Good morning. My name is Debbie and I will be your conference operator today. At this time, I will like to welcome everyone to the American Capital Agency Shareholders Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.
Ms. Katie Wisecarver, Investor Relations, please go ahead.
Thanks, Debbie. Thank you for joining American Capital Agency’s Fourth Quarter 2011 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 facts, 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 www.sec.gov. We disclaim any obligation to update our forward-looking statements unless required by law.
An archive of this presentation will be available on our website and the telephone recording can be accessed through February 21st by dialing 855-859-2056 and the conference ID number is 42070592.
To view the Q4 slide presentation turn to our website agnc.com and click on the Q4 2011 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 Calls section to view the streaming slide presentation during the call.
Participants on today's call include Malon Wilkus, Chairman and Chief Executive Officer; Sam Flax, Director, Executive Vice President and Secretary; John Erickson, 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; Ernie Bell, Vice President and Head of Accounting & Reporting; and Jason Campbell, Senior Vice President and Head of Asset & Liability Management.
With that, I’ll turn the call over to Gary Kain.
Thanks, Katie, and thanks to all of you for your interest in AGNC. The fourth quarter was characterized by a fair amount of uncertainty related to the European debt crisis and prepayment speeds.
As we will discuss on today's AGNC's portfolio continues to perform extremely well and we remain confident that the prepayments speeds in our assets should stay muted despite record low mortgage rates. We also continue to have very little exposure to HARP 2.0 which is likely to begin to impact speeds over the next several months.
Now, for the quarter, slow prepayments and improved valuations on lower loan balance and HARP securities helped to drive our very strong economic returns for both the quarter and for 2011 as a whole. We remain steadfastly focused on actively adjusting our asset selection strategies as the market landscape and as mortgage valuations continue to evolve.
Before discussing our results in greater detail I want to directly acknowledge the adjustment we announced yesterday to the first quarter dividend. We took this proactive action because we believed it is consistent with evolving market conditions and we are serious about transparency. I will address the dividend in my prepared remark as well as in the Q&A. But I want to be clear that we remain extremely optimistic about our ability to produce very attractive returns for our shareholders.
Now, with that, let’s turn to our slides 3 & 4 where I can review a few of the highlights. On page three, we begin by presenting net comprehensive income. We do this because GAAP net income per share has become less constructive given our decision at the end of last quarter to discontinue hedge accounting for our swaps. As such all of our hedges are now mark-to-market to GAAP income while price changes on our assets flow through the other comprehensive income line in shareholders’ equity.
Net comprehensive income is essentially a complete mark-to-market earnings number well GAAP income includes unrealized gains and losses on derivatives but not on our assets. So, our net comprehensive income was $2.27 per share. This number is comprised of $0.99 of GAAP net income and unrealized gains on our assets which are recorded in other comprehensive income of $1.28 per share.
Now, net spread income, which many of you refer to as core income, was only $0.98 during the quarter or $1.1 when we back out approximately $0.03 per share of catch up premium amortization. This result was negatively impacted by a number of factors including our mid-quarter equity risk, temporary increases in repo funding going into year-end, and high intra-quarter swap hedge ratios. It is, therefore, not necessarily indicative of a future run rate.
Again, I want to remind investors that our asset yields and spreads are based on projections of lifetime prepayments rather than just actuals speeds. We are currently projecting an average CPR of 14% for our portfolio versus our actual quarterly CPR of 9%. This projection is roughly 56% higher than what was realized in the quarter.
Now taxable net income, which is not impacted by changes in projected prepayments speeds or by unrealized losses on derivatives, remained strong at a $1.61 per share. Our undistributed taxable income increased during the quarter to a $180 million or $0.80 cents per share after adjusting the share account given our Q4 equity raise. As such, we again did not use any of our undistributed taxable income in paying our dividend.
Importantly, book value rose materially to $27.71 per share from $26.90 during the quarter. Given the combination of the dividend and our strong book value gains annualized economic or mark-to-market earnings were 33% for the quarter.
Now, as you can see on the next slide, our mortgage portfolio increased to $55 billion by quarter end. Leverage during the quarter was impacted by our equity raise and averaged only 7.6 times while yearend leverage came in at 7.9 times. Importantly, our portfolio CPR remained very tame at 9% during the quarter despite significant prepayment increases on generic mortgages. Moreover, our CPR based on the numbers published in January was only 8 CPR. And hot off the presses in the prepayment report released by Freddie & Fannie just last night are initial calculations so that our CPR was again only 8. So now you have two of our three months of speeds for the first quarter and they are both 8.
Despite noticeably higher repo rates and a faster projected CPR our net interest spread as of quarter end remained flat versus Q3 at a 194 basis points. This is a key point and shows that while we are in a lower spread environment, NIM at the end of Q4 would actually have been higher than as of September 30 had repo rates not temporarily spiked.
Lastly, we were very pleased with the timing of our October equity raise which was executed when our book value was at a local low point as mortgage prices had underperformed due to prepay and rate fears. Since the equity raise we have seen significant book value appreciation.
Now, let’s now turn to slide five and we can discuss the action that we took on the dividend. Given that this is the first time in two and a half years that we adjusted our dividend and given our practice of being as transparent as possible, we decided it was important to preannounce or announce this dividend change with our earnings release. The Q1 dividend of a $1.25 per share corresponds to a yield of approximately 17% at a stock price of around $29.5. Clearly this is a very attractive return in today’s market given a ten-year treasury yield of around 1.9%.
Now, look our proactive decision was based on our practice of establishing a given level that is consistent with the market conditions, that allows us to distribute our taxable income in accordance with referrals, that is not expected to reduce our book value over time, and importantly, that should not require regular quarterly adjustments over the near term.
