3 Things to Watch With American Capital Agency

American Capital Agency (Nasdaq: AGNC  ) is a real estate investment trust that invests in residential mortgage pass-through securities and collateralized mortgage obligations that are backed by agencies of the U.S. government. As a REIT, it is required to return a minimum of 90% of its net earnings in the form of a dividend to shareholders.

Today, let's look at three things investors should be watching regarding American Capital Agency, as they'll provide us better insight into the company.

1. Net interest margin
There's nothing more important for mortgage REITs than net interest margin levels. Mortgage REITs earn a profit on the difference of the level at which they borrow (record-low interest rates) and the rate at which they lend. Therefore, the wider this gap, the more profitable mortgage REITs will be.

Recently net interest margin rates (which are already razor-thin) have been tightening, which has put a strain on growth for American Capital and its peers -- and that's not the only worry that's plaguing the mortgage REIT sector.

Operation Twist, the Federal Reserve's program that sells short-term debt securities and buys the same amount of longer-term debt securities, was recently extended and has the potential to further shrink net interest margins, although its effect thus far has been minimal. In addition, non-agency-backed residential MBS pose a threat if the housing market takes a decidedly negative turn. Whereas Agency Capital has its interest and principal backed by the U.S. government, both Invesco Mortgage Capital (NYSE: IVR  ) and Chimera Investment (NYSE: CIM  ) own non-backed agency loans that leave them precariously exposed to economic weakness in a still-weak housing sector. Not surprisingly, these two have fared far worse than their mREIT peers.

2. Leverage
Equally important to mortgage REITs' success is their ability to prudently and successfully leverage their holdings to maximize investor returns without saddling the company with unnecessary risk.

Annaly Capital Management (NYSE: NLY  ) and American Capital are the two largest mREITs by assets, but that doesn't mean they are necessarily leveraged to the brim. In fact, the general trend in the mREIT sector has been to reduce leverage in anticipation of rates rising after 2014.

As Anwar Elgonemy, author of Skin in the Game: The Past, Present, and Future of Real Estate Investments in America, mentioned in his interview in April with the Fool's Chris Hill, the mREIT sector boasts the highest debt levels of the entire REIT sector. With investors still shell-shocked from the danger of high levels of leverage, the risk of using too much leverage compounded with the inevitability that lending rates can't stay this low forever has investors closely examining exactly what type of MBS these mREITs are buying, and how easily it would be for these mREITs to exit these positions if they needed to.

3. Dividend yield
Perhaps no sector is more prone to yield-chasing than mortgage REITs. With yields regularly in the double-digits, traders are sometimes more prone to blindly throwing their money at these companies than actually spending time doing their homework -- and that would be a major no-no!

Mortgage REIT dividends are dependent on the net interest margin level and the amount of leverage an mREIT employs but can be adversely affected by a deterioration in the housing sector or a policy change from the Federal Reserve.

Many mREITs have already seen their quarterly payouts dip moderately from their peak in 2009 or 2010. American Capital's payout is down 17% from its high, Capstead Mortgage (NYSE: CMO  ) , which also invests in MBS, and adjustable-rate MBS backed by U.S. government agencies, has seen its payout dip 27%, and Chimera Investment shareholders have watched their payout get halved. This isn't to say that these mREITs won't continue to pay out high yields, but it does supply evidence that yield in this sector isn't everything and investors need to be careful to avoid chasing yield alone.

Foolish roundup
Now that you know what to watch for, it should be easier to analyze American Capital Agency's successes and pitfalls in the future, and hopefully you'll gain a competitive investing edge.

If you're still craving even more info on American Capital Agency, I would recommend adding the stock to your free and personalized watchlist so you can keep up on all of the latest news with the company.

High-yielding REITs aren't the only path to success in the financial sector. After scouring the markets and looking to the market's smartest investors, like Warren Buffett, for clues, our team of analysts at Motley Fool Stock Advisor has uncovered what stocks these smart investors are buying. Find out what's on their buy list for free by clicking here to get your copy of this latest special report.

Fool contributor Sean Williams has no material interest in any of the companies mentioned in this article. You can follow him on Motley Fool CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of Annaly Capital Management. Motley Fool newsletter services have recommended buying shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that's always of interest, without charging interest.


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  • Report this Comment On July 30, 2012, at 1:57 AM, chris293 wrote:

    These reits seem to have high debt, I wonder if this at adjustable rates for something that seems to have a lot of strings intwined with the government especially the people with inside information?

    This is another reason the government and business should be kept 'at arms lenght'. Has anyone figured out what happens the millions of dollars that disappeared other than used to re-elect some people who gave it to those businesses that went bankrupt. Businesses that are on the road to succeed rarely if ever need government help in a free non-socialism system.

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