What happened
While the housing market boomed in 2020, last year saw uncertainty grow about whether it could maintain its momentum and worries about the Federal Reserve raising interest rates caused the mortgage market to sag a little.
Although Annaly Capital Management (NLY 1.69%) does not originate mortgages -- rather only buying and selling those backed by the full faith and credit of the federal government and packaged from Fannie Mae, Freddie Mac, and Ginnie Mae -- its stock still weakened in 2021 because of the concerns, falling 7.5% for the year, according to data provided by S&P Global Market Intelligence.
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So what
Rising interest rates can hurt mortgage real estate investment trusts' (REITs) profits because they use current low interest rates to borrow money to buy assets (primarily mortgage-backed securities) that will produce high-margin returns in the future. When looking at their financial reports, you'll see net interest spread and net spread, which are the difference between the interest rate they earn on their assets and the rates they pay on their borrowings. The higher the better.
In its last quarterly earnings report, Annaly's net interest spread was 1.97%, up from 1.62% sequentially, though it was down a bit from the 2.03% it realized in the prior year.
Another important metric for investors to watch is the constant prepayment rate, or CPR, which shows the percentage of the portfolio that the company expects to be paid off within a year. Here, lower is better because a loan that's paid off doesn't produce interest for its holder, which can lead to lower rates of return.
Mortgage REITs like Annaly need to juggle these two competing metrics. Because low-rate environments encourage homeowners to refinance while rising-rate environments raise costs and eat into profits, they're constantly seeking a "Goldilocks" situation (but never really achieving it) where the housing market is just right.
Now what
While the Federal Reserve has indicated as many as three interest rate hikes could be on the calendar in 2022, Goldman Sachs has suggested there could be as many as four with the first coming as soon as March.
Runaway inflation due to massive government spending programs and easy-money Fed policies are now a priority, and the Fed has committed to tapering its bond buying program to rein in rising prices.
That is typically seen as a negative environment for Annaly, but the mortgage REIT has successfully navigated through periods like this in the past. Considering its stock is trading at just 10 times earnings and pays a dividend that yields over 11% annually, the REIT may be a bargain to buy.
