2023-10-26 09:45:53 ET
Summary
- Annaly Capital Management reported fiscal 2023 third quarter book value per share of $18.25, a 12% decline from the second quarter.
- The commons are now trading hands at a 17% discount, but with earnings available for distribution that dipped 6 cents from the second quarter.
- A 98.5% payout ratio implies a possible near-term dividend cut as the macroeconomic environment entered an even more marked period of volatility in the fourth quarter.
Annaly Capital Overview
Real estate investment trusts, or REITs, have been fighting the Fed for the last two years. Investors across all tranches in the space, from equity to mortgage, office to multifamily, and investment grade rated to junk rated, all are now nursing material losses over the last year. The situation has been deteriorating since the Fed's September 2023 Federal Open Market Committee meeting, when they encapsulated the higher for longer mantra.
The market has now moved to heavily reprice REITs lower on the back of the possibility of the Fed fund's rate remaining elevated for an extended period. Annaly Capital Management, Inc. ( NLY ) stock is down around 27% since 20 September, when the Fed met, with the current pullback now looking for a currently non-existent floor as new macro-level risks arise to compound the disruption that REITs have realized over the last two years.
Annaly reported turbulent fiscal 2023 third quarter earnings , with book value per share of $18.25 falling by $2.48 sequentially from $20.73 in the second quarter. The 12% decline reflects continued interest rate headwinds, but also means the commons are trading at a 17% discount to book value. The mortgage REIT, or mREIT, last declared a quarterly cash dividend of $0.65 per share , unchanged from its previous distribution for what currently works out to be a 17.3% annualized forward dividend yield. Hence, NLY shareholders are being compensated heavily with a dividend yield that sits amongst the highest levels offered by Annaly in a decade.
Third Quarter Book Value And Earnings Available For Distribution
The current discount to book value is important because it represents potential upside to be captured on a normalization of a turbulent macro backdrop. Annaly is highly invested in assets that are extremely sensitive to interest rates and the broader economy. These range from agency mortgage backed securities, or MBS, which formed 90% of its $76.2 billion total portfolio at the end of the third quarter, to residential credit, which formed 7% of the portfolio, and mortgage servicing rights, which formed the remaining 3%. For some context, MBS are built from the pooling together of a large number of individual mortgage loans. Agency MBS are safer than non-agency MBS in that they're guaranteed by government-sponsored enterprises like Freddie Mac, Ginnie Mae, or Fannie Mae.
GAAP net income was negative at $1.21 per share , a deterioration from a profit of $0.27 per share in the second quarter with Annaly bringing in earnings available for distribution of $0.66 per share, down around 6 cents from the second quarter. This was with its annualized GAAP return on equity coming in at a loss of 20.18% versus a gain of 5.42% in the second quarter. The decline in book value represents the most marked setback, as it is a movement that drives the direction of the stock price and the mREIT's earnings base.
Macro Headwinds As World Faces Its Most Dangerous Time In Decades
EAD covered the dividend by just 102%, or a roughly 98.5% payout ratio. Annaly has had to right-size its quarterly distribution a few times since 2020, and another cut could be on the line, especially as the fourth quarter has ignited intense volatility with 10-year US Treasury yields (US10Y) momentarily breaking above 5% for the first time since 2007 and with U.S. mortgage rates currently at a more than two decade high at 7.63% . Some market participants expect a possible near-term breach of 8%. This comes as U.S. home prices continue to move up, climbing 5% year-over-year to $380,000 in August on the back of a shortage of inventory. To be clear, mortgage rates have been volatile post-period end, the type of movement that disrupts the balance Annaly has to navigate between yields across its portfolio segments and cost of funds.
Annaly's net interest margin excluding PAA came in at 1.48% during the third quarter, an 18 basis points decline from the second quarter even with its average yield on interest earning assets rising 24 basis points over the same time frame. NLY is a ticker meant to be held long term and should perform better in a declining rate environment where both EAD and book value would benefit from a declining cost of funds. Economic cost of funds jumped 51 basis points to 3.28% from 2.77% in the second quarter.
The Annaly mREIT will continue to fight the Fed until inflation comes back to the 2% target. Critically, the third quarter earnings need to be contextualized against what JPMorgan's ( JPM ) Jamie Dimon described as the most dangerous period faced by the world in decades. The 4% decrease in Annaly's Agency portfolio during the third quarter might continue through the fourth quarter, and the current dividend coverage from flagging EAD makes for an uncomfortable earnings result. Like investors in other REITs, positive numbers from the upcoming CPI inflation prints now form near-term salvos against a hostile macroeconomic backdrop. Annaly Capital Management, Inc. stock remains a hold for the fat yield, albeit with a distribution that's at risk.
For further details see:
Annaly Capital: Fight The Fed With A Fat 17.3% Yield