I've held shares of Annaly Capital Management (NLY 0.59%) for over a decade. Unfortunately, the stock has lost a lot of value since I made my initial investment. That made me think recently about finally taking the loss and writing it off on my taxes.
However, after doing the math and taking a closer look at Annaly's prospects, I've decided not to sell this ultra-high yielder. Instead, I plan to keep holding the mortgage real estate investment trust (REIT) for income.
Not a total loss
I'm down about 60% on my initial purchase of Annaly shares. That's largely due to lower mortgage rates' impact on its business. As interest rates fell, many borrowers refinanced their mortgages to lower rates. This forced Annaly to make lower-yielding investments, which impacted its income and its ability to pay dividends.
However, while it has reduced its payouts in the past, it has maintained an above-average yield. Because of that, my total return when adding in dividend payments is approaching 170% (about 6.7% annualized). While that's an underperformance relative to the S&P 500 -- which is up by nearly 300% or 9.4% annualized over the period -- Annaly hasn't been a terrible investment since my primary goal for it has been to generate income.
Further, the mREIT continues to produce an attractive passive income stream. If I sold my shares, I'd need to find a replacement investment with a dividend yield of 16.2% to offset the passive income I currently collect from my Annaly investment. While I'd save some money on my taxes by harvesting the capital loss and reinvesting the proceeds into a stock that paid a qualified dividend, Annaly produces too much dividend income for me to make up for without taking on significantly more risk.
The income stream looks solid
One factor that would have led me to sell is if I didn't think Annaly could maintain its current dividend. While the mREIT has reduced its payout in the past, its current level seems sustainable. The company reported $1.06 per share of earnings available for distribution in the third quarter. That covered its current $0.88 per share quarterly dividend outlay by 120%, continuing its recent trend of dividend coverage at or above that level.
Meanwhile, the company is in a strong financial position. Even though Annaly's economic leverage increased from 6.6 times in the second quarter to 7.1 times in the third, that's still below its pre-pandemic level of more than 7.5 times. The company also has lots of liquidity and several funding sources. Because of that, even if market conditions deteriorate, Annaly likely wouldn't need to reduce its payouts to shore up its financial profile.
In addition, the company owns a massive portfolio that's primarily made up of residential mortgages guaranteed by government agencies. Because of that, there's a minimal risk it will lose money on its investments.
Higher rates might help Annaly
As a mortgage REIT, Annaly profits on the spread between its cost of capital and the interest it earns on its mortgage investments, known as the net interest margin. The company is currently facing a headwind from higher interest rates. Its economic cost of funds rose from 1.11% in the second quarter to 1.54% in the third. Because of that, its net interest margin declined from 2.2% to 1.98%. However, its average yield on investments also rose, from 2.87% to 3.24%.
As mortgage rates remain higher, Annaly's average yield on interest-earning assets should continue expanding. That could eventually increase its net interest margin, making the company more money. Those higher earnings would put Annaly's big-time dividend on an even firmer foundation.
Holding for the passive income
While Annaly's stock price has declined significantly over the years, its shares still produced decent returns thanks to its massive dividend. That big-time payout seems sustainable. Because of that, I'd be hard-pressed to find another investment that could match the income I currently collect from Annaly. That lucrative income stream is why I plan to continue holding the mREIT.
