What will Annaly Capital Management’s stock price be like in three years?

What will Annaly Capital Management’s stock price be like in three years?

The past three years have been difficult for Annaly Capital Management (NLY-0.75%), a real estate investment trust (REIT) that invests in mortgage-backed securities (MBS) backed by government-backed institutions such as Fannie Mae and Freddie Mac. Over time, Annaly’s total return, including reinvested dividends, was around -20%, and its market capitalization fell by almost half.

However, as is often the case with high performing stocks, past performance is not necessarily indicative of future performance. The same goes for Annaly, whose stock could outperform over the next three years.

Why have the past three years been difficult for Annaly?

The reason for Annaly’s poor performance over the past three years is actually quite simple. At its core, the company is an investment company that holds a leveraged portfolio of agency MBS. MBS are essentially bonds backed by residential real estate and guaranteed against default by a government-backed agency. Although corporate-backed securities like Fannie Mae eliminate most of the credit risk associated with these investments, a company’s interest rate risk is not reduced but only increased by the leverage used.

When interest rates rise, mortgage rates tend to rise as well, and the present value of the securities held by Annaly decreases. The Fed began aggressive tightening in March 2022, raising interest rates 11 times. The target for the federal funds rate was raised from a range of 0.25% to 0.50% to 5.25% to 5.50%, and remains unchanged.

In addition to rising interest rates, the widening spread between 10-year Treasury yields and agency MBS yields is putting pressure on Analy’s MBS portfolio. Over the past three years, the spread has widened to twice his historical average. As a result, mortgage interest rates rose more than government bond yields during this period, further impacting the value of MBS securities.

Mortgage REITs like Annaly are typically valued based on the value of their investment holdings. This makes sense because when you buy Annaly stock, you are essentially buying his MBS portfolio within it.

Unsurprisingly, the value of its portfolio has declined given that Annaly faces pressure from rising interest rates and widening spreads. The value of the company’s portfolio, reflected in its book value, has fallen from a split-adjusted $35.68 at the end of 2020 to $19.44 at the end of 2023.

Therefore, over the past three years, Annaly stock has basically seen a decline in book value.

Better days will come

The good thing going forward for Annaly is that the Fed has stopped raising interest rates.

Some Fed officials have said recently that there is no need to rush to cut rates, but based on the March Fed dot plot chart, most Fed officials still expect a 75 basis point cut this year. are doing. This chart shows what interest rates will be for each FOMC member over the next few years.

More importantly, this chart shows that Fed officials expect the federal funds rate to fall from the current 5.25% to 5.50% to 3.00% to 3.25% by the end of 2026.

This would well for Annaly’s portfolio, which is focused on 30-year fixed-rate mortgages with coupon rates of 4% to 6%. This combination allows the company to benefit from lower interest rates while avoiding the risk of early repayments that often occur when many homeowners begin refinancing. The mortgage REIT also shifted nearly 8% of its portfolio to high-quality non-agency MBS to boost returns. A further 4% of the portfolio consists of mortgage servicing rights (MSR), which are expected to be less sensitive to interest rates. Annalee invests in his MSRs with low coupons because the biggest risk with these assets tends to be early repayments.

Once the MBS market starts to improve, Analy should be able to increase leverage. The company ended 2023 with economic leverage of 5.7 times. Before the pandemic, the company’s debt-to-equity ratio was 7.2 times at the end of 2019 and 7.0 times at the end of 2018. The additional leverage allows Analy to generate more net investment to support the dividend.

What’s going on with Annaly

Although there haven’t been many periods of interest rate cuts in recent years, Annaly’s book value and share price did very well during the interest rate cutting cycles of 2001-2003 and 2007-2008.

Interest Rates Although the cuts are unlikely to be as severe in the coming years, Annaly will still benefit significantly from this change. As you can see from the chart above, stock prices nearly doubled during both rate cuts. If the Fed cuts interest rates by about 2% over the next three years, Annaly stock should be well above where it is trading today. Add in the current solid 14% dividend yield, and the stock looks like an attractive buy at current levels.

Share This Post