How Long Can Annaly Keep This Up?

Is it real? That's all anyone wants to know about Annaly Capital's (NYSE: NLY  ) monster 14.7% dividend. After the company reported second-quarter earnings yesterday afternoon, the answer, for now, is a resounding "yes."

GAAP net income came in at $1.09 per share in the second quarter, up from $0.60 in the same period last year. Using a preferred metric the company calls "core earnings," net income was $0.66 per share, up from $0.60 in the same quarter last year.

Annaly declared dividends in the second quarter of $0.60 per share, which annualizes out to a 14.7% dividend yield. With the average dividend-paying stock in the S&P 500 yielding about 2.7%, that ain't bad. And when you consider other financial institutions like Citigroup (NYSE: C  ) , Wells Fargo (NYSE: WFC  ) , and Bank of America (NYSE: BAC  ) yield something close to zero, it's nothing short of fantastic.

How does it do it? At first glance, Annaly's scarcely different from the Wall Street nimrods that blew themselves up. It's a leveraged mortgage shop that buys bundled loans, leverages up to the moon, and prays for the best.

What sets Annaly apart is that it primarily holds so-called agency securities -- those issued by the likes of Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) . These securities always enjoyed a relative blanket of safety thanks to an implied government backing, but really shot into the realm of "about as safe as it gets" territory after the government took Fan and Fred into conservatorship last summer, in essence guaranteeing its securities. Annaly's credit risk, therefore, is quite low.

What can affect its income, thanks in part to a good deal of leverage, are swaying interest rates. Variable interest rate products it holds can squeeze net income if management doesn't stay ahead of the ball. This is one of the only threats our 135,000-member CAPS community sees to Annaly's dividend. As CAPS member zwalt99 writes:

In many ways, this baby has been thrown out with the bathwater. That payout is much safer than your average REIT, as the Fannie and Freddie pools they invest in have been all but guaranteed by the government. My only (but big) concern is the interest rate situation. Their variable rate liabilities adjust at a much shorter duration than their variable rate assets, and interest rates won't stay this low forever. Once they start climbing, we'll find out just how good the management team is.

If it's too good to be true, it probably is. I can guarantee one thing: Annaly's 15% dividend will not last forever. Whether it vanishes thanks to an increasing share price, narrowing asset spreads, or a variable interest rate mishap that squashes net income is up for debate.

What do you think? Is this a looming dividend disaster, or an underfollowed gem? Feel free to share your thoughts in the comment section below.

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Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.

Read/Post Comments (13) | Recommend This Article (50)

Comments from our Foolish Readers

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  • Report this Comment On July 30, 2009, at 1:38 PM, xwarrior wrote:

    Annaly has earned their 2009 income with a leverage of 6X net worth. They have a target leverage of 8-12 x net worth but have always managed their liabilities conservatively. This managment t. team has proven itself over 10 years & i believe their is plenty of upside in the business & the stock price.


  • Report this Comment On July 30, 2009, at 4:23 PM, xsolest wrote:

    I pretty much agree with the first comment. Annaly has been a bit of a rollercoaster as far as share price, but have consistently delivered on managing their portfolio interest rate spread and have taken additional steps when needed.

  • Report this Comment On July 30, 2009, at 5:02 PM, mgdunton wrote:

    I have held this stock for 2 years & have witnessed a constant stream of naysayers, such as James Cramer who praised the stock one day and then screamed "SELL" the very next day. The stock goes up and down, but the dividend just keeps coming.

  • Report this Comment On July 30, 2009, at 6:14 PM, jacks4yu wrote:

    i puchased annaly 2 years ago @ 16.14 and with covered calls @ div have reduced my cost per to 9.98 not counting tax cost it has been knocked down only with association with the mortgage mentality during that period now with citadel @ chimera the income is protected manegment is excellant

  • Report this Comment On July 30, 2009, at 7:44 PM, harleythebrave wrote:

    I started buying NLY over a year ago, and have been delighted with the results. I have been in and out a few times, to advantage on all but once. I keep a "trailing stop" order on the whole pile, set at 4%, just to protect against such disasters as Dubya coming back to life. It provides me with dividends equal to a new car every year, and the stop promises semisecurity. What more could anyone ask for? If some dreadful event gets me out, I'll find another gold mine. Meanwhile, it doesn't get any better than this!

  • Report this Comment On July 30, 2009, at 8:57 PM, rfcoz wrote:

    To a casual reader this would seem like a pump NLY scheme, but I'll second all the comments so far. NLY is the baby that went with the bathwater and Morgan's "underfollowed gem". Thrill seekers wouldn't be interested but longs would be thrilled with this REIT. Fundamentals aside the best aspect is the intelligence, integrity and discipline of management. I'm showing 25%+ over less than 2 yrs.

  • Report this Comment On July 31, 2009, at 1:38 PM, hulagirl100 wrote:

    I have been in NLY for a couple years now, good times and bad, and indeed I feel this stock has been one that went out with the bathwater. The dividend has been, and to all the nay sayers (Jim Cramer included), you need to take a real good look at the management of this company and check their performance- conservative, consistent, forward looking. These guys are the best. Now, if there were to be a substantial change at the top of Annaly, I might not be so excited, but as long as the current team is in place, I am sticking with NLY.

  • Report this Comment On July 31, 2009, at 3:56 PM, iamski wrote:

    I was going to comment until I read the unnecessary Dubya comment

  • Report this Comment On July 31, 2009, at 4:03 PM, nysemember wrote:

    The mgt. team led by Michael Farrell is the best in the business. He is the real deal! The key to this stock is to buy it on the dips. Plain and simple!!

  • Report this Comment On August 01, 2009, at 8:21 PM, echeng23 wrote:

    NLY was a MF Income selection, but no longer is on the list. Does anyone know why?

  • Report this Comment On August 03, 2009, at 5:38 PM, PunPryde wrote:

    I got in this year at $15.21, and im sticking to this one, only wish I'd invested more.

  • Report this Comment On August 04, 2009, at 8:17 PM, rosnick44 wrote:

    I've been investing NLY since 2002 with an original price of $17.28, adding to my position at different times on dips, allowing the dividends to be reinvested and enjoying the wisdom of the management team. Sometimes the dividends were pared when the rate spreads tightened (see late 2006), but they always paid a dividend, shun excessive risk and protect long-term shareholder value. If you have not had the opportunity, make sure you listen to the earnings calls.

  • Report this Comment On August 11, 2009, at 8:54 AM, Fool wrote:

    I've owned NLY for about six to seven years. While I don't slavishly track its quarterly yields, it was in the 10% range when I was first attracted to it, and NLY has consistently had higher yields than utilities and other income stocks, in up-or-down interest rate markets. Mgmt appears to know how to manage their borrowing and investment durations pretty well, regardless which way rates start to go. They are not neophytes. NLY's "Dividend History" on its web site is a matter of record going back to Aug 1997. Study it. I did not buy for capital gains on the stock, but have found you can reliably buy more shs in downward price swings, and enjoy cap gains if that's your objective and strategy.

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