Monday, May 08, 2006

Annaly Mortgage Management NLY :: Making do in touchy times

Annaly Mortgage Management (NLY) is the most plain vanilla of the residential mortgage REITs. They have a very simple business model. Annaly starts by purchasing mortgage pools issued by GSE's (Freddie Mac, Fannie Mae, GNMA), these mortgage pools have implied AAA ratings. Because the quality of the collateral is AAA, Annaly can easily borrow money to finance these mortgages. Because the spread between what Annaly can borrow at and the mortgages pay is so slim; Annaly uses lots of leverage to earn a decent return on equity. Historically NLY works at 10:1 leverage to earn a 14% return on equity.

Because of the great amount of leverage involved, managing interest rate risk is critical. Annaly uses a "barbell" strategy of owning a blend of fixed rate and adjustable mortgages with variable durations. In theory interest rate environments that hurt fixed rate bonds (rising interest rates) benefit floating rate bonds and vice versa. Most of Annaly’s assets are financed using floating rate repurchase agreements. When the yield curve flattened and inverted, NLY was crushed in a vice. And it is slowly recovering. My personal opinion is that NLY is one of the most solid players among the pure RMBS investors. If you think that the yield curve will steepen soon, (and given the threat of inflation from Helicopter Ben, long term rates will rise). Then NLY is very well positioned to take advantage of that.

The Annaly website has collection of insightful commentary that I highly recommend reading. There is an archive of monthly commentary, as well as longer archived articles. I also highly recomend listening to Annaly's 4Q05 and 1Q06 conference calls which can be listed too on yahoo. What makes the conference calls especially interesting is that management spends almost all its time on talking about the mortgage markets and business conditions rather than just reading back the 10-Q or earnings release. If you are interested is learning about the mortgage markets from the trenches, the Annaly conference calls are a gold mine.

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