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American Capital Agency Corp. Message Board

  • greatdeceivah greatdeceivah May 3, 2013 12:35 PM Flag

    Best explanation for Q2 Losses

    Scott Kennedy over at SeekingAlpha has the best explanation for the AGNC losses this quarter:

    Hi Readers,

    So I did some more research on the numbers. Simply put, AGNC made an assumption in Q1 that interest rates would remain basically flat. As such, they made material purchases on forward-settlement MBS’s through the "to-be-announced" (‘TBA’) dollar roll market. Simply put, these are basically a type of option contract on MBS’s (not actually, but trying to give readers an example they might better understand). TBA dollar roll transactions are a form of off-balance sheet financing. The price differential between the MBS’s purchased for a forward settlement date (through the TBA dollar roll market) and the price of MBS’s upon settlement in the current month is referred to as the “price drop”. The price drop is the economic equivalent of the interest income less implied financing costs (“dollar-roll income") on the MBS earned during the roll period (initial purchase of contract and settlement date) of the contract.

    Given the attractive terms available in the dollar roll market, AGNC had a Q1 average of net forward TBA positions of $17.9 billion. This balance has now become somewhat large. AGNC has made a large assumption that interest rates will remain “stifled” for some period to come; hence the increase of these “off-balance sheet” investments. They were trying to receive extra “doll-roll” income on the contract while they wait to purchase it on the settlement date. This is also good in a low interest rate environment because they have freed up capital while not having to pay interest expense on their repurchase (repo) loans during the contract period.

    However, in Q1, as interest rates continued to rise, the value of these TBA dollar roll transactions declined in value. Think of it this way: they entered in a TBA dollar-roll transaction in January 2013 at an interest rate of 3.5%. However, by the end of the month (the settlement date), the current market intere

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    • Bump, don't believe the shortie's misinfo, the real explanation is here.

    • Some quotes from Kain:

      "mortgage price performance was surprisingly weaker in the first quarter ... as fears of an early Fed exit led to extension risk becoming the main focus of mortgage investors."

      "Unfortunately and this is important, given the small move in treasury and swap rates, hedges ... could not offset the weakness in mortgage valuations. ... as we have stressed in the past, our hedges ... are designed to protect us against mortgage price changes that result from large interest rate moves..."

      "Importantly, these conditions appear to be reversing in Q2 and recent Fed statements have been considerably more balanced."

      "... interest rates have come back down and mortgage valuations have strengthened. As such, as of month end [April], our book value had recovered a portion of the Q1 declines..."

      "Looking ahead, we see little reason to believe this prepayment or dollar roll trends will change over the near-term and we’re also seeing repo rates beginning to drop as well, which should further benefit our aggregate cost of funds. It was the combination of these positive factors along with the more attractive MBS valuations that led to our decision to raise additional equity in February."

    • I listened to the call and, if I understood it correctly, I think Gary Kain went to great lengths to explain that what Scott Kennedy claims is NOT what happened.

      Specifically, Kennedy seems to be saying that MBS prices fell (thus lowering BV) because rates rose.

      But Kain says that rates moved very little, and that MBS prices fell not because of that, but because of Fed's talk of early exit from QE, which led to "extension risk" (i.e., the expectation that mortgage durations will grow as interest rates rise in the future, even though they haven't risen yet). And he said specifically that this hurt AGNC's results because its hedges are intended to work when MBS prices change as a result of rate changes, but in this case only MBS prices changed, NOT the rates -- so the hedges did not help.

      At least that's what I understood. Overall, though, Kain was optimistic, and seemed to be saying that this was a freak event (my term) which hurt temporarily but is already correcting (as of the end of April) while it created some investment opportunities which they have exploited. All in all, YBF seems to have the right idea backing up his truck.

    • I just want them to take advantage of the lower BV to do a quick SPO so I can triple up and get all of the benefit of the runup to the next earnings report, which will show recoupment of most of this mark-to-market accounting.

    • 1) On a purely portfolio yield standpoint, these TBA dollar-roll transactions have an average yield lower than most of AGNC’s other MBS investments (this EXCLUDES the doll-roll interest earned while holding the contract). When current market interest rates drop (as they have done so far in Q2, this will be a positive for these MBS investments). AGNC should reap the benefits in a decreasing interest rate environment (for these types of investments).

      2) When the rates fall, the original contract’s interest rates will be better than the rates offered upon settlement of the contract (ex. = at the end of the month). In Q2, this will result in gains on derivative instruments, net (opposite of what occurred in Q1).

