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AGNC > SEC Filings for AGNC > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for AMERICAN CAPITAL AGENCY CORP

Form 10-Q for AMERICAN CAPITAL AGENCY CORP


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide a reader of American Capital Agency Corp.'s consolidated financial statements with a narrative from the perspective of management. Our MD&A is presented in five sections:
Executive Overview

Financial Condition

Results of Operations

Liquidity and Capital Resources

Forward-Looking Statements

EXECUTIVE OVERVIEW
American Capital Agency Corp. ("AGNC", the "Company", "we", "us" and "our") was organized on January 7, 2008 and commenced operations on May 20, 2008 following the completion of our initial public offering. Our common stock is traded on The NASDAQ Global Select Market under the symbol "AGNC". We are externally managed by American Capital AGNC Management, LLC (our "Manager"), an affiliate of American Capital, Ltd. ("American Capital").
We operate so as to qualify to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code"). As such, we are required to distribute annually 90% of our taxable net income. As long as we qualify as a REIT, we will generally not be subject to U.S. federal or state corporate taxes on our taxable net income to the extent that we distribute all of our annual taxable net income to our stockholders. It is our intention to distribute 100% of our taxable income, after application of available tax attributes, within the limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year. We earn income primarily from investing on a leveraged basis in agency mortgage-backed securities. These investments consist of residential mortgage pass-through securities and collateralized mortgage obligations ("CMOs") for which the principal and interest payments are guaranteed by government-sponsored entities, such as the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"), or by a U.S. Government agency, such as the Government National Mortgage Association ("Ginnie Mae") (collectively referred to as "GSEs"). We may also invest in agency debenture securities issued by Freddie Mac, Fannie Mae or the Federal Home Loan Bank ("FHLB"). We refer to agency mortgage-backed securities and agency debenture securities collectively as "agency securities" and we refer to the specific investment securities in which we invest as our "investment portfolio".

Our principal objective is to preserve our net book value (also referred to as "net asset value", "NAV" and "stockholders' equity") while generating attractive risk-adjusted returns for distribution to our stockholders through regular quarterly dividends from the combination of our net interest income and net realized gains and losses on our investments and hedging activities. We fund our investments primarily through borrowings structured as repurchase agreements.
Our Investment Strategy
Our investment strategy is designed to:
manage an investment portfolio consisting of agency securities that seeks to generate attractive risk-adjusted returns;

capitalize on discrepancies in the relative valuations in the agency securities market;

manage financing, interest and prepayment rate risks;

preserve our net book value;

provide regular quarterly distributions to our stockholders;

qualify as a REIT; and

remain exempt from the requirements of the Investment Company Act of 1940, as amended (the "Investment Company Act").

The size and composition of our investment portfolio depends on investment strategies implemented by our Manager, the availability of investment capital and overall market conditions, including the availability of attractively priced investments and suitable financing to appropriately leverage our investment portfolio. Market conditions are influenced by, among other things, current levels of and expectations for future levels of, interest rates, mortgage prepayments, market liquidity, housing prices, unemployment rates, general economic conditions, government participation in the mortgage market, evolving regulations or legal settlements that impact servicing practices or other mortgage related activities.


Trends and Recent Market Impacts
On September 13, 2012, the Federal Reserve announced their third quantitative easing program, commonly known as QE3, and extended their guidance to keep the federal funds rate at "exceptional low levels" through at least mid-2015. QE3 entails large-scale purchases of agency MBS at the pace of $40 billion per month in addition to the Federal Reserve's existing policy of reinvesting principal payments from its holdings of agency MBS into new agency MBS purchases. The program is open-ended in nature, and is intended to put downward pressure on longer-term interest rates, support mortgage markets, and help make the broader financial conditions more accommodative. The Federal Reserve plans to continue their purchases of agency MBS and employ other policy tools, as appropriate, until they foresee substantial improvement in the outlook for the U.S. labor market.
The Federal Reserve's purchases will likely be concentrated in newly-issued, fixed-rate agency MBS (i.e., the part of the mortgage market with the greatest impact on mortgage rates offered to borrowers). We expect that the combined total purchases of agency MBS by the Federal Reserve will be $65 billion to $75 billion per month, which will likely be more than 50% of the average gross agency MBS new issue volume during the fourth quarter of 2012. As of September 30, 2012, prices across the agency MBS spectrum had generally increased following the Federal Reserve's QE3 announcement, with the lowest coupon, 30-year and 15-year fixed-rate agency MBS outperforming higher coupon agency MBS. The table below summarizes interest rates and prices of generic fixed-rate agency MBS for the nine month period ended September 30, 2012.

                                                                                                 September 30, 2012   September 30, 2012
                                                                                                       Versus               Versus
      Interest                                                                                                        December 31, 2011
Rate/Security Price
        (1)            September 30, 2012   June 30, 2012   March 31, 2012   December 31, 2011     June 30, 2012
LIBOR:
1-Month                      0.21%              0.25%           0.24%              0.30%               -0.04                -0.09
3-Month                      0.36%              0.46%           0.47%              0.58%               -0.10                -0.22
U.S. Treasury
Security Rate:
2-Year U.S. Treasury         0.23%              0.30%           0.33%              0.24%               -0.07                -0.01
5-Year U.S. Treasury         0.63%              0.72%           1.04%              0.83%               -0.09                -0.20
10-Year U.S.
Treasury                     1.63%              1.65%           2.21%              1.88%               -0.02                -0.25
Interest Rate Swap
Rate:
2-Year Swap                  0.37%              0.55%           0.58%              0.73%               -0.18                -0.36
5-Year Swap                  0.76%              0.97%           1.27%              1.22%               -0.21                -0.46
10-Year Swap                 1.70%              1.78%           2.29%              2.03%               -0.08                -0.33
30-Year Fixed Rate
MBS Price
3.0%                        $105.58            $102.55          $99.67            $100.22              +$3.03               +$5.36
3.5%                        $107.25            $105.11         $102.72            $102.88              +$2.14               +$4.37
4.0%                        $107.75            $106.44         $104.86            $105.03              +$1.31               +$2.72
4.5%                        $108.25            $107.28         $106.38            $106.42              +$0.97               +$1.83
5.0%                        $109.06            $108.23         $108.03            $108.03              +$0.83               +$1.03
5.5%                        $109.63            $109.08         $108.97            $108.89              +$0.55               +$0.74
6.0%                        $110.44            $109.91         $110.20            $110.16              +$0.53               +$0.28
15-Year Fixed Rate
MBS Price
2.5%                        $105.13            $103.09         $101.42            $101.34              +$2.04               +$3.79
3.0%                        $106.00            $104.77         $103.56            $103.28              +$1.23               +$2.72
3.5%                        $106.41            $105.66         $104.92            $104.58              +$0.75               +$1.83
4.0%                        $106.91            $106.34         $106.00            $105.50              +$0.57               +$1.41
4.5%                        $107.84            $107.17         $107.20            $106.59              +$0.67               +$1.25


 ________________________


1. Price information is for generic instruments only and is not reflective of our specific portfolio holdings. Price information can vary by source. Prices in the table above obtained from a combination of Bloomberg and dealer indications. Interest rates obtained from Bloomberg.

We expect during periods in which the Federal Reserve purchases significant volumes of mortgages, yields on agency MBS will be lower than and refinancing volumes will be higher than would have been absent QE3. Since returns on agency MBS are highly sensitive to prepayment speeds we have positioned our investment portfolio towards agency MBS that we believe have favorable prepayment attributes. As of September 30, 2012, 71% of our fixed-rate investment portfolio was comprised of agency securities backed by lower loan balance mortgages (pools backed by original loan balances of up to


$150,000) and loans originated under the U.S. Government sponsored Home Affordable Refinance Program ("HARP") (pools backed by 100% refinance loans with original loan-to-values of ? 80%), which we believe have a lower risk of prepayment relative to generic agency securities. The remainder of our portfolio as of September 30, 2012 was primarily comprised of low coupon, new issuance fixed-rate agency securities. (See Financial Condition below for further details of our portfolio composition as of September 30, 2012). The following table illustrates the impact of favorable prepayment characteristics on constant prepayment rates ("CPR"), comparing the actual annualized monthly CPR for our portfolio to the Fannie Mae 2011 30-year 4.0% fixed-rate TBA for the nine months ended September 30, 2012.

