14%+ Yielding AGNC Investment May Be Worth a Trade

Image: Mortgage REITs have performed horribly since we warned about them back in May 2013.

By Brian Nelson, CFA

Mortgage REITs (REM) are popular vehicles because of their deceptively enticing dividend yields, but we’ve never been bullish on the group. We’re reiterating our take today that these instruments are not for the individual investor or even prudent financial advisor and are more complicated vehicles than many investors believe.

In May 2013, we first starting warning about the group, and the performance, as shown in the image above, hasn’t been pretty. On a price-only basis, the iShares Mortgage Real Estate ETF is trailing the simpleton S&P 500 index by 250+ percentage points since we first laid out our thesis on the group years ago.

Not much has changed from an analytical perspective since 2013 either. Mortgage market dynamics remain inherently difficult to predict, many mortgage REITs have eye-popping leverage, and their book values tend to be more impacted by changes in ‘other comprehensive income’ (unrealized gains or losses that are marked to market) than net interest spread income. 

AGNC Investment Corp. (AGNC) hasn’t done that well either, with the stock on a price-only basis falling by more than half over the past 10 years. However, that measure doesn’t include the company’s dividend payments, and as of late, the firm has been able to show a consistent payout, something that hasn’t always been the case, with the firm experiencing dividend cuts in 2018 and 2020. AGNC Investment Corp. currently pays a $0.12 per share monthly dividend, and shares yield ~14.7% at the time of this writing.

 

Image: AGNC Investment has managed to level out its dividend payments following a few years of dividend cuts.

Management’s commentary in its press release was actually quite bullish and forms the basis for why shares may be worth a nice trade for high yield dividend income investors:

The fourth quarter of 2023 illustrated the importance of our active portfolio management strategy, as AGNC generated a very favorable 12.1% economic return despite significant intra-quarter volatility. Over the last two years, the Federal Reserve has engineered one of the most aggressive tightening campaigns ever experienced, increasing the Federal Funds rate by 5.25% while simultaneously reducing its balance sheet by $1.3 trillion. Despite this challenging fixed income environment, AGNC generated a positive economic return of 3.0% in 2023, produced a total stock return of 10.0%, and, importantly, provided shareholders with a stable and compelling monthly dividend.

As a levered Agency MBS investor, the two primary drivers of our performance are changes in Agency MBS spreads and interest rate volatility. Over the past two years, as the Federal Reserve aggressively tightened monetary policy, Agency MBS spreads widened by more than 100 basis points, and interest rates and interest rate volatility moved sharply higher. Today, we believe many of the factors that drove these adverse conditions are largely behind us. Historically attractive and stable Agency MBS spreads combined with declining interest rate volatility create a compelling investment environment for AGNC and form the basis for our positive investment outlook. 

We’ve never been fans of the mortgage REIT arena, but some stabilization in the marketplace is likely to be expected, allowing a window for investors to generate what could be a very nice dividend yield on an otherwise very risky, leveraged area. As of the end of last year, AGNC Investment Corp. ended the year with $8.70 in tangible net book value, which increased 7.7% from September. Though the stock trades at a slight premium to its tangible net book value at the time of this writing, management’s positive commentary indicates to us that tangible book value may be poised to rise nicely given a more sanguine backdrop. AGNC Investment Corp. is not for long-term investors, but with its 14%+ dividend yield, the stock could make for a very nice high yield dividend income trade, in our view.