ANNALY CAPITAL MANAGEMENT, INC.
2 0 0 8 A n n u a l R e p o r t
CORPORATE PROFILE
Annaly manages assets on behalf of institutional and
individual investors worldwide. Annaly’s principal
business objective is to generate net income for distri-
bution to investors from our investment securities and
from dividends we receive from our subsidiaries. We
have elected to be taxed as a real estate investment
trust (“REIT”) and are therefore 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, according to which a
combination of adjustable-, floating-, and fixed-rate mortgage-backed securities is
designed to 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 investment securities. On our balance
sheet, these borrowings appear as Repurchase Agreements. Our leverage, measured
as a ratio of debt-to-equity, typically is no more than 12:1.
Annaly has three taxable REIT subsidiaries. Fixed Income Discount Advisory
Company, or FIDAC, is an SEC-registered investment advisor formed in 1994
and acquired by Annaly in 2004. FIDAC specializes in managing interest rate and
credit sensitive strategies and is a leading auction agent for liquidating CDOs.
Merganser Capital Management, Inc., a Boston-based SEC-registered investment
advisor, was formed in 1985 and acquired by Annaly in 2008. Merganser extends
Annaly’s asset management platform into traditional fixed income strategies for
institutional clients. RCap Securities, Inc. was formed by Annaly in 2008 and
operates as a broker-dealer.
Annaly is an asset management company experienced in trading, management
and operations. Our success and future growth prospects are based on the proven
ability of our strong and seasoned management team to successfully take advantage
of investment opportunities and deliver compelling returns in a wide range of
market environments.
176822_NARR_R2 4/2/09 12:39 AM Page 1
ANNALY CAPITAL MANAGEMENT, INC.
During 2008, Annaly executed two secondary common stock
offerings, increasing shareholders’ equity to $7.2 billion by year
end. The effective deployment of this capital, combined with
improving market conditions, allowed us to increase our cash
dividends declared per common share during 2008 to $2.08
versus $1.04 in 2007. This increase marks a milestone event for
our Company as we exceeded over $1 billion in total dividends
declared in any calendar year. Additionally, we grew our Company
through the acquisition of Merganser Capital Management, Inc.,
a Boston-based fixed income manager, and the formation of our
registered broker-dealer, RCap Securities, Inc.
SHAREHOLDERS’
EQUITY
(dollars in millions)
COMMON AND PREFERRED
DIVIDENDS DECLARED
(dollars in millions)
(cid:7)(cid:4)(cid:8)(cid:9)(cid:3)(cid:10)
(cid:7)(cid:6)(cid:8)(cid:11)(cid:2)(cid:6)
$8,000
$7,000
$6,000
$5,000
$4,000
$3,000
$2,000
(cid:7)(cid:9)(cid:8)(cid:6)(cid:2)(cid:12)
$1,000
$0
(cid:7)(cid:11)(cid:8)(cid:6)(cid:12)(cid:10)
(cid:7)(cid:8)(cid:9)(cid:8)(cid:2)(cid:10)
(cid:7)(cid:13)(cid:5)(cid:8)
$1,200
$1,000
$800
$600
$400
$200
(cid:7)(cid:8)(cid:12)(cid:11)
(cid:7)(cid:8)(cid:11)(cid:11)
$0
(cid:0)(cid:2)(cid:6)
(cid:0)(cid:2)(cid:5)
(cid:0)(cid:2)(cid:4)
(cid:0)(cid:2)(cid:3)
(cid:0)(cid:2)(cid:6)
(cid:0)(cid:2)(cid:5)
(cid:0)(cid:2)(cid:4)
(cid:0)(cid:2)(cid:3)
PAGE 1
176822_NARR_R2 4/2/09 12:39 AM Page 2
LETTER FROM THE CHAIRMAN
Dear Fellow Shareholders,
She is one of eleven children, and worked any job she could get to put herself
search for excellence consistently and relentlessly. I’d like to introduce you to them—
not by name, for they are modest folks, but rather by profile:
Iam a lucky guy. I am surrounded by smart, industrious people. Energetic people who
through college. She moved far away from her roots to New York, pawning her
college stereo system to buy the ticket. She came into my office one day for an inter-
view and was offered a job as a trading assistant and, true to form, she worked her way up to
trading in short order. She became a portfolio manager at the relatively young age of 28 years
old and has firmly established herself as a leading voice in the traditionally male-dominated
profession of bond trading and investment. She is a co-founder and the author of the track
record of one of the most successful companies on the NYSE since its listing in 1997. She
has never forgotten her roots and is generous to a fault for people and causes she believes in.
One of her comrades joined the firm in 1997. She grew up in Louisiana and was a
senior officer for a small local bank. Life’s twists and turns led her to New York. We had spent
months looking for someone with public company accounting and regulatory knowledge and
were so stunned when she arrived on our doorstep that we interviewed her four times. In a
world of grey areas and interpretations, she sets a standard for studied, ethical and definitive
replies across all of the regulated structures we manage. Under her leadership, the Company
has never had to file a restatement of any of the myriad reports that we originate in order to
satisfy the reporting standards of our various accountants, regulators and exchanges. She asks,
and answers, the tough questions.
He was raised in Rockland County, New York, the kind of hockey player who made
everyone on his team better. He is well known for supporting all sorts of causes, especially
those that work with military families. In 1996 he took a chance on a growing young
company, started working here on an hourly basis and now runs perhaps the largest mort-
gage-backed securities financing position in the markets. He is often the first to arrive in the
office and the last to leave. He is one of those ‘tipping point’ connectors with a vast social
network—he knows someone who knows someone who knows someone—which serves
him and our company well. He comes from a small, tightly knit family, but his extended
family stretches so far that his wedding was the largest and most joyous I have ever attended.
Down the desk sits another member of the team whose employment date will always
stick in my mind, because it coincided with our Initial Public Offering date, October 8th,
1997. He grew up in upstate New York and became a lacrosse player. He literally married the
‘girl next door’ after reconnecting with her in New York. He started off on our financing desk
and as we grew worked his way onto the asset side and into a leading portfolio management
position. Time after time in the past 12 years he has helped to formulate and design winning
investment strategies for navigating the economy’s turbulence. He is quiet, thoughtful and
totally grounded in what is important in life—family, home, commitment.
Across from him, a woman sits who came to us through a referral. She grew up in
modest roots in New Jersey, a high school soccer star who wasn’t deemed good enough to
get a scholarship at her Division I college team. So she walked on, finally won a starting spot
Continued on page 4
PAGE 2
176822_NARR_R2 4/2/09 12:39 AM Page 3
ANNALY CAPITAL MANAGEMENT, INC.
Left to Right,
Seated: Ronald Kazel, Michael A.J. Farrell, Wellington Denahan-Norris, Jeremy Diamond, Kristopher Konrad
Standing: R. Nicholas Singh, Rose-Marie Lyght, Matthew Lambiase, Eric Szabo, Kathryn Fagan, James Fortescue
“I believe, however, that as
a nation we will prevail because
of people like those who
lead Annaly–problem-solvers,
strategic thinkers, prudent
risk-takers, people who do
things the right way.”
PAGE 3
176822_NARR_R2 4/2/09 12:39 AM Page 4
ANNALY CAPITAL MANAGEMENT, INC.
and ended up team captain and All-American her senior year. She was working for a bank
when we met. We didn’t really have a spot for her, or the budget, but she was too good a
candidate for us to pass up. She accepted a 40% pay cut just to change her career path. She
so impressed us that we made it up to her in six months. Every day, she watches over the uni-
verse of investments that were not even on her radar screen twelve years ago. She took a risk,
managed it and never looked back.
He grew up in Montana and has a healthy respect and love for the outdoors. He was
an investment banker when we first met. We described the puzzle we were trying to piece
together and he helped sculpt that thinking. He moved his family from Washington, DC,
to the New York area to take the opportunity. He has played an integral role in defining
our presence in the asset management space. He negotiates the sometimes difficult waters
of taking and creating companies under the NLY umbrella, and he does it with quiet
efficiency and determination.
This next teammate grew up in Maryland, the son of a track coach, who became a
track star in high school and college. We met him when we were contemplating getting into
credit risk-based assets in 2002. We were building the skill set to analyze those risks and
opportunities and he could rip a balance sheet apart with the best of them. After months
of review, he made the case that we should stay away from the sector. We had believed that
it was unsustainable then, and we began to chart our way around the coming storm, deter-
mined to avoid the missteps of others. To ultimately argue against doing that which you
have been hired to do takes rare courage.
Our final profile belongs to a man who was raised in India. He left his family to attend
college in the United States and ultimately go to law school. We became interested in him as
it became clear that a strong, independent legal voice was necessary for our Company to grow.
His diligence and sound judgment as an outside advisor drew us to the natural conclusion
that he was the logical fit for the culture of our firm, and he moved his family from Virginia
to the New York area to be with us. As anyone running a business today can tell you, thought-
ful, prudent and business-oriented legal advice for a public company is almost priceless.
The leaders of the future have profiles like I have outlined above. We work and live
today in a period of tremendous volatility, where scoundrels are being uncovered by a
staggering bear market and powerful governmental policymaking comes with no guaranteed
outcome. I believe, however, that as a nation we will prevail because of people like those who
lead Annaly—problem-solvers, strategic thinkers, prudent risk-takers, people who do things
the right way.
In a world of 24/7 availability and electronic connectivity, I spend a great deal of time
with these people. As I said in my opening comments, I am one lucky guy.
Prodesse Non Nocere
Michael A. J. Farrell
March 17, 2009
PAGE 4
ANNALY CAPITAL MANAGEMENT, INC.
10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2008
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 1-13447
ANNALY CAPITAL MANAGEMENT, INC.
(Exact Name of Registrant as Specified in its Charter)
(State or other jurisdiction of incorporation of organization)
(I.R.S. Employer Identification Number)
MARYLAND
22-3479661
1211 Avenue of the Americas, Suite 2902
New York, New York
(Address of Principal Executive Offices)
10036
(Zip Code)
(212) 696-0100
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Name of Each Exchange on Which Registered
Common Stock, par value $.01 per share
New York Stock Exchange
7.875% Series A Cumulative Redeemable Preferred Stock New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None.
Indicate by check mark whether the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes X No
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No X
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days:
Yes X_
No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting
company. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer X
Accelerated filer __ Non-accelerated filer __ Smaller reporting company___
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes __ No _X_.
At June 30, 2008, the aggregate market value of the voting stock held by non-affiliates of the Registrant was $8,306,036,131.
The number of shares of the Registrant’s Common Stock outstanding on February 25, 2009 was 544,290,086.
Documents Incorporated by Reference
The registrant intends to file a definitive proxy statement pursuant to Regulation 14A within 120 days of the end of the fiscal year ended
December 31, 2008. Portions of such proxy statement are incorporated by reference into Part III of this Form 10-K.
ANNALY CAPITAL MANAGEMENT, INC.
2008 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1.
BUSINESS
ITEM 1A.
RISK FACTORS
ITEM 1B.
UNRESOLVED STAFF COMMENTS
ITEM 2.
PROPERTIES
ITEM 3.
LEGAL PROCEEDINGS
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 6.
SELECTED FINANCIAL DATA
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
ITEM 9A.
CONTROLS AND PROCEDURES
ITEM 9B.
OTHER INFORMATION
PART III
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 11.
EXECUTIVE COMPENSATION
ITEM 12.
ITEM 13.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
PART IV
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
EXHIBIT INDEX
FINANCIAL STATEMENTS
SIGNATURES
PAGE
1
17
29
29
29
29
30
32
34
54
56
56
6
5
57
57
57
57
57
57
58
58
F-1
I
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this annual report, and certain statements contained in our future filings with the
Securities and Exchange Commission (the “SEC” or the “Commission”), in our press releases or in our other public or
shareholder communications may not be based on historical facts and are “forward-looking statements” within the
meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on
various assumptions (some of which are beyond our control), may be identified by reference to a future period or periods
or by the use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “anticipate,” “continue,” or
similar terms or variations on those terms or the negative of those terms. Actual results could differ materially from
those set forth in forward-looking statements due to a variety of factors, including, but not limited to:
•
•
•
•
•
•
•
•
•
•
•
changes in interest rates,
changes in the yield curve,
changes in prepayment rates,
the availability of mortgage-backed securities and other securities for purchase,
the availability of financing,
changes in the market value of our assets,
changes in business conditions and the general economy,
changes in government regulations affecting our business,
our ability to maintain our qualification as a REIT for federal income tax purposes,
risks associated with the investment advisory business of our wholly owned subsidiaries, including:
o the removal by clients of assets managed,
o their regulatory requirements, and
o competition in the investment advisory business and
risks associated with the broker-dealer business of our subsidiary.
For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the
forward-looking statements, please see the information under the caption “Risk Factors” described in this Form 10-K.
We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions which may
be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
ITEM 1. BUSINESS
Background
PART I
THE COMPANY
Annaly Capital Management, Inc. owns, manages, and finances a portfolio of investment securities, including
mortgage pass-through certificates, collateralized mortgage obligations (or CMOs), agency callable debentures, and
other securities representing interests in or obligations backed by pools of mortgage loans. 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 cost of borrowings to finance our acquisition of investment securities. We are a
Maryland corporation that commenced operations on February 18, 1997. We are self-advised and self-managed.
We acquired Fixed Income Discount Advisory Company (or FIDAC) on June 4, 2004 and Merganser Capital
Management, Inc. (or Merganser) on October 31, 2008. Both are registered investment advisors and are taxable REIT
subsidiaries. FIDAC and Merganser manage a number of investment vehicles and separate accounts for which they earn
fee income. Our subsidiary, RCap Securities Inc. (or RCap), which will operate as a broker-dealer, was granted
membership in the Financial Industry Regulatory Authority (or FINRA) in January 2009. RCap is a taxable REIT
subsidiary.
We have elected and believe that we are organized and have operated in a manner that qualifies us to be taxed
as a real estate investment trust (or REIT) under the Internal Revenue Code of 1986, as amended (or the Code). If we
qualify for taxation as a REIT, we generally will not be subject to federal income tax on our taxable income that is
distributed to our stockholders. Therefore, substantially all of our assets, other than FIDAC, Merganser and RCap, our
taxable REIT subsidiaries, consist of qualified REIT real estate assets (of the type described in Section 856(c)(5)(B) of
the Code). We have financed our purchases of investment securities with the net proceeds of equity offerings and
borrowings under repurchase agreements whose interest rates adjust based on changes in short-term market interest rates.
As used herein, “Annaly,” the “Company,” “we,” “our” and similar terms refer to Annaly Capital Management,
Inc., unless the context indicates otherwise.
Assets
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-quality 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 but 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-family 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.
1
To date, all of the mortgage-backed securities that we have acquired have been agency mortgage-backed
securities which, although not rated, carry an implied “AAA” rating. Agency mortgage-backed securities are mortgage-
backed securities for which a government agency or federally chartered corporation, such as the Federal Home Loan
Mortgage Corporation (“FHLMC” or “Freddie Mac”), the Federal National Mortgage Association (“FNMA” or “Fannie
Mae”), or the Government National Mortgage Association (“GNMA” or “Ginnie Mae”), guarantees payments of
principal or interest on the securities. Agency mortgage-backed securities consist of agency pass-through certificates and
CMOs issued or guaranteed by an agency. Pass-through certificates provide for a pass-through of the monthly interest
and principal payments made by the borrowers on the underlying mortgage loans. CMOs divide a pool of mortgage
loans into multiple tranches with different principal and interest payment characteristics.
At December 31, 2008, approximately 28% of our investment securities were adjustable-rate pass-through
certificates, approximately 64% of our investment securities were fixed-rate pass-through certificates or CMOs, and
approximately 8% of our investment securities were CMO floaters. Our adjustable-rate pass-through certificates are
backed by adjustable-rate mortgage loans and have coupon rates which adjust over time, subject to interest rate caps and
lag periods, in conjunction with changes in short-term interest rates. Our fixed-rate pass-through certificates are backed
by fixed-rate mortgage loans and have coupon rates which do not adjust over time. CMO floaters are tranches of
mortgage-backed securities where the interest rate adjusts in conjunction with changes in short-term interest rates. CMO
floaters may be backed by fixed-rate mortgage loans or, less often, by adjustable-rate mortgage loans. In this Form 10-
K, except where the context indicates otherwise, we use the term “adjustable-rate securities” or “adjustable-rate
investment securities” to refer to adjustable-rate pass-through certificates, CMO floaters, and Agency debentures. At
December 31, 2008, the weighted average yield on our portfolio of earning assets was 5.03% and the weighted average
term to next rate adjustment on adjustable rate securities was 36 months.
We may also invest in Federal Home Loan Bank (“FHLB”), FHLMC, and FNMA debentures. We refer to the
mortgage-backed securities and agency debentures collectively as “Investment Securities.” We intend to continue to
invest in adjustable-rate pass-through certificates, fixed-rate mortgage-backed securities, CMO floaters, and Agency
debentures. We may also invest on a limited basis in mortgage derivative securities such as interest rate swaps, and other
derivative securities which 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 have not and will not invest in real estate mortgage investment conduit (“REMIC”) residuals and
other CMO residuals.
Borrowings
We attempt to structure our borrowings to have interest rate adjustment indices and interest rate adjustment
periods that, on an aggregate basis, correspond generally to the interest rate adjustment indices and periods of our
adjustable-rate investment securities. However, periodic rate adjustments on our borrowings are generally more frequent
than rate adjustments on our investment securities. At December 31, 2008, the weighted average cost of funds for all of
our borrowings was 4.08%, with the effect of swaps, the weighted average original term to maturity was 287 days, and
the weighted average term to next rate adjustment of these borrowings was 238 days.
We generally expect to maintain a ratio of debt-to-equity of between 8:1 and 12:1, although the ratio may vary
from time to time depending upon market conditions and other factors that our management deems relevant. For
purposes of calculating this ratio, our equity is equal to the value of our investment portfolio on a mark-to-market basis,
less the book value of our obligations under repurchase agreements and other collateralized borrowings. At December
31, 2008, our ratio of debt-to-equity was 6.4:1.
Hedging
To the extent consistent with our election to qualify as a REIT, we enter into hedging transactions to attempt to
protect our investment securities and related borrowings against the effects of major interest rate changes. This hedging
would be used to mitigate declines in the market value of our investment securities during periods of increasing or
decreasing interest rates and to limit or cap the interest rates on our borrowings. These transactions would be entered
into solely for the purpose of hedging interest rate or prepayment risk and not for speculative purposes. In connection
with our interest rate risk management strategy, we hedge a portion of our interest rate risk by entering into derivative
2
financial instrument contracts. As of December 31, 2008, we had $17.6 billion in interest rate swaps, which in effect
modify the cash flows on repurchase agreements.
Compliance with REIT and Investment Company Requirements
We constantly monitor our investment securities and the income from these securities and, to the extent we
enter into hedging transactions, we monitor income from our hedging transactions as well, so as to ensure at all times
that we maintain our qualification as a REIT and our exemption from registration under the Investment Company Act of
1940, as amended.
Executive Officers of the Company
The following table sets forth certain information as of February 25, 2009 concerning our executive officers:
Name
Age
Position held with the Company
Michael A.J. Farrell
Wellington J. Denahan-Norris
Kathryn F. Fagan
R. Nicholas Singh
James P. Fortescue
Kristopher Konrad
Rose-Marie Lyght
Jeremy Diamond
Ronald Kazel
57
45
42
49
35
34
35
45
41
Chairman of the Board, Chief Executive Officer and President
Vice Chairman of the Board, Chief Investment Officer and Chief
Operating Officer
Chief Financial Officer and Treasurer
Executive Vice President, General Counsel, Secretary and Chief
Compliance Officer
Managing Director and Head of Liabilities
Managing Director and Co-Head Portfolio Management
Managing Director and Co-Head Portfolio Management
Managing Director
Managing Director
Mr. Farrell and Ms. Denahan-Norris have an average of 25 years experience in the investment banking and
investment management industries where, in various capacities, they have each managed portfolios of mortgage-backed
securities, arranged collateralized borrowings and utilized hedging techniques to mitigate interest rate and other risk
within fixed-income portfolios. Ms. Fagan is a certified public accountant and, prior to becoming our Chief Financial
Officer and Treasurer, served as Chief Financial Officer and Controller of a publicly owned savings and loan association.
Mr. Singh joined Annaly in February 2005. Prior to that, he was a partner in the law firm of McKee Nelson LLP. Mr.
Fortescue joined Annaly in 1997. Mr. Konrad joined Annaly in 1997. Ms. Lyght joined Annaly in April 1999. Mr.
Diamond joined Annaly in March 2002. Mr. Kazel joined Annaly in December 2001. We and our subsidiaries had 65
full-time employees at December 31, 2008.
Distributions
To maintain our qualification as a REIT, we must distribute substantially all of our taxable income to our
stockholders for each year. We have done this in the past and intend to continue to do so in the future. We also have
declared and paid regular quarterly dividends in the past and intend to do so in the future. We have adopted a dividend
reinvestment plan to enable holders of common stock to reinvest dividends automatically in additional shares of common
stock.
3
General
BUSINESS STRATEGY
Our principal business objective is to generate income for distribution to our stockholders, primarily from the
net cash flows on our investment securities. Our net cash flows result primarily from the difference between the interest
income on our investment securities and borrowing costs of our repurchase agreements and from dividends we receive
from our taxable REIT subsidiaries. To achieve our business objective and generate dividend yields, our strategy is:
(cid:2)
(cid:2)
(cid:2)
(cid:2)
(cid:2)
(cid:2)
to purchase mortgage-backed securities, the majority of which we expect to have adjustable interest rates
based on changes in short-term market interest rates;
to acquire mortgage-backed securities that we believe:
-
we have the necessary expertise to evaluate and manage;
- we can readily finance;
-
-
are consistent with our balance sheet guidelines and risk management objectives; and
provide attractive investment returns in a range of scenarios;
to finance purchases of mortgage-backed securities with the proceeds of equity offerings and, to the extent
permitted by our capital investment policy, to utilize leverage to increase potential returns to stockholders
through borrowings;
to attempt to structure our borrowings to have interest rate adjustment indices and interest rate adjustment
periods that, on an aggregate basis, generally correspond to the interest rate adjustment indices and interest
rate adjustment periods of our adjustable-rate mortgage-backed securities;
to seek to minimize prepayment risk by structuring a diversified portfolio with a variety of prepayment
characteristics and through other means; and
to issue new equity or debt and increase the size of our balance sheet when opportunities in the market for
mortgage-backed securities are likely to allow growth in earnings per share.
We believe we are able to obtain cost efficiencies through our facilities-sharing arrangement with FIDAC and
RCap and by virtue of our management’s experience in managing portfolios of mortgage-backed securities and arranging
collateralized borrowings. We will strive to become even more cost-efficient over time by:
(cid:2)
(cid:2)
(cid:2)
(cid:2)
seeking to raise additional capital from time to time in order to increase our ability to invest in mortgage-
backed securities;
striving to lower our effective borrowing costs by seeking direct funding with collateralized lenders, rather
than using financial intermediaries, and investigating the possibility of using commercial paper and
medium term note programs;
improving the efficiency of our balance sheet structure by investigating the issuance of uncollateralized
subordinated debt, preferred stock and other forms of capital; and
utilizing information technology in our business, including improving our ability to monitor the
performance of our investment securities and to lower our operating costs.
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Mortgage-Backed Securities
General
To date, all of the mortgage-backed securities that we have acquired have been agency mortgage-backed
securities which, although not rated, carry an implied “AAA” rating. Agency mortgage-backed securities are mortgage-
backed securities where a government agency or federally chartered corporation, such as FHLMC, FNMA or GNMA,
guarantees payments of principal or interest on the securities. Agency mortgage-backed securities consist of agency
pass-through certificates and CMOs issued or guaranteed by an agency.
Even though to date we have only acquired mortgage backed securities with an implied “AAA” rating, under
our capital investment policy, we have the ability to acquire securities of lower quality. Under our policy, at least 75%
of our total assets must be high quality mortgage-backed securities and short-term investments. High quality securities
are securities (1) that are rated within one of the two highest rating categories by at least one of the nationally recognized
rating agencies, (2) that are unrated but are guaranteed by the United States government or an agency of the United
States government, or (3) that are unrated or whose ratings have not been updated but that our management determines
are of comparable quality to rated high quality mortgage-backed securities.
Under our capital investment policy, the remainder of our assets, comprising not more than 25% of total assets,
may consist of mortgage-backed securities and 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 S&P or the equivalent by another
nationally recognized rating organization) 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 intend to structure our
portfolio to maintain a minimum weighted average rating (including our deemed comparable ratings for unrated
mortgage-backed securities) of our mortgage-backed securities of at least single “A” under the S&P rating system and at
the comparable level under the other rating systems.
Our allocation of investments among the permitted investment types may vary from time-to-time based on the
evaluation by our board of directors of economic and market trends and our perception of the relative values available
from these types of investments, except that in no event will our investments that are not high quality exceed 25% of our
total assets.
We intend to acquire only those mortgage-backed securities that we believe we have the necessary expertise to
evaluate and manage, that are consistent with our balance sheet guidelines and risk management objectives and that we
believe we can readily finance. Since we generally hold the mortgage-backed securities we acquire until maturity, we
generally do not seek to acquire assets whose investment returns are attractive in only a limited range of scenarios. We
believe that future interest rates and mortgage prepayment rates are very difficult to predict. Therefore, we seek to
acquire mortgage-backed securities which we believe will provide acceptable returns over a broad range of interest rate
and prepayment scenarios.
At December 31, 2008, our mortgage-backed securities consisted of pass-through certificates and collateralized
mortgage obligations issued or guaranteed by FHLMC, FNMA or GNMA. We have not, and will not, invest in REMIC
residuals and other CMO residuals.
Recent Developments
Recently, the government passed the Housing and Economic Recovery Act of 2008. Fannie Mae and Freddie
Mac have recently been placed into the conservatorship of the Federal Housing Finance Agency, or FHFA, their federal
regulator, pursuant to its powers under The Federal Housing Finance Regulatory Reform Act of 2008, a part of the
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Housing and Economic Recovery Act of 2008. As the conservator of Fannie Mae and Freddie Mac, the FHFA
controls and directs the operations of Fannie Mae and Freddie Mac and may (1) take over the assets of and operate
Fannie Mae and Freddie Mac with all the powers of the shareholders, the directors, and the officers of Fannie Mae and
Freddie Mac and conduct all business of Fannie Mae and Freddie Mac; (2) collect all obligations and money due to
Fannie Mae and Freddie Mac; (3) perform all functions of Fannie Mae and Freddie Mac which are consistent with the
conservator’s appointment; (4) preserve and conserve the assets and property of Fannie Mae and Freddie Mac; and (5)
contract for assistance in fulfilling any function, activity, action or duty of the conservator.
