NLY Annaly Capital Management Inc

Annaly Capital Management, Inc. (NYSE: NLY) (the “Company” or “Annaly”) today announced its financial results for the quarter ended September 30, 2017.

Quarterly Financial Highlights

• GAAP net income was $367.3 million, $0.31 per average common share
• Core earnings (excluding PAA) were $353.5 million, $0.30 per average common share
• GAAP return on average equity was 10.98% and core return on average equity (excluding PAA) was 10.57%
• Book value per common share of $11.42, up from $11.19 at June 30, 2017
• Economic leverage increased to 6.9x, as compared to 6.4x at June 30, 2017
• Declared common stock dividend of $0.30 per share for the 16th consecutive fiscal quarter
• Annualized year-to-date economic return of 13.9%

Recent Business Highlights

• Raised $2.4 billion of equity capital in three separate offerings in July and October
• Equity issuances largely deployed towards Agency assets and select credit assets. Credit businesses comprise 23% of allocated capital at quarter end
• Redeemed 7.875% Series A Cumulative Redeemable Preferred Stock, resulting in 30 basis point reduction of economic cost of preferred capital
• Completed sale of Pingora Holdings L.P. while maintaining ownership interests in mortgage servicing rights
• Board of Directors appointed Chief Executive Officer and President Kevin Keyes as Chairman, effective January 1, 2018
• Expanding Board of Directors with addition of two new independent directors, Katie Beirne Fallon and Vicki Brinson Williams, effective January 1, 2018
• Established an investment partnership with Capital Impact Partners, a prominent community development financial institution

“Our third quarter financial performance again highlights the benefits of our large, diversified platform as we achieved growth in book value and generated stable earnings,” commented Kevin Keyes, Chief Executive Officer and President. “Our conservative and balanced investment strategies were further endorsed by the market as we successfully raised over $2.4 billion of new equity capital since the beginning of the quarter. Annaly remains uniquely positioned in an equity market where conservatively-valued, yield manufacturing businesses are increasingly difficult to find.”

Financial Performance

The following table summarizes certain key performance indicators as of and for the quarters ended September 30, 2017, June 30, 2017, and September 30, 2016:

          September 30, 2017   June 30, 2017   September 30, 2016 Book value per common share $11.42 $11.19 $11.83 Economic leverage at period-end (1) 6.9:1 6.4:1 6.1:1 GAAP net income (loss) per average common share (2) $0.31 ($0.01) $0.70 Annualized GAAP return (loss) on average equity 10.98% 0.46% 23.55% Net interest margin (3) 1.33% 1.23% 1.40% Average yield on interest earning assets (4) 2.79% 2.58% 2.70% Average cost of interest bearing liabilities (5) 1.82% 1.74% 1.57% Net interest spread 0.97% 0.84% 1.13%

Core Earnings Metrics:

Core earnings (excluding PAA) per average common share *(2)(6) $0.30 $0.30 $0.29 Core earnings per average common share *(2)(6) $0.26 $0.23 $0.29 PAA cost (benefit) per average common share $0.04 $0.07 $0.00 Annualized core return on average equity (excluding PAA) * 10.57% 10.54% 10.09% Net interest margin (excluding PAA) *(3) 1.47% 1.53% 1.42% Average yield on interest earning assets (excluding PAA) *(4) 2.97% 2.93% 2.72% Net interest spread (excluding PAA) * 1.15% 1.19% 1.15%   *   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, to-be-announced (“TBA”) derivative notional outstanding and net forward purchases of investments divided by total equity. Recourse debt consists of repurchase agreements and other secured financing. Securitized debt, participation sold and mortgages payable are non-recourse to the Company and are excluded from this measure. (2) Net of dividends on preferred stock, including cumulative and undeclared dividends on the Company’s Series F Preferred stock of $8.3 million for the quarter ended September 30, 2017. (3) Represents the sum of the Company’s annualized economic net interest income (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 TBA dollar roll transactions) divided by the sum of its average interest earning assets plus average outstanding TBA derivative balances. (4) Average yield on interest earning assets represents annualized interest income divided by average interest earning assets. Average interest earning assets reflects the average amortized cost of our investments during the period. Average yield on interest earning assets (excluding PAA) is calculated using annualized interest income (excluding PAA). (5) Includes interest expense on interest rate swaps used to hedge cost of funds. (6) 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, corporate acquisition related expenses and certain other non-recurring gains or losses, and inclusive of TBA 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). Core earnings (excluding PAA) excludes 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 the Company’s Agency mortgage-backed securities.  

