The followers of American Capital Agency (AGNC) and Annaly Capital Management (NLY) may remember that a quarter ago, we looked extensively at these two companies in a series of articles. Ninety days have passed, so quickly, and we were treated recently to some more data points, as both of these companies have announced their quarterly earnings.
For those that wish to follow along, the AGNC earnings announcement is posted here, and the NLY announcement is posted here.
1. Price Performance
We had a long conversation about these two funds in this article, in which I predicted that because of a higher interest rate spread, higher leverage, and more aggressive growth, AGNC would be the better of the two funds. Here are the actual results:
| 90-Day Price Change | 5/2/2012 | 8/2/2012 | Change |
| AGNC | 31.14 | 34.97 | 12% |
| NLY | 16.29 | 17.31 | 6% |
and here is the stock chart:
(click to enlarge)
Here is the current pricing and yield information:
| Price | Dividend | Div Yield | |
| AGNC | 34.97 | 5 | 14.20% |
| NLY | 17.31 | 2.2 | 12.36% |
In a world of less than 1% money market account rates, both of these companies are in focus because of the high yield situation.
Portfolio Growth
| Portfolio Growth | Q2 2012 | Q1 2012 | Ratio |
| AGNC | 77.9 | 80.6 | 0.966501 |
| NLY | 118.5 | 110.2 | 1.075318 |
For the last quarter, NLY was actually the faster growing of the two funds. Note: AGNC announced the offering of an additional 35,000,000 shares on July 17th, and expects proceeds of $1.09B. At 7.5:1 leverage that will ultimately turn into an additional $8.175B in portfolio, approximately, so AGNC will grow approximately 10% in the upcoming quarter.
Value and ROE
| Net Book Value per Common Share | Q2 2012 | Q1 2012 | Ratio |
| AGNC | 29.41 | 29.06 | 1.012044 |
| NLY | 16.72 | 16.43 | 1.017386 |
| Return on Equity | Q2 2012 | Q1 2012 | Ratio |
| AGNC | 21.5 | 33.7 | 0.637982 |
| NLY | 13.56 | 13.34 | 1.016492 |
Both companies added book value at similar rates during the last quarter, and although AGNC still had a much higher Return on Equity, it did not have as good a quarter as it did in Q1.
Interest Rate Spread and Leverage
| Interest Rate Spread | Q2 2012 | Q1 2012 | Ratio |
| AGNC | 1.65 | 2.31 | 0.714286 |
| NLY | 1.54 | 1.71 | 0.900585 |
| Leverage | Q2 2012 | Q1 2012 | Ratio |
| AGNC | 7.5 | 8.2 | 0.914634 |
| NLY | 6 | 5.8 | 1.034483 |
These are pretty key operating factors. Interest rate spread is the net difference between borrowing costs and income, and factors in the success of the companies' hedging program. Of the two, AGNC has the higher interest rate spread, but it also suffered more than the more conservative NLY in an environment of declining mortgage rates.
This was entirely predictable, based on the "discussion of quantitative and qualitative risk" from the previous quarterly report, that we discussed at length in this article, we knew that AGNC would be the more vulnerable to a change in interest rates, and that is exactly what happened. Note that even at these diminished levels, the net borrowing cost for AGNC are still lower than for NLY.
Leverage is a descriptor for the management's risk tolerance at a given time, and historically, AGNC has run its portfolio between 7.5 and 8.0, but for the first quarter, AGNC had leverage of 8.2. Since then, the management has returned to more like their historical leverage rate. The more conservative NLY has maintained their leverage at about 6:1.
Cash Position
| Q2 2012 | Q1 2012 | Ratio | |
| AGNC ($B) | 2,099 | 1,762 | 1.19126 |
| NLY ($B) | 924 | 932 | 0.991416 |
AGNC had a 19% increase in cash position in the second quarter, NLY's cash position remained unchanged. I had to love the following statement from AGNC's management discussion:
strong book value performance and the substantial amount of undistributed taxable income give us significant flexibility with respect to our dividend despite a lower spread environment.
This suggests that at least for awhile, the dividend is safe. Nothing like having a couple of quarters of dividend payments in cash on the books.
Effects of Hedging
| AGNC Q2 | AGNC Q1 | NLY Q2 | NLY Q1 | |
| Net Interest Income | 384 | 408 | 719 | 721 |
| Gain on Sale of Securities | 417 | 216 | 94 | 80 |
| Loss on Derivatives (Net) | -1029 | 47 | ||
| Unrealized Gain on AFS Securities | 689 | -106 | ||
| Unrealized Gain on Derivative Instruments | 52 | 52 | ||
| Net of Income and Hedging | 513 | 617 | ||
| Net Effect of Hedging Program | 129 | 209 | ||
| Unrealized Gains(loss) on Interest Only MBS | -26.1 | 30.9 | ||
| Realized Gain (Loss) on Interest Rate Swaps | -222 | -219 | ||
| Unrealized Gain (Loss) on Interest Rate Swaps | -611 | 341 | ||
| Net of Income and Hedging | -46 | 954 | ||
| Net Effect of Hedging Program | -765 | 233 | ||
If you net out all of the realized and unrealized gains on securities sales and/or derivative activity, AGNC once again did much better than NLY during the last quarter. For both companies, there were issues, due no doubt to the decline in interest rates. Note the $1B-plus negative swing in derivatives for AGNC and the similarly sized net negative swing in interest rate swaps for NLY.
Additional Financing
Both AGNC and NLY have turned to alternate methods of financing to raise money at a lower cost than issuance of stock. In the case of AGNC, it was the issuance of preferred stock, and in the case of NLY, it was issuance of preferred stock as well as convertible senior notes. From the point of view of the investor, since both noteholders and preferred shareholders have precedence over the common shareholders, it represents a higher degree of security. The tradeoff is that the returns are lower. AGNC's preferred stock pays 8%, NLY's preferred stock pays 7.625% and the notes pay 5%.
So, what to make of all of this?
Both of these companies are making adjustments for the current low interest rate environment. AGNC reduced leverage and temporarily got more conservative on portfolio growth. NLY maintained its conservative approach. Of the two, because of the more successful hedging situation, AGNC did better, as reflected in the stock price, and I would anticipate that it will continue to do better for the next quarter because of their resumed expansion and higher interest rate spread.
The piece of information we are lacking at the moment, pending the release of the 10Q, is whether AGNC has modified its hedging program to anticipate an even further decrease in interest rates, or whether they will maintain their current strategy. We will have to look into that later.
Both of these companies are looking for cheaper ways to raise money. The question in the back of everyone's mind should be: do the investors in these lower-paying instruments know something that the rest of us don't, as it applies to the interest rate environment going forward? We can conjecture on that later.
The world is chaotic, and there are no guarantees on anything. There is much to think about.
