Mortgage REITs are popular with many investors right now for the high dividend yields they currently provide. Sporting a dividend yield of nearly 19%, American Capital Agency
Mortgage REITs issue shares to investors to raise capital, which they use to buy mortgage-backed securities. They also use short-term financing to boost their returns. They repay lenders out of the mortgage payments they collect, and most of the rest is returned to shareholders in dividends.
Here's a simple visualization:
Let's take a quick look at four things investors in American Capital-managed American Capital Agency need to know. After that, we'll find out how American Capital Agency stacks up next to its competitors.
1. Interest rate spread
A REIT's interest rate spread is the difference between its financing costs and its interest income. This provides a decent measure of investing profitability -- and portfolio risk.
2. Debt-to-equity ratio
Since interest rate spreads tend to be pretty narrow, REITs like to leverage those returns to generate bigger returns. Companies with safer portfolios can afford to take on more leverage risk than those with riskier investments.
3. Share growth
Since REITs have to pay out the vast majority of their earnings in dividends, the only way to grow their business is to take on more leverage or issue new shares. If a company issues a lot of shares, we want to make sure it does so at attractive prices so investors aren't diluted.
4. Dividend yield
The main reason to buy mortgage REITs is for their dividend. The forward yield tells us what dividends we'll get paid over the next year if earnings hold constant.
Let's see how American Capital Agency stacks up next to its peers in these four crucial areas:
Interest Rate Spread (Q2 2011)
2-Year Annual Share Count Growth
|American Capital Agency||2.46%||739%||245%||18.7%|
Source: Capital IQ, a division of Standard & Poor's.
Founded in 2008, American Capital Agency grew its share count considerably over the past couple of years in an effort to scale up. The bulk of those shares were issued over the past year, when its stock traded between one and 1.2 times book value, suggesting that the company was able to get decent but not amazing prices for its shares.
Like Annaly and Hatteras, American Capital Agency carries a high debt-to-equity ratio. That's because the three tend to invest in ultra-safe "agency securities" -- mortgages whose interest payments are guaranteed by Fannie Mae and Freddie Mac. Because this is the safest type of mortgage to own (from the perspective of possible default), it produces an interest rate spread that's lower than riskier buyers, like Chimera. Though it means taking on greater leverage, and all the potential interest rate risk that may or may not entail, American Capital Agency's high debt-to-equity ratio and moderate interest rate spread allows the company to carry a lower default risk on its investments, while still paying out a juicy 18%-plus dividend yield.
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Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool owns shares of Annaly Capital Management and Chimera Investment. 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.