Why You Shouldn’t Be Surprised If Annaly Capital Management’s Dividend Is Eventually Cut in Half

It's inevitable that Annaly Capital Management (NYSE: NLY  ) will continue to cut its quarterly dividend. And even though it's already done so multiple times over the last two years, it still has a long way to go. 

The reason for this is simple. Annaly makes money by arbitraging interest rates. It borrows money at low short-term rates and then uses the proceeds to buy mortgage-backed securities, which are subject to higher long-term rates.

As a result, Annaly's profitability is a function of the so-called spread between long- and short-term interest rates. When the spread is large, Annaly makes more money and thus pays a higher dividend. But when the spread contracts, it makes less money and must accordingly cut its payout.

Where are we right now? Thanks in large part to historically low short-term rates, the interest rate spread remains elevated. But this won't last forever. 

It's for this reason that Motley Fool contributor John Maxfield urges current and prospective investors in Annaly to brace themselves for additional dividend cuts in the months and years ahead.

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Comments from our Foolish Readers

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  • Report this Comment On July 04, 2014, at 8:32 PM, sdoia6 wrote:

    NLY and John Maxfield's comments on their dividend were interesting, however, not unexpected, as NLY is a REIT and required by law to pay out 90% of their profit.

    I for one expected this when I bought NLY.

  • Report this Comment On July 05, 2014, at 9:21 AM, will1946 wrote:

    In my humble view, it is hard to make a case for reits. They do have a nice dividend even if they continue to cut it, but they are not very me anyway.

  • Report this Comment On July 16, 2014, at 2:23 PM, tsenyks wrote:

    Many in the industry are waiting for rates to move up. Annaly is well prepared. There might be an adjustment period, but they are not a bank and the spread will widen as interest rates rise. That will happen to many other investment vehicles like high yield bond and MLP's. So, will I be scared off because of an impending change. No, because I choose the best for income, not appreciation. These, at least the well managed, are not monolithic and this is not 2006, so have confidence in your investments and invest for the long term. The whole retail industry is geared to your trade out of this and into that for the commissions and fees.

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John Maxfield

John is The Motley Fool's senior banking specialist. If you're interested in banking and/or finance, you should follow him on Twitter.

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8/27/2015 4:01 PM
NLY $10.21 Up +0.23 +2.30%
Annaly Capital Man… CAPS Rating: ****