TAKING STOCK: Annaly Capital

Dear Mr. Berko:

In early December 2009, I bought 400 shares of Annaly Mortgage on your recommendation at $18.05 because it was yielding l6.7 percent. The dividend has gone down, and so has the yield. Will it go down further? Should I sell my shares? My broker wants me to buy 400 more shares. What should I do?

R.P., Rochester, Minn.

Dear R.P.:

First, fire your broker. He's a gross ignoramus, which is a dozen times dumber than a plain old ignoramus.

Yes, I recommended Annaly Capital Management in 2009, when it as trading at $18, and it's now $17.90. The dividend then was 75 cents a quarter, and the yield was l6.6 percent. Subsequently, the dividend has been reduced twice to 66 cents a quarter. Now the shares yield l4.5 percent, and that dividend is not rooted in stone.

NLY, a mortgage REIT, owns U.S. government-agency, floating-rate, adjustable mortgages guaranteed by Fannie Mae, Freddie Mac and every one of your tax dollars and are not subject to default. The rates on these mortgages adjust every six to 18 months. NLY's management borrows money short term (at l5 to 25 basis points) to own these mortgages that pay 5 percent or 6 percent, so it's this magic of leverage (which I have explained in other columns) that allows NLY to pay its huge dividend.

However, if interest rates rise by one-half of 1 percent next week, NLY's funding costs would increase by that amount, and management may have to reduce its payout by 50 percent. Ouch!

Well, sure as shootin', short-term interest rates will rise and force Annaly to pay more for its short-term loans. When this happens, NLY may reduce its dividend to 64 cents or perhaps 60 cents this year. So I'd sell the stock now and take a teeny capital loss, which can become a big capital loss if you wait.

There are l6 brokers that follow NLY, five of whom rate it as a strong buy, seven of whom rate it a buy and four of whom have a hold recommendation. The consensus has a high l2-month target of $21, but those guys gotta be sniffing glue because there's no way NLY will trade at $5 above its $16 net asset value in a climate of slowly rising rates.

Meanwhile, not a single brokerage has a sell recommendation on NLY. And that's understandable because I don't know of a single brokerage that had a sell recommendation on the homebuilders, autos, REITS, insurance companies or banks before they imploded a few years ago. Wall Street does a superb job presenting buy recommendations in a bull market. But conflicts between a brokerage's investment-banking business and its research department almost always prohibits a sell recommendation. An NLY sell recommendation would incur the displeasure of management and mitigate that brokerage's chances of earning lucrative investment banking fees. And that's how Wall Street works.

NLY may be able to maintain its current trading range for another six months. However, sometime next year, NLY is likely to test the $14 price where it traded in the summer of 2009. And I'm willing to wager my autographed color photo of Euell Gibbons that NLY will reduce its quarterly dividend this year. But if you wait to unload your shares after the dividend has been reduced, you may take a bigger loss.

Please remember that you have received $1,324 in dividend income during the l5 months you've owned NLY, and more than that in principle could be lost if NLY reduces its dividend. And as I've often said, losing an opportunity is a much less regrettable alternative than losing money. So BSTS, or "better save than sorry."

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Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775 or e-mail him at mjberko@yahoo.com. Visit Creators Syndicate website at www.creators.com.

© 2011 Creators Syndicate Inc.

Published: Mon, Mar 14, 2011

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