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More on Annaly (NLY) Q4 earnings: Book value of $15.85 down from $16.60 in Q3. Net interest...

More on Annaly (NLY) Q4 earnings: Book value of $15.85 down from $16.60 in Q3. Net interest margin of 0.95%, down 7 bps from Q3, down 76 bps from a year ago. Leverage of 6.5X. A trader does the math: 6.5 times 0.95% equals 6.17% sustainable dividend yield before expenses (and hedges). CEO Denahan: "Decisions made by policymakers continue to have exceptional influence on pricing and behavior." Shares -0.1% AH. (PR)

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Comments (21)
  • Mktneutralhedger
    , contributor
    Comments (1212) | Send Message
     
    stock is up but IMO dividend will have to be cut. Still an undeperformer in my view. Surprised by the recent strenght of MFA which is a different animal and I'd stick to it.
    6 Feb 2013, 04:49 PM Reply Like
  • Patrick Harden
    , contributor
    Comments (438) | Send Message
     
    Annaly still has plenty of unrealized portfolio gains to harvest. The company trades a certain amount of assets each quarter, so it's not just spread income supporting the dividend. I think a 10% dividend yield would be a good benchmark for 2013, which at $15/share would be a $1.50/share annual payout ($0.375/share each quarter.)
    6 Feb 2013, 04:53 PM Reply Like
  • investing4me
    , contributor
    Comments (33) | Send Message
     
    Patrick,

     

    The reason I own NLY and CXS is because having worked in mortgage on the secondary markets side for several years until my current role in mortgage ops, I understand how they make their money and why they do a lot of what they do.

     

    I can't tell you how many times we would hold back a sale, or increase our pool amount for sale based on the spread that day or week.
    6 Feb 2013, 06:02 PM Reply Like
  • Ray Merola
    , contributor
    Comments (4107) | Send Message
     
    I take the long view on NLY. Current Fed policy is not a "forever" prospect. Over time, the company will recover its margins. Management has a propensity for safety; they will not chase short-term yield for yield sake.

     

    My premise is to reinvest dividends and simply put this security away until the U.S. economy and the Fed return to a semblance of "normal."
    6 Feb 2013, 05:31 PM Reply Like
  • Northwest Investor
    , contributor
    Comments (1446) | Send Message
     
    reinvesting dividends in NLY is a bad idea for most investors.

     

    Why?

     

    Because sooner or later all mREITs face an unfavorable interest rate spread environment, and suffer major reverses. An Agency mREIT is a carry trade, borrow short, lend long. Its great when it works, but of one thing you can be certain: every carry trade eventually breaks down.

     

    The NLY holder who's been banking a healthy dividend for years and redeploying it into other investments has insulated himself against this risk.

     

    The mREIT holder who's kept on reinvesting has dramatically increased his risk.

     

    I like dividend reinvestment for companies with solid long term fundamentals -- a GE, an IBM, an Aflac.

     

    mREITs are simply a financial arbitrage, and prudent investors should be discouraged from reinvesting dividends.
    7 Feb 2013, 12:21 AM Reply Like
  • Ray Merola
    , contributor
    Comments (4107) | Send Message
     
    Northwest Investor

     

    Thanks for taking the time to respond to the question of dividend reinvestment. I agree with your basic premise, but not the subsequent action.

     

    As stated above....."Because sooner or later all mREITs face an unfavorable interest rate spread environment, and suffer major reverses."

     

    This is a true and reasonable premise for many investments: there is a cycle to their profitability and cash flow. Currently, the interest rate spread for mREITS (and other financial institutions for that matter) are very low and unfavorable.

     

    However, my "actionable" view is different.

     

    Since spreads are low and unfavorable, this is precisely the time to reinvest dividends and build up the position. It's not important to me if the spread stays low for a a few months or several years; it just permits me to acquire more shares "on sale." Notably, my view is as a long investor, not a trader.

     

    Stretching the initial premise out further, I envision two future developments.

     

    First, the spreads will widen in the future. The current margins are a Fed creation, not a permanent condition of the U.S. economic landscape. Eventually, the Fed will take their foot off the pedal and rates will rise. With it, spreads will revert to the mean.

     

    Second, NLY trades below book value. This is another key benchmark. While there is noise in the book number, I suggest that over time, Annaly will trade at or above book value once again. Indeed, one might premise the probability of the stock price moving up to stated book value is greater than the book value dropping to the current share price. Continued margin compression or deflation is possible, but I don't believe it's the most likely scenario.

     

    In the meantime, my NLY shares sit in a tax-deferred account and accumulate. At such time that I believe spreads have normalized, and/or the stock price and book value have converged, I plan to discontinue dividend reinvestment and permit the proceeds to build cash again.
    7 Feb 2013, 12:47 PM Reply Like
  • Northwest Investor
    , contributor
    Comments (1446) | Send Message
     
    That's really a misunderstanding of what NLY and other mREITs are. When you're buying shares of an Agency mREIT, you're not buying shares in "a business"

     

    Its a perfectly good contrarian strategy to buy shares in an out of favor business and then sit with them until the markets turn -- buying umbrellas in July. I'm buying natural gas stocks at the moment, on just that logic, and bought oilfield service stocks many years ago on the same logic. Works fine for businesses that have real assets that can ride out ups and downs.

