Annaly Capital Management
Annual Report 1999

Plain-text annual report

Annaly Corporate Profile To Our Fellow Shareholders: Every morning as I walk to the office I pass the steps leading up to the New York Public Library. Flanking the north and south of the steps are two magnificent statues of lions. They are a constant source of inspiration. I’d like to share some of that with you today. As I write this letter I reflect on the incredibly momentous times we live in and the third anniversary of our company. 1999 has been recorded as the worst year for high quality bonds in the past century. It was preceded by 1998, which was the worst year for the credit markets in the century. 1997, the year we went public, was no picnic either, with the Chairman of the Federal Reserve calling the equity markets "irrationally exuberant". The Dow Jones Industrial Average was at about 6500 when he made this statement. Through all of this Annaly has persevered and prospered from an earnings perspective. 1999 will record that Annaly’s earnings were 17% higher than 1998’s. This performance occurred despite the "worst bond market of the century". We watched with amazement while Companies with no earnings soared in market valuation while our positive earnings surprises gained little or no immediate recognition for NLY’s shares. As a result of its continuing strong earnings performance however, on a year over year basis, NLY outperformed the Standard and Poor’s Index in 1999. In the time of "dot.com" mania, I think it is fair to characterize the year as success, with a view that as a company that pays out at least 95% of its earnings, Annaly has created solid returns for its shareholders since its inception in 1997. During my career I have watched the cycles between the growth and earnings sectors grow longer and longer in their duration. Bear markets in either the debt or equity markets are not straight lines as demonstrated in the vivid contrasts of 1999. Throughout it all we have maintained our disciplined approach of keeping to high grade, liquid United States Government or Agency securities. These securities always perform best in volatile times. As tempting as it may be now from a yield perspective, we do not feel that it is still the time to go out and stretch for returns by straying from this discipline. There will be time enough for that when the business cycle turns. In January of this year, the economy passed its 107th month of expansion. This is the longest period of good times in our nation’s history. The result of this growth is now being reflected in the US Treasury’s debt management. We enjoy the luxury, as a nation, of reducing our debt for the first time in generations. Given the high quality rating of our assets, this is a very positive development for Annaly. Our assets should perform very well in this environment, even at lower levels of economic growth, should the expansion slow. In closing, I thought I would share with you one reminder of the timeless qualities that keep us focused on doing the right things for Annaly’s shareholders. It’s the two lions that guard the entrance to the library mentioned above that I walk past each day; I learned their names this year. Patience and Fortitude. Michael A.J. Farrell file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (1 of 33) [05/25/2000 11:53:33 AM] Annaly Corporate Profile Chairman of the Board Chief Executive Officer March 17th, 2000 Return on Average Equity and Dividend Yield ($ in millions) Annaly's Management Team Back Row Left to Right: Timothy J. Guba, Michael A. J. Farrell Bottom Row Left to Right: Kristopher R. Konrad, Rose Marie Miller, Wellington J. St. Claire, Jennifer A. Stephens, Kathryn F. Fagan, James P. Fortescue (not pictured) file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (2 of 33) [05/25/2000 11:53:33 AM] Annaly Corporate Profile Net Income ($ in millions) Net Interest Income ($ in millions) Interest Rate Spread file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (3 of 33) [05/25/2000 11:53:33 AM] Annaly Corporate Profile "Net income increased by 17% for the year ended December 31, 1999 over the previous year. Income for the year ended December 31, 1999 reflects an improvement in net interest income and less dependence on gains on disposition of assets, when compared to the year ended December 31, 1998. This is the result of improved net interest spread. Our net interest spread, which equals the yield on our average assets for the period less the average cost of funds for the period, was 0.98% for 1999 as compared to 0.59% for 1998." Annaly Corporate Profile Annaly Mortgage Management, Inc owns and manages a portfolio of mortgage-backed securities. Our principal business objective is to generate net income for distribution to our stockholders from the spread between the interest income on our mortgage-backed securities and costs of borrowing to finance our acquisition of mortgage-backed securities. We have elected to be taxed as a real estate investment trust (or REIT) under the Internal Revenue Code. We commenced operations on February 18, 1997. We are self-advised and self-managed. Financial Highlights (dollars in thousands, except for per share data) Statement of Operations Date Days in period Interest income Interest expense Net interest income Gain on sale of mortgage-backed securities General and administrative expenses (G&A expense) Net income Basic net income per average share Diluted net income per average share Dividends declared per average share Balance Sheet Data: Mortgage-Backed Securities, net Total assets Repurchase agreements Total liabilities Stockholders’ equity Number of common shares outstanding For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 February 18, 1997 (commencemnt of operations) through December 31, 1997 (1) 365 $89,812 69,846 $19,966 454 2,281 $18,139 $1.41 $1.35 $1.38 365 $89,986 75,735 $14,251 3,344 2,106 $15,489 $1.22 $1.19 $1.21 317 $24,713 19,677 $5,036 735 852 $4,919 $0.83 $0.80 $0.79 December 31, 1999 December 31, 1998 December 31, 1997 $1,437,793 1,491,322 1,338,296 1,388,050 103,272 13,581,316 $1,520,289 1,527,352 1,280,510 1,401,481 125,871 12,648,424 $1,161,779 1,167,740 918,869 1,032,654 135,086 12,713,900 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (4 of 33) [05/25/2000 11:53:33 AM] Annaly Corporate Profile $1,473,765 1,350,230 117,685 6.15% 5.17% $1,499,875 1,360,040 131,265 6.16% 5.57% Other Data: Average total assets Average borrowings Average equity Yield on interest earning assets Cost of funds on interest bearing liabilities Interest rate spread Financial Ratios: Net interest margin (net interest income/average total assets) G&A expense as a percentage of average assets G&A expense as a percentage of average equity Return on average assets Return on average equity (1) Ratios for the 317-day period ended December 31, 1997 have been annualized. 1.03% 11.80% 1.23% 15.41% 0.95% 0.59% 1.60% 1.94% 0.14% 0.15% 1.35% 0.98% $476,855 404,140 61,096 6.34% 5.61% 0.73% 1.22% 0.21% 1.61% 1.19% 9.27% Management’s Discussion and Analysis of Financial Condition and Result of Operation Safe Harbor Statement "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995: Statements in this discussion regarding the Company and its business which are not historical facts are "forward-looking statements" that involve risks and uncertainties. For a discussion of such risks and uncertainties, which could cause actual results to differ from those contained in the forward-looking statements, see "Risk Factors" Form 10-K for the year ended December 31, 1999. Overview We are a real estate investment trust that owns and manages a portfolio of mortgage-backed securities. Our principal business objective is to generate net income for distribution to our stockholders from the spread between the interest income on our mortgage-backed securities and the costs of borrowing to finance our acquisition of mortgage-backed securities. We commenced operations on February 18, 1997 upon the consummation of a private placement. We completed our initial public offering on October 14, 1997. The 317-day period ended December 31, 1997 was a short operating period and not a full twelve months. Also, average assets for the period ended December 31, 1997 totaled $476.9 million, whereas average assets for the year ended December 31, 1998 totaled $1.5 billion. As a result, the comparison of net income for the period ended February 18, 1997 and the year ended December 31, 1998 may show changes that may not be indicative of future periods. Results of Operations Net Income Summary For the year ended December 31, 1999, our GAAP net income was $18.1 million, or $1.41 basic earnings per average share, as compared to $15.5 million, or $1.22 basic earnings per average share, for the year ended December 31, 1998. We compute our GAAP net income per share by dividing net income by the weighted average number of shares of outstanding common stock during the period, which was 12,889,510 for the year ended December 31, 1999 and file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (5 of 33) [05/25/2000 