American Capital Agency Announces A Large Secondary Offering

| About: AGNC Investment (AGNC)
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On Tuesday, July 17, after the markets closed, American Capital Agency Corp (AGNC) announced a large secondary offering. The REIT also released some Q2 2012 pre-earnings information in order to help support the issuance. This secondary offering is likely to bring in approximately $1.2 billion, depending upon pricing and over-allotments.

AGNC's secondary offering is for 32 million shares with an over-allotment option for another 4.8 million. Given the prior popularity of recent AGNC secondaries, it appears likely that the over-allotment option will be fully exercised. AGNC's last secondary was priced on March 7. That secondary ended up being for 62 million shares, though it was initially announced as a 54 million share secondary.

In late June, I noted there was a strong likelihood that some secondaries could show up in mid-July, and others may still be forthcoming within the mREIT space. American Capital Agency is an agency mREIT which buys agency mortgages that are backed by federal agencies. Other well-known agency mREITs include Annaly Capital Management (NLY), Capstead Mortgage (CMO) and Hatteras Financial (HTS). Two Harbors Investment Corp (TWO), an mREIT peer that also invests in non-agency MBSs, announced a secondary just last week.

Generally speaking, investing in AGNC at or around a secondary offering price has been a profitable endeavor. Since the last secondary, AGNC shares have appreciated about 20 percent, or $5.40, while also paying a $1.25 dividend worth about another four percent. See a chart of AGNC since its last secondary.
(Click to enlarge)

Of course, these gains are likely to be pared slightly as AGNC's secondary is priced. In an effort to support this secondary, AGNC also released some preliminary information that can be seen as at least somewhat supportive, though still at least reasonably concerning to agency mREIT investors.

AGNC indicated that:

Interest rates fell significantly during the quarter ended June 30, 2012. As a result, the price of agency mortgage backed securities generally increased during the second quarter. Given the increase in fair value of agency mortgage backed securities held in the Company's investment portfolio relative to the decrease in value of its hedges, the Company estimates that, when finally determined, its net book value per common share as of June 30, 2012 will increase to approximately $29.35 per share from $29.06 per share as of March 31, 2012.

This is an increase in book value of about one percent, which beats a decline to book value, but which is also probably well below what most agency mREIT investors would have anticipated. I was personally expecting AGNC to announce around a five percent increase in book value, or about $1.46 (well above the $0.29 that it did increase).

A large part of the reason that AGNC's book increased by so little even though agency backed MBS paper has appreciated substantially is that AGNC's constant prepayment rate increased from 9 percent to 12 percent at the end of the quarter (a 33.3 percent increase). The issue to AGNC's agency MBS portfolio is that much of the agency paper is trading at a premium, while the agencies call it at par.

A premium is when an income-security is trading above its face value. If a prepayment occurs at face value, or at a stepped up rate that is still below the present market value, that premium is lost. As of the end of Q1, AGNC reported 3.7 billion in unamortized premiums. Here, it appears that AGNC's increase in prepayments nearly completely offset the appreciations the portfolio recognized.

Chances are that several of AGNC's peers, including NLY and HTS, will also report increased prepayment rates. AGNC also reported that its Q2 leverage averaged approximately 7.5x, which is down from 8.2x during Q1. The decline in leverage is also probably primarily due to the increase in prepayments.

Given AGNC's significant premium to book value, this secondary should not be terribly surprising to AGNC holders. AGNC will probably re-leverage up its portfolio with the secondary offering's proceeds and hope that this secondary, like the last several, is accretive to its book.

Disclosure: I am long NLY.