Over the past two months, AGNC Investment Corp. (NASDAQ: AGNC) is in free fall. As a result, its dividend yield soared to an outrageously high 18%. When stocks offer a dividend yield so high, investors have to wonder how sustainable that dividend is over the long term – if the company were able to keep it at that level forever, that would be hugely attractive. But the drop in book value suggests the good times may be coming to an end, especially considering how AGNC’s dividend has changed in the past – the trend was clearly down, unfortunately. Even though AGNC’s dividend yield is therefore very high today, investors should consider whether buying at current prices is within their risk tolerance.
AGNC investment dropped like a rock
AGNC Investment Corp. has, like many of its mREIT peers, seen its shares devastated so far in 2022, with a particularly deep drop in the past two months:
In 2022, stocks have fallen by more than half. In other words, stocks would have to rise more than 100% for investors to have the same amount of capital in AGNC that they had at the start of the year. Of course, stock price increases of 100% or more are hard to come by, especially in the current environment, so investors may have to live with a more permanent loss of capital. This 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 26% over the past year, on par with the book value performance of its close peer Annaly Capital (NLY). Other MREITs such as Chimera Investment (CIM) performed slightly better, although the company also had to report a substantial decline in its book value. Rithm Capital (RITM), formerly known as New Residential, is an outlier as its MSR portfolio has performed well in the current rising rate environment, which is why its book value has risen as other mREITs have seen theirs drop.
The chart above actually underestimates the decline in book value suffered by AGNC and others because it only lasts through the end of the second quarter. Exact third quarter results have yet to be released, but we already know book value is down a lot again – AGNC pre-announced its tangible book value would be just over $9 at the end of the third quarter. , which is down about $2.40 or about 20% from the end of the second quarter. In other words, once the final third quarter results are released, AGNC will have seen its book value drop more than 26% over the past year on a GAAP basis.
With tangible book value down more than $2 in 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 drop in book value in line with what happened in the third quarter would bring AGNC’s book value back below $7 by the end of the year, although that’s not good. sure not sure, because a lot depends on the evolution of interest rates. , so the macro environment plays a very important role in AGNC’s book value performance going forward.
Mortgages held by AGNC decline in value as interest rates rise. This is the same principle that has driven down the price of Treasuries and other bonds in the recent past as interest rates rise:
Given that the Fed is, in all likelihood, not done with raising interest rates while 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 is therefore a reasonable assumption, I believe. A “Fed pivot” could change that, but with PPI inflation and CPI inflation well above the target range, I don’t think such a Fed pivot is particularly likely. In the meantime, the profitability of AGNC’s core business and that of its close peers such as Annaly could also come under pressure.
Interest rates do not increase in the same way everywhere. Instead, short-term rates are rising faster than long-term rates, as shown in the following graph of short-term and long-term Treasury bill rates:
The 2-year Treasury bill rate rose much more, and at a higher absolute level, while the 30-year Treasury bill rate rose less drastically. This reduced the spread between short-term and long-term rates, which is important for lenders like AGNC because their profitability depends on this spread. AGNC does not invest in Treasuries, so the chart above is not a perfect analogy to what is happening with AGNC, but the same principles still hold true: a decline in the spread between short term and long term could put pressure on earnings. This is why Wall Street expects AGNC Investment’s earnings to come under considerable pressure for the foreseeable future:
EPS is expected to fall 10% this year and another 20% next year. Overall, this results in a sharp decline in profits compared to previous years. On the other hand, it’s also important to note that AGNC Investment will still generate a fairly large profit compared to how its shares are valued today – the 2023 earnings multiple is as low as 4 at the moment. . In other words, even if the decline in earnings occurs as expected, AGNC would still deliver a fairly large earnings return next year.
What is the sustainability of AGNC’s dividend?
So while AGNC will likely see its earnings and book value under pressure for the foreseeable future, equities also offer opportunity right now. After all, the earnings yield is quite high, as is the dividend. At current prices, AGNC Investment’s dividend yield is 18%, about 10 times more than what can be obtained in the broader market. Even a 50% dividend cut would leave investors buying today with a fairly high dividend yield of 9%. Is a dividend cut likely? History suggests, I would say:
Over the past 13 years, AGNC Investment has cut its dividend again and again: overall, there have been 9 dividend cuts in this period, and the dividend has decreased by more than 70% overall , from $1.50 per quarter to $0.36 per quarter. The last dividend cut was in 2020, when AGNC cut its payout by a quarter.
We can say without a doubt that AGNC Investment has not been a reliable dividend payer in the past. Instead, investors who were lured into action by its high payout saw their revenue stream dwindle again and again as market realities forced the company to cut its payout to its owners repeatedly. over time. History does not necessarily repeat itself, but the stakes of the past should nevertheless make investors think about whether or not to buy this high-yield today.
The following graph shows what happened to those who bought AGNC Investment ten years ago, when its dividend yield was comparable to what it is today:
Despite its dividend yield being so high ten years ago, AGNC was not a good investment at the time – even if we include dividend payments since then, the total return was negative, at about -20%. In other words, while the broader market has returned over 200% over the past decade, those who bought AGNC Investment and its very high dividend yield a decade ago are in the red : even when dividends are included. To me, this suggests that caution is in order here.
AGNC Investment today offers a very high dividend yield of 18%. Its dividend is currently covered by earnings, as AGNC is expected to earn more than $2 this year and next, while its dividend is costing the company $1.44 a year right now. AGNC is also trading with a very low earnings multiple today.
That being said, its book value continues to decline at a steady pace and could remain below the current share price by the end of the year, assuming the declines in book value during the fourth quarter are close to what happened in the third quarter. Since AGNC is often valued on the basis of its book value, its share price could remain under pressure.
Although AGNC Investment offers a very high dividend yield, this does not automatically make the company an attractive investment. Instead, it might make sense to be cautious, as AGNC has performed very poorly over the past decade, despite the fact that its dividend yield was at a level comparable to where it is now a year ago. ten years. Overall, I’m staying away from AGNC for now until there’s a clearer picture of what future book value performance might look like. Enterprising investors may find that the potential rewards outweigh the risk at current prices, but I don’t want to be optimistic just yet.