Annaly (NLY) is the largest publicly-traded mortgage REIT in the United States, and one of my all-time favorites. This is not without good reason, especially now that it has announced the public offering of its Convertible Senior Notes and Series C Cumulative Redeemable preferred stock. This is against the backdrop of a recovering economy (I am not reading too much into recent downward housing starts release, as I believe the downfall is going to be short-lived).
Annaly is one of my favorite REITs for two big reasons. One, Annaly trades in government-sponsored real estate mortgages that are not just low risk, but also guaranteed. We're talking about the likes of Fannie Mae and Freddie Mac here, unlike some dubious hedge fund or investment company. These are bought from the three government agencies that securitize groups of mortgages: Government National Mortgage Association (GNMA), Federal National Mortgage Association (FNM), and Federal Home Loan Mortgage Corporation (FRE).
Second, Annaly is a mortgage REIT or mREIT, which in this low interest rate environment is a winner. Both my ideas are based on absolute basic financial practicability - buying low and selling high (low interest rates), and making out loans to people who can repay them. In the words of Warren Buffett, "Honesty is very expensive gift. Do not expect it from cheap people". This certainly holds true for Annaly.
Another major factor working for Annaly is its solid management, led by CEO Mark Farrell, who led the company through the subprime storm with relative ease, offloading much of the fund's exposure to low quality mortgages well before the market crashed. In an environment where most REITs are cutting dividends and top management pay packages, Mark Farrell's compensation has increased from $12 million to $35 million.
A brief refresher for those wondering: Raising capital is fundamental to Annaly, as profits are made from investment of funds, borrowed at (hopefully) very low interest rates. The borrowed loans are short term and usually repaid monthly as the rates are lower. Needless to say interest rates are crucial to Annaly's portfolio and profitability thereof.
At the end of Q1 2012, Annaly's average yield on investment securities was 3.21% and the average cost of funds on borrowings was 1.51%, for a spread of 1.70%. However, Annaly's winning streak is not yet running out, as the Fed Reserve has confirmed that low rates are likely to continue for the next few years.
In addition, Annaly's success is in no small part attributable to its conservative policy on leverage and exposure to global credit risks. The company has been issuing equity to decrease its financial leverage, and compared to competitors like American Capital Agency (AGNC), which has a leverage of just over 9 times, Annaly has shown constraint at just under 7 times. Another major peer, Capstead Mortgage (CMO) has a leverage in excess of 10 times.
Having weathered the housing meltdown, when most REITs, even those financed by lending firms such as American Home Mortgage Investment Corp., were failing, Annaly continues to be one of the best managed and best poised REITs, should interest spreads widen or interest rates increase.
For the most recent quarter, Annaly posted a net income of $901.8 or $.92 per share, rising 29% from a year ago when the income was $699.9 million. Net income for the quarter was $529.3 million, or 54 cents a share, nearly equal to the $530.6 million, or 70 cents a share, in Q1 of the previous year. NLY is trading at an all-time price/book ratio of 1.01 and pays a massive dividend of $2.20 per share or 13.5%, compared to $1.72 (12.40%) by Capstead Mortgage or $1.20 (17.30%) by Armour Residential REIT (ARR). It is currently trading at under $17 with a price earnings multiple of 29 times.
Over the last five years, the REIT has paid out an average of over 13% in dividend yield, making it a very secure dividend bet. While some analysts argue that capital appreciation is limited, I believe the dividend alone is reason enough to chase Annaly in the current market conditions. With a cash per share of $4.72 and a most recent quarter balance of $4.6 billion, the dividend is not going anywhere.
As such the announcement of the public offering of its shares has already inflated its price substantially, although plenty of upside still remains, especially since the SEC investigation of Inland American Real Estate Trusts has sparked fears across the industry. Annaly, by the way, is a large publicly traded REIT, and not the focus of the SEC examination. Finally, with the IPO targeting about $750 million of cash raise, Annaly's return on investment could rise further as it takes cheaper financing aboard to finance other projects.