AGNC Investment Corp (AGNCO) 2010 Q4 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the American Capital Agency fourth-quarter 2010 shareholders conference call.

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

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

(Operator instructions).

Thank you.

Ms.

Wisecarver in Investor Relations, you may begin your conference.

Thank you.

Thank you for joining American Capital Agency's fourth quarter of 2010 earnings conference call.

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

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

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

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

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 factors section of AGNC's 10-K dated February 24, 2010, and periodic reports filed with the Securities and Exchange Commission.

Copies are available on the SEC website at www.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 February 23 by dialing 800-642-1687, and the conference ID number is 399 (technical difficulty) 8676.

To review the Q4 slide presentation, turn to our website, AGNC.com, and click on the Q4 2010 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 the call include Malon Wilkus, Chairman, President and Chief Executive Officer; John Erickson, Chief Financial Officer and Executive Vice President; Gary Kain, Chief Investment Officer; Chris Juehl, Senior Vice President, Mortgage Investments; Bernie Bell, VP and Controller; and Jason Campbell, Head of Asset and Liability Management.

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

Thanks, Katie.

Good morning, everyone, and thanks for joining us and for your continued interest in AGNC.

We have a lot to cover today.

First, I want to highlight what happened during the quarter and how it impacted AGNC.

Secondly, I want to briefly summarize 2010 as a whole, because it really was a wild year.

Additionally, I am going to ask the senior members of my team to join me on the call to talk about the areas they oversee.

I think it is important that you get to know them because I depend heavily on them and they are integral to the performance that defines AGNC.

Now, with respect to Q4, what a reversal from what people were expecting.

We began the quarter with a continued bond market rally as the market front ran (technical difficulty) the Fed's QE2.

However, in early November, following the elections, some stronger economic numbers and the actual QE2 announcement, the bond markets sold off quickly and violently.

Now, for those of you who were on our call last quarter or looked at the transcript, you may recall that we got a couple questions about hedging and what would happen in the very unlikely event that rates went up quickly.

Our response on that call, which, again, was late October when interest rates were essentially at their lows, was that we had gotten more defensive on the hedging front and had reduced our duration gap to roughly half of where it had been.

More importantly, we highlighted our purchases of payer swaptions, and we also discussed our use of short TBA mortgage positions in our Q3 earnings materials.

These positions turned out to be critical to our performance, given the selloff.

Now, I want to be clear that we did not call or bet on the increase in rates that occurred during the last half of the quarter.

Sorry, we're not that smart.

We merely did what we felt was necessary to try to protect the portfolio in either direction, which is why we took the actions that we did.

Moreover, because we were confident that our portfolio would have continued to perform well if rates fell further, we could afford to protect against rising rates without having to bet the farm that rates would not go down.

With that as the background, let's review the highlights for the quarter.

GAAP net income totaled $2.50 per share.

Other investment-related income accounted for $1.24 per share and was driven by approximately $1.05 per share of net mark-to-market gains on the hedging instruments I discussed earlier.

Now, excluding other income, net income was $1.26 per share versus $1.11 for the prior quarter with slower prepayment projections providing a significant boost to net interest income.

Taxable income was $1.64 per share.

The main driver of the difference between GAAP and taxable income was timing differences between the recognition of unrealized gains and losses on derivatives.

For tax purposes, unrealized gains or losses on derivative instruments are not recognized until they are realized or settled.

Now, as you know, we declared a dividend of $1.40 per share, and our taxable income for the quarter essentially covered the entire dividend despite the significant increase in shares outstanding.

Undistributed taxable income was essentially unchanged this quarter at $39 million.

This translates to about $0.60 when adjusted for our ending share count as of December 31.

Book value per share as of December 31 was $24.24 versus $23.43 at the end of Q3.

Our economic or market-to-market return for the quarter was 9% or around 37% annualized, which is again comprised of the increase in NAV and our dividend of $1.40 per share.

Now, as you can see on the next slide, our mortgage portfolio totaled $13.5 billion as of December 31, while leverage at year end was around 7.8 times.

Now, actual prepayments on our portfolio came in at 18% CPR for the quarter.

But remember, these speeds were driven by the record low rates we saw in late Q3 and early Q4.

More importantly, it was only 12% CPR in the most recent release of a few days ago in early February.

Now, as you know, we raised a significant amount of equity at the end of the fourth quarter and in early January.

We are confident that these offerings were accretive to both book value and earnings.

Over the past few years we have demonstrated that we can issue equity and continue to produce market-leading results.

We are extremely grateful for the confidence the equity markets have placed in management, and we don't take this privilege lightly.

We welcome our new shareholders to the Company and recognize that our strong performance has only raised the bar going forward.

Now, if you don't mind skipping to slide seven, we can finish discussing Q4 before we come back to slides five and six to conclude the presentation by reviewing our performance for the full year 2010.

So slide seven reviews a key item that led to our record GAAP earnings this quarter and helped protect our book value, our supplemental hedges.

The first thing I want to be clear about is that the mark-to-market gains on our main hedges, our swap book, were not included in either GAAP or taxable income, as they are in hedge relationships and thus are marked to market through OCI and shareholder equity.

Furthermore, our average swap position totaled close to 50% of our repo balance during the quarter and was thus comparable in scale to those of many in our peer group.

The chart on slide seven details the mark-to-market changes on some of the categories of supplemental hedges.

The largest contributor was the first category, which includes our net positions in TBA mortgages and Treasury securities.

