NEW YORK--(BUSINESS WIRE)--
Annaly Capital Management, Inc. (NYSE: NLY) released its monthly
commentary for April and announces the launch of its redesigned website.
Michael Farrell, Chairman, Chief Executive Officer and President of
Annaly, said, "It is my hope that our redesigned website is useful for
our shareholders, and that all investors continue to visit for the
latest news and commentary from the company." Through its monthly
commentary and blog, Annaly
Salvos, Annaly expresses its thoughts and opinions on issues and
events in the financial markets. Please visit our re-designed, user
friendly website, www.annaly.com,
to check out all of the new features and to view the complete commentary
with charts and graphs.
The Economy
Economic data released in March was generally more positive than in
previous months, but was still somewhat spotty. Weekly initial
unemployment claims continued to drift lower, keeping in place the trend
that began a year ago when claims peaked out at 651,000. The 4-week
moving average is now down below 450,000, which is in the right
direction but still high by historical standards. Markets cheered the
addition of 162,000 nonfarm payroll jobs in March, the largest increase
since March of 2007. After accounting for 48,000 temporary Census
workers, and 81,000 jobs added by the so-called "birth/death
model", what is left seems to be a recovery only when compared to
the steep job losses of the previous few years.
The manufacturing sector received more good news in March, with durable
goods, factory orders and industrial production all continuing to
presage recovery. While the pace of expansion has been steady, each of
these metrics still remains well below pre-recession levels. These
readings confirm the slew of positive manufacturing indices, among them
the Institute for Supply Management's Purchasing Managers Index, which
is now at levels not seen since 2004 and 1987 before that.
Inflation remains under wraps. Headline CPI came in flat month-to-month
in February, and core CPI is up just 1.3% year-over-year. Certain money
supply figures have recently begun to turn down; MZM dropped roughly $50
billion in the week of March 22, and our measure of adjusted M2 (M2 plus
institutional money funds) fell nearly $75 billion during the same week.
Home price data during the month showed that prices were slightly up or
slightly down, depending on your index of choice. The Case-Shiller
20-city index showed a slight seasonally-adjusted gain, while the FHFA
and RealPerformance indices were both moderately lower. February
existing home sales have come back down to earth since the initial tax
credit spike (down to 5 million units from the recent peak of 6.5
million in November of 2009, both on a seasonally adjusted annualized
basis). New home sales actually put in a fresh series low of 308,000
units. The extended homebuyer tax credits are set to end by June 30,
2010, but contracts need to be signed by the end of April. We could see
another temporary blip in sales as potential buyers rush to use the
expiring credit.
GDP was "finalized" for the 4th quarter of 2009 during the
month, revised down to 5.6% in the third reading from the advance
estimate of 5.7% and a second look of 5.9%. The bullet points in the
BEA's accompanying technical note highlighted the downward revision of
nonresidential construction, a lower inventory contribution and lowered
personal consumption expenditures. Real final sales remained weak and
got weaker with each subsequent revision to the data, dropping to 1.7%
from 1.9% in the second look and 2.2% in the advance report.
Much attention has been paid to the rebound in corporate profits, which
are up over 30% from a year ago, according to data from the Bureau of
Economic Analysis. So far, it appears that this profit growth has been
concentrated in the financial sector. A graph of domestic corporate
profits (available in our online
version) shows that the rebound in financial sector profits brings
them back to within 7.5% of record profits earned in 2006, while
non-financials are still more than 24% below their previous peak. In
fact, 80% of total corporate profit growth during the trailing 4
quarters is attributable to the financials. Banks are the mechanism by
which the Fed's stimulative monetary policy is transferred to the rest
of the economy, so it makes sense that low rates and a steep curve will
first benefit the financial sector. However, falling loan portfolios and
a massive buildup of excess reserves at the Fed suggest that the
mechanism isn't yet functioning properly. This liquidity trap could be
having the effect of muting the recovery in non-financial sectors, and
the economy as a whole.
The Residential Mortgage Market
Prepayment speeds in February (March release) on 30-year Freddie Mac
collateral experienced a significant month over month spike. The surge
was due to the Agency's February 10th announcement to
purchase "significantly all" of the 120-day or more delinquent loans
from MBS pools within the month of March. In aggregate, 30-year Freddie
Mac speeds came in at a Constant Payment Rate (CPR) of 42.3 (an increase
of 28.0 CPR, or 195%). Broken down by coupon, speeds came in as follows:
4.5% at 5.7 (essentially flat); 5% at 28.2 (+89%); 5.5% at 49.2 (+170%);
6% at 67.2 (+250%); 6.5% at 78.3 (+355%); and 7% at 83.6 (+429%). In
comparison, aggregate Fannie 30-year speeds were actually down, coming
in at 14.7 CPR compared to 15.4 CPR in the prior month. Across the
coupon stack, Fannie Mae 30-year MBS with coupons ranging from 4.5%
through 6.5% prepaid at 3.5 CPR (-26%), 11.9 CPR (-16%), 18.5 CPR (-5%),
22.7 CPR (+4%) and 22.0 CPR (+7%), respectively. Unlike Freddie, Fannie
will be prioritizing buyouts over the next several months based on
"loans in MBS having the highest pass-through rates" and "loans having
the highest unpaid principal balances." Therefore it is reasonable to
assume that speeds on higher coupon MBS will experience significant
increases first in the March factor tape (April release) with the lower
coupon MBS speeds increasing in the forward months as they complete
their buyout program. While detrimental to holders of MBS at a premium
in the short term, the completion of Fannie Mae and Freddie Mac's
combined buyout program of delinquent loans will benefit long term
investors in MBS in that it will create a universe of higher quality
assets.
