NEW YORK--(BUSINESS WIRE)--
Annaly Capital Management, Inc. (NYSE: NLY) released its monthly
commentary for May. 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 website, www.annaly.com,
to check out all of the new features and to view the complete commentary
with charts and graphs.
The Economy
Headlines about Greek debt worries dominated most of the last month. The
cost of insuring Greek sovereign debt started the month at around 400
basis points (bps) and hit 1,300 bps before closing the month out around
1,000 bps. Worries about contagion to the rest of the PIIGS (Portugal,
Ireland, Italy, Greece and Spain) and the wider effects of bank exposure
to these debt-burdened sovereigns brought volatility back to the markets
as the month wore on. How this crisis is handled will have a wide range
of consequences—for the Euro, for funding markets and for the global
economy. At the time of this writing, the Euro has broken below 1.30
against the US dollar, Greece is rioting, the EU and the IMF have joined
forces for an unprecedented bailout of Greece, and the Fed and other
central banks have reopened US dollar swap facilities to ease tensions
in European short-term funding markets. To paraphrase from an earlier
time, this is not contained to Greece.
Back on this side of the Atlantic, incoming data are confirming a slow,
grinding recovery for the US economy. Industrial production and capacity
utilization both improved, though the gains are moderating and the
levels remain far below pre-recession norms. The job market seems to
have mostly leveled out, which compares well to the experience of the
last two years of steep declines. Initial unemployment claims have spent
much of the year in the mid-400 thousand range—better than the worst
levels of early 2009, but in line with some of the worst levels of the
past two recessions. Private employers added 231,000 jobs in April,
while the unemployment rate rose to 9.9% and the duration of the
unemployed continued to lengthen.
A sluggish job market isn’t stopping the consumer from loosening his
purse strings. Despite stagnant real income that is still more than 2%
lower than it was in September of 2007 (even including massive aid from
government transfer receipts), real personal consumption expenditures
(PCE) rose to brand new highs in March. In light of this, it’s not
surprising that the consumer took center stage in the BEA’s recent
release of first quarter 2010 GDP. Real growth came in at 3.2%, a
moderation from 5.6% growth in the previous quarter. PCE contributed
2.55%, or 80% of total economic growth. The star of the show in the
previous quarter, change in inventories, added 1.57% to GDP. While still
relatively strong, this was down from the prior quarter’s 3.79%.
The GDP release reveals one segment of the economy that has not
participated in the recovery: state & local governments. This segment
was one of the larger negative contributors to growth during the quarter
(as shown on the chart in our online
version), and has been getting worse for three quarters running.
Real consumption and investment by state and local governments shrank
3.8% on an annualized quarterly change basis, and the drag on real GDP
growth of -0.48% is the worst since the double-dip recessions of the
early 1980s. On a nominal year-over-year basis, growth in consumption
and investment by state and local governments is just back into positive
territory after three straight quarters of negative readings, the first
in the post-war period. On an annual basis, nominal state and local
consumption and investment fell in 2009 for the first time since 1943.
A look at the absolute level reveals this quarter’s year-over-year
growth to be a disappointment, the result of an “easy comp” due to the
dip in the first quarter of 2009, as illustrated on the chart in our online
version.
The trend remains sideways. It’s hard to imagine a quick resurgence in
growth from this sector, which represents 12% of GDP, given what we know
about the
finances of state and local governments. Our economy is a portfolio
of diverse activities, so we strive to stay focused on the range of
recovery scenarios. Nevertheless, since almost every economically
important activity is correlated to employment, for the moment we are
left cautiously pessimistic.
The Residential Mortgage Market
As anticipated, prepayment speeds in March (April release) on 6.5% pools
and greater increased dramatically, due to the execution of Fannie Mae’s
previously announced delinquency buyout program. (See last
month's commentary for a discussion of Freddie Mac’s buyout
program.) Speeds on 30-year 6.5s and 7s increased to 80 and 99 CPR,
respectively, from the prior month’s reading of 22 and 25 CPR,
respectively. This is the first of four consecutive monthly buyout waves
investors will experience from Fannie Mae’s program that will last
through June and will occur in descending coupon order. On the
aggregate, speeds on Fannie Mae 30-year fixed rate collateral increased
to 27.7 CPR from the previous 13 CPR. To put it in context, Freddie Mac
aggregate prepayment speeds rose from 14.3 CPR in the month before that
company’s buyout program began to 42.3 during the (only) month of their
buyouts and back down to 17.9 CPR last month. Looking ahead, speeds on
30-year 6% Fannie Mae pools in April should experience increases similar
to this month’s jump in 6.5% pools as the remaining 120+ day
delinquencies are purchased out of the pools.