In addition to FHFA becoming the conservator of Fannie Mae and Freddie Mac, (i) the U.S. Department of
Treasury and FHFA have entered into preferred stock purchase agreements between the U.S. Department of Treasury
and Fannie Mae and Freddie Mac pursuant to which the U.S. Department of Treasury will ensure that each of Fannie
Mae and Freddie Mac maintains a positive net worth; (ii) the U.S. Department of Treasury has established a new secured
lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, which is
intended to serve as a liquidity backstop, which will be available until December 2009; and (iii) the U.S. Department of
Treasury has initiated a temporary program to purchase RMBS issued by Fannie Mae and Freddie Mac.
Description of Mortgage-Backed Securities
The mortgage-backed securities that we acquire provide funds for mortgage loans made primarily to residential
homeowners. Our securities generally represent interests in pools of mortgage loans made by savings and loan
institutions, mortgage bankers, commercial banks and other mortgage lenders. These pools of mortgage loans are
assembled for sale to investors (like us) by various government, government-related and private organizations.
Mortgage-backed securities differ from other forms of traditional debt securities, which normally provide for
periodic payments of interest in fixed amounts with principal payments at maturity or on specified call dates. Instead,
mortgage-backed securities provide for a monthly payment, which consists of both interest and principal. In effect, these
payments are a “pass-through” of the monthly interest and principal payments made by the individual borrower on the
mortgage loans, net of any fees paid to the issuer or guarantor of the securities. Additional payments result from
prepayments of principal upon the sale, refinancing or foreclosure of the underlying residential property, net of fees or
costs which may be incurred. Some mortgage-backed securities, such as securities issued by GNMA, are described as
“modified pass-through.” These securities entitle the holder to receive all interest and principal payments owed on the
mortgage pool, net of certain fees, regardless of whether the mortgagors actually make mortgage payments when due.
The investment characteristics of pass-through mortgage-backed securities differ from those of traditional fixed-
income securities. The major differences include the payment of interest and principal on the mortgage-backed
securities on a more frequent schedule, as described above, and the possibility that principal may be prepaid at any time
due to prepayments on the underlying mortgage loans or other assets. These differences can result in significantly
greater price and yield volatility than is the case with traditional fixed-income securities.
Various factors affect the rate at which mortgage prepayments occur, including changes in interest rates, general
economic conditions, the age of the mortgage loan, the location of the property and other social and demographic
conditions. Generally prepayments on mortgage-backed securities increase during periods of falling mortgage interest
rates and decrease during periods of rising mortgage interest rates. We may reinvest prepayments at a yield that is higher
or lower than the yield on the prepaid investment, thus affecting the weighted average yield of our investments.
To the extent mortgage-backed securities are purchased at a premium, faster than expected prepayments result
in a faster than expected amortization of the premium paid. Conversely, if these securities were purchased at a discount,
faster than expected prepayments accelerate our recognition of income.
CMOs may allow for shifting of prepayment risk from slower-paying tranches to faster-paying tranches. This is
in contrast to mortgage pass-through certificates where all investors share equally in all payments, including all
prepayments, on the underlying mortgages.
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FHLMC Certificates
FHLMC is a privately-owned government-sponsored enterprise created pursuant to an Act of Congress on July
24, 1970. The principal activity of FHLMC currently consists of the purchase of mortgage loans or participation
interests in mortgage loans and the resale of the loans and participations in the form of guaranteed mortgage-backed
securities. FHLMC guarantees to each holder of FHLMC certificates the timely payment of interest at the applicable
pass-through rate and ultimate collection of all principal on the holder’s pro rata share of the unpaid principal balance of
the related mortgage loans, but does not guarantee the timely payment of scheduled principal of the underlying mortgage
loans. The obligations of FHLMC under its guarantees are solely those of FHLMC and are not backed by the full faith
and credit of the United States. If FHLMC were unable to satisfy these obligations, distributions to holders of FHLMC
certificates would consist solely of payments and other recoveries on the underlying mortgage loans and, accordingly,
defaults and delinquencies on the underlying mortgage loans would adversely affect monthly distributions to holders of
FHLMC certificates.
FHLMC certificates may be backed by pools of single-family mortgage loans or multi-family mortgage loans.
These underlying mortgage loans may have original terms to maturity of up to 40 years. FHLMC certificates may be
issued under cash programs (composed of mortgage loans purchased from a number of sellers) or guarantor programs
(composed of mortgage loans acquired from one seller in exchange for certificates representing interests in the mortgage
loans purchased).
FHLMC certificates may pay interest at a fixed rate or an adjustable rate. The interest rate paid on adjustable-
rate FHLMC certificates (“FHLMC ARMs”) adjusts periodically within 60 days prior to the month in which the interest
rates on the underlying mortgage loans adjust. The interest rates paid on certificates issued under FHLMC’s standard
ARM programs adjust in relation to the Treasury index. Other specified indices used in FHLMC ARM programs include
the 11th District Cost of Funds Index published by the Federal Home Loan Bank of San Francisco, LIBOR and other
indices. Interest rates paid on fully-indexed FHLMC ARM certificates equal the applicable index rate plus a specified
number of basis points. The majority of series of FHLMC ARM certificates issued to date have evidenced pools of
mortgage loans with monthly, semi-annual or annual interest adjustments. Adjustments in the interest rates paid are
generally limited to an annual increase or decrease of either 100 or 200 basis points and to a lifetime cap of 500 or 600
basis points over the initial interest rate. Certain FHLMC programs include mortgage loans which allow the borrower to
convert the adjustable mortgage interest rate to a fixed rate. Adjustable-rate mortgages which are converted into fixed-
rate mortgage loans are repurchased by FHLMC or by the seller of the loan to FHLMC at the unpaid principal balance of
the loan plus accrued interest to the due date of the last adjustable rate interest payment.
FNMA Certificates
FNMA is a privately-owned, federally-chartered corporation organized and existing under the Federal National
Mortgage Association Charter Act. FNMA provides funds to the mortgage market primarily by purchasing home
mortgage loans from local lenders, thereby replenishing their funds for additional lending. FNMA guarantees to the
registered holder of a FNMA certificate that it will distribute amounts representing scheduled principal and interest on
the mortgage loans in the pool underlying the FNMA certificate, whether or not received, and the full principal amount
of any such mortgage loan foreclosed or otherwise finally liquidated, whether or not the principal amount is actually
received. The obligations of FNMA under its guarantees are solely those of FNMA and are not backed by the full faith
and credit of the United States. If FNMA were unable to satisfy its obligations, distributions to holders of FNMA
certificates would consist solely of payments and other recoveries on the underlying mortgage loans and, accordingly,
defaults and delinquencies on the underlying mortgage loans would adversely affect monthly distributions to holders of
FNMA.
FNMA certificates may be backed by pools of single-family or multi-family mortgage loans. The original term
to maturity of any such mortgage loan generally does not exceed 40 years. FNMA certificates may pay interest at a fixed
rate or an adjustable rate. Each series of FNMA ARM certificates bears an initial interest rate and margin tied to an
index based on all loans in the related pool, less a fixed percentage representing servicing compensation and FNMA’s
guarantee fee. The specified index used in different series has included the Treasury Index, the 11th District Cost of
Funds Index published by the Federal Home Loan Bank of San Francisco, LIBOR and other indices. Interest rates paid
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on fully-indexed FNMA ARM certificates equal the applicable index rate plus a specified number of basis points. The
majority of series of FNMA ARM certificates issued to date have evidenced pools of mortgage loans with monthly,
semi-annual or annual interest rate adjustments. Adjustments in the interest rates paid are generally limited to an annual
increase or decrease of either 100 or 200 basis points and to a lifetime cap of 500 or 600 basis points over the initial
interest rate. Certain FNMA programs include mortgage loans which allow the borrower to convert the adjustable
mortgage interest rate of the ARM to a fixed rate. Adjustable-rate mortgages which are converted into fixed-rate
mortgage loans are repurchased by FNMA or by the seller of the loans to FNMA at the unpaid principal of the loan plus
accrued interest to the due date of the last adjustable rate interest payment. Adjustments to the interest rates on FNMA
ARM certificates are typically subject to lifetime caps and periodic rate or payment caps.
GNMA Certificates
GNMA is a wholly owned corporate instrumentality of the United States within the Department of Housing and
Urban Development (“HUD”). The National Housing Act of 1934 authorizes GNMA to guarantee the timely payment
of the principal of and interest on certificates which represent an interest in a pool of mortgages insured by the Federal
Housing Administration (“FHA”) or partially guaranteed by the Department of Veterans Affairs and other loans eligible
for inclusion in mortgage pools underlying GNMA certificates. Section 306(g) of the Housing Act provides that the full
faith and credit of the United States is pledged to the payment of all amounts which may be required to be paid under any
guaranty by GNMA.
At present, most GNMA certificates are backed by single-family mortgage loans. The interest rate paid on
GNMA certificates may be a fixed rate or an adjustable rate. The interest rate on GNMA certificates issued under
GNMA’s standard ARM program adjusts annually in relation to the Treasury index. Adjustments in the interest rate are
generally limited to an annual increase or decrease of 100 basis points and to a lifetime cap of 500 basis points over the
initial coupon rate.
Single-Family and Multi-Family Privately-Issued Certificates
Single-family and multi-family privately-issued certificates are pass-through certificates that are not issued by
one of the agencies and that are backed by a pool of conventional single-family or multi-family mortgage loans. These
certificates are issued by originators of, investors in, and other owners of mortgage loans, including savings and loan
associations, savings banks, commercial banks, mortgage banks, investment banks and special purpose “conduit”
subsidiaries of these institutions.
While agency pass-through certificates are backed by the express obligation or guarantee of one of the agencies,
as described above, privately-issued certificates are generally covered by one or more forms of private (i.e., non-
governmental) credit enhancements. These credit enhancements provide an extra layer of loss coverage in the event that
losses are incurred upon foreclosure sales or other liquidations of underlying mortgaged properties in amounts that
exceed the equity holder’s equity interest in the property. Forms of credit enhancements include limited issuer
guarantees, reserve funds, private mortgage guaranty pool insurance, over-collateralization and subordination.
Subordination is a form of credit enhancement frequently used and involves the issuance of classes of senior
and subordinated mortgage-backed securities. These classes are structured into a hierarchy to allocate losses on the
underlying mortgage loans and also for defining priority of rights to payment of principal and interest. Typically, one or
more classes of senior securities are created which are rated in one of the two highest rating levels by one or more
nationally recognized rating agencies and which are supported by one or more classes of mezzanine securities and
subordinated securities that bear losses on the underlying loans prior to the classes of senior securities. Mezzanine
securities, as used in this Form 10-K, refers to classes that are rated below the two highest levels, but no lower than a
single “B” rating under the S&P rating system (or comparable level under other rating systems) and are supported by one
or more classes of subordinated securities which bear realized losses prior to the classes of mezzanine securities.
Subordinated securities, as used in this Form 10-K, refers to any class that bears the “first loss” from losses from
underlying mortgage loans or that is rated below a single “B” level (or, if unrated, we deem it to be below that level). In
some cases, only classes of senior securities and subordinated securities are issued. By adjusting the priority of interest
and principal payments on each class of a given series of senior-subordinated mortgage-backed securities, issuers are
able to create classes of mortgage-backed securities with varying degrees of credit exposure, prepayment exposure and
potential total return, tailored to meet the needs of sophisticated institutional investors.
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Collateralized Mortgage Obligations and Multi-Class Pass-Through Securities
We may also invest in CMOs and multi-class pass-through securities. CMOs are debt obligations issued by
special purpose entities that are secured by mortgage loans or mortgage-backed certificates, including, in many cases,
certificates issued by government and government-related guarantors, including, GNMA, FNMA and FHLMC, together
with certain funds and other collateral. Multi-class pass-through securities are equity interests in a trust composed of
mortgage loans or other mortgage-backed securities. Payments of principal and interest on underlying collateral provide
the funds to pay debt service on the CMO or make scheduled distributions on the multi-class pass-through securities.
CMOs and multi-class pass-through securities may be issued by agencies or instrumentalities of the U.S. Government or
by private organizations. The discussion of CMOs in the following paragraphs is similarly applicable to multi-class
pass-through securities.
In a CMO, a series of bonds or certificates is issued in multiple classes. Each class of CMOs, often referred to
as a “tranche,” is issued at a specific coupon rate (which, as discussed below, may be an adjustable rate subject to a cap)
and has a stated maturity or final distribution date. Principal prepayments on collateral underlying a CMO may cause it
to be retired substantially earlier than the stated maturity or final distribution date. Interest is paid or accrues on all
classes of a CMO on a monthly, quarterly or semi-annual basis. The principal and interest on underlying mortgages may
be allocated among the several classes of a series of a CMO in many ways. In a common structure, payments of
principal, including any principal prepayments, on the underlying mortgages are applied to the classes of the series of a
CMO in the order of their respective stated maturities or final distribution dates, so that no payment of principal will be
made on any class of a CMO until all other classes having an earlier stated maturity or final distribution date have been
paid in full.
Other types of CMO issues include classes such as parallel pay CMOs, some of which, such as planned
amortization class CMOs (“PAC bonds”), provide protection against prepayment uncertainty. Parallel pay CMOs are
structured to provide payments of principal on certain payment dates to more than one class. These simultaneous
payments are taken into account in calculating the stated maturity date or final distribution date of each class which, as
with other CMO structures, must be retired by its stated maturity date or final distribution date but may be retired earlier.
PAC bonds generally require payment of a specified amount of principal on each payment date so long as prepayment
speeds on the underlying collateral fall within a specified range.
Other types of CMO issues include targeted amortization class CMOs (or TAC bonds), which are similar to
PAC bonds. While PAC bonds maintain their amortization schedule within a specified range of prepayment speeds,
TAC bonds are generally targeted to a narrow range of prepayment speeds or a specified prepayment speed. TAC bonds
can provide protection against prepayment uncertainty since cash flows generated from higher prepayments of the
underlying mortgage-related assets are applied to the various other pass-through tranches so as to allow the TAC bonds
to maintain their amortization schedule.
A CMO may be subject to the issuer’s right to redeem the CMO prior to its stated maturity date, which may
diminish the anticipated return on our investment. Privately-issued CMOs are supported by private credit enhancements
similar to those used for privately-issued certificates and are often issued as senior-subordinated mortgage-backed
securities. We will only acquire CMOs or multi-class pass-through certificates that constitute debt obligations or
beneficial ownership in grantor trusts holding mortgage loans, or regular interests in REMICs, or that otherwise
constitute qualified REIT real estate assets under the Internal Revenue Code (provided that we have obtained a favorable
opinion of our tax advisor or a ruling from the IRS to that effect).
Adjustable-Rate Mortgage Pass-Through Certificates and Floating Rate Mortgage-Backed Securities
Some of the mortgage pass-through certificates we acquire are adjustable-rate mortgage pass-through
certificates. This means that their interest rates may vary over time based upon changes in an objective index, such as:
• LIBOR or the London Interbank Offered Rate. The interest rate that banks in London offer for deposits
in London of U.S. dollars.
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• Treasury Index. A monthly or weekly average yield of benchmark U.S. Treasury securities, as published
by the Federal Reserve Board.
• CD Rate. The weekly average of secondary market interest rates on six-month negotiable certificates of
deposit, as published by the Federal Reserve Board.
These indices generally reflect short-term interest rates. The underlying mortgages for adjustable-rate mortgage pass-
through certificates are adjustable-rate mortgage loans (“ARMs”).
We also acquire CMO floaters. One or more tranches of a CMO may have coupon rates that reset periodically at
a specified increment over an index such as LIBOR. These adjustable-rate tranches are sometime known as CMO
floaters and may be backed by fixed or adjustable-rate mortgages.
There are two main categories of indices for adjustable-rate mortgage pass-through certificates and floaters:
(1) those based on U.S. Treasury securities, and (2) those derived from calculated measures such as a cost of funds index
or a moving average of mortgage rates. Commonly utilized indices include the one-year Treasury note rate, the three-
month Treasury bill rate, the six-month Treasury bill rate, rates on long-term Treasury securities, the 11th District
Federal Home Loan Bank Costs of Funds Index, the National Median Cost of Funds Index, one-month or three-month
LIBOR, the prime rate of a specific bank, or commercial paper rates. Some indices, such as the one-year Treasury rate,
closely mirror changes in market interest rate levels. Others, such as the 11th District Home Loan Bank Cost of Funds
Index, tend to lag changes in market interest rate levels. We seek to diversify our investments in adjustable-rate
mortgage pass-through certificates and floaters among a variety of indices and reset periods so that we are not at any one
time unduly exposed to the risk of interest rate fluctuations. In selecting adjustable-rate mortgage pass-through
certificates and floaters for investment, we will also consider the liquidity of the market for the different mortgage-
backed securities.
We believe that adjustable-rate mortgage pass-through certificates and floaters are particularly well-suited to our
investment objective of high current income, consistent with modest volatility of net asset value, because the value of
adjustable-rate mortgage pass-through certificates and floaters generally remains relatively stable as compared to
traditional fixed-rate debt securities paying comparable rates of interest. While the value of adjustable-rate mortgage
pass-through certificates and floaters, like other debt securities, generally varies inversely with changes in market interest
rates (increasing in value during periods of declining interest rates and decreasing in value during periods of increasing
interest rates), the value of adjustable-rate mortgage pass-through certificates and floaters should generally be more
resistant to price swings than other debt securities because the interest rates on these securities move with market interest
rates.
Accordingly, as interest rates change, the value of our shares should be more stable than the value of funds which
invest primarily in securities backed by fixed-rate mortgages or in other non-mortgage-backed debt securities, which do
not provide for adjustment in the interest rates in response to changes in market interest rates.
Adjustable-rate mortgage pass-through certificates and floaters typically have caps, which limit the maximum
amount by which the interest rate may be increased or decreased at periodic intervals or over the life of the security. To
the extent that interest rates rise faster than the allowable caps on the adjustable-rate mortgage pass-through certificates
and floaters, these securities will behave more like fixed-rate securities. Consequently, interest rate increases in excess
of caps can be expected to cause these securities to behave more like traditional debt securities than adjustable-rate
securities and, accordingly, to decline in value to a greater extent than would be the case in the absence of these caps.
Adjustable-rate mortgage pass-through certificates and floaters, like other mortgage-backed securities, differ from
conventional bonds in that principal is to be paid back over the life of the security rather than at maturity. As a result, we
receive monthly scheduled payments of principal and interest on these securities and may receive unscheduled principal
payments representing prepayments on the underlying mortgages. When we reinvest the payments and any unscheduled
prepayments we receive, we may receive a rate of interest on the reinvestment which is lower than the rate on the
existing security. For this reason, adjustable-rate mortgage pass-through certificates and floaters are less effective than
longer-term debt securities as a means of “locking in” longer-term interest rates. Accordingly, adjustable-rate mortgage
pass-through certificates and floaters, while generally having less risk of price decline during periods of rapidly rising
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interest rates than fixed-rate mortgage-backed securities of comparable maturities, have less potential for capital
appreciation than fixed-rate securities during periods of declining interest rates.
As in the case of fixed-rate mortgage-backed securities, to the extent these securities are purchased at a premium,
faster than expected prepayments would accelerate our amortization of the premium. Conversely, if these securities were
purchased at a discount, faster than expected prepayments would accelerate our recognition of income.
As in the case of fixed-rate CMOs, floating-rate CMOs may allow for shifting of prepayment risk from slower-
paying tranches to faster-paying tranches. This is in contrast to mortgage pass-through certificates where all investors
share equally in all payments, including all prepayments, on the underlying mortgages.
Other Floating Rate Instruments
We may also invest in structured floating-rate notes issued or guaranteed by government agencies, such as FNMA
and FHLMC. These instruments are typically structured to reflect an interest rate arbitrage (i.e., the difference between
the agency’s cost of funds and the income stream from specified assets of the agency) and their reset formulas may
provide more attractive returns than other floating rate instruments. The indices used to determine resets are the same as
those described above.
Mortgage Loans
As of December 31, 2008, we have not invested directly in mortgage loans, but we may from time-to-time
invest a small percentage of our assets directly in single-family, multi-family or commercial mortgage loans. We expect
that the majority of these mortgage loans would be ARM pass-through certificates. The interest rate on an ARM pass-
through certificate is typically tied to an index (such as LIBOR or the interest rate on Treasury bills), and is adjustable
periodically at specified intervals. These mortgage loans are typically subject to lifetime interest rate caps and periodic
interest rate or payment caps. The acquisition of mortgage loans generally involves credit risk. We may obtain credit
enhancement to mitigate this risk; however, there can be no assurances that we will be able to obtain credit enhancement
or that credit enhancement would mitigate the credit risk of the underlying mortgage loans.
Capital Investment Policy
Asset Acquisitions
Our capital investment policy provides that at least 75% of our total assets will be comprised of high quality
mortgage-backed securities and short-term investments. The remainder of our assets (comprising not more than 25% of
total assets), may consist of mortgage-backed securities and 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) or, if not rated, are
determined by us 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.
Our capital investment policy requires that we structure our portfolio to maintain a minimum weighted average
rating (including our deemed comparable ratings for unrated mortgage-backed securities) of our mortgage-backed
securities of at least single “A” under the S&P rating system and at the comparable level under the other rating systems.
To date, all of the mortgage-backed securities we have acquired have been pass-through certificates or CMOs issued or
guaranteed by FHLMC, FNMA or GNMA which, although not rated, have an implied “AAA” rating.
We intend to acquire only those mortgage-backed securities that we believe we have the necessary expertise to
evaluate and manage, that we can readily finance and that are consistent with our balance sheet guidelines and risk
management objectives. Since we expect to hold our mortgage-backed securities until maturity, we generally do not
seek to acquire assets whose investment returns are only attractive in a limited range of scenarios. We believe that future
interest rates and mortgage prepayment rates are very difficult to predict and, as a result, we seek to acquire mortgage-
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backed securities which we believe provide acceptable returns over a broad range of interest rate and prepayment
scenarios.
Among the asset choices available to us, our policy is to acquire those mortgage-backed securities which we
believe generate the highest returns on capital invested, after consideration of the following:
(cid:2)
(cid:2)
(cid:2)
(cid:2)
the amount and nature of anticipated cash flows from the asset;
our ability to pledge the asset to secure collateralized borrowings;
the increase in our capital requirement determined by our capital investment policy resulting from the
purchase and financing of the asset; and
the costs of financing, hedging and managing the asset.
Prior to acquisition, we assess potential returns on capital employed over the life of the asset and in a variety of interest
rate, yield spread, financing cost, credit loss and prepayment scenarios.
We also give consideration to balance sheet management and risk diversification issues. We deem a specific
asset which we are evaluating for potential acquisition as more or less valuable to the extent it serves to increase or
decrease certain interest rate or prepayment risks which may exist in the balance sheet, to diversify or concentrate credit
risk, and to meet the cash flow and liquidity objectives our management may establish for our balance sheet from time-
to-time. Accordingly, an important part of the asset evaluation process is a simulation, using risk management models,
of the addition of a potential asset and our associated borrowings and hedges to the balance sheet and an assessment of
the impact this potential asset acquisition would have on the risks in and returns generated by our balance sheet as a
whole over a variety of scenarios.
We focus primarily on the acquisition of adjustable-rate mortgage-backed securities, including floaters. We
have, however, purchased a significant amount of fixed-rate mortgage-backed securities and may continue to do so in the
future if, in our view, the potential returns on capital invested, after hedging and all other costs, would exceed the returns
available from other assets or if the purchase of these assets would serve to reduce or diversify the risks of our balance
sheet.
We may purchase the stock of mortgage REITs or similar companies when we believe that these purchases
would yield attractive returns on capital employed. When the stock market valuations of these companies are low in
relation to the market value of their assets, these stock purchases can be a way for us to acquire an interest in a pool of
mortgage-backed securities at an attractive price. We do not, however, presently intend to invest in the securities of
other issuers for the purpose of exercising control or to underwrite securities of other issuers.
We may acquire newly issued mortgage-backed securities, and also may seek to expand our capital base in
order to further increase our ability to acquire new assets, when the potential returns from new investments appears
attractive relative to the return expectations of stockholders. We may in the future acquire mortgage-backed securities
by offering our debt or equity securities in exchange for the mortgage-backed securities.
We generally intend to hold mortgage-backed securities for extended periods. In addition, the REIT provisions
of the Internal Revenue Code limit in certain respects our ability to sell mortgage-backed securities. We may decide
however to sell assets from time to time, for a number of reasons, including our desire to dispose of an asset as to which
credit risk concerns have arisen, to reduce interest rate risk, to substitute one type of mortgage-backed security for
another, to improve yield or to maintain compliance with the 55% requirement under the Investment Company Act, or
generally to re-structure the balance sheet when we deem advisable. Our board of directors has not adopted any policy
that would restrict management’s authority to determine the timing of sales or the selection of mortgage-backed
securities to be sold.
We do not invest in REMIC residuals or other CMO residuals.
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As a requirement for maintaining REIT status, we will distribute to stockholders aggregate dividends equaling
at least 90% of our REIT taxable income (determined without regard to the deduction for dividends paid and by
excluding any net capital gain) for each taxable year. We will make additional distributions of capital when the return
expectations of the stockholders appear to exceed returns potentially available to us through making new investments in
mortgage-backed securities. Subject to the limitations of applicable securities and state corporation laws, we can
distribute capital by making purchases of our own capital stock or through paying down or repurchasing any outstanding
uncollateralized debt obligations.
Our asset acquisition strategy may change over time as market conditions change and as we evolve.
Credit Risk Management
We have not taken on credit risk to date, but may do so in the future. In that event, we will review credit risk
and other risk of loss associated with each investment and determine the appropriate allocation of capital to apply to the
investment under our capital investment policy. Our management will monitor the overall portfolio risk and determine
appropriate levels of provision for loss.
Capital and Leverage
We expect generally to maintain a debt-to-equity ratio of between 8:1 and 12:1, although the ratio may vary
from time-to-time depending upon market conditions and other factors our management deems relevant, including the
composition of our balance sheet, haircut levels required by lenders, the market value of the mortgage-backed securities
in our portfolio and “excess capital cushion” percentages (as described below) set by our board of directors from time to
time. For purposes of calculating this ratio, our equity (or capital base) is equal to the value of our investment portfolio
on a mark-to-market basis less the book value of our obligations under repurchase agreements and other collateralized
borrowings. For the calculation of this ratio, equity includes the Series B Cumulative Convertible Preferred Stock,
which is not included in equity under Generally Accepted Accounting Principles.
Our goal is to strike a balance between the under-utilization of leverage, which reduces potential returns to
stockholders, and the over-utilization of leverage, which could reduce our ability to meet our obligations during adverse
market conditions. Our capital investment policy limits our ability to acquire additional assets during times when our
debt-to-equity ratio exceeds 12:1. At December 31, 2008, our ratio of debt-to-equity was 6.4:1. Our capital base
represents the approximate liquidation value of our investments and approximates the market value of assets that we can
pledge or sell to meet over-collateralization requirements for our borrowings. The unpledged portion of our capital base
is available for us to pledge or sell as necessary to maintain over-collateralization levels for our borrowings.
