Annaly Capital: Book Value Up, Higher Net Interest Margin, 9.7% Yield
Summary
- Annaly expanded on net interest margin gains in the 1st quarter.
- Net interest margin gains were fueled by higher yields and record low funding costs.
- But headwinds are real and the net interest margin is poised to decline.
Annaly (NYSE:NLY) benefited from record low funding costs in the 1st quarter which boosted the mREIT’s net interest margin and supported a Q/Q gain in book value. Rising inflation and a flattening yield curve could pressure Annaly’s net interest margin going forward.
Why Annaly is a buy despite its risks
Annaly continues to benefit from growth in its net interest margin… one of the most important metrics for mREITs.
Annaly buys long duration agency mortgage-backed securities with short-term funds. The thing about short-term funds is that their cost has decreased substantially in FY 2021 and lower funding costs have blown up Annaly’s net interest margin.
The net interest margin is the difference between the yield on longer term investments like mortgage-backed securities and lower short-term funding costs.
Annaly’s net interest margin growth has accelerated in the 2nd quarter 2020 and has surged to 3.39% in the last quarter as funding costs hit a record low of 0.42%.
2021 | 2020 | ||||
1st quarter | 4th quarter | 3rd quarter | 2nd quarter | 1st quarter | |
Net interest margin | 3.39% | 2.14% | 2.15% | 1.89% | 0.18% |
Average yield on interest earning assets | 3.76% | 2.61% | 2.70% | 2.77% | 1.91% |
Average GAAP cost of interest bearing liabilities | 0.42% | 0.51% | 0.60% | 0.96% | 1.86% |
Net interest spread | 3.34% | 2.10% | 2.10% | 1.81% | 0.05% |
(Source: Author, Annaly Earnings Supplements)
On the expense side, Annaly’s funding costs have decreased materially… which is always good since mREITs heavily rely on leverage to earn a net interest spread.
But the income side also improved: Higher yields on interest earning assets have aided Annaly’s net interest margin growth as well. Yields tend to rise with expectations of higher inflation.
(Source: Annaly)
Higher expected inflation also fueled the rally in the 10-year Treasury yield in FY 2021 and the yield could see a new high in the coming months as inflation is heating up.
Inflation expectations are rising due to a confluence of factors: The US economy is set to fully reopen after COVID-19 and massive spending bills have made their way through Congress. Trillions of dollars are proposed to be spent on infrastructure which could possibly fuel more inflation this year.
(Source: Knoema)
The expansion in Annaly’s net interest margin, however, did not come at the cost of higher risk. Annaly’s leverage ratio has successively decreased and hit a low of 4.6x in the 1st quarter.
2021 | 2020 | ||||
1st quarter | 4th quarter | 3rd quarter | 2nd quarter | 1st quarter | |
Leverage, at period-end | 4.6x | 5.1x | 5.1x | 5.5x | 6.4x |
Economic leverage, at period-end | 6.1x | 6.2x | 6.2x | 6.4x | 6.8x |
(Source: Author)
Turning to book value.
Annaly’s book value gained $.03-share Q/Q to $8.95-share in its 1st quarter, and the last quarter saw a continuation of Annaly’s book value recovery.
Annaly's book value was cut 22% in the 1st quarter 2020 and hit a low of $7.50-share on the onset of the pandemic, but has soared 19% since last year’s low.
Annaly’s valuation, measured by its P-B ratio, also recovered from the pandemic low, reflecting growth in the firm's book value and a successively improving net interest margin. Annaly's valuation, based on P-B, is now back to where it was before COVID-19. The mREIT trades for 1.01x book value.
Keep this in mind
As long as Annaly’s net interest margin remains as high as it is now, Annaly can grow its book value but the spread can’t grow like this forever… especially with market yields rising.
Higher yields indicate higher inflation going forward and the Federal Reserve will have no choice but to raise interest rates to meet its policy goals to contain inflation. Higher interest rates will increase borrowing costs for mREITs and pressure Annaly’s margin growth.
A contraction of Annaly’s net interest spread and a flattening yield curve are two big risks for the mREIT in FY 2021.
Closing thoughts
Annaly has support on the funding side through record low borrowing costs and on the income side from surging yields fueled by massive fiscal stimulus. Annaly was able to build on last year’s book value growth in the 1st quarter; growth has slowed. Annaly sells for 1.01x book value and is worth the risk.
This article was written by
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Comments (8)
2) The net realized gains (losses) on interest rate swaps was $772 million in the first quarter, with increases recorded for three consecutive quarters.
3) The net gains (losses) on other derivatives and financial instruments were $405.3 million which included a $249.6 million business divestiture loss on the sale of the commercial real estate business. The business divestiture loss was a one-time expense which will be non-recurring going forward.
4) For the first quarter of 2021, NLY recorded net income available to common shareholders of $1.724 billion up from $841.7 million in the fourth quarter of 2020, an $882 million improvement.
5) Finally for the first quarter of 2021, NLY recorded net unrealized gains (losses) on available-for sale-securities of ($1.372 billion) reducing the comprehensive income attributable to common shareholders to only $351.8 million. With a quarterly common stock dividend of $.22 per share on 1.4 billion shares this payment made on April 30, 2021 approximated $308,000. That said the unrealized loss on available for-sale securities of $1.372 billion resulted primarily to the increase in the benchmark 10 Year Treasury from .93 on 12/31/20 to 1.74 on 03/31/21. Since 03/31/21, the 10 Year has declined from 1.74 to 1.63 on 05/10/21. Provided the ten year stays at 1.63 or less from 05/10/21 to 06/30/21, the $1.372 billion net unrealized loss on available for-sale-securities may swing from a loss to a small gain. This would result in comprehensive income attributable to common shareholders of over $1.724 billion for the second quarter of 2021. NLY needs only $42.0 million of additional cash to pay a quarterly dividend to common shareholder of $.25 per share versus the existing quarterly dividend of $.22 per share, based on 1.4 billion common shares. In summary, the substantial reduction in the unrealized losses on available for sale securities is the significant factor in the argument for the increase in the quarterly dividend to be declared on or about 06/18/21.
