Annaly Capital Management, Inc. — Q2 2015 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2015; comparisons are with Q2 and the first six months of 2014 unless otherwise noted. Annaly is an externally managed mortgage REIT investing primarily in Agency mortgage-backed securities (MBS), with commercial real estate and middle-market lending businesses. It finances much of its portfolio with repurchase agreements and uses derivatives to manage interest-rate risk.
Financial performance and position
| Metric | Q2 2015 / June 30, 2015 | Comparable / prior period |
|---|---|---|
| Net interest income | $511.3 million | $557.9 million, Q2 2014 |
| GAAP net income attributable to common stockholders | $882.2 million; $0.93 per share | Loss of $353.5 million; loss of $0.37 per share, Q2 2014 |
| Core earnings, non-GAAP | $411.1 million; $0.41 per share | $300.4 million; $0.30 per share, Q2 2014 |
| Economic net interest income, non-GAAP | $371.5 million | $336.9 million, Q2 2014 |
| Net interest margin / spread | 2.01% / 1.64% | 1.57% / 1.26%, Q2 2014 |
| Total assets / total equity | $75.5 billion / $12.6 billion | $88.4 billion / $13.3 billion, Dec. 31, 2014 |
| Repurchase agreements | $57.5 billion | $71.4 billion, Dec. 31, 2014 |
| Common book value per share | $12.32 | $13.23, June 30, 2014 |
For the six months ended June 30, net income was $423.6 million ($0.41 per common share), versus a $538.9 million loss ($0.61 per share) in 2014. Net interest income declined to $901.0 million from $1.089 billion. Core earnings rose to $665.1 million ($0.66 per share) from $540.2 million ($0.53 per share).
Q2 average asset yield was 3.23% and average cost of interest-bearing liabilities was 1.59%. The experienced MBS prepayment rate was 12%, versus 7% in Q2 2014. Common dividends declared were $0.30 per share in Q2 and $0.60 for the first half, unchanged from the comparable 2014 amounts.
Six-month cash flows were $4.6 billion used in operating activities, $12.2 billion provided by investing activities and $7.6 billion used in financing activities; cash ended at $1.8 billion, up $43.9 million. The filing reports substantial gross repo activity within operating cash flows, so this cash-flow measure should be interpreted in context.
At June 30, debt-to-equity leverage was 4.8:1 and economic leverage was 5.9:1; the capital ratio was 14.2%. Unencumbered financial assets totaled $8.3 billion. Reported liquid assets were $69.8 billion, or 92.43% of assets, but included $62.7 billion pledged against existing liabilities. Repurchase agreements had a 149-day weighted-average remaining maturity and a 0.76% weighted-average rate before the reported hedge-adjusted borrowing-cost measure.
Material changes versus prior periods
- Q2 GAAP earnings swung to a profit largely because swap results improved: net realized and unrealized swap gains were $556.3 million, compared with an $818.4 million loss in Q2 2014. The change included no Q2 2015 swap-termination loss, versus a $772.5 million loss in Q2 2014, and higher unrealized gains as forward rates rose.
- Q2 interest income fell $59.6 million year over year, mainly because average interest-earning assets declined by $8.3 billion. For the first half, lower average assets and a 36-basis-point decline in average asset yield contributed to lower interest income.
- Net unrealized losses on available-for-sale securities moved to $355.0 million at June 30 from a $204.9 million net unrealized gain at year-end. Annaly attributed MBS unrealized losses to market conditions, not asset quality, and reported no other-than-temporary impairment.
- The Agency MBS portfolio fell about $14.0 billion from year-end; management said it repositioned part of the exposure into $13.0 billion of TBA derivative notional. Commercial real estate rose to 6.0% of the asset portfolio from 2.0% at year-end.
- Annaly repaid its remaining 4% and 5% Convertible Senior Notes at maturity in February and May 2015, respectively. It also consolidated two Freddie Mac multifamily securitizations, adding about $2.6 billion of loans carried at fair value and $2.4 billion of related fair-value debt.
Outlook, commentary, risks and unusual items
Management said longer-term yields rose and Agency MBS spreads widened materially during the quarter, and described its positioning as cautious. It expected the Federal Reserve could raise its target rate later in 2015, with further hikes priced into the curve. No specific company earnings or dividend guidance is provided.
Key exposures include interest-rate, yield-curve, spread and prepayment changes; repo-market funding and collateral calls; credit risk in commercial real estate, corporate debt and Agency CRT holdings; counterparty performance; and regulatory or REIT-qualification changes. A 25-basis-point rate increase was modeled to reduce portfolio value by 0.5% and raise projected 12-month economic net interest income by 5.2%; a 75-basis-point increase was modeled to reduce portfolio value by 1.9% and raise projected income by 7.4%. These are model estimates, not forecasts, and the filing cautions actual outcomes may differ significantly.
Annaly recorded a $23.0 million goodwill impairment tied to its intention to wind down FIDAC’s investment-advisory operations. Subsequent to quarter-end, FIDAC agreed to transfer Chimera’s management to Chimera; Annaly agreed to sell its approximately 9.0 million Chimera shares for $126.4 million, with closing expected August 17, 2015. Annaly also authorized up to $1 billion of common-share repurchases through December 31, 2016. Management reported no material contingencies and no material changes to the prior 10-K risk factors.
Important facts for investors to verify
- Separate recurring spread and core earnings from GAAP profit driven by volatile swap and fair-value results; core earnings is a company-defined non-GAAP measure.
- Review the movement in book value, AOCI and MBS unrealized losses, as well as the effect of further rate or spread shocks on portfolio value and liquidity.
- Assess repo refinancing, collateral requirements and the proportion of liquidity that is pledged; the reported liquid-asset total is not equivalent to unencumbered cash.
- Track prepayment speeds and premium amortization, commercial real estate watch-list/default exposures, and performance of the newly consolidated securitizations.
- Confirm completion and proceeds of the Chimera share sale, the impact of FIDAC’s advisory wind-down, and any execution or funding of the authorized share-repurchase program.