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Summary

  • AGNC’s best-case scenario is a quarterly dividend of $0.75 per share.
  • AGNC’s worst-case scenario is a quarterly dividend of $0.55 per share.
  • AGNC’s “middle-of-the-road” scenario is a quarterly dividend of $0.60-$0.70 per share.
  • AGNC’s management team implied net dollar-roll income generated from the company’s net long TBA MBS position should be considered as an added component to dividends when favorable business conditions exist.
  • My exact AGNC, MTGE, and NLY dividend per share projections for the second quarter of 2014 are stated near the end of the article.

Author's Note: This article provides a detailed analysis with supporting documentation on the "most probable" dividend per share rate American Capital Agency Corp (NASDAQ:AGNC) will declare for the second 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 second 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. After three consecutive quarters of dividend cuts, AGNC maintained the company's quarterly dividend rate of $0.65 per share during the first quarter of 2014. Due to the rapidly declining dividend per share rates seen in 2013, I believe this specific analysis has heightened importance for investors.

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. This analysis will include an exact dividend per share projection for both MTGE and NLY for the second quarter of 2014. At the end of this article, there will be a conclusion regarding my personal projection of what I believe AGNC's dividend per share rate will be for the second quarter of 2014.

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

The links to the prior article's two-part analysis are provided below:

American Capital Agency Corp.'s Dividend Sustainability Analysis (Post Q1 2014 Earnings) - Part 1

American Capital Agency Corp.'s Dividend Sustainability Analysis (Post Q1 2014 Earnings) - Part 2

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

Before specifically analyzing my dividend-range scenarios for the second 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

(click to enlarge)

(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 a prior quarter's dividend-range scenarios article I wrote for an explanation of what each account means and where the information is derived from (look within the 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 has been provided to better understand AGNC's quarterly ERTI and cumulative UTI figures/ratios, three dividend-range scenarios for the second 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. In some instances, "net dollar-roll income (expense)" figures will also be shown to highlight a previous strategy that has once again been recently implemented by AGNC's management team.

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

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 Tables 4 and 5 below).

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

Now let us discuss my projected best-case scenario. This scenario assumes a dividend of $0.75 per share will be declared for the second 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 second quarter of 2014.

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

(click to enlarge)

(Source: Table created entirely by myself, partially using data obtained from AGNC's quarterly investor presentation slides [link provided below Table 1])

Using Table 2 above as a reference, I am projecting AGNC will report quarterly ERTI of $155 million for the second quarter of 2014. When compared to the first quarter of 2014, this is a projected quarterly ERTI increase (decrease) of ($12) million. The main reason for the slight decrease in projected quarterly ERTI is the reduced average balance of the "on-balance sheet" MBS portfolio for the second quarter of 2014 partially offset by a slightly 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 second quarter of 2014, the company would have a quarterly ERTI underpayment (overpayment) of ($117) million. As such, AGNC's cumulative UTI balance would decrease from $146 million as of 3/31/2014 to only $29 million as of 6/30/2014. Such an overpayment would cause AGNC's cumulative UTI balance to increase (decrease) by (80%) during the second quarter of 2014. Furthermore, AGNC's cumulative UTI dividend distributions coverage ratio would modestly decrease from a factor of 0.63 as of 3/31/2014 to a factor of just 0.11 as of 6/30/2014.

From charting past trends regarding AGNC's cumulative UTI balance and cumulative UTI dividend distributions coverage ratio, it has been apparent AGNC is cautious when it comes to this balance/ratio. If this best-case scenario occurred, there would be a material overpayment of AGNC's quarterly ERTI thus a material decrease in the company's cumulative UTI balance and cumulative UTI dividend distributions coverage ratio. As such, this is why I believe this scenario has a very low probability (10% chance) of occurring. I am not saying this scenario "could not" occur. However, I believe this best-case scenario "should not" occur.

