ybf - in the recent Citi Financial Services Conference - GK identified 3 possible/probable scenarios going forward: 1 - Economic activity picks up modestly with a commensurate rise in the 10 yr rate, the yield curve and mtg rates; 2- economy weakens, rates compress (short rate is already at zero), mtg rates continue to drop, prepayments increase, less NIM on new purchases (basically the scenario for the last couple of yrs - but with less portfolio NIM overall); and 3 - economy and/or inflation pick up markedly, as do rates etc.
GK identified scenarios 1 and 2 as the most likely and the ones that AGNC is most prepared for with its current portfolio and hedging strategies. GK identified the 3rd scenario as the least likely and the the scenario presenting the most risk to AGNC.
Of course - the Citi presentation was just prior to the most recent SPO. In short with the SPO AGNC increased the risk associated with scenario 2 (can't cheaply buy HARP loans now) and scenario 3 (rapid rate rise environment) and didn't get to take advantage of 'slightly better' NIMS available to the recent modest increase in mtg rates (scenario 1).
Basically the SPO allowed for a one-time increase in BV - but increased the risk of the now very large portfolio that can't be easily 'repositioned'. Best hope for existing shareholders is that short and long term rates just 'stay where they are' for the forseeable future.
The "rates are staying low" thing is more complicated than the "run if rates rise" bunch are letting on.
They're actually setting up an irrational dip in the stock price with that talk.
The fact is, if rates rise, the yield curve will steepen. BV of current assets will drop, but BV isn't the determinant of value of the company, income is. BV is just a floor.
The BV hounds and the "rates are rising, run!" hounds will take the stock down.
But income frorm those assets will remain the same, and the steep yield curve will add high-performing assets to the book, sending EPS through the roof. The div will go up, and the lower stock price the nellies gave us will make the yield go north of Santa Claus's garage.
The only -- only -- true risk here, is if, after all this happens, the economy gets way hot and the Fed is forced to flatten the yield curve or worse. Then the old assets may not be able to find short-term rates below the mortgage rate they collect. Borrowing to keep them leveraged could end up costing more than they bring in. They'd be an expensive drain unless the leverage is unwound, by selling them off at their lower value. And with an inverted yield curve it'd be impossible to make money even on new assets. The whole system would have to be dismantled, hopefully before it turns into a losing rather than earning system, and hopefully it will be telegraphed to the brain trust who will hedge it to cushion the blow.
But what's the time horizon for an inversion of the yield curve, in a climate where real estate is picking up value while unemployment remains high? Years? Decades? It's certainly not months.
Fearing interest-rate rises is only half the story. Fear short-term rate rises. But love long-term rate rises.