AGNC Investment Corp (AGNCN) 2009 Q3 法說會逐字稿

Good morning.

My name is Demetris, and I will be your conference operator today.

At this time, I would like to welcome everyone to the American Capital Agency third-quarter 2009 shareholder conference call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question and answer session.

(Operator Instructions).

Thank you.

Ms.

[Katie Wisecarver], you may begin your conference.

Thank you, Demetris, and thank you for joining American Capital Agency's third-quarter 2009 earnings call.

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

This conference call and corresponding slide presentation contain 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 forecasts due to the impact of many factors beyond the control of AGNC.

Certain factors that could cause actual results to differ materially are included in the risk factors section of AGNC's 10-K dated February 17, 2009 in periodic reports filed with the Securities and Exchange Commission.

Copies are available on the SEC's website at SEC.gov.

We disclaim any obligation to update our forward-looking statements block an archive of this presentation will be available on our website, and the telephone recording can be accessed through November 4 by dialing 800-642-1687, and the conference ID number is 36505533.

To view the Q3 slide presentation, turn to our website, AGNC.com, and click on the Q3 2009 earnings presentation link in the upper-right corner.

Select the webcast option for both slides and audio, or click on the link in the conference call section to view the streaming slide presentation during the call.

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

At this time, I would like to turn the call over to Gary Kain, Chief Investment Officer.

Thanks, Katie, and good morning to everyone, and thanks for joining us.

Two very favorable themes played out during the quarter.

Prepayments remained benign and the view that the Fed would be on hold for an extended period of time strengthened.

The combination of these factors, coupled with strong technical support for mortgages from the Fed, the treasury, and other investors, continued to drive strong quarterly performance, but they also form the basis for some of the changes to our views of relative value and to our portfolio, which I'm going to go into in greater detail.

Today, I plan to briefly review our results for the quarter, as well as the changes that we made to our portfolio.

I also want to address two other topics that I think are probably of interest to many of you.

First, how we think about our undistributed taxable income and second, the changing market dynamics and our expectations as we look ahead toward 2010.

Let's start with the highlights on page 5.

First, we raised approximately $95 million through the issuance of 4.3 million shares in August.

This issuance was accretive to our book value, and we were able to deploy the capital in Q3.

Now clearly as this capital raise occurred around the midpoint of the quarter, our results were impacted by a higher share count and lower leverage during the period.

For Q3, we declared a dividend of $1.40 per share.

And again, that uses the end of quarter share counts when you look at the dividend.

This dividend was below both our GAAP net income of $1.82 per weighted average share and our taxable income of $1.89 per weighted average share.

Thus, our undistributed taxable income increased again during the quarter to $0.90 from $0.62 at the end of Q2.

And this is, again, adjusted for our new share count.

Now the key drivers of the results were benign prepayments, a larger investment portfolio, reduced repo funding costs and significantly firm revaluations on higher coupon arms, which helped enhance continued realized gains.

To this point, the net income number included $0.73 of other income, which includes realized gains, derivative marked to market and hedging effectiveness.

We also had approximately $0.20 worth of amortization expense associated with terminated swaps.

Earnings net of these two items were approximately $1.30 per share.

As of September 30, our investment portfolio totaled $3.4 billion in assets, and this was an increase of approximately $800 million from June 30.

And while the bulk of this increase can be attributed to our holdings of ARMs, the composition of our ARM portfolio did change significantly during the quarter.

And our leverage as of September 30 dropped to around 7.3 times.

Looking at book value, which increased during the quarter by $1.47 per share to $22.23, this was an increase of 7% for the quarter and 29% year to date.

This book value increase is, again, after netting out our Q3 dividend of $1.40.

So if you go to slide 6, let's look at the undistributed taxable income, and I would like to give you some insight into how we think about this.

But I do need to caution everyone that the actual distributions are dependent on future results and market conditions.

With that said, here are some things to think about.

As of September 30, 2009, we have earned an estimated $0.90 of distributable taxable income, which we have yet to pay out in dividends.

Now the table on the right shows how this number is derived.

If we do not pay out 85% of ordinary income, 95% of capital gains and 100% of taxable income from 2008, by January 30 of 2010, we will be required to pay a 4% excise tax on any unpaid income below these levels.

It is definitely our preference to declare dividends throughout the year, such that we would not incur an excise tax.

We do, however, intend to carry over a significant amount of distributable income into 2010.

And we view this as prudent versus the declaration of an excessively large one-time dividend.

More generally, by carrying over some distributable income, we believe our investors get the benefit of both very attractive current dividends and stronger prospects for future distributions.

As a result, we could end up in a position where we do pay an excise tax.

Now let's move on to slide 7 and discuss what happened to the market during the third quarter.

As you can see in the tables on the left, both treasury and swap yields declined during the quarter with longer-term rates declining slightly more than shorter-term rates.

In our opinion, one factor leading to this decline in rates was the increased comfort on the part of market participants that the Fed would be on hold for an extended period of time.

The chart on the right side of the page shows that mortgage prices increased significantly during the quarter as well.

The changes in prices this quarter were more consistent across coupons in both fixed-rate and ARMs, as the lower coupons benefited more from the declines in interest rates, while the higher coupons continued to benefit from the benign prepayment environment.

