The ongoing tariff situation, along with tensions between President Donald Trump and Federal Reserve Chair Jerome Powell, continued to make for a difficult mortgage-backed security (MBS) market in the second quarter. While mortgage real estate investment trust (mREIT) AGNC Investment (AGNC 0.88%) was able to navigate the market, the environment weighed on its results.
With the stock yielding more than 15%, let’s see if better days could be ahead and whether the stock can maintain its dividend.
Rates remain in focus
AGNC is an mREIT that primarily holds a portfolio of MBSes that are backed by government-sponsored agencies, such as Fannie Mae and Freddie Mac. MBSes are residential mortgages that are bundled into bond-like securities, and since they are backed by government-sponsored agencies, they are generally regarded as being largely free from the risk of default.
However, like other bonds, interest rates have an effect on MBS values, and their yields trade at a spread to U.S. Treasury yields, which are considered the ultimate safe haven. A few years ago, mREITs came under significant pressure due to the Fed raising rates and MBS spreads widening, as the Fed let MBSes that it had acquired as part of earlier quantitative easing roll off its balance sheet. This also led to the highly publicized blowup of Silicon Valley Bank, which was heavily invested in MBSes at the time. Since then, with regulatory tightening, banks have shied away from owning longer-duration assets like MBSes.
On its Q2 call, AGNC said that despite the Federal Reserve and Treasury Department indicating that beneficial regulatory reforms were coming, banks remained largely on the sidelines. It also noted that foreign investor demand appeared subdued due to a weak U.S. dollar and geopolitical risk. However, it noted that MBS spreads have tightened since quarter-end and that it expects banks and foreign investor demand to grow in the future. This dynamic could help the current wide MBS spread to narrow.
Importantly, AGNC said comments from President Trump and Treasury Secretary Scott Bessent should help ease any investor concerns about the future of Fannie and Freddie and their role in the mortgage markets. Trump said that while he wants to take the GSEs (Fannie and Freddie) public, he will do so with the U.S. government keeping its implicit guarantee. In addition, Treasury Secretary Bessent said one requirement of privatization would be for MBS spreads to remain the same, and ideally, he wants them tightened. That should help take a major potential risk off the table for AGNC and other mREITs.
One of the most important metrics for mREITs is their tangible book value (TBV), which is essentially the value of their portfolio. The market turmoil caused AGNC’s TBV to fall 5%, or $0.44 per share, to $7.81 at the end of Q2, down from $8.25 per share at the end of Q1. It said it has risen 1% for July after deducting its dividend.
Looking at other important metrics in the quarter, AGNC’s average net interest spread was 2.01%, compared to 2.69% a year ago and 2.12% in the first quarter. The narrower spread stems from the lessening benefits of its hedges and higher hedge costs.
Overall, AGNC generated $0.38 per share in net spread and income from dollar rolls (a hedging strategy equivalent to short-selling but specifically employed in MBS markets to avoid losses when MBS values decline), which it uses to pay out its dividend. It generated a negative 1% economic return on its tangible common equity, with its TBV falling $0.44 per share while it paid out $0.36 per share in dividends during the quarter.
AGNC ended the quarter with higher debt, with 7.6 times tangible net book value “at risk” leverage (debt + net receivables or payables for unsettled investment securities outstanding/shareholder equity excluding goodwill). That compares to 7.5 at the end of the first quarter and 7.4 a year ago.
The company said it was in a position to deploy capital at a measured pace, but that it has room to increase leverage slightly. During the quarter, it raised $800 million in equity through its ATM (at-the-market) program at a significant premium to its TBV. It had invested less than half the proceeds at quarter-end and will continue to put the money to work. While equity raises are dilutive for companies, when mortgage REITs raise equity above TBV, it actually increases the TBV, so it is a positive.
Image source: Getty Images.
Is AGNC stock a buy?
AGNC is still generating enough income to cover its large dividend, and it expects its net spread and dollar roll income to stay in the mid- to high-$0.30 to the low- to mid-$0.40 range, which should help support it. However, for the stock to really work, it needs to see its TBV rally. The Fed seems reluctant to lower interest rates at the moment, although the biggest TBV catalyst for the mREIT would be tighter MBS spreads.
Wide spreads can be beneficial to AGNC when it’s putting money to work and investing in MBSes, as it can get higher returns. However, it needs the spreads to eventually narrow for the stock to benefit. AGNC said that a high percentage of its mortgage-backed securities is in specified pools with favorable prepayment attributes, so it is not likely to see a lot of refinancing with lower rates. As such, lower rates and spreads would be a big benefit for the stock.
With MBS spreads near historical highs, I think risk-tolerant, income-oriented investors can buy the stock at current levels, as I think further TBV downside appears limited. However, the current stock price does appear to somewhat reflect this.
