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American Capital Mortgage Investment Corp. (NASDAQ:MTGE) is a mortgage REIT. It invests in Agency MBS, non-Agency MBS and other mortgage related investments. For FY2012 it managed a 41% economic return. This was comprised of $3.60 in dividends and $4.87 per share in increased book value. This compares well to a larger and top performing peer, American Capital Agency Corp. (NASDAQ:AGNC), which produced a 32% annual economic return for FY2013.

More recently MTGE had a book value loss of -1.62 per share (-6.7%) for Q2 2013. The book value was down to $22.63 per share as of June 30, 2013, from $24.25 on March 31, 2013. However, this was only a -3.4% economic loss on equity for Q2 2013, if you consider the $0.80 dividend paid for Q2 2013. Much of this loss occurred due to the roughly 1% increase in mortgage rates and long term US Treasury yields in Q2. Naturally low rate Agency MBS fell in value as a result. Some of MTGE's peers' book value losses are in the table below.

Stock

Stock Price at the close August 27, 2013

Book Value Loss in Q2 2013

Book Value % loss in Q2 2013

Book Value As Of Q2E 2013

MTGE

$19.98

-$1.62

-6.68%

$22.63

AGNC

$22.82

-$3.42

-11.82%

$25.51

Western Asset Mortgage Capital Corp. (NYSE:WMC)

$15.71

-$2.03

-10.45%

$17.39

Hatteras Financial Corp. (NYSE:HTS)

$18.27

-$6.00

-21.29%

$22.18

As you can see, MTGE was hurt significantly. However, its book value losses were far less on a percentage basis than the losses of the peers above (and many others). MTGE gained $275 million due to hedges (or $4.75 per share) in Q2 2013. Without these gains the book value losses would have been much worse. MTGE's hedging strategy was good compared to most of its peers. It covered 106% of MTGE's repo and TBA positions, which was very defensive. The relative outcome of this defensiveness shows good leadership in the mortgage REIT sector, and the Q2 relative outcome bodes well for results from future quarters.

Q2 2013 was the "quarter from hell" for mortgage REITs. It should not be viewed as the norm. MTGE, a clear leader in the mortgage REIT sector, has generated a 45% total economic return since its IPO in August 2011, and that is including the very tough 1H 2013. Its returns over the last 12 months have been +18%, which has been even clearer leadership. The chart below shows the economic return history clearly.

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I only showed this because many say a picture is worth a thousand words.

The capital allocation strategy is of particular interest for the future. The table and charts below give a good depiction of the portfolio as of June 30, 2013.

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This is grossly changed from the portfolio allocation as of March 31, 2013 (see table and charts below).

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MTGE has sold off a large amount of Agency MBS and it has purchased a smaller amount of non-Agency MBS. This should make the portfolio less susceptible to big interest rate changes. On top of this MTGE roughly doubled the notional value of its interest rate swaps and swaptions from December 31, 2013, to June 30, 2013 (10-Q). This too should help safeguard MTGE against future interest rate / mortgage rate climbs.

As mentioned previously MTGE lost some of the money that disappeared from the Agency MBS portfolio between March 31, 2013, and June 30, 2013. It sold off a huge amount of Agency MBS at lower than desired prices. However, all of this money was not lost. Some will be put back to work (possibly in non-Agency MBS); and some has been used to buy back MTGE stock. MTGE bought back 2.9 million shares of common stock during Q2 2013 at an average cost of $21.34 per share. This represents 4.9% of shares outstanding as of March 31, 2013. Plus the average cost was at a discount to the book value as of June 30, 2013, of $22.63. This has likely been a good move for shareholders.

MTGE also deleveraged in Q2 2013. At risk leverage as of June 30, 2013, was 6.4x versus 7.4x as of March 31, 2013. The net interest rate spread was a bit lower at 1.96% at the end of Q2 2013 than the 2.09% as of March 31, 2013. However, given the amount of Agency MBS that were sold off during Q2, this is not likely a problem area. In fact, many expect the spread to widen as the market likely settles down in 2H 2013. MTGE is again less likely to lose book value with less overall leverage. The company plans to increase leverage again when the conditions are seen as more favorable.

Unfortunately this likely means a dividend cut is coming up. MTGE only had $0.76 per share in taxable income for Q2 2013, although it did have $1.05 per share in net spread and TBA Dollar Roll income in Q2 2013. With the lower amount of Agency MBS, both of these last numbers could come down in Q3 2013, even if the net interest spread goes up. This likely means a cut to the $0.80 per quarter dividend (16.02% at the close August 27, 2013). It is hard to estimate exactly what the dividend will be. MTGE might even decide to maintain the current dividend if Q3 2013 goes well enough. However, a prudent investor should expect a bit of a drop. Still the dividend will almost assuredly still be above 10%, and the book value will be much safer going forward.

Many expect the mortgage REITs markets to smooth out over 2H 2013. MTGE seems prepared for any eventuality. When you realize many other stocks with less certain values could fall dramatically in the next year, a stock that is relatively safe should be on your watch list (and your buy list). When it pays a great dividend too, it is a buy in the current market, especially when you think of the risk "unhedged" bonds represent.

The two-year chart of MTGE provides some technical trading direction.

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The slow stochastic sub chart shows that MTGE is neither overbought nor oversold. The main chart shows MTGE has been in a downtrend. The main chart also shows that MTGE seems to have bottomed. I wouldn't say there are only clear blue skies ahead. However, MTGE has made moves to safeguard its book value more. It is fundamentally safer, and the technicals seem to indicate that buying is okay at the least. It could even turn out that this is a great buying time.

Still the overall market and the world economy are unstable at the moment. Averaging in may be a good idea. It is reassuring that insiders have increased their stake in the company by +6.4% in the last 6 months. Institutions have increased their stake by +28.14% (+12,491,00 shares) from the prior quarter to the latest quarter. MTGE has an average analysts' recommendation of 2.0 (a buy). It has a four star CAPS rating (a buy). These data should make some worries diminish.

NOTE: Some of the above fundamental financial information is from Yahoo Finance.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in MTGE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: American Capital Mortgage Investment Corp. Outperforming Well-Known Peers