Annaly: Who Needs QE3 When We Have ZIRP?

Aug.31.12 | About: Annaly Capital (NLY)

ZIRP; the initials for the single most important monetary policy by the Fed since the invention of the printing press. Zero Interest Rate Policy, better know as the mREITs best friend!

As I have written about continuously (check this out), Annaly (NLY) and its counterparts have benefited by the Fed policy of keeping short term rates at, or near zero for an extended period of time. Once again, in today's speech from Ben Bernanke, the Fed has reiterated that as long as current conditions remain the same, then more monetary easing could be in our future.

Here is the Seeking Alpha "Market Current";

  • "Friday, August 31, 10:32 AM More Bernanke: The first two rounds of QE have lowered Treasury yields by 80-120 basis points, raised GDP by 3%, and increased payrolls by 2M. This remains a man who clearly believes in the positive effects of QE and still sees credit/financial markets as needing it. He didn't make any explicit promise for another round, but the speech comes close."

That's fine and dandy for the rest of the market, but as far as mREITs are concerned, the really big deal is the zero interest rate policy (or "protection" perhaps?) that the fed has now extended to early 2015.

This reminds me of those furniture commercials that we see on TV touting that no interest payments need to be paid until 2017! Yes, that is a fact. I just saw one from a major low price retailer here in Florida, that has that for its Labor Day sale event. 5 years of free money. Plus, it does not accrue until the 5 years are up, and then the purchase amount needs to be paid in full.

Relating this to Annaly is simple; with a near zero short term interest rate for at least the next 2-3 years, most of the risks that face NLY are reduced drastically.

We have already seen that when the Fed buys longer term Treasuries, the yield does not flatten that much anyway, even though it does impact earnings of all mREITs to a small degree.

Let me once again suggest this article as a must read, to understand how mREITs make money:

  • "An mREIT owns and lends "mortgage backed securities" (MBS).
  • The interest rate that NLY borrows at and the interest rate they lend at, is called the "spread".
  • Annaly has a conservative business model and tends to borrow between the 2 year Treasury, and lend to the 10 year Treasury.
  • There are times when they go "off the charts" and lend further out on the curve, out to 30 years. This is called leverage, but Annaly keeps the percentage of that business lower, and tends to be more conservative than their largest competitor, American Capital (AGNC).
  • The difference between the 2 year Treasury rate and the 10 year rate is the percentage that is considered profit.
  • When that "spread" between the 2 and 10 year rate is compressed, profits can be lower. When the "spreads" widen, profits can be higher."

The Most Intriguing Comment Of Bernanke's Speech

I would also like to point out just a snippet of the commentary, that can be read here in full, that I found to be perhaps the most compelling comment in favor of continuing to own mREIT shares, or maybe even adding to positions.

"Early in my tenure as a member of the Board of Governors, I gave a speech that considered options for monetary policy when the short-term policy interest rate is close to its effective lower bound.31 I was reacting to common assertions at the time that monetary policymakers would be "out of ammunition" as the federal funds rate came closer to zero. I argued that, to the contrary, policy could still be effective near the lower bound. Now, with several years of experience with nontraditional policies both in the United States and in other advanced economies, we know more about how such policies work. It seems clear, based on this experience, that such policies can be effective, and that, in their absence, the 2007-09 recession would have been deeper and the current recovery would have been slower than has actually occurred."

My interpretation of this comment, is that no matter what happens, ZIRP will be part of our lives for as long as our current economic malaise stays the way it is. In Japan, this sort of "malaise" lasted for about 20 years.

Quantitative Easing Part 3? Who needs it when we have ZIRP!

My Opinion

As you all know, Annaly has been a staple in my portfolio for a long time. I recently added American Capital to the mix as well.

I believe that owning either of these stocks (of which I favor NLY), will continue to add dividend returns that will be difficult to beat for years to come.

Disclosure: I am long NLY, AGNC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.