UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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| ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the year ended December 31, 20162017
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| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 001-34057
AGNC INVESTMENT CORP.
(Exact name of registrant as specified in its charter)
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| Delaware | | 26-1701984 |
(State or Other Jurisdiction of Incorporation or Organization) | | (I.R.S. Employer Identification No.) |
2 Bethesda Metro Center, 12th Floor
Bethesda, Maryland 20814
(Address of principal executive offices)
(301) 968-9315
(Registrant’s telephone number, including area code)
Securities registered pursuant to section 12(b) of the Act: |
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| Title of each class | Name of each exchange on which registered |
| Common Stock, $0.01 par value per share | The NASDAQ Global Select Market |
8.000% Series A Cumulative Redeemable Preferred Stock | The NASDAQNasdaq Global Select Market |
| 7.750% Series B Cumulative Redeemable Preferred Stock | The NASDAQNasdaq Global Select Market |
| 7.00% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock | The Nasdaq Global Select Market |
Securities registered pursuant to section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No ý
Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý Accelerated filer ¨ Non-accelerated filer ¨ (Do not check if a smaller reporting company) |
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| Large accelerated filer | ý | | Accelerated filer | ¨ |
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| Non-accelerated filer | ¨ | (Do not check if a smaller reporting company) | Smaller Reporting Company | ¨ |
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| Emerging growth company | ¨ | | | |
If an emerging growth company, indicate by check mark if registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
As of June 30, 2016,2017, the aggregate market value of the Registrant's common stock held by non-affiliates of the Registrant was approximately $5.5$6.3 billion based upon the closing price of the Registrant's common stock of $19.82$21.29 per share as reported on The NASDAQNasdaq Global Select Market on that date. (For this computation, the Registrant has excluded the market value of all shares of its common stock reported as beneficially owned by executive officers and directors of the Registrant and certain other stockholders; such an exclusion shall not be deemed to constitute an admission that any such person is an "affiliate" of the Registrant.)
The number of shares of the issuer's common stock, $0.01 par value, outstanding as ofJanuary 31, 20172018 was331,046,077. 391,316,840.
DOCUMENTS INCORPORATED BY REFERENCE. The Registrant's definitive proxy statement for the 20172018 Annual Meeting of Stockholders is incorporated by reference into certain sections of Part III herein.
Certain exhibits previously filed with the Securities and Exchange Commission are incorporated by reference into Part IV of this report.
AGNC INVESTMENT CORP.
TABLE OF CONTENTS
PART I.I
Item 1. Business
AGNC Investment Corp. ("AGNC," the "Company," "we," "us" and "our") was organized on January 7, 2008 and commenced operations on May 20, 2008 following the completion of our initial public offering. Our common stock is traded on The NASDAQNasdaq Global Select Market under the symbol "AGNC."
We operate so as to qualify to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code"). As such,a REIT, we are required to distribute annually 90% of our taxable net income. AsSo long as we continue to qualify as a REIT, we will generally not be subject to U.S. federalFederal or state corporate taxes on our taxable net income to the extent that we distribute all of our annual taxable net income to our stockholders.stockholders on a timely basis. It is our intention to distribute 100% of our taxable net income after application of available tax attributes, within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year.
We earn income primarily from investing in Agency residential mortgage-backed securities ("Agency RMBS") on a leveraged basis. These investments consist of residential mortgage pass-through securities and collateralized mortgage obligations for which the principal and interest payments are guaranteed by a U.S. Government-sponsored enterprise, such as the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"Mac," and together with Fannie Mae, the "GSEs"), or by a U.S. Government agency, such as the Government National Mortgage Association ("Ginnie Mae") (collectively referred to as "GSEs"). We may also invest in other types of mortgage and mortgage-related residential and commercial mortgage-backed securities where repayment of principal and interest is not guaranteed by a GSE or U.S. Government agency.
Our principal objective is to provide our stockholders with attractive risk-adjusted returns through a combination of monthly dividend distributionsdividends and tangible net book value accretion. We generate income from the interest earned on our investments, net of associated borrowing and hedging costs, and net asset value (also referred to as "net book value," "NAV"realized gains and "stockholders' equity") accretion.losses on our investment and hedging activities. We fund our investments primarily through short-term borrowings structured as repurchase agreements.
Investment Strategy
Our investment strategy is designed to:
generate attractive risk-adjusted returns for our stockholders comprised ofthrough monthly dividend distributions and NAVtangible net book value accretion;
manage an investment portfolio consisting primarily of Agency securities;
invest a subset of the portfolio in mortgage credit risk oriented assets;
capitalize on discrepancies in the relative valuations in the Agency and non-Agency securities market;
manage financing, interest rate, prepayment, extension and credit risks;
continue to qualify as a REIT; and
remain exempt from the requirements of the Investment Company Act of 1940 (the "Investment Company Act").
Targeted Investments
Agency Securities
Agency Residential Mortgage-Backed Securities ("Agency RMBS").Securities. Our primary investments consist of Agency pass-through certificates representing interests in "pools" of mortgage loans secured by residential real property. Monthly payments of principal and interest made by the individual borrowers on the mortgage loans that underlieunderlying the securities, which are guaranteed by a GSE to holders of the securities,pools are in effect "passed through," net of fees paidthrough" to the issuer/guarantorsecurity holders, after deducting GSE or U.S. Government agency guarantee and servicers of the securities, to the holders of the securities.servicer fees. In general, mortgage pass-through certificates distribute cash flows from the underlying collateral on a pro rata basis among the security holders. Security holders of the securities. Holders of the securities also receive guarantor advances of principal and interest for delinquent loans in the mortgage pools. We also invest in Agency collateralized mortgage obligations ("CMOs"), which are structured instruments representing interests in Agency residential pass-through certificates, and interest-only, inverse interest-only and principal-only securities, which represent the right to receive a specified proportion of the contractual interest or principal flows of specific Agency CMO securities.
To-Be-Announced Forward Contracts ("TBAs"). TBAs are forward contracts to purchase or sell Agency RMBS. TBA contracts specify the coupon rate, issuer, term and face value of the bonds to be delivered, with the actual bonds to be delivered only identified shortly before the TBA settlement date.
Non-Agency Securities
Credit Risk Transfer Securities ("CRT"). CRT securities are risk sharing instruments that transfer a portion of the risk associated with credit losses within pools of conventional residential mortgage loans from the GSEs and/or thirdthird- parties to private investors, such as us.investors. Unlike Agency RMBS, full repayment of the original principal balance of CRT securities is not guaranteed by a GSE or other third party;third-party; rather, "credit risk transfer" is achieved by writing down the outstanding principal balance of the CRT securitiessecurity if credit losses on the related pool of loans exceed certain thresholds. By reducing theThe reduced amount that issuers are obligated to repay to the security holders of CRT securities,offsets the issuers of CRT securities are able to offsetissuer's credit losses on the related pool of loans.
Non-Agency Residential Mortgage-Backed Securities ("Non-Agency RMBS"). Non-Agency RMBS are securities backed by residential mortgages, for which payment of principal and interest is not guaranteed by a GSE or governmentU.S. Government agency. Instead, a private institution such as a commercial bank will package residential mortgage loans and securitize them through the issuance of RMBS. Non-Agency RMBS are often referred to as private label RMBS. Non-Agency RMBS may benefit from credit enhancement derived from structural elements, such as subordination, overcollateralization or insurance. We may purchase highly-rated instruments that benefit from credit enhancement or non-investment grade instruments that absorb credit risk. We focus primarily on non-Agency securities where the underlying mortgages are secured by residential properties within the United States. Residential non-Agency securities are backed by residential mortgages that can be comprised of prime mortgage or nonprime mortgage loans. We may also purchase Agency or non-Agency multifamily securities where the collateral backing the securitization consists in whole or in part of loans tofor properties housing multiple tenants.
Commercial Mortgage-Backed Securities ("CMBS"). CMBS are securities that are structured utilizing collateral pools comprised of commercial mortgage loans. CMBS can be structured as pass-through securities, where the cash flows generated by the collateral pool are passed on pro rata to investors after netting servicer or other fees, or where cash flows are distributed to numerous classes of securities following a predetermined waterfall, which may give priority to selected classes while subordinating other classes. We may invest across the capital structure of these securities, and we intend to focus on CMBS where the underlying collateral is secured by commercial properties located within the United States.
Active Portfolio Management Strategy
We employ an active management strategy designed to achieve our principal objectives of generating attractive risk-adjusted returns and managing our net assetbook value within reasonable bands. We invest in securities based on our assessment of the relative risk-return profile of the securities and our ability to effectively hedge a portion of the securities' exposure to market risks. The composition of our portfolio and strategies that we use will vary based on our view of prevailing market conditions and the availability of suitable investment, hedging and funding opportunities. We may experience investment gains or losses when we sell securities that we believe no longer provide attractive risk-adjusted returns or when we believe more attractive alternatives are availableexist elsewhere in the mortgage or mortgage-related securities market, or when we believe it is prudent to reduce aggregate exposure or a particular type of risk embedded in the portfolio.market. We may also experience gains or losses as a result offrom our hedging strategies or due to credit losses on our non-Agency securities.
Financing Strategy
As part of our investment strategy, we use leverage on our investment portfolio to increase potential returns to our stockholders. Our primary source of financing is through repurchase agreements. A repurchase (or "repo") agreement transaction acts as a financing arrangement under which we effectively pledge our investment securities as collateral to secure a loan. Our borrowings pursuant to these repurchase transactions generally have maturities ranging from 30 days to one year, but may have maturities less than 30 days or up to five or more years. Under our repurchase agreements, ourOur financing raterates typically tracks short term rates such astrack one three or six monththree-month London Interbank Offered Rate ("LIBOR"), plus or minus a fixed spread.
Our leverage varies dependingdepends on market conditions, our assessment of risk and returns and our ability to continue to borrow funds sufficient to fund acquisitionsthe acquisition of mortgage securities. We generally expect our leverage to be within six to eleventwelve times the amount of our tangible stockholders' equity. However, under certain market conditions, we may operate at leverage levels outside of this range for extended periods of time.
We seek to diversify our funding exposure by entering into repurchase agreements with multiple counterparties. We had master repurchase agreements with 3843 financial institutions as of December 31, 2016.2017. The terms of our master repurchase agreements generally conform to the terms in the standard master repurchase agreement as published by the Securities Industry and Financial Markets Association ("SIFMA") as to repayment, margin requirements and the segregation of all securities sold under the repurchase transaction. In addition, each lender may require that we include supplemental terms and conditions to the standard master repurchase agreement to address such matters as additional margin maintenance requirements, cross default and
standard master repurchase agreement. Typical supplemental terms and conditions include changes to the margin maintenance requirements, purchase price maintenance requirements, requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction and cross defaultother provisions. TheseThe specific provisions may differ for each lender and certain of these terms may not be determined until we engage in individual repurchase transactions.
During 2015, we formed a specificwholly-owned captive broker-dealer subsidiary, Bethesda Securities, LLC ("BES"). BES became operational and received final membership approval to the Fixed Income Clearing Corporation ("FICC") during the third quarter of 2016. BES has direct access to bilateral and triparty repo funding as a Financial Industry Regulatory Authority ("FINRA") member broker-dealer. As an eligible institution, BES also raises repo funding through the General Collateral Finance ("GCF") Repo service offered by the FICC, with the FICC acting as the central counterparty, which provides us greater depth and diversity of repurchase transaction.agreement funding while also lowering our funding cost, reducing our collateral requirements and limiting our counterparty exposure.
We may also obtain other sources of financing depending on market conditions. We mayeffectively finance the acquisition of Agency RMBS by entering into TBA dollar roll transactions in which we would sell a TBA contract for current month settlement and simultaneously purchase a similar TBA contract for a forward settlement date. Prior to the forward settlement date, we may choose to roll the position out to a later date by entering into an offsetting TBA position, net settling the paired off positions for cash, and simultaneously entering into a similar TBA contract for a later settlement date. In such transactions, theThe TBA contract purchased for athe forward settlement date is priced at a discount to the TBA contract sold for settlement/pair off in the current month. ThisThe difference (or discount) is referred to as the "price drop." The price dropdrop" and is the economic equivalent of net interest carry income on the underlying Agency RMBS over the roll period (interest income less implied financing cost) and, which is commonly referred to as "dollar roll income." We recognize TBA contracts as derivative instruments on our consolidated financial statements at their net carrying value (fair value less the purchase price to be paid or received under the TMA contract). Consequently, dollar roll transactions represent a form of off-balance sheet financing. In evaluating our overall leverage at risk, we consider both our on-balance sheet and off-balance sheet financing.
During 2015, we formed a wholly-owned captive broker-dealer subsidiary, Bethesda Securities, LLC ("BES"). BES became operational and received final membership approval to the Fixed Income Clearing Corporation ("FICC") during the third quarter of 2016. BES has direct access to bilateral and triparty funding as a Financial Industry Regulatory Authority ("FINRA") member broker-dealer. As an eligible institution, BES also raises funds through the General Collateral Finance Repo service offered by the FICC, with the FICC acting as the central counterparty, and thus provides us greater depth and diversity of repurchase agreement funding while also lowering our funding cost and limiting our counterparty exposure.
Risk Management Strategy
We use a variety of strategies to reduce our exposure to market risks, including interest rate, prepayment, extension and credit risks. Our investment strategies take into accountare based on our assessment of these risks, the cost of the hedging transactions and our intention to qualify as a REIT. Our hedging strategies are generally not designed to protect our net assetbook value from "spread risk" (also referred to as "basis risk"),risk," which is the risk that the yield differential between our investments and our hedges fluctuates. In addition, while we use interest rate swaps and other supplemental hedges to attempt to protect our net assetbook value against moves in interest rates, we may not hedge certain interest rate, prepayment or extension risks if we believe that bearing such risks enhances our return profile, or if the hedging transaction would negatively impact our REIT status.
Interest Rate Risk. We hedge a portion of our exposure to interest rate mismatches betweenrisk with respect to both the interest we earn onfixed income nature of our longer term investmentslong-term assets and the interest we pay onshort-term, variable rate nature of our shorter term borrowings. Because afinancing. A majority of our funding is in the form of repurchase agreements, and, as a result, our financing costs fluctuate based on short-term interest rate indices, such as LIBOR. Because ourOur investments are assets that primarily have fixed rates of interest and could mature inmaturities up to 40 years, and the interest we earn on those assets generally does not move in tandem with the interest that we pay on our repurchase agreements; therefore,agreements. As such, we may experience reduced income or losses due to adverse interest rate movements. In order to attempt toTo mitigate a portion of such risk, we utilize certain hedging techniques to attempt to lock in a portion of the net interest spread between the interest we earn on our assets and the interest we pay on our financing costs. We also use certain hedges, such as short U.S. Treasury securities and U.S. Treasury futures positions, to hedge a portion of the price risk associated with our largely fixed-rate asset portfolio due to changes in interest rates.
Additionally, because prepaymentsPrepayments on residential mortgages generally accelerate when interest rates decrease and slow when interest rates increase,rise, and, as a result, mortgage securities typically have "negative convexity." In other words, certain mortgage securities in which we invest may increase in price more slowly than similar duration bonds, or even fall in value, as interest rates decline. Conversely, certain mortgageMortgage securities in which we invest maycould also decrease in value more quickly than similar duration bonds as interest rates increase. In orderrise. This is referred to manage this risk, we monitor, among other things, the "duration gap" between our mortgage assets and our hedge portfolio as well as"negative convexity." To manage our convexity exposure. Duration is the estimated percentage change in market value of our mortgage assets or our hedge portfolio that would be caused by a parallel change in short and long-term interest rates. Convexity exposure, relates to the way the duration of our mortgage assets or our hedge portfolio changes whenwe monitor the interest rate sensitivity of our assets relative to the interest rate sensitivity of our liabilities and interest rate hedge portfolio, referred to as our "duration gap," and we monitor how our convexity and duration gap change if interest rates and prepayment expectations were to increase or prepayment environment changes.decrease.
The value of our mortgage assets may also be adversely impacted by fluctuations in the shape of the yield curve or by changes in the market's expectation about the volatility of future interest rates.rate volatility. We analyze our exposure to non-parallel changes in interest rates and to changes in the market's expectation of future interest rate volatility and take actions to attempt to mitigate these risks.
Prepayment Risk. Because residential borrowers have the option to prepay their mortgage loans at par at any time, we face the risk that we will experience a return of principal on our investments faster than anticipated. Prepayment risk generally increases when interest rates decline. In this scenario, our financial results may be adversely affected as we may have to invest that principal at potentially lower yields.
Extension Risk. Because residential borrowers have the option to make only scheduled payments on their mortgage loans, rather than prepay their mortgage loans, we face the risk that a return of capital on our investment will occur slower than anticipated. Extension risk generally increases when interest rates rise. In this scenario, our financial results may be adversely affected as we may have to finance our investments at potentially higher costs without the ability to reinvest principal into higher yielding securities because the rate at which borrowers refinanceprepay their mortgages sell the property collateralizing the mortgage, or otherwise pay incremental principal payments occurs at a slower pace than was originally expected.
Spread Risk. Because the market spread between the yield on our investments and the yield on benchmark interest rates, such as U.S. Treasury rates and interest rate swap rates, may vary, we are exposed to spread risk. The inherent spread risk associated with our investment securitiesinvestments and the resulting fluctuations in fair value of these securities can occur independent of interest rates and may relate to other factors impacting the mortgage and fixed income markets, such as actual or anticipated monetary policy actions by the Federal Reserve (the "Fed"), liquidity, or changes in required rates of return on different assets. Our strategies are generally not designed to protect our net assetbook value from spread risk.
Credit Risk. We accept mortgage credit exposure related to our CRT and other non-Agency securities at levels we deem to be prudent within the context of our overall investment strategy. Therefore, we may retain all or a portion of the credit risk on the loans underlying our non-Agency securities. We seek to manage this risk through prudent asset selection, pre-acquisition due diligence, post-acquisition performance monitoring, and sale of assets where we identify negative credit trends. We may also manage credit risk with credit default swaps or other financial derivatives that we believe are appropriate. Additionally, we may vary the percentage mix of our Agency and non-Agency mortgage investments or our duration gap, when we believe credit performance is inversely correlated with changes in interest rates, in an effort to actively adjust our credit exposure and/or to improve the return profile of our investment portfolio.
The principal instruments that we use to hedge a portion of our exposure to interest rate, prepayment and extension risks are interest rate swaps, and options to enter into interest rate swaps ("interest rate swaptions"). We also utilize forward contracts for the purchase or sale of Agency RMBS securities in the TBA market on a generic pool basis and, U.S. Treasury securities and U.S. Treasury futures contracts. We also use TBA forward contracts primarily through short sales. We may also purchase or write put or call options on TBA securities and invest in mortgage and other types of derivative instruments, such as interest and principal-only securities.to periodically reduce our exposure to Agency RMBS.
The risk management actions we take may lower our earnings and dividends in the short term to further our objective of maintaining attractive levels of earnings and dividends over the long term. In addition, some of our hedges are intended to provide protection against larger rate moves and as a result may be relatively ineffective for smaller changes in interest rates. There can be no certainty that ourrate changes. Our projections of our exposures to interest rates, prepayments,rate, prepayment, extension orand other risks will be accurate orare also based on models that our hedging activities will be effectiveare dependent on a number of assumptions and therefore,inputs, and actual results could differ materially.materially from our projections.
Income from hedging transactions that we enter into to manage risk may not constitute qualifying gross income under one or both of the gross income tests applicable to REITs (see "Real Estate Investment Trust Requirements"Requirements )below). Therefore, we may have to limit our use of certain hedging techniques, which could expose us to greater risks than we would otherwise want to bear, or implement those hedging techniques through a taxable REIT subsidiary ("TRS"). Implementing our hedges through a TRS could increase the cost of our hedging activities because a TRS would be subject to tax on income and gains.
Management Internalization
Prior to July 1, 2016, we were externally managed by AGNC Management, LLC (our "Manager," formerly known as American Capital AGNC Management, LLC)"Manager"). On July 1, 2016, we completed the acquisition of all the outstanding membership interests of AGNC Mortgage Management, LLC ("AMM," formerly known as American Capital Mortgage Management, LLC)AMM"), the parent company of our Manager, from American Capital Asset Management, LLC ("ACAM"), a wholly owned portfolio company of American Capital, Ltd. ("ACAS"), for a purchase price of $562 million in cash. AMM is also the parent company of MTGE Management, LLC, ("MTGE Manager," formerly known as American Capital MTGE Management, LLC), the external manager of MTGE Investment Corp. ("MTGE," formerly known as American Capital Mortgage Investment Corp.MTGE") (Nasdaq: MTGE). Following the closing of the acquisition of AMM, we became internally managed and the external manager of MTGE.
Prior to our management internalization, we paid our Manager a management fee payable monthly in arrears in an amount equal to one-twelfth of 1.25% of our month-end stockholders' equity, adjusted to exclude the effect of any unrealized gains or losses includedas defined in either retained earnings or accumulated OCI, each as computed in accordance with GAAP,our management agreement, and we were obligated to reimburse our Manager for its expenses incurred directly related to our operations, excluding employment-related expenses ofexpenses. Following our Manager's officers and employees and any American Capital employees who provided services to us pursuant to the management agreement. There was no incentive compensation payable to our Manager pursuant to the management agreement. Following the internalization, of our manager, we no longer incur a management fee, but we incur expenses associated with being an internally managed organization, including compensation expenseexpenses previously borne by our Manager. If we had elected to cancel the
management contract without cause, we would have been obligated to pay management fees through our existing renewal term (plus an additional one year period if we had not provided notice of non-renewal at least 180-days prior to the completion of the then current renewal term) and a termination fee equal to three times our average annual management during the preceding 24-month period. We would have also been precluded from hiring any of the employees for a two year period following termination who had worked for ACAS or any of its affiliates, including our Manager, at any point over the prior two year period.
Employees
As of December 31, 2016,2017, we had 5456 full-time employees.
Exemption from Regulation under the Investment Company Act
We conduct our business so as not to become regulated as an investment company under the Investment Company Act (the "Act"), in reliance on the exemption provided by Section 3(c)(5)(C) of the Investment Company Act. AsSo long as we qualify for this exemption, we will not be subject to leverage and other restrictions imposed on regulated investment companies, which would significantly reduce
our ability to use leverage. Section 3(c)(5)(C), as interpreted by the staff of the SEC,U.S. Securities and Exchange Commission ("SEC"), requires us to invest at least 55% of our assets in "mortgages and other liens on and interest in real estate" or "qualifying real estate interests" and at least 80% of our assets in qualifying real estate interests and "real estate-related assets." In satisfying this 55% requirement, based on pronouncements of the SEC staff and in certain instances our own judgment, we treat Agency RMBS issued with respect to an underlying pool of mortgage loans in which we hold all of the certificates issued by the pool ("whole pool" securities) as qualifying real estate interests. We typically treat "partial pool" and other mortgage securities where we hold less than all of the certificates issued by the pool as real estate-related assets.
Real Estate Investment Trust Requirements
We have elected to be taxed as a REIT under the Internal Revenue Code. AsSo long as we qualify as a REIT, we generally will not be subject to U.S. federalFederal or state corporate income tax on our taxable net income to the extent that we annually distribute all of our taxable net income to stockholders within the time limits prescribed by the Internal Revenue Code. Qualification and taxation as a REIT depends on our ability to continually meet on a continuing basis various qualification requirements imposed upon REITs by the Internal Revenue Code, including satisfying certain organizational requirements, an annual distribution requirement and quarterly asset and annual income tests. The REIT asset and income tests are of particular significancesignificant to our operations as they restrict the extent to which we can invest in certain types of securities and conduct certain hedging activities within the REIT. Consequently, we may be required to limit these activities or conduct them through a TRS. We believe that we have been organized and operate in such a manner as to qualify for taxation as a REIT.
Income Tests
In order toTo continue to qualify as a REIT, we must satisfy two gross income requirements on an annual basis.
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| 1. | At least 75% of our gross income for each taxable year generally must be derived from investments in real property or mortgages on real property. |
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| 2. | At least 95% of our gross income in each taxable year generally must be derived from some combination of income that qualifies under the 75% gross income test described above, as well as other dividends, interest, and gains from the sale or disposition of stock or securities, which need not have any relation to real property. |
Interest income from obligations secured by mortgages on real property (such as Agency and non-Agency MBS) generally constitutes qualifying mortgage interestincome for purposes of the 75% gross income test described above to the extent that the obligation upon which such interest is paid is secured by a mortgage on real property. We expect that substantially all of ourabove. Interest income from our Agency and non-Agency MBS will continue to be qualifying income for purposes of the 75% gross income test. Income from CRT securities is treated as non-qualifying income for the 75% gross income test, which potentially limits our ability to invest in CRT securities.test. There is no direct authority with respect to the qualification of income or gains from TBAs as gains from the sale of real estate assets or other qualifying income for purposes of the 75% gross income test. Wetest; however, we treat gains from TBAsthese as qualifying income for purposes of the 75% gross income test and we treat TBAs as qualifying assets for purposes of the 75% asset test described belowthis purpose based on an opinion of legal counsel. Income and gains that we derive from instruments that we use to hedge the interest rate risk associated with our borrowings incurred, or to be incurred, to acquire real estate assets will generally be excluded from both the numerator and the denominator for purposes of the 75% and 95% gross income test,tests, provided that specified requirements are met.
Asset Tests
At the close of each calendar quarter, we must satisfy fourfive tests relating to the nature of our assets.
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| 1. | At least 75% of the value of our total assets must be represented by some combination of "real estate assets," cash, cash items, U.S. Government securities, and, under some circumstances, temporary investments in stock or debt instruments purchased with new capital. For this purpose, mortgage-backed securities and mortgage loans are generally treated as "real estate assets." Assets that do not qualify for purposes of the 75% asset test are subject to the additional asset tests described below. |
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| 2. | The value of any one issuer's securities that we own may not exceed 5% of the value of our total assets. |
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| 3. | We may not own more than 10% of any one issuer's outstanding securities, as measured by either voting power or value. The 5% and 10% asset tests do not apply to securities of TRSs and qualified REIT subsidiaries and the 10% asset test does not apply to "straight debt" having specified characteristics and to certain other securities. |
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| 4. | The aggregate value of all securities of all TRSs that we hold may not exceed 25%20% of the value of our total assets. (For tax years beginning after December 31, 2017, the limit is reduced to 20% |
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| 5. | No more than 25% of the total value of total assets.)our assets may be represented by certain non-mortgage debt instruments issued by publicly offered REITs (even though such debt instruments qualify under the 75% asset test). |
If we should fail to satisfy the income or asset tests, such a failure would not cause us to lose our REIT qualification if we were able to eliminate the discrepancy within a 30 day30-day cure period, in the case of the asset test, or satisfy certain relief provisions
and pay any applicable penalty taxes and other fines. Please also refer to the "Risks Related to Our Taxation as a REIT" in "Item 1A. Risk Factors" of this Form 10-K for further discussion of REIT qualification requirements and related items.
Corporate Information
Our executive offices are located at Two Bethesda Metro Center, 12th Floor, Bethesda, MD 20814 and our telephone number is (301) 968-9315.
We make available all of our Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports as well as our Code of Ethics and Conduct free of charge on our internet website at www.AGNC.com as soon as reasonably practical after such material is electronically filed with or furnished to the Securities and Exchange Commission ("SEC").SEC. These reports are also available on the SEC internet website at www.sec.gov.
Competition
Our success depends, in large part, on our ability to acquire assets at favorable spreads over our borrowing costs. In acquiring mortgage assets, we compete with mortgage REITs, mortgage finance and specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, other lenders, governmental bodies and other entities. These entities and others that may be organized in the future may have similar asset acquisition objectives and increase competition for the available supply of mortgage assets suitable for purchase. Additionally, our investment strategy is dependent on the amount of financing available to us in the repurchase agreement market, which may also be impacted by the overall supply of repo funding and competing borrowers. Our investment strategy will be adversely impacted if we are not able to secure financing on favorable terms, if at all.
Item 1A. Risk Factors
You should carefully consider the risks described below and all other information contained in this Annual Report on Form 10-K, including our annual consolidated financial statements and the related notes thereto before making a decisiondeciding to purchase our securities. If any of the following risks were to occur, our business, financial condition or results of operations could be materially adversely affected. If that happens, the trading price of our securities could decline, and you may lose all or part of your investment. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us, or not presently deemed material by us, may also impair our operations and performance.
If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. If that happens, the trading price of our securities could decline, and you may lose all or part of your investment.
Risks Related to Our Investing, Portfolio Management and Financing Activities
An increase in our borrowing costs would adversely affect our financial condition and results of operations.
Our borrowing costs may increase for a number of reasons, including increases inWe rely primarily on short-term interest rates, the "haircut" appliedand/or variable rate borrowings to our assets under repurchase agreements, interest rate volatility, decreases in the value of our assets or availability of financing generally. An increase in our borrowing costs will reduce the difference, or spread, that we may earn between the yields on the investments we make and the borrowings we use to finance such investments. Moreover, dueacquire fixed-rate securities with long-term maturities. Due to the short-term or adjustable rate nature of the majority of our repurchase agreements used to finance our investments,financing, our borrowing costs are particularly sensitive to increases in short-term interest rates, as well as overall funding availability, market liquidity, fluctuations in asset values and "haircut" levels applied to assets pledged under repurchase agreements and other factors.
The relationship between short and longer-term interest rates is often referred to as the "yield curve." Ordinarily, short-term interest rates are lower than longer-term interest rates, but a flattening of the yield curve can occur if short-term interest rates rise disproportionately relative to longer-term interest rates. It is also possible that due to higherthe yield curve could invert, with short-term rates exceeding longer-term rates. If either of these conditions occur our borrowing costs could increase more rapidly than the spread on investments could be reduced to a point at which the profitability from investments would be significantly reduced or eliminated. This would adversely affect the returnsinterest income earned on our fixed rate assets and our net interest margin would decline, or in extreme scenarios even turn negative. In this event, we could incur operating losses and our financial condition and results of operations andability to make distributions to our stockholders could require us to liquidate certain or all of our assets.be adversely affected.
Changes to the pace of reinvestment of paydownsthe Fed's purchases or sales of Agency mortgage-backed securities by the Federal Reserve may adversely affect the price and return associated with Agency securities.
In October 2014,2017, the Federal Reserve endedFed began to taper its large scale asset purchases under quantitative easing programs designed to support the mortgage markets and stimulate the economy. The Federal Reserve currently reinvests allreinvestments of principal payments from its U.S. Treasury, Agency debt and Agency RMBS portfolios acquired as a function of its quantitative easing programs, thereby holding the nominal size of the securities it holds in each of these portfolios largely unchanged. In previous statements, members of the Federal Open Market Committee (FOMC) of the Federal Reserve have indicated that full reinvestment of the securities portfolio would continue until "normalization of the level of the federal funds rate is well under way"; therefore, it is difficult to predict when and at what pace the Federal Reserve will end reinvestments of principal payments.programs. We also cannot predict the impact that thisthese or otherfuture actions couldwill have on the prices and liquidity of Agency RMBS or on mortgage spreads relative to interest rate hedges tied to benchmark interest rates. During periods in which the Federal ReserveFed further reduces or ceases reinvestment of principal or undertakes outright sales of its securities portfolio, the price of Agency RMBS and U.S. Treasury securities will likelycould decline, mortgage spreads will likelycould widen, refinancing volumes will likelycould be lower and market volatility will likelycould be considerably higher than would have been the case absent such actions and our net book valueresults of operations and financial condition could be adversely affected.
Our Board of Directors
We may change our targeted investments, investment guidelines and other operational policies without notice or stockholder consent, which may result in riskieradversely affect the market price of our common stock and our ability to make distributions to stockholders.
We may change our targeted investments and does not approve each investment we make.
Our Board of Directors has approved the following investment guidelines:
our investment portfolio shall consist primarily of Agency securities, but may include other types of mortgage and mortgage-related residential and commercial mortgage-backed securities where repayment of principal and interest is not guaranteed by a GSE;
no investment shall be made that would cause us to fail to qualify as a REIT for federal income tax purposes; and
no investment shall be made that would cause us to be regulated as an investment company under the Investment Company Act.
Our Board of Directors periodically reviews our investment guidelines, investment portfolio, and potential investment strategies. However, our Board of Directors does not pre-approve individual investments leaving management with day to day discretion over the portfolio composition within the investment guidelines. Within those guidelines, management has discretion to significantly change the composition of the portfolio. In addition, in conducting periodic reviews, our Board of Directors may rely primarily on information provided to them by our management. Our Board of Directors has the authority to change our investment guidelines at any time without notice to orthe consent fromof our stockholders. In 2015,stockholders, which could result in our Board of Directors amended our investment guidelines permitting us to invest in high credit quality non-Agency MBS. In 2016, our Board of Directors, expanded such authorization to include CRT securities and other mortgage or mortgage-relatedmaking investments with no restriction on the credit rating of those securities. To the extent that our investment guidelines change in the future, we may make investments
that are different from, and possibly riskier than, the investments described in this Annual Report on Form 10-K.herein. Our Board of Directors also determines our other operational policies, including our policies with respect to our REIT qualification, acquisitions, dispositions, operations, indebtedness and distributions. Our Board of Directors may amend or revise such policies or approve transactions that deviate from them, without a vote of, or notice to, our stockholders. A change in our targeted investments, investment guidelines or other operational policies may increase our exposure to interest rate, spread, credit, prepayment, extension, liquidity and real estate market fluctuations.other risks, all of which could adversely affect our results of operations, financial condition and ability to make distributions to our common and preferred stockholders.
We may experience significant gains or losses and, consequently, greater earnings volatility as a result of ourOur active portfolio management strategy.strategy may expose us to significant realized gains or losses.
We employ an active management strategy to achieve our principal objective of preserving our net assetbook value while generating attractive risk-adjusted returns. The composition of our investment portfolio will vary as we believe changes to market conditions, risks and valuations warrant. Consequently, we may experience significant investment gains or losses when we sell investments that we no longer believe provide attractive risk-adjusted returns or when we believe more attractive alternatives are available. We may be incorrect in our assessment of our investment portfolio and select an investment portfolio that could generate lower returns than a more static management strategy. Also, investors may be less able to assess the changes in our valuation and performance by observing changes in the mortgage market since we may have changed our strategy and portfolio from the last publicly available data. WeOur leverage and hedging levels may also experience fluctuations in leveragefluctuate as we pursue our active management strategy.
Our strategy involves significant leverage, which increases the risk that we may incur substantial losses.
We expect our leverage to vary with market conditions and our assessment of risk/returnthe risks and returns on our investments. We incur this leverage by borrowing against a substantial portion of the market value of our assets. By incurring thisWhile leverage we could enhance our returns. Nevertheless, this leverage, which is fundamental to our investment strategy, it also creates significant risks. For example, because of our significant leverage, we may incur substantial losses or lose our ability to maintain the outstanding balance of our borrowings if our borrowing costs increase substantially or if the value of our investments declines substantially.declines.
Failure to procure adequate repurchase agreement and other financing or to renew or replace existing repurchase agreement and other financing as it matures (to which risk we are specifically exposed due to the short-term nature of ourthe financing arrangements we employ) wouldon our mortgage investments) could adversely affect our financial condition and results of operations.
We use debt financing as a strategy to increase our return on equity. However, we may not be able to achieve our desired leverage ratio for a number of reasons, including if:
our lenders do not make repurchase or other financing agreements available to us at acceptable terms;
lenders with whom we enter into repurchase or other financing agreements subsequently exit the market;
our lenders require additional collateral to cover our borrowings, which we may be unable to do; or
we determine that the leverage would expose us to excessive risk.
Furthermore,equity, and because we rely primarily on short-term borrowings to finance our mortgage investments, our ability to achieve our investment objectives depends not only on our ability to borrow money in sufficient amounts and on favorable terms, but also on our ability to renew or replace our maturing short-term borrowings on a continuous basisbasis. However, we may be unable to borrow sufficient funds to achieve our maturing short-term borrowings. desired leverage ratio for several reasons, including the following:
our lenders do not make repurchase or other financing agreements available to us at acceptable rates and terms;
our lenders exit the market;
our lenders require additional collateral to cover our borrowings, which we may be unable to deliver; or
we determine that the leverage would expose us to excessive risk.
Additionally, our wholly-owned captive broker-dealer subsidiary's (or BES's) ability to access bilateral and triparty repo funding, and to raise fundsincluding through the General Collateral FinanceFICC's GCF Repo service, offered by the FICC, requires that it continually meet on a continuous basis the regulatory and membership requirements ofestablished by FINRA and the FICC, which maycould change over time. Iftime, potentially resulting in BES fails to meetlose access to these requirements and is unable to access such funding we would be required to find alternative funding, which we may be unable to do, and our funding costs, "haircuts" and/or counterparty exposure could increase. Additionally, on January 12, 2016, the Federal Housing Finance Agency ("FHFA") released its final rule on changes to regulations concerning Federal Home Loan Bank ("FHLB") membership criteria. The final rule terminated our captive insurance subsidiary's FHLB membership and required repayment of all advances at the earlier of their contractual maturity dates or one year after the effective date of the final rule in February 2017.sources.
If we are not ableunable to renew or replace maturing borrowings, we may have to sell some or all of our assets, possibly under adverse market conditions. In addition, if the regulatory capital requirements imposed on our lenders change, they may be required to significantly increase the cost of the financing that they provide to us. Our lenders also may revise their eligibility requirements for the types of assets they are willing to finance or the terms of such financings, based on, among other factors, the regulatory environment and their management of perceived risk, particularly with respect to assignee liability. Consequently, we cannot make any assurance that financing may notwill be available to us in the future on terms that are acceptable to us. In the event thatIf we cannot obtain sufficient funding on acceptable terms, our investment returns, financial condition and results of operations could be adversely affected and there may be a negative impact on the value of our common and preferred stock and our ability to make distributions onto our common and preferred stock.
Differences in the stated maturity of our fixed rate assets, or in timing of interest rate adjustments on our adjustable-rate assets, and our borrowings may adversely affect our profitability.
We rely primarily on short-term and/or variable rate borrowings to acquire fixed-rate securities with long-term maturities. In addition, we may have adjustable rate assets with interest rates that vary over time based upon changes in an objective index,stockholders.
such as LIBOR orA decline in the U.S. Treasury rate. These indices generally reflect short-term interest rates but these assets may not reset in a manner that matches our borrowings.
The relationship between short-term and longer-term interest rates is often referred to as the "yield curve." Ordinarily, short-term interest rates are lower than longer-term interest rates. If short-term interest rates rise disproportionately relative to longer-term interest rates (a "flattening" of the yield curve), our borrowing costs may increase more rapidly than the interest income earned on our assets. Because our investments generally bear interest at longer-term rates than we pay on our borrowings, a flattening of the yield curve would tend to decrease our net interest income and the marketfair value of our investment portfolio. Additionally, to the extent cash flows from investments that return scheduled and unscheduled principal are reinvested, the spread between the yields on the new investments and available borrowing rates may decline, which would likely decrease our net income. It is also possible that short-term interest rates may exceed longer-term interest rates (a yield curve "inversion"), in which event, our borrowing costs may exceed our interest income and we could incur operating losses and our ability to make distributions to our stockholders could be adversely affected.
Declines in value of the assets in which we invest will adversely affect our financial condition and results of operations, and make it more costlycostlier to finance theseour assets.
We use ourOur investments as collateral for our financings. A decline in their value, or perceived market uncertainty about their value, could make it difficult for us to obtain financing on favorable terms or at all, or maintain our compliance with terms of any financing arrangements already in place. Any fixed-rate securities we invest in generally will be more negatively affected by increases in interest rates than adjustable-rate securities. Most of our investments in mortgage-related securities are recorded at fair value with changes in fair value reported in net income or other comprehensive income (a component of equity). As a result, a decline in the fair value of our mortgage-related securitiesinvestments could reduce both our comprehensivenet income and stockholders' equity. We also use our investments as collateral for our financings. A decline in fair value, or perceived market uncertainty about the value of our assets, could make it difficult for us to obtain financing on favorable terms or at all, or for us to maintain our compliance with terms of any financing arrangements already in place. Since we primarily invest in long-term fixed rate securities, our investment portfolio is particularly sensitive to changes in longer-term interest rates. If interest rates or other market conditions result in a decline in the fair value of our assets we would be subject to margin calls on our existing repurchase agreements and it will decrease the amounts we may borrow to purchase additional mortgage-related investments, which may restrictinvestments. If this occurs, we could be required to sell assets at adverse prices and our ability to maintain or increase our net income andcould be significantly restricted, negatively impacting our financial condition and results of operations could be adversely affected.and ability to make distributions to stockholders.
Our hedging strategies may not be successful in mitigating the risks associated with changes in interest rates.
Subject to complying with REIT tax requirements, we employ techniques that are intended to limit, or "hedge," the adverse effectseffect of changes in interest rates on our repurchase agreements and our net asset value. In general, our hedging strategy depends on our management's viewthe value of our entire investment portfolio, consistingassets and financing costs. Hedging strategies are complex and there are no perfect hedges. Our business model also calls for accepting certain amounts of assets, liabilities and derivative instruments, in light of prevailing market conditions. Ourrisk. Consequently, our hedging activities are generally designed to limit certain exposures andour interest rate exposure, but not to eliminate them. In addition, these strategies may be unsuccessfulit, and we could misjudge the condition ofthey are generally not designed to hedge against spread risk and other risks inherent to our investment portfolio or the market. business model.
Our hedging activity willstrategies vary in scope based on our portfolio composition, liabilities and our assessment of the level and volatility of interest rates, expected prepayments, credit and principal repayments, creditother market conditions, the type of assets held and other changing market conditions. Our hedging decisions will be determined in light of the facts and circumstances existing at the time and may differ from our current hedging strategy. Our hedging strategies may include entering into interest rate swap agreements, interest rate swaptions, TBAs, short sales, caps, collars, floors, forward contracts, options, futures or other types of hedging transactions. We may conduct certain hedging transactions through a TRS, which may subject those transactionsis expected to federal, state and, if applicable, local income tax.
There are no perfect hedging strategies, and interest rate hedging may fail to protect us from loss. Additionally, our business model calls for accepting certain amounts of interest rate, mortgage spread, prepayment, extension, liquidity and credit risks and other exposures and thus some risks will generally not be hedged.change over time. We could also fail to properly assess a risk to our investment portfolio or fail to recognize a risk entirely, leaving us exposed to losses without the benefit of any offsetting hedging activities.hedges. The derivative financial instruments we select may not have the effect of reducing our risk. Therisk, and the nature and timing of hedging transactions may influence thetheir effectiveness of these strategies.in risk mitigation. Poorly designed hedging strategies or improperly executed transactions could actually increase our risk and losses. In addition, hedgingof loss. Hedging activities could also result in losses if the hedged event against which we hedge does not occur. For example,Numerous other factors can also impact the effectiveness of our hedging strategies including, but are not limited to, the following:
the cost of interest rate hedging could fail to protect us or adversely affect us because, among other things:
interest rate hedginghedges can be expensive, particularly during periods of rising and volatile interest rates;rates due to higher costs demanded by counterparties and additional charges that may be incurred to adjust our hedges in such circumstances;
available interest rate hedges may not correspond directly with the interest rate risk for which protection is sought;sought such that the reference rates could reset at a different time or times from the shorter-term rates intended to be limited;
the duration of the hedge may not match the duration of the related asset or liability;
the amount of income that a REIT may earn from hedging transactions other than hedging transactions that satisfy certain requirements of the Internal Revenue Code or that are done through a TRS is limited by federalFederal tax provisions governing REITs;
the party owing money in the hedging transaction owing money to us may default on its obligation to pay;
the credit quality of the party owing money to us on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and
the value of our interest rate hedges declines due to interest rate fluctuations, lapse of time or other factors, reducing our stockholders' equity.factors.
Furthermore, our hedging activities involve costs that we incur regardless of the effectiveness of the hedging activity. These costs may be higher in periods of market volatility, both because the counterparties to our derivative agreements may demand a higher payment for taking risks, and because repeated adjustments of our hedges during periods of interest rate changes also may increase costs. Consequently,activity or whether we could incur significant hedging-related costs withoutreceive any corresponding economic benefits.benefit. For these reasons, our hedging strategies may fail to protect us from loss and could even result in greater losses than if we had not entered in the hedge transaction, which would negatively impact our operating results and financial condition.
Our hedging strategies are generally not designed to mitigate spread risk.
When the market spread between the market yield on our mortgage assets and benchmark interest rates widens, our net assetbook value could decline if the value of our mortgage assets falls by more than the offsetting fair value increases on our hedging instruments tied to the underlying benchmark interest rates.decline. We refer to this as "spread risk" or "basis risk," and we generally do not seek to hedge this risk." The spread risk associated with our mortgage assets and the resulting fluctuations in fair value of these securities is ana risk inherent risk to our business and can occur independent of changes in benchmark interest rates andrates. Spread risk may relate to other factors impacting the mortgage and fixed income markets, such as actual or anticipated monetary policy actions by the Federal Reserve,Fed, market liquidity, or changes in required rates of return on different assets. Consequently, while we use interest rate swaps and other supplemental hedges to attempt to protect against moves in interest rates, such instruments typically will not protect our net assetbook value against spread risk, which could adversely affectrisk. If the value of our
mortgage assets falls by more than the offsetting fair value increases on our hedging instruments tied to the underlying benchmark interest rates, our financial condition and results of operations.operations could be materially adversely affected.
Changes in prepayment rates may adversely affect our profitability and are difficult to predict.
Our investment portfolio includes securities backed by pools of mortgage loans. For securities backed by pools of mortgage loans wewhich receive payments generally, fromrelated to the payments that are made on these underlying mortgage loans. When borrowers prepay their mortgage loans at rates that are faster or slower than expected, it results in prepayments that are faster or slower than expected onprepayment of our assets. TheseWe are exposed to prepayment or extension risk in the event prepayments occur at a faster or slower than expected payments may adversely affect our profitability.
We may purchase securities that have a higher interest rate than we anticipated. Generally, prepayments increase during periods of falling mortgage interest rates and decrease during periods of rising mortgage interest rates. However, this may not always be the then prevailing market interest rate. In exchange for this higher interestcase as other factors can affect the rate we may pay a premium to par value to acquire the security. In accordance with GAAP, we amortize this premium over the expected term of the security based onprepayments, including loan age and size, loan-to-value ratios, housing price trends, general economic conditions and other factors.
If our prepayment assumptions. If a security is prepaid in whole or in partassets prepay at a faster rate than expected rate, however,anticipated, we must expense allmay be unable to reinvest the repayments at acceptable yields. If the proceeds are reinvested at lower yields than our existing assets, our net interest margins would be negatively impacted. We also amortize or a partaccrete any premiums and discounts we pay or receive at purchase relative to the stated principal of our assets into interest income over their projected lives using the effective interest method. If the actual and estimated future prepayment experience differs from our prior estimates, we are required to record an adjustment to interest income for the impact of the remaining unamortized portion ofcumulative difference in the premium that was paid at the time of the purchase,effective yield, which would adverselycould negatively affect our profitability.interest income.
We also may purchase securities that have a lower interest rate than the then prevailing market interest rate. In exchange for this lower interest rate, we may receive a discount to par value to acquire the security. We accrete this discount over the expected term of the security based onIf our prepayment assumptions. If a security is prepaidassets prepay at a slower rate than anticipated, our assets could extend beyond their expected rate, however,maturities and we must accretemay have to finance our investments at potentially higher costs without the remaining portion of the discount at a slower than expected rate, which would result in a lower than expected yield on securities purchased at a discountability to par.
Moreover,reinvest principal into higher yielding securities. Additionally, if prepayment rates decrease due to a rising interest rate environment, the average life or duration of our fixed-rate assets or the fixed-rate portion of our hybrid ARMs and other assets will generally extend. This could have a negative impact on our results from operations, aswould extend, but our interest rate swap maturities arewould remain fixed and, will, therefore, cover a smaller percentage of our funding exposure on our mortgage assets to the extent that their average lives increase due to slower prepayments.exposure. This situation may also cause the market value of our assets to decline, by more than otherwise would be the case while most of our hedging instruments would not receive any incremental offsetting gains. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur realized losses.
Although prepayment rates generally increase when interest rates fall and decrease when interest rates rise, changes in prepaymentPrepayment rates are difficult to predict. Prepayments can also occur when borrowers sell the property and use the sale proceeds to prepay the mortgage or when borrowers default on their mortgages and the mortgages are prepaid from the proceeds of a foreclosure sale of the property. Fannie Mae and Freddie Mac will generally among other conditions, purchase mortgages that are 120 days or more delinquent from mortgage-backed securitiesRMBS trusts when the cost of guarantee payments to security holders, including advances of interest at the security coupon rate, exceeds the cost of holding the nonperforming loans in their portfolios. Consequently, prepayment rates also maycan be affected by conditions in the housing and financial markets which may result in increasedthat impact delinquencies on mortgage loans, the government-sponsored entitiesGSE's cost of capital and their decisions as to when to repurchase delinquent loans, general economic conditions and the relative interest rates on fixed and adjustable rate loans, which could lead to an acceleration of the payment of the related principal. Additionally, changes in the government-sponsored entities' decisions as to when to repurchase delinquent loans can materially impact prepaymentrefinancing rates.
In addition, the introduction of new governmentU.S. Government programs, or changes to existing programs, could increase the availability of mortgage credit to a large number of homeowners, in the United States, which could impact the prepayment rates, for the entire mortgage securities market, and in particularparticularly for Fannie Mae and Freddie Mac Agency securities. These new programs or changes to existing programs could cause substantial uncertainty around the magnitude of changes in prepayment speeds. RMBS.
To the extent that actual prepayment speeds differ from our expectations, it could adversely affect our operating results.results could be adversely affected and we could be forced to sell assets to maintain adequate liquidity, which could cause us to incur realized losses. In addition, should significant prepayments occur, there is no certainty that acceptable new investments could be identified and proceeds of such prepayments could be timely reinvested.
Market conditions may disrupt the historical relationship between interest rate changes and prepayment trends, which may make it more difficult to analyze our investment portfolio.
Our success depends, in part, on our ability to analyze the relationship ofbetween changing interest rates on prepaymentsand the rate of the mortgage loans that underlie securities we may own.prepayments. Changes in interest rates and prepayments affect the market price of the assets that we purchase and any assets that we may hold at a given time.mortgage assets. As part of our overall portfolio risk management, we analyze interest rate changes and prepayment trends separately and collectively to assess their effects on our investment portfolio. In conductingTo a large extent our analysis is based on models that are dependent on a number of assumptions and inputs. Many of the assumptions we depend on certain assumptionsuse are based upon historical trends with respect to the relationship between interest rates and prepayments under normal market conditions. There is risk that our assumptions are incorrect. Dislocations in the residential mortgage market and other developments may disrupt the relationship between the way that prepayment trends have historically responded to interest rate changes and, consequently, may negatively impact our ability to (i) assess the market value of our investment portfolio, (ii) implement our hedging strategies and (iii) implement techniques to reduce our prepayment rate volatility, which could materially adversely affect our financial condition and results of operations.
InvestmentsRecent changes to the U.S. Federal income tax code could have a material impact on the residential mortgage market, which could impact the pricing of RMBS.
On December 22, 2017, the President signed the Tax Cuts and Jobs Act ("TCJA"), which provides for substantial changes to the taxation of individuals and business entities, generally with an effective date of January 1, 2018. For individual taxpayers,
the changes included, among others, lower ordinary income tax rates, higher standard deductions, and suspension or modification of several itemized deductions. The changes to the categories of itemized deductions include a limit on deductions of state and local income and property taxes of $10,000 and a modification to the amount of residential mortgage interest that would be deductible. The new rule would limit the deduction available for mortgage interest by reducing the amount of debt that can qualify from $1 million to $750,000, however mortgage debt borrowed prior to December 15, 2017 would not be affected by the reduction. In addition, home equity mortgage interest is no longer deductible. Many of the changes affecting individual taxpayers would cease to apply after December 31, 2025 and would revert to their pre-2018 form with future legislation required to make the provisions effective beyond 2025. As a result of these changes, it is expected that the number of individual taxpayers that itemize deductions will decrease significantly causing the income tax benefits of residential home ownership to decline materially. It is likely that these factors could result in a decline in the pricing of residential real estate as well as alter the prepayment patterns of residential mortgages, which could have a significant impact on the pricing and returns of RMBS.
The mortgage loans referenced by our CRT securities or that underlie our non-Agency securities potentiallymay be or could become subject us to delinquency or foreclosure, and relatedwhich could result in significant losses on the underlying mortgage loans.to us.
Investments in mortgage and mortgage-related securities, such as CRT securities and non-Agency RMBS and CMBS,MBS, where repayment of principal and interest is not guaranteed by a GSE or U.S. Government agency, subject us to the potential risk of loss of principal and/or interest due to delinquency, foreclosure and related losses on the underlying mortgage loans.
CRT securities are risk sharing instruments issued by Fannie Mae (CAS) and Freddie Mac, (STACR), and similarly structured transactions arranged by third partythird-party market participants. The CRT securities issued in the CRT sectorby Fannie Mae and Freddie Mac are designed to synthetically transfer mortgage credit risk from Fannie Mae and Freddie Macthe entities to private investors. Currently, CAS and STACRThe transactions are structured as unsecured and unguaranteed bonds issued by Fannie Mae or Freddie Mac, respectively,the GSEs whose principal payments are determined by the delinquency and prepayment experience of a reference pool of mortgages guaranteed by Fannie Mae or Freddie Mac in a particular quarter. Transactionsthe GSE. CRT transactions arranged by third partythird-party market participants in the CRT sector are similarly structured to reference a specific pool of loans that have been securitized by Fannie Mae or Freddie Mac and synthetically transfer mortgage credit risk related to those loans to the purchaser of the securities. The holder of CRT securities bears the risk that the borrowers may default on their obligations to make full and timely payments of principal and interest. The return of the principal invested in CRT securities is dependent on the level of borrower defaults on the underlying pool of mortgages. An investor in CRT securities bears the risk that the borrowers in the reference pool of loans may default on their obligations to make full and timely payments of principal and interest.
Residential mortgage loans underlying non-Agency RMBS are secured by residential property and are subject to risks of delinquency, foreclosure and loss. The ability of a borrower to repay a loan secured by residential property is dependent upon the income or assets of the borrower. A number ofMany factors maycould impair a borrower's ability to repay itsthe loan, including: loss of employment; divorce; illness;employment, divorce, illness, acts of God;God, acts of war or terrorism;terrorism, adverse changes in national and local economic and market conditions;conditions, changes in governmental laws and regulations, changes in fiscal policies and zoning ordinances, and the related costs of complying with such laws and regulations, fiscal policies and ordinances; costs of remediation and liabilities associated with environmental conditions such as mold;mold, and the potential for uninsured or under-insured property losses.
Commercial mortgage loans underlying CMBS are generally secured by multifamily or other commercial property and are subject to risks of delinquency and foreclosure, and risks of loss that are greater than similar risks associated with loans made on the security of residential property. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower's ability to repay the loan may be impaired. Net operating income of an income producing property can be affected by, among other things: tenant mix; success of tenant businesses; property management decisions; property location and condition; competition from comparable types of properties; changes in laws that increase operating expense or limit rents that may be charged; any need to address environmental contamination at the property; the occurrence of any uninsured casualty at the property; changes in national, regional or local economic conditions or specific industry segments; declines in regional or local real estate values; declines in regional or local rental or occupancy rates; increases in interest rates; real estate tax rates and other operating expenses; changes in governmental
rules, regulations and fiscal policies, including environmental legislation; acts of God, acts of war or terrorism, social unrest and civil disturbances.
InvestmentsOur assets are also not subject to any geographic, diversification or concentration limitations. Accordingly, our investments in CRT and non-Agency securities could causebe concentrated by geography, asset, property type and/or borrower. Such concentrations could subject us to incur lossesa greater risk of income from, and/or losses in market value relatingloss due to these assets if there are defaults of principal and/or interest on the underlying or referenced pool of mortgagesadverse developments. For example, adverse conditions in the transaction.areas where the properties securing or otherwise referenced to our investments are located (such as business layoffs or downsizing, industry slowdowns, changing demographics and other factors) and local real estate conditions (such as oversupply or reduced demand) could in an adverse way disproportionately affect the value of our investments and our ability to recover interest and principal on our investments.
Our investments in CRT and non-Agency securities may benefit from private mortgage insurance, but this insurance may not be sufficient to cover losses.
In certain instances, mortgage loans in reference to our CRT securities or underlying our non-Agency RMBS may have private insurance. This insurance is often structured to absorb only a portion of the loss if a loan defaults and, as such, we may be exposed to losses on these loans in excess of the insurance. Rescission and denial of mortgage insurance may affect the ability to collect on this insurance. If private mortgage insurers fail to remit insurance payments for insured portions of loans when losses are incurred and where applicable, whether due to breach of contract or to an insurer's insolvency, we may experience a loss on related CRT or non-Agency RMBS securities for the amount that was insured by such insurers.
Any credit ratings assigned to our credit risk oriented investments will be subject to ongoing evaluations and revisions and we cannot assure you that those ratings will not be downgraded.
Some of our investments are rated by Moody's Investors Service, Fitch Ratings or Standard & Poor's. Any credit ratings on our investments are subject to ongoing evaluation by credit rating agencies, and we cannot assure you that any such ratings will not be changed or withdrawn by a rating agency in the future. If rating agencies assign a lower-than-expected rating or reduce or withdraw, or indicate that they may reduce or withdraw, their ratings of our investments in the future, the value of these investments could significantly decline, which would adversely affect the value of our investment portfolio and could result in losses upon disposition.
Changes in credit spreads may adversely affect our profitability.