These were generally concentrated in short positions in lower-coupon TBA mortgages, which added significant value for us, generating $0.71 per share during the quarter.

The next largest category were our [pay-fixed] swaptions, which contributed $0.22 to both net income and NAV.

Importantly, all of these swaptions were purchased in Q4 with the bulk of the purchases occurring early in the quarter, which explains the sizable gains.

In an effort to further transparency, we also broke out our mortgage derivatives, which include I/O and inverse I/O securities.

This relatively small position accounted for net gains of $0.12 per share in Q4.

Lastly, I want to point out that, while the mark-to-market gains on those positions were recognized in GAAP income during Q4, only around 40% of these gains were included in our taxable income.

As an example, none of the mark-to-market gains of the swaptions were included in the tax number.

So, as such, in the absence of market moves that reverse these gains or unless other transactions or our positions generate losses that offset these gains, we should have a good tail wind for taxable income in the first quarter, as some of our unrealized gains are recognized for tax purposes.

So, with that, let me turn the call over to Chris Kuehl, our Head of Mortgage Investments, to review the changes to our mortgage portfolio.

Thanks, Gary.

Q4 turned out to be a very challenging quarter for the bond market.

Interest rates initially fell close to 25 basis points at the start of the quarter, only to rise over 100 basis points during the later half of Q4.

Slide eight depicts the changes to interest rates and to mortgage-backed security prices from the end of Q3 through year end.

But keep in mind that this significantly understate the true volatility experienced during the quarter.

Just to give you an example, a sector that AGNC has generally avoided and was actually short at times during the quarter as a hedge is lower-coupon 30-year MBS.

Let's look at the price movements over the quarter for 30-year 4s as a proxy in the bottom left chart on slide eight.

While the price of 30-year 4s fell by nearly 3.5 points from the start to the end of the quarter, what you don't see is that in early November they hit a high price of nearly 104, and at one point in mid-December there were trading around 97, so almost a 7-point swing in a little over one month.

Now, during the quarter a clear pattern emerged.

Lower-coupon mortgage-backed security prices dropped significantly while higher coupons tended to hold up much better.

This actually makes a lot of sense because the sell-off in rates produced one major benefit for owners of higher-coupon mortgages, slower expected prepayment speeds.

As you can see in the chart, 30-year 5.5s were higher during the quarter as more benign prepayment speed expectations outweighed the discounting effect of higher interest rates.

The same patterns were generally seen in both 15-year pass-throughs and in hybrid ARM's, but to a lesser degree, given their shorter durations and reduced exposure to longer-term interest rates.

Now let's turn to the next slide to review how we positioned the portfolio during the quarter.

As you can see on slide nine, we maintained significant diversification while growing our assets with the equity raised during the fourth quarter.

The biggest change in our portfolio was a greater emphasis on 15-year MBS.

We felt that certain sectors of the 15-year market provided the best risk-adjusted return potential, given mid-3% yields coupled with relatively predictable interest rate and prepayment exposure.

In contrast, we largely avoided newer production ARMs because the combination of greater prepayment uncertainty coupled with the strong demand from ARM-only investors led to relatively unattractive valuations.

Now, with respect to activity since year-end, we have largely deployed the capital that we raised in early January, and our asset portfolio now exceeds $20 billion.

Year-to-date activity has generally been consistent with what we did in December, except that seasoned higher-coupon fixed-right mortgages comprised a larger percentage of our purchases.

These securities, like 15-year pass-throughs, provide the dual benefits of manageable extension risk and predictable prepayment behavior.

As we've discussed on prior calls, asset selection is absolutely critical to our performance, and we remain focused on building a portfolio that will perform well if rates move in either direction.

As the table at the bottom of the slide demonstrates, we continue to be able to manage prepayment exposure despite the influence of record low mortgage rates.

During the quarter, the average prepayment speed on our portfolio remained below 20% CPR, and furthermore our portfolio CPR dropped to only 12% in the most recent speed release as the impact of higher interest rates is just beginning to impact speeds.

Now let me turn it over to Jason Campbell, our Head of Asset and Liability Management, to talk about funding and risk management.

Thank you, Chris.

Please turn to slide 10, and we will briefly go over our financing activity.

In Q4, we added one additional repo counterparty to bring the total to 22, and we have since added two more counterparties in 2011.

So, while repo cost of funds increased in December several basis points over both November and Q3 levels, availability remained plentiful and rates have generally since returned to the Q3/early Q4 levels of around 28 basis points.

Now please turn to slide 11 and we can go over our hedge positions, which is probably the bigger picture issue today, given the volatility that we have witnessed in the markets.

In Q4 we increased both the size and average maturity of our swap book.

The total notional increased by just shy of $2.5 billion to $6.5 billion, and the average maturity increased by 0.2 years to just over three years.

As Gary mentioned last quarter and as you can see in the table, we added a decent amount of payer swaptions.

As a refresher, a payer swaption is a put option on rates.

This convexity profile makes them a very valuable tool in hedging extension risk.

During the quarter we added $850 million of payer swaptions, $300 million of which were set to expire in Q1 and the remaining $550 million will expire thereafter.

The total cost of these options was $4.6 million, and they had a market value as of 12-31 of around $17 million.

We also increased both the magnitude of our hedging activities in both the TBA mortgage and Treasury spaces.

TBA activity allows AGNC to adjust its exposure to various risk factors dynamically and at little transactional cost.

Short positions were generally concentrated in lower-coupon 30-year mortgages.

