Being a numbers guy, the huge decline to lows not seen in over 10 years is rather shocking for Annaly Capital Management (NLY). The company has slashed the dividend, but nowhere near the low levels reached back in 2005 and 2006 when the stock held at much higher levels.
The real estate investment trust that invests primarily in agency mortgage-backed securities, or mREIT, continues to face interest rate risk from a potentially rapidly rising rate environment. Investors though appear to have already locked in massive dividend cut expectations though interest rates might not rise much for years especially considering the 10-year rates in Germany and Japan are significantly lower than the US.
Massive Stock Losses
Though the dividend has been cut over 50% in the last couple of years, the stock has vastly underperformed the dividend action. In the below chart, it is clear that investors knew the increase in the quarterly dividend to $0.75 at the end of 2009 wasn't sustainable. The stock hardly budged as the dividend kept soaring. Now the stock appears to be over-reacting to expected dividend cuts, even though the stock never gained based on the dividends that are now being cut.
The most shocking part of the chart is the stock hung around $13 when the dividend was last cut to around $0.35 back in early 2005. Sure the dividend and consequently the stock fell further, but no where matching this level of panic.
Core Earnings Stability
The amazing stability of core earnings in a volatile mortgage market is impressive indeed. Regardless, investors still fear a quick jump in interest rates that would hammer the NAV that currently sits at $12.70. Annaly has greatly reduced leverage to 5.4x and increased interest rate swaps to 74% to provide a hedge for a sharp rise in interest rates. This combination is placing pressure on core earnings, but investors should expect this to only be transitory as the mortgage market deals with the potential end of tapering by the Fed.
While the market is smart to fear a sharp rise in long-term interest rates due to Fed tapering, a move might not hurt Annaly as much as feared. The wider yield curve would actually allow Annaly to leverage up and possibly increase core earnings going forward. As the above chart highlighted, over the last 10 years the stock hasn't traded this low even with significantly lower dividends. The market is clearly panicking over a situation that the company partly relishes will occur so that it can leverage up. In the end, the low interest rates never benefited the stock, but the fear of higher rates is absolutely crushing the stock. Annaly Capital should be close to an inflection point with the stock at levels that would require a massively lower dividend rate that might never occur.
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