An attractive investment considering shares are trading at a discount to NAV of 23% and the company offers a dividend yield of 12.1% given the current industry climate

Well diversified portfolio with $66.2 billion securities that provide predictable interest income

Shares trade 20% below Book Value and offer compelling upside

Switch from quarterly to monthly dividend distributions offer regular income, more transparency

American Capital Agency Corporation (NASDAQ: AGNC) is a U.S. real estate investment trust (REIT) that invests in residential mortgage pass-through and other agency securities where principal and interest payments are backed by government agencies such as GNMA, FNMA and FHLMC. As a REIT, the company does not pay corporate income tax as long as it distributes at least 90% of its income to shareholders. As of March 31, 2015, American Capital had an investment portfolio comprised of $66.2 billion of mortgage-backed securities (MBS) – primarily fixed rate – with an annualized net interest rate of 1.53%. This predominant focus on fixed-rate securities of varying maturities, with almost 58% ($38.5 billion) in 30-year fixed mortgages, provides long-term interest income visibility and revenue stability, and bodes well for lower-risk income-oriented investors.


American Capital’s 30 year MBS, excluding net to-be-announced (TBA) positions, has an actual conditional prepayment rate (CPR) of 12% (as of April 1, 2015) with a life forecast CPR of 9%. The company’s second largest investment, comprising 37% of the portfolio, is in fixed rate mortgages, 15-years or less, worth $24.3 billion. The actual CPR for these mortgages excluding net TBA positions is 12% with a life forecast CPR of 10%.

Shares Trading at a Discount; Offer Good Investment Opportunity

As of 5/1/2015, American Capital shares were trading at a sizable discount to NBV. With a price-to-book ratio of 0.8x, American Capital’s assets were trading at $0.80 on the dollar, offering sizable upside for investors. Despite the recent drop in interest rates, MBS securities have performed well for the company. With interest rates at all-time lows, this is a good opportunity to invest in a performing REIT such as American Capital.

Attractive 11.6% Dividend Yield

In September 2014, American Capital’s Board of Directors approved a distribution schedule change for its common stock dividend from quarterly to monthly. The first monthly distribution was paid in November 2014. A shift to monthly dividends makes American Capital more attractive to investors looking for income and also evens out stock price declines on the ex-dividend date (red ovals in chart below). Additionally, American Capital announced that it would report month-end net asset value estimates to coincide with monthly dividends. This decreases the waiting time for investors and dilutes significant ups and downs in quarter-over-quarter net asset value per share.


American Capital approved a monthly cash dividend of $0.20 per share for May 2015, to be paid on June 5, 2015, for shareholders on record as of May 28, 2015. The company previously paid monthly dividends of $0.22 per share for January through April 2015. The May dividend represents a decrease of 9% but it’s a strategic response given the current environment of the industry. Since going public in May 2008, the company has paid total dividends of $5.4 billion, or $30.88 per share.


American Capital currently offers an annual dividend of $2.40 per share and a dividend yield of 11.6%. The current yield is in-line with peers Annaly Capital Management Inc (NLY) with 11.5%, Hatteras Financial Corporation (HTS) with 11%, Invesco Mortgage Capital Inc (IVR) with 11.4%, MFA Financial (MFA) with 10.2% and Redwood Trust (RWT) with 6.1%.

The Board also approved a first quarter 2015 cash dividend of $0.50 per 8% Series A Cumulative Redeemable Preferred Stock and $0.484375 per 7.75% Series B Cumulative Redeemable Preferred Stock – payable April 15 to shareholders on record March 30, 2015.


Analysts Bullish On Upside

American Capital shares were most recently trading at $20.75 as of market close on 5/1/2015, giving the company a market capitalization of $7.32 billion. Shares currently trade near the lower end of the company’s 52-week range of $24.06-$20.38 and are below their 50-day moving average of $21.51 and 200-day moving average of $22.01.

Global bank Wells Fargo (WFC) maintained American Capital with a Market Perform rating and share price target range of $22-$23 on hedging uncertain future interest rates with increased allocation to 15 year mortgage-backed securities. Swiss global bank UBS (UBS) downgraded the company from a Neutral to a Sell rating on a recent dividend cut and cautious guidance from management. There are 18 analysts covering American Capital, six have a Buy rating and 11 have a hold rating. Analysts’ consensus is that the company will outperform the market with a price target of $23.16 which is 12% higher than the company’s current price. American Capital has a high share price target of $26.50 which represents potential upside of 28% based on the company’s share closing price on May 1, 2015.

Stable Net Book Value Reduces Investment Risk

As of March 31, 2015, American Capital had a Net Book Value (NBV) of $25.53 per share. As the bar-graph below shows, the lowest NBV number has held fairly steady – in the mid-20s – over the past five years, making the company less risky to investors. Net book value is an important measure for REITs because it represents the value of a company’s assets minus depreciation on a balance sheet.


Hedges Protect Against Interest Rate Fluctuations

American Capital management expects continued volatility in interest rates due to inflation uncertainty, increased regulatory requirements and a drop in fixed income liquidity. Management also expects the Federal Reserve to raise interest rates around September 2015 as the economy strengthens.


As the 10-y rate chart (above) shows, rates have been on a downward trend with significant volatility. Despite the significant volatility, American Capital has maintained a stable net asset value and delivered positive economic returns of 10.26% on an annual basis, with a reported economic return of 5.13% as of March 31, 2015. Economic return is measured by the change in net asset value per share plus dividends declared.


Management Reduces Leveraged Risk to Protect Assets and Book Value

Malon Wilkus serves as Chair and Chief Executive Officer, and is a founder of American Capital Ltd (ACAS). Mr. Wilkus holds the same role for American Capital Mortgage Investment Corporation (MTGE), American Capital Senior Floating (ACSF) and American Capital Asset Management LLC. He serves on the Board of Directors of over 12 middle market companies across several industries.

John Erickson has served as Executive VP and Chief Financial Officer since the company went public. Mr. Erickson previously held senior financial positions with Storage USA and brings over 25 years of financial and accounting leadership. He has worked in both the private and public sector.

Gary Kain was named President in 2011, elevated from Chief Investment Officer. From 1995 to 2009, Mr. Kain served in roles of escalating responsibility at FHLMC (Freddie Mac). He manages and monitors all investment activity to keep the company in line with short-term and long-term investment goals.

Q1 2015 Interest Income Up 16%

For the three months ended March 31, 2015, American Capital had interest income of $383 million (up 16%), net interest income of $297 million (up 19%), comprehensive income of $161 million (down 47%), or $0.46 per share, and net loss of $259 million (down 22%), or $0.73 per share.

After adjusting for unrealized gains of $420 million, the company reported comprehensive income of $161 million, or $0.46 per share, down from $304 million in the prior quarter.

 


As of March 31, 2015, American Capital had $1.71 billion in cash and cash equivalents, $63.75 billion in total liabilities and $9.36 billion in total stockholders’ equity.

Summary

American Capital offers a solid double-digit dividend yield, steady monthly dividends, increased NBV transparency and shares that offer significant upside and are currently trading 20% below book value. The company has veteran management and is well hedged against interest rate volatility. Shares are compelling for investors seeking both income and capital appreciation.


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