Seeking Alpha
Research analyst, portfolio strategy, portfolio management
Profile| Send Message|
( followers)  

I did not think I would be writing a somewhat negative article on one of my all time favorite stocks but the message needs to be sent that the prospects of continued profits by Annaly (NYSE:NLY) could begin being impacted by the tightening yield curve.

As recently as two weeks ago, I wrote this article in defense of my opinion. Let me be clear, my opinion over the long term has not changed, but as prudent investors we do need to look at the reality of any situation that is right before our eyes. To be oblivious is just sticking our collective heads in the sand and hoping for magical thinking to make the boogie-man go away.

Annaly Capital Management, Inc. (<a href='http://seekingalpha.com/symbol/nly' title='Annaly Capital Management, Inc.'>NLY</a>)

The Center Of Attention

One could say that nothing has happened to the stock price to get anyone's nerves frayed and that would be true enough, but all we need to do is scratch away at the surface to reveal the bumps ahead for Annaly.

The 10 year Treasury, which has been the primary playground for Annaly, has fallen to an all time low yield of 1.46%.

click to enlarge image

10 year Treasury yields

While this is not a doomsday scenario largely due to the continued ZIRP (zero interest rate policy) that our Fed has maintained, it could - and probably will - contract profits for the mREITs that do not go a bit further out on the curve to maintain sound profits. Annaly has played the conservative card deftly to this point and kept enough dry powder to deploy using greater leverage.

While I do believe that their management team will take full advantage of what the current scenario gives them, we, as investors, need to monitor the activity closer than we have before.

I feel that now is the time for Annaly to take on more risk by using a bit more leverage. If we are to receive current strong dividends going forward, I feel that this action must be taken, and Annaly has the money to do it.

Our Current Dividend Scenario

We do not own shares of Annaly for any sort of major capital appreciation but the rise in share price has been fun to watch in the face of the naysayers and the NLY bashers. So far the price has held up very well.

By this time we might have seen even further gains leading up to the ex dividend date, and I think that some of that has happened and cushioned the drop in share price because of it.

I also believe that this coming dividend is safe and we will see a solid dividend announcement in the coming weeks. After that, we should monitor this yield curve spread.

Annaly has made strong profits through thick and thin but that does not mean that we should not have a heads up here.

I would not DUMP shares of Annaly at this point, nor would I add shares until the yield curve settles into a more predictable range, OR we gain evidence that NLY is using greater leverage.

I am in a holding pattern for now.

My Opinion

The next dividend is safe in my opinion. Going forward we could see cuts in the yield down to around 10% (down from the current 14%). That obviously is not bad but if the tighter spread continues, the yield could drop further (6-8% perhaps?).

I have seen this before with Annaly and they have always been able to navigate deftly. That being said, prudence is called for right now.

Watch the yield curve spread as I have noted, keep an eye on the potential for more QE3, and let the next 6 months play out before deciding on ANY action with NLY.

Just my opinion folks, but it needs to be out there.

Disclosure: I am long NLY.

Source: Annaly: A Negative Scenario Currently