AGNCO - AGNC Preferred: Pricing To Anxiety And Illiquidity Not Just Interest Rates

2023-03-23 05:59:07 ET

Summary

• The banking system’s recent crisis of confidence, coupled with the Fed’s sustained hiking initiative, has exacerbated volatility in treasury yields.
• All fixed-income securities trade along a spectrum of yield and duration, but lower capitalized sectors, like equity preferreds, are also affected by limited liquidity and relative obscurity.
• The recently issued AGNC Investment Corp.’s 7.75% Series G Preferred is price dislocated and might be a productive fixed income addition to a 60/40 portfolio strategy.

Maintaining a resilient fixed income portfolio was already difficult, but when you throw in this month's declining but still too high CPI report and the back-to-back-back failures/rescues of Silicon Valley Bank (SIVB), Signature Bank, First Republic Bank (FRC), and Credit Suisse (CS), your self confidence in decision-making takes a hit. The bond market has become a roller coaster with 10y Treasuries yields running up to 4.10% before a flight to safety dropped them to as low as 3.30%. Agencies, corporates, and anything yield-tangential experienced similar volatility, and pricing in the more obscure world of REIT preferreds was affected as well. My interest was particularly piqued in watching pricing in AGNC Investment Corp.'s Series G Preferred (AGNCL).

Seeking Alpha readers have been well informed about the high yields available in the agency mREIT preferred space and particularly about AGNC Investment Corp.'s ( AGNC ) offerings.

We earlier became interested in the AGNC preferreds in a search for hedges against rising interest rates. As the table above describes, the fixed to floating structure of the AGNC preferreds can, on conversion, attach the benefit of a 3-month LIBOR that has risen to 5%. We have previously owned AGNCN, which converted last October, and we still have interests in AGNCO, which converts from fixed to floating in October 2024.

We hadn't previously been all that enthused about AGNCL because its scheduled 10/15/2027 conversion seemed too long dated to take advantage of interest rates that could rise to the sky. More recent events, however, might make AGNCL's 7.75% coupon, fixed through October 2027, look like an attractive, bird-in-the hand yield. What if Chair Powell cranks rates high enough to obviate a soft landing so he then has to start cutting rates? What if the yield curve un-inverts and AGNCL's linkage to the longer dated 5y T-Note becomes a superior base rate?

The other aspect of AGNCL that might make it appealing is that it has been trading outside of the yield/pricing parameters of the other, still fixed rate AGNC preferreds. It is currently trading for more than 130 basis point higher yield than the AGNC Series E (AGNCO) and AGNC Series F (AGNCP). Each preferred series comes from the same issuer, but they have individual idiosyncrasies that might lead to trade price discrepancies.

AGNCL was issued in September of 2022 in a market coming to grips with the potential turmoil of rapidly rising interest rates. AGNC's investment banking underwriters delivered AGNCL $25 shares to possibly unwitting investors who quickly saw their new investment trade at discounts of 20% to purchase price.

AGNCL faces numerous difficulties in this volatile interest rate market. First, it is a $150MM issue placed into the accounts of investors who might not know what they hold or how and why they came to own it. Second, those original investors, potentially seeking liquidity, face a market that might be ignorant to the issue's existence. Third, even if seller volume is not elevated in a time of high anxiety, discerning potential buyers will likely exercise patience before entering bids. Prices drop.

Our Entry Point

Decades of experience have created the framework for what makes us want to own any fixed income issue. It basically breaks down to capturing a superior yield, capital appreciation potential to redemption, and the strong-hands position to wait for a favorable market exit.

We bought AGNCO within these considerations and anticipate that the current economic environment and calendar will provide us an opportunity to exit at an appreciated par price. We have now initiated a position in AGNCL in anticipation that it will be a yield workhorse and will rise to par if interest rates fall or the economy stalls or stumbles.

Our Exit Point

An amazing aspect of our financial markets is that we are continuously at liberty to step into or out of participation. Our constant mantra is to ignore anxiety and panic, to remain forever focused on fundamental measures. Be patient.

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