Annaly Capital Management, Inc.

Annaly Capital Management, Inc.

Annaly Capital Management, Inc., began operations in February, 1997 as a self-managed self-advised company. Annaly has elected to be treated as a real estate investment trust (or REIT). Annaly owns and manages a portfolio of mortgage-backed securities. Annaly’s principal business objective is to generate net income for distribution to shareholders from its Investment Securities and from dividends it receives from its operating subsidiaries. Annaly is traded on the New York Stock Exchange under the symbol NLY.

For the quarter ended September 30, 2012, NLY reported GAAP net income of $224.8 million or $0.22 per share as compared to GAAP net loss of $921.8 million or $0.98 per share for the third quarter 2011, and GAAP net loss of $91.2 million or $0.10 per share for the quarter ended June 30, 2012.

Without the effect of the unrealized gains or losses on interest rate swaps and Agency interest-only mortgage-backed securities and net loss on extinguishment of 4% Convertible Senior Notes Due 2015, net income for the quarter ended September 30, 2012, was $449.8 million or $0.45 per share as compared to $622.8 million or $0.65 per share for the third quarter 2011, and $546.2 million or $0.55 per share for the quarter ended June 30, 2012.

During the quarter ended September 30, 2012, the Company disposed of $7.3 billion of investments, resulting in a realized gain of $142.2 million. During the third quarter 2011, the Company disposed of $3.9 billion of investments, resulting in a realized gain of $91.7 million. During the quarter ended June 30, 2012, the Company disposed of $6.4 billion of investments, resulting in a realized gain of $94.8 million.

The dividend for the quarter ended September 30, 2012 was $.50 per share, compared with $.60 per share for the third quarter 2011, and $.55 per share for the quarter ended June 30, 2012.  The Company distributes dividends based on its current estimate of taxable earnings per common share, not GAAP earnings. Taxable and GAAP earnings will typically differ due to items such as non-taxable unrealized and realized gains and losses, differences in premium amortization and discount accretion, and non-deductible general and administrative expenses.

In the third quarter earnings release, CEO Wellington Denahan-Norris said, “The active involvement of policymakers in the mortgage market, particularly the Federal Reserve’s latest, open- ended, large scale asset purchase program, has introduced unique challenges for all investors. ...  We continue to pursue a conservative stance in these conditions, as we assess relative value opportunities across asset classes ....” 

For the third quarter 2012, the yield on assets was 2.54% and the cost of funds on was 1.52%, which resulted in an interest rate spread of 1.02%. This was a 106 basis point decrease from the 2.08% annualized interest rate spread for the third quarter 2011, and a 52 basis point decrease from the 1.54% interest rate spread for the quarter ended June 30, 2012. At September 30, 2012, the yield on investment securities was 2.79% and the cost of funds was 1.55%, which resulted in an interest rate spread of 1.24%. Leverage at September 30, 2012 was 6.0:1.  On September 30, 2011, it was 5.5:1. On June 30, 2012 it was 6.0:1.

Here is Annaly’s dividend history, rounded to the nearest cent:

1997 $  .18 (one quarter)

1998 $1.13

1999 $1.33

2000 $1.25

2001 $1.40

2002 $2.59

2003 $2.16

2004 $1.95

2005 $1.44

2006 $  .46

2007 $  .89

2008 $1.92

2009 $2.34

2010 $2.80

2011 $2.51

2012 $2.17

Annaly has reduced the quarterly dividend in five of the last six quarters:

October, 2011 from $.65 to $.60

January, 2012 from $.60 to $.57

April, 2012 from $.57 to $.55

October, 2012 from $.55 to $.50

January, 2013 from $.50 to $.45.

The current dividend of $.45 per quarter equates to an annual rate of $1.80. At a December 27, 2012 closing price of $14.11, NLY’s yield is 12.76%. As the largest residential mortgage REIT in the US, Annaly is heavily traded and widely followed. 

Opinions vary greatly about Annaly as an investment. The dividend reductions are the result of the Federal Reserve’s policy to hold down interest rates. The Fed has given an unemployment rate of 6.5% as the level at which it may allow rates to rise. Federal Reserve policy is one factor in a decision for or against investing in NLY.

Another factor is the October, 2012 death of CEO Mike Farrell, who was widely respected by the investment community. However, new CEO Wellington Denahan-Norris, like Farrell, has been part of the management team since the firm’s inception, and this could provide important continuity.

I own shares of NLY in a retirement income account. Until clarity is achieved regarding the above two factors, I do not plan to purchase additional shares. Neither do I plan to sell any shares at this depressed price. Should NLY rally to $18.75 or higher, I might sell some shares (if I could get a comparable yield in a closed-end fund such as JLA or ETV). The REIT portion of the portfolio is a bit heavier than I would like, so any sale of NLY would be partly driven by a desire to achieve more diversification.

I believe NLY is worthy of consideration as a possible holding in a dividend portfolio. This is not a recommendation to buy, but rather a suggestion for a stock to study. Do your own homework. Make your own decisions.