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.

Annaly is the biggest virtual bank by far. Its potential dividend for 2009 (at 16%) is the smallest of the four stocks. And Annaly's forward price-to-earnings ratio is the highest (at 6.2) of these businesses. But Annaly has a history of doing well in bad times, so it deserves to sell at a premium to its peers. And it's still cheap.

They can earn a huge interest "spread," thanks to the government. They take on essentially ZERO credit risk by investing 100% in government-guaranteed investments (MFA is 99% in government-guaranteed investments). They collect around 5% interest. And they borrow money at low rates – around 3%

As the government tries to help the economy, it helps the virtual banks on both sides of their balance sheets... letting them borrow cheaply and invest risk-free.

13% with a relatively low risk profile is attractive in this market. Rising short-term rates are a risk, but warning signs should be visible to the wary before they occur.

Now that the federal government made the choice to stand behind Fannie and Freddie's mortgage guarantees, this stock is much safer than it was this time last year. It is also trading marginally lower than a year ago and is paying a great dividend. At its current price level (45% above the short-lived 52 week low) I see it as fairly valued. I don’t expect it to appreciate considerably over the coming year, but it should do better than the overall market from here.

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.

I observed reports but could not really understand to verify the data, but believe it was reliable, not yet reported, however, as part of NLY earnings---not sure of that speculative statement, that is, not to know that is helping or hurting earnings.

My thinking is NLY good management, its offering early this year, may call for NLY to buy back stock. Such a program tells its investors NLY is strong.