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Focus of Article:

The focus of this article is to provide a detailed analysis with supporting documentation (via tables) on the best and worst case scenario of American Capital Agency Corporation's (AGNC) second quarter of 2013 dividend per share amount. This will include a discussion of AGNC's third quarter of 2013 dividend per share amount at times. This analysis will occur after several brief introductory discussions. The following three introductory topics will be discussed: a) general overview of AGNC; b) AGNC's REIT classification; and c) the cause of the recent market turmoil in regards to the mortgage real estate investment trust (mREIT) sector as a whole.

I am writing this particular article due to the recent high demand that such an analysis be performed in light of the recent turmoil in the mREIT sector. Understanding the minimum dividend payout characteristics of this company will provide investors with an overall better understanding of the mREIT sector as a whole. AGNC currently produces an annual dividend yield in excess of 19%. Many investors have begun to price in a potential dividend cut. This article solely discusses the minimum per share amounts AGNC would have to declare in the upcoming second and third quarters of 2013 while still satisfying the following goals/requirements: a) AGNC's own goal of 100% distribution of net REIT taxable income and b) the IRS requirement of 90% distribution of an entity's net REIT taxable income. As mentioned above, the probability of a dividend being near the minimum amount being distributed in the upcoming quarters has greatly increased from the turmoil in the mortgage and secondary MBS markets. Therefore, I feel it is only prudent to perform such an analysis on AGNC's dividend for the second quarter of 2013 in light of recent events.

At the end of this article, there will be a conclusion on my opinions about the current range of AGNC's second quarter of 2013 dividend per share possibilities. This will include my personal opinion of what AGNC's second quarter of 2013 dividend per share amount will be.

General Overview of AGNC:

AGNC is classified as an mREIT, which earns a majority of its income from investing, through leverage, in agency mortgage-backed securities (MBS). These investments consist of residential mortgage pass-through securities and collateralized mortgage obligations (CMOs) for which the principal and interest payments are guaranteed by government-sponsored entities (GSEs). A few examples of GSEs are: 1) the Federal National Mortgage Association [Fannie Mae (OTCQB:FNMA)]; 2) the Federal Home Loan Mortgage Corporation [Freddie Mac (OTCQB:FMCC)]; and 3) the Government National Mortgage Association (Ginnie Mae). AGNC also occasionally invests in agency debenture securities issued by Fannie Mae, Freddie Mac, or the Federal Home Loan Bank. For simplicity, agency debenture securities are also generally referred to as "agency mortgage-backed securities."

One of the main goals for AGNC is to preserve its book value ('BV') while yielding attractive risk-adjusted returns, which ultimately are distributed, to its stockholders. This occurs through quarterly dividends from the following accounts: 1) net interest income; 2) net realized gains on MBS investments; and 3) various gains from derivative/hedging strategies. AGNC funds its activities mainly through short-term borrowings structured as repurchase agreements (repo loans) which it enters into with a number of major investment banks. These repo loans are structured to pay variable interest tied to the London Interbank Offered Rate (LIBOR) of varying lengths ranging from one month to twelve months. On top of this variable component, AGNC pays a small fixed interest percentage on these repo loans. Within the past few quarters, AGNC has greatly increased its "off-balance" sheet portfolio of "to-be-announced" ("TBA") MBS. This is an additional source of revenue for AGNC via the term "dollar-roll" interest income. AGNC's TBA MBS portfolio can also be an added source of financing when the company deems such a strategy appropriate.

AGNC's REIT Classification:

There are numerous REIT provisions that AGNC must adhere by. However, for the purposing of this article, we will focus on one specific provision. Currently, AGNC qualifies to be taxed as a real estate investment trust (REIT) under subchapter M of the internal revenue code ("IRS"). As such, AGNC is required to distribute at least 90% of its annual REIT taxable income in a given year. This figure excludes all net capital gains within its annual REIT taxable income amount. 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. AGNC is allowed to treat dividends declared by September 15th and paid by December 31st of a given year as having been a distribution of its REIT taxable income for the prior tax year. This is basically AGNC's "paid-in-arrears" provision (AGNC uses the term "spill-back" provision). This is an important concept to understand and will be discussed later in this article. AGNC partly bases its quarterly dividend per share amount on these two specific provisions.

Cause of the Recent Market Turmoil in Regards to the MREIT Sector as a Whole

I wrote a previous article detailing why stock prices of virtually all companies within the mREIT sector have materially dropped over the past few weeks.

