Gary Kain is the CEO of American Capital Agency Corp. (AGNC), which some view as "the" blue chip Agency mortgage REIT. AGNC reported a -12.5% economic return for FY2013; but AGNC had been a top performer for many years before then. Gary Kain has an enviable reputation as a good to great manager based on his long term performance. AGNC's 2013 performance was not overly bad for a primarily fixed rate Agency REIT in an extremely tough year. When Gary Kain says it is a good time to buy mortgage REITs, he is still worth listening to. The total return chart of AGNC since 2008 demonstrates why faith in him may be well placed.
Let's take a look at AGNC's latest quarter to get a better idea of how good or bad an idea this may be currently. For Q4 2014 AGNC reported a comprehensive loss per common share of -$0.99. This consisted of a net loss of -$0.28 per common share and an OCI (other comprehensive income) loss of -$0.71 per common share. On the plus side AGNC still had +$0.75 per share in net spread income and dollar roll income. It had $0.65 estimated net taxable income per share. This last matched up well with the $0.65 per common share dividend declared on December 18, 2013. AGNC also had $0.59 estimated undistributed taxable income per common share as of December 31, 2013. As a result of the above, AGNC's book value fell from $25.27 per common share as of September 30, 2013 to $23.93 per share as of December 31, 2013 (-$1.34/common share). A lot of the above statistics make AGNC seem far from attractive.
As a counter to the disappointing Q4 2013 results, Gary Kain pointed out that 10 year US Treasury Note yields rose 125 bps for FY2013; and mortgage rates increased 140 bps. This seems very worrisome, especially if investors should expect the uptrend to continue. However, Gary Kain feels that a good part of the rise was the pricing in of the QE3 tapering. He now feels this is completely priced in; and there is some evidence to substantiate his view. The chart below of the 10 year US Treasury Note yield shows why.
Yes, the yield climbed for most of 2013 to 3.03% on December 31, 2013. However, it then began to fall; and it is as of this writing February 6, 2014 at 2.68%. This is only 7 bps above the yield on September 30, 2013 of 2.61%. The yield has fallen 35 bps since the end of Q4 2013. This 35 bps should translate into substantial book value gains for AGNC investors in Q1 2014. Further as the Fed made its second taper cut to the QE3 bond buying program on January29, 2014, the yield continued to fall. This was counter-intuitive. One would normally expect the increased supply of US Treasuries to cause the yield to go up. When the opposite occurs, the justification is likely a "flight to quality" by worldwide investors.
Many experts believe this "flight to quality" may continue for a large part of 2014. It seems to be being caused in large part by troubles in the emerging markets politics, economies, and currencies. A number of experts are pointing to dire situations in Turkey, Thailand, Argentina, and the Ukraine as problem areas that could cause domino effects on many other world economies. For instance, on January 29, 2014, the Central Bank of the Republic of Turkey raised it marginal funding rate from 7.75% to 12%. The Turkish lira rose 1% against the USD in response; but it had fallen about 14% against the USD in the previous two months. Since May 2013, investors had net sold $3.9B in bonds denominated in Turkish lira. It is hard for a country to operate with a currency that is that unstable.
In Argentina inflation is rampant. The Argentine peso has fallen from about 0.29 USD in 2009 to 0.12 USD in 2014. In other words it has lost almost 60% of its value since 2009; and the losses seem to be accelerating (see chart below as of January 29, 2014).
Some feel that Argentina should double its already high 22% interest rate to ease demand for USD's. JP Morgan (JPM) estimates that the Argentine peso will be worth 45% less at the end of 2014 than it was at the end of 2013. Wealthy investors who may have money invested in Argentina may wish to safeguard their money. This should increase capital outflows, which will hurt the Argentine economy further. With economic growth slowing in Argentina, this is an unsustainable path. Further the EU and US credit crises have caused a major currency liquidity problem in emerging market countries. This is adding to the inflation problems. The increased emerging market economic problems will likely negatively impact US and EU banks. They will make them want to lend to the emerging markets even less. A "death spiral" is a possibility. It is worrisome to investors; and they are reacting accordingly with a flight to quality. Would you rather have your money in Argentine pesos, which may lose 45% of their value in 2014? Or would you rather have it in US Treasuries, which may pay you a few meager percent? Being 45% to 49% better off with US Treasuries sounds like a much more attractive proposition for 2014.
There are many more worldwide problems, including serious worries about the Chinese banking system. China may have its own version of a major credit crisis soon. A recent article, "If You Are Scared Of The Current Market, This Articles Clarifies Why You Should Be", goes into much more depth about these troubles. However, the big point is that the economic slowing, economic instability, and political instability in emerging markets may put downward pressure on the US Treasury Note yields throughout 2014. This may not stop yield increases dead in their tracks, but it seems sure to slow them down.