We are prohibited from acquiring additional assets during periods when our capital base is less than the
minimum amount required under our capital investment policy, except as may be necessary to maintain REIT status or
our exemption from the Investment Company Act of 1940, as amended (the “Investment Company Act”). In addition,
when our capital base falls below our risk-managed capital requirement, our management is required to submit to our
board of directors a plan for bringing our capital base into compliance with our capital investment policy guidelines. We
anticipate that in most circumstances we can achieve this goal without overt management action through the natural
process of mortgage principal repayments. We anticipate that our capital base is likely to exceed our risk-managed
capital requirement during periods following new equity offerings and during periods of falling interest rates and that our
capital base could fall below the risk-managed capital requirement during periods of rising interest rates.
The first component of our capital requirements is the current aggregate over-collateralization amount or
“haircut” the lenders require us to hold as capital. The haircut for each mortgage-backed security is determined by our
lenders based on the risk characteristics and liquidity of the asset. Should the market value of our pledged assets
decline, we will be required to deliver additional collateral to our lenders to maintain a constant over-collateralization
level on our borrowings.
The second component of our capital requirement is the “excess capital cushion.” This is an amount of capital
in excess of the haircuts required by our lenders. We maintain the excess capital cushion to meet the demands of our
lenders for additional collateral should the market value of our mortgage-backed securities decline. The aggregate
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excess capital cushion equals the sum of liquidity cushion amounts assigned under our capital investment policy to each
of our mortgage-backed securities. We assign excess capital cushions to each mortgage-backed security based on our
assessment of the mortgage-backed security’s market price volatility, credit risk, liquidity and attractiveness for use as
collateral by lenders. The process of assigning excess capital cushions relies on our management’s ability to identify and
weigh the relative importance of these and other factors. In assigning excess capital cushions, we also give consideration
to hedges associated with the mortgage-backed security and any effect such hedges may have on reducing net market
price volatility, concentration or diversification of credit and other risks in the balance sheet as a whole and the net cash
flows that we can expect from the interaction of the various components of our balance sheet.
Our capital investment policy stipulates that at least 25% of the capital base maintained to satisfy the excess
capital cushion must be invested in AAA-rated adjustable-rate mortgage-backed securities or assets with similar or better
liquidity characteristics.
A substantial portion of our borrowings are short-term or variable-rate borrowings. Our borrowings are
implemented primarily through repurchase agreements, but in the future may also be obtained through loan agreements,
lines of credit, dollar-roll agreements (an agreement to sell a security for delivery on a specified future date and a
simultaneous agreement to repurchase the same or a substantially similar security on a specified future date) and other
credit facilities with institutional lenders and issuance of debt securities such as commercial paper, medium-term notes,
CMOs and senior or subordinated notes. We enter into financing transactions only with institutions that we believe are
sound credit risks and follow other internal policies designed to limit our credit and other exposure to financing
institutions.
We expect to continue to use repurchase agreements as our principal financing device to leverage our mortgage-
backed securities portfolio. We anticipate that, upon repayment of each borrowing under a repurchase agreement, we
will use the collateral immediately for borrowing under a new repurchase agreement. At present, we have entered into
uncommitted facilities with 30 lenders for borrowings in the form of repurchase agreements. We have not at the present
time entered into any commitment 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.
We may, however, enter into such commitment agreements in the future. We enter into repurchase agreements primarily
with national broker-dealers, commercial banks and other lenders which typically offer this type of financing. We enter
into collateralized borrowings only with financial institutions meeting credit standards approved by our board of
directors, and we monitor the financial condition of these institutions on a regular basis.
A repurchase agreement, although structured as a sale and repurchase obligation, acts as a financing under
which we effectively pledge our mortgage-backed securities as collateral to secure a short-term loan. Generally, the
other party to the agreement makes the loan in an amount equal to a percentage of the market value of the pledged
collateral. At the maturity of the repurchase agreement, we are required to repay the loan and correspondingly receive
back our collateral. While used as collateral, the mortgage-backed securities continue to pay principal and interest which
are for our benefit. In the event of our insolvency or bankruptcy, certain repurchase agreements may qualify for special
treatment under the Bankruptcy Code, the effect of which, among other things, would be to allow the creditor under the
agreement to avoid the automatic stay provisions of the Bankruptcy Code and to foreclose on the collateral without
delay. In the event of the insolvency or bankruptcy of a lender during the term of a repurchase agreement, the lender
may be permitted, under applicable insolvency laws, to repudiate the contract, and our claim against the lender for
damages may be treated simply as an unsecured creditor. In addition, if the lender is a broker or dealer subject to the
Securities Investor Protection Act of 1970, or an insured depository institution subject to the Federal Deposit Insurance
Act, our ability to exercise our rights to recover our securities under a repurchase agreement or to be compensated for
any damages resulting from the lender’s insolvency may be further limited by those statutes. These claims would be
subject to significant delay and, if and when received, may be substantially less than the damages we actually incur.
Substantially all of our borrowing agreements require us to deposit additional collateral in the event the market
value of existing collateral declines, which may require us to sell assets to reduce our borrowings. We have designed our
liquidity management policy to maintain a cushion of equity sufficient to provide required liquidity to respond to the
effects under our borrowing arrangements of interest rate movements and changes in market value of our mortgage-
backed securities, as described above. However, a major disruption of the repurchase or other market that we rely on for
short-term borrowings would have a material adverse effect on us unless we were able to arrange alternative sources of
financing on comparable terms.
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Our articles of incorporation and bylaws do not limit our ability to incur borrowings, whether secured or unsecured.
Interest Rate Risk Management
To the extent consistent with our election to qualify as a REIT, we follow an interest rate risk management
program intended to protect our portfolio of mortgage-backed securities and related debt against the effects of major
interest rate changes. Specifically, our interest rate risk management program is formulated with the intent to offset the
potential adverse effects resulting from rate adjustment limitations on our mortgage-backed securities and the differences
between interest rate adjustment indices and interest rate adjustment periods of our adjustable-rate mortgage-backed
securities and related borrowings.
Our interest rate risk management program encompasses a number of procedures, including the following:
(cid:2)
(cid:2)
we attempt to structure our borrowings to have interest rate adjustment indices and interest rate
adjustment periods that, on an aggregate basis, generally correspond to the interest rate adjustment
indices and interest rate adjustment periods of our adjustable-rate mortgage-backed securities; and
we attempt to structure our borrowing agreements relating to adjustable-rate mortgage-backed
securities to have a range of different maturities and interest rate adjustment periods (although
substantially all will be less than one year).
We adjust the average maturity adjustment periods of our borrowings on an ongoing basis by changing the mix
of maturities and interest rate adjustment periods as borrowings come due and are renewed. Through use of these
procedures, we attempt to minimize the differences between the interest rate adjustment periods of our mortgage-backed
securities and related borrowings that may occur.
We purchase from time-to-time interest rate swaps. We may enter into interest rate collars, interest rate caps or
floors, and purchase interest-only mortgage-backed securities and similar instruments to attempt to mitigate the risk of
the cost of our variable rate liabilities increasing at a faster rate than the earnings on our assets during a period of rising
interest rates or to mitigate prepayment risk. We may hedge as much of the interest rate risk as our management
determines is in our best interests, given the cost of the hedging transactions and the need to maintain our status as a
REIT. This determination may result in our electing to bear a level of interest rate or prepayment risk that could
otherwise be hedged when management believes, based on all relevant facts, that bearing the risk is advisable.
We seek to build a balance sheet and undertake an interest rate risk management program which is likely to
generate positive earnings and maintain an equity liquidation value sufficient to maintain operations given a variety of
potentially adverse circumstances. Accordingly, our interest rate risk management program addresses both income
preservation, as discussed above, and capital preservation concerns. For capital preservation, we monitor our “duration.”
This is the expected percentage change in market value of our assets that would be caused by a 1% change in short and
long-term interest rates. To monitor weighted average duration and the related risks of fluctuations in the liquidation
value of our equity, we model the impact of various economic scenarios on the market value of our mortgage-backed
securities and liabilities. At December 31, 2008, we estimate that the duration of our assets was 2.00 years and giving
effect to the swap transactions, our weighted average duration was 1.21 years. We believe that our interest rate risk
management program will allow us to maintain operations throughout a wide variety of potentially adverse
circumstances. Nevertheless, in order to further preserve our capital base (and lower our duration) during periods when
we believe a trend of rapidly rising interest rates has been established, we may decide to increase hedging activities or to
sell assets. Each of these actions may lower our earnings and dividends in the short term to further our objective of
maintaining attractive levels of earnings and dividends over the long term.
We may elect to conduct a portion of our hedging operations through one or more subsidiary corporations, each
of which we would elect to treat as a “taxable REIT subsidiary.” To comply with the asset tests applicable to us as a
REIT, we could own 100% of the voting stock of such subsidiary, provided that the value of the stock that we own in all
such taxable REIT subsidiaries does not exceed 25% of the value of our total assets at the close of any calendar quarter.
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A taxable subsidiary, such as FIDAC, Merganser, and RCap, would not elect REIT status and would distribute any net
profit after taxes to us. Any dividend income we receive from the taxable subsidiaries (combined with all other income
generated from our assets, other than qualified REIT real estate assets) must not exceed 25% of our gross income.
We believe that we have developed a cost-effective asset/liability management program to provide a level of
protection against interest rate and prepayment risks. However, no strategy can completely insulate us from interest rate
changes and prepayment risks. Further, as noted above, the federal income tax requirements that we must satisfy to
qualify as a REIT limit our ability to hedge our interest rate and prepayment risks. We monitor carefully, and may have
to limit, our asset/liability management program to assure that we do not realize excessive hedging income, or hold
hedging assets having excess value in relation to total assets, which could result in our disqualification as a REIT, the
payment of a penalty tax for failure to satisfy certain REIT tests under the Internal Revenue Code, provided the failure
was for reasonable cause. In addition, asset/liability management involves transaction costs which increase dramatically
as the period covered by the hedging protection increases. Therefore, we may be unable to hedge effectively our interest
rate and prepayment risks.
Prepayment Risk Management
We seek to minimize the effects of faster or slower than anticipated prepayment rates through structuring a
diversified portfolio with a variety of prepayment characteristics, investing in mortgage-backed securities with
prepayment prohibitions and penalties, investing in certain mortgage-backed security structures which have prepayment
protections, and balancing assets purchased at a premium with assets purchased at a discount. We monitor prepayment
risk through periodic review of the impact of a variety of prepayment scenarios on our revenues, net earnings, dividends,
cash flow and net balance sheet market value.
Future Revisions in Policies and Strategies
Our board of directors has established the investment policies and operating policies and strategies set forth in
this Form 10-K. The board of directors has the power to modify or waive these policies and strategies without the
consent of the stockholders to the extent that the board of directors determines that the modification or waiver is in the
best interests of our stockholders. Among other factors, developments in the market which affect our policies and
strategies or which change our assessment of the market may cause our board of directors to revise our policies and
strategies.
Potential Acquisitions, Strategic Alliances and Other Investments
From time-to-time we have explored possible transactions to enhance our operations and growth, including
entering into new businesses, acquisitions of other businesses or assets, investments in other entities, joint venture
arrangements, or strategic alliances. We are entering into the broker-dealer business during the first quarter of January
2009, through our subsidiary RCap, which was granted membership in FINRA in January 2009. On October 31, 2008
we consummated our acquisition of Merganser which is a registered investment advisor. In October 2008 we acquired
approximately 11.7 million shares of common stock of Chimera Investment Corporation, or Chimera, for approximately
$26.3 million. During 2007 we acquired approximately 3.6 million shares of Chimera common stock for approximately
$54.3 million in connection with Chimera’s initial public offering on November 21, 2007. Chimera is a 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 own an investment fund.
We may, from time-to-time, continue to explore possible new businesses, acquisitions, investments, joint
venture arrangements and strategic alliances which may enhance our operations and assist our and our subsidiaries’
growth.
Dividend Reinvestment and Share Purchase Plan
We have adopted a dividend reinvestment and share purchase plan. Under the dividend reinvestment feature of
the plan, existing shareholders can reinvest their dividends in additional shares of our common stock. Under the share
purchase feature of the plan, new and existing shareholders can purchase shares of our common stock. We have an
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effective shelf registration statement on Form S-3 which registered 100,000,000 shares that could be issued under the
plan. We still sell shares covered by this registration statement under the plan.
At the Market Sales Programs
We have entered into an ATM Equity Offeringsm Sales Agreement with Merrill Lynch & Co. and Merrill
Lynch, Pierce, Fenner & Smith Incorporated (or Merrill Lynch), relating to the sale of shares of our common stock from
time to time through Merrill Lynch. We have also entered into a ATM Equity Sales Agreement with UBS Securities
LLC (or UBS Securities), relating to the sale of shares of our common stock from time to time through UBS Securities.
Under these agreements, sales of the shares, if any, will be made by means of ordinary brokers’ transaction of the New
York Stock Exchange at market prices.
Legal Proceedings
From time-to-time, we are involved in various claims and legal actions arising in the ordinary course of
business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect
on our consolidated financial statements.
Employees
As of December 31, 2008, we and our subsidiaries had 65 full time employees. None of our employees are
subject to any collective bargaining agreements. We believe we have good relations with our employees.
Available Information
Our investor relations website is www.annaly.com.
We make available on this website under “Financial
Reports and SEC filings,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file or
furnish such materials to the SEC.
COMPETITION
We believe that our principal competition in the acquisition and holding of the types of mortgage-backed
securities we purchase are financial institutions such as banks, savings and loans, life insurance companies, institutional
investors such as mutual funds and pension funds, and certain other mortgage REITs. Some of our competitors have
greater financial resources and access to capital than we do. Our competitors, as well as additional competitors which
may emerge in the future, may increase the competition for the acquisition of mortgage-backed securities, which in turn
may result in higher prices and lower yields on assets.
ITEM 1A. RISK FACTORS
An investment in our stock involves a number of risks. Before making an investment decision, you should
carefully consider all of the risks described in this Form 10-K. If any of the risks discussed in this Form 10-K actually
occur, our business, financial condition and results of operations could be materially adversely affected. If this were to
occur, the trading price of our stock could decline significantly and you may lose all or part of your investment.
Risks Related to Our Business
An increase in the interest payments on our borrowings relative to the interest we earn on our investment
securities may adversely affect our profitability
We earn money based upon the spread between the interest payments we earn on our investment securities and
the interest payments we must make on our borrowings. If the interest payments on our borrowings increase relative to
the interest we earn on our investment securities, our profitability may be adversely affected.
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The interest payments on our borrowings may increase relative to the interest we earn on our adjustable-rate
investment securities for various reasons discussed in this section.
Differences in timing of interest rate adjustments on our investment securities and our borrowings may adversely
affect our profitability
We rely primarily on short-term borrowings to acquire investment securities with long-term maturities.
Accordingly, if short-term interest rates increase, this may adversely affect our profitability.
Most of the investment securities we acquire are adjustable-rate securities. This means that their interest rates
may vary over time based upon changes in an objective index, such as:
•
•
•
LIBOR. The interest rate that banks in London offer for deposits in London of U.S. dollars.
Treasury Rate. A monthly or weekly average yield of benchmark U.S. Treasury securities, as published by
the Federal Reserve Board.
CD Rate. The weekly average of secondary market interest rates on six-month negotiable certificates of
deposit, as published by the Federal Reserve Board.
These indices generally reflect short-term interest rates. On December 31, 2008, approximately 28% of our
investment securities were adjustable-rate securities.
The interest rates on our borrowings similarly vary with changes in an objective index. Nevertheless, the
interest rates on our borrowings generally adjust more frequently than the interest rates on our adjustable-rate investment
securities. For example, on December 31, 2008, our adjustable-rate investment securities had a weighted average term to
next rate adjustment of 36 months, while our borrowings had a weighted average term to next rate adjustment of 238
days. Accordingly, in a period of rising interest rates, we could experience a decrease in net income or a net loss because
the interest rates on our borrowings adjust faster than the interest rates on our adjustable-rate investment securities.
Interest rate caps on our investment securities may adversely affect our profitability
Our adjustable-rate investment securities are typically subject to periodic and lifetime interest rate caps.
Periodic interest rate caps limit the amount an interest rate can increase during any given period. Lifetime interest rate
caps limit the amount an interest rate can increase through maturity of an investment security. Our borrowings are not
subject to similar restrictions. Accordingly, in a period of rapidly increasing interest rates, we could experience a
decrease in net income or experience a net loss because the interest rates on our borrowings could increase without
limitation while the interest rates on our adjustable-rate investment securities would be limited by caps.
Because we acquire fixed-rate securities, an increase in interest rates may adversely affect our profitability
In a period of rising interest rates, our interest payments could increase while the interest we earn on our fixed-
rate mortgage-backed securities would not change. This would adversely affect our profitability. On December 31,
2008, approximately 64% of our investment securities were fixed-rate securities.
An increase in prepayment rates may adversely affect our profitability
The mortgage-backed securities we acquire are backed by pools of mortgage loans. We receive payments,
generally, from the payments that are made on these underlying mortgage loans. When borrowers prepay their mortgage
loans at rates that are faster than expected, this results in prepayments that are faster than expected on the mortgage-
backed securities. These faster than expected prepayments may adversely affect our profitability.
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We often purchase mortgage-backed securities that have a higher interest rate than the market interest rate at the
time. In exchange for this higher interest rate, we must pay a premium over the market value to acquire the security. In
accordance with accounting rules, we amortize this premium over the term of the mortgage-backed security. If the
mortgage-backed security is prepaid in whole or in part prior to its maturity date, however, we must expense all or a part
of the remaining unamortized portion of the premium that was prepaid at the time of the prepayment. This adversely
affects our profitability.
Prepayment rates generally increase when interest rates fall and decrease when interest rates rise, but changes in
prepayment rates are difficult to predict. Prepayment rates also may be affected by conditions in the housing and
financial markets, general economic conditions and the relative interest rates on fixed-rate and adjustable-rate mortgage
loans.
We may seek to reduce prepayment risk by acquiring mortgage-backed securities at a discount. If a discounted
security is prepaid in whole or in part prior to its maturity date, we will earn income equal to the amount of the remaining
discount. This will improve our profitability if the discounted securities are prepaid faster than expected.
We also can acquire mortgage-backed securities that are less affected by prepayments. For example, we can
acquire CMOs, a type of mortgage-backed security. CMOs divide a pool of mortgage loans into multiple tranches that
allow for shifting of prepayment risks from slower-paying tranches to faster-paying tranches. This is in contrast to pass-
through or pay-through mortgage-backed securities, where all investors share equally in all payments, including all
prepayments. As discussed below, the Investment Company Act of 1940 imposes restrictions on our purchase of CMOs.
As of December 31, 2008, approximately 24% of our mortgage-backed securities were CMOs and approximately 76% of
our mortgage-backed securities were pass-through or pay-through securities.
While we seek to minimize prepayment risk to the extent practical, in selecting investments we must balance
prepayment risk against other risks and the potential returns of each investment. No strategy can completely insulate us
from prepayment risk.
An increase in interest rates may adversely affect our book value
Increases in interest rates may negatively affect the market value of our investment securities. Our fixed-rate
securities, generally, are more negatively affected by these increases. In accordance with accounting rules, we reduce our
book value by the amount of any decrease in the market value of our investment securities.
Failure to procure funding on favorable terms, or at all, would adversely affect our results and may, in turn,
negatively affect the market price of shares of our common stock.
The current dislocation and weakness in the broader mortgage markets could adversely affect one or more of
our potential lenders and could cause one or more of our potential lenders to be unwilling or unable to provide us with
financing. This could potentially increase our financing costs and reduce our liquidity. If one or more major market
participants fails or otherwise experiences a major liquidity crisis, as was the case for Bear Stearns & Co. in March 2008
and Lehman Brothers Holdings Inc. in September 2008, it could negatively impact the marketability of all fixed income
securities, including Agency RMBS, and this could negatively impact the value of the securities we acquire, thus
reducing our net book value. Furthermore, if any of our potential lenders or any of our lenders are unwilling or unable to
provide us with financing, we could be forced to sell our assets at an inopportune time when prices are depressed.
Since June 30, 2008, there have been increased market concerns about Freddie Mac and Fannie Mae’s ability to
withstand future credit losses associated with securities held in their investment portfolios, and on which they provide
guarantees, without the direct support of the federal government. Recently, the government passed the Housing and
Economic Recovery Act of 2008. Fannie Mae and Freddie Mac have recently been placed into the conservatorship of
the Federal Housing Finance Agency, or FHFA, their federal regulator, pursuant to its powers under The Federal
Housing Finance Regulatory Reform Act of 2008, a part of the Housing and Economic Recovery Act of 2008. As the
conservator of Fannie Mae and Freddie Mac, the FHFA controls and directs the operations of Fannie Mae and Freddie
Mac and may (1) take over the assets of and operate Fannie Mae and Freddie Mac with all the powers of the
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shareholders, the directors, and the officers of Fannie Mae and Freddie Mac and conduct all business of Fannie Mae and
Freddie Mac; (2) collect all obligations and money due to Fannie Mae and Freddie Mac; (3) perform all functions of
Fannie Mae and Freddie Mac which are consistent with the conservator’s appointment; (4) preserve and conserve the
assets and property of Fannie Mae and Freddie Mac; and (5) contract for assistance in fulfilling any function, activity,
action or duty of the conservator.
In addition to FHFA becoming the conservator of Fannie Mae and Freddie Mac, (i) the U.S. Department of
Treasury and FHFA have entered into preferred stock purchase agreements between the U.S. Department of Treasury
and Fannie Mae and Freddie Mac pursuant to which the U.S. Department of Treasury will ensure that each of Fannie
Mae and Freddie Mac maintains a positive net worth; (ii) the U.S. Department of Treasury has established a new secured
lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, which is
intended to serve as a liquidity backstop, which will be available until December 2009; and (iii) the U.S. Department of
Treasury has initiated a temporary program to purchase RMBS issued by Fannie Mae and Freddie Mac. Given the
highly fluid and evolving nature of these events, it is unclear how our business will be impacted. Based upon the further
activity of the U.S. government or market response to developments at Fannie Mae or Freddie Mac, our business could
be adversely impacted.
Our strategy involves significant leverage
We seek to maintain a ratio of debt-to-equity of between 8:1 and 12:1, although our ratio may at times be above
or below this amount. We incur this leverage by borrowing against a substantial portion of the market value of our
investment securities. By incurring this leverage, we can enhance our returns. Nevertheless, this leverage, which is
fundamental to our investment strategy, also creates significant risks.
• Our leverage may cause substantial losses
Because of our significant leverage, we may incur substantial losses if our borrowing costs increase. Our
borrowing costs may increase for any of the following reasons:
•
•
•
•
short-term interest rates increase;
the market value of our investment securities decreases;
interest rate volatility increases; or
the availability of financing in the market decreases.
• Our leverage may cause margin calls and defaults and force us to sell assets under adverse market
conditions
Because of our leverage, a decline in the value of our investment securities may result in our lenders initiating
margin calls. A margin call means that the lender requires us to pledge additional collateral to re-establish the ratio
of the value of the collateral to the amount of the borrowing. Our fixed-rate mortgage-backed securities generally
are more susceptible to margin calls as increases in interest rates tend to more negatively affect the market value of
fixed-rate securities.
If we are unable to satisfy margin calls, our lenders may foreclose on our collateral. This could force us to sell
our investment securities under adverse market conditions. Additionally, in the event of our bankruptcy, our
borrowings, which are generally made under repurchase agreements, may qualify for special treatment under the
Bankruptcy Code. This special treatment would allow the lenders under these agreements to avoid the automatic
stay provisions of the Bankruptcy Code and to liquidate the collateral under these agreements without delay.
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•
Liquidation of collateral may jeopardize our REIT status
To continue to qualify as a REIT, we must comply with requirements regarding our assets and our sources of
income. If we are compelled to liquidate our investment securities, we may be unable to comply with these
requirements, ultimately jeopardizing our status as a REIT and our failure to qualify as a REIT will have adverse tax
consequences.
• We may exceed our target leverage ratios
We seek to maintain a ratio of debt-to-equity of between 8:1 and 12:1. However, we are not required to stay
within this leverage ratio. If we exceed this ratio, the adverse impact on our financial condition and results of
operations from the types of risks described in this section would likely be more severe.
• We may not be able to achieve our optimal leverage
We use leverage as a strategy to increase the return to our investors. However, we may not be able to achieve
our desired leverage for any of the following reasons:
• we determine that the leverage would expose us to excessive risk;
•
•
our lenders do not make funding available to us at acceptable rates; or
our lenders require that we provide additional collateral to cover our borrowings.
• We may incur increased borrowing costs which would adversely affect our profitability
Currently, all of our borrowings are collateralized borrowings in the form of repurchase agreements. If the
interest rates on these repurchase agreements increase, it would adversely affect our profitability.
Our borrowing costs under repurchase agreements generally correspond to short-term interest rates such as
LIBOR or a short-term Treasury index, plus or minus a margin. The margins on these borrowings over or under
short-term interest rates may vary depending upon:
•
•
•
the movement of interest rates;
the availability of financing in the market; or
the value and liquidity of our investment securities.
If we are unable to renew our borrowings at favorable rates, our profitability may be adversely affected
Since we rely primarily on short-term borrowings, our ability to achieve our investment objectives depends not
only on our ability to borrow money in sufficient amounts and on favorable terms, but also on our ability to renew or
replace on a continuous basis our maturing short-term borrowings. If we are not able to renew or replace maturing
borrowings, we would have to sell our assets under possibly adverse market conditions.
Our hedging strategies expose us to risks
Our policies permit us to enter into interest rate swaps, caps and floors and other derivative transactions to help
us mitigate our interest rate and prepayment risks described above. We have used interest rate swaps and interest rate
caps to provide a level of protection against interest rate risks, but no hedging strategy can protect us completely.
21
• Our hedging strategies may not be successful in mitigating the risks associated with interest rates
We cannot assure you that our use of derivatives will offset the risks related to changes in interest rates. It is
likely that there will be periods in the future during which we will incur losses on our derivative financial instruments
that will not be fully offset by gains on our portfolio. The derivative financial instruments we select may not have the
effect of reducing our interest rate risk. In addition, the nature and timing of hedging transactions may influence the
effectiveness of these strategies. Poorly designed strategies or improperly executed transactions could significantly
increase our risk and lead to material losses. In addition, hedging strategies involve transaction and other costs. Our
hedging strategy and the derivatives that we use may not adequately offset the risk of interest rate volatility or that our
hedging transactions may not result in losses.
• Our use of derivatives may expose us to counterparty risks
We enter into interest rate swap and cap agreements to hedge risks associated with movements in interest rates.
