AGNC Investment Corp. quarterly report, Q2 FY2011

AGNC Investment Corp. — Q2 2011 Form 10-Q

Reporting period: Three and six months ended June 30, 2011; filed August 9, 2011. AGNC invests primarily in government-backed residential mortgage securities, funded largely with short-term repurchase agreements and managed on a leveraged basis. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.

Financial performance and condition

Metric	Q2 2011	Q2 2010	Six months 2011	Six months 2010
Interest income	$264.7	$50.6	$429.2	$89.4
Net interest income	$200.9	$33.2	$329.8	$56.5
Net income	$177.8	$36.9	$311.4	$90.0
Diluted earnings per share	$1.36	$1.23	$2.82	$3.28
Dividends declared per share	$1.40	$1.40	$2.80	$2.80
Net cash from operating activities	—	$363.5	$75.8

At June 30, 2011, agency securities were $39.9 billion, total assets $43.6 billion, total liabilities $38.9 billion and stockholders’ equity $4.8 billion. Net asset value was $26.76 per share, versus $24.24 at December 31, 2010.
Repurchase agreements were $33.5 billion and other debt $61.8 million. End-period leverage was 7.0x equity before unsettled trades and 7.5x including net unsettled agency trades; average leverage during Q2 was 7.6x.
Cash and cash equivalents were $625.9 million, restricted cash $188.8 million, and management reported $2.1 billion of unpledged agency securities available for liquidity needs, excluding unsettled trades. Most repo financing was short term; weighted average days to maturity were 20.
Average Q2 asset yield was 3.35%, average cost of funds 0.89%, and average net interest rate spread 2.46%. At quarter-end, reported asset yield was 3.45%, cost of funds 1.09%, and spread 2.36%. The reported quarterly net interest spread for Q2 2010 was 2.18% (2.37% excluding prior-period terminated-swap amortization).

Material changes versus comparable periods

Portfolio fair value nearly tripled from $13.5 billion at year-end 2010 to $39.9 billion at June 30, 2011. Repo borrowings rose from $11.7 billion to $33.5 billion, while equity increased from $1.6 billion to $4.8 billion.
Q2 net income increased to $177.8 million from $36.9 million, mainly alongside substantial portfolio growth and higher net interest income. Six-month net income also rose, but diluted EPS fell to $2.82 from $3.28 as weighted average shares increased to 110.5 million from 27.5 million.
Net interest spread improved year over year, while average asset yield declined to 3.35% from 3.44% in Q2 and to 3.37% from 3.58% for the six-month period. Management attributed the lower yields to portfolio mix and lower-yielding asset purchases.
Q2 net losses on derivatives and trading securities increased to $100.0 million from $21.9 million. Management said supplemental hedges intended to protect against near-term rate increases lost value as interest rates declined; agency-security sale gains were $93.9 million versus $29.6 million.
During the first half, AGNC raised approximately $3.0 billion net through three public offerings, issuing 108.8 million shares. Shares outstanding were 178.5 million at June 30.

Outlook, risks and unusual items

No specific earnings, spread, portfolio-growth or dividend guidance was provided. Management stated it believed liquidity and capital resources were sufficient for investments, borrowings, margin requirements and dividends, while noting there was no assurance repo financing could be renewed on favorable terms or at all.
Management’s interest-rate sensitivity estimates for a static portfolio indicated projected net interest income would change by -10.4% for a 100-basis-point increase, -4.7% for a 50-basis-point increase, +1.0% for a 50-basis-point decrease, and -4.7% for a 100-basis-point decrease. Estimated portfolio value, including derivatives, would change by -1.2%, -0.5%, +0.1% and -0.5%, respectively. The filing cautions that actual outcomes may differ materially; rate-decrease estimates reflect a 0% floor on anticipated rates.
Key exposures include interest-rate and spread movements, mortgage prepayments and extensions, short-term funding and collateral margin calls, liquidity, leverage, and the effectiveness of hedges. A 10% portfolio prepayment rate was assumed at quarter-end; management emphasized that actual speeds may differ materially.
At June 30, $35.1 billion of agency securities were pledged under repurchase agreements. AGNC reported meeting all margin calls and having no counterparty exposure above 10% of equity. Swap agreements include collateral, cross-default and other termination provisions; the fair value of swap liabilities was $265.4 million and termination value was $271.2 million.
Available-for-sale securities had $251.2 million of accumulated unrealized gains at June 30. No other-than-temporary impairment charges were recorded for the first six months; management attributed unrealized losses to interest-rate and prepayment changes rather than credit losses.
AGNC declared $1.40 per share for Q2 and reported approximately $78 million of estimated undistributed 2011 taxable income, net of the June dividend payable. As a REIT, it must distribute at least 90% of taxable income to maintain its status.
The filing reported no legal proceedings and no material changes to previously disclosed risk factors, while adding discussion of manager conflicts, Federal Reserve and Treasury agency-security sales, and common-stock price volatility. Disclosure controls were concluded effective.

Important facts for investors to verify

Whether net interest spread, asset yields and per-share earnings remain resilient as the portfolio expands and financing costs or hedging costs change.
How leverage, repo maturities, lender haircuts, collateral requirements and available unpledged assets affect liquidity under adverse market conditions.
Whether actual mortgage prepayments, premium amortization and asset duration differ from the filing’s assumptions, and how those differences affect income and NAV.
The scale and performance of derivative and supplemental hedges, including potential collateral calls and termination obligations.
Effects of substantial equity issuance and dilution on per-share returns, NAV and future dividend coverage, and the sustainability of the declared dividend relative to taxable income.
Potential conflicts arising from external management and the manager’s or affiliates’ activities in other investment vehicles.