Annaly Capital Management Kango and Mango

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Elwin Cole
7 years ago
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1 Annaly Capital Management Kango and Mango

2 Investor Caution!! This is not a real estate pitch And no, we don t have views on property prices on florida beach

3 Now, The Pitch Buy Annaly and potentially short Vanguard REIT Buy Annaly, and potentially short Vanguard REIT etf

5 Glossary of Fixed Income Terminology MBS : pools of mortgage g loans put together by banks Pass through securities: Direct ownership in pool mortgage loans Securitization allows lenders to pool assets together and Securitization allows lenders to pool assets together and split it into shares for sale to investors. It is a way of removing risk from the balance sheet

6 CMOs CMOs are bought and sold between dealers and investors like other debt instruments

7 Standard model: Sequential Pay Average life 1 st tranche : 2-3yrs 2 nd tranche: 5-7yrs 3 rd tranche: 10-12yrs So on.. Lock out period, Window period

8 Others include.. PACs (planned), TACs (targeted) Companion tranche POs lower interest rates are good due to pre-pmt pmt Hedge against pre-payment risk IOs Higher rates are good Hedge against Interest rate risk Floaters & Inverse Floaters Inv.floaters payout returns opposite to interest rates Since pre-pmt is not an option to most homeowners, inv.floaters are not a bad trade..

9 Fixed income securities have prices inversely related to interest rates Interest rates up, MBS prices down Duration: sensitivity s ty of the bond price to interest est rate. Also the weighted average time to maturity. Most fund managers hedge securities by matching duration Repo Market: Party selling a security and repurchasing it at a certain rate Form of short term borrowing in the money market used by most funds, rate based on type of collateral What else..swaps? Exchange fixed rate payment for floating rate, used for hedging

10 REIT Real Estate Investment Trust A corporation that invests in real estate and gets tax benefits but has to then give out at least 90% of NI as dividends At least 75% of their income has to be from At least 75% of their income has to be from rents or mortgage interest

11 High Quality Mortgage securities: Government Agencies Ginnie Mae : govt. national mortgage g association, owned by dept. of housing & urban development GSE : Govt. sponsored entities or federal charters Federal National Mortgage Association (FNMA) - Fannie Maepurchases and securitizes mortgages in order to ensure that funds are consistently available to the institutions that lend money to home buyers Federal Home Loan Mortgage Corporation (FHLMC)- Freddie Mac-buys mortgages on the secondary market, pools them, and sells them as mortgage-backed securities to investors on the open market Government has practically guaranteed all loans from them

12 Annaly Capital Management (NLY) How do they make money? from the interest difference from their MBSs and the costs of borrowing All of the mortgage-backed securities Annaly owns are issued by an agency of the United States government Market Cap ~874B 8.74B

13 Fund Managers Denahan-Norris, Wellington - Chief Investment Officer She was a founder of Fixed Income Discount Advisory Company, a Delaware corporation and wholly-owned subsidiary, or FIDAC, and is its Chief Operating Officer : Vice President for asset selection and financing at Citadel Funding Corporation. Before she had been a trader on the mortgage-backed securities desk at Schroder Wertheim and Co., Inc. Fortescue, James - Portfolio Manager He started with FIDAC in June of 1995 where he was in charge of finding financing on mortgage-backed g and corporate bonds

14 Investment Strategy Income Source: spread between interest income and cost of borrowing (mortgage yield and repos) They have 100% invested in AAA Appx 65% securities are pass throughs, 35% are CMOs Financing source: repo market and equity offering In third quarter, WAC = 3.59% and average 286 days, Average yield = 5.62%, spread income is 2.08% Leverage around 7:1, facilities with 30 lenders

15 In 2007, common shares dilution 44%, but EPS growth 200% ROE 11.17% 17% Net Income Quarterly Growth

16 Interest rates will remain low for a while Income growth explained by low cost of funding Current repo rates are all time low ate proxy Our pal Bernanke -0.5 up at the Fed said -1 he d keep it that -1.5 way. He promised. Growth r Inverse Relation: Net Income and Repo Rates Net Income Repo Rate

17 Dividend Vs. repos div repo 0.5 0

18 Risk Management Invest in ARMs (resistance to price swings) Interest swaps, duration matching Duration of Assets 2.54 yrs, but with swaps it s reduced to 1.39 yrs Securities have interest rate caps Prepayment risk eliminated due to the nature of mortgage securities bought at discount Prepayment occurs when 1. repaying principal for sale, 2. foreclosure of property, 3. refinancing

19 Current Catalysts High dividend payout 16% Arvindh s portfolio is in dire need of this! Low repo rates (.35%), hence low cost of funding Mortgage securities available at high h discount Agency (hence govt.) backed Treasury purchasing $20-23bn 23bn per month since October, Fed commencing the $500bn buying program (that s 10% of MBS market..) Stable or appreciating stock price

20 Two Risks Credit Risk Defaults on mortgages But this is not a problem because they re agency backed Interest Risk If repo rates are on an upward spiral Mortgage yields fall severely

21 Appendix Cmo types Effect of interest rates on CMOs: If interest rates fall and prepayment speeds accelerate, CMO investors may find they get their principal back sooner than expected and have to reinvest it at lower interest rates ( call risk ). If interest rates rise and prepayment speeds are slower, investors may find their principal committed for a longer period of time, causing them to miss the opportunity to earn a higher rate of interest ( extension risk ).

22 Dividend Forcast

23 Repo Mortgage Rate

24 Comparative Returns to BBR-REIT REIT Index

25 NLY WACC

26 Collateral Availability

Mortgage-Backed Sector of the Bond Market

1 Mortgage-Backed Sector of the Bond Market LEARNING OUTCOMES 1. Mortgage Loan: a. cash flow characteristics of a fixed-rate, b. level payment, and c. fully amortized mortgage loan; 2. Mortgage Passthrough