Will American Capital Agency Earnings Force Another Dividend Cut?

American Capital Agency (AGNC +0.00%) will release its quarterly report on Monday, and the real estate investment trust faces the toughest environment it has seen in years. With big share-price declines, the pressure will be on to see if American Capital Agency earnings can sustain the company's generous dividend payouts -- or whether it will have to make further cuts in its dividend that could send the stock falling further.

For years, American Capital Agency has benefited from interest rate policies that have provided cheap financing and appreciating values of the mortgage-backed securities it relies on for its investment portfolio. But the recent boom in bond yields led to steep price declines that took the wind out of the mortgage REIT business, and threats that the Federal Reserve will taper its buying of bonds could put further pressure on the company. Let's take an early look at what's been happening with American Capital Agency over the past quarter and what we're likely to see in its quarterly report.

Stats on American Capital Agency

Source: S&P Capital IQ.

Will American Capital Agency earnings be enough to keep income investors happy?
Recently, analysts have boosted their views on American Capital Agency earnings for the June quarter, with one analyst boosting GAAP estimates for the quarter by nearly 45%. Full-year estimates have also been rising gradually over the past quarter, yet the share price remains firmly in the red, having plunged more than 30% just since late April.

Those declines began after the company reported first-quarter earnings in early May, with American Capital Agency posting a comprehensive loss of $557 million, including unrealized losses on mark-to-market mortgage-backed securities. Fears about the Fed's exit from its quantitative easing program helped stoke mortgage-securities losses, and what turned out to be an ill-timed secondary offering ended up contributing to the poor results.

But those fears continued to expand in the second quarter, and the bond market finally made significant moves that hurt bond prices and sent yields soaring. In response, many mortgage REITs expanded their purview to go beyond their traditional agency-backed securities. Annaly Capital (NLY +0.00%), for instance, started adding securities backed by commercial mortgages, while Armour Residential (ARR +0.00%) set the stage for a shift by changing its charter to allow non-agency purchases. But because American Capital Agency has a sister REIT, American Capital Mortgage (NASDAQ: MTGE), that has a broader scope, CIO Gary Kain plans to keep American Capital Agency's investing strategy true to its name by staying focused on agency-backed bonds.

The other shoe dropped in June, as American Capital Agency cut its dividend by $0.20 to $1.05 per share. With Annaly and Armour both having had to make multiple cuts within the past year, American Capital Agency had actually done a good job of preserving its payout.

The big question for American Capital Agency will be whether its hedging program helps it avoid big losses. CYS Investments (NYSE: CYS) reported a big loss last week, with its book value taking a large hit because of hedging practices that didn't work as well as CEO Kevin Grant would have liked. If its hedges work, then American Capital Agency earnings could give investors a nice surprise next week, forestalling any need for further dividend cuts -- at least for now.

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