|
Repurchase Agreements
|
|
Reverse Repurchase Agreements
|
|
Average Daily
Amount
Outstanding
|
|
Ending Amount
Outstanding
|
|
Average Daily
Amount
Outstanding
|
|
Ending Amount
Outstanding
|
Three Months Ended:
|
(dollars in thousands)
|
September 30, 2017
|
$
|
69,314,576
|
|
|
$
|
69,430,268
|
|
|
$
|
994,565
|
|
|
$
|
—
|
|
June 30, 2017
|
63,191,827
|
|
|
62,497,400
|
|
|
474,176
|
|
|
—
|
|
March 31, 2017
|
64,961,511
|
|
|
62,719,087
|
|
|
1,738,333
|
|
|
—
|
|
December 31, 2016
|
64,484,326
|
|
|
65,215,810
|
|
|
1,064,130
|
|
|
—
|
|
September 30, 2016
|
63,231,246
|
|
|
61,784,121
|
|
|
1,494,022
|
|
|
—
|
|
June 30, 2016
|
54,647,175
|
|
|
53,868,385
|
|
|
1,159,341
|
|
|
—
|
|
March 31, 2016
|
55,753,041
|
|
|
54,448,141
|
|
|
1,294,505
|
|
|
—
|
|
December 31, 2015
|
57,483,870
|
|
|
56,230,860
|
|
|
214,674
|
|
|
—
|
|
September 30, 2015
|
57,102,712
|
|
|
56,449,364
|
|
|
931,522
|
|
|
—
|
|
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
At September 30, 2017, the repurchase agreements and other secured financing outstanding had weighted average remaining maturities of 122 days and the following remaining maturities and weighted average rates:
|
|
September 30, 2017
|
|
|
|
Principal Balance
|
|
|
Weighted
Average Rate
|
|
|
% of Total
|
|
|
|
(dollars in thousands)
|
|
1 day
|
|
$
|
—
|
|
|
|
—
|
|
|
|
—
|
|
2 to 29 days
|
|
|
33,176,429
|
|
|
|
1.34
|
%
|
|
|
45.4
|
%
|
30 to 59 days
|
|
|
6,588,239
|
|
|
|
1.34
|
%
|
|
|
9.0
|
%
|
60 to 89 days
|
|
|
15,873,458
|
|
|
|
1.39
|
%
|
|
|
21.7
|
%
|
90 to 119 days
|
|
|
3,306,328
|
|
|
|
1.40
|
%
|
|
|
4.5
|
%
|
Over 120 days
(1)
|
|
|
14,199,070
|
|
|
|
1.48
|
%
|
|
|
19.4
|
%
|
Total
|
|
$
|
73,143,524
|
|
|
|
1.38
|
%
|
|
|
100.0
|
%
|
(1) Approximately 8% of the total repurchase agreements and other secured financing had a remaining maturity over 1 year.
The table below presents our outstanding debt balances and associated weighted average rates and days to maturity at September 30, 2017:
|
|
|
|
|
Weighted Average Rate
|
|
|
|
|
|
|
Principal Balance
|
|
|
At Period
End
|
|
|
For the
Quarter
(3)
|
|
|
Weighted Average
Days to Maturity
|
|
|
|
(dollars in thousands)
|
|
Repurchase agreements
|
|
$
|
69,430,268
|
|
|
|
1.38
|
%
|
|
|
1.34
|
%
|
|
|
65
|
|
Other secured financing
(1)
|
|
|
3,713,256
|
|
|
|
1.49
|
%
|
|
|
1.63
|
%
|
|
|
1,190
|
|
Securitized debt of consolidated VIEs
(2)
|
|
|
3,287,374
|
|
|
|
1.87
|
%
|
|
|
1.92
|
%
|
|
|
2,150
|
|
Mortgages payable
(2)
|
|
|
314,811
|
|
|
|
4.24
|
%
|
|
|
4.34
|
%
|
|
|
2,661
|
|
Total indebtedness
|
|
$
|
76,745,709
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Includes advances from the Federal Home Loan Bank of Des Moines of $3.6 billion and financing under credit facilities.
(2) Non-recourse to Annaly.
(3) Determined based on estimated weighted-average lives of the underlying debt instruments.
Excess Liquidity
Our primary source of liquidity is the availability of unencumbered assets which may be provided as collateral to support additional funding needs. We target minimum thresholds of available, unencumbered assets to maintain excess liquidity. The following table illustrates our asset portfolio available to support potential collateral obligations and funding needs.
Assets are considered encumbered if pledged as collateral against an existing liability, and therefore no longer available to support additional funding. An asset is considered unencumbered if it has not been pledged or securitized. The following table also provides the carrying amount of our encumbered and unencumbered financial assets at September 30, 2017:
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
|
|
Encumbered
Assets
|
|
|
Unencumbered
Assets
|
|
|
Total
|
|
|
|
(dollars in thousands)
|
|
Financial Assets:
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
689,290
|
|
|
$
|
178,550
|
|
|
$
|
867,840
|
|
Investments, at carrying value:
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency mortgage-backed securities
|
|
|
74,711,243
|
|
|
|
6,942,159
|
|
|
|
81,653,402
|
|
Credit risk transfer securities
|
|
|
251,077
|
|
|
|
313,314
|
|
|
|
564,391
|
|
Non-Agency mortgage-backed securities
|
|
|
670,425
|
|
|
|
555,237
|
|
|
|
1,225,662
|
|
Residential mortgage loans
|
|
|
723,705
|
|
|
|
172,214
|
|
|
|
895,919
|
|
MSRs
|
|
|
2,693
|
|
|
|
567,525
|
|
|
|
570,218
|
|
Commercial real estate debt investments
|
|
|
3,866,629
|
|
|
|
2,481
|
|
|
|
3,869,110
|
|
Commercial real estate debt and preferred equity, held for investment
|
|
|
482,822
|
|
|
|
498,926
|
|
|
|
981,748
|
|
Corporate debt
|
|
|
432,460
|
|
|
|
423,650
|
|
|
|
856,110
|
|
Total financial assets
|
|
$
|
81,830,344
|
|
|
$
|
9,654,056
|
|
|
$
|
91,484,400
|
|
(1) The amounts reflected in the table above are on a settlement date basis and may differ from the total positions reported on the Consolidated Statements of Financial Condition.
We maintain liquid assets in order to satisfy our current and future obligations in normal and stressed operating environments. These are held as the primary means of liquidity risk mitigation. The composition of our liquid assets is considered as well and is subject to certain parameters. The composition is monitored for concentration risk and asset type. We believe the assets we consider liquid can be readily converted into cash, through liquidation or by being used as collateral in
financing arrangements (including as additional collateral to support existing financial arrangements). Our balance sheet also generates liquidity on an on-going basis through mortgage principal and interest repayments and net earnings held prior to payment of dividends. The following table presents our liquid assets as a percentage of total assets at September 30, 2017.
Liquid Assets
|
|
Carrying Value
(1)
|
|
|
|
(dollars in thousands)
|
|
Cash and cash equivalents
|
|
$
|
867,840
|
|
Residential Investment Securities
(2)
|
|
|
83,443,455
|
|
Residential mortgage loans
|
|
|
895,919
|
|
Commercial real estate debt investments
(3)
|
|
|
290,479
|
|
Commercial real estate debt and preferred equity, held for investment
|
|
|
612,860
|
|
Corporate debt
|
|
|
657,612
|
|
Total liquid assets
|
|
$
|
86,768,165
|
|
Percentage of liquid assets to carrying amount of encumbered and unencumbered financial assets
(3)
|
|
|
98.71
|
%
|
(1) Carrying value approximates the market value of assets. The assets listed in this table include $78.2 billion of assets that have been pledged as collateral against existing liabilities at September 30, 2017. Please refer to the Encumbered and Unencumbered Assets table for related information.
