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| AGNC > SEC Filings for AGNC > Form 10-Q on 22-Oct-2009 | All Recent SEC Filings |
22-Oct-2009
Quarterly Report
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide a reader of American Capital Agency Corp. consolidated financial statements with a narrative from the perspective of management. Our MD&A is presented in five sections:
• Executive Overview
• Financial Condition
• Results of Operations
• Liquidity and Capital Resources
• Forward-Looking Statements
EXECUTIVE OVERVIEW
American Capital Agency Corp. (together with its consolidated subsidiary, is referred throughout this report as the "Company", "we", "us" and "our") is a real estate investment trust ("REIT") that invests exclusively in single-family residential mortgage pass-through securities and collateralized mortgage obligations on a leveraged basis. These investments consist of securities for which principal and interest are guaranteed by government-sponsored entities such as the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"), or by a U.S. Government agency such as the Government National Mortgage Association ("Ginnie Mae"). We refer to these types of securities as agency securities and the specific agency securities in which we invest as our investment portfolio.
We were organized on January 7, 2008, and commenced operations on May 20, 2008 following the completion of our initial public offering ("IPO"). In connection with the IPO, we sold ten million shares of our common stock at $20.00 per share for net proceeds of $186 million, net of the underwriters' commission and other offering expenses. Concurrent with our IPO, American Capital, Ltd. ("American Capital") purchased five million shares of our common stock in a private placement at $20.00 per share for aggregate proceeds of $100 million. In July 2009, through a public secondary offering, American Capital sold 2.5 million shares of our common stock that it had purchased in the private placement. In August 2009, we completed a follow-on public offering of a total of 4.3 million shares of our common stock, including the over-allotment, at $23.30 per share. Upon completion of the offering we received proceeds, net of the underwriters' discount and other offering costs, of approximately $95 million. Our common stock is traded on The NASDAQ Global Market under the symbol "AGNC".
We are externally managed by American Capital Agency Management, LLC (our "Manager"). Our Manager is a wholly-owned subsidiary of American Capital, LLC, which is a wholly-owned portfolio company of American Capital. We do not have any employees.
Our principal objective is to generate net income for distribution to our stockholders through regular quarterly dividends from our net interest income, which is the spread between the interest income earned on our investment portfolio and the interest costs of our borrowings and hedging activities. We fund our investments through short-term borrowings structured as repurchase agreements. Since our IPO, we have declared or paid dividends of $6.26 per share.
We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"), commencing with our taxable year ending December 31, 2008. As long as we qualify as a REIT, we generally will not be subject to federal income taxes on our taxable income to the extent that we annually distribute all of our taxable income to stockholders.
Recent Developments
Our business is affected by general U.S. residential real estate fundamentals and the overall U.S. economic environment. In particular, our strategy and performance is influenced by the specific characteristics of these
markets, including prepayment rates, interest rates and the interest rate yield curve. Our results of operations primarily depend on, among other things, the level of our interest income and the amount and cost of borrowings we may obtain by pledging our investment portfolio as collateral for the borrowings. Our interest income, which includes the amortization of purchase premiums and accretion of purchase discounts, varies primarily as a result of changes in prepayment speeds of the agency securities and the size and composition of our investment portfolio. Our borrowing costs vary based on changes in interest rates and changes in the amount we can borrow which is generally based on the fair value of our investment portfolio and the advance rate the lenders are willing to lend against the collateral provided.
Since the middle of 2007, banks, investment banks, independent finance companies and insurance companies have announced extensive losses from exposure to the U.S. mortgage market. These losses have reduced financial industry capital leading to reduced liquidity for mortgage assets, more volatile valuations of mortgage assets and in some cases forced selling of mortgage assets. As a result, there was less financing available on attractive terms for mortgage assets in 2007 and 2008.
In response, actions by the U.S. Federal Reserve ("FRB") and the U.S. Department of Treasury ("U.S. Treasury") appear to have helped to stabilize the investing and financing environment for agency securities. The liquidity facilities created by the FRB during 2007 through 2009 and its lowering of the Federal Funds Rate target to a range of 0.00% to 0.25%, along with the reduction of the 30-day LIBOR to 0.25% as of October 16, 2009, have lowered our financing costs and stabilized the availability of repurchase agreement financing.