11:53:33 AM] Annaly Corporate Profile 12,709,116 for the year ended December 31, 1998. Dividends per weighted average number of shares outstanding for the year ended December 31, 1999 was $1.38 per share, or $18.0 million in total. Dividends per weighted average number of shares outstanding for the year ended December 31, 1998 was $1.22 per share, or $15.4 million in total. Our return on average equity was 15.41% for the year ended December 31, 1999 and 11.80% for the year ended December 31, 1998. Net Income Summary Interest Income Interest Expense Net Interest Income Gain on Sale of Mortgage-Backed Securities General and Administrative Expenses Net Income Average Number of Basic Shares Outstanding Average Number of Diluted Shares Outstanding Basic Net Income Per Share Diluted Net Income Per Share Average Total Assets Average Equity Annualized Return on Average Assets Annualized Return on Average Equity Taxable Income and GAAP Income Year Ended December 31, 1998 $89,812 69,846 19,966 454 2,281 $18,139 12,889,510 13,454,007 $1.41 $1.35 $1,473,765 $117,685 1.23% 15.41% Year Ended December 31, 1999 $89,986 75,735 14,251 3,344 2,106 $15,489 12,709,116 13,020,648 $1.22 $1.19 $1,499,875 $131,265 1.03% 11.80% For the years ended December 31, 1999 and 1998, our income as calculated for tax purposes (taxable income) differed from income as calculated according to GAAP (GAAP income). Our taxable income for the year ended December 31, 1999 was approximately $18.4 million, or $1.43 per share, as compared to taxable income of $16.5 million, or $1.30 per share, for the year ended December 31, 1998. The differences were in the calculations of premium and discount amortization, gains on sale of mortgage-backed securities, and general and administrative expenses. The distinction between taxable income and GAAP income is important to our stockholders because dividends are declared on the basis of taxable income. While we do not pay taxes so long as we satisfy the requirements for exemption from taxation pursuant to the REIT provisions of the Internal Revenue Code, each year we complete a corporate tax form on which taxable income is calculated as if we were to be taxed. This taxable income level determines the amount of dividends we can pay out over time. The table below presents the major differences between our GAAP and taxable income for the years ended December 31, 1999, 1998, and 1997, and the four quarters in 1999. Taxable Income (dollars in thousands) For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 For the Period Ended December 31, 1997 GAAP Net Income $18,139 $15,489 $4,919 Taxable General & Administrative Differences $9 Taxable Mortgage Amortization Differences $814 Taxable Gain on Sale of Securities Differences $(525) $6 $3 $959 $(92) $23 $54 Taxable Net Income $18,437 $16,477 $4,884 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (6 of 33) [05/25/2000 11:53:34 AM] Annaly Corporate Profile For the Quarter Ended December 31, 1999 For the Quarter Ended September 30, 1999 For the Quarter Ended June 30, 1999 For the Quarter Ended March 31, 1999 $4,444 $4,513 $4,864 $4,318 $2 $5 $2 — $21 $(288) $4,179 $(14) $(235) $4,269 $363 $444 — $5,229 $(2) $4,760 Interest Income and Average Earning Asset Yield We had average earning assets of $1.5 billion for the year ended December 31, 1999 and 1998. Our primary source of income for the years ended December 31, 1999 and 1998 was interest income. A portion of our income was generated by gains on the sales of our mortgage-backed securities. Our interest income was $89.8 million for the year ended December 31, 1999 and $90.0 million for the year ended December 31, 1998. Our yield on average earning assets was 6.15% and 6.16% for the same respective periods. Our average earning asset balance decreased by $756,000 for the year ended December 31, 1999 as compared to the year ended December 31, 1998. Interest income decreased by $174,000 for the year ended December 31, 1999 over prior year, due to the slight decline in the average earning asset balance and yield. The table below shows our average balance of cash equivalents and mortgage-backed securities, the yields we earned on each type of earning assets, our yield on average earning assets and our interest income for the years ended December 31, 1999 and 1998, and the period ended December 31, 1997, and the four quarters in 1999. Average Earning Asset Yield Average Cash Equivalents Average Mortgage Backed Securities Average Earning Assets $221 $1,461,033 $1,461,254 Yield on Average Cash Equivalents 4.10% Yield on Average Mortgage-Backed Securities Yield on Average Interest Earning Income Assets 6.15% 6.15% $89,812 $2 $1,461,789 $1,461,791 4.32% 6.16% 6.16% $89,986 $30 $448,276 $0,448,306 4.20% 6.34% 6.34% $24,713 $2 $1,420,308 $1,420,310 4.05% 6.58% 6.58% $23,371 For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 For the Period Ended December 31, 1997 For the Quarter Ended December 31, 1999 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (7 of 33) [05/25/2000 11:53:34 AM] Annaly Corporate Profile For the Quarter Ended September 30, 1999 For the Quarter Ended June 30, 1999 For the Quarter Ended March 31, 1999 $877 $1,416,525 $1,417,404 4.10% 6.26% 6.25% $22,161 $2 $1,504,669 $1,504,671 4.30% 5.92% 5.92% $22,265 $2 $1,502,627 $1,502,629 4.01% 5.87% 5.87% $22,015 The constant prepayment rate (or CPR) on our mortgage-backed securities for the year ended December 31, 1999 was 18% and for the year ended December 31, 1998 was 23%. CPR is an assumed rate of prepayment for our mortgage-backed securities, expressed as an annual rate of prepayment relative to the outstanding principal balance of our mortgage-backed securities. CPR does not purport to be either a historical description of the prepayment experience of our mortgage-backed securities or a prediction of the anticipated rate of prepayment of our mortgage-backed securities. Principal prepayments had a negative effect on our earning asset yield for the years ended December 31, 1999 and 1998 because we adjust our rates of premium amortization and discount accretion monthly based upon the effective yield method, which takes into consideration changes in prepayment speeds. Interest Expense and the Cost of Funds We anticipate that our largest expense will be the cost of borrowed funds. We had average borrowed funds of $1.4 billion and total interest expense of $69.8 million for the year ended December 31, 1999. We had average borrowed funds of $1.4 billion and total interest expense of $75.7 million for the year ended December 31, 1998. Our average cost of funds was 5.17% for the year ended December 31, 1999 and 5.57% for the year ended December 31, 1998. The cost of funds rate declined 0.40% and the average borrowed funds declined by $9.8 million for the year ended December 31, 1999 when compared to the year ended December 31, 1998; consequently, interest expense decreased by 8%. With our current asset/liability management strategy, changes in our cost of funds are expected to be closely correlated with changes in short-term LIBOR, although we may choose to extend the maturity of our liabilities at any time. Our average cost of funds was 0.08% below one-month LIBOR for the year ended December 31, 1999 and equal to average one-month LIBOR for the year ended December 31, 1998. We generally have structured our borrowings to adjust with one-month LIBOR because we believe that one-month LIBOR may continue to be lower than six-month LIBOR in the present interest rate environment. During the year ended December 31, 1999, average one-month LIBOR, which was 5.25%, was 0.28% lower than average six-month LIBOR, which was 5.53%. During the year ended December 31, 1998, average one-month LIBOR, which was 5.57%, was 0.03% higher than average six-month LIBOR, which was 5.54%. The table below shows our average borrowed funds and average cost of funds as compared to average one-month and average six-month LIBOR for the years ended December 31, 1999 and 1998, the period ended December 31, 1997 and the four quarters in 1999. file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (8 of 33) [05/25/2000 11:53:34 AM] Annaly Corporate Profile Average Borrowed Funds $1,350,230 Interest Expense $69,846 Average Average One- Cost of Month Funds LIBOR 5.17% 5.25% Average Six-Month LIBOR 5.53% Average One-Month LIBOR Relative toAverage Six- Month LIBOR (0.28%) Average Cost of Funds Relative to Average One- Month LIBOR (0.08%) Average Cost of Funds Relative to Average Six-Month LIBOR (0.36%) $1,360,040 $75,735 5.57% 5.57% 5.54% 0.03% – 0.03% $404,140 $19,677 5.61% 5.67% 5.87% (0.20%) (0.06%) (0.26%) $1,324,326 $18,597 5.61% 5.78% 6.08% (0.30%) (0.17%) (0.47%) $1,320,776 $17,232 5.22% 5.28% 5.80% (0.52%) (0.06%) (0.58%) $1,374,154 $16,865 4.91% 4.96% 5.19% (0.23%) (0.05%) (0.28%) $1,381,663 $17,151 4.97% 4.96% 5.05% (0.09%) 0.01% (0.08%) (dollars in thousands) For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 For the Period Ended December 31, 1997 For the Quarter Ended December 31, 1999 For the Quarter Ended September 30, 1999 For the Quarter Ended June 30, 1999 