InvestStorm: 2013

Events have overtaken this blog, so, for the record, here is a selection of “time stamped”' commentary (from Seeking Alpha) with some concise notes/charts. For a not very concise look at Seeking Alpha contributions click here.

The selected commentary relates to Annaly Capital (NLY) and TBT, TLT, MREITS, Agency ABS, Treasuries, QE and Fed policy, and specifically ties in with prior blog posts “Still Twisting and Turning”, 24 May 2012, “Operation Twist Is Totally Skewed”, 22 March 2012. It's worth noting that Bernanke has, until very recently (in fact, more clarity was provided at yesterday's Fed meeting, but significant uncertainty remains), not defined concrete policy as it relates to QE.

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Annaly Will Continue To Deliver Strong Returns Despite Near-Term Challenges [View article]

I was highlighting the term "value investor" as it's not common to combine value investing with being a technician. In your article you highlight chart patterns - no one will miss that aspect of your analysis, but the "value investor" aspect appears missing (at least in terms of a Ben Graham inspired take on the term).

Your response to the "QE" issue is correct, at some stage it will end, but I'm sure you'd agree that the Fed's demand for agency paper drives up the price of these investments. No one is saying that 40 billion/month purchases is not affecting the agency paper market, and no one has succinctly identified the correlation between low agency backed mortgage rates and unemployment. Then again, maybe the Fed will proclaim "mission accomplished" if the unemployment rate hits 7.6% again, or maybe the program will be canned when Bernanke retires - who knows.

Now, your specific comment regarding QE 2 and 10 year yields... well, the purpose of the Fed's "Operation Twist", or whatever term people chose for it, was to reduce long term rates, so Fed open market activity favored longer term bonds. This explains the action of the 10 year versus the 30 year, and it'd be hard to avoid agreeing with the consensus - which is that the "twist" accomplished what the Fed set out to do (lower long term rates). That the economy rebounded is also true, but the interest rate environment was shaped by the Fed.

Back to QE 3. In a rate environment where the 30 year recently yielded less than 2.5% being happy with double digit yields is logical. But, we've seen that the Fed is a powerful force, and for the foreseeable future they've decided to decrease agency backed mortgage yields. While the Fed suppresses these yields they also engage in other substantial open market activities, but what it all amounts to, for MREITs, is a lot of uncertainty while they face increased reinvestment risks.

MREITs have been hurt by Operation Twist because mortgages tend to have long maturities, and QE "infinity" further damages their prospects as they have to compete for paper with the Fed.

Finally, is it logical to listen to MREIT senior management complain about the environment and trust that they've found a safe passage protecting shareholders' expectation of a double digit return? It seems like there's ample scope for hoping that things turn out well for MREIT investors - I'll leave you with a George Savile quote:

"Hope is generally a wrong guide, though it is good company along the way."

Nov 3 08:37 AM

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A Low-Risk, High-Reward Way To Play American Capital Agency Now That It Has Broken Down [View article]

The strategy can be altered... but the problem you're up against is that there aren't many options on MREITs which trade efficiently - you're left buying the shares (entitling you to collect the dividends), buying a put (to limit your risk), and selling a call (to reduce the price of buying the put) as the most obvious strategy, but when you look at the huge bid/ask spreads... Anyone who firmly believes that these companies are not in peril, could try simply selling an in-the-money call to mitigate some downside risk, but there's no way to escape the fact that it's a minor and inefficient hedge.

Nov 2 09:32 AM

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A Low-Risk, High-Reward Way To Play American Capital Agency Now That It Has Broken Down [View article]

Also, thinly traded options on AGNC makes this company, over time, a worse vehicle than NLY. Even NLY is thinly traded... in fact, there's no "efficient" MREIT options play - where positions can be rolled with minimal slippage. MREIT options are for position traders.

Nov 1 07:35 PM

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Analysis: The American Capital Agency And Annaly Capital Management Share Buybacks [View article]

Take it to its logical extreme.. don't fight the Fed: liquidate the entire portfolio, don't buy back any shares but wind up operations and return the proceeds to shareholders, then delist and go golfing.

"Managing" an agency portfolio right now equates to fighting the Fed. Share buybacks, expensive hedging strategies, lobbying in DC etc etc is not serving shareholders - only preserving management's pay packets. The Fed's program is a gift to managers ethical enough to cash up and exit the sector.

MREIT managers can easily protect shareholders interests - these are not large "head-count" firms, and they're not managing illequid assets (it's not like winding up GM).

