Best Buy: Annaly Capital Management vs. AGNC Investment
Income investors should keep Mortgage Real Estate Investment Trusts (REITs) on their watch lists. These low-profile companies currently offer some of the best dividend yields. Earlier this year, the sector was hit by margin calls as bond markets faltered in response to the early days of the COVID-19 crisis. While some sector stocks had what can only be called near death experiences, the agency’s SCPIs resisted better than the others.
The two largest agency real estate investment firms are Annaly Capital and AGNC investment. Which one is the best choice for investors? We will take a look.
Mortgage REITs are a different animal than the typical REIT
For those unfamiliar with mortgage REITs, they have a different business model than traditional REITs, which invest in physical real estate and charge rents (such as apartment REITs, office REITs and Retail REIT). The profits of traditional REITs are determined by the difference between the cost of financing and the rents received, after expenses. This has been a difficult year for most REITs as many of their tenants have struggled. Shopping center REITs were probably the hardest hit.
Mortgage REITs do not own property and do not charge rent. Their business model is to invest in real estate debt securities and their income is determined by the difference between the interest they earn on their assets and the interest they pay on financing those assets. AGNC and Annaly are referred to as Agency Mortgage REITs because they invest primarily in “Agency Mortgage Backed Securities,” which are pools of mortgages guaranteed by the US government. Chances are, your mortgage (if you have one) will end up in an agency mortgage-backed title like the ones these companies hold.
Mortgage REITs that take no credit risk can still be risky
Since agency mortgages are guaranteed by the government, the holders do not bear any credit risk. If the borrower stops paying, the government will ensure that the investor receives the interest and principal due. This means that the interest rates on these assets are generally low, so companies have to borrow a lot of money to earn a return. This does not mean that agency REITs are immune to financial stress. Earlier this year, the entire mortgage REIT industry was rocked by volatility in the bond market and forced to sell assets in a declining market to meet margin calls. They all reported decreases in book value and reduced their dividends. It is therefore important to keep in mind that “no credit risk” does not mean “no risk”.
Both companies are trading at similar valuations
Since Annaly and AGNC have very similar business models, their most important stats are quite similar. Annaly has a higher dividend yield and a lower discount to book value. The net interest margin (the difference between what a company earns on its investment portfolio minus the interest it pays on its debt) is in the low range of 2%. Annaly and AGNC both have low credit exposure, but it is low as a percentage of the investment portfolio. AGNC has a lower yield, but it has a larger discount to book value. Annaly has a little less leverage and a slightly lower net interest margin. Annaly also has a little more exposure to credit, which means that she holds assets that are not guaranteed by the government.
|Dividend yield||Discount to
|Annaly Capital (NYSE: NLY)||11%||8.4%||2.10%||5.3|
|AGNC investment (NASDAQ: AGNC)||9.5%||9.4%||2.15%||5.8|
Investors really can’t go wrong with either stock. Both are well-run companies with respected leadership. While the two have been rocked by the early days of COVID-19, they have retained the best in the business.
Both companies cut their dividends this year, although Annaly only cut its dividend by 12%, while AGNC cut its payout by 25%. AGNC said on its call for second quarter results that the dividend cut ended up being unnecessary. Since the two are trading with similar numbers, it’s really hard to say that one is a better buy than the other.
Annaly has a bit more credit risk and a dividend yield, so he probably gets the green light, although I don’t rule out a dividend increase by AGNC. Maybe Annaly’s higher performance gives her the edge, but he’s close.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.