Why Shares of Annaly and American Capital Agency Fell After Janet Yellen’s Speech

Shares of Annaly Capital Management (NYSE: NLY  ) and American Capital Agency (NASDAQ: AGNC  ) fell sharply after the Federal Reserve announced on Wednesday it will keep short-term interest rates near zero while continuing to taper its monthly purchases of long-term bonds.

Although the news on the short end of the yield curve is positive for the two companies, as they borrow at short-term interest rates to finance massive portfolios of agency mortgage-backed securities, the same cannot be said for the Fed's decision to further reduce its monthly bond purchases.

The reason for the latter is simple. As the Fed's open market purchases slow, the interest rate on long-term bonds will increase. And as the interest rate on long-term bonds increases, the price of the securities themselves will decrease, as interest rates and the value of bonds are inversely related.

These forces create an unhospitable environment for mortgage real estate investment trusts like Annaly and American Capital Agency, both of which hold copious amounts of agency-backed paper in their multibillion-dollar portfolios. Lest there be any doubt, the following chart shows the destruction this has wrought on their book values per share since the beginning of 2012.

NLY Book Value (Per Share) Chart

So, what's in store for Annaly and American Capital Agency going forward? That's impossible to responsibly predict with precision. However, one thing we can say is a rising interest rate environment will be painful for mortgage REITs. And the other thing we can say is it appears as if interest rates will be on the rise here for some time.

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Read/Post Comments (7) | Recommend This Article (3)

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  • Report this Comment On March 19, 2014, at 6:29 PM, jonkai3 wrote:

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    Lest there be any doubt, the following chart shows the destruction this has wrought on their book values per share since the beginning of 2012.

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    you've got that a little backwards, actually completely backwards, the book values paled in comparison to spread for what is important, the Fed was Buying massive amounts of MBS, which caused interest rates to fall, which caused lower spreads for the Merits, and lower stock prices now the fed is slowing and at a moderate rate, which has caused the Merits to have higher spreads, and reported more profits in NLY's case... the Fed announced that they will continue this path that increased NLY's profits last quarter... to even more profits in future quarters... lower borrowing costs than any time in it's history for the last few years, and now higher interest rates on the long end from the Fed easing...

    add in the fact that the fed is doing it slowly and you get a perfect mix, low book value volatility on top...

  • Report this Comment On March 19, 2014, at 7:17 PM, JohnMaxfield37 wrote:

    jonkai3,

    The interest rate spread is different from book value.

    Yes, the spread is and may continue to widen. But as long-term rates head higher, the RMBS prices will go lower.

    Thus, regardless of a widening spread, as I wrote and depicted in the chart, the book value per share has gone down.

    John

  • Report this Comment On March 20, 2014, at 10:34 AM, mdglass wrote:

    But John, even thou the market price / book value is falling, all the MBS are redeemed at face value, so there is no loss and as "jonkai3" mentioned, spreads and profitability are increasing. Is this not long term bullish for these REITs?

    As long as they don't sell off there MBS at a capital loss the long term profits should grow, dividends should grow and any redemption at face value will not have a capital loss. Please Respond.

    mdglass

  • Report this Comment On March 20, 2014, at 1:06 PM, JohnMaxfield37 wrote:

    mdglass,

    To your point, agency MBSes are redeemable at face value. But that's at expiration. In the interim, the value is set in the market.

    If NLY didn't use its MBSes as collateral, this wouldn't make any difference. But they do. And as a result, when interest rates go higher, the value of the collateral decreases.

    My guess, though I haven't gone through the numbers to confirm it, is that this will have a negative impact on NLY's borrowing costs. We've seen the cost increase over the last two years, and lower collateral values could be a culprit. (Also playing a potential role is the average duration of NLY's liabilities.)

    So, to answer your question... It's my opinion that a rising interest rate environment is not bullish for a fund like NLY.

    Now, to be clear, this doesn't mean it isn't a good value at today's price, as its shares are trading at a 14% discount to book value. I'm only saying that, in my opinion, the fundamentals aren't bullish.

    John

  • Report this Comment On March 21, 2014, at 12:26 PM, jonkai3 wrote:

    yes, the spread is different from book value that wa not what was being pointed out, so again the important one is the spread, book value pales in comparison to the spreads effect... as you can see today, the all mighty spread produced a new stable dividend for NLY. which brought the NLY price right back up to it's recent high... which was not to hard to predict, since their profits also not only stabilized but went up because of the spread.

    the real reason NLY went down for a day or so.. was the inference from the fed chief that short term rates would rise (more expenses to the spread). but when people look, they will and do notice that we are in a new world. where short term rates will never again be large. (neither will long term rates be all that high) because social programs will continue to inject a huge sludgy backwater on world economies barely able to get out of their own way. and the US is going the way of Europe where social programs can not be voted in to sustainability. hence a backwater economy for as far as the eye can see... and only partial getting one foot out because of the fed's moves to lower interest rates to a new world order of low interest rates for all parts of the curve.. one we will not soon escape.

  • Report this Comment On March 21, 2014, at 12:57 PM, jonkai3 wrote:

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    I'm only saying that, in my opinion, the fundamentals aren't bullish

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    then one is looking at the wrong fundamentals.

    soon NLY will of been in business for 20 years... pretty clearly people will notice decade after decade that gets someone 800% returns... (with dividend re-investment)....

    NLY has proven they know what in the heck they are doing decade after decade, (who could of predicted that :)

    even after a shocker like the fed involvement... and the housing bubble collapse which brought several financial institutions to their knees, while NLY saw more profits than they had at any time in their history, heck more profits comparable than MANY companies saw their history... and that is during a financial meltdown that was the second worst in history... and now someone doesn't see good fundamentals getting out of that?

    hey the FED knows a good thing when they see it when they got into the business of buying MBS... freddie and fannie also not only made back what they lost, but are making huge profits for the government now, and the people who ran those businesses tried their darndest to run the businesses into the ground. not good fundamentals????? seriously? My 94 year old grandmother with Alzheimers could have run those businesses better, yet they are making huge profits for the government now?

    you know the old saying, don't fight the FED, well the FED got in the same business as NLY, and for good reason.

    the FED was like the old crafty bank robbers, they go where the money is, right where NLY has been the whole time. fundamentals indeed.

  • Report this Comment On March 24, 2014, at 7:22 PM, mdglass wrote:

    It will be interesting to see how these tow forces of Book Value vs. Interest rate spreads effect share price. I have to believe that Interest rate spreads will win out in the end.

    Thanks John and jonkai3 for sharing your thoughts..

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