American Capital Agency Corp. (NasdaqGS: AGNC), a leading real estate investment trust (REIT) that focuses on investments in mortgage pass-through securities and collateralized mortgage obligations (CMOs), has recently announced the preliminary results for fourth quarter 2010. The company anticipates quarterly earnings (including non-recurring items) to exceed $2.25 per share.
American Capital’s fourth quarter results were positively affected by non-recurring net realized and unrealized gains on its derivative instruments, and net realized gains on available-for-sale securities. The derivative instruments, such as to-be-announced (TBA) mortgage short positions and payer swaptions, are primarily utilized by the company to hedge increases in interest rates.
A payer swaption is a tool to enter into an interest rate swap where the buyer pays fixed rate and receives floating, thereby benefiting from interest rate rises. The initial cost of the swaption comes in the form of a premium, and this is the maximum amount the buyer can lose. The participants in the swaption market are primarily large corporations, banks, financial institutions and hedge funds, who typically utilize swaptions to manage interest rate risk arising from their financing arrangements.
Agency lenders such as American Capital, which holds a mortgage portfolio, purchases payer swaptions to protect against lower interest rates that might lead to early prepayment of the mortgages. This measure ultimately facilitates the company to continue making money by collecting premium.
American Capital expects taxable net income for the quarter to be lower than GAAP net income due to the deferred recognition of certain unrealized gains/losses for tax purposes and other timing-related differences. The company anticipates undistributed taxable income at year-end 2010 to surpass $40 million, with book value per share exceeding $24.00. American Capital estimates the fair value of its investment portfolio to be approximately $13.5 billion as of December 31, 2010 with a leverage ratio of approximately 7.8x.
In a separate development, American Capital announced a secondary offering of 18 million common shares. The company will also grant the underwriters an option to purchase an additional 2.7 million shares to cover any over-allotments. American Capital intends to utilize the proceeds to purchase additional agency securities and for general corporate purposes.
American Capital invests only in fixed-rate agency securities where payments are guaranteed by the U.S. government or government-owned entities, such as Fannie Mae (OTC BB: FNMA.OB - News), Freddie Mac (OTC BB: FMCC.OB - News) and Ginnie Mae. Specifically, American Capital invests in FMCC Gold certificates, FNMA certificates, and Ginnie Mae certificates. We like the company’s focused investment approach, which is not distracted by originations, servicing, or credit risk from investments in mortgages that do not have the backing of the U.S. government.
American Capital is externally managed by American Capital Agency Management, a wholly-owned subsidiary of American Capital Ltd (NasdaqGS: ACAS), an $18 billion publicly traded asset management company. Agency residential lenders like American Capital are the only residential mortgage REITs left with a viable business model, more specifically, with access to capital-tofund growth during recession. With the government takeover of Freddie and Fannie, American Capital's securities now have an explicit government guarantee, which makes agency REITs a much more attractive prospect for investors. Additionally, the company’s portfolio of government-backed assets is relatively liquid and credit risk is limited.
However, the residential mortgage market in the U.S. has experienced defaults, credit losses and liquidity concerns, which have reduced financial industry capital, leading to reduced liquidity for some institutions. These factors have impacted investor's perception of the risk associated with real estate related assets, including agency securities and other high-quality RMBS (residential mortgage-backed securities) assets.
As a result, values for RMBS assets, including some agency securities and other AAA-rated RMBS assets, have experienced a certain amount of volatility. Increased volatility and deterioration in the broader residential mortgage and RMBS markets may adversely affect the performance of American Capital in the future.
Disclosure I am long AGNC shares Collecting FAT dividends now.
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