Why I’m Banking on Annaly Capital Management, Inc.’s 12% Yield
August 11, 2020
Annaly Capital Management, Inc. Could Be Due for a Big Rebound
The COVID-19 pandemic has hammered units of Annaly Capital Management, Inc. (NYSE:NLY). But that could create an opportunity for investors.
In June, the mortgage real estate investment trust (mREIT) slashed its quarterly distribution by 12% to $0.22 per share. (Source: “Dividends,” Annaly Capital Management, Inc. last accessed August 10, 2020.)
Investors interpreted the news as a loss of confidence in the business on the part of management. Following the announcement, traders pummeled Annaly Capital stock to a multi-month low.
No doubt, income-focused investors should be disappointed with the turn of events at the trust. But the recent downturn could have created an unexpected opportunity for those willing to bet against the crowd (not to mention the chance to lock in a nice 12% yield). And I think dividend hunters should take notice.
Look: I’ll admit that mREITS like Annaly Capital Management face challenges in the face of COVID-19. The industry’s main source of financing, the repurchase (repo) market, seized up at the start of the pandemic. And with the economy on lockdown, millions of homeowners and corporate property landlords have stopped making payments on their mortgages. But we may be approaching the proverbial “light at the end of the tunnel” for the business.
In the case of the repo market, Fed Chairman Jerome Powell pumped trillions of dollars into the marketplace to restore confidence. As a result, companies can now once again borrow money at reasonable rates. And that has given mREITs some much-needed breathing room.
Annaly looks particularly well positioned to survive the downturn. That’s because about 75% of the partnership’s loan book consists of agency debt—mortgage loans to homeowners that are insured by federal agencies like the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). (Source: “Strategy,” Annaly Capital Management, Inc., last accessed August 10, 2020.)
The downside with these investments in good times is that they come with lower yields. But during a downturn, their values tend to hold up because they come with an implicit guarantee from the federal government. So even if the homeowners default on their loans, NLY stock holders will get their money back.
What’s more, Annaly’s lending margins have started to increase once again. mREITs make their money on the difference, called the “spread,” between short- and long-term interest rates. The bigger the difference in yield between these two markets, the more money these firms make.
The Federal Reserve has slashed its overnight lending rate to almost zero percent. But at the same time, mREITs can still earn a healthy three percent yield on a 30-year fixed mortgage.
It’s only a matter of time until this new reality is reflected in Annaly’s profits.
Chart courtesy of StockCharts.com
In the meantime, Annaly Capital stock investors will get well paid while they wait.
Even following the distribution cut, NLY units sport a 12% yield. Moreover, that income stream looks relatively secure, given that Annaly Management, Inc. generates $1.22 in core earnings on every dollar paid out to unitholders.
Bottom line: No doubt, Annaly’s dividend cut won’t impress the many income-focused readers who visit this site. But the partnership looks better positioned to survive the COVID-19 pandemic than its peers.
And that could create quite an opportunity for dividend investors willing to bet against the crowd.
