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MTGE > SEC Filings for MTGE > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for AMERICAN CAPITAL MORTGAGE INVESTMENT CORP.

Form 10-Q for AMERICAN CAPITAL MORTGAGE INVESTMENT CORP.


9-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") provides readers of American Capital Mortgage Investment Corp.'s ("MTGE", the "Company", "we", "us" and "our") consolidated financial statements a narrative from the perspective of management, and should be read in conjunction with the consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q as well as our Annual Report on Form 10-K for the year ended December 31, 2011. Our MD&A is presented in five sections:
Executive Overview

Financial Condition

Results of Operations

Liquidity and Capital Resources

Forward-Looking Statements

EXECUTIVE OVERVIEW
We were incorporated in Maryland on March 15, 2011 and commenced operations on August 9, 2011 following the completion of our IPO. We invest in, finance and manage a leveraged portfolio of mortgage-related investments, which we define to include agency mortgage investments, non-agency mortgage investments and other mortgage-related investments. Agency mortgage investments include residential mortgage pass-through certificates and collateralized mortgage obligations ("CMOs") structured from residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by a government-sponsored entity ("GSE"), 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"). Non-agency mortgage investments include residential mortgage-backed securities ("RMBS") backed by residential mortgages that are not guaranteed by a GSE or U.S. Government agency. Non-agency mortgage investments may also include prime and non-prime residential mortgage loans. Other mortgage-related investments may include commercial mortgage-backed securities ("CMBS"), commercial mortgage loans, mortgage-related derivatives and other mortgage-related investments.
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, among other things, distribute annually at least 90% of our taxable net income. As long as we qualify as a REIT, we will generally not be subject to U.S. federal corporate taxes on our taxable net income to the extent that we distribute all of our annual taxable net income to our stockholders.
We are externally managed by American Capital MTGE Management, LLC (our "Manager"), an affiliate of American Capital, Ltd. ("American Capital"). We do not have any employees.
Our Investment Strategy
Our objective is to provide attractive risk-adjusted returns to our stockholders over the long-term through a combination of dividends and net book value appreciation. In pursuing this objective, we rely on our Manager's expertise to construct and manage a diversified mortgage investment portfolio by identifying asset classes that, when properly financed and hedged, are selected to produce attractive returns across a variety of market conditions and economic cycles, considering the risks associated with owning such investments. Specifically, our investment strategy is designed to:

         manage a leveraged portfolio of mortgage-related investments to
          generate attractive risk-adjusted returns;


         capitalize on discrepancies in the relative valuations in the
          mortgage-related investments market;

manage financing, interest, prepayment rate and credit risks;

preserve our net asset value within reasonable bands;

provide regular quarterly distributions to our stockholders;

qualify as a REIT; and

remain exempt from the requirements of 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 mortgage-backed securities ("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 months ended September 30, 2012.

                                                                                                                               September 30,
                                                                                                         September 30, 2012     2012 Versus
      Interest                                                                                            Versus June 30,      December 31,
 Rate/Security (1)      September 30, 2012     June 30, 2012     March 31, 2012     December 31, 2011           2012               2011
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
Securities:
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 )            (0.2 )
10-Year U.S.
Treasury                             1.63 %            1.65 %             2.21 %                1.88 %              (0.02 )           (0.25 )
Interest Rate Swap
Rates:
2-Year Swap Rate                     0.37 %            0.55 %             0.58 %                0.73 %              (0.18 )           (0.36 )
5-Year Swap Rate                     0.76 %            0.97 %             1.27 %                1.22 %              (0.21 )           (0.46 )
10-Year Swap Rate                    1.70 %            1.78 %             2.29 %                2.03 %              (0.08 )           (0.33 )
30-Year Fixed Rate
MBS Price:
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
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


 ________________________


(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 securities will be lower than yields would have been absent QE3 and that refinancing volumes will be higher than volumes 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, 73% of our fixed-rate agency 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 agency 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 agency portfolio to the Fannie Mae 2011 30-year 4.0% fixed-rate TBA for the nine months ended September 30, 2012.

Annualized
Monthly Actual
Constant
Prepayment Rates   January 2012   February 2012   March 2012   April 2012   May 2012   June 2012   July 2012   August 2012   September 2012
Agency
securities (1)          4%             6%             7%           5%          5%         5%          7%           8%              7%
Fannie Mae 2011
30-year 4.0%
fixed rate
universe (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 as of the preceding month-end.

(2) Source: JP Morgan

The non-agency market environment showed significant signs of improvement with broad market participation during the nine months ended September 30, 2012, as compared to the end of 2011. However, trading volumes remain below those experienced during the first half of 2011, and non-agency security liquidity remains a concern. While market sentiment concerning the general housing market has improved, we believe that any housing recovery will be uneven across the country and are cognizant that other events, such as additional U.S. regulatory actions or further economic weakness in Europe, could have a material negative impact on the market for non-agency securities. As such, we will continue our selective approach to increasing our non-agency portfolio. Summary of Critical Accounting Estimates Our critical accounting estimates relate to the fair value of our investments, recognition of interest income, and derivatives. Certain of these items involve estimates that require management to make judgments that are subjective in nature. We rely on our Manager's experience and analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. Under different conditions, we could report materially different amounts using these critical accounting policies. All of our critical accounting policies are fully described in our MD&A in our Annual Report on Form 10-K for the year ended December 31, 2011. Our significant accounting policies are described in Note 3 to the consolidated financial statements included under Item 1 of Part I of this Quarterly Report on Form 10-Q.
We have elected the option to account for all of our financial assets, including all mortgage-related investments, at fair value, with changes in fair value reflected in income during the period in which they occur. We believe this election more appropriately reflects the results of our operations for a particular reporting period, as financial asset fair value changes are presented in a manner consistent with the presentation and timing of the fair value changes of economic hedging instruments.

FINANCIAL CONDITION
The following analysis of our financial condition should be read in conjunction
with our interim consolidated financial statements and the notes thereto. The
table below presents our condensed consolidated balance sheets as of
September 30, 2012 and December 31, 2011 (dollars in thousands, except per share
amounts):
                                         September 30, 2012      December 31, 2011
Balance Sheet Data:
Total assets                           $          7,546,299    $         2,170,322
Repurchase agreements                  $          6,117,783    $         1,706,281
Total liabilities                      $          6,631,959    $         1,961,521
Total stockholders' equity             $            914,340    $           208,801
Net asset value per common share (1)   $              25.21    $             20.87


--------


(1) Net asset value per common share was calculated by dividing our total stockholders' equity by the number of our common shares outstanding.


The following tables summarize certain characteristics of our investment portfolio by issuer and investment category as of September 30, 2012 and December 31, 2011(dollars in thousands):

                                                              As of September 30, 2012
                                                      Amortized Cost                      Weighted Average
                                       Fair Value         Basis          Par Value      Coupon      Yield (1)
Fannie Mae                            $ 5,376,865     $  5,224,646     $ 4,970,551       3.45 %         2.40 %
Freddie Mac                               960,373          933,781         885,768       3.60 %         2.61 %
Agency total / weighted average         6,337,238        6,158,427       5,856,319       3.47 %         2.43 %
Non-agency securities (2)                 552,787          517,896         879,042       1.81 %         7.24 %
Total / weighted average              $ 6,890,025     $  6,676,323     $ 6,735,361       3.26 %         2.80 %

                                                              As of December 31, 2011
                                                      Amortized Cost                      Weighted Average
                                       Fair Value         Basis          Par Value      Coupon      Yield (1)
Fannie Mae                            $ 1,316,275     $  1,305,135     $ 1,240,435       3.95%        2.85%
Freddie Mac                               423,816          421,139         396,625       4.19%        2.91%
Agency total / weighted average         1,740,091        1,726,274       1,637,060       4.01%        2.87%
Non-agency securities                      25,561           25,994          47,151       2.63%        8.10%
Total / weighted average                1,765,652        1,752,268       1,684,211       3.97%        2.94%
Non-agency securities underlying
Linked Transactions                        50,193           52,050          88,671       1.94%        7.08%
Adjusted total / weighted average     $ 1,815,845     $  1,804,318     $ 1,772,882       3.87%        3.06%



