Is Annaly Capital's 13% Dividend Safe Through a Full Rate Cycle?

The big draw for most investors with Annaly Capital (NYSE: NLY) is its massive 13.7% dividend yield. To put that yield into context, the S&P 500 index (SNPINDEX: ^GSPC) has a yield of just about 1%, and the average real estate investment trust (REIT) yields 3.6%. If you are trying to maximize the income your portfolio generates, it would be hard to say no to Annaly Capital's yield, but here's why you might want to anyway.

What does Annaly Capital do?

Annaly Capital is a mortgage REIT. It issues stock and debt, using the proceeds to buy mortgages pooled into bond-like securities. It also manages the collection of loan payments, known as mortgage servicing rights. While mortgage servicing tends to provide a reliable income stream, owning mortgages is a more volatile business.

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Essentially, Annaly makes the difference between its cost of capital and the interest it earns on its mortgage securities. The mREIT's cost of capital fluctuates with interest rates and market conditions on Wall Street. Just looking at the stock's yield today is a snapshot. To fully understand the income you can expect over time, you need to look back at the history. It's not nearly as compelling a story as you might hope, as the chart below highlights.

NLY Dividend data by YCharts

The first thing to note is the purple line, which is Annaly's dividend. The dividend has been highly variable since the company's IPO. If you are trying to live off the income your portfolio generates, Annaly should be a hard sell. That said, the mREIT did just raise its dividend in June, so that's a positive. And it may continue to increase the dividend over the near term, too. But look at the orange line of the graph, which is the effective Fed Funds Rate. Annaly's dividend tends to move in the opposite direction of that line.

A full rate cycle, then, will likely include a period when Annaly's dividend is rising and another when it is falling. If you are trying to time the rate cycle, buying Annaly could be a good income option. But if you are a buy-and-hold dividend investor, Annaly is probably best avoided.

Annaly isn't a bad company; it just isn't a reliable dividend stock

The truth is, Annaly Capital has done a good job of creating value for investors if you look at total return, which assumes reinvestment of dividends. However, the dividend has a very clear history of being volatile, which makes it difficult to suggest that the 13%+ yield will provide you with an income stream you can count on to pay your bills.