With the continued Fed’s quantitative easing, many expect American Capital Agency Corp. (NASDAQ:AGNC) and other mortgage REITs to report net interest rate compressions and dividends cuts at the end of the first quarter. However, evidence indicates otherwise for American Capital Agency. I believe the following three reasons will lead the company to post an expansion in its net interest rate spread during the first quarter of the current year. Also, I believe the company’s dividends are well intact and might improve.
Asset Mix
American Capital Agency Corp. (NASDAQ:AGNC) is one of the largest mortgage REIT in the United States that seeks to invest in mortgage backed securities for which any of the government sponsored Agencies guarantee the principal and interest payments. The following chart provided in its fourth quarter Investor Fact Sheet shows the proportion of each type of security within the company’s asset portfolio.
It is evident from the chart above that the 30-year fixed rate mortgage backed securities have the largest proportion (61%) in American Capital Agency Corp. (NASDAQ:AGNC)’s fourth quarter end asset portfolio. This is followed by 15-year mortgage backed securities, which are 35%. The 20-year fixed rate securities are a negligible 2%, while the company also has other investments. At the end of the fourth quarter of 2012, around 77% of the company’s fixed rate securities were composed of securities backed by lower loan balance mortgages and loans originated under Home Affordable Refinance Program (HARP). These securities are considered to have favorable prepayment attributes, resulting in low risk of prepayments. Prepayments, measure by CPR (conditional prepayment rates) are one of the hindrances in figuring the net interest rate spread. The composition of the company’s asset portfolio has led to stable CPRs. American Capital reported a CPR of 10% for the fourth quarter, compared to 9% for the third quarter. These are one of the lowest CPRs in the industry, and I believe the company will continue to decrease it prepayment risk going forward.
In comparison, Annaly Capital Management, Inc. (NYSE:NLY) , the largest Agency mortgage REIT invests in high coupon mortgage backed securities which have high loan balances and which are more prone to prepayments. Therefore, the company reported a CPR of 19%. Amour Residential is another pure play mortgage REIT. Its reported CPR stood at 14.1%. In contrast, Two Harbors Investment Corp (NYSE:TWO) is a hybrid mortgage REIT. Two Harbors reported a CPR of 6.6% for its Agency holdings, while the prepayments for its non-Agency securities stood at 3.2% at the end of the fourth quarter.
Climbing Mortgage Rates
Prepayments accelerate during the times when mortgage rates are decreasing. However, the following charts suggest the rates have been on the rise since the beginning of the year.
Despite Fed’s best efforts to keep the rates at their lowest, mortgage rates have continued their upwards journey due to the lack of cooperation by some of the largest US mortgage lenders causing a lender shortage. Rising mortgage rates discourage borrowers to refinance, resulting in less prepayment. This means American Capital Agency’s CPR is likely to remain stable.
Strong Financials
American Capital Agency Corp. (NASDAQ:AGNC) reported a 21 bps expansion in its fourth quarter net interest rate spread, while its peers Annaly Capital Management, Two Harbors and Armour Residential (NYSE:ARR) reported declines of 7 bps, 20 bps and 27 bps, respectively.
American Capital Agency reported a 9.6% sequential growth in its fourth quarter top line (interest income) of $570 million. Also, the bottom line of $810 million climbed up from the previous quarter’s $89 million. During the full year 2012, the company earned $6.78 per common share in taxable income, while it distributed $5 per common shares in dividends. Since the income is already exceeding the dividend distribution, investors can expect at least the current dividend rate to continue.
Conclusion
I believe you can expect American Capital Agency Corp. (NASDAQ:AGNC) to deliver a dividend hike after it announces the results for the first quarter of the current year. It strong financials, the rising mortgage rates and the highly prepayment protected asset mix leads me to recommend American Capital Agency to investors who are looking to enhance their regular income.
The article Are This REITs Dividends In Danger? originally appeared on Fool.com and is written by Adnan Khan.
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