there is significant downside risk to NLY - I am significantly reducing my holdings of both NLY and MFA. I think these issues are known by the institutional investors and this is what has kept the price from rising more. But, when the next conference call and BVs come apparent I seriously think there will be a meaningful correction.
The most near-term issue is the potential impact of the recent announcement by Fannie Mae (FNM) and Freddie Mac (FRE) that they will be repurchasing all seriously delinquent loans out of their guarantee pools. Freddie will be doing this all at once on March 1. Fannie will phase it in over the next few months. Neither reports its delinquencies on a pool-by-pool basis, but it isn't hard to guess where most buyouts will occur -- in "affordability" mortgages, such as interest-only, adjustable-rate and hybrid-ARM pools.
Prior to the announcement, most such outstanding pools were trading with dollar prices of $104-106. We can't tell to what extent, exactly, Annaly is holding such pools, but in its last annual report, the company said it had 21% of assets in adjustable-rate securities. I would suspect it also has a slug of fixed-rate interest-only paper. But even at just 21%, multiplied by 5.7 times leverage, the company has 119.7% of equity capital invested in GSE affordability mortgages. Hybrid-ARM paper is trading down 2% after the buyout announcement, so on that alone, the book value of Annaly's equity should decline by about 2.2%.
The next major problem with this buyout announcement is it radically changes the duration of all higher-coupon MBS. A generic Fannie Mae 30-year 6.5% has been paying a CPR (constant prepayment rate) of about 20 over the last 12 months (implying that about 20% of the mortgage is being prepaid on an annual basis). Bear in mind that the borrowers within a 6.5% coupon MBS actually have a 7% mortgage rate, so that borrower has had an interest-rate incentive to refinance for a while now, but hasn't.
Why not? Most likely, the borrower is either delinquent now or under water, so more likely to go delinquent in future. Thus, it is estimated that the CPR on high-coupon MBS will skyrocket for one month but then remain elevated because of subsequent delinquencies. Say the CPR goes from 20 to 30, which is in line with Street estimates, on a 6.5% MBS, the average life falls from 4.25 years to 2.78 years. Even at a more modest CPR of 25, the average life is 3.38, just about one year shorter. The math is similar for hybrid-ARM mortgages.
This is problematic for two reasons. First, it means Annaly is suddenly over-hedged. It had hedges based on a 4.25-year cash flow that just became a three-ish-year cash flow. The bad news gets worse when you consider that four-year interest rate swap rates have fallen from 2.58% as of end December to 2.21% now. Falling rates mean rising prices, and Annaly is short as part of its hedge. So, the hedge is going against it at the same time as the value of its long portfolio is falling.
Thanks for these numbers. Can I get these numbers somewhere? I presume the average life is lower than 100 divided by the CPR because of monthly principal amortization. I also want to be able to look up MBS market prices and swap rates to learn. Thanks again.
I admire your confidence. My number is a little bit lower, something like $16.50 or lower.
Even NLY itself said it is a rough road ahead. People is afraid of NLY's cutting dividend again and again.
Businesses that move dead inventory -delinquent loans with accrued interest due of 4 months are in for a serious injection of cash and income.
Be smart don't burn yourself on an imaginary downside in the face real payoffs.
Actually that's accrued interest of 120s day or more..
So of the 64 billion in MBS that NLY is holding..
The big question is what % of this MBS is delinquent?
I would have loved to have had some kinda schedule of aged MBS's here back in December. But it's kinda of irrellevant.
We are looking at a strategic business move that wasn't just based on the normal interest rate spread curve here..
What we got here is the sale of toxic assets for profit to Fannie-Freddie-Ginnie complements of Uncle Sam.
You, me and all the rest of america who pay taxes get the bill.
The spicket is in reverse here, so get booked up on some returns.
refer to my earlier post; graff is saying the nly's BV was inflated by the high bid being given to high yielding mbs that was not prepaying as fast as one would have thought - till now presumably with the GSE's stepping in to redeem non-performing assets. Again realize that he's talking about a hit to book value - which is separate from nly's legacy costs for the mbs assets. Lower BV does impact borrowing (nly will have to pledge more assets if priced lower) and therefore leverage.
"... most outstanding pools trading at 104-106... " Except that if he had done any work whatsoever researching nly, he would have picked up that their average (average, not pools being prepayed) is 101.5. This is in their year end filing. Why listen to an analyst who doesn't pick up even the most basic characteristic of the asset pool? When you know the fed will pull the bid, and the GSEs are prepaying defaults, what is the first thing you want to look at? But somehow he missed it. For this, he gets 0% credibility. Someone might want to email him this little oversight.
again brenda - to be fair - I think graff is not referring to nly's "cost basis" in the subject mbs assets; instead he is referring to the fact that book value could be impacted negatively - if/when the mkt stops bidding up high yielding mbs due to redemption risk.
Graff begins with "I am significantly reducing my holdings of both NLY and MFA"
ergo: I am a long that's legitimately concerned about NLY's future
Graff ends with "so I'm keeping my short for now."
the truth: really I'm a wolf in sheep's clothing and trying to hoodwink ya