AGNCM - AGNC Investment: I'm Tempted To Buy The 15.5% Yield Paid Monthly

2023-05-19 13:30:12 ET

Summary

• AGNC Investment is down 11% since the start of the year, continuing a selloff that's been ongoing since the spring of 2021.
• The mREIT's monthly dividend payouts have been a bulwark of stability against the current disruption. However, the tangible net book value continues to fall and total returns have been flat.
• 2023 could still be a positive year if the Fed pauses its rate hikes at its June FOMC meeting. This will form an inflection point against the current disruption.

AGNC Investment ( AGNC ) is down about 11% since the start of the year as wider macroeconomic concerns from a Feds funds rate just hiked to its highest level since 2008 at 5%-5.25% and inflation that remains elevated continues to dominate. The regional banking panic, which is not yet at a definitive close, has not helped. These are dire conditions for investing in mREITs but AGNC has fared better than many of its agency RMBS investor peers. Indeed, the mREIT has kept its monthly dividend payouts stable, last declaring a monthly dividend payout of $0.12 per share , for a 15.5% dividend yield. This has been maintained at its current level since April 2020 with the current yield now moving to its highest level in over three years. The yield is now seemingly flashing buy, and I'm tempted to take a position. However, bears, who form the 5.14% short interest, would be right to flag this as a possible trap.

To be clear here, the current macroeconomic backdrop has forced the stock market to significantly discount AGNC's payout, driving the yield to its highest level since the early pandemic era crash. Such a high yield usually portends disaster and is absolutely a liability against the current market conditions. Income and capital preservation need to go hand in hand, and AGNC has fallen by 28% over the last three years. When you include income, total returns over the last three years are essentially flat. The next three years stand to be markedly different, with the Fed likely set to pause its interest rate hikes from their June FOMC meeting even as inflation continues to linger far above their target.

The Dividend Yield In A Time Of Heavy Disruption

AGNC recently reported earnings for its fiscal 2023 first quarter that saw a tangible net book value per share of $9.41 , down around $0.43 sequentially from the prior fourth quarter and a 28% decline from $13.12 in the year-ago comp. This forms the core reason I've held off taking a position. Tangible book value is in freefall, and it makes no sense to build a position in the security if the payouts stand to be entirely mitigated by capital loss. The mREIT's economic return on tangible common equity fell to negative 0.7% from positive 12.3% in the prior quarter. This was comprised of the three-month total of its payout of $0.36 per share and the $0.43 decrease in tangible net book value per share.

The bulk of AGNC's $56.8 billion investment portfolio is fixed, with 92% formed from 30-year fixed MBS. Its annualized net interest spread during the first quarter stood at 2.88%, up around 12 basis points sequentially over the fourth quarter. This came with a portfolio-weighted average CPR of 5.2% versus 6.8% in the fourth quarter. The first quarter net spread and dollar roll income per share was $0.70, beating consensus by $0.05, but down sequentially from $0.74 in the prior fourth quarter. Hence, the mREIT is only paying out around 51% of its net spread and dollar roll income per share as a dividend. Bears would of course highlight that this payout ratio stands to move higher in the future quarters if net spread and dollar roll income fall. However, management stated during the first quarter earnings call that they're comfortable with the current payout as the broader disruption posed by rising Fed funds rates to its cost of financing is set to moderate if the Fed pauses its rate hikes next month.

2023 As A Dovish Fed Pause Looms

AGNC's preferreds like its Series D Fixed to Floating Cumulative Preferred Shares ( AGNCM ) offer a safer but lower yield way to play the mREIT. The Series D for example is currently trading at $21.35, a roughly 14.6% discount to its $25 par value and with an 8% yield on cost. Whilst I'm tempted to take a position in the commons on the back of a solid payout ratio and a dividend yield that has moved to its highest level in three years, the current market zeitgeist is simply not supportive of the mREIT's tangible book value until the Fed pivots on its rate hikes.

This is what keeps me up at night as preventing an erosion of base capital needs to go hand in hand with income. Bulls are set to enjoy a fat yield here that is backed up by underlying net spread and dollar roll income. However, the mREIT's popularity with retail investors has meant any marked discount to book value simply does not exist. This fully exposes current shareholders to volatility in the absence of a margin of safety. I'm rating AGNC as a hold against this but will reevaluate the mREIT if tangible book value was to stabilize in the coming quarters.

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