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My High Dividend Stocks
This is my high dividend stocks site where I help site members find high dividend stocks with earning power and strong balance sheets.

I've been wrong about AGNC for the past year.

I’ll admit it.  I was wrong about American Capital Agency Corp. (AGNC) share price direction in the last year.  I thought that their shrinking interest rate spreads and dividend cuts would have hurt the share price, but they haven’t.  There has been a sustained 10 month rally in AGNC stock since November 2011.  Eventually this rally must end, but Keynesian investors don’t seem to care.  They love the Federal Reserve’s QE3.

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AGNC is a mortgage REIT.  They make money by borrowing short term and then lend the money long term by buying agency mortgage backed securities.

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American Capital Agency Corp (AGNC) Cut Its 1Q 2012 Dividend 10.7%

It was only a matter of time until American Capital Agency Corp. (AGNC) cut its dividend.  AGNC was paying out more than they were earning for several quarters.  Their dividend payout ratio was over 100%.  I warned about this back on December 13th, 2011.

http://tinyurl.com/blcxzln

At that time faceless, nameless Wall Street analysts expected AGNC to earn $1.18 per share for the 4th quarter of 2011.  Their 4Q 2011 financials revealed that they only earned $0.99.  That pushed the dividend payout ratio all the way up to 141%.  This madness had to stop.  It finally did.

On February 6th, 2012 AGNC’s board of directors announced a 10.7% dividend cut.

http://www.reuters.com/finance/stocks/AGNC.O/key-developments/article/2475150

They cut the dividend from $1.40 per quarter down to $1.25 per quarter for March 2012.  That breaks their streak of ten consecutive quarters of $1.40 dividend payments.

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The Federal Reserve will likely buy more agency mortgage-backed securities in the future.  This will bid up the price of those securities.  That will eat into AGNC’s shrinking profits.  The cost of borrowing is increasing and the asset yield is decreasing.  You can read about that here in AGNC’s 4Q 2011 financials release: http://tinyurl.com/bq5fgfz  

The dividend is not secure.  AGNC is leveraged 7.6 times.  Leverage giveth and leverage taketh away.  I expect another cut in a few quarters.

Disclosure: I don’t own American Capital Agency Corp. (AGNC).

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AGNC declares another $1.40 quarterly dividend. Dividend payout ratio up to 118%, again.

American Capital Agency Corp. has just declared another $1.40 dividend
payable on January 27th, 2012 to common shareholders of record as of
December 22nd, 2011, with an ex-dividend date of December 20th, 2011.

http://tinyurl.com/7banmep

This will be the 10th consecutive quarterly dividend payment of $1.40.
However, the trend of dividend payout ratio over 100% also continues.

Reuters.com financial website shows analyst's concensus estimates for
AGNC's 4th quarter earnings at $1.18 per share. If they are right,
then AGNC's dividend payout ratio will be 118%. They will probably
announce a secondary share offering soon to finance their dividend
deficit. Then the share price will drop again. This has been the
pattern for the last few quarters.

AGNC is not earning enough money to cover their dividend payments at
$1.40 per share. There is a substantial downside risk to your capital
if you buy AGNC at today's price.

DISCLOSURE - I don't own AGNC.

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62 Million Reasons Why Mortgage REIT Investors Should Be Scared

There are actually 62,000,001 reasons not to invest in mortgage REITs like American Capital Agency Corp. (AGNC) and Annaly Capital Management (NLY).  The first reason is that the USA and the world are slipping back into recession.  This will increase the speed of prepayments of mortgages.  Increase prepayment speeds destroys leveraged earnings in mortgage REITs.  Need proof, then check this out.  The ECRI has an amazing track record.  Ignore them at your financial peril.

http://www.advisorperspectives.com/dshort/updates/ECRI-Weekly-Leading-Index.php

Secondly, this article from Minneapolis attorney Bill Butler on LewRockwell.com should bring fear into the hearts of all mortgage REIT investors worldwide.  Here are the other 62 million reasons not to invest in mortgage REITs.  This is a long article, but it shows how nefarious Fannie Mae and Freddie Mac really are.  Mortgage REITs buy their agency securities from these crooks.

http://lewrockwell.com/butler-b/butler-b14.1.html

DISCLOSURE – I don’t own AGNC or NLY.

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USB Analysts Cuts AGNC Earnings Estimates.

