Surging interest rates have made the last few years very challenging for the real estate sector. They've increased borrowing costs while causing a lot of volatility in asset values.
AGNC Investments(NASDAQ: AGNC) hasn't been immune to these issues. While the mortgage real estate investment trust (REIT) invests in low-risk, mortgage-backed securities (MBS) guaranteed against credit-default risk by government agencies, it has battled volatility in interest rates and MBS spreads. That has weighed on its returns. However, it believes those headwinds are about to fade, which bodes well for its ability to maintain its 15.1%-yielding monthly dividend.
Ending on a positive note
AGNC Investments finished strongly in 2023. The REIT recorded $1 per share of comprehensive income during the fourth quarter. That was a notable improvement from the third quarter when it posted a $1.02 per-share comprehensive loss. The company generated $0.30 per share in comprehensive income for the full year.
The REIT also reported a solid 12.1% economic return on its tangible common equity in the final period, consisting of $0.36 per share in dividends and a $0.62 per-share increase in the tangible net book value of its shares. That enabled it to end the year by generating a 3% economic return as dividends ($1.44 per share) offset a $1.14 per-share decrease in its tangible net book value per share.
Those dividends enabled the REIT to deliver a 10% total return for its investors last year. While that underperformed the S&P 500, it was better than the REIT sector average (and AGNC's performance in recent years).
A rather rosy outlook
AGNC Investments has battled two notable headwinds over the past couple of years. CEO Peter Federico remarked in the Q4 earnings release: "As a levered Agency MBS investor, the two primary drivers of our performance are changes in Agency MBS spreads and interest rate volatility." He pointed out that
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.
Meanwhile, "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."
These factors made it very challenging for the company to invest. Its borrowing costs rose while the spread it could earn between its cost of capital and yields on MBS investments varied significantly.
However, the Federal Reserve has signaled that it plans to cut interest rates three times this year. That's driving a more optimistic outlook. Federico stated:
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.
This stabilization should help reduce the volatility in the company's earnings in the coming quarters. Because of that, it should be much easier to maintain its current dividend rate.
However, as the CEO warned on its Q3 conference call, "We continuously evaluate our dividend as market conditions, expected returns, and risk management considerations are always changing." If market conditions were to deteriorate unexpectedly due to volatility in the credit markets, the REIT might need to reduce its payout (which it has done several times in the past). Because of that, while the dividend looks safe for now, it's not the most bankable payout.
A higher-risk, high-yielding payout
AGNC Investments has maintained its big-time dividend during a very challenging period. With its headwinds now appearing to fade, its payout seems much safer. However, it's still a riskier dividend stock, which income investors must be comfortable with before adding it to their portfolio.
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Matthew DiLallo 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.
