AGNC Investment's Q3 2018 Income Statement And Earnings Preview - Part 3 (Notable MBS Price Decreases)

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About: AGNC Investment Corp. (AGNC), Includes: AGNCB, AI, ARR, CHMI, CIM, DX, FMCC, FNMA, IVR, MFA, MITT, MORL, NLY, NRZ, NYMT, NYMTN, ORC, REM, TWO, TWO.PB, WMC
by: Scott Kennedy

Summary

I am projecting AGNC will report a combined notable net unrealized loss on available-for-sale securities and investment securities measured at FMV for the third quarter of 2018.

This is due to the fact most 15- and 30-year fixed-rate agency MBS coupons had modest-notable net price decreases during the third quarter of 2018.

This three-part article also highlights to readers the heightened importance of understanding the relationship between AGNC’s MBS/investment portfolio and the company’s derivatives portfolio regarding changes in quarterly valuations.

My projection for AGNC’s comprehensive loss for the third quarter of 2018 is stated in the “Conclusions Drawn” section.

AGNC’s quarterly results are mainly a result of a more “negative” relationship between fixed-rate agency MBS pricing and derivative instrument valuations during the third quarter of 2018.

Author’s Note: PART 3 of this article is a continuation from PART 1 and PART 2 which were discussed in previous publications. Please see PART 1 and PART 2 of this article for a detailed projection of AGNC Investment Corp.’s (AGNC) income statement (technically speaking, the company’s “consolidated statement of comprehensive income”) for the third quarter of 2018 regarding the following accounts: 1) interest income; 2) interest expense; 3) gain (loss) on sale of investment securities, net; and 4) gain (loss) on derivative instruments and other securities, net (including four “sub-accounts”). PART 2 also discussed AGNC’s projected net income, earnings per share (“EPS”), and net spread + net dollar roll (“NDR”) amounts. PART 1 and PART 2 help lead to a better understanding of the topics and analysis that will be discussed in PART 3. The links to PART 1 and PART 2 are provided below:

AGNC Investment's Q3 2018 Income Statement And Earnings Projection - Part 1 (Including Net Spread Trend)

AGNC Investment's Q3 2018 Income Statement And Earnings Projection - Part 2 (Hedges Partially To The Rescue)

Focus of Article:

The focus of PART 3 of this article is to provide a detailed projection of AGNC’s consolidated statement of comprehensive income for the third quarter of 2018 regarding the following accounts: 5a) “unrealized gain (loss) on investment securities measured at fair market value (“FMV”) through net income, net”; and 5b) “unrealized gain (loss) on available-for-sale (“AFS”) securities, net”. PART 3 will also discuss AGNC’s projected other comprehensive income (loss) (OCI/(OCL)) and comprehensive income (loss) amounts. For readers who just want the summarized account projections, I would suggest to scroll down to the “Conclusions Drawn” section at the bottom of the article.

By understanding the trends that occurred within AGNC’s operations during the third quarter of 2018, one can apply this information to sector peers as well. As such, the discussion/analysis below is not solely applicable to AGNC but to the fixed-rate agency mortgage real estate investment trust (mREIT) sector as a whole. This includes, but is not limited to, the following fixed-rate agency mREIT peers: 1) Arlington Asset Investment Corp. (AI); 2) ARMOUR Residential REIT Inc. (ARR); 3) Cherry Hill Mortgage Investment Corp. (CHMI); 4) Annaly Capital Management Inc. (NLY); and 5) Orchid Island Capital Inc. (ORC). In particular, PART 3 provides a discussion of fixed-rate agency MBS price movements which all of the sector peers listed above are currently heavily invested in when it comes to fair market values (“FMV”). Technically speaking, AI’s current “entity status” is not a REIT per the Internal Revenue Code (“IRC”) but a C-Corporation. However, AI still maintains many “mREIT-like characteristics” including the type of investments held by the company, similar risk management strategies, and the amount of dividend distributions paid to shareholders.

