ANNALY CAPITAL MANAGEMENT INC 10-Q

Item 2. Management’s Discussion and Analysis (1) The three months ended September 30, 2019 exclude cumulative and undeclared dividends of $0.3 million on our Series I Preferred Stock as of June 30, 2019. (2) Debt consists of repurchase agreements, other secured financing, debt issued by securitization vehicles and mortgages payable. Debt issued by securitization vehicles, certain credit facilities (included within other secured financing), and mortgages payable are non-recourse to us. (3) Computed as the sum of Recourse Debt, cost basis of TBA and CMBX derivatives outstanding and net forward purchases (sales) of investments divided by total equity. (4) Calculated as total stockholders’ equity divided by total assets inclusive of outstanding market value of TBA positions and exclusive of consolidated VIEs. (5) Net interest margin represents our interest income less interest expense divided by the average interest earning assets. Net interest margin (excluding PAA) represents the sum of our interest income (excluding PAA) plus TBA dollar roll income and CMBX coupon income less interest expense and the net interest component of interest rate swaps divided by the sum of average interest earning assets plus average outstanding TBA contract and CMBX balances. (6) Average yield on interest earning assets represents annualized interest income divided by average interest earning assets. Average interest earning assets reflects the average amortized cost of our investments during the period. Average yield on interest earning assets (excluding PAA) is calculated using annualized interest income (excluding PAA). (7) Average GAAP cost of interest bearing liabilities represents annualized interest expense divided by average interest bearing liabilities. Average interest bearing liabilities reflects the average balances during the period. Average economic cost of interest bearing liabilities represents annualized economic interest expense divided by average interest bearing liabilities. Economic interest expense is comprised of GAAP interest expense and the net interest component of interest rate swaps. (8) Represents a non-GAAP financial measure. Refer to the “Non-GAAP Financial Measures” section for additional information. (9) Excludes dividends on preferred stock. GAAP Net income (loss) was $1.0 billion, which includes ($0.1) million attributable to noncontrolling interests, or $0.70 per average basic common share, for the three months ended September 30, 2020 compared to ($747.2) million, which includes ($0.1) million attributable to noncontrolling interests, or ($0.54) per average basic common share, for the same period in 2019. We attribute the majority of the change in net income (loss) to favorable changes in realized gains (losses) on termination or maturity of interest rate swaps, unrealized gains (losses) on interest rate swaps, net interest income and net gains (losses) on other derivatives. Realized gains (losses) on termination or maturity of interest rate swaps was ($0.4) million for the three months ended September 30, 2020 compared to ($682.6) million for the same period in 2019. Net unrealized gains (losses) on interest rate swaps was $170.3 million for the three months ended September 30, 2020 compared to ($326.3) million for the same period in 2019. Net interest income for the three months ended September 30, 2020 was $447.3 million compared to $152.4 million for the same period in 2019. Net gains (losses) on other derivatives was $169.3 million for the three months ended September 30, 2020 compared to ($16.9) million for the same period in 2019. Refer to the sections titled “Non-GAAP” and “Realized and Unrealized Gains (Losses)” located within this Item 2 for additional information related to these changes. Net income (loss) was ($1.8) billion, which includes ($28.0) thousand attributable to noncontrolling interests, or ($1.32) per average basic common share, for the nine months ended September 30, 2020 compared to ($3.4) billion, which includes ($0.3) million attributable to noncontrolling interests, or ($2.42) per average basic common share, for the same period in 2019. We attribute the majority of the change in net income (loss) to favorable changes in net gains (losses) on other derivatives, unrealized gains (losses) on interest rate swaps, net gains (losses) on disposal of investments and other and net interest income, partially offset by unfavorable changes in realized gains (losses) on termination or maturity of interest rate swaps, the net interest component of interest rate swaps and net unrealized gains (losses) on instruments measured at fair value through earnings. Net gains (losses) on other derivatives was $546.7 million for the nine months ended September 30, 2020 compared to ($638.5) million for the same period in 2019. Unrealized gains (losses) on interest rate swaps was ($1.2) billion for the nine months ended September 30, 2020 compared to ($2.0) billion for the same period in 2019. Net gains (losses) on disposal of investments and other was $652.2 million for the nine months ended September 30, 2020 compared to ($65.7) million for the same period in 2019. Net interest income for the nine months ended September 30, 2020 was $897.7 million compared to $548.3 million for the same period in 2019. Realized gains (losses) on termination or maturity of interest rate swaps was ($1.9) billion for the nine months ended September 30, 2020 compared to ($1.4) billion for the same period in 2019. The net interest component of interest rate swaps was ($141.1) million for the nine months ended September 30, 2020 compared to $306.2 million for the same period in 2019. Unrealized gains (losses) on instruments measured at fair value through earnings for the nine months ended September 30, 2020 was ($354.1) million compared to $41.7 million for the same period in 2019. Refer to the sections titled “Non-GAAP” and “Realized and Unrealized Gains (Losses)” located within this Item 2 for additional information related to these changes. Non-GAAP 55 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Core earnings (excluding premium amortization adjustment (“PAA”)) were $482.3 million, or $0.32 per average common share, for the three months ended September 30, 2020, compared to $341.9 million, or $0.21 per average common share, for the same period in 2019. Core earnings (excluding premium amortization adjustment (“PAA”)) were $1.2 billion, or $0.80 per average common share, for the nine months ended September 30, 2020, compared to $1.2 billion, or $0.74 per average common share, for the same period in 2019. The changes in core earnings (excluding PAA) during the three and nine months ended September 30, 2020 compared to the same periods in 2019 were primarily due to lower interest expense from lower borrowing rates and average interest bearing liabilities, and higher TBA dollar roll income, partially offset by lower coupon income resulting from a decrease in the average yield on interest earnings assets and lower average interest earning assets, and unfavorable changes in the net interest component of interest rate swaps. Non-GAAP Financial Measures To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide the following non-GAAP financial measures: • core earnings (excluding PAA); • core earnings (excluding PAA) attributable to common stockholders; • core earnings (excluding PAA) per average common share; • annualized core return on average equity (excluding PAA); • interest income (excluding PAA); • economic interest expense; • economic net interest income (excluding PAA); • average yield on interest earning assets (excluding PAA); • average economic cost of interest bearing liabilities; • net interest margin (excluding PAA); and • net interest spread (excluding PAA). These measures should not be considered a substitute for, or superior to, financial measures computed in accordance with GAAP. While intended to offer a fuller understanding of our results and operations, non-GAAP financial measures also have limitations. For example, we may calculate our non-GAAP metrics, such as core earnings (excluding PAA), or the PAA, differently than our peers making comparative analysis difficult. Additionally, in the case of non-GAAP measures that exclude the PAA, the amount of amortization expense excluding the PAA is not necessarily representative of the amount of future periodic amortization nor is it indicative of the term over which we will amortize the remaining unamortized premium. Changes to actual and estimated prepayments will impact the timing and amount of premium amortization and, as such, both GAAP and non-GAAP results. These non-GAAP measures provide additional detail to enhance investor understanding of our period-over-period operating performance and business trends, as well as for assessing our performance versus that of industry peers. Additional information pertaining to our use of these non-GAAP financial measures, including discussion of how each such measure may be useful to investors, and reconciliations to their most directly comparable GAAP results are provided below. Core earnings (excluding PAA), core earnings (excluding PAA) attributable to common stockholders, core earnings (excluding PAA) per average common share and annualized core return on average equity (excluding PAA) Our principal business objective is to generate net income for distribution to our stockholders and optimize our returns through prudent management of our diversified investment strategies. We generate net income by earning a net interest spread on our investment portfolio, which is a function of interest income from our investment portfolio less financing, hedging and operating costs. Core earnings (excluding PAA), which is defined as the sum of (a) economic net interest income, (b) TBA dollar roll income and CMBX coupon income, (c) realized amortization of MSRs, (d) other income (loss) (excluding depreciation and amortization expense on real estate and related intangibles, non-core income allocated to equity method investments and other non-core components of other income (loss)), (e) general and administrative expenses (excluding transaction expenses and non-recurring items), and (f) income taxes (excluding the income tax effect of non-core income (loss) items), and excludes (g) the premium amortization adjustment (“PAA”) representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities, is used by management and, we believe, used by analysts and investors to measure our progress in achieving our principal business objective. We seek to fulfill our principal business objective through a variety of factors including portfolio construction, the degree of market risk exposure and related hedge profile, and the use and forms of leverage, all while operating within the parameters of our capital allocation policy and risk governance framework. 56 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis We believe these non-GAAP measures provide management and investors with additional details regarding our underlying operating results and investment portfolio trends by (i) making adjustments to account for the disparate reporting of changes in fair value where certain instruments are reflected in GAAP net income (loss) while others are reflected in other comprehensive income (loss), and (ii) by excluding certain unrealized, non-cash or episodic components of GAAP net income (loss) in order to provide additional transparency into the operating performance of our portfolio. Annualized core return on average equity (excluding PAA), which is calculated by dividing core earnings (excluding PAA) over average stockholders’ equity, provides investors with additional detail on the core earnings generated by our invested equity capital. The following table presents a reconciliation of GAAP financial results to non-GAAP core earnings for the periods presented: For the Three Months Ended September 30, For the Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands, except per share data) GAAP 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) Adjustments to exclude reported realized and unrealized (gains) losses Realized (gains) losses on termination or maturity of interest rate swaps 427 682,602 1,919,720 1,438,349 Unrealized (gains) losses on interest rate swaps (170,327) 326,309 1,162,768 1,992,884 Net (gains) losses on disposal of investments and other (198,888) (66,522) (652,150) 65,727 Net (gains) losses on other derivatives (169,316) 16,888 (546,658) 638,458 Net unrealized (gains) losses on instruments measured at fair value through earnings (121,255) 1,091 354,133 (41,657) Loan loss provision (1) (21,818) 3,504 150,719 9,207 Other adjustments Depreciation expense related to commercial real estate and amortization of intangibles (2) 11,363 9,974 28,011 30,235 Non-core (income) loss allocated to equity method investments (3) (1,151) 4,541 22,465 25,364 Transaction expenses and non-recurring items (4) 2,801 2,622 11,121 15,650 Income tax effect of non-core income (loss) items 13,890 (2,762) (6,619) (5,543) TBA dollar roll income and CMBX coupon income (5) 114,092 15,554 256,520 86,917 MSR amortization (6) (27,048) (21,963) (70,873) (55,599) Plus: Premium amortization adjustment cost (benefit) 33,879 117,152 376,343 338,786 Core earnings (excluding PAA) (7) 482,323 341,931 1,237,121 1,166,239 Dividends on preferred stock (8) 35,509 36,151 106,527 101,067 Core earnings (excluding PAA) attributable to common stockholders (7) $ 446,814 $ 305,780 $ 1,130,594 $ 1,065,172 GAAP net income (loss) per average common share $ 0.70 $ (0.54) $ (1.32) $ (2.42) Core earnings (excluding PAA) per average common share (7) $ 0.32 $ 0.21 $ 0.80 $ 0.74 GAAP return (loss) on average equity 29.02 % (19.32 %) (16.69 %) (29.57 %) Core return on average equity (excluding PAA) (7) 13.79 % 8.85 % 11.68 % 10.23 % (1) Includes $0.2 million and $4.6 million of loss provision on the Company’s unfunded loan commitments for the three and nine months ended September 30, 2020, respectively, which is reported in Other income (loss) in the Consolidated Statements of Comprehensive Income (Loss). (2) Includes depreciation and amortization expense related to equity method investments. (3) Represents unrealized (gains) losses allocated to equity interests in a portfolio of MSR which is a component of Other income (loss). (4) The three and nine months ended September 30, 2020 includes costs incurred in connection with the a securitization of residential whole loans . The nine months ended September 30, 2020 also includes costs incurred in connection with the Internalization, the CEO search process and a securitization of Agency mortgage-backed securities. The three and nine months ended September 30, 2019 includes costs incurred in connection with a securitization of residential whole loans. The nine months ended September 30, 2019 also includes costs incurred in connection with a securitization of commercial loans. (5) TBA dollar roll income and CMBX coupon income each represent a component of Net gains (losses) on other derivatives. CMBX coupon income totaled $1.5 million and $4.3 million for the three and nine months ended September 30, 2020. CMBX coupon income totaled $1.5 million and $3.4 million for the three and nine months ended September 30, 2019, respectively. (6) MSR amortization represents the portion of changes in fair value that is attributable to the realization of estimated cash flows on the Company’s MSR portfolio and is reported as a component of Net unrealized gains (losses) on instruments measured at fair value. (7) Represents a non-GAAP financial measure. (8) The three months ended September 30, 2019 exclude cumulative and undeclared dividends of $0.3 million on our Series I Preferred Stock as of June 30, 2019. 