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

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED:  June 30, 2021

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)

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
6.95% Series F Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock			NLY.F			New York Stock Exchange
6.50% Series G Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock			NLY.G			New York Stock Exchange
6.75% Series I Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock			NLY.I			New York Stock Exchange

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

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

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

Large accelerated filer

☑

Accelerated filer

☐

Non-accelerated filer

☐

Smaller reporting company

☐

Emerging growth company

☐

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

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

The number of shares of the registrant’s Common Stock outstanding on July 23, 2021 was 1,444,273,077.

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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 June 30, 2021 (Unaudited) and December 31, 2020 (Derived from the audited consolidated financial statements at December 31, 2020)			1
Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the three and six months ended June 30, 2021 and 2020			2
Consolidated Statements of Stockholders’ Equity (Unaudited) for the three and six months ended June 30, 2021 and 2020			3
Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 30, 2021 and 2020			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			6
Note 4. Financial Instruments			9
Note 5. Securities			10
Note 6. Loans			14
Note 7. Mortgage Servicing Rights			22
Note 8. Variable Interest Entities			23
Note 9. Sale of Commercial Real Estate Business			26
Note 10. Derivative Instruments			28
Note 11. Fair Value Measurements			34
Note 12. Goodwill and Intangible Assets			37
Note 13. Secured Financing			38
Note 14. Capital Stock			39
Note 15. Interest Income and Interest Expense			41
Note 16. Net Income (Loss) per Common Share			42
Note 17. Income Taxes			42
Note 18. Risk Management			43
Note 19. Related Party Transactions			44
Note 20. Lease Commitments and Contingencies			44
Note 21. Arcola Regulatory Requirements			45
Note 22. Subsequent Events			46
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			47
Special Note Regarding Forward-Looking Statements			47
Overview			49
Business Environment and COVID-19			49
Results of Operations			51
Financial Condition			66
Capital Management			70
Risk Management			71
Critical Accounting Policies and Estimates			81
Glossary of Terms			83
Item 3. Quantitative and Qualitative Disclosures about Market Risk			92
Item 4. Controls and Procedures			92
PART II  -  OTHER INFORMATION
Item 1. Legal Proceedings			93
Item 1A. Risk Factors			93
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			93
Item 5. Other Information			93
Item 6. Exhibits			93
SIGNATURES			95

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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)
			June 30,						December 31,
			2021						2020 (1)
			(Unaudited)
Assets
Cash and cash equivalents (includes pledged assets of $1,207,566 and $1,137,809, respectively) (2)			$	1,380,456					$	1,243,703
Securities (includes pledged assets of $62,625,413 and $67,471,074, respectively) (3)			69,032,335						75,652,396
Loans, net (includes pledged assets of $1,669,699 and $2,231,035, respectively) (4)			3,563,008						3,083,821
Mortgage servicing rights (includes pledged assets of $0 and $5,541, respectively)			202,616						100,895
Interests in MSR			49,035						—
Assets transferred or pledged to securitization vehicles			4,073,156						6,910,020
Real estate, net			—						656,314
Assets of disposal group held for sale (includes pledged assets of $2,185,727 and $0, respectively) (5)			3,302,001						—
Derivative assets			181,889						171,134
Receivable for unsettled trades			14,336						15,912
Principal and interest receivable			250,210						268,073
Goodwill and intangible assets, net			26,502						127,341
Other assets			300,761						225,494
Total assets			$	82,376,305					$	88,455,103
Liabilities and stockholders’ equity
Liabilities
Repurchase agreements			$	60,221,067					$	64,825,239
Other secured financing			909,655						917,876
Debt issued by securitization vehicles			3,315,087						5,652,982
Participations issued			315,810						39,198
Mortgages payable			—						426,256
Liabilities of disposal group held for sale			2,362,690						—
Derivative liabilities			900,259						1,033,345
Payable for unsettled trades			154,405						884,069
Interest payable			173,721						191,116
Dividends payable			317,714						307,613
Other liabilities			66,721						155,613
Total liabilities			68,737,129						74,433,307
Stockholders’ equity
Preferred stock, par value $0.01 per share, 63,500,000 and 85,150,000 authorized, respectively, 63,500,000 issued and outstanding			1,536,569						1,536,569
Common stock, par value $0.01 per share, 2,936,500,000 and 2,914,850,000 authorized, respectively, 1,444,156,029 and 1,398,240,618 issued and outstanding, respectively			14,442						13,982
Additional paid-in capital			20,178,692						19,750,818
Accumulated other comprehensive income (loss)			1,780,275						3,374,335
Accumulated deficit			(9,892,863)						(10,667,388)
Total stockholders’ equity			13,617,115						14,008,316
Noncontrolling interests			22,061						13,480
Total equity			13,639,176						14,021,796
Total liabilities and equity			$	82,376,305					$	88,455,103

(1)Derived from the audited consolidated financial statements at December 31, 2020.

(2)Includes cash of consolidated Variable Interest Entities (“VIEs”) of $17.2 million and $22.2 million at June 30, 2021 and December 31, 2020, respectively.

(3)Excludes $48.4 million and $81.5 million at June 30, 2021 and December 31, 2020, respectively, of Agency mortgage-backed securities, $191.8 million and $576.6 million at June 30, 2021 and December 31, 2020, respectively, of non-Agency mortgage-backed securities and $0 and $391.0 million at June 30, 2021 and December 31, 2020, 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 $3.7 million and $47.0 million of residential mortgage loans held for sale at June 30, 2021 and December 31, 2020, respectively, and $466.4 million and $0 of corporate loans held for sale at June 30, 2021 and December 31, 2020, respectively.

(5)Excludes $251.0 million at June 30, 2021 of commercial mortgage-backed securities in consolidated VIEs pledged as collateral and eliminated from the Company’s Consolidated Statements of Financial Condition. 

See notes to consolidated financial statements.

1

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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 June 30,												For The Six Months Ended June 30,
			2021						2020						2021						2020
Net interest income
Interest income			$	383,906					$	584,812					$	1,147,284					$	1,139,838
Interest expense			61,047						186,032						137,020						689,505
Net interest income			322,859						398,780						1,010,264						450,333
Realized and unrealized gains (losses)
Net interest component of interest rate swaps			(83,087)						(64,561)						(162,834)						(78,541)
Realized gains (losses) on termination or maturity of interest rate swaps			—						(1,521,732)						—						(1,919,293)
Unrealized gains (losses) on interest rate swaps			(141,067)						1,494,628						631,195						(1,333,095)
Subtotal			(224,154)						(91,665)						468,361						(3,330,929)
Net gains (losses) on disposal of investments and other			16,223						246,679						(49,563)						453,262
Net gains (losses) on other derivatives and financial instruments			(357,808)						170,916						119,060						377,342
Net unrealized gains (losses) on instruments measured at fair value through earnings			3,984						254,772						108,175						(475,388)
Loan loss (provision) reversal			(494)						(68,751)						139,126						(168,077)
Business divestiture-related gains (losses)			1,527						—						(248,036)						—
Subtotal			(336,568)						603,616						68,762						187,139
Total realized and unrealized gains (losses)			(560,722)						511,951						537,123						(3,143,790)
Other income (loss)			1,675						12,328						15,143						19,490
General and administrative expenses
Compensation and management fee			32,013						37,036						63,531						77,861
Other general and administrative expenses			21,513						27,734						37,900						56,774
Total general and administrative expenses			53,526						64,770						101,431						134,635
Income (loss) before income taxes			(289,714)						858,289						1,461,099						(2,808,602)
Income taxes			5,134						2,055						4,813						(24,647)
Net income (loss)			(294,848)						856,234						1,456,286						(2,783,955)
Net income (loss) attributable to noncontrolling interests			794						32						1,115						98
Net income (loss) attributable to Annaly			(295,642)						856,202						1,455,171						(2,784,053)
Dividends on preferred stock			26,883						35,509						53,766						71,018
Net income (loss) available (related) to common stockholders			$	(322,525)					$	820,693					$	1,401,405					$	(2,855,071)
Net income (loss) per share available (related) to common stockholders
Basic			$	(0.23)					$	0.58					$	1.00					$	(2.00)
Diluted			$	(0.23)					$	0.58					$	1.00					$	(2.00)
Weighted average number of common shares outstanding
Basic			1,410,239,138						1,423,909,112						1,404,755,496						1,427,451,716
Diluted			1,410,239,138						1,423,909,112						1,405,764,272						1,427,451,716
Other comprehensive income (loss)
Net income (loss)			$	(294,848)					$	856,234					$	1,456,286					$	(2,783,955)
Unrealized gains (losses) on available-for-sale securities			(191,541)						986,146						(1,620,468)						2,360,942
Reclassification adjustment for net (gains) losses included in net income (loss)			(30,415)						(265,443)						26,408						(657,059)
Other comprehensive income (loss)			(221,956)						720,703						(1,594,060)						1,703,883
Comprehensive income (loss)			(516,804)						1,576,937						(137,774)						(1,080,072)
Comprehensive income (loss) attributable to noncontrolling interests			794						32						1,115						98
Comprehensive income (loss) attributable to Annaly			(517,598)						1,576,905						(138,889)						(1,080,170)
Dividends on preferred stock			26,883						35,509						53,766						71,018
Comprehensive income (loss) attributable to common stockholders			$	(544,481)					$	1,541,396					$	(192,655)					$	(1,151,188)
See notes to consolidated financial statements.

2

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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 June 30,												For The Six Months Ended June 30,
						2021						2020						2021						2020
Preferred stock
Beginning of period						$	1,536,569					$	1,982,026					$	1,536,569					$	1,982,026
End of period						$	1,536,569					$	1,982,026					$	1,536,569					$	1,982,026
Common stock
Beginning of period						$	13,985					$	14,304					$	13,982					$	14,301
Issuance						456						—						456						—
Buyback of common stock						—						(228)						—						(228)
Stock-based award activity						1						—						4						3
Direct purchase and dividend reinvestment						—						1						—						1
End of period						$	14,442					$	14,077					$	14,442					$	14,077
Additional paid-in capital
Beginning of period						$	19,754,826					$	19,968,372					$	19,750,818					$	19,966,923
Issuance						419,970						—						419,970						—
Buyback of common stock						—						(143,436)						—						(143,436)
Stock-based award activity						3,896						1,876						7,904						3,325
Direct purchase and dividend reinvestment						—						404						—						404
End of period						$	20,178,692					$	19,827,216					$	20,178,692					$	19,827,216
Accumulated other comprehensive income (loss)
Beginning of period						$	2,002,231					$	3,121,371					$	3,374,335					$	2,138,191
Unrealized gains (losses) on available-for-sale securities						(191,541)						986,146						(1,620,468)						2,360,942
Reclassification adjustment for net gains (losses) included in net income (loss)						(30,415)						(265,443)						26,408						(657,059)
End of period						$	1,780,275					$	3,842,074					$	1,780,275					$	3,842,074
Accumulated deficit
Beginning of period - unadjusted						$	(9,251,804)					$	(12,382,648)					$	(10,667,388)					$	(8,309,424)
Cumulative effect of change in accounting principle for credit losses						—						—						—						(39,641)
Beginning of period - adjusted						(9,251,804)						(12,382,648)						(10,667,388)						(8,349,065)
Net income (loss) attributable to Annaly						(295,642)						856,202						1,455,171						(2,784,053)
Dividends declared on preferred stock (1)						(26,883)						(35,509)						(53,766)						(71,018)
Dividends and dividend equivalents declared on common stock and stock-based awards (1)						(318,534)						(309,972)						(626,880)						(667,791)
End of period						$	(9,892,863)					$	(11,871,927)					$	(9,892,863)					$	(11,871,927)
Total stockholder’s equity						$	13,617,115					$	13,793,466					$	13,617,115					$	13,793,466
Noncontrolling interests
Beginning of period						$	11,788					$	4,105					$	13,480					$	4,327
Net income (loss) attributable to noncontrolling interests						794						32						1,115						98
Equity contributions from (distributions to) noncontrolling interests						9,479						—						7,466						(288)
End of period						$	22,061					$	4,137					$	22,061					$	4,137
Total equity						$	13,639,176					$	13,797,603					$	13,639,176					$	13,797,603
(1)    Refer to the “Capital Stock” Note for dividends per share for each class of shares.

See notes to consolidated financial statements.

3

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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 Six Months Ended June 30,
			2021						2020
Cash flows from operating activities
Net income (loss)			$	1,456,286					$	(2,783,955)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
Amortization of premiums and discounts of investments, net			313,306						881,012
Amortization of securitized debt premiums and discounts and deferred financing costs			(4,269)						(4,554)
Depreciation, amortization and other noncash expenses			17,718						16,895
Net (gains) losses on disposal of investments and other			49,563						(453,262)
Net (gains) losses on investments and derivatives			(858,430)						3,350,434
Net (gains) losses on business divestitures			248,036						—
Income from unconsolidated joint ventures			5,889						(1,349)
Loan loss provision (reversal)			(139,126)						168,077
Payments on purchases of loans held for sale			(49,586)						(90,287)
Proceeds from sales and repayments of loans held for sale			84,991						95,551
Net receipts (payments) on derivatives			606,454						(2,538,137)
Net change in
Other assets			(121,876)						238,119
Interest receivable			18,677						139,240
Interest payable			(16,165)						(295,392)
Other liabilities			(40,425)						(62,684)
Net cash provided by (used in) operating activities			1,571,043						(1,340,292)
Cash flows from investing activities
Payments on purchases of securities			(12,581,731)						(17,684,740)
Proceeds from sales of securities			6,350,647						46,806,424
Principal payments on securities			10,228,935						9,328,755
Payments on purchases and origination of loans			(2,754,376)						(1,588,531)
Proceeds from sales of loans			116,570						510,407
Principal payments on loans			1,498,768						1,040,569
Payments on purchases of MSR			(98,983)						—
Proceeds from sales of MSR			376						—
Payments on purchases of interests in MSR			(47,098)						—
Investments in real estate			(1,815)						(820)
Proceeds from sales of real estate			53,910						—
Proceeds from reverse repurchase agreements			12,084,313						37,100,000
Payments on reverse repurchase agreements			(12,084,313)						(37,100,000)
Distributions in excess of cumulative earnings from unconsolidated joint ventures			290						6,332
Proceeds from sale of equity securities			6,957						—
Cash acquired in asset acquisition			—						3,793
Net cash provided by (used in) investing activities			2,772,450						38,422,189
Cash flows from financing activities
Proceeds from repurchase agreements and other secured financing			1,129,837,127						1,910,919,740
Payments on repurchase agreements and other secured financing			(1,134,179,055)						(1,948,434,517)
Proceeds from issuances of securitized debt			969,165						1,423,925
Principal payments on securitized debt			(863,095)						(540,928)
Payment of deferred financing cost			—						(553)
Net proceeds from stock offerings, direct purchases and dividend reinvestments			420,426						405
Proceeds from participations issued			499,864						—
Payments on repurchases of participations issued			(223,828)						—
Principal payments on participations issued			(4,015)						—
Net principal receipts (payments) on mortgages payable			(659)						23,373
Net contributions (distributions) from (to) noncontrolling interests			7,466						(288)
Net payment on share repurchase			—						(143,664)
Settlement of stock-based awards in satisfaction of withholding tax requirements			(992)						—
Dividends paid			(669,144)						(786,209)
Net cash provided by (used in) financing activities			(4,206,740)						(37,538,716)
Net (decrease) increase in cash and cash equivalents			$	136,753					$	(456,819)
Cash and cash equivalents including cash pledged as collateral, beginning of period			1,243,703						1,850,729
Cash and cash equivalents including cash pledged as collateral, end of period			$	1,380,456					$	1,393,910
Supplemental disclosure of cash flow information
Interest received			$	1,478,377					$	3,354,991
Dividends received			$	51					$	6,180
Interest paid (excluding interest paid on interest rate swaps)			$	183,952					$	1,498,708
Net interest paid on interest rate swaps			$	137,018					$	358,218
Taxes received (paid)			$	333					$	603
Noncash investing and financing activities
Receivable for unsettled trades			$	14,336					$	747,082
Payable for unsettled trades			$	154,405					$	2,122,735
Net change in unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment			$	(1,594,060)					$	1,703,883
Dividends declared, not yet paid			$	317,714					$	309,686
Derecognition of assets of consolidated VIEs			$	976,690					$	—
Derecognition of securitized debt of consolidated VIEs			$	893,500					$	—

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 with investment strategies across mortgage finance and corporate middle market lending. 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 (“MSR”) and corporate debt. The Company’s principal business objective is to generate net income for distribution to its stockholders and optimize its returns through prudent management of its diversified investment strategies.

The Company is an internally-managed company that 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”). Prior to the closing of the Internalization (as defined in the “Related Pary Transactions” Note) on June 30, 2020, the Company was externally managed by Annaly Management Company LLC (the “Former Manager”).

The Company’s 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 and complementary investments within the Agency market, including MSR and Agency commercial mortgage-backed securities.
Annaly Residential Credit Group			Invests primarily in non-Agency residential whole loans and securitized products within the residential and commercial markets.
Annaly Middle Market Lending Group			Provides financing to private equity backed middle market businesses, focusing primarily on senior debt within select industries.

In March 2021, the Company announced that it had entered into a definitive agreement to sell and exit its Commercial Real Estate (“CRE”) business. Subject to customary closing conditions, including applicable regulatory approvals, the sale of the CRE business is expected to be completed in the second half of 2021. Refer to the “Sale of Commercial Real Estate Business” and “Subsequent Events” Notes for additional information.

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, 2020 (the “2020 Form 10-K”). The consolidated financial information as of December 31, 2020 has been derived from audited consolidated financial statements included in the Company’s 2020 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.

Beginning with the quarter ended June 30, 2021, the Company began classifying certain portfolio activity- or volume-related expenses (including but not limited to brokerage and commission fees, due diligence costs and securitization expenses) as Other income (loss) rather than Other general and administrative expenses in the Consolidated Statements of Comprehensive Income (Loss) to better reflect the nature of the items. As such, prior periods have been conformed to the current presentation. Other general and administrative expenses for the three months ended March 31, 2021 decreased by $1.8 million and for the three and six months ended June 30, 2020 decreased by $2.9 million and $10.7 million, respectively, and Other income (loss) decreased by the same amounts for the three months ended March 31, 2021 and three and six months ended June 30, 2020, respectively.

In the opinion of management, all normal, recurring adjustments have been included for a fair presentation of this interim financial information. Interim period operating results may not be indicative of the operating results for a full year.

5

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

3. SIGNIFICANT ACCOUNTING POLICIES

The Company’s significant accounting policies are described below or are included 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.

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 $1.2 billion and $1.1 billion at June 30, 2021 and December 31, 2020, respectively.

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 FVO in order to simplify the accounting treatment for certain financial instruments. Items for which the FVO has been elected are presented at fair value in the Consolidated Statements of Financial Condition and any change in fair value is recorded in Net unrealized gains (losses) on instruments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss). For additional information regarding financial instruments for which the Company has elected the FVO 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 and financial instruments 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 measures compensation expense for stock-based awards at fair value, which is generally based on the grant-date fair value of the Company’s common stock. Stock-based awards that contain market-based conditions are valued using a model.

6

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

Compensation expense is recognized ratably over the vesting or requisite service period of the award. Compensation expense for awards with performance conditions is recognized based on the probable outcome of the performance condition at each reporting date. Compensation expense for awards with market conditions is recognized irrespective of the probability of the market condition being achieved and is not reversed if the market condition is not met. Stock-based awards that do not require future service (i.e., vested awards) are expensed immediately. Forfeitures are recorded when they occur. The Company generally issues new shares of common stock upon delivery of stock-based awards.

Interest Income - The Company recognizes interest income primarily on Residential Securities (as defined in the “Securities” Note), residential mortgage loans, commercial investments and reverse repurchase agreements. Interest accrued but not paid is recognized as Interest receivable on the Consolidated Statements of Financial Condition. Interest income is presented as a separate line item on the Consolidated Statements of Comprehensive Income. Refer to the “Interest Income and Interest Expense” Note for further discussion.

For its securities, 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 interest-only securities, multifamily and reverse mortgages), taking into account estimates of future principal prepayments in the calculation of the effective yield.  The Company recalculates the effective yield as differences between anticipated and actual prepayments occur. Using third party model and market information to project future cash flows and expected remaining lives of securities, the effective interest rate determined for each security is applied as if it had been in place from the date of the security’s acquisition. The amortized cost of the security is then adjusted to the amount that would have existed had the new effective yield been applied since the acquisition date, which results in a cumulative premium amortization adjustment in each period. The adjustment to amortized cost is offset with a charge or credit to interest income. Changes in interest rates and other market factors will impact prepayment speed projections and the amount of premium amortization recognized in any given period.

Premiums or discounts associated with the purchase of Agency interest-only securities, reverse mortgages and residential credit securities are amortized or accreted into interest income based upon current expected future cash flows with any adjustment to yield made on a prospective basis.

Premiums and discounts associated with the purchase of residential mortgage loans and with those transferred or pledged to securitization trusts are primarily amortized or accreted into interest income over their estimated remaining lives using the effective interest rates inherent in the estimated cash flows from the mortgage loans. Amortization of premiums and accretion of discounts are presented in Interest income in the Consolidated Statements of Comprehensive Income (Loss).

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. Refer to the “Interest Income and Interest Expense” Note for further discussion on interest.

The Company has made an accounting policy election not to measure an allowance for loans losses for accrued interest receivable. If interest receivable is deemed to be uncollectible or not collected within 90 days of its contractual due date for commercial loans or 120 days for corporate debt carried at amortized cost, it is written off through a reversal of interest income. Any interest written off that is recovered is recognized as interest income.

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.

7

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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.

Standard

Description

Effective Date

Effect on the Financial Statements or Other Significant Matters

Standards that have been adopted

ASU 2016-13 Financial instruments - Credit losses (Topic 326): Measurement of credit losses on financial instruments (“ASU 2016-13”)

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 cash and cash equivalents, reverse repurchase agreements, 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

The Company adopted ASU 2016-13 using the modified retrospective method for all financial assets and off-balance-sheet credit exposures in scope. The modified retrospective approach requires an adjustment to beginning retained earnings for the cumulative effect of adopting the standard. Results for reporting periods beginning after January 1, 2020 are presented in accordance with ASU 2016-13, while prior periods continue to be reported in accordance with previously applicable GAAP. As a result of the adoption, the Company recorded an increase to the loan loss allowance of $37.4 million and a liability of $2.2 million for unfunded loan commitments, which reduced beginning retained earnings by $39.6 million as of January 1, 2020.

ASU 2020-04 Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting

This ASU provides optional, temporary relief to accounting for contract modifications resulting from reference rate reform.

January 1, 2020

The Company has elected to retrospectively apply the practical expedients to modifications of qualifying contracts as continuation of the existing contract rather than as a new contract. The adoption had no immediate impact and is not expected to have a material impact on the Company’s consolidated financial statements as the guidance continues to be applied to contract modifications until the ASU’s termination date.

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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 June 30, 2021 and December 31, 2020.

Financial Instruments (1)

Balance Sheet Line Item

Type / Form

Measurement Basis

June 30, 2021

December 31, 2020

Assets

(dollars in thousands)

Securities

Agency mortgage-backed securities (2)

Fair value, with unrealized gains (losses) through other comprehensive income

$

65,898,975

$

73,562,972

Securities

Agency mortgage-backed securities (3)

Fair value, with unrealized gains (losses) through earnings

569,544

504,087

Securities

Residential credit risk transfer securities

Fair value, with unrealized gains (losses) through earnings

827,328

532,403

Securities

Non-agency mortgage-backed securities

Fair value, with unrealized gains (losses) through earnings

1,582,323

972,192

Securities

Commercial real estate debt investments - CMBS(4)

Fair value, with unrealized gains (losses) through other comprehensive income

—

31,603

Securities

Commercial real estate debt investments - CMBS (4)(5)

Fair value, with unrealized gains (losses) through earnings

150,005

45,254

Securities

Commercial real estate debt investments - credit risk transfer securities

Fair value, with unrealized gains (losses) through earnings

4,160

3,885

Total securities

69,032,335

75,652,396

Loans, net

Residential mortgage loans

Fair value, with unrealized gains (losses) through earnings

1,029,929

345,810

Loans, net

Commercial real estate debt and preferred equity, held for investment (4)

Amortized cost

—

498,081

Loans, net

Corporate debt, held for investment

Amortized cost

2,066,709

2,239,930

Loans, net

Corporate debt, held for sale

Lower of amortized cost or fair value

466,370

—

Total loans, net

3,563,008

3,083,821

Interests in MSR

Interest in net servicing cash flows

Fair value, with unrealized gains (losses) through earnings

49,035

—

Assets transferred or pledged to securitization vehicles

Agency mortgage-backed securities

Fair value, with unrealized gains (losses) through other comprehensive income

605,163

620,347

Assets transferred or pledged to securitization vehicles

Residential mortgage loans

Fair value, with unrealized gains (losses) through earnings

3,467,993

3,249,251

Assets transferred or pledged to securitization vehicles

Commercial mortgage loans (4)

Fair value, with unrealized gains (losses) through earnings

—

2,166,073

Assets transferred or pledged to securitization vehicles

Commercial mortgage loans (4)

Amortized cost

—

874,349

Total assets transferred or pledged to securitization vehicles

4,073,156

6,910,020

Liabilities

Repurchase agreements

Repurchase agreements

Amortized cost

60,221,067

64,825,239

Other secured financing

Loans

Amortized cost

909,655

917,876

Debt issued by securitization vehicles

Securities

Fair value, with unrealized gains (losses) through earnings

3,315,087

5,652,982

Participations issued

Participations issued

Fair value, with unrealized gains (losses) through earnings

315,810

39,198

Mortgages payable

Loans (6)

Amortized cost

—

426,256

(1)     Receivable for unsettled trades, Principal and interest receivable, Payable for unsettled trades, Interest payable and Dividends payable are accounted for at cost. Interests in MSR are considered financial assets whereas MSR are servicing assets or obligations. (2)     Includes Agency pass-through, collateralized mortgage obligation (“CMO”) and multifamily securities. (3)     Includes interest-only securities and reverse mortgages. (4)     Excludes Assets of disposal group held for sale at June 30, 2021. (5)     Includes single-asset / single-borrower CMBS. (6)     Excludes Liabilities of disposal group held for sale at June 30, 2021.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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 debt 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 regular-way 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.

Impairment – Management evaluates available-for-sale securities and held-to-maturity debt securities for 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) as a Securities Loss Provision and reflected as an Allowance for Credit Losses on Securities on the Consolidated Statements of Financial Condition, while the balance of losses related to other factors will be recognized as a component of Other comprehensive income (loss). For the three months ended March 31, 2021, the Company recognized a $0.4 million impairment on a commercial mortgage-backed security that it intends to sell. There was no impairment recognized for the three and six months ended June 30, 2020.

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 residential 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 (“CMBS”) are classified as available-for-sale and reported at fair value with any credit loss recognized through an allowance for credit losses and any other unrealized gains and losses reported as a component of Other comprehensive income (loss). Management evaluates its Commercial Securities for impairment at least quarterly. The Company elected the fair value option for all other Commercial Securities, including conduit and credit CMBS, to simplify the accounting where the unrealized gains and losses on these financial instruments are recorded through earnings. As of June 30, 2021 and December 31, 2020, CMBS included in the announced sale of the Company’s CRE business are reported in Assets of disposal group held for sale and Securities, respectively, in the Consolidated Statements of Financial Condition. Refer to the “Sale of Commercial Real Estate Business” Note for additional information on the announced transaction.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following represents a rollforward of the activity for the Company’s securities, excluding securities transferred or pledged to securitization vehicles, for the six months ended June 30, 2021:

			Residential Securities						Commercial Securities						Total
			(dollars in thousands)
Beginning balance January 1, 2021			$	75,571,654					$	80,742					$	75,652,396
Purchases			11,684,613						150,006						11,834,619
Sales and transfers (1)			(6,265,442)						(78,770)						(6,344,212)
Principal paydowns			(10,228,923)						—						(10,228,923)
(Amortization) / accretion			(307,987)						288						(307,699)
Fair value adjustment			(1,575,745)						1,899						(1,573,846)
Ending balance June 30, 2021			$	68,878,170					$	154,165					$	69,032,335
(1)     Includes transfers to assets of disposal group held for sale.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following tables present the Company’s securities portfolio, excluding securities transferred or pledged to securitization vehicles, that was carried at their fair value at June 30, 2021 and December 31, 2020:

			June 30, 2021
			Principal / Notional						Remaining Premium						Remaining Discount						Amortized Cost						Unrealized Gains						Unrealized Losses						Estimated Fair Value
Agency			(dollars in thousands)
Fixed-rate pass-through			$	59,813,415					$	3,280,197					$	(20,729)					$	63,072,883					$	1,905,748					$	(259,706)					$	64,718,925
Adjustable-rate pass-through			375,657						1,972						(3,286)						374,343						20,677						—						395,020
CMO			127,620						2,016						—						129,636						6,720						—						136,356
Interest-only			2,398,620						519,494						—						519,494						781						(157,583)						362,692
Multifamily(1)			2,769,722						169,915						(1,005)						777,380						35,262						(1,260)						811,382
Reverse mortgages			40,939						3,892						—						44,831						—						(687)						44,144
Total agency securities			$	65,525,973					$	3,977,486					$	(25,020)					$	64,918,567					$	1,969,188					$	(419,236)					$	66,468,519
Residential credit
CRT (2)			$	824,024					$	6,925					$	(1,868)					$	818,842					$	10,215					$	(1,729)					$	827,328
Alt-A			78,793						52						(17,019)						61,826						4,031						(6)						65,851
Prime			191,516						5,527						(15,517)						181,526						12,914						(367)						194,073
Prime interest-only			97,065						1,378						—						1,378						—						(854)						524
Subprime			189,138						460						(17,102)						172,496						10,120						(20)						182,596
NPL/RPL			1,056,963						1,281						(2,482)						1,055,762						8,887						(565)						1,064,084
Prime jumbo (>=2010 vintage)			74,981						530						(5,287)						70,224						4,180						(102)						74,302
Prime jumbo (>=2010 vintage) Interest-only			175,420						5,418						—						5,418						—						(4,525)						893
Total residential credit securities			$	2,687,900					$	21,571					$	(59,275)					$	2,367,472					$	50,347					$	(8,168)					$	2,409,651
Total Residential Securities			$	68,213,873					$	3,999,057					$	(84,295)					$	67,286,039					$	2,019,535					$	(427,404)					$	68,878,170
Commercial
Commercial Securities			$	154,000					$	6					$	(107)					$	153,899					$	267					$	(1)					$	154,165
Total securities			$	68,367,873					$	3,999,063					$	(84,402)					$	67,439,938					$	2,019,802					$	(427,405)					$	69,032,335
			December 31, 2020
			Principal / Notional						Remaining Premium						Remaining Discount						Amortized Cost						Unrealized Gains						Unrealized Losses						Estimated Fair Value
Agency			(dollars in thousands)
Fixed-rate pass-through			$	64,800,235					$	3,325,020					$	(22,143)					$	68,103,112					$	3,200,542					$	(1,076)					$	71,302,578
Adjustable-rate pass-through			455,675						2,869						(3,369)						455,175						22,341						—						477,516
CMO			139,664						2,177						—						141,841						7,926						—						149,767
Interest-only			2,790,537						564,297						—						564,297						3,513						(145,901)						421,909
Multifamily (1)			1,910,384						50,148						(1,057)						1,604,913						59,548						(954)						1,663,507
Reverse mortgages			47,585						4,183						—						51,768						252						(238)						51,782
Total agency investments			$	70,144,080					$	3,948,694					$	(26,569)					$	70,921,106					$	3,294,122					$	(148,169)					$	74,067,059
Residential credit
CRT (2)			$	544,780					$	7,324					$	(2,430)					$	538,941					$	3,062					$	(9,600)					$	532,403
Alt-A			93,001						51						(17,368)						75,684						4,644						—						80,328
Prime			177,852						5,126						(15,999)						166,979						14,607						(77)						181,509
Prime interest-only			194,687						1,882						—						1,882						—						(642)						1,240
Subprime			197,779						584						(18,181)						180,182						8,312						(61)						188,433
NPL/RPL			475,108						821						(2,416)						473,513						3,782						(1,448)						475,847
Prime jumbo (>=2010 vintage)			44,696						207						(5,300)						39,603						3,680						—						43,283
Prime jumbo (>=2010 vintage) Interest-only			291,624						6,803						—						6,803						—						(5,251)						1,552
Total residential credit securities			$	2,019,527					$	22,798					$	(61,694)					$	1,483,587					$	38,087					$	(17,079)					$	1,504,595
Total Residential Securities			$	72,163,607					$	3,971,492					$	(88,263)					$	72,404,693					$	3,332,209					$	(165,248)					$	75,571,654
Commercial
Commercial Securities			$	89,858					$	—					$	(7,471)					$	82,387					$	54					$	(1,699)					$	80,742
Total securities			$	72,253,465					$	3,971,492					$	(95,734)					$	72,487,080					$	3,332,263					$	(166,947)					$	75,652,396

(1) Principal/Notional amount includes $2.2 billion and $354.6 million of Agency CMBS interest-only securities as of June 30, 2021 and December 31, 2020, respectively.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

(2) Principal/Notional amount includes $10.2 million and $10.7 million of a CRT interest-only security as of June 30, 2021 and December 31, 2020, respectively.

The following table presents the Company’s Agency mortgage-backed securities portfolio, excluding securities transferred or pledged to securitization vehicles, by issuing Agency at June 30, 2021 and December 31, 2020: 

			June 30, 2021						December 31, 2020
Investment Type			(dollars in thousands)
Fannie Mae			$	52,611,769					$	56,218,033
Freddie Mac			13,762,498						17,735,041
Ginnie Mae			94,252						113,985
Total			$	66,468,519					$	74,067,059

Actual maturities of the Company’s Residential Securities are generally shorter than stated contractual maturities because actual maturities of the portfolio are affected by periodic payments and prepayments of principal on the underlying mortgages.

The following table summarizes the Company’s Residential Securities, excluding securities transferred or pledged to securitization vehicles, at June 30, 2021 and December 31, 2020, according to their estimated weighted average life classifications:

			June 30, 2021												December 31, 2020
			Estimated Fair Value						Amortized Cost						Estimated Fair Value						Amortized Cost
Estimated weighted average life			(dollars in thousands)
Less than one year			$	234,798					$	233,247					$	110,203					$	109,540
Greater than one year through five years			17,843,706						17,273,287						45,643,138						43,404,877
Greater than five years through ten years			50,258,367						49,253,011						28,509,058						27,610,923
Greater than ten years			541,299						526,494						1,309,255						1,279,353
Total			$	68,878,170					$	67,286,039					$	75,571,654					$	72,404,693

The estimated weighted average lives of the Residential Securities at June 30, 2021 and December 31, 2020 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 June 30, 2021 and December 31, 2020.

