NEW YORK--(BUSINESS WIRE)--
Annaly Capital Management, Inc. (NYSE: NLY) ("Annaly" or "the Company")
released its monthly commentary for February. The commentary, set forth
below (but without graphs), addresses and updates the Company's views on
the economy, the residential mortgage market, commercial real estate
finance and the overall markets. The complete commentary, as well as
other research and opinion pieces, can be found at the Company's website
at www.annaly.com/commentary.html:
The Economy
The economic rout intensified in February, with bad data releases on
housing, jobs and consumption, and equity markets continuing to take
back years of gains. The revised estimate of 4th quarter GDP
growth came in worse than anticipated at a negative 6.2% annualized
rate, the worst since first quarter 1982. The number of initial jobless
claims has stayed above 600 thousand for five straight weeks, and
continuing claims rose over the 5 million mark for the first time ever
(measurement began in 1967). The economy has now lost 4.4 million jobs
since January 2008, 2.6 million jobs in the past four months alone. To
give a sense of how deep and sharp these losses are, in the 17 months of
consecutive job losses from August 1981 to December 1982, the economy
lost 2.8 million jobs. US auto sales (cars and light trucks of all
manufacturers) plummeted to a 9.1 million seasonally adjusted annual
rate, down 40% year-over-year. Manufacturing activity is running at just
72% of capacity, a level of slack exceeded to the downside only by the
70.9% level in December 1982. Housing starts, permits, and sales all got
even worse. Housing starts are starkly weak, reflecting the oversupply
in the market. In January just 466 thousand houses were started (at a
seasonally adjusted annual rate), the fourth month in a row that a new
all-time low has been set and a decline of almost 80% from the recent
peak in January 2006 when homebuilders were cranking up at a 2.27
million annual rate. Home prices have now declined by 27% from their
peak in the summer of 2006 (using the S&P/Case-Shiller 20 MSA composite
index).
Not coincidentally, February was also the month in which the Obama
Administration launched its multi-pronged attack on the problem. The
main thrusts of the attack are to fix the economy (with the stimulus
package and a budget with trillions in deficit spending), the housing
market (the Housing Affordability and Stability Plan) and the country's
banking system (the Capital Assistance Program). We are not economic
forecasters, but we think our country's ills will get worse before they
get better; the business cycle must be allowed to run its course and
boom must be followed by bust. A great boom like the debt-bubble boom of
2002-2007 must be followed by an equally great bust like we are in right
now. The Administration should not make the mistake of trying to prevent
that from happening, or else it risks a repetition of the lost decade of
Japan or, worse, causing a new bubble with the cure. The best that the
Administration should hope to do is avoid the kind of collapses along
the way that would make recovery impossible.
To that end, the banks were a focus in February. The S&P 500 finished
down 11% for the month, with the KBW bank index falling more than 15%
and money center banks collapsing to ridiculous lows, as the market
discounted the probability of nationalization. Contributing to these
concerns is the new-found appreciation for bank TCE, or Tangible Common
Equity. After a laser-like focus on Tier 1 capital, bank regulators'
preferred metric, the shift in attention to the stricter TCE ratio marks
an important change. The differences between these two capital adequacy
measures are stark. Tier 1 uses a fairly loose definition of equity
capital that includes some questionable items: "equity-like" hybrid
securities, deferred tax assets (DTAs), and other intangibles. Also,
unrealized losses in available-for-sale securities are not included,
effectively inflating the ratio. The denominator of this ratio is
risk-weighted assets, calculated by a formula that gives varying weights
to asset classes based on their perceived risk.
The TCE ratio is a much simpler measure of capital adequacy, although
much more demanding. This metric divides tangible common equity by total
tangible assets. Preferred stock and hybrid securities and intangibles
like goodwill and DTAs are excluded. Unrealized mark-to-market losses
are included. Total tangible assets are not risk-weighted. Clearly, the
TCE ratio is the more conservative measure of bank balance sheet health,
and it will also be the more onerous method if it is the focus of the
government stress tests that are a part of the new Capital Assistance
Program (CAP). Details of the CAP have been discussed elsewhere ad
nauseum so we won't delve into it here, but in brief, bank capital will
be stressed under a base case and a more severe scenario, and those
banks that are found wanting will have access to government-provided
"contingent common equity." Which ratio will be used to determine
capital adequacy is unknown, but the CAP seems to be leaning toward TCE.
