Annaly Capital Management, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; balance-sheet comparisons are to December 31, 2019 unless stated otherwise. Annaly is a leveraged, diversified real estate capital manager and REIT, investing in Agency and non-Agency mortgage securities, residential and commercial loans, mortgage servicing rights, real estate, and middle-market corporate debt.
Financial performance and position
- GAAP results: Net loss attributable to Annaly was $3.64 billion; loss available to common stockholders was $3.68 billion, or $2.57 per diluted share. Q1 2019 common-stockholder loss was $882 million, or $0.63 per share.
- Interest and margins: Interest income was $555 million, down from $866 million; interest expense was $503 million, versus $648 million. Net interest income fell to $52 million from $218 million. GAAP net interest margin was 0.18% versus 0.79%; net interest spread was 0.05% versus 0.44%.
- Core earnings (non-GAAP): Excluding the premium amortization adjustment (PAA), core earnings were $330 million, or $0.21 per share, compared with $433 million, or $0.29, in Q1 2019. Core net interest margin excluding PAA was 1.18% versus 1.51%. Management cautions that these non-GAAP measures have limitations and may not be comparable with peers.
- Drivers of GAAP loss: Realized and unrealized losses totaled $3.66 billion, including $3.24 billion of losses on interest-rate swaps and $730 million of unrealized losses on instruments measured through earnings. These were partly offset by $207 million of net gains on investment disposals and other derivatives. The swap losses primarily reflected sharply lower forward interest rates; the marks are not the same as core operating earnings.
- Credit costs: Loan-loss provision was $99 million, versus $5.7 million in Q1 2019. The ending loan-loss provision was reported as approximately $138 million. Annaly adopted CECL on January 1, reducing opening retained earnings by $39.6 million.
- Cash flow: Operating activities used $2.02 billion; investing activities provided $34.10 billion, reflecting substantial security sales and principal repayments; financing activities used $31.11 billion. Cash and cash equivalents increased by $973 million to $2.82 billion. These cash-flow totals include significant portfolio and financing turnover and should not be read as recurring operating cash generation.
- Balance sheet and debt: Total assets were $96.9 billion, down from $130.3 billion; total equity was $12.7 billion, down from $15.8 billion. Repurchase agreements were $72.6 billion, versus $101.7 billion; total indebtedness on the company’s principal-balance presentation was $81.6 billion. Period-end debt-to-equity leverage was 6.4x and economic leverage was 6.8x, compared with 7.1x and 7.2x, respectively, at year-end.
- Liquidity and portfolio: Management reported $4.6 billion of cash and unencumbered Agency MBS and $6.9 billion of total unencumbered assets. The portfolio measure in MD&A was $99.3 billion at quarter-end, versus $128.7 billion at year-end, and was 93% Agency MBS. Repo financing had a 48-day weighted-average remaining maturity.
- Book value and dividends: Common book value was $7.50 per share. The company declared a $0.25-per-share common dividend, down from $0.30 in Q1 2019; $357.6 million was payable after quarter-end. Preferred dividends were also declared.
Material changes and management outlook
- COVID-19 market dislocation drove asset sales, deleveraging, a reduction in hedges, and a focus on preserving capital and liquidity. Annaly sold across liquid securities, first reducing Agency MBS and then residential-credit and commercial-MBS positions. It eliminated its futures position and reduced swaps and swaptions.
- Management said short-term capital allocation would be weighted primarily toward Agency MBS while the economic outlook remained uncertain. It viewed Federal Reserve support and improved market functioning as supportive for Agency MBS, while anticipating further disruption in other businesses. The filing provides no quantified earnings or financial guidance.
- Management cited elevated prepayment risk: experienced Agency CPR rose to 13.6% from 7.3% in Q1 2019, and projected long-term CPR was 17.7% versus 11.6%. Faster prepayments can accelerate premium amortization and reduce asset yields.
- On February 12, Annaly agreed to acquire its external manager for nominal consideration and become internally managed; management anticipated closing in Q2 2020, subject to conditions. CEO David Finkelstein was appointed March 13, succeeding interim CEO Glenn Votek.
- COVID-19 risks include borrower forbearance, delinquencies and defaults, lower asset values, refinancing-driven prepayments, wider spreads, margin calls, tighter or unavailable financing, and forced asset sales. The company said residential-loan advances related to forbearance were expected to be small relative to liquidity, but outcomes remained uncertain.
- Other notable items: commercial and corporate lending faced economic stress; the company recorded material loan-loss provisions and disclosed commercial exposures rated substandard or doubtful. Management stated there were no material contingencies or pending material legal proceedings at March 31. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported.
Most important facts for investors to verify
- Whether liquidity, collateral availability, and repo financing remain adequate as short-term borrowings roll over and market volatility or margin requirements change.
- How much of the large GAAP loss reflects market-value changes versus realized losses, and how non-GAAP core earnings reconcile to GAAP results.
- Whether CECL allowances and loan performance adequately reflect COVID-19 exposure, especially in commercial real estate, residential credit, and middle-market lending.
- Whether faster mortgage prepayments, spread movements, and hedge positioning affect future net interest income, book value, and dividend capacity.
- Whether the manager internalization closed as expected, its costs and operating effects, and whether anticipated savings are realized.