Oct 31 06:16 PM

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Should mREITs Copy Annaly's Stock Buyback? [View article]

Have to add this... cashing up provides the best "risk adjusted return" - maybe this term will get some people to look at the situation again.

Oct 19 09:44 AM

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Should mREITs Copy Annaly's Stock Buyback? [View article]

The financially right thing to do is to sell out to the Fed (as per my above comment - I wasn't joking).

The distortion caused by the Fed's current program is, right now, helping agency investors, tomorrow it will hurt these same investors as they try to find new paper.

Chances are that non of the MREIT managers will cash up, but that remains the right thing to do. Investors like picking through the rubble of failed industries, dreaming of the good old days and wishing for their return, but it's no way to professionally manage money. Gambling on the end of QE "Infinity" is an obvious mistake.

Finally, the reason the MREIT managers should sell out and exit the market is because they "can". These managers aren't employing tons of people, they're not loaded up with goodwill, intangible assets, glorious corporate headquarters and other illiquid assets. They have the option to wrap up, cover their repos and outstanding hedges, and return the cash (plus the "Fed" incentive bonus) to shareholders. The fact that they won't protect shareholders' interests we'll all put down to managerial greed and incompetence, but, in the final analysis, we won't say that they were powerless to do so.

Oct 19 09:35 AM

[Today's snapshot]

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Should mREITs Copy Annaly's Stock Buyback? [View article]

The NLY buyback is a mistake - the reasons "why" are too numerous to count... almost.

Seriously, a leveraged agency MREIT with the right management would take the Fed's higher bid (above current book value), cash out and hand over the proceeds to shareholders.

NLY and other leveraged agency investors are up against the Fed, and they'll keep being up against the Fed every single day until the Fed decides unemployment has hit some undefined target level. Linking unemployment with agency rates is beyond problematic - let's put it this way, there's probably not a single hedge fund manager out there who'd dream up the correlation (and these guys are used to dreaming up some pretty unusual and unsound correlations).

So back to NLY, management is supposed to work for shareholders - not scramble for a way to support the share price while they pursue an against-the-odds lobbying campaign in DC. Perhaps they're gambling on Romney getting in and all of QE Infinity being canned.... well, guess what, it doesn't change what they should do today: cash up and surrender - the leveraged agency industry has been nationalized!

Oct 18 02:36 PM

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Annaly Capital Management - Love It Or Hate It? [View article]

Anyone quoting five year returns are going to be posting good numbers during the next one to two years. We all recognize that historical returns aren't a guarantee of future performance, but, in the "game" of presenting performance, five year data sets have certainly been more robust/representative than they're now - perhaps we need to look at two and ten, or more, year data sets to develop a more balanced view of performance. No doubt, 2013 will be a year offering the marketeers fantastic five year statistics with which to mislead the sheeple.

Back to the agency MREITs, now that the Fed is in the process of nationalizing the agency paper investment industry, its tempting to figure out some shorts... Best to wait for the halo effect of portolio appreciations to diminish first though.

Oct 9 04:59 AM

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QE - Infinity: A Game Changer For Mortgage REITs [View article]

1. Banks earn fees sourcing loans.
2. The Fed has effectively nationalized the agency mortgage investment industry.
3. MREITs will post higher book values, thanks to the Fed bid.
4. Fed action now, "QE3", is focused on the agency market - watch the other yields drift up and be thankful you're not under a mandate to invest in agency paper (like some MREITs).

The author's insights, concerns and analyses are all spot on, and he can probably afford to hold on for his last dividend payments. Let's see if any of the agency MREIT managers have the integrity to cash up (sell out to the Fed at the new higher bid).

Sep 27 05:45 PM

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Should Investors Follow Macquarie's Lead When It Comes To The REIT Sector? [View article]

Mr Schilling, thanks for posting and giving us a quick summary. If you have the chance, in a report with comparisons, it'd be valuable to look behind the headline numbers, have a look at the cash flow statements, and, since your main worry is spread compression - assess how you think profits will shape up under different conditions (basically do a quick sensitivity study).

My contention is that the ongoing business of making leveraged investments in agency paper has effectively been nationalized. The Fed's $40 billion/month market action will cause MREITs to have negative spreads (the Fed's clearly stated that their focus is agency paper, and they've more than hinted at the fact that they'll tolerate higher inflation indicators). Agency MREITs will face higher finance costs, higher hedging costs, and lower yields on agency paper.

