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Friday, August 6, 2010

Don't Count NLY Out...

So for today’s blog post I want to talk about Annaly Capital Management which trades on the NYSE under Ticker symbol : NLY. I read and article on CNBC that you can read here. The article talks about Annaly (NLY) from the perspecticve of options traders buying huge numbers of PUTS on the stock. The article states that the stock would have to drop 14% from current levels to make those puts profitable. I don’t see this happening and in fact I think that these options will expire worthless and Annaly will recover.


My reasoning for the recovery of NLY is multifaceted. To start with one has to understand Annaly’s business model. What Annaly does in simple terms is it is a REIT that borrows money at a low interest rate from the FED and buys packaged mortgages. Whoa…they are buying mortgages and you think they will be fine are you nuts? I do have confidence they will be fine because here is the deal. Harry homeowner goes to the bank to get a mortgage and is placed in to the Fannie/ Freddie system. These mortgages are all then bundled up and sold out to the government. The government who is not really supposed to be in the home mortgage business turns to the street to bundle up said mortgages and sell them as a package. It gets better, as the government then adds a 100% payment guarantee. This means that even if Harry Homeowner defaults the mortgage still gets paid by the full faith and credit of Uncle Sam. These are the very same mortgage bundles that Annaly buys.



So we have a company, Annaly, that is borrowing at low rates and buying higher paying mortgages that have no possibility of default and distributing the dividends as pass thru to qualify as a REIT, which seems like a no lose proposition to me. Add to this the fact that the recent pullback in the share prices has brought the stock down to book value makes it very attractive. Moreover, the yield on the stock at this time is in the neighborhood of 15% has been rather consistent and beats many investments out there; especially when you consider that much of the risk is absorbed by the US Government, 75% of their book of business. Recently, Annaly has filed to offer 60 million new shares with another 9 million of over allotment and this has caused concerns of dilution. This concern in my opinion is unfounded as the proceeds are going to be used to increase the size of the portfolio of Mortgage backed securities, therefore I believe it will be accretive for Annaly in the near term not dilutive.



So my impression is that the bearish sentiment put to Annaly is unfounded and it has also reached a level in price and valuation which is very attractive. The fact that so many options players are bearish speaks volumes to the downside potential of this stock being limited, instead all the easy money has been made and the risk is to the upside. The biggest risk to Annaly in my opinion would be rising short term rates controlled by the FED, so one has to ask oneself is that is a true risk in the foreseeable future. The other risk is that 25% of their book of business is outside the government guarantee model, but thus far they have managed that very well and I believe they will continue to do so. In this sea of uncertainty Annaly looks more like a life raft than an anchor. Personally I believe that one could buy this stock up to the $18 level and wait out the storm collecting dividends along the way.




This is not a recommendation to purchase or sell Annaly shares, but instead information and perspective for you to do your own due diligence. Disclosure I am long Annaly for the very reasons I have specified in this post.



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Roger Vertes said...

I do trade the posts and If I have a position I disclose it. I do currently have a position I in NLY and am holding it due to the low interest environment and the fact that its PEG ratio is still very low. NLY will continue to pay handsome dividends and I believe that rates will stay low so at some point other yield hungry investors will discover it and push the price up which will diminish the yield somewhat. If rates begin to rise on the short end of the spectrum i will look to exit the position. Even though NLY has a book value in the $16 range rising rates will cause people to dump. Of course the way things look currently rates are not going higher for the foreseeable future at least not on the short end. In the meantime I am happy collecting my 15% to wait and see what transpires.

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