Summary
- AGNC Investment has seen its shares fall a lot over the last year.
- This has made its dividend yield soar to a very high level.
- Profits could come under pressure going forward, and buying solely for a high dividend yield has not worked well in the past when it comes to AGNC.
Article Thesis
Over the last couple of months, AGNC Investment Corp. ( AGNC ) has been in freefall. As a result, its dividend yield has soared to an outrageously high level of 18%. When shares offer a dividend yield this high, investors have to ask themselves how sustainable that dividend is in the long run -- if the company was able to maintain it at this level forever, that would be extremely attractive. But dropping book value suggests that the good times could be coming to an end, especially when we consider how AGNC's dividend has changed in the past -- the trend was clearly downwards, unfortunately. Even though AGNC's dividend yield is thus very high today, investors should consider whether buying at current prices fits their risk tolerance.
AGNC Investment Has Dropped Like A Rock
AGNC Investment Corp. has, like many of its mREIT peers, seen its shares get devastated so far in 2022, with an especially deep decline in the last couple of months:
In 2022, shares have dropped by more than half. In other words, shares would have to climb by more than 100% for investors to have the same amount of capital in AGNC as they had at the beginning of the year. Of course, share price increases of 100% or more are hard to come by, especially in the current environment, thus investors might have to live with a more permanent loss of capital. That is also suggested by AGNC's book value performance, which has historically been highly correlated with its share price:
AGNC has seen its book value drop by 26% over the last year, on par with the book value performance of its close peer Annaly Capital ( NLY ). Other mREITs such as Chimera Investment ( CIM ) have performed slightly better, although the company also had to report a substantial book value drop. Rithm Capital ( RITM ), formerly known as New Residential, is an outlier, as its MSR portfolio has done well in the current rising rates environment, which is why its book value increased whereas other mREITs saw theirs drop.
The above chart actually understates the book value drop experienced by AGNC and others, as it only runs through the end of the second quarter. Exact Q3 results have not yet been reported, but we already know that book value is down a lot again -- AGNC has pre-announced that its tangible book value would be a little above $9 at the end of the third quarter, which represents a decline of around $2.40 or around 20% from the end of the second quarter. In other words, once the final Q3 results are in, AGNC will have seen its book value drop by way more than 26% over the last year on a GAAP basis.
With tangible book value dropping by more than $2 during the third quarter alone, it also seems important to note that book value by the end of the current year could be well below $9. In fact, another book value decline in line with what happened during the third quarter would bring AGNC's book value to below $7 by the end of the year, although that is of course not certain, as it depends a lot on how interest rates are moving, thus the macro environment plays a very important role for AGNC's book value performance going forward.
The mortgages that AGNC owns do decline in value as interest rates rise. This is the same principle that has sent the price of treasuries and other bonds lower in the recent past as interest rates have been climbing:
Since the Fed is, in all likelihood, not done raising interest rates as inflation remains stubbornly high, it seems likely that the prices of fixed-income investments, including bonds and mortgages, will continue to decline. Further pressure on AGNC's book value thus is a reasonable assumption, I believe. A "Fed pivot" could change that, but with both PPI inflation and CPI inflation running well ahead of the target range, I do not believe that such a Fed pivot is particularly likely. In the meantime, the profitability of AGNC's core business and of that of close peers such as Annaly, could come under pressure as well.
Interest rates are not rising equally across the board. Instead, shorter-term rates are rising faster than longer-term rates, showcased by the following chart of short-term and long-term treasury rates:
The 2-year treasury rate has risen way more, and to a higher absolute level, whereas the 30-year treasury rate has risen less drastically. This has reduced the spread between short-term and long-term rates, which is important for lenders such as AGNC, as their profitability depends on this spread. AGNC does not invest in treasuries, thus the above chart is not a perfect analogy for what happens with AGNC, but still the same principles hold true: A declining spread between short-term and long-term rates could pressure profits. That's why Wall Street expects that AGNC Investment's profits will come under considerable pressure in the foreseeable future:
EPS are forecasted to drop by 10% this year and by an even wider 20% next year. Overall, that makes for a hefty profit decline versus prior years. On the other hand, it's also important to note that AGNC Investment will still generate a pretty sizeable profit relative to how its shares are valued today -- the 2023 earnings multiple is as low as 4 right now. In other words, even if the profit declines happen as expected, AGNC would still offer a pretty large earnings yield next year.
How Sustainable Is AGNC's Dividend?
So while AGNC will likely see its profits and its book value come under pressure in the foreseeable future, shares also offer some opportunities right now. After all, the earnings yield is pretty high, and so is the dividend. At current prices, AGNC Investment's dividend yield is 18%, around 10x as much as what one can get from the broad market. Even a 50% dividend cut would leave investors that buy today with a pretty high 9% dividend yield. Is a dividend cut likely? History suggests that, I'd say:
Over the last 13 years, AGNC Investment has cut its dividend again and again: Overall, there were 9 dividend reductions in that time frame, and the dividend has declined by more than 70% overall, from $1.50 per quarter to $0.36 per quarter. The most recent dividend cut occurred in 2020, when AGNC reduced its payout by one-fourth.
We can undoubtedly say that AGNC Investment hasn't been a reliable dividend payer in the past. Instead, investors that got lured into the stock by its high payout have seen their income stream shrink again and again, as market realities forced the company to lower its payout to its owners repeatedly over time. History does not necessarily repeat, but the issues from the past should nevertheless give investors pause when it comes to the question of whether or not to buy this high-yielder today.
The following chart shows what happened to those that bought into AGNC Investment ten years ago, when its dividend yield was comparable to where it is today:
Despite the fact that its dividend yield was so high a decade ago, AGNC was not a good investment at the time -- even when we include dividend payments since then, the total return was negative , at around -20%. In other words, while the broad market returned more than 200% over the last decade, those that bought into AGNC Investment and its very high dividend yield a decade ago are in the red -- even when dividends are included . To me, that suggests that caution is warranted here.
Takeaway
AGNC Investment offers a very high dividend yield of 18% today. Its dividend is covered by profits right now, as AGNC is forecasted to earn more than $2 this year and next year, while its dividend costs the company $1.44 per year right now. AGNC is also trading with a very low earnings multiple today.
That being said, its book value keeps dropping at a hefty pace and could stand below the current share price by the end of the year, assuming book value declines during Q4 are anywhere close to what happened in the third quarter. Since AGNC is oftentimes valued based on its book value, its share price could remain under pressure.
While AGNC Investment offers a very high dividend yield, that does not automatically make the company an attractive investment. Instead, it could make sense to be cautious, as AGNC has performed very badly over the last decade, despite the fact that its dividend yield was at a comparable level to where it is right now ten years ago. Overall, I'm staying away from AGNC for now until there is a cleaner picture about what future book value performance might look like. Enterprising investors may find that the potential rewards outweigh the risk at current prices, but I do not want to get bullish yet.
For further details see:
AGNC: 18% Yield Trap Or Opportunity?