AGNC Investment Corp (AGNCO) 2009 Q4 法說會逐字稿

Good afternoon.

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

At this time, I would like to welcome everyone to the American Capital Agency fourth quarter 2009 earnings call.

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

After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions).

Thank you.

Ms.

Wisecarver, you may begin your conference.

Thank you.

Thank you for joining American Capital Agency's fourth quarter 2009 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 outcome and results could differ materially from those forecast, due to the impact of many factors beyond the control of AGNC.

Certain factors that could cause actual results to differ materially are included in the risk factors section of AGNC's 10-K dated February 17th, 2009, 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 and the telephone recording can be accessed through February 22nd by dialing 800-642-1687 and the conference ID number is 52724001.

To view the Q4 slide presentation, turn to our website, AGNC.com, and click on the Q4 2009 earnings presentation link in the upper right corner.

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

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

Participants on today's call include, Malon Wilkus, Chairman, President and Chief Executive Officer, John Erickson, Chief Financial Officer, and Executive Vice President, Gary Kain, Chief Investment Officer and [Bernie Belk], Vice President and Controller.

At this time I would like to turn the call over to Gary Kain.

Good afternoon, everyone and thanks for joining us.

I want to start by saying that I am particularly pleased with our results for the quarter, because we were able to produce very strong results for our shareholders, while taking significant steps to curtail both prepayment risk and our exposure of the changes in interest rates.

While I'm going to touch on some specific actions we took later, the evolving prepayment landscape that we witnessed throughout 2009 and now in 2010 really underscores our commitment to active portfolio management, and our actions highlight how we think about balancing the generation of attractive risk adjusted returns with book value preservation.

Now, early in 2009, we felt that the best investment was to purchase high coupon mortgage securities, backed by weaker credit borrowers.

This move produced handsome returns as a result of the extremely slow speeds registered by these securities and by price appreciation that followed.

But as delinquencies continued to accumulate in these pools, these securities became considerably more exposed to the possibility that the non-performing loans could be bought out by the GSEs, which would result in much faster speeds.

At the same time, the valuations remained extremely favorable because the market was focused on the slow speeds these securities had exhibited and was arguably somewhat complacent about the risk looking forward.

Hence, we chose to sell many of these securities, lock in our profits, reduce risk and find other investment alternatives without this exposure.

Look, only time will tell if we made the right choice, but just because something worked well in 2009, does not mean that it will work in 2010.

So what you can expect from us is to continue to rebalance our portfolio as market conditions, valuations and risks evolve.

Now, with that said, why don't we look at some highlights on page five.

For Q4, we again declared a dividend of $1.40 per share.

Our dividend was both below our GAAP net income of $1.79 per weighted average share, and our taxable income of $1.69 per share.

The net income number included $0.78 of other income, which included realized gains, derivative mark-to-market and hedge ineffectiveness.

We also had $0.16 worth of amortization expense associated with our terminated swaps.

Earnings net of these two items were $1.01 per share.

Overall, our undistributed taxable income increased during the quarter by $4.4 million, from $17.3 million to $21.7 million.

Now, given that we raised $122 million in equity during the quarter, via the issuance of 5 million shares, on a per share basis, our undistributed income remained at $0.90.

I want to emphasize that we intend to distribute all of our remaining 2009 taxable income during 2010, as we are required to do so under REIT rules.

As of December 31st, our investment portfolio totaled $4.3 billion in assets, which was an increase of approximately $700 million from September 30th.

Unlike prior quarters, we added a greater percentage of fixed rate assets as we diversified the portfolio in light of the changing prepayment landscape.

Now, on average for the quarter, our leverage was 6.8 times, which was a half turn lower than our leverage at both the start and at the end of the quarter, which were both 7.3 times.

Also, last week, our Board of Directors voted to remove our internal ten times leverage constraint, in recognition of the considerably more favorable financing environment and given their comfort with AGNC's multi-faceted risk management and reporting framework.

This change in the leverage limit puts AGNC on par with its peers, which have no hard leverage constraint.

Now, I do want to say that investors should not assume that this change portends higher leverage in the near term, as we don't believe it is warranted given current mortgage valuation and as we sit today, our leverage is actually lower than it was at year end.

