This Just In: Upgrades and Downgrades


At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock-pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)

Given this, perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about.

Any hope for Annaly?
Last week was no fun for Annaly Capital (NYS: NLY) investors. For days, the bad news had been rolling in from across the REIT industry: both Capstead Mortgage (NYS: CMO) and Invesco (NYS: IVR) missed estimates due to declining earnings, while American Capital Agency (NYS: AGNC) actually suffered a net loss for the quarter. So by the time Annaly's turn rolled around, you have to imagine expectations were low -- and then, a miracle happened.

Annaly reported earnings on Wednesday, and while earnings did in fact decline, a fortuitously timed sale of "Agency mortgage-backed securities and debentures" helped to lift Annaly past consensus numbers and deliver a $0.06 per-share earnings beat of $0.55 per share, versus the expected $0.49.

Great news, right? Well, maybe not, because for whatever reason, Annaly's share price received no boost from the beat. (In fact, the shares actually slid a few cents.) Adding insult to this injury, analysts at Wunderlich Securities decided to downgrade Annaly shares on Friday.

What's with Wunderlich?
So what is the deal with Wunderlich? Don't these guys like earnings beats?

They might. But here's the thing: Not everyone on Wall Street is convinced that Annaly's beat was all that met the eye. What's worse, they fear it may portend darker days ahead. For example, just before Wunderlich rendered its verdict, analysts at Nomura Securities chimed in to warn investors that Annaly's dividend -- currently yielding 12.7% -- is "not sustainable on spread income alone and further dividend cuts are possible if realized gains do not persist."

Translated into plain English, what Nomura is saying is that every time Annaly sells an asset for "realized gains," it may get to book a big profit immediately, but over the long term, the sale of that asset means Annaly has less to work with to generate steady "spread income" from its asset base. It's essentially an example of robbing Peter (long-term income) to pay Paul (a one-time gain that helps to secure an earnings beat).

Pluses and minuses
Last week showed us one tool that REITs like Annaly can use to fund dividends when "spread income" profits are slow. On Friday, Annaly peer Armour Residential REIT (NYS: ARR) announced it would sell 55 million shares in a follow-on offering, raising perhaps $400 million -- an amount equivalent to about five years of dividends. Now we're seeing Annaly demonstrate another tool at the REIT's disposal: selling assets.

In the short term, this suggests that REITs like Annaly, Armour, Capstead, Invesco, and American Capital may be able to put off their dividend "issues" to a later date (assuming, of course, the banking system doesn't get hit by another crisis of confidence that freezes up their short-term debt funding). In the longer term, though, Nomura is right: These asset sales weaken the companies' steady streams of income earned from the "spread" between the rates at which they borrow and the interest paid out by the MBSs.

Over the long term, the fact remains: REITs won't be able to keep paying out dividends at these rates forever.

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Fool contributorRich Smithdoes not own (or short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 306 out of more than 180,000 members.The Fool has adisclosure policy. The Motley Fool owns shares of Annaly Capital Management.Motley Fool newsletter serviceshave recommended buying shares of Annaly Capital Management.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.

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