Fed Chair Kevin Warsh Warned a Rate Hike Could Be Coming. Some Dividend Stocks Would Get Hurt -- Others Could Actually Win.

Fed Chair Kevin Warsh recently rattled investors. His comments at Jackson Hole on Aug. 28 caused the odds of a rate hike to rise. If you've owned high-yielding dividend stocks for any length of time, you're probably getting a little bit nervous because rate hikes tend to negatively impact these investments.

While higher rates are more challenging for some high-yielding dividend stocks, others stand to benefit. Here's a look at the potential losers and winners if the Fed hikes rates.

Image source: Official Federal Reserve Photo.

Higher probability of higher rates

Warsh didn't sugarcoat things at the Jackson Hole meeting at the end of August. While he acknowledged that the inflation rate has slowed a bit, the underlying trends haven't improved enough. If they don't start getting meaningfully better, the Fed will need to act.

The market immediately reacted to these comments. Traders of fed fund futures priced in a 60.4% probability that the Fed will deliver a 25-basis-point hike on Sept. 16. That's up from 56% before Warsh's comments. Some Fed watchers are already assuming two rate hikes this year, with Deutsche Bank expecting quarter-point raises at both the September and December meetings.

Higher rates are bad news for most high-yield dividend stocks

High-yield dividend stocks tend to fall at the hint of higher rates. That's because interest rate increases have two real impacts on these investments. Many higher-yielding companies are heavily reliant on debt. Higher rates make it more expensive to borrow money to fund expansion investments (acquisitions and capital projects) and to refinance existing debt as it matures. Additionally, rising interest rates make lower-risk fixed-income investments like bank CDs and government bonds more attractive to income-seeking investors. As a result, the share prices of high-yielding stocks tend to fall, causing their dividend yields to rise to compensate investors for their higher risk profiles.

Real estate investment trusts (REITs) are among the most rate-sensitive investments. REITs borrow heavily to fund acquisitions and development projects, which helps grow their funds from operations and dividends. Higher rates could stunt their growth, making it harder for them to increase their dividends.

Meanwhile, mortgage REITs like AGNC Investment (NASDAQ:AGNC) are among the most rate-sensitive REITs. AGNC invests in Agency MBS, pools of residential mortgages that are protected against credit losses by government agencies. It uses leverage to boost the returns of these low-risk, fixed-income investments. As a result, its borrowing costs would rise if interest rates increased, narrowing the spread between its costs and income. That could put its 13.5%-yielding monthly dividend at risk.

The energy sector is another place that tends to be highly rate-sensitive. Utilities and pipeline companies operate capital-intensive businesses that require heavy borrowing. Meanwhile, they tend to have higher-yielding dividends, making them susceptible to competition from bonds when rates rise.

Potential winners if rates rise

Not all high-yielding dividend stocks would lose if rates rose. Some business development companies (BDCs) and REITs invest in floating-rate loans. As a result, the interest they earn on these loans would rise if rates increased.

For example, leading BDC Ares Capital (NASDAQ:ARCC) has 71% of its $29.3 billion investment portfolio in floating-rate debt. As a result, the already high yields it earns on its direct loans (10.3% weighted-average yield) would increase as rates rise. While Ares does carry some floating-rate debt on its balance sheet, its ability to capture higher rates on its floating-rate debt investments will help cushion the impact.

Meanwhile, not all mortgage REITs are at risk. Commercial lender Starwood Property Trust (NYSE:STWD) has a predominantly floating-rate loan portfolio. Its commercial lending portfolio (53% of its assets) consists of 97% floating-rate loans. Meanwhile, its infrastructure lending portfolio (9%) is 96% floating rate. Starwood constructed its portfolio to outperform in both higher- and lower-interest rate environments.

Rate hikes aren't all bad news for dividend investors

It's not yet confirmed whether the Fed will hike interest rates this year. However, that doesn't mean worries about a potential rate hike won't weigh on the share prices of higher-yielding dividend stocks. That decline could be a buying opportunity for investors, especially for names like Ares Capital and Starwood, as they could benefit if the Fed hikes rates, given their emphasis on investing in floating-rate debt.

Matt DiLallo has positions in Ares Capital and Starwood Property Trust. The Motley Fool has positions in and recommends Ares Capital and Starwood Property Trust. The Motley Fool has a disclosure policy.