(2) The amounts reflected in the table above are on a settlement date basis and may differ from the total positions reported on the Consolidated Statements of Financial Condition.
(3) Excludes senior securitized commercial mortgage loans of consolidated VIEs carried at fair value of $3.6 billion.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Maturity Profile
We consider the profile of our assets, liabilities and derivatives when managing both liquidity risk as well as investment/market risk employing a measurement of both the maturity gap and interest rate gap.
We determine the amount of liquid assets that are required to be held by monitoring several liquidity metrics. We utilize several modeling techniques to analyze our current and potential obligations including the expected cash flows from our assets, liabilities and derivatives. The following table illustrates the expected final maturities and cash flows of our assets, liabilities and derivatives. The table is based on a static portfolio and assumes no reinvestment of asset cash flows and no future liabilities are entered into. In assessing the maturity of our assets, liabilities and off balance sheet obligations, we use the stated maturities, or our prepayment expectations for assets that exhibit prepayment characteristics. Cash and cash equivalents are included in the ‘Less than 3 Months’ maturity bucket, as they are typically held for a short period of time.
With respect to each maturity bucket, our maturity gap is considered negative when the amount of maturing liabilities exceeds the amount of maturing assets. A negative gap increases our liquidity risk as we must enter into future liabilities.
Our interest rate sensitivity gap is the difference between Interest Earning Assets and Interest Bearing Liabilities maturing or re-pricing within a given time period. Unlike the calculation of maturity gap, interest rate sensitivity gap includes the effect of our interest rate swaps. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities. A gap is considered negative when the amount of interest-rate sensitive liabilities exceeds interest-rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if assets and liabilities were perfectly matched in each maturity category. The amount of assets and liabilities utilized to compute our interest rate sensitivity gap was determined in accordance with the contractual terms of the assets and liabilities, except that adjustable-rate loans and securities are included in the period in which their interest rates are first scheduled to adjust and not in the period in which they mature. The effects of interest rate swaps, which effectively lock in our financing costs for a longer term, are also reflected in our interest rate sensitivity gap. The interest rate sensitivity of our assets and liabilities in the following table at September 30, 2017 could vary substantially based on actual prepayment experience.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
|
|
Less than 3
Months
|
|
|
3-12 Months
|
|
|
More than 1 Year
to 3 Years
|
|
|
3 Years and Over
|
|
|
Total
|
|
Financial Assets:
|
|
(dollars in thousands)
|
|
Cash and cash equivalents
|
|
$
|
867,840
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
867,840
|
|
Agency mortgage-backed securities (principal)
|
|
|
1,193,505
|
|
|
|
—
|
|
|
|
874,164
|
|
|
|
78,806,500
|
|
|
|
80,874,169
|
|
Credit risk transfer securities (principal)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
534,608
|
|
|
|
534,608
|
|
Non-Agency mortgage-backed securities (principal)
|
|
|
14,841
|
|
|
|
60,199
|
|
|
|
220,965
|
|
|
|
978,866
|
|
|
|
1,274,871
|
|
Residential mortgage loans (principal)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
878,574
|
|
|
|
878,574
|
|
Commercial real estate debt investments (principal)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3,808,225
|
|
|
|
3,808,225
|
|
Corporate debt (principal)
|
|
|
—
|
|
|
|
—
|
|
|
|
23,132
|
|
|
|
844,979
|
|
|
|
868,111
|
|
Commercial real estate debt and preferred equity (principal)
|
|
|
157,384
|
|
|
|
249,389
|
|
|
|
464,613
|
|
|
|
114,232
|
|
|
|
985,618
|
|
Total financial assets - maturity
|
|
|
2,233,570
|
|
|
|
309,588
|
|
|
|
1,582,874
|
|
|
|
85,965,984
|
|
|
|
90,092,016
|
|
Effect of utilizing reset dates
(1)
|
|
|
6,807,440
|
|
|
|
2,052,723
|
|
|
|
2,095,171
|
|
|
|
(10,955,334
|
)
|
|
|
|
|
Total financial assets - interest rate sensitive
|
|
$
|
9,041,010
|
|
|
$
|
2,362,311
|
|
|
$
|
3,678,045
|
|
|
$
|
75,010,650
|
|
|
$
|
90,092,016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase agreements
|
|
$
|
55,638,126
|
|
|
$
|
11,834,900
|
|
|
$
|
1,957,242
|
|
|
$
|
—
|
|
|
$
|
69,430,268
|
|
Other secured financing
|
|
|
6,886
|
|
|
|
—
|
|
|
|
91,885
|
|
|
|
3,614,485
|
|
|
|
3,713,256
|
|
Securitized debt of consolidated VIE (principal)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3,287,374
|
|
|
|
3,287,374
|
|
Total financial liabilities - maturity
|
|
|
55,645,012
|
|
|
|
11,834,900
|
|
|
|
2,049,127
|
|
|
|
6,901,859
|
|
|
|
76,430,898
|
|
Effect of utilizing reset dates
(1)(2)
|
|
|
(19,626,228
|
)
|
|
|
(4,300,192
|
)
|
|
|
6,600,208
|
|
|
|
17,326,212
|
|
|
|
|
|
Total financial liabilities - interest rate sensitive
|
|
$
|
36,018,784
|
|
|
$
|
7,534,708
|
|
|
$
|
8,649,335
|
|
|
$
|
24,228,071
|
|
|
$
|
76,430,898
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Maturity gap
|
|
$
|
(53,411,442
|
)
|
|
$
|
(11,525,312
|
)
|
|
$
|
(466,253
|
)
|
|
$
|
79,064,125
|
|
|
$
|
13,661,118
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative maturity gap
|
|
$
|
(53,411,442
|
)
|
|
$
|
(64,936,754
|
)
|
|
$
|
(65,403,007
|
)
|
|
$
|
13,661,118
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate sensitivity gap
|
|
$
|
(26,977,774
|
)
|
|
$
|
(5,172,397
|
)
|
|
$
|
(4,971,290
|
)
|
|
$
|
50,782,579
|
|
|
$
|
13,661,118
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative rate sensitivity gap
|
|
$
|
(26,977,774
|
)
|
|
$
|
(32,150,171
|
)
|
|
$
|
(37,121,461
|
)
|
|
$
|
13,661,118
|
|
|
|
|
|
(1) Maturity gap utilizes stated maturities, or prepayment expectations for assets that exhibit prepayment characteristics, while interest rate sensitivity gap utilizes reset dates, if applicable.
(2) Includes effect of interest rate swaps.
The methodologies we employ for evaluating interest rate risk include an analysis of our interest rate “gap,” measurement of the duration and convexity of our portfolio and sensitivities to interest rates and spreads.
Stress Testing
We utilize liquidity stress testing to ensure we have sufficient liquidity under a variety of scenarios and stresses. These stress tests assist with the management of our pool of liquid assets and influence our current and future funding plans. Our stress tests are modeled over both short term and longer time horizons. The stresses applied include market-wide and firm-specific stresses.
