Annaly: Love That Dividend, but …

by Ethan Roberts | December 6, 2012 11:13 am

Usually, a stock that’s throwing off a double-digit dividend yield is short-term anomaly. And investors will typically speculate on the odds of the dividend being cut.

With a current dividend yield of 13.8%, New York-based mortgage real estate trust (mREIT) Annaly Capital Management (NYSE:NLY[1]) seems to fit in that category. However, this is simply normal for NLY. Except for the three-year period from 2005 to 2007 when interest rates spiked, its dividend has always been in double digits. Even the housing market meltdown in 2008 and 2009 didn’t cut into NLY’s dividend yield.

As an mREIT, Annaly owns, manages, and finances a portfolio of investment securities made up of mortgage-backed securities and collateralized mortgage obligations. It borrows money at very low interest rates from investors, and then puts that money into higher-rate mortgages, mortgage bonds and other real estate-related securities.

Beyond the hefty payout, another positive trait for NLY is that its stock price has been fairly stable over time. Since the market bottom of March 2009, it has slowly and steadily doubled in price, with only minor pullbacks — up until September 2012. The 52-week price range is $13.72 to $17.75.

But as chart below shows, the stock has lost substantial value recently, dropping about 16% over the last 10 weeks. The 50-day moving average has recently crossed below the 200-day, a negative technical pattern known as the “death cross.” Stocks typically struggle for a while when this pattern emerges.

The recent decline is primarily due to the Federal Reserve’s third round of quantitative easing, in which the central bank pledged to buy $40 billion a month in agency mortgage-backed securities, until such time as the labor market “improves substantially” — a loose metric that the Fed hasn’t defined.


The Fed has essentially become a large competitor to the already-crowded mREIT sector, and other sector stocks, such as American Capital Agency (NASDAQ:AGNC[3]), Chimera Investment (NYSE:CIM[4]) and CYS Investments (NYSE:CYS[5]), have also declined since QE3 launched. The Fed’s mortgage-buying has compressed interest rate spreads that are vital to the success of the mREIT stocks.

As a result, NLY missed analyst’s expectations of 47 cents per share by two cents in third-quarter 2012. However, revenues beat the Street’s expectations of $2.5 billion with a $3.1 billion blowout.

Most troubling was a large decline in Annaly’s net interest margin, a measure of the difference between the interest income it generated, versus the amount of interest paid to their lenders, relative to the amount of its interest-earning assets. NLY has a forward price-earnings ratio of only 9.66, but a somewhat tepid return on equity of 8.97%.

Annaly is now seeking to diversify its portfolio by proposing to purchase CreXus Investment (NYSE:CXS[6]), a commercial real estate company with a similar business model of purchasing commercial loans and debt obligations. This would give NLY exposure to commercial mortgage-backed securities as well as residential mortgages.

In terms of relative strength within the mREIT sector, NLY has been a recent laggard, while stocks such as Chimera Investment have trounced NLY’s performance. Over the past three months CIM is up 9.73%, while NLY is down 15.42%. The dividend yield for CIM is almost identical to NLY, and yet the payout ratio for CIM is a manageable 65%, while NLY’s payout ratio is a disturbing 137%. Other stocks recently outperforming NLY include AGNC and CYS.

Fiscal cliff talks have also hit the mREIT stocks, as investors cope with not knowing the future tax rates on dividends. While it’s great to have a 13% dividend yield, the risk of all the mREIT stocks continuing to decline in share value remains high. Therefore, the most prudent course of action with this sector is probably to wait until we get clarification on what the dividend tax rate will be for 2013.

One noteworthy event for Annaly was the recent insider purchase of 100,000 shares at $13.90 per share by company President Kevin Keyes on Nov. 15. This was Keyes’ first purchase since August 2011, and would seem to indicate that insiders have a positive view of the stock at current levels.

It remains to be seen if the Street shares the same view of Annaly.

As of this writing, Ethan Roberts didn’t own any securities mentioned here.

  1. NLY:
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  3. AGNC:
  4. CIM:
  5. CYS:
  6. CXS:

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