American Capital Agency Corp. (NASDAQ:AGNC) recently announced the next monthly dividend, still $.20, and provided some insight on their book value. Their transaction to purchase the external manager is expected to close in Q3 of 2016 so no impact on book value yet. When that does close it should lower book value but improve long-term returns for shareholders. The effective improvement in earnings they can expect from the transaction should run around a 14% return on the purchase price. That is materially better than a mortgage REIT can hope to earn in the current environment without finding ways to ramp up leverage to an absurd level and simply hope for the best.
Dividend Sustained for Now, Should Be Sustained for Later
The dividend at $.20 per month comes out to $2.40 per year. That creates about a 10.86% yield off the book value in place at the end of Q1 of 2016. That would be pushing the unsustainable level if AGNC had high operating expenses costs creating a drag on equity, but AGNC ran 1.72% in the first quarter and the costs are expected to drop materially after the purchase of the manager is completed. AGNC is not the first mortgage REIT to internalize management, since Chimera Investment Corporation (NYSE:CIM) bought out their management contract from Annaly Capital Management (NYSE:NLY) previously.
All around AGNC has one of the more durable dividends. It isn't completely immune to being cut but the outlook for them is better than it is for most mortgage REITs.
As of May 31, 2016, AGNC's estimated book value was $22.36. They started the quarter at $22.09, so their total economic return is looking pretty solid. To pay out two dividends of $.40 and raise BV by $.27 is a very solid return so far this quarter. My closest BV estimate to that time was as of 06/03/2016 and my estimate on BV was at $22.11. In a nutshell, they are doing quite well.
That estimate was made when I was doing BV estimations on the fly following a major shock to bond markets, so it contained more rough approximation than most of my measurements. After updating the model with the corrected values for LIBOR swaps, my estimate moved to $22.26.
The following chart demonstrates my estimates of BV as of 06/12/2016.
I haven't made any changes to the underlying value for AGNC reporting a slightly higher value for the end of March than I had in early June. However, my estimates on book value took a material hit with a decline of $.44 during the last two weeks or so. The big issue has been a substantial increase in the hedge losses as the rates on LIBOR swaps fell materially.
The unrealized losses on LIBOR swaps are a bit of a pain but this is still favorable for creating an environment where mortgage REITs can earn a better spread between LIBOR swap rates and the yields on agency MBS. The negative factor is that the yield curve is flattening. Since 06/03/2015 the 10-year treasury yield fell 9 basis points and the 2-year yield fell by 5 basis points. The flattening of that yield curve is problematic but the low rates on LIBOR swaps remains very favorable for the cost of hedging in future periods.
Where Losses Are Created
The big challenge for AGNC currently is that they have some hedges that are pretty far out on the yield curve. Specifically, they have positions with weighted average maturities that are about 14.5 years and 8.2 years. I'm estimating those positions combined so far this quarter to provide a loss of about $103 million. The most severe loss relative to the notional balance of the hedge came from the longest duration swaps.
American Capital Agency Corp. sustained their dividend and reported a fairly solid performance on book value for the end of the fifth month in 2016. Since then, I see some weakness in book value and the largest culprit is the swaps with a very long maturity. Yields fell by more around the 5- to 6-year mark than the 15-year market, but the fair value movement will be larger on the longer swaps simply because of the longer duration.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PREFERRED SHARES OF AGNC over the next 72 hours.
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