Annaly Leads REIT Retreat

Updated from 10:34 a.m.

Mortgage REITs got hammered Friday as investors fled from a pair of big dividend cuts.

Annaly Mortgage Management (NLY Quote) plunged 12% Friday after the company cut its dividend by 64%. The real estate investment trust, which primarily invests in mortgage-backed securities, is seeing its profits being squeezed by a flat yield curve, reflecting the difference between short-term and long-term interest rates.

The company's third-quarter dividend will be 13 cents, down from 36 cents in the second quarter. Before the cut, the stock had a dividend yield of 9.7%. Now, the dividend yield amounts to 3.9%. In order to get the yield back up above 8%, which is where mortgage REITs have been trading, the stock would have to drop to $6.50.

Two other mortgage REITs also suffered significant slides Friday on dividend concerns. Capstead Mortgage (CMO Quote) fell 7% after the company on Thursday cut its third quarter dividend to 2 cents, from 10 cents in the second quarter. Impac Mortgage Holdings (IMH Quote) fell 7% on concerns the company is likely to cut its third quarter dividend, since it is currently paying out more than it is earning. In late June, Impac said it expected to re-evaluate its dividend policy during the third quarter.

In a research note, J.P. Morgan analysts reiterated their underweight thesis on the sector.

"From a macro perspective, we believe that the RMBS Investor segment of the REIT world is currently facing a 'perfect storm.' That is, not only is the yield curve flat, but prepayments remain high as well. While companies like NLY (who has an eight-year operating history and an experienced management team) have seen both a flatter yield curve and higher prepayments, never have the two occurred simultaneously as they do today," J.P. Morgan wrote.

J.P. Morgan, which provides non-investment banking services to Annaly, reduced its EPS estimates for the company to $1.05 in 2005, well below the analyst consensus of $1.35, and to 92 cents in 2006, below the $1.32 consensus.

On Friday, Annaly fell $1.81 to $13.07, Capstead slid 57 cents to $7.37, and Impac fell $1.04 to $13.08.