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By Joe Escalada

Investments with dividend yields exceeding 10% are precious and few. In today’s low yield environment, such stocks represent an opportunity to boost overall portfolio income.

There are several mortgage funds that are structured as REITs (Real Estate Investment Trusts) which offer such high dividends. Annaly Capital Management, Inc. (NYSE:NLY), Chimera Investment Corporation (NYSE:CIM), MFA Financial, Inc. (NYSE:MFA), and American Capital Agency Corp. (NASDAQ:AGNC) are popular choices in this category. These mortgage REITs employ leverage to invest multiple times in mortgage loans by borrowing against their mortgage holdings.

Frontier Communications Corporation (NASDAQ:FTR) offers high dividends and is a stock. FTR is a telecom company. Though telecom companies tend to offer attractive dividends, they are typically smaller than the dividends offered by mortgage REITs.

Are these large dividends sustainable? What are the risks of these securities? A quick look at relative valuation metrics and dividend payout ratios enables the comparison of these securities:

Ticker

P/E (ttm)

P/E (forward)

P/S (ttm)

P/B

Dividend Yield

Payout Ratio

NLY

6.31

6.76

7.23

1.02

14.1%

87%

CIM

5.27

6.2

4.92

0.89

17.1%

109%

AGNC

4.53

N/A

8.95

1.03

20.3%

78%

MFA

7.27

6.91

7.5

0.9

14.3%

91%

FTR

38.53

19.62

1.13

1.24

10.0%

469%

It is clear from a dividend payout ratio which far exceeds 100% that FTR will have to cut its dividend in the near future unless its earnings jump dramatically. CIM also will either cut its dividend or detract from earnings growth by paying dividends from its asset base. Since their dividends appear unsustainable, investors would need to find evidence to support these securities paying such high distributions into the future.

Though NLY, AGNC, and MFA are earning more income than they distribute, they are still subject to many forms of risk. Indeed, levered mortgage REITs can be dangerous. They lend long and borrow short, which means that increases in short-term rates can cause them to go bust. Moreover, deterioration in the mortgage market manifest in lower payments, delayed payments, or lower market values for the mortgage securities they hold can destroy a levered mortgage REIT. (Remember, since they are borrowing against their mortgage securities, they are exposed to price swings in the mortgage market.) This makes these instruments dangerous.

That being said, using a levered mortgage REIT to lower your total asset allocation in mortgage bonds is prudent. Investing 1% of your portfolio in NLY, CIM, AGNC, or MFA is arguably safer and higher yielding than investing 3% in mortgage bonds funds.

Moreover, investors should also note the tax consequences of REIT distributions, which do not qualify for lower long-term dividend tax rates. REIT holdings are best held in tax-advantaged retirement accounts, which would nullify this disadvantage.

Source: Can These 5 REITs Keep Paying 10% - 20% Dividends?