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 financing; changes in the market value of our assets; changes in business conditions and the general economy; our ability to grow our commercial real estate business; our ability to grow our residential mortgage 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 mortgage servicing rights; our ability to consummate any contemplated investment opportunities; changes in government regulations and 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 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 is a leading diversified capital manager that invests in and finances residential and commercial assets. Annaly’s principal business objective is to generate net income for distribution to its stockholders through capital preservation, prudent selection of investments, and continuous management of its portfolio. Annaly has elected to be taxed as a real estate investment trust, or REIT, for federal income tax purposes. Annaly is externally managed by Annaly Management Company LLC. Additional information on the Company can be found at www.annaly.com.

The Company prepares a supplemental investor presentation and a financial summary for the benefit of its shareholders. Both the Third Quarter 2017 Investor Presentation and the Third Quarter 2017 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 2017 earnings conference call on November 2, 2017 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 8343484. There will also be an audio webcast of the call on www.annaly.com. The replay of the call will be 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 10113329. 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.

Financial Statements

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (dollars in thousands, except per share data)             September 30, June 30, March 31, December 31, September 30, 2017 2017 2017

2016(1)

2016 (Unaudited)   (Unaudited)   (Unaudited)       (Unaudited) ASSETS   Cash and cash equivalents (2) $ 867,840 $ 700,692 $ 819,421 $ 1,539,746 $ 2,382,188 Investments, at fair value: Agency mortgage-backed securities 85,889,131 73,963,998 72,708,490 75,589,873 73,476,105 Credit risk transfer securities 582,938 605,826 686,943 724,722 669,295 Non-Agency mortgage-backed securities 1,227,235 1,234,053 1,409,093 1,401,307 1,460,261 Residential mortgage loans (3) 895,919 779,685 682,416 342,289 310,148 Mortgage servicing rights 570,218 605,653 632,166 652,216 492,169 Commercial real estate debt investments (4) 3,869,110 3,972,560 4,102,613 4,321,739 4,319,077 Commercial real estate debt and preferred equity, held for investment (5) 981,748 928,181 985,091 970,505 1,070,197 Commercial loans held for sale, net - - - 114,425 144,275 Investments in commercial real estate 470,928 474,510 462,760 474,567 500,027 Corporate debt 856,110 773,957 841,265 773,274 716,831 Interest rate swaps, at fair value (2) 12,250 10,472 19,195 68,194 113,253 Other derivatives, at fair value 266,249 154,004 196,935 171,266 87,921 Receivable for investments sold 340,033 9,784 354,126 51,461 493,839 Accrued interest and dividends receivable 293,207 263,217 266,887 270,400 260,583 Other assets 353,708 399,456 388,224 333,063 301,419 Goodwill 71,815 71,815 71,815 71,815 71,815 Intangible assets, net   25,742       28,715       31,517       34,184       39,903   Total assets $ 97,574,181     $ 84,976,578     $ 84,658,957     $ 87,905,046     $ 86,909,306     LIABILITIES AND STOCKHOLDERS’ EQUITY   Liabilities: Repurchase agreements $ 69,430,268 $ 62,497,400 $ 62,719,087 $ 65,215,810 $ 61,784,121 Other secured financing 3,713,256 3,785,543 3,876,150 3,884,708 3,804,742 Securitized debt of consolidated VIEs (6) 3,357,929 3,438,675 3,477,059 3,655,802 3,712,821 Participation sold - - 12,760 12,869 12,976 Mortgages payable 311,886 311,810 311,707 311,636 327,632 Interest rate swaps, at fair value (2) 606,960 614,589 572,419 1,443,765 2,919,492 Other derivatives, at fair value 75,529 99,380 52,496 86,437 73,445 Dividends payable 326,425 305,709 305,691 305,674 269,111 Payable for investments purchased 5,243,868 1,043,379 340,383 65,041 454,237 Accrued interest payable 231,611 185,720 182,478 163,013 173,320 Accounts payable and other liabilities   121,231       84,948       161,378       184,319       115,606     Total liabilities   83,418,963       72,367,153       72,011,608       75,329,074       73,647,503     Stockholders’ Equity: 7.875% Series A Cumulative Redeemable Preferred Stock:

