NLY Annaly Capital Management Inc

• GAAP net income of $730.9 million, $0.70 per average common share
• Core earnings of $0.29 per average common share, unchanged from prior quarteri
• Common stock book value per share of $11.83, up 3% from prior quarter
• Economic leverage of 6.1:1, unchanged from prior quarter
• Credit investment portfolio represents 22% of stockholders’ equity
• Successfully integrated $1.5 billion acquisition of Hatteras Financial Corp.

Annaly Capital Management, Inc. (NYSE:NLY) (the “Company” or “Annaly”) today announced its financial results for the quarter ended September 30, 2016.

“Our diversified investment strategy has proven that we can provide stable, durable earnings while protecting and opportunistically growing our book value. We believe Annaly has a platform for predictable results, as evidenced again in this most recent quarter,” commented Kevin Keyes, Chief Executive Officer and President. “In this world of low and negative yields, our broad menu of complementary investment alternatives, coupled with a prudent and rigorous capital allocation process, allow us to provide our shareholders with dependable and attractive returns.”

“As we progress toward year end and 2017,” Mr. Keyes continued, “we believe the investment landscape in our core Agency strategy will remain favorable and our three credit businesses, which have reached efficient scale, are uniquely positioned to take advantage of market inefficiencies and dislocations resulting from the impact of regulation and structural market changes.”

Financial Performance

The following table summarizes certain key performance indicators as of and for the quarters ended September 30, 2016, June 30, 2016, and September 30, 2015:

        For the quarters ended September 30, 2016     June 30, 2016     September 30, 2015 Book value per common share $11.83     $11.50     $11.99 Economic leverage at period-end (1) 6.1:1 6.1:1 5.8:1 GAAP net income (loss) per common share $0.70 ($0.32) ($0.68) Core earnings per common share* (2) $0.29 $0.29 $0.30 Annualized return (loss) on average equity 23.55% (9.60%) (20.18%) Annualized core return on average equity* 10.09% 9.73% 9.67% Net interest margin 1.40% 1.15% 1.27% Core net interest margin* (3) 1.42% 1.54% 1.65% Net interest spread 1.13% 0.80% 0.83% Core net interest spread* 1.15% 1.27% 1.29% Average yield on interest earning assets 2.70% 2.48% 2.48% Core average yield on interest earning assets* 2.72% 2.95% 2.94%   *   Represents a non-GAAP financial measure. Please refer to the ‘Non-GAAP Financial Measures’ section for additional information. (1) Computed as the sum of recourse debt, TBA derivative notional outstanding and net forward purchases of investments divided by total equity. Recourse debt consists of repurchase agreements, other secured financing and Convertible Senior Notes. Securitized debt, participation sold and mortgages payable are non-recourse to the Company and are excluded from this measure. (2) Core earnings is defined as net income (loss) excluding gains or losses on disposals of investments and termination of interest rate swaps, unrealized gains or losses on interest rate swaps and investments measured at fair value through earnings, net gains and losses on trading assets, impairment losses, net income (loss) attributable to noncontrolling interest, the premium amortization adjustment resulting from the quarter-over-quarter change in estimated long-term CPR, corporate acquisition related expenses and certain other non-recurring gains or losses, and inclusive of dollar roll income (a component of Net gains (losses) on trading assets) and realized amortization of MSRs (a component of net unrealized gains (losses) on investments measured at fair value through earnings). (3) Represents the sum of the Company’s annualized economic core net interest income (exclusive of the premium amortization adjustment (referred to herein as “PAA”) and inclusive of interest expense on interest rate swaps used to hedge cost of funds) plus TBA dollar roll income (less interest expense on swaps used to hedge dollar roll transactions) divided by the sum of its average interest earning assets plus average outstanding TBA derivative balances. PAA excludes the component of premium amortization representing the quarter-over-quarter change in estimated long-term constant prepayment rates (“CPR”). Average interest earning assets reflects the average amortized cost of our investments during the period. iRepresents a non-GAAP financial measure. Please refer to the ‘Non-GAAP Financial Measures’ section for additional information.

GAAP Earnings

The Company reported GAAP net income for the quarter ended September 30, 2016 of $730.9 million, or $0.70 per average common share, compared to a GAAP net loss of ($278.5) million, or ($0.32) per average common share, for the quarter ended June 30, 2016, and a GAAP net loss of ($627.5) million, or ($0.68) per average common share, for the quarter ended September 30, 2015. The increase in GAAP net income (loss) for the quarter ended September 30, 2016 compared to the quarters ended June 30, 2016 and September 30, 2015 is primarily due to favorable changes in realized and unrealized gains (losses) on interest rate swaps, net gains (losses) on trading assets and net unrealized gains on investments measured at fair value through earnings, as well as incremental net interest income earned on the assets acquired as part of the Company’s acquisition of Hatteras Financial Corp. (“Hatteras”) and the resulting bargain purchase gain, offset by transaction expenses, during the quarter ended September 30, 2016.

Core Earnings

The Company periodically reviews its use of non-GAAP financial measures to ensure only those measures relied upon by the Company’s management in assessing the financial performance of the business are disclosed. This review also considers regulatory interpretations and guidance. The Company believes these non-GAAP financial measures are useful for management, investors, analysts, and other interested parties in evaluating the Company’s performance but should not be viewed in isolation and are not a substitute for financial measurements computed in accordance with GAAP. Please refer to the “Non-GAAP Financial Measures” section for additional information including Non-GAAP reconciliations to GAAP.

