We've had numerous questions regarding American Capital Agency (AGNC, $29.58, -0.85, Spy) and its recent sell-off.
We think the sell-off can largely be attributed to guilt by association, as others in the sector have posted some poor results. In particular, we think the issues at Annaly (NLY, $14.46, -0.41, Spy), which had long been considered the top mortgage REIT, have weighed on both the sector and AGNC.
Annaly posted weak Q3 results that saw spread income come in well below estimates and book value rise only a modest 2.3% quarter over quarter and year over year, compared to the 10.5% sequential and 20.8% year-over-year jump for AGNC. Importantly, Annaly's constant prepayment rate (CPR) of 20% was more than double AGNC's 9%.
Annaly management also gave a very muted outlook for the future, and then yesterday enacted a complete strategy shift by offering to buy the stake it didn't already own in commercial mortgage REIT Crexus (CXS, $12.35, -0.08, Spy) and saying it may invest up to a quarter of its portfolio in non-agency MBS.
Citi analysts commented on the deal and its impact on the mortgage REIT space, writing: "The environment has become more challenging for the pure-play agency REITs, where portfolio spreads have tightened on elevated levels of prepayments and tighter reinvestment yields. We believe [Annaly's] transaction is in response to pressures (and lower ROEs) in the agency business, and is a realization the agency only model may be more challenging moving forward given QE3, higher prepayments, and an eventual Fed rate hike. We would not be surprised to see other agency focused REITs shift more capital into commercial real estate and/or non-agency residential assets."
BMR Take: One of our biggest worries holding AGNC is that we always thought there was a possibility that the stock could sell-off even if it was performing well operationally because of struggles with others in the sector. This appears to be what is happening now, although we thought the cause of the sector troubles would be increasing interest rates, not lower ones.
AGNC was perfectly positioned for QE3 with its portfolio, and that can be seen by its big jump in book value and low CPR. That said, the stock is still suffering from the mistakes of Annaly and others who weren't properly positioned.
With the sell-off, AGNC is now trading for only about 0.9x book value, which is a far cry from the 1.2x it had typically commanded. Meanwhile, it's yielding 16.9%. As we noted previously, we think the dividend will come down sometime next year, but with a low CPR and $1.52 per share in undistributed income, it won't come down nearly as much as others in the sector. We think maybe it will be reduced to a $1.00 quarterly dividend early to mid next year.
With a $500 million buyback plan in place, its big yield, and trading well below book value, now doesn't seem like a great time to sell the stock, particularly because we don't see conditions in the mortgage space getting much worse for mortgage REITs. That said, we're going to reduce our target from $36 to $33, because it may be difficult for any agency REIT to command more than 1x book in this environment, even one as well-run as AGNC.
Excellent article regarding AGNC. I want the income and will hold as this stock will come back in time. Great one to hold in an IRA-not taxed until you take the money out as ordinary income; whatever bracket you are in. Panic sellers will be sorry a couple of years from now. Until then, sit back and enjoy the return each qtr.
Two pieces of new came out AH.
Not sure how the market will digest this.
1) 30 year rates for mortages are touching their all time low again
2) One of the fed (yellen) has come out and suggested keeping short term rates low until 2016 now. Yellen is the possible successor for ben bernanke