A significant component of the fair value of CRT and non-Agency securities and other credit risk oriented investments is attributable to the credit spread, or the difference between the value the credit instrument and the value of a financial instrument with similar interest rate exposure, but with no credit risk, such as a U.S. Treasury note, and the credit instrument. Credit spreads are subject to market factors and can be highly volatile. In addition, hedging fair value changes associated with credit spreads can be inefficient and our hedging strategies are generally not designed to mitigate credit spread risk. Consequently, changes in credit spreads could adversely affect our profitability and financial condition.
Actions of the U.S. Government, including the U.S. Congress, U.S. Federal Reserve,Fed, U.S. Treasury, Federal Housing Finance Administration ("FHFA") and other governmental and regulatory bodies may adversely affect our business.
U.S. Government actions may have an adverse impact on the financial and housing markets. To the extent the markets do not respond favorably to any such actions or such actions do not function as intended, they could have broad adverse market implications and could negatively impact our financial condition and results of operations. New regulatory requirements could adversely affect the availability or terms of financing from our lender counterparties, could impose more stringent capital rules on large financial institutions, could restrict the origination of residential mortgage loans and the formation of new issuances of mortgage-backed securities and could limit the trading activities of certain banking entities and other systemically significant organizations that are important to our business. Together or individually these new regulatory requirements could materially affect our financial condition or the results of our operations in an adverse way.
Pursuant to the terms of borrowings under master repurchase agreements, we are subject to margin calls that could result in defaults or force us to sell assets under adverse market conditions or through foreclosure.
We enter into master repurchase agreements with a number ofmultiple financial institutions. We borrow under these master repurchase agreements to finance the assets for our investment portfolio. Pursuant to the terms of borrowings under our master repurchase agreements, a decline in the value of the collateral may result in our lenders initiating margin calls. A margin call means thatcalls, where the lender requires us to pledge additional collateral to re-establish the ratio of the value of the collateral to the amount of the borrowing.collateral. The specific collateral value to borrowing ratio that would trigger a margin call is not set in the master repurchase agreements and is not determined until we engage in a repurchase transaction under these agreements. Our fixed-rate collateral generally may be more susceptible to margin calls as increases in interest rates tend to affect more negatively the market value of fixed-rate securities. In addition, some collateral may be more illiquidless liquid than other instruments, in which we invest, which could cause them to be more susceptible to margin calls in a volatile market environment. Moreover, collateral that prepays more quickly increases the frequency and magnitude of potential margin calls as there is a significant time lag between when the prepayment is reported (which reduces the market value of the security) and when the principal payment is actually received. If we are unable to satisfy margin calls, our lenders may foreclose on our collateral. The threat of or occurrence of a margin call could force us to sell, either directly or through a foreclosure, our collateral under adverse market conditions. Because of the leverage we expect to have, we may incurconditions, which could result in substantial losses upon the threat or occurrence of a margin call.losses.
Our derivative agreements expose us to margin calls that could result in defaults or force us to sell assets under adverse market conditions.
Our derivative agreements typically require that we pledge collateral on such agreements to our counterparties in a similar manner as we are required to under our repurchase agreements.counterparties. Our counterparties, or the central clearing agency, typically have the sole discretion to determine the value of the derivative instruments and the value of the collateral securing such instruments. In the event of a margin call, we must generally provide additional collateral on the same business day. OurFurthermore, our derivative agreements may also contain cross default provisions under which a default under certain of our other indebtedness in excess ofabove a certain threshold amount causeswould cause an event of default under the derivative agreement. Following an event of default, we could be required to settle our obligations under the agreements at their termination values. The threat of or occurrence of margin calls or the forced settlement of our obligations under our derivative agreements at their termination values could force us to sell either directly or through a foreclosure, our investments under adverse market conditions. Because of the leverage we have, we may incurconditions, which could result in substantial losses upon the threat or occurrence of either of these events.losses.
Regulations adopted by the U.S. Commodity Futures Trading Commission ("CFTC") and regulators of other countries could impose increased margin requirements and require additional operational and compliance costs, which could negatively affect our financial condition and results of operations.
The U.S. Commodity Futures Trading Commission (the "CFTC")CFTC subjects certain swaps to clearing and exchange trading requirements, margin requirements, reporting and record keeping requirements and counterparties to business conduct rules. TheCurrent and future rules and regulations promulgated by the CFTC and regulators of other countries may adversely affect our ability to engage in derivative transactions or may increase the cost of our hedging activity. We are required to follow some of these local regulations or help the non-U.S. counterparties comply with these local regulations. It is possible that such regulatory requirements willactivity and potentially result in higher collateral requirements. Such increased costs for OTC derivative counterparties and also lead to an increase in the costs ofpotentially higher collateral which mayrequirements could have an adverse impact on our business and results of operations.
It may be uneconomical to "roll"roll our TBA dollar roll transactions or we may be unable to meet margin calls on our TBA contracts, which could negatively affect our financial condition and results of operations.
We may utilize TBA dollar roll transactions as a means of investing in and financing Agency mortgage-backed securities.RMBS. TBA contracts enable us to purchase or sell, for future delivery, Agency securitiesRMBS with certain principal and interest terms and certain types of collateral, but the particular Agencyspecific securities to be delivered are not identified until shortly before the TBA settlement date. Prior to settlement of the TBA contract we may choose to move the settlement of the securities out to a later date by entering into an offsetting position (referred to as a "pair off"), net settling the paired off positions for cash, and simultaneously purchasing a similar TBA contract for a later settlement date, collectively referred to as a "dollar roll." The Agency securitiesRMBS purchased for a forward settlement date under the TBA contractcontracts are typically priced at a discount to Agency securitiesRMBS for settlement in the current month. This difference (or discount) is referred to as the "price drop." The price drop is the economic equivalent of net interest carry income on the underlying Agency securitiesRMBS over the roll period (interest income less implied financing cost) and is commonly referred to as "dollar roll income." Consequently, dollar roll transactions and such forward purchases of Agency securitiesRMBS represent a form of off-balance sheet financing and increase our "at risk" leverage.
Under certain market conditions, TBA dollar roll transactions may result in negative carry income whereby the Agency securitiesRMBS purchased for a forward settlement date under the TBA contractcontracts are priced at a premium to Agency securitiesRMBS for settlement in the current month. Additionally, sales of some or all of the Fed's holdings of Agency RMBS or declines in purchases of Agency RMBS by the Fed could adversely impact the dollar roll market. Under such conditions, it may be uneconomical to roll our TBA positions prior to the settlement date and we could have to take physical delivery of the underlying securities and settle our obligations for cash. We may not have sufficient funds or alternative financing sources available to settle such obligations. In addition, pursuant to the margin provisions established by the Mortgage-Backed Securities Division ("MBSD") of the FICC we are subject to margin calls on our TBA contracts. Further, our prime brokerage agreements may require us to post additional margin above the levels established by the MBSD. Negative carry income on TBA dollar roll transactions or failure to procure adequate financing to settle our obligations or meet margin calls under our TBA contracts could result in defaults or force us to sell assets under adverse market conditions or through foreclosure and adversely affect our financial condition and results of operations.
Defaults by lenders to our repurchase transactionsagreement counterparties on their obligations to resell the underlying collateral back to us at the end of the transaction term, declines in the value of our collateral, by the end of the term or defaults by us on our obligations under the transaction willcould cause us to lose money on repurchase transactions.
When we engage in a repurchase transaction, we initially transfer securities or loans to the financial institution under one of our master repurchase agreements in exchange for cash, and our counterparty is obligated to resell such assets to us at the end of the term of the transaction, which is typically from 30 days to one year, but which may have terms from one day to up to five years or more.transaction. The cash we receive when we initially sell the collateral is less than the value of that collateral whichand this difference is referred to as the "haircut." As a result, we are able to borrow against a smaller portion ofamount than the collateral that we initially sell in these transactions. Increased haircutstransactions, and increases in "haircuts" may require us to post additional collateral. The haircut rates under our master repurchase agreements are not set until we engage in a specific repurchase transaction under these agreements.transaction. If oura counterparty defaults on itsan obligation to resell collateral to us, we wouldcould incur a loss on the transaction equal to the amount of the haircut (assuming there was no change in the value of the securities). Any losses we incur on our repurchase transactions, which could adversely affect our earnings, and, thus, our cash available for distribution to our stockholders.
If we default on one of our obligations under a repurchase transaction the counterparty cancould terminate the transaction and cease entering into any other repurchase transactions with us. In that case, we would likely need to establish a replacement repurchase facility with another financial institution in order to continue to leverage our investment portfolio and carry out our investment strategy. We may not be able to secure a suitable replacement facility on acceptable terms or at all.
Further, financial institutions providing the repurchase agreements may require us to maintain a certain amount of cash or to set aside non-leveraged assets sufficient to maintain a specified liquidity position which would allow us to satisfy our collateral obligations.obligations should the fair value of our collateral decline. As a result, we may not be able to leverage our assets as fully as we would otherwise choose, which could reduce our return on equity. If we are unable to meet these collateral obligations, our financial condition could deteriorate rapidly. Additionally,rapidly and our counterparties can unilaterallycould choose to cease entering into any further repurchase transactions with us.
Our rights under our repurchase agreements are subject to the effects of the bankruptcy laws in the event of theour or our lender's bankruptcy or insolvency of us or our lenders under the repurchase agreements.insolvency.
In the event of our insolvency or bankruptcy, certain repurchase agreements may qualify for special treatment under the U.S. Bankruptcy Code, the effect of which, among other things, would be to allow the lender under the applicable repurchase agreement to avoid the automatic stay provisions of the U.S. Bankruptcy Code and to foreclose on the collateral agreement without delay. In the event of the insolvency or bankruptcy of a lender during the term of a repurchase agreement, the lender may be permitted,
under applicable insolvency laws, to repudiate the contract, and our claim against the lender for damages may be treated simply as an unsecured creditor. In addition, if the lender is a broker or dealer subject to the Securities Investor Protection Act of 1970, or an insured depository institution subject to the Federal Deposit Insurance Act, our ability to exercise our rights to recover our assets under a repurchase agreement or to be compensated for any damages resulting from the lender's insolvency may be further limited by those statutes. TheseRecoveries on these claims wouldcould be subject to significant delay and, if and when received, maycould be substantially less than the damages we actually incur.incurred.
Our use of derivative agreements may expose us to counterparty risk.
Certain hedging instruments, such as interest rate swaptions, are not traded on regulated exchanges or guaranteed by an exchange or its clearinghouse and, involves risks and costs that could result in material losses. Consequently,consequently, there may not be requirementsthe same level of protections with respect to margin requirements, record keeping, financial responsibility or segregation of customer funds and positions.positions and other requirements designed to protect both us and our counterparties. Furthermore, the enforceability of agreements underlying hedging transactions may depend on compliance with applicable statutory, and commodity and other regulatory requirements and, depending on the domicile of the counterparty, applicable international requirements. Consequently, if a counterparty fails to perform under a derivative agreement we could incur a significant loss.
For example, if a swap counterparty under an interest rate swap agreement that we enter into as part of our hedging strategy cannot perform under the terms of the interest rate swap agreement, we may not receive payments due under that agreement, and, thus, we may lose any potential benefit associated with the interest rate swap. Additionally, we may also risk the loss of any collateral we have pledged to secure our obligations under these swap agreements if the counterparty becomes insolvent or files for bankruptcy. Similarly, if an interest rate swaption counterparty fails to perform under the terms of the interest rate swaption agreement, in addition to not being able to exercise or otherwise cash settle the agreement, we could also incur a loss for the premium paid for that swaption.
Our investments are recorded at fair value, and quoted prices or observable inputswhich may not be readily available to determine such value, resulting in the use of unobservable inputs to determine value, and the fair value of our investmentsdeterminable or may be materially different from the value that we ultimately realize upon their disposal.
The values of our investments may not be readily determinable or ultimately realizable. We measure the fair value of our investments quarterly, in accordance with guidance set forth in Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures. Ultimate realization of the value of an asset depends to a great extent on economic and other conditions that are beyond our control. Further, fairFair value is only an estimate based on good faith judgment of the price at which an investment can be sold since market prices of investments can only be determined by negotiation between a willing buyer and seller. If we were to liquidate a particular asset, the realized value may be more than or less than the amount at which such asset is valued. Accordingly, the value of our common stock could be adversely affected by our determinations regarding the fair value of our investments, whether in the applicable period or in the future. Additionally, such valuations may fluctuate over short periods of time.
Our determination of the fair value of our investments includes inputs provided by third-party dealers and pricing services. Valuations of certain investments in which we invest may be difficult to obtain or unreliable. In general, dealers and pricing services heavily disclaim their valuations. Dealers may claimvaluations and we do not have recourse against them due to furnish valuations only as an accommodationliabilities and without special compensation, and so they may disclaim any and all liability for any direct, incidental, or consequentialother damages arising outfrom inaccurate price quotes or other inputs used to determine the fair value of any inaccuracy or incompleteness in valuations, including any act of negligence or breach of any warranty.our investments. Depending on the complexity and illiquidity of a security, valuations of the same security can vary substantially from one dealer or pricing service to another. Therefore,Moreover, fair value and estimates of fair value may fluctuate over short periods of time. For these reasons, the fair value at which our investments are recorded may not be an indication of their realizable value. Furthermore, the ultimate realization of the value of an asset depends on economic and other conditions that are beyond our control. Consequently, if we were to liquidate an asset, particularly in a forced liquidation, the realized value may be less than the amount at which the asset is recorded, which would negatively affect our results of operations for a given period could be adversely affected if our determinations regarding the fair market value of these investments are materially different from the values that we ultimately realize upon their disposal.and financial condition.
Investments in the common stock of other publicly traded mortgage REITs expose us to incremental risks and costs and may adversely affect our financial condition and results of operations.costs.
We may invest in other mortgage REITs that primarily invest in Agency securities, non-Agency securities, and other mortgage related instruments and/or real estate on a leveraged basis, utilizing short-term borrowings as their primary source of funding. Such mortgage REITs are, therefore, exposed to similar risk factors as those described herein and other risks inherent to investment strategies that they may pursue that diverge from our own. In addition, our investments in other mortgage REITs may expose us to incremental risks and costs due to our lack of control, lack of transparency into their underlying investment portfolios and business operations, stock market volatility and management fees, each of which could adversely affect our financial condition and results of operations. Furthermore, with regard to investments in MTGE common stock, we may be unable to sell, or dispose
of, shares of MTGE common stock in a time frame that we may desire. We are subject to daily transaction volume limits established under the SEC’s safe harbor provisions of Rule 10b-18. We may also be subject to "closed window" periods, during which we are generally limited in the extent to which we can transact in MTGE common stock.
The federalFederal conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship between these agencies and the U.S. Government, may adversely affect our business.
The payments of principal and interest we receive on theour Agency securities in which we investRMBS are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. The guarantees on Agency securities created by Fannie Mae and Freddie Mac are not backed by the full faith and credit of the United States, whereas the guarantee on securities created by Ginnie Mae are backed by the full faith and credit of the United States.
In response to general market instability and, more specifically,U.S. Government, whereas the financial conditions ofguarantees on Agency securities created by Fannie Mae and Freddie Mac in July 2008, the Housing and Economic Recovery Act of 2008, or "HERA", established FHFA as the new regulator for Fannie Mae and Freddie Mac. In September 2008, the U.S. Treasury, the FHFA and the U.S. Federal Reserve announced a comprehensive action plan to help stabilize the financial markets, support the availability of mortgage financing and protect taxpayers. Under this plan, among other things, the FHFA was appointed as conservator of both Fannie Mae and Freddie Mac. are not.
The future roles of Fannie Mae and Freddie Mac could be significantly reducedmodified and the nature of their guarantee obligations could be considerably limited relative to historical measurements. Any such changes to the nature of their guarantee obligations could re-define what constitutes an Agency security and could have broad adverse implications for the market and our business, operations and financial condition.
Future changes to Fannie Mae or Freddie Mac may create market uncertainty and may reduce the actual or perceived credit quality of securities issued or guaranteed by these agencies. Moreover, ifIf the guarantee obligations of Freddie Mac or Fannie Mae or Freddie Mac were repudiated by FHFA, payments of principal and/or interest to holders of Agency securitiesRMBS issued by Freddie Mac or Fannie Mae or Freddie Mac would be reduced in the event of any borrower's late payments or failure to payborrower delinquencies or a servicer's failure to remit borrower payments to the trust. In that case,trust and trust administration and servicing fees could be paid from mortgage payments prior to distributions to holders of Agency securities.RMBS. Any actual direct compensatory damages owed due to the repudiation of Freddie Mac or Fannie Mae or Freddie Mac'sMae's guarantee obligations may not be sufficient to offset any shortfalls experienced by holders of Agency securities. RMBS.
As a result, such laws or changes could increase the risk of loss on our investments in Agency mortgage investments guaranteed by Fannie Mae and/or Freddie Mac or adversely impact the market for such securities and spreads at which they trade and could materially and adversely affect our financial condition and results of operations.
There are conflicts of interest with other funds that we manage.
Through our wholly-owned subsidiary, MTGE Management, LLC, we manage MTGE, Investment Corp., which is also a mortgage REIT that invests in securities and instruments of the type invested by us. Although we have policies in place to seek to mitigate the effects of conflicts of interest, including potential conflicts relating to the allocation of certain types of securities that meet our investment objectives and those of MTGE, these policies will not eliminate the conflicts of interest that our officers and employees who provide services to both us and MTGE, willmay face in making investment decisions on behalf of us orand MTGE. Further,Furthermore, we do not have any agreement or understanding with MTGE that would give us any priority over it in opportunities to invest in overlapping investments. Accordingly, we may compete for access to investments with MTGE.
Our executive officers and other key personnel are critical to our success and the loss of any executive officer or key employee may materially adversely affect our business.
We operate in a highly specialized industry and our success is dependent upon the efforts, experience, diligence, skill and network of business contacts of our executive officers and key personnel. The departure of any of our executive officers and/or key personnel could have a material adverse effect on our operations and performance.
We rely on information technology in our operations, and any material failure, inadequacy, interruption or security failure of that technology could disrupt our business and result in the loss of confidential information.
We rely on information technology networks and systems to process, transmit and store electronic information, and to manage or support a variety of business processes. We purchase some of our information technology from third-party vendors and rely on commercially available systems, software, tools and monitoring to provide security for the processing, transmission and storage of confidential data. While we select third-party vendors carefully, we do not control their actions. Any problems caused by these third parties, including those resulting from breakdowns or other disruptions in communication services, failure to handle current or higher volumes, cyber-attacks and other security breaches could adversely affect our ability to conduct our business.
While we employ measures to protect the security of our information systems and data, it is possible that these measures will not prevent the systems’ improper functioning or damage, or the improper access or disclosure of information in the event of cyber-attacks. In some cases, it may be difficult to anticipate or immediately detect a security breach and the damage caused. Any failure to maintain proper function, security and availability of our information systems could interrupt our operations, damage our reputation, subject us to liability claims or regulatory penalties and could have a materially adverse effect on our business, financial condition and results of operations.
Risks Related to Our Taxation as a REIT
Our failure to qualify as a REIT would have adverse tax consequences.
We believe that we operate in a manner that allows us to qualify as a REIT for federalFederal income tax purposes under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, and Treasury Regulations promulgated thereunder (or the Code). We plan to continue to meet the requirements for taxation as a REIT. The determination that we are a REIT requires an analysis of various factual matters and circumstances that may not be totally within our control and our compliance with the annual REIT income and quarterly asset requirements depends upon our ability to successfully manage the composition of our income and assets on an ongoing basis. For example, to qualify as a REIT, at least 75% of our gross income must come from real estate sources and 95% of our gross income must come from real estate sources and certain other sources that are itemized in the REIT tax laws. Additionally, our ability to satisfy the REIT asset tests depends upon our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Furthermore, the proper classification of an instrument as debt or equity for federalFederal income tax purposes may be uncertain in some circumstances, which could affect the application of the REIT asset requirements. We are also required to distribute to stockholders at least 90% of our REIT taxable income (determined without regard to the deduction for dividends paid and by excluding any net capital gain).
If we fail to qualify as a REIT in any tax year, we would be subject to U.S. federalFederal and state corporate income tax on our taxable net income at regular corporate rates, and dividends paid to our stockholders would not be deductible by us in computing our taxable income. Also, unless the IRS granted us relief under certain statutory provisions, we would remain disqualified as a REIT for four years following the year we first fail to qualify. If we fail to qualify as a REIT, we would have to pay significant income taxes and would, therefore, have less money available for investments or for distributions to our stockholders. This would likely have a significant adverse effect on the value of our equity. In addition, the tax law would no longer require us to make distributions to our stockholders.
If we should fail to satisfy one or more requirements for REIT qualification, we may still qualify as a REIT if there is reasonable cause for the failure and not due to willful neglect and other applicable requirements are met, including completion of applicable IRS filings. It is not possible to state whether we would be entitled to the benefit of these relief provisions in all circumstances. If these relief provisions are inapplicable, to a particular set of circumstances, we will not qualify as a REIT. Furthermore, if we satisfy the relief provisions and maintain our qualification as a REIT, we may be still subject to a penalty tax. The amount of the penalty tax will be at least $50,000 per failure, and, in the case of certain asset test failures, will be determined as the amount of net income generated by the assets in question multiplied by the highest U.S. federalFederal corporate tax rate (currently 35%)in effect at the time of the failure if that amount exceeds $50,000 per failure, and, in case of income test failures, will be a 100% tax on an amount based on the magnitude of the failure, as adjusted to reflect the profit margin associated with our gross income.
Distributions payable by REITs do not qualify for the reduced tax rates available for some dividends.
The maximum tax rate applicable to income from "qualified dividends" payable to domestic stockholders that are individuals, trusts and estates is currently 20%. Distributions of ordinary income payable by REITs, however, generally are not eligible for the reduced rates. Although this legislation does not adversely affect the taxation of REITs or distributions payable by REITs, the more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock.
New legislation or administrative or judicial action, in each instance potentially with retroactive effect, could make it more difficult or impossible for us to remain qualified as a REIT or it could reduce the favorable tax attributes ofotherwise adversely affect REITs toand their stockholders.
The present federalFederal income tax treatment of REITs may be modified, possibly with retroactive effect, by legislative, judicial or administrative action at any time, which could affect the federalFederal income tax treatment of an investment in us. The federalFederal income tax rules dealing with REITs constantly are under review by persons involved in the legislative process, the IRS and the U.S. Treasury Department, which results in statutory changes as well as frequent revisions to regulations and interpretations.
The recently enacted TCJA makes substantial changes to the Internal Revenue Code. Among those changes are a significant permanent reduction in the generally applicable corporate tax rate, a temporary reduction in the highest marginal income tax rate applicable to individuals subject to a "sunset" provision, the elimination or modification of various currently allowed deductions (including substantial limitations on the deductibility of interest), certain additional limitations on the deduction of net operating losses, and preferential rates of taxation on most ordinary REIT dividends and certain business income derived by non-corporate taxpayers in comparison to other ordinary income recognized by such taxpayers. The effect of these, and the many other, changes made in the TCJA is highly uncertain, both in terms of their direct effect on the taxation of an investment in our common stock and their indirect effect on the value of our assets or shares of our common stock or market conditions generally. Furthermore, changesmany of the provisions of the TCJA will require guidance through the issuance of Treasury regulations in corporateorder to assess their effect. There may be a substantial delay before such regulations are promulgated, increasing the uncertainty as to the ultimate effect of the statutory amendments on us. There may also be technical corrections legislation proposed with respect to the TCJA, the effect and individual tax ratestiming of which cannot be predicted and which may reducebe adverse to us or eliminate the favorable tax attributes of REITs to stockholders relative to alternative investment vehicles. our stockholders.
Revisions in federalFederal tax laws and interpretations thereof could affect or cause us to change our investments and commitments and affect the tax considerations of an investment in us.
REIT distribution requirements could adversely affect our ability to execute our business plan.
We generally must distribute annually at least 90% of our taxable income, subject to certain adjustments and excluding any net capital gain, in order for U.S. federalFederal and state corporate income tax not to apply to earnings that we distribute. Distributions of our taxable income must generally occur in the taxable year to which they relate, or in the following taxable year if declared before we timely file our tax return for the year and if paid with or before the first regular dividend payment after such declaration. We may also elect to retain, rather than distribute, our net long-term capital gains and pay tax on such gains if required. In thisrequired, in which case, we could elect for our stockholders to include their proportionate sharesshare of such undistributed long-term capital gains in income, and to receive a corresponding credit for their share of the tax that we paid. Our stockholders would then increase theirthe adjusted basis of their stock by the difference between (a) the amounts of capital gain dividends that we designated and that they include in their taxable income, minus (b) the tax that we paid on their behalf with respect to that income. We intend to make distributions to our stockholders to comply with the REIT qualification requirements of the Internal Revenue Code.
To the extent that we satisfy this distribution requirement, but distribute less than 100% of our taxable income, we will be subject to U.S. federalFederal and state corporate income tax on our undistributed taxable income. Furthermore, if we should fail to distribute during each calendar year at least the sum of (a) 85% of our REIT ordinary income for such year, (b) 95% of our REIT capital gain net income for such year, and (c) any undistributed taxable income from prior periods, we would be subject to a non-deductible 4% excise tax on the excess of such required distribution over the sum of (x) the amounts actually distributed, (y) the amounts of income we retained and on which we have paid corporate income tax and (z) any excess distributions from prior periods.
From time-to-time,time to time, we may generate taxable income greater than our income for financial reporting purposes prepared in accordance with GAAP, or differences in timing between the recognition of taxable income and the actual receipt of cash, or the deductibility of expenses and the actual payment of cash in respect of those expenses, may
occur. For example, if we purchase mortgage securities at issuance with a discount, we are generally required to accrete the discount into taxable income prior to receiving the cash proceedsproceeds. In addition, we generally will be required to take certain amounts into income no later than the time such amounts are reflected on certain financial statements. The application of this rule may require the accretedaccrual of, among other categories of income, income with respect to certain debt instruments or mortgage-backed securities, such as original issue discount or market discount, earlier than would be the case under the general tax rules, although the precise application of this rule is unclear at maturity. Additionally, ifthis time. This rule generally will be effective for tax years beginning after December 31, 2017 or, for debt instruments or mortgage-backed securities issued with original issue discount, for tax years beginning after December 31, 2018. Moreoever, we incur capital losses in excess of capital gains, such net capital losses are not allowed to reduce our taxable income for purposes of determining our distribution requirement. Theya net capital loss incurred; instead, the net capital loss may be carried forward for a period of up to five years and applied against future capital gains subject to the limitation of our ability to generate sufficient capital gains, which cannot be assured. If we do not have other funds available in these situations, we could be required to borrow funds on unfavorable terms, sell investments at disadvantageous prices or distribute amounts that would otherwise be invested in future acquisitions to make distributions sufficient to maintain our qualification as a REIT or avoid corporate income tax and the 4% annual excise tax in a particular year.tax. These alternatives could increase our costs orand reduce our stockholders' equity. Thus, compliance with the REIT requirements may hinder our ability to grow, which could adversely affect the value of our common stock.
We may in the future choose to pay dividends in our own stock, in which case youstockholders may be required to pay income taxes in excess of the cash dividends you receive.received.
We may in the future distribute taxable dividends that are payable in cash and shares of our common stock at the election of each stockholder. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income to the extent of our current and accumulated earnings and profits for U.S. federalFederal income tax purposes. As a result, stockholders may be required to pay income taxes with respect to such dividends in excess of the cash dividends received. If a U.S. stockholder sells the stock that it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our common stock.
Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.
Even if we remain qualified for taxation as a REIT, we may nonetheless be subject to certain federal,Federal, state and local taxes on our income and assets, including, but not limited to, the following items. Any of these or other taxes we may incur would decrease cash available for distribution to our stockholders.
Regular U.S. federalFederal and state corporate income taxes on any undistributed taxable income, including undistributed net capital gains.
A non-deductible 4% excise tax if the actual amount distributed to our stockholders in a calendar year is less than a minimum amount specified under federalFederal tax laws.
Corporate income taxes on the earnings of subsidiaries, to the extent that such subsidiaries are subchapter C corporations and are not qualified REIT subsidiaries or other disregarded entity for federalFederal income tax purposes.
A 100% tax on certain transactions between us and our TRSs that do not reflect arm's-length terms.
If we acquire appreciated assets from a corporation that is not a REIT (i.e., a corporation taxable under subchapter C of the Internal Revenue Code) in a transaction in which the adjusted tax basis of the assets in our hands is determined by reference to the adjusted tax basis of the assets in the hands of the subchapter C corporation, we may be subject to tax on such appreciation at the highest corporate income tax rate then applicable if we subsequently recognize a gain on a disposition of any such assets during the ten-yearfive-year period following their acquisition from the subchapter C corporation.
A 100% tax on net income and gains from "prohibited transactions"
Penalty taxes and other fines for failure to satisfy one or more requirements for REIT qualification.
Complying with REIT requirements may cause us to forgo otherwise attractive opportunities.
To remain qualified as a REIT for federalFederal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts that we distribute to our stockholders and the ownership of our stock. We may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution, and may be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source-of-income or asset-diversification requirements for qualifyingremain qualified as a REIT. Thus, compliance with the REIT requirements may hinder our ability to make and, in certain cases, to maintain ownership of, certain attractive investments.
Complying with REIT requirements may force us to liquidate otherwise attractive investments.
To remain qualified as a REIT, we must ensure that, at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified real estate assets. The remainder of our investmentinvestments in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and for tax years beginning on or before December 31, 2017, no more than 25% of the value of our total assets can be represented by securities of one or more TRSs. For tax years beginning after December 31, 2017, no more than 20% of the value of our total assets can be represented by securities of one or more TRSs. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidatesell otherwise attractive investments from our investment portfolio otherwise attractive investments.portfolio. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.
The failure of assets subject to repurchase agreements to qualify as real estate assets could adversely affect our ability to remain qualified as a REIT.
We enter into certain financing arrangements that are structured as sale and repurchase agreements pursuant to which we nominally sell certain of our assets to a counterparty and simultaneously enter into an agreement to repurchase these assets at a later date in exchange for a purchase price. Economically, these agreements are financings that are secured by the assets sold pursuant thereto. We believe that we would be treated for REIT asset and income test purposes as the owner of the assets that are the subject of any such sale and repurchase agreement notwithstanding that such agreement may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could assert that we did not own the assets during the term of the sale and repurchase agreement, in which case we could fail to remain qualified as a REIT.
Liquidation of assets may jeopardize our REIT qualification or create additional tax liability for us.
To remain qualified as a REIT, we must comply with requirements regarding the composition of our assets and our sources of income. If we are compelled to liquidate our investments to repay obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as dealer property or inventory.
Complying with REIT requirements may limit our ability to hedge effectively and may cause us to incur tax liabilities.
The REIT provisions of the Internal Revenue Code could substantially limit our ability to hedge our liabilities. Any income from a properly designated hedging transaction we enter into to manage risk of interest rate changes with respect to borrowings made or to be made, or ordinary obligations incurred or to be incurred, to acquire or carry real estate assets generally does not constitute "gross
income" for purposes of the 75% or 95% gross income tests. To the extent that we enter into other types of hedging transactions, the income from those transactions is likely to be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules,such, we may have to limit our use of advantageous hedging techniques or implement those hedges through our TRS. This could increase the cost of our hedging activities becauseas our TRS would be subject to tax on gains, or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in our TRS will generally not provide any tax benefit, except for being carried forward against future taxable income in the TRS.
Uncertainty exists with respect to the treatment of our TBAs for purposes of the REIT asset and income tests.
We purchase and sell Agency mortgage-backed securities through TBAs and recognize income or gains from the disposition of those TBAs, through dollar roll transactions or otherwise, and may continue to do so in the future. While thereThere is no direct authority with respect to the qualification of TBAs as real estate assets or U.S. Government securities for purposes of the 75% asset test or the qualification of income or gains from dispositions of TBAs as gains from the sale of real property (including interests in real property and interests in mortgages on real property) or other qualifying income for purposes of the 75% gross income test,test. However, we treat our TBAs as qualifying assets for purposes of the REIT 75% asset test, and we treat income and gains from our TBAs as qualifying income for purposes of the 75% gross income test, based on an opinion of Skadden, Arps, Slate, Meagher & Flom LLP substantially to the effect that (i) for purposes of the REIT asset tests, our ownership of a TBA should be treated as ownership of the underlying Agency securities,RMBS, and (ii) for purposes of the 75% REIT gross income test, any gain recognized by us in connection with the settlement of our TBAs should be treated as gain from the sale or disposition of the underlying Agency securities.RMBS. Opinions of counsel are not binding on the IRS, and no assurance can be given that the IRS will not successfully challenge the conclusions set forth in such opinions. In addition, it must be emphasized that the opinion of Skadden, Arps, Slate, Meagher & Flom LLP is based on various assumptions relating to our TBAs and is conditioned upon fact-based representations
and covenants made by our management regarding our TBAs. No assurance can be given that the IRS would not assert that such assets or income are not qualifying assets or income. If the IRS were to successfully challenge the opinion of Skadden, Arps, Slate, Meagher & Flom LLP, we could be subject to a penalty tax or we could fail to remain qualified as a REIT if a sufficient portion of our assets consists of TBAs or a sufficient portion of our income consists of income or gains from the disposition of TBAs.
Qualifying as a REIT involves highly technical and complex provisions of the Internal Revenue Code.
Qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which only limited judicial and administrative authorities exist. Even a technical or inadvertent violation could jeopardize our REIT qualification. Our qualification as a REIT depends on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. In addition, our ability to satisfy the requirements to remain qualified as a REIT depends in part on the actions of third parties over which we have no control or only limited influence, including in cases where we own an equity interest in an entity that is classified as a partnership for federalFederal income tax purposes.
The tax on prohibited transactions willcould limit our ability to engage in transactions, including certain methods of structuring CMOs, which would be treated as prohibited transactions for federal income tax purposes.transactions.
Net income that we derive from a prohibited transaction is subject to a 100% tax. The term "prohibited transaction" generally includes a sale or other disposition of property (including Agency securities, but other than foreclosure property, as discussed below) that is held primarily for sale to customers in the ordinary course of a trade or business by us or by a borrower that has issued a shared appreciation mortgage or similar debt instrument to us. We could be subject to this tax if we were to dispose of or structure CMOs in a manner that was treated as a prohibited transaction for federalFederal income tax purposes.
We intend to conduct our operations at the REIT level so that no asset that we own (or are treated as owning) at the REIT level will be treated as, or as having been, held for sale to customers, and that a sale of any such asset will not be treated as having been in the ordinary course of our business. As a result, we may choose not to engage in certain transactions at the REIT level and may limit the structures we utilize for our CMO transactions, even though the sales or structuresthat might otherwise be beneficial to us. In addition, whether property is held "primarily for sale to customers in the ordinary course of a trade or business" depends on the particular facts and circumstances. No assurance can be given that any property that we sell will not be treated as property held for sale to customers, or that we can comply with certain safe-harbor provisions of the Internal Revenue Code that would prevent such treatment. The 100% tax does not apply to gains from the sale of property that is held through a TRS or other taxable corporation, although such income will be subject to tax in the hands of the corporation at regular corporate rates. We intend to structure our activities to avoid prohibited transaction characterization.
Distributions to tax-exempt investors, or gains on sale of our common stock by tax-exempt investors, may be classified as unrelated business taxable income.
Neither ordinary nor capital gain distributionsDistributions with respect to our common stock nor gainand gains from the sale of our common stock should generally not constitute unrelated business taxable income to a tax-exempt investor. However, there are certain exceptions to this rule. In particular:
part of the income and gain recognized by certain qualified employee pension trusts with respect to our common stock may be treated as unrelated business taxable incomeFor example, if shares(i) all or a portion of our common stockassets are predominantly held by qualified employee pension trusts, and we are required to rely on a special look-through rule for purposes of meeting one of the REIT ownership tests, and we are not operated in a manner to avoid treatment of such income or gain as unrelated business taxable income;
part of the income and gain recognized by a tax-exempt investor with respect to our common stock would constitute unrelated business taxable income if the investor incurs debt in order to acquire the common stock;
part or all of the income or gain recognized with respect to our common stock by social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts and qualified group legal services plans which are exempt from federal income taxation under the Internal Revenue Code may be treated as unrelated business taxable income; and
subject to the extent that we are (or a part of us, or a disregarded subsidiary of ours, is) arules relating to "taxable mortgage pool,"pools" or if we hold residual interests in a REMIC,real estate mortgage investment conduit (or "REMIC"); (ii) we are a "pension held REIT;" (iii) a tax-exempt stockholder has incurred debt to purchase or hold our common stock; or (iv) a tax-exempt stockholder is classified as a social club, voluntary employee benefit association, supplemental unemployment benefit trust or a qualified group legal services plan, then a portion of our
distributions to tax-exempt stockholders and, in the distributions paid to acase of stockholders described in clauses (iii) and (iv), gains realized on the sale of our common stock by tax-exempt stockholder that is allocable to excess inclusion incomestockholders may be treatedsubject to U.S. Federal income tax as unrelated business taxable income under the Internal Revenue Code.
Our inability to deduct for tax purposes compensation paid to our executives could require us to increase our distributions to stockholders or pay entity level taxes in order to maintain REIT status.
Section 162(m) of the Internal Revenue Code prohibits publicly held corporations from taking a tax deduction for annual compensation in excess of $1 million paid to any of the corporation’s “covered employees.” Prior to the enactment of the TCJA, a publicly held corporation’s covered employees included its chief executive officer and the three other most highly compensated executive officers (other than the chief financial officer), and certain performance-based compensation” was excluded from the $1 million cap. The TCJA made certain changes to Section 162(m), effective for taxable years beginning after December 31, 2017. These changes include, among others, expanding the definition of “covered employee” to include the chief financial officer and repealing the performance-based compensation exception to the $1 million cap, subject to certain transition rules. The TCJA also added that once an individual becomes a covered employee after December 31, 2016, that individual will remain a covered employee for all future years including after termination or death. Since we qualify as a REIT under the Internal Revenue Code and we are generally not subject to Federal income taxes, if compensation did not qualify for deduction under Section 162(m), the payment of compensation that fails to satisfy the requirements of Section 162(m) would not have a material adverse consequence to us, provided we continue to distribute 100% of our taxable income. In the future, if we make compensation payments subject to Section 162(m) limitations on deductibility, we may be required to make additional distributions to shareholders or pay entity level tax to comply with REIT requirements.
Risks Related to Our Business Structure
Loss of our exemption from regulation pursuant to the Investment Company Act would adversely affect us.
We conduct our business so as not to become regulated as an investment company under the Investment Company Act in reliance on the exemption provided by Section 3(c)(5)(C) of the Investment Company Act. Section 3(c)(5)(C), as interpreted by the staff of the SEC, requires that: (i) at least 55% of our investment portfolio consistconsists of "mortgages and other liens on and interest
in real estate," or "qualifying real estate interests," and (ii) at least 80% of our investment portfolio consistconsists of qualifying real estate interests plus "real estate-related assets."
The specific real estate related assets that we acquire are limited by the provisions of the Investment Company Act and the rules and regulations promulgated thereunder. In satisfying the 55% requirement, we treat Agency RMBS issued with respect to an underlying pool of mortgage loans in which we hold all of the certificates issued by the pool ("whole pool" securities) as qualifying real estate interests based on pronouncements of the SEC staff. We treat partial pool securities, CRT and other mortgage related securities as real estate-related assets. If the SEC determines that any of these securities are not qualifying interests in real estate or real estate-related assets, adopts a contrary interpretation with respect to these securities or otherwise believes we do not satisfy the above exceptions or changes its interpretation of the above exceptions, we could be required to restructure our activities or sell certain of our assets. Our compliance with these requirements may at times lead us to adopt less efficient methods of financing certain of our investments, and we may be precluded from acquiring higher yielding securities. Furthermore,Importantly, if we fail to qualify for this exemption, our ability to use leverage would be substantially reduced and we would be unable to conduct our business as we currently conduct it, which could materially and adversely affect our business.
Risks Related to Our Common Stock
The market price and trading volume of our common stock may be volatile.
The market price and trading volume of our common stock may be highly volatile and be subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. Price variations may be unrelated to our operating performance. If the market price of our common stock declines significantly, youstockholders may be unable to resell your shares at a gain. Further, fluctuations in the trading price of our common stock may adversely affect the liquidity of the trading market for our common stock and in the event that we seek to raise capital through future equity financings, our ability to raise suchadditional equity capital.capital
Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our common stock include:
actual or anticipated variations in our quarterly operating results or distributions;
changes in our earnings estimates or publication of research reports about us or the real estate or specialty finance industry;
increases in market interest rates that lead purchasers of our shares of common stock to demand a higher yield;
changes in market valuations of similar companies;
adverse market reaction to any increased indebtedness we incur in the future;
issuance of additional equity securities;
our repurchases of shares of our common stock;
actions by institutional stockholders;
additions or departures of key management personnel;
speculation in the press or investment community;
price and volume fluctuations in the stock market from time to time, which are often unrelated to theour operating performance of particular companies;performance;
changes in regulatory policies, tax laws and financial accounting and reporting standards, particularly with respect to REITs, or applicable exemptions from the Investment Company Act of 1940, as amended;
actual or anticipated changes in our dividend policy and earnings or variations in operating results;
any shortfall in revenue or net income or any increase in losses from levels expected by securities analysts;
decreases in our net assetbook value per share;
loss of major repurchase agreement providers; and
general market and economic conditions.
In addition, the price of our common stock may be below our reported net assetbook value per common share. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly in the future.
Future offerings of debt securities, which would rank senior to our preferredcommon and common stockpreferred upon our liquidation, and future offerings of equity securities, which would dilute our existing stockholders and may be senior to our common stock for the purposes of dividend and liquidating distributions, may adversely affect the market price of our common stock.
In the future, we may raise capital through the issuance of debt or equity securities. Upon liquidation, holders of our debt securities, if any, preferred stock and lenders with respect to other borrowings will be entitled to our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Our preferred stock has a preference on liquidating distributions and a preference on dividend payments that could limit our ability to pay dividends to the holders of our common stock. Sales of substantial amounts of our common stock, or the perception that these sales could occur, could have a material adverse effect on the price of our common stock. Because our decision to issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock bear the risk of our future offerings reducing the market price of our common stock and diluting the value of their stock holdings in us.
Future sales of shares of our common stock may depress the price of our shares.
We cannot predict the effect, if any, of future sales of our common stock or the availability of shares for future sales on the market price of our common stock. Any sales of a substantial number of our shares in the public market, or the perception that sales might occur, may cause the market price of our shares to decline.
We have not established a minimum dividend payment level and we cannot assure you of our ability to pay dividends in the future.
We intend to pay monthly dividends to our common stockholders and to distributein an amount that all or substantially all of our taxable income is distributed within the limits prescribed by the Internal Revenue Code. However, we have not established a minimum dividend payment level and the amount of our dividend willmay fluctuate. Our ability to pay dividends may be adversely affected by the risk factors described herein. All distributions will be made at the discretion of our Board of Directors and will depend on our earnings ourand financial condition, the requirements for REIT qualification and such other factors as our Board of Directors may deemdeems relevant from time to time. We may not be able to make distributions in the future or our Board of Directors may change our dividend policy in the future.policy. In addition, some of our distributions may include a return of capital. To the extent that we decide to pay dividends in excess of our current and accumulated tax earnings and profits, such distributions would generally be considered a return of capital for federalFederal income tax purposes. A return of capital reduces the cost basis of a stockholder's investment in our common stock to the extent of such basis and is treated as capital gain thereafter.
An increase in market interest rates may cause a material decrease in our net book value and the market price of our common stock.
One of the factors that investors may consider in deciding whether to buy or sell shares of our common stock is our distribution rate as a percentage of our share price relative to market interest rates. If the market price of our common stock is based primarily on the earnings and return that we derive from our investments and income with respect to our investments and our related distributions to stockholders, and not from the market value of the investments themselves, thenMarket interest rate fluctuations and capital market conditions are likely to affect adverselycan have a significant adverse effect on our net book value and the market price of our common stock. For instance, if market rates rise without an increase in our distribution rate, the market price of our common stock could decrease as potential investors may require a higher distribution rate on our common stock or seek other securities paying higher distributions or interest. In addition, rising interest rates would result in increased interest expense on our variable rate debt, thereby reducing cash flow and our ability to service our indebtedness and pay distributions. In addition, if market interest rates rise without an increase in our distribution rate, the market price of our common stock could decrease as potential investors may require a higher distribution yield on our common stock or seek other investments paying higher distributions or interest.
The stock ownership limit imposed by the Internal Revenue Code for REITs and our amended and restated certificate of incorporation may restrict our business combination opportunities.
To qualify as a REIT under the Internal Revenue Code, not more than 50% in value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities) at any time during the last half of each taxable year in which we qualify as a REIT. Our amended and restated certificate of incorporation, with certain exceptions, authorizes our Board of Directors to take the actions that are necessary and desirable to qualify as a REIT. Pursuant to our amended and restated certificate of incorporation, no person may beneficially or constructively own more than 9.8% in value or in number of shares, whichever is more restrictive, of our common or capital stock.
Our Board of Directors may grant an exemption from this 9.8% stock ownership limitation, in its sole discretion, subject to such conditions, representations and undertakings as it may determine are reasonably necessary. Pursuant to our amended and restated certificate of incorporation, our Board of Directors has the power to increase or decrease the percentage of common or capital stock that a person may beneficially or constructively own. However, any decreased stock ownership limit will not apply
to any person whose percentage ownership of our common or capital stock as the case may be, is in excess of such decreased stock ownership limit until that person's percentage ownership of our common or capital stock as the case may be, equals or falls below the decreased stock ownership limit. Until such a person's percentage ownership of our common or capital stock as the case may be, falls below such decreased stock ownership limit, any further acquisition of our common or capital stock will be in violation of the decreased stock ownership limit.
The ownership limits imposed by the tax law are based upon direct or indirect ownership by "individuals," but only during the last half of a tax year. The ownership limits contained in our amended and restated certificate of incorporation apply to the ownership at any time by any "person," which term includes entities. Any attempt to own or transfer shares of our common stock or capital stock in violationsviolation of these restrictions may result in the shares being transferred to a charitable trust or may be void. These ownership limitations are intended to assist us in complying with the tax law requirements, and to minimize administrative burdens. However, these ownership limits might also delay or prevent a transaction or a change in our control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
The stock ownership limitation contained in our amended and restated certificate of incorporation generally does not permit ownership in excess of 9.8% of our common or capital stock, and attempts to acquire our common or capital stock in excess of these limits will be ineffective unless an exemption is granted by our Board of Directors.
As described above, our amended and restated certificate of incorporation generally prohibits beneficial or constructive ownership by any person of more than 9.8% (by value or by number of shares, whichever is more restrictive) of our common or capital stock, unless exempted by our Board of Directors. Our amended and restated certificate of incorporation's constructive ownership rules are complex and may cause the outstanding stock owned by a group of related individuals or entities to be deemed to be constructively owned by one individual or entity. As a result, the acquisition of less than these percentages of the outstanding stock by an individual or entity could cause that individual or entity to own constructively in excess of these percentages of the outstanding stock and thus be subject to our amended and restated certificate of incorporation's ownership limit. Any attempt to own or transfer shares of our common or preferred stock in excess of the ownership limit without the consent of the Board of Directors will result in the shares being automatically transferred to a charitable trust or, if the transfer to a charitable trust would not be effective, such transfer being treated as invalid from the outset.
Anti-takeover provisions in our amended and restated certificate of incorporation and bylaws could discourage a change of control that our stockholders may favor, which could also adversely affect the market price of our common stock.
Provisions in our amended and restated certificate of incorporation and bylaws may make it more difficult and expensive for a third partythird-party to acquire control of us, even if a change of control would be beneficial to our stockholders. We could issue a series of preferred stock to impede the completion of a merger, tender offer or other takeover attempt. The anti-takeover provisions in our amended and restated certificate of incorporation and bylaws may impede takeover attempts, or other transactions, that may be in the best interests of our stockholders and, in particular, our common stockholders. In addition, the market price of our common
stock could be adversely affected to the extent that provisions of our amended and restated certificate of incorporation and bylaws discourage potential takeover attempts, or other transactions, that our stockholders may favor.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We do not own any property. Our executive offices are located in Bethesda, Maryland.
Item 3. Legal Proceedings
Neither we, nor anyAGNC is named as a nominal defendant in three stockholder derivative lawsuits filed against the Company and certain of our current and former directors and officers. One case, H&N Management Group and AFF Cos. Frozen Money Purchase Plan v. Couch, et al., (the “Delaware Action”) was filed in the Chancery Court of the State of Delaware on October 21, 2016, and an amended complaint was filed on December 12, 2016. The other two cases, Clem v. Kain, et al., and Wall v. Kain, et al., were filed in the U.S. District Court in the District of Maryland on September 21, 2016 and September 30, 2016, respectively, and were consolidated subsidiaries, are currently subjecton October 25, 2016, under the name In re American Capital Agency Stockholder Derivative Litigation, (collectively, the “Maryland Action” and collectively, with the Delaware Action, the “Derivative Lawsuits”). An amended complaint in the Maryland Action was filed on December 23, 2016.
The amended complaint in the Delaware Action alleges breach of fiduciary duty and corporate waste by certain of our current and former directors and officers relating to any material litigation nor,decisions not to terminate our management agreement with our former external Manager and the internalization of our management through the acquisition of AMM, which was completed on July 1, 2016. The amended complaint in the Maryland Action alleges breach of fiduciary duties against the same individuals related to substantially the same events. In addition, the Maryland Action alleges violations of Section 14(a) of the Securities Exchange Act of 1934, as amended, due to purported omissions from our proxy statements in 2014, 2015 and 2016 and aiding and abetting by ACAM. The plaintiffs in the Derivative Lawsuits demand an unspecified amount of damages, pre-judgment and post-judgment interest, restitution from the individual defendants, attorneys’ fees and other costs, and further relief as the Court deems just and proper. The plaintiffs in the Maryland Action also seek a directive that the Company and the individual defendants take certain actions with respect to our knowledge,corporate governance and procedures. A motion to dismiss the Delaware Action was denied on August 1, 2017, and the Delaware Action is any litigation threatened against us or any consolidated subsidiary,currently in each case,the discovery phase. A motion to dismiss the Maryland Action was filed on September 30, 2017 and is currently pending. We believe the claims in the Derivative Lawsuits lack merit, and we expect that is expected to have a material adverse effect on our business, financial condition or operations.the defendants will vigorously defend these cases. See also "Loss"Loss Contingencies" in Note 2 to the Consolidated Financial Statements included under Item 8 of this Annual Report on Form 10-K.
Item 4. Mine Safety Disclosures
Not applicable.
PART II. FINANCIAL INFORMATIONII
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Quarterly Stock Prices and Dividend Declarations
Our common stock is listed on the NASDAQNasdaq Global Select Market under the symbol "AGNC." As of January 31, 2017,2018, we had 1,0841,100 stockholders of record. Most of the shares of our common stock are held by brokers and other institutions on behalf of stockholders.
The following table sets forth the range of high and low sales prices of our common stock as reported on the NASDAQNasdaq Global Select Market and dividends declared on our common stock for fiscal years 20162017 and 2015:2016:
| | | | Common Stock | Common Stock |
| | Sales Prices | | Dividends Declared 1 | Sales Prices | | Dividends Declared 1 |
| | High | Low | | High | Low | |
| Fiscal Year 2017 | | | | |
| Fourth Quarter | | $ | 21.90 |
| $ | 19.26 |
| | $ | 0.54 |
|
| Third Quarter | | $ | 21.94 |
| $ | 20.76 |
| | $ | 0.54 |
|
| Second Quarter | | $ | 22.34 |
| $ | 19.57 |
| | $ | 0.54 |
|
| First Quarter | | $ | 20.02 |
| $ | 18.10 |
| | $ | 0.54 |
|
| Fiscal Year 2016 | | | | |
| |
| | |
|
| Fourth Quarter | $ | 20.43 |
| $ | 17.30 |
| | $ | 0.54 |
| $ | 20.43 |
| $ | 17.30 |
| | $ | 0.54 |
|
| Third Quarter | $ | 20.10 |
| $ | 18.88 |
| | $ | 0.56 |
| $ | 20.10 |
| $ | 18.88 |
| | $ | 0.56 |
|
| Second Quarter | $ | 19.85 |
| $ | 18.00 |
| | $ | 0.60 |
| $ | 19.85 |
| $ | 18.00 |
| | $ | 0.60 |
|
| First Quarter | $ | 18.80 |
| $ | 15.69 |
| | $ | 0.60 |
| $ | 18.80 |
| $ | 15.69 |
| | $ | 0.60 |
|
| Fiscal Year 2015 | |
| |
| | |
| |
| Fourth Quarter | $ | 19.54 |
| $ | 16.89 |
| | $ | 0.60 |
| |
| Third Quarter | $ | 20.08 |
| $ | 18.21 |
| | $ | 0.60 |
| |
| Second Quarter | $ | 21.83 |
| $ | 18.31 |
| | $ | 0.62 |
| |
| First Quarter | $ | 22.36 |
| $ | 20.74 |
| | $ | 0.66 |
| |
1.Represents the sum of monthly dividends declared during each period presented.
We intend to pay dividends on a monthly dividendsbasis to our common stockholders and to distribute all of our annual taxable income in a timely manner. This will enable uscontinue to qualify for the tax benefits accorded to a REIT under the Internal Revenue Code. We have not established a minimum dividend payment level and our ability to pay dividends may be adversely affected for the reasons described under the caption "Risk Factors."
In addition,Additionally, holders of our 8.000% Series A Cumulative Redeemable Preferred Stock ("Series A Preferred Stock") anddepositary shares underlying our 7.750% Series B Cumulative Redeemable Preferred Stock ("Series B Preferred Stock") (each underlying depositary share representing a 1/1000th interest in a share ofand our 7.00% Series BC Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock)Stock ("Series C Preferred Stock") are entitled to receive cumulative cash dividends at a rate of 8.000% and 7.750% per annum, respectively, of their aggregate liquidation preference of $173 million and $175 million, respectively, before holders of our common stock are entitled to receive any dividends. Under certain circumstances upon a changeHolders of control, the Series A anddepository shares underlying our Series B Preferred Stock are convertibleentitled to receive cumulative cash dividends at a rate of 7.750% per annum of their aggregate liquidation preference of $175 million. Holders of depositary shares underlying our Series C Preferred Stock are entitled to receive cumulative cash dividends at a rate of our common stock.7.00% per annum up to, and including, October 14, 2022 and thereafter at a floating rate equal to three-month LIBOR plus a spread of 5.111% per annum of their aggregate liquidation preference of $325 million. All distributions to stockholders will be made at the discretion of our Board of Directors and will depend on our earnings, our financial condition, maintenance of our REIT status and such other factors as our Board of Directors may deem relevant from time to time.
The following table summarizes the tax characterization of dividends declared on our common stock for fiscal years 20162017 and 2015:2016:
|
| | | | | | | | | | | | | | | | | | | |
| | | | | Tax Characterization |
| | | Dividends Declared Per Share of Common Stock | | Ordinary Income Per Share | | Qualified Dividends | | Long-Term Capital Gains Per Share | Non-Dividend Distributions 2 |
Fiscal Year 2016 1 | | $ | 2.12 |
| | $ | 1.689674 |
| | $ | — |
| | $ | — |
| $ | 0.430326 |
|
| Fiscal Year 2015 | | $ | 2.48 |
| | $ | 2.480000 |
| | $ | — |
| | $ | — |
| $ | — |
|
|
| | | | | | | | | | | | | | | | | | | |
| | | | | Tax Characterization |
| | | Dividends Declared Per Share of Common Stock | | Ordinary Income Per Share | | Qualified Dividends | | Long-Term Capital Gains Per Share | Non-Dividend Distributions 3 |
Fiscal Year 2017 1 | | $ | 2.16 |
| | $ | 0.813744 |
| | $ | — |
| | $ | — |
| $ | 1.346256 |
|
Fiscal Year 2016 2 | | $ | 2.12 |
| | $ | 1.689674 |
| | $ | — |
| | $ | — |
| $ | 0.430326 |
|
| |
| 1. | Includes dividends declared throughduring the 12-month period ended November 30, 2016.2017. The dividend of $0.18 per common share declared on December 14, 2016,12, 2017, which was payablepaid on January 9, 2017,2018, will be reported to stockholders as a fiscal year 20172018 distribution for federalFederal income tax purposes. |
| |
| 2. | Includes dividends declared during the 11-month period ended November 30, 2016. |
| |
| 3. | Also referred to as a "return of capital." Represents dividends paid in excess of our current and accumulated earnings and profit, or "E&P," which is a tax-based measure calculated by making adjustments to taxable income for items that are treated differently for E&P purposes, such as utilization of net capital loss carryforwards. A return of capital reduces the basis of a stockholder's investment in our common stock to the extent of such basis and is treated as capital gain thereafter. |
losses and utilization of net capital loss carryforwards. A return of capital reduces the basis of a stockholder's investment in our common stock to the extent of such basis and is treated as capital gain thereafter.
Our stock transfer agent and registrar is Computershare Investor Services. Requests for information from Computershare can be sent to Computershare Investor Services, P.O. Box 43078, Providence, RI 02940-3078 and their telephone number is 1-800-733-5001.
