By Adnan Khan
Yesterday, Hatteras Financial (HTS), New York Mortgage Trust (NYMT) and American Capital Agency (AGNC) announced their dividends for the second quarter of the current year. As widely expected, the pure-play mREIT, American Capital, announced a 16% cut in its dividend, thanks to the speculations about the Fed's exit from the Agency MBS markets and the resultant rising interest rates. Now the company will pay $1.05 to each of its common shares. In contrast, hybrid mortgage REITs announced dividends in line with the first quarter distributions. Let's see what factors lead to the dividend cuts at American Capital Agency and what steps the management has taken to secure its future dividends and book value.
What went wrong with American Capital?
American Capital Agency had been a star pure-play mREIT during the times when the Fed kept the long-term rates at their record lows. That's because it had prepared an investment portfolio that was designed to create benefit for the company if the rate remained low. The company paid premium prices to purchase the MBS with low prepayment attributes such as low loan balance HARP securities. Anticipations of a further fall in the rates led the company to purchase these MBS. A further fall was also expected to increase the refinancing activity. Since these MBS were high in demand and were purchased at premiums, they offered lower yields.
In contrast to the expectations of American Capital Agency, the rates started climbing. That's because of the speculations that erupted soon after the minutes of the last FOMC meeting were made public in mid-May. The minutes of the meeting revealed that the Fed is considering cooling down its easing soon.
As a result, the markets started pricing in the Fed's exit and the rates started climbing. With the rise in rates, the refinancing activity naturally started to slowdown. Therefore, the securities held by American Capital Agency saw significant declines in their values. That's why American Capital Agency reported 8.6% decline in its book value during the first quarter, compared to 4% and 8% declines in the book values of Annaly Capital Management (NLY) and ARMOUR Residential (ARR).
Future Approach For American Capital Agency
American Capital Agency is managed by a team of highly competent managers, and this has been one of its competitive advantages for some time now. Looking at the current situation, the management decided to rebalance and restructure its asset portfolio to benefit from the rising interest rates.
The company decreased its exposure in the 30-year fixed rate mortgage backed security. At the end of the first quarter of the current year, around 70% of the company's assets were the 30-year fixed rate security. This security is considered to be highly sensitive to changes in interest rates, and since the rates are climbing, the security's value fell. So, I believe getting rid of some of this was a clever move by the management. Besides, the management is also committed to keeping a close eye on the interest rates and actively manage their assets and hedges in order to create attractive investment opportunities.
However, I believe the company should not consider adding more debt in its capital structure. Even though, the company is not facing any pressure from its lenders to reduce leverage, I believe any increase in leverage will further magnify the volatility in results.
I believe the aforementioned factors will make American Capital Agency's book value relatively less sensitive to change in interest rates.
Hybrids maintain dividends
Given the volatility in the interest rates as a result of the speculations about the Fed's exit from the Agency MBS markets, hybrids have been the most preferred mortgage REITs. That's because hybrids invest in assets other than Agency MBS. Their investments in the high yielding non-Agency residential MBS and the commercial MBS markets make their book values less sensitive to changes in interest rates, while making additional returns available.
This is exactly why New York Mortgage maintained its second quarter dividend at $0.27 per share, yielding 15.3%. Similarly, Hatteras Financial announced a dividend rate of $0.70 per share, in line with the first quarter dividend rate. The company yields 10.9% on an annual basis.
Other dividend announcements
Among other dividend announcements within the mortgage REITs sector were the announcements made by Apollo Residential Mortgage (AMTG) and Invesco Mortgage (IVR). Apollo Residential maintained a payout of $0.70 per share for the second quarter, while Invesco Mortgage declared a dividend rate of $0.65 per share in line with the first quarter distribution. Both these companies are hybrid mortgage REITs.
While the situation is still favorable for hybrid mortgage REITs, American Capital Agency has taken some corrective action in order to secure its future dividends and book value. American Capital Agency is one of the most well-managed Agency mortgage REITs. Therefore, I am confident that it will be able to maintain its dividends in the future.
Disclaimer: 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.