With a term yield by 15%, it isn’t stunning that AGNC Funding(NASDAQ:AGNC) usually finds itself on the radar of income-oriented traders trying to complement their revenue with dividends. Better of all, the true property funding belief (REIT) pays a month-to-month dividend, offering traders with a daily month-to-month fee every month. It has paid the identical month-to-month dividend of $0.12 since April 2020.
That stated, the inventory has struggled lately, with the worth down about 44% over the previous 5 years. Bearing in mind the inventory’s dividends, its complete return over this era is roughly 3%. And though the dividend has been paid, it has not modified since April 2020. Although it has all the time generated a constructive yield, it’s not a good return given the power of the market over this era.
That stated, higher days ought to be forward for the REIT.
Earlier than contemplating an funding in AGNC, traders ought to first perceive precisely what the corporate does. Certain, it is somewhat difficult, however let’s attempt to break it down as merely as attainable and clarify why mortgage REITs have struggled lately.
AGNC is a mortgage REIT that invests in mortgage-backed securities (MBS) backed by authorities or government-sponsored businesses, equivalent to Fannie Mae, Freddie MacAnd Ginny Mae. Extra merely, it has a portfolio of mortgage loans. Since these mortgages are basically assured by the federal government, they carry no threat of default.
AGNC makes cash utilizing short-term funding, often within the type of repurchase agreements, after which purchases longer-term MBS. It then makes cash from the distinction between the rate of interest unfold between its financing prices and the revenue generated by its MBS investments. This revenue is then used to pay its dividend.
Quick-term funding charges can fluctuate, so mortgage REITs additionally hedge these charges to higher match the period of the MBS of their portfolios. That is accomplished via broadly used hedging methods, equivalent to the usage of rate of interest swaps.
Hedging has been significantly necessary for mortgage REITs lately as a result of there was a traditionally lengthy inverted yield curve, which solely not too long ago returned to regular earlier this 12 months. An inverted yield curve happens when short-term charges are larger than long-term charges.
Although AGNC’s financing bills have elevated over the previous 12 months, the corporate has nonetheless managed to keep up a wholesome web curiosity unfold, which is the distinction between its financing prices and the yield of its MBS portfolio. Hedging managed to scale back its financing prices by 2.9% final quarter. With out hedging, the return on its portfolio would have been decrease than its financing prices.
Though mortgages have confronted some strain because of narrowing web curiosity spreads this 12 months, the largest downside they’ve confronted lately has been the decline within the worth of MBS. As rates of interest have risen and spreads between MBS and Treasuries have widened, the present guide worth of MBS has fallen.
The reason being fairly easy. If you happen to invested in a hard and fast revenue safety, equivalent to a Treasury bond or MBS, with a yield of 4% and present charges for newly issued comparable securities had been now 7%, you wouldn’t be capable to promote the safety that you simply personal at its face worth. and switch round and purchase the brand new safety with the very best yield. As an alternative, you’ll need to promote the safety you personal at a reduced worth in order that it intently matches the yield of the newly issued safety.
So, as newer MBS started to have larger coupons, the worth of older MBS issued with decrease coupon charges fell. This reveals up in a mortgage REIT’s tangible guide worth (TBV), which represents the present worth of its portfolio. Between the tip of 2021 and the tip of 2023, AGNC noticed its TBV per share drop 45%, from $15.75 per share to $8.70 per share. On the finish of the final quarter (Q3 2024), it was at $8.82, so it stabilized in 2024.
Picture supply: Getty Photos.
The decline in AGNC inventory is straight correlated with the decline in its TBV, pushed each by rising charges and the widening unfold between MBS and Treasuries. At present, every part signifies that charges will fall whereas spreads ought to a minimum of stay secure.
On the rate of interest entrance, the Fed has already lower charges twice this 12 months, decreasing them by 50 foundation factors in September and one other 25 foundation factors in October. In the meantime, Fed officers usually count on charges to proceed falling over the following two years.
In the meantime, the unfold between mortgage charges and Treasuries is at present round 2.5%, which is traditionally excessive. The hole widened largely as a result of the Fed stopped shopping for MBS after its interval of quantitative easing through the pandemic, then let its MBS run out and changed them with Treasuries. On the similar time, many banks and different monetary establishments have additionally given up on shopping for MBS, however there are indicators they may return with charges anticipated to fall, the yield curve not inverted and fewer volatility out there. As charges fall, these establishments are anticipated to begin shifting towards higher-yielding devices equivalent to MBS.
If spreads slender, AGNC will likely be an enormous beneficiary by growing its TBV, however even when they keep round present ranges, which its administration expects, this could make for an excellent funding atmosphere for the REIT by in comparison with current years. . On the similar time, because the Fed lowers short-term charges, it’s anticipated to start lowering its funding prices over the approaching years. Excessive long-term charges and low short-term charges create a great funding atmosphere for mortgage REITs.
As such, with a 15% yield and a significantly better funding atmosphere, AGNC seems to be a stable purchase possibility with its shares priced beneath $10. It ought to present robust dividend revenue with the potential for average inventory worth appreciation sooner or later.
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Geoffrey Seiler has no place in any of the shares talked about. The Motley Idiot has no place in any of the securities talked about. The Mad Motley has a disclosure policy.
