AGNC's Book Value Is Bouncing Upward In 2017; Buy Now?

| About: AGNC Investment (AGNC)
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Summary

AGNC pays an 11.5% annual dividend.

The yield on the 10-year US Treasury Note has fallen from 2.60% on December 15, 2016 to its current 2.31% as of this writing (-29 bps).

AGNC's Agency RMBS assets have gained considerable book value in the last month (after a horrid earlier drop in Q4 2016).

There is reason to believe that the Trump-mediated rise in interest rates is over for the near term. It may even continue downward near term.

Hopefully this article will help you grow your assets.

AGNC Investment Corp. (NASDAQ:AGNC) is a blue-chip mortgage REIT. The recent interest rate uptrend has reversed itself in the last month. It seems likely that interest rates will continue to fall or flatten in the near term. The reasons for this include the roughly month-long downtrend, the likelihood that Trump's stimulus promises will have mid-to-longer-term implementation dates if they do in fact come to fruition, and the slowing effects of the much higher interest rates (after the Q4 2016 rapid rise) will likely have on the US economy. These things should allow AGNC to recoup or at least maintain its book value without large further losses in the near term. This outlook makes AGNC, with its 11.5% annual dividend, a good buy.

In Q4 2016, the yield on the 10-year US Treasury Note rose from 1.59% on September 30, 2016 to 2.60% on December 15, 2016. That was +1.01% in less than one quarter. It was already at 2.38% on November 30, 2016 - the date of AGNC's last book value update. The book value on September 30, 2016 was $22.91 per common share. The book value on November 30, 2016 was $20.97 per common share (-$1.94/share or -8.47%). In my article of December 16, 2016 (using data from December 14, 2016), my ballpark calculation of the book value loss quarter to that date was -$2.73 per common share (-11.91%) or a book value of $20.18 per common share.

The direction of the yield on the 10-year US Treasury Note has dramatically reversed itself since then (see chart below).

From 2.57% on December 14, 2016, the yield on the 10-year US Treasury Note has fallen to 2.31% (-26 bps) as of this writing on January 12, 2017. There is very little doubt that this has pushed the book value of AGNC's Agency RMBS upward.

AGNC's Q3E portfolio is depicted in the tables and charts below.

I will attempt to ballpark the movement since December 14, 2016 and since November 30, 2016 to January 12, 2017. I will use AGNC's largest holding in fair market value to approximate the movement of the portfolio. This is the $15.978B in Agency 30-year 3.5% coupon RMBS (see the FNMA chart below).

The value of this RMBS at the close on November 30, 2016 was 102.34. On December 14, 2016, it was 101.03. On January 10, 2017, it was 102.86. An important point is that the value of this FNMA MBS was 102.86 on January 10, 2017 versus 102.34 on November 30, 2016. In other words, the MBS was 0.54 higher (or about +0.53% higher). I will not try to calculate out all of the leverage, hedging, etc. costs. Instead, I will note that the loss from September 28, 2016 at 105.55 to November 30, 2016 at 102.34 was -3.21 (or -3.04%). AGNC in its December 14, 2016 announcement (for its November 30, 2016 portfolio) said this amounted to a book value loss of -$1.94 per common share (or $0.64 per percentage point of loss). This would theoretically mean you have gained back about +$0.34 of the Q4 losses up to November 30, 2016. This would give you a book value of $20.97 + $0.34 = $21.31 per common share as of January 10, 2017. This is a considerable improvement from the book value of approximately $20.18 per common share (+1.13/share) that I estimated using data from December 14, 2016. AGNC holders have to be happy with this reversal upward in book value.

The whole process is much more complicated than I have indicated above. AGNC likely changed its TBA holdings during the course of Q4. These changes undoubtedly affected the book value, especially since interest rates were so volatile during Q4 2016. AGNC may also have sold some securities at various times during Q4 in order to keep its leverage from spiking too high. Such sales (and perhaps buybacks) would likely have had a further negative effect on book value. I and investors cannot know what effects AGNC's moves on TBA's had during the quarter until AGNC publishes that data. However, it is encouraging to see that AGNC's securities values have had such a big turnaround in late Q4 2016 and early Q1 2017.

The above-described turnaround is undoubtedly due to the drop in interest rates during that time. With this in mind, it is appropriate to try to assess whether interest rates are likely to keep falling, flatten, or begin rising again? In the longer term, many if not almost all believe that interest rates will eventually rise further. Hence I will only look at the next year or so.

