Annaly Capital Management, Inc. — Q2 2017 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2017; unaudited. Annaly is an externally managed REIT investing in residential and commercial assets, including Agency and non-Agency mortgage securities, mortgage loans, servicing rights, commercial real estate and corporate debt. The results include Hatteras, acquired July 12, 2016, which affects comparability with the prior-year period.
Financial performance and position
| Metric | Q2 2017 / June 30, 2017 | Comparable period / prior balance |
|---|---|---|
| Interest income | $537.4 million | Q2 2016: $457.1 million |
| Interest expense; net interest income | $222.3 million; $315.1 million | Q2 2016: $152.8 million; $304.4 million |
| Net income attributable to Annaly | $14.6 million; common-stockholder loss $8.8 million, or $(0.01) per share | Q2 2016: Annaly loss $278.1 million; common-stockholder loss $296.1 million, or $(0.32) per share |
| Core earnings, excluding PAA (non-GAAP) | $332.6 million, or $0.30 per common share | Q2 2016: $282.2 million, or $0.29 per share |
| Net interest spread / margin, excluding PAA (non-GAAP) | 1.19% / 1.53% | Q2 2016: 1.27% / 1.54% |
| Total assets; total equity | $85.0 billion; $12.6 billion | December 31, 2016: $87.9 billion; $12.6 billion |
| Repurchase agreements; total indebtedness | $62.5 billion; $70.0 billion | Repurchase agreements at year-end: $65.2 billion |
| Cash and cash equivalents | $700.7 million | December 31, 2016: $1.54 billion |
| Cash flows, six months ended June 30 | Operating $(62.3) million; investing $2.79 billion; financing $(3.57) billion | 2016: operating $1.87 billion; investing $58.3 million; financing $(958.2) million |
| Common book value per share; common dividend | $11.19; $0.30 declared for Q2 | Book value at June 30, 2016: $11.50; Q2 2016 dividend: $0.30 |
At quarter-end, reported leverage was 5.6:1 and economic leverage 6.4:1; capital ratio was 13.2%. Repurchase agreements had a 1.91% weighted-average borrowing rate after swaps and 88-day weighted-average remaining maturity. Unencumbered financial assets were $7.46 billion. Management reported no impaired, nonaccrual or defaulted loans in the disclosed loan portfolios and no allowance for loan losses.
Material changes versus prior periods
- Q2 net income improved substantially from the prior-year loss, mainly because interest-rate-swap losses were smaller and fair-value investment results improved; trading-asset gains declined to a loss.
- Six-month net interest income rose to $704.4 million from $545.1 million. GAAP net income was $454.9 million versus a $1.15 billion loss in first-half 2016, largely reflecting far smaller unrealized swap losses. These comparisons are affected by market movements and the Hatteras acquisition.
- Residential Investment Securities fair value declined to $75.8 billion from $77.7 billion at year-end; residential mortgage loans rose to $779.7 million from $342.3 million. MSRs fell to $605.7 million from $652.2 million.
- Common book value per share was $11.19 versus $11.50 in Q2 2016. Net unrealized loss in accumulated other comprehensive income improved to $850.8 million from $1.09 billion at year-end.
- Common dividends declared were $0.60 per share for the first half, unchanged from first-half 2016. Interest expense increased, reflecting higher average borrowings and repo rates.
Outlook, commentary, risks and unusual items
- Management said it considered Agency MBS valuations attractive, noted a $4.6 billion increase in Agency MBS exposure including TBAs during Q2, and expected to continue a diversified strategy with conservative portfolio positioning. The filing gives no specific earnings or dividend guidance.
- Management described the quarter’s rate environment as largely range-bound and noted the Federal Reserve’s June rate increase and stated plan to begin gradual balance-sheet normalization. Higher financing costs, rate and spread moves, mortgage prepayments, collateral calls and reduced funding availability could pressure earnings, liquidity or book value.
- Illustrative modeled sensitivity: an immediate +75 basis-point rate shock was estimated to reduce 12-month economic net interest income 4.6% and portfolio value 1.5% (9.9% of NAV); a +25 basis-point MBS spread shock was estimated to reduce portfolio value 1.5% (10.2% of NAV). Management cautioned actual results could differ materially.
- Agency MBS unrealized losses were attributed to market conditions rather than asset quality; substantially all Agency MBS were AAA-rated or implied AAA-rated and Agency-guaranteed. MSR valuation is Level 3 and depends on significant unobservable assumptions.
- Subsequent events: Annaly announced a pending sale of Pingora Holdings, expected to close in Q3 subject to conditions. It raised approximately $816 million gross from common-share offerings completed in July, issued $700 million gross of Series F preferred stock, and announced redemption of Series A preferred stock for $25 per share plus accrued dividends. These events occurred after quarter-end.
- The filing reported no material pending legal proceedings, no material contingencies, and no material changes to previously disclosed risk factors. Management concluded disclosure controls were effective and reported no materially affecting change in internal control over financial reporting.
Key facts for investors to verify
- Reconcile GAAP common-stockholder loss and the $0.30 non-GAAP core earnings per share; review Annaly’s core-earnings definition and limitations.
- Assess repo funding concentration, short maturities, collateral requirements and the distinction between $700.7 million reported cash and variation margin netted against swaps.
- Review the sensitivity of earnings and equity to interest rates, MBS spreads, prepayments and financing costs, including the disclosed model assumptions.
- Track the Pingora sale, July capital raises and Series A redemption, and their effects on shares outstanding, preferred costs and capital allocation.
- Evaluate Hatteras-related comparability and credit/valuation exposures in residential credit, commercial lending and Level 3 MSRs.