American Capital Agency Corp.'s Crazy Idea Really Paid Off

This past February, the CIO of American Capital Agency Corp. , Gary Kain, dropped a bombshell on the company's earnings call. For the first time, a mortgage REIT invested money in the stock of its rivals, rather than adding to its stable of mortgage-backed securities.

Analysts were surprised, to say the least. On the conference call, Kain wouldn't reveal which agency trusts were on his buying list, although a regulatory filing with the SEC a few days later showed that Hatteras Financial was one of the mystery companies. Kain noted at the 2014 Credit Suisse Financial Services Forum within the same week that, since the other companies involved in the stock purchases were not publicly held, he would not divulge their identities.

A big win
The move was a bold one, but it paid off handsomely. Kain remarked that the $400 million invested into other mREIT stocks has produced $50 million in both realized and unrealized gains during the first quarter. By any measure, that is a sweet return. Kain noted that $10 million was dividend income, and the remaining $40 million constituted 20% of American Capital Agency's book value for the first quarter.

Hatteras had a good first quarter, too, noting a jump in book value from the linked quarter despite a $0.50 dividend. Core earnings were up nicely, with Hatteras management reporting earnings per share of $0.64 per share compared to $0.51 for the previous quarter.

Investments in mREITs won't interfere with stock buybacks
Analysts seemed concerned with Kain's investment strategy, fearing that purchasing the stock of other mREITs will reduce American Capital Agency's own stock buyback program. On the conference call, Kain put those fears to rest. He noted that the two are not mutually exclusive and that the company is committed to its share repurchase program. He had also addressed this issue at the CS Financial Services Forum in February, noting that, essentially, the mREIT stock purchases were a "surrogate for mortgages", rather than repurchases of its own stock.

Kain has spent some time explaining and defending this move into buying competitors' stock, and the positive results should certainly help allay any concerns on the part of analysts and investors.

As Kain notes, faith in the management team  is a huge factor in this industry, and he has shown confidence in Hatteras' management ability by buying its stock. By the same token, management should be confident enough of its own ability to undertake such a novel approach in order to deliver value to its investors. And that, it would appear, is exactly what Kain and his team have done.

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Amanda Alix has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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