AGNC Investment Corp.

Moat: 1/5

Understandability: 2/5

Balance Sheet Health: 3/5

A real estate investment trust (REIT) primarily focused on investing in agency residential mortgage-backed securities (MBS).

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

AGNC Investment Corp. (AGNC) operates within the complex realm of mortgage REITs, a sector known for its leverage, sensitivity to interest rates, and often unpredictable performance. It does not directly own or manage properties, unlike other types of REITs. It’s important to understand that the company doesn’t have an actual “moat” of any kind as discussed in several investing books.

Business Overview

AGNC’s revenue comes from the net interest spread it earns between the yields on the mortgage-backed securities (MBS) it owns and the interest it pays on its borrowings. Essentially, they borrow at short-term rates and invest in long-term MBS. The company is heavily reliant on agency residential mortgage-backed securities, specifically those backed by government entities like Fannie Mae, Freddie Mac, and Ginnie Mae. These securities are generally perceived as low-risk due to this government guarantee, which makes them easier to buy and sell in the market. However, the actual returns can be highly volatile based on interest rate fluctuations. The core of their business involves managing this spread carefully, and the ability to do so profitably is the main determinant of their long term viability. Their portfolio typically does not change too much, so large profit and revenue growth is generally not there.

AGNC does not directly own or operate any real estate assets.

The mortgage REIT industry is heavily influenced by broader macroeconomic trends, particularly interest rate policy and the yield curve. The Federal Reserve’s actions and monetary policy changes directly affect the cost of borrowing and the yield on MBS. As interest rates are hiked, AGNC usually has to bear higher costs for their borrowings, and these higher costs may not be quickly recouped from higher yield in assets, leading to a reduction of profits. The REIT space, particularly agency mortgage REITs, is competitive and subject to intense capital market volatility. A few large players, like Annaly Capital Management, dominate the sector and have their operations scaled based on availability of debt. Companies use aggressive leverage to enhance their returns, leaving them exposed when they face an unexpected market downturn.

AGNC and other mortgage REITs face major interest rate and liquidity challenges as rates have risen rapidly. These conditions directly impact their profitability as well as the risk of losses.

What Makes AGNC Different? AGNC specializes exclusively in agency MBS, which are the most liquid assets in the mortgage market. The business plan is simple, borrow at low rates, and buy higher yielding MBS, that are usually backed by the government. This is a straightforward strategy with very little variation. The company is well managed. They have the lowest expense ratio in the sector. They also leverage modern-day tools to track mortgage and interest rates.

Financials Deep Dive

AGNC’s financials are marked by a highly leveraged balance sheet. Their financial health is closely tied to interest rates and the slope of the yield curve. The below points are from the most recent Q1 2024 earnings:

  • Net Income For Q1, 2024, the company reported a comprehensive loss attributable to common stockholders of $488 million or $0.90 per share.
  • Net Interest Income: $206 million, which is impacted by higher borrowing costs and negative impacts of the rates.
  • Book Value: $8.64 per share, this has continued to be under pressure and is the reason for the dividend cuts.

The recent performance of the company shows the problems it is facing. The rapid increase in the cost of borrowing, due to continuous FED rate hikes, as the yields on assets are not matching the costs. AGNC has a substantial amount of “prepayments” which also erode long term earnings. The dividend has been cut in recent years as book value has continued to decline. Their balance sheet is highly sensitive to interest rate fluctuations, liquidity is important to have. Their operations are dependent on a stable yield curve that they can exploit.

Moat Rating: 1 / 5

AGNC has no economic moat. The company does not possess any unique capabilities, tangible or intangible assets that creates any competitive advantages over its peers. Their entire business plan can be copied by other investors. It is not a unique business. Because the agency MBS they invest in are commoditized and traded across the market, there is a lot of competition among competitors to get a small part of it.

Risks to the Moat and Business Resilience

  • Interest Rate Risk: Changes in interest rates can dramatically affect AGNC’s profitability by impacting the cost of borrowing and the yield on mortgage securities, and the company has little to no control over the changes in interest rates.
  • Prepayment Risk: When interest rates decline, borrowers are more likely to refinance mortgages, reducing the value of existing MBS portfolios for AGNC.
  • Leverage Risk: AGNC’s high leverage can amplify both gains and losses, leading to volatile earnings and potential financial distress during market downturns. If a rate hike is not responded to by yield in the underlying mortgages, the company faces lower yields for existing assets, while having higher costs.
  • Market Volatility: Fluctuations in the bond market can lead to unpredictable price movements in the company’s holdings.
  • Regulatory Risk: Changes in regulations regarding mortgage-backed securities or leverage limits can drastically affect AGNC’s business model and profitability. The constant changes in fed policies create a lot of uncertainity.

All of these external forces makes this a very cyclical industry to be in. Due to it’s commoditized offerings, and highly predictable, and transparent financial metrics, it is unlikely for any single player in the agency mortgage REIT space to create a defendable advantage over other players in its sector.

Understandability Rating: 2 / 5

While the basic principle of “buying low and selling high” is straightforward, the nuances of AGNC’s operations, particularly its use of derivatives and financial engineering, makes it hard to value, as well as fully understand by most individual investors. Understanding the complexities of interest rate movements, credit spreads, and the way these affect valuation in mortgage REIT space is essential for a true understanding of the business. The company is also constantly affected by changes in policy and regulations. Most importantly, the way the company generates profit is complex.

Balance Sheet Health: 3 / 5

AGNC’s balance sheet carries a high level of leverage (typically around 8 to 1 times assets to equity) which can make the company quite vulnerable to market swings and interest rate risks. Their assets are mostly made up of mortgage securities that are generally considered safe and liquid. This makes their assets very reliable. The issue is with their debt levels and how well the yields on their assets can outgrow the costs of their borrowing. They do seem to have the capability to tap into a wide range of funding sources, which adds to liquidity and safety. However, the overall structure is still complex.

Despite the company’s ability to weather some degree of volatility, their reliance on leverage and external factors leads to only a mediocre rating for its balance sheet.

Recent Concerns and Controversies

  • Dividend Cuts and Book Value Declines: AGNC has faced pressure due to rising interest rates and a flattening yield curve, leading to a decline in book value, forcing to cut the dividend yield.
  • Volatility: Volatility in markets due to rising rates created a lot of problems for the company.
  • Analyst Downgrades: Due to poor financial performance, many analysts and brokerages have downgraded the rating of AGNC.

Management has stressed they are focused on adapting their portfolio to the current market conditions, emphasizing their goal to deliver stable dividend yield to shareholders. They have also been reducing leverage. Management is also focused on managing risk better and improving the cost of borrowing as to take better advantage of new opportunities that might arise due to this environment. They are also focused on generating higher earnings with low capital intensity.

Disclaimer: This analysis is based on the provided materials and should not be considered financial advice. Investing in mortgage REITs involves substantial risks, and investors should conduct their own due diligence before making investment decisions.