ANNALY CAPITAL MANAGEMENT, INC. REPORTS 4th QUARTER 2016 RESULTS

·	GAAP net income of $1.8 billion, $1.79 per average common share

·	Transition to revised core earnings metrics to conform with regulatory guidance on non-GAAP measures

·	Core earnings (unrevised - excluding premium amortization adjustment (“PAA”)) of $327.0 million, $0.30 per average common share

·	Core earnings (revised - including PAA) of $565.9 million, $0.53 per average common share

·	Common stock book value per share of $11.16

NEW YORK--(BUSINESS WIRE)—February 15, 2017 -- Annaly Capital Management, Inc. (NYSE: NLY) (the “Company” or “Annaly”) today announced its financial results for the quarter and year ended December 31, 2016.

“The fourth quarter of 2016 was yet another period of historically high market volatility with interest rate levels rising meaningfully and credit spreads contracting significantly,” commented Kevin Keyes, Chief Executive Officer and President. “Once again, amidst this uncertainty, Annaly delivered stable core earnings and dividends producing an attractive return on equity for our shareholders. In addition, the effectiveness of our diversification and hedging strategies contributed to our book value for the quarter outperforming expected changes despite the pronounced sell-off in the fixed income markets.

“2016 was also a year of notable milestones for Annaly in which we continued to expand our four complementary business platforms into 25 investment options, completed the largest mortgage REIT acquisition in history and delivered a $0.30 per share dividend for the 13th consecutive quarter.

“Entering 2017, we are prepared for even more volatility and uncertainty.  Importantly, considering the wide range of potential outcomes in the global macro-economies and marketplaces, we are confident our diversified model is uniquely positioned to take advantage of multiple investment opportunities.”

 

To supplement its consolidated financial statements, which are prepared and presented in accordance with U.S. generally accepted accounting principles (GAAP), the Company provides non-GAAP financial measures to enhance investor understanding of the Company’s period-over-period operating performance and business trends, as well as for assessing the Company’s performance versus that of industry peers. Historically, the Company has defined “core earnings”, a non-GAAP measure, as net income (loss) excluding gains or losses on disposals of investments and termination of interest rate swaps, unrealized gains or losses on interest rate swaps and investments measured at fair value through earnings, net gains and losses on trading assets, impairment losses, net income (loss) attributable to noncontrolling interest, the premium amortization adjustment resulting from the quarter-over-quarter change in estimated long-term CPR (“PAA”), corporate acquisition related expenses and certain other non-recurring gains or losses, and inclusive of dollar roll income (a component of Net gains (losses) on trading assets) and realized amortization of mortgage servicing rights (“MSR”) (a component of net unrealized gains (losses) on investments measured at fair value through earnings).

Based upon recent regulatory guidance and interpretations on the use of non-GAAP financial measures, beginning with the fourth quarter 2016, the Company will report core earnings metrics (revised) that include the PAA. In addition, this is the final quarter that the Company will report core earnings metrics (unrevised) that exclude the PAA. In future periods, the Company will not make an adjustment to GAAP net income (loss) to exclude the PAA. However, given its usefulness in evaluating the Company’s financial performance, the Company will continue to separately disclose the PAA. Additionally, comparative prior period results reported in future periods will conform to the revised presentation.

The Company believes its non-GAAP financial measures are useful for management, investors, analysts, and other interested parties in evaluating the Company’s performance but should not be viewed in isolation and are not a substitute for financial measurements computed in accordance with GAAP. Please refer to the “Non-GAAP Financial Measures” section for additional information.

 

 

The following table summarizes certain key performance indicators as of and for the quarters ended December 31, 2016, September 30, 2016, and December 31, 2015:

 

