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Author's Note on Update: This is an UPDATED dividend sustainability analysis for American Capital Agency Corp. (NASDAQ:AGNC) in light of its recent Q1 2013 press release and earnings call. I was going to eventually write this updated analysis a couple of weeks after AGNC reported its first quarter of 2013. However, there was a high demand for such an analysis sooner. This is due to the surprising (and somewhat disappointing) figures reported by AGNC on 5/2/2013. My previous article projected AGNC's dividend sustainability on historical data through the fourth quarter of 2012. I feel it is only prudent to interpret the new data AGNC has provided. This includes drawing conclusions on the new information provided in light of its recent quarter.

The link to my previous dividend sustainability analysis is below (for reference, general topics of discussion, and history of comments/questions posed):

American Capital Agency Corp.'s Detailed Dividend Sustainability Analysis

Focus of Updated Article:

The focus of this article is to provide a detailed, updated analysis with supporting documentation (via tables) on the dividend sustainability of AGNC. I am writing this particular article due to the high demand that such an analysis be performed after AGNC reported its first quarter of 2013.

Table 1 - Overview of Accounts: [See Table 1 Below; Red References "A" Through "F2" Next to the 3 Months Ended: 3/31/2013 Column]

Table 1

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Side Note on Update: I am keeping Table 1's account explanations from my previous article in this updated article for clarity and understanding. All quoted paragraphs within the header Table 1 - Overview of Accounts is a reiteration from my previous article (headers "A" - "F" below). If these account descriptions were omitted, I feel readers will have an extremely difficult time understanding how Table 1 works.

"Before we begin AGNC's dividend sustainability analysis, let us first get accustomed to the information provided in Table 1. Table 1 begins with calculating AGNC's quarterly estimated REIT taxable income from its Q1 2013 and goes back to its first quarter in 2011. This is when I initially began taking an interest in AGNC and started with my personal research on the company. All account figures in Table 1 are for the "three-month" time-frame. The quarterly figures in regards to the red references "A" through "C2" are derived from AGNC's Q1 2013 shareholder presentation slide named Reconciliation of Generally Accepted Accounting Principles (GAAP) Net Income to Estimated Taxable Income."

"Table 1 then shows two separate, but indirectly linked, dividend sustainability calculations (TEST 1 + 2). These specific tests will be discussed later on in the article. For now, I am just describing what the accounts in Table 1 mean and where the information is derived. AGNC does not provide a table that shows any dividend sustainability analysis (red references "D" through "F2"). Therefore, the table (in regards to red references "D" through "F2") is created by my own research. All figures are checked and tied back to various spreadsheets and data from AGNC's supported documentation."

"Let us now take a look at Table 1's accounts (in corresponding order) and briefly describe what these accounts mean and where the information comes from."

A) Net Income:

"The quarterly net income figure is derived from AGNC's quarterly 10-Q or 10-K submissions. When I previously wrote in regards to AGNC's income statement, I explained in great detail how AGNC's net income figure was calculated in any given quarter. Further discussion of these quarterly net income figures will not occur in this article. This article's focus is a dividend sustainability analysis."

B) Book to Tax Differences (Reversals):

"In order for AGNC to come up with a proper estimated REIT taxable income figure, there are specific GAAP (book) to internal revenue code ('tax') adjustments/reversals that need to take place each quarter. Income and expense recognition of certain accounting transactions differ between GAAP (book) and the internal revenue code ('tax')."

"Temporary differences between book and tax accounting transactions can arise for AGNC at or near the end of a given quarter. For example, let us say there is a sale of an MBS between AGNC and a third party near the end of the quarter. GAAP recognizes this sale when an agreement is signed by both parties and perhaps a receivable is set up prior to the quarter-ending date. Therefore, we will say no cash actually was received by AGNC from this sale prior to the quarter-ending date. Per GAAP, revenue will be recognized and recorded prior to the quarter-ending date because a deal was struck and the likelihood of receiving proceeds from this sale is high. The revenue from the sale is recorded and a receivable is set up. However, under the cash method of accounting, the sale of this MBS would not be recognized until the cash was actually received. Therefore, for tax purposes, all accounting for this sale does not occur until after the quarter-ending date."

"Permanent differences arise in regards to GAAP accounts like premium amortization, net. This is a noncash GAAP account that is expensed over the estimated life of the MBS. For tax purposes, this account does not exist because it is a noncash account and needs to be reversed out each quarter. There are other, more-detailed timing differences, but for purposes of this article, further discussion is unwarranted."