Annualized Monthly Constant                                                              May
Prepayment Rates (1)           January 2012   February 2012   March 2012   April 2012    2012   June 2012   July 2012   August 2012   September 2012
AGNC portfolio                      8%             8%            12%          12%        10%       8%          8%           9%             11%
Fannie Mae 2011 30-year 4.0%
fixed rate TBA (2)                 11%             13%           19%          21%        14%       15%         21%          29%            35%


 ________________________


1. Weighted average actual one-month annualized CPR released at the beginning of the month based on securities held/outstanding as of the preceding month-end.

2. Source: JP Morgan.

In addition to strategic asset selection, we attempt to protect our net asset value against significant fluctuations due to market risks, including interest rate and prepayment risk, through the use of economic hedges. We utilize a variety of hedging strategies to aid us in this objective, which are summarized in Notes 3 and 6 of the accompanying financial statements.

FINANCIAL CONDITION
As of September 30, 2012 and December 31, 2011, our investment portfolio consisted of $89.6 billion and $54.7 billion, respectively, of agency mortgage-backed securities ("agency MBS"). The following tables summarize certain characteristics of our agency MBS investment portfolio as of September 30, 2012 and December 31, 2011 (dollars in millions):


                                                             September 30, 2012

                                                                                                                  September
                                                                                            Weighted Average        2012
Agency MBS Classified as                                                                                          Projected
Available-for-Sale                            Amortized     Amortized                                             Life CPR
("AFS")                       Par Value         Cost        Cost Basis     Fair Value      Coupon     Yield (1)      (2)
AFS Investments By
Issuer:
Fannie Mae                  $    64,352     $    67,671       105.2%     $     69,831      3.63%        2.54%        14%
Freddie Mac                      17,512          18,339       104.7%           18,956      3.76%        2.70%        14%
Ginnie Mae                          260             272       104.5%              278      3.78%        1.60%        21%
Total / Weighted Average
AFS Securities              $    82,124     $    86,282       105.1%     $     89,065      3.66%        2.57%        14%

AFS Investments By
Security Type:
Fixed-Rate
 ? 15-Year
Lower Loan Balance (3)      $    14,645     $    15,197       103.7%     $     15,844      3.71%        2.61%        16%
HARP (4)                          1,177           1,221       103.8%            1,271      3.71%        2.54%        17%
Other (2009-2012 Vintage)
(5)                              10,891          11,253       103.3%           11,479      2.72%        1.65%        19%
Other (Pre 2009 Vintage)             35              36       104.7%               37      4.57%        2.63%        18%
Total ? 15-Year                  26,748          27,707       103.6%           28,631      3.31%        2.21%        17%
Total 20-Year:                    2,440           2,542       104.2%            2,627      3.55%        2.43%        17%
30-Year:
Lower Loan Balance (3)           17,317          18,365       106.1%           19,004      3.86%        2.85%        10%
HARP (4)                         23,271          24,674       106.0%           25,529      3.87%        2.80%        11%
Other (2009-2012 Vintage)
(5)                              10,785          11,363       105.4%           11,590      3.65%        2.49%        15%
Other (Pre 2009 Vintage)
(5)                                 455             485       106.7%              501      5.60%        3.55%        21%
Total 30-Year                    51,828          54,887       105.9%           56,624      3.84%        2.76%        12%
Total Fixed-Rate                 81,016          85,136       105.1%           87,882      3.66%        2.57%        14%
Adjustable-Rate                     928             960       103.5%              992      4.18%        2.42%        25%
CMO                                 180             186       103.1%              191      3.70%        2.85%        16%
Total / Weighted Average    $    82,124     $    86,282       105.1%     $     89,065      3.66%        2.57%        14%


                                                             September 30, 2012

                                                                                                       September
                              Underlying                                         Weighted Average        2012
                              Unamortized                                                              Projected
Agency MBS Remeasured at       Principal        Amortized                                              Life CPR
Fair Value Through Earnings     Balance           Cost          Fair Value      Coupon     Yield (1)      (2)
Interest-Only Strips
Fannie Mae                  $       1,447     $       258     $        259      5.73%        6.97%        18%
Freddie Mac                           367              60               48      5.60%       39.73%        20%
Principal-Only Strips
Fannie Mae                            309             250              268        -%         3.19%        10%
Total / Weighted Average    $       2,123     $       568     $        575      4.87%        8.77%        15%


_______________________


1. Portfolio yield incorporates a projected life CPR assumption as of September 30, 2012 and a weighted average reset rate for adjustable rate securities of 2.67%, which is equal to a weighted average underlying index rate of 0.96% based on the current spot rate in effect as of the date we acquired the securities and a weighted average margin of 1.71%.

