As a long time Annaly Capital (NYSE:NLY) shareholder, I can tell you that changing one's opinion on any stock held for a number of years is very difficult. I can also tell you that throughout the time that I have owned NLY shares, I have owned more shares, and then I have owned less shares, but I have always held some sort of a position.
That being said, prudent investors do not "marry" any stock, no matter what stock it is. Either taking profits, or selling for a tax loss, or rebalancing ones portfolio, is just as important, if not more so, than adding to a wonderful position.
There are times when the decisions seem to flip flop the reasons we have recently made, in light of what we thought were positive developments. That is the case with Annaly Capital.
What Are The Headwinds We Currently Face
I can tell you that throughout my analysis and coverage of Annaly, I always cited the risks involved and advised monitoring the current events for any significant changes that would warrant an investor to take different actions.
As of now, investors in all mREITs are faced with a compressed spread between the 2 and 10 year Treasury yields, as well as extremely low interest rates for 30 year fixed mortgages.
The FED has committed $40 billion per month in the purchase of mortgage backed securities which further complicates the business model for mREITs, especially NLY with its conformance to a very conservative approach. Unlike American Capital (NASDAQ:AGNC), which has chosen to use more leverage, and the hybrid mREITs that trade non-agency notes, NLY faces a tighter playground to profit in.
Take a look at this very telling chart:
The spread has compressed significantly while the mortgage originations have increased enough to throw a warning signal our way.
With a ten year rate of 1.68% and the further FED action to compress that yield lower, the likelihood of further dividend cuts by Annaly is much more clear to me. I realize that in the past I have said that the interest rate environment being so sanguine, as well as the zero interest rate policy we have in place, would do well for the conservative approach of NLY, I could not foresee the upward trend in mortgage applications at this rate.
I could not see the impact of the massive MBS buying by the FED either. Yes, we knew that there would be some affect, but now that the FED has acted, we can see that its actions will hinder the profitability of Annaly, as well as other mREITs.
With mortgage originations rising quickly, the prepayment risk once again becomes more clear as well. While the prepayments will raise the book value of NLY, I believe that they will require a secondary stock offering to raise capital. That will dilute shareholder value and probably cause a decline in the share price.
Just last week, it was reported that mortgage applications rose by 2.6%, and as per this report, re-finance applications were up a strong 3.3% as well;
"The refinance index increased 3.3% from the previous week, according to the MBA's weekly survey, which covers more than three-quarters of all U.S. retail-residential-mortgage applications."
While these developments do not mean the end of the "world" as we know it, it does mean we should take action now rather than later.
Actions We Are Taking
For the "Team Alpha" portfolio, as well as our own, we are reducing our exposure in Annaly shares by two thirds. This will give us cash to redeploy almost immediately into another stock.
For now, we will maintain our position in American Capital.
The positives we can take from these actions are that they have come after NLY went ex-dividend, plus we will still hold a core position. We will once again bolster our cash reserves, but not for long, as we look to add to our core holding in General Electric (NYSE:GE), which is our stock pick of the year for 2013 (review this now).