My High Dividend Stocks Blog http://myhighdividendstocks.posterous.com Most recent posts at My High Dividend Stocks Blog posterous.com Tue, 07 Feb 2012 12:28:49 -0800 Don't Be Fooled By Annaly's High Dividend Yield. http://myhighdividendstocks.posterous.com/dont-be-fooled-by-annalys-high-dividend-yield http://myhighdividendstocks.posterous.com/dont-be-fooled-by-annalys-high-dividend-yield

Today I take a look at Annaly Capital Management, Inc. (NLY).  This is the fifth article out of fifteen on stocks that appeared as recommendations by Seeking Alpha contributor Insider Monkey.  Most of these stocks are 4-5% dividend yielding stocks, but NLY is different.  NLY and AGNC are mortgage REITs.  They follow some different government rules to avoid paying taxes, so they tend to have much higher dividend yield than regular businesses.  They are highly leverages and in my opinion are much riskier that most investor can appreciate.

Annaly Capital Management, Inc. (NLY)

Share price: $17.12

Shares: 970.08 million

Market capitalization: $16.61 billion

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Bonds outstanding: $600 million, and there are some preferred shares.

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What the company does - Formerly known as Annaly Mortgage Management, Annaly Capital Management is a real estate investment trust which invests in mortgage pass-through certificates, collateralized mortgage obligations, and other mortgage-backed securities. Interest and principal payments on the firm's investments are guaranteed by government-sponsored agencies including Fannie Mae, Freddie Mac, and Ginnie Mae. Annaly commenced operations in 1997 and is based in New York City.

DIVIDEND RECORD – Annaly has been cutting it dividend since its peak in 4Q 2009.  This ship is sinking.

Dividend: $0.57 quarterly

Dividend yield: 13.3% ($2.28 annual dividend/$17.12 share price)

Dividend payout ratio: 118% ($2.28 annual dividend/$1.92 recent Google Finance EPS) –OR- 300% using the six year average adjusted earnings ($2.28/$0.76)

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EARNING POWER – $0.76 per share @ 970.08 million shares

(Earnings adjusted for changes in capitalization; Annaly issues stock all the time to stay afloat)

EPS

Net income

Shares

Adjusted EPS

2006

$0.44

$74 M

168 M

$0.08

2007

$1.31

$393 M

306 M

$0.41

2008

$0.64

$325 M

507 M

$0.34

2009

$3.52

$1,943 M

553 M

$2.00

2010

$2.04

$1,249 M

625 M

$1.28

2011 (est)

$0.60

$422.53 M

970.08 M

$0.44

EPS

Net income

Shares

Adjusted EPS

2011 Q1

$0.89

$696 M

791 M

$0.72

2011 Q2

$0.14

$117 M

828 M

$0.12

2011 Q3

($0.98)

($926 M)

949 M

($0.95)

2011 Q4 (est)

$0.55

$535.53 M

970.08 M

$0.55

2011 total (est)

$0.60

$422.53 M

970.08 M

$0.44

Six year average adjusted earnings per share is $0.76

Consider contrarian buying below $6.08 (8 times average adjusted EPS)

Consider value buying below $9.12 (12 times average adjusted EPS)

Consider speculative selling above $15.20 (20 times average adjusted EPS)

Annaly Capital Management is currently trading at 22.5 times average adjusted EPS.  This stock is speculatively priced.

BALANCE SHEET – Toxic assets falsely valued at full face value and a mountain of short term liabilities that are real.  The company’s equinity can disappear in moments.  The company possesses no plant, property, or equipment used to produce goods.  That means no real assets; just deficit spending government non-guaranteed mortgage backed securities.

Image012

Book value per share:  $16.40 ($15,910 M/ 970.08 M shares), but the equity is a phony number because the assets are artificially valued higher than the free market would price them.