Said differently, and this is the key point, we believe that the dividend should sustainable for a reasonable period of time given current market conditions and our best estimate of future financial performance.
As we’ve done consistently in the past we remain comfortable not immediately distributing all of our taxable income. Maintaining some undistributed taxable income which is currently at $0.80 per share significantly reduces our need for quarterly dividend adjustments.
Now, some of you maybe thinking that we could have maintained the $1.40 for at least several more quarters and we don’t disagree, however, we felt that the new dividend is more consistent with current market conditions and should give investors more confidence in our ability to maintain the dividend.
Recent statements and actions by the Federal Reserve imply a funding and return environment characterized by somewhat lower stress, but with attractive returns are likely to be available for relatively long period of time.
Now, lastly, I do want to stress the dividends are inherently uncertain and can be impacted by market conditions, changing financial performance and other unforeseen developments and for a complete list of risk factors that can impact the business and, therefore, dividends please refer to our recent 10-Qs and 10-Ks.
I anticipate that we will likely discuss this further in the Q&A portion of the call. So why don’t we turn to slide 6 and take a quick look at AGNC's performance during 2011.
As we have stressed for the last few years, let's focus on the economic return analysis depicted on the top right. In our opinion, this is the best measure of total value added for shareholders as it captures both dividends and changes in book value. It is also a mark-to-market number where unrealized and realized gains are treated equally. By this measure AGNC produces a 37% economic return by growing book value over 14% and paying $5.60 per share in dividends. This result exceeded the strong 32% economic return number Agency put up during 2010.
Now, as you can see on the bottom right, a key driver of this performance was our continued ability to manage our exposure to prepayments, despite falling mortgage rates and elevated speeds on generic mortgages during the second half of the year. And while we are proud of these results, we recognize the opportunities and the risk that lay ahead may differ from those looking backwards. And we are committed to actively managing our portfolio in an effort to appropriately balance the trade-offs between both risk and return. But as Chris will discuss later, we believe our portfolio is very well positioned as we enter 2012. So with that said, lets turn to slide 7 and look at what happened during the quarter.
The tables on the upper left show interest rate movements during the quarter were actually fairly muted for a change. The swap curve flattened as the European debt crisis push shorter swaps spreads wider, but shorter-term treasuries had little room to rally further. On the bottom left and on the top right, you can see that fixed rate mortgage prices were generally up between a few ticks and one half of a percentage point.
Now, some of you may be trying to reconcile our book value growth with this slide where mortgage prices really didn’t move that much. Well, if you turn to slide 8 the picture should get a lot clear. As you can see in the graph the prices a pools back by a HARP loans significantly outperformed more generic securities in the fourth quarter. More specifically, the highest LTV HARP pools with 4.5% coupons depicted in blue on both the graph and in the table increased in price by a full percentage point more than generic mortgagees. Said another way, while 30-year four and a half’s were one of the better performing coupons going up almost three-eighth of a point in price, higher LTV HARP pools appreciated almost four times as much.
Lower loan balance pools shown in gray also performed very well during the quarter outperforming generic mortgages by around half a point. Now, this incremental price appreciation on the types of assets that Chris highlighted for you on prior calls materially enhanced our book value performance during the quarter.
There is another thing really that this graph shows, and that is a that markets are not always efficient. The payouts which are what that market cause the incremental price difference for HARP or loan balance pools versus TBA securities were very low earlier in the year and remained relatively subdued even when rates began to plummet during the third quarter. Ironically, you could have bought HARP Securities at a lower price than generic mortgages at the end of the first quarter of 2011.
So why is that? Because factor in the market was complacent around prepayments speeds and only cared about yield and the added liquidity provided by TBA or generic mortgages. However, as rates fell and prepayment fears intensified, the price performance in the slower prepaid mortgages began to significantly outperform more generic stuff.
Furthermore, in the fourth quarter, when the beneficial speed performance was now undeniable and HARP 2.0 changes were finalized, these price premiums took yet another leg off.
So far this quarter both generic mortgages and our specific holdings continue to perform very well. Prices of generic 30-year, 4.5s are up more than a quarter of a point in price since quarter end and some HARP and loan balance pools have appreciated almost double that amount. And now, while it’s clearly early in the quarter this performance has provided a tailwind to book value as we begin 2012.
So with that, let’s quickly look at slide nine, which shows an updated version of the prepayment differences we've reviewed on a number of prior calls. Consistent with the pricing chart we just went over, the prepayments on both HARP and low loan balance securities continue to significantly outperform those of more generic mortgages.
Mortgage rates though are back at their all time lows and many leading indicators such as the Refi Index are back near their highs. These factors coupled with the changes of the HARP program are likely to negatively impact speeds over the next several months. So this is certainly again no time to be complacent about prepayments.
So with that, let me turn the call over to Chris to discuss how we have positioned the portfolio against this backdrop.
Thank you, Gary. Let’s turn to slide 10 to review the composition of our investment portfolio. If you recall during the third quarter earnings call, we discussed our extensive holdings in securities backed by lower loan balance loans and those originated through the HARP program.
During the fourth quarter, as Gary mentioned, these positions materially outperformed more generic TBA securities. And while we still light pools backed by lower loans balances and loans originated through the HARP program, we selectively reduced our holdings given the significant improvement in valuations. We increased our exposure to lower coupon 20-year and 30-year MBS as we felt it was both prudent to diversify and the relative risk in returns were compelling.
On average, prepayments speeds continued to be very well contained despite record low mortgage rates. Our projected average lifetime CPR increased from 13% CPR to 14% CPR due to a combination of lower rates and portfolio composition. Let’s turn to the next slide for more detail on why we continue to believe that we are well-positioned for the future.
