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American Capital Agency Corp. (NASDAQ:AGNC)

Q4 2013 Earnings Conference Call

February 04, 2014 11:00 AM ET

Executives

Katie Wisecarver – Investor Relations

Gary Kain – President and Chief Investment Officer

Christopher J. Kuehl – Senior Vice President-Agency Portfolio Investments

Peter J. Federico – Senior Vice President and Chief Risk Officer

Analysts

Douglas M. Harter – Credit Suisse Securities LLC

Joel J. Houck – Wells Fargo Securities LLC

Richard B. Shane – JPMorgan Securities LLC

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Steve C. DeLaney – JMP Securities LLC

Eric Beardsley – Goldman Sachs & Co.

Dan L. Furtado – Jefferies LLC

Operator

Good morning and welcome to the American Capital Agency Fourth Quarter 2013 Shareholder Call. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Katie Wisecarver in Investor Relations. Please go ahead.

Katie Wisecarver

Thank you Denise. And thank you all for joining American Capital Agency's fourth quarter 2013 earnings call. Before we begin, I'd like to review the Safe Harbor statement. This conference call and corresponding slide presentation contains statements that to the extent they are not 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 periodic reports filed with the Securities and Exchange Commission. Copies are available on the SEC’s website at 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 18 by dialing 877-344-7529 or 412-317-0088, and the conference ID number is 10039631.

To view the slide presentation turn to our website, agnc.com and click on the Q4 2013 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.

Participants on the call include Malon Wilkus, Chair and Chief Executive Officer; Sam Flax, Director, Executive Vice President and Secretary; John Erickson, Director, Chief Financial Officer and Executive Vice President; Gary Kain, President and Chief Investment Officer; Chris Kuehl, Senior Vice President, Mortgage Investments; Peter Federico, Senior Vice President and Chief Risk Officer; and Bernie Bell, Vice President and Controller.

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

Gary Kain

Thanks, Katie, and thanks to all of you for joining us on our fourth quarter earnings call. I would like to start by acknowledging how difficult 2013 was for our investors. Our goal is to generate outstanding returns for our shareholders and in 2013 that did not happen. Our business is to manage a portfolio of agency mortgage-backed securities and unfortunately there will be episodes where fixed income assets and more specifically agency MBS simply underperformed as an asset class. In fact, 2013 was one of the worst years in the agency market in the past two decades.

In hindsight, the unique open-ended nature of QE3 created an additional level of uncertainty that bond market participants were clearly unprepared for. As the communication out of the Fed surrounding tapering started to escalate and the economy began to show signs of improvement in the first half of the year all fixed income instruments suffered.

Bond markets grew increasingly unstable as participants tried to quantify the timing and the impact of the shift in Fed monetary policy. And given their status as a direct beneficiary of Fed purchases along with size, liquidity and inherit negative convexity agency MBS were uniquely impacted. The possibility of an early than expected tapering of QE3 led wide spread MBS selling from a range of investors. This significantly magnified the typical convexity related rebalancing activities that can be expected in periods when interest rates spike.

In the phase of this uncertainty we took a more conservative approach to our portfolio and prioritized risk management and book value preservation over short-term earnings. On our third quarter earnings call, we pointed out that we have began to gradually shift our poster back toward more normal operating levels, but we still faced very significant idiosyncratic risks such as the potential for a government shutdown, uncertainty around the changing leadership at the Fed and the possibility of a December taper.

When 2013 came to a close the massive repricing in the fixed income market was unmistakable with 10-year treasury rates increasing 125 basis points over the course of the year. Today both the treasury and agency markets are undecidedly firmer footing. Against this backdrop, we have positioned the portfolio with an eye toward a more normal balance between risk and return. As such, we increased our duration gap further in Q4 and took our at-risk leverage up slightly, both of which are supportive of future earnings. In hindsight we are really glad we made these moves.

Here is what we know today that we didn’t know a quarter or two ago. Tapering has begun and it appears to be fully priced into the bottom market. Treasury and mortgage rates are higher and interest rate volatility is significantly lower. The economy is growing, but at a moderate pace and inflation remains well below the Fed’s target. Risk positions and fixed income are much lower and the pace of bond redemptions has stabilized and could even reverse if the current flights of quality rally continues. The majority of MBS investors are under weighed or underinvested and the extension risk that is held outside the Fed by actively managed portfolios is at its lowest level in decades.

The point of this list is not to say that we’re out of the woods, but it’s a highlight that we gaining some clarity and that there are numerous reasons to believe a repeat of 2013 is not in the cards. To this point since the Fed is earlier than expected announcement of tapering in December, interest rates have actually fallen, MBS prices are materially higher and our book value has improved meaningfully, not exactly the outcome most people would have expected post tapering. Interestingly, as we look at the agency market toward the end of the fourth quarter it became very clear to us that the cheapest assets were the mortgage REITs themselves.

The equity value of agency REITs fell at a much faster pace than the book values of the underlying portfolios during 2013. While some of this price-to-book shift is understandable giving the changing sentiments surrounding the Fed. We believe the current valuations in the mortgage REIT space are inconsistent with today's market landscape and with the tremendous liquidity and the transparent pricing of the underlying assets.

