American Capital Agency Corporation: Is This The Turnaround?

Return to book value growth and clarity about monetary policy should provide tailwinds for American Capital Agency.

Jun 27, 2014 at 6:00AM

Source: Company

American Capital Agency Corporation's (NASDAQ:AGNC) net book value per common share has grown for the first time in a year. With a challenging interest rate environment and pressure on mortgage portfolio values throughout much of 2013, American Capital Agency's turnaround in book value growth is an encouraging sign that the worst is over for the company and the mortgage REIT sector in general.

After mortgage REITs fell off a cliff in 2013 thanks to higher interest rate volatility, American Capital Agency's stock price has rebounded strongly in 2014 with a year-to-date total return of more than 27%.


Mortgage REITs benefited from loose monetary policy
The Federal Reserves' monetary policy has had a huge influence on the popularity of mortgage REITs and the valuation of their securities over the last five years.

Mortgage REITs including American Capital Agency were sold off sharply by investors in 2012 and 2013 as investors feared the end of loose monetary policy and ultra-low interest rates, which hugely benefited the capital-intensive business models of mortgage REITs. At the end of the 2013, the Federal Reserve finally announced that it will indeed scale back its mortgage bond buying program.

Now that the Federal Reserve provided investors with more clarity about its future monetary policy, mortgage REITs could have further room to run, especially when mortgage REITs no longer report falling book values.

A return to book value growth
American Capital Agency has been bleeding book value throughout the entire 2013 fiscal year. Its net book value per share has declined more than 15% from $28.93 in the first quarter of 2013 to $24.49 in the first quarter of 2014.

However, American Capital Agency's net book value has slightly rebounded from a fourth quarter 2013 low of $23.93. While the sequential increase in book was only a marginal 2.3%, a return to growth certainly alleviated investors' fears about ongoing book value erosion.


Source: American Capital Agency Corporation, Barclays Americas Select Franchise Conference Presentation, May 14, 2014

Investor sentiment toward mortgage REITs has been improving lately as other companies in the sector also posted a return to positive book value growth in the first quarter of 2014.

Most notably, Annaly Capital Management Inc. (NYSE:NLY), an industry leader with a market capitalization of $11 billion, also posted a slight sequential increase of 1.4% in its book value in the first quarter of this year.

With two of the largest mortgage REITs in the sector reversing their book value growth trends, it increasingly looks as if select mortgage investment companies could be interesting income plays in the years ahead.

American Capital Agency has a solid track record
The last six years have been extraordinary for mortgage REITs. However, the ultra-low interest rate environment benefiting mortgage REITs is not going to persist and a return to normalcy is just around the corner.

While the current market conditions still distort the true earnings potential of American Capital Agency, a look at its past performance record certainly helps to put things into better perspective.

Over a variety of different performance evaluation periods, American Capital Agency has regularly outperformed its mortgage REIT peers. The company has a solid performance track record and benefits from an experienced management team.

As can be seen below, American Capital Agency has handsomely outperformed its rivals before and after the most recent quantitative easing initiative of the Federal Reserve.


Source: American Capital Agency Corporation, Barclays Americas Select Franchise Conference Presentation, May 14, 2014

The Foolish Bottom Line
One of the most encouraging signs, that the worst is over for mortgage REITs and American Capital Agency in particular, is a return to positive book value growth. Investors who desire exposure to a leading mortgage REIT with an 11% dividend yield should consider a company with a convincing track record in growing shareholder value and outperforming its peers.

After devastating losses in 2013, investor sentiment has been returning to the mortgage REIT sector which is another positive sign. American Capital Agency is one of the companies that should continue to see rising share prices in 2014 if it can sustain book value growth.

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