One of the highest-yielding sectors in the stock market is the real estate investment trust (REIT) sector, particularly those in the mortgage space. Over the past year, rising interest rates have crushed mortgage REIT stocks, pushing up dividend yields even higher. One of the biggest mortgage REITs is AGNC Investment (NASDAQ: AGNC). Why does it have such a high dividend yield? And is the dividend safe?
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Mortgage REITs are different
Mortgage REITs are quite different from the typical REIT, so it makes sense to provide a basic primer on what makes them different. Most REITs develop properties, such as office buildings, shopping malls, or apartments, and then lease out the units to individual tenants, collecting the rent that effectively becomes the REIT’s revenue. It is an easy-to-understand business model.
Mortgage REITs, however, don’t buy properties; they buy property debt. In other words, they purchase mortgages. Mortgage REITs borrow a lot of money to buy mortgage-backed securities and pay out the earnings in dividends. They are much closer to banks or hedge funds in how they operate than they are to a typical REIT.
AGNC Investment invests almost exclusively in agency (hence the ticker symbol) mortgage-backed securities, which are guaranteed by the U.S. government. If the borrower fails to make its monthly payment, the government will ensure AGNC Investment still gets the principal and interest payment it is owed.
In other words, agency mortgage-backed securities don’t have the credit risk typical with loans. But they do have interest rate risk — and a lot of it. As we saw with SVB Financial‘s Silicon Valley Bank, even mortgage-backed securities guaranteed by the U.S. government can cause major losses if the risk from fluctuating interest rates isn’t properly managed.
AGNC Investment is not like Silicon Valley Bank
The mortgage REITs did manage their interest rate risk reasonably well in 2022; however, the Fed’s tightening regime was so dramatic over such a short time frame that they still lost money. AGNC Investment saw its book value per share decline from $16.76 per share at the end of 2021 to $10.76 per share at the end of 2022. Despite declining book value per share, AGNC Investment continued to pay its monthly $0.12 per share dividend.
The Fed appears to be close to completing its cycle of hiking the federal funds rate, and that should return some stability to the mortgage-backed securities market. Mortgage-backed securities react negatively to interest rate volatility, and rates were volatile last year. A pause in the rate hikes should cause mortgage-backed securities to outperform in 2023 once the Fed is out of the way.
AGNC Investment’s dividend yield is toward the high end of its historical range
Over the past year, just about every mortgage REIT has cut its dividend, except for AGNC Investment. At current levels, AGNC Investment has a dividend yield of 14.4%. Since 2018, it has mainly traded with a dividend yield between 10% and 15%, with some exceptions.
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AGNC Investment did cut its dividend in 2018 and again in 2020, but since then has maintained its level. If mortgage-backed securities outperform Treasuries going forward, the dividend is probably safe. But if mortgage-backed securities continue to underperform, then all bets are off. Ultimately, mortgage-backed securities are guaranteed by the government, so they can be considered “good money.” These securities have nothing in common with the subprime securities that were so present from 2006 to 2008 and led to the Great Recession.
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AGNC Investment hedges the interest rate risk on its portfolio, so the chance of a Silicon Valley Bank-like situation is pretty remote. The stock is trading at a discount to book value per share, and mortgage REITs rarely stray too far from book value. Overall, AGNC Investment’s risk/reward ratio is on the favorable side, but investors may want to wait for confirmation from the Fed that they are done hiking rates.
