ANNALY CAPITAL MANAGEMENT INC quarterly report, Q1 FY2015

Abrir documento

Business context and reporting period

Annaly Capital Management, Inc. is an externally managed mortgage REIT investing primarily in Agency mortgage-backed securities (MBS), with additional commercial real estate, credit-risk-transfer and corporate debt investments. This unaudited Form 10-Q covers the quarter ended March 31, 2015; comparisons are with the quarter ended March 31, 2014 unless otherwise noted.

Financial results and position

  • Earnings: GAAP net loss attributable to Annaly was $476.4 million, or $0.52 per common share, versus a $203.4 million loss, or $0.23 per share. Comprehensive income was $92.6 million, reflecting $569.1 million of other comprehensive income, largely unrealized gains on available-for-sale securities.
  • Interest income and margins: Interest income was $519.2 million (down from $655.9 million); interest expense was $129.4 million (up from $125.0 million); net interest income was $389.8 million (down from $530.9 million). Economic net interest income, a non-GAAP measure that includes swap interest, was $231.5 million versus $270.5 million. Net interest margin was 1.26% versus 1.32%; net interest spread was 0.83% versus 0.90%.
  • Core earnings: Non-GAAP core earnings were $254.1 million, or $0.25 per average basic share, compared with $239.7 million, or $0.23. The company cautions that this measure is not a substitute for GAAP results and may not be comparable with other companies’ calculations.
  • Other income and expenses: Other loss was $815.3 million versus $682.9 million. Interest-rate-swap losses totaled $850.9 million, including $226.5 million of realized losses on terminations and $466.2 million of unrealized losses. G&A expense increased to $50.9 million from $47.4 million.
  • Cash flow and liquidity: Cash and cash equivalents were $1.92 billion at quarter-end, up $179 million during the quarter. Operating cash flow was negative $5.04 billion, investing cash flow positive $9.95 billion and financing cash flow negative $4.72 billion. These flows include substantial securities and financing activity. Cash pledged as collateral was $1.82 billion.
  • Assets, debt and capital: Total assets were $78.7 billion, down from $88.4 billion at December 31, 2014; total equity was $13.1 billion, versus $13.3 billion. Repurchase agreements were $60.5 billion, down from $71.4 billion. GAAP debt-to-equity leverage was 4.8:1 at March 31, versus 5.4:1 at year-end; economic leverage, including TBA notional, was 5.7:1. The capital ratio was 14.1%. Common book value per share was $12.88; the filing reports $12.30 at March 31, 2014.
  • Portfolio and dividends: Agency MBS fair value was $69.4 billion, down from $81.6 billion at year-end. The company shifted part of its Agency exposure to $13.8 billion of TBA purchase contracts. Commercial real estate debt and preferred equity held for investment totaled $1.50 billion. The common dividend declared remained $0.30 per share, payable April 30, 2015.

Material changes versus the prior comparable period

  • GAAP loss worsened by $273.1 million, primarily reflecting larger swap losses and lower interest income. Management cited higher realized swap-termination losses, unrealized swap losses associated with lower forward rates, and a 74-basis-point decline in average yield on interest-earning assets.
  • Average asset yield fell to 2.47% from 3.21%, while average interest-earning assets increased by approximately $2.1 billion. Mortgage prepayment speed rose to 9% from 6%, increasing premium amortization and weighing on asset yields.
  • Core earnings increased despite lower economic net interest income, as lower swap interest expense and TBA dollar-roll income offset some of the decline in asset income.
  • Compared with December 31, 2014, the Agency MBS portfolio contracted while TBA exposure and consolidated commercial mortgage assets expanded. Total assets declined, and net unrealized gains on available-for-sale investments increased to $774.0 million from $204.9 million.

Outlook, commentary and risks

  • Management said it remained cautious as the Federal Reserve had stopped adding to its Agency MBS portfolio and rate increases were considered likely later in 2015. The filing provides no formal earnings or dividend guidance.
  • Management described first-quarter U.S. GDP growth as weak, inflation below the Fed’s target and the mortgage basis as broadly stable over the quarter. It noted that regulatory and housing-finance reform remained uncertain.
  • Interest-rate, yield-curve, spread, prepayment, refinancing and funding conditions can affect earnings, asset values and collateral requirements. A decline in collateral values could trigger margin calls or forced asset sales. Repurchase agreements totaled $60.5 billion; their weighted-average remaining maturity was 149 days, and approximately 18% had more than one year remaining.
  • Interest-rate swaps had a net negative fair value of approximately $2.0 billion. Certain derivative agreements allow termination following specified events; the related net-liability exposure was approximately $1.9 billion and was fully collateralized at quarter-end.
  • In a modeled parallel 75-basis-point rate increase, projected 12-month economic net interest income rose 4.9%, but portfolio value fell 1.3% and the estimated impact was negative 7.3% of NAV. A 75-basis-point decline was modeled to reduce economic net interest income 14.8%. These are estimates, not forecasts.
  • Commercial real estate credit warrants attention: $290.3 million was rated Watch List, including a $230 million loan maturing June 30, 2015 with refinancing risk; management expected full recovery. A separate $13.0 million loan was in default-recovery status and on non-accrual. No loan-loss allowance was recorded.
  • The remaining $750 million principal of 5% Convertible Senior Notes was due May 15, 2015, after the reporting date. The company repaid $107.5 million of 4% notes at maturity in February 2015.
  • Management reported no material contingencies, no material changes to previously disclosed risk factors, and effective disclosure controls. The company’s ordinary-course legal matters were not expected to have a material effect.

Important facts for investors to verify

  1. Review the composition and drivers of the $476.4 million GAAP loss, particularly swap termination and mark-to-market results, alongside the company’s non-GAAP core earnings reconciliation.
  2. Assess whether the $0.30 common dividend is supported by REIT taxable income and cash generation; GAAP loss and cash-flow figures alone do not establish taxable income or dividend sustainability.
  3. Track the May 2015 maturity and repayment or refinancing of the $750 million 5% Convertible Senior Notes.
  4. Monitor repo funding, collateral availability, margin-call exposure, derivative collateral and the concentration of short-dated borrowings.
  5. Follow prepayment speeds, premium amortization, TBA exposure and interest-rate/spread sensitivity, including whether modeled outcomes remain relevant as market conditions change.
  6. Verify the outcome of the June 30, 2015 maturity and refinancing risk for the $230 million commercial real estate Watch List loan, and developments in the non-accrual loan.