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:  MARCH 31, 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

ANNALY CAPITAL MANAGEMENT, INC.

(Exact Name of Registrant as Specified in its Charter)

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

(212) 696-0100

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all 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  ☑

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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
7.625% Series C Cumulative Redeemable Preferred Stock	NLY.C	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
8.125% Series H Cumulative Redeemable Preferred Stock	NLY.H	New York Stock Exchange

The number of shares of the registrant’s Common Stock outstanding on April 30, 2019 was 1,456,197,143.

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ANNALY CAPITAL MANAGEMENT, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I  -  FINANCIAL INFORMATION	Page
Item 1.  Financial Statements	1
Consolidated Statements of Financial Condition at March 31, 2019 (Unaudited) and December 31, 2018 (Derived from the audited consolidated financial statements at December 31, 2018)	1
Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the three months ended March 31, 2019 and 2018	2
Consolidated Statements of Stockholders’ Equity (Unaudited) for the three months ended March 31, 2019 and 2018	3
Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2019 and 2018	4
Notes to Consolidated Financial Statements (Unaudited)	5
Note 1. Description of Business	5
Note 2. Basis of Presentation	5
Note 3. Significant Accounting Policies	5
Note 4. Financial Instruments	9
Note 5. Securities	9
Note 6. Loans	13
Note 7. Mortgage Servicing Rights	18
Note 8. Variable Interest Entities	18
Note 9. Real Estate	22
Note 10. Derivative Instruments	23
Note 11. Fair Value Measurements	28
Note 12. Goodwill and Intangible Assets	31
Note 13. Secured Financing	32
Note 14. Capital Stock	35
Note 15. Interest Income and Interest Expense	37
Note 16. Net Income (Loss) per Common Share	38
Note 17. Income Taxes	38
Note 18. Risk Management	39
Note 19. Related Party Transactions	39
Note 20. Lease Commitments and Contingencies	40
Note 21. Arcola Regulatory Requirements	41
Note 22. Acquisition of MTGE Investment Corp.	42
Note 23. Subsequent Events	43
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	44
Special Note Regarding Forward-Looking Statements	44
Overview	46
Business Environment	46
Results of Operations	47
Financial Condition	55
Capital Management	59
Risk Management	61
Critical Accounting Policies and Estimates	69
Glossary of Terms	71
Item 3. Quantitative and Qualitative Disclosures about Market Risk	79
Item 4. Controls and Procedures	79
PART II  -  OTHER INFORMATION
Item 1. Legal Proceedings	80
Item 1A. Risk Factors	80
Item 6. Exhibits	80
SIGNATURES	82

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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)
	March 31,				December 31,
	2019				2018 (1)
	(Unaudited)
Assets
Cash and cash equivalents (includes pledged assets of $1,338,507 and $1,581,775, respectively) (2)	$	1,522,605			$	1,735,749
Securities (includes pledged assets of $95,845,559 and $87,193,316, respectively) (3)	104,993,271				92,623,788
Loans, net (includes pledged assets of $2,243,369 and $2,997,051, respectively) (4)	3,879,324				4,585,975
Mortgage servicing rights (includes pledged assets of $3,260 and $3,616, respectively)	500,745				557,813
Assets transferred or pledged to securitization vehicles	4,365,300				3,833,200
Real estate, net	734,239				739,473
Derivative assets	148,178				200,503
Reverse repurchase agreements	523,449				650,040
Receivable for unsettled trades	1,574,251				68,779
Interest receivable	390,930				357,365
Goodwill and intangible assets, net	98,551				100,854
Other assets	441,706				333,988
Total assets	$	119,172,549			$	105,787,527
Liabilities and stockholders’ equity
Liabilities
Repurchase agreements	$	88,554,170			$	81,115,874
Other secured financing	4,144,623				4,183,311
Debt issued by securitization vehicles	3,693,766				3,347,062
Mortgages payable	510,386				511,056
Derivative liabilities	775,980				889,750
Payable for unsettled trades	4,763,376				583,036
Interest payable	424,391				570,928
Dividends payable	434,431				394,129
Other liabilities	89,982				74,580
Total liabilities	103,391,105				91,669,726
Stockholders’ equity
Preferred stock, par value $0.01 per share, 75,950,000 authorized, 73,400,00 issued and outstanding	1,778,168				1,778,168
Common stock, par value $0.01 per share, 1,924,050,000 authorized, 1,448,103,248 and 1,313,763,450 issued and outstanding, respectively	14,481				13,138
Additional paid-in capital	20,112,875				18,794,331
Accumulated other comprehensive income (loss)	(319,376		)		(1,979,865		)
Accumulated deficit	(5,809,931		)		(4,493,660		)
Total stockholders’ equity	15,776,217				14,112,112
Noncontrolling interests	5,227				5,689
Total equity	15,781,444				14,117,801
Total liabilities and equity	$	119,172,549			$	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 $40.7 million and $30.4 million at March 31, 2019 and December 31, 2018, respectively.

(3)	Excludes $273.4 million and $83.6 million at March 31, 2019 and December 31, 2018, respectively, of non-Agency mortgage-backed securities and $246.6 million and $224.3 million at March 31, 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 $101.3 million and $97.5 million of residential mortgage loans held for sale, $42.0 million and $42.2 million of commercial mortgage loans held for sale and $44.5 million and $0 of corporate loans held for sale at March 31, 2019 and December 31, 2018, respectively.

See notes to consolidated financial statements.

