Changes in market conditions can impact the REIT’s big-time dividend.
AGNC Investment (AGNC -3.56%) is a leader in investing in the Agency residential mortgage-backed securities (MBS) market (i.e., MBS protected from credit losses by government agencies like Fannie Mae). The company has a massive MBS portfolio (over $71.8 billion). It also has extensive experience navigating the MBS market and can tell when changes are in the air.
It sees the Federal Reserve’s recent rate cut as a catalyst for a big change in the MBS market. Here’s what it sees ahead and how that might affect the mortgage REIT’s monster dividend that currently yields nearly 14%.
A policy change
AGNC Investment’s CEO, Peter Federico, commented on the changes occurring in the MBS market in the company’s third-quarter earnings press release, noting:
The long-awaited monetary policy pivot by the Fed occurred at its September meeting, with an initial 50-basis-point rate cut. Consistent with historical experience, the Fed is expected to return the federal funds rate to a neutral level over the next 12 to 24 months, which would typically be accompanied by a steepening of the yield curve and growing demand for high-quality fixed-income instruments such as Agency MBS. Although the path of financial markets is never perfectly linear and periods of volatility are inevitable, the outlook for Agency MBS today is decidedly better than it was in 2022 and 2023 as a result of the positive direction of the broader economy, the accommodative Fed monetary policy stance, and the stability of Agency MBS spreads at these historically favorable levels.
After keeping rates high for the past several years to combat inflation, the Federal Reserve instituted a policy change by cutting interest rates last month. It will likely continue to reduce rates for the next one to two years.
In the past, a Fed policy change to lower rates has historically had two notable benefits for a mortgage REIT, such as AGNC Investment. First, it reduces the REIT’s borrowing costs. Mortgage REITs borrow money on the short-term market (which is what a Federal Reserve rate cut influences most) to invest in longer-duration MBS.
On top of that, lower rates tend to drive more stability in the MBS market. Because of that, the REIT should be able to earn a very favorable spread between its borrowing costs and MBS investments. That higher spread or profit margin will enable it to make more money to cover its lucrative dividend.
A strong quarter
The improvement in market conditions was already apparent in the third quarter. Federico noted that AGNC Investment generated a “very strong economic return of 9.3%” in the quarter, driven by a significant $0.42-per-share increase in its tangible book value and its $0.36 per share in dividend payments during the quarter. The REIT generated $0.63 per share of comprehensive net income in the quarter, easily covering its monster dividend.
The CEO noted, “As a levered and hedged investor in Agency MBS, AGNC’s return opportunities are most favorable when Agency MBS spreads to benchmark rates are wide and stable and interest rates and monetary policy are less volatile,” which was the case in the period.
The REIT capitalized on the increasingly positive market conditions by raising additional capital through a $781 million stock sale at a premium to its tangible book value per share. It used that money to fund investments in Agency MBS at attractive levels in the period, which puts it in a strong position to continue generating attractive returns.
With market conditions improving, AGNC Investment’s high-yielding dividend seems increasingly safe. The REIT is already earning more than enough income to cover the payout, which should widen in the future as market conditions continue to improve. As long as there isn’t an unexpected dramatic shift in market conditions, the dividend seems to be on solid ground.
A positive change points to continued dividend stability
AGNC Investment has paid a stable dividend for the last 55 consecutive months, despite more challenging market conditions over the past two years. With an increasingly positive environment, the REIT’s big-time payout looks safe. Because of that, it’s an increasingly enticing option for those seeking a very lucrative monthly income stream.
Matt DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.