Following our management externalization transaction (the “Externalization”), which was approved by approximately 83% of our stockholders on May 23, 2013, we became externally-managed by our Manager. Pursuant to the terms of the Management Agreement, we pay our Manager a management fee and our Manager pays all of the compensation to our management personnel (including our NEOs). The Compensation Committee annually reviews the management fee and the performance of our Manager, including the accomplishments discussed beginning on page IV of the Proxy Summary. The Independent Directors then consider the Compensation Committee’s recommendations when determining whether to renew or amend the terms of the Management Agreement. Based on the review and factors described in more detail below, the Independent Directors have determined that the Management Agreement continues to be in the best interests of the Company and our stockholders. For additional information, see “Certain Relationships and Related Party Transactions”, “Compensation Paid by our Manager to our Named Executive Officers” and “Compensation Discussion and Analysis.”
Management Agreement Terms
We believe that the terms and conditions of the Management Agreement compare favorably to the terms and conditions that exist between our externally-managed mREIT peers and their respective managers. In particular, as illustrated by the table below, when compared to the median for the peer comparison, (i) the management fee paid to our Manager is lower as a percentage of stockholders’ equity, (ii) the term of the Management Agreement was of a shorter duration, and (iii) the Management Agreement has no termination fee, which is expressed in the table below as a multiple of trailing average annual management fees.
|Agency Residential REITs|
|Base management fee(1)||1.13%||1.13%||1.05%||1.20%||1.05%|
|Initial term in years||6.0||6.0||2.0||10.0||2.0|
|Termination fee multiple(2)||4.4x||4.4x||3.3x||5.5x||None|
|Base management fee||1.50%||1.50%||1.50%||1.50%||1.05%|
|Initial term in years||2.8||3.0||2.0||3.0||2.0|
|Termination fee multiple||3.1x||2.9x||2.1x||5.0x||None|
|Non-Agency Residential / Hybrid REITs|
|Base management fee||1.50%||1.50%||1.50%||1.50%||1.05%|
|Initial term in years||2.5||3.0||1.0||3.0||2.0|
|Termination fee multiple||3.1x||3.2x||1.0x||5.0x||None|
Source: Public filings as of year ended December 31, 2016. All base management fees are calculated as a percentage of stockholders’ equity and all termination fees are calculated as a multiple of the average annual base management fee during the prior 24-month period, except as otherwise specified below. Agency Residential REITs represent the Agency mREIT Peers, with the exception of AGNC, CYS and CMO, which are internally-managed companies; Commercial REITs represent the externally-managed commercial mortgage REITs included in the BBREMTG Index as of December 31, 2016 with market capitalization above $200 million and includes Blackstone Mortgage Trust, Inc. (“BXMT”), Ares Commercial Real Estate Corp. (“ACRE”), Resource Capital Corp. (“RSO”), Apollo Commercial Real Estate Finance, Inc. (“ARI”), and Starwood Property Trust, Inc. (“STWD”); Non-Agency Residential/Hybrid REITs represents the externally-managed non-agency residential and hybrid mortgage REITs included in the BBREMTG Index as of December 31, 2016 with market capitalization above $200 million and includes New Residential Investment Corp. (“NRZ”), Western Asset Mortgage Capital Corp. (“WMC”), AG Mortgage Investment Trust, Inc. (“MITT”), PennyMac Mortgage Investment Trust (“PMT”), Invesco Mortgage Capital Inc. (“IVR”) and Two Harbors Investment Corp. (“TWO”).
- For ARR, base management fee is calculated as 1.5% of gross equity raised up to $1.0 billion plus 0.75% of gross equity raised in excess of $1.0 billion.
- ARR’s termination fee is calculated as the greater of (a) the base management fee calculated prior to the effective date of agreement termination for the remainder of the term or (b) 3x the base management fee during the preceding full 12 months.
- Of the five Commercial REITs, four have incentive fees in addition to their base management fees. STWD and RSO have incentive fees of 20% above an 8% hurdle. BXMT has a 20% incentive fee above a 7% hurdle. RSO has a 25% incentive fee above an 8% hurdle. For purposes of this table, the calculation of the mean includes only the four Commercial REITs that have incentive fees.
- NRZ’s termination fee is calculated using the prior 12-month period. Pursuant to the terms of its management agreement, PMT’s termination fee is calculated as a multiple of the base management fee and a performance incentive fee. For purposes of this table, we have disregarded any impact from this performance incentive fee on PMT’s termination fee multiple.
- Of the six Non-Agency Residential/Hybrid REITs, two have incentive fees in addition to their base management fees. NRZ has an incentive fee of 25% above a 10% hurdle. PMT has an incentive fee with a sliding scale above 8%.