One piece of evidence for this bias is the following quote from a
Treasury white paper on the CAP (http://www.treas.gov/press/releases/reports/tg40_capwhitepaper.pdf)
that defends the conversion of government capital injections from
preferred equity to common equity: "Market participants pay particular
attention to common equity as a measure of health in stressed
environments, and regulators have long believed that common equity
should be the dominant component of a banking organization's highest
quality forms of capital."
In any event, the largest banks in the US have razor thin TCE ratios.
According to SNL, the median TCE ratio for publicly-traded banks and
thrifts with assets greater than $1 billion is in the neighborhood of
6.5%. The biggest banks are even lower. And there is a lot of headwind
for the banks, as the negative factors contributing to profitability in
the fourth quarter of 2008 vs the fourth quarter of 2007 far outweigh
the positive. In the fourth quarter of 2008, FDIC-insured commercial
banks and thrifts lost $26.2 billion, the first time since the fourth
quarter of 1990 that the industry posted an aggregate loss, with one out
of three banks reporting a loss. Banks still have work to do on loan
loss reserves. Even after more than doubling loan loss provisions from
the fourth quarter of 2007 to $69.3 billion, our nation's banks still
found their aggregate coverage ratio (loan loss reserves as % of
non-current loans) declined to a 16-year low of 75% (typically this
number is above 160% in healthier times). Until banks get ahead of their
loan loss reserve deficiencies, they will not be able to enjoy the
positive effects of the steep yield curve that Ben Bernanke has
engineered for them.
The Residential Mortgage Market
The market is closely watching prepayment speeds to gauge the effects of
policy decisions that are clearly designed to instigate a refinancing
wave. Prepayment speeds in February (March release) did come in faster
month over month amid lower rates and potential increased capacity. The
aggregate 30 year Fannie Mae prepayment speed rose 34% to 23.1% constant
prepayment rate (CPR) from 17.2% CPR. Speeds for 30 year Fannie Mae 6.5s
and 7s were slower on average than 5s through 6s due to likely credit
impaired profiles for higher coupon borrowers. Looking ahead, most
dealers are anticipating a moderate increase in speeds in the near term
due to increased day count coupled with increased seasonality, with
perhaps a more dramatic increase by May or June on the relaxation of
mortgage insurance requirements and LTV guidelines. However, there is a
minority view that is predicting speeds to decline 10% to 20% next month
due to the back-up in mortgage rates in late January and February.
Borrowers may be waiting for a better entry point.
While prepayments will be driven in the immediate term by mortgage rate
movements and credit factors, in the longer run the dominant determinant
of the marginal prepayment will be the success of the Housing
Affordability and Stability Plan. We published our initial thoughts on
the HASP last month ("The Impact (and Advisability) of the Homeowner
Affordability and Stability Plan" http://www.annaly.com/impactfeb09.pdf),
in which we concluded that the program will likely fall short of the
hoped-for results and that prepayment speeds will therefore come in more
slowly than expectations based solely on rate-related refinanceability.
Among the reasons we listed were frictions associated with industry
administrative capacity and credit availability, borrower documentation
and credit history, little opportunity for equity withdrawal, and
significant Fannie Mae and Freddie Mac guarantee fees. The only update
to this analysis is based on news from last week, when the
Administration released more details on the mechanics of the program,
particularly the loan modification component, and Freddie Mac announced
that it was significantly reducing its guarantee fees. The
Administration's update contained little that addressed the frictions
above, but the Freddie Mac announcement was meaningful. In brief,
Freddie Mac has waived loan level pricing adjustments that would
typically scale higher for lower FICO scores and higher LTVs, as well as
removing the lender's obligation to make representations and warranties
about the value of the borrower's house. These changes (which we assume
Fannie Mae will have to match in the weeks ahead) will reduce some of
the frictions that would otherwise reduce prepayment speeds. These
changes notwithstanding, we believe that the market will see some
sustained increase in speeds but not the type of peak speeds witnessed
in the 2003 refinancing boom.
