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I'm not really sure.

Annaly is a pretty simple company, yet one that keeps providing for learning opportunities (for me anyway). Most of the concern around NLY over the past few months had to do with their assets. Would the market begin to mark down all mortgage backed securities, even those of the highest quality and credit backing, such as the ones NLY owns? So far the answer has been no. NLY was wise to stick to the best quality assets, even when those around them appeared to be making better money on other grades of securities. Good for them (and me so far).

But assets are just half the balance sheet. The other side is the debt that NLY uses for its leverage. The guest writer today for John Mauldin's newsletter had a lot to say about senior secured loans. [read / sign up at] Loans used to provide leverage to buy assets and backed by those assets. Loans that NLY uses (I'm extrapolating). Banks are gun shy on these loans right now, and not surprisingly so. Banks weren't just exposed to subprime assets they held themselves, they were also exposed via the loans they made to those that then bought subprime assets (have we seen these write downs - I think we have, but am not really sure). Anyway the writer sees the collapse of this loan market as a huge opportunity for those capitalized well enough to take advantage (note: this is what CSE has been saying, but not yet executing on).

NLY just recently filed the 10k. Generally, big sections of these are cookie cutter reprints from year to year, but importantly, noticing what is changed can be key. So after reading the notes from the Mauldin newsletter related to senior secured loans, I couldn't help but wonder -- Who is it that loans NLY the money for their leverage? Is the risk to NLY more on the borrowing side (leverage / liquidity) than asset side?

And I noted an addition in the risk section of the 10k; language not present in the fiscal 2006 filing.

Failure to procure funding on favorable terms, or at all, would adversely affect our results and may, in turn, negatively affect the market price of shares of our common stock.

The current situation in the sub-prime mortgage sector, and the current weakness in the broader mortgage market, could adversely affect one or more of our lenders and could cause one or more of our lenders to be unwilling or unable to provide us with additional financing. This could potentially increase our financing costs and reduce liquidity. If one or more major market participants fails, it could negatively impact the marketability of all fixed income securities, including agency mortgage-backed securities, and this could negatively impact the value of the securities in our portfolio, thus reducing our net book value. Furthermore, if many of our lenders are unwilling or unable to provide us with additional financing, we could be forced to sell our assets at an inopportune time when prices are depressed.

Something to chew on. We may indeed be watching the wrong end of the balance sheet.

NLY has become my largest holding, largely due to its success as an investment, but I've always considered it high risk, and still do. I'm not sure I'm inclined to sell it or a part of it. But I may consider some downside protection via a stop loss on a portion (generally I don't like these, they tend to trigger to darn often).

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