And given what happened during the quarter, it explains a lot of the gains that Gary had mentioned earlier.

Now, before we move on to the duration gap slide, I do want to note that the explicit purpose of our supplemental hedges is to dynamically reposition risk as market conditions change or as the embedded exposures in our portfolio evolve.

Therefore, our positions in these securities tend to change in both magnitude and even direction relatively quickly.

With that, please turn to slide 12 and we can briefly over the duration gap slide.

We ended Q3 with a duration gap of approximately 0.7 years.

As we had mentioned on the third-quarter call, we had reduced this gap roughly in half towards the end of October.

As you can see on the slide, we ended Q4 with a duration gap of just over one year.

With that, I would like to hand the call over to Bernie Bell, Head of our Accounting and Reporting team, to discuss business economics.

Bernie?

Thank you, Jason.

Now, if you will please turn to slide 13, given the significant change in the size and composition of our portfolio during the quarter, I'm going to focus on our numbers as of December 31, the far left column.

Our average asset yield as of the end of the quarter was 3.31%, which was up from 3.25% as of the end of the third quarter.

The biggest driver of our higher asset yields at quarter end as well as during the quarter was a decline in our estimated prepayment speeds.

As a refresher, we amortize premiums and discounts on our mortgage securities and to interest income over their estimated lives using the effective yield method.

Therefore, slower prepayment projections can have a meaningful positive impact on our asset yields, especially given the relatively high cost basis of our securities, which was near 105 as of the end of the year.

Our average cost of funds of 1.03 as of year-end also benefited from a decline in the weighted-average fixed pay rate on our interest rate swap portfolio after having added $2.5 billion of new swaps during the quarter at a weighted average pay rate of near 1.35%.

All of this translates into a strong net interest rate spread of 228 basis points as of the end of the year and a good starting point for the first quarter.

But remember, our asset yields are sensitive to prepayment estimates and other factors.

And as Chris mentioned, in January we added a fair amount of new securities on what we believe are attractive yields.

With that I will hand the call back over to Gary.

Thanks, guys.

And before we conclude, I do want to go back to our full-year 2010 results.

So please turn back to slide five.

As I mentioned earlier, 2010 was an extremely volatile year where every quarter brought about unique and significant challenges from GSE buyouts to the Fed's exit from the mortgage market to the European debt crisis to record low mortgage rates to massive refi fears to QE2 and, lastly, to the massive sell-off that ended 2010.

In a normal year, each of the four quarters individually could have stood out as game changers.

But dealing with them back-to-back was really something else.

With that said, we are extremely proud of our results.

We produced net income per share for the year of $7.89, which translated to an ROE of 34%.

Next, our taxable income totaled $6.76 for the year, and since this exceeded the $5.60 we paid in dividends, our undistributed taxable income increased by $17 million to $39 million at the end of 2010.

Importantly, we were able to grow book value by over 7% during the year despite paying the highest dividend in the space.

When we combine our dividends paid plus our book value expansion, we get a full-year economic return of 33%.

We believe this metric is probably the single best way to judge the true performance of AGNC or its peers over time.

Again, economic return is a mark-to-market based number which is driven by only two factors, cash dividends and the market prices for mortgages and hedges.

It is important to recognize that book value fluctuates quarter over quarter, and investors should expect some volatility here.

The bar chart on the right shows our economic returns versus the three other agency REITs that have reported their Q4 results, and the differences are striking, especially in terms of the book value component.

Lastly, our total stock return, which I know many of you care a lot about, totaled 29%.

You should take some comfort that the very strong performance of the stock has actually lagged the economic return calculated from bond market prices for both 2009 and 2010.

So what should we take away from 2010?

If you turn to slide six, we listed a couple of things.

First and foremost, market conditions clearly change very quickly.

There is no time to pat yourself on the back and talk about glory days.

You had better be prepared to react to the next curveball.

Additionally, asset quality has a very big impact on overall performance.

As market conditions change, the types of assets you need changes as well.

On the hedging front, interest rates can move quickly in either direction.

As such, it really helps to have some hedges that can offset some of the negative convexity of your mortgage holdings.

While these hedges do create some mark-to-market volatility, we believe they are critical to helping to mitigate the risks from larger swings in interest rates, which in turn facilitates our ability to capitalize on new market opportunities.

Lastly, the good news -- a levered mortgage portfolio can perform very well under a range of interest rate and prepayment stresses if it is well managed.

With that, let me ask operator to open up the lines for questions.

(Operator instructions) Jason Arnold, RBC Capital Markets.

Good morning, guys, great job this quarter.

What are your thoughts on the long end of the Treasury curve?

I'm just curious; do you expect rates to move into the 4% range and beyond on the 10-year or perhaps stay more range bound?

And then, of course, the implications on mortgages from there?

When it comes to the longer end of the Treasury curve, it's not an easy call, so to speak.

And that was the case last quarter.

I think it's the case this quarter as well.

There are a lot of big-picture forces at work, including government policy, global economic factors and so forth.

Our mindset is that we are confident in the short end of the curve.

We don't think -- despite a few good economic numbers, we don't believe the Fed is about to start a tightening cycle.

We think the Fed is on hold for the foreseeable future.

We do think the back end of the curve is a little bit more of a risk, and so we continue to be focused on being to manage sizable moves in either direction.

But, big picture, we feel like the bond markets adjusted quite a bit at this point.

We have a very steep yield curve, and a very steep yield curve or a steeper yield curve is an environment that tends to lead to very attractive spreads for us.

