Is AGNC Investment a Discounted Purchase Compared to Book Value?


While stock market volatility has received tremendous attention in the press, the fall in interest rates is perhaps even more dramatic. The yield on 10-year bonds has fallen from 1.92% to 0.77% since the start of the year. Falling interest rates are good for bonds, and mortgage-backed securities are bonds, so Mortgage Real Estate Investment Trusts (REITs) like AGNC Investment Corp. (NASDAQ: AGNC) that should be fine, right? Not so fast.

The flight to safety has pushed rates to record highs

We have seen an unprecedented drop in interest rates over the past two months, which is great news for everyone’s bond portfolio. If you had the IShares 20+ Treasury Bond ETF (NASDAQ: TLT), you’ve grown over 23% since the start of the year between dividends and capital gains. Corporate bonds played less of a role, as the IShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEMKT: LQD) rose only about 5.5%, likely due to recession fears offsetting the change in interest rates. Agency mortgage backed securities are government guaranteed, so there is no credit risk. However, large companies investing in these securities did not participate in the rally. Why is that?

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Why Mortgage Backed Securities Don’t Act Like T-Bills

Mortgage-backed securities differ from traditional bonds in one key feature, which is the ability for the borrower to repay the bond at any time. This means that these securities react differently to changes in interest rates. When rates fall, borrowers will choose to refinance their current mortgages, meaning mortgage-backed securities with higher note rates will be more likely to prepay. This limits the benefit they receive when rates fall.

At some point, higher-rate mortgage-backed securities become completely immune to decreases in interest rates. The weighted average coupon of AGNC’s portfolio at year end was 4.26%, with the current 30-year fixed rate mortgage at 3.26%. Much of this portfolio is in the money, which means that it will make financial sense for the borrower to refinance the mortgage. This means that a mortgage-backed security that traded at 104 or 105 cents on the dollar a week ago could be repaid sooner at 100 cents on the dollar in the following month.

AGNC interest rate risk

In AGNC’s most recent 10-K, the company discusses the effect of rate changes on its portfolio. Note that shocks negatively affect the portfolio, although rate hikes have a more severe effect. Also note that changes in profit / loss do not scale linearly with shocks. Finally, these shocks are modeled according to what the company think pricing of mortgage backed securities will do the trick. The mark-to-market will be different from the mark-to-model.

Interest rate change Estimated change in portfolio value Estimated change in tangible book value
– 100 basis points (0.5%) (6%)
– 50 basis points (0.1%) (0.9%)
+ 50 basis points (0.4%) (4.7%)
+ 100 basis points (1.3%) (14.8%)

Source: AGNC 10-K

As at December 31, 2019, the tangible book value per AGNC share was $ 17.66. Applying this 6% decrease results in a book value of $ 16.60 per share. So while the current price as of Friday, March 5 is $ 17.10, it doesn’t really negotiate at a discount to reserve. Book value is probably closer to $ 16.60 per share and decreases faster the longer it lasts. This will put the dividend at risk. As a general rule, financiers (and mortgage REITs in particular) like financial stability. Trying to buy the agency’s mortgage REITs right now with plummeting rates is like trying to grab a falling knife. REITs that are more exposed to credit will be less exposed to this event, and their performance will depend on whether or not the novel coronavirus pandemic causes a recession. For agency REITs, it’s all about interest rate risk. Once things stabilize, it’s time to take a look. But not now.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.


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