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Income-oriented investors won’t be able to find a much higher dividend option right now. AGNC investment (AGNC -2.14%), the dividend yield is almost 15%. This is a much higher annual dividend than the average annual return of the stock market.
However, jumping into this high-yield stock simply because it pays a high dividend isn’t necessarily the best bet. There’s more to this story. Actually, there is more to this story.
But first things first.
What exactly is a mortgage REIT?
You’re probably familiar with traditional company stocks.own shares coca colaFor example, it means sharing the profits made from selling the world’s favorite beverage.position in apple This reflects the revenue-generating and profit-generating success of the iPhone and the company’s other devices and services.
However, AGNC Investment is not a traditional company. That is a real estate investment trust (REIT). Most of these businesses are structured to own rental-generating properties such as hotels, apartment complexes, and shopping malls. As long as 90% of a REIT’s income is returned to shareholders in the form of dividends each year, that income is not taxed first at the corporate level (reducing net income).
But even by REIT standards, AGNC Investment is an anomaly. Does not own real estate. Rather, the company owns a bundle of mortgage loans made by government-run entities such as: fannie mae, freddie mac, Ginnie Mae. These mortgages naturally result in interest payments to their owners.
The twist? AGNC Investment uses borrowed funds (which also accrue interest) to purchase a bundle of these mortgages.
It can be a bit of a headache. REITs pay interest to earn interest. However, this model typically works because AGNC Investment borrows short-term funds at lower interest rates to fund the purchase of long-term mortgages that pay higher interest rates.
Except the model recently broke.
Defensive AGNC investment
Even if you’re only cursorily monitoring market conditions, you’ve probably heard about the yield inversion occurring over the past few months. It only means that interest rates on short-term securities and bonds are higher than interest rates on long-term bonds and other debt, leading investors to question the near-term future of the economy and expect stimulatory rate cuts as a result. This is a phenomenon that can sometimes be seen when . These rate cuts tend to have a large impact on long-term bond prices, so investors gravitate towards relatively stable short-term bonds during times of uncertainty.
And yes, such changes can be very disruptive to mortgage REITs like AGNC Investment.In fact, it is have That’s why I messed things up. AGNC Investments has reported negative net interest income in each of the past four quarters as short-term borrowing costs have gradually increased while interest rates on the long-term mortgage set have gradually declined. The company currently regularly reports unrealized losses on the value of certain of its mortgage-backed securities.
AGNC Operating Cash (Quarterly) Data by YCharts.
That doesn’t prevent it from continuing to pay dividends, at least not yet. AGNC Investment has cash and cash equivalents on its books and can sell securities as necessary to generate dividends.
However, this is a less than ideal situation. Companies do not want to be forced to sell assets on terms other than their own choice. (In terms of price, REITs can be harmed in the long run by giving up on securities that may appreciate in value further in the future.)
It also stands to reason that deficit management is more of a problem than supporting dividend payments.
This is the entire reason why AGNC Investments has performed so dismally since mid-2021, when the cracks in the economy started to show and the first signs that the yield curve was finally inverting. REIT stocks lost about half of their value during that period.
Of course, there are problems for would-be investors. Dividends are still being paid, but AGNC’s unrealized losses are significant. Investors who prefer the option of liquidating dividend-paying positions while keeping at least a large portion of their initial positions will have a hard time enduring such setbacks.
There’s also another ugly reality. The company is still paying dividends, but sooner or later something has to be sacrificed. If the inverted yield curve continues for a while, it may become impossible to maintain dividends.
Not the right high dividend stock for everyone
However, the global economy will probably experience a soft landing as the yield curve inverts. That would definitely work in REITs’ favor. And for the record, interest rates have been moving in that direction ever since preliminary annual gross domestic product (GDP) growth in the fourth quarter came in at 3.3%, well above expectations of 2%. . never say never.
Still, this is not the kind of volatility that the faint-hearted income investor would like…despite the huge dividend yield it provides. Mortgage REITs like AGNC Investment rely heavily on borrowing leverage and are highly sensitive to slight disruptions in interest rates and credit markets. Full-blown economic weakness could be nearly catastrophic for them.
In other words, if safety is a concern, look elsewhere. You may not be able to find any other stock with a higher yield than this one. However, stocks with much lower volatility and risk may offer above-average yields. Being able to sleep at night is also important.
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