THIS IS NOT INVESTMENT ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN
No one likes days like today (unless you short), but such days do help focus. A review of the the portfolio this afternoon reveals the wonder that is Annaly (NLY). This is a mortgage REIT which purchases residential mortgage backed securities (MBS), not mortgages, payments on which are GUARANTEED by Fannie Mae, Freddie Mac or Ginny Mae. This results in a AAA rated portfolio of income producing assets which are virtually immune from default. NLY profits from the spread between the rates received from the MBS in its portfolio and the cost of short term borrowing it uses to purchase same. As you can imagine, this time of low interest rates has resulted in a very low cost of capital. NLY's primary risk (in addition to a rise in borrowing rates) is early prepayment of above market rate mortgages included in the MBS. The worst case scenario for NLY is the purchase of a portfolio of MBS supported by 6% mortgages only to have those mortgages refinanced at 4.5%. NLY not only loses the 6% payment stream but is faced with replacing it with one at only 4.5% thus compressing the spread and lowering profits. Indeed, when I first purchased NLY in May, the pundits were predicting a substantial reduction in profitability precisely because they believed that all above market mortgages would be refinanced. Guess what. It has not happened because the new loan standards are so strict that many do not qualify for refinancing and in addition many homes do not appraise. Add to this the foreclosure moratorium (which stops Fannie and Freddie from foreclosing but not from paying on the guarantee to NLY) and you have a perfect storm of continued profitability for NLY. Oh, and did I mention that it pays a pass through (not qualified for 15% tax treatment) dividend of 15% and that it actually gained ground today.
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