Price to book value ratio: 1.04 (under 1.0 is good)

Current ratio: 0.04 (over 2.0 is good) ($4.311 B in current assets / $97.165 B in current liabilities)

Quick ratio: (over 1.0 is good) ($3.474 B in cash / $97.165 in current liabilities)

Debt to equity ratio: 6.14 (lower is better) (total liabilities / total equity)

Percentage of assets in plant, property, and equipment: 0%

CONCLUSION – Never own a bank or financial stock.  Annaly Capital Management suffers from all the same ills of American Capital Agency Corp. (AGNC). 

http://www.myhighdividendstocks.com/category/high-dividend-stocks/american-capital-agency-corp

They are borrowed short and lent long.  They are susceptible to bankruptcy if the financial markets seize up again like in 2008.  Their assets are toxic, but are carried at full face value even though the market would never buy them at such prices if the company where to be liquidated.  Stay away from the siren song of the high dividend yield.  Besides, the shares are speculatively priced based on earnings and book value.  If I can’t convince you to stay away from financial stocks, then at least buy under $9.00.

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DISCLOSURE – I don’t own Annaly Capital Management, Inc. (NLY) and I never will.

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http://files.posterous.com/user_profile_pics/697493/v_for_vendetta_guy_fawkes_mask11.jpg http://posterous.com/users/4wuf4tt8LZzb Jason Brizic myhighdividendstocks Jason Brizic
Tue, 29 Nov 2011 11:01:04 -0800 62 Million Reasons Why Mortgage REIT Investors Should Be Scared http://myhighdividendstocks.posterous.com/62-million-reasons-why-mortgage-reit-investor http://myhighdividendstocks.posterous.com/62-million-reasons-why-mortgage-reit-investor

There are actually 62,000,001 reasons not to invest in mortgage REITs like American Capital Agency Corp. (AGNC) and Annaly Capital Management (NLY).  The first reason is that the USA and the world are slipping back into recession.  This will increase the speed of prepayments of mortgages.  Increase prepayment speeds destroys leveraged earnings in mortgage REITs.  Need proof, then check this out.  The ECRI has an amazing track record.  Ignore them at your financial peril.

http://www.advisorperspectives.com/dshort/updates/ECRI-Weekly-Leading-Index.php

Secondly, this article from Minneapolis attorney Bill Butler on LewRockwell.com should bring fear into the hearts of all mortgage REIT investors worldwide.  Here are the other 62 million reasons not to invest in mortgage REITs.  This is a long article, but it shows how nefarious Fannie Mae and Freddie Mac really are.  Mortgage REITs buy their agency securities from these crooks.

http://lewrockwell.com/butler-b/butler-b14.1.html

DISCLOSURE – I don’t own AGNC or NLY.

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http://files.posterous.com/user_profile_pics/697493/v_for_vendetta_guy_fawkes_mask11.jpg http://posterous.com/users/4wuf4tt8LZzb Jason Brizic myhighdividendstocks Jason Brizic
Mon, 11 Jul 2011 17:26:46 -0700 Warning: Annaly Capital Management (NLY) announces pricing of public offering of common stock. http://myhighdividendstocks.posterous.com/warning-annaly-capital-management-nly-announc http://myhighdividendstocks.posterous.com/warning-annaly-capital-management-nly-announc

Another day, another public offering of common stock by a leveraged REIT.  These companies including NLY, AGNC, and a few other high dividend stocks offer new shares to bring in money.  They use the money to leverage the purchase of 6x-9x more agency securities (back by the full faith and credit of the US govt – hahaha!!).  The people who run these companies are paid for the amount of equity they accumulate; shareholders do not come first.

Keynesian economics says deficits don’t matter.  They do.  The Greek government is learning this lesson the hard way.  When interest rates rise in the US for the same reasons these high yielding stocks will tank.  Until then they will pay high dividends.  Just know that there are significant risk with these stocks.

NLY has little earning power and a horrible balance sheet.

Disclosure: I don’t own NLY or AGNC.

