Investors who like financials and are looking for dividends should look at the real estate investment trust (REIT) sector. Since REITs must pay out 90% of their earnings as dividends, the companies tend to have outsized yields. While most REITs are in the property and leasing business, some REITs earn their returns as investors.
Annaly Capital (NLY 0.67%) is one of the top mortgage REITs in the space. As an investor in mortgage loans, Annaly bears some resemblance to the one of the leading U.S. banks: JPMorgan Chase (JPM 0.31%).
Which one is the better dividend stock?
Annaly struggled earlier this year with COVID-19
Annaly Capital Management is a mortgage REIT, which means its business model is buying up mortgages and earning interest on them. Since mortgages are nothing more than loans, the model is similar to a bank. The big difference is that mortgage REITs finance their portfolios by borrowing from banks, while banks finance their portfolios via deposits. The mortgage REIT sector has a less stable funding source than banks, which usually rely on deposits. The issues with that funding source became apparent early this year when COVID-19 caused a major disruption in the mortgage markets. Annaly (along with every other mortgage REIT) saw the value of its assets fall, and its creditors began to ask for additional margin. Unable to access that much cash quickly, many mortgage REITs sold off assets into an illiquid market. This is why every mortgage REIT was forced to cut its dividend earlier this year.
JPMorgan is the classic mega-bank, with exposure to the entire global economy. The banking sector was forced to take massive provisions for potential future credit losses earlier this year. This was partially due to the new government-mandated Current Expected Credit Losses (CECL) framework instituted early this year. In addition, JPMorgan took provisions for possible COVID-19-related credit losses.
Annaly doesn't take much credit risk, but that doesn't mean no risk
Annaly Capital invests most of its portfolio in government-guaranteed mortgage-backed securities. These are the most common type of mortgage investment; if you recently refinanced your home with a Fannie Mae or Freddie Mac loan, it probably ended up in a mortgage-backed security similar to what Annaly owns.
Since COVID-19 has increased the number of borrowers in forbearance, that should be a problem for Annaly, right? Actually no, since these mortgage-backed securities are government-guaranteed, which means the government is the backstop if the borrower stops paying. In fact, not only does the government ensure Annaly is paid, the Fed is actively buying mortgage-backed securities in the market to drive down mortgage rates. So Annaly benefits tremendously from the government. What is Annaly's main risk? Interest rate risk and funding (liquidity risk). Interest rate volatility negatively affects mortgage-backed securities. Liquidity risk means that it is subject to margin calls when mortgage-backed securities fall in price.
JPMorgan takes much more credit risk than Annaly does. While JPMorgan does hold some government-guaranteed mortgages, that isn't its main business. JPMorgan is in the business of taking credit risk. JPMorgan has some interest rate risk, however, interest rate volatility generally works in the favor of banks. Second, JPMorgan finances its balance sheet with deposits. Since deposits are government-guaranteed, there is little risk of a bank run. JPMorgan also has a much more diversified portfolio of loans, compared to Annaly which is in mortgages only.
Given that Annaly is a REIT, it generally has a higher dividend yield than the typical non-REIT. Annaly pays a per-share quarterly dividend of $0.22, which works out to be a dividend yield of 10.6%. JPMorgan pays a per-share quarterly dividend of $0.90, which works out to be a much lower yield of 3%.
So which one is the better dividend stock?
Annaly has the higher dividend yield, however, Annaly was forced to cut its per-share dividend from $0.25 to $0.22 during the COVID-19 crisis. JPMorgan was able to maintain its dividend during this whole period. So conservative investors might find more comfort in JPMorgan, while investors who want higher yield but are willing to take some extra risk might be more comfortable with Annaly.