# ANNALY CAPITAL MANAGEMENT INC (NLY) FY 2021 MD&A Verbatim Item 7 Management's Discussion and Analysis from ANNALY CAPITAL MANAGEMENT INC's 10-K for fiscal year 2021. SEC filing source: https://www.sec.gov/Archives/edgar/data/1043219/000162828022003099/nly-20211231.htm Accession: 0001628280-22-003099 Filing date: 2022-02-18 Report date: 2021-12-31 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Confidence: high Company profile: /company/NLY/ All MD&A years: /company/NLY/mda/ Next year: /company/NLY/mda/fy2022/ (FY 2022) Item 7. Management’s Discussion and Analysis ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Special Note Regarding Forward-Looking Statements Certain statements contained in this annual report, and certain statements contained in our future filings with the the Securities and Exchange Commission (the “SEC” or the “Commission”), in our press releases or in our other public or stockholder communications contain or incorporate by reference certain forward-looking statements which are based on various assumptions (some of which are beyond our control) and may be identified by reference to a future period or periods or by the use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “anticipate,” “continue,” or similar terms or variations on those terms or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, risks and uncertainties related to the COVID-19 pandemic, including as related to adverse economic conditions on real estate-related assets and financing conditions (and our outlook for our business in light of these conditions, which is uncertain); changes in interest rates; changes in the yield curve; changes in prepayment rates; the availability of mortgage-backed securities and other securities for purchase; the availability of financing and, if available, the terms of any financing; changes in the market value of our assets; changes in business conditions and the general economy; operational risks or risk management failures by us or critical third parties, including cybersecurity incidents; our ability to grow our residential credit business; our ability grow our middle market lending business; credit risks related to our investments in credit risk transfer securities, residential mortgage-backed securities and related residential mortgage credit assets, and corporate debt; risks related to investments in mortgage-servicing rights (“MSR”); our ability to consummate any contemplated investment opportunities; changes in government regulations or policy affecting our business; our ability to maintain our qualification as a REIT for U.S. federal income tax purposes; and our ability to maintain our exemption from registration under the Investment Company Act. For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in this annual report on Form 10-K and any subsequent quarterly reports on Form 10-Q or current reports on Form 8-K. We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. All references to “Annaly,” “we,” “us,” or “our” mean Annaly Capital Management, Inc. and all entities owned by us, except where it is made clear that the term means only the parent company.  Refer to the section titled “Glossary of Terms” located at the end of this Item 7 for definitions of commonly used terms in this annual report on Form 10-K. This section of our Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form 10-K can be found in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the year ended December 31, 2020. 49 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis [[GREPCENT_TABLE]] [["INDEX TO ITEM 7. MANAGEMENT\u2019S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS"],["","Page"],["Overview","51"],["Recent Developments","51"],["Business Environment and COVID-19","51"],["Economic Environment","52"],["London Interbank Offered Rate (\u201cLIBOR\u201d) Transition Working Group","59"],["Results of Operations","54"],["Net Income (Loss) Summary","55"],["Non-GAAP Financial Measures","55"],["Earnings available for distribution, earnings available for distribution attributable to common stockholders, earnings available for distribution per average common share and annualized EAD return on average equity","56"],["Premium Amortization Expense","58"],["Economic leverage and economic capital ratios","58"],["Interest Income (excluding PAA), economic interest expense and economic net interest income (excluding PAA)","60"],["Experienced and Projected Long-term CPR","60"],["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","61"],["Economic Interest Expense and Average Economic Cost of Interest Bearing Liabilities","62"],["Realized and Unrealized Gains (Losses)","62"],["Other Income (Loss)","63"],["General and Administrative Expenses","64"],["Return on Average Equity","64"],["Unrealized Gains and Losses - Available-for-Sale Investments","64"],["Financial Condition","66"],["Residential Securities","66"],["Contractual Obligations","69"],["Off-Balance Sheet Arrangements","69"],["Capital Management","69"],["Stockholders\u2019 Equity","70"],["Capital Stock","70"],["Leverage and Capital","71"],["Risk Management","71"],["Risk Appetite","71"],["Governance","72"],["Description of Risks","73"],["Capital, Liquidity and Funding Risk Management","74"],["Funding","74"],["Excess Liquidity","75"],["Maturity Profile","76"],["Stress Testing","78"],["Liquidity Management Policies","78"],["Investment/Market Risk Management","79"],["Credit Risk Management","79"],["Counterparty Risk Management","80"],["Operational Risk Management","81"],["Compliance, Regulatory and Legal Risk Management","81"],["Critical Accounting Estimates","82"],["Valuation of Financial Instruments","82"],["Residential Securities","82"],["Residential Mortgage Loans","83"],["MSR","83"],["Interest Rate Swaps","83"],["Revenue Recognition","83"],["Consolidation of Variable Interest Entities","84"],["Use of Estimates","84"],["Glossary of Terms","85"]] [[/GREPCENT_TABLE]] 50 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis Overview We are a leading diversified capital manager with investment strategies across mortgage finance and corporate middle market lending. Our principal business objective is to generate net income for distribution to our stockholders and optimize our returns through prudent management of our diversified investment strategies. We are an internally-managed Maryland corporation founded in 1997 that has elected to be taxed as a REIT. Our common stock is listed on the New York Stock Exchange under the symbol “NLY.” We use our capital coupled with borrowed funds to invest primarily in real estate related investments, earning the spread between the yield on our assets and the cost of our borrowings and hedging activities. For a full discussion of our business, refer to the section titled “Business Overview” of Part I, Item 1. “Business.” Recent Developments Sale of Commercial Real Estate Business On March 25, 2021, we announced that we entered into a definitive agreement to sell our Commercial Real Estate (“CRE”) business to Slate Asset Management L.P. and Slate Grocery REIT (together, “Slate”). The transaction represents the sale of substantially all of the assets that comprise our CRE business, which include equity interests, loan assets and associated liabilities and commercial mortgage-backed securities (other than commercial CRTs). Certain employees who primarily supported the CRE business joined Slate in connection with the sale. During the year ended December 31, 2021, the majority of assets held for sale and the associated liabilities were transferred to Slate with the remaining assets expected to be transferred by the end of the first quarter of 2022, subject to regulatory approvals. Revenues and expenses associated with the CRE business will be reflected in our results of operations and key financial metrics through closing. Refer to the “Sale of Commercial Real Estate Business” in the Notes to the Consolidated Financial Statements included in Item 15. “Exhibits, Financial Statement Schedules for additional information related to the transaction. . Business Environment and COVID-19 Financial markets have seen challenging conditions in recent months as the robust performance of the U.S. economy has made it evident that a withdrawal of pandemic era stimulus is imminent. Strong consumption and investment activity helped the U.S. economy record the best annual growth in nearly forty years in 2021. Meanwhile, the labor market has seen a rapid recovery as employers added 6.7 million jobs last year and the unemployment rate fell to 3.9 percent in December 2021. Stimulus measures have helped this rapid recovery, which has also spurred inflation to generational highs, as seen in December when the consumer price index reached 7.0% year-over-year. Although much of this increase in prices was initially considered temporary, ongoing elevated price gains across various categories of goods and services raise the risk inflation could persist for some time. Accordingly, current macroeconomic conditions have led to a meaningful shift by the Federal Reserve (“Fed"), which now views less accommodative monetary policy as the primary way to ensure both parts of its mandate – full employment and stable prices – are being met. In November, the Fed announced a reduction of its asset purchases, which up to that point had been running at a monthly pace of $120 billion per month across U.S. Treasuries and Agency MBS. At the December Federal Open Market Committee (“FOMC”) meeting, the Fed accelerated the slowdown in its asset purchases, in turn signaling a complete stop in March 2022. In addition, the Fed has signaled increases in the Federal Funds Target Rate (“Fed Funds Rate”) beginning in 2022 and an earlier introduction of balance sheet runoff to stem inflationary pressures. Interest rate markets now expect at least five 25 basis point rate hikes in 2022 and balance sheet runoff to begin in the summer months at a pace faster than the 2017 balance sheet runoff of $50 billion per month. This notable shift in expectations has led to a tightening of financial conditions and an underperformance of assets most closely tied to monetary policy, best seen in the spread widening in Agency MBS in recent weeks. In this environment, Annaly generated a negative tangible economic return of 2.4% during the fourth quarter and 0.0% for the full year 2021. Agency MBS spreads widened in light of an increasingly negative supply and demand picture, with the Fed turning from the largest net buyer of Treasuries and agency MBS to a potential seller in the near future. In anticipation of wider spreads, we managed the portfolio to decrease leverage and optimize our asset allocation, with total assets decreasing by approximately $12.4 billion to $89.2 billion during 2021. In conjunction, economic leverage declined from 6.2x to 5.7x, marking the lowest leverage level since 2015. The defensive leverage profile is further supported by low capital structure leverage and minimal asset-level structural leverage, as highly liquid Agency-MBS makes up the majority of Annaly’s portfolio. Moreover, the firm has substantial liquidity with $9.3 billion of unencumbered assets, up $600 million year-over-year. Finally, Annaly remains conservatively hedged to mitigate interest rate risk - with a year-end hedge ratio of 95% and expect to remain close to fully hedged for at least the near term. The portfolio continued to perform strongly, generating GAAP net income of $1.60 for the year and earnings available for distribution of $1.16 which exceeded our aggregate dividend of $0.88 per share. 51 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis Allocation to Annaly’s credit businesses increased by approximately 10 percentage points to 32% in 2021 as prospective returns and the strong U.S. economy continued to favor credit. This was a transformative year for Annaly marked by the sale of our Commercial Real Estate business, the launch of our Mortgage Servicing Rights platform and the expansion of our residential credit business. The collective impact of these initiatives has increased our presence throughout the residential housing finance market, enhancing our ability us to allocate capital effectively wherever returns are most attractive. Our MSR business had a strong year with assets increasing over $500 million throughout 2021 to $645 million. We successfully established our MSR platform last year through the addition of key hires, procurement of strategic partnerships and buildout of the operations and infrastructure necessary to scale the business efficiently. As a result of these efforts, we have ended the year as the fifth largest bulk buyer of MSR. Meanwhile, we continue to see significant growth from our Residential Credit group, which grew assets by nearly 90% last year. This growth was enhanced by the launch of our residential whole loan correspondent channel, which expanded our whole loan sourcing capabilities through the addition of new strategic partners and product offerings. Altogether, these efforts helped drive the group’s record $4.5 billion in whole loan originations last year. Annaly’s subsidiary Onslow Bay remains a programmatic issuer of securitizations - pricing 13 whole loan securitizations totaling $5.3 billion since the beginning of last year and was the fourth largest non-bank issuer of prime jumbo and expanded prime MBS over the last two years. With housing fundamentals expected to stay strong, residential credit should remain a key driver of our overall portfolio growth in the year ahead. Lastly, our middle market lending platform continues to demonstrate its differentiated strategy with over $1.5 billion in originations throughout 2021 and a strong credit profile with no loans on non-accrual. The close of Annaly’s inaugural private middle-market lending focused closed-end fund allowed for increased capital allocation flexibility to further scale the business and provides recurring fee revenue to the REIT. Notably, fund proceeds have already been deployed at approximately $450 million of assets. Earnings available for distribution is a non-GAAP financial measure. Refer to the “Non-GAAP Financial Measures” section for additional information, including reconciliations to its most directly comparable GAAP results. Business Continuity Our well-established Business Continuity Planning (“BCP”) was designed to ensure continued, effective operations through a variety of scenarios including natural disasters and disease pandemics. It identifies critical systems, processes, roles and third parties, and can be adjusted on a real-time basis to address situations as they arise. The BCP is regularly updated and tested. Annual testing includes