Annaly Capital Management (NLY), a familiar name to income investors, invests in agency MBSs issued by Freddie Mac and Fannie Mae. Annaly consists of 5 subsidiaries and maintains close business ties with Chimera (CIM) and Crexus (CXS). Chimera trades around $3 and Crexus is trading near $10. Annaly's subsidiaries are RCAP Securities, Merganser Capital Management, FIDCA, Shannon Funding LLC and Charlsfort Capital Management. RCAP Securities is a broker-dealer. Meganser Capital and FIDCA are both SEC-registered investment advisors, and FIDCA provides investment management services for Chimera. Shannon Funding LLC provides mortgage warehouse financing, and Charlsfort Capital Management offers customized debt financing to middle markets.
Annaly's revenues come form an interest rate spread created when low interest rate short term financing is used to purchase MBSs that pay a higher long-term interest rate. Short term interest rates are lower than long-term rates, and Annaly makes money on the difference between the two. Annaly is the largest mREIT in the United States with a market capitalization of $15.12 billion. Due to the company's status as a REIT, Annaly must pay out 90% of its earnings as dividends.
Over the last few years, investors have moved money to mREITs in response to the Fed's soft interest rate policy. I think this is an excellent time to add to positions in mREITs, especially a well managed company likes Annaly, which is trading at book value and has a 14% dividend. It is unlikely that the fed is going to raise rates anytime soon, possibly not until 2014. The only risk I see to owning an mREIT is the current prepayment rate. When mortgages are paid off early, Annaly will have to reinvest the funds in lower yielding MBSs that may cause the dividend to fall; regardless that yield will still be higher than you will get on a money market, CD or traditional stock dividend.
Investors looking for more income continue to move money in to mREITs. Investors move to this type of investment because historically mREITs have been a high yielding investment. Total retunes on equity listed REITs out performed the S&P in 2011 and retunes were 4 times greater than the total market return. Annaly's dividend yield currently stands around 14%. This is in line with CYS Investments (CYS) at 15%. CYS Investments trades around $13. Both Annaly and CYS Investments lag Armour Residential REIT (ARR) at 18%, and trades around $7. Annaly is the largest and best managed of the mREITs. The company has consistently paid a 14% dividend for the last 10 years and I look for that to continue as long as the fed keeps its soft interest rate policy in place. The reason for Annaly's outperformance is the low interest rate environment we are currently going through.
Annaly reduced its leverage at the end of 2011, debt to equity declined form 6.7 times at the end of 2010 to 5.4 times and the company reduced the size of the it's portfolio by 2%. Interest rate spreads to narrow in 2012, look for the spread to around 1.8% down form 2.04% in 2011. With $12.2 billion in net assets, Annaly looks to generate fees of $87 million in 2012. S&P earnings estimate for 2012 is $2.20 per share. I think given the company's past performance these numbers are accurate estimates for 2012.
The advantage of holding a company like Annaly is the higher yield, in this interest rate environment your CD returns 3%, that is if it is held for three years. You can take a moderate risk and buy Annaly and get a retune of 42% for the same 3 year period. That's the cumulative return of 14% over three years. I think share price will range between $15 and $18 over the next 12 months. I know that is a pretty tight range, but Annaly is not going to appreciate because it pays out most of its income in dividends in order to meet the requirements to maintain its status as a REIT. With current interest rates being so low you will not find a better income opportunity than Annaly. The company's strong management team successful guided the company through the most recent housing bust and has taken the right steps to maintain maximum returns for investors going forward.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.