Moreover and this was an incredibly important point. Agency MBS completely reprised during 2013 and thus already incorporate the same concerns and the greater risk premiums that the REIT equity market seems to be demanding.

Our price-to-book ratio at 81% essentially says that the equity market is applying an additional 20% discount on top of what is already priced in by the bond market. This in our minds creates a unique opportunity. For this reason we have aggressively bought back our own stock repurchasing around 600 million or 7% of our outstanding shares in the fourth quarter alone.

As a reminder, our policy is that we will only repurchase our shares during our internal open window periods. So there are times during a quarter where stock buybacks won't be executed. In addition to buying our own shares, in December and January when mortgage REIT stocks were near their lows we purchased approximately 400 million of other agency REIT stocks. While it may seem very strange that we would support the stocks of our peers, our actions are indicative of our desire to generate value for our shareholders by extracting value from the agency MBS market both directly and in this instance indirectly.

You can think about the investment decision in this way, regardless of how much stock we buyback we will own significant quantities of agency MBS in our portfolio. Does it make sense only to hold agency mortgage securities directly or should we sell some and buy similar MBS assets in REIT equity form at around 20% discount.

In asset price terms, that is like buying a highly liquid agency MBS 2.5 points in price lower than where you can sell them. To us the choice was straight forward as the almost 20% discount more than compensates us for the incremental fees and reduced transparency into this subset of the portfolio.

To better explain our views on REIT valuations, we included several new pages to the presentation this quarter. But before reviewing those pages I want to quickly summarize some highlights of the quarter before the turning the call over to the team.

Turning to Slide 3; comprehensive income was a loss of $0.99 while net spread income totaled $0.75 per share during Q4. Taxable income came in at $0.65 per share which equaled our dividend for the quarter. The decline in our dividend experienced during 2013 was consistent with the portfolios book value performance and with our defensive positioning.

That said the combination of a more normal balance between risk and return, the improved market environments and our undistributed taxable income are all supportive of our current dividends and allow me to be hopeful that we are transitioning to a more stable dividend environment.

Our economic return was negative 2.7% for the fourth quarter based on a combination of our $0.65 dividend and the $1.34 decline in our book value. Now so far this year, however interest rates have declined and MBS prices have improved significantly, as such our book value has a strong tailwind as we begin 2014.

On Slide 4, I just want to highlight a couple of things. First, as of December 31, our investments in other REITs totaled $237 million and as I mentioned earlier this position increased to almost $400 million by the end of January. I should also point out that quarter end at risk leverage of 7.5x captures our long TBA positions and we reduce our effective equity by the amount of our other REIT stock positions.

Our net interest spread as of December 31, was 139 basis points without including any benefit that would likely accrue from long TBA positions or from dividends on our other REIT holdings.

Lastly as I mentioned earlier we repurchased 28.2 million or approximately 7% of our outstanding shares. Our Board of Directors also approved another $1 billion of additional share buybacks.

With that let’s quickly slip to Slide 5, which gives some summary information for 2013 as a whole. As I said at that outset of this call, 2013 was a disappointing year for AGNC as our economic return was negative 12.5%. The bar chart on the bottom of the page hopefully puts this performance in some context. As this chart shows AGNC's return over any multiyear period is very attractive and our five year average return is over 23% despite the inclusion of 2013. Before turning the call over to Chris, I just want to reconcile two measures of performance that are important to both shareholders and to management.

On Slide 6, we compare our economic returns in the portfolio since our IPO to the total stock returns over the same period. The blue bars on the chart on the top left depict our economic returns over three time periods. As a reminder economic return includes the dividend we have paid plus changes in book value during the period, it is therefore equivalent to the mark-to-market performance of the portfolio itself.

As you can see the aggregate economic return has been very attractive, but with the vast majority of the performance coming from the pre-QE3 timeframe. Since QE3, contrary to what many of you might have expected results have still been positive, but have totaled only 2.6%.

Now let's compare our economic returns to our total stock return over the same time periods, which are depicted by the green bars. Again, total stock return is the combination of dividends plus a change in stock price over the period, excluding any benefits for reinvested dividends. As you can see from the middle panel on the graph our economic return and our total stock return closely track one another for the pre-QE3 period.

In the post-QE3 period, however there’s been a dramatic divergence between the two measures with the total stock return dropping 24%, while our economic return actually increased 3%. Since both measures include the same amount of dividends paid, the difference between economic returns and total stock returns simplifies down to the change in book value versus the change in stock price during the period. You can clearly see this divergence from the table on the top right, which shows that our book value dropped by $5.48 per share over the last six quarters, while the stock price declined by $14.32 per share during the same period.

Said in other way, our price to book ratio went from 114% at the end of Q2 2012 to 81% at the end of 2013. Hopefully, the reconciliation between these two measures helps investors better understand the drivers of the recent divergence and later in the presentation we will highlight why this represents an opportunity.

With that let me turn the call over to Chris.

Christopher J. Kuehl

Thanks Gary. Turning to Slide 7; I will briefly review our market update slide. Notice that we added the year-over-year changes to the table as well. Q4 was another relatively volatile quarter with five-year and 10-year treasury rates selling off 36 and 42 basis points. Swap spreads tightened during the quarter with five year and 10 year swap rates selling off 25 and 32 basis points respectively.

