Annaly Capital Management, Inc. — Q3 2022 Form 10-Q
Business context and reporting period. Annaly is an internally managed mortgage REIT investing across Agency mortgage-backed securities (MBS), residential credit and mortgage servicing rights (MSR). This filing covers the quarter and nine months ended September 30, 2022; balance-sheet comparisons are to December 31, 2021 unless noted. All amounts below are U.S. dollars.
Key financial results and position
| Metric | Q3 2022 / September 30, 2022 | Comparison |
|---|---|---|
| Interest income | $678.5 million | $413.0 million in Q3 2021 |
| Net interest income | $278.0 million | $362.5 million in Q3 2021 |
| Net servicing income | $66.7 million | $14.9 million in Q3 2021 |
| GAAP net income (loss) | $(274.0) million; $(0.70) per common share | $521.5 million; $1.36 per share in Q3 2021 |
| Earnings available for distribution (EAD), non-GAAP | $480.7 million; $1.06 per average common share | $437.5 million; $1.14 per share in Q3 2021 |
| Net interest margin | 1.42% GAAP; 1.98% excluding PAA, non-GAAP | 2.01% GAAP; 2.04% excluding PAA in Q3 2021 |
| Assets / total equity | $85.4 billion / $11.0 billion | $76.8 billion / $13.2 billion at year-end 2021 |
| Common book value per share | $19.94 | $33.55 at September 30, 2021 |
| Repurchase agreements | $54.2 billion; 3.09% weighted-average rate at period-end | $54.8 billion at year-end 2021 |
| Leverage / capital ratio | 5.8:1 GAAP leverage; 7.1:1 economic leverage; 12.8% GAAP capital ratio; 11.8% economic capital ratio | Economic leverage was 5.7:1 and economic capital ratio 14.4% at year-end 2021 |
| Unencumbered assets | $6.1 billion, including $1.5 billion cash and $4.0 billion Agency MBS | Management said this exceeded 50% of equity |
For the nine months ended September 30, 2022, GAAP net income was $2.6 billion ($6.46 per common share), versus $2.0 billion ($5.34 per share) in 2021. Operating cash flow was $5.2 billion, investing cash flow was $(9.0) billion and financing cash flow was $3.9 billion. Cash and cash equivalents were $1.5 billion at quarter-end. Common dividends declared were $0.88 per share for Q3; preferred dividends were also declared.
Material changes versus comparable periods
- Q3 GAAP results swung to a loss amid sharp rate and mortgage-spread moves: investment and other losses were $2.7 billion, including $1.5 billion of realized losses on residential securities sold. Derivative gains of $2.1 billion partly offset those losses.
- Net interest income declined year over year as borrowing costs rose sharply. Q3 interest expense was $400.5 million versus $50.4 million a year earlier; the average GAAP cost of interest-bearing liabilities rose to 2.38% from 0.32%.
- Accumulated other comprehensive loss reached $5.4 billion from $958 million of income at year-end 2021, reflecting significant unrealized available-for-sale securities losses. Equity fell to $11.0 billion from $13.2 billion.
- Economic leverage ended the quarter at 7.1:1, up from 5.7:1 at year-end 2021; management attributed the Q3 increase to the late-quarter market selloff. The company reported a negative 11.7% economic return for Q3.
- Portfolio activity included growth in Agency MBS and residential loans, MSR growth to $1.7 billion from $544.6 million at year-end 2021, and the near-completion of the Middle Market Lending portfolio sale. The Commercial Real Estate business sale was completed by September 30, 2022.
- The company completed a 1-for-4 reverse common-stock split on September 23, 2022. It also issued common equity through public offerings and its at-the-market program during 2022.
Outlook, risks and unusual items
- Management described markets as unusually challenging, citing persistent inflation, rapid Federal Reserve tightening, high volatility and widening Agency MBS spreads. It expects near-term challenges to persist and said it intends to maintain a defensive posture, prioritizing liquidity, leverage and risk management.
- Management reported $6.1 billion in unencumbered assets and said repo and other financing remained available, while acknowledging financing costs had risen. Most repurchase agreements are short term; weighted-average remaining maturity was 57 days. Falling collateral values could trigger margin calls or forced asset sales.
- Management’s sensitivity analysis estimated that an immediate 75-basis-point rate increase would reduce projected 12-month economic net interest income by 4.6% and portfolio value by 0.9%; a 25-basis-point MBS spread widening would reduce portfolio value by 1.7%. These are model estimates and assume no management response.
- Key exposures include interest rates, mortgage spreads, prepayments, funding availability and costs, leverage, credit in non-Agency assets and loans, counterparty performance, and MSR valuation. MSR fair values rely on significant unobservable assumptions.
- LIBOR tenors relevant to the company are scheduled to cease or become non-representative after June 30, 2023. Annaly said it was progressing with its transition plan; $1.5 billion of LIBOR-linked preferred stock could remain outstanding beyond that date.
- Subsequent to quarter-end, the board authorized a preferred-stock repurchase program covering up to approximately $1.6 billion of liquidation value through December 31, 2024; the authorization does not require purchases. Annaly also refreshed its at-the-market common-stock program to up to $1.5 billion of offering capacity.
- The filing reported no material pending legal proceedings or material contingencies at September 30, 2022. Management stated disclosure controls were effective and there were no material changes to internal control over financial reporting during the quarter.
Most important facts for investors to verify
- How book value, accumulated other comprehensive loss and economic leverage changed after September 30 as rates and MBS spreads moved.
- Whether EAD and dividends remain supported by recurring earnings and cash generation; EAD is non-GAAP and is not a substitute for GAAP income.
- Current liquidity, repo maturities, collateral haircuts and margin-call exposure, including whether reported unencumbered assets remain available in stressed markets.
- Effects of further rate and spread changes on asset values, hedges, funding costs, prepayments and MSR assumptions.
- Remaining MML asset transfers, proceeds and any related costs, plus actual use of the preferred-stock repurchase and refreshed ATM authorizations and their capital impact.
- Progress on LIBOR transition, particularly the company’s preferred-stock fallback or liability-management plans.