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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 March 31,
	2019				2018
Net interest income
Interest income	$	866,186			$	879,487
Interest expense	647,695				367,421
Net interest income	218,491				512,066
Realized and unrealized gains (losses)
Net interest component of interest rate swaps	134,035				(48,160		)
Realized gains (losses) on termination or maturity of interest rate swaps	(588,256		)		834
Unrealized gains (losses) on interest rate swaps	(390,556		)		977,285
Subtotal	(844,777		)		929,959
Net gains (losses) on disposal of investments	(93,916		)		13,468
Net gains (losses) on other derivatives	(115,159		)		(47,145		)
Net unrealized gains (losses) on instruments measured at fair value through earnings	47,629				(51,593		)
Loan loss provision	(5,703		)		—
Subtotal	(167,149		)		(85,270		)
Total realized and unrealized gains (losses)	(1,011,926		)		844,689
Other income (loss)	30,502				34,023
General and administrative expenses
Compensation and management fee	44,833				44,529
Other general and administrative expenses	38,904				17,981
Total general and administrative expenses	83,737				62,510
Income (loss) before income taxes	(846,670		)		1,328,268
Income taxes	2,581				564
Net income (loss)	(849,251		)		1,327,704
Net income (loss) attributable to noncontrolling interests	(101		)		(96		)
Net income (loss) attributable to Annaly	(849,150		)		1,327,800
Dividends on preferred stock	32,494				33,766
Net income (loss) available (related) to common stockholders	$	(881,644	)		$	1,294,034
Net income (loss) per share available (related) to common stockholders
Basic	$	(0.63	)		$	1.12
Diluted	$	(0.63	)		$	1.12
Weighted average number of common shares outstanding
Basic	1,398,614,205				1,159,617,848
Diluted	1,398,614,205				1,160,103,185
Other comprehensive income (loss)
Net income (loss)	$	(849,251	)		$	1,327,704
Unrealized gains (losses) on available-for-sale securities	1,599,398				(1,879,479		)
Reclassification adjustment for net (gains) losses included in net income (loss)	61,091				5,419
Other comprehensive income (loss)	1,660,489				(1,874,060		)
Comprehensive income (loss)	811,238				(546,356		)
Comprehensive income (loss) attributable to noncontrolling interests	(101		)		(96		)
Comprehensive income (loss) attributable to Annaly	811,339				(546,260		)
Dividends on preferred stock	32,494				33,766
Comprehensive income (loss) attributable to common stockholders	$	778,845			$	(580,026	)

See notes to consolidated financial statements.

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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 March 31,
		2019				2018
Preferred stock
Beginning of period		$	1,778,168			$	1,720,381
Issuance		—				411,335
Redemption		—				(408,548		)
End of period		$	1,778,168			$	1,723,168
Common stock
Beginning of period		$	13,138			$	11,596
Issuance		1,342				—
Direct purchase and dividend reinvestment		1				1
End of period		$	14,481			$	11,597
Additional paid-in capital
Beginning of period		$	18,794,331			$	17,221,265
Stock compensation expense		178				133
Issuance		1,317,475				—
Redemption of preferred stock		—				(3,952		)
Direct purchase and dividend reinvestment		891				745
End of period		$	20,112,875			$	17,218,191
Accumulated other comprehensive income (loss)
Beginning of period		$	(1,979,865	)		$	(1,126,020	)
Unrealized gains (losses) on available-for-sale securities		1,599,398				(1,879,479		)
Reclassification adjustment for net gains (losses) included in net income (loss)		61,091				5,419
End of period		$	(319,376	)		$	(3,000,080	)
Accumulated deficit
Beginning of period		$	(4,493,660	)		$	(2,961,749	)
Net income (loss) attributable to Annaly		(849,150		)		1,327,800
Dividends declared on preferred stock (1)		(32,494		)		(33,766		)
Dividends and dividend equivalents declared on common stock and share-based awards (1)		(434,627		)		(347,897		)
End of period		$	(5,809,931	)		$	(2,015,612	)
Total stockholder’s equity		$	15,776,217			$	13,937,264
Noncontrolling interests
Beginning of period		$	5,689			$	6,100
Net income (loss) attributable to noncontrolling interests		(101		)		(96		)
Equity contributions from (distributions to) noncontrolling interests		(361		)		(333		)
End of period		$	5,227			$	5,671
Total equity		$	15,781,444			$	13,942,935
(1)    See Note titled “Capital Stock” for dividends per share for each class of shares.

See notes to consolidated financial statements.

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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 Three Months Ended March 31,
	2019				2018
Cash flows from operating activities
Net income (loss)	$	(849,251	)		$	1,327,704
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
Amortization of premiums and discounts of investments, net	246,150				92,976
Amortization of securitized debt premiums and discounts and deferred financing costs	(3,627		)		408
Depreciation, amortization and other noncash expenses	7,072				5,822
Net (gains) losses on disposals of investments	93,916				(13,468		)
Net (gains) losses on investments and derivatives	458,086				(878,547		)
Income from unconsolidated joint ventures	1,960				618
Loan loss provision	5,703				—
Payments on purchases of loans held for sale	(49,070		)		(37,190		)
Proceeds from sales and repayments of loans held for sale	44,817				30,178
Net receipts (payments) on derivatives	(633,221		)		951,021
Net change in
Other assets	(107,040		)		(42,361		)
Interest receivable	(29,491		)		(2,963		)
Interest payable	(146,537		)		31,628
Other liabilities	18,436				(132,910		)
Net cash provided by (used in) operating activities	(942,097		)		1,332,916
Cash flows from investing activities
Payments on purchases of residential securities	(18,374,100		)		(3,718,947		)
Proceeds from sales of residential securities	7,822,334				463,214
Principal payments on residential securities	2,343,383				2,696,245
Payments on purchases of MSRs	—				(249		)
Payments on purchases of corporate debt	(125,351		)		(230,103		)
Proceeds from sales of corporate debt	179,112				—
Principal payments on corporate debt	33,545				92,820
Originations and purchases of commercial real estate investments	(269,489		)		(91,647		)
Proceeds from sales of commercial real estate investments	41,013				9,556
Principal repayments on commercial real estate investments	578,031				130,555
Proceeds from sales of real estate	6,661				—
Proceeds from reverse repurchase agreements	28,107,306				20,050,112
Payments on reverse repurchase agreements	(27,980,715		)		(20,250,571		)
Distributions in excess of cumulative earnings from unconsolidated joint ventures	241				2,813
Payments on purchases of residential mortgage loans held for investment	(373,745		)		(167,124		)
Proceeds from repayments of residential mortgage loans held for investment	107,783				67,384
Net cash provided by (used in) investing activities	(7,903,991		)		(945,942		)
Cash flows from financing activities
Proceeds from repurchase agreements and other secured financing	1,411,469,975				1,299,589,620
Principal payments on repurchase agreements and other secured financing	(1,404,070,367		)		(1,299,277,944		)
Proceeds from issuances of securitized debt	905,265				279,203
Principal repayments on securitized debt	(561,955		)		(317,773		)
Payment of deferred financing cost	(1,781		)		—
Net proceeds from stock offerings, direct purchases and dividend reinvestments	1,319,709				412,081
Redemptions of preferred stock	—				(412,500		)
Principal payments on mortgages payable	(722		)		—
Net contributions (distributions) from (to) noncontrolling interests	(361		)		(333		)
Dividends paid	(426,819		)		(381,642		)
Net cash provided by (used in) financing activities	8,632,944				(109,288		)
Net (decrease) increase in cash and cash equivalents	$	(213,144	)		$	277,686
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	$	1,522,605			$	984,275
Supplemental disclosure of cash flow information
Interest received	$	1,079,294			$	1,017,534
Dividends received	$	2,116			$	1,650
Interest paid (excluding interest paid on interest rate swaps)	$	633,805			$	320,988
Net interest paid on interest rate swaps	$	34,663			$	39,206
Taxes received (paid)	$	(30	)		$	2
Noncash investing activities
Receivable for unsettled trades	$	1,574,251			$	45,126
Payable for unsettled trades	$	4,763,376			$	91,327
Net change in unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment	$	1,660,489			$	(1,874,060	)
Noncash financing activities
Dividends declared, not yet paid	$	434,431			$	347,897

