Annaly Capital Management, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are primarily with December 31, 2016. Annaly is an externally managed REIT investing in residential and commercial real estate assets and middle-market loans. Unless otherwise stated, dollar amounts below are in millions.
Financial performance and condition
| Metric | Q1 2017 | Comparable period / change |
|---|---|---|
| Interest income | $587.7 | $388.1 in Q1 2016 |
| Interest expense | $198.4 | $147.4 in Q1 2016 |
| Net interest income | $389.3 | $240.7 in Q1 2016 |
| Net income attributable to Annaly | $440.5 | Loss of $867.9 in Q1 2016 |
| Net income available to common shareholders / diluted EPS | $417.0 / $0.41 | Loss of $885.9 / $(0.96) in Q1 2016 |
| Core earnings, non-GAAP / per average common share | $318.0 / $0.29 | $123.3 / $0.11 in Q1 2016 |
| Net interest margin / net interest spread | 1.47% / 1.15% | 0.79% / 0.36% in Q1 2016 |
| Annualized return on average equity | 13.97% | (29.47%) in Q1 2016 |
| Common dividend declared | $0.30 per share | Unchanged from Q1 2016 |
Management attributed the year-over-year earnings improvement primarily to the change in unrealized interest-rate-swap results and higher net interest income, including lower premium amortization. Core earnings are non-GAAP and exclude specified fair-value and other items; they are not a substitute for GAAP results.
- Assets and equity: Total assets were $84.7 billion, down from $87.9 billion at year-end, mainly reflecting a $2.9 billion decline in Agency mortgage-backed securities. Total equity was $12.6 billion. Common book value was $11.23 per share.
- Debt and leverage: Repurchase agreements were $62.7 billion, down from $65.2 billion at year-end. Total indebtedness was $70.3 billion. Debt-to-equity leverage was 5.6:1 versus 5.8:1 at year-end; economic leverage was 6.1:1 versus 6.4:1. Management generally expected economic leverage below 10:1.
- Funding: Repurchase agreements had an 88-day weighted-average remaining maturity and a 1.15% period-end weighted-average rate. Approximately 95% of debt was repo or other secured financing. About 10% of repo and other secured financing had remaining maturities over one year.
- Liquidity and cash flow: Cash and equivalents were $819 million, compared with $1.54 billion at year-end. Operating cash flow was $177.6 million (versus $(133.5) million in Q1 2016); investing cash flow was $2.54 billion; financing cash flow was $(3.43) billion. Annaly reported $7.38 billion of unencumbered financial assets and $262 million of unencumbered cash. The filing notes a $673.2 million variation-margin presentation change that reduces reported swap assets and cash; prior-period balances were not adjusted, limiting direct cash-balance comparability.
- Portfolio: Agency MBS were $72.7 billion; residential credit securities were $2.1 billion; residential mortgage loans were $682 million; MSRs were $632 million; commercial real estate debt investments were $4.1 billion; commercial debt and preferred equity held for investment were $985 million; and corporate debt was $841 million.
Material changes and notable items
- Net interest income rose $148.6 million year over year. Management cited lower amortization expense, higher coupon income associated with higher average interest-earning assets, and a lower average cost of interest-bearing liabilities, partly offset by higher average liabilities.
- Interest-rate swaps generated $149.2 million of unrealized gains in Q1 2017, compared with $1.03 billion of unrealized losses in Q1 2016. Management linked the reversal largely to rising forward rates in 2017 versus falling forward rates in the earlier period.
- Net realized and unrealized gains were $74.3 million, versus losses of $1.06 billion in Q1 2016. Annaly sold $2.1 billion of residential investment securities for a $1.2 million gain and sold a commercial property for a $5.1 million gain.
- Residential mortgage loans increased to $682 million from $342 million at year-end. The commercial debt and preferred equity portfolio was $985 million, up from $971 million. The July 2016 Hatteras acquisition expanded Annaly’s residential loans, MSRs, and related activities and affects period-to-period portfolio comparisons.
- Available-for-sale securities had $1.13 billion of net unrealized losses at quarter-end, compared with $1.09 billion at year-end. Management attributed Agency MBS declines to market conditions, not asset quality, and reported no other-than-temporary impairment.
Outlook, risks, and contingencies
The filing provides no quantified earnings or dividend guidance. Management described interest-rate markets as largely range-bound, noted political and regulatory uncertainty, and said it expected to benefit from diversification while maintaining conservative portfolio positioning. It intended to continue financing residential securities largely through repurchase agreements and to preserve unused borrowing capacity and excess liquidity.
- Rate and spread exposure: Company modeling estimated that an immediate 25-basis-point rate increase would reduce projected 12-month economic net interest income by 1.5% and portfolio value by 0.5% (3.0% of NAV). A 75-basis-point increase was estimated to reduce economic net interest income by 4.9% and NAV by 10.8%. A 25-basis-point widening in mortgage spreads was estimated to reduce NAV by 9.8%. These are model scenarios, assume no management response, and actual results could differ materially.
- Liquidity and collateral: Falling collateral values may trigger same-day margin calls, reduce borrowing capacity, or force asset sales. Most assets were pledged, and repurchase funding exposes the company to refinancing, counterparty, and haircut risks.
- Prepayment and valuation: Experienced Agency MBS CPR was 11.5%; projected long-term CPR was 10.0%. Faster prepayments can accelerate premium amortization and reduce income. MSRs are Level 3 assets valued using significant unobservable assumptions; their fair value was $632 million.
- Credit and other risks: Annaly identified credit exposure in CRT, non-Agency, commercial real estate, corporate debt, and mortgage-servicing assets. Commercial loan risk ratings included $430 million performing-closely-monitored and $148 million performing-special-mention balances; the filing said loans were performing, with no impaired, nonaccrual, or defaulted loans and no loan-loss allowance. No material legal proceedings or material contingencies were reported at quarter-end.
- Capital and regulation: Maintaining REIT qualification and the Investment Company Act exemption, and developments affecting the Agencies, funding markets, and financial regulation, remain important uncertainties. Annaly reported no material changes to the risk factors in its latest 10-K.
Investor verification priorities
- Reconcile GAAP net income with non-GAAP core earnings, especially swap marks, TBA dollar-roll income, and premium amortization.
- Assess whether the $0.30 common dividend is supported by recurring earnings and cash generation, rather than fair-value gains or other episodic items.
- Review repo maturities, collateral availability, unencumbered assets, and the effect of margin calls under stressed market conditions.
- Track Agency MBS premium exposure, prepayment assumptions, book value, and rate/spread sensitivities; verify how the variation-margin presentation change affects comparisons.
- Monitor Hatteras-related portfolio integration, MSR valuation assumptions, and credit quality in commercial, residential-credit, and corporate-loan exposures.