AGNC Investment Corp (AGNCO) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the American Capital Agency Corp.'s Second Quarter 2008 Earnings Call.

(Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to our host, Ms.

Amanda Cuthbertson, Director, Investor Relations.

Please go ahead.

Thanks, Pamela.

Good morning and thank you for joining American Capital Agency Corp.'s Second Quarter 2008 Earnings Call.

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

This conference call and corresponding slide presentation contains statements that to the extent they are not presentations 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 those formats.

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

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

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

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

An archive of this presentation will be available on our website at www.agnc.com, and a telephone recording can be accessed through August 14 by dialing 800-475-6701.

The replay pass code is 952934.

To view the Q2 slide presentations, return to our website and click to Q2 2008 Shareholder Presentation link in the upper right corner.

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

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

Now, I'd like to introduce the participants of the American Capital Agency Corp.'s Earnings call.

Malon Wilkus, Chairman, President and CEO of American Capital Agency Corp.; John Erickson, Chief Financial Officer; Russ Jeffrey, Chief Investment Officer; and members of our investment team, Raymond Yu and Edward Smith.

And with that, I'll turn the call over to Malon Wilkus.

Malon?

Thank you, Amanda, and I appreciate everyone joining us today.

This is our first shareholder presentation and we're very excited to talk about the results.

I'd like to ask everyone to turn to slide 3 of the presentation.

I know this is kind of high-level information, but for those who end up looking at this presentation after this call and they are not familiar with American Capital Agency, I just wanted to review very briefly the structure and the overview of AGNC.

American Capital Agency is a REIT externally managed by an affiliate of American Capital, and it's structured to generate attractive risk-adjusted returns and to distribute income through quarterly dividends.

And the asset class and the investment portfolio is that we're invested exclusively in agency securities guaranteed by Ginnie Mae, Fannie Mae, and Freddie Mac, and we are investing to capitalize on the discrepancies in the relative valuations in the agency securities market.

The leverage is limited and intended to range between six and eight times our equity, and the board is required to approve any leverage that would exceed 10 times leverage.

And currently the repurchase agreements we have with 14 global financial institutions at the end of June 30, and in fact our leverage at the end of June 30 was at 8.25 times.

If you move to slide 4, let's just review the highlights for the quarter.

Now, keep in mind this was a stub period.

We went public in the second quarter, we completed a $300 million initial capital raise on May 20, 2008.

We raised $286 million in net proceeds, and for that very short period we generated income that allowed us to declare a dividend of $0.31 per share.

Our net income again during that short period was $5.5 million.

We actually produced a $0.37 per basic and diluted share net income, and that is a 17.45% annualized return on equity.

Our annualized net interest rate spread was 3.15%, and we borrowed $2.2 billion under repurchase agreements as of the end of June 30, and as I mentioned earlier that's an 8.27 times leverage.

We now have, at the end of June 30, a $2.4 billion investment portfolio, 100% of it is in fixed rate agency securities, and on average our portfolio was held for approximately 27 days.

So, we produced this 17% return on equity annualized over that 27-day period, and you can see on the end of the quarter we actually performed better than that.

But before we get into some of those details, let me pass it over to Russ Jeffrey, who is the Senior Portfolio Manager and Managing Director.

Russ will take you through our investment philosophy on page 5.

Thank you, Malon.

And as you turn to page 5, we thought it would be a good idea to review our investment philosophy and how we look at the mortgage market before we get into portfolio specifics.

As many of you recall from our road show, we presented three pillars to successful mortgage investing, and those pillars are value, underwriting and leverage.

And we think everything is a functional value including price volatility and we'll talk about that in future slides.

We think the underwriting process is pretty critical.

Now, obviously we're taking no credit risk, so we're not doing credit underwriting, but we're being very diligent in our collection of pools, so not only have we selected slow paying pools now, we also have pools that remain slow and just a different interest rate environment, and that's important because we have a premium mortgage-backed portfolio.

And we're all aware of the dangers of using excessive leverage and that's why we want to be very prudent in our use of leverage.

Let's turn to slide 6, and what we thought we'd do next is talk about the general mortgage market and what's going on.

As everybody knows from the headlines, the mortgage markets have been very volatile.

There's a lot of talk about what's going on with Freddie and Fannie.

