Annaly Capital Management
Annual Report 2007

Plain-text annual report

A N N A L Y CAPITAL MANAGEMENT, INC. 2 0 0 7 TABLE OF CONTENTS 2 Corporate Profile 4 Letter from the Chairman 6 Selected Financial Data 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 20 Management Report on Internal Control Over Financial Reporting 21 Report of Independent Registered Public Accounting Firm 22 Consolidated Statements of Financial Condition 23 Consolidated Statements of Operations and Comprehensive Income (Loss) 24 Consolidated Statements of Stockholders’ Equity 25 Consolidated Statements of Cash Flows 26 Notes to Consolidated Financial Statements 29 Share Performance Analysis 36 Common Stock and Market Information IBC Corporate Information A N N A L Y CAPITAL MANAGEMENT, INC. 2007 Annual Report Prodesse Non Nocere Our family crest and its motto “Prodesse Non Nocere” are trademarks of the Company. The description figuratively means ‘Proceed without fear.’ That symbolizes the confidence we try to instill in our investors. It is reinforced by years of reliable, highly competitive investment performance. The Brooklyn Bridge, 1900. uring 2007, Annaly executed three secondary common stock offerings, increasing shareholder equity to $5.2 billion at the end of the year. We increased dividends each quarter over the last two years, declaring dividends to common shareholders of $1.04 per share in 2007 D versus $0.57 in 2006, an increase of 82%. FIDAC, our wholly-owned registered investment advisor, increased net assets under management by over 19% and generated $18 million in net fee income. SHAREHOLDERS’ EQUITY (dollars in millions) DIVIDEND GROWTH “The cities of New York and Brooklyn have constructed, and today rejoice in the possession of, the crowning glory of an age memorable for great industrial achievements.” - Abram Hewitt Mayor of NYC, 1887 $6,000 5,000 4,000 3,000 2,000 1,000 0 $0.35 $0.30 $0.25 $0.20 $0.15 $0.10 $0.05 $1,1489 2003 $1,700 2004 $1,504 2005 $2,543 2006 $5,205 2007 $0.00 1st 2nd 3rd 2006 4th 1st 2nd 3rd 2007 4th 1 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report ““II would rather C O R P O R A T E P R O F I L E be the man who bought the Brooklyn Bridge than the man who sold it.”” Will Rogers Annaly’s senior management founded FIDAC in July 1994 and Annaly in November 1996. Annaly celebrated its 10th Anniversary as a publicly traded company in 2007. Looking back from our IPO in October 1997 through 2007, the company has been resilient through turbulent markets returning over 346% to investors and raising over $5.0 billion in additional shareholder equity. Annaly Capital Management, Inc. manages assets on behalf of institutional and individual investors worldwide through Annaly and funds managed by its wholly-owned registered investment advisor, FIDAC. Annaly’s principal business objective is to generate net income for distribution to investors from the spread between the interest income on its Mortgage-Backed Securities and the cost of borrowing to finance their acquisition and from dividends Annaly receives from FIDAC, which earns investment advisory fees. We have elected to be taxed as a real estate investment trust (or REIT) under the Internal Revenue Code and therefore are required to pay out at least 90% of our earnings to our shareholders in order to avoid taxation at the corporate level. All of the investment securities owned by Annaly are issued and guaranteed by US Government Agencies and carry an actual or implied AAA rating. We structure our portfolio using the Annaly MBS Barbell Strategysm. This strategy utilizes a combination of adjustable, floating, and fixed-rate Mortgage-Backed Securities so that it can perform through a wide range of interest rate environments. We employ leverage to enhance our returns. To date, our debt has consisted entirely of borrowings collateralized by a pledge of our Mortgage-Backed Securities. On our balance sheet, these borrowings appear as Repurchase Agreements. Our leverage, measured as a ratio of debt-to-equity, typically is managed in a band of 8:1 to 12:1. The Annaly and FIDAC team is experienced in Wall Street trading, management and operations, with a specialization in investing in mortgage-backed securities on a leveraged basis. Our success and future growth prospects are based on the proven ability of our strong and seasoned management team to successfully take advantage of market opportunities and deliver compelling returns in a wide range of interest rate environments. Michael A. J. Farrell Chairman, President & Chief Executive Officer Wellington J. Denahan-Norris Vice Chairman, Chief Investment Officer & Chief Operating Officer Kathryn F. Fagan Chief Financial Officer & Treasurer R. Nicholas Singh Executive Vice President & General Counsel Chronicling American life like no other illustrated periodical of its time, Harper's Weekly covered the Brooklyn Bridge's construction in text and pictures from 1870 to 1883; its evolution into an icon of New York City. -BrooklynMuseum 2 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. The Great East River Suspension Bridge, Currier and Ives, c1883. FIDAC generated over $18 million in net fee income in 2007 and over $74 million in net fee income since its acquisition by Annaly in 2004. The fee income generated by FIDAC adds to the spread income earned by Annaly to benefit Annaly shareholders. At December 31, 2007, FIDAC managed, advised or sub-advised approximately $3.1 billion in net assets, an increase of 19.2% over the prior year, through numerous offshore and onshore public and private investment funds distributed globally as well as separate accounts for high net worth individuals, municipal funds and school endowments. In 2007, FIDAC became the manager for Chimera Investment Corporation. Chimera (NYSE: CIM) raised over $500 million in gross proceeds in its initial public stock offering in November 2007. Annaly made an investment of approximately $54.3 million in Chimera, representing 9.8% ownership at the date of launch. Chimera is a specialty finance company that invests in residential mortgage loans, residential mortgage-backed securities, real-estate related securities and other asset classes. Chimera is organized as a REIT for federal income tax purposes. The team managing Annaly fills the same roles at FIDAC. The general strategy for the majority of the investment products managed by FIDAC is to provide net interest income for distribution to investors from the spread between the interest income earned from the assets we purchase and the cost of financing their acquisition. Annaly shareholders benefit from the stream of dividend income received from FIDAC. In 1883, the great American showman, P. T. Barnum, best remembered for his Ringling Bros. and Barnum & Bailey Circus, was denied the right to march Jumbo across the Brooklyn Bridge on opening day. One week later, rumor spread that the bridge was unsafe. Fear of collapse caused panic and a stampede, leaving 12 dead and 30 injured. In 1884, officials granted P.T. Barnum permission to cross the bridge with a herd of 21 elephants to demonstrate the strength of New York City's newest landmark. Ronald D. Kazel Managing Director Jeremy Diamond Managing Director James P. Fortescue Executive Vice President, Head of Liabilities Kristopher Konrad Executive Vice President, Co-Head of Portfolio Management Rose-Marie Lyght Executive Vice President, Co-Head of Portfolio Management 3 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report L E T T E R F R O M T H E C H A I R M A N Dear Fellow Shareholders, Growing up in Brooklyn gave me the unique perspective of living in an urban environment that had so many links to the rest of New York City and yet, in a very physical sense, was disconnected from it and the wider world. I learned that the connections and passageways to and from Brooklyn were as important as the place itself. Generations of Brooklynites have observed the construction of these linkages in the form of bridges, tunnels and mass transportation. As a boy, I witnessed the 20 minute ferry ride from 69th Street in Brooklyn to Staten Island turn into the graceful, sweeping presence of the Verrazano Bridge. I have vivid memories of crossing into Manhattan on the Brooklyn Bridge; from a provincial urban blend of families, pubs, synagogues and churches to the canyons of commerce on Wall Street and the possibilities beyond Brooklyn. “Over the past four years, in our commentaries and our filings, we have outlined our growing concerns about the building pressures of the mortgage debt bubble and the risks embedded in the global financial system by poor underwriting standards.” We are bond managers at Annaly. When we first started meeting with equity investors to raise capital in 1997, it became clear that we needed to understand their motivations as well as deepen their understanding of the fixed income markets, particularly the mortgage market. We also sought to establish Annaly as a mechanism by which these investors could understand and access the opportunities on our side of the investment universe. In many ways, over our ten-year history Annaly has become the equity investor’s bridge to the largest fixed income market in the world. Now more than ever, this role has taken on greater importance. Over the past several years, in our commentaries and our filings, we have outlined our growing concerns about the building pressures of the mortgage debt bubble and the risks embedded in the global financial system by poor underwriting standards. While Annaly has navigated its way through the creation and now destruction of this debt bubble, we have adhered to an avoidance of credit risk and continued to focus on assets issued by Ginnie Mae, Fannie Mae and Freddie Mac. These assets, wrapped with principal and interest insurance from those Government Sponsored Enterprises, are secured by the collateral of the mortgage- borrower’s home, the conforming loan underwriting standards (including mortgage size limits, loan-to-value ceilings and loan documentation requirements), and the rights of foreclosure. As the forces that pierced the bubble swept across the economy in the latter half of 2007, these assets continued to perform very well during the turbulence. History will record that Annaly increased its dividend per common share by over 80% during 2007, increased its book value by nearly 9% and increased its stockholders equity over 100%. 4 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. Like all asset managers, the true assets of our company travel up and down in elevators every day. In this year of such extreme market dislocation, it would be less than gracious to not recognize the people with whom I work every day. As evidenced by the numbers above, these people excelled in 2007. In light of the opportunities in front of us, decks were cleared, personal plans cancelled, long hours worked in pursuit of opportunities for the benefit of Annaly shareholders. There are literally no words to express my confidence in and gratitude towards them. Bridges are fundamentally constructed to reach across rivers and valleys. They provide pathways for economic and community development, relieve geographic concentrations and open up new vistas and horizons, even for a boy from Brooklyn. America would be a much different place without these architectural wonders. Bridges are also the medium for transition between one terrain and another. I believe that the United States is going through such a transition right now in the financial markets, the housing market and the economy. Much of what is constructed in the financial markets acts as a metaphorical link to opportunities that investors might not be able to see or access from their side of the bridge. This is true of most investments, and it is especially true about Annaly. Prodesse Non Nocere Michael A. J. Farrell March 17, 2008 5 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report SELECTED FINANCIAL DATA (dollars in thousands, except for per share data) Statement of Operations Data: Interest income Interest expense Net interest income Other income (loss): Investment advisory and service fees Gain (loss) on sale of investment securities Gain on termination of interest rate swaps Income from trading securities Dividend income from available-for-sale equity securities Loss on other-than-temporarily impaired securities Total other income (loss) Expenses: Distribution fees General and administrative expenses Total Expenses Impairment of intangible for customer relationships Income before income taxes Income taxes Income (loss) before minority interest Minority interest Net income (loss) Dividends on preferred stock Net income available (loss related) to common shareholders Basic net (loss) income per average common share Diluted net (loss) income per average common share Dividends declared per common share Dividends declared per preferred Series A share Dividends declared per preferred Series B share Balance Sheet Data: Mortgage-Backed Securities, at fair value Agency Debentures, at fair value Total assets Repurchase agreements Total liabilities Stockholders’ equity Number of common shares outstanding Other Data: Average total assets Average investment securities Average borrowings Average equity Yield on average interest earning assets Cost of funds on average 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 total assets G&A expense as a percentage of average equity Return on average total assets Return on average equity 6 December 31, 2007 December 31, 2006 For the Year Ended December 31, 2005 December 31, 2004 December 31, 2003 $2,355,447 1,926,465 428,982 $1,221,882 1,055,013 166,869 $705,046 568,560 136,486 $532,328 270,116 262,212 $337,433 182,004 155,429 22,028 19,062 2,096 19,147 91 (1,189) 61,235 3,647 62,666 66,313 — 423,904 8,870 415,034 650 414,384 21,493 $392,891 $1.32 $1.31 $1.04 $1.97 $1.50 December 31, 2007 $52,879,528 253,915 53,903,514 46,046,560 48,585,536 5,204,938 401,822,703 December 31, 2007 $41,834,831 40,800,148 37,967,215 3,710,821 5.77% 5.07% 0.70% 1.03% 0.15% 1.69% 0.99% 11.17% 22,351 (3,862) 10,674 3,994 — (52,348) (19,191) 3,444 40,063 43,507 2,493 101,678 7,538 94,140 324 93,816 19,557 35,625 (53,238) — — — (83,098) (100,711) 8,000 26,278 34,278 — 1,497 10,744 (9,247) — (9,247) 14,593 12,512 5,215 — — — — 17,727 2,860 24,029 26,889 — 253,050 4,458 248,592 — 248,592 7,745 — 40,907 — — — — 40,907 — 16,233 16,233 — 180,103 — 180,103 — 180,103 — $74,259 ($23,840) $240,847 $180,103 $0.44 $0.44 $0.57 $1.97 $1.08 December 31, 2006 ($0.19) ($0.19) $1.04 $1.97 — December 31, 2005 $2.04 $2.03 $1.98 $1.45 — December 31, 2004 $30,167,509 49,500 30,715,980 27,514,020 28,056,149 2,543,041 205,345,591 $15,929,864 — 16,063,422 13,576,301 14,559,399 1,504,023 123,684,931 For the Year Ended December 31, 2005 $19,038,386 390,509 19,560,299 16,707,879 17,859,829 1,700,470 121,263,000 $1.95 $1.94 $1.95 — — December 31, 2003 $11,956,512 978,167 12,990,286 11,012,903 11,841,066 1,149,220 96,074,096 December 31, 2006 December 31, 2004 December 31, 2003 $23,130,057 23,029,195 21,399,130 2,006,206 5.31% 4.93% 0.38% $18,724,075 18,543,749 17,408,828 1,614,743 3.80% 3.27% 0.53% $17,293,174 16,399,184 15,483,118 1,550,076 3.25% 1.74% 1.51% $12,975,039 12,007,333 11,549,368 1,122,633 2.81% 1.58% 1.23% 0.72% 0.17% 2.00% 0.41% 4.68% 0.73% 0.14% 1.63% (0.05%) (0.57%) 1.52% 0.14% 1.55% 1.44% 16.04% 1.20% 0.13% 1.45% 1.39% 16.04% 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This annual report and our public documents to which we refer contain or incorporate by reference certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. For- ward-looking statements which are based on various assumptions (some of which are beyond our control) may be identified by refer- ence to a future period or periods or by the use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “antici- pate,” “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 yield curve, changes in prepayment rates, the availabil- ity of mortgage-backed securities for purchase, the availability of financing and, if available, the terms of any financing, changes in the market value of our assets, changes in business conditions and the general economy, and risks associated with the investment advisory business of FIDAC, including the removal by FIDAC’s clients of assets FIDAC manages, FIDAC’s regulatory requirements, and competition in the investment advisory business, changes in gov- ernment regulations affecting our business, and our ability to maintain our qualification as a REIT for federal income tax purposes. 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 Annual Report on Form 10-K for the fiscal year ended December 31, 2007 and all subsequent Quar- terly 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. Overview We are a REIT 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 investment securities and the costs of borrowing to finance our acquisition of investment securities and from dividends we receive from FIDAC. FIDAC is our wholly- owned taxable REIT subsidiary, and is a registered investment advisor that generates advisory and service fee income. We acquired approximately 3.6 million shares of common stock of Chimera Investment Corporation, or Chimera, for approximately $54.3 million in connection with Chimera’s initial public offering on November 21, 2007. In addition to our investment, Chimera raised net proceeds of approximately $479.3 million in its initial public offering. Chimera is a newly-formed, publicly traded, specialty finance company that invests in residential mortgage loans, residential mortgage-backed securities, real estate related securities and various other asset classes. Chimera is externally managed by FIDAC and intends to elect and qualify to be taxed as a REIT for federal income tax purposes. We also have a majority interest in an investment fund. We are primarily engaged in the business of investing, on a leveraged basis, in mortgage pass-through certificates, collateralized mort- gage obligations and other mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans (collectively, “Mortgage-Backed Securities”). We also invest in Federal Home Loan Bank (“FHLB”), Federal Home Loan Mortgage Corporation (“FHLMC”), and Federal National Mortgage Associa- tion (“FNMA”) debentures. The Mortgage-Backed Securities and agency debentures are collectively referred to herein as “Investment Securities.” Under our capital investment policy, at least 75% of our total assets must be comprised of high-quality mortgage-backed securities and short-term investments. High quality securities means securities that (1) are rated within one of the two highest rating categories by at least one of the nationally recognized rating agencies, (2) are unrated but are guaranteed by the United States government or an agency of the United States government, or (3) are unrated but we determine them to be of comparable quality to rated high-qual- ity mortgage-backed securities. The remainder of our assets, comprising not more than 25% of our total assets, may consist of other qualified REIT real estate assets which are unrated or rated less than high quality, but which are at least “investment grade” (rated “BBB” or better by Standard & Poor’s Corporation (“S&P”) or the equivalent by another nationally recognized rating agency) or, if not rated, we determine them to be of comparable credit quality to an investment which is rated “BBB” or better. In addition, we may directly or indirectly invest part of this remaining 25% of our assets in other types of securities, including without limitation, unrated debt, equity or derivative securities, to the extent consistent with our REIT qualification requirements. The derivative securities in which we invest may include securities representing the right to receive interest only or a disproportionately large amount of interest, as well as inverse floaters, which may have imbedded leverage as part of their structural characteristics. We may acquire Mortgage-Backed Securities backed by single-fam- ily residential mortgage loans as well as securities backed by loans on multi-family, commercial or other real estate related properties. To date, all of the Mortgage-Backed Securities that we have acquired have been backed by single-family residential mortgage loans. We have elected to be taxed as a REIT for federal income tax purposes. Pursuant to the current federal tax regulations, one of the requirements of maintaining our status as a REIT is that we must distribute at least 90% of our REIT taxable income (determined with- out regard to the deduction for dividends paid and by excluding any net capital gain) to our stockholders, subject to certain adjustments. The results of our operations are affected by various factors, many of which are beyond our control. Our results of operations primarily depend on, among other things, our net interest income, the market 7 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report value of our assets and the supply of and demand for such assets. Our net interest income, which reflects the amortization of purchase premiums and accretion of discounts, varies primarily as a result of changes in interest rates, borrowing costs and prepayment speeds, the behavior of which involves various risks and uncertainties. Prepay- ment speeds, as reflected by the Constant Prepayment Rate, or CPR, and interest rates vary according to the type of investment, conditions in financial markets, competition and other factors, none of which can be predicted with any certainty. In general, as prepayment speeds on our Mortgage-Backed Securities portfolio increase, related purchase premium amortization increases, thereby reducing the net yield on such assets. The CPR on our Mortgage-Backed Securities portfolio averaged 15% and 17% for the years ended December 31, 2007 and 2006, respectively. Since changes in interest rates may significantly affect our activities, our operating results depend, in large part, upon our ability to effectively manage interest rate risks and prepayment risks while maintaining our status as a REIT. The current situation in the sub-prime mortgage sector, and the current weakness in the broader mortgage market, could adversely affect one or more of our lenders and could cause one or more of our lenders to be unwilling or unable to provide us with additional financing. This could potentially increase our financing costs and reduce liquidity. If one or more major market participants fails, it could negatively impact the marketability of all fixed income securities, including government mortgage securities, and this could negatively impact the value of the securities in our portfolio, thus reducing its net book value. Furthermore, if many of our lenders are unwilling or unable to provide us with additional financing, we could be forced to sell our Investment Securities at an inopportune time when prices are depressed. Even with the current situation in the sub-prime mortgage sector we do not anticipate having difficulty con- verting our assets to cash or extending financing term, due to the fact that our investment securities have an actual or implied “AAA” rat- ing and principal payment is guaranteed. The table below provides quarterly information regarding our average balances, interest income, yield on assets, average repurchase agreement balances, interest expense, cost of funds, net interest income and net interest rate spreads for the quarterly periods presented. (ratios for the quarters have been annualized, dollars in thousands) Quarter Ended December 31, 2007 Quarter Ended September 30, 2007 Quarter Ended June 30, 2007 Quarter Ended March 31, 2007 Average Investment Securities Held(1) $49,619,857 $43,075,489 $38,822,274 $31,682,974 Yield on Average Investment Securities Average Balance of Repurchase Agreements 5.81% $45,272,782 5.84% $40,201,513 5.73% $36,560,359 5.68% $29,834,208 Total Interest Income $720,925 $628,696 $556,262 $449,564 Interest Expense $558,435 $519,118 $468,748 $380,164 Average Cost of Funds Net Interest Income 4.93% $162,490 5.17% $109,578 $87,514 5.13% $69,400 5.10% Net Interest Rate Spread 0.88% 0.67% 0.60% 0.58% (1) Does not reflect unrealized gains/(losses). The following table presents the CPR experienced on our Mortgage-Backed Securities portfolio, on an annualized basis, for the quarterly periods presented. Quarter Ended CPR December 31, 2007 September 30, 2007 June 30, 2007 March 31, 2007 December 31, 2006 September 30, 2006 June 30, 2006 March 31, 2006 12% 14% 15% 17% 15% 16% 19% 18% We believe that the CPR in future periods will depend, in part, on changes in and the level of market interest rates across the yield curve, with higher CPRs expected during periods of declining interest rates and lower CPRs expected during periods of rising interest rates. We continue to explore alternative business strategies, alternative investments and other strategic initiatives to complement our core business strategy of investing, on a leveraged basis, in high quality Investment Securities. No assurance, however, can be provided that any such strategic initiative will or will not be implemented in the future. 8 For the purposes of computing ratios relating to equity measures, throughout this report, equity includes Series B preferred stock, which has been treated under GAAP as temporary equity. Critical Accounting Policies Management’s discussion and analysis of financial condition and results of operations is based on the amounts reported in our financial statements. These financial statements are prepared in con- formity with accounting principles generally accepted in the United States of America. In preparing the financial statements, management is required to make various judgments, estimates and assumptions that affect the reported amounts. Changes in these estimates and assumptions could have a material effect on our financial state- ments. The following is a summary of our policies most affected by management’s judgments, estimates and assumptions. Market Valuation of Investment Securities: All assets classified as available-for-sale are reported at fair value, based on market prices. Although we generally intend to hold most of our Investment Securities until maturity, we may, from time to time, sell any of our Investment Securities as part our overall management of our port- folio. Accordingly, we are required to classify all of our Investment Securities as available-for-sale. Our policy is to obtain market values from independent sources. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. The determination of whether a security is other-than- temporarily impaired involves judgments and assumptions based on subjective and objective factors. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Investments with unrealized losses are not considered other-than-temporarily impaired if the Company has the ability and intent to hold the investments for a period of time, to maturity if necessary, sufficient for a forecasted market price recov- ery up to or beyond the cost of the investments. Unrealized losses on Investment Securities that are considered other than temporary, as measured by the amount of decline in fair value attributable to fac- tors other than temporary, are recognized in income and the cost basis of the Investment Securities is adjusted. Interest income: Interest income is accrued based on the outstanding principal amount of the Investment Securities and their contractual terms. Premiums and discounts associated with the purchase of the Investment Securities are amortized or accreted into interest income over the projected lives of the securities using the interest method. Our policy for estimating prepayment speeds for calculating the effective yield is to evaluate historical performance, Wall Street consensus prepayment speeds, and current market conditions. If our estimate of prepayments is incorrect, we may be required to make an adjustment to the amortization or accretion of premiums and discounts that would have an impact on future income. Repurchase Agreements: We finance the acquisition of our Investment Securities through the use of repurchase agreements. Repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, including accrued interest, as specified in the respective agreements. Income Taxes: We have elected to be taxed as a REIT and intend to comply with the provisions of the Internal Revenue Code of 1986, as amended (or 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. The Company and FIDAC have made a joint election to treat FIDAC as a taxable REIT subsidiary. As such, FIDAC is taxable as a domestic C corporation and subject to federal and state and local income taxes based upon its taxable income. Impairment of Goodwill and Intangibles: The Company’s acquisi- tion of FIDAC was accounted for using the purchase method. The cost of FIDAC was allocated to the assets acquired, including identifiable intangible assets, and the liabilities assumed based on their estimated fair values at the date of acquisition. The excess of cost over the fair value of the net assets acquired was recognized as goodwill. Goodwill and finite-lived intangible assets are period- ically reviewed for potential impairment. This evaluation requires significant judgment. 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. Recent Accounting Pronouncements- In February 2006, the FASB Accounting for Certain Hybrid Instruments ), an amendment of FASB Statements No. 133 and 140. issued FAS No. 155, ( “SFAS 155” Among other things, SFAS 155: (i) permits fair value re-measure- ment for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; (ii) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133; (iii) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurca- tion; (iv) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and (v) amends SFAS 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 was effective for all financial instruments acquired or issued by the Company after January 1, 2007. Securitized interests which only contain an embedded derivative that is tied to the prepayment risk of the underlying prepayable financial assets and for which the investor does not control the right to accelerate the settlement of such financial assets are excluded under a scope exception adopted by the FASB. None of the Company’s assets were subject to SFAS 155 as a result of this scope exception. Consequently, the Company has continued to record changes in the market value of its investment securities through Other Comprehensive Income, a component of stockholders’ equity. Therefore, the adoption of SFAS 155 did not have any impact on the Company’s consolidated financial statements. , (“FIN 48”) Account- In July 2006, the FASB issued FASB Interpretation No. 48, ing for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 Accounting for Income Taxes. and related implementation issues. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the Company’s financial statements in accordance with SFAS No. 109, FIN 48 pre- scribes a threshold and measurement attribute for recognition in the financial statements of an asset or liability resulting from a tax posi- tion taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 was effective for the Company on January 1, 2007. There was no impact to the Company’s financial statements from imple- menting this new standard. Fair Value In September 2006, the FASB issued SFAS No. 157, Measurements (“SFAS 157”). SFAS 157 defines fair value, estab- lishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS 157 requires companies to disclose the fair value of its financial instruments according to a fair value hierarchy (i.e., levels 1, 2, and 3, as defined). Additionally, companies are required to provide enhanced disclosure regarding instruments in the level 3 category (the valuation of which require significant management judgment), including a reconciliation of the beginning and ending balances separately for each major cat- egory of assets and liabilities. SFAS 157 is effective for the Company 9 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report on January 1, 2008. The Company does not believe that the adoption of SFAS 157 will have a significant impact on its financial position or results of operations or the manner in which it estimates fair value, but expects that adoption will increase footnote disclosure to comply with SFAS 157 disclosure requirements for financial state- ments issued after January 1, 2008. The Fair Value In February 2007, the FASB issued SFAS No 159, Option for Financial Assets and Financial Liabilities – including an amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date SFAS 159 is effective for the Company commencing January 1, 2008. The Company is not expecting SFAS 159 to have an effect on the consolidated financial statements. The Company did not elect the fair value option for any existing eligible financial instruments. Proposed FASB Staff Position - The FASB issued a proposed FASB Staff Position (“FSP”) FAS No. 140-d relating to FASB Statement Accounting for Transfers of Financial Assets and Repur- No. 140, chase Financing Transactions to address situations where assets purchased from a particular counterparty and financed through a repurchase agreement with the same counterparty can be considered and accounted for as separate transactions. Currently, the Company records such assets and the related financing on a gross basis in the consolidated statement of financial condition, and the corresponding interest income and interest expense in the Company’s consolidated statement of operations and comprehensive income (loss). For assets representing available-for-sale investment securities, as in the Company’s case, any change in fair value is reported through other comprehensive income under SFAS 115, with the exception of impairment losses, which are recorded in the consolidated statement of operations and comprehensive (loss) income as realized losses. FASB’s proposed staff position requires that all of the following criteria be met in order to continue the application of SFAS 140 as described above: (1) the initial transfer of and repurchase financing cannot be contractually contingent; (2) the repurchase financing entered into between the parties provides full recourse to the transferee and the repurchase price is fixed; (3) the financial asset is “readily obtainable” in the marketplace and the transfer is executed at market rates; (4) the borrower maintains the right to the collateral and the lender cannot re-pledge the asset prior to settlement of the repurchase agreement; and (4) the repurchase agreement and finan- cial asset do not mature simultaneously. At this time, the Company believes that its purchases and subsequent financing through repurchase agreements with the same counterparty meet the criteria enumerated in the proposed FSP FAS No. 140-d for treatment as a non-linked transfer and repurchase under SFAS 140 and the Company believes that if the FSP is ultimately issued in substantially its current form, there will be no effect on the manner in which the Company records such assets, their financings, and the corresponding interest income and interest expense. FSP FAS 140-d 10 may be subject to significant changes prior to finalization, which may impact the Company’s current assessment of its impact. RESULTS OF OPERATIONS Net Income Summary For the year ended December 31, 2007, our net income was $414.4 million or $1.32 basic income per average share related to common shareholders, as compared to $93.8 million net income or $0.44 basic net income per average share for the year ended December 31, 2006. For the year ended December 31, 2005, our net loss was $9.2 million or $0.19 basic loss per average share related to common shareholders. Net income per average share increased by $0.88 per average share available to common shareholders and total net income increased $320.6 million for the year ended December 31, 2007, when compared to the year ended December 31, 2006. We attribute the increase in total net income for the year ended December 31, 2007 from the year ended December 31, 2006 to an increase in net inter- est income, gains on the sale of securities, a reduction in losses on other-than temporarily impaired securities, the increased asset base, and the increase in interest rate spread. Net interest income increased by $262.1 million for the year ended December 31, 2007, as com- pared to the year ended December 31, 2006, due to the increase in interest earning assets from the deployment of additional capital we raised in 2007 and the improved interest rate spread. For the year ended December 31, 2007, net gain on sale of Mortgage-Backed Securities was $19.1 million, as compared to a net loss of $3.9 million for the year ended December 31, 2006. The loss on other- than-temporarily impaired securities totaled $1.2 million for the year ended December 31, 2007, as compared to $52.3 million for the year ended December 31, 2006. During the year ended December 31, 2007, the Company realized a gain on the termination of interest rate swaps of $2.1 million, as compared to a $10.7 million gain for the year ended December 31, 2006. We attribute the increase in total net income for the year ended December 31, 2006 compared to the year ended December 31, 2005 to the increase in net interest income, reduction in losses on sales of securities and losses on other-than-temporarily impaired securities, and gains on termination of interest rate swaps. The interest rate spread decreased from 0.53% for the year ended December 31, 2005 to 0.38% for the year ended December 31, 2006. The total amortiza- tion for the year ended December 31, 2006 was $63.6 million and for the year ended December 31, 2005 was $154.3 million. This decline in amortization increased the yield on interest earning assets. The increased yield was more than offset by the increase funding cost, resulting in a net decline in interest rate spread. For the year ended December 31, 2006, net loss on sale of Mortgage-Backed Securities was $3.9 million, as compared to a net loss of $53.2 million in 2005. 