If a swap counterparty cannot perform under the terms of an interest rate swap, we would not receive payments due
under that agreement, we may lose any unrealized gain associated with the interest rate swap, and the hedged liability
would cease to be hedged by the interest rate swap. We may also be at risk for any collateral we have pledged to secure
our obligations under the interest rate swap if the counterparty become insolvent or file for bankruptcy. Similarly, if a
cap counterparty fails to perform under the terms of the cap agreement, in addition to not receiving payments due under
that agreement that would off-sets our interest expense, we would also incur a loss for all remaining unamortized
premium paid for that agreement.
.
We may face risks of investing in inverse floating rate securities
We may invest in inverse floaters. The returns on inverse floaters are inversely related to changes in an interest
rate. Generally, income on inverse floaters will decrease when interest rates increase and increase when interest rates
decrease. Investments in inverse floaters may subject us to the risks of reduced or eliminated interest payments and
losses of principal. In addition, certain indexed securities and inverse floaters may increase or decrease in value at a
greater rate than the underlying interest rate, which effectively leverages our investment in such securities. As a result,
the market value of such securities will generally be more volatile than that of fixed rate securities.
Our investment strategy may involve credit risk
We may incur losses if there are payment defaults under our investment securities.
To date, all of our mortgage-backed securities have been agency certificates and agency debentures which,
although not rated, carry an implied “AAA” rating. Agency certificates are mortgage pass-through certificates where
Freddie Mac, Fannie Mae or Ginnie Mae guarantees payments of principal or interest on the certificates. Agency
debentures are debt instruments issued by Freddie Mac, Fannie Mae, or the FHLB.
Even though we have only acquired “AAA” securities so far, pursuant to our capital investment policy, we have
the ability to acquire securities of lower credit quality. Under our policy:
•
•
75% of our investments must have a “AA” or higher rating by S&P, an equivalent rating by a similar
nationally recognized rating organization or our management must determine that the investments are of
comparable credit quality to investments with these ratings;
the remaining 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 derivate securities, to the
22
•
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; and
• we seek to have a minimum weighted average rating for our portfolio of at least “A” by S&P.
If we acquire securities of lower credit quality, we may incur losses if there are defaults under those securities
or if the rating agencies downgrade the credit quality of those securities.
There can be no assurance that the actions of the U.S. government, Federal Reserve and other governmental and
regulatory bodies for the purpose of stabilizing the financial markets, or market response to those actions, will
achieve the intended effect, our business may not benefit from these actions and further government or market
developments could adversely impact us.
In response to the financial issues affecting the banking system and financial markets and going concern threats
to investment banks and other financial institutions, the Emergency Economic Stabilization Act of 2008, or EESA, was
recently enacted. The EESA provides the U.S. Secretary of the Treasury with the authority to establish a Troubled Asset
Relief Program, or TARP, to purchase from financial institutions up to $700 billion of equity or preferred securities,
residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to
such mortgages, that in each case was originated or issued on or before March 14, 2008, as well as any other financial
instrument that the U.S. Secretary of the Treasury, after consultation with the Chairman of the Board of Governors of the
Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, upon
transmittal of such determination, in writing, to the appropriate committees of the U.S. Congress. The EESA also
provides for a program that would allow companies to insure their troubled assets.
In addition, the U.S. Government, Federal Reserve and other governmental and regulatory bodies have taken or
are considering taking other actions to address the financial crisis. There can be no assurance that the EESA or other
policy initiatives will have a beneficial impact on the financial markets, including current extreme levels of volatility.
We cannot predict whether or when such actions may occur or what impact, if any, such actions could have on our
business, results of operations and financial condition.
We have not established a minimum dividend payment level
We intend to pay quarterly dividends and to make distributions to our stockholders in amounts such that all or
substantially all of our taxable income in each year (subject to certain adjustments) is distributed. This enables 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 in this section. 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.
Because of competition, we may not be able to acquire mortgage-backed securities at favorable yields
Our net income depends, in large part, on our ability to acquire mortgage-backed securities at favorable spreads
over our borrowing costs. In acquiring mortgage-backed securities, we compete with other REITs, investment banking
firms, savings and loan associations, banks, insurance companies, mutual funds, other lenders and other entities that
purchase mortgage-backed securities, many of which have greater financial resources than us. As a result, in the future,
we may not be able to acquire sufficient mortgage-backed securities at favorable spreads over our borrowing costs.
We are dependent on our key personnel
We are dependent on the efforts of our key officers and employees, including Michael A. J. Farrell, our
Chairman of the board of directors, Chief Executive Officer and President, Wellington J. Denahan-Norris, our Vice
23
Chairman, Chief Operating Officer and Chief Investment Officer, and Kathryn F. Fagan, our Chief Financial Officer
and Treasurer. The loss of any of their services could have an adverse effect on our operations. Although we have
employment agreements with each of them, we cannot assure you they will remain employed with us.
We and our shareholders are subject to certain tax risks
• Our failure to qualify as a REIT would have adverse tax consequences
We believe that since 1997 we have qualified for taxation as a REIT for federal income tax purposes. We
plan to continue to meet the requirements for taxation as a REIT. The determination that we are a REIT
requires an analysis of various factual matters and circumstances that may not be totally within our control. For
example, to qualify as a REIT, at least 75% of our gross income must come from real estate sources and 95% of
our gross income must come from real estate sources and certain other sources that are itemized in the REIT tax
laws. We are also required to distribute to stockholders at least 90% of our REIT taxable income (determined
without regard to the deduction for dividends paid and by excluding any net capital gain). Even a technical or
inadvertent mistake could jeopardize our REIT status. Furthermore, Congress and the Internal Revenue Service
(or IRS) might make changes to the tax laws and regulations, and the courts might issue new rulings that make
it more difficult or impossible for us to remain qualified as a REIT.
If we fail to qualify as a REIT, we would be subject to federal income tax at regular corporate rates.
Also, unless the IRS granted us relief under certain statutory provisions, we would remain disqualified as a
REIT for four years following the year we first fail to qualify. If we fail to qualify as a REIT, we would have to
pay significant income taxes and would therefore have less money available for investments or for distributions
to our stockholders. This would likely have a significant adverse effect on the value of our securities. In
addition, the tax law would no longer require us to make distributions to our stockholders.
A REIT that fails the quarterly asset tests for one or more quarters will not lose its REIT status as a
result of such failure if either (i) the failure is regarded as a de minimis failure under standards set out in the
Internal Revenue Code, or (ii) the failure is greater than a de minimis failure but is attributable to reasonable
cause and not willful neglect. In the case of a greater than de minimis failure, however, the REIT must pay a
tax and must remedy the failure within 6 months of the close of the quarter in which the failure was identified.
In addition, the Internal Revenue Code provides relief for failures of other tests imposed as a condition of REIT
qualification, as long as the failures are attributable to reasonable cause and not willful neglect. A REIT would
be required to pay a penalty of $50,000, however, in the case of each failure.
• We have certain distribution requirements
As a REIT, we must distribute at least 90% of our REIT taxable income (determined without regard to the
deduction for dividends paid and by excluding any net capital gain). The required distribution limits the amount
we have available for other business purposes, including amounts to fund our growth. Also, it is possible that
because of the differences between the time we actually receive revenue or pay expenses and the period we
report those items for distribution purposes, we may have to borrow funds on a short-term basis to meet the
90% distribution requirement.
• We are also subject to other tax liabilities
Even if we qualify as a REIT, we may be subject to certain federal, state and local taxes on our income and
property. Any of these taxes would reduce our operating cash flow.
•
Limits on ownership of our common stock could have adverse consequences to you and could limit your
opportunity to receive a premium on our stock
To maintain our qualification as a REIT for federal income tax purposes, not more than 50% in value of the
outstanding shares of our capital stock may be owned, directly or indirectly, by five or fewer individuals (as
defined in the federal tax laws to include certain entities). Primarily to facilitate maintenance of our
24
qualification as a REIT for federal income tax purposes, our charter will prohibit ownership, directly or by the
attribution provisions of the federal tax laws, by any person of more than 9.8% of the lesser of the number or
value of the issued and outstanding shares of our common stock and will prohibit ownership, directly or by the
attribution provisions of the federal tax laws, by any person of more than 9.8% of the lesser of the number or
value of the issued and outstanding shares of any class or series of our preferred stock. Our board of directors,
in its sole and absolute discretion, may waive or modify the ownership limit with respect to one or more persons
who would not be treated as “individuals” for purposes of the federal tax laws if it is satisfied, based upon
information required to be provided by the party seeking the waiver and upon an opinion of counsel satisfactory
to the board of directors, that ownership in excess of this limit will not otherwise jeopardize our status as a
REIT for federal income tax purposes.
The ownership limit may have the effect of delaying, deferring or preventing a change in control and,
therefore, could adversely affect our shareholders’ ability to realize a premium over the then-prevailing market
price for our common stock in connection with a change in control.
•
A REIT cannot invest more than 25% of its total assets in the stock or securities of one or more taxable
REIT subsidiaries; therefore, our taxable subsidiaries cannot constitute more than 25% of our total
assets
A taxable REIT subsidiary is a corporation, other than a REIT or a qualified REIT subsidiary, in which a
REIT owns stock and which elects taxable REIT subsidiary status. The term also includes a corporate
subsidiary in which the taxable REIT subsidiary owns more than a 35% interest. A REIT may own up to 100%
of the stock of one or more taxable REIT subsidiaries. A taxable REIT subsidiary may earn income that would
not be qualifying income if earned directly by the parent REIT. Overall, at the close of any calendar quarter, no
more than 25% of the value of a REIT’s assets may consist of stock or securities of one or more taxable REIT
subsidiaries.
The stock and securities of our taxable REIT subsidiaries are expected to represent less than 25% of the
value of our total assets. Furthermore, we intend to monitor the value of our investments in the stock and
securities of our taxable REIT subsidiaries to ensure compliance with the above-described 25% limitation. We
cannot assure you, however, that we will always be able to comply with the 25% limitation so as to maintain
REIT status.
•
Taxable REIT subsidiaries are subject to tax at the regular corporate rates, are not required to distribute
dividends, and the amount of dividends a taxable REIT subsidiary can pay to its parent REIT may be
limited by REIT gross income tests
A taxable REIT subsidiary must pay income tax at regular corporate rates on any income that it earns. Our
taxable REIT subsidiaries will pay corporate income tax on their taxable income, and their after-tax net income
will be available for distribution to us. Such income, however, is not required to be distributed.
Moreover, the annual gross income tests that must be satisfied to ensure REIT qualification may limit the
amount of dividends that we can receive from our taxable REIT subsidiaries and still maintain our REIT status.
Generally, not more than 25% of our gross income can be derived from non-real estate related sources, such as
dividends from a taxable REIT subsidiary. If, for any taxable year, the dividends we received from our taxable
REIT subsidiaries, when added to our other items of non-real estate related income, represented more than 25%
of our total gross income for the year, we could be denied REIT status, unless we were able to demonstrate,
among other things, that our failure of the gross income test was due to reasonable cause and not willful neglect.
The limitations imposed by the REIT gross income tests may impede our ability to distribute assets from
our taxable REIT subsidiaries to us in the form of dividends. Certain asset transfers may, therefore, have to be
structured as purchase and sale transactions upon which our taxable REIT subsidiaries recognize taxable gain.
25
•
If interest accrues on indebtedness owed by a taxable REIT subsidiary to its parent REIT at a rate in
excess of a commercially reasonable rate, or if transactions between a REIT and a taxable REIT
subsidiary are entered into on other than arm’s-length terms, the REIT may be subject to a penalty tax
If interest accrues on an indebtedness owed by a taxable REIT subsidiary to its parent REIT at a rate in
excess of a commercially reasonable rate, the REIT is subject to tax at a rate of 100% on the excess of (i)
interest payments made by a taxable REIT subsidiary to its parent REIT over (ii) the amount of interest that
would have been payable had interest accrued on the indebtedness at a commercially reasonable rate. A tax at a
rate of 100% is also imposed on any transaction between a taxable REIT subsidiary and its parent REIT to the
extent the transaction gives rise to deductions to the taxable REIT subsidiary that are in excess of the deductions
that would have been allowable had the transaction been entered into on arm’s-length terms. We will scrutinize
all of our transactions with our taxable REIT subsidiaries in an effort to ensure that we do not become subject to
these taxes. We may not be able to avoid application of these taxes.
Risks of Ownership of Our Common Stock
•
Issuances of large amounts of our stock could cause the market price of our common stock to decline
As of February 25 2009, 544, 290,086 shares of our common stock were outstanding. If we issue a significant
number of shares of common stock or securities convertible into common stock in a short period of time, there could be a
dilution of the existing common stock and a decrease in the market price of the common stock.
• We may change our policies without stockholder approval
Our board of directors and management determine all of our policies, including our investment, financing and
distribution policies. They may amend or revise these policies at any time without a vote of our stockholders. Policy
changes could adversely affect our financial condition, results of operations, the market price of our common stock or
our ability to pay dividends or distributions.
• Our governing documents and Maryland law impose limitations on the acquisition of our common stock and
changes in control that could make it more difficult for a third party to acquire us
Maryland Business Combination Act
The Maryland General Corporation Law establishes special requirements for “business combinations” between
a Maryland corporation and “interested stockholders” unless exemptions are applicable. An interested stockholder is any
person who beneficially owns 10% or more of the voting power of our then-outstanding voting stock. Among other
things, the law prohibits for a period of five years a merger and other similar transactions between us and an interested
stockholder unless the board of directors approved the transaction prior to the party’s becoming an interested
stockholder. The five-year period runs from the most recent date on which the interested stockholder became an
interested stockholder. The law also requires a super majority stockholder vote for such transactions after the end of the
five-year period. This means that the transaction must be approved by at least:
•
•
80% of the votes entitled to be cast by holders of outstanding voting shares; and
two-thirds of the votes entitled to be cast by holders of outstanding voting shares other than shares held
by the interested stockholder or an affiliate of the interested stockholder with whom the business
combination is to be effected.
As permitted by the Maryland General Corporation Law, we have elected not to be governed by the Maryland
business combination statute. We made this election by opting out of this statute in our articles of incorporation. If,
however, we amend our articles of incorporation to opt back in to the statute, the business combination statute could
26
have the effect of discouraging offers to acquire us and of increasing the difficulty of consummating any such offers,
even if our acquisition would be in our stockholders’ best interests.
Maryland Control Share Acquisition Act
Maryland law provides that “control shares” of a Maryland corporation acquired in a “control share acquisition”
have no voting rights except to the extent approved by a vote of the stockholders. Two-thirds of the shares eligible to
vote must vote in favor of granting the “control shares” voting rights. “Control shares” are shares of stock that, taken
together with all other shares of stock the acquirer previously acquired, would entitle the acquirer to exercise voting
power in electing directors within one of the following ranges of voting power:
• One-tenth or more but less than one third of all voting power;
• One-third or more but less than a majority of all voting power; or
• A majority or more of all voting power.
Control shares do not include shares of stock the acquiring person is entitled to vote as a result of having
previously obtained stockholder approval. A “control share acquisition” means the acquisition of control shares, subject
to certain exceptions.
If a person who has made (or proposes to make) a control share acquisition satisfies certain conditions
(including agreeing to pay expenses), he may compel our board of directors to call a special meeting of stockholders to
consider the voting rights of the shares. If such a person makes no request for a meeting, we have the option to present
the question at any stockholders’ meeting.
If voting rights are not approved at a meeting of stockholders then, subject to certain conditions and limitations,
we may redeem any or all of the control shares (except those for which voting rights have previously been approved) for
fair value. We will determine the fair value of the shares, without regard to voting rights, as of the date of either:
•
•
the last control share acquisition; or
the meeting where stockholders considered and did not approve voting rights of the control shares.
If voting rights for control shares are approved at a stockholders’ meeting and the acquirer becomes entitled to
vote a majority of the shares of stock entitled to vote, all other stockholders may obtain rights as objecting stockholders
and, thereunder, exercise appraisal rights. This means that you would be able to force us to redeem your stock for fair
value. Under Maryland law, the fair value may not be less than the highest price per share paid in the control share
acquisition. Furthermore, certain limitations otherwise applicable to the exercise of dissenters’ rights would not apply in
the context of a control share acquisition. The control share acquisition statute would not apply to shares acquired in a
merger, consolidation or share exchange if we were a party to the transaction. The control share acquisition statute could
have the effect of discouraging offers to acquire us and of increasing the difficulty of consummating any such offers,
even if our acquisition would be in our stockholders’ best interests.
Regulatory Risks
•
Loss of Investment Company Act exemption would adversely affect us
We intend to conduct our business so as not to become regulated as an investment company under the
Investment Company Act. If we fail to qualify for this exemption, our ability to use leverage would be substantially
reduced, and we would be unable to conduct our business as described in this Form 10-K.
We rely on the exclusion provided by Section 3(c)(5)(C) of the Investment Company Act. Section 3(c)(5)(C) as
interpreted by the staff of the SEC, requires us to invest at least 55% of our assets in “mortgages and other liens on and
interest in real estate” (or Qualifying Real Estate Assets) and at least 80% of our assets in Qualifying Real Estate Assets
27
plus real estate related assets. The assets that we acquire, therefore, are limited by the provisions of the Investment
Company Act and the rules and regulations promulgated under the Investment Company Act. If the SEC determines that
any of these securities are not qualifying interests in real estate or real estate related assets, adopts a contrary
interpretation with respect to these securities or otherwise believes we do not satisfy the above exceptions, we could be
required to restructure our activities or sell certain of our assets. We may be required at times to adopt less efficient
methods of financing certain of our mortgage assets and we may be precluded from acquiring certain types of higher
yielding mortgage assets. The net effect of these factors will be to lower our net interest income. If we fail to qualify for
exemption from registration as an investment company, our ability to use leverage would be substantially reduced, and
we would not be able to conduct our business as described. Our business will be materially and adversely affected if we
fail to qualify for this exemption.
•
Compliance with proposed and recently enacted changes in securities laws and regulations increase our
costs
The Sarbanes-Oxley Act of 2002 and rules and regulations promulgated by the SEC and the New York Stock
Exchange have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. We
believe that these rules and regulations will make it more costly for us to obtain director and officer liability insurance,
and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These rules
and regulations could also make it more difficult for us to attract and retain qualified members of management and our
board of directors, particularly to serve on our audit committee.
28
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
PROPERTIES
Our executive and administrative office is located at 1211 Avenue of the Americas, Suite 2902 New York, New
York 10036, telephone 212-696-0100. This office is leased under a non-cancelable lease expiring December 31, 2009.
ITEM 3.
LEGAL PROCEEDINGS
From time to time, we are involved in various claims and legal actions arising in the ordinary course of
business. In the opinion of management, the ultimate disposition of these matters will not have a material effect on our
consolidated financial statements.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of our stockholders during the fourth quarter of 2008.
29
PART II
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
Our common stock began trading publicly on October 8, 1997 and is traded on the New York Stock Exchange under
the trading symbol “NLY”. As of February 25, 2009, we had 544,290,086 shares of common stock issued and
outstanding which were held by approximately 290,409 beneficial holders.
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, 2008
Second Quarter ended June 30, 2008
Third Quarter ended September 30, 2008
Fourth Quarter ended December 31, 2008
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, 2008
Second Quarter ended June 30, 2008
Third Quarter ended September 30, 2008
Fourth Quarter ended December 31, 2008
First Quarter ended March 31, 2007
Second Quarter ended June 30, 2007
Third Quarter ended September 30, 2007
Fourth Quarter ended December 31, 2007
Stock Prices
High
Low
$21.00
$17.95
$17.00
$16.12
$14.16
$15.51
$12.92
$11.21
High
Low
$15.48
$16.20
$16.42
$18.18
$13.54
$13.83
$13.03
$15.25
Common Dividends
Declared Per Share
Close
$15.32
$15.51
$13.45
$15.87
Close
$15.48
$14.42
$15.93
$18.18
$0.48
$0.55
$0.55
$0.50
$0.20
$0.24
$0.26
$0.34
We intend to pay quarterly dividends and to distribute to our stockholders all or substantially all of our taxable
income in each year (subject to certain adjustments). 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, 2008, we have paid full cumulative dividends on our preferred stock.
30
EQUITY COMPENSATION PLAN INFORMATION
We have adopted a long term stock incentive plan for executive officers, key employees and nonemployee
directors (the “Incentive Plan”). The Incentive Plan authorizes the Compensation Committee of the board of directors to
grant awards, including incentive stock options as defined under Section 422 of the Code (“ISOs”) and options not so
qualified (“NQSOs”). The Incentive Plan authorizes the granting of options or other awards for an aggregate of the
greater of 500,000 shares or 9.5% of the outstanding shares of our common stock up to a ceiling of 8,932,921 shares.
For a description of our Incentive Plan, see Note 11 to the Financial Statements.
The following table provides information as of December 31, 2008 concerning shares of our common stock
authorized for issuance under our existing Incentive Plan.
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights
Weighted-average exercise
price of outstanding
options, warrants and
rights
Number of securities
remaining available for
future issuance under
Incentive Plan (excluding
previously issued)
5,180,164
-
5,180,164
$15.87
-
$15.87
2,688,350(1)
-
2,688,350
Plan Category
Equity compensation plans
approved by security
holders
Equity compensation plans
not approved by security
holders
Total
(1) The Incentive Plan authorizes the granting of options or other awards for an aggregate of the greater of 500,000 or 9.5% of
the outstanding shares on a fully diluted basis of our common stock up to a ceiling of 8,932,921 shares.
31
ITEM 6.
SELECTED FINANCIAL DATA
The following selected financial data are derived from our audited financial statements for the years ended
December 31, 2008, 2007, 2006, 2005, and 2004. The selected financial data should be read in conjunction with the
more detailed information contained in the Financial Statements and Notes thereto and “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” included elsewhere in this Form 10-K.
SELECTED FINANCIAL DATA
(dollars in thousands, except for per share data)
Statement of Operations Data
Interest income
Interest expense
Net interest income
Other (loss) income:
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
Unrealized loss on interest rate swaps
Total other (loss) income
Expenses:
Distribution fees
General and administrative expenses
Total Expenses
For the Year
Ended
December 31,
2008
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
$3,115,428
1,888,912
1,226,516
$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
27,891
10,713
-
9,695
2,713
(31,834)
(768,268)
(749,090)
1,589
103,622
105,211
22,028
19,062
2,096
19,147
91
(1,189)
-
61,235
3,647
62,666
66,313
22,351
(3,862)
10,674
3,994
35,625
(53,238)
-
-
-
(52,348)
-
(19,191)
-
(83,098)
-
(100,711)
3,444
40,063
43,507
8,000
26,278
34,278
12,512
5,215
-
-
-
-
-
17,727
2,860
24,029
26,889
Impairment of intangible for customer relationships
-
-
2,493
-
-
Income before income taxes
372,215
423,904
101,678
1,497
253,050
Income taxes
25,977
8,870
7,538
10,744
4,458
Income (loss) before minority interest
346,238
415,034
94,140
(9,247)
248,592
Minority interest
Net income (loss)
58
650
324
-
-
346,180
414,384
93,816
(9,247)
248,592
Dividends on preferred stock
21,177
21,493
19,557
14,593
7,745
Net income available (loss related) to common
shareholders
Basic net income (loss) per average common share
Diluted net income (loss) per average common share
Dividends declared per common share
Dividends declared per preferred Series A share
Dividends declared per preferred Series B share
$325,003
$392,891
$74,259
($23,840)
$240,847
$1.32
$1.31
$1.04
$1.97
$1.50
$0.44
$0.44
$0.57
$1.97
$1.08
($0.19)
($0.19)
$1.04
$1.97
-
$2.04
$2.03
$1.98
$1.45
-
$0.64
$0.64
$2.08
$1.97
$1.50
32
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
December 31,
2008
December 31,
2007
December 31,
2006
December 31,
2005
December 31,
2004
$55,046,995
598,945
57,597,615
46,674,885
50,318,301
7,183,272
541,475,366
$52,879,528 $30,167,509
49,500
30,715,980
27,514,020
28,056,149
2,543,041
401,822,703 205,345,591
253,915
53,903,514
46,046,560
48,585,536
5,204,938
$15,929,864 $19,038,386
390,509
19,560,299
16,707,879
17,859,829
1,700,470
123,684,931 121,263,000
-
16,063,422
13,576,301
14,559,399
1,504,023
For the Year
Ended
December 31,
2008
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
$58,540,508
55,962,519
50,270,226
6,679,431
5.57%
$41,834,831
40,800,148
37,967,215
3,710,821
5.77%
$23,130,057
23,029,195
21,399,130
2,006,206
5.31%
$18,724,075 $17,293,174
16,399,184
18,543,749
15,483,118
17,408,828
1,550,076
1,614,743
3.25%
3.80%
3.76%
1.81%
5.07%
0.70%
4.93%
0.38%
3.27%
0.53%
1.74%
1.51%
2.10%
0.18%
1.55%
0.59%
5.18%
1.03%
0.15%
1.69%
0.99%
11.17%
0.72%
0.17%
2.00%
0.41%
4.68%
0.73%
1.52%
0.14%
0.14%
1.63%
(0.05%)
(0.57%)
1.55%
1.44%
16.04%
33
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
We are a REIT that owns and manages a portfolio of principally 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 our taxable REIT subsidiaries. FIDAC and Merganser are our wholly-owned taxable
REIT subsidiaries that are registered investment advisors that generate advisory and service fee income. RCap is our
wholly- owned broker dealer taxable REIT subsidiary which we expect to generate fee income.
We are primarily engaged in the business of investing, on a leveraged basis, in mortgage pass-through
certificates, collateralized mortgage obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans (collectively, “Mortgage-Backed Securities”). We also invest in Federal
Home Loan Bank (“FHLB”), Federal Home Loan Mortgage Corporation (“FHLMC”), and Federal National Mortgage
Association (“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-quality 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-family 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 without 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 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. Prepayment 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 13% ,15% and 17% for the
years ended December 31, 2008, 2007 and 2006,respectively. Since changes in interest rates may significantly affect our
34
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 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.
Average
Investment
Securities
Held (1)
Total
Interest
Income
Yield on
Average
Investment
Securities
Average
Balance of
Repurchase
Agreements
Interest
Expense
Average
Cost of
Funds
Net Interest
Income
Net
Interest
Rate
Spread
(ratios for the quarters have been annualized, dollars in thousands)
$53,838,665
$740,282
5.50%
$47,581,332
$450,805
3.79%
$289,477
1.71%
$57,694,277
$810,659
5.62%
$51,740,645
$458,250
3.54%
$352,409
2.08%
$56,197,550
$773,359
5.50%
$50,359,825
$442,251
3.51%
$331,108
1.99%
$56,119,584
$791,128
5.64%
$51,399,101
$537,606
4.18%
$253,522
1.46%
Quarter Ended
December 31, 2008
Quarter Ended
September 30, 2008
Quarter Ended
June 30, 2008
Quarter Ended
March 31, 2008
(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
December 31, 2008
September 30, 2008
June 30, 2008
March 31, 2008
CPR
10%
11%
16%
15%
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.
