American Capital Agency (NASDAQ:AGNC) reported a rough quarter on Monday, posting a comprehensive loss of $(0.97) per share, which is compared to a gain of $0.46 in the first quarter.
Comprehensive income, unlike net income, includes unrealized gains and losses on investment securities, which is often substantial for mortgage REITs. In this case, $872 million worth of unrealized losses on the company's fixed-income securities dropped its book value by 6% compared to last quarter.
Following the company's earnings release, American Capital Agency's executives shed some light on the quarter as well as gave some reasons to be hopeful.
1. "This time, however, unlike the first quarter, the resulting volatility led to higher rates."
The company's president and chief investment officer, Gary Kain, explained that the weaker quarter was a result of "global economic uncertainly" and fear of rising rates, which is causing volatility.
That may be true, but to be fair, the global economy is always uncertain, and there has been the same fear about interest rates for over a year. What's different now? The difference was that interest rates rose this quarter. In fact, the 10-year Treasury rate rose from 1.85% to 2.35% during the second quarter and because the market value, or price, of fixed-income securities and interest rates have an inverse relationship, when rates went up, American Capital Agency's assets took unrealized losses. That's about the long and short of it.
2. "[W]e do feel good about recognizing the unfavorable risk/return landscape and entering the quarter with the lowest leverage we have employed since 2008."
Along with explaining why American Capital Agency had a disappointing quarter, Kain also noted that while management is not pleased with the results, they've been making the right decisions.
Over the last year and a half, American Capital Agency has been playing it close to the hip, in particular, by reducing leverage (ratio of total debt to shareholders' equity). Similar to the game Jenga, each time you pull a block from the bottom and place the piece on top, the tower gets larger, but it also gets riskier, and leverage works the same way. So, by reducing leverage, it limits the size of the tower, or the company's earnings potential, but, as Kain seems to be indicating, without these actions the losses would have been more substantial.
Kain's statement finished with the following: "our conservative risk profile gives us significant capacity to take advantage of attractive opportunities as they arise."
As mentioned, rising rates have an immediately negative impact by reducing the market value of American Capital Agency's securities portfolio, but it also provides the company with an opportunity to buy new and higher-yielding securities. So, operating with a more "conservative risk profile" -- which involves reducing debt and selling assets -- is like partially emptying out a bucket of silver to make room for when it starts raining gold.
3. "With our stock trading at meaningful discounts to our net book value [...] we repurchased approximately 1% of our outstanding shares of common stock."
The final statement was from the company's CEO, Malon Wilkus, who commented on the repurchase of 4 million shares of common stock worth a total of $79 million during the quarter.
As you can see in the chart above, both American Capital Agency and peer Annaly Capital Management are trading at near-historic discounts to their book value, and have been for most of 2015. However, during their first-quarter conference call, both companies' executives vigorously defended their decision not to buy back stock.
Annaly has yet to report this quarter, but it seems American Capital Agency may have changed its tune. The $79 million buyback is little more than a drop in the bucket for a company with nearly $9 billion in equity, but under its current agreement with its board of directors, American Capital Agency can repurchase up to $900 million worth of shares, and now may be as good a time as any to start using it.
One thing to watch
If there is one thing to watch going forward -- besides when the Federal Reserve is going to raise short-term interest rates -- it is how aggressively American Capital Agency repurchases shares. The company's executives were far from enthusiastic about buybacks in the first quarter, so I'll be curious to see just how serious they are now that the stock is trading at an even more dramatic discount.