President Bush this morning signed a bill that essentially guarantees the viability of Freddie and Fannie.

The mortgage market has since recovered in terms of Freddie and Fannie spread.

The Ginnie Mae spreads has been volatile but back to more historical norm levels.

The yield curve has been steep, mortgage valuations are cheap.

These will be two themes that we think are going to be multi-year themes going forward, that we see the current mortgage market environment as return rich environment; we see mortgage-backed securities exceptionally cheap.

We think that yet they're easy to finance.

And we expect the curve to remain steep for many reasons.

We think that based on what we know in the financial markets, especially with the housing market in a freefall, a slow prepayment environment, weakened financial institutions and rising unemployment that's not typically a time when the Fed aggressively starts raising short-term rates.

So, we see a very constructive environment in terms of where we came out of and for the foreseeable future.

If you turn to slide 7, we're going to talk about our asset mix.

And as we talked about on the road show, we are very strong believers in the relative value of high coupon mortgages, and everything that has happened since the road show has basically verified and reinforced that point of view.

And what specifically has happened is that prepayments have plummeted at a time when most interest rate models would have predicted higher prepayments.

In fact, we're modeling our portfolio at 16% CPR, actual prepayments are coming in at single digit prepayments.

And what that means for a shareholder agency is that slow of prepay translates into an increase of our portfolio for the life of the bond by 25 basis points.

So, that's actually a benefit of having higher mortgage rates than higher interest rates over a longer period of time.

And the other thing we talked about on the road show is the idea of owning Ginnie Mae's, which is unusual in this type of structure.

And the reason we like Ginnie Maes is because it's multiple reasons.

They're full (inaudible) credit of the U.S.

Government, so there is no debate about the creditworthiness of Ginnie Mae even though we think Fannie and Freddie based on all the pronouncements from (inaudible) Senate to Treasury and (inaudible) the Fed look like they're going to be money good as well.

But there are other attributes of Ginnie Mae in terms of their loan attributes, which we find appealing as well.

So, we currently have a 35% as of quarter end, a 35% allocation in Ginnie Mae, a 54% allocation in Fannie Mae, and 11% allocation in Freddie.

And they're all premium mortgages which we think, once again, benefit from the environment we're in of a steep yield curve and slow prepayments.

Turning to page 8, we're going to talk about our financing and hedging strategies.

One issue that once again was the major theme in the financial markets is the ability to get repo counterparties.

Obviously, as a part of American Capital, which has extensive global relationships with all the major financial institutions, that was not a problem for us at all.

We have executed repo agreements with 14 global financial firms.

We're currently using 12 of those counterparties.

We have $2.2 billion in repo as of June 30.

We have no more than 16% exposure with any one counterparty.

Our average in peer cut is less than 5% on some of those securities.

It's as low as 3% [Ginnie Mae].

So, here we are in the midst of the worst financial debacle of all time and [haircuts] of Ginnie Maes have not changed one iota, which is what we expected, because of our highest quality, best fixed income securities on the planet.

And then let's talk about leverage.

We've talked about using leverage and as of June 30, our leverage was about 8.27, and while we've talked about on the road as being between six and eight times.

So, what we've also talked about on the road as being opportunistic and taking advantage of various market conditions.

And what we've done since quarter-end is opportunistically have asset sales that generated realized gains for our portfolio and currently our leverage ratio would be more in that range of six to eight times.

We've also executed SWAP agreements and what we've done with our SWAP agreements which we think is somewhat unique, is that obviously Swaps are used to hedge business rate increases.

Our point of view is there is very little risk of risk are Fed increases in the rest -- in the balance of 2008.

In fact the futures markets are now saying that.

A month or so ago the markets were pricing in a fairly high probability with August increases, September increases.

As you go to your Bloomberg screen, [SFIP] you'll see that the probabilities of any increases are actually the low single digits.

So, our point of view is why pay a cost that even if the Fed raised rates you're getting no benefit, and the whole theme of Agency is to deliver value and benefit to our shareholders.

Let's go to slide 7, we'll talk about the business economics.

There are two columns, the column left talks about where we were going through the first quarter.

Column on the left talks about where we stood at the end of the quarter.

