Thanks to Ben Bernanke and his confusing signals about a halt in the easing programs, mREITs have seen a bloodbath over the past one month. Bernanke's recent speech gave an impression that the Fed might be cooling down with regard to its easing programs by the second half of the current year. The markets have already started pricing in the effects of the Fed's exit, which is why the agency MBS spreads have reached 67 bps after they widened 18 bps.
The widening of the agency MBS spread is a welcome sign for mREITs as far as their net interest rate spreads are concerned. But at the same time, the widening means book value depreciation. Therefore, the current macroeconomic situation requires managements to act in order to secure the book values. While American Capital Agency (AGNC) and ARMOUR Residential (ARR) are among my least favored mREITs, I believe Annaly Capital Management (NLY) will take full benefit of the situation that is unfolding. Let's see how.
Annaly Capital Management is the largest mortgage REIT. The company is well-managed, which is why some of its strategies are providing a cushion to its book value and net income. The following are strategies that will help the company outmaneuver the current challenging macroeconomic situation:
- External management will lead to lower compensation expense, which will support the bottom line.
- Less-sensitive book value due to the presence of CRE (commercial real estate) loans.
- Given the level of volatility, the company has less leverage.
- The composition of its current portfolio.
- Recent acquisition of CreXus can add to the current returns.
Over the past few months, Annaly changed its management structure. It went from an internally managed company to an externally managed company. The company paid 1.18% in management expenses over the past five years; however, the new management structure requires the company to pay only 1.05%. These savings should provide some support to the bottom line.
CRE debt act to minimize book value sensitivity to changes in the interest rates. The company has some CRE loans in its portfolio, but they are small as they represent only 5% of the total equity. More access to capital could lead to more CRE debt in the company's portfolio. Besides, Annaly has constructed its portfolio in a way that the company will benefit from increasing interest rates. According to the latest SEC filings, the company can grow its coming quarter's net interest income by 11.66% if the rates climb 25 bps. Keep in mind that the agency MBS spread has already widened 18 bps.
Last but not the least, Annaly's recent acquisition of CreXus Investment and the relatively lower level of leverage employed by Annaly will act in the benefit of the company. Given the volatility in interest rates, the relatively lower level of leverage (6.7 times) employed by Annaly will reduce some volatility in the company's financial results. Furthermore, CreXus Investments could add low double-digit returns available in the commercial real estate markets.
Is Annaly Alone?
Annaly Capital will not excel alone under the prevailing macroeconomic situation. PennyMac Mortgage Investment (PMT), another mREIT, also has the potential to outmaneuver the prevailing challenges. The company's non-performing loans portfolio is trading well below its economic book value, and the current valuations implies zero value to the company's mortgage origination business. I also believe PennyMac can report a hike in dividends. The company is well-positioned to grow its loan originations and its distressed residential mortgage loans portfolio should benefit from the recovering housing markets and increasing home prices.
Annaly is currently changing hands at an 11% discount to its book value. With the abundance of positive stock price drivers I noted above, I am confident that Annaly will perform better than most of its peers.
Disclaimer: The article has been written by Equity Whisper's Financials Analyst. Equity Whisper is not receiving compensation for it (other than from Seeking Alpha). Equity Whisper has no business relationship with any company whose stock is mentioned in this article.