Please ensure Javascript is enabled for purposes of website accessibility

Here's What Annaly Capital Could Do With the $2.3 Billion It Just Raised

By Brent Nyitray, CFA - Apr 5, 2021 at 8:49AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The government just created an opportunity for this mortgage real estate investment trust.

One of the most vexing challenges for the U.S. government since the 2008-09 Great Recession has been to rebuild the mortgage finance system. During the crisis, Fannie Mae and Freddie Mac were rescued by the government, which took a 79% stake in the companies. Since then, almost all of the mortgages originated in the U.S. have been backed by the U.S. taxpayer.

The government recently took a step in the direction of reducing its footprint by limiting guarantees for investment properties. What does this mean for Annaly Capital (NLY 2.88%), a mortgage real estate investment trust (REIT)? 

Mortgage loan document, a set of house keys, and a calculator

Image source: Getty Images.

Annaly sells its commercial mortgage portfolio

Annaly Capital recently announced that it had reached an agreement to sell its commercial mortgage operations to investment firm Slate Asset Management for $2.3 billion. This will include equity investments, loans, and commercial mortgage-backed securities. Annaly will redeploy that capital back into residential and corporate assets. This transaction is somewhat perfectly timed, given the change in government policy. 

The government wants to limit its guarantee of investment property loans

In the waning days of the Trump administration, Treasury Secretary Steven Mnuchin issued a letter to the Federal Housing Finance Agency (the conservator for Fannie Mae and Freddie Mac) directing it to limit the number of second homes and investment properties the government insures to 7% of the portfolio. This created a reaction in the mortgage markets that made these loans harder to get, and a lot more expensive. Rates increased about 0.75% in general for these types of loans. 

Investment property loans have been profitable in the past

According to the Urban Institute, these loans were insanely profitable for Fannie Mae and Freddie Mac, even before the increase in rates. Originators who still want to do these loans are looking for a new outlet. Mortgage REITs like Annaly will be the perfect buyers. Investment property loans generally require a borrower to put up a 25% down payment and have a strong credit score. Professional real estate investors aren't likely to walk away from a property when they have that much equity invested, so these loans are pretty strong credits. 

Second, the directive to Fannie Mae and Freddie Mac could easily be removed with the stroke of Treasury Secretary Janet Yellen's pen. The Treasury could simply instruct FHFA to remove the restrictions and nothing will change. If Annaly had a portfolio of these loans, they would reap a windfall gain as these loans suddenly become more valuable given that they can now be guaranteed by the government. So mortgage REITs like Annaly get a great risk-adjusted return if nothing changes, and a windfall if they do. 

The goal is to reduce the government's footprint in the mortgage market

Ultimately, the government hopes that this move will restart the private-label mortgage-backed securities market, which vanished during the financial crisis. It is generally a bipartisan consensus that the taxpayer shouldn't bear almost all of the credit risk in the U.S. mortgage market, and certainly not for investment properties or vacation homes. If the directive gets any pushback in Washington, it will be to the other limits on high-risk loans (in other words, low credit score and low down payment loans) that are often targeted to the first-time homebuyer. 

The mortgage REIT sector generally doesn't like bond market volatility, and the last year has been nothing but volatile. That said, a new asset class of mortgages (loans that conform to government guidelines but are not insured by the government) is developing, which should provide an attractive risk/return combination for the sector. Annaly trades with a double-digit dividend yield, just below book value. Income investors should take a look. Annaly is one of my CAPS picks.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Annaly Capital Management, Inc. Stock Quote
Annaly Capital Management, Inc.
NLY
$6.08 (2.88%) $0.17

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
316%
 
S&P 500 Returns
112%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/03/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.