Core earnings for the quarter ended September 30, 2016 were $312.9 million, or $0.29 per average common share, compared to $282.2 million, or $0.29 per average common share, for the quarter ended June 30, 2016, and $300.7 million, or $0.30 per average common share, for the quarter ended September 30, 2015. Core earnings increased for the quarter ended September 30, 2016 compared to the quarter ended June 30, 2016 on higher net interest income earned on the assets acquired as part of the Hatteras acquisition and higher TBA dollar roll income, which were offset by higher interest expense on repurchase agreements. Core earnings per average share remained unchanged for the quarter ended September 30, 2016 when compared to the quarter ended June 30, 2016 due to the additional common shares issued in connection with the Hatteras acquisition. Core earnings increased during the quarter ended September 30, 2016 compared to the quarter ended September 30, 2015 due to higher net interest income earned on the assets acquired as part of the Hatteras acquisition and higher interest income from the Company’s commercial investment portfolio, partially offset by a reduction in TBA dollar roll income and higher borrowing costs during the quarter ended September 30, 2016.

Net Interest Margin, Net Interest Spread, and Book Value

Net interest margin for the quarters ended September 30, 2016, June 30, 2016, and September 30, 2015 was 1.40%, 1.15% and 1.27%, respectively. Core net interest margin for the quarters ended September 30, 2016, June 30, 2016, and September 30, 2015 was 1.42%, 1.54% and 1.65%, respectively. For the quarter ended September 30, 2016, the average yield on interest earning assets was 2.70% and the average cost of interest bearing liabilities, including interest expense on interest rate swaps used to hedge cost of funds, was 1.57%, which resulted in a net interest spread of 1.13%. The average yield on interest earning assets for the quarter ended September 30, 2016 increased when compared to the quarters ended June 30, 2016 and September 30, 2015 due to differences in premium amortization expense on Residential Investment Securities resulting from changes in long-term CPR estimates. The decline in our average cost of interest bearing liabilities for the quarter ended September 30, 2016 when compared to the quarters ended June 30, 2016 and September 30, 2015 is primarily attributable to a reduction in interest expense on swaps, partially offset by higher balances on repurchase agreements during the quarter ended September 30, 2016.

For the quarter ended September 30, 2016, the core average yield on interest earning assets was 2.72%, which resulted in a core net interest spread of 1.15%. The core average yield on interest earning assets for the quarter ended September 30, 2016 decreased when compared to the quarters ended June 30, 2016 and September 30, 2015 primarily due to lower weighted average coupons on Residential Investment Securities and higher weighted average premium amortization expense, exclusive of the PAA, on Residential Investment Securities during the quarter ended September 30 2016.

At September 30, 2016, June 30, 2016, and September 30, 2015, the Company had a common stock book value per share of $11.83, $11.50 and $11.99, respectively.

Asset Portfolio

Residential Investment Securities

Residential Investment Securities, which are comprised of Agency mortgage-backed securities, Agency debentures, credit risk transfer securities and Non-Agency mortgage-backed securities, totaled $75.6 billion at September 30, 2016, compared to $66.6 billion at June 30, 2016 and $67.0 billion at September 30, 2015. The Company’s Residential Investment Securities portfolio at September 30, 2016 was comprised of 81% fixed-rate assets with the remainder constituting adjustable or floating-rate investments.

The total net premium balance on Residential Investment Securities at September 30, 2016, June 30, 2016, and September 30, 2015, was $4.9 billion, $4.6 billion, and $4.8 billion, respectively. The weighted average amortized cost basis of the Company’s non interest-only Residential Investment Securities at September 30, 2016, June 30, 2016, and September 30, 2015, was 104.9%, 105.0% and 105.3%, respectively. The weighted average amortized cost basis of the Company’s interest-only Residential Investment Securities at September 30, 2016, June 30, 2016, and September 30, 2015, was 15.9%, 15.8%, and 16.1%, respectively. The weighted average experienced CPR on our Agency mortgage-backed securities for the quarters ended September 30, 2016, June 30, 2016, and September 30, 2015, was 15.9%, 12.7% and 11.5%, respectively. The weighted average projected long-term CPR on our Agency mortgage-backed securities at September 30, 2016, June 30, 2016, and September 30, 2015, was 14.4%, 13.0% and 9.2%, respectively. The net increase in long-term CPRs is a result of the addition to the overall portfolio of ARM securities from the Hatteras acquisition.

During the quarter ended September 30, 2016, the Company disposed of $3.8 billion of Residential Investment Securities, resulting in a net realized gain of $14.7 million. During the quarter ended June 30, 2016, the Company disposed of $1.8 billion of Residential Investment Securities, resulting in a net realized gain of $11.9 million. During the quarter ended September 30, 2015, the Company disposed of $3.7 billion of Residential Investment Securities, resulting in a net realized gain of $4.5 million.

Amortization

In accordance with GAAP, the Company amortizes or accretes premiums or discounts into interest income for its Agency mortgage-backed securities, excluding interest-only securities, considering estimates of future principal prepayment in the calculation of the effective yield because they are probable and the timing and amount of prepayments can be reasonably estimated. 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 investment 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. The Company’s GAAP metrics include the unadjusted impact of amortization and accretion associated with this method. The Company’s non-GAAP metrics exclude the effect of the PAA, which quantifies the component of premium amortization representing the cumulative effect of quarter-over-quarter changes in estimated long-term CPR.

The following table illustrates the impact of quarter-over-quarter adjustments to long-term CPR estimates on premium amortization expense for the quarters ended September 30, 2016, June 30, 2016, and September 30, 2015:

      For the quarters ended September 30, 2016       June 30, 2016     September 30, 2015

 

   

(dollars in thousands)

    Premium amortization expense $ 213,241 $ 265,475 $ 255,123 Less: PAA cost (benefit)   3,891         85,583       83,136 Premium amortization expense exclusive of PAA $ 209,350       $ 179,892     $ 171,987     September 30, 2016       June 30, 2016     September 30, 2015

 

(per common share)

Premium amortization expense $ 0.21 $ 0.29 $ 0.27 Less: PAA cost (benefit)  

--

1

      0.10       0.09 Premium amortization expense exclusive of PAA $ 0.21       $ 0.19     $ 0.18 (1)   Rounds to less than $0.01 per common share.