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. The table below presents the net income (loss) summary for the years ended December 31, 2007, 2006, and 2005. Net Income (Loss) Summary (dollars in thousands, except for per share data) Interest income Interest expense Net interest income Other income (loss): Investment advisory and service fees Gain (loss) on sale of investment securities Gain on termination of interest rate swaps Income from trading securities Dividend income from available-for-sale equity securities Loss on other-than-temporarily impaired securities Total other income (loss) Expenses Distribution fees General and administrative expenses Total expenses Impairment of intangible for customer relationships Income before income taxes and minority interest Income taxes Income (loss) before minority interest Minority interest Net Income (loss) Dividends on preferred stock Net income available (loss related) to common shareholders Weighted average number of basic common shares outstanding Weighted average number of diluted common shares outstanding Basic net income (loss) per average common share Diluted net income (loss) per average common share Average total assets Average equity Return on average total assets Return on average equity December 31, 2007 $2,355,447 1,926,465 428,982 22,028 19,062 2,096 19,147 91 (1,189) 61,235 3,647 62,666 66,313 — 423,904 8,870 415,034 650 414,384 21,493 $392,891 297,488,394 306,263,766 $1.32 $1.31 $ 41,834,831 3,710,821 0.99% 11.17% For the Year Ended December 31, 2006 December 31, 2005 $1,221,882 1,055,013 166,869 22,351 (3,862) 10,674 3,994 (52,348) (19,191) 3,444 40,063 43,507 2,493 101,678 7,538 94,140 324 93,816 19,557 $74,259 167,666,631 167,746,387 $0.44 $0.44 $23,130,057 2,006,206 0.41% 4.68% $705,046 568,560 136,486 35,625 (53,238) — — (83,098) (100,711) 8,000 26,278 34,278 — 1,497 10,744 (9,247) — (9,247) 14,593 ($23,840) 122,475,032 122,475,032 ($0.19) ($0.19) $18,724,075 1,614,743 (0.05%) (0.57%) Interest Income and Average Earning Asset Yield Interest Expense and the Cost of Funds We had average earning assets of $40.8 billion for the year ended December 31, 2007. We had average earning assets of $23.0 billion for the year ended December 31, 2006. We had average earning assets of $18.5 billion for the year ended December 31, 2005. Our primary source of income is interest income. Our interest income was $2.4 billion for the year ended December 31, 2007, $1.2 billion for the year ended December 31, 2006, and $705.0 million for the year ended December 31, 2005. The yield on average investment securi- ties was 5.77%, 5.31%, and 3.80% for the respective periods. The prepayment speeds decreased to an average of 15% CPR for the year ended December 31, 2007 from an average of 17% CPR for the year ended December 31, 2006. The increase in coupon rates and reduc- tion in prepayment speeds resulted in an increase in yield. Our largest expense is the cost of borrowed funds. We had average borrowed funds of $38.0 billion and total interest expense of $1.9 bil- lion for the year ended December 31, 2007. We had average borrowed funds of $21.4 billion and total interest expense of $1.1 billion for the year ended December 31, 2006. We had average bor- rowed funds of $17.4 billion and total interest expense of $568.6 million for the year ended December 31, 2005. Our average cost of funds was 5.07% for the year ended December 31, 2007 and 4.93% for the year ended December 31, 2006 and 3.27 % for the year ended December 31, 2005. The cost of funds rate increased by 14 basis points and the average borrowed funds increased by $16.6 billion for the year ended December 31, 2007 when compared to the year ended December 31, 2006. Interest expense for the year 2007 11 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report increased by $871.5 million over the prior year due to the substan- tial increase in the average borrowed funds and the increase in the average cost of funds rate. The cost of funds rate increased by 166 basis points and the average borrowed funds increased by $4.0 bil- lion for the year ended December 31, 2006 when compared to the year ended December 31, 2005. Interest expense for the year ended December 31, 2006 increased by $486.5 million over the previous year due to the increase in the average borrowed funds. Since a sub- stantial portion of our repurchase agreements are short term, changes in market rates are directly reflected in our interest expense. Our aver- age cost of funds was 0.12% below average one-month LIBOR and 0.12% below average six-month LIBOR for the year ended Decem- ber 31, 2007. Our average cost of funds was 0.10% below average one-month LIBOR and 0.28% below average six-month LIBOR for the year ended December 31, 2006. Our average cost of funds was 0.06% below average one-month LIBOR and 0.45% below average six-month LIBOR for the year ended December 31, 2005. 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, 2007, 2006, 2005, 2004, and 2003 and the four quarters in 2007. Average Cost of Funds Average Borrowed Funds Interest Expense Average Cost of Funds Average One- Month LIBOR Average Six-Month LIBOR Average One-Month LIBOR Relative to Average Six-Month LIBOR Average of Funds Relative to Average One-Month LIBOR Average Cost of Funds Relative to Average Six-Month LIBOR $37,967,215 $1,926,465 5.07% 5.19% 5.19% (0.00%) (0.12%) (0.12%) $21,399,130 $17,408,828 $15,483,118 $11,549,368 $45,272,782 $40,201,513 $36,560,359 $29,834,208 $1,055,013 $568,560 $270,116 $182,004 $558,435 $519,118 $468,748 $380,164 4.93% 3.27% 1.74% 1.58% 4.93% 5.17% 5.13% 5.10% 5.03% 3.33% 1.50% 1.21% 4.86% 5.37% 5.32% 5.26% 5.21% (0.18%) 3.72% (0.39%) 1.80% (0.30%) 1.23% (0.02%) 0.01% 4.85% 5.31% 0.07% 5.37% (0.05%) 5.30% (0.04%) (0.28%) (0.10%) (0.06%) (0.45%) 0.24% (0.06%) 0.35%) 0.37% 0.08%) 0.07% (0.14%) (0.20%) (0.24%) (0.19%) (0.20%) (0.16%) (Ratios for the four quarters in 2007 have been annualized, dollars in thousands) For the Year Ended December 31, 2007 For the Year Ended December 31, 2006 For the Year Ended December 31, 2005 For the Year Ended December 31, 2004 For the Year Ended December 31, 2003 For the Quarter Ended December 31, 2007 For the Quarter Ended September 30, 2007 For the Quarter Ended June 30, 2007 For the Quarter Ended March 31, 2007 Net Interest Income Our net interest income, which equals interest income less interest expense, totaled $429.0 million for the year ended December 31, 2007, $166.9 million for the year ended December 31, 2006 and $136.5 million for the year ended December 31, 2005. Our net inter- est income increased for the year ended December 31, 2007, as compared to the year ended December 31, 2006, because of the increased average asset base in 2007 and the increased interest rate spread. In 2007 average assets increased because of the deployment of additional capital. 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 0.70% for the year ended December 31, 2007 as com- pared to 0.38% for the year ended December 31, 2006 and 0.53% for the year ended December 31, 2005. This 32 basis point increase in interest rate spread for 2007 over the spread for 2006 was the result in the increased yield of 46 basis points, partially offset by an increase of in the average cost of funds of 14 basis points. Our net interest income increased for the year ended December 31, 2006 as compared to the year ended December 31, 2005 by $30.4 million because of the increased average asset base for 2006. The table below shows our interest income by average Investment Securities held, total interest income, yield on average interest earning assets, average balance of repurchase agreements, interest expense, average cost of funds, net interest income, and net interest rate spread for the years ended December 31, 2007, 2006, 2005, 2004, and 2003 and the four quarters in 2007. Net Interest Income (Ratios for the four quarters in 2007 have been annualized, dollars in thousands) For the Year Ended December 31, 2007 For the Year Ended December 31, 2006 For the Year Ended December 31, 2005 For the Year Ended December 31, 2004 For the Year Ended December 31, 2003 For the Quarter Ended December 31, 2007 For the Quarter Ended September 30, 2007 For the Quarter Ended June 30, 2007 For the Quarter Ended March 31, 2007 12 Average Investment Securities Held $40,800,148 $23,029,195 $18,543,749 $16,399,184 $12,007,333 $49,619,857 $43,075,489 $38,822,274 $31,682,974 Total Interest Income $2,355,447 $1,221,882 $705,046 $532,328 $337,433 $720,925 $628,696 $556,262 $449,564 Yield on Average Interest Earning Assets Net Interest Interest Rate Expense Spread 5.77% $37,967,215 $1,926,465 5.07% $428,982 0.70% Average Balance of Repurchase Agreements Average Cost of Funds Net Interest Income 5.31% $21,399,130 $1,055,013 4.93% $166,869 0.38% $568,560 3.27% $136,486 0.53% 3.80% $17,408,827 $270,116 1.74% $262,212 1.51% 3.25% $15,483,118 $182,004 1.58% $155,429 1.23% 2.81% $11,549,368 $558,435 4.93% $162,490 0.88% 5.81% $45,272,782 $519,118 5.17% $109,578 0.67% 5.84% $40,201,513 $468,748 5.13% $87,514 0.60% 5.73% $36,560,359 $380,164 5.10% $69,400 0.58% 5.68% $29,834,208 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. Investment Advisory and Service Fees Income from Trading Securities FIDAC is a registered investment advisor which specializes in man- aging fixed income securities. FIDAC expanded its business in 2007 to manage Chimera Investment Corporation, a newly-formed spe- cialty finance company that invests in residential mortgage loans, residential mortgage-backed securities, real estate related securities and various other asset classes. In 2006 FIDAC expanded its busi- ness to include the management of equity securities, initially for us and an affiliated person and collateralized debt obligations. FIDAC generally receives annual net investment advisory fees on the assets it manages, assists in managing or supervises. At December 31, 2007, FIDAC had under management approximately $3.1 billion in net assets and $15.4 billion in gross assets, compared to $2.6 billion in net assets and $15.1 billion in gross assets at December 31, 2006. Net investment advisory and service fees for the years ended December 31, 2007, 2006, and 2005 totaled $18.4 million, $18.9 million, and $27.6 million, respectively, net of fees paid to third parties pursuant to distribution service agreements for facilitating and promoting distribution of shares or units to FIDAC’s clients. Gross assets under management will vary from time to time because of changes in the amount of net assets FIDAC manages as well as changes in the amount of leverage used by the various funds and accounts FIDAC manages. Gains and Losses on Sales of Investment Securities and Interest Rate Swaps For the year ended December 31, 2007, we sold Investment Securities with a carrying value of $4.9 billion for an aggregate gain of $19.1 million. In addition, we had a $2.1 million gain on the termination of interest rate swaps with a notional value of $900 million. For the year ended December 31, 2006, we sold investment securities with an aggregate historical amortized value of $3.2 billion for an aggre- gate loss of $3.9 million. In addition, the Company had a $10.7 million gain on the termination of interest rate swaps with a notional value of $1.2 billion. For the year ended December 31, 2005, we sold investment securities with an aggregate historical amortized value of $3.4 billion for an aggregate loss of $53.2 million. The loss on sale of assets for the year ended December 31, 2005 was due to portfolio rebalancing that was initiated in the fourth quarter of 2005. We determined that certain assets purchased in a much lower interest rate environment of 2003 and 2004 were unlikely to receive their amortized cost basis, and commenced selling these assets. The rebal- ancing was done with the objective of improving future financial performance. A positive 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. Gross income from trading securities totaled $19.1 million for the year ended December 31, 2007 and $4.0 million for the year ended December 31, 2006. Dividend Income from Available-For-Sale Equity Securities Dividend income from available-for-sale equity securities total $91,000 for the year ended December 31, 2007. For the years ended December 31, 2006 and 2005, we did not have an investment in avail- able-for-sale equity securities. Loss on Other-Than-Temporarily Impaired Securities At each quarter end, we review each of our securities to determine if an other-than-temporary impairment charge would be necessary. We will take these charges if we determine that we do not intend to hold securities that were in an unrealized loss position for a period of time, to maturity if necessary, sufficient for a forecasted market price recovery up to or beyond the cost of the investments. For the year ended December 31, 2007 the loss on other-than-temporarily impaired securities totaled $1.2 million. For the years ended Decem- ber 31, 2006 and 2005, the loss on other-than-temporarily impaired securities totaled $52.3 million and $83.1 million, respectively. Impairment of Goodwill and Intangibles During the year ended December 31, 2007, it was determined that there was no impairment of intangibles. The total impairment of intangible assets relating to customer relationships was $2.5 million for the year ended December 31, 2006. There was no impairment charges during the year ended December 31, 2005. There were no impairment charges related to goodwill during the years ended 2007, 2006, and 2005. General and Administrative Expenses General and administrative (or G&A) expenses were $62.7 million for the year ended December 31, 2007, $40.1 million for the year ended December 31, 2006, and $26.3 million for the year ended December 31, 2005. General and administrative expenses as a per- centage of average total assets was 0.15%, 0.17%, and 0.14% for the years ended December 31, 2007, 2006, and 2005, respectively. The increase in G&A expenses of $22.6 million for the year December 31, 2007 was primarily the result of increased salaries, directors and officers insurance and additional costs related to FIDAC. Staff increased from 31 at the end of 2005 to 34 at the end of 2006 and 39 at the end of 2007. Salaries and bonuses for the years ended Decem- ber 31, 2007, 2006, and 2005 were $48.1 million, $28.7 million and $18.8 million, respectively. 13 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report The table below shows our total G&A expenses as compared to average total assets and average equity for the years ended December 31, 2007, 2006, 2005, 2004, and 2003 and the four quarters in 2007. G&A Expenses and Operating Expense Ratios (Ratios for the quarters have been annualized, dollars in thousands) For the Year Ended December 31, 2007 For the Year Ended December 31, 2006 For the Year Ended December 31, 2005 For the Year Ended December 31, 2004 For the Year Ended December 31, 2003 For the Quarter Ended December 31, 2007 For the Quarter Ended September 30, 2007 For the Quarter Ended June 30, 2007 For the Quarter Ended March 31, 2007 Total G&A Expenses $62,666 $40,063 $26,278 $24,029 $16,233 $20,174 $17,334 $12,272 $12,886 Total G&A Expenses/Average Assets 0.15% Total G&A Expenses/Average Equity 1.69% 0.17% 0.14% 0.14% 0.13% 0.16% 0.16% 0.12% 0.15% 2.00% 1.63% 1.55% 1.45% 1.72% 1.94% 1.50% 1.70% Net Income and Return on Average Equity Our net income was $414.4 million for the year ended December 31, 2007, net income was $93.8 million for the year ended December 31, 2006, and our net loss was $9.2 million for the year ended Decem- ber 31, 2005. Our return on average equity was 11.17% for the year ended December 31, 2007, was 4.68% for the year ended December 31, 2006, and (0.57%) for the year ended December 31, 2005. Even with the increase in G&A expenses, net income for the year increased by $320.6 million. We attribute the increase in total net income for the year ended December 31, 2007 over the year ended December 31, 2006 to the increase in net interest income, the gains realized on sale of assets and the decrease in loss on other-than-temporarily impaired securities, income realized from trading securities, and the gains real- ized on the termination of interest rate swaps. The table below shows our net interest income, net investment advisory and service fees, gain (loss) on sale of Mortgage-Backed Securities and termination of interest rate swaps, loss on other-than-temporarily impaired securities, income from equity investment, dividend income from available-for-sale equity securities, G&A expenses, income taxes, impairment of intangibles for customer relationships, minority interest, each as a percentage of average equity, and the return on average equity for the years ended December 31, 2007, 2006, 2005, 2004, and 2003, and the four quarters in 2007. Components of Return on Average Equity Net Investment Advisory and Service Gain/(Loss) on Sale of Mortgage- Backed Securities and Interest Fees/ Rate Swaps/ Average Equity Average Equity Net Interest Income/ Average Equity Loss on other-than- Temporarily Impaired Securities/ Average Equity Income from Equity Investment/ Average Equity Dividend Income from Available- for-sale Equity Securities G&A Expenses/ Average Equity Income Taxes/ Average Equity Impairment of Intangible for Customer Relationships /Average Equity Minority Interest/ Average Equity Return on Average Equity 11.56% 0.50% 0.57% (0.03%) 0.52% 0.00% (1.69%) (0.24%) — (0.02%) 11.17% 8.32% 8.45% 16.92% 13.85% 13.89% 12.23% 10.71% 9.14% 0.94% 1.71% 0.62% — 0.41% 0.49% 0.55% 0.61% 0.34% (3.30%) 0.34% 3.64% 0.16% 0.65% 0.89% 0.82% (2.61%) (5.15%) — — 0.20% — — — — (2.00%) — 1.63% — 1.55% — 1.45% — 0.61% 0.00% (1.72%) — (1.94%) — 0.93% — (1.50%) 0.03% — (1.70%) 0.45% (0.09%) (0.06%) (0.38%) 0.67% 0.29% — (0.26%) (0.26%) (0.10%) (0.34%) (0.12%) — — — (0.01%) 4.68% — (0.57%) — 16.04% — 16.04% — (0.02%) — (0.01%) — — (0.04%) 13.07% 12.09% — 10.49% 8.88% (Ratios for the quarters have been annualized) For the Year Ended December 31, 2007 December 31, 2006 December 31, 2005 December 31, 2004 December 31, 2003 For the Quarter Ended December 31, 2007 September 30, 2007 June 30, 2007 March 31, 2007 14 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. FINANCIAL CONDITION Investment Securities, Available for Sale All of our Mortgage-Backed Securities at December 31, 2007, 2006, and 2005 were adjustable-rate or fixed-rate mortgage-backed secu- rities 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 of our mortgage-backed securities were FHLMC, FNMA