How are competitors faring?
American Capital Agency’s competitors that have invested heavily in fixed-rate 30-year MBS are suffering as well.
In its first-quarter earnings results, ARMOUR Residential REIT, Inc. (NYSE:ARR) reported that its book value per share dropped 8% for the quarter. The first-quarter results showed that ARMOUR Residential REIT, Inc. (NYSE:ARR) was heavily invested in 30-year fixed rate MBS with smaller investments in 20-year, 15-year, and hybrid ARM securities. Despite having a more diversified portfolio than American Capital Agency, I expect ARMOUR Residential REIT, Inc. (NYSE:ARR) to perform worse because its leverage of 9.17 times at the end of the first-quarter was much higher than American Capital Agency’s leverage of 5.7 times.
Similarly, Annaly Capital Management, Inc. (NYSE:NLY)’s book value per share dropped 4.2% during the first-quarter. Annaly Capital Management, Inc. (NYSE:NLY) is similar to American Capital Agency in that it invests a large proportion of its capital in fixed-rate 30-year MBS. However, one important difference between Annaly Capital Management and American Capital agency is that American Capital Agency is far more exposed to securities with low prepayment risk that are highly sensitive to rising interest rates.
Moreover, Annaly Capital’s recent acquisition of CreXus Investment Corp (NYSE:CXS) will help it diversify into commercial real estate which may perform better as the economy improves. That is why I expect Annaly Capital Management to do better than American Capital Agency in a rising interest rate environment.
Foolish bottom line
The mREIT sector in general, and American Capital Agency in particular, have been a darling of yield starved income investors as the Fed’s actions created a low and stable interest rate environment. However, the recent rise in interest rates has sent American Capital Agency tumbling since its portfolio is currently designed for a low interest rate environment. I would advise investors to stay away from American Capital Agency for now because a further rise in interest rates would have an adverse impact on its book value, and thereby its stock price.
The article What’s Wrong With This mREIT? originally appeared on Fool.com.
Zain Zafar has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
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