What changed in this filing

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Item 1. Financial Statements

2020-08-06 compared with 2020-05-08 · 1104 added, 508 removed, 548 unchanged (75% of the section changed)

Financial Statements

The following tables present the Company’s securities portfolio, excluding securities transferred or pledged to securitization vehicles, that was carried at their fair value at June 30, 2020 and December 31, 2019 :

June 30, 2020

Remaining Premium

Remaining Discount

Estimated Fair Value

(dollars in thousands)

Fixed-rate pass-through

Adjustable-rate pass-through

Interest-only

Reverse mortgages

Total agency securities

Residential credit

Prime interest-only

Prime jumbo (>=2010 vintage)

Prime jumbo (>=2010 vintage) Interest-only

Total residential credit securities

Total Residential Securities

Commercial Securities

Total securities

December 31, 2019

Remaining Premium

Remaining Discount

Estimated Fair Value

(dollars in thousands)

Fixed-rate pass-through

Adjustable-rate pass-through

Interest-only

Reverse mortgages

Total agency investments

Residential credit

Prime interest-only

Prime jumbo (>=2010 vintage)

Prime jumbo (>=2010 vintage) Interest-only

Total residential credit securities

Total Residential Securities

Commercial Securities

Total securities

Principal/Notional amount includes $ 13.2 million and $ 14.9 million of a CRT interest-only security as of June 30, 2020 and December 31, 2019 , respectively.

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

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

June 30, 2020

December 31, 2019

Investment Type

(dollars in thousands)

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

The following table summarizes the Company’s Residential Securities, excluding securities transferred or pledged to securitization vehicles, at June 30, 2020 and December 31, 2019 , according to their estimated weighted average life classifications:

June 30, 2020

December 31, 2019

Estimated Fair Value

Estimated weighted average life

(dollars in thousands)

Less than one year

Greater than one year through five years

Greater than five years through ten years

Greater than ten years

The estimated weighted average lives of the Residential Securities at June 30, 2020 and December 31, 2019 in the table above are based upon projected principal prepayment rates.

The actual weighted average lives of the Residential Securities could be longer or shorter than projected.

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

June 30, 2020

December 31, 2019

Estimated Fair Value (1)

Gross Unrealized Losses (1)

Number of Securities (1)

Estimated Fair Value (1)

Gross Unrealized Losses (1)

Number of Securities (1)

(dollars in thousands)

Less than 12 months

12 Months or more

(1) Excludes interest-only mortgage-backed securities and reverse mortgages.

The decline in value of these securities is solely due to market conditions and not the quality of the assets.

Substantially all of the Agency mortgage-backed securities are “AAA” rated or carry an implied “AAA” rating.

The investments are not considered to be impaired because the Company currently has the ability and intent to hold the investments to maturity or for a period of time sufficient for a forecasted market price recovery up to or beyond the cost of the investments, and it is not more likely than not that the Company will be required to sell the investments before recovery of the amortized cost bases, which may be maturity.

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

During the three and six months ended June 30, 2020 , the Company disposed of $ 5.5 billion and $ 47.4 billion of Residential Securities, respectively.

During the three and six months ended June 30, 2019 , the Company disposed of $ 9.1 billion and $ 19.5 billion of Residential Securities, respectively.

The following table presents the Company’s net gains (losses) from the disposal of Residential Securities for the three and six months ended June 30, 2020 and 2019.

Gross Realized Gains

Gross Realized Losses

Net Realized Gains (Losses)

For the three months ended

(dollars in thousands)

June 30, 2020

June 30, 2019

For the six months ended

June 30, 2020

June 30, 2019

The Company invests in residential, commercial and corporate loans.

Loans are classified as either held for investment or held for sale.

Loans are also eligible to be accounted for under the fair value option.

Excluding loans transferred or pledged to securitization vehicles, as of June 30, 2020 and December 31, 2019 , the Company reported $ 1.2 billion and $ 1.6 billion , respectively, of loans for which the fair value option was elected.

If loans are held for investment and the fair value option has not been elected, they are accounted for at amortized cost less impairment.

If the Company intends to sell or securitize the loans and the securitization vehicle is not expected to be consolidated, the loans are classified as held for sale.

If loans are held for sale and the fair value option was not elected, they are accounted for at the lower of cost or fair value.

Any origination fees and costs or purchase premiums or discounts are deferred and recognized upon sale.

The Company determines the fair value of loans held for sale on an individual loan basis.

Allowance for Losses – The Company evaluates the need for a loss reserve on each of its loans classified as held-for-investment where the fair value option is not elected.

Allowance for loan losses are written off in the period the loans are deemed uncollectible.

Given the unique nature of each underlying borrower and any collateral, the Company assesses an allowance for each individual loan held-for-investment.

A provision is established at origination or acquisition that reflects management’s estimate of the total expected credit loss over the expected life of the loan.

In estimating the lifetime expected credit losses, management utilizes a probability of default and loss given default methodology (“Loss given default methodology”), which considers projected economic conditions over the reasonable and supportable forecast period.

The forecast incorporates primarily market-based assumptions including, but not limited to, forward interest rate curves, unemployment rate estimates and certain indexes sourced from third party vendors.

For any remaining period of the expected life of the loan after the reasonable and supportable period, the Company reverts to historical losses on a straight-line basis.

Management uses third-party vendors’ loan pool data for loans with similar risk characteristics to estimate historical losses given the limited loss history of the Company’s loan portfolio.

Changes in the lifetime expected credit loss are reflected in Loan loss provision in the Consolidated Statements of Comprehensive Income (Loss).

For loans experiencing credit deterioration, the Company may use a different methodology to determine the expected credit losses such as a discounted cash flow analysis.

For collateral-dependent loans, if foreclosure is probable, expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for any selling costs, if applicable.

Additionally, the Company may elect the practical expedient for a financial asset for which the repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulty by measuring the allowance as the difference between the fair value of the collateral, less costs to sell, if applicable, and the amortized cost basis of the financial asset at the reporting date.

The Company’s commercial loans are collateralized by commercial real estate including, but not limited to, multifamily real estate, office and retail space, hotels and industrial space.

At origination, the fair value of the collateral generally exceeds the principal loan balance.

Management assesses the credit quality of the portfolio and adequacy of loan loss reserves on a quarterly basis, or more frequently as necessary.

Significant judgment is required in this analysis.

Depending on the expected recovery of its investment, the Company considers the estimated net recoverable value of the loans as well as other factors, including but not limited to the fair value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the competitive landscape where the borrower conducts business.

To determine if loan loss allowances are required on investments in corporate debt, the Company reviews the monthly and/or quarterly financial statements of the borrowers, verifies loan compliance packages, if applicable, and analyzes current results relative to budgets and sensitivities performed at inception of the investment.

Because these determinations

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

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

The Company may be exposed to various levels of credit risk depending on the nature of its investments and credit enhancements, if any, supporting its assets.

The Company’s core investment process includes procedures related to the initial approval and periodic monitoring of credit risk and other risks associated with each investment.

The Company’s investment underwriting procedures include evaluation of the underlying borrowers’ ability to manage and operate their respective properties or companies.

Management reviews loan-to-value metrics at origination or acquisition of a new investment and if events occur that trigger re-evaluation by management.

The Company recorded loan loss provisions of $ 68.8 million and $ 168.1 million for the three and six months ended June 30, 2020 , respectively.

The Company recorded loan loss provisions of $ 0.0 and $ 5.7 million for the three and six months ended June 30, 2019 , respectively.

As of June 30, 2020 and December 31, 2019 , the Company’s loan loss provision was $ 206.7 million and $ 20.1 million , respectively.

The following table presents the activity of the Company’s loan investments, including loans held for sale and excluding loans transferred or pledged to securitization vehicles, for the six months ended June 30, 2020 :

Corporate Debt

(dollars in thousands)

Beginning balance January 1, 2020

Impact of adopting CECL

Purchases / originations

Sales and transfers (1)

Principal payments

Gains / (losses) (2)

(Amortization) / accretion

Ending balance June 30, 2020

(1) Includes securitizations, syndications and transfers to securitization vehicles.

(2) Includes loan loss allowances.

The carrying value of the Company’s residential loans held for sale was $ 61.1 million and $ 66.7 million at June 30, 2020 and December 31, 2019 , respectively.

There were no commercial loans held for sale at June 30, 2020 and December 31, 2019 .

The Company also has off-balance-sheet credit exposures related to unfunded loan commitments, including revolvers, delayed draw term loans and future funding commitments that are not unconditionally cancelable by the Company.

The Company utilizes the same methodology in calculating the liability related to the expected credit losses on these exposures as it does for the calculation of the allowance for loan losses.

In determining the estimate of credit losses for off-balance-sheet credit exposures, the Company will consider the contractual period in which the entity is exposed to credit risk and the likelihood that funding will occur, if material.

Estimated credit losses for off-balance-sheet credit exposures are included in Other liabilities on the Company’s Consolidated Statements of Financial Condition.

The Company’s residential mortgage loans are primarily comprised of performing adjustable-rate and fixed-rate whole loans.

The Company’s residential loans are accounted for under the fair value option with changes in fair value reflected in Net unrealized gains (losses) on instruments measured at fair value through earnings in the Statements of Comprehensive Income.

Additionally, the Company consolidates a collateralized financing entity that securitized prime adjustable-rate jumbo residential mortgage loans.

The Company also consolidates securitization trusts in which it had purchased subordinated securities because it also has certain powers and rights to direct the activities of such trusts.

Refer to the “Variable Interest Entities” Note for further information related to the Company’s consolidated residential mortgage loan trusts.

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

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

June 30, 2020

December 31, 2019

(dollars in thousands)

Unpaid principal balance

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

For the Three Months Ended

For the Six Months Ended

June 30, 2020

June 30, 2019

June 30, 2020

June 30, 2019

(dollars in thousands)

Interest income

Net gains (losses) on disposal of investments and other

Net unrealized gains (losses) on instruments measured at fair value through earnings

Total included in net income (loss)

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

Geographic Concentrations of Residential Mortgage Loans

June 30, 2020

December 31, 2019

Property location

All other (none individually greater than 5%)

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

June 30, 2020

December 31, 2019

Portfolio Weighted

Portfolio Weighted Average

(dollars in thousands)

Unpaid principal balance

Interest rate

0.88% - 9.24%

2.00% - 8.38%

7/1/2029 - 4/1/2060

1/1/2028 - 12/1/2059

FICO score at loan origination

Loan-to-value ratio at loan origination

At June 30, 2020 and December 31, 2019 , approximately 34 % and 36 % , respectively, of the carrying value of the Company’s residential mortgage loans, including loans transferred or pledged to securitization vehicles, were adjustable-rate.

The Company’s commercial real estate loans are comprised of adjustable-rate and fixed-rate loans.

The difference between the principal amount of a loan and proceeds at acquisition is recorded as either a discount or premium.

Commercial real estate loans and preferred equity interests that are designated as held for investment and are originated or purchased by the Company are carried at their outstanding principal balance, net of unamortized origination fees and costs, premiums or discounts, less an allowance for losses, if necessary.

Origination fees and costs, premiums or discounts are amortized into interest income over the life of the loan.

Management generally reviews the most recent financial information produced by the borrower, which may include, but is not limited to, net operating income (“NOI”), debt service coverage ratios, property debt yields (net cash flow or NOI divided by the amount of outstanding indebtedness), loan per unit and rent rolls relating to each of the Company’s commercial real estate loans

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

and preferred equity interests (“CRE Debt and Preferred Equity Investments”), and may consider other factors management deems important.

Management also reviews market pricing to determine each borrower’s ability to refinance their respective assets at the maturity of each loan, economic trends (both macro and those affecting the property specifically), and the supply and demand of competing projects in the sub-market in which each subject property is located.

Management monitors the financial condition and operating results of its borrowers and continually assesses the future outlook of the borrower’s financial performance in light of industry developments, management changes and company-specific considerations.

The Company’s internal loan risk ratings are based on the guidance provided by the Office of the Comptroller of the Currency for commercial real estate lending.

The Company’s internal risk rating rubric for commercial loans has nine categories as depicted below:

Risk Rating - Commercial Loans

1-4 / Performing

Meets all present contractual obligations.

5 / Performing - Closely Monitored

Meets all present contractual obligations, but are transitional or could be exhibiting some weaknesses in both leverage and liquidity.

6 / Performing - Special Mention

Meets all present contractual obligations, but exhibit potential weakness that deserves management’s close attention and, if uncorrected, may result in deterioration of repayment prospects.

7 / Substandard

Inadequately protected by sound worth and paying capacity of the obligor or of the collateral pledged with a distinct possibility that loss will be sustained if some of the deficiencies are not corrected.

Substandard loans whereby collection of all contractual principal and interest is highly questionable or improbable.

Considered uncollectible.

Management assesses each loan at least quarterly and assigns an internal risk rating based on its evaluation of the most recent financial information produced by the borrower and consideration of economic conditions.

See below for a tabular disclosure of the amortized cost basis of the Company’s commercial loans by year of origination and internal risk rating.

For the three months ended June 30, 2020 , the Company recorded a loan loss provision on impaired collateral dependent commercial loans of $ 22.0 million with a principal balance and carrying value, net of allowances of $ 96.9 million and $ 57.8 million , respectively, based upon the fair value of the underlying collateral.

There was no provision for loan loss recorded for the three months ended June 30, 2019 .

For the six months ended June 30, 2020 , the Company recorded a loan loss provision on impaired collateral dependent commercial loans of $ 74.1 million with a principal balance and carrying value, net of allowances of $ 175.1 million and $ 95.2 million , respectively, based upon the fair value of the underlying collateral.

The Company uses a discounted cash flow or market based valuation technique based upon the underlying property to project property cash flows.

In projecting these cash flows, the Company reviewed the borrower financial statements, rent rolls, economic trends and other factors management deems important.

These nonrecurring fair value measurements are considered to be in level three of the fair value measurement hierarchy as there are unobservable inputs, which are significant to the overall fair value.

For the six months ended June 30, 2019 , the Company recorded a loan loss provision of $ 5.7 million on commercial loans with a principal balance and carrying value, net of allowances of $ 36.6 million and $ 30.9 million , respectively.

As a result of the implementation of the Loss given default methodology under the modified retrospective method, a cumulative effect loan loss allowance of $ 7.8 million was recorded on January 1, 2020.

For the three and six months ended June 30, 2020, the Company recorded a loan loss allowance of $ 39.1 million and $ 62.3 million , respectively, based upon its Loss given default methodology.

At June 30, 2020 and December 31, 2019 , the amortized cost basis of commercial loans on nonaccrual status was $ 101.0 million and $ 175.2 million , respectively.

At June 30, 2020 and December 31, 2019 , the Company had unfunded commercial real estate loan commitments of $ 129.6 million and $ 181.4 million , respectively.

At June 30, 2020 , the liability related to the expected credit losses on the unfunded commercial loan commitments was $ 5.9 million .

At June 30, 2020 and December 31, 2019 , approximately 94 % and 92 % , respectively, of the carrying value, net of allowances of the Company’s CRE Debt and Preferred Equity Investments, including loans transferred or pledged to securitization vehicles and excluding commercial loans held for sale, were adjustable-rate.

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

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

Sector Dispersion

June 30, 2020

December 31, 2019

Carrying Value

% of Loan Portfolio

Carrying Value

% of Loan Portfolio

(dollars in thousands)

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

June 30, 2020

December 31, 2019

Outstanding Principal

Portfolio (2)

Outstanding Principal

Portfolio (2)

(dollars in thousands)

Senior mortgages

Senior securitized mortgages (3)

Mezzanine loans

Carrying value includes unamortized origination fees of $ 6.9 million and $ 8.3 million at June 30, 2020 and December 31, 2019 , respectively.

Based on outstanding principal.

Represents assets of consolidated VIEs.

The following tables represent a rollforward of the activity for the Company’s commercial real estate investments held for investment at June 30, 2020 and December 31, 2019 :

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

June 30, 2020

Securitized Mortgages (1)

(dollars in thousands)

Beginning balance (January 1, 2020) (2)

Originations & advances (principal)

Principal payments

Principal write off

Net (increase) decrease in origination fees

Realized gain

Amortization of net origination fees

Allowance for loan losses

Beginning allowance, prior to CECL adoption

Impact of adopting CECL

Current period allowance

Ending allowance

Net carrying value (June 30, 2020)

December 31, 2019

Securitized Mortgages (1)

(dollars in thousands)

Net carrying value (January 1, 2019)

Originations & advances (principal)

Principal payments

Net (increase) decrease in origination fees

Amortization of net origination fees

Net (increase) decrease in allowance

Net carrying value (December 31, 2019)

(1) Represents assets of consolidated VIEs.

(2) Excludes loan loss allowances.

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

Amortized Cost Basis by Risk Rating and Vintage (1)

(dollars in thousands)

1-4 / Performing

5 / Performing - Closely Monitored

6 / Performing - Special Mention

7 / Substandard

(1) The amortized cost basis excludes accrued interest.

As of June 30, 2020, the Company had $ 4.3 million of accrued interest receivable on commercial loans which is reported in Principal and interest receivable in the Consolidated Statements of Financial Condition.

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

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

Corporate Debt

The Company’s investments in corporate loans typically take the form of senior secured loans primarily in first or second lien positions.

The Company’s senior secured loans generally have stated maturities of five to seven years .

In connection with these senior secured loans, the Company receives a security interest in certain assets of the borrower and such assets support repayment of such loans.

Senior secured loans are generally exposed to less credit risk than more junior loans given their seniority to scheduled principal and interest and priority of security in the assets of the borrower.

Interest income from coupon payments is accrued based upon the outstanding principal amounts of the debt and its contractual terms.

Premiums and discounts are amortized or accreted into interest income using the effective interest method.

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

Risk Rating - Corporate Debt

1-5 / Performing

Meets all present contractual obligations.

6 / Performing - Closely Monitored

Meets all present contractual obligations but exhibits a defined weakness in either leverage or liquidity, but not both.

Loans at this rating will require closer monitoring, but where we expect no loss of interest or principal.

7 / Substandard

A loan that has a defined weakness in either leverage and/or liquidity, and which may require substantial changes to strengthen the asset.

Loans at this rating level have a higher probability of loss, although no determination of the amount or timing of a loss is yet possible.

A loan that has missed a scheduled principal or interest payment or is otherwise deemed a non-earning account.

The probability of loss is increasingly certain due to significant performance issues.

Considered uncollectible.

See below for a tabular disclosure of the amortized cost basis of the Company’s corporate debt held for investment by year of origination and internal risk rating.

For the six months ended June 30, 2020, the Company recorded a loan loss provision of $ 10.0 million on impaired corporate loans using a discounted cash flow methodology with a beginning principal balance and carrying value, net of allowances of $ 29.3 million and $ 4.3 million , respectively.

During the six months ended June 30, 2020, a loan was restructured and the Company received $ 2.8 million of second lien debt and $ 4.8 million of equity.

As a result of the restructuring, $ 19.6 million of first lien debt was written off and the related allowance of $ 11.9 million was charged off.

There was no provision for loan loss recorded on corporate loans for the six months ended June 30, 2019 .

As a result of the implementation of the Loss given default methodology under the modified retrospective method, a cumulative effect loan loss allowance on corporate loans of $ 29.7 million was recorded on January 1, 2020.

For the three and six months ended June 30, 2020, the Company recorded a loan loss allowance on corporate loans of $ 7.6 million and $ 21.7 million , respectively, based upon its Loss given default methodology.

As of June 30, 2020 and December 31, 2019 , the amortized cost basis of corporate loans on nonaccrual status was $ 0 and $ 12.2 million , respectively.

At June 30, 2020 and December 31, 2019 , the Company had unfunded corporate loan commitments of $ 74.9 million and $ 81.2 million , respectively.

At June 30, 2020 , the liability related to the expected credit losses on the unfunded corporate loan commitments was $ 0.8 million .

The Company invests in corporate loans through its Annaly Middle Market Lending Group.

The industry and rate attributes of the portfolio at June 30, 2020 and December 31, 2019 are as follows:

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

Industry Dispersion

June 30, 2020

December 31, 2019

(dollars in thousands)

Computer Programming, Data Processing & Other Computer Related Services

Management & Public Relations Services

Industrial Inorganic Chemicals

Miscellaneous Business Services

Public Warehousing & Storage

Engineering, Architectural, and Surveying

Metal Cans & Shipping Containers

Offices & Clinics of Doctors of Medicine

Surgical, Medical & Dental Instruments & Supplies

Electronic Components & Accessories

Insurance Agents, Brokers and Service

Telephone Communications

Miscellaneous Health & Allied Services, not elsewhere classified

Miscellaneous Equipment Rental & Leasing

Electric Work

Medical & Dental Laboratories

Metal Forgings & Stampings

Research, Development & Testing Services

Home Health Care Services

Motor Vehicles and Motor Vehicle Parts & Supplies

Legal Services

Petroleum and Petroleum Products

Grocery Stores

Coating, Engraving and Allied Services

Schools & Educational Services, not elsewhere classified

Chemicals & Allied Products

Machinery, Equipment & Supplies

Mailing, Reproduction, Commercial Art and Photography and Stenographic

Offices and Clinics of Other Health Practitioners

Miscellaneous Plastic Products

Nonferrous Foundries (Castings)

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

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

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

June 30, 2020

December 31, 2019

(dollars in thousands)

First lien loans

Second lien loans

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

June 30, 2020

(dollars in thousands)

Beginning balance (January 1, 2020) (1)

Originations & advances

Principal payments

Amortization & accretion of (premium) discounts

Loan restructuring

Allowance for loan losses

Beginning allowance, prior to CECL adoption

Impact of adopting CECL

Current period allowance

Ending allowance

Net carrying value (June 30, 2020)

(1) Excludes loan loss allowances.

December 31, 2019

(dollars in thousands)

Net carrying value (January 1, 2019)

Originations & advances

Principal payments

Amortization & accretion of (premium) discounts

Net (increase) decrease in allowance

Net carrying value (December 31, 2019)

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

The following table provides the amortized cost basis of corporate debt held for investment as of June 30, 2020 by vintage year and internal risk rating.

Amortized Cost Basis by Risk Rating and Vintage (1)

(dollars in thousands)

1-5 / Performing

6 / Performing - Closely Monitored

7 / Substandard

(1) The amortized cost basis excludes accrued interest and costs related to unfunded loans.

As of June 30, 2020, the Company had $ 11.4 million of accrued interest receivable on corporate loans which is reported in Principal and interest receivable in the Consolidated Statements of Financial Condition.

MORTGAGE SERVICING RIGHTS

The Company owns variable interests in an entity that invests in MSRs.

Refer to the “Variable Interest Entities” Note for a detailed discussion on this topic.

MSRs represent the rights associated with servicing pools of residential mortgage loans.

The Company and its subsidiaries do not originate or directly service residential mortgage loans.

Rather, these activities are carried out by duly licensed subservicers who perform substantially all servicing functions for the loans underlying the MSRs.

The Company intends to hold the MSRs as investments and elected to account for all of its investments in MSRs at fair value.

As such, they are recognized at fair value on the accompanying Consolidated Statements of Financial Condition with changes in the estimated fair value presented as a component of Net unrealized gains (losses) on instruments measured at fair value through earnings in the Consolidated Statements of Comprehensive Income (Loss).

Servicing income, net of servicing expenses, is reported in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

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

Three Months Ended

Six Months Ended

June 30, 2020

June 30, 2019

June 30, 2020

June 30, 2019

(dollars in thousands)

Fair value, beginning of period

Change in fair value due to:

Changes in valuation inputs or assumptions (1)

Other changes, including realization of expected cash flows

Fair value, end of period

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

For the three and six months ended June 30, 2020 , the Company recognized $ 16.4 million and $ 39.2 million , respectively, and for the three and six months ended June 30, 2019 , the Company recognized $ 27.5 million and $ 55.2 million , respectively, of net servicing income from MSRs in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

VARIABLE INTEREST ENTITIES

Commercial Trusts

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

Information regarding these securitization trusts are summarized in the table below.

Type of Underlying Collateral

Settlement Date

Cut-off Date Principal Balance

Face Value of Company’s Variable Interest at Settlement Date

(dollars in thousands)

Office Building

December 2019

Upon consolidation, the Company elected the fair value option for the financial assets and liabilities of the Commercial Trusts in order to avoid an accounting mismatch, and to represent more faithfully the economics of its interest in the entities.

The fair value option requires that changes in fair value be reflected in the Company’s Consolidated Statements of Comprehensive Income (Loss).

The Company applied the practical expedient under ASU 2014-07, whereby the Company determines whether the fair value of the financial assets or financial liabilities is more observable as a basis for measuring the less observable financial instruments.

The Company has determined that the fair value of the financial liabilities of the Commercial Trusts are more observable, since the prices for these liabilities are primarily available from third-party pricing services utilized for multifamily and commercial mortgage-backed securities, while the individual assets of the trusts are inherently less capable of precise measurement given their illiquid nature and the limitations on available information related to these assets.

Given that the Company’s methodology for valuing the financial assets of the Commercial Trusts are an aggregate fair value derived from the fair value of the financial liabilities, the Company has determined that the fair value of each of the financial assets in their entirety should be classified in Level 2 of the fair value measurement hierarchy.

The Commercial Trusts mortgage loans had an aggregate unpaid principal balance of $ 2.3 billion and $ 2.3 billion at June 30, 2020 and December 31, 2019 , respectively.

At June 30, 2020 and December 31, 2019 , there were no loans 90 days or more past due or on nonaccrual status.

There is no gain or loss attributable to instrument-specific credit risk of the underlying loans or securitized debt securities at June 30, 2020 and 2019 based upon the Company’s process of monitoring events of default on the underlying mortgage loans.

Commercial Securitizations

The Company also invests in commercial mortgage-backed securities issued by entities that are VIEs because they do not have sufficient equity at risk for the entities to finance their activities without additional subordinated financial support from other parties, but the Company is not the primary beneficiary because it does not have the power to direct the activities that most significantly impact the VIEs’ economic performance.

For these entities, the Company’s maximum exposure to loss is the amortized cost basis of the securities it owns and it does not provide any liquidity arrangements, guarantees or other commitments to these VIEs.

See the “Securities” Note for further information on Commercial Securities.

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

Collateralized Loan Obligation

In February 2019, the Company closed NLY 2019-FL2, a managed commercial real estate collateralized loan obligation (“CLO”) securitization with a face value of $ 857.3 million , which provides non-recourse financing to the Company collateralized by certain commercial real estate mortgage loans originated by the Company.

As of June 30, 2020 a total of $ 610.1 million of notes were held by third parties and the Company retained or purchased $ 196.6 million of subordinated notes and preferred shares, which eliminate upon consolidation.

The Company has determined that it is the primary beneficiary because it has the right to direct the servicer as well as remove the special servicer without cause and it holds variable interests that could be potentially significant to the CLO.

The transfers of loans to the CLO did not qualify for sale accounting because the Company maintains effective control over the loans.

The Company elected the fair value option for the financial liabilities issued by the CLO in order to simplify the accounting;

however, the commercial loans continue to be carried at amortized cost as they were not eligible for the fair value option as it was not elected at origination of the loans.

The Company incurred $ 8.3 million of costs in connection with the CLO that were expensed as incurred during the year ended December 31, 2019.

The aggregate unpaid principal balance of loans in the CLO was $ 857.3 million at June 30, 2020 and there were no loans 90 days or more past due or on nonaccrual status.

There is no gain or loss attributable to instrument-specific credit risk of the debt securities at June 30, 2020 based upon the Company’s process of monitoring events of default on the underlying mortgage loans.

The contractual principal amount of the CLO debt held by third parties was $ 633.9 million at June 30, 2020 .

Multifamily Securitization

In November 2019, the Company repackaged Fannie Mae guaranteed multifamily mortgage-backed securities with a principal cut-off balance of $ 1.0 billion and retained interest only securities with a notional balance of $ 1.0 billion and senior securities with a principal balance of $ 28.5 million .

In March 2020, the Company repackaged Fannie Mae guaranteed multifamily mortgage-backed securities with a principal cut-off balance of $ 0.5 billion and retained interest only securities with a notional balance of $ 0.5 billion .

The Company determined that it was the primary beneficiary based upon its involvement in the design of these VIEs.

The Company elected the fair value option for the financial liabilities of these VIEs in order to simplify the accounting;

however, the financial assets were not eligible for the fair value option as it was not elected at purchase.

The Company incurred $ 1.1 million of costs in connection with this multifamily securitization that were expensed as incurred during the six months ended June 30, 2020 .

Residential Trusts

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

The Company owns the subordinate securities, and a subsidiary of the Company continues to be the master servicer.

As such, the Company is deemed to be the primary beneficiary of the residential mortgage trust and consolidates the entity.

The Company has elected the fair value option for the financial assets and liabilities of this VIE, but has not elected to apply the practical expedient under ASU 2014-13 as prices of both the financial assets and financial liabilities of the residential mortgage trust are available from third-party pricing services.

The contractual principal amount of the residential mortgage trust’s debt held by third parties was $ 43.2 million and $ 57.3 million at June 30, 2020 and December 31, 2019 , respectively.

Residential Securitizations

The Company also invests in residential mortgage-backed securities issued by entities that are VIEs because they do not have sufficient equity at risk for the entities to finance their activities without additional subordinated financial support from other parties, but the Company is not the primary beneficiary because it does not have the power to direct the activities that most significantly impact the VIEs’ economic performance.

See the “Securities” Note for further information on Residential Securities.

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

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

Securitization

Date of Closing

Face Value at Closing

(dollars in thousands)

OBX 2018-EXP1

OBX 2018-EXP2

OBX 2019-INV1

OBX 2019-EXP1

OBX 2019-INV2

OBX 2019-EXP2

OBX 2019-EXP3

OBX 2020-INV1

OBX 2020-EXP1

February 2020

As of June 30, 2020 , a total of $ 2.3 billion of bonds were held by third parties and the Company retained $ 526.3 million of mortgage-backed securities, which were eliminated in consolidation.

The Company is deemed to be the primary beneficiary and consolidates the OBX Trusts because it has power to direct the activities that most significantly impact the OBX Trusts’ performance and holds a variable interest that could be potentially significant to these VIEs.

