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This Reverse Stock-Splitter Is Yielding 27% — And Its Shares Are Rising

Markets were higher early in the day on Tuesday, but they gave up those gains quickly. Ongoing concerns about the economic situation continued to weigh on investor sentiment. As of 11:45 a.m. ET, the Dow Jones Industrial Average (DJINDICES: ^DJI) was down 157 points to 31,282. The S&P 500 (SNPINDEX: ^GSPC) fell 33 points to 3,867, while the Nasdaq Composite (NASDAQINDEX: ^IXIC) gave up 179 points to 11,345.

Investors see stock splits as a positive, but reverse stock splits are often seen as indicating the opposite. Companies that resort to reverse stock splits in order to keep their share prices above regulatory minimums are often in considerable trouble. However, in the case of Invesco Mortgage Capital (NYSE: IVR), investors on Tuesday seemed to be pleased at how well the company's fundamentals have managed to hold up even after needing to do a reverse split, boosting share prices up nearly 8%. They're also quite happy at the income they're 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) that specializes in investing in mortgage-backed securities. In particular, Invesco has traditionally followed a leveraged approach, which involves borrowing considerable amounts of money and then reinvesting that money back into the mortgage-backed bond market. When Invesco can borrow more cheaply than the yields it earns on those bonds, the differences come back to it in profit. As a REIT, Invesco then pays out the bulk of its income to shareholders in order to reap the tax advantages that this type of investment offers. For the past six quarters, that has resulted in a stable dividend payment that works out to $0.90 per current share each quarter.

The problem with mortgage REITs, though, is that they're especially susceptible to adverse conditions in the bond market. For years, the Federal Reserve supported mortgage-backed bonds by buying them as part of its quantitative easing policy. The central bank has reversed course and is now tightening by choosing not to let its balance sheet run up any further. That has put pressure on interest rates generally and on the mortgage market in particular.

Those conditions reared up in the first quarter of 2022. Invesco lost more than half a billion dollars during the period, and book value per common share plunged 28.5% in the first three months of the year, and then were down another 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 execute a 1-for-10 reverse stock split. That took effect on June 6, at which point the stock price essentially jumped tenfold. That prevented the company from having to deal with the potential ramifications of having its share price fall below the $1 mark, which could have triggered delisting procedures on the New York Stock Exchange.

The most recent news from today verified that Invesco would keep its dividend at $0.90 per post-split share for the quarter. However, book value continued to fall, with Invesco estimating a decline of roughly 8% to 11% since the end of April. Based on book value, the distribution yield for the mortgage REIT is a whopping 22%. And with the share price currently below the book value, the actual dividend yield is closer to 27% currently.

Is Invesco Mortgage Capital a good dividend investment?

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

Moreover, the Fed's quantitative tightening has only just begun. Adverse conditions could continue well into the future, with further losses potentially surfacing.

Extremely high dividend yields often signal the potential for falling share prices, as well as future dividend cuts. That would be a tough one-two punch for investors to take, and even though investors seem optimistic about Invesco's prospects today, it's uncertain how long the mortgage REIT will be able to sustain its current dividend.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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