Book value for the quarter increased to $22.48 from $22.23 at the end of the third quarter.

Now, if you turn to slide six, let's take a second on this call and we'll go over some of the 2009 highlights.

2009 was clearly a banner year for AGNC shareholders, both on an absolute basis and relative to our peer group.

The total return for holding AGNC stock inclusive of both price appreciation and dividends was 48%, despite a difficult first quarter.

Net income was $6.78 per share, which resulted in a 31% ROE.

In addition, when you combine our $5.15 per share in dividends and our net increase in book value of another $5.28, the resulting economic return is approximately 60% for 2009, even exceeding the move in our stock.

AGNC was able to raise $222 million of net proceeds in follow-on offerings, which were accretive and will allow the Company greater economies of scale going forward, and better liquidity.

Producing these results was not as they say, shooting fish in a barrel, as we transition to a new portfolio management team during the first quarter.

At that time, we had the lowest leverage of the peer group and a portfolio of 100% fixed rate securities.

As such, despite significant industry concerns around prepayments, AGNC proactively set out to purchase higher coupon hybrid ARMs and build a portfolio that we were confident would outperform more generic securities.

We also were very transparent with respect to communicating our actions to a sometimes skeptical market and revamped our disclosure to show the performance of our assets versus market benchmarks.

When during the year, speeds came in slower than even we anticipated, valuations of these securities improved significantly.

As such, we chose to lock in those favorable valuations and repositioned the portfolio for 2010.

We also took a number of steps during the year to mitigate our exposure to interest rate volatility, which included diversifying the portfolio into 50% variable rate product and increasing the duration of our swap book by terminating one year swaps and adding longer maturity protection.

So now let's return to Q4 and turn to page seven and we'll quickly review what happened in the markets.

As you can see in the tables on the left, Treasury and swap yields increased during the quarter with 10 year rates rising around 50 basis points, versus less than 20 basis points for two year rates.

Almost the entire move in rates occurred during the latter part of December.

Also, as we sit here this afternoon, five year and shorter maturity Treasuries and swaps are now lower in yield than the they were at both the end of the third and fourth quarters.

However, ten year rates have fallen since year end, but they are still more than 20 basis points higher than they were at the end of the third quarter.

Therefore, really the main difference from the end of the third quarter to today is that the yield curve has steepened significantly, which is generally favorable for our business.

Now, commensurate with the increase in rates, fixed rate mortgage prices declined at year end, leaving 5% and lower coupons lower in price for the quarter.

Hybrid ARMs also performed relatively poorly with new issues (inaudible) lower by more than a point and seasoned high coupon ARMs down slightly as well.

The best performing SEC sectors of the ARM market were shorter reset ARMs and some higher coupon 7.1 to 10.1s, which were generally higher in price.

Now, so far in 2010, mortgage performance has been very strong, which will provide a significant tailwind for book value.

For example, 30 year, 5% coupons are now well over 104 dollar price and 30 year 6% coupons are well over 107.

These are both above their third and fourth quarter levels.

Now, with this as a backdrop, let's turn to slide eight so we can look at what we did with the portfolio during the quarter.

First, our portfolio grow 25% to $4.3 billion, as we invested proceeds from our equity offering.

We reduced our overweight to hybrid ARMs as we became more concerned about prepayment speeds on ARM product, particularly as the result of GSE buyouts.

As a quick review, GSE buyouts are merely prepayments that result from Freddie Mac or Fannie Mae removing or buying out seriously delinquent loans from their securities.

Given the significant increase in both GSE's seriously delinquent loan populations and the fact that we know these non-performing loans are concentrated in a subset of pools backed by higher coupon, interest only and ARM loans, AGNC believes that reducing our exposure to these types of securities was warranted.

The GSEs have the financial incentive to pull these loans as soon as possible and that is irrespective of whether or not these loans end up getting modified or end up in foreclosure.

Importantly, this buyout equation just changed in 2010.

Basically a month ago, as new accounting rules, FAS 166 and 167 became effective.

Under the new rules, the GSEs no longer recognize any incremental loss when they buy-out a loan, and, thus, do not need to hold any more capital for a loan that is bought out, versus one what is left in a pool.

They do, however, save a tremendous amount of interest payments if they buy out these loans.

Why?