The Company has elected the fair value option for the financial assets and liabilities of these VIEs, but has not elected the practical expedient under ASU 2014-13 as prices of both the financial assets and financial liabilities of the residential mortgage trusts are available from third-party pricing services.

The Company incurred $ 0.0 and $ 3.0 million of costs during the three months ended June 30, 2020 and 2019 , respectively, and $ 3.7 million and $ 4.7 million of costs during the six months ended June 30, 2020 and 2019 , respectively, in connection with these securitizations that were expensed as incurred.

The contractual principal amount of the OBX Trusts’ debt held by third parties was $ 2.3 billion at June 30, 2020 .

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

Credit Facility VIEs

In June 2016, a consolidated subsidiary of the Company entered into a credit facility with a third party financial institution.

As of June 30, 2020 , the borrowing limit on this facility was $ 625.0 million .

The subsidiary was deemed to be a VIE and the Company was determined to be the primary beneficiary due to its role as collateral manager and because it holds a variable interest in the entity that could potentially be significant to the entity.

The Company has pledged as collateral for this facility corporate loans with a carrying amount of $ 741.3 million at June 30, 2020 .

The transfers did not qualify for sale accounting and are reflected as an intercompany secured borrowing that is eliminated upon consolidation.

At June 30, 2020 , the subsidiary had an intercompany receivable of $ 426.4 million , which eliminates upon consolidation and a secured financing of $ 426.4 million to the third party financial institution.

In July 2017, a consolidated subsidiary of the Company entered into a credit facility with a third party financial institution.

As of June 30, 2020 , the borrowing limit on this facility was $ 320.0 million .

The subsidiary was deemed to be a VIE and the Company was determined to be the primary beneficiary due to its role as servicer and because it holds a variable interest in the entity that could potentially be significant to the entity.

The Company has transferred corporate loans to the subsidiary with a carrying amount of $ 454.9 million at June 30, 2020 , which continue to be reflected in the Company’s Consolidated Statements of Financial Condition under Loans, net.

At June 30, 2020 , the subsidiary had a secured financing of $ 257.8 million to the third party financial institution.

In January 2019, a consolidated subsidiary of the Company (the “Borrower”) entered into a $ 300.0 million credit facility with a third party financial institution.

The Company has pledged as collateral for this facility corporate loans with a carrying amount of $ 336.8 million at June 30, 2020 .

As of June 30, 2020 , the Borrower had a secured financing of $ 211.6 million to the third party financial institution.

The Company also owns variable interests in an entity that invests in MSRs and has structured its operations, funding and capitalization into pools of assets and liabilities, each referred to as a “silo.” Owners of variable interests in a given silo are entitled to all of the returns and subjected to the risk of loss on the investments and operations of that silo and have no substantive recourse to the assets of any other silo.

While the Company previously held 100 % of the voting interests in this entity, in August 2017, the Company sold 100 % of such interests, and entered into an agreement with the entity’s affiliated portfolio manager giving the

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

Company the power over the silo in which it owns all of the beneficial interests.

As a result, the Company is considered to be the primary beneficiary and consolidates this silo.

The Company’s exposure to the obligations of its VIEs is generally limited to the Company’s investment in the VIEs of $ 2.6 billion at June 30, 2020 .

Assets of the VIEs may only be used to settle obligations of the VIEs.

Creditors of the VIEs have no recourse to the general credit of the Company.

The Company is not contractually required to provide and has not provided any form of financial support to the VIEs.

No gains or losses were recognized upon consolidation of existing VIEs.

Interest income and expense are recognized using the effective interest method.

The statements of financial condition of the Company’s VIEs, excluding the CLO, credit facility VIEs and OBX Trusts as the transfers of loans did not meet the criteria to be accounted for as sales, that are reflected in the Company’s Consolidated Statements of Financial Condition at June 30, 2020 and December 31, 2019 are as follows:

June 30, 2020

Commercial Trusts

Residential Trusts

(dollars in thousands)

Cash and cash equivalents

Assets transferred or pledged to securitization vehicles

Mortgage servicing rights

Principal and interest receivable

Debt issued by securitization vehicles (non-recourse)

Other secured financing

Payable for unsettled trades

Interest payable

Other liabilities

Total liabilities

December 31, 2019

Commercial Trusts

Residential Trusts

(dollars in thousands)

Cash and cash equivalents

Assets transferred or pledged to securitization vehicles

Mortgage servicing rights

Principal and interest receivable

Debt issued by securitization vehicles (non-recourse)

Other secured financing

Payable for unsettled trades

Interest payable

Other liabilities

Total liabilities

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

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

Securitized Loans at Fair Value Geographic Concentration of Credit Risk

Commercial Trusts

Residential Trusts

Property Location

Principal Balance

Property Location

Principal Balance

(dollars in thousands)

No individual state greater than 5% .

Real estate investments are carried at historical cost less accumulated depreciation.

Historical cost includes all costs necessary to bring the asset to the condition and location necessary for its intended use, including financing during the construction period.

Costs directly related to acquisitions deemed to be business combinations are expensed.

Ordinary repairs and maintenance are expensed as incurred.

Major replacements and improvements that extend the useful life of the asset are capitalized and depreciated over their useful life.

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

Building and building improvements

Furniture and fixtures

There was no real estate acquired in settlement of residential mortgage loans at June 30, 2020 or December 31, 2019 other than real estate held by securitization trusts that the Company was required to consolidate.

The Company would be considered to have received physical possession of residential real estate property collateralizing a residential mortgage loan, so that the loan is derecognized and the real estate property would be recognized, if either (i) the Company obtains legal title to the residential real estate property upon completion of a foreclosure or (ii) the borrower conveys all interest in the residential real estate property to the Company to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement.

Real estate investments, including REO, that do not meet the criteria to be classified as held for sale are classified in the Consolidated Statements of Financial Condition as held for investment.

Real estate held for sale is reported at the lower of its carrying value or its estimated fair value less estimated costs to sell.

Once a property is determined to be held for sale, depreciation is no longer recorded.

The Company’s real estate portfolio (REO and real estate held for investment) is reviewed on a quarterly basis, or more frequently as necessary, to assess whether there are any indicators that the value of its operating real estate may be impaired or that its carrying value may not be recoverable.

A property’s value is considered impaired if the Company’s estimate of the aggregate future undiscounted cash flows to be generated by the property is less than the carrying value of the property.

In conducting this review, the Company considers U.S.

macroeconomic factors, including real estate sector conditions, together with asset specific and other factors.

To the extent impairment has occurred and is considered to be other than temporary, the loss will be measured as the excess of the carrying amount of the property over the calculated fair value of the property.

During the six months ended June 30, 2020 , the Company entered into a deed-in-lieu of foreclosure agreement and took title of a commercial real estate property with a basis of $ 35.3 million .

There were no new acquisitions of real estate holdings during the six months ended June 30, 2019 .

No properties were sold during the six months ended June 30, 2020 .

The Company sold one of its wholly owned triple net leased properties during the six months ended June 30, 2019 for $ 6.7 million and recognized a gain on sale of $ 2.7 million .

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

The weighted average amortization period for intangible assets and liabilities at June 30, 2020 is 5.4 years.

Above market leases and leasehold intangible assets are included in Intangible assets, net and below market leases are included in Other liabilities in the Consolidated Statements of Financial Condition.

June 30, 2020

December 31, 2019

Real estate, net

(dollars in thousands)

Buildings and improvements

Furniture, fixtures and equipment

accumulated depreciation

Total real estate held for investment, at amortized cost, net

Equity in unconsolidated joint ventures

Total real estate, net

Depreciation expense was $ 6.0 million and $ 11.2 million for the three and six months ended June 30, 2020 , respectively.

Depreciation expense was $ 6.0 million and $ 11.8 million for the three and six months ended June 30, 2019 , respectively.

Depreciation expense is included in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

Rental Income

The minimum rental amounts due under leases are generally either subject to scheduled fixed increases or adjustments.

The leases generally also require that the tenants reimburse the Company for certain operating costs.

Rental income is included in Other income (loss) in the Company’s Consolidated Statements of Comprehensive Income (Loss).

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

June 30, 2020

(dollars in thousands)

2020 (remaining)

DERIVATIVE INSTRUMENTS

Derivative instruments include, but are not limited to, interest rate swaps, options to enter into interest rate swaps (“swaptions”), TBA derivatives, options on TBA securities (“MBS options”), U.S.

Treasury and Eurodollar futures contracts and certain forward purchase commitments.

The Company may also enter into other types of mortgage derivatives such as interest-only securities, credit derivatives referencing the commercial mortgage-backed securities index and synthetic total return swaps.

In connection with the Company’s investment/market rate risk management strategy, the Company economically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts, which include interest rate swaps, swaptions and futures contracts.

The Company may also enter into TBA derivatives, MBS options and U.S.

Treasury or Eurodollar futures contracts, certain forward purchase commitments and credit derivatives to economically hedge its exposure to market risks.

The purpose of using derivatives is to manage overall portfolio risk with the potential to generate additional income for distribution to stockholders.

These derivatives are subject to changes in market values resulting from changes in interest rates, volatility, Agency mortgage-backed security spreads to U.S.

Treasuries and market liquidity.

The use of derivatives also creates exposure to credit risk relating to potential losses that could be recognized if the counterparties to these instruments fail to perform their obligations under the stated contract.

Additionally, the Company may have to pledge cash or assets as collateral for the derivative transactions, the amount of which may vary based on the market value and terms of the derivative contract.

In the case of market agreed coupon

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

(“MAC”) interest rate swaps, the Company may make or receive a payment at the time of entering into such interest rate swaps, which represents fair value of these swaps, to compensate for the out of market nature of such interest rate swaps.

Subsequent changes in fair value from inception of these interest rate swaps are reflected within Unrealized gains (losses) on interest rate swaps in the Consolidated Statements of Comprehensive Income (Loss).

Similar to other interest rate swaps, the Company may have to pledge cash or assets as collateral for the MAC interest rate swap transactions.

In the event of a default by the counterparty, the Company could have difficulty obtaining its pledged collateral as well as receiving payments in accordance with the terms of the derivative contracts.

Derivatives are accounted for in accordance with FASB ASC 815, Derivatives and Hedging , which requires recognition of all derivatives as either assets or liabilities at fair value in the Consolidated Statements of Financial Condition with changes in fair value recognized in the Consolidated Statements of Comprehensive Income (Loss).

The changes in the estimated fair value are presented within Net gains (losses) on other derivatives with the exception of interest rate swaps which are separately presented.

None of the Company’s derivative transactions have been designated as hedging instruments for accounting purposes.

The Company also maintains collateral in the form of cash on margin with counterparties to its interest rate swaps and other derivatives.

In accordance with a clearing organization’s rulebook, the Company presents the fair value of centrally cleared interest rate swaps net of variation margin pledged under such transactions.

At June 30, 2020 and December 31, 2019 , $ 1.8 billion and $ 517.8 million of variation margin was reported as an adjustment to interest rate swaps, at fair value.

Interest Rate Swap Agreements – Interest rate swap agreements are the primary instruments used to mitigate interest rate risk.

In particular, the Company uses interest rate swap agreements to manage its exposure to changing interest rates on its repurchase agreements by economically hedging cash flows associated with these borrowings.

The Company may enter into interest rate swap agreements where the floating leg is linked to the London Interbank Offered Rate (“LIBOR”), the overnight index swap rate or another index.

Interest rate swap agreements may or may not be cleared through a derivatives clearing organization (“DCO”).

Uncleared interest rate swaps are fair valued using internal pricing models and compared to the counterparty market values.

Centrally cleared interest rate swaps, including MAC interest rate swaps, are generally fair valued using the DCO’s market values.

If an interest rate swap is terminated, the realized gain (loss) on the interest rate swap would be equal to the difference between the cash received or paid and fair value.

Swaptions – Swaptions are purchased or sold to mitigate the potential impact of increases or decreases in interest rates.

Interest rate swaptions provide the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay and receive interest rates in the future.

The Company’s swaptions are not centrally cleared.

The premium paid or received for swaptions is reported as an asset or liability in the Consolidated Statements of Financial Condition.

If a swaption expires unexercised, the realized gain (loss) on the swaption would be equal to the premium received or paid.

If the Company sells or exercises a swaption, the realized gain or loss on the swaption would be equal to the difference between the cash received or the fair value of the underlying interest rate swap received and the premium paid.

The fair value of swaptions are estimated using internal pricing models and compared to the counterparty market values.

TBA Dollar Rolls – TBA dollar roll transactions are accounted for as a series of derivative transactions.

The fair value of TBA derivatives is based on methods similar to those used to value Agency mortgage-backed securities.

MBS Options – MBS options are generally options on TBA contracts, which help manage mortgage market risks and volatility while providing the potential to enhance returns.

MBS options are over-the-counter traded instruments and those written on current-coupon mortgage-backed securities are typically the most liquid.

MBS options are measured at fair value using internal pricing models and compared to the counterparty market value at the valuation date.

Futures Contracts – Futures contracts are derivatives that track the prices of specific assets or benchmark rates.

Short sales of futures contracts help to mitigate the potential impact of changes in interest rates on the portfolio performance.

The Company maintains margin accounts which are settled daily with Futures Commission Merchants (“FCMs”).

The margin requirement varies based on the market value of the open positions and the equity retained in the account.

Futures contracts are fair valued based on exchange pricing.

Forward Purchase Commitments – The Company may enter into forward purchase commitments with counterparties whereby the Company commits to purchasing residential mortgage loans at a particular price, provided the residential mortgage loans close with the counterparties.

The counterparties are required to deliver the committed loans on a “best efforts” basis.

Credit Derivatives – The Company may enter into credit derivatives referencing a commercial mortgage-backed securities index, such as the CMBX index, and synthetic total return swaps.

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

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

Derivatives Instruments

June 30, 2020

December 31, 2019

(dollars in thousands)

Interest rate swaps

Interest rate swaptions

TBA derivatives

Futures contracts

Purchase commitments

Credit derivatives (1)

Interest rate swaps

TBA derivatives

Futures contracts

Purchase commitments

Credit derivatives (1)

The notional amount of the credit derivatives in which the Company purchased protection was $ 0.0 and $ 10.0 million at June 30, 2020 and December 31, 2019 , respectively.

The maximum potential amount of future payments is the notional amount of credit derivatives in which the Company sold protection of $ 495.0 million and $ 345.0 million at June 30, 2020 and December 31, 2019 , respectively, plus any coupon shortfalls on the underlying tranche.

The credit derivative tranches referencing the basket of bonds had a range of ratings between AAA and BBB-.

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

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

June 30, 2020

Current Notional (1)(2)

Weighted Average Pay Rate

Weighted Average Receive Rate

Weighted Average Years to Maturity (3)

(dollars in thousands)

Greater than 10 years

Total / Weighted average

December 31, 2019

Current Notional (1)(2)

Weighted Average

Weighted Average Receive Rate

Weighted Average Years to Maturity

(dollars in thousands)

Greater than 10 years

Total / Weighted average

As of June 30, 2020 , 17 % , 80 % and 3 % of the Company’s interest rate swaps were linked to LIBOR, the Federal funds rate and the Secured Overnight Financing Rate, respectively.

