Rising interest rates have pushed dividend yields up. But a yield of nearly 15%? That sounds too good to be true.
Believe it though. Shares of real estate investment trust (REIT) AGNC Investment (AGNC 0.97%) are now dishing out 14.9% of their present value in the form of annual dividends, split evenly among all 12 months of the year. And for the record, yes, these payments are fully covered by actual profits.
How can the company afford such a big dividend yield? To be fair, the stock's relative long-term weakness helps in this regard -- the lack of dividend growth since 2020 following its reduced dividend payments since 2018 is less than inspiring.
However, much of the circumstance behind the 14.9% payout stems from the nature of this REIT itself.
AGNC Investment in focus
There are all kinds of REITs. Most of them own real estate rented out to tenants.
Not all of them though. A handful of them buy and hold mortgage-backed securities (bundled packages of several mortgage loans), ultimately providing funding to borrowers. These purchases are generally leveraged with money borrowed at a lower interest rate. In the case of AGNC Investment, these purchases are often structured as repurchase agreements where the seller agrees to buy the mortgage-backed security back over time at a slightly higher price. It wouldn't be wrong to describe the strategy as interest rate arbitrage with relatively low upfront capital requirements. Net profits may be inconsistent with such an approach, while overall profit margin rates are paper thin. Relative to the REIT's price, though, they're still reasonably healthy.
AGNC Normalized Diluted EPS (Quarterly) data by YCharts
It's a complicated strategy. It can be risky too, particularly when interest rates are rapidly changing as they have since the middle of last year. The REIT's cost of borrowing must reliably remain below the interest payments it's receiving, which requires guesswork as to when rates will change, and by how much.
Then there's an ever-growing risk of defaults on the underlying mortgage loans of these securities, which of course hurts their value. That's a big reason AGNC Investment shares have steadily lost value since mid-2021, driving the REIT's yield higher. Generally speaking, the higher the yield, the greater the perceived risk.
This stock's weakness over the course of the past couple of years, however, may overstate its current risk.
Its underlying assets are holding up quite nicely
It is true that auto loan delinquencies are on the rise. Ditto for credit card delinquencies. And wage growth hasn't kept up with the rising cost of living, financially squeezing plenty of borrowers.
Surprisingly, though, mortgage loans continue to be repaid as agreed. Indeed, they're being repaid more reliably than they have been in the past.
That's the takeaway from a report recently posted by the Mortgage Bankers Association anyway. The organization says that as of the end of the second quarter, overall mortgage loan delinquency rates in the United States fell to only 3.37% of outstanding loans. That's down from 3.64% a year ago, reaching the lowest level seen since the Mortgage Bankers Association began keeping tabs on the data back in 1979.
And the data jives with similar numbers from the Federal Reserve. The nation's central bank indicates that as of the end of the second quarter delinquencies on single-family residential mortgages fell to only 1.72% of the loans of this categorization, reaching levels not seen since 2006. Data from CoreLogic further confirms the trend, noting that delinquencies of more than 90 days past due are still seeing the steepest declines.
With generationally low interest rates locked in, most homebuyers are highly motivated to make sure they can keep their current loan terms intact.
It's a dynamic that comes with a footnote, however. The number of mortgage loans being made is also peeling back from recent sky-high levels. Real estate market research firm ATTOM reports home lending fell 19% to 1.25 million loans during the first quarter of this year, reaching levels last seen in late 2000 in the wake of the dot-com meltdown.
The quality of AGNC Investment's mortgage-backed securities may be holding up just fine. It's just getting increasingly tough to find new ones to buy.
Nevertheless, the underlying support for AGNC Investment's big dividend yield remains intact ... even if most of the market currently appears to doubt it.
Buy AGNC Investment while you can at this yield
It's not a growth investment, to be clear. Even at a lower yield, AGNC Investment's most marketable feature is its healthy dividend and corresponding yield. Even so, the past couple of years' worth of weakness sets the stage for significant capital appreciation in addition to continued dividend payments.
Jackson Square Capital's founder and managing partner Andrew Graham may have said it best in a recently penned op-ed posted by CNBC regarding mortgage REITs. Graham writes, "Were the [Federal Reserve] able to tame inflation without sparking a recession, interest rates would presumably begin to retreat in 2024. Importantly, that scenario would also help the residential mortgage REIT industry avoid what most at the beginning of the year thought was a certainty: widespread defaults." He goes on to say, "Together, that sequence of events would initiate about an 18-month cycle where the book values of mortgage REIT companies spike, juicing their stock prices."
Connect the dots. The market's looking right past an opportunity to plug into a somewhat unusual stock with lots of growth and income potential.
