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| AGNC > SEC Filings for AGNC > Form 10-K on 27-Feb-2013 | All Recent SEC Filings |
27-Feb-2013
Annual Report
• Financial Condition
• Results of Operations
• Liquidity and Capital Resources
• Forward-Looking Statements
EXECUTIVE OVERVIEW
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 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 mortgage-backed
securities into new agency mortgage-backed security 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 mortgage-backed
securities 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 are and likely will continue to be concentrated
in newly-issued, fixed-rate agency mortgage-backed securities (i.e., the part of
the mortgage market with the greatest impact on mortgage rates offered to
borrowers). The combined total purchases of agency mortgage-backed securities by
the Federal Reserve were approximately $70 billion per month during the fourth
quarter of 2012, representing approximately half of the average monthly gross
issuance of fixed-rate agency mortgage-backed securities. Prices across the
agency mortgage-backed security spectrum generally increased following the
Federal Reserve's announcement of QE3, with the lowest coupon 30-year and
15-year fixed-rate agency mortgage-backed securities outperforming higher coupon
securities. During the fourth quarter of 2012, some of the initial gains
reversed; however, as of December 31, 2012 prices generally remained above those
seen prior to the announcement of QE3. The table below summarizes interest rates
and prices of generic fixed-rate agency mortgage-backed securities as of the end
of each respective quarter:
December 31, December 31,
2012 2012
vs. vs.
Interest June March
Rate/Security December September 30, 30, 31, December 31, June 30, 2012 December 31,
Price (1) 31, 2012 2012 2012 2012 2011 (Pre - QE3) 2011
LIBOR:
1-Month 0.21% 0.21% 0.25% 0.24% 0.30% --0.04 bps --0.09 bps
3-Month 0.31% 0.36% 0.46% 0.47% 0.58% --0.15 bps --0.27 bps
6-Month 0.51% 0.64% 0.73% 0.73% 0.81% --0.22 bps --0.30 bps
U.S. Treasury
Security Rate:
2-Year U.S.
Treasury 0.25% 0.23% 0.30% 0.33% 0.24% --0.05 bps +0.01 bps
5-Year U.S.
Treasury 0.72% 0.63% 0.72% 1.04% 0.83% - bps --0.11 bps
10-Year U.S.
Treasury 1.76% 1.63% 1.65% 2.21% 1.88% +0.11 bps --0.12 bps
Interest Rate
Swap Rate:
2-Year Swap 0.39% 0.37% 0.55% 0.58% 0.73% --0.16 bps --0.34 bps
5-Year Swap 0.86% 0.76% 0.97% 1.27% 1.22% --0.11 bps --0.36 bps
10-Year Swap 1.84% 1.70% 1.78% 2.29% 2.03% +0.06 bps --0.19 bps
30-Year Fixed Rate
MBS Price:
3.0% $104.84 $105.58 $102.55 $99.67 $100.22 +$2.29 +$4.62
3.5% $106.66 $107.25 $105.11 $102.72 $102.88 +$1.55 +$3.78
4.0% $107.22 $107.75 $106.44 $104.86 $105.03 +$0.78 +$2.19
4.5% $108.03 $108.25 $107.28 $106.38 $106.42 +$0.75 +$1.61
5.0% $108.33 $109.06 $108.23 $108.03 $108.03 +$0.10 +$0.30
5.5% $108.64 $109.63 $109.08 $108.97 $108.89 -$0.44 -$0.25
6.0% $109.22 $110.44 $109.91 $110.20 $110.16 -$0.69 -$0.94
15-Year Fixed Rate
MBS Price:
2.5% $104.61 $105.13 $103.09 $101.42 $101.34 +$1.52 +$3.27
3.0% $105.61 $106.00 $104.77 $103.56 $103.28 +$0.84 +$2.33
3.5% $106.14 $106.41 $105.66 $104.92 $104.58 +$0.48 +$1.56
4.0% $107.00 $106.91 $106.34 $106.00 $105.50 +$0.66 +$1.50
4.5% $107.55 $107.84 $107.17 $107.20 $106.59 +$0.38 +$0.96
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We expect during periods in which the Federal Reserve purchases significant volumes of mortgages, yields on agency mortgage-backed securities will be lower and refinancing volumes will be higher than would have been absent QE3. Since returns on agency mortgage-backed securities are highly sensitive to prepayment speeds, we have positioned our investment portfolio towards agency securities that we believe have favorable prepayment attributes. As of December 31, 2012, 77% 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 HARP (pools backed by 100% refinance loans with original loan-to-value ratios of greater than 80%), which we believe have a lower risk of prepayment relative to generic agency securities. The remainder of our portfolio as of December 31, 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 December 31, 2012).
