AGNC Investment Reports Stable Book Value, But Are Troubled Waters Ahead?
JThe US economy is struggling to cope with an unusually high level of inflation, which hasn’t been a problem for decades. On the contrary, the Federal Reserve has been unhappy because inflation has been too low for too long in the past.
The latest spurt in inflation has been attributed to supply chain issues, product shortages, labor shortages and rising wage growth, and the Fed is forced to take steps to resolve the problem. To deal with the coronavirus pandemic, the Fed stepped up the purchase of Treasuries and mortgage-backed securities. To cope with rising inflation, the Fed recently announced its intention to start reducing its purchases of these assets.
This move could potentially mean bad things for agency mortgage investors like AGNC Investment (NASDAQ: AGNC).
Mortgage REITs are different from typical REITs
AGNC is a mortgage real estate investment confidence (REIT), which is different from most REITs. The typical REIT develops real estate assets and then leases them out. It could develop apartment complexes, office buildings or shopping malls.
Mortgage REITs do not invest in real estate, but buy back real estate debt. If you recently refinanced your mortgage, chances are it will eventually be secured by Fannie Mae Where Freddie Mac, then securitized. A common investor for these mortgage-backed securities is a mortgage REIT like AGNC Investment. These securities are guaranteed by the US government, so there is almost no risk of default.
Fed actions could negatively affect the sector
The other big investor in these mortgage-backed securities is the Federal Reserve, which has been buying them since the early days of the pandemic. The Fed intervened in this market as broader financial markets became illiquid at the start of the pandemic. This stabilized financial markets, and now the Fed is starting to reduce its footprint. Starting in November, it will reduce its purchases of mortgage-backed securities and treasury bills with the aim of ending excess purchases altogether by next summer. The term for this program is “tapered”.
So far, mortgage-backed securities markets are following the plans announced by the Fed, which is good news for mortgage REIT investors. In 2013, the Fed began to scale back its purchases of mortgage-backed securities following the Great Recession. Interest rates have risen so rapidly that mortgage REITs like AGNC have experienced steep declines in book value per share and have been forced to cut dividends. The Fed seems keen to prevent a recurrence, so it has been much more transparent in its plans.
AGNC positions itself conservatively
Although we are not seeing a sharp increase in interest rates, AGNC Investment still maintains a cautious approach to risk, operating at a low leverage (average debt divided by average equity) of around 7. 5 times. Leverage is another term for borrowed money, and it’s how AGNC Investment turns a portfolio of mortgage-backed securities paying 3% into a dividend yield of 9%. It is the same concept as using margin on your stock trades. If your stock goes up, it amplifies your gains. If your stock is down, you could be subject to margin calls or additional down payment requests.
AGNC reported tangible book value per share in the third quarter (which is one of the most important numbers for mortgage REIT investors) was $16.41, an increase of $0.02 per share. Mortgage REITs generally trade around book value per share and, at current levels, AGNC is trading at a slight discount. Tangible book value will depend on earnings and prices of mortgage-backed securities.
The other crucial number for mortgage REITs is the dividend yield, which is currently 9%. AGNC pays a monthly dividend of $0.12 per share. So far, mortgage-backed securities markets are bullish on Fed policy changes, but mortgage REIT investors should be cautious and price-sensitive. Investors should only intervene when the stock is trading at a high single-digit discount to the tangible book value per share.
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