Because they are paying us, the security holders, around a 6% coupon on average, which they are not receiving from the borrower.

They could, on the other hand, pay us off via a prepayment and borrow at near 0% interest rates to fund the delinquent loan until it reaches its resolution.

Thus, saving on average more than 5.5% in net interest on a monthly basis.

So when you think about that on over $200 billion in delinquent loans, this would save the GSEs over $10 billion per year in interest payments and so it is certainly not a rounding error, even for them.

As such, we do not feel it is prudent to expose our shareholders to this risk, and just to sit around and hope these buyouts will not occur.

As the press would say, we are not going to just pray for the equivalent of another government bail-out, especially given the fact that we could sell the most at risk securities at extremely favorable valuations.

Given these issues, we were more comfortable with a more diversified portfolio, which minimized this exposure.

Therefore, we increased the percentage of 30 year and 15 year mortgages, within the 30 year sector, we concentrated on mortgages originated back in 2003.

These very seasoned securities have the dual benefits of having favorable prepayment characteristics and shorter durations than new originations.

We also selectively added some newer issue 30 year and 15 year fixed rate securities as well.

Now, within hybrid ARMs, we concentrated our positions on 2005 and earlier originations, and some longer maturity 7.1s and 10.1s, where delinquency rates are lower and refinancing activity is still likely to be contained.

Another important thing we did this quarter was to expand our holdings of CMOs through the repackaging of our existing securities.

While some may think of CMOs as potentially more risky, our motivation was exactly the opposite.

Via the CMOs, we essentially were able to purchase protection at very attractive prices against short-term spikes in prepayments, on some of our highest coupon, interest only ARMs and fixed rate securities.

In most cases, the CMO securities that were sold to other investors, and they were generally between 25 and 30% of the total, receive all of the prepayments until they are retired.

Thus, our remaining CMO securities receive no principal payments or net prepayments until after more than 25% of the original collateral has paid off.

Now, overall, the changes to our portfolio paid off for us as our speeds for the quarter declined three CPR to 16%, despite both the recent pickup in speeds and a decline in mortgage rates during most of the quarter.

In the prepayment speed that was just released a few days ago, our portfolio paid around 15% CPR, close to the lowest level we have seen in more than a year.

More importantly, while we are pleased with the recent speed performance, what's more important is that it is reassuring to know that we have significantly reduced our prepayment exposure on a go-forward basis, especially with respect to GSE buyouts.

Now, slides nine and ten give a lot more detail regarding our fixed and ARM positions.

Now, please turn to slide 12 and in sticking with the risk management theme, we also increased the size and quality of our swap book by $650 million to just over $2 billion, an increase of 46%.

Again, that should be compared against only a 25% increase in our assets.

This brought the percentage of our (inaudible) balanced hedge to 53%.

But also of note is that we purchased $300 million in options to enter into swaps in the future.

These swaptions, as they are called in the market, help protect the portfolio against larger moves in interest rates in either direction.

Now let's turn to page 13 and quickly look at the business economics.

The thing that stands out is that it looks like not that much has changed from Q3.

Our asset yields were down by fewer than 18 basis points during the quarter, and our net interest spread contracted by only 5 basis points.

When you look at the as of numbers, you will see that the net interest spread contracted only 2 basis points.

What is interesting here is -- and this is important -- it's against the backdrop of approximately $18 million or $0.78 per share of other income, and a larger portfolio.

Thus, we were able to generate significant gains and grow the portfolio without necessarily depleting our core earnings power going forward.

Now, net ROE for the quarter was 30.3%.

Even when you exclude other income, our gross ROE, which you could see in the middle of the table, was 22.1%.

Now, I want to give you a little bit of insight as we look ahead.

As mortgages have continued to strengthen this quarter, we have sold more of our highest coupon securities, producing significant gains.

In addition, both as a function of these sales and in light of our quarter to date book value appreciation, our leverage is lower at this point.

But I need to caution everyone that we are still at an early point in the quarter, so all of this information is both preliminary and clearly subject to change as the quarter develops.

Now, before I open the call up to questions, I do want to speak quickly about one question that I probably would have gotten anyway and that is probably on a lot of people's minds, which is, what happens to the mortgage market and our book value when the Fed stops buying mortgages?