TBA Contracts

At September 30, 2016, the Company had outstanding $16.0 billion in notional balances of TBA derivative positions. Realized and unrealized gains (losses) on TBA derivatives are recorded in Net gains (losses) on trading assets in the Company’s Consolidated Statements of Comprehensive Income (Loss). The following table summarizes certain characteristics of the Company’s TBA derivatives at September 30, 2016:

TBA Purchase Contracts     Notional     Implied Cost Basis     Implied Market Value     Net Carrying Value    

 

   

(dollars in thousands)

 

      Purchase contracts $ 15,950,000 $ 16,671,196 $ 16,730,009 $ 58,813  

Commercial Investments Portfolio

The Company’s commercial investments portfolio consists of commercial real estate debt and equity investments and corporate debt. Commercial real estate debt, which is comprised of preferred equity, AAA-rated commercial mortgage-backed securities, securitized loans of consolidated variable interest entities (“VIEs”) and loans held for sale totaled $5.5 billion at September 30, 2016 compared to $5.7 billion at June 30, 2016. Loans held for sale, net totaled $144.3 million at September 30, 2016, compared to $164.2 million at June 30, 2016. Investments in commercial real estate totaled $500.0 million at September 30, 2016, down slightly from $504.6 million at June 30, 2016. Corporate debt investments totaled $716.8 million as of September 30, 2016, up from $669.6 million at June 30, 2016. The weighted average levered return on commercial real estate debt and preferred equity, including loans held for sale, as of September 30, 2016, June 30, 2016, and September 30, 2015, was 8.26%, 8.25% and 7.36%, respectively. Excluding loans held for sale, the weighted average levered return on commercial real estate debt and preferred equity was 8.99%, 9.09% and 9.38% at September 30, 2016, June 30, 2016, and September 30, 2015, respectively. The weighted average levered returns on investments in commercial real estate equity as of September 30, 2016, June 30, 2016, and September 30, 2015, was 10.63%, 10.63% and 11.36%, respectively. The weighted average levered returns on investments in corporate debt as of September 30, 2016, June 30, 2016 and September 30, 2015, was 8.12%, 7.53% and 7.38% respectively.ii

iiJune 30, 2016 and September 30, 2015 represent unlevered returns.

During the third quarter 2016, the Company provided additional funding on pre-existing commercial real estate debt commitments totaling $15.2 million with a weighted average coupon of 8.4%. During the third quarter 2016, the Company received cash from its commercial real estate investments of $167.9 million from loan sales (including loans held for sale), partial pay-downs, prepayments and maturities with a weighted average coupon of 4.23%.

At September 30, 2016, June 30, 2016, and September 30, 2015, residential and commercial and corporate credit assets (including loans held for sale) comprised 22%, 24% and 22% of stockholders’ equity, respectively.

Capital and Funding

Leverage

At September 30, 2016, total stockholders’ equity was $13.3 billion. Leverage at September 30, 2016, June 30, 2016, and September 30, 2015, was 5.3:1, 5.3:1 and 4.8:1, respectively. For purposes of calculating the Company’s leverage ratio, debt consists of repurchase agreements, other secured financing, Convertible Senior Notes, securitized debt, participation sold and mortgages payable. Securitized debt, participation sold and mortgages payable are non-recourse to the Company. Economic leverage, which excludes non-recourse debt and includes other forms of financing such as TBA dollar roll transactions, was 6.1:1 at September 30, 2016, compared to 6.1:1 at June 30, 2016, and 5.8:1 at September 30, 2015.

Capital Ratio and Return on Equity

At September 30, 2016, June 30, 2016, and September 30, 2015, the Company’s capital ratio, which represents the ratio of stockholders’ equity to total assets (inclusive of total market value of TBA derivatives and exclusive of consolidated VIEs associated with B Piece commercial mortgage-backed securities), was 13.3%, 13.2%, and 14.0%, respectively. On a GAAP basis, the Company produced an annualized return (loss) on average equity for the quarters ended September 30, 2016, June 30, 2016, and September 30, 2015, of 23.55%, (9.60%) and (20.18%), respectively. On a core earnings basis, the Company provided an annualized return on average equity for the quarters ended September 30, 2016, June 30, 2016, and September 30, 2015, of 10.09%, 9.73%, and 9.67%, respectively.

Funding

At September 30, 2016, June 30, 2016, and September 30, 2015, the Company had outstanding $61.8 billion, $53.9 billion, and $56.4 billion of repurchase agreements, with weighted average remaining maturities of 128 days, 129 days, and 147 days, and with weighted average borrowing rates of 1.71%, 1.81%, and 1.75%, after giving effect to the Company’s interest rate swaps used to hedge cost of funds, respectively. The weighted average rate on repurchase agreements during the quarters ended September 30, 2016, June 30, 2016, and September 30, 2015, was 0.97%, 1.00%, and 0.73%, respectively. Included in these balances is a $350 million repurchase agreement credit facility for the Commercial Real Estate business. As of September 30, 2016, outstanding borrowings under the facility totaled $295.1 million with a weighted average borrowing rate of 2.87%.

At September 30, 2016 and June 30, 2016, the Company had outstanding $3.6 billion of advances from the Federal Home Loan Bank of Des Moines, with weighted average remaining maturities of 1,552 days and 1,644 days, respectively, and with weighted average borrowing rates of 0.65% and 0.60%, respectively.

The following table presents the principal balance and weighted average rate of repurchase agreements and FHLB advances by maturity at September 30, 2016:

Maturity     Principal Balance     Weighted Average Rate

 

   

(dollars in thousands)

    Within 30 days $ 26,508,338 0.99% 30 to 59 days 5,200,350 0.86% 60 to 89 days 6,173,598 0.85% 90 to 119 days 5,309,103 0.79% Over 120 days(1)   22,181,058     1.27% Total $ 65,372,447     1.04%    

(1)

Approximately 16% of the total repurchase agreements and FHLB advances have a remaining maturity over 1 year. The combined weighted average days to maturity for repurchase agreements and FHLB advances was 206 days.