Following the QE taper announcements in early December agency MBS spreads recovered somewhat, but mortgage prices and spreads still ended the quarter lower and wider versus swap hedge ratios, while the 10-year treasury closed at 3.03%, was the highest close of the year. Quarter-to-date, we’ve had a sharp rally in both rates and mortgage prices, five and 10-year swap rates as of last night closed at 1.56% and 2.72% both within five basis points where we ended the third quarter.

Mortgage prices are also up materially year-to-date. And on average inline to slightly higher versus where there where on September 30, with 30-year 4.0%s around 105 and 15-year 3.0%s around 103.5.

Let’s turn to Slide 8, to review our investment portfolio composition. The overall size of the portfolio decreased from $77.8 billion to $68.2 billion as of year-end. The decrease was largely a function of MBS sales related to share repurchases and purchases of shares of other REITS which totaled almost $850 million in Q4.

As Gary mentioned earlier, our quarter-end “at risk” leverage actually picked up during the quarter despite the decline in the overall size of the portfolio. Our 15s, 30s mix was roughly unchanged with 15 year MBS representing 51% of the portfolio as of year-end versus 52% at the end of the third quarter. The only notable change in our asset composition was a shift from a net short to a net long TBA position as of the end of the fourth quarter.

Turning to Slide 9, we have included the comparison of our fixed rate pass through holdings versus the Fannie Mae, Freddie Mac MBS universe. As you may recall last quarter, we stressed the importance of owning shorter spread duration assets from the perspective of protecting our ability to reinvest principal in a higher rate slower pre-payment environments.

You can clearly see that we are significantly overweight 15 year MBS, however I want to highlight that within our 15 year holdings, our weighted average remaining maturity is only 12.5 years, which is considerably shorter than generic 15 year TBA MBS. This seasoning is a critical component of our decision to overweight these securities as the shorter cash flows materially impact our overall risk position.

Therefore, we have generally not willing to roll 15 year positions despite relatively attractive financing opportunities. Leasing on 30 year MBS however is considerably less important than it is on 15 year, and so we are more willing to roll 30 year positions especially in 4.0%s and 4.5%s.

In the lower half of the slide we show our position relative to the 30 year universe and you can see that within 30s we are underweight the lowest coupon, longest duration MBS as well as the highest coupon, least liquid parts of the market. And overall underweight 30 year MBS, again by being underweight 30 year MBS we have less extension risk and spread exposure in the portfolio which gives us considerably greater flexibility with respect to duration gap and leverage.

With that, I will turn the call over to Peter to discuss funding and hedging activities.

Peter J. Federico

Thanks Chris. I will start with our funding activity on Slide 10. Consistent with the decrease in our assets our repo balance fell to $61 billion at the end of the fourth quarter. Our funding cost remained stable at 45 basis points as did our average margin at about 5%.

There are number of factors that make us optimistic about our funding outlook: first, our current unused funding capacity is at an all time high. Second, we continue to see attractive term funding opportunities, and lastly, new capital rules related to the treatment of offsetting repo positions appeared to be less on a risk than the market previously feared.

On Slide 11, we provide an overview of our hedge portfolio. As we mentioned on our third quarter call we began to gradually increase our duration gap as general market conditions began to stabilize and given the changes that Chris highlighted with respect to our asset portfolio. That trend toward lower hedge ratios continued in the fourth quarter with our hedge ratio dropping to 86% from 91% in the third quarter and 101% in the second quarter.

On Slide 12, we show our duration gap and our duration gap sensitivity. Our duration gap at year end was 1.5 years, up from 0.9 years at the end of the third quarter and up from 0.5 year at the end of the second quarter. There are important considerations that go into our decision to operate with the larger duration gap. First and most importantly, the extension risk in our portfolio today is minimal given our asset repositioning into a higher share of more seasons 15-year securities and because the durations of our assets have already experienced significant extension following last year’s rate increase. As you can see from the table, the net extension risk in our portfolio is only three-tenths of a year even in a scenario where rates increased 200 basis points.

Our exposure to higher rates is the combination of our initial duration gap plus the duration extension that occurs as rates rise. Thus, it’s very logical to run a larger duration gap when our extension risk is very low. Second, we are currently operating with lower leverage and less credit risk than we have in the past. Given the lower risk profile of these variables we can prudently operate with the larger duration gap without materially changing our aggregate risk level.

Finally, when operating with a larger duration gap it is important to consider how the aggregate mortgage market will behave in a rising rate scenario. We believe that rebalancing needs of the overall mortgage market are materially lower today. We come to this conclusion for two reasons. First, as I already mentioned, rates our now higher and mortgage durations have extended; second, a significant portion of the mortgage market is now held by investors like bank portfolios, index funds and the Fed who are not active hedges. As an example, the Fed now owns about 30% of all of the agency MBS and an even larger share of the negative convexity. For these reasons we believe mortgage spreads will be considerably less volatile going forward in a rising rate scenario.

With that, I’ll turn the call back over to Gary.

Gary Kain

Thanks Peter. And before I open up the call to questions, I wanted to quickly expand on some of the points I touched on during the introduction. The graph on Slide 13 shows what happened to both the 10-year Treasury and the mortgage rates since the beginning of QE3. What jumps off the page is the spike in rates beginning in early May when the market began to place in significant questions about an early end to QE3.