With a full month now elapsed since the completion of the Federal
Reserve’s mortgage-backed securities (MBS) purchase program, how has the
market fared with the largest buyer now on the sidelines? A good
indicator is the spread of the current or par coupon MBS over the
10-year US Treasury, which increased only marginally from 68 bps on
March 31 to 73 bps on April 30. However the yield on the 10-year US
Treasury during the same period decreased from 3.828% to 3.655% so MBS
should have widened during this period regardless as investors would
demand more spread for the increased prepayment risk they are exposed to
as a result of the rally.
Certainly the market for Agency MBS has been supported by its relative
liquidity and attractive yield, as well as increased buying power from
the buyout program and the Fed’s accommodative stance. However, it may
also be the legacy of the purchase program itself that is partially
aiding MBS, and here’s why: even though the purchase program is now
complete, the Federal Reserve has not taken delivery, or possession, of
all the $1.25 trillion in Agency MBS it has purchased. During the
program the Fed purchased MBS for settlement in the “out” or future
months in the “to-be-announced” or TBA market as origination was
insufficient to meet their buys. Nomura Securities estimates that the
Federal Reserve still has to take delivery of roughly $54 billion in
Agency MBS, primarily in the form of 30-year 4.5s. While origination is
more than sufficient to satisfy dealer delivery to the Fed, it fails to
account for the natural buyers of lower coupons, including the bid for
fixed rate collateral from the CMO structured product market. CMO
issuance increased 5% month over month. As a result of these factors the
available supply will decrease, also helping to support the market.
The need to meet these forward deliveries could push back the ultimate
completion of the Fed’s MBS purchase program for some time.
The Commercial Mortgage Market
The first multi-borrower CMBS transaction since June 2008 was launched
by Royal Bank of Scotland (“RBS”) and Nataxis Real Estate Capital
(“Nataxis”) in late March and priced on April 9. The $310 million
conduit transaction consisted of conservatively leveraged, commercial
mortgages to six different borrowers, five of which were originated by
RBS and one contributed by Nataxis. The small pool size and the fact
that three of the mortgages were secured by single properties, permitted
investors to underwrite all of the loans. The pool was comprised
primarily of retail properties (66.3%) and office properties (32.7%).
Market participants greeted this modestly-sized transaction with
enthusiasm. While certain structural shortfalls observed previously in
CMBS transactions were addressed, the transaction still highlights some
of the hurdles the CMBS market must overcome before it resumes its place
as a dependable source of permanent funding for commercial real estate.
This transaction was completed on an ‘agented’ basis by RBS, meaning the
mortgages in the securitization were funded at or very close to the
pricing date. This highlights the unwillingness of banks to devote
balance sheet capacity for the warehousing of mortgage loans. Lenders
have simply been unwilling to assume the aggregation risk since the
securitization market seized up. Low transaction volumes coupled with
recent memories of spread volatility have not exactly opened up the
warehouse finance spigot either. The CMBS industry has requested that
the Fed consider providing warehouse financing, arguing that this is
consistent with TALF financing provided for AAA-rated securities in a
newly issued CMBS transaction, but the Fed thus far has been unwilling
to agree.
The significant rally in spreads over the last nine months resulted in
the senior and junior AAA securities priced at 80 and 90 basis points
over swaps, respectively, for yields of 2.35% and 3.68%. The subordinate
tranches, AA down to BBB-, were priced to yields of 4.71% to 7.06%,
respectively. As a result, fixed-rate mortgage coupons were set near the
pricing date and now range from 4.21% to 4.28% for five year terms for
the mortgage borrowers. Whereas the underwriting bank previously
warehoused the mortgages and stood to make the most profits from this
transaction, the borrowers were the beneficiaries of the agented
transaction.
As indicated, the transaction was conservatively financed. The
securitized debt service coverage and loan-to-value ratios for the pool
were 2.40 times and 54.4%, respectively. The overall debt service
coverage and loan-to-value ratios for the pool were 1.82 times and
63.7%, respectively. The split between securitization debt and overall
debt is significant because it illustrates the hesitancy of underwriters
to create tranches that will carry a below investment grade rating. Any
transaction-related debt that would result in a below investment grade
rating is privately placed outside of the securitization trust. While
capital is available for commercial real estate debt investment, prudent
risk management practices, low deal volumes and recent memories will
continue to temper the amount of warehouse financing available for
conduit transactions and, by extension, investable conduit product.
May 10, 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,
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including the loss of some or all principal. All information contained
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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. ©2010
by Annaly Capital Management, Inc./FIDAC. All rights reserved. No
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Source: Annaly Capital Management, Inc.