Assessing AGNC Investment’s Results For Q2 2017 (Including Current Price Target And Recommendation) – AGNC Investment Corp. (NASDAQ:AGNC)

Introduction/Recap:

On 7/26/2017, AGNC Investment Corp. (AGNC) reported results for the second quarter of 2017. AGNC reported net income of $24 million, other comprehensive income (“OCI”) of $121 million, comprehensive (total) income of $145 million, and a book value (“BV”) of $20.80 per common share as of 6/30/2017 (tangible BV of $19.25 per common share).

In my prior AGNC Q2 2017 income statement and EPS projection article, I anticipated the company would report the following amounts in relation to the second quarter of 2017: 1) net loss of ($20) million; 2) OCI of $159 million; and 3) comprehensive income of $139 million. In my prior AGNC Q2 2017 and 7/21/2017 BV projection article, I anticipated the company would report a BV of $20.72 per common share as of 6/30/2017. As such, I believe AGNC’s quarterly results were basically “as expected” (if anything a very slight outperformance) when compared to my projections (well within my projected ranges).

Within the first section of this article, I will summarize my prior articles’ account projections and compare each amount to AGNC’s actual results. If a specific account had at least a modest variance between projected and actual results, I will also provide an explanation on the variance. I will list AGNC’s accounts in the same order as projected in my income statement and EPS projection article (see link provided above).

Side Note: Through 7/28/2017, six other mortgage real estate investment trust (“mREIT”) companies that I currently cover recently disclosed to the public preliminary/actual 6/30/2017 BV per share amounts. I believe providing these quarterly BV fluctuations are beneficial for comparative purposes. As such, the following were the recent BV fluctuations for AGNC and six other mREIT companies during the second quarter of 2017 (in order of largest percentage increase to largest percentage decrease):

1) ARMOUR Residential REIT Inc. (ARR) (fixed-rate agency mREIT): Actual Q2 2017 BV increase of 3.04% (no projection provided for this mREIT)

2) CYS Investments Inc. (CYS) (fixed-rate agency mREIT): Actual Q2 2017 BV increase of 0.61% (BV of $8.31 per share as of 6/30/2017 versus my projection of $8.25 per share; $0.06 per share variance within range)

3) Annaly Capital Management Inc. (NLY) (fixed-rate agency mREIT): Preliminary Q2 2017 BV decrease of (0.36%) (BV of $11.19 per share as of 6/30/2017 versus my projection of $11.20 per share; $0.01 per share variance within range)

4) AGNC (fixed-rate agency mREIT): Actual Q2 2017 BV decrease of (0.86%) (BV of $20.80 per share as of 6/30/2017 versus my projection of $20.72 per share; $0.08 per share variance within range)

5) Capstead Mortgage Corp. (CMO) (variable-rate agency mREIT): Actual Q2 2017 BV decrease of (2.37%) (no projection provided for this mREIT)

6) Orchid Island Capital Inc. (ORC) (fixed-rate agency mREIT): Actual Q2 2017 BV decrease of (5.33%) (BV of $9.23 per share as of 6/30/2017 versus my projection of $9.35 per share; $0.12 per share variance within range)

7) Arlington Asset Investment Corp. (AI) (fixed-rate agency mREIT): Actual Q2 2017 BV decrease of (14.85%) (no projection provided for this mREIT)

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.

AGNC Actual Versus Projected Results:

To highlight my projected account figures versus AGNC’s actual reported results for the second quarter of 2017, Table 1 is provided below. Table 1 shows AGNC’s consolidated statement of comprehensive income from a three-months ended timeframe.

Table 1 – AGNC Three-Months Ended Consolidated Statement of Comprehensive Income (Actual Versus Projected)

(Source: Table created entirely by myself, partially using data obtained from AGNC’s quarterly investor presentation slides)

First, let us compare AGNC’s interest income account. My projection for this account was $315 million. AGNC reported interest income of $293 million. As such, AGNC’s interest income was a minor underperformance in my opinion. As discussed in my AGNC income statement projection article (see link provided above), I projected AGNC’s on-balance sheet mortgage-backed securities (“MBS”) portfolio would slightly-modestly increase during the second quarter of 2017. In contrast, AGNC’s on-balance sheet MBS portfolio remained relatively unchanged during the quarter which ultimately led to a slightly lower interest income figure (still within my stated range). As an alternative, AGNC chose to increase the company’s off-balance sheet net long “to-be-announced” (“TBA”) MBS position during the second quarter of 2017 due to the advantage of dollar roll financing. When it comes to AGNC’s quarterly and estimated lifetime “conditional prepayment rate” (“CPR”) percentages, both my projections were extremely close to AGNC’s actual reported percentages (consistent movement amongst most fixed-rate agency mREIT peers).

