In the hunt for dividend yield, mortgage real estate investment trusts (mREITs) are the heavyweights of the stock market. While the sector struggled mightily in the initial days of COVID-19 lockdowns due to margin calls, these mREIT stocks are all back on their feet, albeit with smaller balance sheets and dividends.
Despite every company in the space cutting dividends, these stocks still provide some handsome yields. Here are three mREIT names worth watching.
First, a bit of explanation
Mortgage REITs are a different animal than the typical REIT like Simon Property Group or Equity Residential. These companies build properties and then rent them out to tenants. They earn their return from rental payments minus the interest expense on their debt.
Mortgage REITs don't build malls or towers; they own real estate debt. Their return is driven by the interest paid on their mortgage-backed securities and their cost of financing those securities. This makes mortgage REITs vulnerable to volatility in the bond markets.
Agency mortgage REITs take little credit risk, but they do face interest rate risk
AGNC Investment (NASDAQ:AGNC) is an agency REIT, which means it primarily invests in mortgage-backed securities that are guaranteed by the U.S. government. This means that AGNC Investment takes very little credit risk. If the borrower is unable to make the monthly mortgage payment, AGNC still gets paid.
Like most mortgage REITs, it was forced to cut its dividend in response to margin calls from its bankers. The company did say on an earnings call that it probably didn't need to cut the dividend in retrospect. While AGNC doesn't bear credit risk, it does bear interest rate risk, and the massive refinancing wave currently in effect could potentially cut its earnings.
That said, AGNC invests in mortgage-backed securities with higher levels of pre-payment protection. It pays a monthly dividend of $0.12 per share, which works out to a yield of 9.2%.
Annaly Capital Management (NYSE:NLY) is another agency REIT that has a similar business model to AGNC Investment. Like AGNC, Annaly was buffeted by bond market volatility in mid-2020 and was forced to cut its dividend.
Annaly takes on slightly more credit risk than AGNC because its portfolio is primarily agency securities. Annaly will be negatively affected by any sort of dramatic increase in interest rates, but for the moment, the company has the most important player in the market on its side: the Federal Reserve. The Fed buys mortgage-backed securities in order to support the economy, and this buying supports the value of Annaly's portfolio. The REIT pays a quarterly dividend of $0.22 a share, which works out to be a dividend yield of 10.6%.
A potential spinoff provides a catalyst in addition to the dividend
New Residential (NYSE:NRZ) went through the wringer during the COVID-19 crisis and changed its business model to become an agency REIT like AGNC and Annaly. New Residential is somewhat different in that it has a mortgage origination arm, which means the company is less tied to asset values.
Mortgage bankers are hot right now, as we have seen companies like Rocket Companies -- aka Quicken Loans -- go public. New Residential filed a confidential prospectus with the Securities and Exchange Commission regarding its origination arm, which means the company is thinking of doing something, either spinning off the origination arm into its own company or something else similar. This provides another catalyst to increase the share price. In the meantime, New Residential pays a quarterly dividend of $0.20 a share, which works out to a yield of 8.5%.
While the mortgage REIT sector was beaten up during the initial days of the coronavirus, the companies have all been able to right-size their balance sheets and dividends. While it is highly unlikely these companies will return to their pre-COVID prices anytime soon, they pay some of the best yields in the market, and income investors should take the time to understand these somewhat esoteric stocks.