Over the past few years, Annaly Capital Management (NYSE:NLY) benefited from the zero interest rate policy of the Federal Reserve. With the rising mortgage interest rate in the U.S., the share price of REIT companies has started falling. The average interest rate on a 30-year mortgage has increased from 4.16% to 4.52% on December 6, 2013.
In order to mitigate the impact of increasing interest rates, Annaly is decreasing its investment in fixed-rate agency mortgage backed securities, or MBS. This can help it minimize the loss in the long run. Annaly's strong hedge portfolio is helping the company reduce its interest rate risk. Since the company pays a fixed rate on its borrowing and receives a floating rate on swaps, this can help it reduce the impact of interest change. The company entered into interest rate swaps with an amount of $52.2 billion and interest rate swaptions of $6.8 billion, representing around 74% of the company's agency mortgage backed securities and debentures, because of the fluctuating interest rate in the market. Annaly's portfolio consists primarily of fixed rate agency mortgage backed securities and debentures with 91% share, where the company receives fixed return, and I believe entering into the interest rate swap, can help Annaly reduce the negative impact of interest rate fluctuation.
Net interest rate spread
Annaly Capital Management
American Capital Mortgage Investment
American Capital Agency
Annaly's net interest rate spread increased from 0.98% in June 2013 to 1.01% in September 2013 because of increasing return on interest earning assets. With the increase in interest rate on mortgages, I believe Annaly's investment in interest rate swap portfolio can help it increase the net interest rate spread.
Apart from Annaly, the net interest rate spread of American Capital Agency Corporation (NASDAQ:AGNC) has increased from 1.24% in June 2013 to 1.37% in September 2013. Net interest spread is expected to increase further because the company is migrating its investment from long-term fixed residential mortgage backed security, or RMBS, to short-term fixed RMBS because the interest rate on a 15-year mortgage is 3.42% compared to the interest rate on a 30-year mortgage, which is around 4.38%. Although the interest rates are falling in the short run, interest rates are expected to increase by the end of the year because it is expected that the Federal Reserve may start tapering the quantitative easing program by the end of the year.
Its other competitor American Capital Mortgage Investment's (NASDAQ:MTGE) net interest rate spread decreased from 1.94% in June 2013 to 1.77% in the third quarter because of fluctuating interest rates in the U.S. and is expected to be constant in the current quarter if the interest rate falls. However, the net interest rate may fall in the long run since the company's average yield from its investment is falling. The average yield of investment reduced from 3.17% in June 2013 to 3.04% in September 2013.
Increasing commercial real estate portfolio
In the third quarter, Annaly's investment in its commercial real estate investment portfolio was up 28% quarter over quarter. The commercial real estate investment portfolio consists of real estate investments and corporate debt, which increased from 8% of the equity in June 2013 to 11% of the equity in September 2013. The company has increased its investment in the segment from $1 billion in June 2013 to $1.3 billion in September 2013. As interest rates aren't stable, I believe the company's investment in commercial real estate can be a safer investment because the commercial real estate market is estimated to grow at the rate of 15% this year and 17% next year.
Due to the increase in commercial real estate investment, revenue from this portfolio has also increased by around 87%, from $13.9 million in June 2013 to $26 million in September 2013.
By analyzing the company's increasing investment trend in commercial real estate, I believe the company's revenue may rise in next quarter from commercial real estate.
A company for dividend hungry investors
Annaly declared a dividend of $0.35 for the third quarter ending September 30, 2013, and on November 13, 2013, the company declared a dividend of $0.49 per share for Series A shareholders for the fourth quarter ending in December 2013. The company's fund from operation exceeds dividend cash outflows in the third quarter, which shows dividend stability and sustainability.
In order to avail tax benefits, REIT companies provide 90% of their earnings as dividends, so the trailing annual dividend yield of the company is 16.70% as of Dec. 6, 2013. If the interest rate on mortgages falls, I believe the dividend yield ratio would increase in the year 2014.
On the other hand, American Capital Agency and American Capital Mortgage are also paying good dividends. The trailing twelve months dividend yield of American Capital Agency is around 22% as of December 6, 2013 and the trailing twelve months dividend yield of American Capital Mortgage is around 17.90% as of December 6, 2013.
Currently the stock price of Annaly Capital is the lowest in its 52-week record. As the company is increasing its investment in the commercial real estate segment, I expect the revenue to increase in the long run.
The earnings per share, or EPS, of Annaly Capital Management is falling and is $0.18 in the third quarter 2013 from $0.22 in same quarter last year. I believe, in the long run, the earnings per share will increase as the company diversifies its portfolio and invests more in its commercial real estate segment. I recommend a buy on this stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.