Second, my projection for AGNC’s interest expense account was $112 million. In comparison, AGNC reported interest expense of $112 million. As such, this was an “exact match”. As anticipated, the weighted average interest rate on AGNC’s repurchase loans modestly increased during the second quarter of 2017. AGNC’s weighted average interest rate on the company’s repurchase loans was 1.05% as of 3/31/2017. This rate increased to 1.27% as of 6/30/2017. The relationship between repurchase loan rates and the London Interbank Offered Rate (LIBOR) was originally discussed within my income statement projection article (see link provided above).

Third, my projection for AGNC’s MBS sales account was a minor net loss of ($50) million. In comparison, AGNC reported a minor net gain of $15 million. As discussed in my AGNC income statement projection article (see link provided above), I stated if AGNC’s actual realized gain (loss) amount was above or below my projected figure, this variance would automatically be offset within the company’s “unrealized gain (loss) on available-for-sale (“AFS”) securities, net” account. As such, my COMBINED projected figures would be accurately represented. In my professional opinion, both these accounts should really be looked at as one combined account. The unrealized gain (loss) on AFS securities, net account has an immediate impact on BV while the gain (loss) on sale of agency securities, net account is merely a reclassification out of the unrealized account.

So, when ultimately combining AGNC’s “gain (loss) on sale of agency securities, net” (see boxed blue reference “3”), unrealized gain (loss) on investment securities measured at FMV through net income, net” (see boxed blue reference “5a”), and unrealized gain (loss) on AFS securities, net (see boxed blue reference “5b”) accounts together, I projected the company would report a net gain of $134 million. These three combined accounts are the total valuation fluctuation within AGNC’s MBS portfolio. In comparison, AGNC reported a net gain of $145 million. Due to the sheer size of AGNC’s MBS portfolio ($46.6 billion as of 6/30/2017), I believe only having an $11 million variance within these three combined accounts is an extremely hard “feat” to accomplish/highly accurate.

Fourth, my projection for AGNC’s derivative instruments and other securities account was a modest net loss of ($184) million. In comparison, AGNC reported a modest net loss of ($169) million. Due to the complexities involved within this particular account, I believe this was a very accurate projection. Only having a $15 million variance within this account is another hard feat to accomplish due to the complexities surrounding how one values a company’s derivatives portfolio. I would also note projecting AGNC’s hedging portfolio involves projecting four material derivative sub-accounts (TBA MBS, interest rate swaps, interest rate swaptions, and U.S. Treasury securities) and several other minor derivative sub-accounts. While no one has a “crystal ball” per se regarding future events, being able to project all these derivative sub-accounts, before any sector peer provides quarterly results, takes a great deal of expertise in my opinion. This includes fully understanding how to value all theses derivative instruments and correctly deciding on specific assumptions that one believes coincided with management’s overall risk management strategy during any particular quarter.

Within AGNC’s four material derivative sub-accounts, the company’s TBA MBS slightly outperformed my expectations while its interest rate swaps and U.S. Treasury securities slightly underperformed my expectations. All four derivative sub-account projections were very close/close to my projected valuations (especially when considering each account had notional/face amounts that were valued in billions). Regarding AGNC’s TBA MBS, the company modestly increased its net long position during most of the second quarter of 2017. This ultimately led to higher net dollar roll (“NDR”) income being generated versus my projection. Regarding AGNC’s interest rate swaps, the company slightly increased its notional balance during the quarter (which I correctly anticipated). However, AGNC also went slightly further out on the yield curve regarding newly created interest rate payer swap contracts versus my projection. This ultimately led to a slightly higher net valuation loss for this specific derivative instrument.

