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How Do These High-Yielding REITs Really Make Their Money?

American Capital Agency Corp. (AGNC) and the other high dividend stocks called REITs are quite leveraged.  They are at the mercy of the banks that issue/supply their repurchase agreements.  They are borrowed short (repurchase agreements) and lent long (agency securities) just like commercial banks.  That’s fine so long as there are no financial crisis’s looming in the future.  Guess what?  The structural problems caused by fractional-reserve banking are not fixed.  Central banks around the world are printing money which just masks the problems and make them worse.

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They pledge their existing assets (agency securities) as collateral to other banks in return for a very short term loan through repurchase agreements.  The repurchase agreements loans and new stock offerings get them the capital necessary to purchase new agency securities from Fannie, Freddie, and to a lesser extent Ginnie.  They use the income generated from the agency securities and the sale of some agency securities to pay off the repurchase agreement loans when they come due.  Some of the risks to their income are badly performing agency securities (remember those toxic mortgage backed securities and what happens when people who are unemployed stop paying their mortgages) and a decline in the price of agency securities (for the same reason mentioned and Federal Reserve intervention in the MBS market).

Because they are borrowed short and lent long they won’t have the money coming in to keep their current dividend payments during the next financial crisis.  For example, AGNC has a quick ratio of 0.08.  I like to see this ratio above 1.0 meaning that the company has more current assets than current liabilities.  The cash equivalents that AGNC has on hand (current assets) are miniscule compared to their billions in repurchase agreements (current liabilities).

For comparison let’s look at Safe Bulkers quick ratio.  It is 3.30.  They have over three times their current liabilities in current assets that could be liquidated in an emergency to keep paying their fat dividend.

How Do These High-Yielding REITs Really Make Their Money?

By Jim Royal
January 18, 2011

As investors, we need to understand how our companies truly make their money. And there's a neat trick developed for just that purpose. It's called the DuPont Formula.

By using the DuPont Formula, you can get a better grasp on exactly where your company is producing its profit and where it might have a competitive advantage. Named after the company where it was pioneered, the DuPont Formula breaks down return on equity into three components:

Return on equity = Net margins x asset turnover x leverage ratio

High net margins show that a company is able to get customers to pay more for its products. (Think luxury goods companies.) High asset turnover indicates that a company needs to invest less of its capital, since it uses its assets more efficiently to generate sales. (Think service industries, which often do not have high capital investments.) Finally, the leverage ratio shows how much the company is relying on debt to create profit.

Generally, the higher these numbers, the better. Of course, too much debt can sink a company, so beware of companies with very high leverage ratios.

Let's take a look at Annaly Capital Management (NYSE: NLY) and a few of its sector and industry peers.

Company

Return on Equity

Net Margins

Asset Turnover

Leverage Ratio

Annaly Capital Management

8.2%

79.7%

0.01

8.03

Chimera Investment (NYSE: CIM)

18.5%

91.6%

0.09

2.28

American Capital Agency (Nasdaq: AGNC)

28.4%

92.1%

0.03

10.46

Anworth Mortgage Asset (NYSE: ANH)

12.7%

88.2%

0.02

6.95

Source: Capital IQ, a division of Standard & Poor's.

Each of these companies offers a truly amazing dividend, ranging from 12.7% for Anworth to 19% for American Capital Agency. And how do these guys do it? This DuPont formula screen shows clearly: high leverage and fat net margins. Net margins for these group ranges from 80% to 92%, while most are very highly leveraged, with the exception of Chimera. Those tasty dividends bring out the gambler in some investors, which may explain why you might want to avoid some of these too-tempting stocks.

Breaking down a company's return on equity can often give you some insight into how it's competing against peers and what type of strategy it's using to juice its return on equity.

Jim Royal, Ph.D., owns shares of Annaly. The Fool owns shares of Annaly Capital Management.

Link to the original article: http://www.fool.com/investing/dividends-income/2011/01/18/how-do-these-high-yielding-reits-really-make-their.aspx

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Home price drops exceed Great Depression: Zillow

The price of houses will continue to decline due to excess inventory and high unemployment.  There are millions of foreclosed homes that the banks are keeping off the market.  They are known as the shadow inventory.  I’ve seen some articles put the number of homes in the “shadow inventory” close to 7 million homes.  That is literally years of inventory.

