AGNC Investment Corp. (AGNC) is one of the largest mortgage REITs. They also run a relatively simple portfolio and have very clear investor presentations. Investors who want to understand the sector should make AGNC a top choice for studying. We believe the fundamental operations of the mortgage REITs are weakening.

Earnings are out and we will want you to keep the following in mind while reading this article:

The yield curve is flattening. This results in mortgage REITs having lower net interest spreads.

Net interest income can look better by putting expenses through book value without going through net interest expense.

In general, for mREITs comprised of agency securities, the preferred shares are still safe investments.

AGNC is only sustaining their dividend by losing book value. This doesn’t mean they are a weaker mortgage REIT.

THIRD QUARTER 2017 FINANCIAL HIGHLIGHTS

$0.99 comprehensive income per common share, comprised of:
$0.74 net income per common share

$0.25 other comprehensive income (“OCI”) per common share on investments marked-to-market through OCI

$0.62 net spread and dollar roll income per common share, excluding estimated “catch-up” premium amortization cost 1

Includes $0.24 per common share of dollar roll income associated with the Company’s $18.6 billion average net long position in forward purchases and sales of Agency mortgage-backed securities (“MBS”) in the “to-be-announced” (“TBA”) market

Excludes $(0.03) per common share of estimated “catch-up” premium amortization cost due to change in projected constant prepayment rate (“CPR”) estimates
$19.78 tangible net book value per common share as of September 30, 2017

Increased $0.53 per common share, or 2.8%, from $19.25 per common share as of June 30, 2017

Excludes $552 million, or $1.41 per common share, of goodwill and other intangible assets as of September 30, 2017

$0.54 dividends declared per common share during the quarter

5.6% economic return on tangible common equity for the quarter

Comprised of $0.54 dividends per common share and $0.53 increase in tangible net book value per common share

OTHER THIRD QUARTER HIGHLIGHTS

$72.5 billion investment portfolio as of September 30, 2017, comprised of:

$52.3 billion Agency MBS

$19.4 billion TBA mortgage position

$0.8 billion credit risk transfer (“CRT”) and non-Agency securities

8.0x tangible net book value “at risk” leverage as of September 30, 2017

7.9x average tangible net book value “at risk” leverage for the quarter

12.1% portfolio CPR for the quarter

8.5% average projected portfolio life CPR as of September 30, 2017

1.41% annualized net interest rate spread and TBA dollar roll income for the quarter, excluding estimated “catch-up” premium amortization cost

Excludes -7 bps of “catch up” premium amortization cost due to change in projected CPR estimates

Decreased from 1.55% for the prior quarter, excluding -9 bps of “catch-up” premium amortization cost

Over $1 billion of accretive equity raised during the quarter:

$735 million of common equity raised, net of offering costs, through follow-on and At-the-Market equity offerings

$315 million of preferred equity raised, net of offering costs, through issuance of 7.000% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock offering
$173 million of 8.000% Series A Cumulative Redeemable Preferred Stock redeemed
___________

Represents a non-GAAP measure. Please refer to a reconciliation to the most applicable GAAP measure and additional information regarding the use of non-GAAP financial information later in this release.

MANAGEMENT REMARKS

“We are very pleased with AGNC’s strong financial performance during the third quarter,” commented Gary Kain, the Company’s Chief Executive Officer, President and Chief Investment Officer. “Our $0.54 dividend per common share, when combined with the $0.53 per share improvement in our tangible net book value per common share, produced a very attractive economic return on tangible common equity of 5.6% during the quarter. Through the first three quarters of the year, AGNC’s economic return totaled 9.7% per common share. Importantly, we have been able to produce these results while maintaining a conservative risk profile, as evidenced by our high hedge ratio and our relatively modest duration gap.

“During the third quarter, the Federal Reserve (the “Fed”) announced its intention to begin to reduce the pace of MBS reinvestments beginning in October 2017. Agency MBS performed well during the quarter and drove the 2.8% increase in our net book value, despite the negative backdrop of the Fed’s tapering announcement, heightened geopolitical risk and significant weather-related events. Although MBS spreads tightened modestly, risk-adjusted returns on a levered Agency MBS position continue to look attractive relative to other fixed income or equity markets as credit spreads remain at or near historical lows and prices of equity indices continue to set new highs.”

“In addition to its strong financial performance, AGNC raised over $1 billion in preferred and common equity during the quarter, net of offering costs,” added Peter Federico, the Company’s Executive Vice President and Chief Financial Officer. “Our common stock issuances provide a substantial benefit for our stockholders through book value accretion when they occur above our tangible net book value. Additionally, because we are internally managed, there are no additional management fees associated with any new equity we raise, so these transactions benefit our prospective earnings profile by leveraging our relatively fixed operating costs over a larger capital base. As a result of this dynamic, AGNC’s operating efficiency improved during the third quarter as our annualized operating costs dropped to 0.77% of our quarter-end stockholders’ equity, or to 0.64% net of the fees earned from our management of MTGE Investment Corp.”

TANGIBLE NET BOOK VALUE PER COMMON SHARE
As of September 30, 2017, the Company’s tangible net book value per common share was $19.78 per share, an increase of $0.53 per common share, or 2.8%, from $19.25 per common share as of June 30, 2017, benefiting from modestly tighter mortgage spreads and accretive equity raises during the third quarter. The Company’s tangible net book value per common share excludes $552 million, or $1.41 per common share, of goodwill and other intangible assets as of September 30, 2017.

INVESTMENT PORTFOLIO
As of September 30, 2017, the Company’s investment portfolio totaled $72.5 billion, comprised of:

$71.7 billion of Agency MBS and TBA securities, including:
$70.5 billion of fixed-rate securities, comprised of:
$40.4 billion 30-year fixed-rate securities,
$14.9 billion 30-year net long TBA securities,
$10.0 billion ≤ 15-year securities,
$4.5 billion 15-year net long TBA securities, and
$0.7 billion 20-year fixed-rate securities;
$0.9 billion of collateralized mortgage obligations (“CMOs”), including principal and interest-only strips; and
$0.3 billion of adjustable-rate securities; and
$0.8 billion of CRT and non-Agency securities.
As of September 30, 2017, inclusive of TBA securities, 30 year and ≤ 15-year Agency MBS fixed rate securities represented 76% and 20% of the Company’s investment portfolio, respectively, largely unchanged from 75% and 21%, respectively, as of June 30, 2017.

As of September 30, 2017, the Company’s Agency MBS fixed-rate securities, inclusive of TBA securities, had a weighted average coupon of 3.54%, compared to 3.56% as of June 30, 2017, comprised of the following weighted average coupons:

3.64% for 30-year fixed-rate securities;
3.17% for ≤ 15-year fixed rate securities; and
3.48% for 20-year fixed-rate securities.
The Company accounts for its TBA mortgage portfolio (or “dollar roll funded assets”) as derivative instruments and recognizes dollar roll income in other gain (loss), net on the Company’s financial statements. As of September 30, 2017, the Company’s net TBA position had a total fair value of $19.4 billion and a GAAP net carrying value of $(24) million reported in derivative assets/(liabilities) on the Company’s balance sheet, compared to a total fair value of $17.3 billion and a GAAP net carrying value of $(12) million as of June 30, 2017.

CONSTANT PREPAYMENT RATES
The Company’s investment portfolio had a weighted average CPR of 12.1% for the third quarter, compared to 10.9% for the prior quarter. The weighted average projected CPR for the remaining life of the Company’s Agency securities held as of September 30, 2017 was 8.5%, slightly below the Company’s prior forecast of 8.6% as of June 30, 2017 largely due to the mix of assets acquired during the third quarter.