57 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis From time to time, we enter into TBA forward contracts as an alternate means of investing in and financing Agency mortgage-backed securities. A TBA contract is an agreement to purchase or sell, for future delivery, an Agency mortgage-backed security with a specified issuer, term and coupon. A TBA dollar roll represents a transaction where TBA contracts with the same terms but different settlement dates are simultaneously bought and sold. The TBA contract settling in the later month typically prices at a discount to the earlier month contract with the difference in price commonly referred to as the “drop”. The drop is a reflection of the expected net interest income from an investment in similar Agency mortgage-backed securities, net of an implied financing cost, that would be foregone as a result of settling the contract in the later month rather than in the earlier month. The drop between the current settlement month price and the forward settlement month price occurs because in the TBA dollar roll market, the party providing the financing is the party that would retain all principal and interest payments accrued during the financing period. Accordingly, TBA dollar roll income generally represents the economic equivalent of the net interest income earned on the underlying Agency mortgage-backed security less an implied financing cost. TBA dollar roll transactions are accounted for under GAAP as a series of derivatives transactions. The fair value of TBA derivatives is based on methods similar to those used to value Agency mortgage-backed securities. We record TBA derivatives at fair value on our Consolidated Statements of Financial Condition and recognize periodic changes in fair value in Net gains (losses) on other derivatives in our Consolidated Statements of Comprehensive Income (Loss), which includes both unrealized and realized gains and losses on derivatives (excluding interest rate swaps). TBA dollar roll income is calculated as the difference in price between two TBA contracts with the same terms but different settlement dates multiplied by the notional amount of the TBA contract. Although accounted for as derivatives, TBA dollar rolls capture the economic equivalent of net interest income, or carry, on the underlying Agency mortgage-backed security (interest income less an implied cost of financing). TBA dollar roll income is reported as a component of Net gains (losses) on other derivatives in the Consolidated Statements of Comprehensive Income (Loss). The CMBX index is a synthetic tradable index referencing a basket of 25 commercial mortgage-backed securities of a particular rating and vintage. The CMBX index allows investors to take a long position (referred to as selling protection) or short position (referred to as purchasing protection) on the respective basket of commercial mortgage-backed securities and is structured as a “pay-as-you-go” contract whereby the protection seller receives and the protection buyer pays a standardized running coupon on the contracted notional amount. Additionally, the protection seller is obligated to pay to the protection buyer the amount of principal losses and/or coupon shortfalls on the underlying commercial mortgage-backed securities as they occur. We report income (expense) on CMBX positions in Net gains (losses) on other derivatives in the Consolidated Statements of Comprehensive Income (Loss). The coupon payments received or paid on CMBX positions is equivalent to interest income (expense) and therefore included in core earnings (excluding PAA). Premium Amortization Expense In accordance with GAAP, we amortize or accrete premiums or discounts into interest income for our Agency mortgage-backed securities, excluding interest-only securities, multifamily and reverse mortgages, taking into account estimates of future principal prepayments in the calculation of the effective yield. We recalculate the effective yield as differences between anticipated and actual prepayments occur. Using third-party model and market information to project future cash flows and expected remaining lives of securities, the effective interest rate determined for each security is applied as if it had been in place from the date of the security’s acquisition. The amortized cost of the security is then adjusted to the amount that would have existed had the new effective yield been applied since the acquisition date. The adjustment to amortized cost is offset with a charge or credit to interest income. Changes in interest rates and other market factors will impact prepayment speed projections and the amount of premium amortization recognized in any given period. Our GAAP metrics include the unadjusted impact of amortization and accretion associated with this method. Certain of our non-GAAP metrics exclude the effect of the PAA, which quantifies the component of premium amortization representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term Constant Prepayment Rate (“CPR”). The following table illustrates the impact of the PAA on premium amortization expense for our Residential Securities portfolio and residential securities transferred or pledged to securitization vehicles, for the periods presented: For the Three Months Ended September 30, For the Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Premium amortization expense $ 248,718 $ 376,306 $ 1,136,343 $ 942,339 Less: PAA cost (benefit) 33,879 117,152 376,343 338,786 Premium amortization expense (excluding PAA) $ 214,839 $ 259,154 $ 760,000 $ 603,553 58 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Interest income (excluding PAA), economic interest expense and economic net interest income (excluding PAA) Interest income (excluding PAA) represents interest income excluding the effect of the premium amortization adjustment, and serves as the basis for deriving average yield on interest earning assets (excluding PAA), net interest spread (excluding PAA) and net interest margin (excluding PAA), which are discussed below. We believe this measure provides management and investors with additional detail to enhance their understanding of our operating results and trends by excluding the component of premium amortization expense representing the cumulative effect of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities (other than interest-only securities, multifamily and reverse mortgages), which can obscure underlying trends in the performance of the portfolio. Economic interest expense is comprised of GAAP interest expense and the net interest component of interest rate swaps. We use interest rate swaps to manage our exposure to changing interest rates on repurchase agreements by economically hedging cash flows associated with these borrowings. Accordingly, adding the net interest component of interest rate swaps to interest expense, as computed in accordance with GAAP, reflects the total contractual interest expense and thus, provides investors with additional information about the cost of our financing strategy. We may use market agreed coupon (“MAC”) interest rate swaps in which we may receive or make a payment at the time of entering into such interest rate swap to compensate for the off-market nature of such interest rate swap. In accordance with GAAP, upfront payments associated with MAC interest rate swaps are not reflected in the net interest component of interest rate swaps in the Consolidated Statements of Comprehensive Income (Loss). We did not enter into any MAC interest rate swaps during the three and nine months ended September 30, 2020. Similarly, economic net interest income (excluding PAA), as computed below, provides investors with additional information to enhance their understanding of the net economics of our primary business operations. The following tables provide GAAP measures of interest expense and net interest income and details with respect to reconciling the aforementioned line items on a non-GAAP basis for each respective period: Interest Income (excluding PAA) GAAP Interest Income PAA Cost (Benefit) Interest Income (excluding PAA) (1) For the three months ended (dollars in thousands) September 30, 2020 $ 562,443 $ 33,879 $ 596,322 September 30, 2019 $ 919,299 $ 117,152 $ 1,036,451 For the nine months ended September 30, 2020 $ 1,702,281 $ 376,343 $ 2,078,624 September 30, 2019 $ 2,713,083 $ 338,786 $ 3,051,869 (1) Represents a non-GAAP financial measure. Economic Interest Expense and Economic Net Interest Income (excluding PAA) GAAP Interest Expense Add: Net Interest Component of Interest Rate Swaps Economic Interest Expense (1) GAAP Net Interest Income Less: Net Interest Component of Interest Rate Swaps Economic Net Interest Income (1) Add: PAA Cost (Benefit) Economic Net Interest Income (excluding PAA) (1) For the three months ended (dollars in thousands) September 30, 2020 $ 115,126 $ 62,529 $ 177,655 $ 447,317 $ 62,529 $ 384,788 $ 33,879 $ 418,667 September 30, 2019 $ 766,905 $ (88,466) $ 678,439 $ 152,394 $ (88,466) $ 240,860 $ 117,152 $ 358,012 For the nine months ended September 30, 2020 $ 804,631 $ 141,070 $ 945,701 $ 897,650 $ 141,070 $ 756,580 $ 376,343 $ 1,132,923 September 30, 2019 $ 2,164,817 $ (306,154) $ 1,858,663 $ 548,266 $ (306,154) $ 854,420 $ 338,786 $ 1,193,206 (1) Represents a non-GAAP financial measure. Experienced and Projected Long-Term CPR Prepayment speeds, as reflected by the CPR and interest rates vary according to the type of investment, conditions in financial markets, competition and other factors, none of which can be predicted with any certainty. In general, as prepayment speeds and expectations of prepayment speeds on our Agency mortgage-backed securities portfolio increase, related purchase premium amortization increases, thereby reducing the yield on such assets. The following table presents the weighted average 59 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis experienced CPR and weighted average projected long-term CPR on our Agency mortgage-backed securities portfolio as of and for the periods presented. Experienced CPR (1) Projected Long-term CPR (2) For the three months ended September 30, 2020 22.9 % 17.1 % September 30, 2019 14.6 % 16.3 % For the nine months ended September 30, 2020 18.7 % 17.1 % September 30, 2019 11.0 % 16.3 % (1) For the three and nine months ended September 30, 2020 and 2019, respectively. (2) At September 30, 2020 and 2019, respectively. Average Yield on Interest Earning Assets (excluding PAA), Net Interest Spread (excluding PAA), Net Interest Margin (excluding PAA) and Average Economic Cost of Interest Bearing Liabilities Net interest spread (excluding PAA), which is the difference between the average yield on interest earning assets (excluding PAA) and the average economic cost of interest bearing liabilities, which represents annualized economic interest expense divided by average interest bearing liabilities, and net interest margin (excluding PAA), which is calculated as the sum of interest income (excluding PAA) plus TBA dollar roll income and CMBX coupon income less interest expense and the net interest component of interest rate swaps divided by the sum of average interest earning assets plus average TBA contract and CMBX balances, provide management with additional measures of our profitability that management relies upon in monitoring the performance of the business. Disclosure of these measures, which are presented below, provides investors with additional detail regarding how management evaluates our performance. Net Interest Spread (excluding PAA) Average Interest Earning Assets (1) Interest Income (excluding PAA) (2) Average Yield on Interest Earning Assets (excluding PAA) (2) Average Interest Bearing Liabilities Economic Interest Expense (2)(3) Average Economic Cost of Interest Bearing Liabilities (2)(3) Economic Net Interest Income (excluding PAA) (2) Net Interest Spread (excluding PAA) (2) For the three months ended (dollars in thousands) September 30, 2020 $ 83,286,119 $ 596,322 2.86 % $ 74,901,128 $ 177,655 0.93 % 418,667 1.93 % September 30, 2019 $ 127,207,668 $ 1,036,451 3.26 % $ 116,391,094 $ 678,439 2.28 % 358,012 0.98 % For the nine months ended September 30, 2020 $ 94,607,284 $ 2,078,624 2.93 % $ 86,214,496 $ 945,701 1.44 % 1,132,923 1.49 % September 30, 2019 $ 119,918,692 $ 3,051,869 3.39 % $ 107,182,973 $ 1,858,663 2.29 % 1,193,206 1.10 % (1) Based on amortized cost. (2) Represents a non-GAAP financial measure. (3) Average economic cost of interest bearing liabilities represents annualized economic interest expense divided by average interest bearing liabilities. Average interest bearing liabilities reflects the average balances during the period. Economic interest expense is comprised of GAAP interest expense and the net interest component of interest rate swaps. 60 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Net Interest Margin (excluding PAA) Interest Income (excluding PAA) (1) TBA Dollar Roll and CMBX Coupon Income (2) Interest Expense Net Interest Component of Interest Rate Swaps Subtotal Average Interest Earnings Assets Average TBA Contract and CMBX Balances Subtotal Net Interest Margin (excluding PAA) (1) For the three months ended (dollars in thousands) September 30, 2020 $ 596,322 114,092 (115,126) (62,529) $ 532,759 $ 83,286,119 20,429,935 $ 103,716,054 2.05 % September 30, 2019 $ 1,036,451 15,554 (766,905) 88,466 $ 373,566 $ 127,207,668 9,248,502 $ 136,456,170 1.10 % For the nine months ended September 30, 2020 $ 2,078,624 256,520 (804,631) (141,070) $ 1,389,443 $ 94,607,284 16,341,140 $ 110,948,424 1.67 % September 30, 2019 $ 3,051,869 86,917 (2,164,817) 306,154 $ 1,280,123 $ 119,918,692 12,311,322 $ 132,230,014 1.29 % (1) Represents a non-GAAP financial measure. (2) TBA dollar roll income and CMBX coupon income each represent a component of Net gains (losses) on other derivatives. CMBX coupon income totaled $1.5 million and $4.3 million for the three and nine months ended September 30, 2020, respectively. CMBX coupon income totaled $1.5 million and $3.4 million for the three and nine months ended September 30, 2019, respectively. Economic Interest Expense and Average Economic Cost of Interest Bearing Liabilities Typically, our largest expense is the cost of interest bearing liabilities and the net interest component of interest rate swaps. The table below shows our average interest bearing liabilities and average economic cost of interest bearing liabilities as compared to average one-month and average six-month LIBOR for the periods presented. Economic Cost of Funds on Average Interest Bearing Liabilities Average Interest Bearing Liabilities Interest Bearing Liabilities at Period End Economic Interest Expense (1) Average Economic Cost of Interest Bearing Liabilities (2) Average One- Month LIBOR Average Six- Month LIBOR Average One-Month LIBOR Relative to Average Six- Month LIBOR Average Economic Cost of Interest Bearing Liabilities Relative to Average One- Month LIBOR Average Economic Cost of Interest Bearing Liabilities Relative to Average Six-Month LIBOR For the three months ended September 30, 2020 $ 74,901,128 $ 71,522,396 $ 177,655 0.93 % 0.16 % 0.31 % (0.15 %) 0.77 % 0.62 % September 30, 2019 $ 116,391,094 $ 111,004,216 $ 678,439 2.28 % 2.18 % 2.11 % 0.07 % 0.10 % 0.17 % For the nine months ended September 30, 2020 $ 86,214,496 $ 71,522,396 $ 945,701 1.44 % 0.64 % 0.83 % (0.19 %) 0.80 % 0.61 % September 30, 2019 $ 107,182,974 $ 111,004,216 $ 1,858,663 2.29 % 2.37 % 2.45 % (0.08 %) (0.08 %) (0.16 %) (1) Economic interest expense is comprised of GAAP interest expense and the net interest component of interest rate swaps. (2) Represents a non-GAAP financial measure. Economic interest expense decreased by $500.8 million for the three months ended September 30, 2020 compared to the same period in 2019. Economic interest expense decreased by $913.0 million for the nine months ended September 30, 2020 compared to the same period in 2019. The change in each period was due to lower borrowing rates and decreases in average interest bearing liabilities, partially offset by the change in the net interest component of interest rate swaps, which was ($62.5) million for the three months ended September 30, 2020 compared to $88.5 million for the same period in 2019 and ($141.1) million for the nine months ended September 30, 2020 compared to $306.2 million for the same period in 2019. We do not manage our portfolio to have a pre-designated amount of borrowings at quarter or year end. Our borrowings at period end are a snapshot of our borrowings as of a date, and this number may differ from average borrowings over the period for a number of reasons. The mortgage-backed securities we own pay principal and interest towards the end of each month and the mortgage-backed securities we purchase are typically settled during the beginning of the month. As a result, depending on the amount of mortgage-backed securities we have committed to purchase, we may retain the principal and interest we receive in the prior month, or we may use it to pay down our borrowings. Moreover, we generally use interest rate swaps, swaptions and other derivative instruments to hedge our portfolio, and as we pledge or receive collateral under these agreements, our borrowings on any given day may be increased or decreased. Our average borrowings during a quarter may differ from period 61 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis end borrowings as we implement our portfolio management strategies and risk management strategies over changing market conditions by increasing or decreasing leverage. Additionally, these numbers may differ during periods when we conduct equity capital raises, as in certain instances we may purchase additional assets and increase leverage in anticipation of an equity capital raise. Since our average borrowings and period end borrowings can be expected to differ, we believe our average borrowings during a period provide a more accurate representation of our exposure to the risks associated with leverage than our period end borrowings. At September 30, 2020 and December 31, 2019, the majority of our debt represented repurchase agreements and other secured financing arrangements collateralized by a pledge of our Residential Securities, residential mortgage loans, commercial real estate investments and corporate loans. All of our Residential Securities are currently accepted as collateral for these borrowings. However, we limit our borrowings, and thus our potential asset growth, in order to maintain unused borrowing capacity and maintain the liquidity and strength of our balance sheet. Realized and Unrealized Gains (Losses) Realized and unrealized gains (losses) is comprised of net gains (losses) on interest rate swaps, net gains (losses) on disposal of investments and other, net gains (losses) on other derivatives and net unrealized gains (losses) on instruments measured at fair value through earnings. These components of realized and unrealized gains (losses) for the three and nine months ended September 30, 2020 and 2019 were as follows: For the Three Months Ended September 30, For the Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Net gains (losses) on interest rate swaps (1) $ 107,371 $ (920,445) $ (3,223,558) $ (3,125,079) Net gains (losses) on disposal of investments and other 198,888 66,522 652,150 (65,727) Net gains (losses) on other derivatives 169,316 (16,888) 546,658 (638,458) Net unrealized gains (losses) on instruments measured at fair value through earnings 121,255 (1,091) (354,133) 41,657 Loan loss provision 21,993 (3,504) (146,084) (9,207) Total $ 618,823 $ (875,406) $ (2,524,967) $ (3,796,814) (1) Includes the net interest component of interest rate swaps, realized gains (losses) on termination or maturity of interest rate swaps and unrealized gains (losses) on interest rate swaps. For the Three Months Ended September 30, 2020 and 2019 Net gains (losses) on interest rate swaps for the three months ended September 30, 2020 was $107.4 million compared to ($920.4) million for the same period in 2019. The change was primarily attributable to lower realized losses on termination or maturity of interest rate swaps and favorable changes in unrealized gains (losses) on interest rate swaps. Realized gains (losses) on termination or maturity of interest rate swaps was ($0.4) million resulting from interest rate swaps with a notional amount of $375.0 million for the three months ended September 30, 2020 compared to ($682.6) million resulting from the termination or maturity of interest rate swaps with a notional amount of $30.6 billion for the same period in 2019. Unrealized gains (losses) on interest rate swaps was $0.2 billion for the three months ended September 30, 2020, reflecting a rise in forward interest rates during the period compared to ($326.3) million for the same period in 2019, which reflected a decline in forward interest rates during the earlier period. Net gains (losses) on disposal of investments and other was $198.9 million for the three months ended September 30, 2020 compared to $66.5 million for the same period in 2019. For the three months ended September 30, 2020, w e recognized a realized gain of $104.8 million as a result of deconsolidating a multifamily VIE and we disposed of Residential Securities with a carrying value of $2.8 billion for an aggregate net gain of $103.9 million. For the same period in 2019, we disposed of Residential Securities with a carrying value of $11.1 billion for an aggregate net loss of $76.3 million. Net gains (losses) on other derivatives was $169.3 million for the three months ended September 30, 2020 compared to ($16.9) million for the same period in 2019. The change in net gains (losses) on other derivatives was primarily comprised of higher net gains on TBA derivatives, which was $176.2 million for the three months ended September 30, 2020 compared to $47.8 million for the same period in 2019 and lower net losses on futures derivatives, which was ($9.7) million for the three months ended September 30, 2020 compared to ($59.7) million for the same period in 2019. 