ANNALY CAPITAL MANAGEMENT INC 10-Q

Item 1. Financial Statements Eurodollar futures contracts, certain forward purchase commitments and credit derivatives to economically hedge its exposure to market risks. The purpose of using derivatives is to manage overall portfolio risk with the potential to generate additional income for distribution to stockholders. These derivatives are subject to changes in market values resulting from changes in interest rates, volatility, Agency mortgage-backed security spreads to U.S. Treasuries and market liquidity. The use of derivatives also creates exposure to credit risk relating to potential losses that could be recognized if the counterparties to these instruments fail to perform their obligations under the stated contract. Additionally, the Company may have to pledge cash or assets as collateral for the derivative transactions, the amount of which may vary based on the market value and terms of the derivative contract. In the case of market agreed coupon (“MAC”) interest rate swaps, the Company may make or receive a payment at the time of entering into such interest rate swaps, which represents fair value of these swaps, to compensate for the out of market nature of such interest rate swaps. Subsequent changes in fair value from inception of these interest rate swaps are reflected within Unrealized gains (losses) on interest rate swaps in the Consolidated Statements of Comprehensive Income (Loss). Similar to other interest rate swaps, the Company may have to pledge cash or assets as collateral for the MAC interest rate swap transactions. In the event of a default by the counterparty, the Company could have difficulty obtaining its pledged collateral as well as receiving payments in accordance with the terms of the derivative contracts. Derivatives are accounted for in accordance with FASB ASC 815, Derivatives and Hedging , which requires recognition of all derivatives as either assets or liabilities at fair value in the Consolidated Statements of Financial Condition with changes in fair value recognized in the Consolidated Statements of Comprehensive Income (Loss). The changes in the estimated fair value are presented within Net gains (losses) on other derivatives with the exception of interest rate swaps which are separately presented. None of the Company’s derivative transactions have been designated as hedging instruments for accounting purposes. The Company also maintains collateral in the form of cash on margin with counterparties to its interest rate swaps and other derivatives. In accordance with a clearing organization’s rulebook, the Company presents the fair value of centrally cleared interest rate swaps net of variation margin pledged under such transactions. At September 30, 2020 and December 31, 2019, $ 1.7 billion and $ 517.8 million of variation margin was reported as an adjustment to interest rate swaps, at fair value. Interest Rate Swap Agreements – Interest rate swap agreements are the primary instruments used to mitigate interest rate risk. In particular, the Company uses interest rate swap agreements to manage its exposure to changing interest rates on its repurchase agreements by economically hedging cash flows associated with these borrowings. The Company may enter into interest rate swap agreements where the floating leg is linked to the London Interbank Offered Rate (“LIBOR”), the overnight index swap rate or another index. Interest rate swap agreements may or may not be cleared through a derivatives clearing organization (“DCO”). Uncleared interest rate swaps are fair valued using internal pricing models and compared to the counterparty market values. Centrally cleared interest rate swaps, including MAC interest rate swaps, are generally fair valued using the DCO’s market values. If an interest rate swap is terminated, the realized gain (loss) on the interest rate swap would be equal to the difference between the cash received or paid and fair value. Swaptions – Swaptions are purchased or sold to mitigate the potential impact of increases or decreases in interest rates. Interest rate swaptions provide the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay and receive interest rates in the future. The Company’s swaptions are not centrally cleared. The premium paid or received for swaptions is reported as an asset or liability in the Consolidated Statements of Financial Condition. If a swaption expires unexercised, the realized gain (loss) on the swaption would be equal to the premium received or paid. If the Company sells or exercises a swaption, the realized gain or loss on the swaption would be equal to the difference between the cash received or the fair value of the underlying interest rate swap received and the premium paid. The fair value of swaptions are estimated using internal pricing models and compared to the counterparty market values. TBA Dollar Rolls – TBA dollar roll transactions are accounted for as a series of derivative transactions. The fair value of TBA derivatives is based on methods similar to those used to value Agency mortgage-backed securities. MBS Options – MBS options are generally options on TBA contracts, which help manage mortgage market risks and volatility while providing the potential to enhance returns. MBS options are over-the-counter traded instruments and those written on current-coupon mortgage-backed securities are typically the most liquid. MBS options are measured at fair value using internal pricing models and compared to the counterparty market value at the valuation date. Futures Contracts – Futures contracts are derivatives that track the prices of specific assets or benchmark rates. Short sales of futures contracts help to mitigate the potential impact of changes in interest rates on the portfolio performance. The Company maintains margin accounts which are settled daily with Futures Commission Merchants (“FCMs”). The margin requirement varies based on the market value of the open positions and the equity retained in the account. Futures contracts are fair valued based on exchange pricing. Forward Purchase Commitments – The Company may enter into forward purchase commitments with counterparties whereby the Company commits to purchasing residential mortgage loans at a particular price, provided the residential mortgage loans close with the counterparties. The counterparties are required to deliver the committed loans on a “best efforts” basis. 29 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements Credit Derivatives – The Company may enter into credit derivatives referencing a commercial mortgage-backed securities index, such as the CMBX index, and synthetic total return swaps. The table below summarizes fair value information about our derivative assets and liabilities at September 30, 2020 and December 31, 2019: Derivatives Instruments September 30, 2020 December 31, 2019 Assets (dollars in thousands) Interest rate swaps $ — $ 1,199 Interest rate swaptions 63,601 11,580 TBA derivatives 38,656 15,181 Futures contracts 550 77,889 Purchase commitments 438 2,050 Credit derivatives (1) — 5,657 Total derivative assets $ 103,245 $ 113,556 Liabilities Interest rate swaps $ 1,126,179 $ 706,862 TBA derivatives 21,140 11,316 Futures contracts 7,792 84,781 Purchase commitments 488 907 Credit derivatives (1) 27,082 — Total derivative liabilities $ 1,182,681 $ 803,866 (1) The notional amount of the credit derivatives in which the Company purchased protection was $ 0.0 and $ 10.0 million at September 30, 2020 and December 31, 2019, respectively. The maximum potential amount of future payments is the notional amount of credit derivatives in which the Company sold protection of $ 499.0 million and $ 345.0 million at September 30, 2020 and December 31, 2019, respectively, plus any coupon shortfalls on the underlying tranche. The credit derivative tranches referencing the basket of bonds had a range of ratings between AAA and BBB-. 30 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements The following table summarizes certain characteristics of the Company’s interest rate swaps at September 30, 2020 and December 31, 2019: September 30, 2020 Maturity Current Notional (1)(2) Weighted Average Pay Rate Weighted Average Receive Rate Weighted Average Years to Maturity (3) (dollars in thousands) 0 - 3 years $ 17,816,700 0.14 % 0.41 % 2.27 3 - 6 years 7,255,000 0.69 % 0.09 % 3.87 6 - 10 years 5,806,500 1.43 % 0.65 % 8.09 Greater than 10 years 1,349,000 2.90 % 0.39 % 21.85 Total / Weighted average $ 32,227,200 0.91 % 0.48 % 4.51 December 31, 2019 Maturity Current Notional (1)(2) Weighted Average Pay Rate Weighted Average Receive Rate Weighted Average Years to Maturity (dollars in thousands) 0 - 3 years $ 38,942,400 1.60 % 1.84 % 1.29 3 - 6 years 16,097,450 1.77 % 1.87 % 4.30 6 - 10 years 16,176,500 2.20 % 2.02 % 9.00 Greater than 10 years 2,930,000 3.76 % 1.86 % 17.88 Total / Weighted average $ 74,146,350 1.84 % 1.89 % 4.23 (1) As of September 30, 2020, 12 %, 77 % and 11 % of the Company’s interest rate swaps were linked to LIBOR, the Federal funds rate and the Secured Overnight Financing Rate, respectively. As of December 31, 2019, 75 % and 25 % of the Company’s interest rate swaps were linked to LIBOR and the overnight index swap rate, respectively. (2) As of September 30, 2020, notional amount includes $ 655.0 million of a forward starting pay fixed swap on October 1, 2020. There were no forward starting swaps at December 31, 2019. (3) As of September 30, 2020, the weighted average years to maturity of payer interest rate swaps is offset by the weighted average years to maturity of receiver interest rate swaps. As such, the net weighted average years to maturity for each maturity bucket may fall outside of the range listed. The following table presents swaptions outstanding at September 30, 2020 and December 31, 2019. September 30, 2020 Current Underlying Notional Weighted Average Underlying Fixed Rate Weighted Average Underlying Floating Rate Weighted Average Underlying Years to Maturity Weighted Average Months to Expiration (dollars in thousands) Long pay $ 6,550,000 1.29 % 3M LIBOR 10.60 7.97 Long receive $ 250,000 1.66 % 3M LIBOR 10.27 3.20 December 31, 2019 Current Underlying Notional Weighted Average Underlying Fixed Rate Weighted Average Underlying Floating Rate Weighted Average Underlying Years to Maturity Weighted Average Months to Expiration (dollars in thousands) Long pay $ 4,675,000 2.53 % 3M LIBOR 9.22 4.66 Long receive $ 2,000,000 1.49 % 3M LIBOR 10.29 3.40 31 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements The following table summarizes certain characteristics of the Company’s TBA derivatives at September 30, 2020 and December 31, 2019: September 30, 2020 Purchase and sale contracts for derivative TBAs Notional Implied Cost Basis Implied Market Value Net Carrying Value (dollars in thousands) Purchase contracts $ 20,394,000 $ 21,176,883 $ 21,194,446 $ 17,563 Sale contracts ( 100,000 ) ( 104,844 ) ( 104,891 ) ( 47 ) Net TBA derivatives $ 20,294,000 $ 21,072,039 $ 21,089,555 $ 17,516 December 31, 2019 Purchase and sale contracts for derivative TBAs Notional Implied Cost Basis Implied Market Value Net Carrying Value (dollars in thousands) Purchase contracts $ 10,043,000 $ 10,182,891 $ 10,192,038 $ 9,147 Sale contracts ( 3,144,000 ) ( 3,294,486 ) ( 3,299,768 ) ( 5,282 ) Net TBA derivatives $ 6,899,000 $ 6,888,405 $ 6,892,270 $ 3,865 The following table summarizes certain characteristics of the Company’s futures derivatives at September 30, 2020 and December 31, 2019: September 30, 2020 Notional - Long Positions Notional - Short Positions Weighted Average Years to Maturity (dollars in thousands) U.S. Treasury futures - 10 year and greater $ — $ ( 2,822,800 ) 6.90 Total $ — $ ( 2,822,800 ) 6.90 December 31, 2019 Notional - Long Positions Notional - Short Positions Weighted Average Years to Maturity (dollars in thousands) U.S. Treasury futures - 2 year $ — $ ( 180,000 ) 1.96 U.S. Treasury futures - 5 year — ( 2,953,300 ) 4.42 U.S. Treasury futures - 10 year and greater 2,600,000 ( 5,806,400 ) 9.74 Total $ 2,600,000 $ ( 8,939,700 ) 8.26 The Company presents derivative contracts on a gross basis on the Consolidated Statements of Financial Condition. Derivative contracts may contain legally enforceable provisions that allow for netting or setting off receivables and payables with each counterparty. 