Annaly and the Art of Portfolio Maintenance

Annaly Capital's (NYSE: NLY  ) second-quarter earnings are in, and it's a bit of a mixed bag. The venerable mortgage REIT announced per-share earnings of $0.47, beating earnings estimates by $0.15 per share. After seeing its net interest spread continuously contract over the past year, it edged up to 98 basis points -- a seven point improvement over the first quarter.

But, like fellow American Capital Agency (NASDAQ: AGNC  ) , book value slumped. Though American Capital's drop of 11.8% wasn't as large as the 14.2% Annaly reported, the former trust also lost $2.37 per share and experienced a sizable dent in book value in the first quarter. Poor Armour Residential (NYSE: ARR  ) was severely pummeled in Q2, turning in a tattered book value that fell nearly 19% from the linked quarter. 

So far, a year marked by turmoil
On the conference call, management described another quarter rocked by market chaos and the steps Annaly took to protect investors' interests. CEO Wellington Denahan told analysts that the company reduced leverage and sold $32 billion in assets over the course of the year in order to maintain liquidity.

Annaly also increased its interest rate swaps to cover 53% of its fixed-rate portfolio, which made up 92% of its investments, representing an increase in coverage of 7% from last quarter. The biggest -- and newest -- hedge is, of course, Annaly's absorption of CreXus Investments.

Securitization is part of the plan
Denahan commented that, while stock buybacks are still an option to boost book value, the addition of commercial paper due to the inclusion of CreXus has made that action less necessary. Currently, commercial assets stand at $1 billion, or about 1% of total assets, versus $96 billion of agency mortgage-backed securities. Denahan notes that Annaly can invest up to 25% in assets other than agency paper.

The company revealed some news about future projects, too. Annaly plans to securitize some of its commercial debt -- approximately $2 billion worth, sometime in the fourth quarter. Denahan states that Annaly will originate those loans, and that the pipeline is pretty full.

Another plan for the future concerns originating jumbo home loans through one of Annaly's subsidiaries, Shannon Funding, LLC. In response to a question by an analyst from Jeffries, Denahan notes that, though Annaly can do so, it has not yet originated loans through that channel. When asked if this scenario is an eventuality, however, Denahan responded, "Yes."

Active management pays off
It is obvious that Annaly has a very hands-on approach to management, and the perspective of 17 years of existence when it comes to planning ahead for interest rate changes. Denahan makes a comment to the effect that it's difficult to preserve both earnings and book value in the current environment: one or the other is bound to suffer.

She also mentions that, as far as book value goes, Annaly hasn't suffered as much as most in the sector. She's right about that, and Annaly's management is cognizant of how portfolio adjustment is a constant process of fine-tuning. With the expectation of more market tumult as QE3 winds down, that's just the kind of business savvy that Annaly investors need -- and have come to expect.

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