I have recently written about my positions in two of "Team Alpha's" names: American Capital (AGNC) and Annaly Capital (NLY). Both of these are agency-backed mREITs that have come under intense pressure since the Fed began its open-ended purchasing of mortgage-backed securities at $40 billion per month.
I advised everyone in this article that we were selling AGNC. We sold the shares at about $35 and we will wait for the dust to settle. As of this writing, we have decided to sell the balance of Annaly Capital as well.
Annaly Capital has been a long-term holding of mine, and we have been through thick and thin together. We recently announced that we were reducing our position by two-thirds in this article. I was much younger when I first began holding shares, and now the risks appear to outweigh the rewards.
When Risks Are Greater Than the Rewards
As investors who seek a more secure retirement, we need to know what our risk level is when we decide to buy or hold any particular equity. There are no free lunches, and every investment (including cash) has risk.
Some equities have more risks than others. It is my belief that, right now, Annaly has more risk than reward for my retirement portfolio and, quite frankly, many others as well.
As you can see, the 30-year mortgage rate has dropped to its lowest level ever: 3.39% as of today. The spread between the two-year and 10-year Treasury is holding at about 1.47% for now. I say "for now" because with each purchase by the Fed, those rates can continue to drop. Not only that, but it appears the Fed wants the rates to drop further, given that it has stated the MBS buying plan will continue for as long as it takes for the overall economy to improve.
To me, we could see mortgage rates below 3% at some point. Right now I have no idea where the bottom will be, but the Fed is determined to have just about every homeowner either refinance or take out a mortgage to buy a home.
Some investors believe that this is just more of the same QE as we had before. The QE that we had before actually gave me more confidence, but it seems this time is different. We have all heard that before, right? According to this article, "U.S. home owners are refinancing their mortgages at the fastest clip since 2005, but the difference now is they are putting cash in, not taking it out."
In the past, homeowners used their homes as piggy banks. They would refinance and take money out. Those days are over since fewer homeowners have as much equity due to the housing crisis,and many more have tapped all of their equity already.
The above-inked article goes on to note that "at the going rate, 25% of all first-lien U.S. mortgages will be refinanced this year, according to LPS Applied Analytics." This is in addition to the homeowners who have already refinanced or are currently being processed. The question becomes: How will Annaly continue to make money in this environment?
To be rather blunt, it will be more than challenging form where I sit. That is where the total return issue comes into play. If Annaly has to cut its dividend again, and the share price continues to fall, then what is the point of holding the stock?
This one-month chart shows that the share price has dropped from almost $18.00/share (let's use $17.50 after ex-dividend) to today's current price of $16.04/share. With the current dividend of $0.50/share, it would take three consecutive quarters of the same dividend just to make up for the drop in share price as it stands now. I contend that the dividend will be cut and not even keep pace with the drop in the share price, especially if the share price drops further.
Prepayments are not all bad; they do add money into the cash holdings of Annaly and will increase the book value, but what will it do with the money? To me, the company will be working within a much "tighter" interest rate environment, and the spread between buying and selling the securities will be further squeezed. That is where the risks are greater than the rewards.
It might not be a "doom loop," but it definitely is not the "house of pain" (to coin a Jim Cramer phrase) that I want to live in right now.
Recent Seeking Alpha Market Currents
Friday, October 12, 2:44 PM: Mortgage REITs continue to get repriced for lower yields going forward with earnings reports from JPMorgan and Wells Fargo not bringing good news. Both banks reported sliding net interest margins and booming mortgage business (some, if not most of which is refinancing) -- an ugly combination for leveraged owners of MBS.
Not very appealing for NLY, I would say.
Then there is this Market Current:
Friday, October 12, 2:49 PM: Mortgage REITs like NLY, AGNC, and CYS should show nice gains in book value from increased MBS prices, but Barclays Mark DeVries says the banks may have blown it by spending the money hedging against rising interest rates. Sterne Agee's Jason Weaver disagrees, attributing the recent sell-off to profit-taking. He sees 'a good possibility of significant upside surprises.'
Last but not least:
Wednesday, October 10, 4:26 PM: Annaly Capital (NLY) appoints Vice-Chairman and CIO Wellington Denahan-Norris Co-CEO in order to allow Chairman and CEO Mike Farrell to focus on his ongoing cancer treatment.
For every push, there is a pull, and more than two ways of looking at the same event. Even though one might be wrong and the other right, all I see is confusion and risk. Ergo, I am selling.
I am selling the remainder of shares held in the "Team Alpha" portfolio on Monday. I will also be selling my own shares from all of my personal accounts. This decision does not come easily, and I am not urging anyone else to follow me. I just really believe that until the Fed gets out of the way, Annaly and all other agency mREITs will have a difficult time. I could put the money to work in other equity positions or keep some dry powder. I have not decided on that as yet.
Disclosure: I am long NLY and will be selling my NLY position on Monday, Oct. 15, 2012.