ANNALY CAPITAL MANAGEMENT, INC. REPORTS 2nd QUARTER 2017 RESULTS

NEW YORK—(BUSINESS WIRE)—August 2, 2017 -- Annaly Capital Management, Inc. (NYSE: NLY) (the “Company” or “Annaly”) today announced its financial results for the quarter ended June 30, 2017.

·	GAAP net income was $14.5 million, ($0.01) loss per average common share

·	Core earnings (excluding PAA) were $332.6 million, $0.30 per average common share

·	GAAP return on average equity was 0.46% and core return on average equity (excluding PAA) was 10.54%

·	Book value per common share of $11.19

·	Economic leverage increased modestly to 6.4x as compared to 6.1x at March 31, 2017 and unchanged from December 31, 2016

·	Declared common stock dividend of $0.30 per share for the 15th consecutive fiscal quarter

·	Year-to-date annualized economic return of 11.3%

·	Successfully executed a $1.5 billion combination common and preferred stock capital raise

·	Announced redemption of 7.875% Series A Cumulative Redeemable Preferred Stock, lowering the economic cost of preferred capital by 30 bps

·	Increased stock ownership commitments from CEO, CIO, CLO, CCO and CFO to be achieved solely with open market purchases

·	Establishment of relationships with dedicated third party strategic partners across our four businesses, including Bayview Asset Management through the sale of Pingora Holdings; as well as with Pearlmark Real Estate Partners, through the acquisition of LP and GP interests in a Pearlmark fund

“The second quarter of 2017 was another strong and stable reporting period for Annaly,” commented Kevin Keyes, Chief Executive Officer and President.  “Amidst a relatively favorable investment backdrop we delivered core earnings (excluding PAA) equal to the $0.30 dividend we have now distributed to our shareholders for the 15th consecutive quarter.  We have also recently made several complementary strategic and organizational announcements including: selling Pingora Holdings to Bayview Asset Management, initiating a new joint venture in the MSR asset class with a premier Sovereign Wealth Fund, beginning a Commercial Real Estate partnership, hiring several senior hires to our investment teams and voluntarily increasing the stock purchase commitments by all of our Named Executive Officers.

“Also, subsequent to the end of the quarter, we opportunistically raised over $1.5 billion in two public offerings, executing the fourth largest overnight block trade in the entire US market this year and completing the largest non-rated preferred offering ever,” Mr. Keyes continued.  “These offerings, as well as the announced redemption of our Series A Preferred, are accretive to shareholder value, enhance our liquidity position, efficiently reduce our cost of capital and further position us to capitalize on the numerous growth opportunities for our diversified platform. The strong demand for these sizeable and attractively priced offerings is recognition of our market leadership and the direct result of our comprehensive investor outreach effort, which has successfully broadened and diversified our shareholder base.”

 

The following table summarizes certain key performance indicators as of and for the quarters ended June 30, 2017, March 31, 2017, and June 30, 2016:

 

 

		June 30, 2017				March 31, 2017				June 30, 2016
Book value per common share		$	11.19			$	11.23			$	11.50
Economic leverage at period-end (1)		6.4:1				6.1:1				6.1:1
GAAP net income (loss) per average common share (2)		$	(0.01	)		$	0.41			$	(0.32	)
Core earnings (excluding PAA) per average common share *(2)(3)		$	0.30			$	0.31			$	0.29
Core earnings per average common share *(2)(3)		$	0.23			$	0.29			$	0.19
PAA cost (benefit) per average common share		$	0.07			$	0.02			$	0.10
Annualized return (loss) on average equity			0.46	%			13.97	%			(9.60	%)
Annualized core return on average equity (excluding PAA) *			10.54	%			10.66	%			9.73	%
Average yield on interest earning assets (4)			2.58	%			2.74	%			2.48	%
Average yield on interest earning assets (excluding PAA) *(4)			2.93	%			2.83	%			2.95	%
Net interest margin (5)			1.23	%			1.47	%			1.15	%
Net interest margin (excluding PAA) *(5)			1.53	%			1.55	%			1.54	%
Net interest spread			0.84	%			1.15	%			0.80	%
Net interest spread (excluding PAA) *			1.19	%			1.24	%			1.27	%

 

 