Yes, I think mortgage spreads will widen post Fed, but that widening will likely be much smaller than what many are hoping for.

It is important to be somewhat defensive, but one has to be careful on the other side not to bet the ranch on a major widening as well.

Some people did that almost a year ago and have paid dearly, both in lost income and price appreciation.

And given the strong mortgage performance we have seen to date, even after this widening, it is very possible that spreads are not that far from where they were at the start of this year.

Some people in looking at this are too focused on the Fed's day-to-day purchase volumes and that going away and not enough on the impact the Fed's massive $1.2 trillion worth of purchases have had on the existing stock of mortgages, or on what people call the float.

The bottom line is that way too many mortgages are put away between the Fed, the GSEs, and banks and (inaudible) Also, many market participants that could underweight short, reduced leverage, whatever term you want to use for lightening up, have already done it.

As such, a major widening is not likely without a significant change in market conditions.

However, if interest rates were to continue falling, then mortgage production would likely increase and under that scenario, mortgage spreads could widen more but because prices would still be flat or rising, the erosion of book value even in this scenario would likely be related to hedges and, therefore, be pretty contained.

On the other hand, if interest rates rise, new origination is likely to be very slow and so mortgages are likely to hold in better than they would be expected to versus other products.

Now, in conclusion, I think the pressure on book value due to the Fed's exit is likely to be more moderate than most believe, but there are likely to be some favorable buying opportunities in some products as spreads definitely become more volatile.

So at this point, I'll open up the call to the operator and take questions.

(Operator Instructions).

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Steve Delaney with JMP Securities.

Good afternoon.

And Gary, congratulations on really was an outstanding year for you running the portfolio.

So good job.

Well, thank you.

Your move to -- you had some CMOs I guess at September, maybe about 6% of the the portfolio, but it's obviously much bigger now.

Could you share with us -- we get good data here in the book on pages nine and 10 on the fixed and hybrids but could you give us a little more color about the CMOs and we know the fair value, I mean the market value is $707 million, but could you share the par value and maybe your cost basis and the WAC.

Let me give you a little bit of that data.

We will certainly look at trying to enhance disclosure on any part of the portfolio over time, but let me get you to the book value, so the UPB is $682.4 million.

Cost basis is around 102, and 0.77 and the weighted average coupon is 5.2%.

5.2.

Great.

Just for my simple mind, sounds like you took some fixed pass-throughs that you owned and you just basically carved off sort of a first cash flow piece that you sold and you kept the more delayed cash flow bonds.

Am I thinking right?

You're thinking about it right.

This is not that complicated of a trade.

We weren't -- what we did was we, at a premium, at a significant premium, were able to sell the first 25% of -- or 25 to 30% of the cash flows and to the extent that prepayments are very quick early, our class doesn't get any repayments until that tranche is paid off.

Now, this provides us kind of two benefits.

The obvious one is economics, in that the premium, if prepayments are faster, is lost on the earlier tranche, whereas the second tranche, our tranche has a lot more time for the future slower prepayments after that spurt to maintain its yield.

Second of all, just on the financing side, we don't have our securities paying down rapidly and it gives us much better liquidity in terms of not having margin calls on those securities as well.

So there were really two major benefits that we felt that really warranted doing something, albeit a little bit less liquid part of the agency market.

Makes sense.

Gary, the only other thing I had was could you comment on the jump in your G&A expenses?

They've been running for three straight quarters pretty much right around $1.5 million and then they spiked up to $2 million in the fourth quarter.

So do we have any one-time items there or should we look at that as the closer to the run rate going forward?

Actually, most of it was due to snow removal, I think.

I think that was 2010, wasn't it.

You had it before Christmas.

Outside of snow removal, no, I think you can think of that as mostly due to one-time items, so we had incremental legal and tax expenses related to transactions and some of our mortgage activity.

We also had a little bit of higher transaction volume that also increased those costs, but nothing that we would view as being in any way kind of setting a new bar to a much higher level or anything like that.

And clearly, we expect to get operating leverage from the larger capital base, so you should look at that as mostly one-time items.

Thanks for the color.

Appreciate it.

No problem.

Your next question comes from the line of Bose George with KBW.

Good afternoon.

And again, very nice disclosure.

Thank you.

Couple of questions.

