Annaly Capital Management, Inc. (NLY)

Hey everyone. I just read NLYs earnings transcript. Here are some things I was able to derive from it. Keep in mind. I am not a professional, but just a well educated amateur. So please, feel free to correct or add.

It's going to be a long post.

The core business for NLY is agency MBS, and it will remain this way in the future, but they have been gradually increasing their other businesses, specifically, mortgage servicing rights (MSR) and residential lending. Right now, these businesses are something like about 6-7% of their overall portfolio.

MSR, to put it simply, is managing mortgages for someone else for a fee. The fee is in the high single digits. It's not a leveraged return. It's at the same time conservative (lower return than Agency MBS) and risky because it's not insured. It contributes more than a quarter to book value, which tells you how badly the Agency MBS prices were hit.

Leverage increased but just a little bit. Finkelstein said they will increase it as necessary and I am sure they will do it as soon the Fed signals the end of rate hikes. It will be a big plus.

Out of $76 billion of NLY's MBS portfolio, $16 billion was rotated out from 2-3% to 3-5%. I think we should see the book value increase as a result of this rotation. That's a very big plus.

I didn't see any mention of continued hedging, but I presume they will keep the same amount of swaps since the Fed is not done raising rates. That is a continued minus.

Mortgage rates fell in the past month from 5.7 to 5.4. At the same time, the Fed raised the borrowing rate. Put together, that indicates a decline in earnings on newly originated MBS. It's a minus, but a very small one.

Mortgage delinquencies dropped to the lowest level in 20 years. Refinancing also dropped. That's a plus.

Here is something interesting I learned about their hedges. They use Repo but they also use something called Dollar Roll. It's very similar to Repo, but it creates an opportunity for NLY to make a little bit more money. I don't want to go into too much detail about it. It's very technical. I'll just say, it's an interesting financial instrument. A plus.

They had to adjust Repo to shorter durations. Normally, they re-borrow money every 6-11 months. But because of rate hikes, Repo with longer durations became more expensive and also scarce. Instead of re-borrowing cash every 6-11 months they will do it every 1.5-2 months. My guess is that they will probably pay a higher rate for those Repo. So, it's a minus but I don't know how big it is.

They have 6.3 billion in unencumbered assets. These assets include cash and the last batch of MBS. Someone asked me to explain it. NLY buys MBS, borrows cash using that MBS as collateral, buys more MBS, borrows more cash using that new MBS as collateral, and so on, and so on. The last batch that they buy, that's an unencumbered asset.

With a lower book value, NLY will have to pledge more collateral to keep the same amount of borrowed cash. They can sell some of that last batch and return some cash. Technically it is a minus because it can result in a further reduction of leverage, but so far, it doesn't look like it's happening.

Someone asked Finkelstein about a whopping 15% yield and whether they will have enough earnings to sustain it. Finkelstein said he is perfectly comfortable with this number.

Here is a little exercise for those who might find it interested to see the true power of compounding and price averaging. This has nothing to do with what's going on with NLY today.

I began investing in NLY 11 years ago. I bought my first position in 2011. Then the same amount in 2013, 2016, and 2020. If you blend these investment durations: (2011+2013+2016+2020) / 4 it comes up to the average year 2015. So, technically, you could say my money had been working for 7 years. There is more to it, of course, if you count DRIP, but let's assume it's 7 years.

I have been doing DRIP for 5-6 years but then I stopped and I was just collecting the dividend.

Per my calculation
-- I am down 29% on my principal investment
-- I collected 44% of my principal investment in dividends (both compounded and non-compounded)
-- I collected 6.22% in annual return

These numbers fluctuate with the movement of the price. It goes up and down.

I wouldn't call it a great success story but think about it.

Although I bought my first shares at $15 and $17 and the current price of the stock is $6.65, I still show an annual return of 6.22% a year over a span of years when this country had zero inflation.

Like everyone else, I am seriously disappointed, especially by the sneaky way they did this dilution. If their future earnings are as good as the ones in the last two quarters, they should be fine, but this was a bad move.

Here is a thought on how they might use this money.

The last time they diluted was 5 years ago or so. They did it twice, one issuance shortly after another and they used the money to buy two REITS. They were not mReits, so basically, NLY ventured outside their core business. It was a total waste of money. These two REITS they bought contribute to NLY's earnings.

I pray to God they are not raising money again to buy someone else.

I agree with @P. Right now, I would not be a buyer of NLY, at least not until I know more about what's behind these two latest dilutions. They will have to explain it, if not to the retail investor, then at least to the big boys from Blackrock and Vanguard.

There is a pattern that I've discovered after tracking many stocks over the years.

As much SEC tries to track and punish people who do insider trading, most of the time, that trading goes unpunished. There is one thing that makes it very clear. The price of the stock in days preceding the earnings release goes up when good news is leaked out and down when bad news is leaked out.

It's not always the case, but it's often the case.

Let's see what NLY's earnings will be after hours today and how they will stack up to my theory. The stock is up 1.25%. Maybe they will have a small beat and someone knows it.