Welcome Signs for Annaly Capital Management, Inc. (NLY): Crexus Investment Corp (CXS)

Annaly Capital Management, Inc. (NYSE:NLY) stands to be the largest US mortgage REIT that invests in mortgage backed securities for which any of the government Agencies guarantee the principal and interest payments. It has a market cap of over $15.2 million and is trading above its fourth quarter book value for the first time in a long time. The remainder of the investment thesis aims to discuss the reasons for the company’s recent outperformance and compare it with its peers.

Since Annaly Capital Management, Inc. (NYSE:NLY) is a pure play mortgage REIT, it’s witnessed heavy net interest rate spread contractions at the hands of the Fed’s QE3. During the fourth quarter alone, shares lost 17% in value, while the company’s net interest rate spread plunged 50 bps during the third quarter of 2012. Looking at the situation, the management at Annaly Capital took some strategic moves as follows:

Strategic Moves

Contracting spreads and accelerated prepayments due to the Fed’s QE3 and other stimulus efforts led the management at Annaly Capital to acquire Crexus Investment Corp (NYSE:CXS). Crexus Investment Corp (NYSE:CXS) is another mortgage REIT that invests exclusively in high yielding commercial mortgage-backed securities. Given the prevailing challenging macroeconomic environment in the US, this was the best way to outmaneuver the Fed. Annaly Capital Management, Inc. (NYSE:NLY) has commenced its tender of all shares of the commercial REIT it does not own for $13 per share.

In another move, Annaly’s management has advocated a shift to an external manager called Annaly Management Co. Annaly Capital’s shareholders will be asked to approve this proposal at the annual meeting on May 23. If the proposal is approved, Annaly Capital Management, Inc. (NYSE:NLY) would pay 1.05% in base fee to the external manager. This proposed management fee is considered to be one of the lowest among Annaly’s peers. According to an article on Bloomberg, external management structures for mortgage REITs are a conflict of interest, however Annaly’s proposal is considered to be shareholder-friendly. Further, the proposed structure is expected to bring monetary benefits to Annaly, even if they are short-term. The structure would have saved $48 million in expenses in last year alone.

Competition

Annaly Capital Management, Inc. (NYSE:NLY) competes with other Agency mortgage REITs including American Capital Agency Corp. (NASDAQ:AGNC) and ARMOUR Residential REIT, Inc. (NYSE:ARR). American Capital Agency has been successful in outmaneuvering the Fed. It posted prepayments as low as 9% and 10% during the recent two quarters, while its net interest rate spread increased 21 bps during the fourth quarter. American Capital Agency remained one of the very few mortgage REITs that maintained its quarterly dividends.