I recently developed a model to try to predict the future price of American Capital Agency (AGNC), a widely held mortgage REIT. The basic conclusion at the time was that external events and differences in strategy would have a big effect on the price of AGNC shares going forward.
To be specific:
- An increase in interest rate spread would be favorable.
- An increase in leverage would be favorable, assuming that there was no big disaster in the marketplace that might cause problems.
- There were just a few cases where the expansion strategy of issuing more stock to expand the portfolio would be better than the more conservative strategy of keeping the portfolio stable.
In light of the recent earnings announcement, we can now update the model based on the following information:
- The interest rate spread decreased from 2.31% to 1.65%.
- AGNC's leverage decreased from 8.2% to 7.5%.
- The most recent share offering took place in mid-June and was 32,000,000 shares, for which the company hoped to raise $1.09 billion.
- The dividend remained constant at $1.25 per share.
Here is the model, reflecting the spread remaining constant where it is, at 1.65%. As usual, I will provide the details of my calculations to any of my interested followers who wish to do the calculations on their own or check my work.
Click to enlarge images.
Here is the projected dividend stream:
You can see the whole story in the calculations below:
|Proceeds from Offering||$1,090,000,000|
|Portfolio Increase at 7.5:1||8,175,000,000|
|New Shares Issued||32,000,000|
|Incremental Div Payout/Quarter||40,000,000|
|Incremental Interest Income/Quarter||33,721,875|
As per the company's press release, management hopes to raise $1.09 billion with its 32 million share offering. At the current dividend rate of $1.25 per share, this means that the company is committed to pay an additional $40 million in dividends to get the money.
At the current leverage rate of 7.5:1, AGNC can expand its portfolio by an incremental $8.1 billion. At the current interest rate spread of 1.65% per year, or about 0.4% per quarter, it will only take in $33 million on the incremental portfolio.
So this is the very reason the company recently started to issue preferred stock, at 8%, and I believe this strategy will continue until spreads improve. It can get money at a lower cost, and the incremental portfolio will be profitable.
Here are the calculations:
|Preferred Shares Issued||6,000,000|
|Proceeds from Sale of Preferred||$150,000,000|
|Portfolio Increase at 7.5:1||1,125,000,000|
|Preferred Payment Rate||0.08|
|Incremental Div Payout/Quarter||3,000,000|
|Incremental Interest Income/Quarter||4,640,625|
Keep in mind that per the recent announcement, AGNC has a big cash position -- and non-distributed income -- with which it can maintain the common dividend for a couple of quarters at least. So for the time being, the common stock dividend is likely to remain stable.
What if interest rate spreads decline further?
Keep in mind that the above graphs assume that the marketplace will demand the same yield for AGNC as it is now giving, which is around 14%. But it is possible in a scenario of declining interest rates that traders will be so starved for yield they are willing to pay a premium for AGNC anyway. Up until the last few days, AGNC's price continued to go up despite the shrinking interest rate spread.
Here is the current five-day chart; maybe there is a change in sentiment:
Above all you should keep in mind what we always say, which is that the world is full of chaos and there are no guarantees on anything. Also, remember that sometimes just as soon as you think you have the game figured out, something changes. There is much to think about.