The weighted average cost basis of the Company’s investment portfolio was 104.8% of par value as of September 30, 2017. Net premium amortization cost on the Company’s investment portfolio for the third quarter was $(97) million, or $(0.27) per common share, which includes “catch-up” premium amortization cost of $(12) million, or $(0.03) per common share, due to changes in the Company’s projected CPR estimates for securities acquired prior to the third quarter. This compares to net premium amortization cost for the prior quarter of $(96) million, or $(0.28) per common share, including “catch-up” premium amortization cost of $(13) million, or $(0.04) per common share for securities acquired prior to the second quarter. The net unamortized premium balance as of September 30, 2017 was $2.4 billion.

ASSET YIELDS, COST OF FUNDS AND NET INTEREST RATE SPREAD
The Company’s average asset yield on its investment portfolio, excluding the net TBA position, (also referred to as “balance sheet funded assets”) was 2.72% for the third quarter, an increase from 2.66% for the prior quarter. Excluding “catch-up” premium amortization, the Company’s average asset yield was 2.82% for the third quarter, an increase from 2.78% for the prior quarter.

For the third quarter, the Company’s average cost of funds, excluding the net TBA position, was 1.59%, an increase from 1.51% for the prior quarter. The Company’s average cost of funds, excluding the net TBA position, includes the cost of Agency repurchase agreements (“Agency repo”), other debt and interest rate swaps (including interest rate swaps used to hedge the Company’s net TBA position) measured against the Company’s daily weighted average Agency repo and other debt balance outstanding. The increase in the Company’s average cost of funds was primarily due to higher repo rates, which were partly offset by an increase in the average floating rate received on the Company’s interest rate swaps.

The Company’s combined annualized net interest rate spread on its balance sheet and dollar roll funded assets for the quarter was 1.34%, compared to 1.46% for the prior quarter. Excluding “catch-up” premium amortization, the Company’s combined annualized net interest rate spread for the quarter was 1.41%, a decrease from 1.55% for the prior quarter.

On a per share basis, the Company recognized $0.59 per common share of net spread and dollar roll income (a non-GAAP financial measure) for the third quarter, compared to $0.63 for the prior quarter. Excluding “catch-up” premium amortization, the Company’s net spread and dollar roll income was $0.62 per common share for the third quarter, a decrease from $0.67 per common share for the prior quarter. A reconciliation of the Company’s net interest income to net spread and dollar roll income and additional information regarding the Company’s use of non-GAAP measures are included later in this release.

LEVERAGE
As of September 30, 2017, $45.5 billion of Agency repo and $0.4 billion of other debt were used to fund the Company’s investment portfolio. Inclusive of its net TBA position and net payable/(receivable) for unsettled securities, the Company’s tangible net book value “at risk” leverage ratio was 8.0x as of September 30, 2017, compared to 8.1x as of June 30, 2017.

As of September 30, 2017, the Company’s Agency repurchase agreements had a weighted average interest rate of 1.36%, an increase from 1.27% as of June 30, 2017, and a weighted average remaining days to maturity of 129 days, compared to 154 days as of June 30, 2017. As of September 30, 2017, $13.8 billion, or 30%, of the Company’s Agency repurchase agreements were funded through the Company’s captive broker-dealer subsidiary, Bethesda Securities, LLC, compared to $9.9 billion, or 25%, as of June 30, 2017.

As of September 30, 2017, the Company’s Agency repurchase agreements had remaining maturities of:

$34.4 billion of three months or less;
$4.6 billion from three to six months;
$0.8 billion from six to nine months;
$1.1 billion from nine to twelve months;
$3.7 billion from one to three years; and
$0.9 billion from three to five years.

HEDGING ACTIVITIES

As of September 30, 2017, 92% of the Company’s outstanding balance of Agency repurchase agreements, other debt and net TBA position was hedged with interest rate swaps, swaptions and U.S. Treasury (TSRMF) positions, compared to 98% as of June 30, 2017.

