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More Good News for the Market's Hottest Dividend Sector?

Jim Royal
October 26, 2011

There's been a lot of concern recently regarding the yields of mortgage real estate investment trusts, but the recent results at American Capital Agency (Nasdaq: AGNC  ) might help ease some of those anxieties.

The company reported earnings of $250.4 million, up from $60 million in the year-ago quarter. The company also plumped up book value by $0.14 sequentially, to $26.90 per share.

But perhaps more importantly, the company's interest rate spread was down only slightly year over year, falling to 2.14% from 2.21% in the year-ago quarter. However, the spread at quarter end has narrowed still more, down to 1.94%.

That narrowing could be a concern. American Capital's spread has declined from 2.58% in the first quarter to 2.46% in the second, ending up at 2.14% in this most recently reported quarter.

Fading rate spreads have been an area of anxiety for mortgage REITs, since the companies make money by borrowing at low short-term rates and then buying higher-yielding long-term mortgage securities. While Federal Reserve rates are still anchored at near-zero levels, investors have been concerned that precipitously declining mortgage rates will cut into profitability.

Those worries have pummeled shares of American Capital and peers such as Annaly Capital (NYSE: NLY  ) and Chimera (NYSE: CIM  ) in the last month or so. Fellow mortgage REIT Armour Residential (NYSE: ARR  ) has also been hurt. The latter three businesses report earnings in the next few days. Last week CYS Investments (NYSE: CYS  ) reported declining earnings but saw its rate spread expand year over year. However, its spread declined sequentially, as did American Capital's.

American Capital has taken steps to limit some of the volatility caused by recent market dislocations. It is using longer-term repurchase agreements in order to provide more stable funding for its portfolio and is taking a closer look at its counterparty exposure. The company also estimates that it has low exposure to the recently annou