LOANS

The Company invests in residential, commercial and corporate loans. Loans are classified as either held for investment or held for sale. Loans are also eligible to be accounted for under the fair value option. As of September 30, 2018, the Company reported $1.2 billion of loans elected under the fair value option. If loans are held for investment and the fair value option has not been elected, they are accounted for at amortized cost less impairment. If loans are held for sale and the fair value option has not been elected, they are accounted for at the lower of cost or fair value.

Loans can be classified as held for investment if the Company has the intent and ability to hold the loan for the foreseeable future or to maturity or payoff. If the Company has the intent and ability to sell loans, they are classified as held for sale.

Nonaccrual Status – If collection of a loan’s principal or interest is in doubt or the loan is 90 days or more past due, interest income is not accrued. For nonaccrual status loans carried at fair value or held for sale, interest is not accrued, but is recognized on a cash basis. For nonaccrual status loans carried at amortized cost, if collection of principal is not in doubt, but collection of interest is in doubt, interest income is recognized on a cash basis. If collection of principal is in doubt, any interest received is applied against principal until collectability of the remaining balance is no longer in doubt; at that point, any interest income is recognized on a cash basis. Generally, a loan is returned to accrual status when the borrower has resumed paying the full amount of the scheduled contractual obligation, if all principal and interest amounts contractually due are reasonably assured of repayment within a reasonable period of time and there is a sustained period of repayment performance by the borrower. The Company did not have any impaired loans or loans in default as all of the loans were performing at September 30, 2018 and December 31, 2017. There were no allowances for loan losses at September 30, 2018 or December 31, 2017.

Allowance for Losses – The Company evaluates the need for a loss reserve on its CRE Debt and Preferred Equity Investments and its corporate loans. A provision for losses related to CRE Debt and Preferred Equity Investments and corporate loans, including those accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, may be established when it is probable the Company will not collect amounts contractually due or all amounts previously estimated to be collectible. Management assesses the credit quality of the portfolio and adequacy of loan loss reserves on a quarterly basis, or more frequently as necessary. Significant judgment is required in this analysis. Depending on the expected recovery of its investment, the Company considers the estimated net recoverable value of the CRE Debt and Preferred Equity Investments as well as other factors, including but not limited to the fair value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the competitive landscape where the borrower conducts business. To determine if loan loss allowances are required on investments in corporate debt, the Company reviews the monthly and/or quarterly financial statements of the borrowers, verifies loan compliance packages, if applicable, and analyzes current results relative to budgets and sensitivities performed at inception of the investment. Because these determinations are based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized may differ materially from the carrying value as of the reporting date.

The Company may be exposed to various levels of credit risk depending on the nature of its investments and credit enhancements, if any, supporting its assets. The Company’s core investment process includes procedures related to the initial approval and periodic monitoring of credit risk and other risks associated with each investment. The Company’s investment underwriting procedures include evaluation of the underlying borrowers’ ability to manage and operate their respective properties or companies. Management reviews loan-to-value metrics at origination or acquisition of a new investment and if events occur that trigger re-evaluation by management.

Management generally reviews the most recent financial information produced by the borrower, which may include, but is not limited to, net operating income (“NOI”), debt service coverage ratios, property debt yields (net cash flow or NOI divided by the amount of outstanding indebtedness), loan per unit and rent rolls relating to each of the Company’s CRE Debt and Preferred Equity Investments, and may consider other factors management deems important. Management also reviews market pricing to determine each borrower’s ability to refinance their respective assets at the maturity of each loan, economic trends (both macro and those affecting the property specifically), and the supply and demand of competing projects in the sub-market in which each subject property is located. Management monitors the financial condition and operating results of its corporate borrowers and continually assesses the future outlook of the borrower’s financial performance in light of industry developments, management changes and company-specific considerations.