In addition, the following hybrid mREIT companies had at least a modest portion of each company’s investment portfolio in fixed-rate agency MBS (which typically have higher durations): 1) Chimera Investment Corp. (CIM); 2) Dynex Capital Inc. (DX); 3) Invesco Mortgage Capital Inc. (IVR); 4) MFA Financial Inc. (MFA); 5) AG Mortgage Investment Trust Inc. (MITT); 6) Two Harbors Investment Corp. (TWO);and 7) Western Asset Mortgage Capital Corp. (WMC). As such, the analysis below is not solely applicable to one company but more so the fixed-rate agency/hybrid mREIT sector as a whole.

5a) Unrealized Gain (Loss) on Investment Securities Measured at FMV Through Net Income, Net:

  • Estimate of ($250) Million; Range ($375) – ($125) Million
  • Confidence Within Range = Moderate to High
  • See Boxed Blue Reference “5a” in Table 9 Below Next to the September 30, 2018 Column

AGNC’s unrealized gain (loss) on investment securities measured at FMV through net income, net account was recently created by the company due to a change in accounting treatment of its MBS/investment portfolio. All unrealized FMV fluctuations on investment securities acquired on or after 1/1/2017 are now recognized within this account. All unrealized FMV fluctuations on investment securities acquired prior to 1/1/2017 continue to be recognized in the account described next. Since this is merely a financial reporting/classification change, AGNC’s entire MBS/investment portfolio is analyzed in the next account (even though a portion of the portfolio is classified in the account described here).

5b) Unrealized Gain (Loss) on AFS Securities, Net:

  • Estimate of ($320) Million; Range ($470) – ($170) Million
  • Confidence Within Range = Moderate to High
  • See Boxed Blue Reference “5a” in Table 9 Below Next to the September 30, 2018 Column

Projecting AGNC’s unrealized gain (loss) unrealized gain (loss) on AFS securities, net account is an analysis that includes several assumptions and variables that need to be taken into consideration. Since this account is the summation of the quarterly unrealized valuation changes within AGNC’s MBS/investment portfolio (by far the largest asset class on the company’s balance sheet), a wider projection range should be accompanied with this specific account. The same assumptions used within AGNC’s gain (loss) on sale of investment securities, net account (see PART 1 of article) and gain (loss) on derivative instruments and other securities, net account (regarding the company’s TBA MBS position; see PART 2 of article)will be applied when discussing this account.

Prior to performing an account projection analysis, let us first analyze the fixed-rate agency MBS price movements during the third quarter of 2018. Using Table 7 below as a reference, let us first analyze the 15-year fixed-rate agency MBS price movements. This will then be followed by a similar analysis (via Table 8) of the 30-year fixed-rate agency MBS price movements for the same timeframe. By doing so, this will help readers understand how I come up with my projected valuations discussed later in the article.

Table 7 – 15-Year Fixed-Rate Agency MBS Price Movements (Q3 2018)

(Source: Table created by me, using MBS pricing data via private access to a professional resource [Thomson Reuters])

Table 7 above shows the 15-year fixed-rate agency MBS price movements during the third quarter of 2018. It breaks out these agency MBS holdings by “government-sponsored enterprise/entity” (“GSE”). This includes both Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) MBS. As of 6/30/2018, AGNC’s Ginnie Mae holdings accounted for less than 1% of the company’s MBS portfolio. As such, Ginnie Mae fixed-rate agency MBS price movements are deemed immaterial for discussion purposes and thus excluded from this table. Table 7 further breaks out the 15-year fixed-rate agency MBS price movements into the various coupons on AGNC’s books ranging from 2.5% - 4.0%. AGNC currently holds an immaterial balance over the 4.0% coupon and thus these specific coupons are excluded from Table 7 above.

From the information provided in Table 7, a valuation gain (loss) can be calculated which is broken down by the various coupons. It should also be noted AGNC continually changes the company’s MBS/investment portfolio in any given quarter. As such, I must determine specific purchase and sale assumptions towards the end of my account projection analysis.