As of September 30, 2017, the Company’s interest rate swap position totaled $42.2 billion in notional amount, compared to $40.0 billion as of June 30, 2017. The Company’s interest rate swap position as of September 30, 2017 included $3.4 billion of forward starting swaps, with an average forward start date of 0.4 years, compared to $3.7 billion and 0.2 years, respectively, as of June 30, 2017. Including forward starting swaps, the Company’s interest rate swap portfolio had an average fixed pay rate of 1.66%, an average receive rate of 1.31% and an average maturity of 4.5 years as of September 30, 2017, compared to 1.60%, 1.19% and 4.4 years, respectively, as of June 30, 2017. Excluding forward starting swaps, the Company’s interest rate swap portfolio had an average fixed pay rate of 1.61% as of September 30, 2017, compared to 1.52% as of June 30, 2017.

The Company also utilizes payer swaptions and U.S. Treasury securities and futures to further mitigate exposure to changes in interest rates. As of September 30, 2017, the Company had payer swaptions outstanding totaling $5.0 billion, unchanged from June 30, 2017, and a short U.S. Treasury position outstanding of $12.7 billion, compared to $10.8 billion as of June 30, 2017.

OTHER GAIN (LOSS), NET

For the third quarter, the Company recorded a net gain of $125 million in other gain (loss), net, or $0.34 per common share, compared to a net loss of $(141) million, or $(0.41) per common share, for the prior quarter. Other gain (loss), net for the third quarter was comprised of:

$22 million of net realized gains on sales of investment securities;

$(31) million of net unrealized losses on investment securities measured at fair value through net income;

$(26) million of interest rate swap periodic costs;

$41 million of net gains on interest rate swaps;

$(22) million of net losses on interest rate
$(20) million of net losses on U.S. Treasury positions;

$87 million of TBA dollar roll income;

$71 million of net mark-to-market gains on TBA mortgage positions; and
$3 million of management fee income.

OTHER COMPREHENSIVE INCOME
During the third quarter, the Company recorded other comprehensive income of $90.0 million, or $0.25 per common share, consisting of net unrealized gains on the Company’s Agency securities recognized through OCI, compared to $121.0 million, or $0.35 per common share, of other comprehensive income for the prior quarter.

Starting in fiscal year 2017, the Company elected to recognize unrealized gains and losses on Agency securities acquired after fiscal year 2016 through net income. Unrealized gains and losses on Agency securities acquired prior to fiscal year 2017 will continue to be recognized through OCI until the Company receives full repayment of principal or disposes of the security.

COMMON AND PREFERRED EQUITY TRANSACTIONS
The Company completed several capital markets transactions during the third quarter.

On August 22, 2017, the Company completed a public offering of 13 million depositary shares of 7.000% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (“Series C Preferred Stock”) for net proceeds of $315 million (aggregate liquidation preference of $325 million). Each depositary share represents a 1/1,000th interest in a share of Series C Preferred Stock.

On September 15, 2017, the Company redeemed its 8.000% Series A Cumulative Redeemable Preferred Stock for its aggregate liquidation preference of $173 million plus accrued and unpaid dividends.

On September 15, 2017, the Company completed a public offering of 28.2 million shares of its common stock for net proceeds of $577 million, or $20.47 per common share.

The Company issued 7.6 million shares of its common stock for net proceeds of $159 million through its “At-the-Market Offering Program” during the quarter. As of September 30, 2017, the Company had $589 million of common stock remaining available for issuance under the Program.

THIRD QUARTER 2017 DIVIDEND DECLARATIONS

During the third quarter, the Company’s Board of Directors declared dividends of $0.18 per share to common stockholders of record as of July 31, August 31 and September 29, 2017, respectively, totaling $0.54 per share for the quarter, which were paid on August 7, September 8 and October 10, 2017, respectively. Since its May 2008 initial public offering through the third quarter of 2017, the Company has declared a total of $7.3 billion in common stock dividends, or $36.62 per common share.

On September 14, 2017, the Company’s Board of Directors declared a third quarter dividend on its 7.750% Series B Cumulative Redeemable Preferred Stock of $0.484375 per depositary share and on its Series C Preferred Stock of $0.25764 per depositary share. The dividends were paid on October 16, 2017 to preferred stockholders of record as of October 1, 2017.

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