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Some faceless, nameless analysts on Wall Street cut their earnings estimates for American Capital Agency Corp. (AGNC).  And they were nice enough to provide price targets.

http://localizedusa.com/2011/11/15/ubs-ag-ubs-analysts-cut-american-capital-agency-agnc-eps-estimates-2/

Of course, the analysts didn’t say how much they think AGNC earnings will suffer.

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Corzine, MF Global, and AGNC

Company executives are paid to lie to shareholders.  You should know this from Enron, MCI Worldcom, Bernie Madoff, and Tycho International.  But in case you weren’t paying attention here is another example from none other than ex-Goldman Sachs chairman & CEO, Jon Corzine.  Mr. Corzine was most recently the Chairman & CEO of the now bankrupt MF Global (MF).  Here is a summary of his career:

1975 Begins his career at Goldman Sachs, building a reputation as a hard-nosed bond trader and a big risk taker.
1988 Becomes co-head of the firm's fixed-income division.
1994 Named chairman and CEO of Goldman Sachs at a time when the firm was being hit by big trading losses.
1999 Ousted from the top spot at Goldman in what was viewed by many as a power struggle with co-CEO Henry Paulson. The firm had also suffered steep bond trading losses and a delay of its IPO.
2000 Beats out Republican candidate Bob Franks for a New Jersey Senate seat, spending more than $60 million and breaking the spending record for a statewide race.
2005 Elected New Jersey governor
2007 Involved in car crash that leaves him in critical condition.
2009 Loses New Jersey governor's seat to Republican opponent Chris Christie
March 2010 Appointed CEO and chairman of MF Global.
Oct. 25, 2011 MF Global posts its biggest-ever quarterly loss as a public company.
Oct. 31, 2011 MF Global files for bankruptcy.

The poor schnook let his company release this upbeat report on October 25 -- one week ago.

* Strengthened capital and liquidity position. As of September 30, 2011, the company has over $3.7 billion in available liquidity, including $1.3 billion in available committed revolving credit facilities and $2.5 billion in total capital.

"Reflecting the stressed markets in the quarter, we deliberately chose to reduce overall market exposure in most principal trading activities and focused on preserving capital and liquidity," said Jon S. Corzine, chairman and chief executive officer, MF Global. "We also used the dislocation in the markets to add quality people for strategic roles, as well as expand our client relationships across our businesses."

Mr. Corzine continued, "We were particularly pleased with the repositioning of our mortgage, credit and foreign exchange businesses; the performance of our commodities group; and the common alignment of our brand to strategy. These efforts reflect positively on our ability to execute and deliver competitive returns to shareholders in the quarters ahead."

As of September 30, 2011, MF Global maintained a net long position of $6.3 billion in a short-duration European sovereign portfolio financed to maturity (repo-to-maturity), including Belgium, Italy, Spain, Portugal and Ireland. The laddered portfolio has an average weighted maturity of October 2012 and an end date maturity of December 2012, well in advance of the expiration of the European Financial Stability Facility in June 2013. (see supplemental table for further details)

MF Global bet on the Keynesian central bankers, banks, and politicians to solve the European sovereign debt crisis – and lost!

Pay close attention to the statements company executives make about their liquidity and revolving credit.  Then don’t believe them.

American Capital Agency Corp. (AGNC) is susceptible to the modern bank run in which short term credit is pulled without notice.  The company then no longer has access to funds necessary for their business model and they quickly go bankrupt.  AGNC had 22 lenders in 2010.  I don’t know if MF Global was one of them.  AGNC does not disclose who they make repurchase agreements with.  Check this out.

press release

Nov. 3, 2011, 2:00 p.m. EDT

American Capital Agency Corp. to Present at Sandler O'Neill East Coast Financial Services Conference

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BETHESDA, Md., Nov. 3, 2011 /PRNewswire via COMTEX/ -- American Capital Agency Corp. /quotes/zigman/110324/quotes/nls/agnc AGNC +0.36% ("AGNC" or the "Company") announced today that Peter Federico, Senior Vice President and Chief Risk Officer, is scheduled to make a presentation at the Sandler O'Neill + Partners East Coast Financial Services Conference on November 10, 2011 in Aventura, FL. The AGNC presentation is scheduled to begin at 4:05 pm ET. The presentation will be webcast live and archived for 90 days on the AGNC website in the Investor Relations section at http://ir.agnc.com .