		December 31, 2016				September 30, 2016				December 31, 2015
Book value per common share		$	11.16			$	11.83			$	11.73
Economic leverage at period-end (1)		6.4:1				6.1:1				6.0:1
GAAP net income (loss) per average common share		$	1.79			$	0.70			$	0.69
Core earnings per average common share (unrevised - excluding PAA)* (2)		$	0.30			$	0.29			$	0.31
Less: PAA cost (benefit) per average common share			(0.23	)			-				(0.02	)
Core earnings per average common share (revised - including PAA)* (2)		$	0.53			$	0.29			$	0.33
Annualized return (loss) on average equity			57.23	%			23.55	%			22.15	%
Annualized core return on average equity (unrevised - excluding PAA)*			10.13	%			10.09	%			10.30	%
Annualized core return on average equity (revised - including PAA)*			17.53	%			10.09	%			10.89	%
Net interest margin (3)			2.49	%			1.40	%			1.80	%
Core net interest margin (excluding PAA)*			1.53	%			1.42	%			1.71	%
Net interest spread			2.28	%			1.13	%			1.47	%
Core net interest spread (excluding PAA)*			1.15	%			1.15	%			1.37	%
Average yield on interest earning assets			3.81	%			2.70	%			3.15	%
Core average yield on interest earning assets (excluding PAA)*			2.68	%			2.72	%			3.05	%

 

Among the financial highlights for the fourth quarter 2016 are the following:

-	GAAP net income of $1.8 billion, or $1.79 per average common share

-	Core earnings* (unrevised – excluding PAA) of $327.0 million, or $0.30 per average common share

-	Core earnings* (revised – including PAA) of $565.9 million, or $0.53 per average common share (inclusive of PAA benefit of $238.9 million, or $0.23 per average common share)

-	GAAP return on average equity of 57.23%, core return on average equity* (unrevised – excluding PAA) of 10.13%, core return on average equity* (revised – including PAA) of 17.53% (PAA related benefit of 7.40%)

-	Common dividend declared for the quarter ended December 31, 2016 of $0.30 per common share. The annualized dividend yield on the Company’s common stock for the quarter ended December 31, 2016, based on the December 31, 2016 closing price of $9.97, was 12.04%

Among the business highlights for the year ended December 31, 2016 are the following:

-	Completed the largest mREIT acquisition in history with purchase of Hatteras Financial Corp.

-	Continued diversification strategy with expansion of investment options and targeted growth in select credit assets

-	Advanced funding strategy with dedicated financing facilities for credit businesses while also capitalizing on FHLB term funding

-	Further aligned management and shareholder interests by initiating employee stock ownership program

* Represents a non-GAAP financial measure. Please refer to the ‘Non-GAAP Financial Measures’ section for additional information.

Amortization

In accordance with GAAP, the Company amortizes or accretes premiums or discounts into interest income for its Agency mortgage-backed securities, excluding interest-only securities, considering estimates of future principal prepayment in the calculation of the effective yield because they are probable and the timing and amount of prepayments can be reasonably estimated. The Company recalculates 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 investment 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.

 

 

The Company’s GAAP metrics include the unadjusted impact of amortization and accretion associated with this method. The Company’s non-GAAP measures previously excluded the effect of the PAA, however, beginning with the fourth quarter 2016, the Company revised its definition of core earnings such that no adjustment will be made to exclude the PAA. In addition, this is the final quarter that the Company will report core earnings metrics (unrevised) that exclude the PAA. However, given its usefulness in evaluating the Company’s financial performance, the Company will continue to separately disclose the PAA.

The following table illustrates the impact of quarter-over-quarter changes to long-term CPR estimates on premium amortization expense for the Company’s Residential Investment Securities portfolio for the quarters ended December 31, 2016, September 30, 2016, and December 31, 2015:

 

		For the quarters ended
		December 31, 2016			September 30, 2016				December 31, 2015
		(dollars in thousands)
Premium amortization expense		$	(19,812	)		$	213,241			$	159,720
Less: PAA cost (benefit)			(238,941	)			3,891				(18,072	)
Premium amortization expense exclusive of PAA		$	219,129			$	209,350			$	177,792
		For the quarters ended
		December 31, 2016			September 30, 2016				December 31, 2015
		(per average common share)
Premium amortization expense		$	(0.02	)		$	0.21			$	0.17
Less: PAA cost (benefit)			(0.23	)			-	(1)			(0.02	)
Premium amortization expense exclusive of PAA		$	0.21			$	0.21			$	0.19

 

This news release and our public documents to which we refer 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, 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 financings; changes in the market value of our assets; changes in business conditions and the general economy; our ability to grow our commercial business; our ability to grow our residential mortgage credit business; credit risks related to our investments in credit risk transfer securities, residential mortgage-backed securities and related residential mortgage credit assets, commercial real estate assets and corporate debt; risks related to investments in mortgage servicing rights and ownership of a servicer; our ability to consummate any contemplated investment opportunities; changes in government regulations affecting our business; our ability to maintain our qualification as a REIT; and our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended. For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in our most recent Annual Report on Form 10-K and any subsequent Quarterly Reports on Form 10-Q. We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements, except as required by law.