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press release

July 11, 2011, 7:06 p.m. EDT

Annaly Capital Management Announces Pricing of Public Offering of Common Stock

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NEW YORK, Jul 11, 2011 (BUSINESS WIRE) -- Annaly Capital Management, Inc. /quotes/zigman/189739/quotes/nls/nly NLY -2.29% today announced the pricing of an underwritten public offering of 120,000,000 shares of its common stock at a price per share of $17.70 for expected gross proceeds of approximately $2.1 billion before expenses.

Annaly has also granted the underwriters a thirty-day option to purchase up to an additional 18,000,000 shares of common stock solely to cover overallotments. Annaly expects to use the proceeds of this offering to purchase mortgage-backed securities for its investment portfolio and for general corporate purposes, which may include additional investments and repayment of short-term indebtedness.

Credit Suisse Securities (USA) LLC is acting as the lead book-running manager for the offering. BofA Merrill Lynch, Morgan Stanley, UBS Investment Bank and RCap Securities, Inc. are acting as joint book-running managers.

Annaly has filed a shelf registration statement and prospectus with the Securities and Exchange Commission (SEC), and will file a prospectus supplement for the offering to which this communication relates. Before you invest, you should read the prospectus supplement and the accompanying prospectus and other documents Annaly has filed with the SEC for more complete information about Annaly and this offering. You may obtain these documents for free by visiting EDGAR on the SEC Web site at http://www.sec.gov . Alternatively, Annaly, the underwriters or any dealer participating in the offering will arrange to send you the prospectus supplement and accompanying prospectus if you request them by contacting:

Link to the original press release http://www.marketwatch.com/story/annaly-capital-management-announces-pricing-of-public-offering-of-common-stock-2011-07-11?reflink=MW_news_stmp

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http://files.posterous.com/user_profile_pics/697493/v_for_vendetta_guy_fawkes_mask11.jpg http://posterous.com/users/4wuf4tt8LZzb Jason Brizic myhighdividendstocks Jason Brizic
Wed, 06 Jul 2011 15:40:26 -0700 PIMCO enters the mortgage REIT business. http://myhighdividendstocks.posterous.com/pimco-enters-the-mortgage-reit-business http://myhighdividendstocks.posterous.com/pimco-enters-the-mortgage-reit-business

PIMCO is getting into the mortgage REIT business. 

http://www.bloomberg.com/news/2011-07-05/pimco-reit-agrees-to-slash-fee-if-residential-mortgage-fund-loses-money.html

What is its unique selling proposition?  In other words, why would I want to invest in PIMCO’s REIT instead of Annaly Capital (NLY) or American Capital Agency Corp. (AGNC)?

The trouble with these mortgage REITs is that the management is compensated for the size of their shareholder equity.  Offering additional shares is the easiest, fastest way to grow their equity through the use of 6x-8x leverage.

Avoid the mortgage REITs if you are a long term investor.  Traders can make some money before these REITs implode due to rising interest rates.

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http://files.posterous.com/user_profile_pics/697493/v_for_vendetta_guy_fawkes_mask11.jpg http://posterous.com/users/4wuf4tt8LZzb Jason Brizic myhighdividendstocks Jason Brizic
Mon, 27 Jun 2011 15:23:10 -0700 My 2 cents on Mortgage REITs: Where Danger Lurks http://myhighdividendstocks.posterous.com/my-2-cents-on-mortgage-reits-where-danger-lur http://myhighdividendstocks.posterous.com/my-2-cents-on-mortgage-reits-where-danger-lur

This is a good article on the dangers of mortgage REIT such as AGNC and NLY.

http://seekingalpha.com/article/276613-mortgage-reits-where-danger-lurks

However, I disagree with the author on this statement, “When the economy accelerates again, which I believe could be very soon, rates are likely to rise, perhaps dramatically, even if the Fed doesn’t tighten anytime soon.”

The economy is not going to accelerate unless the commercial bankers expand lending.  Bankers are terrified of more bad loans.  If they cease being terrified and expand lending, then their 1.3 trillion dollars of excess reserves will become part of the money supply.  This will increase the M1 money supply and prices would more than double from where they are no.  See Murray Rothbard’s book “The Mystery of Banking” for more details on how the fractional reserve process works.  http://mises.org/resources/614/Mystery-of-Banking-The

I think we are years away from commercial bankers being brave enough to lend their unprecedented excess reserves that the Federal Reserve printed out of thin air.

