American Capital Agency's Dividend Range Scenarios For Q1 2014

| About: AGNC Investment (AGNC)

Summary

AGNC's best-case scenario: Quarterly dividend of $0.75 per share (20% probability).

AGNC's worst-case scenario: Quarterly dividend of $0.55 per share (10% probability).

AGNC's “middle-of-the-road” scenario: Quarterly dividend of $0.60-$0.70 per share (70% probability).

MTGE's exact dividend projection for the first quarter of 2014: $0.65 per share.

NLY's exact dividend projection for the first quarter of 2014: $0.30 per share.

Author's Note: This article provides a detailed analysis with supporting documentation on the "probable" dividend per share rate American Capital Agency Corp (NASDAQ:AGNC) will declare for the first quarter of 2014. I perform this detailed analysis for readers who anticipate/want such an analysis performed each quarter. For readers who just want the summarized conclusions/results, I would suggest to scroll down to the "Conclusions Drawn" section at the bottom of the article.

Focus of Article:

The focus of this article is to provide a detailed analysis of AGNC's dividend range scenarios for the first quarter of 2014. I am writing this particular article due to the continued high demand that such an analysis be performed. Understanding the dividend payout characteristics of AGNC will provide investors with an overall better understanding of the mortgage real estate investment trust (mREIT) sector as a whole. Within this article, three dividend range scenarios will be analyzed and discussed.

This analysis should prove beneficial to readers due the recent volatile nature of AGNC's dividend per share declarations. During the second quarter of 2013, AGNC cut the company's quarterly dividend rate from $1.25 per share to $1.05 per share. This dividend cut was the first quarterly dividend reduction since the first quarter of 2012. During the third quarter of 2013, AGNC continued to cut the company's quarterly dividend rate from $1.05 per share to $0.80 per share. This trend continued into the fourth quarter of 2013, when AGNC cut the company's quarterly dividend rate from $0.80 per share to $0.65 per share. Due to the rapidly declining dividend per share rate, I feel this specific analysis has heightened importance.

A previous article I wrote laid the groundwork for this dividend range scenarios analysis. Within that article, I analyzed AGNC's general dividend sustainability after the company reported results for the fourth quarter of 2013. This article takes the prior analysis a step further by comparing several possible dividend per share rates for the first quarter of 2014. I would suggest readers to refer back to this prior article to better understand the analysis that will be performed in this dividend range scenarios article.

The link to the prior article's analysis is provided below:

American Capital Agency's Dividend Sustainability Analysis (Post Q4 2013 Earnings) - Part 1

American Capital Agency's Dividend Sustainability Analysis (Post Q4 2013 Earnings) - Part 2

Prior to this article's conclusion, a brief dividend range analysis for AGNC's sister company, American Capital Mortgage Investment Corp. (NASDAQ:MTGE) and the company's closest sector peer, Annaly Capital Management, Inc. (NYSE:NLY) will also be performed for the first quarter of 2014. At the end of this article, there will be a conclusion regarding the probabilities of the three dividend range scenarios portrayed in this analysis. This will be followed by my personal projection of what I feel AGNC's dividend per share rate will be for the first quarter of 2014.

Dividend Range Scenarios for the First Quarter of 2014 - Overview:

Before specifically analyzing my dividend range scenarios for the first quarter of 2014, let us first get accustomed to the information provided in Table 1 below. This will be beneficial when explaining how each dividend range scenario will impact certain AGNC quarterly estimated REIT taxable income ("ERTI") and undistributed taxable income ("UTI") figures and ratios. AGNC's quarterly ERTI and cumulative UTI figures are extremely important when trying to understand why the company declares a certain quarterly dividend per share rate. All figures within Table 1 are for the "three-months ended" (quarterly) time frame, except for AGNC's cumulative UTI balance. AGNC's cumulative UTI balance is a "running balance" that is portrayed at a certain "point-in-time".

Table 1 - AGNC Cumulative UTI Balance + Cumulative UTI Coverage of Quarterly Dividend Distributions Ratio Analysis

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(Source: Table created entirely by myself, partially using data obtained from AGNC's quarterly investor presentation slides)

Regarding the accounts shown in Table 1 above, I would refer readers to my prior quarter's dividend range scenarios article for an explanation of what each account means and where the information is derived from (look within same section of the article).