(1) The weighted average agency security yield incorporates an average future constant prepayment rate assumption of 12.7% and 11.5% as of September 30, 2012 and December 31, 2011 based on forward rates. For non-agency securities, the weighted average yield incorporates expected credit losses.

(2) As of September 30, 2012, there are no non-agency securities accounted for as Linked Transactions.

The following tables summarize certain characteristics of our agency securities portfolio as of September 30, 2012 and December 31, 2011 (dollars in thousands):

                                                            As of September 30, 2012
                                            Amortized Cost                               Weighted Average
                             Fair Value         Basis          Par Value      Coupon        Yield      Projected CPR
HARP (1)                    $ 1,869,072     $  1,808,871     $ 1,709,347       3.74 %        2.74 %          10 %
Lower Loan Balance (2)        2,781,484        2,699,337       2,553,883       3.69 %        2.59 %          11 %
Other                         1,686,682        1,650,220       1,593,088       2.84 %        1.84 %          18 %
Total                       $ 6,337,238     $  6,158,428     $ 5,856,318       3.47 %        2.43 %          13 %


                                                          As of December 31, 2011
                                           Amortized Cost                             Weighted Average
                            Fair Value         Basis          Par Value      Coupon     Yield      Projected CPR
HARP (1)                   $   538,146     $    532,847     $   499,893       4.45 %     3.22 %          12 %
Lower Loan Balance (2)         802,579          795,894         755,632       3.83 %     2.69 %          10 %
Other                          399,366          397,533         381,535       3.79 %     2.74 %          13 %
Total                      $ 1,740,091     $  1,726,274     $ 1,637,060       4.01 %     2.87 %          11 %


--------


(1) Home Affordable Refinance Program ("HARP") securities are defined as 100% refinance loans with original LTVs greater than or equal to 80%.

(2) Lower loan balance securities represent pools with maximum original loan balances less than or equal to $150 thousand.


The following tables summarize certain characteristics of our agency securities portfolio by term and coupon as of September 30, 2012 and December 31, 2011 (dollars in thousands):

                                       As of September 30, 2012
                                                                Weighted Average
          Fair Value     Amortized Cost Basis     Par Value        Yield        Projected CPR
15-Year
2.5%     $ 1,152,375    $           1,129,512    $ 1,095,785        1.55 %              18 %
3.0%         280,276                  272,157        262,412        2.10 %              12 %
3.5%         364,331                  352,713        337,985        2.30 %              15 %
4.0%         340,223                  334,249        312,906        2.03 %              16 %
4.5%          23,339                   22,698         21,220        2.60 %              14 %
Total    $ 2,160,544    $           2,111,329    $ 2,030,308        1.83 %              16 %
20-Year
3.5%     $    88,676    $              85,527    $    82,120        2.53 %              14 %
4.0%           9,779                    9,441          9,038        2.54 %              21 %
5.0%           4,252                    4,310          3,917        2.40 %              17 %
Total    $   102,707    $              99,278    $    95,075        2.52 %              14 %
30-Year
3.5%     $ 2,352,965    $           2,288,639    $ 2,178,590        2.68 %              10 %
4.0%       1,539,826                1,485,615      1,390,355        2.82 %              11 %
4.5%         129,042                  123,311        115,431        3.20 %              12 %
5.0%          52,154                   50,256         46,559        3.04 %              17 %
Total    $ 4,073,987    $           3,947,821    $ 3,730,935        2.75 %              11 %


