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American Capital Agency Saw another Drop in Book Value per Share

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American Capital Agency’s book value per share fell in 1Q16

American Capital Agency’s (AGNC) book value per share fell from $22.59 in the fourth quarter of 2015 to $22.09 in the first quarter. The fall was due in part to widening of MBS (mortgage-backed security) spreads during the quarter.

The ten-year bond yield rose from 2.3% to 1.8% over the quarter, which negatively affected the value of American Capital Agency’s MBS portfolio. Spread-widening exacerbated the move. Note that spread-widening also means that prospective yields on the portfolio are higher.

The Fed raised interest rates for the first time in almost 12 years, and rates at the long end of the curve fell 50 basis points over the quarter. The Fed rate hikes will affect funding costs and narrow interest margins.

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Book value per share: 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 because they must distribute 90% of their earnings as dividends.

Investors interested in trading the mortgage REIT sector as a whole should look at the iShares Mortgage Real Estate Capped ETF (REM).

That being 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 in 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 wound down.

American Capital Agency is more sensitive to interest rates than most other mortgage REITs

American Capital Agency and Annaly Capital Management (NLY) are REITs that mainly invest in 30-year fixed-rate mortgages. They experienced declines in book value per share in late 2013 and early 2014, when interest rates ticked up.

These REITs have a higher interest rate risk than MFA Financial (MFA), Hatteras Financial (HTS), or Capstead Mortgage (CMO). If you’re interested in making directional bets on interest rates, you should look at the iShares Barclays 20+ Year Treasury Bond ETF (TLT). It invests mainly in adjustable-rate mortgage-backed securities. The interest rates on these mortgages increase as rates increase, which reduces the negative effect of rising rates.

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