So just the 10-year backing up somewhat in a manageable fashion, is something that we don't view as a negative.

Great, certainly makes sense.

And, yes, not an easy question, so thank you for your comments.

And then I guess one other -- assuming we remain in the current ballpark on mortgage rates, do you expect that prepaids for the portfolio will remain in the low double-digit range here in coming months as well?

Absolutely.

We don't -- obviously, we don't know what the outcomes are going to be, and there's always risk on any numbers such as prepayments.

But the effects of the increase in interest rates are really just beginning to flow through the prepayment equation.

So we feel like there is a favorable backdrop on the prepayment front.

So big picture, the combination of our portfolio composition and the higher interest rates should continue to keep prepayments very muted over the near-term.

And it's just -- it's something that we can't lose sight of and we don't want to be complacent about because, as we've seen in the past, things change very quickly.

But, big picture, right now, the prepayment picture looks very favorable.

Great, thank you.

And again, great job of managing through a very tricky year.

Mike Widner, Stifel Nicolaus.

Good morning, guys, and again echo the congratulations on a solid quarter and year.

Wondering if you could just talk a little bit about the recent capital raise and how you think about the speed of putting it to work and, related to that, the level of leverage that you feel comfortable with, given current circumstances.

Sure.

As Chris mentioned earlier, our portfolio at this point is over $20 billion.

So we've deployed a large chunk of the capital, or the majority of the raised in early January.

Now, one thing that's important is that's a number in terms of that we've committed to purchase.

There is a lag, generally, in settling those purchases and, quote, getting them on the balance sheet.

But, big picture, we've had good opportunities to deploy the capital.

As Chris mentioned, we've tended to favor fixed rate and, in particular, a combination of 15-year and higher-coupon 30-year mortgages that are seasoned and both produce -- have interest rate sensitivity and prepayment sensitivity that we are comfortable with.

When you then go to -- what was the second part of your question, was what?

I'm sorry; I think you had another part.

Well, I think that actually answers it.

I was talking about speed of investment as well as leverage, but $20 billion -- I could do the math of $20 billion as the asset level that you feel comfortable at.

Yes; I'm sorry.

It was leverage, but I did want to give leverages -- what leverage levels are we comfortable at.

And we are comfortable where we have been operating, call it 8, 8.5 is something that's very comfortable.

And keep in mind that one of the things that helps in terms of on the leverage front is slower prepayment speeds.

So we clearly have to maintain extra cash cushions and so forth for the delay between when prepayments are recognized or show up on securities versus when we actually get the cash from Freddie and Fannie.

And as prepayment speeds come down significantly like they have and where the risk of higher speeds in the near-term is lower, it actually does increase your ability to lever if you so desire.

And just one clarification there -- you talked about deploying the capital.

And of course, there's some lag in settling.

Some of your peers are reasonably aggressive uses of things like forwards.

Are you talking about just the normal time to settle of spot purchases?

Or are we talking any significant level of forward purchases and putting it to work?

We are talking about the normal settlements where you tend to buy something two weeks to a month out.

Our mindset has always been that we want to know, we want to pick the security that we want to invest in.

And we don't really feel that there's any real value to going out on a consistent basis further.

The drops and the economic value of lost interest sort of offset each other, but the ability to control the asset and make sure you know exactly what you're getting and, if you don't like it, get out of it is something that we view as a positive.

So we are not being -- we do it sometimes, but it's not a general kind of strategy that we employ.

And just one other quick one, if I could -- you guys have had a pretty solid track record over the past -- really, since you came on board, Gary, in seeing things and taking advantage of the opportunities when the market was pricing and dislocations where the market kind of had the story wrong.

Down there in DC I hear a lot of talk from some guy called Bernanke who doesn't really seem to get the picture all that right very often.

I'm just wondering, with you guys' proximity to DC, why we might not see you in front of Congress talking about things a little more often.

That's really -- I'm not quite sure how to answer that one.

But I'm not dying to go up in front of Congress anytime soon.

So I think you're going to be stuck listening to me on this earnings call.

But I appreciate the comments.

All right, thanks guys.

Mike Taiano, Sandler O'Neill.

Congrats from me as well.

Just a couple of questions -- I guess, first off, can you give us maybe some quantification of how much the lower CPR assumptions impacted the net interest spread either in basis points or dollar amounts in the [third] quarter?

Actually, I don't have an ability or a number on that front.

Essentially, the way you would get the impact of the prepayment speeds is we have to run our portfolio twice, essentially, at the end of the quarter between using the old speeds and the new speeds, to get a total picture of the value added of the change in prepayment speeds.

It's also, obviously, a function -- it did have a pretty material impact for us because of our higher cost basis.

As has been brought up in the past, the higher your cost basis, then the one impact -- again, we don't think it's a big economic impact.

But it does tend to have a bigger impact.

When prepayment speeds slow down, amortization slows down, and you get a bigger yield pickup.

But I'm sorry; I don't really have like a total yield number with and without -- with old prepayment speeds versus new ones.

Okay, that's fine.

And then I guess also just to touch on -- you had spoke about the long end of the curve and the short end where I think you, as most people, probably think the Fed is probably on hold for a while.

But it looks like Fed futures are now baking in a 100% probability of a Fed rate hike by the end of the year.

Is it fair to say that you think that's probably not likely at this point?

Or would you agree with that?

