The 3 Most Compelling Numbers at Annaly Capital

Stock investors today face data overload.

Aside from basic financial statements, there is a flood of ratios, statistics, multiples, analyst estimates, comps, margins, and industry-specific metrics to wade through.

In this new series, I will choose a company and distill all the data down to three numbers you absolutely need to know before making a buy-sell-ignore decision.

Today's breakdown is for dividend-monster real-estate investment trust (REIT) Annaly Capital (NYSE: NLY  ) .

15%
The number that jumps off the page for Annaly Capital is its 15% dividend yield. As a REIT, Annaly must pay out at least 90% of its taxable income as dividends. In return, it gets favorable tax treatment. If you're following along, that huge dividend yield means Annaly's profits have been huge recently.

Let's see why with the next number.

2.22%
Annaly's net interest rate spread in the first quarter of 2010 was 2.22%. To understand what this means, let's back up to how Annaly makes money.

Annaly is basically a proprietary trading desk that specializes in buying and selling mortgage-backed securities. Yes, proprietary trading desks are one of the things that the Wall Street banks have been criticized for. And mortgage-backed securities haven't had a good run over the last few years. But Annaly is quite different from Goldman Sachs (NYSE: GS  ) , Citigroup (NYSE: C  ) , and their peers. While they've stumbled, Annaly has thrived.

Unlike the banks, Annaly doesn't take deposits, it doesn't borrow from the Fed, and it isn't too big to fail. However, it has found a way to get some indirect government help. The vast majority of the securities it owns is guaranteed by government-backed entities like Fannie Mae (OTC BB: FNMA.OB) and Freddie Mac (OTC BB: FMCC.OB), so it has avoided the default risk that destroyed the portfolios of the Wall Street banks.

The 2.22% represents the difference between the interest Annaly's earning on these securities and the interest it pays on its borrowings. This 2.22% is pretty huge historically. Annaly knows that these amazing spreads likely won't last, so it has partially hedged its portfolio with interest rate swaps totaling $22.8 billion of notional value (vs. total assets of $72.7 billion).   

The final number gives us some more insight into risk.

$53.8 billion
Here's where Annaly is dangerously similar to the Wall Streeters.

Its $72.7 billion in assets is primarily financed by $53.8 billion in short-term repurchase agreements. These are the same types of borrowings that drove Bear Stearns into the arms of JPMorgan Chase (NYSE: JPM  ) , helped bankrupt Lehman Brothers, and forced Bank of America's (NYSE: BAC  ) Merrill Lynch rescue.  

One saving grace is Annaly's low leverage ratio. Whereas the Wall Street firms hit asset-to-equity ratios upwards of 30:1 before their crisis, Annaly's is well under 10.

As you decide whether to buy, sell, or ignore Annaly Capital, keep these three numbers top of mind. They will help you determine whether Annaly's tantalizing dividend yield is a siren song or a tremendous opportunity.

Anand Chokkavelu owns shares in Citigroup. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (19)

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  • Report this Comment On July 12, 2010, at 2:05 PM, nontechie wrote:

    While other people have been carping and frightened, I have owned Annaly. At 15% per year, it doesn't take too many years until you are playing with the house's money and I am pretty close to that point now. This is a stock I too was afraid to own for too many years. You just need to accept that Mike Farrell is a lot smarter than you or most people are.

  • Report this Comment On July 12, 2010, at 2:09 PM, TMFBomb wrote:

    nontechie,

    So if I'm doing the backwards math correctly, you've owned Annaly for 4-5 years?

    Any other nuggets that most investors miss?

    -Anand

  • Report this Comment On July 12, 2010, at 3:02 PM, nontechie wrote:

    I'm not bragging here. Like I said, Annaly looked too good to be true to me too for a long time, but then I just decided to bite the bullet because, after watching it a while, I realized it was doing a lot better than it had any right to be doing--and the track record has continued.

    Since you asked, though, Anworth Mortgage is very similar to Annaly in many ways and I own it too (though I prefer Annaly because no one else is as good as Annaly CEO Farrell if you are going to buy just one).

    For the slightly skittish, both Annaly and Anworth have preferred shares with a fixed yield. I bought Anworth's preferred near its crash bottom at $.68 on the dollar but it's still selling slightly below its call price ($25 per share) and yielding 6.5% (no, not as good as the common's yield but the preferred is "cumulative" so the dividend can't be sliced unless the company goes bankrupt).

  • Report this Comment On July 12, 2010, at 11:31 PM, TMFBomb wrote:

    @nontechie,

    Thanks for the additional comments!

    -Anand

  • Report this Comment On July 13, 2010, at 9:18 AM, FloydsBoys wrote:

    You have to put your extra money somewhere & these companies are a good choice at this time.

    After all you can get out any time. But inflation is a balloon that is going to grow & when it pops it will hit us all hard. Holding well run companies that pay a big dividend may give us a nice cushion for when that time comes.

    Picking companies that will do well when the inflation hits us is not so easy as riding the dividend train now & switching to something else later.

    Even if the dividend rate is cut in half it would still be a good return.

  • Report this Comment On July 13, 2010, at 11:15 AM, Clint35 wrote:

    What if the government stops gauranteeing loans? I think they're idiots but at some point they might decide it's not a good idea. What happens to Annaly then?

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