This article examines various agency REITs as broken down by net interest margin and sensitivity to interest rate changes as of the latest publicly available financial data valid 06/30/2012. The REITs analyzed include Armour Residential REIT (ARR), American Capital Agency (AGNC), Annaly Capital Management (NLY), and CYS Investments (CYS). All of these companies invest primarily in agency securities of which the principal and interest are backed by the US government (e.g., Freddie Mac, Fannie Mae, etc.). A useful metric for evaluating agency REITs is the net interest spread, which is defined as the difference between the yield on assets less both interest costs and interest rate hedging activities. The larger the net interest spread, the greater the net interest income earned all other factors equal. The table below summarizes the second quarter 2012 net interest spread for each of the four aforementioned companies. All data was pulled from the latest 10Qs.
|Company||Net Interest Margin||Leverage|
ARR features the largest net interest margin of the group, which, in part, explains the outsized dividend yield (leverage is the other part of the equation). The current dividend yield of ARR is 16.1%. AGNC was second on the list, with a net interest spread 32 basis points below ARR and modestly lower leverage as well relative to ARR (7.6 vs. 9.0). Not surprisingly, the AGNC yield is a bit lower than ARR at 14.4%.
Net interest margins are sensitive to interest rate fluctuations. Certain companies may be more/less hedged to interest rate movements than their peers. The sensitivity analysis tables presented below reflect the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of each company's interest rate-sensitive investments and net interest income, at June 30, 2012, assuming a static portfolio. As net interest income increases (decreases), dividend payouts will increase (decrease). In the case of NLY and CYS, the hypothetical change in net interest income for a 100 basis point movement is not provided. However, the change is provided for a 75 basis point movement, so the 100 basis point metrics are estimated based on these data.
|stock||up 100 BP||up 50 BP||down 50 BP||down 100 BP|
One interesting observation is the relative minimal impact of interest rate changes to NLY's current portfolio. Interest rate changes have less than a 5% change on net investment income across the board. Both ARR and AGNC are sensitive to significant downward movements in the yield curve, while CYS net investment income is currently most sensitive to upward shifts in the yield curve. Establishing positions in both CYS and ARR can partially hedge against interest rate changes given their current sensitivities.