While many in the market have come out with bearish calls on mortgage real estate investment trusts ("REITs") after bearish comments from mortgage investor Jeffrey Gundlach, we remain positive on mortgage REITs for yield focused investors. Adding to the bearish hype, mortgage REIT bellwether Annaly Capital Management (NLY) recently cut its dividend and reduced leverage levels. However, as we highlighted in a recent article, we believe that this was a positive thing for NLY.
That said, we believe some of the argument on reduced leverage and higher prepayment speeds are too generic. As with all investing, the secret is proper security selection. We believe that American Capital Agency (AGNC) is highly focused on prepayments and has thus selected securities that will insulate their cash flows relative to increases in overall prepayment speeds.
Unlike agency mortgage REIT peers, AGNC has maintained its $1.40 per quarter dividend, which we believe is a result of management's focus on securities that will exhibit lower constant prepayment rates (“CPR”).
The table below outlines prepayment speeds for various mortgage securities.
AGNC management has focused on mortgage securities backed by lower loan balances (balances between $85,000 and $110,000) and Home Affordable Refinance Program (“HARP”) loans. As outlined above, these loans exhibit lower prepayment rates.
The company’s CPRs for lower loan balance have been 9% and 7% for 15 years and 30 years, respectively. Likewise, CPRs for the company’s HARP loans have been 9% and 4% for 15 years and 30 years, respectively.
While dividend cuts and comments from market participants have spooked investors, we think the long-term thesis remains intact for AGNC. Interest rates will likely remain low well into 2013, which is an ideal environment for agency mortgage REITs.
Note: Agency mortgages are guaranteed by government sponsored entities (implying limited credit risk). Conversely, non-agency securities do not carry a similar implied guarantee, making them inherently more risky due to the higher relative credit risk.