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Unemployment was really at 16.7% in December 2010 (the U-6 number  http://www.bls.gov/news.release/empsit.t15.htm ).  And it is not going to improve until the commercial banks increase lending to small businesses.

Unfortunately, that lending will create rising prices in all goods through the fractional-reserve banking process.  This is what happens when the Federal Reserve doubles the monetary base.  It will lead to huge price increases once the commercial bankers increase lending.

This article from Reuters confirms what we know in our heads.  But the newspapers and the TV news coverage tries to cover these facts up.  They avoid comparisons with the Great Depression because they are taught to believe the great Keynesian lie of consumer spending is the only way to grow the economy.

Lower home prices due to increased foreclosures would further erode the value of mortgage backed securities in the market.  That would make the agency securities on American Capital Agency Corp’s (AGNC’s) balance sheet worth less.  This would also hurt their sale price.  All this should hurt AGNC’s earnings.

However, if the FED buys more MBS after the point they previously said they were going to stop, then things change.  If the FED continues to purchase mortgage backed securities from Fannie and Freddie to bailout the big banks that still have MBS’s on their balance sheets, then this would increase their price in the market due to the increased artificial demand.  AGNC might have to pay more to buy its next batch of agency securities and the risk increases of a collapse in market value of MBS’s if the FED decides to sell some of its MBSs.  They would be propping up the MBS market for a bigger bust later.

Home price drops exceed Great Depression: Zillow

NEW YORK | Tue Jan 11, 2011 8:40am EST

NEW YORK (Reuters) - Home prices fell for the 53rd consecutive month in November, taking the decline past that of the Great Depression for the first time in the prolonged housing slump, according to Zillow.

Home prices have fallen 26 percent since their peak in 2006, exceeding the 25.9 percent drop registered in the five years between 1928 and 1933, the housing data company said in a report on Monday. Prices fell 0.8 percent over the month.

It is a dubious milestone for the U.S. housing market which has failed to gain much traction despite a host of government programs to reduce delinquencies and encourage demand with temporary tax credits and lower interest rates. Many economists expect further price drops, even if there are some anecdotal signs of growing demand, such as in pending home sales data.

"For the next six to nine months, the larger factors affecting the housing market that will produce more home price declines will be the excess inventory of homes, high negative equity and foreclosure rates, and weakened demand due to elevated employment, Stan Humphries, Zillow's chief economist, said in a blog post.

Declines are accelerating, and it will take a while before falling unemployment and other signs of economic improvement support the market, Zillow said.

Home prices fell at a 0.78 percent pace in November, the fastest since February 2009, the company said.

(Reporting by Al Yoon, Editing by Kenneth Barry)

http://www.reuters.com/article/idUSTRE70961E20110111

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Warning - AGNC dividend payout ratio might exceed 115%

Warning - AGNC dividend payout ratio might exceed 115% for 4Q2010.

AGNC’s last quarterly dividend was $1.40 per share.  They announced in December that they would pay a $1.40 dividend for 4Q2010.  They have paid $1.40 per share since 3Q2009.  However, AGNC disclosed on January 12th, 2011 that it expects to earn at least $1.20 in 4Q2010.  That isn’t enough to cover the dividend.  I wrote about this on December 17th, 2010.

http://bit.ly/how-much-longer

Their dividend payout ratio will rise above 100%.  That is a warning to high dividend stock investors that a cut to the dividend in coming in future quarters unless something changes that course.  A $1.40 divided by $1.20 equals a dividend payout ratio of 116%.  Yikes!  If the unnamed analysts are correct, then the payout ratio will be 108.5% for 4Q2010.  Factor this into your investment plans if you own AGNC.

Disclosure: I don’t own AGNC shares.

