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Annaly Capital Management Announces Monthly Commentary for May

^{Published on 2010-05-10 14:55:35 - Market Wire}
 

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 consequencesa"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 rangea"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 isna™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, ita™s not surprising that the consumer took center stage in the BEAa™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 quartera™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 quartera™s year-over-year growth to be a disappointment, the result of an aeasy compa due to the dip in the first quarter of 2009, as illustrated on the chart in our [ online version ].

The trend remains sideways. Ita™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 Maea™s previously announced delinquency buyout program. (See [ last month's commentary ] for a discussion of Freddie Maca™s buyout program.) Speeds on 30-year 6.5s and 7s increased to 80 and 99 CPR, respectively, from the prior montha™s reading of 22 and 25 CPR, respectively. This is the first of four consecutive monthly buyout waves investors will experience from Fannie Maea™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 companya™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 montha™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 Reservea™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 Feda™s accommodative stance. However, it may also be the legacy of the purchase program itself that is partially aiding MBS, and herea™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 aouta or future months in the ato-be-announceda 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 Feda™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 (aRBSa) and Nataxis Real Estate Capital (aNataxisa) 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 aagenteda™ 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 Oa™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. (aAnnalya), FIDAC or any other company. Such an offer can only be made by a properly authorized offering document, which enumerates the fees, expenses, and risks associated with investing in this strategy, including the loss of some or all principal. All information contained herein is obtained from sources believed to be accurate and reliable. However, such information is presented aas isa without warranty of any kind, and we make no representation or warranty, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. While we have attempted to make the information current at the time of its release, it may well be or become outdated, stale or otherwise subject to a variety of legal qualifications by the time you actually read it. No 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 part of this commentary may be reproduced in any form and/or any medium, without our express written permission.