Annaly: Dividend At Risk

| About: Annaly Capital (NLY)

Summary

The company has announced it will maintain its dividend.

There was speculation of a dividend cut.

I discuss why the company's dividend is possibly in jeopardy.

After a recent pullback, Annaly Capital Management (NYSE:NLY) remains one of my core mREIT holdings and has traded nicely since I called what I thought was the bottom in the stock since January 2014 when it was trading at $9.75. In names like Annaly, which I contend are to be bought for income, your entry point does make a difference. I also believe that the power of the dividend is why we own this name. I recently discussed what the dividend really meant for the name, and illustrated the power of a long-term buy and hold in the name. Today we learned that the dividend was going to be maintained.

There had been speculation in comments on my recent article that the dividend might not be safe. But we learned that the company declared the second quarter 2016 to once again be $0.30 per common share. This dividend is payable July 29, 2016, to common shareholders of record on June 30, 2016. The ex-dividend date is June 28, 2016. But why would there have been speculation to begin with?

The answer lies in recent performance. Make no mistake the name has struggled of late, but has managed to cover the dividend. This is in large part due to an improving constant prepayment rate in the sector. I have been concerned about prepayments, and these have pressured earnings in prior quarters. That said, Annaly Capital's portfolio saw its constant prepayment fall to 9.0%, down from the 9.7% in Q4 2015. Recall, I had predicted the constant prepayment rate would level off and drop for the sector. I was pleased to see this occur for Annaly, and it drove the spread and net interest income higher. The normalized average yield on interest earning assets was 3.00% and the average cost of interest-bearing liabilities, including interest expense on interest rate swaps used to hedge cost of funds, was 1.73%. This resulted in a spread of 1.27%.

In the end, it comes down to income. This is why there was speculation about the dividend. Annaly's core earnings came in at were $298.1 million or $0.30. I was not pleased with the quarter-over-quarter decline from the $311 million, or $0.31 per share in core earnings in Q4. However, this was the so-called normalized core earnings. If we actually back out the financial engineering (that is, the normalization), we see that core earnings were really $0.11. That is pretty pitiful compared to last quarter's $0.33. Thus, looking ahead, all eyes have to be on the key metrics of the company and the dividend coverage, or else the risk of a cut becomes more likely than not.

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Disclosure: I am/we are long NLY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.