There are only a few mortgage REITs in my portfolio. One of them is American Capital Mortgage Investment (NASDAQ:MTGE). The mortgage REIT was trading at a materially larger discount to book value than most peers and I was confident in the dividend. In previous coverage, I stated:
"While I believe there are several dividends in the sector that are still in jeopardy, I don't believe this is one of them. I would expect the net interest income figures for the next quarter to be stronger. To go along with stronger net interest income, I don't expect a dividend cut here."
True to my expectations, American Capital Mortgage Investment declared $.46 in net interest spread and dollar roll income per share (excluding "catch-up" amortization). That beats analyst estimates by $.05 and beats the prior quarter by $.02. Compared to the quarterly dividend rate of $.40, the earnings look very solid. Perhaps the best part is the mortgage REIT declaring net book value of $19.47 per share.
How Does That Stack Up?
MTGE's book value per share comes in as a book value increase of $.44 even after paying the quarterly dividend of $.40. That should be one of the stronger values posted for the quarter. My estimate on book value for MTGE's end of quarter value was $19.42, so MTGE even beat my estimates. Regardless, being within $.05 per share is more than close enough. I consider anything within 2% to be hitting on book value estimates, so I could've been off almost $.40 in either direction and still been close enough.
More Recent Estimates
At the end of last week, I ran fresh estimates on book value per share for subscribers. Without giving away the values, my estimates indicate that book value per share for MTGE should be higher today than it was at the end of Q2 2016.
Simply using the $19.47 from the end of the second quarter to calculate the latest price to book value ratio indicates a discount of about 15%. This would be still slightly larger than average for the peer group.
Why Does MTGE Trade at a Larger Discount?
Despite exceptional performance for the quarter, the trailing performance for MTGE wasn't so strong. Its performance was severely weakened by a subsidiary engaged in servicing MSRs (Mortgage Servicing Rights). That subsidiary was sold and the transferring duty remains with the subsidiary while the MSRs remain with MTGE. The net impact should be the servicing losses drying up. The servicing loss for Q2 of 2016 was $.13 per share. That means MTGE delivered great performance with a gain of $.44 in book value, paid $.40 in dividends, and absorbed the net servicing loss of $.13. It was a great quarter.
The challenge for the share price is the history of weaker performance driven by the subsidiary combined with a much weaker dividend yield. MTGE has been consistently paying a dividend of $.40, which is fairly small for the industry relative to the book value of equity. Investors that are focusing on the dividend will usually avoid MTGE and chase ones with a higher trailing yield. They may throw a fit when that higher dividend is cut. On the other hand, investors focusing on the history of total economic return (change in BV + dividend) would avoid MTGE because it has a poor history due to that subsidiary.
In a nutshell, MTGE looked like a weak mortgage REIT, but it was hiding a gem. I entered a position in late June when I could acquire shares for just over $15.70. Since then I picked up a dividend worth $.40 and watched shares move up to $16.47. How do you think this earnings beat will impact shares?
It looks like a positive sign to me. If shares rally hard it could push me to sell out of my position.
My prior rating on MTGE is a buy. There is no change in my rating. This should not be seen as re-establishing the rating (the upside isn't as large now), or dropping the rating to neutral (still requires a little more climb in the price).
MTGE delivered a strong quarter with a solid beat on net interest spreads. The result should reassure investors that the dividend is stable (I still believe that), and send share prices higher. As the net servicing losses dry up (from getting rid of the subsidiary), the results shouldn't have the same weight on them for much longer.
The full earnings release can be seen here.
Disclosure: I am/we are long MTGE.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. This article is prepared solely for publication on Seeking Alpha and any reproduction of it on other sites is unauthorized. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.