Within just a few months, 10-year Treasury rates increased 140 basis points and mortgages performed even worse. By the end of the year the Fed had tapered and even laid out an implicit schedule for exiting QE3 altogether. For the full year 2013, the 10-year Treasury increased to 125 basis points from start to finish and mortgages rates had increased 140 basis points.

If you look at agency MBS from a price perspective, 30-year 3% coupons fell almost 10 points in price and even 15-year 2.5s, which are considerably shorter in duration, declined by more than 5.5% points. The key takeaway here is that the bond market completely reprised in 2013 and now appears to have fully incorporated Fed tapering. The significant decline in implied volatility in the interest rate markets over the past several months strongly supports this conclusion.

We see even further evidence by the fact that since the Fed announced the tapering on December 18, both treasury and mortgage yields have actually fallen while MBS valuations have improved materially. So why is this so important? First, it gives us comfort, running a larger duration gap; and second, it really calls into question whether the current price-to-book discounts in REIT stocks make sense given that the underlying mortgage assets and by extension book values have reprised.

The next slide addresses the first point, the importance of duration gap with respect to net interest margins. The table quantifies something that should be intuitively straightforward, that net margins are higher to the extent that a portfolio has less hedges or in other words a larger duration gap.

However, given the current steepness of the yield curve and the meaning increasing yield the carry benefit of a positive duration gap has improved. As you can see in the illustrative examples on the table, 30-year 4% coupon MBS with a hypothetical set of hedges constructed to produce a 1.5 year duration gap, Year where agency is currently operating will have a net interest margin of 180 basis points. A 15 year 3.5% coupon produces 150 basis points margin in this example.

As such, the average of the 30-year and 15-year NBS produce a NIM of 165 basis points. This is approximately 55 basis points more than what would be achieved with no duration gap. Of course a larger duration gap means the portfolio is less protected of interest rate wise, all else being equal. That said, I think Peter did a good job describing the mitigating factors, which are critical to this overall risk equation.

Now, let me change gears and discuss an even more straightforward source of attractive returns, the current price-to-book discounts of agency REIT stocks. Slide 15 is designed to highlight how a price-to-book discount can be thought of as enhancing the underlying yield or net interest margin on our portfolio.

The table on the top left quantifies our price-to-book discount in dollar terms as of December 31. The difference between our book value and our market capitalization was 1.6 billion or a price-to-book ratio of 81%.

Now, if you look on the top right we apply that 1.6 billion to the total fair value of the assets in our portfolio and we display it in both dollar terms and in price. As you can see, the 1.6 billion is equivalent to 2.5 points in price on the entire MBS portfolio. By thinking about this discount in the asset price terms it is easy to see how a lower stock price can significantly improve the all in earnings power of your investment versus purchasing the same portfolio a 100% above.

The lower table quantifies the yield benefit associated with 2.5 point price discount. As you can see, the price reduction increases the yield on the 30-year 4% coupon by 38 basis points. The difference is even more striking in the 15-year 3.5% example as the yield increases by 57 basis points.

Notice that 2.5 point translates to a considerably larger yield benefit on 15 years than 30 year MBS because they are significantly shorter instruments. This is an important take away for investors when it comes to evaluating the benefits of low price-to-book ratios in the REIT space.

On the last page is a summary of what we discussed today and I want to close by reiterating a few of the most important points. First, bond yields rose significantly during 2013 as the market re-priced to new assumptions surrounding the future of debt accommodation in the economy.

Second the downside risk to the MBS market are lower now as the mortgage universe has extended and mortgage investor positions are now extremely conservative. When you combine these two points, a logical conclusion is that the risk return equation has improved as well.

And lastly, when you layer in the benefits of the significant discount to book the calculus gets even stronger. So with that let me stop and open up the call to questions as we’ve covered a lot of ground today.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Douglas Harter of Credit Suisse. Please go ahead.

Douglas M. Harter – Credit Suisse Securities LLC

Thanks. Gary, I was hoping you could talk about, when you weigh either buying back your stock or buying the stock of other agency REITs and sort of how you weigh those two options and sort of how you come to your decisions as to how to allocate your capital that way?

Gary Kain

Thanks Doug, and that’s obviously a very timing question. The first what I really want to say there is, we don’t really allocate between those two. The way you should think about it is that we have been aggressively repurchasing our shares and I think that’s indicated by the 7% of our outstanding shares that we bought back during the quarter over 10% since – over the course of the last year, year and half. So we are committed to buying back our stock environment such as the one we went through. Separately outside of the stock buybacks you really have to look at our existing portfolio and where the – well say other REIT equity comes in is, no matter how much you want us to buyback in stock, whatever that number is, we’re going to still own lots of agency MBS.

And the reality is when we look at that remaining portfolio and we say at certain times there are ways to access that at a 2.5 point discount pre-fees and so forth, then that’s an incredibly compelling situation irrespective of the opportunity to buyback your own stock. And so what I would say is, this is not an either or, we’re not reducing our purchases of our own stock, again evidenced by our activity, it is much more related to irrespective of what we do in stock buybacks. We feel it’s our responsibility to optimize the remainder of our portfolio.