As of December 31, 2019 , 75 % and 25 % of the Company’s interest rate swaps were linked to LIBOR and the overnight index swap rate, respectively.

There were no forward starting swaps at June 30, 2020 and December 31, 2019 .

As of June 30, 2020 , the weighted average years to maturity of payer interest rate swaps is offset by the weighted average years to maturity of receiver interest rate swaps.

As such, the net weighted average years to maturity for each maturity bucket may fall outside of the range listed.

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

June 30, 2020

Current Underlying Notional

Weighted Average Underlying Fixed Rate

Weighted Average Underlying Floating Rate

Weighted Average Underlying Years to Maturity

Weighted Average Months to Expiration

(dollars in thousands)

December 31, 2019

Current Underlying Notional

Weighted Average Underlying Fixed Rate

Weighted Average Underlying Floating Rate

Weighted Average Underlying Years to Maturity

Weighted Average Months to Expiration

(dollars in thousands)

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

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

June 30, 2020

Purchase and sale contracts for derivative TBAs

Implied Cost Basis

Implied Market Value

Net Carrying Value

(dollars in thousands)

Purchase contracts

Net TBA derivatives

December 31, 2019

Purchase and sale contracts for derivative TBAs

Implied Cost Basis

Implied Market Value

Net Carrying Value

(dollars in thousands)

Purchase contracts

Sale contracts

Net TBA derivatives

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

June 30, 2020

Notional - Long

Notional - Short

Weighted Average

Years to Maturity

(dollars in thousands)

Treasury futures - 10 year and greater

December 31, 2019

Notional - Long

Notional - Short

Weighted Average

Years to Maturity

(dollars in thousands)

Treasury futures - 2 year

Treasury futures - 5 year

Treasury futures - 10 year and greater

The Company presents derivative contracts on a gross basis on the Consolidated Statements of Financial Condition.

Derivative contracts may contain legally enforceable provisions that allow for netting or setting off receivables and payables with each counterparty.

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

The following tables present information about derivative assets and liabilities that are subject to such provisions and can be offset on our Consolidated Statements of Financial Condition at June 30, 2020 and December 31, 2019 , respectively.

June 30, 2020

Amounts Eligible for Offset

Gross Amounts

Financial Instruments

Cash Collateral

(dollars in thousands)

Interest rate swaptions, at fair value

TBA derivatives, at fair value

Interest rate swaps, at fair value

TBA derivatives, at fair value

Futures contracts, at fair value

Credit derivatives

December 31, 2019

Amounts Eligible for Offset

Gross Amounts

Financial Instruments

Cash Collateral

(dollars in thousands)

Interest rate swaps, at fair value

Interest rate swaptions, at fair value

TBA derivatives, at fair value

Futures contracts, at fair value

Purchase commitments

Credit derivatives

Interest rate swaps, at fair value

TBA derivatives, at fair value

Futures contracts, at fair value

Purchase commitments

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

Location on Consolidated Statements of Comprehensive Income (Loss)

Net Interest Component of Interest Rate Swaps

Realized Gains (Losses) on Termination of Interest Rate Swaps

Unrealized Gains (Losses) on Interest Rate Swaps

For the three months ended

(dollars in thousands)

June 30, 2020

June 30, 2019

For the six months ended

June 30, 2020

June 30, 2019

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

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

Three Months Ended March 31, 2020

Three Months Ended June 30, 2020

Derivative Instruments

7 unchanged sentences

Credit derivatives

Three Months Ended March 31, 2019

Three Months Ended June 30, 2019

Derivative Instruments

7 unchanged sentences

Credit derivatives

Six Months Ended June 30, 2020

Derivative Instruments

Realized Gain (Loss)

Unrealized Gain (Loss)

Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives

(dollars in thousands)

Net TBA derivatives

Net interest rate swaptions

Purchase commitments

Credit derivatives

Six Months Ended June 30, 2019

Derivative Instruments

Realized Gain (Loss)

Unrealized Gain (Loss)

Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives

(dollars in thousands)

Net TBA derivatives

Net interest rate swaptions

Purchase commitments

Credit derivatives

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

Upon the occurrence of any one of items (i) through (iv), or another default under the agreement, the counterparty to the applicable agreement has a right to terminate the agreement in accordance with its provisions.

The aggregate fair value of all derivative instruments with the aforementioned features that are in a net liability position at March 31, 2020 was approximately $ 1.1 billion , which represents the maximum amount the Company would be required to pay upon termination.

The aggregate fair value of all derivative

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

instruments with the aforementioned features that are in a net liability position at June 30, 2020 was approximately $ 1.1 billion , which represents the maximum amount the Company would be required to pay upon termination.

This amount is fully collateralized.

28 unchanged sentences

These valuations primarily utilize discounted cash flow models that incorporate unobservable market data inputs including prepayment rates, delinquency levels, costs to service and discount rates.

Model valuations are then compared to valuations obtained from third-party pricing providers.

Management reviews the valuations received from third-party pricing providers and uses them as a point of comparison to modeled values.

The valuation of MSRs requires significant judgment by management and the third-party pricing providers.

Assumptions used for which there is a lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s financial statements.

Model valuations are then compared to valuations obtained from third-

ANNALY CAPITAL MANAGEMENT, INC.

1 unchanged sentence

Financial Statements

party pricing providers.

Management reviews the valuations received from third-party pricing providers and uses them as a point of comparison to modeled values.

The valuation of MSRs requires significant judgment by management and the third-party pricing providers.

Assumptions used for which there is a lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s financial statements.

The following tables present the estimated fair values of financial instruments and MSRs measured at fair value on a recurring basis.

There were no transfers between levels of the fair value hierarchy during the periods presented.

March 31, 2020

June 30, 2020

(dollars in thousands)

30 unchanged sentences

Total liabilities

ANNALY CAPITAL MANAGEMENT, INC.

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Financial Statements

Quantitative Information about Level 3 Fair Value Measurements

2 unchanged sentences

The sensitivities of significant unobservable inputs along with interrelationships between and among the significant unobservable inputs and their impact on the fair value measurements are described below.

The effect of a change in a particular assumption in the sensitivity analysis below is considered

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

independently from changes in any other assumptions.

The effect of a change in a particular assumption in the sensitivity analysis below is considered independently from changes in any other assumptions.

In practice, simultaneous changes in assumptions may not always have a linear effect on the inputs discussed below.

7 unchanged sentences

The table does not give effect to the Company’s risk management practices that might offset risks inherent in these Level 3 investments.

March 31, 2020

June 30, 2020

December 31, 2019

23 unchanged sentences

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

The following table summarizes the estimated fair values for financial assets and liabilities that are not carried at fair value at March 31, 2020 and December 31, 2019 .

March 31, 2020

The following table summarizes the estimated fair values for financial assets and liabilities that are not carried at fair value at June 30, 2020 and December 31, 2019 .

June 30, 2020

December 31, 2019

9 unchanged sentences

Commercial real estate debt and preferred equity, held for investment, corporate debt, held for investment and mortgage payable are valued using Level 3 inputs.

The carrying values of short term repurchase agreements and other secured financing approximates fair value.

Long term repurchase agreements and other secured financing are valued using Level 2 inputs.

The carrying values of repurchase agreements and short term other secured financing approximates fair value and are considered Level 2 fair value measurements.

Long term other secured financing are valued using Level 2 inputs.

GOODWILL AND INTANGIBLE ASSETS

2 unchanged sentences

The purchase prices are allocated to the assets acquired, including identifiable intangible assets, and the liabilities assumed based on their estimated fair values at the date of acquisition.

The excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill.

The excess of the purchase price

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

over the fair value of the net assets acquired is recognized as goodwill.

Conversely, any excess of the fair value of the net assets acquired over the purchase price is recognized as a bargain purchase gain.

2 unchanged sentences

The quantitative impairment test for goodwill utilizes a two-step approach, whereby the Company compares the carrying value of each identified reporting unit to its fair value.

If the carrying value of the reporting unit

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

is greater than its fair value, the second step is performed, where the implied fair value of goodwill is compared to its carrying value.

If the carrying value of the reporting unit is greater than its fair value, the second step is performed, where the implied fair value of goodwill is compared to its carrying value.

The Company recognizes an impairment charge for the amount by which the carrying amount of goodwill exceeds its fair value.

At March 31, 2020 and December 31, 2019 , goodwill totaled $ 71.8 million .

At June 30, 2020 and December 31, 2019 , goodwill totaled $ 71.8 million .

Intangible assets, net

Finite life intangible assets are amortized over their expected useful lives.

The following table presents the activity of finite lived intangible assets for the three months ended March 31, 2020 .

As part of the Internalization, which closed on June 30, 2020 , the Company recognized an intangible asset for the acquired assembled workforce of approximately $ 41 million , and accrued liabilities and cash that were recognized on the legal entity acquired.

The following table presents the activity of finite lived intangible assets for the six months ended June 30, 2020 .

Intangible Assets, net

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amortization expense

Balance at March 31, 2020

Balance at June 30, 2020

SECURED FINANCING

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The Company reports cash flows on repurchase agreements as financing activities and cash flows on reverse repurchase agreements as investing activities in the Consolidated Statements of Cash Flows.

The Company had outstanding $ 72.6 billion and $ 101.7 billion of repurchase agreements with weighted average borrowing rates of 1.91 % and 1.99 % , after giving effect to the Company’s interest rate swaps used to hedge cost of funds, and weighted average remaining maturities of 48 days and 65 days at March 31, 2020 and December 31, 2019 , respectively.

The Company has select arrangements with counterparties to enter into repurchase agreements for $ 1.6 billion with remaining capacity of $ 1.2 billion at March 31, 2020 .

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

March 31, 2020

The Company had outstanding $ 67.2 billion and $ 101.7 billion of repurchase agreements with weighted average borrowing rates of 0.70 % and 1.99 % , after giving effect to the Company’s interest rate swaps used to hedge cost of funds, and weighted average remaining maturities of 74 days and 65 days at June 30, 2020 and December 31, 2019 , respectively.

The Company has select arrangements with counterparties to enter into repurchase agreements for $ 2.1 billion with remaining capacity of $ 1.7 billion at June 30, 2020 .

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

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

June 30, 2020

Agency Mortgage-Backed Securities

Non-Agency Mortgage-Backed Securities

Residential Mortgage Loans

Commercial Loans

Commercial Mortgage-Backed Securities

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Over 119 days (1)

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

December 31, 2019

8 unchanged sentences

Over 119 days (1)

No repurchase agreements had a remaining maturity over 1 year at March 31, 2020 and December 31, 2019 .

The following table summarizes the gross amounts of reverse repurchase agreements and repurchase agreements, amounts offset in accordance with netting arrangements and net amounts of repurchase agreements and reverse repurchase agreements as presented in the Consolidated Statements of Financial Condition at March 31, 2020 and December 31, 2019 .

Approximately 1 % of total repurchase agreements had a remaining maturity over one year at June 30, 2020 .

No repurchase agreements had a remaining maturity over one year at December 31, 2019 .

Refer to the “Derivative Instruments” Note for information related to the effect of netting arrangements on the Company’s derivative instruments.

March 31, 2020

June 30, 2020

December 31, 2019

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Borrowings from FHLB Des Moines are reported in Other secured financing in the Company’s Consolidated Statements of Financial Condition.

At March 31, 2020 , $ 0.9 billion of advances from the FHLB Des Moines mature in less than one year.

At December 31, 2019 , $ 1.4 billion of advances from the FHLB Des Moines matured in less than one year and $ 2.1 billion mature between one to three years .

The weighted average rate of the advances from the FHLB Des Moines was 2.04 % and 2.16 % at March 31, 2020 and December 31, 2019 , respectively.

The Company held $ 38.6 million and $ 147.9 million of capital stock in the FHLB Des Moines at March 31, 2020 and December 31, 2019 , respectively, which is reported at cost and included in Other assets on the Company’s Consolidated Statements of Financial Condition.

Investments pledged as collateral under secured financing arrangements and interest rate swaps, excluding residential and senior securitized commercial mortgage loans of consolidated VIEs, had an estimated fair value and accrued interest of $ 80.0 billion and $ 254.6 million , respectively, at March 31, 2020 and $ 112.8 billion and $ 357.9 million , respectively, at December 31, 2019 .

At June 30, 2020 , $ 0.6 billion of advances from the FHLB Des Moines matured in less than one year .

At December 31, 2019 , $ 1.4 billion of advances from the FHLB Des Moines matured in less than one year and $ 2.1 billion matured between one to three years .

The weighted average rate of the advances from the FHLB Des Moines was 1.55 % and 2.16 % at June 30, 2020 and December 31, 2019 , respectively.

The Company held $ 28.8 million and $ 147.9 million of capital stock in the FHLB Des Moines at June 30, 2020 and December 31, 2019 , respectively, which is reported at cost and included in Other assets on the Company’s Consolidated Statements of Financial Condition.

Investments pledged as collateral under secured financing arrangements and interest rate swaps, excluding residential and senior securitized commercial mortgage loans of consolidated VIEs, had an estimated fair value and accrued interest of $ 74.3 billion and $ 225.8 million , respectively, at June 30, 2020 and $ 112.8 billion and $ 357.9 million , respectively, at December 31, 2019 .

ANNALY CAPITAL MANAGEMENT, INC.

1 unchanged sentence

Financial Statements

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

March 31, 2020

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

June 30, 2020

Carrying Value

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1/1/2048 and 1/1/2053

The following table details future mortgage loan principal payments at March 31, 2020 :

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

Mortgage Loan Principal Payments

5 unchanged sentences

CAPITAL STOCK

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

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

Shares authorized

Shares issued and outstanding

March 31, 2020

June 30, 2020

December 31, 2019

March 31, 2020

June 30, 2020

December 31, 2019

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1,430,106,199

During the three months ended March 31, 2019 , the Company closed the public offering of an original issuance of 75.0 million shares of common stock for proceeds of $ 730.5 million before deducting offering expenses.

During the six months ended June 30, 2019 , the Company closed the public offering of an original issuance of 75.0 million shares of common stock for proceeds of $ 730.5 million before deducting offering expenses.

In connection with the offering, the Company granted the underwriters a thirty-day option to purchase up to an additional 11.3 million shares of common stock, which the underwriters exercised in full resulting in an additional $ 109.6 million in proceeds before deducting offering expenses.

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

No shares were purchased pursuant to this authorization during the three months ended March 31, 2020 .

During the three and six months ended June 30, 2020 , the Company repurchased 22.9 million shares of its common stock for an aggregate amount of $ 143.3 million , excluding commission costs, pursuant to this authorization.

All common shares were purchased in open-market transactions.

No shares were purchased pursuant to this authorization during the three and six months ended June 30, 2019 .

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

Three Months Ended

March 31, 2020

March 31, 2019

Six Months Ended

June 30, 2020

June 30, 2019

(dollars in thousands)

1 unchanged sentence

Amount raised from direct purchase and dividend reinvestment program

In January 2018, the Company entered into separate Distribution Agency Agreements (collectively, the “Sales Agreements”) with each of Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith, Incorporated, Barclays Capital Inc., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Goldman Sachs & Co.

In January 2018, the Company entered into separate Distribution Agency Agreements (collectively, the “Sales Agreements”) with each of Wells Fargo Securities, LLC, BofA Securities, Inc.