The Company has access to a $300 million credit facility for the Middle Market Lending business. As of September 30, 2016, outstanding borrowings under the facility totaled $212.2 million with a weighted average borrowing rate of 3.27%.

The following table presents the principal balance, weighted average rate and weighted average days to maturity on outstanding debt at September 30, 2016:

          Weighted Average Principal Balance     Rate (3)     Days to Maturity (4)

 

(dollars in thousands)

    Repurchase agreements $ 61,784,121 0.97% 128 Other secured financing (1) 3,804,742 0.83% 1,560 Securitized debt of consolidated VIEs (2) 3,695,502 1.29% 2,434 Participation sold (2) 12,908 4.81% 213 Mortgages payable (2)   330,946

4.42%

2,881 Total indebtedness $ 69,628,219    

(1)

Comprised of advances from the Federal Home Loan Bank of Des Moines and other credit facilities.

(2)

Non-recourse to the Company.

(3)

Represents the quarterly average rate.

(4)

Determined based on estimated weighted-average lives of the underlying debt instruments.

Hedge Portfolio

At September 30, 2016, the Company had outstanding interest rate swaps with a net notional amount of $25.2 billion. Changes in the unrealized gains or losses on the interest rate swaps are reflected in the Company’s Consolidated Statements of Comprehensive Income (Loss). The Company enters into interest rate swaps to mitigate the risk of rising interest rates that affect the Company’s cost of funds or its TBA dollar roll transactions. As of September 30, 2016, the swap portfolio had a weighted average pay rate of 2.25%, a weighted average receive rate of 0.88% and a weighted average maturity of 6.89 years. There were no forward starting swaps at September 30, 2016.

The following table summarizes certain characteristics of the Company’s interest rate swaps at September 30, 2016:

Maturity     Current Notional (1)     Weighted Average Pay Rate     Weighted Average Receive Rate     Weighted Average Years to Maturity

 

       

(dollars in thousands)

        0 - 3 years $ 4,552,383 1.74% 0.76% 2.77 3 - 6 years 9,675,000 1.92% 0.88% 4.14 6 - 10 years 7,363,550 2.34% 0.98% 7.81 Greater than 10 years   3,634,400     3.70%     0.67%     18.62 Total / Weighted Average     $ 25,225,333     2.25%     0.88%     6.89

(1)

   

There were no forward starting swaps.

At September 30, 2016, the Company had entered into interest rate swaptions with a net notional amount of $0.8 billion. Changes in the unrealized gains or losses on the interest rate swaptions are reflected in the Company’s Consolidated Statements of Comprehensive Income (Loss). The interest rate swaptions provide the Company with the option to enter into an interest rate swap agreement for a specified notional amount, duration, and pay and receive rates.

The following table summarizes certain characteristics of the Company’s interest rate swaptions at September 30, 2016:

Current Underlying Notional   Weighted Average Underlying Pay Rate   Weighted Average Underlying Receive Rate   Weighted Average Underlying Years to Maturity   Weighted Average Months to Expiration

 

   

(dollars in thousands)

    Long $ 950,000 1.08% 3M LIBOR 2.24 2.77 Short $ (200,000 ) 3M LIBOR 1.54% 10.25 2.77  

The Company enters into U.S. Treasury and Eurodollar futures contracts to hedge a portion of its interest rate risk. The following table summarizes outstanding futures positions as of September 30, 2016:

    Notional - Long Positions     Notional - Short Positions     Weighted Average Years to Maturity (dollars in thousands)     2-year swap equivalent Eurodollar contracts $ -     $ (14,991,375) 2.00

U.S. Treasury futures - 5 year

  -       (1,247,200)     4.42 Total $ -     $ (16,238,575)     2.19

At September 30, 2016, June 30, 2016, and September 30, 2015, the Company’s hedge ratio was 52%, 49% and 57%, respectively. Our hedge ratio measures total notional balances of interest rate swaps, interest rate swaptions and futures relative to repurchase agreements, other secured financing and TBA notional outstanding.

Dividend Declarations

Common dividends declared for each of the quarters ended September 30, 2016, June 30, 2016, and September 30, 2015, were $0.30 per common share. The annualized dividend yield on the Company’s common stock for the quarter ended September 30, 2016, based on the September 30, 2016 closing price of $10.50, was 11.43%, compared to 10.84% for the quarter ended June 30, 2016, and 12.16% for the quarter ended September 30, 2015.

Key Metrics

The following table presents key metrics of the Company’s portfolio, liabilities and hedging positions, and performance as of and for the quarters ended September 30, 2016, June 30, 2016, and September 30, 2015:

    For the quarters ended September 30, 2016     June 30, 2016     September 30, 2015

Portfolio Related Metrics:

        Fixed-rate Residential Investment Securities as a percentage of total Residential Investment Securities 81% 92% 93% Adjustable-rate and floating-rate Residential Investment Securities as a percentage of total Residential Investment Securities 19% 8% 7% Weighted average experienced CPR for the period 15.9% 12.7% 11.5% Weighted average projected long-term CPR at period end 14.4% 13.0% 9.2% Weighted average levered return on commercial real estate debt and preferred equity at period-end (1) 8.26% 8.25% 7.36% Weighted average levered return on investments in commercial real estate equity at period-end 10.63%     10.63%     11.36%  

Liabilities and Hedging Metrics:

Weighted average days to maturity on repurchase agreements outstanding at period-end 128 129 147 Hedge ratio (2) 52% 49% 57% Weighted average pay rate on interest rate swaps at period-end (3) 2.25% 2.28% 2.26% Weighted average receive rate on interest rate swaps at period-end (3) 0.88% 0.74% 0.42% Weighted average net rate on interest rate swaps at period-end (3) 1.37% 1.54% 1.84% Leverage at period-end (4) 5.3:1 5.3:1 4.8:1 Economic leverage at period-end (5) 6.1:1 6.1:1 5.8:1 Capital ratio at period-end 13.3%     13.2%     14.0%  