This news release and our public documents to which we refer contain or incorporate by reference certain forward-looking statements which are based on various assumptions (some of which are beyond our control) and may be identified by reference to a future period or periods or by the use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “anticipate,” “continue,” “think,” or similar terms or variations on those terms or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, changes in interest rates; changes in the yield curve; changes in prepayment rates; the availability of mortgage-backed securities and other securities for purchase; the availability of financing and, if available, the terms of any financings; changes in the market value of our assets; changes in business conditions and the general economy; our ability to grow our commercial business; our ability to grow our residential mortgage credit business; credit risks related to our investments in credit risk transfer securities, residential mortgage-backed securities and related residential mortgage credit assets, commercial real estate assets and corporate debt; risks related to investments in mortgage servicing rights and ownership of a servicer; our ability to consummate any contemplated investment opportunities; changes in government regulations affecting our business; our ability to maintain our qualification as a REIT for U.S. federal income tax purposes; and our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended. For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in our most recent Annual Report on Form 10-K and any subsequent Quarterly Reports on Form 10-Q. We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements, except as required by law.

Annaly is a leading diversified capital manager that invests in and finances residential and commercial assets. Annaly’s principal business objective is to generate net income for distribution to its stockholders through capital preservation, prudent selection of investments, and continuous management of its portfolio. Annaly has elected to be taxed as a real estate investment trust, or REIT, for federal income tax purposes. Annaly is externally managed by Annaly Management Company LLC. Additional information on the company can be found at www.annaly.com.

 

The Company prepares a supplemental investor presentation and a financial summary for the benefit of its shareholders. Both the Second Quarter 2017 Investor Presentation and the Second Quarter 2017 Financial Summary can be found at the Company’s website (www.annaly.com) in the Investors section under Investor Presentations.

 

The Company will hold the second quarter 2017 earnings conference call on August 3, 2017 at 10:00 a.m. Eastern Time. The number to call is 888-317-6003 for domestic calls and 412-317-6061 for international calls. The conference passcode is 8632226. There will also be an audio webcast of the call on www.annaly.com. The replay of the call will be available for one week following the conference call. The replay number is 877-344-7529 for domestic calls and 412-317-0088 for international calls and the conference passcode is 10110276. If you would like to be added to the e-mail distribution list, please visit www.annaly.com, click on Investors, then select Email Alerts and complete the email notification form.

 

 

