Nothing is more exciting, or more terrifying, than a dividend yield exceeding 10%. It’s exciting because we all get visions of greenbacks filling our brokerage accounts every quarter. It’s terrifying because big dividends always make me wonder if the payout is sustainable.
I found three stocks yielding about 20% and wanted to see if they were safe dividends, and whether or not the stocks were in danger of cratering and erasing any dividend gains. It turns they’re all in the same sector — mortgage REITs, or MREITs. This means they invest in mortgage-backed securities. If you’re already getting queasy, that’s understandable. These securities contributed mightily to the financial crisis when they became toxic.
But before you run for cover, understand that there are many different MREITs, and investing in them can be quite lucrative. There are agency MREITs, which hold mortgages issued or backed by the infamous Fannie Mae and Freddie Mac. These quasi-government agencies are still in business and still guarantee millions of home mortgages. That guarantee means default risk on this type of mortgage is essentially nonexistent, and because of that lower risk, you see lower yields. Non-agency MREITs are not agency backed or issued. There are also hybrid MREITs, which have a combination of agency and non-agency mortgage assets.
Leverage is the key factor for MREITs. Agency MREITs can use more leverage since their default risk is lower. MREITs make money on the spread — the difference between the short-term interest rates they pay to borrow money and the long-term interest rates on the mortgages they hold in their portfolio. So, these investments depend a lot on the interest rate environment. For now, the Fed has indicated that interest rates aren’t going anywhere. However, with all the money the federal government has been printing, one wonders how much longer that will remain the case.
Invesco Mortgage Capital (NYSE:IVR) pays a 21.6% dividend, or $3.20 per year. This non-agency MREIT isn’t doing very well. In this environment, I would stay completely away from non-agency mortgages. Millions of homeowners are underwater on their loan, and you don’t want exposure to these if they aren’t guaranteed. Maybe that’s why the stock is trading at only 70% of its book value. Investors aren’t placing much faith in the securities the company holds or they’d bid the price up to closer to book value. The stock is down 30% year-to-date, which makes that dividend of small consolation. Stay away.
American Capital Agency (NASDAQ:AGNC) is paying a hefty 20.1%. This is an agency MREIT, so the mortgages are guaranteed. With a history of regular dividends, and the fact that it went public right in the middle of the financial crisis, I have a degree of confidence in this play. The stock is holding up rather well, only down 6% YTD. It’s worthy of more research and a buy consideration.
Chimera Investment (NYSE:CIM) is also a hybrid MREIT paying 20%. Here’s a great reason why you want to look at an MREITs cash position. Chimera has only $16 million of cash vs. $6.5 billion in debt. Earnings are declining, and unless we see the employment situation reverse, mortgages aren’t a great place to be. And since this is a hybrid MREIT, with some nonguaranteed mortgages, you want to avoid it.
Lawrence Meyers does not have a position in any securities mentioned.
