What happened
Annaly Capital Management (NLY 0.55%) endured a rocky February as its stock price plummeted 11.9%, according to S&P Global Market Intelligence.
The mortgage real estate investment trust (REIT) underperformed the S&P 500, which was down 3.2% in February, and the Nasdaq Composite, which was off 3.4%. Annaly Capital is down roughly 10% year to date in 2022 as of March 7, the same as the S&P 500.
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So what
Annaly Capital is a mortgage REIT, which means it doesn't own properties. Instead, it invests in mortgages and mortgage-backed securities and makes money on the interest. The majority of Annaly's portfolio is in agency mortgage-backed securities (MBS), which are mortgages backed by the federal government.
Fourth-quarter earnings came out on Feb. 9, and they showed a 20% year-over-year decline in net interest income to $361 million, while net interest margin shrank to 1.93% from 2.10% in the fourth quarter of 2020.
Annaly also saw a significant drop in book value per share. It fell to $7.97 in the fourth quarter, down from $8.39 in the third quarter and $8.92 in the fourth quarter of 2020. The book value per share, which is the overall value of the assets on the books, was hurt by lower MBS prices.
This occurred in part due to the Federal Reserve winding down its purchases of MBS, which it did after the pandemic hit. Meanwhile, spreads relative to U.S. Treasuries are widening as Treasury yields rise on the expectation of interest rate hikes.
Now what
Mortgage REITs are very sensitive to interest rate fluctuations. In fact, they typically don't do as well in a rising interest-rate environment. That's because most of the mortgages already on their books are fixed rates, so they don't benefit from the higher interest rates. In addition, now they will have to pay higher interest rates to borrow money to fund their operations. The result is shrinking profit margins, which in turn could impact the stock price, not to mention the dividend.
Annaly Capital has, however, taken steps to reduce the impact of rising rates in a couple of ways. One is by deleveraging, or reducing its debt and borrowing. "We have substantial liquidity with $9.3 billion of unencumbered assets, up $500 million year over year," CEO David Finkelstein said on the fourth-quarter earnings call.
Another is by decreasing its portfolio of agency MBS and increasing its investments in non-agency MBS, which typically pay higher interest rates.
