I recently wrote about the many issues that are facing the mREIT sector, specifically the agency mREITs, and most specifically, Annaly Capital (NLY). The other major player in this sector is American Capital (AGNC). (Check this out)
By all metrics, AGNC has outperformed NLY for the last few years by having a keen awareness of when to use more leverage (using longer time frames for MBS maturity dates) in its business model. Annaly has taken the more conservative path by using less leverage (using shorter time frames for MBS maturity dates).
The interesting fact is that these two companies are in the same business. Annaly has been navigating every interest rate environment deftly since 1997 (when it went public), and has also expanded its business to a degree by using FIDAC as its "back office" management arm. They get paid to manage the business of other mREITs, such as Chimera (CIM), and at one time it looked as though they might even buy CIM. That would have given NLY the flexibility to be in two areas of the mREIT business at the same time; agency backed and non agency backed mortgages. Annaly chose just to own shares.
At first I felt that simply reducing our exposure to Annaly would be the right strategy, and by holding on to American, we would capitalize on their more aggressive approach with their use of greater leverage.
As it turned out, we changed our mind and sold both positions completely. (Check this out)
Should We Re-evaluate Annaly Now?
Soon after we sold our positions, and saved quite a bit of money (NLY was sold at about $17, AGNC was sold at about $35) it became clear that not only was the strategy correct, but our long term belief that Annaly was taking the proper course by being conservative was also accurate.
Annaly announced a buyback plan of $1.5 billion worth of shares over the course of the next 12 months. Personally, I feel that this action was the last action of shareholder value by Mike Farrell himself, who passed away just days after this action was announced.
What Mike did was essentially fighting fire with fire. I believe that he basically told the Fed that he would use the company's cash to attempt to offset the initial impact of the MBS buying "plan" by the Fed itself.
By reducing the number of outstanding shares by roughly 10%, as well as increasing book value as pre-payments inevitably rise, Mike and NLY fired a shot across the bow to insulate shareholders to whatever degree he could.
The move was brilliant. Annaly has the cash to do this, and it also sent a message to American Capital that said rather loudly, that Annaly has taken the right course during these tenuous times for the business.
American does not have the money right now (and might never will), and has readily used secondary offerings over the last 18 months to fill its coffers. Annaly did not have to issue a secondary stock offering and they DO have the cash to do this.
Here is the problem however; the Fed has an unlimited amount of money at its disposal. They will continue to purchase an additional $40 billion per month in MBS for as long as it takes for them to reach their goal of ridiculously low long term rates until just about everyone refinances their mortgages, or the job market and economy begins to show signs of sustained growth.
We simply do not know how long that will take. As much as we would like to own Annaly right now, it does not seem prudent, yet.
The share price has dropped by about 10% in one month:
The 30 year mortgage rate stands at 3.37%. The 10 year Treasury is at 1.81% and the spread is at 1.51% as of right now.
The mortgage applications for refinancing dropped this week and has given renewed hope for investors in this sector. However that is a moving target and with the FOMC announcing yesterday their reaffirming, and their continued commitment to their policy on operation twist, and the additional MBS purchasing, the $85 billion/month being spent is pretty tough to ignore.
"To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee will continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of Treasury securities, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee's holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative." [emphasis added]
Now seriously folks, the time just does not appear to be prudent to own Annaly right now. There are simply too many unknowns, and the untimely passing of Mike Farrell does not help this stock.
The infusion that NLY has made with the share buy back plan is a stroke of genius, for now. It might even save a reduced dividend of about $.40-$.45/share for a quarter or two.
The fact is that this business model is being squeezed, and maintaining profitability has become an increasingly burdensome task for the entire sector. It is not being affected by other businesses, it is being affected by the Federal Reserve.
I will not fight the Fed, period.