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9 Reasons I'd Never Invest in Annaly Capital Management

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Lays out nine reasons investors should avoid Annaly Capital Management.

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Page 1: 9 Reasons I'd Never Invest in Annaly Capital Management

9 Reasons I’d Never Invest InANNALY CAPITAL MANAGEMENT

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1 It’s hiding something from you…

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Annaly’s executives have long been the subjects of well-deserved criticism for unjustly enriching themselves at the expense of shareholders. At the 2013 annual meeting only 28% of shareholders supported the compensation of its named executives. In order to hide their pay, in turn, the company has reorganized its corporate structure in such a way that it must no longer disclose the details of its executives’ compensation.

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2Nepotism

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After founding a publically traded portfolio company called Chimera Investments, Annaly installed the son of a board member to be Chimera’s CEO and the sister of Annaly’s now-CEO to be its CFO. What became of Chimera? For the past two years, it’s been embroiled in an accounting fiasco that involved overstating earnings between 2008 and 2011 by 66%.

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3 It disregards shareholder votes

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At Annaly’s 2011 annual meeting, shareholders voted overwhelming (1) in favor of holding say-on-pay votes every year and (2) against the reelection of Jonathon Green to Annaly’s board of directors. What do you suppose Annaly did? It ignored both, choosing at the time to hold say-on-pay votes every three years and reelecting Green to the board despite the shareholder discontent.

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4 Accounting shenanigans

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Nothing screams “bad investment” more than an accounting fiasco. And that’s exactly what took place at Chimera Investments, one of Annaly’s publicly traded portfolio companies, which, it’s critical to appreciate, is managed by the very same people who run Annaly. Between 2009 and 2011, Chimera reported net income of $1.06 billion. In reality, the figure was only $367 million.

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5Previous indiscretions

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In 1994, the year Annaly’s managing entity was founded, its co-founder and former-CEO Michael Farrell was censured by the NASD, fined $150,000, suspended "30 days from associating with any member of the NASD," and had his securities license revoked. The charges? Among other things, "filing inaccurate [regulatory] reports," "filing [an] incomplete and inaccurate annual audit," and keeping "inaccurate books and records."

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6It’s getting riskier

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For virtually all of Annaly’s existence, it’s focused exclusively on agency mortgage-backed securities. As a result, Annaly’s shareholders have never been exposed to credit risk. But those days are over. Starting last year, Annaly began to diversify its portfolio into assets related to commercial real estate that aren’t similarly covered. In my opinion, it’s an egregious mistake and one that shareholders are likely to pay for in years to come.

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7 There’s no incentive to outperform

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As a result of Annaly’s previously mentioned corporate reorganization, its executive compensation package is now completely detached from the company’s performance. Regardless of profitability, they now get a set percentage of shareholder equity every year.

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8The Federal Reserve

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It’s said that one should never fight the Fed. But that’s exactly what Annaly must do. In an effort to boost the economy, the central bank has kept short-term interest rates near zero for much of the past five years. But this is bound to end. And when it does, Annaly’s cost of funds will increase, which is likely to have the concomitant effect of decreasing its earnings.

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9Industry headwinds

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Annaly’s book value is inversely correlated to mortgage rates. As mortgage rates increase, the value of Annaly’s portfolio of mortgage-backed securities decreases. Thus, since there’s essentially only one direction for mortgage rates to go from here (up), there’s also only one direction for Annaly’s book value to go (down).