See notes to consolidated financial statements.

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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, 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.

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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 $1.3 billion and $1.6 billion at March 31, 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. If an item is accounted for at fair 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). 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.

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

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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.

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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 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 has decided to apply a probability of default methodology to loans that will be impacted by the adoption and is continuing to 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. (“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.

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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 March 31, 2019 and December 31, 2018.

Financial Instruments (1)
Balance Sheet Line Item	Type / Form	Measurement Basis	March 31, 2019				December 31, 2018
	Assets	(dollars in thousands)
Securities	Agency mortgage-backed securities (2)	Fair value, with unrealized gains (losses) through other comprehensive income	$	102,222,237			$	89,840,322
Securities	Agency mortgage-backed securities (3)	Fair value, with unrealized gains (losses) through earnings	871,289				912,673
Securities	Credit risk transfer securities	Fair value, with unrealized gains (losses) through earnings	607,945				552,097
Securities	Non-agency mortgage-backed securities	Fair value, with unrealized gains (losses) through earnings	1,116,569				1,161,938
Securities	Commercial real estate debt investments - CMBS	Fair value, with unrealized gains (losses) through other comprehensive income	96,566				138,242
Securities	Commercial real estate debt investments - CMBS (4)	Fair value, with unrealized gains (losses) through earnings	78,665				18,516
Total securities			104,993,271				92,623,788
Loans, net	Residential mortgage loans	Fair value, with unrealized gains (losses) through earnings	1,311,720				1,359,806
Loans, net	Commercial real estate debt and preferred equity, held for investment	Amortized cost	722,962				1,296,803
Loans, net	Commercial loans held for sale, net	Lower of amortized cost or fair value	42,035				42,184
Loans, net	Corporate debt	Amortized cost	1,758,082				1,887,182
Loans, net	Corporate debt held for sale, net	Lower of amortized cost or fair value	44,525				—
Total loans, net			3,879,324				4,585,975
Assets transferred or pledged to securitization vehicles	Residential mortgage loans	Fair value, with unrealized gains (losses) through earnings	1,425,668				1,094,831
Assets transferred or pledged to securitization vehicles	Commercial mortgage loans	Fair value, with unrealized gains (losses) through earnings	2,939,632				2,738,369
Total assets transferred or pledged to securitization vehicles			4,365,300				3,833,200
Reverse repurchase agreements	Reverse repurchase agreements	Amortized cost	523,449				650,040
	Liabilities
Repurchase agreements	Repurchase agreements	Amortized cost	88,554,170				81,115,874
Other secured financing	Loans	Amortized cost	4,144,623				4,183,311
Debt issued by securitization vehicles	Securities	Fair value, with unrealized gains (losses) through earnings	3,693,766				3,347,062
Mortgages payable	Loans	Amortized cost	510,386				511,056
(1)     Receivable for unsettled trades, 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.

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Item 1. Financial Statements

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. 

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 months ended March 31, 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:

March 31, 2019
	Residential Securities				Commercial Securities				Total
	(dollars in thousands)
Beginning balance January 1	$	92,467,030			$	156,758			$	92,623,788
Purchases	23,649,271				98,633				23,747,904
Sales	(10,456,466		)		(39,834		)		(10,496,300		)
Principal paydowns	(2,343,260		)		(42,859		)		(2,386,119		)
Amortization / accretion	(247,447		)		78				(247,369		)
Fair value adjustment	1,748,912				2,455				1,751,367
Ending balance March 31	$	104,818,040			$	175,231			$	104,993,271

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following tables present the Company’s Residential Investment Securities portfolio that was carried at their fair value at March 31, 2019 and December 31, 2018:

