American Capital Mortgage Investment (NASDAQ:MTGE) has joined the preferred parade that we have seen recently with their inaugural issue of a Series A perpetual preferred. Details are:
The prospectus can be found here.
The issue contains the following change of control covenants:
- Upon the occurrence of a Change of Control, MTGE may, at their option, redeem any or all of the shares of Series A Preferred Stock within 120 days after the first date on which such Change of Control occurred at $25.00 per share plus any accumulated and unpaid dividends to, but not including, the redemption date.
- Upon the occurrence of a Change of Control, each holder of Series A Preferred Stock will have the right (subject to our election to redeem the Series A Preferred Stock in whole or in part, as described above, prior to the Change of Control Conversion Date (as defined herein)) to convert some or all of the Series A Preferred Stock held by such holder on the Change of Control Conversion Date into a number of shares of our common stock per share of Series A Preferred Stock equal to the lesser of:
- the quotient obtained by dividing (NYSE:I) the sum of the $25.00 liquidation preference per share of the Series A Preferred Stock plus the amount of any accumulated and unpaid dividends thereon to, but not including, the Change of Control Conversion Date (unless the Change of Control Conversion Date is after a dividend record date (as defined herein) and prior to the corresponding dividend payment date for the Series A Preferred Stock, in which case no additional amount for such accrued and unpaid dividends will be included in this sum) by (ii) the Common Stock Price (as defined herein); and
- (the "Share Cap"), subject to certain adjustments.
While a change of control is not a high probability event here, it is nice to have the language.
For those not familiar with the REIT, American Capital Mortgage invests in, finances and manages a leveraged portfolio of mortgage-related investments, which include agency residential mortgage-backed securities, or RMBS, non-agency mortgage investments and other mortgage-related investments. Agency RMBS include residential mortgage pass-through certificates and collateralized mortgage obligations structured from residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by a government-sponsored entity, or GSE, such as Fannie Mae and Freddie Mac, or by a U.S. Government agency, such as Ginnie Mae. Non-agency mortgage investments include RMBS backed by residential mortgages that are not guaranteed by a GSE or U.S. Government agency. Non-agency mortgage investments may also include prime and non-prime residential mortgage loans. Other mortgage-related investments may include mortgage servicing rights, GSE credit risk transfer securities, commercial mortgage-backed securities, commercial mortgage loans and mortgage-related derivatives.
As per usual, the determination of value should be viewed versus the company's preferred shares and then their peers preferred shares. Let's begin with the company's shares:
You will notice I have included their agency mREIT cousin (managed by the same external manager) as their are no other MTGE preferreds to compare it to. As a "hybrid mREIT" with credit (non-agency) exposure in the portfolio, it should trade "wide" (higher yield) to its agency cousin, which in fact it does. Is it appropriate for it to trader wider? In my opinion, the hybrid model is the future of the mREIT space (note Western Asset Mortgage and Annaly) and is more additive than detractive to value so the "premium yield" often associated with the hybrids is an opportunity. As a result, I believe there is value in this issue relative to their agency REIT cousin.
The next step is to value it versus peers. For the peer group, I have chosen American Capital Agency (NASDAQ:AGNC), Hatteras Financial (NYSE:HTS), NorthStar Realty Finance (NYSE:NRF), Dynex Capital (NYSE:DX), Colony Financial (NYSE:CLNY) and Arbor Realty Trust (NYSE:ABR). The Arbor, it should be noted is a senior unsecured issue and therefore higher up in the capital structure than the others. As well, the duration is my estimate as these figures are not modeled yet. The estimate was drawn from similar issues with similar coupons.
As the table above shows, there is value in this preferred relative to its peers - despite the additional yield offered by NorthStar (which I wrote about here). NorthStar came "cheap" in my opinion due to the spin-off of the asset manager (this quarter) and the greater complexity of their portfolio. I do like the NorthStar deal (I am long the company across their capital structure), but believe this issue is also a decent addition to an income portfolio.
As I did in my NorthStar analysis, the following is a chart which could help investors determine value based on yield per unit of interest rate risk (duration):
Again I have included their agency mREIT cousin as this is the inaugural issue. Unlike the NorthStar analysis, the following chart shows yield per unit of risk for the entire peer group:
From an interest rate risk compensation perspective, the senior unsecured Arbors have the most juice followed by the NorthStar issue. The new MTGE's are right in the ballpark versus the other peers however.
Finally, I like to show the peer group from an equity perspective:
MTGE has been recovering nicely this year after a difficult 2013. And the peer group:
MTGE is in the middle of the peer group pack, showing the equity market does not have outsized idiosyncratic concerns with them.
Bottom Line: I like the new issue and believe it has value versus peers and generally. Book value has stabilized, leverage is reasonable and net interest margin has started to recover. As a new issue typically trades below par before it is listed, there is additional value in the American Capital Mortgage Series A preferred.
Disclosure: I am long NRF, AGNC. 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.