AGNC Investment Corp (AGNCN) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the AGNC shareholders' conference call.

(Operator Instructions).

As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, [Katie Wisecarver].

Please go ahead.

Thanks, Roxanne.

Thank you for joining American Capital Agency's fourth-quarter 2008 earnings call.

Before we begin I would like to review the Safe Harbor statement.

This conference call and corresponding slide presentation contains statements that, to the extent they are not recitations of historical fact, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act.

Actual outcomes and results could differ materially from those forecast due to the impact of many factors beyond the control of the AGNC.

Certain factors that could cause actual results to differ materially are included in the risk factors section of AGNC's prospectus dated May 15, 2008 and periodic reports filed with the Securities and Exchange Commission.

Copies are available on the SEC's web site at www.SEC.gov.

We disclaim any obligation to update our forward-looking statements.

An archive of this presentation will be available on our website, and the telephone recording can be accessed through February 19 by dialing 800-475-6701, and the replay pass code is 982407.

To view the Q4 slide presentation, turn to our website, AGNC.com, and click on the Q4 2008 shareholder presentation link in the upper-right corner.

Select the conference call option to view the streaming slide presentation or the webcast option for both slides and audio.

If you have any trouble with the webcast during this presentation, please hit F5 to refresh.

At this time I would like to turn the call over to Malon Wilkus.

Thank you, Katie.

And thanks everyone for joining us.

Here with me is John Erickson, President of Structured Products and the Chief Financial Officer; Bob Grunewald, who is Vice President and Managing Director of our Financial Services Group; and Gary Kain, our new Senior Vice President and Chief Investment Officer.

Gary most recently served as Senior Vice President of Investments and Capital Markets of Federal Home Loan Mortgage Corporation, and Gary was responsible for managing all of Freddie Mac's mortgage investment activities for the company's $700 billion retained portfolio.

I have to say that the depth and breadth of Gary's experience managing all aspects of Freddie Mac's mortgage investment portfolio -- investment strategies, liability management, hedging, and interest rate risk management -- highlights his extensive knowledge of the agency mortgage-backed security market.

And we're very pleased to have Gary here, and Gary will be conducting a substantial portion of this presentation.

Let me move to slide five to get started.

We are very pleased to report that Agency was able to successfully maneuver through a very harrowing fourth quarter with good results, and we declared -- that led us to declare and pay a $1.20 per share dividend.

We produced $0.73 per share of net income, and $0.47 of that was related to our option strategy, which we will talk more about.

But I do want to point out that we have closed out all our option positions prior to December 31 of '08.

In the fourth quarter we had a 16.5% annualized return on equity, and on an annualized basis we had an interest rate spread of about 1.19%.

That was down in part by because of new assumptions having to do with speed of repayment.

We will talk more about that in a few minutes.

But as of December 31, our annualized net interest rate spread is 1.46%.

We had $1.6 billion of investment portfolio at the end of the year, and we ended the year with 5.2 times leverage and a $17.20 book value.

Inception to date -- and I apologize for the background.

We seem to always get that during these calls, so let me wait till they pass.

Inception to date we declared and paid $2.51 in dividends and earned $2.36 dollars per share of net income.

$0.78 of that was related to our option strategy, and we had a 21.4% annualized return on equity for the year.

And of course this is a stub year starting at our IPO on May 20.

We had an annualized net interest rate spread for the year of 2.41%, and then we have ended the year with $0.29 of undistributed taxable income which we intend to pay out as a dividend in 2009.

The biggest development in the fourth quarter, which I'm sure all of you are pretty aware of, was the tremendous volatility in the mortgage market.

And so on slide seven we show the MOVE index, which is an index of mortgage market volatility.

And you can see that it recorded its highest level in its history in the third and fourth quarter of 2008, and the high point occurred on October 10 at 265 on that index.

We believe that -- we were concerned about the potential of great volatility in the mortgage market prior to the fourth quarter and so in the third quarter delevered quite substantially down to approximate five times.

And as it developed, we are very pleased that we took that initiative.

We think that had the federal government not stepped in to backstop commercial paper in the week of October 10, that the volatility would have actually exceeded the high to 265 and would've extended out for a very long time.

And in that kind of environment you want to -- and it is much safer to -- be far less levered than normal.

So we took that initiative in the third quarter in addressing and adjusting to the developments that were happening in the capital markets.

We delevered and at the same time we entered into a variety of options that -- contracts which we felt were able to take advantage of this great volatility that we were anticipating.

And I have to say, had kind of the worst that were to happen in holding those contracts, were they to be -- cull all our assets away, we would've just ended up the quarter with a lower level of leverage, which -- had that were to have happened, we would've been pleased about.

So we were pleased with the option strategies but, as I said earlier, we have unwound that entirely and we're starting this first quarter entirely in an -- in a position where we have no options.

With that I should also point out that the volatility has declined quite considerably, and it's back to levels that are more consistent with the average experience of the MOVE index.

And with that I would like to turn to slide eight and hand it over to Gary to make a few comments.