(formerly known as Merrill Lynch, Pierce, Fenner & Smith, Incorporated), Barclays Capital Inc., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Goldman Sachs & Co.

Morgan Securities LLC, Keefe, Bruyette & Woods, Inc., RBC Capital Markets, LLC and UBS Securities LLC (the “Sales Agents”).

The Company may offer and sell shares of its common stock, having an aggregate offering price of up to $ 1.5 billion from time to time through any of the Sales Agents.

No shares were issued under the at-the-market sales program during the three months ended March 31, 2020 .

During the three months ended March 31, 2019 , the Company issued 48.0 million shares for proceeds of $ 489.0 million , net of commissions and fees, under the at-the-market sales program.

No shares were issued under the at-the-market sales program during the six months ended June 30, 2020 .

During the three and six months ended June 30, 2019 , the Company issued 8.0 million shares and 56.0 million , respectively, for proceeds of $ 80.1 million and $ 569.1 million , respectively, net of commissions and fees, under the at-the-market sales program.

Preferred Stock

The following is a summary of the Company’s cumulative redeemable preferred stock outstanding at March 31, 2020 and December 31, 2019 .

The following is a summary of the Company’s cumulative redeemable preferred stock outstanding at June 30, 2020 and December 31, 2019 .

In the event of a liquidation or dissolution of the Company, the Company’s then outstanding preferred stock takes precedence over the Company’s common stock with respect to payment of dividends and the distribution of assets.

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Floating Annual Rate

March 31, 2020

June 30, 2020

December 31, 2019

March 31, 2020

June 30, 2020

December 31, 2019

March 31, 2020

June 30, 2020

December 31, 2019

6 unchanged sentences

Each series of preferred stock has a par value of $ 0.01 per share and a liquidation and redemption price of $ 25.00 , plus accrued and unpaid dividends through their redemption date.

Through March 31, 2020 , the Company had declared and paid all required quarterly dividends on the Company’s preferred stock.

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

During the three and six months ended June 30, 2019 , the Company redeemed all 2.2 million of its issued and outstanding shares of 8.125 % Series H Cumulative Redeemable Preferred Stock (“Series H Preferred Stock”) for $ 55.0 million .

The cash redemption amount for each share of Series H Preferred Stock was $ 25.00 plus accrued and unpaid dividends to, but not including, the redemption date of May 31, 2019.

During the three and six months ended June 30, 2019 , the Company issued 16.0 million shares of its 6.750 % Seri es I Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (“Series I Preferred Stock”) for gross proceeds o f $ 400.0 million befo re deducting the underwriting discount and other estimated offering expenses.

In connection with the offering, the Company granted the underwriters a thirty-day option to purchase up to an additional 2.4 million shares of Series I Preferred Stock solely to cover over-allotments.

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

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

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

For the Three Months Ended

March 31, 2020

March 31, 2019

For the Six Months Ended

June 30, 2020

June 30, 2019

June 30, 2020

June 30, 2019

(dollars in thousands, except per share data)

4 unchanged sentences

Date of distributions paid to common stockholders after period end

April 30, 2020

April 30, 2019

July 31, 2020

July 31, 2019

July 31, 2020

July 31, 2019

Dividends declared to series C preferred stockholders

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Dividends declared per share of series I preferred stock

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

INTEREST INCOME AND INTEREST EXPENSE

17 unchanged sentences

(3) Effective yield is recalculated for differences between estimated and actual prepayments and the amortized cost is adjusted as if the new effective yield had been applied since inception.

The following presents the components of the Company’s interest income and interest expense for the three months ended March 31, 2020 and March 31, 2019 .

For the Three Months Ended March 31,

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

The following presents the components of the Company’s interest income and interest expense for the three and six months ended June 30, 2020 and June 30, 2019 .

For the Three Months Ended June 30,

For the Six Months Ended June 30,

Interest income

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NET INCOME (LOSS) PER COMMON SHARE

The following table presents a reconciliation of net income (loss) and shares used in calculating basic and diluted net income (loss) per share for the three months ended March 31, 2020 and March 31, 2019 .

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

The following table presents a reconciliation of net income (loss) and shares used in calculating basic and diluted net income (loss) per share for the three and six months ended June 30, 2020 and June 30, 2019 .

For the Three Months Ended

March 31, 2020

March 31, 2019

For the Six Months Ended

June 30, 2020

June 30, 2019

June 30, 2020

June 30, 2019

(dollars in thousands, except per share data)

7 unchanged sentences

1,456,038,736

1,427,451,716

1,427,485,102

Effect of stock awards, if dilutive

2 unchanged sentences

1,456,038,736

1,427,451,716

1,427,485,102

Net income (loss) per share available (related) to common share

The computations of diluted net income (loss) per share available (related) to common share for the three months ended March 31, 2020 excludes 0.1 million of potentially dilutive restricted stock units and the three months ended March 31, 2019 excludes options to purchase 0.2 million shares of common stock, due to the anti-dilutive effect.

For the three months ended March 31, 2020 the Company was qualified to be taxed as a REIT under Code Sections 856 through 860.

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

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

For the three months ended June 30, 2020 the Company was qualified to be taxed as a REIT under Code Sections 856 through 860.

As a REIT, the Company will not incur federal income tax to the extent that it distributes its taxable income to its stockholders.

To maintain qualification as a REIT, the Company must distribute at least 90% of its annual REIT taxable income to its stockholders and meet certain other requirements that relate to, among other things, assets it may hold, income it may generate and its stockholder composition.

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

It is generally the Company’s policy to distribute 100 % of its REIT taxable income.

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The Company does not have any unrecognized tax benefits that would affect its financial position.

Thus, no accruals for penalties and interest were deemed necessary at March 31, 2020 and December 31, 2019 .

Thus, no accruals for penalties and interest were deemed necessary at June 30, 2020 and December 31, 2019 .

The state and local tax jurisdictions for which the Company is subject to tax-filing obligations recognize the Company’s status as a REIT, and therefore, the Company generally does not pay income tax in such jurisdictions.

1 unchanged sentence

The Company’s TRSs are subject to federal, state and local taxes.

During the three months ended March 31, 2020 and March 31, 2019 , the Company recorded ($ 26.7 ) million and $ 2.6 million , respectively, of income tax expense (benefit) attributable to its TRSs.

During the three and six months ended June 30, 2020 , the Company recorded $ 2.1 million and ($ 24.6 ) million , respectively, of income tax expense (benefit) attributable to its TRSs.

During the three and six months ended June 30, 2019 , the Company recorded ($ 5.9 ) million and ($ 3.3 ) million , respectively of income tax benefit attributable to its TRSs.

The Company’s federal, state and local tax returns from 2016 and forward remain open for examination.

17 unchanged sentences

The Company has established policies and procedures for mitigating credit risk, including reviewing and establishing limits for credit exposure, limiting transactions with specific counterparties, maintaining qualifying collateral and continually assessing the creditworthiness of issuers, borrowers, tenants and counterparties.

The conditions related to Coronavirus Disease 2019 (“COVID-19”) could further impact the aforementioned primary risks to the Company.

The significant decrease in economic activity and/or the resulting decline in the housing market could have an adverse

ANNALY CAPITAL MANAGEMENT, INC.

1 unchanged sentence

Financial Statements

effect on the value of the Company’s investments in mortgage real estate-related assets, particularly residential real estate assets.

The conditions related to Coronavirus Disease 2019 (“COVID-19”) could further impact the aforementioned primary risks to the Company.

The significant decrease in economic activity and/or the resulting decline in the housing market could have an adverse effect on the value of the Company’s investments in mortgage real estate-related assets, particularly residential real estate assets.

Further, borrowers may experience difficulties meeting their obligations or seek to forbear payment on or refinance their mortgage loans to avail themselves of lower rates which may have an adverse impact on the value of the Company’s mortgage real estate related-assets.

4 unchanged sentences

RELATED PARTY TRANSACTIONS

Management Agreement

On February 12, 2020, the Company entered an internalization agreement (the “Internalization Agreement”) with the Manager and certain affiliates of the Manager.

Closing of the Internalization and Termination of Management Agreement

On February 12, 2020, the Company entered into an internalization agreement (the “Internalization Agreement”) with the Manager and certain affiliates of the Manager.

Pursuant to the Internalization Agreement, the Company agreed to acquire all of the outstanding equity interests of the Manager and the Manager’s direct and indirect parent companies from their respective owners (the “Internalization”) for nominal cash consideration ($1.00).

Upon closing of the Internalization, the Management Agreement will be terminated.

If the closing does not occur, the Management Agreement will remain in place on the terms and conditions described herein.

Until the closing of the Internalization, management of the Company will continue to be conducted by the Manager through the authority delegated to it in the Management Agreement and pursuant to the policies established by the Board.

In connection with the closing of the Internalization, on June 30, 2020, the Company acquired all of the assets and liabilities of the Manager (the net effect of which was immaterial in amount), and the Company transitioned from an externally-managed real estate investment trust (“REIT”) to an internally-managed REIT.

At the closing, all employees of the Manager became employees of the Company.

The parties also terminated the Amended and Restated Management Agreement by and between the Company and the Manager (the “Management Agreement”) and therefore the Company no longer pays a management fee to, or reimburses expenses of, the Manager.

Pursuant to the Internalization Agreement, the Manager waived any Acceleration Fee (as defined in the Management Agreement).

Prior to the closing of the Internalization, management of the Company was conducted by the Manager through the authority delegated to it in the Management Agreement and pursuant to the policies established by the Board.

The management agreement was amended and restated on August 1, 2018, and further amended on March 27, 2019 (the management agreement, as amended and restated, is referred to as “Management Agreement”).

Until the closing of the Internalization, the Manager, under the Management Agreement and subject to the supervision and direction of the Board, is responsible for (i) the selection, purchase and sale of assets for the Company’s investment portfolio;

Prior to the closing of the Internalization, the Manager, under the Management Agreement and subject to the supervision and direction of the Board, was responsible for (i) the selection, purchase and sale of assets for the Company’s investment portfolio;

(ii) recommending alternative forms of capital raising;

1 unchanged sentence

and (iv) day to day management functions.

The Manager also performs such other supervisory and management services and activities relating to the Company’s assets and operations as may be appropriate.

In exchange for the management services, the Company pays the Manager a monthly management fee, and the Manager is responsible for providing personnel to manage the Company.

Prior to the most recent amendment to the Management Agreement, which was executed on March 27, 2019, the Company had paid the Manager a flat monthly management fee equal to 1/12th of 1.05% of Stockholders' Equity (as defined in the Management Agreement) for its management services.

Pursuant to the March 27, 2019 amendment to the Management Agreement, the Company now, and until the closing of the Internalization, pays the Manager a monthly management fee for its management services in an amount equal to 1/12th of the sum of (i) 1.05% of Stockholders' Equity (as defined in the Management Agreement) up to $ 17.28 billion , and (ii) 0.75 % of Stockholders' Equity (as defined in the Management Agreement) in excess of $ 17.28 billion .

The Company does not pay the Manager any incentive fees.

For the three months ended March 31, 2020 and 2019 , the compensation and management fee was $ 40.8 million and $ 44.8 million , respectively.

The Manager also performed such other supervisory and management services and activities relating to the Company’s assets and operations as appropriate.

In exchange for the management services, the Company paid the Manager a monthly management fee, and the Manager was responsible for providing personnel to manage the Company.

Prior to the amendment to the Management Agreement, that was executed on March 27, 2019, the Company had paid the Manager a flat monthly management fee equal to 1/12th of 1.05% of Stockholders' Equity (as defined in the Management Agreement) for its management services.

Pursuant to the March 27, 2019 amendment to the Management Agreement, until the closing of the Internalization, the Company paid the Manager a monthly management fee for its management services in an amount equal to 1/12th of the sum of (i) 1.05% of Stockholders' Equity (as defined in the Management Agreement) up to $ 17.28 billion , and (ii) 0.75 % of Stockholders' Equity (as defined in the Management Agreement) in excess of $ 17.28 billion .

The Company did not pay the Manager any incentive fees.

For the three and six months ended June 30, 2020 , the compensation and management fee was $ 37.0 million and $ 77.9 million , respectively.

For the three and six months ended June 30, 2019 , the compensation and management fee was $ 44.2 million and $ 89.1 million , respectively.

Following the unanimous approval of the Company’s independent directors (the “Independent Directors”), in August 2018, the Company began reimbursing the Manager for certain services in connection with the management and operations of the Company and its subsidiaries as permitted under the terms of the Management Agreement.

Such reimbursable expenses include the cost for certain legal, tax, accounting and other support and advisory services provided by employees of the Manager to the Company.

Pursuant to the Management Agreement, until the closing of the Internalization, the Company may reimburse the Manager for the cost of such services, provided such costs are no greater than those that would be payable to comparable third party providers.

Expense reimbursements and related waivers are routinely reviewed with the Audit Committee of the Board in conformance with established policies.

Reimbursement payments to the Manager were $ 7.1 million for the three months ended March 31, 2020 and 2019.

None of the reimbursement payments are attributable to compensation of the Company’s executive officers.

At March 31, 2020 and December 31, 2019 the Company had amounts payable to the Manager of $ 13.9 million and $ 15.8 million , respectively.

The Management Agreement’s current term ends on December 31, 2021 and, if the closing of the Internalization does not occur, will automatically renew for successive two -year terms unless at least two-thirds of the Independent Directors or the holders of a

Such reimbursable expenses included the cost for certain legal, tax, accounting and other support and advisory services provided by employees of the Manager to the Company.

Pursuant to the Management Agreement, until the closing of the Internalization, the Company reimbursed the Manager for the cost of such services, provided such costs were no greater than those that would be payable to comparable third party providers.

ANNALY CAPITAL MANAGEMENT, INC.

1 unchanged sentence

Financial Statements

majority of the outstanding shares of the Company’s common stock in their sole discretion elect to terminate the agreement for any or no reason upon 365 days prior written notice (such notice, a “Termination Notice”).

If the Company makes an election to terminate the Management Agreement as described above, the Company may elect to accelerate the termination date (the “Termination Date”) to a date that is between seven and 90 days after the date of the Company’s delivery of a Termination Notice (the “Notice Delivery Date”).

If the Company does not make an election to accelerate the Termination Date, then the Manager may elect to accelerate the Termination Date to the date that is 90 days after the Notice Delivery Date.

If the Termination Date is accelerated (such date, the “Accelerated Termination Date”) by either the Company or the Manager, in addition to any amounts accrued for the period prior to the Accelerated Termination Date, the Company shall pay the Manager an acceleration fee (the “Acceleration Fee”) in an amount equal to the average annual management fee earned by the Manager during the 24-month period immediately preceding such Accelerated Termination Date multiplied by a fraction with a numerator of 365 minus the number of days from the Notice Delivery Date to the Accelerated Termination Date, and a denominator of 365.

The Management Agreement may also be terminated by the Manager for any reason or no reason upon 365 days prior written notice, or with shorter notice periods by either the Company or the Manager for cause or by the Company in the event of a sale of the Manager that was not pre-approved by the Independent Directors.

The Management Agreement may be amended or modified by agreement between the Company and the Manager.

Expense reimbursements and related waivers were routinely reviewed with the Audit Committee of the Board in conformance with established policies.

