American Capital Agency Corp. (AGNC)

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American Capital Agency Corp. (AGNC)

JPMorgan SMid Cap Conference

December 1, 2011 02:15 pm ET


Gary Kain - President and CIO


Unidentified Analyst

Thank you everybody for coming. Very quickly I am introducing Gary Kain from American Capital Agency REIT, Gary go ahead.

Gary Kain

Thank you guys and first of all I would like to thank JPMorgan for the opportunity to present at this conference. But I also would like to thank all of you for your interest in AGNC, you know there is really a lot we could focus on given the market between Europe and all the volatility we are seeing in the financial markets and I guess the overall concerns related to both the U.S. economy but more so the global economy.

But really what I want to focus on today is related to the low interest-rate environment that we are in and it's really the prepayment picture because in the absence of any real change to this environment which we don't see happening in the near term, prepayments are really going to dominate performance in the REIT space and it's really going to be a key driver of our returns.

So with that I will try to jump right in because we have a lot to cover today. So, first of all the current market landscape is one where again interest rates are at basically record lows, mortgage rates are at record lows. Borrowers can take out of a 30 year fixed-rate mortgage around 4%; they can take out 15 year mortgages around 3% are very low 3%, ARM mortgages are around 3% as well maybe a little below. The other thing that's really important to keep in mind is that most of the borrowers who took out loans over the last two to three years, two years since 2009 are good credit borrowers that qualified under stricter underwriting and so guess what they can refinance.

They will qualify, vast majority of them will qualify for new loans and what we're seeing is our prepayment speeds and we will look at this in a second prepared to look at this the second on new loans through credit mortgages are fast and they probably will continue to be so.

Now the enhancements to the HARP program that FHFA laid out a few weeks ago. They first kind of highlighted a month ago but then laid out in the middle of November. Definitely increased the risk around season’s mortgages and how they may perform because there is more incentive for the originators to refinance that population as the risk around reps and warranties, some of the fees are lower. There is a number of things that were done via that process that increased kind of the prepayment risk on young season’s vintage of mortgages.

So when you put those two pieces – those two bullet points together in a sense, what you have is the newer mortgages exposed because of they are good credit, the older, more seasoned mortgages largely exposed because of the insurance rates to be to the HARP program, so there is greater exposure there.

So the key point there is that prepayments are a clear and present danger for the space. Now when you layer on this the last bullet point relating to the Fed and the risk were the potential for Q3 and mortgages, now different people think the odds of a Q3 very but the Fed has kind of told you that if there is a Q3 it's going to be center of mortgages.

And so if that happens it's going to drive mortgage rates even lower than they would otherwise be and it will give a lot of attention to mortgage rates and to the fact that borrowers could be refinancing so all of these discussions we have, we are going to have around the prepayment picture will get even more important in an environment if the Fed does go down the path of a QE3 on the mortgage side.

So with that lets look at what's going on, on the prepayment front right now and these are our newer mortgages. These two graphs are both 15 year and 30 year mortgages that were originated in 2010 so on the left side we have 15 year, 4% coupon Fannie Mae mortgages and as you can see and this is the most recent data that’s been released. There is another prepayment release next week but this includes what was released in early November.

You can see that the blue line which are kind of generic or TVA 15 year for us got up to 35 CPRs. So these aren’t, these are good credit 15 year borrowers tend to be very good credit, high FICO scores, low LTVs, people that can afford a higher payment.

So they easily qualify and they tend to react to changes in interest rates pretty quickly. On the other hand if you notice a mean model which is apprised of loans with balances between $85,000 and a $110,000 so call it an average of near a $100,000 the loan size.

Those smaller loans repaid much slower, why? Two reasons, one is because the borrower, the fixed cost to refinance a loan whether it's an appraisal, whether it's courier fees, settlement fees, if you have a small loan those dollars you need a much bigger change in interest rate to make it worthwhile to pay those fixed costs.

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