No; I still think that the -- clearly, we recognize what's going on in the bond market with higher implied forward rates and, essentially, that translating to pricing in earlier Fed hikes.

So we don't see one in 2011.

But big picture, as we've said in the past, we are -- we -- it's our responsibility to try to manage the portfolio through any different environment that unfolds.

And so we are -- we are definitely noticing how the market is evolving.

But we do think that a lot of the shape of the yield curve is a risk premium related to a lot of the factors that are out there, not the least of which is the deficit here and factors abroad.

So it is also just very possible that, rather than what the bond market is telling us at this point is that risk premiums from longer-dated treasury securities or similar securities are going up and not necessarily that the Fed is going to be tightening really quickly.

And I think, clearly, the market reflects both of those.

The latter, the risk premium issue, being something that is just something we would make money off of and certainly wouldn't mind continuing to see higher risk premiums built into the market.

Okay, that's helpful.

And then just one last thing -- you had talked about the portfolio, now, I guess, over $20 billion.

And just wondering at what point -- I think in the past, you said $20 billion to $30 billion you thought you could effectively manage your -- the way you manage your portfolio on an active management basis.

Is anything changing now that you're over $20 billion, sort of how you manage the portfolio?

Yes.

I think what we've said in the past, it's $10 million more than wherever we are at the time.

Actually, in all seriousness, it's a very good question, and I want to give a very serious response to it.

Absolutely, as we grow and as the portfolio grows, some of the, we'll call it operational efficiencies of a larger portfolio tend to drop off.

So the impact on our cost of a larger equity base or a larger asset base starts to level off at some point.

Additionally, the impact on the liquidity of the stock -- maybe less so, but levels off somewhat as well.

That being said, accretive equity raises are very good for our shareholders.

And so, as our portfolio gets larger and as the equity base gets larger, I think the best way to think of it is that the bar sort of gets raised over time because, yes, a bigger portfolio has to find larger areas of value.

And that is a factor that we will clearly bring into the equation.

So I think, when you piece all that together, we recognize the change in the size.

We are practical and realistic about how those different factors impact the overall equation.

And the bar goes up as the factors change.

Great, thanks a lot.

Bose George, KBW.

I've got a couple of little things.

One just was -- curious where do you see incremental spreads in the market.

Well, I'll give you yields.

Incremental spreads are -- yields on 15-year mortgages are a little above 3.5%, like low 4s, 4.25% to 4.5% on 30-year mortgages.

ARMs, depending on the type of ARM, we'll call it high 2s.

When you piece together an overall portfolio with those kind of yields and funding costs, you are in the, we'll call it, 2% to 2.5% kind of ZIP code with a 2.25% being not necessarily that far off.

But it's very dependent on your asset mix, and I think that's really -- that you could put together different portfolios with very different spreads and different exposures.

Okay, that's great, thanks.

And just on the swaptions, I just wanted to make sure I understood the accounting.

On that slide, you showed $4.6 million is the cost of that.

And does that just get marked to market over the life of that securities?

How does that work?

Well, what ends up happening is essentially it gets marked to -- as it's -- when you, in a sense, if you were to pair out of it or if it were to expire, then you would take a -- I'm sorry.

From a GAAP perspective, what ends up happening is it's just a mark to market.

I was starting with tax; I'm sorry.

So from a GAAP perspective, it is just marked to market over its life.

So what you will see is, if the value changes, then that change in value is reflected in your GAAP income statement.

With respect to tax, it's essentially at the time, if it expires out of the money or worthless, then you will take a loss at that point equal to your premium, okay.

So on the options we purchased, from a tax perspective, the worst-case scenario would be that you would lose the premium that you paid.

However, if at the time you choose to unwind, if you choose at any point to unwind that swaption, then the gain or the market value that you unwind it versus your cost will be reflected.

So if we had, on December 31, unwound all those swaps from a tax perspective, you would've taken those gains.

I'm not going to get into exactly what happens if you were to exercise the swaptions because it's pretty complicated and we would probably be on the call for quite some time.

Okay, thanks.

And then just one last question, just going back to the political side.

The administration is supposed to come out with their plans for the GSEs at some point pretty soon.

I'm just wondering if you think what comes out could create either risks or opportunities for you guys in the agency MBS market.

I think it could create opportunities more so, I think, than risk.

But because the headlines will be interesting and there clearly will be some volatility with respect to how the market digests different comments from different politicians.

But the picture, I think we've gotten some kind of tidbits out of the administration or Treasury recently about the direction that they are likely to head.

And I think it's very consistent with what we and others probably had been expecting, which is the long run picture is shrink the GSE portfolios, call it over the next eight to 10 years, which is pretty much what is already on the docket, which is good because they were a major competitor, a levered investor that could really lever considerably more than an agency REIT.

So having the portfolio strength is a good thing.

Secondly, on the guarantee business, I think the proposals are designed to get the guarantee business over an extended period of time or a long period of time back down to an area maybe 50% or lower.

So government type securities or GSE securities would be under 50% of the total mortgage market at some point in the future.

The way they would tend to accomplish this is the somewhat tighter credit and lower loan limits so that the larger loans go into the non-agency market.

Well, that evolution is actually absolutely fine, and it's actually not that different from the more historical position of the GSEs.

So historically the GSEs tended to have been roughly 60%-70% of the market.

Of late, they have been 90% plus because the nonagency markets have ceased up and so forth.

But big picture, I think the direction that they are heading is one that isn't really that dissimilar to the kind of longer-run environment.

And I think it's a healthy outcome.