32 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements The following tables present information about derivative assets and liabilities that are subject to such provisions and can be offset on our Consolidated Statements of Financial Condition at September 30, 2020 and December 31, 2019, respectively. September 30, 2020 Amounts Eligible for Offset Gross Amounts Financial Instruments Cash Collateral Net Amounts Assets (dollars in thousands) Interest rate swaptions, at fair value $ 63,601 $ — $ — $ 63,601 TBA derivatives, at fair value 38,656 ( 18,950 ) — 19,706 Futures contracts, at fair value 550 ( 550 ) — — Purchase commitments 438 — — 438 Liabilities Interest rate swaps, at fair value $ 1,126,179 $ — $ ( 117,947 ) $ 1,008,232 TBA derivatives, at fair value 21,140 ( 18,950 ) — 2,190 Futures contracts, at fair value 7,792 ( 550 ) ( 7,242 ) — Purchase commitments 488 — — 488 Credit derivatives 27,082 — ( 27,082 ) — December 31, 2019 Amounts Eligible for Offset Gross Amounts Financial Instruments Cash Collateral Net Amounts Assets (dollars in thousands) Interest rate swaps, at fair value $ 1,199 $ ( 951 ) $ — $ 248 Interest rate swaptions, at fair value 11,580 — — 11,580 TBA derivatives, at fair value 15,181 ( 5,018 ) — 10,163 Futures contracts, at fair value 77,889 ( 10,902 ) — 66,987 Purchase commitments 2,050 — — 2,050 Credit derivatives 5,657 — — 5,657 Liabilities Interest rate swaps, at fair value $ 706,862 $ ( 951 ) $ ( 104,205 ) $ 601,706 TBA derivatives, at fair value 11,316 ( 5,018 ) — 6,298 Futures contracts, at fair value 84,781 ( 10,902 ) ( 73,879 ) — Purchase commitments 907 — — 907 The effect of interest rate swaps on the Consolidated Statements of Comprehensive Income (Loss) is as follows: Location on Consolidated Statements of Comprehensive Income (Loss) Net Interest Component of Interest Rate Swaps Realized Gains (Losses) on Termination of Interest Rate Swaps Unrealized Gains (Losses) on Interest Rate Swaps For the three months ended (dollars in thousands) September 30, 2020 $ ( 62,529 ) $ ( 427 ) $ 170,327 September 30, 2019 $ 88,466 $ ( 682,602 ) $ ( 326,309 ) For the nine months ended September 30, 2020 $ ( 141,070 ) $ ( 1,919,720 ) $ ( 1,162,768 ) September 30, 2019 $ 306,154 $ ( 1,438,349 ) $ ( 1,992,884 ) 33 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements The effect of other derivative contracts on the Company’s Consolidated Statements of Comprehensive Income (Loss) is as follows: Three Months Ended September 30, 2020 Derivative Instruments Realized Gain (Loss) Unrealized Gain (Loss) Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives (dollars in thousands) Net TBA derivatives $ 276,849 $ ( 100,680 ) $ 176,169 Net interest rate swaptions ( 9,836 ) 3,263 ( 6,573 ) Futures ( 19,989 ) 10,337 ( 9,652 ) Purchase commitments — ( 51 ) ( 51 ) Credit derivatives 1,531 7,892 9,423 Total $ 169,316 Three Months Ended September 30, 2019 Derivative Instruments Realized Gain (Loss) Unrealized Gain (Loss) Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives (dollars in thousands) Net TBA derivatives $ 93,919 $ ( 46,124 ) $ 47,795 Net interest rate swaptions ( 2,778 ) ( 4,571 ) ( 7,349 ) Futures ( 424,268 ) 364,613 ( 59,655 ) Purchase commitments — ( 348 ) ( 348 ) Credit derivatives 1,784 885 2,669 Total $ ( 16,888 ) Nine Months Ended September 30, 2020 Derivative Instruments Realized Gain (Loss) Unrealized Gain (Loss) Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives (dollars in thousands) Net TBA derivatives $ 798,459 $ 13,651 $ 812,110 Net interest rate swaptions 11,730 50,762 62,492 Futures ( 299,220 ) ( 350 ) ( 299,570 ) Purchase commitments — ( 1,194 ) ( 1,194 ) Credit derivatives 4,659 ( 31,839 ) ( 27,180 ) Total $ 546,658 Nine Months Ended September 30, 2019 Derivative Instruments Realized Gain (Loss) Unrealized Gain (Loss) Amount of Gain/(Loss) Recognized in Net Gains (Losses) on Other Derivatives (dollars in thousands) Net TBA derivatives $ 481,865 $ ( 154,355 ) $ 327,510 Net interest rate swaptions ( 44,088 ) 7,935 ( 36,153 ) Futures ( 1,430,450 ) 484,146 ( 946,304 ) Purchase commitments — 1,903 1,903 Credit derivatives 5,285 9,301 14,586 Total $ ( 638,458 ) Certain of the Company’s derivative contracts are subject to International Swaps and Derivatives Association Master Agreements or other similar agreements which may contain provisions that grant counterparties certain rights with respect to the applicable agreement upon the occurrence of certain events such as (i) a decline in stockholders’ equity in excess of specified thresholds or dollar amounts over set periods of time, (ii) the Company’s failure to maintain its REIT status, (iii) the Company’s failure to comply with limits on the amount of leverage, and (iv) the Company’s stock being delisted from the New York Stock Exchange. 34 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements Upon the occurrence of any one of items (i) through (iv), or another default under the agreement, the counterparty to the applicable agreement has a right to terminate the agreement in accordance with its provisions. The aggregate fair value of all derivative instruments with the aforementioned features that are in a net liability position at September 30, 2020 was approximately $ 1.1 billion, which represents the maximum amount the Company would be required to pay upon termination. This amount is fully collateralized. 11. FAIR VALUE MEASUREMENTS The Company follows fair value guidance in accordance with GAAP to account for its financial instruments and MSRs that are accounted for at fair value. The fair value of a financial instrument and MSR is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction bet ween market participants at the measurement date. GAAP requires classification of financial instruments and MSRs into a three-level hierarchy based on the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments and MSRs fall within different levels of the hierarchy, the categorization is based on the lowest priority input that is significant to the fair value measurement of the instrument. Financial assets and liabilities recorded at fair value on the Consolidated Statements of Financial Condition or disclosed in the related notes are categorized based on the inputs to the valuation techniques as follows: Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets and liabilities in active markets. Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3 – inputs to the valuation methodology are unobservable and significant to overall fair value. The Company designates its securities as trading, available-for-sale or held-to-maturity depending upon the type of security and the Company’s intent and ability to hold such security to maturity. Securities classified as available-for-sale and trading are reported at fair value on a recurring basis. The following is a description of the valuation methodologies used for instruments carried at fair value. These methodologies are applied to assets and liabilities across the three-level fair value hierarchy, with the observability of inputs determining the appropriate level. Futures contracts are valued using quoted prices for identical instruments in active markets and are classified as Level 1. Residential Securities, interest rate swaps, swaptions and other derivatives are valued using quoted prices or internally estimated prices for similar assets using internal models. The Company incorporates common market pricing methods, including a spread measurement to the Treasury curve as well as underlying characteristics of the particular security including coupon, prepayment speeds, periodic and life caps, rate reset period and expected life of the security in its estimates of fair value. Fair value estimates for residential mortgage loans are generated by a discounted cash flow model and are primarily based on observable market-based inputs including discount rates, prepayment speeds, delinquency levels, and credit losses. Management reviews and indirectly corroborates its estimates of the fair value derived using internal models by comparing its results to independent prices provided by dealers in the securities and/or third party pricing services. Certain liquid asset classes, such as Agency fixed-rate pass-throughs, may be priced using independent sources such as quoted prices for TBA securities. Residential Securities, residential mortgage loans, interest rate swap and swaption markets, TBA derivatives and MBS options are considered to be active markets such that participants transact with sufficient frequency and volume to provide transparent pricing information on an ongoing basis. The liquidity of the Residential Securities, residential mortgage loans, interest rate swaps, swaptions, TBA derivatives and MBS options markets and the similarity of the Company’s securities to those actively traded enable the Company to observe quoted prices in the market and utilize those prices as a basis for formulating fair value measurements. Consequently, the Company has classified Residential Securities, residential mortgage loans, interest rate swaps, swaptions, TBA derivatives and MBS options as Level 2 inputs in the fair value hierarchy. The fair value of commercial mortgage-backed securities classified as available-for-sale is determined based upon quoted prices of similar assets in recent market transactions and requires the application of judgment due to differences in the underlying collateral. Consequently, commercial real estate debt investments carried at fair value are classified as Level 2. 