Should Investors Worry About American Capital Agency (AGNC)?

Analysts have long debated if American Capital Agency's (AGNC) 16% dividend was sustainable or a trap for greedy investors. The mREIT, which has risen over 50% since its inception in 2008, has handsomely rewarded investors with some of the biggest dividend payouts in the market through its business of trading MBS (mortgage-backed securities). Daily Chart

The company's business has traditionally consisted of big share-diluting secondary offerings to generate capital, which result in dips in the share price, followed by hefty dividend payouts to assuage investors.
The capital is then used to purchase more MBS, and the profits, generated from the net spread between short and long-term treasury rates, is mostly returned to shareholders as dividends. As a mREIT, American Capital is required by law to return over 90% of its earnings per share back to shareholders as dividends to avoid being taxed at the corporate tax rate of 35%. Over the past five years, that business model worked very well. Unfortunately, last week American Capital reported its worst quarterly earnings ever, shocking investors and causing shares to plunge over 7% on May 3. For its first quarter, the company reported a loss of $1.57 per share, or $557 million, which dragged down its book value from $31.64 to $28.93. The book value of REITs such as American Capital Agency is extremely important, since they must keep their price-to-book ratio above 1.0 to be considered a safe investment. The company's total economic return, calculated as dividends plus the change in book value, came out to a loss of $1.46 per share, an 18.7% year-on-year decline. Many investors lost most of their recent dividend payment after the bleak news. However, the majority of American Capital's losses did not originate from its primary MBS business, instead coming from unrealized losses on marked-to-market agency securities. However, $26 million of realized losses were attributed to the sale of agency securities. It also attributed $0.55 per share of losses on tax-related settlements of TBA dollar roll positions (which operate like futures/derivatives for MBS securities). AGNC President Gary Kain noted that fixed-rated agency MBS prices unexpectedly declined sharply during the quarter, underperforming both Treasuries and interest rate swaps, making them less desirable investments. In other words, if the economy weakens, this could improve MBS prices, which would once again outperform treasuries. Kain noted that the recent weakness in MBS prices represents a strong opportunity for the company to generate strong cash flows and buy up assets at depressed prices. Therefore, the company's long-term growth still looks relatively healthy. AGNC needs interest rates to decline, and mortgages to recover from their first quarter weakness, to get back on track. Otherwise, its net interest rate spread, the key metric between long and short term treasuries that AGNC needs to profit, remained steady. Excluding TBA income, the net interest rate spread came in at 1.71%. For now, AGNC investors should expect some kind of dividend reduction in the near future, but the company's long-term growth is still attractive, as long as interest rates remain near historic lows. Other News About AGNC American Capital Agency Announces Quarterly Earnings, Misses Expectations By $0.39 EPS AGNC posts its worst quarter ever. Should investors be worried? AGNC Shares Plunge After Earnings Miss, Other mREITs Hit Too AGNC drags down the REIT market. Other Stocks in the News 4 Water Plays for a Thirsty Portfolio How can you invest in the world's most important commodity? Google vs. Apple: Let the Voice Wars Begin! Will Google Now kill Siri? Copyright 2013 by, Inc. InvestorGuide has no control over the sites we link to, is not affiliated with these sites, and cannot take responsibility for their quality or suitability. The news, analysis, commentary and profile information is not meant to be comprehensive, and the data provided is not guaranteed to be accurate. WebFinance Inc., the publisher of this newsletter, is not a registered investment advisor or a broker/dealer. This is not a stock recommendation newsletter but rather a source for investment ideas, and we encourage you to fully research any company before considering investing. The opinions expressed herein are those of the author and do not necessarily represent the views of nor are they endorsed by WebFinance Inc. No employee of WebFinance has owned or currently owns any shares in the company described above. The above is neither an offer nor solicitation to buy or sell any securities. The trading of securities may not be suitable for all potential readers of this newsletter, and the purchase of stocks mentioned in this newsletter may result in the loss of some or all of any investment made. We recommend that you consult a stockbroker or financial advisor before buying or selling securities or making investment decisions. We are not responsible for claims made by advertisers and sponsors. Anyone who makes decisions based on what they read here does so at their own risk and cannot hold WebFinance Inc. (DBA, Inc.) or its employees responsible.

Published on May 9, 2013
By Leo Sun
Leo Sun
Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

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