Annaly Capital Management, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020; balance-sheet comparisons are with December 31, 2019. Annaly is a mortgage REIT and diversified capital manager investing in residential and commercial assets, financed substantially with secured borrowing.
Financial results and position
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Interest income | $584.8 million | $927.6 million | $1,139.8 million | $1,793.8 million |
| Net interest income | $398.8 million | $177.4 million | $450.3 million | $395.9 million |
| Net income (loss) | $856.2 million | ($1,776.4 million) | ($2,784.0 million) | ($2,625.7 million) |
| Common earnings (loss) per share | $0.58 | ($1.24) | ($2.00) | ($1.88) |
| Core earnings per common share, excluding PAA (non-GAAP) | $0.27 | $0.25 | $0.48 | $0.53 |
- Q2 GAAP net income included substantial market-value and disposal gains, alongside $1.52 billion of realized losses on interest-rate swap terminations. Unrealized swap gains were $1.49 billion. For the first half, net losses on swaps were $3.33 billion, including $1.92 billion in realized termination losses.
- Q2 GAAP net interest margin was 1.89%, versus 0.58% a year earlier; first-half margin was 0.90%, versus 0.68%. The company’s non-GAAP net interest margin excluding PAA was 1.88% in Q2 and 1.50% for the first half. Core earnings excluding PAA are non-GAAP and should not be treated as a substitute for GAAP results.
- At June 30, total assets were $93.5 billion, down from $130.3 billion at year-end; total equity was $13.8 billion, down from $15.8 billion. Common book value per share was $8.39; the filing reports $9.33 at June 30, 2019.
- Repurchase agreements were $67.2 billion, compared with $101.7 billion at year-end. Total indebtedness was $75.7 billion. Reported leverage was 5.5:1 and economic leverage 6.4:1, versus 7.1:1 and 7.2:1, respectively, at year-end.
- Cash and cash equivalents were $1.39 billion. The company reported $7.93 billion of unencumbered financial assets and $81.2 billion of liquid assets under its stated measure. Operating cash flow was negative $1.34 billion for the first half; investing cash flow was positive $38.42 billion and financing cash flow negative $37.54 billion.
- Common dividends declared were $0.22 per share for Q2, down from $0.25 a year earlier. The company repurchased 22.9 million common shares for $143.3 million during the first half.
Material changes and notable items
- The portfolio contracted substantially, including a $36.1 billion reduction in Agency MBS excluding assets pledged or transferred to securitization vehicles. Management attributed the balance-sheet reduction primarily to first-quarter portfolio repositioning.
- Annaly completed its internalization on June 30, moving from external to internal management for nominal cash consideration of $1. The management agreement ended, eliminating future management fees and expense reimbursements to the former manager. The filing does not quantify realized long-term cost savings.
- First-half loan-loss provisions were $168.1 million, versus $5.7 million in the prior-year period. Adoption of CECL reduced beginning retained earnings by $39.6 million. Commercial real estate exposures included material office, retail, and hotel concentrations; management reported pandemic-related stress and elevated credit uncertainty.
- Mortgage servicing rights fell to $227.4 million from $378.1 million at year-end, with a first-half fair-value decline driven principally by valuation inputs and realized cash flows.
Outlook, risks and contingencies
- Management described the recovery from COVID-19 as highly uncertain. It viewed Agency MBS as the most attractive opportunity, anticipated potential further spread tightening, and expected credit allocation to remain at the lower end of recent years’ levels while evaluating selective opportunities. These are expectations, not firm financial guidance.
- Management said it aimed to preserve liquidity, use conservative leverage and dividend policies, and operate within conservative risk parameters. Its general economic-leverage objective was below 10:1; actual economic leverage was 6.4:1 at quarter-end.
- Key risks include COVID-19 effects on borrowers, tenants and middle-market companies; collateral value declines, repo margin calls and refinancing or funding availability; interest-rate, yield-curve, spread and prepayment changes; credit losses; counterparty performance; and REIT and regulatory compliance. Repo financing is short-term: weighted-average remaining maturity was 74 days, and 22% of repo balances matured in one day.
- Rate sensitivity estimates showed economic net interest income rising 4.3% under an immediate 25-basis-point rate increase and falling 7.5% under a 25-basis-point decrease. A 25-basis-point widening in MBS spreads was estimated to reduce portfolio value by 1.3%, or 8.7% of NAV. The filing cautions that actual results could differ materially.
- Management reported no material pending legal proceedings or material contingencies at quarter-end. A subsequent July filing-period update noted a $250 million residential-loan credit facility and a $489.4 million residential-loan securitization. In August, Annaly amended its at-the-market sales agreements, permitting up to approximately $675.3 million of common-stock sales.
Important facts for investors to verify
- Reconcile the sharp difference between Q2 GAAP profit and first-half GAAP loss, including the timing and economics of swap terminations, derivative marks and investment sales.
- Review the sustainability of core earnings, dividend coverage and book value, while accounting for the non-GAAP definition and premium-amortization adjustments.
- Assess repo rollover, collateral and margin-call exposure, unencumbered liquidity, and the reported leverage measures under renewed market stress.
- Track CECL allowances and borrower performance in commercial real estate and corporate lending, especially office, retail and hotel exposures.
- Evaluate the effects of internalization on recurring expenses and the potential dilution and capital impact of the amended at-the-market share-sale program.