- CYS had a Q1 2014 economic return of 8.2%. This was comprised of a $0.32 per share dividend and a $0.44 increase in book value.
- AGNC had a Q1 2014 economic return of 5.1%. This was comprised of a $0.65 per share dividend and a $0.56 increase in book value.
- CYS ended Q1 2014 with leverage of 6.32x. It had a net interest rate spread of 1.89% and a CPR of 5.6% for Q1.
- AGNC ended Q1 2014 with leverage of 7.6x. It had a net interest rate spread of 1.43% and a CPR of 7.0% for Q1.
- CYS beat AGNC in performance in Q1 2014, but AGNC may be significantly safer.
American Capital Agency Corp. (NASDAQ:AGNC) is one of the biggest Agency mortgage REITs in the US with a $70.5B portfolio as of March 31, 2014. It is generally considered a "blue chip" Agency mortgage REIT; and it turned in a good to great quarter in Q1 2014 with an economic return of +5.1% for Q1 2014 alone. This was comprised of a $0.65 quarterly dividend (11.55% annualized) and a +$0.56 increase in book value per common share. AGNC also repurchased 3.4 million common shares during the quarter at an average price of $22.10. AGNC has a current stock price of $22.51 per share; and it had a Q1 2014 ending book value of $24.49 per common share. Therefore the repurchase actions during Q1 2014 would seem to have been a good to great business decision.
AGNC ended the quarter with leverage of 7.6x and a 7.0% portfolio CPR (constant prepayment rate). Its net interest rate spread of 1.43% allowed it to earn $0.71 per common share in net spread and dollar roll income in Q1 2014 ($0.14 in dollar roll income). This was supportive of its dividend of $0.65 per common share. Plus it had $0.42 in estimated undistributed taxable income per common share as of March 31, 2014. Given that the average leverage during Q1 2014 was 7.2x, the ending leverage of 7.6x would seem to indicate that AGNC believes the Agency MBS environment is slightly safer; and AGNC will try to capture more net interest rate spread income in Q2 2014. In support of the "safer" thesis, AGNC's net duration gap with swaptions was down to 1.2 as of March 31, 2014 from 1.5 as of December 31, 2013. On top of this AGNC's repo cost was down from 0.45% to 0.43% from Q4 2013E to Q1 2014E; and the average repo days to maturity increased from 124 days as of December 31, 2013 to 162 days as of March 31, 2014. These factors bode well for the Q2 2014 results.
On top of this the 10 year US Treasury Note yield ended Q1 2014 at 2.72%. Even though the Fed has continued to taper, that yield is now down to 2.58% as of May 4, 2014. This means investors have +14 bps in their pockets that would likely translate into book value gains for Q2 2014, if the quarter were to end today. Even if the 10 year US Treasury Note yield rises from this point in Q2 2014, investors have an approximate 14 bps cushion before increases in the yield would begin to translate into book value losses. This is a good position for investors to be in. This continues to make AGNC a buy.
CYS Investments Inc. (NYSE:CYS) is a smaller Agency mortgage REIT than AGNC ($70.5B portfolio) with a portfolio of $13.3B. It has been performing at the top of its subsector in recent quarters. Q1 2014 was an example of that. CYS had a Q1 2014 economic return of 8.2% for Q1 2014 alone. This was comprised of a $0.32 per share quarterly dividend (14.75% annualized) and a $0.44 increase in book value.
CYS ended Q1 2014 with leverage of 6.32x. It had a net interest rate spread of 1.89% and a CPR of 5.6% for Q1. From these figures, CYS appears at first glance to be a less risky agency mortgage REIT with leverage of 6.32x at Q1 2014 end compared to AGNC's higher leverage of 7.2x at Q1 2014 end. Yet it managed to attain a net interest rate spread of 1.89%, which was 46 bps better than AGNC's net interest rate spread. CYS' remarkably low CPR of 5.6% for Q1 2014 helped in this regard. Agency RMBS usually trade at a premium to par. Therefore a smaller number of prepaid loans usually translates into a smaller amount of premium lost.