                                         As of December 31, 2011
                                                                  Weighted Average
           Fair Value      Amortized Cost Basis      Par Value       Yield        Projected CPR
15-Year
3.0%      $     53,265    $               53,082    $   51,448        2.35 %               8 %
3.5%           345,563                   342,475       327,883        2.50 %              10 %
4.0%           245,936                   244,080       230,404        2.48 %              13 %
4.5%            25,654                    25,524        23,735        2.64 %              12 %
Total     $    670,418    $              665,161    $  633,470        2.48 %              11 %
20-Year
3.5%      $    187,075    $              186,333    $  180,216        2.78 %               8 %
4.0%            61,133                    60,679        58,001        2.24 %              26 %
5.0%            54,421                    54,427        50,174        2.95 %              15 %
Total     $    302,629    $              301,439    $  288,391        2.70 %              13 %
30-Year
4.0%           318,918                   316,231       301,996        3.21 %              10 %
4.5%           328,106                   324,686       303,853        3.33 %              11 %
5.0%           120,020                   118,757       109,350        3.25 %              16 %
Total     $    767,044    $              759,674    $  715,199        3.27 %              11 %

Actual maturities of agency MBS are generally shorter than stated contractual maturities primarily as a result of prepayments of principal of the underlying mortgages. The stated contractual final maturity of the mortgage loans underlying our portfolio of securities can range up to 40 years, but the expected maturity is subject to change based on the actual and expected future prepayments of the underlying loans.
In determining the estimated weighted average years to maturity and yields on our agency MBS, we estimate the percentage of outstanding principal that is prepaid over a period of time on an annualized basis, or CPR, based on assumptions for each security using a combination of a third-party service, market data and internal models. The third-party service estimates prepayment speeds using models that incorporate the forward yield curve, mortgage rates, current mortgage rates of the outstanding loans, loan age, volatility and other factors. We have estimated that the CPR over the remaining life of our aggregate agency investment portfolio is 12.7% and 11.5% as of September 30, 2012 and December 31, 2011, respectively. Based on these prepayment assumptions, the weighted average expected life of our agency securities was 6.0 years and 5.9 years as of September 30, 2012 and December 31, 2011, respectively. 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 projected CPRs, using the effective yield method. Since the weighted average cost basis of our agency MBS portfolio was 105.2% 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 securities at fair value, according to their estimated weighted average life classifications as of September 30, 2012 and December 31, 2011 (dollars in thousands):

                                 As of September 30, 2012                     As of December 31, 2011
                                                         Weighted                                    Weighted
                             Fair          Amortized      Average        Fair          Amortized      Average
 Weighted Average Life       Value           Cost          Yield         Value           Cost          Yield
Greater than one year
and less than or equal
to three years           $         -     $         -           - %   $    55,582     $    55,260        2.17 %
Greater than three years
and less than or equal
to five years              2,366,106       2,308,621        1.92 %       425,251         422,406        2.49 %
Greater than five years
and less than or equal
to 10 years                3,949,518       3,828,590        2.74 %     1,259,258       1,248,608        3.02 %
Greater than 10 years         21,614          21,216        2.75 %             -               -           - %
Total / weighted average $ 6,337,238     $ 6,158,427        2.43 %   $ 1,740,091     $ 1,726,274        2.87 %

Non-agency MBS yields are based on our estimate of the timing and amount of future cash flows and our cost basis. Our cash flow estimates for these investments are based on our observations of current information and events and include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses and other factors. The following table summarizes our non-agency securities (including those underlying Linked Transactions) at fair value, by their estimated weighted average life classifications as of September 30, 2012 and December 31, 2011 (dollars in thousands):

                                       As of September 30, 2012                    As of December 31, 2011
                                                              Weighted                                    Weighted
                                                Amortized      Average                      Amortized      Average
   Weighted Average Life        Fair Value         Cost         Yield      Fair Value         Cost          Yield
Less than or equal to five
years                          $    77,542     $   74,166        6.46 %   $    12,394     $    12,423        6.25 %
Greater than five years and
less than or equal to seven
years                              248,776        233,890        6.75 %        63,360          65,621        7.64 %
. . .
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