Annaly’s principal business objectives are to generate net income for distribution to its shareholders from its investments and capital preservation. Annaly is a Maryland corporation that has elected to be taxed as a real estate investment trust (“REIT”). Annaly is managed and advised by Annaly Management Company LLC.

The Company prepares a supplemental investor presentation and a financial summary for the benefit of its shareholders. Both the Fourth Quarter 2016 Investor Presentation and the Fourth Quarter 2016 Financial Summary can be found at the Company’s website (www.annaly.com) in the Investors section under Investor Presentations.

The Company will hold the fourth quarter 2016 earnings conference call on February 16, 2017 at 10:00 a.m. Eastern Time. The number to call is 888-317-6003 for domestic calls and 412-317-6061 for international calls. The conference passcode is 8442755. There will also be an audio webcast of the call on www.annaly.com. The replay of the call is available for one week following the conference call. The replay number is 877-344-7529 for domestic calls and 412-317-0088 for international calls and the conference passcode is 10100346. If you would like to be added to the e-mail distribution list, please visit www.annaly.com, click on Investors, then select Email Alerts and complete the email notification form.

 

 

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share data)
	December 31,				September 30,				June 30,				March 31,				December 31,
	2016				2016				2016				2016				2015(1)
	(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
ASSETS
Cash and cash equivalents	$	1,539,746			$	2,382,188			$	2,735,250			$	2,416,136			$	1,769,258
Investments, at fair value:
Agency mortgage-backed securities		75,589,873				73,476,105				64,862,992				65,439,824				65,718,224
Agency debentures		-				-				-				157,035				152,038
Credit risk transfer securities		724,722				669,295				520,321				501,167				456,510
Non-Agency mortgage-backed securities		1,401,307				1,460,261				1,197,549				1,157,507				906,722
Residential mortgage loans (2)		342,289				310,148				-				-				-
Mortgage servicing rights		652,216				492,169				-				-				-
Commercial real estate debt investments (3)		4,321,739				4,319,077				4,361,972				4,401,725				2,911,828
Commercial real estate debt and preferred equity, held for investment (4)		970,505				1,070,197				1,137,971				1,177,468				1,348,817
Commercial loans held for sale, net		114,425				144,275				164,175				278,600				278,600
Investments in commercial real estate		474,567				500,027				504,605				527,786				535,946
Corporate debt		773,274				716,831				669,612				639,481				488,508
Interest rate swaps, at fair value		68,194				113,253				146,285				93,312				19,642
Other derivatives, at fair value		171,266				87,921				137,490				77,449				22,066
Receivable for investments sold		51,461				493,839				697,943				2,220				121,625
Accrued interest and dividends receivable		270,400				260,583				227,225				232,180				231,336
Other assets		333,063				301,419				237,959				234,407				119,422
Goodwill		71,815				71,815				71,815				71,815				71,815
Intangible assets, net		34,184				39,903				43,306				35,853				38,536
Total assets	$	87,905,046			$	86,909,306			$	77,716,470			$	77,443,965			$	75,190,893
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Repurchase agreements	$	65,215,810			$	61,784,121			$	53,868,385			$	54,448,141			$	56,230,860
Other secured financing		3,884,708				3,804,742				3,588,326				3,588,326				1,845,048
Securitized debt of consolidated VIEs (5)		3,655,802				3,712,821				3,748,289				3,802,682				2,540,711
Participation sold		12,869				12,976				13,079				13,182				13,286
Mortgages payable		311,636				327,632				327,643				334,765				334,707
Interest rate swaps, at fair value		1,443,765				2,919,492				3,208,986				2,782,961				1,677,571
Other derivatives, at fair value		86,437				73,445				154,017				69,171				49,963
Dividends payable		305,674				269,111				277,479				277,456				280,779
Payable for investments purchased		65,041				454,237				746,090				250,612				107,115
Accrued interest payable		163,013				173,320				159,435				163,983				151,843
Accounts payable and other liabilities		184,319				115,606				62,868				54,679				53,088
Total liabilities		75,329,074				73,647,503				66,154,597				65,785,958				63,284,971
Stockholders’ Equity:
7.875% Series A Cumulative Redeemable Preferred Stock: 7,412,500 authorized, issued and outstanding		177,088				177,088				177,088				177,088				177,088
7.625% Series C Cumulative Redeemable Preferred Stock 12,650,000 authorized, 12,000,000 issued and outstanding		290,514				290,514				290,514				290,514				290,514
7.50% Series D Cumulative Redeemable Preferred Stock: 18,400,000 authorized, issued and outstanding		445,457				445,457				445,457				445,457				445,457
7.625% Series E Cumulative Redeemable Preferred Stock: 11,500,000 authorized, issued and outstanding		287,500				287,500				-				-				-
Common stock, par value $0.01 per share, 1,945,437,500, 1,945,437,500, 1,956,937,500, 1,956,937,500 and 1,956,937,500 authorized, 1,018,913,249, 1,018,857,866, 924,929,607, 924,853,133 and 935,929,561 issued and outstanding, respectively		10,189				10,189				9,249				9,249				9,359
Additional paid-in capital		15,579,342				15,578,677				14,575,426				14,573,760				14,675,768
Accumulated other comprehensive income (loss)		(1,085,893	)			1,119,677				1,117,046				640,366				(377,596	)
Accumulated deficit		(3,136,017	)			(4,655,440	)			(5,061,565	)			(4,487,982	)			(3,324,616	)
Total stockholders’ equity		12,568,180				13,253,662				11,553,215				11,648,452				11,895,974
Noncontrolling interest		7,792				8,141				8,658				9,555				9,948
Total equity		12,575,972				13,261,803				11,561,873				11,658,007				11,905,922
Total liabilities and equity	$	87,905,046			$	86,909,306			$	77,716,470			$	77,443,965			$	75,190,893