When Mr. Federico says that AGNC’s liquidity needs are well met at the Sandler O’Neill East Coast Financial Services Conference some in the audience should stand up and read this statement from their 2010 annual reports risk factors section:

Failure to procure adequate repurchase agreement financing, or to renew (roll) or replace existing repurchase agreement financing as it matures, would adversely affect our results of operations and may, in turn, negatively affect the market value of our common stock and our ability to make distributions to our stockholders.

We use repurchase agreement financing as a strategy to increase our return on equity. However, we may not be able to achieve our desired leverage ratio for a number of reasons, including if the following events occur:

• our lenders do not make repurchase agreement financing available to us at acceptable rates;

• certain of our lenders exit the repurchase market;

• our lenders require that we pledge additional collateral to cover our borrowings, which we may be unable to do; or

• we determine that the leverage would expose us to excessive risk.

We cannot assure you that any, or sufficient, repurchase agreement financing will be available to us in the future on terms that are acceptable to us. Since 2008, there have been several mergers, acquisitions or bankruptcies of investment banks and commercial banks that have historically acted as repurchase agreement counterparties. This has resulted in a fewer number of potential repurchase agreement counterparties operating in the market. In addition, since 2008 many commercial banks, investment banks and insurance companies have announced extensive losses from exposure to the residential mortgage market. These losses reduced financial industry capital, leading to reduced liquidity for some institutions. Institutions from which we seek to obtain financing may have owned or financed RMBS that have declined in value and caused them to suffer losses as a result of the recent downturn in the residential mortgage market. If these conditions persist, these institutions may be forced to exit the repurchase market, become insolvent or further tighten their lending standards or increase the amount of equity capital or haircut required to obtain financing, and in such event, could make it more difficult for us to obtain financing on favorable terms or at all. In the event that we cannot obtain sufficient funding on acceptable terms, there may be a negative impact on the value of our common stock and our ability to make distributions, and you may lose part or all of your investment

Furthermore, because we rely primarily on short-term borrowings, our ability to achieve our investment objective depends not only on our ability to borrow money in sufficient amounts and on favorable terms, but also on our ability to renew or replace on a continuous basis our maturing short-term borrowings. If we are not able to renew or replace maturing borrowings, we may have to sell some or all of our assets, possibly under adverse market conditions.

AGNC is borrowed short and lent long like all fractional reserve banks and financial institutions.  The European sovereign debt crisis threatens to lock up the financial system in Europe and the US.  This will mostly likely negatively impact AGNC’s operations.  AGNC’s executives are Keynesian and are subject to the same boneheaded bad bets as MF Global.  Leverage works both ways.

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AGNC announces pricing of public offering of common stock (again)

If you were wondering why AGNC’s stock price was down 3.87% when the DJIA was up almost 3%, then here is the reason why.

So, before the dust has even settled on AGNC’s 3rd quarter 2011 financials they offer to sell more stock to lever up over 7x.  They have to keep doing this to make their $1.40 per share dividend payments and to have some assets to pledge as collateral for more repurchase agreements.  This is a house of cards.  Leverage works both ways – just as Lehman Bros.

American Capital Agency Announces Pricing of Public Offering of Common Stock

BETHESDA, Md., Oct. 26, 2011 /PRNewswire via COMTEX/ -- American Capital Agency Corp. (Nasdaq: AGNC) ("AGNC" or the "Company") announced today that it priced a public offering of 37,000,000 shares of common stock for total estimated gross proceeds of approximately $1.0 billion.

In connection with the offering, the Company has granted the underwriters an option for 30 days to purchase up to an additional 5,550,000 shares of common stock to cover overallotments, if any. The offering is subject to customary closing conditions and is expected to close on November 1, 2011.

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

Citigroup, Deutsche Bank Securities and J.P. Morgan Securities LLC are joint book-running managers for the offering. Barclays Capital Inc., Mitsubishi UFJ Securities and Nomura Securities International, Inc. are co-lead managers for the offering. Keefe, Bruyette & Woods, Inc. and Wunderlich Securities are the co-managers for the offering.

