Annaly Capital Management, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Annaly is an externally managed mortgage REIT investing primarily in Agency mortgage-backed securities (MBS), with additional commercial real estate (CRE), residential credit, and middle-market lending businesses. Figures below are in U.S. dollars; financial statement amounts are generally in millions unless otherwise indicated.
Financial performance and position
| Metric | Q3 2015 / September 30, 2015 | Comparable period / prior date |
|---|---|---|
| Interest income | $450.8 million | $644.6 million in Q3 2014 |
| Net interest income | $340.5 million | $517.6 million in Q3 2014 |
| Net income (loss) | $(627.5) million; $(0.68) per common share | $354.9 million; $0.36 per share in Q3 2014 |
| Nine-month net income (loss) | $(203.9) million; $(0.27) per common share | $(184.0) million; $(0.25) per share in 9M 2014 |
| Core earnings (non-GAAP) | $217.6 million; $0.21 per share | $300.7 million; $0.31 per share in Q3 2014 |
| Normalized core earnings (non-GAAP) | $300.7 million; $0.30 per share | $334.6 million; $0.33 per share in Q3 2014 |
| Total assets | $75.3 billion | $88.4 billion at December 31, 2014 |
| Total liabilities / stockholders’ equity | $63.1 billion / $12.3 billion | $75.0 billion / $13.3 billion at December 31, 2014 |
| Cash and cash equivalents | $2.24 billion, including $2.10 billion pledged as collateral | $1.74 billion at December 31, 2014 |
| Repurchase agreements | $56.45 billion; weighted-average remaining maturity 147 days | $71.36 billion at December 31, 2014 |
| Leverage | Debt-to-equity 4.8:1; economic leverage 5.8:1 | 5.4:1 and 5.4:1, respectively, at December 31, 2014 |
| Common dividend | $0.30 per share for Q3; $0.90 declared for 9M | $0.30 per quarter and $0.90 for 9M 2014 |
For the nine months, operating activities used $3.17 billion of cash, investing activities provided $13.31 billion, and financing activities used $9.65 billion. Cash increased by $496 million to $2.24 billion. These cash-flow totals include substantial securities financing and portfolio transaction activity.
Net interest margin was 1.24% in Q3, versus 1.61% in Q3 2014; normalized net interest margin was 1.62%, versus 1.74%. Average interest-earning assets fell to $74.7 billion from $86.3 billion, while their average yield declined to 2.41% from 2.99%. The average cost of interest-bearing liabilities was 1.65%, compared with 1.64%.
Material changes versus comparable periods
- Q3 GAAP results swung from profit to a substantial loss, principally reflecting an $822.6 million unrealized loss on interest rate swaps, compared with a $98.6 million unrealized gain in Q3 2014. Management attributed the change to falling forward rates.
- Q3 interest income declined $193.8 million year over year, driven by lower average asset balances and yields. Management also cited increased premium amortization, with experienced Agency MBS prepayment speeds rising to 12% from 9%.
- Net interest income declined $177.1 million year over year in Q3. Normalized core earnings also declined, to $300.7 million from $334.6 million.
- Total assets fell by $13.0 billion from year-end 2014. Agency MBS decreased $15.8 billion to $65.8 billion, while the portfolio was repositioned partly into $14.1 billion of TBA derivative purchase contracts and expanded CRE investments, including consolidated securitization assets.
- Repurchase-agreement borrowings fell $14.9 billion from year-end. The 4% and 5% convertible senior notes matured and were repaid in February and May 2015; no convertible notes remained outstanding at quarter-end.
- Stockholders’ equity declined $1.05 billion from year-end. Accumulated other comprehensive income rose to $262.9 million from $204.9 million, while accumulated deficit increased to $3.70 billion from $2.59 billion.
Outlook, management commentary, risks and unusual items
- Management gave no specific earnings, spread, or dividend guidance. It said it remained cautious amid rate and spread volatility and the prospect of Federal Reserve rate increases, while noting uncertainty around financial and housing regulatory reform.
- Management expects to continue financing Investment Securities largely through repurchase agreements, with possible use of FHLB advances, securitizations, mortgages payable, and other term financing. It stated that it limits borrowing to preserve unused capacity and liquidity.
- Liquidity resources included $2.24 billion of cash and $7.98 billion of unencumbered financial assets. The filing reports liquid assets equal to 91.53% of total assets, but notes that $62.7 billion of the liquid assets were pledged as collateral. Repurchase agreements generally permit same-day margin calls.
- Interest-rate and spread risks remain significant. In management’s modeled scenarios, a 75-basis-point rate increase was associated with a 1.5% decline in portfolio value and an 8.7% decline relative to NAV; a 25-basis-point widening in MBS spreads was associated with a 1.4% portfolio-value decline and an 8.2% decline relative to NAV. These are scenario estimates, not forecasts.
- Q3 market conditions included substantial interest-rate and spread volatility. Management identified funding availability, collateral values, prepayments, interest rates, mortgage spreads, counterparty performance, and credit exposure in CRE, CRT, non-Agency MBS, and corporate debt as important risks.
- CRE activity included a $592 million financing for a New York City multifamily portfolio, including a $480 million senior loan classified as held for sale. At quarter-end, one CRE loan with $13.0 million of principal was in default but classified as recovery expected; $9.3 million was on the watch list, and no CRE loans were classified as impaired. No loan-loss allowance was recorded.
- The company recorded a $23.0 million goodwill impairment related to its intention to wind down FIDAC’s investment-advisory operations. Chimera repurchased Annaly’s approximately 9.0 million Chimera shares for $126.4 million, and the Chimera management agreement ended in August 2015.
- The board authorized up to $1.0 billion of common-share repurchases through December 31, 2016; no shares were repurchased during Q3. Management reported no material contingencies or material changes to the risk factors in its latest Form 10-K. Disclosure controls were judged effective.
Most important facts for investors to verify
- Reconcile GAAP losses with core and normalized core earnings, including the treatment of swap marks, TBA dollar-roll income, and premium-amortization adjustments. These non-GAAP measures are not substitutes for GAAP results.
- Assess the sensitivity of equity and earnings to interest rates, MBS spreads, prepayment assumptions, and swap valuation, and confirm the related collateral and margin-call capacity.
- Review the maturity, renewal, counterparty concentration, and haircut terms of the $56.45 billion repurchase-agreement funding base, alongside the amount and availability of unencumbered assets.
- Evaluate the growth and credit quality of CRE and securitized VIE exposures, including the New York multifamily financing, the defaulted recovery loan, and the FREMF trust collateral and non-recourse debt.
- Compare common dividends with REIT taxable income and cash-generation capacity; GAAP net income and the company’s stated distribution policy do not by themselves establish dividend coverage.
- Monitor the FIDAC wind-down, the loss of Chimera advisory fees, and the execution and potential effects of the authorized share-repurchase program.