With the mortgage real estate investment trusts, or mREITs, reporting another quarter of weak numbers, American Capital Agency (NASDAQ:AGNC) surprised the market with a bold move. Not only did the company repurchase a substantial amount of its own stock, but it also bought stock of competitors.
American Capital Agency is an mREIT that focuses on investing in a levered portfolio of agency backed mortgage securities, or MBS.
The FED taper and fears of fast rising interest rates hit the mREIT sector hard during the quarter, but ironically interest rates now sit below the level prior to the FED movement. Was the move by American Capital to purchase mREITs trading at a discount to book value risky or just extremely smart?
Quarterly Results Depressed Again
The Q4'13 results were again characterized by a major decline in book value and an even larger decline in stock value. Below are the highlights of the Q4'13 earnings:
- $0.65 estimated taxable income per share.
- $23.93 net book value per share at the end of Q4'13, a decrease of $1.34 from Q3'13.
- -2.7% economic return on common equity for the quarter, comprised of $0.65 dividend and $1.34 decrease in net book value per share.
- $68.2 billion agency MBS investment portfolio at end of Q4'13.
- 7.5x "at risk" leverage as of end of Q4'13.
- 1.39% annualized net interest rate spread as of December 31, 2013.
The continued larger decline in stock price than economic value presented an interesting investment opportunity at the start of the year. The results, while bad, were far more magnified by the stock price than reality.
The economic return has been somewhat stable after QE3, while the stock returns have been horrible. It was not much of a surprise to investors that the stock did better than expected prior to the peak of FED easing and has done worse now that the FED is slowly pulling back. The real question is whether this is the start or the end of the underperformance, with the FED a long way from actually ending QE.
The slide below from the Q4'13 presentation highlights the different returns since the IPO.
(click to enlarge)
As a proponent of taking advantage of what the market gives you, the move to repurchase shares at below book value is extremely attractive. During the quarter, American Capital bought 28.2 million shares at an average price of $20.82 for roughly $600 million.
For the year, the company repurchased 40.3 million shares at an average price of $21.25. Even more interesting, American Capital actually unloaded 57.5 million shares towards the highs of the year at an average price of $31.33. If anything, management appears excellent at timing the market.
That brings up the revelation that the company not only bought shares in its own stock, but it bought shares of competitors to the tune of $237 million during Q4'13 and up to $400 million at the time of the conference call. The move is no doubt bold, but it does bring up an interesting point about buying MBS assets at current market value, or the equities of MBS stocks at a 20% discount to book value. In essence, the stock market is applying an additional 20% discount on top of the amount priced by the bond market.
The below slide highlights their argument that the move adds 35-55 bps to the net interest rate spread at 139 bps at year end.
The company doesn't list the mREITs purchased, but in slide 18 it compares itself to the following ones: Hatteras Financial (NYSE:HTS), Capstead Mortgage (NYSE:CMO), Annaly Capital Management (NYSE:NLY), Anworth Mortgage Asset (NYSE:ANH), CYS Investments (NYSE:CYS), and ARMOUR Residential REIT (NYSE:ARR). The assumption would be that the investments were made out of this group with Annaly Capital being the only stock of significant size to purchase meaningful shares. Still, an investment of over $500 million in Annaly Capital would trigger registering a 5% ownership position.
Considering the mREIT sector was absolutely crushed during 2013, the risky move by American Capital Agency to purchase shares of competitors actually makes a ton of sense. The move probably adds a small layer of management execution risk, but the sector trades at a 20% discount, providing ample room for that risk. Especially considering the company probably invested a majority of the $400 million in larger Annaly Capital; the risk is probably minimal and easily offset by the discount.
With the discussion during the conference call of a meaningful improvement in book value during Q114, it appears that the risky move to repurchase shares was well worth it. The stock now offers a very attractive entry point.
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