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share data)
		June 30,				March 31,				December 31,				September 30,				June 30,
		2017				2017				2016(1)				2016				2016
		(Unaudited)				(Unaudited)								(Unaudited)				(Unaudited)
ASSETS
Cash and cash equivalents (2)		$	700,692			$	819,421			$	1,539,746			$	2,382,188			$	2,735,250
Investments, at fair value:
Agency mortgage-backed securities			73,963,998				72,708,490				75,589,873				73,476,105				64,862,992
Credit risk transfer securities			605,826				686,943				724,722				669,295				520,321
Non-Agency mortgage-backed securities			1,234,053				1,409,093				1,401,307				1,460,261				1,197,549
Residential mortgage loans (3)			779,685				682,416				342,289				310,148				-
Mortgage servicing rights			605,653				632,166				652,216				492,169				-
Commercial real estate debt investments (4)			3,972,560				4,102,613				4,321,739				4,319,077				4,361,972
Commercial real estate debt and preferred equity, held for investment (5)			928,181				985,091				970,505				1,070,197				1,137,971
Commercial loans held for sale, net			-				-				114,425				144,275				164,175
Investments in commercial real estate			474,510				462,760				474,567				500,027				504,605
Corporate debt			773,957				841,265				773,274				716,831				669,612
Interest rate swaps, at fair value (2)			10,472				19,195				68,194				113,253				146,285
Other derivatives, at fair value			154,004				196,935				171,266				87,921				137,490
Receivable for investments sold			9,784				354,126				51,461				493,839				697,943
Accrued interest and dividends receivable			263,217				266,887				270,400				260,583				227,225
Other assets			399,456				388,224				333,063				301,419				237,959
Goodwill			71,815				71,815				71,815				71,815				71,815
Intangible assets, net			28,715				31,517				34,184				39,903				43,306
Total assets		$	84,976,578			$	84,658,957			$	87,905,046			$	86,909,306			$	77,716,470
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Repurchase agreements		$	62,497,400			$	62,719,087			$	65,215,810			$	61,784,121			$	53,868,385
Other secured financing			3,785,543				3,876,150				3,884,708				3,804,742				3,588,326
Securitized debt of consolidated VIEs (6)			3,438,675				3,477,059				3,655,802				3,712,821				3,748,289
Participation sold			-				12,760				12,869				12,976				13,079
Mortgages payable			311,810				311,707				311,636				327,632				327,643
Interest rate swaps, at fair value (2)			614,589				572,419				1,443,765				2,919,492				3,208,986
Other derivatives, at fair value			99,380				52,496				86,437				73,445				154,017
Dividends payable			305,709				305,691				305,674				269,111				277,479
Payable for investments purchased			1,043,379				340,383				65,041				454,237				746,090
Accrued interest payable			185,720				182,478				163,013				173,320				159,435
Accounts payable and other liabilities			84,948				161,378				184,319				115,606				62,868
Total liabilities			72,367,153				72,011,608				75,329,074				73,647,503				66,154,597
Stockholders’ Equity:
7.875% Series A Cumulative Redeemable Preferred Stock: 7,412,500 authorized, issued and outstanding			177,088				177,088				177,088				177,088				177,088
7.625% Series C Cumulative Redeemable Preferred Stock 12,650,000 authorized, 12,000,000 issued and outstanding			290,514				290,514				290,514				290,514				290,514
7.50% Series D Cumulative Redeemable Preferred Stock: 18,400,000 authorized, issued and outstanding			445,457				445,457				445,457				445,457				445,457
7.625% Series E Cumulative Redeemable Preferred Stock: 11,500,000 authorized, issued and outstanding			287,500				287,500				287,500				287,500				-
Common stock, par value $0.01 per share, 1,945,437,500, 1,945,437,500, 1,945,437,500, 1,945,437,500 and 1,956,937,500 authorized, 1,019,027,880, 1,018,971,441, 1,018,913,249, 1,018,857,866 and 924,929,607 issued and outstanding, respectively			10,190				10,190				10,189				10,189				9,249
Additional paid-in capital			15,581,760				15,580,038				15,579,342				15,578,677				14,575,426
Accumulated other comprehensive income (loss)			(850,767	)			(1,126,091	)			(1,085,893	)			1,119,677				1,117,046
Accumulated deficit			(3,339,228	)			(3,024,670	)			(3,136,017	)			(4,655,440	)			(5,061,565	)
Total stockholders’ equity			12,602,514				12,640,026				12,568,180				13,253,662				11,553,215
Noncontrolling interest			6,911				7,323				7,792				8,141				8,658
Total equity			12,609,425				12,647,349				12,575,972				13,261,803				11,561,873
Total liabilities and equity		$	84,976,578			$	84,658,957			$	87,905,046			$	86,909,306			$	77,716,470

 

 

 

