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American Capital Agency Corp. (AGNC): A Performance Review

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Don’t be fooled by the elevated dividend yields being offered by most of the mortgage REITs. These elevated returns are not without associated risk. American Capital Agency Corp. (NASDAQ:AGNC) is one of the few mREITs that have offered steady returns, and for this reason it has long been  an analyst favorite. The company was able to maintain its dividend rate during the third and fourth quarter of the prior year, when most its peers had to cut their shareholder distributions.

Let’s look at how American Capital Agency has been able to maintain its dividends, and why analysts and investors prefer it the most amongst pure-play mREITs.

Latest quarter’s performance review

American Capital Agency Corp. (NASDAQ:AGNC)Contrary to expectations, American Capital Agency Corp. (NASDAQ:AGNCreported a poor first quarter performance. The company reported estimated REIT taxable income fell 74%, while the income per share came in at $0.64, down 73% over the linked quarter. The company still has $1.08 of undistributed income per share in cash on hand. Keep in mind, the company is offering $1.25 per share in shareholder distributions. Including the undistributed income, the dividend distributions seems sustainable.

Much of the poor performance was attributed to a 4% sequential decline in net interest income, partially offset by 5% decline in the cost of funds. As a result, American Capital Agency Corp. (NASDAQ:AGNC) was left with $407 million in net interest income for the quarter, down 4% over the prior quarter.

Another contributing factor was the decline in so-called Other Income. The company incurred $124 million of losses this quarter, compared to $442 million of Other Income during the fourth quarter of the prior year. So, basically these one-time items did not provide any support to the bottom line.

To top it off, operating expenses increased 5% sequentially on higher management fees. As a result, the company posted a net income figure of $231 million, down a significant 71%, compared to the prior quarter.

Key metrics

Average asset yield at 2.8%, down 2 bps sequentially.
Cost of funds increased 9 bps.
Net interest rate spread at 1.52%, down 11 bps sequentially.

Prepayments

During the quarter, the average actual prepayment speeds for the securities held remained flat at 10%, while the forecast prepayment speed decreased to 9% as mortgage spreads widened during the quarter, resulting in catch-up premium amortization benefit. The company added more prepayment protected papers. Therefore, you can expect the prepayments to remain stable in the coming quarter.

Hedging

Higher swap cost was another major reason for the relatively poor first quarter performance. During the first quarter, American Capital Agency Corp. (NASDAQ:AGNC) Agency added more coverage as its percentage of repos swapped increased 15% sequentially to 78%. Another 35% of its repos are hedged using swaptions, with an aim to protect the book value in an up interest rate environment. Combined, the swaps and swaptions cover 112% of the repos, 30% higher when compared to the linked quarter.

Competition

American Capital Agency Corp. (NASDAQ:AGNC) competes with other pure-play mortgage REITs that invest exclusively in Agency residential mortgage backed securities. CYS Investments Inc (NYSE:CYS) and Capstead Mortgage Corporation (NYSE:CMO) are two such companies. While both are Agency mortgage REITs, they have entirely different investment portfolios as far as their interest rates sensitivities are concerned.

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