Rates May Stay Low: What This Means for Annaly Capital Management and American Capital Agency Corp.

A recent speech by the President and CEO of the Federal Reserve Bank of New York suggested that interest rates may remain low. Here's what that means for Annaly and American Capital Agency.

Jun 3, 2014 at 7:00AM

Dud

William Dudley. Photo: New York Fed

What: In a speech on economic outlook and monetary policy last Tuesday, the President and CEO of the Federal Reserve Bank of New York, William C. Dudley, suggested, "In terms of the level of rates over the longer-term, I would expect them to be lower than historical averages."

Moreover, he noted the federal funds rate (the rate that guides which the rate which mortgage REITs borrow) is likely to "be well below the 4.25% average level." 

He offered three reasons for this:

  1. Persistent economic headwinds remain from the Great Recession
  2. Less economic growth potential due to an aging population
  3. And, low rates encourage banks to lend despite higher capital requirements

So what: Mortgage REITs Annaly Capital (NYSE:NLY) and American Capital Agency (NASDAQ:AGNC) depend on stable borrowing costs to fund their investments in mortgage-backed securities. However, due to the threat of rising interest rates affecting borrowing costs, the two companies have been steadily increasing their use of hedging.

Essentially, the two companies trade their floating interest rates (roughly tied to the federal funds rate) for fixed interest rates. On the plus side, this creates more predictable borrowing costs. The downside is instead of having an average borrowing cost of approximately 0.2%, the companies' are paying closer to 2%. The difference has a severely negative impact on profitability. 

The increase in hedging activity was a bet on short-term interest rates rising, however, considering Dudley's remarks -- as well as similar comments by Federal Reserve Chair Janet Yellen -- we may not see a significant rise in interest rates for well over a year.

Thus, Annaly and American Capital Agency entered into expensive hedging contracts that negatively affected profitability all to protect against rising interest rates that may not actually rise in the foreseeable future.  

Now what: Annaly and American Capital Agency's hedges can be separated into buckets by contract duration, or "maturity" -- Annaly is shown in the chart below. 

Interest Rate Swaps Q

Similar to Annaly, American Capital Agency also has the greatest amount of interest rate swaps (the most highly used form of hedging) in the zero-to-three year maturity bucket.

Considering Dudley's comments it's unlikely short-term interest rates will rise above the 1.78% "Pay Rate" Annaly swapped for in the next two years. Therefore, as Annaly's CEO Wellington Denahan noted in the company first quarter conference call, Annaly is in the process of ending a percentage of these contracts. American Capital Agency is likely to follow suit.

While ending hedging contracts comes at a price, both companies should more than make up the difference by taking advantage of the lower borrowing costs. Ultimately, I see this as one of the few tailwinds mREITs have seen in a long time, and should help the companies post potentially stronger second quarter earnings.  

Is Annaly a top dividend stock for the next decade?
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That’s beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor’s portfolio. To see our free report on these stocks, just click here now.

Dave Koppenheffer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers