Wall Street is generally bullish on Annaly Capital Management (NLY 1.02%). Most analysts who follow the mortgage REIT have a buy rating on its stock. Some have recently reiterated their bullish calls, with JonesTrading reconfirming its buy rating while RBC Capital doubled down on its outperform call.
However, just because analysts think the stock is a buy doesn't mean it's right for your portfolio. Here are a couple of factors to consider before buying shares of the high-yielding mortgage REIT.
Annaly isn't your average REIT
Mortgage REITs have a very different business model than equity REITs that own income-producing real estate. These entities make money on the spread between the interest earned on their mortgage investments and their weighted average cost of capital, known as the net interest margin. They tend to borrow a lot of money (usually short term) that they lend long term by purchasing mortgage-backed securities (MBS). That makes them more like a bank than a real estate company. It also makes them very susceptible to changes in interest rates, especially since short-term rates are more volatile.
Changes in interest rates can cause their net interest margin to narrow considerably, which is what happened to Annaly this year. During the second quarter, Annaly's net interest margin was 1.66%, down from 1.76% in the year-ago period. While the average yield on interest-earning assets increased (from 3.96% to 4.22%), so did its average economic cost of funds (2.34% to 2.77%). As a result, the REIT's earnings available for distribution fell from $1.22 per share in last year's second quarter to $0.72 per share in the second quarter of this year.
Mortgage REITs also face refinancing risk. As interest rates fall, borrowers can take advantage by refinancing and locking in a lower rate. When that happens, mortgage REITs will need to take a lower income yield when they reinvest the proceeds of a refinanced loan into a new one.
Equity REITs aren't immune to changes in interest rates. However, they don't have quite the same impact. While rising interest rates make it more expensive to refinance debt, most equity REITs borrow long-term, which pushes out this impact over several years. Further, these entities benefit from falling rates. They're able to refinance their debt at a lower rate. Meanwhile, tenants can't break their leases to take advantage of lower market rents. That's why equity REITs tend to generate steadier cash flow than mortgage REITs.
The dividend hasn't always been bankable
Annaly's more volatile earnings can impact its ability to pay dividends, which is its biggest draw. The REIT's current dividend payment is $0.65 per share each quarter ($2.60 annualized). That gives it a whopping 13.6% dividend yield at the recent price of around $19 per share. That's a very enticing income stream.
However, one of the problems with Annaly's dividend over the years is it hasn't been sustainable. The REIT has cut its payment several times, including by 26.1% earlier this year:
NLY Dividend data by YCharts
Annaly's dividend could continue falling. If the company's earnings decline further because of additional pressure on its net interest margin, the REIT would need to cut its payout again. It's not an optimal option for investors seeking a sustainable passive income stream.
A higher-risk REIT
Annaly offers an eye-popping dividend yield. However, that payout hasn't proven sustainable over the years because of the impact of interest rate changes on the company's earnings. Given the mortgage REIT's more volatile earnings and dividend, it isn't suitable for everyone, especially those seeking a more stable source of dividend income.
