Annaly Capital Management, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Financial statements are unaudited. Annaly is an externally managed mortgage REIT investing in Agency and credit-related residential assets, commercial real estate and corporate debt.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Interest income | $558.7 million | $450.7 million | $1,403.9 million | $1,594.1 million |
| Net interest income | $384.5 million | $340.4 million | $929.6 million | $1,241.3 million |
| Net income (loss) attributable to Annaly | $731.2 million | ($627.3 million) | ($414.8 million) | ($203.5 million) |
| Common earnings (loss) per share | $0.70 | ($0.68) | ($0.50) | ($0.27) |
| Core earnings per common share (non-GAAP) | $0.29 | $0.30 | $0.87 | $0.97 |
| Net interest margin | 1.40% | 1.27% | 1.12% | 1.54% |
Q3 GAAP results included a $72.6 million bargain purchase gain on Hatteras and favorable changes in swap and trading-asset valuations. Unrealized swap gains were $256.5 million, versus losses of $822.6 million in Q3 2015. Core earnings, which exclude specified market-value and other items, provide a different view of recurring performance and are non-GAAP.
- Margins and funding: Q3 core net interest margin was 1.42%, versus 1.65% a year earlier; nine-month core net interest margin was 1.50%, versus 1.68%. Q3 economic cost of interest-bearing liabilities was 1.57%, compared with 1.65% in Q3 2015.
- Cash flow: For the nine months, operating cash flow was $833.1 million, investing cash flow was $2.21 billion and financing cash flow was negative $2.43 billion. Cash and cash equivalents ended at $2.38 billion, up from $1.77 billion at year-end 2015.
Financial position and material changes
- Total assets were $86.9 billion at September 30, up from $75.2 billion at December 31, 2015. Total equity was $13.26 billion; stockholders’ equity was $13.25 billion.
- Repurchase agreements were $61.78 billion, versus $56.23 billion at year-end; total indebtedness was $69.63 billion. Debt-to-equity was 5.3:1 and economic leverage was 6.1:1. The capital ratio was 13.3%.
- Cash pledged as collateral was $2.27 billion; reported unencumbered financial assets were $8.04 billion. The filing reports liquid assets equal to 92.29% of total assets, while noting that most of those assets were already pledged as collateral.
- Net unrealized gains in accumulated other comprehensive income rose to $1.12 billion from a $377.6 million loss at year-end, substantially reflecting changes in available-for-sale investment values.
- Common book value per share was $11.83. Annaly declared common dividends of $0.30 per share for Q3; $0.90 per share had been declared for the first nine months.
Acquisition, outlook and risks
- Annaly completed its acquisition of Hatteras on July 12, 2016. Consideration to Hatteras common shareholders was approximately $1.5 billion; Annaly issued 93.9 million common shares. The acquisition added adjustable-rate mortgage assets, residential mortgage loans and mortgage servicing rights (MSRs), and resulted in a $72.6 million bargain purchase gain. Annaly recorded $48.9 million of acquisition transaction costs for the first nine months, in addition to other acquisition-related expenses.
- Management described Q3 market conditions as generally supportive, citing low volatility, strong demand for mortgage assets and lower secured funding costs relative to swap payments. It expected repo-to-LIBOR spreads to narrow somewhat from elevated levels. The filing gives no specific earnings or dividend guidance.
- Key exposures include interest-rate and yield-curve movements, mortgage prepayments, funding availability, collateral and margin calls, credit risk, counterparty risk, and fair-value estimation. In the company’s modeled scenarios, a 25-basis-point rate increase raised projected economic net interest income by 5.4% but reduced estimated portfolio value by 0.3% (1.7% of NAV); a 25-basis-point decrease reduced projected income by 8.2% while increasing estimated portfolio value by 0.2% (1.3% of NAV). These are model estimates, not forecasts.
- Annaly cautioned that Hatteras integration may take longer or deliver fewer benefits than expected and identified limited experience with servicing platforms and MSRs as additional operational and regulatory risks. MSRs were valued at $492.2 million and classified as Level 3, relying on significant unobservable valuation assumptions.
- Management reported no impaired, nonaccrual or defaulted commercial loans and no material pending legal proceedings at September 30. It reported no material contingencies and stated that the likelihood of payments under specified joint-venture guarantees was remote.
Important facts for investors to verify
- Reconcile Q3 GAAP earnings to recurring performance: the quarter included the Hatteras bargain purchase gain and substantial derivative and trading-asset valuation changes, while nine-month GAAP results remained a loss.
- Review core earnings and core margin trends, including the effects of premium amortization and prepayment assumptions; core measures are non-GAAP.
- Assess leverage, repo maturities, collateral requirements and genuinely available liquidity, distinguishing unencumbered assets from assets already pledged.
- Track Hatteras integration, acquisition-related costs, share issuance and the performance, valuation and regulatory requirements of the MSR business.
- Evaluate rate, spread and prepayment sensitivities alongside credit exposures in residential credit, commercial real estate and corporate debt.