nly-20200930


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

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED: September 30, 2020

☐ 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


7.50% Series D Cumulative Redeemable Preferred Stock	NLY.D	New York Stock Exchange

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

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

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

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

Large accelerated
filer

☑

Accelerated
filer

☐

Non-accelerated filer

☐

Smaller reporting company

☐

Emerging growth company

☐

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

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

The number of shares of the registrant’s Common Stock outstanding on October 30, 2020 was 1,398,228,330.


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 September 30, 2020 (Unaudited) and December 31, 2019 (Derived from the audited consolidated financial statements at December 31, 2019)			1
Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the three and nine months ended September 30, 2020 and 2019			2
Consolidated Statements of Stockholders’ Equity (Unaudited) for the three and nine months ended September 30, 2020 and 2019			3
Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2020 and 2019			4
Notes to Consolidated Financial Statements (Unaudited)			5
Note 1. Description of Business			5
Note 2. Basis of Presentation			5
Note 3. Significant Accounting Policies			5
Note 4. Financial Instruments			9
Note 5. Securities			9
Note 6. Loans			13
Note 7. Mortgage Servicing Rights			22
Note 8. Variable Interest Entities			23
Note 9. Real Estate			27
Note 10. Derivative Instruments			28
Note 11. Fair Value Measurements			35
Note 12. Goodwill and Intangible Assets			38
Note 13. Secured Financing			39
Note 14. Capital Stock			41
Note 15. Interest Income and Interest Expense			43
Note 16. Net Income (Loss) per Common Share			44
Note 17. Income Taxes			44
Note 18. Risk Management			45
Note 19. Related Party Transactions			46
Note 20. Lease Commitments and Contingencies			47
Note 21. Arcola Regulatory Requirements			48
Note 22. Subsequent Events			48
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			49
Special Note Regarding Forward-Looking Statements			49
Overview			51
Business Environment and Coronavirus Disease 2019 (“COVID-19”)			51
Results of Operations			53
Financial Condition			65
Capital Management			69
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

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

PART I - FINANCIAL INFORMATION


ITEM 1. FINANCIAL STATEMENTS


ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (dollars in thousands, except per share data)
	September 30,		December 31,
	2020		2019 (1)
	(Unaudited)
Assets
Cash and cash equivalents (includes pledged assets of $1,025,431 and $1,648,545, respectively) (2)	$	1,239,982	$	1,850,729
Securities (includes pledged assets of $67,664,458 and $108,809,569, respectively) (3)	76,098,985		114,833,580
Loans, net (includes pledged assets of $2,096,223 and $3,240,583, respectively) (4)	2,788,341		4,462,350
Mortgage servicing rights (includes pledged assets of $3,431 and $3,336, respectively)	207,985		378,078
Assets transferred or pledged to securitization vehicles	7,269,402		7,002,460
Real estate, net	790,597		725,638


Derivative assets	103,245		113,556


Receivable for unsettled trades	54,200		4,792
Principal and interest receivable	281,009		449,906


Goodwill and intangible assets, net	136,900		92,772
Other assets	221,765		381,220

Total assets	$	89,192,411	$	130,295,081
Liabilities and stockholders’ equity
Liabilities
Repurchase agreements	$	64,633,447	$	101,740,728
Other secured financing	861,373		4,455,700

Debt issued by securitization vehicles	6,027,576		5,622,801

Mortgages payable	507,934		485,005


Derivative liabilities	1,182,681		803,866
Payable for unsettled trades	1,176,001		463,387
Interest payable	155,338		476,335

Dividends payable	308,644		357,527
Other liabilities	144,745		93,388
Total liabilities	74,997,739		114,498,737
Stockholders’ equity







Preferred stock, par value $0.01 per share, 85,150,000 authorized, 81,900,000 issued and outstanding	1,982,026		1,982,026
Common stock, par value $0.01 per share, 2,914,850,000 authorized, 1,402,928,317 and 1,430,106,199 issued and outstanding, respectively	14,029		14,301
Additional paid-in capital	19,798,032		19,966,923
Accumulated other comprehensive income (loss)	3,589,056		2,138,191
Accumulated deficit	(11,200,937)		(8,309,424)
Total stockholders’ equity	14,182,206		15,792,017
Noncontrolling interests	12,466		4,327
Total equity	14,194,672		15,796,344
Total liabilities and equity	$	89,192,411	$	130,295,081

(1)Derived from the audited consolidated financial statements at December 31, 2019.

(2)Includes cash of consolidated Variable Interest Entities (“VIEs”) of $84.9 million and $67.5 million at September 30, 2020 and December 31, 2019, respectively.

(3)Excludes $50.3 million and $102.5 million at September 30, 2020 and December 31, 2019, respectively, of Agency mortgage-backed securities, $544.0 million and $468.0 million at September 30, 2020 and December 31, 2019, respectively, of non-Agency mortgage-backed securities and $392.6 million and $500.3 million at September 30, 2020 and December 31, 2019, 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 $50.0 million and $66.7 million of residential mortgage loans held for sale at September 30, 2020 and December 31, 2019, respectively.

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (dollars in thousands, except per share data) (Unaudited)
	For The Three Months Ended September 30,				For The Nine Months Ended September 30,
	2020		2019		2020		2019
Net interest income
Interest income	$	562,443	$	919,299	$	1,702,281	$	2,713,083
Interest expense	115,126		766,905		804,631		2,164,817
Net interest income	447,317		152,394		897,650		548,266
Realized and unrealized gains (losses)
Net interest component of interest rate swaps	(62,529)		88,466		(141,070)		306,154
Realized gains (losses) on termination or maturity of interest rate swaps	(427)		(682,602)		(1,919,720)		(1,438,349)
Unrealized gains (losses) on interest rate swaps	170,327		(326,309)		(1,162,768)		(1,992,884)
Subtotal	107,371		(920,445)		(3,223,558)		(3,125,079)
Net gains (losses) on disposal of investments and other	198,888		66,522		652,150		(65,727)
Net gains (losses) on other derivatives	169,316		(16,888)		546,658		(638,458)
Net unrealized gains (losses) on instruments measured at fair value through earnings	121,255		(1,091)		(354,133)		41,657
Loan loss provision	21,993		(3,504)		(146,084)		(9,207)


Subtotal	511,452		45,039		698,591		(671,735)
Total realized and unrealized gains (losses)	618,823		(875,406)		(2,524,967)		(3,796,814)
Other income (loss)	7,959		35,074		38,109		93,757
General and administrative expenses
Compensation and management fee	29,196		41,161		107,057		130,225
Other general and administrative expenses	19,636		24,977		87,070		98,058
Total general and administrative expenses	48,832		66,138		194,127		228,283
Income (loss) before income taxes	1,025,267		(754,076)		(1,783,335)		(3,383,074)
Income taxes	9,719		(6,907)		(14,928)		(10,241)
Net income (loss)	1,015,548		(747,169)		(1,768,407)		(3,372,833)
Net income (loss) attributable to noncontrolling interests	(126)		(110)		(28)		(294)
Net income (loss) attributable to Annaly	1,015,674		(747,059)		(1,768,379)		(3,372,539)
Dividends on preferred stock (1)	35,509		36,151		106,527		101,067
Net income (loss) available (related) to common stockholders	$	980,165	$	(783,210)	$	(1,874,906)	$	(3,473,606)
Net income (loss) per share available (related) to common stockholders
Basic	$	0.70	$	(0.54)	$	(1.32)	$	(2.42)
Diluted	$	0.70	$	(0.54)	$	(1.32)	$	(2.42)
Weighted average number of common shares outstanding
Basic	1,404,202,695		1,453,359,211		1,419,645,475		1,436,204,582
Diluted	1,404,368,300		1,453,359,211		1,419,645,475		1,436,204,582

Other comprehensive income (loss)
Net income (loss)	$	1,015,548	$	(747,169)	$	(1,768,407)	$	(3,372,833)
Unrealized gains (losses) on available-for-sale securities	(140,671)		1,034,873		2,220,271		4,289,054
Reclassification adjustment for net (gains) losses included in net income (loss)	(112,347)		(86,061)		(769,406)		4,626
Other comprehensive income (loss)	(253,018)		948,812		1,450,865		4,293,680
Comprehensive income (loss)	762,530		201,643		(317,542)		920,847
Comprehensive income (loss) attributable to noncontrolling interests	(126)		(110)		(28)		(294)
Comprehensive income (loss) attributable to Annaly	762,656		201,753		(317,514)		921,141
Dividends on preferred stock (1)	35,509		36,151		106,527		101,067
Comprehensive income (loss) attributable to common stockholders	$	727,147	$	165,602	$	(424,041)	$	820,074

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

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (dollars in thousands) (Unaudited)
	For The Three Months Ended September 30,				For The Nine Months Ended September 30,
	2020		2019		2020		2019
Preferred stock
Beginning of period	$	1,982,026	$	2,110,346	$	1,982,026	$	1,778,168
Issuance	—		41,146		—		428,324

Redemption	—		(169,466)		—		(224,466)
End of period	$	1,982,026	$	1,982,026	$	1,982,026	$	1,982,026
Common stock
Beginning of period	$	14,077	$	14,562	$	14,301	$	13,138
Issuance	—		—		—		1,422
Buyback of common stock	(49)		(182)		(277)		(182)
Stock-based award activity	—		—		3		—

Direct purchase and dividend reinvestment	1		—		2		2
End of period	$	14,029	$	14,380	$	14,029	$	14,380
Additional paid-in capital
Beginning of period	$	19,827,216	$	20,195,419	$	19,966,923	$	18,794,331
Issuance	—		—		(93)		1,397,484
Buyback of common stock	(31,363)		(155,122)		(174,799)		(155,122)
Stock-based award activity	1,510		207		4,928		2,018

Redemption of preferred stock	—		(5,534)		—		(5,534)
Direct purchase and dividend reinvestment	669		—		1,073		1,793
End of period	$	19,798,032	$	20,034,970	$	19,798,032	$	20,034,970
Accumulated other comprehensive income (loss)
Beginning of period	$	3,842,074	$	1,365,003	$	2,138,191	$	(1,979,865)
Unrealized gains (losses) on available-for-sale securities	(140,671)		1,034,873		2,220,271		4,289,054
Reclassification adjustment for net gains (losses) included in net income (loss)	(112,347)		(86,061)		(769,406)		4,626
End of period	$	3,589,056	$	2,313,815	$	3,589,056	$	2,313,815
Accumulated deficit
Beginning of period - unadjusted	$	(11,871,927)	$	(7,982,649)	$	(8,309,424)	$	(4,493,660)
Cumulative effect of change in accounting principle for credit losses	—		—		(39,641)		—
Beginning of period - adjusted	(11,871,927)		(7,982,649)		(8,349,065)		(4,493,660)
Net income (loss) attributable to Annaly	1,015,674		(747,059)		(1,768,379)		(3,372,539)
Dividends declared on preferred stock (1)	(35,509)		(36,451)		(106,527)		(101,067)
Dividends and dividend equivalents declared on common stock and stock-based awards (1)	(309,175)		(359,736)		(976,966)		(1,158,629)

End of period	$	(11,200,937)	$	(9,125,895)	$	(11,200,937)	$	(9,125,895)
Total stockholder’s equity	$	14,182,206	$	15,219,296	$	14,182,206	$	15,219,296
Noncontrolling interests
Beginning of period	$	4,137	$	4,726	$	4,327	$	5,689
Net income (loss) attributable to noncontrolling interests	(126)		(110)		(28)		(294)
Equity contributions from (distributions to) noncontrolling interests	8,455		(208)		8,167		(987)
End of period	$	12,466	$	4,408	$	12,466	$	4,408
Total equity	$	14,194,672	$	15,223,704	$	14,194,672	$	15,223,704

(1) See Note titled “Capital Stock” for dividends per share for each class of shares. The three months ended September 30, 2019 include cumulative and undeclared dividends of $0.3 million on the Company's Series I Preferred Stock as of June 30, 2019.

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
	For The Nine Months Ended September 30,
	2020		2019
Cash flows from operating activities
Net income (loss)	$	(1,768,407)	$	(3,372,833)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities








Amortization of premiums and discounts of investments, net	1,130,285		943,277
Amortization of securitized debt premiums and discounts and deferred financing costs	(7,263)		(11,457)
Depreciation, amortization and other noncash expenses	28,181		24,107
Net (gains) losses on disposal of investments and other	(652,150)		65,727
Net (gains) losses on investments and derivatives	2,889,963		2,589,685
Income from unconsolidated joint ventures	(2,596)		3,350

Loan loss provision	146,084		9,207













Payments on purchases of loans held for sale	(120,855)		(196,252)









Proceeds from sales and repayments of loans held for sale	139,672		220,409














Net receipts (payments) on derivatives	(2,210,881)		(2,561,170)
Net change in

Other assets	291,745		(45,547)




Interest receivable	148,165		(92,959)
Interest payable	(320,997)		(5,131)
Other liabilities	(30,769)		34,194
Net cash provided by (used in) operating activities	(339,823)		(2,395,393)
Cash flows from investing activities
Payments on purchases of securities	(24,970,238)		(51,502,672)
Proceeds from sales of securities	50,295,038		19,713,184
Principal payments on securities	14,392,160		11,206,792
Payments on purchases and origination of loans	(1,658,578)		(2,718,403)

Proceeds from sales of loans	583,040		365,787
Principal payments on loans	1,558,859		2,523,471












Investments in real estate	(6,123)		(12,384)












Proceeds from sales of real estate	—		6,661





Proceeds from reverse repurchase agreements	46,100,000		78,439,755
Payments on reverse repurchase agreements	(46,100,000)		(77,789,715)
Distributions in excess of cumulative earnings from unconsolidated joint ventures	6,641		1,975




Cash acquired in asset acquisition	1,047		—


Net cash provided by (used in) investing activities	40,201,846		(19,765,549)
Cash flows from financing activities
Proceeds from repurchase agreements and other secured financing	2,353,694,509		4,275,937,246


Payments on repurchase agreements and other secured financing	(2,394,417,060)		(4,254,088,297)



Proceeds from issuances of securitized debt	2,385,374		2,030,356

Principal payments on securitized debt	(860,306)		(1,778,314)
Payment of deferred financing cost	(553)		(5,222)
Net proceeds from stock offerings, direct purchases and dividend reinvestments	1,075		1,829,025


Redemptions of preferred stock	—		(230,000)




Net principal receipts (payments) on mortgages payable	22,550		(25,398)
Net contributions (distributions) from (to) noncontrolling interests	8,167		(987)


Net payment on share repurchase	(175,076)		(155,304)
Dividends paid	(1,131,450)		(1,293,991)
Net cash provided by (used in) financing activities	(40,472,770)		22,219,114
Net (decrease) increase in cash and cash equivalents	$	(610,747)	$	58,172
Cash and cash equivalents including cash pledged as collateral, beginning of period	1,850,729		1,735,749
Cash and cash equivalents including cash pledged as collateral, end of period	$	1,239,982	$	1,793,921
Supplemental disclosure of cash flow information
Interest received	$	2,926,598	$	3,583,189
Dividends received	$	4,485	$	6,279


Interest paid (excluding interest paid on interest rate swaps)	$	1,050,203	$	2,041,539
Net interest paid on interest rate swaps	$	290,277	$	(96,169)
Taxes received (paid)	$	1,551	$	274

Noncash investing and financing activities
Receivable for unsettled trades	$	54,200	$	193,229
Payable for unsettled trades	$	1,176,001	$	245,626


Net change in unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment	$	1,450,865	$	4,293,680




Dividends declared, not yet paid	$	308,644	$	359,491

Derecognition of assets of consolidated VIEs	$	1,222,221	$	—
Derecognition of securitized debt of consolidated VIEs	$	1,141,311	$	—

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


1. DESCRIPTION OF BUSINESS

Annaly Capital Management, Inc. (the “Company” or “Annaly”) is a Maryland corporation that commenced operations on February 18, 1997. The Company is a leading diversified capital manager that invests in and finances residential and commercial assets. The Company owns a portfolio of real estate related investments, including mortgage pass-through certificates, collateralized mortgage obligations, credit risk transfer (“CRT”) securities, other securities representing interests in or obligations backed by pools of mortgage loans, residential mortgage loans, mortgage servicing rights (“MSRs”), commercial real estate assets and corporate debt. The Company’s principal business objective is to generate net income for distribution to its stockholders and optimize its returns through prudent management of its diversified investment strategies.

The Company’s four investment groups are primarily comprised of the following:


Investment Groups			Description
Annaly Agency Group			Invests in Agency mortgage-backed securities (“MBS”) collateralized by residential mortgages which are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae.
Annaly Residential Credit Group			Invests primarily in non-Agency residential mortgage assets within securitized products and residential mortgage loan markets.
Annaly Commercial Real Estate Group			Originates and invests in commercial mortgage loans, securities, and other commercial real estate debt and equity investments.
Annaly Middle Market Lending Group			Provides financing to private equity-backed middle market businesses, focusing primarily on senior debt within select industries.

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 Note 19) on June 30, 2020, the Company was externally managed by Annaly Management Company LLC (the “Former Manager”).


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, 2019 (the “2019 Form 10-K”). The consolidated financial information as of December 31, 2019 has been derived from audited consolidated financial statements included in the Company’s 2019 Form 10-K.

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported balance sheet amounts and/or disclosures at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

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


3. SIGNIFICANT ACCOUNTING POLICIES

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

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

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

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

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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 $1.0 billion and $1.6 billion at September 30, 2020 and December 31, 2019, respectively.

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

Fair Value Measurements and the Fair Value Option – The Company reports various investments at fair value, including certain eligible financial instruments elected to be accounted for under the fair value option (“FVO”). The Company chooses to elect the fair value option in order to simplify the accounting treatment for certain financial instruments. Items for which the fair value option has been elected are presented at fair value in the Consolidated Statements of Financial Condition and any change in fair value is recorded in Net unrealized gains (losses) on instruments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss). For additional information regarding financial instruments for which the Company has elected the fair value option see the table in the “Financial Instruments” Note.

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

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

Derivative Instruments – Derivatives are accounted for in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging, which requires recognition of all derivatives as either assets or liabilities at fair value in the Consolidated Statements of Financial Condition with changes in fair value recognized in the Consolidated Statements of Comprehensive Income (Loss). The changes in the estimated fair value are presented within Net gains (losses) on other derivatives with the exception of interest rate swaps which are separately presented. None of the Company’s derivative transactions have been designated as hedging instruments for accounting purposes. Refer to the “Derivative Instruments” Note for further discussion.

Stock-Based Compensation – The Company 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. 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. 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

Interest Income - The Company recognizes interest income primarily on Residential Securities, 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. See the Note “Interest Income and Interest Expense” 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.

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 were 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


4. FINANCIAL INSTRUMENTS

The following table presents characteristics for certain of the Company’s financial instruments at September 30, 2020 and December 31, 2019.

Financial Instruments (1)

Balance Sheet Line Item

Type / Form

Measurement Basis

September 30, 2020

December 31, 2019

Assets

(dollars in thousands)

Securities

Agency mortgage-backed securities (2)

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

74,393,763

112,124,958

Securities

Agency mortgage-backed securities (3)

Fair value, with unrealized gains (losses) through earnings

521,404

768,409

Securities

Credit risk transfer securities

Fair value, with unrealized gains (losses) through earnings

411,538

531,322

Securities

Non-agency mortgage-backed securities

Fair value, with unrealized gains (losses) through earnings

717,602

1,135,868

Securities

Commercial real estate debt investments - CMBS

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

31,140

64,655

Securities

Commercial real estate debt investments - CMBS (4)

Fair value, with unrealized gains (losses) through earnings

23,538

208,368

Total securities

76,098,985

114,833,580

Loans, net

Residential mortgage loans

Fair value, with unrealized gains (losses) through earnings

152,959

1,647,787

Loans, net

Commercial real estate debt and preferred equity, held for investment

Amortized cost

573,504

669,713

Loans, net

Corporate debt held for investment, net

Amortized cost

2,061,878

2,144,850

Total loans, net

2,788,341

4,462,350

Assets transferred or pledged to securitization vehicles

Agency mortgage-backed securities

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

623,650

1,122,588

Assets transferred or pledged to securitization vehicles

Residential mortgage loans

Fair value, with unrealized gains (losses) through earnings

3,588,679

2,598,374

Assets transferred or pledged to securitization vehicles

Commercial mortgage loans

Fair value, with unrealized gains (losses) through earnings

2,174,118

2,345,120

Assets transferred or pledged to securitization vehicles

Commercial mortgage loans

Amortized cost

882,955

936,378

Total assets transferred or pledged to securitization vehicles

7,269,402

7,002,460

Liabilities

Repurchase agreements

Amortized cost

64,633,447

101,740,728

Other secured financing

Loans

Amortized cost

861,373

4,455,700

Debt issued by securitization vehicles

Securities

Fair value, with unrealized gains (losses) through earnings

6,027,576

5,622,801

Mortgages payable

Loans

Amortized cost

507,934

485,005

(1) Receivable for unsettled trades, Principal and interest receivable, Payable for unsettled trades, Interest payable and Dividends payable are accounted for at cost.