62 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Net unrealized gains (losses) on instruments measured at fair value through earnings was $121.3 million for the three months ended September 30, 2020 compared to ($1.1) million for the same period in 2019, primarily due to favorable changes in unrealized gains (losses) on securitized debt of consolidated VIEs backed by Agency mortgage-backed securities, commercial securitized loans of consolidated VIEs and securitized residential whole loans of consolidated VIEs, partially offset by unfavorable changes in unrealized gains (losses) on commercial securitized debt of consolidated VIEs and Agency interest-only securities for the three months ended September 30, 2020 compared to the same period in 2019. For the three months ended September 30, 2020, a net loan loss provision reversal of $22.0 million was recorded on commercial mortgage and corporate loans. For the three months ended September 30, 2019, a loan loss provision of ($3.5) million was recorded on a commercial mortgage loan. Refer to the “Loans” Note located within Item 1 for additional information related to these loan loss provisions. For the Nine Months Ended September 30, 2020 and 2019 Net gains (losses) on interest rate swaps for the nine months ended September 30, 2020 was ($3.2) billion compared to ($3.1) billion for the same period in 2019, primarily attributable to higher realized losses on termination or maturity of interest rate swaps and an unfavorable change in the net interest component of interest rate swaps, partially offset by lower unrealized losses on interest rate swaps. Realized gains (losses) on termination or maturity of interest rate swaps was ($1.9) billion resulting from fixed-rate payer and receiver interest rate swaps with notional amounts of $65.4 billion and $38.1 billion, respectively, for the nine months ended September 30, 2020 compared to ($1.4) billion resulting from fixed-rate payer and receiver interest rate swaps with notional amounts of $75.7 billion and $11.6 billion, respectively, for the same period in 2019. The net interest component of interest rate swaps was ($141.1) million for the nine months ended September 30, 2020, compared to $306.2 million for the same period in 2019, reflecting a decrease in rates combined with the timing of rate resets during the period and changes in notional balance. Unrealized gains (losses) on interest rate swaps was ($1.2) billion for the nine months ended September 30, 2020, reflecting a decline in forward interest rates during the period compared to ($2.0) billion for the same period in 2019, which reflected a steeper decline in forward interest rates during the earlier period. Net gains (losses) on disposal of investments and other was $652.2 million for the nine months ended September 30, 2020 compared to ($65.7) million for the same period in 2019. For the nine months ended September 30, 2020, we disposed of Residential Securities with a carrying value of $50.2 billion for an aggregate net gain of $631.1 million and we recognized a realized gain of $104.8 million as a result of deconsolidating a multifamily VIE. For the same period in 2019, we disposed of Residential Securities with a carrying value of $30.7 billion for an aggregate net loss of ($50.6) million. Net gains (losses) on other derivatives was $546.7 million for the nine months ended September 30, 2020 compared to ($638.5) million for the same period in 2019. The change in net gains (losses) on other derivatives was primarily comprised of higher net gains on TBA derivatives, which was $812.1 million for the nine months ended September 30, 2020 compared to $327.5 million for the same period in 2019 and lower net losses on futures derivatives, which was ($299.6) million for the nine months ended September 30, 2020 compared to ($946.3) million for the same period in 2019. Net unrealized gains (losses) on instruments measured at fair value through earnings was ($354.1) million for the nine months ended September 30, 2020 compared to $41.7 million for the same period in 2019, primarily due to unfavorable changes in unrealized gains (losses) on commercial securitized loans of consolidated VIEs, Agency interest-only securities, credit risk transfer securities and residential loans, partially offset by favorable changes in unrealized gains (losses) on commercial securitized debt of consolidated VIEs for the nine months ended September 30, 2020 compared to the same period in 2019. For the nine months ended September 30, 2020, a loan loss provision of ($146.1) million was recorded on commercial mortgage and corporate loans. For the nine months ended September 30, 2019, a loan loss provision of ($9.2) million was recorded on a commercial mortgage loan. Refer to the “Loans” Note located within Item 1 for additional information related to these loan loss provisions. Other Income (Loss) Other income (loss) includes certain revenues and costs associated with our investments in commercial real estate, including rental income and recoveries, net servicing income on MSRs, operating costs as well as depreciation and amortization expense. We report in Other income (loss) items whose amounts, either individually or in the aggregate, would not, in the opinion of management, be meaningful to readers of the financial statements. Given the nature of certain components of this line item, balances may fluctuate from period to period. 63 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis General and Administrative Expenses General and administrative (“G&A”) expenses consist of compensation and management fee (until closing of the Internalization) and other expenses. The following table shows our total G&A expenses as compared to average total assets and average equity for the periods presented. G&A Expenses and Operating Expense Ratios Total G&A Expenses (1) Total G&A Expenses/Average Assets (1) Total G&A Expenses/Average Equity (1) For the three months ended (dollars in thousands) September 30, 2020 $ 48,832 0.21 % 1.40 % September 30, 2019 $ 66,138 0.20 % 1.71 % For the nine months ended September 30, 2020 $ 194,127 0.25 % 1.83 % September 30, 2019 $ 228,283 0.25 % 2.00 % (1) Includes $2.8 million of transaction costs incurred in connection with securitizations of residential whole loans for the three months ended September 30, 2020. Includes $11.1 million of transaction costs incurred in connection with securitizations of residential whole loans and Agency mortgage-backed securities as well as costs incurred in connection with the Internalization and costs incurred in connection with the CEO search process for the nine months ended September 30, 2020. Includes $2.6 million of transaction costs incurred in connection with a securitization of residential whole loans for the three months ended September 30, 2019. Includes $15.7 million of transaction costs incurred in connection with securitizations of residential whole loans and commercial loans for the nine months ended September 30, 2019. Excluding these transaction costs, G&A expenses as a percentage of average total assets were 0.20% and 0.24% and as a percentage of average equity were 1.32% and 1.73% for the three and nine months ended September 30, 2020, respectively. Excluding these transaction costs, G&A expenses as a percentage of average total assets were 0.19% and 0.23% and as a percentage of average equity were 1.64% and 1.86% for the three and nine months ended September 30, 2019, respectively. G&A expenses were $48.8 million for the three months ended September 30, 2020, a decrease of $17.3 million compared to the same period in 2019, primarily due to lower compensation costs during the third quarter of 2020 compared with the same period in 2019 as a result of cost savings generated from the Internalization which closed on June 30, 2020. G&A expenses were $194.1 million for the nine months ended September 30, 2020, a decrease of $34.2 million compared to the same period in 2019, primarily due to lower compensation costs, reflecting cost savings generated from the Internalization and lower management fees in the first half of 2020 reflecting lower adjusted stockholders’ equity balances compared to the same period in 2019, and lower transaction costs during the nine months ended September 30, 2020 compared to the same period in 2019. Return on Average Equity The following table shows the components of our annualized return on average equity for the periods presented. Components of Annualized Return on Average Equity Economic Net Interest Income/ Average Equity (1) Realized and Unrealized Gains and Losses/Average Equity (2) Other Income (Loss)/Average Equity G&A Expenses/ Average Equity Income Taxes/ Average Equity Return on Average Equity For the three months ended September 30, 2020 11.01 % 19.47 % 0.23 % (1.40 %) (0.29 %) 29.02 % September 30, 2019 6.23 % (24.93 %) 0.91 % (1.71 %) 0.18 % (19.32 %) For the nine months ended September 30, 2020 7.14 % (22.49 %) 0.36 % (1.83 %) 0.13 % (16.69 %) September 30, 2019 7.49 % (35.97 %) 0.82 % (2.00 %) 0.09 % (29.57 %) (1) Economic net interest income includes the net interest component of interest rate swaps. (2) Realized and unrealized gains and losses excludes the net interest component of interest rate swaps. Unrealized Gains and Losses - Available-for-Sale Investments With our available-for-sale accounting treatment on our Agency mortgage-backed securities, which represent the largest portion of assets on balance sheet, as well as certain commercial mortgage-backed securities, unrealized fluctuations in market values of assets do not impact our GAAP net income (loss) but rather are reflected on our balance sheet by changing the carrying value of the asset and stockholders’ equity under accumulated other comprehensive income (loss). As a result of this fair value accounting treatment, our book value and book value per share are likely to fluctuate far more than if we used amortized cost 64 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis accounting. As a result, comparisons with companies that use amortized cost accounting for some or all of their balance sheet may not be meaningful. The table below shows cumulative unrealized gains and losses on our available-for-sale investments reflected in the Consolidated Statements of Financial Condition. September 30, 2020 December 31, 2019 (dollars in thousands) Unrealized gain $ 3,600,389 $ 2,267,577 Unrealized loss (11,333) (129,386) Accumulated other comprehensive income (loss) $ 3,589,056 $ 2,138,191 Unrealized changes in the estimated fair value of available-for-sale investments may have a direct effect on our potential earnings and dividends: positive changes will increase our equity base and allow us to increase our borrowing capacity while negative changes tend to reduce borrowing capacity. A very large negative change in the net fair value of our available-for-sale Residential Securities might impair our liquidity position, requiring us to sell assets with the potential result of realized losses upon sale. The fair value of these securities being less than amortized cost at September 30, 2020 is solely due to market conditions and not the quality of the assets. Substantially all of the Agency mortgage-backed securities are “AAA” rated or carry an implied “AAA” rating. The investments are not considered to be other-than-temporarily impaired because we currently have the ability and intent to hold the investments to maturity or for a period of time sufficient for a forecasted market price recovery up to or beyond the cost of the investments, and it is not more likely than not that we will be required to sell the investments before recovery of the amortized cost bases, which may be maturity. Also, we are guaranteed payment of the principal and interest amounts of the securities by the respective issuing Agency. Financial Condition Total assets were $89.2 billion and $130.3 billion at September 30, 2020 and December 31, 2019, respectively. The change, consistent with our portfolio repositioning to strengthen our balance sheet in the first quarter of 2020, was primarily due to a decrease in Agency mortgage-backed securities of $38.5 billion, including assets transferred or pledged to securitization vehicles, residential mortgage loans of $0.5 billion and non-Agency mortgage-backed securities of $0.4 billion. Our portfolio composition, net equity allocation and debt-to-net equity ratio by asset class were as follows at September 30, 2020: 65 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Residential Commercial Agency MBS and MSRs TBAs (1) CRTs Non-Agency MBS and Residential Mortgage Loans (2) CRE Debt & Preferred Equity Investments Investments in CRE Corporate Debt Total (3) Assets (dollars in thousands) Fair value/carrying value $ 75,746,802 $ 21,089,555 $ 411,538 $ 4,459,240 $ 3,685,255 $ 790,597 $ 2,061,878 $ 87,155,310 Debt Repurchase agreements 62,804,603 21,072,039 231,274 955,451 642,119 — — 64,633,447 Other secured financing 2,745 — — 30,098 — — 828,530 861,373 Debt issued by securitization vehicles 573,108 — — 2,982,247 2,472,221 — — 6,027,576 Net forward purchases 1,115,598 — — 6,203 — — — 1,121,801 Mortgages payable — — — — — 507,934 — 507,934 Net equity allocated $ 11,250,748 $ 17,516 $ 180,264 $ 485,241 $ 570,915 $ 282,663 $ 1,233,348 $ 14,003,179 (4) Net equity allocated (%) 80 % — % 1 % 4 % 4 % 2 % 9 % 100 % Debt/net equity ratio 5.7:1 NM 1.3:1 8.2:1 5.5:1 1.8:1 0.7:1 5.1:1 (5) (1) Fair value/carrying value represents implied market value and repurchase agreements represent the notional value. (2) Includes loans held for sale, net. (3) Excludes the TBA asset, debt and equity balances. (4) Net Equity Allocated, as disclosed in the above table, excludes non-portfolio related activity and may differ from stockholders’ equity per the Consolidated Statements of Financial Condition. (5) Represents the debt/net equity ratio as determined using amounts on the Consolidated Statements of Financial Condition. NM Not meaningful. Residential Securities Substantially all of our Agency mortgage-backed securities at September 30, 2020 and December 31, 2019 were backed by single-family residential mortgage loans and were secured with a first lien position on the underlying single-family properties. Our mortgage-backed securities were largely Freddie Mac, Fannie Mae or Ginnie Mae pass through certificates or CMOs, which carry an actual or implied “AAA” rating. We carry all of our Agency mortgage-backed securities at fair value on the Consolidated Statements of Financial Condition. We accrete discount balances as an increase to interest income over the expected life of the related interest earning assets and we amortize premium balances as a decrease to interest income over the expected life of the related interest earning assets. At September 30, 2020 and December 31, 2019 we had on our Consolidated Statements of Financial Condition a total of $92.1 million and $156.9 million, respectively, of unamortized discount (which is the difference between the remaining principal value and current amortized cost of our Residential Securities, excluding securities transferred or pledged to securitization vehicles, acquired at a price below principal value) and a total of $3.8 billion and $5.3 billion, respectively, of unamortized premium (which is the difference between the remaining principal value and the current amortized cost of our Residential Securities, excluding securities transferred or pledged to securitization vehicles, acquired at a price above principal value). The weighted average experienced prepayment speed on our Agency mortgage-backed securities portfolio for the three months ended September 30, 2020 and 2019 was 22.9% and 14.6%, respectively. The weighted average projected long-term prepayment speed on our Agency mortgage-backed securities portfolio as of September 30, 2020 and 2019 was 17.1% and 16.3%, respectively. Given our current portfolio composition, if mortgage principal prepayment rates were to increase over the life of our mortgage-backed securities, all other factors being equal, our net interest income would decrease during the life of these mortgage-backed securities as we would be required to amortize our net premium balance into income over a shorter time period. Similarly, if mortgage principal prepayment rates were to decrease over the life of our mortgage-backed securities, all other factors being equal, our net interest income would increase during the life of these mortgage-backed securities as we would amortize our net premium balance over a longer time period. The following tables present our Residential Securities, excluding securities transferred or pledged to securitization vehicles, that were carried at fair value at September 30, 2020 and December 31, 2019. 