C) Estimated REIT Taxable Income - Common Shareholders:

"After adding back (or subtracting out) AGNC's book to tax differences from net income, one can now calculate AGNC's estimated REIT taxable income. Once this figure is known, you subtract out AGNC's quarterly dividend distribution amount in regards to its preferred shares. Once this is complete, the estimated REIT taxable income for common shareholders figure is known. This is one of the main figures AGNC bases current and future dividend rate determinations upon and will be used within each dividend sustainability test. Also, as was discussed earlier in this article, AGNC is required to distribute at least 90% of its previous year's REIT taxable income (net of capital gains) in the current tax year to continue to be classified as a REIT per the internal revenue code. These distributions must be declared by September 15th and paid out by December 31st of a given year. In addition, AGNC will not be subject to any federal or state corporate taxes if it distributes all (100%) of its annual REIT taxable income (net of capital gains) to stockholders. This will be calculated and discussed in the third dividend sustainability analysis (TEST 3) later in this article."

D) Distributions to Stockholders from Estimated REIT Taxable Income:

"This figure is the actual quarterly dividend accrual AGNC makes in regards to its outstanding common shares and dividend per share rate. This accrual is made in the current quarter and paid in the following quarter. AGNC does not provide these quarterly distribution figures directly, but through research and analysis, one can find out these amounts. All quarterly distribution figures are reconciled and tied back to AGNC's supported documentation."

E) Under (Over) payment of Estimated REIT Taxable Income:

"This figure is the estimated under (over) payment of AGNC's quarterly estimated REIT taxable income vs. quarterly distributions to outstanding common stock shareholders (Reference "C" minus "D"). I also include what percentage of estimated REIT taxable income is paid out in a given quarter for additional clarity. This calculation will be discussed further under the first dividend sustainability analysis (TEST 1). Once again, AGNC does not provide this specific information, but through research and analysis, one can perform this analysis."

F) Undistributed Taxable Income ('UTI'):

"UTI is the cumulative amount of undistributed estimated REIT taxable income on AGNC's books that remains after AGNC accrues for its quarterly dividend distribution. This is always a "running" balance. This is basically AGNC's cumulative surplus in regards to its estimated REIT taxable income that has yet to be paid out. This calculation will be discussed further under the second dividend sustainability analysis (TEST 2)."

Brief Discussion of the Three Tests to be Performed:

Now that there is a better understanding of what accounts make up Table 1, let us begin to discuss the results from my dividend sustainability analysis. For a complete and thorough analysis, I have performed three semi-related, but different dividend sustainability analyses (three TESTS).

TEST 1 and TEST 2 are shown via Table 1 (see above). Both TEST 1 and TEST 2 determine the probability of the future sustainability of AGNC's dividend beginning in Q4 2013. This will be the first quarter that begins AGNC's 2013 tax calendar. These tests also have an indirect relation to AGNC's Q2 + Q3 2013 dividend sustainability under certain circumstances. TEST 3 involves Table 2 (see below). Table 2's calculation will be discussed under TEST 3 later in the article. TEST 3 discusses in length AGNC's 2012 annual REIT taxable income (net of capital gains) that needs be declared by 9/15/2013 to maintain its REIT status. These dividend distributions must be declared by 9/15/2013 and paid out by 12/31/2013. The three TESTS are as follows:

1) Quarterly Estimated REIT Taxable Income - Common Shareholders vs. Quarterly Distributions Analysis (TEST 1)

2) UTI Cumulative Balance (Quarterly) vs. Quarterly Distributions Analysis (TEST 2)

3) "Paid-In-Arrears / Spill-Back" Provision Analysis (TEST 3)

1) Quarterly Estimated REIT Taxable Income - Common Shareholders vs. Quarterly Distributions Analysis (TEST 1): [See Table 1 Above; Red References "D" Through "E" Next to the 3 Months Ended: 3/31/2013 Column]

This is the simplest of the three tests to perform. For this analysis, I take AGNC's quarterly "estimated REIT taxable income - common shareholders" (red reference "C2" in Table 1) amount and subtract this figure by the quarterly "distributions to stockholders from estimated REIT taxable income" (red reference "D" in Table 1) amount. If AGNC's reference "C2" is greater than reference "D", then AGNC has ample quarterly REIT taxable income to pay out its quarterly distributions to common stockholders. If AGNC's reference "C2" is less than reference "D", then AGNC will tap into its cumulative UTI balance from the previous quarter (Q4 2012) to help pay out its quarterly distributions to common stockholders in the current quarter. After performing TEST 1, I conclude AGNC has consistently had ample quarterly REIT taxable income to pay its quarterly common stock dividend up until Q1 2013. This past quarter was not a particular "pretty" quarter in regards to AGNC's quarterly REIT taxable income (amongst other disappointing figures). AGNC only generated a quarterly estimated REIT taxable income amount of $0.50 per share. Let's take a look at Table 1 for a more detailed analysis of TEST 1.

TEST 1 looked good for AGNC up until Q1 2013. Prior to Q1 2013, only three quarters had an amount distributed by AGNC that was over 90% of its quarterly estimated REIT taxable income. These quarters were: 1) Q2 2012; 2) Q4 2011; and 3) Q1 2011. Even in these three quarters, the dividend distribution payout ratio never exceeded 95% of its quarterly REIT taxable income. This was an extremely positive sign. In Q1 2012, after AGNC's dividend rate cut from $1.40 to $1.25 per share, it only paid a measly 58% of its quarterly estimated REIT taxable income in dividends. This dividend cut was anticipatory for a modest gradual decrease in overall market interest rates in 2012. At the time, people could argue if the dividend cut was actually needed. Also, just in a fairly recent quarter (Q4 2012), AGNC only paid 65% on its estimated REIT taxable income. There was not even a dividend cut from Q3 to Q4 of 2012. As such, AGNC's cumulative UTI balance grew rapidly in Q4 2012.

However, taking into consideration AGNC's Q1 2013, TEST 1 has taken a more negative, cautionary tone. As we will see during our second + third tests later (in regards to UTI and the "paid-in-arrears" provision analysis), these poor Q1 2013 results set the stage for a more cautionary outlook in regards to AGNC's dividend sustainability starting in Q4 2013. In Q1 2013, the quarterly dividend distribution ratio escalated to 282% of its quarterly REIT taxable income. This is a huge outlier. This is the first quarter that has ever showed negative signs in regards to the quarterly dividend distribution payout ratio.

Before people panic though, in AGNC's defense, this quarter was a bit of an oddity. As will be discussed in my conclusion, people should not project out Q1 2013's results for the remaining three quarters of 2013. However, one should note that Q1 2013 was bad in regards to TEST 1's result. Q2 2013 now becomes a key quarter in regards to producing a higher than average estimated REIT taxable income figure to help offset the weak Q1 2013 estimated REIT taxable income figure of $180 million.

TEST 1 does not come without certain drawbacks. This is why it is only the first of three tests that will be performed in this article. This analysis does not take into consideration any UTI data or data in regards to the "paid-in-arrears / spill-back" provision that must be adhered to by AGNC. Since TEST 1 does not specifically include these additional features, it would only be prudent to perform additional tests in regards to AGNC's UTI account (TEST 2) and also its "paid-in-arrears" provision (TEST 3).

Now, let us go on to TEST 2 which is a little more complicated analysis to perform. We need to perform this next analysis to gain further clarity on the probability of AGNC's future dividend sustainability.

2) UTI Cumulative Balance (Quarterly) vs. Quarterly Distributions Analysis (TEST 2): [See Table 1 Above; Red References "D", "F1", and "F2" Next to the 3 Months Ended: 3/31/2013 Column]

For this analysis, I take AGNC's "UTI balance" (red reference "F2" in Table 1) and divide this figure by the quarterly "distributions to stockholders from estimated REIT taxable income" (red reference "D" in Table 1) amount. From this calculation, AGNC's "UTI coverage of current dividend distributions" (red reference "F2 / D" in Table 1) ratio is achieved. This can also be referred to as AGNC's UTI per share amount. The higher this ratio (or per share amount) gets, the more positive the results. This is basically the UTI cumulative balance amount covering the current quarter's dividend distribution amount. This amount is the excess reserve AGNC has if its estimated REIT taxable income falls under its current $1.25 per share amount ($1.40 per share prior to Q1 2012; since Q3 2009) in any given quarter. As noted above, this occurred in Q1 2013. If one reviews this ratio within Table 1, you can see this ratio gradually increased over most quarters since Q1 2011. There are a few quarters within 2011/2012 where the ratio drops slightly. However, eventually the ratio rose even higher in subsequent quarters. In Q1 2011, the UTI to quarterly dividend distributions ratio was only 0.40. AGNC's Q4 2012 ratio grew to a factor of 1.76. At 12/31/2012, AGNC had its highest undistributed taxable income (UTI) balance ever of $749 million. Its quarterly distributions for Q4 2012 were only $427 million. This was an extremely positive sign that was weakened from the past quarter.

However, when AGNC reported a weak Q1 2013 estimated REIT taxable income amount of only $0.50 per share (See TEST 1), TEST 2 also began showing signs of stress in regards to dividend sustainability. The cumulative UTI balance to quarterly distributions ratio fell from a factor of 1.76x in Q4 2012 to only a factor of 0.86x in Q1 2013. As was stated in TEST 1's results, Q1 2013 was not a typical quarter. As will be discussed in my conclusion, people should not project out Q1 2013's results for the remaining three quarters of 2013. However, one should note that Q1 2013's quarter was very bad in regards to TEST 2's results (as was the case for TEST 1).

Q2 2013 now becomes a key quarter in regards to producing a higher than average estimated REIT taxable income figure. This will help offset the large decline in AGNC's cumulative UTI balance from $749 million at 12/31/2012 to $430 million at 3/31/2013. If AGNC's Q2 2013 quarterly estimated REIT taxable income (part of TEST 1 calculation) is above its estimated quarterly distributions figure of $500 million, then its cumulative UTI balance will rise again. As a result, its surplus cumulative UTI vs. quarterly dividend distributions ratio will rise once again. This assumption assumes AGNC will continue its $1.25 quarterly dividend in Q2 2013 (see TEST 3 for reasoning behind this projection).

On the bright side, AGNC still has a surplus in its UTI account at 3/31/2013. If this balance became negative, then the probability of a future quarterly dividend cut would be extremely high. This ratio took a pretty big hit in Q1 2013, but a factor of 0.86x is still a pretty good cumulative ratio to have. To put this ratio in perspective, AGNC had a UTI vs. quarterly dividend distribution ratio of 0.57x in Q4 2011 before it cut its dividend in Q1 2012. AGNC has never had a deficit balance in regards to its cumulative UTI account.

For my third and final analysis (TEST 3), we will examine the "paid-in-arrears / spill-back" provision to see how this might affect AGNC's dividend in regards to Q2 + Q3 2013.

3) "Paid-In-Arrears / Spill-Back" Provision Analysis (TEST 3): [See Table 2 Below; Red References "C2", "G" Through "J" Next to the 3 Months Ended: 3/31/2013 Column]

As was discussed earlier in this article (under "discussion of AGNC's REIT classification"), AGNC is required to distribute at least 90% of its previous year's REIT taxable income (net of capital gains) in the current tax year to continue to be classified as a REIT per the internal revenue code. These distributions must be declared by September 15th and paid out by December 31st of a given year. This is referred to as the "paid-in-arrears / spill-back" provision. In my opinion, this is the most important calculation because AGNC must adhere to this provision or else be declassified as a REIT tax entity per the internal revenue code.

All account figures in Table 2 (see below) are for the "twelve-month" time-frame. The annual figures in regards to the red references "A" through "C2" are derived from AGNC's quarterly shareholder presentation slide named "Reconciliation of Generally Accepted Accounting Principles (GAAP) Net Income to Estimated Taxable Income". AGNC does not provide a table that shows any dividend sustainability analysis (red references "C2a" through "J"). Therefore, the table (in regards to red references "C2a" through "J") is created by my own research. All figures are checked and tied back to various spreadsheets and data from AGNC's presentation slides and/or quarterly submissions to the SEC.

Let us take a look at Table 2 and calculate the amount of distributions that must be declared by 9/15/2013 in order to satisfy AGNC's requirement of maintaining its REIT status:

Table 2

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By performing TEST 1 and TEST 2 earlier, we now can figure out AGNC's annual REIT taxable income by taking Table 1's data and accumulating the quarterly amounts. AGNC's annual figures are shown in Table 2. Within Table 2, I want to mainly discuss AGNC's 2012 annual REIT taxable income figure. This figure is the "starting point" for TEST 3's calculation. This calculation determines how much distributions need to be declared by 9/15/2013 (thus affecting AGNC's remaining Q2 + Q3 2013's dividend). AGNC's 2012 annual REIT taxable income is $2.088 billion. This amount is the figure (within Table 2) that is shaded in pink next to the red reference "C2" for the 12 months ended 12/31/2012 column. However, all net capital gains can be excluded from AGNC's annual REIT taxable income amount. The weighted average of AGNC's net capital gains for years 2009-2012 was 7.34%. I omitted this net capital gains figure for immateriality in my Q4 2012 analysis. However, due to AGNC's rather poor Q1 results, this exclusion percentage will now be included. Therefore, to get the best possible estimate available, one should subtract this weighted average percentage of 7.34% from the original 2012 annual REIT taxable income amount. AGNC's 2012 annual REIT taxable income (net of capital gains) is $1.935 billion. This amount is the figure (within Table 2) that is shaded in light gold next to the red reference "C2 - C2a) = C2b" for the 12 months ended 12/31/2012 column. 90% of AGNC's 2012 annual REIT taxable income (net of capital gains) is $1.741 billion. This amount is the figure (within Table 2) that is shaded in black next to the red reference "C2b * 90% = G" for the 12 months ended 12/31/2012 column. Therefore, $1.741 billion needs to be declared by 9/15/2013 and paid out to common shareholders by 12/31/2013. From this calculation shown within Table 2, we now know the absolute minimum amount of dividend distributions AGNC needs to declare by 9/15/2013 and paid out by 12/31/2013.

In past years, AGNC has declared Q3 dividends on the following dates: 1) 2010's Q3 dividend on 9/14/2010; 2) 2011's Q3 dividend on 9/13/2011; and 3) 2012's dividend on 9/11/2012. Declaring these Q3 dividends on these dates is no coincidence. AGNC declared its Q3 dividend just days before the deadline of September 15th of a given year. September 15th of a given year corresponds to the deadline date of various tax entities' (including REITs) 6-month extension period to file taxes from previous year's operations. This is why AGNC can treat all dividends declared and paid from Q4 of the previous year to Q3 of the following year as being paid on the prior year's business operations. I mention this because from this information, we can be pretty confident that AGNC will declare its Q1-Q3 2013 dividends prior to September 15th, 2013. These distributions will be treated as having been made to AGNC's 2012 annual REIT taxable income (net of capital gains) amount. You also must include the Q4 2012 dividend that was declared on 12/24/2012 but paid out on 1/28/2013. This dividend is also treated as having been a distribution of AGNC's 2012 REIT taxable income and paid in 2013. Therefore, the four quarters' worth of dividends (Q4 2012 - Q3 2013) must equal at least 90% of AGNC's 2012 annual REIT taxable income (net of capital gains) which is $1.741 billion.

From my previously written article on AGNC's Q1 2013 estimated book value, I was pretty confident AGNC accrued a Q1 2013 dividend of approximately $499 million. In this updated article, we can now see this estimated figure was 100% correct (see AGNC's Q1 2013 investor presentation slide "Net Book Value Roll Forward; Slide 23 [$496 million + $3 million]). In Q4 2012, they accrued for a dividend of approximately $427 million. Therefore, AGNC has distributed approximately $926 million of its 2012 annual REIT taxable income (net of capital gains) in 2013 so far. This amount is the figure (within Table 2) shaded in blue next to the red reference "H" for the 12 months ended 12/31/2012 column.

Therefore, at a minimum, AGNC must distribute an additional $816 million of its 2012 annual REIT taxable income (net of capital gains) to satisfy the 90% REIT provision. This amount is the figure (within Table 2) shaded in yellow next to the red reference "(G - H) = J" for the 12 months ended 12/31/2012 column. The remaining balance's average dividend payable (Q2 + Q3 2013) would have to be a minimum of $408 million at the very least. This amount is the figure (within Table 2) shaded in yellow next to the red reference "(J / 2)" for the 12 months ended 12/31/2012 column.

However, AGNC has stated it ultimately wants to pay out 100% of its 2012 annual REIT taxable income in 2013. This is due to the fact AGNC would not pay any federal or state corporate income taxes if it distributes all (100%) of its annual REIT taxable income (net of capital gains) to stockholders by 9/15/2013. AGNC has not commented about changing this goal (even after Q1 2013's weak results). Therefore, at a minimum, AGNC would like to distribute an additional $1.01 billion of its 2012 annual REIT taxable income (net of capital gains) in Q2 + Q3 of 2013. This amount is the figure (within Table 2) shaded in yellow next to the red reference "(C2b - H) = I" for the 12 months ended 12/31/2012 column. The remaining balance's average dividend payable (Q2 + Q3 2013) would have to be at least $505 million. This amount is the figure (within Table 2) shaded in yellow next to the red reference "(I / 2)" for the 12 months ended 12/31/2012 column.

Two scenarios could happen which would affect how AGNC distributes its remaining $816 million (90% distribution requirement) or $1.01 billion (100% distribution election) balance of its 2012 annual REIT taxable income (net of capital gains). By examining these two scenarios, we will be able to see if a possible dividend rate change will occur. Both scenarios will assume AGNC wants to distribute 100% of its 2012 annual REIT taxable income. AGNC has done so in every year since 2008's inception and stated within its last quarterly submission this is still the current goal (even after the weak results in Q1 2013 [to avoid taxation at the corporate and state levels]). If or when AGNC changes its rhetoric in regards to its dividend distribution goals (a change from 100% to 90%), the following two scenarios will be updated accordingly.

The first scenario involves no additional equity offerings between now and 9/15/2013. AGNC would have the option to pay the minimum remaining balance of $1.01 billion (per its 100% distribution goal) over the next two quarters. To satisfy AGNC's goal of 100% distribution, an average quarterly dividend distribution of $505 million for Q2 + Q3 2013 would have to be made. Taking into consideration the recent equity offering in late February / early March, AGNC declared dividend distributions of approximately $499 million in Q1 2013. Q1 2013's dividend distribution of $499 million was $5 million under the remaining average dividend 100% distribution balance of $505 million for Q2 + Q3 2013. Therefore, if AGNC were to just meet its 100% distribution goal (to avoid taxes at the company level), the dividend rate of $1.25 per share seems the most viable option.

After AGNC's Q1 2013 results, the probability of AGNC just paying out the minimum 90% of its 2012 annual REIT taxable income has risen slightly. I originally stated this chance was extremely low. I would now state the probability of this occurring as low to slightly moderate. This low probability projection (as stated above) is based on the fact AGNC stated its goal is still to distribute 100% of its annual 2012 REIT taxable income (net of capital gains). In both 2011 and 2012, AGNC distributed an annual amount in excess of its prior year's annual REIT taxable income. In 2011, AGNC had to pay out (at the minimum 90%) an estimated $206 million (net of capital gains) in regards to its 2010 annual REIT taxable income. This amount is the figure (within Table 2) that is shaded in black next to the red reference "C2b * 90% = G" for the 12 months ended 12/31/2010 column. However, they paid out $664 million from Q4 2010 through Q3 2011. This amount is the figure (within Table 2) shaded in light brown next to the red reference "H" for the 12 months ended 12/31/2010 column. This distribution is approximately 322% of its 2010 annual REIT taxable income (net of capital gains). In 2012, AGNC had to pay out (at the minimum 90%) an estimated $857 million in regards to its 2011 annual REIT taxable income. This amount is the figure (within Table 2) that is shaded in black next to the red reference "C2b * 90% = G" for the 12 months ended 12/31/2011 column. However, it paid out $1.42 billion from Q4 2011 through Q3 2012. This amount is the figure (within Table 2) shaded in light blue next to the red reference "H" for the 12 months ended 12/31/2011 column. This amount is approximately 165% of AGNC's 2011 annual REIT taxable income (net of capital gains). As you can see, AGNC typically does not just pay the minimum "required" distribution of 90% of the prior year's annual REIT taxable income (net of capital gains) amount. In fact, AGNC usually pays at least 100% of the prior year's annual REIT taxable income (net of capital gains) amount to avoid corporate and state taxes. Due to AGNC's weak results in Q1 2013, there will most likely be a lower payout percentage of AGNC's 2012 REIT taxable income (net of capital gains) when compared to years past. However, I see no reason for this payout ratio to be below 100% of AGNC's 2012 annual REIT taxable income (net of capital gains). As stated above several times, AGNC's first quarter results were not typical.

The second scenario would involve one more equity offering between now and 9/15/2013. Even though AGNC reported a rather low leverage factor of 5.7 at 3/31/2013, this excluded all "to-be-announced ('TBA') MBS investments. Including these "off balance sheet" investments, AGNC's leverage factor 3/31/2013 was actually 8.1x. Compared to prior quarters, this is more towards the higher end of its leverage factor rate. Therefore, if these investments were to become "on balance sheet" MBS investments in Q2 or Q3 (purchase outright instead of "re-rolling", AGNC may need additional capital for further regular MBS purchases. This is an important concept to understand. If AGNC has an additional equity offering prior to 9/15/2013, this in turn would increase the number of common shares outstanding. If there's an increase in the number of common shares outstanding, the average dividend distribution of $504 million (AGNC's 100% dividend distribution payout goal) can be satisfied on a lower quarterly dividend per share rate. This happens because there are more outstanding shares. Therefore, a higher quarterly dividend distribution amount occurs if the dividend rate stays the same at $1.25 per share.

Let's use an example for illustration purposes/further clarity:

Table 3

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Let us say in July 2013, AGNC issues an equity offering of 55 million shares (an approximate average of the last several raises; this includes the underwriters' option to issue additional shares). From this offering, the number of common shares outstanding has risen to approximately 450 million in July 2013 (red reference "E" in Table 3). We will assume AGNC paid a Q2 dividend of $1.25 for a total Q2 2013 distribution of approximately $500 million (red reference "B3" in Table 3). Therefore, about $509 million (red reference "D" in Table 3) needs to be paid out in Q3 2012. Per Table 3, AGNC could pay a minimum of $1.13 per share in Q3 2013 to satisfy its 100% of 2012 annual REIT taxable income (net of capital gains) distribution goal. Most investors would see this potential dividend cut as a negative consequence. Again, this example only illustrates the possibility of a dividend cut in Q3 if AGNC wishes to only pay out 100% of the 2012 annual REIT taxable income (net of capital gains).

My personal opinion is if AGNC reports a better than average Q2 2013 result in regards to quarterly estimated REIT taxable income (good likelihood so far), such a potential dividend cut from an additional equity raise prior to 9/15/2013 would not occur. However, it is still prudent to show that a possible cut could arise if an additional equity raise were to occur in either Q2 or Q3 2013. Again, this example assumes AGNC maintains its strategy of wanting to distribute 100% of its 2012 annual REIT taxable income (net of capital gains). If AGNC reports another poor quarter in Q2, then its 100% distribution goal could be revised down to the 90% dividend distribution requirement to maintain its REIT status per the internal revenue code.

Side Note to TEST 3: A particular comment in regards to my previous article on this topic (from Meridanguy) asked if AGNC can use previous years' "over-distributions" (amount in excess of the minimum 90% of a company's annual REIT taxable income [net of capital gains]) to use as a "catch-up" or "carryover" for future tax periods. I can see how this is a justified question for people without a rather high level of taxation knowledge. I will answer this question here. The answer is no.

A "dividend carryover" can only be granted if AGNC is a personal holding company (which it is not). A company is a personal holding company if two requirements are met. This first test is if at least 60% of a company's adjusted gross income ('AGI') is from dividends, interest, rent, and royalties (gross income test). AGNC would pass this first test. Under the second requirement, at least 50% of a company's outstanding shares of stock must be owned by five or fewer individuals. This is known as the stock ownership test. Here AGNC would fail. Furthermore, one of the numerous provisions of being defined as a REIT under the internal revenue code states not more than five (or fewer) individuals can own more than 50% of the outstanding stock (either directly or indirectly) for more than half the taxable year. Therefore, the internal revenue code specifically states in order to qualify as being a REIT under subchapter M of the internal revenue code, this "stock ownership" test has to fail for half the year. This half year clause is irrelevant because AGNC has never had less than five stockholders (directly or indirectly) own over 50% of its outstanding shares to begin with.

This particular reader may have been trying to make a connection between corporate/personal tax "capital-loss" or net-operating loss (NOL) carryovers and a REIT's 90% minimum distribution provision. When AGNC and others REITs file taxes, they use the form "1120-REIT" and are subject to the laws under subchapter M of the internal revenue code. Under such rules, they report income and expense in the same manner as most other tax entities (to an extent; there are some subtle differences). However, unlike most other taxable entities, AGNC is not subject to any federal or state corporate taxes if it distributes at least 100% of its annual REIT taxable income (net of capital gains). This is where the dividend distribution deduction comes into play. The taxation structure in regards to the dividend distribution deduction is similar to that of a yearly estate filing (Form 1041; maybe some readers have had some familiarity with estate taxation situations). I could get more technical, but for purposes of this article, I will not delve further.

Therefore, prior years' "over-distributions" in excess of its annual REIT taxable income (net of capital gains) from years past cannot be "carried-forward" in its current year's distribution deduction within AGNC's 1120-REIT filing. The rules for capital and/or NOL carry-forwards are not the same as distribution deductions in regards to REITs (or several other types of taxable entities). This does not even get into the discussion of AGNC's taxable REIT subsidiary ('TRS') and possible taxation on hedges when certain situations arise.

Conclusions Drawn:

From the three TESTS performed, some evidence has arisen (from Q1 2013's results) that AGNC's quarterly dividend of $1.25 per share could come under pressure in future quarters. As concluded from TEST 1 + TEST 2, if AGNC has another weak quarter in Q2 2013, the future sustainability of AGNC's dividend at the $1.25 per share rate may be in jeopardy starting in Q4 2013. Some negative signs have begun to creep into AGNC's dividend sustainability tests. However, there are still some positive signs for dividend sustainability as well.

Let's summarize each dividend sustainability test and discuss both negative and positive signs:

1) In regards to TEST 1, AGNC's Q1 2013 weak results have caused a huge payout ratio when compared to past quarters. AGNC's Q1 2013 payout ratio was 282%. However, as stated at the end of TEST 1, Q1 2013 was not a "typical" quarter for AGNC. Management timed its expansion into the TBA dollar-roll contracts poorly. AGNC increased its positions in Q1 2013 while interest rates were rising. The revenues it generated from "dollar-roll" transactions were completely offset by the realized losses sustained on the FMV of these TBA MBS investments upon settlement. TBA MBS investments are "realized" on the settlement date which usually occurs monthly. On the settlement date, they have the option to: 1) purchase the MBS where the TBA MBS becomes a typical MBS on AGNC's balance sheet; 2) "re-roll" the TBA MBS to a later date (ex. could be next month); or 3) terminate the TBA MBS's contract by not performing the first two actions above ("non-rolled"/exit of the TBA MBS contract). Q2 2012 should prove much better in regards to a much more favorable payout ratio as long as interest rates hover around current levels till the end of the quarter.

2) In regards to TEST 2, AGNC's Q1 2013 cumulative UTI balance drastically decreased from $749 million on 12/31/2012 to $430 million as of 3/31/2013. As such, the UTI vs. quarterly dividend distributions ratio (or UTI per share) decreased from a factor of 1.76 in Q4 2012 to a factor of 0.86 in Q1 2013. This looks extremely negative. However (as indicated above), AGNC's Q1 2013 was not a typical quarter. In Q2 2013, overall rates have reversed course modestly. Therefore, most unrealized losses within AGNC's portfolio from Q1 2012 have already been recovered in Q2 2012 (so far). If overall interest rates remain at the levels they currently are (early May) through 6/30/2013, AGNC should report a much healthier quarter. Granted, net interest rate spreads will decrease when overall interest rates remain suppressed, but the following should also occur: 1) unrealized gain on regular MBS's which will be positive for OCI; 2) TBA dollar-roll income will boost other income; and 3) the Q1 2013's realized losses on AGNC's TBA MBS's will reverse course and become realized gains from monthly settlements. All these results would most likely cause AGNC's Q2 2013 REIT taxable figure to rise above the current quarterly dividend distribution amount of approximately $500 million. Any quarterly REIT taxable income above $500 million (assuming no Q2 equity offerings) will once again increase AGNC's 6/30/2013 cumulative UTI balance and the UTI cumulative balance (quarterly) vs. quarterly distributions ratio (TEST 2).

