In times of economic uncertainty, in this case of prolonged economic uncertainty, investors routinely run for the shelter of stocks that pay high dividend yields. Real Estate Investment Trusts (REITs) must pay out 100% of their net income in the form of distributions to its shareholders in order to qualify for the tax favored REIT status. Two REITs examined here today, Annaly REIT (NLY) and Capstead Mortgage (CMO) both provide high dividend payouts, 14.10% and 12.80%, respectively. The question is whether the payouts are sustainable, or if the common shares of these companies will increase. We examine both REITs here:
Annaly
Annaly manages assets on behalf of institutional and individual investors worldwide. Rather than distribute income from the ownership of actual real estate assets, Annaly produces income and distributions from investing and trading government guaranteed (Agency) mortgage-backed securities. Its principal objective is to generate net income for distribution to investors from its investment securities and from dividends from its subsidiaries.
Annaly's common shares trade around $16, and have a 52-week range between $18.79 and $14.05. It has a price earnings ratio of 43:62, earnings per share of $0.37, and a dividend yield of 14.10%. Annaly has total cash of $2.78 billion and total debt of $88 billion. Its book value per share is $16.06. Market capitalization is $15.66 billion.
Fourth quarter results reported net income in the quarter of $445.6 million and $0.46 per common share as opposed to net income of $1.2 billion or $1.94 per common share for the same period in 2010. Net income for the year 2011 was $344.5 million or $0.37 per common share compared to $1.3 billion or $2.12 per common share for the year ended December 31, 2010.
The company disposed of $10.3 billion of Agency mortgage backed securities and debentures providing a realized gain of $80.7 million, compared to a gain of $33.8 million on disposal of $3.1 billion of Agency mortgage backed securities for the same quarter 2010. Year-end results for the disposal of $20.1 billion of Agency mortgage-backed securities and debentures resulting in a realized gain of $206.8 billion compared with the disposal of $10.6 billion of Agency mortgage-backed securities and a realized gain of $181.8 million for the year 2010. The annualized dividend for the year ended December 31, 2011, was 15.29% based on the closing price of $15.96 on December 31, 2011, compared to 14.9% for the year ended December 31, 2010.
General and administrative expenses were 0.23% of average assets at the end of the fourth quarter, compared to 0.22% of assets for the same quarter 2010. Book value per share was $16.06 at the end of December 2011 compared to $15.34 in December 2010. Investment advisory fees comprised $20.5 million in at December 31, 2011 compared to $16.3 million at December 31, 2010.
For the quarter ended December 31, 2011, the company provided an annualized return on average equity of 11.23% compared to 49.87% for the same period of 2010. For the year ended December 31, 2011, average return on equity was 2.51% compared to 13.06% for the year ended December 31, 2010. 2011 was not a great year for Annaly, but it increased its distributions to investors
Capstead Mortgage
Capstead Mortgage is a REIT that earns income from investing in real estate related assets on a leveraged basis. It invests in residential adjustable rate government guaranteed (Fannie Mae, Freddie Mac) or agency of the government (Ginnie Mae).
Capstead Mortgage's common stock trades around $13.40, has a year high of $13.95 and year low of $10. The price earnings ratio is 7:66, earnings per share are $1.75. The dividend yield is 12.80%. It has a market capitalization is $1.21 billion. The company has total cash of $427 million and total debt of $11.49 billion. The book value per share is $12.55.
Fourth quarter 2011 results for Capstead showed net income of $41.9 million or $0.43 per common share for the quarter compared to net income of $41 million or $0.43 per share for the third quarter of 2011. Net income in 2011 totaled $160 million or $1.75 per common share compared to $127 million or $1.52 per diluted common share in 2010. The increase in net income is attributed to increases in the investment portfolio, funded by newly raised equity capital and higher leverage levels.
The difference between yields on interest earning assets and rates on interest bearing liabilities were lower, at an average of 156 basis points in 2011 compared to 174 basis points during 2010. The effect of lower portfolio yields is partially offset by lower borrowing rates.