			June 30, 2021																		December 31, 2020
			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			$	17,620,478					$	(260,373)					364						$	777,586					$	(2,030)					30
12 Months or more			—						—						—						—						—						—
Total			$	17,620,478					$	(260,373)					364						$	777,586					$	(2,030)					30
(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 impaired because the Company currently has the ability and intent to hold the investments to maturity or for a period of time sufficient for a forecasted market price recovery up to or beyond the cost of the investments, and it is not more likely than not that the Company will be required to sell the investments before recovery of the amortized cost bases, which may be maturity. 

During the three and six months ended June 30, 2021, the Company disposed of $3.3 billion and $6.2 billion of Residential Securities, respectively. During the three and six months ended June 30, 2020, the Company disposed of $5.5 billion and $47.4 billion of Residential Securities, respectively. The following table presents the Company’s net gains (losses) from the disposal of Residential Securities for the three and six months ended June 30, 2021 and 2020.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

			Gross Realized Gains						Gross Realized Losses						Net Realized Gains (Losses)
For the three months ended			(dollars in thousands)
June 30, 2021			$	52,485					$	(17,680)					$	34,805
June 30, 2020			$	272,382					$	(12,496)					$	259,886
For the six months ended
June 30, 2021			$	57,131					$	(83,021)					$	(25,890)
June 30, 2020			$	811,637					$	(284,494)					$	527,143

6. LOANS

The Company invests in residential 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 June 30, 2021 and December 31, 2020, the Company reported $1.0 billion and $345.8 million, respectively, 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 and prior reserves are reversed. 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.

Allowance for Losses – The Company evaluates the need for a loss reserve on each of its loans classified as held-for-investment where the fair value option is not elected. Allowance for loan losses are written off in the period the loans are deemed uncollectible.

Given the unique nature of each underlying borrower and any collateral, the Company assesses an allowance for each individual loan held-for-investment. A provision is established at origination or acquisition that reflects management’s estimate of the total expected credit loss over the expected life of the loan. In estimating the lifetime expected credit losses, management utilizes a probability of default and loss given default methodology (“Loss Given Default methodology”), which considers projected economic conditions over the reasonable and supportable forecast period. The forecast incorporates primarily market-based assumptions including, but not limited to, forward interest rate curves, unemployment rate estimates and certain indexes sourced from third party vendors. For any remaining period of the expected life of the loan after the reasonable and supportable period, the Company reverts to historical losses on a straight-line basis. Management uses third party vendors’ loan pool data for loans with similar risk characteristics to estimate historical losses given the limited loss history of the Company’s loan portfolio. Changes in the lifetime expected credit loss are reflected in Loan loss (provision) reversal in the Consolidated Statements of Comprehensive Income (Loss).

For loans experiencing credit deterioration, the Company may use a different methodology to determine the expected credit losses such as a discounted cash flow analysis. For collateral-dependent loans, if foreclosure is probable, expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for any selling costs, if applicable. Additionally, the Company may elect the practical expedient for a financial asset for which the repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulty by measuring the allowance as the difference between the fair value of the collateral, less costs to sell, if applicable, and the amortized cost basis of the financial asset at the reporting date. The Company’s commercial loans are collateralized by commercial real estate including, but not limited to, multifamily real estate, office and retail space, hotels and industrial space. At origination, the fair value of the collateral generally exceeds the principal loan balance.

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

14

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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.

The Company recorded net loan loss (provisions) reversals of ($0.5) million and $139.1 million for the three and six months ended June 30, 2021, respectively. The Company recorded net loan loss (provisions) reversals of ($68.8) million and ($168.1) million for the three and six months ended June 30, 2020, respectively. As of June 30, 2021 and December 31, 2020, the Company’s loan loss allowance was $33.9 million and $169.5 million, respectively.

The following table presents the activity of the Company’s loan investments, including loans held for sale and excluding loans transferred or pledged to securitization vehicles, for the six months ended June 30, 2021:

			Residential						Commercial						Corporate Debt						Corporate Debt Held for Sale (1)						Total
			(dollars in thousands)
Beginning balance January 1, 2021			$	345,810					$	498,081					$	2,239,930					$	—					$	3,083,821
Purchases / originations			1,466,056						123,939						859,759						466,370						2,916,124
Sales and transfers (2)			(745,442)						(525,436)						(581,428)						—						(1,852,306)
Principal payments			(20,340)						(84,929)						(464,933)						—						(570,202)
Gains / (losses) (3)			(12,733)						(12,199)						5,693						—						(19,239)
(Amortization) / accretion			(3,422)						544						7,688						—						4,810
Ending balance June 30, 2021			$	1,029,929					$	—					$	2,066,709					$	466,370					$	3,563,008
(1) Represents loans the Company originated during the three months ended June 30, 2021 and subsequently syndicated and closed. At June 30, 2021, these loans were held at the lower of cost or fair value.
(2) Includes securitizations, syndications, transfers to securitization vehicles and commercial loan transfers to assets of disposal group held for sale. Includes transfer of residential loans to securitization vehicles with a carrying value of $987.0 million during the six months ended June 30, 2021.
(3) Includes loan loss allowances.

The carrying value of the Company’s residential loans held for sale was $3.7 million and $47.0 million at June 30, 2021 and December 31, 2020, respectively.

The Company also has off-balance-sheet credit exposures related to unfunded loan commitments, including revolvers, delayed draw term loans and future funding commitments that are not unconditionally cancelable by the Company. The Company utilizes the same methodology in calculating the liability related to the expected credit losses on these exposures as it does for the calculation of the allowance for loan losses. In determining the estimate of credit losses for off-balance-sheet credit exposures, the Company will consider the contractual period in which the entity is exposed to credit risk and the likelihood that funding will occur, if material. Estimated credit losses for off-balance-sheet credit exposures are included in Other liabilities on the Company’s Consolidated Statements of Financial Condition.

Residential

The Company’s residential mortgage loans are primarily comprised of performing adjustable-rate and fixed-rate whole loans. The Company’s residential loans are accounted for under the fair value option with changes in fair value reflected in Net unrealized gains (losses) on instruments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss). Additionally, the Company consolidates a collateralized financing entity that securitized prime adjustable-rate jumbo residential mortgage loans. The Company also consolidates securitization trusts in which it had purchased subordinated securities because it also has certain powers and rights to direct the activities of such trusts. Refer to the “Variable Interest Entities” Note for further information related to the Company’s consolidated residential mortgage loan trusts.

The following table presents the fair value and the unpaid principal balances of the residential mortgage loan portfolio, including loans transferred or pledged to securitization vehicles, at June 30, 2021 and December 31, 2020:

			June 30, 2021			December 31, 2020
			(dollars in thousands)
Fair value			$	4,497,922		$	3,595,061
Unpaid principal balance			$	4,317,278		$	3,482,865

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following table provides information regarding the line items and amounts recognized in the Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2021 and 2020 for these investments:

			For the Three Months Ended												For the Six Months Ended
			June 30, 2021						June 30, 2020						June 30, 2021						June 30, 2020
			(dollars in thousands)
Interest income			$	38,963					$	42,872					$	76,072					$	90,429
Net gains (losses) on disposal of investments and other			(21,721)						(5,376)						(26,941)						(17,376)
Net unrealized gains (losses) on instruments measured at fair value through earnings			14,456						110,545						36,911						(82,218)
Total included in net income (loss)			$	31,698					$	148,041					$	86,042					$	(9,165)

The following table provides the geographic concentrations based on the unpaid principal balances at June 30, 2021 and December 31, 2020 for the residential mortgage loans, including loans transferred or pledged to securitization vehicles:

Geographic Concentrations of Residential Mortgage Loans

June 30, 2021

December 31, 2020

Property location

% of Balance

Property location

% of Balance

California

52.6%

California

48.9%

New York

11.7%

New York

14.0%

Florida

5.9%

Florida

6.0%

All other (none individually greater than 5%)

29.8%

All other (none individually greater than 5%)

31.1%

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 June 30, 2021 and December 31, 2020:

			June 30, 2021												December 31, 2020
			Portfolio Range						Portfolio Weighted Average						Portfolio Range						Portfolio Weighted Average
			(dollars in thousands)
Unpaid principal balance			$0 - $3,500						$525						$1 - $3,448						$473
Interest rate			0.50% - 9.24%						4.55%						0.50% - 9.24%						4.89%
Maturity			7/1/2029 - 7/1/2061						10/21/2049						7/1/2029 - 1/1/2061						4/17/2046
FICO score at loan origination			604 - 829						758						505 - 829						755
Loan-to-value ratio at loan origination			8% - 103%						66%						8% - 104%						67%

At June 30, 2021 and December 31, 2020, approximately 31% and 37%, respectively, of the carrying value of the Company’s residential mortgage loans, including loans transferred or pledged to securitization vehicles, were adjustable-rate.

Commercial

As of June 30, 2021, commercial real estate loans are reported in Assets of disposal group held for sale in the Consolidated Statements of Financial Condition and classified as held for sale. As of December 31, 2020, commercial real estate loans are reported in Loans, net in the Consolidated Statements of Financial Condition and classified as held for investment. Refer to the “Sale of Commercial Real Estate Business” Note for additional information on the announced transaction.

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 and preferred equity interests that were designated as held for investment and were originated or purchased by the Company were 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. 

Management generally reviews the most recent financial information and metrics derived therefrom 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

16

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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 commercial loans are collateral-dependent and, as such, for loans experiencing credit deterioration, the Company is required to record an allowance for loans held for investment based upon the fair value of the underlying collateral if foreclosure is probable or if the practical expedient is elected. For the six months ended June 30, 2021, the Company reversed the loan loss allowance resulting in a loan loss reversal on impaired commercial loans of $67.4 million as the loans are classified as held for sale and are carried at lower of cost or fair value. For the three and six months ended June 30, 2020, the Company recorded a loan loss provision on impaired commercial loans of $22.0 million and $74.1 million, respectively based upon the fair value of the underlying collateral. The Company uses a discounted cash flow or market based valuation technique based upon the underlying property to project property cash flows. In projecting these cash flows, the Company reviewed the borrower financial statements, rent rolls, economic trends and other factors management deems important. These nonrecurring fair value measurements are considered to be in Level 3 of the fair value measurement hierarchy as there are unobservable inputs, which are significant to the overall fair value.

For the six months ended June 30, 2021, the Company reversed the loan loss allowance based upon its Loss Given Default methodology resulting in a loan loss reversal on commercial loans of $62.5 million as the loans are classified as held for sale and are carried at lower of cost or fair value. For the three and six months ended June 30, 2020, the Company recorded a net loan loss provision of $39.1 million and $62.3 million, respectively, based upon its Loss Given Default methodology. As a result of the implementation of the Loss Given Default methodology under the modified retrospective method, a cumulative effect loan loss allowance of $7.8 million was recorded on January 1, 2020.

During the year ended December 31, 2020, the Company modified five commercial loans with a carrying value of $243.8 million at December 31, 2020. The maturity dates on four commercial loans were extended and one commercial loan was granted a 120 day forebearance. Additionally, as part of the restructuring, two loans had partial paydowns totaling $4.5 million. The loan loss allowance recorded for these commercial loans was $23.6 million at December 31, 2020. Future funding commitments on the restructured loans totaled $4.1 million at December 31, 2020.

At December 31, 2020, the amortized cost basis of commercial loans on nonaccrual status was $46.8 million. For the year ended December 31, 2020, the Company recognized interest income on commercial loans on nonaccrual status of $2.1 million.

At December 31, 2020, the Company had unfunded commercial real estate loan commitments of $99.3 million. At December 31, 2020, the liability related to the expected credit losses on the unfunded commercial loan commitments was $5.1 million.

At December 31, 2020, approximately 94% of the carrying value, net of allowances of the Company’s CRE Debt and Preferred Equity Investments, including loans transferred or pledged to securitization vehicles, were adjustable-rate.

The sector attributes of the Company’s commercial real estate investments held for sale at June 30, 2021 and held for investment at December 31, 2020 were as follows:

			Sector Dispersion
			June 30, 2021												December 31, 2020
			Carrying Value						% of Loan Portfolio						Carrying Value						% of Loan Portfolio
			(dollars in thousands)
Office			$	581,039					43.3		%				$	650,034					47.4		%
Retail			249,676						18.6		%				256,493						18.7		%
Multifamily			220,331						16.4		%				250,095						18.2		%
Industrial			116,125						8.7		%				60,097						4.4		%
Hotel			100,942						7.5		%				115,536						8.4		%
Other			54,441						4.1		%				20,302						1.5		%
Healthcare			19,145						1.4		%				19,873						1.4		%
Total			$	1,341,699					100.0		%				$	1,372,430					100.0		%

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

Commercial real estate investments held for sale at June 30, 2021 and held for investment at December 31, 2020 were comprised of the following:

			June 30, 2021																		December 31, 2020
			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			$	388,293					$	364,974					26.4		%				$	387,124					$	373,925					25.7		%
Senior securitized mortgages (3)			908,006						863,425						61.9		%				938,859						874,349						62.3		%
Mezzanine loans			171,979						113,300						11.7		%				181,261						124,156						12.0		%
Total			$	1,468,278					$	1,341,699					100.0		%				$	1,507,244					$	1,372,430					100.0		%

(1)    Carrying value includes unamortized origination fees of $5.3 million and $4.9 million at June 30, 2021 and December 31, 2020, respectively.

(2)    Based on outstanding principal.

(3)    Represents assets of consolidated VIEs.

The following tables represent a rollforward of the activity for the Company’s commercial real estate investments held for sale at June 30, 2021 and held for investment at December 31, 2020:

June 30, 2021
			Senior Mortgages						Senior Securitized Mortgages (1)						Mezzanine Loans												Total
			(dollars in thousands)
Beginning balance (January 1, 2021) (2)			$	373,925					$	874,349					$	124,156											$	1,372,430
Originations & advances (principal)			124,701						69						641												125,411
Principal payments			(75,007)						(79,447)						(9,922)												(164,376)
Transfers (3)			(68,654)						5,819						(58,491)												(121,326)
Net (increase) decrease in origination fees			(1,403)						—						—												(1,403)
Amortization of net origination fees			501						486						43												1,030
Allowance for loan losses
Beginning allowance			(10,911)						(62,149)						(56,873)												(129,933)
Current period (allowance) reversal			10,911						62,149						56,873												129,933
Ending allowance			—						—						—												—
Net carrying value (June 30, 2021)			$	364,974					$	863,425					$	113,300											$	1,341,699

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

December 31, 2020
			Senior Mortgages									Senior Securitized Mortgages (1)						Mezzanine Loans						Total
			(dollars in thousands)
Beginning balance (January 1, 2020) (2)			$	499,690								$	936,378					$	182,726					$	1,618,794
Originations & advances (principal)			206,090									—						12,374						218,464
Principal payments			(77,344)									(144,308)						(78)						(221,730)
Principal write off			—									—						(7,000)						(7,000)
Transfers (3)			(245,120)									142,621						(7,100)						(109,599)
Net (increase) decrease in origination fees			(1,055)									(653)						(80)						(1,788)
Realized gain			204									—						—						204
Amortization of net origination fees			2,371									2,460						187						5,018
Allowance for loan losses
Beginning allowance, prior to CECL adoption			—									—						(12,703)						(12,703)
Impact of adopting CECL			(2,263)									(4,166)						(1,336)						(7,765)
Current period (allowance) reversal			(8,648)									(57,983)						(66,521)						(133,152)
Write offs			—									—						23,687						23,687
Ending allowance			(10,911)									(62,149)						(56,873)						(129,933)
Net carrying value (December 31, 2020)			$	373,925								$	874,349					$	124,156					$	1,372,430
(1)     Represents assets of consolidated VIEs.
(2)     Excludes loan loss allowances.
(3)     Includes transfers to securitization vehicles.

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 eight 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’s internal risk rating rubric for corporate debt has nine categories as depicted below:

Risk Rating - Corporate Debt			Description
1-5 / Performing			Meets all present contractual obligations.
6 / Performing - Closely Monitored			Meets all present contractual obligations but exhibits a defined weakness in either leverage or liquidity, but not both. Loans at this rating will require closer monitoring, but where we expect no loss of interest or principal.
7 / Substandard			A loan that has a defined weakness in either leverage and/or liquidity, and which may require substantial changes to strengthen the asset. Loans at this rating level have a higher probability of loss, although no determination of the amount or timing of a loss is yet possible.
8 / Doubtful			A loan that has missed a scheduled principal or interest payment or is otherwise deemed a non-earning account. The probability of loss is increasingly certain due to significant performance issues.
9 / Loss			Considered uncollectible.

Management assesses each loan at least quarterly and assigns an internal risk rating based on its evaluation of the most recent financial information produced by the borrower and consideration of economic conditions. See below for a tabular disclosure of the amortized cost basis of the Company’s corporate debt held for investment by year of origination and internal risk rating.

There was no provision for loan loss recorded on corporate loans using a discounted cash flow methodology for the six months ended June 30, 2021. For the six months ended June 30, 2020, the Company recorded a loan loss provision of $10.0 million on impaired corporate loans using a discounted cash flow methodology with a principal balance and carrying value, net of

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

allowances of $29.3 million and $4.3 million, respectively. During the six months ended June 30, 2020, a loan was restructured and the Company received $2.8 million of second lien debt and $4.8 million of equity. As a result of the restructuring, $19.6 million of first lien debt was written off and the related allowance of $11.9 million was charged off.

For the three and six months ended June 30, 2021 the Company recorded a net loan loss (provision) reversal on corporate loans of ($0.5) million and $5.7 million, respectively, based upon its Loss Given Default methodology. For the three and six months ended June 30, 2020 the Company recorded a net loan loss provision on corporate loans of $7.6 million and $21.7 million, respectively, based upon its Loss Given Default methodology. As a result of the implementation of the Loss Given Default methodology under the modified retrospective method, a cumulative effect loan loss allowance on corporate loans of $29.7 million was recorded on January 1, 2020.

At June 30, 2021 and December 31, 2020, the Company had unfunded corporate loan commitments of $228.2 million and $87.3 million, respectively. At June 30, 2021 and December 31, 2020, the liability related to the expected credit losses on the unfunded corporate loan commitments was $1.2 million and $0.7 million, respectively.

The Company invests in corporate loans through its Annaly Middle Market Lending Group. The industry and rate attributes of the portfolio at June 30, 2021 and December 31, 2020 are as follows:

															Industry Dispersion
															June 30, 2021																		December 31, 2020
															Total (1)																		Total (1)
															(dollars in thousands)
Computer Programming, Data Processing & Other Computer Related Services															$	457,776																	$	483,142
Management & Public Relations Services															291,404																		300,869
Industrial Inorganic Chemicals															156,642																		156,391
Public Warehousing & Storage															121,314																		132,397
Metal Cans & Shipping Containers															116,098																		115,670
Surgical, Medical & Dental Instruments & Supplies															81,821																		83,161
Electronic Components & Accessories															78,365																		78,129
Engineering, Architectural, and Surveying															75,625																		77,308
Offices & Clinics of Doctors of Medicine															73,532																		104,781
Telephone Communications															58,100																		58,450
Specialty Outpatient Facilities, not elsewhere classified															56,304																		—
Miscellaneous Industrial and Commercial															53,120																		77,163
Miscellaneous Equipment Rental & Leasing															49,693																		49,587
Research, Development & Testing Services															45,558																		62,008
Insurance Agents, Brokers and Service															43,978																		67,193
Electric Work															42,347																		41,128
Petroleum and Petroleum Products															33,784																		33,890
Medical & Dental Laboratories															30,609																		30,711
Schools & Educational Services, not elsewhere classified															29,172																		29,040
Metal Forgings & Stampings															27,340																		27,523
Legal Services															26,382																		26,399
Grocery Stores															22,130																		22,895
Coating, Engraving and Allied Services															19,535																		19,484
Chemicals & Allied Products															14,720																		14,686
Drugs															12,409																		12,942
Mailing, Reproduction, Commercial Art and Photography and Stenographic															12,277																		12,733
Machinery, Equipment & Supplies															11,708																		12,096
Sanitary Services															10,763																		—
Offices and Clinics of Other Health Practitioners															10,092																		9,730
Miscellaneous Business Services															4,111																		12,980
Miscellaneous Food Preparations															—																		58,857
Home Health Care Services															—																		28,587
Total															$	2,066,709																	$	2,239,930
(1)     All middle market lending positions are floating rate.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The table below reflects the Company’s aggregate positions by their respective place in the capital structure of the borrowers at June 30, 2021 and December 31, 2020.

 

			June 30, 2021						December 31, 2020
			(dollars in thousands)
First lien loans			$	1,395,995					$	1,489,125
Second lien loans			670,714						750,805
Total			$	2,066,709					$	2,239,930

The following tables represent a rollforward of the activity for the Company’s corporate debt investments held for investment at June 30, 2021 and December 31, 2020:

June 30, 2021
			First Lien						Second Lien												Total
			(dollars in thousands)
Beginning balance (January 1, 2021) (1)			$	1,489,125					$	750,805											$	2,239,930
Originations & advances			793,278						66,481												859,759
Sales and transfers (2)			(556,980)						(24,448)												(581,428)
Principal payments			(336,054)						(128,879)												(464,933)
Amortization & accretion of (premium) discounts			4,989						2,699												7,688
Allowance for loan losses
Beginning allowance			(18,767)						(20,785)												(39,552)
Current period (allowance) reversal			1,637						4,056												5,693
Ending allowance			(17,130)						(16,729)												(33,859)
Net carrying value (June 30, 2021)			$	1,395,995					$	670,714											$	2,066,709

December 31, 2020
			First Lien						Second Lien												Total
			(dollars in thousands)
Beginning balance (January 1, 2020) (1)			$	1,403,503					$	748,710											$	2,152,213
Originations & advances			834,211						227,433												1,061,644
Sales (2)			(273,887)						(79,203)												(353,090)
Principal payments			(444,759)						(132,000)												(576,759)
Amortization & accretion of (premium) discounts			8,374						3,832												12,206
Loan restructuring			(19,550)						2,818												(16,732)
Allowance for loan losses
Beginning allowance, prior to CECL adoption			(7,363)						—												(7,363)
Impact of adopting CECL			(10,787)						(18,866)												(29,653)
Current period (allowance) reversal			(12,510)						(1,919)												(14,429)
Write offs			11,893						—												11,893
Ending allowance			(18,767)						(20,785)												(39,552)
Net carrying value (December 31, 2020)			$	1,489,125					$	750,805											$	2,239,930

    (1) Excludes loan loss allowances.

    (2) Includes syndications and the period ended June 30, 2021 includes transfers to held for sale.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following table provides the amortized cost basis of corporate debt held for investment as of June 30, 2021 by vintage year and internal risk rating.

Amortized Cost Basis by Risk Rating and Vintage (1)
Risk Rating			Vintage
			Total						2021						2020						2019						2018						2017						2016						2015
(dollars in thousands)
1-5 / Performing			$	1,617,470					$	325,936					$	432,931					$	301,054					$	385,586					$	119,939					$	23,432					$	28,592
6 / Performing - Closely Monitored			369,773						2,933						26,382						—						259,500						80,958						—						—
7 / Substandard			79,466						—						11,708						25,481						42,277						—						—						—
8 / Doubtful			—						—						—						—						—						—						—						—
9 / Loss			—						—						—						—						—						—						—						—
Total			$	2,066,709					$	328,869					$	471,021					$	326,535					$	687,363					$	200,897					$	23,432					$	28,592

(1) The amortized cost basis excludes accrued interest and includes deferred fees on unfunded loans. As of June 30, 2021, the Company had $8.7 million of accrued interest receivable on corporate loans which is reported in Principal and interest receivable in the Consolidated Statements of Financial Condition and $3.3 million of deferred loan fees on unfunded loans, which is reported in Loans, net in the Consolidated Statements of Financial Condition.

7. MORTGAGE SERVICING RIGHTS

The Company owns variable interests in entities that invest in MSR and Interests in MSR. Refer to the “Variable Interest Entities” Note for a detailed discussion on this topic.

MSR represent the rights and obligations 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 MSR. The Company intends to hold the MSR as investments and elected to account for all of its investments in MSR at fair value. As such, they are recognized at fair value on the accompanying Consolidated Statements of Financial Condition with changes in the estimated fair value presented as a component of Net unrealized gains (losses) on instruments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss). Servicing income, net of servicing expenses, is reported in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

Interests in MSR represent agreements to purchase all, or a component of, net servicing cash flows. A third party acts as a master servicer for the loans providing the net servicing cash flows represented by the Interests in MSR. The Company accounts for its Interests in MSR at fair value with change in fair value presented in Net unrealized gains (losses) on instruments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss). Cash flows received for Interests in MSR are recorded in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

The following tables presents activity related to MSR and Interests in MSR for the three and six months ended June 30, 2021 and 2020:  

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

			Three Months Ended												Six Months Ended
Mortgage Servicing Rights			June 30, 2021						June 30, 2020						June 30, 2021						June 30, 2020
			(dollars in thousands)
Fair value, beginning of period			$	113,080					$	280,558					$	100,895					$	378,078
Purchases (1)			98,983						—						98,983						—
Sales			(376)						—						(376)						—
Change in fair value due to:
Changes in valuation inputs or assumptions (2)			4,621						(27,629)						32,296						(106,854)
Other changes, including realization of expected cash flows			(13,692)						(25,529)						(29,182)						(43,824)
Fair value, end of period			$	202,616					$	227,400					$	202,616					$	227,400
(1) Includes adjustments to original purchase price from early payoffs, defaults, or loans that were delivered but were deemed to not be acceptable. (2) Principally represents changes in discount rates and prepayment speed inputs used in valuation model, primarily due to changes in interest rates.

Interests in MSR			Six Months Ended
			June 30, 2021
			(dollars in thousands)
Beginning balance			$	—
Purchases (1)			47,098
Gain (loss) included in net income			1,937
Ending balance June 30, 2021			$	49,035
(1) Includes adjustments to original purchase price from early payoffs, defaults, or loans that were delivered but were deemed to not be acceptable.

For the three and six months ended June 30, 2021, the Company recognized $7.9 million and $14.8 million, respectively, and for the three and six months ended June 30, 2020, the Company recognized $16.4 million and $39.2 million, respectively, of net servicing income from MSR in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

For the three and six months ended June 30, 2021, the Company recognized $2.0 million, and for the three and six months ended June 30, 2020, the Company did not recognize net income from Interests in MSR in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

8. VARIABLE INTEREST ENTITIES

At June 30, 2021, commercial trusts, commercial securitizations and the collateralized loan obligation are reported in Assets of disposal group held for sale in the Consolidated Statements of Financial Condition. Refer to the “Sale of Commercial Real Estate Business” Note for additional information.

Multifamily Securitization

In November 2019, the Company repackaged Fannie Mae guaranteed multifamily mortgage-backed securities with a principal cut-off balance of $1.0 billion and retained interest-only securities with a notional balance of $1.0 billion and senior securities with a principal balance of $28.5 million. In March 2020, the Company repackaged Fannie Mae guaranteed multifamily mortgage-backed securities with a principal cut-off balance of $0.5 billion and retained interest-only securities with a notional balance of $0.5 billion. At the inception of the arrangements, the Company determined that it was the primary beneficiary based upon its involvement in the design of these VIEs and through the retention of a significant variable interest in the VIEs. The Company elected the fair value option for the financial liabilities of these VIEs in order to simplify the accounting; however, the financial assets were not eligible for the fair value option as it was not elected at purchase. In 2020, the Company deconsolidated the 2019 multifamily VIE since it sold all of its interest-only securities and no longer retains a significant variable interest in the entity. The Company incurred $1.1 million of costs in connection with the 2020 multifamily securitization that were expensed as incurred during the six months ended June 30, 2020.

Residential Trusts

The Company consolidates a securitization trust, which is included in “Residential Trusts” in the tables below, that issued residential mortgage-backed securities that are collateralized by residential mortgage loans that had been transferred to the trust by one of the Company’s subsidiaries. The Company owns the subordinate securities, and a subsidiary of the Company

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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 $14.4 million and $23.0 million at June 30, 2021 and December 31, 2020, respectively. As of June 30, 2021, a total of $14.5 million of bonds were held by third parties and the Company retained $12.6 million of mortgage-backed securities, which were eliminated in consolidation.

Residential Securitizations

The Company also invests in residential mortgage-backed securities issued by entities that are VIEs because they do not have sufficient equity at risk for the entities to finance their activities without additional subordinated financial support from other parties, but the Company is not the primary beneficiary because it does not have the power to direct the activities that most significantly impact the VIEs’ economic performance. For these entities, the Company’s maximum exposure to loss is the amortized cost basis of the securities it owns and it does not provide any liquidity arrangements, guarantees or other commitments to these VIEs. See the “Securities” Note for further information on Residential Securities.

OBX Trusts

The entities in the table below are referred to collectively as the “OBX Trusts.” These securitizations represent financing transactions which provide non-recourse financing to the Company that are collateralized by residential mortgage loans purchased by the Company.

Securitization			Date of Closing			Face Value at Closing
						(dollars in thousands)
OBX 2018-1			March 2018			$	327,162
OBX 2018-EXP1			August 2018			$	383,451
OBX 2018-EXP2			October 2018			$	384,027
OBX 2019-INV1			January 2019			$	393,961
OBX 2019-EXP1			April 2019			$	388,156
OBX 2019-INV2			June 2019			$	383,760
OBX 2019-EXP2			July 2019			$	463,405
OBX 2019-EXP3			October 2019			$	465,492
OBX 2020-INV1			January 2020			$	374,609
OBX 2020-EXP1			February 2020			$	467,511
OBX 2020-EXP2			July 2020			$	489,352
OBX 2020-EXP3			September 2020			$	514,609
OBX 2021-NQM1			March 2021			$	257,135
OBX 2021-J1			April 2021			$	353,840
OBX 2021-NQM2			June 2021			$	376,004

As of June 30, 2021, a total of $2.7 billion of bonds were held by third parties and the Company retained $642.3 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 $1.2 million and $0.0 million of costs during the three months ended June 30, 2021 and 2020, respectively, and $1.8 million and $3.7 million of costs during the six months ended June 30, 2021 and 2020, respectively, in connection with these securitizations that were expensed as incurred. The contractual principal amount of the OBX Trusts’ debt held by third parties was $2.7 billion at June 30, 2021.

Although the residential mortgage loans have been sold for bankruptcy and state law purposes, the transfers of the residential mortgage loans to the OBX Trusts did not qualify for sale accounting and are reflected as intercompany secured borrowings that are eliminated upon consolidation.

Credit Facility VIEs

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

In June 2016, a consolidated subsidiary of the Company entered into a credit facility with a third party financial institution. As of June 30, 2021, the borrowing limit on this facility was $675.0 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 $670.4 million at June 30, 2021. The transfers did not qualify for sale accounting and are reflected as an intercompany secured borrowing that is eliminated upon consolidation. At June 30, 2021, the subsidiary had an intercompany receivable of $441.4 million, which eliminates upon consolidation and a secured financing of $441.4 million to the third party financial institution.

In July 2017, a consolidated subsidiary of the Company entered into a credit facility with a third party financial institution. As of June 30, 2021, 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 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 $366.4 million at June 30, 2021, which continue to be reflected in the Company’s Consolidated Statements of Financial Condition under Loans, net. At June 30, 2021, the subsidiary had a secured financing of $239.2 million to the third party financial institution.

In January 2019, a consolidated subsidiary of the Company entered into a credit facility with a third party financial institution. As of June 30, 2021, the borrowing limit on this facility was $400.0 million. The Company has pledged as collateral for this facility corporate loans with a carrying amount of $341.2 million at June 30, 2021. As of June 30, 2021, the subsidiary had a secured financing of $229.1 million to the third party financial institution.

MSR VIEs

The Company owns variable interests in an entity that invests in MSR and has structured its operations, funding and capitalization into pools of assets and liabilities, each referred to as a “silo.” Owners of variable interests in a given silo are entitled to all of the returns and subjected to the risk of loss on the investments and operations of that silo and have no substantive recourse to the assets of any other silo. While the Company previously held 100% of the voting interests in this entity, in August 2017, the Company sold 100% of such interests, and entered into an agreement with the entity’s affiliated portfolio manager giving the Company the power over the silo in which it owns all of the beneficial interests. As a result, the Company is considered to be the primary beneficiary and consolidates this silo.

The Company also owns variable interests in entities that invest in Interests in MSR. These entities are VIEs because they do not have sufficient equity at risk to finance their activities and the Company is the primary beneficiary because it has power to remove the decision makers with or without cause and holds substantially all of the variable interests in the entities.

The Company’s exposure to the obligations of its VIEs is generally limited to the Company’s investment in the VIEs of $2.3 billion at June 30, 2021. 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 multifamily securitization, credit facility VIEs and OBX Trusts as the transfers of loans or securities did not meet the criteria to be accounted for as sales, that are reflected in the Company’s Consolidated Statements of Financial Condition at June 30, 2021 and December 31, 2020 are as follows:

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

June 30, 2021
									Residential Trusts						MSR VIEs
Assets									(dollars in thousands)
Cash and cash equivalents									$	—					$	17,240
Loans									—						3,709
Assets transferred or pledged to securitization vehicles									28,151						—
Mortgage servicing rights									—						89,546
Interests in MSR									—						49,035
Principal and interest receivable									173						—
Other assets									—						14,764
Total assets									$	28,324					$	174,294
Liabilities
Debt issued by securitization vehicles (non-recourse)									$	14,547					$	—
Payable for unsettled trades									—						1,716
Interest payable									34						—
Other liabilities									410						10,038
Total liabilities									$	14,991					$	11,754

 

December 31, 2020
									Residential Trusts						MSR VIEs
Assets									(dollars in thousands)
Cash and cash equivalents									$	—					$	22,241
Loans									—						47,048
Assets transferred or pledged to securitization vehicles									40,035						—
Mortgage servicing rights									—						100,895
Principal and interest receivable									226						—
Total assets									$	40,261					$	170,184
Liabilities
Debt issued by securitization vehicles (non-recourse)									$	23,351					$	—
Other secured financing									—						30,420
Payable for unsettled trades									—						3,076
Interest payable									55						—
Other liabilities									246						13,345
Total liabilities									$	23,652					$	46,841

 

The geographic concentrations of credit risk exceeding 5% of the total loan unpaid principal balances related to the Company’s VIEs, excluding the multifamily securitization, OBX Trusts and credit facility VIEs, at June 30, 2021 are as follows:

Securitized Loans at Fair Value Geographic Concentration of Credit Risk

						Residential Trusts
																		Property Location						Principal Balance						% of Balance
																		California						$	14,222					51.4		%
																		Illinois						3,542						12.8		%
																		Texas						2,938						10.6		%
																		Other (1)						6,983						25.2		%
																		Total						$	27,685					100.0		%

        (1) No individual state greater than 5%.

