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On Jul 18, 2013, we downgraded our long-term recommendation on American Capital Agency Corp. (AGNC - Analyst Report) – a mortgage real estate investment trust (REIT) - from Outperform to Underperform. Amid the increasing yields on the U.S. Treasury 10-year note and apprehensions that the Fed will soon pull out its quantitative easing policies (QE) program, mortgage REIT (commonly known as mREIT) stocks are continuing to lose their shine. The lower-than-expected results during the first quarter came as a disappointment. Alongside, the stock made a dividend cut in the recent past.

Why the Downgrade?

In the past couple of years, with low short-term rates and quantitative easing policies, mREITs have benefited from lower borrowing costs, leading to higher yields. Through interventions in the long-term mortgage and treasury bonds market, the Fed managed to keep the long-term interest rates low.

As REITs are required to pay out 90% of their earnings to shareholders for favorable tax treatment, the mREITs ended up paying double-digit yields, which easily surpassed the returns from the Treasury bonds. Thus, high-yield seeking investors showed preference for mREITs over bonds.

Amid apprehensions of the Fed pulling out its quantitative easing policies and increasing yields on the U.S. Treasury 10-year note, investors are favoring the relatively risk free treasury notes and discarding their investments in mREITs.

In June, American Capital Agency also slashed its quarterly cash dividend by 16% to $$1.05 per share. Also, the company reported disappointing first-quarter 2013 results with its net spread income per share of 78 cents significantly lagging the Zacks Consensus Estimate of $1.08. Hurt by lower pricing on its mortgage-backed securities portfolio, American Capital Agency’s book value suffered a considerable downfall during the quarter.

Over the last 60 days, the Zacks Consensus Estimate for 2013 moved south 13.4% to $3.24. For 2014, it dipped 14.9% to $3.53. Therefore, American Capital Agency now carries a Zacks Rank #5 (Strong Sell).

American Capital Agency is scheduled to report second-quarter 2013 earnings after the closing bell on Jul 29, 2013. The Zacks Consensus Estimate for the upcoming quarter results is pegged at 88 cents per share.

The earnings ESP (Read: Zacks Earnings ESP: A Better Method) for American Capital Agency is +6.82% for the second quarter. However, we are skeptical about a positive earnings surprise owing to the company’s Zacks Rank #5 (Strong Sell).

Other Stock to Consider

REITs that are currently performing better include Walter Investment Management Corp. (WAC - Snapshot Report), Kimco Realty Corporation (KIM - Analyst Report) and The Macerich Company (MAC - Analyst Report). All of them carry a Zacks Rank #2 (Buy).

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