The Raise That Fuels These Big Dividends

Earlier this week, mortgage REIT Annaly Capital announced that it's raising money by selling stock -- for the third time in 2011.

Annaly expects to raise $2.1 billion this time (gross of expenses and before underwriter options), after raising $1.3 billion in January and again in February. That's a total of $4.7 billion for a $14.7 billion company.

Normally, when you see a company this hot for capital in such a short period of time, it's a big red flag; such businesses usually aren't dealing from a position of strength. Recall the big banks' efforts to raise capital during and immediately after the financial crisis.

Like its fellow mortgage REITs, Annaly has a reasonable explanation for this thirst for capital. To get beneficial tax treatment, the IRS requires each REIT to shell out "90% of its taxable income to shareholders every year."

In good times, that means hefty dividend yields. It also means the REITs can't reinvest that capital back into the business. Hence, if they need more capital, they need to either lever up with debt, or float more shares of stock.

They've chosen the latter. Check out the latest stock offerings from Annaly and some of its peers, all of which offer dividend yields at or above Annaly's 14.2%.

Company

Date

Offering Size

Market Cap

Dividend Yield

Annaly Capital (NYSE: NLY  )

July 2011

$2.1 billion*

$14.7 billion

14.2%

American Capital Agency (Nasdaq: AGNC  )

June 2011

$1.2 billion*

$3.8 billion

18.7%

Armour Residential REIT (NYSE: ARR  )

June 2011

$131.2 million

$369.5 million

18.8%

Invesco Mortgage Capital (NYSE: IVR  )

June 2011

$393.9 million**

$1.6 billion

17.9%

Two Harbors (NYSE: TWO  )

May 2011

$235.2 million

$738 million

14.7%

Resource Capital (NYSE: RSO  )

March 2011

$46.6 million

$440 million

15.5%

Cypress Sharpridge Investments (NYSE: CYS  )

February 2011

$276 million

$1.1 billion

18.5%

Source: Company press releases. Includes proceeds from exercised underwriter options and net of expenses except as noted.
*Excludes underwriter options and gross of expenses.
**Includes proceeds from exercised underwriter options, but gross of expenses.

You'll notice that the size of these offerings is quite meaningful. For instance, Armour Residential REIT's June offering comprises over a third of its current market cap.

With the Fed holding down short-term borrowing rates, and thus facilitating large interest rate spreads for longer-duration mortgage-backed securities, the mortgage REITs are having a field day. That's why you see the large capital raises.

For investors, the capital raises aren't necessarily a red flag. Who wouldn't want to capitalize in this environment? But you'll want to pay attention to how these companies are preparing for the rougher times that occur when the music stops. Risky assets and leverage via short-term borrowing boost returns (and yields) when times are good, but can throttle these companies when spreads contract.

As Annaly CEO Michael Farrell puts it, "In this evolving landscape, our management team remains focused on preparing the portfolio and the company for a wide range of outcomes."

So should we as individual investors.

For more dividend ideas, click here for our free report "13 High-Yielding Stocks to Buy Today."

Anand Chokkavelu doesn't own shares of any company mentioned. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 13, 2011, at 2:52 PM, zorro6204 wrote:

    I think you're wide of the mark here. First, you're lumping in companies that do entirely different things, RSO for example is a straight commercial lender, not an agency REIT.

    Second, the agency REIT's are like open mutual funds, their size is not particularly relevant. They're like a chain of fast-food restaurants, if the model works in one location, it will work in the next. If there's a demand for more NLY, then they sell more shares, leverage that capital and inflate the bag. What difference does it make? You could lump all the agency REIT's together or separate them in little bits, and aside from efficiency, each piece of the pie is the same.

    Which has absolutely nothing to do with their tax status. Agency REIT's are not businesses, they don't require capex or other spending that sits on the balance sheet in a non-liquid lump. They simply buy federally-backed notes.

  • Report this Comment On July 13, 2011, at 3:22 PM, TMFBomb wrote:

    @zorro6204,

    The companies, while not exactly the same, are all mortgage REITs that rely on interest spreads between borrowings and mortgages.

    Size is relevant in that new capital coming in has to be marginally effective. Also, the more money (i.e. demand) chasing a limited amount of supply, the harder it is to make outsize profits.

    Agency REITs are businesses...they just have a unique operating model that functions more like a proprietary trading desk.

    Fool on,

    Anand

  • Report this Comment On July 13, 2011, at 4:46 PM, QuickClickSell wrote:

    Ummmmmm anytime they add shares to the pot, that is a SIGNIFIGANT occurence, as those new shares will eat up some of the dividend payments NLY issues. New shares for non-dividend companies are all and good, but for nly, it should lower the dividend payments, therefore lowering the price of the stocks.

    If you're a long term investor holding for over 5 years, big whoop. Dividends are still good enough and will recover after the bad times. If you're a short term guy though, I'd look at selling while I'm ahead, since the price and dividends will be decreasing. Just don't know when

  • Report this Comment On July 13, 2011, at 5:29 PM, TMFBomb wrote:

    @QuickClickSell,

    The new shares also bring in cash to invest, though. So if the investments are done skillfully, dividends per share could increase. If not, you'll see dilution.

    As a long-term investor, I'm speaking to the long-term view here.

    -Anand

  • Report this Comment On July 13, 2011, at 11:43 PM, zorro6204 wrote:

    No, that's my point, new shares are not structurally dilutive. The new money is invested in the same way as the old, the pie simply gets bigger. It's just agency notes, a credit line and equity. Carve it up in little pieces (theoretically) and it's the same thing. Make it ten times bigger, same thing.

    An agency REIT raising capital is exactly and precisely the same as a index mutual fund selling new shares, they simply increase the pot, but it's all invested in the same equivalent assets.

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