For the Quarter Ended March 31, 1999 Net Interest Rate Agreement Expense We have not entered into any interest rate agreements to date. As part of our asset/liability management process, we may enter into interest rate agreements such as interest rate caps, floors or swaps. These agreements would be entered into with the intent to reduce interest rate or prepayment risk and would be designed to provide us income and capital appreciation in the event of certain changes in interest rates. However, even after entering into these agreements, we would still be exposed to interest rate and prepayment risks. We review the need for interest rate agreements on a regular basis consistent with our capital investment policy. Net Interest Income file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (9 of 33) [05/25/2000 11:53:34 AM] Annaly Corporate Profile Our net interest income, which equals interest income less interest expense, totaled $20.0 million for the year ended December 31, 1999 and $14.3 million for the year ended December 31, 1998. Our net interest income increased because of lower funding costs for the year. Our net interest spread, which equals the yield on our average assets for the period less the average cost of funds for the period, was 0.98% for the year ended December 31, 1999 as compared to 0.59% for the year ended December 31, 1998. This 0.39% increase in spread income is reflected in the $6.7 million increase in net interest income. Net interest margin, which equals net interest income divided by average interest earning assets, was 1.35% for the year ended December 31, 1999 and 0.95% for the year ended December 31, 1998. The principal reason that net interest margin exceeded net interest spread is that average interest earning assets exceeded average interest bearing liabilities. A portion of our assets is funded with equity rather than borrowings. We did not have any interest rate agreement expenses to date. The table below shows our interest income by earning asset type, average earning assets by type, total interest income, interest expense, average repurchase agreements, average cost of funds, and net interest income for the years ended December 31, 1999 and 1998, the period ended December 31, 1997, and the four quarters in 1999. GAAP Net Interest Income Average Mortgage- Backed Securities Held $1,461,033 Interest Income on Mortgage- Backed Securities $89,801 Average Cash Equivalents Total Interest Income Cash $89,812 Yield on Average Interest Interest Earning Expense Assets 6.15% $1,350,230 $69,846 Average Balance of Repurchase Agreements Average Net Cost of Interest Income Funds 5.17% $19,966 $1,461,789 $89,986 $2 $89,986 6.16% $1,360,040 $75,735 5.57% $14,251 $448,276 $24,682 $31 $24,713 6.34% $404,140 $19,677 5.61% $5,036 $1,420,308 $23,372 $2 $23,372 6.58% $1,324,326 $18,597 5.61% $4,774 $1,416,525 $22,151 $877 $22,160 6.26% $1,320,776 $17,232 5.22% $4,929 (dollars in thousands) For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 For the Period Ended December 31, 1997 For the Quarter Ended December 31, 1999 For the Quarter Ended September 30, 1999 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (10 of 33) [05/25/2000 11:53:35 AM] Annaly Corporate Profile $1,504,669 $22,265 $2 $22,265 5.92% $1,374,154 $16,865 4.91% $5,399 $1,502,629 $22,015 $2 $22,015 5.87% $1,381,663 $17,151 4.97% $4,864 For the Quarter Ended June 30, 1999 For the Quarter Ended March 31, 1999 Gains and Losses on Sales of Mortgage-Backed Securities For the year ended December 31, 1999, we sold mortgage-backed securities with an aggregate historical amortized cost of $167.3 million for an aggregate gain of $455,000. For the year ended December 31, 1998, we sold mortgage-backed securities with an aggregate historical amortized cost of $565.2 million for an aggregate gain of $3.3 million. As stated above, our gain on the sale of assets declined substantially. For the year ended December 31, 1999, there was a greater emphasis on spread income and not gains. The difference between the sale price and the historical amortized cost of our mortgage-backed securities is a realized gain and increases income accordingly. We do not expect to sell assets on a frequent basis, but may from time to time sell existing assets to move into new assets, which our management believes might have higher risk-adjusted returns, or to manage our balance sheet as part of our asset/liability management strategy. Credit Losses We have not experienced credit losses on our mortgage-backed securities to date. We have limited our exposure to credit losses on our mortgage-backed securities by purchasing only securities, issued or guaranteed by FNMA, FHLMC or GNMA, which, although not rated, carry an implied "AAA" rating. General and Administrative Expenses G&A expenses were $2.3 million for the year ended December 31, 1999 and $2.1 million for the year ended December 31, 1998. G&A expenses as a percentage of average assets was 0.15% and 0.14% for the years ended December 31, 1999 and 1998, respectively. G&A expenses increased by $175,000 for 1999, when compared to 1998. Salaries and benefits increased by $102,000, with the addition of one employee and higher benefits cost. Also, accounting, legal, and printing cost increased for the year as a direct result of secondary offering cost.GAAP G&A Expenses and Operating Expense Ratios Cash Expense Compensation and Benefits $1,312 Other G&A Expenses $969 Total G&A Expenses $2,281 Total G&A Expenses/ Average Assets (annualized) 0.15% Total G&A Expenses/ Average Equity (annualized) 1.94% $1,210 $896 $2,106 0.14% 1.60% (dollars in thousands) For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (11 of 33) [05/25/2000 11:53:35 AM] Annaly Corporate Profile For the Period Ended December 31, 1997 For the Quarter Ended December 31, 1999 For the Quarter Ended September 30, 1999 For the Quarter Ended June 30, 1999 For the Quarter Ended March 31, 1999 $492 $360 $852 0.21% 1.61% $304 $292 $596 0.16% 2.21% $337 $177 $514 0.14% 1.81% $338 $223 $561 0.15% 1.44% $333 $277 $610 0.16% 1.93% Net Income and Return on Average Equity Our net income was $18.1 million for the year ended December 31, 1999 and $15.5 million for the year ended December 31, 1998. Our return on average equity was 15.4% for the year ended December 31, 1999 and 11.8% for the year ended December 31, 1998. The increase in net income is a direct result of an increase in spread income. As previously mentioned, the substantial decline in interest expense was the primary reason that our earnings increased. The table below shows our net interest income, gain on sale of mortgage-backed securities and G&A expenses each as a percentage of average equity, and the return on average equity for the years ended December 31, 1999, 1998, and the period ended December 31, 1997, and for the four quarters in 1999. Components of Return on Average Equity (Ratios for the Quarters Ended December 31, 1999, September 30, 1999, June 30, 1999, March 31, 1999 and the Period ended December 31, 1997 are annualized) For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 For the Period Ended December 31, 1997 For the Quarter Ended December 30, 1999 For the Quarter Ended September 30, 1999 Net Interest Income/Average Equity 16.97% Gain on Sale of Mortgage- Backed Securities/Average Equity 0.38% 10.85% 9.49% 17.65% 17.40% 2.55% 1.39% 0.99% 0.34% file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (12 of 33) [05/25/2000 11:53:35 AM] G&A Expenses/ Average Equity 1.94% Return on Average Equity 15.41% 1.60% 11.80% 1.61% 9.27% 2.21% 16.43% 1.81% 15.93% Annaly Corporate Profile For the Quarter Ended June 30, 1999 For the Quarter Ended March 31, 1999 Dividends and Taxable Income 17.99% 15.43% 0.08% 0.20% 1.87% 16.20% 1.93% 13.70% We have elected to be taxed as a REIT under the Internal Revenue Code. Accordingly, we have distributed substantially all of our taxable income for each year since inception to our stockholders, including income resulting from gains on sales of our mortgage-backed securities. From inception through December 31, 1999, approximate taxable income exceeded dividend declarations by $1.7 million, or $0.12 per share, based on the number of shares of common stock outstanding at period end. Dividend Summary (dollars in thousands, except per share data) For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 For the Period Ended December 31, 1997 For the Quarter Ended December 31, 1999 For the Quarter Ended September 30, 1999 For the Quarter Ended June 30, 1999 For the Quarter Ended March 31, 1999 Weighted Average Taxable Common Net Shares Income Outstanding $18,437 12,889,510 Taxable Net Income Per Share $1.43 Dividends Declared Per Share $1.39 Total Dividends $17,978 Dividend Payout Ratio 97.5% Cumulative Undistributed Taxable Income $1,697 $16,477 12,709,116 $1.30 $1.21 $15,437 93.7% $1,234 $4,884 5,952,123 $0.82 $0.79 $4,690 96.0% $194 $4,179 13,383,426 $0.31 $0.35 $4,754 113.74% $1,697 $4,269 12,745,416 $0.34 $0.35 $4,588 91.1% $2,271 $5,229 12,697,338 $0.41 $0.35 $4,444 87.1% $2,589 $4,760 12,657,884 $0.37 $0.33 $4,190 94.9% $1,804 