American Capital Agency Corp. Issues Q4 2010 EPS Guidance In Line With Analysts' Estimates
Wednesday, 12 Jan 2011 04:08pm EST 

American Capital Agency Corp. announced that for the fourth quarter of 2010, it expects earnings per share (EPS) to exceed $1.20, including an anticipated benefit from slower projected prepayment speeds. According to Reuters Estimates, analysts are expecting the Company to report EPS of $1.29 for the fourth quarter of 2010. 

http://www.reuters.com/finance/stocks/keyDevelopments?rpc=66&symbol=AGNC.O&timestamp=20110113225400

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How Not to Analyze Earnings Deficits.

Analyzing earnings deficits is a tricky thing.  Many stocks earned deficits in 2009 including some high dividend stocks.  Should you only look at the deficits per share when comparing Company A to Company B, especially when both companies are selling for the same price in the market?  Of course not.

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I have been analyzing American Capital Agency Corp. (AGNC) for the last few months.  AGNC has not experienced a deficit in its short history.  The company went public in 2008 and income has been increasing every year (so far).  So the following does not apply to them.

Below is the appropriate excerpt from Benjamin Graham’s and David Dodd’s excellent book “Security Analysis”.  Apply their wisdom to your high dividend stocks that might have some earnings losses over the last five years.

* * * * * * * *

Deficits a Qualitative, Not a Quantitative Factor.  When a company reports a deficit for the year, it is customary to calculate the amount in dollars per share or in relation to interest requirements. The statistical manuals will state, for example, that in 1932 United States Steel Corporation earned its bond-interest “deficit 12.40 times” and that it showed a deficit of $11.08 per share on its common stock. It should be recognized that such figures, when taken by themselves, have no quantitative significance and that their value in forming an average may often be open to serious question.

Let us assume that Company A lost $5 per share of common in the last year and Company B lost $7 per share. Both issues sell at 25. Is this an indication of any sort that Company A stock is preferable to Company B stock? Obviously not; for assuming it were so, it would mean that the more shares there were outstanding the more valuable each share would be. If Company B issues 2 shares for 1, the loss would be reduced to $3.50 per share, and on the assumption just made, each new share would then be worth more than an old one. The same reasoning applies to bond interest. Suppose that Company A and Company B each lost $1,000,000 in 1932. Company A has $4,000,000 of 5% bonds and Company B has $10,000,000 of 5% bonds. Company A would then show interest earned “deficit 5 times” and Company B would earn its interest “deficit 2 times.”  These figures should not be construed as an indication of any kind that Company A’s bonds are less secure than Company B’s bonds. For, if so, it would mean that the smaller the bond issue the poorer its position—a manifest absurdity.

When an average is taken over a period that includes a number of deficits, some question must arise as to whether or not the resultant figure is really indicative of the earning power. For the wide variation in the individual figures must detract from the representative character of the average.  This point is of considerable importance in view of the prevalence of deficits during the depression of the 1930’s. In the case of most companies the average of the years since 1933 may now be thought more representative of indicated earning power than, say, a ten-year  average 1930–1939.

* * * * * * * *

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Last Article Ended Prematurely. Here Is The Rest.

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This article is part of our Rising Star Portfolios series. You can read about the Dada Portfoliohere.

Unemployment is obstinate, companies are operating below capacity, and inflation is low.

Are there any companies that can actually benefit from the slump?

Why, yes there are
The name that's caught my interest is Annaly Capital 

(NYSE: NLY)
, one of the largest publicly traded residential real estate investment trusts (REITs).

Annaly's business model seems complicated, but it's actually pretty straightforward: Imagine if you could borrow $10,000 at 2%, lend it at 4% to a guaranteed borrower, and keep the $200 difference.

That's Annaly's business in a nutshell. The company issues shares to raise capital, which it levers up with short-term financing. It uses this capital to buy longer-term mortgage-backed securities (MBS's), collects the interest on these securities or sells them, and then repays its lenders.

Virtually all the leftover profit is returned to shareholders via dividends. This currently works out to a 15% yield. (As a REIT, Annaly is required to distribute least 90% of its earnings as a dividend in exchange for not having to pay corporate income taxes. However, this dividend can be taxed differently than normal dividends.)

The diagram below shows how it all comes together, with arrows representing money flows:

anImage

Shareholders and lenders provide Annaly with capital which the company uses to buy mortgage-backed securities.

