Banking Cash While Borrowers Default

Tonight, Cramer shared a stock for those looking to actually profit off the subprime crisis rather than lose money because of it. If you’re anything like Jim – and a number of other market gurus – who believes that housing is only going to get worse, then it might make sense to invest in a company that knows how to play the mortgage market. Right now, the Mad Money favorite is Annaly Capital Management.

If you read this blog on Tuesday, you’d know that Cramer had Annaly CEO Mike Farrell on the phone to talk about how he’d positioned his company to do so well given the current subprime troubles. "Thirty years of being a mortgage trader tells you a lot about cashflows from consumers," Farrell said. Cramer was so impressed with Annaly’s market strategy he decided to take a deeper look at it for today’s show.

It’s important to know a little something about investing in mortgages before you understand just how truly great Annaly is right now. When you buy a mortgage or invest in a pool of mortgages, which is what Annaly does, you’re basically investing in risk – the risk that the borrower will default on the loan. But there are two kinds of risk you can bet on: interest rate risk, meaning you’re borrowing money to buy mortgages that are backed up by the full faith and credit of the federal government. This is what’s called agency paper, and it doesn’t have a lot of risk. The second kind is credit risk, where you bet on much chancier bonds that are put together by investment houses and mortgage brokers and made up of subprime borrowers with a really high risk of default.

Now, Farrell’s genius was that even when the residential real estate market was flying high – long before subprime was even a blip on the horizon – he decided to limit his company’s exposure to it. He told Cramer that he would borrow less money because it just wasn’t worth it to buy these mortgages. So while others were racing to snatch up these riskier bonds, Farrell was cutting back his spending, sticking with the interest-rate play and warning of an imminent subprime collapse.

So now all those companies that took on a lot of credit risk are getting killed by subprime – but Farrell and Annaly are in a perfect position to profit. He avoided buying bonds that could default on account of bad borrowers, only going after the lower-risk mortgages like those issued by Fannie and Freddie. Forty subprime lenders have collapsed, and many more will, Cramer says.

Annaly has been increasing its dividend for five straight quarters, while its competitors have been cutting. Now NLY’s yield is over 5%, and Cramer believes it could double. For the income alone, forget about the upside, this could be a great buy, he says. But Cramer is confident that the stock should go up, too. Annaly raised money in an offering and now they can deploy it profitably because housing is taking a beating. And if the Fed does blink because of all this subprime trouble, Cramer thinks Annaly could double.

Bottom Line: Annaly is the last man standing with tons of capital, ready to make itself a fortune. It would behoove Home Gamers to give this stock a serious look.

Questions? Comments?