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Annaly Capital Management Inc. (NLY - Snapshot Report) – the mortgage real estate investment trust (mREIT) reported encouraging fourth-quarter 2013 results following dismal third quarter earnings. The company’s core earnings per share came in at 35 cents, which is 10 cents ahead of the Zacks Consensus Estimate of 25 cents. The results were also ahead of the prior quarter core earnings per share of 28 cents and the year-ago period figure of 32 cents.

Results were driven by an increase in net interest income. The company is also making efforts to diversify and its commercial investment portfolio increased two fold since the CXS acquisition. Annaly has also lowered its leverage level so as to tap opportunistic ways to deploy capital and enhance profitability.

Net interest income came in at $633.9 million, up 11.0% year over year and well ahead of the Zacks Consensus Estimate of $288 million.

The company is boosting its commercial investments portfolio. This portfolio, which includes commercial real estate investments and corporate debt, represented 14% of stockholders’ equity as of Dec 31, 2013, compared with 11% as of Sep 30, 2013. Commercial real estate investments increased 23% sequentially to $1.6 billion as of Dec 31, 2013, from $1.3 billion as of Sep 30, 2013.

Quarter in Detail

For the reported quarter, annualized yield on average interest-earning assets was 3.50% while annualized cost of funds on average interest-bearing liabilities (including the net interest payments on interest rate swaps) was 2.07%.

This led to an average interest rate spread for the quarter of 1.43%, reflecting a 36 basis points increase from the prior quarter. The uptick, primarily driven by higher annualized yield on average interest-earning assets, was helped by lower amortization expense on its investment securities.

However, the company’s Investment Securities (includes Agency mortgage-backed securities, Agency debentures and corporate debt) were $73.4 billion as of Dec 31, 2013, reflecting a decline from $83.0 billion as of Sep 30, 2013.

Moreover, Annaly Capital’s book value per share continued to fall. It came in at $12.13 as of Dec 31, 2013, reflecting a 4.5% sequential decrease and a 23.5% year-over-year decline.

As of Dec 31, 2013, the company’s capital ratio (representing the ratio of stockholders’ equity to total assets) was 15.1%, compared with 13.9% in the prior quarter. Leverage was 5.0:1 as of Dec 31, 2013, compared with 5.4:1 as of Sep 30, 2013. Annaly Capital offered an annualized return on average equity, on a core earnings basis, of 11.05% for fourth-quarter 2013, up from 8.62% in the prior quarter.

Our Take

The beginning of the tapering by the Fed has lowered the uncertainty in the fixed income markets and the company has adjusted its leverage level as well. Moreover, we believe that the diversification of Annaly Capital into the commercial assets would help enhance the company’s top-line growth going forward.

Earlier this month, another mREIT – American Capital Agency Corp. (AGNC - Analyst Report) – reported encouraging fourth-quarter 2013 results with its net spread income per share of 76 cents, significantly exceeding the Zacks Consensus Estimate of 63 cents. The company had shifted its focus on shorter maturity securities and controlled leverage in mid 2013 amid volatility in the interest rate.

Towards the end of the year, the volatility reduced and with increasing yields on MBS and a steeper yield curve, the current return environment looks promising according to the company.

Annaly Capital currently has a Zacks Rank #3 (Hold). Some better-ranked stocks in the same industry include Blackstone Mortgage Trust, Inc. (BXMT - Snapshot Report) and Five Oaks Investment Corp. (OAKS - Snapshot Report). Both these stocks hold a Zacks Rank #2 (Buy).

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