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Focus of Article:

The focus of this article is to examine why American Capital Agency Corp. (AGNC) is due for a dividend cut for the second quarter of 2013. This analysis will compare AGNC to several other mortgage real estate investment trust (mREIT) companies with comparable portfolios (agency holdings). This analysis will show past and current data with supporting documentation (via Table 1). Table 1 will compare past quarterly dividends from six agency mREITs from the first quarter of 2011 to the first quarter of 2013. This analysis will be presented after a quick discussion on the characteristics between agency and non-agency mREITs. This will then be followed by a brief overview of this sector's turbulent market performance over the past month and a half, which has increased the discussion for possible dividend cuts in the current quarter.

I am writing this particular article due to the recent requests that such an analysis be performed in light of the recent volatility in the mREIT sector. Some investors have begun to price in potential dividend cuts on several mREIT companies due to the recent events that have occurred in the bond and mortgage-back securities (MBS) market. However, even after these volatile moves in the sector, a few mREIT companies have either maintained or slightly raised its dividend per share figures for the second quarter of 2013. Therefore, some investors have recently gained confidence AGNC could maintain its current quarterly dividend rate of $1.25 per share. However, it should be noted a few mREIT companies have also cut its second quarter of 2013 dividend per share amounts as well. Therefore, I feel it is necessary to take a step back and see the bigger picture when it comes to the mREIT sector. This article will compare and contrast AGNC's dividend synopsis along-side five agency mREIT companies to gain a better perspective in regards to the current situation at hand.

At the end of this article, there will be a conclusion on my opinions made throughout the article on why AGNC's current dividend scenario is different than its agency mREIT peers for the second quarter of 2013.

Brief Overview of Agency vs. Non-Agency mREITs:

Agency and non-agency MBS are generated when various mortgages are sold to a financial institution (either a GSE or private investment bank) that "bundles" these loans together into a security that can be sold to investors in the MBS market. The mortgages of a MBS may be residential or commercial. A typical mREIT owns pools of MBS where it earns a majority of its income from the difference between interest income yields generated from longer maturity MBS less interest expense that is paid out on shorter maturity debt/borrowings to finance the purchase of MBS. This difference is also known as the "spread" interest rate. Many mREITs fund its operations through repurchase (repo) loans. Through the use of leverage, mREITs can increase its return from the investments it owns. This business model is how mREITs are able to pay the high yields, even if mortgage interest rates remain relatively low.

An agency mREIT is a company that mainly invests in residential mortgage pass-through securities (RMBS) and collateralized mortgage obligations for which the principal and interest payments are guaranteed by government-sponsored entities (GSEs). This can also include agency hybrid MBS and option adjustable rate mortgages (ARMs) that are guaranteed by the GSEs. For purposes of this article, all these types of security holdings will be classified as MBS. A few examples of GSEs are: 1) the Federal National Mortgage Association (Fannie Mae); 2) the Federal Home Loan Mortgage Corporation (Freddie Mac); and 3) the Government National Mortgage Association (Ginnie Mae). An agency mREIT will usually have lower-yielding MBS holdings but also have a higher level of credit safety due to the reduced risk on these certain types of MBS. AGNC is currently classified as an agency mREIT.

A non-agency mREIT is a company that mainly invests in non-agency holdings backed by residential mortgages that are not guaranteed by a GSE or U.S. government agency. Its holdings could include non-agency MBS investments such as prime and subprime mortgage loans, option adjustable rate mortgages (ARMs), and Alt-A loans. The loans within these investment pools may also be jumbo home mortgages that are not eligible for agency underwriting or mortgages on commercial properties that are securitized by private investment banks. Without the agency backing, non-agency MBS typically pay a higher rate of interest but are subject to default risk. However, by bundling these types of mortgage loans together to form a non-agency MBS (which are ultimately sold in the open market to interested parties), overall default risk can be minimized to an extent.