35 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements For the fair value of debt issued by securitization vehicles, refer to the Note titled “Variable Interest Entities” for additional information. The Company classifies its investments in MSRs as Level 3 in the fair value measurements hierarchy. Fair value estimates for these investments are obtained from models, which use significant unobservable inputs in their valuations. These valuations primarily utilize discounted cash flow models that incorporate unobservable market data inputs including prepayment rates, delinquency levels, costs to service and discount rates. Model valuations are then compared to valuations obtained from third-party pricing providers. Management reviews the valuations received from third-party pricing providers and uses them as a point of comparison to modeled values. The valuation of MSRs requires significant judgment by management and the third-party pricing providers. Assumptions used for which there is a lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s financial statements. The following tables present the estimated fair values of financial instruments and MSRs measured at fair value on a recurring basis. There were no transfers between levels of the fair value hierarchy during the periods presented. September 30, 2020 Level 1 Level 2 Level 3 Total Assets (dollars in thousands) Securities Agency mortgage-backed securities $ — $ 74,915,167 $ — $ 74,915,167 Credit risk transfer securities — 411,538 — 411,538 Non-Agency mortgage-backed securities — 717,602 — 717,602 Commercial mortgage-backed securities — 54,678 — 54,678 Loans Residential mortgage loans — 152,959 — 152,959 Mortgage servicing rights — — 207,985 207,985 Assets transferred or pledged to securitization vehicles — 6,386,447 — 6,386,447 Derivative assets Other derivatives 550 102,695 — 103,245 Total assets $ 550 $ 82,741,086 $ 207,985 $ 82,949,621 Liabilities Debt issued by securitization vehicles — 6,027,576 — 6,027,576 Derivative liabilities Interest rate swaps — 1,126,179 — 1,126,179 Other derivatives 7,792 48,710 — 56,502 Total liabilities $ 7,792 $ 7,202,465 $ — $ 7,210,257 36 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements December 31, 2019 Level 1 Level 2 Level 3 Total Assets (dollars in thousands) Securities Agency mortgage-backed securities $ — $ 112,893,367 $ — $ 112,893,367 Credit risk transfer securities — 531,322 — 531,322 Non-Agency mortgage-backed securities — 1,135,868 — 1,135,868 Commercial mortgage-backed securities — 273,023 — 273,023 Loans Residential mortgage loans — 1,647,787 — 1,647,787 Mortgage servicing rights — — 378,078 378,078 Assets transferred or pledged to securitization vehicles — 6,066,082 — 6,066,082 Derivative assets Interest rate swaps — 1,199 — 1,199 Other derivatives 77,889 34,468 — 112,357 Total assets $ 77,889 $ 122,583,116 $ 378,078 $ 123,039,083 Liabilities Debt issued by securitization vehicles $ — $ 5,622,801 $ — $ 5,622,801 Derivative liabilities Interest rate swaps — 706,862 — 706,862 Other derivatives 84,781 12,223 — 97,004 Total liabilities $ 84,781 $ 6,341,886 $ — $ 6,426,667 Quantitative Information about Level 3 Fair Value Measurements The Company considers unobservable inputs to be those for which market data is not available and that are developed using the best information available to us about the assumptions that market participants would use when pricing the asset. Relevant inputs vary depending on the nature of the instrument being measured at fair value. The sensitivities of significant unobservable inputs along with interrelationships between and among the significant unobservable inputs and their impact on the fair value measurements are described below. The effect of a change in a particular assumption in the sensitivity analysis below is considered independently from changes in any other assumptions. In practice, simultaneous changes in assumptions may not always have a linear effect on the inputs discussed below. Interrelationships may also exist between observable and unobservable inputs. Such relationships have not been included in the discussion below. For each of the individual relationships described below, the inverse relationship would also generally apply. For MSRs, in general, increases in the discount, prepayment or delinquency rates or in annual servicing costs in isolation would result in a lower fair value measurement. A decline in interest rates could lead to higher-than-expected prepayments of mortgages underlying the Company’s investments in MSRs, which in turn could result in a decline in the estimated fair value of MSRs. Refer to the Note titled “Mortgage Servicing Rights” for additional information. The table below presents information about the significant unobservable inputs used for recurring fair value measurements for Level 3 MSRs. The table does not give effect to the Company’s risk management practices that might offset risks inherent in these Level 3 investments. September 30, 2020 December 31, 2019 Valuation Technique Unobservable Input (1) Range (Weighted Average ) (2) Unobservable Input (1) Range (Weighted Average ) (2) Discounted cash flow Discount rate 9.0 % - 12.0 % ( 9.4 %) Discount rate 9.0 % - 12.0 % ( 9.3 %) Prepayment rate 14.6 % - 48.0 % ( 34.0 %) Prepayment rate 6.3 % - 26.6 % ( 13.7 %) Delinquency rate 0.0 % - 17.0 % ( 4.9 %) Delinquency rate 0.0 % - 4.0 % ( 2.2 %) Cost to service $ 83 - $ 223 ($ 128 ) Cost to service $ 81 - $ 135 ($ 107 ) (1) Represents rates, estimates and assumptions that the Company believes would be used by market participants when valuing these assets. (2) Weighted average discount rate computed based on the fair value of MSRs, weighted average prepayment rate, delinquency rate and cost to service based on unpaid principal balances of loans underlying the MSRs. 37 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements The following table summarizes the estimated fair values for financial assets and liabilities that are not carried at fair value at September 30, 2020 and December 31, 2019. September 30, 2020 December 31, 2019 Carrying Value Fair Value Carrying Value Fair Value Financial assets (dollars in thousands) Loans Commercial real estate debt and preferred equity, held for investment (1) $ 1,456,459 $ 1,529,485 $ 1,606,091 $ 1,619,018 Corporate debt, held for investment 2,061,878 2,011,153 2,144,850 2,081,327 Financial liabilities Repurchase agreements $ 64,633,447 $ 64,633,447 $ 101,740,728 $ 101,740,728 Other secured financing 861,373 861,373 4,455,700 4,455,700 Mortgages payable 507,934 594,242 485,005 515,994 (1) Includes assets of consolidated VIEs. Commercial real estate debt and preferred equity, held for investment, corporate debt, held for investment and mortgages payable are valued using Level 3 inputs. The carrying values of repurchase agreements and short term other secured financing approximates fair value and are considered Level 2 fair value measurements. Long term other secured financing are valued using Level 2 inputs. 12. GOODWILL AND INTANGIBLE ASSETS Goodwill The Company’s acquisitions are accounted for using the acquisition method if the acquisition is deemed to be a business. Under the acquisition method, net assets and results of operations of acquired companies are included in the consolidated financial statements from the date of acquisition. The purchase prices are allocated to the assets acquired, including identifiable intangible assets, and the liabilities assumed based on their estimated fair values at the date of acquisition. The excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill. Conversely, any excess of the fair value of the net assets acquired over the purchase price is recognized as a bargain purchase gain. The Company tests goodwill for impairment on an annual basis or more frequently when events or circumstances may make it more likely than not that an impairment has occurred. If a qualitative analysis indicates that there may be an impairment, a quantitative analysis is performed. The quantitative impairment test for goodwill utilizes a two-step approach, whereby the Company compares the carrying value of each identified reporting unit to its fair value. If the carrying value of the reporting unit is greater than its fair value, the second step is performed, where the implied fair value of goodwill is compared to its carrying value. The Company recognizes an impairment charge for the amount by which the carrying amount of goodwill exceeds its fair value. At September 30, 2020 and December 31, 2019, goodwill totaled $ 71.8 million. Intangible assets, net Finite life intangible assets are amortized over their expected useful lives. As part of the Internalization, which closed on June 30, 2020, the Company recognized an intangible asset for the acquired assembled workforce of approximately $ 41.2 million, and accrued liabilities and cash that were recognized on the legal entity acquired. The following table presents the activity of finite lived intangible assets for the nine months ended September 30, 2020. Intangible Assets, net (dollars in thousands) Balance at December 31, 2019 $ 20,957 Intangible assets acquired 50,360 Intangible assets divested ( 110 ) Less: amortization expense ( 6,122 ) Balance at September 30, 2020 $ 65,085 38 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements 13. SECURED FINANCING Reverse Repurchase and Repurchase Agreements – The Company finances a significant portion of its assets with repurchase agreements. At the inception of each transaction, the Company assessed each of the specified criteria in ASC 860, Transfers and Servicing , and has determined that each of the financing agreements meet the specified criteria in this guidance. The Company enters into reverse repurchase agreements to earn a yield on excess cash balances. The Company obtains collateral in connection with the reverse repurchase agreements in order to mitigate credit risk exposure to its counterparties. Reverse repurchase agreements and repurchase agreements with the same counterparty and the same maturity are presented net in the Consolidated Statements of Financial Condition when the terms of the agreements meet the criteria to permit netting. The Company reports cash flows on repurchase agreements as financing activities and cash flows on reverse repurchase agreements as investing activities in the Consolidated Statements of Cash Flows. The Company had outstanding $ 64.6 billion and $ 101.7 billion of repurchase agreements with weighted average borrowing rates of 0.81 % and 1.99 %, after giving effect to the Company’s interest rate swaps used to hedge cost of funds, and weighted average remaining maturities of 72 days and 65 days at September 30, 2020 and December 31, 2019, respectively. The Company has select arrangements with counterparties to enter into repurchase agreements for $ 2.4 billion with remaining capacity of $ 2.0 billion at September 30, 2020. At September 30, 2020 and December 31, 2019, the repurchase agreements had the following remaining maturities, collateral types and weighted average rates: September 30, 2020 Agency Mortgage-Backed Securities CRTs Non-Agency Mortgage-Backed Securities Residential Mortgage Loans Commercial Loans Commercial Mortgage-Backed Securities Total Repurchase Agreements Weighted Average Rate (dollars in thousands) 1 day $ 2,700,000 $ — $ — $ — $ — $ — $ 2,700,000 0.13 % 2 to 29 days 23,585,476 68,994 196,748 — — 43,213 23,894,431 0.36 % 30 to 59 days 8,463,636 60,651 73,438 — — 46,466 8,644,191 0.51 % 60 to 89 days 9,078,487 50,871 274,454 — 269,085 29,962 9,702,859 0.33 % 90 to 119 days 5,320,952 50,758 102,189 23,407 — 31,730 5,529,036 0.73 % Over 119 days (1) 13,656,052 — 237,980 47,235 66,026 155,637 14,162,930 0.45 % Total $ 62,804,603 $ 231,274 $ 884,809 $ 70,642 $ 335,111 $ 307,008 $ 64,633,447 0.42 % December 31, 2019 Agency Mortgage-Backed Securities CRTs Non-Agency Mortgage-Backed Securities Commercial Loans Commercial Mortgage-Backed Securities Total Repurchase Agreements Weighted Average Rate (dollars in thousands) 1 day $ — $ — $ — $ — $ — $ — — % 2 to 29 days 36,030,104 237,897 698,091 — 416,439 37,382,531 2.15 % 30 to 59 days 15,079,989 — 115,805 — 104,363 15,300,157 2.00 % 60 to 89 days 21,931,335 30,841 151,920 — 3,639 22,117,735 1.97 % 90 to 119 days 9,992,914 — — — — 9,992,914 1.97 % Over 119 days (1) 16,557,123 — 58,712 303,078 28,478 16,947,391 1.90 % Total $ 99,591,465 $ 268,738 $ 1,024,528 $ 303,078 $ 552,919 $ 101,740,728 2.03 % (1) No repurchase agreements had a remaining maturity over one year at September 30, 2020 and December 31, 2019. The following table summarizes the gross amounts of reverse repurchase agreements and repurchase agreements, amounts offset in accordance with netting arrangements and net amounts of repurchase agreements and reverse repurchase agreements as presented in the Consolidated Statements of Financial Condition at September 30, 2020 and December 31, 2019. Refer to the “Derivative Instruments” Note for information related to the effect of netting arrangements on the Company’s derivative instruments. 