7 Aug

How Does Annaly Finance and Hedge Its Assets?

WRITTEN BY Brent Nyitray, CFA, MBA

Annaly Capital’s liabilities

Annaly Capital Management (NLY) and most other mortgage REITs tend to lever their portfolios with repurchase agreements. On the liability side, Annaly Capital’s repurchase agreements decreased from $60.5 billion to $57.5 billion in 2Q15.

The average days to maturity on its repurchase agreements remained at 149 days. The average rate on repurchase agreements increased from 70 basis points to 76 basis points.

How Does Annaly Finance and Hedge Its Assets?

Swaps and swaptions

Annaly also uses swaps and options on swaps, otherwise known as swaptions, as another way to hedge its interest rate risk. These swaps enable Annaly to earn more as interest rates rise. Annaly pays a weighted average fixed rate of 2.29% and currently receives a floating rate of 40 basis points.

The average years to maturity equaled 7.76 years. So over the next five years, if short-term rates rise above 2.37%, the swaps will be worth more, which will offset some of Annaly’s increased financing costs.

The Fed and asset prices

Annaly Capital (NLY) and American Capital Agency (AGNC) both benefited from the Fed’s continued support of asset prices. Even though QE (quantitative easing) officially ended during the quarter, the Fed is still reinvesting interest and principal payments in the mortgage-backed securities (or MBS) market. This is largely through the TBA (to-be-announced) market, which is primarily agency 30-year fixed-rate mortgage-backed securities.

Adjustable-rate mortgage REITs like MFA Financial (MFA) don’t hold much in the way of TBAs. So they didn’t benefit as much from QE as Annaly and American Capital Agency did. That said, going forward, REITs that invest in adjustable-rate securities could be a good bet as rates rise, given they have less exposure to increasing rates. Other real estate companies like Northstar Realty Finance (NRF) bear credit risk, which may be more favorable than interest rate risk in an environment where economic strength is pushing the Fed to hike rates.

Investors interested in trading in the mortgage REIT sector can consider the iShares Mortgage Real Estate Capped ETF (REM). Investors who want to bet directly on interest rates can look at the iShares 20+ Year Treasury Bond ETF (TLT).

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