Annaly Capital Management (NLY) pays investors a dividend yield in excess of 12%. The company is a mortgage REIT, buying, selling and managing a portfolio of mortgage backed securities (MBS). The REIT's main objective is to generate income for distribution to its shareholders through income received on the MBS.
However, the company, like the rest of its peers in the financial REIT sector, is suffering from falling interest rates on MBS as the U.S. Federal Reserve continues its QE3 program, which involves the buying of some $85 billion in mortgage-backed securities a month, in an attempt to drive down borrowing rates and jump-start economic growth.
Annaly's Income Problem
In order to achieve the income that it requires, Annaly Capital has to borrow money in the form of repurchase agreements (REPOs), for which the company pays a set amount of interest a year. Annaly then uses this borrowed money to buy mortgage-backed securities that issue an interest pay-out. For example, Annaly borrows $100 in the form of a REPO at a rate of interest of 1% a year. The company then uses this cash to buy an MBS, which pays out 2.5% a year in interest. Out of this deal, Annaly receives 1.5% a year, or $1.5 in income. The difference between what the company is paying to borrow and the interest that it receives on its investments is called the interest rate spread. This spread, however, has been squeezed during the past year as the FED buys mortgage related assets, driving down their yield.
Indeed, between the end of March 2012 to March 2013, the company's interest rate spread fell from 1.71% to 0.91%. As a result, Annaly's net income fell from $721 million during Q1 2012, to $559 this year, a decline of 22.5% year-over-year.
Furthermore, falling yields on investments has meant that shareholders have seen a fall in their income as well as the company's quarterly dividend has been reduced from $0.55 per share during 2012, to $0.45 per share in 2013.
Having said that the company still offers $0.45 per share quarterly, which annualized, at the current share price, indicates that Annaly supports a 12% dividend yield.
Should Investors buy Annaly Shares for their yield?
Based on Annaly's dividend history, I do not have much faith that the company will continue to pay its dividend at current rates. In particular, looking back at Annaly's recent dividend history, since the beginning of 2010, the company's dividend has fallen from $0.75 per share quarterly, to $0.45 per share, a 40% fall..
Furthermore, Annaly's closest competitors American Capital Agency Corp. (AGNC) and ARMOUR Residential REIT (ARR) have also seen their interest spreads fall 0.5% and 0.7%, respectively, during 2012, which lead to similar dividend cuts for both companies.
Moreover, while the FED continues to buy mortgage securities at $85 billion a month, I believe these declining spreads will continue and dividends will continue to fall across the sector.
So, how does Annaly compare to its peers?
Annaly Capital Management is in the diversified REIT sector of the market, which means that the company's closest competitors by market capitalization are Vornado Realty Trust (VNO) and Weyerhaeuser Co. (WY), both of which offer a dividend yield that is significantly lower than Annaly's. However, both Vornado and Weyerhaeuser are property REITs, owning real estate and not relying on interest rate spreads to generate income.
Annaly's closest competitors that are involved in the purchase of mortgage securities are American Capital Mortgage Investment Corp. (MTGE) and Chimera Investment Corporation (CIM). That said, Chimera is actually a subsidiary of Annaly and offers a slightly lower dividend yield of 11%, which is still falling due to declining yields on mortgage securities.
Annaly's other closest competitor is American Capital Mortgage Corp, which offers a 14.5% dividend yield and currently appears cheaper than Annaly, trading on a forward P/E ratio of 7.6, compared to Annaly's 10.3. Moreover, during the past year, American Capital Mortgage has maintained its dividend payout, while its peers have been reducing theirs. Compared to the other REITs listed, Annaly is also more expensive.
Overall, Annaly Capital is struggling to maintain its dividend payout and investor returns. With yields on mortgage investments declining and the company's cost of borrowing remaining constant, the company is struggling to generate the same returns for shareholders that it has done in the past.
Annaly is currently trading at only 0.9x the value of its net assets, which makes the company look like a value investment. However, the consensus Wall Street analysts estimate is a solid hold, and the average price target is $15.50, only slightly above where the stock currently trades.
Having said that, since its IPO in 1997, Annaly has returned $9 billion in dividends to shareholders, giving investors a total return of 600% since the company's inception. But despite this history of shareholder returns and Annaly's current dividend yield, investors could be faced with falling dividends in the future. Meanwhile, Annaly's peers could offer a more attractive investment.