Now additionally, mortgage performance so far this quarter has been very strong, and so there's a good tail wind behind book value, again, but there's a fair amount of time on the clock for this quarter.

With this as the backdrop, let's move on to slide 8.

Now we stressed in prior calls that we are committed to looking for relative value in all parts of the mortgage market and that our portfolio will involve as market conditions change.

And this quarter really provides some strong evidence of this.

Until very recently, we believed that higher coupon mortgages and seasoned 5/1 ARMs in particular offered the best risk-adjusted returns.

However, as prepayments on these securities have remained benign, prices have skyrocketed and considerably more favorable outcomes are now priced in for these securities.

Prices on higher-coupon seasoned hybrid ARMs are up almost 3 percentage points from earlier in the year when we began to add significant quantities of these securities.

At this point, we're no longer comfortable with an overweight in this sector.

In addition, while we agree that refinancing activity will remain subdued on most of the mortgage universe, prepayment risk has not declined equally for all sectors of the market.

More specifically, we believe that prepayment risk as a result of GSC buyouts has actually increased for pools backed by the weakest borrowers.

[If] the very slow real-life speeds indicate the potential for a buildup of delinquent loans in some pools.

A significant percentage of the interest-only and seasoned hybrid market are comprised of securities backed by credit-impaired borrowers.

With this in mind, we proactively sold a significant portion of our holdings of these securities.

By doing this, we were essentially locking in the favorable prepayment outcomes and strong price performance, as well as reducing our exposure to negative surprises in this sector.

Now just one minor point to note on this page is that the coupon comparison displayed on the chart on the right has become less relevant as our asset mix has shifted to different coupons, so look for us to swap in some more relevant data going forward.

With that, if you turn to the next slide, I can give you some more specifics related to how the portfolio changed.

The most obvious change to our portfolio was the increase in size as we deployed capital from the August equity offering.

The portfolio grew from $2.6 billion in June to $3.4 billion by quarter end.

And consistent with the prior quarters, most of this increase came from the addition of hybrid ARMs.

But as I mentioned earlier, the composition of the ARM portfolio did change significantly.

First of all, we added some lower coupons, including both new-issued 5/1's and shorter resets.

And as you can see in the table on the bottom right, this brought the percentage of coupons below 5%, up from 2% at the end of Q2 to 20% by the end of Q3.

On the other side, we also significantly reduced our holdings of the higher coupon and interest-only hybrids.

At the end of Q2, 51% of our hybrid portfolio was comprised of 6% or greater coupons.

But by the end of Q3, that number was only 20%.

Along the same lines, we reduced the percentage of interest-only securities from over 80% down to 50% by the end of the quarter.

Now more limited, albeit similar changes, were made to the fixed-rate portfolio, where we reduced the weighted average coupon by about 13 basis points.

Now so far in the fourth quarter, we continue to favor a more balanced and diversified portfolio and have taken incremental steps toward further reducing our exposure to buyouts.

Now given both the larger portfolio and the changing composition, we increased the size of our interest-rate swap position by 50% to $1.4 billion from $950 million in Q2.

The details of the swap portfolio are presented on slide 12.

So please turn to page 13.

Now the changes to the composition of the portfolio that I just discussed did impact our results for the quarter.

In addition to adding to our realized gains, it is important to recognize that these actions did impact our asset yields.

That being said, we were essentially able to lock in, via gains, a significant percentage of the higher yield we would have achieved on the securities we sold, even assuming actual prepayments remained reasonably benign into the future.

As such, we like this trade-off, and we like the lower risk profile.

On a similar note, the increase in the size of our swap portfolio offset some of the drop in funding costs during the quarter.

Now taking a step back and looking at the bigger picture, even with our new portfolio composition and our reduced leverage, our ROE without any of the benefits of gains was still above 20% during the quarter.

This ROE is considerably higher when you remove the amortization expense related to the terminated swaps, which ends in the second quarter of 2010.

Now, if we move on to slide 15, we can discuss the mortgage market as we head into 2010.

On this slide, we've detailed a number of potential market events and their possible implications.

And we're very happy to discuss any of these in more detail in the Q&A session, but I do want to say something about the first one because it's something that gets a lot of attention.

As most of you are aware, the Fed's massive $1.2 trillion mortgage purchase program is now slated to end in March of 2010.

And there's a fair amount of concern that this exit could spur significant dislocations in the mortgage market.

While we do expect some widening in mortgage spreads, especially given the recent tightening, we believe the market will likely hold in both better and longer than the more dire predictions.

Why?

Two main reasons.

One is it's been telegraphed for a long time, and thus, people have been focused on this issue and have set up for it.

In fact, many investors have missed out on very attractive carry and total returns for much of this year, positioning for this or other risks.

The other key reason is the fact that much of the mortgage universe has now been absorbed by buy-and-hold investors, including the Fed, the treasury, the GSEs, banks, and foreign institutions.

This, coupled with a relatively light production, which would slow even further if mortgage rates rose, should help mitigate spread movements.

Now, on a related note, while we believe the Fed is likely to be on hold for an extended period, they have absorbed a ton of duration with their purchase programs, so I wouldn't be surprised to see a bump in long-term rates during the first half of the year.

This, or one of the other developments listed on this slide, could create some interesting opportunities as we look ahead.

