Business context and reporting period
Annaly Capital Management, Inc. (NYSE: NLY) filed this unaudited Form 10-Q for the quarter ended March 31, 2022. Annaly is an internally managed mortgage REIT investing primarily in Agency mortgage-backed securities (MBS), residential credit assets, and mortgage servicing rights (MSR). It seeks to earn income from investment yields relative to funding and hedging costs.
Key financial metrics
| Metric | Q1 2022 | Q1 2021 or prior-period comparison |
|---|---|---|
| Interest income | $655.9 million | $763.4 million |
| Net interest income | $580.9 million | $687.4 million |
| Net servicing income | $31.0 million | $6.9 million |
| Net income attributable to common stockholders | $1.995 billion; $1.37 per basic share | $1.724 billion; $1.23 per basic share |
| Earnings available for distribution (EAD), a non-GAAP measure | $430.6 million; $0.28 per average common share | $439.5 million; $0.29 per average common share |
| Net interest margin / spread (GAAP) | 3.20% / 3.13% | 3.39% / 3.34% |
| Economic net interest margin excluding PAA, non-GAAP | 2.04% | 1.91% |
| Cash flows | Operating +$2.029 billion; investing -$1.631 billion; financing -$784 million; cash decreased $386 million to $955.8 million | Operating +$1.065 billion; investing +$2.442 billion; financing -$3.628 billion |
| Total assets / total equity | $76.2 billion / $11.5 billion | Assets were $76.8 billion at December 31, 2021; equity was $13.2 billion |
| Repurchase agreements / total GAAP debt | $52.6 billion / $61.0 billion | Repurchase agreements were $54.8 billion at December 31, 2021 |
| Leverage and capital | GAAP leverage 5.3:1; economic leverage 6.4:1; GAAP capital ratio 15.1%; economic capital ratio 13.1% | At December 31, 2021: 4.7:1; 5.7:1; 17.2%; 14.4%, respectively |
Common book value per share was $6.77, compared with $8.95 in Q1 2021. Comprehensive loss attributable to common stockholders was $1.429 billion, despite positive net income, principally reflecting $3.424 billion of other comprehensive losses on available-for-sale securities. Management reported a negative 12% economic return for the quarter.
Material changes versus comparable periods
- GAAP net income rose year over year, driven primarily by $1.642 billion of derivative gains and much smaller CRE divestiture-related losses than in Q1 2021. These gains were substantially offset in comprehensive income by sharp declines in available-for-sale security values.
- Net interest income fell 15% year over year as interest income declined; EAD fell modestly. Management attributed the EAD decline chiefly to lower coupon income from reduced average interest-earning assets, partly offset by higher TBA dollar-roll income and net servicing income.
- Mortgage markets were hit by rapid rate increases and wider MBS spreads. Annaly’s securities portfolio fell to $60.7 billion from $63.7 billion at year-end 2021, while MSR increased to $1.109 billion from $544.6 million.
- GAAP and economic leverage increased from year-end levels as equity declined. Agency MBS represented about 79.5% of the portfolio by balance-sheet value.
- The sale of the commercial real estate business was completed in Q1 2022; the prior-year comparison included a $249.6 million divestiture-related loss and a $139.6 million loan-loss reversal.
Outlook, management commentary, risks and unusual items
- Management described a difficult market: the 10-year Treasury yield rose to 2.34% from 1.51% during the quarter, and the mortgage basis widened to 115 basis points from 56. Annaly said it actively adjusted hedges and coupon exposure, maintained stable Agency MBS notional exposure, and saw portfolio prepayment speeds slow to 16.7% CPR from 23.9% a year earlier.
- Management remained constructive on residential credit, citing housing fundamentals, while recognizing higher mortgage rates, affordability pressures, and volatile credit spreads. It reported $2.5 billion of whole loans securitized through six OBX transactions during the quarter; 87% of the whole-loan portfolio was described as financed through securitization at an average 2.30% funding cost.
- In April, Annaly agreed to sell substantially all of its Middle Market Lending (MML) portfolio to Ares for an approximately $2.4 billion transaction, including third-party-managed assets. Closing was expected by the end of Q2 2022, subject to customary conditions; management expected the transaction to be accretive to book value. The filing cautions that it may not close as expected or deliver anticipated benefits.
- Interest-rate, MBS-spread, prepayment, credit, counterparty, and funding risks are significant. Repurchase agreements generally have short maturities and can trigger same-day collateral calls. At quarter-end, approximately $7.15 billion of financial assets were unencumbered; $58.4 billion of assets and cash were pledged against existing liabilities.
- Annaly’s sensitivity analysis estimated that an immediate 25-basis-point rate increase would raise projected 12-month economic net interest income by 3.2% but reduce portfolio value by 0.3% (1.8% of NAV). A 25-basis-point MBS spread widening was estimated to reduce portfolio value by 1.8% (12.0% of NAV). The company cautioned that actual results could differ materially and the estimates assume no management response.
- Relevant LIBOR tenors are scheduled to cease or become nonrepresentative after June 30, 2023. Annaly had $1.5 billion of LIBOR-linked preferred stock that could remain outstanding beyond that date and was evaluating transition and liability-management options.
- No formal earnings or dividend guidance was provided. The quarterly common dividend was $0.22 per share. The company’s stated policy is generally to distribute 100% of REIT taxable income, subject to REIT requirements.
Most important facts for investors to verify
- Reconcile GAAP net income and large derivative gains with the negative economic return, comprehensive loss, and decline in book value; review how rate and spread moves affected the portfolio.
- Track EAD, net interest income, funding costs, and dividend coverage, noting that EAD is a non-GAAP measure and was $0.28 per share versus a $0.22 dividend for the quarter.
- Assess repo refinancing, collateral-call exposure, unencumbered liquidity, and the implications of 6.4:1 economic leverage.
- Confirm completion, terms, and realized book-value effects of the MML sale, as well as the disposition of any retained or managed assets.
- Monitor Agency MBS spreads, prepayments, MSR valuation assumptions, residential-credit performance, and the LIBOR transition for preferred stock and other contracts.