Key Points

Annaly Capital Management recently increased its dividend payment. That increase followed a series of dividend cuts. The REIT is currently earning attractive returns on mortgage investments. 10 stocks we like better than Annaly Capital Management ›

Annaly Capital Management (NYSE: NLY) pays a monster dividend. The real estate investment trust's (REIT) yield is currently over 14%. That's a massive 10 times higher than the S&P 500.

More often than not, dividends with yields over 10% seem to be screaming that a cut is forthcoming. However, that's not the case with this mortgage REIT's payout. Instead, the company recently gave investors a surprise dividend increase. Here's a look at whether Annaly is a solid option for investors seeking a big-time income stream.Image source: Getty Images.

Bouncing back

Annaly Capital Management has a three-pronged investment strategy:

Agency MBS: Annaly invests in pools of residential mortgages guaranteed by government agencies such as Freddie Mac and Fannie Mae.  Mortgage servicing rights: It invests in MSRs, which provide the right to service residential loans in exchange for a portion of the interest payments.  Residential credit: The REIT invests in non-agency residential mortgage assets. It's a leader in investing in prime jumbo mortgages.

The company uses leverage to invest in additional mortgages. It makes money on the spread between the interest it pays and the income earned by its investment portfolio.

Annaly's investment spread was wider during the first quarter. That enabled the mortgage REIT to generate $0.72 per share of earnings available for distribution (EAD), its second straight quarter at that level. As the following table shows, the company's earnings have started to bounce back after declining in recent years: Data source: Annaly Capital Management.

That improvement in its earnings enabled the company to raise its quarterly dividend from $0.65 to $0.70 per share. It's a partial reversal of the company's dividend cut in early 2023, when it slashed its payout from $0.88 to $0.65 per share. That cut was one of many the company has made over the years: NLY Dividend data by YCharts

Where will the dividend go next?

Annaly's dividend history shows it tends to rise and fall with its EAD. While EAD had declined over the past couple of years, it stabilized and started rising during the last few quarters. That's due to a combination of investments to grow parts of its portfolio and higher returns for its mortgage investments.

In early 2023, Annaly had an $85.5 billion investment portfolio consisting of:

Agency MBS: A $77.6 billion investment portfolio earning a 14% to 16% leveraged return. Residential credit: A $5.2 billion portfolio earning a 12% to 15% leveraged return.  MSR: A $1.8 billion portfolio earning a 9% to 12% return, with less leverage employed.

Story Continues

Fast-forward to the first quarter of this year, and the company's overall portfolio is $84.9 billion. However, the makeup has shifted, and returns have improved:

Agency MBS: A $75 billion investment portfolio earning a 16% to 19% return. Residential credit: A $6.6 billion portfolio generating 13% to 16% returns. MSR: A $3.3 billion portfolio delivering 12% to 14% returns.

Overall, the company's returns on all three of its investment strategies have increased over the past two years. Meanwhile, the REIT's dynamic investment strategy has enabled it to shift some capital toward residential credit and MSR to capture the higher returns these lower-leveraged investments currently offer.

Another benefit of this strategy shift is that it has allowed Annaly to employ less leverage to earn even higher returns. CEO David Finkelstein noted in the company's first-quarter earnings release, "We entered the year with our lowest leverage in a decade and substantial liquidity." That prepared the company to navigate the recent turbulence in the market.

Despite the recent market volatility, the CEO noted that "we continue to see attractive returns across our three businesses and believe our diversified housing finance portfolio should allow us to deliver superior risk-adjusted returns over the long term." That suggests the company should be able to continue delivering a high enough EAD to maintain its recently raised dividend payment. However, if its returns start to decline, it might need to reduce its dividend again.

A higher-risk, high-yield dividend stock

Annaly Capital Management's mortgage investment strategy can be very lucrative. When market conditions are strong, it can make a lot of money, most of which it pays out in dividends. However, if its returns fall, the company will make less money, which has led it to cut its dividend in the past. It's a better option for more risk-tolerant investors who can withstand the potential swings in its dividend payment.

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Matt DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This More Than 14%-Yielding Dividend Stock is Surprisingly Raising Its Already Monster Payout was originally published by The Motley Fool

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