The following table summarizes recent prepayment trends for our portfolio and,
for comparison, Fannie Mae 2011 30-year 4.0% fixed-rate generic mortgage-backed
securities for fiscal year 2012.
Annualized Monthly Constant Prepayment May Rates (1) Jan. 2012 Feb. 2012 Mar. 2012 Apr. 2012 2012 June 2012 July 2012 Aug. 2012 Sept. 2012 Oct. 2012 Nov. 2012 Dec. 2012 AGNC portfolio 8% 8% 12% 12% 10% 8% 8% 9% 11% 9% 10% 10% Fannie Mae 2011 30-year 4.0% fixed-rate MBS (2) 11% 13% 19% 21% 14% 15% 21% 29% 35% 32 % 34% 35% ________________________ |
2. Source: JP Morgan.
Summary of Critical Accounting Estimates
Our critical accounting estimates relate to the recognition of interest income
and the fair value of our investments 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 based on such estimates. The remainder of our significant accounting
policies are described in Note 2 to the consolidated financial statements
included under Item 8 of this Annual Report on Form 10-K.
Interest Income
The effective yield on our agency securities is highly impacted by our estimate
of future prepayments. We accrue interest income based on the outstanding
principal amount of our investment securities and their contractual terms and we
amortize or accrete premiums and discounts associated with the purchase of
investment securities into interest income over the projected lives of our
securities, including contractual payments and estimated prepayments, using the
interest method. The weighted average cost basis of our securities as of
December 31, 2012 was 105.6% of par value; therefore, faster actual or projected
prepayments can have a meaningful negative impact, while slower actual or
projected prepayments can have a meaningful positive impact, on our asset
yields.
Future prepayment rates are difficult to predict and we rely on a third-party
service provider and our Manager's experience and analysis of historical and
current market data in order to arrive at what we believe to be reasonable
estimates. Our third-party service provider estimates prepayment speeds using
models that incorporate the forward yield curve, current mortgage rates and
mortgage rates of the outstanding loans, age and size of the outstanding loans,
loan-to-value ratios, volatility and other factors. We review the prepayment
speeds estimated by the third-party service and compare the results to market
consensus prepayment speeds, if available. We also consider historical
prepayment speeds and current market conditions to validate the reasonableness
of the prepayment speeds estimated by the third-party service and, based on our
Manager's judgment, we may make adjustments to their estimates.
We review our actual and anticipated prepayment experience on at least a
quarterly basis and effective yields are recalculated when differences arise
between (i) our previously estimated future prepayments and (ii) actual
prepayments to date plus current estimated future prepayments. If the actual and
estimated future prepayment experience differs from our prior estimate of
prepayments, we are required to record an adjustment in the current period to
the amortization or accretion of premiums and discounts for the cumulative
difference in the effective yield through the reporting date.
The most significant factor impacting prepayment rates on our securities is
changes to long-term interest rates. Prepayment rates generally increase when
interest rates fall and decrease when interest rates rise. However, there are a
variety of other factors that may impact the rate of prepayments on our
securities. Prepayments can also occur when borrowers sell the property and use
the sale proceeds to prepay the mortgage as part of a physical relocation. In
addition, changes to the GSE's underwriting standards, further modifications to
existing U.S. Government sponsored programs such as HARP, or the implementation
of new programs can have a significant impact on the rate of prepayments.
Further, GSE buyouts of loans in imminent risk of default,
loans that have been modified, or loans that have defaulted will generally be
reflected as prepayments on agency securities and also increase the uncertainty
around our estimates. Consequently, under different conditions, we could report
materially different amounts. Item 7A. Quantitative and Qualitative Disclosures
About Market Risk in this Annual Report on Form 10-K includes the estimated
change in our net interest income should interest rates go up or down by 50 and
100 basis points, assuming the yield curves of the rate shocks will be parallel
to each other and the current yield curve.
Fair Value of Investment Securities
We estimate the fair value of our investment securities based on a market
approach using Level 2 inputs from third-party pricing services and non-binding
dealer quotes. The third-party pricing services use pricing models that
incorporate such factors as coupons, primary and secondary mortgage rates,
prepayment speeds, spread to the Treasury and interest rate swap curves,
convexity, duration, periodic and life caps and credit enhancements. The dealer
quotes incorporate common market pricing methods, including a spread measurement
to the Treasury or interest rate swap curve as well as underlying
characteristics of the particular security including coupon, periodic and life
caps, rate reset period, issuer, additional credit support and expected life of
the security. We generally obtain 3 to 6 quotes or prices (referred to as
"marks") per investment security. We attempt to validate marks obtained from
pricing services and broker dealers by comparing them to our recent completed
transactions involving the same or similar securities on or near the reporting
date. Changes in the market environment and other events that may occur over the
life of our investments may cause the gains or losses ultimately realized on
these investments to be different than the valuations currently estimated.
