American Capital Agency Corp.

Transcription

1 January 15, 2015 American Capital Agency Corp. (AGNC-NASDAQ) Current Recommendation Prior Recommendation Neutral Date of Last Change 10/15/2014 Current Price (01/14/15) $21.53 Target Price $26.00 SUMMARY DATA OUTPERFORM 52-Week High $ Week Low $20.14 One-Year Return (%) Beta 0.22 Average Daily Volume (sh) 3,122,822 Shares Outstanding (mil) 353 Market Capitalization ($mil) $7,600 Short Interest Ratio (days) 1.78 Institutional Ownership (%) 54 Insider Ownership (%) 0 SUMMARY American Capital Agency is slated to report its fourth quarter 2014 earnings after market close on Feb 2. The company s third-quarter 2014 net spread and dollar roll income per share (excluding "catch-up" premium amortization) significantly exceeded the Zacks Consensus Estimate. Results benefited from the strategic decisions implemented by the company to counter the changing interest rates and mortgage market scenario. Notably, the Fed had earlier commented about keeping its key lending rate near zero for a considerable time. It replaced the comment with the phrase the committee judges it can be patient in its latest December meeting. Further, with the Fed Chair disclosing that the committee is not expecting rate hikes until at least a couple of meetings later, we believe that the low rate environment would continue for a sufficient time. This, in turn, would allow the company to experience low borrowing costs and reap decent gains over the short term. Risk Level * Low, Type of Stock Large-Value Industry Reit-Mtge Trust Zacks Industry Rank * 42 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) Annual Cash Dividend $2.64 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 56.2 Earnings Per Share (%) Dividend (%) using TTM EPS 6.9 using 2014 Estimate 6.8 using 2015 Estimate A 384 A 381 A 423 A 1,596 A A 414 A 413 A 422 A 1,656 A A 290 A 269 A 322 E 1,172 E ,224 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2012 $1.42 A $0.94 A $0.79 A $0.89 A $4.04 A 2013 $1.09 A $1.01 A $0.61 A $0.67 A $3.38 A 2014 $0.71 A $0.87 A $0.86 A $0.74 E $3.18 E 2015 $2.72 E Zacks Rank *: Short Term 1 3 months outlook 1 - Strong Buy Projected EPS Growth - Next 5 Years % * Definition / Disclosure on last page 2015 Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL N/A

2 OVERVIEW American Capital Agency Corp. is a real estate investment trust (REIT) that focuses on leveraged investments in agency mortgage-backed securities (MBS). That includes residential mortgage passthrough securities and collateralized mortgage obligations (CMOs). Importantly, for them, a U.S. Government agency or a U.S. Government-sponsored enterprise guarantees the principal and interest payments. The company s investment may also comprise agency debenture securities that are issued by Freddie Mac, Fannie Mae or the Federal Home Loan Bank, as well as other assets that are convincingly associated with agency securities. The company purchases single-family residential pass-through securities, which are interests in pooled loans of principal and interest including pre-paid principal, that are made to the holders of the notes. Moreover, collateralized mortgage obligations consist of multiple classes with payments of principal and interest being made to note holders based on the maturity date of the class of security. The mortgages underlying these agency securities are fixed rate, adjustable rate or hybrid (fixed and adjustable) securities. Agency securities differ from traditional fixed-income investments as principal and interest are paid on a regular schedule, and there is a possibility that the principal will be prepaid by mortgage holders if the interest rates fall. American Capital Agency borrows against its investment portfolio pursuant to a master repurchase agreement, which provides short-term financing, typically days. The company expects to make profit and pay dividend from the net interest income, which is the difference between interest earned on investments and its cost of borrowing. American Capital Agency is externally managed and advised by American Capital AGNC Management, LLC, an affiliate of American Capital Ltd. REASONS TO BUY American Capital Agency adheres to an active portfolio management policy that includes reevaluation and adjustment of its portfolio, as well as hedges amid a varying interest rate and mortgage market environment. This is expected to cushion the book value in the current rate environment. The Fed commented that it would keep its key lending rate near zero for a considerable time before replacing it with the phrase the committee judges it can be patient in its latest December meeting. Further, with the Fed Chair disclosing that the committee is not anticipating rate hikes until at least a couple of meetings later, we believe that the company has scope to experience low borrowing cost and reap decent gains over the short term. American Capital Agency invests only in fixed-rate agency securities where payments are guaranteed by the U.S. government or government-owned entities, such as Fannie Mae (FNMA), Freddie Mac (FHLMC) and Ginnie Mae (GNMA). Specifically, American Capital Agency invests in FHLMC Gold certificates, FNMA certificates and GNMA certificates. We approve of the company s focused investment approach, which is not distracted by originations, servicing or credit risk from investments in mortgages that do not have the backing of the U.S. government. With the government takeover of FNMA and FHLMC, American Capital Agency s securities now have an explicit government guarantee, which makes it a much more attractive prospect for investors. Additionally, the company s portfolio of government-backed assets is relatively liquid with a limited credit risk. The company enjoys a solid financial position with adequate access to longer-term funding and substantial excess capacity. Its total Repo funding capacity at the quarter end was about double its Equity Research AGNC Page 2

