I hear everyone talking about rising interest rates and how horrible it's going to be for mortgage REITS. I agree with that. These companies operate best in flat environment, when rates are neither rising or falling. When they do start to rise things will get really bad because NLY and the likes would have to rotate their long term holdings real quick, selling lower paying assets and buying higher paying ones. It will be a painful process because as rates rise the worth of the underlying asset falls. So, there is loss there. However, when rates rise, long term rates rise more than short term rates and that widens the spread. More spread, with right leverage, of course, means more profits. What do you think?
Wrong: The company is funded in the short term market, so most funding re-sets almost immediately as short rates rise, while the actual mortgages they own take time to churn through the portfolio and re-set at a higher yield. Margins shrink, and they will take losses on the premiums they paid over the last several years on nearly all their assets...destroying book value and earnings. Own them when the fed is stable or cutting short term rates. Be out or short when the fed is tightening short rates. Given the extended period of low rates, high leverage, and the premiums these guys all paid for mortgages, they could all go into a massive liquidation process and potential bankruptcy this cycle. IMO
"Own them when the fed is stable or cutting short term rates."
Which is why i believe a better scenario for being in them is when rates are high and looking more likely to drop than rise. Yes, you get re-fi risk off a drop in rates, and yes, you have more chance of default when rates are high (i believe the pmi removes much of that risk though), and yes, you may have the problem of affordability if rates drop off a very poor economic scenario. If, however, the drop comes off a stabilization of inflation at relatively low levels, or a dropping of inflation from high levels, for me that's a fine time for the mreits. They will lose off the refi's but nowhere near what they gain as short term rates fall significantly and long term rates more slowly.
Or don't trade in and out at different cycles and stay and collect dividends to reinvest at on Sale prices. I agree, this management team has done a great job at de levering to minimize their risk.
Supposedly they're hedging their interest rate risk. So they're not that sensitive to rising rates. The spread between the asset and the liability for a given duration is what they're exposed to.
"Supposedly they're hedging their interest rate risk."
Again, it costs them to hedge and i doubt they can hedge enough to totally offset a bad scenario. Luv hedges fuel prices the best of any airline i know but can't hedge enough to totally offset the negative impact of rising fuel prices. That's why they have to raise fares to come anywhere near to making up the extra fuel costs, and they still can't reach break even impact between the two. And that's not just off losing passenger traffic but off direct fuel cost after hedging and their then current cost per seat mile. Abx can reduce the impact of falling gold prices through hedging, but again, not enough to totally offset the impact. Hedging can go just so far until the cost diminishes the value of its return to near 0.
So, you're right, they are not that sensitive. But they are sensitive. How much so i don't know. And again, i believe they stand to handle this better than an agnc. But that comparison's obviously a personal opinion on what i've know more from before than what i know, and don't, now.
I'm holding off buying more if rates continue to rise NLY will be a bad investment....We can keep averaging down, but it may be best to wait.....Rates have been low for many year, and now, they may rise and remain for many years.....Bonds IMO is not going to be a good place to be....NLY is all about bonds from my view....I own AGNC and it's getting hammered......Do i want to hold for who know's how long while my principle fades away?
"However, when rates rise, long term rates rise more than short term rates and that widens the spread."
No disagreement, in the long term. That's the norm. It's the pain that comes until the long rates rates rise sufficiently to widen the spread sufficiently to start overcoming the loss of book value on the current long term holdings. They sell their book of current long term debt holdings so quickly as to take a devastating immediate loss, that's not good. They sell and then rates turn, they look like fools. On the off-chance an inverted yield curve does crop up, they're really screwed. They sell and rates continue higher after they've turned their book and locked in a new one, they have to sell again to keep up and take more loss off the new book? And if that keeps spiraling upward?
It's a combination of expertise and the luck of timing how things turn out. They are pretty darned good in the expertise department imo. The luck department, out of their control though they can make some of their own luck through their expertise. In any case riskier now than before imo, and the pps will have to fall sufficiently to offer a divi return which will provide a decent reward for taking that risk. Where that'll be for both, whatever divi they can sustain and what price the market determines will be sufficient to offer a risk adjusted return, off that dividend, that'll keep the pps from falling further.
Would you accept the same rate of return in a higher risk environment as you would in a lower risk environment? It's been my experience the general market wouldn't, so something would have to give to get that perceived satisfactory risk adjusted rate of return off whatever level the divi changes to. Again, the market will determine what's satisfactory to it once it sees the divi rate, and determines if that divi rate is likely sustainable or not.
rivvir, thank you for a very informative reply. I always prefer to hear an educated opinion than listening to people spewing nonsense like, "$30 per share by the end of December". This may be a stupid or irrelevant question, but what do you think about possibility of NLY going under. Is there a real chance of that? Things are bad already and it seems like at this point they could only get worse.
Good thing they have great management and have deleveraged. They are being extra cautious, and will not dip there toes in the water until they see fit. They don't only look out for the short term, but mostly their long term vision. Not quarter to quarter. They went over this in the conference call.