To briefly summarize that article, this recent market turmoil was initially caused by the speculation by the market that the FED would begin to taper its QE3 program in the near future. This notion was somewhat confirmed by the recent "hinting" by the FED Chairman and members of the Federal Open Market Committee on May 22, 2013 that the tapering of its QE3 program could begin as early as June 2013. Many people believe a September 2013 time frame would be a more appropriate time frame in regards to the start of the tapering of the FED's QE3 program. The tapering of the FED's QE3 program will begin if there are continued positive economic indicators through the summer of 2013. However, just the mere hint that the QE3 program could begin to wind-down operations has caused all mortgage interest rates to "spike" over the past several weeks (starting in the first week in May). Rates have increased 50+ basis points in these past four weeks. As such, existing MBS prices have dropped dramatically in the secondary market (inverse relationship). This has caused the entire mREIT sector to sustain material MBS portfolio valuation losses. The existing MBS price declines become more material the further a MBS settlement date goes out into the future. For instance, a 30-year 3.0% coupon Fannie Mae MBS currently has a price valuation of 100.02. However, this same MBS has a July settlement price valuation of 99.75. An August settlement currently has a price valuation of 99.13. This specific MBS will be trading at a discount in the future because the market believes the three percentage coupon yield offered on this specific type of MBS will continue to be under the currently rising interest rates offered in the future. These additional potential losses are already on top of the current, heavily reduced valuations that have occurred so far during May and into June of 2013.

In the conclusion paragraph from a previously written article on AGNC's overall dividend sustainability for future quarters, I stated AGNC needs to report an "above-average" second quarter of 2013 to ensure the dividend rate of $1.25 per share was safe for future quarters. When this particular article was written, fixed mortgage interest rates were 50+ basis points lower than current rates. Also, existing MBS prices were much higher than current prices indicate. Due to the rapid fixed mortgage interest rate increases and subsequent quick yet substantial MBS price declines over the past several weeks, the prospects of an "above-average" second quarter of 2013 has greatly been reduced. As factors change, one's perception/analysis should change as well.

Therefore, in light of the recent turmoil in the mREIT sector (material asset valuation losses), I feel it is only prudent to perform a detailed, specific analysis on AGNC's second quarter of 2013 dividend per share possibilities.

AGNC's Dividend Scenarios - Overview:

Four dividend scenarios will be discussed during the rest of the article. Each scenario contains slight variations to certain events/internal management judgments that could happen. All information is based on the assumptions provided within Table 1 (see below). The following scenarios portray the minimum that AGNC needs to distribute in order to satisfy either its 100% distribution goal of its net estimated REIT taxable income (best case scenario) or the 90% of net estimated REIT taxable income required by the IRS (worst case scenario). In addition, these two scenarios will include the notion of an equity raise prior to 9/15/2013. With these two additional scenarios (equity raise in the best and worst case scenarios), it will be shown how an equity raise could further impact the minimum per share amounts that could be declared in the second and third quarter of 2013. As mentioned above, the probability of the minimum amount being distributed in the upcoming quarters has greatly increased. This is due to the rapid "spike" in mortgage interest rates and the subsequent material price valuation declines of existing MBS in the secondary market (thus affecting AGNC's asset valuations and net income amounts).

The following four dividend scenarios that could occur are the following:

  • 1a) Best Case Scenario - AGNC's 100% Net REIT Taxable Income Distribution Goal (No Equity Raise Prior to 9/15/2013) (First Scenario)
  • 1b) Best Case Scenario - AGNC's 100% Net REIT Taxable Income Distribution Goal (Equity Raise Prior to 9/15/2013) (Second Scenario)
  • 2a) Worst case scenario - IRS's 90% Net REIT Taxable Income Required Distribution (No Equity Raise Prior to 9/15/2013) (Third Scenario)
  • 2b) Worst case scenario - IRS's 90% Net REIT Taxable Income Required Distribution (Equity Raise Prior to 9/15/2013) (Fourth Scenario)

Table 1 - "Paid-In-Arrears" / "Spill-Back" Provision Analysis Concerning AGNC's Q2 + Q3 2013 Dividend


(Click to enlarge)

In regards to the first and third scenarios (no equity raises prior to 9/15/2013), all calculations and per share amounts are provided within Table 1. In regards to the second and fourth scenarios (where an equity raise prior to 9/15/2013 is assumed), all calculations and per share amounts will be provided in an additional supporting exhibit when each specific scenario is discussed below.

1a) Best Case Scenario - AGNC's 100% Net REIT Taxable Income Distribution Goal (No Equity Raise Prior to 9/15/2013) (First Scenario): ($1.20 Per Share Dividend; Probability - Low)

This first dividend scenario will be one of two best case scenarios in regards to AGNC's second quarter of 2013 dividend per share amount. This first scenario will assume no equity raise occurs prior to 9/15/2013. This example also assumes AGNC still has its 100% distribution goal of its net REIT taxable income amount intact. AGNC has stated its goal is unchanged after reporting its first quarter of 2013. Even though material negative effects have unfolded in the second quarter of 2013 (where AGNC could change its rhetoric on this goal), for this specific example the 100% distribution will still hold true. Again, as stated throughout the article, this per share amount is the minimum AGNC would need to distribute in order to satisfy this specific scenario.