Despite monetizing some of our performance in lower loan balance and HARP securities our portfolio remains heavily weighted towards both of these strategies. With more than 90% of our 15-year position backed by loans that were originated through the HARP program we will have a original loan balances less than or equal to $150,000. Within the 30-year category nearly 70% of our holdings are backed by either HARP loans or loans with lower loan balances. The other category is comprised primarily of newly originated 30-year MBS with lower coupons to help mitigate prepayment risk.
To further improve our disclosure this quarter we have added a more detailed breakdown of our projected lifetime CPRs. While the projected speeds which drive our reported asset yields are significantly higher than what the actual prepayment speeds are currently coming in you have to remember that prepayment speeds do increase as loan season primarily due to housing turnover.
As we have discussed on prior calls, we continue to maintain our disciplined approach with respect to being willing to evolve the composition of our holdings in response to the changing market environment while maintaining responsible diversification.
With that, I will turn over the call to our Chief Risk Officer Peter Federico.
Thanks Chris. Today, I will provide a brief update on our financing and hedging activities. I will begin by reviewing our financing summary on Slide 12. As Gary mentioned, our repo cost increased significantly from 28 basis points in the third quarter to 40 basis points in the fourth quarter. This 12 basis point increase was driven primarily by year end funding pressures which were so much stronger than usual due to concerns related to the European debt crisis. Since yearend balance sheet constraints have eased and repo rates have decreased about 10 basis points bringing our short term borrowing cost back in line with the longer run average.
Additionally during the quarter, we extended the average maturity of our repo funding. The weighted average original days to maturity of our repo funding increased significantly from 57 days at the end of the third quarter to 90 days at the end of the fourth quarter. Looking ahead, we will continue to source funding from across the full spectrum of the repo funding curve.
Turning to our hedging summary on Slide 13, I will briefly discuss our derivative activity during the quarter. First, our pay fix slab portfolio increased slightly from $27 billion at the end of the third quarter to just over $30 billion at the end of the fourth quarter.
On average during the quarter, our paid fix swap portfolio covered 63% of our repo funding, a significant increase from the 52% in the third quarter. As we discussed earlier, this increase in our swap portfolio was one of the factors that contributed to our lower net spread income in the quarter.
Despite the increase in our asset portfolio during the quarter, the notional balance of our put swaptions portfolio remained unchanged at $3.2 billion. The timing of our swaps in activity is heavily dependent on the price of these options. For most of the fourth quarter implied volatility or said in other way, the markets expectations about the volatility of future interest rates was very high. This in turn caused the prices of swaptions to be elevated for most of the quarter.
Late in the quarter, however, as implied volatility in swaption prices fell, we opportunistically replaced $1.2 billion of put swaptions that had expired earlier in the quarter. Since year-end swaptions prices have continued to fall and we in response have continued to grow our swaption portfolio. As of the end of January, our put swaption portfolio totaled $4.6 billion, a 44% increase from the year end balance.
Before turning the call back over to Gary, I would like to briefly discuss slide 21, which provides a reconciliation between GAAP net interest income and our non-GAAP measure which we refer to as net spread income. The key difference between these two measures relates to the geography of interest expense associated within our swap portfolio. Prior to terminating hedge accounting at the end of last quarter, the interest expense associated with these swaps was recorded in GAAP interest expense.
Today broadly speaking, interest expense associated with these swaps that were previously in hedge relationships continues to be recorded through GAAP interest expense. As shown on the table that expense was $53.6 million in the fourth quarter. All other swap related interest expense is recorded through other income. That expense is showing on the table with $33.3 million in the fourth quarter. The combination of these two numbers represents the total interest expense associated with our swap portfolio and, therefore, should be included in net spread income.
And with that, I will turn the call back over to Gary.
Thanks Peter. And as you guys can see in the left most columns of slide 15. our net spreads as of quarter end remained unchanged from September 30th at 194 basis points. This result includes the roughly 12 basis point higher repo cost embedded in the year-end results that Peter mentioned.
Our 194 basis point NIM is also based on our 14% prepayment projection and would have been closer to 210 basis points, had we used actual prepayment fees. The 210 basis point number is likely more comparable to our peers, which we believe use actual quarterly CPRs. Also of note is the decline in our total operating expenses, which are now down to less than 160 basis points.
Now, as you can see at the bottom of the page, our net ROE as of December 31, totaled just under 17%. Now remember, this number does not include any assumption around realized gains and includes the elevated repo cost.
So now let's turn to page 15, so I can conclude by giving you a little more transparency into what we think the future might hold as we begin 2012. First, as I mentioned earlier, we remain optimistic that we can continue to produce strong results for our shareholders. We continue to believe that the repayments on our portfolio will remain well-behaved and we've given you two months of speeds for this quarter so far. We also have very little HARP 2.0 exposure and our asset yields already incorporate significant increases in speeds versus where our portfolio was currently prepay.
In addition, as Peter mentioned earlier, repo rates have come down close to 10 basis points and the Fed has communicated its expectation that short rates will remain near zero and until at least the latter part of 2014.
Now, one other thing to keep in mind is the benefit, our book value increases have had on our earnings power. As book value grows, it facilitates a larger portfolio and greater earnings even assuming that leverage remains the same. As such, the $5.48 of incremental book value gains that we have achieved over the past two years makes generating a fixed amount of earnings per share considerably easier than it would have been in the past.
So with that, let me turn the call back to the operator and open the lines for questions.
Your first question comes from the line of Arren Cyganovich.
Arren Cyganovich - Evercore Partners
Just kind of getting drilling down on to the spread income, I know you kind of walked through some of the benefits that you all have in terms of lower cost response with repo getting back to normal, but can you talked a little bit about the reconciliation of why the 1.01 spread income is not a good run rate for the quarter relative to the 1.25? And what pieces of your portfolio will actually help you reach that more sustainable dividend level without I guess the benefit of realized taxable gains that you have in the quarter?
Yeah, sure. Look, I think what I would tell you, I mean first of all as we said on the call we did do a mid-quarter equity raise, and one thing that was a little different about this equity raise is clearly the market environment in Q4 was more volatile than, let's say, its had been in the past. So in the past we had tend to pre-buy securities for our equity raises, and so you didn’t see as much of an impact due to kind of a time lag for purchases. Clearly, given the market environment in the fourth quarter we would have been less comfortable and were less comfortable doing that. So that’s one factor.
Clearly, you had changing composition of the swap book relative to the asset book and timing differences there. We obviously talked about repo rates. But I think more importantly for you in terms of getting a feel for kind of, we call it, our economics would be let’s look back to page 15 for a second because it has our asset yield as of 12/31 which is 3.07%. It has our cost of funds and again this is the elevated cost of funds of 113 which brings you down to a net margin of 194 basis points.
When you apply the leverage that we had then that brings you up to a gross ROE of 18.5. And again and without any benefits of active management or UTI or any other of those issues your looking at a net ROE that’s pretty close to 17%. And if you just, if you then say just look at the repo rates and say well that’s maybe not for the first quarter but when they normalize given the decline we’ve seen, if they normalize by 10 basis points right, that will bring that net ROE probably to the mid 17s. And if you just do a mathematical calculation on a mid 17s ROE with a book value of $27.71 that gets you to the low 20, $1.20s in earning per share. So that is not a forecast. It’s just a mathematical calculation of defining the net our way, but I think that’s a much better starting point than looking at a noise intra-quarter number.
Arren Cyganovich - Evercore Partners
That’s helpful. And then, also what would you say in terms of spreads on new investments that you are putting on relative to the 194 that you ended up at the end of the quarter?
Surprisingly, they are not really that different. I think if you can find attractive mortgage securities you are still in the area of a couple of hundred basis points, so to speak. And the reason for that is 30-year mortgages are in the low 200s may be two in a quarter again if you can pick good securities, 15-years are clearly lower than that. And more like in the 1.50 to a 1.75 area depending on which coupon. So, I mean the returns are fine on new purchases given the fact that swap rats are very low, I think what you just have to be cognizant of is that we continue to be in a lower rate environment where you have to continue to be very selective around what assets you had.
Your next question comes from the line of Jason Weaver with Sterne Ag.
Jason Weaver - Sterne Ag
(Inaudible) capital works very quickly. Gary, just on the tail of your comment regarding not using the undistributed income to maintain the dividend, I am just trying to understand if the purpose as you backed up is to avoid making quarterly changes to the payout going forward, and how does that not applied now? Am I to understand that 1.25 level is your assumption of a long-term sustainable rate?
Okay. So, let me take that in two pieces. I think the first piece here a question was you cut the dividend even though you had lots of UTI, so what does UTI mean? And look, what I would say is UTI or Undistributed Taxable Income allows us to continue to pay dividends even if taxable income disappoints for a few quarters. And therefore, it would support us paying a dividend that was otherwise consistent with market conditions and not really have to worry about again a weaker quarter here or there. So, it really removes taxable income as a constraint for some period of time on the dividend but it doesn’t mean and if you look at our dividend paying history its never meant that we are going to maintain a particular dividend until we spent all of our undistributed taxable income. That’s not the way we look at it.
And, the key drivers of the new dividend again which is roughly 17% is around being consistent with the current environment as we see it and having a dividend you know that I think investors can have more comfort in are relative to 1.40 and our hope is the $1.25 ends up being very similar to what 1.40 was two and half years ago.
Jason Weaver - Sterne Ag
Got it, thank you. And just turning to slide 11, where you detail the different measures of prepayment protection I noticed that you don’t list any of the 20-year securities but in the reference it looks like most of those are, either or the both either low coupon and relatively new originations type stuff. And I am just wondering why that wasn’t listed as newly seasoned low coupons, it’s the limited prepayment risk?
Well I mean, we chose two strategies to highlight in those - on that page and so we really took the bigger portions of the portfolio, 20-year is roughly 10% and so we detailed really a long but two kind of main strategies that we have talked about historically. To your point we have added 20-year mortgages and those are kind of very new low coupons but they are not low loan balance or for the most – there is very little low loan balance or HARP securities in there, there are some.
I want to be clear even in some of the other categories in 15-year and 30-year, there are some securities that offer, kind of favorable prepayment attributes. So, as an example, there are some securities with loan balances that are between 1.50 and 1.75 that we actually include in the other category, there are other things that we look at such as the FICO scores and borrowers and other kind LTV related issues and geographies that can go in there.
So, you shouldn’t assume that anything that’s not in loan balance or in HARP is just a generic mortgage security that we're -- that we are nervous about. So hopefully that helps.
Jason Weaver - Sterne Ag
Yeah definitely. And then finally one last question, looking at your duration gap table and I know the limitations of modeling something like that but with zero net duration it seems that its parenting. Is your expectation that you are expecting rising long term rates or is the reasoning that the duration estimates look artificially low on your pre-paid protected pools?
So, with respect to we were extracting higher rates, the answer is no. It’s not that we are, we really want to and we’ve stressed this in the past. I think Peter has highlighted this over the last few calls since he’s joined us as well. We’re not trying to make big picture calls on interest rates. We need to have and we’re dedicated to having our portfolio performed in either case.
What’s interesting is that when interest rates are at lows like today and when mortgage durations or you know the price sensitivity of mortgages are at their lows like near two years then you don’t want to run a big duration gap from a risk perspective. Why? Because the risk is much more so to the durations getting longer. So if interest rates went up 200 basis points or more the duration of this portfolio may go to near five years. And so if you think of mortgages is having this range of 2 to 5 or 1.5 to 5 or whatever you want to apply, the closer you get to the low end the less willing you should be from just an overall risk perspective to run a large duration gap, and I think that’s really the key driver of the positioning rather than our view on interest rates.
Your next question is from the line of Bill Carcache with Nomura.
Bill Carcache - Nomura Securities
Good morning, thanking you for taking my question. Can you tell us what portion of the $136.6 million loss on derivative instruments in the P&L is unrealized?
Yeah, this is Peter. Let me give you a quick break down of that. There is really three components to that $136 million number. One is the $33 million that we referred on the table on page 21 related to our interest expenses associated with the swaps. There’s about another $17 million associated with realized gains/losses. It’s a realized loss associated with TBA and treasury hedges. And then the residual which is about $86 million is the unrealized loss associated with our swap portfolio.
Bill Carcache - Nomura Securities
Okay and so I appreciate that you’re no longer applying hedge accounting but from the standpoint of trying to strip out the impact of unrealized gains and losses, if we’re trying to do that what are your thoughts on essentially taking the $86 million unrealized out of the reported number to get to something closer to I guess a little bit more of an apples and apples number that since that won’t include the effect of unrealized gains and losses on either the swaps or the asset side of your balance sheet?
I think that that’s one way of approaching. I think though that if you start may be looking at page 21 slide 21, I think it might be easier if you trying to get as kind as a all in cost from an interest carry prospective associated with our swaps. I would look at two numbers on slide 21 which is the $53.6 million and a $33 million. The combination of those two numbers is the full interest expense on our swap portfolio, regardless of whether the swap was ever in a hedge relationship or not. So, together that $87 million or so million dollars would be the full cost the interest cost of the swap the pay leg versus the receive leg under $30 billion of swaps that we have.
Bill Carcache - Nomura Securities
Got it. And, just finally a big picture question. Do you think that the proceeds from a potential settlement between the banks and the AGs could be used to refinance barrowers from the non-agencies mortgage market into the FHA market? And more broadly, what do you think that could mean for as the market and the agency mortgage REITs in particular?
Well, I mean if you -- the reality is its not really going to affect the agency market very much in that anything on that front would relate up repayments or non-agencies which generally speaking for non-agencies is a good thing. We only kind of ramification would be as FAJ or Jenny production picks up could that impact the technical factors for the agency market, and the short answer is very little. And, there is basically negligible new supply of agency mortgages and I think that supply would be easily absorbed and it wouldn’t be that big picture of an issue.
Generally speaking, just keep in mind when it comes to any of these settlements anything that Freddie or Fannie would do with respect to how they treat to link with loans. The GFEs post 2010, have a policy of pulling out loans that are 120 days of delinquency. So, kind of any of the loans that will be -- that even if they were working them out differently really won’t affect prepayments on the underlying securities as they are already been pulled out.
Next question comes from the line of Douglas Harter with Credit Suisse.
Douglas Harter - Credit Suisse
Thanks. Gary, I was just hoping you could talk a little bit about your hedging strategy now that the fed said that there is going to be on hold for longer if anything changes with that?
Sure. Look, I think what Peter outlined is a direction and we very likely will continue to go which is we like buying -- we feel that obviously four or five years (inaudible) interest rates are going to be reasonably well pegged, so let’s face it, what's the risk factor on interest rates, it's really beyond the five-year that’s the curve could steepen and inflation fears or other factors such as dollar-related issues could push the back-end of the curve up. And so we are kind of, we like the hedging strategy of kind of buying out of the money, put options being (inaudible).
The key thing to do to protect book value against that kind of move. So, when you look at our position as its evolving, the prepayment protection that Chris described in the portfolio kind of allows us to perform if rates stay low or go lower, or in a QE3 environment. And the combination of the hedges that Peter outlined and specifically with the out of the money put swaptions would certainly help in a rising rate environment.
Douglas Harter - Credit Suisse
So, I mean just going forward, would we expect to see more of the sort of the regular way swaps run off and be replaced by swaptions?
Yeah, and you will see new swaps, I don't want to tell you we’re done using swaps. It’s clearly not the case though it remains a main major part of our hedge book, but I think if, I mean, to Peter’s earlier point, it's very much a function of volatility. We like the idea of using out of the money options, but weren’t going to buy any at the end of September and early October when volatility was through the roof, so to speak, and the price of those options was very expensive. Option prices have come down a lot this year and if option prices are pretty cheap, I think you can expect to see more of those.
Your next question is from the line of Bose George with KBW.
Bose George - KBW
Good morning. I just wanted to revisit the issue of repayments, you noted your portfolio speeds are running at 8% like your assumptions are 14%. In terms of reconciling the two, should we assume that your view is that prepaids are going to pick up pretty meaningfully in your portfolio? And secondly ,if it doesn't in the couple of quarters, you have to kind of true down and sort of bring it back down and produce the amortization for one quarter?
So, very good question. The reality is the way we produce our projected prepayment fees is, and I've talked about this on prior calls, it's not like the management team gets in a room and decides that 14% looks like the right number. We use a very well-known Blackrock Solutions, third party solution to come or a system to come up with our prepayment estimates and they are driven by factors such as obviously, interest rates, mortgage prices, house prices, all of the factors that we all talk about. And they make updates to their models periodically and some to keep them up to date. So, there are things like that, that could happen.
