NEW YORK--(BUSINESS WIRE)--
Annaly Capital Management, Inc. (NYSE: NLY) released its second quarter
2012 market commentary providing a review of the economy and the
residential mortgage, commercial mortgage, asset-backed, corporate
credit and treasury markets. Through its quarterly commentary Annaly
expresses its thoughts and opinions on issues and events it monitors in
the financial markets. Please visit our website, www.annaly.com,
to view the complete
commentary with charts and graphs.
The Economy
The world keeps getting flatter. In addition to items of specific
domestic importance, the things that may drive sentiment in US fixed
income and equity markets on any given day could include Spanish
government bond yields, Chinese manufacturing or German unemployment.
And while European headlines and “Fedspeak” are driving the current
conversation, the horizon remains clouded with the uncertainty of the US
election, regulatory flux and visions of a fiscal cliff.
The noise level has risen, and during the second quarter of 2012 the
financial markets reacted with a flight from risk. The S&P 500 fell
2.75% during the second quarter, but is still up 9.49% year-to-date. The
ten-year Treasury ended the quarter at 1.65% versus 2.20% on March 31,
2012, and 1.88% on December 31, 2011. The US Dollar trade-weighted index
rose 2.4% in the second quarter and remains higher by 1.5% for the year.
Commodities, as measured by the CRB Index, remained in a bear market
that began in early 2011. They fell 7.9% in the second quarter and are
down 7% YTD. The CRB index remains at levels similar to late 2004.
In general, scanning the incoming economic data in the second quarter,
the world seems to be in the midst of a global slowdown. Eurozone
manufacturing activity as measured by its Purchasing Managers Index
stands at 45.1 in June and has been indicating contraction since August
of 2011. Unemployment across the EU has risen to a record 11.1%. China’s
PMI came in at 48.2 in June, and excess inventories of metals in China
have been widely reported, another non-government indicator suggesting a
slowdown.
The US is in similar condition. The pace of US nonfarm payroll growth
has declined significantly, from +275 thousand in January 2012 down to
+80 thousand in June. Private nonfarm payrolls averaged only +91
thousand in the second quarter of 2012, significantly slower than the
+226 thousand average of the previous quarter. Real disposable personal
income per capita remains stuck at the same levels of May 2007. Retail
sales are down two months in a row, and the International Council of
Shopping Centers chain store sales index is growing at its slowest pace
since 2009. The Institute of Supply Management (ISM) manufacturing
survey declined to 49.7 from near 55 in April (its lowest level since
2009). The non-manufacturing sector ISM came in at 52.1, the lowest in
more than two years. Headline inflation has continued to slow
meaningfully, down to 1.7% in May from 3.9% in September 2011. Inflation
expectations, as measured by five-year TIPS breakeven rates, have also
declined to 1.7% at quarter end from near 2.2% in March 2012. Corporate
earnings warnings have also increased in the second quarter: As of the
end of June, 94 companies in the S&P 500 had issued negative guidance
versus only 26 positives, the worst ratio since the second quarter of
2001.
Central banks around the globe responded to the slowdown, cutting rates
(the ECB, China, Australia, for example) and extending various balance
sheet programs (the Fed, the Bank of England). These actions soothed
markets and investors, and potentially helped ease the slowdown in
business activity, but there seems to be a shift in sentiment amongst
the central bankers of the world. The annual report of The Bank for
International Settlements (BIS), released in June, contained sharp
criticism regarding the world’s growing dependence on constant central
bank liquidity:
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“Any positive effects of easing monetary policy may be shrinking
whereas the negative side effects may be growing.”
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“…there is a growing risk of overburdening monetary policy.”
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“A vicious circle can develop, with a widening gap between what
central banks are expected to deliver and what they can actually
deliver.”
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“…low short- and long-term interest rates may create risks of renewed
excessive risk-taking.”
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“…aggressive and protracted monetary accommodation may distort
financial markets.”
