Solid News From 1 of the Market's Hottest Dividend Plays

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Annaly Capital (NYS: NLY) is the largest mortgage REIT and generally regarded as the best-run, so I watch its reports on the state of the sector with some interest -- especially any comments from CEO Michael Farrell.

For the quarter, Annaly reported adjusted earnings of $622.8 million, or $0.65 per share. That compares to $0.70 per share in the year-ago quarter and $0.71 in the second quarter 2010.

Part of the decline in per-share earnings is due to the recently completed secondary offering of 138 million shares, which raised $2.4 billion in fresh capital for the company. The offering suggests the company is still seeing plenty of opportunities to deploy its capital effectively, a good sign for investors in this dividend giant.

With shares outstanding at nearly 970 million, share count has exploded since Q2 2010, when the company had just 560 million stubs. But Annaly's ability to keep generating solid dividends even as it raises new money is a welcome sign. The company declared a $0.60 payout for the third quarter and offers a yield of 14.4% at current prices.

The other big concern for mortgage REIT investors is the interest rate spread -- the difference between what it costs the REIT to borrow and the rate it receives on its investments. Last week we saw the spread at peer American Capital Agency (NAS: AGNC) slip year over year, and Annaly followed suit.

Company

Interest Rate Spread Q3 2011

Interest Rate Spread Q2 2011

Interest Rate Spread Q2 2010

Annaly2.08%2.45%2.11%
American Capital Agency2.14%2.46%2.21%
CYS Investments (NYS: CYS) 1.95%2.23%1.91%
Invesco Mortgage (NYS: IVR) TBA2.75%4.11%
Chimera (NYS: CIM) TBA4.20%4.44%
Armour Residential (NYS: ARR) TBA2.36%2.88%

Source: S&P Capital IQ. TBA = to be announced.

Still, Annaly's decline was only 3 basis points year over year, a blip that means very little by itself, much as CYS' small move up does. Chimera and Invesco are due to report on Thursday, so we'll see if that trend continues. Armour reports next week. This is a key metric to keep an eye on, since the spread dictates overall profitability. We'd rather see a larger spread than a smaller one.

Less positive was Annaly's rate spread at quarter-end of 1.96%, suggesting that things became even tighter as the quarter wore on. And Annaly's leverage shrank to 5.5 times, compared to 6.4 times year over year.

CEO Michael Farrell highlighted the challenges for the sector, including regulatory reform and Operation Twist, while noting the tailwinds, such as low Fed funds rates through 2013. Still, the conditions continue to be broadly favorable for the industry, and Annaly is taking actions to reduce the incremental effects of the headwinds.

And that's what I like to see out of Annaly, one of my largest holdings. It's one of the key stocks in my World's Best Dividend Portfolio and I'm interested in reinvesting in shares as the company takes the right moves to keep those dividends flowing.

At the time this article was published Jim Royal, Ph.D., owns shares of Annaly. The Motley Fool owns shares of Annaly and Chimera. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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