American Capital Agency Earnings Call Nuggets: Spread Differential from the TBA Positions and Dollar Rolls
American Capital Agency Corp. (NASDAQ:AGNC) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.
Spread Differential from the TBA Positions
Joel Houck – Wells Fargo: I guess the first question is related to the spread differential from the TBA positions, it’s at the end of the quarter, it’s 22 basis point. How should we for modeling purposes think about that in 2013? I think you also made comments; you believe the strategy is sustainable. However, the relative advantage has also improved so is it one of those things where 20 or 22 basis points is having a starting point we build from there. How should we think about it?
Gary Kain – President and CIO, American Capital Agency Corp.; President, American Capital AGNC Management, LLC: Look Joel, it’s a good question and obviously relevant. I think what you are referring to, are you referring to the difference in the kind of net interest quarter end, net interest spread?
Joel Houck – Wells Fargo: Yes, the 139 versus the 161 including the TBA.
Gary Kain – President and CIO, American Capital Agency Corp.; President, American Capital AGNC Management, LLC: So, look, what’s going to happen there is it’s going to depend on a number of area, right. And you obviously alluded to one, which is how attractive is the dollar roll financing, assuming the dollar roll position remains the same size, right. The other thing – the other key variable is going to be just how big is the TBA position let’s say relative to the on balance sheet position and let’s be practical both of those are going to be could vary meaningfully during the course of the year. So, but what we would say and I just want to reiterate what Chris mentioned is that we do believe when it comes to the dollar roll situation, dollar rolls have been special in the past and plenty of times you look at that you ignore them, but what’s fundamentally different here is the driver is very straightforward. It’s QE3 and the fed. It’s having a very material impact. Even if the dollar roll levels could remain especially even after that program is done given the amount that the fed is purchasing. And it’s going to the absorbing in the lowest coupons and so we feel that those – that these favorable financing levels are really likely to be in place. They are going to bounce around. Could they be negative 20, could they be zero, could they be negative 50, where they are right now or if they go to go negative 70? They could be in all of those places, but I think we’re pretty confident that if you look at them over the course of this year, they are going to be very special using the term that people use in the market and the financing is going to be attractive. So, I would say look you always have noise when you model anything. We don’t know where our repo rates are going to be and there is variability there. There is clearly more variability in the case of where the dollar roll levels are going to be, but we do believe they are likely to be again well through repo rates for the entire year.
Joel Houck – Wells Fargo: And then if I could just one more and I’ll jump off. I can’t help but notice the substantial increase in the swaptions portfolio; it almost tripled currently from where it was, (930). I mean, you guys have always been obviously used swaptions wherever (it’s having), but is this – how should we look at this? Is it a huge signaling effect that you think there’s a substantial risk that rates could move materially higher over the course of the year? How should we think about that?
Peter J. Federico – SVP and Chief Risk Officer, American Capital Agency Corp. and American Capital AGNC Management, LLC: Hey, Joel, this is Peter. No, I wouldn’t look at it as any sort of signal. It’s consistent with the way we’ve approached our portfolio in the past. It’s just a combination of what hedges do we like in what environment, and in this particular environment, we’re particularly attracted to swaptions given the cost profile of the options. I mean, a real benefit from the Fed is that they reduced interest rate volatility to the point where options that we’re buying today are at historically low prices, so we just think it’s a really good time to buy options. And on top of that we continue to point out that there is a lot of extension risk in mortgages, and we see some improving fundamentals in the economy. So, rates have backed up some, but we certainly want to be prudent about hedging for higher interest rates, and we think options would be valuable tool if rates back up anything meaningfully.
Bill Carcache – Nomura: So, it sounds like the opportunity that the dollar rolls are providing certain very attractive. Just trying to understand, Gary, whether it’s reasonable to expect a scenario where dollar roll can kind of help carry you through this kind of period of where artificially expense are being kept artificially tight up until the point where the spread exits let’s say then at that point maybe the 10 years gets back up to kind of just to pick a range, call it 225, 250 level. And now does that get us back into potentially kind of a Goldilocks environment that you talked about in the past, where you had potentially there is a reasonable scenario where you kind of get through all of this and without having to actually cut the dividend. Can you just talk about that thought process and I guess talk about the reasonable something like that being possible.
Gary Kain – President and CIO, American Capital Agency Corp.; President, American Capital AGNC Management, LLC: Our future performance is obviously going to be a function of the market conditions and how they are fold. What we would say to your first point is, and really just to reiterate what Chris said in his comments, mortgages have tied in 10 to 20 basis points depending on where you look and how you evaluate it, but the financing opportunities have improved if you go to the TBA market more than 50 basis points to cross some of the coupons. And so when you look at that, to your point about kind of navigating through QE3, if QE3 laps a long time, mortgage spreads will tie, it will elevate prepayments, it will keep – it would generally keep your – you quote your returns. But on the other hands the financing opportunity should remain in place longer to in which case you lost if they were to last for 10 years you would have lost 10 or 20 basis points but made 50 in financing. That’s unlikely but to your point over – during the period of QE3, there is a very good offset and you could argue even it’s kind of an improvement if these dynamics stay in place. What we have to navigate and what we have to keep in mind is that it goes back to the question about hedging. We are cognizant, and I think there are two possible scenarios over the course of 2013 or over the next six to nine months, let’s say. One is that the economy doesn’t really pick up; this is another kind of false start and the Fed stays with QE3 well into 2014, that’s a very, very realistic possibility. We do need to be cognizant about, say, there is a potential for that. And then the other one; it goes to the hedging side of it, which is, there is also a possibility that the economy does continue to pick up momentum. It picks up significant enough momentum that toward the end of 2013 QE3 is a thing of the past and we’ve got to be positioned to be able to navigate both of those positions – those outcomes, and I think that’s what you are seeing us do.
Bill Carcache – Nomura: Switching gears, can you share your thoughts on the mortgage refi legislation that (indiscernible) introduced yesterday. It seems like some of the controversial provisions were dropped last year and they remain out of this version, but I was just hoping you could share any thoughts there?
Gary Kain – President and CIO, American Capital Agency Corp.; President, American Capital AGNC Management, LLC: Really nothing new. I think we’ve talked a lot about it. We really just don’t view policy risk as being a material issue at this point. I mean, look, there is always risk on that front, but we would say again, that when you sit there and think about the risk, either on the prepayment front or kind of in aggregate, policy risk at this point is pretty low down on our kind of radar screen.