 

 

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(dollars in thousands, except per share data)
	For the quarters ended
	December 31,				September 30,				June 30,				March 31,				December 31,
	2016				2016				2016				2016				2015
Net interest income:
Interest income	$	807,022			$	558,668			$	457,118			$	388,143			$	576,580
Interest expense		183,396				174,154				152,755				147,447				118,807
Net interest income		623,626				384,514				304,363				240,696				457,773
Realized and unrealized gains (losses):
Realized gains (losses) on interest rate swaps(1)		(103,872	)			(124,572	)			(130,762	)			(147,475	)			(159,487	)
Realized gains (losses) on termination of interest rate swaps		(55,214	)			1,337				(60,064	)			-				-
Unrealized gains (losses) on interest rate swaps		1,430,668				256,462				(373,220	)			(1,031,720	)			463,126
Subtotal		1,271,582				133,227				(564,046	)			(1,179,195	)			303,639
Net gains (losses) on disposal of investments		7,782				14,447				12,535				(1,675	)			(7,259	)
Net gains (losses) on trading assets		(139,470	)			162,981				81,880				125,189				42,584
Net unrealized gains (losses) on investments measured at fair value through earnings		110,742				29,675				(54,154	)			128				(62,703	)
Bargain purchase gain		-				72,576				-				-				-
Subtotal		(20,946	)			279,679				40,261				123,642				(27,378	)
Total realized and unrealized gains (losses)		1,250,636				412,906				(523,785	)			(1,055,553	)			276,261
Other income (loss)		30,918				29,271				(9,930	)			(6,115	)			(10,447	)
General and administrative expenses:
Compensation and management fee		39,845				38,709				36,048				36,997				37,193
Other general and administrative expenses		15,608				59,028				13,173				10,948				10,643
Total general and administrative expenses		55,453				97,737				49,221				47,945				47,836
Income (loss) before income taxes		1,849,727				728,954				(278,573	)			(868,917	)			675,751
Income taxes		1,244				(1,926	)			(76	)			(837	)			6,085
Net income (loss)		1,848,483				730,880				(278,497	)			(868,080	)			669,666
Net income (loss) attributable to noncontrolling interest		(87	)			(336	)			(385	)			(162	)			(373	)
Net income (loss) attributable to Annaly		1,848,570				731,216				(278,112	)			(867,918	)			670,039
Dividends on preferred stock		23,473				22,803				17,992				17,992				17,992
Net income (loss) available (related) to common stockholders	$	1,825,097			$	708,413			$	(296,104	)		$	(885,910	)		$	652,047
Net income (loss) per share available (related) to common stockholders:
Basic	$	1.79			$	0.70			$	(0.32	)		$	(0.96	)		$	0.69
Diluted	$	1.79			$	0.70			$	(0.32	)		$	(0.96	)		$	0.69
Weighted average number of common shares outstanding:
Basic		1,018,886,380				1,007,607,893				924,887,316				926,813,588				945,072,058
Diluted		1,019,251,111				1,007,963,406				924,887,316				926,813,588				945,326,098
Net income (loss)	$	1,848,483			$	730,880			$	(278,497	)		$	(868,080	)		$	669,666
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities		(2,206,288	)			18,237				483,930				1,017,707				(648,106	)
Reclassification adjustment for net (gains) losses included in net income (loss)		718				(15,606	)			(7,250	)			255				7,655
Other comprehensive income (loss)		(2,205,570	)			2,631				476,680				1,017,962				(640,451	)
Comprehensive income (loss)		(357,087	)			733,511				198,183				149,882				29,215
Comprehensive income (loss) attributable to noncontrolling interest		(87	)			(336	)			(385	)			(162	)			(373	)
Comprehensive income (loss) attributable to Annaly	$	(357,000	)		$	733,847			$	198,568			$	150,044			$	29,588