39 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements September 30, 2020 December 31, 2019 Reverse Repurchase Agreements Repurchase Agreements Reverse Repurchase Agreements Repurchase Agreements (dollars in thousands) Gross amounts $ 200,000 $ 64,833,447 $ 100,000 $ 101,840,728 Amounts offset ( 200,000 ) ( 200,000 ) ( 100,000 ) ( 100,000 ) Netted amounts $ — $ 64,633,447 $ — $ 101,740,728 Other Secured Financing - The Company previously financed a portion of its financial assets with advances from the Federal Home Loan Bank of Des Moines (“FHLB Des Moines”). Borrowings from FHLB Des Moines are reported in Other secured financing in the Company’s Consolidated Statements of Financial Condition. At September 30, 2020, the Company did not hold advances from the FHLB Des Moines. At December 31, 2019, $ 1.4 billion of advances from the FHLB Des Moines matured in less than one year and $ 2.1 billion matured between one to three years . The weighted average rate of the advances from the FHLB Des Moines was 2.16 % at December 31, 2019. The Company held $ 4.4 million and $ 147.9 million of stock in the FHLB Des Moines at September 30, 2020 and December 31, 2019, respectively, which is reported at cost and included in Other assets on the Company’s Consolidated Statements of Financial Condition. Refer to the Note titled “Variable Interest Entities” for additional information on the Company’s other secured financing arrangements. Investments pledged as collateral under secured financing arrangements and interest rate swaps, excluding residential and senior securitized commercial mortgage loans of consolidated VIEs, had an estimated fair value and accrued interest of $ 70.6 billion and $ 202.7 million, respectively, at September 30, 2020 and $ 112.8 billion and $ 357.9 million, respectively, at December 31, 2019. Mortgage loans payable at September 30, 2020 and December 31, 2019, were as follows: September 30, 2020 Property Mortgage Carrying Value Mortgage Principal Interest Rate Fixed/Floating Rate Maturity Date Priority (dollars in thousands) Joint Ventures $ 316,661 $ 318,371 4.03 % - 4.96 % Fixed 2024 - 2029 First liens Joint Ventures 16,575 16,325 L+ 2.15 % Floating 2/27/2022 First liens Virginia 81,498 83,204 2.34 % - 4.55 % Fixed 2036 - 2053 First liens Virginia 24,457 25,000 L+ 2.85 % Floating 5/1/2023 First liens Texas 31,263 32,730 3.28 % Fixed 1/1/2048 and 1/1/2053 First liens Utah 9,706 9,706 L+ 2.75 % Floating 1/31/2021 First liens Utah 6,996 7,014 3.69 % Fixed 6/1/2053 First liens Minnesota 13,090 13,124 3.69 % Fixed 6/1/2053 First liens Wisconsin 7,688 7,708 3.69 % Fixed 6/1/2053 First liens Total $ 507,934 $ 513,182 December 31, 2019 Property Mortgage Carrying Value Mortgage Principal Interest Rate Fixed/Floating Rate Maturity Date Priority (dollars in thousands) Joint Ventures $ 316,566 $ 318,562 4.03 % - 4.96 % Fixed 2024 - 2029 First liens Joint Ventures 16,029 16,325 L+ 2.15 % Floating 2/27/2022 First liens Virginia 82,940 84,702 2.34 % - 4.55 % Fixed 2036 - 2053 First liens Texas 31,667 33,167 3.28 % Fixed 1/1/2048 and 1/1/2053 First liens Utah 9,706 9,706 L+ 3.50 % Floating 1/31/2020 First liens Utah 7,077 7,096 3.69 % Fixed 6/1/2053 First liens Minnesota 13,243 13,276 3.69 % Fixed 6/1/2053 First liens Wisconsin 7,777 7,797 3.69 % Fixed 6/1/2053 First liens Total $ 485,005 $ 490,631 40 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements The following table details future mortgage loan principal payments at September 30, 2020: Mortgage Loan Principal Payments (dollars in thousands) 2020 (remaining) $ 833 2021 13,197 2022 20,034 2023 28,844 2024 107,929 Later years 342,345 Total $ 513,182 14. CAPITAL STOCK (A) Common Stock The following table provides a summary of the Company’s common shares authorized, and issued and outstanding at September 30, 2020 and December 31, 2019. Shares authorized Shares issued and outstanding September 30, 2020 December 31, 2019 September 30, 2020 December 31, 2019 Par Value Common stock 2,914,850,000 2,914,850,000 1,402,928,317 1,430,106,199 $ 0.01 During the nine months ended September 30, 2019, the Company closed the public offering of an original issuance of 75.0 million shares of common stock for proceeds of $ 730.5 million before deducting offering expenses. In connection with the offering, the Company granted the underwriters a thirty -day option to purchase up to an additional 11.3 million shares of common stock, which the underwriters exercised in full resulting in an additional $ 109.6 million in proceeds before deducting offering expenses. In June 2019, the Company announced that its board of directors (“Board”) had authorized the repurchase of up to $ 1.5 billion of its outstanding shares of common stock through December 31, 2020. During the three and nine months ended September 30, 2020, the Company repurchased 4.8 million and 27.7 million shares of its common stock, respectively, for an aggregate amount of $ 31.3 million and $ 174.7 million, respectively, excluding commission costs, pursuant to this authorization. All common shares were purchased in open-market transactions. During the three and nine months ended September 30, 2019, the Company repurchased 18.3 million shares of its common stock for an aggregate amount of $ 155.0 million, excluding commission costs. All common shares purchased pursuant to this authorization were in open-market transactions. The following table provides a summary of activity related to the Company’s Direct Purchase and Dividend Reinvestment Program. Nine Months Ended September 30, 2020 September 30, 2019 (dollars in thousands) Shares issued through direct purchase and dividend reinvestment program 154,000 180,000 Amount raised from direct purchase and dividend reinvestment program $ 1,075 $ 1,795 In January 2018, the Company entered into separate Distribution Agency Agreements (as amended and restated on August 6, 2020, collectively, the “Sales Agreements”) with each of Wells Fargo Securities, LLC, BofA Securities, Inc. (formerly known as Merrill Lynch, Pierce, Fenner & Smith, Incorporated), Barclays Capital Inc., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Goldman Sachs & Co. LLC, J.P. Morgan Securities LLC, Keefe, Bruyette & Woods, Inc., RBC Capital Markets, LLC and UBS Securities LLC (the “Sales Agents”). The Company may offer and sell shares of its common stock, having an aggregate offering price of up to $ 1.5 billion from time to time through any of the Sales Agents. No shares were issued under the at-the-market sales program during the nine months ended September 30, 2020. During the nine months ended 41 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements September 30, 2019, the Company issued 56.0 million shares for proceeds of $ 569.1 million, net of commissions and fees, under the at-the-market sales program. (B) Preferred Stock The following is a summary of the Company’s cumulative redeemable preferred stock outstanding at September 30, 2020 and December 31, 2019. In the event of a liquidation or dissolution of the Company, the Company’s then outstanding preferred stock takes precedence over the Company’s common stock with respect to payment of dividends and the distribution of assets. Shares Authorized Shares Issued And Outstanding Carrying Value Contractual Rate Earliest Redemption Date (1) Date At Which Dividend Rate Becomes Floating Floating Annual Rate September 30, 2020 December 31, 2019 September 30, 2020 December 31, 2019 September 30, 2020 December 31, 2019 Fixed-rate (dollars in thousands) Series D 18,400,000 18,400,000 18,400,000 18,400,000 445,457 445,457 7.50 % 9/13/2017 NA NA Fixed-to-floating rate Series F 28,800,000 28,800,000 28,800,000 28,800,000 696,910 696,910 6.95 % 9/30/2022 9/30/2022 3M LIBOR + 4.993 % Series G 19,550,000 19,550,000 17,000,000 17,000,000 411,335 411,335 6.50 % 3/31/2023 3/31/2023 3M LIBOR + 4.172 % Series I 18,400,000 18,400,000 17,700,000 17,700,000 428,324 428,324 6.75 % 6/30/2024 6/30/2024 3M LIBOR + 4.989 % Total 85,150,000 85,150,000 81,900,000 81,900,000 $ 1,982,026 $ 1,982,026 (1) Subject to the Company’s right under limited circumstances to redeem preferred stock earlier in order to preserve its qualification as a REIT or under limited circumstances related to a change in control of the Company. Each series of preferred stock has a par value of $ 0.01 per share and a liquidation and redemption price of $ 25.00 , plus accrued and unpaid dividends through their redemption date. Through September 30, 2020, the Company had declared and paid all required quarterly dividends on the Company’s preferred stock. During the three and nine months ended September 30, 2019, the Company redeemed all 7.0 million of its issued and outstanding shares of 7.625 % Series C Cumulative Redeemable Preferred Stock (“Series C Preferred Stock”) for $ 175.0 million. The cash redemption amount for each share of Series C Preferred Stock was $ 25.00 plus accrued and unpaid dividends to, but not including, the redemption date of July 21, 2019. During the nine months ended September 30, 2019, the Company redeemed all 2.2 million of its issued and outstanding shares of 8.125 % Series H Cumulative Redeemable Preferred Stock (“Series H Preferred Stock”) for $ 55.0 million. The cash redemption amount for each share of Series H Preferred Stock was $ 25.00 plus accrued and unpaid dividends to, but not including, the redemption date of May 31, 2019. During the nine months ended September 30, 2019, the Company issued 17.7 million shares of its 6.750 % Seri es I Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (“Series I Preferred Stock”) for gross proceeds o f $ 442.5 million befo re deducting the underwriting discount and other estimated offering expenses. The Series D Cumulative Redeemable Preferred Stock, Series F Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, Series G Preferred Stock and Series I Preferred Stock rank senior to the common stock of the Company. (C) Distributions to Stockholders The following table provides a summary of the Company’s dividend distribution activity for the periods presented: 42 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements For the Three Months Ended For the Nine Months Ended September 30, 2020 September 30, 2019 September 30, 2020 September 30, 2019 (dollars in thousands, except per share data) Dividends and dividend equivalents declared on common stock and share-based awards $ 309,175 $ 359,736 $ 976,966 $ 1,158,629 Distributions declared per common share $ 0.22 $ 0.25 $ 0.69 $ 0.80 Distributions paid to common stockholders after period end $ 308,644 $ 359,491 $ 308,644 $ 359,491 Distributions paid per common share after period end $ 0.22 $ 0.25 $ 0.22 $ 0.25 Date of distributions paid to common stockholders after period end October 30, 2020 October 31, 2019 October 30, 2020 October 31, 2019 Dividends declared to series C preferred stockholders $ — $ 742 $ — $ 7,414 Dividends declared per share of series C preferred stock $ — $ 0.106 $ — $ 1.060 Dividends declared to series D preferred stockholders $ 8,625 $ 8,625 $ 25,875 $ 25,875 Dividends declared per share of series D preferred stock $ 0.469 $ 0.469 $ 1.406 $ 1.407 Dividends