Douglas M. Harter – Credit Suisse Securities LLC

Great. And when you think about the sizing of that potential position and there is the liquidity compared to owning the securities, I mean, I guess how do you think about sizing as to what that could look like over time?

Gary Kain

I think the key thing to keep in mind there is, we do understand that there are differences and what I would say is, we certainly have capacity to do a meaningful amount more of this and we’ll do so if the opportunities present themselves. On the other hand, investor should not think of this as something that’s go announce a 20% of the portfolio or something like that. It is definitely something that we feel can generate attractive returns but when it comes to, we do have to weigh that with things like liquidity and transparency and risk management considerations, totally comfortable with that and feel like we have a lot of room to grow the position if the opportunity presents itself, but this will not be a tremendously large component of the portfolio.

Douglas M. Harter – Credit Suisse Securities LLC

Great. Thanks for that color, Gary.

Operator

The next question will come from Joel Houck of Wells Fargo. Please go ahead.

Joel J. Houck – Wells Fargo Securities LLC

Thanks and good morning. I guess maybe to expand on that topic. I think I heard you say these were agency REIT stocks only. I just wanted to clarify that first. And second, I guess, your comments about the price discount that you get by purchasing another agency REIT or clear, how do you get comfortable with the hedging strategies of other managers? I think one of the things that, at least when we think about agencies, it’s a good risk manager, not that the other ones aren’t, but how did you – what process did you go through to get comfortable that, yes, maybe the securities are cheap, but maybe they’re not properly hedged and therefore the benefits you get could get offset by any one of these companies blowing up?

Gary Kain

No, look it’s obviously a very good question and what I would say there is, first off, remember we do feel that we’re experts on the underlying securities. So we can evaluate a portfolio, add the portfolio hedges and know at least at the beginning of a quarter or at the end of a quarter what the initial conditions are and then we can make our own adjustments for that. That’s not going to be perfect and to your point there is a lot of potential leakage over the course of a quarter where we don’t have information to make adjustment so to speak. But I just want to stress that while this is one area where I think sometimes you have to check your ego at the door, which is why we feel that over time we’re going to add a tremendous amount of value as a management team to the selection of assets and to the hedging of those assets.

In particular periods such as this it’s going to be hard to make up for a 2.5 point discount. And so, I think practically speaking that is why this will be a measured component of the portfolio because there is some idiosyncratic risk. But on the other hand, again the price to book discount coupled with our insight into the underlying assets gets us comfortable with that equation.

Joel J. Houck – Wells Fargo Securities LLC

Okay. And then, if I can, go to a different topic. I think last conference call, Gary, you guys talked about – no, over the next, I guess, two to five years you were expecting mortgages spreads or maybe OEF [ph] to normalize. Certainly we’ve had a rally here in early part of 2014. If you kind of update that comment, what would it look like today given the improvement we’ve seen so far in this year?

Gary Kain

So, that’s a good question and so what I would say is you’ve got to look at the trajectory, and I want to kind of point back to something Chris said that if you just stop the presses today and you compare where the mortgage market and the treasury market for that matter and swap rates are relative to where they were in September at the end of Q3, they’re actually very close. And so, yes, while the mortgage markets had a great month and a half via post tapering, it had a really bad month and a half prior to that and the rates market did as well.

And so, what I would say is just big picture. We still feel that it's imperative for us to have cash flows that will give us back principal, and Chris mentioned, the concentration in season 15-year is important to be able to handle a scenario where, again the Fed goes away, interest rates rise and then, but second of all, we found a way in our minds to balance the current environment and achieving returns with protecting the portfolio against a potential wider spread scenario a year or two from now.

Joel J. Houck – Wells Fargo Securities LLC

Okay. And just, I think maybe I missed the one. Was this all 100% agency REIT stock, I’m sorry?

Gary Kain

Yes, sorry about that. It’s 100% agency focused REITs. Clearly there are agency focused REITs that have some small other positions and which we understand.

Joel J. Houck – Wells Fargo Securities LLC

Yes. Okay, great. Thanks.

Operator

The next question will come from Rick Shane of JPMorgan. Please go ahead.

Richard B. Shane – JPMorgan Securities LLC

Hey, guys. Thanks for taking my question this morning. When we think about you guys, you are really prompt ended purposes a long money manager of an asset class that last year massively underperformed, and that was certainly reflected in the absolute returns that you showed. When you think about it though on the relative return basis, and I'm not saying versus your peers, but versus the opportunities that and decisions that you made, can you sort of keep yourself a fulcrum, what was the thing you think you did right and what was the opportunity that you missed given that sort of backdrop?

Gary Kain

This is always a really tough question in terms of when you look back with perfect information the bottom line is we didn't call the scenario that unfolded. That would have been – that certainly would have helped. But when we look back at how we behaved or managed the portfolio, what I would say that was most critical to our performance relative to, we’ll say to the space and just in general was the fact that we adapted very quickly, I mean we had – we sold and reduced our exposure to pay-ups.

We actively managed and rebalanced our portfolio. We took the market force seriously. If there is another opportunity missed you could say that we should have backed up the truck or something in Q3 2013 kind of at the wides are in early September. The reality is we didn't feel as good then about the idiosyncratic risks being low enough where that risk return trade-off was still a little scary.

So I mean if we look back we feel good about the way we reacted to the market. We were disciplined and practical in our approach. On the other hand we could have made some – of a huge outright call in a couple of places, which obviously would have worked.