(2) Includes Agency pass-through, collateralized mortgage obligation (“CMO”) and multifamily securities.

(3) Includes interest-only securities and reverse mortgages.

(4) Includes single-asset / single-borrower CMBS.


5. SECURITIES

The Company’s investments in securities include agency, credit risk transfer, non-agency and commercial mortgage-backed securities. All of the debt securities are classified as available-for-sale. Available-for-sale 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 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,

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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). There was no impairment recognized for the three or nine months ended September 30, 2020 and 2019.

Agency Mortgage-Backed Securities - The Company invests in mortgage pass-through certificates, collateralized mortgage obligations and other MBS representing interests in or obligations backed by pools of residential or multifamily mortgage loans and certificates. Many of the underlying loans and certificates are guaranteed by the Government National Mortgage Association (“Ginnie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”) or the Federal National Mortgage Association (“Fannie Mae”) (collectively, “Agency mortgage-backed securities”).

Agency mortgage-backed securities may include forward contracts for Agency mortgage-backed securities purchases or sales of a generic pool, on a to-be-announced basis (“TBA securities”). TBA securities without intent to accept delivery (“TBA derivatives”), are accounted for as derivatives as discussed in the “Derivative Instruments” Note.

CRT Securities - CRT securities are risk sharing instruments issued by Fannie Mae and Freddie Mac, and similarly structured transactions arranged by third party market participants. CRT securities are designed to synthetically transfer mortgage credit risk from Fannie Mae and Freddie Mac to private investors.

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

Agency mortgage-backed securities, non-Agency mortgage-backed securities and CRT securities are referred to herein as “Residential Securities.” Although the Company generally intends to hold most of its Residential Securities until maturity, it may, from time to time, sell any of its Residential Securities as part of the overall management of its portfolio.

Commercial Mortgage-Backed Securities (“Commercial Securities”) - Certain commercial mortgage-backed securities are classified as available-for-sale and reported at fair value with 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 commercial mortgage-backed securities, to simplify the accounting where the unrealized gains and losses on these financial instruments are recorded through earnings.

The following represents a rollforward of the activity for the Company’s securities, excluding securities transferred or pledged to securitization vehicles, for the nine months ended September 30, 2020:


	Residential Securities		Commercial Securities		Total
	(dollars in thousands)
Beginning balance January 1, 2020	$	114,560,557	$	273,023	$	114,833,580
Purchases	25,679,591		—		25,679,591
Sales and transfers (1)	(50,079,936)		(204,062)		(50,283,998)
Principal paydowns	(14,354,169)		(4,933)		(14,359,102)
(Amortization) / accretion	(1,135,486)		377		(1,135,109)
Fair value adjustment	1,373,750		(9,727)		1,364,023
Ending balance September 30, 2020	$	76,044,307	$	54,678	$	76,098,985

(1) Includes transfers to securitization vehicles.

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 September 30, 2020 and December 31, 2019:


	September 30, 2020
	Principal / Notional		Remaining Premium		Remaining Discount		Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
Agency	(dollars in thousands)
Fixed-rate pass-through	$	65,676,115	$	3,142,668	$	(23,694)	$	68,795,089	$	3,416,366	$	(885)	$	72,210,570
Adjustable-rate pass-through	502,382		3,436		(3,423)		502,395		24,872		—		527,267
CMO	144,899		2,253		—		147,152		5,361		—		152,513
Interest-only	3,081,524		600,917		—		600,917		7,705		(143,246)		465,376
Multifamily	1,433,340		17,207		(1,083)		1,449,464		62,240		(8,291)		1,503,413
Reverse mortgages	51,189		4,379		—		55,568		563		(103)		56,028
Total agency securities	$	70,889,449	$	3,770,860	$	(28,200)	$	71,550,585	$	3,517,107	$	(152,525)	$	74,915,167
Residential credit
CRT (1)	$	463,482	$	8,280	$	(1,556)	$	459,233	$	1,007	$	(48,702)	$	411,538
Alt-A	104,381		51		(20,322)		84,110		6,845		(1)		90,954
Prime	184,166		4,877		(14,520)		174,523		12,121		(466)		186,178
Prime interest-only	237,377		2,355		—		2,355		—		(1,164)		1,191
Subprime	131,194		—		(19,750)		111,444		8,107		(4)		119,547
NPL/RPL	284,699		697		(2,684)		282,712		1,950		(2,793)		281,869
Prime jumbo (>=2010 vintage)	39,666		—		(5,107)		34,559		1,766		(121)		36,204
Prime jumbo (>=2010 vintage) Interest-only	366,870		7,485		—		7,485		—		(5,826)		1,659
Total residential credit securities	$	1,811,835	$	23,745	$	(63,939)	$	1,156,421	$	31,796	$	(59,077)	$	1,129,140
Total Residential Securities	$	72,701,284	$	3,794,605	$	(92,139)	$	72,707,006	$	3,548,903	$	(211,602)	$	76,044,307
Commercial
Commercial Securities	$	64,458	$	—	$	(7,631)	$	56,827	$	—	$	(2,149)	$	54,678
Total securities	$	72,765,742	$	3,794,605	$	(99,770)	$	72,763,833	$	3,548,903	$	(213,751)	$	76,098,985


	December 31, 2019
	Principal / Notional		Remaining Premium		Remaining Discount		Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
Agency	(dollars in thousands)
Fixed-rate pass-through	$	102,448,565	$	4,345,053	$	(46,614)	$	106,747,004	$	2,071,583	$	(95,173)	$	108,723,414
Adjustable-rate pass-through	1,474,818		72,245		(1,400)		1,545,663		10,184		(31,516)		1,524,331
CMO	156,937		2,534		—		159,471		545		—		160,016

Interest-only	4,486,845		862,905		—		862,905		2,787		(157,130)		708,562
Multifamily	1,619,900		19,981		(2,280)		1,637,601		82,292		(2,696)		1,717,197
Reverse mortgages	54,553		5,053		—		59,606		550		(309)		59,847
Total agency investments	$	110,241,618	$	5,307,771	$	(50,294)	$	111,012,250	$	2,167,941	$	(286,824)	$	112,893,367
Residential credit
CRT (1)	$	517,110	$	15,850	$	(2,085)	$	515,950	$	16,605	$	(1,233)	$	531,322
Alt-A	160,957		250		(22,306)		138,901		12,482		—		151,383
Prime	277,076		3,362		(17,794)		262,644		14,142		(529)		276,257
Prime interest-only	391,234		3,757		—		3,757		—		(590)		3,167
Subprime	370,263		1,356		(59,727)		311,892		37,205		(118)		348,979
NPL/RPL	164,180		351		(440)		164,091		191		(14)		164,268
Prime jumbo (>=2010 vintage)	182,709		1,026		(4,281)		179,454		5,360		(150)		184,664
Prime jumbo (>=2010 vintage) Interest-only	554,189		9,001		—		9,001		—		(1,851)		7,150
Total residential credit securities	$	2,617,718	$	34,953	$	(106,633)	$	1,585,690	$	85,985	$	(4,485)	$	1,667,190
Total Residential Securities	$	112,859,336	$	5,342,724	$	(156,927)	$	112,597,940	$	2,253,926	$	(291,309)	$	114,560,557
Commercial
Commercial Securities	$	263,965	$	10,873	$	(9,393)	$	265,445	$	7,710	$	(132)	$	273,023
Total securities	$	113,123,301	$	5,353,597	$	(166,320)	$	112,863,385	$	2,261,636	$	(291,441)	$	114,833,580

(1) Principal/Notional amount includes $11.0 million and $14.9 million of a CRT interest-only security as of September 30, 2020 and December 31, 2019, respectively.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following table presents the Company’s Agency mortgage-backed securities portfolio, excluding securities transferred or pledged to securitization vehicles, by issuing Agency at September 30, 2020 and December 31, 2019:


	September 30, 2020		December 31, 2019
Investment Type	(dollars in thousands)
Fannie Mae	$	55,191,253	$	76,656,831
Freddie Mac	19,599,587		36,087,100
Ginnie Mae	124,327		149,436
Total	$	74,915,167	$	112,893,367

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 September 30, 2020 and December 31, 2019, according to their estimated weighted average life classifications:


	September 30, 2020				December 31, 2019
	Estimated Fair Value		Amortized Cost		Estimated Fair Value		Amortized Cost
Estimated weighted average life	(dollars in thousands)
Less than one year	$	816,998	$	799,272	$	3,997	$	4,543
Greater than one year through five years	50,911,159		48,461,791		36,290,254		35,581,833
Greater than five years through ten years	23,073,677		22,217,393		77,732,756		76,504,845
Greater than ten years	1,242,473		1,228,550		533,550		506,719
Total	$	76,044,307	$	72,707,006	$	114,560,557	$	112,597,940

The estimated weighted average lives of the Residential Securities at September 30, 2020 and December 31, 2019 in the table above are based upon projected principal prepayment rates. The actual weighted average lives of the Residential Securities could be longer or shorter than projected.

The following table presents the gross unrealized losses and estimated fair value of the Company’s Agency mortgage-backed securities, accounted for as available-for-sale where the fair value option has not been elected, by length of time that such securities have been in a continuous unrealized loss position at September 30, 2020 and December 31, 2019.


	September 30, 2020					December 31, 2019
	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	$	1,154,762	$	(9,176)	23	$	7,388,239	$	(24,056)	139
12 Months or more	—		—		—	11,619,280		(105,329)		352
Total	$	1,154,762	$	(9,176)	23	$	19,007,519	$	(129,385)	491

(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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

During the three and nine months ended September 30, 2020, the Company disposed of $2.8 billion and $50.2 billion of Residential Securities, respectively. During the three and nine months ended September 30, 2019, the Company disposed of $11.1 billion and $30.7 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 nine months ended September 30, 2020 and 2019.


	Gross Realized Gains		Gross Realized Losses		Net Realized Gains (Losses)
For the three months ended	(dollars in thousands)
September 30, 2020	$	117,373	$	(13,440)	$	103,933
September 30, 2019	$	104,427	$	(28,175)	$	76,252
For the nine months ended
September 30, 2020	$	929,010	$	(297,934)	$	631,076
September 30, 2019	$	127,970	$	(178,531)	$	(50,561)


6. LOANS

The Company invests in residential, commercial and corporate loans. Loans are classified as either held for investment or held for sale. Loans are also eligible to be accounted for under the fair value option. Excluding loans transferred or pledged to securitization vehicles, as of September 30, 2020 and December 31, 2019, the Company reported $0.2 million and $1.6 billion, 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. 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 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

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

investment. Because these determinations are based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized may differ materially from the carrying value as of the reporting date.

The Company may be exposed to various levels of credit risk depending on the nature of its investments and credit enhancements, if any, supporting its assets. The Company’s core investment process includes procedures related to the initial approval and periodic monitoring of credit risk and other risks associated with each investment. The Company’s investment underwriting procedures include evaluation of the underlying borrowers’ ability to manage and operate their respective properties or companies. Management reviews loan-to-value metrics at origination or acquisition of a new investment and if events occur that trigger re-evaluation by management.

The Company recorded a net loan loss (reversal) provision of ($22.0) million and $146.1 million for the three and nine months ended September 30, 2020, respectively. The Company recorded loan loss provisions of $3.5 million and $9.2 million for the three and nine months ended September 30, 2019, respectively. As of September 30, 2020 and December 31, 2019, the Company’s loan loss provision was $168.0 million and $20.1 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 nine months ended September 30, 2020:


	Residential		Commercial		Corporate Debt		Total
	(dollars in thousands)
Beginning balance January 1, 2020	$	1,647,787	$	669,713	$	2,144,850	$	4,462,350
Impact of adopting CECL	—		(3,600)		(29,653)		(33,253)
Purchases / originations	935,232		194,926		678,608		1,808,766
Sales and transfers (1)	(2,258,330)		(148,036)		(321,847)		(2,728,213)



Principal payments	(151,708)		(59,675)		(410,421)		(621,804)
Gains / (losses) (2)	(14,980)		(81,659)		(9,842)		(106,481)
(Amortization) / accretion	(5,042)		1,835		10,183		6,976

Ending balance September 30, 2020	$	152,959	$	573,504	$	2,061,878	$	2,788,341

(1) Includes securitizations, syndications and transfers to securitization vehicles or REO.
(2) Includes loan loss allowances.

The carrying value of the Company’s residential loans held for sale was $50.0 million and $66.7 million at September 30, 2020 and December 31, 2019, respectively. There were no commercial loans held for sale at September 30, 2020 and December 31, 2019.

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 Statements of Comprehensive Income. Additionally, the Company consolidates a collateralized financing entity that securitized prime adjustable-rate jumbo residential mortgage loans. The Company also consolidates securitization trusts in which it had purchased subordinated securities because it also has certain powers and rights to direct the activities of such trusts. Refer to the “Variable Interest Entities” Note for further information related to the Company’s consolidated residential mortgage loan trusts.

The following table presents the fair value and the unpaid principal balances of the residential mortgage loan portfolio, including loans transferred or pledged to securitization vehicles, at September 30, 2020 and December 31, 2019:

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


	September 30, 2020		December 31, 2019
	(dollars in thousands)
Fair value	$	3,741,638	$	4,246,161
Unpaid principal balance	$	3,666,420	$	4,133,149

The following table provides information regarding the line items and amounts recognized in the Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2020 and 2019 for these investments:


	For the Three Months Ended				For the Nine Months Ended
	September 30, 2020		September 30, 2019		September 30, 2020		September 30, 2019
	(dollars in thousands)
Interest income	$	42,508	$	37,673	$	132,937	$	102,689
Net gains (losses) on disposal of investments and other	(4,638)		(9,671)		(22,014)		(19,499)
Net unrealized gains (losses) on instruments measured at fair value through earnings	77,837		18,093		(4,381)		61,805
Total included in net income (loss)	$	115,707	$	46,095	$	106,542	$	144,995

The following table provides the geographic concentrations based on the unpaid principal balances at September 30, 2020 and December 31, 2019 for the residential mortgage loans, including loans transferred or pledged to securitization vehicles:

Geographic Concentrations of Residential Mortgage Loans

September 30, 2020

December 31, 2019

Property location

% of Balance

Property location

% of Balance

California

50.1%

California

52.1%

New York

12.8%

New York

10.5%

Florida

5.8%

Florida

5.3%

All other (none individually greater than 5%)

31.3%

All other (none individually greater than 5%)

32.1%

Total

100.0%

The following table provides additional data on the Company’s residential mortgage loans, including loans transferred or pledged to securitization vehicles, at September 30, 2020 and December 31, 2019:


	September 30, 2020		December 31, 2019
	Portfolio Range	Portfolio Weighted Average	Portfolio Range	Portfolio Weighted Average
	(dollars in thousands)
Unpaid principal balance	$1 - $3,448	$458	$1 - $3,448	$459
Interest rate	0.50% - 9.24%	4.88%	2.00% - 8.38%	4.94%
Maturity	7/1/2029 - 10/1/2060	4/29/2048	1/1/2028 - 12/1/2059	12/29/2047
FICO score at loan origination	505 - 829	756	505 - 829	758
Loan-to-value ratio at loan origination	8% - 105%	67%	8% - 105%	67%

At September 30, 2020 and December 31, 2019, approximately 35% and 36%, respectively, of the carrying value of the Company’s residential mortgage loans, including transferred or pledged to securitization vehicles, were adjustable-rate.

Commercial

The Company’s commercial real estate loans are comprised of adjustable-rate and fixed-rate loans. The difference between the principal amount of a loan and proceeds at acquisition is recorded as either a discount or premium. Commercial real estate loans and preferred equity interests that are designated as held for investment and are originated or purchased by the Company are carried at their outstanding principal balance, net of unamortized origination fees and costs, premiums or discounts, less an

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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 produced by the borrower, which may include, but is not limited to, net operating income (“NOI”), debt service coverage ratios, property debt yields (net cash flow or NOI divided by the amount of outstanding indebtedness), loan per unit and rent rolls relating to each of the Company’s commercial real estate loans and preferred equity interests (“CRE Debt and Preferred Equity Investments”), and may consider other factors management deems important. Management also reviews market pricing to determine each borrower’s ability to refinance their respective assets at the maturity of each loan, economic trends (both macro and those affecting the property specifically), and the supply and demand of competing projects in the sub-market in which each subject property is located. Management monitors the financial condition and operating results of its borrowers and continually assesses the future outlook of the borrower’s financial performance in light of industry developments, management changes and company-specific considerations.

The Company’s internal loan risk ratings are based on the guidance provided by the Office of the Comptroller of the Currency for commercial real estate lending. The Company’s internal risk rating rubric for commercial loans has nine categories as depicted below:


Risk Rating - Commercial Loans			Description
1-4 / Performing			Meets all present contractual obligations.
5 / Performing - Closely Monitored			Meets all present contractual obligations, but are transitional or could be exhibiting some weaknesses in both leverage and liquidity.
6 / Performing - Special Mention			Meets all present contractual obligations, but exhibit potential weakness that deserves management’s close attention and, if uncorrected, may result in deterioration of repayment prospects.
7 / Substandard			Inadequately protected by sound worth and paying capacity of the obligor or of the collateral pledged with a distinct possibility that loss will be sustained if some of the deficiencies are not corrected.
8 / Doubtful			Substandard loans whereby collection of all contractual principal and interest is highly questionable or improbable.
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 commercial loans by year of origination and internal risk rating.

The Company’s commercial loans are collateral-dependent and, as such, for loans experiencing credit deterioration, the Company is required to record an allowance based upon the fair value of the underlying collateral if foreclosure is probable or if the practical expedient is elected. For the three months ended September 30, 2020, the Company did not record a loan loss provision on commercial loans based upon the fair value of the underlying collateral. For the three months ended September 30, 2019, the Company recorded a loan loss provision on impaired commercial loans of $3.5 million with a principal balance and carrying value, net of allowances of $7.0 million and $0.0 million, respectively, based upon the fair value of the underlying collateral. For the nine months ended September 30, 2020, the Company recorded a loan loss provision on impaired commercial loans of $74.1 million with a principal balance and carrying value, net of allowances of $160.2 million and $97.0 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 three of the fair value measurement hierarchy as there are unobservable inputs, which are significant to the overall fair value. For the nine months ended September 30, 2019, the Company recorded a loan loss provision of $9.2 million on commercial loans with a principal balance and carrying value, net of allowances of $43.6 million and $30.9 million, respectively.

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. For the three and nine months ended September 30, 2020, the Company recorded a net loan loss (reversal) provision of ($4.9) million and $57.4 million, respectively, based upon its Loss Given Default methodology.

During the three months ended September 30, 2020, the Company restructured two commercial loans with a carrying value of $109.5 million at September 30, 2020. The maturity dates on the two commercial loans were extended and one commercial loan was granted a 120 day forbearance. The loan loss allowance recorded for these commercial loans was $9.9 million at September 30, 2020.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

At September 30, 2020 and December 31, 2019, the amortized cost basis of commercial loans on nonaccrual status was $50.6 million and $175.2 million, respectively.

At September 30, 2020 and December 31, 2019, the Company had unfunded commercial real estate loan commitments of $123.2 million and $181.4 million, respectively. At September 30, 2020, the liability related to the expected credit losses on the unfunded commercial loan commitments was $6.2 million.

At September 30, 2020 and December 31, 2019, approximately 94% and 92%, respectively, 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 and excluding commercial loans held for sale, were adjustable-rate.

The sector attributes of the Company’s commercial real estate investments held for investment at September 30, 2020 and December 31, 2019 were as follows:


	Sector Dispersion
	September 30, 2020				December 31, 2019
	Carrying Value		% of Loan Portfolio		Carrying Value		% of Loan Portfolio
	(dollars in thousands)
Office	$	666,115	45.7	%	$	681,129	42.4	%
Retail	278,714		19.1	%	389,076		24.2	%
Multifamily	279,430		19.2	%	262,302		16.3	%
Hotel	121,829		8.4	%	135,681		8.4	%
Industrial	58,890		4.0	%	82,441		5.1	%
Other	31,805		2.2	%	36,589		2.3	%
Healthcare	19,676		1.4	%	18,873		1.3	%
Total	$	1,456,459	100.0	%	$	1,606,091	100.0	%

At September 30, 2020 and December 31, 2019, commercial real estate investments held for investment were comprised of the following:


	September 30, 2020						December 31, 2019
	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	$	469,813	$	450,177	29.5	%	$	503,499	$	499,690	30.9	%
Senior securitized mortgages (3)	939,654		882,955		59.1	%	940,546		936,378		57.8	%
Mezzanine loans	181,170		123,327		11.4	%	183,064		170,023		11.3	%

Total	$	1,590,637	$	1,456,459	100.0	%	$	1,627,109	$	1,606,091	100.0	%

(1) Carrying value includes unamortized origination fees of $5.9 million and $8.3 million at September 30, 2020 and December 31, 2019, 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 investment at September 30, 2020 and December 31, 2019:

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


September 30, 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)	183,612		—		12,206		195,818
Principal payments	(59,675)		(56,017)		—		(115,692)
Principal write off	—		—		(7,000)		(7,000)

Transfers (3)	(157,623)		54,471		(7,100)		(110,252)
Net (increase) decrease in origination fees	(812)		—		(80)		(892)
Realized gain	204		—		—		204
Amortization of net origination fees	1,695		1,908		140		3,743
Allowance for loan losses
Beginning allowance, prior to CECL adoption	—		—		(12,703)		(12,703)

Impact of adopting CECL	(2,264)		(4,166)		(1,336)		(7,766)
Current period allowance	(14,650)		(49,619)		(67,213)		(131,482)
Write offs	—		—		23,687		23,687
Ending allowance	(16,914)		(53,785)		(57,565)		(128,264)
Net carrying value (September 30, 2020)	$	450,177	$	882,955	$	123,327	$	1,456,459


December 31, 2019
	Senior Mortgages		Senior Securitized Mortgages (1)		Mezzanine Loans		Total
	(dollars in thousands)
Net carrying value (January 1, 2019)	$	981,202	$	—	$	315,601	$	1,296,803
Originations & advances (principal)	572,204		—		21,709		593,913
Principal payments	(16,785)		(150,245)		(149,633)		(316,663)


Transfers	(1,034,754)		1,083,487		(8,675)		40,058
Net (increase) decrease in origination fees	(4,200)		—		(184)		(4,384)
Amortization of net origination fees	2,023		3,136		412		5,571


Net (increase) decrease in allowance	—		—		(9,207)		(9,207)



Net carrying value (December 31, 2019)	$	499,690	$	936,378	$	170,023	$	1,606,091

(1) Represents assets of consolidated VIEs.
(2) Excludes loan loss allowances.
(3) Includes transfers to securitization vehicles or REO.

The following table provides the internal loan risk ratings of commercial real estate investments held for investment as of September 30, 2020.


Amortized Cost Basis by Risk Rating and Vintage (1)
Risk Rating	Vintage
	Total		2020		2019		2018		2017		2016		Prior
(dollars in thousands)
1-4 / Performing	$	354,960	$	92,076	$	168,409	$	—	$	12,447	$	—	$	82,028
5 / Performing - Closely Monitored	158,701		—		158,701		—		—		—		—
6 / Performing - Special Mention	676,700		56,845		216,591		270,767		64,139		68,358		—
7 / Substandard	169,058		9,155		—		67,391		42,716		—		49,796
8 / Doubtful	97,040		—		—		39,668		57,372		—		—
9 / Loss (2)	—		—		—		—		—		—		—
Total	$	1,456,459	$	158,076	$	543,701	$	377,826	$	176,674	$	68,358	$	131,824

(1) The amortized cost basis excludes accrued interest. As of September 30, 2020, the Company had $4.1 million of accrued interest receivable on

commercial loans which is reported in Principal and interest receivable in the Consolidated Statements of Financial Condition.

(2) Includes two commercial mezzanine loans for which the Company recorded a full loan loss allowance of $46.6 million.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

Corporate Debt

The Company’s investments in corporate loans typically take the form of senior secured loans primarily in first or second lien positions. The Company’s senior secured loans generally have stated maturities of five to seven years. In connection with these senior secured loans, the Company receives a security interest in certain assets of the borrower and such assets support repayment of such loans. Senior secured loans are generally exposed to less credit risk than more junior loans given their seniority to scheduled principal and interest and priority of security in the assets of the borrower. Interest income from coupon payments is accrued based upon the outstanding principal amounts of the debt and its contractual terms. Premiums and discounts are amortized or accreted into interest income using the effective interest method.

The Company’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.

For the three months ended September 30, 2020, the Company recorded a reduction in the loan loss provision of ($5.4) million on impaired corporate loans using a discounted cash flow methodology with a principal balance and carrying value, net of allowances of $9.7 million and $9.6 million, respectively. For the nine months ended September 30, 2020, the Company recorded a loan loss provision of $4.5 million on impaired corporate loans using a discounted cash flow methodology with a principal balance and carrying value, net of allowances of $29.3 million and $21.9 million, respectively. During the nine months ended September 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. There was no provision for loan loss recorded on corporate loans for the three and nine months ended September 30, 2019.

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. For the three and nine months ended September 30, 2020, the Company recorded a net loan loss (reversal) provision on corporate loans of ($11.6) million and $10.1 million, respectively, based upon its Loss Given Default methodology.

As of September 30, 2020 and December 31, 2019, the amortized cost basis of corporate loans on nonaccrual status was $12.9 and $12.2 million, respectively.

At September 30, 2020 and December 31, 2019, the Company had unfunded corporate loan commitments of $61.3 million and $81.2 million, respectively. At September 30, 2020, the liability related to the expected credit losses on the unfunded corporate loan commitments was $0.7 million.

The Company invests in corporate loans through its Annaly Middle Market Lending Group. The industry and rate attributes of the portfolio at September 30, 2020 and December 31, 2019 are as follows:

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


	Industry Dispersion
	September 30, 2020		December 31, 2019
	Total (1)		Total (1)
	(dollars in thousands)




Computer Programming, Data Processing & Other Computer Related Services	$	409,644	$	394,193
Management & Public Relations Services	257,404		339,179
Industrial Inorganic Chemicals	141,941		—


Public Warehousing & Storage	124,836		107,029

Engineering, Architectural, and Surveying	110,984		124,201
Metal Cans & Shipping Containers	110,478		118,456
Offices & Clinics of Doctors of Medicine	104,064		106,993

Surgical, Medical & Dental Instruments & Supplies	99,444		102,182
Electronic Components & Accessories	78,114		24,000
Insurance Agents, Brokers and Service	68,577		75,410
Telephone Communications	58,233		61,210
Miscellaneous Health & Allied Services, not elsewhere classified	52,307		78,908
Miscellaneous Equipment Rental & Leasing	49,589		49,776
Electric Work	41,170		43,175
Medical & Dental Laboratories	40,477		41,344
Research, Development & Testing Services	29,648		45,610
Metal Forgings & Stampings	29,390		—
Home Health Care Services	28,914		29,361
Motor Vehicles and Motor Vehicle Parts & Supplies	28,545		28,815
Legal Services	26,420		—
Petroleum and Petroleum Products	24,709		24,923
Grocery Stores	22,937		23,248
Coating, Engraving and Allied Services	19,456		47,249
Schools & Educational Services, not elsewhere classified	19,325		19,586
Chemicals & Allied Products	14,595		15,002
Miscellaneous Business Services	12,953		164,033
Drugs	12,952		15,923
Mailing, Reproduction, Commercial Art and Photography and Stenographic	12,879		14,755
Machinery, Equipment & Supplies	12,080		—
Miscellaneous Plastic Products	9,940		10,000
Offices and Clinics of Other Health Practitioners	9,873		10,098
Nonferrous Foundries (Castings)	—		30,191







Total	$	2,061,878	$	2,144,850

(1) All middle market lending positions are floating rate.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The table below reflects the Company’s aggregate positions by their respective place in the capital structure of the borrowers at September 30, 2020 and December 31, 2019.


	September 30, 2020		December 31, 2019
	(dollars in thousands)
First lien loans	$	1,320,115	$	1,396,140
Second lien loans	741,763		748,710



Total	$	2,061,878	$	2,144,850

The following tables represent a rollforward of the activity for the Company’s corporate debt investments held for investment at September 30, 2020 and December 31, 2019:


September 30, 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	499,623		178,985		678,608
Principal payments	(311,856)		(98,565)		(410,421)
Amortization & accretion of (premium) discounts	6,826		3,357		10,183
Loan restructuring	(19,550)		2,818		(16,732)
Sales (2)	(242,658)		(69,592)		(312,250)

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	(9,517)		(5,084)		(14,601)
Write offs	11,894		—		11,894
Ending allowance	(15,773)		(23,950)		(39,723)

Net carrying value (September 30, 2020)	$	1,320,115	$	741,763	$	2,061,878

(1) Excludes loan loss allowances.

(2) Includes syndications.


December 31, 2019
	First Lien		Second Lien		Total
	(dollars in thousands)
Net carrying value (January 1, 2019)	$	1,346,356	$	540,826	$	1,887,182
Originations & advances	542,463		345,573		888,036
Principal payments	(228,302)		(140,625)		(368,927)
Amortization & accretion of (premium) discounts	5,960		2,936		8,896

Sales	(262,974)		—		(262,974)





Net (increase) decrease in allowance	(7,363)		—		(7,363)
Net carrying value (December 31, 2019)	$	1,396,140	$	748,710	$	2,144,850

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 September 30, 2020 by vintage year and internal risk rating.


Amortized Cost Basis by Risk Rating and Vintage (1)
Risk Rating	Vintage
	Total		2020		2019		2018		2017		2016		2015		Revolvers
(dollars in thousands)
1-5 / Performing	$	1,520,243	$	259,377	$	373,388	$	457,891	$	295,371	$	95,256	$	34,268	$	4,692
6 / Performing - Closely Monitored	294,795		23,574		38,874		168,115		38,178		21,855		—		4,199
7 / Substandard	234,535		—		31,416		142,595		60,524		—		—		—
8 / Doubtful	12,879		—		—		12,879		—		—		—		—
9 / Loss	—		—		—		—		—		—		—		—
Total	$	2,062,452	$	282,951	$	443,678	$	781,480	$	394,073	$	117,111	$	34,268	$	8,891

(1) The amortized cost basis excludes accrued interest and deferred fees on unfunded loans. As of September 30, 2020, the Company had $11.9 million of accrued interest receivable on corporate loans which is reported in Principal and interest receivable in the Consolidated Statements of Financial Condition.


7. MORTGAGE SERVICING RIGHTS

The Company owns variable interests in an entity that invests in MSRs. Refer to the “Variable Interest Entities” Note for a detailed discussion on this topic.

MSRs represent the rights associated with servicing pools of residential mortgage loans. The Company and its subsidiaries do not originate or directly service residential mortgage loans. Rather, these activities are carried out by duly licensed subservicers who perform substantially all servicing functions for the loans underlying the MSRs. The Company intends to hold the MSRs as investments and elected to account for all of its investments in MSRs at fair value. As such, they are recognized at fair value on the accompanying Consolidated Statements of Financial Condition with changes in the estimated fair value presented as a component of Net unrealized gains (losses) on instruments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss). Servicing income, net of servicing expenses, is reported in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

The following table presents activity related to MSRs for the three and nine months ended September 30, 2020 and 2019:


	Three Months Ended				Nine Months Ended
	September 30, 2020		September 30, 2019		September 30, 2020		September 30, 2019
	(dollars in thousands)
Fair value, beginning of period	$	227,400	$	425,328	$	378,078	$	557,813




Change in fair value due to:
Changes in valuation inputs or assumptions (1)	7,633		(17,312)		(99,220)		(116,150)
Other changes, including realization of expected cash flows	(27,048)		(21,965)		(70,873)		(55,612)
Fair value, end of period	$	207,985	$	386,051	$	207,985	$	386,051

(1) Principally represents changes in discount rates and prepayment speed inputs used in valuation model, primarily due to changes in interest rates.

For the three and nine months ended September 30, 2020, the Company recognized $15.1 million and $54.4 million, respectively, and for the three and nine months ended September 30, 2019, the Company recognized $27.7 million and $82.9 million, respectively, of net servicing income from MSRs in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


8. VARIABLE INTEREST ENTITIES

Commercial Trusts

The Company has invested in subordinate mortgage-backed securities issued by commercial securitization trusts (“Commercial Trusts”) and determined that it is the primary beneficiary as a result of its ability to replace the special servicer without cause through its ownership of the subordinate securities and its current designation as the directing certificate holder. Information regarding these securitization trusts are summarized in the table below.


Type of Underlying Collateral	Settlement Date	Cut-off Date Principal Balance		Face Value of Company’s Variable Interest at Settlement Date
		(dollars in thousands)
Multifamily	April 2015	$	1,192,607	$	89,446
Hotels	June 2018	$	982,000	$	93,500
Multifamily	August 2019	$	271,700	$	20,270
Office Building	October 2019	$	60,000	$	60,000
Multifamily	October 2019	$	415,000	$	75,359
Multifamily	December 2019	$	394,000	$	110,350

Upon consolidation, the Company elected the fair value option for the financial assets and liabilities of the Commercial Trusts in order to avoid an accounting mismatch, and to represent more faithfully the economics of its interest in the entities. The fair value option requires that changes in fair value be reflected in the Company’s Consolidated Statements of Comprehensive Income (Loss). The Company applied the practical expedient under ASU 2014-07, whereby the Company determines whether the fair value of the financial assets or financial liabilities is more observable as a basis for measuring the less observable financial instruments. The Company has determined that the fair value of the financial liabilities of the Commercial Trusts are more observable, since the prices for these liabilities are primarily available from third-party pricing services utilized for multifamily and commercial mortgage-backed securities, while the individual assets of the trusts are inherently less capable of precise measurement given their illiquid nature and the limitations on available information related to these assets. Given that the Company’s methodology for valuing the financial assets of the Commercial Trusts are an aggregate fair value derived from the fair value of the financial liabilities, the Company has determined that the fair value of each of the financial assets in their entirety should be classified in Level 2 of the fair value measurement hierarchy.

The Commercial Trusts mortgage loans had an aggregate unpaid principal balance of $2.3 billion and $2.3 billion at September 30, 2020 and December 31, 2019, respectively. At September 30, 2020 and December 31, 2019, there were no loans 90 days or more past due or on nonaccrual status. There is no gain or loss attributable to instrument-specific credit risk of the underlying loans or securitized debt securities at September 30, 2020 and 2019 based upon the Company’s process of monitoring events of default on the underlying mortgage loans.

Commercial Securitizations

The Company also invests in commercial 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 Commercial Securities.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

Collateralized Loan Obligation

In February 2019, the Company closed NLY 2019-FL2, a managed commercial real estate collateralized loan obligation (“CLO”) securitization with a face value of $857.3 million, which provides non-recourse financing to the Company collateralized by certain commercial real estate mortgage loans originated by the Company. As of September 30, 2020 a total of $629.2 million of notes were held by third parties and the Company retained or purchased $205.2 million of subordinated notes and preferred shares, which eliminate upon consolidation. The Company has determined that it is the primary beneficiary because it has the right to direct the servicer as well as remove the special servicer without cause and it holds variable interests that could be potentially significant to the CLO. The transfers of loans to the CLO did not qualify for sale accounting because the Company maintains effective control over the loans. The Company elected the fair value option for the financial liabilities issued by the CLO in order to simplify the accounting; however, the commercial loans continue to be carried at amortized cost as they were not eligible for the fair value option as it was not elected at origination of the loans. The Company incurred $8.3 million of costs in connection with the CLO that were expensed as incurred during the year ended December 31, 2019. The aggregate unpaid principal balance of loans in the CLO was $857.3 million at September 30, 2020 and there were no loans 90 days or more past due or on nonaccrual status. There is no gain or loss attributable to instrument-specific credit risk of the debt securities at September 30, 2020 based upon the Company’s process of monitoring events of default on the underlying mortgage loans. The contractual principal amount of the CLO debt held by third parties was $633.9 million at September 30, 2020.

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. During the three months ended September 30, 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. As a result of the deconsolidation of this VIE, the Company derecognized approximately $1.2 billion of securities and approximately $1.1 billion of debt issued by securitization vehicles and recognized a realized gain of $104.8 million, which is included in Net gains (losses) on disposal of investments and other in the Consolidated Statements of Comprehensive Income (Loss). The Company incurred $1.1 million of costs in connection with the 2020 multifamily securitization that were expensed as incurred during the nine months ended September 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 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 $32.6 million and $57.3 million at September 30, 2020 and December 31, 2019, respectively.

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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

As of September 30, 2020, a total of $2.9 billion of bonds were held by third parties and the Company retained $641.3 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 $2.8 million and $2.6 million of costs during the three months ended September 30, 2020 and 2019, respectively, and $7.1 million and $7.3 million of costs during the nine months ended September 30, 2020 and 2019, 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 $2.9 billion at September 30, 2020.

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

Credit Facility VIEs

In June 2016, a consolidated subsidiary of the Company entered into a credit facility with a third party financial institution. As of September 30, 2020, the borrowing limit on this facility was $625.0 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 $717.5 million at September 30, 2020. The transfers did not qualify for sale accounting and are reflected as an intercompany secured borrowing that is eliminated upon consolidation. At September 30, 2020, the subsidiary had an intercompany receivable of $412.7 million, which eliminates upon consolidation and a secured financing of $412.7 million to the third party financial institution.

In July 2017, a consolidated subsidiary of the Company entered into a credit facility with a third party financial institution. As of September 30, 2020, the borrowing limit on this facility was $320.0 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 $411.7 million at September 30, 2020, which continue to be reflected in the Company’s Consolidated Statements of Financial Condition under Loans, net. At September 30, 2020, the subsidiary had a secured financing of $219.6 million to the third party financial institution.

In January 2019, a consolidated subsidiary of the Company (the “Borrower”) entered into a $300.0 million credit facility with a third party financial institution. The Company has pledged as collateral for this facility corporate loans with a carrying amount of $317.3 million at September 30, 2020. As of September 30, 2020, the Borrower had a secured financing of $196.3 million to the third party financial institution.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

MSR Silo

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

The Company’s exposure to the obligations of its VIEs is generally limited to the Company’s investment in the VIEs of $3.2 billion at September 30, 2020. Assets of the VIEs may only be used to settle obligations of the VIEs. Creditors of the VIEs have no recourse to the general credit of the Company. The Company is not contractually required to provide and has not provided any form of financial support to the VIEs. No gains or losses were recognized upon consolidation of existing VIEs. Interest income and expense are recognized using the effective interest method.

The statements of financial condition of the Company’s VIEs, excluding the CLO, multifamily securitizations, 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 September 30, 2020 and December 31, 2019 are as follows:


September 30, 2020
	Commercial Trusts		Residential Trusts		MSR Silo
Assets	(dollars in thousands)
Cash and cash equivalents	$	—	$	—	$	84,904
Loans	—		—		50,042
Assets transferred or pledged to securitization vehicles	2,174,118		50,810		—


Mortgage servicing rights	—		—		207,985
Principal and interest receivable	5,370		324		—

Other assets	—		—		23,087
Total assets	$	2,179,488	$	51,134	$	366,018
Liabilities
Debt issued by securitization vehicles (non-recourse)	$	1,843,036	$	33,084	$	—
Other secured financing	—		—		32,842

Payable for unsettled trades	—		—		6,203
Interest payable	1,594		78		—
Other liabilities	—		201		2,830
Total liabilities	$	1,844,630	$	33,363	$	41,875


December 31, 2019
	Commercial Trusts		Residential Trusts		MSR Silo
Assets	(dollars in thousands)
Cash and cash equivalents	$	—	$	—	$	67,455
Loans	—		—		66,722
Assets transferred or pledged to securitization vehicles	2,345,120		75,924		—


Mortgage servicing rights	—		—		378,078
Principal and interest receivable	7,085		408		—

Other assets	—		—		27,021
Total assets	$	2,352,205	$	76,332	$	539,276
Liabilities
Debt issued by securitization vehicles (non-recourse)	$	1,967,523	$	57,905	$	—
Other secured financing	—		—		38,981

Payable for unsettled trades	—		—		18,364
Interest payable	3,008		137		—
Other liabilities	—		78		2,393
Total liabilities	$	1,970,531	$	58,120	$	59,738

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The geographic concentrations of credit risk exceeding 5% of the total loan unpaid principal balances related to the Company’s VIEs, excluding the CLO, OBX Trusts and credit facility VIEs, at September 30, 2020 are as follows:

Securitized Loans at Fair Value Geographic Concentration of Credit Risk


Commercial Trusts					Residential Trusts
Property Location	Principal Balance		% of Balance		Property Location	Principal Balance		% of Balance
(dollars in thousands)
California	$	1,236,527	37.9	%	California	$	22,925	45.6	%
Texas	477,642		14.6	%	Texas	7,481		14.9	%
New York	381,425		11.7	%	Illinois	6,504		12.9	%
Florida	180,892		5.5	%	Other (1)	13,343		26.6	%
Other (1)	986,851		30.3	%

Total	$	3,263,337	100.0	%	Total	$	50,253	100.0	%

(1) No individual state greater than 5%.