2. Weighted average projected life CPR based on forward rate assumptions as of September 30, 2012.

3. Lower loan balance securities represent pools backed by a maximum original loan balance of up to $150,000. Our lower loan balance securities had a weighted average original loan balance of $98,000 and $101,000 for 15-year and 30-year securities, respectively, as of September 30, 2012.

4. HARP securities are defined as pools backed by100% refinance loans with loan-to-values ("LTV") ? 80%. Our HARP securities had a weighted average LTV of 95% and 100% for 15-year and 30-year securities, respectively, as of September 30, 2012.


                                                                   December 31, 2011

                                                                                                                  December
                                                                                            Weighted Average        2011
                                                                                                                  Projected
Agency MBS Classified as                      Amortized     Amortized                                             Life CPR
AFS                           Par Value         Cost        Cost Basis     Fair Value      Coupon     Yield (1)      (2)
AFS Investments By
Issuer:
Fannie Mae                  $    37,232     $    38,891       104.5%     $     39,567      4.07%        3.02%        14%
Freddie Mac                      13,736          14,342       104.4%           14,664      4.21%        3.16%        14%
Ginnie Mae                          258             270       104.7%              273      3.74%        1.71%        25%
Total / Weighted AFS
Securities                  $    51,226     $    53,503       104.4%     $     54,504      4.11%        3.05%        14%

AFS Investments By
Security Type:
Fixed-Rate
 ? 15-Year:
Lower Loan Balance (3)      $    16,033     $    16,626       103.7%     $     17,027      3.81%        2.84%        12%
HARP (4)                          1,160           1,208       104.2%            1,235      3.93%        2.87%        12%
Other (5)                         1,814           1,873       103.2%            1,898      3.54%        2.58%        15%
Total ? 15-Year                  19,007          19,707       103.7%           20,160      3.79%        2.82%        13%
Total 20-Year:                    5,462           5,659       103.6%            5,710      3.71%        2.72%        16%
30-Year:
Lower Loan Balance (3)            4,577           4,847       105.9%            4,927      4.48%        3.40%        11%
HARP (4)                         11,676          12,318       105.5%           12,591      4.48%        3.50%        11%
Other (2009-2011 Vintage)         6,987           7,307       104.6%            7,380      4.24%        3.17%        15%
Other (Pre 2009 Vintage)            655             697       106.3%              715      5.59%        3.37%        25%
Total 30-Year                    23,895          25,169       105.3%           25,613      4.44%        3.38%        12%
Total Fixed-Rate                 48,364          50,535       104.5%           51,483      4.10%        3.09%        13%
Adjustable-Rate                   2,627           2,725       103.7%            2,774      4.29%        2.58%        32%
CMO                                 235             243       103.1%              247      3.74%        1.69%        29%
Total / Weighted Average    $    51,226     $    53,503       104.4%     $     54,504      4.11%        3.05%        14%


                                                              December 31, 2011

                                                                                                        December
                               Underlying                                         Weighted Average        2011
                               Unamortized                                                              Projected
Agency MBS Remeasured at        Principal        Amortized                                              Life CPR
Fair Value Through Earnings      Balance           Cost          Fair Value      Coupon     Yield (1)      (2)
Interest-Only Strips
Fannie Mae                   $         687     $        90     $         86      5.55%        6.62%        31%
Freddie Mac                            453              66               56      5.48%       10.35%        25%
Principal-Only Strips
Fannie Mae                              40              35               37        -%         5.40%        31%
Total / Weighted Average     $       1,180     $       191     $        179      5.33%        7.70%        29%


______________________


1. Portfolio yield incorporates a projected life CPR assumption as of December 31, 2011 and a weighted average reset rate for adjustable rate securities of 2.71%, which is equal to a weighted average underlying index rate of 0.94% based on the current spot rate in effect as of the date we acquired the securities and an weighted average margin of 1.77%.

