trending Market Intelligence /marketintelligence/en/news-insights/trending/mRP9TMl5XfCGpPcrWkN2QA2 content esgSubNav
In This List

Annaly proves past consolidation talk to be more than idle chatter


Banking Essentials Newsletter: January 11th Edition


Banking Essentials Newsletter December 21st Edition


The Road to Basel IV: Navigating the challenge facing European banks


Basel Framework- Utilizing data to analyze the capital position of European banks.

Annaly proves past consolidation talk to be more than idle chatter

Presidentand CEO Kevin Keyes opened a conference call to discuss the mortgage REIT's to acquire with a reflectionon the market conditions that culminated in the sector's largest M&A deal todate.

"LastSeptember at an industry conference and in many other investor meetings since then,I've described how the mortgage REIT industry could benefit from strategic consolidation,"Keyes said, according to a transcriptof his remarks.

"Manyof the industry's underdeveloped or monoline strategies are strapped with high fixedoperating costs, lack liquidity and now struggle with reduced financing capacityat higher rates. These limited platforms are now exposed more than ever to the dailyrisks in this challenging and volatile market environment," he added, referencinga "bifurcation" in the valuations assigned of late to those mortgage REITs,like Annaly, with "differentiated" strategies.

Maximizing shareholder value

A reviewof SEC filings detailing the backgrounds of two of the four transactions announcedwithin the past seven weeks that involve publicly traded mortgage REITs as targetsconfirm that Annaly was not the only company in the sector thinking about M&Aduring the latter part of 2015 as market conditions grew more difficult.

In theregistration statementfor Apollo Commercial Real EstateFinance Inc.'s pending acquisitionof Apollo Residential Mortgage Inc.,the target said its external manager had increased efforts during mid to late 2015that had been ongoing since 2013 to find ways to address what it described as the"continuing and increasing challenges" it faced.

ApolloResidential said its goals of increasing stockholder value had been adversely impactedby "significant headwinds" facing the mortgage REIT sector overall. Themortgage REIT noted that its stock had been trading at a "substantial discount"to its net asset value per share for some time, and a 14% decline in net book valueper share during 2015 had rendered the situation "more acute."

Overtime, the external manager had considered steps such as changing Apollo Residential'sstrategic focus, investment strategy and/or capital allocation policies as wellas the pursuit of potential business combinations, including acquisitions, dispositionsand joint ventures with third parties and other entities managed by . During thefall of 2015, Apollo and the external managers of the two mortgage REITs began exploringthe possibility of combining the entities, according to the filing. They concludedin November 2015 that it might be possible to engage in such a deal on terms thatwould address Apollo Residential's "subscale issue" and provide liquidityto its shareholders in a potentially attractive manner.

Afterthe boards of the two mortgage REITs retained advisers and formed special committees,the Apollo Commercial special committee Jan. 11 delivered a preliminary, nonbindingindicative proposal offering to acquire Apollo Residential at 82.5% of the prospectivetarget's book value. A revised proposal delivered 12 days later proposed a relativevaluation of 85.25% of Apollo Residential's common equity book value, which theprospective target would eventually counter with a proposed price equal to 87.75%of book. They ultimately agreed on a relative valuation of 89.25%.

The ApolloResidential board cited the various challenges facing the mortgage REIT and theindustry and the opportunities associated with the economies of scale of the combinedorganization among its reasons for supporting the transaction. It also cited a 35-day"go-shop" period. That period, which ended April 1, did not result inany nondisclosure agreements, but Apollo Residential's financial adviser reachedout to six residential mortgage REITs and four commercial mortgage REITs to gaugetheir interest. An unnamed asset manager contacted the mortgage REIT to expressinterest in a potential deal during the period.

As ApolloResidential's manager stepped up its efforts to consider strategic alternativesduring the second half of 2015, so too did the management of a target of anotherrecent mortgage REIT M&A deal.

reported in a March SEC filingassociated with ARMOUR ResidentialREIT Inc.'s tender offer for the mortgage REIT's outstanding commonstock that its management considered potential actions during that time to maximizeshareholder value in light of the perceived difficulties it faced in remaining apublic company. Capital-raising initiatives, including a rights offering, cost-cuttingmeasures and, at the behestof an activist investor, a potential liquidation were among the options reviewed.

ARMOUR,which was under common external management, ultimately approached nonmanagementmembers of the JAVELIN board regarding a potential acquisition in a deal that wouldgive the mortgage REIT an efficient way to enter the nonagency MBS market in a cost-effectivemanner. The resulting process, which included a "market check" that fieldedexpressions of interest from at least four other parties, culminated in the March2 announcement of a dealthat valued JAVELIN's shares at a premium to their market price at the time andthe mortgage REIT's estimated liquidation value.

'Plenty of opportunities out there'

The deal,which closed April 6, offered another data point to support the rationale behindthe combination of Annaly and Hatteras, as did the recently announced of and in a merger that,among other things, will result in a combined entity with "significantly"increased scale.

"Nowwith the tide no longer rising in most every asset and financing market globally,"Annaly's Keyes said, "investors have sharpened their focus once again and begunto more clearly differentiate management teams, asset quality, liquidity, accessto financing, risk controls, corporate governance and long-term track records inevery industry, including ours. As I've said, volatility equals opportunity forAnnaly, and this transaction is the latest strategic move we've made to ensure thatour shareholders continue to benefit from the opportunities that we've been preparingfor."

Morethan two-thirds of Annaly's existing agency investment portfolio had been allocatedto MBS backed by 30-year fixed-rate mortgages. The addition of the Hatteras agencyportfolio, which is heavily weighted toward MBS backed by hybrid adjustable-ratemortgages, will result in a larger, more diversified book that Annaly believes willenhance the stability of its earnings profile. It also represents what managementdescribed as the next phase of Annaly's transformation to becoming the "leading"hybrid mortgage REIT.

Annalypreviously used M&A to help advance a push for diversification. Its January2013 agreement to acquirecommercial mortgage REIT CreXus Investment Corp. had ranked as the largest M&Atransaction in the mortgage REIT space by announced deal value, as determined bySNL, at $875.8 million until it was superseded by the $1.50 billion Hatteras transaction.But different from the unaffiliated Hatteras, CreXus had close ties to Annaly atthe time of the deal as it had been externally managed by a wholly owned subsidiaryof the mortgage REIT.

Whenasked about the prospect for future deals during the Hatteras merger call, Keyessaid Annaly's entire focus will be on executing the transaction at hand and deliveringthe expected strategic benefits. But he did not directly rule out additional M&Aactivity.

"Ithink that there's plenty of opportunities out there," Keyes said. "Ithink there's opportunities especially for us."