Investment Options Still Viable For Annaly

| About: Annaly Capital (NLY)
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The Fed's recent statements and stance on QE3 have significantly impacted trading in the REIT sector; in particular many analysts downgraded their projections for Annaly Capital Management (NYSE:NLY). There has been an overreaction from many pundits and investors, but 2012 has clearly been challenging for Annaly's earnings. Current shareholders should hold, but may consider hedging potential losses with a REIT that's had stronger positive performance throughout 2012. Interested investors may consider alternative REITs or short Annaly in the near term. Investors that are bullish on Annaly's outlook can consider this quarter an opportune entry point due to its declining stock price based on weak second-quarter earnings, recent downgrades, and the long-term implications of QE3.

American Capital Agency (NASDAQ:AGNC), Capstead Mortgage (NYSE:CMO), Hatteras Financial (NYSE:HTS) and Chimera Investment (NYSE:CIM) are some of the REITs most comparable with Annaly Capital. Annaly's price is over 92 times earnings, substantially higher than the aforementioned REITs. Annaly's price is 4.3 times sales and 0.94 times its book value; these ratios are lower than American Capital Agency and Hatteras Financial's corresponding ratios. Annaly's debt-to-equity ratio is around 6.09, this is lower than American Capital Agency, Capstead Mortgage and Hatteras Financial. Annaly's annualized dividend is around $2.00, while American Capital Agency is around $5.00.

Annaly's 0.17 EPS is the lowest among these REITs; American Capital Agency's $4.16 EPS is the highest among these REITs while Chimera's $0.52 EPS is the lowest aside from Annaly Capital. Annaly's 81% EPS decline in 2012 is also the worst among these REITs while Capstead's 15% EPS growth is the highest. Annaly's EPS is projected to increase 4.4% in 2013 and its sales have increased 23.9% over the past 5 years. Annaly's ROE is around 2.1%, its operating margin is around 11.2% and its profit margin is around 9.5%; these margins are the lowest among the REITs.

Annaly's 4.09% float short and 3.4 short ratio are the highest among these aforementioned REITs. Annaly's beta is the lowest among these firms while Chimera's beta is over one. Annaly's average trading volume is around 11.6 million and its relative volume is around 2.01; these are the highest among the REITs. Annaly currently trades for less than American Capital Agency, Capstead Mortgage, and Hatteras Financial. Annaly's stock has increased 8.4% YTD but is down 5.8% in the past month. Its stock has decreased around 9.9% since its last earnings release.

It's important to consider specific metrics when reviewing REITs' valuation and viability for long-term dividend income. Annaly's second-quarter constant prepayment rate (CPR) increased to 19% from 11%, YOY; American Capital Agency's second-quarter CPR was around 12%, Hatteras Financial's CPR is around 25.7% and Capstead's is around 41.5%. Annaly's funds-from-operations (FFO) growth since 2008 is around 21.8% annually; American Capital Agency's FFO growth in that timeframe is over 1,100% per year while Hatteras Financial's FFO growth is around 64.8%. Annaly's price-to-funds-from-operations ratio is around 4.3 while American Capital Agency's ratio is around 2.5.

The Fed's aggressive and open-ended implementation of QE3 will raise demands for MBS but it will also lower the yield on the future long-term bonds for REITs. Lower long-term rates and the record low short-term rates don't leave much spread for the mREITs to increase revenue. It will also be more challenging and improbable to realized similar yields to current assets for new purchases. Still there is more pressure as refinancing continues to ramp up as do prepayments.

The REITs will be able to realize capital gains on current assets to sustain earnings; this is one benefit Annaly has in its substantial portfolio of assets. Eventually, REITs like Annaly will end up taking a loss on as they try to replace assets sold in order to sustain earnings through this period of record low rates. The direct result may be a much lower dividend for current shareholders in the medium term.

On Annaly's previous earnings release, around 75% of its assets were in government or AAA rated mortgage-backed securities and short-term investments; 25% are allocated to BBB investment grade REIT real estate assets. Due to volatility in the mortgage and credit markets stemming from U.S. and European capital market uncertainties, management remains confident while its debt-to-equity ratio remains below 12:1. Annaly's second-quarter economic net interest income declined to $497.8 million from $626.9 million and its net interest rate spread declined to 1.54% from 2.45%, YOY. The low interest rate environment and higher CPR were the primary catalysts behind the lower net interest rate spread. Annaly realized a second-quarter net loss of $91.2 million, down from its $120.8 million net income, YOY.

Management recently provided its detailed account of the market conditions as they have developed in the third quarter and 2012. This commentary exemplifies management's mature and expert comprehension of the near-term and long-term headwinds that will challenge its revenue growth. This report focuses on the developing economic and political policies' effects on the residential mortgage and commercial mortgage markets as well as the asset-backed securities, treasury and corporate credit markets. Annaly views the primary headwinds in residential mortgage markets are the lower primary mortgage rates, increasing prepayments and the evolving mortgage spreads. Commercial mortgage back securities issuance for 2012 is projected to exceed initial expectations by $15 to $20 billion.

Interest income spreads and yields for REITs focused on mortgage-backed securities are expected to be under more pressure as the FED begins purchasing up to $85 million in MBS monthly. Ultimately, the FED will become the majority owner of these types of bonds. Annaly may eventually need to lower its dividend once interest rates begin to increase again. Investors can have confidence in management's proven expertise, flexibility with over $128 billion in assets, and its commitment to adhere to the conservative approach toward building equity without undertaking uncharacteristic risks. The days of high-yielding REITs are coming to a standstill, but Annaly is currently adept at navigating the current and impending headwinds due to its stout management team and diverse asset portfolio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.