The Fed’s confused signals have sent the stock prices of many mortgage REITs plunging down. As a result, their dividend yields have increased significantly. Western Asset Mortgage Capital Corp (NYSE:WMC) is currently offering a dividend yield of 20.6%. Yes, this is extremely attractive for retail investors who are looking to enhance their regular incomes. However, before individual investors invest, they should look at the sustainability of the dividend rate.
The business model
Western Asset Mortgage Capital Corp (NYSE:WMC) is a mortgage real estate trust that invests in residential mortgage backed securities for which the government guarantees principal and interest payments (Agency MBS). It also has investments in residential non-Agency MBS (with no government backing), commercial mortgage backed securities (CMBS) and asset backed securities (ABS). This wide variety of assets in the company’s investment portfolio gives the company some diversification, particularly in the current challenging times. Let’s see how.
Sustainability of shareholder distributions
Western Asset Mortgage Capital Corp (NYSE:WMC) is currently yielding in excess of 20.6% on its quarterly dividend rate of $0.95 per share. While the 10-year Treasuries are offering only 2.08%, Western Asset Mortgage Capital Corp (NYSE:WMC)’s dividend yield becomes extremely lucrative for income investors. Therefore, it’s important to look at whether the company will be able to maintain its quarterly dividend rate in the future or not.
The most recent quarter’s cash dividend coverage reveals that the company can maintain its current dividend rate. The company generated $52.2 million in cash from its operations while it paid $27 million in quarterly dividends. Therefore, its cash dividend coverage ratio for the first quarter of the current year comes out to be 1.93 times. However, past is not an ideal indicator for the future.
By regulation, mREITs are required to pay 90% of their REIT taxable income. However, the taxable income is largely depended on the change in the interest rates. Net interest income is a key component of the REIT taxable income, and Western Asset Mortgage Capital Corp (NYSE:WMC) provides its interest rate sensitivity in its latest SEC filings. The company reports that if rates go up 50 bps, you should expect Western Asset to report a 2.2% hike in the coming quarter’s net interest income. Given the macroeconomic situation, a further hike in rates is expected, and Western has constructed its investment portfolio to benefit from this anticipated hike. Therefore, it’s fair to assume that more earnings will at least result in the continuation of the dividends.
For American Capital Agency Corp. (NASDAQ:AGNC), the situation is different. While the stock is yielding 19.6% on its quarterly dividend rate of $1.25 per share, its future dividends are in danger, and a dividend cut cannot be ruled out. It’s full year 2012 cash dividend coverage ratio comes out to be only 1.2 times. Further, the company estimates a 5% decline in its net interest income of the coming quarter if interest rates climb 50 bps. Keep in mind the Agency MBS spread has already widened 18 bps. Therefore, it is evident that American Capital Agency’s dividends are in danger.
The sustainability of a 20% dividend yield seems unintuitive in isolation. However, the aforementioned analysis reveals that Western Asset Mortgage’s dividend rate is sustainable, given the prevailing macroeconomic situation. Similarly, it is highly likely that Annaly Capital Management, Inc. (NYSE:NLY) will be able to maintain its current dividend rate.
The article Sustainable Dividends From This 20.6% Yielding mREIT originally appeared on Fool.com and is written by Adnan Khan.
Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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