Corporate Debt Transfers

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The Company manages parallel funds investing in senior secured first and second lien corporate loans (the “Fund Entities”). The Fund Entities are considered VIEs because the investors do not have substantive liquidation, kick-out or participating rights. The fees that the Company earns are not considered variable interests of the VIE. The Company is not the primary beneficiary of the Fund Entities and therefore does not consolidate the Fund Entities. During the three and six months ended June 30, 2021, the Company transferred $59.9 million and $75.0 million of loans for cash. The loan transfers were accounted for as sales.

Residential Credit Fund

The Company manages a fund investing in participations in residential mortgage loans. The residential credit fund is deemed to be a VIE because the entity does not have sufficient equity at risk to permit the legal entity to finance its activities without additional subordinated financial support provided by any parties, including equity holders, as capital commitments are not considered equity at risk. The Company is not the primary beneficiary and does not consolidate the residential credit fund as its only interest in the fund is the management and performance fees that it earns, which are not considered variable interests in the entity. As of June 30, 2021 and December 31, 2020, the Company has issued participating interests in residential mortgage loans in the amount of $315.8 million and $39.2 million, respectively. These transfers do not meet the criteria for sale accounting and are accounted for as secured borrowings, thus the residential loans are reported as Loans, net and the associated liability is reported as Participations issued in the Consolidated Statements of Financial Condition. The Company elected to fair value the participations issued through earnings to more accurately reflect the economics of the transfers as the underlying loans are carried at fair value through earnings.

9. SALE OF COMMERCIAL REAL ESTATE BUSINESS

On March 25, 2021, the Company entered into a definitive agreement to sell substantially all of the assets that comprise its CRE business to Slate Asset Management L.P. and Slate Grocery REIT (together, “Slate”) for $2.33 billion. The transaction includes equity interests, loan assets and associated liabilities, and CMBS (other than commercial CRTs). The Company also intends to sell nearly all of the remaining CRE business assets that are not included in the transaction with Slate. A real estate property that was held for sale, which is not included in the transaction with Slate, was sold during the quarter ended June 30, 2021 and resulted in the recognition of a gain of $4.8 million in Business divestiture-related gains (losses) in the Consolidated Statements of Comprehensive Income (Loss). As of June 30, 2021, the Company met the conditions for held-for-sale accounting which requires that assets and liabilities be carried at the lower of cost or fair value less costs to sell on the Consolidated Statements of Financial Condition. In connection with the execution of the definitive agreement to sell the CRE business, during the three months ended March 31, 2021 the Company performed an assessment of goodwill, which was related to the Company’s 2013 acquisition of CreXus Investment Corp., and recognized an impairment of $71.8 million. During the three and six months ended June 30, 2021, the Company reported Business divestiture-related gains (losses) of $1.5 million and ($248.0) million, respectively, in its Consolidated Statements of Comprehensive Income (Loss) which includes the aforementioned goodwill impairment as well as valuation adjustments resulting from classifying the assets as held for sale and estimated transaction costs. In addition, as a result of classifying the loans as held for sale, the previously recognized allowance for loan losses of $135.0 million, which includes $5.1 million on unfunded loan commitments, was reversed during the three months ended March 31, 2021. Since assets held for sale are recorded at lower of cost or fair value, any gains on sale will not be recorded until such sale closes. The pretax income (loss) of the CRE business was $42.0 million and ($30.7) million for the three and six months ended June 30, 2021, respectively and ($66.9) million and ($162.3) million for the three and six months ended June 30, 2020, respectively. Certain employees who primarily support the CRE business will join Slate in connection with the sale. Subject to customary closing conditions, including applicable regulatory approvals, the disposition of the CRE business is expected to be completed in the second half of 2021.

The carrying values of the major classes of assets and liabilities of the disposal group held for sale as of June 30, 2021 are presented in the table below:

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

			June 30, 2021
			(dollars in thousands)
Cash and cash equivalents			$	14,175
Securities			55,172
Loans, net			478,274
Assets transferred or pledged to securitization vehicles			2,139,944
Real estate, net			566,477
Intangible assets, net			14,528
Other assets			33,431
Total assets of disposal group held for sale			$	3,302,001
Repurchase agreements			$	270,650
Debt issued by securitization vehicles			1,610,109
Mortgages payable			425,873
Interest payable			1,230
Other liabilities			54,828
Total liabilities of disposal group held for sale			$	2,362,690

Certain assets and liabilities of the disposal group held for sale are in VIEs that are consolidated by the Company because it is the primary beneficiary.

The securities in the disposal group held for sale are carried at fair value and are categorized in Level 2 of the fair value measurement hierarchy as the valuation is based upon quoted prices in active markets for similar assets. The loans and assets pledged to securitization vehicles held for sale are carried at lower of cost or fair value and as such those loans that required a valuation allowance had a nonrecurring fair value measurement at June 30, 2021. These fair value measurements are categorized as Level 2 if they are based upon quoted prices in active markets for similar assets. If quotes were unavailable, a discounted cash flow or market based valuation technique based upon the underlying property to project property cash flows was used. In projecting these cash flows, the Company reviewed the borrower financial statements, rent rolls, economic trends and other factors management deems important. These nonrecurring fair value measurements are categorized as Level 3 of the fair value measurement hierarchy as there are unobservable inputs, which are significant to the overall fair value. The real estate held for sale is carried at lower of cost or fair value and was based upon the sale price and allocated to individual properties to determine if a valuation allowance was necessary. These fair value measurements are considered Level 3 of the fair value measurement hierarchy as there are unobservable inputs, which are significant to the overall fair value. The repurchase agreements and debt issued by securitization vehicles are categorized in Level 2 of the fair value measurement hierarchy as the valuation is based upon quoted market prices for similar liabilities. The mortgage loans payable fair value measurement are valued using Level 3 inputs.

At June 30, 2021, the repurchase agreements included in the liabilities of disposal group held for sale had remaining maturities of over 119 days with commercial loans pledged as collateral.

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

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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 and financial instruments 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 June 30, 2021 and December 31, 2020, $1.1 billion and $1.5 billion, respectively, of variation margin was reported as an adjustment 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. The Company may enter into interest rate swap agreements where the floating leg is linked to the London Interbank Offered Rate (“LIBOR”), the overnight index swap rate or another index. 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.  The Company’s swaptions 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 (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 are estimated using internal pricing models and compared to the counterparty market values.

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.

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 a commercial mortgage-backed securities index, such as the CMBX index, and synthetic total return swaps.

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The table below summarizes fair value information about our derivative assets and liabilities at June 30, 2021 and December 31, 2020:

Derivatives Instruments									June 30, 2021						December 31, 2020
Assets									(dollars in thousands)
Interest rate swaptions									$	134,434					$	74,470
TBA derivatives									31,944						96,109
Futures contracts									8,141						506
Purchase commitments									3,174						49
Credit derivatives (1)									4,196						—
Total derivative assets									$	181,889					$	171,134
Liabilities
Interest rate swaps									$	806,952					$	1,006,492
TBA derivatives									2,837						—
Futures contracts									87,814						19,413
Purchase commitments									2,656						—
Credit derivatives (1)									—						7,440
Total derivative liabilities									$	900,259					$	1,033,345

    

(1) The maximum potential amount of future payments is the notional amount of credit derivatives in which the Company sold protection of $445.0 million and $504.0 million at June 30, 2021 and December 31, 2020, respectively, plus any coupon shortfalls on the underlying tranche. As of June 30, 2021 and December 31, 2020 the credit derivative tranches referencing the basket of bonds had a range of ratings between AAA and A.

The following table summarizes certain characteristics of the Company’s interest rate swaps at June 30, 2021 and December 31, 2020:

June 30, 2021
Maturity			Current Notional (1)(2)						Weighted Average Pay Rate						Weighted Average Receive Rate						Weighted Average Years to Maturity (3)
(dollars in thousands)
0 - 3 years			$	31,164,200					0.24		%				0.09		%				1.55
3 - 6 years			3,100,000						0.13		%				0.08		%				3.88
6 - 10 years			5,730,500						1.25		%				0.61		%				8.18
Greater than 10 years			1,984,000						2.68		%				0.28		%				17.50
Total / Weighted average			$	41,978,700					0.81		%				0.34		%				3.38
December 31, 2020
Maturity			Current Notional (1)(2)						Weighted Average Pay Rate						Weighted Average Receive Rate						Weighted Average Years to Maturity (3)
(dollars in thousands)
0 - 3 years			$	23,680,150					0.27		%				0.11		%				1.96
3 - 6 years			3,600,000						0.18		%				0.09		%				4.21
6 - 10 years			5,565,500						1.40		%				0.62		%				7.76
Greater than 10 years			1,484,000						3.06		%				0.36		%				20.52
Total / Weighted average			$	34,329,650					0.92		%				0.37		%				3.94

(1)     As of June 30, 2021, 13%, 59% and 28% of the Company’s interest rate swaps were linked to LIBOR, the Federal funds rate and the Secured Overnight Financing Rate, respectively. As of December 31, 2020, 17%, 72% and 11% of the Company’s interest rate swaps were linked to LIBOR, the Federal funds rate and the Secured Overnight Financing Rate, respectively.

(2)     There were no forward starting swaps at June 30, 2021 and December 31, 2020.

(3)     At June 30, 2021 and December 31, 2020, the weighted average years to maturity of payer interest rate swaps is offset by the weighted average years to maturity of receiver interest rate swaps. As such, the net weighted average years to maturity for each maturity bucket may fall outside of the range listed.

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Item 1. Financial Statements

The following table presents swaptions outstanding at June 30, 2021 and December 31, 2020.

June 30, 2021
						Current Underlying Notional						Weighted Average Underlying Fixed Rate						Weighted Average Underlying Floating Rate						Weighted Average Underlying Years to Maturity						Weighted Average Months to Expiration
(dollars in thousands)
Long pay						$4,550,000						1.35%						3M LIBOR						10.14						2.80
Long receive						$1,500,000						1.51%						3M LIBOR						11.40						16.93
December 31, 2020
						Current Underlying Notional						Weighted Average Underlying Fixed Rate						Weighted Average Underlying Floating Rate						Weighted Average Underlying Years to Maturity						Weighted Average Months to Expiration
(dollars in thousands)
Long pay						$8,050,000						1.27%						3M LIBOR						10.40						5.42
Long receive						$250,000						1.66%						3M LIBOR						10.02						0.13

The following table summarizes certain characteristics of the Company’s TBA derivatives at June 30, 2021 and December 31, 2020:

June 30, 2021
Purchase and sale contracts for derivative TBAs			Notional						Implied Cost Basis						Implied Market Value						Net Carrying Value
(dollars in thousands)
Purchase contracts			$	17,314,000					$	17,662,043					$	17,691,150					$	29,107
December 31, 2020
Purchase and sale contracts for derivative TBAs			Notional						Implied Cost Basis						Implied Market Value						Net Carrying Value
(dollars in thousands)
Purchase contracts			$	19,635,000					$	20,277,088					$	20,373,197					$	96,109

The following table summarizes certain characteristics of the Company’s futures derivatives at June 30, 2021 and December 31, 2020:

 

June 30, 2021
			Notional - Long Positions						Notional - Short Positions						Weighted Average Years to Maturity
			(dollars in thousands)
U.S. Treasury futures - 5 year			—						(2,884,000)						4.42
U.S. Treasury futures - 10 year and greater			$	—					$	(10,227,500)					7.47
Total			$	—					$	(13,111,500)					6.80
December 31, 2020
			Notional - Long Positions						Notional - Short Positions						Weighted Average Years to Maturity
			(dollars in thousands)
U.S. Treasury futures - 5 year			—						(1,240,000)						4.40
U.S. Treasury futures - 10 year and greater			—						(9,183,800)						6.90
Total			$	—					$	(10,423,800)					6.60

 

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The Company presents derivative contracts on a gross basis on the Consolidated Statements of Financial Condition. Derivative contracts may contain legally enforceable provisions that allow for netting or setting off receivables and payables with each counterparty.

The following tables present information about derivative assets and liabilities that are subject to such provisions and can be offset on our Consolidated Statements of Financial Condition at June 30, 2021 and December 31, 2020, respectively.

June 30, 2021
									Amounts Eligible for Offset
			Gross Amounts						Financial Instruments						Cash Collateral						Net Amounts
Assets			(dollars in thousands)
Interest rate swaptions, at fair value			$	134,434					$	—					$	—					$	134,434
TBA derivatives, at fair value			31,944						(2,596)						—						29,348
Futures contracts, at fair value			8,141						(8,141)						—						—
Purchase commitments			3,174						—						—						3,174
Credit derivatives			4,196						—						—						4,196
Liabilities
Interest rate swaps, at fair value			$	806,952					$	—					$	(83,737)					$	723,215
TBA derivatives, at fair value			2,837						(2,596)						—						241
Futures contracts, at fair value			87,814						(8,141)						(79,673)						—
Purchase commitments			2,656						—						—						2,656
December 31, 2020
									Amounts Eligible for Offset
			Gross Amounts						Financial Instruments						Cash Collateral						Net Amounts
Assets			(dollars in thousands)
Interest rate swaptions, at fair value			$	74,470					$	—					$	—					$	74,470
TBA derivatives, at fair value			96,109						—						—						96,109
Futures contracts, at fair value			506						(506)						—						—
Purchase commitments			49						—						—						49
Liabilities
Interest rate swaps, at fair value			$	1,006,492					$	—					$	(108,757)					$	897,735
Futures contracts, at fair value			19,413						(506)						(18,907)						—
Credit derivatives			7,440						—						(7,440)						—

The effect of interest rate swaps on the Consolidated Statements of Comprehensive Income (Loss) is as follows:

Location on Consolidated Statements of Comprehensive Income (Loss)
			Net Interest Component of Interest Rate Swaps						Realized Gains (Losses) on Termination of Interest Rate Swaps						Unrealized Gains (Losses) on Interest Rate Swaps
For the three months ended			(dollars in thousands)
June 30, 2021			$	(83,087)					$	—					$	(141,067)
June 30, 2020			$	(64,561)					$	(1,521,732)					$	1,494,628
For the six months ended
June 30, 2021			$	(162,834)					$	—					$	631,195
June 30, 2020			$	(78,541)					$	(1,919,293)					$	(1,333,095)

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Item 1. Financial Statements

The effect of other derivative contracts on the Company’s Consolidated Statements of Comprehensive Income (Loss) is as follows:

Three Months Ended June 30, 2021
Derivative Instruments			Realized Gain (Loss)						Unrealized Gain (Loss)						Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives and Financial Instruments
(dollars in thousands)
Net TBA derivatives			$	10,045					$	275,226					$	285,271
Net interest rate swaptions			(22,787)						(232,860)						(255,647)
Futures			183,383						(577,899)						(394,516)
Purchase commitments			—						2,376						2,376
Credit derivatives			2,777						1,931						4,708
Total															$	(357,808)

 

Three Months Ended June 30, 2020
Derivative Instruments			Realized Gain (Loss)						Unrealized Gain (Loss)						Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives and Financial Instruments
(dollars in thousands)
Net TBA derivatives			$	250,525					$	(46,363)					$	204,162
Net interest rate swaptions			(29,880)						(22,634)						(52,514)
Futures			246						(17,579)						(17,333)
Purchase commitments			—						9,666						9,666
Credit derivatives			1,203						25,732						26,935
Total															$	170,916

Six Months Ended June 30, 2021
Derivative Instruments			Realized Gain (Loss)						Unrealized Gain (Loss)						Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives
(dollars in thousands)
Net TBA derivatives			$	(277,844)					$	(67,002)					$	(344,846)
Net interest rate swaptions			(44,997)						73,130						28,133
Futures			479,547						(60,766)						418,781
Purchase commitments			—						469						469
Credit derivatives			4,408						10,954						15,362
Total															$	117,899

Six Months Ended June 30, 2020
Derivative Instruments			Realized Gain (Loss)						Unrealized Gain (Loss)						Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives
(dollars in thousands)
Net TBA derivatives			$	521,610					$	114,331					$	635,941
Net interest rate swaptions			21,566						47,499						69,065
Futures			(279,230)						(10,687)						(289,917)
Purchase commitments			—						(1,143)						(1,143)
Credit derivatives			3,128						(39,732)						(36,604)
Total															$	377,342

Certain of the Company’s derivative contracts are subject to International Swaps and Derivatives Association Master Agreements or other similar agreements which may contain provisions that grant counterparties certain rights with respect to the applicable agreement upon the occurrence of certain events such as (i) a decline in stockholders’ equity in excess of specified thresholds or dollar amounts over set periods of time, (ii) the Company’s failure to maintain its REIT status, (iii) the

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Company’s failure to comply with limits on the amount of leverage, and (iv) the Company’s stock being delisted from the New York Stock Exchange.

Upon the occurrence of any one of items (i) through (iv), or another default under the agreement, the counterparty to the applicable agreement has a right to terminate the agreement in accordance with its provisions. The aggregate fair value of all derivative instruments with the aforementioned features that are in a net liability position at June 30, 2021 was approximately $725.2 million, which represents the maximum amount the Company would be required to pay upon termination. This amount is fully collateralized.

11. FAIR VALUE MEASUREMENTS

The Company follows fair value guidance in accordance with GAAP to account for its financial instruments and MSR that are accounted for at fair value. The fair value of a financial instrument and MSR is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Refer to the “Sale of Commercial Real Estate Business” Note for fair value measurements related to the assets and liabilities of the disposal group held for sale as of June 30, 2021.

GAAP requires classification of financial instruments and MSR into a three-level hierarchy based on the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).

If the inputs used to measure the financial instruments and MSR fall within different levels of the hierarchy, the categorization is based on the lowest priority input that is significant to the fair value measurement of the instrument. Financial assets and liabilities recorded at fair value on the Consolidated Statements of Financial Condition or disclosed in the related notes are categorized based on the inputs to the valuation techniques as follows:

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets and liabilities in active markets.

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 – inputs to the valuation methodology are unobservable and significant to overall fair value.

The Company designates its securities as trading, available-for-sale or held-to-maturity depending upon the type of security and the Company’s intent and ability to hold such security to maturity. Securities classified as available-for-sale and trading are reported at fair value on a recurring basis.

The following is a description of the valuation methodologies used for instruments carried at fair value. These methodologies are applied to assets and liabilities across the three-level fair value hierarchy, with the observability of inputs determining the appropriate level.

Futures contracts are valued using quoted prices for identical instruments in active markets and are classified as Level 1.

Residential Securities, interest rate swaps, swaptions and other derivatives are valued using quoted prices or internally estimated prices for similar assets using internal models. The Company incorporates common market pricing methods, including a spread measurement to the Treasury curve as well as underlying characteristics of the particular security including coupon, prepayment speeds, periodic and life caps, rate reset period and expected life of the security in its estimates of fair value. Fair value estimates for residential mortgage loans are generated by a discounted cash flow model and are primarily based on observable market-based inputs including discount rates, prepayment speeds, delinquency levels, and credit losses. Management reviews and indirectly corroborates its estimates of the fair value derived using internal models by comparing its results to independent prices provided by dealers in the securities and/or third party pricing services. Certain liquid asset classes, such as Agency fixed-rate pass-throughs, may be priced using independent sources such as quoted prices for TBA securities.

Residential Securities, residential mortgage loans, interest rate swap and swaption markets, TBA derivatives and MBS options are considered to be active markets such that participants transact with sufficient frequency and volume to provide transparent pricing information on an ongoing basis. The liquidity of the Residential Securities, residential mortgage loans, interest rate swaps, swaptions, TBA derivatives and MBS options markets and the similarity of the Company’s securities to those actively traded enable the Company to observe quoted prices in the market and utilize those prices as a basis for formulating fair value measurements. Consequently, the Company has classified Residential Securities, residential mortgage loans, interest rate swaps, swaptions, TBA derivatives and MBS options as Level 2 inputs in the fair value hierarchy.

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The fair value of commercial mortgage-backed securities classified as available-for-sale is determined based upon quoted prices of similar assets in recent market transactions and requires the application of judgment due to differences in the underlying collateral. Consequently, commercial real estate debt investments carried at fair value are classified as Level 2.

For the fair value of debt issued by securitization vehicles, refer to the “Variable Interest Entities” Note for additional information.

The Company classifies its investments in MSR and Interests in MSR as Level 3 in the fair value measurements hierarchy. Fair value estimates for these investments are obtained from models, which use significant unobservable inputs in their valuations. These valuations primarily utilize discounted cash flow models that incorporate unobservable market data inputs including prepayment rates, delinquency levels, costs to service and discount rates. Model valuations are then compared to valuations obtained from third party pricing providers. Management reviews the valuations received from third party pricing providers and uses them as a point of comparison to modeled values. The valuation of MSR and Interests in MSR require significant judgment by management and the third party pricing providers. Assumptions used for which there is a lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s financial statements. 

The following tables present the estimated fair values of financial instruments and MSR measured at fair value on a recurring basis. There were no transfers between levels of the fair value hierarchy during the periods presented.

June 30, 2021
			Level 1						Level 2						Level 3						Total
Assets			(dollars in thousands)
Securities
Agency mortgage-backed securities			$	—					$	66,468,519					$	—					$	66,468,519
Credit risk transfer securities			—						827,328						—						827,328
Non-Agency mortgage-backed securities			—						1,582,323						—						1,582,323
Commercial mortgage-backed securities			—						154,165						—						154,165
Loans
Residential mortgage loans			—						1,029,928						—						1,029,928
Mortgage servicing rights			—						—						202,616						202,616
Interests in MSR			—						—						49,035						49,035
Assets transferred or pledged to securitization vehicles			—						4,073,156						—						4,073,156
Derivative assets
Other derivatives			8,141						173,748						—						181,889
Total assets			$	8,141					$	74,309,167					$	251,651					$	74,568,959
Liabilities
Debt issued by securitization vehicles			—						3,315,087						—						3,315,087
Participations issued			—						315,810						—						315,810
Derivative liabilities
Interest rate swaps			—						806,952						—						806,952
Other derivatives			87,814						5,493						—						93,307
Total liabilities			$	87,814					$	4,443,342					$	—					$	4,531,156

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December 31, 2020
			Level 1						Level 2						Level 3						Total
Assets			(dollars in thousands)
Securities
Agency mortgage-backed securities			$	—					$	74,067,059					$	—					$	74,067,059
Credit risk transfer securities			—						532,403						—						532,403
Non-Agency mortgage-backed securities			—						972,192						—						972,192
Commercial mortgage-backed securities			—						80,742						—						80,742
Loans
Residential mortgage loans			—						345,810						—						345,810
Mortgage servicing rights			—						—						100,895						100,895
Assets transferred or pledged to securitization vehicles			—						6,035,671						—						6,035,671
Derivative assets
Other derivatives			506						170,628						—						171,134
Total assets			$	506					$	82,204,505					$	100,895					$	82,305,906
Liabilities
Debt issued by securitization vehicles			$	—					$	5,652,982					$	—					$	5,652,982
Participations issued			—						39,198						—						39,198
Derivative liabilities
Interest rate swaps			—						1,006,492						—						1,006,492
Other derivatives			19,413						7,440						—						26,853
Total liabilities			$	19,413					$	6,706,112					$	—					$	6,725,525

Qualitative and Quantitative Information about Level 3 Fair Value Measurements

The Company considers unobservable inputs to be those for which market data is not available and that are developed using the best information available to us about the assumptions that market participants would use when pricing the asset. Relevant inputs vary depending on the nature of the instrument being measured at fair value. The sensitivities of significant unobservable inputs along with interrelationships between and among the significant unobservable inputs and their impact on the fair value measurements are described below. The effect of a change in a particular assumption in the sensitivity analysis below is considered independently from changes in any other assumptions. In practice, simultaneous changes in assumptions may not always have a linear effect on the inputs discussed below. Interrelationships may also exist between observable and unobservable inputs. Such relationships have not been included in the discussion below. For each of the individual relationships described below, the inverse relationship would also generally apply. For MSR and Interests in MSR, in general, increases in the discount, prepayment or delinquency rates or in annual servicing costs in isolation would result in a lower fair value measurement. A decline in interest rates could lead to higher-than-expected prepayments of mortgages underlying the Company’s investments in MSR and Interests in MSR, which in turn could result in a decline in the estimated fair value of MSR and Interests in MSR. Refer to the “Mortgage Servicing Rights” Note for additional information, including rollforwards.

The table below presents information about the significant unobservable inputs used for recurring fair value measurements for Level 3 MSR and Interests in MSR. The table does not give effect to the Company’s risk management practices that might offset risks inherent in these Level 3 investments.

			June 30, 2021
			Unobservable Input (1) / Range (Weighted Average) (2)
			Discount rate						Prepayment rate						Delinquency rate						Cost to service
MSR consolidated with VIE			9.0% - 12.0% (9.0%)						9.4% - 30.7% (20.2%)						0.0% - 6.0% (2.4%)						$84 - $114 ($99)
MSR held directly			1.8% - 21.7% (9.0%)						6.7% - 14.4% (7.5%)						0.9% - 1.8% (1.1%)						$99 - $106 ($101)
Interests in MSR			9.5% - 11.4% (10.0%)						4.8% - 14.6% (9.0%)						0.6% - 5.0% (1.8%)						$78 - $86 ($85)

December 31, 2020

Unobservable Input (1) / Range (Weighted Average) (2)

Discount rate

Prepayment rate

Delinquency rate

Cost to service

MSR consolidated with VIE

9.0% - 12.0% (9.4%)

19.3% - 55.5% (42.0%)

0.0% - 6.0% (2.5%)

$83 - $108 ($98)

(1) Represents rates, estimates and assumptions that the Company believes would be used by market participants when valuing these assets.

(2) Weighted average discount rate computed based on the fair value of MSR, weighted average prepayment rate, delinquency rate and cost to service based on unpaid principal balances of loans underlying the MSR.

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Item 1. Financial Statements

The following table summarizes the estimated fair values for financial assets and liabilities that are not carried at fair value at June 30, 2021 and December 31, 2020.

									June 30, 2021												December 31, 2020
									Carrying Value						Fair Value						Carrying Value						Fair Value
Financial assets									(dollars in thousands)
Loans
Commercial real estate debt and preferred equity, held for investment (1)									$—						$—						$1,372,430						$1,442,071
Corporate debt, held for investment									2,066,709						2,080,002						2,239,930						2,226,045
Assets transferred or pledged to securitization vehicles									—						—						874,349						928,732
Corporate debt, held for sale									466,370						466,370						—						—
Financial liabilities
Repurchase agreements									$60,221,067						$60,221,067						$64,825,239						$64,825,239
Other secured financing									909,655						909,655						917,876						917,876
Mortgages payable									—						—						426,256						474,779
(1)    Includes assets of consolidated VIEs.

 

Commercial real estate debt and preferred equity, held for investment, corporate debt, held for investment, corporate debt, held for sale and mortgages payable are valued using Level 3 inputs. The carrying values of repurchase agreements and short term other secured financing approximates fair value and are considered Level 2 fair value measurements. Long term other secured financing are valued using Level 2 inputs.

12.  GOODWILL AND INTANGIBLE ASSETS

Goodwill

The Company’s acquisitions are accounted for using the acquisition method if the acquisition is deemed to be a business. Under the acquisition method, net assets and results of operations of acquired companies are included in the consolidated financial statements from the date of acquisition. The purchase prices are allocated to the assets acquired, including identifiable intangible assets, and the liabilities assumed based on their estimated fair values at the date of acquisition. The excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill. Conversely, any excess of the fair value of the net assets acquired over the purchase price is recognized as a bargain purchase gain.

The Company tests goodwill for impairment on an annual basis or more frequently when events or circumstances may make it more likely than not that an impairment has occurred. If a qualitative analysis indicates that there may be an impairment, a quantitative analysis is performed. The quantitative impairment test for goodwill compares the fair value of a reporting unit with its carrying value, including goodwill. If the carrying value of a reporting unit exceeds its fair value, an impairment loss is recognized in amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. At June 30, 2021 and December 31, 2020, goodwill totaled $0 and $71.8 million, respectively. The change reflects the goodwill impairment in connection with the sale of the CRE business. Refer to the “Sale of Commercial Real Estate Business” Note for additional information.

Intangible assets, net

Finite life intangible assets are amortized over their expected useful lives. As part of the Internalization, which closed on June 30, 2020, the Company recognized an intangible asset for the acquired assembled workforce of approximately $41.2 million based on the replacement cost of the employee base acquired by the Company. During the three months ended June 30, 2021, the Company recognized an impairment of $4.3 million in Other income (loss) and $5.2 million in Business divestiture-related gains (losses) in the Consolidated Statements of Comprehensive Income (Loss) for changes to the assembled workforce.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following table presents the activity of finite lived intangible assets for the six months ended June 30, 2021.

Intangible Assets, net
(dollars in thousands)
Balance at December 31, 2020			$	55,526
Impairment			(9,549)
Intangible assets included in disposal group held for sale			(14,528)
Less: amortization expense			(4,947)
Balance at June 30, 2021			$	26,502

13. SECURED FINANCING

Reverse Repurchase and Repurchase Agreements – The Company finances a significant portion of its assets with repurchase agreements. At the inception of each transaction, the Company assessed each of the specified criteria in ASC 860, Transfers and Servicing, and has determined that each of the financing agreements should be treated as a securing financing.

The Company enters into reverse repurchase agreements to earn a yield on excess cash balances. The Company receives collateral for reverse repurchase agreements and is required to post collateral for repurchase agreements. To mitigate credit exposure, the Company monitors the market value of these securities and delivers or obtains additional collateral based on changes in market value of these securities. Generally, the Company receives or posts collateral with a fair value approximately equal to or greater than the value of the secured financing.

Reverse repurchase agreements and repurchase agreements with the same counterparty and the same maturity are presented net in the Consolidated Statements of Financial Condition when the terms of the agreements meet the criteria to permit netting. The Company reports cash flows on repurchase agreements as financing activities and cash flows on reverse repurchase agreements as investing activities in the Consolidated Statements of Cash Flows.

The Company had outstanding $60.2 billion and $64.8 billion of repurchase agreements with weighted average remaining maturities of 88 days and 64 days at June 30, 2021 and December 31, 2020, respectively. The Company has select arrangements with counterparties to enter into repurchase agreements for select credit assets for $1.6 billion with remaining capacity of $1.4 billion at June 30, 2021.

At June 30, 2021 and December 31, 2020, the repurchase agreements had the following remaining maturities, collateral types and weighted average rates: 

June 30, 2021
			Agency Mortgage-Backed Securities						CRTs						Non-Agency Mortgage-Backed Securities						Residential Mortgage Loans												Commercial Mortgage-Backed Securities (1)												Total Repurchase Agreements						Weighted Average Rate
			(dollars in thousands)
1 day			$	10,052,550					$	—					$	—					$	—											$	142,617											$	10,195,167					0.09		%
2 to 29 days			15,688,201						178,719						290,174						—												64,188												16,221,282						0.14		%
30 to 59 days			5,981,872						66,309						212,087						177,401												—												6,437,669						0.27		%
60 to 89 days			4,495,510						3,147						126,747						—												14,549												4,639,953						0.16		%
90 to 119 days			5,873,992						—						—						—												—												5,873,992						0.16		%
Over 119 days (2)			16,713,446						—						98,417						41,141												—												16,853,004						0.18		%
Total			$	58,805,571					$	248,175					$	727,425					$	218,542											$	221,354											$	60,221,067					0.16		%

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

December 31, 2020
			Agency Mortgage-Backed Securities						CRTs						Non-Agency Mortgage-Backed Securities						Residential Mortgage Loans						Commercial Loans						Commercial Mortgage-Backed Securities												Total Repurchase Agreements						Weighted Average Rate
			(dollars in thousands)
1 day			$	—					$	—					$	—					$	—					$	—					$	—											$	—					—		%
2 to 29 days			30,151,875						129,993						354,904						$	76,799					—						128,267												30,841,838						0.29		%
30 to 59 days			10,247,972						16,073						161,274						$	—					—						142,336												10,567,655						0.42		%
60 to 89 days			8,181,410						99,620						259,401						$	—					—						28,406												8,568,837						0.30		%
90 to 119 days			2,154,733						—						—						$	—					—						—												2,154,733						0.23		%
Over 119 days (2)			12,008,920						—						274,860						$	107,924					271,801						28,671												12,692,176						0.36		%
Total			$	62,744,910					$	245,686					$	1,050,439					$	184,723					$	271,801					$	327,680											$	64,825,239					0.32		%

 (1)    Includes commercial mortgage-backed securities held for sale.

 (2)    No repurchase agreements had a remaining maturity over 1 year at June 30, 2021. Less than 1% of the total repurchase agreements had a remaining maturity over 1 year at December 31, 2020.

 

The following table summarizes the gross amounts of reverse repurchase agreements and repurchase agreements, amounts offset in accordance with netting arrangements and net amounts of repurchase agreements and reverse repurchase agreements as presented in the Consolidated Statements of Financial Condition at June 30, 2021 and December 31, 2020. Refer to the “Derivative Instruments” Note for information related to the effect of netting arrangements on the Company’s derivative instruments.

			June 30, 2021												December 31, 2020
			Reverse Repurchase Agreements						Repurchase Agreements						Reverse Repurchase Agreements						Repurchase Agreements
			(dollars in thousands)
Gross amounts			$	—					$	60,221,067					$	250,000					$	65,075,239
Amounts offset			—						—						(250,000)						(250,000)
Netted amounts			$	—					$	60,221,067					$	—					$	64,825,239

The fair value of mortgage-backed securities received as collateral in connection with reverse repurchase agreements was approximately $0 and $250.0 million, which the Company fully repledged, at June 30, 2021 and December 31, 2020, respectively.

Other Secured Financing - Refer to the “Variable Interest Entities” Note for additional information on the Company’s other secured financing arrangements.