And our assets yield approximately 5.5%, and once again that's at those high in CPR level, that our net interest rate is about 315 basis points and with our leverage that's generating an ROE of approximately 27%.

And as we know, these SWAPS that we've talked about before are all forward looking.

In other words, we don't really pay anything on those SWAPS until November and December of 2008.

If you factor that into the business economics it adds about 40 basis points to our cost of hedging and financing.

And now I'll turn it over to Amanda to open up the call for questions.

Yes.

We'd like to open up the queue, Pamela.

Will you take the first question, please?

Thank you.

(Operator Instructions) And we'll go first to the line of Steve Delaney with JMP Securities.

Please go ahead.

Thank you.

Good morning, everyone.

Russ, on your hedging strategy, on the surface, if one looks at 32% Swaps on the portfolio that's 100% fixed, that might strike somebody as being a touch on the light side, especially if you kind of lined it up maybe with some of the other companies that are out there.

So, I guess I would ask you this, if you could just give us some color.

I mean, do you see hedging as sort of more of a dynamic process than a static process?

And you're kind of saying to us that your call on the market is that the Fed is on the sidelines at least to the end of the year, and I don't disagree with you on that one.

So, let's say that we've got a job, if you can believe ADT, jobs might be stronger or whatever happens.

If you think the Fed is going to be in your face sooner, should we expect you to react and maybe build that 32% SWAP position?

Thank you.

Yes, thank you, Steve.

That's a great question.

And we talk about those kind of risks you talk about, we think it actually begins with asset selection even before we talk about hedging.

And that's why we're so strongly in favor of buying agency premium mortgage-backed securities, because we think they have let's say a duration of less than three years.

And since we've been on the road with our IPO, if you look at the price volatility of, say, premium mortgages, we would say that we've been kind of -- it's been pretty consistent with that.

And so we think duration and risk management all begins with asset selection, first of all.

And then the other point I would make is we would make no representation that we are 100% hedged or perfectly hedged.

It's not a goal of ours, not something we're necessarily trying to do.

What we're trying to do is create what we think are very cheap mortgage asset and hedge them, to your point, dynamically and opportunistically.

Now, a comment I made earlier was the point that our leverage has also been dynamic.

And so we look at, say, the percentage of hedges, it wouldn't be a stacked number, say, going forward.

And so we would say that sitting here today that we're more hedged than we were at quarter end.

Steve, this is John Erickson.

One of the other things, keep in mind, one of the benefits of being part of the American Capital platform is that we do have not just residential mortgages here, we have commercial mortgages, we have investments in 250 middle market companies.

So, we have a lot of data points on the economy.

And, as Russ said, this is a dynamic strategy.

We are going to adjust the strategy going forward, that he has clearly articulated our current views.

I think in terms of even looking at how we structured the swaps, that kind of reinforces our current view and this is going to be a value strategy.

We're going to look to make a little bit of increment on the margin, but then describe to the market what we are doing.

But I think that we have lots of viewpoints in the economy.

And also keep in mind we have more status on our board, who is one of the leading housing economists.

So we're looking at data every single day.

Russ is getting all the remittance reports and we're looking at all the data that comes out every single day.

And strategy could change a little bit tomorrow.

That's helpful.

And are you still thinking that at some point you might consider using caps as well as SWAPS as part of that strategy?

Yes, that's right, Steve.

We looked at the whole spectrum of hedging choices, specifically we looked at the whole spectrum of assets.

So, we don't rule anything out.

Okay, thanks a lot.

It also goes towards value, right, because some hedges at different times are more expensive than other hedges, right?

And so --

Exactly.

And you will be looking at the overall options available to try and figure out which option we think is the best value for the position we're in in the market.

Thank you.

Then moving to our next question we'll go to the line of Ken Bruce with Merrill Lynch.

Good morning.

Could you provide a little additional color on the agency securities that you own?

Are these straight pass-throughs or is this structure product in any way?

It's no structure product, it's all agency pass-through securities.

It's all coupons for the most part, 6 [shares] and higher, and that's delivered -- once again, we are not a big fan of structured products, the haircuts are worth, the liquidities worth, You can be less opportunistic with structured products.

Great.

And in terms of the durations you had mentioned that you believe that it is inside a three-year zone premium agencies, yet you indicated that prepayments are inside of 10% or single digits, as I believe you'd mentioned.

