Annaly Capital Management, Inc. — 2017 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017; quarterly figures below include the fourth quarter. Annaly is an externally managed REIT investing primarily in Agency residential mortgage-backed securities, with additional residential credit, commercial real estate and middle-market lending businesses. Its core model uses borrowed funds and hedges to earn the spread between asset yields and financing costs.
Financial results and key metrics
| Metric | 2017 | 2016 |
|---|---|---|
| Interest income | $2.493 billion | $2.211 billion |
| Interest expense | $1.008 billion | $657.8 million |
| Net interest income | $1.485 billion | $1.553 billion |
| GAAP net income | $1.569 billion | $1.433 billion |
| Net income available to common stockholders | $1.460 billion | $1.351 billion |
| Diluted earnings per common share | $1.37 | $1.39 |
| Core earnings excluding PAA, non-GAAP | $1.409 billion; $1.22 per share | $1.214 billion; $1.17 per share |
| Net interest margin excluding PAA, non-GAAP | 1.51% | 1.50% |
| Average cost of interest-bearing liabilities | 1.75% | 1.62% |
| Common book value per share, year-end | $11.34 | $11.16 |
| Common dividends declared per share | $1.20 | $1.20 |
At year-end, total assets were $101.8 billion, total equity $14.9 billion, and total liabilities $86.9 billion. Repurchase agreements were $77.7 billion; total indebtedness was $84.8 billion. Debt-to-equity leverage was 5.7:1 and economic leverage, including TBA exposure and forward purchases, was 6.6:1. The capital ratio was 12.9%.
Cash provided by operating activities was $6.9 billion; investing activities used $14.7 billion and financing activities provided $6.9 billion. Cash and cash equivalents ended the year at $706.6 million, down from $1.54 billion. Annaly reported $9.1 billion of unencumbered financial assets and $95.4 billion of liquid assets under its stated definition. Repurchase agreements had a 58-day weighted-average maturity; the weighted-average remaining maturity for repurchase agreements and other secured financing combined was 107 days.
For fourth-quarter 2017, net interest income was $426.7 million and net income available to common stockholders was $714.6 million, or $0.62 per diluted share. Fourth-quarter results included $359.2 million of realized and unrealized gains.
Material changes versus the prior comparable period
- Net interest income fell $68.4 million year over year as higher short-term rates and larger average borrowings raised funding costs; average asset balances and coupon income increased but did not fully offset the pressure.
- GAAP net income rose, while diluted EPS declined slightly, reflecting a larger weighted-average common share count. Management attributed the earnings change principally to improved swap results, partly offset by weaker investment fair-value results and lower net interest income.
- Core earnings excluding PAA increased to $1.409 billion from $1.214 billion. This non-GAAP measure excludes specified fair-value and other items and should not be treated as a substitute for GAAP results.
- Total assets grew to $101.8 billion from $87.9 billion. Residential Investment Securities increased, including a larger Agency portfolio; commercial real estate investments declined. Agency MBS and debentures represented 91.2% of portfolio composition at year-end, versus 89.3% in 2016, while residential credit rose to 3.2% from 2.9%.
- Annaly issued about $1.7 billion of common stock and $720 million of Series F preferred stock in 2017. Common shares outstanding increased to about 1.160 billion from 1.019 billion.
- Experienced Agency mortgage prepayments slowed to 10.6% from 13.3%; projected long-term CPR was 10.4%, versus 10.1%.
Outlook, management commentary, risks and unusual items
- Management described 2017 as a favorable environment for fixed-income returns, with stable growth and low market volatility. It deployed much of the capital raised into Agency MBS, while seeking selective opportunities in residential whole loans and middle-market lending. Management expected growth in residential credit and middle-market lending to continue in 2018. The filing provides no specific earnings or dividend guidance.
- Management noted rising short-term rates and the Federal Reserve’s October 2017 start to balance-sheet runoff. Sensitivity analysis estimated that an instantaneous 50-basis-point rate increase would reduce projected 12-month economic net interest income by 2.9% and portfolio value by 0.8%; a 25-basis-point widening in mortgage spreads was estimated to reduce portfolio value by 1.5%. These are model-based scenarios, not forecasts, and assume no management response.
- Key exposures include higher funding costs, asset-value and book-value declines, repo margin calls or loss of funding, prepayment and reinvestment risk, hedge basis and counterparty risk, and credit losses in non-Agency, residential loan, commercial real estate and corporate loan assets. The business also depends on maintaining REIT status and its Investment Company Act exemption.
- Agency securities had a net unrealized loss of $1.126 billion at year-end, which management attributed to market conditions rather than asset credit quality and did not consider other-than-temporary impairment. A small portion of commercial real estate debt was rated substandard; management reported no impaired, nonaccrual or defaulted loans and no loan-loss allowance at year-end.
- Annaly recorded a $7.1 million gain upon consolidating residential securitization trusts in the fourth quarter. It sold a triple-net-leased property for $12.0 million and recognized a $5.1 million gain. No material pending legal proceedings or material contingencies were reported at December 31, 2017.
- The Tax Cuts and Jobs Act was enacted in December 2017. Annaly said it did not expect a material effect on its operations, while continuing its analysis. Subsequent events included a January 2018 common-stock at-the-market program of up to $1.5 billion, a $425 million Series G preferred offering, and notices to redeem Series E and part of Series C preferred stock.
Important facts for investors to verify
- Reconcile the improvement in GAAP net income with lower net interest income and the contribution of unrealized derivative and investment gains; assess core earnings alongside its stated non-GAAP definition.
- Track the impact of rising short-term rates, Federal Reserve MBS runoff, mortgage-spread changes and prepayments on funding costs, portfolio value and common book value.
- Review repo maturity concentration, collateral haircuts, margin-call capacity and the $9.1 billion unencumbered-asset position; confirm funding access as Truman’s FHLB membership is scheduled to expire in February 2021.
- Assess credit quality and geographic concentration in residential loans, commercial real estate and middle-market lending, including the substandard commercial loan and the California concentration in residential mortgage loans.
- Evaluate common-share dilution, preferred dividends and redemptions, the proposed ATM issuance capacity, and the Board’s discretion over common dividends. The $1.20 annual common dividend was not guaranteed as a minimum.
- Monitor REIT qualification, the Section 3(c)(5)(C) exemption, and the effects of tax-law and regulatory changes; review the external management fee structure and related-party governance disclosures.