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http://files.posterous.com/user_profile_pics/697493/v_for_vendetta_guy_fawkes_mask11.jpg http://posterous.com/users/4wuf4tt8LZzb Jason Brizic myhighdividendstocks Jason Brizic
Fri, 17 Jun 2011 11:40:54 -0700 TIP OF THE WEEK - The Yield Curve: The Best Recession Forecasting Tool http://myhighdividendstocks.posterous.com/tip-of-the-week-the-yield-curve-the-best-rece http://myhighdividendstocks.posterous.com/tip-of-the-week-the-yield-curve-the-best-rece

The Yield Curve: The Best Recession Forecasting Tool

Jason Brizic

June 17, 2011

There is a lot of talk about the economy going into a double-dip recession.  Keep your eye on the yield curve.  Gary North explains.  Visit his site www.garynorth.com.  There is a lot of good free stuff there.  This came from the free portion.  An inverted yield curve will destroy the profitability of mortgage REITs like Annaly Capital (NLY) and American Capital Agency Corp. (AGNC).

The Yield Curve: The Best Recession Forecasting Tool

Gary North

It was on the basis of this indicator that in the November 2006 issue of my Remnant Review newsletter, I predicted a recession in 2007. It arrived in December 2007, according to the National Bureau of Economic Research.

The yield curve is a "curve" of interest rates for debt certificates.

The interest rates for more distant maturities are normally higher the further out in time. Why? First, because lenders fear a depreciating monetary unit: price inflation. To compensate themselves for this expected (normal) falling purchasing power, they demand a higher return. Second, the risk of default increases the longer the debt has to mature.

In unique circumstances for short periods of time, the yield curve inverts. An inverted yield occurs when the rate for 3-month debt is higher than the rates for longer terms of debt, all the way to 30-year bonds. The most significant rates are the 3-month rate and the 30-year rate.

The reasons why the yield curve rarely inverts are simple: there is always price inflation in the United States. The last time there was a year of deflation was 1955, and it was itself an anomaly. Second, there is no way to escape the risk of default. This risk is growing ever-higher because of the off-budget liabilities of the U.S. government: Social Security, Medicare, and ERISA (defaulting private insurance plans that are insured by the U.S. government).

What does an inverted yield curve indicate? This: the expected end of a period of high monetary inflation by the central bank, which had lowered short-term interest rates because of a greater supply of newly created funds to borrow.

This monetary inflation has misallocated capital: business expansion that was not justified by the actual supply of loanable capital (savings), but which businessmen thought was justified because of the artificially low rate of interest (central bank money). Now the truth becomes apparent in the debt markets. Businesses will have to cut back on their expansion because of rising short-term rates: a liquidity shortage. They will begin to sustain losses. The yield curve therefore inverts in advance.

On the demand side, borrowers now become so desperate for a loan that they are willing to pay more for a 90-day loan than a 30-year, locked in-loan.

On the supply side, lenders become so fearful about the short-term state of the economy -- a recession, which lowers interest rates as the economy sinks -- that they are willing to forego the inflation premium that they normally demand from borrowers. They lock in today's long-term rates by buying bonds, which in turn lowers the rate even further.

An inverted yield curve is therefore produced by fear: business borrowers' fears of not being able to finish their on-line capital construction projects and lenders' fears of a recession, with its falling interest rates and a falling stock market.

An inverted yield curve normally signals a recession, which begins about six months later. The stock market usually begins to fall six months prior to any recession. So, the appearance of an inverted yield curve normally is followed very shortly by a falling stock market. Fact: The inverted yield curve is an anomaly, happens rarely, and is almost always followed by a recession.

There have been exceptions, as this report by the Cleveland Federal Reserve Bank indicates.

