American Capital Agency's Q1 2016 And 4/22/2016 Book Value Projection

| About: AGNC Investment (AGNC)

Summary

I am projecting AGNC will report a minor (less than 5%) decrease in quarterly BV and generate a minor economic return for the first quarter of 2016.

The projected minor decrease in quarterly BV is mainly due to a material derivative net valuation loss offset by modest – material price increases in most fixed-rate agency MBS coupons.

My projections for AGNC’s book value per common share as of 3/31/2016 and 4/22/2016 are stated in the “Conclusions Drawn” section of the article.

My projection for MTGE’s and NLY’s book value per common share as of 3/31/2016 is stated just above the “Conclusions Drawn” section of the article.

My buy, sell, or hold recommendation for AGNC, MTGE, and NLY is stated in the “Conclusions Drawn” section of the article.

Focus of Article:

The focus of this article is to provide a detailed projection of American Capital Agency Corp.'s (NASDAQ:AGNC) book value ("BV") per common share as of 3/31/2016. Prior to results being provided to the public on 4/25/2016 (via the company's quarterly press release), I would like to analyze AGNC's BV as of 3/31/2016 and provide readers a general direction on how I believe this recent quarter has panned out. A previous three-part article I wrote laid the ground work for this BV projection. In that article, I projected/analyzed AGNC's income statement (technically speaking, the company's "consolidated statement of comprehensive income") for the first quarter of 2016. The links to that three-part projection article are provided below:

American Capital Agency's Q1 2016 Income Statement And Earnings Projection - Part 1

American Capital Agency's Q1 2016 Income Statement And Earnings Projection - Part 2

American Capital Agency's Q1 2016 Income Statement And Earnings Projection - Part 3

By understanding the trends that occurred within AGNC's operations during the first quarter of 2016, one can apply this information to sector peers as well. As such, the discussion/analysis below is not solely applicable to AGNC but to the fixed-rate agency mortgage real estate investment trust (mREIT) sector as a whole. This includes, but is not limited to, the following fixed-rate agency mREIT peers: 1) ARMOUR Residential REIT Inc. (NYSE:ARR), 2) CYS Investments Inc. (NYSE:CYS), 3) Annaly Capital Management Inc. (NYSE:NLY), and 4) Orchid Island Capital Inc. (NYSE:ORC).

This article will also include a brief BV discussion regarding AGNC's affiliate American Capital Mortgage Investment Corp. (NASDAQ:MTGE) and the company's sector peer NLY. This includes a BV projection as of 3/31/2016 for both companies.

Overview of AGNC's Projected BV as of 3/31/2016:

Due to the fact that several figures needed to project/calculate AGNC's BV as of 3/31/2016 come directly from the company's consolidated statements of comprehensive income, Table 1 is provided below. Table 1 shows AGNC's consolidated statements of comprehensive income from a three-month ended time frame. Using Table 1 below as a reference, one must add certain account figures from the first quarter of 2016 for purposes of projecting a suitable BV as of 3/31/2016.

Table 1 - AGNC Three-Month Ended Consolidated Statements of Comprehensive Income

Click to enlarge

Click to enlarge

(Source: Table created entirely by myself, partially using data obtained from AGNC's quarterly investor presentation slides)

Having provided Table 1 above (in particular AGNC's "Q1 March 31, 2016 [ESTIMATE]" column), we can now begin to calculate AGNC's projected BV as of 3/31/2016. This projection will be calculated in Table 2 below.

There will not be an identical sheet AGNC provides that matches the data I have prepared in Table 2. I have gathered specific information derived from multiple tables/charts for a more detailed analysis of AGNC's BV as of 3/31/2016. AGNC, through the company's quarterly investor presentation slides (see link above), only provides the public with a "Book Value Roll Forward" slide. This roll forward slide uses information based only on a quarterly time frame. Therefore, I perform a more detailed quarterly BV calculation/analysis.

