AGNCO - AGNCM: Less Than 7 Months Until The Big Floating Dividend Period

2023-09-25 09:25:18 ET

Summary

• AGNC Investment has 5 series of preferred shares.
• AGNCM's share price is expected to increase slightly as the floating date approaches, assuming short-term interest rates remain elevated.
• AGNCP is another attractive option with a wider spread, and its share price is also expected to climb as the floating date approaches.

Readers have apparently been searching for data on AGNCM ( AGNCM ) lately. It's time for a quick rundown.

AGNC Investment ( AGNC ) has 5 series of preferred shares:

• AGNCN ( AGNCN ) at $25.85
• AGNCM ((AGNCM)) at $24.05
• AGNCO ( AGNCO ) at $23.77
• AGNCP ( AGNCP ) at $22.05
• AGNCL ( AGNCL ) at $22.41

The first four are fixed-to-floating shares that are switching over from 3-month LIBOR to 3-month SOFR plus the adjustment of about 26 basis points. This is pretty common for shares that referenced 3-month LIBOR. It isn't happening to every single share, but it is happening for the first four shares listed here.

The fifth share, AGNCL, will use the 5-year Treasury rate + a spread of 4.390%.

AGNCM

The main focus of this article is AGNCM.

In my view, AGNCM is a pretty good deal. It's not the best deal among the AGNC preferred shares, but it's pretty good. The big appeal here is that shares will float starting on 4/15/2024. Based on AGNCN as well as the preferred shares from Annaly Capital Management ( NLY ), AGNCM's share price will probably be a bit higher when the floating rate kicks in.

Assuming short-term interest rates remain elevated (comparable to today's rate) and the economy does not slump into a recession, investors should expect AGNCM's price to trend a bit higher. Currently, it is $24.05 and shares will go ex-dividend soon. I'm expecting the ex-dividend date to be September 28, 2023 (based on data from StreetSmart Edge and IEX). The ex-dividend date is the date that new buyers will not be eligible for the upcoming dividend payment.

The most comparable share to AGNCM presently would be NLY-G ( NLY.PR.G ) (NLY.PG). NLY-G has a floating spread of 4.172%. Shares currently trade at $24.66 and have about $0.16 of dividend accrual. Therefore, the stripped price for NLY-G is $24.50.

Right after shares go ex-dividend, there is no accrual. Consequently, the stripped price and the market price are the same. If AGNCM trades around $24.50 right after going ex-dividend for March 2024, investors in AGNCM would see a share price that was $0.45 higher than today. They would also collect three fixed-rate dividends for under seven months. That's a pretty good combination.

AGNCM's spread of 4.332% is better than NLY-G's spread at 4.172%. However, it is inferior to AGNCN's spread of 5.111%. Because AGNCN's spread is so attractive, AGNCN currently trades at $25.85. If a call were announced for AGNCN immediately, investors in AGNCM would end up with less than $25.85 in total cash from dividends plus the $25.00 call value. To accept the risk of a loss on a call in this market, a share must be quite attractive.

Scenarios

The best case scenario for investors is that AGNCM rallies to trade above call value (before dividend accrual), rather than being around $24.50. If rates remain about where they are, the yield on today's price would jump past 10% when the floating rate kicks in. That's much higher than today's stripped yield of 7.27%.

Why would anyone buy before the increase? Because they get a lower price to offset the lower dividend rate.

The worst-case scenario is a big recession (increasing credit spreads) with rates falling (reducing dividend rates). That would make AGNCM significantly less attractive and could put quite a bit of pressure on the share price.

Alternative

Two major alternatives are AGNCO ((AGNCO)) at $23.77 and AGNCP ((AGNCP)) at $22.05. My favorite share of the batch presently is AGNCP. AGNCP also takes the longest to float. It won't float until April 15, 2025. However, the spread is 4.697%. That's better than AGNCM, but weaker than AGNCN.

I would expect AGNCP to have a share price moderately above AGNCM at that point. Compared to the $22.05 share price today, that would require prices to climb quite a bit. One year from today, AGNCP will be as close to floating as AGNCM is today. If AGNCP trades at $24.05 one year from today, it would be up $2.00. That would be a very nice boost to the stripped yield of only 7.06%.

If rates remain elevated and we avoid a recession, AGNCP's wider spread should give it a good chance to achieve that pricing. That would be a pretty strong return.

I forecast the potential annualized returns as being only slightly modestly better for AGNCP, but the elevated rate of annualized returns should last longer. Further, if rates do decline, the bigger spread on AGNCP should provide a little more insulation. Not much, but a little bit. Each of those factors contributes to my preference for AGNCP. However, the first two factors are entirely dependent on the difference in share prices.

AGNCN is also a viable alternative. It has a higher yield today. However, many investors will scorn the call risk. I won't blame them. I don't like the call risk situation either. I think AGNCN might actually be able to issue new preferred shares at a low enough rate to justify calling AGNCN. Consequently, I wouldn't consider going into AGNCN here.

Conclusion

I think several fixed-to-floating preferred shares offer an attractive risk/reward profile today. Investors have the opportunity for a pretty strong annualized return from the combination of current dividends and increasing share prices as floating dates approach. There is still risk with recessions or interest rates falling, but I find the potential appreciation in several of these shares quite appealing.

For AGNCM, I'm taking a very slightly bullish approach . Our price targets are pretty precise and AGNCM is straddling that line between a neutral rating and a bullish rating.

Taking a slightly bullish view reflects the potential returns over the next 6-7 months (slight appreciation + dividend income). I still think AGNCP is the best play at the moment. However, I should mention that I also trade these shares actively based on swings in relative valuation. If the other shares become more attractive than AGNCP, I would have no issue changing my position. My trades for the shares go through tax-advantaged accounts, and my costs for swapping positions are minimal. Consequently, swapping shares is an attractive way to enhance returns with minimal change in the risk profile.

While I find some of the preferred shares attractive, I find the common shares unattractive . AGNC at $9.81 is unappealing. I don't expect any risks to the health of the company. However, valuation is an issue. I think it is more likely that common share prices will decline over the next several months. Of course, that doesn't mean it will be a smooth line trending lower. Volatility will exist. But the price-to-book on the common shares is unappealing.

I like the lower-risk and lower-volatility investments in the preferred shares more than the common shares. What if the Federal Reserve abruptly cut short-term rates to 0% to fight a recession (unlikely)? Swinging interest rates that hard would be bad for the common shares also. Investors who expect that scenario would be better served by having some medium to long-term Treasuries.

For further details see: