This reverse stock splitter yields 27% – and its shares are rising

Markets were higher at the start of the day on Tuesday, but quickly gave up those gains. Ongoing concerns about the economic situation continued to weigh on investor sentiment. At 11:45 a.m. ET, the Dow Jones Industrial Average (^ DJI -1.37%) was down 157 points to 31,282. S&P500 (^GSPC -1.83%) fell 33 points to 3,867, while the Nasdaq Compound (^IXIC -2.66%) gave up 179 points at 11,345.

Investors see stock splits as a positive, but reverse stock splits are often seen as indicating the opposite. Companies that use reverse stock splits to keep their stock prices above regulatory minimums are often in deep trouble. However, in the case of Invesco Mortgage Capital (IVR 6.15%), investors on Tuesday seemed pleased with how the company’s fundamentals managed to hold up even after it had to do a reverse split, sending stock prices up almost 8%. They are also very happy with the income they are getting from its current dividend yield of 27%.

Why is Invesco Mortgage Capital such a big dividend payer?

Invesco Mortgage Capital is a real estate investment trust (REIT) specializing in investing in mortgage-backed securities. In particular, Invesco has traditionally followed a leveraged approach, which involves borrowing large sums of money and then reinvesting that money in the mortgage-backed bond market. When Invesco can borrow for less than the returns it earns on those bonds, the differences accrue to it in terms of profits. As a REIT, Invesco then pays most of its income to shareholders in order to take advantage of the tax advantages that this type of investment offers. Over the past six quarters, this has translated into a stable dividend payout that equates to $0.90 per current share each quarter.

The problem with mortgage REITs, however, is that they are particularly sensitive to adverse bond market conditions. For years, the Federal Reserve has backed mortgage-backed bonds by buying them as part of its quantitative easing policy. The central bank has backtracked and is now tightening by choosing not to let its balance sheet swell any further. This put pressure on interest rates in general and the mortgage market in particular.

These conditions worsened in the first quarter of 2022. Invesco lost more than half a billion dollars during the period, and the book value per common share plunged 28.5% in the first three months of the year, then fell further by 12% to 15% in April.

Why Invesco Mortgage Capital did a reverse stock split

When Invesco announced its latest financial results, it also said it would conduct a 1-for-10 stock split. This took effect on June 6, when the stock price rose almost tenfold. This prevented the company from having to deal with the potential consequences of its share price falling below $1, which could have triggered delisting proceedings on the New York Stock Exchange.

Today’s most recent news confirmed that Invesco will maintain its dividend at $0.90 per share after the split for the quarter. However, the book value has continued to fall, with Invesco estimating a drop of around 8% to 11% since the end of April. On a book value basis, the distribution yield for the mortgage REIT is a whopping 22%. And with the stock price currently below book value, the actual dividend yield is currently closer to 27%.

Is Invesco Mortgage Capital a good dividend investment?

Invesco has reduced its level of leverage to protect against possible further weakness in the mortgage-backed bond market. However, the Mortgage REIT still maintains leverage ratios around 4.1.

Moreover, the Fed’s quantitative tightening has only just begun. Adverse conditions could continue well into the future, with further losses likely to surface.

Extremely high dividend yields often signal the possibility of lower stock prices, as well as future dividend cuts. That would be a blow for investors, and while investors seem optimistic about Invesco’s outlook today, it’s unclear how long the mortgage REIT can maintain its current dividend.

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