If we only faced spread compression then all would be good, relatively speaking.

I'm not short any MREITs... yet; it's probably worth holding off until their portfolio appreciations, thanks to QE3 have been processed, then have a look through their statements to analyze cash flow.

Sep 26 04:13 AM

[And now, today, one chart tells the story:]

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Annaly Will Reduce Its Dividend, But The Balance Sheet Remains Strong [View article]

The Fed has nationalized the mortgage investment industry.

Driving agency debt values higher and yields lower via a constant purchase program until unemployment is lower leads to spread "compression" below zero.

Sep 20 03:35 PM

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Intelligent REIT Investing: Recognizing Risk In Good Times And Bad [View article]

"Yield compression" is a term that implies constant positive numbers, but in this headline dominated market "compression" may result in a net negative yield - try that on for size if you're a leveraged MREIT. Portfolio appreciation is great if you're a flexible portfolio manager (you take your gains and move on), but if you're an MREIT manager you're faced with a well defined mandate and no exit (forced to stick with your core business of investing in mortgages) options. Fed action in the mortgage market, until unemployment numbers are down, may, depending on how much they distort the market, create carnage. Finally, while the Fed recognizes that they're about to massacre private mortgage investors, and while they'll agree that this is a shame, an unemployment solution is the number one priority - it's just unfortunate that their analyses have led them to link nationalizing the mortgage market with getting people back to work.

Sep 18 03:00 PM

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Retirement Strategy: Buy Any Dips In Dividend Winning Stocks [View article]

The term "spread compression" implies a squeeze, but perhaps these terms are wrong, as they don't allow for a negative spread environment.

The Fed is, no doubt, aware of what a negative interest rate equation would do to leveraged mortgage investors. The two questions are:

1. Will Fed intervention lead to a negative spread scenario for MREITs? As the Fed competes for mortgage books with other investors, yields will decrease (stated Fed objective); the concern is that the focus of the latest Fed action will drive these yields below the cost of shorter term debt finance.

2. Considering the Fed's mandate and current intentions, is it likely to act to preserve/respect the interests of leveraged mortgage investors? A mortgage market without private investors seems like a surreal situation, but if the Fed's open ended commitment, both in terms of time and funds, translates into flattening the mortgage paper yield curve while simultaneously creating yield parity with any and all forms of other paper, then there's no spread (and for private companies subject to a market which imposes a risk premium, a negative spread).

I'm wondering if the Fed has just told us that they're going to buy mortgage debt, come-what-may, until unemployment is lower... this is what they've said isn't it?

Sep 17 05:35 AM

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Why QE3 Can't Work: Understanding The Liquidity Trap [View article]

Bernanke believes targeting agency paper will drive down costs in the mortgage market. The proposition is simple and is simply that: anything that reflates the housing market and causes increased velocity/liquidity will, at this juncture, have a series of positive knock-on effects.

Bernanke might be right or wrong, the price to pay later might prove to be too high, but, right now, this is what the Fed have decided to do. And, right now, this has created a whole series of short and medium term trading/investment opportunities - and capital will be reallocated as fast as: 1. traders digest, 2. analysts analyze, 3. investment committees meet, 4. and investors are persuaded.

But back to Bernanke and the Fed again, if you've got their mandate what would you do (never mind the politicians, global agendas etc - as these are obviously nothing but wild cards in any game)? What I'm suggesting here is that the Fed move was basic and simple, and merely reflected 1. what they could do, and 2. something they've not already tried (the lack of skew shows us that this is not a "one, two" combo move).

Sep 16 12:08 PM

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Retirement Strategy: Buy Any Dips In Dividend Winning Stocks [View article]

In the MREIT arena there's the concept of spread compression to reconsider.

The Fed just verified that the basic business premise is sound (borrowing short term to buy longer term debt), but if the Fed targets the purchase of agency backed mortgage paper, then we can expect these assets to appreciate in value (in this current "risk on" environment, the "appreciation" may only be apparent in relation to other similarly rated and dated debt) - making it harder for the MREITs to continue benefiting from their basic business. In the medium term, this headwind will be offset by portfolio appreciation, but nobody is going forecast a maintenance of the spread.

