AGNC Investment Corp. annual report, FY2013

Business Context and Reporting Period

AGNC Investment Corp. (then American Capital Agency Corp.) filed this Form 10-K for the year ended December 31, 2013. AGNC is an externally managed REIT that invests primarily in agency mortgage-backed securities (MBS), financed mainly with repurchase agreements and leverage. It seeks to preserve net asset value while generating distributable returns.

Financial Performance and Position

For Q4 2013, interest income was $542 million, net interest income was $422 million, and net loss was $101 million (or $0.28 per common share). Comprehensive loss attributable to common shareholders was $369 million.

Average asset yield declined to 2.77% from 2.82%; average cost of funds increased to 1.34% from 1.11%, narrowing the average net interest spread to 1.43% from 1.71%. Including estimated TBA dollar-roll income, the average spread was 1.87%, versus 1.84% in 2012. Net spread and dollar-roll income per common share fell to $3.63 from $4.24.

Operating cash flow was $2.501 billion; investing activities provided $8.875 billion, while financing activities used $11.663 billion. Cash and cash equivalents declined by $287 million to $2.143 billion. Year-end repurchase agreements were $63.533 billion, and leverage was 7.3:1 (7.5:1 including net TBA positions). AGNC reported $2.1 billion of unrestricted cash and approximately $1.9 billion of unpledged securities available for liquidity needs.

Material Changes Versus Prior Period

• Rising rates and wider agency MBS spreads drove a 24% decline in NAV per common share during 2013 and a $2.938 billion other comprehensive loss, primarily reflecting unrealized MBS losses.
• The 10-year Treasury rate rose 127 basis points during the year; AGNC said spread widening was the primary driver of the NAV decline.
• The portfolio contracted: year-end agency MBS fair value fell to $65.9 billion from $85.2 billion, and the net long TBA position fell to $2.3 billion from $12.9 billion.
• Management reduced leverage, increased hedges, and repositioned assets, prioritizing risk management over near-term earnings. Asset sales produced a $1.408 billion net loss, versus a $1.196 billion gain in 2012.
• Estimated taxable income available to common shareholders declined to $940 million ($2.48 per share) from $2.089 billion ($6.87 per share). AGNC also reported $1.785 billion of estimated net capital losses, which may be carried forward against future net capital gains for up to five years.
• AGNC repurchased about 40.3 million common shares for $856 million at an average $21.25 per share and completed a $1.803 billion common-stock offering in March 2013.

Outlook, Commentary, Risks, and Unusual Items

Management said it believed the mortgage market was moving toward a more normalized risk-return environment as the Federal Reserve tapered asset purchases, and that AGNC was positioned to pursue opportunities in a steeper-yield-curve, wider-spread environment. This is management’s view, not a quantified earnings or dividend forecast. The Fed announced a $10 billion monthly reduction in asset purchases beginning January 2014 and indicated further reductions could follow.

AGNC stated it believed liquidity and capital resources were sufficient for investments, debt repayments, margin requirements, and dividends, while warning that repo financing may not renew on favorable terms or at all. The company had 32 repo counterparties; weighted-average collateral haircuts were approximately 5%. Short-term funding, margin calls, spread widening, rate and prepayment changes, extension risk, hedge performance, counterparty exposure, and regulatory or REIT-qualification risks remain material.

Interest-rate sensitivity estimates at December 31, 2013 indicated that a parallel 100-basis-point rate increase could reduce projected NAV by 13.1%; a 25-basis-point widening in MBS spreads could reduce NAV by 10.1%. These are model-based estimates for a static portfolio and exclude some market effects. Unrealized MBS losses were not treated as credit losses, and AGNC recorded no OTTI charges in 2013. The company accrued $3 million of federal excise tax and $10 million of tax attributable to its taxable REIT subsidiary.

AGNC had no legal proceedings at year-end. Its independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.

Important Facts for Investors to Verify

• Whether subsequent results support management’s view of market normalization and its assessment of liquidity and financing access.
• How NAV, MBS spreads, leverage, hedges, and repo haircuts evolve; compare actual outcomes with the disclosed rate and spread sensitivities.
• Whether net interest spread, dollar-roll income, taxable income, and dividend coverage can sustain distributions; the board sets dividends and no minimum is established.
• How the $1 billion repurchase authorization remaining at year-end, plus the additional $1 billion authorized in January 2014, was used, and whether buybacks were made below estimated NAV.
• Whether estimated taxable income, capital-loss carryforwards, and REIT qualification assumptions change when tax returns are finalized or reviewed.