Since Ben Bernanke spoke Wednesday I thought hard about writing another article on Annaly Capital (NLY). I wavered back and forth simply because some of the comments that have ensued after previous articles have been a tad too confrontational, which given my proclivity to defend my position, made me sink to the level of some of the commenters. I owe everyone an apology for that.
That being said, there was no way that I could let one day pass after the Fed Chairman spoke and fielded questions Wednesday. I believe that it needs to be stated quite clearly that owning shares of Annaly right now could be profitable in several ways to your portfolio. Both capital appreciation and more importantly, higher dividends.
A glance at yesterday's chart show another pop in PPS which stands now at $16.25 effectively back up to its pre ex-dividend price. It is now a tad above its book value and we might have a secondary offering which puts even more cash in the register to take advantage of prime opportunities.
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I realize that this is my own opinion, and there are no investments that are ever risk free. The sector we are discussing happens to be an unusual one because of the high dividend yields that the major players offer, as well as the track record of the one I focus on, Annaly Capital. It has its own set of risks that come with the territory.
- Flat or inverted yield curve between the 2 and 10 year Treasury Bond interest rates
- A sudden and sharp rise in interest rates across the board
- Discontinuing of the ZIRP policy of the Fed (Zero Interest Rate Program, or policy)
- Massive prepayments of existing mortgages with Government initiatives, such as HARP and HAMP, etc
- The SEC issue of the special REIT tax status
- Share dilution via secondary stock offerings
- A weak housing market
- Operation Twist
Let me be blunt here. The risks have not changed, however, when Bernanke spoke about the FOMC meeting this week he reiterated some of the most important features that lead me to believe that we might be in a "perfect storm" to own shares of Annaly, at least until late 2014.
What Bernanke Had To Say
I could not help but feel as if Bernanke was speaking to me about holding shares of Annaly. It was a little weird because he touched on the key areas that we should all be keenly aware of to make our decision to either buy, hold or sell shares right now.
In this report it stated:
He spoke to reporters after Fed policymakers ended a two-day meeting by sticking to their plan to keep interest rates near zero through at least late 2014. The officials said the economy is growing moderately and that the pace will likely pick up.
But they also cautioned that unemployment won't fall sharply anytime soon and that risks from Europe's debt crisis remain. In a statement, they noted that inflation has risen, mainly because of gasoline prices, and they expect the spike to be temporary.
On the surface this might appear just to be touching on the ZIRP issue, yet Bernanke went on to mention it specifically, again, in front of all the reporters and whoever was watching him speak. To me, saying it once was good, reiterating it last time was great, and now twice in one week sticking to the ZIRP issue is the single most important bit of information I needed to hear to feel even more comfortable with my position.
When short term rates are basically zero, other rates can move up, allowing the mREIT sector make more money and pay greater dividends by virtue of the tax status they enjoy and we benefit from.
When short term rates are basically zero, and other rates stay within the range it has for a few years now, then mREITs can STILL make money.
Sounds like I am taking both sides of the argument, right? Not really, the facts speak for themselves and Annaly has been able to maintain a high yield WITHOUT significant price fluctuations because of what I just stated. Any argument to the contrary simply shows a lack of understanding of what has actually been happening.
The article goes on:
After its bond-buying programs expired, the Fed in September began a $400 billion program dubbed Operation Twist. Under that program, the Fed is not expanding its portfolio but instead selling shorter-term securities it owns and buying longer-term bonds to keep their rates down. The program is scheduled to end in June.
That brings us to a flat yield curve and "Operation Twist". It is over as of June. Bernanke stated that there are NO plans to extend it. The program did not work that well anyway, but it did impact the spread by roughly 10-25 basis points, and now even that is ending. With the 10 year interest rate hovering around 2% or so, the spread is as wide as it has been for 3 years or so, which allows Annaly to play in the most conservative yield curve arena and make more profits.
Some of the folks on the negative side come up with this ridiculous argument: "How can a company that makes about 2% keep paying out 15% in dividends". Do I really need to respond to this? I suppose so because that sort of information is completely misleading.
Earning 2% on an enormous number is NOT equal to paying out 15% on a small number (by comparison), and since the payout is directed by virtue of the IRS tax code itself, the inference that there is a "Ponzi Scheme" going on is vitriolic to say the least. Simply stated, that argument is not valid nor even close to being accurate.
Finally, what does this all mean for interest rates in and of themselves? Well, the article also stated:
Since the financial crisis, the Fed has pursued two rounds of bond purchases to try to push down long-term interest rates, with a goal of encouraging borrowing and spending.
Bernanke told reporters that more bond purchases, or other steps by the Fed, are still an option if the economy weakens. "Those tools remain very much on the table," Bernanke said."
To me, this means that the Fed wants to keep rates low and NOT let them run roughshod over the economy, so Bernanke is leaving the door open to push down interest rates anyway.
For even more information on Wednesday's events read this report from Reuters. It also stated:
Federal Reserve Chairman Ben Bernanke on Wednesday said U.S. monetary policy was "more or less in the right place" even though the central bank would not hesitate to launch another round of bond purchases if the economy were to weaken.
Risks will remain and we need to monitor them. That being said, I feel even more comfortable with my position. I will never tell anyone what to do, but I am thinking of adding more shares here.
One more bit of information can be found by reading this. Wellington Denahan-Norris, Vice Chairman, Chief Investment Officer and COO of Annaly, exercised an option to buy actual shares of the company. 100,000 of them. She could have just exercised the options and taken the difference between her option price of $13.25/share and the current share price, but she chose the shares themselves.
This transaction happened on April 23rd and pokes another hole in some people's argument that insiders are not buying shares. Seems like they are.
I am sticking with my positive opinion. How about you?
Disclosure: I am long NLY.