Corporate Debt Transfers

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 nine months ended September 30, 2020, the Company transferred $22.2 million and $145.5 million, respectively, of loans for cash. The loan transfers were accounted for as sales.


9. REAL ESTATE

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

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


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

There was no real estate acquired in settlement of residential mortgage loans at September 30, 2020 or December 31, 2019 other than real estate held by securitization trusts that the Company was required to consolidate. The Company would be considered to have received physical possession of residential real estate property collateralizing a residential mortgage loan, so that the loan is derecognized and the real estate property would be recognized, if either (i) the Company obtains legal title to the residential real estate property upon completion of a foreclosure or (ii) the borrower conveys all interest in the residential real estate property to the Company to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement.

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

The Company’s real estate portfolio (REO and real estate held for investment) is reviewed on a quarterly basis, or more frequently as necessary, to assess whether there are any indicators that the value of its operating real estate may be impaired or that its carrying value may not be recoverable. A property’s value is considered impaired if the Company’s estimate of the aggregate future undiscounted cash flows to be generated by the property is less than the carrying value of the property. In

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

conducting this review, the Company considers U.S. macroeconomic factors, including real estate sector conditions, together with asset specific and other factors. To the extent impairment has occurred and is considered to be other than temporary, the loss will be measured as the excess of the carrying amount of the property over the calculated fair value of the property.

During the nine months ended September 30, 2020, the Company took title of two commercial real estate properties for $79.8 million through foreclosure or deed-in-lieu of foreclosure. There were no new acquisitions of real estate holdings during the nine months ended September 30, 2019. No properties were sold during the nine months ended September 30, 2020. The Company sold one of its wholly owned triple net leased properties during the nine months ended September 30, 2019 for $6.7 million and recognized a gain on sale of $2.7 million.

The weighted average amortization period for intangible assets and liabilities at September 30, 2020 is 6.0 years. Above market leases and leasehold intangible assets are included in Intangible assets, net and below market leases are included in Other liabilities in the Consolidated Statements of Financial Condition.


	September 30, 2020		December 31, 2019
Real estate, net	(dollars in thousands)
Land	$	173,220	$	121,720
Buildings and improvements	601,783		571,396
Furniture, fixtures and equipment	11,487		11,238
Subtotal	786,490		704,354
Less: accumulated depreciation	(104,978)		(87,532)
Total real estate held for investment, at amortized cost, net	681,512		616,822
Equity in unconsolidated joint ventures	109,085		108,816
Total real estate, net	$	790,597	$	725,638

Depreciation expense was $6.2 million and $17.4 million for the three and nine months ended September 30, 2020, respectively. Depreciation expense was $6.0 million and $17.8 million for the three and nine months ended September 30, 2019, respectively. Depreciation expense is included in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

Rental Income

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

Approximate future minimum rents to be received over the next five years and thereafter for non-cancelable operating leases in effect at September 30, 2020 for consolidated investments in real estate are as follows:


September 30, 2020
(dollars in thousands)
2020 (remaining)	$	14,768
2021	55,088
2022	50,685
2023	47,119
2024	42,429
Later years	191,310
Total	$	401,399


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

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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

Derivatives are accounted for in accordance with FASB ASC 815, Derivatives and Hedging, which requires recognition of all derivatives as either assets or liabilities at fair value in the Consolidated Statements of Financial Condition with changes in fair value recognized in the Consolidated Statements of Comprehensive Income (Loss). The changes in the estimated fair value are presented within Net gains (losses) on other derivatives with the exception of interest rate swaps which are separately presented. None of the Company’s derivative transactions have been designated as hedging instruments for accounting purposes.

The Company also maintains collateral in the form of cash on margin with counterparties to its interest rate swaps and other derivatives. In accordance with a clearing organization’s rulebook, the Company presents the fair value of centrally cleared interest rate swaps net of variation margin pledged under such transactions. At September 30, 2020 and December 31, 2019, $1.7 billion and $517.8 million 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 or loss on the swaption would be equal to the difference between the cash received or the fair value of the underlying interest rate swap received and the premium paid. The fair value of swaptions 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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.

The table below summarizes fair value information about our derivative assets and liabilities at September 30, 2020 and December 31, 2019:


Derivatives Instruments	September 30, 2020		December 31, 2019
Assets	(dollars in thousands)
Interest rate swaps	$	—	$	1,199
Interest rate swaptions	63,601		11,580
TBA derivatives	38,656		15,181
Futures contracts	550		77,889
Purchase commitments	438		2,050
Credit derivatives (1)	—		5,657
Total derivative assets	$	103,245	$	113,556
Liabilities
Interest rate swaps	$	1,126,179	$	706,862

TBA derivatives	21,140		11,316
Futures contracts	7,792		84,781
Purchase commitments	488		907
Credit derivatives (1)	27,082		—
Total derivative liabilities	$	1,182,681	$	803,866

(1) The notional amount of the credit derivatives in which the Company purchased protection was $0.0 and $10.0 million at September 30, 2020 and December 31, 2019, respectively. The maximum potential amount of future payments is the notional amount of credit derivatives in which the Company sold protection of $499.0 million and $345.0 million at September 30, 2020 and December 31, 2019, respectively, plus any coupon shortfalls on the underlying tranche. The credit derivative tranches referencing the basket of bonds had a range of ratings between AAA and BBB-.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following table summarizes certain characteristics of the Company’s interest rate swaps at September 30, 2020 and December 31, 2019:


September 30, 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	$	17,816,700	0.14	%	0.41	%	2.27
3 - 6 years	7,255,000		0.69	%	0.09	%	3.87
6 - 10 years	5,806,500		1.43	%	0.65	%	8.09
Greater than 10 years	1,349,000		2.90	%	0.39	%	21.85
Total / Weighted average	$	32,227,200	0.91	%	0.48	%	4.51


December 31, 2019
Maturity	Current Notional (1)(2)		Weighted Average Pay Rate		Weighted Average Receive Rate		Weighted Average Years to Maturity
(dollars in thousands)
0 - 3 years	$	38,942,400	1.60	%	1.84	%	1.29
3 - 6 years	16,097,450		1.77	%	1.87	%	4.30
6 - 10 years	16,176,500		2.20	%	2.02	%	9.00
Greater than 10 years	2,930,000		3.76	%	1.86	%	17.88
Total / Weighted average	$	74,146,350	1.84	%	1.89	%	4.23

(1) As of September 30, 2020, 12%, 77% and 11% 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, 2019, 75% and 25% of the Company’s interest rate swaps were linked to LIBOR and the overnight index swap rate, respectively.

(2) As of September 30, 2020, notional amount includes $655.0 million of a forward starting pay fixed swap on October 1, 2020. There were no forward starting swaps at December 31, 2019.

(3) As of September 30, 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.

The following table presents swaptions outstanding at September 30, 2020 and December 31, 2019.


September 30, 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	$6,550,000	1.29%	3M LIBOR	10.60	7.97
Long receive	$250,000	1.66%	3M LIBOR	10.27	3.20

December 31, 2019
	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	$4,675,000	2.53%	3M LIBOR	9.22	4.66
Long receive	$2,000,000	1.49%	3M LIBOR	10.29	3.40

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following table summarizes certain characteristics of the Company’s TBA derivatives at September 30, 2020 and December 31, 2019:


September 30, 2020
Purchase and sale contracts for derivative TBAs	Notional		Implied Cost Basis		Implied Market Value		Net Carrying Value
(dollars in thousands)
Purchase contracts	$	20,394,000	$	21,176,883	$	21,194,446	$	17,563
Sale contracts	(100,000)		(104,844)		(104,891)		(47)
Net TBA derivatives	$	20,294,000	$	21,072,039	$	21,089,555	$	17,516


December 31, 2019
Purchase and sale contracts for derivative TBAs	Notional		Implied Cost Basis		Implied Market Value		Net Carrying Value
(dollars in thousands)
Purchase contracts	$	10,043,000	$	10,182,891	$	10,192,038	$	9,147
Sale contracts	(3,144,000)		(3,294,486)		(3,299,768)		(5,282)
Net TBA derivatives	$	6,899,000	$	6,888,405	$	6,892,270	$	3,865

The following table summarizes certain characteristics of the Company’s futures derivatives at September 30, 2020 and December 31, 2019:


September 30, 2020
	Notional - Long Positions		Notional - Short Positions		Weighted Average Years to Maturity
	(dollars in thousands)



U.S. Treasury futures - 10 year and greater	$	—	$	(2,822,800)	6.90
Total	$	—	$	(2,822,800)	6.90


December 31, 2019
	Notional - Long Positions		Notional - Short Positions		Weighted Average Years to Maturity
	(dollars in thousands)

U.S. Treasury futures - 2 year	$	—	$	(180,000)	1.96
U.S. Treasury futures - 5 year	—		(2,953,300)		4.42
U.S. Treasury futures - 10 year and greater	2,600,000		(5,806,400)		9.74
Total	$	2,600,000	$	(8,939,700)	8.26

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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 September 30, 2020 and December 31, 2019, respectively.


September 30, 2020
			Amounts Eligible for Offset
	Gross Amounts		Financial Instruments		Cash Collateral		Net Amounts
Assets	(dollars in thousands)

Interest rate swaptions, at fair value	$	63,601	$	—	$	—	$	63,601
TBA derivatives, at fair value	38,656		(18,950)		—		19,706
Futures contracts, at fair value	550		(550)		—		—
Purchase commitments	438		—		—		438

Liabilities
Interest rate swaps, at fair value	$	1,126,179	$	—	$	(117,947)	$	1,008,232
TBA derivatives, at fair value	21,140		(18,950)		—		2,190
Futures contracts, at fair value	7,792		(550)		(7,242)		—
Purchase commitments	488		—		—		488
Credit derivatives	27,082		—		(27,082)		—

December 31, 2019
			Amounts Eligible for Offset
	Gross Amounts		Financial Instruments		Cash Collateral		Net Amounts
Assets	(dollars in thousands)
Interest rate swaps, at fair value	$	1,199	$	(951)	$	—	$	248
Interest rate swaptions, at fair value	11,580		—		—		11,580
TBA derivatives, at fair value	15,181		(5,018)		—		10,163
Futures contracts, at fair value	77,889		(10,902)		—		66,987
Purchase commitments	2,050		—		—		2,050
Credit derivatives	5,657		—		—		5,657
Liabilities
Interest rate swaps, at fair value	$	706,862	$	(951)	$	(104,205)	$	601,706
TBA derivatives, at fair value	11,316		(5,018)		—		6,298
Futures contracts, at fair value	84,781		(10,902)		(73,879)		—
Purchase commitments	907		—		—		907

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)
September 30, 2020	$	(62,529)	$	(427)	$	170,327
September 30, 2019	$	88,466	$	(682,602)	$	(326,309)
For the nine months ended
September 30, 2020	$	(141,070)	$	(1,919,720)	$	(1,162,768)
September 30, 2019	$	306,154	$	(1,438,349)	$	(1,992,884)

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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 September 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	$	276,849	$	(100,680)	$	176,169
Net interest rate swaptions	(9,836)		3,263		(6,573)
Futures	(19,989)		10,337		(9,652)
Purchase commitments	—		(51)		(51)
Credit derivatives	1,531		7,892		9,423
Total					$	169,316


Three Months Ended September 30, 2019
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	$	93,919	$	(46,124)	$	47,795
Net interest rate swaptions	(2,778)		(4,571)		(7,349)
Futures	(424,268)		364,613		(59,655)
Purchase commitments	—		(348)		(348)
Credit derivatives	1,784		885		2,669
Total					$	(16,888)


Nine Months Ended September 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	$	798,459	$	13,651	$	812,110
Net interest rate swaptions	11,730		50,762		62,492
Futures	(299,220)		(350)		(299,570)
Purchase commitments	—		(1,194)		(1,194)
Credit derivatives	4,659		(31,839)		(27,180)
Total					$	546,658


Nine Months Ended September 30, 2019
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	$	481,865	$	(154,355)	$	327,510
Net interest rate swaptions	(44,088)		7,935		(36,153)
Futures	(1,430,450)		484,146		(946,304)
Purchase commitments	—		1,903		1,903
Credit derivatives	5,285		9,301		14,586
Total					$	(638,458)

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 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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 September 30, 2020 was approximately $1.1 billion, 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 MSRs 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 bet ween market participants at the measurement date.

GAAP requires classification of financial instruments and MSRs 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 MSRs 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

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

The Company classifies its investments in MSRs 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 MSRs requires 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 MSRs measured at fair value on a recurring basis. There were no transfers between levels of the fair value hierarchy during the periods presented.


September 30, 2020
	Level 1		Level 2		Level 3		Total
Assets	(dollars in thousands)
Securities
Agency mortgage-backed securities	$	—	$	74,915,167	$	—	$	74,915,167
Credit risk transfer securities	—		411,538		—		411,538
Non-Agency mortgage-backed securities	—		717,602		—		717,602
Commercial mortgage-backed securities	—		54,678		—		54,678
Loans
Residential mortgage loans	—		152,959		—		152,959
Mortgage servicing rights	—		—		207,985		207,985
Assets transferred or pledged to securitization vehicles	—		6,386,447		—		6,386,447
Derivative assets


Other derivatives	550		102,695		—		103,245
Total assets	$	550	$	82,741,086	$	207,985	$	82,949,621
Liabilities

Debt issued by securitization vehicles	—		6,027,576		—		6,027,576
Derivative liabilities
Interest rate swaps	—		1,126,179		—		1,126,179
Other derivatives	7,792		48,710		—		56,502
Total liabilities	$	7,792	$	7,202,465	$	—	$	7,210,257

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


December 31, 2019
	Level 1		Level 2		Level 3		Total
Assets	(dollars in thousands)
Securities
Agency mortgage-backed securities	$	—	$	112,893,367	$	—	$	112,893,367
Credit risk transfer securities	—		531,322		—		531,322
Non-Agency mortgage-backed securities	—		1,135,868		—		1,135,868
Commercial mortgage-backed securities	—		273,023		—		273,023
Loans
Residential mortgage loans	—		1,647,787		—		1,647,787
Mortgage servicing rights	—		—		378,078		378,078
Assets transferred or pledged to securitization vehicles	—		6,066,082		—		6,066,082
Derivative assets

Interest rate swaps	—		1,199		—		1,199
Other derivatives	77,889		34,468		—		112,357
Total assets	$	77,889	$	122,583,116	$	378,078	$	123,039,083
Liabilities

Debt issued by securitization vehicles	$	—	$	5,622,801	$	—	$	5,622,801
Derivative liabilities
Interest rate swaps	—		706,862		—		706,862
Other derivatives	84,781		12,223		—		97,004
Total liabilities	$	84,781	$	6,341,886	$	—	$	6,426,667

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 MSRs, 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 MSRs, which in turn could result in a decline in the estimated fair value of MSRs. Refer to the Note titled “Mortgage Servicing Rights” for additional information.

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

September 30, 2020

December 31, 2019

Valuation Technique

Unobservable Input (1)

Range (Weighted Average ) (2)

Unobservable Input (1)

Range (Weighted Average ) (2)

Discounted cash flow

Discount rate

9.0% -12.0% (9.4%)

Discount rate

9.0% -12.0% (9.3%)

Prepayment rate

14.6% - 48.0% (34.0%)

Prepayment rate

6.3% - 26.6% (13.7%)

Delinquency rate

0.0% - 17.0% (4.9%)

Delinquency rate

0.0% - 4.0% (2.2%)

Cost to service

$83 - $223 ($128)

Cost to service

$81 - $135 ($107)

(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 MSRs, weighted average prepayment rate, delinquency rate and cost to service based on unpaid principal balances of loans underlying the MSRs.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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 September 30, 2020 and December 31, 2019.


	September 30, 2020		December 31, 2019
	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)	$1,456,459	$1,529,485	$1,606,091	$1,619,018

Corporate debt, held for investment	2,061,878	2,011,153	2,144,850	2,081,327



Financial liabilities
Repurchase agreements	$64,633,447	$64,633,447	$101,740,728	$101,740,728
Other secured financing	861,373	861,373	4,455,700	4,455,700


Mortgages payable	507,934	594,242	485,005	515,994
(1) Includes assets of consolidated VIEs.

Commercial real estate debt and preferred equity, held for investment, corporate debt, held for investment 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 utilizes a two-step approach, whereby the Company compares the carrying value of each identified reporting unit to its fair value. If the carrying value of the reporting unit is greater than its fair value, the second step is performed, where the implied fair value of goodwill is compared to its carrying value. The Company recognizes an impairment charge for the amount by which the carrying amount of goodwill exceeds its fair value. At September 30, 2020 and December 31, 2019, goodwill totaled $71.8 million.

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, and accrued liabilities and cash that were recognized on the legal entity acquired. The following table presents the activity of finite lived intangible assets for the nine months ended September 30, 2020.


Intangible Assets, net
(dollars in thousands)
Balance at December 31, 2019	$	20,957
Intangible assets acquired	50,360
Intangible assets divested	(110)
Less: amortization expense	(6,122)
Balance at September 30, 2020	$	65,085

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


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 meet the specified criteria in this guidance.

The Company enters into reverse repurchase agreements to earn a yield on excess cash balances. The Company obtains collateral in connection with the reverse repurchase agreements in order to mitigate credit risk exposure to its counterparties.

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 $64.6 billion and $101.7 billion of repurchase agreements with weighted average borrowing rates of 0.81% and 1.99%, after giving effect to the Company’s interest rate swaps used to hedge cost of funds, and weighted average remaining maturities of 72 days and 65 days at September 30, 2020 and December 31, 2019, respectively. The Company has select arrangements with counterparties to enter into repurchase agreements for $2.4 billion with remaining capacity of $2.0 billion at September 30, 2020.

At September 30, 2020 and December 31, 2019, the repurchase agreements had the following remaining maturities, collateral types and weighted average rates:


September 30, 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	$	2,700,000	$	—	$	—	$	—	$	—	$	—	$	2,700,000	0.13	%
2 to 29 days	23,585,476		68,994		196,748		—		—		43,213		23,894,431		0.36	%
30 to 59 days	8,463,636		60,651		73,438		—		—		46,466		8,644,191		0.51	%
60 to 89 days	9,078,487		50,871		274,454		—		269,085		29,962		9,702,859		0.33	%
90 to 119 days	5,320,952		50,758		102,189		23,407		—		31,730		5,529,036		0.73	%
Over 119 days (1)	13,656,052		—		237,980		47,235		66,026		155,637		14,162,930		0.45	%
Total	$	62,804,603	$	231,274	$	884,809	$	70,642	$	335,111	$	307,008	$	64,633,447	0.42	%


December 31, 2019
	Agency Mortgage-Backed Securities		CRTs		Non-Agency Mortgage-Backed Securities		Commercial Loans		Commercial Mortgage-Backed Securities		Total Repurchase Agreements		Weighted Average Rate
	(dollars in thousands)
1 day	$	—	$	—	$	—	$	—	$	—	$	—	—	%
2 to 29 days	36,030,104		237,897		698,091		—		416,439		37,382,531		2.15	%
30 to 59 days	15,079,989		—		115,805		—		104,363		15,300,157		2.00	%
60 to 89 days	21,931,335		30,841		151,920		—		3,639		22,117,735		1.97	%
90 to 119 days	9,992,914		—		—		—		—		9,992,914		1.97	%
Over 119 days (1)	16,557,123		—		58,712		303,078		28,478		16,947,391		1.90	%
Total	$	99,591,465	$	268,738	$	1,024,528	$	303,078	$	552,919	$	101,740,728	2.03	%

(1) No repurchase agreements had a remaining maturity over one year at September 30, 2020 and December 31, 2019.