Investments pledged as collateral under secured financing arrangements and interest rate swaps, excluding residential and senior securitized commercial mortgage loans of consolidated VIEs, had an estimated fair value and accrued interest of $65.2 billion and $176.8 million, respectively, at June 30, 2021 and $70.6 billion and $196.9 million, respectively, at December 31, 2020.

14. CAPITAL STOCK

(A)    Common Stock

The following table provides a summary of the Company’s common shares authorized, and issued and outstanding at June 30, 2021 and December 31, 2020.

Shares authorized

Shares issued and outstanding

June 30, 2021

December 31, 2020

June 30, 2021

December 31, 2020

Par Value

Common stock

2,936,500,000

2,914,850,000

1,444,156,029

1,398,240,618

$0.01

In June 2019, the Company announced that its board of directors (“Board”) had authorized the repurchase of up to $1.5 billion of its outstanding shares of common stock, which expired on December 31, 2020 (the “Prior Share Repurchase Program”). In

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

December 2020, the Company announced that its Board authorized the repurchase of up to $1.5 billion of its outstanding common shares through December 31, 2021 (the “Current Share Repurchase Program”). The Current Share Repurchase Program replaced the Prior Share Repurchase Program. During the three and six months ended June 30, 2021, no shares were purchased under the Current Share Repurchase Program. During the three and six months ended June 30, 2020, the Company repurchased 22.9 million shares of its common stock for an aggregate amount of $143.3 million, excluding commission costs, under the Prior Share Repurchase Program. All common shares were purchased in open-market transactions.

In January 2018, the Company entered into separate Distribution Agency Agreements (as amended and restated on August 6, 2020, collectively, the “Sales Agreements”) with each of Wells Fargo Securities, LLC, BofA Securities, Inc. (formerly known as Merrill Lynch, Pierce, Fenner & Smith, Incorporated), Barclays Capital Inc., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Goldman Sachs & Co. LLC, J.P. Morgan Securities LLC, Keefe, Bruyette & Woods, Inc., RBC Capital Markets, LLC and UBS Securities LLC (the “Sales Agents”). The Company may offer and sell shares of its common stock, having an aggregate offering price of up to $1.5 billion from time to time through any of the Sales Agents. During the three and six months ended June 30, 2021, the Company issued 45.5 million shares, for proceeds of $420.4 million, net of commissions and fees under the at-the-market sales program. No shares were issued under the at-the-market sales program during the three and six months ended June 30, 2020.

(B)    Preferred Stock

The following is a summary of the Company’s cumulative redeemable preferred stock outstanding at June 30, 2021 and December 31, 2020. In the event of a liquidation or dissolution of the Company, the Company’s then outstanding preferred stock takes precedence over the Company’s common stock with respect to payment of dividends and the distribution of assets.

			Shares Authorized												Shares Issued And Outstanding												Carrying Value									Contractual Rate			Earliest Redemption Date (1)			Date At Which Dividend Rate Becomes Floating			Floating Annual Rate
			June 30, 2021						December 31, 2020						June 30, 2021						December 31, 2020						June 30, 2021						December 31, 2020
Fixed-rate									(dollars in thousands)
Series D			—						18,400,000						—						—						—						—			7.50%			9/13/2017			NA			NA
Fixed-to-floating rate
Series F			28,800,000						28,800,000						28,800,000						28,800,000						696,910						696,910			6.95%			9/30/2022			9/30/2022			3M LIBOR + 4.993%
Series G			17,000,000						19,550,000						17,000,000						17,000,000						411,335						411,335			6.50%			3/31/2023			3/31/2023			3M LIBOR + 4.172%
Series I			17,700,000						18,400,000						17,700,000						17,700,000						428,324						428,324			6.75%			6/30/2024			6/30/2024			3M LIBOR + 4.989%
Total			63,500,000						85,150,000						63,500,000						63,500,000						$	1,536,569					$	1,536,569
(1) Subject to the Company’s right under limited circumstances to redeem preferred stock earlier in order to preserve its qualification as a REIT or under limited circumstances related to a change in control of the Company.

Each series of preferred stock has a par value of $0.01 per share and a liquidation and redemption price of $25.00, plus accrued and unpaid dividends through their redemption date. Through June 30, 2021, the Company had declared and paid all required quarterly dividends on the Company’s preferred stock.

The Series F Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, Series G Preferred Stock and Series I Preferred Stock rank senior to the common stock of the Company.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

(C)    Distributions to Stockholders

The following table provides a summary of the Company’s dividend distribution activity for the periods presented:

			For the Three Months Ended												For the Six Months Ended
			June 30, 2021						June 30, 2020						June 30, 2021						June 30, 2020
			(dollars in thousands, except per share data)
Dividends and dividend equivalents declared on common stock and share-based awards			$	318,534					$	309,972					$	626,880					$	667,791
Distributions declared per common share			$	0.22					$	0.22					$	0.44					$	0.47
Distributions paid to common stockholders after period end			$	317,714					$	309,686					$	317,714					$	309,686
Distributions paid per common share after period end			$	0.22					$	0.22					$	0.22					$	0.22
Date of distributions paid to common stockholders after period end			July 30, 2021						July 31, 2020						July 30, 2021						July 31, 2020
Dividends declared to series D preferred stockholders			$	—					$	8,625					$	—					$	17,250
Dividends declared per share of series D preferred stock			$	—					$	0.469					$	—					$	0.938
Dividends declared to series F preferred stockholders			$	12,510					$	12,510					$	25,020					$	25,020
Dividends declared per share of series F preferred stock			$	0.434					$	0.434					$	0.869					$	0.869
Dividends declared to series G preferred stockholders			$	6,906					$	6,906					$	13,812					$	13,812
Dividends declared per share of series G preferred stock			$	0.406					$	0.406					$	0.813					$	0.813
Dividends declared to series I preferred stockholders			$	7,467					$	7,468					$	14,934					$	14,936
Dividends declared per share of series I preferred stock			$	0.422					$	0.422					$	0.844					$	0.844

15.  INTEREST INCOME AND INTEREST EXPENSE

Refer to the “Significant Accounting Policies” Note for details surrounding the Company’s accounting policy related to net interest income on securities and loans.

The following table summarizes the interest income recognition methodology for Residential Securities:

			Interest Income Methodology
Agency
Fixed-rate pass-through (1)			Effective yield (3)
Adjustable-rate pass-through (1)			Effective yield (3)
Multifamily (1)			Contractual Cash Flows
CMO (1)			Effective yield (3)
Reverse mortgages (2)			Prospective
Interest-only (2)			Prospective
Residential credit
CRT (2)			Prospective
Alt-A (2)			Prospective
Prime (2)			Prospective
Subprime (2)			Prospective
NPL/RPL (2)			Prospective
Prime jumbo (2)			Prospective
Prime jumbo interest-only (2)			Prospective
(1) Changes in fair value are recognized in Other comprehensive income (loss) on the accompanying Consolidated Statements of Comprehensive Income (Loss). (2) Changes in fair value are recognized in Net unrealized gains (losses) on instruments measured at fair value through earnings on the accompanying Consolidated Statements of Comprehensive Income (Loss). (3) Effective yield is recalculated for differences between estimated and actual prepayments and the amortized cost is adjusted as if the new effective yield had been applied since inception.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following presents the components of the Company’s interest income and interest expense for the three and six months ended June 30, 2021 and June 30, 2020.

			For the Three Months Ended June 30,												For the Six Months Ended June 30,
			2021						2020						2021						2020
Interest income			(dollars in thousands)
Residential Securities (1)			$	275,278					$	457,684					$	919,912					$	868,064
Residential mortgage loans (1)			38,963						42,871						76,072						90,428
Commercial investment portfolio (1) (2)			69,663						84,208						151,264						179,884
Reverse repurchase agreements			2						49						36						1,462
Total interest income			$	383,906					$	584,812					$	1,147,284					$	1,139,838
Interest expense
Repurchase agreements			29,140						136,962						71,725						570,983
Debt issued by securitization vehicles			23,216						38,757						49,492						80,876
Participations issued			1,739						—						2,336						—
Other			6,952						10,313						13,467						37,646
Total interest expense			61,047						186,032						137,020						689,505
Net interest income			$	322,859					$	398,780					$	1,010,264					$	450,333
(1) Includes assets transferred or pledged to securitization vehicles. (2 ) Includes commercial real estate debt and preferred equity and corporate debt.

16.  NET INCOME (LOSS) PER COMMON SHARE

The following table presents a reconciliation of net income (loss) and shares used in calculating basic and diluted net income (loss) per share for the three and six months ended June 30, 2021 and June 30, 2020.

			For the Three Months Ended												For the Six Months Ended
			June 30, 2021						June 30, 2020						June 30, 2021						June 30, 2020
			(dollars in thousands, except per share data)
Net income (loss)			$	(294,848)					$	856,234					$	1,456,286					$	(2,783,955)
Net income (loss) attributable to noncontrolling interests			794						32						1,115						98
Net income (loss) attributable to Annaly			(295,642)						856,202						1,455,171						(2,784,053)
Dividends on preferred stock			26,883						35,509						53,766						71,018
Net income (loss) available (related) to common stockholders			$	(322,525)					$	820,693					$	1,401,405					$	(2,855,071)
Weighted average shares of common stock outstanding-basic			1,410,239,138						1,423,909,112						1,404,755,496						1,427,451,716
Add: Effect of stock awards, if dilutive			—						—						1,008,776						—
Weighted average shares of common  stock outstanding-diluted			1,410,239,138						1,423,909,112						1,405,764,272						1,427,451,716
Net income (loss) per share available (related) to common share
Basic			$	(0.23)					$	0.58					$	1.00					$	(2.00)
Diluted			$	(0.23)					$	0.58					$	1.00					$	(2.00)

The computations of diluted net income (loss) per share available (related) to common share for the three months ended June 30, 2021 excludes 3.2 million and the three and six months ended June 30, 2020 excludes 0.5 million and 0.4 million, respectively, of potentially dilutive restricted stock units because their effect would have been anti-dilutive.

17.  INCOME TAXES

For the three months ended June 30, 2021 the Company was qualified to be taxed as a REIT under Code Sections 856 through 860. As a REIT, the Company will not incur federal income tax to the extent that it distributes its taxable income to its stockholders. To maintain qualification as a REIT, the Company must distribute at least 90% of its annual REIT taxable income to its stockholders and meet certain other requirements that relate to, among other things, assets it may hold, income it may generate and its stockholder composition. It is generally the Company’s policy to distribute 100% of its REIT taxable income.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

To the extent there is any undistributed REIT taxable income at the end of a year, the Company distributes such shortfall within the next year as permitted by the Code.

The Company and certain of its direct and indirect subsidiaries, including Annaly TRS, Inc. and certain subsidiaries of Mountain Merger Sub Corp., have made separate joint elections to treat these subsidiaries as TRSs.  As such, each of these TRSs is taxable as a domestic C corporation and subject to federal, state and local income taxes based upon their taxable income.

The provisions of ASC 740, Income Taxes (“ASC 740”), clarify the accounting for uncertainty in income taxes recognized in financial statements and prescribe a recognition threshold and measurement attribute for uncertain tax positions taken or expected to be taken on a tax return. ASC 740 also requires that interest and penalties related to unrecognized tax benefits be recognized in the financial statements. The Company does not have any unrecognized tax benefits that would affect its financial position. Thus, no accruals for penalties and interest were deemed necessary at June 30, 2021 and December 31, 2020.

The state and local tax jurisdictions for which the Company is subject to tax-filing obligations recognize the Company’s status as a REIT, and therefore, the Company generally does not pay income tax in such jurisdictions. The Company may, however, be subject to certain minimum state and local tax filing fees as well as certain excise, franchise or business taxes. The Company’s TRSs are subject to federal, state and local taxes.

During the three and six months ended June 30, 2021, the Company recorded $5.1 million and $4.8 million, respectively, of income tax expense attributable to its TRSs. During the three and six months ended June 30, 2020, the Company recorded $2.1 million and ($24.6) million, respectively, of income tax expense (benefit) attributable to its TRSs. The Company’s federal, state and local tax returns from 2017 and forward remain open for examination.

18.  RISK MANAGEMENT

The primary risks to the Company are capital, liquidity and funding risk, investment/market risk, credit risk and operational risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the Company’s control. Changes in the general level of interest rates can affect net interest income, which is the difference between the interest income earned on interest earning assets and the interest expense incurred in connection with the interest bearing liabilities, by affecting the spread between the interest earning assets and interest bearing liabilities. Changes in the level of interest rates can also affect the value of the interest earning assets and the Company’s ability to realize gains from the sale of these assets. A decline in the value of the interest earning assets pledged as collateral for borrowings under repurchase agreements and derivative contracts could result in the counterparties demanding additional collateral or liquidating some of the existing collateral to reduce borrowing levels.

The Company may seek to mitigate the potential financial impact by entering into interest rate agreements such as interest rate swaps, interest rate swaptions and other hedges.

Weakness in the mortgage market, the shape of the yield curve, changes in the expectations for the volatility of future interest rates and deterioration of financial conditions in general may adversely affect the performance and market value of the Company’s investments. This could negatively impact the Company’s book value. Furthermore, if many of the Company’s lenders are unwilling or unable to provide additional financing, the Company could be forced to sell its investments at an inopportune time when prices are depressed. The Company has established policies and procedures for mitigating risks, including conducting scenario and sensitivity analyses and utilizing a range of hedging strategies.

The payment of principal and interest on the Freddie Mac and Fannie Mae Agency mortgage-backed securities, which exclude CRT securities issued by Freddie Mac and Fannie Mae, is guaranteed by those respective agencies and the payment of principal and interest on Ginnie Mae Agency mortgage-backed securities is backed by the full faith and credit of the U.S. government. Substantially all of the Company’s Agency mortgage-backed securities have an actual or implied “AAA” rating.

The Company faces credit risk on the portions of its portfolio which are not guaranteed by the respective Agency or by the full faith and credit of the U.S. government. The Company is exposed to credit risk on CRE Debt and Preferred Equity Investments, real estate investments, commercial mortgage-backed securities, residential mortgage loans, CRT securities, other non-Agency mortgage-backed securities and corporate debt. MSR values may also be adversely impacted by rising borrower delinquencies which would reduce servicing income and increase the overall costs to service the underlying mortgage loans. The Company is exposed to risk of loss if an issuer, borrower, tenant or counterparty fails to perform its obligations under contractual terms. The Company has established policies and procedures for mitigating credit risk, including reviewing and establishing limits for credit exposure, limiting transactions with specific counterparties, pre-purchase due diligence, maintaining qualifying collateral and continually assessing the creditworthiness of issuers, borrowers, tenants and counterparties, credit rating monitoring and active servicer oversight.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The Company depends on third-party service providers to perform various business processes related to its operations, including mortgage loan servicers and sub-servicers. The Company’s vendor management policy establishes procedures for engaging, onboarding and monitoring the performance of third-party vendors. These procedures include assessing a vendor’s financial health as well as oversight of its compliance with applicable laws and regulations, cybersecurity and business continuity programs and security of personally identifiable information.

19.  RELATED PARTY TRANSACTIONS

Closing of the Internalization and Termination of Management Agreement

On February 12, 2020, the Company entered into an internalization agreement (the “Internalization Agreement”) with the Former Manager and certain affiliates of the Former Manager. Pursuant to the Internalization Agreement, the Company agreed to acquire all of the outstanding equity interests of the Former Manager and the Former Manager’s direct and indirect parent companies from their respective owners (the “Internalization”) for nominal cash consideration ($1.00). In connection with the closing of the Internalization, on June 30, 2020, the Company acquired all of the assets and liabilities of the Former Manager (the net effect of which was immaterial in amount), and the Company transitioned from an externally-managed REIT to an internally-managed REIT. At the closing, all employees of the Former Manager became employees of the Company. The parties also terminated the Amended and Restated Management Agreement by and between the Company and the Former Manager (the “Management Agreement”) and therefore the Company no longer pays a management fee to, or reimburses expenses of, the Former Manager. Pursuant to the Internalization Agreement, the Former Manager waived any Acceleration Fee (as defined in the Management Agreement).

Prior to the closing of the Internalization, the Former Manager, under the Management Agreement and subject to the supervision and direction of the Board, was responsible for (i) the selection, purchase and sale of assets for the Company’s investment portfolio; (ii) recommending alternative forms of capital raising; (iii) supervising the Company’s financing and hedging activities; and (iv) day to day management functions. The Former Manager also performed such other supervisory and management services and activities relating to the Company’s assets and operations as appropriate. In exchange for the management services, the Company paid the Former Manager a monthly management fee, and the Former Manager was responsible for providing personnel to manage the Company. Prior to the closing of the Internalization, the Company had paid the Former Manager a monthly management fee for its management services in an amount equal to 1/12th of the sum of (i) 1.05% of Stockholders' Equity (as defined in the Management Agreement) up to $17.28 billion, and (ii) 0.75% of Stockholders' Equity (as defined in the Management Agreement) in excess of $17.28 billion. The Company did not pay the Former Manager any incentive fees.

For the three and six months ended June 30, 2020, the compensation and management fee computed in accordance with the Management Agreement was $37.0 million and $77.9 million, respectively, and reimbursement payments to the Former Manager were $7.1 million and $14.2 million, respectively.

20.  LEASE COMMITMENTS AND CONTINGENCIES

The Company’s operating leases are primarily comprised of a corporate office lease with a remaining lease term of approximately four years. The corporate office lease includes an option to extend for up to five years, however the extension term was not included in the operating lease liability calculation. Leases with an initial term of 12 months or less are not recorded on the balance sheet. The Company recognizes lease expense for these leases on a straight-line basis over the lease term. The lease cost for the three and six months ended June 30, 2021 was $0.7 million and $1.6 million, respectively.

Supplemental information related to leases as of and for the six months ended June 30, 2021 was as follows:

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

Operating Leases			Classification			June 30, 2021
Assets			(dollars in thousands)
Operating lease right-of-use assets			Other assets			$	11,843
Liabilities
Operating lease liabilities (1)			Other liabilities			$	15,437
Lease term and discount rate
Weighted average remaining lease term						4.2 years
Weighted average discount rate (1)						2.9%
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases						$	1,983
(1)     As the Company’s leases do not provide an implicit rate, the Company uses an incremental borrowing rate based on the information available at adoption date in determining the present value of lease payments.

The following table provides details related to maturities of lease liabilities:

			Maturity of Lease Liabilities
Years ending December 31,			(dollars in thousands)
2021 (remaining)			$	1,935
2022			3,862
2023			3,862
2024			3,862
2025			2,895
Total lease payments			$	16,416
Less imputed interest			979
Present value of lease liabilities			$	15,437

Contingencies

From time to time, the Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material effect on the Company’s consolidated financial statements. There were no material contingencies at June 30, 2021 and December 31, 2020.

21.  ARCOLA REGULATORY REQUIREMENTS

Arcola is the Company’s wholly owned and consolidated broker-dealer. Arcola is subject to regulations of the securities business that include but are not limited to trade practices, use and safekeeping of funds and securities, capital structure, recordkeeping and conduct of directors, officers and employees. 

Arcola is a member of various clearing organizations with which it maintains cash required to conduct its day-to-day clearance activities. Arcola enters into reverse repurchase agreements and repurchase agreements as part of its matched book trading activity. Reverse repurchase agreements are recorded on settlement date at the contractual amount and are collateralized by mortgage-backed or other securities. Arcola generates income from the spread between what is earned on the reverse repurchase agreements and what is paid on the matched repurchase agreements. Arcola’s policy is to obtain possession of collateral with a market value in excess of the principal amount loaned under reverse repurchase agreements. To ensure that the market value of the underlying collateral remains sufficient, collateral is valued daily, and Arcola will require counterparties to deposit additional collateral, when necessary.  All reverse repurchase activities are transacted under master repurchase agreements or other documentation that give Arcola the right, in the event of default, to liquidate collateral held and in some instances, to offset receivables and payables with the same counterparty.

As a member of the Financial Industry Regulatory Authority (“FINRA”), Arcola is required to maintain a minimum net capital balance. At June 30, 2021, Arcola had a minimum net capital requirement of $0.3 million. Arcola consistently operates with capital in excess of its regulatory capital requirements. Arcola’s regulatory net capital as defined by SEC Rule 15c3-1 at June 30, 2021 was $516.9 million with excess net capital of $516.6 million.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

22.  SUBSEQUENT EVENTS

In July 2021, the Company completed and closed the securitization of residential mortgage loans, OBX 2021-J2 Trust, with a face value of $382.5 million. The securitization represented a financing transaction which provided non-recourse financing to the Company collateralized by residential mortgage loans purchased by the Company.

In July 2021, in the previously announced divestiture of the Company’s CRE business, a significant majority of the assets, including the platform, were transferred to Slate as part of the first closing of the transaction with remaining assets expected to be transferred in the second half of 2021.

In July 2021, the Company syndicated $466.4 million of corporate loans, which were classified as held for sale as of June 30, 2021.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Note Regarding Forward-Looking Statements

Certain statements contained in this quarterly report, and certain statements contained in our future filings with the Securities and Exchange Commission (the “SEC” or the “Commission”), in our press releases or in our other public or stockholder communications contain or incorporate by reference certain forward-looking statements which are based on various assumptions (some of which are beyond our control) and may be identified by reference to a future period or periods or by the use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “anticipate,” “continue,” or similar terms or variations on those terms or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, risks and uncertainties related to the COVID-19 pandemic, including as related to adverse economic conditions on real estate-related assets and financing conditions (and our outlook for our business in light of these conditions, which is uncertain); changes in interest rates; changes in the yield curve; changes in prepayment rates; the availability of mortgage-backed securities and other securities for purchase; the availability of financing and, if available, the terms of any financing; changes in the market value of our assets; changes in business conditions and the general economy; operational risks or risk management failures by us or critical third parties, including cybersecurity incidents; our ability to grow our residential credit business; our ability to grow our middle market lending business; credit risks related to our investments in credit risk transfer securities, residential mortgage-backed securities and related residential mortgage credit assets, and corporate debt; risks related to investments in MSR; our ability to consummate any contemplated investment opportunities; changes in government regulations or policy affecting our business; our ability to maintain our qualification as a REIT for U.S. federal income tax purposes; our ability to maintain our exemption from registration under the Investment Company Act; and the timing and ultimate completion of the sale of our commercial real estate business. For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in our most recent annual report on Form 10-K and Item 1A “Risk Factors” in this quarterly report on Form 10-Q. We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our most recent annual report on Form 10-K. All references to “Annaly,” “we,” “us,” or “our” mean Annaly Capital Management, Inc. and all entities owned by us, except where it is made clear that the term means only the parent company.  Refer to the section titled “Glossary of Terms” located at the end of this Item 2 for definitions of commonly used terms in this quarterly report on Form 10-Q.

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Item 2. Management’s Discussion and Analysis

INDEX TO ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
			Page
Overview			49
Recent Developments			49
Business Environment and COVID-19			49
Economic Environment			50
London Interbank Offered Rate (“LIBOR”) Transition Working Group			48
Results of Operations			51
Net Income (Loss) Summary			53
Non-GAAP Financial Measures			55
Earnings available for distribution, earnings available for distribution attributable to common stockholders, earnings available for distribution per average common share and annualized EAD return on average equity			55
Premium Amortization Expense			57
Economic leverage and economic capital ratios			58
Interest Income (excluding PAA), economic interest expense and economic net interest income (excluding PAA)			59
Experienced and Projected Long-term CPR			60
Average Yield on Interest Earning Assets (excluding PAA), Net Interest Spread (excluding PAA), and Net Interest Margin (excluding PAA), and Average Economic Cost of Interest Bearing Liabilities)			61
Economic Interest Expense and Average Economic Cost of Interest Bearing Liabilities			62
Realized and Unrealized Gains (Losses)			63
Other Income (Loss)			64
General and Administrative Expenses			64
Return on Average Equity			65
Unrealized Gains and Losses - Available-for-Sale Investments			65
Financial Condition			66
Residential Securities			66
Contractual Obligations			69
Off-Balance Sheet Arrangements			69
Capital Management			70
Stockholders’ Equity			70
Capital Stock			70
Leverage and Capital			70
Risk Management			71
Risk Appetite			71
Governance			71
Description of Risks			72
Capital, Liquidity and Funding Risk Management			73
Funding			73
Excess Liquidity			74
Maturity Profile			76
Stress Testing			77
Liquidity Management Policies			77
Investment/Market Risk Management			78
Credit Risk Management			79
Counterparty Risk Management			79
Operational Risk Management			80
Compliance, Regulatory and Legal Risk Management			80
Critical Accounting Policies and Estimates			81
Valuation of Financial Instruments			81
Residential Securities			81
Residential Mortgage Loans			81
MSR			74
Commercial Real Estate Investments			82
Interest Rate Swaps			82
Revenue Recognition			82
Consolidation of Variable Interest Entities			82
Use of Estimates			82
Glossary of Terms			83

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

Overview

We are a leading diversified capital manager with investment strategies across mortgage finance and corporate middle market lending. Our principal business objective is to generate net income for distribution to our stockholders and optimize our returns through prudent management of our diversified investment strategies. We are an internally-managed Maryland corporation founded in 1997 that has elected to be taxed as a REIT. Prior to the closing of the Internalization (as defined in the “Related Party Transactions” Note located within Item 1) on June 30, 2020, we were externally managed by Annaly Management Company LLC (the “Former Manager”). Our common stock is listed on the New York Stock Exchange under the symbol “NLY.”

We use our capital coupled with borrowed funds to invest primarily in real estate related investments, earning the spread between the yield on our assets and the cost of our borrowings and hedging activities.

For a full discussion of our business, refer to the section titled “Business Overview” in our most recent Annual Report on Form 10-K.

Recent Developments

Sale of Commercial Real Estate Business

On March 25, 2021, we announced that we entered into a definitive agreement to sell and exit our Commercial Real Estate (“CRE”) business to Slate Asset Management L.P. and Slate Grocery REIT (together, “Slate”). The transaction represents the sale of substantially all of the assets that comprise our CRE business, which include equity interests, loan assets and commercial mortgage-backed securities (other than commercial CRTs). Certain employees who primarily support the CRE business will join Slate in connection with the sale. Subject to customary closing conditions, including applicable regulatory approvals, the transfer of the CRE business is expected to be completed in the second half of 2021. Revenues and expenses associated with the CRE business will be reflected in our results of operations and key financial metrics through closing. Refer to the “Sale of Commercial Real Estate Business” and “Subsequent Events” Notes located within Item 1 for additional information related to the announced transaction.

Business Environment and COVID-19 

The second quarter of 2021 saw 10-year Treasury rates decline by nearly 30 basis points despite peak economic reopening momentum and a meaningful acceleration in inflation readings. Spreads on Agency mortgage-backed securities (“MBS”), which entered the quarter at tight levels signaling full valuations, widened while credit sector spreads remained well supported. The challenging environment led us to generate a (4.0%) economic return (loss) and tangible economic return (loss), during the quarter on ($0.23) in GAAP net income (loss) per common share, and a $0.58 decline in our book value to $8.37 per common share as of June 30, 2021. Our total portfolio net of securitized debt (which includes market value of TBA purchase contracts and CMBX derivatives and excludes held for sale assets) decreased during the quarter to $92.9 billion, while credit investments as a share of the aggregate portfolio rose from 27% to 29% during the quarter.

The rally in interest rates during the quarter was somewhat contradictory relative to the strong economy seen during the period. Despite the economic reopening and inflation at multi-year highs, the yield curve flattened as rate markets viewed the pace of the current economic expansion as likely to fade, with growth and inflation expected to slow back to pre-pandemic levels in the medium-term. Meanwhile, the Federal Reserve (“Fed”) began signaling a shift in its reaction function at the June Federal Open Market Committee (“FOMC”) meeting. Having become concerned around an upside surprise in inflation, the FOMC signaled that it might raise short-term interest rates sooner than previously anticipated should inflation remain elevated.

Agency MBS, meanwhile, underperformed its rate hedges in this environment as banks slowed their purchases from record pace, investors recalibrated their taper expectations, and mortgage supply continued to remain elevated. More specifically, higher coupon Agency MBS, those with coupons of or above 3.5 percent, continued to face elevated prepayment speeds, which led investors to adjust their models to reflect this reality, thereby lowering the valuations of these securities. Faced with this challenging operating environment in Agency MBS, Annaly continued to prudently manage its portfolio, reducing leverage and hedging incremental moves in interest rates, while allocating capital towards credit investments with more attractive risk-adjusted returns.

As such, our residential credit business experienced another active quarter as we took advantage of opportunities in the unrated non- and re-performing securities market, as well as non-qualified loan market, activity which was boosted by the initiation of our in-house aggregation through Onslow Bay’s correspondent channel. Launched in April 2021, the program offers a diversified suite of mortgage products to purchase residential mortgage loans on a best-efforts flow basis that adhere to our credit standards. Outside of residential credit, we committed to increase our exposure to MSR during the quarter, through direct

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Item 2. Management’s Discussion and Analysis

purchases and third party partnerships bringing Annaly’s total MSR economic exposure (for both portfolios already settled and those committed to be settled at a future date) to approximately $409 million market value as of June 30, 2021. Finally, we also saw considerable portfolio activity in our Middle Market Lending business, which originated six deals for a total of approximately $450 million during the quarter, net of originations subsequently classified as held for sale at the end of the quarter.

The previously announced sale of our Commercial Real Estate business remains on track to be completed in the second half of 2021. After quarter end, the bulk of the platform – including a number of Annaly employees who supported the business – was successfully transferred as part of the first closing of the transaction. A significant majority of the assets were sold during this first close and we have received over 80% of the capital by the time of this filing.

Business Continuity

Our well-established Business Continuity Plan (“BCP”) has been designed to ensure continued, effective operations through a variety of scenarios including natural disasters and disease pandemics. It identifies critical systems, processes, roles and third parties, and can be adjusted on a real-time basis to address situations as they arise.

The BCP is regularly updated and tested. Annual testing includes extensive, remote Disaster Recovery testing and tabletop exercise scenarios with management. Key tenets of the plan include active communication between our Crisis Response Team, which is comprised of senior leaders across a number of functions, and our internal and external stakeholders to afford efficient, thoughtful, effective responses to evolving emergency situations.

Historical tabletop exercises have included use of Center for Disease Control and Prevention Influenza Pandemic exercise materials. That exercise documented our response and possible impacts to a variety of scenarios, including those in which “shelter in place orders” were required and response/impact assessments to those scenarios. Regular meetings were commenced to implement and review active internal and external communications planning. These exercises, along with regulatory and industry guidance, informed our staged response to the conditions created by COVID-19. We took proactive actions, which included canceling non-essential travel and instituting 100% remote working, ahead of New York State-mandated requirements. To protect the health and well-being of our employees, their families and communities remote work requirements began in phases in early March 2020, culminating with a company-wide exercise on March 13, 2020 to test connectivity and functionality. All employees were able to successfully perform their duties in this testing and we have operated largely remotely since that time.

Business activities continue to be performed primarily remotely, though we have seen a number of employees return to the office on a voluntary and periodic basis. At the present, we expect employees to return to the office more regularly starting in the fourth quarter of 2021 subject to continued successful vaccine rollout and accomodative guidance from federal, state and local authorities.

Economic Environment

The pace of growth accelerated in the second quarter, with U.S. gross domestic product (“GDP”) rising 6.5% percent on a seasonally adjusted annualized rate. Growth was boosted as the U.S. economy reopened and service sector consumption rose strongly, while consumers, supported by healthy balance sheets and recent stimulus payments, continued to spend on goods as well.

The unemployment rate fell 0.1 percentage points in the second quarter to 5.9% in June according to the Bureau of Labor Statistics. Meanwhile, seasonally adjusted total non-farm payroll employment rose by an average 567 thousand workers per month to 145.8 million employees, but remains roughly 6.7 million employees below the number of employed in February 2020 at the onset of the COVID-19 pandemic. Employment gains generally disappointed expectations for even better gains into the economic reopening, yet a number of factors including lingering COVID-19 fears, job skill mismatches, and elevated employment benefits appear to have held back employment growth. Wage growth, as measured by the year-over-year change in private sector average hourly earnings, contracted further during the quarter, reading 3.6% in June compared to 4.3% in March 2021. The slowdown in wage growth remains mostly a statistical anomaly, driven by a relatively larger share of job losses among lower-paid employees at the height of the pandemic, which inflated wage gains for most of 2020. As these wage gains fall out of year-over-year calculations, wage gains tend to be somewhat depressed on these metrics. Of note, wage growth has been relatively strong in reopening sectors of late. For example, average hourly earnings in the leisure and hospitality sector have exceeded 1.0% month-over-month growth for four consecutive months, suggesting healthy earnings growth in a sector that is seeing strong demand for labor in the middle of the economic reopening.

Inflation readings, as measured by the year-over-year changes in the Personal Consumption Expenditure Chain Price Index (“PCE”), have risen sharply from their pandemic lows and are currently running meaningfully above the Fed’s 2% inflation target. The headline PCE measure increased by 3.99% year-over-year in June 2021, while the more stable core PCE measure, which excludes volatile food and energy prices, registered 3.54% year-over-year increase, above the 1.97% year-over-year

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Item 2. Management’s Discussion and Analysis

growth measured in March 2021. The acceleration in price increases was driven by the combination of strong demand for goods and services and simultaneous supply bottlenecks. For example, consumers, wary of COVID-19 related risks on public transportation but supported by excess savings from financial stimulus, opted to purchase increased amounts of cars. Car manufacturers, meanwhile, were unable to meet increased demand as the pandemic led to disruptions to supply chains and a shortage in microchip production limited total production of new cars. These bottlenecks are likely to ease in months ahead as production catches up to demand, thereby lowering price pressures.

Disregarding the current sharp rise in inflation measures for now, the FOMC maintained the Federal Funds Target Rate in the 0.00% - 0.25% range and continued to signal that it will maintain the rate at current levels for an extended period of time. In addition, the FOMC continued its quantitative easing program. The combined Fed actions have continued to support financial conditions and market functioning, which in turn has helped the economic recovery.