Equity Compensation Plan Information
The following table summarizes information, as of December 31, 2016,2017, concerning shares of our common stock authorized for issuance under our equity compensation plans, pursuant to which grants of equity-based awards, including stock options,namely restricted stock units and unrestricted stock awards("RSUs"), may be granted from time to time. See "Item 8. Financial Statements" for a description of our equity compensation plans.
| | | Plan Category | | Number of securities to be issued upon exercise of outstanding options, warrants and rights | | Weighted average exercise price of outstanding options, warrants and rights | | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in the first column of this table) | | Number of securities to be issued upon exercise of outstanding options, warrants and rights 1 | | Weighted average exercise price of outstanding options, warrants and rights | | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in the first column of this table) 2 |
Equity compensation plans approved by security holders 1 | | 122,841 | | $ | — |
| | 9,898,593 | |
| Equity compensation plans approved by security holders | | | 901,065 | | $ | — |
| | 9,097,050 |
| Equity compensation plans not approved by security holders | | — | | — |
| | — | | — | | — |
| | — |
| Total | | 122,841 | | $ | — |
| | 9,898,593 | | 901,065 | | $ | — |
| | 9,097,050 |
| |
| 1. | RepresentsIncludes (i) unvested restricted stock unitstime and performance-based RSU awards (unvested performance-based awards assume the maximum payout under the terms of the award); (ii) outstanding previously vested awards, if distribution of such awards has been deferred beyond the vesting date; and (iii) accrued dividend equivalent units.units on items (i) and (ii) through December 31, 2017. |
| |
| 2. | Available shares are reduced by items (i), (ii) and (iii) noted above and by shares issued for vested RSU awards, net of units withheld to cover minimum statutory tax withholding requirements paid by us in cash on behalf of the employee. |
Performance Graph
The following graph and table compare a stockholder's cumulative total return, assuming $100 invested at December 31, 2011,2012, with the reinvestment of all dividends, as if such amounts had been invested in: (i) our common stock; (ii) the stocks included in the Standard & Poor's 500 Stock Index ("S&P 500"); (iii) the stocks included in the FTSE NAREIT Mortgage REIT Index; (iv) an index of selected issuers in our peer group, composed of Annaly Capital Management, Inc., Anworth Mortgage Asset Corporation, Capstead Mortgage Corporation, CYS Investments, Inc. and Armour Residential REIT, Inc. (collectively, the "Agency REIT Peer Group").
_______________________
*$100 invested on 12/31/1112 in stock or index, including reinvestment of dividends.
Fiscal year ending December 31.
Copyright © 20172018 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved.
| | | | | December 31, | | December 31, |
| | | 2016 | | 2015 | | 2014 | | 2013 | | 2012 | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
| AGNC Investment Corp. | | $ | 126.34 |
| | $ | 106.90 |
| | $ | 118.63 |
| | $ | 93.30 |
| | $ | 120.10 |
| | $ | 130.13 |
| | $ | 105.20 |
| | $ | 89.01 |
| | $ | 98.78 |
| | $ | 77.68 |
|
| S&P 500 | | $ | 198.18 |
| | $ | 177.01 |
| | $ | 174.60 |
| | $ | 153.58 |
| | $ | 116.00 |
| | $ | 208.14 |
| | $ | 170.84 |
| | $ | 152.59 |
| | $ | 150.51 |
| | $ | 132.39 |
|
| FTSE NAREIT Mortgage REITs | | $ | 155.11 |
| | $ | 126.26 |
| | $ | 138.56 |
| | $ | 117.54 |
| | $ | 119.89 |
| | $ | 154.98 |
| | $ | 129.38 |
| | $ | 105.31 |
| | $ | 115.57 |
| | $ | 98.04 |
|
Agency REIT Peer Group 1 | | $ | 112.01 |
| | $ | 93.07 |
| | $ | 98.05 |
| | $ | 81.35 |
| | $ | 100.95 |
| | $ | 140.94 |
| | $ | 110.96 |
| | $ | 92.20 |
| | $ | 97.13 |
| | $ | 80.59 |
|
_______________________
1.Agency REIT Peer Group annual return is calculated on a weighted basis by market cap at the end of the previous year.
The information in the share performance graph and table has been obtained from sources believed to be reliable, but neither its accuracy nor its completeness can be guaranteed. The historical information set forth above is not necessarily indicative of future performance. Accordingly, we do not make or endorse any predictions as to future share performance.
Item 6. Selected Financial Data
The following selected financial data is derived from our audited financial statements for the five fiscal years ended December 31, 2016.2017. The selected financial data should be read in conjunction with the more detailed information contained in the Item 8. Financial Statements and Notes thereto and "Management'sItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"Operations included elsewhere in this Annual Report on Form 10-K.
|
| | | | | | | | | | | | | | | | | | | | |
| ($ in millions, except per share amounts) | | | | | | | | | | |
| Balance Sheet Data | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
| Investment securities, at fair value | | $ | 57,080 |
| | $ | 46,499 |
| | $ | 52,473 |
| | $ | 56,748 |
| | $ | 65,941 |
|
| Total assets | | $ | 70,376 |
| | $ | 56,880 |
| | $ | 57,021 |
| | $ | 67,766 |
| | $ | 76,255 |
|
| Repurchase agreements and other debt | | $ | 50,653 |
| | $ | 41,355 |
| | $ | 46,102 |
| | $ | 51,057 |
| | $ | 64,443 |
|
| Total liabilities | | $ | 61,622 |
| | $ | 49,524 |
| | $ | 49,050 |
| | $ | 58,338 |
| | $ | 67,558 |
|
| Total stockholders' equity | | $ | 8,754 |
| | $ | 7,356 |
| | $ | 7,971 |
| | $ | 9,428 |
| | $ | 8,697 |
|
Net book value per common share 1 | | $ | 21.09 |
| | $ | 21.17 |
| | $ | 22.59 |
| | $ | 25.74 |
| | $ | 23.93 |
|
Tangible net book value per common share 2 | | $ | 19.69 |
| | $ | 19.50 |
| | N/A |
| | N/A |
| | N/A |
|
|
| | | | | | | | | | | | | | | | | | | | |
| | | Fiscal Year |
| Statement of Comprehensive Income Data | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
| Interest income | | $ | 1,293 |
| | $ | 1,321 |
| | $ | 1,466 |
| | $ | 1,472 |
| | $ | 2,193 |
|
| Interest expense | | 524 |
| | 394 |
| | 330 |
| | 372 |
| | 536 |
|
| Net interest income | | 769 |
| | 927 |
| | 1,136 |
| | 1,100 |
| | 1,657 |
|
| Other gain (loss), net | | 72 |
| | (199 | ) | | (782 | ) | | (1,192 | ) | | (217 | ) |
| Operating expenses | | 70 |
| | 105 |
| | 139 |
| | 141 |
| | 168 |
|
| Income (loss) before income tax | | 771 |
| | 623 |
| | 215 |
| | (233 | ) | | 1,272 |
|
| Provision for income tax, net | | — |
| | — |
| | — |
| | — |
| | 13 |
|
| Net income (loss) | | 771 |
| | 623 |
| | 215 |
| | (233 | ) | | 1,259 |
|
| Dividend on preferred stock | | 32 |
| | 28 |
| | 28 |
| | 23 |
| | 14 |
|
| Issuance costs of redeemed preferred stock | | 6 |
| | — |
| | — |
| | — |
| | — |
|
| Net income available to common stockholders | | $ | 733 |
| | $ | 595 |
| | $ | 187 |
| | $ | (256 | ) | | $ | 1,245 |
|
| | | | | | | | | | | |
| Net income (loss) | | $ | 771 |
| | $ | 623 |
| | $ | 215 |
| | $ | (233 | ) | | $ | 1,259 |
|
| Other comprehensive income (loss) | | 52 |
| | (331 | ) | | (496 | ) | | 1,813 |
| | (2,938 | ) |
| Comprehensive income (loss) | | 823 |
| | 292 |
| | (281 | ) | | 1,580 |
| | (1,679 | ) |
| Dividend on preferred stock | | 32 |
| | 28 |
| | 28 |
| | 23 |
| | 14 |
|
| Issuance costs of redeemed preferred stock | | 6 |
| | — |
| | — |
| | — |
| | — |
|
| Comprehensive income (loss) available (attributable) to common stockholders | | $ | 785 |
| | $ | 264 |
| | $ | (309 | ) | | $ | 1,557 |
| | $ | (1,693 | ) |
| | | | | | | | | | | |
| Weighted average number of common shares outstanding - basic | | 358.6 |
| | 331.9 |
| | 348.6 |
| | 353.3 |
| | 379.1 |
|
| Weighted average number of common shares outstanding - diluted | | 358.7 |
| | 331.9 |
| | 348.6 |
| | 353.3 |
| | 379.1 |
|
| Net income per common share - basic and diluted | | $ | 2.04 |
| | $ | 1.79 |
| | $ | 0.54 |
| | $ | (0.72 | ) | | $ | 3.28 |
|
| Comprehensive income per common share - basic and diluted | | $ | 2.19 |
| | $ | 0.80 |
| | $ | (0.89 | ) | | $ | 4.41 |
| | $ | (4.47 | ) |
| Dividends declared per common share | | $ | 2.16 |
| | $ | 2.30 |
| | $ | 2.48 |
| | $ | 2.61 |
| | $ | 3.75 |
|
|
| | | | | | | | | | | | | | | | | | | | |
| ($ in millions, except per share amounts) | | | | | | | | | | |
| | | December 31, |
| Balance Sheet Data | | 2016 | | 2015 | | 2014 | | 2013 | | 2012 |
| Investment securities, at fair value | | $ | 46,499 |
| | $ | 52,473 |
| | $ | 56,748 |
| | $ | 65,941 |
| | $ | 85,245 |
|
| Total assets | | $ | 56,880 |
| | $ | 57,021 |
| | $ | 67,766 |
| | $ | 76,255 |
| | $ | 100,453 |
|
| Repurchase agreements, Federal Home Loan Bank advances and other debt | | $ | 41,355 |
| | $ | 46,102 |
| | $ | 51,057 |
| | $ | 64,443 |
| | $ | 75,415 |
|
| Total liabilities | | $ | 49,524 |
| | $ | 49,050 |
| | $ | 58,338 |
| | $ | 67,558 |
| | $ | 89,557 |
|
| Total stockholders' equity | | $ | 7,356 |
| | $ | 7,971 |
| | $ | 9,428 |
| | $ | 8,697 |
| | $ | 10,896 |
|
Net asset value per common share as of period end 1 | | $ | 21.17 |
| | $ | 22.59 |
| | $ | 25.74 |
| | $ | 23.93 |
| | $ | 31.64 |
|
Tangible net asset value per common share as of period end 2 | | $ | 19.50 |
| | N/A |
| | N/A |
| | N/A |
| | N/A |
|
|
| | | | | | | | | | | | | | | | | | | | |
| | | Fiscal Year |
| Statement of Comprehensive Income Data | | 2016 | | 2015 | | 2014 | | 2013 | | 2012 |
| Interest income | | $ | 1,321 |
| | $ | 1,466 |
| | $ | 1,472 |
| | $ | 2,193 |
| | $ | 2,109 |
|
Interest expense 3 | | 394 |
| | 330 |
| | 372 |
| | 536 |
| | 512 |
|
| Net interest income | | 927 |
| | 1,136 |
| | 1,100 |
| | 1,657 |
| | 1,597 |
|
Other gain (loss), net 3 | | (199 | ) | | (782 | ) | | (1,192 | ) | | (217 | ) | | (157 | ) |
| Operating Expenses | | 105 |
| | 139 |
| | 141 |
| | 168 |
| | 144 |
|
| Income (loss) before income tax | | 623 |
| | 215 |
| | (233 | ) | | 1,272 |
| | 1,296 |
|
| Provision for income tax, net | | — |
| | — |
| | — |
| | 13 |
| | 19 |
|
| Net income (loss) | | 623 |
| | 215 |
| | (233 | ) | | 1,259 |
| | 1,277 |
|
| Dividend on preferred stock | | 28 |
| | 28 |
| | 23 |
| | 14 |
| | 10 |
|
| Net income (loss) available (attributable) to common stockholders | | $ | 595 |
| | $ | 187 |
| | $ | (256 | ) | | $ | 1,245 |
| | $ | 1,267 |
|
| | | | | | | | | | | |
| Net income (loss) | | $ | 623 |
| | $ | 215 |
| | $ | (233 | ) | | $ | 1,259 |
| | $ | 1,277 |
|
Other comprehensive income (loss) 3 | | (331 | ) | | (496 | ) | | 1,813 |
| | (2,938 | ) | | 1,244 |
|
| Comprehensive income (loss) available (attributable) to common stockholders | | 292 |
| | (281 | ) | | 1,580 |
| | (1,679 | ) | | 2,521 |
|
| Dividend on preferred stock | | 28 |
| | 28 |
| | 23 |
| | 14 |
| | 10 |
|
| Comprehensive income (loss) available (attributable) to common stockholders | | $ | 264 |
| | $ | (309 | ) | | $ | 1,557 |
| | $ | (1,693 | ) | | $ | 2,511 |
|
| | | | | | | | | | | |
| Weighted average number of common shares outstanding - basic and diluted | | 331.9 |
| | 348.6 |
| | 353.3 |
| | 379.1 |
| | 303.9 |
|
| Net income (loss) per common share - basic and diluted | | $ | 1.79 |
| | $ | 0.54 |
| | $ | (0.72 | ) | | $ | 3.28 |
| | $ | 4.17 |
|
| Comprehensive income (loss) per common share - basic and diluted | | $ | 0.80 |
| | $ | (0.89 | ) | | $ | 4.41 |
| | $ | (4.47 | ) | | $ | 8.26 |
|
| Dividends declared per common share | | $ | 2.30 |
| | $ | 2.48 |
| | $ | 2.61 |
| | $ | 3.75 |
| | $ | 5.00 |
|
| | | Fiscal Year |
| Other Data (unaudited) | | 2016 | | 2015 | | 2014 | | 2013 | | 2012 |
| Average investment securities - at par | | $47,101 | | $51,759 | | $53,578 | | $75,263 | | $71,002 |
| Average investment securities - at cost | | $49,268 | | $54,019 | | $56,051 | | $79,056 | | $74,588 |
| Average total assets - at fair value | | $56,931 | | $63,674 | | $67,007 | | $96,956 | | $86,172 |
| Net TBA dollar roll position - at par (as of period end) | | $10,916 | | $7,295 | | $14,412 | | $2,119 | | $12,477 |
| Net TBA dollar roll position - at cost (as of period end) | | $11,312 | | $7,430 | | $14,576 | | $2,276 | | $12,775 |
| Net TBA dollar roll position - at market value (as of period end) | | $11,165 | | $7,444 | | $14,768 | | $2,271 | | $12,870 |
Net TBA dollar roll position - at carrying value (as of period end) 4 | | $(147) | | $14 | | $192 | | $(5) | | $95 |
| Average net TBA portfolio - at cost | | $10,329 | | $7,547 | | $13,212 | | $11,383 | | $3,294 |
Average mortgage borrowings outstanding 5 | | $44,566 | | $48,641 | | $50,015 | | $71,753 | | $68,810 |
Average stockholders' equity 6 | | $7,718 | | $8,817 | | $9,295 | | $10,394 | | $9,473 |
Average coupon 7 | | 3.64 | % | | 3.62 | % | | 3.63 | % | | 3.59 | % | | 3.90 | % |
Average asset yield 8 | | 2.68 | % | | 2.71 | % | | 2.63 | % | | 2.77 | % | | 2.82 | % |
Average cost of funds 9 | | (1.45 | )% | | (1.49 | )% | | (1.40 | )% | | (1.34 | )% | | (1.11 | )% |
| Average net interest rate spread | | 1.23 | % | | 1.22 | % | | 1.23 | % | | 1.43 | % | | 1.71 | % |
|
| | | | | | | | | | | | | | | |
| | | Fiscal Year |
| Other Data (unaudited) * | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
| Average investment securities - at par | | $45,198 | | $47,101 | | $51,759 | | $53,578 | | $75,263 |
| Average investment securities - at cost | | $47,330 | | $49,268 | | $54,019 | | $56,051 | | $79,056 |
| Net TBA dollar roll position - at par (as of period end) | | $15,474 | | $10,916 | | $7,295 | | $14,412 | | $2,119 |
| Net TBA dollar roll position - at cost (as of period end) | | $15,739 | | $11,312 | | $7,430 | | $14,576 | | $2,276 |
| Net TBA dollar roll position - at market value (as of period end) | | $15,742 | | $11,165 | | $7,444 | | $14,768 | | $2,271 |
Net TBA dollar roll position - at carrying value (as of period end) 3 | | $3 | | $(147) | | $14 | | $192 | | $(5) |
| Average net TBA portfolio - at cost | | $16,859 | | $10,329 | | $7,547 | | $13,212 | | $11,383 |
| Average total assets - at fair value | | $58,727 | | $56,931 | | $63,674 | | $67,007 | | $96,956 |
Average Agency repurchase agreements and other debt outstanding 4 | | $41,942 | | $44,566 | | $48,641 | | $50,015 | | $71,753 |
Average stockholders' equity 5 | | $7,933 | | $7,718 | | $8,817 | | $9,295 | | $10,394 |
Average "at risk" leverage 6 | | 7.4:1 |
| | 7.1:1 |
| | 6.4:1 |
| | 7.0:1 |
| | 8.0:1 |
|
Average tangible net book value "at risk" leverage 7 | | 8.0:1 |
| | 7.5:1 |
| | N/A |
| | N/A |
| | N/A |
|
"At risk" leverage (as of period end) 8 | | 7.6:1 |
| | 7.1:1 |
| | 6.8:1 |
| | 6.9:1 |
| | 7.5:1 |
|
Tangible net book value "at risk" leverage (as of period end) 7 | | 8.1:1 |
| | 7.7:1 |
| | N/A |
| | N/A |
| | N/A |
|
Economic return on common equity 9 | | 9.8 | % | | 3.9 | % | | (2.6 | )% | | 18.5 | % | | (12.5 | )% |
Economic return on tangible common equity 10 | | 12.1 | % | | N/A |
| | N/A |
| | N/A |
| | N/A |
|
| Expenses % of average total assets | | 0.12 | % | | 0.18 | % | | 0.22 | % | | 0.21 | % | | 0.17 | % |
| Expenses % of average assets, including average net TBA position | | 0.09 | % | | 0.16 | % | | 0.20 | % | | 0.18 | % | | 0.15 | % |
| Expenses % of average stockholders' equity | | 0.88 | % | | 1.36 | % | | 1.58 | % | | 1.52 | % | | 1.61 | % |
|
| | | | | | | | | | | | | | | | | | | | |
Average net interest rate spread, including TBA dollar roll income 10 | | 1.39 | % | | 1.48 | % | | 1.75 | % | | 1.63 | % | | 1.77 | % |
Average coupon (as of period end) | | 3.61 | % | | 3.63 | % | | 3.65 | % | | 3.58 | % | | 3.69 | % |
Average asset yield (as of period end) | | 2.77 | % | | 2.78 | % | | 2.74 | % | | 2.70 | % | | 2.61 | % |
Average cost of funds (as of period end) 11 | | (1.44 | )% | | (1.65 | )% | | (1.40 | )% | | (1.31 | )% | | (1.22 | )% |
Average net interest rate spread (as of period end) | | 1.33 | % | | 1.13 | % | | 1.34 | % | | 1.39 | % | | 1.39 | % |
Net comprehensive income return on average common equity 12 | | 3.6 | % | | (3.6 | )% | | 17.3 | % | | (16.6 | )% | | 26.9 | % |
Economic return on common equity 13 | | 3.9 | % | | (2.6 | )% | | 18.5 | % | | (12.5 | )% | | 32.2 | % |
Average "at risk" leverage 14 | | 7.1:1 |
| | 6.4:1 |
| | 7.0:1 |
| | 8.0:1 |
| | 7.6:1 |
|
Average tangible net book value "at risk" leverage 16 | | 7.5:1 |
| | N/A |
| | N/A |
| | N/A |
| | N/A |
|
"At risk" leverage (as of period end) 15 | | 7.1:1 |
| | 6.8:1 |
| | 6.9:1 |
| | 7.5:1 |
| | 8.2:1 |
|
Tangible net book value "at risk" leverage (as of period end) 16 | | 7.7:1 |
| | N/A |
| | N/A |
| | N/A |
| | N/A |
|
| Expenses % of average total assets | | 0.18 | % | | 0.22 | % | | 0.21 | % | | 0.17 | % | | 0.17 | % |
| Expenses % of average assets, including average net TBA position | | 0.16 | % | | 0.20 | % | | 0.18 | % | | 0.15 | % | | 0.16 | % |
| Expenses % of average stockholders' equity | | 1.36 | % | | 1.58 | % | | 1.52 | % | | 1.61 | % | | 1.52 | % |
_______________________
* Except as noted below, average numbers for each period are weighted based on days on our books and records.
N/A - Not applicable
| |
| 1. | Net assetbook value per common share is calculated as our total stockholders' equity, less our Series A and Series B Preferred Stock aggregatepreferred stock liquidation preference, divided by our number of common shares outstanding as of period end. |
| |
| 2. | Tangible net assetbook value per common share excludes goodwill and other intangible assets, net. |
| |
| 3. | We voluntarily discontinued hedge accounting for our interest rate swaps as of September 30, 2011. Please refer to our Interest Expense and Cost of Funds discussion in Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes 2 and 5 of our Consolidated Financial Statements in this Form 10-K for additional information regarding our discontinuance of hedge accounting.
|
| |
4. | The carrying value of our net TBA position represents the difference between the market value and the cost basis of the TBA contract as of period-end and is reported in derivative assets/(liabilities), at fair value on our accompanying consolidated balancebalances sheets. |
| |
5.4. | Average mortgage borrowings include repurchase agreements used to fund Agency securities ("Agency repo"),Other debt includes FHLB advances and debt of consolidated VIEs. Amount excludes U.S. Treasury repo agreements and TBA contracts. |
| |
6.5. | Average stockholders' equity calculated as our average month-endmonth-ended stockholders' equity during the period. |
| |
7. | Average coupon for the period was calculated by dividing our total coupon (or cash) interest income on investment securities by our average investment securities held at par. |
| |
8. | Average asset yield for the period was calculated by dividing our total cash interest income on investment securities, adjusted for amortization of premiums and discounts, by our average amortized cost of investment securities held. |
| |
9. | Average cost of funds includes mortgage borrowings and interest rate swap periodic costs. Amount excludes interest rate swap termination fees, forward starting swaps and costs associated with other supplemental hedges, such as interest rate swaptions and U.S. Treasury positions. Average cost of funds for the period was calculated by dividing our total cost of funds by our average mortgage borrowings outstanding for the period. |
| |
10. | TBA dollar roll income/(loss) is net of short TBAs used for hedging purposes and is recognized in gain (loss) on derivative instruments and other securities, net. |
| |
11. | Average cost of funds as of period end includes mortgage borrowings outstanding and interest rate swap hedges. Amount excludes costs associated with other supplemental hedges such as swaptions, U.S. Treasuries and TBA positions. |
| |
12. | Net comprehensive income (loss) return on average common equity for the period was calculated by dividing our comprehensive income/(loss) available /(attributable) to common stockholders by our average stockholders' equity, net of the Series A and Series B Preferred Stock aggregate liquidation preference. |
| |
13. | Economic return on common equity represents the sum of the change in our net asset value per common share and our dividends declared on common stock during the period over our beginning net asset value per common share. |
| |
14.6. | Average "at risk" leverage is calculated by dividing the sum of our daily weighted average mortgage borrowings outstanding (Agency repo, other debt and our weighted average net TBA dollar positionsecurities (at cost)) for the period by the sum of our average stockholders' equity less our average investment in REIT equity securities for the period. Leverage excludes U.S. Treasury repurchase agreements. |
| |
15.7. | Tangible net book value "at risk" leverage includes the components of "at risk" leverage, with stockholders' equity adjusted to exclude goodwill and other intangible assets, net. |
| |
| 8. | "At risk" leverage as of period end is calculated by dividing the sum of our mortgage borrowings outstanding (Agency repo, other debt and TBA securities (at cost)) and our receivable/payable for unsettled investment securities and our net TBA dollar roll position outstanding as of period end (at cost) by the sum of our total stockholders' equity less the fair value of investments in REIT equity securities at period end. Leverage excludes U.S. Treasury repurchase agreements. |
| |
16.9. | TangibleEconomic return on common equity represents the sum of the change in our net book value "at risk" leverage includesper common share and our dividends declared on common stock during the componentsperiod over our beginning net book value per common share. |
| |
| 10. | Economic return on tangible common equity represents the sum of "at risk" leverage, with stockholders' equity adjusted to exclude goodwillthe change in our tangible net book value per common share and other intangible assets, net.our dividends declared on common stock during the period over our beginning tangible net book value per common share. |
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide a reader of AGNC Investment Corp.'sour consolidated financial statements with a narrative from the perspective of management.management, and should be read in conjunction with the consolidated financial statements and accompanying notes included in this Annual Report on Form 10-K. Our MD&A is presented in eight sections:
Executive Overview
Financial Condition
Summary of Critical Accounting Estimates
Results of Operations
Liquidity and Capital Resources
Off-Balance Sheet Arrangements
Aggregate Contractual Obligations
Forward-Looking Statements
EXECUTIVE OVERVIEW
Our principal objective is to provide our stockholders with attractive risk-adjusted returns through a combination of monthly dividends and tangible net book value accretion. We generate income from the interest earned on our investments, net of associated borrowing and hedging costs, and net realized gains and losses on our investment and hedging activities. We fund our investments primarily through borrowings structured as repurchase agreements.
The size and composition of our investment portfolio depends on the investment strategies we implement, the availability of investment capital and overall market conditions, including the availability of attractively priced investments, and suitable financing to appropriately leverage our investment portfolio.portfolio and overall market conditions. Market conditions are influenced by among other things, current levels of and expectations for future levels of interest rates, mortgage prepayments, marketprepayment expectations, liquidity, housing prices, unemployment rates, general economic conditions, government participation in the mortgage market, evolving regulations, or legal settlements that impact servicing practices orrelative returns on other mortgage related activities.assets and other factors.
Trends and Recent Market Impacts
2016 proved to be a challenging year for many fixed income investments as U.S. interest rates fluctuated significantly during the year in response to changing views on economic growth both domestically and abroad. The yield on the 10 year U.S. Treasury security, for example, hit a low of 1.36% in July following the Brexit vote in the United Kingdom and a high of 2.60% in December following the U.S. Presidential election. Our view at the beginning of the year was that U.S. interest rates would remain "lower for longer," based upon the belief that global economic weakness, secular labor trends and accelerating technological advances would lead to moderate employment growth and persistently low inflation bothEconomic conditions in the U.S. and globally, thus making it difficult forabroad continued to improve throughout 2017 and long-term interest rates remained remarkably stable. Investors generally favored higher risk assets, as evidenced by the strong performance of equities and tighter credit spreads throughout much of the Fed to move away from its ultra-accommodative stancefixed income market. Agency RMBS spreads, on monetary policy. This view proved to be the emerging scenario for mostother hand, widened modestly during the first three quarters of the year and as a result,versus benchmark interest rates in anticipation of the Fed's reduction of its Agency RMBS holdings. In September 2017, the Fed refrainedannounced the details of its plan to gradually reduce the reinvestment of proceeds from raising rates for most of the year.its RMBS holdings beginning in October 2017. Following the unanticipated outcomeannouncement, the price of the U.S. Presidential election in November, however, the direction and level of U.S. interest rates became less certainour Agency RMBS appreciated relative to our hedge instruments, as expectations for economic growthAgency spreads narrowed somewhat in the U.S. improved markedly andfourth quarter. The overall strong performance of Agency RMBS, as the Fed raised the Federal Funds rate by 0.25% in December.
The changing interest rate landscape in the U.S.well as CRT securities, over the course of the year caused Agency RMBS to underperform swap and U.S. Treasury rates. This spread widening negatively impacted AGNC’s net asset value, but also improvedwas a key driver of the return profile on new investments. In response to more favorable investment opportunities, we increasedincrease in our tangible net book value "at risk" leverage to 7.7x as of December 31, 2016, from 6.8x as of December 31, 2015. Our tangible net book value excludes $554 million of goodwill as of December 31, 2016, which we recorded in connection with our acquisition of AMM. This increase in leverage improves the earnings profile of our portfolio but also increases the sensitivity of our net asset value to fluctuations in the spread between Agency RMBS and other benchmark rates.
We also adjusted the composition of our asset portfolio during the year. Our mix of fixed rate 15 year and 30 year securities (including TBAs) remained relatively stable throughout the year, at 27% and 73%, respectively, as of December 31, 2016, but the weighted average loan age, or "seasoning," of our portfolio increased significantly over the year. As of December 31, 2016, the weighted average loan age of our 15 year and 30 year Agency RMBS positions were approximately 5.0 years and 3.4 years, respectively. In aggregate, 75% of our on-balance sheet Agency RMBS position had a weighted average loan age of at least 3.0 years as of December 31, 2016, compared to 62% as of December 31, 2015 and less than 5% was during the "taper tantrum" in 2013. The increase in the weighted average loan age of our Agency RMBS should reduce prepayment speed variability of our portfolio and, therefore, require less interest rate hedging, all other things equal.
In response to higher interest rates and the extension of the duration of our Agency RMBS, particularly in the fourth quarter, we increased the size of our hedge portfolio. As a result, our hedge ratio increased to 91% of our funding liabilities (Agency repo, TBA and other debt) as of December 31, 2016, from an intra-year low of 75% as of September 30, 2016 and from 87% as of December 31, 2015. Ongoing portfolio rebalancing actions during the year, as well as the cumulative increase in our hedge position, enabled us to keep our net asset duration gap relatively stable throughout the year. Our net asset duration gap, which is a measure of our portfolio’s interest rate sensitivity, net of hedges, was 1.1 years as of December 31, 2016, compared to 0.8 years as of December 31, 2015.
The funding landscape for Agency RMBS improved in 2016 as a result of the implementation of money market reform requirements, which took effect in October of 2016 and caused a sizable reallocation of assets from prime funds to U.S. Government bond money market funds. This shift of capital to U.S. Government money market funds was supportive of repo backed by Agency RMBS, ultimately reducing our funding costs relative to LIBOR. As we receive a floating LIBOR rate on our pay fixed/receive floating interest rate swaps, the resultant decline in the spread between our repo borrowing costs and LIBOR had the effect of lowering our all-in cost of funds on the portion of our debt that we have hedged with pay fixed swaps.
In addition, our wholly-owned captive broker-dealer subsidiary, BES, became fully operational in the third quarter of 2016 as a member of the FICC, providing us with access to additional repo funding with favorable rates and haircuts relative to traditional bilateral repo arrangements. As of December 31, 2016, we had placed approximately $4.7 billion of repo financing at BES, providing further diversification of our funding sources and reducing our net interest expense. We anticipate transitioning a greater share of our repo funding to BES during 2017.
In the third quarter of 2016, our Board of Directors expanded our investment guidelines to include credit-sensitive assets, including CRT securities issued by the GSEs and other third parties. We believe CRT securities provide a compelling opportunity to invest in conforming credit, which has previously been the exclusive purview of the GSEs, and could provide incremental returns to our existing Agency RMBS investments over the longer term.
Our net asset value declined to $21.17$19.69 per common share as of December 31, 2016,2017, from $22.59 per common share as of December 31, 2015. Our tangible net book value per common share was $19.50 per common share as of December 31, 2016. The loss$0.19 per common share improvement in our tangible net assetbook value was predominately a result of wider spreads on agency MBS relative to benchmark interest rates and the large increase in interest rates experienced during the fourth quarter.
Our economic return on common equity was 3.9% for 2016, comprised of dividends declared$2.16 per common share of $2.30 and a lossdividends paid for the year resulted in net asset value of $1.42 per common share. Our totalan economic return on our tangible common stock,equity of 12.1% for 2017.
Throughout 2017, the Fed continued to gradually increase short-term interest rates, raising the federal funds rate three times for a total increase of 75 basis points. Over the same period, the yield on the 10-year U.S. Treasury note declined 2 basis points. As a result, the yield differential between short and long-term U.S. Treasury rates narrowed, or flattened, significantly. Despite this flattening, our average net interest margin (including our TBA dollar roll funded assets and interest rate swap hedges and excluding "catch-up" premium amortization cost due to changes in CPR forecasts) increased to 1.45% for 2017, compared to 1.41% for 2016. Our net interest margin benefited from a relative increase in our holdings of higher yielding 30-year fixed rate Agency RMBS, versus 15-year holdings, and favorable funding conditions for both our repo and TBA dollar roll funded assets. Additionally, we increased the portion of our funding raised through our captive broker-dealer subsidiary, BES, which includes stock price appreciationwas generally at more favorable terms than traditional bilateral repo. As of December 31, 2017, 33% of our Agency repo funding was sourced through BES, up from 12% as of the year prior. These conditions provided a favorable investment landscape against which we increased our "at risk" leverage ratio during 2017 to 8.1x our tangible equity as of December 31, 2017, from 7.7x as of December 31, 2016.
During 2017, we generally believed interest rates were biased higher given improving underlying economic fundamentals and dividend reinvestments,a reduction of quantitative easing measures by central banks. As such, we reduced our exposure to higher rates and maintained a relatively large interest rate hedge position. As of December 31, 2017, the notional balance of our interest rate hedges totaled 97% of our Agency repo and TBA position, up from 90% as of December 31, 2016, providing significant protection to our net
book value against potential fluctuations due to interest rate changes. Consistent with our higher hedge ratio, our net "duration gap," which is a measure of the risk due to mismatches that can occur between the interest rate sensitivity of our assets and liabilities, inclusive of hedges, was 18.2%0.1 years as of December 31, 2017, down from 1.3 years as of December 31, 2016. We also adjusted the composition of our hedge positions to include a greater portion of interest rate swaptions, which provide us greater protection against larger interest rate increases and higher interest rate volatility. As of December 31, 2017, we estimate that if interest rates were to immediately increase by 100 basis points, assuming an instantaneous parallel shift in the yield curve and no re-balancing actions, our tangible net book value would decrease by 6.6%, which is significantly lower than our corresponding interest rate sensitivity as of December 31, 2016, which projected an approximate decline of 15% under similar circumstances. Please refer to Item 7A. Quantitative and Qualitative Disclosures about Market Risk for the year.further discussion of our interest rate and spread sensitivity.
The widening ofLooking ahead, we believe Agency RMBS spreads may widen further and favorable funding dynamics that occurred over the course of 2016 have improved the risk-adjustedinterest rates may trend higher. The broader financial markets may also experience greater volatility in comparison to 2017. Although, our tangible net book value may decline if these conditions occur, we believe levered returns on Agency RMBS investments. In addition, with AGNC’s recent expansion into credit-sensitive investments,will remain attractive. We could also opportunistically increase our leverage when we believe that opportunistic investments in CRT securities can provide incrementalthe risk-adjusted returns that are less correlated with the interest rate exposure inherent in our Agency RMBS portfolio. Portfolio returns could be further supported by either higher leverage or a reduction in aggregate hedge or funding cost.
Finally, on July 1, 2016, we completed the acquisition of our external Manager, AMM, thereby internalizing our management, which lowers our operating costs and generates management fee income from managing MTGE.
appropriate.
Market Information
The following table summarizes interest rates and prices of generic fixed rate Agency RMBS as of each date presented below: | | Interest Rate/Security Price 1 | | Dec. 31, 2015 | | Mar. 31, 2016 | | June 30, 2016 | | Sept. 30, 2016 | | Dec. 31, 2016 | | Dec. 31, 2016 vs Dec. 31, 2015 | | Dec. 31, 2016 | | Mar. 31, 2017 | | June 30, 2017 | | Sept. 30, 2017 | | Dec. 31, 2017 | | Dec. 31, 2017 vs Dec. 31, 2016 |
| LIBOR: | | | | | | |
| 1-Month | | 0.43% | | 0.44% | | 0.47% | | 0.53% | | 0.77% | | +0.34 |
| bps | | 0.77% | | 0.98% | | 1.22% | | 1.23% | | 1.56% | | +0.79 |
| bps |
| 3-Month | | 0.61% | | 0.63% | | 0.65% | | 0.85% | | 1.00% | | +0.39 |
| bps | | 1.00% | | 1.15% | | 1.30% | | 1.33% | | 1.69% | | +0.69 |
| bps |
| 6-Month | | 0.85% | | 0.90% | | 0.92% | | 1.24% | | 1.31% | | +0.46 |
| bps | | 1.31% | | 1.42% | | 1.45% | | 1.51% | | 1.84% | | +0.53 |
| bps |
| U.S. Treasury Security Rate: | | | | | | |
| 2-Year U.S. Treasury | | 1.06% | | 0.73% | | 0.59% | | 0.76% | | 1.20% | | +0.14 |
| bps | | 1.20% | | 1.26% | | 1.38% | | 1.48% | | 1.89% | | +0.69 |
| bps |
| 3-Year U.S. Treasury | | 1.32% | | 0.86% | | 0.70% | | 0.87% | | 1.46% | | +0.14 |
| bps | | 1.46% | | 1.50% | | 1.55% | | 1.61% | | 1.98% | | +0.52 |
| bps |
| 5-Year U.S. Treasury | | 1.77% | | 1.22% | | 1.01% | | 1.15% | | 1.92% | | +0.15 |
| bps | | 1.92% | | 1.93% | | 1.89% | | 1.93% | | 2.21% | | +0.29 |
| bps |
| 10-Year U.S. Treasury | | 2.27% | | 1.78% | | 1.49% | | 1.61% | | 2.43% | | +0.16 |
| bps | | 2.43% | | 2.39% | | 2.30% | | 2.33% | | 2.41% | | -0.02 |
| bps |
| 30-Year U.S. Treasury | | 3.01% | | 2.62% | | 2.31% | | 2.33% | | 3.05% | | +0.04 |
| bps | | 3.05% | | 3.02% | | 2.84% | | 2.86% | | 2.74% | | -0.31 |
| bps |
| Interest Rate Swap Rate: | | | | | | |
| 2-Year Swap | | 1.17% | | 0.85% | | 0.74% | | 1.01% | | 1.46% | | +0.29 |
| bps | | 1.46% | | 1.62% | | 1.61% | | 1.73% | | 2.08% | | +0.62 |
| bps |
| 3-Year Swap | | 1.41% | | 0.96% | | 0.81% | | 1.07% | | 1.68% | | +0.27 |
| bps | | 1.68% | | 1.81% | | 1.74% | | 1.84% | | 2.17% | | +0.49 |
| bps |
| 5-Year Swap | | 1.73% | | 1.18% | | 0.99% | | 1.18% | | 1.96% | | +0.23 |
| bps | | 1.96% | | 2.06% | | 1.95% | | 2.00% | | 2.24% | | +0.28 |
| bps |
| 10-Year Swap | | 2.19% | | 1.64% | | 1.38% | | 1.46% | | 2.32% | | +0.13 |
| bps | | 2.32% | | 2.39% | | 2.27% | | 2.28% | | 2.40% | | +0.08 |
| bps |
| 30-Year Swap | | 2.62% | | 2.13% | | 1.84% | | 1.78% | | 2.57% | | -0.05 |
| bps | | 2.57% | | 2.65% | | 2.53% | | 2.52% | | 2.53% | | -0.04 |
| bps |
| 30-Year Fixed Rate Agency Price: | | | | | | |
| 3.0% | | $100.01 | | $102.59 | | $103.75 | | $103.95 | | $99.38 | | -$0.63 | | $99.38 | | $99.15 | | $99.88 | | $100.33 | | $100.02 | | +$0.64 |
| 3.5% | | $103.18 | | $104.86 | | $105.50 | | $105.53 | | $102.50 | | -$0.68 | | $102.50 | | $102.29 | | $102.70 | | $103.09 | | $102.70 | | +$0.20 |
| 4.0% | | $105.83 | | $106.86 | | $107.23 | | $107.41 | | $105.13 | | -$0.70 | | $105.13 | | $104.90 | | $105.12 | | $105.27 | | $104.59 | | -$0.54 |
| 4.5% | | $108.00 | | $108.82 | | $109.17 | | $109.52 | | $107.51 | | -$0.49 | | $107.51 | | $107.24 | | $107.27 | | $107.33 | | $106.40 | | -$1.11 |
| 15-Year Fixed Rate Agency Price: | | | | | | |
| 2.5% | | $100.80 | | $102.66 | | $103.48 | | $103.56 | | $100.20 | | -$0.60 | | $100.20 | | $100.03 | | $100.53 | | $100.69 | | $99.88 | | -$0.32 |
| 3.0% | | $103.02 | | $104.47 | | $104.84 | | $104.99 | | $102.62 | | -$0.40 | | $102.62 | | $102.51 | | $102.64 | | $102.75 | | $101.88 | | -$0.74 |
| 3.5% | | $104.72 | | $105.59 | | $105.97 | | $105.41 | | $104.17 | | -$0.55 | | $104.17 | | $104.06 | | $104.06 | | $104.14 | | $103.23 | | -$0.94 |
| 4.0% | | $104.41 | | $104.31 | | $103.81 | | $103.73 | | $102.69 | | -$1.72 | | $102.69 | | $103.29 | | $103.44 | | $103.13 | | $102.72 | | +$0.03 |
_______________________ | |
| 1. | Price information is for generic instruments only and is not reflective of our specific portfolio holdings. Price information is as of 3:00 p.m. (EST) on such date and can vary by source. Prices and interest rates in the table above were obtained from Barclays. LIBOR rates were obtained from Bloomberg. |
The following table summarizes the monthly weighted average actual one-month annualized constant prepayment rates on our investment portfolio during fiscal year 2016.
|
| | | | | | | | | | | | | | | | | | | | | | | | |
Annualized Monthly Constant Prepayment Rates 1 | | Jan. 2016 | | Feb. 2016 | | Mar. 2016 | | Apr. 2016 | | May 2016 | | June 2016 | | July 2016 | | Aug. 2016 | | Sep. 2016 | | Oct. 2016 | | Nov. 2016 | | Dec. 2016 |
| AGNC portfolio | | 10% | | 8% | | 9% | | 12% | | 11% | | 13% | | 14% | | 13% | | 16% | | 15% | | 14% | | 14% |
________________________
| |
1. | Weighted average actual one-month annualized CPR released at the beginning of the month based on securities held/outstanding as of the preceding month-end. |
FINANCIAL CONDITION
As of December 31, 20162017 and 2015,2016, our investment portfolio consisted of $46.557.1 billion and $52.546.5 billion of investment securities, at fair value, respectively, and an$15.7 billion and $11.2 billion and $7.4 billion net longof TBA position,securities, at fair value, respectively. The following table is a summary of our investment portfolio as of December 31, 20162017 and 20152016 (dollars in millions):
| | | | | December 31, 2016 | | December 31, 2015 | | December 31, 2017 | | December 31, 2016 |
| Investment Portfolio (Includes TBAs) | | Amortized Cost | | Fair Value | | Average Coupon | | % | | Amortized Cost | | Fair Value | | Average Coupon | | % | |
Investment Portfolio (Includes TBAs) 1 | | | Amortized Cost | | Fair Value | | Average Coupon | | % | | Amortized Cost | | Fair Value | | Average Coupon | | % |
| Fixed rate Agency RMBS and TBA securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| ≤ 15-year: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| ≤ 15-year RMBS | | $ | 12,794 |
| | $ | 12,867 |
| | 3.26 | % | | 22 | % | | $ | 16,725 |
| | $ | 16,865 |
| | 3.25 | % | | 28 | % | | $ | 8,951 |
| | $ | 8,933 |
| | 3.31 | % | | 12 | % | | $ | 12,794 |
| | $ | 12,867 |
| | 3.26 | % | | 22 | % |
| 15-year TBA securities | | 2,188 |
| | 2,172 |
| | 2.57 | % | | 4 | % | | 295 |
| | 293 |
| | 3.38 | % | | 1 | % | | 5,025 |
| | 5,015 |
| | 2.90 | % | | 7 | % | | 2,188 |
| | 2,172 |
| | 2.57 | % | | 4 | % |
| Total ≤ 15-year | | 14,982 |
| | 15,039 |
| | 3.16 | % | | 26 | % | | 17,020 |
| | 17,158 |
| | 3.25 | % | | 29 | % | | 13,976 |
| | 13,948 |
| | 3.16 | % | | 19 | % | | 14,982 |
| | 15,039 |
| | 3.16 | % | | 26 | % |
| 20-year RMBS | | 801 |
| | 817 |
| | 3.49 | % | | 1 | % | | 1,061 |
| | 1,088 |
| | 3.48 | % | | 2 | % | | 673 |
| | 687 |
| | 3.48 | % | | 1 | % | | 801 |
| | 817 |
| | 3.49 | % | | 1 | % |
| 30-year: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 30-year RMBS | | 31,553 |
| | 31,052 |
| | 3.63 | % | | 54 | % | | 32,790 |
| | 32,570 |
| | 3.70 | % | | 54 | % | | 45,853 |
| | 45,406 |
| | 3.72 | % | | 62 | % | | 31,553 |
| | 31,052 |
| | 3.63 | % | | 54 | % |
| 30-year TBA securities | | 9,124 |
| | 8,993 |
| | 3.58 | % | | 16 | % | | 7,135 |
| | 7,150 |
| | 3.34 | % | | 12 | % | | 10,714 |
| | 10,727 |
| | 3.40 | % | | 15 | % | | 9,124 |
| | 8,993 |
| | 3.58 | % | | 16 | % |
| Total 30-year | | 40,677 |
| | 40,045 |
| | 3.62 | % | | 70 | % | | 39,925 |
| | 39,720 |
| | 3.63 | % | | 66 | % | | 56,567 |
| | 56,133 |
| | 3.65 | % | | 77 | % | | 40,677 |
| | 40,045 |
| | 3.62 | % | | 70 | % |
| Total fixed rate Agency RMBS and TBA securities | | 56,460 |
| | 55,901 |
| | 3.49 | % | | 97 | % | | 58,006 |
| | 57,966 |
| | 3.52 | % | | 97 | % | | 71,216 |
| | 70,768 |
| | 3.55 | % | | 97 | % | | 56,460 |
| | 55,901 |
| | 3.49 | % | | 97 | % |
| Adjustable rate Agency RMBS | | 371 |
| | 379 |
| | 2.96 | % | | 1 | % | | 484 |
| | 495 |
| | 3.05 | % | | 1 | % | | 278 |
| | 283 |
| | 2.90 | % | | 1 | % | | 371 |
| | 379 |
| | 2.96 | % | | 1 | % |
| CMO Agency RMBS: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| CMO | | 796 |
| | 801 |
| | 3.41 | % | | 2 | % | | 973 |
| | 990 |
| | 3.40 | % | | 2 | % | | 629 |
| | 631 |
| | 3.43 | % | | 1 | % | | 796 |
| | 801 |
| | 3.41 | % | | 2 | % |
| Interest-only strips | | 132 |
| | 151 |
| | 5.03 | % | | — | % | | 152 |
| | 179 |
| | 5.28 | % | | — | % | | 101 |
| | 112 |
| | 4.39 | % | | — | % | | 132 |
| | 151 |
| | 5.03 | % | | — | % |
| Principal-only strips | | 136 |
| | 144 |
| | — | % | | — | % | | 165 |
| | 174 |
| | — | % | | — | % | | 112 |
| | 116 |
| | — | % | | — | % | | 136 |
| | 144 |
| | — | % | | — | % |
| Total CMO Agency RMBS | | 1,064 |
| | 1,096 |
| | 3.89 | % | | 2 | % | | 1,290 |
| | 1,343 |
| | 3.97 | % | | 2 | % | | 842 |
| | 859 |
| | 3.58 | % | | 1 | % | | 1,064 |
| | 1,096 |
| | 3.89 | % | | 2 | % |
| Total Agency RMBS and TBA securities | | 57,895 |
| | 57,376 |
| | 3.50 | % | | 100 | % | | 59,780 |
| | 59,804 |
| | 3.53 | % | | 100 | % | | 72,336 |
| | 71,910 |
| | 3.55 | % | | 99 | % | | 57,895 |
| | 57,376 |
| | 3.50 | % | | 100 | % |
| Non-Agency RMBS | | 102 |
| | 101 |
| | 3.42 | % | | — | % | | 114 |
| | 113 |
| | 3.50 | % | | — | % | | 7 |
| | 7 |
| | 2.50 | % | | — | % | | 102 |
| | 101 |
| | 3.42 | % | | — | % |
| CMBS | | 23 |
| | 23 |
| | 6.55 | % | | — | % | | — |
| | — |
| | — | % | | — | % | | 28 |
| | 29 |
| | 6.55 | % | | — | % | | 23 |
| | 23 |
| | 6.55 | % | | — | % |
| CRT | | 161 |
| | 164 |
| | 5.25 | % | | — | % | | — |
| | — |
| | — | % | | — | % | | 834 |
| | 876 |
| | 5.26 | % | | 1 | % | | 161 |
| | 164 |
| | 5.25 | % | | — | % |
| Total investment portfolio | | $ | 58,181 |
| | $ | 57,664 |
| | 3.51 | % | | 100 | % | | $ | 59,894 |
| | $ | 59,917 |
| | 3.53 | % | | 100 | % | | $ | 73,205 |
| | $ | 72,822 |
| | 3.57 | % | | 100 | % | | $ | 58,181 |
| | $ | 57,664 |
| | 3.51 | % | | 100 | % |
| |
| 1. | TBA securities are presented net of long and short positions. For further details of our TBA securities refer to Note 6 of the accompanying consolidated financial statements. |
Our TBA position issecurities are recorded as derivative instruments in our accompanying consolidated financial statements with theand our TBA dollar roll transactions representingrepresent a form of off-balance sheet financing. As of December 31, 20162017 and 2015,2016, our TBA positionpositions had a net carrying value of $(147)$3 million and $14$(147) million, respectively, reported in derivative assets/(liabilities)assets /(liabilities) on our accompanying consolidated balance sheets. The net carrying value represents the difference between the fair value of the underlying Agency security in the TBA contract and the cost basis or the forwardcontract price to be paid or received for the underlying Agency security.
As of December 31, 2017 and 2016, the weighted average yield on our investment securities (excluding TBA securities) was 2.89% and 2.77%, respectively.
