Is Annaly Ready to Claw Back Its Worst Performance?
Adnan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Annaly Capital Management (NYSE: NLY), which largely invests in government-backed residential mortgage securities and oversees about $133 billion of assets, shares lost 17%in the fourth quarter, leading the decline of a Bloomberg index of 32 REITs. As Fed efforts to stimulate the economy narrowed bond spreads, making it easier for more home borrowers to prepay mortgages, investors became concerned that REITs would need to cut dividends.
However, the situation has reversed since the beginning of the year as economic recovery gains momentum, pushing up bond yields and mortgage rates. While Annaly has appreciated 8.4% since the beginning of the year, it is still below the 11% appreciation of the overall index of diversified investments.
Despite the appreciation in stocks and widening of the bond spreads, I believe the Fed’s bond buying is not dictating mortgage REITs’ pricing. There is a strategic shift that is happening within the agency mortgage REITs sector. Most of the mREITs are now interested in acquiring assets like commercial mortgage backed securities and non-agency mortgage backed securities.
Annaly already owns a 12.4% stake in CreXus Investments (NYSE: CXS), while it agreed to acquire the rest of the commercial mortgage REIT for $872 million. Besides this, Annaly has been busy over the past 12 months in bringing down its cost of capital through the issue of convertible debt and preferred equity, extending the duration of its borrowings, and repurchasing common shares.
Competition
American Capital Agency (NASDAQ: AGNC), the second-largest mortgage REIT, is up 13% since the beginning of 2013. American Capital Agency is also exclusively invested in agency MBS and has taken advantage of favorable financing opportunities and bought back its own shares in November last year, when they were trading a significant discount.
American Capital Mortgage Investment (NASDAQ: MTGE) and Armour Residential REIT (NYSE: ARR) are two other similar RIETs which have announced new equity offerings this year. These equity raises would create a timely source of demand for mortgage backed securities in an environment where banks remain reluctant, waiting for the rates to stabilize. Around 90% of the investments American Mortgage Capital holds are agency MBS, while the rest are non-agency, which is why it is classified as a hybrid REIT.
Within the agency holdings of American Capital Mortgage, 63% are 30-year fixed rate securities, while 35% are 15-year fixed rate securities. This composition of the MBS led American Capital Mortgage to beat most of its peers when it comes to the net interest rate spread that it earned during the most recent quarter. American Capital Mortgage maintains a higher level of leverage at 8.3 times.
Armour Residential recently announced a secondary offering of 65 million shares. The company is exclusively invested in agency MBS, like America Capital Agency. However, Armour Residential’s charter allows the management to include assets other than agency MBS, which to date it hasn’t. The company has a large concentration of 15-year fixed rate MBS with low loan balances, which makes Armour’s investment portfolio less exposed to accelerated prepayments.
Conclusion
Having appreciated over 8% since the beginning of this year, I believe Annaly Capital Management has been able to claw back some of its worst performance. The company is busy striking a deal with CreXus Investments, while at the same time has lowered its cost of funds significantly. Therefore, this presents an investment opportunity.
equityfinancials has no position in any stocks mentioned. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!