The following table below presents interest rates and spreads at each date presented:

			June 30, 2021						December 31, 2020						June 30, 2020
30-Year mortgage current coupon			1.83%						1.34%						1.57%
Mortgage basis			36 bps						43 bps						91 bps
10-Year U.S. Treasury rate			1.47%						0.91%						0.66%
LIBOR
1-Month			0.10%						0.14%						0.15%
6-Month			0.16%						0.26%						0.26%

 

London Interbank Offered Rate (“LIBOR”) Transition Working Group

On March 5, 2021, the United Kingdom Financial Conduct Authority (“FCA”), which regulates LIBOR, announced that all LIBOR tenors relevant to us will cease to be published or will no longer be representative after June 30, 2023. The FCA's announcement coincides with the March 5, 2021 announcement of LIBOR's administrator, the ICE Benchmark Administration Limited (“IBA”), indicating that, as a result of not having access to input data necessary to calculate LIBOR tenors relevant to us on a representative basis after June 30, 2023, IBA would have to cease publication of such LIBOR tenors immediately after the last publication on June 30, 2023. These announcements mean that any of our LIBOR-based borrowings that extend beyond June 30, 2023 will need to be converted to a replacement rate.

We have established a cross-functional LIBOR transition committee to determine our transition plan and facilitate an orderly transition to alternative reference rates. Our plan includes steps to evaluate exposure, review contracts, assess impact to our business, process and technology and define a communication strategy with shareholders, regulators and other stakeholders. The committee also continues to engage with industry working groups and other market participants regarding the transition. We continue to remain on track with our LIBOR transition plan, which requires different solutions depending on the underlying asset or liability. Similar to the rest of the market, the bulk of our exposure is in derivatives contracts. Certain contracts, such as interest rate swaps, have an orderly market transition already in process, whereas other contracts, such as loan agreements require bilateral amendments with transition currently in process and adequate time left to resolve.

Results of Operations

The results of our operations are affected by various factors, many of which are beyond our control. Certain of such risks and uncertainties are described herein (see “Special Note Regarding Forward-Looking Statements” above) and in Part I, Item 1A. “Risk Factors” of our most recent Annual Report on Form 10-K and in Part II, Item 1A. “Risk Factors” in this Quarterly Report on Form 10-Q.

This Management Discussion and Analysis section contains analysis and discussion of financial results computed in accordance with U.S. generally accepted accounting principles (“GAAP”) and non-GAAP measurements. To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide non-GAAP financial measures to enhance investor understanding of our period-over-period operating performance and business trends, as well as for assessing our performance versus that of industry peers.

Refer to the “Non-GAAP Financial Measures” section for additional information.

Commencing with our financial results for the quarter ended June 30, 2021 and for subsequent reporting periods, we relabeled “Core Earnings (excluding PAA)” as “Earnings Available for Distribution” (“EAD”). Earnings Available for Distribution, which is a non-GAAP financial measure intended to supplement our financial results computed in accordance with U.S.

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Item 2. Management’s Discussion and Analysis

generally accepted accounting principles (“GAAP”), has replaced our prior presentation of Core Earnings (excluding PAA). In addition, Core Earnings (excluding PAA) results from prior reporting periods has been relabeled Earnings Available for Distribution. In line with evolving industry practices, we believe the term Earnings Available for Distribution more accurately reflects the principal purpose of the measure than the term Core Earnings (excluding PAA) and will serve as a useful indicator for investors in evaluating our performance and our ability to pay dividends.

The definition of Earnings Available for Distribution is identical to the definition of Core Earning (excluding PAA) from prior reporting periods. As such, Earnings Available for Distribution is defined as the sum of (a) economic net interest income, (b) TBA dollar roll income and CMBX coupon income, (c) realized amortization of MSR, (d) other income (loss) (excluding depreciation expense related to commercial real estate and amortization of intangibles, non-EAD income allocated to equity method investments and other non-EAD components of other income (loss)), (e) general and administrative expenses (excluding transaction expenses and non-recurring items) and (f) income taxes (excluding the income tax effect of non-EAD income (loss) items) and excludes (g) the premium amortization adjustment (“PAA”) representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities.

Earnings Available for Distribution should not be considered a substitute for, or superior to, GAAP net income. Please refer to the “Non-GAAP Financial Measures” section for a detailed discussion of Earnings Available for Distribution.

Beginning with the quarter ended June 30, 2021, we began classifying certain portfolio activity-related or volume-related expenses as Other income (loss) rather than Other general and administrative expenses in the Consolidated Statements of Comprehensive Income (Loss) to better reflect the nature of the items. As such, prior periods have been conformed to the current presentation. Refer to the “General and Administrative Expenses” section for additional information.

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Item 2. Management’s Discussion and Analysis

Net Income (Loss) Summary

The following table presents financial information related to our results of operations as of and for the three and six months ended June 30, 2021 and 2020.

			As of and for the Three Months Ended June 30,												As of and for the Six Months Ended June 30,
			2021						2020						2021						2020
			(dollars in thousands, except per share data)
Interest income			$	383,906					$	584,812					$	1,147,284					$	1,139,838
Interest expense			61,047						186,032						137,020						689,505
Net interest income			322,859						398,780						1,010,264						450,333
Realized and unrealized gains (losses)			(560,722)						511,951						537,123						(3,143,790)
Other income (loss)			1,675						12,328						15,143						19,490
Less: Total general and administrative expenses			53,526						64,770						101,431						134,635
Income (loss) before income taxes			(289,714)						858,289						1,461,099						(2,808,602)
Income taxes			5,134						2,055						4,813						(24,647)
Net income (loss)			(294,848)						856,234						1,456,286						(2,783,955)
Less: Net income (loss) attributable to noncontrolling interests			794						32						1,115						98
Net income (loss) attributable to Annaly			(295,642)						856,202						1,455,171						(2,784,053)
Less: Dividends on preferred stock			26,883						35,509						53,766						71,018
Net income (loss) available (related) to common stockholders			$	(322,525)					$	820,693					$	1,401,405					$	(2,855,071)
Net income (loss) per share available (related) to common stockholders
Basic			$	(0.23)					$	0.58					$	1.00					$	(2.00)
Diluted			$	(0.23)					$	0.58					$	1.00					$	(2.00)
Weighted average number of common shares outstanding
Basic			1,410,239,138						1,423,909,112						1,404,755,496						1,427,451,716
Diluted			1,410,239,138						1,423,909,112						1,405,764,272						1,427,451,716
Other information
Investment portfolio at period-end			$	80,222,151					$	90,442,332					$	80,222,151					$	90,442,332
Average total assets			$	83,872,947					$	95,187,964					$	85,400,332					$	106,890,336
Average equity			$	13,853,386					$	13,252,567					$	13,909,522					$	14,100,492
GAAP leverage at period-end (1)			4.7:1						5.5:1						4.7:1						5.5:1
GAAP capital ratio at period-end (2)			16.6		%				14.8		%				16.6		%				14.8		%
Annualized return on average total assets			(1.41		%)				3.60		%				3.41		%				(5.21		%)
Annualized return on average equity			(8.51		%)				25.84		%				20.94		%				(39.49		%)
Net interest margin (3)			1.66		%				1.89		%				2.54		%				0.90		%
Average yield on interest earning assets (4)			1.97		%				2.77		%				2.89		%				2.27		%
Average GAAP cost of interest bearing liabilities (5)			0.35		%				0.96		%				0.39		%				1.48		%
Net interest spread			1.62		%				1.81		%				2.50		%				0.79		%
Weighted average experienced CPR for the period			26.4		%				19.5		%				25.2		%				16.6		%
Weighted average projected long-term CPR at period-end			12.9		%				18.0		%				12.9		%				18.0		%
Common stock book value per share			$	8.37					$	8.39					$	8.37					$	8.39
Non-GAAP metrics (6)
Interest income (excluding PAA)			$	537,513					$	636,554					$	1,086,321					$	1,482,302
Economic interest expense (5)			$	144,134					$	250,593					$	299,854					$	768,046
Economic net interest income (excluding PAA)			$	393,379					$	385,961					$	786,467					$	714,256
Premium amortization adjustment cost (benefit)			$	153,607					$	51,742					$	(60,963)					$	342,464
Earnings available for distribution (7)			$	451,358					$	424,580					$	890,877					$	754,798
Earnings available for distribution per common share			$	0.30					$	0.27					$	0.59					$	0.48
Annualized EAD return on average equity (excluding PAA)			13.05		%				12.82		%				12.82		%				10.71		%
Economic leverage at period-end (1)			5.8:1						6.4:1						5.8:1						6.4:1
Economic capital ratio at period-end (2)			14.3		%				13.0		%				14.3		%				13.0		%
Net interest margin (excluding PAA) (3)			2.09		%				1.88		%				2.00		%				1.50		%
Average yield on interest earning assets (excluding PAA) (4)			2.76		%				3.01		%				2.73		%				2.96		%
Average economic cost of interest bearing liabilities (5)			0.83		%				1.29		%				0.85		%				1.65		%
Net interest spread (excluding PAA)			1.93		%				1.72		%				1.88		%				1.31		%

 

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Item 2. Management’s Discussion and Analysis

(1) GAAP leverage is computed as the sum of repurchase agreements, other secured financing, debt issued by securitization vehicles, participations issued and mortgages payable divided by total equity. Economic leverage is computed as the sum of recourse debt, cost basis of to-be-announced (“TBA”) and CMBX derivatives outstanding, and net forward purchases (sales) of investments divided by total equity. Recourse debt consists of repurchase agreements and other secured financing (excluding certain non-recourse credit facilities). Certain credit facilities (included within other secured financing), debt issued by securitization vehicles, participations issued, and mortgages payable are non-recourse to the Company and are excluded from economic leverage. (2) GAAP capital ratio is computed as total equity divided by total assets. Economic capital ratio is computed as total equity divided by total economic assets. Total economic assets include the implied market value of TBA derivatives and net of debt issued by securitization vehicles. (3) Net interest margin represents our interest income less interest expense divided by the average interest earning assets. Net interest margin (excluding PAA) represents the sum of our interest income (excluding PAA) plus TBA dollar roll income and CMBX coupon income less interest expense and the net interest component of interest rate swaps divided by the sum of average interest earning assets plus average outstanding TBA contract and CMBX balances. (4) Average yield on interest earning assets represents annualized interest income divided by average interest earning assets. Average interest earning assets reflects the average amortized cost of our investments during the period. Average yield on interest earning assets (excluding PAA) is calculated using annualized interest income (excluding PAA). (5) Average GAAP cost of interest bearing liabilities represents annualized interest expense divided by average interest bearing liabilities. Average interest bearing liabilities reflects the average balances during the period. Average economic cost of interest bearing liabilities represents annualized economic interest expense divided by average interest bearing liabilities. Economic interest expense is comprised of GAAP interest expense and the net interest component of interest rate swaps. (6) Represents a non-GAAP financial measure. Refer to the “Non-GAAP Financial Measures” section for additional information. (7) Excludes dividends on preferred stock.

GAAP

Net income (loss) was ($294.8) million, which includes $0.8 million attributable to noncontrolling interests, or ($0.23) per average basic common share, for the three months ended June 30, 2021 compared to $856.2 million, which includes $0.0 million attributable to noncontrolling interests, or $0.58 per average basic common share, for the same period in 2020. We attribute the majority of the change in net income (loss) to unfavorable changes in unrealized gains (losses) on interest rate swaps, net gains (losses) on other derivatives and financial instruments, net unrealized gains (losses) on instruments measured at fair value through earnings and net gains (losses) on disposal of investments and other, partially offset by a favorable change in realized gains (losses) on termination or maturity of interest rate swaps. Net unrealized gains (losses) on interest rate swaps was ($141.1) million for the three months ended June 30, 2021 compared to $1.5 billion for the same period in 2020. Net gains (losses) on other derivatives and financial instruments was ($357.8) million for the three months ended June 30, 2021 compared to $170.9 million for the same period in 2020. Net unrealized gains (losses) on instruments measured at fair value through earnings was $4.0 million for the three months ended June 30, 2021 compared to $254.8 million for the same period in 2020. Net gains (losses) on disposal of investments and other was $16.2 million for the three months ended June 30, 2021 compared to $246.7 million for the same period in 2020. Realized gains (losses) on termination or maturity of interest rate swaps was $0 for the three months ended June 30, 2021 compared to ($1.5) billion for the same period in 2020. Refer to the section titled “Realized and Unrealized Gains (Losses)” located within this Item 2 for additional information related to these changes.

Net income (loss) was $1.5 billion, which includes $1.1 million attributable to noncontrolling interests, or $1.00 per average basic common share, for the six months ended June 30, 2021 compared to ($2.8) billion which includes $0.1 million attributable to noncontrolling interests, or ($2.00) per average basic common share, for the same period in 2020. We attribute the majority of the change in net income (loss) to favorable changes in unrealized gains (losses) on interest rate swaps, realized gains (losses) on termination or maturity of interest rate swaps, net unrealized gains (losses) on instruments measured at fair value through earnings and net interest income, partially offset by unfavorable changes in net gains (losses) on disposal of investments and other and net gains (losses) on other derivatives and financial instruments. Realized losses on termination or maturity of interest rate swaps was $0 for the six months ended June 30, 2021 compared to ($1.9) billion for the same period in 2020. Net unrealized gains (losses) on interest rate swaps was $631.2 million for the six months ended June 30, 2021 compared to ($1.3) billion for the same period in 2020. Net unrealized gains (losses) on instruments measured at fair value through earnings for the six months ended June 30, 2021 was $108.2 million compared to ($475.4) million for the same period in 2020. Net interest income for the six months ended June 30, 2021 was $1.0 billion compared to $450.3 million for the same period in 2020. Net gains (losses) on disposal of investments and other was ($49.6) million for the six months ended June 30, 2021 compared to $453.3 million for the same period in 2020. Net gains (losses) on other derivatives was $119.1 million for the six months ended June 30, 2021 compared to $377.3 million for the same period in 2020. Refer to the section titled “Realized and Unrealized Gains (Losses)” located within this Item 2 for additional information related to these changes.

Non-GAAP

Earnings available for distribution were $451.4 million, or $0.30 per average common share, for the three months ended June 30, 2021, compared to $424.6 million, or $0.27 per average common share, for the same period in 2020. The change in earnings available for distribution during the three months ended June 30, 2021 compared to the same period in 2020 was primarily due to lower interest expense from lower borrowing rates and average interest bearing liabilities, and higher TBA dollar roll

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Item 2. Management’s Discussion and Analysis

income, partially offset by lower coupon income resulting from lower average interest earning assets and unfavorable changes in the net interest component of interest rate swaps.

Earnings available for distribution were $890.9 million, or $0.59 per average common share, for the six months ended June 30, 2021, compared to $754.8 million, or $0.48 per average common share, for the same period in 2020. The change in earnings available for distribution during the six months ended June 30, 2021 compared to the same period in 2020 was primarily due to lower interest expense from lower borrowing rates and average interest bearing liabilities and higher TBA dollar roll income, partially offset by unfavorable changes in the net interest component of interest rate swaps.

Non-GAAP Financial Measures

To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide the following non-GAAP financial measures:

•earnings available for distribution (“EAD”);

•earnings available for distribution attributable to common stockholders;

•earnings available for distribution per average common share;

•annualized EAD return on average equity;

•economic leverage;

•economic capital ratio;

•interest income (excluding PAA);

•economic interest expense;

•economic net interest income (excluding PAA);

•average yield on interest earning assets (excluding PAA);

•average economic cost of interest bearing liabilities;

•net interest margin (excluding PAA); and

•net interest spread (excluding PAA).

These measures should not be considered a substitute for, or superior to, financial measures computed in accordance with GAAP. While intended to offer a fuller understanding of our results and operations, non-GAAP financial measures also have limitations. For example, we may calculate our non-GAAP metrics, such as earnings available for distribution, or the PAA, differently than our peers making comparative analysis difficult. Additionally, in the case of non-GAAP measures that exclude the PAA, the amount of amortization expense excluding the PAA is not necessarily representative of the amount of future periodic amortization nor is it indicative of the term over which we will amortize the remaining unamortized premium. Changes to actual and estimated prepayments will impact the timing and amount of premium amortization and, as such, both GAAP and non-GAAP results.

These non-GAAP measures provide additional detail to enhance investor understanding of our period-over-period operating performance and business trends, as well as for assessing our performance versus that of industry peers. Additional information pertaining to our use of these non-GAAP financial measures, including discussion of how each such measure may be useful to investors, and reconciliations to their most directly comparable GAAP results are provided below.

Earnings available for distribution, earnings available for distribution attributable to common stockholders, earnings available for distribution per average common share and annualized EAD return on average equity

Our principal business objective is to generate net income for distribution to our stockholders and optimize our returns through prudent management of our diversified investment strategies. We generate net income by earning a net interest spread on our investment portfolio, which is a function of interest income from our investment portfolio less financing, hedging and operating costs. Earnings available for distribution, which is defined as the sum of (a) economic net interest income, (b) TBA dollar roll income and CMBX coupon income, (c) realized amortization of MSR, (d) other income (loss) (excluding depreciation and amortization expense on real estate and related intangibles, non-EAD income allocated to equity method investments and other non-EAD components of other income (loss)), (e) general and administrative expenses (excluding transaction expenses and non-recurring items), and (f) income taxes (excluding the income tax effect of non-EAD income (loss) items), and excludes (g) the premium amortization adjustment (“PAA”) representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities, is used by management and, we believe, used by analysts and investors to measure our progress in achieving our principal business objective. 

We seek to fulfill our principal business objective through a variety of factors including portfolio construction, the degree of market risk exposure and related hedge profile, and the use and forms of leverage, all while operating within the parameters of our capital allocation policy and risk governance framework.

We believe these non-GAAP measures provide management and investors with additional details regarding our underlying operating results and investment portfolio trends by (i) making adjustments to account for the disparate reporting of changes in fair value where certain instruments are reflected in GAAP net income (loss) while others are reflected in other comprehensive income (loss), and (ii) by excluding certain unrealized, non-cash or episodic components of GAAP net income (loss) in order to

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Item 2. Management’s Discussion and Analysis

provide additional transparency into the operating performance of our portfolio. In addition, EAD serves as a useful indicator for investors in evaluating the Company's performance and ability to pay dividends. Annualized EAD return on average equity, which is calculated by dividing earnings available for distribution over average stockholders’ equity, provides investors with additional detail on the earnings available for distribution generated by our invested equity capital.

The following table presents a reconciliation of GAAP financial results to non-GAAP earnings available for distribution for the periods presented:

			For the Three Months Ended June 30,												For the Six Months Ended June 30,
			2021						2020						2021						2020
			(dollars in thousands, except per share data)
GAAP net income (loss)			$	(294,848)					$	856,234					$	1,456,286					$	(2,783,955)
Net income (loss) attributable to noncontrolling interests			794						32						1,115						98
Net income (loss) attributable to Annaly			(295,642)						856,202						1,455,171						(2,784,053)
Adjustments to exclude reported realized and unrealized (gains) losses
Realized (gains) losses on termination or maturity of interest rate swaps			—						1,521,732						—						1,919,293
Unrealized (gains) losses on interest rate swaps			141,067						(1,494,628)						(631,195)						1,333,095
Net (gains) losses on disposal of investments and other			(16,223)						(246,679)						49,563						(453,262)
Net (gains) losses on other derivatives and financial instruments			357,808						(170,916)						(119,060)						(377,342)
Net unrealized (gains) losses on instruments measured at fair value through earnings			(3,984)						(254,772)						(108,175)						475,388
Loan loss provision (reversal) (1)			1,078						72,544						(143,792)						172,537
Business divestiture-related (gains) losses			(1,527)						—						248,036						—
Other adjustments
Depreciation expense related to commercial real estate and amortization of intangibles (2)			5,635						8,714						12,959						16,648
Non-EAD (income) loss allocated to equity method investments (3)			3,141						4,218						(6,539)						23,616
Transaction expenses and non-recurring items (4)			1,150						1,075						1,845						8,320
Income tax effect of non-EAD income (loss) items			7,147						3,353						11,481						(20,509)
TBA dollar roll income and CMBX coupon income (5)			111,592						97,524						210,525						142,428
MSR amortization (6)			(13,491)						(25,529)						(28,979)						(43,825)
Plus:
Premium amortization adjustment cost (benefit)			153,607						51,742						(60,963)						342,464
Earnings available for distribution (7)			451,358						424,580						890,877						754,798
Dividends on preferred stock			26,883						35,509						53,766						71,018
Earnings available for distribution attributable to common stockholders (7)			$	424,475					$	389,071					$	837,111					$	683,780
GAAP net income (loss) per average common share			$	(0.23)					$	0.58					$	1.00					$	(2.00)
Earnings available for distribution per average common share (7)			$	0.30					$	0.27					$	0.59					$	0.48
Annualized GAAP return (loss) on average equity			(8.51		%)				25.84		%				20.94		%				(39.49		%)
Annualized EAD return on average equity (7)			13.05		%				12.82		%				12.82		%				10.71		%

(1)    Includes $0.6 million and $3.8 million for the three months ended June 30, 2021 and 2020, respectively, and ($4.7) million and $4.5 million for the six months ended June 30, 2021 and 2020, respectively, of loss provision (reversal) on unfunded loan commitments which is reported in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

(2)    Includes depreciation and amortization expense related to equity method investments.

(3)    Represents unrealized (gains) losses allocated to equity interests in a portfolio of MSR which is a component of Other income (loss).

(4)    The three and six months ended June 30, 2021 includes costs incurred in connection with securitizations of residential whole loans. The three and six months ended June 30, 2020 includes costs incurred in connection with the Internalization and costs incurred in connection with the CEO search process. The six months ended June 30, 2020 also includes costs incurred in connection with securitizations of residential whole loans and Agency mortgage-backed securities.

(5)    TBA dollar roll income and CMBX coupon income each represent a component of Net gains (losses) on other derivatives and financial instruments. CMBX coupon income totaled $1.4 million and $1.6 million for the three months ended June 30, 2021 and 2020, respectively, and $2.9 million and $2.7 million for the six months ended June 30, 2021 and 2020, respectively.

(6)    MSR amortization represents the portion of changes in fair value that is attributable to the realization of estimated cash flows on our MSR portfolio and is reported as a component of Net unrealized gains (losses) on instruments measured at fair value.

(7)    Represents a non-GAAP financial measure.

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Item 2. Management’s Discussion and Analysis

From time to time, we enter into TBA forward contracts as an alternate means of investing in and financing Agency MBS. A TBA contract is an agreement to purchase or sell, for future delivery, an Agency MBS with a specified issuer, term and coupon. A TBA dollar roll represents a transaction where TBA contracts with the same terms but different settlement dates are simultaneously bought and sold. The TBA contract settling in the later month typically prices at a discount to the earlier month contract with the difference in price commonly referred to as the “drop”. The drop is a reflection of the expected net interest income from an investment in similar Agency MBS, net of an implied financing cost, that would be foregone as a result of settling the contract in the later month rather than in the earlier month. The drop between the current settlement month price and the forward settlement month price occurs because in the TBA dollar roll market, the party providing the financing is the party that would retain all principal and interest payments accrued during the financing period. Accordingly, TBA dollar roll income generally represents the economic equivalent of the net interest income earned on the underlying Agency MBS less an implied financing cost.

TBA dollar roll transactions are accounted for under GAAP as a series of derivatives transactions. The fair value of TBA derivatives is based on methods similar to those used to value Agency MBS. We record TBA derivatives at fair value on our Consolidated Statements of Financial Condition and recognize periodic changes in fair value in Net gains (losses) on other derivatives and financial instruments in our Consolidated Statements of Comprehensive Income (Loss), which includes both unrealized and realized gains and losses on derivatives (excluding interest rate swaps).

TBA dollar roll income is calculated as the difference in price between two TBA contracts with the same terms but different settlement dates multiplied by the notional amount of the TBA contract. Although accounted for as derivatives, TBA dollar rolls capture the economic equivalent of net interest income, or carry, on the underlying Agency MBS (interest income less an implied cost of financing). TBA dollar roll income is reported as a component of Net gains (losses) on other derivatives and financial instruments in the Consolidated Statements of Comprehensive Income (Loss).

The CMBX index is a synthetic tradable index referencing a basket of 25 commercial mortgage-backed securities of a particular rating and vintage. The CMBX index allows investors to take a long position (referred to as selling protection) or short position (referred to as purchasing protection) on the respective basket of commercial mortgage-backed securities and is structured as a “pay-as-you-go” contract whereby the protection seller receives and the protection buyer pays a standardized running coupon on the contracted notional amount. Additionally, the protection seller is obligated to pay to the protection buyer the amount of principal losses and/or coupon shortfalls on the underlying commercial mortgage-backed securities as they occur. We report income (expense) on CMBX positions in Net gains (losses) on other derivatives and financial instruments in the Consolidated Statements of Comprehensive Income (Loss). The coupon payments received or paid on CMBX positions is equivalent to interest income (expense) and therefore included in earnings available for distribution.

Premium Amortization Expense

In accordance with GAAP, we amortize or accrete premiums or discounts into interest income for our Agency MBS, excluding interest-only securities, multifamily and reverse mortgages, taking into account estimates of future principal prepayments in the calculation of the effective yield. We recalculate 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. 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.

Our GAAP metrics include the unadjusted impact of amortization and accretion associated with this method. Certain of our non-GAAP metrics exclude the effect of the PAA, which quantifies the component of premium amortization representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term Constant Prepayment Rate (“CPR”).

The following table illustrates the impact of the PAA on premium amortization expense for our Residential Securities portfolio and residential securities transferred or pledged to securitization vehicles, for the periods presented:

			For the Three Months Ended June 30,												For the Six Months Ended June 30,
			2021						2020						2021						2020
			(dollars in thousands)
Premium amortization expense			$	320,108					$	270,688					$	308,217					$	887,625
Less: PAA cost (benefit)			153,607						51,742						(60,963)						342,464
Premium amortization expense (excluding PAA)			$	166,501					$	218,946					$	369,180					$	545,161

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Item 2. Management’s Discussion and Analysis

Economic leverage and economic capital ratios

We use capital coupled with borrowed funds to invest primarily in real estate related investments, earning the spread between the yield on our assets and the cost of our borrowings and hedging activities. Our capital structure is designed to offer an efficient complement of funding sources to generate positive risk-adjusted returns for our stockholders while maintaining appropriate liquidity to support our business and meet our financial obligations under periods of market stress. To maintain our desired capital profile, we utilize a mix of debt and equity funding. Debt funding may include the use of repurchase agreements, loans, securitizations, participations issued, lines of credit, asset backed lending facilities, corporate bond issuance, convertible bonds, mortgages payable or other liabilities. Equity capital primarily consists of common and preferred stock.

Our economic leverage ratio is computed as the sum of recourse debt, cost basis of TBA and CMBX derivatives outstanding, and net forward purchases (sales) of investments divided by total equity. Recourse debt consists of repurchase agreements and other secured financing (excluding certain non-recourse credit facilities). Certain credit facilities (included within other secured financing), debt issued by securitization vehicles, participations issued, and mortgages payable are non-recourse to us and are excluded from economic leverage.

The following table presents a reconciliation of GAAP debt to economic debt for purposes of calculating our economic leverage ratio for the periods presented:

			As of
			June 30, 2021												June 30, 2020
Economic leverage ratio reconciliation			(dollars in thousands)
Repurchase agreements			$	60,221,067											$	67,163,598
Other secured financing			909,655												1,538,996
Debt issued by securitization vehicles			3,315,087												6,458,130
Participations issued			315,810												—
Mortgages payable			—												508,565
Debt included in liabilities of disposal group held for sale			2,306,633												—
Total GAAP debt			$	67,068,252											$	75,669,289
Less:
Credit facilities (1)			(909,655)												(895,793)
Debt issued by securitization vehicles			(3,315,087)												(6,458,130)
Participations issued			(315,810)												—
Mortgages payable			—												(508,565)
Non-recourse debt included in liabilities of disposal group held for sale			(2,035,982)												—
Total non-recourse debt			$	60,491,718											$	67,806,801
Plus / (Less):
Cost basis of TBA and CMBX derivatives			18,107,549												19,525,825
Payable for unsettled trades			154,405												2,122,735
Receivable for unsettled trades			(14,336)												(747,082)
Economic debt *			$	78,739,336											$	88,708,279
Total equity			$	13,639,176											$	13,797,603
Economic leverage ratio *			5.8:1												6.4:1

* Represents a non-GAAP financial measure.

(1) Included in Other secured financing in the Consolidated Statements of Financial Condition.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

The following table presents a reconciliation of GAAP total assets to economic total assets for purposes of calculating our economic capital ratio for the periods presented:

			As of
			June 30, 2021												June 30, 2020
Economic capital ratio reconciliation			(dollars in thousands)
Total GAAP assets			$	82,376,305											$	93,458,653
Less:
Gross unrealized gains on TBA derivatives (1)			(31,943)												(123,974)
Debt issued by securitization vehicles (2)			(4,925,196)												(6,458,130)
Plus:
Implied market value of TBA derivatives			17,691,150												19,148,701
Total economic assets *			$	95,110,316											$	106,025,250
Total equity			$	13,639,176											$	13,797,603
Economic capital ratio (3) *			14.3%												13.0%

* Represents a non-GAAP financial measure.

(1) Included in Derivative assets in the Consolidated Statements of Financial Condition.

(2) Includes debt issued by securitization vehicles reported in Liabilities of disposal group held for sale in the Consolidated Statements of Financial Condition.

(3) Economic capital ratio is computed as total equity divided by total economic assets.

Interest income (excluding PAA), economic interest expense and economic net interest income (excluding PAA)

Interest income (excluding PAA) represents interest income excluding the effect of the premium amortization adjustment, and serves as the basis for deriving average yield on interest earning assets (excluding PAA), net interest spread (excluding PAA) and net interest margin (excluding PAA), which are discussed below. We believe this measure provides management and investors with additional detail to enhance their understanding of our operating results and trends by excluding the component of premium amortization expense representing the cumulative effect of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency MBS (other than interest-only securities, multifamily and reverse mortgages), which can obscure underlying trends in the performance of the portfolio.

Economic interest expense is comprised of GAAP interest expense and the net interest component of interest rate swaps. We use interest rate swaps to manage our exposure to changing interest rates on repurchase agreements by economically hedging cash flows associated with these borrowings. Accordingly, adding the net interest component of interest rate swaps to interest expense, as computed in accordance with GAAP, reflects the total contractual interest expense and thus, provides investors with additional information about the cost of our financing strategy. We may use market agreed coupon (“MAC”) interest rate swaps in which we may receive or make a payment at the time of entering into such interest rate swap to compensate for the off-market nature of such interest rate swap. In accordance with GAAP, upfront payments associated with MAC interest rate swaps are not reflected in the net interest component of interest rate swaps in the Consolidated Statements of Comprehensive Income (Loss). We did not enter into any MAC interest rate swaps during the three and six months ended June 30, 2021.

Similarly, economic net interest income (excluding PAA), as computed below, provides investors with additional information to enhance their understanding of the net economics of our primary business operations.

The following tables provide GAAP measures of interest expense and net interest income and details with respect to reconciling the aforementioned line items on a non-GAAP basis for each respective period:

Interest Income (excluding PAA)

			GAAP Interest Income						PAA Cost (Benefit)						Interest Income (excluding PAA) (1)
For the three months ended			(dollars in thousands)
June 30, 2021			$	383,906					$	153,607					$	537,513
June 30, 2020			$	584,812					$	51,742					$	636,554
For the six months ended
June 30, 2021			$	1,147,284					$	(60,963)					$	1,086,321
June 30, 2020			$	1,139,838					$	342,464					$	1,482,302
(1) Represents a non-GAAP financial measure. Refer to disclosures within this section above for additional information on non-GAAP financial measures.

        

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Item 2. Management’s Discussion and Analysis

Economic Interest Expense and Economic Net Interest Income (excluding PAA)

			GAAP Interest Expense						Add: Net Interest Component of Interest Rate Swaps						Economic Interest Expense (1)						GAAP Net Interest Income						Less: Net Interest Component of Interest Rate Swaps						Economic Net Interest Income (1)						Add: PAA Cost (Benefit)						Economic Net Interest Income (excluding PAA) (1)
For the three months ended						(dollars in thousands)
June 30, 2021			$	61,047					$	83,087					$	144,134					$	322,859					$	83,087					$	239,772					$	153,607					$	393,379
June 30, 2020			$	186,032					$	64,561					$	250,593					$	398,780					$	64,561					$	334,219					$	51,742					$	385,961
For the six months ended
June 30, 2021			$	137,020					$	162,834					$	299,854					$	1,010,264					$	162,834					$	847,430					$	(60,963)					$	786,467
June 30, 2020			$	689,505					$	78,541					$	768,046					$	450,333					$	78,541					$	371,792					$	342,464					$	714,256
(1)    Represents a non-GAAP financial measure. Refer to disclosures within this section above for additional information on non-GAAP financial measures.

Experienced and Projected Long-Term CPR

Prepayment speeds, as reflected by the CPR and interest rates vary according to the type of investment, conditions in financial markets, competition and other factors, none of which can be predicted with any certainty. In general, as prepayment speeds and expectations of prepayment speeds on our Agency MBS portfolio increase, related purchase premium amortization increases, thereby reducing the yield on such assets. The following table presents the weighted average experienced CPR and weighted average projected long-term CPR on our Agency MBS portfolio as of and for the periods presented.

			Experienced CPR (1)						Projected Long-term CPR (2)
For the three months ended
June 30, 2021			26.4		%				12.9		%
June 30, 2020			19.5		%				18.0		%
For the six months ended
June 30, 2021			25.2		%				12.9		%
June 30, 2020			16.6		%				18.0		%

         (1)    For the three and six months ended June 30, 2021 and 2020, respectively.

         (2)    At June 30, 2021 and 2020, respectively.

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Item 2. Management’s Discussion and Analysis

Average Yield on Interest Earning Assets (excluding PAA), Net Interest Spread (excluding PAA), Net Interest Margin (excluding PAA) and Average Economic Cost of Interest Bearing Liabilities

Net interest spread (excluding PAA), which is the difference between the average yield on interest earning assets (excluding PAA) and the average economic cost of interest bearing liabilities, which represents annualized economic interest expense divided by average interest bearing liabilities, and net interest margin (excluding PAA), which is calculated as the sum of interest income (excluding PAA) plus TBA dollar roll income and CMBX coupon income less interest expense and the net interest component of interest rate swaps divided by the sum of average interest earning assets plus average TBA contract and CMBX balances, provide management with additional measures of our profitability that management relies upon in monitoring the performance of the business.

Disclosure of these measures, which are presented below, provides investors with additional detail regarding how management evaluates our performance.