Now in closing, we are also very optimistic that the investment returns over the long run for the agency REIT community should be considerably more attractive than they have been for the prior 10 years.

And with that, let me ask the operator to open up the line and start taking questions.

(Operator Instructions).

Steve Delaney, JMP Securities.

Good morning, Gary.

So the CMOs are new this quarter, and you give us great data on page 10 and 11 on the fixed and hybrids.

I know it's small, just 7% or 8%, but could you let us know maybe what your approximate cost basis or par is on the $261 million of CMOs fair value?

Can you repeat the last part of the question?

I'm sorry.

Sure.

Just, all you give us on your CMOs are the $261 million of fair value.

Could you let us know what your cost basis or the par is on that?

Yes.

Let me see if we can get that.

Let me address the first part of your question while we are seeing if we have that.

First, we did have 5% of the portfolio at the end of Q2 in CMOs.

And the bulk of our CMOs -- first off obviously, all of our CMOs are backed by Freddie and Fannie and are agency securities.

The other thing is, the bulk of our CMOs are backed actually by hybrid ARMs as the collateral, and so the cash flows are very similar to that of our ARM portfolio.

We have added a few securities that are backed by fixed-rate securities.

And again, the cash flows are not dissimilar to what we have in the fixed-rate portfolio.

Looking ahead, we view the CMO portfolio as being an important way to be able to tailor some cash flows to some of the risks we are concerned about, or to lay off some of the risks that we are concerned about, such as the buy-out risk.

But we do recognize the difference in the liquidity between CMOs and other assets.

And for that reason, we are focused on maintaining a limited percentage of the portfolio in CMOs.

But remember on the other side, we have a fair amount of TBA-eligible fixed rate securities, which are extremely liquid and more liquid than kind of the ARM portfolio.

And so we think that that really balances any liquidity give on the CMO front.

Okay, got it.

So Gary, one, while you're looking to see if you have that data, just one big-picture question about strategy.

You acknowledge that prices have probably trended slightly higher since you completed your purchases with the August capital.

So I guess with respect to your appetite of the market as exists today, are you a buyer today?

Do you see pockets of value at today's price levels?

Or should we assume that you might want to wait and see what impact the Fed's slowing its purchases has on spreads widening out?

I think there's a balance between -- clearly prices are higher and mortgages have done well since -- throughout the year and since August.

I think there are still areas that present relative value, and there's a trade-off because the funding environment right now is very favorable.

And, again, there are parts of the market that provide favorable prepayment where the outlook on the pre-pavement fund is still favorable.

So yes, I think opportunities are harder to find.

On the other hand, kind of the economic backdrop is still pretty favorable.

So what you have to weigh is the trade-off between the very good carry environment we're in with hoping that you're going to get wider spreads if you wait six months.

And that's a balancing act and that changes over time.

Yes.

I mean certainly an opportunity cost, as you say, with the attractive funding.

Well I will drop off, and if you get that data before the call is over, that would be great.

If not, I will follow up later.

So it looks like the UPB was a little over $249 million.

Okay.

At a cost of about 103.

Thank you very much.

Bose George, KBW.

I had a couple of questions.

One was just on the premium amortization number, you had -- it was $9.4 million this quarter, $3.1 million last quarter.

I know the dollar amount of your premium went up quite a bit, but it still seemed like a pretty decent increase given your CPR didn't move up that much.

Also, just given the reduction in your lifetime prepayment assumption, could we see the amortization number lower next quarter if prepaids are pretty stable?

In terms of, so there's a lot of things.

The one thing I would just caution you on, just at a high level, is the portfolio is very different this quarter than last quarter.

When you look at the fact that we raised a fair amount of capital, the portfolio is larger.

And as you know, our cost basis has been going up from quarter to quarter as well.

And the one thing I would caution you is a little over 50% of our portfolio this quarter is new.

And we didn't have it in prior quarters.

So I think that makes some of the comparisons harder.

I don't know, Bernie, if you have anything to add?

Yes.

Yes, I think one thing to recognize about last quarter was we had a fairly sizable catch-up benefit related to premium amortization for the quarter, which last quarter was about $2.25 million.

We don't have a similar catch-up adjustment this quarter.

Okay, great.

And then, just in terms of the -- can you just give us a dollar amount of assets you purchased and the premiums this quarter?

We don't disclose -- I mean, you know the net assets we purchased, obviously, by the difference in the portfolio sizes.

We don't have a disclosed total purchase number and a total purchase price number.

But you can get pretty close to that, given the changes that we put in the -- the portfolios we give you and the cost basis for the ARM and fixed portfolio.

Just one thing of note is that unlike prior quarters, a lot of the increase in the cost basis or some of the increase in the cost basis came actually in the fixed side, and much less of it was on the ARM side, and that related to the repositioning of the ARM portfolio.

Okay.

And then just one little clarification.

The swap on the amortization, does that end at the end of the second quarter of 2010?

It ends during the second quarter, so at the end of the second quarter, there will be no more terminated swap amortization.

Great.

Thanks a lot.

Tim Wengerd, Deutsche Bank.

Good morning.

A quick question.

The derivative income, I think there's a loss of $3.4 million.

Can you provide any more detail about what drove that?

Sure.

We've used -- and this came up on the second-quarter call as well.

We use sales of TBA mortgages as a kind of incremental hedge for our portfolio.

So the bulk of our hedges for duration and risk in the portfolio are the interest-rate swap portfolio, as we've discussed.

But we also use TBA mortgages or sales of TBA mortgages as an incremental hedge.

And given the fact that mortgages -- prices went up throughout the quarter, it's not surprising that there would be losses in that -- in those positions.

Now that being said, I want to point you to a couple of things.

Those are offset by the gains in mortgages, some of which you see in the realized gains.

But more importantly, look at the total picture in book value, and I think you can get very comfortable that, in aggregate, those positions have worked out extremely well.

Okay, got it.

Thank you.

Ben Mackovak, Rivanna Capital.

Just to be clear, you don't disclose the average cost basis of the portfolio?

No, we do disclose the average cost basis of the portfolio.

And that was -- it's on page 17.

And it shows how it changes over time.

And it was basically 103.5%.

Okay.

I'm sorry.

I just missed that.

Okay.

And kind of a bigger picture question, what do you think are the odds that the Fed extends the program, and how would that impact your strategy?

I think at this point, the odds aren't that high that the Fed increase or extends the program.

I think that there are mixed feelings with respect to there was a lot of discussion as to what to do, whether to just end it on schedule, whether to extend it to March.

I think that a decision was made to extend it to March and to complete the program.

And at this point, that's our expectation.

We do believe that the Fed probably is going to consider if the market were to dislocate, and if it felt there was a need to get back involved.

I think it and the Treasury both have kind of learned how to do this, so to speak and would be in a position to come back if there were larger dislocations.

And then, it's also unclear exactly how the GSE portfolios will be used going forward.

So I think there are some, kind of, we'll call it, major backstops if things were to get out of control, but we don't see that happening.

And we actually see the Fed pretty much completing their program as scheduled at this point.

Thank you.

Ken Bruce, Merrill Lynch.

I guess your comment about there being some pockets of relative value in the mortgage market is interesting.

I guess I'd be separately interested in knowing if you would be willing to lever up to buy that opportunity in the market today, or if this is a situation where you think you would be back in the market to raise more equity, just given where violations are on the stock.

And how are you thinking about I guess penetrating those opportunities that you see?

Let me start with your question in a sense on leverage.

At the end of the second quarter, we felt very good about the market, both the mortgage market and the bond market, and felt that -- and so our leverage had increased up until the end of the second quarter.

If you notice, we were somewhat lower at the end of the third quarter at 7.3 times.

Margins have done well since then, so there is a little bit of bias probably towards slightly lower leverage in the very near term versus where we are.

But again, we are balancing the benefits of an extremely attractive carry environment with areas with stable pre-pays against the fact that opportunities may be better down the road.

And so that's an important balancing act that changes as prices and the market evolves.

With respect to the second part of your question relating to capital, what I would say there is kind of the standard answer, which is we always evaluate our price to book, the opportunities available in the marketplace and the economies of scale and operating efficiencies that come from a larger capital base.

And that's a trade-off that has to be evaluated on a continuous basis.

Right.

I guess maybe parlaying on that, you've got a situation where you are trading at a decent premium to book.

You presumably don't want to wait until book value comes under pressure from the assets cheapening up, so now I would suspect that that's going to tilt that bias towards wanting to raise equity shorter term versus waiting for the market to evolve further.

I will -- I think that's said enough around this subject.

I think, again, the factors I looked at -- I listed -- were the things that we think about.

Right, okay.

And maybe just on the commentary you provided with the net short position on TBAs, could you maybe expand on that, how much of a short position do you have on TBAs?

Yes, let me give you a little more color on that.

Basically, if you think about our positions, interest rate swaps are relatively hard or cumbersome to trade in and out of or to put one on and pare one off, as you've seen with terminated swap expense, plus just bid/offer spreads.

So we like to keep something on the order of 10% of our hedges being TBA mortgages.

But that varies over time and it depends on our holdings and it allows us to, if we find attractive assets, but we are not looking to grow our portfolio at the time, we can buy them and decide to put -- to take the mortgage exposure at a later date.

So the short answer is the size of those positions changes over time, but they are a small percentage of our hedges.

But I will reiterate they are extremely effective in that if you are thinking of hedging book value or the performance of mortgage holdings, being short a mortgage holding is the most effective hedge you can come up with.

I agree, and that's why I was interested in the nominal size.

Thank you for your answers and candor.

Matthew Howlett, Fox-Pitt Kelton.

Gary, another question on the leverage.

You've done a good job keeping the leverage higher than your peers.

which only earns you the added extra carrying income.

I think sort of everyone is waiting for the Feds maybe to back down and they are expected to do so in next March or potentially some sell-off in mortgages.

When you look at leverage, have you thought about maybe removing the 10 times cap going to next year?

Potentially it could be, as you said, an opportunity to really bulk up on more mortgages at some point in time without doing a big marketed deal?

You know, when we look at where we are at this point, again, I would say in the short run, our bias is not toward higher leverage at this point.

And we feel like we're in a position where we are earning very attractive ROEs, and we don't feel, right now, that there's any need to grow leverage materially.

Over time, we will look at the environment.

Clearly the financing environment has improved dramatically such that a lot of the concerns around higher leverage, in other words, in terms of being able to finance, are not there anymore.

And so that does get -- in getting to your point, that does set up an environment maybe sometime in the future, where higher leverage may be prudent.

