American Capital Agency: An Opportunity Or More Dividend Cuts Ahead?

| About: AGNC Investment (AGNC)

After the bell Monday, mREIT American Capital Agency Corp (NASDAQ:AGNC) announced results for the fourth quarter of 2011. The key things shareholders should takeaway from the press release are:

  • Book value increased $0.81 quarter over quarter to $27.71, and increased 14% for the year,
  • American Capital Agency had an estimated $0.80 in undistributed taxable income per share at the end of the quarter,

  • Constant Prepayment Risk (CPR) was 9% for Q4, and CPR for January 2012 was 8%,

  • Average net interest rate spread for the quarter was 1.90%, down 0.24% from Q3, and the net interest rate spread as of December 31, 2011 was 1.94%,

  • Declared a Q1 2012 dividend of $1.25 per share, payable 4/27/2012, with a record date of 3/7/2012 and an ex-dividend date of 3/5/2012

The increasing book value per share is the obvious positive of the news release, and is even more important this quarter due to some of the other less positive things in the news release. With shares trading around $29 as of this writing, American Capital Agency currently trades for 1.04x book value. Compare that to Annaly Capital Management (NYSE:NLY) which is currently trading for 1.04x its most recently reported Q3 book value. Annaly should be out with its earning release this month, which will allow for a better comparison.

The next two bullets will be important for investors to monitor going forward. Undistributed taxable income per share was at $0.80 at the end of the year, down a nickel quarter over quarter, but up $0.20 year over year. That's not a huge decline for the quarter, but either way I'd rather see this number increasing than decreasing. Hopefully the quarterly decrease is a one time event, but it will be worth keeping an eye on. The increase in the CPR could have been worse, and hopefully the 8% rate seen in January means that CPR rates will remain under 9% going forward. Any spike in the CPR would be awful for this company, so this is a very important metric to monitor.

The last two bullets are what give me cause for concern. The interest rate spread is the lowest for a quarter since Q4 2008, and was pressured by both decreasing average asset yield and increasing average cost of funds. The prospects of prolonged compressed interest rate spreads was likely the main factor that caused management to reduce the divided to $1.25 for Q1 2012, marking the first time the dividend will be below $1.40 since the Q1 2009 dividend of $0.85.

Assuming that the $1.25 per quarter dividend is maintained throughout the 2012 fiscal year, American Capital Agency still yields a whopping 17.2%, even after the 10.7% dividend reduction. That's a higher yield than competitors Annaly (13.3%), Hatteras Financial (NYSE:HTS) (12.9%), or CYS Investments (NYSE:CYS) (14.8%). A rising book value should help protect investors from a large decline in the shares, and an opportunity to pick up shares below book value would be a gift. However, investors will need to keep an eye on the CPR, undistributed taxable income, and the net interest rate spread going forward. If these metrics continue to deteriorate, the dividend could be on the chopping block again.

Disclosure: I am long AGNC.