	March 31, 2019
	Principal / Notional				Remaining Premium				Remaining Discount				Amortized Cost				Unrealized Gains				Unrealized Losses				Estimated Fair Value
Agency	(dollars in thousands)
Fixed-rate pass-through	$	92,064,633			$	4,060,260			$	(41,614	)		$	96,083,279			$	789,557			$	(1,118,629	)		$	95,754,207
Adjustable-rate pass-through	4,046,258				204,672				(1,317		)		4,249,613				7,395				(104,972		)		4,152,036
CMO	10,699				50				—				10,749				199				—				10,948
Interest-only	5,522,373				1,070,160				—				1,070,160				1,900				(239,282		)		832,778
Multifamily	2,186,848				18,783				(5,249		)		2,200,382				104,664				—				2,305,046
Reverse mortgages	34,415				4,031				—				38,446				68				(3		)		38,511
Total agency securities	$	103,865,226			$	5,357,956			$	(48,180	)		$	103,652,629			$	903,783			$	(1,462,886	)		$	103,093,526
Residential credit
CRT	$	593,949			$	24,891			$	(16,883	)		$	601,957			$	9,488			$	(3,500	)		$	607,945
Alt-A	215,630				374				(30,467		)		185,537				12,926				(95		)		198,368
Prime	312,534				2,205				(21,319		)		293,420				16,786				(179		)		310,027
Subprime	393,362				1,480				(61,911		)		332,931				38,800				(446		)		371,285
NPL/RPL	3,431				—				(22		)		3,409				27				—				3,436
Prime jumbo (>=2010 vintage)	220,289				1,070				(4,626		)		216,733				3,004				(915		)		218,822
Prime jumbo (>=2010 vintage) Interest-only	837,030				12,445				—				12,445				2,517				(331		)		14,631
Total residential credit securities	$	2,576,225			$	42,465			$	(135,228	)		$	1,646,432			$	83,548			$	(5,466	)		$	1,724,514
Total residential securities	$	106,441,451			$	5,400,421			$	(183,408	)		$	105,299,061			$	987,331			$	(1,468,352	)		$	104,818,040
Commercial
Commercial securities	$	180,992			$	497			$	(9,513	)		$	171,976			$	3,546			$	(291	)		$	175,231
Total securities	$	106,622,443			$	5,400,918			$	(192,921	)		$	105,471,037			$	990,877			$	(1,468,643	)		$	104,993,271
	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

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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 March 31, 2019 and December 31, 2018:

 

	March 31, 2019				December 31, 2018
Investment Type	(dollars in thousands)
Fannie Mae	$	66,385,692			$	60,270,432
Freddie Mac	36,564,254				30,397,556
Ginnie Mae	143,580				85,007
Total	$	103,093,526			$	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 March 31, 2019 and December 31, 2018, according to their estimated weighted average life classifications:

	March 31, 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	$	13,863			$	14,032			$	13,447			$	13,670
Greater than one year through five years	16,081,685				16,091,945				11,710,172				11,928,973
Greater than five years through ten years	87,693,108				88,181,059				80,202,479				82,218,464
Greater than ten years	1,029,384				1,012,025				540,932				536,594
Total	$	104,818,040			$	105,299,061			$	92,467,030			$	94,697,701

The estimated weighted average lives of the Residential Securities at March 31, 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 March 31, 2019 and December 31, 2018.

	March 31, 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	$	12,188,284			$	(197,039	)		89			$	22,418,036			$	(432,352	)		713
12 Months or more	42,463,903				(1,026,562		)		1,513			43,134,843				(1,853,257		)		1,476
Total	$	54,652,187			$	(1,223,601	)		1,602			$	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 months ended March 31, 2019 and 2018, the Company disposed of $10.5 billion and $463.4 million of Residential Securities, resulting in net realized gains (losses) of ($92.5) million and $13.0 million, respectively.

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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 March 31, 2019, the Company reported $1.3 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 months ended March 31, 2019, the Company recorded a loan loss provision of $5.7 million.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

As of March 31, 2019 and December 31, 2018, the Company’s loan loss provision was $9.2 million and $3.5 million, respectively. There was no provision for loan loss recorded as of and for three months ended March 31, 2018.

The following table presents the activity of the Company’s loan investments, including loans held for sale, for the three months ended March 31, 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	425,488				165,258				125,351				716,097
Sales and transfers (1)	(444,963		)		(733,922		)		(179,112		)		(1,357,997		)
Principal Payments	(32,676		)		(534		)		(33,545		)		(66,755		)
Gains / (losses)	4,460				(5,703		)		—				(1,243		)
Amortization / accretion	(395		)		911				2,731				3,247
Ending balance March 31, 2019	$	1,311,720			$	764,997			$	1,802,607			$	3,879,324
(1)     Includes securitizations, syndications and transfers to securitization vehicles.

The carrying value of the Company’s residential loans held for sale was $101.3 million and $97.5 million at March 31, 2019 and December 31, 2018, respectively. The carrying value of the Company’s commercial loans held for sale was $42.0 million and $42.2 million at March 31, 2019 and December 31, 2018, respectively. The carrying value of the Company’s corporate loans held for sale was $44.5 million at March 31, 2019.

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 March 31, 2019 and December 31, 2018:

	March 31, 2019			December 31, 2018
	(dollars in thousands)
Fair value	$	2,737,388		$	2,454,637
Unpaid principal balance	$	2,686,557		$	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 months ended March 31, 2019 and 2018 for these investments:

	For the Three Months Ended
	March 31, 2019				March 31, 2018
	(dollars in thousands)
Interest income	$	29,991			$	13,495
Net gains (losses) on disposal of investments	(5,223		)		(1,758		)
Net unrealized gains (losses) on instruments measured at fair value through earnings	17,821				(9,864		)
Total included in net income (loss)	$	42,589			$	1,873

14

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following table provides the geographic concentrations based on the unpaid principal balances at March 31, 2019 and December 31, 2018 for the residential mortgage loans, including loans transferred or pledged to securitization vehicles:

 

Geographic Concentrations of Residential Mortgage Loans
March 31, 2019			December 31, 2018
Property location	% of Balance		Property location	% of Balance
California	54.2%		California	53.7%
Florida	6.7%		Florida	7.1%
New York	6.1%		New York	6.6%
All other (none individually greater than 5%)	33.0%		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 March 31, 2019 and December 31, 2018:

