Patrick Harden

American Agency Mortgage: Huge Dividend REIT

One minor housekeeping note: the company in focus is named American Capital Agency Corporation (AGNC).

As for the agency-backed mortgage REITs in general, the entire sector is guaranteed to succeed in an environment where there is a steeply positive yield curve. The agency backing of their holdings minimizes credit risks, so their business model becomes a virtually pure-play interest-rate gambit. The Federal Reserve has not yet indicated the need to push rates back to historical norms, so the available spread to be earned remains quite wide.

Of course, the companies within the agency-backed mREIT sector differ in certain respects, and as mortgage rates have fallen over the last few years, those companies that have seasoned fixed-rate debt should outperform those with short-reset adjustable-rate holdings. Another factor to consider is those companies with short-duration swaps that are due to roll off. Many of the agency mREITs have swap-adjusted cost of funds that are much higher than the unadjusted market cost of repurchase agreements. Those with higher swap-adjusted COF have limited their spread potential.

As for AGNC itself, although I have criticized AGNC's sponsor, American Capital Ltd as "questionable", AGNC's Q2 financial results were quite robust. The company earned $1.98/share in Q2 taxable income and still has $0.79/share in undistributed taxable income to support the dividend for the rest of the year. I believe the $1.50/share dividend is sustainable for Q3 & Q4 2009 based on AGNC's remaining taxable earnings. 2010 may be a different story.

Snowjob3 made a good point about the capital gains. AGNC's taxable income calculations appear to include both ordinary & capital gain income. Capital gains, of course, are typically non-recurring. Plus, REITs are only required to distribute 90% of ordinary taxable income.