There are also several mREIT companies that acquire both agency and non-agency MBS holdings. These types of companies are also known as "hybrid" mREITs. Since different risk and yield characteristics occur between agency and non-agency mREITs, the remaining discussion for this article will solely discuss agency mREITs. There may be a few instances where hybrid mREITs will be mentioned, as deemed appropriate.

Side Note: Several mREIT companies may own both agency and non-agency MBS. However, for purposes of this analysis, if a particular company has a majority of its current holdings in one type of MBS (agency vs. non-agency; over 95% of holdings), this will be the prevailing category this company is labeled as. For instance, AGNC owns under 1% of non-agency MBS. Therefore, due to immateriality of its non-agency holdings, AGNC is still classified as an agency mREIT.

Recent Market Turmoil in Regards to the mREIT Sector

I previously wrote an article detailing why stock prices of virtually all companies within the mREIT sector have materially dropped over the past six weeks. To briefly summarize this article, due to the recent "tapering" of the FED's Quantitative Easing Program (QE3), markets have already speculated an eventual exit of the FED from the MBS market (including the bond/treasury market). As such, there has been a rapid increase in mortgage interest rates and subsequently quick yet substantial MBS price declines over the past six weeks. As a direct result from this occurrence, all mREIT sector stock prices have come under tremendous pressure due to perceived material book value ("BV") losses for the second quarter of 2013. Further discussion of this topic will not be performed here (see the linked article above for further discussion).

Table 1 - Current Dividend Yields + Historical Quarterly Dividend Per Share Amounts for Ten mREIT Sector Companies (Six Agency and Four Hybrid mREITs)


(Click to enlarge)

Table 1 shows six agency and four hybrid (agency + non-agency) mREIT companies. The table breaks down each company's percentage of agency and non-agency holdings at the end of its first quarter of 2013 portfolio values (see blue lettered reference "A"). This differential is somewhat important (as noted before) because non-agency MBS tend to generate a higher yield in regards to income generated. Therefore, hybrid mREITs may be able to distribute a slightly higher quarterly dividend yield under certain situations. This is why I feel it is prudent to differentiate the two types of mREIT classifications when comparing historical dividend per share amounts and current annual dividend yields.

After Table 1 breaks down agency and hybrid mREIT companies, this table displays each company's 6/14/2013 market capitalization, stock price, and current annual dividend yield based on the most recent quarterly dividend declared. I personally add each company's trailing twelve-month annual dividend yield to this table (see blue lettered reference "B"). This calculation is the actual past four quarterly dividends (per share) divided by its current stock price as of 6/14/2013. I feel this calculation is also an accurate portrayal of past dividend yields actually paid by the companies. The trailing twelve-month annual dividend yields can be used in conjunction with a company's current dividend yield when comparing the six agency and four hybrid mREIT companies.

Table 1 then shows each company's past quarterly dividend from the first quarter of 2011 up to either its first quarter of 2013 or the more recent second quarter of 2013 (where applicable; if declared) (see blue lettered reference "C"). As stated at the beginning of this article, some companies have already reported its second quarter of 2013 dividend while some mREITs have yet to do so (including AGNC).

Now that a brief overview of Table 1 has been established, the article's focus will be to examine AGNC's probability of a second quarter of 2013 dividend cut when comparing its information to a group of five other agency mREITs.

Side Note: As Table 1 shows, I have also performed calculations on four hybrid mREIT companies. However, since AGNC is basically a pure agency mREIT, I have refrained from comparing these four hybrid mREITs to AGNC in this analysis. I keep the hybrid information within Table 1 for informative purposes only. By excluding these four hybrid mREITs from further discussion in this article, it has not changed my opinion on AGNC in regards to its second quarter of 2013 dividend estimates. Furthermore, if I were to include these four hybrid mREITs to my analysis, the same conclusions on AGNC would be drawn. However, at times I may briefly reference these four hybrid mREITs throughout the article.

Past Dividend + Current Annual Dividend Yield Analysis Comparing AGNC to its Agency mREIT Peers:

Using Table 1 as evidence, this article will now look at six agency mREIT companies (including AGNC) in terms of past quarterly dividends paid and both current and trailing twelve-month annual dividend yield percentages. Table 1 lists AGNC at the top of the table. Under AGNC, five agency mREIT companies are listed in order of its trailing twelve-month annual dividend yield percentages.

1) AGNC

When looking at Table 1, AGNC has a current market capitalization of $10.1 billion and has both a current and trailing twelve-month annual dividend yield of 19.59%. AGNC's current annual dividend yield of 19.59% is currently the highest yield out of the six agency and four hybrid mREITs shown in Table 1. For this specific analysis, this is a troubling sign. The higher the current annual dividend yield, the higher probability AGNC cannot produce results that support such a lofty yield. AGNC's trailing twelve-month annual dividend yield of 19.59% is currently the second highest yield out of the six agency and four hybrid mREITs. Again, this is a troubling sign. As will be evidenced later, the only other agency mREIT with a higher yield recently reduced its second quarter of 2013 dividend. This is another notion why a dividend cut is probably coming soon. Compared to its own historical yield, AGNC's current annual dividend yield is hovering near the highest percentage range in AGNC's five-year history of operations. As most other agency mREITs' current annual dividend yields have decreased over the past few years, AGNC's current annual dividend yield is increasing. Again, this is a troublesome sign.

Since the first quarter of 2011, AGNC has had only one quarterly dividend cut in the first quarter of 2012. This was a quarterly dividend reduction from $1.40 per share to $1.25 per share. This equates to an 11% dividend cut. This has been the only dividend cut AGNC has announced from the first quarter of 2011 through the first quarter of 2013. Again, this mere 11% dividend reduction during the past two years is the second lowest dividend cut out of the six agency and four hybrid mREITs. The only company with a lower dividend cut percentage is AGNC's sister company American Capital Mortgage Investment Corp. (MTGE) who has yet to announce a dividend cut in its year and a half existence. MTGE is another company that will probably have to reduce its second quarter of 2013 dividend. AGNC's 11% dividend cut, when compared to the agency mREIT average dividend cut of 29%, is yet another sign an impending dividend cut is probably coming soon.

Side Note: As was evidenced in a previous article I wrote, there are more concrete signs of why AGNC will see a dividend cut in the current quarter. The sole purpose of this article is to compare AGNC's dividend history and current annual dividend yield characteristics to its agency mREIT peers. Therefore, further detailed dividend cut evidence and reasoning will be redirected to this past article.

Let us perform this same analysis on AGNC's peers and see how they compare.

2) Capstead Mortgage Corp. (CMO):

The first agency mREIT within AGNC's peer group is CMO. CMO has a current market capitalization of $1.2 billion with a current annual dividend yield of 9.83% and trailing twelve-month annual dividend yield of 10.15%. Compared to its own historical yield, CMO's current yield is on the lower-end of its range from the past several years. Compared to its peer group, CMO's yield is towards the lowest-end of the agency mREIT spectrum. CMO recently announced a dividend of $0.31 per share for its second quarter of 2013. CMO's second quarter of 2013 dividend remained unchanged from its first quarter of 2013 dividend. As Table 1 indicates, CMO's current dividend yield was not a troubling sign for a maintained second quarter of 2013 dividend. Table 1 also shows CMO has been gradually reducing its dividend per share amount since the first quarter of 2011. In the first quarter of 2011, CMO declared a quarterly dividend of $0.41 per share. By the first quarter of 2013, CYS has reduced its quarterly dividend to only $0.31 per share. Since the first quarter of 2011, CYS has cut its quarterly dividend by 24%. Even though this 24% dividend cut is less than the agency REIT average of 29%, since CMO has already been paying out an overall lower dividend yield in past quarters, the prospects of further cutting its dividend are reduced. As noted above, its current annual dividend yield has been in the neighborhood of 10%. This is a huge difference over AGNC's 19.59% current and trailing twelve-month annual dividend yields. Therefore, CMO had a much better chance of maintaining its dividend when compared to some of its agency mREIT peers (especially AGNC). As noted above, AGNC has only cut its dividend by 11% for the same timeframe (the worst of the agency mREIT peer group). Therefore, it seems AGNC is currently in a worse situation when compared to CMO in regards to maintaining its second quarter of 2013 dividend.

