With the continued Fed’s quantitative easing, many expect American Capital Agency Corp. (NASDAQ:AGNC) and other mortgage REITs to report net interest rate compressions and dividends cuts at the end of the first quarter. However, evidence indicates otherwise for American Capital Agency. I believe the following three reasons will lead the company to post an expansion in its net interest rate spread during the first quarter of the current year. Also, I believe the company’s dividends are well intact and might improve.
American Capital Agency Corp. (NASDAQ:AGNC) is one of the largest mortgage REIT in the United States that seeks to invest in mortgage backed securities for which any of the government sponsored Agencies guarantee the principal and interest payments. The following chart provided in its fourth quarter Investor Fact Sheet shows the proportion of each type of security within the company’s asset portfolio.
It is evident from the chart above that the 30-year fixed rate mortgage backed securities have the largest proportion (61%) in American Capital Agency Corp. (NASDAQ:AGNC)’s fourth quarter end asset portfolio. This is followed by 15-year mortgage backed securities, which are 35%. The 20-year fixed rate securities are a negligible 2%, while the company also has other investments. At the end of the fourth quarter of 2012, around 77% of the company’s fixed rate securities were composed of securities backed by lower loan balance mortgages and loans originated under Home Affordable Refinance Program (HARP). These securities are considered to have favorable prepayment attributes, resulting in low risk of prepayments. Prepayments, measure by CPR (conditional prepayment rates) are one of the hindrances in figuring the net interest rate spread. The composition of the company’s asset portfolio has led to stable CPRs. American Capital reported a CPR of 10% for the fourth quarter, compared to 9% for the third quarter. These are one of the lowest CPRs in the industry, and I believe the company will continue to decrease it prepayment risk going forward.
In comparison, Annaly Capital Management, Inc. (NYSE:NLY) , the largest Agency mortgage REIT invests in high coupon mortgage backed securities which have high loan balances and which are more prone to prepayments. Therefore, the company reported a CPR of 19%. Amour Residential is another pure play mortgage REIT. Its reported CPR stood at 14.1%. In contrast, Two Harbors Investment Corp (NYSE:TWO) is a hybrid mortgage REIT. Two Harbors reported a CPR of 6.6% for its Agency holdings, while the prepayments for its non-Agency securities stood at 3.2% at the end of the fourth quarter.