Let's look at a few of Trump's plans:

  • Trump's infrastructure plan apparently would give $137B in federal tax credits to encourage private investors to back infrastructure projects. Trump planners say this would unleash $1T of private funds for infrastructure over the next 10 years. First, it usually takes an infrastructure plan at least six months (if not a year or more) to begin to feed stimulus monies into the economy. Second if the stimulus monies were coming from private investors, those funds would not be being spent elsewhere. Hence it is a bit questionable how much of a stimulus such building would be. Third the ranking member of the House Transportation and Infrastructure Committee, Rep. Peter DeFazio, says, "The vast majority of the national highway system, and our bridge problems and all our transit problems, do not generate revenues. It will not help them." Trump's plan is also supposed to be revenue neutral. However, many doubt that Trump will be able to satisfy Congress on this point. Rep. Raul Labrador said, "If Trump doesn't find a way to pay for it, then I think the majority of us, if not all of us, are going to vote against it." With all of this in mind, it seems doubtful that the expected infrastructure spending stimulus will get off to a fast start in Trump's Presidency.
  • Trump plans a repatriation holiday in 2017 for the nearly $2.5T in foreign profits being held overseas. Corporations would only be charged a 10% tax rate instead of a $35% rate. The first problem with this is that many corporations would not bring all of that money back even in the case of a tax holiday. Many have expansion plans overseas. Perhaps $1.5T or less is a more realistic figure to start with. Next, many pundits have suggested companies would use much of this money for stock buybacks. Those tend to benefit corporate officers and investors; but they create few, if any, jobs. Other pundits suggest the monies could be used to finance mergers and acquisitions. In this case, synergies might do away with jobs instead of creating them. Only 12.5% of CFOs suggested that repatriated capital would be used to increase head count. I could go on; but readers should begin to see this repatriation may not result in the huge stimulus that some have been expecting.
  • Trump has said he plans to cut corporate taxes from 39% to 15%. This would be far from revenue neutral. About 10.6% of US tax revenues are from corporate income taxes. Let's estimate that this would cut about 60% of that 10.6%. This seems unlikely to gain Congressional approval in 2017. Tea Party Republicans and others will still want to work to balance the budget. Huge increases to the federal budget deficit would be anathema to conservative Republicans. Democrats might oppose such a bill on a party-line basis.
  • Trump has said he plans to simplify and to cut individual taxes. These amount to about 46.2% of federal revenues. Any substantial cut to these revenues would be hard to get through Congress.

I could go on; but readers should be able to see that a lot of Trump's promises may take a long time to get to fruition, if they ever get there. This argues that Trump may not bring huge stimuli to the US economy in the near term. The already large recent rise in interest rates of about +1% and the +0.25% Fed Funds raise in Q4 may instead slow the US economy in the near term. This is what economic theory says should occur. Further, the repeal of ObamaCare, although likely good for the US economy in the long term, may bring short-term economic pain. Even the debate about a repeal may bring economic pain.

With all of the above in mind, it is easy to see that interest rates may not continue to rise dramatically. Instead, they may continue to fall; or they may flatten out for the near term. For either of these cases, mREITs should perform decently, if not well. The book value I estimated for AGNC above of $21.31 per common share is $2.5/share (or +13.3%) above AGNC's current stock price. Alternatively one could say that AGNC was trading at approximately an 11.7% discount to its estimated book value at the close on January 10, 2017. These figures both mean that AGNC can be bought at this time. AGNC's dividend should also be safe. The now higher than Q3E 2016 interest rates should mean a higher net interest spread going forward (more dividend income).

The chart of AGNC since its name change to AGNC Investments provides some technical direction for this trade/investment.

The chart seems to have technically bottomed in mid-December as the 10-year US Treasury Note yield put in a near-term top. The downtrend in the yield on the 10-year US Treasury Note since then is a strong one (see chart above). The expected fiscal stimuli from Trump's proposed/promised policies may take a longer-than-expected time to come to fruition (if the stimuli ever do). Given this, there is a strong likelihood that interest rates will continue to fall. Alternatively, they may flatten out. Either case should be a good environment for AGNC. It is again a buy with its approximately 11.5% annual dividend. Remember it is also selling at a good discount to its book value (my estimated book value as of January 10, 2017).

Note: Some of the fundamental fiscal data above is from Yahoo Finance.

Good Luck Trading/Investing.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AGNC over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.