The past year has been difficult for the financial sector, as banks and real estate investment trusts (REITs) underperformed as a result of efforts to combat the coronavirus epidemic. The mortgage REIT space was hit particularly hard, and many companies operating in that sector had very difficult headwinds to overcome. As markets settled down during the summer, these mortgage REITs eventually recovered some (or all) of their prior valuations.
For AGNC Investment (AGNC -0.81%), the recovery in book value is almost complete. Is it time for the company to reevaluate the current (reduced) dividend payout rate?
Mortgage REITs are a little different than the typical REIT
Mortgage REITs are a slightly different animal than the typical REIT. Most REITs follow a landlord-tenant model, where the company develops real estate assets and then rents them out. A typical example might be Realty Income (O 0.96%), which rents out stand-alone properties to tenants like drug stores, convenience stores, or dollar stores.
Mortgage REITs don't invest in physical real estate assets; they invest in real estate debt. For a mortgage REIT like AGNC Investment, that debt generally means mortgage-backed securities, which are backed by government-guaranteed mortgages. For example, if you recently refinanced your mortgage, it may well have ended up on a mortgage REIT's balance sheet.
AGNC reported strong quarterly results
AGNC reported fourth-quarter earnings per share of $1.16 as the market for mortgage-backed securities remained robust. During the fourth quarter, financial markets were generally benign and credit spreads improved. Surprisingly, mortgage-backed securities spreads outperformed government bonds. Finally, we saw a robust housing market, with median home prices rising by double-digit percentages. All of these factors contributed to AGNC's results.
The recovery is almost complete
During the early days of the COVID-19 crisis, the financial markets underwent a liquidity crisis, and many of the mortgage REITs were forced to sell assets and cut dividends. AGNC Investment was no exception, cutting its monthly dividend from $0.16 per share to $0.12, as book value per share fell from $17.66 at the end of 2019 to $13.62 at the end of March 2020. AGNC reported that book value per share had recovered to $16.71 at the end of 2020, and had picked up another 3% subsequent to the end of the quarter. This recovery prompts questions about increasing the dividend back to prior levels.
Will we see a dividend hike?
On the fourth-quarter earnings conference call on Monday, CEO Gary Kain had this to say about the dividend:
If you look at our current dividend relative to any other dividend vehicle in this environment or really your alternatives around income, the 9% or so yield for AGNC is very, very attractive kind of from a big picture perspective. ... Look, we're going to continue to evaluate the dividend on a go-forward basis. And it is an important component of how AGNC takes care of shareholders. But it again isn't the only piece. And it's the combination of the dividend, book value, which then translates to stock price, we'll continue to be active in buying back stock when it makes sense. And we think in the long run that's the best overall equation for shareholders.
During the quarter, AGNC repurchased $101 million worth of common stock at an average price of $15.32. At the end of the third quarter, book value per share was $15.88, so the company was buying back stock below book value. It sounds like, if AGNC is trading at a big enough discount to book, the company will choose to buy back stock. If the stock price approaches book, then perhaps a dividend hike is in play.
If you look at the chart below, you will see that this is the lowest yield for the stock, pretty much ever. Mortgage REITs do like to keep the yield in a target range, so it wouldn't be a surprise to see the company increase it, especially since the stock is approaching its pre-COVID book value with a 25% lower dividend.
As Kain pointed out on the conference call, AGNC Investment's yield is one of the most attractive in the financial markets. Income investors should take the time to understand the mortgage REIT space since the alternatives are scarce.
AGNC has the most powerful investor on the planet (the Federal Reserve) actively working to support its business model. Income investors should take note of the old market saw: "Don't fight the Fed." AGNC is one of my CAPS picks.