Annaly's Book Value Likely To Continue Increasing In The Third Quarter

• Annaly just reported Q2 results, and it increased its book value by about 7.5% due to gains in agency-backed RMBSs.
• Annaly reduced its hedging and slightly increased leverage in anticipation of strong agency-backed RMBS performance. The strength continues into Q3, which means the strategy should continue to benefit Annaly.
• Annaly's valuation has underperformed government debt ETFs so far in Q3, despite being leveraged to the rates moving those ETFs up, indicating Annaly's equity needs to catch up.

Last week, Annaly Capital Management Inc. (NYSE:NLY) filed its report for the second quarter of 2014. Annaly reported core earnings of $300.4 million, or $0.30 per share, while book value increased to $13.23 per share from $12.30. This $0.93 book value increase is about 7.5 percent, or over three times the dividend Annaly paid out in the quarter. The mREIT is now priced at around a 13 percent discount to this stated book value at the end of the second quarter, with it appearing likely that book value increased further so far in the third quarter.

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Annaly Completes Acquisition of CreXus, Making Annaly a Hybrid mREIT

Annaly Capital Management, Inc. (NYSE: NLY) (“Annaly”) has completed its acquisition of CreXus Investment Corp. (NYSE: CXS) (“CreXus”). Annaly’s commercial real estate business will be operated under the name Annaly Commercial Real Estate Group. This acquisition now makes Annaly a hybrid REIT. Annaly was formerly the poster-child for the agency only mREIT model.

Annaly acquired CreXus pursuant to an Agreement and Plan of Merger dated January 30, 2013. As a result of the merger and related transactions, the New York Stock Exchange terminated trading in CreXus shares following the close of trading on May 23, 2013. In accordance with that agreement, CreXus was merged with a newly formed CreXus subsidiary in a transaction in which Annaly became the sole stockholder of CreXus and the persons who owned CreXus common stock immediately before the merger became entitled to receive cash equal to $13.05206 for each share of CreXus common stock that they owned immediately prior to the merger.

American Capital Agency's Unamortized Net Premium Prepayment Risk Finally Kicks In

Last week, American Capital Agency Corp. (AGNC), the second-largest mortgage real estate investment trust, or mREIT, declined after reporting first quarter earnings that included an 8.6 percent drop in its book value at the end of Q1 of 2012 compared to the end Q4 of 2012. The mREIT's book value declined by $2.71 to $28.93 per share. This is the second consecutive quarter where AGNC's book value declined after increasing substantially in mid-2012. See a recent book value performance chart for AGNC.

AGNC's President and Chief Investment Officer, Gary Kain, noted during the company's conference call that the securities that it acquired in order to protect itself from refinancing and prepayment risk performed "considerably worse than we anticipated." In the second quarter of 2012, Kain noted that AGNC had "repositioned the portfolio during the quarter into lower coupon MBS and lower loan balance and HARP securities, which are less susceptible to prepayment risk, reducing the impact of the decline in long-term interest rates on the Company's prepayment forecast." 

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Annaly, Chimera And CreXus May Soon Combine Into One Diversified Mortgage REIT

Annaly Capital Management Inc. recently agreed to purchase the shares of CreXus Investment Corp. (CXS) it doesn't already own for about $872 million, valuing the company at $996 million. Annaly owns 12.4 percent of CreXus and the commercial mREIT is managed by FIDAC, a wholly-owned subsidiary of Annaly. Chimera is similarly managed by FIDAC and Annaly has a similar ownership interest in it. Crexus was to continue pursuing other deals until March 16, so it should update the public on the status of Annaly's bid this week.

Also, last week Chimera Investment Corp. (CIM) filed its 2011 10-K annual report. The mortgage REIT had not filed any reports in several quarters, and in February, the New York Stock Exchange (NYSE) gave the company a third and final extension for continued listing and trading of the company's stock on its exchange. Chimera is yet to file any results for 2012, but is expected to do so within the next two months. After those reports are filed, and provided Annaly successfully acquires CreXus, a bid for Chimera appears of ever growing probability.