Fifth, my projection for AGNC’s management fee income, compensation expense (formerly management fees), and operating expense accounts were $3, $10, and $7 million, respectively. AGNC reported management fee income, compensation expense, and operating expenses of $4, $10, and $6 million, respectively. Further discussion of these accounts is unwarranted.

When all account projections are combined, I projected AGNC would report comprehensive income of $139 million or $0.38 per common share during the second quarter of 2017. In comparison, AGNC reported comprehensive income of $145 million or $0.40 per common share. A $0.02 per common share variance regarding AGNC’s comprehensive income for the second quarter of 2017 versus my projection was well within my stated range and should be viewed as the company performing as expected.

When including projections within AGNC’s equity section of the balance sheet, this ultimately led to the company reporting a BV of $20.80 per common share versus my projection of $20.72 per common share. An $0.08 per common share variance regarding AGNC’s BV as of 6/30/2017 versus my projection was well within my stated range and should be viewed as a very minor outperformance when compared to my expectations. The variance within AGNC’s equity section of the balance sheet was due to the fact the underwriters actually didn’t exercise their option to purchase additional shares of the company’s common stock in relation to the May 2017 equity offering. In comparison, I anticipated the underwriters would fully exercise their option. As such, this actually led to less dilution when it came to the May 2017 equity offering and also resulted in a slightly less total dividend payment for the quarter.

Readers have continued to request that I provide these types of “update/follow-up” articles showing how my quarterly projections “stacked-up” to AGNC’s actual results. I believe the analysis above accomplishes this request. With that being said, let me briefly highlight some quarterly compositional changes that occurred within AGNC’s MBS and derivatives portfolios.

MBS Portfolio Considerations:

During the second quarter of 2017, AGNC slightly increased the company’s “at-risk” (total) leverage by altering the underlying composition of its on-balance sheet MBS portfolio and its off-balance sheet net long TBA MBS position. AGNC had an at-risk (total) leverage ratio, when including the company’s intangible assets, goodwill, and off-balance sheet net long TBA MBS position, of 7.5x as of 6/30/2017. To show the compositional changes to AGNC’s on- and off-balance sheet MBS portfolio during the second quarter of 2017, Table 2 is provided below.

Table 2 – AGNC MBS Portfolio Quarterly Compositional Changes (6/30/2017 Versus 3/31/2017)

(Source: Table created entirely by myself, including all calculated figures and percentages)

Using Table 2 above as a reference, when comparing AGNC’s portfolio as of 6/30/2017 versus 3/31/2017, the company had a net par value increase (decrease) in its 15-year fixed-rate agency MBS holdings with a 2.5%, 3.0%, 3.5%, 4.0%, and 4.5% coupon of ($0.9), $1.0, ($0.3), ($0.2), and less than ($0.1) billion, respectively. When all 15-year fixed-rate agency MBS holdings are combined, this was a quarterly net par value decrease of ($0.4) billion. This was partially due to portfolio “runoff” and also included some sales and purchases within lower coupons. AGNC had a net par value increase (decrease) in the company’s 30-year fixed-rate agency MBS holdings with a 3.0%, 3.5%, 4.0%, 4.5%, 5.0%, and 5.5% coupon of ($0.3), $3.1, $1.6, ($0.1), less than ($0.1), and less than ($0.1) billion, respectively. When all 30-year fixed-rate agency MBS holdings are combined, this was a quarterly net par value increase of $4.4 billion (rounded). Again, this net increase was mainly due to AGNC’s larger net long TBA MBS position as of 6/30/2017 when compared to 3/31/2017 and a relatively unchanged on-balance sheet MBS portfolio fluctuation.

Since AGNC rotated a small proportional share of the company’s MBS portfolio into higher coupons, I believe management has tentatively come to the conclusion higher mortgage interest rates/U.S. Treasury yields may occur during the rest of 2017. As I have highlighted in various prior mREIT articles, typically fixed-rate MBS portfolios with higher coupons “mitigate” the severity of valuation losses in a rising interest rate environment (typically lower durations). Now let us move on to AGNC’s derivatives portfolio.

Derivatives Portfolio Considerations:

During the second quarter of 2017, AGNC slightly increased the company’s hedging coverage ratio by slightly altering the underlying composition of its derivatives portfolio. To show the compositional changes to AGNC’s derivatives portfolio during the second quarter of 2017, Table 3 is provided below.

