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American Capital Agency Corp. (AGNC), Annaly Capital Management, Inc. (NLY): A Few Reasons to Buy This High Yielding Stock

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American Capital Agency Corp. (NASDAQ:AGNC)’s first-quarter results caused a lot of concern among investors. The market began to price in a premature easing halt by the Fed. As a result, mortgage rates started climbing up. This took a large chunk out of the book value of American Capital Agency Corp. (NASDAQ:AGNC), causing investors to flee. However, investors don’t need to be worried anymore, as American Capital Agency Corp. (NASDAQ:AGNC) has re-positioned its investment portfolio. Now, it is better positioned than it was back in the first quarter to sustain variations in the mortgage rates.

Worst performance for everyone?

Annaly Capital Management, Inc.American Capital Agency Corp. (NASDAQ:AGNC) happens to be the fastest growing real estate investment trust. Its stock price has depreciated more than 10% this month, after it reported one of its worst performances. At the end of the first quarter, American Capital Agency reported a significant drop of 8.6% in its book value, while Annaly Capital Management, Inc. (NYSE:NLY) reported a 4% drop.

Annaly Capital Management, Inc. (NYSE:NLY) happens to be the only mortgage REIT that is larger than American Capital Agency Corp. (NASDAQ:AGNC). ARMOUR Residential REIT, Inc. (NYSE:ARR) is another pure-play mortgage REIT. It reported a sequential decline of over 8% in its book value at the end of the first quarter of the current year.

Losers or gainers?

Companies that buy residential mortgage-backed securities issued and guaranteed by any of the U.S. Agencies are under continuous pressure, as investors keep speculating about the Fed’s exit date each month as the U.S. economy picks up. American Capital Agency’s founder says the Fed’s exit is not the issue. It obviously has to exit. The question is whether the exit will be premature or not.

While the government-backed quantitative easing has made it cheaper for mREITs to borrow funds to invest in RMBS, I believe they are one of the biggest losers from the government’s policy to stimulate the U.S. economy in general, and the housing markets in particular. My opinions are contrary to the ones being published on Bloomberg, where Heather Perlberg thinks they are the biggest winners from this stimulus. While the low borrowing rates have benefited the mREITs, I believe at the same time, the low long-term rates have caused these mREITs to earn less, resulting in dividend cuts and book value depreciation.

The re-positioning

Despite this continues pressure, American Capital Agency has been able to increase its assets many times over the past few years. At the end of the fourth quarter of the last year, it reported $100.5 billion worth of assets that were under its management. Now that the U.S. labor market has stabilized and the housing market is rebounding, speculation about the Fed’s exit is growing.

Looking at the situation, American Capital Agency has re-positioned the exposures of its investment portfolio to better suit a potential premature exit. The company is not investing keeping in mind that the Fed might disturb the markets. The company’s president thinks that the Fed will be reducing its stimulus over the next few months and finally exit by the end of the year. Therefore, the mortgages in which American Capital Agency is now investing should perform reasonably under the aforementioned scenario.

While American Capital Agency is preparing itself for the upcoming events, I don’t see any similar activity among the other two pure-play mREITs (Annaly Capital Management, Inc. (NYSE:NLY) and ARMOUR Residential REIT, Inc. (NYSE:ARR)). Therefore, investors looking to invest in Annaly and ARMOUR must be cautious.

Dividend Sustainability

Using the most recent quarterly operating cash flow and dividends, I arrive at a cash dividend coverage ratio of 1.2 times. The same ratios for Annaly Capital Management, Inc. (NYSE:NLY) and ARMOUR Residential are 1 and 1.15 times, respectively.

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