66 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis September 30, 2020 December 31, 2019 Estimated Fair Value Agency (dollars in thousands) Fixed-rate pass-through $ 72,210,570 $ 108,723,414 Adjustable-rate pass-through 527,267 1,524,331 CMO 152,513 160,016 Interest-only 465,376 708,562 Multifamily 1,503,413 1,717,197 Reverse mortgages 56,028 59,847 Total agency securities $ 74,915,167 $ 112,893,367 Residential credit CRT $ 411,538 $ 531,322 Alt-A 90,954 151,383 Prime 186,178 276,257 Prime interest-only 1,191 3,167 Subprime 119,547 348,979 NPL/RPL 281,869 164,268 Prime jumbo (>= 2010 vintage) 36,204 184,664 Prime jumbo (>= 2010 vintage) interest-only 1,659 7,150 Total residential credit securities $ 1,129,140 $ 1,667,190 Total Residential Securities $ 76,044,307 $ 114,560,557 The following table summarizes certain characteristics of our Residential Securities (excluding interest-only mortgage-backed securities) and interest-only mortgage-backed securities, excluding securities transferred or pledged to securitization vehicles, at September 30, 2020 and December 31, 2019. September 30, 2020 December 31, 2019 Residential Securities (1) (dollars in thousands) Principal amount $ 69,004,541 $ 107,412,143 Net premium 3,091,544 4,309,668 Amortized cost 72,096,084 111,721,811 Amortized cost / principal amount 104.48 % 104.01 % Carrying value 75,576,026 113,841,402 Carrying value / principal amount 109.52 % 105.99 % Weighted average coupon rate 3.59 % 3.91 % Weighted average yield 2.96 % 3.07 % Adjustable-rate Residential Securities (1) Principal amount $ 1,239,156 $ 2,513,310 Weighted average coupon rate 3.33 % 4.13 % Weighted average yield 4.82 % 3.52 % Weighted average term to next adjustment 16 Months 13 Months Weighted average lifetime cap (2) 0.38 % 8.24 % Principal amount at period end as % of total residential securities 1.80 % 2.34 % Fixed-rate Residential Securities (1) Principal amount $ 67,765,385 $ 104,898,833 Weighted average coupon rate 3.59 % 3.90 % Weighted average yield 2.93 % 3.06 % Principal amount at period end as % of total residential securities 98.20 % 97.66 % Interest-only Residential Securities Notional amount $ 3,696,743 $ 5,447,193 Net premium 610,922 876,129 Amortized cost 610,922 876,129 Amortized cost / notional amount 16.53 % 16.08 % Carrying value 468,281 719,155 Carrying value / notional amount 12.67 % 13.20 % Weighted average coupon rate 4.22 % 3.29 % Weighted average yield NM 1.73 % (1) Excludes interest-only mortgage-backed securities. (2) Excludes non-Agency mortgage-backed securities and CRT securities as this attribute is not applicable to these asset classes. NM Not meaningful. 67 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis The following tables summarize certain characteristics of our Residential Credit portfolio at September 30, 2020. Payment Structure Investment Characteristics Product Total Senior Subordinate Coupon Credit Enhancement 60+ Delinquencies 3M VPR (1) (dollars in thousands) Agency credit risk transfer $ 397,665 $ — $ 397,665 4.37 % 0.99 % 4.78 % 41.13 % Private label credit risk transfer 13,873 — 13,873 5.60 % — % 4.69 % 33.94 % Alt-A 90,954 26,379 64,575 3.70 % 8.32 % 19.13 % 16.44 % Prime 186,178 28,640 157,538 4.17 % 8.75 % 12.83 % 22.26 % Prime interest-only 1,191 1,191 — 0.46 % — 6.20 % 40.34 % Subprime 119,547 66,303 53,244 1.05 % 8.97 % 20.96 % 5.93 % Re-performing loan securitizations 273,393 142,960 130,433 4.19 % 33.47 % 22.24 % 5.40 % Non-performing loan securitizations 8,476 8,476 — 3.67 % 31.00 % 83.41 % — % Prime jumbo (>=2010 vintage) 36,204 — 36,204 3.82 % 2.23 % 4.99 % 50.31 % Prime jumbo (>=2010 vintage) interest-only 1,659 1,659 — 0.36 % — 3.91 % 48.78 % Total/weighted average (2) $ 1,129,140 $ 275,608 $ 853,532 3.87 % 11.34 % 13.55 % 23.43 % (1) Represents the 3 month voluntary prepayment rate (“VPR”). (2) Total investment characteristics exclude the impact of IOs. Bond Coupon Product ARM Fixed Floater Interest-Only Estimated Fair Value (dollars in thousands) Agency credit risk transfer $ — $ — $ 397,665 $ — $ 397,665 Private label credit risk transfer — — 13,873 — 13,873 Alt-A 28,251 47,803 14,900 — 90,954 Prime 29,866 130,153 26,159 — 186,178 Prime interest-only — — — 1,191 1,191 Subprime — 3,975 115,415 157 119,547 Re-performing loan securitizations — 273,393 — — 273,393 Non-performing loan securitizations — 8,476 — — 8,476 Prime jumbo (>=2010 vintage) — 36,204 — — 36,204 Prime jumbo (>=2010 vintage) interest-only — — — 1,659 1,659 Total $ 58,117 $ 500,004 $ 568,012 $ 3,007 $ 1,129,140 Contractual Obligations The following table summarizes the effect on our liquidity and cash flows from contractual obligations at September 30, 2020. The table does not include the effect of net interest rate payments on our interest rate swap agreements. The net swap payments will fluctuate based on monthly changes in the floating rate. At September 30, 2020, the interest rate swaps had a net fair value of ($1.1) billion. 68 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Within One Year One to Three Years Three to Five Years More than Five Years Total (dollars in thousands) Repurchase agreements $ 64,633,447 $ — $ — $ — $ 64,633,447 Interest expense on repurchase agreements (1) 59,043 — — — 59,043 Other secured financing 13,923 18,920 828,530 — 861,373 Interest expense on other secured financing (1) 19,090 36,668 19,116 — 74,874 Debt issued by securitization vehicles (principal) — — 185,909 5,841,938 6,027,847 Interest expense on debt issued by securitization vehicles 144,424 217,931 215,675 3,331,920 3,909,950 Mortgages payable (principal) 22,828 65,136 155,686 269,532 513,182 Interest expense on mortgages payable 20,314 39,431 34,312 126,522 220,579 Long-term operating lease obligations 3,955 7,723 7,723 — 19,401 Total $ 64,917,024 $ 385,809 $ 1,446,951 $ 9,569,912 $ 76,319,696 (1) Interest expense on repurchase agreements and other secured financing calculated based on rates at September 30, 2020. In the coming periods, we expect to continue to finance our Residential Securities in a manner that is largely consistent with our current operations via repurchase agreements. We may use securitization structures, credit facilities, mortgages payable or other term financing structures to finance certain of our assets. During the nine months ended September 30, 2020, we received $14.4 billion from principal repayments and $50.3 billion in cash from disposal of Residential Securities. During the nine months ended September 30, 2019, we received $11.2 billion from principal repayments and $19.7 billion in cash from disposal of Residential Securities. Off-Balance Sheet Arrangements We do not have any relationships with unconsolidated entities or financial partnerships which would have been established for the sole purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We have limited future funding commitments related to certain of our unconsolidated joint ventures. In addition, we have provided customary non-recourse carve-out and environmental guarantees (or underlying indemnities with respect thereto) with respect to mortgage loans held by subsidiaries of these unconsolidated joint ventures. We believe that the likelihood of making any payments under these guarantees is remote, and have not accrued a related liability at September 30, 2020. Capital Management Maintaining a strong balance sheet that can support the business even in times of economic stress and market volatility is of critical importance to our business strategy. A strong and robust capital position is essential to executing our investment strategy. Our capital strategy is predicated on a strong capital position, which enables us to execute our investment strategy regardless of the market environment. Our capital policy defines the parameters and principles supporting a comprehensive capital management practice. The major risks impacting capital are capital, liquidity and funding risk, investment/market risk, credit risk, counterparty risk, operational risk and compliance, regulatory and legal risk. For further discussion of the risks we are subject to, please see Part I, Item 1A. “Risk Factors” in 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 quarters ended March 31, 2020 and June 30, 2020. Capital requirements are based on maintaining levels above approved thresholds, ensuring the quality of our capital appropriately reflects our asset mix, market and funding structure. In the event we fall short of our internal thresholds, we will consider appropriate actions which may include asset sales, changes in asset mix, reductions in asset purchases or originations, issuance of capital or other capital enhancing or risk reduction strategies. 69 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Stockholders’ Equity The following table provides a summary of total stockholders’ equity at September 30, 2020 and December 31, 2019: September 30, 2020 December 31, 2019 Stockholders’ equity (dollars in thousands) 7.50% Series D cumulative redeemable preferred stock $ 445,457 $ 445,457 6.95% Series F fixed-to-floating rate cumulative redeemable preferred stock 696,910 696,910 6.50% Series G fixed-to-floating rate cumulative redeemable preferred stock 411,335 411,335 6.75% Series I fixed-to-floating rate cumulative redeemable preferred stock 428,324 428,324 Common stock 14,029 14,301 Additional paid-in capital 19,798,032 19,966,923 Accumulated other comprehensive income (loss) 3,589,056 2,138,191 Accumulated deficit (11,200,937) (8,309,424) Total stockholders’ equity $ 14,182,206 $ 15,792,017 Capital Stock The following table provides activity related to our Direct Purchase and Dividend Reinvestment Program for the periods presented: For the 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 During the nine months ended September 30, 2019, we 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, we 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. No shares were issued under the at-the-market sales program during the nine months ended September 30, 2020. During the nine months ended September 30, 2019, we issued 56.0 million shares for proceeds of $569.1 million, net of commissions and fees, under the at-the-market sales program. In June 2019, we announced that our Board had authorized the repurchase of up to $1.5 billion of our outstanding shares of common stock through December 31, 2020. During the three and nine months ended September 30, 2020, we repurchased 4.8 million and 27.7 million shares of our common stock, respectively, for an aggregate amount of $31.3 million and $174.7 million, respectively, excluding commission costs. All common shares purchased were part of a publicly announced plan in open-market transactions. During the three and nine months ended September 30, 2019, we repurchased 18.3 million shares of our common stock for an aggregate amount of $155.0 million, excluding commission costs. During the three and nine months ended September 30, 2019, we redeemed all 7.0 million of our 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, we redeemed all 2.2 million of our 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, we issued 17.7 million shares of our 6.750% Series I Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock for gross proceeds of $442.5 million before deducting the underwriting discount and other estimated offering costs. Leverage and Capital We believe that it is prudent to maintain conservative debt-to-equity and economic leverage ratios as there may be continued 70 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis volatility in the mortgage and credit markets. Our capital policy governs our capital and leverage position including setting limits. Based on the guidelines, we generally expect to maintain an economic leverage ratio of less than 10:1. Our actual economic leverage ratio varies from time to time based upon various factors, including our opinion of the level of risk of our assets and liabilities, our liquidity position, our level of unused borrowing capacity, the availability of credit, over-collateralization levels required by lenders when we pledge assets to secure borrowings and our assessment of domestic and international market conditions. Our debt-to-equity ratio at September 30, 2020 and December 31, 2019 was 5.1:1 and 7.1:1, respectively. Our economic leverage ratio, which is computed as the sum of Recourse Debt, cost basis of TBA derivative and CMBX notional outstanding and net forward purchases (sales) of investments divided by total equity was 6.2:1 and 7.2:1 at September 30, 2020 and December 31, 2019, respectively. Our capital ratio, which represents our ratio of stockholders’ equity to total assets (inclusive of total market value of TBA derivatives and shown net of debt issued by securitization vehicles), was 13.6% and 12.0% at September 30, 2020 and December 31, 2019, respectively. Risk Management For more information on COVID-19, including actions we have taken in response, please refer to the section titled “Business Environment and Coronavirus Disease 2019 (“COVID-19”)” within this Item 2. We are subject to a variety of risks in the ordinary conduct of our business. The effective management of these risks is of critical importance to the overall success of Annaly. The objective of our risk management framework is to identify, measure and monitor these risks. Our risk management framework is intended to facilitate a holistic, enterprise wide view of risk. We have built a strong and collaborative risk management culture throughout Annaly focused on awareness which supports appropriate understanding and management of our key risks. Each employee is accountable for identifying, monitoring and managing risk within their area of responsibility. Risk Appetite We maintain a firm-wide risk appetite statement which defines the types and levels of risk we are willing to take in order to achieve our business objectives, and reflects our risk management philosophy. We engage in risk activities based on our core expertise that aim to enhance value for our stockholders. Our activities focus on income generation and capital preservation through proactive portfolio management, supported by a conservative liquidity and leverage posture. The risk appetite statement asserts the following key risk parameters to guide our investment management activities: Risk Parameter Description Portfolio Composition We will maintain a portfolio comprised of target assets approved by our Board and in accordance with our capital allocation policy. Leverage We generally expect to maintain an economic leverage ratio no greater than 10:1. Liquidity Risk We will seek to maintain an unencumbered asset portfolio sufficient to meet our liquidity needs under adverse market conditions. Interest Rate Risk We will seek to manage interest rate risk to protect the portfolio from adverse rate movements utilizing derivative instruments targeting both income and capital preservation. Credit Risk We will seek to manage credit risk by making investments which conform within our specific investment policy parameters and optimize risk-adjusted returns. Capital Preservation We will seek to protect our capital base through disciplined risk management practices. Compliance We will seek to comply with regulatory requirements needed to maintain our REIT status and our exemption from registration under the Investment Company Act. Governance Risk management begins with our Board, through the review and oversight of the risk management framework, and executive management, through the ongoing formulation of risk management practices and related execution in managing risk. The Board exercises its oversight of risk management primarily through the Board Risk Committee (“BRC”) and Board Audit Committee (“BAC”). The BRC is responsible for oversight of our risk governance structure, risk management and risk assessment guidelines and policies and our risk appetite. The BAC is responsible for oversight of the quality and integrity of our accounting, internal controls and financial reporting practices, including independent auditor selection, evaluation and review, and oversight of the internal audit function. 71 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Risk assessment and risk management are the responsibility of our management. A series of management committees has oversight or decision-making responsibilities for risk management activities. Membership of these committees is reviewed regularly to ensure the appropriate personnel are engaged in the risk management process. Four primary management committees have been established to provide a comprehensive framework for risk management. The management committees responsible for our risk management include the Enterprise Risk Committee (“ERC”), Asset and Liability Committee (“ALCO”), Investment Committee and the Financial Reporting and Disclosure Committee (“FRDC”). Each of these committees reports to our management Operating Committee which is responsible for oversight and management of our operations, including oversight and approval authority over all aspects of our enterprise risk management. Audit Services is an independent function with reporting lines to the BAC. Audit Services is responsible for performing our internal audit activities, which includes independently assessing and validating key controls within the risk management framework. Our compliance group is responsible for oversight of our regulatory compliance. Our Chief Compliance Officer has reporting lines to the BAC. Description of Risks We are subject to a variety of risks due to the business we operate. Risk categories are an important component of a robust enterprise wide risk management framework. We have identified the following primary categories that we utilize to identify, assess, measure and monitor risk. Risk Description Capital, Liquidity and Funding Risk Risk to earnings, capital or business resulting from our inability to meet our obligations when they come due without incurring unacceptable losses because of inability to liquidate assets or obtain adequate funding. Investment/Market Risk Risk to earnings, capital or business resulting in the decline in value of our assets or an increase in the costs of financing caused by changes in market variables, such as interest rates, which affect the values of investment securities and other investment instruments. Credit Risk Risk to earnings, capital or business resulting from an obligor’s failure to meet the terms of any contract or otherwise failure to perform as agreed. This risk is present in lending and investing activities. Counterparty Risk Risk to earnings, capital or business resulting from a counterparty’s failure to meet the terms of any contract or otherwise failure to perform as agreed. This risk is present in funding, hedging and investing activities. Operational Risk Risk to earnings, capital, reputation or business arising from inadequate or failed internal processes or systems (including proprietary and third party models), human factors or external events. Compliance, Regulatory and Legal Risk Risk to earnings, capital, reputation or conduct of business arising from violations of, or nonconformance with internal and external applicable rules and regulations, losses resulting from lawsuits or adverse judgments, or from changes in the regulatory environment that may impact our business model. 