 

 

 

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(dollars in thousands, except per share data)
		For the years ended
		December 31,				December 31,
		2016				2015 (1)
		(Unaudited)
Net interest income:
Interest income		$	2,210,951			$	2,170,697
Interest expense			657,752				471,596
Net interest income			1,553,199				1,699,101
Realized and unrealized gains (losses):
Realized gains (losses) on interest rate swaps(2)			(506,681	)			(624,495	)
Realized gains (losses) on termination of interest rate swaps			(113,941	)			(226,462	)
Unrealized gains (losses) on interest rate swaps			282,190				(124,869	)
Subtotal			(338,432	)			(975,826	)
Net gains (losses) on disposal of investments			33,089				50,987
Net gains (losses) on trading assets			230,580				29,623
Net unrealized gains (losses) on investments measured at fair value through earnings			86,391				(103,169	)
Bargain purchase gain			72,576				-
Impairment of goodwill			-				(22,966	)
Subtotal			422,636				(45,525	)
Total realized and unrealized gains (losses)			84,204				(1,021,351	)
Other income (loss):
Investment advisory income			-				24,848
Dividend income from affiliate			-				8,636
Other income (loss)			44,144				(47,201	)
Total other income (loss)			44,144				(13,717	)
General and administrative expenses:
Compensation and management fee			151,599				150,286
Other general and administrative expenses			98,757				49,954
Total general and administrative expenses			250,356				200,240
Income (loss) before income taxes			1,431,191				463,793
Income taxes			(1,595	)			(1,954	)
Net income (loss)			1,432,786				465,747
Net income (loss) attributable to noncontrolling interest			(970	)			(809	)
Net income (loss) attributable to Annaly			1,433,756				466,556
Dividends on preferred stock			82,260				71,968
Net income (loss) available (related) to common stockholders		$	1,351,496			$	394,588
Net income (loss) per share available (related) to common stockholders:
Basic		$	1.39			$	0.42
Diluted		$	1.39			$	0.42
Weighted average number of common shares outstanding:
Basic			969,787,583				947,062,099
Diluted			970,102,353				947,276,742
Net income (loss)		$	1,432,786			$	465,747
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities			(686,414	)			(531,952	)
Reclassification adjustment for net (gains) losses included in net income (loss)			(21,883	)			(50,527	)
Other comprehensive income (loss)			(708,297	)			(582,479	)
Comprehensive income (loss)			724,489				(116,732	)
Comprehensive income (loss) attributable to noncontrolling interest			(970	)			(809	)
Comprehensive income (loss) attributable to Annaly		$	725,459			$	(115,923	)

 

 

 

The following table presents key metrics of the Company’s portfolio, liabilities and hedging positions, and performance as of and for the quarters ended December 31, 2016, September 30, 2016, and December 31, 2015:

 