extensive, remote Disaster Recovery testing and tabletop exercise scenarios with management. Key tenets of the planning include active communication between our Crisis Response Team, which is comprised of senior leaders across a number of functions, and our internal and external stakeholders to afford efficient, thoughtful, effective responses to evolving emergency situations. Historical tabletop exercises have included use of CDC Influenza Pandemic exercise materials. That exercise documented our response and possible impacts to a variety of scenarios, including those in which “shelter in place orders” were required and response/ impact assessments to those scenarios. Regular meetings were commenced to implement and review active internal and external communications planning. These exercises, along with regulatory and industry guidance, informed our staged response to the conditions created by COVID-19. In response to COVID-19, our employees largely worked remotely in the first half of 2021 and transitioned to a hybrid model in the second half of 2021 with employees returning to the office on a periodic basis following federal, state and local guidance. At the present, we expect employees to return to the office more regularly starting in the first quarter of 2022 subject to guidance from federal, state and local authorities. For additional information about our response to COVID-19, refer to the section titled “Human Capital” of Part I, Item 1. “Business.” Economic Environment The COVID-19 pandemic continued to provide meaningful challenges to the global economy in 2021. However, U.S. economic growth rebounded sharply as the development and deployment of vaccines and better COVID-19 treatment methods reduced the impact of the virus on economic activity. Combined with the provision of significant fiscal stimulus and easy monetary policy, consumption and investment activity rebounded sharply from their depressed levels immediately following the onset of the pandemic. After registering year-over-year real growth in U.S. gross domestic product (“GDP”) of 5.7% for 2021, marking the highest real output growth since 1984, real output levels now exceed aggregate output at the end of 2019 by 3.1%. Of note, a large share of the growth has been driven by real goods consumption, which has risen 12.1% year-over-year in 2021 as consumers opted to spend increased amounts on cars, furniture, recreational goods and similar items. Services consumption, meanwhile, has seen improvements at a slower rate as COVID-19 restrictions have continued to limit travel and entertainment. 52 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis Private investment activity, meanwhile, rose 7.7% year-over-year on improved activity in structures, equipment, and residential sectors. In line with economic activity, the labor market has seen a meaningful improvement over the course of 2021, with employers hiring an aggregate 6.7 million workers, leading the unemployment rate to decline 2.8 percentage points. This marks one of the largest improvements in the labor market in at least 50 years. At the current level of 3.9 percent, the unemployment rate is below the Federal Reserve’s estimate of the non-accelerating inflation rate of unemployment (“NAIRU”) according to the latest Summary of Economic Projections published following the Federal Open Market Committee meeting held in December 2021. This suggests that meaningful further employment gains are likely only possible at higher rates of wage compensation, although wage gains have been robust in 2021 already. The closely tracked Employment Cost Index rose 4.0% year-over-year in the fourth quarter, up from 2.5% year-over-year in the fourth quarter of 2020. This marks one of the fastest accelerations in wage growth in recent years as workers demanded higher wages, particularly in the highly sought after, lower paid service sector. More broadly, the economy saw a record number of job openings in 2021 as demand for workers soared in the reopening economy. Unfortunately for many businesses, many workers have not reengaged in the labor market during the pandemic as the labor force participation rate – the share of people either working or actively looking for a job as share of the population – remains meaningfully below rates seen ahead of the pandemic. Although adverse demographic trends, such as an aging society, have put downward pressure on the labor force participation rate over a long period of time, the pandemic has accelerated this trend. Inflation has been a major surprise in 2021. Although year-over-year changes in the Personal Consumption Expenditure Chain Price Index (“PCE”) measured 1.3% in December 2020, well below the Fed’s 2% target, headline PCE rose to 5.8% year-over-year in December 2021. The meaningful acceleration in inflation has been driven by higher inflation in consumer goods. For example, goods excluding foods and energy have contributed 18 basis points to the monthly changes in the consumer price index during 2021, meaningfully higher than the 0.2 basis points contribution to monthly changes in the period between 2016 and 2020. The sharp rise in goods prices has been driven by households, who are beneficiaries of healthy balance sheets and sharply rising asset and house prices. This has in turn led to strong demand for cars, furniture, recreational goods and similar items. Services inflation, meanwhile, has been more muted, though sectors that saw strong demand as the pandemic receded, such as travel, and shelter inflation have been increasing. The Fed conducts monetary policy with a dual mandate: full employment and price stability. As the pandemic continued to impact the U.S. economy in meaningful ways, the Fed continued its easy monetary policy for much of the year in a successful attempt to reinvigorate the labor market following the sharp rise in unemployment in 2020. The target range for the Federal Funds rate was kept at 0.0% - 0.25% for all of 2021, while simultaneously purchasing assets at a pace of $80 billion per month in Treasury securities and $40 billion per month in agency MBS between January and October 2021. The Fed announced a slowdown in the pace of its asset purchases at the November Federal Open Market Committee meeting, effectively signaling a gradual end to the asset purchases. During the year ended December 31, 2021, yields on the 10-year U.S. Treasury note rose by 60 bps primarily in the first half of the year as better economic prospects lead investors to reassess the level of interest rates. Given high levels of inflation, the vast majority of the repricing has been driving by inflation compensation, as investors require higher compensation in times when rising inflation erodes their bond market returns. Meanwhile, the mortgage basis, or the spread between the 30-year Agency MBS coupon and 10-year U.S. Treasury rate, widened gradually over the course of the year, ending the year 13 bps wider than at the end of 2020. The following table below presents interest rates and spreads at each date presented: [[GREPCENT_TABLE]] [["","As of December 31,"],["","2021","","2020","","2019"],["30-Year mortgage current coupon","2.07%","","1.34%","","2.71%"],["Mortgage basis","56 bps","","43 bps","","79 bps"],["10-Year U.S. Treasury rate","1.51%","","0.91%","","1.92%"],["LIBOR"],["1-Month","0.10%","","0.14%","","1.76%"],["6-Month","0.34%","","0.26%","","1.91%"]] [[/GREPCENT_TABLE]] 53 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis London Interbank Offered Rate (“LIBOR”) Transition Working Group The United Kingdom Financial Conduct Authority (“FCA”), which regulates LIBOR, announced that all LIBOR tenors relevant to us will cease to be published or will no longer be representative after June 30, 2023. The FCA's announcement coincided with the announcement of LIBOR's administrator, the ICE Benchmark Administration Limited (“IBA”), indicating that, as a result of not having access to input data necessary to calculate LIBOR tenors relevant to us on a representative basis after June 30, 2023, IBA would have to cease publication of such LIBOR tenors immediately after the last publication on June 30, 2023. These announcements mean that any of our LIBOR-based borrowings that extend beyond June 30, 2023 will need to be converted to a replacement rate. We have established a cross-functional LIBOR transition committee to determine our transition plan and facilitate an orderly transition to alternative reference rates. Our plan includes steps to evaluate exposure; review contracts; assess impact to our business; process and technology and define a communication strategy with shareholders; regulators and other stakeholders. The committee also continues to engage with industry working groups and other market participants regarding the transition. We continue to remain on track with our LIBOR transition plan, which requires different solutions depending on the underlying asset or liability. Similar to the rest of the market, the bulk of our exposure is in derivatives contracts. Certain contracts, such as interest rate swaps, have an orderly market transition already in process, whereas other contracts, such as loan agreements, require bilateral amendments and adequate time left to resolve. The State of New York approved legislative solutions for contracts such as residential whole loans that are governed by New York state law, although more legislative work is needed at the federal level. We are supportive of the potential legislative solutions at the state and federal level. We are considering all available options with respect to our preferred stock, which include liability management actions such as tenders, calls, exchange offers, language amendments, changing the calculation agent, and/or allowing fallbacks to trigger. As of December 31, 2021, we had $1.5 billion of USD LIBOR-linked preferred stock that may remain outstanding beyond the June 30, 2023 cessation date. See the risk factor titled “The discontinuation of LIBOR may affect our results” in Part I, Item 1A “Risk Factors” for additional information. Results of Operations The results of our operations are affected by various factors, many of which are beyond our control. Certain of such risks and uncertainties are described herein (see “Special Note Regarding Forward-Looking Statements” above) and in Part I, Item 1A. “Risk Factors”. This Management Discussion and Analysis section contains analysis and discussion of financial results computed in accordance with U.S. generally accepted accounting principles (“GAAP”) and non-GAAP measurements. To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide non-GAAP financial measures to enhance investor understanding of our period-over-period operating performance and business trends, as well as for assessing our performance versus that of industry peers. Refer to the “Non-GAAP Financial Measures” section for additional information. Commencing with our financial results for the quarter ended June 30, 2021 and for subsequent reporting periods, we relabeled “Core Earnings (excluding PAA)” as “Earnings Available for Distribution” (“EAD”). Earnings Available for Distribution, which is a non-GAAP financial measure intended to supplement our financial results computed in accordance with GAAP, has replaced our prior presentation of Core Earnings (excluding PAA). In addition, Core Earnings (excluding PAA) results from prior reporting periods have been relabeled Earnings Available for Distribution. In line with evolving industry practices, we believe the term Earnings Available for Distribution more accurately reflects the principal purpose of the measure than the term Core Earnings (excluding PAA) and will serve as a useful indicator for investors in evaluating our performance and our ability to pay dividends. The definition of Earnings Available for Distribution is identical to the definition of Core Earning (excluding PAA) from prior reporting periods. As such, Earnings Available for Distribution is defined as the sum of (a) economic net interest income, (b) TBA dollar roll income and CMBX coupon income, (c) realized amortization of MSR, (d) other income (loss) (excluding depreciation expense related to commercial real estate and amortization of intangibles, non-EAD income allocated to equity method investments and other non-EAD 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-EAD 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. Earnings Available for Distribution should not be considered a substitute for, or superior to, GAAP net income. Please refer to the “Non-GAAP Financial Measures” section for a detailed discussion of Earnings Available for Distribution. 