With an eye-popping 13.7% dividend yield, AGNC Investment (AGNC +0.48%) is a popular stock for investors seeking passive income.

As a player in the residential housing market, AGNC is vulnerable to fluctuations in interest rates and the broader economy. The company faced challenges in recent years as the Federal Reserve raised its benchmark interest rate to fight inflation. However, the central bank has lowered its rate over the past year and a half, with further reductions expected.

Lower interest rates could bode well for AGNC and its investors, as they improve the economics of its business. With the stock below $11 per share, is this a good time to buy AGNC? Let’s dive into the company and learn more.

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Here’s how AGNC can afford its high dividend yield

When investing in real estate companies, one structure companies use is a real estate investment trust (REIT). These are companies that invest in real estate, typically in a specific niche, such as apartments, shopping centers, or residential mortgages, as in the case of AGNC. The tax structure requires these companies to pay out at least 90% of their taxable income to shareholders, allowing them to avoid corporate taxes while also providing investors with a high-yielding source of passive income.

AGNC Investment Corp.

Today’s Change

(0.48%) $0.05

Current Price

$10.49

AGNC is different from a traditional REIT in that it invests in mortgage-backed securities rather than owning and operating physical properties. These mortgages are backed by government-sponsored enterprises (GSEs), such as the Federal National Mortgage Association (commonly known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (often referred to as Freddie Mac).

The company earns income from the interest rate spread between its borrowing costs and the yield on its mortgage assets. However, with mortgage rates currently hovering around 6%, how does AGNC afford its high dividend yield? The answer is leverage. AGNC borrows money on a short-term basis and then uses these funds to finance its investments. It uses instruments such as repurchase agreements and short-term debt, generally with repayment terms of one year or less.

As of the third quarter, AGNC’s at-risk leverage ratio was about 7.5 times its tangible net book value. This helps boost returns when interest spreads (the difference between its long-term investments and short-term debt) are favorable. On the flip side, it creates drag when short-term rates rise, and the interest rate spread narrows.

AGNC could benefit from this tailwind

AGNC’s recent financial results were mixed. Because the value of its investments is inversely related to interest rates, the decline in rates has benefited its book value. The company saw its tangible net book value per share increase from $7.81 as of June 30 to $8.28 as of Sept. 30.

Additionally, lower funding costs from the September and October rate cuts, along with potential future rate cuts, are likely to benefit net spread and dollar roll income. These are metrics that management uses to measure the company’s earnings potential. Lower funding costs help reduce the cost side of the net spread equation, leading to the expected increase in net spread and dollar roll income.

CEO Peter Federico attributed AGNC’s improved performance to the Federal Reserve’s pivot to a less restrictive monetary policy stance and the easing of fiscal policy concerns, which drove “robust financial market performance and a significant improvement in investor sentiment.”

Is AGNC right for you?

Investors who purchase AGNC should be aware of its interest rate sensitivity and how this can impact the investment value over time. This can lead to periods of underperformance and reductions in its dividend payments.

That said, AGNC stands to benefit from further Federal Reserve interest rate reductions. According to the CME FedWatch Tool, market participants project interest rates could be 0.75% to 1% lower one year from today. Gradually falling rates should benefit AGNC, as it will lower its borrowing costs and help boost its income and book value.

AGNC is a play on residential housing with leverage, and an uptick in inflation and rising interest rates could weigh on this business. If you’re comfortable with these risks and want to boost your passive income, AGNC looks like a good stock to buy ahead of additional interest rate cuts.