Is there someone out there with a mind clear enough to explain it
Here is my problem, people. I read articles about NLY every day and what I get from them makes no sense to me at all.
I understand how MREITs make their money. They borrow short term at lower rate and lend long term at higher rate. They rotate their assets regularly to keep up with the spread. When rates went down, understandably, NLY suffered because the spread had shrunk. If you borrow at 5% and lend at 7% you get 2% spread. If you borrow at .5% you can only lend at 1%, making your spread .5% instead of 2%. Don't hold me to these numbers. It's just an example. But what is the issue now that rates are rising. Shouldn't it increase the spread and make better profits for MREITs? Again, I understand why the profits should decrease in the short term. You have to borrow short term at higher rate and at the same time your long term assets decrease in value. But still, is there a good reason for the price of NLY to plummet like this, from 18 to 11 in just one? I read this articles and they talk about it as if NLY is going out of business tomorrow. Someone, please talk to me.
The Fed has no intention of raising rates from the 0 to 1/2% rate even if they taper off their buying sometime later this year. So with less refinance and higher new mortgages, the dividend should start to stabilze.
This is in anticipation of the hits to book value that the market thinks may occur. As interest rates rise the net present value calculations result in lower asset prices and the market is expecting "mark-to-market" losses on NLY's portfolio. Longer term the interest rate increase will work in NLY's favor but the short term prognosis is book value losses from the increase in rates. This is NOT a cash loss, it is an accounting entry to reflect lower values of the MBS portfolio. If you have a time frame longer than the quarterly obsession the "market" seems to have this is a golden opportunity. I've been buying since the mid-12 level because I think the stock will see $18 again in the next couple of years. Looking at the 10-year price history it has hit $18 in every year except 1 of the last 10 and they have successfully navigated the interest rate cycle multiple times since they went public in '97. Every time the dividend has ended up increasing and the stock price has rebounded strongly. No reason to expect anything different this time around. Market insanity and irrational thought is driving this, NOT reality,.
Income story: Unless they borrow more to invest at higher rates today, the income level isn't really going to change. To do that, they'd have to increase leverage, which would be crazy into an environment of potentially rising rates. So I wouldn't expect the dividend to change much due to a rise only in long-term rates. I would continue to expect the dividend to decrease somewhat as their long-term investments from several years ago hit maturity and are replaced by lower yielding investments today.
Asset story: What is changing (maybe rapidly depending on the duration of their portfolio) is the book value of those long term holdings. Borrowing short-term and investing long-term means they're locked into their portfolio of long-term holdings which have gotten hurt in the past 6 weeks.
Do you value a mortgage REIT as 1) based on the NPV of it's (probability adjusted) future dividends using a discount rate that accounts for the risk of leverage and borrow variable to invest fixed OR 2) at book value (sum of the value of the underlying assets and liabilities)? You SHOULD get the same answer either way, but the income focused group sometimes forgets to probability adjust the future dividends and fails to use a discount rate high enough to account for the risk so that stock often seems cheap and has a high dividend yield.
That's my take on explaining NLY and mortgage REITs in general. With that understanding, I feel pretty confident saying NLY is a good bet at $11.50/sh. This is my first time buying since selling in Aug 2010 in the mid 17s. At that time, I felt like NLY was basically a self-liquidating asset. I was holding something worth $17/sh that was paying a $2 dividend, but I anticipated it would fall in value by the amount of the dividend as rates started to increase. I sold early and missed some upside, but slept better. Now I will sleep well holding it again at these levels.
I'm 100% with you. I starting buying with the majority of my shares at $12.60 and not averaged at $12.55. I actually anticipate a dividend increase this quarter and I have no doubt this stock will recover to the prices you state.