Well thank you, Malon, very much.

And good morning, everybody.

I'm really excited about having joined the AGNC team, and I am looking forward to meeting many of you over the next few months.

Today I want to focus my discussions in four areas.

First, I want to give you my perspective on successful mortgage investing.

Then I want to do a quick recap of the market during the fourth quarter.

An overview of AGNC's investment portfolio and how I see our portfolio evolving given the current market opportunities.

We will begin on slide eight with an overview of the investment framework we will use going forward.

Successful mortgage investing is built on three critical components -- asset selection, risk management, and funding.

And all three are necessary to generate attractive returns while protecting shareholder value.

The first step is obviously asset selection.

I think everyone would agree that selecting securities that provide superior risk-adjusted returns is job one.

But the real question is, how are we going to go about doing that?

So first we need to isolate the sectors of the agency mortgage market that provide the best relative value at any given time.

To do this effectively we must look at all areas of the market from short reset ARMs to 30-year pass-throughs.

Then within each of these sectors and even subsectors below those, we must diligently and proactively isolate individual securities that are going to outperform.

It is absolutely essential to evaluate the loan characteristics backing the individual pools, even though they all have agency guarantees, in order to optimize our prepayment performance.

And while this is generally the case, it is imperative now because of the large numbers of borrowers that face significant hurdles to refinance.

Now, it's important to note we can't make these evaluations in a vacuum, but we must consider the broader, fixed-income trends and the macro developments within the global markets and the global economy.

And American Capital and its Management can provide some unique insights into some of these trends.

Now let's shift over to the right side of the page and talk about the funding piece.

Very cheap assets are great, but they're not going to translate into good returns if they can't be financed at attractive levels and if they can't be levered.

This is something that will continue to be a focus of ours at AGNC.

Our mandate to stay 100% within the agency or government market helps a lot in disregard, but we've got to be careful that even within the agency market there is varying liquidity amongst different types of securities.

Let's face it.

It's a lot easier to finance a 30-year mortgage than it is a typical REMIC tranche.

So lastly, when we are employing leverage, appropriate hedging strategies and risk management are essential to protecting shareholder value.

That is why risk management is at the center of successful investing.

Yes, it begins with appropriate asset selection and prudent use of leverage, but it goes well beyond this.

It is imperative to correctly assess the various risks inherent in our portfolio, and this starts with interest rate risk including duration and convexity and volatility, but it's important to note these risks can't be evaluated and hedged without careful consideration of the prepayment uncertainty and the spread risk.

In today's market the bottom line is that the latter two issues really can dwarf generic interest rate risk issues for a lot of the assets that we're going to be talking about.

As many of you know, the historical correlations between assets and hedges don't apply as much anymore.

A very simple example of this is, take a floating-rate security that has very, very little interest rate risk, but it has a long average life.

This instrument still has substantial spread risk and therefore price risk, and this was very evident during the fourth quarter.

So look, we're committed to evaluating the total of these risks in an effort to balance protecting book value and maintaining that interest income.

That being said, we are not attempting to eliminate risk, but we are willing to take some chips off the table to manage the portfolio within acceptable risk bands.

So with that said, let's move on to slide nine, and I want to briefly talk about Q4.

While it seems like every quarter people have said this on calls throughout the financial services industry, but the volatility during the fourth quarter was unprecedented and even by today's standards.

A rapidly deteriorating economy coupled with the events that transpired in September including the conservatorship of the GSEs, Lehman bankruptcy, AIG and the forced bank mergers led to a complete loss of confidence as we entered the fourth quarter.

LIBOR shot up to over 4%, and the availability of repo financing was scarce to say the least.

Asset prices set new lows as spreads widened in all sectors, and this included the agency mortgage market.

Governments around the globe were forced to intervene, as Malon mentioned, in attempt to add stability and restore liquidity in the markets.

Treasury made substantial capital infusions into the largest financial institutions.

The Fed cut the targets -- the funds target to between zero and 25 basis points and announced a number of other liquidity-oriented facilities.

Importantly, they also announced that they would buy $500 billion in MBS and $100 billion in agency debt.

This was, again, in addition to the Treasury's ongoing mortgage purchases and GSE activity.

Treasury rates fell to levels not seen since the '50s with the five-year closing at around 1.5%, which was down basically 150 basis points for the quarter.

Five-year swap rates dropped almost 190 basis points, and by the end of the quarter 1 month LIBOR had fallen 350 basis points.

The Fed announcements and these market conditions allowed current coupon mortgage rates to participate in the rally and provided support to the mortgage market as a whole.

That being said, premium mortgages in other sectors of the market, while substantially higher in dollar price, did lag other -- did lag current coupons as prepayment uncertainty really moved to the forefront of people's minds.

With this as the backdrop, why don't we move on to slide 10 and talk about the AGNC portfolio.

Now, I've been here for a little over a week, but I already feel comfortable with the portfolio.

It's not because I've been pulling all-nighters, but because the portfolio is actually very straightforward.

