In this article we review the Annaly (NLY) annual report issued in late February, and highlight some of the areas of interest. For comparison, we will also use the most recent report of American Capital Agency (AGNC). Both of these companies are mortgage REITs, and are of great interest in the marketplace because of the high dividend yields available to the shareholders.
First, the top line. This information is found on page F-2 of the NLY annual report:
Last year, NLY had about $3.6B in interest income and only about $480M in interest expense, which gave it a "profit margin", to the extent that it is meaningful in this industry, of about 87%. Note that the company's net interest income grew by about $800M vs. 2010, which would be about a 33% growth rate.
Here's the same data for AGNC:
AGNC is smaller at the moment, it had only about $824M in income last year, but it grew about 4X between 2010 and 2011. Its "profit margin" was more like 75%, so NLY was the more efficient of the two, but AGNC is experiencing much faster growth.
We commented the other day that it is important as to when the growth took place. On page F-23 of the Annaly report we find the results by quarter:
Annaly's interest income actually contracted between the third and fourth quarter, to the point where it was roughly equal to what it was in Q1.
We know from our previous work that the second half of last year was difficult in this industry because of the unexpected decrease in interest rates caused by the Euro issues. In the same time period, AGNC experienced a slowing of growth. This data is from Page 91:
AGNC went from $128M to $200M between the first and second quarter, a rate of increase of about 50% in a 90-day period. Its growth rate decreased to merely 15% or so between the third and fourth quarters.
We ask ourselves-- is growth "good"? This is a matter of opinion, but in general, a higher rate of growth means better cash flow, and the greater likelihood of a continued dividend-- and in this industry, dividends are what is driving the market.
To look at this further let us look at Page F-5 of the NLY annual report:
I do want to point out that Annaly had a net $8B negative change in cash flow from operations between 2010 and 2011. This is the sum of a long column of individual items, which represent the activity of loaning out mortgage money and collecting the income. Here is a clip from the bottom half of the same table:
NLY went from about $2.5 B in cash from its "operating activities" to about $1B in cash and cash equivalents at the end of the year-- a decrease of about 60%.
Let's check the same thing for AGNC, from page 68:
Here is the net of the financing activities:
So, at the very least, we know two things: Despite only being about 40% of the size of NLY, AGNC had the better cash position, mainly as a result of better financing activities, since both had stock issuances during last year. AGNC went from $1B in cash from operations to about $1.4B in cash position at the end of the year.
Now, let's compute the leverage: leverage is the ratio of the portfolio value to the stockholders' equity. It represents the ability of the company to turn paid-in cash from the shareholders into money-earning mortgages. To compute it, we need to know the portfolio value and the paid-in stockholders equity, both of which are on the balance sheet, which for NLY is on page F-1.
As it turns out, there is not much difference between the total assets of the company, $109B and the portfolio value, which is $104B. There is also not much difference between the paid in capital and the total stockholders' equity, both of which are about $15B. The ratio of these two is 6.93:1, a dollar of paid in capital roughly gives an additional $7 of portfolio. I would suggest that if we are interested in the potential effects of a new stock offering, this is an important number. Let's check it for AGNC, from Page 65:
So a portfolio value of $54B, paid in capital of about $6B, a ratio of 9.15. AGNC is more effective in turning capital into mortgages.
So what are we to make of this, so far, given the information at hand?
Of the two funds, Annaly is bigger but slower growing, has half the cash position despite being 2 times larger, and-- if given an opportunity to buy a new issuance of NLY or AGNC-- you might be better off buying AGNC at this point (notwithstanding any of the rest of the information we go into later, and also notwithstanding the fact that AGNC's profit margin was slightly lower).
We also know that AGNC did a better job on its financing activities.
Which company is more likely to give secure dividends in the period going forward? We still have some work to do in order to determine this.
Additional disclosure: I exited CIM before the last dividend was paid in late March.