Performance Related Metrics:

Book value per common share $11.83 $11.50 $11.99 GAAP net income (loss) per common share $0.70 ($0.32) ($0.68) Core earnings per common share* $0.29 $0.29 $0.30 Annualized return (loss) on average equity 23.55% (9.60%) (20.18%) Annualized core return on average equity* 10.09% 9.73% 9.67% Net interest margin 1.40% 1.15% 1.27% Core net interest margin* 1.42% 1.54% 1.65% Average yield on interest earning assets (6) 2.70% 2.48% 2.48% Core average yield on interest earning assets *(6) 2.72% 2.95% 2.94% Average cost of interest bearing liabilities (7) 1.57% 1.68% 1.65% Net interest spread 1.13% 0.80% 0.83% Core net interest spread* 1.15%     1.27%     1.29% *   Represents a non-GAAP financial measure. Please refer to the ‘Non-GAAP Financial Measures’ section for additional information.

(1)

Includes loans held for sale. Excluding loans held for sale, the weighted average levered return on commercial real estate debt and preferred equity was 8.99%, 9.09% and 9.38% at September 30, 2016, June 30, 2016, and September 30, 2015, respectively.

(2)

Measures total notional balances of interest rate swaps, interest rate swaptions and futures relative to repurchase agreements, other secured financing and TBA notional outstanding.

(3)

Excludes forward starting swaps.

(4)

Debt consists of repurchase agreements, other secured financing, Convertible Senior Notes, securitized debt, participation sold and mortgages payable. Securitized debt, participation sold and mortgages payable are non-recourse to the Company.

(5)

Computed as the sum of recourse debt, TBA derivative notional outstanding and net forward purchases of investments divided by total equity.

(6)

Average interest earning assets reflects the average amortized cost of our investments during the period.

(7)

Includes interest expense on interest rate swaps used to hedge cost of funds.

Other Information

This news release and our public documents to which we refer 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, 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 financings; 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 mortgage credit 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 mortgage servicing rights and ownership of a servicer; any potential business disruption following the acquisition of Hatteras; our ability to consummate any contemplated investment opportunities; changes in government regulations affecting our business; our ability to maintain our qualification as a REIT; and our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended. 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 any subsequent Quarterly Reports 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, except as required by law.

Annaly’s principal business objectives are to generate net income for distribution to its shareholders from its investments and capital preservation. Annaly is a Maryland corporation that has elected to be taxed as a real estate investment trust (“REIT”). Annaly is managed and advised by Annaly Management Company LLC.

The Company prepares a supplemental investor presentation and a financial summary for the benefit of its shareholders. Both the Third Quarter 2016 Investor Presentation and the Third Quarter 2016 Financial Summary can be found at the Company’s website (www.annaly.com) in the Investors section under Investor Presentations.

Conference Call

The Company will hold the third quarter 2016 earnings conference call on November 3, 2016 at 10:00 a.m. Eastern Time. The number to call is 888-317-6003 for domestic calls and 412-317-6061 for international calls. The conference passcode is 2832295. There will also be an audio webcast of the call on www.annaly.com. The replay of the call is available for one week following the conference call. The replay number is 877-344-7529 for domestic calls and 412-317-0088 for international calls and the conference passcode is 10095019. If you would like to be added to the e-mail distribution list, please visit www.annaly.com, click on Investors, then select Email Alerts and complete the email notification form.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (dollars in thousands, except per share data)             For the quarters ended September 30, June 30, March 31, December 31, September 30, 2016 2016 2016

20151

2015 (Unaudited)   (Unaudited)   (Unaudited)       (Unaudited) ASSETS   Cash and cash equivalents $ 2,382,188 $ 2,735,250 $ 2,416,136 $ 1,769,258 $ 2,237,423 Investments, at fair value: Agency mortgage-backed securities 73,476,105 64,862,992 65,439,824 65,718,224 65,806,640 Agency debentures - - 157,035 152,038 413,115 Credit risk transfer securities 669,295 520,321 501,167 456,510 330,727 Non-Agency mortgage-backed securities 1,460,261 1,197,549 1,157,507 906,722 490,037 Residential mortgage loans (2) 310,148 - - - - Mortgage servicing rights 492,169 - - - - Commercial real estate debt investments (3) 4,319,077 4,361,972 4,401,725 2,911,828 2,881,659 Commercial real estate debt and preferred equity, held for investment (4) 1,070,197 1,137,971 1,177,468 1,348,817 1,316,595 Commercial loans held for sale, net 144,275 164,175 278,600 278,600 476,550 Investments in commercial real estate 500,027 504,605 527,786 535,946 301,447 Corporate debt 716,831 669,612 639,481 488,508 424,974 Interest rate swaps, at fair value 113,253 146,285 93,312 19,642 39,295 Other derivatives, at fair value 87,921 137,490 77,449 22,066 87,516 Receivable for investments sold 493,839 697,943 2,220 121,625 127,571 Accrued interest and dividends receivable 260,583 227,225 232,180 231,336 228,169 Receivable for investment advisory income - - - - 3,992 Other assets 301,419 237,959 234,407 119,422 67,738 Goodwill 71,815 71,815 71,815 71,815 71,815 Intangible assets, net   39,903       43,306       35,853       38,536       33,424   Total assets $ 86,909,306     $ 77,716,470     $ 77,443,965     $ 75,190,893     $ 75,338,687     LIABILITIES AND STOCKHOLDERS’ EQUITY   Liabilities: Repurchase agreements $ 61,784,121 $ 53,868,385 $ 54,448,141 $ 56,230,860 $ 56,449,364 Other secured financing 3,804,742 3,588,326 3,588,326 1,845,048 359,970 Securitized debt of consolidated VIEs (5) 3,712,821 3,748,289 3,802,682 2,540,711 2,553,398 Participation sold 12,976 13,079 13,182 13,286 13,389 Mortgages payable 327,632 327,643 334,765 334,707 166,697 Interest rate swaps, at fair value 2,919,492 3,208,986 2,782,961 1,677,571 2,160,350 Other derivatives, at fair value 73,445 154,017 69,171 49,963 113,626 Dividends payable 269,111 277,479 277,456 280,779 284,348 Payable for investments purchased 454,237 746,090 250,612 107,115 744,378 Accrued interest payable 173,320 159,435 163,983 151,843 145,554 Accounts payable and other liabilities   115,606       62,868       54,679       53,088       63,280   Total liabilities   73,647,503       66,154,597       65,785,958       63,284,971       63,054,354     Stockholders’ Equity: 7.875% Series A Cumulative Redeemable Preferred Stock:

