Premium To Book Value Encourages Secondary Offering At American Capital Agency

| About: AGNC Investment (AGNC)

After the bell Tuesday, American Capital Agency Corp (AGNC) put out two news releases, one announcing preliminary Q2 numbers, and the other, announcing a large public offering of additional stock. A look at the two releases paints a picture of management taking advantage of a strong stock price, although the overall business of American Capital may be beginning to face some headwinds.

First, the good news. AGNC is predicting that when everything is finally determined, the book value will have increased just under 1% from the first quarter, to $29.35 per share. Undistributed taxable income will be approximately $1.55 per share, up from $1.28 at the end of Q1 2012.

However, the bad news is that net spread income decreased to approximately $0.94 per share, from $1.30 per share in Q1 (excluding approximately $0.12 per share of premium amortization benefit due to change in projected constant prepayment rate ("CPR") estimate). Comprehensive income is projected to be $1.50, down from $2.44 in the first quarter. AGNC's lifetime constant prepayment rate increased from 9% to 12% at the end of the quarter.

The press release discusses the fall in interest rates causing the increase in book value as mortgage backed securities increase in price, but that also cuts the other way as the value of the hedges the company has decline. Also, the decline in interest rates has lead the company to anticipate faster prepayment speeds. Leverage also declined from 8.2% to 7.5%.

The secondary offering, annouced originally at 32 million shares with an over-allotment option of another 4.8 million, will likely be upsized, as has been true of the last several offerings by AGNC. Shares are down 2% to $34.58 after hours, down from the $35.29 close, which was a 52 week closing high.

All in all, I think the stock is ahead of itself, in terms of both the risk to the profitability of the mREITs based on the flattening of the yield curve, and more importantly based on the fact that it closed today a full $6 above the Q1 book value, roughly 20% higher. Even with shares down 2% after hours, shares are still $5.23, or 17.8% above the Q2 book value. It could be argued that given the strong performance of this management team, that AGNC does deserve to trade at a premium to book, and I do not disagree with that notion. However, the flat yield curve, and decrease in the net spread income are both troubling, and I do not thing that risk is reflected in the shares. A continued flattening of the yield curve, or further increasing prepayments, will have an impact on how much money AGNC can make. Management is making a prudent decision in selling shares here, given the premium to book value, but I have to believe that the money will go into lower yielding MBS, which is less than thrilling.

American Capital Agency Corp has been a winner since its IPO, and long time followers of the company know that every single secondary offering has been an opportunity, going back nearly 4 years. However, given the clouds on the horizon for the macro-environment, and the large premium that AGNC is still trading at to book value, I'm sitting this secondary out. I continue to re-invest my dividends in the name, since a 14% yield is worth the risk, but investors should keep an eye on the yield curve.

Disclosure: I am long AGNC.