The link to the prior article's account descriptions is provided below:

American Capital Agency's Dividend Range Scenarios For Q4 2013

Now that a link was provided to better understand AGNC's quarterly ERTI and cumulative UTI figures/ratios, three dividend range scenarios for the first quarter of 2014 will be analyzed and discussed below. Each dividend range scenario contains slight variations to the assumed quarterly dividend per share rate and shows how these subtle changes would affect certain future quarterly ERTI and cumulative UTI figures/ratios that were originally shown within Table 1 above.

The following three dividend range scenarios will be analyzed and discussed:

1) Best-Case Scenario: Quarterly Dividend of $0.75 Per Share

2) Worst-Case Scenario: Quarterly Dividend of $0.55 Per Share

3) "Middle-of-the-Road" Scenario: Quarterly Dividend of $0.60-$0.70 Per Share

Side Note: AGNC typically declares the company's quarterly dividend distributions in increments of $0.05 per share. As such, there are minor "gaps" between the three dividend range scenarios, which are intentional. Regarding the best-case dividend range scenario, I will use a quarterly dividend rate of $0.75 per share (shown in Table 2 below). Regarding the worst-case dividend range scenario, I will use a quarterly dividend rate of $0.55 per share (shown in Table 3 below). For the middle-of-the-road dividend range scenario, I will use a quarterly median dividend of $0.65 per share (shown in Table 4 below).

1) Best-Case Scenario: Quarterly Dividend of $0.75 Per Share (Low Probability)

Now, let us discuss my projected best-case scenario. This scenario assumes a dividend of $0.75 per share will be declared for the first quarter of 2014. Table 2 below projects what would happen to AGNC's cumulative UTI balance and cumulative UTI dividend distributions coverage ratio if a dividend rate of $0.75 per share was declared for the first quarter of 2014.

Table 2 - AGNC Cumulative UTI Balance + Cumulative UTI Coverage of Quarterly Dividend Distributions Ratio Analysis (Best-Case Scenario)

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(Source: Table created entirely by myself, partially using data obtained from AGNC's quarterly investor presentation slides)

Using Table 2 above as a reference, I am projecting AGNC will report quarterly ERTI of $225 million for the first quarter of 2014. When compared to the fourth quarter of 2013, this is a projected quarterly ERTI increase (decrease) of ($16) million. The main reason for the slight decrease in projected quarterly ERTI is the reduced average balance of the MBS portfolio for the first quarter of 2014, partially offset by a higher weighted average coupon ("WAC").

Still using Table 2 as a reference, if AGNC declares a dividend rate of $0.75 per share for the first quarter of 2014, the company would have a quarterly underpayment (overpayment) of ($42) million. As such, AGNC's cumulative UTI balance would decrease from $210 million, as of 12/31/2013, to $169 million, as of 3/31/2014. Such an overpayment would cause AGNC's cumulative UTI balance to decrease by 20% during the first quarter of 2014. Furthermore, AGNC's cumulative UTI dividend distributions coverage ratio would modestly decrease from a factor of 0.90, as of 12/31/2013, to a factor of 0.63, as of 3/31/2014.

From charting past trends regarding AGNC's cumulative UTI balance and cumulative UTI dividend distributions coverage ratio, I have come to the realization AGNC is cautious when it comes to this balance/ratio. If this best-case scenario occurred, there would be a modest overpayment of AGNC's quarterly ERTI, thus a modest decrease in the company's cumulative UTI balance and cumulative UTI dividend distributions coverage ratio. As such, this is why I personally feel this scenario has a low probability (20% chance) of occurring. I am not saying this scenario "could not" occur. However, I feel relatively strong this best-case scenario "should not" occur.

2) Worst-Case Scenario: Quarterly Dividend of $0.55 Per Share (Probability - Very Low)

Now, let us discuss my projected worst-case scenario. This scenario assumes a dividend of $0.55 per share will be declared for the first quarter of 2014. Table 3 below projects what would happen to AGNC's cumulative UTI balance and cumulative UTI dividend distributions coverage ratio if a dividend rate of $0.55 per share was declared for the first quarter of 2014.

Table 3 - AGNC Cumulative UTI Balance + Cumulative UTI Coverage of Quarterly Dividend Distributions Ratio Analysis (Worst-Case Scenario)

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(Source: Table created entirely by myself, partially using data obtained from AGNC's quarterly investor presentation slides)

Using Table 3 above as a reference, if AGNC declares a dividend rate of $0.55 per share for the first quarter of 2014, the company would have a quarterly underpayment (overpayment) of $28 million. As such, AGNC's cumulative UTI balance would increase from $210 million, as of 12/31/2013, to $239 million, as of 3/31/2014. Such an underpayment would cause AGNC's cumulative UTI balance to increase by 14% during the first quarter of 2014. Furthermore, AGNC's cumulative UTI dividend distributions coverage ratio would modestly increase from a factor of 0.90, as of 12/31/2013, to a factor of 1.22, as of 3/31/2014.