Liquidity Management Policies
We utilize a comprehensive liquidity policy structure to inform our liquidity risk management practices including monitoring and measurement, along with well-defined key limits. Both quantitative and qualitative targets are utilized to measure the ongoing stability and condition of the liquidity position, and include the level and composition of unencumbered assets, as well as both short-term and long-term sustainability of the funding composition under stress conditions.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
We also monitor early warning metrics designed to measure the quality and depth of liquidity sources based upon both company-specific and macro environmental conditions. The metrics assess liquidity conditions and are integrated into our escalation protocol, with various liquidity ratings influencing management actions with respect to contingency planning and potential related actions.
Investment/Market Risk Management
One of the primary risks we are subject to is investment/market risk. Changes in the level of interest rates can affect our net interest income, which is the difference between the income we earn on our Interest Earning Assets and the interest expense incurred from Interest Bearing Liabilities and derivatives. Changes in the level of interest rates and spreads can also affect the value of our securities and potential realization of gains or losses from the sale of these assets. We may utilize a variety of financial instruments, including interest rate swaps, swaptions, options, futures and other hedges, in order to limit the adverse effects of interest rates on our results. Our portfolio and the value of our portfolio, including derivatives, may be adversely affected as a result of changing interest rates and spreads.
We simulate a wide variety of interest rate scenarios in evaluating our risk. Scenarios are run to capture our sensitivity to changes in interest rates, spreads and the shape of the yield curve. We also consider the assumptions affecting our analysis such as those related to prepayments. In addition to predefined interest rate scenarios, we utilize Value-at-Risk measures to estimate potential losses in the portfolio over various time horizons utilizing various confidence levels. The following tables estimate the potential changes in economic net interest income over a twelve month period and the immediate effect on our portfolio market value (inclusive of derivative instruments), should interest rates instantaneously increase or decrease by 25, 50 or 75 basis points, and the effect of portfolio market value if mortgage option-adjusted spreads instantaneously increase or decrease by 5, 15 or 25 basis points (assuming shocks are parallel and instantaneous). All changes to income and portfolio market value are measured as percentage changes from the projected net interest income and portfolio value at the base interest rate scenario. The base interest rate scenario assumes interest rates at September 30, 2017. The net interest income simulations incorporate the interest expense effect of rate resets on liabilities and derivatives as well as the amortization expense and reinvestment of principal based on the prepayments on our securities, which varies based on the level of rates. The results assume no management actions in response to the rate or spread changes. Actual results could differ significantly from these estimates in the table below at September 30, 2017.
Change in Interest Rate
(1)
|
|
Projected Percentage Change
in Economic Net Interest
Income
(2)
|
|
Estimated Percentage Change
in Portfolio Value
(3)
|
|
Estimated Change as a
% on NAV
(3)(4)
|
-75 Basis Points
|
|
(10.8)%
|
|
0.4%
|
|
2.8%
|
-50 Basis Points
|
|
(6.2)%
|
|
0.4%
|
|
2.9%
|
-25 Basis Points
|
|
(2.1)%
|
|
0.3%
|
|
2.1%
|
Base Interest Rate
|
|
—
|
|
—
|
|
—
|
+25 Basis Points
|
|
0.6%
|
|
(0.4)%
|
|
(3.1)%
|
+50 Basis Points
|
|
(0.7)%
|
|
(1.0)%
|
|
(6.9)%
|
+75 Basis Points
|
|
(3.0)%
|
|
(1.6)%
|
|
(11.4)%
|
|
|
|
|
|
|
|
MBS Spread Shock
(1)
|
|
Estimated Change in
Portfolio Market Value
|
|
Estimated Change as a %
on NAV
(3)(4)
|
|
|
-25 Basis Points
|
|
1.6%
|
|
11.7%
|
|
|
-15 Basis Points
|
|
1.0%
|
|
7.0%
|
|
|
-5 Basis Points
|
|
0.3%
|
|
2.3%
|
|
|
Base Interest Rate
|
|
—
|
|
—
|
|
|
+5 Basis Points
|
|
(0.3)%
|
|
(2.3)%
|
|
|
+15 Basis Points
|
|
(1.0)%
|
|
(6.9)%
|
|
|
+25 Basis Points
|
|
(1.6)%
|
|
(11.4)%
|
|
|
(1)
|
Interest rate and MBS spread sensitivity are based on results from third party models in conjunction with inputs from our internal investment professionals. Actual results could differ materially from these estimates.
|
(2)
|
Scenarios include Residential Investment Securities, commercial real estate investments, corporate debt, repurchase agreements, other secured financing and interest rate swaps. Economic net interest income includes interest expense on interest rate swaps.
|
(3)
|
Scenarios include Residential Investment Securities, residential mortgage loans, MSRs and derivative instruments.
|
(4)
|
NAV represents book value of equity.
|
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Credit Risk Management
Key risk parameters have been established to specify our credit risk appetite. We will seek to manage credit risk by making investments which conform within the firm’s specific investment policy parameters and optimize risk-return attributes.
While we do not expect to encounter credit risk in our Agency investments, we face credit risk on the non-Agency mortgage-backed securities and CRT securities in our portfolio. In addition, we are also exposed to credit risk on residential mortgage loans, commercial real estate investments and corporate debt. MSR values may also be impacted if overall costs to service the underlying mortgage loans increase due to borrower performance. We are subject to risk of loss if an issuer
or borrower fails to perform its contractual obligations. We have established policies and procedures for mitigating credit risk, including establishing and reviewing limits for credit exposure. We will originate or purchase commercial investments that meet our comprehensive underwriting process and credit standards and are approved by the appropriate committee. Once a commercial investment is made, our ongoing surveillance process includes regular reviews, analysis and oversight of investments by our investment personnel and appropriate committee. We review credit and other risks of loss associated with each investment. Our management monitors the overall portfolio risk and determines estimates of provision for loss. Our portfolio composition at September 30, 2017 and December 31, 2016 was as follows:
Asset Portfolio (using balance sheet values)
|
|
Category
|
|
September 30, 2017
|
|
|
December 31, 2016
|
|
Agency mortgage-backed securities
|
|
|
90.1
|
%
|
|
|
88.5
|
%
|
Credit risk transfer securities
|
|
|
0.6
|
%
|
|
|
0.8
|
%
|
Residential mortgage loans
|
|
|
0.9
|
%
|
|
|
0.4
|
%
|
Mortgage servicing rights
|
|
|
0.6
|
%
|
|
|
0.8
|
%
|
Non-Agency mortgage-backed securities
|
|
|
1.3
|
%
|
|
|
1.7
|
%
|
Commercial real estate
(1)(2)
|
|
|
5.6
|
%
|
|
|
6.9
|
%
|
Corporate debt
|
|
|
0.9
|
%
|
|
|
0.9
|
%
|
(1)
Net of unamortized origination fees.
(2)
Including commercial loans held for sale, net.
Counterparty Risk Management
Our use of repurchase and derivative agreements and trading activities create exposure to counterparty risk relating to potential losses that could be recognized if the counterparties to these agreements fail to perform their obligations under the contracts. In the event of default by a counterparty, we could have difficulty obtaining our assets pledged as collateral. A significant portion of our investments are financed with repurchase agreements by pledging our Residential Investment Securities and certain commercial real estate investments as collateral to the lender. The collateral we pledge generally exceeds the amount of the borrowings under each agreement. If the counterparty to the repurchase agreement defaults on its obligations and we are not able to recover our pledged asset, we are
at risk of losing the over-collateralization or haircut. The amount of this exposure is the difference between the amount loaned to us plus interest due to the counterparty and the fair value of the collateral pledged by us to the lender including accrued interest receivable on such collateral.
