Several mortgage REITs reported first-quarter results last week, among them Annaly Capital (NYSE:NLY), American Capital Agency (NASDAQ:AGNC), and American Capital Mortgage (NASDAQ: MTGE), the hybrid cousin of AGNC. Annaly's report wasn't full of surprises and presented ho-hum earnings in addition to its continually contracting net interest spread.
What no doubt did surprise everyone who keeps an eye on the mREIT sector were the subsequent earnings announcements of the other two companies, both of which lost money -- and share a CIO in the well-respected Gary Kain.
What the heck happened?
Both of Kain's trusts are heavy hitters in the sector, with yields of 16.30% for American Capital Agency and 14.29% for its hybrid sidekick, compared to Annaly's not-too-shabby 11.90%. Dividends have been robust, too. The agency-only American Capital Agency has been paying a hefty $1.25 per share for quite a while now, and American Capital Mortgage has been paying $0.90. Compared with Annaly's dwindling payout, these trusts seemed to be a gold mine.
Then, came the first quarter of 2013. American Capital Agency lost $1.57 per share, and the smaller hybrid mREIT lost $0.56 per share. Why did the agency paper perform so poorly?
According to Kain, the main culprits in the first-quarter earnings/book value massacre were: 1) the drop in values of mortgage-backed securities, with a commensurate uptick in interest rates, due to rumors that QE3 might end early on signs of economic strength; and 2) the secondary offering, which did not foresee the aforementioned changes during the first quarter of the year.
Things are looking better this quarter
American Capital Mortgage also took a hit, but its non-agency portfolio made up for some of the losses suffered by the agency paper. Both REITs experienced a decrease in book value, and the spread dropped from last quarter's 2.07% to 2.01% for the hybrid trust, while its agency-only cousin lost 11 basis points, down to 1.52% from the fourth quarter's 1.63%.
Kain has said that the bullishness around the economy has abated somewhat this quarter, and that American Capital Agency is seeing its book value begin to rise again as chatter regarding an early exit from QE3 calms. Additionally, specified mortgages performed particularly poorly in the first quarter as higher interest rates took their toll. Kain notes that the company likes these particular pools as a way of controlling prepayment risk, which has been a key part of American Capital Agency's approach. On the positive side, however, these products have also been gaining strength.
Will the two mREITs under Gary Kain's care bounce back by next quarter? Time will tell, as usual -- especially for American Capital Agency. I'm betting, however, that investors have seen the last secondary offering from Gary Kain's neck of the woods -- for a while, at least.