Annaly Capital Management Selloff Overdone

Annaly Capital Management (NLY), the bellweather for the publicly-traded agency mREITs, has suffered a serious setback in its stock price after private agency investor Carlyle Capital was margin called to the point of bankruptcy this morning. The Carlyle situation, which was brought on by historically wide spreads between Treasury bonds and agency-backed securities, rattled investors who thought GSE-sponsored securities were immune from the credit crisis. Even long-time Annaly bull, Jim Cramer, dumped his buy rating on the stock last week and sold out of the position.

But is Annaly really that much at risk? The Company's leverage was 8.7 to 1 at December 31, 2007, and Annaly completed a $1 billion equity offering shortly after year-end. With respect to repurchase agreements, the Company did not have an amount at risk greater than 10% of the equity of the Company with any counterparties as of December 31, 2007, indicating that Annaly has a diverse array of counterparties for its repurchase agreements, so there is little risk that one nervous counterparty could deliver a fateful margin call. Through December 31, 2007, NLY did not have any margin calls on its repurchase agreements that it was not able to satisfy with either cash or additional pledged collateral.

The credit markets are volatile and unpredictable, as shown by the Thornburg Mortgage (TMA) situation. However, I believe Annaly is too far up the food chain and has too much liquidity to fall victim to the credit crunch. If Annaly's securities become illiquid, then Fannie and Freddie are both at risk. The government cannot allow this to happen for fear of a complete systemic economic meltdown. With a dividend yield of 14% and a stock price that's just 1.06x book value, Annaly is delivering solid risk-adjusted returns. It's well worth rolling the dice on.

Disclosure: none

Comments

[jack kreg]

I have been following the stock for a year, now I buying on dips. Great management.

[Amidwesternneighbor]

Thanks Patrick! I felt the same way, after seeing NLY plunge along with the Thornburg & Carlyle events. And I had read that those were much more highly leveraged, up to 30 or 32x, vs. NLY's 8-ish. I'm with ya all the way on this one, and it's reassuring for a non-expert like myself to see someone with REIT focus as yourself confirming the same!

[Patmeister]

Good analysis Patrick. I have my Dad and Mother-in-Law in this stock as well as myself because I believe in their management. I think Mike Farrell is smart enough to have seen this coming. The real key is the GSE securities and how well they hold up. No doubt Fannie and Freddie are facing hard times, and these securities ultimately require people to pay the mortgage, but I too agree the government can't allow a wholesale failure of the GSE MBSs. I bought this week with limit orders at $14. The yield is incredible at that level, and Farrell said he sees dividends rising. With all the problems facing the industry, I really doubt Farrell would be so optimistic if he didn't know what he was doing. If this thing gets below book value, I'm buying more. The yield curve is steep, which is very good for Annaly. When others are fearful, it's time to be greedy.
patmeister

[bendlund]

In your opinion, is CMO in a significantly weaker position? Their leverage is slightly higher (around 10), but still nowhere near what Carlyle had.
Also, what is the effect on these companies of repurchase agreement maturity? I assume they can get a margin call whenever the market price of their securities declines, but do they also face the risk of not being able find new short term financing?

[AmesTiedeman]

I don't know what will prevent them from cutting their dividend. The earnings at the current rate cannot support the dividend. This name will be under 10 before the markets start working again.

[westcoastguru]

Many small investors got burnt with the bait of dividends. I will wait till the stock move above $20 and wait till July or August 2008 for any new purchases. Cash is king these days - ask any depression era survivirs. There is more in the closet that need to come out in the next few months.

[asdf439]

Buying any kind of investments with 10x leverage in hope they will return more than financing costs,is hardly a viable business model for the long term.
This is only working as long as there are investors willing to pay enough fo their shares and this can change easily in the future.
There is no reason why mortgage REITs should even exist,i don't know of any "Corporate-Bond-R... or "S&P500-Stock... investing highly leveraged and issuing new shares to pay dividends as high as their captured outperformance.

[Patrick1980SC]

Mortgage REITs are generally dependent upon access to capital markets, both debt and equity, to finance their portfolios. However, prudent balance sheet management has allowed NLY to maintain a dividend throughout its 10-year history. If Annaly can invest my money at a leveraged spread and return 5% - 15% in pre-tax dividends, I'll take it.

[Amidwesternneighbor]

Breaking through resistance today...gap up back to 18s? ;)