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 September 30, 2020 and December 31, 2019. Refer to the “Derivative Instruments” Note for information related to the effect of netting arrangements on the Company’s derivative instruments.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


	September 30, 2020				December 31, 2019
	Reverse Repurchase Agreements		Repurchase Agreements		Reverse Repurchase Agreements		Repurchase Agreements
	(dollars in thousands)
Gross amounts	$	200,000	$	64,833,447	$	100,000	$	101,840,728
Amounts offset	(200,000)		(200,000)		(100,000)		(100,000)
Netted amounts	$	—	$	64,633,447	$	—	$	101,740,728

Other Secured Financing - The Company previously financed a portion of its financial assets with advances from the Federal Home Loan Bank of Des Moines (“FHLB Des Moines”). Borrowings from FHLB Des Moines are reported in Other secured financing in the Company’s Consolidated Statements of Financial Condition. At September 30, 2020, the Company did not hold advances from the FHLB Des Moines. At December 31, 2019, $1.4 billion of advances from the FHLB Des Moines matured in less than one year and $2.1 billion matured between one to three years. The weighted average rate of the advances from the FHLB Des Moines was 2.16% at December 31, 2019. The Company held $4.4 million and $147.9 million of stock in the FHLB Des Moines at September 30, 2020 and December 31, 2019, respectively, which is reported at cost and included in Other assets on the Company’s Consolidated Statements of Financial Condition. Refer to the Note titled “Variable Interest Entities” 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 $70.6 billion and $202.7 million, respectively, at September 30, 2020 and $112.8 billion and $357.9 million, respectively, at December 31, 2019.

Mortgage loans payable at September 30, 2020 and December 31, 2019, were as follows:


September 30, 2020
Property	Mortgage Carrying Value		Mortgage Principal		Interest Rate	Fixed/Floating Rate	Maturity Date	Priority
(dollars in thousands)
Joint Ventures	$	316,661	$	318,371	4.03% - 4.96%	Fixed	2024 - 2029	First liens
Joint Ventures	16,575		16,325		L+2.15%	Floating	2/27/2022	First liens
Virginia	81,498		83,204		2.34% - 4.55%	Fixed	2036 - 2053	First liens
Virginia	24,457		25,000		L+2.85%	Floating	5/1/2023	First liens
Texas	31,263		32,730		3.28%	Fixed	1/1/2048 and 1/1/2053	First liens
Utah	9,706		9,706		L+2.75%	Floating	1/31/2021	First liens
Utah	6,996		7,014		3.69%	Fixed	6/1/2053	First liens
Minnesota	13,090		13,124		3.69%	Fixed	6/1/2053	First liens

Wisconsin	7,688		7,708		3.69%	Fixed	6/1/2053	First liens


Total	$	507,934	$	513,182


December 31, 2019
Property	Mortgage Carrying Value		Mortgage Principal		Interest Rate	Fixed/Floating Rate	Maturity Date	Priority
(dollars in thousands)
Joint Ventures	$	316,566	$	318,562	4.03% - 4.96%	Fixed	2024 - 2029	First liens
Joint Ventures	16,029		16,325		L+2.15%	Floating	2/27/2022	First liens
Virginia	82,940		84,702		2.34% - 4.55%	Fixed	2036 - 2053	First liens
Texas	31,667		33,167		3.28%	Fixed	1/1/2048 and 1/1/2053	First liens
Utah	9,706		9,706		L+3.50%	Floating	1/31/2020	First liens
Utah	7,077		7,096		3.69%	Fixed	6/1/2053	First liens
Minnesota	13,243		13,276		3.69%	Fixed	6/1/2053	First liens

Wisconsin	7,777		7,797		3.69%	Fixed	6/1/2053	First liens






Total	$	485,005	$	490,631

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The following table details future mortgage loan principal payments at September 30, 2020:


Mortgage Loan Principal Payments
(dollars in thousands)
2020 (remaining)	$	833
2021	13,197
2022	20,034
2023	28,844
2024	107,929
Later years	342,345
Total	$	513,182


14. CAPITAL STOCK

(A) Common Stock

The following table provides a summary of the Company’s common shares authorized, and issued and outstanding at September 30, 2020 and December 31, 2019.

Shares authorized

Shares issued and outstanding

September 30, 2020

December 31, 2019

September 30, 2020

December 31, 2019

Par Value

Common stock

2,914,850,000

1,402,928,317

1,430,106,199

$0.01

During the nine months ended September 30, 2019, the Company closed the public offering of an original issuance of 75.0 million shares of common stock for proceeds of $730.5 million before deducting offering expenses. In connection with the offering, the Company granted the underwriters a thirty-day option to purchase up to an additional 11.3 million shares of common stock, which the underwriters exercised in full resulting in an additional $109.6 million in proceeds before deducting offering expenses.

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 through December 31, 2020. During the three and nine months ended September 30, 2020, the Company repurchased 4.8 million and 27.7 million shares of its common stock, respectively, for an aggregate amount of $31.3 million and $174.7 million, respectively, excluding commission costs, pursuant to this authorization. All common shares were purchased in open-market transactions. During the three and nine months ended September 30, 2019, the Company repurchased 18.3 million shares of its common stock for an aggregate amount of $155.0 million, excluding commission costs. All common shares purchased pursuant to this authorization were in open-market transactions.

The following table provides a summary of activity related to the Company’s Direct Purchase and Dividend Reinvestment Program.


	Nine Months Ended
	September 30, 2020		September 30, 2019
	(dollars in thousands)
Shares issued through direct purchase and dividend reinvestment program	154,000		180,000
Amount raised from direct purchase and dividend reinvestment program	$	1,075	$	1,795

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. No shares were issued under the at-the-market sales program during the nine months ended September 30, 2020. During the nine months ended

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

September 30, 2019, the Company issued 56.0 million shares for proceeds of $569.1 million, net of commissions and fees, under the at-the-market sales program.

(B) Preferred Stock

The following is a summary of the Company’s cumulative redeemable preferred stock outstanding at September 30, 2020 and December 31, 2019. 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
	September 30, 2020	December 31, 2019	September 30, 2020	December 31, 2019	September 30, 2020		December 31, 2019
Fixed-rate		(dollars in thousands)

Series D	18,400,000	18,400,000	18,400,000	18,400,000	445,457		445,457		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	19,550,000	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	18,400,000	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	85,150,000	85,150,000	81,900,000	81,900,000	$	1,982,026	$	1,982,026

(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 September 30, 2020, the Company had declared and paid all required quarterly dividends on the Company’s preferred stock.

During the three and nine months ended September 30, 2019, the Company redeemed all 7.0 million of its issued and outstanding shares of 7.625% Series C Cumulative Redeemable Preferred Stock (“Series C Preferred Stock”) for $175.0 million. The cash redemption amount for each share of Series C Preferred Stock was $25.00 plus accrued and unpaid dividends to, but not including, the redemption date of July 21, 2019.

During the nine months ended September 30, 2019, the Company redeemed all 2.2 million of its issued and outstanding shares of 8.125% Series H Cumulative Redeemable Preferred Stock (“Series H Preferred Stock”) for $55.0 million. The cash redemption amount for each share of Series H Preferred Stock was $25.00 plus accrued and unpaid dividends to, but not including, the redemption date of May 31, 2019.

During the nine months ended September 30, 2019, the Company issued 17.7 million shares of its 6.750% Series I Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (“Series I Preferred Stock”) for gross proceeds of $442.5 million before deducting the underwriting discount and other estimated offering expenses.

The Series D Cumulative Redeemable Preferred Stock, 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.

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

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


	For the Three Months Ended				For the Nine Months Ended
	September 30, 2020		September 30, 2019		September 30, 2020		September 30, 2019
	(dollars in thousands, except per share data)
Dividends and dividend equivalents declared on common stock and share-based awards	$	309,175	$	359,736	$	976,966	$	1,158,629
Distributions declared per common share	$	0.22	$	0.25	$	0.69	$	0.80
Distributions paid to common stockholders after period end	$	308,644	$	359,491	$	308,644	$	359,491
Distributions paid per common share after period end	$	0.22	$	0.25	$	0.22	$	0.25
Date of distributions paid to common stockholders after period end	October 30, 2020		October 31, 2019		October 30, 2020		October 31, 2019


Dividends declared to series C preferred stockholders	$	—	$	742	$	—	$	7,414
Dividends declared per share of series C preferred stock	$	—	$	0.106	$	—	$	1.060
Dividends declared to series D preferred stockholders	$	8,625	$	8,625	$	25,875	$	25,875
Dividends declared per share of series D preferred stock	$	0.469	$	0.469	$	1.406	$	1.407


Dividends declared to series F preferred stockholders	$	12,510	$	12,510	$	37,530	$	37,530
Dividends declared per share of series F preferred stock	$	0.434	$	0.434	$	1.303	$	1.303
Dividends declared to series G preferred stockholders	$	6,906	$	6,906	$	20,718	$	20,718
Dividends declared per share of series G preferred stock	$	0.406	$	0.406	$	1.219	$	1.219
Dividends declared to series H preferred stockholders	$	—	$	—	$	—	$	1,862
Dividends declared per share of series H preferred stock	$	—	$	—	$	—	$	0.846
Dividends declared to series I preferred stockholders	$	7,468	$	7,668	$	22,404	$	7,668
Dividends declared per share of series I preferred stock	$	0.422	$	0.436	$	1.266	$	0.436


15. INTEREST INCOME AND INTEREST EXPENSE

Refer to the Note titled “Significant Accounting Policies” 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.

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 nine months ended September 30, 2020 and September 30, 2019.


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2020		2019		2020		2019
Interest income	(dollars in thousands)
Residential Securities (1)	$	439,502	$	784,228	$	1,307,566	$	2,271,893
Residential mortgage loans (1)	42,508		37,673		132,936		102,689
Commercial investment portfolio (1) (2)	80,324		87,946		260,208		281,029

Reverse repurchase agreements	109		9,452		1,571		57,472
Total interest income	$	562,443	$	919,299	$	1,702,281	$	2,713,083
Interest expense
Repurchase agreements	75,386		699,838		646,369		1,962,999

Debt issued by securitization vehicles	32,491		34,524		113,367		102,882


Other	7,249		32,543		44,895		98,936
Total interest expense	115,126		766,905		804,631		2,164,817
Net interest income	$	447,317	$	152,394	$	897,650	$	548,266

(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 nine months ended September 30, 2020 and September 30, 2019.


	For the Three Months Ended				For the Nine Months Ended
	September 30, 2020		September 30, 2019		September 30, 2020		September 30, 2019
	(dollars in thousands, except per share data)
Net income (loss)	$	1,015,548	$	(747,169)	$	(1,768,407)	$	(3,372,833)
Net income (loss) attributable to noncontrolling interests	(126)		(110)		(28)		(294)
Net income (loss) attributable to Annaly	1,015,674		(747,059)		(1,768,379)		(3,372,539)
Dividends on preferred stock (1)	35,509		36,151		106,527		101,067
Net income (loss) available (related) to common stockholders	$	980,165	$	(783,210)	$	(1,874,906)	$	(3,473,606)


Weighted average shares of common stock outstanding-basic	1,404,202,695		1,453,359,211		1,419,645,475		1,436,204,582
Add: Effect of stock awards, if dilutive	165,605		—		—		—
Weighted average shares of common stock outstanding-diluted	1,404,368,300		1,453,359,211		1,419,645,475		1,436,204,582
Net income (loss) per share available (related) to common share
Basic	$	0.70	$	(0.54)	$	(1.32)	$	(2.42)
Diluted	$	0.70	$	(0.54)	$	(1.32)	$	(2.42)

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

The computations of diluted net income (loss) per share available (related) to common share for the three and nine months ended September 30, 2020 excludes 0.5 million of potentially dilutive restricted stock units and 0.8 million of potentially dilutive restricted stock units and performance stock units because their effect would have been anti-dilutive.


17. INCOME TAXES

For the three months ended September 30, 2020 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.

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 September 30, 2020 and December 31, 2019.

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 nine months ended September 30, 2020, the Company recorded $9.7 million and ($14.9) million, respectively, of income tax expense (benefit) attributable to its TRSs. During the three and nine months ended September 30, 2019, the Company recorded ($6.9) million and ($10.2) million, respectively of income tax benefit attributable to its TRSs. The Company’s federal, state and local tax returns from 2016 and forward remain open for examination.


18. RISK MANAGEMENT

The primary risks to the Company are capital, liquidity and funding risk, investment/market risk and credit 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 and changes in the expectations for the volatility of future interest rates 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 if overall costs to service the underlying mortgage loans increase due to borrower performance. 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, maintaining qualifying collateral and continually assessing the creditworthiness of issuers, borrowers, tenants and counterparties.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

The conditions related to Coronavirus Disease 2019 (“COVID-19”) could further impact the aforementioned primary risks to the Company. The significant decrease in economic activity and/or the resulting impact to the housing market could have an adverse effect on the value of the Company’s investments in mortgage real estate-related assets, particularly residential real estate assets. Further, borrowers may experience difficulties meeting their obligations or seek to forbear payment on or refinance their mortgage loans to avail themselves of lower rates which may have an adverse impact on the value of the Company’s mortgage real estate related-assets. In addition to residential mortgage-related assets, the adverse economic conditions could negatively impact tenants in the Company’s commercial property assets and/or businesses in which it lends to in connection with its middle market lending activities, resulting in potential delinquencies, defaults or declines in asset values.

If conditions related to COVID-19 continue to persist, the Company could also experience an unwillingness or inability of its potential lenders to provide the Company with or renew financing, increased margin calls, and/or additional capital requirements particularly in connection with the Company’s less liquid credit assets. These conditions could force the Company to sell its assets at inopportune times or otherwise cause the Company to potentially revise its strategic business initiatives, which could adversely affect its business. The full extent of the COVID 19-related disruptions, the duration of the pandemic and the effectiveness of government policies, laws and plans continue to be highly uncertain.


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 real estate investment trust (“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 six months ended June 30, 2020, the compensation and management fee computed in accordance with the Management Agreement was $77.9 million. For the three and nine months ended September 30, 2019, the compensation and management fee was $41.2 million and $130.2 million, respectively.

Prior to the closing of the Internalization, the Company reimbursed the Former Manager for certain services in connection with the management and operations of the Company and its subsidiaries as permitted under the terms of the Management Agreement. Such reimbursable expenses included the cost for certain legal, tax, accounting and other support and advisory services provided by employees of the Former Manager to the Company. Pursuant to the Management Agreement, until the closing of the Internalization, the Company reimbursed the Former Manager for the cost of such services, provided such costs were no greater than those that would be payable to comparable third party providers. Expense reimbursements and related waivers were routinely reviewed with the Audit Committee of the Board in conformance with established policies. For the nine months ended September 30, 2020 and September 30, 2019, reimbursement payments to the Former Manager were $14.2 million and $14.3 million, respectively. None of the reimbursement payments were attributable to compensation of the Company’s executive officers.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements

At September 30, 2020 and December 31, 2019 the Company had amounts payable to the Former Manager of $0 and $15.8 million, respectively.


20. LEASE COMMITMENTS AND CONTINGENCIES

The Company adopted ASU 2016-02, Leases (Topic 842) on January 1, 2019 with no impact to retained earnings or other components of equity. The Company’s operating leases are primarily comprised of a corporate office lease with a remaining lease term of five 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 nine months ended September 30, 2020 was $0.9 million and $2.4 million, respectively.

Supplemental information related to leases as of and for the nine months ended September 30, 2020 was as follows:

Operating Leases

Classification

September 30, 2020

Assets

(dollars in thousands)

Operating lease right-of-use assets

Other assets

13,831

Liabilities

Operating lease liabilities (1)

Other liabilities

18,059

Lease term and discount rate

Weighted average remaining lease term

4.9 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

2,797

(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)
2020 (remaining)	$	1,002
2021	3,918
2022	3,862
2023	3,862
2024	3,862
Later years	2,895
Total lease payments	$	19,401
Less imputed interest	1,342
Present value of lease liabilities	$	18,059

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 September 30, 2020 and December 31, 2019.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 1. Financial Statements


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 September 30, 2020 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 September 30, 2020 was $422.5 million with excess net capital of $422.2 million.


22. SUBSEQUENT EVENTS

In October 2020, the Company repurchased 4.7 million shares of its common stock for an aggregate amount of $34.3 million, excluding commission costs, under the Company’s stock repurchase program.

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; our ability to grow our commercial business; 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, commercial real estate assets and corporate debt; risks related to investments in MSRs; 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; and our ability to maintain our exemption from registration under the Investment Company Act. 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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			51
Business Environment and Coronavirus Disease 2019 (“COVID-19”)			51
Economic Environment			52
Results of Operations			53
Net Income (Loss) Summary			54
Non-GAAP Financial Measures			56
Core earnings (excluding PAA), core earnings (excluding PAA) attributable to common stockholders, core earnings (excluding PAA) per average common share and annualized core return on average equity (excluding PAA)			56
Premium Amortization Expense			58
Interest Income (excluding PAA), economic interest expense and economic net interest income (excluding PAA)			59
Experienced and Projected Long-term CPR			59
Average Yield on Interest Earning Assets (excluding PAA), Net Interest Spread (excluding PAA) and Net Interest Margin (excluding PAA)			60
Economic Interest Expense and Average Economic Cost of Interest Bearing Liabilities			61
Realized and Unrealized Gains (Losses)			62
Other Income (Loss)			63
General and Administrative Expenses			64
Return on Average Equity			64
Unrealized Gains and Losses - Available-for-Sale Investments			64
Financial Condition			65
Residential Securities			66
Contractual Obligations			68
Off-Balance Sheet Arrangements			69
Capital Management			69
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
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

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

Overview

We are a leading diversified capital manager that invests in and finances residential and commercial assets. 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.

Business Environment and Coronavirus Disease 2019 (“COVID-19”)

The U.S. economy rebounded at a faster pace than many had anticipated in the third quarter, best seen by the 3.2 percentage point decline in unemployment rate during the quarter to 7.9 percent in September. Household spending rose sharply as certain sectors of the economy, most notably housing and goods consumption have shown signs of a v-shaped recovery with current activity well above levels seen ahead of the pandemic-induced economic downturn. However, momentum in the economic recovery, which remains incomplete in aggregate despite the strength in the aforementioned sectors, is slowing as the service sector is unable to fully recover while the virus continues to surge in many states and government regulations limit social and business activities to help curb the spread of the virus. The extended unemployment benefits afforded under the CARES Act, which meaningfully boosted incomes in the second and third quarter, expired in July although nearly half of all jobs lost during the pandemic have yet to be recovered. The timing and speed of a U.S. economic recovery remains highly uncertain and depends on continued monetary and fiscal policy accommodation.

In an environment similar to the second quarter, the Federal Reserve (“Fed”) continued to use all available tools to support market functioning and assist the economic recovery, while signaling it stands ready to provide more accommodation if needed. The stable interest rate environment created by the large-scale Fed intervention and low levels of volatility across financial markets, even in light of uncertainties stemming from the 2020 U.S. Presidential election, remained a positive backdrop for our businesses in the third quarter, allowing us to generate a 6.3% economic return during the quarter, while core earnings (excluding PAA) exceeded our dividend by ten cents. Additionally, we achieved these results while reducing our leverage to 6.2x, reflecting that we maintain a cautious approach following the elevated market volatility back in March 2020.

Although our Agency MBS portfolio was largely unchanged in notional terms over the third quarter, we maintain a positive outlook. The sector performed well during the third quarter as continued sizeable Fed purchases, now totaling more than $700 billion net of paydowns since March, combined with strong demand from banks, offset the high levels of supply and continued elevated prepayment speeds. Given the Fed involvement in the market, we further shifted the Agency portfolio out of higher coupon specified pools into lower coupon specified pools and production coupon to-be-announced (“TBA”) contracts, such as 30-year UMBS 1.5% and 2.0%s. While specified pool collateral offers meaningful call protection, more consistently accurate model durations, and exhibit better supply and demand dynamics than generic pools, TBAs currently offer improved float from Fed purchases removing the most negatively convex pools and attractive implied financing rates, allowing us to finance TBAs well below comparable specified pool collateral. The attractive implied financing rates from TBA dollar roll specialness will not last in perpetuity, but they contribute to excess returns and serve to mitigate potential episodes of spread widening, such that, all other things being equal, we anticipate maintaining TBA positions in excess of their traditional portfolio share while the Fed remains heavily involved in the market. Meanwhile, we continue to find value in specified pools as the investments we have made in specified pools over the last number of years are further paying off in this environment, exemplified by our portfolio prepaying roughly at a level of two third the level of prepayments of the 30-year fixed rate mortgage universe. At September 30, 2020, 96% of our portfolio was comprised of high or medium quality specified pools or mortgages that are seasoned by at least 40 month and remains well positioned to withstand the current environment of elevated prepayment speeds.