One, I was just wondering what's your view on how high prepayment speeds could go this year, especially on some of those securities that you sold and just relative to the stuff you're buying, where do you think prepayments would be on those securities?

That's a great question.

It's interesting.

Everyone in the market clearly talks about CPR and how fast something can be in CPR terms and obviously on a month by month basis, that's very dependent on how quickly these buyouts occur.

The way we think about it is actually more in terms of the percentage of delinquent loans backing a pool.

So let me give you an extreme case.

A high coupon interest only ARM that's all day in nature could have 40% delinquent loans.

So our fear is on a security like that is that either over the course of a month or six months or maybe in a better case, over the course of a year, all of those loans are pulled out.

And again, that worst case scenario, 40% of your pool disappears at par if the delinquent loans are bought out.

If that happens over six months, you essentially have locked in something in the neighborhood of it's not one for one, but it's a CPR well over 60 in the end.

It's not just 40 times two, because of the way the calculation works.

But it gets you to the point where you can't recover from those kind of speeds, and again, so our evaluation of looking at the securities we're worried about what to keep, what it could cost us, is really to think about what is the percentage of delinquent loans, how big of a deal is it, if they're all pulled out over a three to six month period, and does that set us back too much that we can't make up for it over time and that's the way we've tended to evaluate it.

Again, on the high end you've got some agency ARM pools that are probably up to 40% delinquencies.

A benchmark number is that Fannie release at the end of the third quarter that of their interest only mortgages, both ARMs and fixed, 17% were seriously delinquent.

So that's that whole category.

That was three to four months ago.

So you would be looking at something probably over 20% on that category and then again, subsets of that category can be a lot worse.

And I mean, I guess again, read the minds and how the agencies are going to do it, but in your view, how do you think they'll balance preventing the market from being hit too hard versus pulling delinquencies out quickly to protect their potential interest payments that they have to pay?

That's a tough question.

I think the reason why I think there's sort of a misconception here.

In reality, if the agencies did this quicker, very quickly, the prices of the securities, which is what people focus on and which sets kind of liquidity going forward and helps the origination process and all those kind of things, could actually appreciate.

I mean, people would take material losses as their paydowns would be very high that month.

But the securities after the buyouts are better than they were before the buyouts, and so I think people misread, potentially even people in the government, misread that equation because in many ways the liquidity of the market is sort of enhanced by getting this problem over with.

By having these loans just pileup in pools and sit there, over time, people are going to realize there's a bigger accident waiting to happen at some point, and so I don't really see that as being good tore the market, personally.

Thanks a lot for that color.

Your next question comes from the line of Jason Arnold with RBC Capital Markets.

Good afternoon, guys and great job this quarter.

Gary, I know the portfolio allocation strategy tends to be more opportunistic based on the environment but just curious if you can comment on how you would envision a portfolio looking as the year progresses, more CMOs?

More fixed rate?

Maybe more swaps?

See if you could comment on that end.

Sure.

I think, again, obviously it is hard for us to predict, because it will relate to relative value and change in market conditions.

I don't see the CMO portfolio growing materially from here.

We felt this was a unique kind of risk return tradeoff that made sense for us right now.

On an ongoing basis, both for whole pool reasons and liquidity reasons and so forth, we don't see the CMO portfolio growing that much from where it is today and it could very easily shrink.

I think the question on ARMs versus fixed rate, is somewhat dependent on the resolution of going back to the earlier question, of the buyout equation, because a lot of the ARMs that we've tended to like now have this risk embedded in it that's definitely making us defensive toward that product.

We are looking at other sectors of the ARM market and we watch them for relative value versus fixed rate and it's very possible we'll find opportunities in newer issue ARMs over time which could help as well.

But big picture, we definitely -- everything else being equal, will prefer an ARM to a fixed rate.

On the other hand, there are pricing and these types of risks vary over time and so we'll have to see.

And I don't really want to set a target for the weightings but that's the way we think about it.

Okay.

And then I guess on the swap side?

On the swap side, we are going to continue as we've been doing, which is to make sure that the maturities of our swaps are reasonably long, relative to well over two years, because we feel that's imperative in protecting book value, as there's clearly risk in both short-term and long-term rates and so we want to have -- we want to maintain a decent duration of our swap portfolio.

