Why Investors Cheered Annaly Earnings, Plus Key Analyst Upgrade

The biggest news is that Annaly likely will be able to maintain its very high dividend payouts, which has to be the driving concern of investors in M-REITs.

Annaly also ended the quarter with a capital ratio of 15.4% and its leverage was 5.3:1. Annaly’s net interest rate spread was 1.26% in the second quarter, up from only 0.90% in its prior quarter. Another gain was in the book value rising by almost $1 to $13.23 per share.

Annaly’s 1.26% spread was generated by its average yield of 3.20%, versus its annualized average cost of funds of 1.94%. The REIT’s investment securities agency mortgage-backed securities and agency debentures were $82.4 billion at the end of June, up from $77.8 billion the prior sequential quarter but way down from the $95.8 billion in the same period a year earlier.

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Sterne Agee’s analyst team covering M-REITs decided to raise its rating to Buy from Neutral, and they assigned a $12.75 price target. As a reminder, Annaly also comes with that 10% current dividend yield that attracts so many income investors.

Sterne Agee’s analysts on the report were Jason Weaver, Henry Coffey and Calvin Hotrun. Their $12.75 price target considered the lack of positive consensus ratings, increased net interest margins and also the discount to book value. The team feels that the net interest margins will be large enough to sustain the super-high 10% dividend. Annaly’s book value per share rose 7.6% from the previous quarter, due to the outperformance of agency mortgage-backed securities, slowing prepayment speeds, and lower interest rates (borrowing costs).

The Sterne Agee report also pointed out that Annaly took a slight loss in its swap portfolio on unrealized hedging. The book value did grow more than expected because the Annaly portfolio terminated the higher interest rate swaps inter-quarter.

The M-REIT sector has been a bit of a worry on and off for much of the past year. After all, the Federal Reserve has been tapering its bond purchases in Treasury notes and agency mortgage-backed securities each month now. It is also widely expected that the “considerable period” of time when rates will be kept at near-zero is set to end in the first half of 2015.

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Investors like the earnings report, and they like the upgrade. Annaly shares were up by 1.4% at $11.42 on more than 3 million shares after about 50 minutes of trading. The REIT’s 52-week trading range is $9.66 to $12.61, but investors may notice that the share price has now risen to above the $11.38 pre-earnings consensus price target.