I am often asked about the two largest residential finance real estate investment trusts (REITs). The two REITs carry yields of 12% to 13%, which would interest any income-focused investors.
Annaly Capital Management (NLY) has a market cap of $15 billion, and currently yields 12.6%.
AGNC Investment Corp (AGNC) yields 13.8% and has a market cap of $11 billion.
Both REITs employ a similar business model. They own portfolios of agency mortgage-backed securities (MBS). The companies use significant amounts of leverage to turn 4% MBS yields into a 13% dividend yield.
Agency MBSes are created by Fannie Mae, Freddie Mac, and Ginnie Mae. The agencies pool the mortgages they guarantee, turning them into bond-like securities. Agency MBSes have an implied U.S. government guarantee.
AGNC and NLY own large portfolios of agency MBSes, mainly purchased with borrowed money. Let’s look at some details of their financial schemes.
AGNC (data as of the 2025 third quarter):
- Portfolio assets: $90.8 billion
- Average asset yield: 4.95%
- Average reop cost: 4.43%
- Average cost of funds: 3.17%
- Leverage: 7.6 times
Annaly Capital:
- Portfolio assets: $97.8 billion
- Average asset yield: 5.40%
- Average cost of liabilities: 4.73%
- Net interest margin: 0.97%
- Leverage: 7.1 times.
The NLY numbers give us a picture of how these companies make money. Seven times leverage multiplied by the 1% net interest margin yields a 7% net return on the leveraged assets. The company’s $15 billion of equity earns the full 5.4% asset yield. Add them up, and you get pretty close to the 12.6% dividend yield for NLY.
Both companies have other business lines to generate income. Annaly has a $6.9 billion residential credit business investing in non-agency MBS and a $3.5 billion mortgage servicing rights business.
For the third quarter, AGNC generated about half of its income from net spread and dollar roll income.
Grok gives this description of dollar roll income:
A dollar roll is a transaction where an investor sells a TBA MBS for settlement in the current (front) month and simultaneously agrees to buy a substantially similar TBA MBS for settlement in a future (back) month. This is similar to a repurchase agreement (repo) but allows for delivery of similar, not identical, securities.
The key price difference is called the “drop”: the front-month TBA typically trades at a higher price than the back-month TBA. This drop reflects the expected net interest income (coupon payments minus principal paydowns) that the buyer of the roll (financier) retains during the roll period.
Economically, it represents the equivalent of net interest income (carry) on the underlying MBS minus an implied financing cost. Investors (like mortgage REITs) use dollar rolls as an alternative to holding and financing actual MBS via repos, especially when the roll offers better economics.
The significant risk for agency MBS REITs like NLY and AGNC is a rapid change in interest rates. It doesn’t take much change in either short- or long-term interest rates to squeeze the net margin on those highly leveraged assets.
The current interest rate environment is very good for the business operations of these two REITs. It shows in the share prices: AGNC is up 14% year to date, and NLY is up 23%.
My problem with this type of REIT is that I know the high levels of leverage can bite earnings hard if there is a sudden, unexpected change in interest rates. Over time, interest rate shocks will lead to lower dividends. A decade ago, NLY was paying $1.20 per share in quarterly dividends. The current dividend is $0.70 per share. Over that period, the AGNC dividend dropped from $0.22 per share to $0.12 per share.
Because of the leverage’s dangers, I have never recommended either of these REITs in my high-yield investing newsletters.
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