Due to increased market concerns about Freddie Mac and Fannie Mae's ability to
withstand future credit losses associated with securities held in their
investment portfolios, and on which they provide guarantees, without the direct
support of the federal government, the government passed the "Housing and
Economic Recovery Act of 2008" on July 30, 2008. As a result of this
legislation, Fannie Mae and Freddie Mac have been placed into the
conservatorship of the Federal Housing Finance Agency ("FHFA"), their federal
regulator, pursuant to its powers under The Federal Housing Finance Regulatory
Reform Act of 2008, a part of the Housing and Economic Recovery Act of 2008. As
the conservator of Fannie Mae and Freddie Mac, the FHFA now controls and directs
the operations of Fannie Mae and Freddie Mac and may (i) take over the assets of
and operate Fannie Mae and Freddie Mac with all the powers of the stockholders,
the directors, and the officers of Fannie Mae and Freddie Mac and conduct all
business of Fannie Mae and Freddie Mac; (ii) collect all obligations and money
due to Fannie Mae and Freddie Mac; (iii) perform all functions of Fannie Mae and
Freddie Mac which are consistent with the conservator's appointment;
(iv) preserve and conserve the assets and property of Fannie Mae and Freddie
Mac; and (v) contract for assistance in fulfilling any function, activity,
action or duty of the conservator.
In addition to FHFA becoming the conservator of Fannie Mae and Freddie Mac,
(i) the U.S. Treasury and FHFA have entered into separate preferred stock
purchase agreements with Fannie Mae and Freddie Mac pursuant to which the U.S.
Treasury will ensure that Fannie Mae and Freddie Mac maintain a positive net
worth; (ii) the U.S. Treasury has established a new secured lending credit
facility available until December 2009 to Fannie Mae, Freddie Mac and the
Federal Home Loan Banks, which is intended to serve as a liquidity backstop; and
(iii) the U.S. Treasury has initiated a temporary program to purchase
residential mortgage-backed securities ("RMBS") issued by Fannie Mae and Freddie
Mac. Given the highly fluid and evolving nature of these events, it is unclear
how our business will be impacted. Based upon the further activity of the U.S.
Government or market response to developments at Fannie Mae or Freddie Mac, our
business could be adversely impacted.
The FRB announced on November 25, 2008 that it would initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises and agency securities. On December 30, 2008, the FRB announced beginning in January 2009, it would begin purchasing up to $500 billion of agency securities and that it had selected private investment managers to act as its agents in implementing the program. Subsequently, on March 18, 2009, the FRB announced the expansion of its agency securities purchase program to a total of $1.25 trillion by the end of 2009. As part of this expansion, the FRB also decided to purchase $300
billion of U.S. Treasury securities as well as an additional $200 billion of debt issued by Fannie Mae and Freddie Mac. On September 23, 2009, the FRB announced that it will gradually slow the pace of its agency securities purchase program to promote a smooth transition in the markets and anticipates that the $1.25 trillion program will be completed by the end of the first quarter of 2010. The FRB has also announced that its program to purchase U.S. Treasury securities is expected to be completed by the end of October 2009. However, the ultimate size and timing of the U.S. Treasury and agency securities purchase programs are subject to the discretion of the U.S. government. The impact of these events remain highly uncertain and we cannot predict whether or when such actions may occur or what impact, if any, such actions could have on our business, results of operations and financial condition.
On February 18, 2009, the U.S. Treasury announced the Homeowner Affordability and Stability Plan ("HASP"), which was intended to prevent residential mortgage foreclosures by assisting borrowers to restructure or refinance their mortgages to avoid foreclosure by:
• allowing certain homeowners whose homes are encumbered by Fannie Mae or Freddie Mac conforming mortgages to refinance those mortgages into lower interest rate mortgages with either Fannie Mae or Freddie Mac;
• creating the Homeowner Stability Initiative, which is intended to utilize various incentives for banks and mortgage servicers to modify residential mortgage loans with the goal of reducing monthly mortgage principal and interest payments for certain qualified homeowners; and
• allowing judicial modifications of Fannie Mae and Freddie Mac conforming residential mortgages loans during bankruptcy proceedings.
