Business context and reporting period
Annaly Capital Management, Inc. (NYSE: NLY) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2022. Annaly is a mortgage-focused REIT investing primarily in Agency mortgage-backed securities (MBS), residential credit and mortgage servicing rights (MSR), using borrowed funds and hedging strategies. The company said the first half of 2022 was exceptionally challenging for fixed-income markets amid high inflation, geopolitical uncertainty and rapid monetary tightening.
Financial and operating performance
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Net interest income | $475.1 million | $322.9 million | $1,056.1 million | $1,010.3 million |
| Net income (loss) attributable to Annaly | $866.7 million | ($295.6 million) | $2,889.0 million | $1,455.2 million |
| Net income (loss) per common share | $0.55 | ($0.23) | $1.90 | $1.00 |
| Earnings available for distribution (EAD), non-GAAP | $490.8 million; $0.30 per share | $451.4 million; $0.30 per share | $921.4 million; $0.58 per share | $890.9 million; $0.59 per share |
| Net interest margin, GAAP | 2.64% | 1.66% | 2.92% | 2.54% |
| Net interest spread, GAAP | 2.46% | 1.62% | 2.80% | 2.50% |
Q2 GAAP results included $1.016 billion in derivative gains and $615.2 million in losses on investments and other. The six-month results included $2.658 billion in derivative gains and $775.0 million in investment and other losses. These fair-value and realized items materially affect GAAP earnings; EAD is a company-defined non-GAAP measure and is not a substitute for GAAP results.
At June 30, 2022, total assets were $73.64 billion and total equity was $11.09 billion. Common book value was $5.90 per share, versus $8.37 at June 30, 2021. AOCI was a loss of $4.31 billion, compared with income of $958.4 million at December 31, 2021, principally reflecting market-value declines in available-for-sale securities. GAAP leverage was 5.4:1 and economic leverage was 6.6:1, versus 4.7:1 and 5.7:1, respectively, at December 31, 2021. Economic capital ratio was 13.0%, down from 14.4% at year-end.
Repurchase agreements were $51.36 billion at quarter-end, with a 1.60% weighted average rate and 47-day weighted average remaining maturity. Cash and cash equivalents were $853.9 million; disclosed unencumbered financial assets totaled $6.26 billion. The company reported $55.5 billion of financial assets and cash pledged against existing liabilities. For the six months, operating cash flow was $2.72 billion, investing cash flow was negative $2.05 billion and financing cash flow was negative $1.16 billion. Common dividends declared were $0.22 per share for the quarter.
Material changes versus prior periods
- Q2 net income swung to profit from a year-earlier loss, mainly reflecting the reversal to substantial derivative gains, alongside higher net interest income; investment losses offset part of the improvement.
- Q2 EAD per share was unchanged at $0.30 year over year. For the first half, EAD rose in dollars but fell to $0.58 per share from $0.59.
- Rising rates and wider MBS spreads drove large unrealized losses: first-half other comprehensive loss was $5.27 billion. Annaly also sold $9.4 billion of Residential Securities during the first half, recording an $801.8 million net realized loss on those disposals.
- Agency MBS fair value excluding securities transferred or pledged to securitization vehicles fell to $55.59 billion from $60.53 billion at year-end. MSR rose to $1.42 billion from $544.6 million, including purchases and valuation changes.
- Annaly completed the transfer of its commercial real estate business assets held for sale to Slate as of June 30. It also agreed to sell substantially all of its Middle Market Lending portfolio to Ares for $2.4 billion; most assets had transferred by quarter-end, with remaining transfers expected by the end of Q3 2022.
- Common shares issued and outstanding increased to 1.609 billion from 1.460 billion at year-end, including public offering and at-the-market issuances.
Outlook, commentary and risks
Management reported that the Federal Reserve raised its target rate by 125 basis points in Q2 and signaled a further 175 basis points of increases in the second half; the 10-year Treasury yield rose to 3.01% and the mortgage basis widened to 137 basis points by June 30. Management described housing activity as slowing but said structural housing undersupply, low borrower leverage and tight underwriting supported a view that home-price growth was more likely to moderate than sharply decline. Annaly reported a negative 9.6% economic return for Q2 and $0.30 per-share EAD. The filing provides no formal earnings or dividend guidance.
Management’s sensitivity analysis estimated that an immediate 75-basis-point rate increase would reduce projected 12-month economic net interest income by 5.6% and portfolio value by 0.8% (5.4% of NAV). A 25-basis-point widening in MBS spreads was estimated to reduce portfolio value by 1.8% (12.6% of NAV). These are model-based estimates, assume no management response and may differ materially from actual outcomes.
Key risks include interest-rate, yield-curve, spread, prepayment and funding volatility; margin calls and collateral demands; counterparty and credit losses; MSR valuation sensitivity to rates, prepayments and delinquencies; dependence on third-party servicers; operational and cybersecurity risks; and maintaining REIT status and the Investment Company Act exemption. LIBOR tenors relevant to Annaly were expected to cease or become non-representative after June 30, 2023; $1.5 billion of LIBOR-linked preferred stock could remain outstanding beyond that date. No pending material legal proceedings or material contingencies were reported. A $500 million MSR-platform credit facility was closed in July 2022, including a $250 million committed facility and a $250 million incremental provision.
Important facts for investors to verify
- Reconcile GAAP earnings with EAD and assess how much reported earnings depended on derivatives, realized sales and valuation changes.
- Track book value, AOCI, MBS spread sensitivity, leverage and liquidity, particularly the amount of unencumbered assets available under stress.
- Review repo refinancing and margin-call exposure, including the short 47-day average repo maturity and pledged collateral.
- Confirm completion and final economics of the MML sale, including transfer of remaining loans and any continuing obligations.
- Assess the sustainability of the $0.22 quarterly common dividend against EAD, funding costs and future portfolio performance.
- Monitor LIBOR transition plans for preferred stock and other contracts, and the valuation assumptions underlying the growing MSR portfolio.