PennyMac Mortgage Investment Trust (PMT), American Capital Agency Corp. (AGNC): 35% Total Return Potential Not Without Risks

PennyMac is also exposed to credit or default risk. Since the company is exposed to the US housing sector, a home borrower default could result in a foreclosure and loss to the lender. Propagating this risk is the fact that a majority of the securities PennyMac holds are currently nonperforming and 90+ days delinquent. No due diligence can ensure that their mortgage assets and securities will perform in line with their payment and credit expectations. Therefore, any unanticipated behavior could lead to significant losses at PennyMac. Secondly, there is a possibility that none of the major credit rating agencies rate PennyMac’s assets. So, there may be lack of visibility into the credit standing of the portfolio and risk may be difficult to evaluate periodically.

Competition

In comparison, American Capital Agency Corp. (NASDAQ:AGNC) and Annaly Capital Management, Inc. (NYSE:NLY) don’t have credit risk in their portfolios as they are both exclusively invested in Agency RMBS. The Agency RMBS is back by government guarantee.

Amid speculations of QE tapering, both mREITs have seen a bloodbath and I believe the decline in the stock price will continue as speculations turn into reality. Fed’s exit will definitely increase the volatility in the interest rates and may also cause interest rates to increase and widen the Agency spread. In such a scenario, both the mREITs will face downward pressure on their book values.

However, Annaly Capital Management, Inc. (NYSE:NLY) is better positioned to produce higher income under the given situation. Annaly Capital Management, Inc. (NYSE:NLY) has positioned its portfolio in such a way that it can expand its coming quarter’s interest income by 17% if the rates climb 50 bps.

On the other hand, American Capital Agency Corp. (NASDAQ:AGNC) would see 4.3% contraction in its net interest income in a similar situation. Agency MBS spreads have widened by 18 bps in May alone to 67 bps, in line with their 20-year average. So, you can imagine the contraction American Capital Agency Corp. (NASDAQ:AGNC) will report at the end of the second quarter.

Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

The article 35% Total Return Potential Not Without Risks originally appeared on Fool.com is written by Adnan Khan.

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