Using Table 7 above as a reference, let us look at the 15-year fixed-rate agency MBS price movements regarding coupon rates where AGNC held a material balance as of 6/30/2018. The cumulative quarterly net MBS price movements for each coupon rate are shown within Table 7 under the “Cumulative Quarterly Change” column. For example, during the third quarter of 2018, a Fannie 15-year fixed-rate agency MBS with a 2.5%, 3.0%, 3.5%, and 4.0% coupon had a cumulative quarterly price decrease of (0.74), (0.63), (0.69), and (0.61) to settle its price at 96.39, 98.75, 100.48, and 101.94, respectively. As such, a modest price decrease occurred on all four coupons.

When compared to Fannie 15-year fixed-rate agency MBS, Freddie 15-year fixed-rate agency MBS had similar net price movements. Now that we have an understanding of the 15-year fixed-rate agency MBS price movements during the third quarter of 2018, let us take a look at the 30-year fixed-rate agency MBS price movements.

Table 8 – 30-Year Fixed-Rate Agency MBS Price Movements (Q3 2018)

(Source: Table created by me, using MBS pricing data via private access to a professional resource [Thomson Reuters]; link provided below Table 7])

Table 8 above shows the 30-year fixed-rate agency MBS price movements during the third quarter of 2018. It breaks out these MBS holdings by GSE as well. As stated earlier, AGNC’s Ginnie Mae fixed-rate agency MBS holdings are deemed immaterial for discussion purposes and are excluded from this table. Table 8 further breaks out the 30-year fixed-rate agency MBS price movements into the various coupons on AGNC’s books ranging from 3.0% - 4.5%. AGNC currently holds an immaterial balance over the 4.5% coupon and thus these specific coupons are excluded from Table 8 above. From the information provided in Table 8, a valuation gain (loss) can be calculated which is broken down by the various coupons.

Using Table 8 above as a reference, let us look at the 30-year fixed-rate agency MBS price movements regarding coupon rates where AGNC held a material balance as of 6/30/2018. For example, during the third quarter of 2018, a Fannie 30-year fixed-rate agency MBS with a 3.0%, 3.5%, 4.0%, and 4.5% coupon had a cumulative quarterly price decrease of (1.17), (1.14), (1.01), and (0.99) to settle its price at 95.61, 98.34, 100.91, and 103.11, respectively. As such, a notable price decrease occurred on all four coupons.

When compared to Fannie 30-year fixed-rate agency MBS, Freddie 30-year fixed-rate agency MBS had similar net price movements. Now that we have an understanding of the 15- and 30-year fixed-rate agency MBS price movements during the third quarter of 2018, let us take a look at how I believe these price movements impacted AGNC’s MBS/investment portfolio.

I am projecting an “initial” net valuation loss of ($580) million regarding AGNC’s 15- and 30-year fixed-rate agency MBS holdings for the third quarter of 2018. This includes considering a portion of the company’s fixed-rate agency MBS holdings were within “specified pools”. These types of investments are prepayment-protected holdings mainly through the Home Affordable Refinance Program (“HARP”) and low-loan balance [LLB] securities. Detailed data/analysis in relation to AGNC’s specified pools is beyond a “free to the public” article.

In addition, through a detailed calculation that will be omitted from this particular article, I am projecting AGNC had a net valuation loss of ($20) million during the third quarter of 2018 in regards to the following MBS holdings: 1) 20-year fixed-rate; 2) collateralized mortgage obligations (“CMO”); 3) adjustable-rate mortgages (“ARM”); 4) credit risk transfers (“CRT”); and 5) AAA non-agency. Also, when considering the impacts of an assumed partial conversion of AGNC’s net long TBA MBS position and the company’s realignment of its MBS/investment portfolio throughout the quarter, I am projecting a net valuation loss adjustment of ($40) million for the third quarter of 2018. Simply put, most portfolio additions were negatively impacted by the net price movements during the second half of the quarter.