The bulk of Annaly's profit is the difference between the short term rates at which it borrows, and the long term rates at which it lends, multiplied by the amount of leverage it employs – currently 6.4 times.

This is similar to the profit model employed by many proprietary traders at banks likeGoldman Sachs (NYSE: GS)

JPMorganBank of America(NYSE: BAC), and Citigroup (NYSE: C). The difference is that Annaly's investments are probably safer (all of them are issued and guaranteed by U.S. government agencies), a greater portion of the rewards are distributed to shareholders rather than as bonuses to traders, and proprietary trading will theoretically become illegal for the aforementioned banks should regulators actually enforce financial reform legislation.

There are other companies similar to Annaly, such as American Capital Agency (Nasdaq: AGNC)Hatteras Financial (NYSE: HTS), and Annaly-managed Chimera (NYSE: CIM). But Annaly's bigger, has an ultra-safe portfolio, a long track record, and a strong management team headed up by Michael Farrell.

Here's where things get good
When inflation is too low and unemployment too high -- as is the case today -- the Federal Reserve lowers short term interest rates to stimulate the economy. The Fed is currently targeting 0%-0.25%, pretty much as low as you can go.

Since short-term rates are more responsive to the Fed's low interest rate targeting and Annaly borrows at short-term rates to purchase longer-term securities, its costs have fallen significantly faster than the interest it collects.

Check out how the declining Fed funds rate (green) drags down Annaly'sborrowing costs (red) much faster than its investments yield (blue). The area between red and blue is Annaly's interest spread (profit):

anImage


Source: Company filings and the Federal Reserve Bank of New York.

This is an awesome environment for Annaly. The current spread of 2.11% (the area between the blue and red lines and the key determinant of the company's profitability) -- is nearly double its historical average of approximately 1.20%.

And it's one that's likely to persist for some time. As it's exceedingly unlikely we're going to see any meaningful economic stimulus to address unemployment emerge from the soon-to-be Republican-controlled House of Representatives and dysfunctional Senate, we can expect the slump – and low interest rates – to continue for some time. Traditional monetary rules prescribe as many as four years (!) of near-zero percent interest rates to cope even with mainstream economic forecasts.

Scenarios galore
Here are a few possible scenarios and their outcomes for our investment in Annaly, ranked from most to least likely.

  • The slump goes on: We continue to collect dividends on a massive interest spread – approximately 10%-15% annually.
  • Fed gets more aggressive: Intensified policies like quantitative easing that seek to lower long-term interest rates could put the squeeze on Annaly's interest spread. Annaly sells its investments at a profit and pays a dividend.
  • Employment recovers or inflation rises: Fed raises interest rates, Annaly's profits decline and investments fall in value. While Annaly is partially hedged and I don't expect this to happen for at least a couple of years, this would be a bad situation for our investment in Annaly.
  • Radical GSE reform: Legislation pulls the rug out from under the mortgage market by removing federal guarantees for Fannie- and Freddie-issued securities. In this unlikely scenario, Annaly could have to switch business models, but our downside is protected somewhat by the stock's modest (1.2 times book value) valuation.

We're buying
We're buying $500 of Annaly shares. The most likely outcome is that the economy will remain sluggish, interest rates stay more-or-less favorable, and the Dada Portfolio collects a large yield for at least a year or two.

We're not expecting much share appreciation from Annaly, as the company, by law, retains very little of its earnings. Growth is often financed with share offerings, though the company has historically done of good job of selling when its valuation is high.

Instead, we're buying the stock for its tasty 15% yield that should remain high so long as the economy lumbers along and the Fed holds interest rates down.

The Dada Portfolio is a part of the Rising Star series of real money portfolios. It is co-managed by Sean Sun and Ilan Moscovitz

Should You Buy High Dividend REITs? The Motley Fool and I Disagree.

The market is already driving interest rates higher.  This is going to narrow profits at all of the REITs.  These high dividend stocks are for short term investors looking for a quick 3.5-5% quarterly dividend.  Remember that they are not qualified dividends that are taxed at 15%.  They are taxed as ordinary income (meaning 25% - 35%) for higher income investors.  Buy these at the bottom of the next crash if you really believe in the sustainability of there business models.

