Why You Shouldn’t Be Surprised If Annaly Capital Management’s Dividend Is Eventually Cut in Half

Thanks to the relationship between interest rates and Annaly's dividend, it seems inevitable that the high-yielding mortgage REIT will continue to cut the size of its quarter distributions.

John Maxfield
John Maxfield
Jul 4, 2014 at 12:41PM
Financials

It's inevitable that Annaly Capital Management (NYSE:NLY) will continue to cut its quarterly dividend. And even though it's already done so multiple times over the last two years, it still has a long way to go. 

The reason for this is simple. Annaly makes money by arbitraging interest rates. It borrows money at low short-term rates and then uses the proceeds to buy mortgage-backed securities, which are subject to higher long-term rates.

As a result, Annaly's profitability is a function of the so-called spread between long- and short-term interest rates. When the spread is large, Annaly makes more money and thus pays a higher dividend. But when the spread contracts, it makes less money and must accordingly cut its payout.

Where are we right now? Thanks in large part to historically low short-term rates, the interest rate spread remains elevated. But this won't last forever. 

It's for this reason that Motley Fool contributor John Maxfield urges current and prospective investors in Annaly to brace themselves for additional dividend cuts in the months and years ahead.