, the transfers of the residential mortgage loans to the OBX Trusts did not qualify for sale accounting and are reflected as intercompany secured borrowings that are eliminated upon consolidation.
Credit Facility VIEs
In June 2016, a consolidated subsidiary of the Company entered into a credit facility with a third party financial institution. As of September 30, 2019, the borrowing limit on this facility was $500.0 million. The subsidiary was deemed to be a VIE and the Company was determined to be the primary beneficiary due to its role as collateral manager and because it holds a variable interest in the entity that could potentially be significant to the entity. The Company has pledged as collateral for this facility corporate loans with a carrying amount of $748.8 million at September 30, 2019. The transfers did not qualify for sale accounting and are reflected as an intercompany secured borrowing that is eliminated upon consolidation. At September 30, 2019, the subsidiary had an intercompany receivable of $434.7 million, which eliminates upon consolidation and a secured financing of $434.7 million to the third party financial institution.
In July 2017, a consolidated subsidiary of the Company entered into a credit facility with a third party financial institution. As of September 30, 2019, the borrowing limit on this facility was $250.0 million. The subsidiary was deemed to be a VIE and the Company was determined to be the primary beneficiary due to its role as servicer and because it holds a variable interest in the entity that could potentially be significant to the entity. The Company has transferred corporate loans to the subsidiary with a carrying amount of $435.5 million at September 30, 2019, which continue to be reflected in the Company’s Consolidated Statements of Financial Condition under Loans, net. At September 30, 2019, the subsidiary had a secured financing of $246.7 million to the third party financial institution.
In January 2019, a consolidated subsidiary of the Company (the “Borrower”) entered into a $200.0 million credit facility with a third party financial institution. As of September 30, 2019, the Borrower had a secured financing of $152.2 million to the third party financial institution.
MSR Silo
The Company also owns variable interests in an entity that invests in MSRs and has structured its operations, funding and capitalization into pools of assets and liabilities, each referred to as a “silo.” Owners of variable interests in a given silo are entitled to all of the returns and subjected to the risk of loss on the investments and operations of that silo and have no substantive recourse to the assets of any other silo. While the Company previously held 100% of the voting interests in this entity, in August 2017, the Company sold 100% of such interests, and entered into an agreement with the entity’s affiliated portfolio manager giving the Company the power over the silo in which it owns all of the beneficial interests. As a result, the Company is considered to be the primary beneficiary and consolidates this silo.
The Company’s exposure to the obligations of its VIEs is generally limited to the Company’s investment in the VIEs of $2.7 billion at September 30, 2019. Assets of the VIEs may only be used to settle obligations of the VIEs. Creditors of the VIEs have no

20


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

recourse to the general credit of the Company. The Company is not contractually required to provide and has not provided any form of financial support to the VIEs. No gains or losses were recognized upon consolidation of existing VIEs. Interest income and expense are recognized using the effective interest method.
The statements of financial condition of the Company’s VIEs, excluding the CLO, credit facility VIEs and OBX Trusts as the transfers of loans did not meet the criteria to be accounted for as sales, that are reflected in the Company’s Consolidated Statements of Financial Condition at September 30, 2019 and December 31, 2018 are as follows:
September 30, 2019
 
Commercial Trusts
 
Residential Trusts