I recently wrote an article about Annaly Capital (NLY) and the reasons why I was reducing my position in the stock by two thirds. I have come to a similar decision with regards to our holding of American Capital (AGNC).
The similarities end at the actions taken. With NLY, we reduced our "Team Alpha" holding, but did not dump the stock. With AGNC, we are selling our complete position.
Why Dump AGNC And Still Hold A Position In NLY?
The basic reasons are simple for me to articulate, but might not be easy for AGNC fans to accept.
- Annaly takes a much more conservative approach, with their use of leverage.
- Annaly has more experience in many unique interest rate environments than the much newer company, American Capital.
- Annaly has continued to enjoy insider accumulation of shares, most recently by CEO Mike Farrell, while American has seen very little of the same insider activity.
- Annaly has reduced leverage, and American has expanded leverage.
These are quite important to me as I determine whether or not AGNC belongs in the "Team Alpha" portfolio at all, at this time. Keep in mind that I am not changing my mind on Annaly. I am reinforcing my decision to keep a modest position in the stock because of its conservative approach to the business at hand. I have reduced that position significantly however.
I believe that the business model that AGNC has embraced thus far, has served them quite well. They have outperformed Annaly by virtually every metric.
Annaly was consistent in share price and relatively stable in dividends paid since mid 2007. From American's inception in mid 2008, they have soared in share price, and rocketed past Annaly with dividends paid.
This has been a wonderful scenario for investors seeking income and catching the great capital appreciation. Years earlier, I felt the same way with Annaly. The problem is that this was achieved by American using a much more aggressive approach and taking on significantly more risk. Needless to say, it has worked beautifully.
The Game Has Changed
Now that the Fed itself is in the same business as both Annaly and American, by virtue of it buying mortgage backed securities to the tune of $40 billion per month basically open-ended, it makes it very challenging for any agency backed mREIT to compete and make money.
I will contend that it is easier to shift gears from being conservative to more aggressive, than it is to suddenly put the brakes on and de-leverage down into a more conservative approach.
I think AGNC has been painted into a corner right now and I am not certain as to how they can back out of it without significant share price deterioration and serious dividend cuts.
All of the mREITs have been receiving downgrades and negative press. Take a look at the last market current:
"Thursday 1:00 PM More on the Annaly (NLY) downgrade: Morgan's move is part of a larger theme of preferring hybrid mREITs (those buying non-agency MBS) to agency mREITs. The hybrids should benefit from higher non-agency yields and an improving housing market. Upgraded: Invesco (IVR). Downgraded (other than NLY): American Capital (AGNC) and MFA Financial. Everyone's piling into non-agency paper."
My opinion is that eventually, the hybrids will be affected as well. I am staying away from all mREITs for now, and will be selling my entire position in AGNC immediately.
I am reiterating my continued small, "risk" capital position in NLY, simply because I trust its management team, and continue to appreciate their conservative approach. They can also step on the gas a bit to take on more leverage if they decide to do that, but I believe that AGNC will not be able to de-lever rapidly enough to avoid the precarious pitfalls I believe it faces, both from a share price issue and a dividend issue.
It is easy for lead the cheers and buy a great stock to run with while the running is good. It is tough to decide to fold a good hand when it still might be a short-term winner.
I probably will take heat for this article, but I feel that being prudent at this time is the way to go. The Fed has been great for mREITs until they decided to open up shop in that business.
I do not fight the Fed.