For the three and six months ended June 30, 2020 , reimbursement payments to the Manager were $ 7.1 million and $ 14.2 million , respectively.

For the three and six months ended June 30, 2019 , reimbursement payments to the Manager were $ 7.1 million and $ 14.3 million , respectively.

None of the reimbursement payments were attributable to compensation of the Company’s executive officers.

At June 30, 2020 and December 31, 2019 the Company had amounts payable to the Manager of $ 0.0 million and $ 15.8 million , respectively.

LEASE COMMITMENTS AND CONTINGENCIES

4 unchanged sentences

The Company recognizes lease expense for these leases on a straight-line basis over the lease term.

The lease cost for the three months ended March 31, 2020 was $ 0.8 million .

Supplemental information related to leases as of and for the three months ended March 31, 2020 was as follows:

The lease cost for the three and six months ended June 30, 2020 was $ 0.8 million and $ 1.6 million , respectively.

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

Operating Leases

Classification

March 31, 2020

June 30, 2020

(dollars in thousands)

17 unchanged sentences

Contingencies

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Financial Statements

From time to time, the Company is involved in various claims and legal actions arising in the ordinary course of business.

In the opinion of management, the ultimate disposition of these matters will not have a material effect on the Company’s consolidated financial statements.

There were no material contingencies at March 31, 2020 and December 31, 2019 .

There were no material contingencies at June 30, 2020 and December 31, 2019 .

ANNALY CAPITAL MANAGEMENT, INC.

12 unchanged sentences

As a member of the Financial Industry Regulatory Authority (“FINRA”), Arcola is required to maintain a minimum net capital balance.

At March 31, 2020 Arcola had a minimum net capital requirement of $ 0.3 million .

At June 30, 2020 Arcola had a minimum net capital requirement of $ 0.3 million .

Arcola consistently operates with capital in excess of its regulatory capital requirements.

Arcola’s regulatory net capital as defined by SEC Rule 15c3-1 at March 31, 2020 was $ 409.0 million with excess net capital of $ 408.7 million .

Arcola’s regulatory net capital as defined by SEC Rule 15c3-1 at June 30, 2020 was $ 421.7 million with excess net capital of $ 421.4 million .

SUBSEQUENT EVENTS

In July 2020, the Company repurchased 4.8 million shares of its common stock for an aggregate amount of $ 31.3 million , excluding commission costs, under the Company’s stock repurchase program.

In July 2020, the Company completed and closed the securitization of residential mortgage loans, OBX 2020-EXP2 Trust, with a face value of $ 489.4 million .

The securitization represented a financing transaction which provided non-recourse financing to the Company collateralized by residential mortgage loans purchased by the Company.

In July 2020, the Company entered into an additional credit facility for residential mortgage loans with a third party financial institution.

The borrowing limit on this facility is $ 250 million .

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federal income tax purposes;

and our ability to maintain our exemption from registration under the Investment Company Act;

and risks and uncertainties associated with the Internalization, including but not limited to the occurrence of any event, change or other circumstances that could give rise to the termination of the Internalization Agreement;

the outcome of any legal proceedings that may be instituted against the parties to the Internalization Agreement;

the inability to complete the Internalization due to the failure to satisfy closing conditions or otherwise;

risks that the Internalization disrupts our current plans and operations;

the impact, if any, of the announcement or pendency of the Internalization on our relationships with third parties;

and the amount of the costs, fees, expenses charges related to the Internalization;

our ability to maintain our exemption from registration under the Investment Company Act;

and the risk that the expected benefits, including long-term cost savings, of the Internalization are not achieved.

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Our principal business objective is to generate net income for distribution to our stockholders and optimize our returns through prudent management of our diversified investment strategies.

We are a Maryland corporation founded in 1997 that has elected to be taxed as a REIT.

Until the closing of the Internalization (as defined below), we will continue to be externally managed by the Manager.

We are an internally-managed Maryland corporation founded in 1997 that has elected to be taxed as a REIT.

Prior to the closing of the Internalization (as defined below) on June 30, 2020, we were externally managed by Annaly Management Company LLC (the “Manager”).

Our common stock is listed on the New York Stock Exchange under the symbol “NLY.”

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Recent Developments

Internalization

On February 12, 2020, we entered into the Internalization Agreement with our Manager and certain affiliates of our Manager.

Pursuant to the Internalization Agreement, we agreed to acquire all of the outstanding equity interests of our Manager and our Manager’s direct and indirect parent companies from their respective owners (the “Internalization”) for a nominal cash purchase price of one dollar ($1.00).

As a result of the Internalization, our Manager will cease to perform any outside management services for us and we will become an internally-managed REIT.

We anticipate that the closing will occur in the second quarter of 2020.

Closing of the Internalization and Termination of Management Agreement

On February 12, 2020, the Company entered an internalization agreement (the “Internalization Agreement”) with the Manager and certain affiliates of the Manager.

In connection with the closing of the Internalization, on June 30, 2020, Annaly acquired all of the assets and liabilities of the Manager (the net effect of which was immaterial in amount), and Annaly transitioned from an externally-managed real estate investment trust (“REIT”) to an internally-managed REIT.

At the closing, all employees of the Manager became employees of Annaly.

The parties terminated the Amended and Restated Management Agreement by and between Annaly and the Manager (the “Management Agreement”) and therefore we no longer pay a management fee to, or reimburse expenses of, the Manager.

Pursuant to the Internalization Agreement, the Manager waived any Acceleration Fee (as defined in the Management Agreement).

In connection with the Internalization, we entered into employment and severance contracts with our executive officers (other than Mr.

Votek) that will become effective at the closing of the Internalization.

In addition, the Management Agreement will be terminated at the closing of the Internalization, and our Manager has agreed to waive any Acceleration Fee (as defined in the Management Agreement) solely as related to the closing of the Internalization.

If the closing does not occur, the Management Agreement will revert to the form it was in immediately prior to the execution of the Internalization Agreement in all respects, including with respect to the Acceleration Fee.

Upon closing of the Internalization, all employees of the Manager will become employees of Annaly, Annaly will no longer pay a management fee to the Manager, and Annaly going forward will pay the compensation of all employees.

The Internalization Agreement and the related transactions and agreements were approved by our board of directors (“Board”), with the unanimous approval of the independent directors of the Board, following the unanimous recommendation of the Special Committee.

Both the Special Committee and the Manager obtained advice from separate legal and independent financial advisors.

The Special Committee was also assisted by an independent compensation consultant that was retained by the Compensation Committee in connection with the employment arrangements discussed above.

The consummation of the Internalization is subject to the satisfaction or waiver of certain conditions and may not close on the terms or under the conditions described in this Quarterly Report on Form 10-Q, or at all.

For more information regarding the Internalization, the Internalization Agreement and the various related employment arrangement with our employees (including our senior management), please see our Current Report on Form 8-K filed with the SEC on February 12, 2020.

Appointment of Chief Executive Officer

On March 13, 2020, the Board appointed our Chief Investment Officer David L.

Finkelstein as Chief Executive Officer and elected Mr.

Finkelstein as a member of the Board.

On the same date, Glenn A.

Votek stepped down as our Interim Chief Executive Officer and President and was appointed to the role of Senior Advisor for an interim period to assist in the transition of his duties to Mr.

Votek continues to serve as a member of the Board.

Votek) that became effective at the closing of the Internalization.

Strategic Relationships

In line with our focus on establishing and growing strategic relationships with industry leading partners, during the second quarter of 2020, we entered into a relationship with GIC Private Limited, a leading Sovereign Wealth Fund, through the creation of a joint venture with the purpose of investing in residential credit assets, including newly-originated residential loans and securities issued by our subsidiaries.

Retirement of Glenn A.

Votek from Senior Advisor Role

Votek, our former Interim Chief Executive Officer and President, was appointed to the role of Senior Advisor to Annaly on March 13, 2020 to assist with the leadership transition upon the promotion of Mr.

Finkelstein as our Chief Executive Officer.

Votek has notified Annaly of his intention to retire from his role as Senior Advisor effective August 31, 2020.

Votek will continue to serve as a member of our Board of Directors following his retirement as Senior Advisor.

Appointment of Chief Operating Officer

On June 30, 2020, Steven F.

Campbell was appointed as our Chief Operating Officer.

Campbell joined Annaly in April 2015 and was most recently serving as the Head of Business Operations.

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

Description of pandemic

The first quarter of 2020 marked a global outbreak of COVID-19.

The COVID-19 outbreak was declared a pandemic by the World Health Organization on March 11, 2020, and on March 13, 2020, President Trump declared a national emergency in the United States.

These conditions have caused a significant disruption in the U.S.

and world economies.

To slow the spread of COVID-19, many countries, including the U.S., have implemented social distancing measures, which have prohibited large gatherings, including at sporting events, movie theaters, religious services and schools, and many regions, including the majority of U.S.

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required additional measures, such as shelter-in-place and stay-at-home orders.

In certain U.S.

cities and states, the COVID-19 outbreak has caused a near total cessation of all non-essential economic activity.

Many businesses have moved to a remote working environment, temporarily suspended operations, laid off a significant percentage of their workforce and/or shut down completely.

These conditions are expected to continue over the near term and may prevail throughout 2020.

Impact on global and U.S.

economy, markets and sector

COVID-19 and the related social distancing measures have had a broad negative impact on the U.S.

and global economies as many businesses, particularly smaller ones within the service sector, have been forced to close, furlough and/or lay off employees.

As a result, U.S.

unemployment claims have dramatically risen at unprecedented rates.

Other economic activity, including retail sales and industrial production, have slowed as well.

Current forecasts of economic activity suggest a meaningful economic contraction in the first half of 2020, with the potential for some economic recovery later in 2020.

However, the pace, timing and strength of any recovery are unknown and difficult to predict.

Given the sharp reduction in economic activity, financial markets have seen elevated volatility across nearly every asset class.

Interest rate markets have seen yield levels decline to all-time lows, with the entire U.S.

Treasury curve out to 10-years declining to levels below one percent due to a combination of strong demand for risk-free assets and declining expectations for future inflation resulting from the economic contraction.

Meanwhile, equity markets declined sharply and credit spreads widened as expectations for corporate earnings declined and the impact of COVID-19 on credit assets remains unclear.

As the conditions created by the COVID-19 outbreak became more acute, financial markets began to experience severe dislocations and volatility.

In order to maintain adequate liquidity in preparation for the expected economic contraction, companies began to increase cash levels notably in March, in turn de-levering their businesses.

In fixed income markets specifically, this created acute selling pressures in U.S.

Treasuries and Agency MBS, the two markets with the deepest liquidity profile and hence the greatest potential for raising cash.

In order to increase liquidity, fixed income investors were compelled to sell U.S.

Treasuries and Agency MBS, given their comparative liquidity versus other fixed income assets, leading to an excess supply of these assets in need of redistribution.

Pressure in financing markets and the need to meet margin obligations created additional selling pressure in U.S.

Treasury and Agency MBS markets.

This negative feedback loop was ultimately disrupted by the Federal Reserve’s asset purchases and other institutions’ ability to invest sidelined cash at attractive valuations.

Other markets, including the market for residential credit and commercial real estate securities, also saw de-levering flows and similar cyclical feedback loops taking place, albeit on a lesser scale.

The de-levering flows impacted the Agency MBS market due to its greater liquidity relative to other less liquid asset classes, and the sector saw meaningful underperformance versus comparable hedges for a short period of time in mid-March.

Other securitized asset markets saw similar dramatic underperformance in pricing.

Policy makers’ actions appear to have stabilized Agency MBS spreads and other securitized credit markets, both of which tightened meaningfully during the last week of March and continuing into the second quarter of 2020.

The less liquid markets that make up a significant portion of our credit portfolio, such as the residential whole loan, the commercial real estate loan and the middle market lending markets, also experienced significant disruption over this crisis period, marked by a sharp retraction in volumes, and a lack of access to credit for borrowers.

Fed policy and Congressional stimulus

The Federal Reserve and the U.S.

Congress have taken steps to attempt to mitigate the materially adverse economic impact from COVID-19 and the deterioration in risk sentiment in financial markets.

Similar actions have been taken by numerous governments and central banks around the globe, including many European countries, which were among the other hardest hit countries from the virus.

Specifically, in March the Federal Reserve lowered the Federal Funds Target Rate by an aggregate 1.5% to the current target range of 0-0.25%, established numerous lending facilities to support liquidity and credit intermediation including an expansion of repo operations, and restarted quantitative easing programs in U.S.

Treasuries and Agency MBS markets where the Federal Reserve announced it will make “purchases in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.” These measures have helped to support financial markets and may assist an economic recovery after the impact of the virus subsides.

In addition to monetary policy response, the U.S.

Congress has passed three rounds of fiscal stimulus measures, the most notable being the passage of the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (or “CARES Act”), which has included

The second quarter of 2020 marked an improvement in financial conditions from the first quarter, despite protracted disruptions to the U.S.

and world economies from the outbreak of COVID-19.

The COVID-19 pandemic outbreak continues to affect nearly all ways of life and nearly every aspect of the economy.

The far-reaching stimulus measures undertaken in March and April by the U.S.

Congress and the Federal Reserve (“Fed”) have helped consumers and businesses impacted to fight the pandemic and should help support an economic recovery going forward.

Indeed, following the near total cessation of all non-essential economic activity in certain U.S.

cities and states in late March and April, much of the U.S.

began to reopen businesses in the second half

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Management’s Discussion and Analysis

numerous relief measures for households and businesses directly or indirectly impacted by the virus.

Relevant to the mortgage industry, the CARES Act includes provisions for COVID-19 related temporary forbearance on federally backed mortgage loans, which allows borrowers of loans guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae to suspend making principal and interest payments for a period of up to 360 days if they are facing hardship.

Following the period, mortgage servicers would have to provide several options to impacted borrowers, including a repayment schedule or loan modification, depending on the borrowers’ circumstances.

The Federal Housing Finance Agency has affirmed that loans in COVID-19 payment forbearance plans will remain in MBS pools for at least the duration of the forbearance plans.

However, it remains unclear whether temporary forbearance will lead to permanent modifications and thus higher buyouts and prepayments in coming months on some portion of loans that are provided forbearance relief.

We consider this uncertainty when positioning our Agency MBS portfolio.

Additionally, borrowers in our residential credit portfolio are being granted COVID-19 related forbearances on their mortgage payments.

In connection with a portion of mortgage loans in our securitizations, our wholly-owned subsidiary Onslow Bay Financial LLC is responsible for advancing delinquent principal and interest to the securitization trusts for up to four months.

We expect cumulative advancing obligations related to the COVID-19 forbearances to be small relative to our overall liquidity position and that these advances may ultimately be recovered.

Active Portfolio Management During the Quarter

During the period of dislocation in March and through the end of the first quarter, maintaining a strong capital position became the primary focus of our asset and liability management strategy.

Given that our portfolio is comprised of both liquid and illiquid assets, and our funding is a mixture of recourse and non-recourse facilities, we chose to sell across our liquid securities positions, divesting first in Agency MBS securities, followed by both non-agency residential and commercial mortgage backed securities to maintain appropriate liquidity and a prudent leverage ratio.