And in terms of the size, it is very correlated with the types of assets but I think in general, we don't see that coming down very much from here.

Okay.

And then I guess just one final question.

I may have missed it but can you give us the dollar value of the assets sold in the quarter?

Actually, we did not -- I don't have it with me right now.

I'm sure it will be in our Q.

Okay.

All right.

Thank you.

Your next question comes from the line of Mike Widner from Stifel Nicholas.

Good afternoon, Gary and guys and congratulations on a solid quarter and a solid year.

Thank you.

Most of my questions have been asked.

Just wondering if you could provide any additional color commentary on your expectations for I guess the sort of realized gains and the opportunity for gains on trading in the portfolio in the coming year, I'm sure you can't giving us an exact ballpark range but as I look back on 2009, looks like about 40% of our total income came on realized gains on MBS sales.

Just wondering, as you look at the market going forward, do you think there's going to be as big an opportunity, do you think we might see some pressure there?

Do you intend to be as active about rebalancing?

Any additional color there would be helpful.

The first thing is I really can't speak to the market conditions going forward in terms of rebalancing issues.

But again, going forward, there will be a time or there's a likely opportunity where we will probably go back to more ARMs when the conditions are right so that's something that may happen.

But big picture, I want to stress that realized gains are not -- don't only come from selling assets that were bought a long time ago at low cost basis.

There are some that are absolutely generated on a go-forward basis and those opportunities should still be there in any environment that remains reasonably volatile.

And as we see volatility picking up in the market, we think that in general that adds to our opportunity set and then going back to the statement I said earlier on the call, we have generated significant gains quarter to date and significant is a similar term to what I think we've used in prior -- in the last couple quarters.

Well, it's certainly paid off very well as a strategy in 2009 and you guys are fairly unique in the peer group in at least the degree to which you rebalanced and so for those of us modeling going forward, it continues to be a challenge to figure out if the opportunities for that in 2010 are going to be as big as they are in --or were in 2009.

Good to hear things are going well so far.

We understand that and we've tried to be very clear over time as to the motivations and when we walk in every day, we're looking at two -- we're looking at -- for cheap assets, obviously to add to our portfolio.

And we're also looking for either risky or overvalued assets every day, because there's money to be made in shedding those.

And so both of those are on our radar screen on a continuous basis.

Great.

Thanks, guys and again congrats on the quarter and thanks for the color.

Thank you.

Next question comes from the line of Daniel Furtado with Jefferies.

Thanks for taking my call and a great quarter, great year, actually.

Not that I disagree but I'm just trying to kind of understand this, but do you mind helping me understand kind of the down side to the GSE repurchase strategy or whatever you're calling it?

Is it really as simple as if the GSEs don't accelerate repurchases, what we'll have here is just a slightly lower asset yields as well as a slightly less liquid portfolio?

I mean, is it that simple?

Or how do I look -- the risk of establishing the portfolio to protect yourself from this GSE buyout risk?

In general, so if the GSEs don't change at all, their buyout behavior and over the next year or so what we see is just delinquent loans continue to just collect in pools, then in theory what you would see happen is you'd have good carry on those positions and that carry might be better than what it would be on other securities.

But a lot of the price appreciation we've seen in those assets has taken away some of the down sides.

So going back to something I said earlier, we don't feel like we have to bet the ranch that this is a real problem.

It's just not a risk return that we want to take right now.

So again, the down side is that the prepayments on those types of assets will remain actually contained and we might have been in a sense rewarded or kind of been about the same, a little better, if we had kept those assets.

But looking forward, if that happens, you would expect the market still to react over time to the built-up delinquencies.

So at some point you would have to expect the prices of those securities to offset for the continued building risk of these delinquent loans.

The goal really would be to time that trade absolutely perfect to get out at the last month before the process began, which let's face it, is not that simple of a timing exercise.

Perfect.

Thanks a lot.

I appreciate the insight.

Thank you.

(Operator Instructions).

Your next question comes from the line of Mike Taiano with Sandler O'Neill.

Good afternoon.

Good quarter.

Most of my questions have been answered but I just had a couple more.

How should we think about your purchases during the quarter, the relative spread on those compared to your overall -- your average throughout the quarter?

Did it come down quite a bit, relatively flat?

