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Annaly Capital Management, Inc. Message Board

  • frontsept frontsept Dec 24, 2004 12:22 AM Flag

    NFI not equal to NLY but..

    NFI operates in a completely different space than NLY. Subprime mortgages are loans to borrowers with poor credit. The recent years of low rates have enticed the mortgage brokers to originate subprime loans like never before. NLY buys agency and/or prime paper (cant remember if their 100% agy or have some AAA in there). NLY's risk is purely interest rate related. NFI's risk is a combination of credit and interest rate. Most informed people may view it as more credit risk but the reason I think its more nuanced than that is that if the subrpime borrower's loan is indexed off LIBOR (or any floating rate - or if he has other additional debt indexed to LIBOR)than as rates go up, their debt service will increase resulting in higher debt payments that will need to be made thereby squeezing any disposable cashflows the borrower may have had. This in turn could increase the risk of default on their loan.

    To those that dont think impariment matters, they are sadly mistaken. Though I agree GAAP income can often be misleading, recognizing impairment on subprime residuals is due to the expectation that the credit will deteriorate more than rates rising since current GAAP doesnt require you to take an impairment hit soley due to rising rates...though GAAP does require you to take a hit if the impairment "is other than temporary".

    All that said, NLY isnt in any better shape, IMO, since rising, flattening curve will shrink spreads with absolute, complete certainty ... that is unless your hedged but it doesnt seem NLY does any substantive hedging.

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    • I must correct a misleading comment I made in this previous post. I made the comment that current GAAP doesnt require impairment recognition due soley to interest rate moves. In fact current GAAP does require certain write downs on beneficial interest of securitizations. I havent looked at NFIs balace sheet in a while but if I recall, they hold a good amount of the sub-classes of securitizations. If this is indeed the case, then these interests have special GAAP income and cost recognition guidelines that would be followed. Basicially, decreases in prepays have the opposing effects of keeping the residual stream out there longer while by keeping this stream out longer can increase defaults. Need to examine each residual case by case but if higher rates lead to a net decrease in cashflow, then a reduction in forecasted cashflows on any of their residuals would indeed lead to an impairment hit.

      BTW, NLY generally doesnt appear to hold these types of MBS. However, there is a new impairment issue being contemplated that could significantly impact any entity holding positions in the type of MBS NLY holds.

    • Your piece makes a lot of sense.
      One thing that NFI does do (that NLY doesn't do) is it is hedged and this compensates for the GAAP shortfall. Taxble income is the metric that is used for dividends and GAP does not take in account the hedge factor. Both are violatile PPS--subject to short attacks and both have done well over several years in spite of the short attacks. If you have the stomach for the ups and downs of PPS and want to keep on collecting dividends, history has been good--of course there is always the caveat that history doesn't predict future returns.

      Nothing guaranteed, especially when you are asking for double digit divy's--but both of these Reits with their different customer bases have treated me well. Utilizing a DRIP and putting as much as possible in tax defered IRA's makes them even better. I am long on both.

    • From what I have been able to determine about NLY's portfolio and business model, you are right... they are not hedged at all. They use no derivatives or swaps.

      Your comments regarding NFI are right on and are the reason I have stayed away. IMO, rising rates are a greater threat to the quality of NFI's portfolio (interest rate risk and enormous credit rate risk), due to defaults on these subprime loans, than the profit squeeze rising rates will cause NLY.

      • 1 Reply to tdsnumbers
      • As already mentioned I have purchased in both NFI and NLY. Diversification of risk if you will.

        Fact is NFI has been plagued by a very low default rate and although they are non conforming sub prime loans there is the collateral of a house.

        The NFI divvy keeps going up and now they have added a special divvy of $1.25 on top of their quarterly dividend of $1.40 (one can get the special if they buy by Dec 27. The fact that they have just taken a drop of 6 points after a quick astounding rising of 16 points in a couple of weeks makes it once again an attractive buy if you want the dividend imho.


        Long on NLY and NFI as my two complementary mortgage Reit funds.

 
NLY
11.19+0.09(+0.81%)Aug 1 4:00 PMEDT

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