AGNC Investment’s Q2 2017 Income Statement And EPS Projection – Part 3 – AGNC Investment Corp. (NASDAQ:AGNC)

Author’s Note: PART 3 of this article is a continuation from PART 1 and PART 2 which were discussed in previous publications. Please see PART 1 and PART 2 of this article for a detailed projection of AGNC Investment Corp.’s (AGNC) income statement (technically speaking, the company’s “consolidated statement of comprehensive income”) for the second quarter of 2017 regarding the following accounts: 1) interest income; 2) interest expense; 3) gain (loss) on sale of agency securities, net; and 4) gain (loss) on derivative instruments and other securities, net (including four “sub-accounts”). PART 2 also discussed AGNC’s projected net loss and earnings per share (“EPS”) amounts. PART 1 and PART 2 help lead to a better understanding of the topics and analysis that will be discussed in PART 3. The links to PART 1 and PART 2 are provided below:

AGNC Investment Corp.’s Q2 2017 Income Statement Projection – Part 1 (Including Current Recommendation)

AGNC Investment Corp.’s Q2 2017 Income Statement and EPS Projection – Part 2

Focus of Article:

The focus of PART 3 of this article is to provide a detailed projection of AGNC’s consolidated statement of comprehensive income for the second quarter of 2017 regarding the following accounts: 5a) “unrealized gain (loss) on investment securities measured at fair market value (“FMV”) through net income, net”; and 5b) “unrealized gain (loss) on available-for-sale (“AFS”) securities, net”. PART 3 will also discuss AGNC’s projected other comprehensive income (loss) (OCI/(OCL)) and comprehensive income (loss) amounts. For readers who just want the summarized account projections, I would suggest to scroll down to the “Conclusions Drawn” section at the bottom of the article.

By understanding the trends that occurred within AGNC’s operations during the second quarter of 2017, one can apply this information to sector peers as well. As such, the discussion/analysis below is not solely applicable to AGNC but to the fixed-rate agency mortgage real estate investment trust (mREIT) sector as a whole. This includes, but is not limited to, the following fixed-rate agency mREIT peers: 1) Arlington Asset Investment Corp. (AI); 2) ARMOUR Residential REIT Inc. (ARR); 3) Cherry Hill Mortgage Investment Corp. (CHMI); 4) CYS Investments Inc. (CYS); 5) Annaly Capital Management Inc. (NLY); and 6) Orchid Island Capital Inc. (ORC). In particular, PART 3 provides a discussion of fixed-rate agency MBS price movements which all of the sector peers listed above are currently heavily invested in. Technically speaking, several years ago AI changed its “entity status” from a REIT to a C-Corp. per the Internal Revenue Code (“IRC”). However, AI still maintained many “mREIT-like” characteristics including the type of investments held by the company and the amount of annual dividend distributions paid to shareholders.

In addition, the following hybrid mREIT companies had at least a modest portion of each company’s MBS portfolio in fixed-rate agency MBS (also typically having higher durations): 1) Dynex Capital Inc. (DX); 2) Invesco Mortgage Capital Inc. (IVR); 3) MFA Financial Inc. (MFA); 4) AG Mortgage Investment Trust Inc. (MITT); 5) MTGE Investment Corp. (MTGE); 6) Two Harbors Investment Corp. (TWO); and 7) Western Asset Mortgage Capital Corp. (WMC). As such, the analysis below is not solely applicable to one company but more so the agency/hybrid mREIT sector as a whole.

5a) Unrealized Gain (Loss) on Investment Securities Measured at FMV Through Net Income, Net:

– Estimate of $25 Million; Range ($75) – $125 Million

– Confidence Within Range = Moderate to High

– See Boxed Blue Reference “5a” in Tables 8 and 9 Below Next to the June 30, 2017 Column

AGNC’s unrealized gain (loss) on investment securities measured at FMV through net income, net account was recently created by the company due to a change in accounting treatment of its MBS portfolio. All unrealized FMV fluctuations on MBS acquired on or after 1/1/2017 are now recognized within this account. All unrealized FMV fluctuations on MBS acquired prior to 1/1/2017 continue to be recognized in the account described next. Since this is merely a “classification” change, AGNC’s entire MBS portfolio is discussed/analyzed in the next account (even though a portion of the portfolio is reclassified to the account described here).

