Stock price and yield move in opposite directions. Very often, when investors are worried about a dividend cut, a stock's price will be pushed lower and the yield will rocket to unbelievable (and unsustainable) heights. When the cut eventually comes, the stock price doesn't actually change much because the market has already lowered it in anticipation of the cut.
That's exactly what is going on with Annaly Capital Management (NLY -0.32%) these days, which explains its lofty yield.
Not the first time
Before discussing the future of Annaly's dividend and dividend yield, it might be useful to have a quick look at this mortgage real estate investment trust's (mREIT's) business and history. For starters, it doesn't own properties, collecting rent on physical assets leased out to tenants. It owns pooled mortgage loans, which are often referred to as collateralized mortgage obligations (CMOs) or something similar. These securities trade based on supply and demand, with interest rates playing an important role in determining the valuations placed on them by investors.
What can make matters more tenuous for companies like Annaly is that mortgage REITs generally make use of leverage as a way to enhance returns. The problem is that the leverage is usually backed by the CMOs it owns. If the value of these securities falls too far, a margin call may occur. Just the possibility of that happening can cause mREITs to take swift and drastic portfolio actions as they seek to avoid an event that would be viewed very negatively by Wall Street. Given that interest rates have been rising and having a generally negative impact on the housing market, the last year or so has been operationally pretty difficult for most mREITs, Annaly included.
But this isn't actually a new thing. Annaly's dividend has been heading lower for at least a decade. The yield has remained high the entire time because the stock price has fallen right along with the dividend. So mREITs like Annaly are complex and it hasn't been a reliable dividend payer for a long time.
Management is warning you
Which brings us to Annaly's fourth-quarter 2022 earnings conference call. It's probably easiest to let the company's CEO, David Finkelstein, do the talking:
...I wanted to make one last point as it relates to earnings available for distribution. While we generated [earnings available for distribution (EAD)] that covered our dividend this quarter, we witnessed the moderation discussed in recent quarters, and we anticipate some further pressure on EAD going forward.
As a result and subject to determination by our board, we expect to reduce our quarterly dividend in the first quarter of 2023 to a level closer to Annaly's historical yield on book value of 11% to 12%, which compares to the approximately 16% yield on book we are paying today.
Basically, the high yield was an indication that investors expected a dividend cut. And management just confirmed it, though the dividend has yet to be officially reduced. This cut makes logical sense, with Finkelstein adding: "We believe this decision allows us to appropriately manage the portfolio within conservative risk parameters while also delivering a more sustainable yield that is competitive with the peer set and broader fixed income benchmarks, which has always been our objective."
Even if a cut is the right move, it probably won't feel so good if you bought Annaly expecting to collect a huge dividend only to see it get cut. But that's just a continuation of the trend here when you look back over the past decade. This is not a great choice for conservative investors or those that are looking to create a reliable income stream.
Don't get suckered
A huge yield isn't always an indication that a dividend is going to end up being cut, but it is a warning sign that you should at least consider the possibility. Given Annaly's history even before the upcoming cut was effectively confirmed by the CEO, investors should have realized that it was definitely on the table. Right now, though, the yield is artificially high on online quote services because the new dividend policy has not yet been set. In other words, Annaly looks like a yield trap right now.
