American Capital Agency Corp.'s (NASDAQ:AGNC) first fiscal quarter (Q1 2013) has recently come to an end (3/31/2013). Before results are provided to the public next month, via their quarterly press release, I would like to project/analyze AGNC's Q1 2013 Income Statement; broken down by the following accounts:

**A)** *Net Income*

**B)** *Other Comprehensive Income (Loss)*

**C)** *Comprehensive Income (Loss) [A+B combined]*

In a future article, I will project AGNC's Book Value for Q1 2013 (BV at 3/31/2013).

*Note:* Predicting any MREIT's accounting figures are extremely difficult when compared to other industries due to the fact of a company's various hedging strategies that are implemented. There are numerous assumptions + estimates that are used when performing such an analysis. Actual values may differ significantly from the following estimated values and all readers should be aware as such. These projections are my personal estimates and all figures detailed below should not *solely* be used for any investor's buying or selling decisions. Unless otherwise noted, all figures are for the "3-months ended" (quarterly) timeframe.

**A)** *Net Income: [Estimate of $802 million; range $700 - $900 million] [Net Income EPS, excluding OCI/OCL, of $2.22 per share; range $2.00-$2.40 per share] [Confidence Within Range = Moderate to High] [See Table Below Next to the March 31, 2013 column for References]*

We'll first look at AGNC's past quarterly income statements (ACTUAL) for fiscal year 2012 + my projection for Q1 2013 (ESTIMATE). The income statement (ACTUAL) quarterly figures are derived from AGNC's quarterly/annual 10-Q's / 10-K for fiscal year 2012.

*click to enlarge images*

**1)** *Interest Income: [Estimate of $631 million; range $600 - $660 million] [Confidence Within Range = Moderate to High] [See "1" in Table Above Next to the March 31, 2013 column for Reference]*

AGNC's interest income figure consists of two accounts : *a) cash interest income* subtracted by *b) premium amortization*. I based my estimation of these two figures on the table I have created below. All past (ACTUAL) figures (excluding some recalculations + ratio figures) are derived from AGNC's investor presentation slides, AGNC's 10-Q + 10-K fiscal 2012 submissions, or a combination of both. Therefore, there will not be an identical sheet AGNC provides that matches the data I have prepared below. I have gathered specific information derived from multiple tables/charts for a more clear analysis of the cash interest income and premium amortization accounts.

Two assumptions should be noted when projecting the Q1 2013 *a) cash interest income* figure. First, I estimated the average agency securities for AGNC to increase $10 billion from quarter to quarter. This is due to the late 3/5/2013 closing of the 57.5 million share equity offering. I am assuming AGNC has already purchased agency securities from this equity raise thus raising their investment portfolio balance. I am only increasing the average agency securities for Q1 2013 $10 billion because AGNC only had 1 month to deploy this capital. Secondly, I estimate a cash interest income yield increase of 10 basis points (3.87% vs. 3.77%) from Q1 2013 vs. Q4 2013. This is due to an overall modest increase in market interest rates since 12/31/2012. Rates have leveled off somewhat in the 2nd half of March, but still are up when looking at rates as of 3/31/2013 vs. 12/31/2012. The current quarter agency security additions should help bolster a slight increase in the portfolio's overall cash interest income yield.

From the overall cash interest income yield increase of 10 basis points and the higher overall average agency security balance, I am projecting cash interest income to increase to approximately $820 million in Q1 2013 vs. $723 million in Q4 2012.

Now let's take a look at the second component of AGNC's interest income figure, *b) premium amortization*. If you first look at the table above under AGNC's Q3 premium amortization yield, it was -1.26%. If you compare this to AGNC's Q4 premium amortization yield, it dropped to -0.95%. One factor for the significant drop is AGNC did not have a net increase in their average agency securities for Q4 2012. They performed no equity raises in Q4 2012, hence their investment portfolio actually decreased a little due to the stock repurchased during the quarter. When there's less agency securities on the balance sheet, there will accordingly be less of a premium amortization expense (in most cases). This is due to the fact you have expensed a quarter's worth of premium amortization while the agency securities balance (net) has decreased a little. As you can see in the table above, the overall net unamortized premium balance (dark blue highlighted figures) remained constant at $4.4 billion at 12/31/2012 when comparing to 9/30/2012.

The premium amortization I am estimating for Q1 2013 is actually a fairly cautious figure of $189 million (-1.07% yield). One could argue this amount/yield percentage could be lower because, as mentioned above, overall interest rates have increased in Q1 2013. Let's use an example to prove this point. Let's use a typical agency security AGNC carries. We will use a 30-Year HARP Agency Security originally having a 4.5% coupon. Let's say this agency security had an original amortized cost basis of 105.5% at 12/31/2012 (premium to par of 100%). After acquiring this specific agency security, AGNC must expense the "premium" of 5.5% over the remaining life of the agency security. Since interest rates have increased in Q1 2013, the current interest rate on a 30-Year HARP agency security (if purchased in today's market) is now closer to the 4.5% rate than it was at the end of Q4 2012. Therefore, a reduction in the overall premium amortization on this specific 30-Year HARP agency security (we'll say a decrease of 0.5% to 105%) is necessary. Since this is the actual trend of the quarter, the overall net unamortized premium balance + amortized cost basis (if no new MBS's were purchased) would decrease even before expensing an amount for the quarter. In other words, the existing agency securities on AGNC's balance sheet will now have a lower amortized cost basis (hence lower unamortized premium amortization to expense).

Furthermore, since rates have increased during Q1 2013, the likelihood of most agency securities being refinanced decreases (less difference in original coupon rate vs. current market interest rates). This will produce a lower overall CPR on the existing agency securities hence extending their projected life. This will have a positive impact on the premium amortization expense for the quarter due to the fact the agency securities life has been extended. Since premium amortization is expensed over the life of the loan, if the agency securities life increases, quarterly premium amortization expense will decrease. These assumptions just mentioned should help offset the premium amortization increase from the Q1 2013 agency security additions in relation to the 57.5 million share equity raise. I have increased the net unamortized premium balance from $4.4 billion at 12/31/12 to $4.6 billion at 3/31/2013. Again, this estimate is fairly cautious based on my logic above and only increases directly due to the new capital deployment (purchase of additional agency securities) from the equity raise in Q1 2013.

**2)** *Interest Expense: [Estimate of $174 million; range $160 - $190 million] [Confidence Within Range = Moderate to High] [See "2" in 1st Table Above Next to the March 31, 2013 column for Reference]*

Now let's look at AGNC's interest expense account. I base my estimation of this figure on the table I have created below. All past (ACTUAL) figures (excluding some recalculations + ratio figures) are derived from AGNC's investor presentation slides, AGNC's 10-Q + 10-K fiscal 2012 submissions, or a combination of both. Therefore, there will not be an identical sheet AGNC provides that matches the data I have prepared below. I have gathered specific information derived from multiple tables/charts for a more clear analysis of the interest expense account.

Recalculating AGNC's interest expense account is pretty straightforward. One takes the average repurchase agreements (REPO's) that were outstanding within a specified time period (for this analysis, quarterly) and multiply this amount by the average cost of funds rate (%) for the quarter. Once you obtain this figure, you have to back out a portion of this interest expense that is deemed interest costs associated with "other periodic interest costs of interest rate swaps, net" to the account "estimation of gain (loss) on derivative instruments, net" (within the account marked #4 on my fist Table at the top of the article; this account will be discussed in detail in this article a little later). The ending result will provide you with AGNC's interest expense figure.

The two main figures that need to be projected to estimate interest expense are *a) the average repurchase agreements* within the quarter and *b) average cost of funds rate* to be used to calculate the interest expense. Based on my calculated estimation within AGNC's interest income analysis above (see #1 above), approximately $10 billion of average agency securities will be added to AGNC's balance sheet. Once this figure has been projected, I can now estimate the average repurchase agreement liability account. During the past 4 quarters, if one takes the average agency securities figure (in the table above highlighted in purple) and divides this figure over the average repurchase agreements figure (in the table above highlighted in blue), the calculated ratio of average agency securities to average repurchase agreements was between 1.08 to 1.09 for the past 4 quarters. Now, for Q1 2013, let's use this same ratio to estimate the average repurchase agreements figure. For my estimation, if using an average agency security balance for Q1 2013 of $90 billion and ratio of 1.09, the average repurchase agreement balance will be $82.6 billion, an increase of approximately 8 billion for Q1 2013.

I will now obtain a suitable average cost of funds rate (%) for Q1 2013. I am estimating an increase in the cost of funds rate to -1.25% for Q1 2013 from -1.19% for Q4 2012. This projection is based on the fact mentioned earlier in the article about the overall general modest increase in the interest rates. This includes an increase in interest rates on agency securities purchased + repurchase agreements obtained. This rate is somewhat of an aggressive figure. Some may note that AGNC has begun to increase the maturity dates on their average repos which would lead to a general increase in interest rates even if rates were to remain unchanged. However, I feel some offset to an increased interest expense costs can be warranted. This is due to the fact AGNC has entered into multiple "to-be-announced" (TBA) dollar-roll transactions. Since AGNC is now entering into such transactions, there are associated benefits when it comes to repurchase interest expenses that occur. Let's briefly define these TBA transactions when it comes to AGNC. AGNC agrees to purchase, for future delivery, agency securities with certain principal and interest terms. Prior to the settlement date, if favorable, AGNC then moves the settlement of these securities to a later date (pair off), net settling the paired off positions for cash. They then purchase a similar TBA contract for a later settlement date (dollar roll). The new TBA contracts, which have a forward settlement date in the future, are typically priced at a discount to agency securities. This discount is known as the "price drop". The price drop is the economic equivalent of net interest carry income on the underlying agency securities over the roll period (interest income less implied financing costs) and is commonly referred to as "dollar roll income". One can argue where to account for the TBA dollar-roll transactions (increase in interest income vs. decrease in interest expense), but the net effect is the same so I won't delve into this matter further.

Once you have your *a) average repurchase agreements figure* and *b) average cost of funds rate* for the quarter, you can calculate AGNC's Q1 2013 interest expense. I estimate AGNC will incur approximately $174 million in interest expense in Q1 2013, an increase of $27 million over last quarter due largely to the purchase of additional agency securities during the quarter from the equity raise + a slight increase in the overall repurchase agreement interest rates.

**3)** *Gain (Loss) on Sale of Agency Securities, Net: [Estimate of $250 million; range $150 - $350 million] [Confidence Within Range = Moderate] [See "3" in 1st Table Above Next to the March 31, 2013 column for Reference]*

Estimating the gain (loss) on sale of agency securities, net account is somewhat difficult to analyze. Only AGNC's management team fully knows how many existing agency securities will be sold during a specific quarter. One can only determine what a sale on an existing agency security will tend to do in regards to unrealized to realized gains. This also includes the specific agency security's accumulated unrealized gain (loss) balance and the history of interest rates when initially purchased vs. current interest rates.

There was one footnote within AGNC's financial statement submissions which I thought was interesting. AGNC mentions in the submitted financial disclosures (10-Q's + 10-K's) that "proceeds from sale of MBS sold" includes cash received during the period plus any receivable for agency securities sold during the period as of period end. In other words, all quarterly accrued interest income on all sold agency securities are re-classed out of the cash interest income account (discussed in #1 above) and accounted for here. Because of this reclassification, the gain (loss) on sale of agency securities will always start off with a slightly positive balance before taking into consideration the true gain/loss on the agency securities sold.

All past (ACTUAL) figures (excluding some recalculations + ratio figures) are derived from AGNC's investor presentation slides, AGNC's 10-Q + 10-K fiscal 2012 submissions, or a combination of both. Therefore, there will not be an identical sheet AGNC provides that matches the data I have prepared below. I have gathered specific information derived from multiple tables/charts for a more clear analysis of the gain (loss) on sale of agency securities, net account.

I project AGNC's average total assets, at fair value (using the average agency securities, at cost from my analysis in #1 +#2 earlier in the article) will increase approximately $10 billion in Q1 2013. If you look at the "average total assets, fair value > cost basis" figures in my table above, you will notice an overall *decrease* from $13.5 billion in Q3 2012 to $11.3 billion in Q4 2012. This was mainly due to the fact interest rates have begun to rise in Q4 2012. Therefore, the fair value (unrealized gain) of the agency securities actually decreased in Q4 2012. This will be further detailed + shown later in this article under the "unrealized gain (loss) on available-for-sale securities, net" account within other comprehensive income (loss). Since interest rates have continued to rise during Q1 2013, I feel a further reduction in the average total assets at fair value over average agency securities at cost is needed. Due to this further reduction, I project the ratio of "avg. total assets at fair value > avg. agency securities at cost" needs to be lowered to 1.10 in Q1 2013. This is a further decrease from the ratio 1.14 in Q4 2012 and 1.17 in Q3 2012.

The amount of agency securities sold in Q1 2013 is purely speculation. Estimation of this figure is purely at the discretion of management. This account can materially shift quarter to quarter. I will use an overall weighted average of the past 4 quarters of sales data to estimate a proper amount of agency securities sold. To calculate a proper gain on sale of agency securities, I again use a ratio analysis of "proceeds from agency MBS sold vs. agency MBS sold, at cost" to try to estimate the amount of the gains that will occur in Q1 2013. I have lowered the ratio to 1.016 in Q1 2013 from 1.019 in Q4 2012 and 1.021 in Q3 2012. As interest rates continue to rise, this ratio will continue to decrease thus offsetting realized gains in future quarters. Using this ratio, my net gains on sales estimate is $250 million. This is based on $15.9 billion in quarterly agency securities sold with proceeds of $16.15 billion.

**4)** *Gain (Loss) on Derivative Instruments and Other Securities, Net: [Estimate of $150 million; range $50 - $250 million] [Confidence Within Range = Moderate] [See "4" in 1st Table Above Next to the March 31, 2013 column for Reference]*

Estimating the gain (loss) on instruments and other securities, net account is somewhat difficult to analyze. One never fully knows the detailed derivative activities management will undertake in a given quarter. However, one can understand management's overall derivative strategy and take other indirect data to make a general estimation on this type of account.

I base my estimation of this figure on the table I have created below. All past (ACTUAL) information is derived from AGNC's 10-Q + 10-K submissions. The table below is directly recreated from one of the various notes within AGNC's 10-Q + 10-K. My projection for Q1 2013 (ESTIMATE) is based on various derivative assumptions in regards to the current quarter.

The "periodic interest costs of interest rate swaps, net" is the re-classed interest expense figure I calculated within the "2) interest expense" analysis I performed earlier in this article. This figure can be estimated rather precisely. The "realized gain (loss) on derivative instruments and other securities, net" + "unrealized gain (loss) on derivative instruments and other securities, net" is where various assumptions have to be implemented. Generally speaking, I feel management has hedged themselves with the prospect of interest rates ultimately having to rise. Through various derivative instruments (both unrealized + realized), management tries to "hedge" potential losses that would stem from a material fluctuation of interest rates.

If you look at the above table, when interest rates dropped somewhat steeply in Q3 + Q4 of 2012, AGNC had losses of $1.03 billion and $460 million within this account. Management was anticipating rising interest rates, not a continued decrease in interest rates. In Q4, a different scenario occurred. Interest rates bottomed out and began to rise. AGNC's management continued their derivative instrument philosophy of gradual interest rate increases. Therefore, the gain on derivative instruments and other securities swung to a net positive of $89 million for the quarter. Assuming AGNC will continue this derivative instrument philosophy, including the fact that interest rates have rose at an even greater rate in Q1 2013 when compared to Q4 2012, I am estimating an overall gain on derivative instruments and other securities, net to be approximately $150 million.

**5)** *Management Fees: [Estimate of $35 million; range $33 - $37 million] [Confidence Within Range = High] [See "5" in 1st Table Above Next to the March 31, 2013 column for Reference]*

AGNC has a base management fee payable in arrears equal to an amount 1/12th of 1.25% of their stockholder's equity. Equity is defined as AGNC's month-end stockholders' equity, adjusted to exclude the effect of any unrealized gains or losses included in either retained earnings or accumulated other comprehensive income (OCI; deemed a separate component of stockholders' equity), as computed in accordance with GAAP.

I base my estimation of this figure on the table I have created below. Some past (ACTUAL) figures (excluding some recalculations + ratio figures) are derived from AGNC's investor presentation slides, AGNC's 10-Q + 10-K fiscal 2012 submissions, or a combination of both. Therefore, there will not be an identical sheet AGNC provides that matches the data I have prepared below. My projection for Q1 2013 (ESTIMATE) is based on the recalculation of the management fee payable.

The two remaining accounts on AGNC's income statement affecting net income are general/ administrative expenses + income tax provision (benefit). These two accounts are immaterial for projection purposes and will be excluded from any detailed analysis in this article. I don't see any material fluctuations from past quarters when estimating these figures for Q1 2013.

**B)** *Other Comprehensive Income (Loss): [Estimate of ($675) million; range ($450 - $850) million] [Confidence Within Range = Moderate] [See Table Below Next to the March 31, 2013 column for References]*

Having established a net income estimate of $802 million for Q1 2013, let's look at AGNC's past quarterly income statements (ACTUAL) for fiscal year 2012 + my projection for Q1 2013 (ESTIMATE) in regards to Other Comprehensive Income (Loss) (OCI/OCL). The income statements (ACTUAL) quarterly figures are derived from AGNC's 10-Q + 10-K fiscal 2012 submissions.

**6)** *Unrealized Gain (Loss) on Available-For-Sale Securities, Net: [Estimate of ($750) million; range ($550 - $950) million] [Confidence Within Range = Moderate] [See "6" in Table Above Next to the March 31, 2013 column for Reference]*

Estimating the unrealized gain (loss) on available-for-sale securities, net account is somewhat difficult to analyze. However, the same general assumptions that were considered above should still apply when analyzing this account. A continued increase in Q1 2013's interest rates will cause a decrease to the total accumulated unrealized gains valuation on AGNC's agency security portfolio. This is mentioned above within the "3) gain (loss) on sale of agency securities, net" paragraph above. My detailed analysis of this account will be provided after a brief description of the account "Unrealized Gain (Loss) on Interest Rate Swaps, Net".

**7)** *Unrealized Gain (Loss) on Interest Rate Swaps, Net: [Estimate of $75 million; range $25 - $125 million] [Confidence Within Range = High] [See "7" in Table Above Next to the March 31, 2013 column for Reference]*

Since my detailed analysis below contains both 6) + 7), I will discuss both together. I base my estimation of this figure on the table I have created below. All past (ACTUAL) information is derived from AGNC's 10-Q + 10-K submissions. The table below is directly recreated from one of the various notes within AGNC's 10-Q + 10-K. My projection for Q1 2013 (ESTIMATE) is based on various derivative assumptions in regards to the current quarter.

Let's first discuss AGNC's *6) unrealized gain (loss) on AFS securities, net* figure. This consists of two accounts. The first account is *a) unrealized gain (loss), net*. Let's take a look at the past several quarters to understand what has happened in this account. If you look at AGNC's unrealized gain (loss), net account in Q2 + Q3 2012, there were substantial gains in this account. This is because during these two quarters, interest rates continued to decline at a fairly modest rate. Since rates declined, the FMV of AGNC's existing agency securities continued to increase in value (unrealized gains). This is precisely why there were unrealized gains of $1.1 billion in Q2 and $1.4 billion in Q3 of 2012. However, look what happened in Q4 2012 in the same account. There was a reversal of this account and AGNC reported an unrealized loss of $381 million. This is due to the fact interest rates reversed course and began to increase in Q4 2012. Since rates have continued to modestly rise throughout Q1 2013, there most likely will be a further FMV reduction in AGNC's existing agency securities (unrealized losses). I am estimating a $500 million unrealized loss, but this may be an optimistic estimate on my end. This loss could in-fact be greater. I wouldn't be surprised if this account records an actual $700+ million loss. Therefore, I have implemented such a result in my range analysis.

The second account is *b) reversal of prior period unrealized gains, net, upon realization.* If you look at the table above, this is the figure with a reference "3" in Q1 2013 or "A" in 2012's quarters and is highlighted in hot pink. These amounts are the same figures, just reversed out, that are represented within my detailed discussion of AGNC's "gain (loss) on sale of agency securities, net" account (#3 in the net income analysis earlier in this article). For Q1 2013, I am estimating a ($250) million figure (must match to the figure estimated in #3 above, just reversed out).

Therefore, I am estimating an overall *6) unrealized gain (loss) on AFS securities, net* of ($750) million. This is a summation of an unrealized gain (loss), net of ($500) plus the reversal of prior period unrealized gains, net, upon realization of ($250).

Now we'll look at AGNC's *7) unrealized gain (loss) on interest rate swaps, net.* This consists of two accounts. The first account is *a) unrealized gain on interest rate swaps*. I am estimating an unrealized gain on interest rate swaps of $75 million. As mentioned earlier in this article, I feel management has hedged themselves with the prospect of interest rates ultimately having to rise. Through various derivative instruments (both unrealized + realized), management tries to "hedge" potential losses that would stem from a material fluctuation of interest rates. I feel there will be a modest unrealized gain in interest rate swaps due to the fact interest rates have been steadily rising, thus causing an unrealized gain on these derivative instruments.

The second account is *b) reversal of prior period unrealized loss on interest rate swaps, net, upon reclassification to interest* *expense.* AGNC elected to discontinue accounting for their interest rate swaps as cash flow hedges under GAAP as of September 30, 2011. Therefore, the account *"reversal of prior period unrealized loss on interest rate swaps, net, upon reclassification to interest expense"* reversed out in 2012 and shouldn't have a balance in Q1 2013.

Therefore, I am estimating an overall *7) unrealized gain (loss) on interest rate swaps, net* of $75 million. This is a summation of an unrealized gain on interest rate swaps of $75 plus the reversal of prior period unrealized loss on interest rate swaps, net, upon reclassification to interest expense of $0.

After adding up the following two figures: 6) unrealized gain (loss) on AFS securities, net of ($750) million + 7) unrealized gain (loss) on interest rate swaps, net of $75 million, you arrive at your total other comprehensive gain (loss) figure of ($675) million.

**C)** *Comprehensive Income: [Estimate of $127 million ; range ($75) million - $350 million] [Comprehensive Income per Common Share of $0.35 per share; range ($0.25) - $1.00 per share] [Confidence Within Range = Moderate to High] [See Table Above Under Notation "B) Other Comprehensive Income (Loss)" Next to the March 31, 2013 column for References]*

Having established a A) net income + B) other comprehensive loss (OCL) estimate for Q1 2013, let's finally look at AGNC's past quarterly income statements (ACTUAL) for fiscal year 2012 + my projection for Q1 2013 (ESTIMATE) in regards to comprehensive income. This is basically the summation of A) net income of $802 million + other comprehensive income (loss) of ($675) million. Therefore, my estimated Q1 2013 comprehensive income is $127 million. The income statements (ACTUAL) quarterly figures for comprehensive income are derived from AGNC's 10-Q + 10-K fiscal 2012 submissions.

*Conclusion:* To sum up all the information above, I am *estimating* AGNC will report the following figures for Q1 2013:

- Quarterly Net Income of $802 million [$2.22 per common share]
- Quarterly Other Comprehensive Income (Loss) of ($675) million
- Quarterly Comprehensive Income (Loss) [A+B] of $127 million [$0.35 per common share]

Therefore, in regards to quarterly net income, it looks as though AGNC will handily beat analyst forecasts. Net income will increase quarter to quarter, having only a slight decrease in net income per common share (due to the 57.5 million equity raise). This is due to the increase of AGNC's agency security portfolio along with a general increase in interest rates for the quarter.

However, there is not all good news for AGNC. Along with this net income increase there will be a less than desirable other comprehensive income (loss) of ($675) million. This is due to the overall FMV decrease/unrealized loss in AGNC's existing agency security portfolio. As will be evidenced by my next article, this large other comprehensive income (loss) of ($675) million will have a negative effect on AGNC's 3/31/2013 book value. From the two estimated figures above, quarterly comprehensive income will be $127 million, or $0.35 per share.

*Final Note:* As some of my support tables may seem confusing, I welcome any questions/comments in regards to them and I will try to answer accordingly/update in the future to be more reader-friendly. Also, for all my exhibits, I would suggest clicking them to enlarge and saving on your computer. This way, you can see all the data.

**Disclosure: **I am long AGNC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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