Paid 13% To Do Nothing: Annaly (NYSE:NLY)

Co-authored by Treading Softly

There’s a famous country song that’s titled “Waiting on a Woman.” The entire concept behind the song is that the singer, when he passes away, will find a place on the other side to wait on his wife since he’s been waiting on her his entire life. He loves waiting on her. Sometimes, being patient or the willingness to be patient provides greater returns than those who decide to rush off.

When it comes to the market, so many of us are unwilling to be patient. The average holding time for an investment has dropped from several years to several days. This is because it’s easy to pull out our smartphone, grab a flashy investing app, and punch in a buy or sell order rapidly. Brokerages encourage this behavior because it rewards them with the ability to sell order flow and maximize their profits off of your trades.

As a professional income investor, I take a very different approach. I decide that when I buy something, I’m going to hold it for the long term – barring any unforeseen circumstances. This means that when I own an investment that pays a strong dividend, I have nothing more I need to do. I’m paid to do nothing, and I love every second of it.

Today, I want to look at a company that has been beaten down as Treasury prices have fallen. It owns very low-risk securities but does amp up the risk to a degree because of its use of leverage. I’m paid to wait as I know Treasury prices and interest rates aren’t likely to stay where they are forever.

Let’s dive in!

Paid to Wait

Annaly Capital Management(NYSE:NLY), yielding 13.2%, is the oldest mortgage REIT that specializes in “agency MBS.” Agency mortgage-backed securities are mortgages that are guaranteed by the agencies – Fannie Mae and Freddie Mac. They’re AAA investments that are generally considered as low risk as US Treasuries. If a borrower defaults, the agency buys back the mortgage at par value.

For the past three years, having an asset that correlates strongly with US Treasury prices has not been a positive. US Treasuries and agency MBS prices have seen their largest sell-off of all time as interest rates have risen at a rapid pace.

NLY‘s business model is to invest in agency MBS using leverage, and leverage amplifies the volatility of price changes.

NLY has responded to declining MBS prices by buying more. We can see that in nine months in 2023, NLY sold just under $20 billion in MBS and received $4.5 billion in principal paydowns (MBS are amortizing, so some principal is paid every payment). It bought $30 billion in MBS. Source

NLY was also a net buyer of agency MBS in 2022: Source

NLY acquired approximately a net of $7 billion.

This is a stark change in strategy from 2021: Source

Note how NLY sold $11.4 billion and received $17.8 billion in principal paydowns, yet only reinvested $18.9 billion into new MBS. Why? Because MBS was expensive in 2021. In 2020, NLY allowed its portfolio to decline even more dramatically, buying only $33 billion while receiving principal of $19.5 billion and selling $52.3 billion. Source

When we look at the five-year MBS prices, we can see that NLY allowed its portfolio to shrink the most when prices were high in 2020 through 2021: Source

However, through 2022 and 2023, NLY was a net buyer of MBS. The difference is even more dramatic if we look at the par value of the MBS NLY holds: Source

In December 2021, NLY had $60.2 billion in fixed-rate MBS by fair value, but the face value was only $56.2 billion. Today, that has flipped: Source

NLY owns $65.8 billion in market value, but $71.2 billion in face value.

So if you’ve heard that “NLY is being forced to deleverage!” or “NLY is selling MBS at huge losses!” or “NLY can’t hold its MBS to maturity,” you heard wrong.

As MBS prices have declined, NLY hasn’t been a net seller. NLY was a net seller when MBS prices were very high in 2020 and 2021. For the past two years, NLY has been buying MBS. Yes, it does do some trading, selling some MBS and buying others, but the overall size of its portfolio demonstrates that NLY sold when MBS prices were high and has been buying as prices are lower. This will be a huge benefit to NLY’s book value as prices go up.

MBS prices have bounced up with the belief that the Fed is going to pivot and cut rates. Whether this is a “dead cat” bounce that will lead to another run back to recent lows, or whether the bottom is in and the MBS rebound will continue is an unknown, and that will determine the near-term future for NLY’s book value and, ultimately, its share price. However, in the big picture, MBS is clearly trading at cheap prices, every bit as much as it was clearly trading at premium prices in 2020/2021. NLY shrunk its portfolio in 2020/2021 and has been growing its portfolio for the past two years. That is a positive for future returns when MBS prices recover.

NLY reports earnings on Feb. 7.

Conclusion

When I was young, I grew up in the north. Everyone was in a hurry. We all walked fast. We all talked fast. We had things to do and places to go. We did not like to wait.

Now that I live in the South, people walk slower, and talk slower – or perhaps talk more. Even though there are pressing things that need to be done, there is much less of a rush. It’s a different mindset entirely.

When it comes to your retirement, the last thing you want to do is dance between investments. You want to be able to hold the investment you own and own it for the long run. With NLY, we get the option to hold something and know that in the future, it will benefit when interest rates decline. In the meantime, all you need to do is get paid to do nothing. Just hold your shares and enjoy your life while you wait for the cycle to turn.

You worked your entire life for this retirement. Enjoy it!

That’s the beauty of the Income Method. That’s the beauty of income investing.