We also use interest rate swaps and other derivatives to manage interest rate risk. Under these agreements, we pledge securities and cash as collateral or settle variation margin payment as part of a margin arrangement.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
If a counterparty were to default on its obligations, we would be exposed to a loss to a derivative counterparty to the extent that the amount of our securities or cash pledged exceeded the unrealized loss on the associated derivative and we were not able to recover the excess collateral. Additionally, we would be exposed to a loss to a derivative counterparty to the extent that our unrealized gains on derivative instruments exceeded the amount of the counterparty’s securities or cash pledged to us.
We monitor our exposure to counterparties across several dimensions including by type of arrangement, collateral type, counterparty type, ratings and geography.
The following table summarizes our exposure to counterparties by geography at September 30, 2017:
Country
|
|
Number of
Counterparties
|
|
|
Repurchase
Agreement
Financing
|
|
|
Interest Rate
Swaps at Fair
Value
|
|
|
Exposure
(1)
|
|
|
|
(dollars in thousands)
|
|
North America
|
|
|
26
|
|
|
$
|
53,466,643
|
|
|
$
|
(220,248
|
)
|
|
$
|
2,683,427
|
|
Europe
|
|
|
11
|
|
|
|
11,504,955
|
|
|
|
(374,462
|
)
|
|
|
768,677
|
|
Asia (non-Japan)
|
|
|
1
|
|
|
|
254,189
|
|
|
|
—
|
|
|
|
15,738
|
|
Japan
|
|
|
4
|
|
|
|
4,204,481
|
|
|
|
—
|
|
|
|
243,892
|
|
Total
|
|
|
42
|
|
|
$
|
69,430,268
|
|
|
$
|
(594,710
|
)
|
|
$
|
3,711,734
|
|
(1)
|
Represents the amount of cash and/or securities pledged as collateral to each counterparty less the aggregate of repurchase agreement financing and unrealized loss on swaps for each counterparty.
|
Operational Risk Management
We are subject to operational risk in each of our business and support functions. Operational risk may arise from internal or external sources including human error, fraud, systems issues, process change, vendors, business interruptions and other external events. Model risk considers potential errors with a model’s results due to uncertainty in model parameters and inappropriate methodologies used. The result of these risks may include financial loss and reputational damage. We manage operational risk through a variety of tools including policies and procedures which cover topics such as business continuity, personal conduct and vendor management. Other tools include training on topics such as cybersecurity awareness; testing, including disaster recovery testing; systems controls, including access controls; and monitoring, which includes the use of key risk indicators. Employee level lines of defense against operational risk include proper segregation of incompatible duties, activity-level internal controls over financial reporting, the empowerment of business units to identify and mitigate operational risk sources, testing by our internal audit staff, and our overall governance framework.
Compliance, Regulatory and Legal Risk Management
Our business is organized as a REIT, and we plan to continue to meet the requirements for taxation as a REIT. The determination that we are a REIT requires an analysis of various factual matters and circumstances. Accordingly, we closely monitor our REIT status within our risk management program.
The financial services industry is highly regulated and continues to receive increasing attention from regulators, which may impact both our company as well as our business strategy. We proactively monitor the potential impact regulation may have both directly and indirectly on us. We maintain a process to actively monitor both actual and potential legal action that may affect us. Our risk management framework is designed to identify, monitor and manage these risks under the oversight of the ERC.
We currently rely on the exemption from registration provided by Section 3(c)(5)(C) of the Investment Company Act, and we plan to continue to meet the requirements for this exemption from registration. The determination that we qualify for this exemption from registration depends on various factual matters and circumstances. Accordingly, in conjunction with our legal department, we closely monitor our compliance with Section 3(c)(5)(C) within our risk management program. The monitoring of this risk is also under the oversight of the ERC.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the U.S. Commodity Futures Trading Commission (or CFTC) gained jurisdiction over the regulation of interest rate swaps. The CFTC has asserted that this causes the operators of mortgage real estate investment trusts that use swaps as part of their business model to fall within the statutory definition of Commodity Pool Operator (or CPO), and, absent relief from the Division of Swap Dealer and Intermediary Oversight or the CFTC, to register as CPOs. On December 7, 2012, as a result of numerous requests for no-action relief from the CPO registration requirement for operators of mortgage real estate investment trusts, the Division of Swap Dealer and Intermediary Oversight of the CFTC issued no-action relief entitled “No-Action Relief from the Commodity Pool Operator Registration Requirement for Commodity Pool Operators of Certain Pooled Investment Vehicles Organized as Mortgage Real Estate Investment Trusts” that permits a CPO to receive relief by filing a claim to perfect the use of the relief. A claim submitted by a CPO will be effective upon filing, so long as the claim is materially complete.
The conditions that must be met relate to initial margin and premiums requirements, net income derived annually from commodity interest positions that are not qualifying hedging transactions, marketing of interests in the mortgage real estate investment trust to the public, and identification of the entity as a mortgage real estate investment trust in its federal tax filings with the Internal Revenue Service. While we disagree with the CFTC’s position that mortgage real estate investment trusts that use swaps as part of their business model fall within the statutory definition of a CPO, we have submitted a claim for the relief set forth in the no-action relief entitled “No-Action Relief from the Commodity Pool Operator Registration Requirement for Commodity Pool Operators of Certain Pooled Investment Vehicles Organized as Mortgage Real Estate Investment Trusts” and believe we meet the criteria for such relief set forth therein.
Critical Accounting Policies and Estimates
Our critical accounting policies that require us to make significant judgments or estimates are described below. For more information on these critical accounting policies and other significant accounting policies, see “Significant Accounting Policies” in the Notes to the Consolidated Financial Statements.
Valuation of Financial Instruments
Residential Investment Securities
There is an active market for our Agency mortgage-backed securities, Agency debentures, CRT securities and non-Agency mortgage-backed securities. Since we primarily invest in securities that can be valued using actively quoted prices for actively traded assets, there is a high degree of observable inputs and less subjectivity in measuring fair value. Internal fair values are determined using quoted prices from the TBA securities market, the Treasury curve and the underlying characteristics of the individual securities, which may include coupon, periodic and life caps, reset dates and the expected life of the security. Prepayment rates are difficult to predict and are a significant estimate requiring judgment in the valuation of Agency mortgage-backed securities. All internal fair values are compared to external pricing sources and/or dealer quotes to determine reasonableness. Additionally, securities used as collateral for repurchase agreements are priced daily by counterparties to ensure sufficient collateralization, providing additional verification of our internal pricing.
Residential Mortgage Loans
There is an active market for the residential whole loans in which we invest. Since we primarily invest in residential loans that can be valued using actively quoted prices for similar assets, there is a high degree of observable inputs and minimal subjectivity in measuring fair value. Internal fair values are determined using quoted prices for similar market transactions, the Treasury curve and the underlying characteristics of the individual loans, which may include loan term, coupon, and reset dates. Prepayment rates are difficult to predict and are a significant estimate requiring judgment in the valuation of residential whole loans. All internal fair values are compared to external pricing sources to determine reasonableness.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Commercial Real Estate Investments
The fair value of commercial mortgage-backed securities classified as available-for-sale is determined based upon quoted prices of similar assets in recent market transactions and requires the application of judgment due to differences in the underlying collateral. These securities must also be evaluated for other-than-temporary impairment if the fair value of the security is lower than its amortized cost. Determining whether there is an other-than-temporary impairment may require us to exercise significant judgment and make estimates to determine expected cash flows incorporating assumptions such as changes in interest rates and loss expectations.
