There are warning indicators of a attainable recession because the U.S. federal authorities appears to slash jobs, whereas tariffs may spark off a commerce warfare. The Atlanta Federal Reserve’s estimate for actual gross home product (GDP) development for the primary quarter has gone from predicting development 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 properly 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 earnings by way of 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 had 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 shouldn’t be that thrilling, so mortgage REITs usually use leverage, or borrowing, to bolster their returns. Additionally they usually deploy hedges to assist lock of their short-term charges for an extended interval to raised match the maturity period of their portfolios. That is vital as a result of it mitigates the chance of rising funding prices narrowing the unfold, and even funding prices turning into larger than the yield on the MBS. It wasn’t way back that common yields on 30-year mortgages had been lower than 4%. Immediately, short-term charges as measured by the Secured In a single day Financing Price (SOFR) are above 4%.
So why may AGNC carry out properly in a recession? There are a few causes.
The primary is that the mortgage REIT invests nearly solely in MBS which can be backed by authorities or government-sponsored businesses. As such, it carries just about no credit score threat, because the underlying mortgages are basically 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 mounted agency-backed mortgages.
A recession would additionally doubtless result in the Federal Reserve choosing up its tempo of rate of interest cuts. The Fed started decreasing charges final September, however paused this yr as a result of energy of the economic system. With the economic system now clearly weakening, quicker charge cuts look like within the playing cards.
AGNC may benefit in two principal methods from decrease charges. The primary is that by decreasing short-term charges, it may scale back funding prices and widen spreads. AGNC’s common internet curiosity unfold has been trending decrease in latest quarters, going from 2.98% within the first quarter of 2024 to 1.91% within the fourth. That is largely as a consequence of much less hedging earnings.
Nevertheless, 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 earnings. On the finish of This fall 2024, 33% of its hedges had been Treasury-based, whereas on a greenback period 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 principle 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 growing TBV per share ought to assist increase its inventory value.
Picture supply: Getty Pictures.
Is AGNC a purchase?
AGNC pays a $0.12 month-to-month dividend, which equates to a sturdy yield of greater than 14%. The mortgage REIT has paid out its present dividend for practically 60 months, and administration is assured that it will 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.
General, AGNC is a stable high-yield inventory with some reasonable potential value upside that ought to carry out properly 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.