Structure and Amount of the Management Fee
The Compensation Committee annually reviews both the structure of the management fee as well as the amount of such fee to determine whether they incentivize the management team to work towards the Company’s desired goals to the benefit of long-term stockholder interests. The Compensation Committee has determined that the use of a management fee formulated as a percentage of stockholders’ equity (as defined in our Management Agreement) represents a responsible and prudent method of compensating the management team. In particular, in the context of an mREIT that uses leverage as a key component of its business strategy, the Compensation Committee believes that providing for a contractually required payment structured as an “incentive fee” may misalign the goals of the management team from those of the stockholders.
Moreover, the Compensation Committee believes that a management fee that is based upon stockholders’ equity, along with the stock ownership guidelines discussed on page 27, aligns the management team to the goals of the Company. We believe that focusing the management fee on the preservation and growth of the Company’s book value incentivizes our Manager to achieve long-term performance that protects our stockholders’ equity as realized losses decrease such equity and, ultimately, the management fee.
Additionally, for our Manager to earn a larger management fee, the stockholders’ equity of the Company would need to increase. As a result, the growth of the stockholders’ equity is an alignment between the interests of our stockholders and the management team. Further, this alignment is stronger in the REIT industry than in other businesses. REIT regulations require us to pay at least 90% of our earnings to stockholders as dividends. As a result, unlike most companies, we cannot grow our business and our book value by reinvesting our earnings. This places a unique market discipline on us.
We also believe that our management fee structure is more favorable to our stockholders than if it were based on total assets under management, which could potentially incentivize an external manager to excessively leverage assets under management in an attempt to increase short term incentive payouts.
Clawback for the Management Fee
Pursuant to the 2016 amendment and restatement of the Management Agreement, the Company is entitled to receive reimbursement from our Manager if the Board determines that a computation error (regardless of the reason for or amount of such error) resulted in the overpayment of a management fee to our Manager.
Continued Cost Savings Related to the Externalization
We believe that the Externalization has materially reduced the Company’s compensation-related costs. When comparing the management fees we paid for the fiscal years ended December 31, 2013, 2014, 2015 and 2016 against the estimated compensation costs (including tax costs) we would have paid for the same period if those costs remained what they were in 2012, we estimate that the Externalization has resulted in total compensation savings (calculated in accordance with GAAP) of approximately $138 million.
As illustrated by the table below, the management fee for each of 2013(1), 2014, 2015 and 2016 is significantly lower than our 2012 compensation expenses (which is represented by the dashed blue line):
- Although our Manager commenced management of Annaly on July 1, 2013, our stockholders received the benefit of the compensation savings created by the Externalization for the entire 2013 calendar year pursuant to a pro forma adjustment to the 2013 management fee. We calculated a pro forma management fee, which was the management fee as if we were managed by our Manager from January 1, 2013 until July 1, 2013, and the actual amount of cash compensation paid to all of our employees from January 1, 2013 until July 1, 2013 reduced the amount of the management fee owed to our Manager.
- Assumes compensation costs for each of 2013, 2014, 2015 and 2016 would have remained what they were in 2012 (the last full year prior to the Externalization).
Annual Review of Manager Performance and Management Fee Considerations
The Compensation Committee annually reviews our performance and management fee against both our historical results and our mREIT peers, based on a number of metrics, including those discussed above in the “Proxy Summary” and the expense ratios discussed below.
Peer Comparison of Operating Expenses as a Percentage of Average Assets and Average Stockholders’ Equity
The Compensation Committee reviews our total operating expenses (including the management fee), as a percentage of both our average assets and our average stockholders’ equity. The Compensation Committee believes these ratios, which allow us to compare the performance of our Manager to both our internally- and externally-managed mREIT peers, measure the extent to which we operate in an economically efficient manner.
% of Avg Assets
% of Avg Equity
Source: Company Filings, SNL and Bloomberg. Averages are market weighted based on market capitalization as of Dec. 31st of each respective year.
Note: Internally-Managed Peers and Externally-Managed Peers represent the respective internally- and externally-managed members of the BBREMTG Index with market capitalization above $200 million as of December 31st of each respective year. The average for each excludes Annaly and companies during years in which they became public or first listed. Operating Expense is defined as: (i) for Internally-Managed Peers, the sum of compensation & benefits, general & administrative expenses and other operating expenses, and (ii) for Externally-Managed Peers, the sum of net management fees, compensation & benefits (if any), general & administrative expenses and other operating expenses.
- Excludes costs of $49 million related to the Company’s acquisition of Hatteras.
In its review of these operating expense ratios, the Compensation Committee noted that the Company has outperformed both our internally- and externally-managed mREIT peers over the last five fiscal years. In this regard, the Compensation Committee has viewed the Company’s performance as an indicator that, among other things, our Manager has managed the Company in an efficient manner with appropriately scaled operating costs (including the management fee).