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Amid volatility in both interest rates and mortgage spreads environment, the mortgage real estate investment trust (commonly known as mREIT) -- American Capital Agency Corp. (AGNC - Analyst Report) -- reported disappointing third-quarter 2013 results with its net spread income per share of 61 cents significantly lagging the Zacks Consensus Estimate of 84 cents.

Moreover, results compared unfavorably with the prior-quarter figure of 66 cents and the year-ago quarter’s 79 cents per share. The company’s book value continued to decline during the quarter. To counter the challenges, the company repositioned the portfolio and shifted to shorter maturity securities, controlled leverage, and maintained relatively high hedge ratios.

American Capital Agency reported net interest income of $413 million in the reported quarter, marginally missing the prior-quarter figure of $414 but ahead of the Zacks Consensus Estimate of $339 million and the year-ago period figure of $381 million.

Behind the Headline Numbers

American Capital Agency reported an economic gain on common equity for the quarter of 2.2%, or 8.7% annualized. This compared with an economic loss on common equity of 32.9% in the prior quarter. As of Sep 30, 2013, the company's net book value per common share was $25.27, down from $25.51 as of Jun 30 and $28.93 as of Mar 31, 2013.

As of Sep 30, 2013, the company's investment portfolio aggregated $77.8 billion of agency securities. This included $(7.3) billion of net short TBA (to-be-announced) mortgage positions, at fair value.

As of that date, American Capital Agency's investment portfolio comprised $75.1 billion of fixed-rate securities, $1.0 billion of adjustable-rate securities and $1.7 billion of collateralized mortgage obligations (CMOs).

American Capital Agency’s fixed-rate mortgage assets consisted of $42.1 billion less than or equal to 15-year securities, $1.4 billion 20-year fixed-rate securities and $38.8 billion 30-year fixed-rate securities, $(2.0) billion less than or equal to 15-year net short TBA securities and $(5.2) billion 30-year net short TBA securities, at fair value.

Around $78.4 billion of the company's repurchase agreements were utilized for financing acquisitions of agency securities, while $4.1 billion was used to obtain U.S. Treasury securities. The company's average leverage ratio and average "at risk" leverage ratio for the third quarter was 7.8x.

During the reported quarter, the company’s average asset yield on its agency security portfolio was 2.59% (down 33 basis points sequentially) and its average cost of funds was 1.39% (down 4 bps sequentially), resulting in an average net interest rate spread of 1.20% (a sequential decline of 29 bps).

As of Sep 30, 2013, American Capital Agency had cash and cash equivalents of $2.1 billion, down from $2.9 billion at the prior-quarter end.

Dividend Update

On Sep 19, 2013, the company declared a third-quarter dividend on its common stock of 80 cents per share, reflecting nearly 24% decline from the prior quarter. This was paid on Oct 28, 2013 to common stockholders of record as of Sep 30, 2013. As a matter of fact, the company paid a total of $4.0 billion in common dividends, or $26.96 per common share, since its May 2008 initial public offering.

Share Repurchase

In the third quarter, American Capital Agency repurchased approximately 11.9 million shares of its common stock, representing 3% of its outstanding shares as of Jun 30, 2013, at an average price of $22.16 per share, including expenses, and aggregating around $263 million. With this, around 14.8 million shares have been bought back for approximately $347 million since the beginning of the buyback program in the fourth quarter of 2012.

Moreover, the company declared that the share buyback authorization has been elevated to up to $1 billion from $500 million and extended through Dec 31, 2014. The company plans to buyback shares at a time when the repurchase price is less than its current net book value per common share estimate.

In Conclusion

While the volatility in both interest rates and mortgage spreads during the third quarter impacted the company’s results, we believe that the ‘no taper’ announcement brought relief to the company. Moreover, curtailed growth projections by the Fed and a lackluster employment scenario implied a continued low interest rate environment in the near term, which would support mREITs like American Capital Agency.

American Capital Agency is externally managed and advised by American Capital AGNC Management, LLC, an affiliate of American Capital, Ltd. (ACAS - Analyst Report). It currently has a Zacks Rank #3 (Hold).

However, other mREIT stocks which are performing well and deserve a look are AG Mortgage Investment Trust Inc. (MITT - Snapshot Report) and Apollo Commercial Real Estate Finance Inc. (ARI - Snapshot Report). While AG Mortgage Investment Trust has a Zacks Rank #1 (Strong Buy), Apollo Commercial Real Estate Finance carries a Zacks Rank #2 (Buy).

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