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Wednesday July 11, 2012
Annaly: A 'preferred' play for income
by Marvin Appel, editor Systems & Forecasts  We have long recommended buying Annaly Preferred Class A (NLY-A), but it is callable in 2014 and the yield is now a modest 4.2%. Fortunately, Annaly Capital (NLY) has issued a new class of preferred stock, the Annaly Capital Class C with a coupon yield of 7.625% (NLY-C), which is not callable until May, 2017. I recommend it at $26.00 or lower for indefinite holding as a source of income. As with any preferred stock, you will likely have to ride out significant price volatility, so only commit capital that you are confident in not needing to use to meet expenses. Annaly Capital is a mortgage REIT: It purchases mortgage-backed securities using significant leverage. According to its first quarter 2012 financial statements, for every dollar of shareholders’ equity, Annaly borrowed an additional $7. Although its investment policy allows it to invest up to 25% in unrated or “below high quality” holdings, all the current mortgage backed securities in the portfolio are guaranteed by the federal government. The company makes its profi ts mainly on the basis of the spread between its low borrowing costs (average 1.5%, down from 1.6% a year ago) and the yields from its investments (average 3.2%, down from 3.7% a year ago). Annaly made a profit of $659 million last quarter (on shareholder equity of $16 billion). Preferred dividends were just $4 million, while dividends to common shareholders were $556 million. Since the new issue of preferred stocks appeared after 3/31/2012, it was not part of the fi rst quarter results. $275 million in preferred stock, class C was issued. The other preferred, class A, totals just $100 million. Therefore, roughly speaking, the issuance of Annaly Preferred, Class C, will almost quadruple the preferred dividend payout, to approximately $16 million. In terms of credit seniority, the preferreds class C and A rank equally. Even though Annaly utilizes extremely high amounts of leverage, the common dividends represent the margin of safety to preferred shareholders. Profits would have to fall by more than 95% before Annaly earned too little to pay its preferred dividends. Given Federal Reserve policy, there is virtually no risk of this occurring before 2015. Most traditional preferred stocks get the favorable tax treatment for their dividends. However, because Annaly is a REIT that pays no corporate income taxes, the dividends on their preferred stocks is taxed as ordinary income. That makes Annaly Preferred, Class C, especially attractive for retirement accounts. Learn more about this financial newsletter at Marvin Appel's Systems & Forecasts. Related articles: 
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