2. Weighted average projected life CPR based on forward rate assumptions as of December 31, 2011.

3. Lower loan balance securities represent pools backed by a maximum original loan balance of ? $150,000. Our lower loan balance securities had a weighted average original loan balance of $102,029 and $108,432 for 15-year and 30-year securities, respectively, as of December 31, 2011.

4. HARP securities are defined as pools backed by100% refinance loans with LTVs ? 80% and ? 125%. Our HARP securities had a weighted average LTV of 98% and 97% for 15-year and 30-year securities, respectively, as of December 31, 2011.

5. Other 15-year securities include $687 million of securities backed by loans with original loan balances ? $175,000.

Interest-only agency MBS strips represent the right to receive a specified portion of the contractual interest flows of the underlying unamortized principal balance ("UPB" or "par value") of specific agency CMO securities. Principal-only agency MBS strips represent the right to receive contractual principal flows of the UPB of specific agency CMO securities. As of September 30, 2012 and December 31, 2011, the combined weighted average yield of our agency MBS portfolio was 2.61% and 3.07%, respectively.


The stated contractual final maturity of the mortgage loans underlying our agency MBS portfolio ranges up to 40 years. As of September 30, 2012 and December 31, 2011, the weighted average final contractual maturity of our agency MBS portfolio was 24 and 23 years, respectively.
The actual maturities of agency MBS are generally shorter than their stated contractual maturities primarily as a result of prepayments of principal of the underlying mortgages. The weighted average expected maturity of our agency MBS portfolio was 4.9 and 5.1 years as of September 30, 2012 and December 31, 2011, respectively. In determining the estimated weighted average years to maturity of our agency MBS and the yield on our agency MBS, we have assumed a weighted average CPR over the remaining life of our agency MBS portfolio of 14% as of September 30, 2012 and December 31, 2011. We amortize or accrete premiums and discounts associated with purchases of our agency MBS into interest income over the estimated life of our securities based on actual and projected CPRs, using the effective yield method. Since the weighted average cost basis of our agency MBS portfolio was 105.4% of par value as of September 30, 2012, slower actual and projected prepayments can have a meaningful positive impact on our asset yields, while faster actual or projected prepayments can have a meaningful negative impact on our asset yields.
The following table summarizes our agency MBS classified as available-for-sale, at fair value, according to their estimated weighted average life classifications as of September 30, 2012 and December 31, 2011 (dollars in millions):

                                          September 30, 2012                           December 31, 2011
Estimated Weighted Average                                      Weighted                                    Weighted
Life of Agency MBS Classified                     Amortized     Average                       Amortized     Average
as AFS                           Fair Value         Cost         Coupon      Fair Value         Cost         Coupon
Less than or equal to 1 year   $          -     $         -        -%      $        214     $       210      4.61%
Greater than 1 year and less
than or equal to 3 years              9,902           9,656      3.17%            3,392           3,338      4.38%
Greater than 3 years and less
than or equal to 5 years             39,737          38,442      3.66%           26,168          25,616      3.99%
Greater than 5 years and less
than/equal to 10 years               38,832          37,600      3.80%           24,710          24,320      4.19%
Greater than 10 years                   594             584      3.55%               20              19      5.02%
Total                          $     89,065     $    86,282      3.66%     $     54,504     $    53,503      4.11%

The weighted average life of our interest-only agency MBS strips was 4.8 and 3.0 years as of September 30, 2012 and December 31, 2011, respectively, and the weighted average life of our principal-only agency MBS strips was 5.6 and 2.6 years as of September 30, 2012 and December 31, 2011, respectively. As of September 30, 2012 and December 31, 2011, we held pass-through agency MBS collateralized by adjustable rate mortgage loans ("ARMs") and hybrid ARMs with coupons linked to various indices. Hybrid ARMs are mortgage loans that have interest rates that are fixed for an initial period and, thereafter, reset at regular intervals subject to interest rate caps. The following tables detail the characteristics of our ARM and hybrid ARM agency MBS portfolio by interest rate index as of September 30, 2012 and December 31, 2011 (dollars in millions):

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