American Capital Agency: Financial Winner

NEW YORK ( TheStreet) -- American Capital Agency Corp. ( AGNC) was the winner among major U.S. financial names on Tuesday, with shares rising 6% to close at $23.08.

The broad indices ended mixed, although there was some support from a 9% gain for Goodyear Tire and Rubber ( GT), which closed at $18.56 following better-than-expected second-quarter earnings results.

The KBW Bank Index ( I:BKX) was up slightly to close at 65.44, with all but eight of the 24 index components showing gains for the session.

Shares of JPMorgan Chase ( JPM) were down less than 1% to close at $55.33, after the company's energy trading subsidiary agreed to pay $410 million in fines and "disgorgement to ratepayers," to settle market manipulation charges from the Federal Energy Regulatory Commission.

The Federal Open Market Committee began its two-day meeting on Tuesday, which will be followed on Wednesday afternoon with the release of its statement on monetary policy.

The Federal Reserve has been making monthly purchases of $85 billion in long-term securities since September, in an effort to spur economic growth by holding long-term interest rates down. Investors have pushed the yield on 10-year U.S. Treasury bonds up to 2.61% from 1.70% at the end of April.

Recent comments from Fed Chairman Ben Bernanke have led some investors to expect the central bank's bond-buying to be curtailed as early as September, and the FOMC may issue an update to its principals for quantitative easing the committee laid out two years ago.

The rise in the market yield for the 10-year bond has done little over the short-term to expand banks' net interest margins, but it has had a big effect on market values for mortgage backed securities, which fueled the 31% decline in shares of American Capital Agency Corp. (AGNC) from the end April through Monday's market close.

AGNC late on Monday reported a second-quarter comprehensive loss of $936 million, or $2.37 a share, and a net book value of $25.51 per common share as of June 30. "Economic return" for the second quarter was a negative 8.2% when factoring in the dividends paid on common shares and the book-value decline, which the company said represented an annualized return of negative 32.9%.

Despite the 11.8% decline in net book value during the second quarter, driven by marks on mortgage-backed securities investments as long-term interest rates rose, investors reacted with relief, since expectations of even worse results were apparently built into the stock price.

AGNC lowered its dividend to $1.05 a share for the second quarter from $1.25 the previous quarter

AGNC chief investment officer Gary Kain in the company's earnings announcement said that in response to "extreme volatility" in interest rates and mortgage rate spreads, the company "the size of our asset portfolio, adjusted our asset composition to be more consistent with a higher rate environment, and materially increased the duration of our hedges. As a result of these actions and evolving market conditions, our exposure to higher rates is lower than it has been in years and our 'pay-up' risk is now minimal."

"On balance we see the 11.8% decline in book value as a relatively solid performance given the starting point and evolution of rates and MBS prices during the quarter," KBW analyst Michael Widner wrote in a note to clients late Monday wrote. "By our estimates, had AGNC done nothing during the quarter to manage portfolio composition (e.g., simply reinvesting principal paydowns in the same securities) and added no hedges we estimate book value would have been down closer to 20%."

Following the "worst quarter in a couple decades for agency MBS, and a historically bad quarter for the sector," Widner wrote that "improved net interest spread opportunities can't quite make up for the sharp declines in book values and the realistic costs of appropriately hedging. That leaves most mortgage REITs in position where they can either cut the dividends or maintain an elevated risk profile."

The analyst therefore lowered his price target for the REIT to $27 from $30, while maintaining his "outperform" rating for AGNC. KBW's estimates factor-in a continued quarterly dividend of $1.05 a share through the end of 2014.

AGNC Chart AGNC data by YCharts

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-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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