Table 2 - AGNC Three-Month Ended BV Projection (BV as of 3/31/2016)

Click to enlarge

Click to enlarge

(Source: Table created entirely by myself, including all calculated figures and projected valuations)

Using Table 2 above as a reference, let us take a look at the calculation for AGNC's projected BV as of 3/31/2016. Unless otherwise noted, all figures below are for the "three-month ended" time frame. Let us look at the following figures (in corresponding order to the " Ref." column shown in Table 2 next to the March 31, 2016 column):

A) Operations

B) Other Comprehensive Income (Loss) (OCI/(OCL))

C) Stockholder Transactions

D) Capital Share Transactions

A) Operations:

- Decrease in Net Common Equity From Operations Estimate of ($717) Million; Range ($967)-($467) Million.

- Confidence Within Range = Moderate to High.

- See Red Reference "A" in Table 2 Above Next to the March 31, 2016 Column.

This "net increase (decrease) in net common equity from operations" figure consists of the following amounts that come directly from AGNC's consolidated statement of comprehensive income (see Tables 1 and 2 above): 1) net interest income, 2) total other income (loss), 3) total expenses, and 4) excise tax.

Due to the fact I discussed these amounts in my previous three-part AGNC consolidated statement of comprehensive income projection article (see links near the top of this article), further discussion of this figure is redundant/unwarranted.

B) Other Comprehensive Income (Loss) (OCI/(OCL)):

- Increase in Net Common Equity From Other Comprehensive Income (OCI) Estimate of $780 Million; Range $530 Million - $1.030 Billion.

- Confidence Within Range = Moderate to High.

- See Red Reference "B" in Table 2 Above Next to the March 31, 2016 Column.

This "net increase (decrease) in net common equity from OCI/(OCL)" figure consists of the following accounts that come directly from AGNC's consolidated statement of comprehensive income (see Tables 1 and 2 above): 1) unrealized gain (loss) on available-for-sale ("AFS") securities, net; and 2) unrealized gain (loss) on derivative instruments, net (upon reclassification to interest expense).

Due to the fact I also discussed these accounts in my previous three-part AGNC consolidated statement of comprehensive income article (see links near the top of this article), further discussion of this figure is redundant/unwarranted as well.

C) Stockholder Transactions:

- Decrease in Net Common Equity From Stockholder Transactions Estimate of ($207.8) Million; Range ($217.8) - ($197.8) Million.

- Confidence Within Range = High.

- See Red Reference "C" in Table 2 Above Next to the March 31, 2016 Column.

This "net increase (decrease) in net common equity from stockholder transactions" figure is AGNC's dividend distributions for the first quarter of 2016. This figure includes the following types of outstanding shares of stock: 1) common, and 2) preferred.

1) Common Stock:

a) First Quarter of 2016:

Prior to projecting AGNC's common stock dividend distributions for the first quarter of 2016, let us first discuss how the number of the company's outstanding shares of common stock could change during any given quarter. AGNC has three programs, which could affect the number of outstanding shares of common stock when monthly dividends are declared.

AGNC's "at-the-market offering program" enables the company to publicly offer and sell a certain aggregate number of shares of common stock in privately negotiated transactions pursuant to the sales agreement with Mitsubishi UFJ Securities. AGNC has not exercised the company's right to use this offering program for over three years. I am assuming no additional shares were issued under the company's at-the-market offering program during the first quarter of 2016.

AGNC also has a "dividend reinvestment and direct stock purchase program." This plan allows AGNC's shareholders to acquire additional shares of common stock by reinvesting some or all of the cash dividends received. AGNC's shareholders may also make optional cash purchases of the company's common stock subject to certain limitations detailed in the plan's prospectus. The last time activity occurred within this program was the first quarter of 2011. Furthermore, whenever AGNC's stock price trades at a discount to BV, the probability of any activity within this program is very low (would be dilutive to BV). As was the case with AGNC's at-the-market offering program, I am making the assumption there was no activity in regards to this plan during the first quarter of 2016.