54 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis Beginning with the quarter ended June 30, 2021, we began classifying certain portfolio activity-related or volume-related expenses as Other income (loss) rather than Other general and administrative expenses in the Consolidated Statements of Comprehensive Income (Loss) to better reflect the nature of the items. As such, prior periods have been conformed to the current presentation. Refer to the “General and Administrative Expenses” section for additional information. Net Income (Loss) Summary The following table presents financial information related to our results of operations as of and for the years ended December 31, 2021, 2020 and 2019. [[GREPCENT_TABLE]] [["","As of and for the Years Ended December 31,"],["","2021","","2020","","2019"],["","(dollars in thousands, except per share data)"],["Interest income","$","1,983,036","","","$","2,229,625","","","$","3,787,297"],["Interest expense","249,243","","","899,112","","","2,784,875"],["Net interest income","1,733,793","","","1,330,513","","","1,002,422"],["Realized and unrealized gains (losses)","795,195","","","(2,062,824)","","","(3,011,127)"],["Other income (loss)","57,981","","","36,311","","","106,547"],["Less: Total general and administrative expenses","186,014","","","222,195","","","271,768"],["Income (loss) before income taxes","2,400,955","","","(918,195)","","","(2,173,926)"],["Income taxes","4,675","","","(28,423)","","","(10,835)"],["Net income (loss)","2,396,280","","","(889,772)","","","(2,163,091)"],["Less: Net income (loss) attributable to noncontrolling interests","6,384","","","1,391","","","(226)"],["Net income (loss) attributable to Annaly","2,389,896","","","(891,163)","","","(2,162,865)"],["Less: Dividends on preferred stock","107,532","","","142,036","","","136,576"],["Net income (loss) available (related) to common stockholders","$","2,282,364","","","$","(1,033,199)","","","$","(2,299,441)"],["Net income (loss) per share available (related) to common stockholders"],["Basic","$","1.60","","","$","(0.73)","","","$","(1.60)"],["Diluted","$","1.60","","","$","(0.73)","","","$","(1.60)"],["Weighted average number of common shares outstanding"],["Basic","1,427,426,079","","","1,414,659,439","","","1,434,912,682"],["Diluted","1,428,569,003","","","1,414,659,439","","","1,434,912,682"],["Other information"],["Investment portfolio at period-end","$","74,792,041","","","$","86,403,446","","","$","127,402,106"],["Average total assets","$","81,925,499","","","$","99,663,704","","","$","123,202,411"],["Average equity","$","13,728,352","","","$","14,103,589","","","$","15,325,340"],["GAAP leverage at period-end (1)","4.7:1","","5.1:1","","7.1:1"],["GAAP capital ratio at period-end (2)","17.2","%","","15.9","%","","12.1","%"],["Annualized return on average total assets","2.92","%","","(0.89)","%","","(1.76)","%"],["Annualized return on average equity","17.45","%","","(6.31)","%","","(14.11)","%"],["Net interest margin (3)","2.28","%","","1.46","%","","0.83","%"],["Average yield on interest earning assets (4)","2.61","%","","2.44","%","","3.15","%"],["Average GAAP cost of interest bearing liabilities (5)","0.37","%","","1.09","%","","2.57","%"],["Net interest spread","2.24","%","","1.35","%","","0.58","%"],["Weighted average experienced CPR for the period","23.7","%","","20.2","%","","12.7","%"],["Weighted average projected long-term CPR at period-end","12.7","%","","16.4","%","","13.9","%"],["Common stock book value per share","$","7.97","","","$","8.92","","","$","9.66"],["Non-GAAP metrics (6)"],["Interest income (excluding PAA)","$","2,040,194","","","$","2,645,069","","","$","4,042,191"],["Economic interest expense (5)","$","525,385","","","$","1,106,989","","","$","2,433,500"],["Economic net interest income (excluding PAA)","$","1,514,809","","","$","1,538,080","","","$","1,608,691"],["Premium amortization adjustment cost (benefit)","$","57,158","","","$","415,444","","","$","254,894"],["Earnings available for distribution (7)","$","1,768,391","","","$","1,696,167","","","$","1,575,396"],["Earnings available for distribution per common share","$","1.16","","","$","1.10","","","$","1.00"],["Annualized EAD return on average equity (excluding PAA)","12.90","%","","12.03","%","","10.28","%"],["Economic leverage at period-end (1)","5.7:1","","6.2:1","","7.2:1"],["Economic capital ratio at period-end (2)","14.4","%","","13.6","%","","12.0","%"],["Net interest margin (excluding PAA) (3)","2.02","%","","1.74","%","","1.32","%"],["Average yield on interest earning assets (excluding PAA) (4)","2.68","%","","2.90","%","","3.36","%"],["Average economic cost of interest bearing liabilities (5)","0.79","%","","1.34","%","","2.25","%"],["Net interest spread (excluding PAA)","1.89","%","","1.56","%","","1.11","%"],["(1) GAAP leverage is computed as the sum of repurchase agreements, other secured financing, debt issued by securitization vehicles, participations issued and mortgages payable divided by total equity. Economic leverage is computed as the sum of recourse debt, cost basis of to-be-announced (\u201cTBA\u201d) 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). Certain credit facilities (included within other secured financing), debt issued by securitization vehicles, participations issued, and mortgages payable are non-recourse to the Company and are excluded from economic leverage.(2) GAAP capital ratio is computed as total equity divided by total assets. Economic capital ratio is computed as total equity divided by total economic assets. Total economic assets include the implied market value of TBA derivatives and net of debt issued by securitization vehicles.(3) 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.(4) Average yield on interest earning assets represents annualized interest income divided by average interest earning assets. Average interest earning assets reflects the average amortized cost of our investments during the period. Average yield on interest earning assets (excluding PAA) is calculated using annualized interest income (excluding PAA).(5) 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.(6) Represents a non-GAAP financial measure. Refer to the \u201cNon-GAAP Financial Measures\u201d section for additional information.(7) Excludes dividends on preferred stock."]] [[/GREPCENT_TABLE]] GAAP Net income (loss) was $2.4 billion, which includes $6.4 million attributable to noncontrolling interests, or $1.60 per average basic common share, for the year ended December 31, 2021 compared to ($0.9) billion, which includes $1.4 million attributable to noncontrolling interests, or ($0.73) per average basic common share, for the same period in 2020. We attribute the majority of the change in net income (loss) to favorable changes in unrealized gains (losses) on interest rate swaps, realized gains (losses) on termination or maturity of interest rate swaps, net unrealized gains (losses) on instruments measured at fair value through earnings and net interest income, partially offset by unfavorable changes in Net gains (losses) on disposal of investments and other and Net gains (losses) on other derivatives and financial instruments. Net unrealized gains (losses) on interest rate swaps was $2.2 billion for the year ended December 31, 2021 compared to ($0.9) billion for the same period in 2020. Realized losses on termination or maturity of interest rate swaps was ($1.2) billion for the year ended December 31, 2021 compared to ($1.9) billion for the same period in 2020. Net unrealized gains (losses) on instruments measured at fair value through earnings for the year ended December 31, 2021 was $183.7 million compared to ($303.0) million for the same period in 2020. Net interest income for the year ended December 31, 2021 was $1.7 billion compared to $1.3 billion for the same period in 2020. Net gains (losses) on disposal of investments and other was ($62.7) million for the year ended December 31, 2021 compared to $661.5 million for the same period in 2020. Net gains (losses) on other derivatives and financial instruments was $121.7 million for the year ended December 31, 2021 compared to $756.3 million for the same period in 2020. Refer to the section titled “Realized and Unrealized Gains (Losses)” located within this Item 7 for additional information related to these changes. Non-GAAP Earnings available for distribution were $1.8 billion, or $1.16 per average common share, for the year ended December 31, 2021, compared to $1.7 billion, or $1.10 per average common share, for the same period in 2020. The changes in earnings available for distribution for the year ended December 31, 2021 compared to the same period in 2020 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 lower average interest earning assets and an unfavorable change 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: •earnings available for distribution (“EAD”); •earnings available for distribution attributable to common stockholders; •earnings available for distribution per average common share; •annualized EAD return on average equity; •economic leverage; •economic capital ratio; •interest income (excluding PAA); 55 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis •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 earnings available for distribution, 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. Earnings available for distribution, earnings available for distribution attributable to common stockholders, earnings available for distribution per average common share and annualized EAD return on average equity 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. Earnings available for distribution, 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 MSR, (d) other income (loss) (excluding depreciation and amortization expense on real estate and related intangibles, non-EAD income allocated to equity method investments and other non-EAD 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-EAD income (loss) items), and excludes (g) the premium amortization adjustment (“PAA”) representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term prepayment speeds related to our Agency mortgage-backed securities, is used by management and, we believe, used by analysts and investors to measure our progress in achieving our principal business objective. We seek to fulfill our principal business objective through a variety of factors including portfolio construction, the degree of market risk exposure and related hedge profile, and the use and forms of leverage, all while operating within the parameters of our capital allocation policy and risk governance framework. We believe these non-GAAP measures provide management and investors with additional details regarding our underlying operating results and investment portfolio trends by (i) making adjustments to account for the disparate reporting of changes in fair value where certain instruments are reflected in GAAP net income (loss) while others are reflected in other comprehensive income (loss), and (ii) by excluding certain unrealized, non-cash or episodic components of GAAP net income (loss) in order to provide additional transparency into the operating performance of our portfolio. In addition, EAD serves as a useful indicator for investors in evaluating the Company's performance and ability to pay dividends. Annualized EAD return on average equity, which is calculated by dividing earnings available for distribution over average stockholders’ equity, provides investors with additional detail on the earnings available for distribution generated by our invested equity capital. 56 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis The following table presents a reconciliation of GAAP financial results to non-GAAP earnings available for distribution for the periods presented: [[GREPCENT_TABLE]] [["","For the Years Ended December 31,"],["","2021","","2020","","2019"],["","(dollars in thousands, except per share data)"],["GAAP net income (loss)","$","2,396,280","","","$","(889,772)","","","$","(2,163,091)"],["Net income (loss) attributable to noncontrolling interests","6,384","","","1,391","","","(226)"],["Net income (loss) attributable to Annaly","2,389,896","","","(891,163)","","","(2,162,865)"],["Adjustments to exclude reported realized and unrealized (gains) losses"],["Realized (gains) losses on termination or maturity of interest rate swaps","1,236,349","","","1,917,628","","","1,442,964"],["Unrealized (gains) losses on interest rate swaps","(2,198,486)","","","904,532","","","1,210,276"],["Net (gains) losses on disposal of investments and other","62,705","","","(661,513)","","","47,944"],["Net (gains) losses on other derivatives and financial instruments","(121,735)","","","(756,305)","","","680,770"],["Net unrealized (gains) losses on instruments measured at fair value through earnings","(183,663)","","","303,024","","","(36,021)"],["Loan loss provision (1)","(148,632)","","","151,188","","","16,569"],["Business divestiture-related (gains) losses","278,559","","","\u2014","","","\u2014"],["Other adjustments"],["Depreciation expense related to commercial real estate and amortization of intangibles (2)","15,225","","","39,108","","","40,058"],["Non-EAD (income) loss allocated to equity method investments (3)","(10,930)","","","22,493","","","21,385"],["Transaction expenses and non-recurring items (4)","5,579","","","11,293","","","19,284"],["Income tax effect of non-EAD income (loss) items","13,325","","","(17,603)","","","(5,961)"],["TBA dollar roll income and CMBX coupon income (5)","445,768","","","355,547","","","123,818"],["MSR amortization (6)","(72,727)","","","(97,506)","","","(77,719)"],["Plus:"],["Premium amortization adjustment cost (benefit)","57,158","","","415,444","","","254,894"],["Earnings available for distribution (7)","1,768,391","","","1,696,167","","","1,575,396"],["Dividends on preferred stock","107,532","","","142,036","","","136,576"],["Earnings available for distribution attributable to common stockholders (7)","$","1,660,859","","","$","1,554,131","","","$","1,438,820"],["GAAP net income (loss) per average common share","$","1.60","","","$","(0.73)","","","$","(1.60)"],["Earnings available for distribution per average common share (7)","$","1.16","","","$","1.10","","","$","1.00"],["GAAP return (loss) on average equity","17.45","%","","(6.31)","%","","(14.11)","%"],["EAD return on average equity (excluding PAA) (7)","12.90","%","","12.03","%","","10.28","%"],["(1) Includes ($3.6) million and $3.6 million of loss provision (reversal) on the Company\u2019s unfunded loan commitments for the years ended December 31, 2021 and 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) The Company excludes non-EAD (income) loss allocated to equity method investments, which represents the unrealized (gains) losses allocated to equity interests in a portfolio of MSR, which is a component of Other income (loss). (4) Includes costs incurred in connection with securitizations of residential whole loans. The year ended December 31, 2020 also includes costs incurred in connection with the Company\u2019s management internalization, the CEO search process and a securitization of Agency mortgage-backed securities. The year ended December 31, 2019 also includes costs incurred in connection with the securitization of commercial loans and Agency mortgage-backed securities. (5) TBA dollar roll income and CMBX coupon income each represent a component of Net gains (losses) on other derivatives and financial instruments. CMBX coupon income totaled $5.2 million, $5.8 million and $4.6 million for the years ended December 31, 2021, 2020 and 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\u2019s 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. Refer to disclosures within this section above for additional information on non-GAAP financial measures."]] [[/GREPCENT_TABLE]] 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. 57 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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 and financial instruments 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 and financial instruments 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 and financial instruments 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 earnings available for distribution. 