AGNC: Mortgage-Backed-Safety Market Freezing On Volatility (NASDAQ:AGNC) – In search of AlphaAugust 17, 2022
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Over latest months, there was a pointy decline throughout monetary markets within the face of rising recession alerts. This pattern has accelerated in latest weeks as almost all property, together with shares and bonds, have skilled speedy declines. Whereas virtually all fairness sectors have declined, expertise and, extra just lately, financials are faring worst.
The housing and mortgage markets are thrilling in the present day since they traversed from a powerful increase to a bust over a really quick interval. When the Federal Reserve started to buy mortgage-backed securities two years in the past, mortgage charges declined to excessive lows and precipitated the housing market to soar. Conversely, when these purchases ended, mortgage charges soared, inflicting the housing market to sluggish. Mortgage lenders, particularly mortgage REITs, are going through excessive declines.
A 12 months in the past, when many have been fawning mortgage REITs for his or her excessive yields, I used to be one of many few analysts to sign the alarm bells. This view is especially associated to agency-oriented mREITs equivalent to (NASDAQ:AGNC) as detailed in “AGNC: Rising Mortgage Unfold Alerts Hassle For Company REITs.” Most mREITs with vital company mortgage-backed-security property or “MBS” carry excessive publicity to the “mortgage unfold” or the distinction between a mortgage and Treasury rates of interest. My view on the time was that because the Federal Reserve started to sluggish and finish MBS purchases, mortgage charges would spike and trigger the unfold to return to regular ranges, inflicting AGNC’s guide worth to say no by “20-40%.“
Since then, the mortgage unfold has normalized, and AGNC’s worth has declined by 40%. AGNC is now on the finish of my earlier goal vary. Nonetheless, the general state of affairs has shifted as the acute spike in vitality prices and mortgage charges are pushing the financial system right into a recession. Primarily based on an ample provide of latest knowledge concerning each banks and the property market, a technical recession is my base case outlook, with a major slowdown not unlikely. Undoubtedly, this makes a tough state of affairs worse for AGNC is the mortgage-backed-security market has a behavior of freezing when threat notion rises. In my opinion, this will likely probably trigger AGNC and its friends to expertise a wave of pressured asset gross sales.
Like most MBS-oriented mREITs, AGNC’s enterprise mannequin is comparatively easy – purchase low-yielding mortgage-backed securities and amplify their yield through the use of vital leverage. As of Q1, the overwhelming majority of AGNC’s portfolio (over 90%) was made up of 30-year mounted residential company mortgage-backed-securities. These are massive swimming pools of conventional long-term fixed-rate mortgages assured by housing businesses equivalent to Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC). Fannie and Freddie make up the distinction if debtors don’t meet funds.
This assure provides company MBS property low credit score threat, which means their yields are sometimes not far above that of the U.S. Treasury. Nonetheless, contemplating Fannie and Freddie would not have an excellent observe document within the occasion of broad housing market declines (see 2008), the distinction in yields between mortgages and Treasuries tends to widen as threat grows. Whereas greater mortgage charges may increase AGNC’s revenue in the long run, it may additionally trigger its guide worth to break down within the quick time period resulting from its 7.8X leverage on tangible internet guide worth. See the shut inverse relationship under:
On the finish of the final quarter, AGNC had a tangible guide worth of $13.21. At the moment, the bottom 30-year mounted mortgage price was round 4.67%, whereas the 30-year U.S. Treasury price was 2.44%. The distinction between the 2, the mortgage unfold, was 2.23%. Within the firm’s final quarterly submitting, they reported a mortgage price unfold sensitivity and rate of interest sensitivity proven under:
AGNC Q1 2022 Curiosity Charge Sensitivity Tables (AGNC Q1 2022 10-Q)
A 50 bps (half p.c) rise within the mortgage unfold is predicted to trigger AGNC’s guide worth to say no by roughly 30%. Notably, the mortgage unfold had widened dramatically by ~30 bps over the week earlier than the tip of Q1 and by ~50 bps from March Fifteenth-Thirty first. Because it might take time for AGNC’s MBS property and plenty of rate of interest hedges to re-value, the corporate’s reported guide worth might not have absolutely thought of the latest shock.
