American Capital Agency Corp. (NYSE: AGNC) had a very interesting first month after a difficult 2013. Looking back at 2013, the U.S. Chairman of the Federal Reserve made a simple statement in one word that rocked the mREIT world. That one word was "tapering." The markets and investors feared an increase in interest rates that actually made a small blimp on the screen, but drove stock prices down by near 30%. The end result brought stock prices down to a more secure level and a reallocation of funds in their portfolios. After it was done the analysis behind the event will make a stronger market going forward. I will reference last year and the quarterly report to make comparisons, but the past has been reviewed and over-analyzed at this point.
I agree with Gary Kain's (President and Chief Investment Officer of AGNC) position, that the market and AGNC are in for a better 2014. Looking forward, what we see is a solid 2014 based on several factors. I see stability driving the market, opportunity through good investments and the decisiveness to act.
The new Chairwoman of the Federal Reserve - Janet Yellen - has continued the position to maintain interest rates low for at least 2014. This is good for AGNC and the whole mortgage market, where stability creates long term opportunity for not only REITs and financial institutions, but hedge fund managers, large and small investors.
The first taper cut produced a small wave in the mortgage pond, but the second cut in January 2014 the market basically ignored the taper that day and the following. This probably helped stabilize the yield, which on December 31, 2013, the yield on the 10-year was 3.03%, It has now dropped to 2.70% as of the open on February 7, 2014. The yield has fallen 33 bps since the end of Q4 2013 and is only 9 bps above the yield on September 30, 2013, of 2.61%.
AGNC generated roughly $0.75 per share in net spread and dollar roll income in Q4, up 30% from $0.58 in Q3 2013. This increase was almost entirely due to an improvement in American Capital's net interest rate spread, which improved to 1.57% in Q4, up from 1.20% for Q3 2013. This net spread was also the largest since 2012. This direction will allow AGNC and the market to increase the spread to build a cushion of profitability.
Some good news for AGNC as well as investors that partially overlooked when the company reported it had bought approximately 43 million shares of its own shares, which is about 10% of the outstanding shares. The positive side for the company is they now have 43 million shares they can resell at a later date when the stock price increases. This will be driven by several positive quarters and an increase in the book value. The average purchase price was reported near $21.25, and if the company would resell at an average of $26.25, that could be a net gain of $215 million, from just a $5.00 stock price increase. Don't get overly excited about that, but the opportunity is there. Mr. Kain entertained the idea that the book value price has reached the bottom and his expectations would be a stock price appreciation through 2014. American Capital sold its highly liquid MBS portfolio to fund share buybacks. If and when given the chance to resell these company shares there will be plenty of opportunity to reinvest the funds.
The other positive is directed at the stockholders. Since the company bought 10% of the company shares and now holds them as Treasury Stocks, any dividend declared is divided among the outstanding shares, and those 43 million are not eligible. That means the dollar amount is divided among fewer shares and could provide a higher dividend payout in 2014.
AGNC also bought approximately $237 million of competitors' shares and currently holds them. If the mREIT market recovers as Mr. Kain anticipates, these shares would again bear fruit when the company sells them for a sizable profit. For as long as the company holds them, AGNC will benefit from the dividends of the stock. If 2014 does see improvements over 2013, and the mREIT market recovers near 50% of what it lost in 2013, the return will be high for investors. We could expect an increase in the book value and better dividends each quarter.
So far in the first month of 2014, other Real estate investment trusts have had a solid improvement also. Annaly Capital Management (NLY) stock price improved 8%, American Capital Mortgage Investment Corporation (MTGE), up 11% and Armour Residential (ARR) increased 5%. These $237 million of competitor shares are looking more impressive as the market continues to trend upward.
AGNC and other mREITs are still in the process of adjusting their leverage ratios. Many companies have made improvements as the market continues to change and require companies to manage their risk. Low interest rates over the last 5 years have allowed AGNC and other mREITs to prosper and their investors reap impressive double-digit gains. AGNC and other mREITs present a higher risk due to interest rate changes, but investors balance the risks with the rewards and create a profitable middle ground.
We rate AGNC a buy up through $22.50 for through first quarter. We anticipate the continued interest rates on the 10-year below 3%, an improving spread over the next quarter and the first increase in the book value next quarter. Through first and second quarter we expect AGNC to maintain its $0.65 per share dividend, but late fall we could expect a supplementary payment to cover any additional profits the company earns through 2014. Investors who have stayed the course should begin to see the recovery, and investors getting in now should see positive growth in this opportunity.
Being positive is easy when you have a good plan.
Here is my simple guide to Common Sense Investing to remove the emotion. Don't watch the stock price bounce up and down every day. Track the market indicators that effects the stock, not the volatility that affects your trigger finger. Before you buy in, have an exit plan. If these indicators hit these red flags, I will execute.