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American Capital Agency's Issues Another Secondary: 1st of 2013 (2 in 2012 & 4 in 2011)

Last week, American Capital Agency Corp. (AGNC) announced and priced a secondary stock offering of 50 million shares. The offering should raise about $1.58 billion, before expenses. Additionally, the Company granted the underwriters an option for 30 days to acquire up to an additional 7.5 millions shares, which they will likely do. The offering is expected to close on March 5, 2013.

Last year, AGNC had two secondary stock offerings, and the company had four in 2011. These secondaries have helped AGNC balloon in size. It is now the second largest publicly traded mREIT, and after this secondary is completed it will have a market valuation of around $12.3 billion, making it around ten percent smaller than Annaly Capital Management (NLY), the largest mREIT. If AGNC continues to issue secondaries and/or outperforms Annaly from here, it may become the largest mREIT some time this year.

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Annaly's Prepayment Pressure Continues And A Dividend Cut Is Likely, But Its Plan Is Compelling

Last week, Annaly Capital Management (NLY)

reported GAAP net income for the fourth quarter of 2012 of $700.5 million or $0.70 per share, compared to $445.6 million or $0.46 per share for the same quarter the prior year, and $224.8 million or $0.22 per average common share for Q3 of 2012. The Company also reported that it had a book value of $15.85 per share at the end of 2012.

Without the effect of the unrealized gains and losses on agency backed interest-only residential mortgage-backed securities ("RMBSs"), interest rate swaps and the extinguishing of some convertible senior notes, net income was $465.1 million or $0.46 per share, compared to $525.3 million or $0.54 per share for Q4 of 2011, and $449.8 million or $0.45 for Q3 of 2012.

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Annaly Furthers Its Pursuit Of Crexus And Its Commercial Paper

On Januray 31, Annaly Capital Management Inc. (NLY), the largest mortgage real estate investment trust, or mREIT, reported that it agreed to purchase the rest of Crexus Investment Corp. (CXS) for about $872 million. Annaly already owns 12.4 percent of Crexus and will pay $13 per share in cash for the remaining stock, valuing the company at $996 million. The terms of the agreement allow Crexus to pursue alternatives to the deal though March 16, and Crexus has indicated that a special committee and independent advisers will "actively solicit" other options.

In November, Annaly bid $12.50 a share for CXS, a commercial mREIT as part of Annaly's new plan to broaden its business in the wake of Federal Reserve purchases of government-backed residential mortgage debt, which have caused agency security yields to decline and prepayment rates to increase. 

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Is It Time To Start Accumulating Agency Mortgage REITs?

Agency mortgage REITs were some of the best performing investments during the first half of 2012. Their strength then was largely based on the corresponding strength of the dollar and U.S. Treasuries. More recently, though, the asset class has fallen on hard times due to mounting concerns, including decreasing spreads, rising prepayments and probable dividend cuts, not to mention the rapidly approaching fiscal cliff. These increased risks and the uncertainty that now clouds the market have caused most agency mREITs to decline substantially over the last few weeks. Although these declines may continue, these agency mREITs appear considerably more attractive investments than they have been for several quarters.

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Annaly Breaks The Agency Mortgage REIT Mold In Search Of Spread

On November 12, Annaly Capital Management (NLY), the largest mortgage REIT, announced that it plans to buy Crexus Investment Corp (CXS). Annaly is an agency mREIT that usually buys residential mortgage-backed securities that are guaranteed by government-sponsored agency entities such as Fannie Mae and Freddie Mac. Crexus is a commercial mREIT in which Annaly already holds an over 12 percent interest and it is managed by FIDAC, a wholly owned subsidiary of Annaly.