Derivative Financial Instruments/Hedging Activity
We maintain a risk management strategy, under which we may use a variety of
derivative instruments to economically
hedge some of our exposure to market risks, including interest rate and
prepayment risk. Our risk management objective is to reduce fluctuations in net
book value over a range of market conditions. The principal instruments that we
use to hedge a portion of our exposure to interest rate and prepayment risks are
interest rate swaps and swaptions. We also purchase or sell TBAs and specified
agency securities on a forward basis as well as U.S. Treasury securities and
U.S. Treasury futures contracts; purchase or write put or call options on TBA
securities; and invest in other types of mortgage derivatives, such as
interest-only securities, and synthetic total return swaps, such as the Markit
IOS Synthetic Total Return Swap Index ("Markit IOS Index").
We recognize all derivatives as either assets or liabilities on the balance sheet, measured at fair value. During the third quarter of 2011, we elected to discontinue hedge accounting for our interest rate swaps. Accordingly, subsequent to the third quarter of 2011, all changes in the fair value of our derivative instruments are reported in earnings in our consolidated statement of comprehensive income in gain (loss) on derivatives and other securities, net during the period in which they occur.
The use of derivatives creates exposure to credit risk relating to potential
losses that could be recognized in the event that the counterparties to these
instruments fail to perform their obligations under the contracts. We attempt to
minimize this risk by limiting our counterparties to major financial
institutions with acceptable credit ratings, monitoring positions with
individual counterparties and adjusting posted collateral as required.
We estimate the fair value of interest rate swaps using a third-party pricing
model. The third-party pricing model incorporates such factors as the LIBOR
curve and the pay rate on our interest rate swaps. We also incorporate both our
own and our counterparties' nonperformance risk in estimating the fair value of
our interest rate swaps. In considering the effect of nonperformance risk, we
consider the impact of netting and credit enhancements, such as collateral
postings and guarantees, and have concluded that our own and our counterparty
risk is not significant to the overall valuation of these agreements.
We estimate the fair value of interest rate swaptions using a third-party
pricing model based on the fair value of the future interest rate swap that we
have the option to enter into as well as the remaining length of time that we
have to exercise the option, adjusted for non-performance risk, if any.
Recent Accounting Pronouncements
A summary of recent accounting pronouncements is included in Note 2 of the
accompanying consolidated financial statements in this Annual Report on Form
10-K.
FINANCIAL CONDITION
As of December 31, 2012 and 2011, our investment portfolio consisted of $85.2
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 December 31, 2012 and 2011 (dollars in
millions):
December 31, 2012
December
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 Age (Months) (1)
Investments By Issuer:
Fannie Mae $ 58,912 $ 62,120 105.4% $ 63,687 3.59% 2.60% 13 10%
Freddie Mac 19,336 20,284 104.9% 20,758 3.58% 2.58% 14 12%
Ginnie Mae 238 248 104.2% 254 3.77% 1.60% 24 19%
Total / Weighted Average $ 78,486 $ 82,652 105.3% $ 84,699 3.59% 2.59% 13 11%
Investments By Security
Type:
Fixed-Rate
? 15-Year
Lower Loan Balance (2) $ 15,686 $ 16,296 103.9% $ 16,871 3.57% 2.53% 20 13%
HARP (3) 1,312 1,363 103.9% 1,404 3.53% 2.46% 17 14%
Other (2009-2012
Vintages) (4) 11,134 11,612 104.3% 11,670 2.70% 1.62% 7 13%
Other (Pre 2009
Vintages) 31 33 104.7% 34 4.61% 2.71% 88 16%
Total ? 15-Year 28,163 29,304 104.1% 29,979 3.22% 2.17% 15 13%
Total 20-Year: 1,517 1,591 104.9% 1,616 3.33% 2.37% 8 10%
30-Year:
Lower Loan Balance (2) 19,004 20,169 106.1% 20,736 3.76% 2.84% 13 9%
HARP (3) 22,897 24,316 106.2% 24,998 3.84% 2.87% 11 9%
Other (2009-2012
Vintages) (4) 5,510 5,815 105.5% 5,875 3.63% 2.70% 9 10%
Other (Pre 2009
Vintages) (4) 394 422 107.1% 431 5.62% 3.64% 87 19%
Total 30-Year 47,805 50,722 106.1% 52,040 3.80% 2.84% 12 9%
Total Fixed-Rate 77,485 81,617 105.3% 83,635 3.58% 2.59% 13 11%
Adjustable-Rate 837 865 103.4% 891 4.12% 2.40% 43 22%
CMO 164 170 103.2% 173 3.75% 2.85% 66 15%
Total / Weighted Average $ 78,486 $ 82,652 105.3% $ 84,699 3.59% 2.59% 13 11%
December 31, 2012
December
Underlying Weighted Average 2012
Agency MBS Remeasured at Unamortized Projected
Fair Value Through Principal Amortized Life CPR
Earnings Balance Cost Fair Value Coupon Yield Age (Months) (1)
Interest-Only Strips
Fannie Mae $ 1,332 $ 245 $ 249 5.82% 6.98% 30 16%
Freddie Mac 328 55 43 5.60% 11.84% 82 17%
Principal-Only Strips
Fannie Mae 302 241 254 -% 3.17% 14 9%
Total / Weighted Average $ 1,962 $ 541 $ 546 4.89% 5.78% 28 13%
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2. 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 December 31, 2012.
