Wow. This morning American Capital Agency (AGNC) has hit another new 52-week low. As many of you know, I have defended the mREITs on the way down here in 2013. It has been a truly painful portion of my portfolio. For now, I plan to rest on my laurels and collect the dividends being paid in AGNC, as well as my other largest holding Annaly Capital (NLY). This article and the situation discussed is applicable to both names, though I will primarily focus on AGNC here in this article. While I have written many detailed pieces on American Capital Agency, in this piece I want to really want to hammer home just what the heck is going on.
The Big Concern Has Been The Movements In Interest Rates.
As most of us know, AGNC was doing incredibly well until the Q1 2013 report. When that report came out, it was one of the poorest quarters in the history of the company. Earnings had suffered, the portfolios were pressured, the interest rate spreads narrowed and book values were hurt because of interest rate volatility. The rapid ups and downs of rates in Q1 really impacted the portfolio, although rates only moved by about 25 basis points as a whole for the quarter. Then the big wave from May up to mid-September came which saw rates climb rapidly over the next few months. The plain fact is that AGNC, NLY or any other mREIT cannot handle rapid rises in rates. That said, if long-term rates increase gradually while short-term rates stay stagnant this can widen the interest rate spreads. Recall that AGNC pretty much borrows money and lends mortgage backed securities. Mortgage loans are purchased from banks, mortgage companies, and other originators and then assembled into pools by a governmental, quasi-governmental or private entity that turns them into securities. Now, what feeds into their profits? The interest rate that AGNC borrows at and the interest rate they lend at. That spread has been pressured, but stabilized a bit in the Q3 report. There is a fear even among those who recently opened positions in AGNC that the damage is not done yet and Q4 could be a disaster as well. What this stems from and what could and has already hurt earnings has been management's scrambling to reposition.
Need to Reposition Portfolios
The rapid rise in rates that was experienced in the summer of 2013 decreased the value of the mortgage backed securities holdings dramatically. If management held the positions it would lead to their leverage ratios expanding, increasing exposure and ultimately putting a lot of pressure on Gary Kain and the team at AGNC. Thus, they sold and sold hard. They took millions in realized losses during Q2 and Q3. It was a necessary evil. This selling pressure spread further pressure existing mortgage backed security prices. It took two full quarters to adjust. Management sold so many assets that their leverage ratios decreased quarter over quarter. Further, management maximized their hedging against further rate increases. Essentially, Kain and the team at AGNC rebalanced the portfolio to survive. So if this is the case, just why the heck has AGNC dropped double digit percentages in share value in the last few weeks?
Partially Explaining The Share Declines
It is really paradoxical in my opinion. The interesting thing about all of AGNC's protective positioning is that the environment for mREITs has been pretty friendly in Q4. For the last week of Q3, all of October and a chunk of November, rates on the ten year had moved lower and were stable, generally around the 2.65% level. Only recently have rates broken above 2.75%. Investors may be pushing the sell button because they believe current positioning is insufficient to make earnings. There is some truth to this. Had AGNC been levered up, their portfolio would have done quite well here into Q4. But it is a safe position. What else is going on? Tax loss selling. This is something that is further pressuring some of my losing positions this year. AGNC and NLY are both victims. So are my gold and silver related equities. People are locking in losses as the end of the year approaches. I do not expect this to subside until year's end. But that's not all. There is growing concern with the dividend once more. Just last night I had a long conversation with an institutional investor who has recently purchased several hundred thousand shares of mREITs at these depressed levels. He is bucking the trend as almost nobody wants to show they own mREITs at year end to their clients. That's another source of selling. The major concern has been the huge cuts to the dividend. The last cut was a huge cut down to $0.80. Given the protective stance AGNC has taken into Q4, earnings are likely not going to be up to par. They have little in the way of undistributed income. There is a prevalent fear that the dividend is heading south again. My belief is that I do not think the cut will be more than 5 to 10 cents to $0.75 or $0.70. But, some more bearish colleagues see $0.50 to $0.55 as a possibility given the de-levered nature of the portfolio right now.
Are There Any Positives?
Well, there are some. A dividend will continue to be paid. Many shareholders who wanted to sell, have sold. There has been some insider buying at the company. There has been and continues to be a buyback program. The stock still trades at a discount to last known book value. With the stabilization in rates this quarter, book value is likely stabilizing. The interest rate spread is probably going to remain the same if not widen. Finally, the Fed has committed to continuing asset purchases, though the meeting coming up this month has some folks nervous. All in all, the company will survive. The shares are in the discount bin as folks fear for the future. I recently shaved a little of the position to move into other equities, though when I did so, shares were about 15% higher. With this recent sell-off, it provides a very interesting entry point for those willing to take on risk.