Annaly announced the bid for Crexus as part of a change to its strategy in response to continued Federal Reserve purchases of government-backed residential debt. The addition of Crexus's holdings would mean NLY will no longer be an agency-only mREIT, but instead some sort of hybrid mREIT. Annaly normally buys not only residential paper, but residential paper with an agency backing, so CXS's commercial mortgage paper is rather different. Wellington Denahan, Annaly chairman and CEO, commented that:

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Agency Mortgage REITs Decline As The Debt Ceiling Approaches

Recently most agency mREITs have been declining, as prepayments rise and the debt ceiling approaches. See the below one and three-month charts of the performance of some of the largest agency mREITs, American Capital Agency Corp. (AGNC), Annaly Capital Management, Inc. (NLY) and CYS Investments (CYS), as well as two popular mortgage REIT Index ETFs. iShares FTSE NAREIT Mortgage REITs Index ETF (REM) and the Market Vectors Mortgage REIT Income ETF (MORT). Both ETFs also hold non-agency and commercial mortgage REIT exposure.

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See the 1-month comparison chart:

American Capital Agency's Q3 Results: Decreased Leverage and Lower Prepayments, And A New $500 Million Repurchase Plan

On Monday, October 29, American Capital Agency Corp. (AGNC) reported Q3 income of $1.3 billion or $3.98 per share, and net book value of $32.49 per share. On a per share basis, this is an increase to book value of $3.08 per share, from the last reported book value of $29.41 at the end of Q2. AGNC's estimated taxable EPS for Q3 was $1.36, a $0.26 decline from Q2.

AGNC's actual constant prepayment rate during the third quarter was 9%, a decrease from 10% during both the first and second quarters of 2012. Most of AGNC's peer agency mREITs sustained far higher CPRs during the first half of 2012, indicating that AGNC has been competently managing its portfolio in order to mitigate both its leverage and prepayment risks.

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See a chart of AGNC's book value per quarter:

Annaly's Announces A $1.5 Billion Share Repurchase Plan

On Tuesday, after the markets closed, Annaly Capital Management (NLY) announced plans to repurchase up to $1.5 billion of its outstanding common shares over a 12-month period. 

This is a noticeably different and quite contrary move compared to the standard serial secondary stock offerings made by most mortgage REITs. The news is likely to immediately benefit Annaly's shares, as there is a new buyer in town.

During the last few quarters, as interest rates declined, most mortgage REITs have noticed declining spreads and rising prepayment rates. This makes it difficult for an mREIT to maintain its dividend, or it forces the management to buy riskier securities and/or institute higher leverage rates in order to increase profits. Such endeavors generally substitute one risk for another.

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Recent Accelerating Prepayments Are Likely To Affect Agency Mortgage REITs

Mortgage prepayment rates have risen to their highest level since before the subprime crash as homeowners continue to refinance while borrowing costs hover at or near historic lows. According to a report by Lender Processing Services, prepayments are at their highest rate since 2005. At the rate domestic mortgages were paid in August, the entirety of U.S. home loan debt would be rewritten or paid off in about four years.

The cost of a 30-year loan fell to 3.4 percent last week, after the Federal Reserve announced it would buy $40 billion worth of mortgage securities per month in an effort to stimulate the economy. Lower rates will influence borrowers to refinance, and some mortgage holders that refinanced in the last two years are likely again refinancing if they have the credit and terms to do so. Prepayment speeds are also affected by retiring mortgages through existing home sales as well as borrower default.

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Fed Buying Should Benefit Agency RMBSs, Increase Mortgage REIT Prepayments And Spur New Secondaries

Last week, Ben Bernanke announced that the Federal Reserve would increase its holdings by adding open-ended purchases of $40 billion in mortgage debt. While the statement does clearly indicate that the Federal Reserve has concluded that the U.S. economy is not doing well on its own, the move quickly resulted in increased equity valuations.

In the past, each time that the Federal Reserve announced quantitative easing or an extension of its low rate policy, it has been beneficial to agency mortgage REITs. Generally speaking, this announcement should also be mostly beneficial for residential mortgage-backed securities and mREIT valuations, because the increased buying of RMBSs by the Federal Reserve should help support and even increase asset valuations.

