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
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Published on May 9, 2013
By Leo Sun