American Agency Mortgage: Huge Dividend REIT

This is my first post on the Seeking Alpha Instablogs. So without hesitation, I will jump right into my dividend play for the remainder of 2009. American Agency Mortgage Corporation (AGNC) is a mortgage REIT with a whopping dividend of $1.50 per quarter. At the close on August 19, 2009, AGNC was trading at $23.34 (-0.13%) which equates to a 25.80% yearly dividend payout.

As for the underlying price of the stock, it is trading just a few points off its 52-week high. Since peaking at $25.70 on August 10, AGNC has pulled back a little over 9%. The stock is up almost 40% over the last year along with a 76% increase in quarterly dividend (ex-date 6/30/2009).

With the current interest rate environment, you would be hard pressed to find this type of yield in any product with this type of liquidity and resistance to principal depreciation.

There are several reasons for the increased payouts by the REITS. Most notably is the steep yield curve in which interest rates are presenting themselves. REITs typically perform well in low interest rate environments. Right now, most of the market has a hesitation to own any type of long-term debt. This creates a large spread between short and long term interest rates.

REITs such as AGNC profit off of this spread in rates by borrowing capital in the short term at very low rates, then they purchase other debt with longer maturities (years or decades beyond the initial financing) that pay a higher interest rate. The steeper the yield curve the better with this type of strategy.

Agency REIT's yield on their portfolio in Q2 09 was 5.13% while the cost of their funds was only 2.11%. This spread on interest rates of 3.02% coupled with leveraging allows AGNC to attain these dividend payouts.

Something else to note is that Agency REIT (unlike many other REITs) use mostly AAA rated government paper (Fannie Mae and Freddie Mac guaranteed paper) as the majority holdings of their portfolio. This debt they purchase are now government backed and face little credit risk. This might give you a sense of ease when considering the recent history of competing CDO backed products.

Despite the positive outlook on AGNC's current position, the typical risks of fixed income investing still persist. These are the same risks inherent with almost any interest rate play. Namely, there is re-investment risk along with the potential surge in inflation due to recent monetary policy.

We can't forget that investors are also weary of the dangers associated with high leverage operations. The Fed could also buy back securities causing a flattening of the yield curve. Right now, we think AGNC is well worth the risk if it keeps paying out at this rate.

Here are some other high yielding REITs with huge dividends (as of close on 8/19/2009):

American Agency Mortgage Corp (AGNC) - 25.8% yield

^{AGNC invests in agency pass-through securities and collateralized mortgage obligations for which the principal and interest payments are guaranteed by a U.S. Government agency or a U.S. Government sponsored entity.}

Anworth Mortgage Asset Corporation (ANH) - 17.4% yield

^{Anworth invests primarily in United States agency mortgage-backed securities issued or guaranteed by United States government sponsored entities, such as Fannie Mae or Freddie Mac, or an agency of the United States government, such as Ginnie Mae, including mortgage pass-through certificates, collateralized mortgage obligations, and other real estate securities, on a leveraged basis. The company's portfolio includes agency mortgage-backed securities comprising agency adjustable-rate mortgage-backed securities, agency hybrid adjustable-rate mortgage-backed securities, agency fixed-rate mortgage-backed securities, and agency floating-rate collateralized mortgage obligations.}

Capstead Mortgage (CMO) - 17.3% yield

^{The company, together with its subsidiaries, invests in real estate-related assets on a leveraged basis that primarily consists of residential adjustable-rate mortgage securities issued and guaranteed by government-sponsored entities.}

Hatteras(HTS) - 15.2% yield

^{Hatteras Financial invests in adjustable-rate and hybrid adjustable-rate single-family residential mortgage pass-through securities guaranteed or issued by the United States Government agency, or by the United States Government-sponsored entity.}

Annaly Capital (NLY) - 14.3% yield

^{The company invests primarily in mortgage pass-through certificates, collateralized mortgage obligations, agency callable debentures, and other mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans. Annaly Capital also invests in Federal Home Loan Bank, Federal Home Loan Mortgage Corporation, and Federal National Mortgage Association debentures.}

MFA Financial (MFA) - 13.5% yield

^{The company primarily invests in mortgage-backed securities (MBS) that include hybrid and adjustable-rate MBS (ARM-MBS). Its assets primarily consist of ARM-MBS issued or guaranteed by a federally chartered corporation, including Fannie Mae or Freddie Mac, or an agency of the United States government, such as Ginnie Mae; and MBS-related receivables and cash. The company also has indirect investment in Lealand Place, a multifamily apartment property located in Lawrenceville, Georgia. In addition, it provides investment advisory services to a third-party institution with respect to their MBS portfolio investments.}

It is important to note that all stocks in this article are trading within 9% of their 52-week high.

Disclosure: no positions as of 8/19/09. divs info from Yahoo! Finance.

