This 11.46% Yield Was Sustained, Though Some Shareholders Don't Know It Yet

| About: Annaly Capital (NLY)

Summary

Annaly Capital Management declared two dividends for the quarter, but they usually only have one.

Some of the services reading dividend yields may display inaccurate information.

The annual dividend is still $1.20. Based on a recent price of $10.47, the yield is running 11.46%.

If the current environment is extended through the fourth quarter, things will look good for NLY’s dividend.

If the fourth quarter has a flattening yield curve with either asset yields or cost of funds getting hammered, it would put the dividend in jeopardy.

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Annaly Capital Management (NYSE:NLY) has a history of paying out $.30 per quarter, but their latest quarterly dividend of $.2641 left some shareholders confused. Since Annaly Capital Management acquired Hatteras Financial Corp. (NYSE:HTS) earlier in the quarter, they paid a "Short Period Common Stock Dividend" near the start of the quarter to get their books prepared for the acquisition. For the long-term shareholder, there was no change in the total quarterly dividend rate. That won't stop some shareholders from getting nervous, and it won't stop automatic engines from reporting the wrong dividend yield.

Beware Automated Tools

For many investors, the tools they rely on may not function properly for a bit. Since NLY usually pays quarterly dividends, the dividend yield on the stock is often found by annualizing the most recent dividend. That makes the dividend yield on NLY look weaker than it would otherwise be. Based on $1.20 in annual dividends and a share price of $10.47, the dividend yield is 11.46%. Expect some sites to be reporting a dividend yield around 10% due to annualizing the $.2641 rather than the total quarterly value of $.30.

Real Investment Implications

The mortgage REIT market frequently has periods that should make investors question efficient markets. There are periods where things appear efficient, but there are also some incredible failures and the duration of those failures can be as short as a couple hours or as long as a few quarters, perhaps even a few years. In my experience, something between the extremes is far more common.

One of the problems the mortgage REIT sector faces is the presence of investors trading on dividend yield with no idea what levels of dividends are sustainable or not sustainable. If those investors create a large enough group to move the market, they could influence NLY to trade at larger discounts on the basis of their tools showing inaccurate numbers for dividend yields. Remember that prices are still determined by supply and demand, so it is entirely possible for share prices to deviate from comparable value in other similar companies. To be more precise, it is not only possible, it is common and uncovering those discrepancies is a major part of my work.

Stability of the Dividend

Investors should be aware that double-digit yields in this interest rate environment do not come without risks. However, Annaly Capital Management is not merely a large mortgage REIT, they are also one of the better ones. Their quarterly dividend of $.30 pushes on the edge of what is sustainable (regardless of tax classifications), but it wouldn't be too hard to sustain it if the fourth quarter looks like what we have seen so far in the third quarter. A solid spread between the rates earned on MBS and the rates required on LIBOR swaps to hedge the portfolio is critical to the net interest spread. Annaly Capital Management is also using credit risk to boost the yield on the portfolio. In the third quarter, credit risk hasn't done too poorly despite a recent scare in the markets.

Risk Factors

The things that could hurt Annaly Capital Management would be an increase in short-term rates with no favorable impacts on long-term rates or a decrease in mortgage rates which would raise book value slightly but signal more prepayments. Prepayments on the agency RMBS (Residential Mortgage Backed Securities) are a major factor in determining the yield on assets and, consequently, the amount of net interest income Annaly Capital Management reports.

Investors should be aware that as Annaly Capital Management shifts into more credit sensitive assets, the reported yield on assets (gross interest income / average assets) will naturally move higher if nothing else changes.

Conclusion

The dividend was sustained, but some of the services won't show the correct yield. Due to the dissemination of inaccurate yield metrics, share prices may deviate more than normal from comparable values for other mortgage REITs. The dividend at $.30 per quarter is on the edge of being sustainable. If the interest rate environment in the fourth quarter resembles what we saw so far in the third, then I would expect it to be sustained. If the yield curve flattened with NLY getting hammered on either the yield on their agency RMBS or the cost of funds on their repo agreements, it would put the dividend in jeopardy.

This is the second time Annaly Capital Management closed under $10.50. This happened despite their book value being fairly solid on the quarter according to my estimates of book value. I'm not going to say I love Annaly Capital Management at this price, but I do like it. I'm long on NLY-E and contemplating an order on NLY.

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Disclosure: I am/we are long NLY-E.

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.

Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. This article is prepared solely for publication on Seeking Alpha and any reproduction of it on other sites is unauthorized. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.