Huge Dividends Won't Be Enough
Summary
- AGNC’s price-to-book is trading around the top of its range. Future gains to book value will be much harder to achieve.
- AGNC will probably boost their dividend later this year, but even that won’t make the current price appealing.
- NLY’s share price is pushing the upper end of our target ranges as well.
- If you’re not using price-to-book, you’re missing out on a critical part of the analysis for mortgage REITs.
- Many readers will continue to ignore warnings in favor of research that reinforces their decisions.
- Looking for a helping hand in the market? Members of The REIT Forum get exclusive ideas and guidance to navigate any climate. Learn More »
Get ready for charts, images, and tables because they are better than words. The ratings and outlooks we highlight here come after Scott Kennedy provides his weekly updates in the REIT Forum. Your continued feedback is greatly appreciated, so please leave a comment with suggestions.
We're going to look at AGNC Investment Corp. (NASDAQ:AGNC) and Annaly Capital Management, Inc. (NYSE:NLY) today.
The main message here is that dividends aren't enough to overcome the importance of evaluating price-to-book ratios. Getting a capital loss that is offset by a dividend isn't the same as getting a capital gain plus the dividend. If investors are stuck with a material decline in the share price, their annualized return is materially weaker. If they believe that the price change doesn't matter, they can simply put money in a savings account and withdraw some (tax free!). Then they can say the declining balance doesn't matter.
To be clear, the market isn't perfectly efficient. Investors shouldn't be evaluating their gain/loss on a daily basis. Most shouldn't even bother to do it on a weekly basis. Further, if the entire market plunges, investors shouldn't berate themselves for having some level of unrealized loss on their portfolio. Temporary declines happen. That doesn't mean investors should ignore when the risk/reward ratio turns against them.
Here's AGNC price and trailing book value charted over the last 9 years or so:
Source: The REIT Forum
What stands out?
Someone may point out that the line moves down as it goes to the right. That's true, but only one part of the equation. What else?
How about the blue line very rarely exceeding the red line? The share price rarely moves above book value. Why would that happen?
If the share price is at that level, the REIT can issue new shares to continue investing in the same underlying assets.
Investors get a substantial dividend. Don't be surprised if it gets raised later this year. However, it doesn't come without material risk. Some investors are going to argue that book value is going to continue upwards indefinitely because it increased for the last several quarters. Does that really seem like an intelligent argument? Let's see if AGNC's slides provide an explanation:
Source: AGNC Q1 2021 presentation, commentary by author
AGNC has finally broken through the top end of our targets and achieved the bearish outlook briefly over the last few days. Despite the significant potential for a dividend increase, shares are already trading at a high ratio and there isn't much room for those book value gains to continue. Does that mean shares are going to fall tomorrow? No, we're not in this business to make 1-day projections. It means the risk/reward profile starting from this point is unattractive. 
Source: Seeking Alpha
That puts shares slightly into the sell range (over $18.60):
Source: The REIT Forum
We had a real-time alert for subscribers when Scott closed out his position for a total return of more than 175%. Those shares were bought at the bottom of the pandemic and 175% gains are NOT typical for our goals. Of course, investors would probably be more impressed by an alert to purchase shares when they are on sale. How about this one from 3/18/2020?
Source: The REIT Forum
How about that call for no material net spread concerns? How well did that play out? Take a look at AGNC's latest chart for their net interest spread from Q1 2019 through Q1 2021:
Source: AGNC
How about Annaly Capital Management? They are the largest mortgage REIT. How is their valuation stacking up against historical levels?
Source: The REIT Forum, author's calculations
They have moved above trailing book value again. They aren't trading far above it, but these premiums have been a little unusual. Book value has recovered materially (but not entirely) since the pandemic. So what factors helped to drive the fluctuations in book value? Well, one was the change in the MBS spreads. That's the spread between MBS and rates and other rates such as Treasury yields or LIBOR swaps. A change in the spreads between MBS and other securities can have a material impact on book value, as NLY will tell you:
Source: NLY, red text/arrow by author
You can see that a 25 basis point shock in spreads could cause NAV to increase by 9% or fall by 8.9%, depending on which way the shock went.
As it stands, NLY is near the top end of the neutral range:
Source: The REIT Forum
You don't have to believe us, but at least review those charts again for historical price-to-book. That's a strong correlation and when we come to our ratings, we consider the estimated change in book value since the last report. That way we are already including the expected changes, rather than waiting for them to be reported. After they are reported, we can check that against our estimates and see what adjustments (if any) need to be made.
What about the rest of the sector?