The BIS is no small think tank. The BIS, in its own words, is the “bank
for central banks.” The current board of directors consists of the head
of every major central bank, all recognizable names: Bernanke, Draghi,
Carney, King, Noyer, Shirakawa, to name a few. That the BIS annual
report takes such a strong tone toward the limits of monetary policy
should be noted, not only for the self-criticism, but also for the
message that is being sent to those government officials who are holding
the fiscal policy strings.
Indeed, central bankers have their work cut out for them, but they are
only a part of the broader policymaking apparatus. Take the United
States, for example. Even after several years of deleveraging, the ratio
of total debt-to-GDP remains high by historical standards.
The total debt/GDP ratio peaked around 385% in the first quarter of 2009
and has now declined to near 350%. (Total debt includes household,
non-financial business, financial sector and all government debt.) The
financial sector has seen the most deleveraging: Total financial sector
credit market debt outstanding is down by $3.4 trillion dollars, a 20%
decline since the fourth quarter of 2008. Household debt has declined by
roughly $900 billion over the same period, a 6% decline.
At the same time, the Federal Reserve has been aided by a $5.5 trillion
increase in federal government debt, about double the amount from 2008,
and a $1.1 trillion increase in nominal GDP. But a return to the
total debt-to-GDP level of 2000 (around 265%) suggests a reduction in
total debt of $13.6 trillion. Policymakers here and around the world
have some hard decisions to make.
Residential Mortgage
Market
The second quarter of 2012 proved yet again the resilience of the agency
mortgaged-backed securities (MBS) market. Despite the unsettling
headlines regarding the continuing European sovereign debt crisis,
spreads between the 30-year Fannie Mae current coupon and the ten-year
US Treasury ended the quarter just eight basis points (bps) wider than
where they began. This is due to a number of factors, such as the
perceived superior credit quality of agency MBS, the support of the
Federal Reserve and relatively tame prepayment speeds. While overall
prepayment speeds remain muted relative to rates, the 30-year mortgage
universe has undergone a fairly dramatic change over the past two years
(see Table 1 in our online
version). This change has come courtesy of lower rates and a
multitude of programs under the Making Home Affordable Act that aim at
mortgage modification via principal reduction, second lien forgiveness
or rate reduction.
The two most significant programs launched under the Making Home
Affordable Act are the Home Affordable Modification Program (HAMP) and
the Home Affordable Refinance Program (HARP). While most estimates put
HAMP modifications at roughly one million, the combined efforts of HARP
1.0 and 2.0 are expected to generate up to three million refinancings by
the time the program ends on December 31, 2013. In tandem with
government sponsored programs, roughly three million creditworthy
borrowers with equity in their homes have refinanced the old-fashioned
way by taking advantage of lower rates. As a result, the
weighted-average coupon (WAC) on the 30-year Fannie Mae universe has
decreased 46 bps over the past two years from 5.22% to 4.76%.
Commercial Mortgage Market
The desire for yield has continued to support demand for commercial real
estate investments. It hasn’t hurt that the underlying fundamentals have
painted a picture where the glass is half-full rather than half-empty.
Demand has been strong, as evidenced by the Federal Reserve Bank of New
York’s auction of its Maiden Lane III portfolio, announced in April. The
auctioned bonds were the senior portions of two CDOs issued in 2007 and
2008 which contained approximately $7.5 billion of securities. The
announcement was not a surprise given that Maiden Lane II had
successfully sold its remaining securities, but there was a concern that
the market would be negatively affected by the significant supply of
bonds hitting the market. Those concerns were unfounded, as the market
digested the supply with good execution for the Fed.
Commercial real estate valuations show that the market is stabilizing if
not improving. For example, the NCREIF National Property Index
registered a 2.59% positive gain according to the latest release. While
this is slightly less than the 3.0% to 4.0% increases that were achieved
quarterly since the second quarter 2010, it was nonetheless the ninth
consecutive quarterly increase. The revamped Moody’s commercial property
price index also showed a far greater recovery of commercial real estate
prices. This index now shows a nearly 28% increase since the low
observed in early 2010. We believe that pricing is being driven by the
need for current return as well as real estate’s traditional role as an
inflation hedge.
