Annaly: The mREIT Investors Love To Hate

Jul.24.12 | About: Annaly Capital (NLY)

I realize I write numerous articles about Annaly (NYSE:NLY). I have been a continuous shareholder since 1999 and am a huge fan of the management team, as well as the dividends it has paid me over the years.

Comparing the 3 month charts of both Annaly and American Capital (NASDAQ:AGNC), shows a bland yet compelling case for owning American Captial right?

Frankly, the many articles I read on the topic of mREITs, are all along the same lines. They all face the same headwinds and risks that could impact their business and profitability, as well as shareholders dividends. Regular investors can fall asleep reading the articles, as their eyes glaze over with too many "big shot" phrases, words, and explanations.

Since I write for just regular folks, I try to keep my articles easy to understand for the vast majority of regular investors. I intend to continue doing that.

It does seem that whenever I write a positive article on Annaly I get slammed for not dumping it in favor of American Capital. It does not seem to matter that they both play in the same sand box, but have different pails and shovels that might appeal to different investors. Sometimes the comments get vitriolic and obtuse. I figured I would lay out a basic overview as to why I happen to like Annaly over all other mREITs.

First, let's look at the key headwinds and risks for all mREITs, in a manner for us plain folks to grasp.

Risks And Headwinds Of All mREITs

  • If interest rates rise rapidly, causing all yields to rise between the 2 year out to the 30 year Treasuries, profits will begin to suffer.
  • If the yield curve flattens or inverts, mainly between the 2 year and the 10 year Treasury, profits will get squeezed.
  • If pre-payments of existing agency backed mortgages occur more swiftly and increase in number, profits will fall.
  • If an mREIT uses more leverage (lending further out on the yield curve) to increase profits, they stand the risk of having profits impacted MORE than the mREITs who stay "shorter" within the yield curve.

The above risks and headwinds are always with the mREITs, as well as the shareholders, no matter which mREIT an investor owns.

The Positives Of The mREITs Right Now

The same positive conditions have made it a bit easier for every mREIT to continue making solid profits, which means a continuation of very healthy dividends for shareholders.

There have been ups and downs in the dividends, as each mREIT navigates through our interest rate environment, but in general, every investor has been pleased as punch.

  • A more stable interest rate environment courtesy of the Fed.
  • The ZIRP (zero interest rate policy) which keeps the short term rates near zero, apparently through 2014 at least.
  • A spread between the 2 year Treasury and the 10 year Treasury of approximately 125 basis points and 200 basis points depending on what day of the week we happen to wake up on.
  • Less pre-payments in spite of HARP, HAMP, Operation Twist, etc. because banks just are not willing to take the risk for low rewards and just about everyone who could refinance has already done so.

The above positives have been fruitful for all mREITs to this point, and I just do not see them ending very soon. At some point, we will face most of the headwinds, so we need to monitor everything quite regularly, for our portfolios' sakes.

Why I Like Annaly Over All The Rest

Look, folks, I can read. I realize that AGNC has basically eaten Annaly's lunch for a few years. That being said, tons of folks still own NLY shares either by themselves, or with AGNC shares.

Personally, I like the way Annaly approaches the market it plays in, for the following reasons:

  • Their management team has been the best in the business for the longest period of time.
  • The company has navigated through more interest rate environments than any other mREIT on the planet.
  • Yes they have had to cut dividends along the way, while they have navigated through rough waters, but even when the yield curve was virtually dead flat back in 2006/07, they still made money and paid a dividend.
  • Aside from a flash crash 2 years ago, the share price has remained remarkably stable.
  • The share price of late has had some solid moves upward, almost indicating a "momentum stock" move.
  • They continue to use less leverage, which mitigates some risks, but does tend to keep a lid on profits and dividends. At least for now.

Perhaps these are not enough for the naysaying commenters out there, but I also believe that the upcoming earnings quarter for Annaly could be a pretty good one. Why? Well, mainly for all the reasons I have already outlined, plus a few extra:

  • Annaly's book value has increased.
  • The share price is priced at just about dead even to book value.
  • Insiders have been swooping up shares with their company options rather than cashing out.
  • They have a shelf registration of 125 million shares that could be used in conjunction with, or in lieu of, a secondary stock offering.

Even these "extras" probably will not be enough for the commenters who will continue to blast me, but I do not care, and an investor in Annaly should not either.

Yesterday, gave an endorsement to the stock based on their own evaluation of the upcoming earnings, to wit:

TheStreet Ratings rates Annaly Capital Management as a buy. The company's strengths can be seen in multiple areas, such as its revenue growth, attractive valuation levels, expanding profit margins, good cash flow from operations and increase in net income.

That basically sums up the way I view Annaly as well. Not that I feel vindicated because of TheStreet's point of view, but because they happen to be correct.

My Opinion

I believe we could be in for an earnings surprise. I also believe that we will see a stable dividend if not a bit of an increase for the next dividend round or two. It will be interesting to see if I am correct.

Disclosure: I am long NLY.