AGNC

Business Context and Reporting Period

Company: American Capital Agency Corp. (AGNC)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: May 20, 2008 (commencement of operations via IPO) through June 30, 2008.
Business Overview: AGNC is an externally managed Real Estate Investment Trust (REIT) that invests exclusively in single-family residential mortgage pass-through securities and collateralized mortgage obligations (CMOs) guaranteed by Ginnie Mae, Fannie Mae, and Freddie Mac. The company utilizes significant leverage through repurchase agreements to finance its portfolio.

Key Financial Metrics

Material Changes and Portfolio Composition

This filing represents the company's first quarter of operations following its IPO on May 20, 2008. There is no prior comparable period for year-over-year analysis. Key portfolio characteristics as of June 30, 2008 include:

• Portfolio Composition: The $2.4 billion portfolio consists of Fannie Mae (54%), Ginnie Mae (35%), and Freddie Mac (11%) securities.
• Yield and Cost: The weighted average asset yield was 5.50%, while the weighted average cost of funds was 2.35%.
• Unrealized Losses: The portfolio held gross unrealized losses of $24.7 million, primarily due to market conditions affecting agency securities. These losses are recorded in Accumulated Other Comprehensive Loss and do not impact net income unless deemed other-than-temporary.
• Liquidity: The company held $7.8 million in cash and cash equivalents and $15.9 million in restricted cash. Unpledged securities of approximately $90 million were available to meet margin calls.

Outlook, Risks, and Management Commentary

Management Strategy and Outlook: Management intends to maintain a leverage ratio between 6x and 8x stockholders' equity. Due to market volatility and liquidity concerns in the residential mortgage market, management indicated a prudent strategy to reduce leverage to the middle-to-lower end of this range in the third quarter of 2008 by opportunistically selling investments.

Key Risks and Contingencies:

• Financing Liquidity: The company relies on short-term repurchase agreements (average maturity of 24 days). Disruptions in the financial markets could make it difficult to renew financing or could lead to margin calls requiring additional collateral.
• Counterparty Risk: As of June 30, 2008, $31 million was at risk under a repurchase agreement with Deutsche Bank Securities Inc., representing over 10% of stockholders' equity.
• GSE Stability: The portfolio relies on guarantees from Fannie Mae and Freddie Mac. Management noted increased market concerns regarding the financial stability of these entities, though they believe the Housing and Economic Recovery Act of 2008 improved their ability to fulfill guarantees.
• Interest Rate and Prepayment Risk: Rising interest rates could extend the life of the portfolio (extension risk) and reduce the value of fixed-rate assets. A 100 basis point increase in rates is projected to decrease net interest income by 22% and portfolio value by 3.94%.

Investor Verification Checklist

• Margin Call Exposure: Verify the current status of margin requirements and the sufficiency of unpledged collateral ($90 million as of June 30) given potential declines in agency security values.
• Financing Renewal: Confirm the company's ability to roll over its $2.2 billion in repurchase agreements, given the short average maturity (24 days) and market liquidity constraints.
• Counterparty Concentration: Monitor the $31 million exposure to Deutsche Bank and the overall concentration of lending among the 14 financial institution counterparties.
• Impairment Assessment: Review future filings for any determination that the $24.7 million in unrealized losses on agency securities are "other-than-temporary," which would require a charge to earnings.
• Leverage Reduction: Track the execution of management's plan to reduce leverage to the 6x-8x range in response to market volatility.