AGNC Investment Corp (AGNCN) 2014 Q1 法說會逐字稿

Good morning, and welcome to the American Capital Agency first-quarter 2014 shareholder call.

All participants will be in listen-only mode.

(Operator Instructions) Please note that this event is being recorded.

And I would now like to turn the conference over to Ms. Katie Wisecarver in investor relations.

Please go ahead.

Thank you, Maureen.

And thank you all for joining American Capital Agency's first-quarter 2014 earnings call.

Before we begin, I'd 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 forecast due to the impact of many factors beyond the control of AGNC.

All forward-looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice.

Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in the risk factor section of AGNC's 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 unless required by law.

An archive of this presentation will be available on our website, and the telephone recording can be accessed through May 12th by dialing 877-344-7529 or 412-317-0088; and the conference ID number is 10044220.

To view the slide presentation, turn to our website AGNC.com and click on the Q1 2014 earnings presentation link in the upper-right corner.

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

Participants on the call today include Malon Wilkus, Chair and Chief Executive Officer; Sam Flax, Director, Executive Vice President and Secretary; John Erickson, Director, Chief Financial Officer and Executive Vice President; Gary Kain, President and Chief Investment Officer; Chris Kuehl, Senior Vice President, Mortgage Investments; Peter Frederico, Senior Vice President and Chief Risk Officer; and Bernie Bell, Vice President and Controller.

With that, I'll turn the call over to Gary Kain.

Thanks, Katie.

And I want to thank all of you for your interest in AGNC.

It was certainly nice to see some stability returned to the fixed income markets in 2014, and we are pleased with our first-quarter results.

A sizable portion of this performance was attributable to some of the actions we took with respect to the portfolio toward the end of 2013 and rather than just an overall tailwind for MBS.

Our economic return in the first quarter was positive 5.1%, comprised of a $0.56 increase in our book value coupled with a $0.65 dividend.

Our economic return was driven by a number of factors.

First, as we discussed last year, we shifted a significant portion of our assets to 15-year mortgage securities.

15-year MBS generally outperformed 30-year production coupons in the first quarter, and we attribute this to the realization on the part of many investors of the need to position portfolios into assets with shorter average lives and with less exposure to mortgage spread risk both today and in the future.

The second important driver of our book value performance during the quarter was our decision to operate with a larger duration gap and the positioning of our hedges across the yield curve.

Given the rally and longer-term rates, our decision to begin the quarter with a duration gap of 1.5 years, our largest reported duration gap since 2010, was obviously beneficial to overall performance.

Additionally, as we discussed on our last few calls, we felt it was prudent to reduce the size of our swaption portfolio.

Option prices or, in market terms, the level of implied volatility, declined meaningfully during the quarter.

And so losses on our swaption portfolio, while still material, were considerably smaller than they otherwise would have been.

Lastly, our purchases of other agency-focused REITs in December and January also turned out to be a very good move.

These purchases generated about $50 million in both realized and unrealized gains during the quarter.

Looking ahead, we expect a certain amount of yield curve volatility to persist as the market continuously re-prices the timing and the magnitude of future Fed tightenings.

As such, we believe active portfolio rebalancing will remain critical to our performance over the coming quarters.

With respect to the mortgage market, we remain constructive on MBS spreads given many of the same factors we discussed on our last call.

Extension risk remains muted, implied volatility should remain low, the prepayment landscape continues to be benign, and, as we will discuss at the end of this presentation, the supply and demand equation and the overall positioning in the mortgage market remain very favorable.

And this is despite our view that the Fed will continue to taper their purchases along the current trajectory.

Now, before reviewing our financial results, I wanted to spend a few minutes discussing the increase in our dollar roll position and the implications on our taxable earnings outlook.

During the quarter, we increased our dollar roll position to around $14 billion based on the combination of very favorable financing and the reduction in the benefits of holding specified collateral.

Chris will review the economics of these trade-offs in greater detail, but I wanted to highlight an additional benefit of using dollar rolls given the fact that we have a large capital loss carryforward for taxable earnings.

In short, dollar roll income is treated as realized gain on sale each time the TBA is rolled.

As such, the income is treated as capital gains or losses for tax purposes rather than as ordinary income, as would be the case if we held the same position in pool form and funded it with repo.

Dollar roll income therefore nets against the accumulated tax loss carryforward, which allows us to utilize that benefit more rapidly and reduces taxable income in our current period earnings.

Assuming we continue to make significant use of dollar rolls, this difference in tax treatment between dollar rolls and MBS pool positions will have significant implications for our taxable earnings outlook versus both our GAAP earnings and versus our true economic earnings as well.

To this point, taxable earnings as well as UTI will become less relevant in understanding our financial performance and our capacity to pay dividends.

For this reason, we will likely deemphasize taxable earnings as a supplemental non-GAAP measure in the quarters ahead.

Now, it's important to understand that the tax-versus-GAAP differences created by dollar roll income will not impact our decision with regard to where we set our dividends.

As we have said many times in the past, we determine our dividend based on our view of the all-in economics earnings power of our portfolio and not based on earnings geography.