     

    But mREITs aren't "businesses" in the sense of having some ongoing value beyond assets minus liabilities. They're simply a big bundle of leveraged MBS -- in other words, a trade. Now, its a fantastic thing for investors that vehicles like this exist, in essence what you're getting with NLY and AGNC is a kind of trade you couldn't do for yourself (you _could_ buy Agency securities, but you can't get the kind of repo financing that big guys get).

     

    So I'm all for them as a great way of making a leveraged bet; but that's a _trade_ on a specific interest rate scenario which _will_ evaporate at some point. You can compare them to the various levered ETFs, not to ongoing businesses.

     

    Those %15 yields aren't "safe", and the best thing you can do with them is to bank them, not to double down. When you see a yield that's one thousand basis points above the risk free rate in the market . . . you know that that there's a huge amount of risk.
    7 Feb 2013, 01:00 PM Reply Like
  • Ray Merola
    , contributor
    Comments (4107) | Send Message
     
    I'd like to hear from other readers, but I do consider portfolio management a business. mREITs do not keep a static portfolio like an ETF. The management team makes decisions regarding securities hedging, leverage, risk, etc. I agree that mREITs don't operate a manufacturing facility, but I suspect their "business" is a cousin of other financial management organizations.

     

    Indeed, I also believe that portfolio management "managers" can make a difference. Some are better than others.

     

    The reason mREITs can and do trade above book value is investors view of the future of the enterprise. As with any business, investors "pay up" when they believe cash growth is accelerating. They drive down prices when they fear cash is declining and will continue to do so.

     

    By another measure, Price/Operating Cash flow is of value. NLY has a 15-year historic P/FFO ratio of 6.4X; the ten-year average is 6.3X. The current ttm multiple is 4.9X. Most securities revert to the mean over time.

     

    I do agree that mREIT dividends are not "safe." That isn't their intent. It's to distribute cash in conjunction with the performance of a given portfolio.

     

    Over time, margins will normalize, and mREITs will find their share prices once again aligned with book value. Some may even trade at a premium.

     

    7 Feb 2013, 02:08 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (3736) | Send Message
     
    "That's really a misunderstanding of what NLY and other mREITs are. When you're buying shares of an Agency mREIT, you're not buying shares in "a business" "

     

    That is news to me. I don't follow your logic at all.
    7 Feb 2013, 02:13 PM Reply Like
  • Northwest Investor
    , contributor
    Comments (1446) | Send Message
     
    NLY and other mREITS are basically a levered bond fund. There's little there besides a portfolio of MBS, which are levered up with repo financing

     

    You should think of it like a hedge fund or a levered ETF, not a bank or mortgage business.

     

    When you look at, say, Well Fargo, there are client relationships, assets owned, lots of things which add value over the years. The guy whose mortgage they originated has a credit card with them, gets a business loan, and so on. These are all real assets of a bank -- and none of them apply to an mREIT.

     

    On the day that the spread between MBS and repo moves against an mREIT, their income collapses. On the day that MBS prices fall, their NAV collapses-- and consider the massive portfolio of MBS amassed at the Fed, and the fact that the Fed's MBS buying will stop one day. (Yes, they have some hedges, but if you look at any "regression to the mean" scenario from today's extraordinarily low interest rates, you'll see that those hedges will be of little protection . . . they protect against NAV losses on perhaps a 100 basis point move).

     

    At an mREIT, you have a stack of MBS paper, financed with very short term repo borrowings. That's it. Its a bond fund, and a very heavily leveraged one.

     

    (I should note that NLY has some small sidelines as an advisor, but these don't "move the needle" in the equation)

     

    As to how you should take you dividends, consider the late Mike Farrel and current CEO Wellington Denahan-Norris, who take salaries of $30 million plus out of the company. Not stock options, not restricted stock, just "pay me cash"

     

    When NLY pays a dividend, you should too . ..
    7 Feb 2013, 02:49 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (3736) | Send Message
     
    You have your opinion, as do I.

     

    Real assets: "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events."

     

    Annaly has real assets and is engaged in business to earn a profit. It is a going concern or "business" whether it looks like Wells Fargo or not. Most of the assets which Annaly owns are financial assets. That makes them no less "real assets".

     

    Annaly's income has not collapsed and at this point, it doesn't appear to me that it will. It's been in business, under various economic climates, including periods of rapidly increasing and decreasing interest rates since 1997. I don't see it going out of business any time soon. I believe the adverse market conditions created by QE3 have run their course and I believe I see a bottoming process in the net interest spread. Meaning that Annaly will continue to have net income, though the dividend may have to be lowered from here. You can hold me to what I just said.

     

    I simply don't view Annaly as you do.
    7 Feb 2013, 03:38 PM Reply Like
  • Northwest Investor
    , contributor
    Comments (1446) | Send Message
     
    All that NLY or any agency mREIT has is a portfolio of assets. They don't originate mortgages, have no expertise in real estate per se. When they tried their hand at a portfolio which requires credit analysis, they failed disastrously (Chimera).

