ANNALY CAPITAL MANAGEMENT INC annual report, FY2020

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Annaly Capital Management, Inc. — FY2020 Form 10-K

Reporting period: Fiscal year ended December 31, 2020. This is an annual report, not a standalone fourth-quarter filing. Annaly is an internally managed mortgage REIT investing across Agency MBS, residential credit, commercial real estate and middle-market lending.

Financial performance and position

  • GAAP results: Interest income was $2.23 billion, down from $3.79 billion in 2019; interest expense fell to $899 million from $2.78 billion. Net interest income increased to $1.33 billion from $1.00 billion.
  • Profitability: GAAP net loss was $890 million, or $0.73 per diluted common share, versus a $2.16 billion loss, or $1.60 per share, in 2019. Core earnings excluding premium amortization adjustment (a non-GAAP measure) were $1.70 billion, or $1.10 per common share, compared with $1.58 billion, or $1.00, in 2019.
  • Margins and returns: GAAP net interest margin was 1.46%, versus 0.83%; non-GAAP net interest margin excluding PAA was 1.74%, versus 1.32%. Average yield on interest-earning assets excluding PAA declined to 2.90% from 3.36%, while average economic funding cost declined to 1.34% from 2.25%. GAAP return on average equity was negative 6.31%; non-GAAP core return on average equity excluding PAA was 12.03%.
  • Cash flow: Operating cash flow was $528 million, compared with negative $1.20 billion in 2019. Investing cash flow was positive $40.35 billion, largely reflecting portfolio sales and principal repayments; financing cash flow was negative $41.49 billion. Cash and cash equivalents ended the year at $1.24 billion, down from $1.85 billion.
  • Balance sheet and debt: Total assets were $88.46 billion, down from $130.30 billion; total equity was $14.02 billion, down from $15.80 billion. Total debt was approximately $71.86 billion, including $64.83 billion of repurchase agreements. Year-end debt-to-equity leverage was 5.1:1 and economic leverage was 6.2:1, compared with 7.1:1 and 7.2:1, respectively, in 2019. Capital ratio rose to 13.6% from 12.0%.
  • Liquidity and funding: Repurchase agreements had a 64-day weighted average maturity and a 0.32% year-end rate (0.35% average for the quarter). Unencumbered financial assets were $8.71 billion; the filing’s $78.58 billion liquid-assets measure includes assets already pledged as collateral and should not be read as freely available cash.
  • Book value and dividends: Common book value per share was $8.92, versus $9.66 a year earlier. Common dividends declared were $0.91 per share, down from $1.05; the company reported $1.4 billion of aggregate common and preferred dividends returned during 2020. The board authorized a new common-share repurchase program of up to $1.5 billion through December 31, 2021.

Material changes versus 2019

  • Annaly reduced Agency MBS exposure amid the March 2020 market disruption. Agency MBS remained 93% of portfolio composition by assets, while Agency received 78% of allocated equity, compared with 74% in 2019. Total assets declined by about $41.8 billion.
  • Lower short-term rates and reduced average borrowings cut funding expense; non-GAAP net interest margin excluding PAA improved. Higher prepayments and lower asset yields weighed on asset income and increased premium amortization.
  • Realized and unrealized losses improved to $2.06 billion from $3.01 billion. The 2020 figure included $3.03 billion of net losses on interest-rate swaps, partly offset by $662 million of gains on investment disposals and $756 million of gains on other derivatives.
  • Loan-loss provisions rose to $147.6 million from $16.6 million. The year-end allowance for loan losses was $169.5 million; adoption of the CECL standard reduced opening 2020 retained earnings by $39.6 million.
  • Annaly completed its internalization on June 30, 2020, acquiring its former manager for nominal consideration, ending management fees and assuming employee and employer responsibilities. Management cited cost savings; 2020 G&A was $239 million versus $302 million.

Outlook, commentary and risks

  • Management reported a 5.1% economic return for Q4 and 1.8% for full-year 2020. It described financing conditions as highly favorable and noted increased activity in residential credit and middle-market lending. No specific earnings or dividend guidance was provided.
  • Management expected COVID-19-related conditions to continue during 2021. The recovery, borrower payment performance, commercial property income and market liquidity remained uncertain. Management also noted that vaccine deployment and consumer balance sheets could support recovery, while emphasizing meaningful uncertainty.
  • Key exposures include repo funding availability, margin calls, leverage, interest-rate and mortgage-spread movements, prepayment and reinvestment risk, hedging effectiveness, and credit deterioration in residential credit, commercial real estate and middle-market loans. In March 2020, Annaly experienced margin calls substantially above historical norms and counterparties increased haircuts on credit assets; those requirements later moved closer to pre-pandemic levels.
  • Interest-rate sensitivity estimates showed projected economic net interest income rising 7.1% under an immediate +25 bp shock and falling 11.2% under a -25 bp shock. A +25 bp MBS spread shock was estimated to reduce NAV by 1.8%. These model estimates assume no management response and actual outcomes may differ materially.
  • LIBOR transition is an additional operational and valuation risk. Annaly had begun transition planning and reported that most U.S. LIBOR tenors were extended through June 2023; the timing and effects of contract changes remain uncertain.
  • Unusual items include $1.9 billion of realized losses on swap termination or maturity, $1.2 billion of net unrealized gains on available-for-sale securities recorded in other comprehensive income, and a $104.8 million realized gain from deconsolidating a multifamily securitization. The auditor issued unqualified opinions on the financial statements and internal controls; the audit identified loan-loss allowances and Agency MBS premium amortization as critical audit matters.

Important facts for investors to verify

  • Reconcile GAAP losses with non-GAAP core earnings and review the company’s definitions and reconciliation, particularly the treatment of PAA, derivatives and realized swap losses.
  • Check the quarterly dividend rate and coverage against current taxable income, cash generation, capital needs and preferred-stock dividend obligations; the filing provides no assurance of a minimum dividend.
  • Assess available unencumbered liquidity, repo maturities, collateral haircuts and potential margin calls; distinguish pledged liquid assets from unencumbered resources.
  • Review commercial and corporate loan risk ratings, allowances, modifications and concentration exposures, including the $129.9 million commercial and $39.6 million corporate loan-loss allowances.
  • Monitor Agency MBS prepayment speeds, premium amortization, interest-rate and spread sensitivity, and the status of LIBOR-linked contracts and hedges.
  • Track the effects of internalization on operating costs and performance, and any use of the $1.5 billion share-repurchase authorization.