Given macro headwinds and concerns about the housing market, American Capital Agency (AGNC) and Invesco Mortgage Capital (IVR) are an attractive bet on the economy given the opportunity for high risk-adjusted returns. In my view, however, these REITs are not worth the risks due to cuts in dividends and funding problems.
From a multiples perspective, IVR is the cheaper of the two. It trades at a respective 3.7x and 5.1x past and forward earnings while paying off earnings through its dividend yield, which stands at 24.4%. This compares to AGNC, which trades at a respective 4.2x and 5.9x past and forward earrings while offering a dividend yield of 19.8%. However, AGNC is actually preferred on the Street with its "buy" rating versus the "hold" rating for its competitors.
During the third quarter, IVR noted:
The Company reported net income of $82.2 million, or $0.79 per share (basic and diluted), for the quarter ended September 30, 2011 compared to $74.4 million, or $0.99 per share (basic and diluted), for the quarter ended June 30, 2011. During the third quarter of 2011, the Company completed a follow-on common stock offering generating net proceeds of $362.2 million. The 10% increase in quarterly net income was driven by an increase in average earning assets as the Company invested the funds from the follow-on common stock offerings in June and August 2011.
The Company also reported its book value per share as of September 30, 2011 was $16.47 compared to $19.34 per share as of June 30, 2011.During the third quarter, we saw an opportunity to acquire high quality assets at attractive levels given the uncertainty created by the U.S. debt ceiling debate and the turmoil in Europe. We also took the opportunity to participate with WL Ross, Invesco Real Estate, and other partners in buying a package of commercial mortgage loans auctioned by a large financial institution.
Management recently reduced the dividend yield, but helped offset some of the disappointment by announcing a 7M repurchasing program. With higher funding costs and MBS yields likely to decline as prepayments rise, investors are in need of greater security to open a long position. Note that non-agency RMBS portfolio coupons have gone up by a fair degree. Consensus estimates for IVR's EPS forecast that it will decline by 20% to $3.42 in 2011, decline by 19% in 2012, and then grow by 3.2% in 2013. Based on this outlook, I am in agreement with the Street that the company is more towards a "hold" than a "buy".
Where I disagree with the Street is in AGNC, which is rated a "buy". I find myself considerably more bearish given that UD Dollar Funding risks and greenback demand from European banks starts to build. This will consequentially raise LIBO and establish an adverse environment for mortgage securities. High expenses, comparatively high debt, and faster prepayments are three further reasons why the risk/reward is not favorable. Going forward, I anticipate a decline in the dividend yield and ROE to compression as the company focuses on mitigating leverage.
Consensus estimates for AGNC's EPS forecast that it will decline by 31.1% to $5.44 in 2011 and then by 11.9% and 0.6% more in the following two years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