Plus as Gary Kain pointed out, investors would be starting off with 35 bps of yield lowering in their pockets for Q1 and FY2014. This makes book value gains (or much lower losses) a much stronger probability for Q1 and FY2014. The yields on the MBS are also much higher to start 2014 than they were in 2013. For further safety, AGNC (and other fixed rate Agency mortgage REITs) have already adjusted their portfolios in many cases to own more 15 year fixed rate Agency RMBS (to reduce extension risk) versus 30 year fixed rate Agency RMBS. The 15 year fixed rate Agency RMBS lose book value at roughly half the rate of the 30 year fixed rate Agency RMBS as interest rates rise.
CPRs (constant prepayment rates) have gone down. The average CPR in Q4 2013 was 8% compared to an average of 10% in Q3 2013. Plus with the higher interest rates, AGNC's average net interest rate spread for Q4 2013 was 1.57% versus 1.20% for Q3 2013. All told the company is positioned strategically much more safely for 2014 than it was for 2013.
Gary Kain is so convinced of the soundness of the outlook for AGNC (and other Agency mortgage REITs) that he has been buying back AGNC stock. He bought back about $600 million worth (or about 7% of all of AGNC's stock) in Q4, when it was trading at about an 80% discount to book value. AGNC also purchased $400 million of other Agency REIT stocks in December 2013 and January 2014, when mortgage REIT stock prices were near their lows. Again these stocks were generally purchased at large discounts to book value.
Gary Kain's explanation is that he was effectively buying Agency MBS at a roughly 20% discount to book value by doing this. I can't fault his logic; and after the fall in 10 year US Treasury Note yields to start 2014, very few investors would try to fault his logic. That fall increased the value of the Agency RMBS held by those companies. It would seem Gary Kain has made another excellent strategic move. This is what AGNC as a "blue chip" Agency mortgage REIT is well known for. Given these approximately 20% discount buys and the 35 bps drop in the 10 year US Treasury Note yield to date in 2014, investors are far ahead on book value gains for Q1 and FY2014. Further AGNC's price as of the close on February 5, 2014 was $21.77 per common share. This is about a 9% discount to its $23.93 per common share of book value as of December 31, 2013; and that book value as I have already pointed out is already higher based on the above cited interest rate fall.
The chart below of the 30 year fixed rate FNMA 3.5% MBS shows just how much book value may have been regained so far in Q1 2014.
This chart show an almost 2% gain in book value since the beginning of Q1 2014. Keep in mind this is multiplied by the leverage, which was about 7.5x to end Q4 2013. Of course, the hedges will work against investors in this case, but the above still amounts to a good gain. The gains on the 15 year fixed rate FNMA 3.5% MBS have been about half as much; but that should also tell investors that they are that much safer from losses.
At the end of Q4 2013, 15 year fixed rate MBS represented about 51% of AGNC's total portfolio. This was actually not much different from Q3 2013. However, the TBA positions had changed from net short to net long at the end of Q4 2013. This too looks like it will translate into good book value gains for Q1 2014 at least. Historically good manager, Gary Kain, will probably adjust this as the market direction dictates over the course of 2014. He has been right a lot more than he has been wrong. AGNC had a $68.2B MBS investment portfolio as of December 31, 2013.
In sum one has to take solace from the fact that the entire fixed income market did poorly in 2013. Other historically good fixed income managers such as Bill Gross of Pimco experienced losses too. His Total Return Fund (PTTRX) lost -1.92% in FY2013; and it is not levered to the extent AGNC is. I don't think Gary Kain's reputation has been significantly damaged. It is still a good one; and investors may want to follow his advice about Agency mortgage REITs.
AGNC is a buy. Other Agency mortgage REITs that investors may wish to consider are: ARMOUR Residential REIT (ARR) with a Price/Book of 0.79, CYS Investments (CYS) with a Price/Book of 0.81, and Annaly Capital Management (NLY) with a Price/Book of 0.85. There are many others which may also be good bargains.
The two year chart of AGNC provides some technical direction for this trade.
The slow stochastic sub chart shows that AGNC is overbought in the near term. The main chart shows that AGNC appears to have bottomed from a longer term down trend. It has broken up through both its 50-day SMA and its 100-day SMA; and it appears to be headed toward breaking up through its 200-day SMA. If it does that, that should solidify its uptrend. For those who say this recommendation is a bit late, I point out that I recommended AGNC not long before its earnings report, when investors could capture much more of the recent up move. Naturally more people pay attention to the actual numbers (and Gary Kain's charisma), so it has moved up since. For those who were waiting for an easier to understand report, I hope this fits the bill.
Aside from AGNC's buying of its own and other Agency mortgage REIT shares, AGNC has seen +6.2% (315.14K shares) in insider buying in the last six months and +6.9% (12,225,300) shares in net institutional buying from the prior quarter to this one. CAPS gives AGNC a four star rating (a buy). I give it a buy too.
NOTE: Some of the above fundamental financial information is from Yahoo Finance.