On March 20, 2012, after the markets closed, Annaly Capital Management (NYSE:NLY), the largest publicly traded mortgage REIT announced its quarterly dividend for the first quarter of 2012. Annaly declared a Q1 2012 common stock cash dividend of $0.55 per common share, payable April 26, 2012, to shareholders of record on March 39, 2011, with an ex-dividend date is March 28, 2011, or this coming Wednesday.
Last quarter, or for Q4 of 2011, Annaly paid a $0.57 quarterly dividend, and in Q1 of 2011 Annaly paid a $0.62 dividend. Annaly's dividends have been in a steady state of decline for several quarters, with brief interludes of strength. Over the last ten quarters, Annaly's dividend as crept from a high of $0.75 down to its new rate of $0.55, or a 26.66 percent reduction in the dividend.
Though this newest dividend is the lowest within the last ten quarters, it is worth of noting that $0.55 is still far from the lowest dividend NLY has provided. Annaly's dividend reached its bottom in Q4 of 2005, when NLY provided a quarterly dividend of $0.10, an eighty percent cut from the dividend it paid in the Q4 of 2004. As a result, Annaly's annual payout bottomed in 2006, with the company paying $0.57 for the full year.
Mortgage REITs produce high yield returns by leveraging a spread. The spread is the profit margin the REIT can achieve between the rate on the money it borrows and the rate paid by the mortgage paper it holds. For example, if a company can borrow at 3% and buy paper that yields 5%, the spread is 2 percent.
A major risk for mortgage REITs has been that the spreads will get hurt due to increasing interest rates. Spreads have been historically large since the financial crisis started, but most mREITs have reported consistently narrowing spreads over the last several quarters. This has forced the REITs to either increase their leverage or decrease their dividends.
Annaly last reported an average interest rate spread of 1.71% for Q4 of 2011, which is a 14 basis point decrease from a 1.85% spread during Q4 of 2010, and a 37 basis point decrease from the 2.08% average spread Q3 of 2011.
The level of leverage used by the REIT multiplies that spread payout. Most mREITs have a leverage rate between five and ten times their asset valuation. Last quarter, Annaly also reduced its leverage down to 5.4x, from 6.7x during the same quarter in 2010 and 5.5x during the third quarter of 2011. Many mREITs are wary of maintaining excessive leverage rates while Treasury rates remain at historically low levels. Rising rates will reduce the market value of previously issued fixed income securities, and the use of leverage would also multiply that reduction.
Annaly exclusively buys, trades and holds mortgage paper that is backed by federal agencies. An agency RMBS comes with an agency guarantee and an implied U.S. government guarantee. On March 8, CYS Investments (NYSE:CYS) announced a Q1 2012 dividend of $0.50 per share. This was the same dividend CYS paid the prior quarter. On March 12, Hatteras Financial (NYSE:HTS) announced a 1Q 2012 dividend of $0.90 per share, and on March 13, Capstead Mortgage (NYSE:CMO) announced a dividend of $0.43 per share. All of these Q1 2012 dividends are at the same rate each paid out for Q4 of 2011, though all three did reduce dividends last quarter.
On March 7, American Capital Agency Corp (NASDAQ:AGNC), the second largest publicly traded mREIT behind Annaly, announced a massive secondary offering worth about $2 billion, following AGNC going ex-dividend. In February, when AGNC reported Q4 2011 earnings, AGNC lowered its quarterly payout to $1.25 after having maintained a $1.40 dividend for the previous 10 quarters. It is still unclear whether AGNC intends to use those funds to further leverage up, here, or to at least partially maintain funds for potential discounted opportunities that may present themselves.
Annaly investors still appear poised to earn a sizable and likely double digit yield within 2012, but the risks associated with the mechanism by which this yield is obtained are only increasing. Moreover, spreads appear only likely to narrow going forward, given agency RMBS liquidity, and that narrowing has been the trend for a prolonged period. Moreover, Annaly has on several occasions stated that it is trying to take a conservative and opportunistic approach in this environment, which means that it is unlikely to significantly increase leverage here.
As a result, continued dividend cuts appear probable this year, and investors should not be surprised to see forthcoming cuts later this year. Moreover, it is also possible, though by no means a sure thing, that Annaly may announce a secondary after its upcoming ex-dividend date, just as AGNC recently did.
Because mREIT dividends are taxed as regular income and not at the lower corporate dividend rate, mREITs are substantially better performing investments when held within tax deferred or exempt accounts. Nonetheless, and because of the risks associated with mREIT leverage and the potential recent peaking of Treasury valuations, exposure to any agency mREIT should be limited to a reasonable portion of an income and/or real estate portfolio allocation.
Disclosure: I am long (NLY).
Disclaimer: This article is intended to be informative and should not be construed as personalized advice as it does not take into account your specific situation or objectives.