American Capital Agency Corp. Earnings: What's Next for Mortgage REITs?

The mortgage REIT's earnings and revenue are expected to decline, but have shareholders already built that into the share price?

Jan 30, 2014 at 11:05PM

American Capital Agency (NASDAQ:AGNC) will release its quarterly report on Monday, and investors have already sent shares of the mortgage REIT tumbling during the past several months, as fears about the Federal Reserve's tapering of its quantitative easing program have spread across the mortgage-backed securities market. Yet, even as it and peers Annaly Capital (NYSE:NLY) and Two Harbors (NYSE:TWO) have cut their dividends in recent quarters, American Capital Agency earnings could eventually stabilize, and even grow again if short-term rates stay flat, or rise less rapidly than long-term rates during the next couple of years.

American Capital Agency has been one of the favorite investments for dividend lovers in recent years, with its double-digit dividend payouts enticing income-hungry investors to seek to profit from the highly leveraged play on mortgage-backed securities. Yet, American Capital Agency has seen its share price suffer from losses in its securities portfolio, with falling prices for bonds having a definite impact on American Capital Agency's book value. Let's take an early look at what's been happening with American Capital Agency during the past quarter, and what we're likely to see in its report.

Agnc Fed
Will the Federal Reserve hurt American Capital Agency's earnings in 2014? Image source: Motley Fool.

Stats on American Capital Agency

Analyst EPS Estimate

$0.66

Change From Year-Ago EPS

(38%)

Revenue Estimate

$369.02 million

Change From Year-Ago Revenue

(12.8%)

Earnings Beats in Past 4 Quarters

2

Source: S&P Capital IQ.

How much will American Capital Agency earnings fall this quarter?
In recent months, analysts have gotten a lot less enthusiastic about American Capital Agency earnings, cutting their fourth-quarter estimates by about a third. The stock has also delivered poor performance, falling 14% since late October.

The vast bulk of American Capital Agency's share-price decline came after its third-quarter report, in which the mortgage REIT reported several troubling results. Net interest spreads dropped from 1.49 percentage points to 1.20 percentage points, and returns on equity from interest income fell again to just 10.31%.

In order to try to protect itself from rising rates, American Capital Agency moved aggressively from 30-year fixed mortgages to 15-year fixed mortgages in the third quarter. Yet, given that 15-year mortgages earn almost a full percentage point less than 30-year mortgages, the move could further pressure American Capital Agency's interest income if the mortgage REIT didn't reverse course in the fourth quarter. That's what's largely responsible for the company choosing to cut its dividend again last month, making its quarterly payout $0.65 per share.

Yet a big question mark for American Capital Agency is what the Fed decides to do in 2014. So far, tapering has taken away $20 billion in monthly bond purchases, including $10 billion in mortgage-backed securities. Since the taper began, however, interest rates haven't risen. That has taken away much of the pressure that sank book values at American Capital Agency, Annaly, and ARMOUR Residential (NYSE:ARR) by double-digit percentages during the second quarter of 2013, when tapering first made it onto the table.

Still, many argue that American Capital Agency's share-price declines already reflect the impact of the taper. Indeed, the mortgage REIT itself has said that it has bought back about 7% of its outstanding shares in the past quarter, spending $586 million during the fourth quarter, and paying an average share price of $20.82 -- just a bit higher than its closing price on Thursday.

In the American Capital Agency earnings report, watch for a couple of key figures: what the mortgage REIT has done to the alignment of its portfolio, and how it has changed its leverage ratio. With potential opportunities to pick up cheaper mortgage-backed securities as the Fed tapers, while perhaps being able to maintain low borrowing costs if short-term rates stay low, American Capital Agency could be setting itself up for a big rebound later in 2014.

Why people love mortgage REITs so much
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Click here to add American Capital Agency to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Dan Caplinger owns shares of Two Harbors Investment. You can follow him on Twitter @DanCaplinger. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

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