Key Points
Annaly Capital Management‘s (NYSE:NLY) dividend currently yields an impressive 12.8%. While yields this elevated often signal caution, I believe Annaly represents a compelling value opportunity at present.
Here’s why income-oriented investors should take a closer look at this mortgage REIT.
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The case for a trap
It’s worth examining the bearish argument first, as Annaly has historically exhibited characteristics of a high-yield trap. The REIT has reduced its dividend on multiple occasions over the years, most notably in early 2023 when it cut its quarterly payment from $0.88 per share to $0.65 per share amid declining earnings. I sold my long-held position in the mortgage REIT shortly after that reduction, as I grew weary of watching my income stream shrink.
Annaly has been forced to adjust its dividend over the years due to shifts in the interest rate environment. The REIT invests in residential mortgages and mortgage servicing rights (MSR) using leverage, borrowing short-term and investing long-term to profit from the spread between short- and long-term rates. However, interest rate changes affect both sides of its balance sheet. Rising rates drive up borrowing costs, while falling rates encourage borrowers to refinance at lower rates, compelling Annaly to reinvest proceeds at reduced yields.
The case for a bargain
Although declining earnings pressured Annaly’s dividend in the past, the REIT has undergone a significant turnaround over recent quarters. Its earnings available for distribution (EAD) climbed from a trough of $0.64 per share in Q1 2024 to $0.79 per share in Q2 of this year. This earnings recovery has allowed the REIT to increase its dividend twice over the past 18 months — raising the payment from $0.65 to $0.70 per share in Q1 2025, and then to $0.75 per share in Q2 2026.
Annaly has generated $3.02 of EAD over the trailing 12 months, comfortably covering the $2.85 per share it distributed in dividends. Its EAD has now covered its dividend for nine consecutive quarters. With the stock recently trading below $22.50, Annaly is valued at a reasonable 7.5 times earnings.
Although interest rates have begun to rise this year amid persistent inflation, Annaly has fortified its portfolio by diversifying across three investment strategies: Agency MBS, residential credit, and MSR. CEO David Finkelstein noted in the second-quarter earnings report that, “Looking ahead, we see meaningful opportunities across all three of our investment strategies and believe our scale, liquidity, and disciplined capital allocation position us to continue delivering compelling risk-adjusted returns across market cycles.” This diversification affords the company the agility to allocate capital toward the most attractive opportunities. For instance, it expanded its Agency MBS portfolio by $3 billion in the second quarter by leveraging higher mortgage rates, while maintaining the size of its residential credit and MSR portfolios.
Annaly’s a bargain if you’re looking for a big-time yield
I believe Annaly has transitioned from a dividend trap to a genuine bargain over the past several years. Its earnings are on the rise, enabling it to rebuild its dividend. While the REIT carries a higher risk profile, it offers an appealing option for investors seeking a substantial income stream.