7,412,500 authorized, 0, 7,412,500, 7,412,500, 7,412,500, and 7,412,500 issued and outstanding, respectively

- 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

287,500 287,500 287,500 287,500 287,500 6.95% Series F Cumulative Redeemable Preferred Stock:

32,200,000 authorized, 28,800,000 issued and outstanding

696,910 - - - - Common stock, par value $0.01 per share, 1,917,837,500, 1,945,437,500, 1,945,437,500, 1,945,437,500, and 1,945,437,500 authorized, 1,088,083,794, 1,019,027,880, 1,018,971,441, 1,018,913,249, and 1,018,857,866 issued and outstanding, respectively 10,881 10,190 10,190 10,189 10,189 Additional paid-in capital 16,377,805 15,581,760 15,580,038 15,579,342 15,578,677 Accumulated other comprehensive income (loss) (640,149 ) (850,767 ) (1,126,091 ) (1,085,893 ) 1,119,677 Accumulated deficit   (3,320,160 )     (3,339,228 )     (3,024,670 )     (3,136,017 )     (4,655,440 )   Total stockholders’ equity 14,148,758 12,602,514 12,640,026 12,568,180 13,253,662   Noncontrolling interest   6,460       6,911       7,323       7,792       8,141     Total equity   14,155,218       12,609,425       12,647,349       12,575,972       13,261,803     Total liabilities and equity $ 97,574,181     $ 84,976,578     $ 84,658,957     $ 87,905,046     $ 86,909,306     (1)   Derived from the audited consolidated financial statements at December 31, 2016. (2) As a result of a change to a clearing organization’s rulebook effective January 3, 2017, beginning with the first quarter 2017 and in subsequent periods the Company is presenting the fair value of centrally cleared interest rate swaps net of variation margin pledged under such transactions. The variation margin was previously reported under cash and cash equivalents and is currently reported as a reduction to interest rate swaps, at fair value. Balances reported prior to the effective date will not be adjusted. (3) Includes securitized residential mortgage loans of a consolidated variable interest entity (“VIE”) carried at fair value of $139.8 million, $150.9 million, $155.6 million, $165.9 million and $176.7 million at September 30, 2017, June 30, 2017, March 31, 2017, December 31, 2016 and September 30, 2016, respectively. (4) Includes senior securitized commercial mortgage loans of consolidated VIEs with a carrying value of $3.6 billion, $3.7 billion, $3.7 billion, $3.9 billion and $4.0 billion at September 30, 2017, June 30, 2017, March 31, 2017, December 31, 2016 and September 30, 2016, respectively. (5) Includes senior securitized commercial mortgage loans of a consolidated VIE with a carrying value of $0, $0, $0, $0 and $128.9 million at September 30, 2017, June 30, 2017, March 31, 2017, December 31, 2016 and September 30, 2016, respectively. (6) Includes securitized debt of consolidated VIEs carried at fair value of $3.4 billion, $3.4 billion, $3.5 billion, $3.7 billion and $3.7 billion at September 30, 2017, June 30, 2017, March 31, 2017, December 31, 2016 and September 30, 2016, 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, 2017 2017 2017 2016 2016 Net interest income: Interest income $ 622,550 $ 537,426 $ 587,727 $ 807,022 $ 558,668 Interest expense   268,937     222,281     