If we can utilize our capital loss carryforward by generating capital gains via dollar rolls, we can in essence pass along that tax benefit to our shareholders by continuing to base the dividend amount on the economic earnings power of the portfolio and changing the tax characterization of our dividend from ordinary to return of principle.

Dividends characterized as return of principle reduce an investor's basis in their stock, which only impacts the capital gain or loss they have upon sale of the stock.

Again, if this occurs it would generally be beneficial to shareholders in that return of principle dividends represent a deferred tax liability for shareholders and are taxed -- are typically taxed at the lower capital gains tax rate rather than being taxed in the current year at the ordinary income tax rate.

So with this as the introduction, let me quickly touch on a few highlights from the first quarter on slide 4.

First, net spread income, inclusive of dollar roll income but excluding catch-up [am], was $0.71 per share versus $0.67 per share in Q4.

Dollar roll income comprised $0.14 of that figure for the quarter.

As I discussed in my opening remarks, dollar roll income nets against our capital loss carryforward, so taxable income was $0.47 per share, and UTI declined to $0.42 at the end of Q1.

Again, the decline in taxable income and UTI based on the geography of dollar roll income will not impact our decision regarding future dividends.

With respect to the stability of the $0.65 dividend, management views it as an important objective to maintain the current $0.65 dividend and believes that should be achievable assuming market conditions remain favorable.

Book value per share increased 2.3% during the quarter to $24.49 per share in Q1.

Moreover, our current estimates indicate that so far in Q2 book value is up at least as much as it was during the first quarter.

Now turning to slide 5, our portfolio increased to just over $70 billion.

The larger portfolio was essentially offset by the increase in book value, so at-risk leverage was little changed at quarter end at 7.6 times.

Our holdings of other REIT equity increased during the quarter to $352 million.

As I mentioned earlier, total returns on this position totaled $49 million, with approximately $10 million coming in the form of dividends.

The remaining $40 million of realized and unrealized gains on our REIT equity holdings accounted for 20% of our total book value gains for the quarter.

Now at this point, I'd like to hand the call over to Chris to review market developments and changes to our asset portfolio during the quarter.

Thank you, Gary.

Turning to slide 6, I'll quickly review what happened in the markets during the first quarter.

As you can clearly see in the top two panels, both treasury and swap rate curves significantly both flattened during the quarter as the market began to price in Fed tightening.

Three-year treasury rates increased 12 basis points while 10-year treasury rates rallied 31 basis points and five-year rates were roughly unchanged.

Mortgage performance during the quarter was mixed, and one's view of performance was largely a function of hedge positioning on the curve versus the 10-year mortgages significantly underperformed but versus the five-year they did quite well.

Generally speaking, 30-year option-adjusted spreads widened during the quarter 5 to 10 basis points, and 15-year OES' were unchanged to a few basis points tighter.

Let's now turn to slide 7 to review our investment portfolio composition.

Our investment portfolio increased by approximately $2 billion during the quarter to $70.5 billion, with the growth coming from our holdings of 30-year MBS.

Our 15-year position was down slightly in both absolute and percentage terms, declining from 51% to 48%.

The increase in our 30-year position was driven by our view that 30-year MBS performance would improve based on strong technical factors, lower volatility, a flatter yield curve and attractive roll financing.

As I mentioned on the previous slide, 15-year MBS outperformed 30s during the first quarter, and we expect that 15s will remain well supported as investors continue to look for ways to remain invested while reducing interest rate spread and reinvestment risk.

To this point, despite the small increase in our 30-year position this quarter, 15s and other shorter spread duration assets will remain a core position that we will add to if opportunities present themselves.

The other notable change during the quarter is the increase in our TBA roll position, which was approximately $14 billion as of the end of the first quarter.

Turning to slide 8, we have an updated version of the dollar roll economic slide that we introduced this time last year.

Given the increase of our TBA roll position, we wanted to provide you with a snapshot of current market conditions.

On slide 8, we have two examples to highlight the financing advantage of rolling versus repo as of quarter end.

You can see that as of March 31, the advantage of rolling thirty-year 4s and 15-year 3s was 74 basis points and 123 basis points, respectively.

While there are trade-offs in rolling versus carrying specified pools, the risks are lower now for several reasons.

With each additional month of Fed purchases, the TBA deliverable improves as the Fed absorbs more and more of the cheapest-to-deliver float.

Secondly, refinancing activity is extremely low and is expected to remain muted, and therefore prepayment differences on different types of MBS are not a major factor.

For perspective, this time last year the refi index was north of 4500; most recently, it came in around 1360, less than 1/3 of where it was in the spring of last year.

And lastly, with the rally in rates and the flatter yield curve, seasoning is less important than it was a couple of quarters ago.

Now, keep in mind that the margin shown on this table excludes hedging costs that are not intended to depict long-term returns but rather to highlight the relative advantage of roll financing versus one-month repo over the near term.

Furthermore, while we do expect that differences in roll financing versus repo will persist for most of this year, you can expect volatility in month-to-month dollar roll levels.

That said, the current monthly carry advantage from rolling versus repo adds up quickly and can significantly impact returns.

With that, I'll turn the call over to Peter to discuss hedging and risk management.

Thanks, Chris.

