Is This Mortgage REIT Wasting Your Money?

Stock buybacks are generally considered a bullish signal on Wall Street. They return capital to shareholders, while declaring management's belief that its own cheap shares are its best return on investment. As long as profits remain consistent, share repurchases can even increase earnings per share, by dividing the same amount of earnings among a smaller pool of shares outstanding.

But don't forget -- a company isn't obligated to repurchase shares just because it announced its intention to do so. So don't use the announcement as a reason to buy by itself, rather use it as a launching pad for additional research.

On a wing and a prayer
Agency mortgage REITs like Annaly Capital Management (NYSE: NLY  ) and American Capital Agency (Nasdaq: AGNC  ) have lost ground and money since Ben Bernanke launched his quantitative easing policies last year to keep interest rates artificially low. With the launch of a third round of easing last month, the mREITs are under attack again as mortgage refinancings and bond prepayments rise. Annaly's stock has tumbled 8% over the past month while Capstead Mortgage (NYSE: CMO  ) fell 10%, and American Capital is down 6%.

With its stock down from its highs, Annaly announced a $1.5 billion buyback program over the next year that could help support the stock in the face of elevated prepayments and a challenging reinvestment environment. It would seem the REIT is preparing for its stock to go lower still by readying a repurchasing war chest.

Going vertical
Agency REITs like Annaly have long been the preferred vehicle for investors who liked the security of the taxpayer backstopping their investments. With Fannie Mae and Freddie Mac standing ready to pay out in the event of mortgage defaults, it was easy money, and their dividend yields juiced the returns. Annaly itself yields 12.5% while American Capital is north of 15%.

But the easy money is harder to come by now that the Fed promotes easing essentially forever. That's why analysts are looking to hybrid mREITs Chimera Investment (NYSE: CIM  ) and Invesco Mortgage Capital (NYSE: IVR  ) . These mREITs invest in agency-backed securities but also delve into non-agency backed paper.

The risk with Invesco or ARMOUR Residential REIT (NYSE: ARR  ) , another hybrid, is the amount of leverage they use. They've been known to take on enormous amounts of debt to juice their returns, using the leverage to make a profit on the difference in the spread between the cost of what they borrow and the return they make on their investments.

Annaly and others have had to engage in a round of dividend cuts, sometimes several times, and the Wall Street pros think that trend hasn't ended just yet. Morgan Stanley (NYSE: MS  ) forecasts a median dividend cut averaging around 4% through 2013, though it might not simply be pure agency REITs that suffer the ignominy.

Two tickets to paradise
Despite the squeeze to its interest margins, Annaly has been through tough business cycles before and come out intact. Yet considering it only just did a 125 million share offering a few months back, it's a bit odd that it now wants to buy them up. While buybacks prop up the stock and the earnings per share, this looks like Annaly is taking money out of one pocket and putting it in another. That's why I said the announcement made it seem as though it's preparing for a rough patch.

Around the time Annaly did the offering, I marked it to underperform the broad market averages in Motley Fool CAPS, the 180,000-plus member-driven investment community that translates informed opinion into stock ratings of one to five stars. While the mREIT carries a top-tier four-star rating, as 91% of the 2,603 members weighing in on it believe it will still beat Wall Street expectations, I'm going to continue my bearish position.

So far, that's caused my rating to be the one that underperforms as the stock is up more than 8% compared to a sub-3% rise in the S&P 500. But by making the CAPScall here, I hold myself accountable for being bearish, though I ultimately believe it will come out right in the end.

That's the spirit
Annaly is an all-star REIT that has the misfortune of having to fight the Fed in its policies. But let me know in the comments section below if you disagree with my view that the buyback announcement in this instance heralds bad news, not good.

Annaly Capital Management has a history of paying huge dividends to shareholders. But there are some crucial issues investors have to understand about Annaly's business model before buying the stock. In this brand new premium research report on the company, our analyst runs through these absolute must-know topics, as well as the future opportunities and pitfalls of their strategy. Click here now to claim your copy.

Rich Duprey has no positions in the stocks mentioned above. The Motley Fool owns shares of Annaly Capital Management. 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.


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  • Report this Comment On October 22, 2012, at 3:17 PM, jonkai wrote:

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    While buybacks prop up the stock and the earnings per share, this looks like Annaly is taking money out of one pocket and putting it in another. That's why I said the announcement made it seem as though it's preparing for a rough patch.

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    you failed to realize that Annaly offered those shares at above book value, and now are buying them back at below book value, which is taking money out of one pocket at a lower price, and putting them in another pocket at a higher price...

    creating value in the process, since they see that the current paper on the market is not worth buying... where their shares are... which adds value to shareholders dividends in the future...

    this isn't heralding bad news, the news was already bad before, this is management, being management, and doing what they always have done for 15 years, making lemonade out of what ever market lemons are thrown at it.

    you also failed to count the dividends in the poor performance of your call, making it that much worse of a call...

    never "downgrade" when this stock is below book value as you did... because it always returns above book value given a short amount of time.... as you found out, and will find out again it appears...

    and you just once again "downgraded or reiterated your downgrade" at a price below book value... that is a fools errand... pun intended...

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