Annaly Capital Management (NLY -0.70%) and AGNC Investment (AGNC -0.32%) are two of the highest-yielding dividend stocks in the market today. Paying a 17% and 15% dividend yield, respectively, investors can earn a yield nearly 10 times the average of the S&P 500.
AGNC Dividend Yield data by YCharts
While 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 Capital Management and AGNC Investment both invest in agency mortgage-backed securities (MBS), which are guaranteed by the government. If a borrower defaults, the company isn't on the line. Low-risk investments like these don't offer huge returns for mortgage REITs, with yields between 3% to 4%. This doesn't leave much room for the mREITs to pay such a hefty dividend yield.
In order to grow, companies rely heavily on short-term debt to leverage their assets for a greater return. Both mREITs use a variety of derivative investment strategies like interest swaps and Treasury futures to earn more. 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 greater.
But in today's rising interest rate environment, the short-term cost of borrowing is becoming 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 bypass economic pressures for short-term high dividend yields, Annaly Capital stands out as the better buy between the two.
Annaly Capital Management also invests in non-qualifying (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 coverage in the event of a borrower default.
Thankfully, Annaly's underlying credit profiles for these loans are top notch. In its latest third-quarter acquisition of non-QM loans through Onslow's loan portfolio, the average borrower put over 30% down 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 slightly.
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 values more than Annaly. AGNC's book value fell by 20.6% from the second quarter of 2022, while Annaly Capital Management's book value only fell by 15%.
Annaly Capital Management also earns money from servicing mortgages for other companies, earning around $174 million last year from servicing fees. Its mortgage servicing business has over doubled in the last 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 Investment's net interest spread rose slightly to 2.81%, while Annaly's dropped by over 1.3% to a net interest spread of 1.09%. But both companies are still operating at a net loss. Annaly was at a net loss per share of $0.70 in the third quarter, while AGNC was at a net loss of $1.31 per share -- 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.
