Is American Capital Agency Really This Cheap?

Jun.21.13 | About: AGNC Investment (AGNC)

Do you know what 29.7% means to American Capital Agency (NASDAQ:AGNC)? Some might think it's the new dividend yield. That is incorrect. While AGNC did just recently announce its next quarterly distribution, which was cut by 16% to $1.05, that only results in a forward annual yield of 18%. This is based on the current price of AGNC at the time of this writing, which is $23.26. That "29.7%"? Well that's how much AGNC's stock has declined since May 1st 2013 when it was about $33.00 a share. True, AGNC is not the only mortgage real estate investment trust (mREIT) stock that has been absolutely decimated in the last month or so. My favorite AGNC competitor is Annaly Capital (NYSE:NLY) and it recently traded down a similar large percentage, currently going for $12.53 a share for the first time in years. How about my third largest mREIT holding, Western Asset Mortgage (NYSE:WMC)? It has been hit hard, now trading at $17.30, down some 25% since May 2013. How about my holdings in the commercial real estate mREIT, American Capital Mortgage Investment (NASDAQ:MTGE)? It has shed another 5% today (6/20/13) alone, trading at a bargain price of $18.99. With the pressures on mREIT share prices, most stocks cut dividends, including AGNC to $1.05 and yesterday (6/19/13) NLY to $0.40. I hold positions in all of these names, and after diving nearly 10% in two days alone and 30% in less than two months, I have to ask, can AGNC really be this cheap?

Why Has it Sold Off in the Last Two Trading Sessions?

As I predicted, the FOMC meeting, and more importantly the comments by Ben Bernanke weighed heavily on the mREITs. The meeting was the most important one so far for the near-term action in mREITS as we got some clarity as to when tapering would occur of the Fed's purchasing, which will be as early as 2013, but most likely in 2014. It will be data-dependent but the Fed will indeed taper mortgage asset purchases and other balance sheet expansion if the data is strong. We all knew this, but I guess the market needed to hear it. So down we go. Mr. Bernanke also stated that the Fed would not sell their mortgage backed securities (MBS), but likely let them mature. This led to a huge drop in mREITs moments later. While the meeting minutes will not be released until for another few weeks, the market is trading off of Mr. Bernanke's post-meeting talk. Interest rates have been impacted immediately, as the ten year is up 10% while a thirty year mortgage rate fell to 3.93%, narrowing some of the gap between short and long-term debt. The recent rise in rates was a topic of discussion for the FOMC. Ben Bernanke realized that rates have to rise eventually to maintain a healthy market, but the rapid increase in the last month, while potentially putting the housing recovery at risk, seemed to be of little concern. As usual Ben Bernanke purported that the FOMC stands ready to take necessary action if prompted. So, with no announced change in policy and a confirmation that purchasing by the Fed won't continue forever, we got a sale in the mREITs.

AGNC Trading At Large Discount To Book Value

I mentioned the dividend cut was less than expected which is a huge positive and a buy signal for me. A cut in general was expected because one of the most important indicators of mREIT health, the book value, has declined for many mREITs and AGNC was no exception. According to AGNC management's recent presentation, book value was around $26.44. Book value has declined in the last few quarters, and in turn the share price has moved down. However, June 7th was less than two weeks ago. Book value certainly has not fluctuated massively in this short time, which included two weekends of no trading. So, assuming book value is the same as on June 7th (maybe very slightly less), at a current share price of $23.26, AGNC is now trading 12% less than book value. To reach book value, we would need to see a 13.7% increase in share price. Not a bad entry point for a stock that has traded frequently at premium to book value.

My Recent Moves in The Stock

Coupled with the dividend yielding 18%, I think AGNC is exceptionally cheap right now. Therefore, I am expanding my mREIT threshold in my portfolio by double, to allow myself to take advantage of the fire sale in mREITs. I added to my AGNC position yesterday (6/20/13) at $24.50 and today at $23.20.

My Recommendation

I have warned of a flattening of the yield curve in the past and for a time it was widening. In the last few sessions, it has leveled off a bit. This could reduce the pressure that has been on MBS prices have hurt the mREITs as well, and I think the confirmation from the Fed that it will continue its asset purchases for the foreseeable future is healthy for AGNC and its competitors as the companies reposition their portfolios. As a long-term investor, I think it is prudent to buy stocks that are on sale. The volatility in these names has led to incredible long-term buying opportunities for investors as the high dividends, which will always fluctuate over time, can be reinvested to compound one's investment over time. The best course of action is to add to holdings during times of fear, and to always take advantage of buying stock in these companies when they trade at a discount to their net asset book values. Do not buy at a premium, even if these stocks trade at premiums to book value for extended periods of time. Instead, on days like today where the stock trading is over a 12% discount to book value, step in and do some buying. This is the key to long-term success in a stock like AGNC.

Disclosure: I am long AGNC, NLY, MTGE, WMC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.