I'll begin with a review of our financing activity on slide 9. Our access to very attractive funding continued through the first quarter.

Consistent with the shift in our asset composition toward a greater share of off-balance-sheet TBA securities, our repo balance fell to just under $50 billion at quarter end, down from $61 billion in the prior quarter.

With the repo regulatory landscape now clear, capacity appears to be improving further, and slight downward pressure on rates is emerging.

At quarter end, our average repo cost was 43 basis points, down 2 basis points over the quarter.

More importantly, the reduction in our funding costs was realized despite the significant increase in the average term of our funding, which increased to 162 days up almost 40 days from the prior quarter.

Strengthening our liquidity position is always a priority, and as such we will continue to opportunistically extend the maturity of our funding, thereby further reducing rollover risk.

On slide 10, we provide a summary of our hedge portfolio.

Overall, the total notional balance of our hedge portfolio increased to about $61 billion, up from $58 billion last quarter.

The increase in our hedge portfolio is consistent with the shift in our asset composition toward a slightly larger share of 30-year MBS and our decision to modestly reduce our duration gap.

In addition, we also altered the composition of our hedge portfolio during the quarter with swaption hedges decreasing and swap and treasury hedges increasing.

Specifically, our payer swaption portfolio fell to $8 billion last quarter from $14 billion in the prior quarter.

This decline is reflective of our view that interest-rate volatility will likely remain low and that extension risk in our portfolio, and in fact in the entire MBS market, is relatively limited at this time.

During the quarter, we terminated $4.3 billion of payer swaptions at a market value of $72 million.

Importantly, had we not terminated these positions, the market value would be significantly lower today given the rally in the rates and the continued decline in implied volatility.

The reduction in our swaption portfolio last quarter is a continuation of a strategy that we initiated last year following the increase in interest rates.

Over the last three quarters, we have terminated close to $21 billion of swaptions at a realize gain of approximately $270 million.

Lastly, on slide 11 we summarize our duration gap and duration gap sensitivity.

Given the significant rally in longer-term rates during the quarter, we've reduced our duration gap to 1.2 years at quarter end, down from 1.5 years the previous quarter.

With that, I'll turn the call back over to Gary.

Thanks, Peter.

And before opening up the call to questions, I'd like to revisit something I mentioned in my earlier remarks that the supply-and-demand outlook for the mortgage market is likely to remain very favorable despite the Fed tapering.

Slide 12 helps illustrate why we believe this is the case.

The graph on the left compares total agency originations versus Fed and GSE purchases since 2000.

The blue bars show the gross supply, and, as you can see, origination volumes in 2014 are expected to be considerably lower than what we witnessed over the prior five years.

The red bars show that Fed purchases, while declining because of tapering, are still expected to be very immaterial relative to production.

The purple bars on the graph on the right more clearly demonstrate this point by directly showing the actual difference between gross origination and the Fed and GSE purchases.

As a matter of fact, 2014 is projected to have the lowest amount of mortgage supply net of the Fed for any year with the exception of 2009.

Moreover, the supply available to the private sector in 2014 is projected to be roughly half of what it was between 2010 and 2013.

As such, it is really difficult to panic about the implications of lower Fed purchases against the backdrop of plummeting originations.

As an additional point, the blue dots show the average -- the annual average of the daily observations of the option-adjusted spread on new production MBS over the same time period.

Option-adjusted spread is a measure that attempts to isolate the residual spread on agency securities after accounting for all of the embedded options related to borrower prepayments.

While this is only one of the many ways to assess relative value in the mortgage market, and the average annual numbers clearly smooth out significant intra-period volatility, it is very hard to conclude from this graph that agency MBS are mispriced given the current supply-and-demand factors.

Also, keep in mind that the current coupon mortgage OAS as of March 31, which is shown on the graph as the red dot on the far right, was actually wider than the 2014 average as a result of heavy money manager selling during the second half of the quarter.

Some market participants argue that the focus should be on net mortgage supply, which excludes refinancing volumes and only looks at the net growth of mortgage debt outstanding when trying to assess the technical backdrop for the market.

We agree this makes sense over the longer term but think that this approach is very shortsighted in the near term because it completely ignores the stock effect of the Fed's purchases.

To this point, let's turn to the next slide, and we can look at how the investor base for agency mortgages has changed over the last year and a half since the onset of QE3.

First and foremost, as you can see on the far left of the bar chart, the Fed's holdings of agency MBS skyrocketed to around 30% since September 2012 and will continue to grow by another 2% even assuming they end QE3 later this year.

Additionally, and this is often overlooked by market participants, the Fed is widely expected to continue to replace the runoff in their mortgage portfolio, and so they will continue to buy a very significant amount of agency MBS well after QE3 is over.

As such, the Fed would maintain its share of the mortgage market around its peak, which should be in the low 30% area, until such time as it decides to stop replacing runoff.

So what have other investors done over this same period?

As you can see, they have universally reduced their holdings as a percentage of the overall market and on an absolute basis as well.

The GSE and Federal Home Loan Bank holdings have declined and will likely continue to drop but at a somewhat slower rate going forward.

And as most of you on this call know, mortgage REIT holdings of agency MBS have declined as REITs adjusted their portfolios to reflect lower book values, reduced leverage and, in some cases, stock buybacks.

