NEW YORK--(BUSINESS WIRE)--
Annaly Capital Management, Inc. (NYSE: NLY) (“Annaly“ or “the Company“)
released its monthly commentary for April. 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 market is on the lookout for “green shoots,“ for any signs of
improvement in the steep decline in economic activity in the United
States. In an environment like this, less bad is the new good, at least
according to the stock market which has enjoyed two strong months in a
row. Even Ben Bernanke is hedging his bets. In testimony before the
Congressional Joint Economic Committee, he said: “The U.S. economy has
contracted sharply since last autumn, with real gross domestic product
having dropped at an annual rate of more than 6 percent in the fourth
quarter of 2008 and the first quarter of this year. Among the enormous
costs of the downturn is the loss of some 5 million payroll jobs over
the past 15 months. The most recent information on the labor market--the
number of new and continuing claims for unemployment insurance through
late April--suggests that we are likely to see further sizable job losses
and increased unemployment in coming months. However, the recent data
also suggest that the pace of contraction may be slowing, and they
include some tentative signs that final demand, especially demand by
households, may be stabilizing.“ Call him cautiously pessimistic.
This is what passes for “green shoots“: The Case-Shiller 20-city home
price index fell 1.9% in February after a 2.2% drop in January, and
year-over-year the index fell 18.6% versus the 19% decline in the prior
month. It's not worse, but it's still bad. Existing single-family home
sales dropped another 2.8% in March to an annualized 4.10 million homes,
which means that sales are now in a relatively tight range of 4.06 to
4.25 million over the last five months. Economists suggest that this may
mean a bottoming is being established. But the median sales price is
still down over 11% year over year, and months of supply stubbornly
remains at the elevated level of 9.3 months. Construction spending rose
for the first time in six months in March by 0.3%, beating expectations
of a decline of 1.6%, and pending home sales rose 3.2%, the first
back-to-back monthly gains in a year. In the non-farm payrolls number
released this morning, the loss of 539,000 jobs is being characterized
as a sign that the economy is stabilizing, because it was fewer than the
forecast loss of 600,000. In our online
version of the commentary we use two graphs to illustrate that the
longer-term view of these green shoots shows little to cheer about.
Do we see shoots of spring in the economy? Do we view the U.S. economy
as a half-full glass or a half-empty glass? Our answer is that we see it
as a glass that is twice as large as it should be. Our economy and our
national balance sheet have been bulked up by the steroids of credit,
and we are now witnessing what happens when we stop taking our steroids.
The deflation in housing and many financial assets is occurring in the
context of leveraged balance sheets. And nature abhors a balance sheet
that doesn't balance. The highly anticipated stress tests of the 19
largest bank holding companies were designed to address this balance
sheet imbalance by measuring “how much of an additional capital buffer,
if any, each institution would need to establish today to ensure that it
would have sufficient capital if the economy weakens more than
expected.“ The headline results of the stress tests (found in their
entirety at the Fed's
website) are that 10 of the 19 participating bank holding companies
will need to raise an additional $74.6 billion in capital in order to
prepare for what the Federal Reserve called “more adverse“ economic
conditions and loss rate scenarios. Bank of America Corp, Wells Fargo &
Co. and Citigroup Inc. lead the way, needing to raise new capital of
$33.9 billion, $13.7 billion and $5.5 billion, respectively, over the
next six months. There will be debates over the reasonableness of the
loss assumptions used in the “more adverse“ case (for what it's worth,
we think the government's adverse case may be optimistic) and the
methods by which the weaker banks will raise that capital, but the
bigger question is this: Will it spark more lending? Again, please visit
the online
version of the commentary to view supporting graphs. The first,
which is an update of the bank lending officers' survey, shows that more
lending activity is probably unlikely for now, and the second shows that
without increased lending activity our economy will likely stay
recessionary.
The only way out of a mess like this is to take more steroids, i.e.,
inflate the assets again, reduce the debt, or inject new capital.