Richard B. Shane – JPMorgan Securities LLC

Thank you very much, Gary.

Gary Kain

Thank you.

Operator

The next question will come from Mike Widner of KBW. Please go ahead.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Good morning, guys. I guess several questions here. I want to go back first to probably the most interesting topic, which is buying the stocks of other mortgage REITs. I guess just the first question. I mean do you feel like it's appropriate to disclose either in the Q or elsewhere what those stocks are since investors are effectively buying those since you’re buying them?

Gary Kain

What I would say is we’re not going to disclose them on this call. We will obviously file any required regulatory filings, which might contain some of that information. However, we will keep this to a contained size within the portfolio because we don’t want this to be a discussion of what you think of this and this REIT versus that REIT and the reality is these are longer term holdings. We are accessing the underlying securities in our minds and we’ll make adjustment for hedges. And we really just aren’t going to go into the specifics of the underlying names except as required by regulatory filings.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Yes, I mean I don’t frankly know what the requirements there are, but I guess, I mean just to put that it in context with $400 million equity investment, if we look back at last year, not to say that anyone expects last year to repeat itself, but I mean that could pretty easily – if it did repeat itself, contribute $0.50 of book value loss or more to you guys for something that’s in large part beyond your control because you can’t control how other money managers manage their portfolios, particularly in a volatile rate environment and I think one thing we can probably say for sure is that the volatility hasn’t stopped, and then several last months, it’s been rates moving lower.

But I’ll come back to that in a second, but I mean it seems like a very opaque position. It does expose you and obviously, if investors wanted to buy other mortgage REITs other than you they have that option themselves. So I guess I do sort of struggle with whether or not it fits in with the model.

Gary Kain

Well first off, again our responsibility is to our shareholders and it’s to try to extract value from the agency mortgage market. That’s the intention here. We do understand that in every decision you make. So every hedging decision you have repurchase decision, you’re going to take some risk. And again, we fully believe that our investors are compensated for that risk and we are going to be very focused on things like concentration again within the subset of the portfolio.

But what I think is really key for you to understand is we are not buying these – we’re not making these investments, I mean just grossing up our risk. We are selling mortgages, underlying mortgages and essentially maintaining the same leverage. So this is a completely different situation, now you are absolutely right if the price-to-book ratio goes from 80% to 60%, we will lose more money on this transaction than we would’ve lost on the position otherwise and that’s the risk we’re willing to take.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Yes, I mean there is so many ways I could debate this and I won’t continue belabor the point. But I guess, just a two final thought off that are out in the topic are; number one, if you guys believe your outperformed, your peers last year again such – if the money is better managed in your hands than the peers, and then second, and related to that investors everyday, that we have the choice to invest in other stocks and you making that choice for them. Takes a decision out of their hands to a modest degree of did they want to own any of your dozen peers versus your or what concentrations and what weightings did they want to do.

And if we extend what you are doing and assume everyone in the group did then all of the sudden investors can’t help, but own a basket that they might not want to own. So I’m just – may I just leave it that I’m just not sure that you’re making investment decisions on behalf of your investors is necessarily something I want to see proliferated throughout the group?

Gary Kain

Well, I guess, look what I would just want to reiterate is our investor should expect us to make investment decisions on their behalf and that’s the normal course of the business with respect to how we access the agency mortgage market. And this is in our minds not really that different.

Second of all, again we also have tremendous confidence in our ability to manage a mortgage portfolio. But we’re also cognizant that getting a 2, 2.5 point head start is pretty relevant to the equation. And so just bigger picture again, I think that and actually the last point I would want to make is if you just want to think about if someone is worried about this component of the portfolio, they are actually buying that – you can essentially get almost double the discount on an agency REIT in terms of the investment indirectly. Because someone’s buying agency at whatever I will make up a number and 85% discount to book and if that other REIT is at 85% of the book, then that’s already incorporated in the book number and so this is the cheapest way to access it anyway.

So I mean look, we understood that this was going to be a discussion item. We are obviously transparent about it. We aren’t doing this. We are doing this, checking our ego at the door. We are doing this because we think it’s the right thing for shareholders. We absolutely expected lots of different opinions.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Yes, well so, that’s great. I appreciate all that and I know it’s, I mean clearly we’re one of the analysts that’s still bullish on the sector. So I don’t necessarily have a problem there with you guys buying it. It’s just the issue of sort of not disclosing it and then investors not knowing exactly what their risk profile is or even analysts not knowing what the risk profile is. But I’ll let that go.

Let me come back to a related point, which is sort of negotiation through a volatile interest rate environment and the starting question I guess I’ll ask is, rates today are almost 10-year treasury. They’re almost right on, where they were a quarter ago. You guys lost 5%, 5.3% of book value as the rates rose. Now that rates have returned to where they were in September, if I read between the lines in sort of what you’re implying, as rates rose you took – you got more comfortable with the rate environment, took the duration gap wider, took off a lot of hedges. Now that rates have moved back lower, what does that suggest for book value today versus where it was a quarter ago?