Could you give us some sense as to how those two square off with one another, because they don't seem to align?

And if you could also provide some color on the asset sales that you completed in the third quarter as well, as well as any gains that may be associated with those?

Yes, that's a good question, Ken, because the way it works with prepayments, the premium you obviously want slow prepayments because you have more yield, but it also implies that longer average life.

The way we look at the duration is we take all those into account and to us, whenever you have what we would call premium securities is a benefit to having that slow prepay.

And so even though it's -- the model duration may be slightly longer, our expectation is that those securities will actually continue to trade at shorter instruments, especially in a market that we see as what we would call premium product right now.

90% of the mortgage market is at a discount and the trend we would see going forward as more investors buying securities that benefit from these slow prepays.

And the second part of your question was about the asset sales, and I think what we've done, back to the earlier question that we had is we're being opportunistic and what's happened in the month of July is that mortgage volatility has been quite extreme.

And so what we've done is, because we have such a liquid portfolio and that has relatively low durations, we're able to decide when we want to change our leverage and not when, let's say a financial -- Wall Street financial institution.

So, we're opportunistically managing that leverage ratio in the duration of our portfolio by taking advantage of this market volatility and not being a victim to it.

Are there gains involved with the asset sales?

Yes, there are.

Thank you, then.

And we'll take our next question from the line of Stephen Laws with Deutsche Bank.

Please go ahead.

Hi.

Good morning.

I guess, first, congrats on -- congratulations on finishing your first period as a public company.

Question is kind of more follow-up to the questions we've already had.

But can you give us a little bit better color on where we should see leverage come in?

You know, it was higher than I expected at June 30.

I realize asset sales have brought it down, but could you talk about where you expect to come out in the range you provided, or narrow that range some?

And then as a follow-up, could you talk about the weighted average coupon or weighted average yield of the remaining portfolio after asset sales?

Has it changed at all given the sales to where the spread would be different today than what you provided as a quarter-end spread?

As we said before, we intend to be between six and eight times.

You're right, at quarter-end it was a little bit higher and that was because where evaluations went, but we've adjusted it to where we're back between the six and eight times.

We're kind of in the midpoint of that range right this minute.

But as Russ said, we've got a value strategy, so that changes.

We're seeing volatility all across the markets.

I mean, every market you look at there's volatility.

So, on any given day, if Russ feels like there's a good opportunity to take a profit, he may do that, or if he thinks some mortgages are extra cheap, we're going to use that leverage ability to buy a few more cheap mortgages.

So, we are operated even from May until the end of June, we operated pretty much within the six to eight times coming just slightly outside of it at June.

But then using the markets through July to get back within it, and I think that you'll see that going forward, is that we will move within those ranges based on our views of whether we think something is cheap or something is expensive.

The second part of your question about the transactions and where we're gaining income from sales, it would probably be in our lower dollar price, the low coupon mortgages.

Having said that, obviously a lot of mortgages are at a premium, so if anything going into this quarter we would probably have a higher dollar price, more of a premium portfolio than at quarter end.

Great.

Thanks for taking my questions.

Thank you.

And we'll go next then to the line of Mike Widner with Stifel Nicolaus.

Hey, good morning, guys.

Thanks for taking the question.

Some of them have been answered already.

Let me touch on the relatively heavy Ginnie concentration in the portfolio.

I mean, these are generally lower yielding securities than the Fannies or Freddies.

I'm just wondering what the rationale is for being, again, relatively heavy on them relative to where your peers are.

And is it the better haircuts or is there some other reason that you like those?

Yes, I think there's a couple reasons.

If you adjust for the better financing rate and the better haircuts, Ginnie haircuts are around 3%, as I was stating in the early part of the presentation.

That haircut has not changed at all in probably one of the worst financial conditions in maybe the history of the country, the haircut on Ginnies hasn't changed.

The financing rates on Ginnies are superior by anywhere from 10 to 35 basis points.

On top of that, the yield spread of Ginnies to Fannies is only actually based on our calculations 10 to 20 basis points.

So, the irony of it is that you can actually own Ginnies on a levered basis, which we do, we're a REIT.

And the net economics really aren't that much different than, say, typical Freddies and Fannies.