In addition, on July 1, 2009, under HASP, Fannie Mae and Freddie Mac announced that they were expanding the loan-to-value ratios for homeowners eligible to refinance their existing mortgages from 105% to 125%, in order to give homeowners more options to refinance into mortgages with terms that better position them for long-term home ownership.
We expect HASP to increase the availability of mortgage credit to a large number of homeowners in the U.S., which we expect will impact the prepayment rates for the entire mortgage securities market, but primarily for Fannie Mae and Freddie Mac agency securities. While increased prepayment rates negatively impact our interest income, we believe we have sourced agency securities with collateral attributes that improve the prepayment profile of our investment portfolio. However, these are new programs and therefore there is substantial uncertainty around the magnitude of prepayment speed increases and our asset selection process may not provide the desired benefits.
In March 2009, the U.S. Treasury launched the Term Asset-Backed Securities Loan Facility ("TALF"), which is a lending facility of up to $1 trillion that was created to increase securitization activity for various consumer and commercial loans and other financial assets, including student loans, automobile loans and leases, credit card receivables, Small Business Administration ("SBA") small business loans and commercial mortgage-backed securities. In July 2009, the U.S. Treasury expanded the categories of TALF-eligible collateral to include certain high-quality commercial mortgage-backed securities issued before January 1, 2009. The FRB and U.S. Treasury also indicated that they continue to assess whether to expand TALF-eligible collateral to include legacy RMBS as an eligible asset class.
In July 2009, the U.S. Treasury, FRB and FDIC announced the details of the Legacy Securities Public-Private Investment Program ("PPIP"). Under PPIP, the U.S. Treasury will invest up to $30 billion of equity and debt in public-private investment funds established with private sector fund managers and private investors for the purpose of purchasing legacy securities. Initially, this program will participate in the market for commercial mortgage-backed securities and non-agency RMBS. The U.S. Treasury has pre-qualified nine fund managers in the initial round of the program and has recently announced the initial closings of PPIP funds established under the program.
Our Manager
We are externally managed and advised by our Manager pursuant to the terms of a management agreement. Because we have no employees or separate facilities, we rely on our Manager to administer our business activities and day-to-day operations, subject to the supervision and oversight of our Board of Directors. Effective July 1, 2009, Gary Kain, our Senior Vice President and Chief Investment Officer, and several other American Capital employees became full-time employees of our Manager. These organizational changes provide our Manager with a dedicated investment team and support personnel. Our Manager has also entered into an administrative services agreement with American Capital, pursuant to which our Manager has access to American Capital's employees, infrastructure, business relationships, management expertise and capital raising capabilities, which allow it to fulfill all of its responsibilities under the management agreement. Certain of our Manager's officers are also members of American Capital's senior management. Effective October 19, 2009, Gary Kain was promoted to President and Malon Wilkus was promoted to Chief Executive Officer of our Manager.
Our Investment Strategy
Our investment strategy is to build an investment portfolio consisting exclusively of agency securities that seeks to generate attractive, risk-adjusted returns. Our Manager has established an investment committee comprised of its officers. The investment committee has established investment guidelines that have been approved by our Board of Directors. The investment committee can change our investment guidelines at any time with the approval of our Board of Directors. The following are our investment guidelines:
• no investment shall be made in any non-agency securities;
• our leverage may not exceed 10 times our stockholders' equity (as computed in accordance with accounting principles generally accepted in the United States ("GAAP")), which we refer to as our leverage threshold. In the event that our leverage inadvertently exceeds the leverage threshold, we may not utilize additional leverage without prior approval from our Board of Directors or until we are once again in compliance with the leverage threshold;
• no investment shall be made that would cause us to fail to qualify as a REIT for federal income tax purposes;
• no investment shall be made that would cause us to be regulated as an investment company under the Investment Company Act; and
• prior to entering into any proposed investment transaction with American Capital or any of its affiliates, a majority of our independent directors must approve the terms of the transaction.
