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AGNC Investment: Deleveraging During Declines (NASDAQ:AGNC)

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The last time we covered AGNC Investment Corp. (NASDAQ: AGNC) we have reviewed the main risks of investing in this mortgage REIT.

Real economic return for the first quarter will be terrible as the decline in tangible book value overshadows the revenue generated. While a rebound could certainly occur, AGNC is unlikely to repurchase recently liquidated assets. Some losses will be actual permanent losses. We urge investors to assess whether this is the result you are happy with.

Source: Decline in book value in 2022 equivalent to 2.5 years of dividends

The stock decline, while substantial, has actually outperformed the S&P 500 (SPY) since this article was written. With Q1-2022 results and further changes in Treasury and mortgage-backed securities yields, we are looking to see where AGNC stands relative to its intrinsic value.

Q1-2022

Q1-2022 was a quarter of peak pain and AGNC lost $2.63 in tangible book value.

AGNC Q1 2022 Highlights

Presentation AGNC Q1-2022

For those who maintain the accounts at home, this represents approximately 20 months of dividends. As bad as the results were, they actually came in better than market expectations and AGNC shares rallied after the announcement. As of April 30, 2022, the tangible book value had fallen a further 6% to approximately $12.33.

Yes. Bernie mentioned that in his prepared remarks, and I mentioned that the spreads were about 10 basis points wider. And Bernie mentioned that last Friday we estimate our book value to be down about 6%, which would be consistent with the spreads widening event of about 10 basis points.

Source: AGNC Q1-2022 Transcript

Deleveraging during downturns

The importance of tangible book value was visible as AGNC reduced the size of its portfolio by more than $13.4 billion during the quarter, from $82.0 billion to $68.6 billion. .

Historical overview of the AGC

Presentation AGNC Q1-2022

This is the largest decline in a quarter and is the main reason why AGNC was able to maintain and even reduce its debt ratios during the quarter.

tangible net book value at risk leverage

Presentation AGNC Q1-2022

With over $13 billion in undervalued assets, you can rest assured that AGNC will earn less interest than before. The recovery of tangible book value will also be less if the deviations normalize. Even if AGNC goes up in debt again, it would be a “buy high” and “sell low” situation imposed by its debt ratios.

Outlook

Spreads between mortgage rates and Treasury rates have widened further since the early May update.

10-year Treasury rate and 30-year mortgage rate
Data by YCharts

At first glance, AGNC appears “over-hedged”, with hedges covering more than 115% of assets.

AGNC Cover Summary

Presentation AGNC Q1-2022

The overall coverage of the cover unfortunately does not say it all. AGNC’s hedges primarily protect its financing costs. The $51.1 billion fixed swaps are hedges designed to insulate it from increases in Fed Fund rates. Only the short positions of $16.2 billion in Treasuries protect the decline in duration. In the event of a sharp rise in interest rates, AGNC would lose another 5.5% of its tangible book value.

interest rate sensitivity

Presentation AGNC Q1-2022

Fascinatingly, the way it is positioned, it will actually lose tangible book value if rates have a widespread reversal. That’s the opposite of what investors might expect, but that’s how he positions himself. The main vulnerability remains the spreads between mortgage-backed securities and treasury bills.

- Sensitivity to MBS propagation

Presentation AGNC Q1-2022

Here, AGNC has advantages and disadvantages for this asset class. But if buyers aren’t showing up for mortgage-backed securities as the Fed’s QT advances, watch out below.

Verdict

Historically, there have been no instances where the Fed has halted until the fed funds rate has risen above measures of underlying inflation.

inflation vs Fed funds rate

Fred

There has also been no instance of the 10-year Treasury rate peaking so early in a fed funds cycle. Maybe this time is different, but we wouldn’t bet on that. Working in favor of the bond bulls is the collateral damage caused by this massive sell-off.

the greatest wealth destruction in the history of the modern market

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The destruction of the asset bubble will have an impact on consumption within 1 to 2 quarters. Working against AGNC and mortgage REITs in general is their huge leverage. It’s difficult to manage at the best of times. Can they navigate this environment with 6-8X leverage? Our bet is that even the best will struggle and the worst will be wiped out. We consider AGNC to be one of the best. So we believe he will do well, but we are still hesitant to trade common stocks on the long side. Investors’ Best Risk-Adjusted Returns in AGNC May Come From Preferred Stock

AGNC Preferred Share Type

Presentation AGNC Q1-2022

AGNC 7.00% Series C Fixed/Floating Cumulative Redeemable Preferred (AGNCN) has declined since we last wrote about AGNC and now has a stripped yield of over 8%. However, the most relevant number here is the reset rate as it starts floating in October 2022 at Libor +5.111%. Depending on the direction of the fed funds rate, AGNCN could well return over 9.25% by the end of the year. We actually put a buy rating on this one.

AGNC 6.125% Dep Shares Series F Fix/Float Cumulative Redeemable Preferred (NASDAQ: AGNCP) has a floating/call date of April 2025. Its stripped yield is around 7.3% and will float at LIBOR +4.697%. Both are good choices, even if we are biased towards AGNCN. We are still not touching the common, despite the declines.

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

#AGNC #Investment #Deleveraging #Declines #NASDAQAGNC

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