Preferreds Weekly Review: Agency Mortgage REITs Kick Off Earnings

Welcome to another installment of our Preferreds Market Weekly Review, where we discuss preferred stock and baby bond market activity from both the bottom-up, highlighting individual news and events, as well as top-down, providing an overview of the broader market. We also try to add some historical context as well as relevant themes that look to be driving markets or that investors ought to be mindful of. This update covers the period through the last week of July.

Be sure to check out our other weekly updates covering the business development company (“BDC”) as well as the closed-end fund (“CEF”) markets for perspectives across the broader income space.

Market Action

Preferreds managed a positive return despite rising Treasury yields to close out a decent July with a total return of around 1%.

Credit spreads of the sector continued to tighten and have erased nearly all of the bank-related tantrum episode widening in March.

Market Commentary

Agency mortgage REITs have kicked off earnings. So far they look pretty good. AGNC book value was roughly flat while DX book value increased 3%. Annaly put in a good quarter as well with stable book value. Leverage didn’t change much across the sector.

As highlighted earlier, Agency spreads were trading near a decade high level which has historically provided support. It worked this time as well and spreads tightened about 0.15% off the wides.

A common theme which we have tended to see lately is additional common share issuance for AGNC Investment Corp. (AGNC), Annaly Capital Management, Inc. (NLY) and ARMOUR Residential REIT, Inc. (ARR). These issuances continue to support the equity / preferred coverage.

A potential tailwind is a redemption for either AGNC and NLY which would really move the needle on coverage, making the preferreds even stronger. We have seen this happen across hybrid preferreds over the last couple of years.

At this point NLY.PF (NLY.PF) remains a nice option with a double-digit yield. However, for more patient investors NLY.PI (NLY.PI) will soon become more appealing. Basically, NLY.PF gives you a 3% higher yield for about a year however after that NLY.PI will provide a 0.75% higher yield going forward, meaning after 4 years NLY.PI will have been the better choice starting today. Assuming the floating-rate yield differential remains around 0.75%, that breakeven will move lower over time so there may be a better rotation opportunity to NLY.PI ahead.

The sizable equity issuance for ARR overrode the drop in book value and pushed equity coverage from 6.1x to 7.5x which puts it in a close 3rd place behind Dynex Capital, Inc. (DX) and NLY.

ARR has not been a particularly good risk manager. The following chart shows it has suffered the largest drop in book value outside of the basket case Invesco Mortgage Capital Inc. (IVR) since 2018.

ARR.PC (ARR.PC) preferred at a 8.41% yield is only really attractive for investors who need a security with very long duration (both the low stock price of $20.51 and its fixed-rate profile combine to make the duration very long).

Otherwise, for a modest duration fixed-rate option, AGNCL (AGNCL) looks better despite its lower equity / preferred coverage with a 8.77% yield and a slightly higher reset yield for its 2027 first call date.

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