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The Federal Reserve is not currently in control of the Fed Funds rate (the rate that banks charge each other for overnight loans to meet their reserve requirements).  The large commercial banks are in control of this rate because they are flush with over a trillion dollars in excess reserves.  They aren't borrowing from each other overnight.  The short term rates can and will rise outside of the Federal Reserves control.

Recs

108

    Rising Star Buy: Annaly Capital


     | Comments (27)

    Don't let it get away!

    Keep track of the stocks that matter to you.

    Help yourself with the Fool's FREE and easy new watchlist service today.

    This article is part of our Rising Star Portfolios series. You can read about the Dada Portfolio here.

    Unemployment is obstinate, companies are operating below capacity, and inflation is low.

    Are there any companies that can actually benefit from the slump?

    Why, yes there are
    The name that's caught my interest is Annaly Capital(NYSE: NLY), one of the largest publicly traded residential real estate investment trusts (REITs).

    Annaly's business model seems complicated, but it's actually pretty straightforward: Imagine if you could borrow $10,000 at 2%, lend it at 4% to a guaranteed borrower, and keep the $200 difference.

    That's Annaly's business in a nutshell. The company issues shares to raise capital, which it levers up with short-term financing. It uses this capital to buy longer-term mortgage-backed securities (MBS's), collects the interest on these securities or sells them, and then repays its lenders.

    Virtually all the leftover profit is returned to shareholders via dividends. This currently works out to a 15% yield. (As a REIT, Annaly is required to distribute least 90% of its earnings as a dividend in exchange for not having to pay corporate income taxes. However, this dividend can be taxed differently than normal dividends.)

    The diagram below shows how it all comes together, with arrows representing money flows:

    anImage

    Shareholders and lenders provide Annaly with capital which the company uses to buy mortgage-backed securities.

    The bulk of Annaly's profit is the difference between the short term rates at which it borrows, and the long termrates at which it lends, multiplied by the amount ofleverage it employs – currently 6.4 times.

    This is similar to the profit model employed by many proprietary traders at banks likeGoldman Sachs (NYSE:GS)JPMorganBank of America (NYSE: BAC), andCitigroup (NYSE: C). The difference is that Annaly's investments are probably safer (all of them are issued and guaranteed by U.S. government agencies), a greater portion of the rewards are distributed to shareholders rather than as bonuses to traders, and proprietary trading will theoretically become illegal for the aforementioned banks should regulators actually enforce financial reform legislation.

    There are other companies similar to Annaly, such asAmerican Capital Agency (Nasdaq: AGNC)Hatteras Financial (NYSE: HTS), and Annaly-managed Chimera(NYSE: CIM). But Annaly's bigger, has an ultra-safe portfolio, a long track record, and a strong management team headed up by Michael Farrell.

    Here's where things get good
    When inflation is too low and unemployment too high -- as is the case today -- the Federal Reserve lowers short term interest rates to stimulate the economy. The Fed is currently targeting 0%-0.25%, pretty much as low as you can go.

    Since short-term rates are more responsive to the Fed's low interest rate targeting and Annaly borrows at short-term rates to purchase longer-term securities, its costs have fallen significantly faster than the interest it collects.

    Check out how the declining Fed funds rate (green) drags down Annaly's borrowing costs (red) much faster than its investments yield (blue). The area between red and blue is Annaly's interest spread (profit):

    anImage


    Source: Company filings and the Federal Reserve Bank of New York.

    This is an awesome environment for Annaly. The current spread of 2.11% (the area between the blue and red lines and the key determinant of the company's profitability) -- is nearly double its historical average of approximately 1.20%.

    And it's one that's likely to persist for some time. As it's exceedingly unlikely we're going to see any meaningful economic stimulus to address unemployment emerge from the soon-to-be Republican-controlled House of Representatives and dysfunctional Senate, we can expect the slump – and low interest rates – to continue for some time. Traditional monetary rules prescribe as many as four years (!) of near-zero percent interest rates to cope even with mainstream economic forecasts.

    Scenarios galore
    Here are a few possible scenarios and their outcomes for our investment in Annaly, ranked from most to least likely.

    Average earnings vs. trend of earnings. An AGNC example.

