Annaly Capital Management (NLY) Stands out in the crowd of mREITs. At a $14BL market cap, it is by far the largest mREIT out there. It pays off to watch this company closely for what the near future may bring to mREIT industry in general and to income seeking investors in particular.
Back in September 2012, I warned investors that the ~$17 price tag for Annaly was inflated and that the company's dividend will soon be trimmed because the company's cash flow simply cannot support it. Specifically, I wrote that -
mREITs will have to face reality sooner rather than later. I strongly suspect that what keeps the share prices floating for the time being is a desperate clinging on to anything that resembles yield. I believe that dividend cuts in the mREITs sector are imminent. These, in turn, will lead to a strong wave of selling by unsuspecting shareholders."
Since then, the company has indeed experienced a strong wave of selling, plunging from a price of $17.4 per share to the current level of $14, a 20% decline. That is a whopping decline for an mREIT.
Now, it is the turn of the dividend cuts to kick in.
Fewer dividends for you
Eventually, after a long period of time, the company finally realized that it cannot maintain its current high rate of dividends from its operating cash flow. It is simply unsustainable and it must be trimmed.
On December 18th, the company announced its 4th quarter 2012 dividend distribution of $0.45 per common share. This dividend is payable January 29, 2013, to common shareholders of record on December 28, 2012. The ex-dividend date is December 26, 2012.
Paying $0.45 per share seems like a generous dividend, but you must also keep in mind that it represents a 10% decline from its 3rd quarter dividend payout of $0.50. If you take another step back, you'll find that the recent $0.5 dividend was also trimmed by 9% from the previous 2nd quarter 2012 dividend payout of $0.55. Less income translates into fewer dividends.
Driving a car using your rear-view mirror
Buying mREITS in general, and Annaly in particular, simply for the dividends is to assume that the future will look just like the past. It implies that conditions are constant and nothing is changing. This, of course, cannot be further from the truth and it is also one of the famous biases in the world of investing.
Now, I am not saying that to receive a $0.45 dividend on a $14 stock is a bad deal. What I would like to emphasize is that I believe the dividend cuts are far from over.
Based on the company's latest 3Q report, I suspect that in order to align the operating cash flow with the dividend payouts, the rate of dividends must slow down.
Using Net Interest Income as a proxy for discounted cashflow gives us a 30% decline from last year's figures ($754ML in the year 2012 compared to $926ML in the year 2011). Only this fact alone should trim the dividend to the $0.38 level, a 15% decline from current level.
Add to that the looming concerns over imminent narrowing of spreads and the high rate of prepayments, and we are in for a different, much more difficult environment.
I believe that one year down the road, at the end of 2013, we will be looking at a dividend rate in the $0.25 area. Of course, this will not come as a single, sudden move, but as gradual incremental declines of $0.05 over the next 4 quarters.
Value or value-trap?
Annaly is not a lonely player in the mREIT field. The sector, as a whole, has suffered some massive fire in the second half of 2012. The question now arises whether this sector, or specific players in it, have finally reached the 'value zone' and are ripe for investment.
The most important parameter in evaluating mREITs is book value. Earnings, whether GAAP earnings or others, are less important because these companies tend to deliver most of the profits (90%) back to their shareholders in the form of dividends. Over the long run, Mortgage REITs normally float around book value. As of this writing, Annaly is trading at a 15% discount to its book value. This discount is probably due to the uncertainty surrounding the upcoming dividend payouts. Take a look at the table below.
Market Price 01/02/13
Book Value $
% discount to book
American Capital Agency (AGNC)
American Capital Mortgage Investment (MTGE)
Annaly Capital Management
|Invesco Mortgage Capital (IVR)||$20.9||$20.9||0%|
|Chimera Investment Corporation (CIM)||$2.67||$3.37||18.34%|
When you look carefully, you will see that other than Annaly and Chimera, mREITs do not seem to really compensate you for the current inherent risks in the industry. You will be much better off by picking some high yielding tobacco company that has a 6% dividend yield like Phillip Morris International.
As to Annaly and Chimera that do offer a respectable discount to book value, I strongly suspect that this discount is solely attributed to the imminent dividend cuts that will take place in 2013 as I discussed above. Once those dividend cuts kick in and share price falls, then both companies will become good value.
My recommendation for 2013
I recommend NOT to buy into any of the mREITS just yet before the fog fades. Since investing in mREITs is mostly an income play, there is simply no reason whatsoever not to stand on the sidelines, wait until the dividend cuts kick in and then consider any investment in the company.
After all, investing in mREITs is not about surprises and uncertainty, it is about safety and security.