Fed Rate Cut Round the Corner: Should You Make a Bet on AGNC Stock?

AGNC Investment Corp. AGNC is in the limelight with the Federal Reserve's decision to begin an interest rate cut this month. The Fed has kept its influential lending rate at its highest level at 5.25-5.50% since 2001 to tame inflation. The inflation has been gradually cooling down.

On Aug. 23, Fed Chairman Jerome Powell stated that the central bank has "ample room" to maneuver as policy enters its next phase. He stressed that the timing and speed of reduction will "depend on incoming data." With this, as per the CME Fedwatch tool, the market participants are now predicting a 61% chance of a 50 basis point rate cut this month compared with a 26% chance predicted a month ago.

AGNC is one of the mortgage real estate investment trust (mREIT) stocks burdened by the higher-interest-rate environment. With an improving market scenario and rate cut around the corner, investors are turning optimistic about AGNC stock. In the past six months, the shares of AGNC stock have rallied 15.5% compared with the industry's growth of 6%.

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The stock is also trading above the 50-day SMA, representing a bullish trend.

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In the current situation, should investors scoop up AGNC Investment stock? Before making any hasty decision, it would be prudent to take a look at the reasons behind the surge, the stock's growth prospects as well as risks (if any).

How Rate Cut Benefits AGNC?

AGNC's financials have been adversely impacted since early 2022, when the Fed first began its interest rate hiking cycle. The negative return and falling profitability raised concerns about the company's Investment's capacity to sustain its high-yielding payment.

At the end of the six months ended June 30, 2024, AGNC's interest income grew 54% compared with the six months ended June 30, 2022, thanks to higher rates on its MBS portfolio. However, its borrowing costs rose significantly, as interest expenses ballooned from $107 million to $1.4 billion during the same period. As a result, this mREIT had a net interest loss of $33 million at the end of six months ended June 30, 2024, against $763 million of net interest income registered at the end of six months ended June 30, 2022.

As long-term bond yields have declined with the Fed's decision of an interest rate cut, this resulted in a decline in mortgage rates. The average rate on the 30-year fixed-rate mortgage dropped to 6.35% as of Aug. 29 from 6.46% a week ago. A year ago, the metric averaged 7.18%.

As rate cuts begin, it will likely increase net interest spreads. This will ease earnings pressure for AGNC, as it is currently reeling under high funding costs. This will help the company to increase its dividend payout.

Also, the company has solid access to attractive funding across a broad spectrum of counterparties and financing conditions. As a result, it has flexibility in the opportunistic enhancement of its portfolio. AGNC Investment's liquidity as of June 30, 2024, including cash and unencumbered Agency assets, was $5.3 billion. This should alleviate some concerns about its capacity to maintain its payout.

High rates also impacted the book value of AGNC's investments due to "spread risk." From June 30, 2022, to June 30, 2024, the company's book value per share has declined 36.8%.

Nonetheless, the long-term outlook for Agency mortgage-backed securities (MBS) looks favorable. Agency MBS spreads have remained in a range that supports positive long-term risk-adjusted returns for leveraged investors like AGNC. At these levels, Agency MBS provides a significant incremental yield over both U.S. Treasuries and investment-grade corporate paper, which will continue to drive demand for Agency MBS. Given the favorable supply-demand dynamic for Agency MBS and the improving monetary policy outlook, the prospects for AGNC look favorable.

AGNC's Impressive Payout

This publicly traded mREIT offers a lucrative dividend yield.

As the expected rate cut will support AGNC's financials, the company can continue to pay dividends to its shareholders.

Income-seeking investors have a large appetite for REIT stocks, as U.S. law requires REITs to distribute 90% of their annual taxable income in the form of dividends. As for AGNC, the company has a record of paying monthly dividends.

AGNC's current dividend yield is 14.01%. This is impressive compared with the industry's average of 11.2% and attracts investors as it represents a steady income stream.

AGNC is not the only dividend-paying stock among Zacks Industry – REIT and Equity Trust. Stocks like Annaly Capital Management NLY and Ellington Credit Company EARN are also providing investors with solid dividend options.

NLY has an annual dividend yield of 12.9%, while EARN has a dividend yield of 13.9%.

Coming back to AGNC, dividends aside, it has a share repurchase plan in place. In 2022 and 2021, AGNC Investment repurchased 4.7 million shares and 17.7 million shares for $51 million and $281 million, respectively. With no repurchases done in 2023 and the first half of 2024, $1 billion remained under this program for repurchase through Dec. 31, 2024. It plans to buy back shares only when the repurchase price is lower than the then-current estimate of tangible net book value per common share. The buyback program will enable it to respond to the volatility in its stock and boost shareholders' wealth.

Factors to Consider Before Choosing AGNC

The ultra-high dividend yield and regular payout look eye-catching for most investors watching for high-income funds. However, in April 2020, AGNC slashed its dividend to 12 cents per share from 16 cents and continued to pay the same amount in later periods. Also, the company has a history of cutting its dividend.

Further, any volatility in the mortgage market, unfavorable changes in the shape of the yield curve, interest-rate volatility and deterioration of the generic financial conditions may affect the performance of the company's investments.

Also, analyst seems to be bearish about AGNC. Over the past 60 days, the Zacks Consensus Estimate for 2024 and 2025 earnings has moved downward.

Estimate Revision Trend

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Unlocking Valuation for AGNC

From a valuation standpoint, AGNC Investment appears expensive relative to the industry. The company is currently trading at a discount with a forward 12-month Price-to-Tangible Book (P/TB) multiple of 1.16X, above the industry average of 0.99X.

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The stock is more expensive than its peer, NLY's current forward 12-month P/TB of 1.06X. AGNC is trading at a discount to EARN's current forward 12-month P/E of 0.96X.

Should You Make a Bet on AGNC Now?

The Fed's adjustment in monetary policy should benefit AGNC. A rate-cutting cycle should boost its net interest spread and the book value of its portfolio. That could be a strong tailwind for the company in the upcoming period.

However, volatility in the mortgage market, unfavorable changes in the shape of the yield curve, and deterioration of the generic financial conditions may affect the AGNC's performance. Moreover, the company has a track record of lowering dividends during stressful times.

To conclude, investors interested in AGNC should wait for a better entry point, considering its premium valuation. They should analyze the upcoming interest rate changes and market volatility closely for a more appropriate entry point. The stock's Zacks Rank #3 (Hold) supports our thesis.

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