2023-05-09 12:12:19 ET
Summary
- AGNC’s book value declined again in 1Q-23.
- The central bank is on the brink of yet another rate hike. AGNC’s funding costs have risen sharply.
- The stock is set for a steeper book value discount, in my view.
Mortgage real estate investment trusts have been among the hardest hit by the Fed's aggressive rate hike cycle in 2022. Many mortgage REITs, including AGNC Investment Corp. ( AGNC ) , have seen portfolio shrinkage, large book value losses, and significant increases in capital costs.
Since AGNC's book value fell again in the first quarter, I expect the mortgage trust to face ongoing valuation and spread headwinds. The trust's 16% yield is not worth purchasing and carries extremely high risks, especially given AGNC's history of dividend cuts.
The Central Bank Represents AGNC's Biggest Challenge Right Now
During the 2022/2023 rate hike cycle, the Fed raised interest rates at the fastest rate since the 1980s in an attempt to control out-of-control inflation. This policy shift has resulted in an extremely volatile short-term interest rate path and widening mortgage-backed security spreads, both of which have significantly impacted AGNC's ability to make money.
The mortgage trust's portfolio and book value have been severely impacted by the central bank's ongoing rate hikes. Higher interest rates reduce the value of fixed income instruments, posing a problem for mortgage trusts such as AGNC, which invest heavily in agency mortgage-backed securities. The value of AGNC's agency portfolio fell from $59.5 billion at the end of 2022 to $56.8 billion at the end of the first quarter.
If the central bank continues to raise interest rates in the coming months, AGNC's portfolio, book value, and stock price will remain under pressure.
Funding Costs Rose Sharply In 1Q-23
The rapid rise in interest rates has resulted in a significant increase in the cost of capital for AGNC and other mortgage real estate investment trusts in the sector.
AGNC's borrowing costs increased 67% from one quarter to the next, from 0.61% in 4Q-22 to 1.02% in 1Q-23. While interest rates were unquestionably low in the first half of 2022, they are now a direct threat to AGNC's profitability.
Ongoing Book Value Headwinds
AGNC's book value fell again in the first quarter, ending at $10.30 per share, a 4.3% decrease QoQ. The trust's book value appeared to have bottomed out in 3Q-22, but the central bank's ongoing efforts to lower inflation have weighed heavily on the market and AGNC's book value.
Since the end of 1Q-21, a whopping 45.0% of AGNC's book value has vanished, and with the central bank still raising interest rates, I believe that passive income investors have few compelling reasons to jump into the fray and buy AGNC's 16% yield right now.
AGNC's frightening decline in book value over the last two years has resulted in a discount valuation, which I believe could worsen if the central bank surprises with comments about future interest rate policy this week.
AGNC is currently trading at a 16% discount to book value, while Annaly Capital Management, Inc. ( NLY ) is trading at a 9% discount to book value.
Given the current market environment and the uncertainty surrounding future interest rate hikes, I believe both trust's stocks could trade at higher discounts to book value in the near future, especially if AGNC and Annaly report yet another round of new book value declines in the second quarter.
Why AGNC Could See A Lower/Higher Valuation
AGNC has lost 45% of its book value in the last two years, and its book value per share has continued to fall in 1Q-23.
With the Fed raising rates again last week, fixed income assets are expected to remain under pressure. An upside risk here is that the central bank reverses its interest rate trajectory and begins to cut rates, in which case the trust would benefit from lower capital costs and less valuation pressure on its agency MBS portfolio.
My Conclusion
After the mortgage trust reported 1Q-23 earnings, I don't see why passive income investors would want to buy AGNC's 16% dividend yield.
I believe the central bank will continue to put pressure on AGNC's portfolio value and funding costs, at least in the short term. Higher interest rates pose a direct challenge to AGNC's book value, which saw year another QoQ drop in the first quarter.
Unless AGNC's book value stabilizes, I would advise passive income investors to avoid the trust's sky-high 16% dividend yield.
For further details see:
AGNC's 16% Yield Is A Red Flag