7,412,500 authorized, issued and outstanding

177,088 177,088 177,088 177,088 177,088 7.625% Series C Cumulative Redeemable Preferred Stock

12,650,000 authorized, 12,000,000 issued and outstanding

290,514 290,514 290,514 290,514 290,514 7.50% Series D Cumulative Redeemable Preferred Stock:

18,400,000 authorized, issued and outstanding

445,457 445,457 445,457 445,457 445,457 7.625% Series E Cumulative Redeemable Preferred Stock:

11,500,000 authorized, issued and outstanding

287,500 - - - -

Common stock, par value $0.01 per share, 1,945,437,500, 1,956,937,500,1,956,937,500, 1,956,937,500 and 1,956,937,500 authorized, 1,018,857,866,924,929,607, 924,853,133, 935,929,561 and 947,826,176 issued andoutstanding, respectively

10,189 9,249 9,249 9,359 9,478 Additional paid-in capital 15,578,677 14,575,426 14,573,760 14,675,768 14,789,320 Accumulated other comprehensive income (loss) 1,119,677 1,117,046 640,366 (377,596 ) 262,855 Accumulated deficit   (4,655,440 )     (5,061,565 )     (4,487,982 )     (3,324,616 )     (3,695,884 ) Total stockholders’ equity 13,253,662 11,553,215 11,648,452 11,895,974 12,278,828 Noncontrolling interest   8,141       8,658       9,555       9,948       5,505   Total equity   13,261,803       11,561,873       11,658,007       11,905,922       12,284,333   Total liabilities and equity $ 86,909,306     $ 77,716,470     $ 77,443,965     $ 75,190,893     $ 75,338,687   (1)     Derived from the audited consolidated financial statements at December 31, 2015. (2)

Includes securitized mortgage loans of a consolidated VIE carried at fair value of $176.7 million at September 30, 2016.

(3)

Includes senior securitized commercial mortgage loans of consolidated VIEs with a carrying value of $4.0 billion, $4.0 billion, $4.0 billion, $2.6 billion and $2.6 billion at September 30, 2016, June 30, 2016, March 31, 2016, December 31, 2015 and September 30, 2015, respectively.

