Annaly Capital Management (NLY): Dividend Coverage, Hedge Shifts and the Capital Mix

Key Takeaways#

Annaly Capital Management ([NLY]) surprised markets with a quarterly distributable-earnings print that just covered its common payout: Q2 2025 Earnings Available for Distribution (EAD) of $0.73 per share versus a declared common dividend of $0.70 per share, implying coverage of +4.29% on an EAD basis for the quarter, according to the company’s Q2 materials Q2 slides. At the same time, the quarter produced a $389 million net derivatives valuation loss and spotlighted a headline payout-ratio figure that has been reported in other reconciliations at levels well above 100%, creating a tension between short-term distributable cash and broader accounting dynamics.

From a market-data perspective, the common stock is trading at $20.97 with a market capitalization of $13.46 billion, reported EPS of $1.04 and a trailing P/E of 20.16; these market metrics sit against an annualized common dividend of $2.80 per share, which equates to a calculated dividend yield of 13.36% at the prevailing share price (calculated from the market quote and dividend disclosed) StockAnalysis. The yield signals the market’s pricing of elevated earnings volatility and rate sensitivity, even as management has deployed preferred issuance and adjusted hedging to manage funding and NAV risk.

Strategically, the most consequential developments are the calibrated reduction in hedge coverage—from 102% to 95% in Q2—and the targeted use of preferred capital, including the recently announced Series J issuance that provides $250 million of fixed-rate preferred capacity at 8.875% coupon (management disclosures summarized by contemporaneous coverage) Seeking Alpha. Those choices explicitly tilt the portfolio to capture upside if rates decline, while using senior preferred liabilities to stabilize funding costs, but they also increase sensitivity to prepayment and hedge revaluation paths.

Q2 2025 Results and Market Metrics#

Annaly’s Q2 operating results combined stronger core net interest income with pronounced derivatives volatility. The company reported Net Interest Income (NII) of $273.2 million for the quarter, driven by a modest expansion in average asset yields and a continued emphasis on agency MBS Q2 slides. Management highlighted a quarterly NIM ex-PAA of 1.71%, up from 1.24% on a year-ago basis, and an average yield on earning assets of 5.42%, a sequential pickup from the 5.23% reported in Q1 2025 and a YoY improvement from 5.17% in Q2 2024. Those yield moves were the mechanical engine behind the EAD beat for the quarter.

The headline accounting noise came from mark-to-market movements in derivatives: the firm recorded approximately $389 million in derivatives net valuation losses during Q2, a sizable non-cash swing that depressed GAAP measures and book-value headlines even while cash-oriented EAD covered the distribution. Annaly’s reported change in hedge ratio—from 102% to 95%—was management’s explicit lever: moderate de-risking relative to earlier in the year but still defensive compared with pre-tightening norms. That hedge adjustment increased the firm’s exposure to lower rates, a deliberate choice to participate in potential upside should the Fed move toward easing.

Market reaction to the Q2 mix has been measured rather than panicked. The common shares trade at $20.97 and imply a 13.36% dividend yield on the declared run-rate, reflecting investor demand for high income but also the risk premium attached to mREIT cash flows and derivative volatility StockAnalysis. On balance, Q2 shows a company generating sufficient distributable income under EAD rules for the quarter while still wrestling with the translation of mark-to-market accounting into investor confidence.

Capital Structure: Common Dividend, Preferred Issuance and Market Metrics#

Annaly balances a high common dividend with an active preferred issuance program that management uses to stabilize funding and reduce reliance on common equity in stressed markets. The Q2 declaration of $0.70 per share sets an annualized common payout of $2.80, a figure that drives the headline yield calculation when compared to market price. Using the prevailing share price of $20.97, the annualized yield calculation is $2.80 / $20.97 = 13.36%, a straightforward arithmetic result that underscores why the stock remains a high-yield instrument in investor portfolios StockAnalysis.

Preferred issuance plays an essential role in Annaly’s funding toolbox. Management announced a $250 million Series J preferred offering with an 8.875% coupon; that instrument carries higher seniority than common equity and provides a fixed coupon that is less sensitive to short-term earnings volatility than the common dividend. Preferred instruments reduce the need to issue dilutive common equity when raising capital for balance-sheet growth or to meet regulatory and leverage objectives. In practice, preferred issuance is a form of non-dilutive equity-like capital that costs less than many alternatives while giving the company runway to manage common distributions more deliberately Seeking Alpha.

The interaction of common dividend, preferred coupons and market metrics creates notable payout-ratio dynamics. Using reported EPS of $1.04 and the annualized dividend of $2.80, a simple earnings-based payout calculation yields 269.23% (2.80 / 1.04), which differs from other headline payout ratios reported around 277.23% in some reconciliations. The difference arises from whether analysts annualize the most recent distribution, use different EPS definitions (GAAP vs. adjusted), or incorporate other non-recurring items. We prioritize the EAD-based coverage metric for dividend sustainability analysis because it captures the cash-generative spread business central to the mREIT model, while noting that EPS-based payout measures and GAAP swings from derivatives remain material to investor risk assessment StockAnalysis, Q2 slides.

Hedging, Interest-Rate Sensitivity and Risk Profile#

Annaly’s core risk-management playbook centers on reducing duration mismatch between long-duration agency MBS assets and relatively shorter-duration funding. The hedge-ratio move from 102% down to 95% in Q2 shows management’s willingness to accept incremental duration exposure to benefit from potential rate declines; this is a tactical adjustment with measurable consequences for both NAV sensitivity and distributable income potential Q2 slides.