CMBS yields are relatively attractive for fixed income investors in this
low-interest rate environment, thanks to a relative scarcity of
investable product and muted levels of new issuance volumes. Issuance is
projected to be approximately $25 to $30 billion for 2012, basically in
line with 2011 levels. In this environment, investors can consider
opportunities across the capital stack, from AAA CMBS with coupon floors
to higher rated mezzanine tranches that provide additional yield.
Asset-backed Securities (ABS) Market
Supply ramped up sharply during the second quarter of 2012 versus the
second quarter of 2011. Auto issuance continued to dominate supply but
there was also increased issuance in credit cards, fleet lease,
equipment, student loans, and global RMBS. Total ABS issuance
year-to-date is approximately $104 billion versus $67 billion for the
first half of 2011. Halfway through 2012, we are just $32 billion short
of total issuance in 2011.
Issuance has been met with strong demand, with several deals getting
upsized and most launching at tighter spreads than initially expected.
Additionally, several deals (credit card, prime and subprime auto) were
done on reverse inquiry from several large investors. Demand remains
particularly strong in subordinated tranches of prime and subprime auto
and heavy equipment deals as investors continue to hunt for higher
yielding securities.
The collateral story remains positive for most of the subsectors.
Collateral performance in the consumer and equipment segments remains
strong. According to Fitch, cumulative losses in the prime auto segment
hit record lows during the quarter. While delinquencies were modestly
higher in June, they remain well below prior year levels. Performance in
the subprime auto segment was more mixed. Aggregate delinquencies have
been trending higher but annualized net losses were lower on a
month-over-month and year-over-year basis. In the credit card space
nearly all trusts saw lower delinquency and charge-off rates on a
month-over-month and year-over-year basis for the May 31st
reporting period.
During the quarter, a number of subordinated tranches from older vintage
auto and equipment deals were upgraded by one or more ratings agencies.
Improved recoveries, tight underwriting standards on 2010 and 2011
vintages and deleveraging of transactions due to the sequential pay
structures (resulting in increased credit enhancement levels) were the
key drivers of the upgrades.
In this season of market uncertainty, the ABS market continued to show
the benefits of its collateral and structure. As reported by the Bank of
America/Merrill Lynch ABS Index, the asset-backed sector generated a
quarterly return of +0.28%, driven by strong performance in manufactured
housing, autos, utilities and equipment, and credit cards. More
importantly for indexed investors, the asset-backed sector earned 131
basis points of excess returns versus comparable Treasury securities for
the first half of 2012.
Corporate Credit Market
“Quality yield” is a rare thing these days, particularly as the
underlying government rates of core developed countries continue to
grind towards zero thanks to their safe haven status and various forms
of quantitative easing. The behavior of the high yield (HY) market last
quarter was a case-in-point: as equities sold off and Euro sovereign
woes re-emerged, the HY market’s commensurate sell-off was very
short-lived. The behavior of the riskiest end of the yield spectrum
drives home an important market reality: There is tremendous demand for
“quality yield” and not a lot of it.
The macro-induced volatility of last quarter served as a double-edged
sword for HY technicals. First, yields rose and investors built cash to
protect against outflow risk. Second, issuers either pulled deals or sat
on the sidelines. New issues tapered off each successive month of the
quarter, with the June print at a mere $10.2 billion, or 6.8% of total
2012 supply. While ETFs experienced outflows at the first emergence of
renewed macro risk, the stability that higher yields brought to flows is
an example of the underlying demand for “quality yield.” Against the
“risk-off” backdrop in the second quarter, the share-count of a basket
of the most liquid high yield ETFs rose 3.9%, while by quarter’s end the
market yield was unchanged.