As you can see on slide nine, the portfolio's comprised of 100% fixed-rate mortgages, which has been beneficial in an environment where liquidity and financing pressures have been paramount.

The portfolio totals $1.6 billion, and it's split between Fannies, Freddies, and Gennies.

30 year 6's comprise the vast majority of the portfolio, and that is evidenced by the average coupon of 6.1% -- or 6.11%.

I want to quickly touch on a couple of key points here.

First, given the substantial drop in mortgage rates, prepayment expectations have picked up significantly.

AGNC is now projecting lifetime speeds of around 36% on the portfolio.

But it's important to note that this allows for speeds to peak around 50 CPR for a while before declining over time.

As a point of reference, speeds on the portfolio averaged 13% CPR during the quarter, so our current projections incorporate a very substantial increase in prepayments.

Let's turn to slide 11, and I want to take a quick look at the liabilities and hedges.

First of all, the $1.3 billion in repo was diversified over a wide variety of counterparties with no more than 8% of our equity with any one company.

Additionally, the vast majority of the repo entered into during the quarter was in excess of 30 days.

And as you can see in the table on the bottom left, while this adversely impacted the funding costs for the quarter, it did greatly reduce our financing risk over year end.

Importantly for Q1, the weighted average maturity as of December 31 was only 23 days, so these higher-cost repo's will be rolling off relatively quickly.

Now let's look at the swap position at the bottom right.

Rates have fallen since the swaps were put on, so the swaps will clearly increase our weighted average funding cost going forward.

That being said, given our low leverage as of December 31, spreads on incremental purchases will not be affected by these positions.

So if we turn to slide 12, we can take a quick look at the business economics for Q4.

First thing I want to point out to you is the asset yields.

I notice that the average asset yield for Q4, 4.24% -- which is at the top leftmost column -- was 74 basis points lower than the 4.98% yield at December 31 -- and that's in the column on the right.

This is because of catch-up amortization which results from the significant increase in the prepayment expectations that I discussed earlier.

Thus, while this materially impacted our net interest income in Q4, in the absence of further increases in prepayment speeds from the 36% CPR, the 74 basis point catch-up component won't affect us in Q1 as, again, the 4.98% yield already incorporates these faster speed assumptions.

The next thing I want to highlight is the funding cost numbers.

Our weighted average funding cost was 3.05% during Q4 and 3.52% at year end.

These increases were a function of the spike in LIBOR, the extension of the term of our repo's, and the swap cost.

Clearly, we anticipate our funding costs dropping materially during the current quarter given the market conditions.

For example, we have already rolled over $1 billion in repo at average rates below 75 basis points.

The last area to highlight is the leverage ratio, which as Malon mentioned, remains low at 5.2% at year end.

When you look at this picture, it's important to evaluate the combination of these three issues -- the impact of catch-up "am," the decline in repo rates, and the potential to increase leverage when assessing the earnings power of the portfolio going forward.

I think Malon covered the remainder of this page in his overview including the impact of the option strategy, so I will ask you to turn to page 13 so we can look at the changes in book value.

First off, book value per share declined slightly from $17.85 to $17.20 per share during the quarter.

This on its own was a very respectable outcome.

But I want to highlight for you the key driver of that decline because it's pretty important.

First, let's look at the unrealized gain on the asset portfolio coupled with the unrealized losses on the swap book.

Notice they largely offset each other despite the very volatile quarter, and that's important.

The majority of the decline in book value actually resulted from the difference in the size of our dividends -- the $1.20 per share which is, again, based on taxable income -- versus the $0.73 of GAAP net income.

Thus, the bulk of the book value decline related to the dividend payment and thus the GAAP versus tax differences rather than a deterioration in the performance of the portfolio or a mismatch between the swaps and the asset performance.

Having said that, we have now covered the first three topics I discussed at the beginning, and so I want to move on to the last -- and are the most important part of the call from my perspective -- the current market, and how I see our portfolio involving given the current investment landscape.

So as we look forward to 2009, the investment landscape has changed dramatically.

First and foremost, interest rates have plummeted, and the government has committed to massive purchases of agency fixed-rate mortgages.

While the combination of these developments has lowered mortgage yields and increased prices, as I mentioned earlier, risk-adjusted returns on many sectors of the agency market are still attractive.

This is especially true given the significant improvement we've seen on the funding side.

Against a backdrop, our current plans are to increase our leverage to levels closer to that of our peers and to begin to diversify our portfolio to take advantage of opportunities in the other sectors of the agency mortgage market.

And we have recently begun that process.

That being said, these changes will take time and will be done prudently and opportunistically.

So let's take a little closer look at opportunities within the mortgage market.

Despite the increase in prices, we believe that risk-adjusted returns on premium 30-year fixed-rate mortgages, seasoned 15-year product, and some components of the ARM market offer attractive returns.

In general, yields on these instruments average between the low 3% area on seasoned hybrids to the mid-4% area on some of the more attractive 30-year mortgages.

Now, these yields incorporate prepayment assumptions that allow for peak speeds on 30-years to reach 50% CPR and, again, have average speeds between 35 and 40.

But even in a more pessimistic scenario where peak speeds could reach 70 CPR and lifetime speeds are in the mid-50s, yields could still -- would still come in around 3.5% on 30-year 6's, for example, given current market prices.

With respect to seasoned 15-year and hybrid ARMs, yields are somewhat lower -- generally 25 to 75 basis points depending on the instrument.

But there is less extension and obviously less exposure to the long end of the curve, and so the lower all-in funding costs can provide us with very competitive risk return profiles.

In these sectors, individual security selection is more important as these markets are clearly less liquid and harder to evaluate.

However, I want to be clear.

Given my background, I actually view this as an opportunity to add incremental value for our investors, rather than a concern.

So what does this mean for spreads?

Given the asset yields I touched on earlier and the relatively short durations of a diversified portfolio, we're comfortable the net spreads will be attractive when on new purchases given one-month repo rates comfortably below 75 basis points and even two-year swap rates around 160 basis points.

Furthermore as I mentioned earlier, there is room for speeds to come in above or at base expectations and for returns to still remain competitive.

However, I do need to be clear that market conditions can change very quickly, as we have seen a number of times, and as such our plans with respect to both -- with respect to leverage, product diversification, and expected funding mix are going to be sensitive to these changes and could change materially.

In addition, in the environment where government purchases, new legislation, and other actions can rewrite the playbook at any time, prepayment expectations and thus yields and net spreads can change overnight, so our strategies will involve with these changes if they occur.

Now I want to conclude by saying that I'm here because I am extremely optimistic about the prospects for the agency REIT business model and in particular the platform that we are continuing to strengthen here at Agency.

As you all know, the mortgage market has undergone dramatic changes over the past year, and many of these are going to endure for years to come.

The significant decline in both the number of participants and the amount of capital that is dedicated to extracting relative value in the agency market is a real plus for our business model.

Whether you look at Wall Street dealers, their prop desks, hedge funds, the -- actually foreign investors, this retrenchment is abundantly clear.

At least as significant are the changes we've seen at the GSEs and with other government mortgage investment activities.

While their involvement in the market is massive, their main objective is not risk-adjusted returns, but to stabilize and lower mortgage rates.

Agency's expertise, commitment to proactively scouring the entire agency mortgage landscape for value-added investments, and a state-of-the-art third-party analytics and risk management system, positions us very well to continue to provide our investors with attractive returns while effectively managing risk.

It also allows us to take full advantage of this new and fertile investment landscape.

So that's all we have with respect to prepared remarks.

There are some additional slides included for your reference.

And with that actually we would like to open the lines up for questions.

(Operator Instructions).

Steve Delaney, JMP Securities.

Gary, congratulations to you on your new position.

I wonder if you could, given the previous team that was in there I think were three individuals that had been together, could you update us on any progress or plans that Agency has to make any additional hires to help you build out your team for the funding side and the whole bit?

Yes.

That's a great question.

Since I've been here, I've been very impressed with the support and the team that is in place here at American Capital, and there's a lot of -- there is a lot of support already here.

That being said, we absolutely plan on adding a few people to the investment team, and those individuals will be focused not only on the financing side but also directly on the mortgage side.

We have obviously a number of products to cover, and we're very confident in this market that we can add those resources very quickly.

But again, I do want to stress that we do have a fair amount of resources here right now.

This is John Erickson.

One other thing is -- I would say, it is fortunate right now that we have the ability to build this right in Bethesda so (multiple speakers)

I was going to say, you can cherry pick McLean and DC pretty easily, can't you?

Yes.

So -- and I think that one benefit is we like the fact that this is going to be right in our office here, which is nice.

Understood.

And I guess, Gary, it's -- you are no longer with Freddie, so I know you -- and maybe you are limited to what you can say, but I don't know if you read Lockhart's comments yesterday where he spoke to -- at least I was -- I appreciated the fact that there was an awareness expressed or unintended consequences of possible changes in underwriting, meaning the streamlined refi and waiving appraisal.

Any chance you could handicap the odds of that happening for us given how significant it is for the prepay expectations that we all are worried about?

Well, let me give you some kind of color on the topic in general.

I obviously have not been up on any recent deliberations around the subject, and it was I think pretty clear from his statement that there are a lot of recent discussions.

As I -- the one thing that's important to keep in mind is that the market has priced-in a lot of changes kind of on the refi side.

The market is not assuming there -- and market prices are not assuming that all of the credit barriers that are in place right now will be maintained.

So one thing to keep in mind is, I think, there is room for some negative surprises on the refi side without that kind of really hammering mortgages.

On the other side of that, even if we end up with -- we get back to the lows in the mortgage market, even if we see negative surprises on the streamlined refi side, and those things happen, there are a lot of good reasons to believe that prepayments are still going to be below, and maybe well below, what we saw in 2003.

In 2003 a lot of the refi's were cash-out refi's.

Those are not going to happen.

A lot of the prepayments we saw were related to housing turnover.

Obviously I think it goes without saying, a slightly more robust market back then.

And the difference between the spread that originators were working for and the originator capacity was very different back then.

And so all of these things -- in addition to the obvious one, which are the credit barriers -- are still going to be there, and some of them can be addressed, but many of them can't.

So I hope that helps with respect to your question.

No.

It certainly does in a general sense, but -- so I mean I take it you don't have a view on the specific issue though of waiving appraisals for the existing guaranteed book?

To

No, I don't.

I won't press that then.

Then just one final thing is the -- for you Gary, is the -- it's understandable that the leverage was lower while the option strategy was being executed.

For modeling purposes as we go forward -- and I realize we're not talking about next quarter.

But sort of on a run rate, and given the environment as you see it today, would you say that a leverage ratio of about 7 times would seem reasonable to you?

I think that a leverage ratio of around 7 seems reasonable to me, but as I mentioned, there's a lot of factors that we need to consider, and we're going to be watching market conditions very closely.

Our peers seem to range from the mid 6's to above 8.

And I think at this point we would want to wait a little bit before we got to the high end of that range.

But we will -- but we're going to evaluate market conditions.

We will evaluate the opportunities, but the 7% number to me doesn't sound unreasonable.

Thank you for that.

And John, one quick final thing for you, if I may.

I got a question from an account this morning that we've all have understood that -- the option revenue was new to us, to those of us that have been following the agency REITs for many years.

And at first there was some confusion about whether that would be eligible for it to be included in the calculation for dividends.

And I think we've established several months ago, and it was reflected in your $1.20 dividend, that you guys do -- you classify that income such that it is included in the income that must be paid out in dividends; correct?

Yes.

You've got to count all of your income on your tax return.

The question is whether it is qualified or not.

So it's not necessarily qualified.

We have to manage within that bucket.

But nevertheless, you've got to dividend out all of your income, so it is included in the dividend, but you got to manage it to make sure you don't have any issues with your qualifications.

That goes to the point of my question.

Are you comfortable now that -- of course that it has been paid out, and given that the $10 million or so is about 25% of revenue, are your tax guys internally comfortable that when you get to the spring and fall file your return, that the nature of that option revenue, that you're not going to have any kind of tax liability associated with that?

You've got to remember, we've been a BDC for 11 years, and we've got very (technical difficulty) tax regime.

We monitor [MOMAC] very closely, so the REIT regime is not a -- something that new.

I think it goes to Gary's earlier comments about the infrastructure we have in place.

So we've got a slew of accountants and tax people and legal people that have monitoring in place, and so we're quite comfortable with our tax position.

Thanks for clarifying that, John.

That does it for me.

Mike Widner, Stifel Nicolaus.

Let me ask you a question on the big amortization hit that you took this quarter and then -- I realize it was a catch-up for anticipation of higher prepay speeds going forward.

Clearly we haven't seen evidence of prepays accelerating yet.

We'll find out a little more with data tonight or tomorrow.

But assuming speeds remain slow, can we expect you to increase your -- take your amortization rate going forward to a level that's consistent with a 36% CPR even if prepays continue to come in in the teens?

Yes.

I think with GAAP you end up taking adjustments at different points in time as you have data that adjusts the prepayment speeds.

Keep in mind though that doesn't really impact the dividend.

The dividend comes off of taxable earnings, which -- for tax purposes you end up with a constant.

You do your tax assumptions in the beginning, and you hold those over time.

So it won't necessarily impact the dividend, but you will see the GAAP earnings move from time to time.

So yes.

Let's say you create a scenario where you say the government backs away from any of their mortgage plans, and prepayment speeds drop significantly.

You will see adjustments to the GAAP numbers once again reflecting that fact.

And also, we will be evaluating prepayment speeds on a -- actually on a daily basis.

We'll be seeing results on a monthly basis, as you mentioned, and there are reports coming out tonight.

But -- and to the extent that it turns out that our speed assumptions are too conservative, we will over time revise those, and then those would be consumed in terms of the go-forward yields.

Yes.

Keep in mind we use a lot of different modeling tools to do that.

We look at a lot of third-party data, so we may personally have certain prepayment or speed assumptions, but then you tend to look out into the third-party data and different services that are out there to really come up with what the accounting assumptions are going to be.

You mentioned in here that there was $0.29 of undistributed taxable.

I was trying to do the math on getting there, and basically is it the -- I'm coming up with about a $0.31 excess in amortization expense.

Is that roughly what you're talking about that drives that $0.21 undistributed?

I mean, because your distributed was more than your GAAP, so I guess I'm really trying to get to the difference between GAAP and tax.

It looks like it's mostly that amortization hit.

Yes.

I mean that should effectively be it, because you've got a constant prepayment rate going on for the tax purposes.

So --

I guess just one question going forward.

A lot of us that have looked at it -- you guys, and particularly looked at you in the context of an industry that's had a pretty long tradition of not surprising us from a strategic standpoint.

I understand the option strategy is behind you at this point.

Can we expect that going forward, short of -- clearly investing in different agency securities, different flavors of MBSs is fine, but can we expect that we're not going to be surprised quarter to quarter by new strategic initiatives?

Look.

First of all, you got to keep in mind -- go back to the MOVE chart; right?

I think you're talking about an unprecedented time frame, and I think Gary and Malon had outlined all the different things that were occurring in September and October.

So it was absolutely in our opinion a risk adverse strategy.

I think that when we were sitting there October 10, we couldn't really estimate how much repo was going to be available at 12/31, or the price, and so I think that from our standpoint it was a very risk adverse strategy.

I think that if volatility -- if we get back in that kind of an environment, as Gary has outlined before, we're going to have to look at everything that is available.

But I think it was prudent for the time frame that we came through.

And as we talked about, we've actually closed all those out, and you've seen the volatility subside, and we're going to a more normalized strategy.

Do you want to add anything to that Gary?

Yes.

I would just -- what I would like to add is, writing options is a strategy that's been employed by a lot of people within the mortgage market to enhance returns at different times.

And any time you purchase a mortgage, you're implicitly writing options.

Obviously this was a case of explicitly writing options.

But I think going forward our intent is to grow and diversify the portfolio.

And we are going to look at other strategies on the margin over time.

We'll try, but they are not going to be -- or we don't expect them to be the core strategies.

We expect them potentially, whether it's options or something else, to be something we might employ on the margin when the opportunities are right.

And we'll be as transparent as we can when those situations arise.

Great.

Thanks guys.

Appreciate the comments and the color.

And congrats on (technical difficulty)

Ben Mackovak, Rivanna Capital.

Questions have been asked.

Thanks.

Jason Arnold, RBC Capital Markets.

Gary, you talked about some potential changes to the portfolio, just maybe from adding some hybrid ARM exposure.

To what degree would you consider from a portfolio allocation perspective moving into something like a hybrid ARM?

We are definitely considering the hybrid ARM market at this point.

And I have spent a lot of my career very focused on the ARM market.

We've been looking at a lot of ARMs just over the last week, and we feel, again as I mentioned on the call, that the risk-adjusted returns in the hybrid space are competitive.

And in some components of the hybrid space, though, I really don't like the newer issue 2008 vintages because I think these borrowers just qualified for new mortgages.

They met all the tighter underwriting guidelines.

They are in a position to refinance on a dime.

They've got fresh paperwork.

So we're avoiding the -- we're going to avoid at least for now the new-issue hybrid market, but there are components of the seasoned hybrid market that we think fit the portfolio well, and we're looking at those and look and expect to be adding those types of assets shortly.

Okay.

Is that kind of to the note you were making earlier about the security selection process, looking at different pools from a prepayment perspective?

Is that kind of what you were mentioning there?

Absolutely.

Again, as you get into the ARM market, it is imperative to think about not only the prepayment issues but also things like the index.

I'll give you another example of something we will probably avoid.

A lot of ARMs are indexed off of one-year CMT.

And one-year CMT has demonstrated over the last year it doesn't track LIBOR all that well.

So the reason to buy an ARM is for it's attract or funding costs, and so we will probably avoid CMT ARMs in favor of LIBOR ARMs unless pricing changes dramatically.

But in the ARM market, individual security selection is critical.

And it goes to the indices and the caps, the amount of seasoning and, to your point, the prepayment profile.

That makes a lot of sense.

And then one more quick question on the premium amortization outlook.

What is kind of the -- it sounds like 36% is the average over the life.

What would be the kind of short-term, over the next year outlook that you have baked in with the added premium amortization?

Well, what I said earlier is you can define a number of different vectors that will get you to a 36 or so percent CPR over time.

What we think is reasonable on a one-sample vector that would get you there is something that gets up to the neighborhood of 50 CPR and stays there for a while and then starts to come down.

I don't know exactly what that translates into -- into a one-year speed.

But the bottom line is, given the market conditions, we expect peak speeds to occur -- again, given the environment -- over the next -- to occur over the next year.

And then we would expect speeds to burn out like they have in the past and traditionally drop from there, and that's how we get to the lifetime speed.

I guess one final question on the option strategy.

Of course it has now gone away.

But did you guys have any securities that were called in the quarter?

We didn't -- this is Bob Grunewald.

We did not have any securities that were called as a result of that strategy.

Jim Fowler, JMP Asset Management.

Gary, a quick question.

I apologize if this has already been answered.

But on the page that describes each of the portfolio components, have you given or would you give us some idea of the prepayment speeds that you are assuming on a life basis across the three issuer types, please?

We haven't discussed and disclosed the individual prepayment speeds for each of the classes, so I won't give you specific numbers.

But what I can say is the coupons, as you can see, are not that different from each other.

In general, Ginnie Mae speeds have been faster than Freddie and Fannie speeds.

The Freddie and Fannie speeds as a class we would expect to be relatively similar.

But the key thing I want to point out is, again, the individual securities within each of those buckets, while they may be similar in coupon, differ in terms of some are interest-first, some actually may be forty-year securities, some have higher investor concentrations.

All of those things affect the underlying speed assumption, so there are a number of variables in there.