	March 31, 2019				December 31, 2018
	Portfolio Range		Portfolio Weighted Average		Portfolio Range		Portfolio Weighted Average
	(dollars in thousands)
Unpaid principal balance	$1 - $3,448		$457		$0 - $3,500		$457
Interest rate	2.00% - 9.25%		4.85%		2.00% - 7.75%		4.72%
Maturity	1/1/2028 - 1/1/2059		6/24/2046		1/1/2028 - 11/1/2058		1/11/2046
FICO score at loan origination	505 - 823		752		505 - 823		752
Loan-to-value ratio at loan origination	8% - 111%		68%		8% - 111%		68%

At March 31, 2019 and December 31, 2018, approximately 45% 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 March 31, 2019, and December 31, 2018, approximately 90% 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 March 31, 2019 and December 31, 2018, commercial real estate investments held for investment were comprised of the following:

	March 31, 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	$	405,968			$	403,497			27.6	%		$	988,248			$	981,202			75.6	%
Senior securitized mortgages (3)	739,058				733,864				50.1	%		—				—				—	%
Mezzanine loans	329,262				319,465				22.3	%		319,663				315,601				24.4	%
Total	$	1,474,288			$	1,456,826			100.0	%		$	1,307,911			$	1,296,803			100.0	%

(1)	Carrying value includes unamortized origination fees of $8.3 million and $7.6 million at March 31, 2019 and December 31, 2018, respectively.

(2)	Based on outstanding principal.

(3)	Assets of consolidated VIEs.

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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 March 31, 2019 and December 31, 2018:

March 31, 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)	148,341				739,058				18,274				905,673
Principal payments	(385		)		—				—				(385		)
Transfers	(730,235		)		—				(8,675		)		(738,910		)
Net (increase) decrease in origination fees	3,815				(5,488		)		(184		)		(1,857		)
Amortization of net origination fees	759				294				152				1,205
Allowance for loan losses	—				—				(5,703		)		(5,703		)
Net carrying value (March 31, 2019)	$	403,497			$	733,864			$	319,465			$	1,456,826

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 consolidated VIEs.

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

March 31, 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				Total
(dollars in thousands)
Senior mortgages	$	405,968			27.6	%		$	276,479			$	65,099			$	—			$	64,390			$	—			$	—			$	405,968
Senior securitized mortgages (3)	739,058				50.1	%		466,258				217,800				55,000				—				—				—				739,058
Mezzanine loans	329,262				22.3	%		139,721				49,538				96,400				—				43,603				—				329,262
Total	$	1,474,288			100.0	%		$	882,458			$	332,437			$	151,400			$	64,390			$	43,603			—				$	1,474,288

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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

(1)	The Company rated one loan as of March 31, 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 two loans as Doubtful and evaluated for impairment for which a loan loss allowance of $5.7 million was recognized for the three months ended March 31, 2019. The Company rated one loan as Doubtful and evaluated for impairment for which a loan loss allowance of $3.5 million was recognized for the three months ended December 31, 2018.

(3)	Assets of consolidated VIEs.

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 March 31, 2019 and December 31, 2018 are as follows:

17

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

	Industry Dispersion
	March 31, 2019												December 31, 2018
	Fixed Rate				Floating Rate				Total				Fixed Rate				Floating Rate				Total
	(dollars in thousands)
Aircraft and parts	$	—			$	41,394			$	41,394			$	—			$	41,342			$	41,342
Arrangement of transportation of freight & cargo	—				21,715				21,715				—				21,632				21,632
Coating, engraving and allied services	—				54,532				54,532				—				57,223				57,223
Computer programming, data processing & other computer related services	—				282,060				282,060				—				242,185				242,185
Drugs	—				35,926				35,926				—				35,882				35,882
Electrical work	—				41,598				41,598				—				41,760				41,760
Electronic components & accessories	—				24,083				24,083				—				24,059				24,059
Engineering, architectural & surveying	—				109,823				109,823				—				80,748				80,748
Grocery stores	—				23,394				23,394				—				23,431				23,431
Insurance agents, brokers and services	—				48,661				48,661				—				48,942				48,942
Mailing, reproduction, commercial art and photography, and stenographic	—				14,819				14,819				—				14,843				14,843
Management and public relations services	—				312,807				312,807				—				487,046				487,046
Medical and dental laboratories	—				26,811				26,811				—				26,858				26,858
Metal cans & shipping containers	—				118,385				118,385				—				118,248				118,248
Miscellaneous business services	—				19,581				19,581				—				19,622				19,622
Miscellaneous equipment rental and leasing	—				49,674				49,674				—				49,552				49,552
Miscellaneous health and allied services, not elsewhere classified	—				69,217				69,217				—				56,003				56,003
Miscellaneous plastic products	—				10,037				10,037				—				9,953				9,953
Motor vehicles and motor vehicle equipment	—				16,417				16,417				—				16,563				16,563
Motor vehicles and motor vehicle parts and supplies	—				28,984				28,984				—				29,046				29,046
Nonferrous foundries (castings)	—				12,933				12,933				—				12,948				12,948
Offices and clinics of doctors of medicine	—				97,841				97,841				—				97,877				97,877
Offices of clinics and other health practitioners	—				21,051				21,051				—				21,100				21,100
Public warehousing and storage	—				97,245				97,245				—				84,278				84,278
Research, development and testing services	—				45,676				45,676				—				33,381				33,381
Schools and educational services, not elsewhere classified	—				19,809				19,809				—				19,805				19,805
Services allied with the exchange of securities	—				—				—				—				14,877				14,877
Surgical, medical, and dental instruments and supplies	—				96,768				96,768				—				96,607				96,607
Telephone communications	—				61,366				61,366				—				61,371				61,371
Total	$	—			$	1,802,607			$	1,802,607			$	—			$	1,887,182			$	1,887,182

The table below reflects the Company’s aggregate positions by their respective place in the capital structure of the borrowers at March 31, 2019 and December 31, 2018.

