Last week I wrote this article about my opinion of the widening yield curve spread, and if it was a buy signal for Annaly Capital (NYSE:NLY). As of today I will be adding this stock back into the Team Alpha portfolio.
I am basing my decision on the higher 30 year mortgage rates as well as the newly defined mortgage lending guidelines announced by the CFPB.
The Key Highlights Of The Lending Guidelines
- The debt-to-income ratio cannot exceed 43% to qualify for an FHA mortgage.
- Qualified mortgages would not have interest-only features, nor balloon payment "trip-ups."
- There would be a 3.5% cap on loan origination fees.
- Banks that conform to these standards will be shielded from future litigation.
These basic steps could offer stability in an otherwise risk laden business. With stability comes a greater ability for companies like NLY to profit more constantly, since the new loans would be far less prone to prepayments due to foreclosure.
With a strengthening housing market, and greater demand for mortgages, interest rates have also risen to a level that actually has created a wider spread for the agency mREITs to profit from.
A mortgage rate over 3.50% and a spread of 173 basis points just in the treasury yields will enable stable profits going forward for NLY, which has been more conservative with their use of leverage than other companies in this business segment.
Coupling that with a more secure mortgage that is given to more qualified buyers, at low rates and lower housing prices, takes a nice chunk of the pre-payment or default risk out of the equation now.
The Earnings Report Was As Expected
The entire report can be reviewed right here and it should be noted that NLY actually beat analyst estimates on a basic level, and the CEO commented on the results:
Wellington J. Denahan, Chairman and Chief Executive Officer of Annaly, commented on the Companys results. In our market, indeed every market, decisions made by policymakers continue to have exceptional influence on pricing and behavior. Nevertheless, as our results demonstrate, we continue to navigate through these uncertain waters to identify attractive relative value opportunities on both sides of our balance sheet. These market conditions are likely to persist, however, as structural imbalances here and abroad continue to affect economic activity. In this environment, we believe that remaining conservative in our management approach is in the best long-term interests of shareholders.
I have always been drawn to NLY's conservative approach, as well as their management team beginning with Mike Farrell, and now continuing with Denahan. I believe they are straightforward and direct, which also gives me the willingness to once again own shares of NLY.
The earnings conference call can be reviewed right here, and it is fair to note a most telling opening remark by the CEO:
The outright purchases by the Fed have also put strains on the supply of high quality collateral in the REPO markets resulting in attractive financing rates for collateral provides like us.
The recent selloff has been a welcome event and we look forward to more of the same. Mortgages have recently come off their highs by an average of about 2 points which bodes well for spreads going forward.
Earning reports are snapshots of the past that has already occurred, and given this one statement by the CEO, fits quite nicely with my opinion of what the future might hold. I also happen to believe that there could be another dividend cut or two, but going forward I believe the dividends will stabilize just as the profits will.
As my readers know I have followed Annaly up as well as down, and based on the current conditions, and the current share price of $14.66/share I am a buyer as of today.
Team Alpha Will Be Taking Some Profits And Re-Deploying The Cash
Our Team Alpha portfolio now consists of Apple (NASDAQ:AAPL), McDonald's (NYSE:MCD), Exxon Mobil (NYSE:XOM), Johnson & Johnson (NYSE:JNJ), AT&T (NYSE:T), General Electric (NYSE:GE), BlackRock Kelso Capital (NASDAQ:BKCC), KKR Financial (KFN), Procter & Gamble (NYSE:PG), CSX Corp. (NYSE:CSX), Realty Income (NYSE:O), Coca-Cola (NYSE:KO), Linn Co, LLC (NASDAQ:LNCO), Wal-Mart (NYSE:WMT), Cisco (NASDAQ:CSCO), Bristol-Myers Squibb (NYSE:BMY), Healthcare Select Sector SPDR (NYSEARCA:XLV), General Dynamics (NYSE:GD), and iShares S&P U.S. Preferred Stock Index Fund (NYSEARCA:PFF).
With 125 currently held in JNJ shares, I will be selling 25 shares to raise cash. At the current share price of $75.23, Team Alpha has made a significant profit and still has a sizable allocation after the sale of roughly 6%.
By selling JNJ today, we will have roughly $1,800 in cash added to our cash reserves of $1,691. The total of $3,491 will enable us to purchase 200 shares of Annaly at the current price, for roughly $2,900.
At the same time, we will be selling our position in WMT at today's price of $71.43/share. The loss taken here will offset most of the profit gained from the limited JNJ sale, creating a zero capital gains tax liability, and also add another $7,431 to our cash reserves to re-deploy as an opportunity arises.
The total cash reserves, after these transactions are completed will be $8,022. The portfolio will now have 200 shares of NLY as well as maintaining 100 shares of JNJ.
NLY has been a favorite of mine for many years, and I called the original buy-in correctly, as well as the sell-off at the top correctly. I believe that between the company's share repurchase plans, the bid for CreXus, as well as the book value of $15.84/share (yes, it fell last quarter), a dividend seeking investor could potentially benefit from a very strong yield, and potential capital appreciation.
The stock still has risks and headwinds, most notably; quickly rising interest rates if the Fed decides to end the zero interest rate policy (ZIRP) before the anticipated target date of 2015. Therefore, this investment continues a requirement to be closely monitored via the government policies as well as the company policies.
Please do your own research prior to making any investment in this stock, for your own financial circumstance.
Disclosure: I am long AAPL, BKCC, BMY, CSCO, CSX, GD, GE, JNJ, KO, LNCO, MCD, NLY, O, PFF, T, XLV, XOM. 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.