Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / What a Mortgage Lender's Dividend Cut Teaches Us
Transcript
- Lucas: A regional mortgage lender just cut its dividend for the first time in twenty years. And the wild part is, the yield didn't look dangerous at all. Luna: Twenty years is a long streak. What broke it? Lucas: Well, the first thing I noticed is that the stock was yielding around three and a half percent before the cut. That's not the kind of yield that screams trouble, like a ten or twelve percent yield. But the payout ratio was the real tell. If you looked at trailing earnings, it was covering the dividend comfortably. But if you looked at free cash flow, it was a different story. Luna: So the classic free cash flow coverage issue we talked about in episode 131. It's showing up again. Lucas: Exactly. And honestly, that's part of why I wanted to do a special episode today, to dig into this specific case. If our money conversations have helped you think about a decision differently, or even just helped you avoid a bad one, you know the show is ad-free and that's because of listener support. If today's episode was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. Luna: Yeah, and every little bit keeps the lights on here. But back to the lender. Lucas: Right. So this lender, they made most of their money originating mortgages. And when rates were low, refinancing volume was huge, they were printing money. But now, with the ten-year Treasury up at four point six nine percent as of this week, refinancing has just collapsed. And originations have dropped by a third year-over-year. Luna: So their core business is shrinking. But you said the dividend looked safe on earnings. How did they manage that? Lucas: They had a big one-time gain from selling a loan portfolio last year. That boosted earnings, and the board used it to justify the dividend. But that gain wasn't recurring. So the trailing earnings number was flattered. The market saw through it eventually, but the yield still didn't look extreme. Luna: So the red flag was the quality of earnings, not the yield. What other clues were there? Lucas: Well, the other big one was that they were dipping into their cash pile to pay the dividend. Their cash on hand fell by about forty percent over the last two quarters. When a company starts shrinking its cash to maintain the payout, that's a warning sign. Luna: And I've seen that in other sectors too. It's not just mortgage lenders. Realty Income had to cut its guidance last month because of rising interest rates, and their payout ratio is starting to creep up. Lucas: Right, Realty Income's yield is now around five percent, which is high for them. But that's a different situation because their cash flows are more stable from long-term leases. Still, the principle holds: you have to check whether the cash flow actually supports the dividend, not just the earnings. Luna: So what's the practical takeaway for us? How do we spot a dividend cut before it happens? Lucas: I think there are three specific things to look for. First, check the free cash flow payout ratio, not just the earnings payout ratio. If a company is paying out more than ninety percent of its free cash flow, that's a red flag. Second, look for one-time gains that boost earnings. If the dividend is only sustainable because of a non-recurring item, that's a problem. And third, watch the cash balance. If it's declining over several quarters, the company might be borrowing or using cash to maintain the dividend. Luna: That's a good framework. And I think the fourth one is to check the industry's macro environment. For mortgage lenders, refinancing volume is the key driver. For a company like Verizon, it's about subscriber growth and competition. Lucas: Exactly. And that's why you have to understand the business model. Verizon's dividend looks safe because their free cash flow is strong and they're investing in fiber, but the wireless market is saturated. If they start losing subscribers, that could change. Luna: So for someone listening, what's the one thing they should do this week? Lucas: I'd say, pull up your highest-yielding stock, and calculate the free cash flow payout ratio. You can usually find free cash flow in the cash flow statement. If that number is above ninety percent, you should be asking questions. And if the yield is above six percent, the market is already telling you something. Luna: That's a solid homework assignment. And I think it's worth noting that this week, dividend ETFs like VYM and SCHD are up a bit, but they're not immune to these kinds of cuts. Lucas: Right, and that's the thing. Dividend investing is not set-and-forget. You have to monitor the health of the companies behind the dividends. This lender's cut is a reminder that even a twenty-year streak can end if the business fundamentals deteriorate. Luna: So, twenty-year streak, but not a forever streak. What's the biggest lesson for us? Lucas: I think it's that dividend history is not a guarantee. It's a reflection of the past, not the future. The dividend aristocrats like Coca-Cola and Johnson & Johnson have long streaks, but they've also adapted their businesses over time. The mortgage lender didn't adapt to a higher rate environment. Luna: And that's the key: adaptation. Dividend investing rewards companies that can evolve. Those that don't, eventually trip up. Lucas: Exactly. And the good news is, it's not hard to spot the warning signs if you know what to look for. This case gives us a clear playbook for the future. Luna: Well, Lucas, I think this is one of those episodes that's going to save someone from a painful loss. Thanks for breaking it down. Lucas: Absolutely, Luna. And before we go, I want to leave listeners with this thought: the next time you see a dividend yield that looks too good to be true, dig into the cash flow. The answer is usually there. Luna: Well said. Until next time, keep your dividends growing, but keep your eyes open.