But we haven't broken out and disclosed the specifics of the individual speeds for each of them.

Then I might just follow up by -- with the presumption that Ginnie Mae speeds are typically faster than Fannie/Freddie, I'm assuming that a fair amount of those are loans bought out of pools related to defaults.

At Ginnie that's more so the case than Fannie and Freddie.

Would that explain a large portion of the prepaid difference that you're seeing today?

And would therefore -- or presumably that may slow at some point if defaults decline?

Or am I wrong on that?

No.

That's actually a very good point that if we were looking backwards today, that the speed difference that we've seen between conventionals and Ginnies, a very good chunk of that difference could be attributable to in a sense credit and loans being bought out, and those types of issues.

The issue with would then -- that would lead you to believe that Ginnie and the conventionals should be on top of each other going forward.

The only weakness in that argument is the differences between going back to the question asked earlier between the streamlined refi kind of options within the Ginnie market versus the conventional market.

And so if those were to move much closer together, then I think you could expect much more convergence of the speeds.

But for right now I think you'll still see a difference on that front.

Ken Bruce, Banc of America.

As you move away from this option strategy and towards a more conventional REIT strategy, investment strategy, there are obviously quite a few trade-offs that need to be made.

And I was hoping that you might discuss within the context of your risk management what risk you're willing to take, ultimately what you're managing to, and maybe specifically what kind of swap concentrations you are looking to run going forward, please.

So I think that's a very good question.

As we look forward, as I mentioned, there's an important balance that we need to achieve, which is between maintaining attractive net interest income and managing book value.

And both of those are important considerations for us.

I think one of -- when you think about the risks, the old way of talking about that purely in the mortgage market would've been things like duration, convexity, and so forth.

But I think realistically what people have learned is that funding -- and obviously prepayments in this environment -- and those kind of issues, and in general just specific spread risk are also key considerations.

So when you put all of those things together, we're focused on kind of the combination of those risks.

So I'm not going to tell you we have this exact duration kind of limit for the portfolio, because it goes to -- it has to be intertwined with the prepayment expectations.

But I think you can suffice it to say that one of the key reasons to diversify the portfolio relates to avoiding concentrations in any one of those risks.

I think by having a mix of seasoned 15-year, having ARMs and 30-year, we will be doing exactly that and diversifying across different risks.

That being said, we'll do that being very cognizant of relative value.

When it comes to our swap positions, they are obviously going to be very dependent on our asset positions and what we expect our funding to be over time.

And so swap positions will be designed to lock in funding that's appropriate for the asset positions that we end up with.

I know that's general, but I hope that gets to the point of your question.

Well, I'm sure we can refine that over time.

I'm just trying to get a better sense as to -- as you migrate towards this new strategy, where you are looking to position yourself either across the curve or in terms of what risk you're willing to take within the portfolio.

And maybe we can take it off-line, but that does it for me.

Thank you.

Just one quick follow-up.

I think again we will be looking at seasoned 15-year and ARMs, which will reduce some exposure to the long end of the curve.

Jim Delisle, Cambridge Place.

I hate to be the one to address the elephant in the room, but I might as well.

Your largest shareholder has approximately 20 to 25 days worth of volume in your stock right now.

I would like to ask a couple of questions about how that stock is held, just so I can get an understanding as to what the technical headwind might be going forward; right?

Malon, you're still around; right?

Yes.

Okay.

Yes, we own approximately a third of the Company, have about $100 million invested in the Company.

You have 5 million shares.

How is that registered right now?

Is it registered available for sale?

Is it subject to quick turnaround registration?

What is the current classification of it?

Yes.

It's not registered.

And so if we were to sell it in the market we would need to register it.

We have a lock-up on half of the stake, that expires I think in May on the anniversary of the IPO.

And right now of course we have quite -- American Capital has about -- approximately $10 billion of assets that we invest in portfolio companies.

Agencies is one of those investments.

And our job is to make good investments, and I think agency has been a very successful one for us.

Have you used them or are they currently being used as margin against any loans?

And in their current form, are they in fact marginable should the answer be "no" and you decide to do so in the future?

No, no.

We have no collateralized loans at American Capital.

No, no.

I'm saying do you have any loans that are collateralized by the AGNC paper?

No, no.

We don't.

American Capital has no secured debt.

(multiple speakers) Other than -- well, I should say other than the securitizations that we've used to fund ourselves.

But these assets do not reside in the securitization.

I also do the numbers on ACAS.

And by my calculation with $725 million worth of debt coming due on the [EuroCAS] and $125 million on ACAS, and then your spillover dividend requirement, it's like $1 billion worth of cash needed over the next several months.

From a corporate point of view (multiple speakers)

Let me just interrupt you.

First of all European Capital is a portfolio company of American Capital.

Its debts are the obligations of European Capital and not of the obligations of American Capital.

And then with respect to other payments, it's spread out (multiple speakers)

But more generally, we should keep this call in reference to American Capital Agency, and our stake and maybe our intentions for our stake is somewhat related, but that's the limit really of what we're going to talk about on this call.

