AGNC: High Dividend Yield Above 10% But Know The Risks

Investors that buy stocks for income are generally confined to stocks that pay dividends on a quarterly basis. Some stocks pay even less frequently than that, issuing dividends only on a semi-annual or even annual basis. However, there are 39 monthly dividend stocks that actually pay shareholders every month.

This helps those investors that rely upon the income to pay living expenses, but also for those looking to compound their wealth; compounding monthly is certainly more desirable than quarterly.

Out of those 39 monthly payers, we’ve ranked the 10 highest-yielding monthly dividend stocks in the group to narrow investors’ focus on which stocks to take a closer look at for potential investment.

AGNC Investment Corporation (AGNC) is on the list with its 11% dividend yield, and we think the stock is attractive enough to rate it a speculative buy, even after its recent decision to cut its monthly distribution.

In this article, we’ll take a look at AGNC and why we think that despite a somewhat murky outlook, the stock looks set to generate attractive returns for shareholders.

Business Overview And Recent Events

AGNC was founded in 2008 at the height of the financial crisis. It is organized as a mortgage real estate investment trust, or mREIT, that invests primarily in agency mortgage-backed securities, or MBS, on a highly leveraged basis.

The trust’s investment portfolio was $102 billion at the end of the first quarter of 2019, and the vast majority of the securities it owns (86%) are 30-year maturities. The trust owns a variety of securities, including mortgage pass-through securities, collateralized mortgage obligations, and non-agency MBS. However, the majority are agency MBS, where the principal and interest payments are guaranteed by US Government Sponsored Entities, or GSE, such as Fannie Mae, Freddie Mac, or Ginnie Mae.

The stock trades with a $9.4 billion market capitalization and generates more than a billion in total revenue annually.

AGNC reported Q1 earnings on 4/24/2019 and results were predictably weak as the trust is facing a tougher environment than it was a year ago.

The trust reported $0.52 in net spread and dollar roll income, which roughly approximates to distributable income for AGNC. This was down a penny from the fourth quarter and down from $0.60 in the year-ago period.

Net interest income fell from $225 million a year ago to $164 million in this year’s Q1 despite a much larger investment portfolio, which grew from about $70 billion in last year’s Q1 to just over $100 billion this year. The difference is because AGNC, along with other mREITs, is facing spread compression thanks to the way interest rates are behaving.

Source: Q1 earnings presentation

Indeed, as we can see from this recent investor presentation slide, AGNC is grappling with average asset yield growth that is being vastly outpaced by growth in the average cost of funds. Essentially, the way AGNC generates revenue and earnings is to borrow money and then buy securities with it to generate income. This works only when the average asset yield is in excess of the cost of funds, and of course, the more the better.

However, in the past two years, the yield curve has flattened significantly, meaning that AGNC’s net interest spread – the amount between its borrowing costs and its interest income – has compressed significantly.

Indeed, AGNC’s net interest spread was 1.55% in the second quarter of 2017, but that number declined to 1.06% at the end of the most recent quarter. The average cost of funds has risen every quarter since the beginning of 2017, nearly doubling in that time frame from low levels. Average asset yield has also risen, but not nearly as quickly.

As we can see from the chart on the bottom-right, the result of all of this is that AGNC’s net spread and dollar roll income continues to tick lower, having declined from $0.64 two years ago to $0.52 in the most recent quarter.

Because of this, we are quite cautious on AGNC’s ability to grow its income from today’s levels in the current interest rate environment. Indeed, we are forecasting essentially flat net spread and dollar roll income for the foreseeable future, equating to ~$2.25 per share annually.

Given the current share price of $17.48, that puts the trust’s valuation at less than eight times earnings. We see fair value around 8 times earnings, so the stock isn’t necessarily cheap. However, it isn’t expensive, either, increasing the attractiveness because of the sizable dividend the stock pays.

A Highly Attractive Dividend

As mentioned, AGNC pays its dividend monthly, which is quite desirable. Even more so, the trust has paid a total of $39.86 per share in dividends since its IPO in 2008, which is more than double the current share price. Given this, AGNC has produced outstanding total returns for shareholders since coming public despite the fact that the stock trades below the 2008 IPO price of $20.

On the other hand, the environment for interest rates has caused AGNC to become more cautious on its outlook, including cutting the dividend during the Q1 earnings release. The current dividend of 18 cents monthly, or $2.16 annually, will be reduced to 16 cents monthly, or $1.92 annually, for the May payment. While dividend cuts are never a good thing, in AGNC’s case, it was inevitable given the continuing compression in the trust’s spreads.

However, that is priced into the stock at this point and the cut will make the dividend more sustainable for AGNC to continue to pay in the coming months. In addition, even at the lower payout, the stock is yielding 11% on an annualized basis.

AGNC is certainly no stranger to cutting its payout, as it has done many times in the past decade. This is something investors in mREITs must tolerate as a part of owning the stock as results can be volatile depending upon the performance of interest rates.

However, we see the new, lower payout as more sustainable than the prior payout and obviously, the yield is enormously attractive. This is the case not only because of the 11% yield, but the fact that the dividend is paid monthly.

Final Thoughts

In total, we see AGNC as a buy for income investors with the caveat that results will likely continue to be volatile. However, with a monthly dividend that yields 11%, AGNC’s lack of growth potential and fair valuation are afterthoughts; we like this stock for its double-digit yield and track record of producing strong returns for shareholders through a variety of interest rate environments. The current cycle of spread compression appears to be near its worst levels for AGNC and thus, investors that can stomach the volatility are poised to do well in the coming years thanks to the prodigious yield.

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