At the last Fed meeting Dr. Bernanke announced that the Fed would keep rates low through 2014. This is good news for mortgage REITs. They make money on the spreads between their borrowing costs and the yields of the higher interest rate mortgage backed securities they buy. Usually they are leveraged many fold, so this effect is magnified. The problem can come when interest rates rise. Then bundles of fixed rate mortgages will lose their value as borrowing costs become higher. Dr. Bernanke has just announced that this won't happen for another 3 years.
This should mean you will be safe investing in mortgage REITs for at least another two years. Of course, there are many other problems with mortgage REITs such as defaults and prepayments, but a well managed REIT protects you from these problems. American Capital Agency Corp. (NASDAQ:AGNC) appears to be just such an REIT.
AGNC invests in residential mortgage pass-through securities and collateralized mortgage obligations for which the principal and interest payments are guaranteed by a US government agency or a US government sponsored entity such as OTCQB:FNMA or GNMA. The company funds its investments primarily through short term borrowings structured as repurchase agreements. There is still the risk of defaults, haircuts, etc. but thus far the federal government has made good on all guarantees.
Again this year Sec. Geithner has stated that the government will try to address the effective insolvencies of FNMA, GNMA, etc. However, he has said that before, and we have yet to see action. Still, if you invest in a mortgage REIT stock, you will want to watch this issue closely. It may impact the profits the company is likely to accrue. Consequently, it may also impact the stock price.
Another worry is the Fed. It may implement large scale purchases of agency mortgage-backed securities. If the Fed did this, it would increase the prices of MBS, but it would likely cause more prepayments. Plus, it would increase the risk of new acquisitions as the new acquisitions would offer lower yields. If you invest in AGNC you will probably want to watch what the Fed is doing closely too.
Warnings having been given, AGNC has performed well of late. Its stock price has been stable for the past year (+1.64%), and it has recently returned a 19.00% dividend. Most people would be very happy with that return. The dividend yield may fade from this high level as prepayment speeds on newer, generic mortgages have increased over the last few months, but it should remain strong. The following chart shows some of the possibilities given a variety of CPR's (Constant Prepayment Rates) and eight times leverage.
Clearly, there is a lot of variability. AGNC has managed this well with a diversified and balanced portfolio. It has reduced exposure to higher coupon, seasoned fixed-rate and ARM securities. Its average prepayment speed on the portfolio remained stable at approximately 8% CPR in Q3 2011, even with the volatility. However, the average projected prepayment speeds on the portfolio have increased significantly. This may well mean a declining dividend yield to come. In fact AGNC forecast a $1.25 dividend for Q1 (lower than the $1.40 dividend for Q4 2011).
To limit this risk AGNC has approximately 93% of 15 year securities and 86% of 30 year securities backed by lower loan balance or HARP securities. AGNC has less than 2.0% of its portfolio in fixed-rate collateral issued prior to 2009. It has only 1% of its portfolio in single family ARMs issued prior to 2009. AGNC has a proven track record, and it is living up to that record.
Some of AGNC's statistics:
- It has paid $18.86 per share in dividends since its IPO in May 2008.
- It has grown book value 61% from $17.25 per share on Dec. 30, 2008 to $27.71 on Dec. 31, 2011.
- Book value has increased in 11 of the last 12 quarters.
- These results significantly exceed the performance of peers over a volatile multiyear period.
- AGNC uses swaps and other hedges to mitigate the book value risk to its portfolio.
In sum, AGNC appears to be a well run company that has been generating great returns. Since it only invests in federally backed securities, its overall risk is low. You should be able to invest in this company with little worry as long as you keep the above mentioned caveats in mind. This management team has proven their metal. They recently reported Q4 2011 earnings, and they did not disappoint. AGNC declared a Q4 dividend of $1.40 as expected.
However, it did lower its Q1 2012 projected dividend to $1.25. Annualized this new yield comes to $5.00 or 16.81%. Yes, this could go still lower as the year goes on, but AGNC will still likely be outperforming most other investments, including other mortgage REITs. We will hope that this allows AGNC to maintain its stock value. With AGNC's efforts to grow (or at least maintain) its book value (a book value of $26.90 at the end of Q3 2011 moved higher to $27.71 at the end of Q4 2011), this seems reasonable.
If you are looking for other mortgage REITs that also stick to federally backed securities, consider Annaly Capital Management Inc. (NYSE:NLY). Other mortgage REITs that are not quite as safe include: Two Harbors Investment corp. (NYSE:TWO), Invesco Mortgage Capital Inc. (NYSE:IVR), Chimera Investment Corp. (NYSE:CIM), Capstead Mortgage Corp. (NYSE:CMO), and Crexus Investment Corp. (NYSE:CXS). I am sure I have left out many more.
Good Luck Trading.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.