But again, at this point, we see if anything the bias in the short run to slightly lower leverage.

Would it just make sense to remove that cap, just given the difference -- the changes in the environment, the financing, just so you have that at your side at some point, going to potentially into March next year?

I think it's something we would consider, but again, we have the cap -- the Board has the ability to allow agency to go above the 10% if it feels it's prudent.

Okay, fair enough.

And then just on the CPR assumptions, you're doing, I think, a good job positioning for the buyouts, the modification driven by affected [come].

On your 17 CPR lifetime assumption, are we to assume that includes some type of ramp or spike in CPR as if buyouts do drive CPRs up 10%, 15% one quarter and then come back down?

would that impact the amortization schedule at all if that were to happen?

Well we project CPRs over the lifetime, but we don't just use a constant CPR.

So there's a couple of things that go into that.

So yes, our projections are higher over the next year than they are over the lifetime.

However, we don't try to predict two months of really fast feeds and then knock things down from there.

The one thing on the buyout issue that I do want to be clear about is that it's actually something that over the long run, you can get your arms around how big the prepayments could be due to buyouts.

And that is if you assume that 20% of the loans are seriously delinquent or will be, and that all of those are pulled out, if that happens over a two-year period, then you are going to get 10% CPR for each year.

So it's not as much of a long-run pre-payment issue.

And again, we are more focused on the long-run prepayments.

It's much more of a concern around the timing from our perspective.

And again, we do project prepayment speeds to be faster in the short run, but we don't necessarily try to get each month exact.

And it won't affect our particular -- it won't have a large effect on our amortization because we will project forward from there.

Great.

Thanks, Gary.

Henry Coffey, Sterne, Agee.

Yes, this is Henry Coffey.

There are actually two sets of questions from Sterne Agee in there, so if you could just be sure of that.

A couple of things, unrelated questions.

First, I'm looking at slide 7 on your market commentary.

Could you help us, and given your current assumptions in CPRs, translate some of this coupon data into expected yields?

Maybe a rough number would be helpful.

I don't have the numbers in front of me in terms of a yield for each one, but obviously the CPRs are going to vary depending on the individual coupons.

But what I can tell you about yields in the ARM market or the market as a whole, that you --

Yes, that's what we're really trying to get to, is what are your reinvestment rates looking like?

Yes, you can get yields in the fixed rate market up to 4% or the low -- you know, 4%.

So you can get -- and yields in the ARM market, depending on what you are looking at, really range between 2% or up to maybe the low to mid 3%'s, in some sectors of the market, using kind of reasonable prepayment expectations.

And then, it's clearly the higher-yielding instruments tend to have longer durations and will have somewhat higher funding costs, so you're going to look at a mix of those and think about what you're comfortable with.

But it's exactly that point that there is a wide range of yields, and each of those yields has different considerations, that we feel it's imperative to be able to look across that whole spectrum to be able to find things that work on a continuous basis.

And for the areas that we are really uncomfortable with, we will either avoid them or look to sell some of them.

Can you manage in this reinvestment rate environment to keep spreads from falling further?

Or is that just sort of inevitable?

I think what I would say there is something I mentioned earlier, that, as we stood at the end of Q3, 55% or something over 50% of our portfolio was new purchases in the third quarter.

And if you look at our third-quarter ROE run rate or the ROE, even without the benefits of gains and terminated swap expense, was still around 20%.

So I think what that tells you is that even if you are not sitting with a portfolio at historical -- much lower historical valuations -- you can still find a way to get attractive returns.

But if we were going to convert that back to my spread question, your yields are at 4.13%, but are likely to fall further because of the reinvestment rate issue?

Or can you kind of keep them right where they are?

We don't project our asset yields.

It's going to be very dependent on the mix of securities that we hold.

Remember, though, that in the third quarter, we did add a lot of new instruments, and so it depends and we changed the composition of the portfolio.

So it is very dependent on what we see in terms of the relative value and how much of that portfolio turns over and how quickly.

And on the cost of funds side, basically that 120% is relatively stable for awhile unless there's some sort of radical change in repo or LIBOR?

Yes, the 120% would in general be relatively stable in that nothing rolls off in the short run, so it's going to be dependent on repo funding costs.

However, I do want to stress that the terminated bips, 50 basis points or so of terminated swap expense is actually very temporary.

And so that will be going away very shortly.

You mean the 50 bips goes away midyear next year?

Right.

And then on a completely unrelated subject, coping with the $0.90 -- I know other industries, not to point fingers -- but other industries have danced around the spillover issue for some time and did so unsuccessfully.

If you keep the $0.90 it holds book value higher and if you distribute it, it takes book value down but technically it takes cost basis lower for investors.

So how do you manage with that?

It's not -- nobody wants to capitalize and earn a dividend that's not core or sustainable.

Are there levers you can pull, such as creating a deemed dividend do you hold book value high?

Or maybe you could talk through some of the possible outcomes here.

I think what we tried to do on the slide that I went over earlier was build up where the $0.90 came from and some of the considerations we have with respect to using it.

But I think in the end, we are very comfortable with the cash flow of agency, and we've been very comfortable paying out -- we've been in position to pay out very reasonable dividends and still have book value perform very nicely.