Comments

[TryReflexology:]

Congratulations on your first post.

I own HTS and am thankful for your research on the other REIT's. I'll do my DD and thank you for the leads.

Keep contributing. Your post was informative, well written and I'll look forward to reading more of your work.

One thing however, the small type is very hard for me to see. Others with poor eyesight may have the same problem. The font size you used on the majority of the body was just fine. Just a thought to help you succeed.

Aug 20 10:55 AM

[OneRichOne:]

I've owned NLY since 2004 and its been a great investment. While almost all other stocks bottomed out at the last qtr 2008 to first qtr 2009 NLY has not. And the divs are great.

Aug 20 01:08 PM

[FranzSchubert:]

The biggest problem with this article is that it says nothing about whether the AGNC dividend is sustainable at $1.50. Reading the quarterly reports (did the author do that?) might have led him to note that there were some fairly profits classified as non-recurring. The fact that AGNC is trading to a yield so much higher than its direct competitors might suggest that others have also come to the conclusion.that the dividend might not be sustainable at $1.50. FWIW, I own AGNC, NLY, HTS, ANH, MFA and CMO is significant size.

Aug 20 01:40 PM

[tiolorf:]

TryReflexology said: "One thing however, the small type is very hard for me to see. Others with poor eyesight may have the same problem. The font size you used on the majority of the body was just fine. Just a thought to help you succeed."

Just between the title of the article and the body of the article, there is a little tool that can help you determine the font size of the characters. It will only affect the characters in the article, however, and not the comments. Hope that helps.

Disclosure: Long NLY, HTS, ANH.

Aug 20 01:56 PM

[mortgagefin...:]

you forgot about CYS. they had an IPO a couple months ago and are putting the money to work in the current qtr. the management was luckier than smart when they hedged their portfolio in the swap market at the bottom a few months before the IPO. as a result, they will have the lowest all-in cost of funds in the peer group and a very robust net interest margin. i model the 3Q dividend to be 64c, ramping to 70c+ when all the IPO money is put to work for by the end of the third quarter. That's a 20% yield on the current share price.

Aug 20 02:02 PM

[Alan Young:]

I agree, good article about a great investment that the market has undervalued because of its limited track record.

@FranzSchubert: of course, no REIT can guarantee its dividend, because it pays a set percentage of current FFOs and doesn't keep reserves to stabilize dividends. But you knew that, so you weren't misled. I agree, the author might have been clearer about the dividend rate being based only on the last quarter.

I am long AGNC, NLY, and ANH.

On Aug 20 01:40 PM FranzSchubert wrote:

> The biggest problem with this article is that it says nothing about
> whether the AGNC dividend is sustainable at $1.50. Reading the quarterly
> reports (did the author do that?) might have led him to note that
> there were some fairly profits classified as non-recurring.

Aug 20 02:29 PM

[berloe:]

So- what happens when the yield curve reverts. Short term rates will never get lower, but the paper these companies hold will still pay the rates originally issued. When they need to replace ST rates @ higher levels profis get squeezed, no?

Aug 20 04:46 PM

[FranzSchubert:]

actually, its the steepness of the yield curve that counts more than the actual level of short term rates. If short and long term rates rise by the same amount, then there is still opportunity for good returns. Its only when you see short term rising more (faster) than long term, that they start to encounter margin squeeze. Also remember that these guys hedge their purchases too, so they are not completely exposed to rising rates.

On Aug 20 04:46 PM berloe wrote:

> So- what happens when the yield curve reverts. Short term rates will
> never get lower, but the paper these companies hold will still pay
> the rates originally issued. When they need to replace ST rates @
> higher levels profis get squeezed, no?

Aug 20 05:27 PM

[RLLH:]

As to the size of the comments, if using Firefox click on View (in the upper left), then Zoom in as many times as you want until the comments are large enough to read. I also have been a long time holder of Annaly (NLY) and think they have a very conservative and extremely capable management team.

Aug 20 05:57 PM

[Tack:]

There's another item, specific to AGNC, that's been left out of this discussion:

Unlike almost all the other "agency-related REITs, AGNC did not come into existence until near the end of the mortgage meltdown, so they had no pre-existing portfolios, subject to writedowns and/or losses and did have a sizable warchest to "go shopping" for debt that was depressed to unprecedented levels.

This means, not only does AGNC profit from the record spreads, but they make sizable gains on improving mortgage-debt valuations versus their average cost.

Aug 20 09:34 PM

[Alex Khande...:]

Thanks for the comments everyone. I will try to respond to some of the comments shortly. In the meantime, please stay tuned for my upcoming article on Muni Bonds.

* AGNC was up 5.01% today. It must have been my article ; )

Aug 21 12:22 AM

[Snowjob3:]

Absolutely unsustainable.