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: [[GREPCENT_TABLE]] [["","For the Years Ended December 31,"],["","2021","","2020","","2019"],["","(dollars in thousands)"],["Premium amortization expense","$","760,818","","","$","1,375,461","","","$","1,113,786"],["Less: PAA cost (benefit)","57,158","","","415,444","","","254,894"],["Premium amortization expense (excluding PAA)","$","703,660","","","$","960,017","","","$","858,892"]] [[/GREPCENT_TABLE]] Economic leverage and economic capital ratios We use capital coupled with borrowed funds to invest primarily in real estate related investments, earning the spread between the yield on our assets and the cost of our borrowings and hedging activities. Our capital structure is designed to offer an efficient complement of funding sources to generate positive risk-adjusted returns for our stockholders while maintaining appropriate liquidity to support our business and meet our financial obligations under periods of market stress. To maintain our desired capital profile, we utilize a mix of debt and equity funding. Debt funding may include the use of repurchase agreements, loans, securitizations, participations issued, lines of credit, asset backed lending facilities, corporate bond issuance, convertible bonds, mortgages payable or other liabilities. Equity capital primarily consists of common and preferred stock. 58 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis Our economic leverage ratio is computed as the sum of recourse debt, cost basis of TBA and CMBX derivatives outstanding, and net forward purchases (sales) of investments divided by total equity. Recourse debt consists of repurchase agreements and other secured financing (excluding certain non-recourse credit facilities). Certain credit facilities (included within other secured financing), debt issued by securitization vehicles, participations issued, and mortgages payable are non-recourse to us and are excluded from economic leverage. The following table presents a reconciliation of GAAP debt to economic debt for purposes of calculating our economic leverage ratio for the periods presented: [[GREPCENT_TABLE]] [["","As of"],["","December 31, 2021","","December 31, 2020"],["Economic leverage ratio reconciliation","(dollars in thousands)"],["Repurchase agreements","$","54,769,643","","","$","64,825,239"],["Other secured financing","903,255","","","917,876"],["Debt issued by securitization vehicles","5,155,633","","","5,652,982"],["Participations issued","1,049,066","","","39,198"],["Mortgages payable","\u2014","","","426,256"],["Debt included in liabilities of disposal group held for sale","112,144","","","\u2014"],["Total GAAP debt","$","61,989,741","","","$","71,861,551"],["Less Non-Recourse Debt:"],["Credit facilities (1)","(903,255)","","","(887,455)"],["Debt issued by securitization vehicles","(5,155,633)","","","(5,652,982)"],["Participations issued","(1,049,066)","","","(39,198)"],["Mortgages payable","\u2014","","","(426,256)"],["Non-recourse debt included in liabilities of disposal group held for sale","(112,144)","","","\u2014"],["Total recourse debt","$","54,769,643","","","$","64,855,660"],["Plus / (Less):"],["Cost basis of TBA and CMBX derivatives","20,690,768","","","20,780,913"],["Payable for unsettled trades","147,908","","","884,069"],["Receivable for unsettled trades","(2,656)","","","(15,912)"],["Economic debt (2)","$","75,605,663","","","$","86,504,730"],["Total equity","$","13,195,325","","","$","14,021,796"],["Economic leverage ratio (2)","5.7:1","","6.2:1"],["(1) Included in Other secured financing in the Consolidated Statements of Financial Condition.(2) Represents a non-GAAP financial measure. Refer to the disclosure within this section above for additional information on non-GAAP financial measures."]] [[/GREPCENT_TABLE]] The following table presents a reconciliation of GAAP total assets to economic total assets for purposes of calculating our economic capital ratio for the periods presented: [[GREPCENT_TABLE]] [["","As of"],["","December 31, 2021","","December 31, 2020"],["Economic capital ratio reconciliation","(dollars in thousands)"],["Total GAAP assets","$","76,764,064","","","$","88,455,103"],["Less:"],["Gross unrealized gains on TBA derivatives (1)","(52,693)","","","(96,109)"],["Debt issued by securitization vehicles (2)","(5,155,633)","","","(5,652,982)"],["Plus:"],["Implied market value of TBA derivatives","20,338,633","","","20,373,197"],["Total economic assets (3)","$","91,894,371","","","$","103,079,209"],["Total equity","$","13,195,325","","","$","14,021,796"],["Economic capital ratio (3)(4)","14.4%","","13.6%"],["(1) Included in Derivative assets in the Consolidated Statements of Financial Condition.(2) Includes debt issued by securitization vehicles reported in Liabilities of disposal group held for sale in the Consolidated Statements of Financial Condition.(3) Represents a non-GAAP financial measure. Refer to the disclosure within this section above for additional information on non-GAAP financial measures.(4) Economic capital ratio is computed as total equity divided by total economic assets."]] [[/GREPCENT_TABLE]] 59 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. 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 years ended December 31, 2021 and December 31, 2020. Similarly, economic net interest income (excluding PAA), as computed below, provides investors with additional information to enhance their understanding of the net economics of our primary business operations. The following tables present a reconciliation of GAAP interest income and interest expense to non-GAAP interest income (excluding PAA), economic interest expense and economic net interest income (excluding PAA), respectively, for the periods presented: Interest Income (excluding PAA) [[GREPCENT_TABLE]] [["","GAAP Interest Income","","PAA Cost (Benefit)","","Interest Income (excluding PAA) (1)"],["For the years ended","(dollars in thousands)"],["December 31, 2021","$","1,983,036","","","$","57,158","","","$","2,040,194"],["December 31, 2020","$","2,229,625","","","$","415,444","","","$","2,645,069"],["December 31, 2019","$","3,787,297","","","$","254,894","","","$","4,042,191"],["(1) Represents a non-GAAP financial measure. Refer to disclosures within this section above for additional information on non-GAAP financial measures."]] [[/GREPCENT_TABLE]] Economic Interest Expense and Economic Net Interest Income (excluding PAA) [[GREPCENT_TABLE]] [["","GAAP Interest Expense","","Add: Net Interest Component of Interest Rate Swaps","","Economic InterestExpense (1)","","GAAP Net Interest Income","","Less: Net Interest Component of Interest Rate Swaps","","EconomicNet InterestIncome (1)","","Add: PAA Cost (Benefit)","","Economic Net Interest Income (excluding PAA) (1)"],["For the years ended","(dollars in thousands)"],["December 31, 2021","$","249,243","","","$","276,142","","","$","525,385","","","$","1,733,793","","","$","276,142","","","$","1,457,651","","","$","57,158","","","$","1,514,809"],["December 31, 2020","$","899,112","","","$","207,877","","","$","1,106,989","","","$","1,330,513","","","$","207,877","","","$","1,122,636","","","$","415,444","","","$","1,538,080"],["December 31, 2019","$","2,784,875","","","$","(351,375)","","","$","2,433,500","","","$","1,002,422","","","$","(351,375)","","","$","1,353,797","","","$","254,894","","","$","1,608,691"],["(1) Represents a non-GAAP financial measure. Refer to disclosures within this section above for additional information on non-GAAP financial measures."]] [[/GREPCENT_TABLE]] 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 60 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. 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. [[GREPCENT_TABLE]] [["","Experienced CPR (1)","","Long-term CPR (2)"],["For the years ended"],["December 31, 2021","23.7%","","12.7%"],["December 31, 2020","20.2%","","16.4%"],["December 31, 2019","12.7%","","13.9%"],["(1) For the years ended December 31, 2021, 2020 and 2019, respectively.(2) At December 31, 2021, 2020 and 2019, respectively."]] [[/GREPCENT_TABLE]] 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)  [[GREPCENT_TABLE]] [["","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 years ended","(dollars in thousands)"],["December 31, 2021","$76,079,589","","$2,040,194","","2.68%","","$66,607,057","","$525,385","","0.79%","","$1,514,809","","1.89","%"],["December 31, 2020","$91,198,821","","$2,645,069","","2.90%","","$82,719,182","","$1,106,989","","1.34%","","$1,538,080","","1.56","%"],["December 31, 2019","$120,389,507","","$4,042,191","","3.36%","","$108,355,575","","$2,433,500","","2.25%","","$1,608,691","","1.11","%"],["(1) Based on amortized cost.(2) Represents a non-GAAP financial measure. Refer to the \u201cNon-GAAP Financial Measures\u201d section for additional information.(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."]] [[/GREPCENT_TABLE]] Net Interest Margin (excluding PAA) [[GREPCENT_TABLE]] [["","Interest Income (excluding PAA) (1)","","TBA Dollar Roll and CMBX Coupon Income (2)","","Economic Interest Expense (1)","","Subtotal","","Average Interest Earnings Assets","","Average TBA Contract and CMBX Balances","","Subtotal","","Net Interest Margin (excluding PAA) (1)"],["For the years ended","","(dollars in thousands)"],["December 31, 2021","$2,040,194","","445,768","","(525,385)","","$1,960,577","","$76,079,589","","21,131,344","","$97,210,933","","2.02%"],["December 31, 2020","$2,645,069","","355,547","","(1,106,989)","","$1,893,627","","$91,198,821","","17,442,023","","$108,640,844","","1.74%"],["December 31, 2019","$4,042,191","","123,818","","(2,433,500)","","$1,732,509","","$120,389,507","","10,953,117","","$131,342,624","","1.32%"],["(1) Represents a non-GAAP financial measure. Refer to the \u201cNon-GAAP Financial Measures\u201d section for additional information.(2) TBA dollar roll income and CMBX coupon income each represent a component of Net gains (losses) on other derivatives and financial instruments. CMBX coupon income totaled $5.2 million, $5.8 million and $4.6 million for the years ended December 31, 2021, 2020 and 2019, respectively."]] [[/GREPCENT_TABLE]] 61 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis Economic Interest Expense and Average Economic Cost of Interest Bearing Liabilities Typically, our largest expense is the cost of interest bearing liabilities and the net interest component of interest rate swaps. The table below shows our average interest bearing liabilities and average economic cost of interest bearing liabilities as compared to average one-month and average six-month LIBOR for the periods presented. Average Economic Cost of Interest Bearing Liabilities [[GREPCENT_TABLE]] [["","Average Interest Bearing Liabilities","","Interest Bearing Liabilities at Period End","","EconomicInterestExpense (1)(2)","","Average EconomicCost ofInterestBearingLiabilities (2)","","Average One- Month LIBOR","","Average Six- Month LIBOR","","Average One-Month LIBOR Relative to Average Six- Month LIBOR","","Average Economic Cost of Interest Bearing Liabilities Relative to Average One- Month LIBOR","","Average Economic Cost of Interest Bearing Liabilities Relative to Average Six-Month LIBOR"],["For the years ended","(dollars in thousands)"],["December 31, 2021","$","66,607,057","","","$","61,877,597","","","$","525,385","","","0.79","%","","0.10","%","","0.20","%","","(0.10","%)","","0.69","%","","0.59","%"],["December 31, 2020","$","82,719,182","","","$","71,435,295","","","$","1,106,989","","","1.34","%","","0.52","%","","0.69","%","","(0.17","%)","","0.82","%","","0.65","%"],["December 31, 2019","$","108,355,575","","","$","111,819,229","","","$","2,433,500","","","2.25","%","","2.22","%","","2.32","%","","(0.10","%)","","0.03","%","","(0.07","%)"],["(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. Refer to the \u201cNon-GAAP Financial Measures\u201d section for additional information."]] [[/GREPCENT_TABLE]] 2021 Compared with 2020 Economic interest expense decreased by $581.6 million for the year ended December 31, 2021 compared to the same period in 2020. The change 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 ($276.1) million for the year ended December 31, 2021 compared to ($207.9) million for the same period in 2020. 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 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 December 31, 2021 and 2020, the majority of our debt represented repurchase agreements and other secured financing arrangements collateralized by a pledge of our Residential Securities, residential mortgage loans, 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 financial instruments, and net unrealized gains (losses) on instruments measured at fair value through earnings. These components of realized and unrealized gains (losses) for the years ended December 31, 2021, 2020 and 2019 were as follows: 62 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis [[GREPCENT_TABLE]] [["","For the Years Ended December 31,"],["","2021","","2020","","2019"],["","(dollars in thousands)"],["Net gains (losses) on interest rate swaps (1)","$","685,995","","","$","(3,030,037)","","","$","(2,301,865)"],["Net gains (losses) on disposal of investments and other","(62,705)","","","661,513","","","(47,944)"],["Net gains (losses) on other derivatives and financial instruments","121,735","","","756,305","","","(680,770)"],["Net unrealized gains (losses) on instruments measured at fair value through earnings","183,663","","","(303,024)","","","36,021"],["Loan loss provision","145,066","","","(147,581)","","","(16,569)"],["Business divestiture-related gains (losses)","(278,559)","","","\u2014","","","\u2014"],["Total","$","795,195","","","$","(2,062,824)","","","$","(3,011,127)"],["(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."]] [[/GREPCENT_TABLE]] 2021 Compared with 2020 Net gains (losses) on interest rate swaps for the year ended December 31, 2021 was $686.0 million compared to ($3.0) billion for the same period in 2020, primarily attributable to favorable changes in unrealized gains (losses) on interest rate swaps and realized gains (losses) on termination or maturity of interest rate swaps. Unrealized gains (losses) on interest rate swaps was $2.2 billion for the year ended December 31, 2021, reflecting a rise in forward interest rates during the period, compared to ($0.9) billion for the same period in 2020, reflecting a decline in forward interest rates during the earlier period. Realized gains (losses) on termination or maturity of interest rate swaps was ($1.2) billion resulting from the termination or maturity of interest rate swaps with a notional amount of $30.9 billion for the year ended December 31, 2021 compared to ($1.9) billion resulting from the termination or maturity of interest rate swaps with a notional amount of $104.1 billion for the same period in 2020. Net gains (losses) on disposal of investments and other was ($62.7) million for the year ended December 31, 2021 compared with $661.5 million for the same period in 