How Does A Predictable 4th Quarter Lead To A 3% Rally For American Capital Agency?

| About: AGNC Investment (AGNC)

Summary

AGNC declared BV/share of $22.59, within one cent of estimates by two SA authors.

Net spread and dollar roll income came in below the dividend and below analyst estimates.

Share buybacks were a positive factor for the company.

The earnings call was fairly long, but I’ve highlighted the starting points for the most interesting prepared comments.

American Capital Agency Corp. (NASDAQ:AGNC) had a predictable quarter in Q4 2015. While it may not have been predictable in advance, it was predictable by analysts before the company reported. If you've been following AGNC going into the earnings release, you may have seen the projections by Scott Kennedy and my own set of projections. In short, Scott called for BV/Share of $22.60 and I called for $22.58. We ended up with a tie since AGNC reported BV/Share of $22.59. All around, there weren't a great deal of surprises for people very closely following the portfolio.

For reference on projections, if an analyst is within 2% on BV/Share they usually did a decent job. Within 1% is excellent and usually indicates that the company did not actively trade positions. Active management of positions limits the ability of analyst to effectively model the results.

If you haven't seen the company's corrected press release, you can view the source. The first press release had some short comings in the way data was formatted.

The earnings presentation opens as a PDF file. You can use this link to access the page directly linking the presentation.

The Bad

AGNC came in with "net spread and dollar roll income" of $.54 per share. The consensus forecast was calling for $.57. However, AGNC came to their values while excluding the impact of a catch up premium amortization benefit of $.04 per share. Since those words may confuse most investors, it is worth discussing it a bit.

A "catch up premium amortization" event can be either a charge or a benefit. If you prefer, you could simply say it can have either a negative or positive value. In this case AGNC is stating that their estimates for amortization charges at the end of the third quarter were a little too high and they are reversing that impact. Why were they too high? At the end of the third quarter interest rates were fairly low and expected prepayments were exceptionally high. During the fourth quarter interest rates were rising and the prepayment expectations were weakening. It is perfectly normal for mREITs to have some level of catch up premium amortization charge or benefit if they attempt to predict prepayments and charge accordingly. Some mREITs report it more clearly than others, but most have it. There are a few mREITs that don't get into the business of including these projections in their accounting. Those mREITs simply amortize premiums as the prepayments are received (rather than projected). Either accounting method is fine.

If you're familiar with Annaly Capital Management (NYSE:NLY), they recently started reporting normalized Core EPS to get around the challenge of premium catch up amortization charges. I found that treatment to be solid and I'm happy with the way AGNC provides this material as well.

The Good

AGNC repurchased 9 million shares for $161 million during the quarter. This represents 2.6% of the common stock that was outstanding at the end of the third quarter. This is great news for shareholders and boosts the book value per share. Ironically, if I had the total for shares repurchased, it would've pushed my estimate for BV/Share a little too high and there wouldn't have been a tie. I was under by one cent, but I would've been over by a few. That would be a tie breaker in Scott's favor. My most recent estimate of book value is as of January 26th and projected the BV on that date to be $22.35. Since then shares went ex-dividend, which would lower the results by 20 cents. By looking at the movements in MBS prices since then, I believe book value should be up slightly. So essentially book value as of February 2nd should be around:

$22.35 - $.20 dividend + $.10 very rough ball park unrealized gain +$.04 net spread and dollar roll income = $22.31.

Captive Insurer

The FHFA (Federal Housing Finance Agency) released a ruling that will prohibit their captive insurer from accessing member financing through the Federal Home Loan Bank of Des Moines. If you're interested, I provided analysis on the FHFA Ruling.

Earnings Call

If you're holding AGNC or simply interested in mREITs and have some time to do some reading, check out the earnings call transcript. The transcript is fairly long, so allow me to provide some suggestions for how I go through transcripts faster.

The prepared comments, made before questions, are usually fairly standard for mREITs. There is rarely a great deal of insight there. If you've read over the corrected press release, you should know most of what is discussed in the prepared comments. To help readers get through the prepared comments faster, I put together a little guide to which sections I felt were most worthwhile for reading.

If you want to skim through the prepared comments, hit ctrl+F and search for the following sentence:

"There has been a lot of discussion recently about the repo market in response to new regulatory requirements." This sentence marks the beginning of an interesting few paragraphs regarding the funding sources and rates for mREITs using repo agreements to finance agency MBS.

If you have enough time, Gary Kain's comments following that section include some interesting macroeconomic analysis. The rest of this section will relate to Gary Kain's comments. The interesting part starts with the sentence:

"Now, I want to discuss our take on the global economic landscape."

He goes on to state that in the current situation repurchasing shares is an attractive use of capital. The discount to book value at the end of trading on February 2nd is about 23% using their end of quarter numbers or 22% using my estimations of current book value.

Finally, at the end of the prepared comments he states:

"My guess is that one of you may ask me a related question along the lines of would AGNC be willing to buy other REIT stocks like it did in the past? The answer is a qualified yes. It is a consideration, but it has a materially higher hurdle than share repurchases and a number of conditions would need to be met.

First, we would need to be repurchasing as much of our own stock as possible, given SEC volume constraints and window period limitations. Additionally, we have no intentions of purchasing the shares of any other company that is not actively involved in repurchasing its own shares. The equation right now is just too compelling and the accretion too material for an investor-focused management team to ignore."

I agree with AGNC's stance that it probably makes sense to max out their ability to buyback their own shares first. However, if AGNC moved to trade at 10% discount to book value while other mREITs were trading at a 40% discount to book value, I wouldn't see any problem with AGNC buying up shares. The problem is that they are limited in how vocal they can be in advocating buybacks since they are unlikely to be thrilled about the concept of buybacks themselves since buybacks reduce compensation paid to the external manager. This is problem inherent to most mREITs due to the nature of external management agreements.

The Q&A session gets interesting, but is also long enough to be a short book.

Conclusion

American Capital Agency Corp. had a quarter that was right in line with forecasts from Seeking Alpha authors. Despite the performance being in line with projections, the result was shares rising by about 3.1% on the day. The income figures may be legitimately concerning to investors that are worried about the sustainability of the dividend, which is $.20 per month ($.60 per quarter). Clearly the $.54 won't cover it. However, management's comments also indicated more belief in a scenario of "lower for longer" which makes it sound like they may be open to running the portfolio more aggressively. That exposes the portfolio to more fluctuations in value, but it also allows a stronger level of net interest income.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.