The offering will be made pursuant to AGNC's existing effective shelf registration statement, previously filed with the Securities and Exchange Commission. The offering of these securities will be made only by means of a prospectus and a related prospectus supplement, when available. Copies of the prospectus and prospectus supplement may be obtained from Citigroup, Brooklyn Army Terminal, 140 58th Street, 8th Floor, Brooklyn, New York 11220; telephone: (800) 831-9146; Deutsche Bank Securities, Prospectus Department, Harborside Financial Center, 100 Plaza One, Jersey City, New Jersey 07311-3988, telephone: 1-800-503-4611; J.P. Morgan Securities LLC, c/o Broadridge Financial Solutions, 1155 Long Island Ave, Edgewood, NY 11717, telephone: (866) 803-9204.

This press release does not constitute an offer to sell or the solicitation of an offer to buy shares of common stock, nor shall there be any sale of these securities in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such jurisdiction.

Link to AGNC investor relations press release: http://ir.agnc.com/phoenix.zhtml?c=219916&p=irol-newsArticle&ID=1622187&highlight=

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American Capital Agency Corp. (AGNC) report 3Q2011 financials after the market closes today.

American Capital Agency Corp. (AGNC) is a high dividend stock yielding 19.5%.  AGNC reports today after the close of the US markets.  Here is the 3 year chart of AGNC.  It is topping out.  More to follow in the next few days following the earning release this afternoon.

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American Capital Agency Corp (NASDAQ: AGNC) is expected to report their earnings today for quarter ended Jun 2009. Revenues are expected to come in at $22.10M. Shares of American Capital Agency Corp traded higher by 1.05% or $0.3/share to $28.86. In the past year, the shares have traded as low as $22.03 and as high as $30.76. On average, 7038620 shares of AGNC exchange hands on a given day and today's volume is recorded at 3092686. The shares are currently trading below the 200-day moving average but above the 50-day moving average. The stock may be range bound between these two levels where the 200-day moving average of $28.86 represents resistance and the 50-day moving average of $27.74 would be an area of support.

Link to original source: http://www.tickrwatch.com/2011/10/earnings-preview-nasdaq-agnc-nyse-arb.html

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A Rebuttal of An Interview With AGNC's Chief Investment Officer Gary Kain

I think that people who are investing in mortgage REITs are chasing dividend yields and ignoring the downside risk of lower earnings, dividend cuts, and the lower asset values.  This article from Seeking Alpha contributor, Todd Johnson, embodies what I’m talking about.  The article’s contents are indented and my comments should be aligned to the left (not indented).

An Interview With American Capital's Gary Kain

37 comments | by: Todd Johnson October 11, 2011  |  about: AGNC, includes: ANH, CIM, CMO, CYS, HTS, IVR, MFA, NLY, TWO

Notice that there is no explicit Federal guarantee.  Besides, even if there was an explicit Federal guarantee that wouldn’t mean anything either.  The US federal government is running near a $1.5 trillion annual budget deficit.  The budget annual budget deficits will grow when the country lapses into another recession.  There are deficits as far as the eye can see.  The biggest ponzi schemes: Medicare, Social Security, and the FDIC are running in the red now.  Don’t put your investment/savings faith in governments ability to perpetuate their ponzi schemes.

On Monday I had the fortunate experience to interview Gary Kain. Mr. Kain is the President and Chief Investment Officer of American Capital Agency Corporation (AGNC). American Capital Agency Corporation is a mortgage real estate investment trust (mREIT). American Capital Agency invests in only Government Sponsored Entity (GSE) mortgage backed securities (MBS), an agency-mREIT owns MBS which possess an implicit Federal guarantee. The stock currently pays a 21% dividend. The company has paid a quarterly $1.40-dividend, per share, for 9 consecutive quarters.

There are four new risks listed in the most recent 10Q statement.  Each of them had further explanation that should raise your concerns.

·         We have no employees and our Manager is responsible for making all of our investment decisions. Certain of our Manager’s officers are employees of American Capital and are not required to devote any specific amount of time to our business and each of them may provide their services to American Capital, its affiliates and sponsored investment vehicles, which could result in conflicts of interest.

·         We may change our policies at any time without stockholder approval, including our investment policy, which may adversely affect our financial condition, results of operations, the market price of our common stock or our ability to pay dividends or distributions.

·         Federal Reserve programs to purchase securities could have an adverse impact on the agency securities in which we invest.

·         The market price of our common stock may fluctuate significantly.

Gary provided an enormous amount of information during the course of the interview. He answered every question I posed to him. I do not have his breadth of knowledge. Please visit the latest SEC 10Q for any issues which need clarification.