The following tables summarize certain characteristics of our fixed rate Agency RMBS fixed rate portfolio, inclusive of our net TBA position,TBAs, as of December 31, 20162017 and 20152016 (dollars in millions):
| | | | | December 31, 2016 | | December 31, 2017 |
| | | Includes Net TBA Position | | Excludes Net TBA Position | | Includes Net TBA Position | | Excludes Net TBA Position |
| Fixed Rate Agency RMBS and TBA Securities | | Par Value | | Amortized Cost | | Fair Value | | % Lower Loan Balance & HARP 1,2 | | Amortized Cost Basis | | Weighted Average | | Projected Life CPR 4 | | Par Value | | Amortized Cost | | Fair Value | | % Lower Loan Balance & HARP 1,2 | | Amortized Cost Basis | | Weighted Average | | Projected Life CPR 4 |
| | WAC 3 | | Yield 4 | | Age (Months) | | WAC 3 | | Yield 4 | | Age (Months) |
| Fixed rate | | | | | | | | | | | | | | |
| ≤ 15-year | | | | | | | | | | | | | | |
| 2.5% | | $ | 4,877 |
| | $ | 4,945 |
| | $ | 4,912 |
| | 26% | | 101.7% | | 2.96% | | 2.05% | | 50 | | 9% | | $ | 3,041 |
| | $ | 3,061 |
| | $ | 3,046 |
| | 32% | | 101.2% | | 2.98% | | 2.13% | | 63 | | 9% |
| 3.0% | | 3,460 |
| | 3,561 |
| | 3,561 |
| | 73% | | 102.9% | | 3.50% | | 2.20% | | 55 | | 9% | | 5,616 |
| | 5,749 |
| | 5,724 |
| | 33% | | 102.8% | | 3.49% | | 2.18% | | 62 | | 10% |
| 3.5% | | 3,294 |
| | 3,408 |
| | 3,450 |
| | 90% | | 103.4% | | 3.95% | | 2.50% | | 63 | | 10% | | 2,710 |
| | 2,804 |
| | 2,804 |
| | 75% | | 103.5% | | 3.96% | | 2.42% | | 69 | | 11% |
| 4.0% | | 2,655 |
| | 2,766 |
| | 2,810 |
| | 89% | | 104.2% | | 4.40% | | 2.69% | | 72 | | 11% | | 2,054 |
| | 2,134 |
| | 2,145 |
| | 89% | | 103.9% | | 4.40% | | 2.68% | | 84 | | 11% |
| 4.5% | | 285 |
| | 298 |
| | 302 |
| | 98% | | 104.6% | | 4.87% | | 3.03% | | 76 | | 11% | | 215 |
| | 224 |
| | 225 |
| | 98% | | 104.3% | | 4.87% | | 3.01% | | 88 | | 12% |
| ≥ 5.0% | | 4 |
| | 4 |
| | 4 |
| | 22% | | 103.3% | | 6.63% | | 4.65% | | 112 | | 13% | | 4 |
| | 4 |
| | 4 |
| | 17% | | 102.8% | | 6.56% | | 4.47% | | 125 | | 44% |
| Total ≤ 15-year | | 14,575 |
| | 14,982 |
| | 15,039 |
| | 65% | | 103.1% | | 3.72% | | 2.37% | | 60 | | 10% | | 13,640 |
| | 13,976 |
| | 13,948 |
| | 51% | | 103.0% | | 3.77% | | 2.38% | | 70 | | 10% |
| 20-year | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| ≤ 3.0% | | 225 |
| | 223 |
| | 228 |
| | 31% | | 99.4% | | 3.55% | | 3.10% | | 43 | | 8% | | 195 |
| | 193 |
| | 198 |
| | 31% | | 99.4% | | 3.55% | | 3.10% | | 55 | | 9% |
| 3.5% | | 436 |
| | 445 |
| | 454 |
| | 75% | | 102.2% | | 4.06% | | 3.01% | | 46 | | 10% | | 365 |
| | 373 |
| | 380 |
| | 75% | | 102.1% | | 4.05% | | 3.00% | | 58 | | 11% |
| 4.0% | | 54 |
| | 57 |
| | 58 |
| | 50% | | 104.4% | | 4.54% | | 2.97% | | 64 | | 10% | | 45 |
| | 47 |
| | 48 |
| | 51% | | 104.2% | | 4.54% | | 2.96% | | 76 | | 11% |
| 4.5% | | 68 |
| | 73 |
| | 74 |
| | 99% | | 106.7% | | 4.90% | | 2.99% | | 73 | | 11% | | 55 |
| | 58 |
| | 59 |
| | 99% | | 106.5% | | 4.90% | | 2.95% | | 85 | | 11% |
| ≥ 5.0% | | 3 |
| | 3 |
| | 3 |
| | —% | | 106.3% | | 5.94% | | 3.33% | | 104 | | 17% | | 2 |
| | 2 |
| | 2 |
| | —% | | 106.0% | | 5.95% | | 3.32% | | 116 | | 17% |
| Total 20-year: | | 786 |
| | 801 |
| | 817 |
| | 63% | | 101.9% | | 4.03% | | 3.03% | | 49 | | 10% | | 662 |
| | 673 |
| | 687 |
| | 62% | | 101.8% | | 4.02% | | 3.02% | | 61 | | 10% |
| 30-year: | | | | | | | | | | | | | | |
| 3.0% | | 7,390 |
| | 7,482 |
| | 7,357 |
| | 20% | | 100.1% | | 3.57% | | 2.97% | | 26 | | 6% | | 7,583 |
| | 7,576 |
| | 7,592 |
| | 1% | | 100.2% | | 3.58% | | 2.96% | | 43 | | 6% |
| 3.5% | | 16,365 |
| | 17,227 |
| | 16,849 |
| | 72% | | 105.4% | | 4.07% | | 2.75% | | 38 | | 7% | | 24,045 |
| | 25,072 |
| | 24,800 |
| | 56% | | 104.6% | | 4.04% | | 2.84% | | 35 | | 7% |
| 4.0% | | 13,464 |
| | 14,368 |
| | 14,224 |
| | 61% | | 107.4% | | 4.51% | | 2.92% | | 45 | | 7% | | 21,015 |
| | 22,348 |
| | 22,166 |
| | 64% | | 106.5% | | 4.47% | | 2.99% | | 29 | | 9% |
| 4.5% | | 1,246 |
| | 1,341 |
| | 1,352 |
| | 87% | | 107.6% | | 4.97% | | 3.30% | | 67 | | 8% | | 1,271 |
| | 1,366 |
| | 1,369 |
| | 71% | | 107.4% | | 4.98% | | 3.18% | | 62 | | 10% |
| 5.0% | | 119 |
| | 127 |
| | 130 |
| | 65% | | 106.8% | | 5.45% | | 3.73% | | 104 | | 10% | | 97 |
| | 103 |
| | 104 |
| | 65% | | 106.6% | | 5.45% | | 3.69% | | 116 | | 10% |
| ≥ 5.5% | | 120 |
| | 132 |
| | 133 |
| | 38% | | 110.0% | | 6.20% | | 3.40% | | 122 | | 14% | | 92 |
| | 102 |
| | 102 |
| | 36% | | 110.0% | | 6.18% | | 3.34% | | 135 | | 14% |
| Total 30-year | | 38,704 |
| | 40,677 |
| | 40,045 |
| | 56% | | 105.4% | | 4.19% | | 2.86% | | 40 | | 7% | | 54,103 |
| | 56,567 |
| | 56,133 |
| | 52% | | 105.2% | | 4.23% | | 2.93% | | 34 | | 8% |
| Total fixed rate | | $ | 54,065 |
| | $ | 56,460 |
| | $ | 55,901 |
| | 58% | | 104.6% | | 4.05% | | 2.73% | | 46 | | 8% | | $ | 68,405 |
| | $ | 71,216 |
| | $ | 70,768 |
| | 52% | | 104.8% | | 4.15% | | 2.84% | | 40 | | 8% |
_______________________
| |
| 1. | Lower loan balance securities represent pools backed by an original loan balance of ≤ $150,000. Our lower loan balance securities had a weighted average original loan balance of $97,000 and $100,000$109,000 for 15-year and 30-year securities, respectively, as of December 31, 20162017. |
| |
| 2. | HARP securities are defined as pools backed by 100% refinance loans with LTV ≥ 80%. Our HARP securities had a weighted average LTV of 113%114% and 135%136% for 15-year and 30-year securities, respectively, as of December 31, 20162017. Includes $0.8 billion and $5.1 billion of 15-year and 30-year securities, respectively, with >105 LTV pools, which are not deliverable into TBA securities. |
| |
| 3. | WAC represents the weighted average coupon of the underlying collateral. |
| |
| 4. | Portfolio yield incorporates a projected life CPR assumption based on forward rate assumptions as of December 31, 20162017. |
| | | | | December 31, 2015 | | December 31, 2016 |
| | | Includes Net TBA Position | | Excludes Net TBA Position | | Includes Net TBA Position | | Excludes Net TBA Position |
| Fixed Rate Agency RMBS and TBA Securities | | Par Value | | Amortized Cost | | Fair Value | | % Lower Loan Balance & HARP 1,2 | | Amortized Cost Basis | | Weighted Average | | Projected Life CPR 4 | | Par Value | | Amortized Cost | | Fair Value | | % Lower Loan Balance & HARP 1,2 | | Amortized Cost Basis | | Weighted Average | | Projected Life CPR 4 |
| | WAC 3 | | Yield 4 | | Age (Months) | | WAC 3 | | Yield 4 | | Age (Months) |
| Fixed rate | | | | | | | | | | | | | | |
| ≤ 15-year | | | | | | | | | | | | | | |
| ≤ 2.5% | | $ | 4,162 |
| | $ | 4,238 |
| | $ | 4,221 |
| | 47% | | 101.8% | | 2.97% | | 2.04% | | 38 | | 8% | | $ | 4,877 |
| | $ | 4,945 |
| | $ | 4,912 |
| | 26% | | 101.7% | | 2.96% | | 2.05% | | 50 | | 9% |
| 3.0% | | 4,178 |
| | 4,307 |
| | 4,319 |
| | 73% | | 103.1% | | 3.50% | | 2.22% | | 43 | | 9% | | 3,460 |
| | 3,561 |
| | 3,561 |
| | 73% | | 102.9% | | 3.50% | | 2.20% | | 55 | | 9% |
| 3.5% | | 4,332 |
| | 4,489 |
| | 4,557 |
| | 88% | | 103.6% | | 3.95% | | 2.53% | | 51 | | 10% | | 3,294 |
| | 3,408 |
| | 3,450 |
| | 90% | | 103.4% | | 3.95% | | 2.50% | | 63 | | 10% |
| 4.0% | | 3,439 |
| | 3,591 |
| | 3,662 |
| | 89% | | 104.4% | | 4.40% | | 2.71% | | 60 | | 11% | | 2,655 |
| | 2,766 |
| | 2,810 |
| | 89% | | 104.2% | | 4.40% | | 2.69% | | 72 | | 11% |
| 4.5% | | 372 |
| | 390 |
| | 394 |
| | 98% | | 104.9% | | 4.87% | | 3.04% | | 64 | | 12% | | 285 |
| | 298 |
| | 302 |
| | 98% | | 104.6% | | 4.87% | | 3.03% | | 76 | | 11% |
| ≥ 5.0% | | 5 |
| | 5 |
| | 5 |
| | 28% | | 103.8% | | 6.51% | | 4.54% | | 97 | | 13% | | 4 |
| | 4 |
| | 4 |
| | 22% | | 103.3% | | 6.63% | | 4.65% | | 112 | | 13% |
| Total ≤ 15-year | | 16,488 |
| | 17,020 |
| | 17,158 |
| | 75% | | 103.2% | | 3.71% | | 2.38% | | 48 | | 10% | | 14,575 |
| | 14,982 |
| | 15,039 |
| | 65% | | 103.1% | | 3.72% | | 2.37% | | 60 | | 10% |
| 20-year | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| ≤ 3.0% | | 287 |
| | 285 |
| | 294 |
| | 28% | | 99.3% | | 3.55% | | 3.11% | | 31 | | 8% | | 225 |
| | 223 |
| | 228 |
| | 31% | | 99.4% | | 3.55% | | 3.10% | | 43 | | 8% |
| 3.5% | | 600 |
| | 613 |
| | 628 |
| | 64% | | 102.2% | | 4.05% | | 3.04% | | 33 | | 10% | | 436 |
| | 445 |
| | 454 |
| | 75% | | 102.2% | | 4.06% | | 3.01% | | 46 | | 10% |
| 4.0% | | 66 |
| | 69 |
| | 70 |
| | 48% | | 104.5% | | 4.54% | | 2.97% | | 52 | | 11% | | 54 |
| | 57 |
| | 58 |
| | 50% | | 104.4% | | 4.54% | | 2.97% | | 64 | | 10% |
| 4.5% | | 84 |
| | 90 |
| | 92 |
| | 99% | | 106.7% | | 4.90% | | 3.03% | | 61 | | 10% | | 68 |
| | 73 |
| | 74 |
| | 99% | | 106.7% | | 4.90% | | 2.99% | | 73 | | 11% |
| ≥ 5.0% | | 4 |
| | 4 |
| | 4 |
| | —% | | 106.1% | | 5.92% | | 3.35% | | 92 | | 18% | | 3 |
| | 3 |
| | 3 |
| | —% | | 106.3% | | 5.94% | | 3.33% | | 104 | | 17% |
| Total 20-year: | | 1,041 |
| | 1,061 |
| | 1,088 |
| | 56% | | 101.9% | | 4.03% | | 3.06% | | 37 | | 9% | | 786 |
| | 801 |
| | 817 |
| | 63% | | 101.9% | | 4.03% | | 3.03% | | 49 | | 10% |
| 30-year: | | | | | | | | | | | | | | |
| ≤ 3.0% | | 6,837 |
| | 6,852 |
| | 6,845 |
| | 2% | | 100.6% | | 3.59% | | 2.92% | | 31 | | 6% | | 7,390 |
| | 7,482 |
| | 7,357 |
| | 2% | | 100.1% | | 3.57% | | 2.97% | | 26 | | 6% |
| 3.5% | | 16,627 |
| | 17,383 |
| | 17,188 |
| | 51% | | 104.7% | | 4.09% | | 2.84% | | 26 | | 7% | | 16,365 |
| | 17,227 |
| | 16,849 |
| | 72% | | 105.4% | | 4.07% | | 2.75% | | 38 | | 7% |
| 4.0% | | 12,888 |
| | 13,733 |
| | 13,687 |
| | 57% | | 106.7% | | 4.54% | | 2.99% | | 29 | | 8% | | 13,464 |
| | 14,368 |
| | 14,224 |
| | 61% | | 107.4% | | 4.51% | | 2.92% | | 45 | | 7% |
| 4.5% | | 1,524 |
| | 1,629 |
| | 1,664 |
| | 87% | | 106.8% | | 4.96% | | 3.39% | | 55 | | 9% | | 1,246 |
| | 1,341 |
| | 1,352 |
| | 87% | | 107.6% | | 4.97% | | 3.30% | | 67 | | 8% |
| 5.0% | | 148 |
| | 158 |
| | 163 |
| | 66% | | 106.4% | | 5.45% | | 3.74% | | 92 | | 11% | | 119 |
| | 127 |
| | 130 |
| | 65% | | 106.8% | | 5.45% | | 3.73% | | 104 | | 10% |
| ≥ 5.5% | | 155 |
| | 170 |
| | 173 |
| | 38% | | 109.5% | | 6.20% | | 3.40% | | 109 | | 16% | | 120 |
| | 132 |
| | 133 |
| | 38% | | 110.0% | | 6.20% | | 3.40% | | 122 | | 14% |
| Total 30-year | | 38,179 |
| | 39,925 |
| | 39,720 |
| | 46% | | 105.2% | | 4.27% | | 2.93% | | 30 | | 8% | | 38,704 |
| | 40,677 |
| | 40,045 |
| | 56% | | 105.4% | | 4.19% | | 2.86% | | 40 | | 7% |
| Total fixed rate | | $ | 55,708 |
| | $ | 58,006 |
| | $ | 57,966 |
| | 55% | | 104.5% | | 4.08% | | 2.75% | | 36 | | 8% | | $ | 54,065 |
| | $ | 56,460 |
| | $ | 55,901 |
| | 58% | | 104.6% | | 4.05% | | 2.73% | | 46 | | 8% |
_______________ | |
| 1. | Lower loan balance securities represent pools backed by an original loan balance of ≤ $150,000. Our lower loan balance securities had a weighted average original loan balance of $97,000 and $98,000$100,000 for 15-year and 30-year securities, respectively, as of December 31, 2015.2016. |
| |
| 2. | HARP securities are defined as pools backed by 100% refinance loans with LTVs ≥ 80%. Our HARP securities had a weighted average LTV of 110%113% and 127%135% for 15-year and 30-year securities, respectively, as of December 31, 2015. Includes $0.9 billion and $4.0 billion of 15-year and 30-year securities, respectively, with >105 LTV pools which are not deliverable into TBA securities.2016. |
| |
| 3. | WAC represents the weighted average coupon of the underlying collateral. |
| |
| 4. | Portfolio yield incorporates a projected life CPR assumption based on forward rate assumptions as of December 31, 2015.2016. |
As of December 31, 2016 and 2015, the combined weighted average yield on our investment securities (excluding TBAs) was 2.77% and 2.78%, respectively.
Our pass-through Agency RMBS collateralized by adjustable rate mortgage loans, or ARMs, have coupons linked to various indices. As of December 31, 2016 and 2015, our ARM securities had a weighted average next reset date of 39 months and 46 months, respectively.
As of December 31, 20162017 and 2015,2016, our investments in CRT and non-Agency securities had the following credit ratings:
| | | | | December 31, 2016 | | December 31, 2015 | | December 31, 2017 | | December 31, 2016 |
Non-Agency Security Credit Ratings 1 | | CRT | | RMBS | | CMBS | | CRT | | RMBS | | CMBS | |
CRT and Non-Agency Security Credit Ratings 1 | | | CRT | | RMBS | | CMBS | | CRT | | RMBS | | CMBS |
| AAA | | $ | — |
| | $ | 99 |
| | $ | — |
| | $ | — |
| | $ | 113 |
| | $ | — |
| | $ | — |
| | $ | 7 |
| | $ | — |
| | $ | — |
| | $ | 99 |
| | $ | — |
|
| BBB | | — |
| | — |
| | 23 |
| | — |
| | — |
| | — |
| | 20 |
| | — |
| | 29 |
| | — |
| | — |
| | 23 |
|
| BB | | | 136 |
| | — |
| | — |
| | — |
| | — |
| | — |
|
| B | | 164 |
| | 2 |
| | — |
| | — |
| | — |
| | — |
| | 691 |
| | — |
| | — |
| | 164 |
| | 2 |
| | — |
|
| Not Rated | | | 29 |
| | — |
| | — |
| | — |
| | — |
| | — |
|
| Total | | $ | 164 |
| | $ | 101 |
| | $ | 23 |
| | $ | — |
| | $ | 113 |
| | $ | — |
| | $ | 876 |
| | $ | 7 |
| | $ | 29 |
| | $ | 164 |
| | $ | 101 |
| | $ | 23 |
|
________________________________________________________
| |
| 1. | Represents the lowest of Standard and Poor's ("S&P"), Moody's and Fitch credit ratings, stated in terms of the S&P equivalent rating as of each date. |
Our CRT securities reference the performance of loans that have been guaranteedunderlying Agency RMBS issued by Fannie Mae or Freddie Mac, which were subject to their underwriting standards. As of December 31, 2017, our CRT securities had floating rate coupons ranging from 3.9% to 8.5%, referenced to loans originated between 2012 and 2017 with weighted average coupons ranging from 3.6% to 4.4%. As of December 31, 2016, our CRT securities had floating rate coupons ranging from 4.6% to 7.1%, referenced to loans originated between 2015 and 2016 with weighted average coupons of underlying collateral ranging from 4.0% to 4.2%. The loans underlying our CRT securities were originated between 2015 and 2016.
SUMMARY OF CRITICAL ACCOUNTING ESTIMATES
Our critical accounting estimates relate to the recognition of interest income and the fair value of our investments and derivatives. Certain of these items involve estimates that require management to make judgments that are subjective in nature. We rely on our experience and analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. Under different conditions, we could report materially different amounts based on such estimates. The remainder of our significant accounting policies are described in Note 2 to the Consolidated Financial Statements included under Item 8 of this Annual Report on Form 10-K.
Interest Income
The effective yield on our Agency RMBS and non-Agency securities of high credit quality is highly impacted by our estimate of future prepayments. We accrue interest income based on the outstanding principal amount and their contractual terms and we amortize or accrete premiums and discounts associated with our purchase of these securities into interest income over thetheir projected lives, of the securities, includingtaking into account scheduled contractual payments and estimated prepayments, using the interest method. The weighted average cost basis of our securities as of December 31, 20162017 was 104.7%104.9% of par value; therefore, faster actual or projected prepayments can have a meaningful negative impact, while slower actual or projected prepayments can have a meaningful positive impact,could significantly reduce the yield on our asset yields.assets.
Future prepayment rates are difficult to predict and we rely on a third-party service provider and our experience and analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. We use aOur third-party service to provideprovider estimates for prepayment speeds using models that incorporate the forward yield curve, current mortgage rates, and mortgage rates ofon the outstanding loans, age and size of the outstanding loans, loan-to-value ratios, interest rate volatility and other factors. We review the prepayment speeds estimated by the third-party service and compare the results to market consensus prepayment speeds, if available. We also consider historical prepayment speeds and current market conditions to validate the reasonableness of the prepayment speeds estimated by the third-party serviceestimates and, based on our judgment, we may make adjustments to theiradjust the estimates.
We review our actual and anticipated prepayment experience on at least a quarterly basis and effective yields are recalculated when differences arise between (i) our previously estimated future prepayments and (ii) actual prepayments to date plusand current estimated future prepayments. If the actual and estimated future prepayment experience differs from our prior estimate of prepayments, we are required to record an adjustment in the current period to the amortization or accretion of premiums and discounts for the cumulative difference in the effective yield through the reporting date.
The most significant factor impacting prepayment rates on our securities is changes to long-term interest rates. Prepayment rates generally increase when interest rates fall and decrease when interest rates rise. However, there are a variety of other factors that may impact the rate of prepayments on our securities. Consequently, under different conditions, we could report materially different amounts. Item 7A. Quantitative and Qualitative Disclosures About Market Risk in this Form 10-K includes the estimated change in our net interest income should interest rates instantaneously go up or down by 50 and 100 basis points, assuming the yield curves of the rate shocks will be parallel to each other and the current yield curve.points.
At the time we purchase non-Agency securities that are not of high credit quality, we determine an effective interest rate based on our estimate of the timing and amount of cash flows and our cost basis. On at least a quarterly basis, we review the estimated cash flows and make appropriate adjustments, based on input and analysis received from external sources, internal models, and our judgment about interest rates, prepayment rates, the timing and amount of estimated credit losses, and other factors. Any resulting changes in effective yield are recognized prospectively based on the current amortized cost of the investment as adjusted for credit impairment, if any. Our cash flow estimates for these investments are based on our judgment and observations of current information and events. These estimates include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses. Furthermore, other market participants could use materially different assumptions with respect to default rates, severities, loss timing, or prepayments. Our assumptions are subject to future events that may impact our estimates and interest income, and as a result, actual results may differ significantly from these estimates.
Fair Value of Investment Securities
We estimate the fair value of our investment securities based on a market approach using "Level 2" inputs from third-party pricing services and non-binding dealer quotes derived from common market pricing methods. Such methods incorporate, but
are not limited to, reported trades and executable bid and ask prices for similar securities,securities; benchmark interest rate curves, such as the spread to the U.S. Treasury rate and interest rate swap curves,curves; convexity, duration and the underlying characteristics of the particular security, including coupon, periodic and life caps,caps; rate reset period, issuer,period; issuer; additional credit supportsupport; and expected life of the security. We generally obtain 3 to 6 quotes or prices (referred to as "marks") per security. We attempt to validate marks obtained from pricing services and broker dealersthese quotes by comparing them to our recent completed transactions involving the same or similar securities on or near the reporting date. Changes in the market environment and other events that may occur over the life of our investments may cause the gains or losses ultimately realized on these investments to be different from the valuations currently estimated.
We also evaluateAt the time we purchase a security, we either designate it as held-to-maturity, available-for-sale or trading (depending on our ability and intent to hold such security to maturity) or we elect the fair value option of accounting for such securities. All of our securities are reported at fair value as they have either been designated as available-for-sale or trading or we have elected the fair value option of accounting. Unrealized gains and losses on securities classified as available-for-sale are reported in accumulated
OCI. Unrealized gains and losses on securities classified as trading or for which we elected the fair value option are reported in net income through other gain (loss) during the period in which they occur. Prior to fiscal year 2017, we primarily designated our investment securities as available-for-sale. On January 1, 2017, we began electing the fair value option of accounting for all investment securities acquired after fiscal year 2016. In our view, this election simplifies the accounting for investment securities and more appropriately reflects the results of our operations for a reporting period, as the fair value changes for these assets are presented in a manner consistent with the presentation and timing of the fair value changes of our hedging instruments. We are not permitted to change the designation of securities acquired prior to January 1, 2017; accordingly, such securities will continue to be classified as available-for-sale securities until we receive full repayment of principal or we dispose of the security.
We evaluate securities classified as available-for-sale for other-than-temporary impairment ("OTTI") on at least a quarterly basis. The determination of whether a security is other-than-temporarily impaired may involve judgments and assumptions based on subjective and objective factors. When a security is impaired, an OTTI is considered to have occurred if any one of the following three conditions exists as of the financial reporting date: (i) we intend to sell the security (that is, a decision has been made to sell the security), (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis or (iii) we do not expect to recover the security's amortized cost basis, even if we do not intend to sell the security and it is not more likely than not that we will be required to sell the security. A general allowance for unidentified impairments in a portfolio of securities is not permitted.
If either of the first two conditions exists as of the financial reporting date, the entire amount of the impairment loss, if any, is recognized in earnings as a realized loss and the cost basis of the security is adjusted to its fair value. However, with respect to the first condition, since the liquidity of the Agency securities market allows us to obtain competitive bids and execute on a sale transaction typically within a day or two of making the decision to sell a security, we generally do not make decisions to sell specific mortgage securities until shortly prior to initiating a sell order. In some instances, we may sell specific Agency securities by delivering the securities into existing short TBA contracts. TBA market conventions require the identification of the specific securities to be delivered no later than 48 hours prior to settlement. If we settle a short TBA contract through the delivery of securities, we will generally identify the specific securities to be delivered within one to two days before the 48-hour deadline.
If the third condition exists, the OTTI is separated into (i) the amount relating to credit loss (the "credit component") and (ii) the amount relating to all other factors (the "non-credit components"). Only the credit component is recognized in earnings, with the non-credit components recognized in OCI. However, inIn evaluating if the third condition exists, our investments in Agency securities typically would not have a credit component since the principal and interest payments are guaranteed by a GSE or U.S. Government agency, and therefore, any unrealized loss is not the result of a credit loss. In addition, since unrealized gains and losses for securities designatedby their designation as available-for-sale are recognized in OCI,securities, any impairment loss for non-credit components is alreadycomponent would have been fully recognized in OCI.
Derivative Financial Instruments/Hedging Activity
We use a variety of derivative instruments to reducehedge a portion of our exposure to market risks, including interest rate, prepayment, extension and creditliquidity risks. OurThe objective of our risk management objectivestrategy is to reduce fluctuations in net assetbook value over a range of interest rate scenarios. In particular, we attempt to mitigate the risk of the cost of our variable rate liabilities increasing during a period of rising interest rates. The principalprimary instruments that we use are interest rate swaps, swaptions, U.S. Treasury securities and swaptions.U.S. Treasury futures contracts. We also utilizeuse TBA contracts for the forward purchase or sale of Agency RMBS securities on a generic pool basis and we utilize U.S. Treasury securities and U.S. Treasury futures contracts, primarily through short sales. We may also purchase or write put or call options on TBA securities and utilize other types of derivative instruments to hedge a portion of our risk.
RMBS.
We recognize all derivatives as either assets or liabilities on theour consolidated balance sheet,sheets, measured at fair value. Since discontinuing hedge accounting in 2011, weWe do not designate any of our derivative instruments as hedges for GAAP accounting purposes; therefore, all changes in thetheir fair value of our derivative instruments are reported in earnings in our consolidated statementstatements of comprehensive income in gain (loss) on derivatives and other securities, net during the period in which they occur.
The use of derivatives creates exposure to credit risk relating to potential losses that could be recognized in the event thatif the counterparties to these instruments fail to perform their obligations under the contracts. We attempt to minimize this risk by limiting our counterparties to major financial institutions with acceptable credit ratings, monitoring positions with individual counterparties and adjusting posted collateral as required.
We estimate the fair value of our derivative instruments using "Level 1" inputs from unadjusted quoted prices for identical instruments in active markets or "Level 2" inputs from third-party pricing services, non-binding dealer quotes and/or daily settlement prices from central clearing exchanges, which are derived from common market pricing methods. In considering the effect of nonperformance risk on our estimate of fair value, we consider the impact of netting and credit enhancements, such as collateral postings and guarantees, and have concluded that neither our own nor our counterparty risk is significant to the overall valuation of these agreements.
RESULTS OF OPERATIONS
Non-GAAP Financial Measures
In addition to the results presented in accordance with GAAP, our results of operations discussed below include certain non-GAAP financial information, including "adjusted net"economic interest income", "economic interest expense," "net spread and dollar roll income," "net spread and dollar roll income, excluding 'catch-up' premium amortization," "estimated taxable income" and the related per common share measures and certain financial metrics derived from such non-GAAP information, such as "cost of funds" and "net interest rate spread.margin."
"Adjusted netEconomic interest income" is measured as interest income (GAAP measure), adjusted to (i) exclude "catch-up" premium amortization associated with changes in CPR estimates and to (ii) include TBA dollar roll implied interest income. "Economic interest expense" is measured as interest expense (GAAP measure) adjusted to include otherTBA dollar roll implied interest expense and interest rate swap periodic costs. "Net spread and dollar roll income" is measured asincome, excluding "catch-up" premium amortization" includes (i) netthe components of economic interest income (GAAP measure) adjusted to include otherand economic interest rate swap periodic costs, TBA dollar roll income, management fee incomeexpense and dividends on REIT equity securities (referred to as "adjusted("adjusted net interest and dollar roll income"), less (ii) total operating expenses (GAAP measure), adjusted to exclude non-recurring transaction costs (referred to as "adjusted operating expenses"). "Net spread and dollar roll, net of management fee income excluding 'catch-up' premium amortization,(GAAP measure) ("other operating income (expense), net)." further excludes retrospective "catch-up" adjustments to premium amortization cost or benefit due to changes in projected CPR estimates.
By providing such measures, in addition to the related GAAP measures, we believe we give greater transparency into the information used by our management in its financial and operational decision-making. We also believe it is important for users of our financial information to consider information related to our current financial performance without the effects of certain measures that are not necessarily indicative of our current investment portfolio performance and operations.
Specifically, in the case of "adjusted net interest and dollar roll income," we believe the inclusion of TBA dollar roll income is meaningful as TBAs, which are accounted for under GAAP as derivative instruments with gains and losses recognized in other gain (loss) in our consolidated statement of operations,comprehensive income, are economically equivalent to holding and financing generic Agency RMBS using short-term repurchase agreements. Similarly, we believe that the inclusion of periodic interest rate swap settlements in such measure and in "adjusted net"economic interest expense," which are recognized under GAAP in other gain (loss),expense" is meaningful as interest rate swaps are the primary instrument we use to economically hedge against fluctuations in our borrowing costs and inclusion of all periodic interest rate swap settlement costsit is more indicative of our total cost of funds than interest expense alone. In the case of "economic interest income" and "net spread and dollar roll income, excluding 'catch-up' premium amortization," we believe the exclusion of "catch-up" adjustments to premium amortization cost or benefit is meaningful as it excludes the cumulative effect from prior reporting periods due to current changes in future prepayment expectations and, therefore, exclusion of such cost or benefit is more indicative of the current earnings potential of our investment portfolio. We also believe the exclusion of non-recurringissuance costs of redeemed preferred stock reported as a reduction to net income available to common stockholders under GAAP and transactions costs associated with our acquisition of AMM reported in general, administrative and other expense under GAAP is meaningful as they represent non-recurring transaction costs associated with our acquisition of AMM and are not representative of our ongoing operating costs. In the case of estimated taxable income, we believe it is meaningful information because it directly relates to the amount of dividends we are required to distribute in order to maintain our REIT qualification status.
However, because such measures are incomplete measures of our financial performance and involve differences from results computed in accordance with GAAP, they should be considered as supplementary to, and not as a substitute for, results computed in accordance with GAAP. In addition, because not all companies use identical calculations, our presentation of such non-GAAP measures may not be comparable to other similarly-titled measures of other companies. Furthermore, estimated taxable income can include certain information that is subject to potential adjustments up to the time of filing our income tax returns, which occurs after the end of our fiscal year.
FISCAL YEAR 20162017 COMPARED TO FISCAL YEAR 20152016
Economic Interest Income and Asset YieldYields
The following table summarizes our economic interest income (a non-GAAP measure) for fiscal years 20162017 and 20152016 (dollars in millions):, which includes the combination of interest income (a GAAP measure) on our holdings reported as investment securities on our consolidated balance sheets, adjusted to exclude estimated "catch-up" amortization adjustments due to changes in our CPR forecast, and implied interest income on our TBA securities:
|
| | | | | | | | | | | | | |
| | Fiscal Year 2016 | | Fiscal Year 2015 |
| | Amount | | Yield | | Amount | | Yield |
| Cash/coupon interest income | $ | 1,721 |
| | 3.64 | % | | $ | 1,874 |
| | 3.62 | % |
| Net premium amortization | (400 | ) | | (0.96 | )% | | (408 | ) | | (0.91 | )% |
| Interest income | $ | 1,321 |
| | 2.68 | % | | $ | 1,466 |
| | 2.71 | % |
| Weighted average actual portfolio CPR for securities held during the period | 12 | % | | | | 10 | % | | |
| Weighted average projected CPR for the remaining life of securities held as of period end | 8 | % | | | | 8 | % | | |
Average 30-year fixed rate mortgage rate as of period end 1 | 4.32 | % | | | | 4.01 | % | | |
| 10-year U.S. Treasury rate as of period end | 2.43 | % | | | | 2.27 | % | | |
|
| | | | | | | | | | | | | |
| | Fiscal Year 2017 | | Fiscal Year 2016 |
| | Amount | | Yield | | Amount | | Yield |
| Interest income: | | | | | | | |
| Cash/coupon interest income | $ | 1,671 |
| | 3.70 | % | | $ | 1,721 |
| | 3.64 | % |
| Net premium amortization | (378 | ) | | (0.97 | )% | | (400 | ) | | (0.96 | )% |
| Interest income (GAAP measure) | 1,293 |
| | 2.73 | % | | 1,321 |
| | 2.68 | % |
| Estimated "catch-up" premium amortization cost due to change in CPR forecast | 37 |
| | 0.08 | % | | 10 |
| | 0.02 | % |
| Interest income, excluding "catch-up" premium amortization cost | 1,330 |
| | 2.81 | % | | 1,331 |
| | 2.70 | % |
TBA dollar roll income - implied interest income 1,2 | 493 |
| | 2.92 | % | | 264 |
| | 2.56 | % |
| Economic interest income, excluding "catch-up" amortization (non-GAAP measure) | $ | 1,823 |
| | 2.84 | % | | $ | 1,595 |
| | 2.68 | % |
| | | | | | | | |
| Weighted average actual portfolio CPR for investment securities held during the period | 10.9 | % | | | | 12.3 | % | | |
| Weighted average projected CPR for the remaining life of investment securities held as of period end | 8.4 | % | | | | 8.0 | % | | |
Average 30-year fixed rate mortgage rate as of period end 3 | 3.99 | % | | | | 4.32 | % | | |
| 10-year U.S. Treasury rate as of period end | 2.41 | % | | | | 2.43 | % | | |
_______________________________________________________
| |
| 1. | Reported in gain (loss) on derivatives instruments and other securities, net in the accompanying consolidated statements of operations. |
| |
| 2. | TBA implied asset yield is derived from the Company's executed TBA roll levels and TBA delivery assumptions sourced from Barclays Bank, PLC,'s "Barclays Live" research application for the associated weighted average coupon, weighted average maturity, and 1-month projected CPR. Amount is gross of TBA implied funding cost. |
| |
| 3. | Source: Freddie Mac Primary Fixed Mortgage Rate Mortgage Market Survey |
The principal elements impacting our economic interest income are the size of our average investment portfolio and the yield on our investments.securities. The following is a summary of the estimated impact of each of these elements on the decrease inour economic interest income fromfor fiscal year 20152017, compared to 2016the prior year period (in millions):
|
| | | | | | | | | | | |
| Impact of Changes in the Principal Elements Impacting Interest Income |
| Fiscal Year 2016 vs. 2015 |
| | | | Due to Change in Average |
| | Total Increase / (Decrease) | | Portfolio Size | | Asset Yield |
| Interest Income | $ | (145 | ) | | $ | (129 | ) | | $ | (16 | ) |
|
| | | | | | | | | | | |
| Impact of Changes in the Principal Elements Impacting Economic Interest Income |
| Fiscal Year 2017 vs. 2016 |
| | | | Due to Change in Average |
| | Total Increase / (Decrease) | | Portfolio Size | | Asset Yield |
| Interest Income (GAAP measure) | $ | (28 | ) | | $ | (52 | ) | | $ | 24 |
|
| Estimated "catch-up" premium amortization cost due to change in CPR forecast | 27 |
| | — |
| | 27 |
|
| Interest income, excluding "catch-up" premium amortization cost | (1 | ) | | (52 | ) | | 51 |
|
| TBA dollar roll income - implied interest income | 229 |
| | 167 |
| | 62 |
|
| Economic interest income, excluding "catch-up" amortization (non-GAAP measure) | $ | 228 |
| | $ | 115 |
| | $ | 113 |
|
The size of our average investment portfolio decreased in par value, compared toincreased 8% (at cost) from the prior year period, by 9% for fiscal year 2016. The decline was largely due toconsisting of a relative shift from investments recognized4% decrease in holdings reported as investment securities on our consolidated financial statements to investmentsand a 63% increase in TBA contracts recognizedassets reported as derivative assets/(liabilities) on our consolidated financial statements and a declinebalance sheets. The overall increase in our stockholders'investment portfolio was primarily a function of new equity due to share repurchases and price declines on our portfolio, net of hedges.
Our average asset yield was down slightly at 2.68% for fiscal year 2016, compared to 2.71% for the prior year. Excluding "catch-up" premium amortization cost due to changesissuances during 2017. The increase in our projected CPR estimates, our average asset yield was 2.70%on our investment portfolio to 2.84% for fiscal year 2016, compared to 2.72%2017, from 2.68% for the prior year period. The yield decline in our average assetperiod, was largely due to changes in asset composition as we increased our portfolio composition.holdings of 30-year fixed rate securities relative to shorter duration assets.
Leverage
Our primary measuresmeasure of leverage are our "at risk" leverage andis our tangible net book value "at risk" leverage ratio. "AtTangible net book value "at risk" leverage is measured as the sum of our mortgage borrowings (consisting ofAgency repurchase agreements and other debt used to fund our investment securities ("Agency repo"), FHLB advances and debt of consolidated VIEs),our net TBA position (at cost) (together referred to as "mortgage borrowings") and our net receivable/payable for unsettled investment securities divided by the sum of our total stockholders' equity. Tangible net book value "at risk" leverage includes adjustmentsequity adjusted to exclude goodwill and other intangible assets net of accumulated amortization, related to our acquisition of AMM from stockholders' equity.on July 1, 2016.
We include our net TBA position in our measuresmeasure of leverage because a longforward contract to acquire Agency RMBS in the TBA positionmarket carries similar risks as if we had purchased the underlyingto Agency RMBS purchased in the cash market and funded the purchases with on-balance sheet funding liabilities. Similarly, a short TBA positioncontract for the forward sale of Agency securities has substantially the same effect as selling the underlying Agency RMBS and reducing our on-balance sheet funding commitments. (Refer to Liquidity and Capital Resources for further discussion of TBA securities and dollar roll positions)transactions). Repurchase agreements used to fund short-term investments in U.S. Treasury securities ("U.S. Treasury repo") are excluded from our measuresmeasure of leverage due to the temporary and highly liquid nature of these investments.
Our total "at risk" leverage was 7.1x and 6.8x our stockholders' equity as of December 31, 2016 and 2015, respectively. Our tangible net book value "at risk" leverage was 8.1x and 7.7x our tangible stockholders' equity as of December 31, 2016.2017 and 2016, respectively. The table below presents a summary of our average and quarter-end mortgage borrowings, net TBA position and leverage ratios for each of the three month periods listed below (dollars in millions):
| | | | | Mortgage Borrowings 1 | | Net TBA Position
Long/(Short) 2 | | Average Total
"At Risk" Leverage during the Period 3 | | Tangible Net Book Value Average Total "At Risk" Leverage during the Period 4 | | "At Risk" Leverage
as of
Period End 5 | | Tangible Net Book Value "At Risk" Leverage as of Period End 4 | | Agency Repurchase Agreements and Other Debt 1 | | Net TBA Position
Long/(Short) 2 | | Average Tangible Net Book Value "At Risk" Leverage during the Period 3 | | Average
"At Risk" Leverage during the Period 4 | | Tangible Net Book Value "At Risk" Leverage as of Period End 3 | | "At Risk" Leverage
as of
Period End 5 |
| Quarter Ended | | Average Daily Amount | | Maximum Daily Amount | | Ending Amount | | Average Daily Amount | | Ending Amount | | | Average Daily Amount | | Maximum Daily Amount | | Ending Amount | | Average Daily Amount | | Ending Amount | |
| December 31, 2017 | | | $ | 48,122 |
| | $ | 51,322 |
| | $ | 50,653 |
| | $ | 18,355 |
| | $ | 15,739 |
| | 8.1:1 | | 7.6:1 | | 8.1:1 | | 7.6:1 |
| September 30, 2017 | | | $ | 41,406 |
| | $ | 47,442 |
| | $ | 45,885 |
| | $ | 18,616 |
| | $ | 19,433 |
| | 7.9:1 | | 7.4:1 | | 8.0:1 | | 7.6:1 |
| June 30, 2017 | | | $ | 38,945 |
| | $ | 40,112 |
| | $ | 39,463 |
| | $ | 16,931 |
| | $ | 17,283 |
| | 8.0:1 | | 7.4:1 | | 8.1:1 | | 7.5:1 |
| March 31, 2017 | | | $ | 39,203 |
| | $ | 41,221 |
| | $ | 39,809 |
| | $ | 13,460 |
| | $ | 14,377 |
| | 7.8:1 | | 7.2:1 | | 8.0:1 | | 7.4:1 |
| December 31, 2016 | | $ | 41,031 |
| | $ | 42,157 |
| | $ | 41,183 |
| | $ | 14,141 |
| | $ | 11,312 |
| | 7.3:1 | | 7.8:1 | | 7.1:1 | | 7.7:1 | | $ | 41,031 |
| | $ | 42,157 |
| | $ | 41,183 |
| | $ | 14,141 |
| | $ | 11,312 |
| | 7.8:1 | | 7.3:1 | | 7.7:1 | | 7.1:1 |
| September 30, 2016 | | $ | 44,401 |
| | $ | 46,555 |
| | $ | 41,154 |
| | $ | 10,748 |
| | $ | 15,540 |
| | 7.1:1 | | 7.6:1 | | 7.2:1 | | 7.7:1 | | $ | 44,401 |
| | $ | 46,555 |
| | $ | 41,154 |
| | $ | 10,748 |
| | $ | 15,540 |
| | 7.6:1 | | 7.1:1 | | 7.7:1 | | 7.2:1 |
| June 30, 2016 | | $ | 46,948 |
| | $ | 48,875 |
| | $ | 45,502 |
| | $ | 8,238 |
| | $ | 6,975 |
| | 7.2:1 | | N/A | | 7.2:1 | | N/A | | $ | 46,948 |
| | $ | 48,875 |
| | $ | 45,502 |
| | $ | 8,238 |
| | $ | 6,975 |
| | N/A | | 7.2:1 | | N/A | | 7.2:1 |
| March 31, 2016 | | $ | 45,926 |
| | $ | 49,767 |
| | $ | 48,875 |
| | $ | 8,144 |
| | $ | 5,983 |
| | 7.0:1 | | N/A | | 7.3:1 | | N/A | | $ | 45,926 |
| | $ | 49,767 |
| | $ | 48,875 |
| | $ | 8,144 |
| | $ | 5,983 |
| | N/A | | 7.0:1 | | N/A | | 7.3:1 |
| December 31, 2015 | | $ | 47,018 |
| | $ | 50,078 |
| | $ | 46,077 |
| | $ | 7,796 |
| | $ | 7,430 |
| | 6.8:1 | | N/A | | 6.8:1 | | N/A | |
| September 30, 2015 | | $ | 43,308 |
| | $ | 46,049 |
| | $ | 44,683 |
| | $ | 9,434 |
| | $ | 7,265 |
| | 6.2:1 | | N/A | | 6.8:1 | | N/A | |
| June 30, 2015 | | $ | 50,410 |
| | $ | 55,097 |
| | $ | 45,860 |
| | $ | 5,973 |
| | $ | 7,104 |
| | 6.2:1 | | N/A | | 6.1:1 | | N/A | |
| March 31, 2015 | | $ | 53,963 |
| | $ | 58,217 |
| | $ | 55,056 |
| | $ | 6,957 |
| | $ | 4,815 |
| | 6.5:1 | | N/A | | 6.4:1 | | N/A | |
_______________________
| |
| 1. | Mortgage borrowingsOther debt includes Agency repo, FHLB advances and debt of consolidated VIEs. Amounts exclude U.S. Treasury repo agreements. |
| |
| 2. | Daily average and ending net TBA position outstanding measured at cost. |
| |
| 3. | Average "at risk" leverage during the period was calculated by dividing the sum of our daily weighted average mortgage borrowings outstanding and our daily weighted average net TBA position (at cost) during the period by the sum of our average month-end stockholders' equity less our average investment in REIT equity securities for the period. |
| |
4. | Tangible net book value "at risk" leverage includes the components of "at risk" leverage with stockholders' equity adjusted to exclude goodwill and other intangible assets, net. |
| |
| 4. | Average "at risk" leverage during the period was calculated by dividing the sum of our daily weighted average mortgage borrowings outstanding during the period by the sum of our average month-ended stockholders' equity less our average investment in REIT equity securities for the period. |
| |
| 5. | "At risk" leverage as of period end wasis calculated by dividing the sum of the amount ofour mortgage borrowings outstanding net payables and receivablesour receivable/payable for unsettled investment securities and the cost basis (or contract price)as of our net TBA positionperiod end (at cost) by the sum of our total stockholders' equity less the fair value of our investmentinvestments in REIT equity securities at period end. Leverage excludes U.S. Treasury repo agreements. |
Economic Interest Expense and Aggregate Cost of Funds
OurThe following table summarizes our economic interest expense is comprisedand aggregate cost of funds (non-GAAP measures) for fiscal years 2017 and 2016 (dollars in millions), which includes the combination of interest expense on our mortgage borrowings (primarily comprised of Agency repo)repurchase agreements and the reclassification of accumulated OCI into interest expense related to previously de-designated interest rate swaps. Upon our election to discontinue hedge accounting under GAAP as of September 30, 2011, the net deferred loss related to our de-designated interest rate swaps remained in accumulated OCI and has been reclassified from accumulated OCI intoother debt (GAAP measure), implied interest expense on a straight-line basis over the remaining term of eachour TBA securities and periodic interest rate swap through fiscal year 2016.
Our "adjusted net interest expense," also referred to as our "cost of funds" when stated as a percentage of our mortgage borrowings outstanding, includes periodic interest costs on our interest rate swaps reported in gain/loss on derivative instruments and other securities, net in our consolidated statements of comprehensive income. Our cost of funds does not include swap termination fees, forward starting swaps and costs associated with our other supplemental hedges, such as swaptions and U.S. Treasury positions. Our cost of funds also does not include the implied financing cost of our net TBA dollar roll position, although it includes interest rate swap hedge costs related to our TBA dollar roll funded assets. Consequently, our cost of funds measured as a percentage of our outstanding mortgage borrowings is higher than if we allocated a portion of our swap hedge costs to our TBA dollar roll funded assets.
Our average cost of funds declined to 1.45% for fiscal year 2016, compared to 1.49% for the prior year period. The table below presents a reconciliation of our interest expense (the most comparable GAAP financial measure) to our adjusted net interest expense and cost of funds (non-GAAP financial measures) for fiscal years 2016 and 2015 (dollars in millions):
costs:
|
| | | | | | | | | | | | | | |
| | | Fiscal Year 2016 | | Fiscal Year 2015 |
| Adjusted Net Interest Expense and Cost of Funds | | Amount | | % 1 | | Amount | | % 1 |
| Interest expense: | | | | | | | | |
| Interest expense on mortgage borrowings | | $ | 355 |
| | 0.79 | % | | $ | 229 |
| | 0.47 | % |
| Periodic interest costs of interest rate swaps previously designated as hedges under GAAP, net | | 39 |
| | 0.09 | % | | 101 |
| | 0.21 | % |
| Total interest expense | | 394 |
| | 0.88 | % | | 330 |
| | 0.68 | % |
| Other periodic interest costs of interest rate swaps, net | | 255 |
| | 0.57 | % | | 393 |
| | 0.81 | % |
| Total adjusted net interest expense and cost of funds | | $ | 649 |
| | 1.45 | % | | $ | 723 |
| | 1.49 | % |
|
| | | | | | | | | | | | | | |
| | | Fiscal Year 2017 | | Fiscal Year 2016 |
Economic Interest Expense and Aggregate Cost of Funds 1 | | Amount | | Cost of Funds | | Amount | | Cost of Funds |
| Interest expense: | | | | | | | | |
| Repurchase agreements and other debt interest expense | | $ | 524 |
| | 1.25 | % | | $ | 355 |
| | 0.79 | % |
| Periodic interest costs of interest rate swaps previously designated as hedges under GAAP, net | | — |
| | — | % | | 39 |
| | 0.09 | % |
| Interest expense (GAAP measure) | | 524 |
| | 1.25 | % | | 394 |
| | 0.80 | % |
TBA dollar roll income - implied interest expense 2 | | 164 |
| | 0.97 | % | | 48 |
| | 0.47 | % |
| Economic interest expense - before interest rate swap costs | | 688 |
| | 1.17 | % | | 442 |
| | 0.73 | % |
Periodic interest costs of interest rate swaps reported in gain (loss) on derivative instruments and other securities, net 3 | | 127 |
| | 0.22 | % | | 255 |
| | 0.54 | % |
| Total economic interest expense (non-GAAP measure) | | $ | 815 |
| | 1.39 | % | | $ | 697 |
| | 1.27 | % |
_______________________________________________________
| |
| 1. | PercentAmounts exclude interest rate swap termination fees and variation margin settlements paid or received, forward starting swaps or the impact of other supplemental hedges, such as swaptions and U.S. Treasury positions. |
| |
| 2. | Reported in gain (loss) on derivative instruments and other securities, net in our consolidated statements of comprehensive income. TBA implied interest expense is derived from the Company's executed TBA roll levels and TBA delivery assumptions sourced from Barclays Bank, PLC,'s "Barclays Live" research application for the associated weighted average coupon, weighted average maturity, and 1-month projected CPR. Amount is gross of TBA implied interest income. |
| |
| 3. | Interest rate swap cost of funds measured as a percent of average mortgage borrowings outstanding for the period. |
The principal elements impacting our adjusted neteconomic interest expense are (i) the size of our average mortgage borrowings and interest rate swap portfolio outstanding during the period, the size of our average interest rate swap balance outstanding (excluding forward starting swaps),(ii) the average interest rate on our mortgage borrowings and (iii) the average net payinterest rate paid/received on our pay-fixed receive-floating interest rate swaps. The following is a summary of the estimated impact of each of these elements impacting the decrease inon our adjusted neteconomic interest expense for fiscal year 2016,2017, compared to the prior year period (in millions):
|
| | | | | | | | | | | |
| Impact of Changes in the Principal Elements of Adjusted Net Interest Expense |
| Fiscal Year 2016 vs. 2015 |
| | | | Due to Change in Average |
| | Total Increase / (Decrease) | | Borrowing / Swap Balance | | Borrowing / Swap Rate |
| Interest expense on mortgage borrowings | $ | 126 |
| | $ | (21 | ) | | $ | 147 |
|
Periodic interest rate swap costs 1 | (200 | ) | | (23 | ) | | (177 | ) |
| Total change in adjusted net interest expense | $ | (74 | ) | | $ | (44 | ) | | $ | (30 | ) |
_______________________
| |
1. | Includes amounts recognized in interest expense and in gain (loss) on derivatives and other securities, net in our consolidated statements of comprehensive income. The change due to interest rate reflects the net impact of the change in the weighted average fixed pay and variable receive rates. |
|
| | | | | | | | | | | |
| Impact of Changes in the Principal Elements of Economic Interest Expense |
| Fiscal Year 2017 vs. 2016 |
| | | | Due to Change in Average |
| | Total Increase / (Decrease) | | Borrowing / Swap Balance | | Borrowing / Swap Rate |
Repurchase agreements and other debt interest expense
| $ | 169 |
| | $ | (21 | ) | | $ | 190 |
|
| TBA dollar roll income - implied interest expense | 116 |
| | 30 |
| | 86 |
|
| Periodic interest rate swap costs | (167 | ) | | 33 |
| | (200 | ) |
| Total change in economic interest expense | $ | 118 |
| | $ | 42 |
| | $ | 76 |
|
The average interest rate on our mortgage borrowings increased for fiscal year 2016 by 32 bps, which was largely a function of Fed Funds rate increases in December of 2015 and 2016. The size of our average borrowings outstanding decreased 8% for the year, which was2017 largely due to increases in the combinationFederal funds rate, which were partly offset by the benefit of shifting a larger portion of our total Agency repo funding through our captive broker-dealer subsidiary, BES, and a larger relative shift from Agency RMBS toportion of our overall mortgage funding into TBA holdings and portfolio adjustmentsdollar roll positions, which had a lower implied funding cost than traditional repo funding. The decrease in our periodic swap costs was due to the decline in our average shareholders' equity. As shownan increase in the tables below, the size of our interestfloating rate swap portfolio increased relative to our mortgage borrowings, but decreased overall in both absolute dollar terms and relative to the combined total of our mortgage borrowings and TBA securities outstanding during the year. We generally ran a lower interest rate hedge ratio though-out much of 2016, compared to the prior year, before increasing our hedge ratio during the fourth quarter of 2016. The decline in the average net pay ratereceived on our pay-fixed receive-floating interest rate swaps, waspartly offset by a function of both a lower average pay-fixedlarger interest rate and a higher average receive-floating rate.swap balance relative to our total mortgage borrowings.
The table below presents a summary of our average mortgage borrowings andthe ratio of our average interest rates swaps outstanding, excluding forward starting swaps, to our average mortgage borrowings for fiscal years 20162017 and 20152016 (dollars in millions):
|
| | | | | | | | |
| | | Fiscal Year |
| Average Ratio of Interest Rate Swaps Outstanding (Excluding Forward Starting Swaps) to Mortgage Borrowings Outstanding | | 2016 | | 2015 |
| Average mortgage borrowings | | $ | 44,566 |
| | $ | 48,641 |
|
| Average notional amount of interest rate swaps (excluding forward starting swaps) | | $ | 33,541 |
| | $ | 35,220 |
|
| Average ratio of interest rate swaps to mortgage borrowings | | 75 | % | | 72 | % |
| | | | | |
| Weighted average pay rate on interest rate swaps | | 1.56 | % | | 1.68 | % |
| Weighted average receive rate on interest rate swaps | | (0.69 | )% | | (0.28 | )% |
| Weighted average net pay rate on interest rate swaps | | 0.87 | % | | 1.40 | % |
|
| | | | | | | | |
| | | Fiscal Year |
| Average Ratio of Interest Rate Swaps (Excluding Forward Starting Swaps) to Mortgage Borrowings Outstanding | | 2017 | | 2016 |
| Average Agency repo and other debt outstanding | | $ | 41,942 |
| | $ | 44,566 |
|
| Average net TBA portfolio outstanding - at cost | | $ | 16,859 |
| | $ | 10,329 |
|
| Average mortgage borrowings outstanding | | $ | 58,801 |
| | $ | 54,895 |
|
| Average notional amount of interest rate swaps outstanding (excluding forward starting swaps) | | $ | 37,331 |
| | $ | 33,541 |
|
| Ratio of average interest rate swaps to mortgage borrowings outstanding | | 63 | % | | 61 | % |
| | | | | |
| Average interest rate swap pay-fixed rate (excluding forward starting swaps) | | 1.55 | % | | 1.56 | % |
| Average interest rate swap receive-floating rate | | (1.21 | )% | | (0.69 | )% |
| Average interest rate swap net pay/(receive) rate | | 0.34 | % | | 0.87 | % |
For the fiscal year endedyears 2017 and 2016, we had an average forward starting swap balance of $2.4 billion and $4.8 billion, of forward starting interest rate swaps outstanding, compared to $10.2 billion for the prior year period.respectively. Forward starting interest rate swaps do not impact our adjusted neteconomic interest expense and aggregate cost of funds until they commence accruing net interest settlements on their forward start dates. We enter into forward starting interest rate swaps based on a variety of factors, including our view of the forward yield curve and the timing of potential changes in short-term interest rates, time to deploy new capital, amount and timing of expirations of our existing interest rate swap portfolio, current and anticipated swap spreads and our desire to mitigate our exposure to specific sectors of the yield curve.
Including forward starting swaps, and our net TBA position, our average ratio of interest rate swaps outstanding to our average mortgage borrowings and net TBA position (at cost) was 70% for fiscal yearyears 2017 and 2016 compared to 81%was 68% and 70%, respectively.
Net Interest Margin
The following table presents a summary of our net interest margin, including the impact of TBA dollar roll income and interest rate swap costs and excluding "catch-up" premium amortization for fiscal year 2015.years 2017 and 2016:
|
| | | | | | | | |
| | | Fiscal Year |
| Average Ratio of Interest Rate Swaps Outstanding (Including Forward Starting Swaps) to Mortgage Borrowings and Net TBA Position | | 2016 | | 2015 |
| Average mortgage borrowings | | $ | 44,566 |
| | $ | 48,641 |
|
| Average net TBA position - at cost | | 10,329 |
| | 7,547 |
|
| Total average mortgage borrowings and net TBA position | | $ | 54,895 |
| | $ | 56,188 |
|
| Average notional amount of interest rate swaps (including of forward starting swaps) | | $ | 38,362 |
| | $ | 45,446 |
|
| Average ratio of interest rate swaps to mortgage borrowings and net TBA position | | 70 | % | | 81 | % |
|
| | | | | | |
| | | Fiscal Year |
| | | 2017 | | 2016 |
| Investment and TBA securities - average asset yield, excluding "catch-up" premium amortization | | 2.84 | % | | 2.68 | % |
| Investment and TBA securities - average aggregate cost of funds | | (1.39 | )% | | (1.27 | )% |
| Investment and TBA securities - average net interest margin, excluding "catch-up" premium amortization | | 1.45 | % | | 1.41 | % |
Net Spread and Dollar Roll Income
The following table below presents a reconciliationsummary of our net interest income (the most comparable GAAP financial measure) to our net spread and dollar roll income and to our net spread and dollar roll income, excluding estimated "catch-up" premium amortization, cost, (non-GAAPper diluted common share (a non-GAAP financial measures)measure) and a reconciliation to our net interest income (the most comparable GAAP financial measure) for fiscal years 20162017 and 20152016 (dollars in millions):
|
| | | | | | | | |
| | | Fiscal Year |
| | | 2016 | | 2015 |
| Net interest income | | $ | 927 |
| | $ | 1,136 |
|
Other periodic interest costs of interest rate swaps, net 1 | | (255 | ) | | (393 | ) |
TBA dollar roll income 1 | | 216 |
| | 237 |
|
| Management fee income | | 8 |
| | — |
|
Dividend from REIT equity securities 1 | | 2 |
| | 6 |
|
| Adjusted net interest and dollar roll income | | 898 |
| | 986 |
|
| Operating expenses: | | | | |
| Total operating expenses | | 105 |
| | 139 |
|
| Non-recurring transaction costs | | (9 | ) | | — |
|
| Adjusted operating expenses | | 96 |
| | 139 |
|
| Net spread and dollar roll income | | 802 |
| | 847 |
|
| Dividend on preferred stock | | 28 |
| | 28 |
|
| Net spread and dollar roll income available to common stockholders | | 774 |
| | 819 |
|
| Estimated "catch-up" premium amortization cost due to change in CPR forecast | | 10 |
| | 1 |
|
| Net spread and dollar roll income, excluding "catch-up" premium amortization, available to common stockholders | | $ | 784 |
| | $ | 820 |
|
| | | | | |
| Weighted average number of common shares outstanding - basic and diluted | | 331.9 |
| | 348.6 |
|
| Net spread and dollar roll income per common share - basic and diluted | | $ | 2.33 |
| | $ | 2.35 |
|
| Net spread and dollar roll income, excluding "catch-up" premium amortization, per common share - basic and diluted | | $ | 2.36 |
| | $ | 2.35 |
|
|
| | | | | | | | |
| | | Fiscal Year |
| | | 2017 | | 2016 |
| Net interest income (GAAP measure) | | $ | 769 |
| | $ | 927 |
|
TBA dollar roll income, net 1 | | 329 |
| | 216 |
|
Periodic interest costs of interest rate swaps, net 1 | | (127 | ) | | (255 | ) |
Dividend income from REIT equity securities 1 | | 1 |
| | 2 |
|
| Adjusted net interest and dollar roll income | | 972 |
| | 890 |
|
| Other operating income (expense): | | | | |
| Management fee income | | 13 |
| | 8 |
|
| Operating expenses | | (70 | ) | | (105 | ) |
| Non-recurring transaction costs | | — |
| | 9 |
|
| Adjusted operating income (expense), net | | (57 | ) | | (88 | ) |
| Net spread and dollar roll income | | 915 |
| | 802 |
|
| Dividend on preferred stock | | 32 |
| | 28 |
|
| Net spread and dollar roll income available to common stockholders (non-GAAP measure) | | 883 |
| | 774 |
|
| Estimated "catch-up" premium amortization cost due to change in CPR forecast | | 37 |
| | 10 |
|
| Net spread and dollar roll income, excluding "catch-up" premium amortization, available to common stockholders (non-GAAP measure) | | $ | 920 |
| | $ | 784 |
|
| | | | | |
| Weighted average number of common shares outstanding - basic | | 358.6 |
| | 331.9 |
|
| Weighted average number of common shares outstanding - diluted | | 358.7 |
| | 331.9 |
|
| Net spread and dollar roll income per common share - basic | | $ | 2.46 |
| | $ | 2.33 |
|
| Net spread and dollar roll income per common share - diluted | | $ | 2.46 |
| | $ | 2.33 |
|
| Net spread and dollar roll income, excluding "catch-up" premium amortization, per common share - basic | | $ | 2.57 |
| | $ | 2.36 |
|
| Net spread and dollar roll income, excluding "catch-up" premium amortization, per common share - diluted | | $ | 2.56 |
| | $ | 2.36 |
|
_______________________
| |
| 1. | Reported in gain (loss) on derivative instruments and other securities, net in our consolidated statements of comprehensive income |
Net spread and dollar roll income, excluding "catch-up" premium amortization adjustments, for fiscal year 2016 was largely unchanged at $2.362017 increased $0.20 per diluted common share, or 8%, to $2.56 per diluted common share, compared to $2.35$2.36 per diluted common share for the prior year period, as the decline in our interest and TBA dollar roll incomeperiod. The increase was largely offset by the decline in our funding costs, net of interest rate swap hedges, and lower operating costsdue to a larger asset base as a function of new equity issuances during 2017 and lower net operating expenses following our management internalization at the start of the third quarter.
Our average net interest rate spread and dollar roll income (i.e., the difference between the average yield on our assets and our average cost of funds inclusive of TBAs), excluding catch-up premium amortization cost, was 1.41% for fiscal year 2016,
compared to 1.48% for the prior year period. Including catch-up premium amortization adjustments, our net interest rate spread and dollar roll income was 1.39% for fiscal year 2016, compared to 1.48%, respectively.July 1, 2016.
Gain (Loss) on Sale of Investment Securities, Net
The following table is a summary of our net gain (loss) on sale of investment securities for fiscal years 20162017 and 20152016 (in millions):
| | | | Fiscal Year | Fiscal Year |
| | 2016 | | 2015 | 2017 | | 2016 |
| Investment securities sold, at cost | $ | (17,907 | ) | | $ | (27,578 | ) | $ | (19,237 | ) | | $ | (17,907 | ) |
Proceeds from sale 1 | 18,016 |
| | 27,555 |
| |
| Sale proceeds | | 19,174 |
| | 18,016 |
|
| Net gain (loss) on sale of investment securities | $ | 109 |
| | $ | (23 | ) | $ | (63 | ) | | $ | 109 |
|
| | | | | | | |
| Gross gain on sale of investment securities | $ | 123 |
| | $ | 98 |
| $ | 64 |
| | $ | 123 |
|
| Gross loss on sale of investment securities | (14 | ) | | (121 | ) | (127 | ) | | (14 | ) |
| Net gain (loss) on sale of investment securities | $ | 109 |
| | $ | (23 | ) | $ | (63 | ) | | $ | 109 |
|
_______________________
| |
1. | Proceeds include cash received during the period, plus receivable for investment securities sold during the period as of period end. |
Gain (Loss) on Derivative Instruments and Other Securities, Net
The following table is a summary of our gain (loss) on derivative instruments and other securities, net for fiscal years 20162017 and 20152016 (in millions):
| | | | Fiscal Year | Fiscal Year |
| | 2016 | | 2015 | 2017 | | 2016 |
| Periodic interest costs of interest rate swaps, net | $ | (255 | ) | | $ | (393 | ) | $ | (127 | ) | | $ | (255 | ) |
| Realized gain (loss) on derivative instruments and other securities, net: | | | | | | |
| TBA securities - dollar roll income, net | 216 |
| | 237 |
| 329 |
| | 216 |
|
| TBA securities - mark-to-market net gain (loss) | (114 | ) | | 246 |
| |
| TBA securities - mark-to-market net loss | | (150 | ) | | (114 | ) |
| Payer swaptions | (30 | ) | | (77 | ) | (13 | ) | | (30 | ) |
| Receiver swaptions | — |
| | 15 |
| |
| U.S. Treasury securities - long position | 7 |
| | (33 | ) | 1 |
| | 7 |
|
| U.S. Treasury securities - short position | (85 | ) | | (72 | ) | (68 | ) | | (85 | ) |
| U.S. Treasury futures - short position | (12 | ) | | (21 | ) | (9 | ) | | (12 | ) |
| Interest rate swap termination fees | (1,145 | ) | | (327 | ) | |
| Interest rate swaps - termination fees and variation margin settlements, net | | 378 |
| | (1,145 | ) |
| REIT equity securities | — |
| | 4 |
| 1 |
| | — |
|
| Other | 8 |
| | 1 |
| 3 |
| | 8 |
|
| Total realized loss on derivative instruments and other securities, net | (1,155 | ) | | (27 | ) | |
| Total realized gain (loss) on derivative instruments and other securities, net | | 472 |
| | (1,155 | ) |
| Unrealized gain (loss) on derivative instruments and other securities, net: | | | | | | |
| TBA securities - mark-to-market net gain (loss) | (161 | ) | | (178 | ) | 151 |
| | (161 | ) |
| Interest rate swaps | 1,003 |
| | (212 | ) | (184 | ) | | 1,003 |
|
| Payer swaptions | 27 |
| | 42 |
| (53 | ) | | 27 |
|
| Receiver swaptions | — |
| | (11 | ) | |
| U.S. Treasury securities - long position | — |
| | (5 | ) | |
| U.S. Treasury securities - short position | 219 |
| | 4 |
| (73 | ) | | 219 |
|
| U.S. Treasury futures - short position | 7 |
| | 9 |
| 9 |
| | 7 |
|
| Debt of consolidated VIEs | (3 | ) | | 16 |
| (2 | ) | | (3 | ) |
| REIT equity securities | 9 |
| | (9 | ) | — |
| | 9 |
|
| Other | (1 | ) | | — |
| — |
| | (1 | ) |
| Total unrealized gain (loss) on derivative instruments and other securities, net | 1,100 |
| | (344 | ) | (152 | ) | | 1,100 |
|
| Total loss on derivative instruments and other securities, net | $ | (310 | ) | | $ | (764 | ) | |
| Total gain (loss) on derivative instruments and other securities, net | | $ | 193 |
| | $ | (310 | ) |
For further details regarding our use of derivative instruments and related activity refer to Notes 2 and 5 of our Consolidated Financial Statements in this Form 10-K.
Operating Expenses
The following table includes a summary of our operating expenses for fiscal years 2017 and 2016 (dollars in millions):
|
| | | | | | | |
| | Fiscal Year |
| | 2017 | | 2016 |
| Management fee expense | $ | — |
| | $ | 52 |
|
| Compensation and benefits | 42 |
| | 19 |
|
| Other operating expenses | 28 |
| | 34 |
|
| Total operating expenses | $ | 70 |
| | $ | 105 |
|
Prior to our acquisition of AMM and related management internalization on July 1, 2016, we paid our Manager a management fee payable monthly in arrears in an amount equal to one-twelfth of 1.25% of our month-end stockholders' equity, adjusted to exclude the effect of any unrealized gains or losses includedas defined in either retained earnings or accumulated OCI, each as computed in accordance with GAAP. There was no incentive compensation payable to our Manager pursuant to the management agreement. We incurred management fees of $52 million and $116 million for fiscal year 2016 and 2015, respectively. Following our management internalization, we no longer incur a management fee, but we incur expenses associated with an internally managed organization, including compensation expense previously borne by our Manager. For fiscal year 2016, we had
Compensation and benefits expense consist of base salary, bonus, stock-based and other long-term incentive compensation and benefits expense of $19 million, consisting primarily of base salary, accrued bonuses and benefits expense, including approximately $2 million of accrued retention bonuses made to certain members of AMM's legacy work-force at the time offor our Internalization.
We had a negligible amount of equity-based compensation expense during 2016, as our 2016 Equity and Incentive Compensation Plan ("2016 Equity Plan") was not approved by stockholders until December 9, 2016. Our 2016 Equity Plan provides for grants of equity-based compensation to our employees in order to both attract, motivate and retain high quality employees and align our employees' interests with the interests of our stockholders. We expect the equity-based compensation component of our total compensation and benefits expense to increase in future periods as we grant awards to employees under the Plan and expense them over subsequent periods.
We incurred otheremployees. Other operating expenses of $34 million and $23 million for fiscal year 2016 and 2015, respectively, which primarily consistedconsist of prime broker fees; clearing, settlement and regulatory fees incurred by BES; information technology costs,costs; accounting, fees, legal fees,and Board of Director fees, insurance expensefees; amortization of intangible assets associated with our acquisition of AMM; and other general overhead expenses. For fiscal year 2016, our other operating expenses also included $9 million of non-recurring transaction costs and approximately $2 million of intangible asset amortization expense associated with our acquisition of AMM.
Our total annualized operating expense as a percentage of our average stockholders' equity was 1.36% and 1.58%0.88% for fiscal years 2016year 2017, compared to 1.36% for fiscal year 2016. Our total annualized operating expense, net of management fee income from MTGE, was 0.72% of our average stockholders' equity for fiscal year 2017, which includes 0.04% of non-cash amortization expense associated with intangible assets acquired from our acquisition of AMM. This compares to 1.26%, including 0.14% of non-recurring acquisition costs and 2015, respectively.non-cash amortization expense associated with our acquisition of AMM, for fiscal year 2016.
Dividends andEstimated Taxable Income Taxes
For fiscal years 20162017 and 2015,2016, we had estimated taxable income available to common stockholders of $191 million and $260 million (or $0.53 and $431 million (or $0.78 and $1.24 per diluted common share), respectively. Income as determined under GAAP differs from income as determined under tax rules because of both temporary and permanent differences in income and expense recognition. The primary differences are (i) unrealized gains and losses on derivative instruments and other securities marked-to-market in current income for GAAP purposes, but excluded from taxable income until realized or settled, (ii) timing differences, both temporary and potentially permanent, in the recognition of certain realized gains and losses and (iii) temporary differences related to the amortization of premiums and discounts on investments. Furthermore, our estimated taxable income is subject to potential adjustments up to the time of filing our appropriate tax returns, which occurs after the end of our fiscal year.
The following is a reconciliation of our GAAP net income to our estimated taxable income for fiscal years 20162017 and 20152016 (dollars in millions, except per share amounts):
| | | | Fiscal Year | Fiscal Year |
| | 2016 | | 2015 | 2017 | | 2016 |
| Net income (loss) | $ | 623 |
| | $ | 215 |
| |
| Net income | | $ | 771 |
| | $ | 623 |
|
| Estimated book to tax differences: | | | | | | |
| Premium amortization, net | (46 | ) | | (32 | ) | (9 | ) | | (46 | ) |
| Realized gain/loss, net | 1,034 |
| | 14 |
| (654 | ) | | 1,034 |
|
| Net capital loss/(utilization of net capital loss carryforward) | (232 | ) | | (77 | ) | (95 | ) | | (232 | ) |
| Unrealized gain/loss, net | (1,094 | ) | | 339 |
| 223 |
| | (1,094 | ) |
| Other | 3 |
| | — |
| (13 | ) | | 3 |
|
| Total book to tax differences | (335 | ) | | 244 |
| (548 | ) | | (335 | ) |
| Estimated REIT taxable income | 288 |
| | 459 |
| 223 |
| | 288 |
|
| Dividend on preferred stock | 28 |
| | 28 |
| 32 |
| | 28 |
|
| Estimated REIT taxable income available to common stockholders | $ | 260 |
| | $ | 431 |
| $ | 191 |
| | $ | 260 |
|
| Weighted average number of common shares outstanding - basic and diluted | 331.9 |
| | 348.6 |
| |
| Weighted average number of common shares outstanding - basic | | 358.6 |
| | 331.9 |
|
| Weighted average number of common shares outstanding - diluted | | 358.7 |
| | 331.9 |
|
| Estimated REIT taxable income per common share - basic and diluted | $ | 0.78 |
| | $ | 1.24 |
| $ | 0.53 |
| | $ | 0.78 |
|
| | | | | | | |
| Beginning cumulative non-deductible net capital loss | $ | 684 |
| | $ | 761 |
| $ | 452 |
| | $ | 684 |
|
| Utilization of net capital loss carryforward | (232 | ) | | (77 | ) | |
| Ending cumulative non-deductible net capital loss | $ | 452 |
| | $ | 684 |
| |
| Net capital loss / (utilization of net capital loss carryforward) | | (95 | ) | | (232 | ) |
Ending cumulative non-deductible net capital loss 1 | | $ | 357 |
| | $ | 452 |
|
| Ending cumulative non-deductible net capital loss per ending common share | $ | 1.37 |
| | $ | 2.03 |
| $ | 0.91 |
| | $ | 1.37 |
|
________________________________
| |
| 1. | Remaining net capital loss carryforward as of December 31, 2017 expires at the end of fiscal year 2018. |
As of December 31, 2016, we had $0.5 billion (or $1.37 per common share) of net capital loss carryforwards, which can be carried forward2017 and applied against future net capital gains through fiscal year 2018.
As of December 31, 2016, and 2015, we had distributed all of our estimated taxable income for fiscal years 20162017 and 2015,2016, respectively. Accordingly, we do not expect to incur an income tax or excise tax liability on our 20162017 taxable income, nor did we incur such liabilities on our 20152016 taxable income.
The following table summarizes dividends declared on our Series A Preferred Stock, depositary shares underlying our Series B Preferred Stock and common stock during fiscal years 20162017 and 2015:2016:
| | | | | Dividends Declared per Share | | Dividends Declared per Share |
| Quarter Ended | | Series A Preferred Stock | | Series B Preferred Stock (Per Depositary Share) | | Common Stock | | Series A Preferred Stock | | Series B Preferred Stock (Per Depositary Share) | | Series C Preferred Stock (Per Depositary Share) | | Common Stock |
| December 31, 2017 | | | $ | — |
| | $ | 0.484375 |
| | $ | 0.43750 |
| | $ | 0.54 |
|
| September 30, 2017 | | | $ | 0.33300 |
| | $ | 0.484375 |
| | $ | 0.25764 |
| | $ | 0.54 |
|
| June 30, 2017 | | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | — |
| | $ | 0.54 |
|
| March 31, 2017 | | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | — |
| | $ | 0.54 |
|
| Total | | | $ | 1.33300 |
| | $ | 1.937500 |
| | $ | 0.69514 |
| | $ | 2.16 |
|
| | | | | | | | | | |
| December 31, 2016 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.54 |
| | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.484375 |
| | $ | 0.54 |
|
| September 30, 2016 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.56 |
| | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.484375 |
| | $ | 0.56 |
|
| June 30, 2016 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.60 |
| | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.484375 |
| | $ | 0.60 |
|
| March 31, 2016 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.60 |
| | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.484375 |
| | $ | 0.60 |
|
| Total | | $ | 2.00000 |
| | $ | 1.937500 |
| | $ | 2.30 |
| | $ | 2.00000 |
| | $ | 1.937500 |
| | $ | 1.937500 |
| | $ | 2.30 |
|
| | | | | | | | |
| December 31, 2015 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.60 |
| |
| September 30, 2015 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.60 |
| |
| June 30, 2015 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.62 |
| |
| March 31, 2015 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.66 |
| |
| Total | | $ | 2.00000 |
| | $ | 1.937500 |
| | $ | 2.48 |
| |
Other Comprehensive Income (Loss)
Other comprehensive income (loss) primarily consists of unrealized gains and losses(losses) recognized due to the impact of fluctuations in long-term interest rates on the market value of our securitiesAgency RMBS designated as "available-for-sale" (see Note 2 to our Consolidated Financial Statements in this Form 10-K). The following table summarizes the componentsavailable-for-sale securities, net of ourreversals of prior period unrealized amounts upon realization. For fiscal years 2017 and 2016, we had other comprehensive income (loss) for fiscal years 2016 and 2015 (in millions):
|
| | | | | | | |
| | Fiscal Year |
| | 2016 | | 2015 |
| Unrealized gain (loss) on available-for-sale securities, net: | | | |
| Unrealized loss, net | $ | (261 | ) | | $ | (620 | ) |
| Reversal of prior period unrealized (gain) loss, net, upon realization | (109 | ) | | 23 |
|
| Unrealized loss on available-for-sale securities, net: | (370 | ) | | (597 | ) |
| Unrealized gain on interest rate swaps designated as cash flow hedges: | | | |
| Reversal of prior period unrealized loss on interest rate swaps, net, upon reclassification to interest expense | 39 |
| | 101 |
|
| Total other comprehensive loss | $ | (331 | ) | | $ | (496 | ) |
For fiscal years 2016 and 2015, we had net unrealized gains/(losses) on investment securities measured at fair value through net income of $(6)$52 million and $5$(331) million, respectively.
FISCAL YEAR 20152016 COMPARED TO FISCAL YEAR 2014:2015:
Economic Interest Income and Asset YieldYields
The following table summarizes our economic interest income (a non-GAAP measure) for fiscal years 20152016 and 20142015 (dollars in millions):
|
| | | | | | | | | | | | | |
| | Fiscal Year 2015 | | Fiscal Year 2014 |
| | Amount | | Yield | | Amount | | Yield |
| Cash/coupon interest income | $ | 1,874 |
| | 3.62 | % | | $ | 1,945 |
| | 3.63 | % |
| Net premium amortization | (408 | ) | | (0.91 | )% | | (473 | ) | | (1.00 | )% |
| Interest income | $ | 1,466 |
| | 2.71 | % | | $ | 1,472 |
| | 2.63 | % |
| Weighted average actual portfolio CPR for securities held during the period | 10 | % | | | | 9 | % | | |
| Weighted average projected CPR for the remaining life of securities held as of period end | 8 | % | | | | 9 | % | | |
Average 30-year fixed rate mortgage rate as of period end 1 | 4.01 | % | | | | 3.87 | % | | |
| 10-year U.S. Treasury rate as of period end | 2.27 | % | | | | 2.17 | % | | |
|
| | | | | | | | | | | | | |
| | Fiscal Year 2016 | | Fiscal Year 2015 |
| | Amount | | Yield | | Amount | | Yield |
| Interest income: | | | | | | | |
| Cash/coupon interest income | $ | 1,721 |
| | 3.64 | % | | $ | 1,874 |
| | 3.62 | % |
| Net premium amortization | (400 | ) | | (0.96 | )% | | (408 | ) | | (0.91 | )% |
| Interest income (GAAP measure) | 1,321 |
| | 2.68 | % | | 1,466 |
| | 2.71 | % |
| Estimated "catch-up" premium amortization cost due to change in CPR forecast | 10 |
| | 0.02 | % | | 1 |
| | 0.01 | % |
| Interest income, excluding "catch-up" premium amortization cost | 1,331 |
| | 2.70 | % | | 1,467 |
| | 2.72 | % |
TBA dollar roll income - implied interest income 1,2 | 264 |
| | 2.56 | % | | 246 |
| | 3.26 | % |
| Economic interest income, excluding "catch-up" amortization (non-GAAP measure) | $ | 1,595 |
| | 2.68 | % | | $ | 1,713 |
| | 2.78 | % |
| | | | | | | | |
| Weighted average actual portfolio CPR for investment securities held during the period | 12.3 | % | | | | 10.4 | % | | |
| Weighted average projected CPR for the remaining life of investment securities held as of period end | 8.0 | % | | | | 8.4 | % | | |
Average 30-year fixed rate mortgage rate as of period end 3 | 4.32 | % | | | | 4.01 | % | | |
| 10-year U.S. Treasury rate as of period end | 2.43 | % | | | | 2.27 | % | | |
_______________________________________________________
| |
| 1. | Reported in gain (loss) on derivatives instruments and other securities, net in the accompanying consolidated statements of operations. |
| |
| 2. | TBA implied asset yield is derived from the Company's executed TBA roll levels and TBA delivery assumptions sourced from Barclays Bank, PLC,'s "Barclays Live" research application for the associated weighted average coupon, weighted average maturity, and 1-month projected CPR. Amount is gross of TBA implied funding cost. |
| |
| 3. | Source: Freddie Mac Primary Fixed Mortgage Rate Mortgage Market Survey |
The following is a summary of the estimated impact of the principal elements impacting our economic interest income on the decrease in interest income from fiscal year 20142015 to 20152016 (in millions):
|
| | | | | | | | | | | |
| Impact of Changes in the Principal Elements Impacting Interest Income |
| Fiscal Year 2015 vs. 2014 |
| | | | Due to Change in Average |
| | Total Increase / (Decrease) | | Portfolio Size | | Asset Yield |
| Interest Income | $ | (6 | ) | | $ | (53 | ) | | $ | 47 |
|
|
| | | | | | | | | | | |
| Impact of Changes in the Principal Elements Impacting Interest Income |
| Fiscal Year 2016 vs. 2015 |
| | | | Due to Change in Average |
| | Total Increase / (Decrease) | | Portfolio Size | | Asset Yield |
| Interest Income (GAAP measure) | $ | (145 | ) | | $ | (129 | ) | | $ | (16 | ) |
| Estimated "catch-up" premium amortization cost due to change in CPR forecast | 9 |
| | — |
| | 9 |
|
| Interest income, excluding "catch-up" premium amortization cost | (136 | ) | | (129 | ) | | (7 | ) |
| TBA dollar roll income - implied interest income | 18 |
| | 91 |
| | (73 | ) |
| Economic interest income, excluding "catch-up" amortization (non-GAAP measure) | $ | (118 | ) | | $ | (38 | ) | | $ | (80 | ) |
The size of our average investment portfolio decreased in par value,3% (at cost) during fiscal year 2016, compared to the prior year period, by 3%consisting of a 9% decrease in holdings reported as investment securities and a 37% increase in TBA assets reported as derivative assets/(liabilities) on our consolidated balance sheets. The overall decrease in our investment portfolio was primarily a function of share repurchases during fiscal years 2016 and 2015. The decrease in our average asset yield on our investment portfolio to 2.68% for fiscal year 2015. The decline2016, from 2.78% for the prior year period, was largely due to a relative shift from investments recognized as securities on our consolidated financial statements to investments in TBA securities recognized as derivative assets/liabilities on our consolidated financial statements.
Our average asset yield differed from the prior year period largely due to fluctuations in "catch-up" premium amortization cost recognized due to changes in our projected CPR estimates. We recognized "catch-up" premium amortization cost of $1 million for fiscal year 2015, compared to $53 million for the prior year period. Excluding "catch-up" premium amortization cost, our average asset yield was 2.72% for fiscal year 2015, unchanged from fiscal year 2014.portfolio composition.
Leverage
Our total "at risk" leverage was 6.87.1x and 6.96.8x our stockholders' equity as of December 31, 2016 and 2015, and 2014, respectively. Our tangible net book value "at risk" leverage was 7.7x our tangible stockholders' equity as of December 31, 2016. The table below presents a summary of our average and quarter-end mortgage borrowings, net TBA position and "at risk" leverage ratios for each of the three month periods listed below (dollars in millions):
| | | | | Mortgage Borrowings 1 | | Net TBA Position Long / (Short) 2 | | Average Total
"At Risk" Leverage during the Period 1,3 | | "At Risk" Leverage
as of
Period End 1,4 | | Agency Repurchase Agreements and Other Debt 1 | | Net TBA Position
Long/(Short) 2 | | Average Total
"At Risk" Leverage during the Period 3 | | Tangible Net Book Value Average Total "At Risk" Leverage during the Period 4 | | "At Risk" Leverage
as of
Period End 5 | | Tangible Net Book Value "At Risk" Leverage as of Period End 4 |
| Quarter Ended | | Average Daily Amount | | Maximum Daily Amount | | Ending Amount | | Average Daily Amount | | Ending Amount | | | Average Daily Amount | | Maximum Daily Amount | | Ending Amount | | Average Daily Amount | | Ending Amount | |
| December 31, 2016 | | | $ | 41,031 |
| | $ | 42,157 |
| | $ | 41,183 |
| | $ | 14,141 |
| | $ | 11,312 |
| | 7.3:1 | | 7.8:1 | | 7.1:1 | | 7.7:1 |
| September 30, 2016 | | | $ | 44,401 |
| | $ | 46,555 |
| | $ | 41,154 |
| | $ | 10,748 |
| | $ | 15,540 |
| | 7.1:1 | | 7.6:1 | | 7.2:1 | | 7.7:1 |
| June 30, 2016 | | | $ | 46,948 |
| | $ | 48,875 |
| | $ | 45,502 |
| | $ | 8,238 |
| | $ | 6,975 |
| | 7.2:1 | | N/A | | 7.2:1 | | N/A |
| March 31, 2016 | | | $ | 45,926 |
| | $ | 49,767 |
| | $ | 48,875 |
| | $ | 8,144 |
| | $ | 5,983 |
| | 7.0:1 | | N/A | | 7.3:1 | | N/A |
| December 31, 2015 | | $ | 47,018 |
| | $ | 50,078 |
| | $ | 46,077 |
| | $ | 7,796 |
| | $ | 7,430 |
| | 6.8:1 | | 6.8:1 | | $ | 47,018 |
| | $ | 50,078 |
| | $ | 46,077 |
| | $ | 7,796 |
| | $ | 7,430 |
| | 6.8:1 | | N/A | | 6.8:1 | | N/A |
| September 30, 2015 | | $ | 43,308 |
| | $ | 46,049 |
| | $ | 44,683 |
| | $ | 9,434 |
| | $ | 7,265 |
| | 6.2:1 | | 6.8:1 | | $ | 43,308 |
| | $ | 46,049 |
| | $ | 44,683 |
| | $ | 9,434 |
| | $ | 7,265 |
| | 6.2:1 | | N/A | | 6.8:1 | | N/A |
| June 30, 2015 | | $ | 50,410 |
| | $ | 55,097 |
| | $ | 45,860 |
| | $ | 5,973 |
| | $ | 7,104 |
| | 6.2:1 | | 6.1:1 | | $ | 50,410 |
| | $ | 55,097 |
| | $ | 45,860 |
| | $ | 5,973 |
| | $ | 7,104 |
| | 6.2:1 | | N/A | | 6.1:1 | | N/A |
| March 31, 2015 | | $ | 53,963 |
| | $ | 58,217 |
| | $ | 55,056 |
| | $ | 6,957 |
| | $ | 4,815 |
| | 6.5:1 | | 6.4:1 | | $ | 53,963 |
| | $ | 58,217 |
| | $ | 55,056 |
| | $ | 6,957 |
| | $ | 4,815 |
| | 6.5:1 | | N/A | | 6.4:1 | | N/A |
| December 31, 2014 | | $ | 45,554 |
| | $ | 49,170 |
| | $ | 49,150 |
| | $ | 18,492 |
| | $ | 14,576 |
| | 6.9:1 | | 6.9:1 | |
| September 30, 2014 | | $ | 46,694 |
| | $ | 50,989 |
| | $ | 44,368 |
| | $ | 15,680 |
| | $ | 17,769 |
| | 6.7:1 | | 6.7:1 | |
| June 30, 2014 | | $ | 50,448 |
| | $ | 52,945 |
| | $ | 48,362 |
| | $ | 13,963 |
| | $ | 18,184 |
| | 7.1:1 | | 6.9:1 | |
| March 31, 2014 | | $ | 57,544 |
| | $ | 63,117 |
| | $ | 50,454 |
| | $ | 4,534 |
| | $ | 14,127 |
| | 7.2:1 | | 7.6:1 | |
_______________________
| |
| 1. | Mortgage borrowingsOther debt includes Agency repo, FHLB advances and debt of consolidated VIEs. Amounts exclude U.S. Treasury repo agreements. |
| |
| 2. | Daily average and ending net TBA position outstanding measured at cost. |
| |
| 3. | Tangible net book value "at risk" leverage includes the components of "at risk" leverage with stockholders' equity adjusted to exclude goodwill and other intangible assets, net. |
| |
| 4. | Average "at risk" leverage during the period was calculated by dividing the sum of our daily weighted average mortgage borrowings and net TBA position (at cost) outstanding during the period by the sum of our average month-endmonth-ended stockholders' equity less our average investment in REIT equity securities.securities for the period. |
| |
4.5. | "At risk" leverage as of period end wasis calculated by dividing the sum of the amount ofour mortgage borrowings outstanding net payable and receivablesour receivable/payable for unsettled Agencyinvestment securities and the cost basisas of our net TBA positionperiod end (at cost) by the sum of our total stockholders' equity less the fair value of our investmentinvestments in REIT equity securities.securities at period end. Leverage excludes U.S. Treasury repo agreements. |
Economic Interest Expense and Aggregate Cost of Funds
Our average cost of funds increased to 1.49% for fiscal year 2015, compared to 1.40% for the prior year period. The following table below presents a reconciliation ofsummarizes our economic interest expense (the most comparable GAAP financial measure) to our adjusted net interest expense and aggregate cost of funds (non-GAAP financial measures) for fiscal years 20152016 and 20142015 (dollars in millions):
, which includes the combination of interest expense on Agency repurchase agreements and other debt (GAAP measure), implied interest expense on our TBA securities and periodic interest rate swap costs:
|
| | | | | | | | | | | | | | |
| | | Fiscal Year 2015 | | Fiscal Year 2014 |
| Adjusted Net Interest Expense and Cost of Funds | | Amount | | % 1 | | Amount | | % 1 |
| Interest expense: | | | | | | | | |
| Interest expense on mortgage borrowings | | $ | 229 |
| | 0.47 | % | | $ | 216 |
| | 0.43 | % |
| Periodic interest costs of interest rate swaps previously designated as hedges under GAAP, net | | 101 |
| | 0.21 | % | | 156 |
| | 0.31 | % |
| Total interest expense | | 330 |
| | 0.68 | % | | 372 |
| | 0.74 | % |
| Other periodic interest costs of interest rate swaps, net | | 393 |
| | 0.81 | % | | 330 |
| | 0.66 | % |
| Total adjusted net interest expense and cost of funds | | $ | 723 |
| | 1.49 | % | | $ | 702 |
| | 1.40 | % |
|
| | | | | | | | | | | | | | |
| | | Fiscal Year 2016 | | Fiscal Year 2015 |
Economic Interest Expense and Aggregate Cost of Funds 1 | | Amount | | % 1 | | Amount | | % 1 |
| Interest expense: | | | | | | | | |
| Repurchase agreements and other debt interest expense | | $ | 355 |
| | 0.79 | % | | $ | 229 |
| | 0.47 | % |
| Periodic interest costs of interest rate swaps previously designated as hedges under GAAP, net | | 39 |
| | 0.09 | % | | 101 |
| | 0.21 | % |
| Interest expense (GAAP measure) | | 394 |
| | 0.80 | % | | 330 |
| | 0.47 | % |
TBA dollar roll income - implied interest expense 2 | | 48 |
| | 0.47 | % | | 9 |
| | 0.12 | % |
| Economic interest expense - before interest rate swap costs | | 442 |
| | 0.73 | % | | 339 |
| | 0.42 | % |
Periodic interest costs of interest rate swaps reported in gain (loss) on derivative instruments and other securities, net 3 | | 255 |
| | 0.54 | % | | 393 |
| | 0.88 | % |
| Total economic interest expense (non-GAAP measure) | | $ | 697 |
| | 1.27 | % | | $ | 732 |
| | 1.30 | % |
_______________________________________________________
| |
| 1. | PercentAmounts exclude interest rate swap termination fees and variation margin settlements paid or received, forward starting swaps or the impact of other supplemental hedges, such as swaptions and U.S. Treasury positions. |
| |
| 2. | Reported in gain (loss) on derivative instruments and other securities, net in our consolidated statements of comprehensive income. TBA implied interest expense is derived from the Company's executed TBA roll levels and TBA delivery assumptions sourced from Barclays Bank, PLC,'s "Barclays Live" research application for the associated weighted average coupon, weighted average maturity, and 1-month projected CPR. Amount is gross of TBA implied interest income. |
| |
| 3. | Interest rate swap cost of funds measured as a percent of average mortgage borrowings outstanding for the period annualized.period. |
The following is a summary of the estimated impact of the principal elements impacting the increase in our adjusted neteconomic interest expense for fiscal year 2015,2016, compared to the prior year period (in millions):
|
| | | | | | | | | | | |
| Impact of Changes in the Principal Elements of Adjusted Net Interest Expense |
| Fiscal Year 2015 vs. 2014 |
| | | | Due to Change in Average |
| | Total Increase / (Decrease) | | Borrowing / Swap Balance | | Borrowing / Swap Rate |
| Interest expense on mortgage borrowings | $ | 13 |
| | $ | (6 | ) | | $ | 19 |
|
Periodic interest rate swap costs 1 | 8 |
| | 18 |
| | (10 | ) |
| Total change in adjusted net interest expense | $ | 21 |
| | $ | 12 |
| | $ | 9 |
|
_______________________
| |
1. | Includes amounts recognized in interest expense and in gain (loss) on derivatives and other securities, net in our consolidated statements of comprehensive income. The change due to interest rate reflects the net impact of the change in the weighted average fixed pay and variable receive rates. |
|
| | | | | | | | | | | |
| Impact of Changes in the Principal Elements of Economic Interest Expense |
| Fiscal Year 2016 vs. 2015 |
| | | | Due to Change in Average |
| | Total Increase / (Decrease) | | Borrowing / Swap Balance | | Borrowing / Swap Rate |
Repurchase agreements and other debt interest expense
| $ | 126 |
| | $ | (21 | ) | | $ | 147 |
|
| TBA dollar roll income - implied interest expense | 39 |
| | 3 |
| | 36 |
|
| Periodic interest rate swap costs | (200 | ) | | (23 | ) | | (177 | ) |
| Total change in economic interest expense | $ | (35 | ) | | $ | (41 | ) | | $ | 6 |
|
The table below presents a summary of our average mortgage borrowings andthe ratio of our average interest rates swaps outstanding, excluding forward starting swaps, to our average mortgage borrowings for fiscal years 20152016 and 20142015 (dollars in millions):
|
| | | | | | | | |
| | | Fiscal Year |
| Average Ratio of Interest Rate Swaps Outstanding (Excluding Forward Starting Swaps) to Mortgage Borrowings Outstanding | | 2015 | | 2014 |
| Average mortgage borrowings | | $ | 48,641 |
| | $ | 50,015 |
|
| Average notional amount of interest rate swaps (excluding forward starting swaps) | | $ | 35,220 |
| | $ | 33,988 |
|
| Average ratio of interest rate swaps to mortgage borrowings | | 72 | % | | 68 | % |
| | | | | |
| Weighted average pay rate on interest rate swaps | | 1.68 | % | | 1.64 | % |
| Weighted average receive rate on interest rate swaps | | (0.28 | )% | | (0.21 | )% |
| Weighted average net pay rate on interest rate swaps | | 1.40 | % | | 1.43 | % |
|
| | | | | | | | |
| | | Fiscal Year |
| Average Ratio of Interest Rate Swaps (Excluding Forward Starting Swaps) to Mortgage Borrowings Outstanding | | 2016 | | 2015 |
| Average Agency repo and other debt outstanding | | $ | 44,566 |
| | $ | 48,641 |
|
| Average net TBA portfolio outstanding - at cost | | $ | 10,329 |
| | $ | 7,547 |
|
| Average mortgage borrowings outstanding | | $ | 54,895 |
| | $ | 56,188 |
|
| Average notional amount of interest rate swaps outstanding (excluding forward starting swaps) | | $ | 33,541 |
| | $ | 35,220 |
|
| Ratio of average interest rate swaps to mortgage borrowings outstanding | | 61 | % | | 63 | % |
| | | | | |
| Average interest rate swap pay-fixed rate (excluding forward starting swaps) | | 1.56 | % | | 1.68 | % |
| Average interest rate swap receive-floating rate | | (0.69 | )% | | (0.28 | )% |
| Average interest rate swap net pay/(receive) rate | | 0.87 | % | | 1.40 | % |
For the fiscal year endedyears 2016 and 2015, we had an average forward starting swap balance of $4.8 billion and $10.2 billion, of forward starting interest rate swaps outstanding, compared to $2.4 billion for fiscal year 2014.respectively. Including forward starting swaps, and our net TBA position, our average ratio of interest rate swaps outstanding to our average mortgage borrowings and net TBA position (at cost) was 81% for fiscal yearyears 2016 and 2015 compared to 58%was 70% and 81%, respectively.
Net Interest Margin
The following table presents a summary of our net interest margin, including the impact of TBA dollar roll income and interest rate swap costs and excluding "catch-up" premium amortization for fiscal year 2014.years 2016 and 2015:
|
| | | | | | | | |
| | | Fiscal Year |
| Average Ratio of Interest Rate Swaps Outstanding (Including Forward Starting Swaps) to Mortgage Borrowings and Net TBA Position | | 2015 | | 2014 |
| Average mortgage borrowings | | $ | 48,641 |
| | $ | 50,015 |
|
| Average net TBA position - at cost | | 7,547 |
| | 13,212 |
|
| Total average mortgage borrowings and net TBA position | | $ | 56,188 |
| | $ | 63,227 |
|
| Average notional amount of interest rate swaps (including of forward starting swaps) | | $ | 45,446 |
| | $ | 36,408 |
|
| Average ratio of interest rate swaps to mortgage borrowings and net TBA position | | 81 | % | | 58 | % |
|
| | | | | | |
| | | Fiscal Year |
| | | 2016 | | 2015 |
| Investment and TBA securities - average asset yield, excluding "catch-up" premium amortization | | 2.68 | % | | 2.78 | % |
| Investment and TBA securities - average aggregate cost of funds | | (1.27 | )% | | (1.30 | )% |
| Investment and TBA securities - average net interest margin, excluding "catch-up" premium amortization | | 1.41 | % | | 1.48 | % |
Net Spread and Dollar Roll Income
The following table below presents a reconciliationsummary of our net interest income (the most comparable GAAP financial measure) to our net spread and dollar roll income and to our net spread and dollar roll income, excluding estimated "catch-up" premium amortization, cost, (non-GAAPper common share (a non-GAAP financial measures)measure) and a reconciliation to our net interest income (the most comparable GAAP financial measure) for fiscal years 20152016 and 20142015 (dollars in millions):
| | | | | Fiscal Year | | Fiscal Year |
| | | 2015 | | 2014 | | 2016 | | 2015 |
| Net interest income | | $ | 1,136 |
| | $ | 1,100 |
| | $ | 927 |
| | $ | 1,136 |
|
Other periodic interest costs of interest rate swaps, net 1 | | (393 | ) | | (330 | ) | |
TBA dollar roll income 1 | | 237 |
| | 20 |
| |
Dividend from REIT equity securities 1 | | 6 |
| | 505 |
| |
TBA dollar roll income, net 1 | | | 216 |
| | 237 |
|
Periodic interest costs of interest rate swaps, net 1 | | | (255 | ) | | (393 | ) |
Dividend income from REIT equity securities 1 | | | 2 |
| | 6 |
|
| Adjusted net interest and dollar roll income | | 986 |
| | 1,295 |
| | 890 |
| | 986 |
|
| Other operating income (expense): | | | | | |
| Management fee income | | | 8 |
| | — |
|
| Operating expenses | | 139 |
| | 141 |
| | (105 | ) | | (139 | ) |
| Non-recurring transaction costs | | | 9 |
| | — |
|
| Adjusted operating (income) expense, net | | | (88 | ) | | (139 | ) |
| Net spread and dollar roll income | | 847 |
| | 1,154 |
| | 802 |
| | 847 |
|
| Dividend on preferred stock | | 28 |
| | 23 |
| | 28 |
| | 28 |
|
| Net spread and dollar roll income available to common stockholders | | 819 |
| | 1,131 |
| |
| Net spread and dollar roll income available to common stockholders (non-GAAP measure) | | | 774 |
| | 819 |
|
| Estimated "catch-up" premium amortization cost due to change in CPR forecast | | 1 |
| | 53 |
| | 10 |
| | 1 |
|
| Net spread and dollar roll income, excluding "catch-up" premium amortization, available to common stockholders | | $ | 820 |
| | $ | 1,184 |
| |
| Net spread and dollar roll income, excluding "catch-up" premium amortization, available to common stockholders (non-GAAP measure) | | | $ | 784 |
| | $ | 820 |
|
| | | | | | | | | |
| Weighted average number of common shares outstanding - basic and diluted | | 348.6 |
| | 353.3 |
| | 331.9 |
| | 348.6 |
|
| Net spread and dollar roll income per common share - basic and diluted | | $ | 2.35 |
| | $ | 3.20 |
| | $ | 2.33 |
| | $ | 2.35 |
|
| Net spread and dollar roll income, excluding "catch-up" premium amortization, per common share - basic and diluted | | $ | 2.35 |
| | $ | 3.35 |
| | $ | 2.36 |
| | $ | 2.35 |
|
_______________________
| |
| 1. | Reported in gain (loss) on derivative instruments and other securities, net in our consolidated statements of comprehensive income |
Net spread and dollar roll income, excluding "catch-up" premium amortization adjustments, for fiscal year 2015 decreased2016 was largely unchanged at $2.36 per common share compared to $2.35 from $3.35 per common share for fiscalthe prior year 2014, largely due to higher repo costs and aperiod, as the decline in TBA dollar roll income relative to our average TBA position, partiallynet interest margin, inclusive of TBAs and periodic interest rate swap costs, was offset by higher "at risk" leverage and lower operating costs.costs as a function of our management internalization on July 1, 2016.
Our average net interest rate spread and dollar roll income (i.e., the difference between the average yield on our assets and our average cost of funds inclusive of TBAs), excluding catch-up premium amortization cost, was 1.48% for fiscal year 2015, compared to 1.83% for fiscal year 2014. Including catch-up premium amortization adjustments, our net interest rate spread and dollar roll income was 1.48% for fiscal year 2015, compared to 1.75%, for fiscal year 2014.
Gain (Loss) on Sale of Investment Securities, Net
The following table is a summary of our net gain (loss) on sale of investment securities for fiscal years 20152016 and 20142015 (in millions):
| | | | Fiscal Year | Fiscal Year |
| | 2015 | | 2014 | 2016 | | 2015 |
| Investment securities sold, at cost | $ | (27,578 | ) | | $ | (30,123 | ) | $ | (17,907 | ) | | $ | (27,578 | ) |
Proceeds from sale 1 | 27,555 |
| | 30,174 |
| |
| Sale proceeds | | 18,016 |
| | 27,555 |
|
| Net gain (loss) on sale of investment securities | $ | (23 | ) | | $ | 51 |
| $ | 109 |
| | $ | (23 | ) |
| | | | | | | |
| Gross gain on sale of investment securities | $ | 98 |
| | $ | 172 |
| $ | 123 |
| | $ | 98 |
|
| Gross loss on sale of investment securities | (121 | ) | | (121 | ) | (14 | ) | | (121 | ) |
| Net gain (loss) on sale of investment securities | $ | (23 | ) | | $ | 51 |
| $ | 109 |
| | $ | (23 | ) |
_______________________
| |
1. | Proceeds include cash received during the period, plus receivable for MBS sold during the period as of period end. |
Gain (Loss) on Derivative Instruments and Other Securities, Net
The following table is a summary of our gain (loss) on derivative instruments and other securities, net for fiscal years 20152016 and 20142015 (in millions):
| | | | Fiscal Year | Fiscal Year |
| | 2015 | | 2014 | 2016 | | 2015 |
| Periodic interest costs of interest rate swaps, net | $ | (393 | ) | | $ | (330 | ) | $ | (255 | ) | | $ | (393 | ) |
| Realized gain (loss) on derivative instruments and other securities, net: | | | | | | |
| TBA securities - dollar roll income, net | 237 |
| | 505 |
| 216 |
| | 237 |
|
| TBA securities - mark-to-market net gain (loss) | 246 |
| | 416 |
| (114 | ) | | 246 |
|
| Payer swaptions | (77 | ) | | (171 | ) | (30 | ) | | (77 | ) |
| Receiver swaptions | 15 |
| | (1 | ) | — |
| | 15 |
|
| U.S. Treasury securities - long position | (33 | ) | | 7 |
| 7 |
| | (33 | ) |
| U.S. Treasury securities - short position | (72 | ) | | (378 | ) | (85 | ) | | (72 | ) |
| U.S. Treasury futures - short position | (21 | ) | | (34 | ) | (12 | ) | | (21 | ) |
| Interest rate swap termination fees | (327 | ) | | (127 | ) | (1,145 | ) | | (327 | ) |
| REIT equity securities | 4 |
| | 71 |
| — |
| | 4 |
|
| Other | 1 |
| | (10 | ) | 8 |
| | 1 |
|
| Total realized gain (loss) on derivative instruments and other securities, net | (27 | ) | | 278 |
| |
| Total realized loss on derivative instruments and other securities, net | | (1,155 | ) | | (27 | ) |
| Unrealized gain (loss) on derivative instruments and other securities, net: | | | | | | |
| TBA securities - mark-to-market net gain (loss) | (178 | ) | | 196 |
| |
| TBA securities - mark-to-market net loss | | (161 | ) | | (178 | ) |
| Interest rate swaps | (212 | ) | | (1,381 | ) | 1,003 |
| | (212 | ) |
| Payer swaptions | 42 |
| | (22 | ) | 27 |
| | 42 |
|
| Receiver swaptions | (11 | ) | | 12 |
| — |
| | (11 | ) |
| U.S. Treasury securities - long position | (5 | ) | | 59 |
| — |
| | (5 | ) |
| U.S. Treasury securities - short position | 4 |
| | (42 | ) | 219 |
| | 4 |
|
| U.S. Treasury futures - short position | 9 |
| | (42 | ) | 7 |
| | 9 |
|
| Debt of consolidated VIEs | 16 |
| | (10 | ) | (3 | ) | | 16 |
|
| REIT equity securities | (9 | ) | | 4 |
| 9 |
| | (9 | ) |
| Other | — |
| | 3 |
| (1 | ) | | — |
|
| Total unrealized gain (loss) on derivative instruments and other securities, net | (344 | ) | | (1,223 | ) | 1,100 |
| | (344 | ) |
| Total gain (loss) on derivative instruments and other securities, net | $ | (764 | ) | | $ | (1,275 | ) | |
| Total loss on derivative instruments and other securities, net | | $ | (310 | ) | | $ | (764 | ) |
For further details regarding our use of derivative instruments and related activity refer to Notes 2 and 5 of our Consolidated Financial Statements in this Form 10-K.
Management Fees and General and AdministrativeOperating Expenses
We incurred management feesThe following table includes a summary of $116 million and $119 millionour operating expenses for fiscal yearyears 2016 and 2015 (dollars in millions):
|
| | | | | | | |
| | Fiscal Year |
| | 2016 | | 2015 |
| Management fee expense | 52 |
| | 116 |
|
| Compensation and benefits | 19 |
| | — |
|
| Other operating expenses | 34 |
| | 23 |
|
| Total operating expenses | $ | 105 |
| | $ | 139 |
|
Compensation and 2014, respectively. The decline inbenefits expense primarily consisted of base salary, bonus and benefits expense for our employees incurred following our management fees was a function of our smaller capital base due to the combination of share repurchases and net losses realizedinternalization on our portfolio. General and administrative expenses were $23 million and $22 million for fiscal year 2015 and 2014, respectively. Our general and administrativeJuly 1, 2016. Other operating expenses primarily consisted of prime broker fees, information technology costs, accounting fees, legal fees, Board of Director fees, insurance expense and general overhead expense.expenses. For fiscal year 2016, other operating expenses included $9 million of non-recurring transaction costs associated with our acquisition of AMM. Our total annualized operating expense as a percentage of our average stockholders' equity was 1.58%1.36% and 1.52%1.58% for fiscal years 2016 and 2015, respectively. Our total annualized operating expense, net of management fee income from MTGE,
was 1.26%, including 0.14% of non-recurring acquisition costs and 2014, respectively.non-cash amortization expense associated with our acquisition of AMM, for fiscal year 2016.
Dividends and Income Taxes
For fiscal years 20152016 and 2014,2015, we had estimated taxable income available to common stockholders of $260 million and $431 million and $439 million (or $1.24$0.78 and $1.24 per common share), respectively.
The following is a reconciliation of our GAAP net income to our estimated taxable income for fiscal years 20152016 and 20142015 (dollars in millions, except per share amounts):
| | | | Fiscal Year | Fiscal Year |
| | 2015 | | 2014 | 2016 | | 2015 |
| Net income (loss) | $ | 215 |
| | $ | (233 | ) | $ | 623 |
| | $ | 215 |
|
| Estimated book to tax differences: | | | | | | |
| Premium amortization, net | (32 | ) | | 34 |
| (46 | ) | | (32 | ) |
| Realized gain/loss, net | 14 |
| | 495 |
| 1,034 |
| | 14 |
|
| Net capital loss/(utilization of net capital loss carryforward) | (77 | ) | | (1,024 | ) | (232 | ) | | (77 | ) |
| Unrealized gain/loss, net | 339 |
| | 1,191 |
| (1,094 | ) | | 339 |
|
| Other | — |
| | (1 | ) | 3 |
| | — |
|
| Total book to tax differences | 244 |
| | 695 |
| (335 | ) | | 244 |
|
| Estimated REIT taxable income | 459 |
| | 462 |
| 288 |
| | 459 |
|
| Dividend on preferred stock | 28 |
| | 23 |
| 28 |
| | 28 |
|
| Estimated REIT taxable income available to common stockholders | $ | 431 |
| | $ | 439 |
| $ | 260 |
| | $ | 431 |
|
| Weighted average number of common shares outstanding - basic and diluted | 348.6 |
| | 353.3 |
| 331.9 |
| | 348.6 |
|
| Estimated REIT taxable income per common share - basic and diluted | $ | 1.24 |
| | $ | 1.24 |
| $ | 0.78 |
| | $ | 1.24 |
|
| | | | | | | |
| Beginning cumulative non-deductible net capital loss | $ | 761 |
| | $ | 1,785 |
| $ | 684 |
| | $ | 761 |
|
| Utilization of net capital loss carryforward | (77 | ) | | (1,024 | ) | (232 | ) | | (77 | ) |
| Ending cumulative non-deductible net capital loss | $ | 684 |
| | $ | 761 |
| $ | 452 |
| | $ | 684 |
|
| Ending cumulative non-deductible net capital loss per ending common share | $ | 2.03 |
| | $ | 2.16 |
| $ | 1.37 |
| | $ | 2.03 |
|
For fiscal years 20152016 and 2014,2015, we distributed all of our taxable income within the limits prescribed by the Internal Revenue Code. Accordingly, we did not incur an income tax or excise tax liability on our 2016 or 2015 and 2014 taxable income.
The following table summarizes dividends declared on our Series A Preferred Stock, depositary shares underlying our Series B Preferred Stockpreferred and common stock during fiscal years 20152016 and 2014:2015:
| | | | | Dividends Declared per Share | | Dividends Declared per Share |
| Quarter Ended | | Series A Preferred Stock | | Series B Preferred Stock (Per Depositary Share) | | Common Stock | | Series A Preferred Stock | | Series B Preferred Stock (Per Depositary Share) | | Common Stock |
| December 31, 2016 | | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.54 |
|
| September 30, 2016 | | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.56 |
|
| June 30, 2016 | | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.60 |
|
| March 31, 2016 | | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.60 |
|
| Total | | | $ | 2.00000 |
| | $ | 1.937500 |
| | $ | 2.30 |
|
| | | | | | | | |
| December 31, 2015 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.60 |
| | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.60 |
|
| September 30, 2015 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.60 |
| | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.60 |
|
| June 30, 2015 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.62 |
| | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.62 |
|
| March 31, 2015 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.66 |
| | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.66 |
|
| Total | | $ | 2.00000 |
| | $ | 1.937500 |
| | $ | 2.48 |
| | $ | 2.00000 |
| | $ | 1.937500 |
| | $ | 2.48 |
|
| | | | | | | | |
| December 31, 2014 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.66 |
| |
| September 30, 2014 | | $ | 0.50000 |
| | $ | 0.484375 |
| | $ | 0.65 |
| |
| June 30, 2014 | | $ | 0.50000 |
| | $ | 0.360590 |
| | $ | 0.65 |
| |
| March 31, 2014 | | $ | 0.50000 |
| | $ | — |
| | $ | 0.65 |
| |
| Total | | $ | 2.00000 |
| | $ | 1.329340 |
| | $ | 2.61 |
| |
Other Comprehensive Income (Loss)
The following table summarizes the components of our other comprehensive income (loss)loss for fiscal years 20152016 and 20142015 (in millions):
| | | | Fiscal Year | Fiscal Year |
| | 2015 | | 2014 | 2016 | | 2015 |
| Unrealized gain (loss) on available-for-sale securities, net: | | | | | | |
| Unrealized gain (loss), net | $ | (620 | ) | | $ | 1,708 |
| |
| Unrealized loss, net | | $ | (261 | ) | | $ | (620 | ) |
| Reversal of prior period unrealized (gain) loss, net, upon realization | 23 |
| | (51 | ) | (109 | ) | | 23 |
|
| Unrealized gain (loss) on available-for-sale securities, net: | (597 | ) | | 1,657 |
| |
| Unrealized gain on interest rate swaps designated as cash flow hedges: | | | | |
| Unrealized loss on available-for-sale securities, net: | | (370 | ) | | (597 | ) |
| Unrealized gain on interest rate swaps previously designated as cash flow hedges: | | | | |
| Reversal of prior period unrealized loss on interest rate swaps, net, upon reclassification to interest expense | 101 |
| | 156 |
| 39 |
| | 101 |
|
| Total other comprehensive income (loss) | $ | (496 | ) | | $ | 1,813 |
| |
| Total other comprehensive loss | | $ | (331 | ) | | $ | (496 | ) |
For fiscal years 2015 and 2014, we had net unrealized gains on investment securities measured at fair value through net income of $5 million and $32 million, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of funds are borrowings under master repurchase agreements, asset sales, receipts of monthly principal and interest payments on our investment portfolio and equity offerings. We may also enter into TBA contracts as a means of acquiringto acquire or disposingdispose of Agency securitiesRMBS and utilize TBA dollar roll transactions to finance Agency RMBS purchases. Because the level of our borrowings can be adjusted on a daily, basis, the level of cash and cash equivalents carried on our balance sheet is significantly less important than the potential liquidity available under our borrowing arrangements. Our leverage will vary periodically depending on market conditions and our assessment of risks and returns. We generally would expect our leverage to be within six to eleventwelve times the amount of our tangible stockholders' equity. However, under certain market conditions, we may operate at leverage levels outside of this range for extended periods of time.
We currently believe that we have sufficient liquidity and capital resources available for the acquisition of additional investments, repayments on borrowings, maintenance of any margin requirements and the payment of cash dividends as required for our continued qualification as a REIT. We currently expect to distribute 100% of our taxable income so that we are not subject to U.S. federalFederal and state corporate income taxes. Our REIT distribution requirement of at least 90% of our taxable income limits our ability to retain earnings and thereby replenish or increase capital from operations.
Debt Capital
As of December 31, 20162017 and 2015,2016, our mortgage borrowings and net TBA position consisted of the following ($ in millions):
| | | | | December 31, 2016 | | December 31, 2015 | | December 31, 2017 | | December 31, 2016 |
| Mortgage Funding | | Amount | | % | | Amount | | % | |
Repurchase agreements used to fund Agency RMBS 1,2 | | $ | 37,686 |
| | 71 | % | | $ | 41,729 |
| | 78 | % | |
| Mortgage Borrowings | | | Amount | | % | | Amount | | % |
Repurchase agreements used to fund Agency RMBS 1 | | | $ | 50,296 |
| | 75 | % | | $ | 37,686 |
| | 71 | % |
| Debt of consolidated variable interest entities, at fair value | | | 357 |
| | 1 | % | | 460 |
| | 1 | % |
| FHLB advances | | 3,037 |
| | 6 | % | | 3,753 |
| | 7 | % | | — |
| | — | % | | 3,037 |
| | 6 | % |
| Debt of consolidated variable interest entities, at fair value | | 460 |
| | 1 | % | | 595 |
| | 1 | % | |
| Total debt | | | 50,653 |
| | 76 | % | | 41,183 |
| | 78 | % |
| Net TBA position, at cost | | | 15,739 |
| | 24 | % | | 11,312 |
| | 22 | % |
| Total mortgage borrowings | | 41,183 |
| | 78 | % | | 46,077 |
| | 86 | % | | $ | 66,392 |
| | 100 | % | | $ | 52,495 |
| | 100 | % |
| Net TBA position, at cost | | 11,312 |
| | 22 | % | | 7,430 |
| | 14 | % | |
| Total mortgage funding | | $ | 52,495 |
| | 100 | % | | $ | 53,507 |
| | 100 | % | |
______________________
1. Excludes repurchase agreements used to fund U.S. Treasury securities of $172$0 million and $25$172 million as of December 31, 20162017 and 2015,2016, respectively.
2. Excludes aOur tangible net receivable of $21 millionbook value "at risk" leverage was 8.1x and a net payable of $182 million for unsettled purchases and sales of investment securities7.7x as of December 31, 2017 and 2016, and 2015, respectively.
Our "at risk" leverage ratio was 7.1x as of December 31, 2016, compared to 6.8x as of December 31, 2015,respectively, measured as the sum of our total mortgage borrowings, net TBA position (at cost) and net payable / (receivable) for unsettled investment securities divided by the sum of our total stockholders' equity less ouradjusted to exclude goodwill and other intangible assets and investments in REIT equity securities. Our tangible net book value "at risk" leverage was 7.7x our tangible stockholders' equity as of December 31, 2016.
Repurchase Agreements
As part of our investment strategy, we borrow against our investment portfolio pursuant to master repurchase agreements. We expect that the majority of our borrowings under such master repurchase agreements will have maturities ranging up to one year, but we may have longer-term borrowingsterms ranging up to five years or longer. Borrowings under our master repurchase agreements with maturities greater than 90 days willone year typically have floating rates of interest based on LIBOR plus or minus a fixed spread.
As of December 31, 2016 ,2017, we had $37.7$50.3 billion of repurchase agreements outstanding used to fund acquisitions of investment securities with a weighted average cost of funds of 0.98%1.57% and a weighted average remaining days-to-maturity of 187116 days, compared $41.7$37.7 billion, 0.61%0.98% and 173187 days, respectively, as of December 31, 2015.2016.
To limit our exposure to counterparty credit risk,exposure, we diversify our funding across multiple counterparties and by counterparty region. As of December 31, 2016,2017, we had master repurchase agreements with 3843 financial institutions located throughout North America, Europe and Asia, including counterparties accessed through our wholly-owned captive broker-dealer subsidiary, BES. BES has direct access to bilateral and triparty funding, including the General Collateral Finance Repo service offered by the Fixed Income Clearing Corporation, or "FICC," which provides us greater depth and diversity of funding at favorable terms relative to traditional bilateral repurchase agreement funding. As of December 31, 2016, less than 6%2017, $16.6 billion of our stockholders' equityrepurchase agreement funding was at risk with any one repo counterparty, and our top five repo counterparties represented less than sourced through BES.
14% of our stockholders' equity. The table below includes a summary of our Agency RMBS repurchase agreement funding by number of repo counterparties and counterparty region as of December 31, 20162017. For further details regarding our borrowings under repurchase agreements and concentration of credit risk as of December 31, 20162017, please refer to Notes 4 and 6 to our Consolidated Financial Statements in this Form 10-K.
| | | | | December 31, 2016 | | December 31, 2017 |
| Counter-Party Region | | Number of Counter-Parties | | Percent of Repurchase Agreement Funding | | Number of Counter-Parties | | Percent of Agency RMBS Repurchase Agreement Funding |
| North America | | 20 | | 68% | |
| North America: | | | | | |
| FICC | | | 1 | | 30% |
| Other | | | 23 | | 46% |
| Total North America | | | 24 | | 76% |
| Europe | | 13 | | 20% | | 14 | | 15% |
| Asia | | 5 | | 12% | | 5 | | 9% |
| | | 38 | | 100% | |
| Total | | | 43 | | 100% |
Amounts available to be borrowed under our repurchase agreements are dependent upon lender collateral requirements and the lender's determination of the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, credit quality and liquidity conditions within the investment banking, mortgage finance and real estate industries. In addition, our counterparties apply a "haircut" to our pledged collateral, which means our collateral is valued at slightly less than market value. This haircut reflects the underlying risk of the specific collateral and protects our counterparty against a change in its value, but conversely subjects us to counterparty credit risk and limits the amount we can borrow against our investment securities. Our master repurchase agreements do not specify the haircut; rather haircuts are determined on an individual repurchase transaction basis. Throughout fiscal year 2016,2017, haircuts on our pledged collateral remained stable and, as of December 31, 2016,2017, our weighted average haircut was approximately 5%4.3% of the value of our collateral.
Undercollateral, inclusive of collateral funded through BES. As of December 31, 2017, our maximum amount at risk (or the amount of our repurchase liabilities in excess of the value of collateral pledged) with any counterparty related to our repurchase agreements wewas less than 5% of our tangible stockholders' equity, and our top five repo counterparties represented less than 14% of our tangible stockholders' equity.
