Annaly Capital Management, Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual filing, not a standalone fourth-quarter report; quarterly figures are noted where relevant. Annaly is an externally managed mortgage REIT focused on investment income and capital preservation.
Financial results and condition
| Metric | 2016 | 2015 |
|---|---|---|
| Interest income | $2.211 billion | $2.171 billion |
| Interest expense | $657.8 million | $471.6 million |
| Net interest income | $1.553 billion | $1.699 billion |
| Realized and unrealized gains (losses) | $84.2 million | $(1.021) billion |
| Net income attributable to Annaly | $1.434 billion | $466.6 million |
| Net income available to common stockholders | $1.351 billion; $1.39 per share | $394.6 million; $0.42 per share |
| Core earnings, revised definition including premium amortization adjustment | $1.195 billion; $1.15 per share | $1.212 billion; $1.20 per share |
| Total assets | $87.9 billion | $75.2 billion |
| Total equity | $12.6 billion | $11.9 billion |
| Common book value per share | $11.16 | $11.73 |
| Common dividends declared per share | $1.20 | $1.20 |
- Margins and returns: Net interest margin was 1.48%, down from 1.61%; net interest spread was 1.19%, down from 1.23%. Annualized return on average equity was 11.75%, versus 3.68%, reflecting the improvement in reported gains as well as operating results.
- Cash flow: Cash provided by operating activities was $6.86 billion, investing activities used $2.06 billion, and financing activities used $5.02 billion. Cash and cash equivalents fell $229.5 million to $1.54 billion. Operating cash flow includes substantial matched-book repo activity; it should not be read as a simple measure of recurring earnings.
- Debt and leverage: Total indebtedness was $73.05 billion, including $65.22 billion of repurchase agreements. Year-end leverage was 5.8:1 and economic leverage 6.4:1, up from 5.1:1 and 6.0:1, respectively. The capital ratio declined to 13.1% from 13.7%. Management’s stated economic leverage ceiling was generally less than 10:1.
- Liquidity: Cash was $1.54 billion and unencumbered financial assets were $6.79 billion. Repo agreements had a 96-day weighted-average maturity; about 44% of repo balances matured within 2–29 days. The filing’s 96.8% liquid-assets-to-total-assets measure includes assets already pledged as collateral and is not equivalent to unencumbered liquidity.
- Portfolio: Agency mortgage-backed securities represented 89.3% of portfolio value at year-end. Agency MBS and debentures accounted for 80% of stockholders’ equity allocation; residential credit, commercial real estate, and corporate debt made up the balance. Repurchase agreements and other secured financing collateralized 95% of debt.
Material changes versus 2015
- Reported net income rose substantially, primarily because swap losses were lower and trading, fair-value, and acquisition-related gains improved. Net losses on interest-rate swaps narrowed to $338.4 million from $975.8 million; trading-asset gains increased to $230.6 million from $29.6 million.
- Net interest income fell $145.9 million as financing costs rose. Average cost of interest-bearing liabilities was 1.62%, while average yield on interest-earning assets declined to 2.81% from 2.87%; core net interest margin also compressed.
- Assets increased by $12.7 billion, primarily reflecting the Hatteras acquisition and growth in Agency MBS. The acquisition closed July 12, 2016 for approximately $1.5 billion of consideration to Hatteras common stockholders, including about $1.0 billion in Annaly shares, $521.1 million in cash, and 93.9 million Annaly shares issued. Annaly also assumed/conveyed preferred shares as part of the transaction.
- The Hatteras purchase accounting generated a $72.6 million bargain-purchase gain. Annaly reported $48.9 million of acquisition transaction expenses; additional consulting and replacement-award costs were also recognized. The filing attributes $295.8 million of 2016 net income to Hatteras after closing.
- Book value per common share declined 4.9% to $11.16. Net unrealized losses on available-for-sale investments widened to $1.086 billion from $377.6 million, largely reflecting market conditions; management said Agency securities were not other-than-temporarily impaired.
- Experienced Agency MBS prepayment speed increased to 13.3% from 10.6%, raising premium-amortization exposure. Adjustable-rate residential securities grew to 16.5% of residential investment securities principal from 5.8%, principally due to Hatteras.
Outlook, commentary, risks, and unusual items
- Management provided no specific earnings or dividend guidance. It described the portfolio as defensively positioned amid political and policy uncertainty and cited diversification and conservative leverage as intended sources of resilience. It expected to continue financing residential securities primarily through repurchase agreements.
- Common dividends remained $0.30 per quarter, or $1.20 for 2016. The board has discretion over distributions; REIT rules generally require distribution of at least 90% of taxable income, which may differ materially from GAAP earnings and cash flow.
- Management identified rising short-term rates, changes in yield curve and mortgage spreads, prepayments, asset valuations, and the availability and cost of repo funding as key sensitivities. Falling collateral values can trigger same-day margin calls and forced asset sales. The filing’s modeled +50-basis-point rate shock showed a 2.3% increase in projected 12-month economic net interest income but a 7.3% decline in portfolio value relative to NAV; results assume no management actions and may differ materially from actual outcomes.
- Other significant risks include counterparty and derivative exposure, credit losses in non-Agency and commercial assets, concentration and refinancing risk, and changes to REIT or Investment Company Act requirements. Captive-insurer subsidiary Truman’s FHLB membership is scheduled to end in February 2021 under the FHFA rules.
- At year-end, interest-rate swaps had a net negative fair value of approximately $1.4 billion. Derivatives with specified termination triggers had a net liability fair value of approximately $1.3 billion and were reported as fully collateralized.
- Annaly reported no material pending legal proceedings and no material contingencies at year-end. The financial statement audit and the auditor’s internal-control opinion were unqualified; however, management’s internal-control evaluation excluded certain acquired subsidiaries representing $1.1 billion of assets and $178.9 million of 2016 net income.
Important facts for investors to verify
- Reconcile core earnings and per-share figures using the revised definition: the filing’s reconciliation gives $1.195 billion and $1.15 per share for 2016, versus $1.212 billion and $1.20 for 2015. Core earnings are non-GAAP and should be compared with GAAP results and cash distributions.
- Assess the sustainability of the $1.20 annual common dividend against taxable income, financing costs, and the decline in book value per share; REIT taxable income is not the same as GAAP income.
- Review repo maturity concentration, unencumbered collateral, haircuts, counterparty exposure, and potential margin calls—not just the headline liquid-assets ratio.
- Evaluate the impact of higher funding rates and faster prepayments on net interest margin, premium amortization, hedge effectiveness, and book value.
- Track integration and performance of Hatteras-related assets, particularly adjustable-rate MBS and MSRs, whose fair value depends on significant assumptions.
- Monitor the widening available-for-sale unrealized loss position, credit performance in residential and commercial portfolios, and the FHLB funding transition before February 2021.