The Company’s internal loan risk ratings are based on the guidance provided by the Office of the Comptroller of the Currency for commercial real estate lending. The Company’s internal risk rating categories include “Performing”, “Performing - Closely Monitored”, “Performing - Special Mention”, “Substandard”, “Doubtful” or “Loss”. Performing loans meet all present contractual obligations. Performing - Closely Monitored loans meet all present contractual obligations, but are transitional or could be exhibiting some weakness in both leverage and liquidity. Performing - Special Mention loans meet all present contractual obligations, but exhibit potential weakness that deserves management’s close attention and, if uncorrected, may result in deterioration of repayment prospects. Substandard loans are inadequately protected by sound worth and paying capacity of the obligor or of the collateral pledged with a distinct possibility that loss will be sustained if some of the deficiencies are not corrected. Doubtful loans are Substandard loans whereby collection of all contractual principal and interest is highly questionable or improbable. Loss loans are considered uncollectible. The Company did not have any impaired loans, nonaccrual loans, or loans in default in the commercial loan portfolio as all of the loans were performing at September 30, 2018 and December 31, 2017. As such, no provision for loan losses was deemed necessary at September 30, 2018 or December 31, 2017.

The following table presents the activity of the Company’s loan investments for the nine months ended September 30, 2018:



	Residential			Commercial			Corporate			Total
	(dollars in thousands)
Beginning balance January 1, 2018	$	958,546		$	1,029,327		$	1,011,275		$	2,999,148
Purchases	430,854			528,835			788,213			1,747,902
Syndications	—			—			(44,125		)	(44,125		)
Principal Payments	(156,198		)	(124,559		)	(235,423		)	(516,180		)
Change in fair value	(13,812		)	—			—			(13,812		)
Amortization	(2,251		)	2,262			8,934			8,945
Ending balance September 30, 2018	$	1,217,139		$	1,435,865		$	1,528,874		$	4,181,878

The carrying value of the Company’s loans held for sale was $42.3 million and $0 at September 30, 2018 and December 31, 2017, respectively.

Residential

The Company’s residential mortgage loans are primarily comprised of performing adjustable-rate and fixed-rate whole loans. Additionally, the Company consolidates a collateralized financing entity that securitized prime adjustable-rate jumbo residential mortgage loans. The Company also consolidates securitization trusts in which it had purchased subordinated securities because it also has certain powers and rights to direct the activities of such trusts. Please refer to the “Variable Interest Entities” Note for further information related to the Company’s consolidated Residential Mortgage Loan Trusts.

The following table presents the fair value and the unpaid principal balances of the residential mortgage loan portfolio, including loans transferred or pledged to securitization vehicles, at September 30, 2018 and December 31, 2017:



	September 30, 2018		December 31, 2017
	(dollars in thousands)
Fair value	$	1,983,015	$	1,438,322
Unpaid principal balance	$	1,976,077	$	1,419,807

The following table provides information regarding the line items and amounts recognized in the Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2018 and 2017 for these investments:



	Three Months Ended						Nine Months Ended
	September 30, 2018			September 30, 2017			September 30, 2018			September 30, 2017
	(dollars in thousands)
Net interest income	$	16,423		$	8,226		$	45,702		$	18,935
Net gains (losses) on disposal of investments ⁽¹⁾	(2,975		)	(2,093		)	(7,924		)	(3,407		)
Net unrealized gains (losses) on instruments measured at fair value through earnings	(3,633		)	(725		)	(14,802		)	5,400
Total included in net income (loss)	$	9,815		$	5,408		$	22,976		$	20,928

⁽¹⁾ Includes loan premium write offs.