The Commercial Mortgage Market
For the last few years of the bull market, commercial real estate
lending had taken a 'Field of Dreams' approach. Instead of "If you build
it, they will come," the mantra was "If you finance it, it will
perform." In the short run this has clearly been the case: In January
the aggregate default rate for CMBS was only 1.1%. Storm clouds are on
the horizon, though, as we believe that some of the very optimistic
underwriting pro formas will not materialize. Two transactions in our
hometown of New York, Stuyvesant Town/Peter Cooper Village (Stuy Town)
and the Riverton, illustrate how these business models will lead to
disaster for the lenders.
Stuy Town and the Riverton are two large scale, middle income housing
projects that contained a number of rent-stabilized units. They were
never the sort of properties that made commercial real estate finance
headlines until the properties passed into private hands. The new
owners' strategy, the foundation of the debt's feasibility, was to
convert these rent-stabilized units into de-regulated units and then
raise all units to market rents.
To acquire Stuy Town in November 2006, the buyer (Tishman Speyer) needed
debt financing of $4.4 billion at a weighted coupon of 6.38%. Annual
debt service was $280.7 million. At closing, 73% of the units were
rent-stabilized and the property generated net cash flow (NCF) of
approximately $112.2 million, which translates to a 2.1% cap rate at
acquisition. The annual debt service shortfall of $168 million would be
supported by various reserves totalling $640 million funded at closing.
NCF was projected to grow to $334 million by 2010 through annual
conversion and market rent growth rates of 11% and 8%, respectively.
Although cash flow has suffered because of higher expenses and smaller
increases in market rents, the rating agencies downgraded the CMBS
backed by this mortgage primarily because the new owners could not
convert as many units as planned. Historical conversion rates have
typically been in the 6% range, nowhere near the assumption used for
Stuy Town. Naturally, they have remained in the single-digit range since
closing. Is this surprising? It wouldn't have been if anyone had
bothered to speak with Rose Associates, the property manager from 2002
until April 2007. It would appear that the lenders and rating agencies
failed their due diligence on this assumption.
Although the Riverton employed a similar business strategy to Stuy Town,
the $250 million of financing proceeds completed in December 2006
allowed the owners, Stellar Management and Rock Point Group, to cash out
some equity, pay down debt and fund reserves. When the deal closed, the
Riverton was already over 50 years old and had only 55 fair market units
out of a total of 1,230 apartments. By 2012, the owners projected that
650 of the complex's apartments would be converted to fair market units,
an increase of 595 from closing. By July 2008, the property had only
converted 128 units, more than 100 behind schedule. Anyone who thought
this through at the beginning should have clearly seen that the
conversion assumptions were unrealistic.
Stuy Town and the Riverton may be unique properties, but they are
emblematic of the bull market mindset. Both are confronting debt default
as debt service reserves have been burned through and net cash flows
haven't grown. Market events like these will weigh on the market in the
coming months, which will hurt legacy portfolios already reeling from
market softness but open up terrific investment opportunities for
lenders and buyers with fresh capital. Ultimately, we are hopeful that
in this next investment cycle investors, lenders and rating agencies
will remember what used to be the primary rule of commercial real estate
underwriting: the only income to underwrite is the current income of the
project.
The Markets
Global stock markets continue to decline, as the discounting mechanism
factors in weaker growth outlook and corporations slash dividends. In
2008, 61 companies in the S&P 500 cut their dividends a combined $40.6
billion. Just two months into 2009, that number has already been beaten,
as 33 companies have cut an additional $40.8 billion in dividends. Banks
are leading the capital preservation effort; financials now account for
less than 11% of the index's dividend income, down from a peak of 30%.
At the current rate, dividend income is expected to fall 23% in 2009,
which would make it the biggest decline since 1938. The dividend yield
on the S&P 500 is now 3.6%, higher than the 30-year Treasury.