The average price-to-book ratio has increased materially throughout the sector. This is true in mortgage REITs and true in BDCs. Investors overall are simply willing to pay much higher ratios today. We're not interested in paying higher ratios. We weren't interested in paying higher ratios before the pandemic either. This strategy has worked pretty well:
Source: Seeking Alpha
However, when the prices get low, we want to be bullish instead:
Source: Seeking Alpha
We're following a relatively simple strategy. We're executing it better.
We aren't saying that dividends don't matter. They are an important part of generating return. However, there is often an overwhelming emphasis on dividends that can lead investors to ignore some pretty obvious warning signs.
This is the opposite of being bullish on mortgage REITs before the pandemic and throwing in the towel in early April 2020. Sometimes that happens to investors.
Source: Seeking Alpha
Interesting. The news blurb mentions "limited visibility into current book value". Scott predicted $7.50 for the ending Q1 2020 with a range of $7.15 to $7.85. What did Annaly report? On 4/29/2020 Annaly reported that their book value as of 3/31/2020 had been $7.50. We won't hit every single estimate precisely, but forecasting book value is a great technique.
Stock Table
We will close out the rest of the article with the tables and charts we provide for readers to help them track the sector for both common shares and preferred shares.
We're including a quick table for the common shares that will be shown in our tables:
Type of REIT or BDC | ||||
Agency | Hybrid | Multipurpose | Commercial | BDC |
Let the images begin!
Residential Mortgage REIT Charts
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Source: The REIT Forum
Commercial Mortgage REIT Charts
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BDC Charts
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Notes on Price-to-Trailing Book Ratios - Using Q4 2020 Book Value
Remember that these are price-to-trailing-book ratios. They are not using estimates of current book value. Book values continue to change every day. Scott Kennedy provides frequent updates on estimated book value, ratings, and price targets through The REIT Forum.
Repeated Note: There are three points we need to highlight here:
- AG Mortgage Investment Trust - We are using the Q4 2020 book value reported by management and classified as "adjusted book value per share". Adjusted book value of $3.94 is lower than GAAP book value of $4.13.
- MFA Financial reports "GAAP book value" and "economic book value". We've chosen to use the GAAP book value to remain consistent. GAAP book value per share of $4.54 is lower than economic book value per share of $4.92.
- If the book value per share ratio is absent in the chart, the company has not reported Q4 2020 yet (or did it so recently it isn't in this sheet yet).
Unfortunately, we have to repeat those bullet points every time we publish because it regularly comes up if we don't mention it.
Notes on Common Share Dividend Yield
Dividend yield often comes up in the comments, but picking based on dividend yield is stupid and regularly results in terrible performance. Don't do it.
This chart is still in the same order as the prior charts. Consequently, you know the highest price-to-book ratios (using trailing GAAP book value) for each segment will be at the top. If you see a mistake, please feel free to say something. Occasionally the data for dividend rates requires a manual update.
Notes on Earning Yields
One of the next things investors may ask about is the yield using core earnings. This chart puts together the core earnings based on the consensus analyst estimate. Beware that the consensus estimate may not always be the best estimate. Further, there are ways to increase "Core Earnings" through accounting decisions or modifying hedges. Consequently, investors should still take these values cautiously. We do not depend on the consensus estimate to make decisions.
Preferred Share Charts
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Notes on Preferred Share Prices
This chart gives you a pretty quick feel for which shares are trading at a discount to call value. Each of these preferred shares has a call value of $25.00, but that doesn't mean a share will be called. The company decides if they want to issue a call or not.
Notes on Dividend Yield / Stripped Yield
Stripped yields are vastly more useful than "current" yields for preferred shares. The stripped yield uses the stripped price. That's different from using the current price because it means we already adjusted for dividend accrual. This makes the process easier for investors.
We can talk about shares using "regular prices". Those are the prices an investor would actually use when entering an order.
However, we will provide the stripped yield to adjust for the dividend accrual. In the spreadsheets we host for subscribers, we include the actual ex-dividend date, or the projected ex-dividend date if the actual date isn't yet known. If you're planning to buy a share, it's always wise to check if the shares just went ex-dividend so you can adjust your targets accordingly.
Notes on Floating Yield on Price
Since many of these shares switch over to floating rates, we also want to consider what the yield would be if the floating rate was in effect and shares were still at the current price. To demonstrate that, we use the "Floating Yield On Price". If the share remains at a fixed-rate indefinitely, then the value doesn't change.
One point we need to emphasize here is that we are dealing with yields. A yield must involve the share price. We aren't simply showing the new "rate" if the share began floating, we are adjusting the new rate for the stripped price.
Floor
ACR-C has a floor that interferes with the eventual floating rate. The floor prevents the floating rate from being less than the initial fixed-rate. Consequently, while ACR-C is one of the FTF shares, it doesn't exhibit the same decrease as other FTF shares when we switch over to the "Floating Yield on Price". However, it remains a higher-risk share because of the type of assets the REIT owns.