Here is a great page, published by Fidelity, that explains the four major slopes of the yield curve and how they form. There is even an animated graph that lets you run through almost 30 years of curves, month by month. You can click the Play button, and the graph scrolls by. Stop it at any point. Click here.

For skeptics who want a detailed explanation of the relationship between the inverted yield curve and recession, they can read a 2004 Ph.D dissertation by Paul F. Cwik, which is available on-line at The Ludwig von Mises Institute's web site.

The yield curve for U.S. Treasury debt certificates is the one that investors use to predict the economy. Investors assume that the Treasury is the safest lender -- the least likely to default -- and therefore the rates on Treasury debt are least affected by risk.

The Treasury publishes the various rates here: Treasury debt rates

For more tips, go here:

http://www.myhighdividendstocks.com/category/tip-of-the-week

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http://files.posterous.com/user_profile_pics/697493/v_for_vendetta_guy_fawkes_mask11.jpg http://posterous.com/users/4wuf4tt8LZzb Jason Brizic myhighdividendstocks Jason Brizic
Mon, 18 Apr 2011 10:23:05 -0700 AGNC's liabilities are real and their book value must be questioned. http://myhighdividendstocks.posterous.com/agncs-liabilities-are-real-and-their-book-val http://myhighdividendstocks.posterous.com/agncs-liabilities-are-real-and-their-book-val

I wonder what Wunderlich Securities analysts are smoking?  These people are obviously devotees to Keynesian economics.  They believe that printing money to buy US Treasuries or agency MBS will only make the economic crisis worse later and destroy AGNC’s profitability.  The Federal Reserve is attempting to paper over the problem they created.  AGNC’s liabilities are real, but their asset values must be questioned.  The book value of AGNC is bogus.  I wrote about this recently:

http://bit.ly/EconFools

Anyone who assumes that AGNC’s book value as stated in their financial reports is trustworthy will be sorely mistaken when the next financial crisis hits.  The loss of book value can be caused by several factors.  They will happen.  It is just a matter of time.  The laws of economics assure it.

The structural problem in the world financial system remain unfixed.  Keynesian central bankers are inflating wildly forestall the day of reckoning.  The next financial crisis will destroy MBS REITs profitability and book values.  Enjoy the high dividend yields while they last.

So be warned that there is trouble on the horizon for the MBS high dividend stocks and plan your exit accordingly.  Annaly Capital Management (NLY) has decreased its dividend during the last two quarters.  I expect AGNC to do the same.

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-------------------

Wunderlich Securities has a research report on housing finance and mortgage REITs. In the note, Wunderlich mentions American Capital Agency Corp. (NASDAQ: AGNC).”

In a note to clients, Wunderlich writes, "Market concerns over the pending termination of QE2 pressured the mortgage REITs. Though we believe the homeowner lacks the financial flexibility to carry the economy out of the ongoing sluggish economy, we do expect that interest rates could tend to rise through May and the end of this round of easing. At the same time, we believe that easing will continue, though perhaps in different forms. For example, a policy to keep mortgage rates low could be executed through purchases of agency MBS, which could sustain liquidity in the housing finance secondary market. Higher benchmark rates could put pressure on book value and tighten spreads, but we believe that relatively high dividends in our coverage universe will be sustainable. With dividends providing price support, we expect the group to stage a slow recovery to an average 15% premium to trailing book value."”

Shares of AGNC lost 17 cents on Friday to close at $28.53, a loss of 0.6%.

Read more: http://www.benzinga.com/analyst-ratings/analyst-color/11/04/1010248/wunderlich-securities-discusses-housing-finance-and-mort#ixzz1JtQ8Nw1C

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Mon, 31 Jan 2011 13:16:53 -0800 Don't believe the REIT dividend stablity hype. http://myhighdividendstocks.posterous.com/dont-believe-the-reit-dividend-stablity-hype http://myhighdividendstocks.posterous.com/dont-believe-the-reit-dividend-stablity-hype

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Don’t believe the hype that REIT’s dividends are any more stable than government bonds.  REITs like American Capital Agency Inc. (AGNC) are benefiting temporarily from abnormally low interest rates caused by massive Federal Reserve money printing.  Interest rates have nowhere to go but upward.  It is just a matter of time until bond investors wake up, smell the smoke, and start running for the exits.  Don’t get trampled.

