Need a good scare this Halloween? Annaly Capital's (NYSE: NLY ) business model will make you shudder. It buys loads of mortgage-backed securities, leverages up to the gills, and pockets the difference. Sound familiar? It's not too different from the strategy that sent Bear Stearns and Lehman Brothers to the graveyard.
Ha! Time to bail on this looming disaster? Nah. Annaly sets itself apart with one very important factor that's keeping this baby afloat: it only buys government-insured Fannie Mae (NYSE: FNM ) and Freddie Mac (NYSE: FRE ) securities. Since those securities are guaranteed by the full faith and credit of the government, the risk of default is about as close to zero as it gets.
The sweet, sweet taste of fear
Luckily for Annaly, global markets will hear nothing of the sort, and have been dumping Fannie and Freddie securities in droves. That selling -- rational or not -- has blown up Annaly's "spread" -- the difference between what it pays on its leverage and what it takes in from the securities -- resulting in a flood of profits that's fueling a ridiculous 16% dividend yield.
Annaly booked $302 million, or $0.55 per share in net income during the third quarter, 66% above the $0.33 per share earned in the same period last year. The aforementioned interest spread surged to over 2%, more than three times last year's 0.67%.
Common dividends came out to $0.55 per share, more than double last year's $0.26 per share. Annualize it out, and you get a dividend yield of over 16%. Pretty sweet.
There's one big question everyone wants to know about Annaly: Is it too good to be true? The easy answer is, yeah, it probably is. One thing is for sure, spreads will eventually tighten, and the amount of profit Annaly's been able to squeeze out of mortgage-backed securities will subside. If there's one thing we do know about today's market madness, it's that it'll eventually end ... we just don't know when.
Nonetheless, with a 16% yield, there's sizeable room for a drop in earnings that would still render Annaly a lucrative investment. Even if earnings and dividends reverted back to where they were last year, investors would be sitting on an 8% yield with minimal risk. Analysts expect it to earn $2.59 in 2009 -- a figure that, if held true, will be making investors mighty happy at today's prices.
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