	December 31, 2016			September 30, 2016				December 31, 2015
Portfolio Related Metrics:
Fixed-rate Residential Investment Securities as a percentage of total Residential Investment Securities		83	%			81	%			93	%
Adjustable-rate and floating-rate Residential Investment Securities as a percentage of total Residential Investment Securities		17	%			19	%			7	%
Weighted average experienced CPR for the period		15.6	%			15.9	%			9.7	%
Weighted average projected long-term CPR at period end		10.1	%			14.4	%			8.8	%
Liabilities and Hedging Metrics:
Weighted average days to maturity on repurchase agreements outstanding at period-end		96				128				151
Hedge ratio (1)		56	%			52	%			55	%
Weighted average pay rate on interest rate swaps at period-end (2)		2.22	%			2.25	%			2.26	%
Weighted average receive rate on interest rate swaps at period-end (2)		1.02	%			0.88	%			0.53	%
Weighted average net rate on interest rate swaps at period-end (2)		1.20	%			1.37	%			1.73	%
Leverage at period-end (3)	5.8:1			5.3:1				5.1:1
Economic leverage at period-end (4)	6.4:1			6.1:1				6.0:1
Capital ratio at period-end		13.1	%			13.3	%			13.7	%
Performance Related Metrics:
Book value per common share	$	11.16			$	11.83			$	11.73
GAAP net income (loss) per common share	$	1.79			$	0.70			$	0.69
Core earnings per common share (unrevised - excluding PAA)*	$	0.30			$	0.29			$	0.31
Less: PAA cost (benefit)		(0.23	)			-				(0.02	)
Core earnings per common share (revised - including PAA)*	$	0.53			$	0.29			$	0.33
Annualized return (loss) on average equity		57.23	%			23.55	%			22.15	%
Annualized core return on average equity (unrevised - excluding PAA)*		10.13	%			10.09	%			10.30	%
Annualized core return on average equity (revised - including PAA)*		17.53	%			10.09	%			10.89	%
Net interest margin		2.49	%			1.40	%			1.80	%
Core net interest margin (excluding PAA)*		1.53	%			1.42	%			1.71	%
Average yield on interest earning assets (5)		3.81	%			2.70	%			3.15	%
Core average yield on interest earning assets (excluding PAA)* (6)		2.68	%			2.72	%			3.05	%
Average cost of interest bearing liabilities (6)		1.53	%			1.57	%			1.68	%
Net interest spread		2.28	%			1.13	%			1.47	%
Core net interest spread (excluding PAA)*		1.15	%			1.15	%			1.37	%

 

 

Based upon recent regulatory guidance and interpretations on the use of non-GAAP financial measures, beginning with the fourth quarter 2016, the Company will report core earnings metrics (revised) that include the PAA. In addition, this is the final quarter that the Company will report core earnings metrics (unrevised) that exclude the PAA. In future periods, the Company will not make an adjustment to GAAP net income (loss) to exclude the PAA. However, given its usefulness in evaluating the Company’s financial performance, the Company will continue to separately disclose the PAA. Additionally, comparative prior period results reported in future periods will conform to the revised presentation.

To supplement its consolidated financial statements, which are prepared and presented in accordance with U.S. generally accepted accounting principles (“GAAP”), the Company provides the following non-GAAP financial measures. These measures should not be considered a substitute for, or superior to, financial measures computed in accordance with GAAP.

·	core earnings;

·	core earnings per average common share;

·	annualized core return on average equity;

·	core interest income (excluding PAA);

·	economic interest expense;

·	economic core net interest income (excluding PAA);

·	core average yield on interest earning assets (excluding PAA);

·	core net interest margin (excluding PAA); and

·	core net interest spread (excluding PAA).

These non-GAAP measures provide additional detail to enhance investor understanding of the Company’s period-over-period operating performance and business trends, as well as for assessing the Company’s performance versus that of industry peers. Additional information pertaining to the Company’s use of these non-GAAP financial measures, including discussion of how each such measure is useful to investors, and reconciliations to their most directly comparable GAAP results are provided below.

Core earnings, core earnings per average common share and annualized core return on average equity

One of the Company’s principal business objectives is to generate net income by earning a net interest spread on its investment portfolio, which is a function of the Company’s interest income from its investment portfolio less financing, hedging and operating costs. Core earnings, which is comprised of interest income plus TBA dollar roll incomeⁱ, less financing and hedging costsⁱⁱ and general and administrative expenses, is used by management to measure its progress in achieving this objective.

