Fundamental Analysis of Hatteras Financial Corp. (HTS): A Historical Review of an Acquired mREIT

 

Fundamental Analysis of Hatteras Financial Corp. (HTS): A Historical Review of an Acquired mREIT

Hatteras Financial Corp. (HTS) was a mortgage Real Estate Investment Trust (mREIT) that was acquired by Annaly Capital Management, Inc. (NLY) in 2016. As HTS is no longer an independent, publicly traded entity, a fundamental analysis is purely a historical review of its business model, performance prior to the merger, and the mechanics of the acquisition that ended its corporate life.

Fundamental Analysis of Hatteras Financial Corp. (HTS): A Historical Review of an Acquired mREIT

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1. Company Profile and Business Model (The mREIT Structure)

Hatteras Financial Corp. was an externally-managed mREIT that specialized in investing in Agency residential mortgage-backed securities (RMBS).

• Investment Focus: HTS primarily acquired adjustable-rate and hybrid adjustable-rate residential mortgage pass-through securities issued or guaranteed by U.S. government agencies (like Ginnie Mae, Fannie Mae, or Freddie Mac). These are known as Agency MBS.

• REIT Status: As an mREIT, HTS was required to distribute at least 90% of its taxable income to shareholders, which resulted in it paying high dividend yields—a key attraction for income-focused investors.

• Leverage Strategy: Like most mREITs, HTS employed a significant amount of leverage (borrowed money, typically through repurchase agreements) to finance its portfolio acquisitions. The goal was to profit from the net interest margin—the spread between the interest income earned on its mortgage assets and the borrowing costs of its liabilities.

• Risk Management: The company specifically focused on securities with short effective durations (adjustable and hybrid-adjustable rates) to try and reduce the impact of changes in interest rates on the market value of its portfolio and its net interest income, particularly in anticipation of rising rates.

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2. Financial Performance (Pre-Acquisition)

Analyzing HTS's fundamentals before the 2016 merger focused on key metrics relevant to mREITs:

A. Book Value Per Share (BVPS)

The most critical metric for an mREIT. It represents the net asset value of the company's mortgage portfolio per share.

• Significance: mREITs often trade at a discount or premium to their BVPS. Hatteras's BVPS was subject to fluctuations based on changes in interest rates, which affect the market value of its fixed-income portfolio.

• Acquisition Context: The final acquisition price of $15.85 per share by Annaly was notably a multiple of 0.85x Hatteras' estimated book value per share at the time, indicating the company was acquired at a discount to its intrinsic net asset value.

B. Net Interest Margin (NIM)

The difference between the average yield on its assets and the average cost of its funding, which drives its earnings.

• Risk Factor: The risk to NIM came from two primary areas:

  1. Yield Curve Risk: A "flattening" of the yield curve (short-term rates rising faster than long-term rates) would compress the NIM and hurt profitability.

  2. Prepayment Risk: If interest rates fell, homeowners might refinance their mortgages, causing HTS to receive its principal back earlier than expected, forcing it to reinvest at lower yields.

C. Dividends and Core Earnings

• Dividends: As a REIT, HTS paid substantial dividends, which were directly tied to its "Core Earnings"—a non-GAAP measure generally defined as net income excluding realized and unrealized gains/losses on investments and derivatives.

• Sustainability: Fundamental analysis focused on the sustainability of the dividend payout by comparing it to the Core Earnings per share. A weakening NIM or declining BVPS typically signaled a future dividend cut.

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3. The Acquisition by Annaly Capital Management (2016)

The fundamental story of HTS concluded with its sale to Annaly Capital Management (NLY) in April 2016, a strategic move that solidified NLY's position as the market leader.

A. The Transaction Terms:

The deal was valued at approximately $1.5 billion and offered Hatteras shareholders an election of consideration:

1. Cash-and-Stock Mix: $5.55 in cash and 0.9894 shares of NLY common stock.

2. All Cash: $15.85 per share.

3. All Stock: 1.5226 shares of NLY common stock.

The aggregate consideration was subject to proration to ensure the total payout consisted of approximately 65% Annaly common stock and 35% cash.

B. Strategic Rationale (Fundamental Fit):

• For Annaly (The Acquirer): The acquisition was fundamentally driven by a desire to increase scale, diversification, and market dominance. Hatteras's portfolio of Agency RMBS and other mortgage assets was complementary, and the transaction was expected to be accretive (adding value) to Annaly's book value per share and core earnings.

• For Hatteras (The Acquired): The sale provided shareholders with a liquidity event and a premium of approximately 24% over the stock's 60-day volume-weighted average price. In a challenging mREIT environment characterized by interest rate uncertainty, the merger offered shareholders a clear exit and the opportunity to become shareholders in a larger, more diversified market leader.

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4. Post-Merger Status and Investment Takeaway

The stock ticker HTS is now delisted and defunct. All former HTS shareholders either received cash or Annaly (NLY) stock (or a combination) in exchange for their shares, and the Hatteras portfolio was fully integrated into Annaly's operations.

Investment Takeaway: The HTS acquisition demonstrates how fundamental analysis in the mREIT sector must deeply consider Book Value Per Share and the ability of management to navigate interest rate cycles. The ultimate sale, even at a discount to BVPS, was a common outcome for smaller mREITs in a consolidating industry facing stiff macroeconomic headwinds.