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Annaly is one REIT that has kept on rolling

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Dear Mr. Berko:

I would like to buy 5,000 shares of Annaly Capital Management Inc., and I can afford the risk. However, I’d certainly appreciate your opinion, which would help make my decision. I would like to own this position for two reasons. The current 14.3 percent yield is very attractive, and I think the stock could move up to the $20-$22 level in the coming six months. So tell me what you think.

S.O., Seattle

Dear S.O.:

Annaly Capital (NLY – $18.51) is a real estate investment trust with 65 employees, who together manage a multibillion-dollar portfolio of mortgage-backed securities, including pass-throughs, collateralized mortgage obligations and other mortgage-related assets.

It appears that NLY may come through these economic trials and travails in decent shape. And (cross your fingers) it looks like anticipated 2009 earnings of $2.48 a share will be higher than 2007 earnings of $1.04 and 2008 earnings of $2.08 a share. However, 2010 earnings are anticipated to be lower at $2.35.

Certainly, low funding costs may continue to generate higher returns. Certainly, the Federal Reserve’s “zero interest rate” policy has been a silver lining for NLY’s earnings. And the Fed intends to keep rates low for the foreseeable future, which would certainly nudge 2010 earnings past the anticipated $2.35 a share. However, I doubt that even the Fed has the power to keep those rates low in 2010, which does not bode well for NLY’s earnings.

NLY’s balance sheet is surprisingly good. A very steep yield curve plus a low refinance rate permitted the company to boost its assets by nearly 20 percent this year. This has allowed NLY to reward its shareholders with some generous dividends – $2.08 last year, $2.65 this year and $2.55 (possibly higher) in 2010. Based upon Annaly’s $18.51 market price, today’s dividend yields an audacious 14.3 percent, which certainly ain’t chopped liver. NLY trades about 7 points over its $11.50 book value, which reflects a $20 billion increase (for 2009) in net assets.

Those are some of the reasons Credit Suisse ranks NLY as outperform, Ned Davis Research ranks NLY as a solid buy and Morningstar believes NLY could trade in the mid $20s, and why 70 percent of Annaly shares are institutionally owned, and why Vanguard, Allianz, Barclays, Bank of New York, Waddell & Reed, Legg Mason and Wells Fargo have huge positions in the stock.

We know that good times never last as long as we want them to last, and that bad times always follow good times. We also know that almost all of NLY’s mortgages are “reverse purchase agreements” and, without a boring discussion of the details, provide a much stronger cushion for equity holders than general debt. We also know that low short-term rates allow NLY to earn huge profits between its borrowing cost and its higher mortgage rates.

Still, I have no objections to your purchase of 5,000 shares, providing you consider this purchase to be a high-quality speculation, and after you buy the stock, you place an open-stop, good-till-canceled order two points under your purchase price. You will have protected yourself should you awake one morning and find that the Fed unexpectedly raised rates while you were “sleeping in Seattle.”

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net. © Copley News Service