      3) In regards to REIT taxable income, the loss on the realization of the TBA doll-roll MBS transactions that occurred in Q1 will now have an opposite effect in a declining interest rate environment. Again, this will be positive (so far) for AGNC in Q2.

      Lastly, AGNC’s leverage positions are actually pretty high when taking into consideration these TBA dollar roll investments. Therefore, an equity raise from now till 9/15/2013 seems more of a possibility if AGNC exercises a majority of these TBA dollar-roll positions. As an investor, since AGNC has “ramped-up” their TBA dollar-roll MBS investments, it will be prudent to understand how these transactions work and what specific changes in interest rates mean for this derivative activity in regards to gains and losses.

      In conclusion, things look brighter so far for AGNC in regards to the TBA dollar-roll transactions in Q2. As stated in my comments earlier, AGNC’s management picked the wrong quarter to being full implementation of this strategy. It’s basically a hedge against prolonged interest rate controlling by the FED through quantitative easing (QE). If rates continue to hold and not rise for the rest of Q2, AGNC should benefit greatly by implementing this certain type of derivative strategy.

      Hopefully th

    • This basically accounts for the material loss on derivative instruments, net (within Other Income) for AGNC. They made an assumption interest rates would not rise in Q1. They were wrong. The rise in interest rates “back-fired” on AGNC in regards to Q1.

      Furthermore, in regards to this article’s topic, the losses on the TBA transactions also negatively affected their Q1 REIT Taxable Income per share. For Q1, their estimated REIT taxable income was only $0.50 per share. As stated in their press release:
      “Estimated taxable income for the quarter was negatively impacted by net realized losses of approximately $(0.55) per common share recognized for tax purposes due to monthly settlements of the Company's TBA dollar roll positions during a period of price declines.”

      Therefore, not only did the TBA dollar roll transactions/positions negatively affect net income, it also was bad to AGNC’s Q1 REIT taxable income.

      With that being said, let’s look ahead now to Q2’s operations. AGNC’s average net TBA position for Q1 was $17.9 billion. However, their ending TBA position ballooned up to $27.3 billion. Even though these transactions are “off-balance sheet”, in regards to assets under investment, they basically should be on AGNC’s books. They aren’t because it’s only a possibility AGNC will exercise the contract on the settlement date. The possibility is there (on the settlement date) that AGNC acquires the MBS’s if the yield is attractive. From looking at these the two TBA positions, AGNC had strong notions in Q1 that in Q2 rates would be decreasing (thus the increases in TBA positions in Q1). I saw this because of the following:

      1) On a purely portfolio yield standpoint, these TBA dollar-roll transactions have an average yield lower than most of AGNC’s other MBS investments (this EXCLUDES the doll-roll interest earned while holding the contract). When current market interest rates drop (as they have done so far in Q2, this will be a positive for these MBS investments). AGNC

    • However, in Q1, as interest rates continued to rise, the value of these TBA dollar roll transactions declined in value. Think of it this way: they entered in a TBA dollar-roll transaction in January 2013 at an interest rate of 3.5%. However, by the end of the month (the settlement date), the current market interest rate on this same MBS (that’s in the MBS market and not part of the TBA contract) now would yield 3.8%. If the MBS (through the dollar-roll market) was not purchased by the end of the settlement date, or “rolled-over” to a later date in the future, AGNC had to take the loss on the expired contract (loss on the spread). If they take the contract, no discount is received and AGNC now has an investment already yielding less than what they could have purchased in the MBS market. Either way, not good news.

      This was why these TBA dollar-roll transactions are under derivative instruments, net (realized) under “other income” on the income statement. It’s basically a hedging strategy implemented when management feels interest rates will be low for an extended period of time. While they made dollar roll income for holding the contract, once the contract expired or was exercised, the market interest rates were greater than the originally stated interest rate of the contract. Therefore, upon expiration or purchase, a net realized loss was incurred. Most of these contracts are very-short term related (monthly). As per their press release, notice the following two accounts within Other Income (Loss):

      1) 142 million of dollar roll income (when holding on to the contract when earn interest up until the settlement date
      2) ($244) million of net losses on TBA positions and forward settling securities

      This basically accounts for the material loss on derivative instruments, net (within Other Income) for AGNC. They made an assumption interest rates would not rise in Q1. They were wrong. The rise in interest rates “back-fired” on AGNC in regards to Q1.

      Furthermore, in rega

 
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