72 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Capital, Liquidity and Funding Risk Management Our capital, liquidity and funding risk management strategy is designed to ensure the availability of sufficient resources to support our business and meet our financial obligations under both normal and adverse market and business environments. Our capital, liquidity and funding risk management practices consist of the following primary elements: Element Description Funding Availability of diverse and stable sources of funds. Excess Liquidity Excess liquidity primarily in the form of unencumbered assets and cash. Maturity Profile Diversity and tenor of liabilities and modest use of leverage. Stress Testing Scenario modeling to measure the resiliency of our liquidity position. Liquidity Management Policies Comprehensive policies including monitoring, risk limits and an escalation protocol. Funding Our primary financing sources are repurchase agreements provided through counterparty arrangements and through Arcola, other secured financing, debt issued by securitization vehicles, mortgages, credit facilities, note sales and various forms of equity. We maintain excess liquidity by holding unencumbered liquid assets that could be either used to collateralize additional borrowings or sold. We seek to conservatively manage our repurchase agreement funding position through a variety of methods including diversity, breadth and depth of counterparties and maintaining a staggered maturity profile. Our wholly-owned subsidiary, Arcola, provides direct access to third party funding as a FINRA member broker-dealer. Arcola borrows funds through the General Collateral Finance Repo service offered by the FICC, with FICC acting as the central counterparty. In addition, Arcola has borrowed funds through direct repurchase agreements. To reduce our liquidity risk we maintain a laddered approach to our repurchase agreements. At September 30, 2020 and December 31, 2019, the weighted average days to maturity was 72 days and 65 days, respectively. Our repurchase agreements generally provide that in the event of a margin call we must provide additional securities or cash on the same business day that a margin call is made. Should prepayment speeds on the mortgages underlying our Agency and Residential mortgage-backed securities and/or market interest rates or other factors move suddenly and cause declines in the market value of assets posted as collateral, resulting margin calls may cause an adverse change in our liquidity position. We maintain membership in the Federal Home Loan Bank (“FHLB”) through our captive insurance subsidiary Truman Insurance Company LLC (“Truman”). A 2016 rule from the Federal Housing Finance Agency (“FHFA”) requires captive insurance companies to terminate their FHLB membership, however, given the length of its membership at the time the rule was enacted, Truman was granted a five year sunset provision whereby its membership will expire in February 2021. We believe our business objectives align well with the mission of the FHLB System. While there can be no assurances that such steps will be taken, we believe it would be appropriate for there to be legislative or other action to permit Truman and similar captive insurance subsidiaries to retain their membership status beyond the current sunset period. However, in anticipation of the expiration of our membership, we have refinanced our prior FHLB advances with alternative funding sources, including credit facilities and securitization funding. At September 30, 2020, we had total financial assets and cash pledged against existing liabilities of $71.7 billion. The weighted average haircut was approximately 4% on repurchase agreements. The quality and character of the Residential Securities and commercial real estate investments that we pledge as collateral under the repurchase agreements and interest rate swaps did not materially change at September 30, 2020 compared to the same period in 2019, and our counterparties did not materially alter any requirements, including required haircuts, related to the collateral we pledge under repurchase agreements and interest rate swaps during the three months ended September 30, 2020. 73 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis The following table presents our quarterly average and quarter-end repurchase agreement and reverse repurchase agreement balances outstanding for the periods presented: Repurchase Agreements Reverse Repurchase Agreements Average Daily Amount Outstanding Ending Amount Outstanding Average Daily Amount Outstanding Ending Amount Outstanding For the three months ended (dollars in thousands) September 30, 2020 $ 67,542,187 $ 64,633,447 $ 286,792 $ — June 30, 2020 68,468,813 67,163,598 183,423 — March 31, 2020 96,756,341 72,580,183 461,123 — December 31, 2019 102,760,107 101,740,728 1,006,487 — September 30, 2019 108,389,796 102,682,104 1,459,070 — June 30, 2019 101,983,828 105,181,241 3,478,510 — March 31, 2019 87,781,404 88,554,170 3,937,769 523,449 December 31, 2018 83,984,254 81,115,874 2,741,022 650,040 September 30, 2018 79,214,382 79,073,026 2,330,519 1,234,704 The following table provides information on our repurchase agreements and other secured financing by maturity date at September 30, 2020. The weighted average remaining maturity on our repurchase agreements and other secured financing was 90 days at September 30, 2020: September 30, 2020 Principal Balance Weighted Average Rate % of Total (dollars in thousands) 1 day $ 2,700,000 0.13 % 4.1 % 2 to 29 days 23,894,431 0.36 % 36.5 % 30 to 59 days 8,644,191 0.51 % 13.2 % 60 to 89 days 9,702,860 0.33 % 14.8 % 90 to 119 days 5,529,035 0.73 % 8.4 % Over 120 days (1) 15,024,303 0.55 % 23.0 % Total $ 65,494,820 0.44 % 100.0 % (1) Approximately 1% of the total repurchase agreements and other secured financing had a remaining maturity over 1 year. The table below presents our outstanding debt balances and associated weighted average rates and days to maturity at September 30, 2020: Weighted Average Rate Principal Balance As of Period End For the Quarter Weighted Average Days to Maturity (1) (dollars in thousands) Repurchase agreements $ 64,633,447 0.42 % 0.44 % 72 Other secured financing (2) 861,373 2.23 % 2.56 % 1,432 Securitized debt of consolidated VIEs (3) 6,027,847 2.15 % 2.03 % 9,336 Mortgages payable (3) 513,182 3.99 % 3.95 % 4,174 Total indebtedness $ 72,035,849 (1) Determined based on estimated weighted-average lives of the underlying debt instruments. (2) Includes financing under credit facilities. (3) Non-recourse to Annaly. Excess Liquidity 74 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Our primary source of liquidity is the availability of unencumbered assets which may be provided as collateral to support additional funding needs. We target minimum thresholds of available, unencumbered assets to maintain excess liquidity. The following table illustrates our asset portfolio available to support potential collateral obligations and funding needs. Assets are considered encumbered if pledged as collateral against an existing liability, and therefore are no longer available to support additional funding. An asset is considered unencumbered if it has not been pledged or securitized. The following table also provides the carrying amount of our encumbered and unencumbered financial assets at September 30, 2020: Encumbered Assets Unencumbered Assets Total Financial assets (dollars in thousands) Cash and cash equivalents $ 1,025,431 $ 214,551 $ 1,239,982 Investments, at carrying value (1) Agency mortgage-backed securities (2) 67,321,920 7,109,080 74,431,000 Credit risk transfer securities 313,863 97,675 411,538 Non-agency mortgage-backed securities 597,647 119,955 717,602 Residential mortgage loans (2) 3,661,516 80,122 3,741,638 MSRs 3,431 204,554 207,985 Commercial real estate debt investments (2) 2,035,747 193,049 2,228,796 Commercial real estate debt and preferred equity, held for investment (2) 1,330,069 126,390 1,456,459 Corporate debt, held for investment 1,446,512 615,366 2,061,878 Other assets (3) — 74,548 74,548 Total financial assets $ 77,736,136 $ 8,835,290 $ 86,571,426 (1) The amounts reflected in the table above are on a settlement date basis and may differ from the total positions reported on the Consolidated Statements of Financial Condition. (2) Includes assets transferred or pledged to securitization vehicles. (3) Includes interests in certain joint ventures and equity instruments. We maintain liquid assets in order to satisfy our current and future obligations in normal and stressed operating environments. These are held as the primary means of liquidity risk mitigation. The composition of our liquid assets is also considered and is subject to certain parameters. The composition is monitored for concentration risk and asset type. We believe the assets we consider liquid can be readily converted into cash, through liquidation or by being used as collateral in financing arrangements (including as additional collateral to support existing financial arrangements). Our balance sheet also generates liquidity on an on-going basis through mortgage principal and interest repayments and net earnings held prior to payment of dividends. The following table presents our liquid assets as a percentage of total assets at September 30, 2020: Carrying Value (1) Liquid assets (dollars in thousands) Cash and cash equivalents $ 1,239,982 Residential Securities (2) (3) 74,936,333 Residential mortgage loans (4) 152,959 Commercial real estate debt investments (5) 54,678 Commercial real estate debt and preferred equity, held for investment (6) 450,177 Corporate debt, held for investment (7) 1,565,166 Total liquid assets $ 78,399,295 Percentage of liquid assets to carrying amount of encumbered and unencumbered financial assets (8) 98.86 % (1) Carrying value approximates the market value of assets. The assets listed in this table include $71.7 billion of assets that have been pledged as collateral against existing liabilities at September 30, 2020. Please refer to the Encumbered and Unencumbered Assets table for related information. (2) The amounts reflected in the table above are on a settlement date basis and may differ from the total positions reported on the Consolidated Statements of Financial Condition. (3) Excludes securitized Agency mortgage-backed securities of consolidated VIEs carried at fair value of $0.6 billion. (4) Excludes securitized residential mortgage loans transferred or pledged to consolidated VIEs carried at fair value of $3.6 billion. (5) Excludes securitized commercial mortgage loans of consolidated VIEs carried at fair value of $2.2 billion. (6) Excludes senior securitized commercial mortgage loans of consolidated VIEs carried at fair value of $0.9 billion. (7) Excludes certain second lien loans. (8) Denominator is computed based on the carrying amount of encumbered and encumbered financial assets, excluding assets transferred or pledged to securitization vehicles of $7.3 billion. 75 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Maturity Profile We consider the profile of our assets, liabilities and derivatives when managing both liquidity risk as well as investment/market risk employing a measurement of both the maturity gap and interest rate sensitivity gap. We determine the amount of liquid assets that are required to be held by monitoring several liquidity metrics. We utilize several modeling techniques to analyze our current and potential obligations including the expected cash flows from our assets, liabilities and derivatives. The following table illustrates the expected final maturities and cash flows of our assets, liabilities and derivatives. The table is based on a static portfolio and assumes no reinvestment of asset cash flows and no future liabilities are entered into. In assessing the maturity of our assets, liabilities and off balance sheet obligations, we use the stated maturities, or our prepayment expectations for assets and liabilities that exhibit prepayment characteristics. Cash and cash equivalents are included in the ‘Less than 3 Months’ maturity bucket, as they are typically held for a short period of time. With respect to each maturity bucket, our maturity gap is considered negative when the amount of maturing liabilities exceeds the amount of maturing assets. A negative gap increases our liquidity risk as we must enter into future liabilities. Our interest rate sensitivity gap is the difference between interest earning assets and interest bearing liabilities maturing or re-pricing within a given time period. Unlike the calculation of maturity gap, interest rate sensitivity gap includes the effect of our interest rate swaps. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities. A gap is considered negative when the amount of interest-rate sensitive liabilities exceeds interest-rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if assets and liabilities were perfectly matched in each maturity category. The amount of assets and liabilities utilized to compute our interest rate sensitivity gap was determined in accordance with the contractual terms of the assets and liabilities, except that adjustable-rate loans and securities are included in the period in which their interest rates are first scheduled to adjust and not in the period in which they mature. The effects of interest rate swaps, whereby we generally pay a fixed rate and receive a floating rate and effectively lock in our financing costs for a longer term, are also reflected in our interest rate sensitivity gap. 76 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis The interest rate sensitivity of our assets and liabilities in the following table at September 30, 2020 could vary substantially based on actual prepayment experience. Less than 3 Months 3-12 Months More than 1 Year to 3 Years 3 Years and Over Total Financial assets (dollars in thousands) Cash and cash equivalents $ 1,239,982 $ — $ — $ — $ 1,239,982 Agency mortgage-backed securities (principal) 51,189 8,806 1,816,658 65,931,272 67,807,925 Credit risk transfer securities (principal) 16,426 19,832 80,375 335,876 452,509 Non-agency mortgage-backed securities (principal) 744,106 — — — 744,106 Commercial mortgage-backed securities (principal) — — — 64,458 64,458 Total securities 811,721 28,638 1,897,033 66,331,606 69,068,998 Residential mortgage loans (principal) — — — 153,066 153,066 Commercial real estate debt and preferred equity (principal) 76,970 51,658 477,053 45,302 650,983 Corporate debt (principal) 2,506 40,649 328,143 1,895,613 2,266,911 Total loans 79,476 92,307 805,196 2,093,981 3,070,960 Assets transferred or pledged to securitization vehicles (principal) — — — 7,305,027 7,305,027 Total financial assets - maturity 2,131,179 120,945 2,702,229 75,730,614 80,684,967 Effect of utilizing reset dates (1) 8,063,965 1,313,480 (616,442) (8,761,003) — Total financial assets - interest rate sensitive $ 10,195,144 $ 1,434,425 $ 2,085,787 $ 66,969,611 $ 80,684,967 Financial liabilities Repurchase agreements $ 44,992,493 $ 19,640,954 $ — $ — $ 64,633,447 Other secured financing — 13,923 18,920 828,530 861,373 Debt issued by securitization vehicles (principal) — — — 6,027,847 6,027,847 Total financial liabilities - maturity 44,992,493 19,654,877 18,920 6,856,377 71,522,667 Effect of utilizing reset dates (1)(2) (27,046,228) (524,645) 20,016,750 7,554,123 Total financial liabilities - interest rate sensitive $ 17,946,265 $ 19,130,232 $ 20,035,670 $ 14,410,500 $ 71,522,667 Maturity gap $ (42,861,314) $ (19,533,932) $ 2,683,309 $ 68,874,237 $ 9,162,300 Cumulative maturity gap $ (42,861,314) $ (62,395,246) $ (59,711,937) $ 9,162,300 Interest rate sensitivity gap $ (7,751,121) $ (17,695,807) $ (17,949,883) $ 52,559,111 $ 9,162,300 Cumulative rate sensitivity gap $ (7,751,121) $ (25,446,928) $ (43,396,811) $ 9,162,300 (1) Maturity gap utilizes stated maturities, or prepayment expectations for assets that exhibit prepayment characteristics, while interest rate sensitivity gap utilizes reset dates, if applicable. (2) Includes effect of interest rate swaps. The methodologies we employ for evaluating interest rate risk include an analysis of our interest rate “gap,” measurement of the duration and convexity of our portfolio and sensitivities to interest rates and spreads. Stress Testing We utilize liquidity stress testing to ensure we have sufficient liquidity under a variety of scenarios and stresses. These stress tests assist with the management of our pool of liquid assets and influence our current and future funding plans. Our stress tests are modeled over both short term and longer time horizons. The stresses applied include market-wide and firm-specific stresses. Liquidity Management Policies We utilize a comprehensive liquidity policy structure to inform our liquidity risk management practices including monitoring and measurement, along with well-defined key risk indicators. Both quantitative and qualitative targets are utilized to measure the ongoing stability and condition of the liquidity position, and include the level and composition of unencumbered assets, as well as both short-term and long-term sustainability of the funding composition under stress conditions. We also monitor early warning metrics designed to measure the quality and depth of liquidity sources based upon both company-specific and market conditions. The metrics assist in assessing our liquidity conditions and are integrated into our escalation protocol. 