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No. of Recommendations: 12
Annaly 2005 10-K

Just to remind ourselves, NLY makes money from the spread between the interest income on investment securities and the cost of borrowings to finance their acquisition of investment securities. Income is therefore NOT dependent on interest rates per se but rather the SPREAD and the change in the components of the spread as related to prior borrowing/purchases.

MBS have all been AAA implied rating consisting of agency pass through certificates and CMO's (divide a pool of mortgage loans in to multiple tranches with different principal and interest payment characteristics). Bottom line: NLY believes it does not assume risk of the loans themselves defaulting.

See conference call outline above in Board for discussion of investment security content. The weighted average yield of portfolio is 4.68% and weighted average term to next rate adjustment on adjustable rate securities was 22 months.

NLY will not invest in any MBS with imbedded leverage as part of their structural characteristics.

Borrowing: weighted average cost of funds was 4.16% and term to maturity was 163 days and days to adjustment was 79 days.

Soo….. their investments are longer term and have higher returns (for now). If short term interest rates rise and long term do not (the spread shrinks), then we are screwed. NLY exercised one option which was to sell their investments at a realized loss (mark to market value) in order to be able to re-invest.

Debt to equity was 9.0:1.

Hedging: not for speculative purposes.

Drip still exists.

Remarks on the nature of investments: monthly payment and possibility of CRP.

Remarks on the requirements of lenders to NLY about over collateralization (haircut). Please see my first discussion of NLY last year for explanation (the 10-K gets easier every year!). In a sense, the requirements of lenders provides some insulation against Annaly doing stupid things (although susan400 will point out that there are plenty of stupid lenders on the planet).

NLY itself then determines an excess capital cushion on top of the haircut.

Interest rate risk management: structuring of borrowing with adjustment indices and periods that correspond with time frame of MBS securities that are adjustable and also to create borrowing agreements that mature on a ladder or rolling fashion.

They also use interest rate swaps. “ we believe that our interest rate risk management program will allow us to maintain operations throughout a wide variety of potentially adverse circumstances….” Investor acceptance of this statement is a little bit of a leap of faith!

NLY lean and mean: 31 employees!

Risks: leverage works both ways! Over the long term, leverage will work to NLY's advantage since the spread has historically worked to NLY's advantage. The key is to hedge enough so that bad times don't wipe you out.

Stock options: 123m total shares. Authorized to issue up to 9.5% as options (ugh) up to 8.5m shares. Currently have issued 2.3m with weighted exercise price of $16.10. So currently within acceptable range (a hair under 2%).

Income and balance sheets: NLY lost money in 2005 ($9m or 19 cents/share). Number would have been substantially worse without the $40m in proceeds from issuance of 2.3m shares under Equity Shelf program.

Equity (note: I am talking about end of year figures, not average figures, which are listed in a separate and less relevant, in my opinion, table) dropped correspondingly (all securities are mark to market) although liabilities also dropped, just less so than assets. Wisely, NLY issued few shares (it is interesting to see the progression of shares from 2001 – 60m to 84m to 96m to 121m year by year) meaning that equity was issued, then leveraged to take advantage of the spread at the time to generate income that in turn was paid out. Since NLY cannot hold onto income, when the spread becomes favorable again, look for more equity issuance.

Management discussion: 4/2005 decision to sell assets turning unrealized at mark to market losses into realized losses. Took a $83m impairment charge as a result. Net interest rate spread shrank steadily from 1.18% in 3/2005 to 0.09% in 12/2005 (ouch). CPR's actually rose (a little bit) during the year.

FIDAC: generally gets 10-20 basis point of gross AUM. Had 2.3b in net and 18.7b gross which is up from 2004, although this will be down as $130m will be withdrawn Net take was $27m.

Admin costs: $26m up from $24m 2004
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