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(dollars in thousands, except per share data)
		For the quarters ended
		June 30,				March 31,				December 31,				September 30,				June 30,
		2017				2017				2016				2016				2016
Net interest income:
Interest income		$	537,426			$	587,727			$	807,022			$	558,668			$	457,118
Interest expense			222,281				198,425				183,396				174,154				152,755
Net interest income			315,145				389,302				623,626				384,514				304,363
Realized and unrealized gains (losses):
Realized gains (losses) on interest rate swaps(1)			(96,470	)			(104,156	)			(103,872	)			(124,572	)			(130,762	)
Realized gains (losses) on termination of interest rate swaps			(58	)			-				(55,214	)			1,337				(60,064	)
Unrealized gains (losses) on interest rate swaps			(177,567	)			149,184				1,430,668				256,462				(373,220	)
Subtotal			(274,095	)			45,028				1,271,582				133,227				(564,046	)
Net gains (losses) on disposal of investments			(5,516	)			5,235				7,782				14,447				12,535
Net gains (losses) on trading assets			(14,423	)			319				(139,470	)			162,981				81,880
Net unrealized gains (losses) on investments measured at fair value through earnings			16,240				23,683				110,742				29,675				(54,154	)
Bargain purchase gain			-				-				-				72,576				-
Subtotal			(3,699	)			29,237				(20,946	)			279,679				40,261
Total realized and unrealized gains (losses)			(277,794	)			74,265				1,250,636				412,906				(523,785	)
Other income (loss)			30,865				31,646				30,918				29,271				(9,930	)
General and administrative expenses:
Compensation and management fee			38,938				39,262				39,845				38,709				36,048
Other general and administrative expenses			15,085				14,566				15,608				59,028				13,173
Total general and administrative expenses			54,023				53,828				55,453				97,737				49,221
Income (loss) before income taxes			14,193				441,385				1,849,727				728,954				(278,573	)
Income taxes			(329	)			977				1,244				(1,926	)			(76	)
Net income (loss)			14,522				440,408				1,848,483				730,880				(278,497	)
Net income (loss) attributable to noncontrolling interest			(102	)			(103	)			(87	)			(336	)			(385	)
Net income (loss) attributable to Annaly			14,624				440,511				1,848,570				731,216				(278,112	)
Dividends on preferred stock			23,473				23,473				23,473				22,803				17,992
Net income (loss) available (related) to common stockholders		$	(8,849	)		$	417,038			$	1,825,097			$	708,413			$	(296,104	)
Net income (loss) per share available (related) to common stockholders:
Basic		$	(0.01	)		$	0.41			$	1.79			$	0.70			$	(0.32	)
Diluted		$	(0.01	)		$	0.41			$	1.79			$	0.70			$	(0.32	)
Weighted average number of common shares outstanding:
Basic			1,019,000,817				1,018,942,746				1,018,886,380				1,007,607,893				924,887,316
Diluted			1,019,000,817				1,019,307,379				1,019,251,111				1,007,963,406				924,887,316
Net income (loss)		$	14,522			$	440,408			$	1,848,483			$	730,880			$	(278,497	)
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities			261,964				(59,615	)			(2,206,288	)			18,237				483,930
Reclassification adjustment for net (gains) losses included in net income (loss)			13,360				19,417				718				(15,606	)			(7,250	)
Other comprehensive income (loss)			275,324				(40,198	)			(2,205,570	)			2,631				476,680
Comprehensive income (loss)			289,846				400,210				(357,087	)			733,511				198,183
Comprehensive income (loss) attributable to noncontrolling interest			(102	)			(103	)			(87	)			(336	)			(385	)
Comprehensive income (loss) attributable to Annaly		$	289,948			$	400,313			$	(357,000	)		$	733,847			$	198,568

 

 

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(dollars in thousands, except per share data)
(Unaudited)
		For the six months ended
		June 30,				June 30,
		2017				2016
Net interest income:
Interest income		$	1,125,153			$	845,261
Interest expense			420,706				300,202
Net interest income			704,447				545,059
Realized and unrealized gains (losses):
Realized gains (losses) on interest rate swaps(1)			(200,626	)			(278,237	)
Realized gains (losses) on termination of interest rate swaps			(58	)			(60,064	)
Unrealized gains (losses) on interest rate swaps			(28,383	)			(1,404,940	)
Subtotal			(229,067	)			(1,743,241	)
Net gains (losses) on disposal of investments			(281	)			10,860
Net gains (losses) on trading assets			(14,104	)			207,069
Net unrealized gains (losses) on investments measured at fair value through earnings			39,923				(54,026	)
Subtotal			25,538				163,903
Total realized and unrealized gains (losses)			(203,529	)			(1,579,338	)
Other income (loss)			62,511				(16,045	)
General and administrative expenses:
Compensation and management fee			78,200				73,045
Other general and administrative expenses			29,651				24,121
Total general and administrative expenses			107,851				97,166
Income (loss) before income taxes			455,578				(1,147,490	)
Income taxes			648				(913	)
Net income (loss)			454,930				(1,146,577	)
Net income (loss) attributable to noncontrolling interest			(205	)			(547	)
Net income (loss) attributable to Annaly			455,135				(1,146,030	)
Dividends on preferred stock			46,946				35,984
Net income (loss) available (related) to common stockholders		$	408,189			$	(1,182,014	)
Net income (loss) per share available (related) to common stockholders:
Basic		$	0.40			$	(1.28	)
Diluted		$	0.40			$	(1.28	)
Weighted average number of common shares outstanding:
Basic			1,018,971,942				925,850,452
Diluted			1,019,357,697				925,850,452
Net income (loss)		$	454,930			$	(1,146,577	)
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities			202,349				1,501,637
Reclassification adjustment for net (gains) losses included in net income (loss)			32,777				(6,995	)
Other comprehensive income (loss)			235,126				1,494,642
Comprehensive income (loss)			690,056				348,065
Comprehensive income (loss) attributable to noncontrolling interest			(205	)			(547	)
Comprehensive income (loss) attributable to Annaly		$	690,261			$	348,612

