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Annaly Capital Management (NLY) |
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WIKI ANALYSIS
Annaly Capital Management, Inc. (NYSE:NLY) is a unique real estate investment trust focused on the government sponsored mortgage-backed securities market. Annaly makes money by trading a portfolio of Government National Mortgage Association (GNMA), Federal National Mortgage Association (FNM), and Federal Home Loan Mortgage Corportation (FRE) securities and derivatives. These three government agencies securitize groups of mortgages and then sell them as low-risk bonds similar to treasury bonds because they have the implicit support of the federal government. The company holds just over $54 billion in these securities. Through its advisory subsidiary, Annaly has $15.4 billion in assets under management (AUM). For tax purposes, Annaly is classified as a REIT.
Despite this tax classification, Annaly, unlike other mortgage REITs, does not own any actual commercial or residential real estate. Annaly borrows via short-term loans (usually lasting only thirty days) and uses the money to buy mortgages that are packaged and guaranteed by Government Sponsored Entities (GSE's) like Fannie Mae. These mortgages earn the company interest. At the end of the thirty days, Annaly will borrow again to pay off the previous loan. Because the short term interest rates that Annaly pays to borrow money are typically lower than the long-term rates it earns on Mortgage-Backed Securities, it makes a narrow profit.
Company Overview
Business Financials
In 2009, NLY earned a total of $3.1 billion in 2009.[1] This was almost identical to its previous year's revenues, which were also $3.1 billion in 2008. Even though NLY's total revenues remained relatively flat, it strongly improved its net income situation in 2009. Between 2008 and 2009, NLY's net income increased from a net profit of $346 million in 2008 to a net profit of $2 billion in 2009.[1]
Breakdown of Segments
Annaly
Annaly Capital's basic business model is to raise capital and invest in government-sponsored real estate backed securities (REBS). NLY profits when the return on its investment in the REBS exceeds the interest it pays on the money it borrows to invest in the REBS. Per its investment agreement with shareholders, Annaly is allowed to invest up to 25% of its assets in non-AAA equivalent securities. These bond-like instruments are similar to Treasury Securities in that they are (effectively) backed by the full faith and credit of the U.S. Government (i.e.- they are risk free). However, while the Ginnie Mae securities are still explicitly guaranteed as the GNMA is still owned and operated by the Federal Government. This means that although they have implicit AAA ratings on their MEBS, they do not have the stronger, explicit backing off the full faith and credit of the U.S. Government.
FIDAC
Fixed Income Discount Advisory Company is the asset management arm of Annaly Capital. This segment makes profits by receiving fees from third parties to implement Annaly's strategies with outside capital. This adds additional revenue without risking any Annaly or shareholder capital. The subsidiary has a publicly listed closed end fund with First Trust (FHI) , FMY. This fund allows any investor to have access to one of Annaly's strategy. They then proceed to collect a risk free management fee from the fund's returns. FIDAC also collects a fee by acting as the advisor to Chimera Investment Corporation (CIM).
Key Trends and Forces
Falling Interest Rates Will Increase Profits
The most important determinant in valuing Annaly's portfolio and profitability are interest rates. These rates determine the borrowing cost of Annaly's securities, and the margin that the firm earns on its investments. The spreads between borrowing cost and returns on securities - the yield curve - is Annaly's profit. Because of the current make up of the portfolio, decreased interest rates benefit Annaly, while higher interest rates will squeeze margins. This comes from the weighting of its holdings/borrowings with regard to rate adjustments.
Rising Interest Rates Will Cut Into Annaly’s Margins
If the U.S. economy begins growing at a pace that requires interest rate increases, or inflation spins out of control, Annaly will have to pay more out in interest to its lenders. As rates go up, Annaly’s margins fall. This is a result of the aforementioned lag in resetting of investments vs. borrowings. This is not static, though. The weighting of the portfolio is determined by Annaly’s management. Management has clearly articulated that their strategy was based on the belief in short term rate decreases. If the market environment turns to one that is unfavorable to Annaly, management will have to take serious action to correct the weighting of the portfolio.
Free Flowing Credit Markets Are Essential
As we are seeing now, a teetering economy with lower rates to spur growth but free flowing capital markets is the ideal mix for NLY. The main reason that Annaly relies on U.S. economic health is ease of capital. There must be access to low cost financing to create leverage. As Fed Chairman Ben Bernanke cuts rates, it will ensure that Annaly has access to low cost financing. The threat to Annaly lied in the freezing of U.S. credit markets, but this crisis has been avoided for now.
Subprime Lending
As hard as it is to believe, since it is a mortgage REIT, Annaly has largely avoided the subprime mess. The composition of its portfolio, along with well managed interest rate exposure, has allowed Annaly to dodge this bullet. Additionally, Annaly is making record profits indirectly through this mess. The subprime mess has caused a major shock to U.S. credit markets. This has caused the Federal Reserve to step in and lower rates to ensure proper flow. The lowering of rates allows Annaly to borrow at a lower cost, and values their current index-based holdings at a higher value. Thus, subprime has benefited Annaly immensely.
Competition
Some of NLY's major competitors include MFA Mortgage Investments (MFA), |Capstead Mortgage (CMO), and Anworth Mortgage Asset (ANH).
References
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