Table 3 – AGNC Derivatives Portfolio Quarterly Compositional Changes (6/30/2017 Versus 3/31/2017)

(Source: Table created entirely by myself, partially using data obtained from AGNC’s quarterly investor presentation slides [link provided below Table 1])

Using Table 3 above as a reference, AGNC had a hedging coverage ratio of 90% as of 3/31/2017. AGNC’s hedging coverage ratio slightly increased to 98% as of 6/30/2017. This includes a net (short) position increase within AGNC’s interest rate payer swaps and swaptions. This also includes a relatively unchanged net (short) position within AGNC’s U.S. Treasury securities. AGNC also increased the company’s weighted average tenor/maturity from 5.2 years as of 3/31/2017 to 5.7 years as of 6/30/2017. As discussed earlier, I believe management has tentatively come to the conclusion higher mortgage interest rates/U.S. Treasury yields may occur during the rest of 2017 (since maintaining a high hedging coverage ratio). As I have highlighted in various prior mREIT articles, typically a derivatives portfolio with a higher hedging coverage ratio mitigates the severity of BV losses in a rising interest rate environment.

Conclusions Drawn:

I believe AGNC’s results for the second quarter of 2017 were as expected when compared to my projections. When all account projections are combined, I projected AGNC would report comprehensive income of $139 million or $0.38 per common share during the second quarter of 2017. In comparison, AGNC reported comprehensive income of $145 million or $0.40 per common share.

All of the accounts that I projected were either very close or close to actual reported results. I believe AGNC’s performance, when compared to the six other sector peers discussed earlier, should be seen as a “cautious” trend (“middle of the pack” per se). Through a detailed analysis that will be omitted from this particular article, I am projecting AGNC’s BV as of 7/28/2017 has fluctuated $0.05–$0.35 per common share when compared to the company’s BV as of 6/30/2017. This projection includes the July 2017 monthly dividend of $0.18 per common share (ex-dividend was 7/27/2017). During July 2017, there has been a more positive relationship that has developed between agency MBS pricing and derivative instrument valuations (tightening of spreads).

My BUY, SELL, or HOLD Recommendation:

From the analysis provided above, including additional catalysts/factors not discussed within this particular article, I currently rate AGNC as a SELL when I believe the company’s stock price is trading at less than a (2.5%) discount to the mean of AGNC’s projected CURRENT BV range (BV as of 7/28/2017; $21.00 per share), a HOLD when trading at or greater than a (2.5%) but less than a (10.0%) discount to the mean of AGNC’s projected CURRENT BV range, and a BUY when trading at or greater than a (10.0%) discount to the mean of AGNC’s projected CURRENT BV range. These ranges are unchanged when compared to my last AGNC article (approximately two weeks ago).

Therefore, I currently rate AGNC as a SELL (however fairly close to my HOLD range) since the stock is trading at less than a (2.5%) discount to the mean of AGNC’s projected CURRENT BV range ($21.00 per share). My current price target for AGNC is approximately $20.50 per share. This is currently the price where my recommendation would change to a HOLD. This is a $0.25 per share increase when compared to my last AGNC article. The current price where my recommendation would change to a BUY is approximately $18.90 per share. This is also a $0.25 per share increase when compared to my last AGNC article.

Along with the data presented within this article, this recommendation considers the following mREIT catalysts/factors: 1) projected future MBS price movements; 2) projected future derivative valuations; and 3) projected near-term dividend per share rates. This recommendation also considers the high probability of multiple Federal (“Fed”) Funds Rate increases by the Federal Open Market Committee (“FOMC”) during 2017-2018 (this is a more hawkish view when compared to most of last year) due to recent macroeconomic trends/events. This also considers the eventual “wind-down” of the Fed’s balance sheet.

Final Note: 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.

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.

On 7/21/2017, I initiated a position in AGNCP; Series A preferred stock. On 7/31/2017, I increased my position in AGNCP. When combined, my AGNCP position has a weighted average purchase price of $25.331 per share. I currently hold (personally and through affiliated entities) 0.49% of the outstanding shares of AGNCP. Each AGNCP 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/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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 am currently long AGNCB and AGNCP.

Leave a Reply

Your email address will not be published. Required fields are marked *

*

5 × 3 =