Agency securities consist of single-family residential pass-through certificates and collateralized mortgage obligations for which the principal and interest are guaranteed by a U.S. Government agency or a U.S. Government sponsored entity.
• Single-Family Residential Pass-Through Certificates. Single-family residential pass-through certificates are securities representing interests in "pools" of mortgage loans secured by residential real property where payments of both interest and principal, plus pre-paid principal, on the securities are made monthly to holders of the security, in effect "passing through" monthly payments made by the individual borrowers on the mortgage loans that underlie the securities, net of fees paid to the issuer/guarantor and servicers of the securities.
• Collateralized Mortgage Obligations ("CMOs"). CMOs are structured instruments comprised of agency securities. Interest and principal, if applicable, plus pre-paid principal, on a CMO are paid on a monthly basis. CMOs consist of multiple classes of securities, with each class bearing different stated maturity dates and other differences in characteristics such as coupons, weighted average lives and rules governing principal and interest distribution. Monthly payments of principal, including prepayments, are
These securities are collateralized by either fixed-rate mortgage loans ("FRMs"), adjustable-rate mortgage loans ("ARMs"), or hybrid ARMs. Hybrid ARMs are mortgage loans that have interest rates that are fixed for an initial period (typically three, five, seven or 10 years) and thereafter reset at regular intervals subject to interest rate caps. Our allocation between securities collateralized by FRMs, ARMs or hybrid ARMs will depend on various factors including, but not limited to, relative value, expected future prepayment trends, supply and demand, costs of financing, costs of hedging, expected future interest rate volatility and the overall shape of the U.S. Treasury and interest rate swap yield curves. We take these factors into account when we make these types of investments.
As of September 30, 2009, our $3.4 billion investment portfolio was financed with $2.9 billion of repurchase agreements and $0.4 billion of equity capital, resulting in a leverage ratio of approximately 6.9 times our stockholders' equity. When adjusted for the net payable for agency securities purchased but not yet settled, the leverage ratio was approximately 7.3 times our stockholders' equity as of September 30, 2009. Financing spreads (the difference between yields on our investments and rates on related borrowings, including amortization expense related to terminated swaps) averaged 268 basis points during the three months September 30, 2009.
The size and composition of our investment portfolio depends on investment strategies being implemented by management, the availability of investment capital and overall market conditions, including the availability of attractively priced investments and suitable financing to appropriately leverage our investment portfolio. Market conditions are influenced by, among other things, current levels of, and expectations for future levels of, short-term interest rates, mortgage prepayments and market liquidity.
Our Financing Strategy
As part of our investment strategy, we borrow against our investment portfolio pursuant to master repurchase agreements with financial institutions. We expect that our borrowings pursuant to repurchase transactions under such master repurchase agreements generally will have maturities that range from 30 to 90 days, but may have maturities of less than 30 days or up to 364 days. Per our investment guidelines approved by our Board of Directors, we would need Board of Director approval for our leverage to exceed 10 times the amount of our stockholders' equity.
Our Hedging Strategy
As part of our risk management strategy, we may hedge our exposure to interest rate and prepayment risk as our Manager determines is in our best interest given our investment strategy, the cost of the hedging transactions and our intention to qualify as a REIT. As a result, we may elect to bear a level of interest rate or prepayment risk that could otherwise be hedged when management believes, based on all relevant facts, that bearing the risk enhances our risk/return profile. We may enter into interest rate caps, collars, floors, forward contracts, put and call options on securities or securities underlying futures contracts, futures or swap agreements or purchase or sell to-be-announced ("TBA") agency securities to attempt to manage the overall interest rate risk of the portfolio, reduce fluctuations in book value and generate additional income distributable to stockholders.
Summary of Critical Accounting Policies
Investments
Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities codified primarily in Financial Accounting Standards Board (the "FASB") Accounting Standards Codification ("ASC") 320, Investments-Debt and Equity Securities ("ASC 320"),
requires that at the time of purchase, we designate a security as held-to-maturity, available-for-sale or trading depending on our ability and intent to hold such security to maturity. Securities classified as trading and available-for-sale are reported at fair value, while securities classified as held-to-maturity are reported at amortized cost. Although we generally intend to hold most of our agency securities long-term, we may, from time to time, sell any of our agency securities as part of our overall management of our investment portfolio. Accordingly, we are required to classify all of our agency securities as available-for-sale. All securities classified as available-for-sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported in accumulated other comprehensive income (loss) ("OCI"), a component of stockholders' equity.