    Which is more important - 1) the average earnings of a period of years or 2) the trend of earnings over those same years?  The answer is not clear cut.  AGNC, the stock I have been analyzing lately, has only been in business since 2008.  It hasn't been around long enough to even create a trend with three yearly data points.
     
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    American Capital Agency Corporation earned the following per share in recent years:
     
    2008 = $2.36
    2009 = $6.78
    2010 = at least $6.28 (my estimate)
     
    AGNC earned $5.05 in the first three quarters of 2010.  I think it is safe to say that AGNC will earn at least $6.28 per share in 2010.  That is the total of the first three quarters ($5.05) plus a repeat performance of their worst quarter of the year ($1.23).  It will earn $6.73 if it can simply earn the average of the first three quarters ($1.68) in the fourth quarter of 2010.
     
    Here are AGNC's most recent quarterly earnings from their SEC filings:
    1Q2010 = $2.13
    2Q2010 = $1.23
    3Q2010 = $1.69
    4Q2010 = $1.68 (my estimate based on a simple average of the first three quarters of 2010)
     
    Its annual earnings trend appears to be flattening.  If AGNC's earnings stagnates at around $6.00, then the maximum of the stock price could reach and still qualify at a conservative investment according to the late-great Benjamin Graham is $120.00/share ($6.00 earnings time a 20 P/E multiple = $120).  AGNC is currently trading at around $28.74 per share.  That would equate to a multiple of 4.5 times earnings.  That is a very low multiple even for REITs which are averaging around a 8.5 multiple right now. 
     
    Let's assume for a moment that AGNC earns $6.28 in 2010.  In that case the three year earnings average would be $5.14.  Place a twenty multiple on top of the $5.14 figure an you get a maximum value of $102.80 per share.
     
    AGNC's earnings are a function of their portfolio size and their interest rate spread.  Their earnings won't stagnate unless one or both of those change their trends.
     
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    AGNC Declares $1.40 Fourth Quarter Dividend - How much longer can they sustain this?

    AGNC just declared that it will pay a $1.40 dividend for the fourth quarter 2010.  According to Google Finance there are 56.85 million shares outstanding.  So that equals a dividend payment of roughly $78.89 million.  Net income last quarter was around $60 million.  Will AGNC earn that much in 4Q2010?  I don’t think so.  If they don’t cover the dividend with earnings, then they will have to raid their piggy bank.

    AGNC Declares $1.40 Fourth Quarter Dividend

     

    BETHESDA, Md., Dec. 17, 2010 /PRNewswire-FirstCall/ -- American Capital Agency Corp. (Nasdaq: AGNC) ("AGNC" or the "Company") announced today that its Board of Directors has declared a cash dividend of $1.40 per share for the fourth quarter 2010.  The dividend is payable on January 27, 2011 to common shareholders of record as of December 31, 2010, with an ex-dividend date of December 29, 2010.

    Here is the link to the press release: http://www.prnewswire.com/news-releases/agnc-declares-140-fourth-quarter-dividend-112091904.html

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    AGNC news: American Capital down after starting offering

    American Capital down after starting offering

    AMERICAN CAPITAL AGENCY CORP.

    NEW YORK | Fri May 14, 2010 8:53am EDT

    NEW YORK (Reuters) - Shares of American Capital Agency Corp (AGNC.O) fell 6.9 percent to $25.65 in premarket trading on Friday, a day after the company commenced a public offering of common stock.

    (Reporting by Ryan Vlastelica; Editing by Theodore d'Afflisio)

    Article link: http://www.reuters.com/article/idUKTRE64D34P20100514?type=companyNews

    Here is the press release courtesy of www.PRnewswire.com:

    AGNC Announces Pricing of Public Offering of Common Stock

     

    BETHESDA, Md., Dec. 9, 2010 /PRNewswire-FirstCall/ -- American Capital Agency Corp. (Nasdaq: AGNC) (“AGNC” or the “Company”) announced today that it priced a public offering of 8,000,000 shares of common stock for total net proceeds of approximately $219 million. Citi and Deutsche Bank Securities acted as underwriters for the offering.  In connection with the offering, the Company has granted the underwriters an option for 30 days to purchase up to an additional 1,200,000 shares of common stock to cover overallotments, if any. The offering is subject to customary closing conditions and is expected to close on December 14, 2010.

