On the 12th of November 2012, Annaly Capital (NYSE:NLY), one of the large cap US Agency mortgage REITs, announced the proposed acquisition of CreXus Investment (NYSE:CXS) for a price of $12.5 per share. CreXus is a commercial mortgage REIT that does not only invest in agency residential mortgage backed securities but also in commercial mortgage loans and other commercial real estate debt. It also invests in commercial real estate property, commercial mortgage-backed securities and other commercial real estate-related assets.
The acquisition signifies Annaly Capital's attempts to diversify its asset base in a challenging environment where the Fed is committed to buying Agency mortgage backed securities. This has resulted in a decline in the yields for these securities. In several of our previous reports, we favored mortgage REITs with significant holdings of non-agency mortgage backed securities as opposed to agency mortgage backed securities. Annaly Capital is committed to allocating up to one fourth of its equity to assets other than agency residential mortgage backed securities. The company is also committed to restructuring its capital by buying back convertible notes worth $441 million, extending the duration of its short-term borrowings (repurchase agreements) by another 93 days to 220 days, and lowering the company's cost of capital by issuing preferred shares and convertible notes worth $1.5 billion.
Implications of the Acquisition:
The latest move will help the company to somewhat recover from the decline in its net interest rate spread that plunged over 100 basis points to 1.02% during the third quarter of the current year. In comparison, CreXus earned a 10.4% net interest margin during the third quarter of the current year. As a result of Quantitative Easing 3 conducted by the Fed, Annaly Capital lost 117 basis points in the average yield that the company earned during the third quarter. In comparison, American Capital Agency (NASDAQ:AGNC) witnessed a decline of merely 18 and 23 basis points in its average asset yield and net interest margin, respectively, over the same time period. American Capital is another large cap mortgage REIT that invests in agency residential mortgage backed securities. Since the Fed is only interested in agency MBS, the inclusion of commercial mortgage backed securities will help improve Annaly Capital's net interest margin in the coming quarters.
With 76.6 million shares of CreXus outstanding and Annaly paying $12.5 per share, the acquisition would cost around $839 million, with Annaly already holding a 12.4% stake in CreXus. This represents a premium of around 13% at the closing price of November 9, 2012. However, soon after the announcement of the acquisition, CreXus' share price climbed up to $12.4 per share, eliminating most of the premium. Annaly Capital generated $3.6 billion at the end of the third quarter of the current year, which is more than sufficient to finance the acquisition.
Faruqi & Faruqi, LLP, a civil litigation firm, has already started investigating the proposed acquisition and whether or not the Board of Directors of CreXus are acting in accordance with their fiduciary duties to the company's shareholders in valuing the company.
In conclusion, Annaly Capital's move to acquire CreXus may be enough to put a floor on the company's share price. Annaly has sufficient cash from operations to support the acquisition. The acquisition will help reduce the downward pressure on Annaly Capital's net interest margin and, ultimately, to improve its bottom line. Therefore, we recommend investors to long Annaly Capital in order to benefit from this proposed acquisition.