On August 3, less than three months ago, American Capital Mortgage Investment Corp. (MTGE) announced that its initial offering of stock was to be 8 million shares priced at $20 a share. At the same time it announced that its parent and manager, American Capital Ltd (ACAS), bought 2 million shares at that price in a private placement. MTGE is a mortgage REIT, a company that invests in mortgage securities and pays out almost all of its earnings to its shareholders.
The shares of MTGE began trading the next day on Nasdaq and closed at 18.41, significantly below the IPO price. In trading since then the stock never closed higher than 19.69 and for the past few weeks it has been trading around 16.50.
American Capital has been very successful in its management of American Capital Agency Corp (AGNC), another mortgage REIT that has been in business since May of 2008, just four months before the failure of Lehman Brothers. It has paid a dividend every quarter since then, and since Q3 2009 it has paid a steady $1.40 a quarter ($5.60 a year), resulting in a yield of around 20% based on its recent stock price.
AGNC invests only in U.S. government guaranteed mortgages, while MTGE will invest in both guaranteed and non-guaranteed mortgages. This means that MTGE will have credit risk, while AGNC does not. They will share exposure to other kinds of risk, but MTGE will have a significantly higher overall exposure to risk based on the wide range of instruments it is able invest in.
Of course, the performance of MTGE will depend on the expertise of American Capital, its manager. Judging by its record in running AGNC, we can expect, qualitatively, that it will do well. One suspects that in running AGNC, American Capital came upon attractive investment opportunities that it had to pass up due to the restrictions of the charter of AGNC, so it formed MTGE to take advantage of those opportunities.
But what should be our quantitative expectations for MTGE? Well, one way to try to get some ideas of what to expect from MTGE is to think of what American Capital must have expected in forming it. They are investing experts, and so far they know a lot more about what has been going on with the money they raised, so these expectations are probably the best estimates available. The rest of us will find out after market close this Wednesday and in the conference call on Thursday.
It seems reasonable to expect that the experience of American Capital with AGNC should provide a baseline for its expectations from MTGE. Don't forget that MTGE is inherently more risky (if it buys non-agency paper) than AGNC, so even if its benchmark is "attractive risk-adjusted returns" (from its website) the NON-adjusted returns should be no lower than those of AGNC. The most neutral way to compare the returns would be on their respective book values, since this is an objective (that is, market-price-based) measure of what is really there, so to speak.
The managers of MTGE have been able to deploy something close to $20 per share from the proceeds of the initial sale in early August. This deployment took place after the downgrade of U.S. debt at the beginning of August, and it would take something extraordinary (either unusual incompetence or unusual bad luck) for the book value of a share of MTGE to be below $19 at the end of September. From its record, we can discount the possibility that American Capital deployed the capital with incompetence, and we can even hope that the book value has risen.
On its latest reported book value of around $27, AGNC has been paying $5.40 a year. If MTGE is to yield at the same level as AGNC, with a $19 book value it would have to pay $0.95 a quarter, or $3.80 a year. These would be minimal expectations on the part of American Capital in launching the new fund.
On Wednesday we should find out what the book value of MTGE was as of the end of the quarter, and there will be probably be some sort of guidance as to the yield.
The current price of $16.42 is at least 15% below the probable minimal book value of MTGE, which means that you can buy a dollar for less than 85 cents. The yield on the current price is about 25% based on these expectations.
The bottom line: MTGE is a outstanding value for a pop on Thursday morning after results are announced (if it does not rise before then) and also as a long-term hold if you are comfortable with the management.