Last week, Annaly Capital
Shares promptly fell 3% to $17.37 on the news, though they have since risen to $17.56.
What does it all mean for investors, including the Dada portfolio?
This is a fairly normal -- though intriguing -- event. As a REIT exempted from corporate income taxes, Annaly is required to pay out at least 90% of its earnings in the form of dividends. Since it can't retain much of its earnings, the company has to increase leverage or issue shares if it wants to expand. Together, American Capital Agency
But capital comes with a cost -- shareholders will be diluted some 12%. So a critical test for REIT shareholders is whether management issues shares at opportune times. You want to see new shares issued when the stock is expensive, and/or when Annaly needs the capital.
In the 10-year graph below, the blue line shows how pricey Annaly's shares have been, while the red line depicts stock sales. Ideally, share issuance should spike when the valuation is expensive, and rest when it's cheap.
Source: Author's calculations and Capital IQ, a division of Standard & Poor's.
On this measure, Annaly seems to have done a good job timing its selling in 2000 through 2003, resting as valuations plummeted in 2005, selling again as prices rose somewhat, before resisting the urge to raise capital after valuations collapsed in the financial crisis.
I'm more curious about the timing of the most recent $1 billion offering depicted in the chart, as well as the upcoming one. After all, these are some of the cheapest price-to-book multiples at which Annaly has issued shares during the last decade.
Why would management issue shares for around a mere 1.1 times book value? I can see three possible explanations:
- Annaly hasn't sold significant amounts of stock since the second quarter of 2008. It's patiently waited more than two years, and with valuations beginning to rebound, it may be eager to finally raise more capital.
- Management could expect a prolonged period of large interest rate spreads (the current 200-basis-point range is historically very high for the company) and high profitability, and it wants to capitalize.
- The move could also be a protective measure against an eventual rise in short-term rates.
I think Annaly probably based its decision on a combination of these factors. The current interest rate environment is extremely favorable for Annaly, but the company had to wait until now for a decent valuation before issuing new shares. At the same time, management is cautious because of the possibility that interest rates could rise. As COO Wellington Denahan-Norris noted earlier this month, in explaining why Annaly isn't using more leverage, "You're going into an environment where you potentially have monetary policy changes.... I just think that it's a good idea to continue to operate with maximum flexibility."
In short, issuing shares now is a safe way for Annaly to continue taking advantage of great market conditions. The Dada Portolio is happy to continue owning shares.