Annaly Series F Preferred: I saved the truck today (NYSE: NLY.PF)

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On September 30, Annaly Capital’s Cumulative Floating Fixed Rate Preferred Series F (NYSE: NLY.PF) converts to 3-month LIBOR plus 4.99 percentage points. This will represent a 23% increase in dividend with current LIBOR at 3.6%. Even higher after the Fed raised rates again.

Still, the NLY.PF traded below $22.50 today against its face value of $25 per share. This is a 10% upside call protection if Annaly replaces this issue anytime after September 30th.

It would seem that Annaly is in very big trouble based on these values. Is this true or is the market throwing money at us?

under the hood

Let’s first look at Annaly’s mortgage portfolio. Is it about to get in trouble? If by problem we mean that interest rates will continue to rise until at least the first quarter of 2023, then there are problems. However, this disorder is not fatal. Annually, the managers have already been there, probably know how to play the interest rate cycle and will probably allow the portfolio to weather this downturn as well. Don’t forget that Annaly is one of the MREITs that survived 2008.

If you want a deeper dive, I highly recommend Scott Kennedy’s most recent analysis of Annaly’s book value a few weeks ago. He found that Annaly had pulled her horns for the coming recession – that’s very good news for preferred stocks.

Of its current assets of $59 billion, Annaly holds $55 billion in quasi-guaranteed loans from the US government. Although the risk of default is generally low, this portfolio will be in very good shape during the next recession.

Then, will there be revenue to pay for the preferred stock? That’s the nice part because distributable income increases. This increase comes from two sources: (1) Annaly bought a mortgage manager that produces a lot of cash when mortgages are not prepaid en masse, and (2) widening spreads between borrowing costs and loan.

All of this income cannot fully offset capital losses as rates rise, but it does create income Annually has distribute or lose its SIR tax status. So even if common stocks crash due to falling asset values, preferred dividends for all classes after interest bonds are covered more than 50 times by TTM distributable income!

That sounds a lot better than junk credit at the preferred level, but what about equity coverage? We calculate more than 6 times common stock backing preferred stock, which seems pretty comfortable.

Speaking of bric-a-brac, high-yield general credit spreads are about 5% today. This is equal to the floating rate margin of NLY.PF; but show me a junk credit covered 50 times cash because I never found any.

I think the answer may be that the market views equities as worse than CCC risk, who has a 12% + credit spread today. If that’s true, how could privileged commerce love good high-yield credit?

When investors ignore the effect of distributable income on preferred dividend payments, they miss the whole deal, in my opinion.

To me, it’s just crazy. So crazy, I doubled my position today. NLY.PF is about 15% of my portfolio at an average of $22.90. From here, I expect NLY.PF to peg over the next few months near $25 per share, where I can sell when I see the next good move.

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