Called
A call has been announced for shares of IVR-A. For investors considering an investment there, that would be a huge consideration.
Preferred Share Data
Beyond the charts, we're also providing our readers with access to several other metrics for the preferred shares.
After testing out a series on preferred shares, we decided to try merging it into the series on common shares. After all, we are still talking about positions in mortgage REITs. We don't have any desire to cover preferred shares without cumulative dividends, so any preferred shares you see in our column will have cumulative dividends. You can verify that by using Quantum Online. We've included the links in the table below.
To better organize the table, we needed to abbreviate column names as follows:
- Price = Recent Share Price - Shown in Charts
- BoF = Bond or FTF (Fixed-to-Floating)
- S-Yield = Stripped Yield - Shown in Charts
- Coupon = Initial Fixed-Rate Coupon
- FYoP = Floating Yield on Price - Shown in Charts
- NCD = Next Call Date (the soonest shares could be called)
- Note: For all FTF issues, the floating rate would start on NCD.
- WCC = Worst Cash to Call (lowest net cash return possible from a call)
- QO Link = Link to Quantum Online Page
Ticker | Price | BoF | S-Yield | Coupon | FYoP | NCD | WCC | QO Link | P-Link |
$25.83 | FTF | 6.74% | 6.88% | 4.37% | 4/15/2024 | $4.33 | |||
$26.05 | FTF | 6.80% | 7.00% | 5.09% | 10/15/2022 | $1.58 | |||
$25.47 | FTF | 6.46% | 6.50% | 5.09% | 10/15/2024 | $5.22 | |||
$25.18 | FTF | 6.15% | 6.13% | 4.85% | 4/15/2025 | $5.95 | |||
$25.90 | FTF | 6.72% | 6.95% | 4.95% | 9/30/2022 | $1.29 | |||
$25.34 | FTF | 6.42% | 6.50% | 4.25% | 3/31/2023 | $2.52 | |||
$25.90 | FTF | 6.53% | 6.75% | 4.95% | 6/30/2024 | $4.18 | |||
$25.68 | 6.85% | 7.00% | 6.85% | 1/28/2025 | $5.74 | ||||
$25.74 | FTF | 6.79% | 6.90% | 5.50% | 4/15/2025 | $6.16 | |||
$25.51 | 7.45% | 7.50% | 7.45% | 6/30/2021 | -$0.12 | ||||
$25.42 | FTF | 6.70% | 6.75% | 5.29% | 10/30/2024 | $5.49 | |||
$25.30 | FTF | 7.49% | 7.50% | 5.93% | 8/15/2024 | $5.81 | |||
$25.03 | FTF | 7.19% | 7.13% | 5.82% | 8/15/2024 | $5.77 | |||
$23.70 | FTF | 6.79% | 6.38% | 5.43% | 2/15/2025 | $7.29 | |||
$26.14 | FTF | 7.79% | 8.13% | 5.71% | 3/15/2024 | $4.46 | |||
$26.62 | FTF | 7.53% | 8.00% | 5.76% | 6/15/2024 | $4.40 | |||
$25.30 | Bond | 6.68% | 6.75% | 6.68% | 6/30/2021 | -$0.23 | |||
$25.40 | Bond | 6.58% | 6.63% | 6.58% | 6/30/2021 | -$0.14 | |||
$25.38 | 7.90% | 8.00% | 7.90% | 10/30/2021 | $0.30 | ||||
$25.51 | FTF | 7.86% | 8.00% | 5.81% | 3/30/2024 | $5.01 | |||
$25.11 | FTF | 7.73% | 7.75% | 4.86% | 9/30/2025 | $8.15 | |||
$25.02 | FTF | 8.01% | 8.00% | 5.51% | 3/30/2024 | $5.50 |
Second Batch:
Ticker | Price | BoF | S-Yield | Coupon | FYoP | NCD | WCC | QO Link | P-Link |
$26.34 | FTF | 7.81% | 8.13% | 5.56% | 4/27/2027 | $10.86 | |||
$25.37 | FTF | 7.61% | 7.63% | 5.47% | 07/27/2027 | $11.55 | |||
$24.81 | FTF | 7.39% | 7.25% | 5.24% | 01/27/2025 | $7.00 | |||
$26.24 | 7.93% | 8.20% | 7.93% | 08/17/2022 | $1.43 | ||||
$26.05 | FTF | 8.04% | 8.25% | 5.61% | 4/15/2024 | $5.06 | |||
$25.26 | 7.78% | 7.75% | 7.78% | 6/16/2021 | $0.03 | ||||
$24.99 | FTF | 7.76% | 7.75% | 5.31% | 12/27/2024 | $6.81 | |||
$24.90 | FTF | 7.54% | 7.50% | 5.44% | 9/27/2027 | $11.84 | |||
$25.48 | FTF | 7.84% | 7.88% | 6.53% | 1/15/2025 | $6.90 | |||
$25.19 | FTF | 8.06% | 8.00% | 5.87% | 10/15/2027 | $12.81 | |||
$24.78 | 8.06% | 7.88% | 8.06% | 6/30/2021 | $0.62 | ||||
$24.72 | 7.95% | 7.75% | 7.95% | 6/30/2021 | $0.67 | ||||
$24.90 | 7.53% | 7.50% | 7.53% | 6/30/2021 | $0.09 | ||||
$22.90 | FTF | 7.10% | 6.50% | 5.98% | 3/31/2025 | $8.19 | |||
$25.15 | 7.10% | 7.00% | 7.10% | 5/12/2022 | $1.82 | ||||
$25.15 | FTF | 8.39% | 8.25% | 5.89% | 3/30/2024 | $6.06 | |||
$25.15 | 8.22% | 8.25% | 8.22% | 6/30/2021 | -$0.10 | ||||
