Capstead Mortgage Corporation (CMO), Hatteras Financial Corp. (HTS): This mREIT Offers Book Value Preservation and a 10% Yield

In contrast to Capstead Mortgage and Hatteras Financial Corp. (NYSE:HTS) that invest in hybrid ARMs, American Capital Agency Corp. (NASDAQ:AGNC) is an mREIT that invests mostly in seasoned long duration fixed rate MBS securities with low prepayment risk. This strategy exposes American Capital Agency Corp. (NASDAQ:AGNC) to a lot of interest rate risk, but its second quarter results were better than investors’ worst fears.

In these results, American Capital Agency Corp. (NASDAQ:AGNC) reported a comprehensive loss per share of $2.37 as compared to a comprehensive loss per share of $1.57 in the previous quarter. The company’s net interest spread declined by 12 basis points to 1.59% for the quarter; however, unlike with Hatteras Financial Corp. (NYSE:HTS) and Capstead, the drop in interest spread for American Capital Agency Corp. (NASDAQ:AGNC) was due to a higher cost of capital rather than an increase in prepayments.

In order to decrease the duration of its portfolio, American Capital Agency Corp. (NASDAQ:AGNC) swapped out of the more troubled 30-year fixed rate MBS and into 15-year fixed rate MBS. Active portfolio management coupled with effective hedging meant that American Capital Agency Corp. (NASDAQ:AGNC) was able to limit its book value decline to 11.8% from the first quarter, which is much better than that of the theoretically more conservative Hatteras Financial Corp. (NYSE:HTS).

Foolish take

Agency mREITs suffered sharp book value losses across the board in the second quarter due to rising interest rates and widening mortgage spreads. However, Capstead Mortgage was a star performer that survived the bloodbath in this space. Capstead has a dividend yield of over 10%, is trading at a 6% discount to its second-quarter book value, and has demonstrated that it can preserve its book value in a highly volatile interest rate environment. Due to these factors, I would rate Capstead Mortgage a buy.

I would rate American Capital Agency a hold since its management has done an excellent job in limiting the book value loss in very tough conditions. This gives me confidence that the management has the capacity to deal with tough circumstances. However, I’m not at all convinced by Hatteras Financial’s book value decline, especially since it follows a relatively conservative strategy, and would recommend getting out of any long positions in this name.

The article This mREIT Offers Book Value Preservation and a 10% Yield originally appeared on Fool.com and is written by Zain Zafar.

Zain Zafar has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Zain 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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