Right now, Annaly Capital, a mortgage real estate investment trust, is trading at $11.62 per share. That is intriguing because the firm’s book value is currently $12.13 per share. Anytime a company is worth more dead than alive according to the stock market valuation, it’s worth a look to see what’s going on (especially given Annaly’s long-term tendency to trade at valuation ranges of 10-25% in excess of its book value).
What causes this to happen? There are three reasons why a mortgage REIT can become cheap: (1) no one wants to touch it because dividends and earnings are all over the place, (2) they are highly leveraged, (3) and they tend to get whacked around a bit when interest rates rise sharply. I’ll elaborate a bit on that last point—the general strategy of most mortgage REITs is to borrow money at the short-term rate and then park in a fixed rate, mortgage-backed security for the long term. When interest rates rise sharply, they tend to run into trouble because they have to borrow at a higher rate to make new short-term investments, while their existing portfolio of mortgage-backed securities is baked into lower rates than what the new normal has become.