The U.S. Treasury yield curve has steepened over the past three months. See a comparison of the present Treasury yield curve compared to the yield curve just last month.

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American Capital Agency Maintains A $1.25 Dividend For Q3

After the United States equity markets closed on Sept. 11, American Capital Agency Corp (AGNC) reported that it will maintain its quarterly dividend at $1.25 per share for the third quarter of 2012. The dividend is payable on October 26, 2012 to shareholders of record as of September 21, 2012, with an ex-dividend date of September 19, 2012, or next Wednesday.

Investors will be pleased to hear that the dividend was maintained, as dividend cuts have proliferated throughout the asset class over the last year. AGNC has maintained this rate for the last three quarters, after paying $1.40 for 10 consecutive quarters.

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U.S. Treasury Further Modifies Fannie, Freddie Backing

On Friday, August 17, the United States Treasury Department announced that it is changing the terms of its financial backing for Fannie Mae  and Freddie Mac. The new terms will accelerate reducing the holdings of the two agency mortgage companies, and will require the companies to pay the government any quarterly profits they earn. Prior to this new system, Fannie and Freddie were paying a 10% quarterly dividend payment to the U.S. Treasury.

The Treasury also added that Fannie and Freddie's massive mortgage portfolios shall be wound down at an annual rate of 15%, up from the prior rate of ten percent. This will hasten the plan to reduce each agency's portfolio to $250 billion in assets by four years, to 2018. This maneuver should be beneficial for mortgage originators, homebuilders and government debt in the near to mid-term, as it will delay more substantial reform of the two giant government-seized firms. This change in policy is likely at least partially designed to promote China's continued purchasing of U.S. Treasury bonds and agency issued residential mortgage backed securities.

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American Capital Agency Reports Strong Q2 Results With Reduced Leverage Risk

On Thursday, August 2, American Capital Agency Corp. (AGNC) reported earnings for the second quarter of 2012. The mortgage REIT reported comprehensive income of $480 million, or $1.58 per share, and a net loss of $261 million, or $0.88 per share. American Capital Agency also reported that its net book value per share totaled $29.41 at the end of the second quarter, an increase of $0.35 from the end of Q1.

At the start of 2012, AGNC lowered its dividend from $1.40 to $1.25 per share, after maintaining the prior payout for 10 quarters. Shortly after AGNC went ex-dividend during Q1, the company instituted a large secondary offering that it used to acquire more agency RMBSs. Since then, the value of most RMBS paper has appreciated and provided income, and AGNC shares have performed exceedingly well. Shares have appreciated by 24.79%, or $6.96, since the start of 2012, and provided an additional $2.50 in dividends.

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Annaly Beats Estimates, Excluding Unrealized Losses, As Spreads Continue To Narrow

On Wednesday, August 1, after the markets closed, Annaly Financial (NLY), the largest publicly traded mortgage REIT, reported its results for the second quarter of 2012. Excluding unrealized losses on interest rate swaps and agency interest-only mortgage-backed securities, net income for the quarter was $546.2 million, or $0.55 per share, compared to $587.5 million, or $0.71 per share, for the second quarter of 2011 and $529.3 million, or $0.54 per share, for the first quarter of 2012. These results are one penny better than average Wall Street estimates.

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American Capital Agency Announces A Large Secondary Offering

On Tuesday, July 17, after the markets closed, American Capital Agency Corp (AGNC) announced a large secondary offering. The REIT also released some Q2 2012 pre-earnings information in order to help support the issuance. This secondary offering is likely to bring in approximately $1.2 billion, depending upon pricing and over-allotments, before commissions and fees.

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Annaly Maintains Its 55-Cent Quarterly Dividend For Q2

On Tuesday, June 19, after the markets closed, Annaly Capital Management (NLY) reported that it will pay a Q2 2012 common stock dividend of $0.55 per share. This is in line with Annaly's dividend for the first quarter of 2012, but ten cents below its Q2 2011 dividend. The dividend is payable July 26, to shareholders of record on June 29, with an ex-dividend date of June 27.

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