declared to series F preferred stockholders $ 12,510 $ 12,510 $ 37,530 $ 37,530 Dividends declared per share of series F preferred stock $ 0.434 $ 0.434 $ 1.303 $ 1.303 Dividends declared to series G preferred stockholders $ 6,906 $ 6,906 $ 20,718 $ 20,718 Dividends declared per share of series G preferred stock $ 0.406 $ 0.406 $ 1.219 $ 1.219 Dividends declared to series H preferred stockholders $ — $ — $ — $ 1,862 Dividends declared per share of series H preferred stock $ — $ — $ — $ 0.846 Dividends declared to series I preferred stockholders $ 7,468 $ 7,668 $ 22,404 $ 7,668 Dividends declared per share of series I preferred stock $ 0.422 $ 0.436 $ 1.266 $ 0.436 15. INTEREST INCOME AND INTEREST EXPENSE Refer to the Note titled “Significant Accounting Policies” for details surrounding the Company’s accounting policy related to net interest income on securities and loans. The following table summarizes the interest income recognition methodology for Residential Securities: Interest Income Methodology Agency Fixed-rate pass-through (1) Effective yield (3) Adjustable-rate pass-through (1) Effective yield (3) Multifamily (1) Contractual Cash Flows CMO (1) Effective yield (3) Reverse mortgages (2) Prospective Interest-only (2) Prospective Residential credit CRT (2) Prospective Alt-A (2) Prospective Prime (2) Prospective Subprime (2) Prospective NPL/RPL (2) Prospective Prime jumbo (2) Prospective Prime jumbo interest-only (2) Prospective (1) Changes in fair value are recognized in Other comprehensive income (loss) on the accompanying Consolidated Statements of Comprehensive Income (Loss). (2) Changes in fair value are recognized in Net unrealized gains (losses) on instruments measured at fair value through earnings on the accompanying Consolidated Statements of Comprehensive Income (Loss). (3) Effective yield is recalculated for differences between estimated and actual prepayments and the amortized cost is adjusted as if the new effective yield had been applied since inception. 43 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements The following presents the components of the Company’s interest income and interest expense for the three and nine months ended September 30, 2020 and September 30, 2019. For the Three Months Ended September 30, For the Nine Months Ended September 30, 2020 2019 2020 2019 Interest income (dollars in thousands) Residential Securities (1) $ 439,502 $ 784,228 $ 1,307,566 $ 2,271,893 Residential mortgage loans (1) 42,508 37,673 132,936 102,689 Commercial investment portfolio (1) (2) 80,324 87,946 260,208 281,029 Reverse repurchase agreements 109 9,452 1,571 57,472 Total interest income $ 562,443 $ 919,299 $ 1,702,281 $ 2,713,083 Interest expense Repurchase agreements 75,386 699,838 646,369 1,962,999 Debt issued by securitization vehicles 32,491 34,524 113,367 102,882 Other 7,249 32,543 44,895 98,936 Total interest expense 115,126 766,905 804,631 2,164,817 Net interest income $ 447,317 $ 152,394 $ 897,650 $ 548,266 (1) Includes assets transferred or pledged to securitization vehicles. (2 ) Includes commercial real estate debt and preferred equity and corporate debt. 16. NET INCOME (LOSS) PER COMMON SHARE The following table presents a reconciliation of net income (loss) and shares used in calculating basic and diluted net income (loss) per share for the three and nine months ended September 30, 2020 and September 30, 2019. For the Three Months Ended For the Nine Months Ended September 30, 2020 September 30, 2019 September 30, 2020 September 30, 2019 (dollars in thousands, except per share data) Net income (loss) $ 1,015,548 $ ( 747,169 ) $ ( 1,768,407 ) $ ( 3,372,833 ) Net income (loss) attributable to noncontrolling interests ( 126 ) ( 110 ) ( 28 ) ( 294 ) Net income (loss) attributable to Annaly 1,015,674 ( 747,059 ) ( 1,768,379 ) ( 3,372,539 ) Dividends on preferred stock (1) 35,509 36,151 106,527 101,067 Net income (loss) available (related) to common stockholders $ 980,165 $ ( 783,210 ) $ ( 1,874,906 ) $ ( 3,473,606 ) Weighted average shares of common stock outstanding-basic 1,404,202,695 1,453,359,211 1,419,645,475 1,436,204,582 Add: Effect of stock awards, if dilutive 165,605 — — — Weighted average shares of common stock outstanding-diluted 1,404,368,300 1,453,359,211 1,419,645,475 1,436,204,582 Net income (loss) per share available (related) to common share Basic $ 0.70 $ ( 0.54 ) $ ( 1.32 ) $ ( 2.42 ) Diluted $ 0.70 $ ( 0.54 ) $ ( 1.32 ) $ ( 2.42 ) (1) The three months ended September 30, 2019 exclude cumulative and undeclared dividends of $ 0.3 million on the Company's Series I Preferred Stock as of June 30, 2019. The computations of diluted net income (loss) per share available (related) to common share for the three and nine months ended September 30, 2020 excludes 0.5 million of potentially dilutive restricted stock units and 0.8 million of potentially dilutive restricted stock units and performance stock units because their effect would have been anti-dilutive. 17. INCOME TAXES For the three months ended September 30, 2020 the Company was qualified to be taxed as a REIT under Code Sections 856 through 860. As a REIT, the Company will not incur federal income tax to the extent that it distributes its taxable income to its stockholders. To maintain qualification as a REIT, the Company must distribute at least 90% of its annual REIT taxable income to its stockholders and meet certain other requirements that relate to, among other things, assets it may hold, income it may generate and its stockholder composition. It is generally the Company’s policy to distribute 100 % of its REIT taxable income. 44 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements To the extent there is any undistributed REIT taxable income at the end of a year, the Company distributes such shortfall within the next year as permitted by the Code. The Company and certain of its direct and indirect subsidiaries, including Annaly TRS, Inc. and certain subsidiaries of Mountain Merger Sub Corp., have made separate joint elections to treat these subsidiaries as TRSs. As such, each of these TRSs is taxable as a domestic C corporation and subject to federal, state and local income taxes based upon their taxable income. The provisions of ASC 740, Income Taxes (“ASC 740”), clarify the accounting for uncertainty in income taxes recognized in financial statements and prescribe a recognition threshold and measurement attribute for uncertain tax positions taken or expected to be taken on a tax return. ASC 740 also requires that interest and penalties related to unrecognized tax benefits be recognized in the financial statements. The Company does not have any unrecognized tax benefits that would affect its financial position. Thus, no accruals for penalties and interest were deemed necessary at September 30, 2020 and December 31, 2019. The state and local tax jurisdictions for which the Company is subject to tax-filing obligations recognize the Company’s status as a REIT, and therefore, the Company generally does not pay income tax in such jurisdictions. The Company may, however, be subject to certain minimum state and local tax filing fees as well as certain excise, franchise or business taxes. The Company’s TRSs are subject to federal, state and local taxes. During the three and nine months ended September 30, 2020, the Company recorded $ 9.7 million and ($ 14.9 ) million, respectively, of income tax expense (benefit) attributable to its TRSs. During the three and nine months ended September 30, 2019, the Company recorded ($ 6.9 ) million and ($ 10.2 ) million, respectively of income tax benefit attributable to its TRSs. The Company’s federal, state and local tax returns from 2016 and forward remain open for examination. 18. RISK MANAGEMENT The primary risks to the Company are capital, liquidity and funding risk, investment/market risk and credit risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the Company’s control. Changes in the general level of interest rates can affect net interest income, which is the difference between the interest income earned on interest earning assets and the interest expense incurred in connection with the interest bearing liabilities, by affecting the spread between the interest earning assets and interest bearing liabilities. Changes in the level of interest rates can also affect the value of the interest earning assets and the Company’s ability to realize gains from the sale of these assets. A decline in the value of the interest earning assets pledged as collateral for borrowings under repurchase agreements and derivative contracts could result in the counterparties demanding additional collateral or liquidating some of the existing collateral to reduce borrowing levels. The Company may seek to mitigate the potential financial impact by entering into interest rate agreements such as interest rate swaps, interest rate swaptions and other hedges. Weakness in the mortgage market, the shape of the yield curve and changes in the expectations for the volatility of future interest rates may adversely affect the performance and market value of the Company’s investments. This could negatively impact the Company’s book value. Furthermore, if many of the Company’s lenders are unwilling or unable to provide additional financing, the Company could be forced to sell its investments at an inopportune time when prices are depressed. The Company has established policies and procedures for mitigating risks, including conducting scenario and sensitivity analyses and utilizing a range of hedging strategies. The payment of principal and interest on the Freddie Mac and Fannie Mae Agency mortgage-backed securities, which exclude CRT securities issued by Freddie Mac and Fannie Mae, is guaranteed by those respective agencies and the payment of principal and interest on Ginnie Mae Agency mortgage-backed securities is backed by the full faith and credit of the U.S. government. Substantially all of the Company’s Agency mortgage-backed securities have an actual or implied “AAA” rating. The Company faces credit risk on the portions of its portfolio which are not guaranteed by the respective Agency or by the full faith and credit of the U.S. government. The Company is exposed to credit risk on CRE Debt and Preferred Equity Investments, real estate investments, commercial mortgage-backed securities, residential mortgage loans, CRT securities, other non-Agency mortgage-backed securities and corporate debt. MSR values may also be adversely impacted if overall costs to service the underlying mortgage loans increase due to borrower performance. The Company is exposed to risk of loss if an issuer, borrower, tenant or counterparty fails to perform its obligations under contractual terms. The Company has established policies and procedures for mitigating credit risk, including reviewing and establishing limits for credit exposure, limiting transactions with specific counterparties, maintaining qualifying collateral and continually assessing the creditworthiness of issuers, borrowers, tenants and counterparties. 