or GNMA mortgage pass-through certificates or CMOs, which carry an actual or implied “AAA” rating. All of our agency debentures are callable and carry a “AAA” rating. We carry all of our earning assets at fair value. We accrete discount balances as an increase in interest income over the life of discount investment securities and we amortize premium balances as a decrease in interest income over the life of premium investment securities. At December 31, 2007, 2006, and 2005 we had on our balance sheet a total of $77.4 million, $78.4 million and $21.5 million, respectively, of unamortized discount (which is the differ- ence between the remaining principal value and current historical amortized cost of our investment securities acquired at a price below principal value) and a total of $405.8 million, $219.1 million and $242.1 million, respectively, of unamortized premium (which is the difference between the remaining principal value and the current historical amortized cost of our investment securities acquired at a price above principal value). We received mortgage principal repayments of $6.8 billion for the year ended December 31, 2007, $5.1 billion for the year ended December 31, 2006, and $7.1 billion for the year ended December 31, 2005. The average prepayment speed for the year ended Decem- ber 31, 2007, 2006 and 2005 was 15%, 17%, and 27%, respectively. During the year ended December 31, 2007, the average CPR declined to 15% from 17% during the year ended December 31, 2006, due to a decline in refinancing activity. Given our current portfolio com- position, 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 certain characteristics of our Investment Securities at December 31, 2007, 2006, 2005, 2004, and 2003 and September 30, 2007, June 30, 2007, and March 31, 2007. Investment Securities (dollars in thousands) At December 31, 2007 At December 31, 2006 At December 31, 2005 At December 31, 2004 At December 31, 2003 At September 30, 2007 At June 30, 2007 At March 31, 2007 Principal Amount $52,569,598 $30,134,791 $15,915,801 $19,123,902 $12,682,130 $44,904,820 $39,102,277 $39,053,196 Net Premium $328,376 $140,709 $220,637 $425,792 $299,810 $229,713 $211,438 $195,649 Amortized Cost $52,897,974 $30,275,500 $16,136,438 $19,549,694 $12,981,940 $45,134,533 $39,313,715 $39,248,845 Amortized Cost/Principal Amount 100.62% 100.47% 101.39% 102.23% 102.36% 100.51% 100.54% 100.50% Fair Value $53,133,443 $30,217,009 $15,929,864 $19,428,895 $12,934,679 $44,890,633 $38,753,509 $39,230,648 Fair Value/ Principal Amount 101.07% 100.27% 100.09% 101.59% 101.99% 99.97% 99.11% 100.45% Weighted Average Yield 5.75% 5.63% 4.68% 3.43% 2.96% 5.74% 5.71% 5.67% The table below summarizes certain characteristics of our Investment Securities at December 31, 2007, 2006, 2005, 2004, and 2003 and September 30, 2007, June 30, 2007, and March 31, 2007. The index level for adjustable-rate Investment Securities is the weighted average rate of the various short-term interest rate indices, which determine the coupon rate. Adjustable-Rate Investment Security Characteristics (dollars in thousands) Principal Amount At December 31, 2007 At December 31, 2006 At December 31, 2005 At December 31, 2004 At December 31, 2003 At September 30, 2007 At June 30, 2007 At March 31, 2007 $15,331,447 $8,493,242 $9,699,133 $13,544,872 $9,294,934 $13,148,355 $9,553,827 $9,657,221 Weighted Average Coupon Rate 5.90% 5.72% 4.76% 4.23% 3.85% 5.99% 5.85% 5.79% Weighted Average Term to Next Adjustment 39 months 19 months 22 months 24 months 23 months 41 months 32 months 30 months Weighted Average Lifetime Cap 9.89% 9.76% 10.26% 10.12% 9.86% 10.02% 10.11% 10.05% Weighted Average Asset Yield 5.63% 5.57% 4.74% 3.24% 2.47% 5.68% 5.77% 5.66% Principal Amount at Period End as % of Total Investments Securities 29.16% 28.18% 60.94% 70.83% 73.29% 29.28% 24.43% 24.73% 15 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report Fixed-Rate Investment Security Characteristics (dollars in thousands) At December 31, 2007 At December 31, 2006 At December 31, 2005 At December 31, 2004 At December 31, 2003 At December 31, 2002 At September 30, 2007 At June 30, 2007 At March 31, 2007 Principal Amount $37,238,151 $21,641,549 $6,216,668 $5,579,030 $3,387,196 $4,195,322 $31,756,465 $29,548,450 $29,395,975 Weighted Average Coupon Rate 6.00% 5.83% 5.37% 5.24% 5.77% 6.76% 5.93% 5.87% 5.85% Weighted Average Asset Yield 5.80% 5.65% 4.60% 3.89% 4.29% 4.78% 5.76% 5.69% 5.67% Principal Amount at Period End as % of Total Investment Securities 70.84% 71.82% 39.06% 29.17% 26.71% 37.45% 70.72% 75.57% 75.27% At December 31, 2007 and 2006, we held Investment Securities with coupons linked to various indices. The following tables detail the portfolio characteristics by index. Adjustable-Rate Investment Securities by Index December 31, 2007 Weighted Average Term to Next Adjustment Weighted Average Annual Period Cap Weighted Average Lifetime Cap at December 31, 2007 Investment Principal Value as Percentage of Investment Securities at December 31, 2007 One- Month LIBOR Six- Month LIBOR Twelve- Month LIBOR Twelve- Month Moving Average 11th District Cost of Funds 1-Year Treasury Index 3-Year Treasury Index Monthly Federal Cost of Funds One- Month LIBOR- USD Twelve- Month LIBOR- Other USD Indexes(1) 1 mo. 38 mo. 72 mo. 1 mo. 1 mo. 36 mo. 18 mo. 1 mo. 1 mo. 60 mo. 10 mo. 6.48% 1.72% 2.00% .42% 0.00% 1.88% 2.07% 0.00% 2.00% 2.00% 1.84% 7.13% 11.25% 11.08% 9.15% 12.08% 10.73% 13.18% 13.43% 12.8% 10.94% 10.73% 8.24% 1.89% 7.23% 0.67% 0.19% 3.39% 0.05% 0.13% 0.19% 7.14% 0.04% (1) Combination of indexes that account for less than 0.05% of total investment securities. Adjustable-Rate Investment Securities by Index December 31, 2006 Weighted Average Term to Next Adjustment Weighted Average Annual Period Cap Weighted Average Lifetime Cap at December 31, 2006 Investment Principal Value as Percentage of Investment Securities at December 31, 2006 One- Month LIBOR Six- Month LIBOR Twelve- Month LIBOR Twelve Month Moving Average 11th District Cost of Funds Six- Month CD Rate 1-Year Treasury Index 3-Year Treasury Index Monthly Federal Cost of Funds Other Indexes(1) 1 mo. 35 mo. 36 mo. 1 mo. 1 mo. 3 mo. 13 mo. 17 mo. 1 mo. 24 mo. 6.70% 1.88% 2.00% 0.16% 0.00% 1.75% 1.00% 2.03% 0.00% 1.89% 7.32% 10.39% 10.70% 10.53% 12.07% 9.75% 10.81% 13.17% 13.41% 12.39% 8.29% 2.71% 9.89% 0.07% 0.41% 0.06% 6.34% 0.10% 0.28% 0.03% (1) Combination of indexes that account for less than 0.05% of total investment securities. 16 Trading Securities and Trading Securities Sold, Not Yet Purchased Trading securities and trading securities sold, not yet purchased, are included in the balance sheet as a result of consolidating the finan- cial statements of an affiliated investment fund. The resulting realized and unrealized gains and losses are reflected in the statements of operations. The fair value of the trading securities was $11.7 million and the trading securities sold, not yet purchased, was $32.8 million at December 31, 2007. The fair value of the trading securities was $18.4 million and the trading securities sold, not yet purchased, was $41.9 million at December 31, 2006. Borrowings To date, our debt has consisted entirely of borrowings collateralized by a pledge of our investment securities. These borrowings appear on our balance sheet as repurchase agreements. At December 31, 2007, we had established uncommitted borrowing facilities in this market with 30 lenders in amounts which we believe are in excess of our needs. All of our Investment 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 bor- rowing capacity and thus increase the liquidity and strength of our balance sheet. For the year ended December 31, 2007, the term to maturity of our borrowings ranged from one day to three years. Additionally, we have entered into structured borrowings giving the counterparty the right to call the balance prior to maturity. The weighted average orig- inal term to maturity of our borrowings was 286 days at December 31, 2007. For the year ended December 31, 2006, the term to matu- rity of our borrowings ranged from one day to three years, with a weighted average original term to maturity of 194 days at Decem- ber 31, 2006. For the year ended December 31, 2005, the term to maturity of our borrowings ranged from one day to three years, with a weighted average original term to maturity of 163 days at December 31, 2005. At December 31, 2007, the weighted average cost of funds for all of our borrowings was 4.76%, with the effect of the interest rate swaps, and the weighted average term to next rate adjustment was 234 days. At December 31, 2006, the weighted average cost of funds for all of our borrowings 5.14% and the weighted average term to next rate adjustment was 125 days. At December 31, 2005, the weighted average cost of funds for all of our borrowings was 4.16% and the weighted average term to next rate adjustment was 79 days. Liquidity Liquidity, which is our ability to turn non-cash assets into cash, allows us to purchase additional investment securities and to pledge additional assets to secure existing borrowings should the value of our pledged assets decline. Potential immediate sources of liquidity 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. for us include cash balances and unused borrowing capacity. Unused borrowing capacity will vary over time as the market value of our investment securities varies. Our non-cash assets are largely actual or implied “AAA”-rated assets, and accordingly, we have not had, nor do we anticipate having, difficulty in converting our assets to cash. 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 in most circumstances our investment securities could 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 capac- ity for liquidity management purposes. Borrowings under our repurchase agreements increased by $18.5 billion to $46.0 billion at December 31, 2007, from $27.5 billion at December 31, 2006. The increase in borrowings was the result of our deployment of additional capital raised during 2007, which permit- ted us to increase our borrowings. We anticipate that, upon repayment of each borrowing under a repur- chase agreement, we will use the collateral immediately for borrowing under a new repurchase agreement. We have not at the present time entered into any committed agreements under which the lender would be required to enter into new repurchase agreements during a specified period of time, nor do we presently plan to have liquidity facilities with commercial banks. Under our repurchase agreements, we may be required to pledge additional assets to our repurchase agreement counterparties (i.e., lenders) in the event the estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral (a “margin call”), which may take the form of additional securities or cash. Similarly, if the estimated fair value of investment securities increases due to changes in market interest rates or market factors, lenders may release collateral back to us. Specifically, margin calls result from a decline in the value of our Mortgage-Backed Securities securing our repurchase agreements, prepayments on the mortgages securing such Mortgage-Backed Securities and to changes in the estimated fair value of such Mortgage-Backed Securities generally due to principal reduction of such Mortgage-Backed Securities from scheduled amortization and resulting from changes in market interest rates and other market factors. Through December 31, 2007, we did not have any margin calls on our repurchase agreements that we were not able to satisfy with either cash or additional pledged collateral. However, should prepayment speeds on the mortgages underlying our Mortgage- Backed Securities and/or market interest rates suddenly increase, margin calls on our repurchase agreements could result, causing an adverse change in our liquidity position. 17 The following table summarizes the effect on our liquidity and cash flows from contractual obligations for repurchase agreements, interest expense on repurchase agreements, the non-cancelable office lease and employment agreements at December 31, 2007. Contractual Obligations Within One Year One to Three Years Three to Five Years More than Five Years $39,646,560 384,255 532 23,157 $40,054,504 $3,100,000 427,089 532 – $3,527,621 $1,800,000 215,223 – – $2,015,223 $1,500,000 262,993 – – $1,762,993 Total $46,046,560 1,289,560 1,064 23,157 $47,360,341 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report (dollars in thousands) Repurchase agreements Interest expense on repurchase agreements Long-term operating lease obligations Employment contracts Total Stockholders’ Equity On January 23, 2008, we entered into an underwriting agreement pursuant to which we sold 58,650,000 shares of our common stock for net proceeds following underwriting expenses of approximately $1.1 billion. This transaction settled on January 29, 2008. During the year ended December 31, 2007, we declared dividends to common shareholders totaling $339.8 million or $1.04 per share, of which $136.6 million was paid on January 28, 2008. During the year ended December 31, 2007, we declared and paid dividends to Series A Preferred shareholders totaling $14.6 million or $1.97 per share, and Series B Preferred shareholders totaling $6.9 million or $1.50. During the year ended December 31, 2006, we declared dividends to common shareholders totaling $102.6 million or $0.57 per share, of which $39.0 million was paid on January 26, 2007. Dur- ing the year ended December 31, 2006, we declared and paid dividends to Series A Preferred shareholders totaling $14.6 million or $1.97 per share, and Series B Preferred shareholders totaling $5.0 million or $1.08 per share. On October 11, 2007, we entered into an underwriting agreement pursuant to which we sold 71,300,000 shares of our common stock for net proceeds following underwriting expenses of approximately $1.0 billion. This transaction settled on October 17, 2007. On July 12, 2007, we entered into an underwriting agreement pur- suant to which we sold 54,050,000 shares of our common stock for proceeds of $720.8 million net of underwriting fees. This transaction settled on July 18, 2007. On March 7, 2007, we entered into an underwriting agreement pur- suant to which we sold 57,500,000 shares of our common stock for net proceeds following underwriting expenses of approximately $737.4 million. This transaction settled on March 13, 2007. During the year ended December 31, 2007, we raised $116.5 million by issuing 8.0 million shares through the Direct Purchase and Dividend Reinvestment Program. During the year ended December 31, 2007, 55,738 options were exercised under the Long-Term Stock Incentive Plan, or Incentive Plan, for an aggregate exercise price of $576,000. On August 3, 2006, we entered into an ATM Equity Offeringsm Sales Agreement with Merrill Lynch & Co. and Merrill Lynch, Pierce, Fen- 18 ner & Smith Incorporated, relating to the sale of shares of our com- mon stock from time to time through Merrill Lynch. Sales of the shares, if any, are made by means of ordinary brokers’ transaction on the New York Stock Exchange. During the year ended December 31, 2007, 4.5 million shares of our common stock were issued pursuant to this program, totaling $66.2 million in net proceeds. On August 3, 2006, we entered into an ATM Equity Sales Agreement with UBS Securities LLC, relating to the sale of shares of our common stock from time to time through UBS Securities. Sales of the shares, if any, will be made by means of ordinary brokers’ trans- action on the New York Stock Exchange. During the year ended December 31, 2007, 1.1 million shares of our common stock were issued pursuant to this program, totaling $14.7 million in net proceeds. On August 16, 2006, we entered into an underwriting agreement pursuant to which we sold 40,825,000 shares of our common stock for net proceeds before expenses of approximately $476.7 million. This transaction settled on August 22, 2006. On April 6, 2006, we entered into an underwriting agreement pursuant to which we sold 39,215,000 shares of our common stock for net proceeds before expenses of approximately $437.7 million. On April 6, 2006, we entered into a second underwriting agreement pursuant to which we sold 4,600,000 shares of our 6% Series B Cumulative Convertible Preferred Stock for net proceeds before expenses of approximately $111.5 million. Each of these transactions settled on April 12, 2006. The 6% Series B Cumulative Preferred Stock has been treated under GAAP as temporary equity. For the pur- pose of computing ratios relating to equity measures, the Series B Preferred Stock has been included in equity. During the year ended December 31, 2006, 22,160 options were exercised under the Incentive Plan for an aggregate exercise price of $183,000. During the year ended December 31, 2006 we sold 500,000 shares of our common stock, for net proceeds of $6.7 million, under the ATM Equity Sales Agreement with Merrill Lynch and we did not sell any shares under the ATM Equity Sales Agreement with UBS Securities. During the year ended December 31, 2006, we sold 1.1 million shares of our common stock for net proceeds of $14.2 million under our Equity Shelf Program with UBS Securities, pur- suant to which sales are made by means of ordinary brokers’ transaction on the New York Stock Exchange. 