2020. For the year ended December 31, 2021, we disposed of Residential Securities with a carrying value of $11.5 billion for an aggregate net loss of ($3.1) million. For the same period in 2020, we disposed of Residential Securities with a carrying value of $51.8 billion for an aggregate net gain of $637.0 million and we recognized a realized gain of $104.8 million as a result of deconsolidating a multifamily VIE. Net gains (losses) on other derivatives and financial instruments was $121.7 million for the year ended December 31, 2021 compared to $756.3 million for the same period in 2020. The change in net gains (losses) on other derivatives and financial instruments was primarily comprised of changes in net gains (losses) on TBA derivatives, which was ($401.7) million for the year ended December 31, 2021 compared to $985.4 million for the same period in 2020, and interest rate swaptions, which was ($76.0) million for the year ended December 31, 2021 compared to $58.0 million for the same period in 2020, partially offset by the change in net gains (losses) on futures contracts, which was $582.3 million for the year ended December 31, 2021 compared to ($280.1) million for the same period in 2020. Net unrealized gains (losses) on instruments measured at fair value through earnings was $183.7 million for the year ended December 31, 2021 compared to ($303.0) million for the same period in 2020, primarily due to favorable changes in unrealized gains (losses) on MSR, including Interests in MSR, of $275.8 million, securitized commercial loans of $268.4 million, residential securitized debt of consolidated VIEs of $88.5 million and securitized debt of consolidated VIEs backed by Agency mortgage-backed securities of $59.7 million, partially offset by an unfavorable change in commercial securitized debt of consolidated VIEs of ($211.6) million for the year ended December 31, 2021 compared to the same period in 2020. For the year ended December 31, 2021, a loan loss (provision) reversal of $145.1 million was recorded on commercial mortgage and corporate loans compared to ($147.6) million for the same period in 2020. Refer to the “Loans” Note located within Item 15 for additional information related to these loan loss provisions. For the year ended December 31, 2021, a business divestiture-related gain (loss) of ($278.6) million was recorded on the sale of our CRE business to Slate. There was no comparative transaction for the same period in 2020. Refer to the “Sale of Commercial Real Estate Business” Note located within Item 15 for additional information related to to the transaction. Other Income (Loss) Other income (loss) includes certain revenues and costs associated with our investments in commercial real estate, including rental income and recoveries, operating costs as well as depreciation and amortization expense, net servicing income on MSR, brokerage and commission fees, due diligence costs and securitization expenses. We also report in Other income (loss) items 63 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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. General and Administrative Expenses General and administrative (“G&A”) expenses consist of compensation and other expenses. Prior to the closing of the Company's management internalization transaction (the "Internalization") on June 30, 2020, G&A also consisted of management fees paid to Annaly Management Company LLC (our “Former Manager”). Beginning with the quarter ended June 30, 2021, we began classifying certain portfolio activity- or volume-related expenses (including but not limited to brokerage and commission fees, due diligence costs and securitization expenses) as Other income (loss) rather than Other general and administrative expenses in the Consolidated Statements of Comprehensive Income (Loss) to better reflect the nature of the items. As such, prior periods have been conformed to the current presentation with Other general and administrative expenses for the three months ended March 31, 2021 adjusted downward by $1.8 million and for the years ended December 31, 2020 and 2019 adjusted downward by $17.0 million and $29.9 million, respectively. The following table shows our total G&A expenses as compared to average total assets and average equity for the periods presented. G&A Expenses and Operating Expense Ratios [[GREPCENT_TABLE]] [["","Total G&AExpenses (1)","","Total G&A Expenses/Average Assets (1)","","Total G&A Expenses/Average Equity (1)"],["For the years ended","(dollars in thousands)"],["December 31, 2021","$","186,014","","","0.23","%","","1.35","%"],["December 31, 2020","$","222,195","","","0.22","%","","1.58","%"],["December 31, 2019","$","271,768","","","0.22","%","","1.77","%"],["(1) Includes $2.9 million of costs incurred in connection with the Company\u2019s management internalization and costs incurred in connection with the CEO search process for the year ended December 31, 2020. Excluding these transaction costs, G&A expenses as a percentage of average total assets and as a percentage of average equity were 0.22% and 1.55%, respectively, for the year ended December 31, 2020."]] [[/GREPCENT_TABLE]] 2021 Compared with 2020 G&A expenses decreased $36.2 million to $186.0 million for the year ended December 31, 2021 compared to the same period in 2020. The change was largely attributable to lower professional fees, lower compensation costs due to the sale of the CRE business and cost savings generated from the Company’s management internalization, which closed on June 30, 2020, during the year ended December 31, 2021 compared with the same period in 2020. 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 [[GREPCENT_TABLE]] [["","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 years ended"],["December 31, 2021","10.62","%","","7.80","%","","0.42","%","","(1.35","%)","","(0.04","%)","","17.45","%"],["December 31, 2020","7.96","%","","(13.15","%)","","0.26","%","","(1.58","%)","","0.20","%","","(6.31","%)"],["December 31, 2019","8.83","%","","(21.93","%)","","0.69","%","","(1.77","%)","","0.07","%","","(14.11","%)"],["(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."]] [[/GREPCENT_TABLE]] 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 64 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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 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. [[GREPCENT_TABLE]] [["","December 31, 2021","","December 31, 2020"],["","(dollars in thousands)"],["Unrealized gain","$","1,444,434","","","$","3,378,523"],["Unrealized loss","(486,024)","","","(4,188)"],["Accumulated other comprehensive income (loss)","$","958,410","","","$","3,374,335"]] [[/GREPCENT_TABLE]] 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 December 31, 2021 is solely due to market conditions and not the quality of the assets. Substantially all of the Agency mortgage-backed securities have an actual or implied credit rating that is the same as the U.S. government. The investments do not require an allowance for credit losses 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. 65 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis Financial Condition Total assets were $76.8 billion and $88.5 billion at December 31, 2021 and 2020, respectively. The change was primarily due to a decrease in Agency mortgage-backed securities, including assets transferred or pledged to securitization vehicles, of $13.6 billion and commercial real estate debt investments, including assets transferred or pledged to securitization vehicles, of $1.7 billion, partially offset by an increase in residential mortgage loans, including assets transferred or pledged to securitization vehicles, of $4.2 billion. Our portfolio composition, net equity allocation and debt-to-net equity ratio by asset class were as follows at December 31, 2021: [[GREPCENT_TABLE]] [["","Residential","Commercial"],["","Agency MBS and MSR","","Residential Credit (1)","","Commercial Real Estate (2)","","Corporate Debt","","Total"],["Assets","(dollars in thousands)"],["Fair value/carrying value","$","61,729,356","","","$","10,369,051","","","$","692,169","","","$","1,968,991","","","$","74,759,567"],["Implied market value of derivatives (3)","20,338,633","","","\u2014","","","400,579","","","\u2014","","","20,739,212"],["Debt"],["Repurchase agreements","52,724,923","","","1,658,817","","","385,903","","","\u2014","","","54,769,643"],["Implied cost basis of derivatives (3)","20,289,856","","","\u2014","","","400,912","","","\u2014","","","20,690,768"],["Other secured financing","\u2014","","","\u2014","","","\u2014","","","903,255","","","903,255"],["Debt issued by securitization vehicles","548,567","","","4,607,066","","","\u2014","","","\u2014","","","5,155,633"],["Participations issued","\u2014","","","1,049,066","","","\u2014","","","\u2014","","","1,049,066"],["Net forward purchases","142,164","","","3,088","","","\u2014","","","\u2014","","","145,252"],["Liabilities of disposal group held for sale","\u2014","","","\u2014","","","112,144","","","\u2014","","","112,144"],["Other"],["Other assets / liabilities (4)","474,740","","","7,878","","","4,024","","","35,665","","","522,307"],["Net equity allocated","$","8,837,219","","","$","3,058,892","","","$","197,813","","","$","1,101,401","","","$","13,195,325"],["Net equity allocated (%)","68","%","","24","%","","\u2014","%","","8","%","","100","%"],["Debt/net equity ratio","6.0:1","","2.4:1","","2.0:1","","0.8:1","","4.7:1","(5)"],["(1) Fair value/carrying includes residential loans held for sale.(2) Fair value/carrying includes commercial real estate investments held for sale. (3) Derivatives include TBA contracts under Agency MBS and MSR and CMBX balances under Commercial Real Estate.(4) Dedicated capital allocations assume capital related to held for sale assets will be redeployed within the Agency business line.(5) Represents the debt/net equity ratio as determined using amounts on the Consolidated Statements of Financial Condition. Excludes liabilities of disposal group held for sale."]] [[/GREPCENT_TABLE]] Residential Securities Substantially all of our Agency mortgage-backed securities at December 31, 2021 and December 31, 2020 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 have an actual or implied credit rating that is the same as that of the U.S. government. 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 December 31, 2021 and December 31, 2020 we had on our Consolidated Statements of Financial Condition a total of $77.7 million and $88.3 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 $4.0 billion, respectively, of unamortized premium (which is the difference between the remaining principal value and the current amortized cost of our Residential Securities, excluding securities transferred or pledged to securitization vehicles, acquired at a price above principal value). The weighted average experienced prepayment speed on our Agency mortgage-backed securities portfolio for the years ended December 31, 2021 and 2020 was 23.7% and 20.2%, respectively. The weighted average projected long-term prepayment speed on our Agency mortgage-backed securities portfolio as of December 31, 2021 and 2020 was 12.7% and 16.4%, respectively. Given our current portfolio composition, if mortgage principal prepayment rates were to increase over the life of our mortgage-backed securities, all other factors being equal, our net interest income would decrease during the life of these mortgage-backed securities as we would be required to amortize our net premium balance into income over a shorter time period. Similarly, if mortgage principal prepayment rates were to decrease over the life of our mortgage-backed securities, all other factors being 66 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis equal, our net interest income would increase during the life of these mortgage-backed securities as we would amortize our net premium balance over a longer time period. The following tables present our Residential Securities, excluding securities transferred or pledged to securitization vehicles, that were carried at fair value at December 31, 2021 and December 31, 2020. [[GREPCENT_TABLE]] [["","","","","","","","","","","","","","December 31, 2021","","December 31, 2020"],["","","","","","","","","","","","","","Estimated Fair Value"],["Agency","","","","","","","","","","","","","(dollars in thousands)"],["Fixed-rate pass-through","","","","","","","","","","","","","$","58,296,605","","","$","71,302,578"],["Adjustable-rate pass-through","","","","","","","","","","","","","321,273","","","477,516"],["CMO","","","","","","","","","","","","","121,698","","","149,767"],["Interest-only","","","","","","","","","","","","","293,914","","","421,909"],["Multifamily","","","","","","","","","","","","","1,452,713","","","1,663,507"],["Reverse mortgages","","","","","","","","","","","","","39,402","","","51,782"],["Total agency securities","","","","","","","","","","","","","$","60,525,605","","","$","74,067,059"],["Residential credit"],["Credit risk transfer","","","","","","","","","","","","","$","936,228","","","$","532,403"],["Alt-A","","","","","","","","","","","","","69,487","","","80,328"],["Prime","","","","","","","","","","","","","275,441","","","182,749"],["Subprime","","","","","","","","","","","","","163,076","","","188,433"],["NPL/RPL","","","","","","","","","","","","","983,438","","","475,847"],["Prime jumbo (= 2010 vintage)","","","","","","","","","","","","","171,894","","","44,835"],["Total residential credit securities","","","","","","","","","","","","","$","2,599,564","","","$","1,504,595"],["Total Residential Securities","","","","","","","","","","","","","$","63,125,169","","","$","75,571,654"]] [[/GREPCENT_TABLE]] 67 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis The following table summarizes certain characteristics of our Residential Securities (excluding interest-only mortgage-backed securities) and interest-only mortgage-backed securities, excluding securities transferred or pledged to securitization vehicles, at December 31, 2021 and December 31, 2020. [[GREPCENT_TABLE]] [["","December 31, 2021","","December 31, 2020"],["Residential Securities (1)","(dollars in thousands)"],["Principal amount","$","58,676,833","","","$","68,521,464"],["Net premium","2,973,471","","","3,280,439"],["Amortized cost","61,650,304","","","71,801,903"],["Amortized cost / principal amount","105.07","%","","104.79","%"],["Carrying value","62,577,398","","","75,116,466"],["Carrying value / principal amount","106.65","%","","109.62","%"],["Weighted average coupon rate","3.35","%","","3.58","%"],["Weighted average yield","2.69","%","","2.86","%"],["Adjustable-rate Residential Securities (1)"],["Principal amount","$","1,476,250","","","$","1,257,966"],["Weighted average coupon rate","2.81","%","","3.20","%"],["Weighted average yield","6.57","%","","5.20","%"],["Weighted average term to next adjustment (2)","11 Months","","15 Months"],["Weighted average lifetime cap (3)","0.18","%","","0.41","%"],["Principal amount at period end as % of total residential securities","2.52","%","","1.84","%"],["Fixed-rate Residential Securities (1)"],["Principal amount","$","57,200,583","","","$","67,263,498"],["Weighted average coupon rate","3.36","%","","3.58","%"],["Weighted average yield","2.60","%","","2.82","%"],["Principal amount at period end as % of total residential securities","97.48","%","","98.16","%"],["Interest-only Residential Securities"],["Notional amount","$","6,583,768","","","$","3,642,143"],["Net premium","720,235","","","602,790"],["Amortized cost","720,235","","","602,790"],["Amortized cost / notional amount","10.94","%","","16.55","%"],["Carrying value","547,771","","","455,188"],["Carrying value / notional amount","8.32","%","","12.50","%"],["Weighted average coupon rate","2.01","%","","3.99","%"],["Weighted average yield","NM","","NM"],["(1) Excludes interest-only mortgage-backed securities.