The Fed's Janet Yellen Could Be Annaly Capital Management's Best Friend

On Wednesday, Janet Yellen said the Fed intents to keep rates very low for a considerable amount of time, which could do wonders for mortgage REIT profitability.

Apr 18, 2014 at 7:00AM

On Wednesday, Federal Reserve Chair Janet Yellen said the central bank will keep interest rates very low for the foreseeable future, even after the economy recovers some more. This could have a tremendous impact on mortgage REITs like Annaly Capital Management (NYSE:NLY) which rely on interest rate stability to make money. Could this development give Annaly the shot of confidence it needs to boost its leverage once again? And what could this mean for investors over the next few years?


Uncertain rates are no good, but Annaly handles them well
When interest rates go up suddenly, it causes the spread between the interest rate mortgage REITs can borrow money for and the rate they collect on their investments to narrow. Since these companies are very highly leveraged to begin with, a spike in rates can drastically reduce their income.

Worse yet, a rate spike causes the mortgage-backed securities in the portfolio to be worth less, which can quickly erode book value and even lead to bankruptcy. Let's say one mREIT has $7 billion in assets, which it bought at a 7-to-1 leverage ratio, meaning the trust has $1 billion in equity. If the value of the assets drops by 20% due to a rate spike, this would be a loss of $1.4 billion, or more than the company's equity! This is why being highly leveraged is so dangerous in an uncertain rate environment.

Fortunately, Annaly's management has done a great job of adjusting to uncertain times, through both lower leverage and diversifying the portfolio. Commercial real estate now represents about 14% of Annaly's holdings, and the company has made it clear it plans to continue to grow this area of their business.

Annaly's leverage: now and what it could be
Some companies responded to the mREITs' discount to book value by buying back shares at a discount. While it's hard to argue with the logic of buying something for less than its worth, Annaly felt the best course of action was to keep leverage relatively low for the time being and to capitalize on new opportunities in a more stable rate environment.

Annaly's leverage ratio currently sits at 5-to-1, which is very low on a historic basis for the company, and even lower relative to most other mREITs. The company's leverage was about 7-to-1 in 2012, so around there would be a decent expectation if management feels rates are stable.

Annaly's CEO has already made her intentions clear. With new money spreads approaching 200bps, the company plans to significantly add to its positions as opportunities present themselves. To get back to 7-to-1, Annaly could purchase about $24 billion in new assets, meaning it has plenty of room to capitalize as conditions grow more favorable.

The dividend and Annaly's share price
If Annaly were to boost its leverage as mentioned; the company could increase its income and dividend by 40%, theoretically. This would represent a $0.42 quarterly payout, but let's conservatively say a $0.40 dividend is a reasonable target once leverage rises, as Annaly adjusts its payout in five-cent increments.

Now, Annaly's share price tends to gravitate toward a 12% annual yield, but adjusts to price in the possibility of increases or cuts in the dividend. For example, once the cut to $0.30 per quarter was announced in December, the share price immediately dropped to $10.00 per share. At $0.35 (September), we would expect about $11.67. Take a look at the chart and see for yourself where the price was, and how the yield hovers around 12% regardless of the dividend or share price:

NLY Chart

Annaly currently has an annual yield of about 10.5%, which tells me the market thinks the dividend cuts are over and conditions are growing more favorable for mREITs to make money. At 12%, a $0.40 quarterly dividend corresponds to a $13.33 share price, which is a reasonable target if the Fed makes good on their pledge to keep rates low and stable.

Is this an even better investment than mREITs?
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Matthew Frankel owns shares of Annaly Capital Management. 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.

A Financial Plan on an Index Card

Keeping it simple.

Aug 7, 2015 at 11:26AM

Two years ago, University of Chicago professor Harold Pollack wrote his entire financial plan on an index card.

It blew up. People loved the idea. Financial advice is often intentionally complicated. Obscurity lets advisors charge higher fees. But the most important parts are painfully simple. Here's how Pollack put it:

The card came out of chat I had regarding what I view as the financial industry's basic dilemma: The best investment advice fits on an index card. A commenter asked for the actual index card. Although I was originally speaking in metaphor, I grabbed a pen and one of my daughter's note cards, scribbled this out in maybe three minutes, snapped a picture with my iPhone, and the rest was history.

More advisors and investors caught onto the idea and started writing their own financial plans on a single index card.

I love the exercise, because it makes you think about what's important and forces you to be succinct.

So, here's my index-card financial plan:


Everything else is details. 

Something big just happened

I don't know about you, but I always pay attention when one of the best growth investors in the world gives me a stock tip. Motley Fool co-founder David Gardner (whose growth-stock newsletter was rated #1 in the world by The Wall Street Journal)* and his brother, Motley Fool CEO Tom Gardner, just revealed two brand new stock recommendations moments ago. Together, they've tripled the stock market's return over 12+ years. And while timing isn't everything, the history of Tom and David's stock picks shows that it pays to get in early on their ideas.

Click here to be among the first people to hear about David and Tom's newest stock recommendations.

*"Look Who's on Top Now" appeared in The Wall Street Journal which references Hulbert's rankings of the best performing stock picking newsletters over a 5-year period from 2008-2013.