2022 was a tough year for mortgage real estate investment trusts (mREITs). Pressure from rising interest rates, a slowing housing market, and weakening demand for mortgage-backed securities (MBS) sent most mREITs tanking -- AGNC Investment (AGNC +1.47%) included.
The company, which invests in agency-backed mortgage securities (MBS) saw its share price fall as much as 40% from its high. However, it seems investor concern is easing. The stock had a massive rally at the end of 2022, jumping 48% over the last 3 months.
NASDAQ: AGNC
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And yet, even with its impressive comeback, it's a stock I'm avoiding in 2023. Here's why I think you may want to, too.
Pressures haven't gone away; they've just subsided slightly
AGNC Investment deals in commercial and residential government-backed mortgages. These loans carry very little risk because if a borrower stops paying, the government fronts the principal and interest payments -- not AGNC. This added security means it has little-to-no credit risk, but the company is still highly susceptible to interest-rate and general-market risks, both of which have been weighing on the company this past year.
Mortgage REITs like AGNC rely heavily on short-term debt to increase their earnings. They leverage borrowed money to purchase large pools of loans, earning money from the interest collected on the loans. In 2022, the Federal Reserve bumped the federal funds rate, which determines its cost of borrowing, from nearly 0% to 4.35%.
The Fed has indicated it plans to slow the number of hikes it makes in 2023. But more federal funds rate bumps will be coming until it reaches a rate between 5.1% and 5.25%. That means the company is likely to face continued pressure on its cost of borrowing.
In addition to mortgage interest, mREITS use hedging strategies like swapping interest rates and trading Treasury futures to increase their returns. Last year, MBS saw a dip in demand as Treasuries outperformed MBS. 2023 is off to a better start with MBS performance surpassing Treasuries once again. But there's no guarantee MBS will stay ahead.
A big part of mREITs fall in 2022 was the growing concern that the government would start selling the billions of dollars worth of MBS it purchased during the global pandemic. This would hurt companies like AGNC because it could lead to an imbalance in supply and demand, and lead to a decrease in value for MBS on the secondary market. In the third quarter of 2022, AGNC's book values were down 20% from the prior quarter.
The government hasn't started unloading any assets yet, but if pressures for reducing its massive balance sheet continue or liquidity becomes a concern, there's a good chance the government will start selling in 2023. This means book values are far from safe for AGNC.
AGNC has more risk than reward
As a fairly conservative long-term income investor, I look for stocks that have opportunities for dividend and share-price growth, which is something AGNC has a poor track record of providing.
Since it made the move to paying dividends monthly in October 2014, the company has cut its dividend payouts by 45%. It wasn't much better when dividends were paid quarterly. From 2009 to 2014, AGNC cut its dividend 5 times, amounting to a 61% decrease in dividends since its initial public offering (IPO).
The REIT's stock has also largely underperformed the S&P 500 over the last one, three, five, and 10-year periods. Some contributors at the Motley Fool take a bullish stance on the company. For more risk-tolerant investors, it may be a worthwhile stock to consider. Its lack of credit risk does give the company an added layer of protection in today's economy, but its 11% yield simply isn't worth the risk to me.
I've widely advocated against buying AGNC Investment along with other high-risk mortgage REITs. I'd much rather invest in a more conservative dividend stock that pays half of AGNC's yield but can maintain its share value and dividend payments over the long term.