The third program that could affect the number of outstanding shares of common stock is AGNC's "stock repurchase program." This program, which was created in October 2012, originally allowed AGNC to repurchase up to $500 million of the company's outstanding shares of common stock through 12/31/2013. In September 2013, the authorized amount was increased to $1 billion and was extended through 12/31/2014. In January 2014, this program was amended once again to allow AGNC to repurchase up to $2 billion of the company's outstanding shares of common stock through 12/31/2014.

In October 2014, it was announced AGNC's stock repurchase program was extended until 12/31/2015. In October 2015, it was announced AGNC's stock repurchase program was extended until 12/31/2016. As of 12/31/2015, AGNC had $707 million remaining under the company's stock repurchase program. AGNC intends to buy back outstanding shares of common stock only when the repurchase price is materially accretive to BV. Since this variable was met throughout the first quarter of 2016, I believe management wanted to continue to take advantage of this accretive effect and repurchased some outstanding shares of common stock.

When taking all of the assumptions above into consideration, I am projecting the number of outstanding shares of common stock as of 1/27/2016, 2/25/2016, and 3/29/2016 (ex-dividend dates) was 337.5, 337.5, and 330.0 million, respectively. The dividend distributions declared to common shareholders for the first quarter of 2016 totaled $0.60 per share. This was an unchanged dividend when compared to the fourth quarter of 2015.

When calculated, I am projecting AGNC's dividend distributions to common shareholders were ($201.0) million for the first quarter of 2016 and for the three months ended 3/31/2016. Now let us project AGNC's preferred stock dividend distributions.

2) Preferred Stock:

a) First Quarter of 2016:

The dividend declared on AGNC's "Series A Preferred Stock" (AGNCP) for the first quarter of 2016 was $0.50 per share. This was an unchanged dividend when compared to the prior quarter. There were still 6.9 million outstanding shares of Series A Preferred Stock as of 3/30/2016 (ex-dividend date). When calculated, I am projecting AGNC had dividend distributions to Series A Preferred Stock shareholders of ($3.5) million for the first quarter of 2016.

The dividend declared on AGNC's "Series B Preferred Stock" (AGNCB) for the first quarter of 2016 was $0.484375 per depositary share. This was an unchanged dividend when compared to the prior quarter as well. There were still 7.0 million outstanding shares of Series B Preferred Stock as of 3/30/2016 (ex-dividend date). When calculated, I am projecting AGNC had dividend distributions to Series B Preferred Stock shareholders of ($3.4) million for the first quarter of 2016.

Therefore, I am projecting AGNC's dividend distributions to Series A and B Preferred Stock shareholders were ($6.8) million (rounded) for the first quarter of 2016 and for the three-months ended 3/31/2016.

After combining the common and preferred stock dividend distributions for the first quarter of 2016, I am projecting AGNC's total "distributions to stockholders from estimated REIT taxable income/undistributed taxable income ("UTI")" and decrease in net common equity from stockholder transactions was ($207.8) million for the three months ended 3/31/2016 (see red reference "C" in Table 2 above).

D) Capital Share Transactions:

- Decrease in Net Common Equity From Capital Share Transactions Estimate of ($135) Million; Range ($270) Million-$0 Million.

- Confidence Within Range = Moderate to High.

- See Red Reference "D" in Table 2 Above Next to the March 31, 2016 Column.

As stated earlier, I am making the assumption no additional shares of common stock were issued under AGNC's at-the-market offering, dividend reinvestment, or direct stock purchase programs during the first quarter of 2016. Also, since there were no additional common or preferred stock equity offerings during the first quarter of 2016, the following figures should have no activity: 1) "issuance of common stock," 2) "issuance of restricted stock," 3) "issuance of common stock under stock-based compensation program," 4) "issuance of preferred stock," and 5) "preferred stock $25,000 per share liquidation preference."

Regarding AGNC's "repurchases of common stock" figure, I am making the assumption AGNC repurchased 7.5 million outstanding shares of common stock under the company's stock repurchase program during the first quarter of 2016. It should be noted this is a fairly cautious projection. I believe management wanted to take advantage of the company's stock trading at a (15%)-(25%) discount to my projected CURRENT BV (calculated weekly) throughout the quarter. Therefore, I am projecting AGNC had a decrease in "net common equity from capital share transactions" of ($135) million for the three-months ended 3/31/2016 (see red reference "D" in Table 2 above).