Gary Kain

Look I think you’re looking at it appropriately which is that if you think about what Chris said in his prepared remarks, he talked about the fact that interest rates as of last night are pretty much on top of where they were at the end of September. And mortgage prices are kind of at or slightly better than they were at the end of September. So if you follow that logic then you would conclude that in the absence of significant rebalancing actions, time to K-on [ph] options or changes in volatility kind of performance of the swaptions portfolio, outside of those issues changes in duration gap or leverage, then book value should not be that different from where it was in September. There is no information that I have that kind of troubles me with making that comparison.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Okay, and so the implication of that clearly is that, you see like book value today is probably in the vicinity of where it was at Q3 end, is that a fair summarization of that?

Gary Kain

Yes, I think that’s fair.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Okay, well I appreciate it. And I’ll let some other people ask some questions. Thanks.

Operator

The next question will come from Steve DeLaney of JMP Securities. Please go ahead.

Steve C. DeLaney – JMP Securities LLC

Thank you. Good morning everyone and congrats on a very solid quarter, especially the significant effort you’re making on the repurchase activity that is despite the noise on the mortgage REIT equities. What you’re doing with your own stock should be applauded. Gary, I just want to follow-on Mike’s question here. When you look at your stock today with respect to the buy back, your stocks moved up 8% through last night, was up another 1.5% today. Would you describe given the commentary about book value and for what it’s worth we last migrated back of the envelope we were up 5% to 6%. So put this in that ballpark. So when you look at the buy back plan and the increase to 2 billion, would you describe your shares today as still attractive for repurchase given the move up of 8% year-to-date?

Gary Kain

Yes, Steve, it’s obviously a very good question and as you probably expect I won’t give you like a very specific answer. First off, I’m not sure how the stock is performing today.

Steve C. DeLaney – JMP Securities LLC

You’re up 1.5%.

Gary Kain

All right. Well, thanks. Thanks for the update. What I would say is, look, remember the most important variable and it’s not the only variable and I really need to stress this. The most important variable is the price to book ratio. That’s the starting point for our stock repurchases. And so, while the stock is up and performs reasonably this year, as we’ve just talked about the mortgage market has improved and book value has improved a decent amount as well from the lows and we’ll say mid to early December. So big picture, the key there is the relationship and then there are a lot of other factors that go into it, but one thing I would stress is that we are still committed to stock buybacks. The thresholds and levels may adjust with market conditions, but I think we’ve absolutely demonstrated the fact that we feel it’s important and we’ll continue to look for opportunities to buy back our stock where we think it makes sense.

Steve C. DeLaney – JMP Securities LLC

Okay. And then, thank you, Gary. And turning more to the sort of the fundamental spread business, repo market conditions, I mean we’ve seen a pretty sharp drop in 30-day repo rates, and we’re seeing low 30s now versus low 40s at the end of the year. Just looking empirically the shrinkage in your portfolio was about $10 billion from September to December. Should we read into that, are we getting a benefit from this supply demand like this less demand while the mortgage REITs for repo is their shrinking portfolios and buying back shares? If it’s not just that technical are there any other factors that you could comment on as far as why short-term repo rates have fallen so much?

Peter J. Federico

Sure, Steve. This is Peter. I think you’re right on with that. I mean we have clearly seen that there is less demand for repo on the marketplace, but at the same time a couple of things that I mentioned in my prepared remarks are really significant. We continue to see on the supply side of the equation real stability and in fact growing supply of counterparties interested in doing mortgage repo with us and I’m sure it’s the case around them.

So we expect our counterparty base to grow over the next six months, our unused capacity continues to grow and I think part of what’s happening both on the demand side and on the supply side is that there are some easing of the fears related to all of the new capital rules. Recall six months ago there was lots of concern that if the capital were adopted as proposed, we could see may be a 25% reduction in repo capacity in ultimately higher cost in a real allocation of that resource. I think what we are seeing today is some easing of those fears and certainly with our counter parties, we feel real confident with the capacity that we have with them and we feel like we have a lot of capacity to expand if we needed it.

So we are pretty optimistic about the outlook in the funding space for the next six to 12 months.

Steve C. DeLaney – JMP Securities LLC

Thanks, Peter, I appreciate the color guys.

Peter J. Federico

Okay.

Operator

The next question will come from Eric Beardsley of Goldman Sachs. Please go ahead.

Eric Beardsley – Goldman Sachs & Co.

Hi there thank you. One of you could comment on yields on new investments in terms of what types of ROE are you getting on new money, that you put to work.

Peter J. Federico

I guess I would point you to Page 14 and I do want to stress, these are simplified examples. But I think when you look at the NIMs that those are representative of, those are market prices at the end of the year. So prices are obviously higher and spreads are not really that much they aren’t that different, but it’s again very important, it’s less important in the sense as to what is the instrument maybe than it was before, but the hedging mix is extremely important. So what I would say is this metrics is critical when it comes to thinking about the returns, if you are going to run no duration gap the returns are nothing to ride home about, but if you are comfortable with the overall level of rates and if you can afford that incremental risk based on the position of your portfolio then I think these NIMs saw – specially when you think about the discount to book provide pretty attractive ROEs.

Eric Beardsley – Goldman Sachs & Co.

Okay thanks. Then as you balance I guess higher leverage versus going further out in a duration gap, how do you think about that and as your book value is appreciated here, how should we think about the portfolio composition moving forward as you, either maintain leverage or increased leverage on that higher equity base?

Gary Kain

Sure, so I mean it’s a great question about the trade-offs between both between leverage and duration gap in a sense both allow you to maybe increase returns of your increased leverage versus increased duration gap and right now, we feel that given the tapering process given the adjustments we’ve seen in the market, we feel that the better end approach is to maintain we call it conservative leverage with a conservative lead position to asset portfolio, and then run a somewhat larger duration gap. But one thing I’d really want to stress is that the duration gap is also consistent with the lack of extension risk in our portfolio that Peter highlighted, and that really is a key driver of this decision, because we are not just doubling down on interest rate risk many of the other components of the risk equation have kind of reduced on their own, let me have Tim add something to that.

Unidentified Company Representative

Yes, I just point out when you’re asking about the trade-off between the duration and the leverage you are actually right in that we certainly think about our risk and our risk management at the aggregate level, we actually added a page at the end of the presentation, the appendix at Page 31, but I think it’s really informative is to sort of highlighting the points that Gary was just trying to make, if you have an opportunity to look at page, what it shows you is that – and we did a comparison of where we stand with regard to our sort of duration gap, and our interest rate risk today versus where it was at the end of the first quarter of 2013.

Our extension risk in our portfolio today is actually lower given the composition of our portfolio in terms of the assets and you can see that our duration gap extension is also lower, but the final piece as to lower part of that panel actually shows how sensitive our net asset value is to a 100 basis point change in rates. And we now have a duration gap of one and a half years versus at the time, half a year, so three times the size and yet our “at risk” is only 2% higher than it was at that time. So that helps to sort of frame the aggregate risk assess. We are taking a larger duration gap. It’s giving us a better carry profile. But our aggregate risk is not very different than where it was a year ago when our duration gap was a lot smaller and that all goes to the fact that mortgages have already extended and our composition of our assets is much safer today than it was six months or 12 months ago.

Eric Beardsley – Goldman Sachs & Co.

Got it. I guess just on the point in terms of your comfort with growing the portfolio as your book value grows and either maintaining leverage here. And I guess with that risk management is there enough of the season 15 year collateral out there that you could buy and keep your composition where it is today?

Gary Kain

Yes, the short answer is, we do like the composition of the portfolio and whether interest rates drop a little further or they go up a little bit, we don't see any major changes. Certainly we don't see a significant decline in our holdings of 15 year. The other thing I would say is that we sort of have gathered incremental 15 year securities that are seasoned and we have 15 year short positions to the hedge against those for almost that exact reason which is the seasoning is really important to the whole 15 year equation and so are supporting the aggregate risk management of the portfolio. And so when you can get a hold of it and so what I would say is we’ve stored some and we will continue to do that most likely for when we want to add the product outright.

Eric Beardsley – Goldman Sachs & Co.

Okay, great thank you.

Gary Kain

Thanks.

Operator

And ladies and gentlemen we do have time for one more question, and that will come from Dan Furtado of Jeffries. Please go ahead.

Dan L. Furtado – Jefferies LLC

Good morning everybody. Thank you for the opportunity. Just one or two quick ones. On Page 15, can you help me just I guess post a skeptical question, is it if long-term over time as a long money manager in the space, we would expect these assets to pay off at par. And you are showing this box here that you know the total MBS with market discount of 100.5. What would your pushback be to somebody who would say well, the stock should be priced at 100 because that's what these assets will pay off over the long term?

Gary Kain

I think that the key thing there is that it's not really the absolute dollar price. I mean like in any bond the coupon yields or the yield that you're going to return over the course of the light of the security is going to move the price around from par irrespective of where the end price will be. I think what’s important about this example more specifically is just that it’s intended to show the difference between the value of purchasing something at a discount versus pushing it, purchasing it at 100% a book. All right and it’s really intended to show that difference and you can look at that in a lot of ways. What we’re trying to show is that even if the price to book ratio doesn’t improve over time, you are essentially getting a higher effective yield on that portfolio because of the fact that you had a lower entry point.

And so I think it’s a fair representation. Again, the number one way to use this is just think of the difference between buying the stock at 81% of book versus buying it at 100% of book. It’s not and it’s supposed to be a simplified example.

Dan L. Furtado – Jefferies LLC

Got you. Okay. And then my final question which will just be, is there any AGNC stock in that pool of common REIT holdings, the equity stock?

Gary Kain

No. I mean, the AGNC stock buybacks obviously are treated differently. They are explorations of the outstanding stock and they can’t be sold back out whereas the holdings of the other REITs are obviously just holdings, which we have the flexibility to be able to sell if we feel that that’s the right thing to do.

Dan L. Furtado – Jefferies LLC

Understood. Thanks, Gary. Appreciate the time.

Gary Kain

Thank you.

Operator

We have now completed the question-and-answer session. I’d like to turn the call back over to Gary Kain for concluding remarks.

Gary Kain

Well, I’d like to thank everyone for joining us on the Q4 2013 earnings call and I look forward to talking to you next quarter. Thank you.

Operator

The conference has now concluded. An archive of this presentation will be available on AGNC’s website, and a telephone recording of this call can be accessed through February 18 by dialing 877-344-7529, using the conference ID 10039631. Thank for joining today’s call. You may now disconnect.

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