Annaly's Stock Is Upgraded on Cheaper Valuation

Tickers in this article: NLY

NEW YORK (TheStreet) -- Annaly Capital Management(NLY) was raised to "neutral" from "underperform" by Sterne Agee on Friday following Thursday's selloff in the shares. Analyst Henry Coffey expects the mortgage REIT to steadily lower its dividend.

Annaly shares lost nearly 2% to close at $14.66 Thursday after the company reported a fourth-quarter gain of 32 cents per share excluding realized and trading gains, missing consensus estimates of 37 cents. Coffey had expected 26 cents. Shares were little changed Friday.

The upgrade appears to have been driven largely by valuation, as Coffey noted the shares "are selling at our expected price-to-book multiple of 90% and only modestly above our new price target of $14.25."

Annaly paid a fourth-quarter dividend of 45 cents per share, which translates to an annualized yield of 12.3% based on Friday's $14.68 share price. Coffey sees the quarterly payout falling "over time" to 30 cents per share. "A logical yield target would be 8.25% to 8.50%," he wrote.

Annaly makes money by investing in mortgage-backed securities (MBS) that pay higher interest rates than the company requires to fund itself. It faces pressure from an expected rise in rates, which could cause its funding costs to accelerate faster than the rate it earns from its MBS portfolio. The sustained low-rate environment, meanwhile, has caused a rise in prepayments as homeowners pay down mortgage faster than expected in order to refinance. That, in turn, forces Annaly to reinvest in MBS that offer a lower yield.

Still, Coffey notes that rising rates have the positive effect of causing prepayments to slow, as refinancing no longer looks attractive to homeowners.

-- Written by Dan Freed in New York