How Does Annaly Capital Finance Its Balance Sheet?



Annaly Capital’s liabilities

Annaly Capital (NLY) and most other mortgage REITs tend to lever their portfolios with repurchase agreements. On the liability side, Annaly Capital’s repurchase agreements fell from $56.2 billion to $54.4 billion in 1Q16.

The average days to maturity on its repurchase agreements fell to 136 days. The average rate on repurchase agreements rose from 9 basis points to 99 basis points. This is where Fed rate hikes will impact Annaly the most.

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Swaps and swaptions

Annaly also uses swaps and options on swaps, otherwise known as “swaptions,” as another way to hedge its interest rate risk. These swaps enable Annaly to earn more as interest rates rise. Annaly pays a weighted average fixed rate of 2.26%. Currently, it receives a floating rate of 69 basis points.

The average years to maturity were seven years. So, over the next five years, if the short-term rates rise above 2.3%, the swaps will be in the money. This would offset some of Annaly’s increased financing costs.

The Fed and asset prices

Annaly Capital and American Capital Agency (AGNC) both benefited from the Fed’s continued support of asset prices. Even though QE (quantitative easing) officially ended during the quarter, the Fed’s still reinvesting interest and principal payments in the MBS (mortgage-backed securities) market. This measure is largely through the TBA (to-be-announced) market. This market is mostly agency 30-year fixed-rate MBS.

Adjustable-rate mortgage REITs like MFA Financial (MFA) don’t hold much in the way of TBAs. So they didn’t benefit as much from QE as Annaly and American Capital Agency. Going forward, REITs that invest in adjustable-rate securities could be a good bet as rates rise. They have less exposure to rising rates. Other real estate companies, like Northstar Realty Finance (NRF), bear credit risk. This kind of risk could be more favorable than interest rate risk in an environment where economic strength is pushing the Fed to hike rates.

Investors who are interested in trading in the mortgage REIT sector can consider the iShares Mortgage Real Estate Capped ETF (REM). Investors who want to bet directly on interest rates can look at the iShares 20+ Year Treasury Bond ETF (TLT).


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