Historically, the Company has defined “core earnings”, a non-GAAP measure, as net income (loss) excluding gains or losses on disposals of investments and termination of interest rate swaps, unrealized gains or losses on interest rate swaps and investments measured at fair value through earnings, net gains and losses on trading assets, impairment losses, net income (loss) attributable to noncontrolling interest, the premium amortization adjustment resulting from the quarter-over-quarter change in estimated long-term CPR (“PAA”), corporate acquisition related expenses and certain other non-recurring gains or losses, and inclusive of dollar roll income (a component of Net gains (losses) on trading assets) and realized amortization of mortgage servicing rights (“MSR”) (a component of net unrealized gains (losses) on investments measured at fair value through earnings).

Beginning with the fourth quarter 2016, the Company will report core earnings metrics (revised) that include the PAA. In addition, this is the final quarter that the Company will report core earnings metrics (unrevised) that exclude the PAA. In future periods, the Company will not make an adjustment to GAAP net income (loss) to exclude the PAA.

The Company believes these measures provide management and investors with additional details regarding the Company’s 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 the Company’s portfolio. Annualized core return on average equity, which is calculated by dividing core earnings over average stockholders’ equity, provides investors with additional detail on the core earnings generated by the Company’s invested equity capital.

ⁱ TBA dollar roll transactions are accounted for as derivatives, with gains and losses reflected as a component of Net gains (losses) on trading assets in the Company’s Consolidated Statements of Comprehensive Income (Loss). TBA dollar roll income represents the economic equivalent of interest income on the underlying security less the implied cost of financing.

ⁱⁱ The interest component of hedging costs are reported as realized gains (losses) on interest rate swaps in the Company’s Consolidated Statements of Comprehensive Income (Loss).

 

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

		For the quarters ended
		December 31, 2016				September 30, 2016				December 31, 2015
		(dollars in thousands)
GAAP net income (loss)		$	1,848,483			$	730,880			$	669,666
Less:
Realized (gains) losses on termination of interest rate swaps			55,214				(1,337	)			-
Unrealized (gains) losses on interest rate swaps			(1,430,668	)			(256,462	)			(463,126	)
Net (gains) losses on disposal of investments			(7,782	)			(14,447	)			7,259
Net (gains) losses on trading assets			139,470				(162,981	)			(42,584	)
Net unrealized (gains) losses on investments measured at fair value through earnings			(110,742	)			(29,675	)			62,703
Bargain purchase gain			-				(72,576	)			-
Corporate acquisition related expenses (1)			-				46,724				-
Net (income) loss attributable to noncontrolling interest			87				336				373
Premium amortization adjustment cost (benefit)			(238,941	)			3,891				(18,072	)
Plus:
TBA dollar roll income (2)			98,896				90,174				94,914
MSR amortization (3)			(27,018	)			(21,634	)			-
Core earnings (unrevised - excluding PAA)*			326,999				312,893				311,133
Add back:
Premium amortization adjustment			238,941				(3,891	)			18,072
Core earnings (revised - including PAA)*		$	565,940			$	309,002			$	329,205
GAAP net income (loss) per average common share		$	1.79			$	0.70			$	0.69
Core earnings per average common share (unrevised - excluding PAA)*		$	0.30			$	0.29			$	0.31
Core earnings per average common share (revised - including PAA)*		$	0.53			$	0.29			$	0.33
Annualized GAAP return (loss) on average equity			57.23	%			23.55	%			22.15	%
Annualized core return on average equity (unrevised - excluding PAA)*			10.13	%			10.09	%			10.30	%
Annualized core return on average equity (revised - including PAA)*			17.53	%			10.09	%			10.89	%

 

