Annaly's Opportunity by Jacqueline Doherty
Summary: Annaly Capital Management (NLY) profits from differentials between funds borrowed at short-term rates (5.1%) and the mortgage-backed security rates (5.68%) it buys. As interest rates have risen, Annaly's reduced yields have brought dividends down from 2002's $2.67 to a current $0.57/share—low for a REIT's 90%-of-earnings-payout through dividends. Bulls say the housing slump will force Fed rate cuts. Even a 1% reduction could push dividends back up to $2/share, and Annaly's $15.86 shares could rise to $21. Anticipation has widened spreads, and Annaly's Q1 results show it. With $0.26/share earnings, $0.02 above forecasts and $0.10 higher than Q1'06, analysts now expect $1.19/share for 2007, on $410 million in income. Bears say the economy's strength will push interest rates higher, squeezing yields and raising borrowing costs on Annaly's highly (9.8-1 ratio) leveraged funds. If rates do fall, borrowers may prepay mortgages to refinance at lower rates, narrowing spreads further. A risky bet, but Annaly trades at 33% premium to book because investors like CEO Michael Farrell and his management team. Banks concur, offering credit at 0.05% under LIBOR, while rivals trade at book and generally pay 0.10% over LIBOR. Annaly's asset management unit also adds value. Barron's Bottom Line: Lower interest rates could increase Annaly's dividends to $2 again, shares could rise 30%.
NLY 1-yr. chart: