American Capital Agency Corp.'s Mid-Q3 2013 Composition And Valuation Analysis - Part 1

| About: AGNC Investment (AGNC)

Focus of Article:

The focus of this article is to provide a mid-third quarter of 2013 update of American Capital Agency Corp.'s (NASDAQ:AGNC) mortgage-back security ('MBS') and hedging portfolio regarding composition and valuation. I feel this mid-quarter update will provide readers a general direction on how the first-half of the third quarter of 2013 has panned out regarding AGNC's overall MBS and derivative strategy. This article will mainly compare and contrast what has occurred so far in the third quarter of 2013 vs. the second quarter of 2013 regarding MBS and derivative composition and valuation. This will also help readers understand how the second-half of the current quarter could pan out as interest rates fluctuate.

I would like to first analyze AGNC's MBS portfolio as of 6/30/2013 and identify the changes AGNC made in the prior quarter which will impact the current quarter. In conjunction with this portfolio, specific MBS price changes will be provided and discussed. This information will assist in projecting AGNC's MBS portfolio valuation as of 8/16/2013. I would then like to analyze AGNC's derivative portfolio as of 6/30/2013 and identify the changes AGNC made in the prior quarter which will impact the current quarter. In conjunction with this portfolio, specific MBS price, swap rate, and US Treasury yield changes will be provided and discussed. This information will assist in projecting AGNC's derivative portfolio valuation as of 8/16/2013.

Due to the length of the material covered in this article, I feel it is necessary to break this particular article into two parts. This article will be broken-down by the following two account portfolios:

A) AGNC's MBS Portfolio -Composition and Valuation Analysis (PART 1)

B) AGNC's Derivative Portfolio - Composition and Valuation Analysis (PART 2)

Side Note Regarding Using Prior Quarter's Ending MBS Balances as an Appropriate Current Quarter Valuation Technique:

Prior to showing AGNC's 6/30/2013 MBS portfolio via Table 1 (see below), I feel a discussion regarding why I use this specific valuation technique should be addressed.

A certain "critic" in the comments section of a few of my past mREIT articles (including other authors' articles) highlighted that an mREIT will have numerous quarterly activities which will change a MBS portfolio within any stated quarter. Therefore, this critic feels it is basically useless to even try and value an mREIT's MBS portfolio (or any account for that matter) in a current quarter. I would have to firmly disagree with this notion.

The asset valuations of any account on the balance sheet that represent the prior quarter's ending balances are definitive in nature. Regarding an mREIT's MBS portfolio, even if some of these securities are sold in the current quarter, they still must be accounted for. They simply are not "washed away" and disposed of without having an accounting effect. Regarding this particular topic, all of AGNC's MBS fair market values ('FMV') represented as of 6/30/2013 will either be "realized" or "unrealized" by the end of the current quarter on 9/30/2013.

Therefore, the only aspects left open to interpretation are the amount of MBS sales and the amount of MBS purchases that occur in a given quarter (including at what coupon rates). This is where a level of "projection" based on certain "assumptions" must be taken into consideration. AGNC's overall MBS valuation changes will be entirely accounted for in either the respected "gain (loss) on sale of agency securities, net" or "unrealized gain (loss) on available-for-sale securities, net" accounts within the income statement in any given quarter. The balance sheet account that would be affected is the "agency securities, at fair value" account. Through some detailed research and data compilation, one can project (to a reasonable degree) how management "should" act within any given quarter regarding sales and purchases. However, this will not be an "exact science" each quarter. There will be some variances that occur in a quarter if more/less sales and/or purchases actually occur than projected. Additionally, the minor change in coupon rates exchanged in the process would also cause a slight deviation in asset valuations.