In light of the low volatility interest rate environment, we were able to focus on our hedging activity on protecting the portfolio from tail risk as we opportunistically added out of the money swaptions at attractive pricing given low implied volatility in option pricing, while we also added modestly to our swaps and futures positions. Funding remains widely available and balance sheet availability is strong given the abundance in reserves in the system. Financing spreads have tightened for certain credit products. and we have been able to amend and renegotiate a portion of our warehouse lines, which has decreased costs and improved our flexibility in light.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

The aggregate portfolio of our credit businesses declined slightly in the third quarter, resulting in capital allocated to the credit businesses to decline to 20% as of September 30, 2020. The decline was mainly driven by two residential credit securitizations we completed during the third quarter totaling $1 billion, which was the main reason for our reduced capital allocated in the quarter. Fundamentals in the residential credit sectors continue to improve on the back of the strong housing market, as evidenced by less than 5% of the market is now in forbearance which is down from 9% in late May. We continue to expand the sourcing of mortgage loans, activity which has increased slowly following the cessation in the activity following the market volatility in March. Meanwhile, we have seen a reopening of loan channels in the Commercial Real Estate sector and are selectively evaluating new opportunities. We do remain focused on portfolio management we continue to be in active dialogue with our borrowers to closely monitor underlying performance trends. It is likely that parts of the commercial real estate landscape will be persistently changed by the pandemic, but it is still early to judge the full extent. With respect to portfolio fundamentals in the Middle Market Lending business, underlying cash flow trends have been encouraging year over year, as sound EBITDA and revenue growth have helped to consistently delever our portfolio’s underlying portfolio companies.

Despite the decline in capital allocated to our credit businesses, tighter Agency spreads and the potential for improving macroeconomic indicators leave us focused on finding opportunities in credit sectors. We anticipate potentially higher capital allocation on the margin to Residential Credit and Middle Market Lending, all else equal over the next few quarters. Additionally, we analyze the buyback of common stock as part of our capital allocation framework. We repurchased over $200 million in stock throughout the past six months at times when our evaluation deemed it the most attractive use of capital, and we will continue to consider using the buyback authorization as a tool to generate shareholder return when prudent to do so.

Business Continuity

Our well-established Business Continuity Planning (“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 planning 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 CDC 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, 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.

A majority of our business activities continue to be performed remotely, though we have seen a limited number of employees return to the office on a voluntary and periodic basis. We continue to monitor guidance from federal, state and local authorities to gauge how to further proceed in any efforts to return to the office.

Economic Environment

Following the meaningful contraction in the second quarter, the pace of economic growth rebounded in the third quarter, with U.S. gross domestic product (“GDP”) rising 33.1% on a seasonally adjusted annualized rate. The rebound in U.S. economic output was driven by the gradual reopening of manufacturing and services businesses, as well as a strong rebound in consumption. The degree of the economic recovery nonetheless varies greatly between strong demand for goods and more muted demand for services, which continue to face the majority of impediments from social distancing measures and capacity limits to fight the pandemic. Despite the improvements from the COVID-19 recession lows, much further progress must be made to reach output levels seen prior to the pandemic. The degree, timing and velocity of the remaining recovery is highly uncertain and it is unlikely that the economy will be able to fully replace the lost output in aggregate before sometime in 2021 at the earliest.

The Fed conducts monetary policy with a dual mandate: full employment and price stability. The unemployment rate fell 3.2 percentage points in the third quarter to 7.9% in September according to the Bureau of Labor Statistics. This marks a faster speed to the labor market recovery than previously anticipated as many workers were able to regain employment as pandemic restrictions were lifted or modified. However, the job gains, while strong late in the second and early in third quarter, have

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

slowed in recent months, suggesting that the remaining 48 percent of workers that have not been able to regain employment will have more difficulty obtaining employment. Wage growth, as measured by the year-over-year change in private sector Average Hourly Earnings, contracted modestly during the quarter, reading 4.7% in the month of September compared to 4.9% in June 2020. The continued elevated wage growth is largely seen as a statistical anomaly. A majority of the layoffs appear to have occurred in traditionally lower-paying sectors, such as the leisure industry, which in turn inflated the wages of the remaining employed individuals.

Similar to the labor market, inflation readings, as measured by the year-over-year changes in the Personal Consumption Expenditure Chain Price Index (“PCE”), have rebounded from their lows in the second quarter, though remain below the Fed’s 2% target in the third quarter of 2020. The headline PCE measure increased by 1.37% year-over-year in September 2020. The more stable core PCE measure, which excludes volatile food and energy prices, registered a similar 1.55% year-over-year increase, above the 1.14% year-over-year growth measured in June.

In support of the U.S. economic recovery, Federal Open Market Committee (“FOMC”) maintained the Federal Funds Rate in the 0.00% - 0.25% range during the third quarter of 2020 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 and a number of lending programs. The combined Fed actions have continued to support financial conditions and market functioning, which in turn has helped the economic recovery.

During the third quarter of 2020, the 10-year U.S. Treasury rate remained nearly unchanged at 0.68% as Fed monetary policy actions maintained a range-bound interest rate environment in U.S. Treasuries and LIBOR-based interest rates. The mortgage basis, or the spread between the 30-year Agency mortgage-backed security coupon and 10-year U.S. Treasury rate, continued to compress following much volatility during the first half of 2020 as mortgage-backed securities saw strong demand from numerous investors.

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


	September 30, 2020	December 31, 2019	September 30, 2019
30-Year mortgage current coupon	1.40%	2.71%	2.61%
Mortgage basis	72 bps	79 bps	95 bps
10-Year U.S. Treasury rate	0.68%	1.92%	1.66%
LIBOR
1-Month	0.15%	1.76%	2.02%
6-Month	0.26%	1.91%	2.06%

London Interbank Offered Rate (“LIBOR”) Transition

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. As part of the transition from LIBOR, in October 2020, we participated in the Chicago Mercantile Exchange (“CME”) Group’s transitioning for price alignment and discounting for USD OTC cleared swaps from the daily effective federal funds rate to the secured overnight financing rate (“SOFR”). As a result of this activity, our existing swap and swaption positions have been updated with the new SOFR discounting curve and basis swaps entered into during this transition were sold in the CME Group’s auction on October 19, 2020.

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 and in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020.

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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

Net Income (Loss) Summary

The following table presents financial information related to our results of operations as of and for the three and nine months ended September 30, 2020 and 2019.


	As of and for the Three Months Ended September 30,						As of and for the Nine Months Ended September 30,
	2020			2019			2020			2019
	(dollars in thousands, except per share data)
Interest income	$	562,443		$	919,299		$	1,702,281		$	2,713,083
Interest expense	115,126			766,905			804,631			2,164,817
Net interest income	447,317			152,394			897,650			548,266
Realized and unrealized gains (losses)	618,823			(875,406)			(2,524,967)			(3,796,814)
Other income (loss)	7,959			35,074			38,109			93,757
Less: Total general and administrative expenses	48,832			66,138			194,127			228,283
Income (loss) before income taxes	1,025,267			(754,076)			(1,783,335)			(3,383,074)
Income taxes	9,719			(6,907)			(14,928)			(10,241)

Net income (loss)	1,015,548			(747,169)			(1,768,407)			(3,372,833)
Less: Net income (loss) attributable to noncontrolling interests	(126)			(110)			(28)			(294)
Net income (loss) attributable to Annaly	1,015,674			(747,059)			(1,768,379)			(3,372,539)
Less: Dividends on preferred stock (1)	35,509			36,151			106,527			101,067
Net income (loss) available (related) to common stockholders	$	980,165		$	(783,210)		$	(1,874,906)		$	(3,473,606)
Net income (loss) per share available (related) to common stockholders
Basic	$	0.70		$	(0.54)		$	(1.32)		$	(2.42)
Diluted	$	0.70		$	(0.54)		$	(1.32)		$	(2.42)
Weighted average number of common shares outstanding
Basic	1,404,202,695			1,453,359,211			1,419,645,475			1,436,204,582
Diluted	1,404,368,300			1,453,359,211			1,419,645,475			1,436,204,582
Other information
Asset portfolio at period-end	$	87,155,310		$	125,840,378		$	87,155,310		$	125,840,378
Average total assets	$	91,325,532		$	130,378,448		$	102,465,855		$	121,429,243
Average equity	$	13,996,138		$	15,465,556		$	14,124,037		$	15,207,589
Leverage at period-end (2)	5.1:1			7.3:1			5.1:1			7.3:1
Economic leverage at period-end (3)	6.2:1			7.7:1			6.2:1			7.7:1
Capital ratio (4)	13.6		%	11.2		%	13.6		%	11.2		%
Annualized return on average total assets	4.45		%	(2.29		%)	(2.30		%)	(3.70		%)
Annualized return on average equity	29.02		%	(19.32		%)	(16.69		%)	(29.57		%)


Net interest margin (5)	2.15		%	0.48		%	1.27		%	0.61		%

Average yield on interest earning assets (6)	2.70		%	2.89		%	2.40		%	3.02		%

Average GAAP cost of interest bearing liabilities (7)	0.60		%	2.58		%	1.23		%	2.66		%

Net interest spread	2.10		%	0.31		%	1.17		%	0.36		%

Weighted average experienced CPR for the period	22.9		%	14.6		%	18.7		%	11.0		%
Weighted average projected long-term CPR at period-end	17.1		%	16.3		%	17.1		%	16.3		%
Common stock book value per share	$	8.70		$	9.21		$	8.70		$	9.21
Non-GAAP metrics (8)
Interest income (excluding PAA)	$	596,322		$	1,036,451		$	2,078,624		$	3,051,869
Economic interest expense (7)	$	177,655		$	678,439		$	945,701		$	1,858,663
Economic net interest income (excluding PAA)	$	418,667		$	358,012		$	1,132,923		$	1,193,206

Premium amortization adjustment cost (benefit)	$	33,879		$	117,152		$	376,343		$	338,786
Core earnings (excluding PAA) (9)	$	482,323		$	341,931		$	1,237,121		$	1,166,239


Core earnings (excluding PAA) per common share	$	0.32		$	0.21		$	0.80		$	0.74
Annualized core return on average equity (excluding PAA)	13.79		%	8.85		%	11.68		%	10.23		%
Net interest margin (excluding PAA) (5)	2.05		%	1.10		%	1.67		%	1.29		%
Average yield on interest earning assets (excluding PAA) (6)	2.86		%	3.26		%	2.93		%	3.39		%
Average economic cost of interest bearing liabilities (7)	0.93		%	2.28		%	1.44		%	2.29		%
Net interest spread (excluding PAA)	1.93		%	0.98		%	1.49		%	1.10		%

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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

(2) Debt consists of repurchase agreements, other secured financing, debt issued by securitization vehicles and mortgages payable. Debt issued by securitization vehicles, certain credit facilities (included within other secured financing), and mortgages payable are non-recourse to us.

(3) 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.

(4) Calculated as total stockholders’ equity divided by total assets inclusive of outstanding market value of TBA positions and exclusive of consolidated VIEs.

(5) 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.

(6) 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).

(7) 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.

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

(9) Excludes dividends on preferred stock.

GAAP

Net income (loss) was $1.0 billion, which includes ($0.1) million attributable to noncontrolling interests, or $0.70 per average basic common share, for the three months ended September 30, 2020 compared to ($747.2) million, which includes ($0.1) million attributable to noncontrolling interests, or ($0.54) per average basic common share, for the same period in 2019. We attribute the majority of the change in net income (loss) to favorable changes in realized gains (losses) on termination or maturity of interest rate swaps, unrealized gains (losses) on interest rate swaps, net interest income and net gains (losses) on other derivatives. Realized gains (losses) on termination or maturity of interest rate swaps was ($0.4) million for the three months ended September 30, 2020 compared to ($682.6) million for the same period in 2019. Net unrealized gains (losses) on interest rate swaps was $170.3 million for the three months ended September 30, 2020 compared to ($326.3) million for the same period in 2019. Net interest income for the three months ended September 30, 2020 was $447.3 million compared to $152.4 million for the same period in 2019. Net gains (losses) on other derivatives was $169.3 million for the three months ended September 30, 2020 compared to ($16.9) million for the same period in 2019. Refer to the sections titled “Non-GAAP” and “Realized and Unrealized Gains (Losses)” located within this Item 2 for additional information related to these changes.

Net income (loss) was ($1.8) billion, which includes ($28.0) thousand attributable to noncontrolling interests, or ($1.32) per average basic common share, for the nine months ended September 30, 2020 compared to ($3.4) billion, which includes ($0.3) million attributable to noncontrolling interests, or ($2.42) per average basic common share, for the same period in 2019. We attribute the majority of the change in net income (loss) to favorable changes in net gains (losses) on other derivatives, unrealized gains (losses) on interest rate swaps, net gains (losses) on disposal of investments and other and net interest income, partially offset by unfavorable changes in realized gains (losses) on termination or maturity of interest rate swaps, the net interest component of interest rate swaps and net unrealized gains (losses) on instruments measured at fair value through earnings. Net gains (losses) on other derivatives was $546.7 million for the nine months ended September 30, 2020 compared to ($638.5) million for the same period in 2019. Unrealized gains (losses) on interest rate swaps was ($1.2) billion for the nine months ended September 30, 2020 compared to ($2.0) billion for the same period in 2019. Net gains (losses) on disposal of investments and other was $652.2 million for the nine months ended September 30, 2020 compared to ($65.7) million for the same period in 2019. Net interest income for the nine months ended September 30, 2020 was $897.7 million compared to $548.3 million for the same period in 2019. Realized gains (losses) on termination or maturity of interest rate swaps was ($1.9) billion for the nine months ended September 30, 2020 compared to ($1.4) billion for the same period in 2019. The net interest component of interest rate swaps was ($141.1) million for the nine months ended September 30, 2020 compared to $306.2 million for the same period in 2019. Unrealized gains (losses) on instruments measured at fair value through earnings for the nine months ended September 30, 2020 was ($354.1) million compared to $41.7 million for the same period in 2019. Refer to the sections titled “Non-GAAP” and “Realized and Unrealized Gains (Losses)” located within this Item 2 for additional information related to these changes.

Non-GAAP

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

Core earnings (excluding premium amortization adjustment (“PAA”)) were $482.3 million, or $0.32 per average common share, for the three months ended September 30, 2020, compared to $341.9 million, or $0.21 per average common share, for the same period in 2019.

Core earnings (excluding premium amortization adjustment (“PAA”)) were $1.2 billion, or $0.80 per average common share, for the nine months ended September 30, 2020, compared to $1.2 billion, or $0.74 per average common share, for the same period in 2019.

The changes in core earnings (excluding PAA) during the three and nine months ended September 30, 2020 compared to the same periods in 2019 were primarily due to lower interest expense from lower borrowing rates and average interest bearing liabilities, and higher TBA dollar roll income, partially offset by lower coupon income resulting from a decrease in the average yield on interest earnings assets and lower average interest earning assets, and 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:

•core earnings (excluding PAA);

•core earnings (excluding PAA) attributable to common stockholders;

•core earnings (excluding PAA) per average common share;

•annualized core return on average equity (excluding PAA);

•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 core earnings (excluding PAA), 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.

Core earnings (excluding PAA), core earnings (excluding PAA) attributable to common stockholders, core earnings (excluding PAA) per average common share and annualized core return on average equity (excluding PAA)

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. Core earnings (excluding PAA), 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 MSRs, (d) other income (loss) (excluding depreciation and amortization expense on real estate and related intangibles, non-core income allocated to equity method investments and other non-core 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-core 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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 provide additional transparency into the operating performance of our portfolio. Annualized core return on average equity (excluding PAA), which is calculated by dividing core earnings (excluding PAA) over average stockholders’ equity, provides investors with additional detail on the core earnings generated by our invested equity capital. The following table presents a reconciliation of GAAP financial results to non-GAAP core earnings for the periods presented:


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2020			2019			2020			2019
	(dollars in thousands, except per share data)
GAAP net income (loss)	$	1,015,548		$	(747,169)		$	(1,768,407)		$	(3,372,833)
Net income (loss) attributable to noncontrolling interests	(126)			(110)			(28)			(294)
Net income (loss) attributable to Annaly	1,015,674			(747,059)			(1,768,379)			(3,372,539)
Adjustments to exclude reported realized and unrealized (gains) losses
Realized (gains) losses on termination or maturity of interest rate swaps	427			682,602			1,919,720			1,438,349
Unrealized (gains) losses on interest rate swaps	(170,327)			326,309			1,162,768			1,992,884
Net (gains) losses on disposal of investments and other	(198,888)			(66,522)			(652,150)			65,727
Net (gains) losses on other derivatives	(169,316)			16,888			(546,658)			638,458
Net unrealized (gains) losses on instruments measured at fair value through earnings	(121,255)			1,091			354,133			(41,657)
Loan loss provision (1)	(21,818)			3,504			150,719			9,207




Other adjustments
Depreciation expense related to commercial real estate and amortization of intangibles (2)	11,363			9,974			28,011			30,235
Non-core (income) loss allocated to equity method investments (3)	(1,151)			4,541			22,465			25,364


Transaction expenses and non-recurring items (4)	2,801			2,622			11,121			15,650
Income tax effect of non-core income (loss) items	13,890			(2,762)			(6,619)			(5,543)

TBA dollar roll income and CMBX coupon income (5)	114,092			15,554			256,520			86,917
MSR amortization (6)	(27,048)			(21,963)			(70,873)			(55,599)

Plus:
Premium amortization adjustment cost (benefit)	33,879			117,152			376,343			338,786
Core earnings (excluding PAA) (7)	482,323			341,931			1,237,121			1,166,239

Dividends on preferred stock (8)	35,509			36,151			106,527			101,067

Core earnings (excluding PAA) attributable to common stockholders (7)	$	446,814		$	305,780		$	1,130,594		$	1,065,172
GAAP net income (loss) per average common share	$	0.70		$	(0.54)		$	(1.32)		$	(2.42)

Core earnings (excluding PAA) per average common share (7)	$	0.32		$	0.21		$	0.80		$	0.74
GAAP return (loss) on average equity	29.02		%	(19.32		%)	(16.69		%)	(29.57		%)
Core return on average equity (excluding PAA) (7)	13.79		%	8.85		%	11.68		%	10.23		%

(1) Includes $0.2 million and $4.6 million of loss provision on the Company’s unfunded loan commitments for the three and nine months ended September 30, 2020, respectively, 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 nine months ended September 30, 2020 includes costs incurred in connection with the a securitization of residential whole loans . The nine months ended September 30, 2020 also includes costs incurred in connection with the Internalization, the CEO search process and a securitization of Agency mortgage-backed securities. The three and nine months ended September 30, 2019 includes costs incurred in connection with a securitization of residential whole loans. The nine months ended September 30, 2019 also includes costs incurred in connection with a securitization of commercial loans.

(5) TBA dollar roll income and CMBX coupon income each represent a component of Net gains (losses) on other derivatives. CMBX coupon income totaled $1.5 million and $4.3 million for the three and nine months ended September 30, 2020. CMBX coupon income totaled $1.5 million and $3.4 million for the three and nine months ended September 30, 2019, respectively.

(6) MSR amortization represents the portion of changes in fair value that is attributable to the realization of estimated cash flows on the Company’s 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.

(8) The three months ended September 30, 2019 exclude cumulative and undeclared dividends of $0.3 million on our Series I Preferred Stock as of June 30, 2019.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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 mortgage-backed securities. A TBA contract is an agreement to purchase or sell, for future delivery, an Agency mortgage-backed security 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 mortgage-backed securities, 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 mortgage-backed security 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 mortgage-backed securities. 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 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 mortgage-backed security (interest income less an implied cost of financing). TBA dollar roll income is reported as a component of Net gains (losses) on other derivatives 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 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 core earnings (excluding PAA).

Premium Amortization Expense

In accordance with GAAP, we amortize or accrete premiums or discounts into interest income for our Agency mortgage-backed securities, 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 September 30,				For the Nine Months Ended September 30,
	2020		2019		2020		2019
	(dollars in thousands)
Premium amortization expense	$	248,718	$	376,306	$	1,136,343	$	942,339
Less: PAA cost (benefit)	33,879		117,152		376,343		338,786
Premium amortization expense (excluding PAA)	$	214,839	$	259,154	$	760,000	$	603,553

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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 mortgage-backed securities (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 nine months ended September 30, 2020.

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)
September 30, 2020	$	562,443	$	33,879	$	596,322
September 30, 2019	$	919,299	$	117,152	$	1,036,451
For the nine months ended
September 30, 2020	$	1,702,281	$	376,343	$	2,078,624
September 30, 2019	$	2,713,083	$	338,786	$	3,051,869
(1) Represents a non-GAAP financial measure.