The following table provides the geographic concentrations based on the unpaid principal balances at September 30, 2018 and December 31, 2017, for the residential mortgage loans, including loans transferred or pledged to securitization trusts:



Geographic Concentrations of Residential Mortgage Loans
September 30, 2018			December 31, 2017
Property Location	% of Balance		Property Location	% of Balance
California	54.5	%	California	49.8	%
New York	8.1	%	Florida	9.3	%
Florida	6.6	%	New York	7.1	%
All other (none individually greater than 5%)	30.8	%	All other (none individually greater than 5%)	33.8	%
Total	100.0	%	Total	100.0	%

The following table provides additional data on the Company’s residential mortgage loans, including loans transferred or pledged to securitization trusts, at September 30, 2018 and December 31, 2017:



	September 30, 2018		December 31, 2017
	Portfolio Range	Portfolio Weighted Average	Portfolio Range	Portfolio Weighted Average
	(dollars in thousands)
Unpaid principal balance	$1 - $3,500	$494	$1 - $3,663	$514
Interest rate	2.00% - 7.50%	4.74%	1.63% - 7.50%	4.25%
Maturity	1/1/2028 - 9/1/2058	1/5/2045	1/1/2028 - 5/1/2057	2/1/2043
FICO score at loan origination	510 - 823	754	468 - 823	748
Loan-to-value ratio at loan origination	11% - 100%	67%	11% - 100%	68%

At September 30, 2018 and December 31, 2017, approximately 54% and 78%, respectively, of the carrying value of the Company’s residential mortgage loans, including loans transferred or pledged to securitization trusts, were adjustable-rate.

Commercial

The Company’s commercial real estate loans are comprised of fixed-rate and adjustable-rate loans. The Company designates loans as held for investment if it has the intent and ability to hold the loans until maturity or payoff. The difference between the principal amount of a loan and proceeds at acquisition is recorded as either a discount or premium. Commercial real estate loans that are designated as held for investment and are originated or purchased by the Company are carried at their outstanding principal balance, net of unamortized origination fees and costs, premiums or discounts, less an allowance for losses, if necessary. Origination fees and costs, premiums or discounts are amortized into interest income over the life of the loan.

If the Company intends to sell or securitize the loans and the securitization vehicle is not expected to be consolidated, they are classified as held for sale. Commercial real estate loans that are designated as held for sale are carried at the lower of amortized cost or fair value in the accompanying Consolidated Statements of Financial Condition. Any origination fees and costs or purchase premiums or discounts are deferred and recognized upon sale. The Company determines the fair value of commercial real estate loans held for sale on an individual loan basis.

Preferred equity interests are designated as held for investment and are carried at their outstanding principal balance, net of unamortized origination fees and costs, premiums or discounts, less a reserve for estimated losses, if necessary.

At September 30, 2018 and December 31, 2017, approximately 87% and 85%, respectively, of the carrying value of the Company’s CRE Debt and Preferred Equity Investments, excluding loans held for sale, was comprised of floating-rate debt investments.

On December 11, 2015, the Company originated a $335.0 million recapitalization financing with respect to eight class A/B office properties in Orange County, California. The Company previously classified the senior mortgage loan as held for sale. During the nine months ended September 30, 2017, the Company sold the remaining balance of $115.0 million ($114.4 million, net of origination fees) of the senior loan to unrelated third parties at carrying value. Accordingly, no gain or loss was recorded in connection with the sale.

At September 30, 2018 and December 31, 2017, commercial real estate investments held for investment were comprised of the following:



	September 30, 2018						December 31, 2017
	Outstanding Principal		Carrying Value ⁽¹⁾		Percentage of Loan Portfolio ⁽²⁾		Outstanding Principal		Carrying Value ⁽¹⁾		Percentage of Loan Portfolio ⁽²⁾
(dollars in thousands)
Senior mortgages	$	1,090,849	$	1,084,167	75.6	%	$	629,143	$	625,900	60.9	%
Mezzanine loans	343,354		342,700		23.8	%	395,015		394,442		38.2	%
Preferred equity	9,000		8,998		0.6	%	9,000		8,985		0.9	%
Total	$	1,443,203	$	1,435,865	100.0	%	$	1,033,158	$	1,029,327	100.0	%


⁽¹⁾	Carrying value includes unamortized origination fees of $5.7 million and $3.8 million at September 30, 2018 and December 31, 2017, respectively.