3) Hatteras Financial Corp. (HTS):

The second agency mREIT within AGNC's peer group is HTS. HTS has a current market capitalization of $2.6 billion with a current annual dividend yield of 10.70% and trailing twelve-month annual dividend yield of 11.85%. Compared to its own historical yield, HTS's current yield is on the lower-end of its range from the past several years. Compared to its peer group, HTS's yield is towards the lower-end of the agency mREIT spectrum. As is the case with most of its agency mREIT peers, HTS has been gradually reducing its dividend per share amount since the first quarter of 2011. In the first quarter of 2011, HTS declared a quarterly dividend of $1.00 per share. By the first quarter of 2013, HTS has reduced its quarterly dividend to only $0.70 per share. Since the first quarter of 2011, HTS has cut its quarterly dividend by 30%. This 30% dividend cut is basically in line with its agency mREIT peers. Therefore, HTS has an average chance of maintaining its current quarter dividend when compared to some of its agency mREIT peers. Some agency mREIT companies are in slightly better shape while others are notably worse-off. As noted earlier, AGNC has only cut its dividend by 11% for the same timeframe (the worst of the agency mREIT peer group). Therefore, it seems AGNC is currently in a worse situation when compared to both CMO and HTS in regards to maintaining its second quarter of 2013 dividend.

4) Annaly Capital Management Inc. (NLY):

The third agency mREIT within AGNC's peer group (and one of AGNC's closest peers in regards to portfolio size and MBS holdings) is NLY. NLY has a current market capitalization of $12.9 billion with a current annual dividend yield of 13.19% and trailing twelve-month annual dividend yield of 14.29%. Compared to its own historical yield, NLY's current yield is in-line with its range from the past several years. Compared to its peer group, NLY's yield is towards the middle of the agency mREIT spectrum. Since the first quarter of 2011, NLY has gradually been reducing its dividend per share amount. In the first quarter of 2011, NLY declared a quarterly dividend of $0.60 per share. By the first quarter of 2013, NLY has reduced its quarterly dividend to only $0.45 per share. Since the first quarter of 2011, NLY has cut its quarterly dividend by 27%. Therefore, NLY has an average chance of maintaining its current quarter dividend when compared to some of its agency mREIT peers. Some agency mREIT companies are in slightly better shape while others are notably worse-off. As noted earlier, AGNC has only cut its dividend by 11% for the same time frame (the worst of the agency mREIT peer group). Therefore, it seems AGNC is currently in a worse situation when compared to CMO, HTS, and now NLY in regards to maintaining its second quarter of 2013 dividend.

5) CYS Investments Inc. (CYS):

The fourth agency mREIT within AGNC's peer group is CYS. CYS has a current market capitalization of $1.8 billion with a current annual dividend yield of 12.90% and trailing twelve-month annual dividend yield of 14.33%. Compared to its own historical yield, CYS's current yield is in-line with its range from the past several years. Compared to its peer group, CYS's yield is towards the middle of the agency mREIT spectrum. CYS recently announced a dividend of $0.34 per share for its second quarter of 2013. CYS's second quarter of 2013 dividend increased 6% (or $0.02 per share) from its first quarter of 2013 dividend. As Table 1 indicates, CYS's current dividend yield was not a troubling sign for a maintained second quarter of 2013 dividend. Table 1 also shows CYS has been gradually reducing its dividend per share amount since the first quarter of 2011. In the first quarter of 2011, CYS declared a quarterly dividend of $0.60 per share. By the first quarter of 2013, CYS has reduced its quarterly dividend to only $0.36 per share. Since the first quarter of 2011, CYS has cut its quarterly dividend by 47%. This 47% dividend cut was much higher than the average agency mREIT dividend cut of 29%. Therefore, CYS had a much better chance of either maintaining or slightly increasing its dividend when compared to its agency mREIT peers.

