Annaly Capital: Getting Your Slice of the Bail-Out Pie

Dec.11.08 | About: Annaly Capital (NLY)

Annaly Capital (NYSE:NLY) offers investors a way to profit from the government’s intervention in Freddie (FRE) and Fannie (FNM) as well as from the various other bail-outs. NLY is a REIT whose principal business objective is to generate net income for distribution to investors from the spread between the interest income earned on its mortgage-backed securities and the cost of borrowing to finance their purchase. NLY owns only AAA-rate, highly liquid GSE mortgage backed securities on their balance sheet.

  • Attractive total return and valuation: NLY is classified as a REIT so they pay out substantially all of their free cash flow to investors. NLY offers an attractive and fairly certain total return opportunity as the stock is currently yielding 15%. Investors have stayed away from the stock due to concerns about the credit markets, Freddie and Fannie drama, and the exodus from financial stocks in general. NLY earns revenue from the cash flows of the GSE MBS that they own in their portfolio. The GSE MBS are now backed by the explicit guarantee of the US government so NLY is not subject to any credit risk. The beauty of NLY is that investors do not need the stock to appreciate to still earn +15% which, with no credit risk, is an attractive return in this chaotic market environment.
  • Asset value provides downside support: The assets on NLY”s balance sheet are liquid and transparent agency debt issues resulting in a tangible book value of $13.32 that should provide a fairly firm valuation floor. The firmness of the asset support has been shown throughout this year as NLY has managed to hold around these levels even in the panic surrounding the Bear Stearns collapse, the Freddie and Fannie drama, and the various panic selling days. The historic average book value multiple is 1.4x which would equal a price target of $18.64. Below is a historical perspective on price/book multiple for NLY: the high was 1.77x in 2004 and the low was .76x set earlier this year. The eight year average is 1.32x.