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. Unrealized Gains and Losses 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 use- ful 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, com- parisons 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 Investment Securities, available-for-sale equity securities and interest rate swaps in our portfolio. Unrealized Gains and Losses At December 31 2005 (dollars in thousands) 2007 2006 2004 2003 Unrealized gain Unrealized loss Net Unrealized (loss) gain $379,348 (531,545) ($152,197) $112,596 (188,708) ($76,112) $5,027 (211,601) ($206,574) $23,021 (143,821) ($120,800) $24,886 (72,147) ($47,261) Unrealized changes in the estimated net market value of investment securities have one direct effect on our potential earnings and divi- dends: positive mark-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 invest- ment securities might impair our liquidity position, requiring us to sell assets with the likely result of realized losses upon sale. Leverage Our debt-to-equity ratio at December 31, 2007, 2006 and 2005 was 8.7:1, 10.4:1 and 9.0:1, respectively. We generally expect to main- tain 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 vari- ous 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-equity ratio is determined under our capital invest- ment policy. Should our actual debt-to-equity ratio increase above the target level due to asset acquisition or market value fluctuations in assets, we 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 over 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. Our goal is to provide attractive risk-adjusted stockholder returns while maintain- ing what we believe is 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, we have attempted to mitigate the potential impact on net income of periodic and life- time coupon adjustment restrictions in our portfolio of investment securities by entering into interest rate swaps. At December 31, 2007, we had entered into swap agreements with a total notional amount of $16.2 billion. We agreed to pay a weighted average pay rate of 5.03% and receive a floating rate based on one month LIBOR. At December 31, 2006, we entered into swap agreements with a total notional amount of $9.3 billion. We agreed to pay a weighted aver- age pay rate of 5.17% and receive a floating rate based on one month LIBOR. We may enter into similar derivative transactions in the future by entering into interest rate collars, caps or floors or purchasing interest only securities. Changes in interest rates may also affect the rate of mortgage prin- cipal prepayments and, as a result, prepayments on mortgage-backed securities. We seek to mitigate the effect of changes in the mortgage principal repayment rate by balancing assets we purchase at a pre- mium 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. Off-Balance Sheet Arrangements We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been estab- lished for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment or intent to provide funding to any such entities. As such, we are not materially exposed to any market, credit, liquidity or financing risk that could arise if we had engaged in such relationships. 19 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report Capital Resources At December 31, 2007, we had no material commitments for capital expenditures. 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 neces- sarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our dividends are 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 at least 75% of our assets were qualified REIT assets, as defined in the Code for the years ended December 31, 2007 and 2006. We also calculate that our revenue qualifies for the 75% source of income test and for the 95% source of income test rules for the years ended December 31, 2007 and 2006. Consequently, we met the REIT income and asset test. We also met all REIT require- ments regarding the ownership of our common stock and the distribution of our net income. Therefore, for the years ended of December 31, 2007, 2006, and 2005, we believe that we qualified as a REIT under the 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 of 1940, or 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 and at least 80% of our assets in qualifying interests plus other real estate related assets. 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, 2007 and Decem- ber 31, 2006, we were in compliance with this requirement. MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Dated: February 23, 2008 Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) under the Securities Exchange Act as a process designed by, or under the supervision of, the Company’s principal execu- tive and principal financial officers and effected by the Company’s Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of finan- cial reporting and the preparation of financial statements for external purposes in accordance with generally accepted account- ing principles and includes those policies and procedures that: • pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; • provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and • provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. 20 Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. As a result, even systems determined to be effective can provide only reasonable assurance regarding the preparation and presentation of financial statements. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. In making this assessment, the Company’s management used criteria set forth by the Committee of Spon- soring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on management’s assessment, the Company’s management believes that, as of December 31, 2007, the Company’s internal con- trol over financial reporting was effective based on those criteria. There have been no changes in the Company’s internal controls over financial reporting that occurred during the quarter ended December 31, 2007 that have materially affected, or are reasonably likely to affect its internal control over financial reporting. The Company’s independent registered public accounting firm, Deloitte & Touche LLP, has issued an attestation report on the Company’s internal control over financial reporting. 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Annaly Capital Management, Inc. New York, New York We have audited the accompanying consolidated statements of financial condition of Annaly Capital Management, Inc. and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. We also have audited the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Com- mittee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report On Internal Control Over Financial Reporting at Item 9A. Our responsibility is to express an opinion on these finan- cial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included exam- ining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and valuating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that trans- actions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over finan- cial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Annaly Capital Management, Inc. and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. New York, New York February 26, 2008 21 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION December 31, 2007, and 2006 (dollars in thousands, except for share data) DECEMBER 31, 2007 DECEMBER 31, 2006 Assets Cash and cash equivalents Mortgage-Backed Securities, at fair value Agency debentures, at fair value Available for sale equity securities, at fair value Trading securities, at fair value Receivable for Mortgage-Backed Securities sold Accrued interest receivable Receivable for advisory and service fees Intangible for customer relationships, net Goodwill Interest rate swaps, at fair value Other assets Total assets Liabilities & Stockholders’ Equity Liabilities: Repurchase agreements Payable for Investment Securities purchased Trading securities sold, not yet purchased, at fair value Accrued interest payable Dividends payable Accounts payable Interest rate swaps, at fair value Total liabilities Minority interest in equity of consolidated affiliate 6.00% Series B Cumulative Convertible Preferred Stock: 4,600,000 shares authorized, issued and outstanding Commitments and contingencies (Note 11) : Stockholders’ Equity 7.875% Series A Cumulative Redeemable Preferred Stock: 7,637,500 shares authorized 7,412,500 issued and outstanding Common stock: par value $.01 per share; 487,762,500 shares authorized, 401,822,703 and 205,345,591 issued and outstanding, respectively Additional paid-in capital Accumulated other comprehensive loss Accumulated deficit Total stockholders’ equity $00,103,960 52,879,528 253,915 64,754 11,675 276,737 271,996 3,598 9,842 22,966 — 4,543 $53,903,514 $46,046,560 1,677,131 32,835 257,608 136,618 36,688 398,096 48,585,536 1,574 111,466 177,088 4,018 5,297,922 (152,197) (121,893) 5,204,938 $000,91,782 30,167,509 49,500 — 18,365 200,535 146,089 3,178 11,184 22,966 2,558 2,314 $30,715,980 $27,514,020 338,172 41,948 83,998 39,016 18,816 20,179 28,056,149 5,324 111,466 177,088 2,053 2,615,016 (76,112) (175,004) 2,543,041 Total liabilities, minority interest, Series B Preferred Stock and stockholders’ equity $53,903,514 $30,715,980 See notes to consolidated financial statements. 22 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) Years Ended December 31, 2007, 2006, and 2005 (dollars in thousands, except for per share data) Interest income Interest expense Net interest income Other income (loss): Investment advisory and service fees Gain (loss) on sale of Investment Securities Gain on termination of interest rate swaps Income from trading securities Dividend income from available-for-sale equity securities Loss on other-than-temporarily impaired securities Total other income (loss) Expenses: Distribution fees General and administrative expenses Total expenses Impairment of intangible for customer relationships Income before income taxes and minority interest Income taxes Income (loss) before minority interest Minority interest Net income (loss) Dividends on preferred stock Net income available (loss related) to common shareholders Net income available (loss related) to common shareholders per average common share: Basic Diluted Weighted average number of common shares outstanding: Basic Diluted Net income (loss) Comprehensive income (loss): Unrealized gain (loss) on available-for-sale securities Unrealized loss on interest rate swaps Reclassification adjustment for net gains (losses) included in net income or loss Other comprehensive income (loss) Comprehensive income (loss) See notes to consolidated financial statements. December 31, 2007 $2,355,447 1,926,465 428,982 22,028 19,062 2,096 19,147 91 (1,189) 61,235 3,647 62,666 66,313 — 423,904 8,870 415,034 650 414,384 21,493 $392,891 $1.32 $1.31 297,488,394 306,263,766 $414,384 322,264 (378,380) (19,969) (76,085) $338,299 For the Year Ended December 31, 2006 December 31, 2005 $1,221,882 1,055,013 166,869 22,351 (3,862) 10,674 3,994 — (52,348) (19,191) 3,444 40,063 43,507 2,493 101,678 7,538 94,140 324 93,816 19,557 $705,046 568,560 136,486 35,625 (53,238) — — — (83,098) (100,711) 8,000 26,278 34,278 — 1,497 10,744 (9,247) — (9,247) 14,593 $74,259 ($23,840) $0.44 $0.44 ($0.19) ($0.19) 167,666,631 167,746,387 122,475,032 122,475,032 $93,816 ($9,247) 91,873 (6,404) 45,536 131,005 $224,821 (222,110) (543) 136,336 (86,317) ($95,564) 23 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY Years Ended December 31, 2007, 2006, and 2005 (dollars in thousands, except per share data) Balance, December 31, 2004 Preferred Stock Common Stock Par Value Other Additional Paid-In Capital Accumulated Comprehensive Income (Loss) Retained (Deficit) Earnings Total $177,077 $1,213 $1,638,635 ($120,800) $004,345 $1,700,470 Net loss Other comprehensive loss Comprehensive loss Reduction in estimated legal cost of preferred offering Exercise of stock options Net proceeds from direct purchase and dividend reinvestment Net proceeds from equity shelf program Preferred dividends declared, $1.97 per share Common dividends declared, $1.04 per share Balance, December 31, 2005 Net income Other comprehensive income Comprehensive income Exercise of stock options Option expense Net proceeds from follow-on offerings Net proceeds from equity shelf program Preferred Series A dividends declared $1.97 per share Preferred Series B dividends declared $1.08 per share Common dividends declared, $0.57 per share Balance, December 31, 2006 Net income Other comprehensive loss Comprehensive income Exercise of stock options Option and long-term compensation expense Net proceeds from follow-on offerings Net proceeds from ATM program Net proceeds from direct purchase and dividend reinvestment Preferred Series A dividends declared $1.97 per share Preferred Series B dividends declared $1.50 per share Common dividends declared, $1.04 per share Balance, December 31, 2007 — — — 11 — — — — — 177,088 — — — — — — — — — — 177,088 — — — — — — — — — — — $177,088 — — — — — — 24 — — 1,237 — — — — — 800 16 — — — 72,053 — — — — — 1,829 56 80 — — — $4,018 — — — — 253 — (86,317) — — — (9,247) — — — — — — (95,564) 11 253 440 40,124 — — 1,679,452 — — — 183 1,285 913,200 20,896 — — — 2,615,016 — — — 576 1,355 2,483,700 80,862 — — — — (14,593) — — (127,142) (146,637) (207,117) 440 40,148 (14,593) (127,142) $1,504,023 93,816 — — 131,005 — — — — — — — — — — (14,594) — — (4,966) — (102,623) (175,004) (76,112) — — 224,821 183 1,285 914,000 20,912 (14,594) (4,966) (102,623) 2,543,041 — (76,085) — — — — — — 414,384 — — 338,299 — 576 — — 1,355 — 2,485,529 80,918 — 116,413 — — — $5,297,922 — — — (14,593) (6,900) — — (339,780) ($121,893) ($152,197) 116,493 (14,593) (6,900) (339,780) $5,204,938 See notes to consolidated financial statements. 24 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2007, 2006, and 2005 (dollars in thousands) Cash flows from operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Amortization of Mortgage Backed Securities premiums and discounts, net Amortization of intangibles Amortization of trading securities premiums and discounts Loss (gain) on sale of Investment Securities Gain on termination of interest rate swaps Stock option and long-term compensation expense Net realized gain on trading investments Unrealized (appreciation) depreciation on trading investments Market value adjustment on long-term repurchase agreements Loss on other-than-temporarily impaired securities Impairment of intangibles (Increase) decrease in accrued interest receivable Increase in other assets Purchase of trading investments Proceeds from sale of trading securities Purchase of trading securities sold, not yet purchased Proceeds for securities sold, not yet purchased (Decrease) increase in advisory and service fees receivable Increase (decrease) in interest payable Increase in accrued expenses and other liabilities Net cash provided by operating activities Cash flows from investing activities: Purchase of Mortgage-Backed Securities Proceeds from sale of Investment Securities Principal payments of Mortgage-Backed Securities Purchase of agency debentures Proceeds from called agency debentures Purchase of equity investment Net cash (used in) provided by investing activities Cash flows from financing activities: Proceeds from repurchase agreements Principal payments on repurchase agreements Proceeds from exercise of stock options Proceeds from termination of interest rate swaps Proceeds from direct purchase and dividend reinvestment Net proceeds from follow-on offerings Net proceeds from preferred stock offering Net proceeds from equity shelf program and ATM Equity Sales Agreement Minority interest Dividends paid Net cash provided by (used in) 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 Taxes paid Noncash financing activities: Net change in unrealized loss on available-for-sale securities and interest rate swaps, net of reclassification adjustment Dividends declared, not yet paid See notes to consolidated financial statements. December 31, 2007 For the Year Ended December 31, 2006 December 31, 2005 $414,384 65,185 1,377 (11) (19,062) (2,096) 1,355 (4,430) (11,013) — 1,189 — (123,322) (2,264) (18,479) 23,640 (13,620) 21,489 (420) 173,610 17,872 525,384 (32,832,687) 4,847,909 6,831,406 (256,241) — (54,324) (21,463,937) 393,750,907 (375,218,367) 576 2,096 116,493 2,485,529 — 80,918 (3,750) (263,671) 20,950,731 12,178 91,782 $103,960 $1,752,855 $10,272 $93,816 ($9,247) 63,625 1,589 — 3,862 (10,674) 1,285 (1,200) 1,180 (149) 52,348 2,493 (76,224) (238) (44,200) 28,838 (16,096) 55,073 319 56,004 9,978 221,629 154,309 571 — 53,238 — 56 — — (2,514) 83,098 — 10,555 (425) — — — — (1,138) (7,727) 753 281,529 (23,196,076) 3,040,984 5,115,693 — — — (15,039,399) 292,418,807 (278,481,088) 183 10,674 — 914,000 111,466 20,912 5,324 (95,534) 14,904,744 86,974 4,808 $91,782 (7,416,869) 3,231,219 7,053,867 — 130,000 — 2,998,217 245,514,548 (248,646,126) 197 — 440 — — 40,148 (189,998) (3,280,791) (1,045) 5,853 $4,808 $999,009 $7,242 $576,287 $11,740 ($76,085) $136,618 $131,005 $39,016 ($86,317) $12,368 25 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 2007, 2006, and 2005 1. Organization and Significant Accounting Policies Annaly Capital Management, Inc. (the “Company”) was incorpo- rated in Maryland on November 25, 1996. The Company changed its name from Annaly Mortgage Management, Inc. to Annaly Capital Management, Inc. effective August 2, 2006. The Company com- menced 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 cap- ital. An initial public offering was completed on October 14, 1997. The Company is a real estate investment trust (REIT) under the Internal Revenue Code of 1986, as amended. The Company acquired Fixed Income Discount Advisory Company (“FIDAC”) on June 4, 2004. FIDAC is a registered investment advisor and is a taxable REIT subsidiary of the Company. On June 27, 2006, the Company made a majority equity investment in an affiliated investment fund (the “Fund”). The Company acquired approximately 3.6 million shares of common stock of Chimera Investment Corporation (“Chimera”) for approximately $54.3 million on November 21, 2007. Chimera is a newly-formed, publicly traded, specialty finance com- pany that invests in residential mortgage loans, residential mortgage- backed securities, real estate related securities and various other asset classes. Chimera is externally managed by FIDAC and intends to elect and qualify to be taxed as a REIT for federal income tax purposes. A summary of the Company’s significant accounting policies follows: The consolidated financial statements include the accounts of the Company, FIDAC and the Fund. All intercompany balances and transactions have been eliminated. The minority shareholder’s inter- est in the Fund is reflected as minority interest in the consolidated financial statements. Cash and Cash Equivalents – Cash and cash equivalents include cash on hand and money market funds. Mortgage-Backed Securities and Agency Debentures – The Com- pany invests primarily in mortgage pass-through certificates, collateralized mortgage obligations and other mortgage-backed secu- rities representing interests in or obligations backed by pools of mortgage loans (collectively, “Mortgage-Backed Securities”). The Company also invests in agency debentures issued by Federal Home Loan Bank (“FHLB”), Federal Home Loan Mortgage Corporation (“FHLMC”), and Federal National Mortgage Association (“FNMA”). The Mortgage-Backed Securities and agency deben- tures are collectively referred to herein as “Investment Securities.” Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities, requires the Company to classify its Investment Securities as either trading investments, available-for-sale investments or held-to- maturity investments. Although the Company generally intends to hold most of its Investment Securities until maturity, it may, from 26 time to time, sell any of its Investment Securities as part of its overall management of its portfolio. Accordingly, SFAS No. 115 requires the Company to classify all of its Investment Securities as available-for-sale. All assets classified as available-for-sale are reported at estimated fair value, based on market prices from inde- pendent sources, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity. The investment in Chimera is accounted for as available-for- sale under the provisions of SFAS 115. Management evaluates securities for other-than-temporary impair- ment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been lower than carrying value, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Unrealized losses on Investment Securities that are considered other than temporary, as measured by the amount of decline in fair value attributable to other-than-temporary factors, are recognized in income and the cost basis of the Investment Securities is adjusted. The loss on other-than-temporarily impaired securities was $1.2 million, $52.3 million and $83.1 million during the years ended December 31, 2007, 2006 and 2005, respectively. Disclosure About Fair Value of Financial Instruments, SFAS No. 107, requires disclosure of the fair value of financial instruments for which it is practicable to estimate that value. The estimated fair value of Investment Securities and interest rate swaps is equal to their carrying value presented in the consolidated statements of financial condition. The estimated fair value of trading securities and trading securities sold, not yet purchased, is equal to their carrying value presented in the consolidated statements of financial condition. The estimated fair value of cash and cash equivalents, accrued interest receivable, receivable for securities sold, receivable for advisory and service fees, repurchase agreements with maturities shorter than one year, and payable for mortgage-backed securities purchased, dividends payable, accounts payable, and accrued interest payable, generally approximates cost as of December 31, 2007 due to the short term nature of these financial instruments. Interest income is accrued based on the outstanding principal amount of the Investment Securities and their contractual terms. Premiums and discounts associated with the purchase of the Investment Secu- rities are amortized into interest income over the projected lives of the securities using the interest method. The Company’s policy for estimating prepayment speeds for calculating the effective yield is to evaluate historical performance, consensus prepayment speeds, and current market conditions. Investment Securities transactions are recorded on the trade date. Purchases of newly-issued securities are recorded when all signifi- cant uncertainties regarding the characteristics of the securities are removed, generally shortly before settlement date. Realized gain and losses on sale of Investment Securities are determined on the specific identification method. Derivative Financial Instruments/Hedging Activity – The Company hedges interest rate risk through the use of derivative financial instruments, comprised of interest rate caps and interest rate swaps (collectively, “Hedging Instruments”). The Company accounts Account- for Hedging Instruments in accordance with SFAS No. 133, ing for Derivative Instruments and Hedging Activities , (“SFAS 133”) as amended and interpreted. The Company carries all Hedging Instruments at their fair value, as assets, if their fair value is positive, or as liabilities, if their fair value is negative. As the Company’s interest rate swaps are designated as cash flow hedges under SFAS No. 133, the change in the fair value of any such derivative is recorded in other comprehensive income or loss for hedges that qualify as effective. At December 31, 2007, the Company did not have any interest rate caps. The ineffective amount of all Hedging Instruments, if any, is recognized in earnings each year. To date, the Company has not recognized any change in the value of its interest rate swaps in earnings as a result of the hedge or a portion thereof being ineffective. Upon entering into hedging transactions, the Company documents the relationship between the Hedging Instruments and the hedged liability. The Company also documents its risk-management policies, including objectives and strategies, as they relate to its hedging activities. The Company assesses, both at inception of a hedge and on an on-going basis, whether or not the hedge is “highly effective,” as defined by SFAS 133. The Company discontinues hedge account- ing on a prospective basis with changes in the estimated fair value reflected in earnings when (i) it is determined that the derivative is no longer effective in offsetting cash flows of a hedged item (includ- ing hedged items such as forecasted transactions); (ii) it is no longer probable that the forecasted transaction will occur; or (iii) it is determined that designating the derivative as a Hedging Instrument is no longer appropriate. When the Company enters into an interest rate swap, it agrees to pay a fixed rate of interest and to receive a variable interest rate, gener- ally based on the London Interbank Offered Rate (“LIBOR”). The Company’s interest rate swaps are designated as cash flow hedges against the benchmark interest rate risk associated with the Company’s borrowings. All changes in the unrealized gains/losses on any interest rate swap are recorded in accumulated other comprehensive income or loss and are reclassified to earnings as interest expense is recognized on the Company’s hedged borrowings. If it becomes probable that the fore- casted transaction, which in this case refers to interest payments to be made under the Company’s short-term borrowing agreements, will not occur by the end of the originally specified time period, as documented at the inception of the hedging relationship, then the related gain or loss in accumulated other comprehensive income or loss would be reclassified to income or loss. 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. Realized gains and losses resulting from the termination of an interest rate swap are initially recorded in accumulated other com- prehensive income or loss as a separate component of stockholders’ equity. The gain or loss from a terminated interest rate swap remains in accumulated other comprehensive income or loss until the fore- casted interest payments affect earnings. If it becomes probable that the forecasted interest payments will not occur, then the entire gain or loss would be recognized in earnings. Credit Risk – The Company has limited its exposure to credit losses on its portfolio of Investment Securities by only purchasing securities issued by FHLMC, FNMA, or 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 princi- pal and interest on the GNMA Mortgage-Backed Securities are backed by the full faith and credit of the U.S. government. All of the Com- pany’s Investment Securities have an actual or implied “AAA” rating. Trading Securities and Trading Securities sold, not yet purchased – Trading securities and trading securities sold, not yet purchased, are presented in the consolidated statements of financial conditions as a result of consolidating the financial statements of the Fund, and are carried at fair value at December 31, 2007. The realized and unreal- ized gains and losses, as well as other income or loss from trading securities, are recorded in the income from trading securities balance in the accompanying consolidated statements of operations. Trading securities sold, not yet purchased, represent obligations of the Fund to deliver the specified security at the contracted price, and thereby create a liability to purchase the security in the market at prevailing prices. Repurchase Agreements – The Company finances the acquisition of its Investment Securities through the use of repurchase agreements. Repurchase agreements are treated as collateralized financing trans- actions and are carried at their contractual amounts, including accrued interest, as specified in the respective agreements. Cumulative Convertible Preferred Stock – The Company classifies its Series B Cumulative Convertible Preferred Stock on the consol- idated statements of financial condition using the guidance in SEC Presentation in Financial State- Accounting Series Release No. 268, ments of “Redeemable Preferred Stocks,” and Emerging Issues Task Classification and Measurement of Force (“EITF”) Topic D-98, Redeemable Securities. The Series B Cumulative Convertible Preferred Stock contains fundamental change provisions that allow the holder to redeem the preferred stock for cash if certain events occur. As redemption under these provisions is not solely within the Company’s control, the Company has classified the Series B Cumu- lative Convertible Preferred Stock as temporary equity in the accompanying consolidated statement of financial condition. The Company has analyzed whether the embedded conversion option should be bifurcated under the guidance in SFAS No. 133 and EITF Accounting for Derivative Financial Instruments Issue No. 00-19, Indexed to, and Potentially Settled in, a Company’s Own Stock, and has determined that bifurcation is not necessary. 27 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report Income Taxes – The Company has elected to be taxed as a 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. The Company and FIDAC have made a joint election to treat FIDAC as a taxable REIT subsidiary. As such, FIDAC is taxable as a domestic C corporation and subject to federal and state and local income taxes based upon its taxable income. Use of Estimates – The preparation of the consolidated financial statements in conformity with Generally Accepted Accounting Principles or (“GAAP”), requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Goodwill and Intangible Assets – The Company’s acquisition of FIDAC was accounted for using the purchase method. Under the purchase method, net assets and results of operations of acquired companies are included in the consolidated financial statements from the date of acquisition. In addition, the cost of FIDAC was allo- cated to the assets acquired, including identifiable intangible assets, and the liabilities assumed based on their estimated fair values at the date of acquisition. The excess of purchase price over the fair value of the net assets acquired was recognized as goodwill. Intangible assets are periodically (but not less frequently than annually) reviewed for potential impairment. Intangible assets with an estimated useful life are expected to amortize over a 7.8 year weighted average time period. During the year ended December 31, 2007, there were no impairment losses. During the year ended December 31, 2006 the Company recognized $2.5 million in impairment losses on intangi- ble assets relating to customer relationships. During the year ended December 31, 2005, the Company did not have impairment losses. Stock Based Compensation – Share-Based Payment On December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (Revised 2004) – (“SFAS 123R”). SFAS 123R, which replaced SFAS 123, requires the Company to measure and recognize in the consolidated financial statements the compensation cost relat- ing to share-based payment transactions. The compensation cost should be reassessed based on the fair value of the equity instruments issued. The Company adopted SFAS 123R effective January 1, 2006 under the modified prospective transition method. Accord- ingly, prior period amounts have not been restated. Under this application, the Company is required to record compensation expense for all awards granted or modified on or after January 1, 2006 and for the unvested portion of all outstanding awards that remain out- standing at the date of adoption. The Company elected to recognize compensation expense on a straight-line basis over the requisite service period for the entire award (that is, over the requisite service period of the last separately vesting portion of the award). The Company estimated fair value using the Black-Scholes valuation model. The Company granted 28 687,250 options during the year ended December 31, 2007. During the year ended December 31, 2007, the Company granted 7,000 shares of restricted common stock to certain of its employees. As of December 31, 2007, 5,250 of these restricted shares were unvested and subject to forfeiture. Recent Accounting Pronouncements – In February 2006, the FASB Accounting for Certain Hybrid Instruments, an issued FAS No. 155, amendment of FASB Statements No. 133 and 140 (“SFAS 155”). Among other things, SFAS 155: (i) permits fair value re-measure- ment for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; (ii) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133; (iii) establishes a requirement to eval- uate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; (iv) clarifies that concentrations of credit risk in the form of subordina- tion are not embedded derivatives; and (v) amends SFAS 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 was effective for all financial instruments acquired or issued by the Company after January 1, 2007. Securitized interests which only con- tain an embedded derivative that is tied to the prepayment risk of the underlying prepayable financial assets and for which the investor does not control the right to accelerate the settlement of such financial assets are excluded under a scope exception adopted by the FASB. None of the Company’s assets were subject to SFAS 155 as a result of this scope exception. Consequently, the Company has continued to record changes in the market value of its investment securities through Other Comprehensive Income, a component of stockholders’ equity. Therefore, the adoption of SFAS 155 did not have any impact on the Company’s consolidated financial statements. Account- In July 2006, the FASB issued FASB Interpretation No. 48, ing for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 Accounting for Income Taxes (“FIN 48”), and related implementation issues. FIN 48 clarifies the accounting for uncertainty in income taxes rec- ognized in the Company’s financial statements in accordance with SFAS No. 109, . FIN 48 prescribes a threshold and measurement attribute for recognition in the financial statements of an asset or liability resulting from a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 was effective for the Company on January 1, 2007. There was no impact to the Com- pany’s financial statements from implementing this new standard. Fair Value In September 2006, the FASB issued SFAS No. 157, Measurements (“SFAS 157”). SFAS 157 defines fair value, estab- lishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS 157 requires companies to disclose the fair value of its financial instruments according to a fair value hierarchy (i.e., levels 1, 2, and 3, as defined). Additionally, companies are required to provide enhanced disclosure regarding instruments in the level 3 category (the valuation of which require significant management judgment), including a reconciliation of the beginning and ending balances separately for each major cat- egory of assets and liabilities. SFAS 157 is effective for the Company on January 1, 2008. The Company does not believe that the adoption of SFAS 157 will have a significant impact on its financial position or results of operations the manner in which it estimates fair value, but expects that adoption will increase footnote disclosure to com- ply with SFAS 157 disclosure requirements for financial statements issued after January 1, 2008. The Fair Value In February 2007, the FASB issued SFAS No 159, Option for Financial Assets and Financial Liabilities – including an amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date SFAS 159 is effective for the Company commencing January 1, 2008. The Company did not elect the fair value option for any existing eligible financial instruments. Proposed FASB Staff Position – The FASB issued a proposed FASB Staff Position (“FSP”) FAS No. 140-d relating to FASB Statement Accounting for Transfers of Financial Assets and Repur- No. 140, chase Financing Transactions to address situations where assets purchased from a particular counterparty and financed through a repurchase agreement with the same counterparty can be considered and accounted for as separate transactions. Currently, the Company records such assets and the related financing on a gross basis in the consolidated statement of financial condition, and the corresponding 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. interest income and interest expense in the Company’s consolidated statement of operations and comprehensive income (loss). For assets representing available-for-sale investment securities, as in the Com- pany’s case, any change in fair value is reported through other comprehensive income under SFAS 115, with the exception of impairment losses, which are recorded in the consolidated statement of operations and comprehensive (loss) income as realized losses. FASB’s proposed staff position requires that all of the following criteria be met in order to continue the application of SFAS 140 as described above: (1) the initial transfer of and repurchase financing cannot be contractually contingent; (2) the repurchase financing entered into between the parties provides full recourse to the trans- feree and the repurchase price is fixed; (3) the financial asset is “readily obtainable” in the marketplace and the transfer is executed at market rates; (4) the borrower maintains the right to the collateral and the lender cannot re-pledge the asset prior to settlement of the repurchase agreement; and (4) the repurchase agreement and finan- cial asset do not mature simultaneously. At this time, the Company believes that its purchases and subsequent financing through repurchase agreements with the same counterparty meet the criteria enumerated in the proposed FSP FAS No. 140-d for treatment as a non-linked transfer and repurchase under SFAS No. 140 and the Company believes that if the FSP is ultimately issued in substantially its current form, there will be no effect on the manner in which the Company records such assets, their financings, and the corresponding interest income and interest expense. FSP FAS No. 140-d may be subject to significant changes prior to finalization, which may impact the Company’s current assessment of its impact. SHARE PERFORMANCE ANALYSIS (UNAUDITED) The following graph and table set forth certain information comparing the yearly percentage change in cumulative total return on the Company’s Common Stock to the cumulative total return of the Standard & Poor’s 500 Index, or S&P 500 Index, and the Bloomberg REIT Mortgage Index, or BBG REIT index, an industry index of mortgage REITs. The comparison is for the period from December 31, 2002 to December 31, 2007 and assumes the reinvestment of dividends. The graph and table assume that $100 was invested in the Company’s Common Stock and the two other indices on December 31, 2002. Upon written request we will provide stockholders with a list of the REITs included in the BBG REIT Index. 