A more comprehensive measure of supply-side technicals is the par
outstanding balances of the fixed income benchmarks. They are a good
proxy for net supply because they incorporate not only gross new
issuance but also calls, tenders, and maturing bonds. Based on Bank of
America’s Merrill Lynch (BAML) Bond indices, the growth of “quality”
high yield— single- and double-B— has slowed dramatically from two years
ago (see Table 2 of our online
version). For those with yield needs, it’s a bit sobering to accept
that the growth of the investible universe of dollar fixed income is
concentrated in Treasurys (currently yielding on average 0.96%) and
investment grade (3.31%). The reality is that it’s hard to find 5%
yielding assets, let alone 8%.
Another source of yield that is being diminished is hybrid capital
securities. The U.S. preferred stock index, for example, has a current
yield of 5.5%, but this market is on the cusp of dramatic shrinkage.
Under Basel III, Trust Preferred securities (TRups) will no long qualify
as Tier 1 capital. In early June, the Federal Reserve released its
Notice of Proposed Rulemaking (NPR) regarding the implementation of
Basel III capital rules for U.S. banks. The NPR specifies that the Fed
will follow Basel guidelines for the phase-out of TRups as Tier 1
capital, making them expensive sub-debt. Many U.S. banks view the NPR as
the trigger of the regulatory-event par call in most TRups indentures.
Since the majority of these securities have high coupons, several banks
have stated that they will call outstanding TRups. According to
Barclays, of the $87 billion TRups outstanding, $61 billion have coupons
below 6%, and thus are potentially callable.
Treasury/Rates Market
Price movement in Treasurys in the second quarter of 2012 was similar to
the same period last year: the market rallied and yields trended lower
as economic data weakened and European concerns continued. The move this
year, however, was more of a flattening trend as front end yields have
been anchored near record lows. Over the quarter, the two-year was
richer (or lower in yield) by only three bps while the five-, ten- and
thirty-year fell in yield by 32.5 bps, 56.5 bps, and 58 bps respectively.
The auction schedule was unchanged in the second quarter from the first,
with the Treasury auctioning off $501 billion of nominal notes and
bonds. The tone out of Europe has led to solid auction statistics for
most of the quarter as the flight to quality bid was the dominant theme.
April and May had the strongest auction results across the curve. New
issue thirty-year bond auctions have been the hardest for the market to
digest but May’s auction saw strong enough demand for it to come 2.5 bps
richer than where it was trading just prior to the auction deadline. The
end of June brought about a different result for the two-, five- and
seven-year auctions. While these auctions have typically been on the
stronger side of late, all three had weaker auction statistics and came
at yield levels cheaper (or higher in yield) than where they were
trading just prior to auction.
At the June 20th FOMC meeting, the Fed’s policy committee
announced it would extend “Operation Twist” through the end of the year.
The operation will include sales and purchases totaling about $267
billion. The FOMC also reiterated their “late 2014” rate guidance and
downgraded their economic outlook. The market seemed to be hoping for
more clues on whether “QE3” might be a reality but that will likely have
to wait until the August 1st meeting.
One of the market’s favorite charts is the Citigroup Economic Surprise
Index, an objective and quantitative measure of how economic news
relates to expectations. Chart 2 in our online
version graphs the index compared with ten-year Treasury yields. As
the Citi index has been steadily declining all year (ie, actual data has
generally come in below consensus), ten-year yields have mostly followed
suit, with one exception: In the latter part of March some market
participants made the painful mistake of anticipating better data only
to see yields revert back lower as the economic data continued to weaken
and Europe deteriorated. It will be interesting to see if the market
makes the same mistake again.
*Please direct media inquiries to Jeremy Diamond at (212) 696-0100
This material is not intended to be relied upon as a forecast,
research or investment advice, and is not a recommendation, offer or
solicitation to buy or sell any securities, including securities of
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sole discretion of the reader. ©2012 by Annaly Capital Management,
Inc./FIDAC/Merganser. All rights reserved. No part of this commentary
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Annaly Capital Management, Inc.
Investor Relations
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www.annaly.com
Source: Annaly Capital Management, Inc.