The market participants can see all the money printing.  They will demand an inflation premium for the bonds they are prepared to purchase.  This means that they demand higher interest rates.  Higher interest rates will squeeze AGNC’s profits.  They will be forced to cut their dividend drastically.  Just understand the risks of owning AGNC shares.  Their dividends are enormous right now.  That is mighty tempting.  Don’t let your AGNC shares exceed 5% of your high dividend stock portfolio.

Subscribe today at www.myhighdividendstocks.com/feed to discover high dividend stocks with earning power and strong balance sheets.  AGNC’s earning power is very precarious.

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SOURCE: The Bedford Report

 

Jan 31, 2011 11:25 ET

REITs Remain the Top Destination for Dividend Investors

The Bedford Report Provides Analyst Research on Annaly Capital & American Capital Agency

NEW YORK, NY--(Marketwire - January 31, 2011) - In the past year Real Estate Investment Trusts (REITs) have been one of the most popular investments in the financial sector. Since the start of 2010, the Vanguard REIT ETF has surged more than 30 percent while the overall financial sector has been relatively neutral. REITs' ability to generate this significant capital appreciation is one of the industry's main allures, as most investors flock to REITs for their hefty dividends and stability. In fact, most of the success of the industry in the last year can be attributed to low interest rates. When interest rates get this low the return on dividends can far exceed that of bonds. The Bedford Report examines the outlook for diversified REITs and provides research reports on Annaly Capital Management, Inc. (NYSE: NLY) and American Capital Agency Corporation (NASDAQ: AGNC). Access to the full company reports can be found at:

www.bedfordreport.com/2011-01-NLY

www.bedfordreport.com/2011-01-AGNC

The Vanguard REIT index had been stagnant for most of January, however it surged last week as investors bought up a number of the fund's top components on speculation of a wave of M&A activity in the industry.

M&A speculation in the REIT sector increased after ProLogis confirmed it is in talks with rival AMB Property about a possible merger. The two industrial REIT giants have a combined market cap of $13.9B, and are considering an "all-stock, at-market transaction, based upon the unaffected trading prices of the two companies' stock prior to media reports of a possible merger."

The Bedford Report releases regular market updates on REITs so investors can stay ahead of the crowd and make the best investment decisions to maximize their returns. Take a few minutes to register with us free at www.bedfordreport.com and get exclusive access to our numerous analyst reports and industry newsletters.

Companies such as American Capital Agency and Annaly earn their money on the spread between low-interest short-term borrowing and purchasing high-interest long-term securities, which leads to solid profits given the current conditions. Federal Reserve Chairman Ben Bernanke says that he is prepared to keep rates in the range of 0 - 0.25 percent for an extended period if the unemployment numbers don't drop significantly.

Solid profits for a REIT keep those dividend payments stable. Presently, American Capital pays an annual dividend of 5.60 for yield of about 19.60%. Annaly, meanwhile, pays an annual dividend of 2.56 for a yield of 14.40%. While high yielding dividend paying stocks are appealing, be forewarned that companies can cut, slash, or suspend dividends at any time, often without notice.

Link to original article: http://www.marketwire.com/press-release/REITs-Remain-the-Top-Destination-for-Dividend-Investors-1387799.htm

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http://files.posterous.com/user_profile_pics/697493/v_for_vendetta_guy_fawkes_mask11.jpg http://posterous.com/users/4wuf4tt8LZzb Jason Brizic myhighdividendstocks Jason Brizic
Thu, 20 Jan 2011 12:04:18 -0800 How Do These High-Yielding REITs Really Make Their Money? http://myhighdividendstocks.posterous.com/how-do-these-high-yielding-reits-really-make http://myhighdividendstocks.posterous.com/how-do-these-high-yielding-reits-really-make

American Capital Agency Corp. (AGNC) and the other high dividend stocks called REITs are quite leveraged.  They are at the mercy of the banks that issue/supply their repurchase agreements.  They are borrowed short (repurchase agreements) and lent long (agency securities) just like commercial banks.  That’s fine so long as there are no financial crisis’s looming in the future.  Guess what?  The structural problems caused by fractional-reserve banking are not fixed.  Central banks around the world are printing money which just masks the problems and make them worse.

