Please ensure Javascript is enabled for purposes of website accessibility

How the Federal Reserve Has Helped AGNC Investment

By Brent Nyitray, CFA - Updated Aug 7, 2020 at 10:51AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

An assist from the central bank.

The COVID-19 crisis has been particularly unkind to the mortgage real estate investment trust (REIT) sector. In March and April, the financial markets tightened up and mortgage REITs were peppered with margin calls, which caused forced selling, decreased book values, and forced every mREIT to cut its dividend. It looks like the worst is over and the sector is in recovery mode. AGNC Investment Corp. (AGNC 1.31%) recently gave an update on where things stand.

An earnings document overlaid with a graph and data.

Image source: Getty Images.

The Fed rides to the rescue

In the company's earnings press release on July 27, AGNC CEO Gary Kain had this to say about the quarter:

We were very pleased with the performance of our portfolio in the second quarter. Market conditions during the quarter improved significantly as a result of the unprecedented domestic monetary and fiscal stimulus. Interest rate volatility was muted as the Federal Reserve communicated its intention to hold short-term rates at current levels for several years. Against this favorable backdrop, risk assets rallied dramatically during the quarter. Equity markets, along with many credit-centric fixed-income sectors, recouped most of their first-quarter losses.

This is important because mortgage-backed securities (MBSes) are highly exposed to interest rate volatility, and not in a good way. They perform best in a stable interest rate environment, and that looks to be the case through 2022, at least according to the Federal Open Market Committee's own forecasts. For leveraged agency mREITs (in other words, mREITs that focus on MBSes issued by a government agency), the best possible economic scenario is what we have now: low interest rates, low interest rate volatility, and an improving economy.

Big jump in book value

During the quarter, AGNC reported a 9.5% increase in tangible book value per share, from $13.62 to $14.92. Given the discount-to-book value, AGNC Investment purchased $147 million of stock at an average price of $11.99 per share. This is accretive to book value per share for the shareholders who don't sell. The company reported fully diluted earnings per share of $1.24 for the second quarter and paid $0.36 in dividends.

The dividend cut may not have been necessary in retrospect

On the conference call, Kain was asked about reinstating the dividend back to previous levels. He acknowledged that AGNC probably didn't have to cut its dividend in retrospect, and that with current income the company could have easily supported the previous monthly payout of $0.16 per share. The company will continue to revisit the dividend, but it likes the position of having a tailwind to book value per share, and it considers the current dividend yield of over 10% to be appropriate.

The biggest near-term risk for AGNC is a big pickup in prepayment speeds, which happens when homeowners refinance their mortgages en masse. When you refinance your home, you close out a high-rate loan and take out a low-rate loan. That's great for homeowners, but not so much for investors -- the high-rate MBSes get paid back early and AGNC has to reinvest in lower-coupon MBSes. This effect is why mortgage investors hate interest rate volatility. But compared to margin calls or credit risk, this is a minor issue.

Like just about every mortgage REIT out there, AGNC trades at a discount to book value. AGNC's current discount is just about 15% as of Friday morning. Historically, mortgage REITs stay close to book value, so it is likely for AGNC's stock price to approach book value over the next few months. In addition, the company pays a $1.44 annual dividend, which works out to a 10.5% dividend yield. Finally, book value per share should increase as the company buys back stock and earns much more than it pays out. For income and value investors, AGNC Investment Corp. should be worth considering.

Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

AGNC Investment Corp. Stock Quote
AGNC Investment Corp.
AGNC
$12.41 (1.31%) $0.16

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
377%
 
S&P 500 Returns
123%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/09/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.