5b) Unrealized Gain (Loss) on AFS Securities, Net:

– Estimate of $159 Million; Range $34 – $284 Million

– Confidence Within Range = Moderate to High

– See Boxed Blue Reference “6” in Table 8 Below Next to the June 30, 2017 Column

Projecting AGNC’s unrealized gain (loss) unrealized gain (loss) on AFS securities, net account is an analysis that includes several assumptions and variables that need to be taken into consideration. Since this account is the summation of the quarterly unrealized valuation changes within AGNC’s MBS portfolio (by far the largest asset class on the company’s balance sheet), a wider projection range should be accompanied with this specific account. The same assumptions used within AGNC’s gain (loss) on sale of agency securities, net account (see PART 1 of article) and gain (loss) on derivative instruments and other securities, net account (regarding the company’s TBA MBS position; see PART 2 of article) will be applied when discussing this account.

Prior to performing an account projection analysis, let us first analyze the fixed-rate agency MBS price movements during the second quarter of 2017. Using Table 6 below as a reference, let us first analyze the 15-year fixed-rate agency MBS price movements. This will then be followed by a similar analysis (via Table 7) of the 30-year fixed-rate agency MBS price movements. By doing so, this will help readers understand how I come up with my projected valuations discussed later in the article.

Table 6 – 15-Year Fixed-Rate Agency MBS Price Movements (Q2 2017)

(Source: Table created entirely by myself, using MBS pricing data via private access to a professional resource [Thomson Reuters])

Table 6 above shows the 15-year fixed-rate agency MBS price movements during the second quarter of 2017. It breaks out these agency MBS holdings by “government-sponsored enterprise/entity” (“GSE”). This includes both Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) MBS. As of 3/31/2017, AGNC’s Ginnie Mae holdings accounted for less than 1% of the company’s MBS portfolio (excluding TBA MBS positions). As such, Ginnie Mae fixed-rate agency MBS price movements are deemed immaterial for discussion purposes and thus excluded from this table. Table 6 further breaks out the 15-year fixed-rate agency MBS price movements into the various coupons on AGNC’s books ranging from 2.5% – 4.0%. AGNC currently holds an immaterial balance over the 4.0% coupon and thus these specific coupons are excluded from Table 6 above.

From the information provided in Table 6, a valuation gain (loss) can be calculated which is broken down by the various coupons. It should also be noted AGNC continually changes the company’s MBS portfolio in any given quarter. As such, I must determine specific purchase and sale assumptions towards the end of my account projection analysis.

Using Table 6 above as a reference, let us look at the 15-year fixed-rate agency MBS price movements regarding coupon rates where AGNC held a material balance as of 3/31/2017. The cumulative quarterly net MBS price movements for each coupon rate are shown within Table 6 under the “Cumulative Quarterly Change” column. For example, during the second quarter of 2017, a Fannie 15-year fixed-rate agency MBS with a 2.5%, 3.0%, 3.5%, and 4.0% coupon had a cumulative quarterly price increase (decrease) of 0.42, 0.06, (0.06), and 0.11 to settle its price at 100.47, 102.59, 104.00, and 103.39, respectively. As such, a modest price increase occurred on the 2.5% coupon while a minor price fluctuation occurred on the 3.0%, 3.5%, and 4.0% coupons.

When compared to Fannie 15-year fixed-rate agency MBS, Freddie 15-year fixed-rate agency with a 3.0%, 3.5% and 4.0% coupon had slight differences (or no difference) in cumulative net price valuations. However, there was a more notable difference when it came to the 2.5% coupon. Now that we have an understanding of the 15-year fixed-rate agency MBS price movements during the second quarter of 2017, let us take a look at the 30-year fixed-rate agency MBS price movements.

Table 7 – 30-Year Fixed-Rate Agency MBS Price Movements (Q2 2017)

(Source: Table created entirely by myself, using MBS pricing data via private access to a professional resource [Thomson Reuters]; link provided below Table 6])

Table 7 above shows the 30-year fixed-rate agency MBS price movements during the second quarter of 2017. It breaks out these MBS holdings by GSE as well. As stated earlier, AGNC’s Ginnie Mae fixed-rate agency MBS holdings are deemed immaterial for discussion purposes and are excluded from this table. Table 7 further breaks out the 30-year fixed-rate agency MBS price movements into the various coupons on AGNC’s books ranging from 3.0% – 4.5%. AGNC holds an immaterial balance over the 4.5% coupon and thus these specific coupons are excluded from Table 7 above. From the information provided in Table 7, a valuation gain (loss) can be calculated which is broken down by the various coupons.

