Business context and reporting period
Annaly Capital Management, Inc. (NYSE: NLY) filed this Form 10-K for the fiscal year ended December 31, 2019. The company is a REIT and diversified mortgage and credit investor, using borrowed funds to invest principally in Agency mortgage-backed securities, alongside residential credit, commercial real estate and middle-market loans. Although the request references 2019 Q4, this filing reports full-year results; selected fourth-quarter figures are noted below.
At year-end, Agency assets represented 93% of portfolio composition; equity allocation was 74% Agency, 10% residential credit, 7% commercial real estate and 9% middle-market lending.
Financial results and key metrics
| Metric | 2019 | 2018 |
|---|---|---|
| Interest income | $3.787 billion | $3.333 billion |
| Interest expense | $2.785 billion | $1.898 billion |
| Net interest income | $1.002 billion | $1.435 billion |
| Net income (loss) | ($2.163 billion) | $54.1 million |
| Net income (loss) available to common stockholders | ($2.299 billion), or ($1.60) per share | ($74.9 million), or ($0.06) per share |
| Core earnings excluding premium amortization adjustment (non-GAAP) | $1.575 billion, or $1.00 per share | $1.575 billion, or $1.20 per share |
| Year-end total assets / total equity | $130.3 billion / $15.8 billion | $105.8 billion / $14.1 billion |
| Common book value per share | $9.66 | $9.39 |
| Common dividends declared per share | $1.05 | $1.20 |
GAAP net interest margin was 1.13%, down from 1.57%; net interest spread was 0.90%, down from 1.19%. On the company’s non-GAAP basis excluding the premium amortization adjustment, net interest margin was 1.32% versus 1.52%, and spread was 1.11% versus 1.13%. Average asset yield excluding that adjustment rose to 3.36% from 3.17%, while average cost of interest-bearing liabilities increased to 2.25% from 2.04%.
Realized and unrealized losses totaled $3.011 billion, principally reflecting losses on interest-rate swaps and other derivatives. Swap losses included $1.2 billion of unrealized losses and $1.4 billion of realized losses on terminations or maturities; futures losses were $962.7 million. In contrast, available-for-sale securities generated $4.118 billion of other comprehensive income, moving accumulated other comprehensive income from a $2.0 billion loss to a $2.1 billion gain. The company attributed the overall GAAP deterioration mainly to swap-related results and higher interest expense; core earnings excluding the premium amortization adjustment were nearly unchanged year over year.
Cash flows were ($1.2 billion) from operating activities, ($20.6 billion) from investing activities and $22.0 billion from financing activities, producing a $115.0 million increase in cash and cash equivalents. These cash flow totals include substantial portfolio transactions and derivative activity.
Balance sheet, funding and material changes
Repurchase agreements were $101.7 billion at year-end, up from $81.1 billion. Total debt was $112.3 billion; reported debt-to-equity leverage was 7.1:1 and economic leverage was 7.2:1, compared with 6.3:1 and 7.0:1, respectively. The company’s stated general target was economic leverage below 10:1. Repo agreements had a 65-day weighted-average remaining maturity. Unencumbered financial assets were $7.9 billion; the filing also reports liquid assets of $120.0 billion, or 98.92% of the specified financial-asset base, a measure that includes assets pledged as collateral.
Total assets rose 23% year over year, primarily from a $22.1 billion increase in Agency mortgage-backed securities. Experienced Agency prepayment speed increased to 12.7% from 9.3%, while projected long-term speed rose to 13.9% from 10.1%. Higher prepayments can accelerate premium amortization. Agency securities were largely fixed-rate; their year-end fair value was $112.9 billion, compared with $90.8 billion in 2018.
Common equity issuance and at-the-market sales raised capital, while Annaly repurchased 26.2 million common shares for $223.2 million. It issued $442.5 million gross of Series I preferred stock and redeemed Series C and Series H preferred shares. Common dividends declared fell 12.5% year over year.
Outlook, risks and unusual items
Management reported a 14.1% economic return for 2019, supported by tighter credit spreads and accommodative Federal Reserve policy, while describing broad credit markets as fully valued and emphasizing selectivity. The company expected credit businesses to continue growing in 2020. This is management commentary, not quantified earnings guidance. The filing noted that market participants expected the Federal Reserve to hold rates unchanged during 2020.
On February 12, 2020, after year-end, Annaly agreed to acquire its external manager and become internally managed for nominal cash consideration of $1. The expected second-quarter 2020 closing was subject to conditions; expected savings and benefits were not assured. The CEO was interim while the Board conducted a permanent CEO search. The company also identified the February 2021 scheduled end of its captive subsidiary’s FHLB membership as a potential funding transition.
Principal risks include leverage and repo refinancing, margin calls, interest-rate and mortgage-spread movements, prepayment and reinvestment risk, derivative and counterparty exposure, credit losses in non-Agency and loan portfolios, and execution risks associated with internalization. The filing’s modeled, static-portfolio scenarios estimated that a 75-basis-point rate increase would raise economic net interest income 20.4% but reduce portfolio value 1.0% (8.1% of NAV); a 75-basis-point decrease would reduce modeled income 41.0%. A 25-basis-point widening in mortgage spreads would reduce portfolio value 1.2% (10.2% of NAV). Actual outcomes could differ materially, and the scenarios assume no management response. The company reported no pending material legal proceedings and no material contingencies at year-end.
Important facts for investors to verify
- Reconcile the large GAAP derivative losses and available-for-sale gains with book value, and assess the limits of non-GAAP core earnings as a performance measure.
- Track repo renewal terms, collateral and margin requirements, unencumbered liquidity, and the planned transition away from FHLB funding.
- Confirm whether internalization closed as expected, its realized costs and savings, and the resulting management and compensation structure.
- Monitor the common dividend against taxable income, cash generation, leverage and future equity issuance.
- Evaluate sensitivity to mortgage prepayments, interest rates and spreads, and credit performance in residential, commercial and middle-market investments.