Thursday, October 06, 2005

Why I like Annaly Mortgage? NLY as a short term trade

This will be a first post of a stock I like -- a rarity due to my bearish posture, even rarer in the sense that I believe the housing bubble will soon implode. Having said that, I have absolutely no idea the timing of that happening. So my guide will be fundamentals and technicals, both of which will be my beacon of light in the darkening clouds of storm soon to hit the financial markets GLOBALLY.

Fundamentals: NLY is basically a hedge fund (one of the best in my opinion), by borrowing somebody's money, leverage it 9:1 and buy AAA rated MBS (Mortgage Backed Securities - to put it simply - your mortgage and my mortgage that may have been sliced and packaged in several forms). It's income is basically the spread between the assets and what they pay in interests. Times are good when spreads widen but recently spreads have been narrowing to the point of inverting (spread between 10yr and 2 yr treasure is as low as 12 bps at one time).
NLY also pays out almost all of its interest income in the form of dividends. Yields were as high as 10% at a time but due to the narrowing spread, NLY were forced to cut those dividends to only about 4% at current prices.

NLY has a book value of $12.5, which is what it is trading at right now with a yield of 4%. For a fiancial company such as NLY, book value is what you get literally if the company liquidates today, because they don't own many fixed assets such as a steel company that may need to be auctioned at prices most investors couldn't appraise.

Off course, there's always a chance that stock trades below its book but for that to happen, there may have to have yield curve inversion first. I personally believe there is a good chance that this may happen, however, I have learned from my investment career that don't invest in what you believe in (as you can be wrong in big picture, especially timing of which) but what you think you could make money on given the risk rewards. And I'll use negative yield spread as my exit signal or stock hit lower than $11.9 on a closing basis, whichever comes first. At that time I'll reevaluate and likely reinvest at a lower price.

The other risks, is off course, credit risks. 75% of its MBS are agency-guaranteed with 25% not. We could debate all day the debacle of the agency debt but I believe in the likely event of defaults, FNM and FRE will guarantee most of it in the first on slaught of defaults. Subsequently as situations get worst, then it is anyone's guess what's going to happen. So we have at least 75% of its asset taken care of, and the other 25% are all AAA rate as well. This is at least managable. Frankly, the best time to buy financials are when credit defaults manifest themselves to the fullest and there is fear on the Street. Then, you'll know who is the best credit risk manager and back-up the truck. That is the reason I'm shorting many financials but put a gun to my head, NLY would be the one I'm comfortable in buying (I may have said investing but buying for a short term trade is the only viable option due to my bearish stance).

This post is for educational purposes only and is not advice for buy and sell the aforementioned security! The blogger may have a position (long/short) on any of the securities mentioned in this blog


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