One thing you want to keep in mind with respect to the prepayment estimates is that we do have some newer mortgages. And newer mortgages as they season tend to pick up in speed. So, a brand new mortgage that’s one or two months old typically pays a very low CPRs. Well, we don’t like the idea of assuming a two CPR because it paid there in the second month for the life of the security; we want to use a longer run number, and that’s one of the things that’s captured in those differences. Now, there are other things captured in those differences such as how HARP loans prepay versus kind of reality, and those are the kinds of things that we will revisit over time as we get new information and as the market environment changes.
Bose George - KBW
Okay great thanks makes a lot of sense. And then I just a macro question there is an article in the Journal today just on potential changes to the money market industry. I'm curious if you had any thoughts about how any changes that industry could potentially impact the repo funding markets? Do you think if there is any sort of cross over there?
We are really not concerned about it. I mean again the repo market is extremely deep the reality is that there is plenty of short term money on the sidelines right now and agency repo or US government type securities are a necessary thing for people to invest in both money funds and banks and plenty of other institutions. We have just seen kind of really good stability there. So the short answer is no, we are not concerned.
Your next question is from the line of Joel Houck with Wells Fargo.
Joel Houck - Wells Fargo
Just, Gary, as a follow up on the higher CPR assumption is another way of looking that is that is it the average age launching your portfolio is newer than it was several quarters ago because if you look at it seems to be the only logical explanation because the prepayment speeds for Fannie & Freddie now have been coming down a couple of months obviously your own portfolio is well behaved, so its seems like its either really conservative or some other shift in the portfolio that we don’t see in the slide presentation?
Well look, I mean the portfolio was newer so that is a factor but I do want to also point out that while prepayments speed actuals or have slowed down over the last couple of months, as Chris said in his prepared remarks we mortgage rates are now back down at their all time lows again, and so it may be we’re not going to look at the actual speed we just saw two months ago based on rates two months ago when mortgage rates were maybe 40 basis points higher. So practically speaking, there’s a combination of the fact there are newer mortgages. Another piece is that we have some unique types of mortgages that continue to perform very well and maybe performing well relative to model estimates. But also keep in mind that mortgage rates have come back down.
Joel Houck - Wells Fargo
Maybe a follow-up on it, Gary. Is it possible that the Blackrock model because obviously based on historical relationship between changes in rate and refi are prepaid is perhaps overly conservative because of all the friction cost and I mean I hear just saying about rates are now historically lows, but we’ve been in a very favorable prepayment environment now for quite a while and we’re just not seeing the follow through and perhaps that changes, but I guess the question is, is there any consideration that the model is too conservative?
Look we are going to continuously review the model along and do you know if Blackrock reviews it our auditors look at it and you know this clearly tests for reasonable miss, and we’ll continue to monitor it as we get new data. Let me give you an example where focus probably over time over the quarter or two will be higher which is the best example are HARP securities. Okay, the prepayment advantages afforded by HARP securities are not something that’s easy to model looking backwards. The new program alone that goes that the securities that we’re buying have gone through the HARP Program and they don’t have another refinance option.
So while Blackrock or we or anyone can make a projection about how that’s going to perform as interest rates change, there is no real reliable history to look at. So as we continue to get informed on prepayment speeds on a newer product like that, then that’s an area where you’re more likely to see model adjustments.
Lower loan balance, as an example, is something that has been there a long time and so some pretty good adjustments are being made. Are they perfect? No. Could they be revised? But I think you’re likely to see the bigger revisions, so to speak, the things like the Harp Securities.
Just to look quickly at the numbers is an example. They’re nine months old on 30-year we had $12 billion or $12.5 billion of HARP 30-year securities where the actual one month average speed was 3 CPR and our projection is 11. We’re clearly going to have to look at that over time and make sure that as we get new information we are updating our estimates.
Your next question comes from the line of Mark DeVries with Barclays Capital.
Mark DeVries - Barclays Capital
Given the strength in the prepayment particular securities you laid out in the presentation, have you seen enough richening in those forms of pay up that now on a relative value perspective those types of investments on kind of newer reinvested money are less attractive?
Well, this is Chris. Valuations have improved, but we still generally speaking like the risk adjusted returns afforded by these strategies. We did sell some of these pools during the fourth quarter versus both other call protected pools and also lower coupon 20 or 30-year passthroughs. But it’s important to recognize that even within these specified pool categories there are certain attribute that can drive materially different performance. And for example, some servicers are significantly more efficient at reaching borrowers when there is an incentive to refinance. In the case of HARP securities, loans backed by or securities backed by loans that were originated through the HARP program, while there are different pricing relationships and different pay ups for different LVT buckets two pools with the exact same LTV could have very different performance if the loan level LTV distribution is very different. And so, we will continue to look for ways to upgrade and improve our position, and I think the fourth quarter is a good example of that.
Mark DeVries - Barclays Capital
Okay, thanks. And I am sorry if you already addressed this. But were you surprised that HARP 2.0 seem to have little to no effect on the February repayments too?
Well, not really. I mean it shouldn’t have had an impact in February. If you really think about it, the changes were implemented we will call in late December. Implemented meaning that people would start taking applications. The change -- some of the key changes aren’t even in Freddie and Fannie’s systems. There would have been almost no time to close a HARP loan in January even if they were in the systems. And some of the bigger changes such as the use of automated valuations or appraisals versus actually having it appraiser out there having even been implemented now. So, I think it’s just a fallacy I mean to have expected the impact. I mean that’s why what we said and what we continue to believe is that you will start to see those effects really over the next couple of months. But I wouldn’t expect to see a one-time pop, I think what you will see is as systems get updated both at Freddie and Fannie and on the part of the originators that any impacts of HARP 2.0 will sort of gradually be phased in over the next three or so months.