How should we think about that?

Well, I think what you can say is the portfolio grew.

I'll go back to what we said earlier.

One of the problems is we purchased a wide range of asset classes, and so the yields and the spreads are clearly different across the different asset classes.

But what I think really speaks to the quarter from our perspective is the fact we were able to generate significant gains and yet our spread going forward, when you look at the as of numbers, stayed relatively constant.

And that includes a larger portfolio and a capital raise, so keep in mind really that's kind of the summation of the entire quarter.

And then just secondly, you had given sort of where prices had tracked quarter to date on some of the fixed rate MBS.

Could you maybe give us a sense of also on the longer to reset hybrid ARMs, where those are right now versus the end of the year?

They've also gone up quite a bit, so longer reset, so if you looked at higher coupon, 10-1s, the close to 6% ARMs are around a 107 dollar price.

New issue ARMs have come back a fair amount as well.

Not as much as fixed rate but they've certainly improved in price and some of the higher coupon 6%, 36 month to roll type ARMs that we've listed on our chart are also back into the 106s.

So across the board, we've seen improvement in prices in the mortgage universe with probably the new issue front relative to its expected price appreciation lagging a little bit.

Okay.

Great.

Then just the last question.

How should we think about the undistributed income flow through in 2010?

Should we think about it just sort of flowing equally through the quarters or more front-loaded?

Back-loaded?

Any particular way to think about that?

Not really.

I think it's a function of market conditions and results.

But clearly it will all be paid out in 2010 as we have to.

Now, the one thing to keep in mind is that the way it is recognized from a tax perspective is the first dividends paid are deemed to be paid off of 2009 income.

And so essentially under most scenarios in the first or second quarter, that income will have been paid out.

But in terms of paying down, which I think is more the gist of your question, in terms of paying down the undistributed taxable income balance, it's going to be a function of time, market conditions and earnings going forward.

Okay.

Thanks.

Your next question comes from the line of [Matt Tolick] with Macquarie Capital.

Thanks for taking my question and congratulations on a nice job.

Just on the portfolio, again, you've done a good job obviously preparing for buyouts.

My question more relates to extension risks in the portfolio.

You look at your fixed rate portfolio's been prepaid very shortly.

Which has been great.

It's almost alarmingly slow.

How would you look at it if there was 100 basis point pickup in interest rates, is there sort of some type of color you can give us in terms of how much the assets would extend, mainly your fixed rate and your longer dated hybrids.

Sure.

Clearly, we recognize that the duration of our assets or the interest rate sensitivity of the assets on their own has gotten longer as we've rebalanced the portfolio and we recognize that and have accounted for that with a larger swap book and then I really do want to point to as well the swaption portfolio which we've begun to build which really does help us.

The technical term in the mortgage market is convexity.

These are purchased options and they help us if interest rates move a lot in either direction.

Give u the right to enter a swap if the price goes up.

$200 million of the $300 million are payer swaptions is the term which protect us.

Essentially, allowing us to at the price specified in the option to add $200 million more in pay, fix swaps if it's -- but in and only if it's needed.

The other $100 million helps us if rates were to fall.

So one of -- that's another important piece, in addition to growing the size of the swap book, adding the swaptions really give us some incremental protection no matter which way interest rates go.

Going specifically to the duration of the assets, yes, they're longer but we've taken a number of steps, buying very seasoned fix rates helps significantly reduce the duration difference versus other types of products.

And in the longer term securities, the coupons are higher than 7.1s and 10.1s, which also help to keep the duration down.

So we feel pretty confident and we're continuing to take steps to protect against interest rate increases, without kind of setting ourselves up if rates fell a lot.

I think the Fed mentioned or someone from the Fed mentioned that they would increase buying, mortgage rates were to rise significantly.

Would you look to sell maybe some of that fixed rate portfolio in that type of environment?

Absolutely.

I mean, if we feel that -- if the Fed were to come back and fixed rates were to go much tighter, especially versus ARMs, especially if we could get some kind of clarity and more comfort on the buyout side, for the higher coupon ARMs, I mean, we're consistently looking at the relative value and that is absolutely on a risk return basis and risk being a big piece of that equation and if fixed rates were to tighten up further, then we would be very open to going back the other way.

Great.