As noted above, CYS had a second quarter of 2013 dividend increase of 6%. An investor may initially see this dividend raise as a positive sign for the rest of the agency mREIT sector. However, from this analysis, it is now known CYS reduced its dividend in past quarters more than any other company and was way over the agency mREIT average of a 29% dividend cut for the same time frame. As indicated earlier, AGNC has only cut its dividend by 11%. This is a 36% difference. Therefore, it seems AGNC is currently in a worse situation when compared to CMO, HTS, NLY, and now CYS in regards to maintaining its second quarter of 2013 dividend.

6) ARMOUR Residential REIT Inc. (ARR):

The fifth and final agency mREIT within AGNC's peer group is ARR. ARR has a current market capitalization of $1.8 billion with a current annual dividend yield of 17.39% and trailing twelve-month annual dividend yield of 21.12%. ARR has the highest trailing twelve-month annual dividend yield out of the six agency and four hybrid mREITs analyzed. Compared to its own historical yield, ARR's current yield is on the lower-end of its range from the past several years. This is due to ARR cutting its quarterly dividend by approximately 10% in four of the last five quarters. Compared to its peer group, ARR's yield is at the highest-end of the agency mREIT spectrum. As direct evidence this yield is a troubling sign, ARR recently announced yet another dividend cut of 11% for its second quarter of 2013. Since the first quarter of 2011, ARR has been gradually reducing its dividend per share amount. In the first quarter of 2011, ARR declared a quarterly dividend of $0.36 per share. It should be noted ARR declares a monthly dividend. For this analysis, these three monthly dividends are added together for a quarterly dividend per share amount. By the first quarter of 2013, ARR has reduced its quarterly dividend to only $0.24 per share. Since the first quarter of 2011, ARR has cut its quarterly dividend by 33%. Therefore, ARR had a slightly better chance of maintaining its dividend when compared to its agency mREIT peer group. However, this one positive sign was over-ridden by ARR's currently extremely high current annual dividend yield of 17.39% and even worse trailing twelve-month annual dividend yield of 21.12%. Table 1 showed once again troubling data in regards to ARR's current dividend maintainability. As indicated earlier, AGNC's current dividend yield is the second highest of the six agency and four hybrid mREITs. Therefore, it seems AGNC is currently in a worse situation when compared to CMO, HTS, NLY, and CYS in regards to maintaining its second quarter of 2013 dividend. The only higher trailing twelve-month annual dividend yield currently is ARR. Since ARR cut its second quarter of 2013 dividend, this is yet another troubling sign for AGNC. AGNC is currently slightly better off than ARR, but not by much (depending on which type of dividend yield percentage one chooses).

Conclusions Drawn:

This article has examined (via Table 1) six agency mREIT peers in regards to the following: a) current annual dividend yield; b) trailing twelve-month annual dividend yield; c) past quarterly dividend rates; and d) dividend cut percentages over the past eight to nine quarters. By analyzing such information, it can now be seen why AGNC has a high probability of a dividend cut in the second quarter of 2013.

AGNC has been a stellar agency mREIT over the past several years. Many would argue AGNC has been the "best-of-breed" within the entire mREIT sector. However, due to the recent market instability and recent weak results reported for the first quarter of 2013, an increasing amount of skeptics and critics have risen. From all the following events just depicted, AGNC's stock price has suffered more than the average mREIT. Therefore, a closer look at its current dividend was needed.