Without it, these banks would be insolvent. We believe the government,
in its alphabet soup of programs, has staved off collapse in the
financial system by attempting to do all three. But because our
country's growth has largely been driven by credit creation over the
last several decades our economy is also larger than it should be. Cory
Booker, mayor of Newark, NJ, put it this way: “New Jersey will go
bankrupt in 10 to 20 years because we cannot afford our employees as a
state...we have more government per person than we need.“ An additional
two graphs in our online
version tell a story of what happens when an economy shrinks back
down after the steroids stop. It will be a painful process, despite the
“green shoots.“
The Residential Mortgage Market
Prepayment speeds for March (April release) were essentially flat month
over month, with 30-year FNMA collateral paying 21 CPR. Looking ahead,
most dealers are anticipating a 15% to 25% increase for April speeds as
a result of additional Treasury related mortgage-backed securities (MBS)
buying, the corresponding multi-decade low on 30-year mortgage rates of
4.625% in April, as well as increased seasonality.
We have discussed in prior
commentaries some of the reasons why prepayment speeds may be slower
than those of the refinancing boom of 2003 (link directly to last
month's commentary here),
but there is a technical development that may actually help make them
faster. It relates to Fannie Mae and Freddie Mac policies on buying
delinquent loans out of the loan pools backing Agency mortgage-backed
securities.
Fannie Mae and Freddie Mac are, for the most part, required to buy any
individual loan that is modified due to delinquency out of a loan pool.
Such a purchase results in a prepayment. Prior to December 2007 Fannie
Mae and Freddie Mac typically purchased all loans that were 120 days
delinquent out of a pool, whether they were modified or not. In 2008, in
an effort to preserve capital, the two GSE's changed their policies to
only purchase delinquent loans out of the pool if they meet one of four
qualifications: 1) they are more than 24 months overdue, 2) a
foreclosure sale has happened, 3) the loans have been modified, 4) the
cost of carrying the loan (principal and interest advances) exceeds that
of a buyout. This servicing change significantly reduced delinquency
related prepayments in 2008, a period which Barclays Capital estimates
loans were defaulting at “near historically high speeds“. Additionally,
shortly after they were taken into conservatorship the agencies
implemented a moratorium on foreclosures in accordance with the
Streamline Modification Program (SMP) and Home Affordable Modification
Program (HAMP). Barclays further believes this moratorium added to the
significant increase in the number of seriously delinquent loans (at
least 90 days past due) at the agencies over the past year (graphical
evidence is available in our online
version).
This buildup in serious delinquencies, and the looming increase in loan
modifications from government programs, should result in higher amounts
of delinquency-related buyouts going forward. Barclays estimates that as
these ramp up, it will add 9 to 10 CPR for recent vintage mortgages and
should account for over 20% of prepayments over the next year, but like
all aspects of trying to forecast prepayment speeds, this is
hypothetical. It does not take into account real world issues such as
the cost of capital for Fannie and Freddie and the changing events on
the ground, so it remains to be seen how big the true effect of
delinquency-related buyouts will be.
The Commercial Mortgage Market
Like an upset stomach that you know will lead to a messy outcome,
rumblings continue in the commercial mortgage market. Barron's
declared the commercial property market “The Other Shoe“ on the cover of
its May 4 edition, and the Sunday New York Times spilled several
thousand words worth of ink on Lehman's real estate legacy. On Friday,
May 1, the Fed announced that newly issued commercial mortgage-backed
securities (CMBS) would be included under the Term Asset-Backed
Securities Loan Facility (TALF) program. Details are still sketchy, but
there were two items we found noteworthy. First, the CMBS market sold
off because the updated terms do not address legacy positions. Given
that the Fed's primary objective under TALF is to jump start lending,
the sell-off may have been premature. Second, there is uncertainty over
which and how many rating agencies can rate a TALF-eligible CMBS. The
market still needs more clarification.
The other big rumbling in the market in April was the bankruptcy filing
of General Growth Properties, Inc. (GGP), the second largest regional
shopping mall owner in the United States. GGP has been an unabashed user
of leverage to finance its operations and growth. The majority of GGP's
liabilities are mortgages that have been securitized through Special
Purpose Entities (SPEs), with the remainder unsecured debt and
non-securitized direct mortgage placements. New management of GGP,
installed during the fourth quarter of 2008, filed the biggest
real-estate bankruptcy in US history on April 16, 2009, a filing that
included GGP, the operating company and debtor to the unsecured
bondholders, as well as 158 of its individual property holdings (another
eight individual properties were added on April 22, 2009). While there
are many impacts, legal and financial, that are specific to the
creditors of GGP, this month's commentary will spotlight some issues and
the ramifications for the broader CMBS market.