45 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements The conditions related to Coronavirus Disease 2019 (“COVID-19”) could further impact the aforementioned primary risks to the Company. The significant decrease in economic activity and/or the resulting impact to the housing market could have an adverse effect on the value of the Company’s investments in mortgage real estate-related assets, particularly residential real estate assets. Further, borrowers may experience difficulties meeting their obligations or seek to forbear payment on or refinance their mortgage loans to avail themselves of lower rates which may have an adverse impact on the value of the Company’s mortgage real estate related-assets. In addition to residential mortgage-related assets, the adverse economic conditions could negatively impact tenants in the Company’s commercial property assets and/or businesses in which it lends to in connection with its middle market lending activities, resulting in potential delinquencies, defaults or declines in asset values. If conditions related to COVID-19 continue to persist, the Company could also experience an unwillingness or inability of its potential lenders to provide the Company with or renew financing, increased margin calls, and/or additional capital requirements particularly in connection with the Company’s less liquid credit assets. These conditions could force the Company to sell its assets at inopportune times or otherwise cause the Company to potentially revise its strategic business initiatives, which could adversely affect its business. The full extent of the COVID 19-related disruptions, the duration of the pandemic and the effectiveness of government policies, laws and plans continue to be highly uncertain. 19. RELATED PARTY TRANSACTIONS Closing of the Internalization and Termination of Management Agreement On February 12, 2020, the Company entered into an internalization agreement (the “Internalization Agreement”) with the Former Manager and certain affiliates of the Former Manager. Pursuant to the Internalization Agreement, the Company agreed to acquire all of the outstanding equity interests of the Former Manager and the Former Manager’s direct and indirect parent companies from their respective owners (the “Internalization”) for nominal cash consideration ($ 1.00 ). In connection with the closing of the Internalization, on June 30, 2020, the Company acquired all of the assets and liabilities of the Former Manager (the net effect of which was immaterial in amount), and the Company transitioned from an externally-managed real estate investment trust (“REIT”) to an internally-managed REIT. At the closing, all employees of the Former Manager became employees of the Company. The parties also terminated the Amended and Restated Management Agreement by and between the Company and the Former Manager (the “Management Agreement”) and therefore the Company no longer pays a management fee to, or reimburses expenses of, the Former Manager. Pursuant to the Internalization Agreement, the Former Manager waived any Acceleration Fee (as defined in the Management Agreement). Prior to the closing of the Internalization, the Former Manager, under the Management Agreement and subject to the supervision and direction of the Board, was responsible for (i) the selection, purchase and sale of assets for the Company’s investment portfolio; (ii) recommending alternative forms of capital raising; (iii) supervising the Company’s financing and hedging activities; and (iv) day to day management functions. The Former Manager also performed such other supervisory and management services and activities relating to the Company’s assets and operations as appropriate. In exchange for the management services, the Company paid the Former Manager a monthly management fee, and the Former Manager was responsible for providing personnel to manage the Company. Prior to the closing of the Internalization, the Company had paid the Former Manager a monthly management fee for its management services in an amount equal to 1/12th of the sum of (i) 1.05% of Stockholders' Equity (as defined in the Management Agreement) up to $ 17.28 billion, and (ii) 0.75 % of Stockholders' Equity (as defined in the Management Agreement) in excess of $ 17.28 billion. The Company did not pay the Former Manager any incentive fees. For the six months ended June 30, 2020, the compensation and management fee computed in accordance with the Management Agreement was $ 77.9 million. For the three and nine months ended September 30, 2019, the compensation and management fee was $ 41.2 million and $ 130.2 million, respectively. Prior to the closing of the Internalization, the Company reimbursed the Former Manager for certain services in connection with the management and operations of the Company and its subsidiaries as permitted under the terms of the Management Agreement. Such reimbursable expenses included the cost for certain legal, tax, accounting and other support and advisory services provided by employees of the Former Manager to the Company. Pursuant to the Management Agreement, until the closing of the Internalization, the Company reimbursed the Former Manager for the cost of such services, provided such costs were no greater than those that would be payable to comparable third party providers. Expense reimbursements and related waivers were routinely reviewed with the Audit Committee of the Board in conformance with established policies. For the nine months ended September 30, 2020 and September 30, 2019, reimbursement payments to the Former Manager were $ 14.2 million and $ 14.3 million, respectively. None of the reimbursement payments were attributable to compensation of the Company’s executive officers. 46 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements At September 30, 2020 and December 31, 2019 the Company had amounts payable to the Former Manager of $ 0 and $ 15.8 million, respectively. 20. LEASE COMMITMENTS AND CONTINGENCIES The Company adopted ASU 2016-02, Leases (Topic 842) on January 1, 2019 with no impact to retained earnings or other components of equity. The Company’s operating leases are primarily comprised of a corporate office lease with a remaining lease term of five years . The corporate office lease includes an option to extend for up to five years , however the extension term was not included in the operating lease liability calculation. Leases with an initial term of 12 months or less are not recorded on the balance sheet. The Company recognizes lease expense for these leases on a straight-line basis over the lease term. The lease cost for the three and nine months ended September 30, 2020 was $ 0.9 million and $ 2.4 million, respectively. Supplemental information related to leases as of and for the nine months ended September 30, 2020 was as follows: Operating Leases Classification September 30, 2020 Assets (dollars in thousands) Operating lease right-of-use assets Other assets $ 13,831 Liabilities Operating lease liabilities (1) Other liabilities $ 18,059 Lease term and discount rate Weighted average remaining lease term 4.9 years Weighted average discount rate (1) 2.9 % Cash paid for amounts included in the measurement of lease liabilities Operating cash flows from operating leases $ 2,797 (1) As the Company’s leases do not provide an implicit rate, the Company uses an incremental borrowing rate based on the information available at adoption date in determining the present value of lease payments. The following table provides details related to maturities of lease liabilities: Maturity of Lease Liabilities Years ending December 31, (dollars in thousands) 2020 (remaining) $ 1,002 2021 3,918 2022 3,862 2023 3,862 2024 3,862 Later years 2,895 Total lease payments $ 19,401 Less imputed interest 1,342 Present value of lease liabilities $ 18,059 Contingencies From time to time, the Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material effect on the Company’s consolidated financial statements. There were no material contingencies at September 30, 2020 and December 31, 2019. 47 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 1. Financial Statements 21. ARCOLA REGULATORY REQUIREMENTS Arcola is the Company’s wholly owned and consolidated broker-dealer. Arcola is subject to regulations of the securities business that include but are not limited to trade practices, use and safekeeping of funds and securities, capital structure, recordkeeping and conduct of directors, officers and employees. Arcola is a member of various clearing organizations with which it maintains cash required to conduct its day-to-day clearance activities. Arcola enters into reverse repurchase agreements and repurchase agreements as part of its matched book trading activity. Reverse repurchase agreements are recorded on settlement date at the contractual amount and are collateralized by mortgage-backed or other securities. Arcola generates income from the spread between what is earned on the reverse repurchase agreements and what is paid on the matched repurchase agreements. Arcola’s policy is to obtain possession of collateral with a market value in excess of the principal amount loaned under reverse repurchase agreements. To ensure that the market value of the underlying collateral remains sufficient, collateral is valued daily, and Arcola will require counterparties to deposit additional collateral, when necessary. All reverse repurchase activities are transacted under master repurchase agreements or other documentation that give Arcola the right, in the event of default, to liquidate collateral held and in some instances, to offset receivables and payables with the same counterparty. As a member of the Financial Industry Regulatory Authority (“FINRA”), Arcola is required to maintain a minimum net capital balance. At September 30, 2020 Arcola had a minimum net capital requirement of $ 0.3 million. Arcola consistently operates with capital in excess of its regulatory capital requirements. Arcola’s regulatory net capital as defined by SEC Rule 15c3-1 at September 30, 2020 was $ 422.5 million with excess net capital of $ 422.2 million. 22. SUBSEQUENT EVENTS In October 2020, the Company repurchased 4.7 million shares of its common stock for an aggregate amount of $ 34.3 million, excluding commission costs, under the Company’s stock repurchase program. 