Dear Fellow Shareholders,
2016 was a threshold year for Annaly. Amidst historic volatility in virtually every asset class and marketplace, we continued to outperform the industry and the broader market indices. We grew our capital base, while most other industry participants shrank or were forced to reorganize. We maintained our dividend for our shareholders, while many others cut distributions. We continued to optimally scale our four investment strategies while others operated less efficiently and with more risk in single asset classes. Through our Stock Ownership Guidelines, our management team and employees purchased stock with their own money instead of selling it as numerous others have. Outlined below is a summary of both how Annaly was able to outperform during the past year and, as importantly, why we remain confident in our ability to continue to produce stable earnings while protecting book value in the future.
In the first quarter of 2017, we distributed another $0.30 per share dividend to our shareholders — the same exact quarterly dividend we have now offered for over three years, or 14 consecutive quarters. It is important to note, and it is no coincidence, that our outstanding performance during this time period coincides with the arrival of most of our current investment and financing teams. In comparison, over that same time period, 75% of the companies in the residential mREIT sector have cut dividends at least once – in fact, there have been 47 dividend cuts in total within this sector. Annaly's total return of 61% since 2014 has outperformed all yield-oriented equity strategies and has far exceeded the returns of the S&P 500 and the Bloomberg Mortgage REIT indices by 66% and 33%, respectively. Specifically with respect to performance in 2016, despite the Oil Crash, Brexit and the one of the largest single-quarter moves in the 10-year Treasury this century, we delivered a total shareholder return of 19%.
We continue to benefit from our enhanced size and our conservative leverage profile; we are now 19x the size of the median mREIT and maintained $6.8 billion of unencumbered assets on our balance sheet as of year-end. As we've highlighted since the onset of QE3 in the fourth quarter of 2012, liquidity is of paramount importance when operating in this volatile marketplace. At the end of the fourth quarter of 2016, our economic leverage of 6.4x remained 20% lower than the agency industry average. Moreover, our credit businesses, which have achieved critical mass, currently operate at leverage levels well below the industry averages. We have now procured new and dedicated funding options across each of the investment disciplines, which serve to optimize our use of equity capital unlocking incremental return for our shareholders.
Our diversification efforts continued in 2016 as each of our portfolios achieved increased scale and enhanced operational efficiencies. During the year, our Residential Credit and Middle Market Lending businesses grew 81% and 58% respectively, to $2.5 billion and $800 million in assets. As the fourth quarter of 2016 displayed, the advantage of the optionality embedded within our shared capital model is that we are not restricted to a single asset class— rather, we are able to rotate our investment and financing exposures to maximize our risk-adjusted return while mitigating the impact of unexpected market volatility or economic cyclicality. Regardless of the market or economic forecast, for rising or falling rates, for accelerating or slowing growth, Annaly is a proven cyclical and countercyclical yield investment alternative given the scale achieved in our credit disciplines.
Annaly is better positioned than ever to continue to produce high-quality stable earnings while protecting book value in various market environments. As a direct result of our comprehensive diversification efforts, which now include over 25 investment options across four investment groups, our more developed hedging strategies and enhanced liquidity, Annaly's interest rate sensitivity has been meaningfully reduced. This proactive rebalancing of our capital and interest rate exposure can act as a significant cushion to our book value especially during a larger selloff in rates, as we demonstrated with our outperformance during the fourth quarter of 2016.
It is critical to highlight that while we have made broad investments over the past few years in both our investment platforms and financing strategies, we have not asked our shareholders to bear any of the incremental costs for this growth and diversification. We currently operate our multi-strategy model with four distinct investment groups, in addition to a servicing platform, on a highly efficient basis compared to the monoline companies in the industry. Consequently, our outsized returns are in part attributable to our diversified, scalable model, with an operating expense to equity ratio of 1.59%, 51% lower than the average of our industry peers.(1) As a percentage of assets, this ratio is merely 0.23%, or 66% lower than the average mortgage REIT.(2)
Our prudent risk management is reflective of the fact that within our shared capital model, our investment teams’ interests are aligned with our shareholders. In 2016, we expanded our Employee Stock Ownership Guidelines whereby over 40% of our employees were not granted stock, but rather, were asked to purchase predetermined amounts of shares in the open market based on certain criteria including seniority, compensation level and role. Establishing more of an ownership culture – for the long term – throughout the Firm is extremely important to me and I’m pleased that as of March 31, 2017, all individuals subject to these guidelines either met, or within the applicable period are expected to meet, the stock ownership guidelines. This broad-based initiative is not just unique in our industry, it is unique in all of corporate America.
On July 12th, 2016 we completed the $1.5 billion acquisition of Hatteras Financial Corp. This transaction marked the largest mortgage REIT M&A deal in history and further established Annaly as the market leader, growing our pro forma market capitalization to 20% of the entire industry. The acquired portfolio advanced our diversification strategy by providing added exposure to Adjustable Rate Mortgages (ARMs) and mortgage servicing rights (MSRs) and augmented our Residential Credit platform with whole loans. Following this acquisition and the onset of further consolidation, there has been a demonstrable increase in value for shareholders across the industry with the total market valuation of the Bloomberg Mortgage REIT Index increasing 21%, while the number of companies in the index actually decreased from 40 to 33.(3)
Finally, in October of 2017 Annaly will celebrate its 20th anniversary as a public company. We have come a long way since the Company’s $120 million initial public offering in 1997 to our industry leading model and diversified platform with over $12.5 billion of capital as of December 31, 2016. For the benefit of our shareholders, Annaly has transformed over time – the fundamental strategic characteristic of all market leaders. Within our four complementary investment groups, we continue to be uniquely positioned to capture market share in the competition for superior asset selection and most favorable financing structures and terms. We have evolved into a diversified capital manager and equity yield investment option noticeably distinct from the mortgage REIT universe in terms of our size, liquidity, diversity and stability.
I am confident and energized by all of our opportunities to achieve our stated goals and cross new thresholds in 2017 and beyond. I strongly believe we are well positioned to continue to reward our shareholders in this challenging marketplace, where conservatively-valued, yield manufacturing businesses like Annaly are increasingly difficult to find.
Kevin G. Keyes
Chief Executive Officer & President
April 11, 2017
- Represents the % difference of operating expense as a % of average equity for Annaly vs. the Bloomberg Mortgage REIT (“BBREMTG”) Index average.
- Represents the % difference of operating expense as a % of average assets for Annaly vs. the BBREMTG average.
Notes: From 2012 to 2016. Average excludes BBREMTG members with market capitalization below $200 million. Operating Expense is defined as: (i) for internally-managed BBREMTG members, the sum of compensation & benefits, general & administrative expenses and other operating expenses, and (ii) for externally-managed BBREMTG members, the sum of net management fees, compensation & benefits (if any), general & administrative expenses and other operating expenses.
- Time period reflects announcement of the Hatteras Transaction (April 11, 2016) to March 31, 2017.