If you are a dividend investor, AGNC Investment's (AGNC 0.97%) massive 14% dividend yield will probably sound quite attractive. However, when yields get up to the double-digit range it is prudent to step back and ask why. Although the market can be irrational over short periods of time and present investment opportunities, it is generally rational over the longer term.
So is AGNC's high yield an opportunity or a sign of investors demanding a high yield to justify taking on extra risk?
The basic business
AGNC is a mortgage real estate investment trust (REIT), which means it owns a portfolio of mortgage securities (generally called collateralized mortgage obligations, or CMOs). That's very different from a property REIT, which is pretty simple to understand as it owns buildings that it leases out to tenants. A mortgage REIT essentially owns a portfolio of bond-like securities. In some ways, AGNC is more like a bond mutual fund than a traditional REIT.
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This is because CMOs trade on the open market and can be bought and sold all day long. Physical properties are far less liquid. CMOs are also complex with their values impacted by interest rate movements, the housing market, and market supply and demand. Moreover, AGNC uses leverage with the hope of improving its returns. The REIT makes the difference between its cost of capital and the interest it earns on the CMOs it owns, but the risk is that leverage can also magnify losses.
There are a lot of moving parts with a mortgage REIT like AGNC that make these stocks inappropriate for more conservative investors. To highlight all of this, here are three interesting facts from the REIT's first-quarter 2023 earnings update.
1. AGNC is still losing book value
The value of a mortgage REIT is basically the value of its portfolio. Given the inherent volatility of CMOs, that means that AGNC's book value can swing around. That said, thanks to rising interest rates of late, the company's book value has been shrinking. Bond prices and interest rates generally move in opposite directions.
In the first quarter, the company highlighted that its $9.41 book value per share fell $0.43, or roughly 4.4%, from the end of 2022. That's not a great piece of news, but makes sense given interest rates. However, that's just three months. If you compare the current book value per share to what it was in the first quarter of 2022 the numbers are pretty upsetting. You have dig down pretty deep into the quarterly news release, but the book value per share a year ago was $13.12, meaning that in a year the book value has declined 28%.
To be fair, if interest rates suddenly started to fall the value of the company's CMOs would likely increase. But for most dividend investors that's probably not a bet worth taking.
2. Dividends go down, but the yield stays high
So the value of AGNC is shrinking, but so is the dividend. Over the past decade, the dividend has headed steadily lower. And yet the yield over that span has mostly remained around, or above, 10%. Price and yield move in opposite directions, so the only way the yield has remained as high as it has is because the stock price has shrunk along with the dividend.
If a dividend investor bought AGNC with the hope of collecting a fat yield, they would have not only suffered a reduced income stream, but also capital losses. In fairness, the dividend has held steady for a few years (including in the first quarter), but the long-term trend is not great here and, at this point, shows no sign of dramatically improving.
3. AGNC is selling more stock
In addition to the above issues, AGNC sold 17.1 million common shares in the first quarter, raising roughly $171 million. The average selling price was $9.95 per share, which is above the ending book value. So, on the one hand, you could argue that management's decision to sell stock was a benefit for shareholders. And that cash can be invested in more CMOs.
The flip side is that AGNC's book value has been declining because of rising rates. Putting more cash to work in this environment doesn't seem like a great idea unless you expect rates to go down. And those extra shares increase the ongoing cost of paying dividends, which is an added stress on the payment. Meanwhile, in most scenarios, investors would prefer a REIT to sell shares when the stock is high, not when the stock is near its lowest levels over the past decade, as AGNC has done. Mortgage REITs are not your typical company, so that logic isn't a perfect fit here, but that still doesn't mean that selling stock today is in the long-term best interest of shareholders.
A pass for dividend investors
None of this is meant to suggest that AGNC is a bad mortgage REIT. But it is meant to highlight the very real issue that the stock is likely to be a very bad fit for investors trying to live off of the income their portfolios generate. Before you buy this high-yielder you really need to understand both what you are buying and why you want to buy it. Most dividend investors will probably be better off elsewhere.
