(Source: Business Wire)
Annaly Capital Management, Inc. (NYSE: NLY) ("Annaly" or "the Company") released its monthly commentary for May. The commentary set forth below addresses and updates the company's views on the economy, the residential mortgage market, commercial real estate finance and the overall markets. Please visit the commentary section of our website (www.annaly.com), to see the complete commentary with charts and graphs, as well as other research and opinion pieces.
The Economy
The bond market selloff that has been ongoing since the beginning of the year accelerated in May. The reasons are many: fears of oversupply (to the point that equity markets are beginning to react to news of how well Treasury auctions are received), gossip about the U.S. losing its AAA rating, concern that the Federal Reserve would choose to not defend a particular interest rate level with their Treasury buying program, headlines about Asians selling their dollar assets, convexity trading (more on that below) and, not least, a growing frenzy over inflation prospects.
We are currently experiencing deflation, with year-over-year CPI down 0.7%, so the real yield on the 10-year Treasury is well north of 4%. Despite this fact, the burden of proof clearly rests upon the deflation crowd, of which we have been a member. The reasons that we feel deflation is the war we are fighting now and for the foreseeable future are many and varied, but can be quickly summed up by the following statement: We have a deleveraging consumer and a struggling banking sector. That we have an overleveraged consumer should be beyond debate, and we've spoken at length on this in the past. Annaly CEO Michael Farrell is on record calling for the national savings rate to hit 15% as part of the household balance sheet restoration project.
Notwithstanding the stress test results of the Supervisory Capital Assessment Program”that showed only 10 of the 19 test subjects had to take capital-raising actions”banks in the US are ailing. Reading the results of the stress test, it appears that if the situation plays out how the Fed modeled the "more adverse scenario case," most of the 19 banks will have less capital at the end of 2010 than they had at the end of 2008. For instance, Capital One Financial is estimated to take $13.4 billion in estimated losses in 2009 and 2010, and will have only $9 billion in resources other than capital to absorb these losses. Capital One was not required to raise capital. Regardless of whether investors consider this to be well capitalized, one thing remains true: If banks have shrinking capital, they cannot expand their lending activities. Just as in the consumer's case, deleveraging and protecting capital are not inflationary. As for the massive amount of money that has been thrown at this crisis, much of it has simply gone to fill the hole left by capital destruction in the financial sector.
We would argue the capital hole is still being dug. In the FDIC's most recent quarterly report on the banks (the title of which has an upbeat spin: "FDIC-Insured Institutions Earned $7.6 Billion in the First Quarter of 2009"), news on the collective balance sheet of the industry was dour. Noncurrent loans (that is, non-accruing loans and loans past due 90 days or more) rose 25.5% in the first quarter to $291 billion from $232 billion just one quarter ago. Those looking for a moderation in the pace of deterioration will not find it in this data series. The 25.5% increase is accelerating over the past two quarters (23.8% in Q42008 and 12.8% in Q32008). As a percentage of total loans, the noncurrent rate rose to 3.8% from 2.9% last quarter, which is as bad as it got during the early 1990s. Despite these credit trends, the banks are still behind the curve. The coverage ratio at our nation's banks (reserve for losses/noncurrent loans) fell to 66% at March 31, 2009 from 75% at December 31, 2008 and 93% at the end of 2007. (The ratio stood at 160% at March 31, 2006.) If reserves had been increased by enough to maintain a 75% coverage ratio, the banks should have added another $24 billion to reserves. This would have turned the $7.6 billion profit into a $16.8 billion loss for the quarter.
The day after the FDIC release, the Mortgage Bankers Association confirmed this trend with their first quarter national mortgage delinquency survey. There is no second derivative improvement to be found here either, as the seasonally adjusted delinquency rate of 9.12% is the highest since the MBA started keeping records in 1972. Also, the delinquency rate only includes late loans (30-days or more), but not loans in foreclosure. In the first quarter, the percentage of loans in foreclosure was 3.85%, an increase of 55 basis points from the prior quarter and 138 basis points from a year ago. Both the overall percentage and the quarter-to quarter increase are records. The combined percentage of loans in foreclosure and at least one payment late is 12.07%, another record.