The following table presents key metrics of the Company’s portfolio, liabilities and hedging positions, and performance as of and for the quarters ended June 30, 2017, March 31, 2017, and June 30, 2016:

		June 30, 2017				March 31, 2017				June 30, 2016
Portfolio Related Metrics:
Fixed-rate Residential Investment Securities as a percentage of total Residential Investment Securities			86	%			85	%			92	%
Adjustable-rate and floating-rate Residential Investment Securities as a percentage of total Residential Investment Securities			14	%			15	%			8	%
Weighted average experienced CPR for the period			10.9	%			11.5	%			12.7	%
Weighted average projected long-term CPR at period-end			10.6	%			10.0	%			13.0	%
Liabilities and Hedging Metrics:
Weighted average days to maturity on repurchase agreements outstanding at period-end			88				88				129
Hedge ratio (1)			67	%			63	%			49	%
Weighted average pay rate on interest rate swaps at period-end (2)			2.26	%			2.25	%			2.28	%
Weighted average receive rate on interest rate swaps at period-end (2)			1.28	%			1.15	%			0.74	%
Weighted average net rate on interest rate swaps at period-end (2)			0.98	%			1.10	%			1.54	%
Leverage at period-end (3)		5.6:1				5.6:1				5.3:1
Economic leverage at period-end (4)		6.4:1				6.1:1				6.1:1
Capital ratio at period-end			13.2	%			13.8	%			13.2	%
Performance Related Metrics:
Book value per common share		$	11.19			$	11.23			$	11.50
GAAP net income (loss) per average common share (5)		$	(0.01	)		$	0.41			$	(0.32	)
Core earnings (excluding PAA) per average common share *(5)		$	0.30			$	0.31			$	0.29
Core earnings per average common share *(5)		$	0.23			$	0.29			$	0.19
PAA cost (benefit) per average common share		$	0.07			$	0.02			$	0.10
Dividend declared per common share		$	0.30			$	0.30			$	0.30
Annualized dividend yield (6)			9.96	%			10.80	%			10.84	%
Annualized return (loss) on average equity			0.46	%			13.97	%			(9.60	%)
Annualized core return on average equity (excluding PAA) *			10.54	%			10.66	%			9.73	%
Net interest margin			1.23	%			1.47	%			1.15	%
Net interest margin (excluding PAA) *			1.53	%			1.55	%			1.54	%
Average yield on interest earning assets (7)			2.58	%			2.74	%			2.48	%
Average yield on interest earning assets (excluding PAA) *(7)			2.93	%			2.83	%			2.95	%
Average cost of interest bearing liabilities (8)			1.74	%			1.59	%			1.68	%
Net interest spread			0.84	%			1.15	%			0.80	%
Net interest spread (excluding PAA) *			1.19	%			1.24	%			1.27	%

 

To supplement its consolidated financial statements, which are prepared and presented in accordance with U.S. generally accepted accounting principles (“GAAP”), the Company provides the following non-GAAP measures.

·	core earnings and core earnings (excluding PAA);

·	core earnings and core earnings (excluding PAA) per average common share;

·	annualized core return on average equity (excluding PAA);

·	interest income (excluding PAA);

·	economic interest expense;

·	economic net interest income (excluding PAA);

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

·	net interest margin (excluding PAA) and

·	net interest spread (excluding PAA).

These measures should not be considered a substitute for, or superior to, financial measures computed in accordance with GAAP. While intended to offer a fuller understanding of the Company’s results and operations, non-GAAP financial measures also have limitations. For example, the Company may calculate its non-GAAP metrics, such as core earnings or the PAA, differently than its peers making comparative analysis difficult. Additionally, in the case of non-GAAP measures that exclude the PAA, the amount of amortization expense excluding the PAA is not necessarily representative of the amount of future periodic amortization nor is it indicative of the term over which the Company will amortize the remaining unamortized premium. Changes to actual and estimated prepayments will impact the timing and amount of premium amortization and, as such, both GAAP and non-GAAP results.

