Business Context and Reporting Period
Company: American Capital Agency Corp. (AGNC)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2009
Business Overview: AGNC is an externally managed Real Estate Investment Trust (REIT) that invests exclusively in residential mortgage pass-through securities and collateralized mortgage obligations (CMOs) guaranteed by U.S. Government-sponsored entities (Fannie Mae, Freddie Mac) or agencies (Ginnie Mae). The company employs a leveraged strategy, funding investments primarily through short-term repurchase agreements to generate net interest income and realized gains for distribution to stockholders.
Key Financial Metrics
| Metric | 2009 (Year Ended) | 2008 (Period Ended Dec 31) |
|---|---|---|
| Net Income | $118.6 million | $35.4 million |
| Net Income Per Share (Basic/Diluted) | $6.78 | $2.36 |
| Total Assets | $4.63 billion | $1.66 billion |
| Investment Portfolio (Fair Value) | $4.30 billion | $1.57 billion |
| Total Stockholders' Equity | $546.8 million | $258.2 million |
| Book Value Per Share | $22.48 | $17.20 |
| Repurchase Agreements (Debt) | $3.84 billion | $1.35 billion |
| Leverage Ratio (Period End) | 7.3:1 | 5.2:1 |
| Net Interest Income | $84.4 million | $30.2 million |
| Net Interest Rate Spread | 2.93% | 2.41% |
| Dividends Declared Per Share | $5.15 | $2.51 |
Material Changes Versus Prior Period
- Portfolio Expansion: Total assets and the investment portfolio more than doubled, growing from $1.66 billion to $4.63 billion and $1.57 billion to $4.30 billion, respectively. This growth was driven by two follow-on public equity offerings in 2009 raising approximately $222 million and increased leverage.
- Portfolio Composition Shift: The portfolio diversified significantly. In 2008, it consisted entirely of fixed-rate agency securities. By year-end 2009, it included $1.7 billion in adjustable-rate securities and $0.7 billion in CMOs, alongside $1.9 billion in fixed-rate securities.
- Profitability Surge: Net income increased by 235% to $118.6 million. This was driven by a $49.9 million net gain on the sale of agency securities (compared to $0.1 million in 2008) and higher net interest income.
- Cost of Funds: The average cost of funds decreased significantly from 2.63% in 2008 to 1.30% in 2009, reflecting lower short-term interest rates, though this was partially offset by $10.3 million in amortization expense from terminated interest rate swaps.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Strategy
Management actively repositioned the portfolio in 2009 to mitigate "GSE buyout" risk (the purchase of delinquent loans by Fannie Mae and Freddie Mac). This involved selling securities with high refinancing risk and acquiring CMOs structured to receive principal repayments after other investors, thereby reducing exposure to prepayment spikes. In February 2010, the Board removed a guideline limiting leverage to 10 times stockholders' equity.
Risks and Contingencies
- GSE Buyouts: Announced in February 2010, Fannie Mae and Freddie Mac plans to purchase delinquent loans could substantially increase prepayment speeds, potentially triggering margin calls and forcing asset sales at unfavorable prices.
- Liquidity and Financing: The company relies on short-term repurchase agreements. A failure to renew or roll these agreements, or a decline in collateral value triggering margin calls, could force asset liquidation.
- Interest Rate and Prepayment Risk: The portfolio has "negative convexity," meaning values may not rise as much as other bonds when rates fall (due to prepayments) and may fall more quickly when rates rise (extension risk).
- REIT Qualification: Failure to meet distribution requirements (90% of taxable income) or asset tests could result in corporate taxation or loss of REIT status.
Unusual Items
- Excise Tax: The company incurred a $0.3 million federal excise tax in 2009 because distributions did not meet the minimum required amount to avoid the tax.
- Derivative Losses: A net loss of $4.2 million was recorded on derivative instruments, primarily due to realized losses on TBA and forward settling agency securities.
Investor Verification Checklist
- Prepayment Speeds: Verify the actual impact of GSE buyouts on prepayment rates and the resulting effect on premium amortization and net interest income.
- Liquidity Position: Confirm the company's ability to meet margin calls given the $3.84 billion in repurchase agreements and the current fair value of pledged collateral.
- Dividend Sustainability: Assess whether net income and cash flow from operations are sufficient to maintain the $5.15 per share dividend rate declared in 2009.
- Swap Amortization: Monitor the impact of the $6.3 million unamortized fees from terminated swaps on future interest expense.
- Equity Dilution: Review the terms of the shelf registration statement allowing for up to $750 million in future equity offerings.