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They pledge their existing assets (agency securities) as collateral to other banks in return for a very short term loan through repurchase agreements.  The repurchase agreements loans and new stock offerings get them the capital necessary to purchase new agency securities from Fannie, Freddie, and to a lesser extent Ginnie.  They use the income generated from the agency securities and the sale of some agency securities to pay off the repurchase agreement loans when they come due.  Some of the risks to their income are badly performing agency securities (remember those toxic mortgage backed securities and what happens when people who are unemployed stop paying their mortgages) and a decline in the price of agency securities (for the same reason mentioned and Federal Reserve intervention in the MBS market).

Because they are borrowed short and lent long they won’t have the money coming in to keep their current dividend payments during the next financial crisis.  For example, AGNC has a quick ratio of 0.08.  I like to see this ratio above 1.0 meaning that the company has more current assets than current liabilities.  The cash equivalents that AGNC has on hand (current assets) are miniscule compared to their billions in repurchase agreements (current liabilities).

For comparison let’s look at Safe Bulkers quick ratio.  It is 3.30.  They have over three times their current liabilities in current assets that could be liquidated in an emergency to keep paying their fat dividend.

How Do These High-Yielding REITs Really Make Their Money?

By Jim Royal
January 18, 2011

As investors, we need to understand how our companies truly make their money. And there's a neat trick developed for just that purpose. It's called the DuPont Formula.

By using the DuPont Formula, you can get a better grasp on exactly where your company is producing its profit and where it might have a competitive advantage. Named after the company where it was pioneered, the DuPont Formula breaks down return on equity into three components:

Return on equity = Net margins x asset turnover x leverage ratio

High net margins show that a company is able to get customers to pay more for its products. (Think luxury goods companies.) High asset turnover indicates that a company needs to invest less of its capital, since it uses its assets more efficiently to generate sales. (Think service industries, which often do not have high capital investments.) Finally, the leverage ratio shows how much the company is relying on debt to create profit.

Generally, the higher these numbers, the better. Of course, too much debt can sink a company, so beware of companies with very high leverage ratios.

Let's take a look at Annaly Capital Management (NYSE: NLY) and a few of its sector and industry peers.

Company

Return on Equity

Net Margins

Asset Turnover

Leverage Ratio

Annaly Capital Management

8.2%

79.7%

0.01

8.03

Chimera Investment (NYSE: CIM)

18.5%

91.6%

0.09

2.28

American Capital Agency (Nasdaq: AGNC)

28.4%

92.1%

0.03

10.46

Anworth Mortgage Asset (NYSE: ANH)

12.7%

88.2%

0.02

6.95

Source: Capital IQ, a division of Standard & Poor's.

Each of these companies offers a truly amazing dividend, ranging from 12.7% for Anworth to 19% for American Capital Agency. And how do these guys do it? This DuPont formula screen shows clearly: high leverage and fat net margins. Net margins for these group ranges from 80% to 92%, while most are very highly leveraged, with the exception of Chimera. Those tasty dividends bring out the gambler in some investors, which may explain why you might want to avoid some of these too-tempting stocks.

Breaking down a company's return on equity can often give you some insight into how it's competing against peers and what type of strategy it's using to juice its return on equity.

Jim Royal, Ph.D., owns shares of Annaly. The Fool owns shares of Annaly Capital Management.

Link to the original article: http://www.fool.com/investing/dividends-income/2011/01/18/how-do-these-high-yielding-reits-really-make-their.aspx

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