NLY - AGNC: Billionaire Says At This Rate He Will Be Forced To Live Like A Millionaire

2023-10-24 09:32:09 ET

Summary

• AGNC's spread income was reported as "solid," but it holds no meaning and the market ignored it.
• AGNC's tangible book value per share dropped by $2.71 or about 28%, a significant loss.
• AGNC's woes are incredible considering that the company issued equity at an extremely rapid clip, far above today's market price.

On our last article, like every other one, we told you why you should stay away from mortgage REITs in general and AGNC Investment Corp. ( AGNC ) in particular.

Asset bubbles enhance inflation and at least two more rate hikes are very probable at this point. AGNC will face steeply rising costs by early 2024 as hedges get lower. We would look for things to break down in the mortgage REIT space. Despite all the cry about how undervalued mortgage backed securities are, there is really no cure for such an inverted yield curve. Yes, the Fed will likely cut after things really break in the equity markets but we don't want to own a leveraged play into that outcome.

Source: Seeking Alpha

The stock once again predictably dropped, by far more than its distributions. It then got destroyed post market hours as the real story came to light.

We dissect what was said and tell you where you go from here.

1) Spread Income

AGNC reported "solid" spread income.

For the third quarter 2023, AGNC's net spread and dollar roll income (a non-GAAP financial measure) was estimated to be $0.65 per common share, excluding $0.05 per common share of estimated "catch-up" premium amortization benefit.

Source: AGNC Press Release

In our last article we explained why this was about the most useless piece of information you got from AGNC. If spread income had any meaning, book value would be rising by the difference of spread income and dividends paid every quarter. That never happens. This was a meaningless piece of information and the market rightly ignored it.

2) Tangible Book Value

This was where the meat was.

AGNC's book value went lower during the quarter, by a lot.

As of September 30, 2023, AGNC's tangible net book value was estimated to be $8.08 per share of common stock;

For the third quarter 2023, AGNC's total comprehensive loss was estimated to be $(1.02) per common share.

Source: AGNC Press Release

AGNC's horror show did not stop there.

The Company estimated that its tangible net book value per common share as of October 20, 2023 was between $6.80 and $7.00 per common share, or between $6.68 and $6.88 per common share after deduction for the Company's common dividend previously declared for the month of October 2023.

Source: AGNC Press Release

How bad was this? Well, AGNC's tangible book value per share was $9.39 about 110 days back.

So AGNC lost $2.71 of tangible book value per share or about 28%. That is one of the most stunning losses over this timeframe.

3) Equity Dilution

As stunning as those losses were, we were just floored at the fact that this occurred AFTER they issued a ton of equity well above tangible book value.

During the third quarter, the Company issued 44.7 million shares of common stock through "at the market" offerings at an average offering price of $9.67 per share, net of offering costs, or $432 million.

Source: AGNC Press Release

So that tangible book value is lost and they have 44.7 million more shares to pay distributions on.

4) Portfolio Size & At-Risk Ratio

The portfolio size actually crept up. In one of the rarer displays of backing the idea that mortgage backed securities were undervalued, AGNC actually slightly increased the assets it held by about $1.3 billion ($59.3 billion from $58 billion). While that may sound great, keep in mind that it also increased the leverage to about 8.2X.

Outlook

Can these assets have a bounce? Of course they can. Mortgage backed securities are trading with some of the widest spreads to Treasuries and AGNC is an 8.2X leveraged play on the situation. But it is an incredibly problematic place to navigate. You have to hedge on front end interest costs and you have to hedge on spreads and you have to hedge on duration. It is hard with 2X leverage and it is next to impossible with 8X leverage.

To trade these mortgage REITs, you have to first throw out this "income investor" mentality. They don't make any money long term and your only hope is to trade them when you get opportunities (preferably from the short side). On that front the next distribution cut is now set in stone. AGNC will likely do a reverse split and go to the equivalent of 6 cents a month.

Imagine If You Were A Billionaire

Everywhere you look people cite billionaires as if they carry the only correct way to invest. We will dive in too, but with an imaginary one who actually had the misfortune of using mortgage REITs as an income investment.

Imagine if you actually went into AGNC a long time back expecting $5.60 of dividends every year. AGNC actually paid that run-rate in 2011. Let's say you were excited with this great source of income and you the billionaire, invested a lot in this for income. Your income stream would be down 75%.

After the next distribution cut, which we see as inevitable, your income stream would be down 85%-90%. What about the share price? Depending on your exact start point? It would be down about 75%-80%. This is not just AGNC . As we said in our Annaly Capital Management, Inc. ( NLY ) article.

Over the last 40 years, the price returns on the mortgage REIT index have been negative 7.55% annually. That means that if you invested $100, you would have $4.50 left today. Assuming you get a 14% yield on that, it works to a 0.63% yield on your original investment.

Source: Seeking Alpha

So if you were the lucky billionaire that invested in this sector, guess what? You would be living like a millionaire.

Preferred Shares

AGNC has five listed preferred shares.

1. AGNC Investment Corp. 6.12% DP SH PFD F ( AGNCP )
2. AGNC Investment Corp. 6.5% DP SH PFD E ( AGNCO )
3. AGNC Investment Corp. 6.875% DEP REP D ( AGNCM )
4. AGNC Investment Corp. CUM 1/1000 7% C ( AGNCN ).
5. AGNC Investment Corp. 7.75% DP PFD G ( AGNCL ).

These are generally the best investments for mortgage REITs as they tend to be the only ones that deliver longer term total returns that are worth the risk. Here we would be a little cautious as book values are crumbling really quick. On top of that AGNC has increased its leverage. We think other REITs in this space have a better risk-reward ratio even for preferred shares.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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