The immediate accounting consequence of hedge rebalancing was the $389 million derivatives valuation loss in Q2, which weighed on GAAP results and compressed book-value headlines. That non-cash loss does not negate the quarter’s cash earnings—EAD still covered the distribution—but it demonstrates the volatility that mark-to-market hedging can introduce into reported equity metrics even when operations generate positive spreads. Reducing hedge coverage increases the sensitivity to falling rates (which can boost asset valuations and NII), but also elevates exposure to sudden rate moves or a reversal that would force defensive hedging at unfavorable levels.

Crucially, falling interest rates are a mixed blessing for mREITs. Lower short-term rates typically reduce funding costs and lift long-duration MBS valuations—supporting EAD and NAV—but they also accelerate mortgage prepayments, shortening asset durations and potentially forcing reinvestment at lower yields. Annaly’s decision to modestly trim hedge coverage while growing the agency MBS book by ~6% QoQ is a calibrated bet: capture upside from easing while relying on preferred issuance to lock in term funding and preserve flexibility. Execution discipline on prepayment modeling and active hedge management will determine whether that calibration produces durable improvements to distributable income or merely shifts accounting volatility between periods Q2 slides.

Historical Context and Peer Positioning#

Annaly has historically anchored its model on agency MBS spread capture and active liability management. Across cycles Annaly’s management has leaned on leverage, swaps and preferred issuance to smooth returns to common shareholders while protecting book value. The current pattern—regular common dividends supplemented by preferred offerings and dynamic hedge posture—is consistent with that longer-term playbook, though the magnitude of derivatives swings in recent quarters has increased investor scrutiny of headline volatility.

Within the mREIT peer group, Annaly’s scale and access to capital markets set it apart. The company’s common yield in the low-to-mid teens and its ability to source substantial preferred tranches (such as the Series J) illustrate that scale advantage. That said, headline payout ratios that exceed 100% on certain accounting bases place the common equity at the riskier end of the income spectrum compared with some smaller peers that might target lower yields but also exhibit lower volatility in distributable metrics. Comparing payout and coverage across peers requires harmonizing distributable earnings definitions—EAD for Annaly versus sometimes different adjusted metrics for peers—making simple apples-to-apples ranking difficult without detailed reconciliations Seeking Alpha.

Institutional activity in recent weeks—both buys and sells reported in regulatory filings—illustrates the bifurcated market for Annaly: some investors are increasing exposure to secure higher yields (e.g., the Korea Investment Corp filing), while others have pared stakes amid headline volatility (institutional selling reported by other filers) MarketBeat, MarketBeat. That mixed institutional behavior is exactly what one expects for a large, high-yield mREIT with active balance-sheet management.

What This Means For Investors#

The most immediate implication is that dividend sustainability is a conditional, not absolute, statement. On an EAD basis for Q2 2025 Annaly covered the declared common payout—EAD $0.73 vs dividend $0.70—but EAD is sensitive to net interest income drivers (asset yields, funding costs) and to prepayment and hedge outcomes. Investors focused solely on the cash-distribution line should track EAD trends quarter-to-quarter and watch funding costs and hedging adjustments as leading indicators of sustainability Q2 slides.

Second, accounting volatility from derivatives will continue to be a material investor consideration. The $389 million net derivatives loss in Q2 is non-cash but it affects book value and can pressure investor sentiment and capital flows. Management’s use of preferred issuance (e.g., Series J at 8.875%) provides a degree of funding stability, but the interplay between preferred coupons, common dividends and mark-to-market swings means that headline equity metrics may remain noisy even when distributable income is intact Seeking Alpha.

Finally, the hedge-ratio posture is now explicitly a tactical lever for Annaly’s risk/reward profile. With hedging at 95%, the company is positioned to capture more upside from lower rates than it would have at higher coverage, but it also increases sensitivity to prepayments and to the risk that rates move higher unexpectedly. Monitoring prepayment speeds, the trajectory of short-term funding costs, and the pace of agency MBS purchases will be the clearest way to anticipate changes to EAD and the company’s ability to sustain the common distribution over coming quarters Q2 slides.

Conclusion#

Annaly’s Q2 2025 report stitched together a clear message: core spread-generating activity remains sufficient to cover the common dividend in the quarter under EAD rules, yet the business remains exposed to large mark-to-market swings from derivatives and is actively reshaping its capital and hedge posture to benefit from potential rate easing. The firm’s $0.73 EAD versus a $0.70 quarterly dividend, the $389M derivatives valuation loss, and the shift in hedge coverage from 102% to 95% together encapsulate the trade-off management is making between income stability and upside participation in a pivoting rate environment Q2 slides.

For investors, the story is not a single metric but the intersection of distributable cash (EAD), mark-to-market volatility (derivatives and book value), and capital structure choices (preferred issuance and leverage). Those three vectors will determine whether Annaly’s high headline yield translates into steady income or episodic volatility. Absent a material change in macro rates or a different hedging posture, the company’s toolbox—active hedging, preferred issuance and portfolio rotation—gives it the means to manage outcomes, but the margin for error remains narrow and monitoring will remain essential.

(Selected disclosures and quarter summaries referenced throughout are available in the company’s Q2 materials and contemporaneous analyst coverage listed in the article.)