48 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Special Note Regarding Forward-Looking Statements Certain statements contained in this quarterly report, and certain statements contained in our future filings with the Securities and Exchange Commission (the “SEC” or the “Commission”), in our press releases or in our other public or stockholder communications contain or incorporate by reference certain forward-looking statements which are based on various assumptions (some of which are beyond our control) and may be identified by reference to a future period or periods or by the use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “anticipate,” “continue,” or similar terms or variations on those terms or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, risks and uncertainties related to the COVID-19 pandemic, including as related to adverse economic conditions on real estate-related assets and financing conditions (and our outlook for our business in light of these conditions, which is uncertain); changes in interest rates; changes in the yield curve; changes in prepayment rates; the availability of mortgage-backed securities and other securities for purchase; the availability of financing and, if available, the terms of any financing; changes in the market value of our assets; changes in business conditions and the general economy; our ability to grow our commercial business; our ability to grow our residential credit business; our ability to grow our middle market lending business; credit risks related to our investments in credit risk transfer securities, residential mortgage-backed securities and related residential mortgage credit assets, commercial real estate assets and corporate debt; risks related to investments in MSRs; our ability to consummate any contemplated investment opportunities; changes in government regulations or policy affecting our business; our ability to maintain our qualification as a REIT for U.S. federal income tax purposes; and our ability to maintain our exemption from registration under the Investment Company Act. For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in our most recent annual report on Form 10-K and Item 1A “Risk Factors” in this quarterly report on Form 10-Q. We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our most recent annual report on Form 10-K. All references to “Annaly,” “we,” “us,” or “our” mean Annaly Capital Management, Inc. and all entities owned by us, except where it is made clear that the term means only the parent company. Refer to the section titled “Glossary of Terms” located at the end of this Item 2 for definitions of commonly used terms in this quarterly report on Form 10-Q. 49 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis INDEX TO ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page Overview 51 Business Environment and Coronavirus Disease 2019 (“COVID-19”) 51 Economic Environment 52 Results of Operations 53 Net Income (Loss) Summary 54 Non-GAAP Financial Measures 56 Core earnings (excluding PAA), core earnings (excluding PAA) attributable to common stockholders, core earnings (excluding PAA) per average common share and annualized core return on average equity (excluding PAA) 56 Premium Amortization Expense 58 Interest Income (excluding PAA), economic interest expense and economic net interest income (excluding PAA) 59 Experienced and Projected Long-term CPR 59 Average Yield on Interest Earning Assets (excluding PAA), Net Interest Spread (excluding PAA) and Net Interest Margin (excluding PAA) 60 Economic Interest Expense and Average Economic Cost of Interest Bearing Liabilities 61 Realized and Unrealized Gains (Losses) 62 Other Income (Loss) 63 General and Administrative Expenses 64 Return on Average Equity 64 Unrealized Gains and Losses - Available-for-Sale Investments 64 Financial Condition 65 Residential Securities 66 Contractual Obligations 68 Off-Balance Sheet Arrangements 69 Capital Management 69 Stockholders’ Equity 70 Capital Stock 70 Leverage and Capital 70 Risk Management 71 Risk Appetite 71 Governance 71 Description of Risks 72 Capital, Liquidity and Funding Risk Management 73 Funding 73 Excess Liquidity 74 Maturity Profile 76 Stress Testing 77 Liquidity Management Policies 77 Investment/Market Risk Management 78 Credit Risk Management 79 Counterparty Risk Management 79 Operational Risk Management 80 Compliance, Regulatory and Legal Risk Management 80 Critical Accounting Policies and Estimates 81 Valuation of Financial Instruments 81 Residential Securities 81 Residential Mortgage Loans 81 Commercial Real Estate Investments 82 Interest Rate Swaps 82 Revenue Recognition 82 Consolidation of Variable Interest Entities 82 Use of Estimates 82 Glossary of Terms 83 50 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Overview We are a leading diversified capital manager that invests in and finances residential and commercial assets. Our principal business objective is to generate net income for distribution to our stockholders and optimize our returns through prudent management of our diversified investment strategies. We are an internally-managed Maryland corporation founded in 1997 that has elected to be taxed as a REIT. Prior to the closing of the Internalization (as defined in the “Related Party Transactions” Note located within Item 1) on June 30, 2020, we were externally managed by Annaly Management Company LLC (the “Former Manager”). Our common stock is listed on the New York Stock Exchange under the symbol “NLY.” We use our capital coupled with borrowed funds to invest primarily in real estate related investments, earning the spread between the yield on our assets and the cost of our borrowings and hedging activities. For a full discussion of our business, refer to the section titled “Business Overview” in our most recent Annual Report on Form 10-K. Business Environment and Coronavirus Disease 2019 (“COVID-19”) The U.S. economy rebounded at a faster pace than many had anticipated in the third quarter, best seen by the 3.2 percentage point decline in unemployment rate during the quarter to 7.9 percent in September. Household spending rose sharply as certain sectors of the economy, most notably housing and goods consumption have shown signs of a v-shaped recovery with current activity well above levels seen ahead of the pandemic-induced economic downturn. However, momentum in the economic recovery, which remains incomplete in aggregate despite the strength in the aforementioned sectors, is slowing as the service sector is unable to fully recover while the virus continues to surge in many states and government regulations limit social and business activities to help curb the spread of the virus. The extended unemployment benefits afforded under the CARES Act, which meaningfully boosted incomes in the second and third quarter, expired in July although nearly half of all jobs lost during the pandemic have yet to be recovered. The timing and speed of a U.S. economic recovery remains highly uncertain and depends on continued monetary and fiscal policy accommodation. In an environment similar to the second quarter, the Federal Reserve (“Fed”) continued to use all available tools to support market functioning and assist the economic recovery, while signaling it stands ready to provide more accommodation if needed. The stable interest rate environment created by the large-scale Fed intervention and low levels of volatility across financial markets, even in light of uncertainties stemming from the 2020 U.S. Presidential election, remained a positive backdrop for our businesses in the third quarter, allowing us to generate a 6.3% economic return during the quarter, while core earnings (excluding PAA) exceeded our dividend by ten cents. Additionally, we achieved these results while reducing our leverage to 6.2x, reflecting that we maintain a cautious approach following the elevated market volatility back in March 2020. Although our Agency MBS portfolio was largely unchanged in notional terms over the third quarter, we maintain a positive outlook. The sector performed well during the third quarter as continued sizeable Fed purchases, now totaling more than $700 billion net of paydowns since March, combined with strong demand from banks, offset the high levels of supply and continued elevated prepayment speeds. Given the Fed involvement in the market, we further shifted the Agency portfolio out of higher coupon specified pools into lower coupon specified pools and production coupon to-be-announced (“TBA”) contracts, such as 30-year UMBS 1.5% and 2.0%s. While specified pool collateral offers meaningful call protection, more consistently accurate model durations, and exhibit better supply and demand dynamics than generic pools, TBAs currently offer improved float from Fed purchases removing the most negatively convex pools and attractive implied financing rates, allowing us to finance TBAs well below comparable specified pool collateral. The attractive implied financing rates from TBA dollar roll specialness will not last in perpetuity, but they contribute to excess returns and serve to mitigate potential episodes of spread widening, such that, all other things being equal, we anticipate maintaining TBA positions in excess of their traditional portfolio share while the Fed remains heavily involved in the market. Meanwhile, we continue to find value in specified pools as the investments we have made in specified pools over the last number of years are further paying off in this environment, exemplified by our portfolio prepaying roughly at a level of two third the level of prepayments of the 30-year fixed rate mortgage universe. At September 30, 2020, 96% of our portfolio was comprised of high or medium quality specified pools or mortgages that are seasoned by at least 40 month and remains well positioned to withstand the current environment of elevated prepayment speeds. In light of the low volatility interest rate environment, we were able to focus on our hedging activity on protecting the portfolio from tail risk as we opportunistically added out of the money swaptions at attractive pricing given low implied volatility in option pricing, while we also added modestly to our swaps and futures positions. Funding remains widely available and balance sheet availability is strong given the abundance in reserves in the system. Financing spreads have tightened for certain credit products. and we have been able to amend and renegotiate a portion of our warehouse lines, which has decreased costs and improved our flexibility in light. 51 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis The aggregate portfolio of our credit businesses declined slightly in the third quarter, resulting in capital allocated to the credit businesses to decline to 20% as of September 30, 2020. The decline was mainly driven by two residential credit securitizations we completed during the third quarter totaling $1 billion, which was the main reason for our reduced capital allocated in the quarter. Fundamentals in the residential credit sectors continue to improve on the back of the strong housing market, as evidenced by less than 5% of the market is now in forbearance which is down from 9% in late May. We continue to expand the sourcing of mortgage loans, activity which has increased slowly following the cessation in the activity following the market volatility in March. Meanwhile, we have seen a reopening of loan channels in the Commercial Real Estate sector and are selectively evaluating new opportunities. We do remain focused on portfolio management we continue to be in active dialogue with our borrowers to closely monitor underlying performance trends. It is likely that parts of the commercial real estate landscape will be persistently changed by the pandemic, but it is still early to judge the full extent. With respect to portfolio fundamentals in the Middle Market Lending business, underlying cash flow trends have been encouraging year over year, as sound EBITDA and revenue growth have helped to consistently delever our portfolio’s underlying portfolio companies. Despite the decline in capital allocated to our credit businesses, tighter Agency spreads and the potential for improving macroeconomic indicators leave us focused on finding opportunities in credit sectors. We anticipate potentially higher capital allocation on the margin to Residential Credit and Middle Market Lending, all else equal over the next few quarters. Additionally, we analyze the buyback of common stock as part of our capital allocation framework. We repurchased over $200 million in stock throughout the past six months at times when our evaluation deemed it the most attractive use of capital, and we will continue to consider using the buyback authorization as a tool to generate shareholder return when prudent to do so. Business Continuity Our well-established Business Continuity Planning (“BCP”) has been designed to ensure continued, effective operations through a variety of scenarios including natural disasters and disease pandemics. It identifies critical systems, processes, roles and third parties, and can be adjusted on a real-time basis to address situations as they arise. The BCP is regularly updated and tested. Annual