Annaly Capital Could Be A Very Risky Investment Now - Stay Away

| About: Annaly Capital (NLY)

I have been repeatedly stating that the agency mREIT sector stocks -- specifically the largest of them all, Annaly Capital (NYSE:NLY) -- have been under severe pressure from the biggest competitor ever, the Federal Reserve. I am not sure if there is a complete understanding as to how this can affect the entire business models of agency mREITs, but actually it is quite simple when an investor reads between the "high hat" jargon of either professional spin artists or some other "professionals."

Let's be clear about this: I have no skin in the game now. I have no axe to grind, and all I hope to do is to break this confusing situation down into something that any average investor can understand, within the opinions that I believe to be true.

The agency mREIT sector is a higher risk investment right now. Annaly has reacted somewhat aggressively, while its competitor American Capital (NASDAQ:AGNC) claims to be content with its business model.

What Are the Key Reasons for the Risks?

To be very blunt would be to simply state that the ability to produce profits is worse than I have ever seen it. That would be subjective at best, so here are some issues that can support my opinion:

  • The Federal Reserve has upped the ante by buying an additional $40 billion each and every month of mortgage-backed securities. This is on top of what it already purchases.
  • These additional purchases are open-ended and have no expiration date.
  • These mortgage-backed securities are the same ones that the agency mREITs trade in. This creates a competitor in the market that has the financial capability to do whatever it wants for as long as it wants for as much as it costs. Can NLY compete with that competitor?
  • Operation Twist is not over as yet, which buys bonds at the longer end of the maturity spectrum forcing the 10-year Treasury rates down. This reduces the spread between the short end and the long end, making the spread needed for NLY to profit to an extent that it can maintain its business model and its profitability.
  • If the yield curve flattens, profits become squeezed and dividends could be cut more than they have been recently.
  • If dividends are cut to a great extent, investors will seek other investments that do not have the Federal Reserve in the way. Business development companies come to mind.
  • If investors sell their positions, the share price of NLY could be under pressure as it has been over the last month or so.
  • If the share price is under pressure, even more investors will flee because their total return could be in the negative column.
  • The Federal Reserve has an endless money supply, NLY does not.

The yield curve and the spread has compressed quite significantly.

A drop of almost 20% in the NLY share price has eaten up over one year of dividends paid at the current dividend payment. A negative total return.

Perhaps selling into a dead cat bounce can save investors money?

What has Annaly Done to Fight Back

Kudos to NLY for at the very least acknowledging that the game has changed for the sector. The company has made a bid to take over CreXus investments (NYSE:CXS) recently, which could help diversify a portion of the NLY business, and it also could go after Chimera (NYSE:CIM) to further give itself options in the non-agency mREIT sector.

While I believe that these moves are prudent, we should keep in mind that nothing has been finalized and there could be other agency mREITs that might want to join the fracas. If NLY proves successful in its bid to change, I am not certain if it is too little too late or not.

Uncertainty is an important component to my opinion because, as we all know, investors dislike uncertainty. The very fact that all the balls "are up in the air" leads me to conclude that this sector is more of a risk investment than ever before.

Caveat emptor is the buzzword of the week for Annaly Capital, as well as American Capital. I, personally, am not in any position to fight the Fed.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.