We may be required to pledge additional assets to the repurchase agreementour counterparties in the event the estimated fair value of the existing collateral pledged collateral under suchour agreements declines and suchour counterparties demand additional collateral (a "margin call"), which may take the form of additional securities or cash. Specifically, margin calls would result from a decline in the fair value of our investment securities securing our repurchase agreements andas well as due to prepayments on the mortgages securing such securities. Similarly, if the estimated fair value of our investment securities increases due to changes in interest rates or other factors, counterparties may release collateral back to us. Our repurchase agreements generally provide that the valuations of securities securing our repurchase agreements are to be obtained from a generally recognized source agreed to by the parties. However, inIn certain circumstances, under certain of our repurchase agreementshowever, our lenders have the sole discretion to determine their value.the value of pledged collateral. In such instances, our lenders are required to act in good faith in making determinations of value. Our repurchase agreements generally provide that in the event of a margin call, we must provide additional securities or cash on the same business day that a margin call is made if the lender provides us notice prior to the margin notice deadline on such day.
As of December 31, 2016,2017, we had met all of our margin requirements and we had unrestricted cash and cash equivalents of $1.2$1.0 billion and unpledged securities of approximately $1.8$3.6 billion,, including securities pledged to us and unpledged interests in our consolidated VIEs, available to meet margin calls on our repurchase agreements and other funding liabilities, derivative instruments and for other corporate purposes.
Although we believe we will have adequate sources of liquidity available to us through repurchase agreement financing to execute our business strategy, there can be no assurances that repurchase agreement financing will be available to us upon the maturity of our current repurchase agreements to allow us to renew or replace our repurchase agreement financing on favorable terms or at all. If our repurchase agreement lenders default on their obligations to resell the underlying collateral back to us at the end of the term, we could incur a loss equal to the difference between the value of the collateral and the cash we originally received.
During 2015, we formed a wholly-owned captive broker-dealer subsidiary, Bethesda Securities, LLC. BES became operational and received final membership approval to the FICC during the third quarter of 2016. BES has direct access to bilateral and triparty funding as a FINRA member broker-dealer. As an eligible institution, BES also raises funds through the General Collateral Finance Repo service offered by the FICC, with the FICC acting as the central counterparty, and thus provides us greater depth and diversity of repurchase agreement funding while also lowering our funding costs and limiting our counterparty exposure. As of December 31, 2016, we had entered into $4.7 billion of repurchase agreement funding through BES and expect to continue to expand our financing activity through BES during 2017.
To help manage the adverse impact of interest rate changes on the value of our investment portfolio as well as our cash flows, we utilize an interest rate risk management strategy under which we use derivative financial instruments. In particular, we attempt to mitigate the risk of the cost of our variable rate liabilities increasing at a faster rate than the earnings of our long-term fixed rate assets during a period of rising interest rates. The principalprimary derivative instruments that we use are interest rate swaps, supplemented with the use of interest rate swaptions, U.S. Treasury securities and U.S. Treasury futures contracts, TBA securities and other instruments.contracts. Please refer to Notes 2 and 5 to our Consolidated Financial Statements in this Form 10-K for further details regarding our use of derivative instruments.
OurAs with repurchase agreements, our derivative agreements typically require that we pledge/receive collateral on such agreements to/from our counterparties in a similar manner as we are required to under our repurchase agreements.counterparties. Our counterparties, or the central clearing agency, typically have the sole discretion to determine the value of the derivative instruments and the value of the collateral securing such instruments. In the event of a margin call, we must generally provide additional collateral generally on the same or next business day.
Similar to repurchase agreements, our use of derivatives exposes us to We minimize counterparty credit risk relating to potential losses that could be recognized in the event thatassociated with our counterparties to thesederivative instruments fail to perform their obligations under the contracts. We minimize this risk by limiting our counterparties to central clearing exchanges and major financial institutions with acceptable credit ratings and by monitoring positions with individual counterparties. Excluding centrally cleared interest rate swaps,derivative instruments, as of December 31, 2016,2017, our amount at risk with any counterparty related to our interest rate swap and swaption agreements was less than 1% of our stockholders' equity. In the case of centrally cleared interest rate swap contracts,derivative instruments, we could be exposed to credit risk if the central clearing agency or a clearing member defaults on its respective obligation to perform under the contract. However, we believe that the risk is minimal due to the exchange'sexchanges' initial and daily mark to market margin requirements and a clearinghouse guarantee fundfunds and other resources that are available in the event of a clearing member default.
TBA Dollar Roll Transactions
TBA dollar roll transactions represent a form of off-balance sheet financing accounted for as derivative instruments and weinstruments. We may also use them as a means of leveragingTBAs to leverage (or deleveraging)deleverage) our investment portfolio through the use ofusing long (or short) TBA contracts (see Notes 2 and 5 to our Consolidated Financial Statements in this Form 10-K)10-K additional details on of our TBA transactions).
Under certain market conditions, it may be uneconomical for us to roll our TBA contracts into future months and we may need to take or make physical delivery of the underlying securities. If we were required to take physical delivery to settle a long TBA contract, we would have to fund our total purchase commitment with cash or other financing sources and our liquidity position could be negatively impacted. As of December 31, 20162017, we had a net long TBA position with a total market value and a total cost basis of $11.2$15.7 billion and $11.3 billion, respectively, and a net carrying value of $(147)$3 million recognized in derivative assets/(liabilities), at fair value, on our Consolidated Balance Sheets in this Form 10-K.
Our TBA dollar roll contracts are also subject to margin requirements governed by the Mortgage-Backed Securities Division ("MBSD") of the FICC and by our prime brokerage agreements, which may establish margin levels in excess of the MBSD. Such provisions require that we establish an initial margin based on the notional value of the TBA contract, which is subject to increase if the estimated fair value of our TBA contract or the estimated fair value of our pledged collateral declines. The MBSD has the sole discretion to determine the value of our TBA contracts and of the pledged collateral securing such contracts. In the event of a margin call, we must generally provide additional collateral on the same business day.
Settlement of our TBA obligations by taking delivery of the underlying securities as well as satisfying margin requirements could negatively impact our liquidity position. However, since we do not use TBA dollar roll transactions as our primary source of financing, we believe that we will have adequate sources of liquidity to meet such obligations.
Bethesda Securities Regulatory Capital Requirements
Federal Home Loan Bank Membership
In April 2015, our wholly-owned captive insurance subsidiary, Old Georgetown Insurance Co., LLC ("OGI"), was approved as a memberBES is subject to regulations of the FHLBsecurities business that include but are not limited to trade practices, capital structure, recordkeeping and conduct of Des Moines. The FHLBs providedirectors, officers and employees. As a variety of products and servicesself-clearing registered broker-dealer, BES is required to their members, including short and long-term secured loans, called "advances." In January 2016, the FHFA released its final rule on changes to regulations concerning FHLB membership criteria. The final rule terminated OGI's FHLB membership and required repayment of all advances at the earlier of their contractual maturity dates or a one year period after the effective date of the final rule that concluded in February 2017.maintain minimum net regulatory capital as defined by SEC Rule 15c3-1 (the "Rule"). As of December 31, 2016, we2017, the minimum net capital required was $0.3 million and BES had $3.0 billionexcess net capital of FHLB advances outstanding with a weighted average interest rate$258.8 million. Regulatory capital in excess of 0.73%the minimum required by the Rule is held to meet levels required by clearing organizations, the clearing bank and a weighted average remaining days to maturity of 28 days up to February 2017. We do not expect the termination of our FHLB membership to negatively impact our liquidity position, since FHLB advances do not represent our primary source of funding.
other repo counterparties.
Asset Sales and TBA Eligible Securities
We maintain a portfolio of highly liquid mortgage-backed securities. We may sell our Agency securities through the TBA market by delivering them into TBA contracts, subject to "good delivery" provisions promulgated by the SIFMA. We may
alternatively sell Agency securities that have more unique attributes on a specified basis when such securities trade at a premium over generic TBA securities or if the securities are not otherwise eligible for TBA delivery. Since the TBA market is the second most liquid market (second to(after the U.S. Treasury market), maintaining a significant level of Agency securities eligible for TBA delivery enhances our liquidity profile and provides price support for our TBA eligible securities at or above generic TBA prices. As of December 31, 2016,2017, approximately 86%90% of our fixed rate Agency RMBS portfolio was eligible for TBA delivery.
Equity Capital
To the extent we raise additional equity capital through follow-on equity offerings or under our dividend reinvestment and direct stock purchase plan, we may use cash proceeds from such transactions to purchase additional investment securities, to make scheduled payments of principal and interest on our funding liabilities andand/or for other general corporate purposes. There can be no assurance, however, that we will be able to raise additional equity capital at any particular time or on any particular terms. Furthermore, when the trading price of our common stock is significantly less than our estimate of our current tangible net assetbook value per common share, among other conditions, we may repurchase shares of our common stock, subject to the provisions of oura stock repurchase program (see Note 9 to our Consolidated Financial Statements in this Form 10-K).effect at such time.
OFF-BALANCE SHEET ARRANGEMENTS
As of December 31, 2016,2017, we did not maintain any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, or special purpose or variable interest entities, established for the purpose of facilitatingto facilitate off-balance sheet arrangements or other contractually narrow or limited purposes. Furthermore,Additionally, as of December 31, 2016,2017, we had not guaranteed any obligations of unconsolidated entities or entered into anya commitment or intent to provide funding to any such entities.
AGGREGATE CONTRACTUAL OBLIGATIONS
The following table summarizes the effect on our liquidity and cash flows from contractual obligations for repurchase agreements FHLB advances and related interest expense (in millions):
| | | | | Fiscal Year | | | | Fiscal Year | | |
| | | 2017 | | 2018 | | 2019 | | 2020 | | 2021 | | Total | | 2018 | | 2019 | | 2020 | | 2021 | | 2022 | | Total |
| Repurchase agreements and FHLB advances | | $ | 35,567 |
| | $ | 1,203 |
| | $ | 1,300 |
| | $ | 2,200 |
| | $ | 625 |
| | $ | 40,895 |
| |
| Repurchase agreements | | | $ | 45,771 |
| | $ | 1,700 |
| | $ | 2,200 |
| | $ | 625 |
| | $ | — |
| | $ | 50,296 |
|
Interest expense 1 | | 121 |
| | 63 |
| | 44 |
| | 14 |
| | 1 |
| | 243 |
| | 191 |
| | 61 |
| | 20 |
| | 1 |
| | — |
| | 273 |
|
| Total | | $ | 35,688 |
| | $ | 1,266 |
| | $ | 1,344 |
| | $ | 2,214 |
| | $ | 626 |
| | $ | 41,138 |
| | $ | 45,962 |
| | $ | 1,761 |
| | $ | 2,220 |
| | $ | 626 |
| | $ | — |
| | $ | 50,569 |
|
________________________
| |
| 1. | Interest expense is calculated based on the weighted average interest rates on our repurchase agreements and FHLB advances as of December 31, 2016.2017. |
FORWARD-LOOKING STATEMENTS
All statements contained herein that are not historical facts including, but not limited to, statements regarding anticipated activity areThis document contains forward looking in naturestatements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward looking statements are based on estimates, projections, beliefs and assumptions of our management as of the date of this Annual Report on Form 10-K and involve a number of risks and uncertainties. Actualuncertainties in predicting future results may differ materially. Among the factors thatand conditions. Our actual performance could cause actual results to differ materially arefrom those projected or anticipated in any forward looking statements due to a variety of factors, including, without limitation, changes in interest rates, the following: (i)yield curve or prepayment rates; the availability and terms of financing; changes in the market value of our assets; (ii) changesthe effectiveness of our risk mitigation strategies; conditions in net interest rate spreads; (iii) changes in prepayment rates of the market for Agency and other mortgage loans underlying our Agency securities; (iv) risks associated with our hedging activities; (v) availability and terms of financing arrangements; (vi) further actions by the U.S. government to stabilize the economy; (vii) changes in our business or investment strategy; (viii) legislative andor regulatory changes (including changes to laws governing the taxation of REITs); (ix)that affect our ability to meet the requirements ofstatus as a REIT (including income and asset requirements); and (x)or our ability to remain exemptexemption from registration under the Investment Company Act of 1940. For a1940 or that affect the GSE’s or secondary mortgage market in which we participate. A discussion of the risks and uncertainties whichthat could cause actual results to differ from those contained in the forward-lookingany of our forward looking statements please see the information under the caption "Risk Factors" describedis included in this Annual Report on Form 10-K.document under Item 1A. Risk Factors. We caution readers not to place undue reliance on any such forward-looking statements, which statements are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such, speak only as of the date made.our forward looking statements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the exposure to loss resulting from changes in market factors such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risks that we are exposed to are interest rate, prepayment, spread, liquidity, extension and credit risk.
Interest Rate Risk
Interest rate risk isrates are highly sensitive to many factors, including governmentalfiscal and monetary policies and tax policies, domestic and international economic and political considerations, andas well as other factors beyond our control.
Changes We are subject to interest rate risk in the general levelconnection with our assets and related financing obligations. Subject to maintaining our qualification as a REIT, we engage in a variety of interest rates can affectrate management techniques to mitigate the influence of interest rate changes on our net interest income which isand fluctuations of our net asset value.
We seek to hedge interest rate risk with respect to both the differencefixed income nature of our assets and short-term, variable rate nature of our financing. In hedging interest rates with respect to our fixed income assets, we attempt to reduce the risk of losses on the value of our investments that may result from changes in interest rates in the broader markets. In utilizing interest rate hedges with respect to our financing, we attempt to improve risk-adjusted returns and, where possible, to obtain a favorable spread between the yield on our assets and the cost of our financing. The principal instruments that we use to hedge our interest rate risk are interest rate swaps, swaptions, U.S. Treasury securities and U.S. Treasury futures contracts.
Our operating results depend in large part on differences between the income earned on interest-earningour assets and our cost of borrowing and hedging activities. The costs associated with our borrowings are generally based on prevailing market interest rates. During a period of rising interest rates, our borrowing costs generally will increase while the yields earned on our existing portfolio of leveraged fixed-rate assets will largely remain static. This can result in a decline in our net interest margin. The severity of any such decline would depend on our asset, liability and hedge composition at the time, as well as the magnitude and duration of the interest expense incurred in connection with our interest-bearing liabilities, by affecting the spread between our interest-earning assets and interest-bearing liabilities. rate increase.
Changes in the level of interest rates can also affect the rate of prepayments of our securities and the value of the mortgage securities that constitute our investment portfolio, which affects our net income and ability to realize gains from the sale of these assets and impacts our ability and the amount that we can borrow against these securities.
We utilize a variety of strategies to limit the effects of changes in interest rates on our operations. The principal instruments that we use are interest rate swaps and swaptions. We also utilize U.S. Treasury securities and U.S. Treasury futures contracts, primarily through short sales, as well as TBA contracts. We may also purchase or write put or call options on TBA securities and utilize other types of derivative instruments. Derivative instruments may expose us to certain risks, including the risk that losses on a hedge position will reduce the funds available for payments to holders of our common stock and that the losses may exceed the amount we invested in the instruments.
Our profitabilityprepayments and the value of our investment portfolio (including derivatives used forassets. Our hedging purposes)techniques are highly complex and are partly based on assumed levels of prepayments of our assets. If prepayments are slower or faster than assumed, the maturity our investments will also differ from our expectations, which could reduce the effectiveness of our hedging strategies and may because losses on such transactions and adversely affected during any period as a result of changing interest rates including changes in the forward yield curve.affect our cash flow.
Primary measures of an instrument's price sensitivity to interest rate fluctuations are its duration and convexity. Duration measures the estimated percentage change in market value of our mortgage assets or our hedge portfolio that would be caused by a parallel change in short and long-term interest rates. The duration of our investment portfolioassets changes with interest rates and tends to increase when interest rates rise and decrease when interest rates fall. This "negative convexity" generally increases the interest rate exposure of our investment portfolio in excess of what is measured by duration alone.
We estimate the duration and convexity of our portfolioassets using both a third-party risk management system and market data. We review the duration estimates from the third-party model and may make adjustments based on our judgment. These adjustments are intendedjudgment to better reflect theany unique characteristics and market trading conventions associated with certain types of securities.
The table below quantifies the estimated changes in (i) net interest income (including periodic interest costs on our interest rate swaps); (ii) the fair value of our investment portfolio (including derivatives and other securities used for hedging purposes); and (iii) our tangible net assetbook value as of December 31, 20162017 and 20152016 should interest rates go up or down by 50 and 100 basis points, assuming instantaneous parallel shifts in the yield curve and including the impact of both duration and convexity.
All changes in income and value in the table below are measured as percentage changes from the base interest rate scenario. The base interest rate scenario assumes interest rates and prepayment projections as of December 31, 20162017 and 2015.2016. We apply a floor of 0% for the down rate scenarios on our interest bearinginterest-bearing liabilities and the variable leg of our interest rate swaps, such that any hypothetical interest rate decrease would have a limited positive impact on our funding costs beyond a certain level.
Actual results could differ materially from estimates, especially in the current market environment. To the extent that these estimates or other assumptions do not hold true, which is likely in a period of high price volatility, actual results will likelycould differ materially from our projections. Moreover, if different models were employed in the analysis, materially different projections could result. Lastly, while the table below reflects the estimated impact of interest rate changes on a static portfolio, we actively manage our portfolio and we continuously make adjustments toadjust the size and composition of our asset and hedge portfolio.
| | Interest Rate Sensitivity 1 | Interest Rate Sensitivity 1 | Interest Rate Sensitivity 1 |
| | | Percentage Change in Projected | | Percentage Change in Projected |
| Change in Interest Rate | | Net Interest Income 2 | | Portfolio Market Value 3,4 | | Net Asset Value 3,5 | | Net Interest Income 2 | | Portfolio Market Value 3,4 | | Tangible Net Asset Value 3,5 |
| As of December 31, 2017 | | |
| -100 Basis Points | | | -10.4% | | -1.0% | | -9.1% |
| -50 Basis Points | | | -3.9% | | -0.2% | | -1.9% |
| +50 Basis Points | | | +0.4% | | -0.2% | | -2.0% |
| +100 Basis Points | | | +0.2% | | -0.7% | | -6.6% |
| | | |
| As of December 31, 2016 | | |
| -100 Basis Points | | -9.7% | | +0.6% | | +4.6% | | -9.7% | | +0.6% | | +4.9% |
| -50 Basis Points | | -1.8% | | +0.5% | | +4.1% | | -1.8% | | +0.5% | | +4.4% |
| +50 Basis Points | | +4.1% | | -0.8% | | -6.4% | | +4.1% | | -0.8% | | -6.9% |
| +100 Basis Points | | +6.2% | | -1.7% | | -14.1% | | +6.2% | | -1.7% | | -15.3% |
| | | |
| As of December 31, 2015 | | |
| -100 Basis Points | | -17.3% | | -0.4% | | -2.8% | |
| -50 Basis Points | | -4.2% | | +0.1% | | +0.6% | |
| +50 Basis Points | | +2.0% | | -0.5% | | -3.7% | |
| +100 Basis Points | | +2.5% | | -1.2% | | -9.4% | |
________________
| |
| 1. | Interest rate sensitivity is derived from models that are dependent on inputs and assumptions provided by third parties, assumes there are no changes in mortgage spreads and assumes a static portfolio. Actual results could differ materially from these estimates. |
| |
| 2. | Represents the estimated dollar change in net interest income expressed as a percent of net interest income based on asset yields and cost of funds as of such date. It includes the effect of periodic interest costs on our interest rate swaps, but excludes costs associated with our forward starting swaps and other supplemental hedges, such as swaptions and U.S. Treasury securities. Amounts also exclude costs associated with our TBA position and TBA dollar roll income/loss, which are accounted for as derivative instruments in accordance with GAAP. Base case scenario assumes interest rates and forecasted CPR of 8%8.4% and 8.0% as of December 31, 20162017 and 2015.2016, respectively. As of December 31, 20162017, rate shock scenarios assume a forecasted CPR of 10%13%, 9%10%, 7% and 7% for the -100, -50, +50 and +100 basis points scenarios, respectively. As of December 31, 2015,2016, rate shock scenarios assume a forecasted CPR of 12%, 10%, 8%9%, 7% and 7% for such scenarios, respectively. Estimated dollar change in net interest income does not include the impact of retroactive "catch-up" premium amortization adjustments due to changes in our forecasted CPR. Down rate scenarios assume a floor of 0% for anticipated interest rates. |
| |
| 3. | Includes the effect of derivatives and other securities used for hedging purposes. |
| |
| 4. | Estimated dollar change in investment portfolio value expressed as a percent of the total fair value of our investment portfolio as of such date. |
| |
| 5. | Estimated dollar change in portfolio value expressed as a percent of tangible stockholders' equity, net of the Series A and Series B Preferred Stockaggregate preferred stock liquidation preference, as of such date. |
Prepayment Risk
Because residential borrowers have the option to prepay their mortgage loans at par at any time, we facePrepayment risk is the risk that weour assets will experiencebe repaid at a return of principal on our investments faster rate than anticipated. VariousInterest rates and numerous other factors affect the rate at which mortgageof prepayments, occur, including changes in the level of and directional trends in housing prices, interest rates, general economic conditions, loan age, size and size, loan-to-value ratio, the location of the propertyratios, and social and demographic conditions. Additionally, changes to GSE underwriting practices or other governmental programs could also significantly impact prepayment rates or expectations. Also, the pace at which theof GSE buyouts of delinquent loans underlying our securities become seriously delinquent or are modified and the timing of GSE repurchases of such loans from our securities can materially impact the rate of prepayments.among other factors. Generally, prepayments on residential mortgage-backed securities increase during periods of falling mortgage interest rates and decrease during periods of rising mortgage interest rates. However, this may not always be the case.
WeIf our assets prepay at a faster rate than anticipated, we may be unable to reinvest principalthe repayments at a yield that isacceptable yields. If the proceeds are reinvested at lower or higheryields than the yield on the repaid investment, thus affectingour existing assets, our net interest income by altering the average yield on our assets.would be negatively impacted. We also amortize or accrete premiums and discounts associated withwe pay or receive at purchase relative to the purchasestated principal of mortgage securitiesour assets into interest income over thetheir projected lives of the securities, including contractual payments and estimated prepayments using the effective interest method. Our policy for estimating prepayment speeds for calculating the effective yield is to evaluate published prepayment data for similar securities, market consensus and current market conditions. If the actual and estimated future prepayment experiencedexperience differs from our estimate of prepayments,prior estimates, we will beare required to makerecord an adjustment to interest income for the amortization or accretionimpact of premiumsthe cumulative difference in the effective yield.
Extension Risk
Similar to prepayment risk, extension risk is the risk that our assets will be repaid at a slower rate than anticipated. Extension risk generally increases when interest rates rise. In this scenario, we may have to finance our investments at potentially higher costs without the ability to reinvest principal into higher yielding securities because borrowers prepay their mortgages at a slower pace than originally expected, adversely impacting our net interest margin, and discounts that would have an impact on futurethus our net interest income.
Spread Risk
WhenSpread risk is the risk that the market spread between the yield on our investment securitiesassets and the yield on benchmark interest rates, widens, our net book value could decline if the value of our investment securities fall by more than the offsetting fair value increases on our hedging instruments tied to the underlying benchmarksuch as U.S. Treasury rates and interest rates. We refer to this as "spread risk" or "basis risk."rate swap rates, may vary. The inherent spread risk associated with our mortgage assetsinvestment securities and the resulting fluctuations in fair value of these securities can occur independent of changes in benchmark interest rates and may relate to other factors impacting the mortgage and fixed income markets, such as actual or
anticipated monetary policy actions by the Federal Reserve, marketFed, liquidity, or
changes in required rates of return on different assets. Consequently,Our strategies are generally not specifically designed to protect against spread risk, thus while we use interest rate swaps and other supplemental hedges to attempt to protect against moves in interest rates, such instrumentsour hedges will typically will not protect our net book value against spread risk.risk and our tangible net book value could decline if spreads widen.
The table below quantifies the estimated changes in the fair value of our investment portfolio (including derivativesassets, net of hedges, and other securities used for hedging purposes) and in our tangible net assetbook value as of December 31, 20162017 and 20152016 should spreads widen or tighten by 10 and 25 basis points. The estimated impact of changes in spreads is in addition to our interest rate shock sensitivity included in the interest rate shock table above. The table below assumes a spread duration of 5.4 years5.3 and 5.25.4 years as of December 31, 20162017 and 2015,2016, respectively, based on interest rates and RMBS prices as of such dates. However, our portfolio's sensitivity of mortgage spread changes will vary with changes in interest rates and in the size and composition of our investment portfolio. Therefore, actual results could differ materially from our estimates.
| | | Spread Sensitivity of Agency RMBS Portfolio 1 | |
Spread Sensitivity 1 | | Spread Sensitivity 1 |
| | | Percentage Change in Projected | | Percentage Change in Projected |
| Change in MBS Spread | | Portfolio Market Value 2,3 | | Net Asset Value 2,4 | | Portfolio Market Value 2,3 | | Tangible Net Asset Value 2,4 |
| As of December 31, 2017 | | | |
| -25 Basis Points | | | +1.3% | | +12.6% |
| -10 Basis Points | | | +0.5% | | +5.0% |
| +10 Basis Points | | | -0.5% | | -5.0% |
| +25 Basis Points | | | -1.3% | | -12.6% |
| | | |
| As of December 31, 2016 | | | |
| -25 Basis Points | | +1.3% | | +11.0% | | +1.3% | | +12.0% |
| -10 Basis Points | | +0.5% | | +4.4% | | +0.5% | | +4.8% |
| +10 Basis Points | | -0.5% | | -4.4% | | -0.5% | | -4.8% |
| +25 Basis Points | | -1.3% | | -11.0% | | -1.3% | | -12.0% |
| | | |
| As of December 31, 2015 | | |
| -25 Basis Points | | +1.3% | | +10.2% | |
| -10 Basis Points | | +0.5% | | +4.1% | |
| +10 Basis Points | | -0.5% | | -4.1% | |
| +25 Basis Points | | -1.3% | | -10.2% | |
________________
| |
| 1. | Spread sensitivity is derived from models that are dependent on inputs and assumptions provided by third parties, assumes there are no changes in interest rates and assumes a static portfolio. Actual results could differ materially from these estimates. |
| |
| 2. | Includes the effect of derivatives and other securities used for hedging purposes. |
| |
| 3. | Estimated dollar change in investment portfolio value expressed as a percent of the total fair value of our investment portfolio as of such date. |
| |
| 4. | Estimated dollar change in portfolio value expressed as a percent of tangible stockholders' equity, net of the Series A and Series B Preferred Stockaggregate preferred stock liquidation preference, as of such date. |
Liquidity Risk
The primaryOur liquidity risk for usprincipally arises from financing long-term fixed rate assets with shorter-term, borrowings through repurchase agreements and other short-term funding agreements.variable rate borrowings. As of December 31, 20162017, we had unrestricted cash and cash equivalents of $1.21.0 billion and unpledged securities of approximately $1.83.6 billion, including securities pledged to us and unpledged interests in our consolidated VIEs, available to meet margin calls on our funding liabilities and derivative contracts and for other corporate purposes. However, should the value of our collateral or the value of our derivative instruments suddenly decrease, margin calls relating to our funding liabilities and derivative agreements could increase, causing an adverse change in our liquidity position. Furthermore, there is no assurance that we will always be able to renew (or roll) our short-term funding liabilities. In addition, our counterparties have the option to increase our haircuts (margin requirements) on the assets we pledge against our funding liabilities, thereby reducing the amount that can be borrowed against an asset even if they agree to renew or roll suchour funding liabilities. Significantly higher haircuts can reduce our ability to leverage our portfolio or even force us to sell assets, especially if correlated with asset price declines or faster prepayment rates on our assets.
In addition, we often utilize TBA dollar roll transactions as a means of investingto invest in and financingfinance Agency RMBS. Under certain economic conditions it may be uneconomical to roll our TBA dollar roll transactions prior tobeyond the next settlement date and we could have to take physical delivery of the underlying securities and settle our obligations for cash, which could negatively impact our liquidity position, result in defaults or force us to sell assets under adverse conditions.
ExtensionCredit Risk
The projected weighted-average lifeCredit risk is the risk that we may not receive full repayment of principal, interest or other remuneration related credit sensitive instruments. Investments in CRT and estimated duration, or interest rate sensitivity,non-Agency securities expose us to credit risk. We are also exposed to credit risk in the event our derivative counterparties do not perform under the terms of our investments is basedderivative agreements or in the event our repurchase agreement counterparties default on our assumptions regarding the rate at which the borrowers will prepaytheir obligations to resell the underlying mortgage loans. In general, we use interest ratecollateral back to us at the end of the repo term.
swaps and swaptions to help manage our funding cost on our investments in the event that interest rates rise. These swaps (or swaptions) allow us to reduce our fundingWe accept credit exposure on the notional amount of the swap for a specified period of time by establishing a fixed rate to pay in exchange for receiving a floating rate that generally tracks our financing costs under our funding liabilities.
However, if prepayment rates decrease in a rising interest rate environment, the average life or duration of our fixed rate assets generally extends. This could have a negative impact on our results from operations, as our interest rate swap maturities are fixed and will, therefore, cover a smaller percentage of our funding exposure on our mortgage assets to the extent that their average lives increase due to slower prepayments. This situation may also cause the market value of our fixed rate securities to decline by more than otherwise would be the case while most of our hedging instruments would not receive any incremental offsetting gains. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur realized losses.
Credit Risk
We are exposed to credit risk related to our CRT and non-Agency investments, certain derivative transactions, and our collateral held by funding and derivative counterparties. We accept credit exposuresecurities at levels we deem to be prudent as an integral partwithin the context of our overall investment and hedging strategy. We seekattempt to manage this risk through prudent asset selection, pre-acquisition due diligence, post-acquisition performance monitoring, and sale of assets where we have identifiedidentify negative credit trends and the use of various types of credit enhancements.trends. We may also use non-recourse financing, which limits our exposure tomanage credit losses to the specific pool of mortgages subject to the non-recourse financing. Our overall management of credit exposure may also include the use ofrisk with credit default swaps or other financial derivatives that we believe are appropriate. Additionally, we may vary the percentage mix of our investmentsAgency and credit sensitive assets or our duration gap, when we believe credit performance is inversely correlated with changes in interest rates, in an effort to actively adjust our credit exposure and toand/or improve the risk/return profile of our investment portfolio.
assets. Our credit risk related to certain derivative and repo transactions is largely mitigated through daily adjustments to collateral pledged based on changes in market value and we limitby limiting our counterparties to major financial institutions with acceptable credit ratings. ratings and monitoring concentration levels with any one counterparty. We also monitor and adjust the amount of collateral pledged based on changes in market value.
There is no guarantee that our efforts to manage credit risk will be successful and we could suffer losses if credit performance is worse than our expectations or if economic conditions worsen.our counterparties default on their obligations. As of December 31, 2017, our amount at risk with any counterparty related to our repurchase agreements was less than 5% of our tangible stockholders' equity and our maximum amount at risk with any counterparty related to our interest rate swap and swaption agreements, excluding centrally cleared swaps, was less than 1% of our stockholders' equity.
Item 8. Financial Statements
Our management is responsible for the accompanying consolidated financial statements and the related financial information. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States and necessarily include certain amounts that are based on estimates and informed judgments. Our management also prepared the related financial information included in this Annual Report on Form 10-K and is responsible for its accuracy and consistency with the consolidated financial statements.
The consolidated financial statements as of December 31, 20162017 and 20152016 and fiscal years 2017, 2016 2015 and 20142015 have been audited by Ernst & Young LLP, an independent registered public accounting firm, who conducted their audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). The independent registered public accounting firm's responsibility is to express an opinion on these consolidated financial statements.statements based on their audit. For further information refer to the Ernst & Young LLP audit opinion included in this Item 8 of our Annual Report.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of our management and Board of Directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2016,2017, utilizing the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in its Internal Control-Integrated Framework (2013 framework). Based on this assessment and those criteria, management determined that our internal control over financial reporting was effective as of December 31, 2016.2017. The effectiveness of our internal control over financial reporting as of December 31, 20162017 has been audited by Ernst & Young LLP, our independent registered public accounting firm, as stated in their attestation report included in this Form 10-K.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of AGNC Investment Corp.
We have audited AGNC Investment Corp.’s internal control over financial reporting as of December 31, 2016,2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, AGNC Investment Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based onthe COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of AGNC Investment Corp. as of December 31, 2017 and 2016, and the related consolidated statements of comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes, and our report dated February 26, 2018 expressed an unqualified opinion thereon.
Basis for Opinion
AGNC Investment Corp.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to AGNC Investment Corp. in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, AGNC Investment Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of AGNC Investment Corp. as of December 31, 2016 and 2015, and the related consolidated statements of comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016 of AGNC Investment Corp., and our report dated February 27, 2017 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
McLean,Tysons, Virginia
February 27, 201726, 2018
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of AGNC Investment Corp.
We have audited the accompanying consolidated balance sheets of AGNC Investment Corp. as of December 31, 20162017 and 2015,2016, and the related consolidated statements of comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2016. 2017, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of AGNC Investment Corp. at December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), AGNC Investment Corp.'s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 26, 2018 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company'sAGNC Investment Corp.'s management. Our responsibility is to express an opinion on these financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to AGNC Investment Corp. in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includesmisstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supportingregarding the amounts and disclosures in the financial statements. An auditOur audits also includes assessingincluded evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of AGNC Investment Corp. at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), AGNC Investment Corp.'s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 27, 2017 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
McLean,We have served as AGNC Investment Corp.’s auditor since 2008.
Tysons, Virginia
February 27, 201726, 2018
AGNC INVESTMENT CORP.
CONSOLIDATED BALANCE SHEETS
(in millions, except per share data)
| | | | December 31, | December 31, |
| | 2016 | | 2015 | 2017 | | 2016 |
| Assets: | | | | | | |
| Agency securities, at fair value (including pledged securities of $43,943 and $48,380, respectively) | $ | 45,393 |
| | $ | 51,331 |
| |
| Agency securities, at fair value (including pledged securities of $53,055 and $43,943, respectively) | | $ | 55,506 |
| | $ | 45,393 |
|
| Agency securities transferred to consolidated variable interest entities, at fair value (pledged securities) | 818 |
| | 1,029 |
| 662 |
| | 818 |
|
| Non-Agency securities, at fair value (including pledged securities of $90 and $113, respectively) | 124 |
| | 113 |
| |
| Credit risk transfer securities, at fair value | 164 |
| | — |
| 876 |
| | 164 |
|
| U.S. Treasury securities, at fair value (including pledged securities of $173 and $25, respectively) | 182 |
| | 25 |
| |
| Non-Agency securities, at fair value (including pledged securities of $0 and $90, respectively) | | 36 |
| | 124 |
|
| U.S. Treasury securities, at fair value (including pledged securities of $0 and $173, respectively) | | — |
| | 182 |
|
| REIT equity securities, at fair value | — |
| | 33 |
| 29 |
| | — |
|
| Cash and cash equivalents | 1,208 |
| | 1,110 |
| 1,046 |
| | 1,208 |
|
| Restricted cash and cash equivalents | 74 |
| | 1,281 |
| 317 |
| | 74 |
|
| Derivative assets, at fair value | 355 |
| | 81 |
| 205 |
| | 355 |
|
| Receivable for securities sold (pledged securities) | 21 |
| | — |
| — |
| | 21 |
|
| Receivable under reverse repurchase agreements | 7,716 |
| | 1,713 |
| 10,961 |
| | 7,716 |
|
| Goodwill and other intangible assets, net | 554 |
| | — |
| 551 |
| | 554 |
|
| Other assets | 271 |
| | 305 |
| 187 |
| | 271 |
|
| Total assets | $ | 56,880 |
| | $ | 57,021 |
| $ | 70,376 |
| | $ | 56,880 |
|
| Liabilities: | | | | | | |
| Repurchase agreements | $ | 37,858 |
| | $ | 41,754 |
| $ | 50,296 |
| | $ | 37,858 |
|
| Debt of consolidated variable interest entities, at fair value | | 357 |
| | 460 |
|
| Federal Home Loan Bank advances | 3,037 |
| | 3,753 |
| — |
| | 3,037 |
|
| Debt of consolidated variable interest entities, at fair value | 460 |
| | 595 |
| |
| Payable for securities purchased | — |
| | 182 |
| 95 |
| | — |
|
| Derivative liabilities, at fair value | 256 |
| | 935 |
| 28 |
| | 256 |
|
| Dividends payable | 66 |
| | 74 |
| 80 |
| | 66 |
|
Obligation to return securities borrowed under reverse repurchase agreements, at
fair value | 7,636 |
| | 1,696 |
| 10,467 |
| | 7,636 |
|
| Accounts payable and other liabilities | 211 |
| | 61 |
| 299 |
| | 211 |
|
| Total liabilities | 49,524 |
| | 49,050 |
| 61,622 |
| | 49,524 |
|
| Stockholders' equity: | | | | | | |
| Preferred stock - $0.01 par value; 10.0 shares authorized: | | | | |
| Redeemable Preferred Stock; $0.01 par value; 6.9 shares issued and outstanding (aggregate liquidation preference of $348) | 336 |
| | 336 |
| |
| Common stock - $0.01 par value; 600 shares authorized; | | | | |
| 331.0 and 337.5 shares issued and outstanding, respectively | 3 |
| | 3 |
| |
| 8.000% Series A Cumulative Redeemable Preferred Stock (aggregate liquidation preference of $0 and $173, respectively) | | — |
| | 167 |
|
| 7.750% Series B Cumulative Redeemable Preferred Stock (aggregate liquidation preference of $175) | | 169 |
| | 169 |
|
| 7.000% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (aggregate liquidation preference of $325 and $0, respectively) | | 315 |
| | — |
|
| Common stock - $0.01 par value; 600.0 shares authorized; 391.3 and 331.0 shares issued and outstanding, respectively | | 4 |
| | 3 |
|
| Additional paid-in capital | 9,932 |
| | 10,048 |
| 11,173 |
| | 9,932 |
|
| Retained deficit | (2,518 | ) | | (2,350 | ) | (2,562 | ) | | (2,518 | ) |
| Accumulated other comprehensive loss | (397 | ) | | (66 | ) | (345 | ) | | (397 | ) |
| Total stockholders' equity | 7,356 |
| | 7,971 |
| 8,754 |
| | 7,356 |
|
| Total liabilities and stockholders' equity | $ | 56,880 |
| | $ | 57,021 |
| $ | 70,376 |
| | $ | 56,880 |
|
See accompanying notes to consolidated financial statements.
AGNC INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions, except per share data)
| | | | For the year ended December 31, | For the year ended December 31, |
| | 2016 | | 2015 | | 2014 | 2017 | | 2016 | | 2015 |
| Interest income: | | | | | | | | | | |
| Interest income | $ | 1,321 |
| | $ | 1,466 |
| | $ | 1,472 |
| $ | 1,293 |
| | $ | 1,321 |
| | $ | 1,466 |
|
| Interest expense | 394 |
| | 330 |
| | 372 |
| 524 |
| | 394 |
| | 330 |
|
| Net interest income | 927 |
| | 1,136 |
| | 1,100 |
| 769 |
| | 927 |
| | 1,136 |
|
| Other gain (loss), net: | | | | | | | | | | |
| Gain (loss) on sale of investment securities, net | 109 |
| | (23 | ) | | 51 |
| (63 | ) | | 109 |
| | (23 | ) |
| Unrealized gain (loss) on investment securities measured at fair value through net income, net | (6 | ) | | 5 |
| | 32 |
| (71 | ) | | (6 | ) | | 5 |
|
| Loss on derivative instruments and other securities, net | (310 | ) | | (764 | ) | | (1,275 | ) | |
| Gain (loss) on derivative instruments and other securities, net | | 193 |
| | (310 | ) | | (764 | ) |
| Management fee income | 8 |
| | — |
| | — |
| 13 |
| | 8 |
| | — |
|
| Total other loss, net: | (199 | ) | | (782 | ) | | (1,192 | ) | |
| Total other gain (loss), net: | | 72 |
| | (199 | ) | | (782 | ) |
| Expenses: | | | | | | | | | | |
| Management fee expense | 52 |
| | 116 |
| | 119 |
| — |
| | 52 |
| | 116 |
|
| Compensation and benefits | 19 |
| | — |
| | — |
| 42 |
| | 19 |
| | — |
|
| Other operating expenses | 34 |
| | 23 |
| | 22 |
| 28 |
| | 34 |
| | 23 |
|
| Total operating expenses | 105 |
| | 139 |
| | 141 |
| 70 |
| | 105 |
| | 139 |
|
| Net income (loss) | 623 |
| | 215 |
| | (233 | ) | |
| Net income | | 771 |
| | 623 |
| | 215 |
|
| Dividend on preferred stock | 28 |
| | 28 |
| | 23 |
| 32 |
| | 28 |
| | 28 |
|
| Net income (loss) available (attributable) to common stockholders | $ | 595 |
| | $ | 187 |
| | $ | (256 | ) | |
| Issuance costs of redeemed preferred stock | | 6 |
| | — |
| | — |
|
| Net income available to common stockholders | | $ | 733 |
| | $ | 595 |
| | $ | 187 |
|
| | | | | | | | | | | |
| Net income (loss) | $ | 623 |
| | $ | 215 |
| | $ | (233 | ) | |
| Net income | | $ | 771 |
| | $ | 623 |
| | $ | 215 |
|
| Other comprehensive income (loss): | | | | | | | | | | |
| Unrealized gain (loss) on available-for-sale securities, net | (370 | ) | | (597 | ) | | 1,657 |
| 52 |
| | (370 | ) | | (597 | ) |
| Unrealized gain on derivative instruments, net | 39 |
| | 101 |
| | 156 |
| — |
| | 39 |
| | 101 |
|
| Other comprehensive income (loss) | (331 | ) | | (496 | ) | | 1,813 |
| 52 |
| | (331 | ) | | (496 | ) |
| Comprehensive income (loss) | 292 |
| | (281 | ) | | 1,580 |
| 823 |
| | 292 |
| | (281 | ) |
| Dividend on preferred stock | 28 |
| | 28 |
| | 23 |
| 32 |
| | 28 |
| | 28 |
|
| Issuance costs of redeemed preferred stock | | 6 |
| | — |
| | — |
|
| Comprehensive income (loss) available (attributable) to common stockholders | $ | 264 |
| | $ | (309 | ) | | $ | 1,557 |
| $ | 785 |
| | $ | 264 |
| | $ | (309 | ) |
| | | | | | | | | | | |
| Weighted average number of common shares outstanding - basic and diluted | 331.9 |
| | 348.6 |
| | 353.3 |
| |
| Net income (loss) per common share - basic and diluted | $ | 1.79 |
| | $ | 0.54 |
| | $ | (0.72 | ) | |
| Weighted average number of common shares outstanding - basic | | 358.6 |
| | 331.9 |
| | 348.6 |
|
| Weighted average number of common shares outstanding - diluted | | 358.7 |
| | 331.9 |
| | 348.6 |
|
| Net income per common share - basic and diluted | | $ | 2.04 |
| | $ | 1.79 |
| | $ | 0.54 |
|
See accompanying notes to consolidated financial statements.
AGNC INVESTMENT CORP.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in millions)
| | | | Preferred Stock | | Common Stock | | Additional
Paid-in
Capital | | Retained
Deficit | | Accumulated
Other
Comprehensive
Income (Loss) | | Total | 8.000% Series A Cumulative Redeemable Preferred Stock | | 7.750% Series B Cumulative Redeemable Preferred Stock | | 7.000% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock | | Common Stock | | Additional
Paid-in
Capital | | Retained
Deficit | | Accumulated
Other
Comprehensive
Income (Loss) | | Total |
| | Shares | | Amount | | Shares | | Amount | | | Shares | | Amount | |
| Balance, December 31 2013 | 6.9 |
| | $ | 167 |
| | 356.2 |
| | $ | 4 |
| | $ | 10,406 |
| | $ | (497 | ) | | $ | (1,383 | ) | | $ | 8,697 |
| |
| Net loss | — |
| | — |
| | — |
| | — |
| | — |
| | (233 | ) | | — |
| | (233 | ) | |
| Other comprehensive income: | | | | | | | | | | | | | | | | |
| Unrealized gain on available-for-sale securities, net | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 1,657 |
| | 1,657 |
| |
| Unrealized gain on derivative instruments, net | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 156 |
| | 156 |
| |
| Issuance of preferred stock | — |
| | 169 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 169 |
| |
| Repurchase of common stock | — |
| | — |
| | (3.4 | ) | | — |
| | (74 | ) | | — |
| | — |
| | (74 | ) | |
| Preferred dividends declared | — |
| | — |
| | — |
| | — |
| | — |
| | (23 | ) | | — |
| | (23 | ) | |
| Common dividends declared | — |
| | — |
| | — |
| | — |
| | — |
| | (921 | ) | | — |
| | (921 | ) | |
| Balance, December 31, 2014 | 6.9 |
| | 336 |
| | 352.8 |
| | 4 |
| | 10,332 |
| | (1,674 | ) | | 430 |
| | 9,428 |
| $ | 167 |
| | $ | 169 |
| | $ | — |
| | 352.8 |
| | $ | 4 |
| | $ | 10,332 |
| | $ | (1,674 | ) | | $ | 430 |
| | $ | 9,428 |
|
| Net income | — |
| | — |
| | — |
| | — |
| | — |
| | 215 |
| | — |
| | 215 |
| |
| Net Income | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 215 |
| | — |
| | 215 |
|
| Other comprehensive income (loss): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Unrealized loss on available-for-sale securities, net | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (597 | ) | | (597 | ) | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (597 | ) | | (597 | ) |
| Unrealized gain on derivative instruments, net | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 101 |
| | 101 |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 101 |
| | 101 |
|
| Repurchase of common stock | — |
| | — |
| | (15.3 | ) | | (1 | ) | | (284 | ) | | — |
| | — |
| | (285 | ) | — |
| | — |
| | — |
| | (15.3 | ) | | (1 | ) | | (284 | ) | | — |
| | — |
| | (285 | ) |
| Preferred dividends declared | — |
| | — |
| | — |
| | — |
| | — |
| | (28 | ) | | — |
| | (28 | ) | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (28 | ) | | — |
| | (28 | ) |
| Common dividends declared | — |
| | — |
| | — |
| | — |
| | — |
| | (863 | ) | | — |
| | (863 | ) | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (863 | ) | | — |
| | (863 | ) |
| Balance, December 31, 2015 | 6.9 |
| | 336 |
| | 337.5 |
| | 3 |
| | 10,048 |
| | (2,350 | ) | | (66 | ) | | 7,971 |
| 167 |
| | 169 |
| | — |
| | 337.5 |
| | 3 |
| | 10,048 |
| | (2,350 | ) | | (66 | ) | | 7,971 |
|
| Net income | — |
| | — |
| | — |
| | — |
| | — |
| | 623 |
| | — |
| | 623 |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 623 |
| | — |
| | 623 |
|
| Other comprehensive income (loss): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
|
| Unrealized loss on available-for-sale securities, net | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (370 | ) | | (370 | ) | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (370 | ) | | (370 | ) |
| Unrealized gain on derivative instruments, net | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 39 |
| | 39 |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 39 |
| | 39 |
|
| Repurchase of common stock | — |
| | — |
| | (6.5 | ) | | — |
| | (116 | ) | | — |
| | — |
| | (116 | ) | — |
| | — |
| | — |
| | (6.5 | ) | | — |
| | (116 | ) | | — |
| | — |
| | (116 | ) |
| Preferred dividends declared | — |
| | — |
| | — |
| | — |
| | — |
| | (28 | ) | | — |
| | (28 | ) | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (28 | ) | |
|
| | (28 | ) |
| Common dividends declared | — |
| | — |
| | — |
| | — |
| | — |
| | (763 | ) | | — |
| | (763 | ) | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (763 | ) | | — |
| | (763 | ) |
| Balance, December 31, 2016 | 6.9 |
| | $ | 336 |
| | 331.0 |
| | $ | 3 |
| | $ | 9,932 |
| | $ | (2,518 | ) | | $ | (397 | ) | | $ | 7,356 |
| 167 |
| | 169 |
| | — |
| | 331.0 |
| | 3 |
| | 9,932 |
| | (2,518 | ) | | (397 | ) | | 7,356 |
|
| Net income | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 771 |
| | — |
| | 771 |
|
| Other comprehensive income: | | | | | | | | | | | | | | | | | | |
| Unrealized gain on available-for-sale securities, net | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 52 |
| | 52 |
|
| Stock-based compensation | | — |
| | — |
| | — |
| | — |
| | — |
| | 4 |
| | — |
| | — |
| | 4 |
|
| Issuance of preferred stock | | — |
| | — |
| | 315 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 315 |
|
| Redemption of preferred stock | | (167 | ) | | — |
| | — |
| | — |
| | — |
| | — |
| | (6 | ) | | — |
| | (173 | ) |
| Issuance of common stock | | — |
| | — |
| | — |
| | 60.3 |
| | 1 |
| | 1,237 |
| | — |
| | — |
| | 1,238 |
|
| Preferred dividends declared | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (32 | ) | | — |
| | (32 | ) |
| Common dividends declared | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (777 | ) | | — |
| | (777 | ) |
| Balance, December 31, 2017 | | $ | — |
| | $ | 169 |
| | $ | 315 |
| | 391.3 |
| | $ | 4 |
| | $ | 11,173 |
| | $ | (2,562 | ) | | $ | (345 | ) | | $ | 8,754 |
|
See accompanying notes to consolidated financial statements.
AGNC INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
| | | | For the year ended December 31, | For the year ended December 31, |
| | 2016 | | 2015 | | 2014 | 2017 | | 2016 | | 2015 |
| Operating activities: | | | | | | | | | | |
| Net income (loss) | $ | 623 |
| | $ | 215 |
| | $ | (233 | ) | |
| Adjustments to reconcile net loss to net cash provided by operating activities: | | | | | | |
| Net income | | $ | 771 |
| | $ | 623 |
| | $ | 215 |
|
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | |
| Amortization of premiums and discounts on mortgage-backed securities, net | 400 |
| | 408 |
| | 472 |
| 378 |
| | 400 |
| | 408 |
|
| Amortization of accumulated other comprehensive loss on interest rate swaps de-designated as qualifying hedges | 39 |
| | 101 |
| | 156 |
| — |
| | 39 |
| | 101 |
|
| Amortization of intangible assets | 2 |
| | — |
| | — |
| 3 |
| | 2 |
| | — |
|
| Stock based compensation | 1 |
| | — |
| | — |
| |
| (Gain) loss on sale of mortgage-backed securities, net | (109 | ) | | 23 |
| | (51 | ) | |
| Unrealized loss on investment securities measured at fair value through net income, net | 6 |
| | 5 |
| | 32 |
| |
| Loss on derivative instruments and other securities, net | 310 |
| | 754 |
| | 1,211 |
| |
| Stock-based compensation | | 4 |
| | 1 |
| | — |
|
| (Gain) loss on sale of investment securities, net | | 63 |
| | (109 | ) | | 23 |
|
| Unrealized gain (loss) on investment securities measured at fair value through net income, net | | 71 |
| | 6 |
| | (5 | ) |
| (Gain) loss on derivative instruments and other securities, net | | (193 | ) | | 310 |
| | 764 |
|
| (Increase) decrease in other assets | 34 |
| | (83 | ) | | 55 |
| 82 |
| | 34 |
| | (83 | ) |
| Increase (decrease) in accounts payable and other accrued liabilities | 46 |
| | 5 |
| | (20 | ) | |
| Increase in accounts payable and other accrued liabilities | | 81 |
| | 46 |
| | 5 |
|
| Net cash provided by operating activities | 1,352 |
| | 1,428 |
| | 1,622 |
| 1,260 |
| | 1,352 |
| | 1,428 |
|
| Investing activities: | | | | | | | | | | |
| Purchases of mortgage-backed securities | (20,836 | ) | | (32,770 | ) | | (26,349 | ) | |
| Purchases of non-Agency securities | (34 | ) | | (116 | ) | | — |
| |
| Proceeds from sale of mortgage-backed securities | 18,030 |
| | 27,794 |
| | 30,587 |
| |
| Principal collections on mortgage-backed securities | 8,137 |
| | 7,922 |
| | 7,358 |
| |
| Purchases of credit risk transfer securities | (195 | ) | | — |
| | — |
| |
| Purchases of U.S. Treasury securities | (4,483 | ) | | (49,724 | ) | | (51,511 | ) | |
| Proceeds from sale of U.S. Treasury securities | 10,393 |
| | 48,354 |
| | 56,068 |
| |
| Purchases of Agency mortgage-backed securities | | (35,920 | ) | | (20,836 | ) | | (32,770 | ) |
| Purchases of credit risk transfer and non-Agency securities | | (1,074 | ) | | (229 | ) | | (116 | ) |
| Proceeds from sale of Agency mortgage-backed securities | | 18,701 |
| | 18,030 |
| | 27,794 |
|
| Proceeds from sale of credit risk transfer and non-Agency securities | | 494 |
| | — |
| | — |
|
| Principal collections on Agency mortgage-backed securities | | 6,869 |
| | 8,114 |
| | 7,920 |
|
| Principal collections on credit risk transfer and non-Agency securities | | 5 |
| | 23 |
| | 2 |
|
| Payments on U.S. Treasury securities | | (11,756 | ) | | (4,483 | ) | | (49,724 | ) |
| Proceeds from U.S. Treasury securities | | 14,557 |
| | 10,393 |
| | 48,354 |
|
| Net proceeds from (payments on) reverse repurchase agreements | (6,003 | ) | | 3,505 |
| | (3,337 | ) | (3,162 | ) | | (6,003 | ) | | 3,505 |
|
| Net proceeds from (payments on) other derivative instruments | (1,399 | ) | | (300 | ) | | 313 |
| |
| Net proceeds from (payments on) derivative instruments | | 253 |
| | (1,292 | ) | | (328 | ) |
| Purchases of REIT equity securities | — |
| | (11 | ) | | (234 | ) | (28 | ) | | — |
| | (11 | ) |
| Proceeds from sale of REIT equity securities | 39 |
| | 35 |
| | 416 |
| — |
| | 39 |
| | 35 |
|
| Purchase of AGNC Mortgage Management, LLC, net of cash acquired | (555 | ) | | — |
| | — |
| — |
| | (555 | ) | | — |
|
| (Increase) decrease in restricted cash and cash equivalents | 1,244 |
| | (568 | ) | | (612 | ) | |
| Other investing cash flows, net | 107 |
| | (28 | ) | | (350 | ) | |
| Net cash provided by investing activities | 4,445 |
| | 4,093 |
| | 12,349 |
| |
| (Increase) decrease in restricted cash pledged for derivative instruments | | (267 | ) | | 1,244 |
| | (568 | ) |
| Net cash provided by (used in) investing activities | | (11,328 | ) | | 4,445 |
| | 4,093 |
|
| Financing activities: | | | | | | | | | | |
| Proceeds from repurchase arrangements | 217,501 |
| | 380,580 |
| | 291,736 |
| 483,516 |
| | 217,538 |
| | 380,580 |
|
| Payments on repurchase agreements | (221,434 | ) | | (389,122 | ) | | (304,973 | ) | (471,078 | ) | | (221,434 | ) | | (389,122 | ) |
| Proceeds from Federal Home Loan Bank advances | 2,098 |
| | 12,957 |
| | — |
| — |
| | 2,098 |
| | 12,957 |
|
| Payments on Federal Home Loan Bank advances | (2,814 | ) | | (9,204 | ) | | — |
| (3,037 | ) | | (2,814 | ) | | (9,204 | ) |
| Payments on debt of consolidated variable interest entities | (135 | ) | | (155 | ) | | (158 | ) | (104 | ) | | (135 | ) | | (155 | ) |
| Net proceeds from preferred stock issuance | — |
| | — |
| | 169 |
| 315 |
| | — |
| | — |
|
| Payment for preferred stock redemption | | (173 | ) | | — |
| | — |
|
| Net proceeds from common stock issuances | | 1,238 |
| | — |
| | — |
|
| Payments for common stock repurchases | (116 | ) | | (285 | ) | | (74 | ) | — |
| | (116 | ) | | (285 | ) |
| Cash dividends paid | (799 | ) | | (902 | ) | | (1,094 | ) | (795 | ) | | (799 | ) | | (902 | ) |
| Net cash used in financing activities | (5,699 | ) | | (6,131 | ) | | (14,394 | ) | |
| (Increase) decrease in restricted cash pledged for derivative instruments | | 24 |
| | (37 | ) | | — |
|
| Net cash provided by (used in) financing activities | | 9,906 |
| | (5,699 | ) | | (6,131 | ) |
| Net change in cash and cash equivalents | 98 |
| | (610 | ) | | (423 | ) | (162 | ) | | 98 |
| | (610 | ) |
| Cash and cash equivalents at beginning of period | 1,110 |
| | 1,720 |
| | 2,143 |
| 1,208 |
| | 1,110 |
| | 1,720 |
|
| Cash and cash equivalents at end of period | $ | 1,208 |
| | $ | 1,110 |
| | $ | 1,720 |
| $ | 1,046 |
| | $ | 1,208 |
| | $ | 1,110 |
|
| | | | | | | | | | | |
| Supplemental disclosure to cash flow information: | | | | | | | | | | |
| Interest paid | $ | 332 |
| | $ | 215 |
| | $ | 217 |
| $ | 474 |
| | $ | 332 |
| | $ | 215 |
|
| Taxes paid | $ | — |
| | $ | 1 |
| | $ | 3 |
| $ | — |
| | $ | — |
| | $ | 1 |
|
See accompanying notes to consolidated financial statements.
AGNC INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Organization
We were organized in Delaware on January 7, 2008 and commenced operations on May 20, 2008 following the completion of our initial public offering ("IPO").offering. Our common stock is traded on The NASDAQNasdaq Global Select Market under the symbol "AGNC."
We operate so as to qualify to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code"). As a REIT, we are required to distribute annually 90% of our taxable net income. AsSo long as we continue to qualify as a REIT, we will generally not be subject to U.S. federalFederal or state corporate taxes on our taxable net income to the extent that we distribute our annual taxable net income to our stockholders on a timely basis. It is our intention to distribute 100% of our taxable net income, after application of available tax attributes, within the limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxabletax year.
We earn income primarily from investing in Agency residential mortgage-backed securities ("Agency RMBS") on a leveraged basis. These investments consist of residential pass-through mortgage securities for which the principal and interest payments are guaranteed by a U.S. Government-sponsored enterprise or a U.S. Government agency.agency ("Agency RMBS") on a leveraged basis. We may also invest in other types of mortgage and mortgage-related securities, such as credit risk transfer ("CRT") securities and non-Agency residential mortgage-backed securities ("non-Agency RMBS") and commercial mortgage-backed securities ("CMBS")non-Agency RMBS" and "CMBS," respectively), where repayment of principal and interest is not guaranteed by a U.S. Government-sponsored enterprise or U.S. Government agency (see Note 2 for further details).agency.
Our principal objective is to provide our stockholders with attractive risk-adjusted returns through a combination of monthly dividends and tangible net asset value (also referred to as "net book value" "NAV" and "stockholders' equity") accretion. We generate income from the interest earned on our investment assets, net of associated borrowing and hedging activities, and net realized gains and losses on our investments and hedging activities. We fund our investments primarily through borrowings structured as repurchase agreements.
Prior to July 1, 2016, we were externally managed by AGNC Management, LLC (formerly known as American Capital AGNC Management, LLC) (our "Manager"). On July 1, 2016, we completed the acquisition of all of the outstanding membership interests of AGNC Mortgage Management, LLC ("AMM," formerly known as American Capital Mortgage Management, LLC)AMM"), the parent company of our Manager, from American Capital Asset Management, LLC, ("ACAM"), a wholly owned portfolio company of American Capital, Ltd. ("ACAS"). AMM is also the parent company of MTGE Management, LLC, ("MTGE Manager," formerly known as American Capital MTGE Management, LLC), the external manager of MTGE Investment Corp. ("MTGE," formerly known as American Capital Mortgage Investment Corp.MTGE") (Nasdaq: MTGE). Following the closing of the acquisition of AMM, we became internally managed and are no longer affiliated with ACAS (see Notes 11and 12 for further details).the external manager of MTGE.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation and Consolidation
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). Our consolidated financial statements include the accounts of all subsidiaries and variable interest entities for which we are the primary beneficiary. Significant intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the period reported. Actual results could differ from those estimates.
Earnings per Share
Basic earnings per share ("EPS") is computed by dividing net income (loss) available (attributable) to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS assumes the conversion, exercise or issuance of all potential common stock equivalents unless the effect is to reduce a loss or increase the income per share.
Accumulated Other Comprehensive Income (Loss)
Accounting Standards Codification ("ASC") Topic 220, Comprehensive Income, divides comprehensive income into net income and other comprehensive income (loss) ("OCI"), which includes unrealized gains and losses on securities classified as available-for-sale and unrealized gains and losses on derivative financial instruments that are designated and qualify for cash flow hedge accounting under ASC Topic 815, Derivatives and Hedging ("ASC 815"). During fiscal year 2011, we discontinued designating our derivative financial instruments, principally interest rate swaps, as cash flow hedges. For further information regarding our discontinuation of cash flow hedge accounting, see Derivatives Instruments below and Note 5.
Cash and Cash Equivalents
Cash and cash equivalents consist of unrestricted demand deposits and highly liquid investments with original maturities of three months or less. Cash and cash equivalents are carried at cost, which approximates fair value.
Restricted Cash and Cash Equivalents
Restricted cash and cash equivalents includes cash and cash equivalents pledged as collateral for clearing and executing trades, repurchase agreements and other borrowings, and interest rate swaps and other derivative instruments. Restricted cash and cash equivalents are carried at cost, which approximates fair value.
Investment Securities
We primarily invest in Agency RMBS.The Agency RMBS in which we invest consist of residential mortgage pass-through securities and collateralized mortgage obligations ("CMOs") for which the principal and interest payments are guaranteed by a U.S. Government-sponsored enterprise, such as the Federal National Mortgage Association ("Fannie Mae") and the, Federal Home Loan Mortgage Corporation ("Freddie Mac"Mac," and together with Fannie Mae, the "GSEs"), or by a U.S. Government agency, such as the Government National Mortgage Association ("Ginnie Mae") (collectively referred to as "GSEs"). Interest-only and inverse interest-only securities (together referred to as "interest-only securities") represent the right to receive a specified proportion of the contractual interest flows of specific Agency CMO securities. Principal-only securities represent the right to receive the contractual principal flows of specific Agency CMO securities.
CRT securities are risk sharing instruments issued by the GSEs, and similarly structured transactions issued by third partythird-party market participants, that transfer a portion of the risk associated with credit losses within pools of conventional residential mortgage loans from the GSEs and/or third parties to private investors. Unlike Agency RMBS, full repayment of the original principal balance of CRT securities is not guaranteed by a GSE or governmentU.S. Government agency; rather, "credit risk transfer" is achieved by writing down the outstanding principal balance of the CRT securities if credit losses on a related pool of loans exceed certain thresholds. By reducing the amount that they are obligated to repay to holders of CRT securities, the GSEs and/or other third parties are able to offset credit losses on the related loans.
Non-Agency RMBS and CMBS (together, "Non-Agency MBS") are backed by residential and commercial mortgage loans, respectively, packaged and securitized by a private institution, such as a commercial bank. Non-Agency MBS typically benefit from credit enhancements derived from structural elements, such as subordination, overcollateralization or insurance, but nonetheless carry a higher level of credit exposure than Agency RMBS.
REIT equityMortgage-related securities representmay also include investments in the common stock of other publicly traded mortgage REITs, including MTGE, that primarily invest primarily in Agency RMBS.securities, non-Agency securities, other mortgage related instruments and/or real estate on a leveraged basis. As of December 31, 2017, our investments in REIT equity securities consisted solely of MTGE common stock.
Accounting Standards Codification ("ASC") Topic 320, Investments—Debt and Equity Securities, requires that at the time of purchase, we designate a security as held-to-maturity, available-for-sale or trading, depending on our ability and intent to hold such security to maturity. Alternatively, we may elect the fair value option of accounting for such securities pursuant to ASC Topic 825, Financial Instruments. We reportAll of our securities classifiedare reported at fair value as they have either been designated as available-for-sale or trading or available-for-sale or for which if we have elected the fair value option at fair value, while securities classified as held-to-maturity are reported at amortized cost.of accounting. Unrealized gains and losses on securities classified as available-for-sale are reported in accumulated other comprehensive income (loss) ("OCI").OCI. Unrealized gains and losses on securities classified as trading or for which we elected the fair value option are reflectedreported in net income through other gain (loss) during the period in which they occur. We may sell any of our securities as part of our overall management of our investment portfolio. Accordingly, unless we elect the fair value option, we typically designate our investment securities as available-for-sale. Investments in REIT equity securities are designated as trading securities. Upon the sale of a security designated as available-for-sale, we determine the cost of the security and the amount of unrealized gains or losses to reclassify out of accumulated OCI into earnings based on the specific identification method.
We have electedPrior to fiscal year 2017, we primarily designated our investment securities as available-for-sale. On January 1, 2017, we began electing the fair value option to accountof accounting for CRTall investment securities interest and principal-only securities and CMBS asacquired after fiscal year 2016. In our view, this election simplifies the accounting for such securities. Effective January 1, 2017, we elected the fair value option for future purchases of all investment securities including Agency RMBS and non-Agency MBS. In our view, this election will more appropriately
reflect reflects the resultresults of our operations for a particular reporting period, as the fair value changes for these financial assets will beare presented in a manner consistent with the presentation and timing of the fair value changes of our hedging instruments. We are not permitted to change the designation of available-for-sale securities acquired prior to January 1, 2017,2017; accordingly, such securities will continue to be classified as available-for-sale securities until such time as we receive full repayment of principal or we dispose of the security.
We estimate the fair value of Agency RMBS, non-Agency MBS and CRTour investment securities based on a market approach using "Level 2" inputs from third-party pricing services and non-binding dealer quotes derived from common market pricing methods. Such methods incorporate, but are not limited to, reported trades and executable bid and asked prices for similar securities, benchmark interest rate curves, such as the spread to the U.S. Treasury rate and interest rate swap curves, convexity, duration and the underlying characteristics of the particular security, including coupon, periodic and life caps, rate reset period, issuer, additional credit support and expected life of the security. We estimate the fair value of REIT equity securities based on a market approach using "Level 1" inputs based on quoted market prices. Refer to Note 7 for further discussion of fair value measurements.
We evaluate our investments designated as available-for-sale for other-than-temporary impairment ("OTTI") on at least a quarterly basis. The determination of whether a security is other-than-temporarily impaired may involve judgments and assumptions based on subjective and objective factors. When a security is impaired, an OTTI is considered to have occurred if any one of the following three conditions exists as of the financial reporting date: (i) we intend to sell the security (that is, a decision has been made to sell the security), (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis or (iii) we do not expect to recover the security's amortized cost basis, even if we do not intend to sell the security and it is not more likely than not that we will be required to sell the security. A general allowance for unidentified impairments in a portfolio of securities is not permitted.
If either of the first two conditions exists as of the financial reporting date, the entire amount of the impairment loss, if any, is recognized in earnings as a realized loss and the cost basis of the security is adjusted to its fair value. However, with respect to the first condition, since the liquidity of the Agency securities market allows us to obtain competitive bids and execute on a sale transaction typically within a day of making the decision to sell a security, we generally do not make decisions to sell specific mortgage securities until shortly prior to initiating a sell order. In some instances, we may sell specific Agency securities by delivering the securities into existing short "to-be-announced" ("TBA") contracts. TBA market conventions require the identification of the specific securities to be delivered no later than 48 hours prior to settlement. If we settle a short TBA contract through the delivery of securities, we will generally identify the specific securities to be delivered within one to two days before the 48-hour deadline.
If the third condition exists, the OTTI is separated into (i) the amount relating to credit loss (the "credit component") and (ii) the amount relating to all other factors (the "non-credit components"). Only the credit component is recognized in earnings, with the non-credit components recognized in OCI. However, in evaluating if the third condition exists, our investments in Agency securities typically would not have a credit component since the principal and interest are guaranteed by a GSE and, therefore, any unrealized loss is not the result of a credit loss. In addition, since unrealized gains and losses for securities designated as available-for-sale are recognized in OCI, any impairment loss for non-credit components is already recognized in OCI.
We did not recognize any OTTI charges on our investment securities for fiscal years 2017, 2016 2015 or 2014.2015.
Interest Income
Interest income is accrued based on the outstanding principal amount of the investment securities and their contractual terms. Premiums or discounts associated with the purchase of Agency RMBS and non-Agency MBS of high credit quality are amortized or accreted into interest income, respectively, over the projected lives of the securities, including contractual payments and estimated prepayments using the effective interest method in accordance with ASC Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs.
We estimate long-term prepayment speeds of our mortgage securities using a third-party service and market data. The third-party service provider estimates prepayment speeds using models that incorporate the forward yield curve, current mortgage rates, and mortgage rates of the outstanding loans, age and size of the outstanding loans, loan-to-value ratios, interest rate volatility and other factors. We review the prepayment speeds estimated by the third-party service and compare the results to market consensus prepayment speeds, if available. We also consider historical prepayment speeds and current market conditions to validate the reasonableness of the prepayment speeds estimated by the third-party serviceestimates and, based on our judgment, we may make adjustments to itsadjust the estimates. ActualWe review our actual and anticipated prepayment experience is reviewedon at least a quarterly basis and effective yields are recalculated when differences arise between (i) our previously estimated future prepayments and (ii) the actual prepayments to date plusand our currentlycurrent estimated future prepayments. If the actual and estimated future prepayment experience differs from our prior estimate of prepayments, we are required to record an adjustment in the current period to the amortization or accretion of premiums and discounts for the cumulative difference in the effective yield through the reporting date.
At the time we purchase CRT securities and non-Agency MBS that are not of high credit quality, we determine an effective yield based on our estimate of the timing and amount of future cash flows and our cost basis. Our initial cash flow estimates for these investments are based on our observations of current information and events and include assumptions related to interest rates, prepayment rates and the impact of default and severity rates on the timing and amount of credit losses. On at least a quarterly basis, we review the estimated cash flows and make appropriate adjustments, based on inputs and analysis received from external sources, internal models, and our judgment about interest rates, prepayment rates, the timing and amount of credit losses,regarding such inputs and other factors. Any resulting changes in effective yield are recognized prospectively based on the current amortized cost of the investment as adjusted for credit impairment, if any.
Repurchase Agreements
We finance the acquisition of securities for our investment portfolio primarily through repurchase transactions under master repurchase agreements. Pursuant to ASC Topic 860, Transfers and Servicing ("ASC 860"), we account for repurchase transactions as collateralized financing transactions, which are carried at their contractual amounts (cost), plus accrued interest, as specified in the respective transactions.interest. Our repurchase agreements typically have maturities of less than one year, but may extend up to five years or more. Interest rates underon our repurchase agreements generally correspond to one three or six monththree-month LIBOR plus or minus a fixed spread. The fair value of our repurchase agreements is assumed to equal cost as the interest rates are considered to be at market.
Federal Home Loan Bank Advances
Federal Home Loan Bank ("FHLB") advances are secured loans from the FHLB of Des Moines used to finance the acquisitions of investment securities. We account for FHLB advances as collateralized financing transactions, which are carried at their contractual amounts (cost), plus accrued interest, as specified in the respective transactions. In April 2015, our wholly-owned captive insurance subsidiary, Old Georgetown Insurance Co., LLC ("OGI"), was approved as a member of the FHLB of Des Moines. The FHLBs provide a variety of products and services to their members, including short and long-term secured loans. In January 2016, the Federal Housing Finance Agency released its final rule on changes to regulations concerning FHLB membership criteria. The final rule terminated OGI's FHLB membership and required repayment of all advances at the earlier of their contractual maturity dates or a one year period after the effective date of the final rule that concluded in February 2017. Interest rates under our FHLB advances generally correspond to the FHLB's Member Option Variable Rate or to one or three month LIBOR plus or minus a fixed spread. The fair value of our FHLB advances is assumed to equal cost as the interest rates are considered to be at market.
Reverse Repurchase Agreements and Obligation to Return Securities Borrowed under Reverse Repurchase Agreements
We from time to time borrow securities to cover short sales of U.S. Treasury securities through reverse repurchase transactions under our master repurchase agreements (see DerivativesDerivative Instruments below). We account for these as securities borrowing transactions and recognize an obligation to return the borrowed securities at fair value on the balance sheet based on the value of the underlying borrowed securities as of the reporting date. Our reverse repurchase agreements generally mature daily.typically have maturities of 30 days or less. The fair value of our reverse repurchase agreements is assumed to equal cost as the interest rates are generally reset daily.
Derivative Instruments
We use a variety of derivative instruments to hedge a portion of our exposure to market risks, including interest rate, prepayment, extension and liquidity risk.risks. The objective of our risk management strategy is to reduce fluctuations in net book value over a range of interest rate scenarios. In particular, we attempt to mitigate the risk of the cost of our variable rate liabilities increasing during a period of rising interest rates. The principalprimary instruments that we use are interest rate swaps, and options to enter into interest rate swaps ("swaptions"). We also utilize, U.S. Treasury securities and U.S. Treasury futures contracts, primarily through short sales, andcontracts. We also use forward contracts forin the purchase or sale of Agency RMBS securities on a generic pool basis in the "to-be-announced" market ("TBA securities"TBA") and on a specified pool basis. We may also purchase or write put or call options on TBA securities and utilize other types of derivative instruments to hedge a portion of our risk.
We also enter into TBA contracts as a means of investinginvest in and financingfinance Agency securities (thereby increasing our "at risk" leverage) or as a means of disposing of or reducingwell as to periodically reduce our exposure to Agency securities (thereby reducing our "at risk" leverage). Under TBA contracts, we agree to purchase or sell, for future delivery, Agency securities with certain principal and interest terms and certain types of collateral, but the particular Agency securities to be delivered are not identified until shortly before the TBA settlement date. We may also choose, prior to settlement, to move the settlement of these securities out to a later date by entering into an offsetting short or long position (referred to as a "pair off"), net settling the paired off positions for cash, and simultaneously purchasing or selling a similar TBA contract for a later settlement date. This transaction is commonly referred to as a "dollar roll." The Agency securities purchased or sold for a forward settlement date are typically priced at a discount to Agency securities forRMBS.
settlement in the current month. This difference (or discount) is referred to as the "price drop." The price drop is the economic equivalent of net interest carry income on the underlying Agency securities over the roll period (interest income less implied financing cost) and is commonly referred to as "dollar roll income/loss." Consequently, forward purchases of Agency securities and dollar roll transactions represent a form of off-balance sheet financing.
We account for derivative instruments in accordance with ASC Topic 815, Derivatives and Hedging ("ASC 815").815. ASC 815 requires an entity to recognize all derivatives as either assets or liabilities in our accompanying consolidated balance sheets and to measure those instruments at fair value.
Our derivative agreements generally contain provisions that allow for netting or setting off derivative assets and liabilities with the counterparty; however, we report related assets and liabilities on a gross basis in our consolidated balance sheets. Derivative instruments in a gain position are reported as derivative assets at fair value and derivative instruments in a loss position are reported as derivative liabilities at fair value in our consolidated balance sheets. Changes in fair value of derivative instruments and periodic settlements related to our derivative instruments are recorded in gain (loss) on derivative instruments and other securities, net in our consolidated statements of comprehensive income. Cash receipts and payments related to derivative instruments are classified in our consolidated statements of cash flows according to the underlying nature or purpose of the derivative transaction, generally in the investing section.
The use of derivative instruments creates exposure to credit risk relating to potential losses that could be recognized in the event thatif the counterparties to these instruments fail to perform their obligations under the contracts. Our derivative agreements require that we post or receive collateral to mitigate such risk. We also attempt to minimize thisour risk of loss by limiting our counterparties to major financial institutions with acceptable credit ratings, monitoring positions with individual counterparties and adjusting posted collateral as required.
Discontinuation ofInterest rate swap agreements
We use interest rate swaps to hedge accounting forthe variable cash flows associated with our borrowings made under repurchase agreements. Under our interest rate swap agreements, we typically pay a fixed rate and receive a floating rate based on one or three-month LIBOR ("payer swaps") with terms up to 20 years. Our swap agreements are privately negotiated in the over−the−counter ("OTC") market.
Swap agreements entered into after May 2013 are centrally cleared through a registered commodities exchange. We value centrally cleared interest rate swaps using the daily settlement price, or fair value, determined by the clearing exchange based on a pricing model that references observable market inputs, including LIBOR, swap rates and the forward yield curve. Our centrally cleared swaps require that we post an "initial margin" amount determined by the clearing exchange, which is generally intended to be set at a level sufficient to protect the exchange from the interest rate swap's maximum estimated single-day price movement. We also exchange "variation margin" based upon daily changes in fair value, as measured by the exchange. As a result of amendments to rules governing certain central clearing activities, which took effect January 3, 2017, the exchange of variation margin is a settlement of the interest rate swap, as opposed to pledged collateral. Accordingly, beginning 2017, we account for the receipt or payment of variation margin as a direct reduction to the carrying value of the interest rate swap asset or liability. Variation margin pledged / (received) was previously reported in restricted cash and cash equivalents / (other liabilities) in our consolidated balance sheet.
We value non-centrally cleared swaps using a combination of third-party valuations obtained from pricing services and the swap counterparty. The third-party valuations are model-driven using observable inputs, including LIBOR, swap rates and the forward yield curve. We also consider both our own and our counterparties' nonperformance risk in estimating the fair value of our interest rate swaps. In considering the effect of nonperformance risk, we assess the impact of netting and credit enhancements, such as collateral postings and guarantees, and have concluded that our own and our counterparty risk is not significant to the overall valuation of these agreements.
Prior to fiscal year 2011, we entered into interest rate swap agreements typically with the intention of qualifying for hedge accounting under ASC 815. However, during fiscal year 2011, we elected to discontinue hedge accounting for our interest rate swaps. Upon discontinuation of hedge accounting, the net deferred loss related to our de-designated interest rate swaps remained in accumulated OCI and has beenwas reclassified from accumulated OCI into interest expense on a straight-line basis over the remaining term of each interest rate swap through December 2016.
Interest rate swap agreements
We use interest rate swaps to hedge the variable cash flows associated with borrowings made under our repurchase agreement facilities. Under our interest rate swap agreements, we typically pay a fixed rate and receive a floating rate based on one, three or six-month LIBOR ("payer swaps") with terms up to 20 years. The floating rate we receive under our swap agreements has the effect of offsetting the repricing characteristics of our repurchase agreements and cash flows on such liabilities. Our swap agreements are privately negotiated in the over−the−counter ("OTC") market. Swap agreements entered into subsequent to May 2013 are centrally cleared through a registered commodities exchange ("centrally cleared swaps").
We estimate the fair value of our centrally cleared interest rate swaps using the daily settlement price determined by the respective exchange. Centrally cleared swaps are valued by the exchange using a pricing model that references the underlying rates including the overnight index swap rate and LIBOR forward rate to produce the daily settlement price.
We estimate the fair value of our "non-centrally cleared" swaps using a combination of inputs from counterparty and third-party pricing models to estimate the net present value of the future cash flows using the forward interest rate yield curve in effect as of the end of the measurement period. We also incorporate both our own and our counterparties' nonperformance risk in estimating the fair value of our interest rate swaps. In considering the effect of nonperformance risk, we consider the impact of netting and credit enhancements, such as collateral postings and guarantees, and have concluded that our own and our counterparty risk is not significant to the overall valuation of these agreements.
Interest rate swaptions
We purchase interest rate swaptions generally to help mitigate the potential impact of larger, more rapid changes in interest rates on the performance of our investment portfolio. Interest rate swaptions provide us the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay and receive interest rates in the future. Our swaption agreements typically provide us the option to enter into a pay-fixed rate interest rate swap which we refer as "payer swaptions."("payer swaptions"). We may also enter into swaption agreements that provide us the option to enter into a receive-fixed interest rate swap which we refer("receiver swaptions").
Our interest rate swaption agreements are privately negotiated in the OTC market and are not subject to as "receiver swaptions."central clearing. The premium paid for interest rate swaptions is reported as an asset in our consolidated balance sheets. The premium is valued at an amount equal toWe estimate the fair value of interest rate swaptions using a combination of inputs from counterparty and third-party pricing models based on the fair value of the swaptionfuture interest rate swap that wouldwe have the effectoption to enter into as well as the remaining length of closingtime that we have to exercise the positionoption, adjusted for nonperformancenon-performance risk, if any. The difference between the premium paid and the fair value of the swaption is reported in
gain (loss) on derivative instruments and other securities, net in our consolidated statements of comprehensive income. If a swaption expires unexercised, the realized loss on the swaption would be equal to the premium paid. If we sell or exercise a swaption, the realized gain or loss on the swaption would be equal to the difference between the cash or the fair value of the underlying interest rate swap received and the premium paid.
Our interest rate swaption agreements are privately negotiated in the OTC market and are not subject to central clearing. We estimate the fair value of interest rate swaptions using a combination of inputs from counterparty and third-party pricing models based on the fair value of the future interest rate swap that we have the option to enter into as well as the remaining length of time that we have to exercise the option, adjusted for non-performance risk, if any.
TBA securities
A TBA security is a forward contract for the purchase ("long position") or sale ("short position") of Agency RMBS at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date. The specific Agency RMBS to be delivered into the contract upon the settlement date, published each month by the Securities Industry and Financial Markets Association, are not known atuntil shortly before the time of the transaction.settlement date. We may enterchoose, prior to settlement, to move the settlement of these securities out to a later date by entering into an offsetting TBA contractsposition, net settling the offsetting positions for cash, and simultaneously purchasing or selling a similar TBA contract for a later settlement date (together referred to as a means of hedging against short-term changes"dollar roll transaction"). The Agency securities purchased or sold for a forward settlement date are typically priced at a discount to equivalent securities settling in the current month. This difference, or "price drop," is the economic equivalent to interest rates. We may also enter into TBA contractsincome on the underlying Agency securities, less an implied funding cost, over the forward settlement period (referred to as a means of acquiring or disposing"dollar roll income"). Consequently, forward purchases of Agency securities and utilize TBA dollar roll transactions to finance Agency RMBS purchases.represent a form of off-balance sheet financing.
We account for TBA contracts as derivative instruments since either the TBA contracts do not settle in the shortest period of time possible or we cannot assert that it is probable at inception and throughout the term of the TBA contract that we will take physical delivery ofphysically settle the Agency security uponTBA contract on the settlement of the contract.date. We account for TBA dollar roll transactions as a series of derivative transactions. Gains, losses and dollar roll income associated with our TBA contracts and dollar roll transactions are recognized in our consolidated statements of comprehensive income in gain (loss) on derivative instruments and other securities, net.
net in our consolidated statements of comprehensive income. We estimate the fair value of TBA securities based on similar methods used to value our Agency RMBS securities.
U.S. Treasury securities
We purchase and sell short U.S. Treasury securities and U.S. Treasury futures contracts to help mitigate the potential impact of changes in interest rates on the performance of our portfolio. We borrow securities to cover short sales of U.S. Treasury securities under reverse repurchase agreements. We account for these as securities borrowing transactions and recognize an obligation to return the borrowed securities at fair value on our accompanying consolidated balance sheets based on the value of the underlying borrowed securities as of the reporting date. Gains and losses associated with purchases and short sales of U.S. Treasury securities and U.S. Treasury futures contracts are recognized in gain (loss) on derivative instruments and other securities, net in our consolidated statements of comprehensive income.
Variable Interest Entities
ASC Topic 810, Consolidation ("ASC 810"), requires an enterprise to consolidate a variable interest entity ("VIE") if it is deemed the primary beneficiary of the VIE. Further, ASC 810 requires a qualitative assessment to determine the primary beneficiary of a VIE and ongoing assessments of whether an enterprise is the primary beneficiary of a VIE as well as additional disclosures for entities that have variable interests in VIEs.
We have entered into transactions involving CMO trusts, which are VIEs. We will consolidate a CMO trust if we are the CMO trust's primary beneficiary; that is, if we have a variable interest that provides us with a controlling financial interest in the CMO trust. An entity is deemed to have a controlling financial interest if the entity has the power to direct the activities of a VIE that most significantly impact the VIE's economic performance and the obligation to absorb losses of or right to receive benefits from the VIE that could potentially be significant to the VIE. As part of the qualitative assessment in determining if we have a controlling financial interest, we evaluate whether we control the selection of financial assets transferred to the CMO trust. For each of our consolidated CMO trusts we controlled the selection of the Agency RMBS transferred from our investment portfolio
to an investment bank in exchange for cash proceeds and at the same time entered into a commitment with the investment bank to purchase to-be-issued securities collateralized by the Agency RMBS transferred, which resulted in our consolidation of the CMO trusts.
Agency RMBS transferred to consolidated VIEs are reported on our consolidated balance sheets in Agency securities transferred to consolidated VIEs, at fair value and can only be used to settle the obligations of each respective VIE. We elected the option to account for the consolidated debt at fair value, with changes in fair value reflected in earnings during the period in which they occur, because we believe this election more appropriately reflects our financial position as both the consolidated assets and consolidated debt are presented in a consistent manner on our consolidated balance sheets.
We estimate the fair value of the consolidated debt based on the fair value of the Agency RMBS transferred to consolidated VIEs, less the fair value of our retained interests, which are measured on a market approach using "Level 2" inputs from third-party pricing services and dealer quotes. The fair value of the Agency RMBS transferred to the consolidated VIEs and the fair value of our retained interests are based on more observable inputs than inputs used to independently determine the value of our consolidated debt.
Long-Term Incentive Compensation
Stock-Based Compensation
We measure and recognize compensation expense for all stock-based payment awards made to employees and independent directors based on their fair values. Stock-based awards issued under our equity incentive plan include time-based and performance-based restricted stock unit ("RSU") awards. An RSU award is an agreement to issue an equivalent number of shares of our common stock, plus any equivalent shares for dividends declared on our common stock, at the time the award vests, or later if distribution of such shares has been deferred beyond the vesting date. Time-based RSU awards vest over a specified service period. Performance-based RSU awards vest over a specified service period subject to achieving long-term performance criteria.
We value RSU awards based on the fair value of our common stock on the date of grant. Compensation expense is recognized over each award’s respective service period. In the case of performance awards, we estimate the probability that the performance criteria will be achieved, and recognize expense only for those awards expected to vest. We reevaluate our estimates each reporting period and recognize a cumulative effect adjustment to expense if our estimates change from the prior period. We do not estimate forfeiture rates; rather, we adjust for forfeitures in the periods in which they occur.
Shares underlying RSUs are issued on the vesting dates, or later if distribution of such shares has been deferred beyond the vesting date, net of any minimum statutory tax withholdings to be paid by us on behalf of our employees. As a result, the actual number of shares issued will be fewer than the actual number of RSUs outstanding. When RSUs vest, we record a liability for withholding amounts to be paid by us as a reduction to additional paid-in capital.
Other Long-Term Incentive Compensation
Other long-term incentive compensation granted to employees consists of dollar denominated awards granted under our AGNC Mortgage Management, LLC Performance Incentive Plan-MTGE ("MTGE Incentive Plan"), which vest over a specified service period. The awards are cash funded by us and used to purchase shares of MTGE common stock on the open market, or we may alternatively contribute an equivalent number of shares of MTGE common stock from our investment holdings based on the closing price of a share of MTGE common stock on the grant date. The shares acquired or contributed by us are held in a trust during the requisite service period or longer, if distribution of such shares has been deferred beyond the vesting date. Awards granted under the MTGE Incentive Plan are intended to help facilitate the alignment of compensation for our personnel who are involved in the management of MTGE with MTGE’s actual performance.
We initially value MTGE Incentive Plan awards based on the dollar denominated value of the awards and subsequently remeasure the value of outstanding awards as of each reporting date based on the fair value of MTGE common stock held in the trust, including accrued dividend reinvestments. Compensation expense is recognized over each award’s requisite service period, with the impact of changes in the fair value of MTGE common stock and dividend reinvestments recognized as a cumulative adjustment to compensation expense, and we record a liability on our accompanying consolidated balance sheets for our obligation to deliver shares of MTGE common stock on the vesting date, or subsequent distribution date if deferred beyond the vesting date. We report the fair value of MTGE common stock held in the trust in other assets on our accompanying consolidated balance sheets.
Goodwill and Other Intangible Assets, Net
Goodwill is the cost of an acquisition in excess of the fair value of identified assets acquired and liabilities assumed and is recognized as an asset on our consolidated balance sheets. Acquired intangible assets that do not meet the criteria for recognition as a separate asset are included in goodwill. Goodwill is not subject to amortization but must be tested for impairment at least
annually. Intangible assets meeting the criteria for recognition as separate assets are recorded at their respective fair market values at the date of acquisition. Intangible assets with an estimated useful life are amortized over their expected useful life. As of December 31, 2017 and 2016, we had $526 million of goodwill and $25 million and $28 million, respectively, of other intangible assets, net of accumulated amortization, reported in goodwill and other intangible assets, net in our accompanying consolidated balance sheets related to our acquisition of AMM on July 1, 2016. Other intangible assets have a remaining weighted average amortization period of 8.5 years as of December 31, 2017.
A large majority our goodwill is associated with our pre-existing management agreement with AMM that did not qualify for separate recognition. We test goodwill for impairment on an annual basis and at interim periods when events or circumstances may make it more likely than not that an impairment has occurred. If a qualitative analysis indicates that there may be an impairment, a quantitative analysis is performed. The quantitative analysis requires that we compare the carrying value of the identified reporting unit comprising the goodwill to its fair value. If the carrying value of the reporting unit is greater than its fair value, an impairment charge is recognized to the extent the carrying amount of the reporting unit exceeds its fair value. We did not recognize a goodwill impairment charge during fiscal years 2017 or 2016.
Loss Contingencies
We evaluate the existence of any pending or threatened litigation or other potential claims against the Company in accordance with ASC Topic 450, Contingencies, which requires that we assess the likelihood and range of potential outcomes of any such matters. We are the defendant in twothree stockholder derivative lawsuits alleging that certain of our current and former directors and officers breached fiduciary duties and wasted corporate assets in connection withrelating to past renewals of the management agreement with our former external Manager and the internalization of our management, which occurred on July 1, 2016. Although the outcomes of these cases cannot be predicted with certainty, we do not believe that these cases have merit or will result in a material liability, and, as of December 31, 2016,2017, we did not accrue a loss contingency related to these matters.
Income Taxes
We elected to be taxed as a REIT under the provisions of the Internal Revenue Code and the corresponding provisions of state law, commencing with our initial tax year ended December 31, 2008. In order toTo continue to qualify as a REIT, we must annually distribute, in a timely manner to our stockholders, at least 90% of our taxable ordinary income, amongst other conditions. A REIT is generally not subject to U.S. federalFederal and state corporate income tax on its earnings to the extent that it distributes all its annual taxable net income to its stockholders and asso long as certain asset, income and stock ownership tests are met. We operate in a manner that willto allow us to be taxed as a REIT. As permitted by
During December of 2017, the Internal Revenue Code,Tax Cuts and Jobs Act ("TCJA") was signed into law. The TCJA includes sweeping changes to the U.S. tax system starting in fiscal year 2018, including a reduction of the maximum Federal corporate tax rate to 21% from 35% and a lower effective pass-through business income tax rate through the creation of a new deduction for individuals, estates, and trusts of 20 percent of their combined qualified business income amount and REIT can designate dividends paidordinary dividend distributions received. Since we typically distribute all our annual taxable income and, as such, do not pay corporate income taxes, we do not expect the TCJA to have a significant impact now or in the subsequent year as dividends of the current year if those dividends are both declared by the extended due date of the REIT's federal income tax return and paid to stockholders by the last day of the subsequent year; however, we may still be subject to a non-deductible 4% excise tax if the actual amount distributed tofuture on our stockholders in a calendar year is less than the minimum amount specified under federal tax laws.
We have a wholly-owned subsidiary for which we elected to treat as taxable REIT subsidiary. As such it is subject to federal and state income tax based on its taxable income. All other subsidiaries are disregarded entities for U.S. federal income tax purposes. As such, their assets, liabilities and income are generally treated as our assets, liabilities and income for purposes of U.S. federal and state corporate income taxes.consolidated financial statements.
We evaluate uncertain income tax positions, if any, in accordance with ASC Topic 740, Income Taxes ("ASC 740"). To the extent we incur interest and/or penalties in connection with our tax obligations, such amounts shall be classified as income tax expense on our consolidated statements of operations.
Goodwill and Other Intangible Assets, Net
Goodwill is the cost of an acquisition in excess of the fair value of identified assets acquired and liabilities assumed. Goodwill is recorded as an asset on our balance sheet. Acquired intangible assets that do not meet the criteria for recognition as a separate asset are included in goodwill. Goodwill is not subject to amortization but must be tested for impairment at least annually. Intangible assets meeting the criteria for recognition as separate assets are recorded at their respective fair market values at the date of acquisition. Intangible assets with an estimated useful life are amortized over their expected useful life. As of December 31, 2016, we had $526 million of goodwill and $28 million of other intangible assets, net of accumulated amortization, reported in goodwill and other intangible assets, net in our accompanying consolidated balance sheets related to our acquisition of AMM on July 1, 2016 (see Note 12 for further details).
We test goodwill for impairment on an annual basis and at interim periods when events or circumstances may make it more likely than not that an impairment has occurred. If a qualitative analysis indicates that there may be an impairment, a quantitative analysis is performed. The quantitative impairment test for goodwill utilizes a two-step approach whereby we compare the carrying value of the identified reporting unit comprising the goodwill to its fair value. If the carrying value of the reporting unit is greater than its fair value, the second step is performed, where the implied fair value of goodwill is determined and compared to its carrying value. An impairment charge is recognized to the extent the carrying amount of goodwill exceeds its fair value.
Recent Accounting Pronouncements
We consider the applicability and impact of all Accounting Standards Updates (“ASUs”("ASUs") issued by the Financial Accounting Standards Board. ASUs not listed below were determined to be either not applicable, are not expected to have a significant impact
on our consolidated financial statements when adopted, or did not have a significant impact on our consolidated financial statements upon adoption.
ASU 2014-09, Revenue from Contracts with Customers (Topic 606): ASU 2014-09 is a comprehensive revenue recognition standard that supersedes virtually all existing revenue guidance under U.S. GAAP. The standard’s core principle is that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. Revenue recognition with respect to financial instruments is not within the scope of ASU 2014-09 and therefore,our review of each of our revenue streams indicates that it iswill not expected to have a significant impact on our consolidated financial statements. ASU 2014-09 is effective on January 1, 2018.
ASU 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting: ASU 2016-09 simplifies several aspects of the accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The ASU is effective on January 1, 2017, with early adoption permitted. We early adopted ASU 2016-09 during fiscal year 2016, which did not have a significant impact on our consolidated financial statements.
ASU 2016-13, Financial Instruments - Credit Losses (Topic 606)326): ASU 2016-13 changes the impairment model for most financial assets and certain other instruments. Allowances for credit losses on available-for-sale debt securities will be recognized, rather than direct reductions in the amortized cost of the investments. The new model also requires the estimation of lifetime expected credit losses and corresponding recognition of allowance for losses on trade and other receivables, held-to-maturity debt
securities, loans, and other instruments held at amortized cost. The ASU requires certain recurring disclosures and is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2019, with early adoption permitted for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2018. ASU 2016-13 is not expected to have a significant impact on our consolidated financial statements.
ASU 2016-18, Statement of Cash Flows (Topic 230) - Restricted Cash: ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 will be effective on January 1, 2018 and is not expected to have a significant impact on our consolidated financial statements.
Note 3. Investment Securities
As of December 31, 20162017 and 2015,2016, our investment portfolio consisted of $46.5$57.1 billion and $52.5$46.5 billion of investment securities, at fair value, respectively, summarized in the tables below,and $15.7 billion and $11.2 billion and $7.4 billion netof TBA securities, at fair value, respectively. Our TBA position is reported at its net carrying value of $(147)$3 million and $14$(147) million as of December 31, 20162017 and 2015,2016, respectively, in derivative assets/assets / (liabilities) on our accompanying consolidated balance sheets. The net carrying value of our TBA position represents the difference between the fair value of the underlying Agency security in the TBA contract and the cost basis or the forward price to be paid or received for the underlying Agency security (see Note 5 for further details of our net TBA position as of December 31, 2016 and 2015).security.
As of December 31, 20162017 and 2015,2016, our investment securities had a net unamortized premium balance of $2.1$2.7 billion and $2.3$2.1 billion, respectively, including interest and principal-only securities.
The following tables summarize our investment securities as of December 31, 2017 and 2016, and 2015excluding TBA securities, (dollars in millions):. Details of our TBA securities as of each of the respective dates are included in Note 5.
|
| | | | | | | | | | | | | | | | |
| | | December 31, 2016 |
| Investment Securities | | Amortized Cost | | Gross Unrealized Gain | | Gross Unrealized Loss | | Fair Value |
| Agency RMBS: | | | | | | | | |
| Fixed rate | | $ | 45,145 |
| | $ | 210 |
| | $ | (619 | ) | | $ | 44,736 |
|
| Adjustable rate | | 371 |
| | 8 |
| | — |
| | 379 |
|
| CMO | | 796 |
| | 7 |
| | (2 | ) | | 801 |
|
| Interest-only and principal-only strips | | 268 |
| | 31 |
| | (4 | ) | | 295 |
|
| Total Agency RMBS | | 46,580 |
| | 256 |
| | (625 | ) | | 46,211 |
|
| Non-Agency RMBS | | 102 |
| | — |
| | (1 | ) | | 101 |
|
| CMBS | | 23 |
| | — |
| | — |
| | 23 |
|
| CRT securities | | 161 |
| | 3 |
| | — |
| | 164 |
|
| Total investment securities | | $ | 46,866 |
| | $ | 259 |
| | $ | (626 | ) | | $ | 46,499 |
|
| | | | | December 31, 2015 | | December 31, 2017 | | December 31, 2016 |
| Investments Securities | | Amortized Cost | | Gross Unrealized Gain | | Gross Unrealized Loss | | Fair Value | |
| Investment Securities | | | Amortized Cost | | Fair Value | | Amortized
Cost | | Fair Value |
| Agency RMBS: | | | | | | | | | | | | | | | | |
| Fixed rate | | $ | 50,576 |
| | $ | 339 |
| | $ | (393 | ) | | $ | 50,522 |
| | $ | 55,477 |
| | $ | 55,026 |
| | $ | 45,145 |
| | $ | 44,736 |
|
| Adjustable rate | | 484 |
| | 11 |
| | — |
| | 495 |
| | 278 |
| | 283 |
| | 371 |
| | 379 |
|
| CMO | | 973 |
| | 18 |
| | (1 | ) | | 990 |
| | 629 |
| | 631 |
| | 796 |
| | 801 |
|
| Interest-only and principal-only strips | | 317 |
| | 39 |
| | (3 | ) | | 353 |
| | 213 |
| | 228 |
| | 268 |
| | 295 |
|
| Total Agency RMBS | | 52,350 |
| | 407 |
| | (397 | ) | | 52,360 |
| | 56,597 |
| | 56,168 |
| | 46,580 |
| | 46,211 |
|
| Non-Agency RMBS | | 114 |
| | — |
| | (1 | ) | | 113 |
| | 7 |
| | 7 |
| | 102 |
| | 101 |
|
| CMBS | | | 28 |
| | 29 |
| | 23 |
| | 23 |
|
| CRT securities | | | 834 |
| | 876 |
| | 161 |
| | 164 |
|
| Total investment securities | | $ | 52,464 |
| | $ | 407 |
| | $ | (398 | ) | | $ | 52,473 |
| | $ | 57,466 |
| | $ | 57,080 |
| | $ | 46,866 |
| | $ | 46,499 |
|
| | | | | December 31, 2016 | | December 31, 2017 |
| | | Agency RMBS | | Non-Agency | | | | | | Agency RMBS | | Non-Agency | | | | |
| Investment Securities | | Fannie Mae | | Freddie Mac | | Ginnie Mae | | RMBS | | CMBS | | CRT | | Total | | Fannie Mae | | Freddie Mac | | Ginnie Mae | | RMBS | | CMBS | | CRT | | Total |
| Available-for-sale securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Par value | | $ | 34,244 |
| | $ | 10,008 |
| | $ | 44 |
| | $ | 101 |
| | $ | — |
| | $ | — |
| | $ | 44,397 |
| | $ | 24,200 |
| | $ | 8,219 |
| | $ | 34 |
| | $ | 7 |
| | $ | — |
| | $ | — |
| | $ | 32,460 |
|
| Unamortized discount | | (43 | ) | | (3 | ) | | — |
| | — |
| | — |
| | — |
| | (46 | ) | | (25 | ) | | (3 | ) | | — |
| | — |
| | — |
| | — |
| | (28 | ) |
| Unamortized premium | | 1,518 |
| | 544 |
| | — |
| | 1 |
| | — |
| | — |
| | 2,063 |
| | 1,119 |
| | 447 |
| | — |
| | — |
| | — |
| | — |
| | 1,566 |
|
| Amortized cost | | 35,719 |
| | 10,549 |
| | 44 |
| | 102 |
| | — |
| | — |
| | 46,414 |
| | 25,294 |
| | 8,663 |
| | 34 |
| | 7 |
| | — |
| | — |
| | 33,998 |
|
| Gross unrealized gains | | 176 |
| | 48 |
| | 1 |
| | — |
| | — |
| | — |
| | 225 |
| | 98 |
| | 22 |
| | 1 |
| | — |
| | — |
| | — |
| | 121 |
|
| Gross unrealized losses | | (442 | ) | | (179 | ) | | — |
| | (1 | ) | | — |
| | — |
| | (622 | ) | | (325 | ) | | (141 | ) | | — |
| | — |
| | — |
| | — |
| | (466 | ) |
| Total available-for-sale securities, at fair value | | 35,453 |
| | 10,418 |
| | 45 |
| | 101 |
| | — |
| | — |
| | 46,017 |
| | 25,067 |
| | 8,544 |
| | 35 |
| | 7 |
| | — |
| | — |
| | 33,653 |
|
| Securities remeasured at fair value through earnings: | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Par value 1 | | 171 |
| | — |
| | — |
| | — |
| | 24 |
| | 157 |
| | 352 |
| |
| Par value | | | 13,558 |
| | 7,956 |
| | — |
| | — |
| | 29 |
| | 801 |
| | 22,344 |
|
| Unamortized discount | | (35 | ) | | — |
| | — |
| | — |
| | (1 | ) | | — |
| | (36 | ) | | (34 | ) | | — |
| | — |
| | — |
| | (1 | ) | | — |
| | (35 | ) |
| Unamortized premium | | 118 |
| | 14 |
| | — |
| | — |
| | — |
| | 4 |
| | 136 |
| | 711 |
| | 415 |
| | — |
| | — |
| | — |
| | 33 |
| | 1,159 |
|
| Amortized cost | | 254 |
| | 14 |
| | — |
| | — |
| | 23 |
| | 161 |
| | 452 |
| | 14,235 |
| | 8,371 |
| | — |
| | — |
| | 28 |
| | 834 |
| | 23,468 |
|
| Gross unrealized gains | | 28 |
| | 3 |
| | — |
| | — |
| | — |
| | 3 |
| | 34 |
| | 26 |
| | 2 |
| | — |
| | — |
| | 1 |
| | 42 |
| | 71 |
|
| Gross unrealized losses | | (3 | ) | | (1 | ) | | — |
| | — |
| | — |
| | — |
| | (4 | ) | | (70 | ) | | (42 | ) | | — |
| | — |
| | — |
| | — |
| | (112 | ) |
| Total securities remeasured at fair value through earnings | | 279 |
| | 16 |
| | — |
| | — |
| | 23 |
| | 164 |
| | 482 |
| | 14,191 |
| | 8,331 |
| | — |
| | — |
| | 29 |
| | 876 |
| | 23,427 |
|
| Total securities, at fair value | | $ | 35,732 |
| | $ | 10,434 |
| | $ | 45 |
| | $ | 101 |
| | $ | 23 |
| | $ | 164 |
| | $ | 46,499 |
| | $ | 39,258 |
| | $ | 16,875 |
| | $ | 35 |
| | $ | 7 |
| | $ | 29 |
| | $ | 876 |
| | $ | 57,080 |
|
| Weighted average coupon as of December 31, 2016 | | 3.59 | % | | 3.67 | % | | 2.75 | % | | 3.42 | % | | 6.55 | % | | 5.25 | % | | 3.61 | % | |
Weighted average yield as of December 31, 2016 2 | | 2.77 | % | | 2.72 | % | | 2.00 | % | | 3.27 | % | | 7.54 | % | | 6.28 | % | | 2.77 | % | |
| Weighted average coupon as of December 31, 2017 | | | 3.67 | % | | 3.73 | % | | 2.84 | % | | 2.50 | % | | 6.55 | % | | 5.26 | % | | 3.71 | % |
Weighted average yield as of December 31, 2017 1 | | | 2.84 | % | | 2.87 | % | | 2.02 | % | | 3.08 | % | | 7.30 | % | | 5.19 | % | | 2.89 | % |
________________________________________________________
| |
| 1. | Par value amount excludes the underlying unamortized principal balance ("UPB") of interest-only securities of $0.9 billion as of December 31, 2016. |
| |
2. | Incorporates a weighted average future constant prepayment rate assumption of 8% based on forward rates as of December 31, 20162017. |
| | | | | December 31, 2015 | | December 31, 2016 |
| | | Agency RMBS | | Non-Agency | | | | Agency RMBS | | Non-Agency | | | | |
| Investment Securities | | Fannie Mae | | Freddie Mac | | Ginnie Mae | | RMBS | | Total | | Fannie Mae | | Freddie Mac | | Ginnie Mae | | RMBS | | CMBS | | CRT | | Total |
| Available-for-sale securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Par value | | $ | 39,205 |
| | $ | 10,575 |
| | $ | 62 |
| | $ | 113 |
| | $ | 49,955 |
| | $ | 34,244 |
| | $ | 10,008 |
| | $ | 44 |
| | $ | 101 |
| | $ | — |
| | $ | — |
| | $ | 44,397 |
|
| Unamortized discount | | (32 | ) | | (4 | ) | | — |
| | — |
| | (36 | ) | | (43 | ) | | (3 | ) | | — |
| | — |
| | — |
| | — |
| | (46 | ) |
| Unamortized premium | | 1,707 |
| | 519 |
| | 1 |
| | 1 |
| | 2,228 |
| | 1,518 |
| | 544 |
| | — |
| | 1 |
| | — |
| | — |
| | 2,063 |
|
| Amortized cost | | 40,880 |
| | 11,090 |
| | 63 |
| | 114 |
| | 52,147 |
| | 35,719 |
| | 10,549 |
| | 44 |
| | 102 |
| | — |
| | — |
| | 46,414 |
|
| Gross unrealized gains | | 286 |
| | 80 |
| | 2 |
| | — |
| | 368 |
| | 176 |
| | 48 |
| | 1 |
| | — |
| | — |
| | — |
| | 225 |
|
| Gross unrealized losses | | (283 | ) | | (111 | ) | | — |
| | (1 | ) | | (395 | ) | | (442 | ) | | (179 | ) | | — |
| | (1 | ) | | — |
| | — |
| | (622 | ) |
| Total available-for-sale securities, at fair value | | 40,883 |
| | 11,059 |
| | 65 |
| | 113 |
| | 52,120 |
| | 35,453 |
| | 10,418 |
| | 45 |
| | 101 |
| | — |
| | — |
| | 46,017 |
|
| Securities remeasured at fair value through earnings: | | | | | | | | | | | | | | | | | | | | | | | | |
Par value 1 | | 208 |
| | — |
| | — |
| | — |
| | 208 |
| |
| Par value | | | 171 |
| | — |
| | — |
| | — |
| | 24 |
| | 157 |
| | 352 |
|
| Unamortized discount | | (42 | ) | | — |
| | — |
| | — |
| | (42 | ) | | (35 | ) | | — |
| | — |
| | — |
| | (1 | ) | | — |
| | (36 | ) |
| Unamortized premium | | 132 |
| | 19 |
| | — |
| | — |
| | 151 |
| | 118 |
| | 14 |
| | — |
| | — |
| | — |
| | 4 |
| | 136 |
|
| Amortized cost | | 298 |
| | 19 |
| | — |
| | — |
| | 317 |
| | 254 |
| | 14 |
| | — |
| | — |
| | 23 |
| | 161 |
| | 452 |
|
| Gross unrealized gains | | 35 |
| | 4 |
| | — |
| | — |
| | 39 |
| | 28 |
| | 3 |
| | — |
| | — |
| | — |
| | 3 |
| | 34 |
|
| Gross unrealized losses | | (2 | ) | | (1 | ) | | — |
| | — |
| | (3 | ) | | (3 | ) | | (1 | ) | | — |
| | — |
| | — |
| | — |
| | (4 | ) |
| Total securities remeasured at fair value through earnings | | 331 |
| | 22 |
| | — |
| | — |
| | 353 |
| | 279 |
| | 16 |
| | — |
| | — |
| | 23 |
| | 164 |
| | 482 |
|
| Total securities, at fair value | | $ | 41,214 |
| | $ | 11,081 |
| | $ | 65 |
| | $ | 113 |
| | $ | 52,473 |
| | $ | 35,732 |
| | $ | 10,434 |
| | $ | 45 |
| | $ | 101 |
| | $ | 23 |
| | $ | 164 |
| | $ | 46,499 |
|
| Weighted average coupon as of December 31, 2015 | | 3.62 | % | | 3.69 | % | | 3.18 | % | | 3.50 | % | | 3.63 | % | |
Weighted average yield as of December 31, 2015 2 | | 2.79 | % | | 2.77 | % | | 1.97 | % | | 3.33 | % | | 2.78 | % | |
| Weighted average coupon as of December 31, 2016 | | | 3.59 | % | | 3.67 | % | | 2.75 | % | | 3.42 | % | | 6.55 | % | | 5.25 | % | | 3.61 | % |
Weighted average yield as of December 31, 2016 1 | | | 2.77 | % | | 2.72 | % | | 2.00 | % | | 3.27 | % | | 7.54 | % | | 6.28 | % | | 2.77 | % |
________________________________________________________
| |
| 1. | Par value amount excludes the UPB of interest-only securities of $1.0 billion as of December 31, 2015. |
| |
2. | Incorporates a weighted average future constant prepayment rate assumption of 8% based on forward rates as of December 31, 2015.2016. |
As of December 31, 20162017 and 2015,2016, our investments in CRT and non-Agency securities had the following credit ratings:
| | | | | December 31, 2016 | | December 31, 2015 | | December 31, 2017 | | December 31, 2016 |
Non-Agency Security Credit Ratings 1 | | CRT | | RMBS | | CMBS | | CRT | | RMBS | | CMBS | |
CRT and Non-Agency Security Credit Ratings 1 | | | CRT | | RMBS | | CMBS | | CRT | | RMBS | | CMBS |
| AAA | | $ | — |
| | $ | 99 |
| | $ | — |
| | $ | — |
| | $ | 113 |
| | $ | — |
| | $ | — |
| | $ | 7 |
| | $ | — |
| | $ | — |
| | $ | 99 |
| | $ | — |
|
| BBB | | — |
| | — |
| | 23 |
| | — |
| | — |
| | — |
| | 20 |
| | — |
| | 29 |
| | — |
| | — |
| | 23 |
|
| BB | | | 136 |
| | — |
| | — |
| | — |
| | — |
| | — |
|
| B | | 164 |
| | 2 |
| | — |
| | — |
| | — |
| | — |
| | 691 |
| | — |
| | — |
| | 164 |
| | 2 |
| | — |
|
| Not Rated | | | 29 |
| | — |
| | — |
| | — |
| | — |
| | — |
|
| Total | | $ | 164 |
| | $ | 101 |
| | $ | 23 |
| | $ | — |
| | $ | 113 |
| | $ | — |
| | $ | 876 |
| | $ | 7 |
| | $ | 29 |
| | $ | 164 |
| | $ | 101 |
| | $ | 23 |
|
________________________________________________________
| |
| 1. | Represents the lowest of Standard and Poor's ("S&P"), Moody's and Fitch credit ratings, stated in terms of the S&P equivalent rating as of each date. |
Our CRT securities reference the performance of loans that have been guaranteedunderlying Agency RMBS issued by Fannie Mae or Freddie Mac, which were subject to their underwriting standards. As of December 31, 2017, our CRT securities had floating rate coupons ranging from 3.9% to 8.5%, referenced to loans originated between 2012 and 2017 with weighted average coupons ranging from 3.6% to 4.4%. As of 2016, our CRT securities had floating rate coupons ranging from 4.6% to 7.1%, referenced to loans originated between 2015 and 2016 with weighted average coupons of underlying collateral ranging from 4.0% to 4.2%. The loans underlying our CRT securities were originated between 2015 and 2016.
The actual maturities of our investment securities are generally shorter than their stated contractual maturities. Actual maturities are affected by the contractual lives of the underlying mortgages, periodic contractual principal payments and principal prepayments. As of December 31, 20162017 and 2015,2016, the weighted average expected constant prepayment rate ("CPR") over the remaining life of our aggregate investment portfolio was 8%.8.4% and 8.0%, respectively. Our estimates can differ materially for different types of securities and thus our individual holdings have a wide range of projected CPRs.
The following table summarizes our investments classified as available-for-sale as of December 31, 20162017 and 20152016 according to their estimated weighted average life classification (dollars in millions):
| | | | | December 31, 2016 | | December 31, 2015 | | December 31, 2017 | | December 31, 2016 |
| Estimated Weighted Average Life of Securities Classified as Available-for-Sale | | Fair Value | | Amortized Cost | | Weighted Average Coupon | | Weighted Average Yield | | Fair Value | | Amortized Cost | | Weighted Average Coupon | | Weighted Average Yield | |
| Estimated Weighted Average Life of Investment Securities | | | Fair Value | | Amortized Cost | | Weighted Average Coupon | | Weighted Average Yield | | Fair Value | | Amortized Cost | | Weighted Average Coupon | | Weighted Average Yield |
| ≥ 1 year and ≤ 3 years | | $ | 414 |
| | $ | 410 |
| | 3.99% | | 2.52% | | $ | 167 |
| | $ | 163 |
| | 4.02% | | 2.66% | | $ | 2,712 |
| | $ | 2,693 |
| | 3.90% | | 2.67% | | $ | 419 |
| | $ | 416 |
| | 4.33% | | 2.27% |
| > 3 years and ≤ 5 years | | 13,534 |
| | 13,449 |
| | 3.26% | | 2.40% | | 17,497 |
| | 17,343 |
| | 3.27% | | 2.40% | | 7,499 |
| | 7,518 |
| | 3.31% | | 2.39% | | 13,601 |
| | 13,509 |
| | 3.38% | | 2.44% |
| > 5 years and ≤10 years | | 30,226 |
| | 30,713 |
| | 3.65% | | 2.86% | | 34,206 |
| | 34,391 |
| | 3.67% | | 2.93% | | 45,977 |
| | 46,398 |
| | 3.75% | | 2.95% | | 30,513 |
| | 30,979 |
| | 3.74% | | 2.89% |
| > 10 years | | 1,843 |
| | 1,842 |
| | 3.02% | | 3.07% | | 250 |
| | 250 |
| | 3.56% | | 3.08% | | 892 |
| | 857 |
| | 4.87% | | 4.74% | | 1,966 |
| | 1,962 |
| | 3.17% | | 3.27% |
| Total | | $ | 46,017 |
| | $ | 46,414 |
| | 3.52% | | 2.73% | | $ | 52,120 |
| | $ | 52,147 |
| | 3.54% | | 2.75% | | $ | 57,080 |
| | $ | 57,466 |
| | 3.71% | | 2.89% | | $ | 46,499 |
| | $ | 46,866 |
| | 3.61% | | 2.77% |
The following table presents the gross unrealized loss and fair values of oursecurities classified as available-for-sale securities by length of time that such securities have been in a continuous unrealized loss position as of December 31, 20162017 and 20152016 (in millions):
| | | | | Unrealized Loss Position For | | Unrealized Loss Position For |
| | | Less than 12 Months | | 12 Months or More | | Total | | Less than 12 Months | | 12 Months or More | | Total |
| Securities Classified as Available-for-Sale | | Estimated Fair Value | | Unrealized Loss | | Estimated Fair Value | | Unrealized Loss | | Estimated Fair Value | | Unrealized Loss | | Fair Value | | Unrealized Loss | |
Fair Value | | Unrealized Loss | | Fair Value | | Unrealized Loss |
| December 31, 2017 | | | $ | 3,582 |
| | $ | (15 | ) | | $ | 20,577 |
| | $ | (451 | ) | | $ | 24,159 |
| | $ | (466 | ) |
| December 31, 2016 | | $ | 28,397 |
| | $ | (554 | ) | | $ | 1,719 |
| | $ | (68 | ) | | $ | 30,116 |
| | $ | (622 | ) | | $ | 28,397 |
| | $ | (554 | ) | | $ | 1,719 |
| | $ | (68 | ) | | $ | 30,116 |
| | $ | (622 | ) |
| December 31, 2015 | | $ | 24,035 |
| | $ | (200 | ) | | $ | 6,793 |
| | $ | (195 | ) | | $ | 30,828 |
| | $ | (395 | ) | |
We did not recognize any OTTI charges on our investment securities for fiscal years 20162017 and 2015.2016. As of the end of each respective reporting period, a decision had not been made to sell any of our securities in an unrealized loss position and we did not believe it was more likely than not that we would be required to sell such securities before recovery of their amortized cost basis. The unrealized losses on our securities were not due to credit losses given the GSE or U.S. Government agency guarantees, but rather were due to changes in interest rates and prepayment expectations. However, as we continue to actively manage our portfolio, we may recognize additional realized losses on our investment securities upon selecting specific securities to sell.