Therefore, when all the figures stated above are combined, I am projecting a total net valuation loss of ($640) million on AGNC’s MBS/investment portfolio for the third quarter of 2018. This figure is prior to all sold MBS/investments being reversed out in the current quarter (discussed in PART 1 of the article) and the reclassification of all unrealized gains (losses) regarding MBS/investments purchased after 1/1/2017. These two reversals are shown in Table 9 below.

Table 9- AGNC Quarterly Unrealized Gain (Loss) on AFS Securities, Net Projection

(Source: Table created by me, partially using AGNC data obtained from the SEC’s EDGAR Database)

Table 9 above shows AGNC’s projected total net valuation loss of ($640) million on the company’s MBS/investment portfolio (see red reference “AB” in Table 9 above). This amount is highlighted in teal. The second amount shown is AGNC’s projected “reversal of prior period unrealized (“gain”) loss, net, (upon realization)” figure (see red reference “AC” in Table 9 above). This amount is highlighted in pink. The third amount shown is AGNC’s projected “reversal of unrealized (“gain”) loss on investment securities measured at FMV through net income, net” figure (see red reference “AD” in Table 9 above). This amount is highlighted in dark teal.

After AGNC’s projected net realized loss on the sale of investment securities of $70 million and net unrealized loss on investment securities measured at FMV through net income of $250 million are reversed-out, the company’s total net unrealized loss on AFS securities is projected to be ($320) million for the third quarter of 2018 (see red reference “(AB + AC + AD) = AE” in Table 9 above). This amount is highlighted in grey.

Brief Discussion of NLY’s Unrealized Gain (Loss) on Agency/Investment Securities, Net Account:

When it comes to AGNC’s sector peer NLY, I see several minor-modest differences that would impact the accounts described above. For instance, as of 6/30/2018, only 5% of NLY’s fixed-rate agency MBS portfolio consisted of 15-year maturities whereas AGNC had 14% of the company’s MBS portfolio in 15-year maturities (excluding TBA MBS positions). It should also be noted NLY fairly recently diversified the company’s investment portfolio by allocating more capital into commercial debt/real estate, preferred equity, corporate debt, residential whole loans, mortgage servicing rights (“MSR”), and middle market (“MM”) lending. NLY’s added diversification should result in reduced volatility during certain interest rate cycles (reduction in duration). Generally speaking, most of these asset classes, when compared to fixed-rate agency MBS, experienced more favorable price fluctuations during the third quarter of 2018. In addition, several years ago NLY acquired a variable-rate agency mREIT, Hatteras Financial Corp. (NYSE:HTS) and completed its acquisition of a hybrid mREIT, MTGE Investment Corp. (NASDAQ:MTGE) in September 2018. However, a vast majority of NLY’s investment portfolio still was comprised of fixed-rate agency MBS as of 6/30/2018 (based on FMV; 83%). Further discussion of NLY’s MBS/investment portfolio is beyond the scope of this article.

B) Other Comprehensive Income (Loss) (OCI/(OCL)):

  • Estimate of ($320) Million; Range ($470) – ($170) Million
  • Confidence Within Range = Moderate to High
  • See Red Reference “B” in Table 10 Below Next to the September 30, 2018 Column

Let us now take a look at AGNC's projected OCI/(OCL) and comprehensive income (loss) amounts. This information is provided in Table 10 below.

Table 10 – AGNC Quarterly OCI/(OCL) and Comprehensive Income (Loss) Projection

(Source: Table created by me, partially using data obtained from AGNC's quarterly investor presentation slides)

After combining the company’s net unrealized loss on AFS securities of ($320) million and its net unrealized gain on interest rate swaps designated as cash flow hedges of $0, I am projecting AGNC will report an OCL of ($320) million for the third quarter of 2018 (see red reference “B” in Table 10 above).

