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

Annaly Capital (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.

Comments

[ScrapingBottom:]

I can't find a single short or long term fault with a (NLY) position.

2008 Dec 11 07:42 AM

[JAZ:]

I love NLY too, see my post at seekingalpha.com/artic... The only thing that bears watching is the prepayment speeds of NLY's mortgage portfolio (see www.annaly.com/mc/rmbs... for a good explanation on how prepayments impact profitability).
The recent drop in mortgage rates due the Fed's MBS purchase program is driving refi activity which effectively results in prepayments of existing mortgages. I am awaiting the December commentary from the company to get their views on this refi induced prepayment impact.

2008 Dec 11 09:04 AM

[User 317413:]

The Book Value is about $12.70 as of the recent earnings report, (after preferred stock is figured in) it went down a little after agency MBS paper started going down in market value because of the crisis. however it has gone up because of the announcement of direct purchases of that paper even more recently. a wash....

the fed wants to get those rates down to 4.5% that is paid out to owners like NLY of agency paper, which is down almost a point from where NLY usually gets them... however the borrowing costs have also gone down by large amounts... probably a wash there,

there is also prepayment risk, where those AAA paper gets paid off, because it is AAA paper, ( a comment for the lees than smart people who think 92% or more of people don't pay their mortgage) but this means less earnings for NLY... pay off your mortgage, or refinance, no more payments to NLY... however this is off balanced by NLY having an extremely low leverage ratio of something like 7 historically, an absurdly low number compared to more idiots like Bear sterns, merrill, goldman sachs..etc......

NLY can simply and easily raise that to a leverage of 9 to offset that too... since NLY's creditors are even more comfortable with what NLY does.

all in all people who were stupid enough to sell short, or simply sell NLY at or below book value are going to get their head handed to them, which has happened. but any one thinking this is an easy market for NLY is also diluding themselves.

at or near book value may never happen again in this cycle, i think we've run out of stupid people (and stupid hedge funds) who were selling at or below book value.

2008 Dec 11 09:16 AM

[drbob66:]

" any one thinking this is an easy market for NLY is also diluding themselves. "

You got that right...I've been holding NLY since March, and it's been a WILD ride. I'm hoping that most of the sellers are washed out for now...the technicals are looking better. My only concern is that they might report a lower dividend payment for next quarter (since the markets have been so challenging)...that could spark more selling. I'll continue to sit tight, though, since I've been enjoying the dividend payouts so far.

2008 Dec 13 04:40 PM

[kellerd:]

NLY has very good management and good assets. Its business model risk is the inability to predict the yield curve. In the current environment a significant delation could result in much flatter curve and significant reduction of dividend.


On Dec 11 09:16 AM User 317413 wrote:

> The Book Value is about $12.70 as of the recent earnings report,
> (after preferred stock is figured in) it went down a little after
> agency MBS paper started going down in market value because of the
> crisis. however it has gone up because of the announcement of direct
> purchases of that paper even more recently. a wash....
>
> the fed wants to get those rates down to 4.5% that is paid out to
> owners like NLY of agency paper, which is down almost a point from
> where NLY usually gets them... however the borrowing costs have also
> gone down by large amounts... probably a wash there,
>
> there is also prepayment risk, where those AAA paper gets paid off,
> because it is AAA paper, ( a comment for the lees than smart people
> who think 92% or more of people don't pay their mortgage) but this
> means less earnings for NLY... pay off your mortgage, or refinance,
> no more payments to NLY... however this is off balanced by NLY having
> an extremely low leverage ratio of something like 7 historically,
> an absurdly low number compared to more idiots like Bear sterns,
> merrill, goldman sachs..etc......
>
> NLY can simply and easily raise that to a leverage of 9 to offset
> that too... since NLY's creditors are even more comfortable with
> what NLY does.
>
> all in all people who were stupid enough to sell short, or simply
> sell NLY at or below book value are going to get their head handed
> to them, which has happened. but any one thinking this is an easy
> market for NLY is also diluding themselves.
>
> at or near book value may never happen again in this cycle, i think
> we've run out of stupid people (and stupid hedge funds) who were
> selling at or below book value.
>
>
>
>

2008 Dec 14 12:24 AM

[chiker:]

Chimera (cim) is really a sub of nly in all ways - and it is not agency paper. nly left the shire when they created cim - so toss out fat historical px/book premiums. then if u think their is prepayment risk ask how the funding will look if rates subsequently rise?

Jan 12 12:52 AM