In October 2008 I bought Annaly Capital Management (NLY) at around $13. Annaly Capital is a REIT that buys mortgage-backed real estate securities that are essentially guaranteed by the government via GSEs (or government sponsored agencies).
According to Google finance “it owns mortgage pass-through certificates, collateralized mortgage obligations, agency callable debentures, and other securities representing interests in or obligations backed by pools of mortgage loans. The Company is focused in generating net income for distribution to the stockholders from the spread between the interest income on the investment securities and the cost of borrowings to finance the acquisition of investment securities”.
It basically borrrows money and invests it in MBS and CMOs. When the short term borrowing rate is hovering around 2% and mortgage yields are around 5%, the spread is pretty juicy and it can afford to pay out pretty decent dividends.
At the time I bought it, I think it had ~10% dividend yield and it looked like interest rates were going to stay low for quite some time. The Federal Funds rate which was 1.50% in early October 2008, bottomed out at close to 0% in a few months and has stayed in the 0-0.25% for most of the past year. Since then, the dividends have increased to about 21% based on my purchase price. At its current purchase price, its still yields around 17-18%. That is still a pretty stellar dividend, especially for a company that’s in the real estate financing sector.
However, if interest rates raise, its spread decreases and it no longer throws off enough cash flow to maintain its dividend yield. Will the rates rise any time soon? I don’t think so, but over the long-term, rates cannot stay this low. The country cannot keep on issuing new debt at 3-4% indefinitely. At some point, demand for low rate debt will dry up and rates will start creeping up. When this happens, NLY will cut dividends and its stock price will tank.
During the 15 months that I’ve held the stock, it has appreciated 30% and I’ve received ~20% in dividends as well. Not a bad return (though it’s beaten the S&P500, its not my best trade of last year). Many people think that the economy will continue to stay weak, interest rates will stay low, and NLY will continue to do well. Maybe. But I’d rather book some profit and build up some cash reserves in case the market pulls back. I sold 100% of NLY in my brokerage account and 50% of it in my Roth IRA today. With this sale, the retirement account is currently 50% in cash. Its time to go stock hunting!