Nonetheless, as of the final knowledge, the bottom 30-year mortgage price was a lot greater at 5.23%, with the Treasury price presently (as of writing) at 3.37%. The unfold between the 2 is barely decrease at 1.86%, probably benefiting AGNC’s guide worth. Nonetheless, mortgage charges are printed on a weekly foundation whereas Treasuries are every day, and this week’s huge decline within the company MBS ETF (MBB) implies the unfold has risen sharply greater. See under:
The mortgage price knowledge can also be lagging since it’s not primarily based on dwell market costs, as is the MBS ETF. Nonetheless, given the connection between the MBS ETF (MBB) and mortgage charges, I estimate this week’s 30-year base mortgage price is probably going nearer to five.7% in the present day and probably barely greater. This will increase the estimated unfold to 2.33% (5.7% minus 3.37%). A latest survey additionally suggests mortgage charges of round 5.7% to five.8%.
General, there was a slight improve within the MBS unfold from the tip of Q1 to in the present day as of the time of writing. That time is vital for the reason that market is extraordinarily risky in the present day, and as each mortgage charges and Treasuries rise, their potential every day change does as properly. Currently, we’re seeing vital speedy 15-30 bps rises and declines within the mortgage unfold, which implies that AGNC’s internet asset worth is probably going swinging by 5-15% on any given week.
Because the finish of Q1, Treasury charges have risen by round 1%, probably pushing AGNC’s guide worth round 8% decrease (given its -5.5% B.V. publicity to a 75 bps improve in Treasury charges). However, mortgage spreads are doubtless round 10-20 bps greater than when AGNC valued its portfolio, implying an extra ~15% in guide worth. The mixed 23% anticipated decline brings AGNC’s estimated NAV per share to $10.17 (23% under $13.21), virtually precisely the place the inventory is in the present day.
Primarily based on my price estimates, AGNC could also be buying and selling virtually exactly at its present estimated internet asset worth per share. The corporate additionally has a 13.5% yield, and so long as Fannie and Freddie can proceed to make ends meet, a few of that revenue ought to stay. In fact, AGNC is borrowing underneath short-term repurchase agreements, which carried a borrowing price of 0.37% final quarter. At the moment, after the latest Fed hikes, that borrowing price is round 1.5% to 1.75%, so AGNC’s revenue margins are underneath strain. Over the approaching months, I count on this issue to end in a dividend lower, significantly contemplating the Fed funds price could also be round 3.5% to 4% by year-end.
Contemplating the anticipated decline in AGNC’s revenue margin and its vital and rising NAV volatility, I consider the inventory is greatest averted. In 2020, because the spiraling financial outlook led to sharp declines in market liquidity, MBS property plummeted in worth. Nearly all MBS mREITs are topic to tight covenants resulting from their excessive leverage, inflicting many to expertise a pointy wave in margin calls throughout March of 2020.
Most mREITs, together with AGNC, have barely decreased leverage ranges, however the potential for a repeat state of affairs appears to be rising by the day. Final week, the MBS market went ‘no-bid’ because the excessive CPI knowledge precipitated the market to unwind. Whereas not completely associated, I take advantage of the floating price ETF (FLOT) as an indicator of economic market liquidity. That fund has plummeted at a comparatively excessive tempo over the previous week and a half – indicating banks and different massive traders are speeding for liquidity.
In my opinion, this creates a cloth chance that the mortgage-backed-securities market might quickly see a bigger shock. Not like in 2020, resulting from inflation, the Federal Reserve won’t be able to shortly rush in to avoid wasting the market. In my opinion, if it weren’t for the Fed’s huge $2T MBS shopping for program, most mREITs, together with AGNC, wouldn’t be solvent in the present day. Certainly, such actions from the Fed might have solely delayed the inevitable and even worsened the problem by inflicting house costs to inflate artificially (because of the excessive drop in mortgage charges throughout MBS Q.E.).
General, I’m bearish on AGNC and consider it’s a very dangerous guess in in the present day’s risky market. The mortgage unfold is now barely above its long-term ranges, so my bearish thesis on AGNC from final 12 months has now performed out. If house costs start to tumble (which I count on) as unemployment rises (which it might be), then there might be an unlimited potential pressure on these businesses. Current rule adjustments make it so taxpayers can’t simply bail out the businesses. Contemplating they carry ~$6T in obligations with a leverage of 140 to 1. In my opinion, the potential repeat failure of those establishments is probably probably the most distinguished potential adverse catalyst for AGNC, and its peer Annaly (NLY), going ahead.
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Disclosure: I/we now have no inventory, possibility or related spinoff place in any of the businesses talked about, however might provoke a useful Brief place by way of short-selling of the inventory, or buy of put choices or related derivatives in NLY over the subsequent 72 hours. I wrote this text myself, and it expresses my very own opinions. I’m not receiving compensation for it (aside from from In search of Alpha). I’ve no enterprise relationship with any firm whose inventory is talked about on this article.