Annaly Capital Management (NLY 1.08%) currently offers a monster dividend yield. At 14%, it's 10 times higher than the S&P 500's 1.4% dividend yield.
However, the mortgage REIT's earnings during the first quarter were less than its dividend payment. That's a concern because the company has cut its payout in the past due to its inability to outearn its dividend. With market conditions growing more volatile in recent weeks, the dividend could be about to hit the chopping block again.
The decline continues
Annaly Capital Management recorded $0.64 per share of earnings available for distribution (EAD) during the first quarter. That fell short of its first-quarter dividend payment of $0.65 per share. The EAD shortfall is a concern. Annaly cut its dividend by around 26.1% last March due to its expectations that EAD would fall below its dividend level, which is exactly what happened:
Data source: Annaly Capital Management. Chart by author.
As that chart shows, Annaly's EAD outpaced its dividend throughout 2022. However, declining earnings in the second half of that year (which it expected would continue in 2023) drove it to reduce its dividend payment in the first quarter of 2023. While its earnings have since stabilized around the current dividend level over the past few quarters, that doesn't leave Annaly much room for error.
On a more positive note, Annaly's leverage ratio has also declined. Leverage was 5.6 times at the end of the first quarter, an improvement from 5.7x at the end of 2023 (and down from the 6.4x level in the first and third quarters of last year). Meanwhile, the REIT has significant liquidity, including $3.5 billion of cash and unencumbered agency MBS.
Renewed volatility
Annaly delivered relatively steady earnings during the first quarter thanks to stable market conditions in the period. CEO David Finkelstein noted in the first-quarter earnings release that "our core Agency MBS portfolio performed well, as spreads were supported during the first quarter by lower volatility and an improved supply and demand picture." Meanwhile, the company's residential credit business expanded its market share, while its mortgage servicing rights (MSR) portfolio gained value due to the interest rate environment.
The concern is that market conditions have deteriorated in recent weeks, with the CEO noting that elevated volatility has materialized since the quarter ended. On the one hand, "Annaly remains prepared for elevated volatility," stated Finkelstein. He pointed out that the REIT has a "well-hedged portfolio, a responsible leverage and liquidity profile, and a capital allocation that can perform throughout different interest rate and macro environments."
Further, Finkelstein noted that the company continues to see attractive returns across its three investment strategies and can capitalize on the most attractive future opportunities that come its way. For example, the company highlighted in its investor presentation that current illustrative market levered returns for MSR investments have increased from the 10%-12% range it saw at the end of last year to 12%-14% at the end of the first quarter.
However, Annaly will need to continue delivering stable earnings at or above its current dividend level to maintain that payout. That could become more challenging if volatility increases or market returns deteriorate significantly. If the REIT can't consistently earn enough to cover its dividend, it might need to reduce that payout again.
Another dividend cut is becoming increasingly possible
Annaly Capital didn't earn enough money to cover its dividend during the first quarter. That's a concern because while the market environment was very supportive during that period, volatility reemerged in the second quarter. If its earnings keep falling, the REIT might have to cut its dividend again. Because of that, Annaly isn't the best option for investors seeking a sustainable passive income stream right now.