Using Table 7 above as a reference, let us look at the 30-year fixed-rate agency MBS price movements regarding coupon rates where AGNC held a material balance as of 3/31/2017. For example, during the second quarter of 2017, a Fannie 30-year fixed-rate agency MBS with a 3.0%, 3.5%, 4.0%, and 4.5% coupon had a cumulative quarterly price increase of 0.64, 0.33, 0.16, and 0.00 to settle its price at 99.83, 102.67, 105.09, and 107.23, respectively. As such, a modest price increase occurred on the 3.0% and 3.5% coupons, a minor price increase occurred on the 4.0% coupon, and no price fluctuation occurred on the 4.5% coupon.

When compared to Fannie 30-year fixed-rate agency MBS, Freddie 30-year fixed-rate agency MBS with similar coupons had slight differences in cumulative net price fluctuations. Now that we have an understanding of the 15- and 30-year fixed-rate agency MBS price movements during the second quarter of 2017, let us take a look at how I believe these price movements impacted AGNC’s MBS portfolio.

I am projecting an “initial” net valuation gain of $100 million regarding AGNC’s 15- and 30-year fixed-rate agency MBS holdings for the second quarter of 2017. However, as stated earlier, several other adjustments need to be performed within AGNC’s unrealized gain (loss) on AFS securities, net account before a final projection can be made. Since AGNC had a portion of the company’s fixed-rate agency MBS holdings within “specified pools” (prepayment protected MBS; mainly through the Home Affordable Refinance Program [HARP] and low-loan balance [LLB] securities), a quarterly valuation adjustment needs to be calculated. Through a detailed calculation that will be omitted from this particular article (data/support in relation to AGNC’s specified pools is beyond a “free to the public” article), I am projecting AGNC had an additional net valuation gain of $19 million for the second quarter of 2017 in regards to the company’s specified pools. When these two figures are combined, I am projecting AGNC had a net valuation gain of $119 on the company’s 15- and 30-year fixed-rate agency MBS portfolio.

In addition, through a detailed calculation that will be omitted from this particular article, I am projecting AGNC had a net valuation gain of $20 million during the second quarter of 2017 in regards to the following MBS holdings: 1) 20-year fixed-rate; 2) collateralized mortgage obligations (“CMO”); 3) adjustable-rate mortgages (“ARM”); 4) credit risk transfers (“CRT”); and 5) AAA non-agency. Also, when considering the impacts of an assumed partial conversion of AGNC’s net long TBA MBS position and the company’s realignment of its MBS portfolio throughout the quarter, I am projecting a net valuation loss adjustment of ($5) million for the second quarter of 2017.

Therefore, when all the figures stated above are combined, I am projecting a total net valuation gain of $134 million on AGNC’s MBS portfolio for the second quarter of 2017. This figure is PRIOR to all sold MBS being reversed out in the current quarter (discussed in PART 1 of the article) and the reclassification of all unrealized gains (losses) regarding MBS purchased after 1/1/2017. These two reversals are shown in Table 8 below.

Table 8- AGNC Quarterly Unrealized Gain (Loss) on AFS Securities, Net Projection

(Source: Table created entirely by myself, partially using AGNC data obtained from the SEC’s EDGAR Database)

Table 8 above shows AGNC’s projected total net valuation gain of $134 million on the company’s MBS portfolio (see red reference “AB” in Table 8 above). This amount is highlighted in teal. The second amount shown is AGNC’s projected “reversal of prior period unrealized (“gain”) loss, net, (upon realization)” figure (see red reference “AC” in Table 8 above). This amount is highlighted in pink. The third amount shown is AGNC’s projected “reversal of unrealized (“gain”) loss on investment securities measured at FMV through net income, net” figure (see red reference “AD” in Table 8 above). This amount is highlighted in dark teal.

Therefore, after AGNC’s projected net realized loss on the sale of agency securities of $50 million and net unrealized gain on investment securities measured at FMV through net income of ($25) million is reversed-out, the company’s total net unrealized gain on AFS securities is projected to be $159 million for the second quarter of 2017 (see red reference “(AB + AC + AD) = AE” in Table 8 above). This amount is highlighted in grey.