2) Worst-Case Scenario: Quarterly Dividend of $0.55 Per Share (Probability - 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 second 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 second quarter of 2014.

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

(click to enlarge)

(Source: Table created entirely by myself, partially using data obtained from AGNC's quarterly investor presentation slides [link provided below Table 1])

Using Table 3 above as a reference, if AGNC declares a dividend rate of $0.55 per share for the second quarter of 2014, the company would have a quarterly ERTI underpayment (overpayment) of ($46) million. As such, AGNC's cumulative UTI balance would decrease from $146 million as of 3/31/2014 to $100 million as of 6/30/2014. Such an overpayment would cause AGNC's cumulative UTI balance to increase (decrease) by (32%) during the second quarter of 2014. Furthermore, AGNC's cumulative UTI dividend distributions coverage ratio would slightly decrease from a factor of 0.63 as of 3/31/2014 to a factor of 0.50 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, it has been apparent AGNC is cautious when it comes to this balance/ratio. If this worst-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.

HOWEVER, as was highlighted in a previous article (see link above), I believe as long as favorable economic conditions persist in regards to AGNC having a net long TBA MBS portfolio (which generates net dollar-roll income), the company will base its dividend payout level on both quarterly ERTI/AREITTI and net dollar-roll income. This specific topic will be further analyzed within the middle-of-the-road scenario below.

Furthermore, rather than have markets react negatively to another dividend cut, I believe AGNC would like to continue to maintain 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 materially decreased from nearly $500 million during the second quarter of 2013 to approximately $237 million during the second quarter of 2014. Now that AGNC's quarterly ERTI break-even has increased (decreased) in excess of (50%), I believe the company can continue to achieve this dividend stabilization. As such, this is why I believe this scenario has a low probability (15% chance) of occurring. I am not saying this scenario "could not" occur. However, I believe this worst-case scenario "should not" occur.

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

In my opinion, out of the three dividend-range scenarios, the middle-of-the-road scenario is the most likely to occur. This scenario assumes a dividend range of $0.60-$0.70 per share will be declared for the second 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 second quarter of 2014.

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

(click to enlarge)

(Source: Table created entirely by myself, partially using data obtained from AGNC's quarterly investor presentation slides [link provided below Table 1])

Using Table 4 above as a reference, if AGNC declares a median dividend rate of $0.65 per share for the second quarter of 2014, the company would have a quarterly ERTI underpayment (overpayment) of ($82) million. As such, AGNC's cumulative UTI balance would decrease from $146 million as of 3/31/2014 to $64 million as of 6/30/2014. This material overpayment would cause AGNC's cumulative UTI balance to increase (decrease) by (56%) during the second quarter of 2014. Furthermore, AGNC's cumulative UTI dividend distributions coverage ratio would decrease from a factor of 0.63 as of 3/31/2014 to a factor of 0.27 as of 6/30/2014.

However, as stated above, this data excludes AGNC's dollar-roll income which is generated from a net long TBA MBS position. AGNC's net long (short) TBA MBS position increased from $2.1 billion as of 12/31/2014 to a materially higher $13.9 billion as of 3/31/2014. The material increase of this position will inherently provide a higher net dollar-roll income during the second quarter of 2014. AGNC's Chief Investment Officer ('CIO') Gary Kain stated the company will be treating net dollar-roll income differently than the "official" tax treatment per the IRC. The following quote is from AGNC's earnings call for the first quarter of 2014:

"…Assuming we continue to make significant use of dollar rolls, this difference in tax treatment between dollar-rolls and MBS pool positions will have significant implications for our taxable earnings outlook versus both our GAAP earnings and versus our true economic earnings as well…If we can utilize our capital loss carry forward by generating capital gains via dollar-rolls, we can in essence pass along that tax benefit to our shareholders by continuing to base the dividend amount on the economic earnings power of the portfolio and changing the tax characterization of our dividend from ordinary to return of principal..."

