Annaly Capital: You Don’t Always Have To Buy The 11% Yielding Common Stock

Common shares of high-yielding mortgage REITs make for great additions to high-yield income portfolios, but they are not the only instruments available to income investors to produce steady dividend income. Preferred shares, for instance, have a lot of appealing risk and return features, too, that make them also very compelling for income investors to consider.

A case in point is Annaly Capital Management, Inc. (NYSE:NLY), the largest mortgage REIT in the land. Annaly Capital’s shares have enjoyed a great run this year, advancing ~17 percent in value. By any standard, this is a great price return for a high-yield income vehicle, and especially considering that income investors have not had much love for mortgage REITs at the beginning of the year.

Though Annaly Capital is up strongly year-to-date, the mortgage REIT is not too expensive just yet, particularly on a core earnings basis. I have discussed Annaly Capital’s market valuation at length after the mortgage REIT released 2nd quarter results earlier this month in this article here, ‘Annaly Has Had A Great Run In 2016, But Is Still Not Overpriced’.

Annaly Capital today sells for ~0.95x accounting book value, and ~9.4x Q2-16 run-rate core earnings (Annaly Capital had 2nd quarter core earnings of $0.29/share).

An alternative to Annaly Capital’s common stock, however, is the mortgage REIT’s 7.50% Series D Cumulative Redeemable Preferred Stock, trading under the ticker symbol (NLY.PRD). On Friday, Annaly’s preferred stock finished the day at $25.91, thereby selling for a 3.64 percent premium to its liquidation preference value of $25.00/share.

The Series D pays a quarterly dividend of $0.4688/share, and sells for a nice and decent 7.24 percent yield. Since preferred shares have seniority over common shares within a company’s capital structure, an investment in Annaly Capital’s preferred stock layer comes with significantly less risk compared to the common stock layer. As a result, preferred shares also tend to yield less, much less, than the common shares of the same issuer.

Preferred shares are therefore a great way to invest in a high-yield income vehicle like Annaly Capital, while controlling for risk, but ‘sacrificing’ yield for more safety.

Your Takeaway

Preferred shares of high-yield income vehicles are an attractive way of structuring recurring dividend income. While most of the coverage centers around the common stock of mortgage REITs, there is no reason to neglect the preferred stock layer that offers a compelling combination of high yield and moderate risk.

In particular, Annaly Capital’s Series D Preferred Stock is an alternative way to invest in the mortgage REIT without accepting the high risk that comes with an investment in the mortgage REIT’s common shares. Though the preferred shares come with a yield disadvantage of 373 bps compared to the common shares, a 7 percent yield is nothing to scoff at. Buy for income.

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Disclosure: I am/we are long NLY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Stock Plaza). I have no business relationship with any company whose stock is mentioned in this article.