Income is a big part of investors' returns. Stocks, mutual funds and fixed income ideas in this column are featured because they are relatively solid in their ability to pay dividends or interest. We're giving income investors a resource to start their research for investments that give better yields with lower risk.

August 5, 2009 - Annaly Capital Management, Inc. (NLY-NYSE) a real estate investment trust (REIT), engages in the ownership, management, and financing of a portfolio of investment securities. The company invests primarily in mortgage pass-through certificates, collateralized mortgage obligations, agency callable debentures, and other mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans.

The company has elected to be taxed as a real estate investment trust (REIT). As a REIT, the company would not be subject to federal corporate income tax, provided it distributes at least 90% of its taxable income to its stockholders. It was formerly known as Annaly Mortgage Management, Inc. and changed its name to Annaly Capital Management, Inc. in August 2006. Annaly Capital Management was incorporated in 1996 and is based in New York City.

The first thing to know about NLY is that most of its mortgage investments are in Fannie and Freddie instruments (also known as agency securities) which are both run under government conversatorship which means these mortgages are mostly bullet proof. There's an implied assurance that the government will make good on any of these loans. While not guaranteed, it's as close to one as you'll find. That makes NLY's portfolio much safer than most other mortgage portfolios.

The next thing to know is the dividend yield is much, much better than most other investments. At 13.9% an investor would be hard pressed to find another REIT or stock that gave this kind of return. The average dividend yield for the S&P 500 stocks is 2.7%.

Right now, NLY is enjoying some of the widest spreads (the difference between the cost of funds and the return on investments). Currently that spread is close to 2%, twice the more normal 1%. That's because the funding costs for NLY are relatively low. Its fundings are closely allied with short-term borrowing costs which are controlled by the Fed. The Fed has been most accomodative since the recession started and appears it will stay that way. That bodes well for NLY into 2010.

A couple of things to consider. When interest rates go higher (and they most certainly will once a recovery is obvious), the cost of funding for NLY will also rise. In order to grow, NLY has to always be in the capital markets to raise more money so it is very sensitive to interest rate moves. Another concern: refinancing of existing mortgages. The pools of mortgages NLY owns contain many individual mortgages. Some of them will refinance or be paid off. If too many mortgages are bought at a premium, the refinancing causes losses for NLY. Right now, most new mortgage pools are bought at a discount rather than a premium so payoffs aren't a major consideration. Furthermore with interest rates above 5% recently, refinancing has slowed. But keep these two influences in mind if this REIT appeals. Currently, it's the best of times for NLY.

The biggest concern for investors in NLY is rising interest rates. They reduce margins. While the company hedges against higher rates for about 1/3 of its portfolio, it doesn't cover all of it. When rates rise, this stock will most likely lose some ground.

Dig deeper into this high paying REIT. It's got great quality in its mortgage holdings, a stronger spread than usual, and a benign interest rate environment. Just don't think things will always be this perfect.

- Company Web site: www.annaly.com

 Ted Allrich