AGNC Investment Corp (AGNC) has a sky-high dividend yield of 10.3%.

It is one of 295 stocks with a 5%+ dividend yield.

And, it is one of a select few with a 10%+ dividend yield.

AGNC yields roughly five times the S&P 500 Index, which has a 2% dividend yield on average.

In addition, AGNC pays its dividend each month, rather than on a quarterly or semi-annual basis. Monthly dividends give investors the ability to compound dividends even faster.

AGNC is one of just 21 stocks that pay monthly dividends.

That said, it is also important for investors to assess the sustainability of such a high dividend yield.

This article will discuss AGNC’s business model, and whether the stock is appealing to income investors.

Business Overview

AGNC was founded in 2008. It is an internally-managed real estate investment trust, or REIT.

Whereas most REITs own properties that are leased to tenants, AGNC has a different business model. It operates in a niche industry, mortgages.

AGNC invests in agency mortgage-backed securities. It generates income by generating interest on its invested assets, minus borrowing costs. It also records gains or losses from its investments and hedging practices.

Source: 2017 First Quarter Presentation, page 7

As of March 31st, its portfolio consisted of $59.5 billion in securities, including $45.0 billion in residential mortgage-backed securities.

The vast majority of AGNC’s portfolio is comprised of fixed-rate mortgages. Approximately 72% of investments are in 30-year fixed rate mortgages. Another 23% of investments are in mortgages with a duration of 15 years or less.

AGNC’s financial performance has suffered over the past year, due primarily to rising interest rates. Net book value declined 6.3% in 2016.

Source: 2017 First Quarter Presentation, page 22

Net interest income fell by 18% in 2016. Net interest income fell by 33% in the first quarter of 2017, compared the previous quarter.

Lower net interest income has resulted in declining book value.

This has also resulted in several dividend reductions over the past few years.

In addition to rising interest rates, the Federal Reserve is likely to taper its mortgage-backed security and Treasury reinvestment program.

A further reduction of the Federal Reserve’s balance sheet would likely be a continued headwind for AGNC.

Going forward, there could be additional downside risk to AGNC’s book value and dividends.

Growth Prospects

One major drawback to mortgage REITs is that the business model is hurt by rising interest rates.

AGNC makes money by borrowing at short-term rates, lending at long-term rates, and pocketing the difference. To amplify returns, mortgage REITs are highly leveraged.

In a rising interest rate environment, mortgage REITs typically see the value of their investments reduced. And, higher rates usually cause their interest margins to contract.

This has negatively impacted AGNC over the past year. To offset this, AGNC has employed hedges to mitigate this interest rate risk.

Source: 2017 First Quarter Presentation, page 9

Hedging helped the company in 2016, and will continue to be an area of focus for the company in 2017.

Last quarter, AGNC’s hedge ratio remained stable, at approximately 90% of funding liabilities. Since the Federal Reserve will likely hike rates again in 2017, and perhaps multiple times, AGNC has stated it will likely maintain or even increase its hedge position.

But, as the U.S. Federal Reserve is likely to continue raising interest rates in 2017, this means the growth prospects for AGNC are quite limited going forward.

AGNC is highly sensitive to fluctuations in interest rates. For every 100-basis point increase in interest rates, AGNC will see a 1.6% change in portfolio market value.

The impact can also be expressed as a percentage of net asset value, which incorporates the impact of leverage.

From this perspective, a 100 basis-point increase in interest rates would reduce AGNC’s portfolio market value by 13.9%, as of March 31st.

On the plus side, agency mortgage-backed security spreads remained stable during the first quarter, and ended the quarter slightly wider.

Moreover, while the Federal Reserve is widely expected to keep raising interest rates moving forward, it will most likely do so at a slower rate.

However, mortgages are still under-performing, as the market is pricing in the potential for the Federal Reserve to begin reducing the size of its balance sheet.

Therefore, AGNC should be thought of more as an income stock than a growth stock.

Dividend Analysis

AGNC declared a monthly dividend of $0.18 per share for June. On an annualized basis, its dividend payout is $2.16.

This means AGNC has a 10% dividend yield.

A double-digit dividend yield is often a sign of elevated company risk. And, AGNC’s dividend does carry significant risk.

As its fundamentals have deteriorated, AGNC has reduced its dividend several times over the past few years.

For example, in the first quarter 2017, AGNC paid dividends of $0.54 per share. In the same quarter last year, dividends totaled $0.60 per share.

AGNC paid $0.66 per share in the first quarter of 2015.

One major risk is that the mortgage REIT business model involves heavy use of leverage. AGNC makes investments that are financed primarily through collateralized borrowings.

AGNC ended the first quarter with a leverage ratio of 7.4, which is quite high. Its high leverage, combined with the effects of higher interest rates, could lead to more dividend reductions going forward.

A dividend yield is only as good as a company’s ability to make the payouts.

If AGNC reduces its dividend by another 10%-15% over the next year, its real yield to shareholders will not be as good as advertised.

A 10%-15% dividend reduction would lower the effective dividend yield for investors buying right now, to roughly 8.8%-9.3%.

Final Thoughts

Mortgage REITs performed very well from 2009-2012, as interest rates remained low and the Federal Reserve expanded its balance sheet.

This gave mortgage REITs a sustained tailwind.

But since 2013, tightening monetary policy has taken a steep toll on AGNC.

It has cut its dividend several times, and the stock price has declined 35% in the past five years.

While AGNC should continue to pay a dividend yield substantially higher than the S&P 500 average, it is not an attractive option for dividend growth investors.