- Annaly Capital (NLY) shares have surged over 11% since 12/28/2013.
- The Fed tapering of QE has not led to a rapid rise in interest rates.
- Could an increase in dividends be at hand?
Since writing this article a mere 5+ weeks ago, the share price of Annaly Capital has increased from $9.77/share to $10.92/share as of yesterday, 2/10/2014. It appears that with all of the hand wringing and fears of the tapering of the quantitative easing policy by the Federal Reserve, that the elephant in the room turned out to be a mouse.
Yes, we did have a healthy pullback in the overall market, but I cannot connect the dots to the Fed buying $20 billion less in mortgage backed securities and bonds, to the dip whatsoever. As a matter of fact, the sector that has weathered the storm (mREITs) was feared to be the sector that would get battered the worst.
It simply did not happen.
Let's Look At Some Key Components
Clearly, since tapering began, the 10 year Treasury rates have not risen as many investors feared. As a matter of fact, they have declined from over 3% to the current 2.71%. The steady increase in the share price of NLY has coincided with the decline, and actual stability of the rates.
What this suggests to me is that Annaly has had the time to adjust its "inventory" without a severe disruption in the overall business. Its hedging has had time to settle in, and the company has had time to decide the amount of leverage required to maintain, or even increase, profits.
The Impact On Dividends
The dividends had been sliced from $.65/share (quarterly) down to the current $.30/share, or nearly 60%. Tracking the share price drop during the same time at nearly the same rate. During this time, not only were the 10 year rates lower, but the spread between the 2 and 10 year rates made it difficult for NLY to navigate all of the headwinds.
- Pre-payments and refinances continued as mortgage rates remained low.
- The spread was too narrow to increase profits.
- Hedging and leverage remained confusing to manage.
- Shareholders suffered with a significant drop in share value as well as steep dividend cuts.
All of this made sense to me, which is why I was negative on the stock and the sector, and was very confused about the future, after tapering began.
Now, we seem to have a road map being carved before our very eyes.
- Pre-payments and refinancing have slowed due to higher mortgage rates.
- The spread has widened from its worst levels, 90 basis points, to roughly 150 basis points between the 2 and 10 year treasury rates.
- A more stable hedging strategy is apparently in place, and leverage is where NLY feels more comfortable, obviously.
- Shareholders have seen share value increase by over 11%, and it is my opinion that in the next quarter, dividends will no longer be cut.
I might even go out on a limb and say that there is a good chance that the dividends could be increased as soon as the very next quarter, and if the stable interest rate environment continues on the current course, more increases in dividends throughout 2014 could be coming our way.
The key is that as long as the Fed keeps ZIRP in place (zero interest rate policy) for the shorter-term rates, and the longer rates continue to "play nice," shareholders could have a very good year by owning shares of Annaly Capital. Even if the dividends stay right where they are now!
The Bottom Line
I purchased shares at about $9.80/share when the price to book was at an 18% discount. While the price to book has tightened, there is still room to run with the current book value and even more if the company announces a higher book value in its next earnings report.
It still is a risk position for me, and should be for any prudent investor, but the dividend opportunity right now is hard to ignore.
Disclaimer: The opinions of the author are not recommendations to either buy or sell any security. The author is not an expert in the mREIT sector so please remember to do your own research prior to making any investment decisions.