Side Note: As of 12/31/2015, AGNC (in conjunction with the company's affiliate American Capital Mortgage Management LLC ("ACMM")) owned 4.7 million shares of CYS (3.07% of CYS's outstanding shares of common stock as of 12/31/2015). These shares were valued at $33.2 million as of 12/31/2015. During 2015, AGNC sold all of the company's shares in Hatteras Financial Corp. (NYSE:HTS).

Brief Discussion of MTGE's Projected BV as of 3/31/2016:

When compared to AGNC, I am projecting MTGE had a fairly similar BV per share fluctuation (percentage wise) for the first quarter of 2016. Each company's agency MBS and derivatives portfolios as of 12/31/2015 had several differences, which were discussed in my three-part AGNC income statement projection article (see links near the top of this article). When combined, these differences should basically "offset" each other. MTGE also had a sizable non-agency MBS portfolio whereas AGNC did not (only an extremely small non-agency balance). MTGE had a total non-agency MBS portfolio of $1.480 billion as of 9/30/2015.

This balance increased by $78 million to $1.558 billion as of 12/31/2015. When compared to MTGE's agency MBS portfolio of $3.217 billion, management increased the proportional share of the company's non-agency MBS portfolio by 4% during the fourth quarter of 2015. Due to the flat to slight depreciation in real estate prices, the continued relatively minor net change in mortgage delinquencies and foreclosures, and the heightened volatility in credit markets (which typically impact non-agency MBS valuations), I believe most non-agency MBS slightly - modestly underperformed most fixed-rate agency MBS coupons during the first quarter of 2016.

In addition, one facet of MTGE's results that continues to be a disappointment is the company's operations surrounding its acquired mortgage servicer, Residential Credit Solutions ("RCS"). RCS generated a net servicing loss of ($5.0) million during the fourth quarter of 2015. This was the ninth consecutive quarterly loss for this mortgage servicing rights ("MSR") company.

Since acquiring RCS, MTGE has reported a cumulative net servicing loss of ($36.7) million. When calculated, MTGE's MSR has accounted for a cumulative net decrease in BV of approximately ($1.12) per share since its acquisition (based on the weighted average outstanding shares of common stock for the fourth quarter of 2015). In my opinion, it appears management knows RCS is performing materially below expectations.

In fact, management provided a "strategic" update regarding RCS. A majority of RCS's assets and operations were recently sold to Ditech Financial, LLC (Ditech). This included the transition of most of RCS's employees and subservicing agreements. Simply put, it would appear MTGE was never fully "comfortable" branching out into this specialized business/sector. In addition, the implied "synergies" from acquiring RCS never fully materialized.

Since I was "skeptical" when MTGE first announced this MSR acquisition, I like the recent strategy management executed in regards to the sale. If a particular company/sector is challenging, I believe it is better to "cut one's losses" and focus management's attention back to MTGE's core strengths. Even with the recently announced sale/transition, MTGE has projected a net servicing loss of ($7) - ($9) million for RCS during the first quarter of 2016 with an additional minor loss over the second - fourth quarters of 2016.

However, it should also be noted MTGE repurchased outstanding shares of common stock during the first quarter of 2016. When MTGE declared its first quarter of 2016 dividend of $0.40 per share (unchanged when compared to the prior quarter), management also stated the company repurchased 2.0 million outstanding shares of common stock during the quarter at a weighted average price that was a material discount to BV. As such, this strategy will have an accretive effect on BV during the first quarter of 2016.

