Annaly Capital Management, Inc. — Q1 2011 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three months ended March 31, 2011, with income-statement and cash-flow comparisons to Q1 2010. Annaly is a REIT primarily investing, on a leveraged basis, in agency mortgage-backed securities (MBS) and agency debentures; it also operates advisory, broker-dealer, warehouse-financing, and lending businesses.
Financial results and position
| Metric | Q1 2011 / March 31, 2011 | Prior comparable period |
|---|---|---|
| Total interest income | $844.0 million | $654.4 million, Q1 2010 |
| Net interest income | $522.4 million | $377.9 million, Q1 2010 |
| Net income | $699.9 million | $281.1 million, Q1 2010 |
| Net income available to common shareholders | $695.6 million; $0.92 basic and $0.89 diluted per share | $276.4 million; $0.50 basic and $0.49 diluted, Q1 2010 |
| Net interest spread | 2.17% | 2.22%, Q1 2010 |
| Average cost of funds / asset yield | 1.62% / 3.79% | 2.00% / 4.22%, Q1 2010 |
| Cash flows | Operating +$4.96 billion; investing -$17.10 billion; financing +$12.22 billion; cash rose $74.4 million to $357.0 million | Operating +$1.82 billion; investing -$571.5 million; financing -$1.85 billion; cash fell $598.6 million, Q1 2010 |
| Total assets / total liabilities | $98.43 billion / $85.53 billion | $83.03 billion / $73.12 billion, December 31, 2010 |
| Repurchase agreements | $79.98 billion | $65.53 billion, December 31, 2010 |
| Stockholders’ equity | $12.85 billion | $9.86 billion, December 31, 2010 |
| Debt-to-equity | 6.3:1 | 6.7:1, December 31, 2010 |
At quarter-end, agency MBS fair value was $93.64 billion; the broader investment-securities portfolio was reported at $94.08 billion. The company reported a $498.7 million common dividend declared for the quarter, or $0.62 per share, paid April 27, 2011. Average return on equity was 24.56% (annualized), versus 11.67% in Q1 2010.
Material changes and management commentary
- Net income increased $418.8 million year over year. Management attributed the increase principally to a $169.3 million unrealized gain on interest-rate swaps, versus a $116.7 million unrealized loss in Q1 2010, and $144.5 million higher net interest income.
- Net interest income benefited from a larger average asset base and slower mortgage prepayments; the asset yield and net interest spread nevertheless declined year over year. Average interest-earning assets grew to $89.2 billion from $62.0 billion, while average cost of funds fell to 1.62% from 2.00%.
- Average CPR on agency MBS declined to 17% from 34% in Q1 2010. Management noted that faster prepayments can accelerate amortization of the portfolio’s net premium and reduce income; net purchase premiums were $2.9 billion at quarter-end.
- Two common-stock offerings generated approximately $2.94 billion of net proceeds during the quarter. Shares outstanding increased materially; weighted-average basic shares rose to 752.4 million from 555.0 million year over year.
- Management’s stated general leverage range is 8:1 to 12:1, but actual leverage was below that range at 6.3:1. Management said it may limit asset growth to preserve liquidity and unused borrowing capacity.
Outlook, risks, contingencies, and unusual items
- No specific earnings or dividend guidance was provided. Management said future prepayments depend partly on market rates and that it continues to consider complementary strategies, without assurance of implementation.
- Interest-rate exposure is central: the company reported $33.4 billion notional of pay-fixed, receive-floating swaps. Its modeled parallel-rate scenarios showed net interest income down 2.00%, 4.53%, and 7.32% for rate increases of 25, 50, and 75 basis points, respectively; modeled portfolio value including swaps fell 1.15%, 1.80%, and 2.50%. These are estimates and actual results may differ.
- Funding and liquidity depend heavily on repurchase agreements, collateral values, lender access, and margin requirements. Repurchase agreements had a 1.63% weighted-average borrowing rate after swaps and a 120-day weighted-average remaining maturity. The company reported no margin calls it could not satisfy through March 31, 2011; future calls could impair liquidity.
- Other principal risks include MBS market-value declines, changing yield curves, prepayment and premium-amortization uncertainty, derivative counterparty exposure, and regulatory or policy changes affecting Fannie Mae and Freddie Mac. The Treasury’s housing-finance proposals were under evaluation; their effects were not yet determinable.
- Recovery of assets associated with Lehman Brothers International (Europe) remained uncertain. Certain assets believed held by LBIE affiliates were valued at an 80% discount; the company gave no assurance of recovery.
- Unrealized losses on agency MBS were $751.8 million at March 31, 2011, primarily attributed by management to market conditions; no other-than-temporary impairment was recorded. Other comprehensive loss for the quarter was $155.1 million.
- Ordinary-course legal matters were not expected by management to have a material effect. Additional Merganser earn-out payments may be due in 2012 if performance goals are met; the amount was not determinable.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material changes to the prior Form 10-K risk factors were reported.
Important facts for investors to verify
- How much of the reported earnings increase reflects recurring net interest income versus volatile swap marks and other realized or unrealized gains.
- Whether the larger, premium-heavy MBS portfolio can sustain yields if rates, prepayment speeds, or financing costs change.
- The scale and terms of repo funding, collateral headroom, lender concentration, and sensitivity to margin calls as leverage and assets grow.
- The earnings-per-share and dividend implications of the substantial share issuance and the declared $0.62 common dividend.
- Whether the modeled interest-rate sensitivities, MBS valuation assumptions, and uncertain Lehman-related recoveries remain reasonable as market conditions evolve.