77 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Investment/Market Risk Management One of the primary risks we are subject to is investment/market risk. Changes in the level of interest rates can affect our net interest income, which is the difference between the income we earn on our interest earning assets and the interest expense incurred from interest bearing liabilities and derivatives. Changes in the level of interest rates and spreads can also affect the value of our securities and potential realization of gains or losses from the sale of these assets. We may utilize a variety of financial instruments, including interest rate swaps, swaptions, options, futures and other hedges, in order to limit the adverse effects of interest rates on our results. In the case of interest rate swaps, we utilize contracts linked to LIBOR but may also enter into interest rate swaps where the floating leg is linked to the overnight index swap rate or another index, particularly in light of a potential transition away from LIBOR. In addition, we may use MAC interest rate swaps in which we may receive or make a payment at the time of entering such interest rate swap to compensate for the off-market nature of such interest rate swap. MAC interest rate swaps offer price transparency, flexibility and more efficient portfolio administration through compression which is the process of reducing the number of unique interest rate swap contracts and replacing them with fewer contracts containing market defined terms. Our portfolio and the value of our portfolio, including derivatives, may be adversely affected as a result of changing interest rates and spreads. We simulate a wide variety of interest rate scenarios in evaluating our risk. Scenarios are run to capture our sensitivity to changes in interest rates, spreads and the shape of the yield curve. We also consider the assumptions affecting our analysis such as those related to prepayments. In addition to predefined interest rate scenarios, we utilize Value-at-Risk measures to estimate potential losses in the portfolio over various time horizons utilizing various confidence levels. The following tables estimate the potential changes in economic net interest income over a twelve month period and the immediate effect on our portfolio market value (inclusive of derivative instruments), should interest rates instantaneously increase or decrease by 25, 50 or 75 basis points, and the effect of portfolio market value if mortgage option-adjusted spreads instantaneously increase or decrease by 5, 15 or 25 basis points (assuming shocks are parallel and instantaneous). All changes to income and portfolio market value are measured as percentage changes from the projected net interest income and portfolio value at the base interest rate scenario. The net interest income simulations incorporate the interest expense effect of rate resets on liabilities and derivatives as well as the amortization expense and reinvestment of principal based on the prepayments on our securities, which varies based on the level of rates. The results assume no management actions in response to the rate or spread changes. The following table presents estimates at September 30, 2020. Actual results could differ materially from these estimates. Change in Interest Rate (1) Projected Percentage Change in Economic Net Interest Income (2) Estimated Percentage Change in Portfolio Value (3) Estimated Change as a % on NAV (3)(4) -75 Basis points (28.0%) —% (0.3%) -50 Basis points (19.6%) 0.1% 0.7% -25 Basis points (9.7%) 0.2% 1.5% +25 Basis points 7.0% (0.1%) (0.9%) +50 Basis points 14.1% (0.3%) (2.1%) +75 Basis points 20.2% (0.6%) (3.9%) MBS Spread Shock (1) Estimated Change in Portfolio Market Value Estimated Change as a % on NAV (3)(4) -25 Basis points 1.4% 8.9% -15 Basis points 0.9% 5.3% -5 Basis points 0.3% 1.8% +5 Basis points (0.3%) (1.7%) +15 Basis points (0.8%) (5.2%) +25 Basis points (1.4%) (8.7%) (1) Interest rate and MBS spread sensitivity are based on results from third party models in conjunction with inputs from our internal investment professionals. Actual results could differ materially from these estimates. (2) Scenarios include Residential Securities, commercial real estate investments, corporate debt, repurchase agreements, other secured financing and interest rate swaps. Economic net interest income includes the net interest component of interest rate swaps. (3) Scenarios include Residential Securities, residential mortgage loans, MSRs and derivative instruments. (4) NAV represents book value of equity. 78 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Credit Risk Management Key risk parameters have been established to specify our credit risk appetite. We seek to manage credit risk by making investments which conform within the firm’s specific investment policy parameters and optimize risk-return attributes. While we do not expect to encounter credit risk in our Agency mortgage-backed securities, we face credit risk on the non-Agency mortgage-backed securities and CRT securities in our portfolio. In addition, we are also exposed to credit risk on residential mortgage loans, commercial real estate investments and corporate debt. MSR values may also be impacted if overall costs to service the underlying mortgage loans increase due to borrower performance. We are subject to risk of loss if an issuer or borrower fails to perform its contractual obligations. We have established policies and procedures for mitigating credit risk, including establishing and reviewing limits for credit exposure. We will originate or purchase commercial investments that meet our comprehensive underwriting process and credit standards and are approved by the appropriate committee. Once a commercial investment is made, our ongoing surveillance process includes regular reviews, analysis and oversight of investments by our investment personnel and appropriate committee. We review credit and other risks of loss associated with each investment. Our management monitors the overall portfolio risk and determines estimates of provision for loss. Additionally, ALCO has oversight of our credit risk exposure. Our portfolio composition, based on balance sheet values, at September 30, 2020 and December 31, 2019 was as follows: September 30, 2020 December 31, 2019 Category Agency mortgage-backed securities (1) 86.7 % 89.5 % Credit risk transfer securities 0.5 % 0.4 % Non-agency mortgage-backed securities 0.8 % 0.9 % Residential mortgage loans (1) 4.3 % 3.3 % Mortgage servicing rights 0.2 % 0.3 % Commercial real estate (1) (2) 5.1 % 3.9 % Corporate debt 2.4 % 1.7 % (1) Includes assets transferred or pledged to securitization vehicles. (2) Net of unamortized origination fees. Counterparty Risk Management Our use of repurchase and derivative agreements and trading activities create exposure to counterparty risk relating to potential losses that could be recognized if the counterparties to these agreements fail to perform their obligations under the contracts. In the event of default by a counterparty, we could have difficulty obtaining our assets pledged as collateral. A significant portion of our investments are financed with repurchase agreements by pledging our Residential Securities and certain commercial real estate investments as collateral to the applicable lender. The collateral we pledge generally exceeds the amount of the borrowings under each agreement. If the counterparty to the repurchase agreement defaults on its obligations and we are not able to recover our pledged asset, we are at risk of losing the over-collateralization or haircut. The amount of this exposure is the difference between the amount loaned to us plus interest due to the counterparty and the fair value of the collateral pledged by us to the lender including accrued interest receivable on such collateral. We also use interest rate swaps and other derivatives to manage interest rate risk. Under these agreements, we pledge securities and cash as collateral or settle variation margin payments as part of a margin arrangement. If a counterparty were to default on its obligations, we would be exposed to a loss to a derivative counterparty to the extent that the amount of our securities or cash pledged exceeded the unrealized loss on the associated derivative and we were not able to recover the excess collateral. Additionally, we would be exposed to a loss to a derivative counterparty to the extent that our unrealized gains on derivative instruments exceeded the amount of the counterparty’s securities or cash pledged to us. We monitor our exposure to counterparties across several dimensions including by type of arrangement, collateral type, counterparty type, ratings and geography. Additionally, ALCO has oversight of our counterparty exposure. 79 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis The following table summarizes our exposure to counterparties by geography at September 30, 2020: Number of Counterparties Repurchase Agreement Financing Interest Rate Swaps at Fair Value Exposure (1) Geography (dollars in thousands) North America 25 $ 50,950,065 $ (402,402) $ 3,217,881 Europe 10 9,794,270 (723,777) 950,431 Japan 2 3,889,112 — 206,590 Total 37 $ 64,633,447 $ (1,126,179) $ 4,374,902 (1) Represents the amount of cash and/or securities pledged as collateral to each counterparty less the aggregate of repurchase agreement financing and unrealized loss on swaps for each counterparty. Operational Risk Management We are subject to operational risk in each of our business and support functions. Operational risk may arise from internal or external sources including human error, fraud, systems issues, process change, vendors, business interruptions and other external events. Model risk considers potential errors with a model’s results due to uncertainty in model parameters and inappropriate methodologies used. The result of these risks may include financial loss and reputational damage. We manage operational risk through a variety of tools including policies and procedures that cover topics such as business continuity, personal conduct, cybersecurity and vendor management. Other tools include testing, including disaster recovery testing; systems controls, including access controls; training, including cybersecurity awareness training; and monitoring, which includes the use of key risk indicators. Employee-level lines of defense against operational risk include proper segregation of incompatible duties, activity-level internal controls over financial reporting, the empowerment of business units to identify and mitigate operational risk sources, testing by our internal audit staff, and our overall governance framework. We have established a Cybersecurity Committee to help mitigate cybersecurity risks. The role of the committee is to oversee cyber risk assessments, monitor applicable key risk indicators, review cybersecurity training procedures, oversee our Cybersecurity Incident Response Plan and engage third parties to conduct periodic penetration testing. Our cybersecurity risk assessment includes an evaluation of cyber risk related to sensitive data held by third parties on their systems. The Cybersecurity Committee periodically reports to the ERC, and the Board via the BRC and the BAC. There is no assurance that these efforts will effectively mitigate cybersecurity risk and mitigation efforts are not an assurance that no cybersecurity incidents will occur. We currently maintain cybersecurity insurance, however, there is no assurance that the insurance policy will cover all cybersecurity breaches or that the policy will cover all losses. Compliance, Regulatory and Legal Risk Management Our business is organized as a REIT, and we seek to continue to meet the requirements for taxation as a REIT. The determination that we are a REIT requires an analysis of various factual matters and circumstances. Accordingly, we closely monitor our REIT status within our risk management program. We also regularly assess our risk management in respect of our regulated and licensed subsidiaries, which include our registered broker-dealer subsidiary Arcola and our subsidiary that is registered with the SEC as an investment adviser under the Investment Advisers Act. The financial services industry is highly regulated and receives significant attention from regulators, which may impact both our company as well as our business strategy. We proactively monitor the potential impact regulation may have both directly and indirectly on us. We maintain a process to actively monitor both actual and potential legal action that may affect us. Our risk management framework is designed to identify, measure and monitor these risks under the oversight of the ERC. We currently rely on the exemption from registration provided by Section 3(c)(5)(C) of the Investment Company Act, and we seek to continue to meet the requirements for this exemption from registration. The determination that we qualify for this exemption from registration depends on various factual matters and circumstances. Accordingly, in conjunction with our legal department, we closely monitor our compliance with Section 3(c)(5)(C) within our risk management program. The monitoring of this risk is also under the oversight of the ERC. 80 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis As a result of the Dodd-Frank Act, the U.S. Commodity Futures Trading Commission (“CFTC”) gained jurisdiction over the regulation of interest rate swaps. The CFTC has asserted that this causes the operators of mortgage real estate investment trusts that use swaps as part of their business model to fall within the statutory definition of Commodity Pool Operator (“CPO”), and, absent relief from the Division of Swap Dealer and Intermediary Oversight or the CFTC, to register as CPOs. On December 7, 2012, as a result of numerous requests for no-action relief from the CPO registration requirement for operators of mortgage real estate investment trusts, the Division of Swap Dealer and Intermediary Oversight of the CFTC issued no-action relief entitled “No-Action Relief from the Commodity Pool Operator Registration Requirement for Commodity Pool Operators of Certain Pooled Investment Vehicles Organized as Mortgage Real Estate Investment Trusts” that permits a CPO to receive relief by filing a claim to perfect the use of the relief. A claim submitted by a CPO will be effective upon filing, so long as the claim is materially complete. The conditions that must be met relate to initial margin and premiums requirements, net income derived annually from commodity interest positions that are not qualifying hedging transactions, marketing of interests in the mortgage real estate investment trust to the public, and identification of the entity as a mortgage real estate investment trust in its federal tax filings with the Internal Revenue Service. While we disagree with the CFTC’s position that mortgage REITs that use swaps as part of their business model fall within the statutory definition of a CPO, we have submitted a claim for the relief set forth in the no-action relief entitled “No-Action Relief from the Commodity Pool Operator Registration Requirement for Commodity Pool Operators of Certain Pooled Investment Vehicles Organized as Mortgage Real Estate Investment Trusts” and believe we meet the criteria for such relief set forth therein. Critical Accounting Policies and Estimates Our critical accounting policies that require us to make significant judgments or estimates are described below. For more information on these critical accounting policies and other significant accounting policies, see “Significant Accounting Policies” in the Notes to the Consolidated Financial Statements. Valuation of Financial Instruments Residential Securities There is an active market for our Agency mortgage-backed securities, CRT securities and non-Agency mortgage-backed securities. Since we primarily invest in securities that can be valued using actively quoted prices for actively traded assets, there is a high degree of observable inputs and less subjectivity in measuring fair value. Internal fair values are determined using quoted prices from the TBA securities market, the Treasury curve and the underlying characteristics of the individual securities, which may include coupon, periodic and life caps, reset dates and the expected life of the security. While prepayment rates may be difficult to predict and require estimation and judgment in the valuation of Agency mortgage-backed securities, we use several third party models to validate prepayment speeds used in fair value measurements of residential securities. All internal fair values are compared to external pricing sources and/or dealer quotes to determine reasonableness. Additionally, securities used as collateral for repurchase agreements are priced daily by counterparties to ensure sufficient collateralization, providing additional verification of our internal pricing. Residential Mortgage Loans There is an active market for the residential whole loans in which we invest. Since we primarily invest in residential loans that can be valued using actively quoted prices for similar assets, there are observable inputs in measuring fair value. Internal fair values are determined using quoted prices for similar market transactions, the swap curve and the underlying characteristics of the individual loans, which may include loan term, coupon, and reset dates. While prepayment rates may be difficult to predict and are a significant estimate requiring judgment in the valuation of residential whole loans, we validate prepayment speeds against those provided by independent pricing analytic providers specializing in residential mortgage loans. Internal fair values are generally compared to external pricing sources to determine reasonableness. MSRs Fair value estimates for our investment in MSRs 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. 