Your next question comes from the line of Steven Delaney, JMP Securities.
Steven Delaney - JMP Securities
Hi, good morning everyone, just a couple of quick things. First on repo, on your page 12 in your deck, you are indicating that you believe that the repo costs have come down close to 10 basis points from the 40 basis points at the end of the year. We've heard of some quotes in the high 20s. Could you give us a little color sort of, I don’t know if you just kind of be conservative, close to 10, maybe kind of, which you are seeing is a range for 30 to 90-day quotes currently?
Hi, Steve, it’s Jason Campbell. Right now, we are averaging about 30 on one month ranging probably at mid 20s to the low 30s.
Steven Delaney – JMP Securities
And then three month is probably about 32, 34.
Steven Delaney - JMP Securities
Okay, great. ICAP is showing sort of a 25, 26 on Bloomberg and I know that's not the real market, but it’s helpful, I know there is some funding available inside of 30 basis points.
And there are people at those levels, but more generically it’s around 30.
Steven Delaney – JMP Securities
Understood. Okay, thank you for that. And then the final thing I had is, this question, the meaning to ask for some time and we can take it offline, but is it possible for you to break out of your premium amortization of $121 million, is it possible for you to give us the amount that is associated with your long IO positions?
Why don’t we take that offline, but the bottom line is, our IO position is absolutely tiny at this point. We had a larger long IO position and we were glad we had at the back in the first quarter and into the beginning of the second quarter. But as we told you, we have really reduced that position, and at this point it’s not really material.
Steven Delaney - JMP Securities
Okay, so we should just assume, I think it’s around $200 million cost from one of your slides, but what you’re saying is the vast majority of that is associated with the past service.
That’s just not going to be a driving factor.
The next question comes from the line of Matthew Howlett with Macquarie.
Matthew Howlett - Macquarie
Gary, just again on prepayment and I want to circle back to potential policy changes. I know those HARP 2.0s in the books and I know that Obama would like to expand HAMP and do this FHA short refinancing program, which is, I guess would be mainly non-agencies. But my question is, do you think is your risk to policy change that, one, HARP 2.0 could be changed again, which could one move to cut off day fall ending May ’09 to more recent (inaudible) or two allow HARP 1.0 loans to refinance to new loans? I mean is that the biggest policy risk? And what do you see, Obama, I guess, he hasn't really announced lot of details. What do you think is going to be said from him?
Well, I think we've gotten a feel for what he would like to do, so to speak, and there clearly is ambiguity there. I think there is a general perception both on our part and on the part of the mortgage market that the material changes to GSE underwriting and GSE programs are over with. The President gave his speech, there was a day maybe where mortgage prices, higher coupon mortgage prices were impacted since then they have done extremely well.
I think more instructive maybe than our opinion, which again is that we're past most of this stuff. The market seems to believe that, I mean, it’s kind of tired of hearing about this and it views there is very little risk of anything material getting through Congress. So I will start with that piece. And the one thing that people don't realize is the Treasury and HUD okay, outside of just FHFA were integral in the process to update HARP 2.0. Okay, this wasn’t everyone else complaining about FHFA on HARP 2.0 treasury and HUD were at the table. And you can see quotes and clear involvement on that front. So keep that in mind.
Now, just going to what's the worst-case scenario, yeah, probably is that basically any loan is available for the HARP program. Why is that a bad scenario? Because it means every loan is available for a streamline, a very, very streamlined refi program. But remember, we would have in essence incremental risk that the HARP 1.0 security is maybe could be refinanced in that scenario, so we understand that risk and that's exactly why we manage concentration risk.
One thing on the other side of that is lower loan balance becomes even more important in that situation. So with every loan is available for a streamlined refinance then what ends up becoming the key constrain. Capacity in the system, okay. And what is a mortgage originator or a loan officer going to do when their only issue is how money loans they can process. The first thing they are going to do is, they're going to focus on larger loans because they get paid a percentage off of that loan. And so while the HARP securities may become more normal in that scenario; the low loan balance securities in some ways become even more valuable on a relative basis because, there are really bad kind of thing to focus on for the origination society so to speak. So big picture, look, its not something we would like to see we think it’s a very low probability but I want to stress that the composition of our portfolio both in terms of coupons, in terms of loan balance is diversified and set up because there are some risks that are outside off our control.
Matthew Howlett - Macquarie
Just be clear, they have not allowed loans originated after May’09 to refinance through HARP and they are not allowed HARP 1.0 loans to refinance. That’s still of the table right as of now.
Absolutely, no one is looking at that expect that if some bill gets passed could that change, yes or -- but absolutely it is not allowed at this point, and but I want to make very clear is that - that has given a lot of discussion and thought when the HARP 2.0 changes were made. and there were some very logical reasons why FHFA, HUD and treasury decided not to change the dates.
As Chris mentioned to you and as we show you in the slides there are substantial what we say the pay-ups or premiums or the HARP securities. Well, what are those premiums do. Those allow borrowers who go through the HARP program now, the people that GSEs want to reach, they allow them to pay less points and less cost and have a lower rate on a new HARP loan. And so when you think about it, that’s a very important reason why it may not be in the best interest and probably isn’t in the best interests of the GSEs or others in the government to allow HARP loans to re-HARP because that pay up will be much smaller. So again something they gave a lot of thought to something they left in place, it would take a kind of a pretty big change at this point probably be an act of Congress can change that.
Matthew Howlett - Macquarie
Just a little last pop on that question, there has been new suggestions that they could get -- Obama could just replace the DeMarco. He's been holding this process apparently to recess appointment, I mean what do you handicap that at?
