As a REIT, American Capital Agency must pay out 90% of its net income in dividends
Companies like Annaly (NLY), American Capital Agency (AGNC), Capstead (CMO), Hatteras (HTS), and MFA Financial (MFA) are real estate investment trusts, which means they don’t pay Federal income tax at the corporate level. Instead, as long as they distribute 90% of their net income via dividends, they escape corporate taxation.
This means REITs will offer volatile dividends. Most corporations loathe cutting their dividend because of the message it sends to Wall Street. So volatile dividends are generally rare. But for REITs, they’re a fact of life. Since 2008, they’ve paid a quarterly dividend of as low as 31 cents and as high as $1.50 a share.
Highlights of the income statement
AGNC’s average asset yield for the quarter was 2.71%, as opposed to 2.54% for the end of the first quarter. The first quarter’s yield was influenced by changes in assumptions about prepayment speeds. During the first quarter, changes in prepayment assumptions shaved 16 basis points from average asset yield. In the fourth quarter, AGNC added 14 basis points. So on an apples-to-apples basis, the adjusted average asset yields was 2.71% for the second quarter, as opposed to 2.70% for the first quarter.
Prepayment assumptions represent the fact that mortgages can be paid off early, which means the amount of interest an investor will receive on an MBS is uncertain. Changes in prepayment assumptions will affect the returns of the bond since any premium or discount must be amortized, and if the expected life of the bond changes, the amortization amount will change as well. This makes yields somewhat more volatile. But these are largely non-cash adjustments.
American Capital Agency ended up declaring a dividend of $0.65 a share for the second quarter. This is what it paid last quarter. In the second quarter of 2013, though, it paid $1.05 a share. This volatility show one of the biggest mistakes you can make when looking at a mortgage REIT—annualizing the current dividend and assuming that dividend yield will stay intact over time. Almost by definition, it won’t.