Nonetheless, one can still reasonably predict how management "should" perform regarding such activities in a specified quarter. This should be evidenced by my past articles regarding AGNC's MBS valuation projections for the second quarter of 2013. On a valuation basis, when including both realized and unrealized valuation losses regarding AGNC's MBS portfolio, I was basically "spot-on" with my projected ($2.8) billion in MBS valuation losses. AGNC's management took the appropriate steps in the second quarter of 2013 to try and minimize book value ('BV') losses given its MBS portfolio as of 3/31/2013. The following are links to my second quarter of 2013 income statement and BV articles where such MBS valuations were accurately projected:

American Capital Agency Corp.'s Upcoming Q2 2013 Income Statement Projection (Part 1)

American Capital Agency Corp.'s Upcoming Q2 2013 Income Statement Projection (Part 2)

American Capital Agency Corp.'s Upcoming Q2 2013 Book Value Projection (As of June 30, 2013)

To appropriately begin a current quarter's account valuation analysis, this specific technique has proved to be the best methodology in my years of research and data compilation. If a similar valuation analysis was attempted without using this specific methodology, material valuation variances would most likely occur.

A) AGNC's MBS Portfolio - Composition and Valuation Analysis:

Let us first understand AGNC's MBS portfolio as of 6/30/2013 regarding its overall composition. This will include a net change analysis when comparing its 6/30/2013 balance to its 3/31/2013 balance. This will be followed by a first-half of the third quarter of 2013 MBS portfolio valuation analysis.

Side Note: AGNC has continued to have an overwhelming proportion of its 6/30/2013 MBS holdings in fixed-rate, agency holdings (roughly 99% of its total MBS portfolio). As such, all references to AGNC's MBS portfolio below will automatically be implied as being both "fixed-rate" and "agency" MBS unless otherwise noted. Also, all analysis and discussion within this section of the article excludes AGNC's TBA MBS forward contract positions. These TBA MBS forward contract positions are "off balance sheet" in nature and will be properly discussed under AGNC's derivative portfolio in PART 2 of this article.

1) AGNC's MBS Portfolio - Composition Analysis (As of 6/30/2013; Including Net Change Analysis):

Table 1 below shows AGNC's MBS portfolio as of 6/30/2013. All columns are sorted by the maturity (15, 20, or 30-year) of the MBS and further specified by the coupon grouping (2.5% - 6%) of the MBS. Table 1 displays the following columns: 1) MBS coupon rate; 2) original par value; 3) current amortized cost value (basis); 4) market value ('FMV'); 5) percentage of Lower Loan Balance ('LLB') or Home Affordable Refinance Program ('HARP') MBS; 6) current amortized cost basis as a percentage to par; 7) FMV as a percentage to par; 8) weighted average coupon ('WAC') rate; 9) average yield; 10) average age of MBS on AGNC's books; 11) projected life constant prepayment rate ('CPR'); and finally 12) average duration of MBS.

Table 1 - AGNC MBS Portfolio Balance (As of 6/30/2013)

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Having Table 1 as a reference, let us first discuss how AGNC's MBS portfolio as of 6/30/2013 compared to its MBS portfolio as of 3/31/2013 to better understand what changes were made during the second quarter of 2013 regarding composition. This will ultimately help when performing a valuation analysis on AGNC's MBS portfolio as of 6/30/2013 for the first-half of the third quarter of 2013.

To better understand how AGNC's MBS portfolio as of 6/30/2013 changed when compared to its MBS portfolio as of 3/31/2013, Table 2 is shown below. Table 2 provides key information about some recent net changes to AGNC's MBS portfolio regarding the following: 1) 15 and 30-year maturity amounts; 2) FMV versus amortized cost basis amounts; 3) amortized cost basis percentages; 4) FMV MBS price percentages; 4) WAC percentages and 5) CPR percentages. Table 2 further breaks out these three key characteristics into the associated coupon groupings. For purposes of this particular article, only the topic of 15 and 30-year maturity amounts will be directly discussed below.

Table 2 - AGNC MBS Portfolio Balance Net Changes (6/30/2013 vs. 3/31/2013)

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Using Table 2 as a reference, AGNC sold a rather large portion of its 30-year 4.0% coupon MBS during the second quarter of 2013. The net quarterly change within AGNC's 30-year 4.0% coupon MBS was ($4.6) billion. AGNC specified this was due to the rather large "specified pool price premium" deteriorations that were occurring during the prior quarter. Rather than sustain additional valuation losses within this specific MBS pool (due to originally high price premiums upon acquisition), AGNC decided to sell a large portion of this particular type of MBS. This would help AGNC offset future additional valuation losses if MBS prices were further suppressed in the coming quarters. However, some of these 30-year 4.0% coupon MBS were replaced with a slightly lower-yielding 30-year 3.5% coupon MBS due to the currently lower specified pool price premiums. As such, this slightly lower yield could have a minor negative effect regarding future cash interest income generated.

AGNC also sold its 30-year 2.5% coupon MBS completely. This resulted in a ($2.4) billion reduction of AGNC's 30-year 2.5% coupon MBS balance. Again, AGNC is trying to mitigate future valuation losses if interest rates rise in current and future quarters. As the coupon rate of a particular existing MBS drifts lower and farther away from the current coupon rate offered on a similar type of MBS in the market, the existing lower coupon MBS escalates its valuation losses. Instead of incurring continued unrealized losses in current and future quarters, AGNC quickly sold these 30-year 2.5% coupon MBS for a material realized loss in the second quarter of 2013. AGNC feared the continued valuation declines on these 30-year 2.5% coupon MBS in a rising interest rate environment scenario. Therefore, in selling these types of MBS, AGNC offset future valuation losses and also has new capital to deploy into the currently higher-yielding MBS with a coupon rate of 3.5%. AGNC could also wait further into redeploying this capital if management feels rates will continue to rise rather rapidly (wait till a higher coupon MBS becomes available and its price is attractive).

Regarding purchases, Table 2 reveals that AGNC made some rather large acquisitions of 15-year 2.5% coupon MBS. The determination of which MBS coupons are usually available is in correlation to where current fixed mortgage rates stand. The net quarterly change within AGNC's 15-year 2.5% coupon MBS was an increase of $10.3 billion. It should be noted a majority of these 15-year 2.5% coupon acquisitions were in regards to AGNC's TBA MBS forward contracts that it held as of 3/31/2013. AGNC decided to take possession of these TBA MBS forward contracts during the second quarter of 2013 due to certain accounting and taxation treatments regarding TBA MBS positions as a whole. AGNC's TBA MBS portfolio is accounted for within its derivatives portfolio and will be discussed further in PART 2 of this article. It seems all other MBS coupon rates had immaterial net price changes and will not be mentioned within this article.

Still using Table 2 as a reference, AGNC had a net increase of $9.4 billion regarding its 15-year MBS holdings. Furthermore, it had a net decrease of ($5.6) billion regarding its 30-year MBS holdings. AGNC's management team has taken a "defensive posture" regarding its current quarter's MBS portfolio. This was a direct result of the volatile nature of the markets during the latter half of the second quarter of 2013 regarding MBS price movements. AGNC made the conscience decision of lowering its exposure to 30-year MBS holdings which have more pronounced price movements when compared to its 15-year MBS counterparts with similar coupons. This was the main reason why AGNC decided to shift a portion of its MBS holdings into 15-year MBS. AGNC is trying to "defend" its BV through the acquisition of less "price sensitive" 15-year MBS. On a BV perspective, this makes sense and is generally good news. However, along with a less price sensitive 15-year MBS comes an overall lower coupon yield. For cash interest income purposes, this is a slight cause for concern starting with the current quarter.

Now that we have an understanding of AGNC's MBS portfolio regarding its recent past and current composition, let us shift topics and now focus on AGNC's MBS portfolio regarding its overall valuation through the first-half of the third quarter of 2013.

2) AGNC's MBS Portfolio - Valuation Analysis (Through the First-Half of the Third Quarter of 2013):

Prior to performing a valuation analysis on AGNC's MBS portfolio as of 6/30/2013, let us first analyze the MBS movements through the first-half of the third quarter of 2013. The first analysis will look at AGNC's 15-year MBS holdings. This will then be followed by a similar analysis of AGNC's 30-year MBS holdings. By first looking at the 15 and 30-year MBS price movements, it will help us understand how I come up with the figures within my projected MBS portfolio valuation analysis later in the article (regarding positive (negative) and size of gain (loss)).

Side Note: If a particular reader already knows the current quarter's MBS price movements and just wants my projected mid-quarter valuation on AGNC's MBS portfolio, I would suggest skipping down to Table 5 shown later in the article.

Table 3 - 15-Year MBS Price Movements (Through the First-Half of the Third Quarter of 2013)

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Table 3 above shows AGNC's 15-year MBS price movements during the first-half of the third quarter of 2013. It breaks out AGNC's 15-year MBS holdings by GSE. This includes both Fannie Mae (OTCQB:FMCC) and Freddie Mac (OTCQB:FNMA) MBS holdings. AGNC's current Ginnie Mae MBS holdings are immaterial for projection purposes and thus excluded from this table and article. Table 3 further breaks out the 15-year MBS into the various coupons on AGNC's books ranging from 2.5% - 4.5%. AGNC holds an immaterial balance of 15-year MBS over the 4.5% coupon and thus will not be discussed in this specific analysis.

From the information portrayed via Table 3, a valuation gain (loss) can be calculated which is broken down by the various coupons. This is performed in a separate table later in the article. As stated in my side note earlier in the article, an exact valuation figure cannot be obtained because AGNC continually changes its portfolio holdings in a given quarter. As such, I must include specific purchase and sale assumptions and interpretations towards the end of my valuation analysis. Therefore, the overall projected valuations calculated within this analysis (by using the MBS price information provided in Table 3 above) have been extremely close when compared to past quarterly actual results reported by AGNC. The total variance of the combined "gain (loss) on sale of agency securities, net" and "unrealized gain (loss) on available-for-sale securities, net" accounts within the income statement has been under 5% of the total account's balance.

Using Table 3 above, let us look at the MBS price movements for the current quarter regarding a few of the coupon rates in which AGNC currently holds its larger balances. The cumulative quarterly net MBS price movements are evidenced within Table 3 under the "Cumulative Quarterly Change" column.

To illustrate, for the week ending on 8/16/2013, the Fannie 15-year MBS with a 2.5% coupon (largest 15-year MBS balance as of 6/30/2013) has a cumulative quarterly price decline of (1.94) to settle its price at 98.56 (100 being par). In comparison, 15-year MBS with a 2.5% coupon had a cumulative quarterly price decline of (3.34) for the second quarter of 2013. When compared to the prior quarter, the current quarter's price decline is more modest in comparison. In particular, last week's MBS price declines caused this coupon to move modestly negative from a slightly negative position. Just last week, this particular coupon went from a cumulative quarterly MBS price decline of (0.41) when compared to 6/30/2013 to (1.84). This was directly caused by the rapid increase in mortgage interest rates and US Treasury yields on fear of the upcoming "tapering" by the Federal Reserve ('FED'). For the Fannie 15-year MBS with a 4.0% coupon (second largest 15-year MBS balance as of 6/30/2013), the cumulative quarterly MBS price decline is (0.16) to settle its price at 105.19 (100 being par). In comparison, the 30-year MBS with a 4.0% coupon had a cumulative quarterly price decline of (1.66) for the second quarter of 2013. When compared to the prior quarter, the current quarter's cumulative MBS price movement has gone from a large decline to only a slight decrease. This will directly have a positive effect on the valuation of AGNC's 15-year MBS with a 4.0% coupon when compared to the prior quarter. Prior to last week's dismal MBS price movements, this particular coupon MBS had a rather modest increase in its cumulative quarterly MBS price movement when compared to 6/30/2013. Currently, most of the 15-year MBS coupon rates that AGNC currently owns have once again turned negative due to last week's events. These losses accelerate as the coupon decreases. When compared to the second quarter of 2013, the MBS price movements through 8/16/2013 have continued to decline but less severely.

For the Freddie 15-year MBS, the same conclusions hold true. When compared to the Fannie 15-year MBS, Freddie 15-year MBS usually have slight differences in weekly (hence quarterly) price valuations across the same coupon rates. However, the same general themes hold true.

Now that we have an understanding of the 15-year MBS price movements, let us take a look at the 30-year MBS price movements.

Table 4 - 30-Year MBS Price Movements (Through the First-Half of the Third Quarter of 2013)

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Table 4 shows AGNC's 30-year MBS price movements during the first-half of the third quarter of 2013. It breaks out AGNC's 30-year MBS holdings by government sponsored entity ('GSE'). As was the case with AGNC's 15-year MBS, this includes both Fannie Mae and Freddie Mac MBS holdings. AGNC's current Ginnie Mae MBS holdings are immaterial for projection purposes and thus excluded from this table and article. Table 4 further breaks out the 30-year MBS into the various coupons on AGNC's books ranging from 3.0% - 5.0%. AGNC holds an immaterial balance of 30-year MBS over the 5.0% coupon and thus will not be discussed in this specific analysis.

From the information portrayed via Table 4, a valuation gain (loss) can be calculated which is broken down by the various coupons. This is performed in a separate table later in the article. As stated in my side note earlier in the article, an exact valuation figure cannot be obtained because AGNC continually changes its portfolio holdings in a given quarter. As such, I must include specific purchase and sale assumptions and interpretations towards the end of my valuation analysis. Therefore, the overall projected valuations calculated within this analysis (by using the MBS price information provided in Table 4 above) have been extremely close when compared to past quarterly actual results reported by AGNC. The total variance of the combined "gain (loss) on sale of agency securities, net" and "unrealized gain (loss) on available-for-sale securities, net" accounts within the income statement has been under 5% of the total account's balance.

Using Table 4 above, let us look at the MBS price movements for the current quarter regarding a few of the coupon rates in which AGNC currently holds its larger balances. The cumulative quarterly net MBS price movements are evidenced within Table 4 under the "Cumulative Quarterly Change" column.

To illustrate, for the week ending on 8/16/2013, the Fannie 30-year MBS with a 3.5% coupon (largest 30-year MBS balance as of 6/30/2013) has a cumulative quarterly price decline of (2.38) to settle its price at 99.03 (100 being par). In comparison, 30-year MBS with a 3.5% coupon had a cumulative quarterly price decline of (4.33) for the second quarter of 2013. When compared to the prior quarter, the current quarter's price decline is more modest in comparison. In particular, last week's MBS price declines caused this coupon to move modestly negative from a slightly negative position. Just last week, this particular coupon went from a cumulative quarterly MBS price decline of (0.44) when compared to 6/30/2013 to (2.38). This was directly caused by the rapid increase in mortgage interest rates and US Treasury yields on fear of the upcoming "tapering" by the FED.

For the Fannie 30-year MBS with a 4.0% coupon (second largest 30-year MBS balance as of 6/30/2013), the cumulative quarterly price decline is (1.50) to settle its price at 102.53 (100 being par). In comparison, the 30-year MBS with a 4.0% coupon had a cumulative quarterly price decline of (2.56) for the second quarter of 2013. When compared to the prior quarter, the current quarter's price decline is more modest in comparison. As was the case with AGNC's 15-year MBS, this will directly have a positive effect on the valuation of AGNC's 15-year MBS with a 4.0% coupon when compared to the prior quarter. Prior to last week's dismal MBS price movements, this particular coupon MBS had a slight increase in its cumulative quarterly MBS price movement when compared to 6/30/2013. Currently, most of the 15-year MBS coupon rates that AGNC currently owns have once again turned negative due to last week's events. These losses accelerate as the coupon decreases. When compared to the second quarter of 2013, the MBS price movements through 8/16/2013 have continued to decline but less severely.

For the Freddie 30-year MBS, the same conclusions hold true. When compared to the Fannie 30-year MBS, Freddie 30-year MBS usually have slight differences in weekly (hence quarterly) price valuations across the same coupon rates. However, the same general themes hold true.

Now that we have an understanding of the 15 and 30-year MBS price movements that occurred for the first-half of the third quarter of 2013, let us take a look at how these MBS price movements affect AGNC's MBS portfolio regarding valuation (quantified in dollar amounts).

Table 5 - AGNC Summarized Weekly and Cumulative Quarterly Valuation Gains (Losses) on its MBS Portfolio (Through the Week Ending 8/16/2013)

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Table 5 above shows AGNC's weekly and cumulative quarterly projected valuation gains or losses on its 15 and 30-year Fannie and Freddie MBS holdings across all coupon rates (including immaterial MBS coupon rates). For this specific analysis, Table 5 shows the projected valuation gains or losses through the week ending 8/16/2013 and quantifies these gains or losses in dollar amounts.