⁽²⁾	Based on outstanding principal.

The following tables represent a rollforward of the activity for the Company’s commercial real estate investments held for investment at September 30, 2018 and December 31, 2017:



	September 30, 2018
	Senior Mortgages			Mezzanine Loans			Preferred Equity		Total
	(dollars in thousands)
Beginning balance (January 1, 2018)	$	625,900		$	394,442		$	8,985	$	1,029,327
Originations & advances (principal)	489,271			45,334			—		534,605
Principal payments	(27,565		)	(96,993		)	—		(124,558		)
Net (increase) decrease in origination fees	(5,400		)	(370		)	—		(5,770		)
Amortization of net origination fees	1,961			287			13		2,261
Net carrying value (September 30, 2018)	$	1,084,167		$	342,700		$	8,998	$	1,435,865



	December 31, 2017
	Senior Mortgages			Mezzanine Loans			Preferred Equity		Total
	(dollars in thousands)
Beginning balance (January 1, 2017)	$	510,071		$	451,467		$	8,967	$	970,505
Originations & advances (principal)	338,242			69,121			—		407,363
Principal payments	(221,421		)	(127,799		)	—		(349,220		)
Amortization & accretion of (premium) discounts	(44		)	28			—		(16		)
Net (increase) decrease in origination fees	(3,317		)	(605		)	—		(3,922		)
Amortization of net origination fees	2,369			2,230			18		4,617
Net carrying value (December 31, 2017)	$	625,900		$	394,442		$	8,985	$	1,029,327

The following table provides the internal loan risk ratings of commercial real estate investments held for investment as of September 30, 2018 and December 31, 2017.



September 30, 2018
	Outstanding Principal		Percentage of CRE Debt and Preferred Equity Portfolio		Internal Ratings
Investment Type	Outstanding Principal		Percentage of CRE Debt and Preferred Equity Portfolio		Performing		Performing - Closely Monitored		Performing - Special Mention		Substandard ⁽¹⁾		Doubtful		Loss		Total
(dollars in thousands)
Senior mortgages	$	1,090,849	75.6	%	$	724,111	$	302,348	$	—	$	64,390	$	—	$	—	$	1,090,849
Mezzanine loans	343,354		23.8	%	135,334		64,323		107,094		36,603		—		—		343,354
Preferred equity	9,000		0.6	%	—		—		9,000		—		—		—		9,000
Total	$	1,443,203	100.0	%	$	859,445	$	366,671	$	116,094	$	100,993	$	—	$	—	$	1,443,203



December 31, 2017
	Outstanding Principal		Percentage of CRE Debt and Preferred Equity Portfolio		Internal Ratings
Investment Type	Outstanding Principal		Percentage of CRE Debt and Preferred Equity Portfolio		Performing		Performing - Closely Monitored		Performing - Special Mention		Substandard ⁽¹⁾		Doubtful		Loss		Total
(dollars in thousands)
Senior mortgages	$	629,143	60.9	%	$	409,878	$	115,075	$	36,800	$	67,390	$	—	$	—	$	629,143
Mezzanine loans	395,015		38.2	%	206,169		66,498		122,348		—		—		—		395,015
Preferred equity	9,000		0.9	%	—		—		9,000		—		—		—		9,000
Total	$	1,033,158	100.0	%	$	616,047	$	181,573	$	168,148	$	67,390	$	—	$	—	$	1,033,158


⁽¹⁾	The Company rated two loans as Substandard as of September 30, 2018. The Company evaluated whether an impairment exists and determined in each case that, based on quantitative and qualitative factors, the Company expects repayment of contractual amounts due.

