Annaly Capital Management, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Annaly is a diversified mortgage and real-estate investment manager and REIT. It became internally managed on June 30, 2020, after acquiring its former manager.
Financial performance and condition
| Metric | Q3 2020 | Comparison / period-end |
|---|---|---|
| Interest income | $562.4 million | $919.3 million in Q3 2019 |
| Net interest income | $447.3 million | $152.4 million in Q3 2019 |
| Net income attributable to Annaly | $1.016 billion | Net loss of $747.1 million in Q3 2019 |
| Net income available to common stockholders | $980.2 million; $0.70 per diluted share | Net loss of $783.2 million; loss of $0.54 per share in Q3 2019 |
| Core earnings, excluding PAA (non-GAAP) | $482.3 million; $0.32 per common share | $341.9 million; $0.21 per share in Q3 2019 |
| Net interest margin | 2.15% | 0.48% in Q3 2019; 1.27% for the first nine months versus 0.61% in 2019 |
| Assets / equity | $89.2 billion / $14.2 billion | Assets were $130.3 billion and equity $15.8 billion at December 31, 2019 |
| Common book value per share | $8.70 | $9.21 at September 30, 2019 |
| Leverage | 5.1x GAAP debt-to-equity; 6.2x economic leverage | Economic leverage was 7.7x at September 30, 2019 |
| Common dividend | $0.22 per share declared | Core earnings excluding PAA exceeded the dividend by $0.10 per share |
For the first nine months, Annaly reported a GAAP net loss of $1.77 billion, or $1.32 per common share, compared with a $3.37 billion loss, or $2.42 per share, in 2019. Core earnings excluding PAA were $1.24 billion, or $0.80 per share, versus $1.17 billion, or $0.74 per share. These are non-GAAP measures and are not substitutes for GAAP results.
At September 30, repurchase agreements were $64.6 billion; total indebtedness was approximately $72.0 billion. Cash and cash equivalents were $1.24 billion. The company reported $8.84 billion of unencumbered financial assets and $78.4 billion of liquid assets under its stated definition. For the nine months, operating cash flow was negative $339.8 million, investing cash flow was positive $40.2 billion, and financing cash flow was negative $40.5 billion.
Material changes and unusual items
- Total assets declined about $41.1 billion from year-end 2019, primarily reflecting portfolio repositioning and a $38.5 billion decrease in Agency MBS, including assets pledged to securitization vehicles. Repurchases and principal payments contributed to portfolio turnover.
- Q3 results improved sharply year over year as net interest income rose and swap and other derivative results improved. For the nine-month period, however, GAAP results remained deeply negative, including $1.92 billion of realized losses on interest-rate swap terminations or maturities and $1.16 billion of unrealized swap losses.
- The company recorded a $104.8 million gain when it deconsolidated a multifamily securitization after selling its interest-only securities. It also reported a $146.1 million net loan-loss provision for the first nine months, and a $168.0 million loan-loss allowance at quarter-end. CECL adoption reduced opening retained earnings by $39.6 million.
- Common shares repurchased during the first nine months totaled 27.7 million for $174.7 million, excluding commissions. In October, Annaly repurchased another 4.7 million shares for $34.3 million.
Outlook, management commentary and risks
- Management cited continued Federal Reserve support, stable low rates, strong Agency MBS demand and widely available funding as supportive conditions. It described the economic recovery as incomplete and uncertain, with pandemic-related restrictions and elevated unemployment continuing to weigh on activity.
- Management maintained a positive outlook on Agency MBS, noting elevated prepayments and continued Fed purchases. It expected to keep TBA positions above their traditional portfolio share while the Fed remained heavily involved, and said it may modestly increase allocation to residential credit and middle-market lending. These are management views, not formal earnings guidance.
- Experienced Agency portfolio prepayment speed was 22.9% in Q3, versus 14.6% a year earlier. Faster prepayments can increase premium amortization and pressure asset yields. Management said 96% of the Agency portfolio consisted of high- or medium-quality specified pools or mortgages seasoned at least 40 months.
- Key risks include COVID-19 impacts on borrowers, commercial tenants and business borrowers; interest-rate, yield-curve, mortgage-spread and prepayment changes; credit losses; repo rollover and margin-call demands; collateral values; and counterparty performance. The company’s modeled scenarios show that a 25-basis-point rise in rates could reduce 12-month economic net interest income by 9.7%, while a 25-basis-point mortgage-spread widening could reduce portfolio value by 1.4%; actual results may differ materially.
- Annaly generally expects economic leverage below 10x; quarter-end economic leverage was 6.2x. Funding access was described as strong, but a large share of repo funding is short term and can require same-day collateral for margin calls. The company also continued planning for the transition from LIBOR to alternative reference rates.
- The internalization ended the external management fee arrangement; management cited cost savings. No material pending legal proceedings or material contingencies were reported. Disclosure controls were assessed as effective.
Most important facts for investors to verify
- How much of reported earnings and book value reflects market movements and derivative accounting, versus recurring net interest income and core earnings.
- Whether core earnings excluding PAA remain sufficient to cover the common dividend, and how prepayment speeds affect premium amortization.
- Changes in repo funding, collateral haircuts, unencumbered assets and margin-call exposure, particularly under renewed market stress.
- Credit performance and reserve adequacy in commercial real estate, residential credit and middle-market lending, including restructured or closely monitored loans.
- Execution and realized cost savings following internalization, alongside progress in the LIBOR transition and any changes to capital allocation or leverage.