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American Capital: A Capital Opportunity?

By Rich Duprey – Updated Apr 7, 2017 at 12:45PM

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Does Federal Reserve monetary policy benefit or hurt this mortgage REIT?

The real winners of Ben Bernanke's latest iteration of quantitative easing will be the banks -- of course. His policies have been bailing them out ever since the financial crisis arose, but by ensuring that short-term borrowing costs perpetually stay near 0%, banks are able to profit from the spread -- they lend the money back to the government by buying Treasuries.

Earlier this year some of the countries biggest banks -- JPMorgan Chase, Bank of America, Citigroup, and Goldman Sachs -- all made money every single day over the first quarter through proprietary trading models, which one analytical wit said was "just another way of measuring the subsidy the Fed is giving to the banks."

But Bernanke bails out the banks at the peril of other industries. Mortgage REITs, for example, have been left twisting in the wind by the Fed's Operation Twist policy that encouraged homeowners to swap out of higher-rate mortgages and into lower-rate ones. With the mREIT model counting on the spread between the rates paid for mortgages and the yields returned on investments, CYS Investments (NYSE: CYS) and Annaly Capital Management (NYSE: NLY) have incurred heavy prepayments that narrowed their returns.

American Capital Agency (Nasdaq: AGNC), on the other hand, was one mREIT that hasn't faced the same influx of prepayments because it focused instead on those mortgages that had a lower risk of prepayment than others. The question for investors is, however, will it continue winning in the new low-interest rates-forever environment?

American Capital Agency snapshot

Market Cap $11.8 billion
Revenues, TTM $1.7 billion
1-Yr. Stock Return 47.9%
Return on Investment 10.1%
Est. 5-Yr. EPS Growth 2%
Dividend / Yield $5.00 / 14.4%
Recent Price $34.64
CAPS Rating ****


Setting the table
The Fed said it will be buying up mortgage-backed securities at a rate of $40 billion a month for as long as necessary, with the likelihood it will keep rates low and give the housing market a chance to jump-start itself. Of course, the previous episodes of quantitative easing did nothing of the sort, and one Philadelphia Fed president Charles Prosser had the temerity to suggest yesterday that this round won't either, that there will be negligible impact on rates, the economy, or employment. The markets subsequently quailed at the thought and tumbled more than 100 points.

While that's going to keep pressure on the ability of mREITs to profit from yields, the values of the securities already in their portfolios is likely going to rise.

It's a big tent
American Capital has proven itself to be a premier investment with its shares rising well ahead of most of its peers over the past year. The stock is up 47% compared to 15% at Annaly, 26% at Hatteras Financial (NYSE: HTS), or the 33% gain at ARMOUR Residential REIT (NYSE: ARR). But its stock has performed well because its business has grown.

Funds from operations are up an average of 1,100% over the past five years, having enjoyed exponential growth from 2010 until now. Analysts have pegged Hatteras's FFO growth at a comparatively measly 64% while Capstead Mortgage seems niggardly at less than 9% growth. Despite Annaly being presented as the epitome of mREIT investing, American Capital presents the better price and risk profile these days.

I made a CAPScall on the REIT back in March, believing housing's malaise coupled with Fed monetary policy would doom it to underperformance. While acknowledging its better prepayment situation, I said, "Despite all the jawboning about an improving situation and massive intervention in the market by the Fed, housing (is) not recovering at all and is getting worse. That signals a top for residential REITs like AGNC."

Although I think the Fed is building a house of cards that will come crashing down around us, it's tough fighting the trend, so I've closed out my underperform rating on Motley Fool CAPS, even as I'm not yet tempted to reverse it with an outperform. Tell me in the comments section below though whether you agree American Capital Agency will continue riding higher, at least until the Fed completely wrecks the economy.

A sky-high opportunity
While I think American Capital offers a better bet for investors at the moment, Annaly has been a star performer in the mREIT sector, producing stellar returns for 30 years. To find out more about this tested-by-fire income producer, access the Motley Fool's premium report that gives you the rundown on this impressive company, complete with the risks and opportunities it faces down the road. Click here to get the full story.

Fool contributor Rich Duprey holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Bank of America, JPMorgan Chase, Annaly Capital Management, and Citigroup. Motley Fool newsletter services have recommended buying shares of Annaly Capital Management and Goldman Sachs Group. The Motley Fool has a disclosure policy.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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Stocks Mentioned

AGNC Investment Corp. Stock Quote
AGNC Investment Corp.
$8.42 (-3.00%) $0.26
Annaly Capital Management, Inc. Stock Quote
Annaly Capital Management, Inc.
$17.16 (-2.00%) $0.35
ARMOUR Residential REIT, Inc. Stock Quote
ARMOUR Residential REIT, Inc.
$4.87 (1.25%) $0.06

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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