Corporate Debt

The Company’s investments in corporate loans are designated as held for investment when the Company has the intent and ability to hold the investment until maturity or payoff. These investments are carried at their principal balance outstanding plus any premiums or discounts less allowances for loan losses. Interest income from coupon payments is accrued based upon the outstanding principal amounts of the debt and its contractual terms. Premiums and discounts are amortized or accreted into interest income using the effective interest method. These investments typically take the form of senior secured loans primarily in first or second lien positions. The Company’s senior secured loans generally have stated maturities of three to eight years. In connection with these senior secured loans the Company receives a security interest in certain assets of the borrower and such assets support repayment of such loans. Senior secured loans are generally exposed to less credit risk than more junior loans given their seniority to scheduled principal and interest and priority of security in the assets of the borrower.

The Company invests in corporate loans through its Annaly Middle Market Lending Group. The industry and rate attributes of the portfolio at September 30, 2018 and December 31, 2017 are as follows:



	Industry Dispersion
	September 30, 2018						December 31, 2017
	Fixed Rate		Floating Rate		Total		Fixed Rate		Floating Rate		Total
	(dollars in thousands)
Aircraft and Parts	$	—	$	41,344	$	41,344	$	—	$	34,814	$	34,814
Coating, Engraving and Allied Services	—		58,850		58,850		—		64,034		64,034
Computer Programming, Data Processing & Other Computer Related Services	—		212,969		212,969		—		209,624		209,624
Drugs	—		38,735		38,735		—		38,708		38,708
Electrical Work	—		43,266		43,266		—		—		—
Electronic Components & Accessories	—		24,029		24,029		—		23,916		23,916
Engineering, Architectural & Surveying	—		80,741		80,741		—		—		—
Groceries and Related Products	—		14,725		14,725		—		14,794		14,794
Grocery Stores	—		23,461		23,461		—		23,531		23,531
Home Health Care Services	—		—		—		—		23,779		23,779
Insurance Agents, Brokers and Services	—		49,211		49,211		—		28,872		28,872
Mailing, Reproduction, Commercial Art and Photography, and Stenographic	—		14,855		14,855		—		—		—
Management and Public Relations Services	—		240,740		240,740		—		94,871		94,871
Medical and Dental Laboratories	—		26,876		26,876		—		26,956		26,956
Metal Cans & Shipping Containers	—		118,006		118,006		—		—		—
Miscellaneous Business Services	—		19,650		19,650		—		19,723		19,723
Miscellaneous Equipment Rental and Leasing	—		49,433		49,433		—		49,129		49,129
Miscellaneous Health and Allied Services, not elsewhere classified	—		54,189		54,189		—		25,963		25,963
Miscellaneous Nonmetallic Minerals, except Fuels	—		—		—		—		25,992		25,992
Miscellaneous Plastic Products	—		9,963		9,963		—		9,879		9,879
Motor Vehicles and Motor Vehicle Equipment	—		16,937		16,937		—		—		—
Motor Vehicles and Motor Vehicle Parts and Supplies	—		27,979		27,979		—		12,212		12,212
Nonferrous Foundries (Castings)	—		12,953		12,953		—		—		—
Offices and Clinics of Doctors of Medicine	—		97,760		97,760		—		600		600
Offices and Clinics of Other Health Practitioners	—		21,122		21,122		—		18,979		18,979
Public Warehousing and Storage	—		61,912		61,912		—		48,890		48,890
Research, Development and Testing Services	—		33,334		33,334		—		33,155		33,155
Schools and Educational Services, not elsewhere classified	—		19,794		19,794		—		20,625		20,625
Services Allied with the Exchange of Securities	—		14,895		14,895		—		13,960		13,960
Surgical, Medical, and Dental Instruments and Supplies	—		39,806		39,806		—		29,687		29,687
Telephone Communications	—		61,339		61,339		—		59,182		59,182
Total	$	—	$	1,528,874	$	1,528,874	$	—	$	1,011,275	$	1,011,275

The table below reflects the Company’s aggregate positions by their respective place in the capital structure of the borrowers at September 30, 2018 and December 31, 2017.



	September 30, 2018		December 31, 2017
	(dollars in thousands)
First lien loans	$	888,860	$	582,724
Second lien loans	640,014		428,551
Total	$	1,528,874	$	1,011,275