Annaly Capital: 1 Big Risk We Are Facing Right Now


This time of year is oodles of fun for investors, when companies' annual reports and letters to shareholders shed a bit more light on the inner workings of investment favorites.

The "Risk Factors" section is an especially good read and, while often filled with generalized statements about the economy, future legislation, and such, can sometimes give a real clue as to what these companies themselves consider a threat to their bottom lines.

Such is the case with Annaly Capital Management , whose latest 10-K filing I recently perused. One particular risk the company identified caught my eye, as I had been thinking about this issue myself -- and it's a doozy: the winding down of Fannie Mae and Freddie Mac.

Fannie, Freddie wind-down will cause upheaval
As Annaly management notes in its 10-K, the idea to unwind Fannie and Freddie was first floated by the Treasury Department in early 2011, in a white paper regarding housing finance reform. As an entity that invests primarily in mortgage-backed securities backed by these government-sponsored entities, any change in the status of these behemoths would have an impact on Annaly and other pure-agency mREITs, such as American Capital Agency and Armour Residential .

Lately, the changes to those GSEs have been accelerated. Just this week, Edward DeMarco, the acting director of the Federal Housing Finance Agency decreed that the two must work together to create a new, joint company that will securitize home loans for a fee. This new entity could end up being either public or private, depending upon which way the political winds blow.

Since the two GSEs currently insure about 90% of all home loans being written, shutting them down, no matter how slowly, will cause issues for mREITs. As Annaly points out, market uncertainty pursuant to this process can easily cause market jitters that could decrease the value of the company's holdings. Not a good thing, of course, since it is these very securities that Annaly, American Capital Agency, and Armour use to secure financing with which to invest further.

And that's not the worst of it. Management notes that elimination of Fannie and Freddie -- or even substantial changes to those enterprises -- just might also eliminate the government guarantee for those coveted agency MBSes, effectively putting the pure-agency players out of business.

A real and abiding concern
While these assessments of risk may sound dire, they are well within the realm of possibility. This seems to be the year of change at the GSEs, and a group of legislators have recently sought to bump the issue of GSE reform into the spotlight. The Wall Street Journal notes that much of the debate concerns the continued availability of 30-year, fixed rate mortgages -- the bread and butter of mREITs -- which are common products in the U.S. and Denmark, but not in other parts of the world.

Once again, Annaly management is showing forethought in keeping a close eye on these developments. Mortgage REIT investors should do the same.

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