Annaly Capital Management, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Annaly is an internally managed mortgage REIT investing across Agency mortgage-backed securities (MBS), residential credit and mortgage servicing rights (MSR). Comparisons below are to Q2 and the first six months of 2022, or to December 31, 2022 for balance-sheet data, as applicable.
Financial performance and position
- Q2 earnings: GAAP net income was $161.2 million and income available to common stockholders was $131.3 million, or $0.27 per diluted share. GAAP net income was $863.3 million, or $2.21 per basic share, in Q2 2022.
- First-half earnings: GAAP net loss was $678.1 million; loss available to common stockholders was $744.9 million, or $1.51 per share. First-half 2022 net income was $2.9 billion, or $7.60 per basic share.
- Net interest and servicing: GAAP net interest income was negative $32.0 million in Q2 and negative $12.5 million for the first half, versus positive $475.1 million and $1.06 billion, respectively, in 2022. Net servicing income increased to $74.9 million in Q2 and $151.3 million in the first half, from $49.7 million and $80.7 million.
- Non-GAAP earnings: Earnings available for distribution (EAD) was $389.5 million, or $0.72 per average common share, in Q2; first-half EAD was $816.6 million, or $1.52 per share. The comparable 2022 figures were $490.8 million/$1.22 and $921.4 million/$2.33. EAD is a company-defined non-GAAP measure, not a substitute for GAAP results.
- Portfolio and equity: Total assets were $89.3 billion, up from $81.9 billion at year-end 2022; total equity was $11.9 billion, versus $11.4 billion. Investment portfolio fair value was $85.7 billion, including $67.8 billion of Agency MBS, $15.5 billion of residential credit assets and $2.0 billion of MSR. Common book value per share was $20.73; the filing cites $23.59 for June 30, 2022.
- Debt and leverage: Repurchase agreements were $61.6 billion, with a 5.29% period-end weighted-average rate and 44-day weighted-average remaining maturity. Total GAAP debt was $72.4 billion, including $9.8 billion of securitization debt and $0.5 billion of other secured financing. GAAP leverage was 6.1:1; economic leverage was 5.8:1, compared with 6.6:1 in June 2022. The economic leverage measure excludes specified non-recourse financing.
- Liquidity and cash flow: Cash and cash equivalents were $1.24 billion at quarter-end, down $339.8 million from year-end. For the first half, operating cash flow was $117.7 million, investing cash flow was negative $4.25 billion and financing cash flow was positive $3.79 billion. The company reported $6.04 billion of unencumbered financial assets; $77.5 billion of financial assets were encumbered. Its broader liquid-assets measure was $70.1 billion and includes assets already pledged as collateral.
- Distributions: Annaly declared a common dividend of $0.65 per share for Q2, down from $0.88 in Q2 2022. It issued 25.3 million common shares through its at-the-market program during the first half for $562.7 million net proceeds.
Material changes and management commentary
- Higher borrowing costs and higher average funding balances pushed GAAP interest expense sharply higher; the company reported a 5.00% average GAAP cost of interest-bearing liabilities in Q2 versus 1.12% a year earlier. The non-GAAP economic net interest margin, which incorporates swap interest and excludes the premium amortization adjustment, was 1.66%, down from 2.20%.
- Investment losses were partly offset by derivative gains. Q2 net losses on investments and other were $1.31 billion, compared with $615.2 million of losses a year earlier; net derivative gains were $1.48 billion, versus $1.02 billion. First-half net derivative gains were $574.6 million, down from $2.66 billion.
- Management said it reduced Agency MBS exposure by about $5 billion in notional value during Q2 amid spread volatility, rotated toward higher coupons and maintained a broadly stable hedge ratio. It described Agency MBS spreads as wide historically, but said they tightened modestly over the quarter.
- Residential credit spreads tightened. Annaly reported approximately $1.5 billion of Q2 loan securitizations and said first-half securitization volume exceeded $3 billion across eight transactions after a July transaction. MSR fair value rose to $2.02 billion from $1.75 billion at year-end, reflecting purchases and valuation changes.
- Management described the U.S. economy as resilient and inflation as moderating but still above the Federal Reserve’s target. It believed rates may be near the cycle peak after the July increase, while noting that inflation surprises could prompt another hike. This is management’s view, not formal company earnings or dividend guidance; the filing provides no specific forward earnings or dividend target.
Risks, contingencies and unusual items
- The business is exposed to interest-rate, yield-curve, MBS-spread, prepayment, credit, funding, liquidity and counterparty risks. Repo financing is short-dated and may require same-day additional collateral after a margin call; falling collateral values or reduced lender availability could pressure liquidity or force asset sales.
- At June 30, the company estimated that an immediate 25-basis-point rate increase would reduce portfolio value by 0.2% and projected economic net interest income by 1.5%; a 25-basis-point MBS spread widening was estimated to reduce portfolio market value by 1.3%. These modeled sensitivities assume no management response and actual results may differ materially.
- Accumulated other comprehensive loss improved to $2.38 billion from $3.71 billion at year-end 2022, but the filing states that available-for-sale securities remained below amortized cost primarily due to market conditions, not credit quality. Realized losses on Residential Securities disposals were $599.2 million in Q2 and $1.12 billion in the first half.
- MSR valuations depend on significant unobservable assumptions; lower rates and faster prepayments could reduce MSR value. The portfolio also has residential credit exposure, including geographic concentration: California represented 43.2% of residential loan unpaid principal balance.
- Management reported no material contingencies at June 30 and no pending material legal proceedings. A $400.5 million residential-loan securitization closed in July, after quarter-end. Disclosure controls were assessed as effective, with no material change to internal control over financial reporting during the quarter.
Investor verification points
- Review the reconciliation and limitations of EAD, economic leverage and economic net interest margin against GAAP measures.
- Track funding costs, repo maturities and haircuts, unencumbered liquidity, collateral calls and the availability of counterparties.
- Assess whether hedge gains, asset valuation changes and rate/spread sensitivity meaningfully offset pressures on recurring net interest income and book value.
- Monitor dividend coverage against EAD and GAAP results, along with continued share issuance under the at-the-market program.
- Verify securitization volumes, residential loan credit performance and MSR valuation assumptions, including prepayment and delinquency trends.