And I think going forward, I've kind of laid out as much as I can about what we are going to do -- what we think about with respect to the dividend.

Thank you.

Rob Roell, RiverSource Investments.

Good morning.

I wanted to go back to page 15 and some comment, the first bullet you addressed and a concern just generally in market about what happens when the US -- the Federal Reserve ends their purchase program.

But one of the things you mentioned that piqued my interest, you mentioned that GSE is a buy-and-hold investor.

And I guess under current law, they are scheduled to begin selling their combined $1.5 trillion portfolio beginning in 2010.

And so I thought that in light of the current loss and the situation, I thought that was an interesting comment, so can you maybe further elaborate on your thoughts on this subject?

Thank you.

Absolutely.

And clearly when it comes to the GSEs, there's a lot of debate as to what their future will actually look like.

But if you look at the current arrangement with the GSEs, and I think it's embedded in the stock purchase, the treasury stock purchase agreement, it's that they shrink 10% a year.

But that would generally occur via runoff and would not require them to actually sell assets.

So that was the reason that -- I agree with you that that's probably the right base case to think about.

But that is not a situation that requires them to be a seller of mortgages unless their runoff were to be significantly slower than it probably would be.

So I think that's a key point to keep in mind.

But, clearly, the future business model of the GSEs is something that is going to get a lot of discussion over the next six months or more.

But I think in the end, it's actually something that's very favorable or likely -- whatever outcome that occurs there is going to likely be favorable for the agency REIT space over the long run.

Good points.

But do you think the absence of effectively --well, even if they are in runoffs, that's $150 billion a year, roughly.

Do you think there's buying power out there to offset that?

Well, in a sense, what you are saying is that in the past, if they were keeping their portfolios constant, then they would be buying $150 billion.

I think what you have to remember is that a lot of investors clearly have reduced their weighting in mortgages, and that it pretty much includes almost all investors classes.

And so I think that to the extent that spreads are more attractive, I think you can -- you will be able to find buyers for the product.

That being said, I think there is likely to be modest widening in order to get to the point where spreads are attractive enough for other people to play.

Over the long run, there is -- I think the market should have -- a government-type backstop that the GSEs played an important role in the market, and I do think that it would be good to have something like that over the long run.

But I think in the short run, people -- the fact that this change or the Fed's program has been telegraphed for so long, and the fact that production at this point is relatively light and would get lighter if mortgage spreads widened, should keep spreads at reasonable levels, albeit wider.

Thanks very much.

Ariel Schochet, Ladenburg.

Hi, it's Ari Schochet.

Can we go back -- I know we talked about it a couple of questions ago, but if we could talk again about the $0.90 on slide 6.

And I apologize if you have gone into this, so maybe you could just redo it one more time but focusing on the problems I'm having.

I don't totally understand what caused the $0.90.

But also when you say that you would consider putting an excise tax under certain circumstances, I'm not exactly sure I understand under what type of circumstance you would do the excise tax and what circumstance would you decide to not do that?

Then I have one other question as well.

All right.

Well first off, the way that the $0.90 we'll say comes about is that in the chart on the right kind of goes through that.

We carried some income over -- well do it in millions, $4.3 million from 2008.

Then you add in our taxable income for the year, and in the end, you hit both ordinary income and capital gains, and then you are going to subtract out what dividends we've paid.

And --

So essentially I'm underpaying the 95% requirement in the past?

Well basically you would say --

Rolling it over.

Take out 100% in the past gets you to having what this undistributed taxable income.

And so now the second half of your question was under what circumstances would you consider paying an excise tax?

I think what's important, there's a couple things to think about.

When you think about that excise tax, it's not necessarily that large of a number.

Let me give you just a simple example.

If a realized gain was 1 percentage point, then, so you had an instrument that you had a 1 percentage point gain from 103 to 104, and you were deciding whether you were going to sell that toward the end of the year, and you decided you didn't want to because of the excise tax, you'd essentially be making a decision over a tiny percentage of that gain which the market moves or would dwarf in a matter of hours probably, let alone days or weeks.

And so for that reason, I think you have to think about the excise tax as being not irrelevant and certainly an issue that we think about, but not something that should be avoided at all costs and something that we can manage through.

But big picture, when you take a step back, I think investors are best served by not having one-time very large dividends, but by having very attractive dividends that are sustainable over a long period of time.

But don't you also think that philosophically that investors are buying a mortgage REIT because by definition the mortgage REIT pays out?

And that in a sense, by not doing that, then investors may question well why are we buying -- why are -- this is supposed to be a tax efficient investment and why have this charter at all?

Or why -- I feel like it questions the stability of the premise.

I guess the one comment I would just make there on this issue is we completely understand that, that we are -- and if you look at Agency's track record, we've paid very attractive dividends over our history, and we certainly intend to continue to try to do that.

That's fair enough, and I appreciate that.

If I could ask one more question on the following slide, again, this has been asked in different ways and so maybe I'll ask it in my simplistic way and see.

Is there a premium above which you would not feel comfortable paying, just on the basis of it's too much risk if you have to be in a write-off scenario?

Or is the prepayment maybe, if I could ask it, throw in this, perhaps your prepayment assumptions and your views on what a refi boom could actually look like, given the different structural changes we've have, change that notion and there, just by definition you'd be willing to pay higher premiums than you might otherwise have a couple years ago, for instance?

