What You Need to Know About Annaly Capital

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Mortgage REITs are popular with many investors right now for the high dividend yields they currently provide. Sporting a dividend yield of 14.9%, Annaly Capital (NYS: NLY) is certainly no exception.

Mortgage real estate investment trusts issue shares to investors to raise capital, which they use to buy mortgage-backed securities. They also use short-term financing to boost their returns. They repay lenders out of the mortgage payments they collect, and most of the rest is returned to shareholders in dividends.

Here's a simple visualization:

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Let's take a quick look at four things investors in Annaly need to know. After that, we'll find out how Annaly stacks up next to its competitors.

1. Interest rate spread
A REIT's interest rate spread is the difference between a REIT's financing costs and its interest income. It's a decent measure of investing profitability -- and portfolio risk.

2. Debt-to-equity ratio
Since interest rate spreads tend to be pretty narrow, REITs like to leverage those returns to generate bigger returns. Companies with safer portfolios can afford to take on more leverage risk than those with riskier investments.

3. Share growth
Since REITs have to pay out the vast majority of their earnings in dividends, the only way to grow their business is to take on more leverage or issue new shares. If a company issues a lot of shares, we want to make sure it does so at attractive prices so investors aren't diluted.

4. Dividend yield
The main reason to buy mortgage REITs is for their dividend. The forward yield tells us what dividends we'll get paid over the next year if earnings hold constant.

Let's see how Annaly stacks up next to its peers in these four crucial areas:

Company

Interest Rate Spread (Q2 2011)

Debt-to-Equity Ratio

3-Year Annual Share Count Growth

Dividend Yield

Annaly Capital2.45%576%24%14.9%
Chimera (NYS: CIM) 4.20%189%24%*17.4%
American Capital Agency (NAS: AGNC) 2.46%662%193%*18.7%
Cypress Sharpridge (NYS: CYS) 2.23%745%234%19.0%

Source: Capital IQ, a division of Standard & Poor's. *Two-year growth.

Like many of its peers, Annaly has grown its share count quite a bit over the past few years to raise capital for buying more securities. Its price-to-book multiple ranged from 0.91 to 1.27 over that time frame, suggesting that the company was able to get reasonable but not amazing prices for its shares.

Like American Capital and Cypress, Annaly invests mostly in ultra-safe "agency securities" -- mortgages whose interest payments are guaranteed by Fannie Mae and Freddie Mac. All three are producing historically high interest rate spreads, thanks to the low cost of capital made possible by economic pessimism and the Federal Reserve's low short-term rates. With the exception of Chimera, which tends to invest in riskier assets, Annaly carries a slightly lower debt-to-equity ratio than its peers. Annaly's more conservative leverage is what accounts for its slightly lower dividend yield, but it should also help shareholders sleep a bit more soundly at night.

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At the time this article was published Ilan Moscovitzdoesn't own shares of any company mentioned. The Motley Fool owns shares of Annaly Capital Management and Chimera Investment. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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