Using Table 1 above as a reference, AGNC had an estimated $2.09 billion of gross REIT taxable income for fiscal year 2012. This amount is highlighted in pink and is next to the red reference "C2." This includes all estimated REIT taxable income from the first quarter of 2012 through the fourth quarter of 2012. However, to properly compute AGNC's 100% distribution goal, one must back out all net capital gains (not GAAP; tax basis) from AGNC's gross REIT taxable income figure. This will then provide us with AGNC's net REIT taxable income for the fiscal year 2012. The fourth quarter of 2012 is the first dividend declaration quarter past the "paid-in-arrears / spill-back provision" deadline of 9/15/2012 for AGNC's 2011 annual REIT taxable income. Therefore, the fourth quarter of 2012 will be the first quarter to begin using AGNC's quarterly dividend distributions against the net estimated REIT taxable income figure for 2012.

However, this net capital gains figure is not actually known until AGNC completes its finalized 2012 return, which is due by 9/15/2013 (after a six-month extension period is filed which is usually exercised each year). In a previous article on AGNC's updated dividend sustainability analysis, I took a five-year weighted average for AGNC's net capital gains (not GAAP; tax basis) estimated percentage for 2012. This can still be seen within Table 1's account description under the gross estimated REIT taxable income account. This percentage came out to be a weighted average of 7.34%. However, I am updating this percentage to be more cautious for this particular article. The percentage I will now use is 10%. This new percentage is more in line with higher ranges reported by AGNC over the past four years. The net change due to the percentage change is an overall decrease of AGNC's net estimated REIT taxable income by approximately $50 million. This is not a huge change, but to ensure the most precise figure possible, I felt this change should be implemented for this specific analysis.

Therefore, AGNC's estimated net capital gain (not GAAP; tax basis) is $209 million for the 2012 tax year. This amount is shown within Table 1 and is next to the red reference "(C2 * 10%) = C2a". This net capital gains figure is then subtracted from AGNC's estimated gross REIT taxable income (the $2.09 billion mentioned earlier) to come up with an estimated net REIT taxable income figure of $1.88 billion. This amount is shown in Table 1 and highlighted in light brown and is next to the red reference "(C2 - C2a) = C2b".

Prior to the upcoming second quarter of 2013 dividend declaration, AGNC has already paid a fourth quarter 2012 dividend of $427 million and a first quarter 2013 dividend of $499 million. The total dividend distribution for these two quarters comes out to be $926 million. This amount is shown in Table 1 and highlighted in blue and is next to the red reference "H." Therefore, a remaining declaration of $953 million needs to be declared prior to 9/15/2013 thus satisfying AGNC's 100% distribution goal. This amount is shown in Table 1 and highlighted in olive green and is next to the red reference "(C2b - H) = I." Already knowing AGNC's typical declaration dates, the second and third quarter of 2013 will meet this 9/15/2013 declaration requirement. This comes out to an average remaining dividend distribution of $477 million per quarter. This amount is shown in Table 1 and highlighted in olive green and is next to the red reference "(I / 2)."

This specific scenario assumes there will be no equity raises prior to 9/15/2013. That being said, AGNC's outstanding common shares as of 3/31/2013 were 396,451,470. The number of common shares outstanding has not changed through 5/16/2013. This information was obtained from AGNC's SEC filed Form S-3. This scenario further assumes no changes in the number of common outstanding shares will occur from 5/16/2013 through AGNC's second quarter of 2013 declaration date (no equity raises; no share buy-backs). Therefore, the minimum AGNC would need to distribute to meet its 100% distribution goal of net REIT taxable income would be calculated at $1.20 per share. This figure is shown within Table 1 under the same line item as the highlighted olive green average dividend distribution figure of $477 million.

This specific best case scenario of $1.20 per share has a low probability (< 15% chance) of occurring in my opinion. My main support to this opinion is shown within Table 2 below. Table 2 is AGNC's cumulative undistributed taxable income ("UTI") account. This account is a running "surplus / (deficit)" account that changes each quarter as AGNC under / (over) pays its quarterly dividend.

Table 2 - AGNC's Quarterly Cumulative UTI Coverage Analysis (First Scenario)


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AGNC has been gradually accumulating its cumulative UTI balance since its inception in 2008. Table 2 shows AGNC's quarterly cumulative UTI changes that have occurred in recent quarters. As Table 2 shows, 2012's results proved to be no different. At the beginning of 2012, AGNC had a cumulative UTI surplus of $384 million after reporting its first quarter of 2012. After reporting its fourth quarter of 2012, AGNC increased this cumulative UTI surplus to $749 million. Even though the number of outstanding common stock shares increased as well, the UTI coverage ratio (based as each specific quarter's dividend rate) grew from a factor of 1.34 to 1.76 by the end of the year in 2012. This indicates AGNC was accumulating its cumulative UTI surplus at a rate that outpaced its increase in number of outstanding common shares. This was a very positive indicator. This was in part because AGNC cautiously cut its first quarter of 2012 dividend from $1.40 to $1.25 per share. As such, its total quarterly dividend distributions dropped on a monetary basis; hence the increase in quarterly UTI surpluses. Some argued this dividend cut was not necessary at the time.