So what does that mean for AGNC over the long run?

It means that the agency market is currently $5 trillion.

At some point, maybe it's $10 trillion, maybe it's $20 trillion.

Who knows how many years from now?

That number is 50% of the total market.

It's still an absolutely huge market.

It's still going to present great opportunities for us.

And we just don't view that or anything that we've heard along those lines as being a big picture thing to be concerned about.

Great, thanks for that.

Steve Delaney, JMP Securities.

My main question was also on GSE reforms.

I'm glad that you covered that with those.

Can I just clarify that the 228 estimated spread at December 31 -- does that incorporate your new forecasted lifetime CPR of 12%?

Yes, it does.

It does?

Okay.

And could you comment -- you kind of -- in answering Bose's question about current spreads, you touched on this.

But for modeling purposes, you still have suggested 2% to 2.5%, maybe 2.25% as a midpoint.

For modeling purposes, would it be best for us just to assume that the spread on the new assets with the January equity were pretty much in line with the legacy portfolio at 12-31?

Or do you feel like maybe you've done a little bit better on the new investment, given the curve steepening?

I guess what I would say is that those numbers I threw out there were generic and not intended to be reflective of the actual purchases that we made.

I would take you back to the yields of, let's say, higher-coupon fixed-rate, 30-year fixed-rate mortgages and the yields on 15-year mortgages, let's say throughout most of January, because those are the areas that we focused our attention on.

So I think, if you look at the yields on 15-year mortgages, call them a little below 3.5%, probably, for most of that period, and 30-years are very dependent on prepayment assumptions and the types of securities.

We tended to buy seasoned securities where we are comfortable with prepayment assumptions.

So I'm not going to throw out a number on that because there's more variability, but I think you have to look toward that information.

And I know it doesn't make your job of modeling easier, but I think that's the best we're going to do in terms of color on that front.

Okay, that's helpful.

I guess just the last thing on the GSE reform.

We don't know the specific nature of it, but given that it seems to be likely that the GSEs are not going to be acting as a buffer for the capital markets or arbitraging any relative value differences, would it seem logical to you that maybe the cost of retail mortgage credit, but also sort of the spreads between MBS and treasuries and swaps are maybe more likely to widen than they would tighten as we go forward in the New World?

I think that's generally true.

Clearly, I think the analogy we have kept using with respect to this is, in a sense, Fannie and Freddie were sort of like Coke and Pepsi to the investment universe, and without their portfolios playing a major role, I think that leaves better opportunities for others.

But I think it's also a function of a lot of other factors.

Right now, mortgage production is relatively low.

The yield curve is very steep, so there's a lot of carry in mortgages.

So it's not that difficult to find other buyers.

I think where you're going to see the biggest difference in terms of the attractiveness of mortgages to other players will be at a flatter yield curve environment.

Historically, flatter yield curve environments have been pretty unattractive for other investors.

And (multiple speakers) the reason is because there isn't a lot of carry and because a player that could lever 40 or 50 to one is going to be able to buy mortgages way before anyone else is.

So that's where we expect to see really the biggest difference in terms of our opportunity set with and without the GSE portfolios.

Interesting, well thank you for that, and good luck in 2011.

Jim Ballan, Lazard Capital Markets.

After all the volatility that you guys talked about last year, are you anticipating that the market gets less volatile here?

And what does that mean for asset selection?

And maybe more important, what does that mean for your ability to create realized gains in 2011?

I think there's kind of two questions, I think, in that.

In terms of asset selection, as we said in our concluding remarks, assets selection is always important, and it always adds value.

We may buy an instrument that we know will prepay much better than something else, if interest rates fall 50 or 100 basis points.

And even if they don't fall 50 or 100 basis points, that allows us to have a different hedge on in place because we have that comfort, if that scenario were to happen.

So, I guess the first piece is, in our ability to find value-added assets, we are still very, very focused on it, because it really does help us across the board, irrespective of the scenario.

There are also other strategies that help you in terms of having mortgages that will perform better if interest rates rise.

And obviously, that's something everyone should be thinking about right now.

In terms of realized gains or other -- in terms of those kinds of issues, we don't really focus on it from that perspective as much.

And yes, if prices across the board are going down, then clearly you're going to have less opportunities to sell something at a gain; I think that's straightforward.

On the other hand, our supplemental hedging activities tend to make money in that environment.

And so, again, our mindset in looking at the business is about generating long-term economic value for shareholders.

And that is the combination of paying an attractive dividend and being able to maintain our book value.

And I think that being focused on asset selection, being focused on hedges is still going to be absolutely critical as we go through 2011.

Okay, great, that's it for me.

Thanks a lot, guys.

Matthew Howlett, Macquarie.

What's the sensitivity with the duration gap to changes in prepayments?

And specifically, it's just the fixed-rate, the 15-year and the 30-year -- could you tell us what the -- I know the 12 CPR is the long-term average for everything.

But what is it for that part of the portfolio?

We haven't broken out the information.

Generally, the 15-years tend to be lower coupon and newer, and they are going to tend to be lower than, let's say, the 30-years.

The 30-years tend to be higher coupons, so those numbers are going to be higher.

But with respect to your sensitivity of duration in a sense to interest rates or convexity, what happens to the durations, if you compared our duration gap slide in this quarter, Q4, versus our Q3 slide, you will see that the durations of our portfolio extended a fair amount.

And that extended because of the slowdown in prepayment speeds and the higher interest rates.

