Annaly Capital Management, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; balance-sheet comparisons are to December 31, 2018 unless noted. Annaly is an externally managed REIT investing in and financing residential and commercial real estate assets, primarily using secured borrowing. Figures below are in U.S. dollars.
Financial performance and position
| Metric | Q1 2019 / March 31, 2019 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $866.2 million | $879.5 million in Q1 2018 |
| Interest expense | $647.7 million | $367.4 million in Q1 2018 |
| Net interest income | $218.5 million | $512.1 million in Q1 2018 |
| Net income (loss) attributable to Annaly | $(849.2) million | $1.328 billion in Q1 2018 |
| Net income (loss) per common share | $(0.63) | $1.12 in Q1 2018 |
| Core earnings, excluding PAA (non-GAAP) | $433.2 million; $0.29 per average common share | $385.3 million; $0.30 per share in Q1 2018 |
| Net interest margin | 1.25%; 1.51% excluding PAA (non-GAAP) | 1.94%; 1.52% excluding PAA in Q1 2018 |
| Average yield on interest-earning assets / average cost of interest-bearing liabilities | 3.15% / 2.15% | 3.45% / 1.90% in Q1 2018 |
| Total assets | $119.2 billion | $105.8 billion at December 31, 2018 |
| Total stockholders’ equity | $15.8 billion | $14.1 billion at December 31, 2018 |
| Common book value per share | $9.67 | $10.53 in Q1 2018 |
| Cash and cash equivalents | $1.52 billion | $1.74 billion at December 31, 2018 |
| Repurchase agreements / total debt-to-equity leverage | $88.6 billion / 6.1:1 | $81.1 billion / 6.3:1 at December 31, 2018 |
| Economic leverage | 7.0:1 | 7.0:1 at December 31, 2018; 6.5:1 in Q1 2018 |
Cash flow: Operating activities used $942.1 million and investing activities used $7.9 billion; financing activities provided $8.6 billion. The financing inflow included $1.32 billion of net proceeds from stock offerings, direct purchases and dividend reinvestment. These cash flows reflect substantial portfolio and financing turnover.
Portfolio and liquidity: Agency MBS were the dominant investment, with reported securities totaling $105.0 billion. The company reported $9.0 billion of unencumbered financial assets and stated that liquid assets were 98.57% of encumbered and unencumbered financial assets. The figures are affected by collateral pledges and the filing’s liquidity classifications.
Material changes and notable items
- GAAP results moved from a large profit to a loss, principally due to interest-rate swap losses and higher interest expense. Interest-rate swaps produced a net loss of $844.8 million, including $588.3 million of realized termination or maturity losses and $390.6 million of unrealized losses, partly offset by the swaps’ $134.0 million net interest component. Annaly terminated or matured swaps with $38.2 billion notional during the quarter.
- Interest expense rose 76% year over year, while net interest income fell by $293.6 million. Management cited higher borrowing rates and greater average interest-bearing liabilities. Core earnings excluding PAA rose to $433.2 million, but declined slightly per average common share year over year.
- Available-for-sale securities generated $1.66 billion of other comprehensive income; accumulated other comprehensive loss narrowed to $319.4 million from $2.0 billion at year-end 2018. This fair-value movement is distinct from GAAP net income.
- Annaly issued common shares in a public offering and under its at-the-market program, with reported proceeds before or after fees as applicable. Common shares outstanding increased to 1.448 billion at quarter-end from 1.314 billion at year-end 2018.
- Annaly closed a commercial real estate CLO with $857.3 million face value in February; $629.0 million of notes were held by third parties. The company expensed $8.3 million of related costs. A $5.7 million loan-loss provision was recorded on commercial real estate investments.
- The management agreement was amended in March: the monthly fee remains based on 1.05% of defined stockholders’ equity up to $17.28 billion, with 0.75% applied to the excess. No incentive fee is payable.
Outlook, commentary and risks
Management described Q1 financial conditions as improving after the Federal Reserve adopted a more patient rate stance. Credit spreads tightened, while Agency MBS underperformed other credit assets; management cited a flat yield curve, high expected Agency MBS issuance and pressure on asset yields relative to funding costs. It remained selective on credit and viewed risk-adjusted Agency MBS returns as attractive. Management said lower asset-to-funding spreads could pressure core earnings and dividends.
On May 1, 2019, after quarter-end, Annaly announced that it expected to declare a quarterly common dividend of $0.25 per share for the remainder of 2019 beginning in Q2, subject to Board discretion and approval. The Q1 common dividend was $0.30 per share.
Key exposures include interest-rate and spread changes, prepayments and premium amortization, repo funding availability and collateral margin calls, leverage and liquidity, counterparty performance, and credit exposure in non-Agency securities, loans, commercial real estate, CRT securities and corporate debt. Sensitivity analysis estimated that a 25-basis-point rate increase would raise projected economic net interest income 10.0% but reduce portfolio value 0.2%; a 25-basis-point MBS spread widening would reduce portfolio value 1.3%. Management cautioned that actual outcomes could differ materially and the scenarios assume no management response.
The filing reported no pending material legal proceedings and no material contingencies at March 31, 2019; management said ordinary-course claims were not expected to have a material effect. No material changes to previously disclosed risk factors were reported. A post-quarter event: Annaly announced redemption of all 2.2 million Series H preferred shares on May 31, 2019, at $25 per share plus accrued and unpaid dividends.
Important facts for investors to verify
- Reconcile GAAP loss and the large swap termination losses with core earnings, a non-GAAP measure whose definition and adjustments differ from GAAP.
- Review the sustainability of the announced $0.25 common dividend against core earnings, funding costs, portfolio spreads and Board approval; it was not a firm commitment.
- Assess repo dependence, short-term maturities, collateral requirements and the availability of unencumbered assets under stressed market conditions.
- Check the effects of share issuance and dilution on per-share book value and earnings, and confirm subsequent share counts.
- Monitor commercial loan credit quality and the $5.7 million provision, as well as the performance and financing terms of the new CLO.
- Evaluate assumptions behind fair values, prepayment speeds, derivative positions and interest-rate/spread sensitivity; model and market estimates may change.
- Consider the timing and terms of the Series H redemption and the post-quarter residential loan securitization when reviewing subsequent liquidity and capital changes.