As stated earlier, from charting past trends regarding AGNC's cumulative UTI balance and cumulative UTI dividend distributions coverage ratio, I have come to the realization AGNC is cautious when it comes to this balance/ratio. If this worst-case scenario occurred, there would be a modest underpayment of AGNC's quarterly ERTI, thus a modest increase in the company's cumulative UTI balance and cumulative UTI dividend distributions coverage ratio.

Rather than have the markets react negatively to yet another dividend cut, I feel AGNC would like to stabilize the company's quarterly dividend per share rate. Due to the recent material dividend cuts that occurred in the second, third, and fourth quarters of 2013, AGNC's quarterly ERTI "break-even" has now materially decreased from nearly $500 million during the first quarter of 2013 to approximately $235 million during the fourth quarter of 2013. Now that AGNC's quarterly ERTI break-even has decreased over 50%, I feel the company can finally start to achieve this dividend stabilization. As such, this is why I personally feel this scenario has a very low probability (10% chance) of occurring. I am not saying this scenario "could not" occur. However, I feel fairly certain this worst-case scenario "should not" occur.

3) Middle-of-the-Road Scenario: Quarterly Dividend of $0.60 - $0.70 Per Share (Probability - Moderate-to-High)

In my opinion, out of the three dividend range scenarios, the middle-of-the-road scenario is most likely to occur. This scenario assumes a dividend range of $0.60-$0.70 per share will be declared for the first quarter of 2014. Table 4 below projects what would happen to AGNC's cumulative UTI balance and cumulative UTI dividend distributions coverage ratio if a median dividend rate of $0.65 per share was declared for the first quarter of 2014.

Table 4 - AGNC Cumulative UTI Balance + Cumulative UTI Coverage of Quarterly Dividend Distributions Ratio Analysis (Middle-of-the-Road Scenario)

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(Source: Table created entirely by myself, partially using data obtained from AGNC's quarterly investor presentation slides)

Management "hinted" during AGNC's earnings call for the fourth quarter of 2013 that the company's quarterly ERTI should begin to stabilize during the first quarter of 2014. The following is a quote from AGNC's Chief Investment Officer ('CIO') Gary Kain during the same earnings call referenced above:

"… Taxable income came in at $0.65 per share which equaled our dividend for the quarter. The decline in our dividend experienced during 2013 was consistent with the portfolios book value performance and with our defensive positioning. That said, the combination of a more normal balance between risk and return, the improved market environments, and our undistributed taxable income are all supportive of our current dividends and allow me to be hopeful that we are transitioning to a more stable dividend environment.…"

The quoted text above helps support my projected quarterly ERTI of $225 million for the first quarter of 2014. Using Table 4 above as a reference, if AGNC declares a median dividend rate of $0.65 per share for the first quarter of 2014, the company would have a quarterly underpayment (overpayment) of ($7) million. As such, AGNC's cumulative UTI balance would decrease from $210 million, as of 12/31/2013, to $204 million, as of 3/31/2014. This minor overpayment would cause AGNC's cumulative UTI balance to decrease by only 3% during the first quarter of 2014. Furthermore, AGNC's cumulative UTI dividend distributions coverage ratio would only slightly decrease from a factor of 0.90, as of 12/31/2013, to a factor of 0.88, as of 3/31/2014.

If this middle-of-the-road scenario occurred, there would be an extremely minor overpayment of AGNC's quarterly ERTI, thus a slight decrease in the company's cumulative UTI balance and cumulative UTI dividend distributions coverage ratio. As stated earlier, I feel AGNC can finally start to achieve a dividend stabilization. This leads me to believe the middle-of-the-road scenario has the highest probability of occurring. As such, this is why I personally feel this scenario has a moderate-to-high probability (70% chance) of occurring. I am not saying this scenario "will definitely" occur. However, I feel confident this middle-of-the-road scenario "should" occur.

Let us now perform a brief dividend range analysis regarding AGNC's sister company, MTGE for the first quarter of 2014.