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (13 of 33) [05/25/2000 11:53:35 AM] Annaly Corporate Profile Financial Condition Mortgage-Backed Securities All of our mortgage-backed securities at December 31, 1999 were adjustable-rate or fixed-rate mortgage-backed securities backed by single-family mortgage loans. All of the mortgage assets underlying these mortgage-backed securities were secured with a first lien position on the underlying single-family properties. All our mortgage-backed securities were FHLMC, FNMA or GNMA mortgage pass-through certificates or CMOs, which carry an implied "AAA" rating. We mark-to-market all of our earning assets at liquidation value. We accrete discount balances as an increase in interest income over the life of discount mortgage-backed securities and we amortize premium balances as a decrease in interest income over the life of premium mortgage-backed securities. At December 31, 1999 and 1998, we had on our balance sheet a total of $1.1 million and $609,000 respectively, of unamortized discount (which is the difference between the remaining principal value and current historical amortized cost of our mortgage-backed securities acquired at a price below principal value) and a total of $23.6 million and $24.9 million, respectively, of unamortized premium (which is the difference between the remaining principal value and the current historical amortized cost of our mortgage-backed securities acquired at a price above principal value). We received mortgage principal repayments of $362.7 million for the year ended December 31, 1999 and $486.3 million for the year ended December 31, 1998. Given our current portfolio composition, if mortgage principal prepayment rates were to increase over the life of our mortgage-backed securities, all other factors being equal, our net interest income would decrease during the life of these mortgage-backed securities as we would be required to amortize our net premium balance into income over a shorter time period. Similarly, if mortgage principal prepayment rates were to decrease over the life of our mortgage-backed securities, all other factors being equal, our net interest income would increase during the life of these mortgage-backed securities as we would amortize our net premium balance over a longer time period. The table below summarizes our mortgage-backed securities at December 31, 1999, 1998 and 1997, September 30, 1999, June 30, 1999, and March 31, 1999. Mortgage-Backed Securities Principal Value $1,452,917 Amortized Net Premium Cost $22,444 $1,475,361 Amortized Cost/ Principal Value 101.54% Estimated Fair Value $1,437,793 Estimated Fair Value/ Principal Value 98.96% Weighted Yield Average 6.77% $1,502,414 $24,278 $1,526,692 101.62% $1,520,289 101.19% 6.43% $1,138,365 $21,390 $1,159,755 101.88% $1,161,779 102.06% 6.57% $1,402,565 $22,981 $1,425,546 101.64% $1,401,770 99.94% 6.41% $1,468,547 $24,985 $1,493,532 101.70% $1,474,104 100.38% 6.21% (dollars in thousands) At December 31, 1999 At December 31, 1998 At December 31, 1997 At September 30, 1999 At June 30, 1999 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (14 of 33) [05/25/2000 11:53:36 AM] Annaly Corporate Profile At March 31, 1999 $1,527,530 $26,071 $1,553,601 101.71% $1,547,618 101.32% 5.94% The tables below set forth certain characteristics of our mortgage-backed securities. The index level for adjustable-rate mortgage-backed securities is the weighted average rate of the various short-term interest rate indices, which determine the coupon rate. Adjustable-Rate Mortgage-Backed Security Characteristics Weighted Average Coupon Rate Weighted Average Index Level 7.33% 5.84% Principal Value $951,839 Weighted Weighted Average Average Term to Net Next Margin Adjustment 1.49% 11 months Weighted Average Lifetime Cap 10.30% Weighted Average Asset Yield 7.64% Principal Value at Period End as % of Total Mortgage- Backed Securities 65.51% $1,030,654 6.84% 5.18% 1.66% 12 months 10.63% 6.42% 68.60% $994,653 7.13% 5.52% 1.61% 22 months 10.78% 6.50% 87.38% $889,293 6.76% 5.13% 1.63% 9 months 10.82% 6.14% 63.40% $941,559 6.67% 4.96% 1.71% 11 months 11.00% 5.84% 64.12% $1,036,947 6.63% 4.97% 1.66% 11 months 11.01% 5.64% 67.88% (dollars in thousands) At December 31, 1999 At December 31, 1998 At December 31, 1997 At September 30, 1999 At June 30, 1999 At March 31, 1999 Fixed-Rate Mortgage-Backed Security Characteristics (dollars in thousands) At December 31, 1999 At December 31, 1998 At December 31, 1997 At December 31, 1999 At September 30, 1999 At June 30, 1999 At March 31, 1999 Principal Value $501,078 $471,760 $143,712 $513,272 $526,988 $401,002 Weighted Average Coupon Rate 6.58% 6.55% 7.50% Weighted Average Asset Yield 7.01% 6.47% 7.08% Principal Value as % of Total Mortgage- Backed Securities 34.49% 31.40% 12.62% 6.58% 6.58% 6.82% 6.91% 6.88% 6.65% 36.60% 35.88% 26.02% At December 31, 1999 and 1998 we held mortgage-backed securities with coupons linked to the one-year, three-year, and five-year Treasury indices, one-month LIBOR and the six-month CD rate. Adjustable-Rate Mortgage-Backed Securities by Index file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (15 of 33) [05/25/2000 11:53:36 AM] Annaly Corporate Profile December 31, 1999 Weighted Average Adjustment Frequency Weighted Average Term to Next Adjustment Weighted Average Annual Period Cap Weighted Average Lifetime Cap at December 31, 1999 Mortgage Principal Value as Percentage of Mortgage-Backed Securities at December 31, 1999 One-Month LIBOR 1 mo. Six-Month CD Rate 6 mo. 1-Year Treasury Index 12 mo. 3-Year Treasury Index 36 mo. 5-Year Treasury Index 60 mo. 1 mo. 2 mo. 25 mo. 16 mo. 36 mo. None 1.00% 1.93% 1.57% 1.35% 9.20% 11.36% 11.19% 13.23% 11.68% 34.89% 2.12% 22.62% 5.22% 0.66% Adjustable-Rate Mortgage-Backed Securities by Index One-Month LIBOR 1 mo. Six-Month CD Rate 6 mo. 1-Year Treasury Index 12 mo. 3-Year Treasury Index 36 mo. 5-Year Treasury Index 60 mo. 1 mo. 3 mo. 23 mo. 9 mo. 2 mo. None 1.00% 1.83% 2.00% 2.00% 9.16% 11.04% 11.76% 13.07% 11.57% 29.60% 3.73% 33.33% 1.62% 0.32% December 31, 1998 Weighted Average Adjustment Frequency Weighted Average Term to Next Adjustment Weighted Average Annual Period Cap Weighted Average Lifetime Cap at December 31, 1998 Mortgage Principal Value as Percentage of Mortgage-Backed Securities at December 31, 1998 Interest Rate Agreements Interest rate agreements are assets that are carried on a balance sheet at estimated liquidation value. We have not entered into any interest rate agreements since our inception. Borrowings To date, our debt has consisted entirely of borrowings collateralized by a pledge of our mortgage-backed securities. These borrowings appear on our balance sheet as repurchase agreements. At December 31, 1999, we had established uncommitted borrowing facilities in this market with twenty-three lenders in amounts, which we believe, are in excess of our needs. All of our mortgage-backed 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 thus increase the liquidity and strength of our balance sheet. For the years ended December 31, 1999 and 1998, the term to maturity of our borrowings ranged from one day to one year, with a weighted average original term to maturity of 50 days at December 31, 1999 and 49 days at December 31, 1998. At December 31, 1999, the weighted average cost of funds for all of our borrowings was 5.26% and the weighted average term to next rate adjustment was 20 days. At December 31, 1998, the weighted average cost of funds for all of our borrowings was 5.21% and the weighted average term to next rate adjustment was 29 days. file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (16 of 33) [05/25/2000 11:53:36 AM] Annaly Corporate Profile Liquidity Liquidity, which is our ability to turn non-cash assets into cash, allows us to purchase additional mortgage-backed securities and to pledge additional assets to secure existing borrowings should the value of our pledged assets decline. Potential immediate sources of liquidity for us include cash balances and unused borrowing capacity. Unused borrowing capacity will vary over time as the market value of our mortgage-backed securities varies. Our balance sheet also generates liquidity on an on-going basis through mortgage principal repayments and net earnings held prior to payment as dividends. Should our needs ever exceed these on-going sources of liquidity plus the immediate sources of liquidity discussed above, we believe that our mortgage-backed securities could in most circumstances be sold to raise cash. The maintenance of liquidity is one of the goals of our capital investment policy. Under this policy, we limit asset growth in order to preserve unused borrowing capacity for liquidity management purposes. Stockholders’ Equity We use "available-for-sale" treatment for our mortgage-backed securities; we carry these assets on our balance sheet at estimated market value rather than historical amortized cost. Based upon this "available-for-sale" treatment, our equity base at December 31, 1999 was $103.3 million, or $7.60 per share. If we had used historical amortized