It'd be interesting to do a few sensitivity studies to determine various spread compression vs asset appreciation scenarios. At a guess, the "mechanics" would look like this:

1. higher leverage = greater appreciation
2. longer duration = greater appreciation
3. fixed rate > ARMs appreciation
4. shorter term financing > longer term/hedged spread

Most of the MREITs have a mix of the above, plus, to outsiders, proprietary/"black box" repo/hedging programs... and then there'll be the people saying that a mere $40BN/month by the Fed in the agency market is irrelevant.

No MREIT exposure currently.

Sep 16 10:04 AM

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Annaly Capital Management: Point-Counterpoint With Regarded Solutions [View article]

Not taking sides here... but it's interesting to see that NLY have recently increased their leverage. This is the same as admitting that they've been wrong about the interest rate environment for the last two, call it three years perhaps. NLY has been a conservatively managed MREIT, of that there can be little doubt (though some might argue any leveraged MREIT is not conservative enough), and they've paid a price for their conservative stance: high share/FFO ratio (as pointed out in this article), and high losses on all their hedges. This might come across as a bit perverse, but if NLY shows a decrease in their share price/FFO ratio combined with a reduction in hedging losses (which would feed in to the ratio) then it has become a less attractive proposition.

Now, here are the outstanding questions:

Have NLY management finally decided to adopt the consensus view on low interest rates "forever" (which would be evidenced by reduced hedging losses - nothing said about this will be as important as what's actually done)?

Have NLY management increased their leverage to coincide with a new interest rate model, or are they simply trying to maintain profits in a low margin environment (and will "pay the piper" by increasing their exposure to hedging losses)?

Aug 8 12:55 PM

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Annaly: Expect Fat Dividend Checks Into 2013 [View article]

There are a few assertions that seem frequent enough for us to try to gain more clarity.

First, the Fed has indicated low short term rates well into 2014. This is not an absolute undertaking by the Fed, but, barring a market dislocation, any short term increases in financing costs affecting MREITs are likely to be minimal.

Second, the current low interest rate environment is good for MREITs. This contention is incorrect. While low short term rates is good for MREIT financing operations, these rates are combined with low long term rates which negatively impact MREIT profits. Low long term rates reduce MREITs' spread.

Third, MREITs should take advantage of low financing costs to increase their leverage, and maintain profitability in a low spread environment. This is another misconception. While MREITs incomes depend on their leverage, MREITs values depend on their portfolios' interest rate coupons. In a low interest rate environment, MREIT portfolios are subject to refinancing risks, but, in the current low spread environment, this risk is second to the risk of portfolio devaluation caused by a rise in long term interest rates. While there may be agreement that short term rates will remain low for the foreseeable future, long term rates are now rising and the consensus is that these rates are likely to keep rising as the Fed's Operation Twist "unwinds".

Less Fed participation in the longer duration Treasury markets will provide a MREITs with a larger spread. This contention is correct; and, the MREITs best positioned to take advantage of a widening spread will be those with the lowest leverage. MREITs entering a period of widening spreads (where long term rates are rising faster than short term rates) will see their existing portfolios decrease in value. While MREITs with portfolios with lower average maturities will be less affected than peers maintaining longer duration portfolios - net MREIT performance will be most affected by leverage and the rate of change in interest rates.

Apr 18 08:00 AM

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Two Harbors, Invesco Mortgage Maintain Dividends, Bolstering Hybrid Mortgage REITs [View article]

At crucial moments correlations break down. So, if you use ETF puts to hedge against a position in one of the ETF components, then you're not hedged. If you find another historic correlation, chances are, when things get ugly for your long position the correlation evaporates. People are always chasing the "best of breed" and using broader indexes to hedge. Over time you'll do well if you're properly diversified - if you're not diversified and blessed with some years left to live, you'll probably get to witness a correlation breakdown which will hamstring your non-diversified portfolio.

One of the reasons certain companies become institutional darlings is because they can be hedged - either because there's an active OTC or exchange traded option market for them.

Mar 19 10:47 AM

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Annaly: What Is Going On? [View article]

TBT is a depreciating asset. On any given day it's maybe a 2x inverse, but over time it's not. Too expensive to operate to maintain value. Not saying it's not a good instrument, but its prospects as a long term hedge by being long is poor.

Mar 10 02:42 PM

[And here is today's update:]

InvestStorm

Friday, February 1, 2013

More Historic Commentary (TLT, NYMEX, UNG, AAPL, IYR, XHB, BUD, F, ELLI, VIX)

Thursday, January 31, 2013

For Record - an Update (NLY, TLT, TBT, MREITS, ABS, Treasuries, QE and Fed policy)

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