Now having said that, somebody may ask, well, why don't you have all Ginnie Maes?

And the reason for that is some of the Freddies and Fannies that we do buy have superior loan attributes because the loan that was detailed is better than Freddies and Fannies.

So, we have in our Freddie and Fannie book securities that we think are going to have very compelling characteristics going forward, and those would be based on the extensive due diligence we do in terms of loan lever detail, in terms of loan-to-value ratio and geographic dispersion, and all these unique Freddie and Fannie terms that have been issued in the last year or so.

So, we're big fans of Ginnie Maes and the Freddies and Fannies that we do buy we think the yield spread is more like 25 to 50 basis points than Ginnie Maes.

Great, thanks.

And if I could just ask a follow-up to actually somebody else's question.

When you guys sort of take the opportunity to sell assets when you can, that generates some other income.

I'm wondering if the 448K of other income you showed in the quarter is related to that.

And related to that question, most of your peers we don't see trading in and out of securities all that often, generally because of REIT rules and the income that you do get is non-qualifying.

So, I'm just wondering if you can comment on those two?

There was some amount of some gain in that quarter.

It wasn't all gain.

Probably about half of that was -- is a gain.

And then the trading in and out of securities, that's part of the value strategy.

What we went out -- when we differentiated ourselves out in the market for the IPOs, we said we're going to have a value strategy and you're going to start to see real time.

What that means, quarter-by-quarter you see an adjust in position.

That's because we're finding value in the market.

Okay.

But no concerns about, I guess there's a certain level you have to manage that, too, to not run afoul.

Absolutely.

We are well versed in -- as you know, we've managed the RIC BDC rules for 11 years at American Capital.

They're not dissimilar at all from the REIT rules.

We have a whole team here.

I mean, one of the benefits of American Capital's platform, we have 600 people.

We've got a great accounting and regulatory and tax team, and they're actually monitoring all that.

So, we will do all this type of activity being cognizant of the tax rules and the things we have to manage with it.

Great.

Well, thanks, guys.

Appreciate answering the questions and great quarter.

Thank you.

And we go next to the line of Jim Fowler with JMP Asset Management.

Good morning.

Thank you for taking the question.

Russ, just a question on the Ginnie portfolio.

I know it's a bit early, but have you been able to see any impact on prepayments, or do you expect any impact on prepayments from the FHA secured program?

Thanks.

None so far.

In fact, the Refi Index came up this morning and that's a good measure of future prepayment, and it's at a low for the century.

It's like at a 1,000.

And just to put that in perspective, just six months ago it was 2,000 to 4,000.

At the peak in 2003, it was 5,000.

There is nothing that we see to indicate any type of pickup in prepayments, whether it's actual prepaid data or forward-looking data we see.

So, if it's a mortgage originated, which is something else we do.

So we don't think that we're going to -- as we talked about on the road, we don't think that this is the odd period of slow prepayments.

We think we're coming out of a strange period and that strange period was '03 to '06, and this is going to be back to the norm, back to (inaudible) of prepayment.

If I might follow up.

What's been the response to the Fannie, Ginnie swap with the improvement in the outlook for the agency versus the FHA secured program on the Ginnies?

Has that spread tightened or become more volatile?

You know what to understand about Ginnie, Fannie swaps that you allude to is intermonth they've been extremely volatile, but the irony of it is, if you look at it today versus the last six months or four years, they're really not that much different.

For instance, the price spread of, say, Ginnie [sixes] to Fannie [sixes] as we sit here today is like 12, 30 seconds of one point, it was three-quarters of a point at some point in July.

Back in February it was three-eighths of a point.

A year ago it was roughly three (inaudible) point.

So, the irony of it is we've had a lot of intermonth volatility between Fannie and Freddies, but if you sit here today and look at those price spreads and those yield spreads, they're actually very close to their historical norms.

We'll move next then to the line of [Jeremy Banker] with City.

Jeremy Banker.

Hi, how are you doing?

I was wondering whether or not you could provide any update as to where payout ratio can go?

It seemed a bit low this quarter at 85%.

Once again, we'll manage them under the REIT rules.

Obviously, for the stub period in the first quarter we wanted to be ultra-conservative, but we will management it in the REIT rules and so the payout ratio arguably will go up a little bit from here.

