Book value per share is a critical metric for mortgage REITs
Since REITs are financials, they tend to trade off of two important metrics—dividend yield and book value per share. Dividend yield is typically why investors buy REITs in the first place. REITs tend to have much higher dividend yields than a typical S&P 500 stock. This is due to the fact that they must distribute 90% of their earnings as dividends.
That said, investors often think of book value per share as a floor level for the stock. In other words, if dividends are high, the stock may trade at an excess of book value. However, REITs tend to trade at or just under book value. In theory, book value represents what a stockholder would expect to receive if the company were wound down.
American Capital Agency reports an increase in book value
American Capital Agency’s (AGNC) book value per share increased from $25.54 in the third quarter to $25.74 in the fourth quarter. The increase was due in part to mortgage-backed securities’, or MBS, rising prices. The prices increased as interest rates rose. It was also due to increased prepayment assumptions.
Book value only slowed during the bond market rally
American Capital and Annaly Capital are REITs that primarily invest in 30-year fixed-rate mortgages. They experienced declines in book value per share during late 2013 and early 2014 as interest rates ticked up. Part of this is due to convexity risk. This means that MBS become less sensitive to decreases in interest rates as they fall.
American Capital Agency made some adjustments to its portfolio as rates fell. It swapped out of higher coupon TBAs into lower coupon TBAs.
These REITs have a higher interest rate risk than MFA Financial (MFA), Hatteras (HTS), or Capstead (CMO). They invest primarily in adjustable-rate mortgage-backed securities. These mortgages have a fixed rate for the first three, five, or seven years. Then, the interest rate floats. This means they have a shorter duration. This is another way of saying that they have less exposure to changing interest rates.
When this post was originally published, it mistakenly indicated a REIT invests in 30-year fixed-rate mortgages. We have since updated the post to indicate that, in fact, American Capital and Annaly Capital are REITs that invest in 30-year fixed-rate mortgages. We regret this error.