Mortgage REITs have a special place in the hearts of the investors due to their elevated dividend yields. A majority of the mortgage REITs have dividend yields over 10% during times when there are little opportunities for investors to enhance their regular income. Therefore, mortgage REITs present an excellent investment opportunity for yield hungry investors. However, an investment in mortgage REITs is not without its risks. Mortgage REITs have a complex business model, which is why you need to be aware whether the investment you are making can maintain its dividend distributions. In this investment thesis, I will discuss whether American Capital Agency (NASDAQ:AGNC), Annaly Capital Management (NYSE:NLY) and Armour Residential REIT (NYSE:ARR) have the ability to sustain their current dividends.
You should keep in mind that the mortgage rates and Treasury yields are on the rise since beginning of the year, therefore, this article assumes the rates will continue to increase.
American Capital Agency
American Capital Agency is currently yielding 15.5% on its $1.25 per share dividend distribution. It remains one of the very few Agency mortgage REIT to have maintained its dividends during the third and fourth quarters of the prior year, when a majority of the Agency mREITs were pushed to slash their dividends. The follow table shows some historic cash dividend coverage ratios for the past four quarters. It seems the company had comfortable margin to cover its distributions in the past.
However, past ratios are not ideal indicators of future performance. Therefore, I look at the company's latest annual SEC filing for its net interest income's interest rate sensitivity. The company mentions that a 50 bps increase in the interest rates (instantaneous parallel shift in the yield curve) will bring about a 3.5% decrease in its projected net interest income. Assuming the company generates the same net interest income as it earned during the fourth quarter of 2012, then the decreased interest income for the first quarter of 2013 comes out to be $550 million or $1.62 per common share. This is well above the company's current dividend distribution of $1.25, therefore, you can expect American Capital Agency to maintain its dividends.
Annaly Capital Management
Annaly Capital Management is currently yielding 11.2% on its quarterly dividend distribution of $0.45 per share, which came down from the fourth quarter's dividend of $0.5 per share. The company was forced to cut its dividend during the third quarter of 2012 as well. Its historical cash dividend coverage ratio has varied a lot over the past four quarters, largely due to the adjustments Annaly made to its income statement. Therefore, the ratios are of little value, however, looking at the most recent quarter's ratio, you can see the company was not able to finance its dividend distribution through the cash it generated from its regular operations.
Going forward, I look at the company's projected net interest income's sensitivity to changes in interest rates. Annaly provides in its latest SEC filings that a 50 bps increase in interest rates will bring about a 3.27% increase in its projected net interest income. Assuming the company earns the same net interest income during the first quarter of 2013 as it earned during the fourth quarter of 2012, its increased net interest income for the first quarter comes out to be $590 million or $0.62 per common share. Considering the bottom line is also supported on gain on sale of MBS, the increased net interest income would be more than sufficient to sustain Annaly's current dividend rate.
Among Agency mortgage REITs, Armour Residential has a special place in the hearts of investors due to its monthly dividend distributions. The company is currently distributing $0.08 per share per month and yields 13.2%. Armour Residential was forced to cut its dividends twice during the prior year and once this year. You can see the average cash dividend coverage ratio for the past four quarters comes out to be 1.3 times, while the most recent quarter's ratio was 1.8 times, which is why Armour was able to sustain its dividend rate for the first quarter.
Armour provides an interest rate sensitivity analysis in its latest SEC filing. According to the filing, the company's net interest rate income is expected to increase by 12.81% if the interest rates increase 50 bps. Assuming the company generates the same net interest income during the first quarter of 2013 as it did during the fourth quarter of 2012 and the rates increase 50 bps, then its increased net interest income comes out to be $112 million or $0.36 per common share. This is much higher than the current quarterly dividend rate of $0.24 per share. Therefore, you can expect Armour Residential to continue its current dividend distribution in the second quarter of 2013 as well.
Additional disclosure: The article has been written by Equity Whisper's Financials Analyst. Equity Whisper is not receiving compensation for it (other than from Seeking Alpha). Equity Whisper has no business relationship with any company whose stock is mentioned in this article.