Is Management a Reason to Sell Annaly Capital Management, Inc.?

For those attempting to supplement income, or investors that just plain love dividends, Annaly Capital Management's (NLY 1.33%) double digit yields are extremely attractive.

So attractive, it's easy to forget it's the people behind the business -- their expertise and intuition -- that have to build and sustain that dividend. 

However over the past year, compared to similar companies, Annaly's stock has under-performed, management has blamed the Federal Reverse for short-comings, and several high-level executives have fled the company.

Is it time to sell? 

1. Under-performing 
Due to extreme interest rate volatility, the last three years have been particularly difficult for mREITs. This makes it the perfect time to judge management's ability to turn nothing into something.

The chart below shows total shareholder returns (stock price appreciation plus dividends) over the last three years. 

Much of Annaly's poor return can be attributed to significantly reducing the size of its asset portfolio in reaction to the volatile interest rate environment. While this was certainly the safe play, it squeezed earnings and, therefore, shareholder returns.   

Ultimately, investors should look for management that can create value through all environments. While Annaly has performed much better in 2014, interest rate uncertainly could continue, and based on Annaly's past performance it's hard to trust the company will perform better in a similar situation. 

It's the Feds fault!
Despite several mREITs performing well over the past few years, CEO Wellington Denahan has been clear about what's causing Annaly problems: The Federal Reserve.

Denahan opened Annaly's third quarter conference call with a rant about former Federal Reserve Chairman Alan Greenspan. Followed by how policy uncertainty is negatively affecting the business.

Then in Denahan's 2013 letter to shareholders, she discussed the difficult environment the company faced due to the Federal Reserving tapering efforts. And in the most recent conference call, she referred to current Federal Reserve Chair Yellen's remarks about interest rates to be "sheepish." Effectively blaming the lack of clarity for for Annaly having to increase and then decrease hedges all in a matter of months, leading to depressed earnings.

Honestly, I don't see the "finger pointing" as a big problem. First of all, there are plenty of good businesses with outspoken CEOs. Wynn Resort's Steve Wynn and JPMorgan's Jamie Dimon are just a couple that come to mind. 

Also, to be fair, the Federal Reserve has an enormous impact on interest rates, and therefore can drastically effect the value of its bond portfolio. Moreover, I find Denahan's commentary on policy not only entertainingly, but a necessity to inform shareholder's how the environment is impacting business and how Annaly is combating the situation -- which I believe she does extremely well. 

Where'd everyone go? 
Including the passing of former CEO and co-founder Michael Farrell, Annaly has lost four executives and a board member since late 2012 -- all of which had served, at least, since the company initiated operations in 1997. 

It's fair to assume longtime board member John Lambiase, 74, may have simply retired. However, considering the other three executive's were under 50 years old, that's unlikely the case for them. It's more likely that with the company struggling, they were looking for greener pastures elsewhere. Or, perhaps, Denahan is attempting to craft her own team and is nudging people out. 

That much is unclear, but what's seem more certain is that while there's a new crew manning the ship, I think the captain's vision is still very much the same. Denahan has been clear Annaly will continue to buy mainly high-grade mortgage-backed securities, be patient with increasing assets, and continue to add to the company's portfolio of commercial mortgages -- which management seems most excited about.

The last word
While I prefer the more Warren Buffett-like, steady-as-she-goes type management, my problem isn't with Denahan's outspoken nature. I don't have a problem with the recent high rate of executive turnover -- I think that will work itself out. Nor do I have an issue with the company's vision. 

My problem is with execution. Despite the Federal Reserve suggesting it will end it's easing program later this year, the success of a mortgage REIT business is, and always had been, based on management's ability to look into the future and make decisions with that potential reality in mind.

If Denahan finds the Federal Reserve's actions, or general interest rate uncertainly, to be problematic and continues to show an inability to preemptively position the company's portfolio, then it's time to sell Annaly.