American Capital Agency (NASDAQ:AGNC):
- Q3 2013: Net Spread $0.58 vs $0.85 est., NBV $25.27 vs $25.97 est. (NYSE:CS), CPR 10%, avg NIRS 1.14% vs 1.86% QoQ and 1.42% YoY
- Est. FY 2013: CPR of 8% - up from 7% forecast at the end of Q2.
- Further reduced exposure to lowest-coupon (and high-duration) 30-year MBS and combined leverage (inluding TBAs) - further lowering the interest rate spread.
American Capital Agency Group missed third quarter expectations by a wide margin, once again raising fears whether another dividend cut is in the works as the $0.58 net spread and dollar roll income per share is far below the already cut $0.80 quarterly dividend that was paid out earlier. On the positive note however, the book value declined just (0.9)% - a much welcome improvement from (11.8)% drop in Q2, albeit still below analyst expectations. Further yet, company significantly reduced it's investment portfolio and "at-risk" leverage - from $91.7 bil to $77.8 bil and from 8.5x to just 7.2x respectively, actually goingshort in its TBA positions. Portfolio composition shows further shift from 30-year to more matching shorter term 15-year MBS which are more correlated in movement to the spot-market rates (cost of funds). Management feels confident in risk reduction measures, commenting on slightly raising duration at quarter end. Lastly, CPR came in slightly lower compared to Q2 and was much lower at quarter end - yet CPR projection was increased, likely on interest rate environment bouncing back down in the near term.
On the sidelines, management has also doubled share repurchase program to $1 billion and extended the due date until end of 2014.
First of all - a disclaimer: I'm not a professional fixed income trader or a banker. While I understand (at least to some degree) all the intrinsics of interest-rate spread profit making, I must admit that reading an earnings release from a tech giant or a retail store operator makes much more sense to me. With that in mind, I believe I can still well judge actions taken by financial companies and the expected results these actions target.
When during the second quarter conference call AGNC management explicitly stated that a "prudent course of action is to prioritize risk management over earnings maximization", it would be silly for someone to expect that a recovery in MBS valuations and decline in interest rates after Fed's "no-September-taper" decision would simply bring back all the lost profits. Yet, the 9% decline in AGNC shares witnessed following the report certainly confirm this was exactly what the markets expected. Management however has prudently stuck to its plan - reducing the overall size of the portfolio, reducing leverage and shifting the portfolio mix towards 15-year vs 30-year securities, which while resulting in lower interest-rate income spread provides for much less fluctuation - whether interest rates move up or down.
The impact has been obvious, with company earning less than it has lost in the prior quarter and although providing for a positive return of 8.7% annualized - these results missed expectations by a significant margin. The positive takeaway - company still earned $0.56 per share (the difference between $(0.24) NBV decline and $0.80 dividend payout) versus a net loss of $(2.37) per share in the second quarter. This is a positive movement, and should the rates continue to stabilize and remain low, more profit recovery is likely to stem - and I remain highly confident in management's ability to deliver and wisely manage the portfolio in the existing volatile interest rate environment. Whether tapering is coming this December, March or July of next year -tapering will happen and actions taken today will position American Capital to outperform peers in the future and provide for stable and consistent dividends, albeit much lower than the $1.05 and even $0.80 payouts that we have seen not so long ago.
Where would the dividend come down to? Likely to what the earnings are at this point in time, towards the$0.55-0.60/sh range, yielding roughly 10-11% on an annualized basis at the current sub-$22 share price level. And that is what I would expect to be a likely trough, with earnings slowly recovering going forth (in the less-taper-concernedenvironment) and much higher likelihood of dividend upside versus further cutback.
And one more very important piece that needs to be noted… the aggressive share repurchase program and the extension announced in the third quarter release… One must realize, that with book value at $25.27/sh and $22/sh market price, company is simply making a 15% return by selling its book assets and repurchasing the outstanding shares. This activity is certainly limited, as doing so while keeping debt stable will raise leverage. But nonetheless, to some degree, this will amortize book value declines after dividend payouts even further.
Lastly, I would like to conclude with a reference to a great article by D. White on SeekingAlpha which puts a bit more professionalperspective on the issue and is certainly worth a read.
It is much unfortunate that my exposure to AGNC shares is already at the level where my mREIT exposure makes up more than a fair share of my long-term dividend yielding portfolio. I did pick up a few more shares into my IRA account on Tuesday in the morning at around $22 per share. But that is pretty much where I draw the line for the near term. I must say I was in the hyped-up camp, expecting great results and thinking that $24/sh prior to ER was undervalued. I took the dive along with everyone else, but have not changed my stance - looking out into the future (5-10 years) mREITs should be part of everyone's portfolio. As a result, if you are an investor, I would suggest you take opportunity of the dip and grow/establish a position here. And if you are a trader - I'm hopeful you took advantage of the miss and price drop, but I would certainly not advise to establish short positions at these levels. The results posted, while below expectations, certainly poise for a turnaround story and I do not believe present for all that much more of a downward action as risk-based portfolio restructuring appears complete and upside is more likely than decline continuation.
Disclosure: I am long AGNC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.