When taking all quarterly activities into consideration (including additional data not discussed within this specific article), I am projecting MTGE will report the following BV per common share as of 3/31/2016:

MTGE's Projected BV as of 3/31/2016 = $19.25 Per Common Share (Range $18.75-$19.75 Per Common Share)

Brief Discussion of NLY's Projected BV as of 3/31/2016:

When compared to AGNC, I am projecting NLY had a less severe BV per share decrease (percentage wise) for the first quarter of 2016. As was highlighted in my three-part AGNC income statement projection article (see links near the top of this article), I discussed certain subtle differences in each company's agency MBS portfolio.

Furthermore, each company had a different strategy regarding derivative instruments going into the first quarter of 2016. AGNC and NLY had a material difference in each company's hedging coverage ratio as of 12/31/2015. AGNC had a hedging coverage ratio of 87% as of 12/31/2015. In sharp contrast, NLY had a hedging coverage ratio of only 53% as of 12/31/2015. As such, NLY was more vulnerable if mortgage interest rates/U.S. Treasury yields modestly - materially increased during the first quarter of 2016. However, this specific scenario did not occur.

In fact, basically the opposite occurred as mortgage interest rates/U.S. Treasury yields across basically the entire yield curve sharply decreased. As such, NLY's lower hedging coverage ratio at the start of the first quarter of 2016 was an advantage for the company regarding a less severe total net valuation loss within the company's derivatives portfolio. Partially offsetting this factor was NLY had a minor net (short) position in Eurodollar future contracts, which underperformed when compared to interest rate payer swaps. However, to put things in better perspective, NLY's ratio of interest rate payer swaps to net (short) Eurodollar future contracts was approximately 4.3:1 as of 12/31/2015.

When taking all quarterly activities into consideration (including additional data not discussed within this specific article), I am projecting NLY will report the following BV per common share as of 3/31/2016:

NLY's Projected BV as of 3/31/2016 = $11.65 Per Common Share (Range $11.25-$12.05 Per Common Share).

Conclusions Drawn:

To sum up all the information discussed above, I am projecting AGNC will report the following BV per common share as of 3/31/2016:

AGNC's Projected BV as of 3/31/2016 = $22.25 Per Common Share (Range $21.75-$22.75 Per Common Share)

This projection is a ($0.34) per common share decrease from AGNC's BV as of 12/31/2015. This minor (less than 5%) decrease can be attributed to two factors.

The first factor is in relation to the activity within AGNC's consolidated statement of comprehensive income. I am projecting AGNC reports a net loss of ($717) million for the first quarter of 2016 while reporting OCI of $780 million. When both figures are combined, I am projecting AGNC reports comprehensive income of $63 million for the first quarter of 2016.

The second factor is in relation to the activity within AGNC's equity section of the balance sheet. AGNC had paid for/accrued quarterly dividend distributions of ($0.60) per common share during the first quarter of 2016. In addition, I am projecting AGNC repurchased 7.5 million outstanding shares of common stock during the first quarter of 2016. These projected repurchases calculate to minor BV accretion.

When combined, these two factors account for a projected quarterly BV decrease of ($0.34) per common share. When calculated, I am projecting AGNC's BV per common share had a minor decrease of (1.50%) during the first quarter of 2016. However, I am also projecting AGNC generated an "economic return" (dividends paid/accrued for and net change in BV) of 1.19% for the first quarter of 2016.

I believe AGNC's results will be disappointing for some readers who anticipated a "strong" quarter. However, due to the volatile nature of market rates in general and the continued unattractive correlation between MBS prices and derivative instrument valuations during the first quarter of 2016 ("option adjusted spreads"; OAS), I believe most mREIT peers will either report a decrease or "flat" quarterly earnings (several exceptions apply). This unfavorable correlation between MBS prices and derivative instrument valuations is always a possibility in the mREIT sector and is termed "spread/basis risk." While companies can take steps to minimize spread/basis risk, a company can never completely "mitigate" this risk.

I believe four key factors to analyze within the fixed-rate agency mREIT sector this quarter are the following: 1) each company's proportion of 15-year MBS holdings versus 30-year MBS holdings, 2) each company's hedging coverage ratio, 3) each company's proportion of long-term derivative instruments versus short-term derivative instruments, and 4) each company's proportion of specified pools (for instance HARP and LLB securities). Dependent upon these factors, I believe results will vary across the fixed-rate agency mREIT sector for the first quarter of 2016.

