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Factors Setting the Tone for Annaly (NLY) in Q3 Earnings

Annaly Capital Management Inc. NLY is scheduled to report third-quarter 2020 results on Oct 28, after market close. The company’s results are expected to reflect year-over-year growth in earnings per share (EPS) and net interest income (NII).

In the last reported quarter, this mortgage real estate investment trust (mREIT) posted core earnings, excluding premium amortization adjustment (PAA), of 27 cents per share, surpassing the Zacks Consensus Estimate of 23 cents. Moreover, NII was $398.8 million, surpassing the Zacks Consensus Estimate of $205 million.

Over the last four quarters, the company’s earnings beat the Zacks Consensus Estimate on two occasions, missed in one and met the mark in another quarter. The average surprise was 2.4%. The graph below depicts this surprise history:

Annaly Capital Management Inc Price and EPS Surprise

 

Annaly Capital Management Inc Price and EPS Surprise

Annaly Capital Management Inc price-eps-surprise | Annaly Capital Management Inc Quote

Let’s see how things have shaped up prior to this announcement.

The residential mortgage market witnessed one of the most robust recoveries during the third quarter since the peak of the pandemic sell-off in March that continued into April. In fact, favorable regulatory changes and continued Fed purchases of mortgage bonds have fueled this rebound.

These positive developments indicate the stability of the Agency mortgage backed securities (“MBS”) market. As for Annaly, the company is expected to have gained from this stability, given the short-term capital allocation strategy that is focused primarily on the Agency sector. In fact, amid the improvement in the Agency MBS market, the company is expected to have increased its Agency portfolio. Notably, in the second quarter, Annaly expanded its Agency portfolio by 5%.

Moreover, this portfolio is expected to have enjoyed attractive risk-adjusted returns, given the tighter spreads in the agency residential MBS market prevailing during the third quarter.

In fact, tighter asset spread along with continued share buyback efforts should have continued to drive incremental book value gains for the company in the July-September quarter.

Further, a decline in average Agency repo costs during the quarter is expected to have reduced interest expenses related to Annaly’s outstanding short-term repurchase agreements or repos to finance its operations. This is because borrowing costs on such repos are closely related to the Fed’s target rate, which has been hovering close to zero. Hence, lower interest expenses are likely to have alleviated pressure from NII.

In fact, the consensus estimate for third-quarter NII of $345 million indicates a 126.4% year-over-year increase.

However, a modest decline in mortgage rates during the third quarter is expected to have accelerated mortgage prepayments. This suggests an increase in premium amortization expenses and high levels of conditional prepayment rate for the quarter under review for Annaly’s agency portfolio, which consists primarily of fixed-rate MBS. It is also likely to have hurt asset yield.

Prepayment headwind along with higher Agency MBS balances is likely to have resulted in a drop in asset yield. This is turn is projected to have affected third-quarter net interest margin (NIM). In fact, NIM for the third quarter is estimated to be 1.79%, contracting from the second quarter’s 1.89%. 

Moreover, the Zacks Consensus Estimate for third-quarter net interest spread is pinned at 1.20%, indicated a decline from the prior quarter’s reported figure of 1.81%.

Moreover, the non-agency share of mortgage securitizations has been low, owing to the pandemic-led dislocations. This has likely been concerning for Annaly’s residential credit business.

Additionally, the company’s activities during the September-end quarter were inadequate to gain analysts’ confidence. Consequently, the Zacks Consensus Estimate for third-quarter earnings has been unchanged at 26 cents in a month, indicating 23.8% year-over-year growth.

Earnings Whispers

Our proven model does not conclusively predict an earnings beat for Annaly this time around. This is because a stock needs to have both a positive Earnings ESP and a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold), which is not the case here as you will see below.

You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

Earnings ESP: Annaly’s Earnings ESP is 0.00%.

Zacks Rank: The company currently carries a Zacks Rank of 3. You can see the complete list of today’s Zacks #1 Rank stocks here.

Stocks That Warrant a Look

Here are a few stocks in the REIT sector that you may want to consider, as our model shows that these have the right combination of elements to report a surprise this quarter:

Lexington Realty Trust LXP, set to report quarterly numbers on Nov 5, currently has an Earnings ESP of +1.33% and a Zacks Rank of 3.

National Storage Affiliates Trust NSA, slated to release third-quarter earnings on Nov 5, has an Earnings ESP of +2.88% and a Zacks Rank of 3 at present.

Ventas, Inc. VTR, slated to release third-quarter earnings on Nov 6, has an Earnings ESP of +2.03% and a Zacks Rank of 3 at present.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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