cost accounting, our equity base at December 31, 1999 would have been $140.8 million, or $10.37 per share. Our equity base at December 31, 1998 was $125.9 million, or $9.95 per share. If we had used historical amortized cost accounting, our equity base at December 31, 1998 would have been $132.3 million, or $10.46 per share. During the year ended December 31, 1999, the Company raised additional capital in the amount of $8.2 million through its direct purchase program. With our "available-for-sale" accounting treatment, unrealized fluctuations in market values of assets do not impact our GAAP or taxable income but rather are reflected on our balance sheet by changing the carrying value of the asset and stockholders’ equity under "Accumulated Other Comprehensive Income (Loss)." By accounting for our assets in this manner, we hope to provide useful information to stockholders and creditors and to preserve flexibility to sell assets in the future without having to change accounting methods. As a result of this mark-to-market accounting treatment, our book value and book value per share are likely to fluctuate far more than if we used historical amortized cost accounting. As a result, comparisons with companies that use historical cost accounting for some or all of their balance sheet may not be meaningful. The table below shows unrealized gains and losses on the mortgage-backed securities in our portfolio. Unrealized Gains and Losses (dollars in thousands) Unrealized Gain Unrealized Loss Net Unrealized Gain (Loss) Net Unrealized Gain (Loss) as % of Mortgage-Backed Securities Principal Value Net Unrealized Gain (Loss) as % of Mortgage-Backed Securities Amortized Cost At December 31, 1999 $1,531 (39,100) $(37,569) (2.59%) At Decmber 31, 1998 $3,302 (9,706) $(6,404) (0.43%) At Decmber 31, 1997 $3,253 (1,229) $(2,024 0.18% (2.54%) (0.42%) 0.17% Unrealized changes in the estimated net market value of mortgage-backed securities have one direct effect on our potential earnings and dividends: positive market-to-market changes increase our equity base and allow us to increase our borrowing capacity while negative changes tend to limit borrowing capacity under our capital investment policy. A very large negative change in the net market value of our mortgage-backed securities might impair our liquidity position, requiring us to sell assets with the likely result of realized losses upon sale. "Unrealized Losses on Available for Sale Securities" was $37.6 million, or 2.54% of the amortized cost of our mortgage-backed securities at December file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (17 of 33) [05/25/2000 11:53:36 AM] Annaly Corporate Profile 31, 1999. "Unrealized Losses on Available for Sale Securities" was $6.4 million or 0.43% of the amortized cost of our mortgage-backed securities at December 31, 1998. The table below shows our equity capital base as reported and on a historical amortized cost basis at December 31, 1999, 1998, and 1997, and September 30, 1999, June 30, 1999 and March 31,1999. Issuances of common stock, the level of GAAP earnings as compared to dividends declared, and other factors influence our historical cost equity capital base. The GAAP reported equity capital base is influenced by these factors plus changes in the "Net Unrealized Losses on Assets Available for Sale" account. Stockholders’ Equity (dollars in thousands, except per share data) At December 31, 1999 At December 31, 1998 At December 31, 1997 At September 30, 1999 At June 30, 1999 At March 31, 1999 Leverage Historical Amortized Cost Equity Base $140,841 Net Unrealized Gains on Assets Available for Sale $(37,569) GAAP Reported Equity Base (Book Value) $103,272 Historical Amortized Cost Equity Per Share $10.37 GAAP Reported Equity (Book Value) Per Share $7.60 $132,275 $(6,404) $125,871 $10.46 $133,062 $2,024 $135,086 $10.47 $136,850 $(23,776) $113,074 $10.44 $133,020 $133,055 $(19,428) $(1,910) $113,592 $131,145 $10.48 $10.43 $9.95 $10.62 $8.63 $8.95 $10.28 Our debt-to-GAAP reported equity ratio at December 31, 1999 and, 1998 was 12.9:1 and 10.1:1, respectively. We generally expect to maintain a ratio of debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this range 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 and over-collateralization levels required by lenders when we pledge assets to secure borrowings. Our target debt-to-GAAP reported equity ratio is determined under our capital investment policy. Should our actual debt-to-equity ratio increase above the target level due to asset acquisition or market value fluctuations in assets, we will cease to acquire new assets. Our management will, at that time, present a plan to our Board of Directors to bring us back to our target debt-to-equity ratio; in many circumstances, this would be accomplished in time by the monthly reduction of the balance of our mortgage-backed securities through principal repayments. Asset/Liability Management and Effect of Changes in Interest Rates We continually review our asset/liability management strategy with respect to interest rate risk, mortgage prepayment risk, credit risk and the related issues of capital adequacy and liquidity. We seek attractive risk-adjusted stockholder returns while maintaining a strong balance sheet. We seek to manage the extent to which our net income changes as a function of changes in interest rates by matching adjustable-rate assets with variable-rate borrowings. In addition, although we have not done so to date, we may seek to mitigate the potential impact on net income of periodic and lifetime coupon adjustment restrictions in our portfolio of mortgage-backed securities by entering into interest rate agreements such as interest rate caps and interest rate swaps. Changes in interest rates may also have an effect on the rate of mortgage principal prepayments and, as a result, file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (18 of 33) [05/25/2000 11:53:37 AM] Annaly Corporate Profile prepayments on mortgage-backed securities. We will seek to mitigate the effect of changes in the mortgage principal repayment rate by balancing assets we purchase at a premium with assets we purchase at a discount. To date, the aggregate premium exceeds the aggregate discount on our mortgage-backed securities. As a result, prepayments, which result in the expensing of unamortized premium, will reduce our net income compared to what net income would be absent such prepayments. Inflation Virtually all of our assets and liabilities are financial in nature. As a result, interest rates and other factors drive our performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our dividends based upon our net income as calculated for tax purposes; in each case, our activities and balance sheet are measured with reference to historical cost or fair market value without considering inflation. Other Matters We calculate that our qualified REIT assets, as defined in the Internal Revenue Code, are 99.5% of our total assets at December 31, 1999 and 1998, as compared to the Internal Revenue Code requirement that at least 75% of our total assets be qualified REIT assets. We also calculate that 99.5% and 96.4% of our revenue qualifies for the 75% source of income test, and 100% of its revenue qualifies for the 95% source of income test, under the REIT rules for the years ended December 31, 1999 and 1998, respectively. We also met all REIT requirements regarding the ownership of our common stock and the distribution of our net income. Therefore, as of December 31, 1999 and 1998, we believe that we qualified as a REIT under the Internal Revenue Code. We at all times intend to conduct our business so as not to become regulated as an investment company under the Investment Company Act. If we were to become regulated as an investment company, then our use of leverage would be substantially reduced. The Investment Company Act exempts entities that are "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate" (qualifying interests). Under current interpretation of the staff of the SEC, in order to qualify for this exemption, we must maintain at least 55% of our assets directly in qualifying interests. In addition, unless certain mortgage securities represent all the certificates issued with respect to an underlying pool of mortgages, the mortgage-backed securities may be treated as securities separate from the underlying mortgage loans and, thus, may not be considered qualifying interests for purposes of the 55% requirement. We calculate that as of December 31, 1999 and 1998 we were in compliance with this requirement. Balance Sheets December 31, 1999 and 1998 Assets Cash and Cash Equivalents Mortgage-Backed Securities—At fair value Receivable for Mortgage-Backed Securities sold Accrued interest receivable Other assets Total assets Liabilities and Stockholders’ Equity Liabilities: Repurchase agreements Payable for Mortgage-Backed Securities purchased Accrued interest payable 1999 1998 71,918 1,437,792,631 46,402,360 6,857,683 197,896 1,491,322,488 69,020 1,520,288,762 — 6,782,043 212,214 1,527,352,039 1,338,295,750 