 

	March 31, 2019				December 31, 2018
	(dollars in thousands)
First lien loans	$	1,232,524			$	1,346,356
Second lien loans	570,083				540,826
Total	$	1,802,607			$	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

18

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial 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 three months ended March 31, 2019 and 2018:

 

	March 31, 2019				March 31, 2018
	(dollars in thousands)
Fair value, beginning of period	$	557,813			$	580,860
Change in fair value due to
Changes in valuation inputs or assumptions (1)	(43,089		)		36,674
Other changes, including realization of expected cash flows	(13,979		)		(21,156		)
Fair value, end of period	$	500,745			$	596,378
(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 months ended March 31, 2019 and 2018, the Company recognized $27.8 million and $28.5 million of net servicing income from MSRs in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

8. VARIABLE INTEREST ENTITIES

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 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.

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 $2.2 billion at March 31, 2019.  At March 31, 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 March 31, 2019 based upon the Company’s process of monitoring events of default on the underlying mortgage loans.

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 March 31, 2019 a total of $629.0 million of notes were held by third parties and the Company retained or purchased $228.5 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

19

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

that were expensed as incurred during the three months ended March 31, 2019. The aggregate unpaid principal balance of loans in the CLO was $739.1 million at March 31, 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 March 31, 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 $628.9 million at March 31, 2019.

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 $82.8 million at March 31, 2019.

In March 2018, the Company closed OBX 2018-1, with a face value of $327.5 million. In July 2018, the Company closed OBX 2018-EXP1 with a face value of 383.4 million. In October 2018, the Company closed OBX 2018-EXP2 with a face value of $384.0 million. In January 2019, the Company closed OBX 2019-INV1, with a face value of $394.0 million. The OBX 2018-1 Trust, the OBX 2018-EXP1 Trust, the OBX 2018-EXP2 Trust and the OBX 2019-INV1 Trust 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. As of March 31, 2019, a total of $966.4 million of bonds were held by third parties and the Company retained $363.0 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 $1.7 million and $1.5 million of costs in connection with these securitizations that were expensed as incurred during the three months ended March 31, 2019 and 2018, respectively. The contractual principal amount of the OBX Trusts’ debt held by third parties was $963.4 million at March 31, 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.

In June 2016, a consolidated subsidiary of the Company entered into a credit facility with a third party financial institution. As of March 31, 2019, the borrowing limit on this facility was $400.0 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 $555.4 million at March 31, 2019. The transfers did not qualify for sale accounting and are reflected as an intercompany secured borrowing that is eliminated upon consolidation. At March 31, 2019, the subsidiary had an intercompany receivable of $350.1 million, which eliminates upon consolidation and an Other secured financing of $350.1 million to the third party financial institution.

In July 2017, a consolidated subsidiary of the Company entered into a $150.0 million credit facility with a third party financial institution. 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 $233.8 million at March 31, 2019, which continue to be reflected in the Company’s Consolidated Statements of Financial Condition in Loans. At March 31, 2019, the subsidiary had an Other secured financing of $148.5 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 March 31, 2019, the Borrower had not drawn on the credit facility.

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.

20

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The Company’s exposure to the obligations of its VIEs is generally limited to the Company’s investment in the VIEs of $2.1 billion at March 31, 2019. Assets of the VIEs may only be used to settle obligations of the VIEs. Creditors of the VIEs have no recourse to the general credit of the Company. The Company is not contractually required to provide and has not provided any form of financial support to the 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 March 31, 2019 and December 31, 2018 are as follows:

March 31, 2019
	Commercial Trusts				Residential Trusts				MSR Silo
Assets	(dollars in thousands)
Cash and cash equivalents	$	—			$	—			$	40,714
Loans	—				—				101,344
Assets transferred or pledged to securitization vehicles	2,205,768				101,994				—
Mortgage servicing rights	—				—				500,744
Interest receivable	11,269				540				—
Derivative assets	—				—				15
Other assets	—				—				27,290
Total assets	$	2,217,037			$	102,534			$	670,107
Liabilities
Debt issued by securitization vehicles (non-recourse)	$	2,016,202			$	82,220			$	—
Other secured financing	—				—				57,667
Payable for unsettled trades	—				—				15,924
Interest payable	4,334				196				—
Other liabilities	—				179				1,736
Total liabilities	$	2,020,536			$	82,595			$	75,327

 

December 31, 2018
	Commercial Trusts				Residential Trusts				MSR Silo
Assets	(dollars in thousands)
Cash and cash equivalents	$	—			$	—			$	30,444
Loans	—				—				97,464
Assets transferred or pledged to securitization vehicles	2,738,369				105,003				—
Mortgage servicing rights	—				—				557,813
Interest receivable	11,451				539				—
Other assets	—				4				28,756
Total assets	$	2,749,820			$	105,546			$	714,477
Liabilities
Debt issued by securitization vehicles (non-recourse)	$	2,509,264			$	71,324			$	—
Other secured financing	—				—				68,385
Interest payable	4,594				238				—
Other liabilities	—				—				1,975
Total liabilities	$	2,513,858			$	71,562			$	70,360

 

The geographic concentrations of credit risk exceeding 5% of the total loan unpaid principal balances related to the Company’s VIEs, excluding the credit facility VIEs, OBX Trusts and CLO, at March 31, 2019 are as follows:

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

Securitized Loans at Fair Value Geographic Concentration of Credit Risk

Commercial Trusts									Residential Trusts
Property Location		Principal Balance				% of Balance			Property Location		Principal Balance				% of Balance
(dollars in thousands)
Texas		$	546,190			17.9	%		California		$	45,023			44.5	%
California		461,478				15.1	%		Texas		13,261				13.1	%
Maryland		407,266				13.4	%		Washington		7,466				7.4	%
Virginia		349,921				11.5	%		Illinois		7,197				7.1	%
Pennsylvania		280,201				9.2	%		Florida		5,165				5.1	%
Other (1)		1,005,457				32.9	%		Other (1)		23,155				22.8	%
Total		$	3,050,513			100.0	%				$	101,267			100.0	%

(1)	No individual state greater than 5%.

