Annaly Capital Management (NLY)

Below is an assessment of NLY Capital. I would love to get additional input from more experienced and/or knowledgeable investors.

I've always loved the idea of investing in rental properties that essentially pay you to own them. The thing that kept me from doing so was the fact that…

  1. Risk Profile: Purchasing a single property is capital intensive and would represent a large part of my portfolio with very little actual diversity
  2. Management: Rental properties require actual work and I'm not exactly like my dad where I can go in and fix anything
  3. Liquidity: There are substantial costs in unloading a property and, depending on the market conditions, may take significant time

After some thought, I began considering REITs which would give me exposure to real-estate while solve pretty much all of these problems. I really liked NLY due to the high yield, currently sitting at nearly 12%.

Based on what I've read about NLY, they purchase mortgage-backed securities (MBS) from Fannie and Freddie. To amplify their profits, they borrow money. Thus, their profits are the difference between their borrowing costs and the MBS they hold. This means they are incredibly sensitive to changes in interest rates, which is of particular concern right now. Additionally, as with any dividend-based investment, there are some serious questions about how safe that dividend is.

The upside is that, by law, an REIT is required to distribute their profits to shareholders, so as long as the company is profitable, there will be some sort of dividend. The real risk seems to be whether or not they can continue as a going concern and the actual dividend being paid out.

NLY has a long history, having started in 1997. During this time, NLY has had to weather quite a few crisis:

  • Dot Com Bust
  • 2007 Subprime Meltdown
  • 2018-19 Taper Tantrum
  • 2020 COVID

Based on the information I was able to cobble together, it looks like they've maintained their dividend since at least June of 2013. The TTM yield has varied between 9% and around 12.1% during this time. It seems fairly correlated to stock prices, so this suggests that either management is intentionally maintaining the dividend in this range or the underlying fundamental market forces keep this locked in that range.

On the surface, this is a good thing: it means they were able to maintain their dividend during a period where sharp rate increases seem likely.

A quick view of their Net Income paints an uglier story. Between 2018Q4 and 2020Q1, Net Income was negative. TTM Net Income was negative for 9 quarters straight. In fact, Net Income wasn't consistently positive until after the Pandemic and the rates began getting slashed. This immediately makes me question how they were able to fund their dividend.

I looked at their share count and since May of 2013, share count has increased from 947M to 1.45B–about a 55% increase in total shares, suggesting significant dilution. A huge portion of this stems from changes made in late 2017 and late 2018. My guess is that this was how they managed to fund their dividend during the rate hikes

Based on what I've read, I don't personally believe that this is an investment that I want to take on. Even though their dividend was stable, it seems that they were not able to navigate a situation where rates were increasing and in fact, had to fund their dividend using other people's money, not cash from operations.

My consensus is to take a pass on this.



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