While most people will be happy to see 2020 in their rearview mirror, investors in financial stocks will be particularly eager to put this year behind them. COVID-19 dinged up most financial stocks, from banks to real estate investment trusts (REITs). Mortgage REITs were hit particularly hard as the initial reaction to the pandemic created extreme volatility in the sector.
Invesco Mortgage Capital (IVR 2.50%) had what could only be called a near-death experience in 2020. Citigroup (C 2.45%) has struggled as well, but it entered the crisis with a strong balance sheet. At this stage, which one would be better for a dividend investor?
Mortgage REITs are a different animal
While most investors are pretty familiar with Citi and what it does, people who haven't paid much attention to mortgage REITs may not be familiar with Invesco Mortgage Capital. It's a mortgage REIT, which is a bit different than the typical retail, apartment, or office REIT. Those REITs buy property and then lease it out to tenants. The difference between the rents they collect and interest expense is the income for these companies, more or less. It is a pretty easy-to-understand model.
Mortgage REITs don't buy property, they buy mortgage debt. Their income is the difference between what they earn on their portfolio and their cost of financing. In many ways, mortgage REITs are quite similar to banks.
A tough year for both companies
Invesco struggled early this year, and the stock was absolutely hammered. The chart below shows the relative performance of Citi versus Invesco year to date.
Invesco's big decline was due to a liquidity crunch in the mortgage market early this year. Riskier mortgage assets dropped in price, which triggered margin calls from the company's lenders. It became a vicious cycle, and eventually, Invesco was forced to enter forbearance with its creditors.
Invesco eventually sold off most of its asset portfolio over the spring and summer and is a fundamentally different company now. It is much safer but smaller. It sold off most of its nongovernment guaranteed assets and now is almost completely invested in mortgage-backed securities guaranteed by the U.S. government. The chance of it recovering its pre-COVID prices anytime soon is remote since those assets were not marked down, they were sold. They may well recover, but the company no longer holds them.
Citi on the other hand has struggled along with the rest of the banking sector. With the news of a potential COVID-19 vaccine (or vaccines) acting as a light at the end of the tunnel, the stock has been recovering with the rest of the market.
Let's look at the major financial metrics for both. Invesco has the higher dividend yield, a higher net interest margin, along with a lower leverage ratio (total liabilities/total equity). It also has less credit risk than Citi, given that most of its assets are guaranteed by the government. Citi's main advantage is its size and stability and the fact it trades at a higher discount to book value.
|Dividend Yield||Price to Book||Net Interest Margin||Leverage|
|Invesco Mortgage Capital||5.73%||0.99||2.79%||4.3|
No credit risk does not mean no risk
So, is Invesco Mortgage Capital a better dividend stock? Certainly, going by the metrics above, you would have to say it is. It has lower leverage, a wider interest margin, a better yield, and limited credit risk. That said, as we saw last spring with mortgage REITs, even the ones that were invested primarily in government-guaranteed mortgage-backed securities (REITs like Annaly Capital and AGNC Investment) reported big declines in book value and were forced to cut their dividends. Just because a mortgage REIT has limited credit risk doesn't mean it has no risk.
Citi entered 2020 paying a quarterly dividend of $0.51 per share. It will exit 2020 paying a dividend of $0.51 per share. Invesco entered 2020 paying a dividend of $0.50 per share. It cut its dividend by 90% to $0.05 per share in May, cut it again to $0.02 in July, and then hiked it back to $0.05 in October. Most dividend investors simply have no tolerance for that kind of volatility.
So which one is better?
I would say it depends on your risk tolerance. Citi is a steady performer, and will probably continue to pay its dividend with modest increases. Invesco's portfolio is arguably less risky and probably has more upside to its dividend than Citi. That said, Invesco's historical price and dividend volatility might be too much for many investors.