For commercial real estate loans and preferred equity investments classified as held for investment, we apply significant judgment in evaluating the need for a loss reserve. Estimated net recoverable value of the commercial real estate loans and preferred equity investments and other factors such as the fair value of any collateral, the amount and status of senior debt, the prospects of the borrower and the competitive landscape where the borrower conducts business must be considered in determining the allowance for loan losses. For commercial real estate loans held for sale, significant judgment may need to be applied in determining fair value of the loans and whether a valuation allowance is necessary. Factors that may need to be considered to determine fair value of a loan held for sale include the borrower’s credit quality, liquidity and other market factors and the fair value of the underlying collateral.
Interest Rate Swaps
We use the overnight indexed swap (or OIS) curve as an input to value substantially all of our uncleared interest rate swaps. We believe using the OIS curve, which reflects the interest rate typically paid on cash collateral, enables us to most accurately determine the fair value of uncleared interest rate swaps. Consistent with market practice, we exchange collateral (also called margin) or settle variation margin payments based on the fair values of our interest rate swaps. Through this margining process, we may be able to compare our recorded fair value with the fair value calculated by the counterparty or derivatives clearing organization, providing additional verification of our recorded fair value of the uncleared interest rate swaps. We value our cleared interest rate swaps using the prices provided by the derivatives clearing organization.
Revenue Recognition
Interest income from coupon payments is accrued based on the outstanding principal amounts of the Residential Investment Securities and their contractual terms. Premiums and discounts associated with the purchase of the Residential Investment Securities are amortized or accreted into interest income over the projected lives of the securities using the interest method. We use third-party model and market information to project prepayment speeds. Our prepayment speed projections incorporate underlying loan characteristics (i.e., coupon, term, original loan size, original loan-to-value ratio, etc.) and market data, including interest rate and home price index forecasts and expert judgment. Prepayment speeds vary according to the type of investment, conditions in the financial markets and other factors, and cannot be predicted with any certainty. Changes to model assumptions, including interest rates and other market data, as well as periodic revisions to the model will cause changes in the results. Adjustments are made for actual prepayment activity as it relates to calculating the effective yield. Gains or losses on sales of Residential Investment Securities are recorded on trade date based on the specific identification method.
Consolidation of Variable Interest Entities
Determining whether an entity has a controlling financial interest in a VIE requires significant judgment related to assessing the purpose and design of the VIE and determination of the activities that most significantly impact its economic performance. We must also identify explicit and implicit variable interests in the entity and consider our involvement in both the design of the VIE and its ongoing activities. To determine whether consolidation of the VIE is required, we must apply judgment to assess whether we have the power to direct the most significant activities of the VIE and whether we have either the rights to receive benefits or the obligation to absorb losses that could be potentially significant to the VIE.
Use of Estimates
The use of GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
A
Adjustable-Rate Loan / Security
A loan / security on which interest rates are adjusted at regular intervals according to predetermined criteria. The adjustable interest rate is tied to an objective, published interest rate index.
Agency
Refers to a federally chartered corporation, such as the Federal National Mortgage Association, or the Federal Home Loan Mortgage Corporation, or an agency of the U.S. Government, such as the Government National Mortgage Association.
Agency Debentures
Debt issued by a federal agency or a government-sponsored enterprise (GSE) for financing purposes. These types of debentures are not backed by collateral, but by the integrity and credit-worthiness of the issuer. Agency debentures issued by a GSE are backed only by that GSE’s ability to pay. The callable feature allows the Agency to repay the bond prior to maturity.
Agency Mortgage-Backed Securities
Refers to residential mortgage-backed securities that are issued or guaranteed by an Agency.
Amortization
Liquidation of a debt through installment payments. Amortization also refers to the process of systematically reducing a recognized asset or liability (e.g., a purchase premium or discount for a debt security) with an offset to earnings.
Average Life
On a mortgage-backed security, the average time to receipt of each dollar of principal, weighted by the amount of each principal prepayment, based on prepayment assumptions.
B
Basis Point (BP)
One hundredth of one percent, used in expressing differences in interest rates. One basis point is 0.01% of yield. For example, a bond’s yield that changed from 3.00% to 3.50% would be said to have moved 50 basis points.
Benchmark
A bond or an index referencing a basket of bonds whose terms are used for comparison with other bonds of similar maturity. The global financial market typically looks to U.S. Treasury securities as benchmarks.
Beneficial Owner
One who benefits from owning a security, even if the security’s title of ownership is in the name of a broker or bank.
B-Note
Subordinate mortgage notes and/or subordinate mortgage loan participations.
B-Piece
The most subordinate commercial mortgage-backed security bond class.
Board
Refers to the board of directors of Annaly.
Bond
The written evidence of debt, bearing a stated rate or stated rates of interest, or stating a formula for determining that rate, and maturing on a date certain, on which date and upon presentation a fixed sum of money plus interest (usually represented by interest coupons attached to the bond) is payable to the holder or owner. Bonds are long-term securities with an original maturity of greater than one year. For purposes of computations tied in to “per bond,” a $1,000 increment of an issue is used (no matter what the actual denominations are).
Book Value Per Share
Calculated by summing common stock, additional paid-in capital, accumulated other comprehensive income (loss) and accumulated deficit and dividing that number by the total common shares outstanding.
Broker
Generic name for a securities firm engaged in both buying and selling securities on behalf of customers or its own account.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
C
Capital Buffer
Includes unencumbered financial assets which can be either sold or utilized as collateral to meet liquidity needs.
Capital Ratio
Calculated as total stockholders’ equity divided by total assets inclusive of outstanding market value of TBA positions and exclusive of consolidated VIEs associated with B-Piece commercial mortgage-backed securities.
Carry
The amount an asset earns over its hedging and financing costs. A positive carry happens when the rate on the securities being financed is greater than the rate on the funds borrowed. A negative carry is when the rate on the funds borrowed is greater than the rate on the securities that are being financed.
Collateral
Securities, cash or property pledged by a borrower or party to a derivative contract to secure payment of a loan or derivative. If the borrower fails to repay the loan or defaults under the derivative contract, the secured party may take ownership of the collateral.
Collateralized Mortgage Obligation (CMO)
A multiclass bond backed by a pool of mortgage pass-through securities or mortgage loans.
Commodity Futures Trading Commission (CFTC)
An independent U.S. federal agency established by the Commodity Futures Trading Commission Act of 1974. The CFTC regulates the swaps, commodity futures and options markets. Its goals include the promotion of competitive and efficient futures markets and the protection of investors against manipulation, abusive trade practices and fraud.
Commercial Mortgage-Backed Security (CMBS)
Securities collateralized by a pool of mortgages on commercial real estate in which all principal and interest from the mortgages flow to certificate holders in a defined sequence or manner.
Constant Prepayment Rate (CPR)
The percentage of outstanding mortgage loan principal that prepays in one year, based on the annualization of the Single Monthly Mortality, which reflects the outstanding mortgage loan principal that prepays in one month.
Convertible Securities
Securities which may be converted into shares of another security under stated terms, often into the issuing company’s common stock.
Convexity
A measure of the change in a security’s duration with respect to changes in interest rates. The more convex a security is, the more its duration will change with interest rate changes.
Core Earnings and Core Earnings Per Average Common Share
Non-GAAP measure that 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 (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. Core earnings per average common share is calculated by dividing core earnings by average basic common shares for the period.
Corporate Debt
Non-government debt instruments issued by corporations. Long-term corporate debt can be issued as bonds or loans.
Counterparty
One of two entities in a transaction. For example, in the bond market a counterparty can be a state or local government, a broker-dealer or a corporation.