In addition to the above beats, CYS paid only a 0.31% average interest rate on its repurchase agreements (repos) versus 0.43% for AGNC. This was substantially down from CYS' average repo interest rate in Q4 2013 of 0.41%. Like AGNC, CYS increased its weighted average maturity of its repos in Q1. CYS increased the weighted average maturity to 43.4 days at the end of Q1 2014 versus 39.9 days at the end of Q4 2013. However, when you are comparing CYS' and AGNC's repo interest rates you are comparing apples and oranges. AGNC had an average maturity of 162 days as of March 31, 2014. By comparison CYS had an average weighted maturity of 43.4 days. There is really little comparison. AGNC's longer average maturity protects it much more from medium-term movements in repo rates. CYS has complete turnover in repos approximately every 1.5 months. AGNC has complete turnover in repo rates approximately every 5.5 months. This could translate into significantly better or significantly worse results in any medium term period (roughly 6 months). However, in this case AGNC appears to be the much safer option.
After looking at the above, it behooves to look at the two portfolios too. AGNC's portfolio as of March 31, 2014 is below.
CYS' portfolio as of March 31, 2014 is in the table below.
Both of the above companies have moved substantial amounts of their Agency MBS securities into 15 year Agency RMBS. AGNC has about 50% of its portfolio in 15 year Agency RMBS; and CYS with 48% has almost an equal amount. The main difference seems to be that CYS has about 15% of its securities in Agency Hybrid ARMs. This is probably a plus in the current environment. However, AGNC has a decided advantage in the average coupon rate of 15 year and 30 year fixed rate Agency RMBS. AGNC has an weighted average coupon rate of 3.72% on its 15 year fixed rate Agency RMBS. It has a 4.38% weighted average coupon rate on its 30 year fixed rate Agency RMBS. By comparison CYS has a weighted average coupon rate of 3.13% on its 15 year fixed rate Agency RMBS. CYS has a weighted average coupon rate of 3.96% on its 30 year fixed rate Agency RMBS. These differences make AGNC much less susceptible to extension risk. For those interested in safety, this may be a big consideration.
Both companies were significantly hedged at the end of Q1 2014. AGNC increased its hedges from 86% as of December 31, 2013 to 94% as of March 31, 2014. CYS had a $9.7B notional amount in hedges as of March 31, 2014 (approximately 73% of its portfolio value). This was probably another factor that helped CYS profit as 10 year US Treasury Note yields went down in Q1 2014. However, the lesser hedging may leave CYS more open to large interest rate moves upward later in 2014. AGNC appears to be the safer of the two in this case too.
CYS did not repurchase any common shares in Q1 2014. To some this might indicate it has less faith in its strategy longer term. However, insiders did purchase 1.22 million shares of CYS (+11.5%) over the last six months. This would indicate faith in the company and its strategy. AGNC insiders purchased 289,300 shares (+6.8%) in the last six months. This too indicates faith in the company and its strategy. This indicator may be something of a tossup; but AGNC does appear to be "walking the walk" more than CYS does in this case. In fact AGNC increased its holdings of other REITs to $352 million in Q1 2014. These holdings (bought mostly in December and January) led to realized and unrealized gains of approximately $49 million for Q1 2014. These also accounted for about 20% of AGNC's book value gains in Q1 2014. CEO Gary Kain's strong belief in the near-term direction of the MBS market paid off nicely.
Overall both companies appear to be buys. AGNC is currently lower yielding than CYS. However, it appears to have positioned itself to be safer against more market move conditions than CYS. Plus AGNC is known as an Agency mortgage REIT "blue chip" stock for good reason. Since its IPO in May 2008 at $20.00 per share, it has paid $28.26 per common share in dividends; and it has $24.49 per common share in book value. This is approximately a 164% total economic return over the period since the IPO. That is very good considering the tumble the market took from 2008 to March 2009. It is no wonder many people like the stock. If you want a slightly safer dividend, you can consider the 8.000% Series A Cumulative Redeemable Preferred Stock, which trades under the symbol AGNCP.
