Annaly Capital Management, Inc. — 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010. The filing also reports quarterly results; it is an annual report, not a standalone fourth-quarter filing. Amounts below are U.S. dollars unless indicated.
Business context
Annaly is a mortgage REIT whose core business is investing, primarily with repurchase-agreement financing, in agency mortgage-backed securities (MBS) and related assets. Its principal earnings driver is the spread between asset income and financing costs. Subsidiaries also generate investment-advisory, service, and broker-dealer income. The company elected REIT tax treatment.
Financial performance and position
| Metric | FY 2010 | FY 2009 |
|---|---|---|
| Total interest income | $2.683 billion | $2.923 billion |
| Net interest income | $1.520 billion | $1.627 billion |
| Net interest rate spread | 2.08% | 2.52% |
| Net income | $1.267 billion | $1.961 billion |
| Net income available to common shareholders | $1.249 billion | $1.943 billion |
| Basic / diluted EPS | $2.12 / $2.04 | $3.55 / $3.52 |
| Return on average equity | 13.06% | 22.69% |
| Common dividends declared per share | $2.65 | $2.54 |
- Average earning-asset yield fell to 4.01% from 4.99%; average cost of funds declined to 1.93% from 2.47%. The lower funding cost only partly offset lower asset yields.
- At year-end, total assets were $83.0 billion, versus $69.4 billion a year earlier; stockholders’ equity was $9.865 billion. Repurchase-agreement borrowings were $65.5 billion, up from $54.6 billion, and convertible senior notes totaled $600 million. Reported debt-to-equity was 6.7:1, compared with 5.7:1 in 2009.
- Year-end MBS fair value was $78.4 billion; agency debentures were $1.1 billion. Weighted-average portfolio yield was reported as 3.80% in the business section and 3.88% in the financial-condition table; the filing text presents both figures.
- Cash and cash equivalents were $282.6 million, down from $1.505 billion. Cash-flow statements report $10.9 billion provided by operating activities, $13.8 billion used in investing, and $1.8 billion provided by financing; repo and broker-dealer matched-book transactions make reported operating cash flow less representative of core earnings.
- Annual common dividends rose to $2.65 per share, but the quarterly declaration declined from $0.75 in Q4 2009 to $0.64 in Q4 2010. Dividends remain discretionary and the company has no established minimum payment.
Material changes and notable items
- Net income fell $694 million year over year. A $318.8 million unrealized loss on interest-rate swaps in 2010 contrasted with a $349.5 million unrealized gain in 2009; net interest income also declined by $107 million.
- Average mortgage prepayment speed rose to 27% CPR from 19%. Mortgage principal repayments increased to $29.0 billion from $13.8 billion, contributing to faster premium amortization. Net purchase premiums reached $2.3 billion, or 3.0% of current par value.
- Quarterly results were unusually volatile: Q2 and Q3 reported net losses, followed by Q4 net income of $1.219 billion and common EPS of $1.94. Q4 included an $839.2 million unrealized swap gain; full-year swap results were a net unrealized loss.
- The company issued $600 million of 4% convertible senior notes due 2015, raising approximately $582 million net, and sold 60 million common shares in July for approximately $1.0 billion net. It also raised $278.8 million through its direct-purchase and dividend-reinvestment program.
- Subsequent to year-end, Annaly sold 86.25 million common shares in January and another 86.25 million in February 2011, raising approximately $1.5 billion net in each offering.
Outlook, risks, and contingencies
- The filing gives no specific earnings, spread, or dividend guidance. Management described monetary-policy support and Federal Reserve asset purchases as supporting asset prices and lowering yields, while noting that market and regulatory conditions remained in flux.
- Key exposures include changes in short- and long-term interest rates, yield-curve movements, prepayments, asset prices, and financing availability. Most year-end investment securities were fixed-rate, while short-term borrowing costs can reset more quickly than asset coupons.
- Interest-rate swaps had $27.1 billion notional value and a $751.9 million net negative fair value at year-end. Management’s sensitivity analysis estimated that a parallel 75-basis-point rate increase would reduce projected net interest income by 4.11% and portfolio value by 1.58%; these are model estimates, not forecasts.
- Repo financing creates collateral and rollover risk. Annaly reported 30 uncommitted lenders and no unmet repo margin calls through year-end, but it had no committed facility requiring lenders to renew financing. A market disruption or collateral decline could require asset sales or additional collateral.
- Policy uncertainty around Fannie Mae and Freddie Mac, including Treasury proposals to limit or wind down their roles, could affect agency-MBS supply, pricing, guarantees, and financing. The filing also cites mortgage modification programs and Dodd-Frank rulemaking as uncertain factors.
- The company reported no material expected impact from ordinary-course legal proceedings. Recovery of investment-fund assets associated with Lehman Brothers International (Europe) remained uncertain; certain assets were valued at an 80% discount. Additional Merganser earn-out payments may be due in 2012, but the amount was not clear because it depends on performance goals.
- Management and the auditor concluded that internal control over financial reporting was effective; the auditor issued an unqualified opinion on the financial statements and controls.
Most important facts for investors to verify
- Reconcile the reported portfolio yield figures (3.80% and 3.88%) and assess how asset-yield declines and premium amortization affect prospective net interest income.
- Review the drivers and accounting treatment of swap gains and losses, including how much reported earnings volatility is non-cash and how hedges perform under changing rates.
- Assess repo maturity, counterparty concentration, collateral haircuts, unused borrowing capacity, and sensitivity to margin calls; financing facilities are uncommitted.
- Evaluate the implications of the 2011 equity offerings for per-share earnings, book value, leverage, and dividend coverage, and verify the applicable post-offering share count.
- Track prepayment speeds, the $2.3 billion premium balance, and the effect of agency delinquent-loan repurchases on portfolio yield and dividend capacity.
- Monitor agency-guarantee and housing-finance policy changes, REIT and Investment Company Act compliance, and the uncertain recovery of Lehman-related fund assets.