The SPEs are not necessarily bankruptcy remote. Lessons
were learned from the real-estate recession of the early 1990s. One was
that you should know all of the creditor relationships of your borrower
because non-performance of debt, especially if it was recourse, could
force that borrower to seek the protections of a bankruptcy court. This
could be especially irksome if your loan was performing and was the
largest of that borrower's portfolio. To mitigate this risk, the
developers of the CMBS market required that borrowing entities had to be
through SPEs which were serviced by specific underlying properties and
ostensibly bankruptcy remote. The bond investor, then, is solely focused
on underwriting for those specific properties, and his due diligence
should not, and most likely could not, encompass the borrower's total
financial dealings. From a legal perspective, the purpose for the
creation of the bankruptcy remote SPE was to prevent the consolidation
of those properties in a Chapter 11 filing if they were performing.
Wrong. This Chapter 11 filing is a clear signal that GGP's management
desires to consolidate performing properties with non-performing
properties in order to effectuate an overall debt restructuring that is
most advantageous to GGP, but not necessarily to individual bond holders.
Of course, the court could reject or modify the Chapter 11 filing. But
in the meantime, investors in GGP securitized mortgages have clearly
been blindsided. A larger issue is the role of the SPE in other
structured finance transactions. Just to name one, what will new
investors require to insure their participation in the TALF program so
they are not exposed to other financial stresses of a real estate
borrower?
A lockbox is not always locked. Most loan documents of the
GGP properties that were securitized required the tenants to remit their
rent checks to a designated bank account, the so-called lockbox. All
expenses of the subject property, including its debt service, are paid
from that account. From GGP's filing, it appears that the tenants' rent
checks were deposited in the lockbox for each individual property, but
it didn't stay there. Instead, all cash collected was swept into a
master cash account prior to liabilities being satisfied. Apparently all
property-specific liabilities have been satisfied in GGP, but perhaps
another chink in the armor of securitization was exposed. Namely, who
oversees the lockbox to ensure that it is performing as anticipated? The
rating agency? The servicer? The trustee? Did GGP adhere to the word of
the document but not to its intent? Do others?
With each rumbling in the CMBS market, whether it is a Stuyvesant Town
or a GGP, bond investors are getting affected in ways they neither
imagined nor bargained for. Maybe this is the ultimate lesson of the
downside of a bull market.
April 9, 2009
Jeremy Diamond
Managing Director
Kevin Riordan
Director
Ryan O'Hagan
Vice President
Robert Calhoun
Vice President
This commentary is neither an offer to sell, nor a solicitation of an
offer to buy, any securities of Annaly Capital Management, Inc.
(“Annaly“), FIDAC or any other company. Such an offer can only be made
by a properly authorized offering document, which enumerates the fees,
expenses, and risks associated with investing in this strategy,
including the loss of some or all principal. All information contained
herein is obtained from sources believed to be accurate and reliable.
However, such information is presented “as is“ without warranty of any
kind, and we make no representation or warranty, express or implied, as
to the accuracy, timeliness, or completeness of any such information or
with regard to the results to be obtained from its use. While we have
attempted to make the information current at the time of its release, it
may well be or become outdated, stale or otherwise subject to a variety
of legal qualifications by the time you actually read it. No
representation is made that we will or are likely to achieve results
comparable to those shown if results are shown. Results for the fund, if
shown, include dividends (when appropriate) and are net of fees. (C)2009
by Annaly Capital Management, Inc./FIDAC. All rights reserved. No
part of this commentary may be reproduced in any form and/or any medium,
without our express written permission.
Source: Annaly Capital Management, Inc.
Contact: Annaly Capital Management, Inc.
Investor Relations
1-(888) 8Annaly
www.annaly.com