HomeMost Popular AGNC Investment: A Golden Opportunity For Mortgage REITs in 2024

AGNC Investment: A Golden Opportunity For Mortgage REITs in 2024

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Mortgage-backed security MBS, financial concept : House model, stacks of rising coins, US dollar, money bags, a clock on a table over green background, depicts investment in home bought from the bank

A few days back, I argued the case for investing in fixed income assets, like those in the PIMCO Dynamic Income Fund (PDI). I firmly believe that PDI and similar funds are poised to thrive in the upcoming shift in the interest rate landscape in 2024. Another investment set to benefit from the Federal Reserve’s projected policy shift are mortgage REITs, particularly AGNC Investment (NASDAQ:AGNC).

In October, I made a bold move by acquiring shares in competitor mortgage REIT, Annaly Capital Management (NLY). My decision was primarily driven by the anticipation of a positive change in the inflation trajectory, which is expected to improve the spread/income scenario in the short run. Given that AGNC is one of the top two mortgage REITs in the U.S. with a substantial portfolio of mortgage-backed securities, I see a strong potential for a revaluation for AGNC, along with a catalyst for the growth in the REIT’s book value in a rising-rate environment!

Chart

Data by YCharts

Previous assessments

I previously covered AGNC more than two years ago, identifying it as a strong quarter for this mortgage REIT, but also pointing out the growing risks. At that time, I rated the mortgage REIT as a hold, primarily due to the escalating inflation risks. With the current indication of an impending decline in interest rates, I believe mortgage REITs with substantial portfolios of mortgage-backed securities are poised for a valuation rebound.

MBS investments and their recent performance

Mortgage-backed securities are fixed income assets whose values move inversely to interest rates. During periods of rising rates, the values of mortgage-backed securities, along with other fixed income assets, decline, and vice versa. The only exception I am aware of are mortgage servicing rights, whose values increase during periods of rising rates.

AGNC’s portfolio mainly consists of MBS with varying maturity dates, the majority of which are related to 30-year fixed mortgages. As expected, AGNC’s portfolio value has been under pressure due to the rising rates over the past year. The combined value of the REIT’s MBS declined from $61.5B in Q3’22 to $59.3B in Q3’23. While AGNC’s portfolio also includes commercial and residential credit assets, the assigned value for this segment is only $1.0B, relatively small compared to the MBS portion.

What sets AGNC apart from other mortgage REITs is its position as one of the two largest MBS investors in the market. Consequently, the company has been particularly affected by the surge in interest rates over the past year or so. With the Federal Reserve signaling a potential decrease in the federal fund rate three times in 2024 (Source), this could serve as a significant catalyst for AGNC’s book value.

AGNC

Mortgage REITs typically struggle during high-rate periods, as the values of MBS come under pressure, leading to a deterioration of the spread situation. The chart below illustrates the substantial decline in the REIT’s asset base since FY 2021, although the MBS portfolio as a whole has started to grow again over the last three quarters…

AGNC

High interest rates not only affect the value of fixed income assets such as mortgage-backed securities but also make debt significantly more expensive – a trend that has played out in the past year.

AGNC’s net interest income, a critical profitability measure for mortgage REITs, plummeted from a positive $177M in Q3’22 to a negative $53M in Q3’23, largely due to a much faster growth in interest expenses compared to interest income. AGNC endured three consecutive quarters of negative net interest income in FY 2023.

AGNC

The driving force behind the altered net interest income trajectory for AGNC has been the inflation trend, as the Federal Reserve attempted to clamp down on inflation by rapidly raising interest rates in 2022.

However, with inflation taking a downturn in the past year, it is widely anticipated that the Federal Reserve will terminate its tightening policy in 2024… a move that could potentially reverse AGNC’s net interest income trajectory. U.S. inflation dropped to 3.24% in October, and I anticipate this trend will continue into 2024. With inflation rates now below long-term U.S. interest rates, I firmly believe the Federal Reserve is virtually guaranteed to begin reducing interest rates next year.

Chart

Data by YCharts

Balance sheet insights

Mortgage REITs heavily rely on debt to invest in mortgage securities, and AGNC had a leverage ratio (based on net book value) of 7.9X in Q3’23, compared to 8.7X in Q3’22. While the leverage trend is positive, the firm’s overall leverage remains notably high. The largest asset on the company’s balance sheet were agency securities, with a fair market value of $55.8B, accounting for 80% of the REIT’s investments.

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