Annaly Capital Management, Inc. (NLY) Is Still The Best Pick In REITs: Starwood Property Trust, Inc. (STWD), Redwood Trust, Inc. (RWT)

Annaly Capital (NLY)Annaly Capital Management, Inc. (NYSE:NLY) , a company that has long been dubbed an attractive investment, reported its results for the fourth quarter of 2012. In this article, I will examine the company’s fourth quarter financials to determine whether or not the stock continues to be an attractive investment.

Annaly Capital Management, Inc. (NYSE:NLY) reported GAAP net income for the fourth quarter of 2012 of $700.5 million, or $0.70 per average common share. This was compared to
GAAP
net income of $445.6 million, or $0.46 per average common share for the same quarter of 2011. The company reported GAAP net income of $224.8 million, or $0.22 per average common share for the preceding (third) quarter.

GAAP net income was $1.7 billion, or $1.74 per average common share, for 2012, compared to $344.5 million, or $0.37 per average common share, for 2011. Excluding the unrealized gains or losses on interest rate swaps and agency interest-only mortgage-backed securities and net loss on redemption of Senior Notes, net income for the quarter was $465.1 million, or $0.46 per average common share, compared to $525.3 million, or $0.54 per average common share, for the same quarter of the previous year, and $449.8 million, or $0.45 per average common share for the preceding quarter. On the same basis, net income for 2012 was $2 billion, or $2.01 per average common share, compared to $2.3 billion, or $2.57 per average common share, year-over-year.

The annualized dividend yield on the company’s common stock for the fourth quarter based on the closing price of $14.04 as of Dec. 31, 2012, was 12.82%, compared to 14.29% year-over-year and 11.88% for the preceding quarter. The dividend yield on the common stock for 2012, based on the Dec. 31, 2012 closing price of $14.04, was 14.60%, in comparison to 15.29% for 2011.

For the quarter, the average annualized yield on interest-earning assets was 2.45%, compared to the average annualized cost of funds on interest-bearing liabilities, including the net interest payments on interest rate swaps, 1.50%, resulting in an average interest rate spread of 0.95%. This was a decrease of 76 basis points from the 1.71% annualized interest rate spread year over year and a 7 basis point decrease from the average 1.02% interest rate spread for the preceding quarter. On Dec. 31, 2012, the weighted average yield on investment securities was 2.75%, compared to 1.55%, the weighted average cost of funds on borrowings, including the net interest payments on interest rate swaps, resulting in an interest rate spread of 1.20%.

Fixed-rate Agency mortgage-backed securities and debentures formed 93% of the investment portfolio as at Dec. 31, 2012, while the balance of 7% consisted of adjustable-rate Agency mortgage-backed securities and debentures.  As of Dec. 31, 2012, interest rate swaps amounted to a notional amount of $46.9 billion, making up 40% of the company’s agency mortgage-backed securities and debentures.

Completion of CreXus acquisition

Annaly Capital Management, Inc. (NYSE:NLY) also announced that it has reached a definitive agreement with Crexus Investment Corp (NYSE:CXS) to acquire, for $13.00 per share in cash (plus a payment instead of a prorated dividend), all the shares of CreXus that it does not currently own. CreXus is a specialty finance company that acquires, manages and finances commercial mortgage loans and other commercial real estate debt, commercial mortgage-backed securities, and other commercial real estate-related assets.

“This transaction represents a significant step toward Annaly’s commitment to investing directly in commercial real estate assets,” commented Wellington Denahan, Annaly’s Chairman and Chief Executive Officer.  He added that “this transaction is part of a broad evolution of our capital allocation strategy. Our commercial real estate expertise, as well as our capabilities in other asset classes, are valuable strategic tools, and we look forward to updating the market on our portfolio as it evolves.” There are other highlights to the deal. It will add immediately to taxable earnings and dividends per share. It confers a strategic advantage on Annaly Capital Management, Inc. (NYSE:NLY) because of the diversification into commercial real estate assets. It also provides a scalable platform for commercial assets combined with the strength of Annaly’s capital base.

Peers

Now that the CreXus acquisition has been finalized, it is time to look at a peer to analyze the commercial real estate asset markets. Starwood Property Trust, Inc. (NYSE:STWD) is in the business of origination of and investment in commercial mortgages and other commercial debt.  The company reported record fourth-quarter earnings with an eye-popping 38% jump in non-GAAP core earnings in the last quarter of 2012, and a 37% increase in net income compared to the same quarter of the previous year.

Starwood Property Trust, Inc. (NYSE:STWD) excels in the business of commercial real estate and mortgages, and has been busy expanding its reach by making new deals. The company originated over $1 billion in loans in just the fourth quarter of 2012, and in January Starwood Property Trust, Inc. (NYSE:STWD) agreed to purchase LNR Property.  The deal has been described by an analyst from Stifel Nicolaus as “major-league transformative.” Starwood’s CEO Barry Sternlicht has observed that money is moving from fixed income securities to real estate as values begin to recover. Bloomberg reported that commercial property prices have risen 38% over the past two years.  Based on its track record and the growth potential of commercial real estate values, I would rate the stock as a Buy.

The recovery of the housing market is creating a recovery in the jumbo mortgage market (these are large mortgages that are granted to wealthy home buyers). These loans have not been popular since the financial crisis mainly because they are not insured by any government sponsored entity, and are therefore considered risky.

With that said, one mREIT that has been receiving some attention lately is Redwood Trust, Inc. (NYSE:RWT) , which has been packaging and selling jumbo mortgage-backed securities, and doing so profitably. Jumbo loans have been growing as the housing market for high-end property rebounds.  In New York, for example, the jumbo market on Long Island in the first six months of 2012 has grown to $4.3 billion, in comparison to $2.4 billion for the first half of 2011. Jumbo loans in this region are defined as loans exceeding $625,000, though in other areas the figure is lower at around $400,000.

Another trend that is helping to boost this market is the growth of the non-agency MBS market. With the Fed’s QE3 program keeping down yields in agency MBS, the growth of private label securities has accelerated. Redwood Trust, Inc. (NYSE:RWT) has been leading the pack and has introduced several such offerings to the market since 2010. These securities have consisted of loans to credit-worthy borrowers, and there have been no defaults since Redwood started marketing these instruments. As a result, Redwood Trust, Inc. (NYSE:RWT) showed net income of $42 million in the latest quarter compared to a $3 million loss year over year. The market for jumbo loans is expected to grow by 15% this year, and as long as the housing market continues to improve, this stock looks like a good investment.

Annaly is easily the largest and arguably the best-managed of the companies in this industry. Borrowing costs should stay low at least through 2015 judging by the pronouncements of the Fed. I expect the company to maintain a double-digit dividend yield, which makes it an excellent investment for income investors. Investors should consider buying the stock with the expectation of enjoying these returns over the next few years.

The article Annaly Is Still The Best Pick In REITs originally appeared on Fool.com and is written by Maxwell Fisher.

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