(4) Includes senior securitized commercial mortgage loans of consolidated VIE with a carrying value of $128.9 million, $187.2 million, $211.9 million, $262.7 million and $314.9 million at September 30, 2016, June 30, 2016, March 31, 2016, December 31, 2015 and September 30, 2015, respectively. (5) Includes securitized debt of consolidated VIEs carried at fair value of $3.7 billion, $3.7 billion, $3.7 billion, $2.4 billion and $2.4 billion at September 30, 2016, June 30, 2016, March 31, 2016, December 31, 2015 and September 30, 2015, respectively. ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED) (dollars in thousands, except per share data)             For the quarters ended September 30, June 30, March 31, December 31, September 30, 2016     2016     2016     2015     2015   Interest income $ 558,668 $ 457,118 $ 388,143 $ 576,580 $ 450,726 Interest expense   174,154       152,755       147,447       118,807       110,297   Net interest income   384,514       304,363       240,696       457,773       340,429   Realized and unrealized gains (losses): Realized gains (losses) on interest rate swaps(1) (124,572 ) (130,762 ) (147,475 ) (159,487 ) (162,304 ) Realized gains (losses) on termination of interest rate swaps 1,337 (60,064 ) - - - Unrealized gains (losses) on interest rate swaps   256,462       (373,220 )     (1,031,720 )     463,126       (822,585 ) Subtotal   133,227       (564,046 )     (1,179,195 )     303,639       (984,889 ) Net gains (losses) on disposal of investments 14,447 12,535 (1,675 ) (7,259 ) (7,943 ) Net gains (losses) on trading assets 162,981 81,880 125,189 42,584 108,175 Net unrealized gains (losses) on investments measured at fair value through earnings 29,675 (54,154 ) 128 (62,703 ) (24,501 ) Bargain purchase gain   72,576       -       -       -       -   Subtotal   279,679       40,261       123,642       (27,378 )     75,731   Total realized and unrealized gains (losses)   412,906       (523,785 )     (1,055,553 )     276,261       (909,158 ) Other income (loss): Investment advisory income - - - - 3,780 Other income (loss)   29,271       (9,930 )     (6,115 )     (10,447 )     (13,455 ) Total other income (loss)   29,271       (9,930 )     (6,115 )     (10,447 )     (9,675 ) General and administrative expenses: Compensation and management fee 38,709 36,048 36,997 37,193 37,450 Other general and administrative expenses   59,028       13,173       10,948       10,643       12,007   Total general and administrative expenses   97,737       49,221       47,945       47,836       49,457   Income (loss) before income taxes 728,954 (278,573 ) (868,917 ) 675,751 (627,861 ) Income taxes   (1,926 )     (76 )     (837 )     6,085       (370 ) Net income (loss) 730,880 (278,497 ) (868,080 ) 669,666 (627,491 ) Net income (loss) attributable to noncontrolling interest   (336 )     (385 )     (162 )     (373 )     (197 ) Net income (loss) attributable to Annaly 731,216 (278,112 ) (867,918 ) 670,039 (627,294 ) Dividends on preferred stock   22,803       17,992       17,992       17,992       17,992   Net income (loss) available (related) to common stockholders $ 708,413     $ (296,104 )   $ (885,910 )   $ 652,047     $ (645,286 ) Net income (loss) per share available (related) to common stockholders: Basic $ 0.70     $ (0.32 )   $ (0.96 )   $ 0.69     $ (0.68 ) Diluted $ 0.70     $ (0.32 )   $ (0.96 )   $ 0.69     $ (0.68 ) Weighted average number of common shares outstanding: Basic   1,007,607,893       924,887,316       926,813,588       945,072,058       947,795,500   Diluted   1,007,963,406       924,887,316       926,813,588       945,326,098       947,795,500   Net income (loss) $ 730,880     $ (278,497 )   $ (868,080 )   $ 669,666     $ (627,491 ) Other comprehensive income (loss): Unrealized gains (losses) on available-for-sale securities 18,237 483,930 1,017,707 (648,106 ) 609,725 Reclassification adjustment for net (gains) losses included in net income (loss)   (15,606 )     (7,250 )     255       7,655       8,095   Other comprehensive income (loss)   2,631       476,680       1,017,962       (640,451 )     617,820   Comprehensive income (loss) 733,511 198,183 149,882 29,215 (9,671 ) Comprehensive income (loss) attributable to noncontrolling interest   (336 )     (385 )     (162 )     (373 )     (197 ) Comprehensive income (loss) attributable to Annaly $ 733,847     $ 198,568     $ 150,044     $ 29,588     $ (9,474 ) (1)   Interest expense related to the Company’s interest rate swaps is recorded in Realized gains (losses) on interest rate swaps on the Consolidated Statements of Comprehensive Income.         ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED) (dollars in thousands, except per share data)   For the nine months ended September 30, September 30, 2016     2015 Net interest income: Interest income $ 1,403,929 $ 1,594,117 Interest expense   474,356         352,789   Net interest income   929,573         1,241,328   Realized and unrealized gains (losses): Realized gains (losses) on interest rate swaps(1) (402,809 ) (465,008 ) Realized gains (losses) on termination of interest rate swaps (58,727 ) (226,462 ) Unrealized gains (losses) on interest rate swaps   (1,148,478 )       (587,995 ) Subtotal   (1,610,014 )       (1,279,465 ) Net gains (losses) on disposal of investments 25,307 58,246 Net gains (losses) on trading assets 370,050 (12,961 ) Net unrealized gains (losses) on investments measured at fair value through earnings (24,351 ) (40,466 ) Bargain purchase gain 72,576 - Impairment of goodwill   -         (22,966 ) Subtotal   443,582         (18,147 ) Total realized and unrealized gains (losses)   (1,166,432 )       (1,297,612 ) Other income (loss): Investment advisory income - 24,848 Dividend income from affiliate - 8,636 Other income (loss)   13,226         (36,754 ) Total other income (loss)   13,226         (3,270 ) General and administrative expenses: Compensation and management fee 111,754 113,093 Other general and administrative expenses   83,149         39,311   Total general and administrative expenses   194,903         152,404   Income (loss) before income taxes (418,536 ) (211,958 ) Income taxes   (2,839 )       (8,039 ) Net income (loss) (415,697 ) (203,919 ) Net income (loss) attributable to noncontrolling interest   (883 )       (436 ) Net income (loss) attributable to Annaly (414,814 ) (203,483 ) Dividends on preferred stock   58,787         53,976   Net income (loss) available (related) to common stockholders $ (473,601 )     $ (257,459 ) Net income (loss) per share available (related) to common stockholders: Basic $ (0.50 )     $ (0.27 ) Diluted $ (0.50 )     $ (0.27 ) Weighted average number of common shares outstanding: Basic   953,301,855         947,732,735   Diluted   953,301,855         947,732,735   Net income (loss) $ (415,697 )     $ (203,919 ) Other comprehensive income (loss): Unrealized gains (losses) on available-for-sale securities 1,519,874 116,154 Reclassification adjustment for net (gains) losses included in net income (loss)   (22,601 )       (58,182 ) Other comprehensive income (loss)   1,497,273         57,972   Comprehensive income (loss) 1,081,576 (145,947 ) Comprehensive income (loss) attributable to noncontrolling interest   (883 )       (436 ) Comprehensive income (loss) attributable to Annaly $ 1,082,459       $ (145,511 ) (1)  

Interest expense related to the Company’s interest rate swaps is recorded in Realized gains (losses) on interest rate swaps on the Consolidated Statements of Comprehensive Income.

Non-GAAP Financial Measures

To supplement its consolidated financial statements, which are prepared and presented in accordance with U.S. generally accepted accounting principles (“GAAP”), the Company provides the following non-GAAP financial measures. These measures should not be considered a substitute for, or superior to, financial measures computed in accordance with GAAP.

 

• Core earnings
• Core earnings per common share;
• Annualized core return on average equity;
• Core interest income;
• Economic interest expense;

• Economic core net interest income;
• Core average yield on interest earning assets;
• Core net interest margin; and
• Core net interest spread

These non-GAAP measures provide additional detail to enhance investor understanding of the Company’s period-over-period operating performance and business trends, as well as for assessing the Company’s performance versus that of industry peers.

Additional information pertaining to the Company’s use of these non-GAAP financial measures, including discussion of how each such measure is useful to investors, and reconciliations to their most directly comparable GAAP results are provided below.

