ANNALY CAPITAL MANAGEMENT NLY
August 09, 2011 - 1:28am EST by
bruno677
2011 2012
Price: 16.34 EPS $0.00 $0.00
Shares Out. (in M): 823 P/E 0.0x 0.0x
Market Cap (in $M): 13,500 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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Description

For background and business model please see chuck307 writeup from Feb 2011
 
Simple business synopsis - NLY is a mortgage reit that borrows a lot of money ($80 bil.) in the repo market to buy long duration (30 year fixed) agency mortgage paper.    Its portfolio is close to $100 bil. and it pays a very high (leverage generated) dividend of over 15% and is carry trade - borrow at repo rates and buy long duration spread paper.
 
So why get long a highly levered carry trade  
 
I am going to focus on the current market turmoil and value dislocations cause by a series of macro events - US government debt downgrade by S&P, equity market fears of repo markets and why one may want to be long the carry trade. 
 
Carry Trade
 
The current market turmoil has cause a flight to safety and US treasuries - the 30 year bond is now sub 4%.  Given the constraints of a political environment that is focused on (at least in political conversations) on fiscal budget balancing and a federal reserve chairman who lives in fear of re-living the great depression on which he is a academic scholar - I don't see any short term risk on the federal reserve increasing the fed funds rate or in away way moving the short end of the curve.  Financial repression of maintaining zero short term interest rates should continue into 2013.  
 
The federal reserve could also implement a QE3 or just extend the duration of its balance sheet out by recycling short term paper that it owns into longer duration to reduce long term rates to act as a stimulus.  
 
The slowing economy, fiscal budget balancing, monetary policy/stimulus all are directing towards a good 2 year environment for the carry trade in my view.  
 
Repo
 
Given this positive backdrop and recent underlying price action (appreciation) of securities in NLY portfolio - NLY stock has traded poor based on fears of repo market/US govt downgrade and very volatile financial markets.
 
The downgrade by S&P of US government credit has only caused a flight to quality to US government bonds.  The repo markets have not seized up as feared by some market participants as federal reserve has ruled that capital requirement for financial institutions it regulates are not impacted by S&P ratings.
 
NLY is 6 to 1 levered - the repo haircut on its bonds is 5% - allowing it to be up to 20 times levered.  NLY has a lot of flexibility to deal with haircut changes even in a 2008 scenario.  Repo rates have been well behaved since the ratings downgrade.
 
There is no fundamental operation risk to NLY business model since the downgrade.  
 
The market turmoil in the last 10 days has create a opportunity to buy NLY at a discount to book value (around $16.50-$17) and collect a nice div stream as markets reprice its risk.  I expect it to trade over 17-18 - a slight premium to book as markets settle over next 5 months into year end.
 
I don't see much near term risk to the carry trade given the weak economic outlook.  I do see a lot of mark to market and short term price swings as this tape settles in and so buying opportunities.  Upside of $1.30 in div and $1-$2 in price appreciation to year end - this is not a long term buy and forget investment.  The main risk is a short term interest rates moving higher - something unlikely in the near term.  Has traded as low at 14 briefly intra-day.  
 
Street research is starting to lay out the case that mortgage reits are oversold and this may get institutional investors interested.   

Catalyst

street research, fear of repo markets functioning going away, book value, dividend/carry 
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    Description

    For background and business model please see chuck307 writeup from Feb 2011
     
    Simple business synopsis - NLY is a mortgage reit that borrows a lot of money ($80 bil.) in the repo market to buy long duration (30 year fixed) agency mortgage paper.    Its portfolio is close to $100 bil. and it pays a very high (leverage generated) dividend of over 15% and is carry trade - borrow at repo rates and buy long duration spread paper.
     
    So why get long a highly levered carry trade  
     
    I am going to focus on the current market turmoil and value dislocations cause by a series of macro events - US government debt downgrade by S&P, equity market fears of repo markets and why one may want to be long the carry trade. 
     