Coupon
The interest rate on a bond that is used to compute the amount of interest due on a periodic basis.
Credit and Counterparty Risk
Risk to earnings, capital or business, resulting from an obligor’s or counterparty’s failure to meet the terms of any contract or otherwise failure to perform as agreed. Credit and counterparty risk is present in lending, investing, funding and hedging activities.
Credit Derivatives
Derivative instruments that have one or more underlyings related to the credit risk of a specified entity (or group of entities) or an index that exposes the seller to potential loss from specified credit-risk related events. An example is credit derivatives referencing the commercial mortgage-backed securities index.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Credit Risk Transfer (CRT) Securities
Credit Risk Transfer securities are risk sharing transactions issued by Fannie Mae and Freddie Mac and similarly structured transactions arranged by third party market participants. The securities issued in the CRT sector are designed to synthetically transfer mortgage credit risk from Fannie Mae, Freddie Mac and/or third parties to private investors.
Current Face
The current remaining monthly principal on a mortgage security. Current face is computed by multiplying the original face value of the security by the current principal balance factor.
D
Dealer
Person or organization that underwrites, trades and sells securities, e.g., a principal market-maker in securities.
Default Risk
Possibility that a bond issuer will fail to pay principal or interest when due.
Derivative
A financial product that derives its value from the price, price fluctuations and price expectations of an underlying instrument, index or reference pool (e.g. futures contracts, options, interest rate swaps, interest rate swaptions and certain to-be-announced securities).
Discount Price
When the dollar price is below face value, it is said to be selling at a discount.
Duration
The weighted maturity of a fixed-income investment’s cash flows, used in the estimation of the price sensitivity of fixed-income securities for a given change in interest rates.
E
Economic Capital
A measure of the risk a firm is subject to. It is the amount of capital a firm needs as a buffer to protect against risk. It is a probabilistic measure of potential future losses at a given confidence level over a given time horizon.
Economic Interest Expense
Non-GAAP financial measure that is composed of GAAP interest expense adjusted for realized gains or losses on interest rate swaps used to hedge cost of funds.
Economic Leverage Ratio (Economic Debt-to-Equity Ratio)
Calculated as the sum of recourse debt, TBA derivative notional outstanding and net forward purchases of investments divided by total equity.
Economic Net Interest Income
Non-GAAP financial measure that is composed of GAAP net interest income adjusted for realized gains or losses on interest rate swaps used to hedge cost of funds.
Encumbered Assets
Assets on the company’s balance sheet which have been pledged as collateral against a liability.
Eurodollar
A U.S. dollar deposit held in Europe or elsewhere outside the United States.
F
Face Amount
The par value (i.e., principal or maturity value) of a security appearing on the face of the instrument.
Factor
A decimal value reflecting the proportion of the outstanding principal balance of a mortgage security, which changes over time, in relation to its original principal value.
Fannie Mae
Federal National Mortgage Association.
Federal Deposit Insurance Corporation (FDIC)
An independent agency created by the U.S. Congress to maintain stability and public confidence in the nation’s financial system by insuring deposits, examining and supervising financial institutions for safety and soundness and consumer protection, and managing receiverships.
Federal Funds Rate
The interest rate charged by banks on overnight loans of their excess reserve funds to other banks.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Federal Home Loan Banks (FHLB)
U.S. Government-sponsored banks that provide reliable liquidity to member financial institutions to support housing finance and community investment.
Federal Housing Financing Agency (FHFA)
The FHFA is an independent regulatory agency that oversees vital components of the secondary mortgage market including Fannie Mae, Freddie Mac and the Federal Home Loan Banks.
Financial Industry Regulatory Authority (FINRA)
FINRA is a non-governmental organization tasked with regulating all business dealings conducted between dealers, brokers and all public investors.
Fixed-Rate Mortgage
A mortgage featuring level monthly payments, determined at the outset, which remain constant over the life of the mortgage.
Fixed Income Clearing Corporation (FICC)
The FICC is an agency that deals with the confirmation, settlement and delivery of fixed-income assets in the U.S. The agency ensures the systematic and efficient settlement of U.S. Government securities and mortgage-backed security transactions in the market.
Floating Rate Bond
A bond for which the interest rate is adjusted periodically according to a predetermined formula, usually linked to an index.
Floating Rate CMO
A CMO tranche which pays an adjustable rate of interest tied to a representative interest rate index such as the LIBOR, the Constant Maturity Treasury or the Cost of Funds Index.
Freddie Mac
Federal Home Loan Mortgage Corporation.
Futures Contract
A legally binding agreement to buy or sell a commodity or financial instrument in a designated future month at a price agreed upon at the initiation of the contract by the buyer and seller. Futures contracts are standardized according to the quality, quantity, and delivery time and location for each commodity. A futures contract differs from an option in that an option gives one of the counterparties a right and the other an obligation to buy or sell, while a futures contract represents an obligation of both counterparties, one to deliver and the other to accept delivery. A futures contract is part of a class of financial instruments called derivatives.
G
GAAP
U.S. generally accepted accounting principles.
Ginnie Mae
Government National Mortgage Association.
H
Hedge
An investment made with the intention of minimizing the impact of adverse movements in interest rates or securities prices.
I
In-the-Money
Description for an option that has intrinsic value and can be sold or exercised for a profit; a call option is in-the-money when the strike price (execution price) is below the market price of the underlying security.
Interest Bearing Liabilities
Refers to repurchase agreements, securitized debt of consolidated VIEs, participation sold, FHLB Des Moines advances, credit facilities, U.S. Treasury securities sold, not yet purchased and securities loaned. Average Interest Bearing Liabilities is based on daily balances.
Interest Earning Assets
Refers to Residential Investment Securities, securities borrowed, U.S. Treasury securities, reverse repurchase agreements, commercial real estate debt investments, commercial real estate debt and preferred equity interests and corporate debt. Average Interest Earning Assets is based on daily balances.
Interest-Only (IO) Bond
The interest portion of mortgage, Treasury or bond payments, which is separated and sold individually from the principal portion of those same payments.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Interest Rate Risk
The risk that an investment’s value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship. As market interest rates rise, the value of current fixed income investment holdings declines. Diversifying, deleveraging and hedging techniques are utilized to mitigate this risk. Interest rate risk is a form of market risk.
Interest Rate Swap
A binding agreement between counterparties to exchange periodic interest payments on some predetermined dollar principal, which is called the notional principal amount. For example, one party will pay fixed and receive a variable rate .
Interest Rate Swaption
Options on interest rate swaps. The buyer of a swaption has the right to enter into an interest rate swap agreement at some specified date in the future. The swaption agreement will specify whether the buyer of the swaption will be a fixed-rate receiver or a fixed-rate payer.
Internal Capital Adequacy Assessment Program (ICAAP)
The ongoing assessment and measurement of risks, and the amount of capital which is necessary to hold against those risks. The objective is to ensure that a firm is appropriately capitalized relative to the risks in its business.
International Swaps and Derivatives Association (ISDA) Master Agreement
Standardized contract developed by ISDA used as an umbrella under which bilateral derivatives contracts are entered into.
Inverse IO Bond
An interest-only bond whose coupon is determined by a formula expressing an inverse relationship to a benchmark rate, such as LIBOR. As the benchmark rate changes, the IO coupon adjusts in the opposite direction. When the benchmark rate is relatively low, the IO pays a relatively high coupon payment, and vice versa.
Investment/Market Risk
Risk to earnings, capital or business resulting in the decline in value of our assets caused from changes in market variables, such as interest rates, which affect the values of Residential Investment Securities and other investment instruments.