		For the years ended
		December 31, 2016				December 31, 2015
			(dollars in thousands)
GAAP net income (loss)		$	1,432,786			$	465,747
Less:
Realized (gains) losses on termination of interest rate swaps			113,941				226,462
Unrealized (gains) losses on interest rate swaps			(282,190	)			124,869
Net (gains) losses on disposal of investments			(33,089	)			(50,987	)
Net (gains) losses on trading assets			(230,580	)			(29,623	)
Net unrealized (gains) losses on investments measured at fair value through earnings			(86,391	)			103,169
Bargain purchase gain			(72,576	)			-
Impairment of goodwill			-				22,966
Corporate acquisition related expenses (1)			48,887				-
Net (income) loss attributable to noncontrolling interest			970				809
Premium amortization adjustment cost (benefit)			18,941				73,365
Plus:
TBA dollar roll income (2)			351,778				348,531
MSR amortization (3)			(48,652	)			-
Core earnings (unrevised - excluding PAA)*			1,213,825				1,285,308
Add back:
Premium amortization adjustment			(18,941	)			(73,365	)
Core earnings (revised - including PAA)*		$	1,194,884			$	1,211,943
GAAP net income (loss) per average common share		$	1.39			$	0.42
Core earnings per average common share (unrevised - excluding PAA)*		$	1.17			$	1.28
Core earnings per average common share (revised - including PAA)*		$	1.15			$	1.20
Annualized GAAP return (loss) on average equity			11.75	%			3.73	%
Annualized core return on average equity (unrevised - excluding PAA)*			9.96	%			10.17	%
Annualized core return on average equity (revised - including PAA)*			9.81	%			9.59	%

 

 

 

Core interest income (excluding PAA), economic interest expense and economic core net interest income (excluding PAA)

Core interest income (excluding PAA) represents interest income excluding the effect of the PAA, and serves as the basis for deriving core average yield on interest bearing assets (excluding PAA), core net interest margin (excluding PAA) and core net interest spread (excluding PAA), which are discussed below. The Company believes this measure provides management and investors with additional detail to enhance their understanding of the Company’s 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 the Company’s Agency mortgage-backed securities (other than interest-only securities), which can obscure underlying trends in the performance of the portfolio.

Economic interest expense is comprised of interest expense, as computed in accordance with GAAP, plus interest expense on interest rate swaps used to hedge cost of funds, which is a component of Realized gains (losses) on interest rate swaps in the Company’s Consolidated Statements of Comprehensive Income (Loss). The Company uses interest rate swaps to manage its exposure to changing interest rates on its repurchase agreements by economically hedging cash flows associated with these borrowings. Accordingly, adding the contractual interest payments on 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.

Similarly, economic core 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.

 

		For the quarters ended
		December 31, 2016				September 30, 2016				December 31, 2015
		(dollars in thousands)
Core Interest Income Reconciliation
GAAP interest income		$	807,022			$	558,668			$	576,580
Premium amortization adjustment			(238,941	)			3,891				(18,072	)
Core interest income (excluding PAA)*		$	568,081			$	562,559			$	558,508
Economic Interest Expense Reconciliation
GAAP interest expense		$	183,396			$	174,154			$	118,807
Add:
Interest expense on interest rate swaps used to hedge cost of funds			92,841				103,100				135,267
Economic interest expense*		$	276,237			$	277,254			$	254,074
Economic Core Net Interest Income Reconciliation
Core interest income (excluding PAA)*		$	568,081			$	562,559			$	558,508
Less:
Economic interest expense*			276,237				277,254				254,074
Economic core net interest income (excluding PAA)*		$	291,844			$	285,305			$	304,434

 

Core average yield on interest earnings assets (excluding PAA), core net interest margin (excluding PAA) and core net interest spread (excluding PAA)

Core net interest spread (excluding PAA), which is the difference between the core average yield on interest earning assets (excluding PAA) and the average cost of interest bearing liabilities, and core net interest margin (excluding PAA), which is calculated by dividing the economic core net interest income (excluding PAA) by average interest earning assets, provide management with additional measures of the Company’s 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 the Company’s performance.

 

		For the quarters ended
		December 31, 2016				September 30, 2016				December 31, 2015
Economic Core Metrics		(dollars in thousands)
Core interest income (excluding PAA)*		$	568,081			$	562,559			$	558,508
Average interest earning assets		$	84,799,222			$	82,695,270			$	73,178,965
Core average yield on interest earning assets (excluding PAA)*			2.68	%			2.72	%			3.05	%
Economic interest expense*		$	276,237			$	277,254			$	254,074
Average interest bearing liabilities		$	72,032,600			$	70,809,712			$	60,516,996
Average cost of interest bearing liabilities			1.53	%			1.57	%			1.68	%
Core net interest spread (excluding PAA)*			1.15	%			1.15	%			1.37	%
Core net interest margin (excluding PAA)*			1.53	%			1.42	%			1.71	%