American Capital Agency Corp [AGNC]

[phandal]

Hi fellow VBs... So I was running my stock screener and I found this interesting and very low profile counter. They are a mortgage REIT which

" invests in agency securities for which the principal and interest payments are guaranteed by

a U.S. Government agency (such as the Government National Mortgage Association, or GNMA), or
a U.S. Government-sponsored entity (such as the Federal National Mortgage Association, or FNMA, and the Federal Home Loan Mortgage Corporation, or FHLMC)."

Any of you familiar with this space or the associated risks care to enlighten me? I'm attracted to this counter mainly because of the P/B of 0.9 and a Div yield of close to 12%.

[d.o.g.]

There are some important points to note about AGNC:

1. The distributions from AGNC would be considered US-sourced income, meaning that non-US citizens face an automatic 30% tax unless their country has a tax treaty with the US. Singapore does not have such a treaty so Singapore-based investors will get a yield 30% below the gross figure. Last dividend was $0.22 on a monthly basis, or $2.64 annualized, making the yield 12.06% gross, or 8.4% net to Singapore-based investors.

2. The underlying yield from its investments is only 2.71%. The high dividend is achieved by leverage, currently this stands at 5x. Its cost of funds is 1.44%, so there is a positive carry. This positive carry is achieved through maturity mismatch - the average tenure of its debt is 152 days, while its assets are mostly 30-year fixed debt (65%) and less-than-15-year fixed debt (20%).

So, for a Singapore-based investor the risk-adjusted return does not seem attractive.

Sure, the underlying assets are guaranteed by US Government entities, but this was no protection during the 2008 GFC when every bank cut back on lending.

And if interest rates rise, the long-tenure debt will depreciate considerably in capital value, meaning the REIT could face a margin call and be forced to delever by selling its assets at the worst possible time, thus crystallizing a massive decline in NAV.

Taking the 30-year Treasuries as an example, the duration is about 20, meaning a 1% change in interest rates would move the capital value by 20%. So a 1% rise in interest rates could chop 20% off the value of the 30-year debt that AGNC holds, causing a 13% decline in NAV. The 10-year Treasuries have a duration of about 9, so the same 1% rise in rates could chop 9% from the value of the less-than-15 year debt, causing a further 1.8% decline in NAV. This would total a 14.8% decline in NAV.

The current factsheet shows leverage at 5x, it is almost certain that with only a 20% equity position the lenders would force a margin call once the decline in NAV exceeds 10%, maybe even at 5%. A 0.5% interest rate hike would already cause an 8% drop in NAV, risking or triggering a margin call.

So, to quote the movie Dirty Harry, ask yourself, "Do I feel lucky?"

In short, if you fully understand and accept the risks outlined above, caveat emptor. If none of the above makes any sense, it would probably be wise not to get involved.

As usual, YMMV.

[brattzz]

waos! soo detail and yes, dun understand at all!

STAY AWAY!!

[tanjm]

Mortgage REITs or (mREITs) should not be confused with regular REITs. They do not have remotely the same risk profile.

I tend to regard mREITs as a class of equity which hold a portfolio of fixed income derivatives. It isn't necessarily a class of investments to stay away from, but you **MUST** understand the underlying assets. For this class of assets, you would be betting on both income and price returns (the price return depending on short/long rate interest rate levels and the mortgage market characteristics, such as prepayments).

If you are still interested in mREITs as a class, instead of buying into something like AGNC, there are ETFs available, including REM, MORT and MORL (the last one is a 2x leveraged ETF with a 23% yield). This will insulate you from non-systematic risk.

As for the 30% withholding tax, you might be surprised. I am holding one of the ETFs above and D.O.G.'s statement is wrong about one of them empirically. It is possible that the US IRS will get around to it eventually however so caveat emptor.

What D.O.G. said about the interest rate risk is generally correct. But I generally think that over the last 2-3 years, the market has adjusted to this risk. Also, the mREIT companies themselves been anticipating and adjusting. What is critical over the long run is not book value (determined by 10/20/30 T bill yields) but spread risk (long term rates minus short rates). As long as these companies continue to have a significant positive spread, they will continue to distribute cash. There could be some bankruptcy risk - but that's what ETFs are for - to spread your bets.

In my opinion, the market has already adjusted to account for smallish short rate increases by the FED. As for mortgage rates, I believe there are politics involved that will moderate the rates involved for at least a few years. i.e. as long as any rate changes are gradual, this will be positive for mREIT holders.

[phandal]

Thanks d.o.g. for the very detailed analysis. I'll make sure that I'll stay away from mREITS.

[phandal]

Thanks d.o.g. for the very detailed analysis, and tanjm for the balancing opinion. To be honest I'm not familiar with this class of assets, so I'll make sure that I'll stay away from mREITS for now, perhaps even the mREIT ETFs.