American Capital Agency Corp.: Dividend Cuts Coming

High-flying, agency-backed mortgage REIT, American Capital Agency Corp. (AGNC), recently turned in its third quarter numbers, making the company the first in its sector to report for Q3. The headline numbers were impressive, with $1.82/share in GAAP earnings and $1.89/share in taxable income - well above the $1.40/share Q3 dividend. However, a quick review of the earnings release and the shareholder presentation reveals that AGNC's stunning results were once again the result of selling off its appreciated MBS holdings.

Last quarter, the company traded out its high-yield fixed MBS for higher-yielding ARMs, using the capital gains to boost EPS by $0.72/share. This quarter, the company traded out the high-yielding ARMs for lower-yielding ARMs, again achieving capital gains that boosted EPS by about $0.73/share.

To AGNC's credit, the company included a new slide in its Q3 shareholder presentation noting that its year to date taxable income of $3.90/share includes $1.26/share in (potentially non-recurring) capital gain income. Ordinary taxable income was just $2.64/share, well below AGNC's YTD distributions of $3.75/share. For the quarter, the company earned $1.16/share in ordinary taxable income; below the $1.40/share dividend. It's clear from the slide presentation that the 2009 dividend is being supported by $0.22/share in 2008 TI spillover plus 2009 capital gain income.

Given AGNC's portfolio actions - swapping into lower-yielding coupon securities - it's likely that the net interest spread for the company has peaked, pressuring the ordinary taxable income run rate going forward. Although AGNC has $0.90/share in undistributed taxable income remaining to support the dividend in Q4 09 and 2010, it won't be enough to sustain the dividend at current levels. AGNC will likely have to cut its dividend to $1.00/share or lower in future quarters, bringing the yield down to a more reasonable 14% or so. Although the yield will remain attractive, at a price/book value of 1.27x, AGNC is already fairly valued compared to peers. A dividend cut will likely send retail investors fleeing to other names in the sector that have pursued a more stable dividend policy.

Disclosure: Author has no position in AGNC.

Comments

[bz1516:]

I think you are basically right. The NIM should decline. We have no idea how much as we don't know whether the transactions took place in the early or late part of the quarter.

Oct 21 05:16 PM

[Lou Siegs:]

While I do believe AGNC will lower its dividend as capital markets improve, the potential for up-side gain on sale of term securities is always there. Leverage is a very manageable 7.3% and could be increased to support loftier dividends. Leverage most likely will be increased as capital markets normalize. Most important is US gov getting out of the mortgage business in March, which should offer excellent buying opportunities and support wider spreads in 2010.

As to price to book, I am pegging the stock at 1.5x book by Q3 2010. I base this valuation on MLP and real estate REIT yields relative to their price to book and the fact that portfolio valuation in the agency REITS is far, far more transparent.

All in all, AGNC has a top management team who has navigated the downturn as well as anyone.

Oct 21 05:20 PM

[edjgolfer:]

So the glass is half empty? As a new company AGNC already trades at a significant discount to its competitors. I think the stock price already discounts much of of the points made by this author. I'm very happy with a 20% yield and will still be satisfied with a 14 - 15% yield. It certainly beats the yield on CDs or Treasuries. Until the yield curve flattens or management misjudges the market, I'm a buyer.

Oct 21 07:15 PM

[pork7mm:]

CYS issued a 10% yield, own it, but my AGNC returned much higher, also own HTS....I believe you don't put all of your eggs in one basket....AGNC is the biggest of those I own...also own Invesco's....probably sell the laggards and buy AGNC on the way down since it seems to be better managed and more nimble. If AGNC's yield goes down that will also mean the others might also go down some.

Oct 24 09:03 AM