Annaly: Leave The Common Shares Alone, Ride The Preferred

| About: Annaly Capital (NLY)

On February 21st, I first recommended to sell short the shares of Annaly Capital Management (NYSE:NLY).

We shorted it at $16.63 (the closing price on that day), rode it down all the way to the $15.50 lows, only to see the price bounce back to current levels. We are now exactly at the price we initially shorted the stock minus one dividend check of $0.55 on March 28th.

Although we could have closed the trade then for a 7.7% profit in less than a month, we are now back to the starting line. In order to avoid a second dividend check at or around May 28th, we will buy to cover our position for a 3.3% loss. Certainly not our best trade, but not a big deal either.

How to play Annaly - the right way

I still believe that the business model of Annaly is very fragile due to a potential refinancing rush and other macro events. That is why I believe that true income seeking investors should not be satisfied with simply holding the common shares of the company.

This type of investor believes that the current dividend yield, implied by the share price, is sustainable and will remain intact. I do not believe this is the case.

Now, there is a much better way to play Annaly for income seekers. On May 9th, the company announced that it has priced a public offering of 11 million shares of series C Preferred stock at 7.625%.

A few brief characteristics of this series:

  1. The preferred issue, by definition, enjoys a much higher status than the common shares. With preferred, the company is obligated to distribute the aforementioned dividend whereas the current $0.55 dividend of common is at the company's sole discretion.
  2. This preferred issue is cumulative which means that even though the company might skip a payout, this payout is accumulated and will be repaid to the holders of this series at a later time.
  3. The pricing is set at $25, which basically means that if an investor is able to get in at a better (lower) price - his or her yield will be fixed higher than the 7.625% stated above. Later on, if the price rises, the investor may choose to cash on the appreciation and sell it in the open market.

The short end of the stick here is, of course, the current interest rate environment. Although a 7.625% seems attractive in today's terms, it might not be the case two or three years down the road. When interest rates will rise, the price of fixed preferred issues are likely fall to fall.

In conclusion, taking into consideration the various headwinds that Annaly and other mREITs might face in the future, going long preferred is a much better choice. Leave the common shares to the common people.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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