     

    They don't own anything you can't buy yourself. The only thing they do which you can't is to finance the portfolio with repo (you could do this too if you had $100 million).

     

    There's nothing "special" or proprietary about what they're doing. It's a very lucrative carry trade when the spreads are attractive, and when they're not, it won't be.

     

    They're a levered bond fund. I own it, but wouldn't reinvest dividends, nor suggest that anyone else should.
    7 Feb 2013, 04:59 PM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (3736) | Send Message
     
    What I see from the 10-Q of 3rd qtr of 2012 is that Annaly had $665.614 million in realized losses on interest rate swaps for the first 9 months of 2012, while they had $317.308 of gains in disposition of investments or sales of MBS. So if your "regression to the mean" argument were valid, working in the reverse, I would think that the interest rate swaps losses would have been a lot less. (The hedges would not have had that much of an impact on earnings.) From what I see in their 10-Q, I believe that the hedges do play a more significant role than you estimate, which will help to offset the future losses in value of the MBS for the most part.
    8 Feb 2013, 01:38 PM Reply Like
  • batitude
    , contributor
    Comments (118) | Send Message
     
    Author quotes "6.17% sustainable dividend yield" - since the dividends are based on Taxable Income, and the financial statements are GAAP based, how did you come up with that statement?

     

    I agree that the spread is narrowing, and we have a huge political and rising interest rate risk, but the "math" on the sustainable dividend is fuzzy math...
    6 Feb 2013, 05:59 PM Reply Like
  • DeepValueLover
    , contributor
    Comments (9718) | Send Message
     
    I may have to roll a little out of (NLY) and add to (CLCT) and (AINV) for those really fat dividend payments.
    6 Feb 2013, 08:05 PM Reply Like
  • joecap4c
    , contributor
    Comments (74) | Send Message
     
    between the shorts and others who think 10 % dividend is greater then 12.5% it is hard to find any sharp people here on SA. GAAPdoes compute with Mreits
    6 Feb 2013, 09:42 PM Reply Like
  • alloptstrat
    , contributor
    Comments (68) | Send Message
     
    Watching people lose has been painful. Seeing people willing to fight the Fed makes me wonder how people compute their odds - NLY's business has been nationalized and its management is scrambling to get into other lines of business. Did shareholders hire NLY management just to do "something" and impoverish shareholders? This has been a very sad story of management ineptitude and delusional shareholders.
    7 Feb 2013, 05:31 AM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (3736) | Send Message
     
    Net income, excluding unrealized gains/losses, increased slightly from the 3rd qtr. as gains from sales of assets decreased. CPR for 4th qtr was 19% versus 20% for 3rd qtr. The net interest spread decline was not material, possibly indicating a bottom has been reached. Are things bottoming out? Have things become about as bad as they are going to get? It looks like the Fed's purchases are no longer causing rates to decline, which is a plus for the CPR rate as well.

     

    Don't know how they calculated book value per share. Unrealized gains/losses are included in net income, correct? So how meaningful is the book value number if that is the case?
    7 Feb 2013, 08:27 AM Reply Like
  • batitude
    , contributor
    Comments (118) | Send Message
     
    Book value is very important - because that is what the liquidation value of the company is - when NLY is trading below book value, then there is no premium in the stock price, and the probability of the stock rising from there is strong. There used to be a premium to book back before the Fed was meddling...
    7 Feb 2013, 09:13 AM Reply Like
  • Bryce_in_TX
    , contributor
    Comments (3736) | Send Message
     
    I hear what you are saying. Most, 90% or perhaps a little more, of what comprises book value, as I understand it, is based upon actual historical transactions. But the unrealized gains/losses of derivatives comprise part of net income, and hence a portion of book value. I'm just wondering what caused the drop in book value. Could the unrealized derivative gains/losses been a component of the drop between quarters. If so, book value is mostly, but not entirely reliable, IMO. So, I should have asked, "How meaningful is the decline in the book value", with such "junk" included in BV.

     

    Secondly:
    "Without the effect of the unrealized gains or losses on interest rate swaps and Agency interest-only mortgage-backed securities and net loss on extinguishment of 4% Convertible Senior Notes due 2015 (the “4% Convertible Notes”), net income for the quarter ended December 31, 2012, was $465.1 million or $0.46 per average common share"

     

    Why are they taking out the net loss on the extinguishment of debt to determine adjusted net income?

     

    "During the quarter and year ended December 31, 2012, the Company repurchased approximately $211.8 million and $492.5 million of the outstanding 4% Convertible Notes for $260.3 million and $617.5 million, respectively. "

     

    This appears to me as a real cash expense, buying the debt back for more than it was issued for. Why would you exclude that loss to figure adjusted net income, as it appears Annaly is doing?
    7 Feb 2013, 12:14 PM Reply Like
  • clark441122
    , contributor
    Comments (27) | Send Message
     
    just looking at the nice cash in my account from the last dividend! I have a stock that is selling under book value on a portfolio of mostly gov backed securities whose last quarter EPS is larger than the dividend payout. Dah
    8 Feb 2013, 07:49 PM Reply Like
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