38,154,012 6,682,687 1,280,510,000 111,921,205 5,052,626 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (19 of 33) [05/25/2000 11:53:37 AM] Annaly Corporate Profile Dividends payable Accounts payable Total liabilities Stockholders’ Equity: Common stock: par value $.01 per share;100,000,000 authorized, 13,581,316 and 12,648,424 shares issued and outstanding, respectively Additional paid-in capital Accumulated other comprehensive loss Retained earnings Total stockholders’ equity 4,753,461 164,100 1,388,050,010 3,857,663 139,236 1,401,480,730 135,813 126,484 140,262,657 (37,568,510) 442,518 103,272,478 131,868,108 (6,404,275) 280,992 125,871,309 Total Liabilities and Stockholders’ Equity 1,491,322,488 1,527,352,039 See notes to financial statements. Statements of Operations Years Ended December 31, 1999 and 1998 Interest Income: Mortgage-Backed Securities Other interest income Total interest income Interest Expense: Repurchase agreements Net Interest Income Gain on sale of Mortgage-Backed Securities General and administrative expenses Net Income Other Comprehensive Loss: Unrealized loss on available-for-sale securities Less reclassification adjustment for gains included in net income Other comprehensive gain (loss) Comprehensive Income Net Income Per Share: Basic Diluted Average Number of Shares Outstanding: Basic Diluted See notes to financial statements. Statement of Stockholders Equity 1999 1998 $89,801,353 10,641 89,811,994 69,846,206 19,965,788 454,782 2,281,290 18,139,280 (30,709,453) (454,782) (31,164,235) $(13,024,955) $1.41 $1.35 $89,985,526 105 89,985,631 75,735,280 14,250,351 3,344,106 2,105,534 15,488,923 (5,083,920) (3,344,106) (8,428,026) $7,060,897 $1.22 $1.19 12,889,510 13,454,007 12,709,116 13,020,648 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (20 of 33) [05/25/2000 11:53:37 AM] Annaly Corporate Profile Years Ended December 31, 1999 and 1998 Balance, December 31, 1997 Net income Other comprehensive income:Unrealized net losses on securities, net of reclassification adjustment Comprehensive income Exercise of stock options Additional cost of initial public offering Stock buyback Dividends declared for the year ended December 31, 1998, $1.22 per average share Balance, December 31, 1998 Net income Other comprehensive income:Unrealized net losses on securities, net of reclassification adjustment Comprehensive income Exercise of stock options Proceeds from direct purchase Dividends declared for the year ended December 31, 1999, $1.39 per average share Common Stock Par Value Additional Paid-in Capital $127,139 $132,705,765 Comprehensive Income Retained Earnings $— $229,623 Other Comprehensive Income Total $2,023,751 $135,086,278 — — — — 15,488,923 15,488,923 — (8,428,026) — (8,428,026) — — — — $7,060,897 441 194,658 — (130,248) (1,096) (902,067) — — — — — — — — 7,060,897 195,099 (130,248) (903,163) — — (15,437,554) — (15,437,554) 126,484 131,868,108 280,992 (6,404,275) 125,871,309 — — — $18,139,280 18,139,280 — (31,164,235) — — (31,164,235) — — — — $(13,024,955) 572 232,704 — 8,757 8,161,845 — — — — (13,024,955) 233,276 — 8,170,602 — — (17,977,754) — (17,977,754) file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (21 of 33) [05/25/2000 11:53:38 AM] Annaly Corporate Profile Balance, December 31, 1999 Disclosure of reclassification amounts:Unrealized holding losses arising during period Less reclassification adjustment of gains included in net income Net unrealized losses on securities $135,813 $140,262,657 $442,518 $(37,568,510) $103,272,478 — — $(30,709,453) — — — — — — (454,782) — $(31,164,235) — — — — — — See notes to financial statements. Statement of Cash Flows Years Ended December 31, 1999 and 1998 Cash Flows From Operating Activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Amortization of mortgage premiums and discounts, net Depreciation of fixed assets Gain on sale of Mortgage-Backed Securities Increase in accrued interest receivable Decrease (increase) in other assets Increase in accrued interest payable Increase (decrease) in accounts payable Net cash provided by operating activities Cash Flows From Investing Activities: Purchase of Mortgage-Backed Securities Proceeds from sale of Mortgage-Backed Securities Principal payments on Mortgage-Backed Securities Net cash used in investing activities Cash Flows From Financing Activities: Proceeds from repurchase agreements Principal payments on repurchase agreements Proceeds from exercise of stock options Proceeds from direct equity offering Additional cost of initial public offering Purchase of Treasury Stock 1999 1998 $18,139,280 6,103,239 $15,488,923 8,235,371 22,670 (454,782) (98,310) 14,318 1,630,061 24,864 14,154 (3,344,106) (1,443,182) (115,112) 60,179 (62,740) 25,381,340 18,833,487 (559,695,956) 122,552,293 362,657,549 (1,420,592,798) 568,553,814 486,337,605 (74,486,114) (365,701,379) 11,202,660,000 11,506,566,000 (11,144,874,250) (11,144,925,000) 195,100 — (130,248) (903,163) 233,276 8,170,602 — — file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (22 of 33) [05/25/2000 11:53:38 AM] Annaly Corporate Profile Dividends paid Net cash provided by financing activities Net Increase (decrease) in Cash and Cash Equivalents Cash and Cash Equivalents, Beginning Of Year Cash and Cash Equivalents, End Of Year Supplemental Disclosure Of Cash Flow Information: Interest paid (17,081,956) (14,376,949) 49,107,672 2,898 69,020 $71,918 346,425,740 (442,152) 511,172 $69,020 $68,216,145 $75,675,101 Noncash Financing Activities: Net change in unrealized loss on available-for-sale securities Dividends declared, not yet paid $(31,164,235) $4,753,461 $(8,428,026) $3,857,663 See notes to financial statements. Notes to Financial Statements Years Ended December 31, 1999 and 1998 1. Organization and Significant Accounting Policies Annaly Mortgage Management, Inc. (the "Company") was incorporated in Maryland on November 25, 1996. The Company commenced its operations of purchasing and managing an investment portfolio of Mortgage-Backed Securities on February 18, 1997, upon receipt of the net proceeds from the private placement of equity capital. An initial public offering was completed on October 14, 1997. A summary of the Company’s significant accounting policies follows: Cash and Cash Equivalents–Cash and cash equivalents includes cash on hand and money market funds. The carrying amounts of cash equivalents approximates their value. Mortgage-Backed Securities–The Company invests primarily in mortgage pass-through certificates, collateralized mortgage obligations and other mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed Securities"). Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS 115"), requires the Company to classify its investments as either trading investments, available-for-sale investments or held-to-maturity investments. Although the Company generally intends to hold most of its Mortgage-Backed Securities until maturity, it may, from time to time, sell any of its Mortgage-Backed Securities as part of its overall management of its balance sheet. Accordingly, this flexibility requires the Company to classify all of its Mortgage-Backed Securities as available-for-sale. All assets classified as available-for-sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity. Unrealized losses on Mortgage-Backed Securities that are considered other than temporary, as measured by the amount of decline in fair value attributable to factors other than temporary, are recognized in income and the cost basis of the Mortgage-Backed Securities is adjusted. There were no such adjustments for the years ended December 31, 1999 and 1998. Interest income is accrued based on the outstanding principal amount of the Mortgage-Backed Securities and their contractual terms. Premiums and discounts associated with the purchase of the Mortgage-Backed Securities are amortized into interest income over the lives of the securities using the effective yield method. file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (23 of 33) [05/25/2000 11:53:38 AM] Annaly Corporate Profile Mortgage-Backed Securities transactions are recorded on the date the securities are purchased or sold. Purchases of newly issued securities are recorded when all significant uncertainties regarding the characteristics of the securities are removed, generally shortly before settlement date. Realized gains and losses on Mortgage-Backed Securities transactions are determined on the specific identification basis. Credit Risk–At December 31, 1999 and 1998, the Company has limited its exposure to credit losses on its portfolio of Mortgage-Backed Securities by only purchasing securities from Federal Home Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA"), or Government National Mortgage Association ("GNMA"). The payment of principal and interest on the FHLMC and FNMA Mortgage-Backed Securities are guaranteed by those respective agencies and the payment of principal and interest on the GNMA Mortgage-Backed Securities are backed by the full-faith-and-credit of the U.S. government. At December 31, 1999 and 1998, all of the Company’s Mortgage-Backed Securities have an implied "AAA" rating. Income Taxes–The Company has elected to be taxed as a Real Estate Investment Trust ("REIT") and intends to comply with the provisions of the Internal Revenue Code of 1986, as amended (the "Code") with respect thereto. Accordingly, the Company will not be subjected to Federal income tax to the extent of its distributions to shareholders and as long as certain asset, income and stock ownership tests are met. Use of Estimates–The preparation of financial statements in conformity with generally accepted accounting principles 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 from those estimates. Reclassifications–Certain prior year amounts have been reclassified to conform to the current year presentation. 