AGNC Investment (NASDAQ: AGNC) is not a dividend stock, despite the huge 14% or so dividend yield. It is a total return stock, which basically means to fully benefit here you need to reinvest dividends. But there's another open secret about AGNC's business model that you need to understand before you buy the mortgage real estate investment trust (REIT).
What does AGNC Investment do?
It is important to understand that AGNC Investment is not your typical property-owning REIT . Property-owning REITs are fairly simple to understand: They buy a property (like an apartment building, warehouse, or mall) and then lease the property out to tenants. This is what you would do if you bought a rental home. Mortgage REITs like AGNC buy mortgages that have been pooled into bond-like securities.
Image source: Getty Images.
In this way, AGNC is more like a bond fund than a traditional REIT. However, it is still a company so it has more leeway in the way its business gets financed. The big open secret here is that AGNC, like other mortgage REITs , makes liberal use of leverage in an effort to enhance shareholder returns. The goal is to generate more in interest from the mortgage bonds than it pays in interest costs.
At the end of the second quarter of 2024 AGNC Investment's balance sheet noted that it had pledged nearly $55 billion of its roughly $59.6 billion agency securities (this is its mortgage bond portfolio). Some simple math shows that the company has basically pledged roughly 92% of its bond portfolio. But what does "pledged" mean?
AGNC's leverage increases risk
In the company's 10Q (which is its quarterly report to the SEC), it states that:
We pledge our securities as collateral under our borrowings structured as repurchase agreements with financial institutions. Amounts available to be borrowed are dependent upon the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, type of security and liquidity conditions within the banking, mortgage finance and real estate industries. If the fair value of our pledged securities declines, lenders will typically require us to post additional collateral or pay down borrowings to reestablish agreed upon collateral requirements, referred to as "margin calls."
There's a lot to unpack there. For starters, pledging basically means the company is using its mortgage bond portfolio as collateral for loans. But go back to the percentage of the portfolio that is pledged -- virtually the entire thing, at 92% or so! Mortgage bonds aren't like buildings that trade infrequently. They trade all day long so their value can be impacted quickly, with AGNC offering just some of the possible catalysts (from interest rates to housing market dynamics) that could cause price volatility.
In and of itself using leverage isn't a bad thing, but it increases risk. That's particularly true when you use a lot of leverage, like pledging 92% of your mortgage bond portfolio as collateral. So investors have to ask what happens when things don't go as well as planned, meaning the value of the collateral falls. Well, that's when a margin call might come up, which would require AGNC to post additional collateral (there's not much more to pledge) or pay down its borrowings. A margin call would likely mean selling mortgage bonds at what would, presumably, be an inopportune time.
Although AGNC Investment hasn't had any problems with the loans it has taken out, it also didn't live through the bull brunt of the housing-led Great Recession , having come public in May, 2008. (That might have been a great time to start out, since the mortgage market at that point was in a deep downturn.) For example, American Home Mortgage, once a top-10 mortgage lender, went bankrupt in 2007. New Century Financial sought out bankruptcy protections the same year. But there were numerous mortgage REITs that were hit hard by margin calls during the coronavirus pandemic, as well, including MFA Financial , Invesco Mortgage Capital , and AG Mortgage Investment Trust . In fact, the mere fear of a margin call can lead the entire mortgage REIT sector lower.
In other words, when things go south they can go south in dramatic fashion because AGNC might get caught up in a mortgage REIT sell off or, perhaps, end up being a forced seller itself. Downturns can quickly turn into downward spirals.
AGNC data by YCharts
AGNC is not meant for the average investor
The problem with AGNC Investment is that dividends are an important part of its return profile, noting that the stock has a roughly 14% dividend yield . Only, as the chart above highlights, the dividend has been cut regularly for years. The yield has stayed high because the stock price has tracked the dividend lower. That's a terrible outcome if you spend the dividend income your portfolio generates. This is not an income stock.
But if you reinvested the dividends , AGNC Investment has actually turned out to be a positive investment. That's because the huge dividend is buying a lot of additional shares, allowing investors to benefit from compounding. Asset allocators looking for mortgage exposure will probably be interested here. You just need to go in understanding the dynamics of the business, which involves the added risk of leverage. The company isn't hiding that fact, but it often gets overlooked because the downside it can cause isn't a frequent occurrence. The problem is that when the risk does make itself known it can be a quick and painful reminder that leverage can increase both profits and losses.
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Reuben Gregg Brewer 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 .
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