Brief Discussion of MTGE’s and NLY’s Unrealized Gain (Loss) on Agency Securities, Net Account:

I see general similarities between AGNC and the company’s affiliate MTGE regarding agency MBS portfolio strategies. As such, I see a fairly similar projection between AGNC’s unrealized gain (loss) on AFS securities, net account and MTGE’s “unrealized gain (loss) on agency securities, net” account for the second quarter of 2017 (proportionally speaking). With that being said, when compared to AGNC, MTGE had a slightly higher proportional share of 30-year fixed-rate agency MBS holdings as of 3/31/2017 which needs to be considered regarding projected valuations. Furthermore, one should consider that AGNC likely “deployed” at least some of the company’s newly raised capital from its May 2017 equity offering during the quarter.

In addition, MTGE also had a much larger non-agency MBS portfolio (proportionately speaking). Due to this fact, MTGE also has an “unrealized gain (loss) on non-agency securities, net” account that needs to be incorporated into the company’s financials. MTGE’s non-agency MBS portfolio has different valuation methods which are mainly based on specific indexes and simulated models which are classified as level 3 assets per Accounting Standards Codification (“ASC”) 820. This includes, but is not limited to, prime, CRT, Alt-A, option ARM, and subprime holdings. MTGE’s non-agency MBS portfolio had a conditional prepayment rate (“CPR”) of 14%, a conditional default rate (“CDR”) of 3%, and a voluntary prepayment rate (“VPR”) of 12% as of 3/31/2017. I anticipate a relatively flat-minor increase to these three metrics during the second quarter of 2017 which would slightly impact valuations. Further discussion of MTGE’s non-agency MBS portfolio is beyond the scope of this article.

When it comes to AGNC’s sector peer NLY, I see one modest difference that would impact the account described above. As of 3/31/2017, only 9% of NLY’s fixed-rate agency MBS portfolio consisted of 15-year maturities whereas AGNC had 26% of the company’s MBS portfolio in 15-year maturities (excluding TBA MBS positions). Since most 30-year fixed-rate agency MBS coupons had additional price increases when compared to 15-year fixed-rate agency MBS with similar coupons, NLY should have a slightly higher combined total net valuation gain on AFS securities (realized and unrealized) when compared to AGNC during the second quarter of 2017 (proportionally speaking). In addition, it should also be noted management has recently broadened NLY’s investment portfolio by allocating more capital into commercial debt/real estate, preferred equity, corporate debt, and most recently middle market (“MM”) lending. Furthermore, NLY recently acquired a variable-rate agency mREIT, Hatteras Financial Corp. (HTS). Generally speaking most of these asset classes, when compared to fixed-rate agency MBS, also experienced relatively flat-minor price increases during the second quarter of 2017. A further discussion of NLY’s MBS/investment portfolio is beyond the scope of this article.

B) Other Comprehensive Income (Loss) (OCI/(OCL)):

– Estimate of $159 Million; Range ($41) – $359 Million

– Confidence Within Range = Moderate to High

– See Red Reference “B” in Table 9 Below Next to the June 30, 2017 Column

Let us now take a look at AGNC’s projected OCI/(OCL) and comprehensive income (loss) amounts. This information is provided in Table 9 below.

Table 9 – AGNC Quarterly OCI/(OCL) and Comprehensive Income (Loss) Projection (Source: Table created entirely by myself, partially using data obtained from AGNC’s quarterly investor presentation slides)

After combining the company’s net unrealized gain on AFS securities of $159 million and its net unrealized gain on interest rate swaps (upon reclassification) of $0, I am projecting AGNC will report OCI of $159 million for the second quarter of 2017 (see red reference “B” in Table 9 above).

C) Comprehensive Income (Loss):

– Estimate of $139 Million; Range ($61) – $339 Million

– Comprehensive Income Available to Common Shareholders of $0.38 Per Share; Range ($0.20) – $0.96 Per Share

– Confidence Within Range = Moderate to High

– See Red Reference “C” in Table 9 Above Next to the June 30, 2017 Column

Finally, let us look at AGNC’s comprehensive income for the second quarter of 2017. This is the summation of the following amounts: A) net loss of ($20) million (see PART 1 and PART 2); and B) OCI of $159 million (see analysis above). Therefore, when these two amounts are combined, I am projecting AGNC will report comprehensive income of $139 million for the second quarter of 2017.

