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Dividend Cut at American Capital

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American Capital Agency Corp. (AGNC - Free Report) , a mortgage REIT (mREIT) firm, finally announced the much-awaited dividend cut. Over the past six weeks the stock witnessed a substantial decline (down 23.4% since May 2, 2013) owing to apprehensions over a rising interest rate and a negative impact on the book value.

In particular, American Capital Agency slashed its quarterly dividend rate by 16%. The company will now pay a second-quarter dividend of $1.05 per share instead of the prior dividend rate of $1.25. The revised dividend will be paid on Jul 26 to shareholders of record as of Jun 28.

How Rising Interest Rates Hurt mREITs?

Usually, mREITs invest in mortgage backed securities and use short-term debt for financing their purchases. They make money from the spread and are generally highly leveraged.

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

However, the situation reversed and presently amid apprehensions of the Fed pulling out its QE program and increasing yields on the U.S. Treasury 10-year note (2.17% as of Jun 17, 2013, compared with 1.68% at the end of April), investors are favoring the relatively risk free treasury notes and discarding their investments in mREITs.

As a result, the stock prices of the mREITs have registered a significant decline since May. Subsequently, the FTSE NAREIT Mortgage REITs total returns dropped 12.91% from the beginning of the second quarter till Jun 17, 2013.

American Capital Mortgage Investment Corp. also joined the bandwagon of slashing dividend payout. It reduced dividend by over 11% to 80 cents from 90 cents paid earlier.

Amid speculations of rising rates and the Fed’s QE program pull out, we expect the mREITs stocks to continue losing shine.

However, we note that even after the dividend cut at American Capital Agency, the company still ranks among the regular dividend payers. At the new rate, the annualized dividend stands at $4.20, representing a yield of 16.6% based on the closing price of Jun 18.

American Capital Agency currently has a Zacks Rank #3 (Hold). However, two other mREITs that are performing well and deserve a look are Five Oaks Investment Corp. with a Zacks Rank #1 (Strong Buy) and iStar Financial Inc. having a Zacks Rank #2 (Buy).

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