For the past year, mortgage real estate investment trusts (REITs) have been treated as damaged goods by investors. Fears of rising rates and divestitures have put the entire mortgage-backed security asset class under pressure. AGNC Investment (AGNC -1.28%) was not immune to the carnage. However, ANGC management sees value in the space going forward. Is the worst over for this sector?
AGNC Investment is the classic agency mortgage REIT. It invests almost entirely in mortgage-backed securities (MBS), which are guaranteed by the U.S. government. This means that investors will get their principal and interest even if the borrower defaults on the mortgage. If you recently bought a house and got a Fannie Mae or Freddie Mac mortgage, chances are it ended up in an agency mortgage-backed security, which might have ended up in a mortgage REIT's portfolio.
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Federal Reserve policy changes have wreaked havoc on the mortgage market
In March of 2020, when the pandemic was forcing lockdowns and the economy slowed dramatically, the Fed started buying MBS and Treasuries as a way to stimulate the economy. Since the days of the financial crisis, the Fed has amassed a portfolio of MBS worth trillions of dollars. The purchases had the intended effect on the economy, but inflation is a problem and stimulus is no longer needed. MBS investors have been wary of the Fed's plans -- if the Fed decided to sell its portfolio, it could swamp the market with supply. The net effect has been an underperformance of MBS relative to Treasuries. In trader parlance, MBS spreads "widened" 25 basis points during the quarter, and this was the driver of AGNC's losses.
This widening of MBS caused AGNC Investment's book value per share to decline from $15.75 at the end of 2021 to $13.12 per share. CEO Peter Federico said that the investment environment was "very challenging" as the Bloomberg Aggregate Bond Index posted its worst quarterly performance in 40 years. The company is optimistic about the future as the sell-off in MBS has "significantly improved" its outlook for the asset class going forward. While the company cannot predict when this turbulence will end, management said on the conference call that "further MBS weakness, if it occurs, will likely be characterized as an overreaction and will likely represent a compelling investment opportunity for AGNC."
The dividend is safe ... for now
Despite the losses, AGNC has maintained its monthly dividend of $0.12 per share. AGNC cut its dividend in early 2020 as margin calls beset the mortgage industry. The company then had an exceptional year where it covered its dividend by more than 100%. It didn't raise its dividend in response, so it was able to retain those funds. The flip side of mark-to-market losses is higher future expected returns, which supports the dividend going forward. That said, it will be hard to sustain the dividend if the turmoil in the mortgage markets lasts for the rest of the year. At current levels, the company has an 11.6% dividend yield, which is more or less in the middle of its historical range.
AGNC Dividend Yield data by YCharts
As you can see in 2013 and 2014, the dividend yield spiked over 20% as mortgage REITs got slammed by the "taper tantrum." The bottom line is that AGNC is not cheap enough to be considered a value stock. Given the Fed's posture, the stock is going to be under pressure until the Fed accomplishes its goal of lowering inflation. Once the inflation numbers start coming down and it looks like the Fed will take its foot off the brakes, the stock might be worth a look.