Look, that's an excellent, excellent question.

And I think we don't think about it as a dollar price premium.

You won't hear from the agency, we don't buy anything over 104 or something like that.

But we absolutely think about the fact that there are a range of possible prepayment outcomes, and we are aware that while we may understand or have intuition around the prepayment dynamics, that clearly it's not an exact science.

So we look at a range of sensitivities when we are evaluating instruments and then make decisions from there.

But going back to kind of the -- some of the discussions of six months ago, just because something is at a high dollar price, if the funding environment is very favorable and the prepayment speeds are not going to be that fast, then that high dollar price might be warranted.

Now there are other times when -- and I think we have kind of demonstrated that this quarter -- where high dollar prices over time, in certain types of instruments, do scare us a little bit or they make us think that we are better off looking at some other types of instruments.

So I think there's a balance there.

And I think the one thing that we are very cognizant of, there is not an exact right answer, and you have got to look at a range of possible scenarios.

If you could -- if I could ask one more question.

If I look at you and I look at all your competitors and when I say even the agency, non-agency companies, the question I have is, you have such a range of leverage ratios and where people feel comfortable with leverage right now.

And I guess my question is, you know, how can we think about that in terms of what's the right leverage ratio for you or and to such a large extent it's based off of your own feelings of risk and what will happen if, when these different scenarios happen if the Fed moves out, I mean when the Fed moves out and what have you.

But, I guess the question is, if I have one company that's I decided on another company that said 9 and another company that said 5, it's very hard for me to look at their portfolios and say oh, I see the different risk that they are taking and it's just risk-based.

It seems much more based off of a view of the future and what have you.

And I guess any color or comments you have on that and how we should be thinking about it would be helpful.

And then I will drop off.

I thank you for all the questions.

That's a good question.

And let me just kind of give you the background.

I think for the agency REIT space prior to 2009, 8 to 12 was probably kind of a generic range for leverage.

And I think a couple things I think everyone in this space thinks about are the funding capabilities, the availability of repo, where are haircuts, other kind of cash needs.

And that is an extremely favorable picture right now, whereas, a year ago, it clearly was not.

And so that's one issue.

And then to your point, the other considerations are the trade-offs between the excellent recurrent returns and the perceived risk down the road.

And those are the things that we are certainly thinking about.

But what I do want to highlight is we go way beyond just our opinion on certain risks.

We have an outside third-party risk system, Blackrock Solutions, that we use.

We have sophisticated modeling that we use on a daily basis to look at our portfolio, and we assess the risks against a lot of different variables, such as changes in interest rates, changes in prepayment speeds, and spread moves just due to liquidity and so forth.

And those drive a lot of our risk management decisions.

But I do want to stress that risk management is something we think quite a bit about and has been a factor in every one of the decisions that we make on a daily basis.

Fair enough.

Thank you so much.

Gary, I just wanted to go back to the excise tax question and highlight a couple of points.

One is, don't forget to maintain our REIT status, we are required to distribute 90% of our taxable income.

And the other point is, just to clarify on the excise tax, that is a (technical difficulty) tax as opposed to a corporate income tax rate of 35%.

[John Sykes], Sterne Agee.

Good morning, everyone, and thanks for your time today.

Gary, I had a question about -- a couple of follow-on questions about the portfolio.

Given the environment we're in and the strength in the mortgage market so far in the fourth quarter, can we assume a similar trend lower in the coupon stack for your investments?

I think what I said in the earlier part was that so far in the fourth quarter, we do prefer kind of a more continued kind of move toward greater balance, and so we have incrementally moved kind of in the same direction that we moved during the third quarter.

But again, market conditions could change, and that could change our perspectives relatively quickly.

But at this point, we are looking at a more of a balanced range of coupons and we continue to see reducing our exposure to buy-out risk even though we've moved a lot in that direction, as something we would do on the margin.

Okay.

And as it relates to CMO portion, thanks for the color you already gave there.

But I was wondering if you could provide a little more clarity on that 8% of your portfolio roughly in terms of duration risk, coupon, yield, that sort of thing on the CMO portion.

We don't go -- we haven't given a lot of detail around the CMO portfolio largely due to the fact that it is relatively small and as you can imagine, it's -- there are lots of different types of cash flows.

Again, I just want to reiterate that our CMO portfolio is a way to invest in the same cash flows that we buy in the pass-through perform, either in an ARM pass-through or in a fixed pass-through.

They're just cut a little differently.

And in some cases it allows us to buy lower coupons than we could otherwise or to get better yields than we could otherwise.

And we may trade-offs.

And so, that's the reason for playing there.

But in terms of describing the specifics of the CMO portfolio, it's kind of hard to do on this call.

Okay.

That's all I have.

Thanks.

[Robert Fitger], Private Investor.

Hello, Gary.

Thank you very much for a nice quarter.

One easy question is can you give us some color on the swaps amortization costs for the fourth and first quarter?

Is it up or down?

Well the terminated swap expenses is a fixed number, so it won't change.

And I think we have it listed on page 13 on the bottom in a footnote.

So, it, we have a total remaining of $9.9 million to amortize through the second quarter of 2010.

So that is a fixed number.

So you can roughly take that as, so it's over three quarters.

It's probably least in the second quarter of next year.

