The mortgage industry is going through a wrenching retrenchment right now, and the stocks of companies in this sector have underperformed. Mortgage bankers have been crushed by rising interest rates and declining volumes.

Mortgage real estate investment trusts (REITs) have struggled as mortgage-backed securities they hold have underperformed Treasuries. These declines have created high dividend yields for many of the stocks. Mortgage REIT MFA Financial (MFA 1.46%), for example, has a dividend yield of more than 15%. Is it sustainable?

Picture of the Federal Reserve Building

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MFA Financial has more credit risk than agency REITs

MFA Financial is a mortgage REIT that focuses primarily on loans that are not guaranteed by the U.S. government. These loans are often referred to as non-qualifying, or non-QM, which means they don't fit into the box to be guaranteed by the government-sponsored enterprises Fannie Mae and Freddie Mac. These loans look nothing like the subprime loans of the bubble years and are generally targeted toward professional real estate investors or self-employed borrowers. These loans will have higher yields than government-guaranteed loans and will be more sensitive to inflation, interest rates and the overall economy. 

Non-QM loans are a growing business, although liquidity in the sector tends to come and go. The biggest problem for non-QM loans is interest rate risk, which is so difficult to hedge that most market participants don't even do it. Liquidity risk is another reason for the higher rates on these loans. Aside from non-QM loans, MFA financial has a portfolio of business purpose loans, which are made primarily for fix-and-flip homes or rentals. The rates on non-QM loans are about 5.2% and 96% of the portfolio is current (in other words, the borrower is making payments). The business-purpose loans have rates of more than 7.5%.

MFA also has a portfolio of nonperforming and reperforming mortgage loans. A nonperforming loan is one where the borrower is not making payments, and a reperforming loan is one where the borrower went seriously delinquent but has brought the loan current (usually through some sort of loan modification). These loans will either get foreclosed or refinanced. Nonperforming loans generally trade at a 20% to 30% discount, which gives them a higher yield.

MFA's performance will depend on the economy

MFA Financial is almost the polar opposite of a so-called agency REIT like AGNC Investment (AGNC 0.99%). AGNC Investment's portfolio is almost entirely made up of securities guaranteed by the U.S. government. If the U.S. enters a recession, and the Federal Reserve starts cutting rates, AGNC Investment will be better positioned than MFA Financial. If the U.S. economy manages to avoid a recession, and the housing market returns to growth, then MFA Financial will be the better bet. 

MFA Financial pays a quarterly dividend of $0.44, which gives the company a yield of 15.4%. The company had a per-share loss of $0.66 in the third quarter, which was primarily the result of by a mark-to-market loss on its loans. This bookkeeping loss was driven by rising interest rates and mortgage underperformance. Beyond that, the dividend's sustainability is no sure thing; it will depend on mortgage-backed securities returning to their historical relationship with Treasuries. If the U.S. enters a recession and credit losses start building up, the dividend is at risk.