Can American Capital Keep Making Money from Mortgage REITs?

American Capital will release its quarterly report on Tuesday, and investors have had to endure some big ups and downs over the past six months. Yet while most investors know the business-development company best for its role as manager for the mortgage REITs American Capital Agency and American Capital Mortgage , American Capital also has equity investments in many small private companies that can also contribute substantially to its long-term success.

Even within the business-development company universe, American Capital is an outlier. Unlike most BDCs, American Capital hasn't paid a dividend in years, instead preferring to buy back shares at regular intervals. Shareholders aren't complaining about the lack of income, as the stock has climbed steadily since the financial crisis. Recently, though, interest rate concerns have hit American Capital Agency and American Capital Mortgage hard, and that could eventually hurt the management fees that American Capital reaps from the mortgage REITs. Let's take an early look at what's been happening with American Capital over the past quarter and what we're likely to see in its report.

Stats on American Capital

Source: Yahoo! Finance.

How will American Capital earnings fare this quarter?
In recent months, analysts have marked down their views on American Capital earnings, reducing their third-quarter estimates by a penny per share and their full-year 2014 projections by 6%. The stock has rebounded somewhat, though, climbing 4% since early August.

American Capital warned investors in its second-quarter earnings release just how dependent the BDC is on American Capital Agency and American Capital Mortgage. In his statement about earnings, CEO Malon Wilkus noted that "a reduction in projected management fees from the two mortgage REITs that it manages" would hurt results at its American Capital Asset Management subsidiary. The company projected a $75 million drop in portfolio value due to the subsidiary, although it was able to offset that with other investments to eke out a small gain in net unrealized appreciation during the quarter.

At the same time, though, American Capital Asset Management only makes up about a fifth of American Capital's overall asset value. For the most part, the rest of the BDC's portfolio generates relatively little income, especially in comparison to some of American Capital's rivals. One reason is that the companies in which American Capital invests tend to have a lot of debt on their balance sheets, with substantial interest expense weighing on their cash flow. Concerns about transparency of those portfolio-companies' financials and a failure to cash in with successful exits has caused American Capital to trade at a substantial discount to the BDC's stated net asset value for years.

Given American Capital Agency's poor earnings report last week, American Capital might face more headwinds this quarter. Falling book value at mortgage REITs means that American Capital's management arm could get still less in fees than it did in the second quarter, prompting another valuation reduction.

In the American Capital earnings report, watch to see whether the company makes any moves with the rest of its investment portfolio. In addition, if the company makes any changes to its share repurchase plan, it could have a big impact on investors' sentiment about the BDC.

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The article Can American Capital Keep Making Money from Mortgage REITs? originally appeared on Fool.com.

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