I read an interesting article from another Seeking Alpha author the other day. This article stated something quite intriguing to me, which leads me to believe that the worst might not be over for Annaly Capital (NLY);
"The NY Fed web site also shows that of the $78B of MBS purchases made between 9/14/2012 and 10/11/2012, around $15B of purchases have not been settled yet, and of the $75B of MBS purchases made between 10/12/2012 and 11/13/2012, around $60B of purchases have not been settled yet (as of 11/29/2012)."
By the way, the NY Fed has the responsibility to purchase the mortgage backed securities, and the actions can be viewed on their website.
Does this mean that not all of the Fed purchases have been factored into the interest rate picture yet? I believe we might see further erosion in the yield curve spread, and further downward pressure on longer term interest rates as well.
Here is where we stand right now:
The spread has compressed to 137 basis points and that could mean even more pressure on Annaly profits going forward. It will also pressure the dividends to be cut once again, and if the majority of the latest round of MBS purchases have NOT been factored in here, I feel Annaly can be in for more pain.
The cycle becomes head swirling to say the least. Investors sell the stock, the share price drops, the dividend yield goes up. This lends itself to some investors just looking at the current yield. These investors could find themselves in a yield trap, which erodes the total value of their holdings as the dividends get cut and the share price drops further.
The Allure Of Chasing Yield
The first figure that jumps out at some yield seeking investors, is that 13.60% yield that NLY currently has. If they just stop there and see that the share price is "reasonable" to buy a good number of shares, they MIGHT fall victim to this yield trap.
The other part of the allure is the share price discount to book value which now stands at about 12%. These fundamentals cannot be denied of course. As the chart above shows, the yield has increased as the share price has decreased, and the share price to BV has become "attractive".
Headwinds Remain Plus Some More Wrinkles
Nothing has changed since my last report. The sector is still under pressure from the declining interest rates and yield curve spread compression, and now that I have learned that the majority of the MBS purchases have not even been settled yet, we have to see how that affects just about everything in the agency mREIT sector, and most specifically Annaly Capital.
Operation Twist has ended but according to the latest FOMC minutes the committee stated;
"The Committee will closely monitor incoming information on economic and financial developments in coming months. If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability" (Emphasis added by this author)
What has been bandied about is keeping the spending rate at the current $85 billion (that includes Operation Twist) but with a more focused purchase of MBS rather than just longer term bonds, or possibly both.
We won't know that until the Fed acts, but I believe QE4 is right around the corner. The impact this will have on Annaly and the other companies in this sector is uncertain at best.
The Bottom Line
Do your own due diligence prior to making any decisions. Do not rely on anyone else's opinion. As for me, I will not fight the Fed.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.