MTGE: One Year On

A year after its introduction, American Capital Mortgage Investment Corp. (MTGE articles here) proves ACAS can manage a mortgage fund. Investors in American Capital Agency Corp. (AGNC articles here) won't find this surprising.

The real story is at the manager, ACAS. More on ACAS soon.

MTGE's New Offering Defers ~42¢/sh

At Seeking Alpha, I show how the at-NAV issuance of the new MTGE shares gives shareholders a tax benefit akin to indefinite deferral of 42¢ of income, without requiring a tax-deferred account. This is a single-instance case of the hidden deferral available when ACAS-managed mREITs issue shares following the earning of taxable income.

Since ACAS is now a taxable entity, this indefinite deferral amounts to about 15¢ per MTGE share of income tax it won't pay (or tax asset it won't consume). With 2m shares, this is a $300k one-time bonus. ACAS has done this already this year (I didn't do the math on the first secondary offering), and will surely do it again at its managed fund. Growth in ACAS' holdings of MTGE work to its advantage both by growing its management fees and by growing the fair value of its holdings of MTGE.

Enjoy the new article!

MTGE's 1Q2012: More Growth

Having Your Cake And Eating It Too At American Capital Mortgage explains how MTGE's 1Q2012 amounts to getting a dividend while the company reinvests a copy of the same dividend. The big question is to what extent – with time and asset growth – MTGE will enjoy the lower costs now enjoyed by AGNC.

American Capital Update

Shortly after American Capital Ltd. announced its quarterly results, so too did American Capital Agency Corp.

The important figure for ACAS – the NAV growth to $15.71 – is discussed in the article Why American Capital Is Buying American Capital. That article rebuts a thin work at The Motley Fool, which pitches ACAS share buybacks as a waste of shareholder funds. Its evidence? ACAS "can't afford" a dividend. Uh, it can afford share buybacks. The only difference is that shareholders aren't taxed on the NAV increases caused by below-NAV share buybacks, whereas they would be taxed on dividends. Were share price above NAV, the same funds would be directed into dividends under the recently continued (through 2013) dividend/buyback policy first announced last year. News the Fool apparently missed.

At American Capital Agency, NAV grew even more than the dividend over the quarter. Share price was more volatile, but that's of more import to traders than to investors. The key for investors is that the dividend remains safe while management reinvests further earnings with the added boost of some hidden tax deferral.

Meanwhile, American Capital Mortgage Investment Corp. announced its 1Q2012 results. As with AGNC, MTGE grew NAV in an amount exceeding the dividend it paid (net of the dividend payment, so it's like getting the dividend and having them reinvest it for you, both). Article to follow :-)

Hidden Tax Deferral at AGNC, MTGE

Just published at Seeking Alpha, the newest article from the Jaded Consumer looks at the effect on your taxes of all those share issuances ACAS is conducting at its managed funds AGNC and MTGE.

In a word: it's good news.

Why Issuing Shares Isn't All Bad For Shareholders

I've seen one too many articles describing accretive share issuance as "dilution". I wrote an article at Seeking Alpha (which gets more page hits than I did when I wrote about it here in 2011) in order to explain the difference between issuance that dilutes shareholder value, and issuance that accretes shareholder value.

I hope they get it.

I also hope ACAS maintains its issuance discipline in its managed funds. It's been wonderful and I'd rather not see a good thing spoiled.

MTGE Announces Offering Up To 11.5m Shares

In an offering that could more than double MTGE's shares outstanding at a post-ex-date price that is nearly a dollar north of then-likely NAV, American Capital Mortgage Agency has announced its intention to sell shares under its registration mentioned by the Jaded Consumer at Seeking Alpha. The updated proposed price of the latest 1.5m share registration is $21.86, though the price is "[e]stimated solely for purposes of calculating the registration fee" rather than posing a hard limit. The recent registrations and amended registrations combine to over 11.5m shares.

MTGE's wild price range – recently past $24 – makes an ultimate issuance price hard to pin down. However, MTGE's last-published NAV was less than $21 and its last-quarter NAV increase was nearly a dollar per share – increasing shareholders' value per share 91¢ after paying an 80¢ dividend. With a 90¢ dividend about to go ex-, MTGE's NAV would be near $22.68 near quarter-end if its results were (other than the dividend increase) exactly the same this quarter as last quarter. Of course, MTGE's performance would have to decline to return the exact same result as last quarter, as it began the quarter with more invested capital this quarter than it did last quarter.

Today's close of $22.47 doesn't leave much room for above-NAV issuance if buyers are to receive a discount to market. When is this issuance, exactly?

MTGE past 24

MTGE's meteoric rise – from trading at a NAV discount to trading both above its last-published NAV but also above the intended offering price filed with the SEC on February 23 (but thankfully subject to amendment) – has been stunning. The stock, which took a couple quarters of demonstrated performance to claw its way back to the IPO price of $20, just passed $24. It's been barely over half a year.

At the recently-announced dividend of 90¢ per quarter, the current price presents an annual dividend yield of about 15%, but 18% of the IPO price. Since the investment underlying each share has been growing quarterly, ACAS' ability to get MTGE to produce future income seems solid.

Understanding ACAS' 2011 Results

Confused by the tax asset impact of Q4? Wondering whether a dividend makes sense, and when we'd see it again?

All this and more on "Understanding American Capital's 2011 Results".

Therein, we see American Capital's real NAV improvement (that is, recognizing that the "tax asset" isn't an income-producing asset and wasn't really even new in 2011 as it resulted from crash-era loss carryforwards), revisit the share buyback, and think about the effect of taxes as ACAS changes between a RIC and a C-corp (and maybe back?). We also weigh the impact of AGNC and MTGE on ACAS' per-share results, and suggest that income investors wanting ACAS' management expertise look to MTGE and AGNC until the tax treatment of potential dividends becomes clear.

Enjoy!

MTGE Trading At NAV Premium

MTGE's current price of $21.54 is over 3% more than its last-published NAV of 20.87. This is quite a change from the below-$17 days in October!

If run under the same playbook as MTGE, ACAS will be in a position to grow the assets behind its 2m share investment in MTGE by issuing new shares above NAV, thereby increasing both its management fees in MTGE and its ability to generate dividends to pay itself as a shareholder.

Hopefully ACAS can keep these shares, unlike its exited stake in AGNC.

And speaking of AGNC, there's a new Jaded Consumer article on AGNC at Seeking Alpha. After more than three years, it was time for a follow-up to the first article there. Upshot? Reduced AGNC dividend (exceeding 16%, not too bad) allows ACAS to reinvest more money per share at AGNC. Fun stuff.

4Q2011 at MTGE: AGNC All Over Again, And Better

After MTGE's $20 IPO, the Jaded Consumer followed the company with optimism, and I began investing at $16.75 after the ex-dividend date for its $0.20 stub-quarter dividend. After MTGE announced the size of its first full-quarter dividend, the Jaded Consumer wrote an above-average-readership article at Seeking Alpha, making the call that MTGE's total return wasn't just $0.80/sh in quarterly dividends but would include over a dime per quarter in reinvestment – churning out solid dividends atop a growing base of capital investment capable of driving share price north.

With MTGE's first full-quarter results, it appears ACAS' MTGE-managing team is following the same successful playbook it fine-tuned working on AGNC. The earnings are north of The Jaded Consumer's conservative estimates, the NAV is over $20 as expected, but – best of all – the reinvestment of undistributed income is much more than the Jaded Consumer was willing to predict in a publicly-viewable place. The result? As of this morning, MTGE at least briefly traded above its just-published December 31 NAV of $20.87.

MTGE is performing like AGNC, but faster. Very nice.

What does this mean for MTGE's manager, ACAS? Having invested $40 million in a private sale at the moment of MTGE's public launch, ACAS became a shareholder of 2 million shares, which pay a growing dividend atop an increasing NAV. To the extent MTGE comes (with a few more quarters of outstanding performance) to trade consistently at the sort of NAV premium frequently seen at AGNC, ACAS' investment will be looking pretty smart even without considering the monthly management fees it collects from MTGE in its role as manager. To the extent MTGE trades above NAV, ACAS has an incentive to issue more MTGE (above NAV), driving NAV upward beyond even the extent of reinvestment (and tax-free to MTGE!). Frankly, I hope as an ACAS shareholder that it keeps its shares. I think I'm going to like this ride.

MTGE Likely Better Than Its Dividend

The Jaded Consumer has a new article at Seeking Alpha.

Enjoy!

MTGE: On the First Full Quarter's Dividend

Previously, the Jaded Consumer wrote about American Capital Mortgage Investment Corp.'s $0.20 stub-quarter dividend. Now, MTGE has announced its first full-quarter dividend of $0.80. What could have happened to quadruple MTGE's dividend?

Looking at MTGE's quarterly announcement following its stub quarter, we can see that MTGE moved from an average leverage of 4.7x during the stub period to 7.8x leverage, to turn its $200 million in IPO proceeds (counting ACAS' direct investment as IPO proceeds here) into a $1.7 billion investment portfolio. Annualized net interest rate spread moved from 2.13% during the stub period to 2.41% as of September 30, 2011. At 7.8x leverage, the 2.41% spread suggests a return at quarter-end of 18.8% (less management fees of 1.5%, paid monthly). On an estimated post-IPO-costs NAV of $19.90, this suggests annual returns on the order of $3.44 (considering the 1.5% management fee paid to American Capital Ltd.), or a quarterly earnings number of about 86¢.

But the recent dividend announcement was just 80¢, right? Right.

Looking back to MTGE's sister AGNC, which began its dividend payments with a 27-day stub-period dividend of 31¢, we can draw some parallels. The stub-period dividend at AGNC didn't represent all AGNC's economic benefit; the company actually earned 37¢ in its stub period, or nearly 20% more than paid. The resulting increases in NAV lead to increases in per-share earnings and thus per-share dividends. The dividend history of AGNC from 31¢/share/quarter to $1.40/share/quarter – not the exact progression one expects repeated; AGNC had some windfall derivatives gains during the economic panic that might not be readily replicated – is something management surely hopes to repeat.

And it's on the road to do so. MTGE's 20¢ stub-quarter dividend was backed with 25¢ in earnings, 25% more than paid. The $0.80 declared as the next quarterly payment is $0.06 below the Jaded Consumer's calculated expected earnings (assuming the stability of the financial situation obtaining at MTGE at the end of the stub quarter). This means that MTGE should add over 20¢ to NAV while making payouts exceeding 17%. Mind you, this neglects the benefit ACAS (as MTGE's manager) can bring MTGE from the reinvested nickels, and assumes pricing that remains stable at about $18.50. The fact is, MTGE's been volatile and to date I've never paid more than $17.50 for a share. Most of the shares held here were picked up at $16.75. From where I stand, dividend yield looks to stand north of 19%. Since I've enrolled all my shares in dividend-reinvestment, the basis will definitely creep up – but assuming pricing returns to the $20 level last seen on the day of the IPO, dividends will reinvest at about 16% while NAV continues to be be pushed up over a nickel a quarter. Adding the expected but unpaid $0.06 in earnings – a benefit that accrues to the DRIP investor in the form of share price rather than share count – a $20 share price would leave a yield north of 17%. At present prices (last traded at $18.63), that's a yield of 18.5%. On the other hand, that's also based on current dividends.

Like AGNC, which was priced below NAV for some time before the market recognized what it was doing, MTGE is likely to continue retaining gains on which to build the assets under management that drive ACAS' management fees (and shareholders' earnings). While MTGE's partial-year results and stub-quarter performance continue to be reported as full-year results (as happened for a while in AGNC), we should expect to find below-NAV share pricing (DRIP opportunity!) and to enjoy NAV increases based on dividends that leave room for reinvestment. The long-term benefit of MTGE is that while management can pursue the winning strategy used at AGNC, it has the freedom to pick up non-Agency mortgage products when the price is right. When is the price right? Some mortgage bundle – perhaps with an insurer's guarantee instead of the government's – may have characteristics that lead ACAS (MTGE's manager and AGNC's) to expect a payout of 83¢ on the dollar, will be hated by the market for its lack of government guarantee and its ugly (but discoverable) default rate, and could sell for 50¢ on the dollar. An ugly duckling like that can contain mortgages reflecting ugly levels of prepayment and default and – because it was underpriced – return much more than was invested. This kind of underpricing is not going to overwhelm MTGE's portfolio – indeed, the use of its portfolio as collateral likely depends on this kind of product being a minority among MTGE's holdings – but it offers a yield boost simply not available to AGNC.

My initial thesis in investing in MTGE was that it was trading below NAV and should be expected to perform along the lines of AGNC. While MTGE continues to trade below NAV, it's an extremely attractive alternative to AGNC as a subject of dividend reinvestment. Like AGNC, MTGE makes its money by investing largely borrowed funds in a portfolio of largely government-backed securities. MTGE (like AGNC) must manage prepayment risk (if principal is returned early, money paid for government guarantees of interest aren't worth much and premiums to face value are lost) and risks related to interest-rate spread. With yields as low as they are now, it's not easy to believe that MTGE's investment targets would drop in yield much, but factors affecting MTGE's borrowing rates would impair the spread – the profit potential between MTGE's borrowing rate and its rate of return on its own holdings – are of material concern to MTGE. Given the leverage with which MTGE operates, small changes in yield spread are magnified – for good or ill – into big changes in performance.