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)
September 30, 2020	$	115,126		$	62,529	$	177,655	$	447,317	$	62,529	$	384,788	$	33,879	$	418,667
September 30, 2019	$	766,905		$	(88,466)	$	678,439	$	152,394	$	(88,466)	$	240,860	$	117,152	$	358,012
For the nine months ended
September 30, 2020	$	804,631		$	141,070	$	945,701	$	897,650	$	141,070	$	756,580	$	376,343	$	1,132,923
September 30, 2019	$	2,164,817		$	(306,154)	$	1,858,663	$	548,266	$	(306,154)	$	854,420	$	338,786	$	1,193,206
(1) Represents a non-GAAP financial measure.

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 mortgage-backed securities portfolio increase, related purchase premium amortization increases, thereby reducing the yield on such assets. The following table presents the weighted average

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

experienced CPR and weighted average projected long-term CPR on our Agency mortgage-backed securities portfolio as of and for the periods presented.


	Experienced CPR (1)		Projected Long-term CPR (2)
For the three months ended
September 30, 2020	22.9	%	17.1	%
September 30, 2019	14.6	%	16.3	%
For the nine months ended
September 30, 2020	18.7	%	17.1	%
September 30, 2019	11.0	%	16.3	%

(1) For the three and nine months ended September 30, 2020 and 2019, respectively.

(2) At September 30, 2020 and 2019, respectively.

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)
September 30, 2020	$	83,286,119	$	596,322	2.86	%	$	74,901,128	$	177,655	0.93	%	418,667	1.93	%
September 30, 2019	$	127,207,668	$	1,036,451	3.26	%	$	116,391,094	$	678,439	2.28	%	358,012	0.98	%
For the nine months ended
September 30, 2020	$	94,607,284	$	2,078,624	2.93	%	$	86,214,496	$	945,701	1.44	%	1,132,923	1.49	%
September 30, 2019	$	119,918,692	$	3,051,869	3.39	%	$	107,182,973	$	1,858,663	2.29	%	1,193,206	1.10	%

(1)Based on amortized cost.

(2)Represents a non-GAAP financial measure.

(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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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)
September 30, 2020	$	596,322	114,092	(115,126)	(62,529)	$	532,759	$	83,286,119	20,429,935	$	103,716,054	2.05	%
September 30, 2019	$	1,036,451	15,554	(766,905)	88,466	$	373,566	$	127,207,668	9,248,502	$	136,456,170	1.10	%
For the nine months ended
September 30, 2020	$	2,078,624	256,520	(804,631)	(141,070)	$	1,389,443	$	94,607,284	16,341,140	$	110,948,424	1.67	%
September 30, 2019	$	3,051,869	86,917	(2,164,817)	306,154	$	1,280,123	$	119,918,692	12,311,322	$	132,230,014	1.29	%

(1)Represents a non-GAAP financial measure.

(2)TBA dollar roll income and CMBX coupon income each represent a component of Net gains (losses) on other derivatives. CMBX coupon income totaled $1.5 million and $4.3 million for the three and nine months ended September 30, 2020, respectively. CMBX coupon income totaled $1.5 million and $3.4 million for the three and nine months ended September 30, 2019, respectively.

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
September 30, 2020	$	74,901,128	$	71,522,396	$	177,655	0.93	%	0.16	%	0.31	%	(0.15	%)	0.77	%	0.62	%
September 30, 2019	$	116,391,094	$	111,004,216	$	678,439	2.28	%	2.18	%	2.11	%	0.07	%	0.10	%	0.17	%
For the nine months ended
September 30, 2020	$	86,214,496	$	71,522,396	$	945,701	1.44	%	0.64	%	0.83	%	(0.19	%)	0.80	%	0.61	%
September 30, 2019	$	107,182,974	$	111,004,216	$	1,858,663	2.29	%	2.37	%	2.45	%	(0.08	%)	(0.08	%)	(0.16	%)
(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.

Economic interest expense decreased by $500.8 million for the three months ended September 30, 2020 compared to the same period in 2019. Economic interest expense decreased by $913.0 million for the nine months ended September 30, 2020 compared to the same period in 2019. The change in each period was due to lower borrowing rates and decreases in average interest bearing liabilities, partially offset by the change in the net interest component of interest rate swaps, which was ($62.5) million for the three months ended September 30, 2020 compared to $88.5 million for the same period in 2019 and ($141.1) million for the nine months ended September 30, 2020 compared to $306.2 million for the same period in 2019.

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

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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 September 30, 2020 and December 31, 2019, 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.

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 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 September 30, 2020 and 2019 were as follows:


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2020		2019		2020		2019
	(dollars in thousands)
Net gains (losses) on interest rate swaps (1)	$	107,371	$	(920,445)	$	(3,223,558)	$	(3,125,079)
Net gains (losses) on disposal of investments and other	198,888		66,522		652,150		(65,727)
Net gains (losses) on other derivatives	169,316		(16,888)		546,658		(638,458)
Net unrealized gains (losses) on instruments measured at fair value through earnings	121,255		(1,091)		(354,133)		41,657
Loan loss provision	21,993		(3,504)		(146,084)		(9,207)


Total	$	618,823	$	(875,406)	$	(2,524,967)	$	(3,796,814)

(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 September 30, 2020 and 2019

Net gains (losses) on interest rate swaps for the three months ended September 30, 2020 was $107.4 million compared to ($920.4) million for the same period in 2019. The change was primarily attributable to lower realized losses on termination or maturity of interest rate swaps and favorable changes in unrealized gains (losses) on interest rate swaps. Realized gains (losses) on termination or maturity of interest rate swaps was ($0.4) million resulting from interest rate swaps with a notional amount of $375.0 million for the three months ended September 30, 2020 compared to ($682.6) million resulting from the termination or maturity of interest rate swaps with a notional amount of $30.6 billion for the same period in 2019. Unrealized gains (losses) on interest rate swaps was $0.2 billion for the three months ended September 30, 2020, reflecting a rise in forward interest rates during the period compared to ($326.3) million for the same period in 2019, which reflected a decline in forward interest rates during the earlier period.

Net gains (losses) on disposal of investments and other was $198.9 million for the three months ended September 30, 2020 compared to $66.5 million for the same period in 2019. For the three months ended September 30, 2020, we recognized a realized gain of $104.8 million as a result of deconsolidating a multifamily VIE and we disposed of Residential Securities with a carrying value of $2.8 billion for an aggregate net gain of $103.9 million. For the same period in 2019, we disposed of Residential Securities with a carrying value of $11.1 billion for an aggregate net loss of $76.3 million.

Net gains (losses) on other derivatives was $169.3 million for the three months ended September 30, 2020 compared to ($16.9) million for the same period in 2019. The change in net gains (losses) on other derivatives was primarily comprised of higher net gains on TBA derivatives, which was $176.2 million for the three months ended September 30, 2020 compared to $47.8 million for the same period in 2019 and lower net losses on futures derivatives, which was ($9.7) million for the three months ended September 30, 2020 compared to ($59.7) million for the same period in 2019.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

Net unrealized gains (losses) on instruments measured at fair value through earnings was $121.3 million for the three months ended September 30, 2020 compared to ($1.1) million for the same period in 2019, primarily due to favorable changes in unrealized gains (losses) on securitized debt of consolidated VIEs backed by Agency mortgage-backed securities, commercial securitized loans of consolidated VIEs and securitized residential whole loans of consolidated VIEs, partially offset by unfavorable changes in unrealized gains (losses) on commercial securitized debt of consolidated VIEs and Agency interest-only securities for the three months ended September 30, 2020 compared to the same period in 2019.

For the three months ended September 30, 2020, a net loan loss provision reversal of $22.0 million was recorded on commercial mortgage and corporate loans. For the three months ended September 30, 2019, a loan loss provision of ($3.5) million was recorded on a commercial mortgage loan. Refer to the “Loans” Note located within Item 1 for additional information related to these loan loss provisions.

For the Nine Months Ended September 30, 2020 and 2019

Net gains (losses) on interest rate swaps for the nine months ended September 30, 2020 was ($3.2) billion compared to ($3.1) billion for the same period in 2019, primarily attributable to higher realized losses on termination or maturity of interest rate swaps and an unfavorable change in the net interest component of interest rate swaps, partially offset by lower unrealized losses on interest rate swaps. Realized gains (losses) on termination or maturity of interest rate swaps was ($1.9) billion resulting from fixed-rate payer and receiver interest rate swaps with notional amounts of $65.4 billion and $38.1 billion, respectively, for the nine months ended September 30, 2020 compared to ($1.4) billion resulting from fixed-rate payer and receiver interest rate swaps with notional amounts of $75.7 billion and $11.6 billion, respectively, for the same period in 2019. The net interest component of interest rate swaps was ($141.1) million for the nine months ended September 30, 2020, compared to $306.2 million for the same period in 2019, reflecting a decrease in rates combined with the timing of rate resets during the period and changes in notional balance. Unrealized gains (losses) on interest rate swaps was ($1.2) billion for the nine months ended September 30, 2020, reflecting a decline in forward interest rates during the period compared to ($2.0) billion for the same period in 2019, which reflected a steeper decline in forward interest rates during the earlier period.

Net gains (losses) on disposal of investments and other was $652.2 million for the nine months ended September 30, 2020 compared to ($65.7) million for the same period in 2019. For the nine months ended September 30, 2020, we disposed of Residential Securities with a carrying value of $50.2 billion for an aggregate net gain of $631.1 million and we recognized a realized gain of $104.8 million as a result of deconsolidating a multifamily VIE. For the same period in 2019, we disposed of Residential Securities with a carrying value of $30.7 billion for an aggregate net loss of ($50.6) million.

Net gains (losses) on other derivatives was $546.7 million for the nine months ended September 30, 2020 compared to ($638.5) million for the same period in 2019. The change in net gains (losses) on other derivatives was primarily comprised of higher net gains on TBA derivatives, which was $812.1 million for the nine months ended September 30, 2020 compared to $327.5 million for the same period in 2019 and lower net losses on futures derivatives, which was ($299.6) million for the nine months ended September 30, 2020 compared to ($946.3) million for the same period in 2019.

Net unrealized gains (losses) on instruments measured at fair value through earnings was ($354.1) million for the nine months ended September 30, 2020 compared to $41.7 million for the same period in 2019, primarily due to unfavorable changes in unrealized gains (losses) on commercial securitized loans of consolidated VIEs, Agency interest-only securities, credit risk transfer securities and residential loans, partially offset by favorable changes in unrealized gains (losses) on commercial securitized debt of consolidated VIEs for the nine months ended September 30, 2020 compared to the same period in 2019.

For the nine months ended September 30, 2020, a loan loss provision of ($146.1) million was recorded on commercial mortgage and corporate loans. For the nine months ended September 30, 2019, a loan loss provision of ($9.2) million was recorded on a commercial mortgage loan. 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, net servicing income on MSRs, operating costs as well as depreciation and amortization expense. 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

General and Administrative Expenses

General and administrative (“G&A”) expenses consist of compensation and management fee (until closing of the Internalization) and other expenses. The following table shows our total G&A expenses as compared to average total assets and average equity for the periods presented.

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)
September 30, 2020	$	48,832	0.21	%	1.40	%
September 30, 2019	$	66,138	0.20	%	1.71	%
For the nine months ended
September 30, 2020	$	194,127	0.25	%	1.83	%
September 30, 2019	$	228,283	0.25	%	2.00	%

(1) Includes $2.8 million of transaction costs incurred in connection with securitizations of residential whole loans for the three months ended September 30, 2020. Includes $11.1 million of transaction costs incurred in connection with securitizations of residential whole loans and Agency mortgage-backed securities as well as costs incurred in connection with the Internalization and costs incurred in connection with the CEO search process for the nine months ended September 30, 2020. Includes $2.6 million of transaction costs incurred in connection with a securitization of residential whole loans for the three months ended September 30, 2019. Includes $15.7 million of transaction costs incurred in connection with securitizations of residential whole loans and commercial loans for the nine months ended September 30, 2019. Excluding these transaction costs, G&A expenses as a percentage of average total assets were 0.20% and 0.24% and as a percentage of average equity were 1.32% and 1.73% for the three and nine months ended September 30, 2020, respectively. Excluding these transaction costs, G&A expenses as a percentage of average total assets were 0.19% and 0.23% and as a percentage of average equity were 1.64% and 1.86% for the three and nine months ended September 30, 2019, respectively.

G&A expenses were $48.8 million for the three months ended September 30, 2020, a decrease of $17.3 million compared to the same period in 2019, primarily due to lower compensation costs during the third quarter of 2020 compared with the same period in 2019 as a result of cost savings generated from the Internalization which closed on June 30, 2020. G&A expenses were $194.1 million for the nine months ended September 30, 2020, a decrease of $34.2 million compared to the same period in 2019, primarily due to lower compensation costs, reflecting cost savings generated from the Internalization and lower management fees in the first half of 2020 reflecting lower adjusted stockholders’ equity balances compared to the same period in 2019, and lower transaction costs during the nine months ended September 30, 2020 compared to the same period in 2019.

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
September 30, 2020	11.01	%	19.47	%	0.23	%	(1.40	%)	(0.29	%)	29.02	%
September 30, 2019	6.23	%	(24.93	%)	0.91	%	(1.71	%)	0.18	%	(19.32	%)
For the nine months ended
September 30, 2020	7.14	%	(22.49	%)	0.36	%	(1.83	%)	0.13	%	(16.69	%)
September 30, 2019	7.49	%	(35.97	%)	0.82	%	(2.00	%)	0.09	%	(29.57	%)
(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 mortgage-backed securities, 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

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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.


	September 30, 2020		December 31, 2019
	(dollars in thousands)
Unrealized gain	$	3,600,389	$	2,267,577
Unrealized loss	(11,333)		(129,386)
Accumulated other comprehensive income (loss)	$	3,589,056	$	2,138,191

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 September 30, 2020 is solely due to market conditions and not the quality of the assets. Substantially all of the Agency mortgage-backed securities are “AAA” rated or carry an implied “AAA” rating. The investments are not considered to be other-than-temporarily impaired because 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 $89.2 billion and $130.3 billion at September 30, 2020 and December 31, 2019, respectively. The change, consistent with our portfolio repositioning to strengthen our balance sheet in the first quarter of 2020, was primarily due to a decrease in Agency mortgage-backed securities of $38.5 billion, including assets transferred or pledged to securitization vehicles, residential mortgage loans of $0.5 billion and non-Agency mortgage-backed securities of $0.4 billion. Our portfolio composition, net equity allocation and debt-to-net equity ratio by asset class were as follows at September 30, 2020:

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis


	Residential												Commercial
	Agency MBS and MSRs			TBAs (1)			CRTs			Non-Agency MBS and Residential Mortgage Loans (2)				CRE Debt & Preferred Equity Investments			Investments in CRE			Corporate Debt			Total (3)
Assets	(dollars in thousands)
Fair value/carrying value	$	75,746,802		$	21,089,555		$	411,538		$	4,459,240			$	3,685,255		$	790,597		$	2,061,878		$	87,155,310
Debt
Repurchase agreements	62,804,603			21,072,039			231,274			955,451				642,119			—			—			64,633,447
Other secured financing	2,745			—			—			30,098				—			—			828,530			861,373
Debt issued by securitization vehicles	573,108			—			—			2,982,247				2,472,221			—			—			6,027,576
Net forward purchases	1,115,598			—			—			6,203				—			—			—			1,121,801

Mortgages payable	—			—			—			—				—			507,934			—			507,934
Net equity allocated	$	11,250,748		$	17,516		$	180,264		$	485,241			$	570,915		$	282,663		$	1,233,348		$	14,003,179		(4)

Net equity allocated (%)	80		%	—		%	1		%	4		%		4		%	2		%	9		%	100		%
Debt/net equity ratio	5.7:1			NM			1.3:1			8.2:1				5.5:1			1.8:1			0.7:1			5.1:1			(5)

(1) Fair value/carrying value represents implied market value and repurchase agreements represent the notional value. (2) Includes loans held for sale, net. (3) Excludes the TBA asset, debt and equity balances. (4) Net Equity Allocated, as disclosed in the above table, excludes non-portfolio related activity and may differ from stockholders’ equity per the Consolidated Statements of Financial Condition. (5) Represents the debt/net equity ratio as determined using amounts on the Consolidated Statements of Financial Condition. NM Not meaningful.

Residential Securities

Substantially all of our Agency mortgage-backed securities at September 30, 2020 and December 31, 2019 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 mortgage-backed securities 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 September 30, 2020 and December 31, 2019 we had on our Consolidated Statements of Financial Condition a total of $92.1 million and $156.9 million, respectively, of unamortized discount (which is the difference between the remaining principal value and 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 $3.8 billion and $5.3 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 mortgage-backed securities portfolio for the three months ended September 30, 2020 and 2019 was 22.9% and 14.6%, respectively. The weighted average projected long-term prepayment speed on our Agency mortgage-backed securities portfolio as of September 30, 2020 and 2019 was 17.1% and 16.3%, 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 September 30, 2020 and December 31, 2019.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis


	September 30, 2020		December 31, 2019
	Estimated Fair Value
Agency	(dollars in thousands)
Fixed-rate pass-through	$	72,210,570	$	108,723,414
Adjustable-rate pass-through	527,267		1,524,331
CMO	152,513		160,016
Interest-only	465,376		708,562
Multifamily	1,503,413		1,717,197
Reverse mortgages	56,028		59,847
Total agency securities	$	74,915,167	$	112,893,367
Residential credit
CRT	$	411,538	$	531,322
Alt-A	90,954		151,383
Prime	186,178		276,257
Prime interest-only	1,191		3,167
Subprime	119,547		348,979
NPL/RPL	281,869		164,268
Prime jumbo (>= 2010 vintage)	36,204		184,664
Prime jumbo (>= 2010 vintage) interest-only	1,659		7,150
Total residential credit securities	$	1,129,140	$	1,667,190
Total Residential Securities	$	76,044,307	$	114,560,557

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 September 30, 2020 and December 31, 2019.


	September 30, 2020			December 31, 2019
Residential Securities (1)	(dollars in thousands)
Principal amount	$	69,004,541		$	107,412,143
Net premium	3,091,544			4,309,668
Amortized cost	72,096,084			111,721,811
Amortized cost / principal amount	104.48		%	104.01		%
Carrying value	75,576,026			113,841,402
Carrying value / principal amount	109.52		%	105.99		%
Weighted average coupon rate	3.59		%	3.91		%
Weighted average yield	2.96		%	3.07		%
Adjustable-rate Residential Securities (1)
Principal amount	$	1,239,156		$	2,513,310
Weighted average coupon rate	3.33		%	4.13		%
Weighted average yield	4.82		%	3.52		%
Weighted average term to next adjustment	16 Months			13 Months
Weighted average lifetime cap (2)	0.38		%	8.24		%
Principal amount at period end as % of total residential securities	1.80		%	2.34		%
Fixed-rate Residential Securities (1)
Principal amount	$	67,765,385		$	104,898,833
Weighted average coupon rate	3.59		%	3.90		%
Weighted average yield	2.93		%	3.06		%
Principal amount at period end as % of total residential securities	98.20		%	97.66		%
Interest-only Residential Securities
Notional amount	$	3,696,743		$	5,447,193
Net premium	610,922			876,129
Amortized cost	610,922			876,129
Amortized cost / notional amount	16.53		%	16.08		%
Carrying value	468,281			719,155
Carrying value / notional amount	12.67		%	13.20		%
Weighted average coupon rate	4.22		%	3.29		%
Weighted average yield	NM			1.73		%
(1) Excludes interest-only mortgage-backed securities. (2) Excludes non-Agency mortgage-backed securities and CRT securities as this attribute is not applicable to these asset classes. NM Not meaningful.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

The following tables summarize certain characteristics of our Residential Credit portfolio at September 30, 2020.


			Payment Structure				Investment Characteristics
Product	Total		Senior		Subordinate		Coupon		Credit Enhancement		60+ Delinquencies		3M VPR (1)
(dollars in thousands)
Agency credit risk transfer	$	397,665	$	—	$	397,665	4.37	%	0.99	%	4.78	%	41.13	%
Private label credit risk transfer	13,873		—		13,873		5.60	%	—	%	4.69	%	33.94	%
Alt-A	90,954		26,379		64,575		3.70	%	8.32	%	19.13	%	16.44	%
Prime	186,178		28,640		157,538		4.17	%	8.75	%	12.83	%	22.26	%
Prime interest-only	1,191		1,191		—		0.46	%	—		6.20	%	40.34	%
Subprime	119,547		66,303		53,244		1.05	%	8.97	%	20.96	%	5.93	%
Re-performing loan securitizations	273,393		142,960		130,433		4.19	%	33.47	%	22.24	%	5.40	%
Non-performing loan securitizations	8,476		8,476		—		3.67	%	31.00	%	83.41	%	—	%
Prime jumbo (>=2010 vintage)	36,204		—		36,204		3.82	%	2.23	%	4.99	%	50.31	%
Prime jumbo (>=2010 vintage) interest-only	1,659		1,659		—		0.36	%	—		3.91	%	48.78	%
Total/weighted average (2)	$	1,129,140	$	275,608	$	853,532	3.87	%	11.34	%	13.55	%	23.43	%

(1) Represents the 3 month voluntary prepayment rate (“VPR”). (2) Total investment characteristics exclude the impact of IOs.


