2023-10-26 11:32:44 ET
Summary
- Annaly Capital Management, Inc. common equity dropped by over $1.2 billion in Q3 2023.
- Earnings available for distribution dropped 6 cents from the previous quarter and are now down 40 cents from last year's high.
- We tell you why we are upgrading this one.
It seems like an eternity since the last time we penned a piece on Annaly Capital Management, Inc. ( NLY ). But it was in reality, just two weeks back.
NLY stock has lost a sixth of its value since then and also released its Q3 results . That combinations is what leads us to write this update.
Q3 2023
One aspect that investors fail to realize when looking at some of these real estate investment trusts ("REITs") is that they are really, really leveraged. It is always helpful to just see the sheer movement in equity and compare that to the giant debt load that is outstanding. Here we see that common equity dropped by over $1.2 billion in a quarter. That amount is about 1.5% of the total liabilities outstanding.
The key highlights for the quarter were once again on the way interest margins kept getting crushed. Earnings available for distribution, or EADS as the company likes to call it, dropped 6 cents from the previous quarter and is now down 40 cents from last year's high of $1.06.
The traditional net interest margin went further into negative territory at negative 0.20%. The line which quotes "Net Interest Margin (excluding PAA)" is one the that more closely approximates with NLY's assessment of EADS, and that dropped from 1.66% to 1.48%. In general, despite hedges, earning yields went up at a slower pace than cost on liabilities.
Outlook
There are two big factors weighing on the NLY stock price. The first is the deterioration in tangible book value. Despite the chronic chorus that "this is best time to own mortgage backed securities," the market values the stock on tangible book value. A long-term chart will show that the price and dividends are closely tied to that value. We saw the deterioration during Q3 2023 and the further drop-off after Q3 2023.
Bose George
Can I get an update for book value quarter-to-date?
David Finkelstein
Sure, Bose. So I have as of Tuesday evening, which was off 11% for the quarter. So we're still trading well below book value.
Source: TIKR.
The second aspect is the volatility on the interest rate side. Below, we have shown the MOVE index (shown in blue below), which is the volatility index of the bond market, alongside NLY stock price. We can see the COVID-19 price drop corresponding with the MOVE spike. In 2021, NLY topped out as bond market volatility picked up.
While some analysis of mortgage REITs, or mREITs, focuses on the earning potential at high mortgage backed security ("MBS") yields, one must keep in mind that they cannot earn those returns risk-free. There is a hedging cost, and that hedging cost is very dependent on volatility of the underlying assets. As long as that volatility remains high, NLY will struggle to generate economic returns. We will add here that as long as the Federal Reserve engages in quantitative tightening and unloads Treasuries mortgage backed securities off its balance sheet, the MOVE index is likely to remain high.
That all said, there are still three reasons we are upgrading today.
1) Bears Are Pressing Their Luck
The damage to book value and to the stock price look like they are in the rearview mirror, at least in the short term. One measure we like is the ratio of the price relative to 200 day moving average. NLY trades 24% below it as of October 25, 2023 close. This is a crash, and there is no other way to frame it.
Over the last 25 years, NLY has had few sustained periods that deep below its 200-day moving average. Could it go lower? Sure it can. But that is not a point at which bears press their luck. You can refuse to buy, but to actually put a sell rating here is risky.
2) Favorable Seasonality
November and December are generally positive months for the stock market, and the third year of the presidential cycle is even more so. We did hit extreme fear levels and likely will do so again before we make a bottom, but again, it is risky to push sell ratings here.
3) Above-Average Performance
Relative to the book value destruction we saw at AGNC Investment Corp. ( AGNC ), NLY has done a solid job. Yes, this might be equivalent to an exercise of comparing gravity on two different planets (how fast these stocks can fall in essence). But relative tangible book value preservation, both during the quarter and post it, and a slightly stronger EADS than what we expected, are good markers for us to dial down the hostility.
Verdict
We are moving this to a "hold" and think bears will struggle to gain traction here. The longer-term Annaly Capital Management, Inc. story remains the same: extremely poor returns whether or not you consume or reinvest your dividends.
That story for those consuming the dividends gets really bad (and really negative) when you factor in the taxes on the income. We would look at the Annaly Capital Management, Inc. preferred shares for those that are interested in relatively safer income choices.
1) Annaly Capital Management, Inc. 6.95% PFD SER F (NYSE: NLY.PR.F ) currently floating .
2) Annaly Capital Management, Inc. 6.50% PFD SER G (NYSE: NLY.PR.G ) currently floating .
3) Annaly Capital Management, Inc. 6.75% PFD SER I (NYSE: NLY.PR.I ) will start floating at the end of June 2024 at 3 month LIBOR plus 4.989%. NLY is using SOFR for calculations on all three and we appreciate their clarity on the situation.
For further details see:
Annaly Capital Q3: Crash Is King (Rating Upgrade)