JAZ

Annaly Capital Management: Epitome of Low Risk, High Reward

Not sure since I have not done a detailed analysis of their financials. Would depend on what proportion of the Antworth and Capstead portfolio is in GSE debt, what level of leverage they have in place and their cash position.


On Aug 10 04:00 PM Stuart, Atlanta, Ga wrote:

> Would these observations apply equally to Anworth and Capstead?

Annaly Capital Management: Epitome of Low Risk, High Reward

Charlie, it is hard to figure out the average duration on the long side of the NLY portfolio, based on publicly available data. However, during the last earnings call the CEO emphasized, multiple times, that they are in much shorter duration on the long side than is usual for them. Based on this, I have taken a simplistic view and have assumed that over the next 4-8 quarters the cumulative markup will be in the order of 10% which at current GSE pricing assumes an average narrowing of the spread (to treasuries of similar maturity) by 50-60 basis points. Do you think this is off the mark based on any publicly available data you have seen on the NLY portfolio?


On Aug 04 05:05 PM Charlie_Bott le wrote:

> JAZ, what about my question on the relationship between the yield
> and the mark to market of the assets? What are your assumptions
> on the duration or the portfolio?

Annaly Capital Management: Epitome of Low Risk, High Reward

So how would the 92 or 94 cent value be more explicitly guaranteed by the US treasury? However they achieve it on paper, only a second test would reveal the strength of the second guarantee and if the treasury has reneged on (or negotiated) the original guarantee when it was tested for the first time how would it make the second guarantee more believable? Any move in the direction of negotiating (or arbitrarily fixing at a value below par) the value of Agency MBS would completely undermine the credibility of the US treasury and by extension undermine the entire US financial system. The government cannot and will not allow this to happen. Yes, there will be harsh consequences all around but such is the nature of our government's fiscal policy.

On Aug 04 11:53 AM Greg Weston wrote:

> Of course it would be a huge shock to the financial system if GSE
> debt were suddenly worth 0 and there is not way the gov will let
> that happen, but that is not the question here.
>
> But a forced trade of current GSE debt for explicitly guaranteed
> debt at 92 or 94 cents on the dollar would only cause major pain
> to _leveraged_ holders of GSE debt. Like NLY.
>
> You guys think the 14% div on NLY is a free lunch. You are sorely
> wrong. Repairing bridges, health care for the uninsured, repairing
> the military after Iraq, or free money for the mostly rich and/or
> foreign GSE bondholders? No way, not in this political environment.
>
>
> By the way, the housing bill allows the GSEs to continue to fritter
> away their money in dividends. That is cash that won't be available
> for bondholders later on. There was a proposal to stop the GSE dividends,
> but it was killed.
>
> Also, we are looking at a deficit next year well north of $600 billion,
> and higher if the FDIC needs a capital infusion. It had $48 billion
> when the year started, and IndyMac's failure alone is going to wipe
> out $4 to $10 billion of that. WaMu's impending failure will be several
> times larger.
>
> NLY is a trip to a casino, and the substantial odds of a 100% loss
> on the stock in the next 12-18 months just don't justify the extra
> 11% dividend you get above CD rates. If you want to gamble, there
> are plenty of bets with much better risk/reward than this.
>
> Not to mention the other concerns raised here about an increase in
> short-term rates.

Annaly Capital Management: Epitome of Low Risk, High Reward

I am extracting from Paulson's recent PR below (entire press release can be viewed at treasury.gov/press/rel...)

"GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure."

So, yes the above does not make the specifics of the guarantee explicit, but the agency debt market is trading as if the implicit guarantee that existed (untested) in the past has been diminished in some way - instead of trading in a fashion that reflects the fact that the US Treasury has stepped in with legislation that reinforces their commitment to back this debt i.e to redeem the debt at 100 cents on the dollar - not 99.5, 99 or 98 since the latter is an extremely slippery slope with no backstop and cannot even be construed as a verbal backing.

Therein lies the opportunity - eventually the market will realize (and reflect in pricing) the fact that the guarantee is more explicit than it has ever been in the past which means narrower spreads to treasuries than ever in the past. That is the only assumption being made and regardless of the propriety or fairness of Paulson's approach, is where I think we are today.

Annaly Capital Management: Epitome of Low Risk, High Reward

Yes, the slope of the yield curve (i.e the spread b/w short and long term rates) as opposed to absolute short term rates is the key driver here. In a flat or inverted curve environment (i.e spread is zero or negative) Annaly's business model won't work quite as well. Only assumption being made here is that this spread will average between 100-150 basis points over the next few quarters, which given where we are in the economic cycle is not a big ask.

On Charlie's question regarding how the 10% markup was computed - yes the fall in yield implies a proportionate increase in the bond price. For example if we assume an agency yield of 6%, a 9% drop in yield to 5.46% (i.e. by 54 basis points) implies the bond price is up by 10%.

Annaly Capital Management: Epitome of Low Risk, High Reward

The key assumptions being made here are:
1) that with the US government explicitly backing Agency bonds (which has never happened before) the spread between Agency and Treasury bonds will fluctuate in a much narrower range than ever before. So its not about reversion to a mean that was established in the pre-explicit-guarantee period. Annaly has successfully navigated the high volatility and widening spread environment and can now look forward to calmer waters with the explicit government guarantee for agency paper.
2) that the current economic malaise is too pervasive for the Fed to raise short term rates aggressively anytime soon - which would otherwise seriously crimp Annaly' spread capture and profitability.