I would like to share my interview thoughts in this article. First, I would like to sincerely thank Gary Kain for taking the time for the interview. His professional attitude and industry knowledge were very impressive and illuminating.

Notice the dividend payout ratio at 106% estimated for the year 2011.  This is a warning that AGNC will not be able to keep paying its $1.40 quarterly dividend with current earnings.  This measurement of dividend safety will only get worse as AGNC issues new shares multiple times per year, to raise capital, to leverage 8x, to buy more agency securities.


click to enlarge

AGNC does not disclose which 26 counter parties it has agreements with.  This is very opaque.  Perhap they are doing business with AIG, Lehmen Bros., Bear Sterns, or some of the big European banks who foolishly leant money to the PIIGS (Portugal, Italy, Ireland, Greece, and Spain).  We don’t know, but Gary Kain says, “Trust me.”  Corporate executives are paid to lie.  Do you need proof?  Look at what any executive of a bankrupt company said before the bankruptcy.  Enron’s Chairman, Ken Lay, is a good example that most people are familiar with.  Counter parties can change the amount they are willing to lend in a moments notice.  This is the modern bank run.  Financial institutions are borrowed short and lent long.  This is how Lehman Bros. went down so quick.  Their lenders cut off their access to short term funding.

Liquidity Risk

My first question concerned liquidity risk. I asked if the Euro sovereign-debt could carry over to American Capital Agency's 26 counter parties. The counter parties provide liquidity for repurchase (repo) agreements. Gary confirmed this was not the case. In fact, counter parties have "increased lines" for repo agreements. Gary discussed this aspect with an example. If a counter party had a $1.5 billion lending line to the company, in some cases that has been raised to $2 billion.

If there is a rise in the one-month repo rate, the increase is likely to be limited to 5 basis points. At present time, the one-month repo rate is approximately 25 basis points.

The US is going back into recession.  The unemployment rate is going to climb.  More people will default on their mortgages.  The GSE will have to guarantee the payments on the agency securities.  There will be prepayments.  This will hurt AGNC’s book value as some of the formerly prime MBSs become more toxic.  Also, there will be prepayments from those who can refinance at historic low interest rates.  This will be front page new in 3-6 months.  I don’t think the GSE’s will break their promises until they run out of money.  If the GSEs fail to guarantee the MBSs, then their book value will fall even more.

I watched the presentation that Gary Kain gave in September.  He did a good job explaining the coming prepayment risk.  Watch it here: http://wsw.com/webcast/jmp15/agnc/ .  Of note is that 34% of AGNC’s portfolio are susceptible to high prepayment risks.  At the end of his speech on slide 10 of his presentation he said, “Prepayment speeds are going to dominate our results [over the next six months].”  You need to hope that the models are based on Keynesian economics.  If they are, then the forward yield curves will be optimistically steep.  If they are grounded in Austrian economics (this is unlikely), then the forward yield curves would be flat or inverting because of the coming recession.  We read this at the bottom of page 7 in the latest 10Q report:

“We estimate long-term prepayment speeds using a third-party service and market data. The third-party service estimates prepayment speeds using models that incorporate the forward yield curve, current mortgage rates, current mortgage rates of the outstanding loans, loan age, volatility and other factors. We review the prepayment speeds estimated by the third-party service and compare the results to market consensus prepayment speeds, if available. We also consider historical prepayment speeds and current market conditions to validate the reasonableness of the prepayment speeds estimated by the third-party service and based on our Manager’s judgment we may make adjustments to their estimates. Actual and anticipated prepayment experience is reviewed quarterly and effective yields are recalculated when differences arise between the previously estimated future prepayments and the amounts actually received plus current anticipated future prepayments. If the actual and anticipated future prepayment experience differs from our prior estimate of prepayments, we are required to record an adjustment in the current period to the amortization or accretion of premiums and discounts for the cumulative difference in the effective yield through the reporting date.”

Prepayment Risk

This is the essential - and core aspect of the interview - area of focus. Gary reiterated this point on numerous accounts. He said, "In 3-6 months time, the focus will be on how we handled prepayment risk." American Capital Agency is clearly focused upon this issue. The company addressed this topic very clearly at the September 26th JMP Securities Financial Services and Real Estate Conference.

The company has focused upon owing GSE-MBS with the lowest prepayment risks. The GSE-MBS with the lowest prepayment risk include:

1.    GSE-MBS with low balances,

2.    GSE-MBS associated with the Federal Housing Finance Agency's (FHFA) Home Affordable Refinance Program (.pdf) (HARP).

The company, as of June 30th, has over 66% of its GSE-MBS portfolio invested in the two above categories. American Capital Agency was proactive in taking this stance prior to Federal intervention coming to page one of the Wall Street Journal. Gary reiterated during the course of the interview that AGNC's management and staff are focused upon maintaining or increasing American Capital Agency's book value per share. "We are not looking for any home runs in our book value", [but only to do our best to] "maintain or increase" [the book value per share].

If there is one key aspect this article should communicate is the impact of "prepayment risk".

Hedging Practices

I was curious to know if the company used "hedging" to only hedge its positions, or also to "speculate" on a high-probability event. Gary confirmed the company's hedging practices are designed to be agnostic towards the noise on the markets. His staff hedges the GSE-MBS to protect the book value per share. Gary wants to be able to walk into the office tomorrow and have a sound portfolio regardless if interest rates are "increasing or decreasing".

Gary commented, "we don't know how much is already priced in the markets. It's the same as with the stock market." My question resonated because I wanted to know if a high probability of "Operation Twist" (ie, the Fed selling short-term Treasury Bills and purchasing longer duration Treasury Bonds) was likely, would the company position themselves based upon this likelihood? The answer was "no". The focus is to be consistent and neutral on agency MBS price movement. Clearly, the company is focused upon protecting the book value and be a consistent performer.

Gary took the time and patience of Job to explain the "hypothetical yield sensitivity analysis" for prepayment risk based upon the Constant Prepayment Rate (CPR), which is the percentage of principal that is prepaid over a period of time on an annualized basis. A couple of notes to highlight the prepayment risk:

·         The highlighted "green" numbers reflect the percentage of prepayments in a given year,

·         The highlighted "yellow" numbers reflect the net interest rate spread,

·         The highlighted "salmon" numbers reflects the reflect on equity based upon an 8x leverage.

The key issue is Gary and American Capital have focused upon reducing the CPR a) to benefit the net yield spread, b) to benefit the return of equity, c) to benefit the book value per share, and d) to benefit the dividends for shareholders: "institutional and small". The company is 100% aligned with the goals of the common shareholder.

You might be asking yourself what constant repayment rate AGNC thinks they are going to experience in the near future.  You should be asking yourself this because it greatly affect the company’s financial results.  The answer lies on page 15 of the latest 10Q report.  We read.

“The weighted average lives of the agency securities as of June 30, 2011 and December 31, 2010 incorporates anticipated future prepayment assumptions. As of June 30, 2011, our weighted average expected constant prepayment rate (“CPR”) over the remaining life of our aggregate investment portfolio is 10%.”

I believe this is overly optimistic.

Gary Kain used to work for Freddie Mac.  You have to be Keynesian to work for a Government Sponsored Enterprise.  Keynesians are leading the world off and economic cliff.  Need I say more.

Benefits of Freddie Mac Experience

I asked Gary what benefits were gained by his extensive Federal Home Loan Mortgage Corporation (“Freddie Mac") work experience. There were some very intriguing responses on this issue.

·         Gary's Freddie Mac experience required managing a "40 to 50x leveraged portfolio". This is in stark contrast to a current 8x leverage rate. He gained a greater "respect for hedging" when dealing with a high leverage rate.

·         He learned how the GSE operates and thinks. Gary gained insight into the regulatory oversight as a GSE manager.

·         Historically, mREITs traded GSE adjustable rate mortgages (ARMs). Gary's Freddie Mac experience was, historically, with both ARMs and fixed rate mortgages. It wasn't until much later did the publicly traded mREIT industry move more to the the fixed rate mortgage segment.

Leverage works both ways.  Just ask Lehman Bros and Bear Stearns.  More leverage will make mREITs a taller house of cards.

Will the mREIT Industry Expand its Leverage Rate

Presently, the agency-mREIT leverage rate is approximately 7x to 8x. This is historically lower than prior leverage rates. Gary believed the move, in the future, will offer opportunities to increase leverage. Presently, there are GSE unknowns which must sort themselves out.

GSEs will be shrinking in market size over the next 7 years. The ability to increase leverage levels upward from a 7x-leverage rate to higher levels clearly is an opportunity for the agency-mREITs once there is stability amongst the Euro sovereign debt, SEC 60-day review period, Fed Operation Twist, Treasury programs, and Policy Risk - HARP. Gary's focus is ignoring the noise and recognizing what truly matters. Time will pass and well-prepared companies will be at the center of attention.

This is expected.  The profits that the current mREITs are generating are the signal to other entrepreneurs to enter the mREIT markets.  More competition will bid up MBS prices all other things being equal.  This will lower profits at the existing mREITs.  What bothers me is that this is an artificially lucrative market caused by perceived government guarantees of MBS.  That means that capital will be misallocated.  Someday there will be a bust when the next financial crisis hits.

Backlog of mREIT IPOs

I wanted to know Gary's thoughts on the backlog of mREIT initial public offerings. The SEC is asking for feedback on a couple of issues:

·        

o    The SEC, as of August 31st, is seeking "Public Comment on Asset-Backed Issuers and Mortgage-Related Pools Under Investment Company Act".

o    The SEC, as of August 31st, is seeking under a separate concept release, public comment on "interpretations of a provision in the Investment Company Act – Section 3(c)(5)(C) – that may be used by some companies engaged in the business of acquiring mortgages and mortgage-related instruments such as some REITs".

Agency mREITs provide a fluid buy and sell marketplace for the $10 trillion mREIT sector. There are, however, a few companies who are interested in entering this sector. It is important to note the difference between a non-agency mREIT and an agency mREIT. Agency mREITs own only GSE-MBS implicitly backed by the U.S. Federal government.

One of the companies who is interested is Pimco. Pimco's "Bill Gross" is almost synonymous with the word "bond". He has certainly gained a following over the years. Pimco would like to enter the mREIT sector, per its April 5th filing.

My bet is with Benjamin Graham and Austrian economics.  Graham recommended that average investors should not own financial stocks and insurance stocks because you don’t know what is really going on in those companies from their reporting.  The Austrian school teaches that central banks cause the boom-bust cycle.  The Federal Reserve’s actions caused the financial crisis of 2008 and they are also the source of the coming crisis in 2011-2012.  Keynesians predict that the stimulus will get economies out of recession, but the stimulus has noticeably failed.  The Austrians predict that stimulus makes things worse.

In full disclosure, Jeffrey Gundlach, chief executive of DoubleLine Capital LLC and a veteran of more than 20 years in the industry, said in August he was passing on the mREIT sector. Mr. Gunlach recently discussed his desire for absolute returns instead of political ambitions. Mr. Gunlach stated to the Wall Street Journal, "I'm too old to raise money then go around the world and apologize," he said. Time will tell who had the insights and knowledge to prepare accordingly. On the agency mREIT sector, my bet is with Gary and American Capital.

Gary said as the GSEs exit the market place over the coming 7 years, there will be ample room for new mREITs to enter into the $10 trillion market place. The annual GSE MBS exit will result in shrinkage amounts of "$150 million to $200 million per year".

Summary

He calls at least 34% very little exposure.  That is laughable.  Operation Twist will make things worse for AGNC.  So will the next FED operation after Twist, and the next one, and the next one after that.  The Keynesians all think the next stimulus is the one that will work.  This is nonsense.

American Capital Agency has very little exposure to GSE-MBS with "high prepayment risks". Management is cognizant of this risk and addressed the risks before Fed Chairman Bernanke came in with Operation Twist and CNBC had the topic as headline news.

I concluded the interview with complete confidence in Gary Kain's leadership and industry expertise. Gary was willing to discuss the challenges, opportunities, and unknowns. American Capital Agency has a leader to tackle any Federal government action, interest rate move, and prepayment risk in the best interests of shareholders.

Know the real risks of owning AGNC stock before you buy it.  To read all my critiques of AGNC click here: http://www.myhighdividendstocks.com/category/high-dividend-stocks/american-capital-agency-corp

I believe the interview provides insights on the rewards of owning AGNC stock. The company has produced industry-best returns. The company is aligned with achieving a solid book value per share, dealing with the political and Euro sovereign-debt issue, and provide outstanding absolute positive shareholder returns. What more could a common shareholder desire?

mREIT-Sector Peer Comparison

For background purposes, directly blow is a table showing the mREIT sector's financial performance. The chart assumes dividends are not reinvested. The dividends are assumed to be kept in cash.

