It is not easy to be an agency mortgage investor, particularly not with uncertainty about the longevity of Fed intervention and government-sponsored enterprise reform pending, Annaly Capital Management Inc. CEO and chair Wellington Denahan noted in her company’s recent earnings call.
The call nonetheless had been received fairly well by investors at deadline, causing its stock at least to initially rise in its wake on Aug. 8, as Denahan explained, exemplifying the dilemma investors throughout this market have been facing and strategies used to address it.
“Make no mistake about it, the mortgage market is going through a transitional period,” she said.
“Historically, when interest rates rise, spreads tighten to the curve. With the distortion, I’ll call it, that the Fed has introduced into the market by their assets purchases you have a tremendous amount of negative convexity in the market that is atypical. But recent activity has rendered the market a bit more normalized.”
There has been a lack of exact precedent in the market’s volatility, she said.
“In seeking precedent for the rate move over the last quarter we can look to the extremes of the ’80s for the comparable percentage change in rates, when the 10-year rose 66% from nine and a half to 15.8% in about 450 days,” Denahan said. “But the current 66% move took a mere 70 days.”
“I know I invoke the ’80s, but I don’t think you’re going to see anything like that,” she said.
So how does an experienced mortgage investor contend with the kind of volatility seen in the second quarter? Denahan said the company “increased liquidity by operating with lower leverage, protected capital by maintaining large interest rate swap positions, and reduced our overall exposure to the effects of large-scale asset purchases by reallocating capital into less interest sensitive strategies through our expansion into commercial assets.
“With this volatility comes opportunity,” she noted. “Investment spreads have improved markedly, risk has been more properly priced, and demand for high-quality collateral in the funding markets remains robust.”
As has often been the case, Denahan during the call’s question-and-answer session was asked to defend her company’s somewhat defensive position and asked what it would take for it to take a more aggressive stance leverage-wise.
She said she would like to know more about the Fed’s exit plan, adding that her opinion is that “the Fed’s not going to sell. The Fed is going to stop buying.”
“The impact may not be as dramatic as last quarter’s selloff would suggest,” Denahan added.
“We’d like to see them lay out their plan,” she said, noting that “the other big caveat out there it you don’t know whether you have a Bernanke clone or a Washington insider as the next chairman of the Fed.”
Denahan added, “You also have regulation out there.”
Another question she would like to see answered is “whether Fannie and Freddie’s earnings get them a more permanent seat at the table.
“There are a lot of things that still need to be answered,” she said.
“I just don’t think this is the time to say, 'The coast is all clear, let’s go ahead and put the foot on the gas,’” said Denahan, also noting, “The nice thing about our leveraged position is that you can easily lever back up.”
She reminded listeners that the company has been diversifying into the potentially less rate-sensitive commercial market with plans for securitization, has a nonagency investment affiliaate and said the company also is getting involved in jumbo whole loan originations.