At the same time we reduced securitized product asset holdings, we also reduced the size of our hedge portfolio to manage portfolio interest rate exposure in light of MBS duration contraction.

During the first quarter of 2020, we eliminated our futures position and reduced interest rate swaps and interest rate swaptions where prudent.

We also benefited from our receiver interest rate swaption positioning, which we had entered into late in 2019 and earlier in the first quarter of 2020, a strategy that was explicitly designed to protect us against scenarios of extreme declines in interest rate yield levels.

Following these actions, as of March 31, 2020, our portfolio consisted of 93% Agency MBS, and our total portfolio was $99.3 billion, compared to $128.7 billion at December 31, 2019, while our repo balance was accordingly reduced to $72.6 billion from $101.7 billion at December 31, 2019.

In light of portfolio repositioning, we closed the quarter with a strong liquidity position comprised of cash and unencumbered Agency MBS totaling $4.6 billion and total unencumbered assets of $6.9 billion.

The profile of our repurchase agreement portfolio remains shorter in average days relative to prior quarters, as term markets have not been as fluid in this environment.

However, the health and the liquidity in the FICC market appears relatively stable and we are able to access this financing market through our wholly-owned broker-dealer subsidiary, Arcola.

Moreover, our economic leverage at March 31, 2020 was 6.8x, 0.4x lower than at December 31, 2019.

Our repo operations remained orderly with no collateral or margining issues, and we continue to focus on protecting our capital through this period of elevated uncertainty.

While January and February saw continued activity in our new origination loan and securitization businesses, there were limited executions in our loan portfolios over the course of March as loan markets across these assets classes have abruptly come to a near-halt since the onset of the pandemic.

Our origination and underwriting teams have concentrated their efforts on continued active monitoring of our existing loans, and on maintaining outreach with our borrowers.

We engage in regular dialogue with our servicers on the residential credit portion of our portfolio, to ensure that we are keeping in line with the developing industry stance on forbearance.

We are in active contact with our sponsors and borrowers in our middle market lending portfolio, and we continue to monitor the specific economic landscape and developments that apply to these borrowers.

We believe our middle market lending portfolio is well positioned to withstand the near-term effects of the pandemic given our defensive industry composition and concentrations.

In our commercial real estate equity portfolio, we and our operating partners are in frequent communication with our tenants and lenders.

Requests for COVID-19-related relief from tenants and commercial real estate borrowers are being handled on a case-by-case basis.

All three of our lending businesses continue to engage in active dialogue with their respective credit providers and have had minimal, if any, disruptions.

of the quarter.

As a result, economic activity saw a recovery from the activity lows in May and June, though the recent spike in COVID-19 cases risks delaying a continued recovery.

The outlook for the economic recovery remains uncertain as COVID-19 cases in the U.S.

have been rising sharply in recent weeks.

While social distancing measures and the shutdown to the economy were much less significant than during the early spring months, it remains difficult to judge the recovery timeline and the degree to which changes across the economy will be structural versus just cyclical.

In the current environment, we continue to believe the Agency sector presents the most attractive investment opportunity, aided in part by the sector’s strong liquidity and lower volatility.

Given the sector’s fundamental and technical factors, we anticipate further room for spread tightening throughout the remainder of the year.

While we expect our allocation to credit to remain at the lower end of recent years allocation, we continue to evaluate opportunities to deploy capital across our three credit businesses, an analysis informed by increasing clarity into the underlying fundamentals of each credit sector.

Overall, we maintain a constructive view of the operating environment and our ability to deliver compelling returns as each of our businesses’ respective markets begin to emerge from the volatility and disruption caused by the pandemic.

Agency mortgage-backed security (“MBS”) spreads stabilized meaningfully from the extreme volatility seen in March as the Fed intervened by buying more than $830 billion gross of portfolio paydowns between March and June, to improve market functioning.

Agency MBS spreads have stabilized at levels somewhat above their average levels in 2019 as the market continues to face two major headwinds, high levels of supply and meaningfully elevated levels of prepayments, both a result of the record low in mortgage rates.

In this environment, we further increased our position in MBS to-be-announced (“TBA”) contracts as these offer attractive financing conditions given the Fed’s involvement, while simultaneously rotating out of higher coupon pools into lower coupon pools to reduce premium dollar price MBS positions.

Meanwhile, funding conditions have improved meaningfully from the stresses seen in March.

Driven by the large-scale liquidity injections from the Fed’s asset purchases and temporary repo operations, financial system liquidity rose meaningfully, in turn increasing repo counterparties’ ability to provide funding.

Moreover, with short-term interest rates at levels close to zero percent, funding costs have improved meaningfully as seen in the significant decline in the average economic cost of funds quarter over quarter.

Over the quarter, our credit business portfolios remained largely unchanged.

Market conditions improved meaningfully across all credit businesses in the second quarter, though recovery varied between individual sectors.

Residential credit saw a stronger recovery on the back of continued supply/demand imbalances in the loan and securitized product markets combined with the fading impact of forbearance policies implemented earlier this year.

Meanwhile, commercial credit investment activity remained lackluster, with investment volumes falling some estimated 80 percent year-over-year.

The reduced transaction volumes were in large part driven by continued elevated uncertainties around Commercial Real Estate (“CRE“) operating fundamentals, primarily in the hardest hit sectors such as hospitality and retail sector, while multifamily and office sector valuations have held up on continued strong rent collections.

Similar to CRE, our middle market lending business has seen reduced activity, but valuations improved on better market technicals.

We took prudent steps during the second quarter with an aim of positioning the Company to be prepared to capitalize on potential opportunities that could arise in later parts of the economic recovery.

As part of our preparation, we have strived to be conservative with respect to our leverage as well as our dividend.

Our goal in this market environment has been to maintain strong liquidity and to manage the portfolio within conservative risk parameters to produce high quality earnings without using excess leverage or risk.

Business Continuity

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It identifies critical systems, processes, roles and third parties, and can be adjusted on a real-time basis to address situations as they arise.

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Management’s Discussion and Analysis

The BCP is regularly updated and tested.

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We took proactive actions, which included canceling non-essential travel and instituting 100% remote working, ahead of New York State-mandated requirements.

To protect the health and well-being of our employees, their families and communities remote work requirements began in phases in early March, culminating with a company-wide exercise on March 13, 2020 to test connectivity and functionality.

To protect the health and well-being of our employees,

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Management’s Discussion and Analysis

their families and communities remote work requirements began in phases in early March, culminating with a company-wide exercise on March 13, 2020 to test connectivity and functionality.

All employees were able to successfully perform their duties in this testing and we have operated remotely since that time.

As a result, all of our business activities are currently and will continue to be performed remotely until such time that federal, state and local authorities issue further guidance and our Crisis Response Team deems it appropriate for employees to return to our corporate office.

As a result, all of our business activities continue to be performed remotely until such time that federal, state and local authorities issue further guidance and our Crisis Response Team deems it appropriate for employees to return to our corporate office.

Throughout this period there were no significant changes to processes or controls resulting from remote work requirements.

As a diversified capital manager, we strategically allocate capital to seek attractive risk adjusted returns in any operating environment.

Looking ahead, we anticipate that our short-term capital allocation strategy will be weighted primarily in the Agency sector while we obtain more information on the outlook for the economy.

Given that there are still many unknowns regarding the effects of COVID-19 and considering that, as a levered participant, we must remain focused on the stability of financing available for our investments, we believe that Agency MBS appears to provide an opportunity for strong risk and liquidity adjusted returns in the current market.

We view the technical environment for Agency MBS to be positive as we expect that the sector will see continued support from the Federal Reserve.

Additionally, we expect the actions of policymakers to dampen volatility and support a normalization of market functioning.

While a great deal of uncertainty remains, we view the environment for managing the interest rate and convexity risk in Agency MBS as favorable heading into the second quarter of 2020.

Meanwhile, we anticipate that there may be further dislocations in our other businesses as the economic impact of the actions taken to contain COVID-19 become more pronounced.

As we look past the near term, we expect that market participants with sufficient liquidity will be able to take advantage of the numerous options and methods for investment that will likely develop as the residential and commercial finance markets recalibrate.

Economic Environment

The pace of economic growth slowed meaningfully during the first quarter, with U.S.

gross domestic product (“GDP”) registering a 4.8% decline on a seasonally adjusted annualized rate.

Economic growth contracted as the COVID-19 pandemic led to wide-spread closures of manufacturing and services businesses, while disrupting global supply chains.

The economic downturn is expected to increase in the second quarter.

Thereafter, the degree, timing and velocity of any recovery is highly uncertain.

The Federal Reserve (“Fed”) currently conducts monetary policy with a dual mandate:

The pace of economic growth recorded its most meaningful contraction in several decades in the second quarter, with U.S.

gross domestic product (“GDP”) registering a 32.9% decline on a seasonally adjusted annualized rate as the COVID-19 pandemic led to wide-spread closures of manufacturing and services businesses, while disrupting global supply chains.

Economic growth is expected to reverse a portion of the contraction and expand in the second half of 2020 as restrictions on social distancing were eased and economic activity appears to have increased in certain parts of the country.

However, the degree, timing and velocity of any recovery remains highly uncertain and it is unlikely that the economy will be able to fully replace the lost output before sometime in 2021 at the earliest.

The Fed conducts monetary policy with a dual mandate:

full employment and price stability.

The unemployment rate rose to 4.4% in March after reading just 3.5% in February according to the Bureau of Labor Statistics.

The more than nine years of consecutive rising employment came to a halt in March, which recorded 701 thousand job losses, with average monthly job growth in the first quarter of 2020 to decline by 71 thousand, well below the average monthly 210 thousand job gains seen in the prior quarter.

The job losses and rise in the unemployment rate are expected to accelerate in the second quarter, as the period since the end of March and throughout April saw a cumulative record 30 million Americans file for unemployment benefits.

Though it remains unclear as to how many of these individuals will be reported as unemployed, the likelihood that most of these job seekers have not been able to find work is very high.

Wage growth, as measured by the year-over-year change in private sector Average Hourly Earnings, remained roughly unchanged, reading 3.1% in the month of March 2020 compared to 3.0% in December 2019.

Inflation remained below the Fed’s 2% target in the first quarter of 2020 as measured by the year-over-year changes in the Personal Consumption Expenditure Chain Price Index (“PCE”).

The headline PCE measure increased by 1.3% year-over-year in March 2020.

The more stable core PCE measure, which excludes volatile food and energy prices, registered a similar 1.7% year-over-year increase, roughly in line with the 1.6% year-over-year growth measured in December 2019.

Despite the stability in inflation measures in the first quarter, the Fed appears worried that the core and headline PCE measures will continue to decline in coming months given the sharp economic downturn.

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Management’s Discussion and Analysis

In March, the Federal Open Market Committee (“FOMC”) reduced the Federal Funds Rate outside of regularly scheduled meetings twice by a total of 150 bps to a range 0.00% - 0.25% to fight the COVID-19 related slowdown in the U.S.

The unemployment rate rose to 11.1% in June after reading just 3.5% in February prior to the COVID-19 pandemic according to the Bureau of Labor Statistics.

The sharp rise in the unemployment rate was driven by employers reporting a 13.3 million decline in non-farm payrolls during the quarter as many industries laid off workers in light of closed businesses and reduced activity.

The labor market saw a modest improvement in the later parts of the second quarter, with a portion of employees regaining work, though the disruption to employment remains nearly unprecedented and will take significant time to fully repair.

Wage growth, as measured by the year-over-year change in private sector Average Hourly Earnings, rose sharply during the quarter, reading 5.0% in the month of June compared to 3.4% in March 2020.

The sharp rise in wage growth is largely seen as a statistical anomaly.

A majority of the layoffs appear to have occurred in traditionally lower-paying sectors, such as the leisure industry, which in turn inflated the wages of the remaining employed individuals.

Inflation has declined meaningfully below the Fed’s 2% target in the second quarter of 2020 as measured by the year-over-year changes in the Personal Consumption Expenditure Chain Price Index (“PCE”).

The headline PCE measure increased by 0.75% year-over-year in June 2020.

The more stable core PCE measure, which excludes volatile food and energy prices, registered a similar 0.95% year-over-year increase, below the 1.7% year-over-year growth measured in March.

In light of the sharp economic downturn and the fast deceleration in inflation, the Fed appears worried that the core and headline PCE measures will remain significantly below its target for an extended period of time.

Following its nearly unprecedented action in the first quarter of 2020, the Federal Open Market Committee (“FOMC”) maintained the Federal Funds Rate in the 0.00% - 0.25% range during the second quarter.

Moreover, the FOMC began to signal that it will maintain the rate at current levels for an extended period of time in order to aid the economic recovery following the COVID-19 related slowdown in the U.S.

and global economy.

In addition, the FOMC restarted the quantitative easing program and announced a number of lending and liquidity programs to support the U.S.

As such, asset purchases and liquidity provisions have increased the Fed’s balance sheet in excess of 50% between the March and April FOMC meetings, a rate of unprecedented growth in light of the severe economic impact of the pandemic.

During the first quarter ending March 31, 2020, the 10-year U.S.

Treasury rate rallied 125 bps as the impact of COVID-19 and the related social distancing measures led to sharp underperformance of risk assets and strong demand for interest rate products.

In addition, the FOMC continued its quantitative easing program while implementing a number of lending programs to support the U.S.

The combined Fed actions have meaningfully improved financial conditions and market functioning, which in turn has helped the economic recovery in its infancy.

During the second quarter ending June 30, 2020, the 10-year U.S.

Treasury rate remained nearly unchanged at 0.66% as Fed monetary policy actions maintained a range-bound interest rate environment in U.S.

Treasuries, while LIBOR-based interest rates continued to decline in light of reduced concerns about liquidity and credit risk.

The mortgage basis, or the spread between the 30-year Agency mortgage-backed security coupon and 10-year U.S.

Treasury rate, had a volatile first quarter, rising meaningfully amid higher volatility and increased investor concerns over mortgage refinancing activity.

The meaningful widening in the mortgage basis, however, was ultimately predominantly driven by a short period in March, when investors sought liquidity, forcing them to sell U.S.

Treasuries and Agency MBS.

The widening appeared to be ultimately halted by the Fed’s asset purchases, which have helped to normalize market functioning on a relative basis.

Treasury rate, normalized following a volatile first quarter, but remained somewhat higher than seen during most of 2019 amid investor concerns over mortgage refinancing activity.

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

March 31, 2020

June 30, 2020

December 31, 2019

March 31, 2019

June 30, 2019

30-Year mortgage current coupon

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London Interbank Offered Rate (“LIBOR”) Transition

We have established a cross-functional LIBOR transition committee to determine our transition plan and facilitate an orderly transition to alternative reference rates.

Our plan includes steps to evaluate exposure, review contracts, assess impact to our business, process and technology and define a communication strategy with shareholders, regulators and other stakeholders.

The committee also continues to engage with industry working groups and other market participants regarding the transition.

Results of Operations

The results of our operations are affected by various factors, many of which are beyond our control.

Certain of such risks and uncertainties are described herein (see “Special Note Regarding Forward-Looking Statements” above) and in Part I, Item 1A.

“Risk Factors” of our most recent Annual Report on Form 10-K and in Part II, Item 1A.

“Risk Factors” in this Quarterly Report on Form 10-Q.

