The past year was downright awful for the mortgage industry. Mortgage originators saw volumes decline as refinancing activity waned and homebuyers become more cautious.
Mortgage real estate investment trusts (REITs) got hammered by outsized volatility in the bond market, which depressed book values. This translated into underperformance, which lowers earnings and stock prices and led to higher dividend yields. Some of the yields in the mortgage REIT space approached 20% earlier this year.
Mortgage REIT AGNC Investment (AGNC 0.97%) has a mid-teens percentage dividend yield. Is this sustainable?
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Mortgage REITs invest in real estate debt
As noted above, AGNC Investment is a mortgage REIT, which is different than the typical REIT. Most REITs follow a landlord-tenant business model. They build structures like shopping malls, apartment buildings, or office parks and then rent out individual units to tenants. Mortgage REITs don't invest in properties, they invest in property debt -- in other words, mortgages. They borrow money at low interest rates and invest that in mortgage-backed securities, earning revenue off the spread. In this way, they are more similar to a bank.
AGNC Investment concentrates primarily on mortgage-backed securities (MBS) which are guaranteed by the U.S. government. These securities are often referred to as "agency MBS" and are typically made up of loans issued by government-sponsored agencies Fannie Mae and Freddie Mac. If you bought your home with a conventional loan, chances are it ended up in an agency MBS held by a mortgage REIT.
The past year was brutal for the mortgage space
Over the past year, the mortgage business suffered as a result of rising interest rates. The Federal Reserve was forced to take aggressive action to battle inflation, which resulted in one of the most rapid increases in interest rates in decades. Rising rates are generally bad news for bonds, but when rates move rapidly, it is doubly bad for mortgage-backed securities. Over the past year, mortgage-backed securities underperformed benchmark Treasury bonds by a wide margin.
AGNC has experienced declines in book value per share for several quarters as mortgage-backed securities fell in value, and its interest-rate hedges did not increase in value enough to keep up. So far, the company hasn't been forced to cut the dividend, but the rise in yield suggests that investors think it is a possibility.
The tensions may be easing, however. At a recent speech at the Brookings Institution, Fed Chairman Jerome Powell said that the Fed may choose to moderate the pace of rate hikes as soon as the December meeting. Investors reacted positively to this news, and longer-term Treasury rates began to fall. Mortgage-backed securities have begun to outperform Treasuries, which means AGNC should see increases in book value per share.
Dividend sustainability depends on the Fed
The big question is whether AGNC Investment's dividend is sustainable. The company currently pays a monthly dividend of $0.12 per share. A lot will depend on the path of inflation and federal policy. The Fed signaled it is done with the steady diet of 75-basis-point increases every meeting; the federal funds futures index predicts a 75% chance of a 50-basis-point hike at the December meeting and only a 25% chance of a 75-basis-point hike. They also see rates increasing only slightly next year.
If this forecast turns out to be correct, mortgage-backed securities should revert to their historical relationship with Treasuries, which means good things for book value and income, which should help get AGNC's dividend yield back down to more sustainable levels. If inflation reaccelerates, all bets are off.
