Annaly Capital’s book value is shaken by the Fed
JLast year was terrible for the mortgage real estate investment trusts (REITs) in general. The Federal Reserve has been buying mortgage-backed securities since the early days of the COVID-19 pandemic, which has helped bolster the book value of these companies. These policies are about to be reversed and mortgage REITs like Annaly Capital (NYSE: NLY) saw their book values depressed before the changes.
The Federal Reserve shifts from a tailwind to a headwind
The Federal Reserve has signaled that it is about to begin reducing the size of its balance sheet and will look towards selling mortgage-backed securities to achieve this. Annaly Capital is one of the big buyers of agency mortgage-backed (in other words, government-backed) securities, which are similar to Fed holdings.
The Fed’s plan in the past has been to let its bond holdings mature, which will gradually reduce the balance over time. This time around, the Fed may choose to sell some of its stakes in the market. The first option would be preferable for mortgage REITs as no additional selling pressure will be added to the market. Uncertainty around the Fed’s plans weighed on mortgage-backed securities valuations in the first quarter of 2022, and Annaly’s holdings of agency mortgage-backed securities fell quite dramatically.
Annaly’s book value per share fell 15%
As of March 31, Annaly Capital reported book value had fallen to $6.77 per share from $7.97 at the end of 2021. This is a 15% drop, which is a lot for that the book value of a mortgage REIT changes in a quarter. The decline in book value per share was primarily driven by mortgage-backed securities which underperformed Treasuries.
Annaly CEO David Finkelstein said in the press release that the environment was “one of the most challenging for fixed income in decades.” Not only have rates increased, but the volatility of rates (in other words, the speed and distance at which they move) has also increased. Volatility is also bad for mortgage-backed securities, so Annaly suffered a double whammy.
Mortgage servicing rights helped offset some of the losses
On the positive side, the decline in mortgage-backed securities was offset by the company’s holdings of mortgage servicing rights, which is an esoteric asset whose value rises as rates rise. A mortgage agent handles the administrative duties of a mortgage – things like collecting monthly payments, making sure property taxes are paid, and dealing with defaulting borrowers.
The repairer receives a commission of 0.25% (or a quarter of one percent) of the outstanding balance of the loan. When rates rise, borrowers are unlikely to refinance, so the manager can expect to collect these fees for a longer period. Mortgage management assets are extremely popular right now and valuations are high.
It’s hard to like mortgage REITs in this environment just because the Fed is such a threat to them. That said, the whole sector has been under pressure for a year, and Annaly has fallen 28% since May 2021.
The dividend is covered…for now
Annaly said earnings available for distribution were $0.28 per share, meaning the $0.22 dividend is covered. At current levels, that gives the stock a yield of nearly 14%, which is hard to beat in this interest rate environment. The fact that the dividend remains well covered should reassure investors. For intrepid income investors, Annaly might be worth a look, but she will be subject to volatility thanks to Fed and economic data.
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