Conclusions Drawn From PART 1, PART 2, and PART 3:

To sum up the analysis from all three parts of the article, I am projecting AGNC will report the following amounts for the second quarter of 2017:

A) Quarterly Net Loss of ($20) Million; Earnings Available to Common Shareholders of ($0.08) Per Share

B) Quarterly OCI of $159 Million

C) Quarterly Comprehensive Income (A and B Combined) of $139 Million; Comprehensive Income Available to Common Shareholders of $0.38 Per Share

AGNC’s projected net loss of ($20) million for the second quarter of 2017 is a minor decrease when compared to net income of $76 million for the first quarter of 2017. This is mainly due to AGNC’s projected net valuation loss of ($184) million regarding the company’s derivatives portfolio for the second quarter of 2017. For the same account in the prior quarter, AGNC recognized a net valuation loss of only ($40) million.

I am also projecting AGNC will report OCI of $139 million for the second quarter of 2017. This projected amount is a very minor increase when compared to OCI of $122 million for the first quarter of 2017.

I believe AGNC will slightly underperform the fixed-rate agency mREIT peer average in regards to valuation fluctuations for the second quarter of 2017. This is mainly due to AGNC’s higher hedging coverage ratio and the composition of the company’s MBS portfolio heading into the second quarter of 2017 when compared to its fixed-rate agency mREIT peers.

I believe four key factors to analyze within the fixed-rate agency mREIT sector this quarter are the following: 1) each company’s proportion of 15-year MBS holdings versus 30-year MBS holdings; 2) each company’s hedging coverage ratio; 3) each company’s proportion of long-term derivative instruments versus short-term derivative instruments; and 4) each company’s proportion of specified pools (for instance HARP and LLB securities). Dependent upon these factors, I believe results will modestly vary across the fixed-rate agency mREIT sector for the second quarter of 2017.

My BUY, SELL, or HOLD Recommendation:

For my AGNC BUY, SELL, or HOLD recommendation, please see PART 1 of this article (link provided at the beginning of the article).

Final Note: The projected amounts from this three-part article will have a direct impact on AGNC’s projected book value (“BV”) as of 6/30/2017. My upcoming AGNC BV projection article will be available to readers prior to the company’s earnings press release for the second quarter of 2017 on 7/26/2017.

Each investor’s BUY, SELL, or HOLD decision is based on one’s risk tolerance, time horizon, and dividend income goals. My personal recommendation will not fit each reader’s current investing strategy. The factual information provided within this article is intended to help assist readers when it comes to investing strategies/decisions.

During January-March 2014, I initiated (and subsequently add to) a position in MTGE at a weighted average purchase price of $18.47 per share. On 3/4/2016 and 4/8/2016, I directly increased my position in MTGE at a weighted average purchase price of $14.36 and $14.47 per share, respectively. These two combined purchases had the same approximate monetary value of my combined 2014 purchases. My entire MTGE position had a weighted average purchase price of $16.443 per share. On 6/15/2017, I sold my entire MTGE position at a weighted average price of $19.09 per share as my price target of $19.10 was met that day. My MTGE total return (when including change in stock price and dividends received/gains on reinvested dividends), was 45.4%. My 2016 purchases were disclosed, at the time, to readers in subsequent AGNC articles over the following several months. My 2017 sale was disclosed to readers in “real time” (that day) via the StockTalks feature of Seeking Alpha.

On 11/27/2015, I initiated a position in AGNCB; Series B preferred stock. On 12/7/2015, 12/9/2015, 12/14/2015, 1/14/2016, and 1/20/2016 I selectively increased my position in AGNCB. When combined, my AGNCB position has a weighted average purchase price of $23.215 per share. This weighted average per share price excludes all dividends received/reinvested. I currently hold (personally and through affiliated entities) 0.71% of the outstanding shares of AGNCB. Each AGNCB trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha.

All trades/investments I have performed over the past few years have been disclosed to readers in real time (that day at the latest) via the StockTalks feature of Seeking Alpha. Through this resource, readers can look up all my prior disclosures (buys/sells) regarding all companies I cover here at Seeking Alpha (see my profile page for a list of all stocks covered).

Disclosure: I am/we are long CHMI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I currently have no position in AGNC, AI, ARR, CYS, DX, FMCC, FNMA, IVR, MFA, MITT, MTGE, NLY, ORC, TWO, or WMC. I am currently long AGNCB. I may initiate a position in AGNCP over the next 72 hours.

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