Thus far in 2014 the 10 year US Treasury Note yield has dropped from 3.03% on December 31, 2013 to 2.58% on May 4 2014 (-45 bps). This has led to increases in book value. Many are worried that 10 year US Treasury Note yields will skyrocket later in 2014. However, recent data argues against this. The US Q1 GDP growth first estimate was only +0.1%. This may get revised upward in later estimates. Most of the better data came in March. However, the result is still terrible compared to the 2.6% GDP growth rate in Q4 2013. Many expect 3%+ in Q2 2014; but this is still very much up in the air. The IMF says Russia is already in recession. A Russian recession is bound to hurt European economies. The Chinese HSBC manufacturing PMI for April 2014 was 48.1 (contraction). This was below even the flash HSBC PMI for April of 48.3. Other China data has been weak too (such as imports and exports). Thus far in 2014, we seem to be seeing worldwide economic slowing. If this continues or worsens, it is unlikely that US Treasury Note yields will go up. Rather they are more likely to go down. Even perma-hawk Fed Governor Fisher does not think the Fed will consider raising Fed Funds rates until at least October. The Fed may not do this at all in 2014. If you are worried about a big up move in interest rates, you probably want to hold AGNC as opposed to CYS. However, if you believe in a weak worldwide economy in 2014, you may wish to invest in the riskier CYS, which may average much better returns under that circumstance. Considering the other options in the stock market (and the bond market) both stocks are viable buy options.
The two year chart of AGNC provides some technical direction for this trade.
The slow stochastic sub chart of AGNC shows that AGNC is near overbought levels. The main chart shows that it has bottomed in the last year; and it is currently in a weak uptrend. Given all of the above, it is a buy; but investors may wish to average in (or wait for it to cycle down a bit). CAPS gives it four stars (a buy). Analysts' give it a mean recommendation of 2.7 (a high hold).
The two year chart of CYS provides some technical direction for this trade.
The slow stochastic sub chart shows that CYS is neither overbought nor oversold. The main chart shows that CYS appears to have bottomed in the last year. It now appears to be in a weak uptrend. With its great annual dividend of 14.75% it is a buy. CAPS gives it five stars (a strong buy). The average analysts' recommendation is 2.4 (a buy).
Many different things may happen depending on world economic events. However, the above two stocks have great dividends. They look stable for the immediate term. AGNC has a Beta of 0.09. CYS has a Beta of 0.3. Both should be more immune than most stocks to rapid changes in the equities market. With their hedging strategies both should be more immune to rapid movements in the bond markets. Since both are also trading at substantial discounts to book value, they probably have even less downside. This makes them both good buys. AGNC closed at $22.51 on May 2, 2014. Its current book value is $24.49 per share. CYS closed at $8.68 on May 2, 2014. Its current book value is $9.68 per share.
NOTE: Some of the above fundamental financial information is from Yahoo Finance.
WARNING: The Fed is cutting its buying of Agency MBS. This will mean more Agency MBS availability. At the same time the expectation for 2014 is that many fewer new Agency MBS will be created. There are the new Basel III requirements. Plus there are the recently approved US supplementary leverage ratio requirements. At 5% this is higher than the Basel III requirements. This should restrict the number of new loans made in 2014 (and hence new Agency MBS constructed). It is unclear at this time exactly how this will turn out. However, there is the chance that the premium on Agency RMBS will go down if there are substantially more available in the market. This would hurt Agency mortgage REITs' book values later in 2014, if this in fact does occur. It is unclear if it will. One decrease may approximately offset the other increase.
Good Luck Trading.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AGNC, CYS over the next 72 hours. 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.