This specific analysis was performed due to the fact several other agency mREIT companies have declared its second quarter of 2013 dividend rates recently. One company maintained its quarterly dividend per share rate. One company slightly raised its quarterly dividend. One company continued to reduce its dividend. Since a wide array of dividend scenarios have already played out for the second quarter of 2013, I felt a peer comparison (agency mREIT) was needed in regards to AGNC.

Through the conclusions drawn from Table 1, it can be shown why ARR continued its recent dividend cuts from prior quarters. ARR has a current dividend yield of 17.39% and a trailing twelve-month annual dividend of 21.12%. Compared to past performance, these two dividend yields are unsustainable for ARR; hence the need for a further dividend cut. Table 1 also showed why CMO was able to maintain its quarterly dividend rate and CYS was able to slightly increase its quarterly dividend rate for the second quarter of 2013. Simply put, AGNC currently does not show any similar characteristics of CMO or CYS but has a few similarities with ARR in regards to an extremely high current and trailing twelve-month annual dividend yield.

Out of the six agency mREITs analyzed earlier, AGNC ranked the second highest in regards to its dividend yield. Simply put, the higher the yield, the more the likelihood of a dividend cut because the company cannot achieve such highly anticipated results. AGNC has both a current dividend yield and a trailing twelve-month annual dividend yield of 19.59%. This is a particularly high dividend yield, even for AGNC. AGNC's historical yield has been around 15% - 16%. This does not even include the recent poor performance by this company where a reduction to this historical 15% - 16% may be initiated.

Out of the six agency mREITs analyzed earlier, AGNC ranked the worst in regards to its past dividend reductions between the first quarter of 2011 and the first quarter of 2013. AGNC has only reduced its quarterly dividend by 11% over the past two years. The second worst company had a quarterly dividend reduction of 24%. This is more than double the dividend reduction percentage when compared to AGNC. This compares to an average agency mREIT dividend cut of 29% over the same time frame. Granted, AGNC's past performance has dictated the reasoning behind a lower reduced dividend percentage in quarters past. However, AGNC has and will report weak results for its first and second quarters of 2013. As indicated in other articles, AGNC's cumulative undistributed taxable income (UTI) amount has already been heavily tapped into in the first quarter of 2013. It seems AGNC will once again have to tap into a majority of its remaining cumulative UTI surplus amount for the second quarter of 2013. This does not bode well for AGNC in regards to currently maintaining its second quarter of 2013 dividend.

Final Conclusion:

Therefore, I find it difficult to conclude a dividend cut will not occur for AGNC in the second quarter of 2013. The newly derived information from this article is on top of indirectly related information provided from a recent article I wrote on AGNC. This article takes a totally different perspective on this same topic of AGNC's second quarter of 2013 dividend prospects.

From all the information examined above and my past article, the probability of AGNC maintaining its current quarterly dividend yield of $1.25 per share is very low (< 10%).

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. MBS valuation declines should also lessen in the future thus stabilizing AGNC's book value as well.

Full Disclosure on "Long" Position of AGNC: 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 compare the prospects of AGNC's second quarter of 2013 dividend when compared to its agency mREIT peers. As I have concluded in this article, I am predicting a second quarter of 2013 cut for AGNC's dividend based on several conclusions stated in this article above and other past indirect articles written about AGNC.

I am "long" AGNC for the longer-term prospects of this specific company. This means I may just "hold" my position during this turbulent time frame. 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.

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. However, I feel the market has currently "over-panicked" while overall mortgage interest rates have risen too fast too soon. These events have subsequently caused MBS valuations to be overly undervalued. In the coming months, I feel a stabilization of rates will occur and MBS price will appreciate on most coupon rates. As such, I am long AGNC in regards to its longer-term fundamentals and prospects. This would entail a 1-3 year time horizon.

Source: American Capital Agency's Q2 2013 Dividend Compared To Its Peers