Should You Worry About American Capital Agency's Strategy?

One enemy of every equity investor? Dilution.

Shares of American Capital Agency are down sharply today after the mREIT announced its intention to issue 50 million new shares of common stock plus up to an additional 7.5 million upon the exercise of underwriters' options. Despite the shares closing slightly above book value per share on Wednesday, shareholders did not appreciate the dilutive impact of the pending offering, as well as raising capital during a time of historically low long-term interest rates.

Playing the yo-yo
American Capital Agency primarily uses issuance proceeds to buy agency mortgage-backed securities and then engage in short-term repurchase agreements to buy additional long-term agency MBSes. Simply, the spread between the cost of its short-term repo agreements and the income from its long-term holdings generates net interest income. Today's increased selling pressure may also be attributed to the fact that the announcement comes after the company repurchased some of its outstanding common stock when shares traded slightly below book value in November.


While issuing additional common stock when shares are trading at a premium to book value is more favorable than issuing shares trading at a discount, the sell-off highlights the market's skepticism of American Capital's management team's ability to effectively allocate and position capital during the continued low-rate environment and the Federal Reserve's involvement in the agency MBS marketplace via QE3.

Jockeying for position
While American Capital has shown willingness to diversify its income streams, such as increased activity in the dollar roll market, other mREITs like Annaly Capital Management have been to positioning their portfolios for the potentially higher interest environment in the future. By scaling back its exposure to current long-term rates, in the most recent quarter, Annaly (0.95%) felt a stronger squeeze on its interest rate spread compared to American Capital (1.63%).

Today's move in the share price is not a reason for long-term mREIT investors to make impulsive decisions, but it does highlight one of the true differentiating factors of companies in this industry: Management. When investing in mREITs, in additional to betting on certain interest movements or balance sheet appreciation prospects, investors are choosing to stand with a management team who they feel will allocate their capital in the most effective way to generate long-term price and dividend appreciation. Based on today's share price reaction, the ego of American Capital's management may have taken a hit.

Like American Capital Agency, Annaly Capital Management has a history of paying huge dividends to shareholders. But there are some crucial issues investors have to understand about Annaly's business model before buying the stock. In this premium research report on the company, our analyst runs through these absolute must-know topics, as well as the future opportunities and pitfalls of the company's strategy. Click here now to claim your copy.

The article Should You Worry About American Capital Agency's Strategy? originally appeared on Fool.com.

David Hanson has no position in any stocks mentioned. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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