Mortgage real estate investment trusts (mREITs) are often known for their alluring high-yielding dividends. AGNC Investment (AGNC 0.76%) and Annaly Capital Management (NLY 1.31%), for example, currently pay a 15% and 16.4% yield, respectively.
It's easy to get drawn into a dividend stock that pays five to 10 times the average yield of the S&P 500, but investors shouldn't be fooled. Cuts are coming for these ultra-high-yielding dividend stocks. Here's why.
Why mortgage REITs are struggling right now
Rising interest rates impact nearly every facet of a mortgage REIT's business. Mortgage REITs rely on borrowing heavily in order to grow their balance sheets. When the cost of borrowing increases, the company's spread between its cost of capital and the interest collected on the loan (called a net spread or net margin) narrows. This leads to smaller profits for the company on its portfolio of loans.
Higher mortgage rates also result in decreased consumer demand for home loans and refinancing. Less origination volume hinders the mREITs' ability to grow.
On top of that, The Federal Reserve has stopped the quantitative easing program it started in 2020 to help offset the sudden drop in demand for mortgage-backed securities (MBS) and bonds. With the Fed no longer buying MBS, mortgage REITs' demand could weaken, in turn, lowering the value of its assets and the mREITs' book value. These factors combined have created difficult conditions for mREITs to maintain their dividend payments.
Dividend cut risk 1: AGNC Investment
AGNC Investment specializes in buying, investing, and selling agency-backed mortgages, or loans guaranteed by the government. The company uses short-term lending structures like interest rate swaps and repurchase agreements to fund the acquisition of new loans. This means the rapidly rising federal funds rate isn't great for its cost of borrowing.
Its agency repurchasing agreements increased by a full percentage point in the third quarter of 2022. Its total cost of borrowing went from 0.18% to 0.50% this past quarter. In turn, its net spread thinned, and it reported a net loss of $1.31 per share. This is its fourth consecutive quarter of operating at a net loss, which puts its 15% dividend in danger territory.
Treasury bonds are currently outperforming MBS, resulting in a dramatic drop-off in demand for the agency-backed securities AGNC Investment buys and sells. As a result, AGNC Investment Corp's book value fell 20% since last quarter. Declining book values and a rough year of net losses in today's rising-rate environment put the stock at risk for a dividend cut in the near future.
Dividend cut risk 2: Annaly Capital Management
Annaly Capital also specializes in investing in agency-backed securities as well as non-qualifying mortgages (non-QM), which are loans not backed by a government agency. These loans are primarily high-credit individuals who may be purchasing a rental property or are in need of a jumbo loan.
Like AGNC Investment Corp, Annaly Capital Management is dealing with pressures from rising interest rates. Its net interest margin fell for the third consecutive quarter, down from 3.20% at the start of the year to 1.42% in Q3. Book value decreased 18% since the last quarter, and Annaly Capital reported a net loss for the third quarter of 2022.
Investors are concerned the company will be unable to maintain its dividend yield of 16.4% after its less-than-inspiring third-quarter earnings. Analysts recently cut their pricing target for the company, which pushed its share price 37.4% lower than last year. A net loss for a single quarter isn't enough to put its dividend at risk for an immediate cut, but if its net loss is sustained for the next few quarters -- a cut could be coming.