AGNC has shown that ACAS can manage this risk toward a stable dividend, while growing NAV. While the jury is out on how significant a factor the ability to buy non-agency MBS will be for MTGE, my favorable experience with AGNC leaves me completely willing to pay ACAS a management fee to find out.

MTGE Announces First Quarter Results (3Q2011)

MTGE, which announced a stub-quarter dividend of $0.20 for 3Q2011, has now revealed that it earned $0.25 in net income during its inaugural partial-quarter, and taxable income of $0.17. The other big-ticket news is that NAV at the close of the quarter was $19.96, which is up from the net MTGE would have received from its $20 IPO, after issuance-related fees were deducted.

MTGE used 4.7x average leverage during the stub period, but closed the period with 7.8x leverage (compared to 7.7x leverage at AGNC on the same date). Net interest spread in the stub quarter was 2.13%, but at quarter-close it was 2.41%. Increasing leverage and increasing spreads should mean dramatic increases in income. That is, up from 10.01% to 18.80%. MTGE hasn't got the fat investment sizes with which AGNC can manage transaction costs, but (with leverage) has $1.7B to work with.

Crazy risks?

"With book calue preservation in mind, and given the volatility and liquidity conditions in the credit markets, we have been cautious on non-agency investments. We expect to patiently develop this portfolio as compelling opportunities arise."
- Jeff Winkler, S.V.P. & Co-Chief Investment Officer

This is exactly what I was hoping for in MTGE: a portfolio that mirrors AGNC's successful formula, but keeps its eyes peeled for material mispricing in assets more susceptible to fear-based avoidance (as opposed to fundamentals-based avoidance) than the agency-backed instruments whose principal and interest, being guaranteed by the federal government, tend to assuage terror regardless the fundamentals of the asset bundle. The non-agency opportunities are thus a nice place to get capital appreciation: a mispriced asset will, in time, end up valued at its worth. (As Buffett has said, markets may be a popularity contest in the short run but in the long run they are a weighing machine.) Carefully scrutinizing opportunity rather than rushing in is exactly how I'd like to see non-agency assets approached.

The price for this opportunity in MTGE is a 0.25% increase in management fee over the fee paid by AGNC. It's described here. ACAS, which had hoped to issue a lot more shares of MTGE than actually changed hands on IPO day, may want to raise some more money in order to support big deals in really mispriced non-agency bundles – but for my money, ACAS just wants to be ready to capitalize on opportunity and hasn't got a deal it's dying to do or it'd have done it.

MTGE: the first dividend

American Capital Mortgage Investment Corp. (MTGE) recently announced that for the less-than-a-quarter period from August 9 through September 30 (about 54 days), it is declaring a $0.20 dividend payable October 27, 2011. (As after AGNC's first stub quarter, nitwits are already proclaiming MTGE to have a single-digit yield based on a quarterly dividend of $0.20. Yawn.) As with the 31¢ stub-period dividend initially paid by AGNC, this isn't a full quarter of revenue and doesn't reflect what the company will ultimately do over the duration of a fully-invested quarter.

And it's fair to conclude that MTGE is now fully invested:

During the course of the stub period MTGE's investment team has invested these proceeds, along with proceeds from borrowings under the Company's repurchase agreements, to purchase a portfolio of approximately $1.5 billion of agency, non-agency and other mortgage-related investments.
from MTGE's Press Release

Not only is its equity fully invested, but it's used $200m of equity to invest in approximately $1.5b worth of investments. One concludes that with investment approximating 7.5x equity, the investment is one part equity and 6.5 parts borrowings. Leverage of 6.5:1 may have been a result of the recent marketplace uncertainty – MTGE was first issued during the first day of a marketplace bloodbath, after all. If MTGE's rate spread is like AGNC's was last quarter – above 2% – then MTGE should be making something above 15% on its equity of more than $19/share. ACAS has managed AGNC with leverage that varies with market conditions, and using leverage less than 7:1 is conservative in comparison to the 8x leverage with which AGNC launched.

Interpreting the 20¢ stub-quarter dividend in light of that math suggests that MTGE wasn't fully invested on IPO Day but took some time to ramp to full investment. In light of the market turmoil, this isn't hard to believe. AGNC's first stub quarter was 27 days, and it paid $0.31 – but there was no panic underway at the time. The real question facing investors seeking to read the tea leaves of the stub-quarter dividend is the fraction of the quarter in which MTGE was actually invested. The Jaded Consumer strongly suspects that becoming fully invested involved multiple parties and agreements and was slowed by the fact that everyone in the financial industry was distracted by the apparent meltdown underway in the marketplace.

As I previously wrote, I hoped to buy under $19 – and now I have bought under $17. Deutche Bank's target price of $22 doesn't impress me as much as the fact that MTGE is AGNC with an option to buy non-agency securities (thus improving the possibility of occasionally buying a more feared/hated, and thus potentially irrationally mispriced, mortgage bundle). Since AGNC has performed well and trades at a premium to NAV, the prospects of a similarly-managed MTGE for trading above its $19+ NAV appear favorable over the intermediate term.

At the moment, I expect MTGE's price represents a discount of over $2 to NAV. At today's price of about $16.75, this represents over 12% upside just retracing to NAV – and AGNC's experience suggests normalcy will represent trading at a premium to NAV. Now that the misinformation and uncertainty about MTGE is high, investment is much more interesting than immediately following the IPO.

ACAS Launches MTGE IPO

[Note: This post was begun 8/3/11 and, due to distractions, not completed until it was noticed in a draft bin weeks later. Sorry about that.]

As previously discussed, ACAS is launching a REIT to invest in mortgage bundles. Unlike American Capital Agency (AGNC), American Capital Mortgage Investment Corp. (MTGE) will invest mortgage-related investments that aren't necessarily backed by the guarantee of a United States agency. Selling fewer shares than initially planned (8m rather than the planned 17.5m) on the first day of the recent market rout, ACAS maintained pricing at $20. In conjunction with the public offering, ACAS directly purchased a $40m block (2m shares) of MTGE for itself.

Despite a prediction that the investment was doomed to be a loser at issuance prices – based on comparisons with other recent mREITs rather than with ACAS' other mREIT – MTGE shares (which dropped with the whole market over the first two days) have recovered to $19 and above before MTGE even demonstrated any investment performance.

I had hoped to buy under $19, but my plan had been to make the purchase in a new account funded with money I hadn't received yet, and it looks like my window for a steal has closed. I suspect that MTGE will in many ways replay AGNC, with the exception that MTGE will not have access to the derivatives income that aided AGNC during the 2008 panic. This prediction is based on the assumption that non-Agency-backed mortgage securities will be less liquid, and thus will not have a ready derivatives market to use as a hedge.

The investment thesis in MTGE is surely a reflection of ACAS' broader investment thesis: illiquid investments are likely to be underpriced due to the inefficiency of the markets for illiquid hard-to-price investments, so ACAS will buy not to resell but to hold. To counter the risk of being stuck until maturity, I expect ACAS to do things like buy variable-rate mortgages. Without the government guarantee, I expect ACAS to be looking for – and finding – medium-grade mortgage packages at afwul-grade prices, with the intent to hold for the upside of the repayments the sellers are too impatient to bet on. I believe ACAS' experience pricing AGNC's portfolio has given it a good idea where the inefficiency is in the market, and given it a hunger to buy at dirt-cheap prices mortgage bundles that aren't nearly as bad as their pricing would imply.

On the other hand, MTGE isn't barred from investing in the exact same investments as AGNC. MTGE merely has the freedom to invest more flexibly.

Oh, and ACAS is paid by MTGE an advisory fee of 1.5% of MTGE's assets, not the 1.25% it is paid by AGNC. So maybe the MTGE issuance is less exciting than it looks: ACAS gives itself a 0.25% raise while broadening its freedom to invest funds beyond agency-backed securities. The 185m raised in the initial round of funding doesn't all become MTGE assets; the 8m shares actually in the IPO are subject to underwriting fees. Assets were reportedly expected to be something like $199m, meaning that ACAS' monthly advisory fee (1/12 of 1.5% of $199m) is approaching a quarter million dollars a month. By my own math, I expect $242,000 per month to be paid to ACAS, but there may be some assets in MTGE that weren't raised on IPO Day; the expected post-IPO assets are a bit above what I calculated based on the 80¢/sh underwriting fee disclosed here. Based on the greater advisory fee in MTGE, I expect ACAS to try to raise in MTGE funds it previously raised in AGNC. MTGE's performance – and its consequent price relative to NAV – will determine how successful that effort will be.

The other advantage to ACAS? With growing management fee income, ACAS' asset management subsidiary becomes more valuable. As a component of ACAS' NAV, the asset manager is as valuable as any profitable subsidiary.

You heard it here first: MTGE is just like AGNC, but allows ACAS to deploy funds into underpriced mortgage bundles that aren't backed by an agency (which is a factor potentially exacerbating pessimism and thus creating an exciting underpricing opportunity); because ACAS is paid more to hold funds in MTGE than in AGNC, expect ACAS to try to raise future funds in MTGE, where it will also have more investment flexibility.