The mortgage real estate investment trust (REIT) sector has been under a cloud since the spring amid fears that the Federal Reserve will soon begin reducing its purchases of mortgage-backed securities. In a recent speech, Federal Reserve Chairman Jerome Powell said the Fed could begin that pullback this year. We've seen this movie before: During the "taper tantrum" of 2013, mortgage REITs like AGNC Investment (NASDAQ:AGNC) were hit particularly hard. But this time may be different. The following three charts explain why investors probably don't need to fear a repeat.
AGNC invests in what the Fed has been buying
AGNC Investment is an agency mortgage REIT, which means it invests almost exclusively in mortgage-backed securities guaranteed by the US Government. As of June 30, AGNC had $56.8 billion of agency mortgage-backed securities in its $58.4 billion investment portfolio. These agency securities are very similar (but not identical) to the types of securities purchased by the Fed.
In 2013, the Federal Reserve began to remove some of the emergency measures it took in the wake of the 2008 financial crisis -- including its purchases of mortgage-backed securities and Treasury bonds as a way to push down longer-term interest rates. In Congressional testimony in May of 2013, Fed Chairman Ben Bernanke hinted that the Fed could begin reducing its purchases. The Fed then began reducing purchases at the December 2013 meeting. Take a look at the chart below, which shows the 30 year mortgage rate and the 10 year Treasury rate during 2013. You can see that both took off right around May of 2013 and rose rapidly:
One of the basics of bond math is that when rates rise, bond prices fall. For a mortgage REIT like AGNC Investment, rising rates will diminish the value of its assets, which will translate into lower book value per share. Mortgage REITs will use derivatives to hedge some of this risk, but they're still exposed to rising rates.
AGNC got crushed during 2013
Take a look at the chart below, which shows AGNC's book value and share price during 2013. The company started the year with a book value of $10.9 billion and ended the year with $8.7 billion -- a 20% drop. That helped to push AGNC's stock price down 33%, and drove the company to cut its dividend from $1.25 a quarter to $0.65.
So, are investors going to see a repeat of 2013? It is certainly possible -- but it probably won't be that dramatic. Back in 2013, investors had no idea what the Fed intended to do with its asset portfolio. This was uncharted territory for the Fed and investors. All options were on the table, including selling the assets into the market and returning the Fed's balance sheet to its pre-2008 levels of under $1 trillion in assets.
We have the benefit of hindsight
With the benefit of history this time around, we saw that the Fed didn't sell assets, and it wouldn't even let the portfolio shrink by simply letting the assets mature. The chart below shows the assets of the Federal Reserve from the pre-financial crisis days to today.
You can see that once the Fed started reducing its bond purchases, it never sold anything. If it did, you would see the assets fall. In 2018, the Fed did experiment with letting the portfolio run off -- but it returned to reinvesting maturing bonds after noticing some unintended consequences in the financial markets.
The difference between 2013 and today is the benefit of hindsight. We now know that the Fed isn't going to sell its portfolio into the market, and, it will probably follow its pre-COVID gameplan of maintaining a set asset value. The possible negative scenarios that drove the the taper tantrum of 2013 don't seem to be on the table this time around.
There is still risk for the company
AGNC Investment will still have a headwind as the Fed reduces asset purchases. We could well see mortgage rates increase relative to Treasuries, which would hurt the company's book value per share. It is hard to like the mortgage REIT sector when the Fed is taking actions negative to mortgage-backed security pricing. However, mortgage rates are up only about 0.2% this year, compared to the full 1% increase we saw in the immediate aftermath of Ben Bernanke's 2013 comments. The market seems to be taking the potential reduction in purchases much better than it did eight years ago.
As we publish this, AGNC is trading at a roughly 8% discount to its June 30 book value per share of $17.39. The stock price has already begun to discount the possibility of losses going forward. This gives shareholders a bit of a safety cushion should book value begin to fall. The end of 2013 was sort of a short-term bottom for the stock, and between a rebound and dividends, shareholders recouped a good chunk of 2013's losses in 2014. AGNC is probably not a sell at these levels -- but it's tough to like the stock with the Fed's tapering on the horizon.