Annaly Capital Management, Inc. — Q1 2010 Form 10-Q
Reporting period: Quarter ended March 31, 2010. Financial statements are unaudited. Annaly is a REIT that primarily invests in leveraged agency mortgage-backed securities (MBS), funded largely through repurchase agreements; subsidiaries also provide investment advisory and broker-dealer services.
Financial results and position
| Metric | Q1 2010 / March 31, 2010 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $654.4 million | $716.0 million in Q1 2009 |
| Net interest income | $377.9 million; net interest spread 2.22% | $337.4 million; 2.11% in Q1 2009 |
| Net income | $281.1 million; $0.50 basic and $0.49 diluted per share | $349.9 million; $0.64 basic and $0.63 diluted in Q1 2009 |
| Net income available to common shareholders | $276.4 million | $345.3 million in Q1 2009 |
| Returns | Annualized return on average assets 1.58%; return on average equity 11.67% | 2.37% and 18.06%, respectively, in Q1 2009 |
| Cash flows | Operating +$1.821 billion; investing −$571.5 million; financing −$1.848 billion; cash decreased $598.6 million to $906.0 million | Q1 2009: operating +$1.158 billion; investing −$2.147 billion; financing +$1.116 billion |
| Total assets / equity | $72.7 billion / $9.58 billion | $69.4 billion / $9.55 billion at Dec. 31, 2009 |
| Debt and liquidity | $53.8 billion of repurchase agreements and $600 million of convertible notes; cash $906.0 million | Repurchase agreements $54.6 billion and cash $1.505 billion at Dec. 31, 2009 |
MBS fair value was $67.24 billion, while agency debentures were $2.93 billion. Repurchase agreements had a 2.09% weighted-average borrowing rate after swaps and 166-day weighted-average remaining maturity. Debt-to-equity was 5.6:1, versus 5.7:1 at year-end; management said it generally expected leverage of 8:1 to 12:1, subject to risk and liquidity conditions. Management reported 30 lenders and unused borrowing capacity but did not quantify the capacity.
Material changes versus prior periods
- Net income fell $68.8 million year over year, primarily reflecting a $116.7 million unrealized loss on interest-rate swaps, compared with a $35.5 million unrealized gain in Q1 2009. Swap fair-value liabilities were $608.7 million at quarter-end.
- Net interest income increased $40.5 million year over year as lower funding costs more than offset lower asset yields: average cost of funds declined to 2.00% from 3.12%, while average MBS yield declined to 4.22% from 5.23%. The spread widened 11 basis points to 2.22%.
- Quarterly net interest income declined from $464.9 million in Q4 2009 to $377.9 million in Q1 2010; the reported spread declined from 2.79% to 2.22%.
- Average portfolio prepayment speed increased to 34% CPR from 16% a year earlier. Management attributed this partly to agency repurchases of seriously delinquent loans, which accelerate principal returns and premium amortization.
- The company issued $600 million of 4% convertible senior notes due 2015, receiving approximately $582 million net proceeds. It also raised $115.5 million through its direct purchase and dividend reinvestment program. Common shares outstanding increased to about 559.7 million from 553.1 million at year-end.
- Common dividends declared were $0.65 per share, versus $0.50 in Q1 2009; the Q1 2010 dividend was paid April 29, 2010.
Outlook, risks, and unusual items
- No numerical earnings, spread, or dividend guidance is provided. Management said future prepayments depend partly on interest rates and market conditions and that it continues to consider complementary strategies, without assurance of implementation.
- Management identified interest-rate, yield-curve, mortgage-prepayment, financing, collateral-value, lender, and market-liquidity risks. Margin calls or reduced lender financing could constrain liquidity or force sales of securities at depressed prices. The company reported no repurchase-agreement margin calls it could not meet through March 31, 2010.
- Rate-sensitivity modeling estimated that a parallel 75-basis-point increase would reduce projected net interest income 4.00% and portfolio value 1.69%; a 75-basis-point decrease would increase them 4.11% and 1.01%, respectively. Management cautioned that actual results could differ materially.
- Net MBS purchase premiums were approximately $1.3 billion, or 2.0% of current par value. Faster prepayments can accelerate premium amortization and weigh on net interest income.
- The company held MBS unrealized losses of $42.2 million at quarter-end but recorded no other-than-temporary impairment, stating that losses reflected market conditions and securities were agency-guaranteed. Most investment securities were agency-backed and rated or implied AAA.
- Recovery of assets associated with Lehman Brothers International (Europe) remained uncertain. The company valued assets believed held by LBIE affiliates at an 80% discount and said it could not assure recovery of any amount.
- Management said ordinary-course legal matters were not expected to materially affect the financial statements. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether elevated prepayments persist and how they affect MBS premium amortization, asset yields, and dividends.
- Whether swap valuation losses, funding costs, or refinancing conditions materially change; review swap exposure and repurchase-agreement maturity and collateral terms.
- The amount and accessibility of unused borrowing capacity, and the potential effect of collateral declines or lender disruptions on liquidity.
- The assumptions behind reported fair values, interest-rate sensitivity estimates, and the expected recovery of the Lehman-related assets.
- Whether dividend levels remain supported by taxable income, cash generation, and REIT distribution requirements.