9. REAL ESTATE

Real estate investments are carried at historical cost less accumulated depreciation. Historical cost includes all costs necessary to bring the asset to the condition and location necessary for its intended use, including financing during the construction period.  Costs directly related to acquisitions deemed to be business combinations are expensed. Ordinary repairs and maintenance are expensed as incurred. Major replacements and improvements that extend the useful life of the asset are capitalized and depreciated over their useful life.

Real estate investments are depreciated using the straight-line method over the estimated useful lives of the assets, summarized as follows:

Category	Term
Building and building improvements	1 - 44 years
Furniture and fixtures	1 - 4 years

There was no real estate acquired in settlement of residential mortgage loans at March 31, 2019 or December 31, 2018 other than real estate held by securitization trusts that the Company was required to consolidate. The Company would be considered to have received physical possession of residential real estate property collateralizing a residential mortgage loan, so that the loan is derecognized and the real estate property would be recognized, if either (i) the Company obtains legal title to the residential real estate property upon completion of a foreclosure or (ii) the borrower conveys all interest in the residential real estate property to the Company to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement.

Real estate investments, including REO, that do not meet the criteria to be classified as held for sale are separately presented in the Consolidated Statements of Financial Condition as held for investment. Real estate held for sale is reported at the lower of its carrying value or its estimated fair value less estimated costs to sell. Once a property is determined to be held for sale, depreciation is no longer recorded.

The Company’s real estate portfolio (REO and real estate held for investment) is reviewed on a quarterly basis, or more frequently as necessary, to assess whether there are any indicators that the value of its operating real estate may be impaired or that its carrying value may not be recoverable. A property’s value is considered impaired if the Company’s estimate of the aggregate future undiscounted cash flows to be generated by the property is less than the carrying value of the property. In conducting this review, the Company considers U.S. macroeconomic factors, including real estate sector conditions, together with asset specific and other factors. To the extent impairment has occurred and is considered to be other than temporary, the loss will be measured as the excess of the carrying amount of the property over the calculated fair value of the property.

The Company acquired real estate holdings in connection with the MTGE Acquisition during the year ended December 31, 2018; refer to the “Acquisition of MTGE Investment Corp.” Note for additional information. There were no acquisitions of new real estate holdings during the three months ended March 31, 2019. The company sold one of its wholly owned triple net leased properties during the three months ended March 31, 2019 for $6.7 million and recognized a gain on sale of $2.7 million.

The weighted average amortization period for intangible assets and liabilities at March 31, 2019 is 5.0 years.  Above market leases and leasehold intangible assets are included in Intangible assets, net and below market leases are included in Other liabilities in the Consolidated Statements of Financial Condition.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

	March 31, 2019				December 31, 2018
Real estate, net	(dollars in thousands)
Land	$	128,114			$	128,742
Buildings and improvements	578,067				581,320
Furniture, fixtures and equipment	12,333				11,602
Subtotal	718,514				721,664
Less: accumulated depreciation	(72,008		)		(67,026		)
Total real estate held for investment, at amortized cost, net	646,506				654,638
Equity in unconsolidated joint ventures	87,733				84,835
Total real estate, net	$	734,239			$	739,473

Depreciation expense was $5.8 million and $3.7 million for the three months ended March 31, 2019 and 2018, respectively and is included in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

Rental Income

The minimum rental amounts due under leases are generally either subject to scheduled fixed increases or adjustments. The leases generally also require that the tenants reimburse the Company for certain operating costs. Rental income is included in Other income (loss) in the Company’s Consolidated Statements of Comprehensive Income (Loss).

Approximate future minimum rents to be received over the next five years and thereafter for non-cancelable operating leases in effect at March 31, 2019 for consolidated investments in real estate are as follows:

March 31, 2019
(dollars in thousands)
2019 (remaining)	$	38,061
2020	45,616
2021	44,314
2022	40,459
2023	37,635
Later years	208,841
Total	$	414,926

10. DERIVATIVE INSTRUMENTS

Derivative instruments include, but are not limited to, interest rate swaps, options to enter into interest rate swaps (“swaptions”), TBA derivatives, options on TBA securities (“MBS options”), U.S. Treasury and Eurodollar futures contracts and certain forward purchase commitments.  The Company may also enter into other types of mortgage derivatives such as interest-only securities, credit derivatives referencing the commercial mortgage-backed securities index and synthetic total return swaps. 

In connection with the Company’s investment/market rate risk management strategy, the Company economically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts, which include interest rate swaps, swaptions and futures contracts. The Company may also enter into TBA derivatives, MBS options and U.S. Treasury or Eurodollar futures contracts, certain forward purchase commitments and credit derivatives to economically hedge its exposure to market risks. The purpose of using derivatives is to manage overall portfolio risk with the potential to generate additional income for distribution to stockholders. These derivatives are subject to changes in market values resulting from changes in interest rates, volatility, Agency mortgage-backed security spreads to U.S. Treasuries and market liquidity. The use of derivatives also creates exposure to credit risk relating to potential losses that could be recognized if the counterparties to these instruments fail to perform their obligations under the stated contract. Additionally, the Company may have to pledge cash or assets as collateral for the derivative transactions, the amount of which may vary based on the market value and terms of the derivative contract. In the case of market agreed coupon (“MAC”) interest rate swaps, the Company may make or receive a payment at the time of entering into such interest rate swaps, which represents fair value of these swaps, to compensate for the out of market nature of such interest rate swaps. Subsequent changes in fair value from inception of these interest rate swaps are reflected within Unrealized gains (losses) on interest rate swaps in the Consolidated Statements of Comprehensive Income (Loss). Similar to other interest rate swaps, the Company may have to pledge cash or assets as collateral for the MAC interest rate swap transactions. In the event of a default by the counterparty, the Company could have difficulty obtaining its pledged collateral as well as receiving payments in accordance with the terms of the derivative contracts.

Derivatives are accounted for in accordance with FASB 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. 

