There are warning signs of a possible recession as the U.S. federal government looks to slash jobs, while tariffs could touch off a trade war. The Atlanta Federal Reserve's estimate for real gross domestic product (GDP) growth for the first quarter has gone from predicting growth of more than 2% in late February to a 2.4% decline as of its last estimate on March 6.
While the specter of a recession is generally not good for the market, there is one high-yielding dividend stock that could perform well in this environment: AGNC Investment (AGNC +3.31%).
NASDAQ: AGNC
Key Data Points
A high yield in a tumultuous market
AGNC is a mortgage real estate investment trust (REIT), which is an investment company that owns a portfolio of mortgage-backed securities (MBS). It generates income through the spread between the yield of the mortgages it holds in its portfolio and its funding costs (the short-term debt it takes on to buy the MBS). For example, if funding costs were 4% and it bought a mortgage-backed security with a 7% yield, it would earn a 3% spread on its investment.
A 3% return is not that exciting, so mortgage REITs typically use leverage, or borrowing, to bolster their returns. They also generally deploy hedges to help lock in their short-term rates for a longer period to better match the maturity duration of their portfolios. This is important because it mitigates the risk of rising funding costs narrowing the spread, or even funding costs becoming higher than the yield on the MBS. It wasn't long ago that average yields on 30-year mortgages were less than 4%. Today, short-term rates as measured by the Secured Overnight Financing Rate (SOFR) are above 4%.
So why could AGNC perform well in a recession? There are a couple of reasons.
The first is that the mortgage REIT invests almost exclusively in MBS that are backed by government or government-sponsored agencies. As such, it carries virtually no credit risk, as the underlying mortgages are essentially backstopped by the government. At the end of 2024, 98.6% of AGNC's portfolio was in agency-backed MBS, with 96% in 30-year fixed agency-backed mortgages.
A recession would also likely lead to the Federal Reserve picking up its pace of interest rate cuts. The Fed began lowering rates last September, but paused this year due to the strength of the economy. With the economy now clearly weakening, faster rate cuts appear to be in the cards.
AGNC could benefit in two main ways from lower rates. The first is that by lowering short-term rates, it could reduce funding costs and widen spreads. AGNC's average net interest spread has been trending lower in recent quarters, going from 2.98% in the first quarter of 2024 to 1.91% in the fourth. This is largely due to less hedging income.
However, some of this stems from AGNC management turning more toward Treasury-based hedges, which are not reported in its net interest spread or net spread income. At the end of Q4 2024, 33% of its hedges were Treasury-based, while on a dollar duration basis (since these are longer hedges), it represented 53% of its hedging portfolio. About 70% to 80% of its hedges are typically interest rate swaps, which are used to help stabilize interest rates. Treasury-based hedges have been the better value recently, but AGNC would look to move back more toward swaps when swap spreads begin to stabilize.
The main point, though, is that lower short-term rates should help improve funding costs.
In addition, any reduction in longer-term interest rates should help the value of AGNC's portfolio. Since MBS are a fixed-income instrument like bonds, their current values are affected by interest rates, or in the case of MBS specifically, mortgage rates. If mortgage rates fall, the value of AGNC's portfolio, as represented by its tangible book value (TBV), should rise. Mortgage REITs are typically valued at a multiple of their TBV, so an increasing TBV per share should help boost its stock price.
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Is AGNC a buy?
AGNC pays a $0.12 monthly dividend, which equates to a robust yield of more than 14%. The mortgage REIT has paid out its current dividend for nearly 60 months, and management is confident that it can continue to maintain its current dividend. This is backed by AGNC's projected returns of 17% to 18.5% in this current environment.
Overall, AGNC is a solid high-yield stock with some moderate potential price upside that should perform well in the current environment, even if we head to a recession.