So I think it's around $3.7 million a quarter.

That's correct.

Okay, thank you.

And I thought I had all my big questions answered, but the woman there surprised me with one answer.

And to maintain the REIT status, you are required to pay out 90% of your income?

Is that a hard and fast rule?

Or is there a way that you can carry over enough so that you don't pay out 90%?

That's a hard and fast rule.

And to clarify, you can distribute a portion of that in the subsequent year, but our intent would be to distribute all of our taxable income such that we would avoid corporate income tax.

Oh, the 90% is where you avoid corporate tax?

The 90% is a threshold to maintain our REIT status.

Okay.

So we would distribute all of our taxable income by the end of September of the following year.

So that's what I was getting at.

There is a way you can carry it over until September of next year?

Until September, but in September is really when this 90% kicks in.

It's over year end where the excise tax issues that we discussed kind of play out.

I understand.

Thank you for the clarification and that ends my questions.

Bose George, KBW.

I think he has withdrawn his question.

Henry Coffee, Sterne Agee.

I hate to keep coming back to this dividend issue.

The original concept of the spillover or rollover or retaining or whatever label people put on it came from a different industry and there was a lot of attempt at smoothing dividends and that worked for about a year.

Given that most of your mortgage REIT investors are institutional investors, isn't there just a certain logic to just every 12 months paying out 100% of what you earn, getting us some clarification as to how much of it came from operating and how much of it came from gains?

And then sort of moving forward, the quote, the present value of cash received today is always greater than the present value of cash received next year.

And it seems this whole issue of spillover and not paying out all the dividend is really just kind of a hangover from a different age.

I don't -- I guess everybody is spending a lot of time on it, but I'm curious as to what the real driver is here.

We've noticed most of the other REITs pay out what they earn, and that number goes up and down.

Look, we are, again, I just want to reiterate that we've paid out very attractive dividends, and by September, we will pay out in accordance with all the REIT rules.

But remember, we are a more actively managed portfolio.

And to the extent that we just happen to have gains that occur toward the end of the year or whatever, there is, it's a little bit different of an equation.

And I think we do also for purposes of managing our leverage and managing our cash flows, there are other considerations that impact the decision to make a one-time dividend.

But big picture, we are focused and have been, and I think it's very evident in the past, to making distributions and having attractive dividends, and we will continue to do so in the future.

Thank you.

[John Carmichael], Stockholder.

I did have a question just on strategy for repo financing currently.

It seems that you guys are still using a lot of the 30-day financing.

Just based on what I'm seeing in your information now and what I'm seeing on CNBC, it seems like the 90-day stuff is almost as cheap.

And I'm just wondering if you guys are, especially now that we're in the last quarter, are you guys thinking about moving more towards the longer-term financing?

That's a great question, and a very good point, and the short answer is yes.

As you went over the third quarter, if you had longer-term financing, it brought you right into let's say November, December, and we didn't feel that added that much value.

But to the extent that you are doing three- or four-month financing and it's getting you over year end and so forth, then, I think it is something that we definitely intend to look at more regularly.

That was -- I guess that was my thought because I know sometimes at year end there's issues, but now you would be in January, so --

No, excellent point and good question.

The other point that I at least wanted to get some clarification of was I wasn't 100% sure that I understood how the yield, the asset yield, was as low as it was.

Based on the information in the presentation that seems to suggest that the coupons -- I think you only gave it for the fixed at 5.77% and the hybrid at 5.43%.

Before I recall from -- I have my presentation from the previous quarter -- that some of that was impacted by the CPR multiplier and you had different assumptions.

You didn't have -- that was on page 14 of the previous presentation, but you didn't have that same slide for this presentation.

So I just didn't understand why it was so low at 4.38% for Q3 and 4.13% as of 9/30.

You know, it's a difficult comparison to make, again, because the portfolio is very different from Q2, and there's so many factors that go into the yield calculation.

So what I would say is again, over 50% of our portfolio at this point is purchases in the third quarter.

And if you go to page 9, you will see the composition of the ARM portfolio and somewhat the fixed portfolio is pretty different.

The purchase prices are also different and so forth.

And then to your point, there's other things that go into the calculation, including indices and CTRs and so forth.

But bottom line is that you are looking at very different things between the two quarters.

Oh, okay.

I guess I'm just saying though the coupon is 5.43% for the hybrid ARM and 5.77%, yet the yield is 4.13%.

So how do we get from somewhere around in the 5%'s to 4.13%?

But you're not counting in the premium -- the fact that those are purchased at premiums.

So you have to amortize the premium, and then you can't just do it as simply as look at the coupon.

There's lots of other factors that go into that.

I mean, again, there's a pretty big distribution within coupons and resets and everything.

So it's a relatively complicated calculation.

I got you.

Okay.

All right.

I appreciate it.

Thank you very much.

There are no further questions at this time.

Do you have any closing remarks?

No, thank you.

Thank you for participating in today's American Capital Agency third-quarter 2009 shareholder conference call.

This call will be available for replay beginning at 2 PM Eastern Standard Time today through 11:59 Eastern Standard Time November 4, 2009.

The conference ID number for the replay is 36505533.

Again, the conference ID number for the replay is 36505533.

The number to dial for the replay is 1-800-642-1687, or 1-706-645-9291.

Thank you, and you may now disconnect.