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American Capital Agency Corp. Message Board

  • alf_1986e alf_1986e Sep 26, 2013 3:44 PM Flag

    Was it worth improper hedging?

    The drop from around $32 to $22 occurred mostly because AGNC did not hedge properly. They were saving money on hedges in order to boost profits. That worked great while interest rates were dropping or steady, but it bit them when interest rates jumped up.

    So was the 30% drop worth it? I do not think so. I think they gained at the most 10% per year due to the reduced hedges. The problem is that the yield on the 10 year was only sub 2% for 1 year. In order to gain the 10% during that year, they ended up losing 30%.

    When the 10 year was artificially pushed below 10% by the Fed, it was time to increase hedges. That would have cost income at the time and resulted in a dividend cut, but that was going to happen eventually anyway.

    Of course hindsight is 20/20.

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    • I don't completely agree. I cannot comprehend how you could do hedge against a large drop in book value that would be affordable enough to buy that it didn’t wipe out your current profits. After all, the guys on the other side of the hedge are smart guys too and they aren't going to lose their shirts. When interest rates go up the value of the old loans go down. How do you hedge against that long term? I can imagine a short term hedge that compensates for a few quarters of losses but these old loans will yield lower than new loans forever. Eventually you are stuck with the lower spread when the hedges run out. That said AGNCs borrowing rate from the Fed is still low so in theory they should have higher spreads for now so it is beyond me why they lowered the dividend unless they are preparing for Armageddon in the future.

      • 1 Reply to raybans2
      • ray, they have to hedge both sides so the cost of hedging is low. It would be like if you owned a dividend paying stock, and you only wanted to collect the dividend. You could buy puts on the stock to protect you if the stock went down, and they you could sell calls on the stock to raise money to pay for the puts, assuming the puts and calls were trading for about the same price. Then you would have very little exposure to moves in the stock price. Of course interest rate swaps are a little more complex then that, but that is the general idea.

        AGNC was making money off the drop in interest rates, so they did not want to fully hedge. That was great while interest rates were dropping, but it was disaster when the party ended. AGNC has since gone back to fully hedging, so they are no longer trying to make money off interest rate moves. This has reduced the dividend, but it has also allowed the fund to get back to its roots. The idea here is to make money off the spread between short and long rates. This was never supposed to be a play on interest rates.

        Sentiment: Buy

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