	Bond Coupon
Product	ARM		Fixed		Floater		Interest-Only		Estimated Fair Value
(dollars in thousands)
Agency credit risk transfer	$	—	$	—	$	397,665	$	—	$	397,665
Private label credit risk transfer	—		—		13,873		—		13,873
Alt-A	28,251		47,803		14,900		—		90,954
Prime	29,866		130,153		26,159		—		186,178
Prime interest-only	—		—		—		1,191		1,191
Subprime	—		3,975		115,415		157		119,547
Re-performing loan securitizations	—		273,393		—		—		273,393
Non-performing loan securitizations	—		8,476		—		—		8,476
Prime jumbo (>=2010 vintage)	—		36,204		—		—		36,204
Prime jumbo (>=2010 vintage) interest-only	—		—		—		1,659		1,659
Total	$	58,117	$	500,004	$	568,012	$	3,007	$	1,129,140

Contractual Obligations

The following table summarizes the effect on our liquidity and cash flows from contractual obligations at September 30, 2020. The table does not include the effect of net interest rate payments on our interest rate swap agreements. The net swap payments will fluctuate based on monthly changes in the floating rate. At September 30, 2020, the interest rate swaps had a net fair value of ($1.1) billion.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis


	Within One Year		One to Three Years		Three to Five Years		More than Five Years		Total
	(dollars in thousands)
Repurchase agreements	$	64,633,447	$	—	$	—	$	—	$	64,633,447
Interest expense on repurchase agreements (1)	59,043		—		—		—		59,043
Other secured financing	13,923		18,920		828,530		—		861,373
Interest expense on other secured financing (1)	19,090		36,668		19,116		—		74,874
Debt issued by securitization vehicles (principal)	—		—		185,909		5,841,938		6,027,847
Interest expense on debt issued by securitization vehicles	144,424		217,931		215,675		3,331,920		3,909,950
Mortgages payable (principal)	22,828		65,136		155,686		269,532		513,182
Interest expense on mortgages payable	20,314		39,431		34,312		126,522		220,579
Long-term operating lease obligations	3,955		7,723		7,723		—		19,401
Total	$	64,917,024	$	385,809	$	1,446,951	$	9,569,912	$	76,319,696

(1) Interest expense on repurchase agreements and other secured financing calculated based on rates at September 30, 2020.

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, mortgages payable or other term financing structures to finance certain of our assets. During the nine months ended September 30, 2020, we received $14.4 billion from principal repayments and $50.3 billion in cash from disposal of Residential Securities. During the nine months ended September 30, 2019, we received $11.2 billion from principal repayments and $19.7 billion in cash from disposal of Residential 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 September 30, 2020.

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 and in our Quarterly Report on Form 10-Q for the quarters ended March 31, 2020 and June 30, 2020.

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

Stockholders’ Equity

The following table provides a summary of total stockholders’ equity at September 30, 2020 and December 31, 2019:


	September 30, 2020		December 31, 2019
Stockholders’ equity	(dollars in thousands)


7.50% Series D cumulative redeemable preferred stock	$	445,457	$	445,457

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	14,029		14,301
Additional paid-in capital	19,798,032		19,966,923
Accumulated other comprehensive income (loss)	3,589,056		2,138,191
Accumulated deficit	(11,200,937)		(8,309,424)
Total stockholders’ equity	$	14,182,206	$	15,792,017

Capital Stock

The following table provides activity related to our Direct Purchase and Dividend Reinvestment Program for the periods presented:


	For the Nine Months Ended
	September 30, 2020		September 30, 2019
	(dollars in thousands)
Shares issued through direct purchase and dividend reinvestment program	154,000		180,000
Amount raised from direct purchase and dividend reinvestment program	$	1,075	$	1,795

During the nine months ended September 30, 2019, we closed the public offering of an original issuance of 75.0 million shares of common stock for proceeds of $730.5 million before deducting offering expenses. In connection with the offering, we granted the underwriters a thirty-day option to purchase up to an additional 11.3 million shares of common stock, which the underwriters exercised in full resulting in an additional $109.6 million in proceeds before deducting offering expenses.

No shares were issued under the at-the-market sales program during the nine months ended September 30, 2020. During the nine months ended September 30, 2019, we issued 56.0 million shares for proceeds of $569.1 million, net of commissions and fees, under the at-the-market sales program.

In June 2019, we announced that our Board had authorized the repurchase of up to $1.5 billion of our outstanding shares of common stock through December 31, 2020. During the three and nine months ended September 30, 2020, we repurchased 4.8 million and 27.7 million shares of our common stock, respectively, for an aggregate amount of $31.3 million and $174.7 million, respectively, excluding commission costs. All common shares purchased were part of a publicly announced plan in open-market transactions. During the three and nine months ended September 30, 2019, we repurchased 18.3 million shares of our common stock for an aggregate amount of $155.0 million, excluding commission costs.

During the three and nine months ended September 30, 2019, we redeemed all 7.0 million of our issued and outstanding shares of 7.625% Series C Cumulative Redeemable Preferred Stock (“Series C Preferred Stock”) for $175.0 million. The cash redemption amount for each share of Series C Preferred Stock was $25.00 plus accrued and unpaid dividends to, but not including, the redemption date of July 21, 2019.

During the nine months ended September 30, 2019, we redeemed all 2.2 million of our issued and outstanding shares of 8.125% Series H Cumulative Redeemable Preferred Stock (“Series H Preferred Stock”) for $55.0 million. The cash redemption amount for each share of Series H Preferred Stock was $25.00 plus accrued and unpaid dividends to, but not including, the redemption date of May 31, 2019.

During the nine months ended September 30, 2019, we issued 17.7 million shares of our 6.750% Series I Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock for gross proceeds of $442.5 million before deducting the underwriting discount and other estimated offering costs.

Leverage and Capital

We believe that it is prudent to maintain conservative debt-to-equity and economic leverage ratios as there may be continued

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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 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.

Our debt-to-equity ratio at September 30, 2020 and December 31, 2019 was 5.1:1 and 7.1:1, respectively. Our economic leverage ratio, which is computed as the sum of Recourse Debt, cost basis of TBA derivative and CMBX notional outstanding and net forward purchases (sales) of investments divided by total equity was 6.2:1 and 7.2:1 at September 30, 2020 and December 31, 2019, respectively. Our capital ratio, which represents our ratio of stockholders’ equity to total assets (inclusive of total market value of TBA derivatives and shown net of debt issued by securitization vehicles), was 13.6% and 12.0% at September 30, 2020 and December 31, 2019, respectively.

Risk Management

For more information on COVID-19, including actions we have taken in response, please refer to the section titled “Business Environment and Coronavirus Disease 2019 (“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 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.
Compliance						We will seek to comply with regulatory requirements needed to maintain our REIT status and our exemption from registration under the Investment Company Act.

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”). 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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.
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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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 has borrowed funds through direct repurchase agreements.

To reduce our liquidity risk we maintain a laddered approach to our repurchase agreements. At September 30, 2020 and December 31, 2019, the weighted average days to maturity was 72 days and 65 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.

We maintain membership in the Federal Home Loan Bank (“FHLB”) through our captive insurance subsidiary Truman Insurance Company LLC (“Truman”). A 2016 rule from the Federal Housing Finance Agency (“FHFA”) requires captive insurance companies to terminate their FHLB membership, however, given the length of its membership at the time the rule was enacted, Truman was granted a five year sunset provision whereby its membership will expire in February 2021. We believe our business objectives align well with the mission of the FHLB System. While there can be no assurances that such steps will be taken, we believe it would be appropriate for there to be legislative or other action to permit Truman and similar captive insurance subsidiaries to retain their membership status beyond the current sunset period. However, in anticipation of the expiration of our membership, we have refinanced our prior FHLB advances with alternative funding sources, including credit facilities and securitization funding.

At September 30, 2020, we had total financial assets and cash pledged against existing liabilities of $71.7 billion. The weighted average haircut was approximately 4% 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 September 30, 2020 compared to the same period in 2019, 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 September 30, 2020.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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)
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		—
March 31, 2019	87,781,404		88,554,170		3,937,769		523,449
December 31, 2018	83,984,254		81,115,874		2,741,022		650,040
September 30, 2018	79,214,382		79,073,026		2,330,519		1,234,704

The following table provides information on our repurchase agreements and other secured financing by maturity date at September 30, 2020. The weighted average remaining maturity on our repurchase agreements and other secured financing was 90 days at September 30, 2020:


	September 30, 2020
	Principal Balance		Weighted Average Rate		% of Total
	(dollars in thousands)
1 day	$	2,700,000	0.13	%	4.1	%
2 to 29 days	23,894,431		0.36	%	36.5	%
30 to 59 days	8,644,191		0.51	%	13.2	%
60 to 89 days	9,702,860		0.33	%	14.8	%
90 to 119 days	5,529,035		0.73	%	8.4	%
Over 120 days (1)	15,024,303		0.55	%	23.0	%
Total	$	65,494,820	0.44	%	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 September 30, 2020:


			Weighted Average Rate
	Principal Balance		As of Period End		For the Quarter		Weighted Average Days to Maturity (1)
	(dollars in thousands)
Repurchase agreements	$	64,633,447	0.42	%	0.44	%	72
Other secured financing (2)	861,373		2.23	%	2.56	%	1,432
Securitized debt of consolidated VIEs (3)	6,027,847		2.15	%	2.03	%	9,336
Mortgages payable (3)	513,182		3.99	%	3.95	%	4,174
Total indebtedness	$	72,035,849

(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

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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 September 30, 2020:


	Encumbered Assets		Unencumbered Assets		Total
Financial assets	(dollars in thousands)
Cash and cash equivalents	$	1,025,431	$	214,551	$	1,239,982

Investments, at carrying value (1)
Agency mortgage-backed securities (2)	67,321,920		7,109,080		74,431,000
Credit risk transfer securities	313,863		97,675		411,538
Non-agency mortgage-backed securities	597,647		119,955		717,602
Residential mortgage loans (2)	3,661,516		80,122		3,741,638
MSRs	3,431		204,554		207,985
Commercial real estate debt investments (2)	2,035,747		193,049		2,228,796
Commercial real estate debt and preferred equity, held for investment (2)	1,330,069		126,390		1,456,459
Corporate debt, held for investment	1,446,512		615,366		2,061,878

Other assets (3)	—		74,548		74,548
Total financial assets	$	77,736,136	$	8,835,290	$	86,571,426

(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) Includes interests in certain joint ventures and equity instruments.

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 September 30, 2020:


	Carrying Value (1)
Liquid assets	(dollars in thousands)
Cash and cash equivalents	$	1,239,982

Residential Securities (2) (3)	74,936,333
Residential mortgage loans (4)	152,959
Commercial real estate debt investments (5)	54,678
Commercial real estate debt and preferred equity, held for investment (6)	450,177
Corporate debt, held for investment (7)	1,565,166

Total liquid assets	$	78,399,295
Percentage of liquid assets to carrying amount of encumbered and unencumbered financial assets (8)	98.86		%

(1)Carrying value approximates the market value of assets. The assets listed in this table include $71.7 billion of assets that have been pledged as collateral against existing liabilities at September 30, 2020. 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 mortgage-backed securities 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 $3.6 billion.

(5)Excludes securitized commercial mortgage loans of consolidated VIEs carried at fair value of $2.2 billion.

(6)Excludes senior securitized commercial mortgage loans of consolidated VIEs carried at fair value of $0.9 billion.

(7)Excludes certain second lien loans.

(8)Denominator is computed based on the carrying amount of encumbered and encumbered financial assets, excluding assets transferred or pledged to securitization vehicles of $7.3 billion.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

The interest rate sensitivity of our assets and liabilities in the following table at September 30, 2020 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	$	1,239,982	$	—	$	—	$	—	$	1,239,982

Agency mortgage-backed securities (principal)	51,189		8,806		1,816,658		65,931,272		67,807,925
Credit risk transfer securities (principal)	16,426		19,832		80,375		335,876		452,509
Non-agency mortgage-backed securities (principal)	744,106		—		—		—		744,106
Commercial mortgage-backed securities (principal)	—		—		—		64,458		64,458
Total securities	811,721		28,638		1,897,033		66,331,606		69,068,998
Residential mortgage loans (principal)	—		—		—		153,066		153,066

Commercial real estate debt and preferred equity (principal)	76,970		51,658		477,053		45,302		650,983
Corporate debt (principal)	2,506		40,649		328,143		1,895,613		2,266,911
Total loans	79,476		92,307		805,196		2,093,981		3,070,960
Assets transferred or pledged to securitization vehicles (principal)	—		—		—		7,305,027		7,305,027
Total financial assets - maturity	2,131,179		120,945		2,702,229		75,730,614		80,684,967
Effect of utilizing reset dates (1)	8,063,965		1,313,480		(616,442)		(8,761,003)		—
Total financial assets - interest rate sensitive	$	10,195,144	$	1,434,425	$	2,085,787	$	66,969,611	$	80,684,967
Financial liabilities
Repurchase agreements	$	44,992,493	$	19,640,954	$	—	$	—	$	64,633,447
Other secured financing	—		13,923		18,920		828,530		861,373
Debt issued by securitization vehicles (principal)	—		—		—		6,027,847		6,027,847
Total financial liabilities - maturity	44,992,493		19,654,877		18,920		6,856,377		71,522,667
Effect of utilizing reset dates (1)(2)	(27,046,228)		(524,645)		20,016,750		7,554,123
Total financial liabilities - interest rate sensitive	$	17,946,265	$	19,130,232	$	20,035,670	$	14,410,500	$	71,522,667

Maturity gap	$	(42,861,314)	$	(19,533,932)	$	2,683,309	$	68,874,237	$	9,162,300

Cumulative maturity gap	$	(42,861,314)	$	(62,395,246)	$	(59,711,937)	$	9,162,300

Interest rate sensitivity gap	$	(7,751,121)	$	(17,695,807)	$	(17,949,883)	$	52,559,111	$	9,162,300

Cumulative rate sensitivity gap	$	(7,751,121)	$	(25,446,928)	$	(43,396,811)	$	9,162,300

(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. Our stress tests are modeled over both short term and longer time horizons. 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 both short-term and long-term 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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 securities 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 September 30, 2020. 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	(28.0%)	—%	(0.3%)
-50 Basis points	(19.6%)	0.1%	0.7%
-25 Basis points	(9.7%)	0.2%	1.5%

+25 Basis points	7.0%	(0.1%)	(0.9%)
+50 Basis points	14.1%	(0.3%)	(2.1%)
+75 Basis points	20.2%	(0.6%)	(3.9%)
MBS Spread Shock (1)	Estimated Change in Portfolio Market Value	Estimated Change as a % on NAV (3)(4)
-25 Basis points	1.4%	8.9%
-15 Basis points	0.9%	5.3%
-5 Basis points	0.3%	1.8%

+5 Basis points	(0.3%)	(1.7%)
+15 Basis points	(0.8%)	(5.2%)
+25 Basis points	(1.4%)	(8.7%)
(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, MSRs and derivative instruments. (4) NAV represents book value of equity.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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 if overall costs to service the underlying mortgage loans increase 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 commercial investments that meet our comprehensive underwriting process and credit standards and are approved by the appropriate committee. Once a commercial 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 September 30, 2020 and December 31, 2019 was as follows:


	September 30, 2020		December 31, 2019
Category
Agency mortgage-backed securities (1)	86.7	%	89.5	%
Credit risk transfer securities	0.5	%	0.4	%
Non-agency mortgage-backed securities	0.8	%	0.9	%
Residential mortgage loans (1)	4.3	%	3.3	%
Mortgage servicing rights	0.2	%	0.3	%
Commercial real estate (1) (2)	5.1	%	3.9	%
Corporate debt	2.4	%	1.7	%
(1) Includes assets transferred or pledged to securitization vehicles. (2) Net of unamortized origination fees.

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

The following table summarizes our exposure to counterparties by geography at September 30, 2020:


	Number of Counterparties	Repurchase Agreement Financing		Interest Rate Swaps at Fair Value		Exposure (1)
Geography	(dollars in thousands)
North America	25	$	50,950,065	$	(402,402)	$	3,217,881
Europe	10	9,794,270		(723,777)		950,431

Japan	2	3,889,112		—		206,590
Total	37	$	64,633,447	$	(1,126,179)	$	4,374,902
(1) Represents the amount of cash and/or securities pledged as collateral to each counterparty less the aggregate of repurchase agreement 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.

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 and our subsidiary that is registered with the SEC as an investment adviser under the Investment Advisers Act.

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. 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 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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.

MSRs

Fair value estimates for our investment in MSRs 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 MSRs requires significant judgment by management and the third-party pricing providers.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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 other-than-temporary 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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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

Calculated as total stockholders’ equity divided by total assets inclusive of outstanding market value of TBA positions and exclusive of consolidated VIEs.

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.

Core Earnings (excluding PAA) and Core Earnings (excluding PAA) Per Average Common Share

Core earnings (excluding PAA) is defined as the sum of (a) economic net interest income, (b) TBA dollar roll income and CMBX coupon income, (c) realized amortization of MSRs, (d) other income (loss) (excluding depreciation expense related to commercial real estate and amortization of intangibles, non-core income allocated to equity method investments and other non-core 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-core 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. Core earnings (excluding PAA) per average common share is calculated by dividing core earnings (excluding PAA) by average basic common shares for the period.

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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.

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

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 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)

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). Debt issued by securitization vehicles, certain credit facilities (included within other secured financing) 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.

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.


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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

Federal Home Loan Banks (“FHLB”)

U.S. Government-sponsored banks that generally provide reliable liquidity to member financial institutions to support housing finance and community investment.

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, FHLB Des Moines advances and credit facilities. Average interest bearing liabilities is based on daily balances.

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.

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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 (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 and mortgages payable. Certain credit facilities (included within other secured financing), debt issued by securitization vehicles 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.


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 (“MSRs”)

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis


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.

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis

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.

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). Debt issued by securitization vehicles, certain credit facilities (included within other secured financing) 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.


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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis


T

Target Assets

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

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.

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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis


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.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES


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 September 30, 2020 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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 September 30, 2020, we were not party to any pending material legal proceedings.


ITEM 1A. RISK FACTORS

Other than the risk factors relating to the coronavirus disease 2019 disclosed in Item 1A. “Risk Factors” of our quarterly report on Form 10-Q for the quarter ended March 31, 2020, 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

On June 3, 2019 we announced that our Board of Directors authorized the repurchase of up to $1.5 billion of our outstanding common shares through December 31, 2020. The following table sets forth information with respect to this share repurchase program for the quarter ended September 30, 2020. All common shares were purchased in open-market transactions.


	Total Number of Shares Purchased	Average Price Paid Per Share (1)		The total number of shares purchased as part of publicly announced repurchase plans or programs	Maximum Dollar Value of Shares That May Yet Be Purchased Under The Plan (1)
				(dollars in thousands)
July 1, 2020 - July 31, 2020	4,825,000	$	6.50	4,825,000	$	1,102,158
Total	4,825,000			4,825,000

(1) Excludes commission costs.


ITEM 5. OTHER INFORMATION

None.


ITEM 6. EXHIBITS

Exhibits:

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

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES


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 September 30, 2020 (Unaudited) and December 31, 2019 (Derived from the audited Consolidated Statement of Financial Condition at December 31, 2019); (ii) Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the three and nine months ended September 30, 2020 and 2019; (iii) Consolidated Statements of Stockholders’ Equity (Unaudited) for the three and nine months ended September 30, 2020 and 2019; (iv) Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2020 and 2019; 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 September 30, 2020 (formatted in Inline XBRL and contained in Exhibit 101).

† Submitted electronically herewith.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

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:	November 5, 2020	By: /s/ David L. Finkelstein
		David L. Finkelstein
		Chief Executive Officer and Chief Investment Officer (Principal Executive Officer)

Dated:	November 5, 2020	By: /s/ Serena Wolfe
		Serena Wolfe
		Chief Financial Officer (Principal Financial Officer)

II-1