A recent filing with the Securities and Exchange Commission reveals some interesting plans for the Annaly Capital (NYSE:NLY) shareholders' meeting. It seems that the well-established mortgage REIT wants to significantly change its management structure -- and it will ask its shareholders at the company's annual meeting this May to approve this modification.
A drastic change
Since going public in 1997, Annaly has been internally managed by its board of directors, which oversees its management team -- most of whom are also on the board. A note on Annaly's website from the late Michael Farrell, former CEO, states that the trust's governance is geared toward transparency, which accounts for the company's excellent performance.
Now, the mREIT wants to become externally managed, using a company called, quite appropriately, Annaly Management Company LLC. All managers and officers would become employees of the Manager, and the new regime would begin on July 1 of this year.
A management contract beneficial to Annaly
Annaly says that the decision to move to an external management system is in the best interests of both the company and the stockholders. The company lays out several ways that its new paradigm would be superior to other external management agreements, after researching the subject thoroughly with the help of advisors from Credit Suisse.
For instance, Annaly will pay an annual management fee of 1.05% of stockholder equity, less than the industry average of 1.50%. Also, if the Manager is sold, Annaly would receive the proceeds, not the Manager's owners. The Manager would oversee Annaly only, avoiding conflicts of interest. Annaly would also require the officers who own the Manager to purchase stock at a rate of times times their base salary -- thus cementing their loyalty to the company. Interestingly, the five owners of the Manager all sit on Annaly's board.
Not an unusual setup
Annaly is familiar with outside management contracts. Its wholly owned subsidiary, FIDAC, manages both Chimera Investment (NYSE:CIM), a hybrid mREIT, and CreXus Investment (UNKNOWN:CXS.DL.DL), the purchaser of commercial mortgage-backed securities that Annaly is in the process of acquiring.
Chimera's recent 10-K report notes that there is a risk of conflict when an outside Manager is in charge of more than one entity, something Annaly is seeking to avoid. Chimera has also paid higher management fees than average -- the most recent being 1.87%, including expenses, for the last quarter of 2011 As I've recently noted, there are close familial relationships between Chimera's and Annaly's boards.
Why the change?
As Annaly notes, many other mREITs use outside management, such as American Capital Agency and Two Harbors. The reasons for the desired change seem to be mostly financial, and tied to the way the company pays its executives. Annaly estimates that the savings will be in the neighborhood of $210.9 million over the next five years, if the proposal is ratified. One way Annaly would realize these savings, assumedly, is because the company would be able to deduct expenses tied to "certain payments made to certain of our executive officers."
Interestingly, Annaly represents the bucking of a trend noted in 2007 by Moody's, which noted a movement by U.S. REITs toward internal management. Rating agencies seem to consider internally managed trusts more stable than those with external managers.
Moody's report touches on many of the concerns brought up by Annaly in regards to external management, such as the managers not being vested in the company enough to properly align their loyalties, and the issues concerning conflicts of interest when managers control more than one REIT. However, most of these matters seem to be applicable to a true outside management system, whereby different persons are involved in the REIT structure and the company managing the trust. For instance, the report notes that an external manager can make succession plans easier, since the management company usually has a much larger pool of employees from which to choose new executives.
Benefits seem geared toward management
Is this a good deal for stockholders? The savings seem hefty, though the entire project seems geared toward the financial aspects. Most of the other reasons, such as the notion that this new structure will help Annaly retain its experienced executives sound odd, particularly when paired with the fact that they are the very same people. Also, the idea that investors will be more attracted to the trust due to the management change-up seems a little sketchy.
Then, again, there's that issue about the make-up of the Manager. Personally, I find the fact that the very executives who will own the Manager will also be its employees to be confusing, at best.
One thing seems certain, though -- this year's annual meeting should be pretty exciting, for both shareholders and management.