Net Interest Spread (excluding PAA)

			Average Interest Earning     Assets (1)						Interest Income (excluding PAA) (2)						Average Yield on Interest Earning Assets (excluding PAA) (2)						Average Interest Bearing Liabilities						Economic Interest Expense (2)(3)						Average Economic Cost of Interest Bearing Liabilities (2)(3)						Economic Net Interest Income (excluding PAA) (2)						Net Interest Spread (excluding PAA) (2)
For the three months ended			(dollars in thousands)
June 30, 2021			$	77,916,766					$	537,513					2.76		%				$	68,469,413					$	144,134					0.83		%				393,379						1.93		%
June 30, 2020			$	84,471,839					$	636,554					3.01		%				$	76,712,894					$	250,593					1.29		%				385,961						1.72		%
For the six months ended
June 30, 2021			$	79,519,053					$	1,086,321					2.73		%				$	70,235,722					$	299,854					0.85		%				786,467						1.88		%
June 30, 2020			$	100,267,867					$	1,482,302					2.96		%				$	91,871,180					$	768,046					1.65		%				714,256						1.31		%

(1)Based on amortized cost.

(2)Represents a non-GAAP financial measure. Refer to the “Non-GAAP Financial Measures” section for additional information.

(3)Average economic cost of interest bearing liabilities represents annualized economic interest expense divided by average interest bearing liabilities. Average interest bearing liabilities reflects the average balances during the period. Economic interest expense is comprised of  GAAP interest expense and the net interest component of interest rate swaps.

Net Interest Margin (excluding PAA)

			Interest Income (excluding PAA) (1)						TBA Dollar Roll and CMBX Coupon Income (2)						Interest Expense						Net Interest Component of Interest Rate Swaps						Subtotal						Average Interest Earnings Assets						Average TBA Contract and CMBX Balances						Subtotal						Net Interest Margin (excluding PAA) (1)
For the three months ended									(dollars in thousands)
June 30, 2021			$	537,513					111,592						(61,047)						(83,087)						$	504,971					$	77,916,766					18,761,062						$	96,677,828					2.09		%
June 30, 2020			$	636,554					97,524						(186,032)						(64,561)						$	483,485					$	84,471,839					18,628,343						$	103,100,182					1.88		%
For the six months ended
June 30, 2021			$	1,086,321					210,525						(137,020)						(162,834)						$	996,992					$	79,519,053					20,313,516						$	99,832,569					2.00		%
June 30, 2020			$	1,482,302					142,428						(689,505)						(78,541)						$	856,684					$	100,267,867					14,296,743						$	114,564,610					1.50		%

(1)Represents a non-GAAP financial measure. Refer to the “Non-GAAP Financial Measures” section for additional information.

(2)TBA dollar roll income and CMBX coupon income each represent a component of Net gains (losses) on other derivatives and financial instruments. CMBX coupon income totaled $1.4 million and $2.9 million for the three and six months ended June 30, 2021, respectively. CMBX coupon income totaled $1.6 million and $2.7 million for the three and six months ended June 30, 2020, respectively.

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Item 2. Management’s Discussion and Analysis

Economic Interest Expense and Average Economic Cost of Interest Bearing Liabilities

Typically, our largest expense is the cost of interest bearing liabilities and the net interest component of interest rate swaps. The table below shows our average interest bearing liabilities and average economic cost of interest bearing liabilities as compared to average one-month and average six-month LIBOR for the periods presented.

Economic Cost of Funds on Average Interest Bearing Liabilities

			Average Interest Bearing Liabilities						Interest Bearing Liabilities at Period End						Economic Interest Expense (1)						Average Economic Cost of Interest Bearing Liabilities (2)						Average One- Month LIBOR						Average Six- Month LIBOR						Average One-Month LIBOR Relative to Average Six- Month LIBOR						Average Economic Cost of Interest Bearing Liabilities Relative to Average One- Month LIBOR						Average Economic Cost of Interest Bearing Liabilities Relative to Average Six-Month LIBOR
For the three months ended
June 30, 2021			$	68,469,413					$	66,642,378					$	144,134					0.83		%				0.10		%				0.19		%				(0.09		%)				0.73		%				0.64		%
June 30, 2020			$	76,712,894					$	75,160,724					$	250,593					1.29		%				0.35		%				0.70		%				(0.35		%)				0.94		%				0.59		%
For the six months ended
June 30, 2021			$	70,235,722					$	64,761,619					$	299,854					0.85		%				0.11		%				0.20		%				(0.09		%)				0.74		%				0.65		%
June 30, 2020			$	91,871,180					$	75,160,724					$	768,046					1.65		%				0.89		%				1.10		%				(0.21		%)				0.76		%				0.55		%
(1)     Economic interest expense is comprised of GAAP interest expense and the net interest component of interest rate swaps. (2)    Represents a non-GAAP financial measure. Refer to the “Non-GAAP Financial Measures” section for additional information.

Economic interest expense decreased by $106.5 million for the three months ended June 30, 2021 compared to the same period in 2020. Economic interest expense decreased by $468.2 million for the six months ended June 30, 2021 compared to the same period in 2020. The change was due to lower borrowing rates and a decrease in average interest bearing liabilities, partially offset by the change in the net interest component of interest rate swaps, which was ($83.1) million for the three months ended June 30, 2021 compared to ($64.6) million for the same period in 2020 and ($162.8) million for the six months ended June 30, 2021 compared to ($78.5) million for the same period in 2020.

We do not manage our portfolio to have a pre-designated amount of borrowings at quarter or year end. Our borrowings at period end are a snapshot of our borrowings as of a date, and this number may differ from average borrowings over the period for a number of reasons. The mortgage-backed securities we own pay principal and interest towards the end of each month and the mortgage-backed securities we purchase are typically settled during the beginning of the month. As a result, depending on the amount of mortgage-backed securities we have committed to purchase, we may retain the principal and interest we receive in the prior month, or we may use it to pay down our borrowings. Moreover, we generally use interest rate swaps, swaptions and other derivative instruments to hedge our portfolio, and as we pledge or receive collateral under these agreements, our borrowings on any given day may be increased or decreased. Our average borrowings during a quarter may differ from period end borrowings as we implement our portfolio management strategies and risk management strategies over changing market conditions by increasing or decreasing leverage. Additionally, these numbers may differ during periods when we conduct equity capital raises, as in certain instances we may purchase additional assets and increase leverage in anticipation of an equity capital raise. Since our average borrowings and period end borrowings can be expected to differ, we believe our average borrowings during a period provide a more accurate representation of our exposure to the risks associated with leverage than our period end borrowings.

At June 30, 2021 and December 31, 2020, the majority of our debt represented repurchase agreements and other secured financing arrangements collateralized by a pledge of our Residential Securities, residential mortgage loans, commercial real estate investments and corporate loans. All of our Residential Securities are currently accepted as collateral for these borrowings. However, we limit our borrowings, and thus our potential asset growth, in order to maintain unused borrowing capacity and maintain the liquidity and strength of our balance sheet.

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Item 2. Management’s Discussion and Analysis

Realized and Unrealized Gains (Losses)

Realized and unrealized gains (losses) is comprised of net gains (losses) on interest rate swaps, net gains (losses) on disposal of investments and other, net gains (losses) on other derivatives and financial instruments and net unrealized gains (losses) on instruments measured at fair value through earnings. These components of realized and unrealized gains (losses) for the three and nine months ended June 30, 2021 and 2020 were as follows:

			For the Three Months Ended June 30,												For the Six Months Ended June 30,
			2021						2020						2021						2020
			(dollars in thousands)
Net gains (losses) on interest rate swaps (1)			$	(224,154)					$	(91,665)					$	468,361					$	(3,330,929)
Net gains (losses) on disposal of investments and other			16,223						246,679						(49,563)						453,262
Net gains (losses) on other derivatives and financial instruments			(357,808)						170,916						119,060						377,342
Net unrealized gains (losses) on instruments measured at fair value through earnings			3,984						254,772						108,175						(475,388)
Loan loss (provision) reversal			(494)						(68,751)						139,126						(168,077)
Business divestiture-related gains (losses)			1,527						—						(248,036)						—
Total			$	(560,722)					$	511,951					$	537,123					$	(3,143,790)

(1)Includes the net interest component of interest rate swaps, realized gains (losses) on termination or maturity of interest rate swaps and unrealized gains (losses) on interest rate swaps.

For the Three Months Ended June 30, 2021 and 2020

Net gains (losses) on interest rate swaps for the three months ended June 30, 2021 was ($224.2) million compared to ($91.7) million for the same period in 2020, primarily attributable to an unfavorable change in unrealized gains (losses) on interest rate swaps, partially offset by a favorable change in Realized gains (losses) on termination or maturity of interest rate swaps. Unrealized gains (losses) on interest rate swaps was ($141.1) million for the three months ended June 30, 2021, reflecting a decline in forward interest rates during the period, compared to $1.5 billion for the same period in 2020, resulting from the unwinding of interest rate swaps during the earlier period. Realized gains (losses) on termination or maturity of interest rate swaps was $0 for the three months ended June 30, 2021 compared to ($1.5) billion for the same period in 2020, resulting from terminations of fixed-rate payer and receiver interest rate swaps with notional amounts of $38.2 billion and $38.1 billion, respectively.

Net gains (losses) on disposal of investments and other was $16.2 million for the three months ended June 30, 2021 compared to $246.7 million for the same period in 2020. For the three months ended June 30, 2021, we disposed of Residential Securities with a carrying value of $3.3 billion for an aggregate net gain of $34.8 million. For the same period in 2020, we disposed of Residential Securities with a carrying value of $5.5 billion for an aggregate net gain of $259.9 million.

Net gains (losses) on other derivatives and financial instruments was ($357.8) million for the three months ended June 30, 2021 compared to $170.9 million for the same period in 2020. The change in net gains (losses) on other derivatives and financial instruments was primarily comprised of higher net losses on futures derivatives, which was ($394.5) million for the three months ended June 30, 2021 compared to ($17.3) million for the same period in 2020, and interest rate swaptions, which was ($255.6) million for the three months ended June 30, 2021 compared to ($52.5) million for the same period in 2020, partially offset by higher net gains on TBA derivatives, which was $285.3 million for the three months ended June 30, 2021 compared to $204.2 million for the same period in 2020.

Net unrealized gains (losses) on instruments measured at fair value through earnings was $4.0 million for the three months ended June 30, 2021 compared to $254.8 million for the same period in 2020, primarily due to unfavorable changes in unrealized gains (losses) on securitized commercial loans of ($190.8) million, credit risk transfer securities of ($173.7) million, securitized residential whole loans of consolidated VIEs of ($76.9) million, Agency interest-only securities of ($69.2) million and non-Agency MBS of ($67.2) million, partially offset by favorable changes in unrealized gains (losses) on commercial securitized debt of consolidated VIEs of $219.9 million, residential securitized debt of consolidated VIEs of $76.9 million and MSR, including Interests in MSR, of $44.2 million for the three months ended June 30, 2021 compared to the same period in 2020.

For the three months ended June 30, 2021 and 2020, net loan loss (provisions) were ($0.5) million on corporate loans and ($68.8) million on commercial mortgage and corporate loans, respectively. Refer to the “Loans” Note located within Item 1 for additional information related to the loan loss (provisions) reversals.

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Item 2. Management’s Discussion and Analysis

For the Six Months Ended June 30, 2021 and 2020

Net gains (losses) on interest rate swaps for the six months ended June 30, 2021 was $468.4 million compared to ($3.3) billion for the same period in 2020, primarily attributable to favorable changes in unrealized gains (losses) on interest rate swaps and realized gains (losses) on termination or maturity of interest rate swaps. Unrealized gains (losses) on interest rate swaps was $631.2 million for the six months ended June 30, 2021, reflecting a decline in forward interest rates during the period, compared to ($1.3) billion for the same period in 2020, reflecting a rise in forward interest rates during the earlier period. Realized gains (losses) on termination or maturity of interest rate swaps was zero for the six months ended June 30, 2021 compared to ($1.9) billion, resulting from fixed-rate payer and receiver interest rate swaps with notional amounts of $65.0 billion and $38.1 billion, respectively, for the same period in 2020.

Net gains (losses) on disposal of investments and other was ($49.6) million for the six months ended June 30, 2021 compared to $453.3 million for the same period in 2020. For the six months ended June 30, 2021, we disposed of Residential Securities with a carrying value of $6.2 billion for an aggregate net loss of ($25.9) million. For the same period in 2020, we disposed of Residential Securities with a carrying value of $47.4 billion for an aggregate net loss of $527.1 million.

Net gains (losses) on other derivatives was $119.1 million for the six months ended June 30, 2021 compared to $377.3 million for the same period in 2020. The change in net gains (losses) on other derivatives was primarily due to the change in net gains (losses) on TBA derivatives, which was ($344.8) million for the six months ended June 30, 2021 compared to $635.9 million for the same period in 2020, partially offset by the change in futures derivatives, which was $418.8 million for the six months ended June 30, 2021 compared to ($289.9) million for the same period in 2020.

Net unrealized gains (losses) on instruments measured at fair value through earnings was $108.2 million for the six months ended June 30, 2021 compared to ($475.4) million for the same period in 2020, primarily due to favorable changes in unrealized gains (losses) on securitized commercial loans of $320.8 million, MSR, including Interests in MSR, of $154.0 million, securitized debt of consolidated VIEs backed by Agency mortgage-backed securities of $132.2 million, securitized residential whole loans of consolidated VIEs of $98.8 million, credit risk transfer securities of $86.5 million and non-Agency MBS of $59.6 million, partially offset by unfavorable changes on commercial securitized debt of consolidated VIEs of ($270.8) million for the six months ended June 30, 2021 compared to the same period in 2020.

For the six months ended June 30, 2021 and 2020, net loan loss (provisions) reversals of $139.1 million and ($168.1) million, respectively, was recorded on commercial mortgage and corporate loans. Refer to the “Loans” Note located within Item 1 for additional information related to these loan loss provisions.

Other Income (Loss)

Other income (loss) includes certain revenues and costs associated with our investments in commercial real estate, including rental income and recoveries, operating costs as well as depreciation and amortization expense, net servicing income on MSRs, brokerage and commission fees, due diligence costs and securitization expenses. We report in Other income (loss) items whose amounts, either individually or in the aggregate, would not, in the opinion of management, be meaningful to readers of the financial statements. Given the nature of certain components of this line item, balances may fluctuate from period to period.

General and Administrative Expenses

General and administrative (“G&A”) expenses consist of compensation and management fee (until closing of the Internalization on June 30, 2020) and other expenses. Beginning with the quarter ended June 30, 2021, we began classifying certain portfolio activity- or volume-related expenses (including but not limited to brokerage and commission fees, due diligence costs and securitization expenses) as Other income (loss) rather than Other general and administrative expenses in the Consolidated Statements of Comprehensive Income (Loss) to better reflect the nature of the items. As such, prior periods have been conformed to the current presentation with Other general and administrative expenses for the three months ended March 31, 2021 adjusted downward by $1.8 million and for the three and six months ended June 30, 2020 adjusted downward by $2.9 million and $10.7 million, respectively. The following table shows our total G&A expenses as compared to average total assets and average equity for the periods presented.

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Item 2. Management’s Discussion and Analysis

G&A Expenses and Operating Expense Ratios

			Total G&A Expenses (1)						Total G&A Expenses/Average Assets (1)						Total G&A Expenses/Average Equity (1)
For the three months ended			(dollars in thousands)
June 30, 2021			$	53,526					0.26		%				1.55		%
June 30, 2020			$	64,770					0.27		%				1.95		%
For the six months ended
June 30, 2021			$	101,431					0.24		%				1.46		%
June 30, 2020			$	134,635					0.25		%				1.91		%

(1) Includes $0.5 million and $2.9 million of costs incurred in connection with the Internalization and costs incurred in connection with the CEO search process for the three and six months ended June 30, 2020, respectively. Excluding these transaction costs, G&A expenses as a percentage of average total assets were unchanged at 0.27% and 0.25% and as a percentage of average equity were 1.94% and 1.87% for the three and six months ended June 30, 2020, respectively.

G&A expenses were $53.5 million for the three months ended June 30, 2021, a decrease of $11.2 million compared to the same period in 2020. G&A expenses were $101.4 million for the six months ended June 30, 2021, a decrease of $33.2 million compared to the same period in 2020. The change in each period was largely attributable to cost savings generated from the Internalization which closed on June 30, 2020 and lower professional fees during the second quarter and first half of 2021 compared with the same periods in 2020.

Return on Average Equity

The following table shows the components of our annualized return on average equity for the periods presented.

Components of Annualized Return on Average Equity

			Economic Net Interest Income/ Average Equity (1)						Realized and Unrealized Gains and Losses/Average Equity (2)						Other Income (Loss)/Average Equity						G&A Expenses/ Average Equity						Income Taxes/ Average Equity						Return on Average Equity
For the three months ended
June 30, 2021			6.92		%				(13.79		%)				0.06		%				(1.55		%)				(0.15		%)				(8.51		%)
June 30, 2020			10.09		%				17.40		%				0.37		%				(1.95		%)				(0.07		%)				25.84		%
For the six months ended
June 30, 2021			12.18		%				10.06		%				0.25		%				(1.48		%)				(0.07		%)				20.94		%
June 30, 2020			5.27		%				(43.48		%)				0.28		%				(1.91		%)				0.35		%				(39.49		%)
(1)     Economic net interest income includes the net interest component of interest rate swaps. (2)     Realized and unrealized gains and losses excludes the net interest component of interest rate swaps.

Unrealized Gains and Losses - Available-for-Sale Investments

With our available-for-sale accounting treatment on our Agency MBS, which represent the largest portion of assets on balance sheet, as well as certain commercial mortgage-backed securities, unrealized fluctuations in market values of assets do not impact our GAAP net income (loss) but rather are reflected on our balance sheet by changing the carrying value of the asset and stockholders’ equity under accumulated other comprehensive income (loss). As a result of this fair value accounting treatment, our book value and book value per share are likely to fluctuate far more than if we used amortized cost accounting. As a result, comparisons with companies that use amortized cost accounting for some or all of their balance sheet may not be meaningful.

The table below shows cumulative unrealized gains and losses on our available-for-sale investments reflected in the Consolidated Statements of Financial Condition.

			June 30, 2021						December 31, 2020
			(dollars in thousands)
Unrealized gain			$	2,040,648					$	3,378,523
Unrealized loss			(260,373)						(4,188)
Accumulated other comprehensive income (loss)			$	1,780,275					$	3,374,335

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Item 2. Management’s Discussion and Analysis

Unrealized changes in the estimated fair value of available-for-sale investments may have a direct effect on our potential earnings and dividends: positive changes will increase our equity base and allow us to increase our borrowing capacity while negative changes tend to reduce borrowing capacity. A very large negative change in the net fair value of our available-for-sale Residential Securities might impair our liquidity position, requiring us to sell assets with the potential result of realized losses upon sale.

The fair value of these securities being less than amortized cost at June 30, 2021 is solely due to market conditions and not the quality of the assets. Substantially all of the Agency MBS are “AAA” rated or carry an implied “AAA” rating. The investments are not considered to be other-than-temporarily impaired because we currently have 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 we will be required to sell the investments before recovery of the amortized cost bases, which may be maturity. Also, we are guaranteed payment of the principal and interest amounts of the securities by the respective issuing Agency.

Financial Condition

Total assets were $82.4 billion and $88.5 billion at June 30, 2021 and December 31, 2020, respectively. The change was primarily due to a decrease in Agency MBS, including assets transferred or pledged to securitization vehicles, of $7.6 billion partially offset by increases in residential mortgage loans, including assets transferred or pledged to securitization vehicles, of $0.9 billion and non-Agency MBS of $0.6 billion. Our portfolio composition, net equity allocation and debt-to-net equity ratio by asset class were as follows at June 30, 2021:

			Residential									Commercial
			Agency MBS and MSR												Residential Credit (1)						Commercial Real Estate (2)						Corporate Debt						Total
Assets			(dollars in thousands)
Fair value/carrying value			$	67,325,333											$	6,907,573					$	3,394,032					$	2,533,079					$	80,160,017
Implied market value of derivatives (3)			17,691,150												—						449,196						—						18,140,346
Debt
Repurchase agreements			58,805,571												1,194,142						221,354						—						60,221,067
Implied cost basis of derivatives (3)			17,662,043												—						445,506						—						18,107,549
Other secured financing			—												—						—						909,655						909,655
Debt issued by securitization vehicles			558,894												2,756,193						—						—						3,315,087
Participations issued			—												315,810						—						—						315,810
Net forward purchases			145,138												(5,069)						—						—						140,069
Liabilities of disposal group held for sale			—												—						2,306,632						—						2,306,632
Other
Other assets / liabilities (4)			1,821,036												2,090						(857,773)						(310,672)						654,681
Net equity allocated			$	9,665,873											$	2,648,587					$	11,963					$	1,312,752					$	13,639,175
Net equity allocated (%)			71		%										19		%				—		%				10		%				100		%
Debt/net equity ratio			6.1:1												1.6:1						NM						0.7:1						4.7:1			(5)
(1) Fair value/carrying includes residential loans held for sale. (2) Fair value/carrying includes commercial real estate investments held for sale. (3) Derivatives include TBA contracts under Agency MBS and MSRs and CMBX balances under Commercial Real Estate. (4) Dedicated capital allocations as of June 30, 2021 assume capital related to held for sale assets will be redeployed within the Agency business line. (5) Represents the debt/net equity ratio as determined using amounts on the Consolidated Statements of Financial Condition. Excludes liabilities of disposal group held for sale. NM Not meaningful.

Residential Securities

Substantially all of our Agency MBS at June 30, 2021 and December 31, 2020 were backed by single-family residential mortgage loans and were secured with a first lien position on the underlying single-family properties. Our mortgage-backed securities were largely Freddie Mac, Fannie Mae or Ginnie Mae pass through certificates or CMOs, which carry an actual or implied “AAA” rating. We carry all of our Agency MBS at fair value on the Consolidated Statements of Financial Condition.

We accrete discount balances as an increase to interest income over the expected life of the related interest earning assets and we amortize premium balances as a decrease to interest income over the expected life of the related interest earning assets. At June 30, 2021 and December 31, 2020 we had on our Consolidated Statements of Financial Condition a total of $84.3 million and $88.3 million, respectively, of unamortized discount (which is the difference between the remaining principal value and

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Item 2. Management’s Discussion and Analysis

current amortized cost of our Residential Securities, excluding securities transferred or pledged to securitization vehicles, acquired at a price below principal value) and a total of $4.0 billion and $4.0 billion, respectively, of unamortized premium (which is the difference between the remaining principal value and the current amortized cost of our Residential Securities, excluding securities transferred or pledged to securitization vehicles, acquired at a price above principal value).

The weighted average experienced prepayment speed on our Agency MBS portfolio for the three months ended June 30, 2021 and 2020 was 26.4% and 19.5%, respectively. The weighted average projected long-term prepayment speed on our Agency MBS portfolio as of June 30, 2021 and 2020 was 12.9% and 18.0%, respectively.

Given our current portfolio composition, if mortgage principal prepayment rates were to increase over the life of our mortgage-backed securities, all other factors being equal, our net interest income would decrease during the life of these mortgage-backed securities as we would be required to amortize our net premium balance into income over a shorter time period. Similarly, if mortgage principal prepayment rates were to decrease over the life of our mortgage-backed securities, all other factors being equal, our net interest income would increase during the life of these mortgage-backed securities as we would amortize our net premium balance over a longer time period.

The following tables present our Residential Securities, excluding securities transferred or pledged to securitization vehicles, that were carried at fair value at June 30, 2021 and December 31, 2020.

																																							June 30, 2021						December 31, 2020
																																							Estimated Fair Value
Agency																																							(dollars in thousands)
Fixed-rate pass-through																																							$	64,718,925					$	71,302,578
Adjustable-rate pass-through																																							395,020						477,516
CMO																																							136,356						149,767
Interest-only																																							362,692						421,909
Multifamily																																							811,382						1,663,507
Reverse mortgages																																							44,144						51,782
Total agency securities																																							$	66,468,519					$	74,067,059
Residential credit
Residential CRT																																							$	827,328					$	532,403
Alt-A																																							65,851						80,328
Prime																																							194,073						181,509
Prime interest-only																																							524						1,240
Subprime																																							182,596						188,433
NPL/RPL																																							1,064,084						475,847
Prime jumbo (>= 2010 vintage)																																							74,302						43,283
Prime jumbo (>= 2010 vintage) interest-only																																							893						1,552
Total residential credit securities																																							$	2,409,651					$	1,504,595
Total Residential Securities																																							$	68,878,170					$	75,571,654

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Item 2. Management’s Discussion and Analysis

The following table summarizes certain characteristics of our Residential Securities (excluding interest-only mortgage-backed securities) and interest-only mortgage-backed securities, excluding securities transferred or pledged to securitization vehicles, at June 30, 2021 and December 31, 2020.

			June 30, 2021						December 31, 2020
Residential Securities (1)			(dollars in thousands)
Principal amount			$	63,371,277					$	68,521,464
Net premium			3,226,135						3,280,439
Amortized cost			66,597,412						71,801,903
Amortized cost / principal amount			105.09		%				104.79		%
Carrying value			68,351,303						75,116,466
Carrying value / principal amount			107.86		%				109.62		%
Weighted average coupon rate			3.45		%				3.58		%
Weighted average yield			2.98		%				2.86		%
Adjustable-rate Residential Securities (1)
Principal amount			$	1,419,815					$	1,257,966
Weighted average coupon rate			2.79		%				3.20		%
Weighted average yield			7.72		%				5.20		%
Weighted average term to next adjustment			13 Months						15 Months
Weighted average lifetime cap (2)			0.24		%				0.41		%
Principal amount at period end as % of total residential securities			2.24		%				1.84		%
Fixed-rate Residential Securities (1)
Principal amount			$	61,951,462					$	67,263,498
Weighted average coupon rate			3.46		%				3.58		%
Weighted average yield			2.87		%				2.82		%
Principal amount at period end as % of total residential securities			97.76		%				98.16		%
Interest-only Residential Securities
Notional amount			$	4,842,596					$	3,642,143
Net premium			688,627						602,790
Amortized cost			688,627						602,790
Amortized cost / notional amount			14.22		%				16.55		%
Carrying value			526,867						455,188
Carrying value / notional amount			10.88		%				12.50		%
Weighted average coupon rate			2.94		%				3.99		%
Weighted average yield			1.13		%				NM
(1)     Excludes interest-only MBS. (2)     Excludes non-Agency MBS and CRT securities as this attribute is not applicable to these asset classes. NM     Not meaningful.

The following tables summarize certain characteristics of our Residential Credit portfolio at June 30, 2021.

 

									Payment Structure												Investment Characteristics
Product			Total						Senior						Subordinate						Coupon						Credit Enhancement						60+ Delinquencies						3M VPR (1)
(dollars in thousands)
Agency credit risk transfer			$	789,895					$	—					$	789,895					3.21		%				2.26		%				4.94		%				46.94		%
Private label credit risk transfer			37,433						—						37,433						3.93		%				0.58		%				2.73		%				5.68		%
Alt-A			65,851						16,852						48,999						3.09		%				8.95		%				16.90		%				24.97		%
Prime			194,073						66,128						127,945						4.15		%				9.04		%				6.16		%				37.67		%
Prime interest-only			524						524						—						0.48		%				—						3.65		%				64.95		%
Subprime			182,596						110,264						72,332						2.04		%				19.74		%				13.24		%				12.72		%
Re-performing loan securitizations			707,958						305,775						402,183						3.82		%				25.69		%				24.14		%				10.82		%
Non-performing loan securitizations			356,126						330,875						25,251						2.38		%				27.80		%				43.70		%				5.40		%
Prime jumbo (>=2010 vintage)			74,302						—						74,302						3.44		%				4.39		%				2.75		%				57.08		%
Prime jumbo (>=2010 vintage) interest-only			893						893						—						0.37		%				—						6.54		%				55.85		%
Total/weighted average (2)			$	2,409,651					$	831,311					$	1,578,340					3.26		%				14.99		%				17.25		%				27.78		%
(1)    Represents the 3 month voluntary prepayment rate (“VPR”). (2)    Total investment characteristics exclude the impact of interest-only securities.

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Item 2. Management’s Discussion and Analysis

			Bond Coupon
Product			ARM						Fixed						Floater						Interest-Only						Estimated Fair Value
(dollars in thousands)
Agency credit risk transfer			$	—					$	51					$	789,793					$	51					$	789,895
Private label credit risk transfer			—						—						37,433						—						37,433
Alt-A			7,043						46,545						12,263						—						65,851
Prime			35,635						153,507						4,931						—						194,073
Prime interest-only			—						—						—						524						524
Subprime			7,377						77,896						97,124						199						182,596
Re-performing loan securitizations			—						707,958						—						—						707,958
Non-performing loan securitizations			—						356,126						—						—						356,126
Prime jumbo (>=2010 vintage)			—						74,302						—						—						74,302
Prime jumbo (>=2010 vintage) interest-only			—						—						—						893						893
Total			$	50,055					$	1,416,385					$	941,544					$	1,667					$	2,409,651

Contractual Obligations

The following table summarizes the effect on our liquidity and cash flows from contractual obligations at June 30, 2021. The table does not include the effect of net interest rate payments on our interest rate swap agreements and excludes assets and liabilities of the disposal group held for sale. The net swap payments will fluctuate based on monthly changes in the floating rate. At June 30, 2021, the interest rate swaps had a net fair value of ($0.8) billion.

			Within One Year						One to Three Years						Three to Five Years						More than Five Years						Total
			(dollars in thousands)
Repurchase agreements			$	60,221,067					$	—					$	—					$	—					$	60,221,067
Interest expense on repurchase agreements (1)			25,356						—						—						—						25,356
Other secured financing			—						—						909,655						—						909,655
Interest expense on other secured financing (1)			19,416						38,885						29,181						—						87,482
Debt issued by securitization vehicles (principal)			—						—						—						3,239,390						3,239,390
Interest expense on debt issued by securitization vehicles			76,651						153,302						153,302						2,101,560						2,484,815
Participations issued (principal)			—						—						—						302,865						302,865
Interest expense on participations issued			10,398						20,797						20,797						268,710						320,702
Long-term operating lease obligations			3,865						7,724						4,827						—						16,416
Total			$	60,356,753					$	220,708					$	1,117,762					$	5,912,525					$	67,607,748

(1)     Interest expense on repurchase agreements and other secured financing calculated based on rates at June 30, 2021.

In the coming periods, we expect to continue to finance our Residential Securities in a manner that is largely consistent with our current operations via repurchase agreements. We may use securitization structures, credit facilities or other term financing structures to finance certain of our assets. During the six months ended June 30, 2021, we received $10.2 billion from principal repayments and $6.4 billion in cash from disposal of securities. During the six months ended June 30, 2020, we received $9.3 billion from principal repayments and $46.8 billion in cash from disposal of securities.

Off-Balance Sheet Arrangements

We do not have any relationships with unconsolidated entities or financial partnerships which would have been established for the sole purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

We have limited future funding commitments related to certain of our unconsolidated joint ventures. In addition, we have provided customary non-recourse carve-out and environmental guarantees (or underlying indemnities with respect thereto) with respect to mortgage loans held by subsidiaries of these unconsolidated joint ventures. We believe that the likelihood of making any payments under these guarantees is remote, and have not accrued a related liability at June 30, 2021.

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Item 2. Management’s Discussion and Analysis

Capital Management

Maintaining a strong balance sheet that can support the business even in times of economic stress and market volatility is of critical importance to our business strategy. A strong and robust capital position is essential to executing our investment strategy. Our capital strategy is predicated on a strong capital position, which enables us to execute our investment strategy regardless of the market environment. Our capital policy defines the parameters and principles supporting a comprehensive capital management practice.

The major risks impacting capital are capital, liquidity and funding risk, investment/market risk, credit risk, counterparty risk, operational risk and compliance, regulatory and legal risk. For further discussion of the risks we are subject to, please see Part I, Item 1A. “Risk Factors” in our most recent Annual Report on Form 10-K and in Part II, Item 1A. “Risk Factors” in this Quarterly Report on Form 10-Q.

Capital requirements are based on maintaining levels above approved thresholds, ensuring the quality of our capital appropriately reflects our asset mix, market and funding structure. In the event we fall short of our internal thresholds, we will consider appropriate actions which may include asset sales, changes in asset mix, reductions in asset purchases or originations, issuance of capital or other capital enhancing or risk reduction strategies.

Stockholders’ Equity

The following table provides a summary of total stockholders’ equity at June 30, 2021 and December 31, 2020:

			June 30, 2021						December 31, 2020
Stockholders’ equity			(dollars in thousands)
6.95% Series F fixed-to-floating rate cumulative redeemable preferred stock			696,910						696,910
6.50% Series G fixed-to-floating rate cumulative redeemable preferred stock			411,335						411,335
6.75% Series I fixed-to-floating rate cumulative redeemable preferred stock			428,324						428,324
Common stock			14,442						13,982
Additional paid-in capital			20,178,692						19,750,818
Accumulated other comprehensive income (loss)			1,780,275						3,374,335
Accumulated deficit			(9,892,863)						(10,667,388)
Total stockholders’ equity			$	13,617,115					$	14,008,316

Capital Stock

Common Stock

During the three and six months ended June 30, 2021, we issued 45.5 million shares for proceeds of $420.4 million, net of commissions and fees, under the at-the-market sales program. No shares were issued under the at-the-market sales program during the three and six months ended June 30, 2020.

In June 2019, we announced that our Board authorized the repurchase of up to $1.5 billion of our outstanding shares of common stock, which expired on December 31, 2020 (“the Prior Share Repurchase Program”). In December 2020, we announced that our Board authorized the repurchase of up to $1.5 billion of our outstanding common shares through December 31, 2021 (the “Current Share Repurchase Program”). The Current Share Repurchase Program replaced the Prior Share Repurchase Program. During the three and six months ended June 30, 2021, no shares were purchased pursuant to these authorizations. During the three and six months ended June 30, 2020, we repurchased an aggregate of 22.9 million shares of our common stock for an aggregate amount of $143.3 million, excluding commission costs. All common shares purchased were part of a publicly announced plan in open-market transactions.

Leverage and Capital

We believe that it is prudent to maintain conservative GAAP leverage ratios and economic leverage ratios as there may be continued volatility in the mortgage and credit markets. Our capital policy governs our capital and leverage position including setting limits. Based on the guidelines, we generally expect to maintain an economic leverage ratio of less than 10:1. Our actual economic leverage ratio varies from time to time based upon various factors, including our management’s opinion of the level of risk of our assets and liabilities, our liquidity position, our level of unused borrowing capacity, the availability of credit, over-collateralization levels required by lenders when we pledge assets to secure borrowings and our assessment of domestic and international market conditions.

