Business context and reporting period
Annaly Capital Management, Inc. is an externally managed mortgage REIT. This Form 10-K covers the fiscal year ended December 31, 2015; it is an annual report, not a standalone fourth-quarter filing. Annaly primarily invests in Agency mortgage-backed securities (MBS), using borrowing and derivatives, and is expanding into residential credit, commercial real estate and middle-market corporate debt.
Key financial metrics
| Metric | FY 2015 | FY 2014 |
|---|---|---|
| Interest income | $2.171 billion | $2.632 billion |
| Interest expense / net interest income | $471.6 million / $1.699 billion | $512.7 million / $2.120 billion |
| GAAP net income (loss) | $465.7 million; $0.42 per basic common share | $(842.3) million; $(0.96) per share |
| Net income available to common stockholders | $394.6 million | $(914.1) million |
| Core earnings (non-GAAP) | $1.212 billion; $1.20 per average basic share | $1.148 billion; $1.14 per share |
| Normalized core earnings (non-GAAP) | $1.285 billion; $1.28 per average basic share | $1.173 billion; $1.16 per share |
| Net interest margin / normalized net interest margin (non-GAAP) | 1.61% / 1.69% | 1.54% / 1.57% |
| Return on average equity | 3.68% | (6.49%) |
| Common book value per share | $11.73 | $13.10 |
At year-end, total assets were $75.2 billion, total equity $11.9 billion and cash and cash equivalents $1.77 billion. Repurchase agreements totaled $56.2 billion; total indebtedness was $61.0 billion. Leverage was 5.1:1 and economic leverage 6.0:1, versus 5.4:1 for both measures in 2014. The capital ratio fell to 13.3% from 15.1%. Reported operating cash flow was $(3.17) billion, investing cash flow was $11.67 billion, and financing cash flow was $(8.47) billion; cash increased $28 million. Operating cash flow includes substantial repo activity through broker-dealer subsidiary RCap, so it should not be read as a conventional operating-cash measure without reviewing the cash-flow details.
Material changes versus the prior comparable period
- GAAP results returned to profit from a 2014 loss, largely as interest-rate-swap losses narrowed to $975.8 million from $2.55 billion and trading-asset results improved. Interest income nevertheless declined $461.7 million, mainly reflecting a smaller average asset base and higher premium amortization.
- Core and normalized core earnings increased, while GAAP net interest income declined. Normalized average asset yield fell to 2.96% from 3.17%; average funding cost declined to 1.64% from 1.88%.
- Total assets contracted to $75.2 billion from $88.4 billion. Agency MBS and debentures were 90.5% of portfolio value at year-end, down from 97.8%; residential credit rose to 1.8%, commercial real estate to 7.0%, and corporate debt to 0.7%.
- Commercial real estate investment exposure expanded, including new securitized loan assets. Agency MBS exposure was repositioned partly into TBA contracts; year-end TBA purchase notional was $13.8 billion.
- Net unrealized losses on available-for-sale investments changed to $377.6 million from a $204.9 million net unrealized gain. Common book value per share decreased $1.37.
- Common dividends remained $1.20 per share for the year, or $0.30 each quarter, compared with $1.50 in 2013. Annaly repurchased 11.95 million common shares for $114.3 million in 2015.
Outlook, commentary, risks and unusual items
Management provided no specific earnings or dividend guidance. It described a cautious stance amid global economic turbulence, heightened interest-rate and spread volatility, and uncertainty about the Federal Reserve’s future rate path. The Fed raised its target range by 25 basis points in December 2015, its first increase since 2006. Annaly’s February 2016 capital-allocation policy update broadened flexibility among approved asset classes.
- Funding and liquidity: The business depends heavily on secured short-term repo funding and collateral values. Margin calls, higher haircuts, reduced lender availability or forced asset sales could impair liquidity. Repo weighted-average remaining maturity was 151 days; weighted-average haircut was approximately 5%. The filing reported $7.34 billion of unencumbered financial assets, while 93.4% of total assets met the company’s broader liquid-asset definition, which includes pledged assets.
- Interest-rate and prepayment exposure: Rates, yield-curve shifts, MBS spreads and mortgage prepayments can affect both earnings and book value. A 25-basis-point rate increase was modeled to raise 12-month economic net interest income by 10.1% but reduce portfolio value by 0.4% (2.1% of NAV); a 25-basis-point MBS spread widening was modeled to reduce portfolio value by 1.4% (8.2% of NAV). These are static scenarios, not forecasts, and exclude management responses.
- Credit and diversification: CRT, non-Agency MBS, commercial loans, real estate and corporate debt carry credit, valuation and liquidity risks not present to the same extent in Agency MBS. In the commercial loan portfolio, $234.6 million was classified as special mention; no allowance for loan losses was recorded at year-end.
- Funding-rule change: FHFA rules issued in January 2016 phase out captive insurers’ FHLB membership. Truman’s membership may continue through February 2021; outstanding advances then were reported at $3.8 billion as of February 19, 2016.
- Unusual items: Annaly recorded a $23.0 million goodwill impairment related to its intention to wind down FIDAC’s investment-advisory operations. It also repaid $857.5 million of convertible notes that matured in 2015. Agency MBS unrealized losses were attributed by management to market conditions, not asset credit quality; no other-than-temporary impairment was recorded.
- Other risks: REIT qualification and the Investment Company Act exemption are essential to the business model. The external management arrangement creates conflicts of interest; the fee is based on stockholders’ equity and has no incentive component. Management reported no pending material legal proceedings and no material contingencies at year-end.
Most important facts for investors to verify
- Reconcile GAAP earnings with core and normalized core earnings, including the company’s non-GAAP definitions and treatment of TBA dollar-roll income and premium amortization.
- Review the drivers of the $1.37 decline in book value per share and the year-end swap and MBS valuation exposures.
- Assess repo maturities, collateral requirements, unencumbered assets, counterparty concentrations and the planned transition away from FHLB advances.
- Track whether diversification into commercial real estate and residential credit improves risk-adjusted returns without increasing credit or liquidity losses.
- Confirm dividend sustainability against taxable income, cash generation and preferred-stock obligations; the filing states that common dividends are discretionary and no minimum is established.
- Check the effects of the February 2016 capital-allocation policy change, subsequent share repurchases and management’s FIDAC wind-down on later-period results.