C) Comprehensive Income (Loss):

  • Estimate of ($101) Million; Range ($251) – $49 Million
  • Comprehensive Loss Available to Common Shareholders of ($0.24) Per Share; Range ($0.56) – $0.09 Per Share
  • Confidence Within Range = Moderate to High
  • See Red Reference “C” in Table 10 Above Next to the September 30, 2018 Column

Conclusions Drawn From PART 1, PART 2, and PART 3:

To sum up the analysis from all three parts of the article, I am projecting AGNC will report the following amounts for the third quarter of 2018:

A) Quarterly Net Income of $219 Million; Earnings Available to Common Shareholders of $0.45 Per Share

B) Quarterly OCL of ($320) Million

C) Quarterly Comprehensive Loss (A and B Combined) of ($101) Million; Comprehensive Loss Available to Common Shareholders of ($0.24) Per Share

I believe AGNC’s results for the third quarter of 2018, in regards to valuation fluctuations, will be a slight-modest disappointment by most market participants. The same holds true for most of the fixed-rate agency mREIT sector.

I believe four key factors to analyze within the fixed-rate agency mREIT sector this quarter are the following: 1) each company’s proportion of 15-year MBS holdings versus 30-year MBS holdings; 2) each company’s hedging coverage ratio; 3) each company’s proportion of long-term derivative instruments versus short-term derivative instruments; and 4) each company’s proportion of specified pools (for instance HARP and LLB securities). Dependent upon these factors, I believe results will slightly-modestly vary across the fixed-rate agency mREIT sector for the third quarter of 2018.

My BUY, SELL, or HOLD Recommendation:

From the analysis provided above, including additional catalysts/factors not discussed within this particular article, I currently rate AGNC as a SELL when I believe the company’s stock price is trading above my projected non-tangible BV as of 9/30/2018, a HOLD when trading at through less than a (7.5%) discount to my projected non-tangible BV as of 9/30/2018, and a BUY when trading at or greater than a (7.5%) discount to my projected non-tangible BV as of 9/30/2018. These ranges are unchanged when compared to my last AGNC article (PART 2).

Therefore, I currently rate AGNC as a HOLDsince the stock is trading at through less than a (7.5%) discount to my projected non-tangible BV as of 9/30/2018.

Final Note: The projected amounts from this three-part article will have a direct impact on AGNC’s projected book value (“BV”) as of 9/30/2018. My upcoming AGNC BV projection article will be available to readers prior to the company’s earnings press release for the third quarter of 2018 in late October.

Each investor's BUY, SELL, or HOLD decision is based on one's risk tolerance, time horizon, and dividend income goals. My personal recommendation will not fit each reader’s current investing strategy. The factual information provided within this article is intended to help assist readers when it comes to investing strategies/decisions.

Current/Recent mREIT Sector Stock Disclosures:

On 11/27/2015, I initiated a position in AGNC’s Series B preferred stock, (AGNCB). On 12/7/2015, 12/9/2015, 12/14/2015, 1/14/2016, and 1/20/2016 I selectively increased my position in AGNCB. When combined, my AGNCB position had a weighted average purchase price of $23.215 per share which excluded all dividends received/reinvested. On 10/11/2017- 10/16/2017 I selectively sold 50% of my existing position in AGNCB at a weighted average sales price of $26.425 per share. On 10/23/2017, 11/20/2017, and 12/7/2017, I selectively sold 7%, 14%, and 9% of my existing position in AGNCB at a weighted average sales price of $26.615, $26.30, and $26.50 per share, respectively. On 10/12/2018-10/14/2018, I selectively sold the remaining portion of my AGNCB position at a weighted average sales price of $25.915 per share. When combined, my AGNCB position had a weighted average sales price of $26.324 per share. Each AGNCB trade was disclosed to readers in “real time” (that day) via the StockTalks feature of Seeking Alpha.

On 2/9/2018, I re-entered a position in ORC at a weighted average purchase price of $6.845 per share. This weighted average per share price excluded all dividends received/reinvested. On 7/17/2018, I sold my entire position in ORC at a weighted average sales price of $8.042 per share as my price target, at the time, of $8.05 per share was met. This calculates to a non-annualized realized gain of 17.5% in roughly 5 months and a non-annualized total return (when including dividends received) of 24.4%. Each ORC trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha.