3. HARP securities are defined as pools backed by100% refinance loans with loan-to-value ratios ("LTV") ? 80%. Our HARP securities had a weighted average LTV of 95% and 104% for 15-year and 30-year securities, respectively, as of December 31, 2012.
4. Other 15-year and 30-year securities include $1.2 billion and $920 million, respectively, of securities backed by loans with original loan balances ? $175,000.
December 31, 2011
December
Weighted Average 2011
Projected
Amortized Amortized Life CPR
Agency MBS Classified as AFS Par Value Cost Cost Basis Fair Value Coupon Yield Age (Months) (1)
Investments By Issuer:
Fannie Mae $ 37,232 $ 38,891 104.5% $ 39,567 4.07% 3.02% 11 14%
Freddie Mac 13,736 14,342 104.4% 14,664 4.21% 3.16% 13 14%
Ginnie Mae 258 270 104.7% 273 3.74% 1.71% 12 25%
Total / Weighted Average $ 51,226 $ 53,503 104.4% $ 54,504 4.11% 3.05% 12 14%
Investments By Security Type:
Fixed-Rate
? 15-Year:
Lower Loan Balance (2) $ 16,033 $ 16,626 103.7% $ 17,027 3.81% 2.84% 12 12%
HARP (3) 1,160 1,208 104.2% 1,235 3.93% 2.87% 10 12%
Other (4) 1,814 1,873 103.2% 1,898 3.54% 2.58% 10 15%
Total ? 15-Year 19,007 19,707 103.7% 20,160 3.79% 2.82% 12 13%
Total 20-Year: 5,462 5,659 103.6% 5,710 3.71% 2.72% 4 16%
30-Year:
Lower Loan Balance (2) 4,577 4,847 105.9% 4,927 4.48% 3.40% 15 11%
HARP (3) 11,676 12,318 105.5% 12,591 4.48% 3.50% 9 11%
Other (2009-2011 Vintages) 6,987 7,307 104.6% 7,380 4.24% 3.17% 6 15%
Other (Pre 2009 Vintages) 655 697 106.3% 715 5.59% 3.37% 72 25%
Total 30-Year 23,895 25,169 105.3% 25,613 4.44% 3.38% 11 12%
Total Fixed-Rate 48,364 50,535 104.5% 51,483 4.10% 3.09% 11 13%
Adjustable-Rate 2,627 2,725 103.7% 2,774 4.29% 2.58% 31 32%
CMO 235 243 103.1% 247 3.74% 1.69% 56 29%
Total / Weighted Average $ 51,226 $ 53,503 104.4% $ 54,504 4.11% 3.05% 12 14%
December 31, 2011
December
Underlying Weighted Average 2011
Unamortized Projected
Agency MBS Remeasured at Fair Principal Amortized Life CPR
Value Through Earnings Balance Cost Fair Value Coupon Yield Age (Months) (1)
Interest-Only Strips
Fannie Mae $ 687 $ 90 $ 86 5.55% 6.62% 63 31%
Freddie Mac 453 66 56 5.48% 10.35% 79 25%
Principal-Only Strips
Fannie Mae 40 35 37 -% 5.40% 48 31%
Total / Weighted Average $ 1,180 $ 191 $ 179 5.33% 7.70% 65 29%
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2. 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 . . .
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