198,425     183,396     174,154   Net interest income   353,613     315,145     389,302     623,626     384,514     Realized and unrealized gains (losses): Realized gains (losses) on interest rate swaps (1) (88,211 ) (96,470 ) (104,156 ) (103,872 ) (124,572 ) Realized gains (losses) on termination of interest rate swaps - (58 ) - (55,214 ) 1,337 Unrealized gains (losses) on interest rate swaps   56,854     (177,567 )   149,184     1,430,668     256,462   Subtotal   (31,357 )   (274,095 )   45,028     1,271,582     133,227   Net gains (losses) on disposal of investments (11,552 ) (5,516 ) 5,235 7,782 14,447 Net gains (losses) on trading assets 154,208 (14,423 ) 319 (139,470 ) 162,981 Net unrealized gains (losses) on investments measured at fair value through earnings (67,492 ) 16,240 23,683 110,742 29,675 Bargain purchase gain   -     -     -     -     72,576   Subtotal   75,164     (3,699 )   29,237     (20,946 )   279,679   Total realized and unrealized gains (losses)   43,807     (277,794 )   74,265     1,250,636     412,906     Other income (loss) 28,282 30,865 31,646 30,918 29,271   General and administrative expenses: Compensation and management fee 41,993 38,938 39,262 39,845 38,709 Other general and administrative expenses   15,023     15,085     14,566     15,608     59,028   Total general and administrative expenses   57,016     54,023     53,828     55,453     97,737     Income (loss) before income taxes 368,686 14,193 441,385 1,849,727 728,954   Income taxes   1,371     (329 )   977     1,244     (1,926 )   Net income (loss) 367,315 14,522 440,408 1,848,483 730,880   Net income (loss) attributable to noncontrolling interest   (232 )   (102 )   (103 )   (87 )   (336 )   Net income (loss) attributable to Annaly 367,547 14,624 440,511 1,848,570 731,216   Dividends on preferred stock (2)   30,355     23,473     23,473     23,473     22,803     Net income (loss) available (related) to common stockholders $ 337,192   $ (8,849 ) $ 417,038   $ 1,825,097   $ 708,413     Net income (loss) per share available (related) to common stockholders: Basic $ 0.31   $ (0.01 ) $ 0.41   $ 1.79   $ 0.70   Diluted $ 0.31   $ (0.01 ) $ 0.41   $ 1.79   $ 0.70     Weighted average number of common shares outstanding: Basic   1,072,566,395     1,019,000,817     1,018,942,746     1,018,886,380     1,007,607,893   Diluted   1,073,040,637     1,019,000,817     1,019,307,379     1,019,251,111     1,007,963,406     Net income (loss) $ 367,315   $ 14,522   $ 440,408   $ 1,848,483   $ 730,880   Other comprehensive income (loss): Unrealized gains (losses) on available-for-sale securities 195,251 261,964 (59,615 ) (2,206,288 ) 18,237 Reclassification adjustment for net (gains) losses included in net income (loss)   15,367     13,360     19,417     718     (15,606 ) Other comprehensive income (loss)   210,618     275,324     (40,198 )   (2,205,570 )   2,631   Comprehensive income (loss) 577,933 289,846 400,210 (357,087 ) 733,511 Comprehensive income (loss) attributable to noncontrolling interest   (232 )   (102 )   (103 )   (87 )   (336 ) Comprehensive income (loss) attributable to Annaly 578,165 289,948 400,313 (357,000 ) 733,847 Dividends on preferred stock (2)   30,355     23,473     23,473     23,473     22,803   Comprehensive income (loss) attributable to common stockholders $ 547,810   $ 266,475   $ 376,840   $ (380,473 ) $ 711,044     (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. (2) Includes cumulative and undeclared dividends on the Company’s Series F Preferred stock of $8.3 million for the quarter ended September 30, 2017.     ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (dollars in thousands, except per share data) (Unaudited)       For the nine months ended September 30, September 30, 2017 2016     Net interest income: Interest income $ 1,747,703 $ 1,403,929 Interest expense   689,643     474,356   Net interest income   1,058,060     929,573     Realized and unrealized gains (losses): Realized gains (losses) on interest rate swaps (1) (288,837 ) (402,809 ) Realized gains (losses) on termination of interest rate swaps (58 ) (58,727 ) Unrealized gains (losses) on interest rate swaps   28,471     (1,148,478 ) Subtotal   (260,424 )   (1,610,014 ) Net gains (losses) on disposal of investments (11,833 ) 25,307 Net gains (losses) on trading assets 140,104 370,050 Net unrealized gains (losses) on investments measured at fair value through earnings (27,569 ) (24,351 ) Bargain purchase gain   -     72,576   Subtotal   100,702     443,582   Total realized and unrealized gains (losses)   (159,722 )   (1,166,432 )   Other income (loss) 90,793 13,226   General and administrative expenses: Compensation and management fee 120,193 111,754 Other general and administrative expenses   44,674     83,149   Total general and administrative expenses   164,867     194,903     Income (loss) before income taxes 824,264 (418,536 )   Income taxes   2,019     (2,839 )   Net income (loss) 822,245 (415,697 )   Net income (loss) attributable to noncontrolling interest   (437 )   (883 )   Net income (loss) attributable to Annaly 822,682 (414,814 )   Dividends on preferred stock (2)   77,301     58,787     Net income (loss) available (related) to common stockholders $ 745,381   $ (473,601 )   Net income (loss) per share available (related) to common stockholders: Basic $ 0.72   $ (0.50 ) Diluted $ 0.72   $ (0.50 )   Weighted average number of common shares outstanding: Basic   1,037,033,076     953,301,855   Diluted   1,037,445,177     953,301,855     Net income (loss) $ 822,245   $ (415,697 ) Other comprehensive income (loss): Unrealized gains (losses) on available-for-sale securities 397,600 1,519,874 Reclassification adjustment for net (gains) losses included in net income (loss)   48,144     (22,601 ) Other comprehensive income (loss)   445,744     1,497,273   Comprehensive income (loss) 1,267,989 1,081,576 Comprehensive income (loss) attributable to noncontrolling interest   (437 )   (883 ) Comprehensive income (loss) attributable to Annaly 1,268,426 1,082,459 Dividends on preferred stock (2)   77,301     58,787   Comprehensive income (loss) attributable to common stockholders $ 1,191,125   $ 1,023,672     (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. (2) Includes cumulative and undeclared dividends on the Company’s Series F Preferred stock of $8.3 million for the nine months ended September 30, 2017.  

