More Good News for the Market's Hottest Dividend Sector?

There's been a lot of concern recently regarding the yields of mortgage real estate investment trusts, but the recent results at American Capital Agency (NAS: AGNC) might help ease some of those anxieties.

The company reported earnings of $250.4 million, up from $60 million in the year-ago quarter. The company also plumped up book value by $0.14 sequentially, to $26.90 per share.

But perhaps more importantly, the company's interest rate spread was down only slightly year over year, falling to 2.14% from 2.21% in the year-ago quarter. However, the spread at quarter end has narrowed still more, down to 1.94%.

That narrowing could be a concern. American Capital's spread has declined from 2.58% in the first quarter to 2.46% in the second, ending up at 2.14% in this most recently reported quarter.

Fading rate spreads have been an area of anxiety for mortgage REITs, since the companies make money by borrowing at low short-term rates and then buying higher-yielding long-term mortgage securities. While Federal Reserve rates are still anchored at near-zero levels, investors have been concerned that precipitously declining mortgage rates will cut into profitability.

Those worries have pummeled shares of American Capital and peers such as Annaly Capital (NYS: NLY) and Chimera (NYS: CIM) in the last month or so. Fellow mortgage REIT Armour Residential (NYS: ARR) has also been hurt. The latter three businesses report earnings in the next few days. Last week CYS Investments (NYS: CYS) reported declining earnings but saw its rate spread expand year over year. However, its spread declined sequentially, as did American Capital's.

American Capital has taken steps to limit some of the volatility caused by recent market dislocations. It is using longer-term repurchase agreements in order to provide more stable funding for its portfolio and is taking a closer look at its counterparty exposure. The company also estimates that it has low exposure to the recently announced changes to the Home Affordable Refinance Program, with less than 5% of its portfolio eligible for the revised program.

It will be interesting to see how other mortgage REITs respond to the quarter's volatility and whether they have taken similar steps to secure their positions.

Of most interest to investors in this space is the dividend. American Capital declared a dividend of $1.40 per share, as it has since the third quarter of 2009. And the company's yield sits near those of peers, as you can see in the table below.









American Capital Agency


Hatteras Financial (NYS: HTS)


Armour Residential


Invesco Mortgage (NYS: IVR)


Source: S&P Capital IQ.

While volatility has been the name of the game in the latest quarter, there still looks to be plenty of strong tailwinds for the sector, including near-zero interest rates till mid-2013 and a lackluster economy. The results at American Capital help bear that out.

Stay tuned as we hear shortly from one of the best players in the space, Annaly.

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At the time thisarticle was published Jim Royal, Ph.D., owns shares of Annaly. The Motley Fool owns shares of Annaly and Chimera. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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