(2) Excludes non-Agency mortgage-backed securities and CRT securities.(3) Excludes non-Agency mortgage-backed securities and CRT securities as this attribute is not applicable to these asset classes.NM Not meaningful."]] [[/GREPCENT_TABLE]] The following tables summarize certain characteristics of our Residential Credit portfolio at December 31, 2021. [[GREPCENT_TABLE]] [["","","","Payment Structure","Investment Characteristics"],["Product","Total","","Senior","","Subordinate","","Coupon","","Credit Enhancement","","60+ Delinquencies","","3M VPR (1)"],["(dollars in thousands)"],["Credit risk transfer","$","936,228","","","$","\u2014","","","$","936,228","","","3.15","%","","3.04","%","","3.47","%","","35.35","%"],["Alt-A","69,487","","","14,090","","","55,397","","","3.33","%","","7.89","%","","10.77","%","","26.10","%"],["Prime","275,441","","","46,820","","","228,621","","","3.89","%","","8.27","%","","3.23","%","","18.53","%"],["Subprime","163,076","","","89,391","","","73,685","","","2.14","%","","21.34","%","","12.79","%","","15.29","%"],["Re-performing loan securitizations","612,742","","","273,041","","","339,701","","","3.53","%","","26.57","%","","24.30","%","","12.49","%"],["Non-performing loan securitizations","370,696","","","352,027","","","18,669","","","2.27","%","","31.57","%","","68.98","%","","6.14","%"],["Prime jumbo (=2010 vintage)","171,894","","","663","","","171,231","","","3.64","%","","3.16","%","","3.93","%","","8.58","%"],["Total/weighted average (2)","$","2,599,564","","","$","776,032","","","$","1,823,532","","","3.16","%","","14.55","%","","18.56","%","","23.04","%"],["(1) Represents the 3 month voluntary prepayment rate (\u201cVPR\u201d). Excludes the impact of interest-only securities.(2) Total investment characteristics exclude the impact of interest-only securities."]] [[/GREPCENT_TABLE]] 68 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis [[GREPCENT_TABLE]] [["","Bond Coupon"],["Product","ARM","","Fixed","","Floater","","Interest-Only","","Estimated Fair Value"],["(dollars in thousands)"],["Credit risk transfer","$","\u2014","","","$","\u2014","","","$","936,223","","","$","5","","","$","936,228"],["Alt-A","4,960","","","54,517","","","10,010","","","\u2014","","","69,487"],["Prime","30,977","","","234,840","","","9,341","","","283","","","275,441"],["Subprime","6,039","","","65,940","","","90,925","","","172","","","163,076"],["Re-performing loan securitizations","\u2014","","","612,742","","","\u2014","","","\u2014","","","612,742"],["Non-performing loan securitizations","\u2014","","","370,696","","","\u2014","","","\u2014","","","370,696"],["Prime jumbo (=2010 vintage)","\u2014","","","109,883","","","61,348","","","663","","","171,894"],["Total","$","41,976","","","$","1,448,618","","","$","1,107,847","","","$","1,123","","","$","2,599,564"]] [[/GREPCENT_TABLE]] Contractual Obligations The following table summarizes the effect on our liquidity and cash flows from contractual obligations at December 31, 2021.  The table does not include the effect of net interest rate payments on our interest rate swap agreements and excludes assets and liabilities of the disposal group held for sale. The net swap payments will fluctuate based on monthly changes in the receive rate. At December 31, 2021, the interest rate swaps had a net fair value of ($0.7) billion. [[GREPCENT_TABLE]] [["","Within One Year","","One to Three Years","","Three to Five Years","","More than Five Years","","Total"],["","(dollars in thousands)"],["Repurchase agreements","$","54,769,643","","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","54,769,643"],["Interest expense on repurchase agreements (1)","17,981","","","\u2014","","","\u2014","","","\u2014","","","17,981"],["Other secured financing","\u2014","","","\u2014","","","903,255","","","\u2014","","","903,255"],["Interest expense on other secured financing (1)","25,804","","","51,679","","","38,762","","","\u2014","","","116,245"],["Debt issued by securitization vehicles (principal)","\u2014","","","\u2014","","","\u2014","","","5,098,785","","","5,098,785"],["Interest expense on debt issued by securitization vehicles","117,089","","","234,178","","","234,178","","","3,150,591","","","3,736,036"],["Participations issued (principal)","\u2014","","","\u2014","","","\u2014","","","1,022,188","","","1,022,188"],["Interest expense on participations issued","31,603","","","63,207","","","63,207","","","805,788","","","963,805"],["Long-term operating lease obligations","3,862","","","7,724","","","2,895","","","\u2014","","","14,481"],["Total","$","54,965,982","","","$","356,788","","","$","1,242,297","","","$","10,077,352","","","$","66,642,419"],["(1) Interest expense on repurchase agreements and other secured financing calculated based on rates at December 31, 2021."]] [[/GREPCENT_TABLE]] 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, or other term financing structures to finance certain of our assets. During the year ended December 31, 2021, we received $18.7 billion from principal repayments and $11.5 billion in cash from disposal of Residential Securities. During the year ended December 31, 2020, we received $19.6 billion from principal repayments and $52.6 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 December 31, 2021. 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 69 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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” of this annual report on Form 10-K. 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. Stockholders’ Equity The following table provides a summary of total stockholders’ equity at December 31, 2021 and 2020: [[GREPCENT_TABLE]] [["","December 31, 2021","","December 31, 2020"],["Stockholders\u2019 equity","(dollars in thousands)"],["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","14,597","","","13,982"],["Additional paid-in capital","20,313,832","","","19,750,818"],["Accumulated other comprehensive income (loss)","958,410","","","3,374,335"],["Accumulated deficit","(9,653,582)","","","(10,667,388)"],["Total stockholders\u2019 equity","$","13,169,826","","","$","14,008,316"]] [[/GREPCENT_TABLE]] Capital Stock Common Stock The following table provides activity related to our Direct Purchase and Dividend Reinvestment Program for the periods presented: [[GREPCENT_TABLE]] [["","","For the Years Ended"],["","","December 31, 2021","","December 31, 2020"],["","","(dollars in thousands)"],["Shares issued through direct purchase and dividend reinvestment program","","\u2014","","","166,000"],["Amount raised from direct purchase and dividend reinvestment program","","$","\u2014","","","$","1,175"]] [[/GREPCENT_TABLE]] In June 2019, we announced that our Board authorized the repurchase of up to $1.5 billion of our outstanding shares of common stock, which expired on December 31, 2020 (the “2019 - 2020 Repurchase Program”). In December 2020, we announced that our Board authorized the repurchase of up to $1.5 billion of our outstanding common shares, which expired on December 31, 2021 (the “2021 Share Repurchase Program”). In January 2022, we announced that our Board authorized the repurchase of up to $1.5 billion of our outstanding shares of common stock through December 31, 2024 (the “Current Share Repurchase Program”). The Current Share Repurchase Program replaced the 2021 Share Repurchase Program, which had replaced the 2019 - 2020 Share Repurchase Program. During the year ended December 31, 2021, no shares were repurchased under the 2021 Share Repurchase Program. During the year ended December 31, 2020, we repurchased 32.4 million shares of our common stock for an aggregate amount of $208.9 million, excluding commission costs, respectively. All common shares purchased were part of a publicly announced plans in open-market transactions. In January 2018, the Company entered into separate Distribution Agency Agreements (as amended and restated on August 6, 2021 and August 6, 2020, collectively, the “Sales Agreements”) with each of Wells Fargo Securities, LLC, BofA Securities, Inc. (formerly known as Merrill Lynch, Pierce, Fenner & Smith, Incorporated), Barclays Capital Inc., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Goldman Sachs & Co. LLC, J.P. Morgan Securities LLC, Keefe, Bruyette & Woods,Inc., RBC Capital Markets, LLC and UBS Securities LLC (the “Sales Agents”). The Company may offer and sell shares 70 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis of its common stock, having an aggregate offering price of up to $1.5 billion, from time to time through any of the Sales Agents. During the years ended December 31, 2021, we issued 60.9 million shares of common stock for proceeds of $552.4 million, net of commissions and fees, under the at-the-market sales program. No shares were issued under the at-the-market sales program during the year ended December 31, 2020. Preferred Stock During the year ended December 31, 2020, the Company redeemed all 18.4 million of its issued and outstanding shares of 7.50% Series D Cumulative Redeemable Preferred Stock (“Series D Preferred Stock”) for $460.0 million. The cash redemption amount for each share of Series D Preferred Stock was $25.00. Leverage and Capital We believe that it is prudent to maintain conservative GAAP leverage ratios and economic leverage ratios as there may be continued 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 management’s 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 GAAP leverage ratio at December 31, 2021 and 2020 was 4.7:1 and 5.1:1, respectively. Our economic leverage ratio, which is 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 was 5.7:1 and 6.2:1, at December 31, 2021 and 2020, respectively. Our GAAP capital ratio at December 31, 2021 and 2020 was 17.2% and 15.9%, respectively. Our economic capital ratio, which represents our ratio of stockholders’ equity to total economic assets (inclusive of the implied total market value of TBA derivatives and net of debt issued by securitization vehicles), was 14.4% and 13.6% at December 31, 2021 and 2020, respectively. Economic leverage ratio and economic capital ratio are non-GAAP financial measures. Refer to the “Non-GAAP Financial Measures” section for additional information, including reconciliations to their most directly comparable GAAP results. Risk Management For more information on COVID-19, including actions we have taken in response, please refer to the section titled “Business Environment and COVID-19” within this Item 7. 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 believe 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: 71 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis [[GREPCENT_TABLE]] [["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 considerate of our overall capital allocation framework."],["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."],["Operational","We will seek to limit impacts to our business through disciplined operational risk management practices addressing areas including but not limited to, management of key third party relationships (i.e. originators, sub-servicers), human capital management, cybersecurity and technology related matters, business continuity and financial reporting risk."],["Compliance, Regulatory and Legal","We will seek to comply with regulatory requirements needed to maintain our REIT status and our exemption from registration under the Investment Company Act and the licenses and approvals of our regulated and licensed subsidiaries."]] [[/GREPCENT_TABLE]] 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”) with support from the other Board Committees. The BRC is responsible for oversight of our risk governance structure, risk management (operational and market risk) 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. The Management Development and Compensation Committee is responsible for oversight of risk related to our compensation policies and practices and other human capital matters such as succession and culture. The Corporate Responsibility Committee assists the Board in its oversight of any matters that may present reputational or ESG risk to us, and the Nominating/Corporate Governance Committee assists the Board in its oversight of our corporate governance framework and the annual self-evaluation of the Board. 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. 72 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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. [[GREPCENT_TABLE]] [["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\u2019s 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\u2019s 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 business continuity planning), human factors or external events. This risk also applies to our use of proprietary and third party models, software vendors and data providers and oversight of third-party service providers such as sub-servicers, due diligence firms etc."],["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."]] [[/GREPCENT_TABLE]] 73 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. 