Annaly Capital Management, Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Annaly is a mortgage REIT whose portfolio was primarily Agency mortgage-backed securities (MBS), financed largely through repurchase agreements. In Q2 it also acquired CreXus, expanding into commercial real estate investments.
Key financial metrics
| Metric | Q2 / June 30, 2013 | Comparable period / prior date |
|---|---|---|
| Interest income | $712.9 million | $886.3 million in Q2 2012 |
| GAAP net interest income | $548.7 million | $719.9 million in Q2 2012 |
| Economic net interest income, including swap interest expense (non-GAAP) | $336.0 million; spread 0.98% | $497.9 million; spread 1.54% in Q2 2012 |
| Net income / income available to common | $1.638 billion / $1.620 billion | Net loss of $91.2 million / common loss of $97.7 million in Q2 2012 |
| EPS available to common | $1.71 basic; $1.64 diluted | $(0.10) basic and diluted in Q2 2012 |
| Common dividend declared per share | $0.40 | $0.55 in Q2 2012 |
| Total assets / stockholders’ equity | $102.47 billion / $13.26 billion | $133.45 billion / $15.92 billion at Dec. 31, 2012 |
| Agency MBS / repurchase agreements | $92.49 billion / $81.40 billion | $123.96 billion / $102.79 billion at Dec. 31, 2012 |
| Cash and cash equivalents | $725.5 million | $615.8 million at Dec. 31, 2012 |
Q2 average asset yield was 2.51% versus 3.04% a year earlier; average funding cost including swaps was 1.53% versus 1.50%. Debt-to-equity was 6.2:1, compared with 6.5:1 at year-end; management generally expected to remain below 12:1. The filing reports no conventional operating margin.
For the six months, net income was $2.508 billion versus $810.6 million in 2012, and basic EPS was $2.61 versus $0.82. Economic net interest income was $670.1 million versus approximately $1.0 billion; the economic spread was 0.95% versus 1.62%.
Cash flows for the six months were $(7.703) billion from operating activities, $19.031 billion from investing activities, and $(11.218) billion from financing activities; cash increased $109.7 million. The large operating cash outflow reflects substantial repo and securities-financing activity and should be read alongside the investing and financing flows.
Material changes and unusual items
- Q2 net income was driven chiefly by a $1.109 billion unrealized gain on interest-rate swaps, compared with a $611.2 million unrealized loss in Q2 2012. The gain reflected rising rates; it is not representative of recurring spread income.
- Available-for-sale securities generated a $3.292 billion Q2 other comprehensive loss. For the first half, the loss was $4.342 billion, bringing accumulated other comprehensive income to a $1.289 billion deficit from $3.053 billion positive at year-end.
- Agency MBS fair value declined to $92.49 billion from $123.96 billion at year-end. Net unrealized losses on the MBS portfolio were $2.419 billion, compared with $188.0 million of losses at year-end. Management attributed the decline to market conditions, not asset credit quality, and reported no other-than-temporary impairment.
- Annaly completed its CreXus acquisition on April 17 for $876.3 million cash consideration. It recognized a $71.4 million preliminary goodwill balance and an $18.9 million loss on remeasuring its previously held CreXus interest; it also recorded a $24.0 million goodwill impairment.
- Beginning July 1, management was externalized to Annaly Management Company LLC under a fee equal to 1.05% per year of defined stockholders’ equity. A majority of Annaly’s employees moved to the Manager; the agreement’s initial term runs through December 31, 2014.
Outlook, risks and contingencies
The filing gives no specific earnings, spread, dividend, or portfolio guidance. Management said it remained committed to Agency investments while considering diversification, including allocating up to 25% of stockholders’ equity to other real estate assets. It expected to continue financing through repurchase agreements and described preserving unused borrowing capacity as a liquidity priority.
- Interest-rate and MBS-spread volatility can affect portfolio values, net interest income, collateral requirements, and book value. The 10-year Treasury yield rose from 1.63% on May 2 to 2.49% on June 30; management said the bond-market sell-off adversely affected book value.
- Management’s modeled +75-basis-point rate shock projected a 19.9% increase in annual economic net interest income but a 1.9% decline in portfolio value; a −75-basis-point shock projected a 28.7% decline in income and a 1.1% increase in portfolio value. These are model estimates, not forecasts.
- Repo borrowing was $81.4 billion, with a 0.64% weighted-average repo rate before the separately described swap effects and a 1.72% weighted-average rate after swaps. Collateral was approximately $89.3 billion, the average repo haircut was about 5%, and the excess collateral cushion was about $4.0 billion. Annaly reported no repo margin calls it could not meet through June 30.
- Net interest-rate swap liabilities were $1.189 billion; the swaps had $48.5 billion notional. Certain agreements permit counterparties to terminate following specified events; the related net liability was fully collateralized. European financial institution counterparties represented $1.502 billion of disclosed exposure, or 1.47% of total assets.
- Commercial real estate loans and preferred equity totaled $938.4 million carrying value. A $13.0 million senior mortgage was on non-accrual/watch list; the filing reported no allowance for loan losses at June 30.
- Management identified risks from prepayments and premium amortization, financing availability, counterparty defaults, REIT qualification, and the SEC’s ongoing review of the Investment Company Act exemption. Ordinary-course legal matters were not expected to have a material effect; no material change to previously disclosed risk factors was reported.
Important facts for investors to verify
- How much of reported earnings and common EPS reflects noncash swap fair-value gains, versus recurring net interest income and realized results.
- Book value and collateral sensitivity after the sharp increase in MBS unrealized losses, including the potential effect of further rate or spread moves and margin calls.
- Repo financing terms, counterparty concentration, available borrowing capacity, and the assumptions behind the reported $4.0 billion excess collateral cushion.
- The CreXus integration, commercial-loan credit quality and non-accrual exposure, and any subsequent goodwill or valuation adjustments.
- The total cost and governance implications of the external management arrangement, including how the 1.05% fee is calculated and how expenses are allocated.
- Whether the lower common dividend and reduced economic spread remain consistent with future earnings and distributions; the filing provides no forward dividend commitment.