However, this trend has likely run its course, as leverage levels across this space are at historical lows.

If we look at domestic banks, they have also not grown their holdings of MBS despite significant increases in their deposit base and relatively anemic loan demand.

As such, it is likely that banks will begin to increase their mortgage portfolios over the remainder of 2014, especially if rates were to rise or spreads were to widen.

Foreign investors also saw a decrease in their holdings of MBS, but there are some reasons why this should -- could reverse.

Yields on European and Japanese sovereign debt have declined significantly relative to the yields on treasuries and agency mortgages.

And so it is very possible that overseas investors may become buyers of US debt during the remainder of 2014.

If you are an overseas investor and you have a choice between an agency MBS or an Italian 10-year bond, and both yield around 3.25%, which would you choose?

At the beginning of 2013, you could have picked up over 250 basis points or more than doubled your yields if you opted for Spanish or Italian debt.

As of today, that entire yield advantage has disappeared.

Last, but certainly not least, domestic money managers have been the largest source of bonds for the Fed.

Domestic money managers are meaningfully underweight agency MBS versus their indices.

Remember some money managers are pure index players and have mandates to replicate the indices and thus don't have the option to underweight MBS.

Actively managed fixed-income funds will likely need greater and greater incentive to decrease already underweight positions.

Moreover, spreads on competing product, including high-yield corporate debt and other sovereign debt, have generally tightened at least as much if not more than mortgages over the past several years.

And they don't enjoy the same financing advantages.

Lastly, if bond fund redemptions were to reverse, then even without a change in weightings versus an index, money manager holdings of MBS would increase.

So in conclusion, all the categories of investors have reduced their holdings of agency MBS as the Fed ownership of the market has increased.

There are numerous reasons why many of these investors may begin to reverse this trend.

Therefore, when you combine the impact the Fed has already had on the investor base of agency MBS with the favorable supply-and-demand equation that we looked at on the previous slide, it seems like a very risky bet to assume that agency mortgages are going to widen significantly in the near term.

So with that, let me stop and ask the operator to open up the lines for questions.

(Operator Instructions) Joel Houck, Wells Fargo.

Thank you.

Just a question on the increase in 30-year exposure.

I guess most of the agency REITs -- and you guys included going back last year kind of cautioned -- it sounds like that's easing a bit.

I don't want to put words in your mouth.

I guess I'm more interested in how you think about the opportunity set and the 30-year MBS as the taper kind of ends into the second half of this year.

Sure.

What I would say on 30-year MBS is we've obviously always been comfortable with them.

But we do care about pricing implications between 15 years and 30 years, and that's something we're always going to think about.

And, yes, if we -- theoretically, I would rather have 70% of the portfolio be in 15 years or ARMs or shorter duration assets.

But -- and, you know, there's no reason on our part to try to replicate the mortgage index or anything like that.

So we'll call it the 20% of that 15 years comprised in the mortgage index are -- that's kind of off the table completely.

But, big picture, we also have to be cognizant of what's going on in the mortgage market, which -- or in the overall rates environment completely, which is implied volatility has plummeted, the yield curve has flattened and financing advantages of 30-year have improved.

And so we are comfortable with 30-year mortgages in the portfolio, and we are comfortable with the spread environment at this point for a lot of the reasons we've talked about.

So, yes, there is still a preference on our part for 15 years, but we are going to be opportunistic with respect to both portions of the market and are totally comfortable playing in both cases.

And Gary, would be a fair statement to say that, even though perhaps you're still cautious into the end of the taper, you are less concerned about volatility and spread widening than perhaps six to nine months ago?

Well, clearly, six to nine months ago there were a lot of other factors going on.

And, yes, we were considerably more concerned about market positioning; about a number of different factors.

I think at this point it's pretty clear that the market has adjusted to Fed tapering.

Okay -- the bond market has adjusted to Fed tapering.

And, in particular, the mortgage market has adjusted to expectations around Fed tapering.

And I think that you can see that in the positioning of investors across the board.

And so, yes, that kind of positioning gives us greater comfort that spread volatility will be more contained at this point.

All right, great.

Thanks for the comments.

Mark DeVries, Barclays.

Thank you.

Gary, you just -- you made a long, convincing case as to why you don't see spreads widening much from here.

Could you talk a little bit more, though, about why it is you guys don't see the dollar roll cheapening much over the next year relative to repo?

Thanks for the question.

This is Chris.

Well, it's in part because the float continues to improve each month with the Fed taking delivery of a large portion of the cheapest-to-deliver bonds.

It's also simply the demand technicals versus gross issuance, and the fact that the would-be sellers of the basis are already underway for the most part or at least very much on sides and not overweight.

I mean, the rolls also benefit from accounts that had set short positions expecting the basis to widen.

The short base has to either cover their position or buy the roll each month.

And the reality is, given low levels of gross issuance, a lot of the short positions were bought by going-away types of accounts; the Fed; small-to-mid size banks.

And so we expect the technicals to remain very favorable for this year.

Ultimately, the imbalances will work themselves through, but it will take time.

Okay, great.