3 outstanding Repo position. As a result of excess capacity, the company enjoys flexibility in the opportunistic enhancement of its portfolio. Also, repo funding is well diversified by counterparty and geography. RISKS During the third quarter, mortgage spreads widened, resulting in reasonably larger price declines on agency MBS, relative to Treasuries and swaps of comparable duration. The company s book value declined in the quarter. Though the company has taken steps to counter the challenges, we remain skeptical about any robust improvement in its book value amid volatility in mortgage market. Moreover, prepayment risk generally increases when interest rates decline, and as a result, the company s financial results may be adversely affected, which may lead it to invest that principal at potentially lower yields. In fact, amid the sharp lower trends in rates since the end of the third quarter, the company expects prepayment speeds to pick up on certain segments of the mortgage market. However, the company anticipated that higher overall origination cost and borrower burnouts would possibly bound the extents of the refinance response, as compared to the reaction experienced at similar rate levels in prior years. While the company s hedges are sketched to help offset book-value fluctuations arising from interest rate changes, they are not designed to shield it against market-value fluctuations in its assets resulting from changes in the spread between the company s investments and other benchmark rates like swap and treasury rates. This exposes the company s business to the risk of adverse spread changes. RECENT NEWS AGNC Beats Q3 Earnings Estimates, Book Value Falls Oct 27, 2014 American Capital Agency Corp. s third-quarter 2014 net spread and dollar roll income of $0.86 per share (excluding "catch-up" premium amortization) significantly exceeded the Zacks Consensus Estimate of $0.77. Results benefited from the strategic decisions implemented by the company to counter the changing interest rates and mortgage market scenario. For the third quarter, net spread and dollar roll income included $0.43 per share of dollar roll income, reflecting an uptick from $0.39 in the preceding quarter. However, results came $0.01 per share below the prior-quarter figure of $0.87. The company s annualized economic loss on common equity was 1.1% in the reported quarter, compared with the economic return on common equity of 39.6% in the prior quarter. Moreover, as of Sep 30, 2014, the company s net book value per share was $25.54, down 2.7% from $26.26 per share as of Jun 30, 2014, driven by wider mortgage spreads. Net interest income of $269 million came below the prior-quarter level of $290 million and also missed the Zacks Consensus Estimate of $297 million. Behind the Headline Numbers As of Sep 30, 2014, the company's investment portfolio aggregated $69.5 billion of agency MBS. This included $17.7 billion of net long TBA (to-be-announced) mortgage position at fair value. Equity Research AGNC Page 3

4 Including its net TBA position, American Capital Agency s "at risk" leverage ratio was 6.7x as of Sep 30, 2014, compared with 6.9x as of Jun 30, For the third quarter, the company s investment portfolio had a CPR (constant prepayment rate) of 10%, versus 9% in the prior quarter. Average asset yield on the company s agency security portfolio was 2.71%, unchanged sequentially. Combined annualized net interest rate spread on its repo and dollar roll funded assets was 1.90%, compared with 1.84% in the prior quarter. Moreover, as of Sep 30, 2014, American Capital Agency had cash and cash equivalents of $1.71 billion, down from $1.75 billion at the end of the prior quarter. In September, the company disclosed a change in its common stock dividend distribution schedule the distributions would now be made monthly instead of quarterly. As per this move, the company announced its first monthly dividend of $0.22 per share on Oct 16. This dividend would be paid on Nov 7, 2014 to shareholders of record on Oct 31. On Sep 18, 2014, the company declared a third-quarter dividend on its common stock of $0.65 per share, unchanged from the preceding quarter. This was paid on Oct 27 to common stockholders of record as of Sep 30, As a matter of fact, the company paid a total of $4.9 billion or $29.56 per share in common dividends, since its initial public offering in May Share Repurchase Update American Capital Agency disclosed an extension of its current share repurchase program through Dec 31, Notably, during the third quarter, the company did not buy back any of its common stock and as of Sep 30, 2014, the company had an authorization of $992 million left. Dividend and net asset value ("NAV") Announcement On Dec 15, 2014, American Capital Agency disclosed that its Board of Directors has declared a cash dividend of $0.22 per share of common stock for Dec The dividend was paid on Jan 9, 2015 to common shareholders of record as of Dec 31, The company also revealed its estimated NAV of $25.74 per share of common stock as of Nov 30, This is net of its Nov 2014 common stock dividend, which was paid on Dec 5, Equity Research AGNC Page 4

5 VALUATION Shares of American Capital Agency currently trade at 6.8x the Zacks Consensus Estimate for 2014, a 21.8% discount to the industry average. On a price-to-book basis, the shares trade at 0.9x, a 43.8% discount to the industry average. Therefore, the valuation looks attractive both on a and price-tobook basis. Our six-month target price of $26.00 equates to 8.2x the Zacks Consensus Estimate for Considering the monthly dividend payout, this target price implies an expected return of 26.9% over that period. This is consistent with our Outperform recommendation on the shares. Also, American Capital Agency currently carries a Zacks Rank #1 (Strong Buy). Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low American Capital Agency Corp. (AGNC) NA Industry Average S&P Walter Investment Management Corp. (WAC) Annaly Capital Management, Inc. (NLY) Altisource Portfolio Solutions S.A. (ASPS) Starwood Property Trust, Inc. (STWD) 11.7 NA TTM is trailing 12 months; F1 is 2014 and F2 is 2015, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA American Capital Agency Corp. (AGNC) Industry Average S&P Equity Research AGNC Page 5

6 Earnings Surprise and Estimate Revision History Equity Research AGNC Page 6

7 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of AGNC. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1106 companies covered: Outperform %, Neutral %, Underperform 5.8%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Coverage Team QCA Lead Analyst Analyst Copy Editor Content Ed. 11C Kalyan Nandy Moumita C. Chattopadhyay Moumita C. Chattopadhyay Anuja Mitra Moumita C. Chattopadhyay Equity Research AGNC Page 7