The Company also maintains collateral in the form of cash on margin with counterparties to its interest rate swaps and other derivatives. In accordance with a clearing organization’s rulebook, the Company presents the fair value of centrally cleared interest rate swaps net of variation margin pledged under such transactions. At March 31, 2019, $126.0 million of variation margin was reported as a reduction to interest rate swaps, at fair value.

Interest Rate Swap Agreements – Interest rate swap agreements are the primary instruments used to mitigate interest rate risk.  In particular, the Company uses interest rate swap agreements to manage its exposure to changing interest rates on its repurchase agreements by economically hedging cash flows associated with these borrowings.  Interest rate swap agreements may or may not be cleared through a derivatives clearing organization (“DCO”).  Uncleared interest rate swaps are fair valued using internal pricing models and compared to the counterparty market values.  Centrally cleared interest rate swaps, including MAC interest rate swaps, are generally fair valued using the DCO’s market values. If an interest rate swap is terminated, the realized gain (loss) on the interest rate swap would be equal to the difference between the cash received or paid and fair value.

Swaptions – Swaptions are purchased or sold to mitigate the potential impact of increases or decreases in interest rates.  Interest rate swaptions provide the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay and receive interest rates in the future.  They are not centrally cleared.  The premium paid or received for swaptions is reported as an asset or liability in the Consolidated Statements of Financial Condition. If a swaption expires unexercised, the realized gain (loss) on the swaption would be equal to the premium received or paid. If the Company sells or exercises a swaption, the realized gain or loss on the swaption would be equal to the difference between the cash received or the fair value of the underlying interest rate swap received and the premium paid.

The fair value of swaptions is estimated using internal pricing models and compared to the counterparty market value.

TBA Dollar Rolls – TBA dollar roll transactions are accounted for as a series of derivative transactions. The fair value of TBA derivatives is based on methods similar to those used to value Agency mortgage-backed securities.

MBS Options – MBS options are generally options on TBA contracts, which help manage mortgage market risks and volatility while providing the potential to enhance returns.  MBS options are over-the-counter traded instruments and those written on current-coupon mortgage-backed securities are typically the most liquid.  MBS options are measured at fair value using internal pricing models and compared to the counterparty market value at the valuation date.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

Futures Contracts – Futures contracts are derivatives that track the prices of specific assets or benchmark rates. Short sales of futures contracts help to mitigate the potential impact of changes in interest rates on the portfolio performance. The Company maintains margin accounts which are settled daily with Futures Commission Merchants (“FCMs”). The margin requirement varies based on the market value of the open positions and the equity retained in the account. Futures contracts are fair valued based on exchange pricing.

Forward Purchase Commitments – The Company may enter into forward purchase commitments with counterparties whereby the Company commits to purchasing residential mortgage loans at a particular price, provided the residential mortgage loans close with the counterparties. The counterparties are required to deliver the committed loans on a “best efforts” basis.

Credit Derivatives – The Company may enter into credit derivatives referencing the commercial mortgage-backed securities index, such as the CMBX index, and synthetic total return swaps. Refer to the section titled “Glossary of Terms” located in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information related to the CMBX index.

The table below summarizes fair value information about our derivative assets and liabilities at March 31, 2019 and December 31, 2018:

Derivatives Instruments		March 31, 2019				December 31, 2018
Assets		(dollars in thousands)
Interest rate swaps		$	26,020			$	48,114
Interest rate swaptions		8,250				7,216
TBA derivatives		106,960				141,688
Futures contracts		357				—
Purchase commitments		2,434				844
Credit derivatives (1)		4,157				2,641
		$	148,178			$	200,503
Liabilities
Interest rate swaps		$	509,485			$	420,365
TBA derivatives		5,212				—
Futures contracts		260,354				462,309
Purchase commitments		478				33
Credit derivatives (1)		451				7,043
		$	775,980			$	889,750

(1)

The notional amount of the credit derivatives in which the Company purchased protection was $45.0 million and $30.0 million at March 31, 2019 and December 31, 2018, respectively. The maximum potential amount of future payments is the notional amount of credit derivatives in which the Company sold protection of $346.0 million and $451.0 million at March 31, 2019 and December 31, 2018, respectively, plus any coupon shortfalls on the underlying tranche. The credit derivative tranches referencing the basket of bonds had a range of ratings between AAA and BBB-.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following table summarizes certain characteristics of the Company’s interest rate swaps at March 31, 2019 and December 31, 2018:

 

March 31, 2019
Maturity	Current Notional (1)				Weighted Average Pay Rate			Weighted Average Receive Rate			Weighted Average Years to Maturity
(dollars in thousands)
0 - 3 years	$	32,201,400			1.93	%		2.66	%		1.46
3 - 6 years	13,567,000				2.12	%		2.63	%		4.22
6 - 10 years	18,112,000				2.52	%		2.70	%		8.94
Greater than 10 years	3,578,000				3.59	%		2.58	%		17.81
Total / Weighted average	$	67,458,400			2.20	%		2.66	%		4.77
December 31, 2018
Maturity	Current Notional (1)				Weighted Average Pay Rate			Weighted Average Receive Rate			Weighted Average Years to Maturity
(dollars in thousands)
0 - 3 years	$	31,900,200			1.84	%		2.73	%		1.21
3 - 6 years	16,603,200				2.29	%		2.70	%		4.30
6 - 10 years	18,060,900				2.57	%		2.56	%		8.62
Greater than 10 years	3,901,400				3.63	%		2.59	%		17.33
Total / Weighted average	$	70,465,700			2.17	%		2.68	%		4.26

(1)	There were no forward starting swaps at March 31, 2019 and December 31, 2018.

The following table presents swaptions outstanding at March 31, 2019 and December 31, 2018.

March 31, 2019
		Current Underlying Notional		Weighted Average Underlying Pay Rate		Weighted Average Underlying Receive Rate		Weighted Average Underlying Years to Maturity		Weighted Average Months to Expiration
(dollars in thousands)
Long		$2,800,000		3.12%