American Capital Agency Earnings Call Nuggets: HARP, Capital Raise

On Thursday, American Capital Agency Corp. (NASDAQ:AGNC) reported its first quarter earnings and discussed the following topics in its earnings conference call. Here’s what the C-suite revealed.

HARP 

Jason Arnold – RBC Capital Markets: You did very well with the low balance of HARP specific pools trade, although it sound like you took some profits here, so I was just curious if you could share with us your thoughts on kind of broader thoughts on value right here between the two segments and then perhaps comment on the incremental spreads on the new investments you are seeing right here?

Gary Kain – President and CIO, American Capital Agency Corp. President, American Capital AGNC Management, LLC: The HARP and Lower loan balance pools have performed very well and by definition they are not as attractive as they were a couple of quarters ago. But overall, we still very much like the risk adjusted returns of these strategies released to most of them and they are going to continue to a core position for us for a number of reasons. Peter reviewed with you on Slide 12 the importance of slower prepayments with respect to repo and margin calls. It’s critical to have a portion of your position that you can count on to not drive increases in repo margin calls due to prepayments in a stress scenario. These positions are also extremely important from a convexity risk management perspective again knowing that you can count on these positions to perform in a rally allows you to hedge more effectively. So, we’re not managing to just today’s prepay and interest rate environment, it’s important that we perform across a range of different environment and these positions will helps us do that. So, there continue to be a core position for us and we still find the risk adjusted returns as being attractive. The positions that we sold during the quarter were largely very high coupons backed by lower loan balance and HARP loans.

Gary Kain – President and CIO, American Capital Agency Corp. President, American Capital AGNC Management, LLC: Just one other thing, as Slide 7 point out, we are however cutting our aggregate exposure to those back downs what we would say are more kind of normal levels. So, our bias over the last few months has been not that we’ve still been buying some, we’ve been selling some, but depending on coupon and strategy, but our bias has been to be more balanced given today’s pricing.

Jason Arnold – RBC Capital Markets: So for like dollar for dollar, you’re putting probably more into the lower coupon side and then perhaps kind of balancing that out with other interest, is that fair statement?

Gary Kain – President and CIO, American Capital Agency Corp. President, American Capital AGNC Management, LLC: It is, but I do want to stress that you know it’s not all or enough. I mean we still look at – we don’t buy accepting kind of one-off cases what we would call TBA, so even if we’re not buying something like a HARP or a loan balance pool. We’re certainly thinking about the amount of third-party originations. We’re looking at plenty of other factors. So, I don’t want you to – but to be frank those things don’t matter, I mean, they’re important, but they don’t matter nearly as much as some of the stories we’ve talked to you about, but there is – I just don’t want to give you the impression that it’s kind of all or nothing. I mean, even if you are not involved in something that has, kind of, really strong prepayment protection, you certainly in everything you do you absolutely have to avoid the worst, and we feel like we can do that across the board.

Jason Arnold – RBC Capital Markets: Just one quick follow-up. Thanks for the color on the rate hedges. I know, the plain vanilla swaps aren’t ideal given our complexity and prepayment optionality, but I was curious, if you could comment on what really led to the uptick in use of swaptions from a view, a macro view or rate view standpoint, and then perhaps you could also comment on the use of the short TBAs and treasuries, and specifically what component of the rate risk spectrum you’re hedging out with those?

Peter J. Federico – SVP and Chief Risk Officer: This is Peter. On our last call, I mentioned the fact that, we’re opportunistic in our purchases, and that we were seeing the cost of these options decline as – ones we got through the year, and so in December and early in the first quarter, we saw implied volatility in the marketplace come down. The combination of the lower cost from an option perspective, as well as the strike of the options with rates coming down, the combination of those two things really led us to view these much more attractive in the first quarter than they have been in the past. Subsequently, right during the quarter, the prices went up a little bit and now they have come back down to close to 12-month lows again. So, they continue to look attractive to us. With regard to the treasury hedges, I’m glad you pointed that out, we do use a combination of hedges and in this quarter we used treasuries more extensively than we have in the past with about $5.5 billion at quarter end, and again it’s just opportunistic hedging. We use treasuries, we use swaps, we use swaptions, so we just look at them on a relative value perspective, what do we think is going to happen to swap spreads and try to just position the portfolio as best we can from a hedging perspective. Chris may want to add a comment on the TBA?

Christopher J. Kuehl – SVP, Mortgage Investments: I mean, again the TBAs give us again exposure to different parts of the curve, and partial durations and at times are very effective hedges, and allow us to source call protection through some of these specified pool strategies at times where we don’t necessarily find the mortgage swap base as attractive.

Capital Raise

Dean Choksi – UBS: Can you talk about your expectations for HARP 2 prepayments?

Gary Kain – President and CIO, American Capital Agency Corp. President, American Capital AGNC Management, LLC: Sure, this is Gary. On HARP 2, we absolutely think HARP 2 is irrelevant. You can take comments from any of the large originators or FHFA, you can look at the flow of kind of the over 125 LTV new mortgage securities into the marketplace, we’re definitely seeing the impacts that HARP 2.0 will have impacts, and we’ve seen faster somewhat faster speeds on the higher coupons. We think this is still very early and interestingly, as you can tell from our portfolio, we are still avoiding HARP 2.0 risk, and let me give you the main reason. It’s kind of interesting. Again, as we’ve talked to you about we can’t just manage for one scenario. We’ve got to manage over a range of interest rate scenarios and for that matter, prepayment scenarios. The thing that usually people like about higher coupon season mortgages and they were a very sizable part of our portfolio back in 2010 when interest rates go up a 100 basis points, 50 or 100 basis point, they tend to outperform other mortgages, so they are shorter duration and they add a lot of value in that scenario. Right now given HARP 2.0, we actually think they would perform very poorly in that scenario and the reason is that, right now originators seem to be dedicating maybe 30% of their capacity to HARP 2.0. If rates went up 75 basis points all the other refinancing activity that they are doing that’s using 70% of their capacity would go away which would leave them to dedicating all of their capacity in our minds, the vast majority to HARP 2.0, plus the coupons are high enough that they’d still be very much refinanceable. So that’s probably the biggest concern we have with the universe that’s exposed to HARP 2.0, so I hope that helps.

Dean Choksi – UBS: I appreciate the color as well as the incremental disclosure in the slides. Can you also talk to about how you deployed the capital around the capital raise couple of months ago?

Gary Kain – President and CIO, American Capital Agency Corp. President, American Capital AGNC Management, LLC: Sure I think you could kind of see it from the portfolio and what you can infer is, we put less of it into lower loan balance and HARP securities, but we still bought some, we put more into 30-year than 15-year mortgages. But on that front, we also were well positioned for the capital raise and had acquired some of what we did buy in the specified mortgages earlier, and that’s one of the reasons we use TBA hedges is to kind of stockpile good assets or good prices. So, when you put all that together, we were able to deploy the capital raise much quicker this time versus the quarter before where the capital raise was very much opportunistic with respect to a very specific opportunity. To be perfectly honest, we weren’t able to forecast it as well, so the deployment time, well I think it was a great time back in October. It took a little longer.