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Minyan Mailbag: Mortgage Reits




Hi Fil -

Love your comments on MV. I see you had a note up on Annaly as a bull. While you make several good arguments for NLY, I would like your thoughts on the two points below (realize I am short a decent chunk of 20 puts).

1) NLY and most MREITS trade on both book value but also dividend yield because of Retail demand. For example, look at the chart on CMO, a short that I used to have on, which at one point was trading 2.5x book. The dividend yield drives a fair number of retail investors who do not look at the book value necessarily.

2) Look at NLY's and the sector's stock performance in the period of rising rates, flattening curve and huge prepayments. The sector trades below book during these periods.

Any thoughts on the above? Am I missing something?

My biggest worry as a long would be that the fed raises rates up to 4.25% over the next 6 months (which essentially eliminates the dividend) and then some sort of 100 bps shock to the long end of the curve. NLY potentially has to de-lever at that point.

Good weekend,
-Minyan Amit


I could not pull up Book Value data on Annaly Mortgage Management (NLY) further back than 2001, and it does not appear to me that since then NLY ever traded below book value. I take your word that other MREITs have, but I suspect that the credit quality of some of the portfolios may also have had something to do with it. Some MREIT's are hauling around frightening amounts of junk paper, and some take the liberty of valuing them rather "generously." That being said, I agree with your view that should the curve invert, NLY might face a whole new painful set of problems, book value decreases and deleveraging included.

In fact, Pimco's Paul McCulley's most recent piece suggests that, should the yield curve invert, market forces might end up really inverting it. As I noted at the end of my piece, my long position in NLY is to give me some "balance" with other positions that should benefit if the yield curve turns south and the economy follows. On its own NLY hardly looks to me like an appealing position. It is the "best" of a group with storm-size winds in its face.

As far as the impact of retail investors on the stock price, at 1x Book, I am OK taking the other side of the trade if their selling is driven by their current disappointment with the yield, much as I am tempted to short companies like New Century Financial (NEW) and Novastar Financial (NFI), were they not already so crowded. Yields of 16% from mortgage portfolios (non tax advantaged, and/or often involving return of capital or payouts from secondaries) in the current rates environment are either "the proverbial free lunch" or a siren song. I am skeptical of the first (Plunge Protection Team / Elmer's Put notwithstanding), and more than comfortable waiting for the shipwreck with regard to the latter.

-Professor Fil

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Position in NLY
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