Investment Company Act
Refers to the Investment Company Act of 1940 as amended.
L
Leverage
The use of borrowed money to increase investing power and economic returns.
Leverage Ratio (Debt-to-Equity Ratio)
Calculated as total debt to total stockholders’ equity. For purposes of calculating this ratio total debt includes repurchase agreements, other secured financing, securitized debt of consolidated VIEs, loan participation sold and mortgages payable which are non-recourse to us, subject to customary carveouts.
LIBOR (London Interbank Offered Rate)
The rate banks charge each other for short-term Eurodollar loans. LIBOR is frequently used as the base for resetting rates on floating-rate securities and the floating-rate legs of interest rate swaps.
Liquidity Risk
Risk to earnings, capital or business arising from our inability to meet our obligations when they come due without incurring unacceptable losses because of inability to liquidate assets or obtain adequate funding.
Long-Term CPR
The Company’s projected prepayment speeds for certain Agency mortgage-backed securities using third-party model and market information. The Company’s prepayment speed projections incorporate underlying loan characteristics (e.g., coupon, term, original loan size, original loan-to-value ratio, etc.) and market data, including interest rate and home price index forecasts. Changes to model assumptions, including interest rates and other market data, as well as periodic revisions to the model will cause changes in the results.
Long-Term Debt
Debt which matures in more than one year.
M
Monetary Policy
Action taken by the Board of Governors of the Federal Reserve System to influence the money supply or interest rates.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Mortgage-Backed Security (MBS)
A security representing a direct interest in a pool of mortgage loans. The pass-through issuer or servicer collects the payments on the loans in the pool and “passes through” the principal and interest to the security holders on a pro rata basis.
Mortgage Loan
A mortgage loan granted by a bank, thrift or other financial institution that is based solely on real estate as security and is not insured or guaranteed by a government agency.
Mortgage Servicing Rights (MSRs)
Contractual agreements constituting the right to service an existing mortgage where the holder receives the benefits and bears the costs and risks of servicing the mortgage.
N
NAV
Net asset value.
Net Equity Yield
Calculated using GAAP net income, excluding depreciation and amortization expense, divided by average net equity.
Net Interest Income
Represents interest income earned on our portfolio investments, less interest expense paid for borrowings.
Net Interest Margin
Represents 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 interest rate swaps used to hedge TBA dollar roll transactions divided by the sum of its average Interest Earning Assets plus average outstanding TBA derivative balances.
Net Interest Spread
Calculated by taking the average yield on Interest Earning Assets minus the average cost of Interest Bearing Liabilities, including the net interest payments on interest rate swaps used to hedge cost of funds.
Non-Performing Loan (NPL)
A loan that is close to defaulting or is in default.
Notional Amount
A stated principal amount in a derivative contract on which the contract is based.
O
Operational Risk
Risk to earnings, capital, reputation or business arising from inadequate or failed internal processes or systems, human factors or external events.
Option Contract
A contract in which the buyer has the right, but not the obligation, to buy or sell an asset at a set price on or before a given date. Buyers of call options bet that a security will be worth more than the price set by the option (the strike price), plus the price they pay for the option itself. Buyers of put options bet that the security’s price will drop below the price set by the option. An option is part of a class of financial instruments called derivatives, which means these financial instruments derive their value from the worth of an underlying investment.
Original Face
The face value or original principal amount of a security on its issue date.
Out-of-the-Money
Description for an option that has no intrinsic value and would be worthless if it expired today; for a call option, this situation occurs when the strike price is higher than the market price of the underlying security; for a put option, this situation occurs when the strike price is less than the market price of the underlying security.
Over-The-Counter (OTC) Market
A securities market that is conducted by dealers throughout the country through negotiation of price rather than through the use of an auction system as represented by a stock exchange.
P
Par
Price equal to the face amount of a security; 100%.
Par Amount
The principal amount of a bond or note due at maturity. Also known as par value.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
Pass-Through Security
A securitization structure where a GSE or other entity “passes” the amount collected from the borrowers every month to the investor, after deducting fees and expenses.
Pool
A collection of mortgage loans assembled by an originator or master servicer as the basis for a security. In the case of Ginnie Mae, Fannie Mae, or Freddie Mac mortgage pass-through securities, pools are identified by a number assigned by the issuing agency.
Premium
The amount by which the price of a security exceeds its principal amount. When the dollar price of a bond is above its face value, it is said to be selling at a premium.
Premium Amortization Adjustment (PAA)
The component of premium amortization representing the quarter-over-quarter change in estimated long-term CPR.
Prepayment
The unscheduled partial or complete payment of the principal amount outstanding on a mortgage loan or other debt before it is due.
Prepayment Risk
The risk that falling interest rates will lead to increased prepayments of mortgage or other loans, forcing the investor to reinvest at lower prevailing rates.
Prime Rate
The indicative interest rate on loans that banks quote to their best commercial customers.
Principal and Interest
The term used to refer to regularly scheduled payments or prepayments of principal and payments of interest on a mortgage or other security.
R
Rate Reset
The adjustment of the interest rate on a floating-rate security according to a prescribed formula.
Real Estate Investment Trust (REIT)
A special purpose investment vehicle that provides investors with the ability to participate directly in the ownership or financing of real-estate related assets by pooling their capital to purchase and manage mortgage loans and/or income property.
Recourse Debt
Debt on which the economic borrower is obligated to repay the entire balance regardless of the value of the pledged collateral. By contrast, the economic borrower’s obligation to repay non-recourse debt is limited to the value of the pledged collateral. Recourse debt consists of repurchase agreements, and other secured financing.
Reinvestment Risk
The risk that interest income or principal repayments will have to be reinvested at lower rates in a declining rate environment.
Re-Performing Loan (RPL)
A type of loan in which payments were previously delinquent by at least 90 days but have resumed.
Repurchase Agreement
The sale of securities to investors with the agreement to buy them back at a higher price after a specified time period; a form of short-term borrowing. For the party on the other end of the
transaction (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement.
Residential
Investment Securities
Refers to Agency mortgage-backed securities, Agency debentures, CRT securities and non-Agency mortgage-backed securities.
Residual
In a CMO, the residual is the tranche that collects any cash flow from the collateral that remains after obligations to the other tranches have been met.
Return on Average Equity
Calculated by taking earnings divided by average stockholders’ equity.
Reverse Repurchase Agreement
Refer to Repurchase Agreement. The buyer of securities effectively provides a collateralized loan to the seller.
Risk Appetite Statement
Defines the types and levels of risk we are willing to take in order to achieve our business objectives, and reflects our risk management philosophy.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
S
Secondary Market
Ongoing market for bonds previously offered or sold in the primary market.
Settlement Date
The date securities must be delivered and paid for to complete a transaction.
Short-Term Debt
Generally, debt which matures in one year or less. However, certain securities that mature in up to three years may be considered short-term debt.
Spread
When buying or selling a bond through a brokerage firm, an individual investor will be charged a commission or spread, which is the difference between the market price and cost of purchase, and sometimes a service fee. Spreads differ based on several factors including liquidity.
T
Target Assets
Includes Agency mortgage-backed securities, to-be-announced forward contracts, Agency debentures, CRT securities, MSRs, non-Agency mortgage-backed securities, residential mortgage loans, commercial real estate investments, and corporate debt.
To-Be-Announced Securities (TBAs)
A contract for the purchase or sale of a mortgage-backed security to be delivered at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date but does not include a specified pool number and number of pools.
