NLY - Annaly Capital Management

[rayfinkle]

has anyone thought about how these guys do in a steady rising rate environment?

 

They seem well managed. But I’m trying to think through in a rising environment where spreads generally widen how they would preform.

 

My initial cut suggests that so long as yields don’t change in an unexpected rapid fashion the can manage their portfolio.  But still in early days of thinking on this.

[walkie518]

has anyone thought about how these guys do in a steady rising rate environment?

 

They seem well managed. But I’m trying to think through in a rising environment where spreads generally widen how they would preform.

 

My initial cut suggests that so long as yields don’t change in an unexpected rapid fashion the can manage their portfolio.  But still in early days of thinking on this.

 

have been watching for a while along with Chimera...difference historically being that CIM is non-agency and NLY is agency

 

that said, even though mgmt has reduced debt, NLY carries a lot of leverage so even if the paper doesn't lose money in the longer-term, book value can erode as rates rise, which might beget selling

 

at $10.xx, however, it seems like risk/reward might be anticipating higher rates than where the stock might be trading?

 

 

[rayfinkle]

Thanks @ walkie518-

 

Just to make sure I'm following, can you confirm that this is the logic:

1. Their mark-to-market book value is sensitive to rising rates

2. If rates rise in a way that is either a) unexpected, or b) occurs faster than expected then management may not be able to manage the book with ample speed

3. if [2] occurs, BV likely decreases (though cash flow characteristics of the book are unchanged)

 

So, we'd expect:

-The stock to go down (assuming no change in P / BV)

-The yield to go up (based on [3] above)

 

Is this right?

 

 

 

has anyone thought about how these guys do in a steady rising rate environment?

 

They seem well managed. But I’m trying to think through in a rising environment where spreads generally widen how they would preform.

 

My initial cut suggests that so long as yields don’t change in an unexpected rapid fashion the can manage their portfolio.  But still in early days of thinking on this.

 

have been watching for a while along with Chimera...difference historically being that CIM is non-agency and NLY is agency

 

that said, even though mgmt has reduced debt, NLY carries a lot of leverage so even if the paper doesn't lose money in the longer-term, book value can erode as rates rise, which might beget selling

 

at $10.xx, however, it seems like risk/reward might be anticipating higher rates than where the stock might be trading?

[walkie518]

Thanks @ walkie518-

 

Just to make sure I'm following, can you confirm that this is the logic:

1. Their mark-to-market book value is sensitive to rising rates

2. If rates rise in a way that is either a) unexpected, or b) occurs faster than expected then management may not be able to manage the book with ample speed

3. if [2] occurs, BV likely decreases (though cash flow characteristics of the book are unchanged)

 

So, we'd expect:

-The stock to go down (assuming no change in P / BV)

-The yield to go up (based on [3] above)

 

Is this right?

 

 

 

has anyone thought about how these guys do in a steady rising rate environment?

 

They seem well managed. But I’m trying to think through in a rising environment where spreads generally widen how they would preform.

 

My initial cut suggests that so long as yields don’t change in an unexpected rapid fashion the can manage their portfolio.  But still in early days of thinking on this.

 

have been watching for a while along with Chimera...difference historically being that CIM is non-agency and NLY is agency

 

that said, even though mgmt has reduced debt, NLY carries a lot of leverage so even if the paper doesn't lose money in the longer-term, book value can erode as rates rise, which might beget selling

 

at $10.xx, however, it seems like risk/reward might be anticipating higher rates than where the stock might be trading?

 

NLY marks the bonds at fair value

 

and in theory, if you own a bond and the face value falls, the yield on the bond will rise

 

if you own a portfolio of bonds that have been pledged and the loan proceeds are used to buy more bonds then the price of those bonds fall and you have a margin call, you will end up selling more bonds as prices fall to satisfy lenders

 

I don't have a position, but I would argue that there is material risk unless you think rates rise more slowly than the market expects or management is better at predicting rises of rates than the market; in either case, I think this is a very tough call

[tede02]

I've owned NLY for about 10 years and have worried about rising rates the entire period. My position is relatively small. It's been a while but several years ago I read the annual reports and reviewed the financials for the 2004-2006 period when rates were rising. It was worth reading and the firm successfully navigated that period. I'll probably circle back to it. I can't remember which year but the founder of NLY, Mike Farrell (died of cancer a number of years ago), wrote presciently about the housing market and credit bubble in one of those reports (2004-2006). Reading it was mind-blowing in hindsight.