Core earnings, core earnings per common share and annualized core return on average equity

One of the Company’s principal business objectives is to generate net income by earning a net interest spread on its investment portfolio, which is a function of the Company’s interest income from its investment portfolio less financing, hedging and operating costs. Core earnings, which is comprised of interest income plus TBA dollar roll income,iii less financing and hedging costsiv and general and administrative expenses, is used by management to measure its progress in achieving this objective. Accordingly, core earnings, includes MSR amortization and excludes gains and losses on disposals of investments and termination of interest rate swaps, unrealized gains and losses on interest rate swaps and investments measured at fair value through earnings, net gains and losses on trading assets, impairment losses, net income (loss) attributable to noncontrolling interest, the premium amortization adjustment and certain non-recurring gains and losses. The Company believes these measures provide management and investors with additional details regarding the Company’s 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 the Company’s portfolio. Annualized core return on average equity, which is calculated by dividing core earnings over average stockholders’ equity, provides investors with additional detail on the core earnings generated by the Company’s invested equity capital.

The following table presents a reconciliation of GAAP financial results to non-GAAP core earnings for the periods presented.

    For the quarters ended September 30, 2016   June 30, 2016   September 30, 2015

 

 

(dollars in thousands)

  GAAP net income (loss) $ 730,880 $ (278,497) $ (627,491) Less: Realized (gains) losses on termination of interest rate swaps (1,337) 60,064 - Unrealized (gains) losses on interest rate swaps (256,462) 373,220 822,585 Net (gains) losses on disposal of investments (14,447) (12,535) 7,943 Net (gains) losses on trading assets (162,981) (81,880) (108,175)

Net unrealized (gains) losses on investments measured at fair value throughearnings

(29,675) 54,154 24,501 Bargain purchase gain (72,576) - - Corporate acquisition related expenses (1) 46,724 2,163 - Net (income) loss attributable to noncontrolling interest 336 385 197 Premium amortization adjustment cost (benefit) 3,891 85,583 83,136 Plus: TBA dollar roll income (2) 90,174 79,519 98,041 MSR amortization (3)   (21,634)     -     - Core earnings* $ 312,893   $ 282,176   $ 300,737 GAAP net income (loss) per average common share $ 0.70   $ (0.32)   $ (0.68) Core earnings per average common share* $ 0.29   $ 0.29   $ 0.30

*

   

Represents a non-GAAP financial measure.

(1) Represents non-recurring transaction costs incurred in connection with the Company’s acquisition of Hatteras.

(2)

Represents a component of Net gains (losses) on trading assets.

(3)

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 investments measured at fair value.

iiiTBA dollar roll transactions are accounted for as derivatives, with gains and losses reflected as a component of Net gains (losses) on trading assets in the Company’s Consolidated Statements of Comprehensive Income (Loss). TBA dollar roll income represents the economic equivalent of interest income on the underlying security less the implied cost of financing. ivThe interest component of hedging costs are reported as realized gains (losses) on interest rate swaps in the Company’s Consolidated Statements of Comprehensive Income (Loss).

Core interest income, economic interest expense and economic core net interest income

Core interest income represents interest income excluding the effect of the premium amortization adjustment (“PAA”), and serves as the basis for deriving core average yield on interest bearing assets, core net interest spread and core net interest margin, which are discussed below. The Company believes this measure provides management and investors with additional detail to enhance their understanding of the Company’s 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 the Company’s Agency mortgage-backed securities (other than interest-only securities), which can obscure underlying trends in the performance of the portfolio.

Economic interest expense is comprised of interest expense, as computed in accordance with GAAP, plus interest expense on interest rate swaps used to hedge the cost of funds, which is a component of Realized gains (losses) on interest rate swaps in the Company’s Consolidated Statements of Comprehensive Income (Loss). The Company uses interest rate swaps to manage its exposure to changing interest rates on its repurchase agreements by economically hedging cash flows associated with these borrowings. Accordingly, adding the contractual interest payments on 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.

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

    For the quarters ended September 30, 2016   June 30, 2016   September 30, 2015

Core Interest Income Reconciliation

 

 

(dollars in thousands)

  GAAP interest income $ 558,668 $ 457,118 $ 450,726 Premium amortization adjustment   3,891     85,583     83,136 Core interest income* $ 562,559   $ 542,701   $ 533,862  

Economic Interest Expense Reconciliation

GAAP interest expense $ 174,154 $ 152,755 $ 110,297 Add: Interest expense on interest rate swaps used to hedge cost of funds   103,100     108,301     137,744 Economic interest expense* $ 277,254   $ 261,056   $ 248,041  

Economic Core Net Interest Income Reconciliation

Core interest income* $ 562,559 $ 542,701 $ 533,862 Less: Economic interest expense*   277,254     261,056     248,041 Economic core net interest income* $ 285,305   $ 281,645   $ 285,821

* Represents a non-GAAP financial measure.

Core average yield on interest earnings assets, core net interest margin and core net interest spread

Core net interest spread, which is the difference between the core average yield on interest earning assets and the average cost of interest bearing liabilities, and core net interest margin, which is calculated by dividing the economic core net interest income by average interest earning assets, provide management with additional measures of the Company’s 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 the Company’s performance.

    For the quarters ended September 30, 2016   June 30, 2016   September 30, 2015

Economic Core Metrics

 

 

(dollars in thousands)

  Core interest income* $ 562,559 $ 542,701 $ 533,862 Average interest earning assets $ 82,695,270 $ 73,587,753 $ 72,633,314 Core average yield on interest earning assets*   2.72%     2.95%     2.94% Economic interest expense* $ 277,254 $ 261,056 $ 248,041 Average interest bearing liabilities $ 70,809,712 $ 62,049,474 $ 59,984,298 Average cost of interest bearing liabilities   1.57%     1.68%     1.65% Core net interest spread*   1.15%     1.27%     1.29% Core net interest margin*   1.42%     1.54%     1.65%

* Represents a non-GAAP financial measure.

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