During the week of March 29th the Federal Reserve completed
the final purchases in its $1.25 trillion MBS purchase program. Was the
money well spent in stabilizing the bond market? According to Bank of
America/Merrill Lynch, in Harley Bassman's March 15th
commentary, "Bringing the Boat to Harbor While not Taking out the Dock,"
the answer is a resounding yes.
In their commentary BAML uses four metrics to judge the overall
effectiveness of the program. For the first, duration (as measured by
the cost of that duration, i.e., the yield on a 10-year Treasury), they
point out that the current rate on the 10-year Treasury, roughly 4%, is
within striking distance of where it was when the crisis first hit in
force in September of 2008. The second metric is credit spreads, as
measured by BAML High Yield (Junk Bond) Master Spread Index, which
measures the spread of the high yield index to Treasuries. As Bassman
notes, the index is in the mid 500s which is "barely 60 bps above the
decade long average of 487bps," down from the crisis level peak of about
1300.
Another indication of how well a market is functioning is implied
volatility, which is just a few percentage points above its long term
average. The fourth metric discussed by BAML is the spread of the par or
current coupon MBS to 10-year swaps. While this spread, or the basis, is
slightly "rich to the long term average of 72bps, when you remove the
'Lehman Debacle' from the dataset, the 'true' average since 1997 has
been about 66bps."
It is hard to pin causality on any one variable in a complex market, but
it would be difficult to look at the hard data and say that the MBS
purchase program--as a one tool of many the Fed has deployed over the
past three years--has been anything but a stabilizing force for the bond
markets over the past eighteen stormy months. As for its effect on
housing, the jury is still out.
The Commercial Mortgage Market
On March 31, 2010, the Federal Reserve ended its support for the legacy
Commercial Mortgage-Backed Securities (CMBS) Term Auction Loan Facility
(TALF) program. Briefly, the program enabled purchasers of seasoned
AAA-rated CMBS to apply to the Fed to finance their acquisitions
approximately 5.6 times with either 3-year or 5-year, non-recourse loans
at a rate of Libor +100 bps. The Fed's other TALF program to lend
against newly-issued CMBS is set to expire June 30, 2010. The purpose of
the legacy TALF program was to generate increases in the value of these
securities, help start the securitization markets and provide room on
investor's balance sheets for new investments. This month we take a look
at the impact of the program.
Since the announcement of the program in May 2009 spreads across
TALF-eligible AAA rated CMBS have tightened considerably, thereby
increasing the prices of the related securities. As seen in the graph in
our online
version, depending on the tranche, spreads have rallied anywhere
from 200 to 800 basis points.
If 'a rising tide lifts all boats,' then the program appears validated
by the overall price appreciation realized by the sector. In addition,
the TALF-inspired rally of CMBS unequivocally aided the incipient
recovery of the commercial mortgage securitization market.
As the market now moves past government support, the question for the
market is how these senior bonds will perform from a relative value
perspective. Since the final subscription date, the benchmark GSMS
2007-GG10 A4 class, a security that was NEVER submitted to the Fed, has
rallied by approximately 40 basis points to an offering level of swaps
plus 370 basis points. On a select basis, we also looked at bonds that
had been most recently rejected by the Fed such as the WBCMT 2006-C29 A4
class. With a recent cover bid of swaps plus 193 bps, this security is
pricing in line with TALF-approved submitted securities. It would appear
that any TALF tiering may be dissipating. However, as we have observed,
spread tightening has been fueled by technical factors including
significant capital allocations to fixed income in sectors where product
is scarce.
Finally, a word on the TALF process. Securities submitted to the Fed for
financing had to meet certain objective eligibility requirements (i.e.
two AAA ratings, no securities on watch or downgrade, etc.), although
the Fed maintained its exclusive right to reject collateral submitted.