2. Mortgage-Backed Securities The following table pertains to the Company’s Mortgage-Backed Securities classified as available-for-sale as of December 31, 1999, which are carried at their fair value: Mortgage-Backed Securities, gross Unamortized discount Unamortized premium Federal Home Loan Mortgage Corporation $454,711,462 Federal National Mortgage Association $900,782,563 Government National Mortgage Association $97,423,038 Total Mortgage Assets $1,452,917,063 (171,241) 8,454,547 (964,133) 13,359,448 – 1,765,457 (1,135,374) 23,579,452 Amortized cost 462,994,768 913,177,878 99,188,495 1,475,361,141 Gross unrealized gains Gross unrealized losses 359,888 1,171,250 – 1,531,138 (12,091,145) (22,966,353) (4,042,150) (39,099,648) Estimated fair value $451,263,511 $891,382,775 $95,146,345 $1,437,792,631 The following table pertains to the Company’s Mortgage-Backed Securities classified as available-for-sale as of December 31, 1998, which are carried at their fair value: Federal Home Loan Mortgage Corporation Federal National Mortgage Association Government National Mortgage Association Total Mortgage Assets file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (24 of 33) [05/25/2000 11:53:39 AM] Annaly Corporate Profile Mortgage-Backed Securities, gross Unamortized discount Unamortized premium $449,433,408 $955,650,670 $97,330,495 $1,502,414,573 (184,996) (423,583) – (608,579) 8,852,370 14,264,277 1,770,397 24,887,044 Amortized cost 458,100,782 969,491,364 99,100,892 1,526,693,038 Gross unrealized gains Gross unrealized losses 659,557 2,092,119 549,900 3,301,576 (3,487,784) (5,692,759) (525,309) (9,705,852) Estimated fair value $455,272,555 $965,890,724 $99,125,483 $1,520,288,762 The adjustable rate Mortgage-Backed Securities are limited by periodic caps (generally interest rate adjustments are limited to no more than 1% every six months) and lifetime caps. The weighted average lifetime cap was 10.6% at December 31, 1999 and 1998. During the year ended December 31, 1999, the Company realized $563,259 in gains from sales of Mortgage-Backed Securities. Losses totaled $108,477 for the year ended December 31, 1999. During the year ended December 31, 1998, the Company realized $3,344,070 in gains from sales of Mortgage-Backed Securities. Losses totaled $9,964 for the year ended December 31, 1998. 3. Repurchase Agreements The Company had outstanding $1,338,295,750 and $1,280,510,000 of repurchase agreements with a weighted average borrowing rate of 5.26% and 5.21% and a weighted average remaining maturity of 20 days and 29 days as of December 31, 1999 and 1998, respectively. At December 31, 1999 and 1998, Mortgage-Backed Securities actually pledged had an estimated fair value of $1,376,684,559 and $1,458,669,078, respectively. At December 31, 1999 and 1998, the repurchase agreements had the following remaining maturities: Within 30 days 30 to 59 days 60 to 89 days 90 to 119 days 4. Common Stock 1999 $1,197,416,250 25,767,000 – 115,112,500 $1,338,295,750 1998 $1,222,542,000 31,346,000 26,622,000 – $1,280,510,000 During the year ended December 31, 1999, 57,204 options were exercised at $233,276. Also, 875,688 shares were purchased in direct offerings, totaling $8,170,602. During the year ended December 31, 1998, 44,124 options were exercised at $195,099. Stock buybacks during the year ended December 31, 1998 totaled 109,600 shares at a cost of $903,163. During the Company’s year ending December 31, 1999, the Company declared dividends to shareholders totaling $17,977,754, or $1.39 per weighted average share, of which $13,224,293 was paid during the year and $4,753,461 was file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (25 of 33) [05/25/2000 11:53:39 AM] Annaly Corporate Profile paid on January 27, 2000. During the Company’s year ending December 31, 1998, the Company declared dividends to shareholders totaling $15,437,554, or $1.22 per weighted average share, of which $11,579,891 was paid during the year and $3,857,663 was paid on January 25, 1999. 5. Earnings Per Share (EPS) In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting No. 128, Earnings Per Share (SFAS No. 128), which requires dual presentation of Basic EPS and Diluted EPS on the face of the income statement for all entities with complex capital structures. SFAS No. 128 also requires a reconciliation of the numerator and denominator of Basic EPS and Diluted EPS computation. For the year ended December 31, 1999, the reconciliation is as follows: Years Ended December 31, 1999 Net income Basic EPS Effect of dilutive securities: Dilutive stock options Diluted EPS Income (Numerator) Shares (Denominator) Per-Share Amount $18,139,280 18,139,280 12,889,510 $1.41 – $18,139,280 564,497 13,454,007 $1.35 Options to purchase 708,380 shares were outstanding during the year (Note 6) and were dilutive as the exercise price (between $4.00 and $8.94) was less than the average stock price for the year for the Company of $9.58. Options to purchase 135,676 shares of stock were outstanding and not considered dilutive. The exercise price (between $10.00 and $11.25) was greater than the average stock price for the year of $9.58. For the year ended December 31, 1998, the reconciliation is as follows: Year Ending December 31, 1998 Net income Basic EPS Effect of dilutive securities: Dilutive stock options Diluted EPS Income (Numerator) $15,488,923 15,488,923 Shares (Denominator) Per-Share Amount 12,709,116 $1.22 – $15,488,923 311,532 13,020,648 $1.19 Options to purchase 446,084 shares were outstanding during the year (Note 6) and were dilutive as the exercise price (between $4.00 and $8.13) was less than the average stock price for the year for the Company of $9.36. Options to purchase 147,676 shares of stock were outstanding and not considered dilutive. The exercise price (between $10.00 and $11.28) was greater than the average stock price for the year of $9.36. 6. Long Term Stock Incentive Plan The Company has adopted a Long Term Stock Incentive Plan for executive officers, key employees and nonemployee directors (the "Incentive Plan"). The Incentive Plan authorizes the Compensation Committee of the Board of Directors to grant awards, including incentive stock options as defined under section 422 of the Code ("ISOs") and options not so qualified ("NQSOs"). The Incentive Plan authorizes the granting of options or other awards for an aggregate of the greater of 500,000 shares or 9.95% of the outstanding shares of the Company’s common stock. The Company adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation cost for the Incentive Plan has been determined based on the fair value at the grant date for awards consistent with the provisions of SFAS No. 123. For file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (26 of 33) [05/25/2000 11:53:39 AM] Annaly Corporate Profile the Company’s pro forma net earnings, the compensation cost will be amortized over the vesting period of the options. The Company’s net earnings per share would have been reduced to the pro forma amounts indicated below: Year Ending December 31, Net earnings–as reported Net earnings–pro forma Earnings per share–as reported Earnings per share–pro forma 1999 $18,139,280 18,010,908 $1.41 $1.40 1998 $15,488,925 15,280,631 $1.22 $1.20 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in the year ended December 31, 1999: dividend yield of 15%; expected volatility of 32%; risk-free interest rate of 5.61%; and the weighted average expected lives of seven years. For the year ended December 31, 1998, dividend yield of 10%; expected volatility of 33%; risk-free interest rate of 5.56%; and the weighted average expected lives of six years. Information regarding options at December 31, 1999 is as follows: Outstanding, January 1, 1999 Granted (298,068 ISOs, 545,988 NQSOs) Exercised Expired Outstanding, December 31, 1999 Weighted average fair value of options granted during the year (per share) Options Outstanding Weighted Average Exercise Price $7.42 8.63 593,760 307,500 (57,204) – 844,056 $0.63 4.08 – $8.03 Information regarding options at December 31, 1998, is as follows: Outstanding, January 1, 1998 Granted (282,272 ISOs, 311,488 NQSOs) Exercised Expired Outstanding, December 31, 1998 Weighted average fair value of options granted during the year (per share) Options Outstanding Weighted Average Exercise Price $6.42 8.17 348,500 289,384 (44,124) – 593,760 $1.99 4.34 – $7.42 The following table summarizes information about stock options outstanding at December 31, 1999: Range of Exercise Prices $4.00 8.13 8.63 8.94 10.00 Options Outstanding 122,502 278,378 300,000 /FONT> 7,500 125,750 Weighted Average Remaining Contractual Life (Yrs.) 2 9 10 3 2 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (27 of 33) [05/25/2000 11:53:39 AM] Annaly Corporate Profile 10.75 11.25 7,500 2,426 844,056 3 3 7.2 At December 31, 1999 and 1998, 162,389 and 56,241 options were vested and not exercised, respectively. 