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Item 2. Management’s Discussion and Analysis

Our GAAP leverage ratio at June 30, 2021 and December 31, 2020 was 4.7:1 and 5.1:1, respectively. Our economic leverage ratio, which is computed as the sum of Recourse Debt, cost basis of TBA and CMBX derivatives outstanding, and net forward purchases (sales) of investments divided by total equity was 5.8:1 and 6.2:1 at June 30, 2021 and December 31, 2020, respectively. Our GAAP capital ratio at June 30, 2021 and December 31, 2020 was 16.6% and 15.9%, respectively. Our economic capital ratio, which represents our ratio of stockholders’ equity to total economic assets (inclusive of the implied market value of TBA derivatives and net of debt issued by securitization vehicles), was 14.3% and 13.6% at June 30, 2021 and December 31, 2020, respectively. Economic leverage ratio and economic capital ratio are non-GAAP financial measures. Refer to the “Non-GAAP Financial Measures” section for additional information, including reconciliations to their most directly comparable GAAP results.

 

Risk Management

For more information on COVID-19, including actions we have taken in response, please refer to the section titled “Business Environment and COVID-19” within this Item 2.

We are subject to a variety of risks in the ordinary conduct of our business. The effective management of these risks is of critical importance to the overall success of Annaly. The objective of our risk management framework is to identify, measure and monitor these risks.

Our risk management framework is intended to facilitate a holistic, enterprise wide view of risk. We believe we have built a strong and collaborative risk management culture throughout Annaly focused on awareness which supports appropriate understanding and management of our key risks. Each employee is accountable for identifying, monitoring and managing risk within their area of responsibility.

Risk Appetite

We maintain a firm-wide risk appetite statement which defines the types and levels of risk we are willing to take in order to achieve our business objectives, and reflects our risk management philosophy. We engage in risk activities based on our core expertise that aim to enhance value for our stockholders. Our activities focus on income generation and capital preservation through proactive portfolio management, supported by a conservative liquidity and leverage posture.

The risk appetite statement asserts the following key risk parameters to guide our investment management activities:

Risk Parameter						Description
Portfolio Composition						We will maintain a portfolio comprised of target assets approved by our Board and in accordance with our capital allocation policy.
Leverage						We generally expect to maintain an economic leverage ratio no greater than 10:1.
Liquidity Risk						We will seek to maintain an unencumbered asset portfolio sufficient to meet our liquidity needs under adverse market conditions.
Interest Rate Risk						We will seek to manage interest rate risk to protect the portfolio from adverse rate movements utilizing derivative instruments targeting both income and capital preservation.
Credit Risk						We will seek to manage credit risk by making investments which conform within our specific investment policy parameters and optimize risk-adjusted returns.
Capital Preservation						We will seek to protect our capital base through disciplined risk management practices.
Operational						We will seek to limit impacts to our business through disciplined operational risk management practices.
Compliance, Regulatory and Legal						We will seek to comply with regulatory requirements needed to maintain our REIT status and our exemption from registration under the Investment Company Act and the licenses and approvals of our regulated and licensed subsidiaries.

Governance

Risk management begins with our Board, through the review and oversight of the risk management framework, and executive management, through the ongoing formulation of risk management practices and related execution in managing risk. The Board exercises its oversight of risk management primarily through the Board Risk Committee (“BRC”) and Board Audit Committee (“BAC”) with support from the other Board Committees. The BRC is responsible for oversight of our risk governance structure, risk management and risk assessment guidelines and policies and our risk appetite. The BAC is responsible for oversight of the quality and integrity of our accounting, internal controls and financial reporting practices, including independent auditor selection, evaluation and review, and oversight of the internal audit function. The Management Development and Compensation Committee is responsible for oversight of risk related to our compensation policies and practices. The Corporate Responsibility Committee assists the Board in its oversight of any matters that may present reputational or Environment, Social,

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Item 2. Management’s Discussion and Analysis

and Governance risk to us, and the Nominating/Corporate Governance Committee assists the Board in its oversight of our corporate governance framework and the annual self-evaluation of the Board.

Risk assessment and risk management are the responsibility of our management. A series of management committees has oversight or decision-making responsibilities for risk management activities. Membership of these committees is reviewed regularly to ensure the appropriate personnel are engaged in the risk management process. Four primary management committees have been established to provide a comprehensive framework for risk management. The management committees responsible for our risk management include the Enterprise Risk Committee (“ERC”), Asset and Liability Committee (“ALCO”), Investment Committee and the Financial Reporting and Disclosure Committee (“FRDC”). Each of these committees reports to our management Operating Committee which is responsible for oversight and management of our operations, including oversight and approval authority over all aspects of our enterprise risk management. 

Audit Services is an independent function with reporting lines to the BAC. Audit Services is responsible for performing our internal audit activities, which includes independently assessing and validating key controls within the risk management framework.

Our compliance group is responsible for oversight of our regulatory compliance. Our Chief Compliance Officer has reporting lines to the BAC.

Description of Risks

We are subject to a variety of risks due to the business we operate. Risk categories are an important component of a robust enterprise wide risk management framework.

We have identified the following primary categories that we utilize to identify, assess, measure and monitor risk.

Risk						Description
Capital, Liquidity and Funding Risk						Risk to earnings, capital or business resulting from our inability to meet our obligations when they come due without incurring unacceptable losses because of inability to liquidate assets or obtain adequate funding.
Investment/Market Risk						Risk to earnings, capital or business resulting in the decline in value of our assets or an increase in the costs of financing caused by changes in market variables, such as interest rates, which affect the values of investment securities and other investment instruments.
Credit Risk						Risk to earnings, capital or business resulting from an obligor’s failure to meet the terms of any contract or otherwise failure to perform as agreed. This risk is present in lending and investing activities.
Counterparty Risk						Risk to earnings, capital or business resulting from a counterparty’s failure to meet the terms of any contract or otherwise failure to perform as agreed. This risk is present in funding, hedging and investing activities.
Operational Risk						Risk to earnings, capital, reputation or business arising from inadequate or failed internal processes or systems (including proprietary and third party models), human factors or external events. This risk also applies to our use of software vendors and data providers.
Compliance, Regulatory and Legal Risk						Risk to earnings, capital, reputation or conduct of business arising from violations of, or nonconformance with internal and external applicable rules and regulations, losses resulting from lawsuits or adverse judgments, or from changes in the regulatory environment that may impact our business model.

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Item 2. Management’s Discussion and Analysis

Capital, Liquidity and Funding Risk Management

Our capital, liquidity and funding risk management strategy is designed to ensure the availability of sufficient resources to support our business and meet our financial obligations under both normal and adverse market and business environments. Our capital, liquidity and funding risk management practices consist of the following primary elements:

Element						Description
Funding						Availability of diverse and stable sources of funds.
Excess Liquidity						Excess liquidity primarily in the form of unencumbered assets and cash.
Maturity Profile						Diversity and tenor of liabilities and modest use of leverage.
Stress Testing						Scenario modeling to measure the resiliency of our liquidity position.
Liquidity Management Policies						Comprehensive policies including monitoring, risk limits and an escalation protocol.

Funding

Our primary financing sources are repurchase agreements provided through counterparty arrangements and through Arcola, other secured financing, debt issued by securitization vehicles, mortgages, credit facilities, note sales and various forms of equity. We maintain excess liquidity by holding unencumbered liquid assets that could be either used to collateralize additional borrowings or sold.

We seek to conservatively manage our repurchase agreement funding position through a variety of methods including diversity, breadth and depth of counterparties and maintaining a staggered maturity profile.

Our wholly-owned subsidiary, Arcola, provides direct access to third party funding as a FINRA member broker-dealer. Arcola borrows funds through the General Collateral Finance Repo service offered by the FICC, with FICC acting as the central counterparty. In addition, Arcola borrows funds through direct repurchase agreements.

To reduce our liquidity risk we maintain a laddered approach to our repurchase agreements. At June 30, 2021 and December 31, 2020, the weighted average days to maturity was 88 days and 64 days, respectively.

Our repurchase agreements generally provide that in the event of a margin call we must provide additional securities or cash on the same business day that a margin call is made. Should prepayment speeds on the mortgages underlying our Agency and Residential mortgage-backed securities and/or market interest rates or other factors move suddenly and cause declines in the market value of assets posted as collateral, resulting margin calls may cause an adverse change in our liquidity position.

At June 30, 2021, we had total financial assets and cash pledged against existing liabilities of $66.4 billion. The weighted average haircut was approximately 3% on repurchase agreements. The quality and character of the Residential Securities and commercial real estate investments that we pledge as collateral under the repurchase agreements and interest rate swaps did not materially change at June 30, 2021 compared to the same period in 2020, and our counterparties did not materially alter any requirements, including required haircuts, related to the collateral we pledge under repurchase agreements and interest rate swaps during the three months ended June 30, 2021.

The following table presents our quarterly average and quarter-end repurchase agreement and reverse repurchase agreement balances outstanding for the periods presented:

			Repurchase Agreements												Reverse Repurchase Agreements
			Average Daily Amount Outstanding						Ending Amount Outstanding						Average Daily Amount Outstanding						Ending Amount Outstanding
For the three months ended			(dollars in thousands)
June 30, 2021			$	62,440,803					$	60,221,067					$	42,581					$	—
March 31, 2021			65,461,539						61,202,477						143,395						—
December 31, 2020			65,528,297						64,825,239						210,484						—
September 30, 2020			67,542,187						64,633,447						286,792						—
June 30, 2020			68,468,813						67,163,598						183,423						—
March 31, 2020			96,756,341						72,580,183						461,123						—
December 31, 2019			102,760,107						101,740,728						1,006,487						—
September 30, 2019			108,389,796						102,682,104						1,459,070						—
June 30, 2019			101,983,828						105,181,241						3,478,510						—

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Item 2. Management’s Discussion and Analysis

The following table provides information on our repurchase agreements and other secured financing by maturity date at June 30, 2021. The weighted average remaining maturity on our repurchase agreements and other secured financing was 111 days at June 30, 2021:

			June 30, 2021
			Principal Balance						Weighted Average Rate						% of Total
			(dollars in thousands)
1 day			$	10,195,167					0.09		%				16.7		%
2 to 29 days			16,221,281						0.14		%				26.5		%
30 to 59 days			6,437,669						0.27		%				10.5		%
60 to 89 days			4,639,954						0.16		%				7.6		%
90 to 119 days			5,873,992						0.16		%				9.6		%
Over 120 days (1)			17,762,659						0.28		%				29.1		%
Total			$	61,130,722					0.19		%				100.0		%

     (1)    Approximately 1% of the total repurchase agreements and other secured financing had a remaining maturity over 1 year.

The table below presents our outstanding debt balances and associated weighted average rates and days to maturity at June 30, 2021:

									Weighted Average Rate
			Principal Balance						As of Period End						For the Quarter						Weighted Average Days to Maturity (1)
			(dollars in thousands)
Repurchase agreements			$	60,221,067					0.16		%				0.17		%				88
Other secured financing (2)			909,655						2.13		%				2.92		%				1,645
Debt issued by securitization vehicles (3)			3,239,390						2.29		%				2.20		%				11,599
Participations issued (3)			302,865						3.43		%				2.22		%				11,257
Total indebtedness			$	64,672,977
(1)    Determined based on estimated weighted-average lives of the underlying debt instruments. (2)    Includes financing under credit facilities. (3)    Non-recourse to Annaly.

Excess Liquidity

Our primary source of liquidity is the availability of unencumbered assets which may be provided as collateral to support additional funding needs. We target minimum thresholds of available, unencumbered assets to maintain excess liquidity. The following table illustrates our asset portfolio available to support potential collateral obligations and funding needs.

Assets are considered encumbered if pledged as collateral against an existing liability, and therefore are no longer available to support additional funding. An asset is considered unencumbered if it has not been pledged or securitized. The following table also provides the carrying amount of our encumbered and unencumbered financial assets at June 30, 2021:

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

			Encumbered Assets						Unencumbered Assets						Total
Financial assets			(dollars in thousands)
Cash and cash equivalents			$	1,207,566					$	172,890					$	1,380,456
Investments, at carrying value (1)
Agency mortgage-backed securities (2)			62,375,349						4,565,421						66,940,770
Credit risk transfer securities			244,907						587,490						832,397
Non-agency mortgage-backed securities			610,320						972,003						1,582,323
Commercial mortgage-backed securities			—						154,165						154,165
Residential mortgage loans (2)			3,244,342						1,253,580						4,497,922
MSR			—						202,616						202,616
Interests in MSR			—						49,035						49,035
Corporate debt, held for investment			1,378,036						688,673						2,066,709
Corporate debt, held for sale			—						466,370						466,370
Assets of disposal group held for sale (3)			2,185,727						487,663						2,673,390
Other assets (4)			—						45,121						45,121
Total financial assets			$	71,246,247					$	9,645,027					$	80,891,274

(1)    The amounts reflected in the table above are on a settlement date basis and may differ from the total positions reported on the Consolidated Statements of Financial Condition.

(2)    Includes assets transferred or pledged to securitization vehicles.

(3)    Comprised of commercial real estate investments held for sale.

(4)    Includes interests in certain joint ventures.

We maintain liquid assets in order to satisfy our current and future obligations in normal and stressed operating environments. These are held as the primary means of liquidity risk mitigation. The composition of our liquid assets is also considered and is subject to certain parameters. The composition is monitored for concentration risk and asset type. We believe the assets we consider liquid can be readily converted into cash, through liquidation or by being used as collateral in financing arrangements (including as additional collateral to support existing financial arrangements). Our balance sheet also generates liquidity on an on-going basis through mortgage principal and interest repayments and net earnings held prior to payment of dividends. The following table presents our liquid assets as a percentage of total assets at June 30, 2021:

			Carrying Value (1)
Liquid assets			(dollars in thousands)
Cash and cash equivalents			$	1,380,456
Residential Securities (2) (3)			68,750,128
Commercial mortgage-backed securities			154,165
Residential mortgage loans (4)			1,029,929
Corporate debt, held for investment (5)			1,630,452
Corporate debt, held for sale			466,370
Assets of disposal group held for sale (6)			55,172
Total liquid assets			$	73,466,672
Percentage of liquid assets to carrying amount of encumbered and unencumbered financial assets (7)			98.38		%

(1)Carrying value approximates the market value of assets. The assets listed in this table include $66.4 billion of assets that have been pledged as collateral against existing liabilities at June 30, 2021. Please refer to the Encumbered and Unencumbered Assets table for related information.

(2)The amounts reflected in the table above are on a settlement date basis and may differ from the total positions reported on the Consolidated Statements of Financial Condition.

(3)Excludes securitized Agency MBS of consolidated VIEs carried at fair value of $0.6 billion.

(4)Excludes securitized residential mortgage loans transferred or pledged to consolidated VIEs carried at fair value of $3.5 billion.

(5)Excludes certain second lien loans.

(6)Comprised of commercial real estate investments held for sale. Excludes securitized commercial mortgage loans and senior securitized commercial mortgage loans of consolidated VIEs carried at fair value of $2.1 billion.

(7)Denominator is computed based on the carrying amount of encumbered and unencumbered financial assets, excluding assets transferred or pledged to securitization vehicles of $6.2 billion.

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Item 2. Management’s Discussion and Analysis

Maturity Profile

We consider the profile of our assets, liabilities and derivatives when managing both liquidity risk as well as investment/market risk employing a measurement of both the maturity gap and interest rate sensitivity gap. We determine the amount of liquid assets that are required to be held by monitoring several liquidity metrics. We utilize several modeling techniques to analyze our current and potential obligations including the expected cash flows from our assets, liabilities and derivatives. The following table illustrates the expected final maturities and cash flows of our assets, liabilities and derivatives. The table is based on a static portfolio and assumes no reinvestment of asset cash flows and no future liabilities are entered into. In assessing the maturity of our assets, liabilities and off balance sheet obligations, we use the stated maturities, or our prepayment expectations for assets and liabilities that exhibit prepayment characteristics. Cash and cash equivalents are included in the ‘Less than 3 Months’ maturity bucket, as they are typically held for a short period of time.

With respect to each maturity bucket, our maturity gap is considered negative when the amount of maturing liabilities exceeds the amount of maturing assets. A negative gap increases our liquidity risk as we must enter into future liabilities.

Our interest rate sensitivity gap is the difference between interest earning assets and interest bearing liabilities maturing or re-pricing within a given time period. Unlike the calculation of maturity gap, interest rate sensitivity gap includes the effect of our interest rate swaps. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities. A gap is considered negative when the amount of interest-rate sensitive liabilities exceeds interest-rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if assets and liabilities were perfectly matched in each maturity category. The amount of assets and liabilities utilized to compute our interest rate sensitivity gap was determined in accordance with the contractual terms of the assets and liabilities, except that adjustable-rate loans and securities are included in the period in which their interest rates are first scheduled to adjust and not in the period in which they mature. The effects of interest rate swaps, whereby we generally pay a fixed rate and receive a floating rate and effectively lock in our financing costs for a longer term, are also reflected in our interest rate sensitivity gap.

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Item 2. Management’s Discussion and Analysis

The interest rate sensitivity of our assets and liabilities, excluding assets and liabilities of the disposal group held for sale and corporate loans held for sale, in the following table at June 30, 2021 could vary substantially based on actual prepayment experience.

			Less than 3 Months						3-12  Months						More than 1 Year to 3 Years						3 Years and Over						Total
Financial assets			(dollars in thousands)
Cash and cash equivalents			$	1,380,456					$	—					$	—					$	—					$	1,380,456
Agency mortgage-backed securities (principal)			—						5,508						1,037,144						59,923,449						60,966,101
Residential credit risk transfer securities (principal)			—						6,700						440,615						366,470						813,785
Non-agency mortgage-backed securities (principal)			458						219,907						880,186						490,840						1,591,391
Commercial mortgage-backed securities (principal)			—						—						—						154,000						154,000
Total securities			458						232,115						2,357,945						60,934,759						63,525,277
Residential mortgage loans (principal)			—						—						—						996,221						996,221
Corporate debt (principal)			—						—						241,280						1,886,093						2,127,373
Total loans			—						—						241,280						2,882,314						3,123,594
Assets transferred or pledged to securitization vehicles (principal)			—						—						—						3,848,719						3,848,719
Total financial assets - maturity			1,380,914						232,115						2,599,225						67,665,792						71,878,046
Effect of utilizing reset dates (1)			5,360,341						1,452,698						(468,887)						(6,344,152)						—
Total financial assets - interest rate sensitive			$	6,741,255					$	1,684,813					$	2,130,338					$	61,321,640					$	71,878,046
Financial liabilities
Repurchase agreements			$	37,494,071					$	22,726,996					$	—					$	—					$	60,221,067
Other secured financing			—						—						—						909,655						909,655
Debt issued by securitization vehicles (principal)			—						—						—						3,239,390						3,239,390
Participations issued (principal)			—						—						—						302,865						302,865
Total financial liabilities - maturity			37,494,071						22,726,996						—						4,451,910						64,672,977
Effect of utilizing reset dates (1)(2)			(39,411,653)						11,548,513						18,874,400						8,988,740
Total financial liabilities - interest rate sensitive			$	(1,917,582)					$	34,275,509					$	18,874,400					$	13,440,650					$	64,672,977
Maturity gap			$	(36,113,157)					$	(22,494,881)					$	2,599,225					$	63,213,882					$	7,205,069
Cumulative maturity gap			$	(36,113,157)					$	(58,608,038)					$	(56,008,813)					$	7,205,069
Interest rate sensitivity gap			$	8,658,837					$	(32,590,696)					$	(16,744,062)					$	47,880,990					$	7,205,069
Cumulative rate sensitivity gap			$	8,658,837					$	(23,931,859)					$	(40,675,921)					$	7,205,069

(1)Maturity gap utilizes stated maturities, or prepayment expectations for assets that exhibit prepayment characteristics, while interest rate sensitivity gap utilizes reset dates, if applicable.

(2)Includes effect of interest rate swaps.

The methodologies we employ for evaluating interest rate risk include an analysis of our interest rate “gap,” measurement of the duration and convexity of our portfolio and sensitivities to interest rates and spreads.

Stress Testing

We utilize liquidity stress testing to ensure we have sufficient liquidity under a variety of scenarios and stresses. These stress tests assist with the management of our pool of liquid assets and influence our current and future funding plans. The stresses applied include market-wide and firm-specific stresses.

Liquidity Management Policies

We utilize a comprehensive liquidity policy structure to inform our liquidity risk management practices including monitoring and measurement, along with well-defined key risk indicators. Both quantitative and qualitative targets are utilized to measure the ongoing stability and condition of the liquidity position, and include the level and composition of unencumbered assets, as well as sustainability of the funding composition under stress conditions.

We also monitor early warning metrics designed to measure the quality and depth of liquidity sources based upon both company-specific and market conditions. The metrics assist in assessing our liquidity conditions and are integrated into our escalation protocol.

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Item 2. Management’s Discussion and Analysis

Investment/Market Risk Management

One of the primary risks we are subject to is investment/market risk. Changes in the level of interest rates can affect our net interest income, which is the difference between the income we earn on our interest earning assets and the interest expense incurred from interest bearing liabilities and derivatives. Changes in the level of interest rates and spreads can also affect the value of our assets and potential realization of gains or losses from the sale of these assets. We may utilize a variety of financial instruments, including interest rate swaps, swaptions, options, futures and other hedges, in order to limit the adverse effects of interest rates on our results. In the case of interest rate swaps, we utilize contracts linked to LIBOR but may also enter into interest rate swaps where the floating leg is linked to the overnight index swap rate or another index, particularly in light of a potential transition away from LIBOR. In addition, we may use MAC interest rate swaps in which we may receive or make a payment at the time of entering such interest rate swap to compensate for the off-market nature of such interest rate swap. MAC interest rate swaps offer price transparency, flexibility and more efficient portfolio administration through compression which is the process of reducing the number of unique interest rate swap contracts and replacing them with fewer contracts containing market defined terms. Our portfolio and the value of our portfolio, including derivatives, may be adversely affected as a result of changing interest rates and spreads.

We simulate a wide variety of interest rate scenarios in evaluating our risk. Scenarios are run to capture our sensitivity to changes in interest rates, spreads and the shape of the yield curve. We also consider the assumptions affecting our analysis such as those related to prepayments. In addition to predefined interest rate scenarios, we utilize Value-at-Risk measures to estimate potential losses in the portfolio over various time horizons utilizing various confidence levels. The following tables estimate the potential changes in economic net interest income over a twelve month period and the immediate effect on our portfolio market value (inclusive of derivative instruments), should interest rates instantaneously increase or decrease by 25, 50 or 75 basis points, and the effect of portfolio market value if mortgage option-adjusted spreads instantaneously increase or decrease by 5, 15 or 25 basis points (assuming shocks are parallel and instantaneous). All changes to income and portfolio market value are measured as percentage changes from the projected net interest income and portfolio value at the base interest rate scenario. The net interest income simulations incorporate the interest expense effect of rate resets on liabilities and derivatives as well as the amortization expense and reinvestment of principal based on the prepayments on our securities, which varies based on the level of rates. The results assume no management actions in response to the rate or spread changes. The following table presents estimates at June 30, 2021. Actual results could differ materially from these estimates.

Change in Interest Rate (1)			Projected Percentage Change in Economic Net Interest Income (2)						Estimated Percentage Change in Portfolio Value (3)						Estimated Change as a % on NAV (3)(4)
-75 Basis points			(34.1%)						(0.2%)						(1.1%)
-50 Basis points			(20.6%)						—%						(0.2%)
-25 Basis points			(8.7%)						0.1%						0.3%
+25 Basis points			10.3%						(0.1%)						(0.6%)
+50 Basis points			18.9%						(0.4%)						(2.2%)
+75 Basis points			26.9%						(0.8%)						(4.5%)
MBS Spread Shock (1)			Estimated Change in Portfolio Market Value						Estimated Change as a  % on NAV (3)(4)
-25 Basis points			1.6%						9.2%
-15 Basis points			1.0%						5.5%
-5 Basis points			0.3%						1.8%
+5 Basis points			(0.3%)						(1.8%)
+15 Basis points			(0.9%)						(5.5%)
+25 Basis points			(1.6%)						(9.0%)
(1)    Interest rate and MBS spread sensitivity are based on results from third party models in conjunction with inputs from our internal investment professionals. Actual results could differ materially from these estimates. (2)    Scenarios include Residential Securities, commercial real estate investments, corporate debt, repurchase agreements, other secured financing and interest rate swaps. Economic net interest income includes the net interest component of interest rate swaps. (3)    Scenarios include Residential Securities, residential mortgage loans, MSR and derivative instruments. (4)    NAV represents book value of equity.

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Item 2. Management’s Discussion and Analysis

Credit Risk Management

Key risk parameters have been established to specify our credit risk appetite. We seek to manage credit risk by making investments which conform within the firm’s specific investment policy parameters and optimize risk-return attributes.

While we do not expect to encounter credit risk in our Agency mortgage-backed securities, we face credit risk on the non-Agency mortgage-backed securities and CRT securities in our portfolio. In addition, we are also exposed to credit risk on residential mortgage loans, commercial real estate investments and corporate debt. MSR values may also be impacted through reduced servicing fees and higher costs to service the underlying mortgage loans due to borrower performance. We are subject to risk of loss if an issuer or borrower fails to perform its contractual obligations. We have established policies and procedures for mitigating credit risk, including establishing and reviewing limits for credit exposure. We will originate or purchase investments that meet our comprehensive underwriting process and credit standards and are approved by the appropriate committee. In the case of residential mortgage loans and MSR, we may engage a third party to perform due diligence on a sample of loans that we believe sufficiently represents the entire pool. Once an investment is made, our ongoing surveillance process includes regular reviews, analysis and oversight of investments by our investment personnel and appropriate committee. We review credit and other risks of loss associated with each investment. Our management monitors the overall portfolio risk and determines estimates of provision for loss. Additionally, ALCO has oversight of our credit risk exposure. Our portfolio composition, based on balance sheet values, at June 30, 2021 and December 31, 2020 was as follows:

			June 30, 2021						December 31, 2020
Category
Agency mortgage-backed securities (1)			87.2		%				86.4		%
Credit risk transfer securities			1.1		%				0.6		%
Non-agency mortgage-backed securities			2.1		%				1.1		%
Residential mortgage loans (1)			5.8		%				4.2		%
Mortgage servicing rights (2)			0.3		%				0.1		%
Commercial real estate (1) (3)			0.2		%				5.0		%
Corporate debt (4)			3.3		%				2.6		%
(1) Includes assets transferred or pledged to securitization vehicles. (2) Includes Interests in MSR. (3) Net of unamortized origination fees. Excludes commercial real estate assets held for sale as of June 30, 2021. (4) Includes corporate loans held for sale as of June 30, 2021.

Counterparty Risk Management

Our use of repurchase and derivative agreements and trading activities create exposure to counterparty risk relating to potential losses that could be recognized if the counterparties to these agreements fail to perform their obligations under the contracts. In the event of default by a counterparty, we could have difficulty obtaining our assets pledged as collateral. A significant portion of our investments are financed with repurchase agreements by pledging our Residential Securities and certain commercial real estate investments as collateral to the applicable lender. The collateral we pledge generally exceeds the amount of the borrowings under each agreement. If the counterparty to the repurchase agreement defaults on its obligations and we are not able to recover our pledged asset, we are at risk of losing the over-collateralization or haircut. The amount of this exposure is the difference between the amount loaned to us plus interest due to the counterparty and the fair value of the collateral pledged by us to the lender including accrued interest receivable on such collateral.

We also use interest rate swaps and other derivatives to manage interest rate risk. Under these agreements, we pledge securities and cash as collateral or settle variation margin payments as part of a margin arrangement.

If a counterparty were to default on its obligations, we would be exposed to a loss to a derivative counterparty to the extent that the amount of our securities or cash pledged exceeded the unrealized loss on the associated derivative and we were not able to recover the excess collateral. Additionally, we would be exposed to a loss to a derivative counterparty to the extent that our unrealized gains on derivative instruments exceeded the amount of the counterparty’s securities or cash pledged to us.

We monitor our exposure to counterparties across several dimensions including by type of arrangement, collateral type, counterparty type, ratings and geography. Additionally, ALCO has oversight of our counterparty exposure.

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Item 2. Management’s Discussion and Analysis

The following table summarizes our exposure to counterparties by geography at June 30, 2021:

			Number of Counterparties						Secured Financing (1)						Interest Rate Swaps at Fair Value						Exposure - Secured Financing (2)						Exposure - Interest Rate Swaps (2)
Geography			(dollars in thousands)
North America			22						$	50,546,684					$	(290,239)					$	3,367,896					$	(1,216,620)
Europe			9						7,567,356						(516,713)						1,345,823						(678,276)
Japan			3						3,016,682						—						63,402						—
Total			34						$	61,130,722					$	(806,952)					$	4,777,121					$	(1,894,896)
(1) Includes repurchase agreements and other secured financing.
(2) Represents the amount of cash and/or securities pledged as collateral to each counterparty less the aggregate of repurchase agreement and other secured financing and unrealized loss on swaps for each counterparty.

 

Operational Risk Management

We are subject to operational risk in each of our business and support functions. Operational risk may arise from internal or external sources including human error, fraud, systems issues, process change, vendors, business interruptions and other external events. Model risk considers potential errors with a model’s results due to uncertainty in model parameters and inappropriate methodologies used. The result of these risks may include financial loss and reputational damage. We manage operational risk through a variety of tools including policies and procedures that cover topics such as business continuity, personal conduct, cybersecurity and vendor management. Other tools include testing, including disaster recovery testing; systems controls, including access controls; training, including cybersecurity awareness training; and monitoring, which includes the use of key risk indicators. Employee-level lines of defense against operational risk include proper segregation of incompatible duties, activity-level internal controls over financial reporting, the empowerment of business units to identify and mitigate operational risk sources, testing by our internal audit staff, and our overall governance framework.  

We have established a Cybersecurity Committee to help mitigate cybersecurity risks. The role of the committee is to oversee cyber risk assessments, monitor applicable key risk indicators, review cybersecurity training procedures, oversee our Cybersecurity Incident Response Plan and engage third parties to conduct periodic penetration testing. Our cybersecurity risk assessment includes an evaluation of cyber risk related to sensitive data held by third parties on their systems. The Cybersecurity Committee periodically reports to the ERC, and the Board via the BRC and the BAC. There is no assurance that these efforts will effectively mitigate cybersecurity risk and mitigation efforts are not an assurance that no cybersecurity incidents will occur. We currently maintain cybersecurity insurance, however, there is no assurance that the insurance policy will cover all cybersecurity breaches or that the policy will cover all losses.

We depend on third party service providers to perform various business processes related to our operations, including mortgage loan servicers and sub-servicers. Our vendor management policy establishes procedures for engaging, onboarding and monitoring the performance of third party vendors. These procedures include assessing a vendor’s financial health as well as oversight of its compliance with applicable laws and regulations, cybersecurity and business continuity programs and security of personally identifiable information.

Compliance, Regulatory and Legal Risk Management

Our business is organized as a REIT, and we seek to continue to meet the requirements for taxation as a REIT. The determination that we are a REIT requires an analysis of various factual matters and circumstances. Accordingly, we closely monitor our REIT status within our risk management program. We also regularly assess our risk management in respect of our regulated and licensed subsidiaries, which include our registered broker-dealer subsidiary Arcola, our subsidiary that is registered with the SEC as an investment adviser under the Investment Advisers Act and our subsidiary that operates as a licensed mortgage aggregator and master servicer.

The financial services industry is highly regulated and receives significant attention from regulators, which may impact both our company as well as our business strategy. Our investments in residential whole loans and MSR require us to comply with applicable state and federal laws and regulations, and maintain appropriate governmental licenses, approvals and exemptions. We proactively monitor the potential impact regulation may have both directly and indirectly on us. We maintain a process to actively monitor both actual and potential legal action that may affect us. Our risk management framework is designed to identify, measure and monitor these risks under the oversight of the ERC.

We currently rely on the exemption from registration provided by Section 3(c)(5)(C) of the Investment Company Act, and we seek to continue to meet the requirements for this exemption from registration. The determination that we qualify for this

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Item 2. Management’s Discussion and Analysis

exemption from registration depends on various factual matters and circumstances. Accordingly, in conjunction with our legal department, we closely monitor our compliance with Section 3(c)(5)(C) within our risk management program. The monitoring of this risk is also under the oversight of the ERC.

As a result of the Dodd-Frank Act, the U.S. Commodity Futures Trading Commission (“CFTC”) gained jurisdiction over the regulation of interest rate swaps. The CFTC has asserted that this causes the operators of mortgage real estate investment trusts that use swaps as part of their business model to fall within the statutory definition of Commodity Pool Operator (“CPO”), and, absent relief from the Division of Swap Dealer and Intermediary Oversight or the CFTC, to register as CPOs. On December 7, 2012, as a result of numerous requests for no-action relief from the CPO registration requirement for operators of mortgage real estate investment trusts, the Division of Swap Dealer and Intermediary Oversight of the CFTC issued no-action relief entitled “No-Action Relief from the Commodity Pool Operator Registration Requirement for Commodity Pool Operators of Certain Pooled Investment Vehicles Organized as Mortgage Real Estate Investment Trusts” that permits a CPO to receive relief by filing a claim to perfect the use of the relief. A claim submitted by a CPO will be effective upon filing, so long as the claim is materially complete. The conditions that must be met relate to initial margin and premiums requirements, net income derived annually from commodity interest positions that are not qualifying hedging transactions, marketing of interests in the mortgage real estate investment trust to the public, and identification of the entity as a mortgage real estate investment trust in its federal tax filings with the Internal Revenue Service. While we disagree with the CFTC’s position that mortgage REITs that use swaps as part of their business model fall within the statutory definition of a CPO, we have submitted a claim for the relief set forth in the no-action relief entitled “No-Action Relief from the Commodity Pool Operator Registration Requirement for Commodity Pool Operators of Certain Pooled Investment Vehicles Organized as Mortgage Real Estate Investment Trusts” and believe we meet the criteria for such relief set forth therein.

Critical Accounting Policies and Estimates

Our critical accounting policies that require us to make significant judgments or estimates are described below. For more information on these critical accounting policies and other significant accounting policies, see “Significant Accounting Policies” in the notes to the consolidated financial statements.