220 180 140 100 60 20 Annaly S&P 500 Index BBG Reit Index 128 117 108 100 116 111 175 122 115 161 105 68 127 111 48 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06 12/31/07 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/29/2006 12/31/2007 Annaly Capital Management, Inc. S&P 500 Index BBG Reit Index 100 100 100 108 128 117 116 111 116 68 105 161 122 115 175 127 111 48 The information in the share performance graph and table has been obtained from sources believed to be reliable, but neither its accuracy nor its com- pleteness can be guaranteed. The historical information set forth above is not necessarily indicative of future performance. Accordingly, the Company does not make or endorse any predictions as to future share performance. The share performance graph and table shall not be deemed, under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, to be (i) “soliciting material” or “filed” or (ii) incorporated by reference by any general statement into any filing made by the Company with the Securities and Exchange Commission, except to the extent that the Company specifically incorporates such share performance graph and table by reference. 29 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report 2. Mortgage-Backed Securities The following tables present the Company’s available-for-sale Mortgage-Backed Securities portfolio as of December 31, 2007 and 2006: December 31, 2007 (dollars in thousands) Mortgage-Backed Securities, gross Unamortized discount Unamortized premium Amortized cost Gross unrealized gains Gross unrealized losses Estimated fair value Adjustable rate Fixed rate Total December 31, 2006 (dollars in thousands) Mortgage-Backed Securities, gross Unamortized discount Unamortized premium Amortized cost Gross unrealized gains Gross unrealized losses Estimated fair value Adjustable rate Fixed rate Total Federal Home Loan Mortgage Corporation $19,789,792 (30,679) 136,780 19,895,893 141,248 (52,623) Federal National Mortgage Association $32,155,740 (45,496) 266,357 32,376,601 224,795 (75,949) $19,984,518 $32,525,447 Gross Unrealized Gain $96,310 271,962 $368,272 Government National Mortgage Association $367,066 (506) 2,678 369,238 2,229 (1,904) $369,563 Gross Unrealized Loss ($76,853) (53,623) Total Mortgage-Backed Securities $52,312,598 (76,681) 405,815 52,641,732 368,272 (130,476) $52,879,528 Estimated Fair Value $15,380,488 37,499,040 ($130,476) $52,879,528 Federal National Mortgage Association Government National Mortgage Association Total Mortgage-Backed Securities $19,085,218 (56,517) 133,164 19,161,865 74,498 (92,548) $19,143,815 Gross Unrealized Gain $12,764 97,274 $110,038 $324,338 (204) 3,271 327,405 366 (2,736) $325,035 Gross Unrealized Loss ($61,483) (106,926) $30,084,791 (78,053) 219,142 30,225,880 110,038 (168,409) $30,167,509 Estimated Fair Value $8,497,644 21,669,865 ($168,409) $30,167,509 Amortized Cost $15,361,031 37,280,701 $52,641,732 Federal Home Loan Mortgage Corporation $10,675,235 (21,332) 82,707 10,736,610 35,174 (73,125) $10,698,659 Amortized Cost $8,546,363 21,679,517 $30,225,880 Actual maturities of Mortgage-Backed Securities are generally shorter than stated contractual maturities. Actual maturities of the Company’s Mortgage-Backed Securities are affected by the contractual lives of the underlying mortgages, periodic payments of principal, and prepay- ments of principal. The following table summarizes the Company’s mortgage-backed securities on December 31, 2007 and 2006, according to their estimated weighted-average life classifications: December 31, 2007 December 31, 2006 Weighted-Average Life (dollars in thousands) Fair Value Amortized Cost Fair Value Amortized Cost Less than one year Greater than one year and less than five years Greater than or equal to five years Total $00,324,495 35,772,813 16,782,220 $52,879,528 $00,326,754 35,586,721 16,728,257 $52,641,732 00, $ 379,967 21,788,975 7,998,567 $30,167,509 00, $ 382,268 21,851,659 7,991,953 $30,225,880 The weighted-average lives of the mortgage-backed securities at December 31, 2007 and 2006 in the table above are based upon data provided through subscription-based financial information services, assuming constant principal prepayment rates to the reset date of each security. The prepayment model considers current yield, forward yield, steepness of the yield curve, current mortgage rates, mortgage rate of the outstanding loans, loan age, margin and volatility. 30 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. The following table presents the gross unrealized losses, and estimated fair value of the Company’s Mortgage-Backed Securities by length of time that such securities have been in a continuous unrealized loss position at December 31, 2007 and December 31, 2006. (dollars in thousands) Estimated Fair Value Unrealized Loss Estimated Fair Value Unrealized Loss Estimated Fair Value Unrealized Loss Less than 12 Months 12 Months or More Total December 31, 2007 December 31, 2006 $7,593,443 ($62,594) $5,340,667 ($67,882) $12,934,110 ($130,476) $6,324,266 ($30,244) $6,817,667 ($138,165) $13,141,933 ($168,409) Unrealized Loss Position for The decline in value of these securities is solely due to market conditions and not the quality of the assets. All of the Mortgage- Backed Securities are “AAA” rated or carry an implied “AAA” rating. The investments are not considered other-than-temporarily impaired because the Company currently has the ability and intent to hold the investments to maturity or for a period of time sufficient for a forecasted market price recovery up to or beyond the cost of the investments. Also, the Company is guaranteed payment of the principal amount of the securities. The adjustable rate Mortgage-Backed Securities are limited by periodic caps (generally interest rate adjustments are limited to no more than 1% every nine months) and lifetime caps. The weighted average lifetime cap was 9.9% at December 31, 2007 and 9.8% at December 31, 2006. During the year ended December 31, 2007, the Company realized $19.1 million in net gains from sales of Investment Securities. During the year ended December 31, 2006, the Company realized $3.9 million in net losses from sales of Investment Securities. 3. Repurchase Agreements The Company had outstanding $46.0 billion and $27.5 billion of repurchase agreements with weighted average borrowing rates of 4.76% and 5.14%, with the effect of interest rate swaps, and weighted average remaining maturities of 234 days and 125 days as of December 31, 2007 and December 31, 2006, respectively. Investment Securities pledged as collateral under these repurchase agreements had an estimated fair value of $48.3 billion at December 31, 2007 and $28.6 billion at December 31, 2006. At December 31, 2007 and December 31, 2006, the repurchase agreements had the following remaining maturities: (dollars in thousands) December 31, 2007 December 31, 2006 Within 30 days 30 to 59 days 60 to 89 days 90 to 119 days Over 120 days Total $34,940,600 4,005,960 300,000 — 6,800,000 $46,046,560 $22,778,703 2,285,317 200,000 — 2,250,000 $27,514,020 The Company has entered into repurchase agreements which provide the counterparty with the right to call the balance prior to maturity date. The repurchase agreements totaled $6.4 billion and the market value of the option to call is $176.7 million. Management has deter- mined that the call option is not required to be bifurcated under the provisions of FASB No.133 as it is deemed clearly and closely related to the debt instrument, therefore the option value is not recorded in the consolidated financial statements. The current situation in the sub-prime mortgage sector, and the current weakness in the broader mortgage market, could adversely affect one or more of the Company’s lenders and could cause one or more of the Company’s lenders to be unwilling or unable to provide it with additional financing. This could potentially increase the Company’s financing costs and reduce liquidity. If one or more major market participants fails, it could negatively impact the mar- ketability of all fixed income securities, including government mortgage securities, and this could negatively impact the value of the securities in the Company’s portfolio, thus reducing its net book value. Furthermore, if many of the Company’s lenders are unwilling or unable to provide it with additional financing, the Company could be forced to sell our Investment Securities at an inopportune time when prices are depressed. Even with the current situation in the sub-prime mortgage sector, the Company does not anticipate having difficulty converting its assets to cash or extending financing term, due to the fact that its Investment Securities have an actual or implied “AAA” rating and principal payment is guaranteed. 4. Interest Rate Swaps In connection with the Company’s interest rate risk management strategy, the Company hedges a portion of its interest rate risk by entering into derivative financial instrument contracts. As of Decem- ber 31, 2007, such instruments are comprised of interest rate swaps, which in effect modify the cash flows on repurchase agreements. The use of interest rate swaps creates exposure to credit risk relating to potential losses that could be recognized if the counterparties to these instruments fail to perform their obligations under the contracts. In the event of a default by the counterparty, the Company could have difficulty obtaining its Mortgage-Backed Securities pledged as collateral for swaps. The Company does not anticipate any defaults by its counterparties. The Company did not have an amount at risk greater than 10% of the equity of the Company with any counterparties as of December 31, 2007 or December 31, 2006. The Company’s swaps are used to lock-in the fixed rate related to a portion of its current and anticipated future 30-day term repurchase agreements. 31 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report The table below presents information about the Company’s swaps outstanding at December 31, 2007. (dollars in thousands) Notional Amount Weighted Average Pay Rate Weighted Average Receive Rate Net Estimated Fair Value Carrying Value On August 16, 2006, the Company entered into an underwriting agreement pursuant to which it sold 40,825,000 shares of its common stock for net proceeds before expenses of approximately $476.7 million. This transaction settled on August 22, 2006. 2007 2006 $16,243,500 5.03% 5.06% ($398,096) $9,328,400 5.17% 5.35% ($17,621) During the year ended December 31, 2007, the Company had a $2.1 million realized gain on the termination of interest rate swaps with a notional value of $900 million. During the year ended Decem- ber 31, 2006, the Company had a $10.7 million gain on the termination of interest rate swaps with a notional value of $1.2 billion. 5. Preferred Stock and Common Stock (A) Stock Issuances On October 11, 2007, the Company entered into an underwriting agreement pursuant to which it sold 71,300,000 shares of its common stock for net proceeds following underwriting expenses of approx- imately $1.0 billion. This transaction settled on October 17, 2007. On July 12, 2007, the Company entered into an underwriting agreement pursuant to which it sold 54,050,000 shares of its common stock for proceeds of $720.8 million net of underwriting fees. This transaction settled on July 18, 2007. On March 7, 2007, the Company entered into an underwriting agree- ment pursuant to which it sold 57,500,000 shares of its common stock for net proceeds following underwriting expenses of approximately $737.4 million. This transaction settled on March 13, 2007. During the year ended December 31, 2007, the Company raised $116.5 million by issuing 8.0 million shares through the Direct Pur- chase and Dividend Reinvestment Program. During the year ended December 31, 2007, 55,738 options were exercised under the Long-Term Stock Incentive Plan, or Incentive Plan, for an aggregate exercise price of $576,000. On August 3, 2006, the Company entered into an ATM Equity Offeringsm Sales Agreement with Merrill Lynch & Co. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, relating to the sale of shares of its common stock from time to time through Merrill Lynch. Sales of the shares, if any, are made by means of ordinary brokers’ transaction on the New York Stock Exchange. During the year ended December 31, 2007, 4.5 million shares of our common stock were issued pursuant to this program, totaling $66.2 million in net proceeds. On August 3, 2006, the Company entered into an ATM Equity Sales Agreement with UBS Securities LLC, relating to the sale of shares of our common stock from time to time through UBS Securities. Sales of the shares, if any, will be made by means of ordinary brokers’ transaction on the New York Stock Exchange. During the year ended December 31, 2007, 1.1 million shares of its common stock were issued pursuant to this program, totaling $14.7 million in net proceeds. 32 On April 6, 2006, the Company entered into an underwriting agree- ment pursuant to which it sold 39,215,000 shares of its common stock for net proceeds before expenses of approximately $437.7 million. On April 6, 2006, the Company entered into a second underwriting agreement pursuant to which if sold 4,600,000 shares of its 6% Series B Cumulative Convertible Preferred Stock for net proceeds before expenses of approximately $111.5 million. Both of these transactions settled on April 12, 2006. During the year ended December 31, 2006, 22,160 options were exercised under the long-term compensation plan for an aggregate exercise price of $183,000. During the year ended December 31, 2006, 500,000 shares of the Company’s common stock, with net proceeds of $6.7 million, were issued pursuant to the Merrill ATM Program. During the year ended December 31, 2006, 1.1 million shares of the Company’s common stock were issued through the Equity Shelf Program with UBS Securities, totaling net proceeds of $14.2 million. During the year ended December 31, 2007, the Company declared dividends to common shareholders totaling $339.8 million or $1.04 per share, of which $136.6 million were paid on January 28, 2008. During the year ended December 31, 2007, the Company declared and paid dividends to Series A preferred shareholders totaling $14.6 million or $1.97 per share and Series B Preferred shareholders totaling $6.9 million or $1.50 per share. During the year ended December 31, 2006, the Company declared dividends to common shareholders totaling $102.6 million or $.57 per share, of which $39.0 million were paid on January 26, 2007. During the year ended December 31, 2006, the Company declared and paid dividends to Series A preferred shareholders totaling $14.6 million or $1.97 per share and Series B Preferred shareholders total- ing $5.0 million or $1.08 per share. During the year ended December 31, 2005, the Company declared dividends to common shareholders totaling $127.1 million, or $1.04 per share, and the Company declared and paid dividends to preferred shareholders totaling $14.6 million or $1.97 per share. During the year ended ended December 31, 2005, 2,381,550 shares of the Company’s common stock were issued through the Equity Shelf Program, totaling net proceeds of $40.1 million. During the year ended December 31, 2005, 16,128 options were exercised under the long-term compensation plan for an aggregate exercise price of $253,000. In addition, 24,253 common shares were sold through the dividend reinvestment and direct purchase program for $440,000 during the year ended December 31, 2005. (B) Preferred Stock At December 31, 2007, the Company had issued and outstanding 7,412,500 shares of Series A Cumulative Redeemable Preferred Stock, with a par value $0.01 per share and a liquidation preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared). The Series A preferred stock must be paid a dividend at a rate of 7.875% per year on the $25.00 liquidation preference before the common stock is entitled to receive any dividends. The Series A pre- ferred stock is redeemable at $25.00 per share plus accrued and unpaid dividends (whether or not declared) exclusively at the Company’s option commencing on April 5, 2009 (subject to the Company’s right under limited circumstances to redeem the Series A preferred stock ear- lier in order to preserve its qualification as a REIT). The Series A preferred stock is senior to the Company’s common stock and is on par- ity with the Series B preferred stock with respect to dividends and distributions, including distributions upon liquidation, dissolution or winding up. The Series A preferred stock generally does not have any voting rights, except if the Company fails to pay dividends on the Series A preferred stock for six or more quarterly periods (whether or not consecutive). Under such circumstances, the Series A preferred stock, together with the Series B preferred stock, will be entitled to vote to elect two additional directors to the Board, until all unpaid dividends have been paid or declared and set apart for payment. In addition, cer- tain material and adverse changes to the terms of the Series A preferred stock cannot be made without the affirmative vote of holders of at least two-thirds of the outstanding shares of Series A preferred stock and Series B preferred stock. Through December 31, 2007, the Company had declared and paid all required quarterly dividends on the Series A preferred stock. At December 31, 2007, the Company had issued and outstanding 4,600,000 shares of Series B Cumulative Convertible Preferred Stock, with a par value $0.01 per share and a liquidation preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared). The Series B preferred stock must be paid a dividend 6. Net Income (Loss) Per Common Share 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. at a rate of 6% per year on the $25.00 liquidation preference before the common stock is entitled to receive any dividends. The Series B preferred stock is not redeemable. The Series B preferred stock is convertible into shares of common stock at a conversion rate that adjusts from time to time upon the occurrence of certain events, including if the Company distributes to its common shareholders in any calendar quarter cash dividends in excess of $0.11 per share. Initially, the conversion rate was 1.7730 shares of common shares per $25 liquidation preference. Commencing April 5, 2011, the Com- pany has the right in certain circumstances to convert each Series B preferred stock into a number of common shares based upon the then prevailing conversion rate. The Series B preferred stock is also con- vertible into common shares at the option of the Series B preferred shareholder at any time at the then prevailing conversion rate. The Series B preferred stock is senior to the Company’s common stock and is on parity with the Series A preferred stock with respect to dividends and distributions, including distributions upon liquidation, dissolution or winding up. The Series B preferred stock generally does not have any voting rights, except if the Company fails to pay dividends on the Series B preferred stock for six or more quarterly