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: [[GREPCENT_TABLE]] [["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."]] [[/GREPCENT_TABLE]] 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 borrows funds through direct repurchase agreements. To reduce our liquidity risk we maintain a laddered approach to our repurchase agreements. At December 31, 2021 and December 31, 2020, the weighted average days to maturity was 52 days and 64 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. At December 31, 2021, we had total financial assets and cash pledged against existing liabilities of $60.4 billion. The weighted average haircut was approximately 3% on repurchase agreements. The quality and character of the Residential Securities that we pledge as collateral under the repurchase agreements and interest rate swaps did not materially change at December 31, 2021 compared to the same period in 2020, and our counterparties did not materially alter any requirements, including required haircuts, related to the collateral we pledge under repurchase agreements and interest rate swaps during the year ended December 31, 2021. 74 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis The following table presents our quarterly average and quarter-end repurchase agreement and reverse repurchase agreement balances outstanding for the periods presented: [[GREPCENT_TABLE]] [["","Repurchase Agreements","Reverse Repurchase Agreements"],["","Average Daily Amount Outstanding","","Ending Amount Outstanding","","Average Daily Amount Outstanding","","Ending Amount Outstanding"],["For the three months ended","(dollars in thousands)"],["December 31, 2021","$","56,977,019","","","$","54,769,643","","","$","39,247","","","$","\u2014"],["September 30, 2021","57,504,986","","","55,475,420","","","44,964","","","\u2014"],["June 30, 2021","62,440,803","","","60,221,067","","","42,581","","","\u2014"],["March 31, 2021","65,461,539","","","61,202,477","","","143,395","","","\u2014"],["December 31, 2020","65,528,297","","","64,825,239","","","210,484","","","\u2014"],["September 30, 2020","67,542,187","","","64,633,447","","","286,792","","","\u2014"],["June 30, 2020","68,468,813","","","67,163,598","","","183,423","","","\u2014"],["March 31, 2020","96,756,341","","","72,580,183","","","461,123","","","\u2014"],["December 31, 2019","102,760,107","","","101,740,728","","","1,006,487","","","\u2014"]] [[/GREPCENT_TABLE]] The following table provides information on our repurchase agreements and other secured financing by maturity date at December 31, 2021. The weighted average remaining maturity on our repurchase agreements and other secured financing was 78 days at December 31, 2021: [[GREPCENT_TABLE]] [["","December 31, 2021"],["","Principal Balance","","Weighted Average Rate","","% of Total"],["","(dollars in thousands)"],["1 day","$","\u2014","","","\u2014","%","","\u2014","%"],["2 to 29 days","27,013,475","","","0.14","%","","48.5","%"],["30 to 59 days","10,212,453","","","0.19","%","","18.3","%"],["60 to 89 days","6,377,347","","","0.17","%","","11.5","%"],["90 to 119 days","4,824,918","","","0.15","%","","8.7","%"],["Over 120 days (1)","7,244,705","","","0.59","%","","13.0","%"],["Total","$","55,672,898","","","0.21","%","","100.0","%"],["(1) Approximately 2% of the total repurchase agreements and other secured financing had a remaining maturity over 1 year."]] [[/GREPCENT_TABLE]] The table below presents our outstanding debt balances and associated weighted average rates and days to maturity at December 31, 2021: [[GREPCENT_TABLE]] [["","","","Weighted Average Rate"],["","Principal Balance","","As of Period End","","For the Quarter","","Weighted AverageDays to Maturity (1)"],["","(dollars in thousands)"],["Repurchase agreements","$","54,769,643","","","0.17","%","","0.16","%","","52"],["Other secured financing (2)","903,255","","","2.86","%","","3.50","%","","1,644"],["Debt issued by securitization vehicles (3)","5,098,785","","","2.23","%","","2.06","%","","11,474"],["Participations issued (3)","1,022,188","","","3.09","%","","3.17","%","","11,131"],["Total indebtedness","$","61,793,871"],["(1) Determined based on estimated weighted-average lives of the underlying debt instruments.(2) Includes financing under credit facilities.(3) Non-recourse to Annaly."]] [[/GREPCENT_TABLE]] Excess Liquidity 75 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis Our primary source of liquidity is the availability of unencumbered assets which may be provided as collateral to support additional funding needs. We target minimum thresholds of available, unencumbered assets to maintain excess liquidity. The following table illustrates our asset portfolio available to support potential collateral obligations and funding needs. Assets are considered encumbered if pledged as collateral against an existing liability, and therefore are no longer available to support additional funding. An asset is considered unencumbered if it has not been pledged or securitized. The following table also provides the carrying amount of our encumbered and unencumbered financial assets at December 31, 2021: [[GREPCENT_TABLE]] [["","Encumbered Assets","","Unencumbered Assets","","Total"],["Financial assets","(dollars in thousands)"],["Cash and cash equivalents","$","1,222,505","","","$","119,585","","","$","1,342,090"],["Investments, at carrying value (1)"],["Agency mortgage-backed securities (2)","55,933,623","","","5,086,790","","","61,020,413"],["Credit risk transfer securities","134,317","","","801,911","","","936,228"],["Non-agency mortgage-backed securities","778,792","","","884,544","","","1,663,336"],["Commercial mortgage-backed securities","418,588","","","111,917","","","530,505"],["Residential mortgage loans (2)","6,622,577","","","1,145,930","","","7,768,507"],["MSR","\u2014","","","511,080","","","511,080"],["Interests in MSR","\u2014","","","69,316","","","69,316"],["Corporate debt, held for investment","1,463,480","","","505,511","","","1,968,991"],["Other assets (3)","\u2014","","","81,748","","","81,748"],["Total financial assets","$","66,573,882","","","$","9,318,332","","","$","75,892,214"],["(1) The amounts reflected in the table above are on a settlement date basis and may differ from the total positions reported on the Consolidated Statements of Financial Condition.(2) Includes assets transferred or pledged to securitization vehicles.(3) Includes commercial real estate investments held for sale and interests in certain joint ventures."]] [[/GREPCENT_TABLE]] We maintain liquid assets in order to satisfy our current and future obligations in normal and stressed operating environments. These are held as the primary means of liquidity risk mitigation. The composition of our liquid assets is also considered and is subject to certain parameters. The composition is monitored for concentration risk and asset type. We believe the assets we consider liquid can be readily converted into cash, through liquidation or by being used as collateral in financing arrangements (including as additional collateral to support existing financial arrangements). Our balance sheet also generates liquidity on an on-going basis through mortgage principal and interest repayments and net earnings held prior to payment of dividends. The following table presents our liquid assets as a percentage of total assets at December 31, 2021: [[GREPCENT_TABLE]] [["","Carrying Value (1)"],["Liquid assets","(dollars in thousands)"],["Cash and cash equivalents","$","1,342,090"],["Residential Securities (2) (3)","63,029,932"],["Commercial mortgage-backed securities","530,505"],["Residential mortgage loans (4)","2,272,072"],["Corporate debt, held for investment (5)","1,615,502"],["Total liquid assets","$","68,790,101"],["Percentage of liquid assets to carrying amount of encumbered and unencumbered financial assets (6)","98.60","%"],["(1) Carrying value approximates the market value of assets. The assets listed in this table include $60.4 billion of assets that have been pledged as collateral against existing liabilities at December 31, 2021. 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 $5.5 billion.(5) Excludes unpledged second lien loans.(6) Denominator is computed based on the carrying amount of encumbered and unencumbered financial assets, excluding assets transferred or pledged to securitization vehicles and certain assets of disposal group held for sale of $6.1 billion."]] [[/GREPCENT_TABLE]] 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 76 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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. The interest rate sensitivity of our assets and liabilities, excluding assets and liabilities of the disposal group held for sale and corporate loans held for sale, in the following table at December 31, 2021 could vary substantially based on actual prepayment experience. 77 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis [[GREPCENT_TABLE]] [["","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","$","1,342,090","","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","1,342,090"],["Agency mortgage-backed securities (principal)","\u2014","","","2,823","","","1,030,724","","","55,035,649","","","56,069,196"],["Residential credit risk transfer securities (principal)","90","","","124,917","","","360,843","","","434,127","","","919,977"],["Non-agency mortgage-backed securities (principal)","5,994","","","117,376","","","962,774","","","601,516","","","1,687,660"],["Commercial mortgage-backed securities (principal)","\u2014","","","\u2014","","","\u2014","","","533,071","","","533,071"],["Total securities","6,084","","","245,116","","","2,354,341","","","56,604,363","","","59,209,904"],["Residential mortgage loans (principal)","\u2014","","","\u2014","","","\u2014","","","2,212,587","","","2,212,587"],["Corporate debt (principal)","\u2014","","","\u2014","","","264,786","","","1,755,389","","","2,020,175"],["Total loans","\u2014","","","\u2014","","","264,786","","","3,967,976","","","4,232,762"],["Assets transferred or pledged to securitization vehicles (principal)","\u2014","","","\u2014","","","\u2014","","","5,850,474","","","5,850,474"],["Total financial assets - maturity","1,348,174","","","245,116","","","2,619,127","","","66,422,813","","","70,635,230"],["Effect of utilizing reset dates (1)","9,373,018","","","1,025,464","","","(491,834)","","","(9,906,648)"],["Total financial assets - interest rate sensitive","$","10,721,192","","","$","1,270,580","","","$","2,127,293","","","$","56,516,165","","","$","70,635,230"],["Financial liabilities"],["Repurchase agreements","$","43,603,275","","","$","11,166,368","","","$","\u2014","","","$","\u2014","","","$","54,769,643"],["Other secured financing","\u2014","","","\u2014","","","\u2014","","","903,255","","","903,255"],["Debt issued by securitization vehicles (principal)","\u2014","","","\u2014","","","\u2014","","","5,098,785","","","5,098,785"],["Participations issued (principal)","\u2014","","","\u2014","","","\u2014","","","1,022,188","","","1,022,188"],["Total financial liabilities - maturity","43,603,275","","","11,166,368","","","\u2014","","","7,024,228","","","61,793,871"],["Effect of utilizing reset dates (1)(2)","(42,574,242)","","","11,389,751","","","20,429,336","","","10,755,155"],["Total financial liabilities - interest rate sensitive","$","1,029,033","","","$","22,556,119","","","$","20,429,336","","","$","17,779,383","","","$","61,793,871"],["Maturity gap","$","(42,255,101)","","","$","(10,921,252)","","","$","2,619,127","","","$","59,398,585","","","$","8,841,359"],["Cumulative maturity gap","$","(42,255,101)","","","$","(53,176,353)","","","$","(50,557,226)","","","$","8,841,359"],["Interest rate sensitivity gap","$","9,692,159","","","$","(21,285,539)","","","$","(18,302,043)","","","$","38,736,782","","","$","8,841,359"],["Cumulative rate sensitivity gap","$","9,692,159","","","$","(11,593,380)","","","$","(29,895,423)","","","$","8,841,359"],["(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."]] [[/GREPCENT_TABLE]] 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. 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 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. 78 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. 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 assets 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 December 31, 2021. Actual results could differ materially from these estimates. [[GREPCENT_TABLE]] [["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","(37.8%)","","(0.5%)","","(2.6%)"],["-50 Basis points","(23.4%)","","(0.2)%","","(1.0)%"],["-25 Basis points","(10.7%)","","\u2014%","","(0.1)%"],["+25 Basis points","6.9%","","(0.2%)","","(0.9%)"],["+50 Basis points","12.5%","","(0.4%)","","(2.5%)"],["+75 Basis points","17.4%","","(0.9%)","","(5.0%)"],["MBS Spread Shock (1)","Estimated Change in Portfolio Market Value","","Estimated Change as a %on NAV (3)(4)"],["-25 Basis points","1.7%","","9.6%"],["-15 Basis points","1.0%","","5.7%"],["-5 Basis points","0.3%","","1.9%"],["+5 Basis points","(0.3%)","","(1.9%)"],["+15 Basis points","(1.0%)","","(5.6%)"],["+25 Basis points","(1.6%)","","(9.4%)"],["(1) Interest rate and MBS spread sensitivity are based on results from third party models in conjunction with inputs from our internal investment professionals. Actual results could differ materially from these estimates.(2) Scenarios include Residential 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, MSR and derivative instruments.(4) NAV represents book value of equity."]] [[/GREPCENT_TABLE]] 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 79 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis residential mortgage loans, commercial real estate investments and corporate debt. MSR values may also be impacted through reduced servicing fees and higher costs to service the underlying mortgage loans due to borrower performance. Generally, 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. In the case of residential mortgage loans and MSR, we may engage a third party to perform due diligence on a sample of loans that we believe sufficiently represents the entire pool. Once an 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 December 31, 2021 and 2020 was as follows: [[GREPCENT_TABLE]] [["","December 31, 2021","","December 31, 2020"],["Category"],["Agency mortgage-backed securities (1)","81.9","%","","86.4","%"],["Credit risk transfer securities","1.3","%","","0.6","%"],["Non-agency mortgage-backed securities","2.2","%","","1.1","%"],["Residential mortgage loans (1)","10.4","%","","4.2","%"],["Mortgage servicing rights","0.7","%","","0.1","%"],["Interests in MSR","0.1","%","","\u2014","%"],["Commercial real estate (1) (2)","0.7","%","","5.0","%"],["Corporate debt (3)","2.7","%","","2.6","%"],["(1) Includes assets transferred or pledged to securitization vehicles.(2) Net of unamortized origination fees. Excludes commercial real estate assets held for sale as of December 31, 2021."]] [[/GREPCENT_TABLE]] 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 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. 