However, under the recent volatile mREIT market dynamics, which ultimately began in the first quarter of 2013, AGNC's cumulative UTI surplus has been put to use. From its weak first quarter of 2013 results, AGNC's UTI coverage ratio (based as each specific quarter's dividend rate) plummeted from a factor of 1.76 at the end of the fourth quarter of 2012 to only a factor of 0.86 by the end of the first quarter of 2013. This was nearly a 50% reduction to this ratio in just one quarter. As will be discussed shortly, the current remaining cumulative UTI balance of $430 million (UTI dividend distribution coverage ratio of 0.86) will be needed once again for this upcoming quarter's dividend declaration based on my estimation of another very weak second quarter of 2013.

If AGNC pays out this scenario's assumed $1.20 dividend per share amount, its UTI dividend distribution coverage ratio drastically drops once again. This ratio would drop all the way down to a factor of 0.09 by the end of the second quarter. This amount is shown at the bottom of Table 2 and is next to the red reference "(F2 / D)."

This figure takes into consideration another very weak quarterly estimated REIT taxable income figure of only $96 million for the second quarter of 2013. This figure is still a rough approximation of my estimated second quarter of 2012 estimated quarterly REIT taxable income figure. However, to fully understand my opinion on the probability of this article's four dividend rate scenarios, one must make a rough approximation of this specific figure prior to the close of the quarter. Therefore, I will briefly state why I think such a weak number will occur in the second quarter of 2013.

The second quarter of 2013 has been very negative for the entire mREIT sector in general as of lately. This is a sharp contrast on how this sector looked only one month ago. Most of the mREIT sector will experience (at the very least) a modest deleveraging of its portfolio from the unrealized and realized valuation losses that have occurred from the first week of May 2013 through the first week of June 2013. This is a direct result of the rapid "spike" in mortgage interest rates and thus the subsequent existing material price declines in the secondary MBS market (discussed earlier). These MBS valuation declines directly increase an entity's leverage factor ratio. As such, companies will need to "deleverage" its portfolios, thus sustaining material realized losses, which directly affect its net income and estimated REIT taxable income. This will also lower a company's interest spread income due to the decrease in its overall portfolio size from deleveraging.

AGNC's derivative instruments should help offset some of these losses. However, since AGNC had a rather large TBA balance as of 3/31/2013 ("long" the TBA market), these specific derivative instruments will not act in AGNC's best interests when interest rates rise. The valuation gains from AGNC's interest rate swaps and swaptions will be offset by the monthly realized settlement losses sustained by AGNC's TBA positions. As is the case with AGNC's regular MBS portfolio, when there is a rise in interest rates, AGNC's TBA MBS portfolio will sustain valuation losses that must be recognized when settlement occurs (this is net of the interest income obtained from the "dollar-roll" of these specific off-balance sheet investments). As such, these TBA MBS monthly realized losses will offset some of the derivative valuation gains that will occur on the other derivative instruments for the second quarter of 2013.

As stated earlier, if AGNC distributes a second quarter of 2013 dividend of $1.20 per share, its UTI dividend distribution coverage ratio is reduced to a factor of basically zero (0.09). AGNC would only have an estimated $45 million of cumulative UTI surplus by the end of the second quarter of 2013. From charting past trends of its UTI dividend distribution coverage ratio, AGNC is extremely cautious in nature when it comes to this ratio. I would be very surprised if AGNC completely uses up its cumulative UTI surplus for just two quarter's worth of weak results. This is why I personally feel this scenario has a low probability (< 10% chance) of occurring. I'm not saying it could not happen; however, I feel it will not happen.

1b) Best Case Scenario - AGNC's 100% Net REIT Taxable Income Distribution Goal (Equity Raise Prior to 9/15/2013) (Second Scenario): ($1.06 Per Share Dividend; Probability - Low to Moderate)

This second dividend scenario takes most of the information stated in the first scenario. However, this scenario will now assume AGNC performs an equity raise prior to 9/15/2013. This analysis will determine the minimum per share amount AGNC needs to distribute to satisfy its 100% distribution goal of net estimated REIT taxable income with this added variable.

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 is an increase in the number of outstanding common shares, the average dividend distribution of $477 million for the second and third quarter of 2013 can be satisfied by a lower quarterly dividend per share amount. Again, this assumes AGNC would only want to declare the minimum of its 100% distribution goal of its estimated net REIT taxable income.