In April 2009, the FASB issued FASB Staff Position No. FAS 115-2 and 124-2, Recognition and Presentation of Other-Than-Temporary Impairment ("FSP FAS 115-2"), which is codified in FASB ASC 320-10-35 ("ASC 320-10-35"). FSP FAS 115-2 changed the other-than-temporary impairment ("OTTI") model for debt securities such that an OTTI is triggered if (i) an entity has the intent to sell the security, (ii) it is more likely than not that it will be required to sell the security before recovery, or (iii) it does not expect to recover the entire amortized cost basis of the security. In addition, if there was an OTTI charge, FSP FAS 115-2 generally required that any credit loss component of the OTTI charge be recognized in earnings and the remainder of the OTTI charge remains in OCI. ASC 320-10-35 as it relates to FSP FAS 115-2 is effective for interim and annual reporting periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. We adopted the requirements of ASC 320-10-35 as they relate to FSP FAS 115-2 as of March 31, 2009. The adoption did not have a material impact on our consolidated financial statements.
We evaluate securities for OTTI on at least a quarterly basis, and more
frequently when economic or market conditions warrant such evaluation. Based on
the criteria in ASC 320-10-35, the determination of whether a security is
other-than-temporarily impaired involves judgments and assumptions based on
subjective and objective factors. When a security is impaired, an OTTI is
considered to have occurred if (i) we intend to sell the agency security,
(ii) it is more likely than not that we will be required to sell the agency
security before recovery of its amortized cost basis or (iii) we do not expect
to recover its amortized cost basis (i.e. there is a credit loss). If it is more
likely than not that we will be required to sell the agency security before
recovery of its amortized cost basis, the entire amount of the impairment loss
is recognized in earnings as an unrealized loss and the cost basis of the
security is adjusted. If we do not intend to sell the agency security but there
is a credit loss, the impairment loss is separated into the amount representing
the credit loss, which is recognized in earnings, and the amount related to
other factors is recognized in OCI. In determining whether a credit loss exists,
consideration is given to (i) the length of time and the extent to which the
fair value has been less than amortized cost, (ii) the financial condition and
near-term prospects of recovery in the fair value of the agency security,
(iii) the historical and implied volatility in the fair value of the agency
security, (iv) the payment structure of the agency security and the likelihood
of the issuer being able to make payments that increase in the future,
(v) failure of the issuer of the agency security to make scheduled interest or
principal payments, (vi) any changes to the rating of the agency security by a
rating agency and (vii) recoveries or additional declines in fair value
subsequent to the balance sheet date.
Recent Accounting Standards
In May 2009, the FASB issued SFAS No. 165, Subsequent Events which is codified in FASB ASC 855, Subsequent Events ("ASC 855"). ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. We adopted ASC 855 in the second quarter of 2009 and evaluated all events or transactions through the date of this filing. During this period, we did not have any material subsequent events that impacted our consolidated financial statements.
In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles-a replacement of FASB Statement No. 162, which is
codified in FASB ASC 105, Generally Accepted Accounting Principles ("ASC 105"). ASC 105 establishes the Codification as the source of authoritative GAAP in the United States (the "GAAP hierarchy") recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission ("SEC") under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. Once the Codification is in effect, all of its content will carry the same level of authority and the GAAP hierarchy will be modified to include only two levels of GAAP, authoritative and non-authoritative. ASC 105 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. We adopted the requirements of ASC 105 in the third quarter of 2009.
In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets-an amendment of FASB Statement No. 140 ("SFAS No. 166"), which amends the derecognition guidance in SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, eliminates the concept of a "qualifying special-purpose entity" ("QSPE") and requires more information about transfers of financial assets, including securitization transactions as well as a company's continuing exposure to the risks related to transferred financial assets. SFAS No. 166 has not yet been codified and in accordance with ASC 105, remains authoritative guidance until such time that it . . .
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