The 2012 second quarter earnings release from Annaly Capital Management (NLY) had me digging out the calculator to get a handle on the company's cash flow and dividend payment for the quarter. Here is my math.
- Net interest income: $719.9 million
- Other income including advisory fees and dividends received from affiliates: $28.5 million
- Total positive cash flow from continuing sources: $748.4 million
- General and administrative expenses: $64.5 million
- Realized losses on interest rate swaps: $222 million - this number has been consistently at $225 million plus or minus $5 million for the last 5 quarters.
- Total interest and expenses outflow: minus $286.5 million.
- Total positive cash flow minus outflow equals $461.9 million net cash flow.
The total dividends paid in the quarter were $526 million - $64 million greater than the net cash from continuing operations. The deficit was made up by $95 million on gains made from the sales of mortgage-backed securities. Again, this level of gains from the sale of securities is pretty much in line with what Annaly Capital has reported for the previous few quarters.
One more bit of math before moving on to a discussion of these results. American Capital Agency Corp. (AGNC) often calculates and publishes a gross interest rate spread, multiplying the net interest spread times the level of leverage and adding in the net spread one more time. At the end of the second quarter, Annaly was earnings a gross interest rate spread of 11.13%. Back out the general and admin expenses of 0.21% and the result is Annaly Capital is currently earning 10.9% on its leveraged portfolio holdings. Apply the yield to the book value of $16.23 per share and you get a final result of quarterly portfolio earnings of 44 cents per share. The actual dividend rate for the quarter was 55 cents.
Investors should take away a couple of points from the math exercises outlined above. First, the current level of interest earnings is not enough to support the current dividend rate. However, falling mortgage rates are producing bond price gains, allowing Annaly to sell bonds at a profit, generating enough cash flow to support the dividend. The high demand for agency mortgage-backed securities has turned the MBS market into a low rate, trading for capital gains business. In the second quarter, it seems Annaly did a nice job at pulling out some capital gains profits as rates continued to decline.
Annaly is conservatively managing its portfolio - not issuing new capital to buy more premium bonds and not boosting the leverage to keep the interest earnings up. After reviewing the earnings from the quarter and the trend in the interest rate spread, it is very possible that the dividend will be reduced to the 40 to 45 cents range over the balance of 2012. As I noted several months ago, the interest rate squeeze affecting the agency REIT companies cannot be avoided, only managed to protect shareholder value.
Recommended Reading: Long, Slow Squeeze In The Cards For Mortgage REIT Yields
For those of you following the ongoing Chimera Investment Corp. (CIM) story, Chimera historically reported earnings on the same day as Annaly, which manages the Chimera portfolio. No mention in the Annaly press release and no news from Chimera this time.