Do you still expect to be closer to the 95%+ range which was talked about previously?

Sure.

I mean, absolutely.

I mean, obviously, to comply with the REIT rules, you've got to.

So, we will be moving that up.

And lastly, following up on conversations in the past, in the past you said that the portfolio duration was going to be around one year or less.

Is that still the case today?

I don't know if we've ever really said one year or less.

I think we've always talked about being at like one and a half to three-year range.

That's kind of where we see it, you know, as a quarter end and as of this morning.

I'm sorry, is that for portfolio or asset duration?

We look at the net effective duration of everything we manage.

That's how we look at it.

Yes, okay.

Great.

Thank you.

Thank you.

And we'll move on, then, to the line of Anton Schutz with Mendon Capital.

Thanks for the surprise on the upside this quarter.

My question relates to relative value and what you're doing with your securities versus your equity.

We all know obviously since the offering your equity has dropped pretty dramatically.

I'm pretty puzzled as to why, but nevertheless you're trading still well below your current book value, at least as of the end of June.

Have you considered, especially since you've taken leverage down, another way to take leverage back up again, opportunistically, is to potentially even just retire some of your own stock back below book.

Certainly the models that have succeeded in this industry have been ones that have issued stock above book and created accretion to book in earnings.

And obviously with you trading well below book value, have you considered a stock buyback?

Look, certainly we understand having run a BDC for 11 years, we certainly understand the dynamics of issuing equity when it's accretive and buying it back when it's diluted, and we're certainly prepared to buy it back when it makes sense.

One of the things we have to look at right now are other factors as well, such as the float in the stock and the opportunity to make great returns.

And I think when we were on the road we described the environment where we would buy the stock back and it's more likely in an environment where you're seeing ROEs decline in seeing low spreads.

And in that environment where the stock price is down, I think that we would certainly be thinking about a buyback.

In this environment, where arguably trading below book is just a phenomenon of all the financials, in this environment I think we've got to look at what are our opportunities for investing in that capital versus buying it back.

And we think today --

There's another point, too, here, and that is that being -- this being our first reporting period, we assumed that there was great lack of information about the portfolio and performance.

We did do one press release upon the payment of the dividend.

But because of the nature of it, we just weren't able to be very descriptive and provide as much disclosure as we knew we would at this call and at our earnings release of yesterday.

So, we're going to have to see how the stock reacts.

If after getting and disseminating the information, if we still are trading at levels that would be highly accretive if we were to buy them back, it would be something we would consider.

But we do run those models.

We run them very carefully.

We know very precisely whether the investment opportunity would be more accretive than the buyback opportunity, and we would only do it, really, if we thought it would be more accretive if upon buying back.

And we'll see where the stock trades in the next few days.

By the way, we're also subject to our window on these buyback programs, and we found with respect to American Capital and our European Capital entity, both public, that the trading window really does limit some of what we can do with respect to the buyback program.

I think you answered the question very well.

I appreciate it.

You do not have a buyback program in place yet?

You haven't authorized one, correct?

That's correct.

Okay.

Thank you very much.

Thank you.

And we go then to the line of Jason Arnold, RBC Capital Markets.

Hi.

Good morning, guys.

Most of my questions were taken already, but I was wondering if you could offer any color on portfolio pricing really since the end of the quarter?

I think since the end of the quarter valuation is probably not far from where we were at quarter end.

I mean, we've had some pretty volatile times intermonth, but I think from, say, quarter-end to this morning where we sit, I don't think there is much change in portfolio valuations.

Okay, perfect.

Thank you.

Thank you.

And our next question comes from the line of Mark Jacobs with MLK Investment Management.

Hello.

Thank you for taking my call.

I'm not an expert in mortgage finance, so it's basically a simple question.

But Merrill Lynch wrote a report earlier this month and mentioned that your book value was $17.92.

According to the press release from yesterday it was $17.45, which is about 2.5% less than the previous month.

Could you explain why that has happened and can one assume that because of the volatility of the market that the book value has continued to go down?

Thank you very much.

So, I think that the mortgage prices change value and our book value is changing daily, and we report all these numbers on a quarterly basis.

Yes, I think the Merrill number is obviously an estimate, as was our number, and you'll be able to track our book value from our numbers now.