For the purposes of computing ratios relating to equity measures, throughout this report, equity includes Series B
preferred stock, which has been treated under accounting principles generally accepted in the United States, or GAAP,,
as temporary equity.
Recent Developments
The liquidity crisis which commenced in August 2007 escalated throughout 2008. During this period of market
dislocation, fiscal and monetary policymakers have established new liquidity facilities for primary dealers and
commercial banks, reduced short-term interest rates, and passed legislation that is intended to address the challenges of
mortgage borrowers and lenders. This legislation, the Housing and Economic Recovery Act of 2008, seeks to forestall
home foreclosures for distressed borrowers and assist communities with foreclosure problems. Although these aggressive
steps are intended to protect and support the US housing and mortgage market, we continue to operate under very
difficult market conditions.
Subsequent to June 30, 2008, there were increased market concerns about Freddie Mac and Fannie Mae’s
ability to withstand future credit losses associated with securities held in their investment portfolios, and on which they
provide guarantees, without the direct support of the federal government. In September 2008 Fannie Mae and Freddie
Mac were placed into the conservatorship of the Federal Housing Finance Agency, or FHFA, their federal regulator,
35
pursuant to its powers under The Federal Housing Finance Regulatory Reform Act of 2008, a part of the Housing and
Economic Recovery Act of 2008. As the conservator of Fannie Mae and Freddie Mac, the FHFA controls and directs the
operations of Fannie Mae and Freddie Mac and may (1) take over the assets of and operate Fannie Mae and Freddie Mac
with all the powers of the shareholders, the directors, and the officers of Fannie Mae and Freddie Mac and conduct all
business of Fannie Mae and Freddie Mac; (2) collect all obligations and money due to Fannie Mae and Freddie Mac; (3)
perform all functions of Fannie Mae and Freddie Mac which are consistent with the conservator’s appointment; (4)
preserve and conserve the assets and property of Fannie Mae and Freddie Mac; and (5) contract for assistance in
fulfilling any function, activity, action or duty of the conservator.
In addition to FHFA becoming the conservator of Fannie Mae and Freddie Mac, (i) the U.S. Department of
Treasury and FHFA have entered into preferred stock purchase agreements between the U.S. Department of Treasury
and Fannie Mae and Freddie Mac pursuant to which the U.S. Department of Treasury will ensure that each of Fannie
Mae and Freddie Mac maintains a positive net worth; (ii) the U.S. Department of Treasury has established a new secured
lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, which is
intended to serve as a liquidity backstop, which will be available until December 2009; and (iii) the U.S. Department of
Treasury has initiated a temporary program to purchase RMBS issued by Fannie Mae and Freddie Mac. Given the
highly fluid and evolving nature of these events, it is unclear how our business will be impacted. Based upon the further
activity of the U.S. government or market response to developments at Fannie Mae or Freddie Mac, our business could
be adversely impacted.
The Emergency Economic Stabilization Act of 2008, or EESA, was recently enacted. The EESA provides the
U.S. Secretary of the Treasury with the authority to establish a Troubled Asset Relief Program, or TARP, to purchase
from financial institutions up to $700 billion of equity or preferred securities, residential or commercial mortgages and
any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was
originated or issued on or before March 14, 2008, as well as any other financial instrument that the U.S. Secretary of the
Treasury, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the
purchase of which is necessary to promote financial market stability, upon transmittal of such determination, in writing,
to the appropriate committees of the U.S. Congress. The EESA also provides for a program that would allow companies
to insure their troubled assets.
In addition, the U.S. Government, Federal Reserve and other governmental and regulatory bodies have taken or
are considering taking other actions to address the financial crisis. There can be no assurance that the EESA or other
policy initiatives will have a beneficial impact on the financial markets, including current extreme levels of volatility.
We cannot predict whether or when such actions may occur or what impact, if any, such actions could have on our
business, results of operations and financial condition.
The liquidity crisis 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 converting our assets to cash or extending financing terms, due to the fact that our investment securities have
an actual or implied “AAA” rating and principal payment is guaranteed.
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 conformity with GAAP. 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 statements.
The following is a summary of our policies most affected by management’s judgments, estimates and assumptions.
36
Fair Value 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 portfolio. Accordingly, we are
required to classify all of our Investment Securities as available-for-sale. Our policy is to obtain fair 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 recovery 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 factors 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.
Derivative Financial Instruments/Hedging Activity : Prior to the fourth quarter of 2008, we designated interest rate
swaps as cash flow hedges, whereby the swaps were recorded at fair value on the balance sheet as assets and liabilities
with any changes in fair value recorded in accumulated other comprehensive income. In a cash flow hedge, a swap
would exactly match the pricing date of the relevant repurchase agreement. Through the end of the third quarter 2008,
we continued to be able to match the swaps with the repurchase agreements therefore entering into effective hedge
transactions. However, due to the volatility of the credit markets, it is no longer practical to match the pricing dates of
both the swaps and the repurchase agreements.
As a result, we voluntarily discontinued hedge accounting in the fourth quarter of 2008 through a combination of
de-designating previously defined hedge relationships and not designating new contracts as cash flow hedges. The de-
designation of cash flow hedges was done in accordance with Derivatives Implementation Group (DIG) Issue Nos. G3,
G17, G18 & G20, which generally require that the net derivative gain or loss related to the discontinued cash flow hedge
should continue to be reported in accumulated other comprehensive income, unless it is probable that the forecasted
transaction will not occur by the end of the originally specified time period or within an additional two-month period of
time thereafter. As such we continue to hold repurchase agreements in excess of swap contracts and have no indication
that interest payments on the hedged repurchase agreements are in jeopardy of discontinuing. Therefore, the deferred
losses related to these derivatives that have been de-designated were not recognized immediately and are expected to be
reclassified into earnings during the contractual terms of the swap agreements starting as of October 1, 2008. Changes in
the unrealized gains or losses on the interest rate swaps subsequent to September 30, 2008 will be reflected in our
income statement.
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.
37
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, we will not be subjected to federal
income tax to the extent of our distributions to shareholders and as long as certain asset, income and stock ownership
tests are met. We, FIDAC, Merganser, and RCap have made a joint election to treat FIDAC, Merganser, and RCap as
taxable REIT subsidiaries. As such, FIDAC, Merganser, and RCap are taxable as a domestic C corporations and subject
to federal and state and local income taxes based upon their taxable income.
Impairment of Goodwill and Intangibles: The Company’s acquisitions of FIDAC and Merganser were
accounted for using the purchase method. The cost of FIDAC and Merganser were 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 periodically reviewed for potential impairment. This evaluation requires significant
judgment.
Recent Accounting Pronouncements:
In February 2007, the FASB issued SFAS No. 159, The Fair Value 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 was
effective for us commencing January 1, 2008.
In April 2007, the FASB issued FASB Staff Position FIN 39-1 (“FSP FIN 39-1”) which modifies FASB
Interpretation No. 39, Offsetting of Amounts relating to Certain Contracts (“FIN 39”). FSP FIN 39-1 addresses whether
a reporting entity that is party to a master netting arrangement can offset fair value amounts recognized for the right to
reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts
recognized for derivative instruments that have been offset under the same master netting arrangement in accordance
with FIN 39. Upon adoption of this guidance, a reporting entity is permitted to change its accounting policy to offset or
not offset fair value amounts recognized for derivative instruments under master netting arrangements. This guidance
was effective for us on January 1, 2008. The implementation did not have an effect on our financial statements.
In February 2008, FASB issued FASB Staff Position No. FAS 140-3 Accounting for Transfers of Financial Assets
and Repurchase Financing Transactions, (“FSP FAS 140-3”). FSP FAS 140-3 addresses whether transactions 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, or are required to be considered “linked” transactions and
may be considered derivatives under SFAS 133 Accounting for Derivative Instruments and Hedging Activities. FSP
FAS 140-3 requires purchases and subsequent financing through repurchase agreements be considered linked
transactions unless all of the following conditions apply: (1) the initial purchase and the use of repurchase agreements to
finance the purchase are not contractually contingent upon each other; (2) the repurchase financing entered into between
the parties provides full recourse to the transferee and the repurchase price is fixed; (3) the financial assets are readily
obtainable in the market; and (4) the financial instrument and the repurchase agreement are not coterminous. This FSP is
effective for us on January 1, 2009. We are currently evaluating FSP FAS 140-3 but do not expect its application to have
a significant impact on our financial reporting.
In March 2008, the FASB issued SFAS No. 161 (“SFAS 161”), Disclosures about Derivative Instruments and
Hedging Activities, and an amendment of FASB Statement No. 133. SFAS 161 attempts to improve the transparency of
financial reporting by providing additional information about how derivative and hedging activities affect an entity’s
financial position, financial performance and cash flows. This statement changes the disclosure requirements for
derivative instruments and hedging activities by requiring enhanced disclosure about (1) how and why an entity uses
derivative instruments, (2) how derivative instruments and related hedged items are accounted for under SFAS Statement
133 and its related interpretations, and (3) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows. To meet these objectives, SFAS 161 requires qualitative
disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts and of
gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative
38
agreements. This disclosure framework is intended to better convey the purpose of derivative use in terms of the risks
that an entity is intending to manage. SFAS 161 is effective for us on January 1, 2009. We expect that adoption of
SFAS 161 will increase footnote disclosure to comply with the disclosure requirements for financial statements issued
after January 1, 2009.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines
fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value
measurements. SFAS 157 requires companies to disclose the fair value of their 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 category of assets and
liabilities. SFAS 157 was adopted by us on January 1, 2008. SFAS 157 did not have an impact on the manner in which
we estimate fair value, but it required additional disclosure, which is included in Note 6.
On October 10, 2008, FASB issued FASB Staff Position (FSP) 157-3, Determining the Fair Value of a Financial
Asset When the Market for That Asset Is Not Active (“FSP 157-3”), in response to the deterioration of the credit markets.
This FSP provides guidance clarifying how SFAS 157 should be applied when valuing securities in markets that are not
active. The guidance provides an illustrative example that applies the objectives and framework of SFAS 157, utilizing
management’s internal cash flow and discount rate assumptions when relevant observable data does not exist. It further
clarifies how observable market information and market quotes should be considered when measuring fair value in an
inactive market. It reaffirms the notion of fair value as an exit price as of the measurement date and that fair value
analysis is a transactional process and should not be broadly applied to a group of assets. FSP 157-3 is effective upon
issuance including prior periods for which financial statements have not been issued. FSP 157-3 does not have a
material effect on the fair value of our assets as we intend to continue to hold assets that can be valued via level 1 and
level 2 criteria, as defined under SFAS No. 157.
Results of Operations:
Net Income Summary
For the year ended December 31, 2008, our net income was $346.2 million or $0.64 basic income per average
share related to common shareholders, as compared to $414.4 million net income or $1.32 basic net income per average
share for the year ended December 31, 2007. For the year ended December 31, 2006, our net income was $93.8 million
or $0.44 basic net income per average share related to common shareholders. Net income per average share decreased
by $0.68 per average share available to common shareholders and total net income decreased $68.2 million for the year
ended December 31, 2008, when compared to the year ended December 31, 2007. We attribute the decrease in total net
income for the year ended December 31, 2008 from the year ended December 31, 2007 primarily to recording of
unrealized losses related to interest rate swaps in the fourth quarter of 2008. An unrealized loss of $768.3 million was
recorded in the income statement for the year ended December 31, 2008, as the result of de-designation of cash flow
hedges. Prior to the fourth quarter of 2008, we recorded changes in the fair values in our interest rate swaps in the
Accumulated Other Comprehensive Income in our Statement of Financial Condition. Net interest income increased by
$797.5 million for the year ended December 31, 2008, as compared to the year ended December 31, 2007, due to the
increase in interest earning assets from the deployment of additional capital we raised in 2008 and the improved interest
rate spread. For the year ended December 31, 2008, net gain on sale of Mortgage-Backed Securities was $10.7 million,
as compared to a net gain of $19.1 million for the year ended December 31, 2007. The loss on other-than-temporarily
impaired securities totaled $31.8 million for the year ended December 31, 2008, as compared to $1.2 million for the year
ended December 31, 2007. During the year ended December 31, 2008, our general and administrative expenses
increased to $103.6 million, as compared to $62.7 million for the year ended December 31, 2007.
We attribute the increase in total net income for the year ended December 31, 2007 compared to the year ended
December 31, 2006 primarily to the increase in net interest 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. The
interest rate spread increased from 0.38% for the year ended December 31, 2006 to 0.70% for the year ended December
31, 2007. 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 in 2006. The table below presents the net income (loss) summary for the years
ended December 31, 2008, 2007, and 2006.
39
Net Income (Loss) Summary
(dollars in thousands, except for per share data)
Year Ended
December 31,
2008
$3,115,428
1,888,912
1,226,516
Year Ended
December 31,
2007
$2,355,447
1,926,465
428,982
Year Ended
December 31,
2006
$1,221,882
1,055,013
166,869
Interest income
Interest expense
Net interest income
Other (loss) income:
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
Unrealized loss on interest rate swaps
Total other (loss) income
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 before minority interest
Minority interest
Net Income
27,891
10,713
-
9,695
2,713
(31,834)
(768,268)
(749,090)
1,589
103,622
105,211
-
372,215
25,977
346,238
58
22,028
19,062
2,096
19,147
91
(1,189)
-
61,235
3,647
62,666
66,313
-
22,351
(3,862)
10,674
3,994
-
(52,348)
-
(19,191)
3,444
40,063
43,507
2,493
423,904
101,678
8,870
415,034
650
7,538
94,140
324
93,816
19,557
346,180
414,384
Dividends on preferred stock
21,177
21,493
Net income available to common shareholders
$325,003
$392,891
$74,259
Weighted average number of basic common shares
outstanding
Weighted average number of diluted common shares
outstanding
507,024,596
297,488,394
167,666,631
507,024,596
306,263,766
167,746,387
Basic net income per average common share
Diluted net income per average common share
$0.64
$0.64
$1.32
$1.31
$0.44
$0.44
Average total assets
Average equity
Return on average total assets
Return on average equity
58,540,508
6,679,431
41,834,831
3,710,821
$23,130,057
2,006,206
0.59%
5.18%
0.99%
11.17%
0.41%
4.68%
40
Interest Income and Average Earning Asset Yield
We had average earning assets of $56.0 billion for the year ended December 31, 2008. 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. Our primary source of income is interest income. Our interest income was $3.1 billion for
the year ended December 31, 2008, $2.4 billion for the year ended December 31, 2007, and $1.2 billion for the year
ended December 31, 2006. The yield on average investment securities was 5.57%, 5.77%, and 5.31% for the respective
years. The prepayment speeds decreased to an average of 10% CPR for the year ended December 31, 2008 from an
average of 15% CPR for the year ended December 31, 2007.
Interest Expense and the Cost of Funds
Our largest expense is the cost of borrowed funds. We had average borrowed funds of $50.3 billion and total
interest expense of $1.9 billion for the year ended December 31, 2008. We had average borrowed funds of $38.0 billion
and total interest expense of $1.9 billion for the year ended December 31, 2007. We had average borrowed funds of
$21.4 billion and total interest expense of $1.1 million for the year ended December 31, 2006. Our average cost of
funds was 3.76% for the year ended December 31, 2008 and 5.07% for the year ended December 31, 2007 and 4.93 %
for the year ended December 31, 2006. The cost of funds rate decreased by 131 basis points and the average borrowed
funds increased by $12.3 billion for the year ended December 31, 2008 when compared to the year ended December 31,
2007. Interest expense for the year ended December 31, 2008 decreased by $37.6 million over the prior year due to the
substantial decrease in the average cost of funds rate. 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 ended December 31, 2007 increased by $871.5 million over the
previous year due to the substantial increase in the average borrowed funds and the increase in the average cost of funds
rate. Since a substantial portion of our repurchase agreements are short term, changes in market rates are directly
reflected in our interest expense. Our average cost of funds was 1.08% above average one-month LIBOR and 0.70%
above average six-month LIBOR for the year ended December 31, 2008. Our average cost of funds was 0.12% below
average one-month LIBOR and 0.12% below average six-month LIBOR for the year ended December 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.
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, 2008, 2007, 2006, 2005, and 2004 and the four
quarters in 2008.
41
Average Cost of Funds
(Ratios for the four quarters in 2008 have been annualized, dollars in thousands)
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 Cost
of Funds
Relative to
Average
One-Month
LIBOR
Average
Cost of
Funds
Relative to
Average
Six-Month
LIBOR
For the Year Ended
December 31, 2008
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 Quarter Ended
December 31, 2008
For the Quarter Ended
September 30, 2008
For the Quarter Ended
June 30, 2008
For the Quarter Ended
March 31, 2008
$50,270,226
$1,888,912
3.76%
2.68%
3.06%
(0.38%)
1.08%
0.70%
$37,967,215
$1,926,465
5.07%
5.19%
5.19%
(0.00%)
(0.12%)
(0.12%)
$21,399,130
$1,055,013
4.93%
5.03%
5.21%
(0.18%)
(0.10%)
(0.28%)
$17,408,828
$568,560
3.27%
3.33%
3.72%
(0.39%)
(0.06%)
(0.45%)
$15,483,118
$270,116
1.74%
1.50%
1.80%
(0.30%)
0.24%
(0.06%)
$47,581,332
$450,805
3.79%
2.23%
2.94%
(0.71%)
1.56%
$51,740,645
$458,250
3.54%
2.62%
3.19%
(0.57%)
0.92%
$50,359,825
$442,251
3.51%
2.59%
2.93%
(0.34%)
0.92%
$51,399,101
$537,606
4.18%
3.31%
3.18%
0.13%
0.87%
0.85%
0.35%
0.58%
1.00%
Net Interest Income
Our net interest income, which equals interest income less interest expense, totaled $1.2 billion for the year
ended December 31, 2008 and $429.0 million for the year ended December 31, 2007 and $166.9 million for the year
ended December 31, 2006. Our net interest income increased for the year ended December 31, 2008, as compared to the
year ended December 31, 2007, because of the increased average asset base in 2008 and the increased interest rate
spread. Our net interest income increased for the year ended December 31, 2007 as compared to the year ended
December 31, 2006 by $262.1 million because of the increased average asset base for 2007. In 2008 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 1.81% for the year ended December 31, 2008 as
compared to 0.70% for the year ended December 31, 2007 and 0.38% for the year ended December 31, 2006. This 111
basis point increase in interest rate spread for 2008 over the spread for 2007 was the result in the decrease in the average
cost of funds of 131 basis points, which was only partially offset by a decrease in average yield on average interest
earning assets of 20 basis points.
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, 2008, 2007, 2006, 2005,
and 2004 and the four quarters in 2008.
42
Net Interest Income
(Ratios for the four quarters in 2008 have been annualized, dollars in thousands)
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
Net
Interest
Rate
Spread
$55,962,519
$3,115,428
5.57%
$50,270,226
$1,888,912
3.76%
$1,226,516
1.81%
$40,800,148
$2,355,447
5.77%
$37,967,215
$1,926,465
5.07%
$428,982
0.70%
$23,029,195
$1,221,882
5.31%
$21,399,130
$1,055,013
4.93%
$166,869
0.38%
$18,543,749
$705,046
3.80%
$17,408,827
$568,560
3.27%
$136,486
0.53%
$16,399,184
$532,328
3.25%
$15,483,118
$270,116
1.74%
$262,212
1.51%
$53,838,665
$740,282
5.50%
$47,581,332
$450,805
3.79%
$289,477
1.71%
$57,694,277
$810,659
5.62%
$51,740,645
$458,250
3.54%
$352,409
2.08%
$56,197,550
$773,359
5.50%
$50,359,825
$442,251
3.51%
$331,108
1.99%
$56,119,584
$791,128
5.64%
$51,399,101
$537,606
4.18%
$253,522
1.46%
For the Year Ended
December 31, 2008
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 Quarter Ended
December 31, 2008
For the Quarter Ended
September 30, 2008
For the Quarter Ended
June 30, 2008
For the Quarter Ended
March 31, 2008
Investment Advisory and Service Fees
FIDAC and Merganser are registered investment advisors specializing in managing fixed income securities. At
December 31, 2008, FIDAC and Merganser had under management approximately $7.0 billion in net assets and $15.3
billion in gross assets, compared to $3.1 billion in net assets and $15.4 billion in gross assets at December 31, 2007. Net
investment advisory and service fees for the years ended December 31, 2008, 2007, and 2006 totaled $26.3 million,
$18.4 million, and $18.9 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 and Merganser manage 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, 2008, we sold Investment Securities with a carrying value of $15.2 billion for
aggregate net gain of $10.7 million. For the year ended December 31, 2007, we sold investment securities with a
aggregate historical amortized value of $4.9 billion for a net gain of $19.1 million. In addition, for the year ended
December 31, 2007, we had a $2.1 million gain on the termination of interest rate swaps with a notional amount 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 aggregate loss of $3.9 million. In addition, for the year ended December 31, 2006, we had a
$10.7 million gain on the termination of interest rate swaps with a notional amount of $1.2 billion. 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.
Income from Trading Securities
Gross income from trading securities totaled $9.7 million, $19.1 million, and $4.0 million for the year ended
December 31, 2008, 2007 and 2006.
43
Dividend Income from Available-For-Sale Equity Securities
Dividend income from our investment in Chimera totaled $2.7 million for the year ended December 31, 2008
and $91,000 for the year ended December 31, 2007. For the year 2006 we did not have an investment in available-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, 2008 the loss on other-than-
temporarily impaired securities totaled $31.8 million related to our equity investment in Chimera. For the years ended
December 31, 2007 and 2006 the loss on other-than-temporarily impaired securities totaled $1.2 million and $52.3
million, respectively.
Impairment of Goodwill and Intangibles
During the years ended December 31, 2008 and 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 were no impairment charges related to goodwill during the years ended 2008, 2007,
and 2006.
General and Administrative Expenses
General and administrative (or G&A) expenses were $103.6 million for the year ended December 31, 2008,
$62.7 million for the year ended December 31, 2007, and $40.1 million for the year ended December 31, 2006. G&A
expenses as a percentage of average total assets was 0.18%, 0.15%, and 0.17% for the years ended December 31, 2008,
2007, and 2006, respectively. The increase in G&A expenses of $40.9 million for the year December 31, 2008 was
primarily the result of increased compensation, directors and officers insurance and additional costs related to our
subsidiaries. Staff increased from 34 at the end of 2006 to 39 at the end of 2007 and 65 at the end of 2008.
The table below shows our total G&A expenses as compared to average total assets and average equity for the
years ended December 31, 2008, 2007, 2006, 2005, and 2004 and the four quarters in 2008.
G&A Expenses and Operating Expense Ratios
(ratios for the quarters have been annualized, dollars in thousands)
For the Year Ended December 31, 2008
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 Quarter Ended December 31, 2008
For the Quarter Ended September 30, 2008
For the Quarter Ended June 30, 2008
For the Quarter Ended March 31, 2008
Total G&A Expenses
$103,622
$62,666
$40,063
$26,278
$24,029
$26,957
$25,455
$27,215
$23,995
Total G&A
Expenses/Average
Assets
0.18%
0.15%
0.17%
0.14%
0.14%
0.18%
0.17%
0.18%
0.17%
Total G&A
Expenses/Average
Equity
1.55%
1.69%
2.00%
1.63%
1.55%
1.50%
1.40%
1.59%
1.64%
Net Income and Return on Average Equity
Our net income was $346.2 million for the year ended December 31, 2008, net income was $414.4 million for
the year ended December 31, 2007, and net income was $93.8 million for the year ended December 31, 2006. Our return
on average equity was 5.18% for the year ended December 31, 2008, was 11.17% for the year ended December 31, 2007,
and 4.68% for the year ended December 31, 2006. Net interest income increased by $797.5 million for the year ended
44
December 31, 2008, as compared to the year ended December 31, 2007, due to the increase in interest earning assets
from the deployment of additional capital we raised in 2008 and the improved interest rate spread. Even with the
increase in net interest income of $797.5 million, net income for the year decreased by $68.2 million. We attribute the
decrease in total net income for the year ended December 31, 2008 from the year ended December 31, 2007 primarily to
the de-designation of interest rate swaps as cash flow hedges in the fourth quarter of 2008, which resulted in an
unrealized loss of $768.3 million being recorded in the income statement for the year ended December 31, 2008. Prior to
the fourth quarter of 2008 and the de-designation of cash flow hedges, we recorded these changes in the market values of
interest rate swaps in the Statement of Financial Condition.
We attribute the increase in total net income for the year ended December 31, 2007 compared to the year ended
December 31, 2006 primarily to the increase in net interest 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.
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 trading 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, 2008, 2007, 2006, 2005, and 2004, and the four quarters in 2008.
Components of Return on Average Equity
(Ratios for the quarters have been annualized)
Gain/(Loss) on
Sale of
Mortgage-
Backed
Securities and
Realized and
Unrealized
Gain/(Loss)
Interest Rate
Swaps/
Average Equity
Net
Investment
Advisory and
Service
Fees/Average
Equity
Net Interest
Income/
Average
Equity
Loss on
other-than-
temporarily
impaired
securities/
Average
Equity
Income
from
trading
securities
/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
18.36%
0.39%
(11.34%)
(0.48%)
0.15%
0.04%
(1.55%)
(0.39%)
11.56%
0.50%
0.57%
(0.03%)
0.52%
0.00%
(1.69%)
(0.24%)
-
-
-
5.18%
(0.02%)
11.17%
8.32%
0.94%
0.34%
(2.61%)
0.20%
(2.00%)
(0.38%)
(0.12%)
(0.01%)
4.68%
8.45%
1.71%
(3.30%)
(5.15%)
16.92%
0.62%
0.34%
16.06%
0.38%
(42.63%)
-
-
-
-
-
-
-
1.63%
0.67%
1.55%
0.29%
(0.11%)
0.03%
(1.50%)
(0.35%)
19.52%
0.41%
(0.07%)
(1.76%)
0.42%
0.03%
(1.40%)
(0.42%)
19.40%
0.35%
17.38%
0.41%
0.16%
0.64%
-
-
0.13%
0.03%
(1.59%)
(0.44%)
0.13%
0.06%
(1.64%)
(0.32%)
0.00%
-
-
-
-
-
-
-
-
-
-
-
(0.57%)
16.04%
(28.12%)
16.73%
18.04%
16.66%
For the Year Ended
December 31, 2008
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 Quarter Ended
December 31, 2008
For the Quarter Ended
September 30, 2008
For the Quarter Ended
June 30, 2008
For the Quarter Ended
March 31, 2008
Financial Condition
Investment Securities, Available for Sale
All of our Mortgage-Backed Securities at December 31, 2008, 2007, and 2006 were adjustable-rate or fixed-rate
mortgage-backed securities backed by single-family mortgage loans. All of the mortgage assets underlying these
mortgage-backed securities were secured with a first lien position on the underlying single-family properties. All of our
mortgage-backed securities were FHLMC, FNMA or GNMA mortgage pass-through certificates or CMOs, which carry
an implied “AAA” rating. All of our agency debentures are callable and carry an implied “AAA” rating. We carry all
of our earning assets at fair value.