81 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Commercial Real Estate Investments The fair value of commercial mortgage-backed securities classified as available-for-sale is determined based upon quoted prices of similar assets in recent market transactions and requires the application of judgment due to differences in the underlying collateral. These securities must also be evaluated for impairment if the fair value of the security is lower than its amortized cost. Determining whether there is an other-than-temporary impairment may require us to exercise significant judgment and make estimates to determine expected cash flows incorporating assumptions such as changes in interest rates and loss expectations. For commercial real estate loans and preferred equity investments classified as held for investment, we apply significant judgment in evaluating the need for a loss reserve. Estimated net recoverable value of the commercial real estate loans and preferred equity investments and other factors such as the fair value of any collateral, the amount and status of senior debt, the prospects of the borrower and the competitive landscape where the borrower conducts business must be considered in determining the allowance for loan losses. For commercial real estate loans held for sale, significant judgment may need to be applied in determining the fair value of the loans and whether a valuation allowance is necessary. Factors that may need to be considered to determine the fair value of a loan held for sale include the borrower’s credit quality, liquidity and other market factors and the fair value of the underlying collateral. Interest Rate Swaps We use the overnight indexed swap (“OIS”) curve as an input to value substantially all of our uncleared interest rate swaps. We believe using the OIS curve, which reflects the interest rate typically paid on cash collateral, enables us to most accurately determine the fair value of uncleared interest rate swaps. Consistent with market practice, we exchange collateral (also called margin) based on the fair values of our interest rate swaps. Through this margining process, we may be able to compare our recorded fair value with the fair value calculated by the counterparty or derivatives clearing organization, providing additional verification of our recorded fair value of the uncleared interest rate swaps. We value our cleared interest rate swaps using the prices provided by the derivatives clearing organization. Revenue Recognition Interest income from coupon payments is accrued based on the outstanding principal amounts of the Residential Securities and their contractual terms. Premiums and discounts associated with the purchase of the Residential Securities are amortized or accreted into interest income over the projected lives of the securities using the interest method. To aid in determining projected lives of the securities, we use third-party model and market information to project prepayment speeds. Our prepayment speed projections incorporate underlying loan characteristics (i.e., coupon, term, original loan size, original loan-to-value ratio, etc.) and market data, including interest rate and home price index forecasts and expert judgment. Prepayment speeds vary according to the type of investment, conditions in the financial markets and other factors and cannot be predicted with any certainty. Changes to model assumptions, including interest rates and other market data, as well as periodic revisions to the model will cause changes in the results. Adjustments are made for actual prepayment activity as it relates to calculating the effective yield. Gains or losses on sales of Residential Securities are recorded on trade date based on the specific identification method. Consolidation of Variable Interest Entities Determining whether an entity has a controlling financial interest in a VIE requires significant judgment related to assessing the purpose and design of the VIE and determination of the activities that most significantly impact its economic performance. We must also identify explicit and implicit variable interests in the entity and consider our involvement in both the design of the VIE and its ongoing activities. To determine whether consolidation of the VIE is required, we must apply judgment to assess whether we have the power to direct the most significant activities of the VIE and whether we have either the rights to receive benefits or the obligation to absorb losses that could be potentially significant to the VIE. Use of Estimates The use of GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. 82 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Glossary of Terms A Adjustable-Rate Loan / Security A loan / security on which interest rates are adjusted at regular intervals according to predetermined criteria. The adjustable interest rate is tied to an objective, published interest rate index. Agency Refers to a federally chartered corporation, such as the Federal National Mortgage Association, or the Federal Home Loan Mortgage Corporation, or an agency of the U.S. Government, such as the Government National Mortgage Association. Agency Mortgage-Backed Securities Refers to residential mortgage-backed securities that are issued or guaranteed by an Agency. Amortization Liquidation of a debt through installment payments. Amortization also refers to the process of systematically reducing a recognized asset or liability (e.g., a purchase premium or discount for a debt security) with an offset to earnings. Average GAAP Cost of Interest Bearing Liabilities and Average Economic Cost of Interest Bearing Liabilities Average GAAP cost of interest bearing liabilities represents annualized interest expense divided by average interest bearing liabilities. Average interest bearing liabilities reflects the average balances during the period. Average economic cost of interest bearing liabilities represents annualized economic interest expense divided by average interest bearing liabilities. Average Life On a mortgage-backed security, the average time to receipt of each dollar of principal, weighted by the amount of each principal prepayment, based on prepayment assumptions. Average Yield on Interest Earnings Assets and Average Yield on Interest Earnings Assets (excluding PAA) Average yield on interest earning assets represents annualized interest income divided by average interest earning assets. Average interest earning assets reflects the average amortized cost of our investments during the period. Average yield on interest earning assets (excluding PAA) is calculated using annualized interest income (excluding PAA). B Basis Point (“bp”) One hundredth of one percent, used in expressing differences in interest rates. One basis point is 0.01% of yield. For example, a bond’s yield that changed from 3.00% to 3.50% would be said to have moved 50 basis points. Benchmark A bond or an index referencing a basket of bonds whose terms are used for comparison with other bonds of similar maturity. The global financial market typically looks to U.S. Treasury securities as benchmarks. Beneficial Owner One who benefits from owning a security, even if the security’s title of ownership is in the name of a broker or bank. B-Note Subordinate mortgage notes and/or subordinate mortgage loan participations. B-Piece The most subordinate commercial mortgage-backed security bond class. Board Refers to the board of directors of Annaly. Bond The written evidence of debt, bearing a stated rate or stated rates of interest, or stating a formula for determining that rate, and maturing on a date certain, on which date and upon presentation a fixed sum of money plus interest (usually represented by interest coupons attached to the bond) is payable to the holder or owner. Bonds are long-term securities with an original maturity of greater than one year. Book Value Per Share Calculated by summing common stock, additional paid-in capital, accumulated other comprehensive income (loss) and accumulated deficit and dividing that number by the total common shares outstanding. Broker Generic name for a securities firm engaged in both buying and selling securities on behalf of customers or its own account. 83 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis C Capital Buffer Includes unencumbered financial assets which can be either sold or utilized as collateral to meet liquidity needs. Capital Ratio Calculated as total stockholders’ equity divided by total assets inclusive of outstanding market value of TBA positions and exclusive of consolidated VIEs. Carry The amount an asset earns over its hedging and financing costs. A positive carry happens when the rate on the securities being financed is greater than the rate on the funds borrowed. A negative carry is when the rate on the funds borrowed is greater than the rate on the securities that are being financed. CMBX The CMBX index is a synthetic tradable index referencing a basket of 25 CMBS of a particular rating and vintage. The CMBX index allows investors to take a long position (referred to as selling protection) or short position (referred to as purchasing protection) on the respective basket of CMBS securities and is structured as a “pay-as-you-go” contract whereby the protection seller receives and the protection buyer pays a standardized running coupon on the contracted notional amount. Additionally, the protection seller is obligated to pay to the protection buyer the amount of principal losses and/or coupon shortfalls on the underlying CMBS securities as they occur. Collateral Securities, cash or property pledged by a borrower or party to a derivative contract to secure payment of a loan or derivative. If the borrower fails to repay the loan or defaults under the derivative contract, the secured party may take ownership of the collateral. Collateralized Loan Obligation (“CLO”) A securitization collateralized by loans and other debt instruments. Collateralized Mortgage Obligation (“CMO”) A multiclass bond backed by a pool of mortgage pass-through securities or mortgage loans. Commodity Futures Trading Commission (“CFTC”) An independent U.S. federal agency established by the Commodity Futures Trading Commission Act of 1974. The CFTC regulates the swaps, commodity futures and options markets. Its goals include the promotion of competitive and efficient futures markets and the protection of investors against manipulation, abusive trade practices and fraud. Commercial Mortgage-Backed Security Securities collateralized by a pool of mortgages on commercial real estate in which all principal and interest from the mortgages flow to certificate holders in a defined sequence or manner. Constant Prepayment Rate (“CPR”) The percentage of outstanding mortgage loan principal that prepays in one year, based on the annualization of the Single Monthly Mortality, which reflects the outstanding mortgage loan principal that prepays in one month. Convexity A measure of the change in a security’s duration with respect to changes in interest rates. The more convex a security is, the more its duration will change with interest rate changes. Core Earnings (excluding PAA) and Core Earnings (excluding PAA) Per Average Common Share Core earnings (excluding PAA) is defined as the sum of (a) economic net interest income, (b) TBA dollar roll income and CMBX coupon income, (c) realized amortization of MSRs, (d) other income (loss) (excluding depreciation expense related to commercial real estate and amortization of intangibles, non-core income allocated to equity method investments and other non-core components of other income (loss)), (e) general and administrative expenses (excluding transaction expenses and non-recurring items), and (f) income taxes (excluding the income tax effect of non-core income (loss) items) and excludes (g) the premium amortization adjustment representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities. Core earnings (excluding PAA) per average common share is calculated by dividing core earnings (excluding PAA) by average basic common shares for the period. Corporate Debt Non-government debt instruments issued by corporations. Long-term corporate debt can be issued as bonds or loans. Counterparty One of two entities in a transaction. For example, in the bond market a counterparty can be a state or local government, a broker-dealer or a corporation. Coupon The interest rate on a bond that is used to compute the amount of interest due on a periodic basis. Credit and Counterparty Risk Risk to earnings, capital or business, resulting from an obligor’s or counterparty’s failure to meet the terms of any contract or otherwise failure to perform as agreed. Credit and counterparty risk is present in lending, investing, funding and hedging activities. 84 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Credit Derivatives Derivative instruments that have one or more underlyings related to the credit risk of a specified entity (or group of entities) or an index that exposes the seller to potential loss from specified credit-risk related events. An example is credit derivatives referencing the commercial mortgage-backed securities index. Credit Risk Transfer (“CRT”) Securities Credit Risk Transfer securities are risk sharing transactions issued by Fannie Mae and Freddie Mac and similarly structured transactions arranged by third party market participants. The securities issued in the CRT sector are designed to synthetically transfer mortgage credit risk from Fannie Mae, Freddie Mac and/or third parties to private investors. Current Face The current remaining monthly principal on a mortgage security. Current face is computed by multiplying the original face value of the security by the current principal balance factor. D Dealer Person or organization that underwrites, trades and sells securities, e.g., a principal market-maker in securities. Default Risk Possibility that a bond issuer will fail to pay principal or interest when due. Derivative A financial product that derives its value from the price, price fluctuations and price expectations of an underlying instrument, index or reference pool (e.g. futures contracts, options, interest rate swaps, interest rate swaptions and certain to-be-announced securities). Discount Price When the dollar price is below face value, it is said to be selling at a discount. Duration The weighted maturity of a fixed-income investment’s cash flows, used in the estimation of the price sensitivity of fixed-income securities for a given change in interest rates. E Economic Capital A measure of the risk a firm is subject to. It is the amount of capital a firm needs as a buffer to protect against risk. It is a probabilistic measure of potential future losses at a given confidence level over a given time horizon. Economic Interest Expense Non-GAAP financial measure that is comprised of GAAP interest expense and the net interest component of interest rate swaps. Economic Leverage Ratio (Economic Debt-to-Equity Ratio) Calculated as the sum of recourse debt, cost basis of TBA and CMBX derivatives outstanding and net forward purchases (sales) of investments divided by total equity. Recourse debt consists of repurchase agreements and other secured financing (excluding certain non-recourse credit facilities). Debt issued by securitization vehicles, certain credit facilities (included within other secured financing) and mortgages payable are non-recourse to us and are excluded from this measure. Economic Net Interest Income Non-GAAP financial measure that is composed of GAAP net interest income less Economic Interest Expense. Encumbered Assets Assets on the company’s balance sheet which have been pledged as collateral against a liability. Eurodollar A U.S. dollar deposit held in Europe or elsewhere outside the United States. F Face Amount The par value (i.e., principal or maturity value) of a security appearing on the face of the instrument. Factor A decimal value reflecting the proportion of the outstanding principal balance of a mortgage security, which changes over time, in relation to its original principal value. Fannie Mae Federal National Mortgage Association. Federal Deposit Insurance Corporation (“FDIC”) An independent agency created by the U.S. Congress to maintain stability and public confidence in the nation’s financial system by insuring deposits, examining and supervising financial institutions for safety and soundness and consumer protection, and managing receiverships. Federal Funds Rate The interest rate charged by banks on overnight loans of their excess reserve funds to other banks. 