Next question -- I know you guys mentioned material production in the swaption position reflect income, lower implied volatility.

I'm just wondering, though, with kind of the big move in particular the long end of the curve during the quarter.

And presumably, I guess it would imply volatility lower; swaptions are now cheaper protection.

Does that make you -- given rates are -- you know, the fact it's still relatively low absolute levels, does it not make it more attractive to think about adding swaptions here?

Yes, this is Peter.

The short answer is it could.

And you are absolutely right.

The drop in swaption prices has been really significant over the quarter; call it 15% to 20% drop in prices.

But when you look at the prices relative to rates, they are at the lower end of the range so that would imply that they're fairly cheap.

The flip side, though, is that we just don't see a lot of extension risk in the mortgage market, and that's, I think, the unique difference about today's environment versus environments in the past.

If we get a 100-basis-point move in rates, for example, mortgages might extend a year or something in that neighborhood.

The other significant point about rate volatility is that the Fed not only owns a huge amount of the outstanding supply, as Gary mentioned about 30%, they also own an even larger percent of the outstanding negative convectioning -- probably 40% or more.

So the extension risk that will occur is going to be in the hands of the feds as opposed to in the hands of privates investors who have to rebalance it.

So we think there could be opportunity to add swaptions in the future, but right now we likely don't need them for our portfolio.

Okay.

Thanks.

And then just one last question, I think if we back out the change in value in your investments and REIT holdings, it looks like you put about as much capital to work again in buying other REITs this quarter than you did buying back your own stock.

Can you just talk about how you're thinking about allocating capital between those two opportunities?

Yes, this is Gary.

We don't allocate capital in the sense between those.

The stock buybacks or something that we are committed to, we have demonstrated our willingness to do those.

But I want to point you back to what we said on the Q1 -- or on the call in February related to Q4 2013, which is at that point in December and January was when we did the vast majority of these purchases.

So most of if not all of the increase in the other REIT equity positions were in the month of January; and that's what we had given you the $400 million number on that call, which was the position essentially at that time.

So, while we've been in window periods this quarter, the conclusion that you came to that we bought more of other stocks then we did of our own just does not apply.

Okay, got it.

Thanks.

Douglas Harter, Credit Suisse.

Thanks.

Gary, I was hoping you could expand on that -- on the net supply -- sorry, the gross supply for 2014 and how you're thinking about that sort of today versus kind of the end of the year.

Because obviously that's a different picture as the Fed tapers.

It absolutely is.

And you can think of as the Fed purchases drop and over the summer, originations will pick up some, clearly because of seasonals and housing activity.

But toward the end of the year, it's very possible that mortgage production -- and, again, is kind of back at its lows.

And even -- and then remember that the Fed will still be replacing runoff, which is something they didn't do after QE1.

So, big picture, even in that environment with production of maybe $60 billion-ish, maybe $70 billion in the winter -- in the fourth quarter, let's say, versus Fed purchases of something like $10 billion to $15 billion, that's still an incredibly small number of securities kind of available for the overall market.

And then when you put that against the positioning of other investors, in no way -- and take a look at that versus a larger time -- over a larger history in the mortgage market, those are still pretty close to record low amounts of bonds available for other investors.

So that's our -- the driver for our kind of lack of concern, so to speak, that there's an accident waiting to happen.

And how do you think about it within sort of the specific coupons that the Fed is buying today?

Do you have sort of a similar mindset there?

I think -- look, obviously we have different opinions of different coupons both on the 30-year side of things and on the 15-year side of things.

I think the one -- and so, I think the coupon performance, one big factor is going to be what happens with the shape of the yield curve and what happens with the overall level of rates as well as things like implied volatility.

But the one thing you have to understand in this overall equation, to your point there are some coupons that are more dependent on the Fed than other coupons.

And that's something we'll certainly keep in mind.

But, again, most of those conclusions are going to be dependent on the evolution of interest rates and some of those other factors.

And so those decisions are things we can deal with over the course of the year.

Great.

Thanks for that color, Gary.

Arren Cyganovich, Evercore.

Thanks.

With your larger TBA position, I'm just curious what you think about taking those on balance sheet and what the net impact would be if you were to actually take delivery of all of the TBA and how that would impact your yield and cost of funds.

Sure.

We talk about -- and Chris showed you the difference between on-balance-sheet returns versus the dollar roll returns.

And so, yes, dollar rolls present a good opportunity.

But I want to be very clear -- and Peter highlighted this in his discussion.

We have -- we are at record amounts of unused repo capacity.

And so we have multiples of repo capacity to handle this dollar roll position and even a much larger dollar roll position if that were to come around.

So we have absolutely no concern whatsoever about taking on dollar roll positions when we have experience settling securities and so forth.

And actually one of the advantages of AGNC's size is that if we were to take positions in, given the size of those positions, it's almost impossible for dealers to adversely select you.

If you're going to take in $5 billion or $10 billion of a particular coupon, it's hard enough for people to find those securities, let alone to find the absolute worst securities for you.

And, as Chris mentioned, given the absorption that the Fed has had, given the other conditions that we talked about, the difference in what you're going to get delivered in most coupons is just not that significant right now.

So not an area of concern.