Fairly recently, I provided readers the following article, which compared various metrics (including some of the key factors listed above) which directly impact a company's quarterly BV fluctuation:

Annaly Capital's BV, Dividend, And Valuation Compared To 17 mREIT Peers (Post Q4 2015 Earnings) - Part 1

I am projecting AGNC's results will be near the fixed-rate agency mREIT average regarding BV fluctuations for the first quarter of 2016. I believe NLY will outperform most (if not all) fixed-rate agency mREIT peers while ARR and ORC will underperform its peers.

Looking ahead to the second quarter of 2016, mortgage interest rates/U.S. Treasury yields have slightly - modestly net increased (through 4/22/2016) when compared to what occurred during the first quarter of 2016. The fixed-pay rate on interest rate swaps, U.S. Treasury yields, and MBS prices across most coupons have had minor - modest cumulative net fluctuations through 4/22/2016 (when compared to 3/31/2016).

Through a detailed analysis that will be omitted from this particular article, I am projecting AGNC's BV as of 4/22/2016 has fluctuated ($0.10) - $0.10 per common share when compared to the company's BV as of 3/31/2016. This projection excludes the April 2016 monthly dividend of $0.20 per common share (ex-dividend is 4/27/2016).

My BUY, SELL, or HOLD Recommendation:

From the analysis provided above, including additional factors not discussed within this article, I currently rate AGNC and NLY as a SELL when I believe the company's stock price is trading at less than a material (10%) discount to my projected BV as of 3/31/2016, a HOLD when trading at or greater than a (10%) but less than a (20%) discount to my projected BV as of 3/31/2016, and a BUY when trading at or greater than a (20%) discount to my projected BV as of 3/31/2016.

Therefore, I currently rate AGNC and NLY as a HOLD since both stocks are trading at or greater than a (10%) but less than a (20%) discount to each company's projected BV as of 3/31/2016. My current price target for AGNC and NLY is approximately $20.00 and $10.50 per share, respectively. This is currently the price where my HOLD recommendation would change to a SELL.

I currently rate MTGE as a SELL when I believe the company's stock price is trading at less than a (15%) discount to my projected BV as of 3/31/2016, a HOLD when trading at or greater than a (15%) but less than a (25%) discount to my projected BV as of 3/31/2016, and a BUY when trading at or greater than a (25%) discount to my projected BV as of 3/31/2016.

Therefore, I currently rate MTGE as a HOLD since the stock is trading at or greater than a (15%) but less than a (25%) discount to my projected BV as of 3/31/2016. My current price target for MTGE is approximately $16.35 per share. This is currently the price where my HOLD recommendation would change to a SELL.

This recommendation considers the following mREIT factors: 1) projected future MBS price movements, 2) projected future derivative valuations, and 3) projected near-term dividend per share rates. This recommendation also considers the recent lowered probability of several Fed Funds Rate increases by the FOMC during 2016 due to recent macroeconomic trends/events.

Final Note: Each investor's BUY, SELL, or HOLD decision is based on one's risk tolerance, time horizon, and dividend income goals. My personal recommendation will not fit each reader's current investing strategy. Within the past 120 days, I have not directly increased or decreased my AGNC or MTGE position (only through reinvested dividends).

On 11/27/2015, I initiated a position in AGNC's Series B Preferred Stock, which trades under the symbol "AGNCB." Subsequent to 11/27/2015, I have selectively increased my position in AGNCB. When combined, my current AGNCB position has a weighted average price of $23.215 per share. This weighted average per share price excludes all dividends received/reinvested. I currently hold 0.71% of the outstanding shares of AGNC's Series B Preferred Stock. Each AGNCB trade was disclosed to readers in "real time" (that day) via the "StockTalks" feature of Seeking Alpha.

Disclosure: I am/we are long AGNC, MTGE.

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: I currently have no position in ARR, CYS, HTS, NLY, or ORC.