Annaly Capital Management Inc. (NYSE:NLY) is one of the largest mortgage REITs in the US. Historically it has weathered the economic storms better than most of the others. NLY had what can only be described as a terrible 2013. However, in Q4 2013 there were positive signs for NLY. NLY had Core Earnings of $350.1 million (or +$0.35 per common share -- a substantial beat of the expected $0.26 per share) for Q4 2013. These compared well to Core Earnings of $282.3 million ($0.28 per share) for Q3 2013 and $335.1 million ($0.32 per share) for Q4 2012. NLY ended Q4 with a strong capital position with a capital ratio of 15.1%, a net capital ratio of 15.9%, and leverage of 5.0:1. NLY's CPR (constant prepayment rate) dropped from 13% at the end of Q3 2013 to 7% at the end of Q4 2013. NLY's net interest rate spread increased from 1.07% for Q3 2013 to 1.43% for Q4 2013. This last contributed substantially to the core earnings number of +$0.35 per common share for Q4 2013. This covered the $0.30 per common share dividend with room to spare. This was good news since the dividend had decreased from $0.45 in Q4 2012 to $0.35 in Q3 2013 to $0.30 per common share in Q4 2013. Finally the dividend has begun to look stable.
Unfortunately in Q4 2013, there was the negative of a book value loss. On September 30, 2013 NLY's book value was $12.70 per common share. On December 31, 2013 NLY's book value was $12.13 per common share -- a loss of -$0.57 per common share (about -4.5%). The movement in yield of the 10 year US Treasury Note probably indicates why this happened. The yield moved up 42 bps from 2.61% on September 30, 2013 to 3.03% on December 31, 2013. This helped the net interest rate spread rise for Q4 2013; but it also meant that the value NLY's Agency RMBS decreased as the interest rates rose (10 year US Treasury Note yield rose). The chart below shows the 10 year US Treasury Note yield.
The chart of the 30 year fixed rate FNMA 4.0% MBS (see below).
As readers can see, this Agency MBS lost 1%+ from September 30, 2013 to December 31, 2013. This loss and comparable losses in the other RMBS NLY owned in Q4 2013 accounted for a lot of the book value losses in Q4 2013. Remember the 5x leverage.
The good news is that the US Treasury 10 year note yield fell from 3.03% on December 31, 2013 to 2.72% on March 31, 2014 (-31 bps). The chart of the 30 year fixed rate FNMA 4.0% MBS also shows a gain in value of 1%+ during the same period. This should lead to book value gains for NLY for Q1 2013. One would expect these to be slightly less than the losses in Q4 2013; but they should still be significant gains. Further the 10 year US Treasury note yield has fallen an additional -8 bps since March 31, 2013 until this writing April 15, 2014. This means investors currently have 8 bps in their pockets that would lead to slight book value gains in Q2 2014 (if Q2 2014 ended today, April 15, 2014).
The average CPR for NLY's portfolio may have increased slightly from the 7% at the end of Q4 2013. However, it is not likely to have increased tremendously. People had plenty of time to replace loans at much lower interest rates at the beginning of 2013. We still have a long way to go to approach the 1.63% on the 10 year of last May 3, 2013. This should mean a good book value gain for NLY in Q1 2014. At the same time it will probably mean a decrease in the net interest rate spread; but that should still be far above the 1.07% of Q3 2013. Remember that the portfolio CPR fell precipitously from 13% at the end of Q3 2013 to 7% at the end of Q4 2013. I am not sure of the exact figure, but it seems unlikely that the average CPR rose to more than 9% by the end of Q1 2014. Overall these two factors should lead to a net interest rate spread for Q1 2014 of 1.20%+. This should allow NLY to maintain its current $0.30 per common share per quarter dividend. Plus there should be a substantial book value gain.
One might ballpark that the book value would be about $12.40+ at the end of Q1 2014. Plus you would have the previously described -8 bps decrease in the 10 year US Treasury Note yield in your pocket for Q2. NLY closed at $11.46 per share on April 11, 2014. At that price it is trading at a discount of roughly 8.2% to the ballpark book value of $12.40+ at the end of Q1 2014. With the 10.5% annual dividend, which looks stable at this time, that makes NLY very much of a buy in a market that is showing signs of possibly falling significantly in the near future. NLY has a Beta of only 0.09. This should make it relatively immune to an overall market downturn. It is already selling at a discount to its fundamental value.
For those interested in getting a better overall picture of the Agency portfolio, it is described in the tables below.
The other big part of NLY's holdings are its commercial real estate investments. These amounted to about $1.6B as of December 31, 2014 (see table below).
DebtX (the Debt Exchange) reported the following for February 2014:
- Its CMBS universe increased to 94.7% as of February 28, 2014 from 94.1% as of January 31, 2014.
- Impaired performing loans at DebtX's marketplace traded at 81.4% in February 2014. This was up from 79.8% in January 2014.
- Non-performing loans at DebtX's marketplace traded at 49.6% in February 2014. This was down from 50.5% in January 2014. Prices were 52.9% in February 2013.
- Marketplace liquidity was up in February to 118.2 from 114.5 in January 2014. The Index was 109.9 in February 2013.
All in all this data appears to say that NLY's commercial real estate investments may be flat to higher for Q1 2014. As of December 31, 2013, the commercial real estate portfolio yielded 9.2%; and it accounted for 14% of NLY's capital. NLY expects to continue to grow its portfolio of investments other than Agency MBS to 25% of total equity. With all of this in mind, Dave Finklestein (Head of Agency Trading at NLY) says he is constructive on a near term basis and even beyond. That makes NLY a buy for the near term at least.
When investors consider the possibly worsening world economic problems in China, India, Russia, and the EU, there is a lot of potential for slowing in 2014. We have already seen Chinese exports and imports slow demonstrably in the last two months. For March 2014 exports fell -6.6% year over year; and imports fell -11.3% year over year. This was after exports had fallen -18.1% in February 2014 year over year. These numbers indicate a lot more slowing for China than is currently being projected. Other data look weak too. If the world economy is significantly slower in FY2014 than is being currently projected, interest rates may remain flat; or they could even fall. This situation would buoy book values for Agency MBS investment companies such as NLY. This possibility or even probability for a longer term effect means NLY is that much more of a buy.
The two year chart of NLY provides some technical direction for this trade.
The slow stochastic sub chart shows that NLY is nearing overbought levels. The main chart shows that NLY has apparently bottomed after an extended downtrend. NLY appears to be at the beginning of a new uptrend. The price line has already broken through NLY's 50-day, 100-day, and 200-day SMA's heading upward. The 50-day SMA has already broken through the 100-day SMA heading upward. These are buy signals. NLY is a buy on the relatively certain good results from Q1 2014. It is a buy on the relatively weak outlook for world economic growth, which could keep interest rates low. NLY has an average analysts rating of 3.0 (a hold); and it has a CAPS rating of three stars (a hold). With a good Q1 2014, a good and sustainable dividend, and a Q1 2014 book value increase already in the bag, my rating for NLY is a buy. My belief is that some analysts will follow my lead once the Q1 2014 results are published; but enough is already known now to make this determination.
NOTE: Some of the fundamental fiscal information above is from Yahoo Finance.
Good Luck Trading.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NLY over 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.