AGNC: 14.8% yield paid monthly, could get fatter

AGNC (NASDAQ: AGNC) last declared a monthly cash dividend of $0.12 per share, in line with its previous payout and for a 14.8% yield. That payout is down from $0.16 per share just before the pandemic with a recovery hampered by the impact of the Fed’s rising interest rates on residential mortgage-backed securities, which form the bulk of AGNC’s portfolio.

The internally managed mREIT invests primarily in agency RMBS on a leveraged basis through the use of repurchase agreements. The portfolio was valued at $59.5 billion at the end of the last reported fourth quarter of fiscal 2022, and agency MBS formed $39.5 billion of it. AGNC also had a mortgage position of $18.6 billion TBA. That made for a tangible book value of $5.7 billion at the end of the fourth quarter, about $9.84 per share.

The tangible book value must be fully stabilized

However, the impact of rising Federal Reserve funds rates is notable, and the corresponding rise in prime mortgage rates forms a structural headwind for AGNC’s book value.

The 30-year prime mortgage rate of 6.6% is at its highest level since 2008, a move that puts AGNC’s positive duration as a barrier to book value growth. Therefore, the most relevant short-term catalyst remains the formation of a clear top and then a decline in the Fed funds rate. Book value is the most important metric because it drives the underlying price of common goods and supports dividends. And while that was under pressure, AGNC said it had risen to between $10.80 and $10.90 a share as of February.

That would be an increase of about 8.9% on the low end from the fourth quarter. This would also mean that the commons are currently trading at a 10% discount to tangible book value. The mREIT recorded GAAP EPS of $0.93 per share, beating consensus estimates by $0.27 for a payout ratio of 38.7% on the 3-month monthly dividend aggregate. While I don’t expect an increase in the near term, as the low coverage ratio masks dividend payouts for five outstanding preferred stocks, the yield could still go higher if the commons face more weakness in the near term.

Preferred E series from fixed to floating

AGNC Series E Fixed to Floating Cumulative Preferred Stock (NASDAQ: AGNCO) offer clear advantages over common commodities and have traded lower in recent weeks. What’s to like here? The annual fixed coupon of $1.63 represents a 7.9% yield on cost, with the preferreds currently trading at $20.75 per share. While this is about 700 basis points lower than the common stock’s dividend yield, its price return over the past 12 months has outperformed the common stock by roughly 1,000 basis points, with Series E down 15.3% versus 25.3% for common stock.

The coupon is paid in quarterly installments, so it may be less attractive to investors looking to mimic salaries compared to monthly payouts. They are currently trading at a $4.25 per share discount to their par value, forming yet another avenue for shareholders to accrue positive returns. This 17% discount to their intrinsic value of $25 represents value that needs to be captured upwards. The uncertainty about this is the timeline for a return to par. Preferreds have traded above this level for most of 2021, with the current downtrend also driven by the rising Fed funds rate and in place since early 2022.

The dichotomy in performance between the two securities on a total return basis is obvious and likely reflects common stocks that have suffered from the specter of dividend cuts and quarterly balance sheets in a seemingly constant downward trend. Series E investors would realize a total return of 55.65% over the past three years, compared to a total return of 14.49% for mutual funds. Over the past 12 months, preference shares are also down 8.91% on a total return basis, compared to a loss of 14.65% for common shares.

This performance gap is likely to persist this year as rising interest rates and a weak economy continue to weigh on AGNC’s underlying book value and payout ratio. The Series E will be redeemed on October 15, 2024 and will also transition to a floating interest rate of three-month LIBOR plus 4.993% per annum. It is important to note that LIBOR will be withdrawn in June this year and replaced by the Guaranteed Overnight Funding Rate (SOFR). For some context, the SOFR currently stands at 4.57%, up from near zero a year ago. Therefore, assuming the coupon is released today, preferred holders will realize a yield of 9.56%.

While the SOFR is likely set to track higher, which looks likely to be two more 25 basis point increases in the Fed funds rate, the SOFR on a Q4 2024 repurchase could be lower than now level if the US falls into recession. This would be especially likely if inflation reaches the Fed’s 2% target. Whether to go with the E series over the generics will come down to two factors. Risk tolerance and confidence in the safety of common stock dividends. The cumulative preference clause essentially eliminates any propensity to stop in the event of future economic hardship, as any unpaid coupon payments will accrue as a redemption payment obligation. I am neutral on both stocks, but total assets could be looked at once the Fed stops raising rates.