Valuation of Financial Instruments

Residential Securities

There is an active market for our Agency mortgage-backed securities, CRT securities and non-Agency mortgage-backed securities. Since we primarily invest in securities that can be valued using actively quoted prices for actively traded assets, there is a high degree of observable inputs and less subjectivity in measuring fair value. Internal fair values are determined using quoted prices from the TBA securities market, the Treasury curve and the underlying characteristics of the individual securities, which may include coupon, periodic and life caps, reset dates and the expected life of the security. While prepayment rates may be difficult to predict and require estimation and judgment in the valuation of Agency mortgage-backed securities, we use several third party models to validate prepayment speeds used in fair value measurements of residential securities. All internal fair values are compared to external pricing sources and/or dealer quotes to determine reasonableness. Additionally, securities used as collateral for repurchase agreements are priced daily by counterparties to ensure sufficient collateralization, providing additional verification of our internal pricing.

Residential Mortgage Loans

There is an active market for the residential whole loans in which we invest. Since we primarily invest in residential loans that can be valued using actively quoted prices for similar assets, there are observable inputs in measuring fair value. Internal fair values are determined using quoted prices for similar market transactions, the swap curve and the underlying characteristics of the individual loans, which may include loan term, coupon, and reset dates. While prepayment rates may be difficult to predict and are a significant estimate requiring judgment in the valuation of residential whole loans, we validate prepayment speeds against those provided by independent pricing analytic providers specializing in residential mortgage loans. Internal fair values are generally compared to external pricing sources to determine reasonableness.

MSR

Fair value estimates for our investment in MSR are obtained from models, which use significant unobservable inputs in their valuations. These valuations primarily utilize discounted cash flow models that incorporate unobservable market data inputs including prepayment rates, delinquency levels, costs to service and discount rates. Model valuations are then compared to valuations obtained from third party pricing providers. Management reviews the valuations received from third party pricing

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Item 2. Management’s Discussion and Analysis

providers and uses them as a point of comparison to modeled values. The valuation of MSR requires significant judgment by management and the third party pricing providers.

Commercial Real Estate Investments

The fair value of commercial mortgage-backed securities classified as available-for-sale is determined based upon quoted prices of similar assets in recent market transactions and requires the application of judgment due to differences in the underlying collateral.  These securities must also be evaluated for impairment if the fair value of the security is lower than its amortized cost. Determining whether there is an impairment may require us to exercise significant judgment and make estimates to determine expected cash flows incorporating assumptions such as changes in interest rates and loss expectations. For commercial real estate loans and preferred equity investments classified as held for investment, we apply significant judgment in evaluating the need for a loss reserve. Estimated net recoverable value of the commercial real estate loans and preferred equity investments and other factors such as the fair value of any collateral, the amount and status of senior debt, the prospects of the borrower and the competitive landscape where the borrower conducts business must be considered in determining the allowance for loan losses. For commercial real estate loans held for sale, significant judgment may need to be applied in determining the fair value of the loans and whether a valuation allowance is necessary. Factors that may need to be considered to determine the fair value of a loan held for sale include the borrower’s credit quality, liquidity and other market factors and the fair value of the underlying collateral.

Interest Rate Swaps

We use the overnight indexed swap (“OIS”) curve as an input to value substantially all of our uncleared interest rate swaps. We believe using the OIS curve, which reflects the interest rate typically paid on cash collateral, enables us to most accurately determine the fair value of uncleared interest rate swaps. Consistent with market practice, we exchange collateral (also called margin) based on the fair values of our interest rate swaps. Through this margining process, we may be able to compare our recorded fair value with the fair value calculated by the counterparty or derivatives clearing organization, providing additional verification of our recorded fair value of the uncleared interest rate swaps. We value our cleared interest rate swaps using the prices provided by the derivatives clearing organization.

Revenue Recognition

Interest income from coupon payments is accrued based on the outstanding principal amounts of the Residential Securities and their contractual terms. Premiums and discounts associated with the purchase of the Residential Securities are amortized or accreted into interest income over the projected lives of the securities using the interest method. To aid in determining projected lives of the securities, we use third party model and market information to project prepayment speeds. Our prepayment speed projections incorporate underlying loan characteristics (i.e., coupon, term, original loan size, original loan-to-value ratio, etc.) and market data, including interest rate and home price index forecasts and expert judgment. Prepayment speeds vary according to the type of investment, conditions in the financial markets and other factors and cannot be predicted with any certainty. Changes to model assumptions, including interest rates and other market data, as well as periodic revisions to the model will cause changes in the results. Adjustments are made for actual prepayment activity as it relates to calculating the effective yield. Gains or losses on sales of Residential Securities are recorded on trade date based on the specific identification method.

Consolidation of Variable Interest Entities

Determining whether an entity has a controlling financial interest in a VIE requires significant judgment related to assessing the purpose and design of the VIE and determination of the activities that most significantly impact its economic performance. We must also identify explicit and implicit variable interests in the entity and consider our involvement in both the design of the VIE and its ongoing activities. To determine whether consolidation of the VIE is required, we must apply judgment to assess whether we have the power to direct the most significant activities of the VIE and whether we have either the rights to receive benefits or the obligation to absorb losses that could be potentially significant to the VIE.

Use of Estimates

The use of GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

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Item 2. Management’s Discussion and Analysis

Glossary of Terms

A

Adjustable-Rate Loan / Security

A loan / security on which interest rates are adjusted at regular intervals according to predetermined criteria. The adjustable interest rate is tied to an objective, published interest rate index.

Agency

Refers to a federally chartered corporation, such as the Federal National Mortgage Association, or the Federal Home Loan Mortgage Corporation, or an agency of the U.S. Government, such as the Government National Mortgage Association.

Agency Mortgage-Backed Securities

Refers to residential mortgage-backed securities that are issued or guaranteed by an Agency.

Amortization

Liquidation of a debt through installment payments.  Amortization also refers to the process of systematically reducing a recognized asset or liability (e.g., a purchase premium or discount for a debt security) with an offset to earnings.

Average GAAP Cost of Interest Bearing Liabilities and Average Economic Cost of Interest Bearing Liabilities

Average GAAP cost of interest bearing liabilities represents annualized interest expense divided by average interest bearing liabilities. Average interest bearing liabilities reflects the average balances during the period. Average economic cost of interest bearing liabilities represents annualized economic interest expense divided by average interest bearing liabilities.

Average Life

On a mortgage-backed security, the average time to receipt of each dollar of principal, weighted by the amount of each principal prepayment, based on prepayment assumptions.

Average Yield on Interest Earnings Assets and Average Yield on Interest Earnings Assets (excluding PAA)

Average yield on interest earning assets represents annualized interest income divided by average interest earning assets. Average interest earning assets reflects the average amortized cost of our investments during the period. Average yield on interest earning assets (excluding PAA) is calculated using annualized interest income (excluding PAA).

B

Basis Point (“bp”)

One hundredth of one percent, used in expressing differences in interest rates.  One basis point is 0.01% of yield. For example, a bond’s yield that changed from 3.00% to 3.50% would be said to have moved 50 basis points.

Benchmark

A bond or an index referencing a basket of bonds whose terms are used for comparison with other bonds of similar maturity. The global financial market typically looks to U.S. Treasury securities as benchmarks.

Beneficial Owner

One who benefits from owning a security, even if the security’s title of ownership is in the name of a broker or bank.

B-Note

Subordinate mortgage notes and/or subordinate mortgage loan participations.

B-Piece

The most subordinate commercial mortgage-backed security bond class.

Board

Refers to the board of directors of Annaly.

Bond

The written evidence of debt, bearing a stated rate or stated rates of interest, or stating a formula for determining that rate, and maturing on a date certain, on which date and upon presentation a fixed sum of money plus interest (usually represented by interest coupons attached to the bond) is payable to the holder or owner. Bonds are long-term securities with an original maturity of greater than one year.

Book Value Per Share

Calculated by summing common stock, additional paid-in capital, accumulated other comprehensive income (loss) and accumulated deficit and dividing that number by the total common shares outstanding.

Broker

Generic name for a securities firm engaged in both buying and selling securities on behalf of customers or its own account.

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Item 2. Management’s Discussion and Analysis

C

Capital Buffer

Includes unencumbered financial assets which can be either sold or utilized as collateral to meet liquidity needs.

Capital Ratio (GAAP Capital Ratio)

Calculated as total stockholders’ equity divided by total assets. 

Carry

The amount an asset earns over its hedging and financing costs. A positive carry happens when the rate on the securities being financed is greater than the rate on the funds borrowed. A negative carry is when the rate on the funds borrowed is greater than the rate on the securities that are being financed.

CMBX

The CMBX index is a synthetic tradable index referencing a basket of 25 CMBS of a particular rating and vintage. The CMBX index allows investors to take a long position (referred to as selling protection) or short position (referred to as purchasing protection) on the respective basket of CMBS securities and is structured as a “pay-as-you-go” contract whereby the protection seller receives and the protection buyer pays a standardized running coupon on the contracted notional amount. Additionally, the protection seller is obligated to pay to the protection buyer the amount of principal losses and/or coupon shortfalls on the underlying CMBS securities as they occur.

Collateral

Securities, cash or property pledged by a borrower or party to a derivative contract to secure payment of a loan or derivative. If the borrower fails to repay the loan or defaults under the derivative contract, the secured party may take ownership of the collateral.

Collateralized Loan Obligation (“CLO”)

A securitization collateralized by loans and other debt instruments.

Collateralized Mortgage Obligation (“CMO”)

A multiclass bond backed by a pool of mortgage pass-through securities or mortgage loans.

Commodity Futures Trading Commission (“CFTC”)

An independent U.S. federal agency established by the Commodity Futures Trading Commission Act of 1974. The CFTC regulates the swaps, commodity futures and options markets. Its goals include the promotion of competitive and efficient futures markets and the protection of investors against manipulation, abusive trade practices and fraud.

Commercial Mortgage-Backed Security

Securities collateralized by a pool of mortgages on commercial real estate in which all principal and interest from the mortgages flow to certificate holders in a defined sequence or manner.

Constant Prepayment Rate (“CPR”)

The percentage of outstanding mortgage loan principal that prepays in one year, based on the annualization of the Single Monthly Mortality, which reflects the outstanding mortgage loan principal that prepays in one month.

Convexity

A measure of the change in a security’s duration with respect to changes in interest rates. The more convex a security is, the more its duration will change with interest rate changes.

Corporate Debt

Non-government debt instruments issued by corporations. Long-term corporate debt can be issued as bonds or loans.

Counterparty

One of two entities in a transaction. For example, in the bond market a counterparty can be a state or local government, a broker-dealer or a corporation.

Coupon

The interest rate on a bond that is used to compute the amount of interest due on a periodic basis.

Credit and Counterparty Risk

Risk to earnings, capital or business, resulting from an obligor’s or counterparty’s failure to meet the terms of any contract or otherwise failure to perform as agreed. Credit and counterparty risk is present in lending, investing, funding and hedging activities.

Credit Derivatives

Derivative instruments that have one or more underlyings related to the credit risk of a specified entity (or group of entities) or an index that exposes the seller to potential loss from specified credit-risk related events. An example is credit derivatives referencing the commercial mortgage-backed securities index.

 

Credit Risk Transfer (“CRT”) Securities

Credit Risk Transfer securities are risk sharing transactions issued by Fannie Mae and Freddie Mac and similarly structured transactions arranged by third party market participants. The securities issued in the CRT sector are designed to synthetically transfer mortgage credit risk from Fannie Mae, Freddie Mac and/or third parties to private investors.

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Item 2. Management’s Discussion and Analysis

Current Face

The current remaining monthly principal on a mortgage security. Current face is computed by multiplying the original face value of the security by the current principal balance factor.

D

Dealer

Person or organization that underwrites, trades and sells securities, e.g., a principal market-maker in securities.

Default Risk

Possibility that a bond issuer will fail to pay principal or interest when due.

Derivative

A financial product that derives its value from the price, price fluctuations and price expectations of an underlying instrument, index or reference pool (e.g. futures contracts, options, interest rate swaps, interest rate swaptions and certain to-be-announced securities).

Discount Price

When the dollar price is below face value, it is said to be selling at a discount.

Duration

The weighted maturity of a fixed-income investment’s cash flows, used in the estimation of the price sensitivity of fixed-income securities for a given change in interest rates.

E

Earnings available for distribution (“EAD”) and Earnings available for distribution Per Average Common Share

Earnings available for distribution is defined as the sum of (a) economic net interest income, (b) TBA dollar roll income and CMBX coupon income, (c) realized amortization of MSR, (d) other income (loss) (excluding depreciation expense related to commercial real estate and amortization of intangibles, non-EAD income allocated to equity method investments and other non-EAD components of other income (loss)), (e) general and administrative expenses (excluding transaction expenses and non-recurring items), and (f) income taxes (excluding the income tax effect of non-EAD income (loss) items) and excludes (g) the premium amortization adjustment representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities. Earnings available for distribution per average common share is calculated by dividing earnings available for distribution by average basic common shares for the period.

This metric was previously labeled Core Earnings (excluding PAA) and Core Earnings (excluding PAA) Per Average Common Share). The definition of EAD is identical to the definition of Core Earnings (excluding PAA) from prior reporting periods.

Economic Capital

A measure of the risk a firm is subject to.  It is the amount of capital a firm needs as a buffer to protect against risk.  It is a probabilistic measure of potential future losses at a given confidence level over a given time horizon.

Economic Capital Ratio

Non-GAAP financial measure that is calculated as total stockholders’ equity divided by total economic assets. Total economic assets includes the implied market value of TBA derivatives and are net of debt issued by securitization vehicles.

Economic Interest Expense

Non-GAAP financial measure that is comprised of GAAP interest expense and the net interest component of interest rate swaps.

Economic Leverage Ratio (Economic Debt-to-Equity Ratio)

Non-GAAP financial measure that is calculated as the sum of recourse debt, cost basis of TBA and CMBX derivatives outstanding, and net forward purchases (sales) of investments divided by total equity. Recourse debt consists of repurchase agreements and other secured financing (excluding certain non-recourse credit facilities). Certain credit facilities (included within other secured financing), debt issued by securitization vehicles, participations issued, and mortgages payable are non-recourse to us and are excluded from this measure.

Economic Net Interest Income

Non-GAAP financial measure that is composed of GAAP net interest income less Economic Interest Expense.

Economic Return

Refers to the Company’s change in book value plus dividends declared divided by the prior period’s book value.

Encumbered Assets

Assets on the company’s balance sheet which have been pledged as collateral against a liability.

Eurodollar

A U.S. dollar deposit held in Europe or elsewhere outside the United States.

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Item 2. Management’s Discussion and Analysis

F

Face Amount

The par value (i.e., principal or maturity value) of a security appearing on the face of the instrument.

Factor

A decimal value reflecting the proportion of the outstanding principal balance of a mortgage security, which changes over time, in relation to its original principal value.

Fannie Mae

Federal National Mortgage Association.

Federal Deposit Insurance Corporation (“FDIC”)

An independent agency created by the U.S. Congress to maintain stability and public confidence in the nation’s financial system by insuring deposits, examining and supervising financial institutions for safety and soundness and consumer protection, and managing receiverships.

Federal Funds Rate

The interest rate charged by banks on overnight loans of their excess reserve funds to other banks.

Federal Housing Financing Agency (“FHFA”)

The FHFA is an independent regulatory agency that oversees vital components of the secondary mortgage market including Fannie Mae, Freddie Mac and the Federal Home Loan Banks.

Financial Industry Regulatory Authority, Inc. (“FINRA”)

FINRA is a non-governmental organization tasked with regulating all business dealings conducted between dealers, brokers and all public investors.

Fixed-Rate Mortgage

A mortgage featuring level monthly payments, determined at the outset, which remain constant over the life of the mortgage.

Fixed Income Clearing Corporation (“FICC”)

The FICC is an agency that deals with the confirmation, settlement and delivery of fixed-income assets in the U.S. The agency ensures the systematic and efficient settlement of U.S. Government securities and mortgage-backed security transactions in the market.

Floating Rate Bond

A bond for which the interest rate is adjusted periodically according to a predetermined formula, usually linked to an index.

Floating Rate CMO

A CMO tranche which pays an adjustable rate of interest tied to a representative interest rate index such as the LIBOR, the Constant Maturity Treasury or the Cost of Funds Index.

Freddie Mac

Federal Home Loan Mortgage Corporation.

Futures Contract

A legally binding agreement to buy or sell a commodity or financial instrument in a designated future month at a price agreed upon at the initiation of the contract by the buyer and seller. Futures contracts are standardized according to the quality, quantity, and delivery time and location for each commodity. A futures contract differs from an option in that an option gives one of the counterparties a right and the other an obligation to buy or sell, while a futures contract represents an obligation of both counterparties, one to deliver and the other to accept delivery. A futures contract is part of a class of financial instruments called derivatives.

G

GAAP

U.S. generally accepted accounting principles.

Ginnie Mae

Government National Mortgage Association.

H

Hedge

An investment made with the intention of minimizing the impact of adverse movements in interest rates or securities prices.

I

In-the-Money

Description for an option that has intrinsic value and can be sold or exercised for a profit; a call option is in-the-money when the strike price (execution price) is below the market price of the underlying security.

Interest Bearing Liabilities

Refers to repurchase agreements, debt issued by securitization vehicles and credit facilities. Average interest bearing liabilities is based on daily balances.

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Item 2. Management’s Discussion and Analysis

Interest Earning Assets

Refers to Residential Securities, U.S. Treasury securities, reverse repurchase agreements, commercial real estate debt and preferred equity interests, residential mortgage loans and corporate debt. Average interest earning assets is based on daily balances.

Interest-Only (IO) Bond

The interest portion of mortgage, Treasury or bond payments, which is separated and sold individually from the principal portion of those same payments.

Interests in MSR

Represents agreements to purchase all, or a component of, net servicing cash flows.

Interest Rate Risk

The risk that an investment’s value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship. As market interest rates rise, the value of current fixed income investment holdings declines. Diversifying, deleveraging and hedging techniques are utilized to mitigate this risk. Interest rate risk is a form of market risk.

Interest Rate Swap

A binding agreement between counterparties to exchange periodic interest payments on some predetermined dollar principal, which is called the notional principal amount. For example, one party will pay fixed and receive a variable rate.

Interest Rate Swaption

Options on interest rate swaps. The buyer of a swaption has the right to enter into an interest rate swap agreement at some specified date in the future. The swaption agreement will specify whether the buyer of the swaption will be a fixed-rate receiver or a fixed-rate payer.

 

International Swaps and Derivatives Association (“ISDA”) Master Agreement

Standardized contract developed by ISDA used as an umbrella under which bilateral derivatives contracts are entered into.

Inverse IO Bond

An interest-only bond whose coupon is determined by a formula expressing an inverse relationship to a benchmark rate, such as LIBOR. As the benchmark rate changes, the IO coupon adjusts in the opposite direction. When the benchmark rate is relatively low, the IO pays a relatively high coupon payment, and vice versa.

Investment/Market Risk

Risk to earnings, capital or business resulting in the decline in value of our assets caused from changes in market variables, such as interest rates, which affect the values of Residential Securities and other investment instruments.

Investment Advisers Act

Refers to the Investment Advisers Act of 1940, as amended.

Investment Company Act

Refers to the Investment Company Act of 1940, as amended.

L

Leverage

The use of borrowed money to increase investing power and economic returns.

Leverage Ratio (GAAP Leverage Ratio or Debt-to-Equity Ratio)

Calculated as total debt to total stockholders’ equity. For purposes of calculating this ratio total debt includes repurchase agreements, other secured financing, debt issued by securitization vehicles, participations issued and mortgages payable. Certain credit facilities (included within other secured financing), debt issued by securitization vehicles, participations issued and mortgages payable are non-recourse to us.

LIBOR (London Interbank Offered Rate)

The rate banks charge each other for short-term Eurodollar loans. LIBOR is frequently used as the base for resetting rates on floating-rate securities and the floating-rate legs of interest rate swaps.

Liquidity Risk

Risk to earnings, capital or business arising from our inability to meet our obligations when they come due without incurring unacceptable losses because of inability to liquidate assets or obtain adequate funding.

Long-Term CPR

Our projected prepayment speeds for certain Agency mortgage-backed securities using third party model and market information. Our prepayment speed projections incorporate underlying loan characteristics (e.g., coupon, term, original loan size, original loan-to-value ratio, etc.) and market data, including interest rate and home price index forecasts.  Changes to model assumptions, including interest rates and other market data, as well as periodic revisions to the model will cause changes in the results.

Long-Term Debt

Debt which matures in more than one year.

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Item 2. Management’s Discussion and Analysis

M

Market Agreed Coupon (“MAC”) Interest Rate Swap

An interest rate swap contract structure with pre-defined, market agreed terms, developed by SIFMA and ISDA with the purpose of promoting liquidity and simplified administration.

Monetary Policy

Action taken by the Federal Open Market Committee of the Federal Reserve System to influence the money supply or interest rates.

Mortgage-Backed Security (“MBS”)

A security representing a direct interest in a pool of mortgage loans. The pass-through issuer or servicer collects the payments on the loans in the pool and “passes through” the principal and interest to the security holders on a pro rata basis.

Mortgage Loan

A mortgage loan granted by a bank, thrift or other financial institution that is based solely on real estate as security and is not insured or guaranteed by a government agency.

Mortgage Servicing Rights (“MSR”)

Contractual agreements constituting the right to service an existing mortgage where the holder receives the benefits and bears the costs and risks of servicing the mortgage.

N

NAV

Net asset value.

Net Interest Income

Represents interest income earned on our portfolio investments, less interest expense paid for borrowings.

Net Interest Margin and Net Interest Margin (excluding PAA)

Net interest margin represents our interest income less interest expense divided by average interest earning assets. Net interest margin (excluding PAA) represents the sum of our interest income (excluding PAA) plus TBA dollar roll income and CMBX coupon income less interest expense and the net interest component of interest rate swaps divided by the sum of average interest earning assets plus average outstanding TBA contract and CMBX balances.

Net Interest Spread and Net Interest Spread (excluding PAA)

Net interest spread represents the average yield on interest earning assets less the average GAAP cost of interest bearing liabilities. Net interest spread (excluding PAA) represents the average yield on interest earning assets (excluding PAA) less the average economic cost of interest bearing liabilities.

Non-Performing Loan (“NPL”)

A loan that is close to defaulting or is in default.

Notional Amount

A stated principal amount in a derivative contract on which the contract is based.

O

Operational Risk

Risk to earnings, capital, reputation or business arising from inadequate or failed internal processes or systems, human factors or external events.

Option Contract

A contract in which the buyer has the right, but not the obligation, to buy or sell an asset at a set price on or before a given date. Buyers of call options bet that a security will be worth more than the price set by the option (the strike price), plus the price they pay for the option itself. Buyers of put options bet that the security’s price will drop below the price set by the option. An option is part of a class of financial instruments called derivatives, which means these financial instruments derive their value from the worth of an underlying investment.

Original Face

The face value or original principal amount of a security on its issue date.

Out-of-the-Money

Description for an option that has no intrinsic value and would be worthless if it expired today; for a call option, this situation occurs when the strike price is higher than the market price of the underlying security; for a put option, this situation occurs when the strike price is less than the market price of the underlying security.

Overnight Index Swaps (“OIS”)

An interest rate swap in which a fixed rate is exchanged for an overnight floating rate.

Over-The-Counter (“OTC”) Market

A securities market that is conducted by dealers throughout the country through negotiation of price rather than through the use of an auction system as represented by a stock exchange.

P

Par

Price equal to the face amount of a security; 100%.

Par Amount

The principal amount of a bond or note due at maturity. Also known as par value.

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Item 2. Management’s Discussion and Analysis

 Pass-Through Security

A securitization structure where a GSE or other entity “passes” the amount collected from the borrowers every month to the investor, after deducting fees and expenses.

Pool

A collection of mortgage loans assembled by an originator or master servicer as the basis for a security. In the case of Ginnie Mae, Fannie Mae, or Freddie Mac mortgage pass-through securities, pools are identified by a number assigned by the issuing agency.

Premium

The amount by which the price of a security exceeds its principal amount. When the dollar price of a bond is above its face value, it is said to be selling at a premium.

Premium Amortization Adjustment (“PAA”)

The cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities.

Prepayment

The unscheduled partial or complete payment of the principal amount outstanding on a mortgage loan or other debt before it is due.

Prepayment Risk

The risk that falling interest rates will lead to increased prepayments of mortgage or other loans, forcing the investor to reinvest at lower prevailing rates.

Prepayment Speed

The estimated rate at which mortgage borrowers will pay off the mortgages that underlie an MBS.

Primary Market

Market for offers or sales of new bonds by the issuer.

Prime Rate

The indicative interest rate on loans that banks quote to their best commercial customers.

 

Principal and Interest

The term used to refer to regularly scheduled payments or prepayments of principal and payments of interest on a mortgage or other security.

R

Rate Reset

The adjustment of the interest rate on a floating-rate security according to a prescribed formula.

Real Estate Investment Trust (“REIT”)

A special purpose investment vehicle that provides investors with the ability to participate directly in the

ownership or financing of real-estate related assets by pooling their capital to purchase and manage mortgage loans and/or income property.

Recourse Debt

Debt on which the economic borrower is obligated to repay the entire balance regardless of the value of the pledged collateral. By contrast, the economic borrower’s obligation to repay non-recourse debt is limited to the value of the pledged collateral. Recourse debt consists of repurchase agreements and other secured financing (excluding certain non-recourse credit facilities). Certain credit facilities (included within other secured financing), debt issued by securitization vehicles, participations issued and mortgages payable are non-recourse to us and are excluded from this measure.

Reinvestment Risk

The risk that interest income or principal repayments will have to be reinvested at lower rates in a declining rate environment.

Re-Performing Loan (“RPL”)

A type of loan in which payments were previously delinquent by at least 90 days but have resumed.

Repurchase Agreement

The sale of securities to investors with the agreement to buy them back at a higher price after a specified time period; a form of short-term borrowing. For the party on the other end of the  transaction (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement.

Residential Securities

Refers to Agency mortgage-backed securities, CRT securities and non-Agency mortgage-backed securities.

Residual

In securitizations, the residual is the tranche that collects any cash flow from the collateral that remains after obligations to the other tranches have been met.

Return on Average Equity

Calculated by taking earnings divided by average stockholders’ equity.

Reverse Repurchase Agreement

Refer to Repurchase Agreement. The buyer of securities effectively provides a collateralized loan to the seller.

Risk Appetite Statement

Defines the types and levels of risk we are willing to take in order to achieve our business objectives, and reflects our risk management philosophy.

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Item 2. Management’s Discussion and Analysis

S

Secondary Market

Ongoing market for bonds previously offered or sold in the primary market.

Secured Overnight Financing Rate (“SOFR”)

Broad measure of the cost of borrowing cash overnight collateralized by Treasury securities and was chosen by the Alternative Reference Rate Committee as the preferred benchmark rate to replace dollar LIBOR in coming years.

Settlement Date

The date securities must be delivered and paid for to complete a transaction.

Short-Term Debt

Generally, debt which matures in one year or less. However, certain securities that mature in up to three years may be considered short-term debt.

Spread

When buying or selling a bond through a brokerage firm, investors will be charged a commission or spread, which is the difference between the market price and cost of purchase, and sometimes a service fee. Spreads differ based on several factors including liquidity.

T

Target Assets

Includes Agency mortgage-backed securities, to-be-announced forward contracts, CRT securities, MSR, non-Agency mortgage-backed securities, residential mortgage loans, commercial real estate investments, and corporate debt.

Tangible Economic Return

Refers to the Company’s change in tangible book value (calculated by summing common stock, additional paid-in capital, accumulated other comprehensive income (loss) and accumulated deficit less intangible assets) plus dividends declared divided by the prior period’s tangible book value.

Taxable REIT Subsidiary (“TRS”)

An entity that is owned directly or indirectly by a REIT and has jointly elected with the REIT to be treated as a TRS for tax purposes. Annaly and certain of its direct and indirect subsidiaries have made separate joint elections to treat these subsidiaries as TRSs.

To-Be-Announced Securities (“TBAs”)

A contract for the purchase or sale of a mortgage-backed security to be delivered at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date but does not include a specified pool number and number of pools.

TBA Dollar Roll Income

TBA dollar roll income is defined as the difference in price between two TBA contracts with the same terms but different settlement dates. The TBA contract settling in the later month typically prices at a discount to the earlier month contract with the difference in price commonly referred to as the “drop”. TBA dollar roll income represents the equivalent of interest income on the underlying security less an implied cost of financing.

Total Return

Investment performance measure over a stated time period which includes coupon interest, interest on interest, and any realized and unrealized gains or losses.

Total Return Swap

A derivative instrument where one party makes payments at a predetermined rate (either fixed or variable) while receiving a return on a specific asset (generally an equity index, loan or bond) held by the counterparty.

U

Unencumbered Assets

Assets on our balance sheet which have not been pledged as collateral against an existing liability.

U.S. Government-Sponsored Enterprise (“GSE”) Obligations

Obligations of Agencies originally established or chartered by the U.S. government to serve public purposes as specified by the U.S. Congress, such as Fannie Mae and Freddie Mac; these obligations are not explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the U.S. government.

V

Value-at-Risk (“VaR”)

A statistical technique which measures the potential loss in value of an asset or portfolio over a defined period for a given confidence interval.

Variable Interest Entity (“VIE”)

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.

Variation Margin

Cash or securities provided by a party to collateralize its obligations under a transaction as a result of a change in value of such transaction since the trade was executed or the last time collateral was provided.

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ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

Volatility

A statistical measure of the variance of price or yield over time. Volatility is low if the price does not change very much over a short period of time, and high if there is a greater change.

Voting Interest Entity (“VOE”)

An entity that has sufficient equity to finance its activities without additional subordinated financial support from other parties and in which equity investors have a controlling financial interest.

W

Warehouse Lending

A line of credit extended to a loan originator to fund mortgages extended by the loan originators to property purchasers. The loan typically lasts from the time the mortgage is originated to when the mortgage is sold into the secondary market, whether directly or through a securitization.  Warehouse lending can provide liquidity to the loan origination market.

Weighted Average Coupon

The weighted average interest rate of the underlying mortgage loans or pools that serve as collateral for a security, weighted by the size of the principal loan balances.

Weighted Average Life (“WAL”)

The assumed weighted average amount of time that will elapse from the date of a security’s issuance until each dollar of principal is repaid to the investor. The WAL will change as the security ages and depending on the actual realized rate at which principal, scheduled and unscheduled, is paid on the loans underlying the MBS.

Y

Yield-to-Maturity

The expected rate of return of a bond if it is held to its maturity date; calculated by taking into account the current market price, stated redemption value, coupon payments and time to maturity and assuming all coupons are reinvested at the same rate; equivalent to the internal rate of return.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Quantitative and qualitative disclosures about market risk are contained within the section titled “Risk Management” of Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

ITEM 4. CONTROLS AND PROCEDURES

Our management, including our Chief Executive Officer (the CEO) and Chief Financial Officer (the CFO), reviewed and evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act) as of the end of the period covered by this report.  Based on that review and evaluation, the CEO and CFO have concluded that our current disclosure controls and procedures, as designed, (1) were effective in ensuring that information required to be disclosed by the Company in reports it files or submits under the Securities Exchange Act is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure and (2) were effective in ensuring that information required to be disclosed by the Company in reports it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms. 

There have been no changes in our internal controls over financial reporting that occurred during the three months ended June 30, 2021 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, we are involved in various claims and legal actions arising in the ordinary course of business. At June 30, 2021, we were not party to any pending material legal proceedings.

ITEM 1A. RISK FACTORS

Other than the risk factor relating to the announced sale of the CRE business disclosed in Item 1A. “Risk Factors” of our quarterly report on Form 10-Q for the quarter ended March 31, 2021, there have been no material changes to the risk factors disclosed in Item 1A. “Risk Factors” of our most recent annual report on Form 10-K. The materialization of any risks and uncertainties identified in our Special Note Regarding Forward-Looking Statements contained in this report together with those previously disclosed in our most recent annual report on Form 10-K or those that are presently unforeseen could result in significant adverse effects on our financial condition, results of operations and cash flows. See Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Special Note Regarding Forward-Looking Statements” in this quarterly report or our most recent annual report on Form 10-K.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

In December 2020, we announced that our Board authorized the repurchase of up to $1.5 billion of our outstanding common shares through December 31, 2021. No shares were repurchased with respect to this share repurchase program during the quarter ended June 30, 2021. As of June 30, 2021, the maximum dollar value of shares that may yet be purchased under this plan was $1.5 billion.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

Exhibits:

The exhibits required by this item are set forth on the Exhibit Index attached hereto. 

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Exhibit Number			Exhibit Description
31.1			Certification of David L. Finkelstein, Chief Executive Officer and Chief Investment Officer (Principal Executive Officer) of the Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. †
31.2			Certification of Serena Wolfe, Chief Financial Officer (Principal Financial Officer) of the Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. †
32.1			Certification of David L. Finkelstein, Chief Executive Officer and Chief Investment Officer (Principal Executive Officer) of the Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. †
32.2			Certification of Serena Wolfe, Chief Financial Officer (Principal Financial Officer) of the Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. †
101.INS XBRL			The instance document does not appear in the interactive data file because its Extensible Business Reporting Language (XBRL) tags are embedded within the Inline XBRL document. The following documents are formatted in Inline XBRL: (i) Consolidated Statements of Financial Condition at June 30, 2021 (Unaudited) and December 31, 2020 (Derived from the audited Consolidated Statement of Financial Condition at December 31, 2020); (ii) Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the three and six months ended June 30, 2021 and 2020; (iii) Consolidated Statements of Stockholders’ Equity (Unaudited) for the three and six months ended June 30, 2021 and 2020; (iv) Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 30, 2021 and 2020; and (v) Notes to Consolidated Financial Statements (Unaudited).
101.SCH XBRL			Taxonomy Extension Schema Document †
101.CAL XBRL			Taxonomy Extension Calculation Linkbase Document †
101.DEF XBRL			Additional Taxonomy Extension Definition Linkbase Document Created †
101.LAB XBRL			Taxonomy Extension Label Linkbase Document †
101.PRE XBRL			Taxonomy Extension Presentation Linkbase Document †
104			The cover page for the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2021 (formatted in Inline XBRL and contained in Exhibit 101).

† Submitted electronically herewith.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of New York, State of New York.

 

									ANNALY CAPITAL MANAGEMENT, INC.
Dated:			August 5, 2021						By: /s/ David L. Finkelstein
									David L. Finkelstein
									Chief Executive Officer and Chief Investment Officer (Principal Executive Officer)
Dated:			August 5, 2021						By: /s/ Serena Wolfe
									Serena Wolfe
									Chief Financial Officer (Principal Financial Officer)

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