I think what’s really important is that I am not going to try to handicap DeMarco’s job security. What I think I would rather say is that I think there is some misconception out there that DeMarco as an individual the sole reason that the HARP program isn’t broader so to speak. And DeMarco is operating under kind of under essentially orders from Congress which is that he supposed to have preserved the GSEs and also he supposed to be focused on more U.S. mortgage market and its liquidity and its viability and so forth. And so, again HUD and treasury were very involved in the HARP program and I think they had absolutely recognized a lot of these things that we are talking about.
Lastly, there is an inspector general that Congress has appointed that oversees Fannie, Freddie and FHFA who’s very active and who’s there to ensure that who ever is the head of FHFA is abiding the laws and the orders that he is given which is to protect the GSEs bottom line and not just to act as a an arm of the administration. So I think there is misconception about how critical DeMarco is in that outcome.
Unidentified Analyst: Great, thanks guys.
Operator: Your next question comes from the line of Jim Young with West Family Investments.
Jim Young - West Family Investments
Yeah, Hi Gary are you and your team have obviously navigated the market very well over the course of last year, but you start the year with assets, how was certain assets in $30.5 billion and ended the year with about $55 billion in the portfolio. So my question is what size of your portfolio do gives you a comfortable you and your team to continue to navigate the exchanges in the market to continue to produce the attractive risk adjusted returns that you have done in the past? Thank you.
Thanks for the question and what I would say is if you look at we are obviously a lot bigger than we were in 2009 and 2010. And one thing just on the surface is our economic returns which is what we told you to focus on for a while are actually stronger in 2011 than they were in 2010, if you look at our performance versus our peers, if you look our prepayments on our portfolio, if you look in the positioning relative to HARP 2.0, I think the facts are that we continue to be able to manage that.
I think to the other side of that question which is, is there are limit? The answer is yes, there is a limit. But remember that this is a $5 trillion market, where there is give or take likely to be trillion dollars of originations every year. So as big as agency could become, its still going to be a tiny percentage of the market but the reality is there is a limit and we are not going to -- we evaluate our decisions around growth, from the perspective that at this point, size is not -- it can make sense if offerings are accretive, if there is good opportunities to buy good assets but you don’t just it won’t go one go for the heck of it, so to speak.
And I think if you look over the last month, there was a lot of there was sort of lot of assumptions that AGNC was going to raise equity during the quarter. We chose during January, we chose not to and the big driver of that was we didn’t feel that it was the right thing, given the number of factors including the growth and book value both last quarter and what we are seeing so far this quarter.
And your next question comes from the line of Mike Widner with Stifel Nicolaus.
Mike Widner - Stifel Nicolaus
Two quick questions, most of the my questions is already been addressed here but just following up one of the things you mentioned in the course of conversation at the outset, Gary, you guys do have a history sort of pre-buying when you MBS opportunities that are attractive and then raising the capital. You noted specifically though that last quarter, the capital rates kind of mid-quarter was an exception to that. Just wondering if you could talk a little bit about how you see the opportunities for pre-buying. We had a little bit of pullback kind of mid-late January and be its prices and some recent strength but all things considered they're still attractive. How do you feel that the pre-buying opportunities now and recently?
The reality is I just go back what I said earlier. I will give you kind of two separate answers that are close as I can get to your question. First off, returns are reasonably attractive if you can find the right assets now, but they are not as attractive as they were three or four months ago, I think that’s pretty straight forward. And then the other thing is that what we told you is that we’ve obviously disclosed the book value number, we have also told you that mortgages have performed well this quarter and our specific holdings have performed well. Those are obviously both factors that go into any decision on capital raising as well as other factors are new on the market, our views on QE3 and its likelihood things like that, and really outside of that there is not much more I can add.
Mike Widner - Stifel Nicolaus
You have got some new faces over there and I think one of the interesting things may be for one of those guys and you can choose who is. I think one of the finest theses of explanatory footnotes I ever read is notes five on the bottom of page 24. And, I thought may be interesting if you can ask one of the new guys to may be explain that one for those of us that didn’t find it completely transparent.
Okay. Which one was that again can you repeat it?
Mike Widner - Stifel Nicolaus
Its footnote five on the bottom of page 24, that goes to the book value calculation.
Yeah. What we are tying to describe there refers to the table, and if you think about the capital raise impact they can have really two impacts, it can have the price that we issue stock relative to the current book value. That’s the first line. That’s the accretive nature of the capital raise which was $0.9 million. That’s why the (inaudible) refer to represents the kind of negative drag that the incremental shares had on our overall equity. So, it’s think about those two net together with a $0.06 drag to our equity. Go ahead.
Mike Widner - Stifel Nicolaus
So, I mean there the line -- there has been note that I am taking about is note five at the bottom of the page which was the negative $0.15 reference there. But that was a good piece of sort of explanation, Pete, is that right?
Mike Widner - Stifel Nicolaus
I think I know exactly what the line item is which is sort of the plug that’s necessary to make all the numbers jive, but the explanation for I think is priceless there and the way you guys put that together. And your proximity to Washington DC and legislation might have helped your wording on that one a bit?
We can take that on offline if you want to discuss it further, I mean well one thing I just want to on this subject just to close out on is again this basically applies accretion based on the closing book value. As we said earlier, book value we track it in for quarter and mortgage prices were a fair amount lower. And, we are extremely confident that the equity raise was accretive and I think it’s kind of pretty obvious after the fact that it was good timing.
Mike Widner - Stifel Nicolaus
Yeah. Well, I don’t doubt that at all. There is really more specifically the language of that footnote that was wonderful.
We have to answer one final question from the line of Daniel Furtado from Jefferies.
Dan, are you there? Well, thank you guys for your interest in AGNC. And at this point, we will close the call.
This concludes today's conference. You may now disconnect.
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