Side Note: As briefly mentioned earlier, AGNC's 20-year MBS holdings were only $455 million or 0.59% of AGNC's 6/30/2013 portfolio balance. Ginnie Mae MBS holdings were only $207 million or 0.26% of AGNC's 6/30/2013 portfolio balance. For purposes of this analysis, both these amounts are deemed immaterial and excluded from Table 5. However, when I compute my quarterly income statement and book value projections for AGNC, these immaterial holdings are also considered, calculated, and included.

Specifically looking at the week ending date of 7/4/2013, AGNC had a projected weekly valuation loss of ($1.3) billion on its MBS portfolio. The first week of July had a "carryover" effect regarding mortgage interest rates and US Treasury yields. The was yet another week where the broader markets were reacting to the notion of the FED beginning to end its Quantitative Easing (QE3) Bond Purchasing Program as early as July 2013. The first week of July was the last week in a series of weeks where mortgage interest rates and US Treasury yields "spiked" nearly 100 basis points ('bps') overall causing material MBS price declines.

As the FED/FOMC meeting minutes and economic indicators were released in July and into August, a modest "retraction" of mortgage interest rates and US Treasury yields has occurred. As such, MBS valuations across all coupons have increased as a direct result (degree of "retraction" depends on the MBS coupon rate). This is evident within the varying weeks of Table 5's "Cumulative Total" amounts. The valuation loss of ($1.3) billion as of 7/4/2013 sharply reversed course and basically netted itself out by 7/19/2013. Minor valuation adjustments have been incurred from 7/19/2013 - 8/9/2013. As discussed earlier, the week ending 8/16/2013 was yet another horrendous week regarding MBS price declines. As such, strictly on a MBS portfolio basis, AGNC lost approximately ($1.1) billion worth of MBS value in one week. Last week was not particular a "friendly" week regarding MBS valuations.

Since one can accurately track existing MBS price movements throughout the various coupons, a general sense of valuation gains or losses on a company's MBS portfolio can be achieved. As of 8/16/2013, I have projected a valuation loss of approximately ($1.4) billion regarding AGNC's MBS portfolio. Compared to AGNC's second quarter of 2013 MBS portfolio valuation loss of ($2.8) billion, the first-half of the third quarter of 2013's decline is more modest in comparison. However, this is still a material loss and needs to be closely watched as events unfold.

Brief Discussion of MTGE's MBS Portfolio Composition and Valuation:

American Capital Mortgage Investment Corp. (NASDAQ:MTGE) is classified as an mREIT which also currently earns a majority of its income from investing (through leverage) in agency MBS. Approximately 89% of MTGE's 6/30/2013 portfolio is in agency MBS. MTGE can further diversify its holdings (via management's discretion) into non-agency investments including prime and subprime mortgage loans, option adjustable rate mortgages ('ARM'), and Alt-A loans. Non-agency mortgage investments include residential mortgage-backed securities ('RMBS') backed by residential mortgages and are not guaranteed by a GSE or US government agency. MTGE increased its non-agency RMBS holdings from a total of $727 million as of 3/31/2013 to $931 million as of 6/30/2013. When compared to its agency MBS holdings of $7.9 billion as of 6/30/2013, AGNC slightly increased its non-agency RMBS holdings during the second quarter of 2013 to 11% of its entire investment portfolio from 9% as of 3/31/2013.

MTGE's 6/30/2013 fixed-rate agency MBS portfolio mainly consisted of 15 and 30-year MBS that had similar characteristics when compared to AGNC's fixed-rate agency MBS portfolio. This includes a somewhat similar proportion of LLB and HARP loans and similar MBS coupon rate breakdowns (some slight percentage differences).

One difference between AGNC's and MTGE's investment portfolio that should be noted is the composition of 15 and 30-year fixed-rate agency MBS (as a percentage of its total investment portfolio). As stated earlier in this article, AGNC increased its 15-year fixed-rate agency MBS holdings to 41% of its investment portfolio as of 6/30/2013. As such, AGNC has approximately 58% of its investment portfolio in 30-year fixed-rate agency MBS (remaining 1% in collateralized mortgage obligations ('CMO') and ARMS). MTGE has approximately 26% of its investment portfolio in 15-year fixed-rate agency MBS holdings as of 6/30/2013. MTGE has approximately 62% of its investment portfolio in 30-year fixed-rate agency MBS holdings as of 6/30/2013. As such, slight valuation differences would occur between AGNC's 15-year fixed-rate MBS holdings and MTGE's 11% non-agency portfolio.

