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Bad Time To Buy AGNC

Bad Time To Buy AGNC

AGNC Investment Corp. (NASDAQ:AGNC) is currently trading at an unusually high valuation, and it seems that many investors have forgotten the fundamentals of mortgage REITs. While the allure of a big dividend might be tempting, it’s important to remember that dividends alone should not be the sole basis for valuing a REIT. In order to make an informed decision, it’s crucial to understand how earnings play into the equation.

Understanding Net Spread and Dollar Roll Income

When evaluating mortgage REITs, we typically refer to earnings as “Core EPS.” AGNC uses different terminology, but the calculations are essentially the same. Based on their latest data, the annualized Core EPS stands at $2.68, which is impressive given that the company’s tangible book value per share at the end of Q2 2023 was $9.39.

However, it’s important to read between the lines here. The $2.68 earnings yield on book value per share implies a 28.5% return, but the sustainability of such high earnings is questionable. In other words, it might not be wise to solely rely on this metric to gauge AGNC’s financial health.

Let’s Take a Closer Look

To put things into perspective, let’s examine AGNC’s historical price performance alongside their trailing book value per share. This comparison reveals some interesting insights and raises some important questions.

Additionally, it’s worth noting that AGNC recently issued over 10 million shares at a price below $10. This strategic move indicates that the company capitalized on its premium valuation compared to book value. However, whether AGNC’s management is truly superior to other players in the market, such as Annaly Capital Management (NLY), Dynex Capital (DX), Rithm Capital Corp. (RITM), PennyMac Mortgage (PMT), and Ready Capital (RC), remains to be seen.

Unveiling the Mathematics Behind AGNC’s Success

AGNC’s hedge ratio has experienced significant growth over the years, primarily due to the inverted yield curve. As a result, net interest income from interest rate hedges has become a substantial part of their overall financial performance.

However, a closer look at the numbers reveals that the average cost of funds exceeds the repo cost, indicating that interest rate swaps are generating attractive net interest income for AGNC. It’s important to note that the present value of these cash flows is already factored into the book value, meaning that while it may seem like substantial income, it’s not necessarily indicative of sustainable growth.

The Bottom Line

While the mortgage REIT sector presents some promising investment opportunities, AGNC might not be one of them. The current price-to-book ratio suggests that the stock is overvalued, and our estimates show that book value per share has decreased further in Q3 2023.

It’s true that Treasury to MBS spreads are currently high, which benefits AGNC’s economic returns. However, it’s important to consider the negative convexity associated with mortgage REITs, especially when interest rates fluctuate. AGNC’s hedging strategy primarily focuses on rates going down rather than up, which could pose a risk in a rising rate environment.

In conclusion, while preferred shares of AGNC may still be worth considering, it might not be the best time to invest in their common shares. As an investor, it’s important to stay informed and be patient for better opportunities in the future.