However, most of the lower-coupon securities, in particular the 15-year, have largely extended.

There's always room for them to extend a little bit more.

But for the most part, the prepayment declines on a lot of our securities have happened.

There still may be more room for that on some of the higher coupons, the highest-coupon fixed rates.

But I think one thing that allows us some comfort around the duration gap and in how we manage it is the fact that that extension or that prepayment slowdown -- a good chunk of it has already occurred.

And so our convexity is lower now, and we are less exposed to the durations getting longer and longer.

Just with even the last 35 days, are the 3.5s below par now on the 15?

They are at par, as of the last couple of days, yes..

They are below par?

Can we assume that you are sort of a high single-digit CPR in those and that, if they were -- rates were just back up, but you would still target that one-year duration gap?

I mean, you'd do the other things, if even the asset yields got a little longer?

Look, we haven't said that we have a one-year duration gap target over the long run.

I think many of our -- I think, in the past we've tended, because of the unique environment that we've been in, and given the fact that durations on mortgages were relatively short and had this extension risk, we tended to want to run shorter duration gaps.

We're going to look at the risk/return profile.

And we would be comfortable with a longer duration gap than one year.

And I think you've definitely seen that in the REIT space over the years.

I don't think there's anything magical about a one-year duration gap.

We look at the overall risk picture, and we factor in a lot of different things.

But we would be comfortable running a duration gap noticeably longer than one year under many circumstances.

And then just the last thing on leverage, do you look at (inaudible) -- I mean, look what happened in the fourth quarter.

You ended the third quarter with a higher leverage than you had today.

You've done the capital raise.

Do you feel as if you could go back to nine times, or are things just, are the risks heightened that with the possible extension of the portfolio that you wouldn't go up there at this point in time?

Well, just remember the 9.75 at the end of the third quarter was sort of an aberration.

It was just totally reflective of the equity raise that settled on October 1.

So we really haven't operated at that level in a long time.

We are very comfortable in the, we'll call it 8.5 type ZIP code, where we did operate and have operated.

And again, I want to stress the point I made earlier that the biggest change has been a drop in prepayment speeds for our expected prepayment speeds and actual drops in the February release of the January speed.

And a lower prepayment speed essentially serves as a considerably lower haircut for us with respect to financing.

And so the ability to lever more is absolutely there than the 8.5 level.

And it's something that, under the right circumstances, we would absolutely look at.

And just on haircuts, are they at sort of 5%?

Are they -- have they dropped a little bit?

They're below 5% on average.

I'm sorry; what was that?

They are below 5% on average..

Great, thanks, good job.

Jason Weaver, Sterne Agee.

I was just hoping you could expand a bit on the previous question about forward purchase commitments.

Specifically, how important is individual security selection to the strategy right now?

And what exactly are you giving up by utilizing the forward purchase transaction?

Well, we really don't utilize that like a long forward purchase lag.

So I think the question relates to, do we purchase things three months forward so that we can essentially lower the price by three-quarters of a point but give up carry worth a quarter of a point each month for those three months.

And we don't do that very often.

We do it in some cases where there's availability of a particular security further out, or if there are unique economic circumstances that make it useful.

But in general, we prefer to know exactly what we are getting, to take it in and not leave an option for getting something different or getting something when we don't want it because conditions have changed three months down the road and we don't have the option to sell that security.

So a lot of the securities that we would have wanted to or three months ago to have purchased because they would have had good prepayment characteristics, some of them we may not want right now because we are more worried or we are focused on higher interest rates.

And so our mindset is we want the securities that we want.

Asset selection is too important, and we're just not worried about our GAAP cost basis, and we don't let that run our business.

Okay, thank you.

Jim Fowler, Harvest Capital.

Thanks for taking the question; I've got a couple.

On page 12 of the presentation -- is that a good proxy for your current hedge ratio on the $20 billion of assets that I believe you quoted?

Well, page 12 is the duration gap.

Right, and I'm looking at the swap and swaptions as a percentage of the total assets.

Okay, so the swap and swaptions -- it changes over time.

I think, in general, we -- I don't want to lock in a -- to give you a particular percentage for swaptions and, in particular, a particular percentage on TBA hedges and stuff like that because, as Jason mentioned, they move relatively quickly over time -- or they can vary relatively quickly as market conditions change.

I would say that the 55% of the repo balance hedge for the swaps actually isn't that far from a number that we are at currently.

The swaption percentage is probably actually a little higher than where it was at the time.

And again, I'll kind of defer on giving day-to-day updates on the TBAs and Treasury positions.

Thanks for that.

Although it's a very small part of your portfolio, I'm interested to know your thinking behind utilizing swaptions versus buying more I/Os.

And in particular, in the I/O market I'm assuming -- the trust I/O market, in particular -- do you find that market attractive right now, given where rates are currently and what is being discounted in prices versus prepayment expectations?

It's interesting, and it varies.

We have used more I/Os at some points in the past when -- and we'll call it in the second and third quarter, we felt like we had enough prepayment risk embedded in the portfolio and when rates were at record lows.

And we felt that, even though I/Os had some good qualities and in the end we probably would have been better off if we had had more of them.

But our mindset at that point was prepayment risk was the biggest driver, and so I/Os weren't necessarily a good big picture fit for the overall risk position.

As rates go up and prepayments drop, as they kind of -- in their current kind of position in terms of exposure, then I think I/Os make more sense.

And it is something we have been doing more of, of late, let's say, than where we were last quarter, in those second and third quarters.