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

Amortization

In accordance with GAAP, the Company amortizes or accretes premiums or discounts into interest income for its Agency mortgage-backed securities, excluding interest-only securities, taking into account estimates of future principal prepayments in the calculation of the effective yield. The Company recalculates the effective yield as differences between anticipated and actual prepayments occur. Using third-party model and market information to project future cash flows and expected remaining lives of securities, the effective interest rate determined for each security is applied as if it had been in place from the date of the security’s acquisition. The amortized cost of the security is then adjusted to the amount that would have existed had the new effective yield been applied since the acquisition date. The adjustment to amortized cost is offset with a charge or credit to interest income. Changes in interest rates and other market factors will impact prepayment speed projections and the amount of premium amortization recognized in any given period.

The Company’s GAAP metrics include the unadjusted impact of amortization and accretion associated with this method. Certain of the Company’s non-GAAP metrics exclude the effect of the PAA, which quantifies the component of premium amortization representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term CPR.

The following table illustrates the impact of the PAA on premium amortization expense for the Company’s Residential Investment Securities portfolio for the quarters ended June 30, 2017, March 31, 2017, and June 30, 2016:

		For the quarters ended
		June 30, 2017				March 31, 2017				June 30, 2016
		(dollars in thousands)
Premium amortization expense (accretion)		$	251,084			$	203,634			$	265,475
Less: PAA cost (benefit)			72,700				17,870				85,583
Premium amortization expense exclusive of PAA		$	178,384			$	185,764			$	179,892

		For the quarters ended
		June 30, 2017				March 31, 2017				June 30, 2016
		(per average common share)
Premium amortization expense (accretion)		$	0.25			$	0.20			$	0.29
Less: PAA cost (benefit)			0.07				0.02				0.10
Premium amortization expense exclusive of PAA		$	0.18			$	0.18			$	0.19

 

Core earnings and core earnings (excluding PAA), core earnings and core earnings (excluding PAA) per average common share and annualized core return on average equity (excluding PAA)

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

The Company defines “core earnings”, a non-GAAP measure, as net income (loss) excluding gains or losses on disposals of investments and termination of interest rate swaps, unrealized gains or losses on interest rate swaps and investments measured at fair value through earnings, net gains and losses on trading assets, impairment losses, net income (loss) attributable to noncontrolling interest, corporate acquisition related expenses and certain other non-recurring gains or losses, and inclusive of TBA dollar roll income (a component of Net gains (losses) on trading assets) and realized amortization of MSRs (a component of net unrealized gains (losses) on investments measured at fair value through earnings). Core earnings (excluding PAA) excludes the premium amortization adjustment representing the cumulative impact on prior periods, but not the current period, of  quarter-over-quarter changes in estimated long-term prepayment speeds related to the Company’s Agency mortgage-backed securities.

The Company believes these non-GAAP measures provide management and investors with additional details regarding the Company’s underlying operating results and investment portfolio trends by (i) making adjustments to account for the disparate reporting of changes in fair value where certain instruments are reflected in GAAP net income (loss) while others are reflected in other comprehensive income (loss), and (ii) by excluding certain unrealized, non-cash or episodic components of GAAP net income (loss) in order to provide additional transparency into the operating performance of the Company’s portfolio. Annualized core return on average equity (excluding PAA), which is calculated by dividing core earnings (excluding PAA) over average stockholders’ equity, provides investors with additional detail on the core earnings generated by the Company’s invested equity capital.

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

 

*	Represents a non-GAAP financial measure.
(1)	Represents transaction costs incurred in connection with the Company’s acquisition of Hatteras Financial Corp.
(2)	Represents a component of Net gains (losses) on trading assets.
(3)	Represents the portion of changes in fair value that is attributable to the realization of estimated cash flows on the Company’s MSR portfolio and is reported as a component of Net unrealized gains (losses) on investments measured at fair value.
(4)	Net of dividends on preferred stock.

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From time to time, the Company enters into TBA forward contracts as an alternate means of investing in and financing Agency mortgage-backed securities. A TBA contract is an agreement to purchase or sell, for future delivery, an Agency mortgage-backed security with a specified issuer, term and coupon. A TBA dollar roll represents a transaction where TBA contracts with the same terms but different settlement dates are simultaneously bought and sold. The TBA contract settling in the later month typically prices at a discount to the earlier month contract with the difference in price commonly referred to as the “drop”. The drop is a reflection of the expected net interest income from an investment in similar Agency mortgage-backed securities, net of an implied financing cost, that would be foregone as a result of settling the contract in the later month rather than in the earlier month. The drop between the current settlement month price and the forward settlement month price occurs because in the TBA dollar roll market, the party providing the financing is the party that would retain all principal and interest payments accrued during the financing period. Accordingly, TBA dollar roll income generally represents the economic equivalent of the net interest income earned on the underlying Agency mortgage-backed security less an implied financing cost.