Fair enough.

And then just the -- my last question.

On leverage, the Board removed the cap on the leverage level.

What do you view as the optimal level of leverage today?

We've seen some new entrants come in and kind of look towards an eight to nine times.

If we were to see a selloff in MBS like we saw in May last year, could agency get to that level very quickly?

Would you consider it?

Absolutely we would consider it over time, given where repo haircuts are and given our cash positions and our ability to manage risks.

Higher leverage than where we've been operating is absolutely something we would be comfortable with over time but it's very dependent on market conditions.

So when we look at our leverage today, we see a number of factors.

The valuations on mortgages, the prepayment environment and the certainty or uncertainty related to it, the interest rate and spread environment.

When you put all those together in other environments, there are times when I think leverage in the 8 to 10% area is certainly something we would be comfortable with.

And just could you just remind us what your average haircut is?

The average haircut right now is around 5%, but we have some haircuts that are below that.

Great.

Thanks, Gary.

Thank you.

Your next question comes from the line of [Gordon Paisley], Generational Wealth.

Hey, fellows, good afternoon.

Thanks for taking my call.

I think this is a little bit of a repeat from a question, but if I'm understanding correctly you have extended the duration of your liability side with your swaps heading out a little bit.

Obviously your repo book is repricing at lower cost than Q4.

But can you quantify any impact on spread in Q1 by the, quote, purchasing a wider range of asset classes.

I'm guessing at presumably a lower yield to the portfolio.

Can you quantify the impact on spread for Q1?

I can't quantify the impact on any of the changes for Q1.

But I think that the key issue really relates to the types of assets we continue to look at because, again, yields on fixed rate are still quite a bit higher than ARMs and we did sell some of our higher coupon fixed rate securities this quarter, which were higher yielding securities, so there are a number of moving parts in the equation.

And so it's hard to quantify things, especially for Q1.

Okay.

Thanks.

Your next question comes from the line of Jim DeLisle of Cambridge Place.

It's Jim DeLisle.

Good afternoon.

Hi, Jim, how you doing?

I'm doing well.

Thanks.

Looking at swaption would I be correct in assuming that any income generated from the sale of swaption is not good income, and losses generated by the purchase of swaptions that are not exercised might have the same treatment?

First off, the income or sale, what we do is we mark-to-market our swaptions on a daily basis.

They are not in a hedge relationship.

So in general, the marks are going to be flowing through on a consistent basis, whether they're realized or unrealized.

Okay.

But being that they are not on a hedge purpose, I presume it would not be classic good REIT income for tax purposes.

That's not necessarily the case.

The payer swaptions would result in good income.

Only the receiver swaption book would be considered bad income.

How is your book broken down right now?

It's $200 million in payer swaptions and $100 million in receiver swaptions.

But again, even with that portfolio growing a decent amount, we do see an issue in terms of bumping into any of the limitations there.

Again, I do want to highlight, these are purchased options.

We obviously did have over a year ago a fair amount of options where we were writing options to generate income, not that we can't get benefits and income out of these options.

But these are purchased options with a clear risk management objective.

Thank you.

Your final question comes from the line of Bose George with KBW.

Just had a follow-up, Gary, on a earlier response you made on the dividend for this year.

Since it's the first in, first out and your dividend requirement would essentially be met probably by the dividend in the first quarter, is there a requirement after that or you could you revisit this in 2011 with an even bigger excess dividend.

No, that is the earlier paying out the 2009, whatever as a first out, first in, first out kind of method is the only requirement and, yes, technically we can evaluate whether we wanted to pay an excise tax on 2010 income and carry it forward into 2011.

That is always an option that any REIT would have, and clearly under certain circumstances we would think about that.

However, we're very early in the year and I think it's very premature to start thinking along those lines.

There are no further questions at this time.

I will now turn the call back over to management for closing remarks.

I think that's it.

If you could read the replay instructions that would be great.

Thank you for participating in today's American Capital Agency fourth quarter 2009 earnings call.

This call will be available for replay beginning at 5 PM Eastern standard time today, through 1159 PM Eastern standard time on February 22nd, 2010.

The conference ID for the replay is 52724001, again, the conference ID number for the replay is 52724001.

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

This concludes today's conference call.

You may now disconnect.