There are warning indicators of a doable recession because the U.S. federal authorities appears to slash jobs, whereas tariffs might spark off a commerce battle. The Atlanta Federal Reserve’s estimate for actual gross home product (GDP) progress for the primary quarter has gone from predicting progress of greater than 2% in late February to a 2.4% decline as of its final estimate on March 6.
Whereas the specter of a recession is usually not good for the market, there may be one high-yielding dividend inventory that might carry out effectively on this atmosphere: AGNC Funding (AGNC -0.50%).
A excessive yield in a tumultuous market
AGNC is a mortgage actual property funding belief (REIT), which is an funding firm that owns a portfolio of mortgage-backed securities (MBS). It generates revenue via the unfold between the yield of the mortgages it holds in its portfolio and its funding prices (the short-term debt it takes on to purchase the MBS). For instance, if funding prices have been 4% and it purchased a mortgage-backed safety with a 7% yield, it could earn a 3% unfold on its funding.
A 3% return is just not that thrilling, so mortgage REITs usually use leverage, or borrowing, to bolster their returns. Additionally they typically deploy hedges to assist lock of their short-term charges for an extended interval to higher match the maturity length of their portfolios. That is necessary as a result of it mitigates the chance of rising funding prices narrowing the unfold, and even funding prices changing into larger than the yield on the MBS. It wasn’t way back that common yields on 30-year mortgages have been lower than 4%. Immediately, short-term charges as measured by the Secured In a single day Financing Charge (SOFR) are above 4%.
So why might AGNC carry out effectively in a recession? There are a few causes.
The primary is that the mortgage REIT invests virtually completely in MBS which might be backed by authorities or government-sponsored businesses. As such, it carries just about no credit score danger, because the underlying mortgages are primarily backstopped by the federal government. On the finish of 2024, 98.6% of AGNC’s portfolio was in agency-backed MBS, with 96% in 30-year fastened agency-backed mortgages.
A recession would additionally possible result in the Federal Reserve selecting up its tempo of rate of interest cuts. The Fed started reducing charges final September, however paused this yr because of the power of the financial system. With the financial system now clearly weakening, quicker price cuts seem like within the playing cards.
AGNC may gain advantage in two most important methods from decrease charges. The primary is that by reducing short-term charges, it might scale back funding prices and widen spreads. AGNC’s common internet curiosity unfold has been trending decrease in current quarters, going from 2.98% within the first quarter of 2024 to 1.91% within the fourth. That is largely resulting from much less hedging revenue.
Nonetheless, a few of this stems from AGNC administration turning extra towards Treasury-based hedges, which aren’t reported in its internet curiosity unfold or internet unfold revenue. On the finish of This autumn 2024, 33% of its hedges have been Treasury-based, whereas on a greenback length foundation (since these are longer hedges), it represented 53% of its hedging portfolio. About 70% to 80% of its hedges are usually rate of interest swaps, that are used to assist stabilize rates of interest. Treasury-based hedges have been the higher worth just lately, however AGNC would look to maneuver again extra towards swaps when swap spreads start to stabilize.
The primary level, although, is that decrease short-term charges ought to assist enhance funding prices.
As well as, any discount in longer-term rates of interest ought to assist the worth of AGNC’s portfolio. Since MBS are a fixed-income instrument like bonds, their present values are affected by rates of interest, or within the case of MBS particularly, mortgage charges. If mortgage charges fall, the worth of AGNC’s portfolio, as represented by its tangible ebook worth (TBV), ought to rise. Mortgage REITs are usually valued at a a number of of their TBV, so an rising TBV per share ought to assist increase its inventory worth.
Picture supply: Getty Photographs.
Is AGNC a purchase?
AGNC pays a $0.12 month-to-month dividend, which equates to a strong yield of greater than 14%. The mortgage REIT has paid out its present dividend for almost 60 months, and administration is assured that it may possibly proceed to take care of its present dividend. That is backed by AGNC’s projected returns of 17% to 18.5% on this present atmosphere.
Total, AGNC is a strong high-yield inventory with some average potential worth upside that ought to carry out effectively within the present atmosphere, even when we head to a recession.
Geoffrey Seiler has no place in any of the shares talked about. The Motley Idiot has no place in any of the shares talked about. The Motley Idiot has a disclosure coverage.
