Annaly Capital Management (NLY)

Annaly is a one of the best hedges in the market right now. Because of the composition of its portfolio, it moves inversely with the Fed Funds rate. So when Ben brings out the knife, Annaly's portfolio becomes more valuable.

Annaly Capital recently reported solid first quarter 2008 results, with core EPS of $0.51/share that was in-line with analyst estimates. Spreads improved by an impressive 58 bps on a sequential basis to 1.46%. Leverage remained at 8.1:1, however, which seems slightly aggressive. However, with no exposure to non-agency assets and no apparent margin call pain, the 8.1:1 ratio appears reasonably comfortable to me.

Annaly's strong results are rooted in the Company's significant investment in fixed-rate assets several months ago. The Company had 69% of its portfolio in fixed-rate instruments at period-end, though some of that exposure was hedged. NLY's repo financing had a weighted average cost of just 4.18% during the quarter and 3.85% at period-end. With funding becoming even cheaper on the heels of yet another Fed rate cut, Annaly can look forward to several more quarters of wide spreads and flush earnings.

Annaly's book value at 3/31/08 was $13.38, so the stock is trading at 1.3x the after-hours closing price of $17.25. This valuation is on the lower end of Annaly's historical trading price, suggesting that the stock could have more room to run.

Additionally, the dividend yield is currently a robust 11%, much higher than Annaly's typical dividend yield.

The credit markets are volatile and unpredictable. However,Annaly seems to be too far up the food chain and has too much liquidity to fall victim to the credit crunch. If Annaly's securities become illiquid, then Fannie and Freddie are both at risk. The government cannot allow this to happen for fear of a complete systemic economic meltdown. With a dividend yield of 14% and a stock price that's just 1.06x book value, Annaly is delivering solid risk-adjusted returns. It's well worth rolling the dice on.

The Company's leverage was 8.7 to 1 at December 31, 2007, and Annaly completed a $1 billion equity offering shortly after year-end. With respect to repurchase agreements, the Company did not have an amount at risk greater than 10% of the equity of the Company with any counter parties as of December 31, 2007, indicating that Annaly has a diverse array of counter parties for its repurchase agreements, so there is little risk that one nervous counter party could deliver a fateful margin call.