All right.

You've certainly got to understand how the technical overhang might be a question mark.

Well, I -- you know, certainly we would have to make appropriate filings if we were going to sell our stake.

So I think you would certainly end up seeing those kind of filings.

And question about the 50 CPR, you mentioned earlier that you have 36 CPR as kind of a GAAP assumption, and you mentioned that you might see it spike up to 50 CPR over the course of the next year.

By my calculation that would make your taxable income fall far below your GAAP income, and also the -- kind of with the two-week lag that would be kind of a difficult -- difficult to make delivery on a lot of the pools.

This is Bob Grunewald.

I think the point of confusion is that we have a lifetime CPR assumption built into our current GAAP numbers of 36 CPR.

What we're saying is in that lifetime assumption there is actually a vector with different CPR assumptions over different periods of time and that that vector assumes a peak somewhere between 50 and 60.

So the 36 CPR that's already baked into the GAAP yield that you see and the gap income that we provided you is already assuming much higher CPRs over the next six to eight months.

So you're saying that the 36 GAAP is -- is not -- I mean, the 36 is not flat lined for GAAP purposes but is vectored in there, and 36 is just the average that you're reporting?

Correct.

Matthew Howlett, Fox-Pitt Kelton.

Just have a few quick questions.

Could you give us a breakdown on the vintages that underlie the portfolio?

I'm sure you see where I'm going with the question.

Sure.

And I understand the reason for the question, and clearly in my discussion I have stressed the importance of the underlying collateral and so forth.

What I think you are aware of, in a sense, the beginning date of agency, and so you should be relatively confident that the collateral is not absolutely -- is not brand-new.

But we haven't disclosed a complete breakdown of the vintages of the underlying collateral.

I will say, again, a lot of collateral is specified collateral, and there was a desire to pick collateral that would perform well.

Right.

It looks as if your speeds are slower than what's come in on average in the fixed-rate market.

But we will go from there.

The second question I had was related to sort of the repo market.

As you look at it, Gary, you spent a lot of time at Freddie Mac.

Where do you see it evolving to?

Could Fannie and Freddie both potentially be repo providers at some point?

Do you see it moving away from the primary dealer market directly to the money markets?

Could you give us sort of any color on a long-term view on that?

I will give you -- yes, I definitely can give you some color.

I think what you've seen is with short-term rates basically hovering near zero and with people very concerned about making sure that they have safe collateral, I'm highly confident that agency mortgage collateral will continue to be the favorite amongst repo providers.

The end providers of repo financing will continue to be depository institutions and funds that -- and short-term money market funds, and so I'm pretty confident that given, again, the lack of yield that is available kind of in the safe, short end of the curve, that it makes sense for large financial institutions and others to provide repo funding.

Exactly which institutions are going to do that I think will evolve.

But I do want to reiterate that the number of counterparties that we have is relatively high, but it goes beyond the quantity of the counterparties, and it goes to the fact that at this point our counterparties seem very willing to kind of increase their lines with us and so forth.

So we do feel like things are going in the right direction.

Then just last question.

Average haircut today, if possible, and how many of your counterparties have taken down haircuts since the end of the year?

The haircuts are in the 5% to 7% range in general.

There are some that may be a little below that, but nothing that we are concerned of.

Yes, haircuts -- if anything -- seem like they are going in the right direction rather than the wrong direction.

And given our anticipated leverage, the haircuts are not a concerned to us.

Sam [McIntyre], [McIntyre Assets].

Given ACAS's precarious financial position and your desire to get more invested, what's the chance that you'd raise equity in this environment?

Well, I think American Capital Agency will take its opportunities of raising additional equity when it would make sense for it.

It is certainly in a very good position to expand and grow.

And really beyond that we probably can't make any other comments about it.

Would you sell equity below book?

American Capital Agency?

Sam McIntyre Yes.

It probably would not make sense.

Okay.

Any dividend guidance going forward?

No.

We've only pointed out that we would generally intend to pay out dividends that would at minimum meet our requirements as a REIT.

Terry Robinson, private investor.

I probably missed it, but I wanted to talk about the dividend.

I'm a retiree and enjoy the dividend that we've had.

What's the future?

Yes, we are not forecasting dividends that Agency.

What we have made clear is that we will continue to operate so that we can maintain our REIT status, and that would require paying out taxable income, and that so far has been substantial in 2008.

And we will have to see how Agency performs as we go forward in 2009 to make dividend decisions.

But it's worth -- this is Bob Grunewald reiterating what Gary has already said, which is that given the cost of funds, net spreads on our existing portfolio and additional assets as we increase leverage are very attractive from a historical perspective.

Right.

But also just keep in mind that long term if you follow all the agency REITs, the dividend is not a steady and growing one.

It is volatile based on how the spreads in that market change from time to time.

It's still going to be paid out quarterly?

Yes.

That concludes the question-and-answer session.

There are no other people in queue.

Thank you very much.

We appreciate everyone joining us today and look forward to talking to you again in three months.

Have a good day.

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