TBA dollar roll transactions are accounted for under GAAP as a series of derivatives transactions. The fair value of TBA derivatives is based on methods similar to those used to value Agency mortgage-backed securities. The Company records TBA derivatives at fair value on its Consolidated Statements of Financial Condition and recognizes periodic changes in fair value as Net gains (losses) on trading assets in the Consolidated Statements of Comprehensive Income (Loss), which includes both unrealized and realized gains and losses on derivatives (excluding interest rate swaps).

TBA dollar roll income is calculated as the difference in price between two TBA contracts with the same terms but different settlement dates multiplied by the notional amount of the TBA contract. Although accounted for as derivatives, TBA dollar rolls capture the economic equivalent of net interest income, or carry, on the underlying Agency mortgage-backed security (interest income less an implied cost of financing). TBA dollar roll income is reported as a component of Net gains (losses) on trading assets in the Consolidated Statements of Comprehensive Income (Loss).

 

 

Interest income (excluding PAA), economic interest expense and economic net interest income (excluding PAA)

Interest income (excluding PAA) represents interest income excluding the effect of the PAA, and serves as the basis for deriving average yield on interest earning assets (excluding PAA), net interest spread (excluding PAA) and net interest margin (excluding PAA), which are discussed below. The Company believes this measure provides management and investors with additional detail to enhance their understanding of the Company’s operating results and trends by excluding the component of premium amortization expense representing the cumulative impact on prior periods, but not the current period, of quarter-over-quarter changes in estimated long-term prepayment speeds related to the Company’s Agency mortgage-backed securities (other than interest-only securities), which can obscure underlying trends in the performance of the portfolio.

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

Similarly, economic net interest income (excluding PAA), as computed below, provides investors with additional information to enhance their understanding of the net economics of our primary business operations.

 

		For the quarters ended
		June 30, 2017				March 31, 2017				June 30, 2016
		(dollars in thousands)
Interest Income (Excluding PAA) Reconciliation
GAAP interest income		$	537,426			$	587,727			$	457,118
Premium amortization adjustment			72,700				17,870				85,583
Interest income (excluding PAA) *		$	610,126			$	605,597			$	542,701
Economic Interest Expense Reconciliation
GAAP interest expense		$	222,281			$	198,425			$	152,755
Add:
Interest expense on interest rate swaps used to hedge cost of funds			84,252				88,966				108,301
Economic interest expense *		$	306,533			$	287,391			$	261,056
Economic Net Interest Income (Excluding PAA) Reconciliation
Interest income (excluding PAA) *		$	610,126			$	605,597			$	542,701
Less:
Economic interest expense *			306,533				287,391				261,056
Economic net interest income (excluding PAA) *		$	303,593			$	318,206			$	281,645

 

Average yield on interest earning assets (excluding PAA), net interest spread (excluding PAA) and net interest margin (excluding PAA)

Net interest spread (excluding PAA), which is the difference between the average yield on interest earning assets (excluding PAA) and the average cost of interest bearing liabilities, and net interest margin (excluding PAA), which is calculated by dividing the economic net interest income (excluding PAA) by average interest earning assets, provide management with additional measures of the Company’s profitability that management relies upon in monitoring the performance of the business.

 

Disclosure of these measures, which are presented below, provides investors with additional detail regarding how management evaluates the Company’s performance.

 

		For the quarters ended
		June 30, 2017				March 31, 2017				June 30, 2016
		(dollars in thousands)
Economic Metrics (Excluding PAA)
Interest income (excluding PAA) *		$	610,126			$	605,597			$	542,701
Average interest earning assets		$	83,427,268			$	85,664,151			$	73,587,753
Average yield on interest earning assets (excluding PAA) *			2.93	%			2.83	%			2.95	%
Economic interest expense *		$	306,533			$	287,391			$	261,056
Average interest bearing liabilities		$	70,486,779			$	72,422,968			$	62,049,474
Average cost of interest bearing liabilities			1.74	%			1.59	%			1.68	%
Net interest spread (excluding PAA) *			1.19	%			1.24	%			1.27	%
Net interest margin (excluding PAA) *			1.53	%			1.55	%			1.54	%