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, 2017, June 30, 2017, and September 30, 2016:

         

September 30, 2017

  June 30, 2017  

September 30, 2016

Portfolio Related Metrics:

Fixed-rate Residential Investment Securities as a percentage of total Residential Investment Securities 89% 86% 81% Adjustable-rate and floating-rate Residential Investment Securities as a percentage of total Residential Investment Securities 11% 14% 19% Weighted average experienced CPR for the period 10.3% 10.9% 15.9% Weighted average projected long-term CPR at period-end 10.4%   10.6%   14.4%  

Liabilities and Hedging Metrics:

Weighted average days to maturity on repurchase agreements outstanding at period-end 65 88 128 Hedge ratio (1) 67% 67% 52% Weighted average pay rate on interest rate swaps at period-end (2) 2.27% 2.26% 2.25% Weighted average receive rate on interest rate swaps at period-end (2) 1.35% 1.28% 0.88% Weighted average net rate on interest rate swaps at period-end (2) 0.92% 0.98% 1.37% Leverage at period-end (3) 5.4:1 5.6:1 5.3:1 Economic leverage at period-end (4) 6.9:1 6.4:1 6.1:1 Capital ratio at period-end 12.3%   13.2%   13.3%  

Performance Related Metrics:

Book value per common share $11.42 $11.19 $11.83 GAAP net income (loss) per average common share (5) $0.31 ($0.01) $0.70 Annualized GAAP return (loss) on average equity 10.98% 0.46% 23.55% Net interest margin 1.33% 1.23% 1.40% Average yield on interest earning assets (6) 2.79% 2.58% 2.70% Average cost of interest bearing liabilities (7) 1.82% 1.74% 1.57% Net interest spread 0.97% 0.84% 1.13% Dividend declared per common share $0.30 $0.30 $0.30 Annualized dividend yield (8) 9.84% 9.96% 11.43% Core Earnings Metrics Core earnings (excluding PAA) per average common share *(5) $0.30 $0.30 $0.29 Core earnings per average common share *(5) $0.26 $0.23 $0.29 PAA cost (benefit) per average common share $0.04 $0.07 $0.00 Annualized core return on average equity (excluding PAA) * 10.57% 10.54% 10.09% Net interest margin (excluding PAA) * 1.47% 1.53% 1.42% Average yield on interest earning assets (excluding PAA) *(6) 2.97% 2.93% 2.72% Net interest spread (excluding PAA) * 1.15%   1.19%   1.15%   *   Represents a non-GAAP financial measure. Please refer to the ‘Non-GAAP Financial Measures’ section for additional information. (1) Measures total notional balances of interest rate swaps, interest rate swaptions and futures relative to repurchase agreements, other secured financing and TBA notional outstanding. (2) Excludes forward starting swaps. (3) Debt consists of repurchase agreements, other secured financing, securitized debt, participation sold and mortgages payable. Securitized debt, participation sold and mortgages payable are non-recourse to the Company. (4) Computed as the sum of recourse debt, TBA derivative notional outstanding and net forward purchases of investments divided by total equity. (5) Net of dividends on preferred stock, including cumulative and undeclared dividends on the Company’s Series F Preferred stock of $8.3 million for the quarter ended September 30, 2017. (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) Includes interest expense on interest rate swaps used to hedge cost of funds. (8) Based on the closing price of the Company’s common stock of $12.19, $12.05 and $10.50 at September 30, 2017, June 30, 2017 and September 30, 2016, respectively.  

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 measures:

• core earnings and core earnings (excluding PAA);
• core earnings and 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);
• 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 the Company’s results and operations, non-GAAP financial measures also have limitations. For example, the Company may calculate its non-GAAP metrics, such as core earnings or the PAA, differently than its 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 the Company 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 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.

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, 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. 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. Certain of the Company’s 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 CPR.

The following table illustrates the impact of the PAA on premium amortization expense for the Company’s Residential Investment Securities portfolio for the quarters ended September 30, 2017, June 30, 2017, and September 30, 2016:

          For the quarters ended September 30, 2017   June 30, 2017   September 30, 2016 (dollars in thousands) Premium amortization expense (accretion) $ 220,636 $ 251,084 $ 213,241 Less: PAA cost (benefit)   39,899     72,700     3,891 Premium amortization expense exclusive of PAA $ 180,737   $ 178,384   $ 209,350     For the quarters ended September 30, 2017   June 30, 2017   September 30, 2016 (per average common share) Premium amortization expense (accretion) $ 0.21 $ 0.25 $ 0.21 Less: PAA cost (benefit)   0.04     0.07     - Premium amortization expense exclusive of PAA $ 0.17   $ 0.18   $ 0.21  

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

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 incomei, less financing and hedging costsii and general and administrative expenses, and core earnings (excluding PAA), are used by management and, we believe, used by our analysts and investors, to measure its progress in achieving this objective.

The Company defines “core earnings”, a non-GAAP measure, 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, corporate acquisition related expenses and certain other non-recurring gains or losses, and inclusive of TBA 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). Core earnings (excluding PAA) excludes 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 the Company’s Agency mortgage-backed securities.

The Company believes these non-GAAP 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 (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 the Company’s invested equity capital.

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i TBA 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.

ii The interest component of hedging costs is reported as realized gains (losses) on interest rate swaps in the Company’s Consolidated Statements of Comprehensive Income (Loss).