45
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, 2008, 2007, and 2006 we had on our balance sheet a total of $64.4 million, $77.4 million and $78.4
million, respectively, of unamortized discount (which is the difference 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 $619.5
million, $405.8 million and $219.1 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 $8.6 billion for the year ended December 31, 2008, $6.8 billion
for the year ended December 31, 2007, and $5.1 billion for the year ended December 31, 2006. The average prepayment
speed for the year ended December 31, 2008, 2007 and 2006 was 13%, 15%, and 17%, respectively. During the year
ended December 31, 2008, the average CPR declined to 13% from 15% during the year ended December 31, 2007, due
to a decline in refinancing activity. Given our current portfolio composition, if mortgage principal prepayment rates
were to increase over the life of our mortgage-backed securities, all other factors being equal, our net interest income
would decrease during the life of these mortgage-backed securities as we would be required to amortize our net premium
balance into income over a shorter time period. Similarly, if mortgage principal prepayment rates were to decrease over
the life of our mortgage-backed securities, all other factors being equal, our net interest income would increase during
the life of these mortgage-backed securities as we would amortize our net premium balance over a longer time period.
The table below summarizes certain characteristics of our Investment Securities at December 31, 2008, 2007,
2006, 2005, and 2004 and September 30, 2008, June 30, 2008, and March 31, 2008.
Investment Securities
(dollars in thousands)
Principal Amount
$54,508,672
$52,569,598
$30,134,791
$15,915,801
$19,123,902
$55,211,123
$58,304,678
$56,006,707
Net
Premium
$555,043
$328,376
$140,709
$220,637
$425,792
$525,394
$500,721
$383,334
Amortized
Cost
$55,063,715
$52,897,974
$30,275,500
$16,136,438
$19,549,694
$55,736,517
$58,805,399
$56,390,041
Amortized
Cost/Principal
Amount
101.02%
100.62%
100.47%
101.39%
102.23%
100.95%
100.86%
100.68%
Fair Value
$55,645,940
$53,133,443
$30,217,009
$15,929,864
$19,428,895
$55,459,280
$58,749,300
$56,853,862
Fair
Value/Principal
Amount
102.09%
101.07%
100.27%
100.09%
101.59%
100.45%
100.76%
101.51%
Weighted
Average
Yield
5.15%
5.75%
5.63%
4.68%
3.43%
5.41%
5.33%
5.36%
At December 31, 2008
At December 31, 2007
At December 31, 2006
At December 31, 2005
At December 31, 2004
At September 30, 2008
At June 30, 2008
At March 31, 2008
The table below summarizes certain characteristics of our Investment Securities at December 31, 2008, 2007,
2006, 2005, and 2004 and September 30, 2008, June 30, 2008, and March 31, 2008. 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)
Weighted
Average
Coupon
Rate
4.75%
5.90%
5.72%
4.76%
4.23%
5.27%
5.16%
5.19%
Weighted
Average Term to
Next Adjustment
36 months
39 months
19 months
22 months
24 months
37 months
36 months
35 months
Principal Amount
$19,540,152
$15,331,447
$8,493,242
$9,699,133
$13,544,872
$19,310,012
$18,418,637
$17,487,518
Weighted
Average Lifetime
Cap
Weighted
Average
Asset
Yield
Principal Amount at
Period End as % of
Total Investment
Securities
10.00%
9.89%
9.76%
10.26%
10.12%
9.98%
9.89%
9.73%
3.93%
5.63%
5.57%
4.74%
3.24%
4.65%
4.54%
4.40%
35.85%
29.16%
28.18%
60.94%
70.83%
34.97%
31.59%
31.22%
At December 31, 2008
At December 31, 2007
At December 31, 2006
At December 31, 2005
At December 31, 2004
At September 30, 2008
At June 30, 2008
At March 31, 2008
46
Fixed-Rate Investment Security Characteristics
(dollars in thousands)
Principal
Amount
$34,968,520
$37,238,151
$21,641,549
$6,216,668
$5,579,030
$3,387,196
$35,901,111
$39,886,041
$38,519,189
Weighted Average
Coupon Rate
6.13%
6.00%
5.83%
5.37%
5.24%
5.77%
6.06%
6.00%
5.98%
Weighted Average
Asset Yield
5.84%
5.80%
5.65%
4.60%
3.89%
4.29%
5.82%
5.70%
5.80%
Principal Amount at Period
End as % of Total Investment
Securities
64.15%
70.84%
71.82%
39.06%
29.17%
26.71%
65.03%
68.41%
68.78%
At December 31, 2008
At December 31, 2007
At December 31, 2006
At December 31, 2005
At December 31, 2004
At December 31, 2003
At September 30, 2008
At June 30, 2008
At March 31, 2008
At December 31, 2008 and 2007, 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, 2008
One-
Month
Libor
Six-
Month
Libor
Twelve
Month
Libor
12-
Month
Moving
Average
11th
District
Cost of
Funds
1-Year
Treasury
Index
Monthly
Federal
Cost of
Funds
Other
Indexes(1)
1 mo.
25 mo.
55 mo.
1 mo.
1 mo.
37 mo.
1 mo.
14 mo.
6.28%
1.95%
1.98%
0.00%
1.26%
1.93%
0.00%
1.94%
7.07% 10.87%
10.92%
8.86% 11.35% 10.86% 13.44%
11.98 %
Weighted Average Term
to Next Adjustment
Weighted Average
Annual Period Cap
Weighted Average
Lifetime Cap at
December 31, 2008
Investment Principal
Value as Percentage of
Investment Securities at
December 31, 2008
0.60%
Combination of indexes that account for less than 0.05% of total investment securities.
19.32%
0.99%
8.11%
2.53%
(1)
4.12%
0.11%
0.07%
47
Adjustable-Rate Investment Securities by Index
December 31, 2007
One-
Month
Libor
Six-
Month
Libor
Twelve
Month
Libor
12-
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-
USD
Other
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%
0.42%
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 %
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
7.23%
(1) Combination of indexes that account for less than 0.05% of total investment securities.
8.24%
1.89%
0.67%
0.19%
3.39%
0.05%
0.13%
0.19%
7.14%
0.04%
Reverse Repurchase Agreements
At December 31, 2008, we lent $562.1 million to Chimera in an overnight reverse repurchase agreement. This
amount is included at fair value in our Statement of Financial Condition. The interest rate at December 31, 2008 was an
at the market rate of 1.43%. The average rate on all reverse repurchase agreements for the year was 2.99%. The
collateral for this loan is mortgage-backed securities.
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 financial statements of an affiliated investment fund. The resulting realized and unrealized gains and
losses are reflected in the statements of operations. There were no trading securities and trading securities sold, not yet
purchased at December 31, 2008. 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.
Receivable from Prime Broker on Equity Investment
The net assets of the investment fund are subject to English bankruptcy law, which governs the
administration of Lehman Brothers International (Europe) (LBIE), as well as the law of New York, which governs the
contractual documents. Until our contractual documents with LBIE are terminated, the value of the assets and liabilities
in our account with LBIE will continue to fluctuate based on market movements. We do not intend to terminate these
contractual documents until LBIE's administrators have clarified the consequences of us doing so. We have not received
notice from LBIE's administrators that LBIE has terminated the documents. LBIE’s administrators have advised us
that they can provide us with no additional information about our account at this time. As a result, we have presented the
market value of our account with LBIE as of September 15, 2008, which is the date of the last statement we received
from LBIE on the account’s assets and liabilities. We can provide no assurance, however, that we will recover all or any
portion of these assets following completion of LBIE's administration (and any subsequent liquidation).
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, 2008, 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 borrowing capacity and thus increase the
liquidity and strength of our balance sheet.
48
For the year ended December 31, 2008, 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 original term to maturity of our borrowings was 287 days at December 31,
2008. For the year ended December 31, 2007, the term to maturity of our borrowings ranged from one day to three
years, with a weighted average original term to maturity of 286 days at December 31, 2007. For the year ended
December 31, 2006, the term to maturity of our borrowings ranged from one day to three years, with a weighted average
original term to maturity of 194 days at December 31, 2006.
At December 31, 2008, the weighted average cost of funds for all of our borrowings was 4.08%, with the effect
of the interest rate swaps, and the weighted average term to next rate adjustment was 238 days. At December 31, 2007,
the weighted average cost of funds for all of our borrowings 4.76% and the weighted average term to next rate
adjustment was 234 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 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 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 capacity for liquidity
management purposes.
Borrowings under our repurchase agreements increased by $700 million to $46.7 billion at December 31, 2008,
from $46.0 billion at December 31, 2007. Even though borrowing increased over the year, leverage declined from 8.7:1
to 6.4:1.
We anticipate that, upon repayment of each borrowing under a repurchase agreement, we will use the collateral
immediately for borrowing under a new repurchase agreement. We have not at the present time entered into any
commitment 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 of market factors, lenders may release collateral back to us. Specifically, margin calls result from a decline
in the value of the 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, 2008, we did not have
49
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.
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, 2008. The table does not include the effect of net interest rate payments under our interest
rate swap agreements. The net swap payments will fluctuate based on monthly changes in the receive rate, At
December 31, 2008, the interest rate swaps had a negative fair value of $1.1 billion.
Contractual Obligations
Repurchase agreements
Interest expense on repurchase
agreements, based on rates at 12-31-08
Long-term operating lease obligations
Employment contracts
Total
Stockholders’ Equity
Within One
Year
$40,195,726
One to
Three Years
$2,930,000
(dollars in thousands)
Three to
Five Years
$2,049,159
More than
Five Years
$1,500,000
Total
$46,674,885
367,979
395,150
183,269
196,838
1,143,236
532
36,645
$40,600,882
-
$3,325,150
-
-
$2,232,428
-
-
$1,696,838
532
36,645
$47,855,298
On May 13, 2008 we entered into an underwriting agreement pursuant to which we sold 69,000,000 shares of
our common stock for net proceeds following underwriting expenses of approximately $1.1 billion. This transaction
settled on May 19, 2008.
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, 2008, we raised $93.7 million by issuing 5.8 million shares through our
Direct Purchase and Dividend Reinvestment Program.
On August 3, 2006, we entered into an ATM Equity Offering(sm) Sales Agreement with Merrill Lynch & Co.
and Merrill Lynch, Pierce, Fenner & Smith Incorporated, relating to the sale of shares of our 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, 2008, 588,000 shares of our common stock were issued
pursuant to this program, totaling $11.5 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, are made by
means of ordinary brokers' transaction on the New York Stock Exchange. During the year ended December 31, 2008, 3.8
million shares of our common stock were issued pursuant to this program, totaling $60.3 million in net proceeds.
During the year ended December 31, 2008, 300,000 options were exercised under the Long-Term Stock
Incentive Plan, or Incentive Plan, for an aggregate exercise price of $2.8 million.
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 pursuant 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.
50
On March 7, 2007, we entered into an underwriting agreement pursuant 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 sold 4.5 million shares of our common stock, for net proceeds of
$66.2 million, under the ATM Equity Sales Agreement with Merrill. During the year ended December 31, 2007, we sold
1.1 million shares of our common stock for net proceeds of $14.7 million under our Equity Shelf Program with UBS
Securities, pursuant to which sales are made by means of ordinary brokers' transaction on the New York Stock
Exchange.
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 Incentive Plan for an
aggregate exercise price of $576,000.
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 following underwriting 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 following underwriting 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 following underwriting 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 purpose of computing ratios relating to equity measures, the Series B
Preferred Stock has been included in equity.
During the year ended December 31, 2006, 1,598,500 shares of the Company’s common stock were issued
through the ATM Programs and Equity Shelf Program with UBS Securities, totaling net proceeds of $20.9 million.
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.
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).” As a result of the de-
designation of interest rate swaps as cash flow hedges during the quarter ended December 31, 2008, unrealized gains
and losses in our interest rate swaps impact our GAAP income.
As a result of this mark-to-market accounting treatment, our book value and book value per share are likely to
fluctuate far more than if we used historical amortized cost accounting. As a result, comparisons with companies that
use historical cost accounting for some or all of their balance sheet may not be meaningful.
The table below shows unrealized gains and losses on the Investment Securities, available-for-sale equity
securities and interest rate swaps in our portfolio prior to de-designation.
Unrealized Gains and Losses
(dollars in thousands)
At December 31,
Unrealized gain
Unrealized loss
Net Unrealized (loss) gain
2008
$785,087
(532,857)
$252,230
2007
$379,348
(531,545)
($152,197)
2006
$112,596
(188,708)
($76,112)
2005
$ 5,027
(211,601)
($206,574)
2004
$ 23,021
(143,821)
($120,800)
51
Unrealized changes in the estimated net fair value of investment securities have one direct effect on our potential
earnings and dividends: positive 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 fair value of our investment 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, 2008, 2007 and 2006 was 6.4:1, 8.7:1 and 10.4:1, respectively. We
generally expect to maintain a ratio of debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this
range from time to time based upon various factors, including our management’s opinion of the level of risk of our assets
and liabilities, our liquidity position, our level of unused borrowing capacity and over-collateralization levels required by
lenders when we pledge assets to secure borrowings.
Our target debt-to-equity ratio is determined under our capital investment policy. Should our actual debt-to-
equity ratio increase above the target level due to asset acquisition or market value fluctuations in assets, we would 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 maintaining 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 lifetime coupon adjustment restrictions in our portfolio of investment securities by
entering into interest rate swaps. At December 31, 2008, we had entered into swap agreements with a total notional
amount of $17.6 billion. We agreed to pay a weighted average pay rate of 4.66% and receive a floating rate based on
one month LIBOR. At December 31, 2007, we 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.
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 principal 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 premium with assets we purchase at a discount. To date, the
aggregate premium exceeds the aggregate discount on our mortgage-backed securities. As a result, prepayments, which
result in the expensing of unamortized premium, will reduce our net income compared to what net income would be
absent such prepayments.
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 established 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.
Capital Resources
At December 31, 2008, we had no material commitments for capital expenditures.
52
Inflation
Virtually all of our assets and liabilities are financial in nature. As a result, interest rates and other factors drive
our performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation rates
or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our dividends 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, 2008 and 2007. 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, 2008 and 2007. Consequently, we met the
REIT income and asset test. We also met all REIT requirements regarding the ownership of our common stock and the
distribution of our net income. Therefore, for the years ended of December 31, 2008, 2007, and 2006, 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, 2008 and December 31, 2007, we were in
compliance with this requirement.
53
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates,
commodity prices and equity prices. The primary market risk to which we are exposed is interest rate risk, which is
highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic
and political considerations and other factors beyond our control. Changes in the general level of interest rates can affect
our net interest income, which is the difference between the interest income earned on interest-earning assets and the
interest expense incurred in connection with our interest-bearing liabilities, by affecting the spread between our interest-
earning assets and interest-bearing liabilities. Changes in the level of interest rates also can affect the value of our
Mortgage-Backed Securities and our ability to realize gains from the sale of these assets. We may utilize a variety of
financial instruments, including interest rate swaps, caps, floors, inverse floaters and other interest rate exchange
contracts, in order to limit the effects of interest rates on our operations. When we use these types of derivatives to
hedge the risk of interest-earning assets or interest-bearing liabilities, we may be subject to certain risks, including the
risk that losses on a hedge position will reduce the funds available for payments to holders of securities and that the
losses may exceed the amount we invested in the instruments.
Our profitability and the value of our portfolio (including interest rate swaps) may be adversely affected during
any period as a result of changing interest rates. The following table quantifies the potential changes in net interest
income, portfolio value should interest rates go up or down 25, 50 and 75 basis points, assuming the yield curves of the
rate shocks will be parallel to each other and the current yield curve. All changes in income and value are measured as
percentage changes from the projected net interest income and portfolio value at the base interest rate scenario. The base
interest rate scenario assumes interest rates at December 31, 2008 and various estimates regarding prepayment and all
activities are made at each level of rate shock. Actual results could differ significantly from these estimates.
Change in Interest Rate
Projected Percentage Change in
Net Interest Income
Projected Percentage Change in
Portfolio Value, with Effect of
Interest Rate Swaps
-75 Basis Points
-50 Basis Points
-25 Basis Points
Base Interest Rate
+25 Basis Points
+50 Basis Points
+75 Basis Points
8.82%
5.19%
1.85%
-
(3.68%)
(7.62%)
(11.57%)
1.64%
1.58%
1.41%
-
0.74%
0.25%
(0.34%)
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and magnitude of the repricing of assets and
liabilities. We attempt to control risks associated with interest rate movements. Methods for evaluating interest rate risk
include an analysis of our interest rate sensitivity "gap", which is the difference between interest-earning assets and
interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the
amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities. A gap is considered
negative when the amount of interest-rate sensitive liabilities exceeds interest-rate sensitive assets. During a period of
rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to
result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result
in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because
different types of assets and liabilities with the same or similar maturities may react differently to changes in overall
market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an
institution were perfectly matched in each maturity category.
54
The following table sets forth the estimated maturity or repricing of our interest-earning assets and interest-
bearing liabilities at December 31, 2008. The amounts of assets and liabilities shown within a particular period were
determined in accordance with the contractual terms of the assets and liabilities, except adjustable-rate loans, and
securities are included in the period in which their interest rates are first scheduled to adjust and not in the period in
which they mature and does include the effect of the interest rate swaps. The interest rate sensitivity of our assets and
liabilities in the table could vary substantially based on actual prepayment experience.
Rate Sensitive Assets:
Investment Securities
(Principal)
Cash Equivalents
Reverse Repurchase Agreements
Total Rate Sensitive Assets
Rate Sensitive Liabilities:
Repurchase Agreements,
with the effect of swaps
Within 3
Months
$ 5,722,108
909,353
562,119
7,193,580
4-12 Months
More than 1
Year to 3
Years
(dollars in thousands)
3 Years and
Over
$ 2,294,550
-
$ 3,196,475
-
$43,295,539
-
2,294,550
3,196,475
43,295,539
Total
$54,508,672
909,353
562,119
55,980,144
21,369,035
5,880,891
12,243,050
7,181,909
46,674,885
Interest rate sensitivity gap
($14,175,455)
($3,586,341)
($9,046,575)
$36,113,630
$9,305,259
Cumulative rate sensitivity gap
($14,175,455)
($17,761,796)
($26,808,371)
$ 9,305,259
Cumulative interest rate
sensitivity gap as a percentage
of total rate-sensitive assets
(26%)
(33%)
(49%)
17%
Our analysis of risks is based on management’s experience, estimates, models and assumptions. These analyses
rely on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or
implementation of investment decisions by our management may produce results that differ significantly from the
estimates and assumptions used in our models and the projected results shown in the above tables and in this report.
These analyses contain certain forward-looking statements and are subject to the safe harbor statement set forth under the
heading, “Special Note Regarding Forward-Looking Statements.”
55
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our financial statements and the related notes, together with the Report of Independent Registered Public
Accounting Firm thereon, are set forth on pages F-1 through F-22 of this Form 10-K.
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A CONTROLS AND PROCEDURES
Our management, including our Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”),
reviewed and evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as
defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act) as of the end of the period covered by this
annual report. Based on that review and evaluation, the CEO and CFO have concluded that our current disclosure
controls and procedures, as designed and implemented, (1) were effective in ensuring that information regarding the
Company and its subsidiaries is made known to our management, including our CEO and CFO, by our employees, as
appropriate to allow timely decisions regarding required disclosure and (2) were effective in providing reasonable
assurance that information the Company must disclose in its periodic reports under the Securities Exchange Act is
recorded, processed, summarized and reported within the time periods prescribed by the SEC’s rules and forms.
Management Report On Internal Control Over Financial Reporting
Dated: February 25, 2009
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 executive 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 financial reporting and the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles and includes those policies and procedures that:
(cid:129)
(cid:129)
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
(cid:129)
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 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, 2008. In making this assessment, the Company’s management used criteria set forth by the
56
Committee of Sponsoring 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, 2008, the
Company’s internal control 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, 2008 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. This report appears on page F-1 of this
annual report on Form 10-K.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10
DIRECTORS , EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 as to our directors is incorporated herein by reference to the proxy
statement to be filed with the SEC within 120 days after December 31, 2008. The information regarding our executive
officers required by Item 10 appears in Part I of this Form 10-K. The information required by Item 10 as to our
compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference to the proxy
statement to be filed with the SEC within 120 days after December 31, 2008.
We have adopted a Code of Business Conduct and Ethics within the meaning of Item 406(b) of Regulation S-K.
This Code of Business Conduct and Ethics applies to our principal executive officer, principal financial officer and
principal accounting officer. This Code of Business Conduct and Ethics is publicly available on our website at
www.annaly.com. If we make substantive amendments to this Code of Business Conduct and Ethics or grant any waiver,
including any implicit waiver, we intend to disclose these events on our website.
ITEM 11
EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference to the proxy statement to be filed with
the SEC within 120 days after December 31, 2008.
ITEM 12
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by Item 12 is incorporated herein by reference to the proxy statement to be filed with
the SEC within 120 days after December 31, 2008.
ITEM 13
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Item 13 is incorporated herein by reference to the proxy statement to be filed with
the SEC within 120 days after December 31, 2008.
ITEM 14
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is incorporated herein by reference to the proxy statement to be filed with
the SEC within 120 days after December 31, 2008.
57
ITEM 15
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
PART IV
(a) Documents filed as part of this report:
1.
2.
Financial Statements.
Schedules to Financial Statements:
All financial statement schedules not included have been omitted because they are either inapplicable or the
information required is provided in our Financial Statements and Notes thereto, included in Part II, Item 8, of this
Annual Report on Form 10-K.
3.
Exhibits:
Exhibit
Number
Exhibit Description
EXHIBIT INDEX
3.1
3.2
3.3
3.4
3.5
3.6
3.7
4.1
4.2
4.3
4.4
Articles of Amendment and Restatement of the Articles of Incorporation of the Registrant
(incorporated by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-
11 (Registration No. 333-32913) filed with the Securities and Exchange Commission on
August 5, 1997).
Articles of Amendment of the Articles of Incorporation of the Registrant (incorporated by
reference to Exhibit 3.1 of the Registrant’s Registration Statement on Form S-3 (Registration
Statement 333-74618) filed with the Securities and Exchange Commission on June 12, 2002).
Articles of Amendment of the Articles of Incorporation of the Registrant (incorporated by
reference to Exhibit 3.1 of the Registrant's Form 8-K (filed with the Securities and Exchange
Commission on August 3, 2006).
Form of Articles Supplementary designating the Registrant’s 7.875% Series A Cumulative
Redeemable Preferred Stock, liquidation preference $25.00 per share (incorporated by
reference to Exhibit 3.3 to the Registrant’s 8-A filed April 1, 2004).
Articles Supplementary of the Registrant’s designating an additional 2,750,000 shares of the
Company’s 7.875% Series A Cumulative Redeemable Preferred Stock, as filed with the State
Department of Assessments and Taxation of Maryland on October 15, 2004 (incorporated by
reference to Exhibit 3.2 to the Registrant’s 8-K filed October 4, 2004).
Articles Supplementary designating the Registrant’s 6% Series B Cumulative Convertible
Preferred Stock, liquidation preference $25.00 per share (incorporated by reference to Exhibit
3.1 to the Registrant’s 8-K filed April 10, 2006).
Bylaws of the Registrant, as amended (incorporated by reference to Exhibit 3.3 to the
Registrant’s Registration Statement on Form S-11 (Registration No. 333-32913) filed with the
Securities and Exchange Commission on August 5, 1997).
Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to Amendment
No. 1 to the Registrant’s Registration Statement on Form S-11 (Registration No. 333-32913)
filed with the Securities and Exchange Commission on September 17, 1997).
Specimen Preferred Stock Certificate (incorporated by reference to Exhibit 4.2 to the
Registrant’s Registration Statement on Form S-3 (Registration No. 333-74618) filed with the
Securities and Exchange Commission on December 5, 2001).
Specimen Series A Preferred Stock Certificate (incorporated by reference to Exhibit 4.1 of the
Registrant's Registration Statement on Form 8-A filed with the SEC on April 1, 2004).
Specimen Series B Preferred Stock Certificate (incorporated by reference to Exhibit 4.1 to the
Registrant’s Form 8K filed with the Securities and Exchange Commission on April 10, 2006).
58
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
12.1
23.1
31.1
31.2
32.1
32.2
Long-Term Stock Incentive Plan (incorporated by reference to Exhibit 10.3 to the Registrant’s
Registration Statement on Form S-11 (Registration No. 333-32913) filed with the Securities
and Exchange Commission on August 5, 1997).*
Form of Master Repurchase Agreement (incorporated by reference to Exhibit 10.7 to the
Registrant’s Registration Statement on Form S-11 (Registration No. 333-32913) filed with the
Securities and Exchange Commission on August 5, 1997).
Amended and Restated Employment Agreement, effective as of June 4, 2004, between the
Registrant and Michael A.J. Farrell (incorporated by reference to Exhibit 10.3 of the
Registrant’s Form 10-K filed with the Securities and Exchange Commission on March 10,
2005).*
Amended and Restated Employment Agreement, dated as of February 25, 2008, between the
Registrant and Wellington J. Denahan.*
Amended and Restated Employment Agreement, effective as of June 4, 2004,between the
Registrant and Kathryn F. Fagan (incorporated by reference to Exhibit 10.5 of the Registrant’s
Form 10-K filed with the Securities and Exchange Commission on March 10, 2005).*
Amended and Restated Employment Agreement, effective as of June 4, 2004, between the
Registrant and James P. Fortescue (incorporated by reference to Exhibit 10.7 of the Registrant’s
Form 10-K filed with the Securities and Exchange Commission on March 10, 2005).*
Amended and Restated Employment Agreement, dated as of January 23, 2006, between the
Registrant and Jeremy Diamond (incorporated by reference to Exhibit 10.7 for Diamond of the
Registrant’s Form 10-K filed with the Securities and Exchange Commission on March 13,
2006).*
Amended and Restated Employment Agreement, dated as of January 23, 2006, between the
Registrant and Ronald D. Kazel. Diamond (incorporated by reference to Exhibit 10.7 for Kazel
of the Registrant’s Form 10-K filed with the Securities and Exchange Commission on March
13, 2006).*
Amended and Restated Employment Agreement, dated as of April 21, 2006, between the
Registrant and Rose-Marie Lyght (incorporated by reference to Exhibit 10.9 of the Registrant’s
Form 10-Q filed with the Securities and Exchange Commission on May 9, 2006).*
Amended and Restated Employment Agreement, effective as of June 4, 2004, between the
Registrant and Kristopher R. Konrad (incorporated by reference to Exhibit 10.11 of the
Registrant’s Form 10-K filed with the Securities and Exchange Commission on March 10,
2005).*
Amended and Restated Employment Agreement, dated January 23, 2006, between the
Registrant and R. Nicholas Singh. Diamond (incorporated by reference to Exhibit 10.7 for
Singh of the Registrant’s Form 10-K filed with the Securities and Exchange Commission on
March 13, 2006).*
Computation of ratio of earnings to combined fixed charges and preferred stock dividends.
