Annaly Capital Management, Inc. (NLY)

Bathwater, baby, bar of soap, rubber ducky. Check. It's all in there.

They seem to have managed their portfolio and financing pretty well, but any company using leverage to buy mortgage securities should be a thrill ride in the near future.

I'm heartened by the recent dividend increase. With the recent price plunge, the yield is roughly 11%.

There is an old saying . . .

The more complex the poker game -- the more it advantages the experts.

Consider the following:

NLY gives you the opportunity to invest in a leveraged portfolio of MBS that might be underpriced in the market. Their borrowing costs have dropped substantially in recent months whilst the credit quality of their MBS portfolio has increased due to actions taken by the US Treasury. I view the credit quality of their portfolio as being that of callable treasuries and not of traditional Agency MBS. I don’t believe the market is pricing the portfolio risk appropriately. Furthermore, the Company for tax purposes is a REIT, but holds a basket of assets that is quite different from other REITs. However, NLY is viewed generally by the market as a REIT, which allows for a buying opportunity at these levels. One should note that given the lumping of NLY with other REITs, the vicissitudes of the market may move the share price up and down with a less than desired correlation with NLY fundamentals.

A new buyer -- the most credible buyer in the entire world (The Fed) has said that they will buy about 10% of the exact asset class that NLY owns in the next few months. Because they managed their leverage and risk exposure correctly, NLY now has a substantial opportunity to lever up their portfolio in an environment where their risk parameters have dropped substantially.

There are some other factors...

1. The mortgage space is out of favor currently and poorly understood by many – unfortunately some of these folks include those in the mortgage industry

2. NLY management’s track record conveys an understanding of market dynamics over a long period of time and market conditions. Management’s decision making has historically limited portfolio & capital risk. My confidence in the management team is a leading rational for making an investment in NLY and I believe a competitive advantage for the Company

3. Investors have upside exposure to a sector of the mortgage market that has been totally decimated and will recover some day: non Agency investment grade MBS (CIM)

4. There is growth potential at NLY via recent acquisitions and their FIDAC subsidiary

5. There is strong potential for dividend growth at NLY as their lever up their portfolio

6. NLY is the best in class in the mREIT sector according to sources such as Barron’s and James Grant

7. mREITs are a tax advantaged asset class

8. Company’s recent $0.50 dividend announcement validates that they are weathering the storm and poised for future growth

Its time to make some $$$ on the right side for once. Look at their history and the incredible crop in 2005. I predict this will happen within the next 2 - 3 weeks. I have loaded up on big PUTS$$$$$$$

One of Fortune mag's top picks for this year. The worry with this company was involved with Fannie failing. With Fannie under the governments wing now, and a low Fed rate, NLY should be set well into 2009.

Picking NLY is in keeping with a new strategy I'm using for CAPs which should mimic a double down in my real portfolio. The idea is, when a stock drops 30% from my pick price, I immediately close it out and then repick it. While I lock in the inaccuracy of my original pick, a move back to the original pick price results in a 43% return to offset the 30% loss, giving me a net gain of 13%. Of course this approach is employed only for stocks of which I would buy more at the lower price. If there is something materially wrong with the story which caused the price dive in the first place, I'll merely close the pick and not re-up.

As for NLY specifically, the market is in enormous turmoil right now with the Bear Stearns fiasco and any business remotely related to MBSs and CDOs and the rest of the alphabet soup. All are likely to be punished. NLY is one of the best run mREITs and this lower price simply locks in a larger dividend yield. Once the market comes to its senses, NLY should continue to perform quite well in an environment of dropping interest rates. Once the rates begin to go up again - which I suspect they will later in the year - watch for a good exit price.

It's a conservatively well run Reit. Top management. The time is ripe for this issue. I have held this issue for years and equate it to a

cash deposit in a quality bank but paying somewhat more interest.

Say in excess of 10 %. I think that will drive the stock into the mid 20's.

Potential zero.

I am cautious about including this, as they may do well. BUT - if there is any sort of haircut put on Freddie and Fannie debt, they're done. Absolutely done.

Instantaneous bankrupt done.

The math is simple - they lever up and buy GSE paper using borrowed funds and their (small) amount of capital.

Nice business, provided nothing happens to that paper.

Instantaneous explosion if something does.

Now here's the issue - Freddie and Fannie's book has 10% of its value (~530 billion between them) in liar loans of various sorts - I/Os, stated income, Option ARMs and Subprime. Why? Because THEY played "hedge fund."

This is why the GSEs WILL blow and why they WILL have to be rescued.

Ok, so what happens if The Fed's new model for that rescue is "tried" on them? You know, the one they talked about today at Jackson Hole? Creditors get a haircut?

Hmmm.... let's see, if the companies go into rundown and the bonds fetch 90 on average, and you're geared 8:1, how much do you lose?

"What is 80% of my money, Alex?"

Oh, and you still have operating expenses to pay, which means you are instantly on the edge of insolvency - if not breathing water.

Yep.

Annaly Capital Management (NLY) is a real estate investment trust (REIT) that owns and manages portfolio of mortgage-backed securities. The company is primarily engaged in the business of investing, on a leveraged basis, in mortgage pass-through certificates, collateralized mortgage obligations and other mortgage-backed securities.

