2023-03-19 03:25:23 ET
Summary
- AGNC is paying a 14.8% yield monthly that's fully covered by earnings.
- Tangible book value seems to have stabilized with a growth of just under 9% recorded in February over the fiscal 2022 year-end figure.
- The preferreds offer a lower 7.9% yield on cost but have outperformed on a total return basis over the last three years.
AGNC (AGNC) last declared a monthly cash dividend of $0.12 per share , in line with its prior payout and for a 14.8% yield. This payout is a decline from $0.16 per share just before the pandemic with a recovery hampered by the impact of rising Fed funds rates on the residential mortgage-backed securities that form the bulk of AGNC's portfolio.
The internally managed mREIT invests primarily in agency RMBS on a leveraged basis through the use of repurchase agreements. The portfolio was valued at $59.5 billion as of the end of its last reported fiscal 2022 fourth quarter and agency MBS formed $39.5 billion of this. AGNC also held an $18.6 billion TBA mortgage position. This formed a tangible book value of $5.7 billion as of the end of the fourth quarter, around $9.84 per share.
Tangible Book Value Needs To Be Fully Stabilized
However, the impact of rising Fed funds rates has been marked and the corresponding rise in primary mortgage rates has formed a structural headwind to AGNC's book value.
The 30-year primary mortgage rate at 6.6% is at its highest level since 2008, a movement which places AGNC's positive duration as a barrier to book value growth. Hence, the most pertinent near-term catalyst remains a clear peak forming and then decline of the Fed funds rate. Book value is the most important metric as its drives the underlying price of the commons and supports the dividends. And whilst this has been under pressure, AGNC has stated that it has risen to between $10.80 and $10.90 per share as of February.
This would be an increase of around 8.9% at the low end versus the fourth quarter. It would also mean the commons are currently trading at a 10% discount to tangible book value. The mREIT recorded a GAAP EPS of $0.93 per share, a beat by $0.27 on consensus estimates to form a payout ratio of 38.7% versus the 3-month aggregate of the monthly dividend. Whilst I don't anticipate a near-term raise as the low coverage ratio masks dividend payments to five outstanding preferred shares, the yield could still get fatter if the commons face more near-term weakness.
The Fixed To Floating Series E Preferreds
AGNC's Series E Fixed to Floating Cumulative Preferred Shares ( AGNCO ) offer distinct advantages over the commons and have been trading lower in recent weeks. What's to like here? The $1.63 annual fixed coupon works out to be a 7.9% yield on cost with the preferreds currently trading at $20.75 per share. Whilst this is around 700 basis points lower than the dividend yield from the common shares, its price returns over the last 12 months outperform the commons by roughly 1,000 basis points with the Series E down 15.3% versus 25.3% for the commons.
The coupon is paid out in quarterly instalments so could be less attractive to investors looking to mimic salaries versus the monthly paying commons. They're currently trading at a $4.25 per share discount to their par value to form another avenue for shareholders to accrue positive returns. This 17% discount to their $25 intrinsic value represents value to be captured on the upside. The uncertainty on this is the timeline for a move back up to par. The preferreds were trading above this level for much of 2021 with the current downtrend also sparked by rising Fed funds rate and in place since the start of 2022.
The performance dichotomy between both securities on a total return basis is stark and likely reflects common shares that have suffered from the specter of dividend cuts and quarterly book values in a seemingly perpetual downtrend. Investors in the Series E would have realized a total return of 55.65% over the last three years versus a total return of 14.49% for the commons. Over the last 12 months and the preferreds are down by 8.91% on a total return basis versus a loss of 14.65% for the commons.
This divergence of performance is likely to persist this year as interest rate hikes and a weak economy continue to weigh down on AGNC's underlying book value and payout ratio. The Series E come up for redemption on October 15, 2024, and will also move to a floating rate of three-month LIBOR plus 4.993% per annum. It's important to note that LIBOR will be retired in June this year and will be replaced by the secured overnight financing rate (SOFR). For some context, SOFR currently stands at 4.57% and is up from near zero a year ago. Hence, assuming the coupon floated today would see preferred holders realize a 9.56% yield.
Whilst SOFR is likely set to track higher what looks likely to be another two 25 basis points hikes to the Fed funds rates, SOFR at redemption in the fourth quarter of 2024 could be lower than its current level if the US falls into a recession. This would be especially likely if inflation reaches the Fed's 2% target. Whether to go with the Series E over the commons will come down to two factors. Risk tolerance and confidence in the safety of the common share dividends. The cumulative clause on the preferreds essentially eliminates any propensity for a suspension in the event of future economic headwinds as any unpaid coupon payments will accrue as a liability for repayment at redemption. I'm neutral on both securities but the commons could come up for consideration once the Fed stops hiking rates.
For further details see:
AGNC: The 14.8% Yield Paid Monthly Could Get Fatter