AGNC Investment Corp. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Amounts are in millions of dollars, except per-share data and ratios, unless stated otherwise.
Business context
AGNC is an internally managed mortgage REIT that primarily invests in Agency residential mortgage-backed securities (RMBS) using leverage and repurchase-agreement financing. It also holds smaller positions in credit risk transfer (CRT) and other mortgage securities. Its stated objective is to provide risk-adjusted returns through monthly dividends and net book value accretion. REIT status requires annual distributions of at least 90% of taxable income; management intends to distribute 100%.
Financial and operating performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Interest income | $318 | $315 | $907 | $928 |
| Interest expense | $140 | $96 | $350 | $296 |
| Net interest income | $178 | $219 | $557 | $632 |
| Other gain (loss), net | $125 | $307 | $(121) | $(940) |
| Net income (loss) | $286 | $511 | $386 | $(396) |
| Net income (loss) available to common stockholders | $271 | $504 | $357 | $(417) |
| GAAP diluted earnings (loss) per common share | $0.74 | $1.52 | $1.03 | $(1.26) |
| Common dividends declared per share | $0.54 | $0.56 | $1.62 | $1.76 |
- Margins and funding: Q3 average asset yield was 2.72%, average cost of funds 1.59%, and average net interest rate spread 1.13%; including TBA dollar-roll income, the spread was 1.34%. Management’s non-GAAP net spread and dollar-roll income, excluding catch-up premium amortization, was $0.62 per common share in Q3 and $1.94 for the first nine months.
- Cash flows, nine months: Operating activities provided $935, versus $1,029 in 2016. Investing activities used $6,394, compared with providing $4,722 in 2016; financing activities provided $5,349, versus using $5,607. Cash and cash equivalents ended at $1,098, down from $1,208 at year-end 2016.
- Balance sheet at September 30: Total assets were $65,490 and total liabilities $56,699; stockholders’ equity was $8,791. Cash and cash equivalents were $1,098, with restricted cash of $294. Investment securities were $53,091 at fair value; the portfolio including net TBA positions had fair value of $72,500.
- Debt and leverage: Repurchase agreements totaled $45,505, up from $37,858 at December 31, 2016. Consolidated VIE debt was $380; FHLB advances had been repaid and were zero at quarter-end. Tangible net book value “at risk” leverage was 8.0x, versus 7.7x at year-end.
- Book value and capital: Net asset value was $21.19 per common share, versus $21.17 at year-end; tangible net asset value was $19.78, versus $19.50. The filing reports tangible book value up 2.8% for the quarter and 1.4% year to date; including declared dividends, year-to-date economic return on tangible common equity was 9.7%.
Material changes versus comparable periods
- Q3 net income and common earnings declined year over year, primarily alongside lower net interest income and smaller other gains. The Q3 net interest spread including TBA dollar-roll income declined to 1.34% from 1.42% a year earlier; higher funding costs contributed to the pressure.
- Nine-month GAAP results moved from a $396 loss in 2016 to $386 income in 2017. The comparison reflects a much smaller derivative and other-securities loss in 2017, partly offset by lower net interest income and a $47 net loss on investment-security sales, versus a $114 gain in 2016.
- Investment securities at fair value increased to $53.1 billion from $46.5 billion at year-end, while net TBA position fair value increased to $19.4 billion from $11.2 billion. Agency RMBS and TBA positions accounted for 99% of the reported investment portfolio including TBAs.
- Common shares outstanding increased following 2017 equity issuance. May and September public offerings raised $503 and $577, respectively, net of estimated offering costs; at-the-market sales raised a further $159. AGNC issued $315 of Series C preferred stock and redeemed $173 of Series A preferred stock.
- The Fed raised short-term rates by 50 basis points during the first nine months, while the 10-year Treasury yield fell 10 basis points. Management said the Fed’s September announcement to begin tapering reinvestment of bond proceeds from October helped tighten Agency RMBS spreads and supported book value in Q3.
Outlook, risks, contingencies and unusual items
- No formal earnings or dividend guidance is provided. Management said it believed liquidity and capital resources were sufficient for investments, debt repayments, margin requirements and dividends. It generally expected leverage in a range of six to eleven times tangible equity, while noting actual leverage may fall outside that range.
- Management reported aggregate cost of funds of 1.46% at quarter-end, up 31 basis points from year-end 2016, and repo funding cost of 1.36%, up 38 basis points. It cited a flattening yield curve and modest net interest margin compression. Repo funding through its captive broker-dealer reached 30%, versus 12% at year-end.
- Liquidity included $1.1 billion of unrestricted cash and approximately $3.6 billion of unpledged securities available for margin calls and other needs. AGNC reported it had met all margin requirements. Risks include repo renewal availability, collateral haircuts and margin calls, potential TBA settlement cash needs, interest-rate and prepayment changes, spread widening, extension risk, and credit and counterparty exposure. Hedging does not generally protect book value from spread risk.
- At September 30, modeled parallel-rate shocks showed estimated tangible net asset value declines of 3.7% for a 50-basis-point rise and 9.8% for a 100-basis-point rise. A 25-basis-point spread widening was estimated to reduce tangible net asset value by 12.3%. These are static-model estimates, not forecasts, and management cautioned actual results could differ materially.
- Estimated taxable income available to common stockholders was $0.12 per share for Q3 and $0.34 for the first nine months. The filing notes that estimates may change; $337 of cumulative net capital loss carryforwards, or $0.86 per ending common share, were reported as expiring at the end of fiscal 2018.
- Two stockholder derivative lawsuits concern past management-agreement renewals and management internalization. AGNC said it believed the claims lacked merit and were not expected to create material liability; no loss contingency was accrued. Management reported no material change to previously disclosed risk factors and concluded disclosure controls were effective.
- After quarter-end, the board declared a monthly common dividend of $0.18 per share, payable November 9, 2017.
Important facts for investors to verify
- Whether net interest income, funding costs and TBA dollar-roll economics support the declared dividend, and how non-GAAP spread income compares with GAAP results.
- How sensitive tangible book value and liquidity remain to Agency spread widening, interest-rate moves, slower prepayments and higher repo haircuts or margin demands.
- The effect of the higher leverage and larger TBA position, including potential funding or cash requirements if TBA rolls become uneconomic or settle physically.
- The impact of 2017 common and preferred share issuance on per-share book value, earnings and future dividend capacity.
- Whether the estimated taxable income and expiring capital-loss carryforwards change the required distribution profile; taxable-income estimates are subject to adjustment.
- Any developments in the stockholder derivative lawsuits or in the availability and terms of repo financing.