We absolutely want to be clear before we put on a dollar roll position, we are always assuming there may be a circumstance where we can -- we'll take it in, and we're completely comfortable doing that.

I guess I was just thinking more or less how that would impact your profitability.

So if you were to add those all on balance sheet, your core for your earnings of $0.71 on dollar roll included basis.

How would that be negatively impacted if you add those all on balance sheet?

Yes, I'm sorry, I forgot the more specific piece of that.

But basically if you think about it, your -- the $0.14 basis -- the $0.14 that we talked to you about in dollar roll income for Q1 would be -- on balance sheet income would be lower than that.

I don't know exactly what the number would be, but maybe it's $0.10 or something in that ZIP Code.

So that's -- as of Q1's number, that's the kind of exposure, $0.05, that you're looking at if we were to do that.

Okay, thanks.

And then I guess getting back to the OAS spread illustration you had being wider today.

I guess what my question would be would be why would the money manager be underweight, the sector with OAS spreads wider?

What are they waiting for in terms of -- does that need to widen out further for them to actually increase demand?

Or do you believe they're just waiting for the Fed to exit their full taper?

Sure.

Look, what I want to be clear is, look, there are logical reasons why -- and especially larger investors may want to reduce their exposure to the mortgage market.

I mean, let's -- it's a popular concern to be worried about the Fed tapering and to the implications.

The other thing I'd like to be clear, in no way the money managers selling didn't just occur at the very end of March at the wides.

The money managers selling was significant enough to push mortgages to the wides, and a lot of that was done at much tighter levels.

So I think, big picture though, what you're -- what you have to think about and what we're trying to explain to investors is there are a number of ways to think about these technical factors.

And if you focus on the fact that the Fed to bid is going to be smaller, then it would be logical to sell prior to that.

If you focus on the overall picture and if you think about how the landscape of investors has changed, then from our perspective it just becomes a real concern if you reduce -- we'll just talk for ourselves -- if we were to, let's say, reduce leverage significantly, you forego significant income opportunities especially with dollar rolls.

And then you are hoping that all of these investors that have reduced their positions all win and that spreads are much wider, and that they all can get back in at wider levels within a relatively short period of time.

And, again, from our perspective that seems like a pretty big risk.

Okay.

Thank you.

Steve DeLaney, JMP Securities.

Gary, thanks for the clarity on the dividend policy with respect to the tax efficiency of dollar rolls.

That was definitely my first question.

So I appreciate that -- those comments.

The thing that struck me, looking at the presentation in terms of the financing benefits of dollar rolls, was the advantage that -- or the benefit, if you will -- the greater benefit that 15-year rolls have over the 30 years.

It looks like the -- it's about a 50-basis-point greater benefit.

And when I look back at the portfolio on page 7, overall you're about 50-50 -- 15s and 30s.

But, specifically, the TBA position, the 15-year TBAs are only about half of the 30-year TBAs despite that financing.

Could you explain why we're seeing it that way?

Yes, look, one thing is there's two sides of that coin, right?

And what we want to stress is -- look, the financing advantages, as to your point, are excellent on the 15-year side.

But there is a little bit of a higher cost to not owning the particular seasoning buckets within 15s.

And so that's a key trade-off, and that's very different in, let's say, 30 to 15-year 3.5s and 3s and 2.5s and so forth.

And so there are implications on both sides of that.

But, you know, it's -- again, 15s when you factor in the financing advantages on incremental positions there are very attractive, even with lower yields.

I don't know, Chris, if you wanted to add anything.

The one thing I'd add, Steve, is just, if you recall, last quarter we had a net short $4 billion TBA position in 15s versus seasoned pools that basically served as an option on rates.

And given the rally combined with the flatter curve, really strong roll valuations and actually reasonably strong seasoned spec pool bids, we chose to -- we shifted that position basically $8 billion over the course of the quarter.

So we didn't -- it was a material shift from a short position of [$4 billion] to a long position of [$4 billion].

Okay, that's helpful.

And it sounds like, as you are saying, they may be cheaper on financing.

But I think, Gary, what I heard you say is the characteristics of some of those bonds, if you were to be -- take delivery on the bonds, it may be paper you wouldn't necessarily want to have.

Is that sort of --

Or it's less desirable if you have something that's three or four years old and 15 years, you don't necessarily want to give that up.

So there are trade-offs that I think we spend a lot of time thinking about.

But I do want to reiterate this is another example where the bigger positions -- some people worry that the bigger positions are harder to manage or you give up opportunities.

In some cases with respect to rolls, if you were to choose to take in bigger positions, you sometimes get much, much better securities in the end because of the issues around the outstanding float.

And so we actually feel very comfortable in the case of 15s that, in certain areas, we'll get very good securities if we were to take these rolls in.

Okay.

Thanks.

And just one final thing just kind of thinking big picture, not too far from your office the Senate banking committee is kicking around Johnson-Crapo on GSE reform.

And one specific question and then just a general open-ended.

Would it be your understanding as the way things are drafted that, if this were to proceed -- and I know we're talking about years down the road before it would be in place -- but would it be your view that Fannies and Freddies would become full faith in credit bonds?

That would be the specific question, and therefore possibly close to Ginnies.

