A Look Inside: Annaly's Move to Counter Fed Policies, CreXus Bid

Jan 15, 2013, 08:14 ET from National Traders Association

NEW YORK, January 15, 2013 /PRNewswire/ --

With the Recent Performance Weighing on Investors' Minds, Analysts Look to Whether the Company Can Remain Strong in the Face of Considerable Change

In a bid to out-maneuver the Federal Reserve's recent policy changes involving interest rate spreads, Annaly Capital Management, Inc. (NYSE: NLY) [Full Research Report](1) is looking to fully acquire shares of CreXus Investment Corp. (NYSE: CXS) [Free Research Report](2). The acquisition is seen by Annaly as a way provide stable risk-adjusted returns to shareholders, while at the same time acting to diversify its asset portfolio.

Over the last 12 months, Annaly has been busy improving its broad capital strategy. The company has successfully lowered its cost of capital through the issuance of $1.5 billion of preferred equity and convertible notes (standing at a weighted average of 6.3%), while also extending the duration of its borrowings by 93 days. It has also restructured capital by repurchasing $447.1 million of convertible notes and finally, announcing an up to $1.5 billion common stock repurchase program.

The proposal to acquire CreXus is one of Annaly's plans to continue delivering income for its investors. In recent years, Annaly has received plenty of attention because of its double-digit dividend. Despite a drop in value in the fourth quarter of last year, analysts assert that Annaly will continue to perform well in 2013.  This is because the real estate investment trust (REIT) has shown a long-term ability to manage its business and maintain strong cash flows.

Annaly generates net income by investing in mortgage-backed securities, earning the spread between its own cost of capital and interest payments received on the securities. The company also receives dividends from its subsidiaries, many of which are engaged in a similar business structure. Because the company's business model depends largely on Federal Reserve's policies, the company may experience a downturn soon. In the third quarter of last year, the Federal Reserve lowered the interest rate spreads, cutting income for REITs like Annaly. The Federal Reserve also announced its plans to buy mortgage-backed securities worth $40 billion every month, causing interest rate spreads to fall further. As a result, Annaly reported $0.45 earnings per share for the fourth quarter of 2012, missing the consensus estimate of $0.47 by $0.02.

To counter the Fed's recent actions, Annaly is diversifying its portfolio by offering to buy CreXus Investment. CreXus will give Annaly access to commercial mortgage-backed securities along with residential mortgages. The company issued the following statement on its purchase, "While we remain committed to the agency market, given the current environment, we believe it is prudent to diversify a portion of our investment portfolio. Therefore, we may allocate up to 25 percent of our shareholders' equity to real estate assets other than Agency mortgage-backed securities." This strategy may soon pay off.

CreXus is a commercial real estate firm with the same business model as Annaly. Since Crexus' commercial loan portfolio earns four times more than that of Annaly's portfolio of residential mortgage-backed securities, the deal will potentially increase income for Annaly and give it leverage in the commercial mortgage-backed securities market.

Since Annaly already owns 12.4% of CreXus' shares, it only needs to pay $839 million more to fully acquire the company.  This deal will help increase Annaly's net interest rate spread. Furthermore, analysts believe that Annaly should be able to cope due to sufficient amount of cash flow from operations, growth in earnings per share and expanding profit margins.

As of now, the deal has been received by the Board of Directors of CreXus and is awaiting approval.

Reference Links:

(1) The Full Research Report on Annaly Capital Management - including full detailed breakdown, analyst ratings and price targets - is available to download free of charge at: [http://www.nationaltradersassociation.org/r/entire_report/f84a_NLY]

(2) The Free Research Report on CreXus Investment Corp. - including full detailed breakdown, analyst ratings and price targets - is available to download free of charge at: [http://www.nationaltradersassociation.org/r/entire_report/da3a_CXS]

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SOURCE National Traders Association