Brief Dividend Range Analysis for the First Quarter of 2014 Regarding MTGE:

Let us take a look at MTGE's prior cumulative UTI balance and cumulative UTI dividend distributions coverage ratio.

Table 5 - MTGE Cumulative UTI Balance + Cumulative UTI Coverage of Quarterly Dividend Distributions Ratio Analysis

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(Source: Table created entirely by myself, partially using data obtained from MTGE's quarterly investor presentation slides)

Using Table 5 above as a reference, MTGE had a quarterly dividend distributions underpayment (overpayment) of ($15.3) million during the first quarter of 2013. Such a material overpayment caused MTGE's cumulative UTI balance to decrease 37% during the first quarter of 2013. MTGE's cumulative UTI balance went from $41.9 million, as of 12/31/2012, to $26.6 million, as of 3/31/2013. For just one quarter's worth of activity, this was a material decrease to MTGE's cumulative UTI balance.

MTGE reported a cumulative UTI balance of $23.9 million, as of 6/30/2013. As such, MTGE had a quarterly dividend distributions underpayment (overpayment) of ($2.7) million during the second quarter of 2013 (included a quarterly "true-down" adjustment of approximately ($2.0) million). Since there was a cut to the company's dividend during the second quarter of 2013 (including outstanding shares of common stock being repurchased), instead of having to achieve quarterly ERTI of $53.1 million before "breaking-even" within the cumulative UTI balance, MTGE now only needed to achieve quarterly ERTI of $44.9 million to break-even. As such, MTGE's cumulative UTI coverage of quarterly dividend distributions ratio increased from a factor of 0.50, as of 3/31/2013, to a factor of 0.53, as of 6/30/2013.

MTGE reported a cumulative UTI balance of $31.7 million, as of 9/30/2013. For just one quarter's worth of activity, this was a nice "bounceback" to MTGE's cumulative UTI balance. As such, MTGE had a quarterly dividend distributions underpayment (overpayment) of $7.8 million during the third quarter of 2013. Since there was another cut to the company's dividend during the third quarter of 2013 (including outstanding shares of common stock being repurchased), instead of having to achieve quarterly ERTI of $44.9 million before breaking-even within the cumulative UTI balance, MTGE now only needed to achieve quarterly ERTI of $37.0 million to break-even. As such, MTGE's cumulative UTI coverage of quarterly dividend distributions ratio increased from a factor of 0.53 as of 6/30/2013 to a factor of 0.86, as of 9/30/2013.

Continuing the prior quarter's trend, MTGE reported a cumulative UTI balance of $39.8 million, as of 12/31/2013. As such, MTGE had a quarterly dividend distributions underpayment (overpayment) of $8.1 million during the fourth quarter of 2013. Since there was a minor cut to the company's dividend during the fourth quarter of 2013 (including outstanding shares of common stock being repurchased), instead of having to achieve quarterly ERTI of $37.0 million before breaking-even within the cumulative UTI balance, MTGE now only needed to achieve quarterly ERTI of $33.4 million to break-even. As such, MTGE's cumulative UTI coverage of quarterly dividend distributions ratio increased from a factor of 0.86, as of 9/30/2013, to a factor of 1.19, as of 12/31/2013.

When compared to AGNC, I feel the data shows MTGE's dividend has an even higher probability of being maintained during the first quarter of 2014 (if not having a slight increase). This is mainly highlighted by each company's cumulative UTI coverage of quarterly dividend distributions ratio. As of 12/31/2013, AGNC's ratio was a factor of 0.90, while MTGE's ratio was a factor of 1.19, which was modestly better. For this reason (and other detailed factors omitted from this analysis), I am projecting MTGE will either maintain the company's dividend at $0.65 per share or slightly increase the dividend to $0.70 per share for the first quarter of 2014.

With that being said, the following are my dividend projections for MTGE:

MTGE's Dividend Range Projection for the First Quarter of 2014: $0.65-$0.70 per share

MTGE's Exact Dividend Projection for the First Quarter of 2014: $0.65 per share

A dividend rate of $0.65 per share for the first quarter of 2014 helps MTGE continue increasing the company's cumulative UTI balance and the cumulative UTI coverage of quarterly dividend distributions ratio.

Side Note: I would note my probabilities between for the $0.65 per share rate (60%) and $0.70 per share rate (40%) are pretty close to one another. As such, I would not be surprised if either per share rate was declared for the first quarter of 2014.