Consent of Independent Registered Public Accounting Firm.
Certification of Michael A.J. Farrell, Chairman, Chief Executive Officer, and President of the
Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
Certification of Kathryn F. Fagan, Chief Financial Officer and Treasurer of the Registrant,
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
Certification of Michael A.J. Farrell, Chairman, Chief Executive Officer, and President of the
Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Certification of Kathryn F. Fagan, Chief Financial Officer and Treasurer of the Registrant,
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
*
Exhibits to this Form 10-K.
Exhibit Numbers 10.1 and 10.3-10.11 are management contracts or compensatory plans required to be filed as
59
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2008 and 2007:
Consolidated Statements of Financial Condition
Consolidated Statements of Operations and Comprehensive Income (Loss)
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Page
F-1
F-2
F-3
F-4
F-5
F-7
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, 2008 and 2007, 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, 2008. We also have audited the
Company's internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control —
Integrated Framework issued by the Committee 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 financial 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 examining, 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 evaluating 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
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 (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 financial 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, 2008 and 2007, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2008, 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, 2008, based on the criteria established in Internal Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
/s/ Deloitte & Touche LLP
New York, New York
February 25, 2009
F-1
Part I
Item1. Financial Statements
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2008 AND 2007
(dollars in thousands, except for share data)
ASSETS
Cash and cash equivalents
Reverse repurchase agreements with affiliate
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 and dividends receivable
Receivable from Prime Broker
Receivable for advisory and service fees
Intangible for customer relationships, net
Goodwill
Other assets
December 31, 2008
December 31, 2007
$ 909,353
562,119
55,046,995
598,945
52,795
-
75,546
282,532
16,886
6,103
12,380
27,917
6,044
$ 103,960
-
52,879,528
253,915
64,754
11,675
276,737
271,996
-
3,598
9,842
22,966
4,543
Total assets
$57,597,615
$53,903,514
LIABILITIES AND 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 and other liabilities
Interest rate swaps, at fair value
$46,674,885
2,062,030
-
199,985
270,736
8,380
1,102,285
$46,046,560
1,677,131
32,835
257,608
136,618
36,688
398,096
Total liabilities
50,318,301
48,585,536
Minority interest in equity of consolidated affiliate
-
1,574
6.00% Series B Cumulative Convertible Preferred Stock:
4,600,000 shares authorized 3,963,525 and 4,600,000 shares issued
and outstanding respectively.
Commitments and contingencies (Note 13)
Stockholders’ Equity:
7.875% Series A Cumulative Redeemable Preferred Stock:
7,412,500 shares authorized, issued and outstanding
Common stock: par value $.01 per share; 987,987,500 shares
authorized, 541,475,366 and 401,822,703 issued and outstanding,
respectively
Additional paid-in capital
Accumulated other comprehensive income (loss)
Accumulated deficit
96,042
-
111,466
-
177,088
177,088
5,415
7,633,438
252,230
(884,899)
4,018
5,297,922
(152,197)
(121,893)
Total stockholders’ equity
7,183,272
5,204,938
Total liabilities, minority interest, Series B Cumulative Convertible
Preferred Stock and stockholders’ equity
$57,597,615
$53,903,514
See notes to consolidated financial statements.
F-2
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2008, 2007, AND 2006
(dollars in thousands, except per share amounts)
Interest income
Interest expense
Net interest income
Other (loss) income:
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
Unrealized loss on interest rate swaps
Total other (loss) income
Expenses:
Distribution fees
General and administrative expenses
Total expenses
For the Year
Ended
December 31,
2008
$3,115,428
1,888,912
1,226,516
For the Year
Ended
December 31,
2007
$2,355,447
1,926,465
428,982
For the Year
Ended
December 31,
2006
$1,221,882
1,055,013
166,869
27,891
10,713
-
9,695
2,713
(31,834)
(768,268)
(749,090)
1,589
103,622
105,211
22,028
19,062
2,096
19,147
91
(1,189)
-
61,235
3,647
62,666
66,313
22,351
(3,862)
10,674
3,994
-
(52,348)
-
(19,191)
3,444
40,063
43,507
Impairment of intangible for customer relationships
-
-
2,493
Income before income taxes and minority interest
372,215
423,904
101,678
Income taxes
Income before minority interest
Minority interest
Net income
Dividends on preferred stock
25,977
346,238
8,870
7,538
415,034
94,140
58
650
324
346,180
21,177
414,384
93,816
21,493
19,557
Net income available to common shareholders
$325,003
$392,891
$74,259
Net income available per share to common shareholders:
Basic
Diluted
Weighted average number of common shares outstanding:
Basic
Diluted
Net income
Other comprehensive gain (loss):
Unrealized gain on available-for-sale securities
Unrealized gain (loss) on interest rate swaps
Reclassification adjustment for net loss (gains)
included in net income
Other comprehensive income (loss)
Comprehensive income
See notes to consolidated financial statements.
$0.64
$0.64
$1.32
$1.31
$0.44
$0.44
507,024,596
297,488,394
167,666,631
507,024,596
306,263,766
167,746,387
$346,180
$414,384
$93,816
319,226
64,080
322,264
(378,380)
91,873
(6,404)
21,121
404,427
$750,607
(19,969)
(76,085)
$338,299
45,536
131,005
$224,821
F-3
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B
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2008, 2007, AND 2006
(dollars in thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income 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
(Gain) loss on sale of Investment Securities
Gain on termination of interest rate swaps
Stock option and long-term compensation expense
Unrealized loss on interest rate swaps
Net realized gain on trading investments
Unrealized depreciation (appreciation) on trading investments
Market value adjustment on long-term repurchase agreements
Loss on other-than-temporarily impaired securities
Impairment of intangibles
Increase in accrued interest receivable
Decrease (increase) in other assets
Purchase of trading securities
Proceeds from sale of trading securities
Purchase of trading securities sold, not yet purchased
Proceeds from securities sold, not yet purchased
Decrease (increase) in advisory and service fees receivable
(Decrease) Increase in interest payable
(Decrease) Increase in accrued expenses and other liabilities
Receivable from Prime Broker
Reduction of net assets in the fund
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
Purchase of equity securities
Purchase of reverse repurchase agreements
Investment to purchase subsidiary
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from repurchase agreements
Principal payments on repurchase agreements
Proceeds from exercise of stock options
Proceeds from 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 ATM programs
Minority interest
Dividends paid
Net cash provided by financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents, beginning of period
For the Year
Ended
December 31,
2008
For the Year
Ended
December 31,
2007
For the Year
Ended
December 31,
2006
$346,180
$414,384
$93,816
99,603
4,133
(3)
(10,713)
-
2,534
768,268
(12,578)
2,994
-
31,834
-
(8,405)
340
(13,048)
30,986
(22,290)
21,483
345
(57,623)
(28,867)
(16,886)
(28,704)
1,109,583
(25,281,183)
15,491,408
8,619,102
(500,000)
(26,283)
(562,119)
(12,628)
(2,271,703)
434,042,799
(433,414,474)
2,780
-
93,675
2,147,543
-
71,832
(1,574)
(975,068)
1,967,513
805,393
103,960
65,185
1,377
(11)
(19,062)
(2,096)
1,355
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(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
63,625
1,589
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3,862
(10,674)
1,285
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(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
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221,629
(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
(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
12,178
91,782
86,974
4,808
Cash and cash equivalents, end of period
909,353
$103,960
$91,782
Supplemental disclosure of cash flow information:
Interest paid
Taxes paid
$1,946,535
$18,866
$1,752,855
$10,272
$999,009
$7,242
F-5
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
Noncash investing activities:
Receivable for Investment Securities Sold
Payable for Investment Securities Purchased
See notes to consolidated financial statements.
$404,427
$270,736
$75,546
$2,062,030
($76,085)
$136,618
$276,737
$1,677,131
$131,005
$39,016
$200,535
$338,172
F-6
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Annaly Capital Management, Inc. (“Annaly” or the “Company”) was incorporated in Maryland on November 25,
1996. The Company commenced its operations of purchasing and managing an investment portfolio of mortgage-backed
securities on February 18, 1997, upon receipt of the net proceeds from the private placement of equity capital, and
completed its initial public offering on October 14, 1997. The Company is a real estate investment trust (“REIT”) under
the Internal Revenue Code of 1986, as amended. Fixed Income Discount Advisory Company (“FIDAC”) is a registered
investment advisor and is a wholly owned taxable REIT subsidiary of the Company. On June 27, 2006, the Company
made a majority equity investment in an affiliated investment fund (the “Fund”), which is now wholly owned by the
Company. During the third quarter of 2008, the Company formed RCap Securities Inc. (“RCap”). RCap was granted
membership in the Financial Industry Regulatory Authority (“FINRA”) on January 26, 2009, and will operate as broker-
dealer. RCap is a wholly owned taxable REIT subsidiary of the Company. On October 31, 2008, the Company acquired
Merganser Capital Management, Inc. (“Merganser”). Merganser is a registered investment advisor and is a wholly
owned taxable REIT subsidiary of the Company.
A summary of the Company’s significant accounting policies follows:
The consolidated financial statements include the accounts of the Company, FIDAC, Merganser, RCap and the
Fund. All intercompany balances and transactions have been eliminated. The minority shareholder’s interest in the
earnings of 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 cash held in money market
funds on an overnight basis.
Reverse Repurchase Agreements - The Company may invest its daily available cash balances via reverse
repurchase agreements to provide additional yield on its assets. These investments will typically be recorded as short
term investments and will generally mature daily. Reverse repurchase agreements are recorded at cost and are
collateralized by mortgage-backed securities pledged by the counterparty to the agreement.
Mortgage-Backed Securities and Agency Debentures - The Company invests primarily in mortgage pass-through
certificates, collateralized mortgage obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans, and certificates guaranteed by the Government National Mortgage
Association (“GNMA”) (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 debentures 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 (“SFAS 115”), 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 time to time, sell any of its Investment Securities as part of its
overall management of its portfolio. Accordingly, the Company classifies 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
independent sources, with unrealized gains and losses excluded from earnings and reported as a separate component of
stockholders’ equity. The Company’s investment in Chimera Investment Corporation (“Chimera”) is accounted for as
available-for-sale equity securities under the provisions of SFAS 115.
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. Based on the guidance provided by Financial
Accounting Standards Board (“FASB”) Staff Position Nos. FAS 115-1 and FAS 124-1, The Meaning of Other-Than-
Temporary-Impairment and its Application to Certain Investments, 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
F-7
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 $31.8 million, $1.2 million and $52.3 million during the years ended December 31,
2008, 2007 and 2006, respectively.
SFAS No. 107, Disclosure About Fair Value of Financial Instruments, 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,
available-for-sale equity securities, trading securities, trading securities sold, not yet purchased, receivable from prime
broker and interest rate swaps is equal to their carrying value presented in the consolidated statements of financial
condition. The estimated fair value of cash and cash equivalents, reverse repurchase agreements, accrued interest and
dividends receivable, receivable for securities sold, receivable for advisory and service fees, repurchase agreements with
maturities shorter than one year, payable for Investment Securities purchased, dividends payable, accounts payable and
other liabilities, and accrued interest payable, generally approximates cost as of December 31, 2008 due to the short term
nature of these financial instruments. The estimated fair value of long term structured repurchase agreements is reflected
in the Footnote 7 to the financial statements.
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 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. Dividend income on available-for-sale equity securities is recorded on the ex-
date on an accrual basis.
Investment Securities transactions are recorded on the trade date. Purchases of newly-issued securities are recorded
when all significant uncertainties regarding the characteristics of the securities are removed, generally shortly before
settlement date. Realized gains and losses on sales of Investment Securities are determined on the specific identification
method.
Derivative Financial Instruments/Hedging Activity - Prior to the fourth quarter of 2008, the Company designated
interest rate swaps as cash flow hedges, whereby the swaps were recorded at fair value on the balance sheet as assets and
liabilities with any changes in fair value recorded in accumulated other comprehensive income (“OCI”). In a cash flow
hedge, a swap would exactly match the pricing date of the relevant repurchase agreement. Through the end of the third
quarter the Company continued to be able to effectively match the swaps with the repurchase agreements therefore
entering into effective hedge transactions. However, due to the volatility of the credit markets, it is no longer practical to
match the pricing dates of both the swaps and the repurchase agreements.
As a result, the Company voluntarily discontinued hedge accounting in the fourth quarter of 2008 through a
combination of de-designating previously defined hedge relationships and not designating new contracts as cash flow
hedges. The de-designation of cash flow hedges was done in accordance with SFAS 133, Accounting for Derivative
Instruments and Hedging Activities, and Derivatives Implementation Group “DIG” Issue Nos. G3, G17, G18 & G20,
which generally requires that the net derivative gain or loss related to the discontinued cash flow hedge should continue
to be reported in accumulated OCI, unless it is probable that the forecasted transaction will not occur by the end of the
originally specified time period or within an additional two-month period of time thereafter. The Company continues to
hold repurchase agreements in excess of swap contracts and has no indication that interest payments on the hedged
repurchase agreements are in jeopardy of discontinuing. Therefore, the deferred losses related to these derivatives that
have been de-designated will not be recognized immediately and will remain in OCI. These losses are expected to be
reclassified into earnings during the contractual terms of the swap agreements starting as of October 1, 2008. Changes in
the unrealized gains or losses on the interest rate swaps subsequent to September 30, 2008 were reflected in the
Company’s statement of operations and comprehensive income.
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 and agency debentures issued by the FHLB, FHLMC and
FNMA. The payment of principal and interest on the FHLMC, and FNMA Mortgage-Backed Securities are guaranteed
by those respective agencies, and the payment of principal and interest on the GNMA Mortgage-Backed Securities are
F-8
backed by the full faith and credit of the U.S. government. Principal and interest on agency debentures are guaranteed
by the agency issuing the debenture. All of the Company’s Investment Securities have an actual or implied “AAA”
rating. The Company faces credit risk on the portions of its portfolio which are not Investment Securities.
Market Risk - The current situation in the 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 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 marketability of all
fixed income securities, including government mortgage securities. 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 additional financing, the Company could be forced to sell its Investment Securities at
an inopportune time when prices are depressed. Even with the current situation in the mortgage sector, the Company
does not anticipate having difficulty converting its assets to cash or extending financing terms due to the fact that its
Investment Securities have an actual or implied “AAA” rating and principal payment is guaranteed by FHLMC, FNMA,
or GNMA.
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. The realized and unrealized 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 transactions 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
(“Series B Preferred Stock”) on the consolidated statements of financial condition using the guidance in SEC Accounting
Series Release No. 268, Presentation in Financial Statements of “Redeemable Preferred Stocks,” and Emerging Issues
Task Force (“EITF”) Topic D-98, Classification and Measurement of Redeemable Securities. The Series B Preferred
Stock contains fundamental change provisions that allow the holder to redeem the Series B 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 Preferred Stock as temporary equity in the accompanying consolidated statements of financial
condition.
The Company has analyzed whether the embedded conversion option should be bifurcated under the guidance in
SFAS 133 and EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company’s Own Stock, and has determined that bifurcation is not necessary.
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 each of its subsidiaries, FIDAC, Merganser, and RCap have made
separate joint election to treat the subsidiaries as a taxable REIT subsidiary. As such, each of the taxable REIT
subsidiaries are taxable as a domestic C corporation and subject to federal, state, and local income taxes based upon its
taxable income. The affiliated investment fund is a partnership and the income and expense flow through to the
Company.
Use of Estimates - The preparation of the consolidated financial statements in conformity with 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.
F-9
Goodwill and Intangible assets - The Company’s acquisitions of FIDAC and Merganser were 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 costs of FIDAC and
Merganser were 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 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 10.5
year weighted average time period. During the years ended December 31, 2008 and 2007, there were no impairment
losses. During the year ended December 31, 2006 the Company recognized $2.5 million in impairment losses on
intangible assets relating to customer relationships.
Stock Based Compensation - The Company accounts for its stock-based compensation in accordance with SFAS No.
123 (Revised 2004) – Share-Based Payment (“SFAS 123R”). SFAS 123R requires the Company to measure and
recognize in the consolidated financial statements the compensation cost relating to share-based payment transactions.
The compensation cost should be reassessed based on the fair value of the equity instruments issued.
The Company recognizes 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.
Recent Accounting Pronouncements - In February 2007, the FASB issued SFAS No. 159, The Fair Value 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 was effective for the Company commencing January 1, 2008. The Company
did not elect the fair value option for any of its financial instruments.
In April 2007, the FASB issued FASB Staff Position FIN 39-1 (“FSP FIN 39-1”) which modifies FASB
Interpretation No. 39, Offsetting of Amounts relating to Certain Contracts (“FIN 39”). FSP FIN 39-1 addresses whether
a reporting entity that is party to a master netting arrangement can offset fair value amounts recognized for the right to
reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts
recognized for derivative instruments that have been offset under the same master netting arrangement in accordance
with FIN 39. Upon adoption of this guidance, a reporting entity is permitted to change its accounting policy to offset or
not offset fair value amounts recognized for derivative instruments under master netting arrangements. This guidance
was effective for the Company on January 1, 2008. The implementation did not have an effect on the financial
statements of the Company.
In February 2008, FASB issued FASB Staff Position No. FAS 140-3 Accounting for Transfers of Financial Assets
and Repurchase Financing Transactions, (“FSP FAS 140-3”). FSP FAS 140-3 addresses whether transactions 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, or are required to be considered “linked” transactions and
may be considered derivatives under SFAS 133. FSP FAS 140-3 requires purchases and subsequent financing through
repurchase agreements be considered linked transactions unless all of the following conditions apply: (1) the initial
purchase and the use of repurchase agreements to finance the purchase are not contractually contingent upon each other;
(2) the repurchase financing entered into between the parties provides full recourse to the transferee and the repurchase
price is fixed; (3) the financial assets are readily obtainable in the market; and (4) the financial instrument and the
repurchase agreement are not coterminous. This FSP is effective for the Company on January 1, 2009. The Company is
currently evaluating FSP FAS 140-3 but does not expect its application to have a significant impact on its financial
reporting.
In March 2008, the FASB issued SFAS No. 161 (“SFAS 161”), Disclosures about Derivative Instruments and
Hedging Activities, and an amendment of FASB Statement No. 133. SFAS 161 attempts to improve the transparency of
financial reporting by providing additional information about how derivative and hedging activities affect an entity’s
financial position, financial performance and cash flows. This statement changes the disclosure requirements for
derivative instruments and hedging activities by requiring enhanced disclosure about (1) how and why an entity uses
derivative instruments, (2) how derivative instruments and related hedged items are accounted for under SFAS Statement
F-10
133 and its related interpretations, and (3) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows. To meet these objectives, SFAS 161 requires qualitative
disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts and of
gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative
agreements. This disclosure framework is intended to better convey the purpose of derivative use in terms of the risks
that an entity is intending to manage. SFAS 161 is effective for the Company on January 1, 2009. The Company
expects that adoption of SFAS 161 will increase footnote disclosure to comply with the disclosure requirements for
financial statements issued after January 1, 2009.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines
fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value
measurements. SFAS 157 requires companies to disclose the fair value of their 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 category of assets and
liabilities. SFAS 157 was adopted by the Company on January 1, 2008. SFAS 157 did not have an impact on the
manner in which the Company estimates fair value, but it requires additional disclosure, which is included in Note 5.
On October 10, 2008, FASB issued FASB Staff Position (FSP) 157-3, Determining the Fair Value of a Financial
Asset When the Market for That Asset Is Not Active (“FSP 157-3”), in response to the deterioration of the credit markets.
This FSP provides guidance clarifying how SFAS 157 should be applied when valuing securities in markets that are not
active. The guidance provides an illustrative example that applies the objectives and framework of SFAS 157, utilizing
management’s internal cash flow and discount rate assumptions when relevant observable data does not exist. It further
clarifies how observable market information and market quotes should be considered when measuring fair value in an
inactive market. It reaffirms the notion of fair value as an exit price as of the measurement date and that fair value
analysis is a transactional process and should not be broadly applied to a group of assets. FSP 157-3 is effective upon
issuance including prior periods for which financial statements have not been issued. FSP 157-3 does not have a
material effect on the fair value of its assets as the Company intends to continue to hold assets that can be valued via
level 1 and level 2 criteria, as defined under SFAS 157.
F-11
2.
MORTGAGE-BACKED SECURITIES
The following tables present the Company’s available-for-sale Mortgage-Backed Securities portfolio as of
December 31, 2008 and 2007 which were carried at their fair value:
December 31, 2008
Mortgage-Backed
Securities, gross
Unamortized discount
Unamortized premium
Amortized cost
Gross unrealized gains
Gross unrealized losses
Federal Home Loan
Mortgage
Corporation
Federal National
Mortgage
Association
Government
National Mortgage
Association
Total Mortgage-
Backed Securities
(dollars in thousands)
$19,898,430
(26,733)
212,354
20,084,051
297,366
(71,195)
$32,749,123
(36,647)
381,433
33,093,909
468,824
(123,443)
$1,259,118
(787)
25,694
1,284,025
14,606
(1,148)
$53,906,671
(64,167)
619,481
54,461,985
780,796
(195,786)
Estimated fair value
$20,310,222
Amortized Cost
Adjustable rate
$19,509,017
$33,439,290
Gross Unrealized
Gain
$1,297,483
Gross Unrealized
Loss
$55,046,995
Estimated Fair
Value
(dollars in thousands)
$287,249
($178,599)
$19,617,667
Fixed rate
Total
34,952,968
493,547
(17,187)
35,429,328
$54,461,985
$780,796
($195,786)
$55,046,995
December 31, 2007
Mortgage-Backed
Securities, gross
Unamortized discount
Unamortized premium
Amortized cost
Gross unrealized gains
Gross unrealized losses
Federal Home Loan
Mortgage
Corporation
Federal National
Mortgage
Association
Government
National Mortgage
Association
Total Mortgage-
Backed Securities
(dollars in thousands)
$19,789,792
(30,679)
136,780
19,895,893
141,248
(52,623)
$32,155,740
(45,496)
266,357
32,376,601
224,795
(75,949)
$367,066
(506)
2,678
369,238
2,229
(1,904)
$52,312,598
(76,681)
405,815
52,641,732
368,272
(130,476)
Estimated fair value
$19,984,518
Amortized Cost
$15,361,031
37,280,701
$32,525,447
Gross Unrealized
Gain
$369,563
Gross Unrealized
Loss
$52,879,528
Estimated Fair
Value
(dollars in thousands)
$96,310
271,962
($76,853)
$15,380,488
(53,623)
37,499,040
$52,641,732
$368,272
($130,476)
$52,879,528
F-12
Adjustable rate
Fixed rate
Total
Actual maturities of Mortgage-Backed Securities are generally shorter than stated contractual maturities
because actual maturities of Mortgage-Backed Securities are affected by the contractual lives of the underlying
mortgages, periodic payments of principal, and prepayments of principal. The following table summarizes the
Company’s Mortgage-Backed Securities on December 31, 2008 and 2007, according to their estimated weighted-average
life classifications:
Weighted-Average Life
Fair Value
Amortized
Cost
(dollars in thousands)
Fair Value
Amortized
Cost
December 31, 2008
December 31, 2007
Less than one year
Greater than one year and less than five years
Greater than or equal to five years
$ 4,147,646
37,494,312
13,405,037
$ 4,181,282
37,102,706
13,177,997
$ 324,495
35,772,813
16,782,220
$ 326,754
35,586,721
16,728,257
Total
$55,046,995
$54,461,985
$52,879,528
$52,641,732
The weighted-average lives of the Mortgage-Backed Securities at December 31, 2008 and 2007 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. The actual weighted average lives of the Mortgage-Backed Securities could be longer or shorter than
estimated.
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, 2008 and December 31, 2007.
Unrealized Loss Position For:
(dollars in thousands)
Less than 12 Months
12 Months or More
Total
Estimated
Fair Value
Unrealized
Losses
Estimated
Fair Value
Unrealized
Losses
Estimated
Fair Value
Unrealized
Losses
$4,631,897
($65,790)
$4,267,448
($129,996)
$8,899,345
($195,786)
$7,593,443
($62,594)
$5,340,667
($67,882)
$12,934,110
($130,476)
December 31,
2008
December 31,
2007
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 by the government
agency which created them.
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 10.0% at
December 31, 2008 and 9.9% at December 31, 2007.
During the year ended December 31, 2008, the Company sold $15.1 billion of Mortgage-Backed Securities,
resulting in a realized gain of $10.7 million. During the year ended December 31, 2007, the Company sold $4.9 billion
of Mortgage-Backed Securities, resulting in a realized gain of $19.1 million.
F-13
3.
AVAILABLE FOR SALE EQUITY SECURITIES
All of the available-for-sale equity securities are shares of Chimera and are reported at fair value. The
Company owns approximately 15.3 million shares of Chimera at a carrying value of $52.8 million. Although the
Company has the intent and ability to retain the investment in Chimera indefinitely, the Company determined based on
the FSP FAS–115 that an other-than-temporarily impaired charge of $31.8 million was appropriate in the third quarter of
2008 and is reflected in the income statement for the year ended of December 31, 2008. This determination is based on
the extent of the decline in value of the Chimera shares combined with the current state of the mortgage and credit
markets. At December 31, 2008, the investment in Chimera had an unrealized gain of $4.0 million.
4.
REVERSE REPURCHASE AGREEMENT
During the first quarter of 2008, the Company began using excess cash to do reverse repurchase agreements. At
December 31, 2008, the Company had lent $562.1 million to Chimera in an overnight reverse repurchase agreement.
This amount is included at the principal amount which approximates fair value in the Company’s Statement of Financial
Condition. The interest rate at December 31, 2008 was an at the market rate of 1.43%. The average rate on all reverse
repurchase agreements for the year was 2.99%. The collateral for this loan is mortgage-backed securities with a fair
value of $680.8 million.
5.
RECEIVABLE FROM PRIME BROKER
These net assets of the investment fund owned by the Company are subject to English bankruptcy law,
which governs the administration of Lehman Brothers International (Europe) (“LBIE”), as well as the law of New York,
which governs the contractual documents. Until the Company’s contractual documents with LBIE are terminated, the
value of the assets and liabilities in its account with LBIE will continue to fluctuate based on market movements. The
Company does not intend to terminate these contractual documents until LBIE's administrators have clarified the
consequences of doing so. The Company has not received notice from LBIE's administrators that LBIE has terminated
the documents. LBIE’s administrators have advised the Company that they can provide no additional information about
the account at this time. As a result, the Company has recorded a receivable from LBIE based on the fair value of its
account with LBIE as of September 15, 2008 of $16.9 million, which is the date of the last statement it received from
LBIE on the account’s assets and liabilities. The Company can provide no assurance, however, that it will recover all or
any portion of these assets following completion of LBIE's administration (and any subsequent liquidation).