From the quote above, I believe AGNC's net dollar-roll income will have a material influence on the company's dividend for the second quarter of 2014. To show this impact, Table 5 is provided below.

Table 5 - AGNC ERTI + Net Dollar Roll Income (Expense) Analysis (Middle-of-the-Road Scenario)

(click to enlarge)

(Source: Table created entirely by myself, partially using data obtained from AGNC's quarterly investor presentation slides [link provided below Table 1])

Using Table 5 above as a reference, if AGNC declares a median dividend rate of $0.65 per share for the second quarter of 2014, the company would have a quarterly ERTI and net dollar roll underpayment (overpayment) of $18 million. This equates to a payout ratio of only 93%.

Furthermore, when using this new methodology and "back-testing" its results on AGNC's recent dividend declarations, one can see the company's quarterly ERTI and net dollar roll payout ratios equated to 108% and 100% for the fourth quarter of 2013 and first quarter of 2014, respectively. Furthermore, the material underpayment in the first quarter of 2013 was basically "netted-out" by the material overpayment in the second quarter of 2013.

As such, this new methodology supports AGNC's recent transition back to a modest to material net long TBA MBS position which generates net dollar-roll income (at the cost of lower ERTI). In other words, when keeping it simple (excluding other factors), AGNC's quarterly ERTI and net dollar-roll income have an inverse relationship. When the off-balance sheet TBA MBS portfolio become less attractive, AGNC can take delivery on the net long positions and convert these derivative instruments into on-balance sheet regular MBS which generate taxable income thus boosting ERTI (at the cost of lower net dollar-roll income).

If this specific middle-of-the-road scenario occurred, there would be a minor underpayment of AGNC's quarterly ERTI and net dollar-roll income thus a slight increase in the company's cumulative UTI and net dollar-roll income balance and cumulative UTI and net dollar-roll income dividend distributions coverage ratio. This leads me to believe the middle-of-the-road scenario has the highest probability of occurring. As such, this is why I believe this scenario has a high probability (75% chance) of occurring. I am not saying this scenario "will definitely" occur. However, I believe this middle-of-the-road scenario "should" occur.

Let us now perform a brief dividend-range analysis regarding AGNC's sister company MTGE and the company's closet sector peer NLY for the second quarter of 2014.

MTGE's Brief Dividend-Range Analysis for the Second Quarter of 2014:

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

Table 6 - MTGE Cumulative UTI Balance + Cumulative UTI Coverage of Quarterly Dividend Distributions Ratio Analysis

(click to enlarge)

(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 ($2.2) million during the first quarter of 2014. Such a slight overpayment caused MTGE's cumulative UTI balance to increase (decrease) only (5%) during the first quarter of 2014. MTGE's cumulative UTI balance went from $39.8 million as of 12/31/2013 to $37.3 million as of 3/31/2014. When compared to AGNC's cumulative UTI balance increase (decrease) of (31%), MTGE clearly had the more attractive ERTI during the first quarter of 2014.

However, investors should also understand MTGE's "at risk" leverage ratio was only 5.7x as of 3/31/2014. In comparison, AGNC's at risk leverage ratio was 7.6x as of 3/31/2014. As events have unfolded during the second quarter of 2014, the additional leverage at the beginning of the quarter currently favors AGNC regarding generating ERTI AND net dollar-roll income. AGNC's net long (short) TBA MBS position was $13.9 billion as of 3/31/2014. This was the equivalent to 27% of AGNC's on-balance sheet MBS portfolio. In contrast, MTGE's net long (short) TBA MBS position was $0.7 billion as of 3/31/2014. This was the equivalent to just 10% of MTGE's on-balance sheet agency and non-agency MBS portfolio. Proportionally speaking, MTGE may still generate higher quarterly ERTI when compared to AGNC. However, AGNC should generate more quarterly net dollar-roll income (proportionally speaking). I believe these factors offset each other.

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 (70% probability) or slightly increase the dividend to $0.70 per share (30% probability) for the second quarter of 2014.