Let us use an example for illustration purposes/further clarity:

Table 3 - Example of a Future Equity Raise and its Impact on Per Share Distributions (100% Distribution Goal)


(Click to enlarge)

Note Regarding Table 3: Table 3 takes the same exact dollar amounts shown in Table 1 for red references "A," " C," and "D." The remaining two figures (red references "E" and "(D / E) / 2") are new calculations performed when an equity raise is added to this second scenario.

As Table 3 indicates, let us say in July 2013 AGNC issues an equity offering of 55 million shares (an approximate average of the last several equity raises). After this offering is complete, the number of outstanding common shares has risen from 396,451,470 at 5/16/2013 to approximately 450 million in July 2013. This is shown within Table 3 and is next to the red reference "E." Already calculated within Table 1 from the first scenario, about $953 million (red reference "D" in Table 3) needs to be paid out in the second and third quarters of 2013. As Table 3 shows, AGNC could distribute an average minimum of $1.06 per share in the two upcoming quarters to satisfy its 100% distribution goal of its net REIT taxable income. As concluded in scenario one (no equity raise), the average minimum amount that is needed to be distributed in the second and third quarter of 2013 was $1.20 per share.

This is a ($0.14) per share reduction from the first scenario where an equity raise did not occur. These per share reductions would change depending on how much of an equity raise were to occur. Therefore, the main conclusion drawn between the first scenario (no equity raise) and second scenario (equity raise) is that there is a possibility AGNC can still satisfy its 100% distribution goal of its estimated net REIT taxable income with a lower per share quarterly dividend distribution when an equity raise occurs. Also, it should be noted that it does not matter if this equity raise were to occur in the third quarter of 2013. AGNC could anticipate such an occurrence happening and therefore still reduce the second quarter of 2013 dividend. This specific scenario might not even occur prior to 9/15/2013. However, to be prudent, this scenario should be left on the table and illustrated to understand what could happen if such an event unfolds. I personally feel this specific scenario has a low to moderate probability (20% - 40% chance) of occurring.

Now that a minimum second quarter of 2013 per share dividend has been calculated in regards to AGNC satisfying its 100% distribution goal, let us examine AGNC's worst case scenario. This worst case scenario assumes AGNC only wants to distribute the minimum dividend per share amount to satisfy the IRS's 90% distribution requirement. This would entail a minimum required distribution of 90% of an entity's net REIT taxable income.

2a) Worst case scenario - IRS's 90% Net REIT Taxable Income Required Distribution (No Equity Raise Prior to 9/15/2013) (Third Scenario): ($0.97 Per Share Dividend; Probability - Moderate)

This third dividend scenario will be one of two worst case scenarios in regards to AGNC's second quarter of 2013 dividend per share amount. This third scenario will assume no equity raise occurs prior to 9/15/2013. This example also assumes AGNC has now abandoned its 100% distribution goal of its net REIT taxable income amount. To maintain its REIT status per the IRS, AGNC must distribute a minimum of 90% of its net REIT taxable income from the 2012 tax fiscal year before 9/15/2013. This scenario further assumes AGNC will only distribute its minimum required distribution for the second and third quarter of 2013.

These assumptions are made as a direct result of the rapid "spike" in mortgage interest rates and thus the subsequent existing material price declines in the secondary MBS market. Due to these events unfolding in recent weeks, AGNC's second quarter of 2013 results will directly suffer as a result. Therefore, the probability of AGNC merely covering its 90% of REIT taxable income requirement for the second and third quarter of 2013 has recently increased modestly. Again, as stated throughout the article, this per share amount is the minimum AGNC would need to distribute in order to satisfy this specific scenario.

Using Table 1 above as a reference once again, AGNC had an estimated $2.09 billion of gross REIT taxable income for fiscal year 2012. This amount is highlighted in pink and is next to the red reference "C2." This includes all estimated REIT taxable income from the first quarter of 2012 through the fourth quarter of 2012. However, to properly compute AGNC's 90% distribution requirement per the IRS, one must back out all net capital gains (not GAAP; tax basis) from AGNC's gross REIT taxable income figure. This will then provide us with AGNC's net REIT taxable income for the fiscal year 2012. The fourth quarter of 2012 is the first dividend declaration quarter past the "paid-in-arrears / spill-back provision" deadline of 9/15/2012 for AGNC's 2011 annual REIT taxable income. Therefore, the fourth quarter of 2012 will be the first quarter to begin using AGNC's quarterly dividend distributions against the net estimated REIT taxable income figure for 2012.

As was discussed in the first scenario (see above), I have cautiously changed the percentage of net capital gains for AGNC. The old percentage was 7.34%. The percentage I will now use is a more cautious 10%. See the discussion under the first scenario for further details as to why this change occurred.

