Sell! Warns Goldman Sachs About Annaly Capital Management and American Capital Agency
There's only one thing worse than being ignored by Wall Street analysts if you're a publicly traded company. That is, when they take one look at your stock and encourage investors to sell, which is exactly the situation that Annaly Capital Management and American Capital Agency found themselves in this week.
On Thursday, Goldman Sachs initiated coverage of the two high-yielding mortgage REITs with recommendations to sell both. While Goldman is a little late to the party -- shares of Annaly Capital Management and American Capital Agency are down 31% and 36%, respectively, year to date -- its rationale is nevertheless worth considering.
Here are portions of Goldman analyst Eric Beardsley's research note:
We estimate 10-15% downside risk to book value as interest rates rise and mortgage OAS (option adjusted spread to Treasuries) widens following Fed tapering...
While agency mortgage REITs have already significantly underperformed the market this year ... we think investors and sell-side analysts have been slow to realize the downside potential. With Fed tapering on the horizon, we feel that it's better to get ahead of the risks and "not own" the stocks going into a potentially volatile period for agency MBS spreads. We believe it will be very difficult for the stocks to generate total returns that perform in-line with or beat the market in a rising rate environment -- even with the stocks already trading at significant discounts to book value.
Dividends have already been cut 22% by NLY and 36% by AGNC since 1Q13, and we expect additional cuts of 40% over the next year, in-line with our projected decline in earnings.
In layman's terms, Beardsley believes the Federal Reserve is on the cusp of reducing its monthly purchases of long-term bonds (QE3). This will push long-term interest rates higher, which will reduce the value of the agency mortgage-backed securities in mREIT portfolios -- by 10% to 15%, according to his estimate. This, in turn, will pressure earnings, which will then weigh on dividends.
Should this concern you? Perhaps, as this is anything but a friendly environment for mREITs. Additionally, at least in Annaly's case, the behavior of its management team has done anything but assuage investors' concerns over the last few years.
But when you consider how late Beardsley is to the party, how inaccurate analyst estimates generally are, and how far both of these companies' stocks have already dropped year-to-date, then I can't help but wonder if this latest call should be interpreted rather as a sign to buy. I'm obviously thinking out loud here, but I believe it's worth taking into consideration.
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