Financing spreads averaged 1.46% for the quarter, compared to 1.37% for the third quarter of 2011. Yields on interest earning assets averaged 2.07% in the quarter, a decline of 5 basis points from yields reported in the third quarter of 2011. Yields declined by 22 basis points from the second quarter to the third quarter of 2011.
Capstead's book value increased $0.50 in 2011. The company stated that market conditions are favorable for investing in agency guaranteed securities, despite European sovereign debt concerns and the failure of MF Global - a lending counterparty to the mortgage REIT sector. The company goes on to say that the differentiating factor Capstead is that their investment portfolio in focused on investing solely in adjustable rate mortgage (ARM) securities.
Guidance for 2012 indicates that the economic conditions will likely show low levels for the federal funds rate for the next two years. If this does become a reality, Capstead anticipates portfolio yields on their current reset ARM securities will be modestly lower. The company's portfolio of mortgage backed securities and Agency debentures was comprised of 42% floating rate, 9% adjustable rate and 49% fixed rate assets.
Capstead's investments are managed by the company and not an external advisor, providing a higher level of transparency to stakeholders. The company states that 70% of its compensation to its internal advisors is performance based, and much of the compensation was given in the form of shares in the company. There was an 11.2% increase in compensation costs in 2011. General and administrative expenses increased to $16.3 million in 2011, but showed a decline as a percentage of average long term investment capital to 1.27%.
Capstead is one of the lowest cost providers as a percentage of invested capital in the agency-REIT sector. Future returns are dependent on the company's ability to produce attractive dividends, which will fluctuate with changes in market conditions. In January 2012, the rates declined from higher levels experienced from the fourth quarter in 2011, and are expected to remain low, with declining hedging costs providing offset to lower portfolio yields. The company is confident that the portfolio of agency guarantees residential ARM securities can provide risk-adjusted returns over the long term, and will reduce the sensitivity to changes in interest rates.
In January 2012, the rates declined from the higher levels experienced from the fourth quarter in 2011, and are expected to remain low with declining hedging costs providing offset to lower portfolio yields. The company is confident that the portfolio of agency guarantees residential ARM securities can provide risk adjusted returns over the long term, and will reduce the sensitivity to changes in interest rates.
Difficulties with sovereign credit risks in the U.S. and abroad, and continued weak global economic predictions continue to provide challenges to companies engaged in the investment of government guaranteed securities. Most companies in this space are adapting to the current environment by being conservative in their approach to risk and performance.
As long as these REITS are able to provide increased net income, they can sustain their dividend payouts. An increase in share price does not bode well for the stock price, as it will likely offset any dividend payments. With yields remaining low, there will be little to recommend the increase in share price or dividend increases, as the companies will have to deliver consistent net income numbers to continue their distributions. Lower yields mean lower earnings - either share price suffers or dividend payouts suffer. Book value is also vulnerable to fluctuations dependent on the yield received and the difference between the actual yield and the profit on trading in mortgage backed securities. The conservative approach in the current interest rate environment does not see any additional risk being taken on by either Capstead or Annaly.
REITS usually trade at or near book value for reasons that net income is paid out to holders every quarter. An increase in rates is about the only event that would drive stock prices in either direction, depending on what the portfolio managers see in the near term. The Federal Reserve's current stance on rates into 2014 it does not signal any capital appreciation for investors in the near term. A flat yield curve will continue to pose a threat to dividend yields.
Capstone may have more risk in its investment in only ARM securities, while Annaly does invest in ARMs and other mortgage securities that are not government guaranteed through its subsidiaries. These type of investments are likely to yield better returns; however, the risk in the current environment of slow recovery in the U.S. and the sovereign debt crises in Europe does not warrant entering into a more risk oriented portfolio for either company. Capstone wins the prize for most improved at 2011 year-end, and is a hold in the near term. In the absence of a dividend cut, Annaly is also a hold.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
