Should one Buy, Sell, or Maintain Positions in AGNC Investment's Stock?
Should one Buy, Sell, or Maintain Positions in AGNC Investment's Stock?
AGNC Capital Investment Corporation (AGNC 0.42%), functioning as a real estate investment trust (REIT), concentrates on investing in residential mortgage-backed securities. This investment choice sparks controversy among income-focused investors. On one hand, supporters celebrate its substantial forward yield of 15%, while skeptics view it as a high-yield trap that has failed to deliver substantial gains for its income-oriented investors. Let's delve into AGNC's business model to determine whether purchasing, selling, or holding its stock is advisable.
How does AGNC create revenue?
Most REITs pursue property acquisition, rent it out, and share rental income with their investors. Contrarily, mortgage REITs (mREITs) such as AGNC bypass property ownership; instead, they provide their own mortgages or buy mortgage-backed securities (MBSes) to generate interest income.
Like REITs, mREITs are obligated to distribute at least 90% of their taxable earnings as dividends to maintain an advantageous tax status. Although this seems like a dependable business model, it exposes mREITs to a myriad of interest rate, prepayment, credit, and rollover risks.
In low-interest-rate environments, mREITs generate less income. Furthermore, borrowers may refinance loans at competitive rates, or sell underlying properties as mortgage rates fall. Conversely, if interest rates are unreasonably high, demand for new mortgages will diminish, affecting mREITs' potential for growth. Moreover, borrowers frequently secure loans at lower short-term interest rates than high long-term rates. An inverted yield curve (when short-term rates surpass long-term rates) harms their ability to renew loans with more appealing interest rates as they mature.
These unpredictable factors increase mREITs' risk levels and volatility compared to traditional REITs. However, mREITs reward investors with higher yields due to their tolerance for higher risk and greater profitability.
Reasons to buy or hold AGNC
AGNC dedicates over 98% of its portfolio to agency MBS assets supported by Fannie Mae, Freddie Mac, or Ginnie Mae. Fannie and Freddie are government-sponsored organizations, while Ginnie is a government-owned entity within the U.S. Department of Housing and Urban Development (HUD).
AGNC claims that government backing "substantially reduces credit risk and shields us from mortgage default payments." The remaining portion of its portfolio funds non-agency investments, providing it with more flexibility during market fluctuations. In essence, AGNC represents a more secure option than other mREITs that invest in non-agency MBSes and riskier mortgages.
AGNC stands out as one of the few mREITs with an exclusive "captive" broker-dealer. Its deal is with Bethesda Securities, a member of the Fixed Income Clearing Corporation (FICC) and the Financial Industry Regulatory Authority (FINRA). This partnership allows AGNC access to reduced wholesale funding rates and reduced credit requirements, distinguishing it from competitors with non-captive arrangements with their brokers and dealers. Additionally, AGNC is one of the rare mREITs that delivers monthly dividends, and its payout ratio remains below 100%. Moreover, its price-to-book ratio is 1.1, indicating an appealing valuation.
Reasons to sell or avoid AGNC
Critics argue that despite AGNC's substantial dividends, its overall performance is disappointing and underperforms the market. Over the past decade, AGNC's stock price plummeted by 58%. Moreover, it reduced its dividend by 25% in 2020 to cope with pandemic-related challenges, and it has not adjusted its payout since.
Assuming you reinvested your dividends, AGNC's 10-year total return would be 38%. However, most investors purchase REITs for reliable, steady dividends rather than reinvesting their payments. During this same period, the S&P 500 generated a 245% total return.
In comparison, Realty Income - a prominent player in the retail REIT sector - surged by 27% and delivered a 101% total return during this timeframe. Furthermore, Realty Income consistently elevated its dividends throughout the pandemic, proving more successful than AGNC in various aspects. In conclusion, AGNC's unimpressive performance contrasts with market standards and traditional REITs.
Is AGNC the right choice for buying, selling, or holding?
AGNC presents a tempting low price and high dividend, but its vulnerability to varying credit and interest rate risks diminishes its appeal compared to other REITs. Therefore, for now, I would sell or avoid this stock (as well as most mREITs) and opt for resilient retail REITs like Realty Income instead.
Given the focus on AGNC's investment strategy in mortgage-backed securities and its high dividend yield, two additional sentences could be:
- Investors considering AGNC as part of their diversified finance portfolio might want to closely monitor changes in interest rates, as fluctuations could significantly impact its revenues from mortgage-backed securities.
- In the context of investing strategies, some financial advisors suggest a balanced approach towards AGNC and other high-yielding mREITs, pairing them with more stable income-generating assets to mitigate associated risks.