Why AGNC Investment Stock Surged 11.2% in December

Shares of AGNC Investment (AGNC 3.75%) rallied by 11.2% in December, according to data provided by S&P Global Market Intelligence. Two catalysts propelled the mortgage real estate investment trust (REIT) higher. First, it declared its latest monthly dividend payment, maintaining its double-digit percentage yield. On top of that, the Federal Reserve indicated that it will likely reduce interest rates in 2024, which could benefit the company.

Falling rates make the dividend more sustainable

When AGNC Investment declared its latest monthly dividend in mid-December, it kept its payout rate at $0.12 per share. That’s the level it has maintained since April 2020, when it reduced its monthly payment from $0.16 per share.

Before that reaffirmation, there had been some concern that the REIT might trim its payout again. On the company’s third-quarter conference call in October, CEO Peter Federico said, “one of the primary factors that we evaluate in setting our dividend is the economic return that we expect to earn on our portfolio at current MBS valuation levels.” He noted that at the company’s current dividend yield (15%), its total capital cost was over 16% when adding in operating expenses. That meant it needed to earn a more than 16% return on equity to fund its operations and dividend. That’s not a problem now, given that it can earn a levered return percentage in the mid-teens to low-20s range. However, the CEO said the company will continue to evaluate the dividend as market conditions and expected returns change.

While market conditions could change this year, those changes could be for the better. The Federal Reserve hinted last month that it will likely cut the federal funds rate three times this year, which would bring the benchmark interest rate from its current range of 5.25% to 5.5% down to around 4.6% by the end of 2024.

Lower interest rates would have dual benefits for AGNC Investment. First, they would reduce the mortgage REIT‘s borrowing costs. On top of that, falling rates typically increase the value of income-generating investments, driving down their yields. As such, we could expect to see AGNC Investment’s stock price rise as rates fall. A higher stock price (and thus a lower dividend yield at the same payout rate) would reduce its cost of capital and lower the return threshold it needs to earn on investments to cover its operating expenses and the dividend. That would reduce the risk of the REIT needing to cut its dividend.

Is AGNC Investment a buy after last month’s rally?

AGNC Investment rallied last month on the belief that the Federal Reserve will cut interest rates a few times this year. Lower rates increase the probability that the mortgage REIT will be able to maintain its sky-high dividend.

However, while its payout looks safer, AGNC is still a risky dividend stock since changing market conditions or returns could cause the REIT to reduce its payout again. Because of that, it’s not the best stock to buy for those seeking a sustainable income stream.