7. Comprehensive Income The Company adopted FASB Statement No. 130, Reporting Comprehensive Income. Statement No. 130 requires the reporting of comprehensive income in addition to net income from operations. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. The Company at December 31, 1999 and 1998 held securities classified as available-for-sale. At December 31, 1999, the net unrealized losses totaled $37,568,510 and at December 31, 1998, the net unrealized losses totaled $6,404,275. 8. Lease Commitments The Corporation has a noncancelable lease for office space, which commenced in April 1998 and expires in December 2007. The Corporation’s aggregate future minimum lease payments are as follows: 2000 2001 2002 2003 2004 2005 2006 2007 Total remaining lease payments 9. Related Party Transaction $95,299 97,868 100,515 110,261 113,279 116,388 119,590 122,888 $876,088 Included in "Other Assets" on the Balance sheet is an investment in Annaly International Money Management, Inc. On June 24, 1998, the Company acquired 99,960 nonvoting shares, at a cost of $49,980. The officers and directors of Annaly International Money Management Inc. are also officers and directors of the Company. 10.Summarized Quarterly Results (Unaudited) The following is a presentation of the quarterly results of operations for the year ended December 31, 1999. Quarters Ending Interest income from Mortgage-Backed Securities and cash Interest expense on repurchase agreements Net interest income Gain on sale of Mortgage-Backed Securities March 31, 1999 $22,014,941 June 30, 1999 September 30, 1999 December 31, 1999 $23,370,851 $22,161,272 $22,264,930 17,151,041 16,865,824 17,232,086 18,597,255 4,863,900 64,560 5,399,106 25,853 4,929,186 97,656 4,773,596 266,713 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (28 of 33) [05/25/2000 11:53:40 AM] Annaly Corporate Profile General and administrative expenses Net income Net income per share: Basic Dilutive Average number of shares outstanding: Basic Dilutive 610,004 561,010 513,60 596,676 $4,318,456 $4,863,949 $4,513,242 $4,443,633 $0.34 $0.33 $0.38 $0.37 $0.35 $0.35 $0.33 $0.32 12,657,884 12,952,822 12,697,338 13,110,275 12,745,416 13,025,096 13,383,426 13,992,414 The following is a presentation of the quarterly results of operations for the year ended December 31, 1998. Quarters Ending Interest income from Mortgage-Backed Securities and cash Interest expense on repurchase agreements Net interest income Gain on sale of Mortgage-Backed Securities General and administrative expenses Net income Net income per share: Basic Dilutive Average number of shares outstanding: Basic Dilutive Independent Auditors Report March 31, 1998 $20,078,721 June 30, 1998 September 30, 1998 December 31, 1999 $22,136,390 $24,008,567 $23,761,953 16,313,474 20,177,580 20,765,301 18,478,925 3,765,247 1,427,084 3,584,373 295,875 3,243,266 993,630 3,657,465 627,517 484,181 493,718 528,240 599,185 $4,708,150 $3,386,530 $3,708,656 $3,685,797 $0.37 $0.36 $0.27 $0.26 $0.29 $0.29 $0.29 $0.29 12,727,405 12,923,195 12,757,674 12,959,771 12,704,194 12,785,765 12,648,116 12,731,192 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (29 of 33) [05/25/2000 11:53:40 AM] Annaly Corporate Profile Independent Auditors Report To the Stockholders of Annaly Mortgage Management, Inc. We have audited the accompanying balance sheets of Annaly Mortgage Management, Inc. (the "Company") as of December 31, 1999 and 1998, and the related statements of operations, stockholders’ equity and cash flows for the years ended December 31, 1999 and 1998. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1999 and 1998 and the results of its operations and its cash flows for the year ended December 31, 1999 and 1998 in conformity with generally accepted accounting principles. Deloitte & Touche, L.L.P. New York, New York February 11, 2000 Common Stock and Market Data The Company’s Common Stock began trading October 8, 1997 on the New York Stock Exchange under the trading symbol NLY. The following tables set forth, for the quarters indicated, the high, low, and closing sales price per share of common Stock as reported on the New York Stock Exchange and the cash dividends declared per share of Common Stock. First Quarter ended March 31, 1999 Second Quarter ended June 30, 1999 Third Quarter ended September 30, 1999 Fourth Quarter ended December 31, 1999 First Quarter ended March 31, 1998 Second Quarter ended June 30, 1998 Third Quarter ended September 30, 1998 High $10.25 $11.38 $11.50 $9.44 $11.75 $11.31 $9.00 Stock Prices Low $7.94 $9.31 $9.19 $8.06 $10.00 $8.69 $6.75 Close $10.25 $11.25 $9.31 $8.75 $11.81 $9.06 $8.13 file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (30 of 33) [05/25/2000 11:53:40 AM] Annaly Corporate Profile Fourth Quarter ended December 31, 1998 $9.00 $6.13 $8.25 First Quarter ended March 31, 1999 Second Quarter ended June 30, 1999 Third Quarter ended September 30, 1999 Fourth Quarter ended December 31, 1999 First Quarter ended March 31, 1998 Second Quarter ended June 30, 1998 Third Quarter ended September 30, 1998 Fourth Quarter ended December 31, 1998 Fourth Quarter ended December 31, 1997 Cash Dividends Declared Per Share $0.33 $0.35 $0.35 $0.35 $0.32 $0.32 $0.27 $0.305 $0.22 We intend to pay quarterly dividends and to make distributions to our stockholders in amounts that all or substantially all of our taxable income in each year (subject to certain adjustments) is distributed. This will enable us to qualify for the tax benefits accorded to a REIT under the Code. All distributions will be made at the discretion of our Board and will depend on our earnings, our financial condition, maintenance of our REIT status and such other factors as our Board of Directors may deem relevant from time to time. Corporate Officers Michael A.J. Farrell Chairman of the Board & Chief Executive Officer Wellington J. St. Claire Vice Chairman & Chief Investment Officer Timothy J. Guba President & Chief Operating Officer Kathryn F. Fagan Chief Financial Officer & Treasurer Jennifer A. Stephens Senior Vice President & Corporate Secretary James P. Fortescue Vice President Kristopher R. Konrad Assistant Vice President Rose-Marie Miller file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (31 of 33) [05/25/2000 11:53:41 AM] Annaly Corporate Profile Assistant Vice President Board of Directors Michael A.J. Farrell Chairman of the Board & Chief Executive Officer Wellington J. St. Claire Vice Chairman & Chief Investment Officer Timothy J. Guba President & Chief Operating Officer Kevin P. Brady Founder & Principal KPB Associates Spencer I. Browne Former President & Chief Executive Officer Asset Investors Corporation Jonathan D. Green President & Chief Executive Officer Rockefeller Group Development Corporation John A. Lambiase Former Managing Director Salomon Brothers, Inc. Donnell A. Segalas Principal Maplewood Partners Corporate Headquarters Annaly Mortgage Management, Inc. 12 East 41st Street, Suite 700 New York, New York 10017 (888) 8ANNALY Legal Counsel Morgan, Lewis & Bockius L.L.P. 101 Park Avenue New York, New York 10178-0060 Auditors Deloitte & Touche L.L.P. Two World Financial Center New York, New York 10281-1434 Stock Transfer Agent Shareholder inquiries concerning dividend payments, lost certificates, change of address: ChaseMellon Shareholder Services, L.L.C file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (32 of 33) [05/25/2000 11:53:41 AM] Annaly Corporate Profile PO Box 3315 South Hackensack, New Jersey 07606-1915 (800) 851-9677 www.chasemellon.com Stock Exchange Listing The common stock is listed on the New York Stock Exchange (symbol: NLY) Annual Meeting The Annual Meeting of Stockholders will be held Monday, May 15, 2000 at 9 a.m. at 101 Park Avenue, New York, New York 39th Floor Shareholder Communications Copies of the Companys Annual Report and Financials may be obtained by writing the Corporate Secretary, by calling the investor relations hot line at 888-8ANNALY, or by visiting our website at www.annaly.com About the cover: Annaly Mortgage Management invests in mortgage-backed securities. To date, all of the mortgage assets underlying these mortgage-backed securities were secured with a first lien on the underlying single-family properties. Therefore, we hosted a contest for elementary school students to draw a picture of their house. We would like to thank all participants for the excellent drawings. file:///H|/new deals/ns1/Annaly/NLYFilings/99Annual/Annaly99.html (33 of 33) [05/25/2000 11:53:41 AM] 

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