AGNC Investment (NASDAQ: AGNC) has one of the highest dividend yields around. At over 17%, it's more than 10 times higher than the broader market (the S&P 500's dividend yield is less than 1.5%).
Usually, a dividend yield that high tends to indicate that a cut is forthcoming. However, a payout reduction doesn't seem to be in the cards for AGNC Investment. Instead, the company believes it's a good investment in the current market.
In a strong position to handle instability
AGNC Investment is a real estate investment trust (REIT) that invests in mortgage-backed securities (MBS) protected against credit risk by government agencies like Freddie Mac. Because of that, they're very low-risk investments. Given the low-risk profiles of MBS, AGNC Investment uses leverage to enhance its returns.
While utilizing leverage increases the REIT's risk profile, it doesn't believe this strategy will cause problems for the company amid the current market instability. Instead, CEO Peter Federico stated in the first-quarter earnings report his belief that "With our conservative leverage profile and ample liquidity at quarter end, AGNC was well-positioned for this instability." He noted that the company ended the first quarter with "tangible 'at risk' leverage of 7.5x and a substantial liquidity position of $6 billion of unencumbered cash and Agency MBS." That's a meaningful amount of liquidity compared to its $78.9 billion investment portfolio.
A compelling investment environment
There's a lot of uncertainty in the market these days regarding the impact of tariffs on the economy. There are growing concerns that they could cause a significant recession. That could have a major impact on stock returns.
However, the picture for MBS investments is much brighter despite all the uncertainty. In AGNC's recent earnings report, Federico commented: "In the first quarter, the prospect that potential governmental policy actions could adversely impact economic growth and accelerate inflationary pressures caused investor sentiment to turn decidedly more cautious. These concerns, in turn, initially drove a flight to high-quality assets – U.S. Treasuries, Agency MBA, and cash – from higher-risk assets such as equities and corporate debt." That helped boost the REIT's returns during that period. Its investment portfolio produced an economic return of 2.4%, while its stock delivered a 7.8% total return to investors despite a declining stock market.
Market volatility has only increased in the second quarter following the April tariff announcement. As a result, "Agency MBS spreads to benchmark rates widened," noted Federico. However, the CEO remarked, "Although the widening of Agency MBS spreads drove a modest decline in our tangible book value, our anticipated portfolio returns have increased commensurately with today's wider spread environment. Moreover, at current valuation levels, we believe Agency MBS offer investors a compelling return opportunity on both a levered and unlevered basis."
The company's ability to generate a compelling return in the current environment is noteworthy. That's because, as Federico has highlighted in the past, its returns, not its earnings, are the key driver of the REIT's dividend policy. Add the compelling return potential to the company's low leverage and ample liquidity, and it should be able to continue covering its monster monthly dividend.
The potential to produce a large tangible return
AGNC Investment believes it's in a strong position to weather the current market instability. Its solid financial position empowers it to continue investing in what it views as a compelling environment for MBS. Because of that, it should continue generating a high enough return to maintain its monster monthly dividend. That lucrative income stream can provide investors with a meaningful, tangible return in an environment where returns could be hard to find.
However, AGNC isn't without risk. If market conditions deteriorate significantly, the REIT's returns could suffer, which could cause it to cut its dividend, something it has done several times in the past. Because of that, it's not the best option for investors seeking a bankable income stream.
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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.
