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Annaly Capital Management, Inc. (NLY), American Capital Agency Corp. (AGNC): Another Story of Compressed Spreads and Book Value, But the Outlook is Brighter

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Annaly Capital Management, Inc. (NYSE:NLY) reported yet another story of spread and book value compression. However, the outlook for the second quarter of the current year looks promising. The remaining of the investment thesis will discuss the latest financial disclosures and see which factors will lead the company to reported growth in the second quarter.

Annaly Capital Management, Inc. (NYSE:NLY)

Financial review

While Annaly Capital Management, Inc. (NYSE:NLY) reported EPS of $0.47, marginally above it’s $0.45 per share dividend rate, a large portion of it was from one-time items. Annaly Capital recognized $0.19 per share as gain on sale of securities, which is not considered part of the regular business at a mortgage REIT. Therefore, the adjusted EPS comes out to be $0.28, far behind the current dividend rate.

Spreads

Remember, spread is the difference between the interest earned on the interest earnings assets and the interest paid on the interest bearing liabilities- the wider the spread, the greater the income. Aggressive bond buying by the Fed resulted in a 4 bps compression in the interest rate spread (0.91%), as the average asset yield fell 8 bps over the linked quarter, partially offset by the 4 bps decline in the cost of funds.

Annaly Capital Management, Inc. (NYSE:NLY)’s spreads going forward are expected to increase, as the decreased funding costs and Crexus Investment Corp (NYSE:CXS)’ acquisition will increase Annaly Capital’s average spread and be immediately accretive to the spread.

In comparison, American Capital Agency Corp. (NASDAQ:AGNC) reported an 11 bps decline in its net interest rate spread, while its cousin American Capital Mortgage Investment Crp (NASDAQ:MTGE) reported 6 bps sequential decline in its net interest rate spread.

Funding maturities

Annaly Capital Management, Inc. (NYSE:NLY) continued to extend the weighted average maturity of its interest bearing liabilities. The weighted average maturity has now increased to 202 days from the linked quarter’s 197 days.

While the extension in the funding maturities reduces the risk short-term (or wholesale) funding poses, it also has the ability to reduce Annaly Capital’s net interest rate spread further, because liabilities with increased maturities demand higher interest payments. Therefore, I believe if Annaly Capital Management, Inc. (NYSE:NLY) continued to increase its funding maturity, it might escape regulators’ wrath; but at the same time it will hurt its future profitability.

Looking at its competitors, I see American Capital Mortgage Investment Crp (NASDAQ:MTGE) and American Capital Agency Corp. (NASDAQ:AGNC) doing the same. American Capital Mortgage Investment Crp (NASDAQ:MTGE) extended the weighted average maturity of its securities from 87 days at the end of the fourth quarter to 108 days at the end of the most recent quarter. Similarly, American Capital Agency Corp. (NASDAQ:AGNC) extended the weighted average maturity of its interest bearing liabilities to 183 days. However, the extension was only a modest one as the weighted average maturity for its liabilities at the end of the prior quarter was 181 days.

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