Mortgage REIT American Capital Agency (AGNC) has released preliminary 2012 second quarter numbers and the results were quite surprising. The adjusted net income per share and the very important interest spread income per share for the just-ended quarter show that American earned significantly less on its portfolio during the quarter than in the 2012 first quarter and in the 2011 second quarter.
Here are the projected second quarter income numbers:
- Comprehensive income: $1.50 per share
- Net interest spread income: $0.94 per share
- GAAP income: a loss of $0.90 per share
Comprehensive income includes unrealized gains on owned mortgage securities which are not included in GAAP. Unrealized losses on interest rate hedges are included in comprehensive income and GAAP income. The net interest income is the cash in the bank for the quarter.
For the 2012 first quarter, American Capital Agency reported comprehensive income of $2.44 per share and $1.32 of net interest spread per share. For the second quarter of 2011, comprehensive income was $1.36 per share and net interest income was $1.41 per share. A year ago, the company's portfolio generated a small amount of losses on security values.
The point here is the second quarter interest earnings of 94 cents per share is a big - 29% - drop from what the leveraged MBS portfolio earned just one quarter earlier and one-third lower than net interest earnings of a year ago. American Capital Agency blames the lower interest earnings on lower leverage for the quarter, a higher percentage of interest rate swaps and an increase in prepayment rates.
A recent article here on Seeking Alpha rated American Capital Agency with the most secure dividend using a metric comparing the interest spread earned to the current dividend rate. In the 2012 first quarter, the interest earnings handily covered the dividend. For the second quarter the net interest earnings are going to be woefully short of the dividend paid for the quarter.
Declining mortgage rates and MBS rates have produced security value market price gains for the agency mortgage REITS like American Capital Agency and Annaly Capital Management (NLY). If interest rates stop falling, the gains will stop boosting the quarterly net reported earnings. If interest rates increase, both earnings and the book value will take significant hits as MBS prices decline. Rising mortgage rates trigger the biggest risk of mortgage-backed securities - negative convexity - an extension of effective maturities just when an investor would like to get back principal to reinvest at the new, higher rates.
Conclusions
I was quite surprised by the drop in net income for the second quarter. My belief was the relatively steady interest rate environment and American Capital Agency's portfolio tactics to minimize prepayment rates would result in a very slow net interest earnings compression, not a 30% drop in one quarter. American Capital Agency company has enough earnings reserves to cover the current dividend rate through at least the end of the quarter, so the payout should be safe. Plus, the book value keeps increasing, which should push the share price higher. The problems as far as profits and book value for AGNC will be more apparent near the end of 2012 if this trend continues. As the second quarter results start to roll in, keep an eye on the net interest results of the other mortgage REITS. For investors owning AGNC, hopefully the interest earnings drop for the second quarter will be a one-time blip with a recovery in the third quarter.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