MOM YOY
2/28/2009 1/31/2009 2/29/2008 % change % change
Fed Funds 0.25% 0.25% 3.00% 0.0% -91.7%
2-year US Treasury 0.974% 0.950% 1.620% 2.5% -39.9%
10-year US Treasury 3.015% 2.842% 3.511% 6.1% -14.1%
10-year JGB 1.280% 1.297% 1.365% -1.3% -6.2%
10-year euro 3.112% 3.296% 3.891% -5.6% -20.0%
10-year UK Gilt 3.623% 3.704% 4.469% -2.2% -18.9%
10-year Canada Treasury 3.131% 3.050% 3.640% 2.7% -14.0%
30 yr conventional mortgage 4.759% 4.724% 5.728% 0.7% -16.9%
Dollar Index 88.01 85.99 73.71 2.3% 19.4%
Japanese Yen 97.96 89.93 104.21 8.9% -6.0%
S&P 500 735.09 825.88 1330.63 -11.0% -44.8%
Nasdaq Composite 1377.84 1476.42 2271.48 -6.7% -39.3%
Gold $/oz (nearby contract) $942.50 $927.30 $975.00 1.6% -3.3%
Oil $/bbl (nearby contract) $44.76 $41.68 $101.84 7.4% -56.0%
MBA Refi Index (month end) 3063.4 3906.3 2569.0 -21.6% 19.2%
Source: Bloomberg; Japanese Yen quote is the London feed
March 10, 2009
Jeremy Diamond
Managing Director
Kevin Riordan
Director
Ryan O'Hagan
Vice President
Robert Calhoun
Vice President
This commentary is neither an offer to sell, nor a solicitation of an
offer to buy, any securities of Annaly Capital Management, Inc.
("Annaly"), FIDAC or any other company. Such an offer can only be made
by a properly authorized offering document, which enumerates the fees,
expenses, and risks associated with investing in this strategy,
including the loss of some or all principal. All information contained
herein is obtained from sources believed to be accurate and reliable.
However, such information is presented "as is" without warranty of any
kind, and we make no representation or warranty, express or implied, as
to the accuracy, timeliness, or completeness of any such information or
with regard to the results to be obtained from its use. While we have
attempted to make the information current at the time of its release, it
may well be or become outdated, stale or otherwise subject to a variety
of legal qualifications by the time you actually read it. No
representation is made that we will or are likely to achieve results
comparable to those shown if results are shown. (C)2009 by Annaly Capital
Management, Inc./FIDAC. All rights reserved. No part of this
commentary may be reproduced in any form and/or any medium, without our
express written permission.
This news release and our public documents to which we refer contain or
incorporate by reference certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended.
Forward-looking statements which are based on various assumptions (some
of which are beyond our control) may be identified by reference to a
future period or periods or by the use of forward-looking terminology,
such as "may," "will," "believe," "expect," "anticipate," "continue," or
similar terms or variations on those terms or the negative of those
terms. Actual results could differ materially from those set forth in
forward-looking statements due to a variety of factors, including, but
not limited to, changes in interest rates, changes in the yield curve,
changes in prepayment rates, the availability of mortgage-backed
securities for purchase, the availability of financing and, if
available, the terms of any financing, changes in the market value of
our assets, changes in business conditions and the general economy,
changes in government regulations affecting our business, our ability to
maintain our qualification as a REIT for federal income tax purposes,
risks associated with the broker-dealer business of our subsidiary, and
risks associated with the investment advisory business of our
subsidiaries, including the removal by clients of assets they manage,
their regulatory requirements and competition in the investment advisory
business. For a discussion of the risks and uncertainties which could
cause actual results to differ from those contained in the
forward-looking statements, see "Risk Factors" in our most recent Annual
Report on Form 10-K and any subsequent Quarterly Reports on Form 10-Q.
We do not undertake, and specifically disclaim any obligation, to
publicly release the result of any revisions which may be made to any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
Source: Annaly Capital Management, Inc.
Contact: Annaly Capital Management, Inc.
Investor Relations
1-888-8Annaly
www.annaly.com