Saturday, November 13, 2010

Annaly Remains A Reasonable Position Despite Cramer's Endorsement

A 15% yield is normally an omen of impending dividend suspension. Combine that yield with leverage usage and the mortgage industry and one should generally avoid the security in question. Now toss in a recommendation from Jim Cramer and it is often time to duck. I'm now worried, but I agree with Cramer that I should keep my position in Annaly Capital Management [NLY].

Annaly is a REIT that invests in agency securities, therefore it takes no credit risk assuming you view the U.S. Goverment's guarantee as solid. It leverages its capital to purchase more securities, although not like the financial time bombs of several years ago, and enhance earnings. It does take on interest rate risk, but through asset/liability management attempts to limit the impact of interest swings. It uses a barbell strategy of floating rates on the shorter durations and fixed rates on the longer holdings. How well it will work as QE2 accelerates interest rates remains to be seen, but the management team has done a credible job since its creation in 1997.

Is a dividend cut coming down the road? Don't know. As a REIT they have to distribute 90% of their net income, so it is all dependent on NLY's continued earnings ability. Clearly the current rate environment is one that is working for them. As rates rise their profitability will depend on how well they execute their A/L strategy. A sudden, sharp interest spike would be the worst scenario, but with a Fed intent on keeping rates low, NLY probably faces a slow creeping interest rate environment which is easier to navigate. Thus, several more years of attractive dividends and yields. Continued dividends and low yield alternative investments also leave room for share price appreciation.

NLY has treated me well for quite some time and I remain confident it can overcome Cramer's recent praise.

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