Annaly Capital Management, Inc. (NLY) reported Q1 2012 results yesterday. The basic takeaways are: NLY reported GAAP net income for the quarter ended March 31, 2012, of $0.92 per average common share as compared with GAAP net income of $0.92 per average common share for the quarter ended March 31, 2011, and GAAP net income of $0.46 per average common share for the quarter ended December 31, 2011. Making the GAAP net income the first line of the press release certainly indicates the importance of this figure, at least for the company, despite what some long-investors think who question the applicability of this figure. This discussion always reminds me, when new media companies in 2000 were telling us that we cannot use EBITDA, but must use EBITDA adjusted for marketing expenses. Or real estate companies insisting that the FFO is a better cashflow measure than the one from the cashflow statement. And, in the case of mREITs, investors insisting that GAAP earnings are not relevant. By choosing to open the press release with a GAAP measure I think long-investors have been clearly proven incorrect by their own investment. The only reason anyone would ever insist on using alternative measures is because GAAP numbers simply do not look good for the company and for its investors.
In addition to more or less underlying GAAP income, NLY relied on unrealized gains or losses on interest rate swaps and Agency interest-only mortgage-backed securities to drive net income. Without this NLY only earned $0.54 per average common share compared with $0.70 per average common share a year ago. Without unrealized gains on derivatives the dividend of $0.55 per share would not be covered.
As driver of shareholder returns, the net interest spread is often mentioned. NLYs spread declined from 2.17% a year ago to 1.71%: A decline of 20% and even more impactful when considering a leverage ratio von 5.8:1. The current market environment obviously severely impacted the underlying earnings capability. The dependence on, technically non-recurring, unrealized gains just attests to that.
As NLY sets its dividends based on its current estimate of taxable earnings per common share a reduction in its dividend is a clear indication of management's negative view of future earnings and distribution potential. Investors should rather pay attention to the prospect of continued dividend declines and yields than believing baseless propaganda about sustainability. The next up-market will mark the decline of more than one mREIT.
The bottom line is, NLY is already running into constraints regarding its payouts. The market environment will make it more difficult for NLY to maintain its current yield. I am reiterating my strong bearish outlook for NLY, American Capital Agency (AGNC), Armour Residential (ARR), Hatteras (HTS) and Chimera (CIM).