Brief Dividend Range Analysis for the First Quarter of 2014 Regarding NLY:

To analyze the possible dividend range scenarios for NLY, let us take a look at Table 6 below. Table 6 will help readers understand the history of NLY's quarterly dividend per share rate, the company's recent book value ("BV") as of 12/31/2013, and quarterly BV change (when compared to AGNC and MTGE). Readers should be aware the data shown in Table 6 below is not the only metrics to research when projecting a company's quarterly dividend per share rate. However, I feel the data in Table 6 provides a good comparison between the three companies discussed within this article (AGNC, MTGE, and NLY). As such, I feel the information contained within Table 6 below is relevant to the article's topic and a brief discussion of the data should be presented.

Table 6 - Quarterly Dividend Rate History and Book Value ("BV") Change Analysis (AGNC, MTGE, and NLY)

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(Source: Table created entirely by myself, partially using data obtained from AGNC's quarterly investor presentation slides, MTGE's quarterly investor presentation slides, and NLY's quarterly investor presentation slides)

Using Table 6 above as a reference, when compared to AGNC, NLY also had material dividend cuts over the past few years. NLY cut the company's quarterly dividend from $0.55 per share during the second quarter of 2012 to $0.30 per share during the fourth quarter of 2013. Going back even further, NLY paid a quarterly dividend of $0.65 per share in the second quarter of 2011. When calculated, NLY's dividend cut between the second quarter of 2011 and the fourth quarter of 2013 was 54% ($0.65 per share versus $0.30 per share). In comparison, AGNC paid a quarterly dividend of $1.40 per share during the second quarter of 2011. When calculated, AGNC's dividend cut between the second quarter of 2011 and the fourth quarter of 2013 was also 54% ($1.40 per share versus $0.65 per share). Since NLY continued to cut the quarterly dividend throughout most of 2011-2013 (more frequent dividend cuts, but in smaller increments when compared to AGNC), the probability of the company being able to sustain the dividend at $0.30 per share has modestly increased.

When NLY reported "core earnings" of $0.35 per share for the fourth quarter of 2013, it would appear the company's quarterly dividend rate of $0.30 per share should stabilize this quarter (as I am projecting with AGNC's dividend). However, readers should be aware that a quarterly core earnings figure is not an exact comparison to quarterly ERTI. A core earnings figure is the closest metric NLY provides that resembles a "taxable income" comparison of AGNC's quarterly ERTI. Readers should also be aware the quarterly decline in each company's BV was fairly similar for the fourth quarter of 2013.

With that being said, the following are my dividend projections for NLY:

NLY's Dividend Range Projection for the First Quarter of 2014: $0.25-$0.35 per share

NLY's Exact Dividend Projection for the First Quarter of 2014: $0.30 per share

Conclusions Drawn:

This article provided a detailed analysis with supporting documentation on the probable dividend per share rate AGNC will declare for the first quarter of 2014. This was performed by showing an analysis of three dividend range scenarios. Through the analysis of these three dividend range scenarios, I believe AGNC's dividend should remain unchanged when compared to the prior quarter. If this were to occur, this ensures a modest cumulative UTI balance remains in place for future quarters.

The following are my best- and worst-case dividend range scenarios regarding AGNC for the first quarter of 2014:

1) Best-Case Scenario = Quarterly Dividend of $0.75 Per Share
2) Worst-Case Scenario = Quarterly Dividend of $0.55 Per Share

I personally feel the best-case scenario has a low probability (20% chance) of occurring, while the worst-case scenario has a very low probability (10% chance) of occurring. Through the analysis performed and discussed above, I believe the following middle-of-the-road scenario has the highest probability (70% chance) of occurring:

AGNC's Dividend Range Projection for the First Quarter of 2014: $0.60-$0.70 per share

AGNC's Exact Dividend Projection for the First Quarter of 2014: $0.65 per share

I would also like to point out I have projected AGNC's stock price (as of 2/28/2014) is trading at a material discount (>10%) to the company's CURRENT BV as of 2/28/2014. As such, I feel AGNC will continue to take advantage of this steep discount by buying back the company's outstanding common shares. This has a positive cumulative BV effect, and enhances long-term shareholder value. During the fourth quarter of 2013, AGNC repurchased 27.2 million shares of the company's outstanding common shares. While I am projecting management will not be as aggressive as the prior quarter, I am projecting AGNC will continue to repurchase outstanding shares of common stock during the first quarter of 2014.

Disclosure: I am long AGNC, MTGE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no position in NLY.