On Thursday, American Capital Agency Corp. (AGNC) announced that it was raising $1.58 billion through a 50 million share sale. This move comes just months after AGNC announced a stock buyback program of up to $500 million. To some, at first glance, this move may come as a surprise. However, a closer look reveals that this move was both predictable and logical for AGNC. Similarly, I expect Annaly Capital Management Inc. (NLY) to follow AGNC and announce a stock offering of its own in the near future.
When AGNC announced its stock buyback program, it stated that the company would only repurchase stock when shares were trading below current book value. As shown by the chart below, for some time, in late 2012, AGNC traded at a discount to book value. On a few occasions, AGNC's price/book dropped below 0.90. However, AGNC shares are no longer trading at a discount to book value. Instead, AGNC is now trading essentially at book value.
Like AGNC, as shown by the chart below, NLY has gone from trading at a discount to book value to trading at book value. Also like AGNC, NLY had been repurchasing stock when NLY shares traded below book value.
Now that both NLY and AGNC are no longer trading below book value, share buybacks do not make sense. The buybacks do not make sense because NLY and AGNC have built their businesses by continuing to offer stock and then by using that money along with significant leverage to capture the spread between longer-dated securities and shorter-dated securities. In a sense, share buybacks actually shrink the business for NLY and AGNC. The only reason why AGNC and NLY announced share buyback plans was because their stocks were being undervalued by the market on a price-to-book basis. This is no longer true.
Interest Rates Rise
Over the past few months, long-term interest rates have increased somewhat as the economic outlook has improved. In particular, the US 30-year Mortgage Rate, shown below, has increased. This has been an important positive development for both NLY and AGNC as this means their spreads have increased from prior levels because short-term interest rates have remained unchanged thanks to Fed policy.
The change in rates, a near 20 basis points increase, may not seem all that significant for AGNC and NLY, but it is when leverage is taken into effect. Right now, AGNC uses leverage of about 8x. Of late, due in part to the Fed's buying of longer-dated securities, spreads have been declining for AGNC and NLY. The recent rise in rates presents an opportunity for AGNC and NLY to buy long-term securities at a better price than before.
A Word on Stock Issuance
The charts below make an important point: stock issuance is a key part of doing business for both AGNC and NLY.
In his piece, Offerings Continue At American Capital Agency Corp, SA contributor Mike Maher discusses how past AGNC stock offerings have worked out well for investors.
Given the fact that NLY is no longer trading below book value and mortgage rates have risen, I expect NLY to follow AGNC with a large stock issuance. Simply put, NLY relies on increased issuance to expand its business and now is the first opportunity in a while that NLY has had to come to market. As far as my outlook goes for both AGNC and NLY, I remain bullish on both. Investors should use the current weakness in AGNC shares, and potential weakness in NLY if it decides to come to market, as a buying opportunity.
Disclosure: I am long NLY.