Annaly Capital Management, Inc. (NLY) has delivered diminished revenues and income to investors since 2009, not because of bad management, but because of macro-economic factors domestically and abroad. The diminished returns are not a surprise to any market watcher, given that yields are at an all time low, the yield curve is somewhat flat and there is not as much margin to be squeezed out of the trading of Agency-guaranteed, mortgage-backed securities.
Annaly manages assets on behalf of institutional and individual investors from all over the globe, its objective is to distribute net income from its investment securities and from dividends it receives from its subsidiaries to its investors.
Annaly owns and manages its portfolio of real estate investments through a series of wholly owned subsidiaries and passes along its profits from trading in Agency-guaranteed, mortgage-backed securities to the holders of REIT shares.
Annaly's common shares trade around $15, between a 52-week range of $14.05 and $18.79. It has a price earnings ratio of 42:11, earnings per share of $0.37 and a dividend yield of 14.10%. Annaly has total cash of $2.78 billion and total debt of $88 billion. Its book value per share is $16.06. Market capitalization is $15.66 billion. Shares sold short as of March 15, 2012 are 48.27 million or 6% of the float, up from 40.68 million in the prior month.
The Treasury market is the bellwether for the Agency-backed securities markets. A few things counteracted each other in the Treasury market. Better-than-expected economic numbers, should have led to higher yields, ongoing problems in Europe and "Operation Twist". Operation Twist was the Fed, unable to reduce short-term interest rates any further, reducing long-term interest rates by buying long-term bonds. Rising prices of long-term bonds lowered the yield, meaning the Fed also lowered long-term interest rates. The Fed might have paid for these bonds by using Quantitative Easing 1 and 2 (QE1, QE2) money which came from the printing press. Instead, the Fed sold short-term bonds and used the proceeds to buy long-term bonds. Selling the short-term bonds lowered the price and raised the interest rates, hence the name, "Operation Twist", meaning it should twist the yield curve, lowering long-term interest rates. The actual effect was that short-term rates barely rose, while long-term rates fell from 3.75% to 1.80% in 2011. The ongoing problems in Europe led to the implementation of Operation Twist. Better-than-expected economic numbers had a cold reception, as investors still need the safety of yield to stay in the capital markets.
The annualized yield on average interest earning assets was 3.31% in the fourth quarter, with the annualized cost of fund being 1.60%. This was a 14 basis point decrease from the 1.85% annualized interest rate spread for the fourth quarter 2010. In the fourth quarter 2011, fixed rate mortgage-backed securities and Agency debentures comprised 90% of the company's portfolio. The balance was comprised of 9% adjustable rate mortgage backed securities and agency debentures and 1% LIBOR floating rate collateralized mortgage obligations.
General and administrative expenses were 0.23% in the fourth quarter of 2010 compared to 0.22% in the same quarter 2010. Revenues at the year end of 2011 were $1.12 billion compared to $1.9 billion at the end of 2010. Revenue growth year-over-year is negative and this is not a surprise to anyone - traders in these assets cannot be expected to get blood from a stone. Low yields, plus economic crises at home and abroad, the danger that the housing market slows to non-existent, and there is no longer any paper to keep the market in trading mortgage-backed securities liquid - are all factors in this decline.
Net income for the quarter ended December 31, 2011 was $445.6 million or $0.46 per share. In the same period of 2010 net income was $1.2 billion or $1.94 per share. Lower net income means less money to distribute to shareholders so any cut in dividend rates should not come as a big surprise to any investor. Annaly's Vice Chairman stated: "the company continues to manage the company conservatively, taking advantage of market opportunities to realize gains and maintain a prudent level of leverage".
The company expects that the upturn in commercial mortgages that occurred in 2011 since the summer of 2010, as a result of built up investor demand and lenders having lower financing costs, to continue into 2012 within major urban hubs that present more steady yields. Any commercial properties outside of these areas may present higher yields, but with that comes higher risk, which is just not a tolerated position of market investors these days.
During 2011, property owners locked in historically low long-term rates as long as the property value supported the financing. Volatility caused by macro trends reversed this activity. Life insurers have been a constant in commercial mortgage portfolios which managed to emerge from the recession in solid shape and are viewed as being attractive in value relative to other fixed income instruments.
The company expects to see the continued support of the insurance industry, renewed bank lending activity but the demand for large loans with long amortization periods are more likely to be reduced because of the macro economic difficulties which tempered the markets in 2011. The company feels that despite all the bad news, investors will continue to look to commercial real estate as an arena to generate income with relatively high rates of return.
The float of 970.27 million is owned 48.10% by institutions, and 0.41% by institutions, leaving 51.59% in the hands of retail investors. This is great access for the retail investor. Usually, retail investors do not great access to high yield, liquid securities as mostly institutions like to hold them to guarantee yields in portfolios. The market thinks this stock is going lower. It is.
Annaly has a shelf offering of 125 million common shares at $16.16 open for 2012. This offering is going to dilute the float by better than 10% during the year, so there must be a price drop and a dividend cut coming. Despite the dilution, the shares are trading below the current book value per share of $16.06. Funds or institutions sometimes short stocks after the dividend is paid to pick up the shares at a lower price going into the ex-dividend date to pick up a small return on the shares and the dividend - great strategy for income portfolios. This stock displays an accurate view of investor sentiment, yield is what it paramount, risk is not.
Income from assets is in high demand but the Fed's actions in keeping interest rates low for the next few years make it difficult to achieve this. Annaly's yield right now is a function of its share price, which will continue to decline in the near term. Short-term rates have taken as much of a beating as possible. The yield on Annaly in this interest rate environment continues to be impressive. Revenues have fallen year-over-year in excess of 50%. The yield is in danger of being cut because there is less revenue from operations, which is directly related to the yield. Still, in this sea of negativity, Annaly represents a good investment at lower prices, even if the yield takes a substantial cut (in the area of a 35%). Investors in at a higher price should buckle up, it is going to be a bumpy ride.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.