Annaly Capital Management, Inc. — 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011; the filing also presents unaudited quarterly results. Annaly is a mortgage REIT whose core business is financing primarily Agency mortgage-backed securities with repurchase agreements and earning the spread between asset income and funding costs. It also operates investment-advisory, broker-dealer, and other financial subsidiaries.
Financial performance and position
| Metric | 2011 | 2010 |
|---|---|---|
| Total interest income | $3.58 billion | $2.68 billion |
| GAAP net interest income | $3.10 billion | $2.25 billion |
| Economic net interest income, including swap interest | $2.22 billion | $1.52 billion |
| Economic net interest rate spread | 2.09% | 2.08% |
| Net income | $344.5 million | $1.27 billion |
| Net income per average common share | $0.37 | $2.12 |
| Common dividends declared per share | $2.44 | $2.65 |
| Total assets at year-end | $109.63 billion | $83.03 billion |
| Stockholders’ equity at year-end | $15.76 billion | $9.86 billion |
- Average asset yield declined to 3.70% from 4.01%; average cost of interest-bearing liabilities, including swaps, fell to 1.61% from 1.93%. Average interest-earning assets increased to $96.7 billion from $67.0 billion.
- Fourth-quarter economic net interest income was $489.9 million, down from $577.5 million in Q3; the annualized spread narrowed to 1.71% from 2.08%. Q4 GAAP net income was $445.6 million, or $0.46 per common share, following a Q3 net loss of $921.8 million, or $0.98 per share.
- Cash and cash equivalents were $994.2 million at year-end. Cash flows were $2.42 billion from operating activities, negative $25.12 billion from investing activities, and positive $23.41 billion from financing activities. These figures include substantial securities and financing transactions.
- Repurchase agreements totaled $84.10 billion; year-end debt-to-equity was 5.4:1, below the company’s stated usual target range of 8:1–12:1. The filing reports weighted-average remaining repo maturity of 103 days in its notes; a separate MD&A discussion gives 110 days for all borrowings.
- Interest-rate swaps had $40.1 billion notional and a $2.55 billion net fair-value liability at year-end. The portfolio’s weighted-average asset duration was 1.2 years and duration after swaps was negative 0.4 years.
Material changes versus comparable periods
- Net income fell by $922.8 million year over year, primarily reflecting $1.82 billion of unrealized swap losses in 2011 versus $318.8 million in 2010. Swap fair-value changes flow through earnings; the company stated these mark-to-market losses were a principal reason GAAP results diverged from underlying economic spread performance.
- Economic net interest income rose by $697.1 million as the average portfolio expanded, while the economic spread was nearly unchanged year over year. The portfolio’s average prepayment rate fell to 17% from 27% in 2010.
- Agency mortgage-backed securities increased to $104.25 billion fair value from $78.44 billion. Net purchase premiums on Agency securities, debentures, and corporate debt were $3.33 billion at year-end, up from $2.31 billion.
- Common equity grew substantially through issuance: the company raised about $5.35 billion net from follow-on offerings and $455.5 million through its direct-purchase and dividend-reinvestment program. Common shares outstanding rose to about 970.2 million from 631.6 million.
- Common dividends declared declined to $2.44 per share from $2.65; quarterly dividends moved from $0.62 in Q1 to $0.57 in Q4. The company has no established minimum dividend.
Outlook, risks, and unusual items
- Management expects to continue financing primarily through repurchase agreements and describes its objective as generating distributable income from investment spreads and subsidiary dividends. No quantified earnings or dividend guidance is provided.
- Management’s modeled interest-rate scenarios estimated economic net interest income would decline 1.87% with a 25-basis-point rise and 8.47% with a 75-basis-point rise; results are estimates based on assumptions, not forecasts. Operation Twist and other market developments could flatten the yield curve, increase prepayments, and pressure spreads.
- Key exposures include short-term funding renewal and margin calls, rising funding costs, asset-value volatility, prepayments and accelerated premium amortization, hedge ineffectiveness or counterparty failure, and changes to Fannie Mae and Freddie Mac or their guarantees. The company also flagged the SEC’s review of the Investment Company Act exemption it relies on, REIT qualification requirements, and European-counterparty risk.
- At year-end, exposure to European financial counterparties was reported as $1.66 billion, or 1.51% of total assets; the company had no credit-default swaps or other credit protection for these exposures. It reported no repo margin calls it could not meet through December 31, 2011.
- CEO Michael A. J. Farrell was undergoing chemotherapy, a disclosed key-personnel risk. Management said ordinary-course legal matters were not expected to materially affect the financial statements. The filing reports effective disclosure controls and internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.
Investor verification priorities
- Reconcile GAAP income and per-share results with swap-related realized and unrealized losses, and assess economic net interest income and spread trends separately.
- Review the size and sensitivity of the $3.33 billion premium balance, prepayment trends, and the effect of faster repayments on asset yields and dividends.
- Verify repo maturity, funding availability, collateral haircuts, liquidity buffers, and counterparty concentration, including the discrepancy in reported average borrowing maturity.
- Assess whether equity issuance, dilution, and a 5.4:1 leverage ratio support future portfolio growth and per-share returns; confirm the sustainability of dividends against taxable income and cash generation.
- Monitor Agency guarantee and regulatory developments, REIT and Investment Company Act compliance, and the company’s ability to manage interest-rate, hedge, and key-personnel risks.