I remember I’m here not because of the road in front of me but because of the road behind me.
Source: Morpheus on the eventual sale of his mortgage REIT
Annaly Capital Management (New York Stock Exchange:NYSE: NLY) Got Add to the midcap index and celebrate the news with a reverse split. The stock remains a popular income option, and one we generally avoid. We pick up where our reporting left off and weigh in on the unusually poor returns of the past decade. We also tell you why 2023 could be the toughest test yet for this mortgage REIT.
What do you ask income investors to do?
Over the past decade, NLY’s total dividend reinvested return has been 19.37%, or less than 2% per year.
Of course, this claim is questioned by those who simply “like” the “fat bonus”. If you’re investing for income, you’re obviously not reinvesting dividends. If you’re consuming dividends, you’re actually doing worse, with a 10-year total return of 4.5%, or less than a 0.45% CAGR.
The point here is that a lot of shareholders have those shares in taxable accounts, and then when you do the accounts for Uncle Sam, your total return is going to be pretty bad.
Why do you earn so little?
You can’t squeeze blood from a stone. Mortgage REITs can only make money from tangible assets. Most sophisticated investors know this, and they scoff at the idea of chasing dividend streams without paying attention to tangible book value. While price, tangible book value, and dividends per share can deviate from each other, they are plump companions on longer time horizons.
So guess where that light blue line will point?
Over the past 12 months, we have seen a significant decline in NLY’s book value.
NLY has also increased leverage, which is essentially selling less assets than would be necessary to maintain constant leverage. This is a useful exercise for investors who should start with a book value of $8.37 and leverage of 5.8x. This equates to approximately $56.92 in total assets per share, supported by equity capital of $8.37 per share. If you drop that equity to $5.90, your economic leverage rises to 8.64x. So you sell assets to reduce leverage and that’s what NLY does. But they stopped quite a distance before the original lever mark. In the case of NLY, there was also a secondary equity offering, allowing them to hold a larger portfolio.
Amid all this turmoil, spreads have been relatively unaffected. NLY’s hedge book, which locks in low interest rates when things are good, helps a lot in this regard. That hedge book is rolling, and interest rates are rising with it.
Funding costs will be quite different in 2023, and we’ll likely see significant spread compression as we move into the second quarter of 2023.
NLY still has a few months in 2022 and could be tested on mortgage-backed securities, or MBS, to spread the blowout. But the real test will come in 2023, as the yield curve inverts and its short-term hedges are used up or repriced higher.
We expect NLY to struggle to make money in 2023 based on the forward curve and could implement a new dividend of about 15 cents per share in Q2 or Q3. Under the impending reverse split, that would be 60 cents per share.
NLY has the following dividend safety ratings on our proprietary Kenny Loggins scale.
A “Call Kenny Loggins” rating implies a 90%+ chance of a dividend cut within 12 months. This is of course our forecast and has nothing to do with NLY’s current commentary.
Over the next 12 months, NLY’s common stock is likely to become another value trap, as it has been for the past decade. Of course, investors can trade these deals and maybe make money.
Still, all other things being equal, you’ll make more money from the longs, in stocks that are sloping up rather than stocks that are sloping down.
Source: Razor for mining value
Keep this in mind if you decide to trade NLY.
NLY’s preferred stocks are another matter, and they tend to present opportunities from time to time to income seekers who care about total returns. NLY currently has three excellent classes.
1) Annaly Capital Management, Inc. 6.95% PFD SER F (New York Stock Exchange:NYSE: NLY.PF).
2) Annaly Capital Management, Inc. 6.50% PFD SER G (New York Stock Exchange:NYSE: NLY.PG)
3) Annaly Capital Management, Inc. 6.75% PFD SER I (New York Stock Exchange:NYSE: NLY.PI)
NLY.PF is the most interesting as it is floating at LIBOR +4.993% at the end of the month, which should bring its yield closer to 8.5% soon. It’s a big leap forward for coupons, so it’s likely that NLY will try to redeem it. This could be a safety issue as an aggressive Fed will guarantee the man’s redemption. AGNC Investment Corp. (AGNC) recently offered new preferred stock, and NLY may also try to tap the market.
NLY.PG floats with a slightly smaller LIBOR spread (+4.172%) at the end of March 2023. We think this is a reasonably priced issue at the moment, and NLY wouldn’t call it that.
NLY.PI call date June 2024, LIBOR + 4.989% yield on float. We think this is the most expensive issue relative to the options available. We previously described two preferred issues, one from Dynex Capital, Inc. (DX) and the other from PennyMac Mortgage Investment Trust (PMT). We consider both problems to be superior to this one.
Note that this is not financial advice. It might look and sound like it, but surprisingly, it’s not. Investors should conduct their own due diligence and consult with professionals who understand their objectives and limitations.