    Carry Trade
     
    The current market turmoil has cause a flight to safety and US treasuries - the 30 year bond is now sub 4%.  Given the constraints of a political environment that is focused on (at least in political conversations) on fiscal budget balancing and a federal reserve chairman who lives in fear of re-living the great depression on which he is a academic scholar - I don't see any short term risk on the federal reserve increasing the fed funds rate or in away way moving the short end of the curve.  Financial repression of maintaining zero short term interest rates should continue into 2013.  
     
    The federal reserve could also implement a QE3 or just extend the duration of its balance sheet out by recycling short term paper that it owns into longer duration to reduce long term rates to act as a stimulus.  
     
    The slowing economy, fiscal budget balancing, monetary policy/stimulus all are directing towards a good 2 year environment for the carry trade in my view.  
     
    Repo
     
    Given this positive backdrop and recent underlying price action (appreciation) of securities in NLY portfolio - NLY stock has traded poor based on fears of repo market/US govt downgrade and very volatile financial markets.
     
    The downgrade by S&P of US government credit has only caused a flight to quality to US government bonds.  The repo markets have not seized up as feared by some market participants as federal reserve has ruled that capital requirement for financial institutions it regulates are not impacted by S&P ratings.
     
    NLY is 6 to 1 levered - the repo haircut on its bonds is 5% - allowing it to be up to 20 times levered.  NLY has a lot of flexibility to deal with haircut changes even in a 2008 scenario.  Repo rates have been well behaved since the ratings downgrade.
     
    There is no fundamental operation risk to NLY business model since the downgrade.  
     
    The market turmoil in the last 10 days has create a opportunity to buy NLY at a discount to book value (around $16.50-$17) and collect a nice div stream as markets reprice its risk.  I expect it to trade over 17-18 - a slight premium to book as markets settle over next 5 months into year end.
     
    I don't see much near term risk to the carry trade given the weak economic outlook.  I do see a lot of mark to market and short term price swings as this tape settles in and so buying opportunities.  Upside of $1.30 in div and $1-$2 in price appreciation to year end - this is not a long term buy and forget investment.  The main risk is a short term interest rates moving higher - something unlikely in the near term.  Has traded as low at 14 briefly intra-day.  
     
    Street research is starting to lay out the case that mortgage reits are oversold and this may get institutional investors interested.   

    Catalyst

    street research, fear of repo markets functioning going away, book value, dividend/carry 

    Messages


    Subjectprepayment risk
    Entry08/09/2011 11:20 AM
    Memberagape1095

    I rated this a 2 because one of the biggest risk - prepayment risk - was not mentioned at all. 

    When an agency-backed mortgage bond defaults, the agency repays the debt holder at par.  Problem is, if the debt holder bought the bond above par, they would lose.

    If housing prices continue to drop, CPR will go up.  The CPR number for NLY's book has jumped from 13% in 2008 to 27% in 2010 and back down in 1H11.  As of 2Q11, NLY has $3 billion of unamortized premium on its book vs an equity base of about $13.9 billion.  I will not be surprised if tangible book value drops by 10% or more due to an increase in CPR.


    SubjectFOMC minutes
    Entry08/09/2011 05:53 PM
    MemberAggie1111
    Today's FOMC statement has virtually removed interest rate risk to NLY through 2013.  With the 10-year at 2.10% NLY is well worth the look

    Subjectcut position in nly
    Entry08/23/2011 10:47 PM
    Memberbruno677
    i have cut my position in nly after the recent price move close to $2 in the last two weeks
     
    the position has been cut by selling calls 
     
    i expect the stock to trade between 17.50-18.50 in the near term 

    Subjectstill following
    Entry05/13/2013 02:22 PM
    Membertyler939
    Is anyone still following this?  If they are, how would you compare this to the other mreits in the space.  It seems overvalued (based solely on book value) compared to its peers to me.
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