Annaly Capital Management's EAD Topped Its Dividend for a 9th Straight Quarter. Here's Why That Matters for Its 12.5%+ Yielding Payout.

Annaly Capital Management (NYSE: NLY) towers above most dividend stocks. The real estate investment trust (REIT) currently has a dividend yield of more than 12.5%. That's over 10 times higher than the S&P 500's current yield of around 1.1%.

A double-digit dividend yield is usually a bright red flag for income investors. However, that's not the case with the mortgage REIT's big-time payout. That's because the one metric that matters most for its dividend continues to top its payout.

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It's all about Annaly's EAD

Investors need to shift their focus when evaluating a REIT's financial results from reported net income to its underlying earnings. That metric can vary by REIT, as some use funds from operations (FFO) while others use an adjusted earnings metric. For Annaly, the metric that matters most for its dividend is its earnings available for distribution (EAD).

During the second quarter, the mortgage REIT generated $0.79 per share of EAD, comfortably above the $0.75 per share dividend it paid. That marked the ninth straight quarter that Annaly's EAD exceeded its dividend payment:

Data source: Annaly Capital Management. Chart by the author.

Annaly's rising EAD over the past nine quarters has enabled it to increase its dividend twice during this period, including a recent boost from $0.70 to $0.75 per share. That has reversed the prior downtrend in Annaly's EAD and dividend.

Will Annaly's EAD remain above its dividend?

Annaly's recent decision to raise its dividend reflects "the durable earnings power of our portfolio," stated CEO David Finkelstein in the second-quarter earnings press release. Several factors contribute to this durability, including Annaly's scale (it's the largest residential mortgage REIT by market cap), diversification (it invests in Agency MBS, residential credit, and mortgage servicing rights (MSR)), and financial strength (economic leverage of 5.6 times, down from 5.7x in the prior quarter and ample liquidity).

Those factors drive the REIT's expectation that it can continue to generate attractive risk-adjusted returns across market cycles. It currently sees meaningful investment opportunities across its three strategies. Annaly can earn levered returns of 11% to 13% on new MSR investments, 12% to 15% on residential credit, and 14% to 16% on Agency MBS investments. It has the flexibility to allocate new capital to the best investment opportunities it identifies. That was in Agency MBS during the second quarter, as it grew that portfolio by $3 billion while maintaining the size of its residential credit and MSR portfolios. As long as Annaly can earn high returns on new investments, it should be able to continue its trend of generating EAD in excess of its dividend.

Excess EAD means the dividend is safe

Annaly ran into trouble several years ago when its EAD began to decline, forcing it to cut its dividend a few times. However, that trend has reversed, enabling the REIT to boost its payout as its EAD has risen. As long as that metric remains above the dividend, the payout is safe. That appears to be the case for now, given the company's increasingly durable earnings and the strong returns it can earn on new investments. However, it's a metric investors need to watch closely, as changes in EAD will directly affect the dividend.

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.