On 1/31/2017, I initiated a position in New Residential Investment Corp. (NRZ) at a weighted average purchase price of $15.10 per share. On 6/29/2017 and 7/7/2017, I increased my position in NRZ at a weighted average purchase price of $15.775 and $15.18 per share, respectively. When combined, my NRZ position has a weighted average purchase price of $15.349 per share. This weighted average per share price excludes all dividends received/reinvested. Each NRZ trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha. I currently have a HOLD recommendation on NRZ.

On 6/29/2017, I initiated a position in CHMI at a weighted average purchase price of $18.425 per share. On 10/6/2017, 10/26/2017, 11/6/2017, and 1/29/2018 I increased my position in CHMI at a weighted average purchase price of $18.015, $18.245, $17.71, and $17.145 per share, respectively. When combined, my CHMI position has a weighted average purchase price of $17.797 per share. This weighted average per share price excludes all dividends received/reinvested. Each CHMI trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha. I currently have a BUY recommendation on CHMI.

On 8/23/2017, I initiated a position in TWO’s Series B preferred stock, (TWO.PB). On 8/24/2017, I increased my position in TWO-B. When combined, my TWO-B position has a weighted average purchase price of $25.283 per share. I currently hold (personally and through affiliated entities) 0.26% of the outstanding shares of TWO-B. Each TWO-B trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha.

On 8/31/2017, I initiated a position in CHMI’s Series A preferred stock, (CHMI.PA). On 9/12/2017, I increased my position in CHMI-A. When combined, my CHMI-A position has a weighted average purchase price of $25.198 per share. I currently hold (personally and through affiliated entities) 1.36% of the outstanding shares of CHMI-A. Each CHMI-A trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha.

On 1/29/2018, I initiated a position in TWO at a weighted average purchase price of $15.155 per share. This weighted average per share price excludes all dividends received/reinvested. This TWO trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha. I currently have a HOLD recommendation on TWO.

On 3/1/2018, I initiated a position in CYS Investments Inc. (NYSE:CYS) at a weighted average purchase price of $6.34 per share. This weighted average per share price excluded all dividends received/reinvested. On 6/18/2018, I sold my entire position in CYS at a weighted average sales price of $7.515 per share as my price target, at the time, of $7.50 per share was met. This calculates to a non-annualized realized gain of 18.5% in roughly 3.5 months and a non-annualized total return (when including dividends received) of 22.0%. Each CYS trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha.

On 3/8/2018, I initiated a position in New York Mortgage Trust, Inc.’s (NYMT) Series D preferred stock, (NYMTN). On 4/6/2018 and 4/27/2018, I increased my position in NYMTN. When combined, my NYMTN position has a weighted average purchase price of $23.489 per share. This weighted average per share price excludes all dividends received/reinvested. I currently hold (personally and through affiliated entities) 0.64% of the outstanding shares of NYMTN. Each NYMTN trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha.

All trades/investments I have performed over the past few years have been disclosed to readers in real time (that day at the latest) via the StockTalks feature of Seeking Alpha (which cannot be changed/altered). Through this resource, readers can look up all my prior disclosures (buys/sells) regarding all companies I cover here at Seeking Alpha (see my profile page for a list of all stocks covered). Through StockTalk disclosures, at the end of September 2018, I had an unrealized/realized gain “success rate” of 93.9% and a total return (includes dividends received) success rate of 100% out of 33 positions (see my profile for more detailed investing statistics). The slight decrease in the first percentage, when compared to August 2018, was due to the fact my position in TWO recently turned slightly negative (when excluding dividends received; still had a total return). I encourage other Seeking Alpha contributors to provide real time buy and sell updates for their readers which would ultimately lead to greater transparency/credibility.

Disclosure: I am/we are long CHMI, CHMI.PA, NRZ, NYMTN, TWO, TWO.PB.

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.

Additional disclosure: I currently have no position in AGNC, AGNCB, AI, ARR, CIM, DX, FMCC, FNMA, IVR, MFA, MITT, MORL, NLY, NYMT, ORC, REM, or WMC.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.