When the average yield of stocks in the S&P 500 index is 1.2%, it's easy to see why high-paying dividend stocks like Annaly Capital Management (NYSE: NLY) and AGNC Investment Corp (NASDAQ: AGNC) can look so appealing.
These mortgage real estate investment trusts (mREITs) pay a 14% and a 13.5% yield, respectively, which is over 10 times more than the S&P 500 right now. But don't let these high yields fool you. I believe these high-paying dividend stocks simply aren't worth the risk. Here's why.
They have massive exposure to macroeconomic pressures
Mortgage REITs don't own and collect income from a rental property like traditional REITs. Rather, they make their money from collecting interest on residential loans, commercial mortgages, or through mortgage servicing rights (MSRs). Many mREITs originate loans, but they can also invest in mortgage-backed securities (MBS). These are loans originated by other entities that are securitized and then sold to investors like Annaly Capital Management and AGNC Investment Corp.
These mREITs use heavy amounts of debt to buy large pools of government-sponsored (agency) mortgage securities, making a spread between its cost of borrowing and the interest collected on the loans over time, called net-interest margin. Agency loans have low credit risk since the government will front the bill if a borrower stops paying. But these loans have significant interest-rate risk.
Rising interest rates not only increase mREITs' cost of borrowing, narrowing its net-interest spread and profit margins, but also impacts demand for MBS on the secondary market. As bond yields and interest rates have climbed over the last year, value and demand for MBS assets have fallen notably. In turn, AGNC and Annaly's net book value per share is down 38% and 35% over the last year.
Interest rate-risk exposure isn't over. The Fed may hold back on near-term interest rate spikes after the Silicon Valley Bank collapse, but if inflation continues to run rampant, more interest rate increases will be coming.
They haven't made investors money historically
AGNC Investment Corp and Annaly Capital Management have been losing stocks over the last one-, five-, and 10-year periods. Over the last decade, they've provided a negative 1% and 2% total return for investors.
NLY Total Return Level data by YCharts.
They've also cut their dividends by 90% and 64%, respectively. The only reason the companies have been able to sustain dividend yields in the double digits for the past several years is that their share prices have consistently decreased, which pushes their yield up.
I personally don't recommend buying shares in either of these companies, but if you're dead set on buying one of these high-yield dividend stocks, Annaly would definitely be the better buy of the two. The company reported stronger earnings in the fourth quarter of 2022 with positive earnings per share vs a net loss per share for AGNC Investment Corp. It also improved its economic-leverage ratio substantially, which reduces its debt and credit-risk exposure.
But its risks are far from over. The cost of capital is still high, and demand for MBS amid the Silicon Valley Banking crisis is still quite shaky. I personally prefer stocks that pay high-dividend yields in the 3% to 6% range but can be sustained over the long term and have a history of delivering positive returns. Thankfully, there are plenty of REITs that meet both of these criteria and have far less risk exposure for my portfolio.
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Liz Brumer-Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.