American Capital Agency's 1Q14 earnings: Important takeaways (Part 4 of 5)
As a REIT, American Capital Agency must pay out 90% of its net income in dividends
Mortgage REITs like Annaly (NLY), American Capital Agency (AGNC), Capstead (CMO), Hatteras (HTS), and MFA Financial (MFA) are real estate investment trusts, which means they do not 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 that a REIT will experience a volatile dividend. Most corporations loath cutting their dividend because of the message it sends to the Street, so volatile dividends are generally rare. For REITs, they are a fact of life. Since 2008, they have paid a quarterly dividend of as low as 31 cents and as high as $1.50 a share.
Highlights of the income statement
The company’s average asset yield for the quarter was 2.54%, as opposed to 2.82% for the end of the fourth quarter. The drop in yield was due to a change 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, it added 14 basis points. So on an apples-to-apples basis, the adjusted average asset yields was 2.72% for the quarter, as opposed to 2.70% for the fourth quarter.
Prepayment assumptions represent the fact that mortgages can be paid off early, which means that the amount of interest an investor will receive on a 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 has the effect of making yields somewhat more volatile, however these are largely non-cash adjustments.
American Capital Agency ended up declaring a dividend of $0.65 a share for the first quarter, which is what they paid last quarter. In the first quarter of 2013, they paid $1.25 a share. This volatility demonstrates one of the biggest mistakes an investor 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.
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