Last quarter was management trying to inflate share prices to sell new shares at a substantial premium to book value. As ACAS is a major share holder, (and the board is tied to ACAS) it was an opportunity for them to sell 50% of their stake to Duetche Bank and raise capital.

Quarter was a result of selling a good deal of its portfolio of fixed mortgages to the government at premiums and reinvsting everything in Option / Alt etc mortgages. This also alowed them to continue to write up book value as these have a substantially lower prepayment risk.(which they were conservative about their markdowns in January)

Dividends from normal opperations will likely be in the .70 to .80 cent range excluding any remaining cash from this quarter (they do have betwen 50-80 cents If I remember) This of course assumes libor stays low. They are not hedged well in the short term for libor fluctuations but have some protection in the 2-5 year time frames. I've been looking to add some more in the 20-21 range (book value) but at a 20-25% premium right now, this is more on the expensive side.

Aug 21 07:18 AM

[Patrick Harden:]

One minor housekeeping note: the company in focus is named American Capital Agency Corporation (AGNC).

As for the agency-backed mortgage REITs in general, the entire sector is guaranteed to succeed in an environment where there is a steeply positive yield curve. The agency backing of their holdings minimizes credit risks, so their business model becomes a virtually pure-play interest-rate gambit. The Federal Reserve has not yet indicated the need to push rates back to historical norms, so the available spread to be earned remains quite wide.

Of course, the companies within the agency-backed mREIT sector differ in certain respects, and as mortgage rates have fallen over the last few years, those companies that have seasoned fixed-rate debt should outperform those with short-reset adjustable-rate holdings. Another factor to consider is those companies with short-duration swaps that are due to roll off. Many of the agency mREITs have swap-adjusted cost of funds that are much higher than the unadjusted market cost of repurchase agreements. Those with higher swap-adjusted COF have limited their spread potential.

As for AGNC itself, although I have criticized AGNC's sponsor, American Capital Ltd as "questionable", AGNC's Q2 financial results were quite robust. The company earned $1.98/share in Q2 taxable income and still has $0.79/share in undistributed taxable income to support the dividend for the rest of the year. I believe the $1.50/share dividend is sustainable for Q3 & Q4 2009 based on AGNC's remaining taxable earnings. 2010 may be a different story.

Snowjob3 made a good point about the capital gains. AGNC's taxable income calculations appear to include both ordinary & capital gain income. Capital gains, of course, are typically non-recurring. Plus, REITs are only required to distribute 90% of ordinary taxable income.

Aug 21 01:11 PM

[Snowjob3:]

Remember, management's goal as stated many times is to conservatively raise book value. They priced their secondary offering above that book value by 10-15%, the stock trades now about 25%+. That should tell people right now where this is in relation to where management thinks book value can go. If this continues to trade north of this level I think people may be overpaying considerably. We are still in an environment with rediculusly low libor and if you look back to the previous two quarters you were looking at the income from traditional spread dividends in the .70 cent range not a dollar 1.50. The rest has always been supplimented by a 1 time favorable options strategy which they said they will not be employing again and by capital gains. Great company, I do have about 15-20% of my relatively small portfolio in them, but at these prices tread lightly.

Aug 26 06:54 AM

[Mr. Wynn:]

Thanks for the article and also thanks to the many, clearly above-average intelligence commenters! I was thinking that the price of the REIT today looked a little high. What price is comfortable here? I realize we are talking about dividends so stock price should not figure in as much as a stock we might be trading, however the price does affect how many shares one might buy and hence affects the overall dividend payout each quarter. I welcome anything here including telling me how ignorant I am for asking this question!

Aug 26 01:28 PM

[Snowjob3:]

Mr. Wynn.

While I can't deduce on such little correspendence if you are a longterm holder of equities, the wording of your comments most certainly indicates your not short term trader. In that case, I would suggest you start the decision making process by examining book value. Dividends will fluctuate and in my opinion (see my previous comments) will trend substantially less then the recent one dollar and fifty cents a quarter. I personally love the stock but will not buy any more untill it settles in the low 20 dollar range or below. My moderately bearish sentiment seems to be confirmed by atleast one professional as AGNC was recently downgraded by an analyst with a price target of 23.


On Aug 26 01:28 PM Mr. Wynn wrote:

> Thanks for the article and also thanks to the many, clearly above-average
> intelligence commenters! I was thinking that the price of the REIT
> today looked a little high. What price is comfortable here? I realize
> we are talking about dividends so stock price should not figure in
> as much as a stock we might be trading, however the price does affect
> how many shares one might buy and hence affects the overall dividend
> payout each quarter. I welcome anything here including telling me
> how ignorant I am for asking this question!

Aug 31 06:54 PM

[bill levy:]

how do the accounting and delinquency problems at their parent company (or managing co.) american capital affect this reit?

Sep 04 01:52 PM