80 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis The following table summarizes our exposure to counterparties by geography at December 31, 2021: [[GREPCENT_TABLE]] [["","Number of Counterparties","","Secured Financing (1)","","Interest Rate Swaps at Fair Value","","Exposure (2)"],["Geography","(dollars in thousands)"],["North America","22","","","$","46,773,062","","","$","(264,342)","","","$","2,297,203"],["Europe","10","","","6,561,854","","","(482,694)","","","1,646,618"],["Japan","3","","","2,337,982","","","\u2014","","","114,423"],["Total","35","","","$","55,672,898","","","$","(747,036)","","","$","4,058,244"],["(1) Includes repurchase agreements and other secured financing.(2) Represents the amount of cash and/or securities pledged as collateral to each counterparty less the aggregate of repurchase agreement and other secured financing and derivatives for each counterparty."]] [[/GREPCENT_TABLE]] 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 relevant Board committees. 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 our current policy will cover all cybersecurity breaches or our related losses, or that we will be able to continue to maintain cybersecurity insurance in the future. We depend on third party service providers to perform various business processes related to our operations, including mortgage loan servicers and sub-servicers. Our vendor management policy establishes procedures for engaging, onboarding and monitoring the performance of third party vendors. These procedures include assessing a vendor’s financial health as well as oversight of its compliance with applicable laws and regulations, cybersecurity and business continuity programs and security of personally identifiable information. 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 and our subsidiary that operates as a licensed mortgage aggregator and master servicer. The financial services industry is highly regulated and receives significant attention from regulators, which may impact both our company and our business strategy. Our investments in residential whole loans and MSR require us to comply with applicable state and federal laws and regulations and maintain appropriate governmental licenses, approvals and exemptions. 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 81 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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. 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 Estimates The preparation of our consolidated financial statement in accordance with generally accepted accounting principles in the United States requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results may differ materially from these estimates and changes in assumptions could have a significant effect on the consolidated financial statements. 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 the Note titled “Significant Accounting Policies” in the Notes to the Consolidated Financial Statements included in Item 15. “Exhibits, Financial Statement Schedules.” Valuation of Financial Instruments Residential Securities Description: The Company carries its residential securities at estimated fair value. There is an active market for our Agency mortgage-backed securities, CRT securities and non-Agency mortgage-backed securities. Judgments and Uncertainties: Since we primarily invest in securities that can be valued using 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. Sensitivity of Estimates to Change: Changes in underlying assumptions used in estimating fair value impact the carrying value of the residential securities as well as their yield. For example, an increase in CPR would decrease the carrying value and yield of our Agency mortgage-backed securities. Our valuations are most sensitive to changes in interest rate, which also impacts prepayment speeds. See Experienced and Projected Long-Term CPR, Financial Condition – Residential Securities and the interest rate sensitivity and interest rate and MBS spread shock analysis and discussions within this Item 7. for further information. 82 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis Residential Mortgage Loans Description: The Company has elected to account for its Residential Mortgage Loans at fair value. There is an active market for the residential whole loans in which we invest. Judgments and Uncertainties: 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. Sensitivity of Estimates to Change: Changes to model assumptions, including prepayment speeds may significantly impact the fair value estimate of residential mortgage loans as well as unrealized gains and losses and yield on these assets. Our valuations are most sensitive to changes in interest rate, which also impacts prepayment speeds. See the interest rate sensitivity and interest rate shock analysis and discussions within this Item 7. for further information. MSR Description: The Company has elected to account for its MSR at fair value. The market for mortgage servicing rights is considered less active and transparent compared to securities. As such fair value estimates for our investment in MSR are obtained from models, which use significant unobservable inputs in their valuations. Judgments and Uncertainties: 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 MSR requires significant judgment by management and the third party pricing providers. Sensitivity of Estimates to Change: Changes in the underlying assumptions used to estimate the fair value of MSR impact the carrying value as well as the related unrealized gains and losses recognized. For further discussion of the sensitivity of the model inputs see the Note titled “Fair Value Measurements” in the Notes to the Consolidated Financial Statements included in Item 15. “Exhibits, Financial Statement Schedules.” Interest Rate Swaps Description: The Company is required to account for its derivative assets and liabilities at fair value, which may or may not be cleared through a derivative clearing organization. We value our cleared interest rate swaps using the prices provided by the derivatives clearing organization. Judgments and Uncertainties: 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. Sensitivity of Estimates to Change: Changes in the OIS curve will impact the carrying value of our interest rate swap assets and liabilities. Our valuations are most sensitive to changes in interest rate, which also impacts prepayment speeds. See the interest rate sensitivity and interest rate shock analysis and discussions within this Item 7. for further information. Revenue Recognition Description: 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. Gains or losses on sales of Residential Securities are recorded on trade date based on the specific identification method. 83 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis Judgments and Uncertainties: 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. Sensitivity of Estimates to Change: 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. The sensitivity of changes in interest rates to our economic net interest income is included in the interest rate shock analysis and discussions within this Item 7. Consolidation of Variable Interest Entities Description: The Company is required to determine if it is required to consolidate entities in which it holds a variable interest. Judgments and Uncertainties: 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. 84 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. 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. 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. C Capital Buffer Includes unencumbered financial assets which can be either sold or utilized as collateral to meet liquidity needs. Capital Ratio (GAAP Capital Ratio) Calculated as total stockholders’ equity divided by total assets.  85 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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. Corporate Debt Non-government debt instruments issued by corporations. Long-term corporate debt can be issued as bonds or loans. Counterparty One of two entities in a transaction. For example, in the bond market a counterparty can be a state or local government, a broker-dealer or a corporation. Coupon The interest rate on a bond that is used to compute the amount of interest due on a periodic basis. Credit and Counterparty Risk Risk to earnings, capital or business, resulting from an obligor’s or counterparty’s failure to meet the terms of any contract or otherwise failure to perform as agreed. Credit and counterparty risk is present in lending, investing, funding and hedging activities. Credit Derivatives Derivative instruments that have one or more underlyings related to the credit risk of a specified entity (or group of entities) or an index that exposes the seller to potential loss from specified credit-risk related events. An example is credit derivatives referencing the commercial mortgage-backed securities index. 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. 86 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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 Earnings available for distribution (“EAD”) and Earnings available for distribution Per Average Common Share Earnings available for distribution is defined as the sum of (a) economic net interest income, (b) TBA dollar roll income and CMBX coupon income, (c) realized amortization of MSR, (d) other income (loss) (excluding depreciation expense related to commercial real estate and amortization of intangibles, non-EAD income allocated to equity method investments and other non-EAD 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-EAD 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. Earnings available for distribution per average common share is calculated by dividing earnings available for distribution by average basic common shares for the period. This metric was previously labeled Core Earnings (excluding PAA) and Core Earnings (excluding PAA) Per Average Common Share). The definition of EAD is identical to the definition of Core Earnings (excluding PAA) from prior reporting periods. 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 Capital Ratio Non-GAAP financial measure that is calculated as total stockholders’ equity divided by total economic assets. Total economic assets includes the implied market value of TBA derivatives and are net of debt issued by securitization vehicles. 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) Non-GAAP financial measure that is 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). Certain credit facilities (included within other secured financing), debt issued by securitization vehicles, participations issued, 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. Economic Return Refers to the Company’s change in book value plus dividends declared divided by the prior period’s book value. 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. 87 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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. 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 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. 88 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis Interest Rate Risk The risk that an investment’s value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship. As market interest rates rise, the value of current fixed income investment holdings declines. Diversifying, deleveraging and hedging techniques are utilized to mitigate this risk. Interest rate risk is a form of market risk. Interest Rate Swap A binding agreement between counterparties to exchange periodic interest payments on some predetermined dollar principal, which is called the notional principal amount. For example, one party will pay fixed and receive a variable rate. Interest Rate Swaption Options on interest rate swaps. The buyer of a swaption has the right to enter into an interest rate swap agreement at some specified date in the future. The swaption agreement will specify whether the buyer of the swaption will be a fixed-rate receiver or a fixed-rate payer. 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 (GAAP Leverage Ratio or 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, participations issued and mortgages payable. Certain credit facilities (included within other secured financing), debt issued by securitization vehicles, participations issued 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.The United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that all LIBOR tenors relevant to us will cease to be published or will no longer be representative after June 30, 2023. 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 89 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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 (“MSR”) Contractual agreements constituting the right to service an existing mortgage where the holder receives the benefits and bears the costs and risks of servicing the mortgage. N NAV Net asset value. Net 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. 90 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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. 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. Primary Market Market for offers or sales of new bonds by the issuer. 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). Certain credit facilities (included within other secured financing), debt issued by securitization vehicles, participations issued 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. 91 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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. T Target Assets Includes Agency mortgage-backed securities, to-be-announced forward contracts, CRT securities, MSR, non-Agency mortgage-backed securities, residential mortgage loans, commercial real estate investments, and corporate debt. Tangible Economic Return Refers to the Company’s change in tangible book value (calculated by summing common stock, additional paid-in capital, accumulated other comprehensive income (loss) and accumulated deficit less intangible assets) plus dividends declared divided by the prior period’s tangible book value. 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. 92 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES Item 7. Management’s Discussion and Analysis 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. 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. 93 ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES