Investors in American Capital Agency Corp (AGNC) got a nasty surprise after the bell last Thursday, with the company reporting results that sent shares reeling Friday. The headline numbers look bad, with the company reporting a loss of $1.57 per share, and net book value of $28.93 per share, down $2.71 (8.6%) from the previous quarter. The loss included $0.64 net income per share, offset by a loss of $2.21 on other comprehensive income, including net unrealized losses (paper losses) due to portfolio positions being marked to market at the end of the quarter. Digging a little deeper we see that the company earned $0.78 in net spread income per share, and another $0.40 in TBA dollar rolls, for a total of $1.18 per share. Undistributed taxable income per share was down $1.13 to $1.08. Net interest rate spread as of the end of the quarter was 1.71% including the TBA, which actually increased .10% quarter over quarter.
So if you own the stock, what does all this mean? The headline numbers look pretty awful, there's no positive way to spin it. The size of the decrease in BV is a bit surprising, but the stock market has been running, which is encouraging investors to get out of bonds and into stocks. There was also some talk during the quarter about maybe the Fed ending QE 3 early, although after the last few economic reports it looks like that is off the table. BV is basically back to where it was at the end of Q1 last year, and interest rates have been falling, so BV could be a bit higher now than it was March 31, as Mr. Kain alluded to in the conference call.
The other comprehensive income loss was all unrealized losses, partially offset by gains, so that doesn't change the cash flow of the bonds, only the carrying value. Still, not great to see BV drop 8.6%. Net spread at quarter end, not including the TBA dollar rolls, is above where it was at the end of Q3 2012, and including the rolls its above where it was last quarter's end, so that's a positive development. The drop in undistributed taxable income per share worries me a bit, just because it was such a drastic drop.
Anyone savvy enough to read Annaly's (NLY) report before AGNC's earnings (I wasn't) would have seen them report a drop in BV of a little over 4%, so that could have been a red flag to watch for weakness in AGNC. The fact that mortgage rates have been pushing lower in the last few weeks, near new all time lows, had led me to believe this report would have looked better. Be that as it may, this is really only the first time the company has put out a bad headline number since the IPO a few years ago, so it's not the end of the world. Net spread is still at a reasonable level, so money should keep rolling into AGNC, and into investors' pockets as dividends.
Shares finished Friday down 7.4%, not surprisingly close to the 8.6% drop in reported BV. I'd imagine a decent portion of the 28 million shares that changed hands were people who bought the offering in February of 57.5 million shares at $31.32. The weak hands are going to dump shares. The conference call didn't specifically say the dividend level was set in stone, and that has led to many people questioning the sustainability of the $1.25 per quarter going forward. Personally, I think the dividend is safe over the next quarter, since I do not believe that the company will reduce the dividend due to a single noisy quarter.
Longer term, if QE3 continues, as I expect it to, the company can increase leverage, or put more money to work into the dollar rolls, to get the spread income back up to the $1.25/quarter level that is needed to sustain the dividend. Based on the last two quarters, including the dollar rolls, I think a dividend of $1.15/quarter is probably a low ball sustainable level given the current market and performance of AGNC, and with a slight improvement in the market, the dividend should be safe. Either way we should get an announcement sometime in mid- June, so we'll know soon enough.
I'd caution people not to over-react after a single quarter from this company. The shares had been trading at a premium to BV, and likely should never have traded as close to $37 as they did. However, if shares are to trade at a more reasonable 1.1x book, the stock gets back to $31.90, yielding almost 16%. Not a bad investment, given the low rate environment.