2023-03-29 03:33:15 ET
Summary
- The Preferred Stock Sector Sold Off Hard In Recent Banking Scare.
- Floating Rate Securities Have Benefitted As Fed Hiked Rates.
- NLY pfdF Has Quietly Reset To Over 10% Coupon.
Buy NLY Preferred Series F To Win Whether It's Called Or Just Stays Around A While
Annaly Capital Management ( NLY ) is the largest and best-known mortgage REIT out there. Its business is mostly about levering up its capital to buy GSE mortgages and attempt to hedge out both interest rates risk and prepayment risk and still generate a positive return to pay out large dividends. These mortgage REITs (mREITs) are poorly understood in terms of the risks and rewards but it's worth noting that if one bought NLY at IPO in 1997 and held thru today, you have generated a 625% return or 8 1/8% annualized. If you had bought the S&P 500 instead on same date, you have generated a 550% return on your investment or 7 5/8% annualized. Some might argue NLY should be compared to banks so looking at the premier bank in USA ( JPM ), we see if you bought that on same date, your total return is +533% or 7 ½% annualized. Yes, NLY track record is stellar and it's also a great example of the wealth you can create by compounding in high dividend stocks.
NLY creates its capital by issuing both common stock and preferred stock (pfds) from time to time when its shares are trading very strong and/or mortgage spreads are very wide (i.e., cheap). I’m not going to get into the metrics of what preferred stocks are or the merits of NLY as a company. There are many articles on Seeking Alpha discussing both.
Within the world of mortgage REIT pfds, most are now issued with a fixed coupon for 4-5-6yrs and then it reverts to floating rate at a spread over 3mo Libor along with being callable on or after the conversion date. The floating rate conversion is attractive to many because Libor floaters tend to trade around PAR thus buyers don’t worry about buying a security that might have 50yrs to legal maturity when it's going to price around PAR once it converts to floating in just a few years or it gets called which is usually what happens. In fact there are only a handful of mREIT pfds in existence that have flipped from fixed rate to floating rate and the NLY pfd F is one of them.
NLY-F was issued in July 2017. Was a 7% coupon fixed until 8/30/2022 when it first reset to +499.3bps over 3mo Libor for an 8.062570 coupon. Its issue price was $25 (pretty standard for pfds) and it spent much of its time between $25 and $26 ½ in first few years with rates so low back then. Just today, we got the next reset announced and the new coupon is 10.13614% per Bloomberg. One would expect NLY management would call the issue given it has two other issues outstanding (the series I and G with 6.75% and 6.5% coupons trading over $22) but these are not normal times in pfd stocks which are mostly issued by banks which as most people know has been a very bad sector lately. PFF is the big pfd stock ETF and its down about 10% since bank crisis started which has dragged down virtually all pfd stocks.
This is where it gets interesting. NLY-F was trading up near $25 ½ before banks plunged recently and had a 9+% coupon at the time. This equated to about a 3% yield-to-call which the markets assumed might be coming. With the sell-off in virtually every single publicly traded pfd since banks crashed, NLY-F is now in mid-$23’s. At today’s close of $23.66, the yield to call is now 90% (to 4/27/23 call date) and the current yield on the new coupon is 10.7%. Both are absurdly high vs NLY history but strange things happen when you have a banking scare.
So, will it get called anytime soon? I doubt it as the CEO in recent Q4 earnings call was asked by a Street analyst about calling the issue and his response was they could make more money buying GSE bonds than they could save calling the issue. It's also worth noting the dividend yield on the common is 13 ¾% thus they would net-net lose money issuing more common shares to pay for the pfd call.
So, what does this all mean? My suspicion is it means NLY-F is going to be around a lot longer than many would think and will have a huge coupon on it as long as Libor is over 4% and if Jay Powell is telling the truth and The Fed holds rates up where they are until inflation is back to 2%, we could see this issue carry a 10+% coupon for years to come. Of course, if they do choose to call it, it’s a windfall given its trading at a discount to PAR. Really, its win-win either way.
My view is the current bank situation is calming down already and as it does, their pfd stocks will rebound. I believe with all the noise in the markets lately, few have even noticed that this pfd issue is trading at cheapest levels ever seen in NLY’s 25yr existence except a few days in 2007-2008 and at start of COVID scare for a few days. I think it will grind back up to $25 ½ and that even there it won’t get called unless GSE mortgage spreads have tightened a ton and/or NLY stock is closer to $25 where they could justify issue a secondary to call the pfdF. Meanwhile, enjoy the 10 ¾% yield waiting.
For further details see:
Annaly Capital: Buy Preferred Series F To Benefit If It's Called Or Sticks Around For A While