Annaly Capital Management, Inc. — Q1 2013 Form 10-Q
Quarter ended March 31, 2013. Annaly is a mortgage REIT primarily investing in agency mortgage-backed securities (MBS), financed largely with repurchase agreements. It also operates investment-advisory, broker-dealer, warehouse-financing and lending businesses.
Financial performance and position
| Metric | Q1 2013 | Comparable period / change |
|---|---|---|
| Interest income | $737.2 million | $854.9 million in Q1 2012 |
| GAAP net interest income | $559.6 million | $721.6 million in Q1 2012 |
| Economic net interest income, including swap interest | $334.2 million; 0.91% spread | $502.2 million; 1.71% spread in Q1 2012 |
| Net income / income available to common | $870.3 million / $852.3 million | $901.8 million / $897.9 million in Q1 2012 |
| EPS | $0.90 basic; $0.87 diluted | $0.92 basic; $0.89 diluted in Q1 2012 |
| Common dividend declared | $0.45 per share | $0.55 per share in Q1 2012 |
| Comprehensive income (loss) | $(179.7) million | $659.2 million in Q1 2012 |
Q1 2013 operating cash flow was negative $3.9 billion, investing cash flow was positive $7.2 billion, and financing cash flow was negative $2.0 billion. Cash and cash equivalents increased $1.25 billion to $1.86 billion. Operating cash flow includes substantial short-term financing and matched-book trading flows.
At March 31, total assets were $125.5 billion, down from $133.5 billion at year-end; stockholders’ equity was $15.3 billion, down from $15.9 billion. Agency MBS fair value was $108.3 billion, compared with $124.0 billion at year-end. Accumulated other comprehensive income fell to $2.0 billion from $3.1 billion, reflecting market-value changes.
Repurchase agreements totaled $100.3 billion, versus $102.8 billion at year-end; their reported weighted-average rate was 0.59% before the separately described swap effects. The company reported a 1.49% weighted-average borrowing rate after swaps, and debt-to-equity of 6.6:1, versus 6.5:1. Management generally expected leverage below 12:1. Repurchase-agreement and swap collateral was $103.1 billion, with an approximately 5% average repo haircut and an $8.4 billion excess collateral cushion.
Material changes and management commentary
- Net income declined $31.5 million year over year. Management attributed most of the decrease to a $168.1 million fall in economic net interest income, partly offset by a $102.5 million increase in realized investment-sale gains.
- Average interest-earning assets rose to $124.4 billion from $105.7 billion, but their yield declined to 2.37% from 3.23%. The economic cost of funds was 1.46%, versus 1.52% a year earlier. Management linked the narrowing spread primarily to the low-rate environment.
- The company sold $16.3 billion of agency MBS, recording $182.8 million of net realized gains; Q1 2012 sales were $5.1 billion with $80.3 million of gains. Average MBS prepayment speed was 18%, compared with 19% in Q1 2012 and 19% in Q4 2012.
- Management said it intended to continue financing through repurchase agreements, preserve unused borrowing capacity, and diversify selectively. Its policy permits up to 25% of stockholders’ equity in real-estate assets other than agency MBS.
- After quarter-end, Annaly bought approximately 55.1 million CreXus shares for about $718.7 million, raising direct and indirect ownership to approximately 84.3%. It exercised an option to exceed 90% ownership and planned a short-form merger, then expected on May 23, 2013.
Outlook, risks and contingencies
The filing provides no specific earnings or dividend guidance. Management expected swap pay rates to continue declining as higher-rate swaps matured or were replaced. Its rate-sensitivity model estimated that a 25-basis-point rate increase would raise economic net interest income 11.66% and reduce portfolio value 0.22%; a 25-basis-point decrease would reduce economic net interest income 7.04% and increase portfolio value 0.14%. These are modeled estimates, not forecasts, and actual results could differ materially.
Key risks include interest-rate and yield-curve changes, MBS prepayments and premium amortization, asset-value declines, repo funding availability and margin calls, counterparty performance, and the ability to maintain REIT and Investment Company Act status. The company disclosed approximately $2.3 billion of net swap liabilities subject to certain termination provisions; it stated this amount was fully collateralized. Exposure to specified European financial counterparties was $1.79 billion, or 1.43% of total assets. Management reported no repo margin calls it could not meet through March 31.
The company reported no material change to the risk factors in its latest Form 10-K. Ordinary-course legal matters were not expected by management to have a material financial-statement effect. Disclosure controls were judged effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether the narrower economic net interest spread and lower asset yield persist, and how they affect earnings and the common dividend.
- How agency MBS values, prepayments and premium amortization affect book value, collateral capacity and liquidity.
- Repo financing terms, haircuts, counterparty concentration and the company’s ability to meet potential margin calls.
- The completion, funding and financial-statement effects of the CreXus acquisition and planned merger.
- The assumptions and limitations behind the interest-rate sensitivity estimates and management’s leverage and diversification policies.