Nov 29 Annaly Capital Management Inc
pioneered the mortgage REIT business in late 1990s, and became
an instant hit with investors who enjoyed generous dividend
Now its business model, and those big dividends, are under
threat from the Federal Reserve's latest round of bond buying,
forcing the company to diversify by making an $840 million bid
for the remainder of CreXus Investment Corp.
And with its cash hoard of $2.26 billion it may not stop
there, analysts said.
Annaly typically borrows short term at low rates and buys
mortgage-backed securities (MBS) guaranteed by agencies such as
Fannie Mae and Freddie Mac that make up more than 90 percent of
However, the third round of quantitative easing initiated by
the Fed in September to mop up $40 billion of agency mortgage
backed securities every month is flattening the yield curve,
compressing the company's interest rate spreads.
"What has been the best dividend game in the town is getting
squeezed," Stifel Nicolaus analyst Michael Widner said.
The decision to buy the 88 percent of CreXus that it does
not already own is an acknowledgment by Annaly that it needs
other lines of business to create attractive risk-adjusted
returns, FBR analyst Gabe Poggi said in a note to clients.
CreXus invests mainly in commercial mortgage loans and
commercial mortgage-backed securities.
"The company's proposed acquisition of CXS is an admittance
by NLY that its current agency MBS model cannot work in the
current environment from a risk/reward perspective," Poggi said.
Annaly shares, trading at a three-year low, have fallen
about 17 percent since Sept. 13, when the Fed announced its
decision to buy mortgage-backed securities.
Annaly's strategy to diversify into other asset classes and
its steadily falling investment income may make the stock less
attractive to investors.
The company, which has a $130 billion agency mortgage-backed
securities (MBS) portfolio, plans to allocate up to 25 percent
of shareholders' equity to other assets.
Of 20 analysts covering the stock, 11 rate it a hold, five
have a buy or strong buy, and the rest rate it a sell or strong
sell, according to Thomson Reuters Starmine.
"In terms of returns or economic returns or core income,
they face material pressures, and their earnings and dividends
are coming down further," Macquarie Capital analyst Jasper Burch
Annaly reported core-spread earnings, excluding one-time
gains from MBS sales, of 30 cents per share in the third
quarter, well below the 50-cent dividend it paid.
The company's interest rate spread, its key profit driver,
fell by a whopping 52 basis point to 1.02 percent from the prior
quarter and its net interest income shrank nearly 20 percent.
The annualized dividend yield on Annaly's stock for the
quarter ended Sept. 30 was 11.88 percent, based on the closing
price of $16.84, compared with 14.43 percent, a year earlier.
CHIMERA A POSSIBLE TARGET
"The active involvement of policymakers in the mortgage
market, particularly the Federal Reserve's latest, open-ended,
large-scale asset purchase program, has introduced unique
challenges for all investors," CEO Wellington Denahan-Norris
said in the company's earnings release on Nov. 5.
Annaly has a market value of about $14.4 billion, well ahead
of its closest rival, American Capital Agency Corp,
which has a market capitalization of about $10.8 billion.
As Annaly seeks to diversify, some analysts think Chimera
Investment Corp, in which Annaly already owns a 4.4
percent stake, could be its next target.
"The easiest asset class for them is residential, non-agency
RMBS (residential mortgage-backed securities) and their next
target could be Chimera Investment Corp, which is
similar to CreXus but harder to acquire as the former has
regulatory issues," Macquarie's Burch said.
Chimera, which has a market value of about $2.7 billion, is
externally managed by Annaly unit Fixed Income Discount Advisory
Company (FIDAC), a unit of Annaly.
However, Chimera is still working through the toxic assets
it accumulated during the sub-prime boom and is in the process
of restating its results for the last four years.
The company faces delisting from the New York Stock Exchange
if it does not file its restated results before a Jan. 15
"The issue right now for Chimera is that they have not
published signed off financials in almost a year," said Stifel
"So they certainly need to get the accounting issues
straightened out at Chimera first and if they get that done then
(a bid is) a possibility."