AGNC Investment Corp. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; balance-sheet comparisons are with December 31, 2017. AGNC is a leveraged mortgage REIT investing primarily in Agency residential mortgage-backed securities (RMBS), funded mainly through repurchase agreements. Amounts are in U.S. dollars.
Financial performance and position
- Q2 earnings: Interest income was $414 million, up from $293 million a year earlier; interest expense rose to $237 million from $112 million. Net interest income was $177 million versus $181 million. Net income was $293 million versus $24 million, and diluted earnings per common share were $0.70 versus $0.05. Other gains were $134 million, compared with a $141 million loss in Q2 2017, led by gains on derivatives and other securities.
- First-half earnings: Interest income was $845 million versus $589 million; net interest income was $402 million versus $379 million. Net income was $717 million versus $100 million, but comprehensive income was a loss of $49 million versus income of $267 million, reflecting a $766 million other comprehensive loss on available-for-sale securities.
- Spread and dividends: Management’s non-GAAP average net interest spread, including TBA dollar-roll income and swap effects and excluding catch-up premium amortization, was 1.35% in Q2, down from 1.55% a year earlier. Common dividends declared were $0.54 per share in Q2 and $1.08 for the first half, unchanged from the comparable 2017 periods.
- Assets, equity and book value: Total assets were $73.1 billion, including $57.1 billion of investment securities and a $20.0 billion net long TBA position. Total stockholders’ equity was $9.0 billion. Tangible net book value per common share was $18.41, down from $19.69 at year-end; reported net book value was $19.68 versus $21.09.
- Debt and leverage: Repurchase agreements totaled $48.8 billion, down from $50.3 billion at year-end; consolidated VIE debt was $313 million. Repurchase agreements had a 2.18% weighted-average rate and 101-day weighted-average remaining maturity, compared with 1.57% and 116 days at year-end. At-risk leverage was 8.3x tangible equity versus 8.1x at year-end.
- Liquidity and cash flow: Cash and cash equivalents were $863 million and restricted cash was $447 million. Management reported $0.9 billion of unrestricted cash and approximately $3.9 billion of unpledged securities available for liquidity needs. For the first half, operating cash flow was $410 million, investing cash flow was $695 million, financing cash flow was negative $1.16 billion, and cash, cash equivalents and restricted cash declined by $53 million to $1.31 billion.
- Portfolio and funding: The investment portfolio, including TBAs, increased to $77.1 billion from $72.8 billion at year-end. Thirty-year fixed-rate Agency RMBS rose to 81% of the portfolio from 77%. The estimated weighted-average yield on investment securities, excluding TBAs, was 3.03%, up from 2.89% at year-end.
Changes and management commentary
- Management reported a Q2 economic return of 1.7%, comprising a $0.22 per-share decline in tangible book value and $0.54 per-share dividends. For the first half, economic return was negative 1.0%; Q1’s negative 2.6% return was partly offset by Q2.
- During Q2, the 10-year Treasury yield rose 11 basis points to 2.85%; management said Agency RMBS and credit spreads were largely unchanged. Average repo funding cost rose to 1.99% in Q2 from 1.43% in Q4 2017, while average total cost of funds reached 1.67%. The average asset yield rose to 3.02%, leaving the reported non-GAAP spread near the prior quarter’s level.
- AGNC maintained substantial hedging: its hedge position was 99% of funding liabilities at June 30, and estimated duration gap was 0.8 years. Management said hedges mitigate, but do not fully offset, further rate increases. Its stated typical leverage range is six to twelve times tangible equity; no earnings or dividend guidance was provided.
- AGNC raised $788 million net from common stock issuance during the first half, including a May public offering and at-the-market sales. On August 3, after quarter-end, it completed another offering of 43.7 million shares for $817 million net proceeds.
Risks, contingencies and unusual items
- Key exposures include interest-rate, mortgage-spread, prepayment and extension risk, liquidity and refinancing risk, and credit and counterparty risk. Repurchase financing is collateralized and subject to margin calls; short-term funding may not be renewable on acceptable terms. TBA dollar rolls can also create cash-settlement and margin requirements.
- At June 30, management’s modeled 100-basis-point rate increase indicated an 11.8% decline in tangible net book value; a 25-basis-point widening in mortgage spreads indicated a 14.0% decline. These are static-portfolio estimates based on assumptions, not forecasts.
- Available-for-sale securities had $1.119 billion of gross unrealized losses, attributed by the company primarily to interest rates and prepayment expectations; no other-than-temporary impairment charge was recorded. The first-half $766 million OCI loss also materially reduced reported comprehensive income.
- Following MTGE Investment Corp.’s proposed acquisition by Annaly, AGNC amended its management agreement with MTGE. The amendment provides for a $41.7 million termination fee, with the transaction expected to close in 2018 subject to conditions. The filing does not establish that the fee had been received by June 30.
- Three stockholder derivative lawsuits remain disclosed. A court dismissed some claims in July 2018 but allowed certain claims concerning prior decisions not to terminate a management agreement to proceed; AGNC says it believes the claims lack merit and has not accrued a loss contingency.
- Management stated that risk factors were not materially changed from the 2017 Form 10-K. It also reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether net interest spread and dividend capacity remain adequate as repo costs rise; compare taxable income available to common stockholders ($0.26 per share in Q2 and $0.46 for the first half) with dividends declared ($0.54 and $1.08, respectively). Taxable income is an estimate and may be adjusted.
- How book value, portfolio valuation and hedge effectiveness respond to rate and spread changes, especially given the disclosed sensitivity estimates and substantial unrealized losses.
- Funding concentration, repo rollover terms, collateral haircuts, margin-call capacity and the liquidity implications of the $20.0 billion net long TBA position.
- The effects of the May and August 2018 equity offerings on share count, per-share book value and future returns.
- Completion and accounting treatment of the MTGE transaction and termination fee, and subsequent developments in the derivative lawsuits.