And then lastly, is there just anything about this proposal, about this whole concept of GSE reform, that we should be thinking about with respect to the pure agency mortgage REIT model?

Thanks.

Now look, Stephen, appreciate the question.

It's a good one and timely, as you pointed out.

Big picture, we are not worried about the legislation.

We don't see it as drafted, or even most of the other drafts have been out there, as being, let's say, a threat to our business model.

To your point about the Freddies and Fannies -- or the new version of Freddies and Fannies being full faith in credit of the government and looking like Ginnies, we agree that that's the likely outcome.

But we think that the pricing of that combined universe will actually be much closer to Freddies and Fannies than it is to Ginnies.

Ginnies get the beneficial pricing that they get because there aren't enough of them to fill that specific Ginnie-only bid, so to speak.

But when you combine the three agencies, if the three agencies were all full faith in credit, you'd fill that bid and you'd still be requiring to get the incremental bid from people that are buying Freddies and Fannies today.

Got it.

So, big picture, we are not really -- we don't see the legislation as something that concerns us.

And, again, we remain just very, very comfortable with the agency REIT business model.

We think that it really does provide investors with a very liquid alternative that they can't duplicate in other strategies.

Appreciate the comments, and great quarter.

Thanks.

(Operator Instructions) Mike Widner, KBW.

I guess the first one, just a detail here.

You indicated you sold $2.8 billion in swaps during the quarter.

Could you just -- where were they on the curve?

What kind of part of the duration spectrum were they at?

Hi Mike.

This is Peter.

They were more on the front part of the curve.

And, as you can see, we also added about $5.9 billion of swaps.

And, in fact, we added most of our swaptions -- in fact, all of our swaptions we added were forward-starting swaps, which we chose specifically because they give us the ability to sort of tailor our exposure to the intermediate to longer-term part of the curve.

So call it the three-year to five-year part of the curve, but in forward spaced by a couple of years.

So we unwound some of our shorter spot starting swaps and replaced them with forward starting swaps.

Yes, because I was just trying to figure out what exactly the interest rate that was, if you were.

And basically -- I mean, it sounds like you're taking advantage of -- I mean, to a large degree, the curve flattened in that kind of three- to 10-year range.

And it sounds like you sold high and bought low, basically.

Yes, we still have a significant portion -- and obviously, as Chris mentioned at the beginning, dependent on where you had your hedges, obviously, it was a huge driver of performance of the mortgage portfolio.

We still need and want a lot of our hedges in the intermediate to longer-term part of the curve.

It's close to about 60% today.

Now obviously, if we had them all shorter this last quarter, our book value would've been up much more.

But that wouldn't have been the right position to have in the long run.

Yes, that makes sense.

Let me just ask you a quick follow-up on the mortgage REIT holdings.

You indicated I think on the last call somewhere around end of January that the position was $400 million; it's $352 million now.

So suggest that you did some selling because this stuff generally is up in pricing across the sector.

So how do we think about that balance, and can we read any kind of trajectory into that?

Are you winding the position down?

Or how should we think about that?

Sure.

This is Gary.

And I appreciate you asking the question along those lines where it looks like we did some selling versus we tried to find a way to lose money on a sector that went up during that period.

But we did take a targeted approach to selling out some of the REIT equity that we bought.

We are in no hurry on that from that perspective.

They weren't kind of blanket across-the-board sales.

But, look, we understand the mortgage market.

We remain comfortable with the market.

We can analyze other REITs' portfolios reasonably well.

And so the bottom line is we don't feel like in any way, shape or form that we are in a hurry to divest of these positions.

We, again, are comfortable holding them for an extended period.

On the other hand, if they appreciate enough then we're totally comfortable selling off more.

So kind of similar to last quarter, we don't give a ton of information about the kind of -- the -- our quote strategy there.

But, to your point, I think it's pretty -- it should be pretty straightforward.

Yes, it makes sense.

Is there -- I'm sure you're not going to answer this.

But is there a price-to-book level at which you kind of feel like you've gotten what you're going to get out of them?

So when you were buying them, a lot of them were trading 80s of book, and now we're kind of low 90s probably on a lot of the group -- high 90s, or even over [90] or over [100] on some.

But is there a level at which you feel I guess it doesn't make a whole lot of sense in your portfolio anymore?

Yes.

There are levels.

I'm not really going to go into the specifics of it.

And it also depends on the underlying portfolio and whether or not we feel that the underlying portfolio is complementary or not -- complementary and so forth.

So there aren't set thresholds.

But, look, if they were above book, all of the reasons why we gave you for owning them would not apply.

And so that's really the most I'll say about that.

Yes, no, that makes -- certainly makes a lot of sense.

And a final one, you added $1 billion of receiver swaptions this quarter.

And I guess what I'm just sort of wrestling with trying to figure out is, what is the rate scenario that that position is a benefit to you?

And I guess I'm just trying to think about the value of those in a mortgage REIT.

Yes, this is Peter.

I would think about that more in the context of the types of assets that we are owning.

And, obviously, we talked a lot about our TBA position and the fact that we have more 30 years, and some of those in TBA form.

So you don't have the same prepayment protection that we would normally have on our assets.