Therefore, AGNC's estimated net capital gain (not GAAP; tax basis) is $209 million for the 2012 tax year. This amount is shown within Table 1 and is next to the red reference "(C2 * 10%) = C2a." This net capital gains figure is then subtracted from AGNC's estimated gross REIT taxable income (the $2.09 billion mentioned earlier) to come up with an estimated net REIT taxable income figure of $1.88 billion. This amount is shown in Table 1 and highlighted in light brown and is next to the red reference "(C2 - C2a) = C2b."

The additional step that now needs to be performed for this specific scenario is to take 90% of the calculated net REIT taxable income figure. After performing this additional step, the minimum 90% estimated net REIT taxable income for 2012 AGNC needs to declare by 9/15/2013 to maintain its REIT status per the IRS is $1.69 billion. This amount is highlighted in black within Table 1 and is next to the red reference "(C2b * 90%) = G."

As illustrated in the first scenario, AGNC has already paid a fourth quarter 2012 dividend of $427 million and a first quarter 2013 dividend of $499 million. The total dividend distribution of these two quarters comes out to be $926 million. This amount is shown in Table 1 and highlighted in blue and is next to the red reference "H."

Therefore, in order to satisfy AGNC's 90% distribution requirement per the IRS a remaining dividend of $766 million needs to be declared prior to 9/15/2013. This amount is shown in Table 1 and highlighted in burgundy red and is next to the red reference "(G - H) = J." Already knowing AGNC's typical declaration dates, the second and third quarter of 2013 will meet this 9/15/2013 declaration requirement. This comes out to an average remaining dividend distribution of $383 million per quarter. This amount is shown in Table 1 and highlighted in burgundy red and is next to the red reference "(J / 2)."

Again, this specific scenario assumes there will be no equity raises prior to 9/15/2013. This scenario further assumes no changes in the number of common outstanding shares will occur from 5/16/2013 through AGNC's second quarter of 2013 declaration date (no equity raises; no share buy-backs). These are the same assumptions that were portrayed in the first scenario. Therefore, the minimum AGNC would need to distribute to meet its 90% distribution requirement per the IRS of its net REIT taxable income would be calculated at $0.97 per share. This figure is shown within Table 1 under the same line item as the highlighted burgundy red average dividend distribution figure of $383 million.

This specific worst case scenario has a moderate (50% chance) of occurring in my opinion. My main support to this opinion is shown within Table 4 below. Table 4 is AGNC's cumulative undistributed taxable income ('UTI') account. This account is a running "surplus / (deficit)" account that changes each quarter as AGNC under / (over) pays its quarterly dividend.

Table 4 - AGNC's Quarterly Cumulative UTI Coverage Analysis (Third Scenario)


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Note Regarding Table 4: Table 4 is the same exhibit as shown in Table 2 with the exception of the change in amount of dividends distributed for the second quarter of 2013. As such, amounts within the "Q2 2012 ESTIMATE" column have subsequently been changed starting with the red reference "D" and below. Since all other past data is the same, please refer to the first scenario's discussion on past UTI figures. This table will solely be used to compare and contrast the first scenario's $1.20 per share amount vs. the third scenario's $0.97 per share amount in regards to the UTI coverage of current dividend distributions ratio and overall cumulative UTI balances between both scenarios.

Table 4 shows if AGNC distributes scenario three's assumed $0.97 per share dividend, its UTI dividend distribution coverage ratio still drops down to a factor of 0.35 by the end of the second quarter. This amount is shown at the bottom of Table 4 and is next to the red reference "(F2 / D)." This figure takes into consideration another very poor quarterly estimated REIT taxable income figure of $96 million for the second quarter of 2013. Please refer to the first scenario on a detailed discussion why I feel such a poor second quarter of 2013 number will be reported.

However, this UTI dividend distribution coverage ratio factor of 0.35 per share is more attractive than scenario one's ratio factor of 0.09 obtained earlier. AGNC would have an estimated $135 million of cumulative UTI surplus by the end of the second quarter of 2013 under this third scenario. This is more attractive than the $44 million of cumulative UTI surplus calculated in the first scenario. Understand, both of these UTI dividend distribution coverage ratios are pretty unattractive when compared to past ratio factors. However, the less AGNC pays out in the next two quarters, the higher the cumulative UTI surplus for future quarters. At least under this third scenario, AGNC does not completely use up this surplus in the second quarter of 2013. This is why I personally feel this scenario has a higher probability of occurring. I would give this a moderate (50% chance) probability of occurring.

2b) Worst case scenario - IRS's 90% Net REIT Taxable Income Required Distribution (Equity Raise Prior to 9/15/2013) (Fourth Scenario): ($0.85 per Share Dividend; Probability - Moderate)

This fourth and final dividend scenario takes most of the information stated in the third scenario. However, this scenario will now assume AGNC performs an equity raise prior to 9/15/2013. This analysis will determine the minimum per share amount AGNC needs to distribute to satisfy its 90% distribution of its net estimated REIT taxable income requirement per the IRS with this added variable.

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 is an increase in the number of outstanding common shares, the average dividend distribution of $383 million for the second and third quarter of 2013 can be satisfied by a lower quarterly dividend per share amount. Again, this assumes AGNC would only want to declare the minimum of its 90% distribution of its estimated net REIT taxable income requirement per the IRS.

Let us use an example for illustration purposes/further clarity:

Table 5 - Example of a Future Equity Raise and its Impact on Per Share Distributions (90% Distribution Requirement)


(Click to enlarge)

Note Regarding Table 5: Table 5 takes the same exact dollar amounts shown in Table 1 for red references "A," " B," "D," and "E." The remaining two figures (red references "F" and "(E / F) / 2") are new calculations performed when an equity raise is added to this fourth scenario. Also, Tables 3 and 5 both use the same exact equity raise scenario to simplify the points made between the various scenarios.

As Table 5 indicates, let us say in July 2013 AGNC issues an equity offering of 55 million shares (an approximate average of the last several equity raises). After this offering is complete, the number of outstanding common shares has risen from 396,451,470 at 5/16/2013 to approximately 450 million in July 2013. This is shown within Table 5 and is next to the red reference "F." Already calculated within Table 1 from the third scenario, about $766 million (red reference "E" in Table 5) needs to be paid out in the second and third quarters of 2013. As Table 5 shows, AGNC could distribute an average minimum of $0.85 per share in the two upcoming quarters to satisfy its 90% required distribution of its net REIT taxable income per the IRS. As concluded in scenario three (no equity raise), the average minimum amount that needed to be distributed in the second and third quarter of 2013 was $0.97 per share.

This is a ($0.12) per share reduction from the third scenario where an equity raise did not occur. These per share reductions would change depending on how much of an equity raise were to occur. Therefore, the main conclusion drawn between the third scenario (no equity raise) and fourth scenario (equity raise) is that there is a possibility AGNC can still satisfy its 90% required distribution of its estimated net REIT taxable income per the IRS with a lower per share quarterly dividend distribution when an equity raise occurs. As stated in the second scenario earlier, it should be noted that it does not matter if this equity raise were to occur in the third quarter of 2013. AGNC could anticipate such an occurrence happening and therefore still reduce the second quarter of 2013 dividend. This specific scenario might not even occur prior to 9/15/2013. However, to be prudent, this scenario should be left on the table and illustrated to understand what could happen if such an event unfolds. I personally feel this specific scenario has a moderate probability (50% chance) of occurring.

Conclusions Drawn:

Through the analysis of these four dividend scenarios, I believe a dividend cut is necessary in the current quarter to ensure AGNC's cumulative UTI surplus balance remains as far as possible in the current environment. In regards to just the possibility of a cut, I would say this is currently an extremely high probability (> 90% chance) of occurring.

This probability has greatly been increased due to the recent market turmoil from the possible "tapering" of the FED's QE3 program. As such, mortgage interest rates have increased 50+ basis points during the past four weeks. This subsequently causes the material existing MBS price declines that directly affect AGNC's asset valuations. AGNC's derivative instruments should help offset some of these losses. However, since AGNC had a rather large TBA balance as of 3/31/2013 ("long" the TBA market), these specific derivative instruments will not act in AGNC's best interests in a rising interest rate environment. The valuation gains from AGNC's interest rate swaps and swaptions will be offset by the monthly realized settlement losses sustained by AGNC's TBA positions. As will be the case with AGNC's regular MBS portfolio, it will take time to "roll-over" these TBA MBS. Therefore, unless a sharp reversal of rates occurs between now and 6/30/2013 (this probability has recently lowered from last Friday's slightly bullish May Jobs Report figure), AGNC will be reporting another weak quarter. The stock market has already priced these events occurring (to an extent).

The question that remains (and what this article attempts to predict through various scenarios) is how much a second quarter of 2013 dividend AGNC will declare. All four scenarios discussed in this article take into consideration the amount of estimated net REIT taxable income that needs to be distributed in the second and third quarter of 2013. It also assumes how much cumulative UTI surplus AGNC currently has at the end of the first quarter of 2013.

Best Case Scenarios 1a) and 1b) (First and Second Scenarios):

In the past, AGNC has maintained the notion it would like to distribute (at a minimum) 100% of its annual net REIT taxable income. Under its "paid-in-arrears" / "spill-back" provision, AGNC has until September 15th of the following year to distribute this amount. If no equity raise occurs, AGNC could pay a dividend of $1.20 per share for the second and third quarter of 2013. However, as discussed under the first scenario, AGNC's cumulative UTI would basically be wiped out if such a dividend was made for the second quarter of 2013. Personally, I do not see this happening (hence the low probability mentioned earlier in the article).

If AGNC were to complete an equity offering, it could trim its second and third quarter of 2013 dividend to $1.06 per share. Since I personally believe an equity raise will occur, I believe this has a slightly higher probability of occurring. However, AGNC again runs into the problem of maintaining an extremely low cumulative UTI surplus amount if it announces this $1.06 per share dividend for the second and third quarters of 2013. Therefore, I personally feel this scenario has a low to moderate probability (20% - 40% chance) of occurring.

Worst Case Scenarios 2a) and 2b) (Third and Fourth Scenarios):

Due to the recent events within the MREIT sector, AGNC may be forced to only distribute the remaining minimum 90% of its annual net REIT taxable income in the second and third quarter of 2013 (as required by the IRS). As such, the dividend per share amounts can be further reduced in the current quarter while still satisfying the IRS's REIT requirement in regards to dividend distributions. If no equity raise occurs, AGNC could pay a dividend of $0.97 per share for the second and third quarter of 2013. Under this third scenario, AGNC's cumulative UTI surplus would still modestly decrease. However, AGNC would still have some cumulative UTI surplus left over in case it is needed for future quarters. Personally, I see this scenario have a higher probability of occurrence when compared to the first two scenarios described above. Therefore, I personally feel this scenario has a moderate probability (50% chance) of occurring.

If AGNC were to complete an equity offering, it could trim its second and third quarter dividend to $0.85 per share. Since I personally believe an equity raise will occur prior to 9/15/2013, I believe this has a higher probability of occurring. As stated within the article, AGNC is usually very cautious when declaring its dividend when compared to its cumulative UTI surplus. The lower the dividend per share amount in the current quarter, the higher the overall cumulative UTI surplus for future quarters. Since AGNC did not cut the dividend in the first quarter of 2013, I feel a higher-than-normal cut needs to be made in regards to the second quarter of 2013. This determination goes back to AGNC's weak first quarter of 2013 results. This is further supported by my projected weak second quarter of 2013 results that I feel will occur. Therefore, I personally feel this scenario also has a moderate probability (50% chance) of occurring.

Lastly, another possible scenario that could occur and was not discussed is AGNC could declare an extremely low second quarter of 2013 dividend but then increase its third quarter of 2013 dividend as overall mortgage interest rates stabilize and some value is added back to its existing MBS portfolio.

Final Conclusion:

Therefore, I am extremely less optimistic in regards to AGNC's second quarter of 2013 dividend being maintained at its current level. The likelihood of a dividend cut for the second quarter of 2013 is now raised to extremely high (> 90% chance). The "nail in the coffin" was this past Friday's slightly bullish May Jobs Report. As such, overall mortgage interest rates further increased from Friday's economic data. As a direct result, existing MBS price valuations declined to new twelve month lows. These events unfolding basically confirmed the probability of a very weak quarter for AGNC. I do not see anything occurring to materially reverse rates by 6/30/2013.

The following are this article's best and worst case dividend ranges (based on AGNC's 100% distribution goal or the IRS's 90% distribution requirement in regards to net REIT taxable income):

  • Article's Best Case Scenario = Q2 2013 dividend of $1.20 per share
  • Article's Worst Case Scenario = Q2 2013 dividend of $0.85 per share

However, due to my own projected very weak results for AGNC in regards to its second quarter of 2013, I believe the following range has a higher probability of occurring:

  • Personal Q2 2013 Dividend Range Estimate: $0.85 per share - $1.00 per share
  • Personal exact Q2 2013 Dividend Estimate: $0.90 per share

Finally, it should be noted I do not expect this newly reduced dividend rate to be declared for more than several quarters. Once AGNC "re-rolls" its MBS portfolio into higher-yielding securities, AGNC's assets should stabilize in valuation while these new higher-yielding MBS eventually generate a higher net spread income (steepening of the yield curve). This will eventually cause a rise to AGNC's dividend per share rate in future quarters to come.

Full Disclosure on "Long" Position: I have owned AGNC since early 2011. I have gradually increased my position in AGNC when certain pullbacks have occurred. I have also sold minor positions when I felt the stock was highly overpriced. I have taken both cash + reinvested dividends depending on the stock price of AGNC when the quarterly dividends were distributed.

The main focus of this article is to project AGNC's second quarter of 2013 dividend per share amount. As I have concluded in this article, a rising interest rate environment will cause short-term negative consequences to AGNC (which is currently happening). I am "long" AGNC for the longer-term prospects of this specific company. This means I may just "hold" my position during this turbulent timeframe. It also means I may purchase additional shares when I feel the company is undervalued from a stock price vs. book value basis. I am not a high frequency trader, and usually look at the longer-term prospects of a particular company. Even though I believe there's a good chance AGNC will continue reporting several future quarters that are "disappointing" if interest rates continue to sharply rise/existing MBS prices were to quickly decline further, I am long AGNC in regards to its longer-term fundamentals and prospects. This would entail a 3-5 year time horizon.

Source: American Capital Agency Corp.'s Dividend Range Scenarios For Q2 2013