The current bear market has hit hard, but for savvy investors, it has brought prices and valuations down to create some great buying opportunities. The question investors should be asking themselves is, Which stocks are great buys right now?
Let's take a look at Annaly Capital Management (NYSE:NLY), a New York City-based mortgage real estate investment trust (REIT). Is Annaly Capital a buy?
REITs are down big
Like the rest of the market, REITs have been pounded this year. The FTSE Nareit All REITs Index, which tracks all REITs, dropped 17.8% on Monday alone -- the worst day for the stock market since 1987. A major catalyst was the Federal Reserve's decision on March 15 to lower interest rates to the 0%-to-0.25% range. Year to date, the FTSE Nareit Mortgage REIT Index is down 42.3%. Home financing REITs are down 39.6%, while commercial financing REITs are down 48.1%.
Annaly Capital, a mortgage REIT, is currently down 43.6% year to date. Annaly invests primarily in agency mortgage-backed securities (MBS), mortgages issued by federal agencies like Fannie Mae and Freddie Mac. Agency mortgage REITs typically generate lower yields than nonagency mortgage REITs, but they are less risky.
"Annaly is invested primarily in agency mortgage-backed securities (MBS), which are insured against default by the federal government and guarantee the timely payment of interest and principal," said Calvin Schnure, senior vice president of research and economic analysis at the National Association of Real Estate Investment Trusts. "They have very little credit exposure or risk of delinquencies or defaults." Specifically, Annaly had about 88% of its assets in agency-backed mortgage securities at the end of 2019.
In general, agency REITs have experienced a drop in share price in this sell-off that is out of line with their low credit risk exposure, Schnure said. However, the Fed's decision on March 15 to buy $200 billion of agency MBS will help REITs like Annaly. "The Fed's commitment to buy $200 billion of agency securities provides liquidity and that prevents a fire sale," said Schnure. "That means they're pretty well protected by a Fed backstop right now."
Looking back to the 2008-09 market crash, agency mortgage REITs were the only major sector that invests in MBS to weather the crisis without government support, said Schnure. "That tells you something," he said. During the crisis, Annaly posted returns of 30.7% in 2007, -12.7% in 2008, 9.3% in 2009, and 3.3% in 2010.
An attractive time for the business model
The company held a call on March 16 to update investors and analysts on its status and to introduce new CEO David Finkelstein. He has been with the company since 2013 and since 2016 has been CIO, a position he maintains after taking on the new leadership role.
Elevated volatility and prepayment concerns have had an impact on agency REITs, said Finkelstein on the call. When rates drop so low and so sharply, many consumers refinance or prepay their mortgages, which eliminates future interest payments. The REIT modestly reduced its agency positions in January and February and gravitated further down in coupon to offset prepayments, Finkelstein said. In its commercial mortgages, it employs rigid underwriting standards and focuses on defensive industries. It is underweight in retail and hotels and has no direct exposure to energy or travel-related sectors.
But to echo Schnure, Finkelstein added that the liquidity offered to the market by the Fed should "provide a meaningful tailwind to our business. With respect to agency MBS, this is arguably the cheapest the sector has been since the onset." The added liquidity should tighten the spreads between MBS and Treasury yields, which have widened. Also, Finkelstein said a prolonged period with 0% interest rates should be highly supportive of financing markets. "As the dust settles, we expect this to be an incredibly attractive time for our business model," Finkelstein said on the call.
Is Annaly a buy?
Also, on March 16, the company announced plans to keep its quarterly dividend at $0.25 per share. It has a dividend yield of 17.4%, which is higher than the average REIT. The high dividend, along with the extremely low price and the recent Fed actions, should cause the REIT to begin to reverse its decline. Times are so uncertain, it is hard to recommend a buy right now, but keep an eye on trends in agency MBS and consider this REIT a good option if the market starts turning.