testing includes extensive, remote Disaster Recovery testing and tabletop exercise scenarios with management. Key tenets of the planning include active communication between our Crisis Response Team, which is comprised of senior leaders across a number of functions, and our internal and external stakeholders to afford efficient, thoughtful, effective responses to evolving emergency situations. Historical tabletop exercises have included use of CDC Influenza Pandemic exercise materials. That exercise documented our response and possible impacts to a variety of scenarios, including those in which “shelter in place orders” were required and response/ impact assessments to those scenarios. Regular meetings were commenced to implement and review active internal and external communications planning. These exercises, along with regulatory and industry guidance, informed our staged response to the conditions created by COVID-19. We took proactive actions, which included canceling non-essential travel and instituting 100% remote working, ahead of New York State-mandated requirements. To protect the health and well-being of our employees, their families and communities remote work requirements began in phases in early March, culminating with a company-wide exercise on March 13, 2020 to test connectivity and functionality. All employees were able to successfully perform their duties in this testing and we have operated largely remotely since that time. A majority of our business activities continue to be performed remotely, though we have seen a limited number of employees return to the office on a voluntary and periodic basis. We continue to monitor guidance from federal, state and local authorities to gauge how to further proceed in any efforts to return to the office. Economic Environment Following the meaningful contraction in the second quarter, the pace of economic growth rebounded in the third quarter, with U.S. gross domestic product (“GDP”) rising 33.1% on a seasonally adjusted annualized rate. The rebound in U.S. economic output was driven by the gradual reopening of manufacturing and services businesses, as well as a strong rebound in consumption. The degree of the economic recovery nonetheless varies greatly between strong demand for goods and more muted demand for services, which continue to face the majority of impediments from social distancing measures and capacity limits to fight the pandemic. Despite the improvements from the COVID-19 recession lows, much further progress must be made to reach output levels seen prior to the pandemic. The degree, timing and velocity of the remaining recovery is highly uncertain and it is unlikely that the economy will be able to fully replace the lost output in aggregate before sometime in 2021 at the earliest. The Fed conducts monetary policy with a dual mandate: full employment and price stability. The unemployment rate fell 3.2 percentage points in the third quarter to 7.9% in September according to the Bureau of Labor Statistics. This marks a faster speed to the labor market recovery than previously anticipated as many workers were able to regain employment as pandemic restrictions were lifted or modified. However, the job gains, while strong late in the second and early in third quarter, have 52 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis slowed in recent months, suggesting that the remaining 48 percent of workers that have not been able to regain employment will have more difficulty obtaining employment. Wage growth, as measured by the year-over-year change in private sector Average Hourly Earnings, contracted modestly during the quarter, reading 4.7% in the month of September compared to 4.9% in June 2020. The continued elevated wage growth is largely seen as a statistical anomaly. A majority of the layoffs appear to have occurred in traditionally lower-paying sectors, such as the leisure industry, which in turn inflated the wages of the remaining employed individuals. Similar to the labor market, inflation readings, as measured by the year-over-year changes in the Personal Consumption Expenditure Chain Price Index (“PCE”), have rebounded from their lows in the second quarter, though remain below the Fed’s 2% target in the third quarter of 2020. The headline PCE measure increased by 1.37% year-over-year in September 2020. The more stable core PCE measure, which excludes volatile food and energy prices, registered a similar 1.55% year-over-year increase, above the 1.14% year-over-year growth measured in June. In support of the U.S. economic recovery, Federal Open Market Committee (“FOMC”) maintained the Federal Funds Rate in the 0.00% - 0.25% range during the third quarter of 2020 and continued to signal that it will maintain the rate at current levels for an extended period of time. In addition, the FOMC continued its quantitative easing and a number of lending programs. The combined Fed actions have continued to support financial conditions and market functioning, which in turn has helped the economic recovery. During the third quarter of 2020, the 10-year U.S. Treasury rate remained nearly unchanged at 0.68% as Fed monetary policy actions maintained a range-bound interest rate environment in U.S. Treasuries and LIBOR-based interest rates. The mortgage basis, or the spread between the 30-year Agency mortgage-backed security coupon and 10-year U.S. Treasury rate, continued to compress following much volatility during the first half of 2020 as mortgage-backed securities saw strong demand from numerous investors. The following table presents interest rates and spreads at each date presented: September 30, 2020 December 31, 2019 September 30, 2019 30-Year mortgage current coupon 1.40% 2.71% 2.61% Mortgage basis 72 bps 79 bps 95 bps 10-Year U.S. Treasury rate 0.68% 1.92% 1.66% LIBOR 1-Month 0.15% 1.76% 2.02% 6-Month 0.26% 1.91% 2.06% London Interbank Offered Rate (“LIBOR”) Transition We have established a cross-functional LIBOR transition committee to determine our transition plan and facilitate an orderly transition to alternative reference rates. Our plan includes steps to evaluate exposure, review contracts, assess impact to our business, process and technology and define a communication strategy with shareholders, regulators and other stakeholders. The committee also continues to engage with industry working groups and other market participants regarding the transition. As part of the transition from LIBOR, in October 2020, we participated in the Chicago Mercantile Exchange (“CME”) Group’s transitioning for price alignment and discounting for USD OTC cleared swaps from the daily effective federal funds rate to the secured overnight financing rate (“SOFR”). As a result of this activity, our existing swap and swaption positions have been updated with the new SOFR discounting curve and basis swaps entered into during this transition were sold in the CME Group’s auction on October 19, 2020. Results of Operations The results of our operations are affected by various factors, many of which are beyond our control. Certain of such risks and uncertainties are described herein (see “Special Note Regarding Forward-Looking Statements” above) and in Part I, Item 1A. “Risk Factors” of our most recent Annual Report on Form 10-K and in Part II, Item 1A. “Risk Factors” in this Quarterly Report on Form 10-Q and in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020. This Management Discussion and Analysis section contains analysis and discussion of financial results computed in accordance with U.S. generally accepted accounting principles (“GAAP”) and non-GAAP measurements. To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide non-GAAP financial measures to enhance investor understanding of our period-over-period operating performance and business trends, as well as for assessing our performance versus that of industry peers. 53 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Refer to the “Non-GAAP Financial Measures” section for additional information. Net Income (Loss) Summary The following table presents financial information related to our results of operations as of and for the three and nine months ended September 30, 2020 and 2019. As of and for the Three Months Ended September 30, As of and for the Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands, except per share data) Interest income $ 562,443 $ 919,299 $ 1,702,281 $ 2,713,083 Interest expense 115,126 766,905 804,631 2,164,817 Net interest income 447,317 152,394 897,650 548,266 Realized and unrealized gains (losses) 618,823 (875,406) (2,524,967) (3,796,814) Other income (loss) 7,959 35,074 38,109 93,757 Less: Total general and administrative expenses 48,832 66,138 194,127 228,283 Income (loss) before income taxes 1,025,267 (754,076) (1,783,335) (3,383,074) Income taxes 9,719 (6,907) (14,928) (10,241) Net income (loss) 1,015,548 (747,169) (1,768,407) (3,372,833) Less: Net income (loss) attributable to noncontrolling interests (126) (110) (28) (294) Net income (loss) attributable to Annaly 1,015,674 (747,059) (1,768,379) (3,372,539) Less: Dividends on preferred stock (1) 35,509 36,151 106,527 101,067 Net income (loss) available (related) to common stockholders $ 980,165 $ (783,210) $ (1,874,906) $ (3,473,606) Net income (loss) per share available (related) to common stockholders Basic $ 0.70 $ (0.54) $ (1.32) $ (2.42) Diluted $ 0.70 $ (0.54) $ (1.32) $ (2.42) Weighted average number of common shares outstanding Basic 1,404,202,695 1,453,359,211 1,419,645,475 1,436,204,582 Diluted 1,404,368,300 1,453,359,211 1,419,645,475 1,436,204,582 Other information Asset portfolio at period-end $ 87,155,310 $ 125,840,378 $ 87,155,310 $ 125,840,378 Average total assets $ 91,325,532 $ 130,378,448 $ 102,465,855 $ 121,429,243 Average equity $ 13,996,138 $ 15,465,556 $ 14,124,037 $ 15,207,589 Leverage at period-end (2) 5.1:1 7.3:1 5.1:1 7.3:1 Economic leverage at period-end (3) 6.2:1 7.7:1 6.2:1 7.7:1 Capital ratio (4) 13.6 % 11.2 % 13.6 % 11.2 % Annualized return on average total assets 4.45 % (2.29 %) (2.30 %) (3.70 %) Annualized return on average equity 29.02 % (19.32 %) (16.69 %) (29.57 %) Net interest margin (5) 2.15 % 0.48 % 1.27 % 0.61 % Average yield on interest earning assets (6) 2.70 % 2.89 % 2.40 % 3.02 % Average GAAP cost of interest bearing liabilities (7) 0.60 % 2.58 % 1.23 % 2.66 % Net interest spread 2.10 % 0.31 % 1.17 % 0.36 % Weighted average experienced CPR for the period 22.9 % 14.6 % 18.7 % 11.0 % Weighted average projected long-term CPR at period-end 17.1 % 16.3 % 17.1 % 16.3 % Common stock book value per share $ 8.70 $ 9.21 $ 8.70 $ 9.21 Non-GAAP metrics (8) Interest income (excluding PAA) $ 596,322 $ 1,036,451 $ 2,078,624 $ 3,051,869 Economic interest expense (7) $ 177,655 $ 678,439 $ 945,701 $ 1,858,663 Economic net interest income (excluding PAA) $ 418,667 $ 358,012 $ 1,132,923 $ 1,193,206 Premium amortization adjustment cost (benefit) $ 33,879 $ 117,152 $ 376,343 $ 338,786 Core earnings (excluding PAA) (9) $ 482,323 $ 341,931 $ 1,237,121 $ 1,166,239 Core earnings (excluding PAA) per common share $ 0.32 $ 0.21 $ 0.80 $ 0.74 Annualized core return on average equity (excluding PAA) 13.79 % 8.85 % 11.68 % 10.23 % Net interest margin (excluding PAA) (5) 2.05 % 1.10 % 1.67 % 1.29 % Average yield on interest earning assets (excluding PAA) (6) 2.86 % 3.26 % 2.93 % 3.39 % Average economic cost of interest bearing liabilities (7) 0.93 % 2.28 % 1.44 % 2.29 % Net interest spread (excluding PAA) 1.93 % 0.98 % 1.49 % 1.10 % 54 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES