Considering the current price drop below $10, is it wise to invest in AGNC?
With a forward yield of 15%, it's no surprise that AGNC Capital Investment Corporation (AGNC 1.72%) often attracts the interest of income-focused investors seeking supplemental income from dividends. What makes it even more appealing is its monthly dividend distribution, providing a consistent payment to investors every month. Since April 2020, the same $0.12 dividend has been paid out consistently.
Despite this, the stock has faced challenges over the past few years, with its price decreasing around 44% over a five-year period. When considering the dividends, the total return for this period is approximately 3%. While dividends have been consistent, their value has remained unchanged since April 2020. Although it still managed a positive return, this performance was subpar given the market's strength during this time span.
However, better times are likely ahead for this investment trust.
Understanding AGNC Capital Investment Corporation
Before considering an investment in AGNC, it's essential to comprehend its business operations. Admittedly, the concept may appear complex, but let us provide a simplified explanation.
AGNC is a mortgage real estate investment trust (REIT) that invests in mortgage-backed securities (MBS) that are supported by government or government-guaranteed agencies, such as Fannie Mae, Freddie Mac, and Ginnie Mae. Simply put, it manages a portfolio of mortgages. Since these mortgages are backed by the government, they carry no default risk.
AGNC generates income through short-term financing, often using repurchase agreements, and then purchases longer-term MBS. The income generated from these MBS investments is used to pay the dividend.
Short-term financing rates may fluctuate, so mortgage REITs also employ hedging strategies to align the financing duration with that of their MBS investments. This is typically achieved through the use of interest rate swaps.
Using hedging has been crucial for mortgage REITs in recent years, as there has been an extended inverted yield curve, which only recently returned to normal earlier this year. An inverted yield curve occurs when short-term rates surpass long-term rates.
Although AGNC's funding expenses have risen over the past year, it has managed to maintain a healthy net interest spread, which is the difference between its funding expenses and the yield of its MBS portfolio. Hedging was instrumental in reducing its funding expenses by 2.9% in the last quarter. Without hedging, the yield of its portfolio would have falling short of its funding expenses.
While mortgages have faced some strain with narrowing net interest spreads this year, the most significant challenges they've faced over the past few years have been the decline in the value of MBS. As interest rates have risen and spreads between MBS and Treasury bonds have widened, the current carrying values of MBS have decreased.
The reason for this is rather straightforward. If an investor purchased a fixed-income security, like a Treasury bond or MBS, with a 4% yield, and current rates for similar newly issued securities were now 7%, the investor would not be able to sell the original security at its face value and then buy the new security with the higher yield. Instead, the investor would have to sell the original security at a discount, which would align itself more closely with the yield of the newly issued security.
As a result, as new MBS began to offer higher coupons, the value of older MBS with lower coupon rates decreased. This is reflected in a mortgage REIT's tangible book value (TBV), which represents the current value of its portfolio. During the periods between 2021 and 2023, AGNC's TBV per share dipped 45%, dropping from $15.75 per share to $8.70 per share. By the end of last quarter (Q3 2024), it had stabilized at $8.82.
Expecting Better Performance for AGNC in the Future
The decline in AGNC shares directly correlates with the decrease in its TBV, which was driven by rising rates and the widening spread between MBS and Treasuries. Currently, there is a strong indication that rates will fall, while spreads should remain stable or possibly narrow.
On the interest rate front, the Fed has already decreased rates twice this year, reducing them by 50 basis points in September and an additional 25 basis points in October. Fed officials have hinted that rates are likely to continue to fall over the next two years. Meanwhile, the spread between mortgage rates and Treasuries currently stands at around 2.5%, which is historically high. As interest rates decrease, the spread should narrow. Many banks and other financial institutions will likely revisit higher-yielding instruments like MBS as rates decrease, the yield curve returns to its normal state, and market volatility subsides.
If the spreads narrow down, AGNC stands to gain substantially, enhancing its net asset value (TBV). Even if the spreads merely maintain their current levels, as per the company's predictions, it's expected to offer an excellent investment setting for the REIT, surpassing the past few years. Furthermore, with the Fed reducing short-term rates, AGNC's funding costs are set to decrease significantly over the next few years. The combination of high long-term rates and low short-term rates forms an ideal investment climate for mortgage REITs.
Consequently, given a 15% yield and a more promising investment scene, AGNC appears to be a solid acquisition at its current stock price below $10. It's projected to provide consistent dividend income, coupled with a potential for modest stock price growth in the future.
Investors interested in finance and seeking income-focused opportunities might consider AGNC Capital Investment Corporation, as its notable forward yield of 15% draws interest. This mortgage real estate investment trust (REIT) generates income by investing in mortgage-backed securities, such as those supported by agencies like Fannie Mae, Freddie Mac, and Ginnie Mae, and leverages hedging strategies to manage risk and alignment of financing duration.
With recent gains in hedging, AGNC has successfully maintained a healthy net interest spread, which benefits from reduced funding expenses. In the coming years, forecasted declines in interest rates and potential narrowing of spreads between MBS and Treasuries could significantly improve AGNC's net asset value, making it an attractive investment opportunity for those interested in investing and finance.
