Why Annaly Capital Boosted Its Leverage in the First Quarter



Mortgage REITs are preparing for more rate hikes

Both Annaly Capital (NLY) and American Capital Agency (AGNC) went into 2016 carrying lower leverage than they have historically. The “taper tantrum” of 2013 caught many REITs off guard. As a result, their book value per share suffered. Now they’re concerned about how the Fed will impact asset prices—in particular MBS (mortgage-backed securities) spreads. Investors who want to bet directly on interest rates should look at the iShares 20+ Year Treasury Bond ETF (TLT).

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As the markets continue to churn due to changing expectations of a liftoff and a fallout from Europe’s shaky situation, it made sense for Annaly to decrease its leverage. In this sort of environment, volatility is a constant headwind to earnings. Most other REITs so far have remained conservative, but Annaly decided to increase its leverage in the fourth quarter. So far, that bet has paid off. Interest rates have fallen about 55 basis points since the Fed hiked rates at its December meeting.

Annaly Capital’s leverage

Annaly Capital ended 1Q16 at 5.3x leverage, which was an increase from its 5.1x ratio at the end of the fourth quarter. This number is still less than the 6.3x ratio it operated with before the taper tantrum. So Annaly will be less vulnerable to rate hikes than it was in early 2013. It also has some flexibility to pick up any distressed paper that’s being discarded by investors who might be forced to sell.

Economic leverage includes TBAs (to-be-announced) and forward purchases. It was 6.2 x at the end of March. This number was a rise from 6.0x at the end of 2015. Annaly has still maintained a relatively defensive posture. This was the right call, given the volatility in the financial markets and widening MBS spreads, but it increased leverage while most other REITs are maintaining low levels.

Real estate companies like Colony Capital (CLNY) take credit risk. This setup inherently reduces the interest rate risk. Other REITs, like MFA Financial (MFA), invest in adjustable-rate MBS. They’re also less sensitive to interest rate moves. Investors who are interested in trading in the mortgage REIT sector as a whole should look at the iShares Mortgage Real Estate Capped ETF (REM).


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