    AGNC expects to use the net proceeds from this offering to acquire additional agency securities as market conditions warrant and for general corporate purposes.

    To read the whole press release go here: http://www.prnewswire.com/news-releases/agnc-announces-pricing-of-public-offering-of-common-stock-111598429.html

    Let’s do some simple back of the envelope math.  The press release mentions that AGNC expects $219 million in new capital will be raised by the new offering.  $219 million divided by 8 million shares = $27.38/share.  If the full 9.2 million shares are purchased then the per share price drops to $23.48/share.

    No wonder AGNC dropped from $29.50/share at the close on December 8th, to $25.65 in pre-market trading.  At 9:42 am MST it has climbed to $28.52.

    So how many agency securities can AGNC buy with $216 million dollars in new capital.  AGNC maintained an average leverage level of 8.5x in the third quarter of 2010 according to their latest 10-K quarterly report.  If we apply that leverage level to the amount of new capital to be leveraged we get:

    $216 million times 8.5 equals $1.836 billion dollars in new agency securities.

    Their portfolio size was $9.7 billion at the end of the third quarter 2010.  Add the $1.836 billion in new agency securities and I expect their portfolio to grow to $11.536 billion by the end of the fourth quarter 2010.  I also expect AGNC interest rate spread to tighten.  If I use the tighter interest rate spread of 2.12% from 2009, then I get a total revenue of $244.6 million for four quarters.  Divide that number by four to represent expected net income in the 4th quarter 2010 and you get: $61,140,000 per quarter net income.

    According to Google Finance there are 52.19 million AGNC shares outstanding.  If AGNC keep its dividend of $1.40/share, then it will need to pay a $73,066,000 dividend payment in the 4th quarter of 2010.  That is unlikely to happen because net income in the 3rd quarter was $60.0 million with a $9.7 billion portfolio and an interest rate spread of 2.21%.  The question remains whether AGNC can grow the portfolio and the interest rate spread sufficiently to generate enough income to keep paying that $1.40/share dividend.  I don’t think they can do it.  Time will tell.

    Be seeing you!

    AGNC earnings power

    American Capital Agency Corp. (AGNC) has a massive dividend of near
    20%. That easily meets my first criteria for a high dividend stock
    which is a dividend yield greater than 6%.

    But what about its earning power? I like at least five years of
    annual earnings to examine, but ten years is even better. A longer
    record of earnings will usually encompass at least one Keynesian
    central bank induced boom-bust cycle (e.g. 2001 - present). It is
    important to know how the business performed at the top of the boom
    and the bottom of the bust in order to determine the average earning
    power.

    AGNC earnings power

    Year, Earnings
    2005, not in business
    2006, not in business
    2007, not in business
    2008, $2.36, MAY to DEC ($3.15 annualized)
    2009, $6.78
    2010 (my est.), $6.28 - $7.18*

    Low average = $5.40 EPS/year [($3.15+$6.78+$6.28)/3]
    High average = $5.70 EPS/year [($3.15+$6.78+$7.18)/3]

    AGNC has been paying a $1.40 quarterly dividend for the last 5
    quarters. That equates to a $5.60 annual dividend payment per share
    if the company does not change the dividend. It is just too soon to
    tell if the average earnings power of AGNC can sustain that $1.40
    quarterly dividend. The company's interest rate spreads tightened in
    the last quarter. The company's net income will decline if the
    interest rates spread tightens and that will lower earnings per share.

    I would personally stay away from any bank, financial, insurance, or
    REIT unless you can understand how the company makes money. I'm still
    confused by much of what I read in AGNC's annual and quarterly
    reports. I'm staying away from AGNC despite its huge dividend. I
    don't think the dividend is very safe.

    AGNC closed today at $29.47.

    *2010 earnings by quarter
    2010 Q1, $2.13
    2010 Q2, $1.23
    2010 Q3, $1.69
    2010 Q4, $?.?? (low $1.23 - high $2.13)

    Be seeing you!