3) In regards to TEST 3, 100% of AGNC's 2012 annual REIT taxable income (net of capital gains) is an estimated $1.935 billion. This is a rather large figure that AGNC wants to be declared by 9/15/2013. AGNC has distributed approximately $926 million of its 100% distribution goal in 2013 so far (Q4 2012's + Q1 2013's dividend). This leaves an estimated $1.01 billion of AGNC's 2012 annual REIT taxable income (net of capital gains) in 2013 to be paid out in Q2 + Q3 2013. If AGNC simply wants to only pay out 100% of its 2012 annual REIT taxable income (net of capital gains), maintaining the $1.25 dividend is still a viable option. Two scenarios could arise from now till 9/15/2013 which would possibly affect AGNC's dividend rate in Q2 and/or Q3 2013. These scenarios would involve an additional equity offering prior to 9/15/2013.

If there are no equity offerings from now till 9/15/2013, there is a good probability AGNC maintains its $1.25 per share quarterly dividend till at least the fourth quarter of 2013. This would be in alignment with AGNC's goal of 100% distribution of its 2012 annual REIT taxable income (net of capital gains). These conclusions came about from the "'paid-in-arrears / spill-back' provision analysis" (TEST 3). If AGNC decides to pay out 100% or more (as was the case in all previous years) of its 2012 annual REIT income (net of capital gains), then the $1.25 per share amount for Q2 + Q3 will most likely remain unchanged. However, the probability of a dividend increase in Q2 + Q3 has become very low due to Q1 2013's results.

Cutting the dividend during Q2 + Q3 2013 should not happen unless there is an equity offering that occurs between now and 9/15/2013. If an equity offering occurs, the probability of a dividend cut in Q2 or Q3 2013 rises to a fairly moderate level (see Table 3). Again, Table 3 is an example of the minimum dividend distribution quarterly rate needed to satisfy AGNC's goal of 100% distribution of its 2012 annual REIT taxable income (net of capital gains). It is also possible that AGNC does not cut its Q2 or Q3 dividend even if it makes an additional equity offering prior to 9/15/2013. Table 3 just illustrates that the possibility is there if it wanted to cut the dividend.

Final Conclusion:

Therefore, in regards to the three detailed dividend sustainability tests performed, AGNC has shown more vulnerability towards maintaining its dividend rate of $1.25 per share beginning in Q4 2013. AGNC needs to report a "better-than-average" Q2 2013 result. This is a fairly high probability due to the fact interest rates reversed course in Q2 2013 (so far). If rates remain relatively flat for the remainder of Q2 2013, AGNC will report much better figures due to the reversal of interest rates that has already occurred in April 2013. However, if rates suddenly rise back to Q1 2013 levels, results will suffer (to an extent). If AGNC reports a good Q2 2013, then it will get back on track in maintaining the $1.25 per share quarterly dividend for 2014 (beginning in Q4 2013).

In Q1 2013, AGNC reported an estimated REIT taxable income figure of only $180 million. In order to maintain the $1.25 per share quarterly dividend, AGNC needs report a strong quarterly estimated REIT taxable income figure of at least $700 million for Q2 2013. This would also include (at a minimum) an average Q3 + Q4 2013 estimated REIT taxable income figure of at least $500 million. If another quarter like Q1 2013 occurs in these next few quarters, AGNC's 2014 dividend rate of $1.25 will have a high probability of being in jeopardy/cut. It all depends on the interest rate movements, investment timing strategies in regards to TBA MBS investments through the "dollar-roll" market, and better derivative strategies that can better adjust to short term, fairly modest interest rate movements (as opposed to a derivative strategy based on longer-term, higher interest rate [basis] movements).

I still have confidence that AGNC's management is one of the best in the mREIT sector. One quarter of "ill-timed" TBA MBS purchase activities was unfortunate (hence the realized TBA MBS losses in Q1 2013). However, this alone should not make investors question the overall performance of management just yet. If improper decisions continue for several quarters to come, then investors may feel obligated to begin questioning management's overall performance. I personally believe management had a bad Q1 2013, but AGNC's overall strategy is sound when taking a step back and looking at the overall picture. Again, Q2 2013 will be an extremely important quarter to follow in regards to AGNC's dividend sustainability for 2014.

Final Note: If upon "clicking" the tables in this article one cannot fully see the entire table, I suggest you right click the table(s) and "Save As" to your computer.

Source: American Capital Agency Corp.'s Updated Dividend Sustainability Analysis (Through Q1 2013)