I guess as Russ was indicating earlier, July was a volatile month, so book value was changing during July, both probably dropping and going up.

And I think you sort of answered the question in terms of where pricing is today relative to June 30, and it's close to being where it was June 30, which would suggest the book value is similar.

And keep in mind these are assets that to the great extent we are intending to hold to maturity, and they will ultimately resolve to face values.

Okay.

Thank you very much.

Thank you.

And we'll move then to the line of [Jay Buck] with Rockwood Partners.

Yes.

Hi, good morning.

Thanks for taking the call.

I was just looking at your business economics on page 9, and I'm wondering if you could help me out.

I was looking at the operating expenses and the percentage of equity.

I was just curious, is there an incentive compensation feature in this situation?

And so following up, is there a high watermark and is it based on mark-to-market NAV or is it income, and how frequently is it paid, if there is one?

Yes.

Unfortunately, we wish there was incentive comp, but there's not.

So, it's just a straight management fee.

So, there is no incentive comp.

All right.

So, the extra --

And we would have to say since this is externally managed, you also don't have any kind of stock option plan for employees residing at the fund itself.

So, unlike some of our competitors out there, we really have an extraordinarily attractive management structure -- fee structure arrangement from the point of view of our shareholders.

It's just simply that $1.3 million, it's the management fee and then the balance of that is the interest expense fees?

Is that what generates that 4%?

Yes.

I mean, just the other operating expenses, which included startup costs.

You know, our overall G&A right now is probably going to be high for the first couple of quarters because we're putting some systems in place, we obviously absorbed some startup costs in the first quarter with legal and some other things.

So, that's the other component of it is direct pass-through on the G&A for direct expenses of the agency REIT.

Okay.

So, it would just be the 4.25% annualized over the 2.86 equity piece, and there is no incentive compensation.

That's correct.

And on this chart on page 9, this is all a return on equity analysis.

So, every line item is a percent of that line item to our equity.

Right.

Okay.

Thanks very much.

Appreciate it.

Why don't we take one last question?

Okay, thank you.

And we'll take our last question, then, from John [Hute] with Blackmont Capital.

Yes, thank you very much, gentlemen.

First question, I presume that the management fee is paid to American Capital Corporation?

It's paid to our manager, which is, I guess is American Capital LLC.

All right.

So, American Capital would essentially book the management fee as income on their reporting?

American Capital LLC is a 100% wholly-owned portfolio company of American Capital, and it does dividend up its income to American Capital on a quarterly basis.

Okay.

And could you tell me exactly what that 1.33% represents in dollars at this particular time?

Yes, it was about $400,000, if you look at slide 10, which is the income statement with that detail.

So, it's $400,000 for approximately 40 days, is that correct?

Correct.

Okay.

ACAS's accounting of AGNC on its books, could you talk about that for a minute?

Yes, this is just a public stock investment.

So, as an investment company of BDC, we just -- we put our cost basis on there and then you fair value it and record it for ourselves.

Okay.

So, essentially the income flow from dividends goes to American Capital, and they would adjust their holdings depending on the book value of the company or the market value?

Fair value, the trading price.

This is a publicly traded security.

This would be a tier one, or level one asset.

We use the trading price.

All right.

Finally, how many people work for AGNC?

We have a 600-person organization of which frankly the Agency does not pay for that.

They have -- American Capital Agency has a contract with the Company, so the cost is fixed to American Capital Agency.

For American Capital, we have about 12 people in our Providence office, which are wholly dedicated to this fund and another fund.

And then, of course, as we've mentioned, we have a very substantial back office that is providing support for the fund as well, the accounting, some legal work, and there's a variety of other factors.

But, again, for American Capital Agency, it's really getting this huge organization with tremendous amount of capabilities and subject to a fixed fee schedule.

Got it.

Okay, that's it.

Thank you very much, and have a good afternoon.

Thank you.

Thank you.

And presenters, I'll turn the call back to you for closing remarks.

Amanda Cuthbertson.

Great.

Thank you for joining American Capital Agency Corp.'s first quarterly call.

Yes.

Certainly, if anyone else has any questions, feel free to contact us directly or contact anyone on our Capital Market staff and we'll be glad to answer your questions.

Thank you so much, and you all take care and we'll see you again in three months.

Thank you.

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