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, 2017   June 30, 2017   September 30, 2016 (dollars in thousands, except per share data) GAAP net income (loss) $ 367,315   $ 14,522   $ 730,880 Less: Realized (gains) losses on termination of interest rate swaps - 58 (1,337 ) Unrealized (gains) losses on interest rate swaps (56,854 ) 177,567 (256,462 ) Net (gains) losses on disposal of investments 11,552 5,516 (14,447 ) Net (gains) losses on trading assets (154,208 ) 14,423 (162,981 ) Net unrealized (gains) losses on investments measured at fair value through earnings 67,492 (16,240 ) (29,675 ) Bargain purchase gain - - (72,576 ) Corporate acquisition related expenses (1) - - 46,724 Net (income) loss attributable to noncontrolling interest 232 102 336 Plus: TBA dollar roll income (2) 94,326 81,051 90,174 MSR amortization (3)   (16,208 )     (17,098 )     (21,634 ) Core earnings * 313,647 259,901 309,002 Less: Premium amortization adjustment cost (benefit)   39,899       72,700       3,891   Core earnings (excluding PAA) * $ 353,546     $ 332,601     $ 312,893     GAAP net income (loss) per average common share (4) $ 0.31     $ (0.01 )   $ 0.70   Core earnings per average common share *(4) $ 0.26     $ 0.23     $ 0.29   Core earnings (excluding PAA) per average common share *(4) $ 0.30     $ 0.30     $ 0.29     Annualized GAAP return (loss) on average equity   10.98 %     0.46 %     23.55 % Annualized core return on average equity (excluding PAA) *   10.57 %     10.54 %     10.09 %   *   Represents a non-GAAP financial measure. (1) Represents transaction costs incurred in connection with the Company’s acquisition of Hatteras Financial Corp. (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. (4) Net of dividends on preferred stock, including cumulative and undeclared dividends on the Company’s Series F Preferred stock of $8.3 million for the quarter ended September 30, 2017.  

From time to time, the Company enters 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. The Company records TBA derivatives at fair value on its Consolidated Statements of Financial Condition and recognizes periodic changes in fair value as Net gains (losses) on trading assets in the 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 trading assets in the Consolidated Statements of Comprehensive Income (Loss).

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 PAA, 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. 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 impact on prior periods, but not the current period, 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 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 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.

      For the quarters ended September 30, 2017   June 30, 2017   September 30, 2016 (dollars in thousands)

Interest Income (Excluding PAA) Reconciliation

    GAAP interest income $ 622,550 $ 537,426 $ 558,668 Premium amortization adjustment   39,899     72,700     3,891 Interest income (excluding PAA) * $ 662,449   $ 610,126   $ 562,559  

Economic Interest Expense Reconciliation

GAAP interest expense $ 268,937 $ 222,281 $ 174,154 Add: Interest expense on interest rate swaps used to hedge cost of funds   78,564     84,252     103,100 Economic interest expense * $ 347,501   $ 306,533   $ 277,254  

Economic Net Interest Income (Excluding PAA) Reconciliation

Interest income (excluding PAA) * $ 662,449 $ 610,126 $ 562,559 Less: Economic interest expense *   347,501     306,533     277,254 Economic net interest income (excluding PAA) * $ 314,948   $ 303,593   $ 285,305   * Represents a non-GAAP financial measure.  

Average yield on interest earning assets (excluding PAA), net interest spread (excluding PAA) and net interest margin (excluding PAA)

Net interest spread (excluding PAA), which is the difference between the average yield on interest earning assets (excluding PAA) and the average cost of interest bearing liabilities, and net interest margin (excluding PAA), which is calculated by dividing the economic net interest income (excluding PAA) by the sum of average interest earning assets and average TBA balances, 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, 2017

 

June 30, 2017

 

September 30, 2016

Economic Metrics (Excluding PAA)

(dollars in thousands) Interest income (excluding PAA) * $ 662,449   $ 610,126   $ 562,559 Average interest earning assets $ 89,253,094 $ 83,427,268 $ 82,695,270 Average yield on interest earning assets (excluding PAA) *   2.97 %     2.93 %     2.72 % Economic interest expense * $ 347,501 $ 306,533 $ 277,254 Average interest bearing liabilities $ 76,382,315 $ 70,486,779 $ 70,809,712 Average cost of interest bearing liabilities   1.82 %     1.74 %     1.57 % Net interest spread (excluding PAA) *   1.15 %     1.19 %     1.15 % Net interest margin (excluding PAA) *   1.47 %     1.53 %     1.42 %   * Represents a non-GAAP financial measure.

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Annaly Capital Management, Inc.Investor Relations1-888-8Annalywww.annaly.com