$24.73 | 8.11% | 8.00% | 8.11% | 6/30/2021 | $0.32 | ||||
$23.65 | FTF | 8.48% | 8.00% | 7.00% | 9/17/2024 | $7.84 | |||
$25.49 | FTF - Floor | 8.60% | 8.63% | 8.60% | 7/30/2024 | $6.52 |
There are a few things you should know at the start:
- When a share can be called on short notice, the annualized yield-to-call reaches absurd levels. Investors shouldn't put too much weight on it. On the other hand, a negative number can be a significant concern. Consequently, we decided to include it in the chart.
- We sort our spreadsheet for subscribers by risk ratings within each sector. We decided to use the same technique for this series since it communicates more information to readers. You'll notice a general correlation where lower risk correlates with a higher price and lower yield, though this link isn't absolute.
- Worst Cash to Call example: Imagine a preferred share that could be called in a few months and would pay out a total of $.75 in dividends by that time. If an investment in those shares ends in a call, the smallest amount of cash inflows possible would be $25.00 (call value) plus $.75 (total dividends). If the share price was $25.60, then the "Worst Cash to Call" would be $.15. That comes from the following equation: $25.00 + $.75 - $25.60 = $.15. If the share price increased by $.20 in the next hour, the "Worst Cash to Call" would decline to negative $.05.
Strategy
Our goal is to maximize total returns. We achieve those most effectively by including "trading" strategies. We regularly trade positions in the mortgage REIT common shares and BDCs because:
- Prices are inefficient.
- Long-term, share prices generally revolve around book value.
- Short-term, price-to-book ratios can deviate materially.
- Book value isn't the only step in analysis, but it is the cornerstone.
We also allocate to preferred shares and equity REITs. We encourage buy-and-hold investors to consider using more preferred shares and equity REITs.
Performance
We compare our performance against 4 ETFs that investors might use for exposure to our sectors:
Source: The REIT Forum
The 4 ETFs we use for comparison are:
Ticker | Exposure |
One of the largest mortgage REIT ETFs | |
One of the largest preferred share ETFs | |
Largest equity REIT ETF | |
The high-yield equity REIT ETF. Yes, it has been dreadful. |
When investors think it isn't possible to earn solid returns in preferred shares or mortgage REITs, we politely disagree. The sector has plenty of opportunities, but investors still need to be wary of the risks. We can't simply reach for yield and hope for the best. When it comes to common shares, we need to be even more vigilant to protect our principal by regularly watching prices and updating estimates for book value and price targets.
Conclusion
AGNC finally reached the bearish territory again. It's been a long time coming. NLY is nearly there as well. The mortgage REITs have delivered absolutely massive returns since they bottomed out. It was critical for investors to be picking up shares in late March and for several months afterwards. Now investors can look to harvest some of the gains in their portfolio. Unfortunately, such suggestions rarely resonate with readers who simply want to hear another reason to keep owning whatever they own.
Ratings:
- Neutral on NLY
- Bearish on AGNC
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This article was written by
Disclosure: I am/we are long AGNCO, NYMTM, CIM-A, AGNCP, ARR-C, CMO-E, NRZ, SLRC, GPMT, PMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Scott Kennedy is also an author for the REIT Forum. You may see his commentary featured in our articles and may notice an extremely high amount of overlap in our ratings. Subscribers reading this article should see Scott’s latest REIT Forum sector update for more detail.