6.
FAIR VALUE MEASUREMENTS
SFAS 157 defines fair value, establishes a framework for measuring fair value, establishes a three-level
valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value
measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability
as of the measurement date. The three levels are defined as follow:
Level 1– inputs to the valuation methodology are quoted prices (unadjusted) for identical assets and liabilities in
active markets.
Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active
markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the
full term of the financial instrument.
Level 3 – inputs to the valuation methodology are unobservable and significant to overall fair value.
Available for sale equity securities, trading securities, and trading securities sold, not yet purchased are valued
based on quoted prices (unadjusted) in an active market. Investment Securities and interest rate swaps are valued using
quoted prices for similar assets and dealer quotes. The dealer will incorporate common market pricing methods,
including a spread measurement to the Treasury curve or interest rate swap curve as well as underlying characteristics of
the particular security including coupon, periodic and life caps, rate reset period and expected life of the security.
Management reviews all prices used to ensure that current market conditions are represented. This review includes
F-14
comparisons of similar market transactions and comparisons to a pricing model. The Company’s financial assets and
liabilities carried at fair value on a recurring basis are valued as follows:
Assets:
Mortgage-Backed Securities
Agency debentures
Available for sale equity securities
Liabilities:
Interest rate swaps
Level 1
Level 2
(dollars in thousands)
Level 3
-
-
$52,795
$55,046,995
598,945
-
-
1,102,285
-
-
-
-
The classification of assets and liabilities by level remains unchanged at December 31, 2008, when compared to
the previous quarter.
7.
REPURCHASE AGREEMENTS
The Company had outstanding $46.7 billion and $46.0 billion of repurchase agreements with weighted average
borrowing rates of 4.08% and 4.76%, after giving effect to the Company’s interest rate swaps, and weighted average
remaining maturities of 238 days and 234 days as of December 31, 2008 and December 31, 2007, respectively.
Investment Securities pledged as collateral under these repurchase agreements and interest rate swaps had an estimated
fair value of $51.8 billion at December 31, 2008 and $48.3 billion at December 31, 2007.
At December 31, 2008 and 2007, the repurchase agreements had the following remaining maturities:
Within 30 days
30 to 59 days
60 to 89 days
90 to 119 days
Over 120 days
Total
December 31, 2008
December 31, 2007
(dollars in thousands)
$32,025,186
5,205,352
209,673
254,674
8,980,000
$46,674,885
$34,940,600
4,005,960
300,000
-
6,800,000
$46,046,560
The Company did not have an amount at risk greater than 10% of the equity of the Company with any
counterparty as of December 31, 2008 or December 31, 2007.
The Company has entered into repurchase agreements which provide the counterparty with the right to call the
balance prior to maturity date. These repurchase agreements totaled $8.1 billion and the fair value of the option to call
was ($574.3 million) at December 31, 2008. The repurchase agreements totaled $6.4 billion and the fair value of the
option to call was ($176.7 million) at December 31, 2007. Management has determined that the call option is not
required to be bifurcated under the provisions of SFAS 133 as it is deemed clearly and closely related to the debt
instrument, therefore the fair value of the option is not recorded in the consolidated financial statements.
8.
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 December 31, 2008, 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.
F-15
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.
The table below presents information about the Company’s swaps outstanding at December 31, 2008 December
31, 2007.
Notional Amount
(dollars in thousands)
Weighted
Average Pay Rate
Weighted Average
Receive Rate
Net Estimated Fair
Value/Carrying Value
(dollars in thousands)
December 31, 2008
$17,615,750
December 31, 2007
$16,243,500
4.66%
5.03%
1.18%
5.06%
($1,102,285)
($398,096)
9.
PREFERRED STOCK AND COMMON STOCK
(A) Common Stock Issuances
On May 13, 2008 the Company entered into an underwriting agreement pursuant to which it sold 69,000,000
shares of its common stock for net proceeds following underwriting expenses of approximately $1.1 billion. This
transaction settled on May 19, 2008.
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 approximately $1.1 billion. This
transaction settled on January 29, 2008.
During the year ended December 31, 2008, the Company raised $93.7 million by issuing 5.8 million shares,
through the Direct Purchase and Dividend Reinvestment Program.
During the year ended December 31, 2008, 300,000 options were exercised under the Long-Term Stock
Incentive Plan, or Incentive Plan, for an aggregate exercise price of $2.8 million.
On August 3, 2006, the Company entered into an ATM Equity Offering(sm) Sales Agreement with Merrill Lynch
& Co. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, relating to the sale of shares of the Company’s 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, 2008, 588,000 shares of the
Company’s common stock were issued pursuant to this program, totaling $11.5 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 the Company’s 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, 2008, 3.8 million shares of the Company’s common stock were issued pursuant to this program,
totaling $60.3 million in net proceeds.
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 approximately $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 agreement 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 Purchase and Dividend Reinvestment Program.
F-16
During the year ended December 31, 2007, 56,000 options were exercised under the Long-Term Stock
Incentive Plan, or Incentive Plan, for an aggregate exercise price of $576,000.
During the year ended December 31, 2007, 4.5 million shares of the Company’s common stock were issued
pursuant to the Company’s ATM Equity Offering(sm) Sales Agreement with Merrill Lynch, totaling $66.2 million in net
proceeds. During the year ended December 31, 2007, 1.1 million shares of its common stock were issued pursuant to the
Company’s ATM Equity Sales Agreement with UBS Securities, totaling $14.7 million in net proceeds.
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 following underwriting expenses of approximately $476.7 million. This
transaction settled on August 22, 2006.
On April 6, 2006, the Company entered into an underwriting agreement pursuant to which it sold 39,215,000
shares of its common stock for net proceeds following underwriting 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 following underwriting expenses of approximately
$111.5 million. Both of these transactions settled on April 12, 2006.
During the year ended December 31, 2006, 500,000 shares of the Company’s common stock were issued
pursuant to the Company’s ATM Equity Offering(sm) Sales Agreement with Merrill Lynch, totaling $6.7 million in net
proceeds. During the year ended December 31, 2006, no shares of the Company’s common stock were issued pursuant
to the Company’s ATM Equity Sales Agreement with UBS Securities.
During the year ended December 31, 2006, 1.1 million shares of the Company’s common stock were issued
through the Equity Shelf Program, totaling net proceeds of $14.2 million. During the year ended December 31, 2006,
22,160 options were exercised under the Incentive Plan for an aggregate exercise price of $183,000.
(B) Preferred Stock
At December 31, 2008 and 2007, the Company had issued and outstanding 7,412,500 shares of Series A
Cumulative Redeemable Preferred Stock (“Series A 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 Preferred 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 earlier 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 parity 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, certain 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, 2008, the Company had declared and paid all
required quarterly dividends on the Series A Preferred Stock.
At December 31, 2008, the Company had issued and outstanding 3,963,525 shares of Series B Cumulative
Convertible Preferred Stock (“Series B 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 at a rate of 6% per year on the $25.00 liquidation preference before the common stock is entitled to
receive any dividends.
At December 31, 2007, the Company had issued and outstanding 4,600,000 shares of Series B Preferred Stock.
F-17
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. At December 31,
2008, the conversion ratio was 2.0650 shares of common stock per $25 liquidation preference. Commencing April 5,
2011, the Company 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 convertible into
common shares at the option of the Series B preferred shareholder at anytime 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, 2008, the Company had declared and paid all required quarterly dividends on the Series B
Preferred Stock. During the year ended December 31, 2008, 636,475 shares of Series B Preferred Stock were converted
into 1,268,081 shares of common stock. During the year ended December 31, 2007, no shares of Series B Preferred
Stock were converted.
(C) Distributions to Shareholders
During the year ended December 31, 2008, the Company declared dividends to common shareholders totaling
$1.1 billion or $2.08 per share, of which $270.7 million were paid to shareholders on January 29, 2009. During the year
ended December 31, 2008, the Company declared dividends to Series A Preferred shareholders totaling approximately
$14.6 million or $1.97 per share, and Series B shareholders totaling approximately $6.6 million or $1.50 per share,
which were paid to shareholders on December 31, 2008.
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 totaling $5.0 million or $1.08 per share.
10.
NET INCOME PER COMMON SHARE
The following table presents a reconciliation of the net income and shares used in calculating basic and diluted
earnings per share for the years ended December 31, 2008, 2007, and 2006.
Net income
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
For the years ended
(amounts in thousands)
December 31,
2007
December 31,
2006
$414,384
21,493
392,891
$93,816
19,557
74,259
December 31,
2008
$346,180
21,177
325,003
-
6,900
-
F-18
Net income, as adjusted
$325,003
$399,791
$74,259
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
507,025
297,488
167,667
-
8,775
79
507,025
306,263
167,746
Options to purchase 5.2 million shares of common stock, were outstanding and considered anti-dilutive as their
exercise price and option expense exceeded the average stock price for the year ended December 31, 2008. The Series B
Cumulative Convertible Preferred Stock was anti-dilutive for the years ended December 31, 2008 and 2006.
11.
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 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 period
Options exercisable at the end of the period
December 31, 2008
December 31, 2007
For the year ended
Number of
Shares
3,437,267
2,043,700
(293,243)
(2,550)
(5,010)
5,180,164
Weighted
Average
Exercise
Price
$15.23
16.02
9.59
15.84
20.67
$15.87
Number of
Shares
2,984,995
687,250
(55,738)
(174,240)
(5,000)
3,437,267
Weighted
Average
Exercise Price
$15.10
15.69
10.34
16.06
20.35
$15.23
2,119,964
$16.36
1,286,004
$14.98
The weighted average remaining contractual term was approximately 7.6 years for stock options outstanding
and approximately 5.6 years for stock options exercisable as of December 31, 2008. As of December 31, 2008, there
was approximately $9.3 million of total unrecognized compensation cost related to nonvested share-based compensation
awards. That cost is expected to be recognized over a weighted average period of 3.3 years.
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 compensation 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, 2008, 3,360 of these restricted shares were unvested and subject to
forfeiture.
F-19
12.
INCOME TAXES
As a REIT, the Company is not subject to federal income tax on earnings 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, 2008, FIDAC recorded $4.0 million of income tax expense for income
attributable to FIDAC, and the portion of earnings retained based on Code Section 162(m) limitations. During the year
ended December 31, 2008, Merganser recorded $94,000 of income tax expense for income attributable to Merganser.
During the year ended December 31, 2008, the Company recorded $21.9 million of income tax expense for a portion of
earnings retained based on Section 162(m) limitations. The effective tax rate was 53% for the year ended December 31,
2008.
During the year ended December 31, 2007, the Company did not record 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, 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 Section 162(m) limitations. The effective tax rate was 45% for the
year ended December 31, 2006.
The Company’s effective tax rate was 53%, 51%, and 45% for the years ended December 31, 2008, 2007, and
2006, respectively. These rates differed from the federal statutory rate as a result of state and local taxes and permanent
difference pertaining to employee remuneration as discussed above.
The statutory combined federal, state, and city corporate tax rate is 45%. This amount is applied to the amount
of estimated REIT taxable income retained (if any, and only up to 10% of ordinary income as all capital gain income is
distributed) and to taxable income earned at the taxable subsidiaries. Thus, as a REIT, the Company’s effective tax rate
is significantly less as it is allowed to deduct dividend distributions.
13.
LEASE COMMITMENTS AND CONTINGENCIES
The Company has a non-cancelable lease for office space, which commenced in May 2002 and expires in
December 2009. The Company’s aggregate future minimum lease payments total $532,000.
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 management, the ultimate disposition of these matters will not have a material effect on the
Company’s consolidated financial statements and therefore no accrual is required as of December 31, 2008.
Merganser’s prior owner may receive additional consideration as an earn-out during 2010, 2011 and 2012 if
Merganser meets specific performance goals under the merger agreement. The Company cannot currently calculate how
much consideration will be paid under the earn-out provisions because the payment amount will vary depending upon
whether and the extent to which Merganser achieves specific performance goals. Any amounts paid under this provision
will be recorded as additional goodwill.
F-20
14.
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 control. Changes in the general level of interest rates can affect net interest income,
which is the difference between the interest income earned on interest-earning assets and the interest expense incurred in
connection with 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 realize gains from the sale of these assets. A decline in the value of the Investment Securities
pledged as collateral for borrowings under repurchase agreements could result in the counterparties demanding
additional collateral pledges or liquidation of some of the existing collateral to reduce borrowing levels. Liquidation of
collateral at losses could have an adverse accounting impact, as discussed in Note 1.
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 Securities by
entering into interest rate agreements such as interest rate caps and interest rate swaps. As of December 31, 2008, the
Company entered into interest rate swaps to pay a fixed rate and receive a floating rate of interest, with a total notional
amount of $17.6 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 Mortgage-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.
15.
RELATED PARTY TRANSACTIONS
At December 31, 2008, the Company had lent $562.1 million to Chimera in an overnight reverse repurchase
agreement. This amount is included at the principal amount which approximates fair value in the Company’s Statement
of Financial Condition. The interest rate at December 31, 2008 was an at the market rate of 1.43%. The average rate for
the year was 2.96%. The collateral for this loan is mortgage-backed securities with a fair value of $680.8 million.
On October 29, 2008, the Company purchased approximately 11.7 million shares of Chimera common stock at
a price of $2.25 per share for aggregate proceeds of approximately $26.3 million. Chimera is managed by FIDAC, and
the Company owns approximately 8.6% of Chimera’s common stock.
16.
MERGANSER CAPITAL MANAGEMENT, INC.
The Company acquired Merganser pursuant to a merger which was consummated before the opening of
business on October 31, 2008. The merger was accounted for using the purchase method of accounting in accordance
with SFAS No. 141, and the purchase price was allocated to the acquired assets and liabilities based on their fair values,
with the excess allocated to goodwill. The purchase price was paid in cash and Company’s stock. Accordingly, the
consolidated balance sheet as of December 31, 2008 includes the effects of the merger and the Company’s application of
the purchase method of accounting. Additionally, the consolidated statements of operations and of cash flows for the
year ended December 31, 2008 include the results of the Merganser for the period from October 31, 2008 to December
31, 2008.
F-21
A summary of the fair values of the net assets acquired is as follows:
Receivable for advisory fees and services
Other assets
Customer relationships
Trade name
Goodwill
Favorable leasehold interest
Payables
Total purchase price
17.
SUBSEQUENT EVENTS
(dollars in thousands)
$2,849
654
6,600
330
4,488
1,310
(1,169)
$15,062
Pursuant to NASD Rule 1014, the application of RCap was granted membership in FINRA on January 26,
2009. RCap is expected to commence operations as a broker dealer during the first quarter of 2009.
F-22
18.
SUMMARIZED QUARTERLY (UNAUDITED)
The following is a presentation of the quarterly results of operations for the year ended December 31, 2008.
Interest income
Interest expense
Net interest income
March 31,
2008
June 30,
2008
September 30,
2008
December 31,
2008
(dollars in thousands, except per share data)
$791,128
$773,359
$810,659
$740,282
537,606
442,251
458,250
450,805
253,522
331,108
352,409
289,477
Other income:
Investment advisory and service fees
Gain (loss) on sale of Investment Securities
Income (loss) from trading securities
Dividend income from available-for-sale equity
securities
Loss on other-than-temporarily impaired securities
Unrealized loss on interest rate swaps
6,598
9,417
1,854
941
-
-
6,406
2,830
2,180
580
-
-
7,663
(1,066)
7,671
580
(31,834)
-
7,224
(468)
(2,010)
612
-
(768,268)
Total other income
18,810
11,996
(16,986)
(762,910)
Expenses:
Distribution fees
General and administrative expenses
Total expenses
633
23,995
24,628
370
27,215
27,585
299
25,455
25,754
287
26,957
27,244
Income (loss) before income taxes and minority
interest
247,704
315,519
309,669
(500,677)
Income taxes
4,610
7,527
7,538
6,302
Income (loss) before minority interest
243,094
307,992
302,131
(506,979)
Minority interest
Net Income
58
243,036
-
307,992
-
302,131
-
(506,979)
Dividends on preferred stock
5,373
5,334
5,335
5,135
Net income (loss) available (related) 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
$237,663
$302,658
$296,796
($512,114)
443,812,432
503,758,079
538,706,131
541,099,147
452,967,457
512,678,975
547,882,488
541,099,147
$0.54
$0.53
$0.60
$0.59
$0.55
$0.54
($0.95)
($0.95)
F-23
The following is a presentation of the quarterly results of operations for the year ended December 31, 2007.
Interest income
Interest expense
Net interest income
March 31,
2007
June 30,
2007
September 30, December 31,
2007
2007
(dollars in thousands, except per share data)
$449,564
$556,262
$628,696
$720,925
380,164
468,748
519,118
558,435
69,400
87,514
109,578
162,490
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
5,562
6,145
67
3,429
-
(491)
5,366
7,293
-
243
-
(698)
5,464
3,795
2,029
8,288
-
-
5,636
1,829
-
7,187
91
-
Total other income
14,712
12,204
19,576
14,743
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
904
12,886
13,790
861
12,272
13,133
1,100
17,334
18,434
782
20,174
20,956
70,322
86,585
110,720
156,277
2,604
67,718
839
85,746
2,327
108,393
3,100
153,177
286
13
106
245
67,432
85,733
108,287
152,932
Dividends on preferred stock
5,373
5,373
5,373
5,374
Net income available to common
shareholders
$62,059
$80,360
$102,914
$147,558
Weighted average number of basic common shares
outstanding
Weighted average number of diluted common shares
outstanding
217,490,205
264,990,422
315,969,814
389,410,812
225,928,127
273,578,836
324,614,534
398,247,632
Net income available to common
shareholders per average common share:
Basic
Diluted
$0.29
$0.28
$0.30
$0.30
$0.33
$0.32
$0.38
$0.37
F-24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of New York, State
of New York.
Date: February 25, 2009
By:
ANNALY CAPITAL MANAGEMENT, INC.
/s/ Michael A. J. Farrell
Michael A. J. Farrell
Chairman, Chief Executive Officer, and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on the date indicated.
Signature
/s/ KEVIN P. BRADY
Kevin P. Brady
/s/ KATHRYN F. FAGAN
Kathryn F. Fagan
/s/ MICHAEL A.J. FARRELL
Michael A. J. Farrell
/s/ JONATHAN D. GREEN
Jonathan D. Green
Title
Director
Chief Financial Officer and Treasurer
(principal financial and accounting
officer)
Date
February 25 , 2009
February 25, 2009
Chairman of the Board, Chief Executive
Officer, President and Director (principal
executive officer)
Director
February 25, 2009
February 25, 2009
/s/ MICHAEL E. HAYLON
Director
February 25, 2009
Michael E. Haylon
/s/ JOHN A. LAMBIASE
John A. Lambiase
Director
February 25, 2009
/s/ E. WAYNE NORDBERG
Director
February 25, 2009
E. Wayne Nordberg
/s/ DONNELL A. SEGALAS
Director
February 25, 2009
Donnell A. Segalas
/s/ WELLINGTON DENAHAN-NORRIS
Wellington Denahan-Norris
Vice Chairman of the Board, Chief
Investment Officer, Chief Operating
Officer and Director
February 25, 2009
I
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statements No. 333-151069 and No. 333-134404
on Form S-3 of our report dated February 25, 2009, relating to the consolidated financial statements of Annaly Capital
Management, Inc., and the effectiveness of Annaly Capital Management, Inc.’s internal control over financial reporting,
appearing in this Annual Report on Form 10-K of Annaly Capital Management, Inc. for the year ended December 31,
2008.
/s/ Deloitte & Touche LLP
New York, New York
February 25, 2009
II
CERTIFICATIONS
Exhibit 31.1
I, Michael A.J. Farrell, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Annaly Capital Management, Inc.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for
the registrant and have:
a. Designed such disclosure controls and procedures or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being
prepared;
b. Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, 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;
c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this report based on such evaluation;
and
d. Disclosed in this report any change in the registrant’s internal control over financial
reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s
fourth fiscal quarter in the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal control over financial
reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the
registrant’s board of directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design or operation of internal
controls over financial reporting which are reasonably likely to adversely affect the
registrant’s ability to record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who
have a significant role in the registrant’s internal control over financial reporting.
Date: February 25, 2009
/s/ Michael A.J. Farrell
Michael A.J. Farrell
Chairman, Chief Executive Officer, and President (Principal Executive Officer)
III
CERTIFICATIONS
Exhibit 31.2
I, Kathryn F. Fagan, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Annaly Capital Management, Inc.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for
the registrant and have:
e. Designed such disclosure controls and procedures or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being
prepared;
f. Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, 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;
g. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this report based on such evaluation;
and
h. Disclosed in this report any change in the registrant’s internal control over financial
reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s
fourth fiscal quarter in the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal control over financial
reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the
registrant’s board of directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design or operation of internal
controls over financial reporting which are reasonably likely to adversely affect the registrant’s
ability to record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: February 25, 2009
/s/ Kathryn F. Fagan
Kathryn F. Fagan
Chief Financial Officer and Treasurer (Principal Financial Officer)
IV
Exhibit 32.1
ANNALY CAPITAL MANAGEMENT, INC.
1211 AVENUE OF THE AMERICAS
SUITE 2902
NEW YORK, NEW YORK 10036
CERTIFICATION
PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002, 10 U.S.C. SECTION 1350
In connection with the annual report on Form 10-K of Annaly Capital Management, Inc. (the “Company”) for the period
ended December 31, 2008 to be filed with Securities and Exchange Commission on or about the date hereof (the
“Report”), I, Michael A.J. Farrell, Chairman of the Board, President, and Chief Executive Officer of the Company,
certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that:
1.
2.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934; and
The information contained in the Report fairly presents, in all material respects, the financial condition and
results of operations of the Company at the dates of, and for the periods covered by, the Report.
It is not intended that this statement be deemed to be filed for purposes of the Securities Exchange Act of 1934.
/s/ Michael A.J. Farrell
Michael A.J. Farrell
Chairman of the Board of Directors, Chief
Executive Officer and President
February 25, 2009
V
ANNALY CAPITAL MANAGEMENT, INC.
1211 AVENUE OF THE AMERICAS
SUITE 2902
NEW YORK, NEW YORK 10036
CERTIFICATION
PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002, 10 U.S.C. SECTION 1350
In connection with the annual report on Form 10-K of Annaly Capital Management, Inc. (the “Company”) for the period
ended December 31, 2008 to be filed Kathryn F. Fagan, Chief Financial Officer of the Company, certify, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that:
1.
2.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934; and
The information contained in the Report fairly presents, in all material respects, the financial condition and
results of operations of the Company at the dates of, and for the periods covered by, the Report.
It is not intended that this statement be deemed to be filed for purposes of the Securities Exchange Act of 1934.
/s/ Kathryn F. Fagan
Kathryn F. Fagan
Chief Financial Officer and Treasurer
February 25, 2009
VI
Ratio of Earnings To Combined Fixed Charges And Preferred Stock Dividends
The following table sets forth the calculation of our ratio of earnings to combined fixed charges and preferred stock
dividends for the periods shown (dollars in thousands):
Exhibit 12.1
For the Year
Ended
December 31,
2008
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
Net (loss) income before taxes
Add: fixed charges (interest expense)
$ 372,157
1,888,912
$ 423,254
1,926,465
$ 101,354
1,055,013
$ 1,497
568,560
$253,050
270,116
Earnings as adjusted
$2,261,069 $2,349,719
$1,156,367
$570,057
$523,166
Fixed charges (interest expense) +
preferred stock dividend
$1,910,089 $1,947,958
$1,074,570
$583,153
$277,861
Ratio of earnings to combined fixed
charges and preferred stock dividends
1.18X
1.21X
1.08X
0.98X
1.88X
VII
SHARE PERFORMANCE GRAPH
The following graph and table set forth certain information comparing the yearly percentage change in cumulative total
return on our Common Stock to the cumulative total return of the Standard & Poor’s Composite-500 stock 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, 2003 to December 31, 2008 and assumes the reinvest-
ment of dividends. The graph and table assume that $100 was invested in our Common Stock and the two other
indices on December 31, 2003. Upon written request we will provide stockholders with a list of the REITs included
in the BBG REIT Index.
Comparison of Cumulative Total Return
175
150
125
100
75
50
25
0
12/31/03
12/31/04
12/30/05
12/29/06
12/31/07
12/31/08
Annaly
S&P 500 Index
BBG REIT Index
Annaly
S&P 500 Index
BBG REIT Index
12/31/03
100
100
100
12/31/04
117
111
127
12/30/05
76
116
108
12/29/06
95
134
125
12/31/07
124
141
83
12/31/08
123
92
65
The information in the share performance graph and table has been obtained from sources believed to be reliable,
but neither its accuracy nor its completeness can be guaranteed. The historical information set forth above is not
necessarily indicative of future performance. Accordingly, we do 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 us with the Securities and Exchange Commission, except
to the extent that we specifically incorporate such share performance graph and table reference.
CORPORATE OFFICERS
Michael A. J. Farrell
Chairman of the Board,
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, Secretary &
Chief Compliance Officer
BOARD OF DIRECTORS
Michael A. J. Farrell
Chairman of the Board,
President &
Chief Executive Officer
Wellington J. Denahan-Norris
Vice Chairman,
Chief Investment Officer &
Chief Operating Officer
Kevin P. Brady
Vice President, Tax & Accounting
Thomson Reuters Corporation
Jonathan D. Green
Vice Chairman
Rockefeller Group International, Inc.
ADDITIONAL INFORMATION
James P. Fortescue
Managing Director,
Head of Liabilities
Kristopher R. Konrad
Managing Director,
Co-Head of Portfolio Management
Rose-Marie Lyght
Managing Director,
Co-Head of Portfolio Management
Jeremy Diamond
Managing Director
Ronald D. Kazel
Managing Director
Michael Haylon
Former Executive Vice President &
Chief Financial Officer
Phoenix Companies
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.
The Company has included as exhibits to its Annual Report on Form 10-K for
fiscal year ended 2008 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 2008, 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.
CORPORATE INFORMATION
CORPORATE HEADQUARTERS
Annaly Capital Management, Inc.
1211 Avenue of the Americas
Suite 2902
New York, NY 10036
LEGAL COUNSEL
K&L Gates LLP
1601 K Street, N.W.
Washington, D.C. 20006
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
TwoWorld Financial Center
New York, NY 10281
STOCK TRANSFER AGENT
Shareholder inquiries concerning
dividend payments, lost certificates,
change of address:
BNY Mellon Shareowner Services
480 Washington Boulevard
Jersey City, NJ 07310
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
Friday, May 29, 2009 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 2008 Form 10-K may be
obtained by writing the Secretary, by
calling the investor relations hotline
at 1–888–8ANNALY, or by visiting
our website at www.annaly.com.
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ANNALY CAPITAL MANAGEMENT, INC.
1211 AVENUE OF THE AMERICAS
SUITE 2902
NEW YORK, NEW YORK 10036
1-888-8ANNALY
WWW.ANNALY.COM