Buy better: AGNC investment vs New Residential

The mortgage industry is deeply unpopular right now. Mortgage bankers are facing lower origination volumes as interest rates rise, and mortgage real estate investment trusts (REITs) are under the dark cloud of Fed policy.

Despite the difficult environment, some mortgage stocks are better positioned than others. AGNC Investment ( AGCN -0.76% ) is the classic agency mortgage REIT, while New Residential (NRZ 0.05% ) is a mortgage REIT that also originates mortgages. Which is best positioned for this environment?

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To get an idea of ​​who is best positioned, it is important to first understand the economic context. The economy is strong, inflation is up and interest rates are rising. The Federal Reserve is entering a tightening cycle – in other words, a series of increases in the federal funds rate, and will begin to reduce its holdings of mortgage-backed securities.

AGNC Investment is more exposed to the Fed

These two effects will affect AGNC Investment more directly. AGNC invests primarily in agency mortgage-backed securities, which are guaranteed by the US government. That said, AGNC invests in slightly different agency securities than the Fed – it has sophisticated algorithms that help it select securities that are better protected against prepayments – but it will still be affected by moves. of the whole market.

New residential is more exposed to credit

New Residential also invests in agency mortgage-backed securities, but it also invests in loans that are not eligible for government guarantees. These loans usually carry higher interest rates; however, if the borrower defaults, New Residential could lose money. These loans typically have a minimum 20% down payment, so most borrowers won’t forego this type of equity, especially in a time of rising house prices.

Rising rates are good for mortgage servicing assets

New Residential also invests in mortgage servicing, which is an unusual asset. Mortgage managers are responsible for administering the loan. They collect payments, pay taxes and insurance, and deal with the borrower if he gets in trouble. The servicer is paid a quarter of 1% of the loan per year. If rates rise, the service agent is expected to collect this payment longer, which means that maintenance is an asset that increases in value as rates rise. There are few assets that have this characteristic.

Given the Federal Reserve’s stance, along with growing house price appreciation and a tight labor market, investors should prefer to take credit risk over interest rate risk. AGNC Investment has practically no credit risk since its assets are guaranteed by the government. On the other hand, it presents a high interest rate risk. New residential, on the other hand, has less interest rate risk but has a lot of credit risk.

If we hit a recession then the math changes

If the Fed drags the economy into a recession, investors will be better off with AGNC Investment than with New Residential. If we hit a recession, more borrowers may lose their jobs and be unable to make mortgage payments. This will not be a problem for AGNC, as these payments are supported by the government. In addition, rates generally drop during a recession, which will benefit AGNC more than New Residential. So, in choosing between these two stocks, you have to keep the economic context in mind. But given the current environment, New Residential is positioned more attractively as an investment option.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

About Ian Crawford

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