Will Annaly Earnings Impress or Depress?

The popular and high-yielding mortgage REIT Annaly Capital Management (NYSE: NLY  ) reports earnings in less than a month. Given everything that's going on in the mREIT space, I thought it'd be helpful to quickly review the positive and negative factors that are likely to impact Annaly's performance.

On the one hand, all mREITs are currently experiencing a number of industry headwinds. The biggest of which comes courtesy of the Federal Reserve. Last September, the Fed announced a third round of quantitative easing under which the central bank committed to purchasing $40 billion in agency mortgage-backed securities until the employment situation improves substantially.

Although the increased demand in the MBS market has no doubt increased the value of the underlying securities held by mREITs -- and particularly those like Annaly, American Capital Agency (NASDAQ: AGNC  ) , and ARMOUR Residential (NYSE: ARR  ) , which focus on agency paper -- it's also driven down the yield on their portfolios.

This has been inordinately detrimental for funds with high constant prepayment rates. In the third quarter of last year, for instance, it's not a coincidence that Annaly had the highest CPR and the lowest interest rate spread of its peers like American Capital and ARMOUR. However, even putting the CPR aside, Annaly is far from the only mREIT that's been forced to reduce its dividend payouts over the last year, as the list similarly includes both American Capital and ARMOUR.

On the other hand, Annaly has taken a number of proactive steps to mitigate the impacts from the Fed's policies. In the first case, it's lowered its cost of funds by issuing preferred shares and restructured the liability portion of its balance sheet by extending the duration of its borrowings.

In addition, it recently submitted a proposal to acquire CreXus Investment Corp. (UNKNOWN: CXS.DL.DL  ) , a REIT focused on commercial property. As I noted at the time, because CreXus is both effectively unleveraged and contains a higher yielding portfolio compared to Annaly's, there's every reason to believe that the move will be immediately accretive to Annaly's bottom line.

At the end of the day, in turn, the question for investors is: Which of these forces will overpower the other? And while I won't venture a guess here, it's best to keep the following maxim in mind: "Never fight the Fed."

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  • Report this Comment On January 22, 2013, at 4:14 PM, jonkai3 wrote:

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    which focus on agency paper -- it's also driven down the yield on their portfolios.

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    in reality however the spread has been INCREASING since about 2.5 months ago.... no one wants to fight the fed, but the fed appears to have set the bottom,

    so the better saying would be: "if the fed says 3.4% is the bottom of the 30 year rate, then who am i to argue".

  • Report this Comment On January 22, 2013, at 4:21 PM, jonkai3 wrote:

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    it's lowered its cost of funds by issuing preferred shares and restructured the liability portion of its balance sheet by extending the duration of its borrowings

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    again in reality, rather than a "restructuring" it was more a "spend more money" on duration... completely optional to do, yet this is also figured into their "interest rate spread", so in fact, NLY didn't have nearly the "low interest rate spread" that this blog is making out. they purposely spent money increasing their duration, something they didn't have to do, which distorts what really is happening with the interest rate spread.

    in otherwords, their CPR didn't harm them any more than it did the quarter before, or the quarter before that. the CPR had the same exact effect, their proactive step of increasing of the duration is what brought the final spread number down rather than the CPR...

    which makes sense, since CPR CHANGE is what effects earnings one quarter over the next, and there was no real CPR change. it was about the same as it has been for several quarters.

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