The company generates bulk of its revenue from spread between the interest income on investment securities and the costs of borrowing to finance acquisition of investment securities. During the quarter, short-term and long-term rates were relatively range-bound, which helped the company to stabilize their cost of funds and thereby their asset values. The company has also been able to bounce back, thanks to Federal Reserve, which has remained on hold since mid-2006. Continuing weakness in hosing market and easing of inflationary pressure has provided favorable signal to Fed.

The company strategy to rebalance its portfolio during mid of 2006 has paid off handsomely with yield on average earning assets for fourth quarter 2006 improved to 5.64%, which earned them a valuable 49 basis point spread, a mammoth increase when compared to 9 basis points for same period last year. Moreover, the company has also been able to lower its constant prepayment rates by 1,300 basis points to 15%.

The company through its formidable capital investment policy has ensured strong total assets with at least 75% of it comprising of high-quality mortgage-backed securities and short-term investments. This should enable the company to withstand any diverse nature of economic cycle. Moreover, a stabile interest rate scenario should put Annaly back on winning track in the coming time.

NLY has been unfairly hurt by the negative press surrounding the mortgage market. NLY only buys Freddie and Fannie backed mortgages (rated AAA). The default risk has been transferred to these agencies.

Additionally, the yield curve is steep, allowing NLY to make big profits by borrowing short and lending long. NLY will have a monster year in terms of earnings (I wouldn't be surprised to see a doubling of revenue in 2008). Add to that a double digit dividend yield (which will increase to an off-the-charts level if revenue doubles due to rules governing REITs), and you have the potential for sizzling returns over a 2 - 4 year time period.

The only real negatives I see here are 1) NLY getting unfairly lumped in with sector, and 2) the potential for a doubling of shares available for trading, diluting current investors. These negatives are more than made up for with potential revenue growth and dividend growth.

This stock has excellent management and seems like a great long term investment.
Because of their market position, the government basically forces them to pay out a massive chunk of their income as dividends, hence giving them a fantastic dividend rate in double digits.
The only problem is all their mortages were not assured by the government. Hey, wait a minute, didn't the government just save Freddie and Fannie, keeping them afloat? By ensuring their survival, the government ensures that Annaly Capital Management won't go belly up as well.
So basically we have an almost guaranteed yield in double digits every year, unless the stock price skyrockets, which wouldn't be bad at all.

It dropped from $18 to $13 a half year ago and has started to climb back up it has also increased its dividend payout. I believe the drop was due to the market change not the company it self.

The bulk of NLY's lending comes from US Gov't MBS (Freddie Mac, Fannie Mae and Ginnie Mae). Meaning that they are backed by the full faith and credit of the US. Annaly has a margin of safety built into its lending unlike NFI and NEW. I think Annaly has been unfairly lumped in with the rest of subprime garbage.

This stock has nothing to do with subprime. It has everything to do with the shape of the yield curve, and the market has already priced into this stock about a 100 bps cut in the Fed Funds rate. That means you need a full 1% cut in rates until NLY gets back to its historic multiple and yield.

its all good from here on out... nothing but profits!!

Annaly is a tough one as its profitability is mainly driven by the yield curve. Currently with the yield curve flat there is not much opportunity to make money, however, an expectation of yield curve inversion may help them out as their long book should benefit from a positive mark to market in the short term while their cost of funding gets lower (Annaly short funds itself into longer term mortgage backed securities). They should remain relatively immune to any changing credit cycles as they invest in higher rated MBS, which is fairly insensitive to the credit cycle.

Jim Cramer is checking it out, the fundamentials check out, and the shorted shares are 3 times todays volume and six times daily average volume... sounds like a short squeeze to me!

They profit on the spread - Collecting interest on MBS and financing the purchases with loans (plus capital). Rates (their cost) is expected to remain low while the economy recovers - while they continue to collect on MBS. Also, as the economy recovers, interest rates should increase, but the company should start to shift to higher yielding MBS.

It’s important to know a little something about investing in mortgages before you understand just how truly great Annaly is right now. When you buy a mortgage or invest in a pool of mortgages, which is what Annaly does, you’re basically investing in risk – the risk that the borrower will default on the loan. But there are two kinds of risk you can bet on: interest rate risk, meaning you’re borrowing money to buy mortgages that are backed up by the full faith and credit of the federal government. This is what’s called agency paper, and it doesn’t have a lot of risk. The second kind is credit risk, where you bet on much chancier bonds that are put together by investment houses and mortgage brokers and made up of subprime borrowers with a really high risk of default.

So now all those companies that took on a lot of credit risk are getting killed by subprime – but Annaly is in a perfect position to profit. They avoided buying bonds that could default on account of bad borrowers, only going after the lower-risk mortgages like those issued by Fannie and Freddie. Forty subprime lenders have collapsed, and many more will.

While the share price and dividend of NLY will fluctuate with the interest rate spread, I think it's in a favorable position at this time for a nice capital gain over the next cycle. Whether the Fed continues its pause, raises, or cuts its benchmark rate, the yield curve has already flattened to a point where Annaly will accelerate its increase in profits (which bottomed a little over a year ago). They've increased the div four straight quarters as they've written down and realigned their assets to provide them with the flexibility they need in this rate environment. They're an incredibly well-run, experienced organization.

The kicker for their earnings is their fee-based asset management company, FIDAC.

Look for NLY to continue to increase its dividend every quarter this year, and probably next, eventually returning to about $0.40 - $0.50 and yielding 7 - 10% per quarter by the end of 2008