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

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

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

A dividend rate of $0.65 per share for the second quarter of 2014 would allow MTGE to continue stabilizing the company's cumulative UTI balance and the cumulative UTI coverage of quarterly dividend distributions ratio. The net dollar-roll income generated by MTGE during the second quarter of 2014 should have less of an impact when compared to AGNC.

NLY's Brief Dividend-Range Analysis for the Second Quarter of 2014:

As was the case with both AGNC and MTGE, NLY was able to stabilize the company's dividend during the first quarter of 2014. Since NLY continued to cut its quarterly dividend throughout various quarters during the past several years, the probability of the company being able to maintain the dividend at $0.30 per share had modestly increased. This was mainly due to the material decrease in NLY's quarterly dividend distributions break-even amount.

However, when NLY reported weak quarterly "core earnings" (the company's taxable income equivalent) of $0.23 per share for the first quarter of 2014, signs of stress rose once again in regards to NLY's future dividend sustainability.

Regarding net dollar-roll income, AGNC and NLY had material differences in each company's TBA MBS portfolio as of 3/31/2014. AGNC had a net long (short) TBA MBS position was $13.9 billion as of 3/31/2014. In sharp contrast, NLY had a net long (short) TBA MBS position of ($0.6) billion as of 3/31/2014. Since NLY actually had a minor net (short) TBA MBS position as of 3/31/2014, the probability of the company generating material net dollar-roll income during the second quarter of 2014 is relatively low. As such, NLY cannot offset any overpayment of dividends during the second quarter of 2014 by stating net dollar-roll income will be a material component along with core earnings / ordinary taxable income. Therefore, NLY needs to improve on the company's core earnings for the second quarter of 2014.

However, it should also be noted that a company's quarterly core earnings is not an "exact" comparison to quarterly ERTI (close comparison). Core earnings is the closest metric NLY provides that resembles a "taxable income" comparison to AGNC's and MTGE's quarterly ERTI. This slight distinction should be considered when performing an analysis of NLY's future dividend sustainability. Additional accounts need to be reconciled accordingly. While I have performed this reconciliation on NLY during the second quarter of 2014, that specific analysis is beyond the scope of this article (AGNC's dividend-range scenarios).

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

NLY's Dividend-Range Projection for the Second Quarter of 2014: $0.25-$0.30 per share

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

Conclusions Drawn:

This article provided a detailed analysis with supporting documentation on the most probable dividend per share rate AGNC will declare for the second 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 and net dollar-roll income balance remains in place for future quarters.

The following are my best- and worst-case dividend-range scenarios regarding AGNC for the second 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 believe the best case scenario has a very low probability (10% chance) of occurring while the worst case scenario has a low probability (15% chance) of occurring. Through the analysis performed and discussed above, I believe the following middle-of-the-road scenario has the highest probability (75% chance) of occurring:

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

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

As stated in the conclusion of a prior article (see link near beginning of article), I continue to rate both AGNC/MTGE as a SOLID HOLD when each company's stock price is trading at a minor to modest discount to CURRENT BV (which I internally update weekly). I will continue to increase my AGNC/MTGE holdings (rate each company as a BUY) when I believe each company's stock price is trading a material discount (over 10% discount) to CURRENT BV.

I am projecting AGNC's stock price as of 6/6/2014 was trading at a modest (5%-10%) discount to the company's CURRENT BV (BV as of 6/6/2014). When including the projected dividend of $0.65 per share for the second quarter of 2014, AGNC's stock price was trading towards the lower end of this modest discount range (towards a 5% discount). When excluding the projected dividend of $0.65 per share for the second quarter of 2014 (which I would recommend is the proper methodology since the "ex dividend date" has yet to occur within this quarter), AGNC's stock price was trading towards the higher end of this modest discount range (towards a 10% discount).

Source: American Capital Agency's Dividend Range Scenarios For Q2 2014

Additional disclosure: I have no position in NLY.