Due to its size and its long-for-the-mortgage-REIT-industry history, Annaly is a bellwether company for the mortgage REIT industry. Its actions are, of course, pertinent to Chimera -- whose portfolio Annaly manages -- but also to shareholders of competitors like American Capital Agency.
Since Annaly and its peers make money from interest rate spreads, the specter of rising interest rates is a concern. Lower spreads could result in lower dividends (Annaly's dividend yield is still at 12.6%, despite lowering its quarterly dividend rate to $0.55 from $0.65 a year ago). Here's what Annaly CEO Michael Farrell said about the interest rate environment:
We continue to monitor and evaluate the challenges facing the Euro countries and their institutions, regulatory uncertainty about the function and structure of the global financial system and election-year brinksmanship on fiscal and tax policy. In addition, we see long-term risks related to the general direction of monetary policy and its effect on the financial markets. Our concerns about embedded risks in the markets continues to be reflected in the way we manage the Company. We believe our stance maintains our flexibility while continuing to generate attractive risk-adjusted returns for our shareholders.
Beyond the words, Annaly uses interest rate swaps to hedge its interest rate risk. Before the swaps are factored in, Annaly's portfolio of mortgage-backed securities is 92% fixed rate. Afterwards, the percentage is 51%. That's a material amount of hedging.
Lingering questions include whether that hedging will be effective and whether it will be enough (or too much, if rates stay low). Bottom line: Beyond a good knowledge of the financial mechanisms being employed, investors in mortgage REITs must trust management to invest in them.
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Anand Chokkavelu has no positions in the stocks mentioned above. Andrew Tonner has no positions in the stocks mentioned above. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.