While we believe the investable market for TALF-eligible CMBS is
approximately $400 billion, the Fed only provided $12.3 billion in
financing. Of the 549 bonds submitted (representing 293 discreet CUSIPs)
in nine different subscription periods, 44 were rejected. It is not
known who submitted each bond, or in what amount. Of the 44 bonds that
were rejected, 27 were consistently rejected by the Fed while 17
submissions were initially accepted and then rejected. It should be
noted that most of this flip-flopping occurred towards the end of the
program. And although the rejection rate of 8.0% did not seem overly
troublesome, market participants nevertheless expressed chagrin about
the opaqueness of the Fed when publishing its rejected collateral.
Overall, we rate the program a success, although the Fed may have been
just plain lucky for launching it in the midst of strong money flows to
fixed income products.
The Corporate Credit Market
In the lexicon of finance the term "positive feedback loop" is not
without its synonyms. Among them, the term "virtuous cycle" describes
the process that is fostering the continued improvement in the corporate
credit market and the commensurate tightening in valuations. Firms
continue to exploit the abundance of liquidity flooding into the capital
markets. High yield companies have issued debt at a record pace, with
refinancing constituting the bulk of the proceeds. Debt maturity
profiles have extended, fixed-term coupons are low, and firms are
replacing bank debt with less restrictive high yield bonds. At the same
time, investors have been rewarded for taking risk with return, which
has propelled risk appetite and opened the door for the return of the
credit crisis' "fallen" for the first time in two years. The recent
opening of the primary market to formerly distressed financial credits
reflects the maturing of credit's virtuous cycle. But the cycle has one
glaring imperfection - low absolute yields. A change in the interest
rate regime is the foremost threat to future performance.
Credit enjoyed a strong first quarter. Good earnings, strong inflows, a
material decline in corporate defaults/fallen angels, and the
uncertainty-reducing passage of health care reform contributed to
performance. In the cash market, investment grade and high yield bonds
posted quarterly returns of 2.7% and 4.8%, respectively. Within the IG
segment Financials outperformed (4.8%), despite heavy issuance of $84.1
billion of index-eligible debt or 427% more than Q1-2009. IG Financial
bonds' yields dropped a hefty 43 bps to 4.80% and now trade only 19 bps
wide relative to their IG Industrial counterparts, a spread last seen in
the pre-calamity period of late 2007. Similarly, in HY, risk
differentials are compressing. Triple-C bonds returned 6.5% in Q1-2010
and at 11.87% their yield vs. double-B bonds stands at 483 bps, the
tightest levels since early 2008.
The reach for yield and positive returns continues to drive inflows into
the fixed income asset class. In 2009, net inflows into bond mutual
funds represented over 30% of total assets at the end of 2008. In
contrast, both money market funds and equity funds experienced net
outflows. This year, net inflows into debt asset classes range from 1.9%
to 19% higher than 2009. Interestingly, loan funds are among the most
popular funds this year. We suspect this partly reflects the appeal of
floating rate assets given widespread expectations of rising long-term
rates. The table in our online
version shows net inflows across asset classes since 2005. The old
adage that "flows follow returns" is evident. In 2009, money market
funds, for example, experienced sharp outflows. Likewise, in 2008, the
last net outflow year for high grade bonds, total returns were -6.82%.
Lastly, some "rate protest" is evident in HY: at the end of 2005, the
BAML HY index was only producing 8.13% of yield. At the time, 3-month
LIBOR was 4.5%.
Clearly, absolute yield, yield relative to short term rates and total
return are powerful drivers of demand for risky credit assets. While the
curve is likely to remain steep for an "extended period," low asset
yields and the prospects of higher Treasury rates present the biggest
risk to the performance and demand for corporate credit. Currently, both
the IG and HY market have become more sensitive to both spread and rate
duration. While firms began extending debt structures aggressively last
year, we suspect part of the aggregate duration effect in the market was
offset by the Fed's purchases of mortgage securities. Now, with the Fed
out of the picture, the outlook for long-term rates has changed. First
quarter returns were helped by the fact that Treasury rates held in at
the end of the quarter. But more recently, the 10-year Treasury yield is
close to breeching its sub-4% trading range.
The chart online
paints the picture: as issuers have termed out debt and dollar prices
have risen, the average effective duration of the market-- as defined by
the BAML combined IG and HY cash index-- has increased. While the index's
par dollar value outstanding has grown by 12% over the past year to
$3,755 billion, it has grown a massive 26% on a 10-year Treasury
duration-equivalent basis. So when considering the virtuous cycle in
credit, beware of its duration.
April 9, 2010
Jeremy Diamond*
Managing Director
Robert Calhoun
Vice President
Ryan O'Hagan
Senior Vice President
Mary Rooney
Executive Vice President
*Please direct media inquiries to Jeremy Diamond at (212)696-0100
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. Results for the fund, if
shown, include dividends (when appropriate) and are net of fees. (C)2010
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.
Source: Annaly Capital Management, Inc.
Contact: Annaly Capital Management, Inc.
Investor Relations
1-888-8Annaly
www.annaly.com