With this slight difference noted, the current MBS valuations between AGNC and MTGE are pretty similar. There have only been minor valuation differences between AGNC and MTGE through the first half of the third quarter of 2013. As such, the points and data provided above can generally be assumed of MTGE as well. This excludes any comparison between AGNC's and MTGE's TBA MBS forward contract position. As stated earlier, all TBA MBS forward contract positions are classified under the derivatives account and will be discussed in PART 2 of this article.

Conclusions Drawn:

By examining AGNC's investment portfolio as of 6/30/2013, I have shown how and analyzed why AGNC changed its business strategy regarding MBS composition. AGNC has changed its overall investment portfolio composition by acquiring or keeping MBS holdings that generate a slightly lower yield for the sake of less price sensitive MBS. This was mainly shown via Tables 1 and 2. These two tables showed the composition changes that AGNC incorporated regarding its 15 and 30-year MBS holdings. AGNC increased its proportion of 15-year MBS holdings while decreasing its 30-year MBS holdings. This change in MBS proportions is for the preservation of BV over the short-term in case mortgage interest rates and US Treasury yields continue to increase at a modest to rapid pace. 15-year MBS are less volatile when it comes to MBS price movements. However, this increase in 15-year MBS comes at a slightly lesser yield obtained. The decrease in yield could negatively affect AGNC's cash interest income generated in the current and future quarters by a slim to modest amount.

By the end of the first week for the third quarter of 2013, AGNC had a projected weekly valuation loss of ($1.3) billion on its MBS portfolio. This valuation loss sharply reversed course and basically netted itself out by 7/19/2013. After these three volatile weeks, minor valuation adjustments have been incurred from 7/19/2013 through 8/9/2013. From 7/15/2013 through 8/9/2013, average fixed mortgage interest rates on both 15 and 30-year home loans and the yields on US Treasuries with varying maturities have been fluctuating around the ending rates/yields that were seen at the end of the prior quarter (as of 6/30/2013). As such, cumulative quarterly 15 and 30-year MBS price valuations ranged from slightly negative towards to the lower-end of the MBS coupon spectrum to slightly positive towards the higher-end of the MBS coupon spectrum. However, this past week ending on 8/16/2013 once again broke this trend. Substantial MBS price declines were felt thus negatively affecting AGNC's MBS portfolio per a valuation standpoint. Within this past week's worth of market events, AGNC's MBS portfolio declined by approximately ($1.1) billion.

For the second quarter of 2013, AGNC recorded an extremely large MBS valuation loss of ($2.8) billion. For the first-half of the third quarter of 2013, I am projecting AGNC's MBS portfolio sustained an additional valuation loss of ($1.4) billion (through 8/16/2013). Although this currently is not as bad as the prior quarter, this ($1.4) billion valuation loss is still extremely large. The FED's tapering decision in September will prove to be a pivotal event regarding rates in general (hence MBS price movements). AGNC's derivatives will help offset some of these MBS losses. AGNC's derivatives will be discussed and analyzed in PART 2 of this article.

Similar overall MBS portfolio valuations have occurred on MTGE's investment portfolio as well (minor subtle differences).

Final Note: I would caution readers that MBS price movements change daily. As a direct result, valuation gains or losses change daily as well. One quick, sharp move in mortgage interest rates and US Treasury yields can materially change MBS prices thus changing AGNC's MBS portfolio valuation by hundreds of millions of dollars. This is why I feel it is imperative readers understand how AGNC values its MBS portfolio and how modest changes in overall rates/yields have a direct impact on MBS prices (hence asset valuations). Furthermore, I thought it would be extremely beneficial to provide readers a mid-quarter update regarding the valuation of AGNC's updated MBS portfolio as of 6/30/2013 and projected third quarter of 2013 MBS activities regarding purchases and sales.

PART 2 of this analysis will be out shortly. PART 2 will include a projected BV per share amount as of 8/16/2013. This will be followed by an article about AGNC's third quarter of 2013 dividend range scenarios (prior to AGNC's quarterly dividend declaration in September 2013).

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.