The market dislocations from the early days of the COVID crisis are largely in the rearview mirror, and the mortgage real estate investment trusts (mREITs) have mostly adjusted to the situation. With interest rates so low, income can be hard to obtain, and it's creating situations where mREIT companies are often generating double-digit dividend yields. Why that's happening and what it really means are worth understanding.
The most conservative of these mREIT stocks, AGNC Investment (NASDAQ:AGNC), just reported that it has nearly put the crisis behind it. Does that mean a dividend hike could be in its near future?
"Nearly reversed" the economic losses from COVID-19
AGNC Investment reported earnings of $1.28 per share for the third quarter ending Sept. 30. This is a decrease from the second quarter, where the company earned $1.60 per share. In the press release, CEO Gary Kain offered further insight on this particular metric, saying that AGNC had "nearly reversed" the economic loss in the first quarter stemming from the market dislocations associated with COVID-19.
Tangible book value per share rose 6.4% to $15.88 per share. On the earnings conference call, Chief Financial Officer Bernie Bell estimated that book value per share had increased by about 2% since the end of the quarter. Leverage fell from 9.2 times tangible book to 8.8 times during the quarter, largely due to asset price appreciation.
AGNC's investment portfolio remained mainly agency mortgage-backed securities, which are guaranteed by the U.S. government. The overall agency book fell in size from $75 billion to $67 billion, while repurchase agreements, which are the main source of leverage, fell from $70 billion to $55 billion. AGNC sold many of its higher coupon mortgage-backed securities and purchased lower coupon bonds as a way to protect against prepayment risk. Prepayment risk represents the possibility that mortgage-backed securities get paid back early (due to the underlying mortgage holders refinancing their mortgages).
Credit risk remained limited, with only small holdings (about $1 billion) of credit risk transfer securities and non-government guaranteed mortgage-backed securities.
The question of the dividend
AGNC Investment paid total dividends of $0.36 per share during the quarter and bought back a total of 11 million shares at an average price of $13.95, for a total of $153.5 million. Subsequent to the end of the quarter, the company terminated a buyback plan set to expire on Dec. 31 and introduced a new plan to permit buybacks of $1 billion through the end of 2021.
Spread income (which represents the interest earned minus the interest paid on financing) came in at $0.81 per share for the quarter, which easily covered the dividend of $0.36 per share. One of the first questions asked on the earnings conference call concerned the company's plans regarding the dividend. Kain had this to say regarding the dividend:
...[W]e are really confident about the outlook for net spread and dollar roll income. And yes, we expect that measure to be well above the current dividend for the foreseeable future. ... The decision whether to raise the dividend [and] by how much we -- or if we do is really just a function of assessing the optimal, or appropriate cushion really between expected earnings and the dividend. ... I mean the most important thing here is, this is a great problem to have as we're currently paying and comfortably as you mentioned, a dividend in excess of 10% which is extremely attractive in today's environment. While we're building book value, and we're buying back our stock.
On the second-quarter earnings call, Kain said that in retrospect the dividend cut (of $0.15 per share monthly to $0.12 monthly) was "unnecessary." Given the size of the announced buyback, it looks like AGNC will be happy to continue to purchase stock at below book value; however, the company does have the breathing room for a dividend hike. Taking the company's 2% increase in book value since the end of the quarter, AGNC is trading at a 13% discount to book value and has a 10% yield.
This mREIT stock represents value as well as income. It is one of my CAPS picks.