Will Annaly Earnings Impress or Depress?


The popular and high-yielding mortgage REIT Annaly Capital Management reports earnings in less than a month. Given everything that's going on in the mREIT space, I thought it'd be helpful to quickly review the positive and negative factors that are likely to impact Annaly's performance.

On the one hand, all mREITs are currently experiencing a number of industry headwinds. The biggest of which comes courtesy of the Federal Reserve. Last September, the Fed announced a third round of quantitative easing under which the central bank committed to purchasing $40 billion in agency mortgage-backed securities until the employment situation improves substantially.

Although the increased demand in the MBS market has no doubt increased the value of the underlying securities held by mREITs -- and particularly those like Annaly, American Capital Agency , and ARMOUR Residential , which focus on agency paper -- it's also driven down the yield on their portfolios.

This has been inordinately detrimental for funds with high constant prepayment rates. In the third quarter of last year, for instance, it's not a coincidence that Annaly had the highest CPR and the lowest interest rate spread of its peers like American Capital and ARMOUR. However, even putting the CPR aside, Annaly is far from the only mREIT that's been forced to reduce its dividend payouts over the last year, as the list similarly includes both American Capital and ARMOUR.

On the other hand, Annaly has taken a number of proactive steps to mitigate the impacts from the Fed's policies. In the first case, it's lowered its cost of funds by issuing preferred shares and restructured the liability portion of its balance sheet by extending the duration of its borrowings.

In addition, it recently submitted a proposal to acquire CreXus Investment Corp. , a REIT focused on commercial property. As I noted at the time, because CreXus is both effectively unleveraged and contains a higher yielding portfolio compared to Annaly's, there's every reason to believe that the move will be immediately accretive to Annaly's bottom line.

At the end of the day, in turn, the question for investors is: Which of these forces will overpower the other? And while I won't venture a guess here, it's best to keep the following maxim in mind: "Never fight the Fed."

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John Maxfield has no position in any stocks mentioned. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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