American Capital Agency (AGNC) is one of the large cap mortgage REITs that operate in the U.S. It offers elevated returns, primarily in the form of dividends. In a scenario where the 10-year treasury is offering 1.64%, the stock currently offers one of the highest dividend yields of 14.3%. Where most of the mortgages REITs have been forced to cut their dividends, American Capital Agency maintained its shareholder distribution, and recently announced $1.25 per common share as the quarterly cash dividend for the third quarter of the current year. The remainder of the investment thesis aims to check the stock's dividend sustainability. We believe the company will be able to sustain its unmatched dividend yield in the coming quarter.
On September 11, 2012, American Capital Agency announced that it will maintain a quarterly cash dividend of $1.25 per common share. The dividend will be payable on October 26, 2012. Besides American Capital Agency, Invesco Mortgage Capital (IVR) also maintained its shareholder distribution for the third quarter of the current year. This happened amidst dividend cuts by other major mortgage REITs, including Annaly Capital Management (NLY) (9% dividend cut), Anworth Mortgage Asset (ANH) (16% dividend slashed) and MFA Financial (MFA) (8.7% dividend cut). Dividend cuts have come as a result of the flattening of the yield curve, which led to compressed interest rate spreads earned by mortgage REITs.
A closer look at the company's quarterly operating cash flows and its dividend distributions reveal that the average cash dividend coverage ratio for the company is 1.7 times. This is the average of the past four quarters. On average, the company generated $435 million and paid $259 million, reflecting that the company generated sufficient cash flows from its operations to support this unmatched dividend yield. Cash dividend coverage ratio for the most recent quarter remained 2.15 times, which is even more encouraging for fixed income oriented investors.
During the most recent quarter, the company generated $384 million through net interest income, which is significantly greater (91%) than what was generated in the same quarter of the previous year. A 50 basis points decline in the interest rate yield curve will result in a 7% decline in the projected net interest income for the coming quarter. This is stated by the company in its SEC filings. The purchase of bonds by the Fed, under the third round of easing, is intended to bring down the MBS yields closer to the treasury yields. A 50 basis points decline in the spreads between MBS and treasury yields will bring about, approximately, a $27 million decline in the net interest income for the fourth quarter of the current year. The projected net interest income of $357 million is still sufficient to cover a dividend payment of $286 million.
American Capital Agency has one of the lowest projected conditional prepayment rate (CPR) of 12%. CPR is the best measure to calculate the percentage of mortgage-backed securities maturing. This means that the company will replace only 12% of its portfolio with the new lower coupon mortgage-backed securities.
Therefore, we believe American Capital Agency, by all means, will be able to continue its dividend distribution in the fourth quarter of the current year.
As opposed to a premium of 4% for Annaly Capital Management, the stock of American Capital Management trades at a premium of 19% to its book value.