 

I don't know where the firm is precisely at this moment but management had been hedging for rising rates in recent years.

 

One reason I've maintained ownership of this position is just to keep an eye on management and learn from them. The annual reports are interesting to read and the company has been incredibly successful.  However, one thing I don't particularly like is, with the company's success, the organization has become a lot more complex. If you look at the first annual reports from the late 90s, if my memory serves me right, they started with around $100 million in capital and the balance sheet was super simple. Vastly more complicated today.

 

With the dividend being so rich since the crisis, at various times I've looked into taking a big position and hedging it out with options. But the option cost has never made it a viable approach.

[SnarkyPuppy]

Does anyone have any specific thoughts on the recent moves?  Seems to be clearly liquidity related.

 

Although these guys are levered up the wazoo (7.7x leverage it looks like), why should Agency MBS trade for anything less than book?

 

I'm having trouble fully understanding how to discount book specifically for the negative convexity of agency mbs (generally, when rates go down bonds go up - but for mortgage securities such as agency mbs as rates continue to go down, bond prices increase at a reduced rate). 

 

Does anyone have any simple frameworks for valuing the book here? 

 

Quite simply - book value is roughly ~$8.21 today with 94% of the book in agency mbs and it is unclear why a book of agency MBS should trade at such a sizable discount. 

[TwoCitiesCapital]

Does anyone have any specific thoughts on the recent moves?  Seems to be clearly liquidity related.

 

Although these guys are levered up the wazoo (7.7x leverage it looks like), why should Agency MBS trade for anything less than book?

 

I'm having trouble fully understanding how to discount book specifically for the negative convexity of agency mbs (generally, when rates go down bonds go up - but for mortgage securities such as agency mbs as rates continue to go down, bond prices increase at a reduced rate). 

 

Does anyone have any simple frameworks for valuing the book here? 

 

Quite simply - book value is roughly ~$8.21 today with 94% of the book in agency mbs and it is unclear why a book of agency MBS should trade at such a sizable discount.

 

The discounts didn't even approach this level in 2008. It's absurd and I was burned by owning them going into this.

 

Have sold all of my cash position and have replaced with LEAPs for more shares b/c this is going to rectify itself in the next 24-months and I'm not going to care about missing the dividend when the stock jumps 75-100% as mortgage spreads and NAV premium/discount normalizes.

 

Same thoughts on AGNC.

[rayfinkle]

twocities- how are you thinking about strike and duration

[TwoCitiesCapital]

twocities- how are you thinking about strike and duration

 

My LEAPS expire Jan of 2022. Probably, won't need that amount of time, but I'm more comfortable having it. My current strikes are $3 for NLY and $5 for AGNC. That being said, I did most of the exchange from shares to options the other day when they were down 30-40%.

 

It may be more worthwhile to do higher higher strikes at this point, but was also trying to hedge my bets that this may get a lot worse before it gets better.

[SnarkyPuppy]

Does anyone have any specific thoughts on the recent moves?  Seems to be clearly liquidity related.

 

Although these guys are levered up the wazoo (7.7x leverage it looks like), why should Agency MBS trade for anything less than book?

 

I'm having trouble fully understanding how to discount book specifically for the negative convexity of agency mbs (generally, when rates go down bonds go up - but for mortgage securities such as agency mbs as rates continue to go down, bond prices increase at a reduced rate). 

 

Does anyone have any simple frameworks for valuing the book here? 

 

Quite simply - book value is roughly ~$8.21 today with 94% of the book in agency mbs and it is unclear why a book of agency MBS should trade at such a sizable discount.

 

The discounts didn't even approach this level in 2008. It's absurd and I was burned by owning them going into this.

 

Have sold all of my cash position and have replaced with LEAPs for more shares b/c this is going to rectify itself in the next 24-months and I'm not going to care about missing the dividend when the stock jumps 75-100% as mortgage spreads and NAV premium/discount normalizes.

 

Same thoughts on AGNC.

 

Why do you think the market is mispricing this? 

 

I'm concerned about movements in fair value from prepayments on a book that is levered 7.7x.  Obviously the government will ensure timely payments on the bonds but isn't there some significant risk if FV deteriorates from prepayments?   

 

At 7.7x leverage, book value (fair value of the bonds) goes to 0 if you see just an 11% reduction in fair value.

 

[TwoCitiesCapital]

Does anyone have any specific thoughts on the recent moves?  Seems to be clearly liquidity related.

 

Although these guys are levered up the wazoo (7.7x leverage it looks like), why should Agency MBS trade for anything less than book?

 

I'm having trouble fully understanding how to discount book specifically for the negative convexity of agency mbs (generally, when rates go down bonds go up - but for mortgage securities such as agency mbs as rates continue to go down, bond prices increase at a reduced rate). 

 

Does anyone have any simple frameworks for valuing the book here? 

 

Quite simply - book value is roughly ~$8.21 today with 94% of the book in agency mbs and it is unclear why a book of agency MBS should trade at such a sizable discount.

 

The discounts didn't even approach this level in 2008. It's absurd and I was burned by owning them going into this.

 

Have sold all of my cash position and have replaced with LEAPs for more shares b/c this is going to rectify itself in the next 24-months and I'm not going to care about missing the dividend when the stock jumps 75-100% as mortgage spreads and NAV premium/discount normalizes.

 

Same thoughts on AGNC.

 

Why do you think the market is mispricing this? 

 

I'm concerned about movements in fair value from prepayments on a book that is levered 7.7x.  Obviously the government will ensure timely payments on the bonds but isn't there some significant risk if FV deteriorates from prepayments?   

 

At 7.7x leverage, book value (fair value of the bonds) goes to 0 if you see just an 11% reduction in fair value.

 

Prepayments have been in line with expectations so far even with the massive wave last 2 weeks.

 

Both companies were moving lower in coupon stack as rates moved lower so will be less impacted by prepayments AND if you haven't checked, mortgage spreads have blown out to the widest they've been to the 10-year treasury in awhile. 10-days ago or so you could refinance @ 3.125%. Now rates are 3.5% or higher and the financing rates on that leverage has come down dramatically with the rate cuts. Borrow. Close to zero and collect close to 3.5%.

 

Also, the good thing about everyone blowing the refinancing load early is people who refinanced at 3.1-3.5% probably don't refinance again until below 2.5% so it protects them in the event of lower rates (which I think is a fairly likely outcome).

 

I would like to see leverage come down a hair as coupons come in - maybe back to something like 5-6x, but I haven't seen anything to concern me. At the peak of the mania last week, NLY's book value was down like 6% even with massively wide mortgage spreads and 7x leverage.

[TwoCitiesCapital]

Also, I'd add these guys weathered 2008/2009 just fine too. Hell, even better because they never went to 50-60% of NAV during that period.

 

If a mortgage/credit related crisis didn't impair them, I don't imagine this will be much worse for them.

[ERICOPOLY]

RWT also made it through 2009 and they are getting pounded even more right now.  Is the common thread between these two the short-term funding of their leverage?

 

 

[Kaegi2011]

Not familiar with this name / space.  For folks more experienced in the space - did anyone blow up during the GFC? 

 

Is the model basically to raise short/medium term funding to buy fannie/freddie MBS with some sort of prepayment hedge overlay?  Like, basically the equity component of a structured vehicle (CLO/CDO/etc.)?

[Spekulatius]

RWT also made it through 2009 and they are getting pounded even more right now.  Is the common thread between these two the short-term funding of their leverage?

 

It’s a spread business. It’s hard to hedge duration when duration can drastically change. Also, the leverage works against them when there are issued with MBS valuation, even if short term. I think some mortgage funds did. blow up and had to raise capital in 3008 but I don’t recall details.

[HJ]

 

I would like to see leverage come down a hair as coupons come in - maybe back to something like 5-6x, but I haven't seen anything to concern me. At the peak of the mania last week, NLY's book value was down like 6% even with massively wide mortgage spreads and 7x leverage.

 

Can you elaborate on how you estimate that their book value was down 6%? 

[Jurgis]

I think some mortgage funds did. blow up and had to raise capital in 3008 but I don’t recall details.

 

988 years in the future and they are still blowing up. Nobody learns from history... /shakes head

[TwoCitiesCapital]

 

I would like to see leverage come down a hair as coupons come in - maybe back to something like 5-6x, but I haven't seen anything to concern me. At the peak of the mania last week, NLY's book value was down like 6% even with massively wide mortgage spreads and 7x leverage.

 

Can you elaborate on how you estimate that their book value was down 6%?

 

They announced it in a press release.

[TwoCitiesCapital]

Not familiar with this name / space.  For folks more experienced in the space - did anyone blow up during the GFC? 

 

Is the model basically to raise short/medium term funding to buy fannie/freddie MBS with some sort of prepayment hedge overlay?  Like, basically the equity component of a structured vehicle (CLO/CDO/etc.)?

 

Yes.

 

Worst case scenario is that they can't get roll funding (not happening yet). If that happens, they liquidate a portion of the portfolio at roughly NAV. The downside is that shrinks the earnings basis for lower dividends in the future. The positive is that it would force the recognition of market values near NAV and shrink leverage/fear going forward.

 

These are primarily agency MBS. They're backed by Fannie/Freddie (currently wards of the US govt) and generally highly liquid.

 

Maybe other mREITS blew up in 2098/2009. NLY did not. Not did AGNC. Depending on where you start and stop your observation, these guys were actually massively positive during parts of that crisis because their funding rates dropped near-to-zero.

 

 

[Jurgis]

I took a look at this.

It is more complicated than Fannie/Freddie MBS. The "other" segment is pretty small, but it is significant because they are very levered. If there is a 50% haircut on the non-GSE assets, equity goes down 50% too.

 

Relevant table "Financial condition" page 65

https://www.sec.gov/ix?doc=/Archives/edgar/data/1043219/000162828020001548/a2019nly10-k.htm

 

It's quite possible that you all will make a killing assuming management can handle the "other" segment.

I think it's too hard pile for me.

 

Best.

[aglittell]

NLY & AGNC were the two pure-agency MBS mREITs operating before the GFC. Most if not all mREITs that took credit risk blew up. I own NLY, but their expansion into non-agency MBS, CRE, and MML make this much less of a sure-thing this time around. However, with a yield north of 20% on today's pricing, a steeper curve and somewhat functioning repo markets, the equity is attractive.

[TwoCitiesCapital]

I took a look at this.

It is more complicated than Fannie/Freddie MBS. The "other" segment is pretty small, but it is significant because they are very levered. If there is a 50% haircut on the non-GSE assets, equity goes down 50% too.

 

Relevant table "Financial condition" page 65

https://www.sec.gov/ix?doc=/Archives/edgar/data/1043219/000162828020001548/a2019nly10-k.htm

 

It's quite possible that you all will make a killing assuming management can handle the "other" segment.

I think it's too hard pile for me.

 

Best.

 

More like a 50% reduction in now GSE assets would lead to 25% decline n book, no? Levered 7:1 and only 7% of the book is non-agency?

 

Also, high yield isn't even down anywhere near 50% yet so not very concerned about the potential for a 50% drop in non-agency debt just yet.

 

 

[Jurgis]

I took a look at this.

It is more complicated than Fannie/Freddie MBS. The "other" segment is pretty small, but it is significant because they are very levered. If there is a 50% haircut on the non-GSE assets, equity goes down 50% too.

 

Relevant table "Financial condition" page 65

https://www.sec.gov/ix?doc=/Archives/edgar/data/1043219/000162828020001548/a2019nly10-k.htm

 

It's quite possible that you all will make a killing assuming management can handle the "other" segment.

I think it's too hard pile for me.

 

Best.

 

More like a 50% reduction in now GSE assets would lead to 25% decline n book, no? Levered 7:1 and only 7% of the book is non-agency?

 

There's ~12B of non-GSE assets and the book is ~14.6B. But sure not all non-GSE assets are the same.

[fareastwarriors]

What do you guys think of the preferred?

"safer" place to find yield?

[dcollon]

I would spend time paying attention to the Repo markets.  If they are functioning with any kind of a curve, NLY will likely make it to the other side of the valley.