American Capital Agency Corp. - Book Value Resilience In The Face Of Rates Back-Up

REIT Analyst profile picture
REIT Analyst

Treasury yields and mortgage rates have backed up massively over the past few weeks. Mortgage-backed securities (MBS) prices have fallen, some by 5 or 6 points. And agency mortgage REITs have been killed, the implicit logic being that leverage of 7 or 8 times on something falling like a rock can't be good. American Capital Agency Corp. (NASDAQ:AGNC), in that respect, is the poster child of the entire mortgage REIT market.

Many investors and analysts have followed this simple logic, (leverage x MBS price drop) modulo some fudge factor, in order to estimate book value losses on mREITs. Analyzing the drivers of agency mortgage REIT value (MBS, TBAs, specifieds, repos, swaps, swaptions, caps, floors, etc.) is complicated -- it takes many years of intense daily focus for people in these various fixed-income and derivatives markets to really understand the way they operate and interact. It's natural that those without the appropriate tools and framework should resort to what is perceived as reasonable approximations.

However, this approach leads to materially wrong conclusions. Mortgage REITs are a leveraged difference: long MBS, short hedges, times a lot of leverage. What accuracy can we expect if we take an approximation, subtract another approximation, and multiply all that by a leverage of 8?

In stable market conditions, making such extreme approximations is not necessarily a huge issue, because the prior quarter is probably not a bad estimate for the current quarter. In such conditions detailed analysis can to some extent help with better precision (some REIT's assets could be marginally better than some other REIT's, for example). But when large market movements occur, significant non-linearities develop, and one cannot just extrapolate anymore, proper analysis is essential.

Based on the non trivial analysis I lay out below, I derived an estimation that AGNC's BV as of the

This article was written by

REIT Analyst profile picture
Former head of strategy on mortgage-backed securities at large investment banks. Spent over 15 years analyzing, structuring and trading MBS. Holds a PhD in mathematics.

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