So it's something we look at very carefully.

We are very focused on the particular coupons and the prepayment exposures and the exposures to interest rates because, as an example, something that's not very interesting to us are very low-coupon I/Os because they are ready-priced for almost perfection at this point, and the only thing that will happen to them is that if we were to rally back, then perfection would get priced out of them, whereas we are more interested in securities that have more of an asymmetrical payoff, and that's something that we focus more of our attention on.

I hope that helps.

Yes, that's helpful.

And one last question, and I know this is probably too general, but maybe you can comment -- I'm looking at page 13.

If I look at your cost of funds as of the end of the year at 103, and I look at the current LIBOR market.

and I factor in your hedge ratio that we just discussed, and I look at where the euro curve -- where euro dollars look to be at the end of December, where do you think -- December 12 -- where do you think your spread would be bounded if the euro dollar curve becomes cash LIBOR on a 55% to 60% swap/hedge ratio?

Where do you think that 2.28 is bounded on the low end?

Against -- it's obviously a function of a number of things.

It's a function of time, it's a function of prepayment speeds, it's a function of how our assets evolve over time.

So I sense I'm going to have to leave it to you to build up scenarios.

We give you our swap expirations.

We give you swaptions and some general information there.

And you have to make assumptions around correlations between prepayment speeds, expirations of swaps and so forth.

And it's not something that I want to say the minimum scenario is X.

But I think what I would say is I think it's -- and this is a really important point with respect to the agency REITs.

It's, if you just take some simple math and we just say -- let's just make up a spread of 150 basis points for a second.

It's not a spread that's an answer to your question, but just take that number.

At nine times leverage, that gives you a 13.5% levered return.

You add -- at this point yields are going up, so let's add 3.5% to that.

It gives you a 17% gross ROE.

And that's, again, a spread of 150 basis points with nine times leverage.

I think the point, is you don't need spreads where they are today to produce very attractive long-run returns with this business model.

Right, fair, okay, great, thanks for your time.

Ken Bruce, Banc of America.

It was helpful to hear from some of your other team members.

It's nice to see the depth coming on.

So my question actually builds off of that last comment.

It's pretty clear that you've had a lot of success managing the portfolio over a volatile period of time; the last few quarters are a great testament to that.

If we get into a period where volatility is significantly lower, obviously some of that gain-related income becomes a little bit more of a question.

And I guess what I'm really, really wondering is, how confident are you that you can generate enough to earnings off of just your spread income to effectively deliver against your current dividend?

And, I think I understand, just based on your last comment there, where some of the leverage will be coming from.

But if you could just discuss the dynamic as to how you will produce returns in a less volatile period?

Sure.

The first thing is, I'm not going to give you, obviously, projections around GAAP income or taxable income, and some of the variables are obviously tough to measure.

But remember, so you have a core or a net interest kind of number off of the portfolio that you can work with and that you and your peers project.

And then, remember that you have a fair amount of undistributed taxable income at this point.

And then, as we told you in the presentation, another variable to consider is the fact that a lot of the unrealized gains -- that there are a number of unrealized gains in our portfolio already, or in the hedged portfolio already, that -- some of which are certainly likely to be realized over the next couple quarters.

So that's your current set of building blocks to think about.

But I think, big picture, the environment is one of a steep yield curve -- we don't see that changing -- and a very benign prepayment environment.

And we think that's very likely for, we'll call it, at least the next three, maybe six months before it could change.

And when you piece those together, those are pretty good drivers for income in terms of the kind of key variables that people look for.

Right; I guess where I was going is, if you look over a little longer term, recognizing you've got some insurance here in the near-term, your spreads in the business produce -- let's just use what you have on slide 13, just inside 20% return on equity.

Clearly, that is inside of the dividend rate today.

I would presume that you would take up some leverage if we got into a situation where there was just less gains coming out of the portfolio, whether that be on the derivatives or on the assets themselves, and you would take up leverage in order to kind of accommodate that.

Is that a fair expectation?.

Not necessarily.

I don't want you or anyone to think that we have engraved the dividend in stone, so to speak, and we'll kind of do whatever it takes over an extended period of time to try to maintain a particular dividend level.

Our mindset is that this business can produce strong risk-adjusted returns over the long-term, and we will take what the market provides us and work with that.

And I wouldn't want people to take away from this call or our performance in the past that we will do whatever it takes to produce $1.40 per share for as long as we possibly can.

Our mindset is about total value to our shareholders, that we will pay a dividend that we feel is reasonable and where we can maintain our book value and our shareholders' dry powder and working capital, so to speak, to be able to continue to make money.

Great, well, that's helpful and I think that's a fair point.

And the last question I have is just, can you remind us as to what limitations you have as a REIT in terms of having gain-related income as a source of income, generally speaking, for tax purposes?

Well, I think the key issue -- it's not as much gain-related income.

A key -- the biggest obstacle is what is considered good REIT income or not good REIT income.

And certain of these mark-to-market hedges will fit into the category of we'll call it not good REIT income.

So there is a limitation that over an annual basis, not a quarterly basis, on an annual basis you can't have more than 25% of not good income.

So that's kind of the main issue that comes into play, so to speak.

It's not something we have been close to over the past couple of years.

But that's something we obviously will consider.

Thank you, and I'd also like to congratulate you on another successful quarter.

Well, thanks a lot, Ken, appreciate it.

At this time, we would like to thank everyone for joining today's conference call.

You may now disconnect your lines at this time.