Annaly Capital Management (NLY 2.07%) and AGNC Investment (AGNC 1.30%) are two of the highest-yielding dividend stocks in the market today. Paying a 16% and 15% dividend yield, respectively, investors can earn a yield roughly 10 times the average of the S&P 500.
AGNC Dividend Yield data by YCharts
Although the companies operate in similar industries, there are some notable differences between these two mortgage real estate investment trusts (mREITs), especially when it comes to dividend safety.
With that in mind, let's see which stock is the better investment as we move into 2023.
Both companies are feeling economic pressures
Annaly and AGNC both invest in agency mortgage-backed securities (MBS), which are guaranteed by the government. If a borrower defaults, the company isn't out of luck. Low-risk investments like these don't offer huge returns for mortgage REITs, with yields of 3% to 4%. This doesn't leave much room for the mREITs to pay a hefty dividend yield.
To grow and profit, companies rely heavily on short-term debt to leverage their assets and boost returns. Both mREITs use a variety of derivative investment strategies like interest swaps and Treasury futures to do this. In low-interest rate environments, these strategies can be lucrative because their cost of borrowing is cheap, which makes their net spread (the money earned from interest on the loans after its cost of borrowing) much wider.
But in today's rising interest rate environment, the short-term cost of borrowing is becoming more expensive. In turn, this hurts both companies' net spread. Treasury yields have also surpassed MBS yields, reducing the pool of buyers in the market for MBS, which has hurt asset values and book values for both companies.
Why Annaly Capital looks like the better investment
It's not a great time to be a mortgage REIT. Challenging economic conditions are putting both companies' long-term dividend payouts at risk. However, if you're willing to overlook economic pressures for short-term high dividend yields, Annaly stands out as the better buy of the two.
Annaly also invests in non-qualified (non-QM) mortgages. These loans don't fit the underwriting standards to be backed by a government agency -- things like jumbo loans or loans on investment properties. These slightly higher-risk loans often offer much higher yields than their lower-risk counterparts but carry a credit risk because there is no backstop in the event of a borrower default.
Fortunately, Annaly's underlying credit profiles for these loans are top notch. In its latest third-quarter acquisition of non-QM loans through its subsidiary Onslow Bay, the average borrower put down more than 30% on the property and had a credit score of 760. High credit quality doesn't mean things can't deteriorate if a recession follows, but it does reduce Annaly's credit risk somewhat.
It also gives the company a different way to grow by having more diversified income streams. AGNC, which invests solely in agency-backed mortgages, is at the whim of demand in the secondary market, hurting its book value more than Annaly's. AGNC's book value fell by 21% from the second quarter of 2022, while Annaly's book value declined by 15%.
Annaly also earns money from servicing mortgages for other companies, collecting around $174 million last year in servicing fees. Its mortgage servicing business has more than doubled in the past year. It's likely Annaly will continue to make the growth of this sector of its business a priority, as the market continues to deal with interest rate pressures.
In the third quarter of 2022, AGNC's net interest spread widened slightly to 2.81%, while Annaly's narrowed by about 1.3 percentage points to a net interest spread of 1.09%. But both companies are still operating at a net loss. Annaly reported a per-share loss of $0.70 in the third quarter, while AGNC had a loss of $1.31 -- its fourth consecutive quarter of operating at a loss.
A year of losses in a weakening economic environment puts AGNC at greater risk for a dividend cut in the near future. Add in Annaly's more diverse mix of assets, and it's clear why it's the better pick of the two.
