I was waiting to see American Capital Agency Corporation (NASDAQ:AGNC) trading at a 15% discount to book value before increasing my position. However, a 10%-11% discount to book value combined with AGNC's stable dividend and the low probability of a spike in interest rates makes it a strong buy. AGNC is not similar to the mREITs that went bankrupt in the past. The major difference between AGNC and the mREITs that went bankrupt in the past is the fact that AGNC is an agency mREIT, which means that it is guaranteed by GSEs (Government-Sponsored Enterprises). GSEs carry the implicit backing of the U.S. Government, but they are not direct obligations of the U.S. Government. For this reason, these securities will offer a yield premium over Treasuries. Examples of GSEs include: Federal Home Loan Bank, Federal Home Loan Mortgage Corporation (Freddie Mac), Federal Farm Credit Bank and the Resolution Funding Corporation. Additionally, the mREITs and financial institutions that got crushed during the financial crisis had leverage of 30x-1 and sometimes as high as 60x-1. AGNC's leverage is between 5x-10x depending on the interest rate environment and management's decisions to navigate the best economic returns.
AGNC has no credit risk, however, there is interest rate risk.
AGNC's earnings from AGNC's website:
AMERICAN CAPITAL AGENCY CORP.REPORTS $2.43 COMPREHENSIVE INCOME PER COMMON SHARE AND $26.26 NET BOOK VALUE PER COMMON SHARE
Bethesda, MD - July 28, 2014 - American Capital Agency Corp. ("AGNC" or the "Company") (Nasdaq: AGNC) today reported comprehensive income for the second quarter of 2014 of $862 million, or $2.43 per common share, and net book value of $26.26 per common share. Economic return for the period, defined as dividends per common share plus the change in net book value per common share, was a gain of $2.42 per common share, or 9.9% for the quarter, or 39.6% on an annualized basis.
The book value increased $1.77 per common share, or 7.2%, from $24.49 net book value per common share as of March 31, 2014 to $26.26 net book value per common share as of June 30. 2014.
Gary Kain stated:
"I am pleased with the very strong performance of our portfolio during the second quarter. In Q2, our economic return total 10%, making it one of our best quarters since the end of 2009."
"If you turn to Slide 6, I want to quickly point out something that may be surprising to many of you. Our strong 2014 economic returns have offset almost all of the economic losses incurred during 2013."
"With respect to the stability of the $0.65 dividend, management views it as an important objective to maintain the current $0.65 dividend and believes that should be achievable assuming market conditions remain favorable."
This was a Gary Kain quote from Q1 2014
The best AGNC analyst in my opinion is Scott Kennedy:
I have been an AGNC investor since late 2011. When I found Scott Kennedy's analysis here at Seeking Alpha in 2013, I was very impressed, to say the least. His accuracy at projecting the dividend sustainability, dividend ranges, book value and all of the other key metrics associated with AGNC's business is superior to the professional analysts on Wall Street who cover AGNC. Therefore, his credibility is superb, in my opinion. I would like to quote some excerpts of his articles.
Kennedy's article states:
"AGNC has implied all net dollar roll income generated from the company's net long TBA MBS position would be an added component to dividend distributions when favorable business conditions persist."
"Due to the attractive off-balance sheet dollar roll implied financing rates (versus the on-balance sheet repo financing rates), AGNC's net interest rate spread increased (decreased) by 41 bps during the second quarter of 2014 (which was another positive sign; 1.84% versus 1.43%)."
"Unless the GSEs default, the principle and interest associated with agency MBS are guaranteed. That's why agency MBS have lower interest rates associated with their packaged securities (amongst the various other characteristics). Lower risk = lower reward (via coupon rates) Non-agency MBS don't have this guarantee. As such, they inherently have higher coupons and ultimately higher yields (in most cases)". Scott was answering the following quoted comment "Just because AGNC deals in "agency backed securities", it does not mean their income is "federally guaranteed". If you are implying there is less risk in AGNC vs MTGE, I think the opposite is true."
See Kennedy's latest AGNC article: American Capital Agency Corp.'s Dividend Sustainability Analysis (Post Q2 2014 Earnings) - Part 2. He details the positive and the negative aspects regarding AGNC from an accounting and financial perspective. I want readers to see his non-biased balanced analysis, since I am only discussing the positive aspects.
I am bullish on AGNC based on its current trading price of $23.50, which is a material discount to its book value. Additionally, AGNC has added a layer of net dollar roll income as a source to cover their dividend -- this is combined with their ERTI and $0.04 remaining undistributed taxable income amount to pay the dividend. In my opinion, the probability of an interest rate spike that would cause damage to AGNC's portfolio is low. AGNC is not of the same ilk as the mREITs that went bankrupt in the past. AGNC is an agency mREIT, and is therefore, guaranteed by the GSEs. AGNC never employs insane leverage (30x-1 +), which was a common practice of the mREITs and financial institutions that went bankrupt or got decimated during the financial crisis. As a matter of fact, AGNC's dividend history shows that they paid $1 on 10/10/2008, $1.20 on 1/26/2009, $0.85 on 4/27/2009, $1.50 on 7/27/2009 and then a steady $1.40 for the next 10 quarters. So AGNC has an outstanding overall history of dividend payments. Their dividends and their business did not falter during the financial crisis like some of the other mREITs. Some will continue to cite the fact that AGNC's dividend has decreased to its current $0.65, a decrease of 54% from its $1.40 level. An extreme interest rate "spike" in 2013 in a short amount of time was responsible for AGNC's price decline, book value decline and dividend cuts. AGNC's management was caught off guard, however, they took the corrective measures by lowering leverage, increasing their hedging and went into defensive mode and preserved book value at the expense of the dividend. They think outside of the box and I believe their short-term defensive strategy will pay off in the long run. When the time is right, they will increase their leverage and their ERTI will rise. There are many other important factors regarding AGNC, however, for brevity's sake, I will save them for another article. Patience is key when investing in AGNC.
I have done my due diligence regarding AGNC, now it is time for you to do yours. Should AGNC be in your portfolio? Only you can make that decision.
Here is a link to my past article regarding the mindset needed to invest in AGNC.
Disclosure: The author is long AGNC, MO, KMR, ED.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not recommending anyone buy this stock. Please do your own due diligence to decide what investments meet your individual goals and income needs. I take 100% responsibility for my decisions to buy or sell stocks and for managing my portfolio. I advocate all investors do the same with their investments and portfolio. Each investor's BUY, SELL, or HOLD decision is based on one's risk tolerance, time horizon, and dividend income goals. My personal recommendation may not fit each investor's current investing strategy.