periods (whether or not consecutive). Under such circumstances, the Series B preferred stock, together with the Series A preferred stock, will be entitled to vote to elect two additional directors to the Board, until all unpaid dividends have been paid or declared and set apart for payment. In addition, certain material and adverse changes to the terms of the Series B preferred stock cannot be made without the affirmative vote of holders of at least two-thirds of the outstanding shares of Series B preferred stock and Series A preferred stock. Through December 31, 2007, the Company had declared and paid all required quarterly dividends on the Series B preferred stock. The following table presents a reconciliation of the net income (loss) and shares used in calculating basic and diluted earnings per share for the years ended December 31, 2007, 2006 and 2005. For the years ended December 31, 2006 Net income (loss) Less: Preferred stock dividends Net income available to common shareholders, prior to adjustment for Series B dividends, if necessary Add: Preferred Series B dividends, if Series B shares are dilutive Net income, as adjusted Weighted average shares of common stock outstanding-basic Add: Effect of dilutive stock options and Series B Cumulative Convertible Preferred Stock Weighted average shares of common stock outstanding-diluted The Series B Cumulative Convertible Preferred Stock was anti- dilutive for the years ended December 31, 2006 and 2005. Because the Company had a net loss related to common shareholders for the year ended December 31, 2005, options to purchase 2,333,593 shares of common stock were considered anti-dilutive for the year ended December 31, 2005. December 31, 2007 $414,384 21,493 392,891 6,900 399,791 297,488 8,775 306,263 $93,816 19,557 74,259 — 74,259 167,667 79 167,746 December 31, 2005 ($9,247) 14,593 (23,840) — (23,840) 122,475 — 122,475 7. Long-Term Stock Incentive Plan The Company has adopted a long term stock incentive plan for executive officers, key employees and non-employee directors (the “Incentive Plan”). The Incentive Plan authorizes the Compensation Committee of the board of directors to grant awards, including non-qualified options as well as incentive stock options as defined 33 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report under Section 422 of the Code. The Incentive Plan authorizes the granting of options or other awards for an aggregate of the greater of 500,000 shares or 9.5% of the diluted outstanding shares of the Company’s common stock, up to ceiling of 8,932,921 shares. Stock options are issued at the current market price on the date of grant, subject to an immediate or four year vesting in four equal installments with a contractual term of 5 or 10 years. The grant date fair value is calculated using the Black-Scholes option valuation model. Options outstanding at the beginning of year Granted Exercised Forfeited Expired Options outstanding at the end of year Options exercisable at the end of the year December 31, 2007 For the years ended December 31, 2006 December 31, 2005 Number of Shares 2,984,995 687,250 (55,738) (174,240) (5,000) 3,437,267 1,286,004 Weighted Average Exercise Price $15.10 15.69 10.34 16.06 20.35 $15.23 $14.98 Number of Shares 2,333,593 737,250 (22,160) (60,000) (3,688) 2,984,995 1,298,496 Weighted Average Exercise Price $16.10 11.72 8.25 15.39 13.69 $15.10 $15.28 Number of Shares 1,645,721 737,750 (16,128) — (33,750) 2,333,593 831,906 Weighted Average Exercise Price $15.66 17.08 12.21 — 17.87 $16.10 $13.84 The weighted average remaining contractual term was approximately 7.0 years for stock options outstanding and approximately 5.3 years for stock options exercisable as of December 31, 2007. As of December 31, 2007, there was approximately $2.9 million of total unrecognized compensa- tion cost related to nonvested share-based compensation awards. That cost is expected to be recognized over a weighted average period of 2.7 years. During the year ended December 31, 2007, the Company granted 7,000 shares of restricted common stock to certain of its employees. As of December 31, 2007, 5,250 of these restricted shares were unvested and subject to forfeiture. The following table summarizes information about stock options outstanding at December 31, 2007: Weighted Average Exercise Price on Total Outstanding $15.23 20.70 $15.23 Weighted Average Remaining Contractual Life (Years) on Total Outstanding 7.0 0.5 7.0 Total Options Outstanding 3,432,267 5,000 3,437,267 Total Options Exercisable 1,286,004 5,000 1,291,004 Weighted Average Exercise Price on Exercisable $14.98 20.70 $15.00 Weighted Average Remaining Contractual Life (Years) on Exercisable 5.3 0.5 5.3 Range of Exercise Prices 0$7.94-$19.99 $20.00-$29.99 8. Income Taxes As a REIT, the Company is not subject to Federal income tax on earn- ings distributed to its shareholders. Most states recognize REIT status as well. The Company has decided to distribute the majority of its income and retain a portion of the permanent difference between book and taxable income arising from Section 162(m) of the Code pertaining to employee remuneration. During the year ended December 31, 2007, the Company did not record income tax expense for income attributable to FIDAC, its tax- able REIT subsidiary, and the portion of earnings retained based on Code Section 162(m) limitations. During the year ended December 31, 2007, the Company recorded $9.0 million of income tax expense for a portion of earnings retained based on Section 162(m) limitations. The effective tax rate was 51% for the year ended December 31, 2007. During the year ended December 31, 2006, the Company recorded $3.1 million of income tax expense for income attributable to FIDAC, its taxable REIT subsidiary, and the portion of earnings retained based on Code Section 162(m) limitations. During the year ended December 31, 2006, the Company recorded $4.5 million of income tax expense for a portion of earnings retained based on Sec- tion 162(m) limitations. The effective tax rate was 45% for the year ended December 31, 2006. 34 During the year ended December 31, 2005, the Company recorded $8.7 million of income tax expense for income attributable to FIDAC and the portion of earnings retained based on Code Section 162(m) limitations. The Company’s effective tax rate was 47% for the year ended December 31, 2005. The Company’s effective tax rate was 51%, 45%, and 47% for the year ended December 31, 2007, 2006, and 2005, respectively. These rates differed from the federal statutory rate as a result of state and local taxes and permanent difference pertaining to employee remu- neration as discussed above. 9. Lease Commitments The Company has a noncancelable lease for office space, which com- menced in May 2002 and expires in December 2009. Gross office rent expense was $725,000, $618,000, and $573,000 for the years ended December 31, 2007, 2006 and 2005, respectively. The gross expense was offset by sub-lease payments received of $96,000, $91,000, and $84,000 for the years ended December 31, 2007, 2006 and 2005, respectively. The Company’s aggregate future minimum lease payments are $532,000 in 2008 and in 2009. 10. Interest Rate Risk The primary market risk to the Company is interest rate risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the Company’s con- trol. Changes in the general level of interest rates can affect net interest income, which is the difference between the interest bearing liabilities, by affecting the spread between the interest earning assets and interest- bearing liabilities. Changes in the level of interest rates also can affect the value of the Investment Securities and the Company’s ability to real- ize gains from the sale of these assets. A decline in the value of the Investment Securities pledged as collateral for borrowings under repur- chase agreements could result in the counterparties demanding additional collateral pledges or liquidation of some of the existing collateral to borrowing levels. Liquidation of collateral at losses could have an adverse accounting impact, as discussed in Note 3. The Company seeks to manage the extent to which net income changes as a function of changes in interest rates by matching adjustable-rate assets with variable-rate borrowings. The Company may seek to mitigate the potential impact on net income of periodic and lifetime coupon adjustment restrictions in the portfolio of Investment Securi- ties by entering into interest rate agreements such as interest rate caps and interest rate swaps. As of December 31, 2007, the Company 13. Summarized Quarterly Results (Unaudited) 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. entered into interest rate swaps to pay a fixed rate and receive a float- ing rate of interest, with total notional amount of $16.2 billion. Changes in interest rates may also have an effect on the rate of mortgage principal prepayments and, as a result, prepayments on Mortgage- Backed Securities. The Company will seek to mitigate the effect of changes in the mortgage principal repayment rate by balancing assets purchased at a premium with assets purchased at a discount. To date, the aggregate premium exceeds the aggregate discount on the Mort- gage-Backed Securities. As a result, prepayments, which result in the expensing of unamortized premium, will reduce net income compared to what net income would be absent such prepayments. 11. Commitments And Contingencies From time to time, the Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of man- agement, the ultimate disposition of these matters will not have a material effect on the Company’s consolidated financial statements. 12. Subsequent Events On January 23, 2008, the Company entered into an underwriting agreement pursuant to which it sold 58,650,000 shares of its common stock for net proceeds following underwriting expenses of approxi- mately $1.1 billion. This transaction settled on January 29, 2008. The following is a presentation of the quarterly results of operations for the year ended December 31, 2007. (dollars in thousands, except per share data) Interest income Interest expense Net interest income Other income: Investment advisory and service fees Gain on sale of Investment Securities Gain on termination of interest rate swaps Income from trading securities Dividend income from available-for-sale equity securities Loss on other-than-temporarily impaired securities Total other income Expenses: Distribution fees General and administrative expenses Total expenses Income before income taxes and minority interest Income taxes Income before minority interest Minority interest Net Income Dividends on preferred stock Net income available to common shareholders Weighted average number of basic common shares outstanding Weighted average number of diluted common shares outstanding Net income available to common shareholders per average common share: Basic Diluted March 31, 2007 $449,564 380,164 69,400 June 30, 2007 $556,262 468,748 87,514 September 30, 2007 $628,696 519,118 109,578 5,562 6,145 67 3,429 (491) 14,712 904 12,886 13,790 70,322 2,604 67,718 286 67,432 5,373 $62,059 5,366 7,293 — 243 (698) 12,204 861 12,272 13,133 86,585 839 85,746 13 85,733 5,373 $80,360 5,464 3,795 2,029 8,288 — 19,576 1,100 17,334 18,434 110,720 2,327 108,393 106 108,287 5,373 $102,914 December 31, 2007 $720,925 558,435 162,490 5,636 1,829 — 7,187 91 — 14,743 782 20,174 20,956 156,277 3.,100 153,177 245 152,932 5,374 $147,558 217,490,205 225,928,127 264,990,422 273,578,836 315,969,814 324,614,534 389,410,812 398,247,632 $0.29 $0.28 $0.30 $0.30 $0.33 $0.32 $0.38 $0.37 35 ANNALY CAPITAL MANAGEMENT, INC. 2007 Annual Report The following is a presentation of the quarterly results of operations for the year ended December 31, 2006. (dollars in thousands, except per share data) March 31, 2006 June 30, 2006 September 30, 2006 Interest income Interest expense Net interest income Other (loss) income: Investment advisory and service fees (Loss) gain on sale of Investment Securities Gain on termination of interest rate swaps Income from trading securities Loss on other-than-temporarily impaired securities Total other (loss) income Expenses: Distribution fees General and administrative expenses Total expenses Impairment of intangible for customer relationships (Loss) income before income taxes and minority interest Income taxes (Loss) income before minority interest Minority interest Net (loss) income Dividends on preferred stock Net (loss related) income available to common shareholders Weighted average number of basic common shares outstanding Weighted average number of diluted common shares outstanding Net (loss related) income available to common shareholders per average common share: $194,882 167,512 27,370 6,997 (7,006) — — (26,730) (26,739) 1,170 7,177 8,347 1,148 (8,864) 2,085 (10,949) — (10,949) 3,648 ($14,597) $280,171 242,473 37,698 5,210 (1,239) — — (20,114) (16,143) 755 8,985 9,740 1,345 10,470 1,892 8,578 —28 8,578 5,163 $3,415 $339,737 295,726 44,011 4,966 (446) 8,414 612 — 13,546 724 11,682 12,406 — 45,151 2,273 42,878 42,850 5,373 $37,477 December 31, 2006 $407,092 349,302 57,790 5,178 4,829 2,260 3,382 (5,504) 10,145 795 12,219 13,014 — 54,921 1,288 53,633 296 53,337 5,373 $47,964 123,693,851 123,693,851 158,632,865 158,703,614 181,767,106 189,952,159 205,092,330 213,455,555 Basic Diluted ($0.12) ($0.12) $0.02 $0.02 $0.21 $0.20 $0.23 $0.23 COMMON STOCK AND MARKET INFORMATION (UNAUDITED) The following table sets forth, for the periods indicated, the high, low, and closing sales prices per share of our common stock as reported on the New York Stock Exchange composite tape and the cash dividends declared per share of our common stock. First Quarter ended March 31, 2007 Second Quarter ended June 30, 2007 Third Quarter ended September 30, 2007 Fourth Quarter ended December 31, 2007 First Quarter ended March 31, 2006 Second Quarter ended June 30, 2006 Third Quarter ended September 30, 2006 Fourth Quarter ended December 31, 2006 First Quarter ended March 31, 2007 Second Quarter ended June 30, 2007 Third Quarter ended September 30, 2007 Fourth Quarter ended December 31, 2007 First Quarter ended March 31, 2006 Second Quarter ended June 30, 2006 Third Quarter ended September 30, 2006 Fourth Quarter ended December 31, 2006 36 High $15.48 $16.20 $16.42 $18.18 High Stock Prices Low $13.54 $13.83 $13.03 $15.25 Low Close $15.48 $14.42 $15.93 $18.18 Close $12.82 $14.04 $13.25 $14.42 $12.14 $12.81 $13.14 $13.91 $11.34 $11.57 $12.17 $13.01 Common Dividends Declared Per Share $0.20 $0.24 $0.26 $0.34 $0.11 $0.13 $0.14 $0.19 We intend to pay quarterly dividends and to distrib- ute to our stockholders all or substantially all of our taxable income in each year (subject to certain ad- justments). This will enable us to qualify for the tax benefits accorded to a REIT under the Code. We have not established a minimum dividend payment level and our ability to pay dividends may be adversely affected for the reasons described under the caption “Risk Factors.” All distributions will be made at the discretion of our board of directors 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. No dividends can be paid on our common stock unless we have paid full cumulative dividends on our preferred stock. From the date of issuance of our preferred stock through December 31, 2007, we have paid full cumu- lative dividends on our preferred stock. CORPORATE OFFICERS BOARD OF DIRECTORS CORPORATE HEADQUARTERS 2007 Annual Report ANNALY CAPITAL MANAGEMENT, INC. Michael A. J. Farrell Chairman of the Board, President & Chief Executive Officer Michael A. J. Farrell Chairman of the Board, President & Chief Executive Officer Wellington J. Denahan-Norris Wellington J. Denahan-Norris Vice Chairman, Chief Investment Officer & Chief Operating Officer Kevin P. Brady General Manager Thomson Corporation Jonathan D. Green President & Chief Executive Officer Rockefeller Group International, Inc. John A. Lambiase Former Managing Director Salomon Brothers, Inc. E. Wayne Nordberg Chairman & Chief Executive Officer Hollow Brook Associates, LLC Donnell A. Segalas Managing Partner & Chief Executive Officer Pinnacle Asset Management, L.P. Vice Chairman, Chief Investment Officer & Chief Operating Officer Kathryn F. Fagan Chief Financial Officer & Treasurer R. Nicholas Singh Executive Vice President, General Counsel, Secretary & Chief Compliance Officer James P. Fortescue Executive Vice President Head of Liabilities Kristopher Konrad Executive Vice President Co-Head of Portfolio Management Rose-Marie Lyght Executive Vice President Co-Head of Portfolio Management Jeremy Diamond Managing Director Ronald D. Kazel Managing Director ADDITIONAL INFORMATION Annaly Capital Management, Inc. 1211 Avenue of the Americas, Suite 2902 New York, NY 10036 LEGAL COUNSEL Kirkpatrick & Lockhart Preston Gates Ellis LLP 1601 K. Street, N.W. Washington, D.C. 20006 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, NY 10281-1434 STOCK TRANSFER AGENT Shareholder inquiries concerning dividend payments, lost certificates, change of address: BNY Mellon Shareowner Services 480 Washington Blvd Jersey City, NJ 07310-1900 800-301-5234 www.bnymellon.com/shareowner/isd STOCK EXCHANGE LISTING The common stock is listed on the New York Stock Exchange (symbol: NLY). The Series A preferred stock is listed on the New York Stock Exchange (symbol: NLY-A). ANNUAL SHAREHOLDERS MEETING The Annual Meeting will be held Tuesday, May 20, 2008 at 9:00 a.m. at: New York Marriott Marquis 1535 Broadway New York, NY 10036 SHAREHOLDER COMMUNICATIONS Copies of the Company’s Annual Report and 2007 Form 10-K may be obtained by writing the Secretary, by calling the investor relations hot line at , or by visiting our website 1–888–8annaly www.annaly.com The Company has included as exhibits to its annual report on Form 10-K for fiscal year ended 2007 certificates of the Company’s Chief Executive Officer and Chief Financial Officer certifying the quality of the Company’s public disclosure controls, and the Company has submitted to the New York Stock Exchange (NYSE) in 2007, a certificate of the Company’s Chief Executive Officer certifying that he is not aware of any violations by the Company of the NYSE corporate governance listing standards. Photos Courtesy of: Cover: ©age fotostock/SuperStock. Inside front cover: Jorg Greuel/Photographer’s Choice/Getty Images; Button photosofoldamerica.com. Page 1: 26, 1912, Collection of the Brooklyn Museum. Page 3: Tibbals Digital Collection/ht2004500. Page 2-5 side panels , 1983, Collection of the Brooklyn Museum. Page 2: Gerrit A. Beneker, The Library of Congress; top right top left photosofoldamerica.com. The John & Mable Ringling Museum of Art, bottom Cover from Harper’s Weekly , October top A N N A L Y CAPITAL MANAGEMENT, INC. 1211 Avenue of the Americas Suite 2902 New York, New York 10036 1-888-8annaly www.annaly.com 

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