So I would think about it just in the context of giving us some prepayment protection on some of our TBA positions.

Okay.

Thanks.

That's an interesting way to think about it, but I wouldn't have come up with it on my own.

So thanks, and appreciate the comments as always, guys.

And good quarter.

Eric Beardsley, Goldman Sachs.

I was just curious what the original date the maturity was on your repo.

It looks like you extended the term quite a bit there.

Just curious where that started out.

Well, last quarter our average was 124 days versus 162.

Yes.

So I guess the disclosure that you used to give, I think as recent as your 2Q 2013 presentation, had the original days versus the remaining days.

We don't disclose that just for simplicity.

But I can tell you that, just ballpark, is numbers give or take 10 days of 162.

Okay, great.

It will be very close the original days to maturity.

One thing to keep in mind is, given that we have so much more -- we have so much excess capacity, I'm glad you asked the question.

As we also do dollar rolls, which are sort of like replace some of the shortest-term financing, we've found it both cost effective and relatively easy to extend the maturity of our repo borrowings, which is actually very significant for investors in terms of reducing risk either around rollover risk around repo, and also just any kind of risk around haircuts changing because they are locked in for the term.

Yes.

Just to build on that point, at the end of the first quarter, about 10% of our repo funding was longer than a year.

That's up about 3% from 7% last quarter.

And, importantly, we're seeing liquidity and really attractive financing, to Gary's point, from one all the way up to five years.

So we will continue to opportunistically take advantage of those funding opportunities as they present themselves.

Great.

Just what have the conversations been from the dealer side in terms of capacity and pricing?

I think you mentioned that you felt that the market had priced in new rules whether it be SLR or NSFR.

Are you thinking that that is fully there now, and there is more tightening to come?

Well, from what we hear from our counterparties, I think the answer to that is yes.

Our counterparties seem to have gotten ahead of that and made the adjustment that they need to make.

And, if anything, we're seeing our existing counterparties looking for more business.

So I think that they fully captured the regulatory obligations that they will face.

I don't expect a lot of change from them.

And then, in addition, we're seeing increased number of counterparties coming into the market that we hadn't seen before.

I suspect, for example, in the second quarter of this year we might add two more counterparties.

And we're talking about significant size repo positions.

So we think the environment really is attractive for finance right now.

Okay, great.

Thank you.

Dan Furtado, Jefferies.

Most of them are actually (inaudible) -- I just wanted to kind of look at this slide 12, the gross supply versus Fed GSE gross purchases.

Can we roll that out the year into 2015?

I think the consensus would be that the blue bar stays about the same.

That red bar comes in pretty substantially.

It opens up some supply.

When you think about out into 2015, is that the right way to think about it?

And I guess the response from your -- where you sit would be that you'd readjust the portfolio going into that?

Or how should we think about that, the turn of the year, that rolling into 2015?

I think there are two things to keep in mind.

And by most estimates, let's -- you got to keep in mind that the Fed is still reinvesting paydowns at that point.

So the red bar is not zero, which people, I think, make a mistake on often.

And if you just netted, we'll call it, those two bars with a pretty small Fed bar and you compare that going back in history, that's still a relatively small amount of net -- of kind of supply that needs to be absorbed by the private sector.

And so the idea that there, again, is this massive imbalance about to hit the market, I think is misplaced.

Where that becomes an issue -- and I want to be clear -- is if we were to have a significant rally in rates and if the Fed were not replacing runoff, which was the scenario that occurred in 2010, right?

So the Fed exited QE3 and the market performed great following the Fed's exit until we had a pretty significant rally in rates.

Production picked up pretty dramatically.

The Fed was not reinvesting paydowns, and so very quickly all of the Fed's holdings were in a sense -- or a good chunk of the Fed's holdings were being thrown out to the overall market.

At the same time, we had lower yield levels.

And so there were some, in particular, overseas selling the mortgages.

And then you had a pretty healthy widening in mortgage spreads.

But if you think about the scenario you are describing, none of those things apply unless we were to rally significantly to lower rates where you get a pretty significant pickup in refinancing activity.

And that's going to, again, require more than a 50-basis-point rally from here.

And I'm not going to try to say that's not possible; it obviously it is possible.

But there are other benefits of that scenario as well.

So I think that's kind of the key is in thinking about it.

The supply numbers that the market is looking at either at the end of 2014 or even in 2015 are manageable -- are very manageable.

Especially, again, given that the market is completely positioned for it.

And I think one of the things that happened was, given the stress on the market in 2013, basically it forced investors to make the adjustments they would be making, let's say, in the middle of this year.

It forced them all to make them last year, including the REITs and including us.

And so I think that you've seen those adjustments.

And now I think too many people are sitting there waiting for mortgages to widen.

Great point.

I appreciate the commentary, Gary.

Well, thanks a lot, Dan.

I appreciate the question.

And I want to thank everyone for participating on the call, and we'll turn it over to the operator.

We would now like to complete the question-and-answer session.

I'd now like to turn the call back over to Mr. Gary Kain.

Well, thank you.

And, again, I want to thank everyone for participating on the call, and we look forward to talking to you next quarter.

The conference has now concluded.

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