American Capital Agency: Dividend Unsafe, Avoid This REIT For Now

| About: AGNC Investment (AGNC)

Summary

American Capital Agency (AGNC) is a mid-sized mortgage REIT investing only in agency-backed mortgage securities.

American Capital Agency's current leverage is 7.8x, which is very high. It has not come down even after it lowered its dividend from $0.20 per share to $0.18 per share.

The author recommends that investors stay away from this REIT for now.

Company Introduction

American Capital Agency (NASDAQ:AGNC) is an agency mortgage REIT that has underperformed as of late. It is extremely concerning that the company reported a leverage of 7.8x in addition to a comprehensive income loss of $1.00 per share during the fourth quarter of 2016. These indicate that the trust is struggling in the current economic environment and failing to pay its dividend. Due to this fact, it is recommended that investors stay away from this trust for now. Instead, take a look at Annaly Capital Management (NYSE:NLY), which is doing much better and fairly valued.

Company Facts

Share Price: $19.54 per share

Market cap: $6.44 billion

Book value: $21.17 per share

Valuation: 8% discount to book

Dividend: $0.18 per share, annualized at 11.05%

Leverage: 7.8x at risk leverage

High Leverage and Lower Dividend

Recently, American Capital Agency has disappointed investors by lowering its dividend (from $0.20 to $0.18 per share) and significantly increasing its leverage (to 7.8x). As a matter of fact, the company's leverage is now significantly above its competitors - see a comparison below.

Company Leverage
American Capital Agency 7.8x
Armour Residential REIT Inc. (NYSE:ARR) 6.2x
Annaly Capital Management 6.1x


The reason for the changes is that the company announced its plans to acquire ACMM in May 2016, which cost the company $562 million, or $1.70 per share. Since the company needed cash and liquidity to execute this transaction, it increased its leverage and decreased its dividend to help finance the purchase.

Valuation

American Capital Agency is an established mortgage REIT but has performed poorly lately. Its current valuation is 8% discount to book, which is moderate within the industry. In fact, the company's current share price rests at $19.54, and its book value is $21.17 per common share. Refer to below for a comparison of AGNC's valuation with its competitors:

Company Valuation: discount to book value
American Capital Agency 8%
Annaly Capital Agency 6.5%
Armou Residential REIT 11%

Given that the trust is struggling to make a positive comprehensive income at a leverage of 7.8x, the trust's current valuation is quite hefty as its valuation is near that of blue chip mREIT Annaly Capital Management. Both alternatives to AGNC, Armour and Annaly, are more attractively priced at this point in time.

Dividend Safety and Investor Considerations

Without a doubt, having a leverage of 7.8x at any time is a dangerous sign for any mortgage REIT's dividends. As a result, investors should look for the trust to trend lower on leverage and normalize. If the at-risk leverage does not decrease to the low 7s in a few month, consider it a sign of a future dividend cut.

For taxation purposes, it is advisable to keep NLY out of most cash management accounts because dividends from REITs are taxed at the ordinary tax rate. This usually results in a large tax bill, and it is prudent to avoid this tax by putting the company's shares in a Roth IRA or self directed 401k account.

Conclusion

In conclusion, a leverage of 7.8x looks very scary for American Capital Agency, especially when it is failing to garner a positive comprehensive income with this leverage. However, company's dividend will likely stay in line at $0.18 per share. As a result, the author recommends staying away from AGNC for now.

Disclosure: I am/we are long AGNC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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