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American Capital Agency Corp. Message Board

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  • divyinvstr divyinvstr Aug 22, 2012 3:41 PM Flag

    quick question

    The question concerning whether AGNC can continue its dividend if rates rise is a good question. The answer, of course, is that it depends upon which part of the yield curve rates rise and by how much. Remember, AGNC makes its income primarily through the spread game. By that I mean the AGNC borrows short and lends long. The difference between these two rates times the leverage determines profitability (I'm keeping this simple). For example, if AGNC borrows at 0.5% and lends (purchases mortgage backed securities) at 3% the firm can book a 2.5% profit on the purchase. Leveraged 8x this 2.5% becomes a 20% return.

    If loner-term rates rise, including yields mortgage backed securities, but short rates remain unchanged then the spread increases and AGNC can earn a larger profit on new purchases.

    If short rates rise but longer rates remain unchanged the spread would tighten and profitability would fall, as would the ability of AGNC to maintain its dividend.

    Anyway, you get the idea. Note that when interest rate sensitivity studies are shown they often show instantaneous parallel yield curve shifts - the entire curve shifting by the same amount at the same time. While some information is conveyed with this type of analysis, it tends to be a rather unrealistic scenario. Particularly when the FED Chairman has publicly pledged to keep short rates at current levels for at least a couple of years.

    Note, however, that book value can be negatively impacted by higher rates as assets in the portfolio will likely decline in market value. Management hedges but hedging mortgage securities is difficult. However, AGNC has a very experienced management team handling this operation and should do relatively well.

    Hope this helps.

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