Disclosure: I am long AGNC, CMO, CYS, HTS, NLY, TWO.

I don’t own AGNC or any other financial stock.

Link to the original Seeking Alpha article: http://seekingalpha.com/article/298768-an-interview-with-american-capital-s-gary-kain

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Another risk to AGNC's profitability. Prepayments.

American Capital Agency Corp. (AGNC) profits will erode as the housing market declines further for at least two reasons.  First, Fannie Mae and Freddie Mac payoff the previous mortgage after a foreclosure.  This accelerates the payment of that mortgage within the mortgage backed security pool it is in.  Second, when Federal Reserve policy and the US federal government programs artificially drive interest rates down, then more people can refinance their homes.  The old mortgage gets paid off early (prepayment) in a refinance.  AGNC management must estimate prepayment rates correctly to protect profits.  I have little faith in them because they believe in Keynesian economics.  Keynesians are leading us all off the cliff.

We read in this article that the US federal government is trying to introduce new subsidies to allow homeowners to refinance.  http://seekingalpha.com/article/293341-nationwide-mortgage-refinancing-impacts-on-mreits   This is bad news for mortgage REITs like AGNC.  For more info on the nefarious plans of the government read this: http://www.cbo.gov/ftpdocs/124xx/doc12405/09-07-2011-Large-Scale_Refinancing_Program.pdf

From the AGNC 2010 annual report:

 

Changes in prepayment rates may adversely affect our profitability.

The agency securities in our investment portfolio are backed by pools of mortgage loans. We receive payments, generally, from the payments that are made on these underlying mortgage loans. When borrowers prepay their mortgage loans at rates that are faster or slower than expected, it results in prepayments that are faster or slower than expected on the related agency securities. These faster or slower than expected payments may adversely affect our profitability.

We may purchase agency securities that have a higher interest rate than the then prevailing market interest rate. In exchange for this higher interest rate, we may pay a premium to par value to acquire the security. In accordance with GAAP, we amortize this premium over the expected term of the agency security based on our prepayment assumptions. If the agency security is prepaid in whole or in part at a faster than expected rate, however, we must expense all or a part of the remaining unamortized portion of the premium that was paid at the time of the purchase, which will adversely affect our profitability.

We also may purchase agency securities that have a lower interest rate than the then prevailing market interest rate. In exchange for this lower interest rate, we may pay a discount to par value to acquire the security.  We accrete this discount over the expected term of the agency security based on our prepayment assumptions. If the agency security is prepaid at a slower than expected rate, however, we must accrete the remaining portion of the discount at a slower than expected rate. This will extend the expected life of the portfolio and result in a lower than expected yield on securities purchased at a discount to par.

Prepayment rates generally increase when interest rates fall and decrease when interest rates rise, but changes in prepayment rates are difficult to predict. Prepayments can also occur when borrowers sell the property and use the sale proceeds to prepay the mortgage as part of a physical relocation or when borrowers default on their mortgages and the mortgages are prepaid from the proceeds of a foreclosure sale of the property. Fannie Mae and Freddie Mac will generally, among other conditions, purchase mortgages that are 120 days or more delinquent from MBS trusts when the cost of guarantee payments to security holders, including advances of interest at the security coupon rate, exceeds the cost of holding the nonperforming loans in their portfolios.

Consequently, prepayment rates also may be affected by conditions in the housing and financial markets, which may result in increased delinquencies on mortgage loans, the government-sponsored entities cost of capital, general economic conditions and the relative interest rates on FRM and ARM loans, which could lead to an acceleration of the payment of the related principal. Additionally, changes in the government-sponsored entities’ decisions as to when to repurchase delinquent loans can materially impact prepayment rates.

In addition, the introduction of new government programs, such as the U.S. Treasury’s HASP program, could increase the availability of mortgage credit to a large number of homeowners in the U.S., which we would expect would impact the prepayment rates for the entire mortgage securities market, but primarily for Fannie Mae and Freddie Mac agency securities. These new programs along with any new additional programs or changes to existing programs may cause substantial uncertainty around the magnitude of changes in prepayment speeds. To the extent that actual prepayment speeds differ from our expectations, it could adversely affect our operating results.

Conclusion

Stay away from unstable high dividend stocks like AGNC.  Leverage works both ways – just ask Lehman Bros.

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