Although American Capital Agency Corp. (NASDAQ:AGNC) recently slashed its quarterly dividend by 16%, its impressive yield of 21.95% is still one of the highest yields existing today. The Street has been cheering dividend cuts throughout the mortgage REIT industry, as it allows companies like American Capital Agency Corp. (NASDAQ:AGNC) to cope up with shrinking margins.
With hedged positions, a low CPR of 10%, and slashed dividends, I believe that American Capital is is a good stock to hold.
No risk no rewards
Meanwhile, shares of Annaly Capital Management, Inc. (NYSE:NLY) have lost around 13% over the last year. Its quarterly CPR of 19% is relatively higher, yet Annaly has been reporting better growth as compared to American Capital. This is because Annaly doesn’t pay a premium (like American Capital) to acquire securities with low prepayment rates.
However, one thing to note here is that if interest rates continue to rise, market liquidity will shrink gradually, which will eventually lower the industry wide conditional prepayment rates. Since Annaly operates with higher than industry average CPRs, the REIT seems to have the highest improvement potential in its CPRs.
One of its main catalysts is its recent acquisition of Crexus. It deals in commercial mortgage backed securities that are backed by federal agencies. Although commercial paper carries greater risk, it also carries better interest spreads and will eventually improve Annaly’s margins. Since Crexus operates with little or no debt, Anally can now leverage further and boost its returns. Besides that, having commercial paper will also diversify Annaly and position it as a hybrid REIT.
At the current price, shares of Annaly Capital Management, Inc. (NYSE:NLY) yield 14.16% with a payout ratio of 113.4%, and the acquisition of Crexus is expected to further boost Annaly’s dividend payouts.
Conclusion
If interest rates continue to rise, the interest income of REITs will continue to shrink, but their interest spreads will most likely widen. Thus, REITs will be able to operate with better margins without having the need to leverage their operations. Hence, investors should proceed likewise.
Since Apollo Residential Mortgage Inc (NYSE:AMTG) and Annaly Capital Management, Inc. (NYSE:NLY) are hybrid REITs, they have relatively stable top lines due to their presence in the high-margin commercial sector. So, while Apollo Residential Mortgage Inc (NYSE:AMTG) offers the resilience of low CPRs and high margins, Annaly Capital Management, Inc. (NYSE:NLY) complements it with a tremendous improvement potential in its CPRs. Meanwhile, American Capital Agency Corp. (NASDAQ:AGNC) presents an upside due to its hedged positions, and stands to gain from the rebound in the housing market. Thus, I believe that holding all three REITs is a great way to spread the risks and rewards.
Piyush Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article Don’t Be Shocked by the Fed’s Latest Actions originally appeared on Fool.com.
Piyush is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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