85 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Federal Home Loan Banks (“FHLB”) U.S. Government-sponsored banks that generally provide reliable liquidity to member financial institutions to support housing finance and community investment. Federal Housing Financing Agency (“FHFA”) The FHFA is an independent regulatory agency that oversees vital components of the secondary mortgage market including Fannie Mae, Freddie Mac and the Federal Home Loan Banks. Financial Industry Regulatory Authority, Inc. (“FINRA”) FINRA is a non-governmental organization tasked with regulating all business dealings conducted between dealers, brokers and all public investors. Fixed-Rate Mortgage A mortgage featuring level monthly payments, determined at the outset, which remain constant over the life of the mortgage. Fixed Income Clearing Corporation (“FICC”) The FICC is an agency that deals with the confirmation, settlement and delivery of fixed-income assets in the U.S. The agency ensures the systematic and efficient settlement of U.S. Government securities and mortgage-backed security transactions in the market. Floating Rate Bond A bond for which the interest rate is adjusted periodically according to a predetermined formula, usually linked to an index. Floating Rate CMO A CMO tranche which pays an adjustable rate of interest tied to a representative interest rate index such as the LIBOR, the Constant Maturity Treasury or the Cost of Funds Index. Freddie Mac Federal Home Loan Mortgage Corporation. Futures Contract A legally binding agreement to buy or sell a commodity or financial instrument in a designated future month at a price agreed upon at the initiation of the contract by the buyer and seller. Futures contracts are standardized according to the quality, quantity, and delivery time and location for each commodity. A futures contract differs from an option in that an option gives one of the counterparties a right and the other an obligation to buy or sell, while a futures contract represents an obligation of both counterparties, one to deliver and the other to accept delivery. A futures contract is part of a class of financial instruments called derivatives. G GAAP U.S. generally accepted accounting principles. Ginnie Mae Government National Mortgage Association. H Hedge An investment made with the intention of minimizing the impact of adverse movements in interest rates or securities prices. I In-the-Money Description for an option that has intrinsic value and can be sold or exercised for a profit; a call option is in-the-money when the strike price (execution price) is below the market price of the underlying security. Interest Bearing Liabilities Refers to repurchase agreements, debt issued by securitization vehicles, FHLB Des Moines advances and credit facilities. Average interest bearing liabilities is based on daily balances. Interest Earning Assets Refers to Residential Securities, U.S. Treasury securities, reverse repurchase agreements, commercial real estate debt and preferred equity interests, residential mortgage loans and corporate debt. Average interest earning assets is based on daily balances. Interest-Only (IO) Bond The interest portion of mortgage, Treasury or bond payments, which is separated and sold individually from the principal portion of those same payments. Interest Rate Risk The risk that an investment’s value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship. As market interest rates rise, the value of current fixed income investment holdings declines. Diversifying, deleveraging and hedging techniques are utilized to mitigate this risk. Interest rate risk is a form of market risk. Interest Rate Swap A binding agreement between counterparties to exchange periodic interest payments on some predetermined dollar principal, which is called the notional principal amount. 86 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis For example, one party will pay fixed and receive a variable rate . Interest Rate Swaption Options on interest rate swaps. The buyer of a swaption has the right to enter into an interest rate swap agreement at some specified date in the future. The swaption agreement will specify whether the buyer of the swaption will be a fixed-rate receiver or a fixed-rate payer. International Swaps and Derivatives Association (“ISDA”) Master Agreement Standardized contract developed by ISDA used as an umbrella under which bilateral derivatives contracts are entered into. Inverse IO Bond An interest-only bond whose coupon is determined by a formula expressing an inverse relationship to a benchmark rate, such as LIBOR. As the benchmark rate changes, the IO coupon adjusts in the opposite direction. When the benchmark rate is relatively low, the IO pays a relatively high coupon payment, and vice versa. Investment/Market Risk Risk to earnings, capital or business resulting in the decline in value of our assets caused from changes in market variables, such as interest rates, which affect the values of Residential Securities and other investment instruments. Investment Advisers Act Refers to the Investment Advisers Act of 1940, as amended. Investment Company Act Refers to the Investment Company Act of 1940, as amended. L Leverage The use of borrowed money to increase investing power and economic returns. Leverage Ratio (Debt-to-Equity Ratio) Calculated as total debt to total stockholders’ equity. For purposes of calculating this ratio total debt includes repurchase agreements, other secured financing, debt issued by securitization vehicles and mortgages payable. Certain credit facilities (included within other secured financing), debt issued by securitization vehicles and mortgages payable are non-recourse to us. LIBOR (London Interbank Offered Rate) The rate banks charge each other for short-term Eurodollar loans. LIBOR is frequently used as the base for resetting rates on floating-rate securities and the floating-rate legs of interest rate swaps. Liquidity Risk Risk to earnings, capital or business arising from our inability to meet our obligations when they come due without incurring unacceptable losses because of inability to liquidate assets or obtain adequate funding. Long-Term CPR Our projected prepayment speeds for certain Agency mortgage-backed securities using third-party model and market information. Our prepayment speed projections incorporate underlying loan characteristics (e.g., coupon, term, original loan size, original loan-to-value ratio, etc.) and market data, including interest rate and home price index forecasts. Changes to model assumptions, including interest rates and other market data, as well as periodic revisions to the model will cause changes in the results. Long-Term Debt Debt which matures in more than one year. M Market Agreed Coupon (“MAC”) Interest Rate Swap An interest rate swap contract structure with pre-defined, market agreed terms, developed by SIFMA and ISDA with the purpose of promoting liquidity and simplified administration. Monetary Policy Action taken by the Federal Open Market Committee of the Federal Reserve System to influence the money supply or interest rates. Mortgage-Backed Security (“MBS”) A security representing a direct interest in a pool of mortgage loans. The pass-through issuer or servicer collects the payments on the loans in the pool and “passes through” the principal and interest to the security holders on a pro rata basis. Mortgage Loan A mortgage loan granted by a bank, thrift or other financial institution that is based solely on real estate as security and is not insured or guaranteed by a government agency. Mortgage Servicing Rights (“MSRs”) Contractual agreements constituting the right to service an existing mortgage where the holder receives the benefits and bears the costs and risks of servicing the mortgage. 87 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis N NAV Net asset value. Net Interest Income Represents interest income earned on our portfolio investments, less interest expense paid for borrowings. Net Interest Margin and Net Interest Margin (excluding PAA) Net interest margin represents our interest income less interest expense divided by average interest earning assets. Net interest margin (excluding PAA) represents the sum of our interest income (excluding PAA) plus TBA dollar roll income and CMBX coupon income less interest expense and the net interest component of interest rate swaps divided by the sum of average interest earning assets plus average outstanding TBA contract and CMBX balances. Net Interest Spread and Net Interest Spread (excluding PAA) Net interest spread represents the average yield on interest earning assets less the average GAAP cost of interest bearing liabilities. Net interest spread (excluding PAA) represents the average yield on interest earning assets (excluding PAA) less the average economic cost of interest bearing liabilities. Non-Performing Loan (“NPL”) A loan that is close to defaulting or is in default. Notional Amount A stated principal amount in a derivative contract on which the contract is based. O Operational Risk Risk to earnings, capital, reputation or business arising from inadequate or failed internal processes or systems, human factors or external events. Option Contract A contract in which the buyer has the right, but not the obligation, to buy or sell an asset at a set price on or before a given date. Buyers of call options bet that a security will be worth more than the price set by the option (the strike price), plus the price they pay for the option itself. Buyers of put options bet that the security’s price will drop below the price set by the option. An option is part of a class of financial instruments called derivatives, which means these financial instruments derive their value from the worth of an underlying investment. Original Face The face value or original principal amount of a security on its issue date. Out-of-the-Money Description for an option that has no intrinsic value and would be worthless if it expired today; for a call option, this situation occurs when the strike price is higher than the market price of the underlying security; for a put option, this situation occurs when the strike price is less than the market price of the underlying security. Overnight Index Swaps (“OIS”) An interest rate swap in which a fixed rate is exchanged for an overnight floating rate. Over-The-Counter (“OTC”) Market A securities market that is conducted by dealers throughout the country through negotiation of price rather than through the use of an auction system as represented by a stock exchange. P Par Price equal to the face amount of a security; 100%. Par Amount The principal amount of a bond or note due at maturity. Also known as par value. Pass-Through Security A securitization structure where a GSE or other entity “passes” the amount collected from the borrowers every month to the investor, after deducting fees and expenses. Pool A collection of mortgage loans assembled by an originator or master servicer as the basis for a security. In the case of Ginnie Mae, Fannie Mae, or Freddie Mac mortgage pass-through securities, pools are identified by a number assigned by the issuing agency. Premium The amount by which the price of a security exceeds its principal amount. When the dollar price of a bond is above its face value, it is said to be selling at a premium. Premium Amortization Adjustment (“PAA”) The cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities. Prepayment The unscheduled partial or complete payment of the principal amount outstanding on a mortgage loan or other debt before it is due. 88 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Prepayment Risk The risk that falling interest rates will lead to increased prepayments of mortgage or other loans, forcing the investor to reinvest at lower prevailing rates. Prepayment Speed The estimated rate at which mortgage borrowers will pay off the mortgages that underlie an MBS. Prime Rate The indicative interest rate on loans that banks quote to their best commercial customers. Principal and Interest The term used to refer to regularly scheduled payments or prepayments of principal and payments of interest on a mortgage or other security. R Rate Reset The adjustment of the interest rate on a floating-rate security according to a prescribed formula. Real Estate Investment Trust (“REIT”) A special purpose investment vehicle that provides investors with the ability to participate directly in the ownership or financing of real-estate related assets by pooling their capital to purchase and manage mortgage loans and/or income property. Recourse Debt Debt on which the economic borrower is obligated to repay the entire balance regardless of the value of the pledged collateral. By contrast, the economic borrower’s obligation to repay non-recourse debt is limited to the value of the pledged collateral. Recourse debt consists of repurchase agreements and other secured financing (excluding certain non-recourse credit facilities). Debt issued by securitization vehicles, certain credit facilities (included within other secured financing) and mortgages payable are non-recourse to us and are excluded from this measure. Reinvestment Risk The risk that interest income or principal repayments will have to be reinvested at lower rates in a declining rate environment. Re-Performing Loan (“RPL”) A type of loan in which payments were previously delinquent by at least 90 days but have resumed. Repurchase Agreement The sale of securities to investors with the agreement to buy them back at a higher price after a specified time period; a form of short-term borrowing. For the party on the other end of the transaction (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement. Residential Securities Refers to Agency mortgage-backed securities, CRT securities and non-Agency mortgage-backed securities. Residual In securitizations, the residual is the tranche that collects any cash flow from the collateral that remains after obligations to the other tranches have been met. Return on Average Equity Calculated by taking earnings divided by average stockholders’ equity. Reverse Repurchase Agreement Refer to Repurchase Agreement. The buyer of securities effectively provides a collateralized loan to the seller. Risk Appetite Statement Defines the types and levels of risk we are willing to take in order to achieve our business objectives, and reflects our risk management philosophy. S Secondary Market Ongoing market for bonds previously offered or sold in the primary market. Secured Overnight Financing Rate (“SOFR”) Broad measure of the cost of borrowing cash overnight collateralized by Treasury securities and was chosen by the Alternative Reference Rate Committee as the preferred benchmark rate to replace dollar LIBOR in coming years. Settlement Date The date securities must be delivered and paid for to complete a transaction. Short-Term Debt Generally, debt which matures in one year or less. However, certain securities that mature in up to three years may be considered short-term debt. Spread When buying or selling a bond through a brokerage firm, investors will be charged a commission or spread, which is the difference between the market price and cost of purchase, and sometimes a service fee. Spreads differ based on several factors including liquidity. 89 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis T Target Assets Includes Agency mortgage-backed securities, to-be-announced forward contracts, CRT securities, MSRs, non-Agency mortgage-backed securities, residential mortgage loans, commercial real estate investments, and corporate debt. Taxable REIT Subsidiary (“TRS”) An entity that is owned directly or indirectly by a REIT and has jointly elected with the REIT to be treated as a TRS for tax purposes. Annaly and certain of its direct and indirect subsidiaries have made separate joint elections to treat these subsidiaries as TRSs. To-Be-Announced Securities (“TBAs”) A contract for the purchase or sale of a mortgage-backed security to be delivered at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date but does not include a specified pool number and number of pools. TBA Dollar Roll Income TBA dollar roll income is defined as the difference in price between two TBA contracts with the same terms but different settlement dates. The TBA contract settling in the later month typically prices at a discount to the earlier month contract with the difference in price commonly referred to as the “drop”. TBA dollar roll income represents the equivalent of interest income on the underlying security less an implied cost of financing. Total Return Investment performance measure over a stated time period which includes coupon interest, interest on interest, and any realized and unrealized gains or losses. Total Return Swap A derivative instrument where one party makes payments at a predetermined rate (either fixed or variable) while receiving a return on a specific asset (generally an equity index, loan or bond) held by the counterparty. U Unencumbered Assets Assets on our balance sheet which have not been pledged as collateral against an existing liability. U.S. Government-Sponsored Enterprise (“GSE”) Obligations Obligations of Agencies originally established or chartered by the U.S. government to serve public purposes as specified by the U.S. Congress, such as Fannie Mae and Freddie Mac; these obligations are not explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the U.S. government. V Value-at-Risk (“VaR”) A statistical technique which measures the potential loss in value of an asset or portfolio over a defined period for a given confidence interval. Variable Interest Entity (“VIE”) An entity in which equity investors (i) do not have the characteristics of a controlling financial interest, and/or (ii) do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Variation Margin Cash or securities provided by a party to collateralize its obligations under a transaction as a result of a change in value of such transaction since the trade was executed or the last time collateral was provided. Volatility A statistical measure of the variance of price or yield over time. Volatility is low if the price does not change very much over a short period of time, and high if there is a greater change. Voting Interest Entity (“VOE”) An entity that has sufficient equity to finance its activities without additional subordinated financial support from other parties and in which equity investors have a controlling financial interest. W Warehouse Lending A line of credit extended to a loan originator to fund mortgages extended by the loan originators to property purchasers. The loan typically lasts from the time the mortgage is originated to when the mortgage is sold into the secondary market, whether directly or through a securitization. Warehouse lending can provide liquidity to the loan origination market. Weighted Average Coupon The weighted average interest rate of the underlying mortgage loans or pools that serve as collateral for a security, weighted by the size of the principal loan balances. Weighted Average Life (“WAL”) The assumed weighted average amount of time that will elapse from the date of a security’s issuance until each dollar of principal is repaid to the investor. The WAL will change as the security ages and depending on the actual realized rate at which principal, scheduled and unscheduled, is paid on the loans underlying the MBS. 90 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 2. Management’s Discussion and Analysis Y Yield-to-Maturity The expected rate of return of a bond if it is held to its maturity date; calculated by taking into account the current market price, stated redemption value, coupon payments and time to maturity and assuming all coupons are reinvested at the same rate; equivalent to the internal rate of return. 91 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Quantitative and qualitative disclosures about market risk are contained within the section titled “Risk Management” of Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”