This Management Discussion and Analysis section contains analysis and discussion of financial results computed in accordance with U.S.

generally accepted accounting principles (“GAAP”) and non-GAAP measurements.

To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide non-GAAP financial measures to enhance investor understanding of our period-over-period operating performance and business trends, as well as for assessing our performance versus that of industry peers.

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

Net Income (Loss) Summary

The following table presents financial information related to our results of operations as of and for the three months ended March 31, 2020 and 2019 .

As of and for the Three Months Ended March 31,

(dollars in thousands, except per share data)

Interest income

Interest expense

Net interest income

Realized and unrealized gains (losses)

Other income (loss)

Total general and administrative expenses

Income (loss) before income taxes

Net income (loss)

Net income (loss) attributable to noncontrolling interests

Net income (loss) attributable to Annaly

Dividends on preferred stock

Net income (loss) available (related) to common stockholders

Net income (loss) per share available (related) to common stockholders

Weighted average number of common shares outstanding

1,430,994,319

1,398,614,205

1,430,994,319

1,398,614,205

Other information

Asset portfolio at period-end

Average total assets

Average equity

Leverage at period-end (1)

Economic leverage at period-end (2)

Capital ratio (3)

Annualized return on average total assets

Annualized return on average equity

Net interest margin (4)

Average yield on interest earning assets (5)

Average GAAP cost of interest bearing liabilities (6)

Net interest spread

Weighted average experienced CPR for the period

Weighted average projected long-term CPR at period-end

Common stock book value per share

Non-GAAP metrics (7)

Interest income (excluding PAA)

Economic interest expense (6)

Economic net interest income (excluding PAA)

Premium amortization adjustment cost (benefit)

Core earnings (excluding PAA) (8)

Core earnings (excluding PAA) per common share

Annualized core return on average equity (excluding PAA)

Net interest margin (excluding PAA) (4)

Average yield on interest earning assets (excluding PAA) (5)

Average economic cost of interest bearing liabilities (6)

Net interest spread (excluding PAA)

(1) Debt consists of repurchase agreements, other secured financing, debt issued by securitization vehicles and mortgages payable.

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

(2) Computed as the sum of Recourse Debt, cost basis of TBA and CMBX derivatives outstanding and net forward purchases (sales) of investments divided by total equity.

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

(4) Net interest margin r epresents our interest income less interest expense divided by the average interest earning assets.

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

(5) 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).

(6) Average GAAP cost of interest bearing liabilities represents annualized interest expense divided by average interest bearing liabilities.

Average interest bearing liabilities reflects the average balances during the period.

Average economic cost of interest bearing liabilities represents annualized economic interest expense divided by average interest bearing liabilities.

Economic interest expense is comprised of GAAP interest expense and the net interest component of interest rate swaps.

(7) Represents a non-GAAP financial measure.

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

(8) Excludes dividends on preferred stock.

Net income (loss) was ($3.6) billion , which includes $0.1 million attributable to noncontrolling interests, or ($2.57) per average basic common share, for the three months ended March 31, 2020 compared to ($849.3) million , which includes ($0.1) million attributable to noncontrolling interests, or ($0.63) per average basic common share, for the same period in 2019 .

We attribute the majority of the change in net income (loss) to unfavorable changes in unrealized gains (losses) on interest rate swaps and net unrealized gains (losses) on instruments measured at fair value through earnings, partially offset by favorable changes in net gains (losses) on disposal of investments and other and net gains (losses) on other derivatives.

Net unrealized gains (losses) on interest rate swaps was ($2.8) billion for the three months ended March 31, 2020 compared to ($390.6) million for the same period in 2019 .

Unrealized gains (losses) on instruments measured at fair value through earnings was for the three months ended March 31, 2020 was ($730.2) million compared to $47.6 million for the same period in 2019 .

Net gains (losses) on other derivatives was $206.4 million for the three months ended March 31, 2020 compared to ($115.2) million for the same period in 2019 .

Net gains (losses) on disposal of investments and other was $206.6 million for the three months ended March 31, 2020 compared to ($93.9) million for the same period in 2019 .

Refer to the section titled “Realized and Unrealized Gains (Losses)” located within this Item 2 for additional information related to this change.

Core earnings (excluding premium amortization adjustment (“PAA”)) were $330.2 million , or $0.21 per average common share, for the three months ended March 31, 2020 , compared to $433.2 million , or $0.29 per average common share, for the same period in 2019 .

The change in core earnings (excluding PAA) during the three months ended March 31, 2020 compared to the same period in 2019 was primarily due to increased amortization due to asset sales, lower coupon income resulting from a decrease in the average yield on interest earnings assets and unfavorable changes in the net interest component of interest rate swaps, partially offset by lower interest expense from lower borrowing rates.

Non-GAAP Financial Measures

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Management’s Discussion and Analysis

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

core earnings (excluding PAA);

core earnings (excluding PAA) attributable to common stockholders;

core earnings (excluding PAA) per average common share;

annualized core return on average equity (excluding PAA);

interest income (excluding PAA);

economic interest expense;

economic net interest income (excluding PAA);

average yield on interest earning assets (excluding PAA);

average economic cost of interest bearing liabilities;

net interest margin (excluding PAA);

net interest spread (excluding PAA).

These measures should not be considered a substitute for, or superior to, financial measures computed in accordance with GAAP.

While intended to offer a fuller understanding of our results and operations, non-GAAP financial measures also have limitations.

For example, we may calculate our non-GAAP metrics, such as core earnings (excluding PAA), or the PAA, differently than our peers making comparative analysis difficult.

Additionally, in the case of non-GAAP measures that exclude the PAA, the amount of amortization expense excluding the PAA is not necessarily representative of the amount of future periodic amortization nor is it indicative of the term over which we will amortize the remaining unamortized premium.

Changes to actual and estimated prepayments will impact the timing and amount of premium amortization and, as such, both GAAP and non-GAAP results.

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

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

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

Our principal business objective is to generate net income for distribution to our stockholders and optimize our returns through prudent management of our diversified investment strategies.

We generate net income by earning a net interest spread on our investment portfolio, which is a function of interest income from our investment portfolio less financing, hedging and operating costs.

Core earnings (excluding PAA), which is defined as the sum of (a) economic net interest income, (b) TBA dollar roll income and CMBX coupon income, (c) realized amortization of MSRs, (d) other income (loss) (excluding depreciation and amortization expense on real estate and related intangibles, non-core income allocated to equity method investments and other non-core components of other income (loss)), (e) general and administrative expenses (excluding transaction expenses and non-recurring items), and (f) income taxes (excluding the income tax effect of non-core income (loss) items), and excludes (g) the premium amortization adjustment (“PAA”) representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities, is used by management and, we believe, used by analysts and investors to measure our progress in achieving our principal business objective.

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

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

Annualized core return on average equity (excluding PAA), which is calculated by dividing core earnings (excluding PAA) over average stockholders’ equity, provides investors with additional detail on the core earnings generated by our invested equity capital.

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Management’s Discussion and Analysis

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

For the Three Months Ended March 31,

(dollars in thousands, except per share data)

GAAP net income (loss)

Net income (loss) attributable to noncontrolling interests

Net income (loss) attributable to Annaly

Adjustments to exclude reported realized and unrealized (gains) losses

Realized (gains) losses on termination or maturity of interest rate swaps

Unrealized (gains) losses on interest rate swaps

Net (gains) losses on disposal of investments and other

Net (gains) losses on other derivatives

Net unrealized (gains) losses on instruments measured at fair value through earnings

Loan loss provision (1)

Adjustments to exclude components of other (income) loss

Depreciation and amortization expense related to commercial real estate (2)

Non-core (income) loss allocated to equity method investments (3)

Adjustments to exclude components of general and administrative expenses and income taxes

Transaction expenses and non-recurring items (4)

Income tax effect of non-core income (loss) items

Adjustments to add back components of realized and unrealized (gains) losses

TBA dollar roll income and CMBX coupon income (5)

MSR amortization (6)

Premium amortization adjustment cost (benefit)

Core earnings (excluding PAA) (7)

Dividends on preferred stock

Core earnings (excluding PAA) attributable to common stockholders (7)

GAAP net income (loss) per average common share

Core earnings (excluding PAA) per average common share (7)

GAAP return (loss) on average equity

Core return on average equity (excluding PAA) (7)

Includes $0.7 million of loss provision on the Company’s unfunded loan commitments for the three months ended March 31, 2020 which is reported in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss).

Includes depreciation and amortization expense related to equity method investments.

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

The three months ended March 31, 2020 includes costs incurred in connection with securitizations of Agency mortgage-backed securities and residential whole loans as well as costs incurred in connection with the expected Internalization and costs incurred in connection with the CEO transition.

The three months ended March 31, 2019 includes costs incurred in connection with a securitization of commercial loans and a securitization of residential whole loans.

TBA dollar roll income and CMBX coupon income each represent a component of Net gains (losses) on other derivatives.

CMBX coupon income totaled $1.2 million and $1.1 million for the three months ended March 31, 2020 and 2019 , respectively.

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

Represents a non-GAAP financial measure.

From time to time, we enter into TBA forward contracts as an alternate means of investing in and financing Agency mortgage-backed securities.

A TBA contract is an agreement to purchase or sell, for future delivery, an Agency mortgage-backed security with a specified issuer, term and coupon.

A TBA dollar roll represents a transaction where TBA contracts with the same terms but different settlement dates are simultaneously bought and sold.

The TBA contract settling in the later month typically prices at a discount to the earlier month contract with the difference in price commonly referred to as the “drop”.

The drop is a reflection of the expected net interest income from an investment in similar Agency mortgage-backed securities, net of an implied financing cost, that would be foregone as a result of settling the contract in the later month rather than in the earlier month.

The drop between the current settlement month price and the forward settlement month price occurs because in the TBA dollar roll market, the party providing the financing is the party that would retain all principal and interest payments accrued during the financing period.

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Management’s Discussion and Analysis

Accordingly, TBA dollar roll income generally represents the economic equivalent of the net interest income earned on the underlying Agency mortgage-backed security less an implied financing cost.

TBA dollar roll transactions are accounted for under GAAP as a series of derivatives transactions.

The fair value of TBA derivatives is based on methods similar to those used to value Agency mortgage-backed securities.

We record TBA derivatives at fair value on our Consolidated Statements of Financial Condition and recognize periodic changes in fair value in Net gains (losses) on other derivatives in our Consolidated Statements of Comprehensive Income (Loss), which includes both unrealized and realized gains and losses on derivatives (excluding interest rate swaps).

TBA dollar roll income is calculated as the difference in price between two TBA contracts with the same terms but different settlement dates multiplied by the notional amount of the TBA contract.

Although accounted for as derivatives, TBA dollar rolls capture the economic equivalent of net interest income, or carry, on the underlying Agency mortgage-backed security (interest income less an implied cost of financing).

TBA dollar roll income is reported as a component of Net gains (losses) on other derivatives in the Consolidated Statements of Comprehensive Income (Loss).

The CMBX index is a synthetic tradable index referencing a basket of 25 commercial mortgage-backed securities of a particular rating and vintage.

The CMBX index allows investors to take a long position (referred to as selling protection) or short position (referred to as purchasing protection) on the respective basket of commercial mortgage-backed securities and is structured as a “pay-as-you-go” contract whereby the protection seller receives and the protection buyer pays a standardized running coupon on the contracted notional amount.

Additionally, the protection seller is obligated to pay to the protection buyer the amount of principal losses and/or coupon shortfalls on the underlying commercial mortgage-backed securities as they occur.

We report income (expense) on CMBX positions in Net gains (losses) on other derivatives in the Consolidated Statements of Comprehensive Income (Loss).

The coupon payments received or paid on CMBX positions is equivalent to interest income (expense) and therefore included in core earnings (excluding PAA).

Premium Amortization Expense

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

We recalculate the effective yield as differences between anticipated and actual prepayments occur.

Using third-party model and market information to project future cash flows and expected remaining lives of securities, the effective interest rate determined for each security is applied as if it had been in place from the date of the security’s acquisition.

The amortized cost of the security is then adjusted to the amount that would have existed had the new effective yield been applied since the acquisition date.

The adjustment to amortized cost is offset with a charge or credit to interest income.

Changes in interest rates and other market factors will impact prepayment speed projections and the amount of premium amortization recognized in any given period.

Our GAAP metrics include the unadjusted impact of amortization and accretion associated with this method.

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

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

For the Three Months Ended March 31,

(dollars in thousands)

Premium amortization expense

PAA cost (benefit)

Premium amortization expense (excluding PAA)

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

Interest income (excluding PAA) represents interest income excluding the effect of the premium amortization adjustment, and serves as the basis for deriving average yield on interest earning assets (excluding PAA), net interest spread (excluding PAA) and net interest margin (excluding PAA), which are discussed below.

We believe this measure provides management and investors with additional detail to enhance their understanding of our operating results and trends by excluding the component of premium amortization expense representing the cumulative effect of quarter-over-quarter changes in estimated long-term prepayment speeds

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Management’s Discussion and Analysis

related to our Agency mortgage-backed securities (other than interest-only securities, multifamily and reverse mortgages), which can obscure underlying trends in the performance of the portfolio.

Economic interest expense is comprised of GAAP interest expense and the net interest component of interest rate swaps.

We use interest rate swaps to manage our exposure to changing interest rates on repurchase agreements by economically hedging cash flows associated with these borrowings.

Accordingly, adding the net interest component of interest rate swaps to interest expense, as computed in accordance with GAAP, reflects the total contractual interest expense and thus, provides investors with additional information about the cost of our financing strategy.

We may use market agreed coupon (“MAC”) interest rate swaps in which we may receive or make a payment at the time of entering into such interest rate swap to compensate for the off-market nature of such interest rate swap.

In accordance with GAAP, upfront payments associated with MAC interest rate swaps are not reflected in the net interest component of interest rate swaps in the Consolidated Statements of Comprehensive Income (Loss).

We did not enter into any MAC interest rate swaps during the three months ended March 31, 2020 .

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

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

Interest Income (excluding PAA)

GAAP Interest Income

Interest Income (excluding PAA) (1)

For the three months ended

(dollars in thousands)

March 31, 2020

March 31, 2019

(1) Represents a non-GAAP financial measure.

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

Net Interest Component of Interest Rate Swaps

Economic Interest

Net Interest Component

of Interest Rate Swaps

Economic Net Interest Income (excluding PAA) (1)

For the three months ended

(dollars in thousands)

March 31, 2020

March 31, 2019

(1) Represents a non-GAAP financial measure.

Experienced and Projected Long-Term CPR

Prepayment speeds, as reflected by the CPR and interest rates vary according to the type of investment, conditions in financial markets, competition and other factors, none of which can be predicted with any certainty.

In general, as prepayment speeds and expectations of prepayment speeds on our Agency mortgage-backed securities portfolio increase, related purchase premium amortization increases, thereby reducing the yield on such assets.

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

Experienced CPR (1)

Projected Long-term CPR (2)

For the three months ended

March 31, 2020

March 31, 2019

For the three months ended March 31, 2020 and 2019 , respectively.

At March 31, 2020 and 2019 , respectively.

ANNALY CAPITAL MANAGEMENT, INC.

AND SUBSIDIARIES

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 1. Financial Statements