AGNC Investment Corp. quarterly report, Q3 FY2016

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AGNC Investment Corp. — Q3 2016 Form 10-Q

Reporting period: Quarter ended September 30, 2016; comparisons are with Q3 2015 unless otherwise noted. Amounts are in U.S. dollars. AGNC is a leveraged mortgage REIT focused primarily on agency mortgage-backed securities (MBS), funded mainly through repurchase agreements.

Financial results and key metrics

  • Q3 earnings: Interest income was $315 million versus $295 million; net interest income was $219 million versus $218 million. Net income was $511 million, compared with a $633 million net loss. Net income available to common stockholders was $504 million, or $1.52 per diluted share, versus a $640 million loss, or $1.84 per share.
  • Nine-month results: Interest income was $928 million versus $1.092 billion; net interest income was $632 million versus $848 million. Net loss was $396 million versus $373 million, and loss available to common stockholders was $417 million, or $1.26 per share, versus $394 million, or $1.12 per share.
  • Comprehensive income: Q3 was $421 million versus a $142 million loss; nine-month comprehensive income was $680 million versus a $308 million loss. Nine-month 2016 results included $1.076 billion of other comprehensive income, primarily unrealized MBS gains.
  • Spread and operating costs: Q3 net spread and dollar roll income, a non-GAAP measure, was $211 million ($0.62 per common share), or $212 million ($0.64 per share) excluding catch-up premium amortization. Nine-month amounts were $498 million ($1.44 per share) and $572 million ($1.72 per share), respectively. Q3 net interest rate spread was 1.28%, versus 0.72%; including TBA dollar roll income it was 1.42%, versus 1.14%. Nine-month spreads were 0.99% and 1.18%, respectively, versus 1.21% and 1.48%.
  • Cash flow: For the nine months, operating activities provided $1.029 billion, investing activities provided $4.722 billion, and financing activities used $5.607 billion. Cash and cash equivalents ended at $1.254 billion, up $144 million from year-end 2015.
  • Balance sheet and liquidity: At September 30, total assets were $55.889 billion, total liabilities $47.958 billion, and stockholders’ equity $7.931 billion. Unrestricted cash was $1.254 billion; restricted cash was $681 million. Management also reported approximately $2.2 billion of unpledged securities available for liquidity and margin needs.
  • Debt and leverage: Repurchase agreements were $37.668 billion, FHLB advances $3.037 billion, and consolidated-VIE debt $494 million. Total mortgage borrowings were $41.154 billion; including the $15.540 billion net long TBA position at cost, total mortgage funding was $56.694 billion. Period-end at-risk leverage was 7.2x, versus 6.8x at December 31, 2015; tangible at-risk leverage was 7.7x.
  • Portfolio and shareholder measures: Investment securities at fair value were $47.356 billion, down from $52.473 billion at year-end; including net TBA positions, portfolio fair value was $62.942 billion. NAV per common share was $22.91 versus $22.59; tangible NAV per share was $21.23. Common dividends declared were $0.56 per share in Q3 and $1.76 for the first nine months, compared with $0.60 and $1.88 in the prior-year periods.

Material changes versus comparable periods

  • Q3 GAAP income swung to profit, principally alongside a $242 million net gain on derivatives and other securities, compared with a $778 million loss in Q3 2015. The Q3 2016 derivative result included $299 million of interest-rate-swap termination fees; the nine-month total was $865 million. Market-value movements and hedge results make reported earnings volatile.
  • Nine-month net interest income declined $216 million year over year, as interest income fell and interest expense rose. The nine-month net spread and dollar roll income per share excluding catch-up amortization declined to $1.72 from $1.81, with higher repo costs and lower TBA dollar roll income relative to average TBA exposure cited as offsets to higher leverage and lower operating costs.
  • AGNC completed its $562 million cash acquisition of AGNC Mortgage Management, LLC on July 1 and became internally managed. It recorded $526 million of goodwill and $29 million of net intangible assets. Q3 operating expenses were $15 million versus $34 million, including the prior external management fee; Q3 2016 included $9 million of compensation and benefits. The nine-month period included $9 million of acquisition transaction costs.
  • Agency repo and FHLB balances fell from year-end, while the net long TBA position increased from $7.430 billion to $15.540 billion. The portfolio’s projected weighted-average CPR rose from 8% to 11%; actual September CPR was 16% annualized.
  • Common shares outstanding declined to 331.0 million from 337.5 million at year-end. AGNC repurchased 6.5 million shares for $116 million during the first nine months; none were repurchased in Q3.

Outlook, commentary, and risks

  • Management said it expected U.S. rates to remain relatively range-bound, reduced its hedge ratio to 75% of funding liabilities and net TBA position from 87% at year-end, and reduced its net duration gap to 0.3 years from 0.8 years. It also increased average at-risk leverage to 7.1x during the first nine months, citing attractive agency MBS opportunities.
  • Management expected September’s elevated prepayments to ease for the rest of 2016, citing seasonal housing turnover and modestly higher primary mortgage rates. The filing provides no quantified earnings or dividend guidance.
  • The company revised investment guidelines to permit credit-sensitive assets and made initial investments in GSE credit risk transfer (CRT) securities. Management described CRT as a long-term opportunity; these securities, unlike agency MBS, are exposed to credit losses.
  • AGNC said money-market reform supported agency repo funding costs in Q3. However, FHLB membership termination requires repayment of all FHLB advances by February 2017; management said it expected alternative funding to be adequate. FHLB advances outstanding were $3.037 billion at quarter-end.
  • Key risks include interest-rate and spread changes, prepayment and extension risk, short-term financing renewal and margin calls, TBA settlement liquidity, counterparty exposure, and credit risk on CRT and non-agency holdings. The filing’s modeled static-portfolio sensitivities estimate that a 100-basis-point rate increase would reduce NAV by 10.5%, while a 25-basis-point spread widening would reduce NAV by 9.3%; management cautioned actual outcomes could differ materially.
  • Management stated liquidity was sufficient for investment, debt repayment, margin requirements, and dividends. It also noted that REIT status requires distribution of at least 90% of ordinary taxable income and that it intended to distribute 100% of taxable income. The board declared a $0.18-per-share monthly common dividend for November 2016.
  • The company reported effective disclosure controls, no material litigation, and no material changes to previously disclosed risk factors.

Important facts for investors to verify

  • How recurring earnings and dividend coverage compare with GAAP results, particularly after excluding swap termination fees, valuation changes, and catch-up premium amortization.
  • Whether internalization delivers the expected cost savings and management-fee income, and how employee compensation and equity awards affect future expenses.
  • How AGNC will refinance or repay the $3.037 billion of FHLB advances due under the membership termination rule, and the availability and cost of replacement funding.
  • Whether prepayment speeds, repo costs, leverage, and the large net long TBA position remain manageable under changing rate and spread conditions.
  • The pace and credit performance of CRT and other credit-sensitive investments, and the impact of distributions and repurchases on NAV and capital.