TBA Dollar Roll Income
TBA dollar roll income is defined as the difference in price between two TBA contracts with the same terms but different settlement dates. The TBA contract settling in the later month typically prices at a discount to the earlier month contract with the difference in price commonly referred to as the “drop.” TBA dollar roll income represents the equivalent of interest income on the underlying security less an implied cost of financing.
Total Return
Investment performance measure over a stated time period which includes coupon interest, interest on interest, and any realized and unrealized gains or losses.
Total Return Swap
A derivative instrument where one party makes payments at a predetermined rate (either fixed or variable) while receiving a return on a specific asset (generally an equity index, loan or bond) held by the counterparty.
U
Unencumbered Assets
Assets on our balance sheet which have not been pledged as collateral against an existing liability.
U.S. Government-Sponsored Enterprise (GSE) Obligations
Obligations of Agencies originally established or chartered by the U.S. government to serve public purposes as specified by the U.S. Congress, such as Fannie Mae and Freddie Mac; these obligations are not explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the U.S. government.
V
Value-at-Risk (VaR)
A statistical technique which measures the potential loss in value of an asset or portfolio over a defined period for a given confidence interval.
Variable Interest Entity (VIE)
An entity in which equity investors (i) do not have the characteristics of a controlling financial interest, and/or (ii) do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.
Variation Margin
Cash or securities provided by a party to collateralize its obligations under a transaction as a result of a change in value of such transaction since the trade was executed or the last time collateral was provided.
Volatility
A statistical measure of the variance of price or yield over time. Volatility is low if the price does not change very much over a short period of time, and high if there is a greater change.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion And Analysis
W
Warehouse Lending
A line of credit extended to a loan originator to fund mortgages extended by the loan originators to property purchasers. The loan typically lasts from the time the mortgage is originated to when the mortgage is sold into the secondary market, whether directly or through a securitization. Warehouse lending can provide liquidity to the loan origination market.
Weighted Average Coupon
The weighted average interest rate of the underlying mortgage loans or pools that serve as collateral for a security, weighted by the size of the principal loan balances.
Weighted Average Life (WAL)
The assumed weighted average amount of time that will elapse from the date of a security’s issuance until each dollar of principal is repaid to the investor. The WAL will change as the security ages and depending on the actual realized rate at which principal, scheduled and unscheduled, is paid on the loans underlying the MBS.
Y
Yield-to-Maturity
The expected rate of return of a bond if it is held to its maturity date; calculated by taking into account the current market price, stated redemption value, coupon payments and time to maturity and assuming all coupons are reinvested at the same rate; equivalent to the internal rate of return.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and qualitative disclosures about market risk are contained within the section titled “Risk Management” of Item 2. “Management’s Discussion
and Analysis of Financial Condition and Results of Operations.”
ITEM 4.
CONTROLS AND PROCEDURES
Our management, including our Chief Executive Officer (the CEO) and Chief Financial Officer (the CFO), reviewed and evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act) as of the end of the period covered by this report. Based on that review and evaluation, the CEO and CFO have concluded that our current disclosure controls and procedures, as designed, (1) were effective in ensuring that information required to be disclosed by the Company in reports it files or submits under the Securities Exchange Act is accumulated and communicated to our management,
including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure and (2) were effective in ensuring that information required to be disclosed by the Company in reports it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms.
There have been no changes in our internal controls over financial reporting that occurred during the three months ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
PART II – OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS
From time to time, we are involved in various claims and legal actions arising in the ordinary course of business.
At September 30, 2017, we were not party to any pending material legal proceedings.
There have been no material changes to the risk factors disclosed in Item 1A. “Risk Factors” of our most recent annual report on Form 10-K. The materialization of any risks and uncertainties identified in our Special Note Regarding Forward-Looking Statements contained in this report together with those previously disclosed in our most recent annual report on Form 10-K or those
that are presently unforeseen could result in significant adverse effects on our financial condition, results of operations and cash flows. See Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Special Note Regarding Forward-Looking Statements” in this quarterly report or our most recent annual report on Form 10-K.
ITEM 5.
OTHER INFORMATION
On October 31, 2017, we filed Articles Supplementary (the “Articles Supplementary”) to the Charter of the Company (the “Charter”) with the State Department of Assessments and Taxation of Maryland, which Articles Supplementary were accepted for record. The Articles Supplementary reclassified and designated (1) 7,412,500 authorized but unissued shares of the our preferred stock, $0.01 par value per share, without designation as to series or class, as shares of our undesignated common stock, $0.01 par value per share (the “Common Stock”); (2) 650,000 authorized but unissued shares of the Company’s 7.625% Series C Cumulative Redeemable Preferred Stock, $0.01 par value per share (the “Series C Preferred Stock”), as shares of undesignated Common Stock; and (3) 3,400,000 authorized but unissued shares of the
Company’s 6.95% Series F Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, $0.01 par value per share (the “Series F Preferred Stock”), as shares of undesignated Common Stock.
Following the filing of the Articles Supplementary, the total number of shares of capital stock which we have authority to issue is 2,000,000,000, consisting of 1,929,300,000 shares of Common Stock; 12,000,000 shares Series C Preferred Stock; 18,400,000 shares of 7.50% Series D Cumulative Redeemable Preferred Stock, $0.01 par value per share; 11,500,000 shares of 7.625% Series E Cumulative Redeemable Preferred Stock, $0.01 par value per share; and 28,800,000 shares of Series F Preferred Stock.
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Item 6. Exhibits
Exhibits:
The exhibits required by this item are set forth on the Exhibit Index attached hereto.
Exhibit
Number
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Exhibit Description
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Articles Supplementary reclassifying and designating (1) 7,412,500 authorized but unissued shares of the Registrant’s preferred stock, $0.01 par value per share, without designation as to series or class, as shares of undesignated Common Stock; (2) 650,000 authorized but unissued shares of the Registrant’s 7.625% Series C Cumulative Redeemable Preferred Stock, $0.01 par value per share, as shares of undesignated Common Stock; and (3) 3,400,000 authorized but unissued shares of the Registrant’s 6.95% Series F Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, $0.01 par value per share, as shares of undesignated Common Stock.†
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Exhibit 101.INS XBRL
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Instance Document †
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Exhibit 101.SCH XBRL
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Taxonomy Extension Schema Document †
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Exhibit 101.CAL XBRL
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Taxonomy Extension Calculation Linkbase Document †
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Exhibit 101.DEF XBRL
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Additional Taxonomy Extension Definition Linkbase Document Created†
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Exhibit 101.LAB XBRL
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Taxonomy Extension Label Linkbase Document †
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Exhibit 101.PRE XBRL
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Taxonomy Extension Presentation Linkbase Document †
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† Submitted electronically herewith. Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition at September 30, 2017 (Unaudited) and December 31, 2016 (Derived from the audited Consolidated Statement of Financial Condition at December 31, 2016); (ii) Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the three and nine months ended September 30, 2017 and 2016; (iii) Consolidated Statements of Stockholders’ Equity (Unaudited) for the nine months ended September 30, 2017 and 2016; (iv) Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2017 and 2016; and (v) Notes to Consolidated Financial Statements (Unaudited).
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
Signatures
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of New York, State of New York.
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ANNALY CAPITAL MANAGEMENT, INC.
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Dated:
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November 2, 2017
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By: /s/ Kevin G. Keyes
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Kevin G. Keyes
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Chief Executive Officer, President and Director
(Principal Executive Officer)
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Dated:
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November 2, 2017
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By: /s/ Glenn A. Votek
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Glenn A. Votek
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Chief Financial Officer (Principal Financial Officer)
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