Gains and Losses on Sale of Investment Securities
The following table is a summary of our net gain (loss) from the sale of investment securities classified as available-for-sale for fiscal years 2017 and 2016 2015 and 2014by investment classification of accounting (in millions). Please refer to Note 8 for a summary of changes in accumulated OCI for the same periods.
|
| | | | | | | | | | | | |
| | | Fiscal Year |
| Securities Classified as Available-for-Sale | | 2016 | | 2015 | | 2014 |
| RMBS sold, at cost | | $ | (17,907 | ) | | $ | (27,578 | ) | | $ | (30,123 | ) |
Proceeds from RMBS sold 1 | | 18,016 |
| | 27,555 |
| | 30,174 |
|
| Net gain (loss) on sale of RMBS | | $ | 109 |
| | $ | (23 | ) | | $ | 51 |
|
| | | | | | | |
| Gross gain on sale of RMBS | | $ | 123 |
| | $ | 98 |
| | $ | 172 |
|
| Gross loss on sale of RMBS | | (14 | ) | | (121 | ) | | (121 | ) |
| Net gain (loss) on sale of RMBS | | $ | 109 |
| | $ | (23 | ) | | $ | 51 |
|
|
| | | | | | | | | | | | | | | | | | | | |
| | | Fiscal Year 2017 | | Fiscal Year 2016 |
| Investment Securities | | Available-for-Sale Securities 2 | Fair Value Option Securities | Total | | Available-for-Sale Securities 2 | Fair Value Option Securities | Total |
| Investment securities sold, at cost | | $ | (6,324 | ) | $ | (12,913 | ) | $ | (19,237 | ) | | $ | (17,907 | ) | $ | — |
| $ | (17,907 | ) |
Proceeds from investment securities sold 1 | | 6,241 |
| 12,933 |
| 19,174 |
| | 18,016 |
| — |
| 18,016 |
|
| Net gain (loss) on sale of investment securities | | $ | (83 | ) | $ | 20 |
| $ | (63 | ) | | $ | 109 |
| $ | — |
| $ | 109 |
|
| | | | | | | | | |
| Gross gain on sale of investment securities | | $ | 16 |
| $ | 48 |
| $ | 64 |
| | $ | 123 |
| $ | — |
| $ | 123 |
|
| Gross loss on sale of investment securities | | (99 | ) | (28 | ) | (127 | ) | | (14 | ) | — |
| (14 | ) |
| Net gain (loss) on sale of investment securities | | $ | (83 | ) | $ | 20 |
| $ | (63 | ) | | $ | 109 |
| $ | — |
| $ | 109 |
|
________________________________________________________
| |
| 1. | Proceeds include cash received during the period, plus receivable for RMBSinvestment securities sold during the period as of period end. |
| |
| 2. | See Note 9 for a summary of changes in accumulated OCI. |
Securitizations and Variable Interest Entities
As of December 31, 20162017 and 2015,2016, we held investments in CMO trusts, which are variable interest entities ("VIEs").VIEs. We have consolidated certain of these CMO trusts in our consolidated financial statements where we have determined we are the primary beneficiary of the trusts. All of our CMO securities are backed by fixed or adjustable-rate Agency RMBS. Fannie Mae or Freddie Mac guarantees the payment of interest and principal and acts as the trustee and administrator of their respective securitization trusts. Accordingly, we are not required to provide the beneficial interest holders of the CMO securities any financial or other support. Our maximum exposure to loss related to our involvement with CMO trusts is the fair value of the CMO securities and interest and principal-only securities held by us, less principal amounts guaranteed by Fannie Mae and Freddie Mac.
In connection with our consolidated CMO trusts, we recognized Agency securities with a total fair value and approximate unpaid principal balance of $0.80.7 billion and $1.0$0.8 billion as of December 31, 20162017 and 2015,2016, respectively, and debt with a total fair value and approximate unpaid principal balance of $460 million0.4 billion and $595 million,$0.5 billion, respectively, in our accompanying consolidated balance sheets. As of December 31, 2016 and 2015, the Agency securities had an aggregate unpaid principal balance of $0.8 billion and $1.0 billion, respectively, and the debt had an aggregate unpaid principal balance of $452 million and $587 million, respectively. We re-measure our consolidated debt at fair value through earnings in gain (loss) on derivative instruments and other securities, net in our consolidated statements of comprehensive income. For fiscal years 2016, 2015 and 2014, we recorded a loss of $3 million, a gain of $16 million and a loss of $10 million, respectively, associated with our consolidated debt. Our involvement with the consolidated trusts is limited to the Agency securities transferred by us upon the formation of the trusts and the CMO securities subsequently held by us. There are no arrangements that could require us to provide financial support to the trusts.
As of December 31, 20162017 and 2015,2016, the fair value of our CMO securities and interest and principal-only securities was $1.10.9 billion and $1.3$1.1 billion, respectively, excluding the consolidated CMO trusts discussed above, or $1.51.2 billion and $1.8$1.5 billion, respectively, including the net asset value of our consolidated CMO trusts. Our maximum exposure to loss related to our CMO securities and interest and principal-only securities, including our consolidated CMO trusts, was $182124 million and $238$182 million as of December 31, 20162017 and 2015,2016, respectively.
Note 4. Repurchase Agreements and Other Secured Borrowings
We pledge certain of our securities as collateral under our repurchaseborrowing agreements with financial institutions and under our secured borrowing facility with the Federal Home Loan Bank ("FHLB") of Des Moines.institutions. Interest rates on our borrowings are generally based on LIBOR plus or minus a margin and amounts available to be borrowed are dependent upon the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, type of security and liquidity conditions within the banking, mortgage finance and real estate industries. If the fair value of our pledged securities declines, lenders will typically require us to post additional collateral or pay down borrowings to re-establish agreed upon collateral requirements, referred to as "margin calls." Similarly, if the fair value of our pledged securities increases, lenders may release collateral back to us. As of December 31, 20162017, we had met all margin call requirements. For additional information regarding our pledged assets, please refer to Note 6.
Repurchase Agreements
As of December 31, 20162017 and 2015,2016, we had $37.9$50.3 billion and $41.8$37.9 billion, respectively, of repurchase agreements outstanding. The terms and conditions of our repurchase agreements are typically negotiated on a transaction-by-transaction basis.
Our repurchase agreements with original maturities greater than 90 daysone year have floating interest rates based on an index plus or minus a fixed spread. Substantially all of our repurchase agreements were used to fund purchases of Agency securities ("Agency repo"). The remainder of our repurchase agreements were used to fund temporary holdings of U.S. Treasury securities ("U.S.
Treasury repo").
The following table summarizes our borrowings under repurchase agreements by their remaining maturities as of December 31, 20162017 and 20152016 (dollars in millions):
| | | | | December 31, 2016 | | December 31, 2015 | | December 31, 2017 | | December 31, 2016 |
| Remaining Maturity | | Repurchase Agreements | | Weighted Average Interest Rate | | Weighted Average Days to Maturity | | Repurchase Agreements | | Weighted Average Interest Rate | | Weighted Average Days to Maturity | | Repurchase Agreements | | Weighted Average Interest Rate | | Weighted Average Days to Maturity | | Repurchase Agreements | | Weighted Average Interest Rate | | Weighted Average Days to Maturity |
| Agency repo: | | | | | | | | | | | | | | | | | | | | | | | | |
| ≤ 1 month | | $ | 17,481 |
| | 0.90 | % | | 11 |
| | $ | 17,579 |
| | 0.54 | % | | 14 |
| | $ | 19,771 |
| | 1.59 | % | | 11 |
| | $ | 17,481 |
| | 0.90 | % | | 11 |
|
| > 1 to ≤ 3 months | | 10,011 |
| | 0.93 | % | | 55 |
| | 14,283 |
| | 0.64 | % | | 58 |
| | 16,150 |
| | 1.50 | % | | 50 |
| | 10,011 |
| | 0.93 | % | | 55 |
|
| > 3 to ≤ 6 months | | 2,030 |
| | 1.02 | % | | 136 |
| | 3,154 |
| | 0.61 | % | | 121 |
| | 7,287 |
| | 1.50 | % | | 130 |
| | 2,030 |
| | 1.02 | % | | 136 |
|
| > 6 to ≤ 9 months | | 1,270 |
| | 0.98 | % | | 214 |
| | 589 |
| | 0.65 | % | | 199 |
| | 2,361 |
| | 1.66 | % | | 225 |
| | 1,270 |
| | 0.98 | % | | 214 |
|
| > 9 to ≤ 12 months | | 1,566 |
| | 1.08 | % | | 299 |
| | 1,201 |
| | 0.65 | % | | 307 |
| | 202 |
| | 1.64 | % | | 297 |
| | 1,566 |
| | 1.08 | % | | 299 |
|
| > 12 to ≤ 24 months | | 1,203 |
| | 1.28 | % | | 538 |
| | 1,473 |
| | 0.73 | % | | 600 |
| | 1,700 |
| | 1.84 | % | | 468 |
| | 1,203 |
| | 1.28 | % | | 538 |
|
| > 24 to ≤ 36 months | | 1,300 |
| | 1.36 | % | | 865 |
| | 650 |
| | 0.81 | % | | 901 |
| | 2,200 |
| | 1.80 | % | | 803 |
| | 1,300 |
| | 1.36 | % | | 865 |
|
| > 36 to ≤ 48 months | | 2,200 |
| | 1.32 | % | | 1,168 |
| | 1,300 |
| | 0.86 | % | | 1,231 |
| | 625 |
| | 1.90 | % | | 1,141 |
| | 2,200 |
| | 1.32 | % | | 1,168 |
|
| > 48 to < 60 months | | 625 |
| | 1.38 | % | | 1,506 |
| | 1,500 |
| | 0.76 | % | | 1,477 |
| | — |
| | — |
| | — |
| | 625 |
| | 1.38 | % | | 1,506 |
|
| Total Agency repo | | 37,686 |
| | 0.98 | % | | 187 |
| | 41,729 |
| | 0.61 | % | | 173 |
| | 50,296 |
| | 1.57 | % | | 116 |
| | 37,686 |
| | 0.98 | % | | 187 |
|
| U.S. Treasury repo: | | | | | | | | | | | | | | | | | | | | | | | | |
| 1 day | | — |
| | — | % | | — |
| | 25 |
| | — | % | | 1 |
| |
| > 1 day to ≤ 1 month | | 172 |
| | (0.30 | )% | | 17 |
| | — |
| | — | % | | — |
| | — |
| | — |
| | — |
| | 172 |
| | (0.30 | )% | | 17 |
|
| Total | | $ | 37,858 |
| | 0.98 | % | | 186 |
| | $ | 41,754 |
| | 0.61 | % | | 173 |
| | $ | 50,296 |
| | 1.57 | % | | 116 |
| | $ | 37,858 |
| | 0.98 | % | | 186 |
|
As of December 31, 2017 and 2016, $5.3 billion and $150 million, respectively, of our Agency repurchase agreements matured overnight and none of our repurchase agreements were due on demand.
Federal Home Loan Bank Advances
On January 12,As of December 31, 2016, we had $3.0 billion of outstanding secured Federal Home Loan Bank ("FHLB") advances, with a weighted average borrowing rate of 0.73%. Our FHLB advances matured in February 2017, coinciding with the Federal Housing Finance Agency ("FHFA") released its final rule on FHLB membership, which terminatedtermination of our wholly-owned captive insurance subsidiary's FHLB membership and required repayment of all FHLB advances at the earlier of their contractual maturity or a one year period that concluded in February 2017.2017 pursuant to the Federal Housing Finance Agency's ("FHFA") final rule on FHLB membership released in January 2016. As of December 31, 2016 and 2015,a result, we had $3.0 billion and $3.8 billion, respectively, ofno outstanding secured FHLB advances with a weighted average borrowing rateas of 0.73% and 0.53%, respectively, and a weighted average remaining term to maturity of 28 and 141 days, respectively, consisting of 30 day and longer-term floating rate advances:
|
| | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2016 | | December 31, 2015 |
| Remaining Maturity | | FHLB Advances | | Weighted
Average
Interest
Rate | | Weighted
Average Days
to Maturity | | FHLB Advances | | Weighted
Average
Interest
Rate | | Weighted
Average Days
to Maturity |
| ≤ 1 month | | $ | 1,353 |
| | 0.67 | % | | 7 |
| | $ | 1,952 |
| | 0.47 | % | | 14 |
|
| > 1 to ≤ 3 months | | 1,684 |
| | 0.77 | % | | 44 |
| | 681 |
| | 0.60 | % | | 84 |
|
| 13 months | | — |
| | — | % | | — |
| | 1,120 |
| | 0.58 | % | | 397 |
|
| Total FHLB advances | | $ | 3,037 |
| | 0.73 | % | | 28 |
| | $ | 3,753 |
| | 0.53 | % | | 141 |
|
December 31, 2017.
Debt of Consolidated Variable Interest Entities
As of December 31, 20162017 and 2015,2016, debt of consolidated VIEs, at fair value, was $460357 million and $595$460 million, respectively, and had a weighted average interest rate of LIBOR plus 3637 and 3436 basis points, respectively, and a principal balance of $452349 million and $587$452 million, respectively. The actual maturities of our debt of consolidated VIEs are generally shorter than the stated contractual maturities. The actual maturities are affected by the contractual lives of the underlying Agency RMBS securitizing the debt of our consolidated VIEs and periodic principal prepayments of such underlying securities. The estimated weighted average life of the debt of our consolidated VIEs as of December 31, 20162017 and 20152016 was 5.85.7 years and 4.95.8 years, respectively.
Note 5. Derivative and Other Hedging Instruments
As a function of our risk management strategy, weWe hedge a portion of our interest rate risk by entering into derivative and other hedging instrument contracts. The principal instruments that we use are interest rate swaps, and interest rate swaptions and U.S. Treasury securities and U.S. Treasury futures contracts, primarily through short sales. We may also utilize TBA securities, purchase or write put or call options on TBA securities and other types of derivative instruments to hedge a portion of our risk. We also enter into TBA contracts as a means of investing in and financing Agency securities (thereby increasing our "at risk" leverage) or as a means of disposing of or reducing our exposure to Agency securities (thereby reducing our "at risk" leverage). Our risk management strategy attempts to manage the overall risk of the portfolio, reduce fluctuations in our net book value and generate additional income distributable to stockholders. For additional information regarding our derivative instruments and our overall risk management strategy, please refer to the discussion of derivative and other hedging instruments in Note 2.
Prior to September 30, 2011, our interest rate swaps were typically designated as cash flow hedges under ASC 815; however, as of September 30, 2011, we elected to discontinue hedge accounting for our interest rate swaps in order to increase our funding flexibility. For fiscal years 2016, 2015 and 2014, we reclassified $39 million, $101 million and $156 million, respectively, of net deferred losses from accumulated OCI into interest expense related to our de-designated interest rate swaps and recognized an equal, but offsetting, amount in other comprehensive income. Our total net periodic interest costs on our swap portfolio were $294 million, $494 million and 486 million for fiscal years 2016, 2015 and 2014, respectively. The difference between our total net periodic interest costs on our swap portfolio and the amount recorded in interest expense related to our de-designated hedges is reported in gain (loss) on derivative instruments and other securities, net in our accompanying consolidated statements of comprehensive income (totaling $255 million, $393 million and 330 million for fiscal years 2016, 2015 and 2014, respectively). As of December 31, 2016, all of the net deferred losses related to de-designated interest rate swaps had been reclassified from accumulated OCI into interest expense.
Derivative and Other Hedging Instrument Assets (Liabilities), at Fair Value
The table below summarizes fair value information about our derivative and other hedging instrument assets/(liabilities) as of December 31, 20162017 and 20152016 (in millions):
| | | | | December 31, | | | | | | | |
| Derivative and Other Hedging Instruments | | Balance Sheet Location | | 2016 | | 2015 | | Balance Sheet Location | | 2017 | | 2016 |
| Interest rate swaps | | Derivative assets, at fair value | | $ | 321 |
| | $ | 31 |
| | Derivative assets, at fair value | | $ | 81 |
| | $ | 321 |
|
| Swaptions | | Derivative assets, at fair value | | 22 |
| | 17 |
| | Derivative assets, at fair value | | 75 |
| | 22 |
|
| TBA securities | | Derivative assets, at fair value | | 4 |
| | 29 |
| | Derivative assets, at fair value | | 30 |
| | 4 |
|
| U.S. Treasury futures - short | | Derivative assets, at fair value | | 8 |
| | 4 |
| | Derivative assets, at fair value | | 19 |
| | 8 |
|
| Total derivative assets, at fair value | | $ | 355 |
| | $ | 81 |
| | $ | 205 |
| | $ | 355 |
|
| | | | | | | | | |
| Interest rate swaps | | Derivative liabilities, at fair value | | $ | (105 | ) | | $ | (920 | ) | | Derivative liabilities, at fair value | | $ | (1 | ) | | $ | (105 | ) |
| TBA securities | | Derivative liabilities, at fair value | | (151 | ) | | (15 | ) | | Derivative liabilities, at fair value | | (27 | ) | | (151 | ) |
| Total derivative liabilities, at fair value | | $ | (256 | ) | | $ | (935 | ) | | $ | (28 | ) | | $ | (256 | ) |
| | | | | | | | | |
| U.S. Treasury securities - long | | U.S. Treasury securities, at fair value | | $ | 182 |
| | $ | 25 |
| | U.S. Treasury securities, at fair value | | $ | — |
| | $ | 182 |
|
| U.S. Treasury securities - short | | Obligation to return securities borrowed under reverse repurchase agreements, at fair value | | (7,636 | ) | | (1,696 | ) | | Obligation to return securities borrowed under reverse repurchase agreements, at fair value | | (10,467 | ) | | (7,636 | ) |
| Total U.S. Treasury securities, net at fair value | | $ | (7,454 | ) | | $ | (1,671 | ) | | $ | (10,467 | ) | | $ | (7,454 | ) |
The following table summarizestables summarize certain characteristics of our interest rate swap agreementsderivative and other hedging instruments outstanding as of December 31, 20162017 and 20152016 (dollars in millions):
| | | | | December 31, 2016 | | December 31, 2015 | | December 31, 2017 | | December 31, 2016 |
| Payer Interest Rate Swaps | | Notional
Amount 1 | | Average
Fixed Pay Rate 2 | | Average
Receive
Rate 3 | | Net
Fair Value | | Average
Maturity
(Years) | | Notional
Amount 1 | | Average
Fixed Pay Rate 2 | | Average
Receive
Rate 3 | | Net
Fair Value | | Average
Maturity
(Years) | |
| Interest Rate Swaps | | | Notional
Amount 1 | | Average
Fixed Pay Rate 2 | | Average
Receive
Rate | | Average
Maturity
(Years) | | Notional
Amount 1 | | Average
Fixed Pay Rate 2 | | Average
Receive
Rate | | Average
Maturity
(Years) |
| ≤ 3 years | | $ | 19,775 |
| | 1.16% | | 0.92% | | $ | 39 |
| | 1.5 | | $ | 14,775 |
| | 1.06% | | 0.40% | | $ | (23 | ) | | 1.6 | | $ | 21,025 |
| | 1.40% | | 1.46% | | 1.5 | | $ | 19,775 |
| | 1.16% | | 0.92% | | 1.5 |
| > 3 to ≤ 5 years | | 7,450 |
| | 1.62% | | 0.91% | | 44 |
| | 4.0 | | 9,950 |
| | 2.03% | | 0.40% | | (203 | ) | | 4.0 | | 6,825 |
| | 1.82% | | 1.43% | | 4.1 | | 7,450 |
| | 1.62% | | 0.91% | | 4.0 |
| > 5 to ≤ 7 years | | 4,725 |
| | 1.89% | | 0.91% | | 28 |
| | 5.9 | | 7,175 |
| | 2.47% | | 0.44% | | (230 | ) | | 6.1 | | 5,775 |
| | 2.02% | | 1.44% | | 5.9 | | 4,725 |
| | 1.89% | | 0.91% | | 5.9 |
| > 7 to ≤ 10 years | | 3,325 |
| | 1.90% | | 0.91% | | 114 |
| | 9.2 | | 7,450 |
| | 2.57% | | 0.39% | | (342 | ) | | 8.3 | | 6,650 |
| | 2.10% | | 1.42% | | 9.1 | | 3,325 |
| | 1.90% | | 0.91% | | 9.2 |
| > 10 years | | 1,900 |
| | 2.64% | | 0.91% | | (9 | ) | | 13.8 | | 1,175 |
| | 3.20% | | 0.39% | | (91 | ) | | 14.7 | | 3,425 |
| | 2.49% | | 1.45% | | 12.9 | | 1,900 |
| | 2.64% | | 0.91% | | 13.8 |
| Total | | $ | 37,175 |
| | 1.48% | | 0.92% | | $ | 216 |
| | 3.9 | | $ | 40,525 |
| | 1.89% | | 0.40% | | $ | (889 | ) | | 4.6 | | $ | 43,700 |
| | 1.74% | | 1.44% | | 4.5 | | $ | 37,175 |
| | 1.48% | | 0.92% | | 3.9 |
________________________
| |
| 1. | As of December 31, 20162017 and 2015,2016, notional amount includes forward starting swaps of $0.6$4.6 billion and $4.5$0.6 billion, respectively, with an average forward start date of 1.20.3 and 0.7 years, respectively, and an average maturity of 10.7 and 5.51.2 years, respectively. |
| |
| 2. | Average fixed pay rate includes forward starting swaps. Excluding forward starting swaps, the average fixed pay rate was 1.46%1.68% and 1.75%1.46% as of December 31, 20162017 and 2015,2016, respectively. |
| |
3. | Average receive rate excludes forward starting swaps. |
The following tables summarize our interest rate payer swaption agreements, U.S. Treasury securities and U.S. Treasury futures outstanding as of December 31, 2016 and 2015 (dollars in millions):
| | | Payer Swaptions | | Option | | Underlying Payer Swap | |
| Years to Expiration | | Cost | | Fair Value | | Average Months to Expiration | | Notional Amount | | Average Fixed Pay Rate | | Average Receive Rate (LIBOR) | | Average Term (Years) | |
| Swaptions | | | Option | | Underlying Payer Swap |
| Current Option Expiration Date | | | Cost Basis | | Fair Value | | Average Months to Current Option Expiration Date 1 | | Notional Amount | | Average Fixed Pay Rate | | Average Receive Rate (LIBOR) | | Average Term (Years) |
| December 31, 2017 | | | | | | | | | | | | | | | |
| ≤ 1 year | | | $ | 118 |
| | $ | 46 |
| | 7 | | $ | 5,100 |
| | 2.71% | | 3M | | 8.8 |
| > 1 year ≤ 2 years | | | 23 |
| | 16 |
| | 18 | | 1,050 |
| | 2.71% | | 3M | | 8.7 |
| > 2 year ≤ 3 years | | | 18 |
| | 13 |
| | 30 | | 500 |
| | 2.78% | | 3M | | 10.0 |
| Total | | | $ | 159 |
| | $ | 75 |
| | 10 | | $ | 6,650 |
| | 2.72% | | 3M | | 8.9 |
| December 31, 2016 | | | | | | | | | | | | | | | | | | | | | |
| Total ≤ 1 year | | $ | 52 |
| | $ | 22 |
| | 6 | | $ | 1,200 |
| | 3.06% | | 3M | | 8.3 | | $ | 52 |
| | $ | 22 |
| | 6 | | $ | 1,200 |
| | 3.06% | | 3M | | 8.3 |
| December 31, 2015 | | | | | | | | |
| Total ≤ 1 year | | $ | 74 |
| | $ | 17 |
| | 4 | | $ | 2,150 |
| | 3.51% | | 3M | | 7.0 | |
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Treasury Securities | | December 31, 2016 | | December 31, 2015 |
| Maturity | | Face Amount Net Long / (Short) | | Cost Basis | | Net Fair Value | | Face Amount Net Long / (Short) | | Cost Basis | | Net Fair Value |
| 5 years | | $ | (400 | ) | | $ | (404 | ) | | $ | (392 | ) | | $ | (250 | ) | | $ | (249 | ) | | $ | (249 | ) |
| 7 years | | (3,056 | ) | | (3,041 | ) | | (2,930 | ) | | (354 | ) | | (353 | ) | | (352 | ) |
| 10 years | | (4,416 | ) | | (4,236 | ) | | (4,132 | ) | | (1,085 | ) | | (1,078 | ) | | (1,070 | ) |
| Total U.S. Treasury securities, net | | $ | (7,872 | ) | | $ | (7,681 | ) | | $ | (7,454 | ) | | $ | (1,689 | ) | | $ | (1,680 | ) | | $ | (1,671 | ) |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Treasury Futures | | December 31, 2016 | | December 31, 2015 |
| Maturity | | Notional Amount - Long (Short) 1 | | Cost Basis 2 | | Market Value 3 | | Net Carrying Value 4 | | Notional Amount - Long (Short) 1 | | Cost Basis 2 | | Market Value 3 | | Net Carrying Value 4 |
| 5 years | | $ | (730 | ) | | $ | (862 | ) | | $ | (859 | ) | | $ | 3 |
| | $ | (730 | ) | | $ | (866 | ) | | $ | (864 | ) | | $ | 2 |
|
| 10 years | | (1,080 | ) | | (1,347 | ) | | (1,342 | ) | | 5 |
| | (1,130 | ) | | (1,424 | ) | | (1,422 | ) | | 2 |
|
| Total U.S. Treasury futures | | $ | (1,810 | ) | | $ | (2,209 | ) | | $ | (2,201 | ) | | $ | 8 |
| | $ | (1,860 | ) | | $ | (2,290 | ) | | $ | (2,286 | ) | | $ | 4 |
|
_____________________
| |
| 1. | U.S. Treasury futuresAs of December 31, 2017 and 2016, ≤ 1 year notional amount representsincludes $700 million of Bermudan swaptions where the par value (or principal balance) ofoptions may be exercised on predetermined dates up to their final exercise date, which is six months prior to the underlying U.S. Treasury security.swaps' maturity date. |
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Treasury Securities | | December 31, 2017 | | December 31, 2016 |
| Maturity | | Face Amount Net Long / (Short) | | Cost Basis | | Fair Value | | Face Amount Net Long / (Short) | | Cost Basis | | Fair Value |
| 5 years | | $ | (288 | ) | | $ | (286 | ) | | $ | (283 | ) | | $ | (400 | ) | | $ | (404 | ) | | $ | (392 | ) |
| 7 years | | (6,131 | ) | | (6,106 | ) | | (6,029 | ) | | (3,056 | ) | | (3,041 | ) | | (2,930 | ) |
| 10 years | | (4,280 | ) | | (4,230 | ) | | (4,155 | ) | | (4,416 | ) | | (4,236 | ) | | (4,132 | ) |
| Total U.S. Treasury securities, net | | $ | (10,699 | ) | | $ | (10,622 | ) | | $ | (10,467 | ) | | $ | (7,872 | ) | | $ | (7,681 | ) | | $ | (7,454 | ) |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Treasury Futures | | December 31, 2017 | | December 31, 2016 |
| Maturity | | Notional Amount - Long (Short) | | Cost Basis | | Fair Value | | Net Carrying Value 1 | | Notional Amount - Long (Short) | | Cost Basis | | Fair Value | | Net Carrying Value 1 |
| 5 years | | $ | (730 | ) | | $ | (852 | ) | | $ | (848 | ) | | $ | 4 |
| | $ | (730 | ) | | $ | (862 | ) | | $ | (859 | ) | | $ | 3 |
|
| 10 years | | (2,180 | ) | | (2,718 | ) | | (2,703 | ) | | 15 |
| | (1,080 | ) | | (1,347 | ) | | (1,342 | ) | | 5 |
|
| Total U.S. Treasury futures | | $ | (2,910 | ) | | $ | (3,570 | ) | | $ | (3,551 | ) | | $ | 19 |
| | $ | (1,810 | ) | | $ | (2,209 | ) | | $ | (2,201 | ) | | $ | 8 |
|
| |
2.1. | U.S. Treasury futuresNet carrying value represents the difference between the fair market value and the cost basis represents(or the forward price to be paid/(received) for the underlying U.S. Treasury security. |
| |
3. | security) of the U.S. Treasury futures market value represents the current market value of U.S. Treasury futures as of period-end. |
| |
4. | Net carrying value represents the difference between the fair value and the cost basis of U.S. Treasury futurescontract as of period-end and is reported in derivative assets/(liabilities), at fair value in our consolidated balance sheets. |
The following tables summarize our TBA securities as of December 31, 2016 and 2015 (in millions):
| | | | | December 31, 2016 | | December 31, 2015 | | December 31, 2017 | | December 31, 2016 |
| TBA Securities by Coupon | | Notional Amount - Long (Short) 1 | | Cost Basis 2 | | Market Value 3 | | Net Carrying Value 4 | | Notional Amount - Long (Short) 1 | | Cost Basis 2 | | Market Value 3 | | Net Carrying Value 4 | | Notional Amount - Long (Short) | | Cost Basis | | Fair Value | | Net Carrying Value 1 | | Notional Amount - Long (Short) | | Cost Basis | | Fair Value | | Net Carrying Value 1 |
| 15-Year TBA securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2.5% | | $ | 1,853 |
| | $ | 1,870 |
| | $ | 1,856 |
| | $ | (14 | ) | | $ | (80 | ) | | $ | (81 | ) | | $ | (80 | ) | | $ | 1 |
| | $ | 1,373 |
| | $ | 1,372 |
| | $ | 1,370 |
| | $ | (2 | ) | | $ | 1,853 |
| | $ | 1,870 |
| | $ | 1,856 |
| | $ | (14 | ) |
| 3.0% | | 292 |
| | 302 |
| | 300 |
| | (2 | ) | | 225 |
| | 233 |
| | 232 |
| | (1 | ) | | 3,161 |
| | 3,225 |
| | 3,217 |
| | (8 | ) | | 292 |
| | 302 |
| | 300 |
| | (2 | ) |
| 3.5% | | 15 |
| | 16 |
| | 16 |
| | — |
| | 136 |
| | 143 |
| | 142 |
| | (1 | ) | | 414 |
| | 428 |
| | 428 |
| | — |
| | 15 |
| | 16 |
| | 16 |
| | — |
|
| Total 15-Year TBA securities | | 2,160 |
| | 2,188 |
| | 2,172 |
| | (16 | ) | | 281 |
| | 295 |
| | 294 |
| | (1 | ) | | 4,948 |
| | 5,025 |
| | 5,015 |
| | (10 | ) | | 2,160 |
| | 2,188 |
| | 2,172 |
| | (16 | ) |
| 30-Year TBA securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 3.0% | | 3,027 |
| | 3,114 |
| | 3,007 |
| | (107 | ) | | 3,914 |
| | 3,911 |
| | 3,916 |
| | 5 |
| | 4,317 |
| | 4,303 |
| | 4,312 |
| | 9 |
| | 3,027 |
| | 3,114 |
| | 3,007 |
| | (107 | ) |
| 3.5% | | 1,209 |
| | 1,251 |
| | 1,236 |
| | (15 | ) | | 1,497 |
| | 1,536 |
| | 1,539 |
| | 3 |
| | 3,932 |
| | 4,027 |
| | 4,034 |
| | 7 |
| | 1,209 |
| | 1,251 |
| | 1,236 |
| | (15 | ) |
| 4.0% | | 4,530 |
| | 4,769 |
| | 4,760 |
| | (9 | ) | | 1,575 |
| | 1,658 |
| | 1,665 |
| | 7 |
| | 2,338 |
| | 2,449 |
| | 2,446 |
| | (3 | ) | | 4,530 |
| | 4,769 |
| | 4,760 |
| | (9 | ) |
| 4.5% | | (10 | ) | | (10 | ) | | (10 | ) | | — |
| | 28 |
| | 30 |
| | 30 |
| | — |
| | (61 | ) | | (65 | ) | | (65 | ) | | — |
| | (10 | ) | | (10 | ) | | (10 | ) | | — |
|
| Total 30-Year TBA securities, net | | 8,756 |
| | 9,124 |
| | 8,993 |
| | (131 | ) | | 7,014 |
| | 7,135 |
| | 7,150 |
| | 15 |
| | 10,526 |
| | 10,714 |
| | 10,727 |
| | 13 |
| | 8,756 |
| | 9,124 |
| | 8,993 |
| | (131 | ) |
| Total TBA securities, net | | $ | 10,916 |
| | $ | 11,312 |
| | $ | 11,165 |
| | $ | (147 | ) | | $ | 7,295 |
| | $ | 7,430 |
| | $ | 7,444 |
| | $ | 14 |
| | $ | 15,474 |
| | $ | 15,739 |
| | $ | 15,742 |
| | $ | 3 |
| | $ | 10,916 |
| | $ | 11,312 |
| | $ | 11,165 |
| | $ | (147 | ) |
| | | | | | | | | | | | | | | | | | |
| | | December 31, 2016 | | December 31, 2015 | |
| TBA Securities by Issuer | | Notional Amount - Long (Short) 1 | | Cost Basis 2 | | Market Value 3 | | Net Carrying Value 4 | | Notional Amount - Long (Short) 1 | | Cost Basis 2 | | Market Value 3 | | Net Carrying Value 4 | |
| Fannie Mae | | $ | 9,881 |
| | $ | 10,251 |
| | $ | 10,118 |
| | $ | (133 | ) | | $ | 6,033 |
| | $ | 6,145 |
| | $ | 6,159 |
| | $ | 14 |
| |
| Freddie Mac | | 1,035 |
| | 1,060 |
| | 1,047 |
| | (13 | ) | | 689 |
| | 703 |
| | 703 |
| | — |
| |
| Ginnie Mae | | — |
| | 1 |
| | — |
| | (1 | ) | | 573 |
| | 582 |
| | 582 |
| | — |
| |
| TBA securities, net | | $ | 10,916 |
| | $ | 11,312 |
| | $ | 11,165 |
| | $ | (147 | ) | | $ | 7,295 |
| | $ | 7,430 |
| | $ | 7,444 |
| | $ | 14 |
| |
_____________________
| |
| 1. | Notional amountNet carrying value represents the pardifference between the fair market value (or principal balance) ofand the underlying Agency security. |
| |
2. | Costcost basis represents(or the forward price to be paid/(received) for the underlying Agency security. |
| |
3. | Market value represents the current market value of the TBA contract (or of the underlying Agency security) as of period-end. |
| |
4. | Net carrying value represents the difference between the market value and the cost basis of the TBA contract as of period-end and is reported in derivative assets/(liabilities), at fair value in our consolidated balance sheets. |
Gain (Loss) From Derivative Instruments and Other Securities, Net
The tables below summarizefollowing table summarizes changes in our derivative and other hedge portfolio and their effect on our consolidated statements of comprehensive income for fiscal years 2017, 2016 2015 and 20142015 (in millions):
| | | | | Fiscal Year 2016 | | | | | | | | | | | |
| Derivative and Other Hedging Instruments | | Notional Amount December 31, 2015 | | Additions | | Settlement, Termination, Expiration or Exercise | | Notional Amount December 31, 2016 | | Amount of Gain/(Loss) Recognized in Income on Derivatives 1 | | Beginning Notional Amount | | Additions | | Settlement, Termination, Expiration or Exercise | | Ending Notional Amount | | Gain/(Loss) on Derivative Instruments and Other Securities, Net 1 |
| Fiscal Year 2017: | | | | | | | | | | | |
| TBA securities, net | | $ | 7,295 |
| | 116,439 |
| | (112,818 | ) | | $ | 10,916 |
| | | $ | (59 | ) | | $ | 10,916 |
| | 237,601 |
| | (233,043 | ) | | $ | 15,474 |
| | | $ | 330 |
|
| Interest rate swaps | | $ | 40,525 |
| | 15,650 |
| | (19,000 | ) | | $ | 37,175 |
| | | (397 | ) | | $ | 37,175 |
| | 14,825 |
| | (8,300 | ) | | $ | 43,700 |
| | | 67 |
|
| Payer swaptions | | $ | 2,150 |
| | 500 |
| | (1,450 | ) | | $ | 1,200 |
| | | (3 | ) | | $ | 1,200 |
| | 6,450 |
| | (1,000 | ) | | $ | 6,650 |
| | | (66 | ) |
| U.S. Treasury securities - short position | | $ | (1,714 | ) | | (9,884 | ) | | 3,537 |
| | $ | (8,061 | ) | | | 134 |
| | $ | (8,061 | ) | | (14,030 | ) | | 11,392 |
| | $ | (10,699 | ) | | | (141 | ) |
| U.S. Treasury securities - long position | | $ | 25 |
| | 961 |
| | (797 | ) | | $ | 189 |
| | | 7 |
| | $ | 189 |
| | 404 |
| | (593 | ) | | $ | — |
| | | 1 |
|
| U.S. Treasury futures contracts - short position | | $ | (1,860 | ) | | (7,840 | ) | | 7,890 |
| | $ | (1,810 | ) | | | (5 | ) | | $ | (1,810 | ) | | (11,340 | ) | | 10,240 |
| | $ | (2,910 | ) | | | — |
|
| | | | | | | | | | | | $ | (323 | ) | | | | | | | | | | | $ | 191 |
|
| Fiscal Year 2016: | | | | | | | | | | | |
| TBA securities, net | | | $ | 7,295 |
| | 116,439 |
| | (112,818 | ) | | $ | 10,916 |
| | | $ | (59 | ) |
| Interest rate swaps | | | $ | 40,525 |
| | 15,650 |
| | (19,000 | ) | | $ | 37,175 |
| | | (397 | ) |
| Payer swaptions | | | $ | 2,150 |
| | 500 |
| | (1,450 | ) | | $ | 1,200 |
| | | (3 | ) |
| U.S. Treasury securities - short position | | | $ | (1,714 | ) | | (9,884 | ) | | 3,537 |
| | $ | (8,061 | ) | | | 134 |
|
| U.S. Treasury securities - long position | | | $ | 25 |
| | 961 |
| | (797 | ) | | $ | 189 |
| | | 7 |
|
| U.S. Treasury futures contracts - short position | | | $ | (1,860 | ) | | (7,840 | ) | | 7,890 |
| | $ | (1,810 | ) | | | (5 | ) |
| | | | | | | | | | | | | $ | (323 | ) |
| Fiscal Year 2015: | | | | | | | | | | | |
| TBA securities, net | | | $ | 14,412 |
| | 119,922 |
| | (127,039 | ) | | $ | 7,295 |
| | | $ | 305 |
|
| Interest rate swaps | | | $ | 43,700 |
| | 4,950 |
| | (8,125 | ) | | $ | 40,525 |
| | | (932 | ) |
| Payer swaptions | | | $ | 6,800 |
| | 1,500 |
| | (6,150 | ) | | $ | 2,150 |
| | | (35 | ) |
| Receiver Swaptions | | | $ | (4,250 | ) | | — |
| | 4,250 |
| | $ | — |
| | | 4 |
|
| U.S. Treasury securities - short position | | | $ | (5,392 | ) | | (12,503 | ) | | 16,181 |
| | $ | (1,714 | ) | | | (68 | ) |
| U.S. Treasury securities - long position | | | $ | 2,411 |
| | 33,525 |
| | (35,911 | ) | | $ | 25 |
| | | (38 | ) |
| U.S. Treasury futures contracts - short position | | | $ | (730 | ) | | (4,480 | ) | | 3,350 |
| | $ | (1,860 | ) | | | (12 | ) |
| | | | | | | | | | | | | $ | (776 | ) |
________________________________ | |
| 1. | Excludes a net loss of $3 million from debt of consolidated VIEs andAmounts above exclude other miscellaneous net gains of $16 million recognized in gain (loss) on derivative instruments and other securities, net in our consolidated statements of comprehensive income. |
|
| | | | | | | | | | | | | | | | | | | |
| | | Fiscal Year 2015 |
| Derivative and Other Hedging Instruments | | Notional Amount
December 31, 2014 | | Additions | | Settlement, Termination, Expiration or Exercise | | Notional Amount December 31, 2015 | | | Amount of Gain/(Loss) Recognized in Income on Derivatives 1 |
| TBA securities, net | | $ | 14,412 |
| | 119,922 |
| | (127,039 | ) | | $ | 7,295 |
| | | $ | 305 |
|
| Interest rate swaps | | $ | 43,700 |
| | 4,950 |
| | (8,125 | ) | | $ | 40,525 |
| | | (932 | ) |
| Payer swaptions | | $ | 6,800 |
| | 1,500 |
| | (6,150 | ) | | $ | 2,150 |
| | | (35 | ) |
| Receiver swaptions | | $ | (4,250 | ) | | — |
| | 4,250 |
| | $ | — |
| | | 4 |
|
| U.S. Treasury securities - short position | | $ | (5,392 | ) | | (12,503 | ) | | 16,181 |
| | $ | (1,714 | ) | | | (68 | ) |
| U.S. Treasury securities - long position | | $ | 2,411 |
| | 33,525 |
| | (35,911 | ) | | $ | 25 |
| | | (38 | ) |
| U.S. Treasury futures contracts - short position | | $ | (730 | ) | | (4,480 | ) | | 3,350 |
| | $ | (1,860 | ) | | | (12 | ) |
| | | | | | | | | | | | $ | (776 | ) |
______________________
| |
1. | Excludes a net gain of $16 million from debt of consolidated VIEs and other miscellaneous net losses of $4 million recognized in gain (loss) on derivative instruments and other securities, net in our consolidated statements of comprehensive income. |
|
| | | | | | | | | | | | | | | | | | | |
| | | Fiscal Year 2014 |
| Derivative and Other Hedging Instruments | | Notional Amount
December 31, 2013 | | Additions | | Settlement, Termination, Expiration or Exercise | | Notional Amount December 31, 2014 | | | Amount of Gain/(Loss) Recognized in Income on Derivatives 1 |
| TBA securities, net | | $ | 2,119 |
| | 213,627 |
| | (201,334 | ) | | $ | 14,412 |
| | | $ | 1,117 |
|
| Interest rate swaps | | $ | 43,250 |
| | 20,550 |
| | (20,100 | ) | | $ | 43,700 |
| | | (1,838 | ) |
| Payer swaptions | | $ | 14,250 |
| | 5,250 |
| | (12,700 | ) | | $ | 6,800 |
| | | (193 | ) |
| Receiver swaptions | | $ | — |
| | (5,500 | ) | | 1,250 |
| | $ | (4,250 | ) | | | 11 |
|
| U.S. Treasury securities - short position | | $ | (2,007 | ) | | (36,489 | ) | | 33,104 |
| | $ | (5,392 | ) | | | (420 | ) |
| U.S. Treasury securities - long position | | $ | 3,927 |
| | 18,549 |
| | (20,065 | ) | | $ | 2,411 |
| | | 66 |
|
| U.S. Treasury futures contracts - short position | | $ | (1,730 | ) | | (2,920 | ) | | 3,920 |
| | $ | (730 | ) | | | (76 | ) |
| TBA put option | | $ | — |
| | (150 | ) | | 150 |
| | $ | — |
| | | — |
|
| | | | | | | | | | | | $ | (1,333 | ) |
______________________
| |
1. | Excludes a net gain of $75 million from investments in REIT equity securities, a net loss of $10 million from debt of consolidate VIEs and other miscellaneous net losses of $7 million recognized in gain (loss) on derivative instruments and other securities, net in our consolidated statements of comprehensive income. |
Note 6. Pledged Assets
Our funding agreements require us to fully collateralize our obligations under the agreements based upon our counterparties' collateral requirements and their determination of the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, credit quality and liquidity conditions within the investment banking, mortgage finance and real estate industries. Our derivative contracts similarly require us to fully collateralize our obligations under such agreements, which will vary over time based on similar factors as well as our counterparties' determination of the value of the derivative contract. We are typically required to post initial collateralmargin upon execution of derivative transactions, such as under our interest rate swap agreements and TBA contracts.contracts, and subsequently post or receive variation margin based on daily fluctuations in fair value. Our prime brokerage agreements, pursuant to which we receive custody and settlement services, and the clearing organizations utilized by our wholly-owned captive broker-dealer subsidiary, Bethesda Securities, LLC, also require that we post minimum daily clearing deposits. If we breach our collateral requirements, we will be required to fully settle our obligations under the agreements, which could include a forced liquidation of our pledged collateral.
Our counterparties also apply a "haircut" to our pledged collateral, which means our collateral is valued at slightly less than market value and limits the amount we can borrow against our securities. This haircut reflects the underlying risk of the specific collateral and protects our counterparty against a change in its value. Our agreements do not specify the haircut; rather haircuts are determined on an individual transaction basis. Consequently, our funding agreements and derivative contracts expose us to
credit risk relating to potential losses that could be recognized in the event thatif our counterparties fail to perform their obligations under such agreements. We minimize this risk by limiting our counterparties to major financial institutions with acceptable credit ratings or to registered clearinghouses and U.S. government agencies, and we monitor our positions with individual counterparties. In the event of a default by a counterparty, we may have difficulty obtaining our assets pledged as collateral to such counterparty and may not receive payments provided for under the terms of our derivative agreements. In the case of centrally cleared instruments,
we could be exposed to credit risk if the central clearing agency or a clearing member defaults on its respective obligation to perform under the contract. However, we believe that the risk is minimal due to the clearing exchanges' initial and daily mark to market margin requirements, and clearinghouse guarantee funds and other resources that are available in the event of a clearing member default.
Further, each of ourOur International Swaps and Derivatives Association ("ISDA") Master Agreements also containscontain a cross default provision under which a default under the terms of certain of our other indebtedness in excess of certain thresholds causes an event of default under the ISDA Master Agreement. Threshold amounts vary by lender. Following an event of default, we could be required to settle our obligations under the agreements. Additionally, under certain of our ISDA Master Agreements, we could be required to settle our obligations under the agreements if we fail to maintain certain minimum stockholders' equity thresholds or our REIT status or if we fail to comply with limits on our leverage up to certain specified levels. As of December 31, 20162017, the fair value of additional collateral that could be required to be posted as a result of the credit-risk-related contingent features being triggered was not material to our financial statements.
As of December 31, 2016,2017, our maximum amount at risk with any counterparty related to our repurchase agreements was less than 6%5% of our tangible stockholders' equity and our maximum amount at risk with any counterparty related to our interest rate swap and swaption agreements, excluding centrally cleared swaps, was less than 1% of our stockholders' equity. The following table summarizes certain characteristics of our repurchase agreements outstanding with counterparties representing amounts at risk greater than or equal to 5% of our stockholders' equity as of December 31, 2016 (dollars in millions). As of December 31, 2015 the maximum amount of risk with any counterparty related to our repurchase agreements was less than 5% of our stockholders equity.
|
| | | | | | | | | | | | | | |
| | | December 31, 2016 |
| | | Amount Outstanding | | Net Counterparty Exposure 1 | | Percent of Equity | | Weighted Average Months to Maturity |
| J.P. Morgan Securities, LLC | | $ | 4,875 |
| | $ | 405 |
| | 5.5 | % | | 34 |
|
______________________
1. Represents the net carrying value of the securities pledged under repurchase agreements, including accrued interest plus any cash or assets on deposit to secure the repurchase obligation, less the amount of the repurchase liability, including accrued interest.
Assets Pledged to Counterparties
The following tables summarize our assets pledged as collateral under our funding, derivative and prime broker agreements by type, including securities pledged related to securities sold but not yet settled, as of December 31, 20162017 and 20152016 (in millions):
| | | | | December 31, 2016 | | December 31, 2017 |
| Assets Pledged to Counterparties | | Repurchase Agreements and FHLB Advances 1 | | Debt of Consolidated VIEs | | Derivative Agreements | | Prime Broker Agreements | | Total | | Repurchase Agreements 1 | | Debt of Consolidated VIEs | | Derivative Agreements | | Prime Broker Agreements 2 | | Total |
| Agency RMBS - fair value | | $ | 43,005 |
| | $ | 818 |
| | $ | 275 |
| | $ | 865 |
| | $ | 44,963 |
| | $ | 52,497 |
| | $ | 662 |
| | $ | 221 |
| | $ | 519 |
| | $ | 53,899 |
|
| Non-Agency RMBS - fair value | | 90 |
| | — |
| | — |
| | — |
| | 90 |
| |
| U.S. Treasury securities - fair value | | 173 |
| | — |
| | — |
| | — |
| | 173 |
| |
U.S. Treasury securities - fair value 3 | | | 113 |
| | — |
| | 72 |
| | — |
| | 185 |
|
| Accrued interest on pledged securities | | 122 |
| | 3 |
| | 1 |
| | 2 |
| | 128 |
| | 153 |
| | 2 |
| | 1 |
| | 2 |
| | 158 |
|
| Restricted cash and cash equivalents | | 60 |
| | — |
| | 14 |
| | — |
| | 74 |
| | 35 |
| | — |
| | 281 |
| | 1 |
| | 317 |
|
| Total | | $ | 43,450 |
| | $ | 821 |
| | $ | 290 |
| | $ | 867 |
| | $ | 45,428 |
| | $ | 52,798 |
| | $ | 664 |
| | $ | 575 |
| | $ | 522 |
| | $ | 54,559 |
|
______________________
1. Includes $181 million of retained interests in our consolidated VIEs pledged as collateral under repurchase agreements. | | | | | December 31, 2015 | | December 31, 2016 |
| Assets Pledged to Counterparties | | Repurchase Agreements and FHLB Advances 1 | | Debt of Consolidated VIEs | | Derivative Agreements | | Prime Broker Agreements | | Total | | Repurchase Agreements and FHLB Advances 1 | | Debt of Consolidated VIEs | | Derivative Agreements | | Prime Broker Agreements 2 | | Total |
| Agency RMBS - fair value | | $ | 47,992 |
| | $ | 1,029 |
| | $ | 148 |
| | $ | 485 |
| | $ | 49,654 |
| | $ | 43,005 |
| | $ | 818 |
| | $ | 275 |
| | $ | 865 |
| | $ | 44,963 |
|
| Non-Agency RMBS - fair value | | 113 |
| | — |
| | — |
| | — |
| | 113 |
| | 90 |
| | — |
| | — |
| | — |
| | 90 |
|
| U.S. Treasury securities - fair value | | 25 |
| | — |
| | — |
| | — |
| | 25 |
| | 173 |
| | — |
| | — |
| | — |
| | 173 |
|
| Accrued interest on pledged securities | | 135 |
| | 3 |
| | — |
| | 2 |
| | 140 |
| | 122 |
| | 3 |
| | 1 |
| | 2 |
| | 128 |
|
| Restricted cash and cash equivalents | | 23 |
| | — |
| | 1,226 | | 32 |
| | 1,281 |
| | 60 |
| | — |
| | 14 | | — |
| | 74 |
|
| Total | | $ | 48,288 |
| | $ | 1,032 |
| | $ | 1,374 |
| | $ | 519 |
| | $ | 51,213 |
| | $ | 43,450 |
| | $ | 821 |
| | $ | 290 |
| | $ | 867 |
| | $ | 45,428 |
|
______________________
1. Includes $245 million of retained interests in our consolidated VIEs pledged as collateral under repurchase agreements.
| |
| 1. | Includes $182 million and $181 million of retained interests in our consolidated VIEs pledged as collateral under repurchase agreements as of December 31, 2017 and 2016, respectively. |
| |
| 2. | Includes margin for TBAs cleared through prime brokers and other clearing deposits. |
| |
| 3. | Includes repledged securities received as collateral from counterparties. |
As of December 31, 2016, and 2015, we held $126 million and $150 million, respectively, of membership and activity-based stock in the FHLB of Des Moines.Moines, which was redeemed in February 2017 with the termination of our captive insurance subsidiary's FHLB membership such that we held no such stock as of December 31, 2017. FHLB stock is reported at cost, which equals par value, in other assets on our accompanying consolidated balance sheets. FHLB stock can only be redeemed or sold at its par value, and only to the FHLB of Des Moines.
The cash and cash equivalents and Agency securities pledged as collateral under our derivative agreements are included in restricted cash and cash equivalents and Agency securities, at fair value, respectively, on our consolidated balance sheets.
The following table summarizes our securities pledged as collateral under our repurchase agreements and FHLB advances by the remaining maturity of our borrowings, including securities pledged related to sold but not yet settled securities, as of December 31, 20162017 and 20152016 (in millions). For the corresponding borrowings associated with the following amounts and the interest rates thereon, refer to Note 4.
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2017 | | December 31, 2016 |
| Securities Pledged by Remaining Maturity of Repurchase Agreements and FHLB Advances | | Fair Value of Pledged Securities | | Amortized Cost of Pledged Securities | | Accrued Interest on Pledged Securities | | Fair Value of Pledged Securities | | Amortized Cost of Pledged Securities | | Accrued Interest on Pledged Securities |
RMBS:1,2 | | | | | | | | | | | | |
| ≤ 30 days | | $ | 20,162 |
| | $ | 20,313 |
| | $ | 59 |
| | $ | 19,681 |
| | $ | 19,863 |
| | $ | 56 |
|
| > 30 and ≤ 60 days | | 12,950 |
| | 13,061 |
| | 38 |
| | 8,103 |
| | 8,158 |
| | 23 |
|
| > 60 and ≤ 90 days | | 4,000 |
| | 4,013 |
| | 11 |
| | 4,034 |
| | 4,070 |
| | 11 |
|
| > 90 days | | 15,385 |
| | 15,512 |
| | 45 |
| | 11,278 |
| | 11,380 |
| | 32 |
|
| Total RMBS | | 52,497 |
| | 52,899 |
| | 153 |
| | 43,096 |
| | 43,471 |
| | 122 |
|
| U.S. Treasury securities: | | | | | | | | | | | | |
| > 1 day ≤ 30 days | | — |
| | — |
| | — |
| | 173 |
| | 173 |
| | — |
|
| Total | | $ | 52,497 |
| | $ | 52,899 |
| | $ | 153 |
| | $ | 43,269 |
| | $ | 43,644 |
| | $ | 122 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2016 | | December 31, 2015 |
| Securities Pledged by Remaining Maturity of Repurchase Agreements and FHLB Advances | | Fair Value of Pledged Securities | | Amortized Cost of Pledged Securities | | Accrued Interest on Pledged Securities | | Fair Value of Pledged Securities | | Amortized Cost of Pledged Securities | | Accrued Interest on Pledged Securities |
RMBS:1 | | | | | | | | | | | | |
| ≤ 30 days | | $ | 19,681 |
| | $ | 19,863 |
| | $ | 56 |
| | $ | 20,053 |
| | $ | 20,075 |
| | $ | 57 |
|
| > 30 and ≤ 60 days | | 8,103 |
| | 8,158 |
| | 23 |
| | 8,311 |
| | 8,340 |
| | 23 |
|
| > 60 and ≤ 90 days | | 4,034 |
| | 4,070 |
| | 11 |
| | 7,534 |
| | 7,525 |
| | 21 |
|
| > 90 days | | 11,278 |
| | 11,380 |
| | 32 |
| | 12,207 |
| | 12,187 |
| | 34 |
|
| Total MBS | | 43,096 |
| | 43,471 |
| | 122 |
| | 48,105 |
| | 48,127 |
| | 135 |
|
| U.S. Treasury securities: | | | | | | | | | | | | |
| 1 day | | — |
| | — |
| | — |
| | 25 |
| | 25 |
| | — |
|
| > 1 day ≤ 30 days | | 173 |
| | 173 |
| | — |
| | — |
| | — |
| | — |
|
| Total | | $ | 43,269 |
| | $ | 43,644 |
| | $ | 122 |
| | $ | 48,130 |
| | $ | 48,152 |
| | $ | 135 |
|
______________________ | |
| 1. | Includes $181$182 million and $245$181 million of retained interests in our consolidated VIEs pledged as collateral under repurchase agreements as of December 31, 20162017 and 2015,2016, respectively. |
As of December 31, 2016 and 2015, none of our borrowings backed by RMBS were due on demand or mature overnight.
| |
| 2. | December 31, 2017 amounts exclude $113 million of repledged U.S. Treasury securities received as collateral from counterparties. |
The table above excludes Agency securities transferred to our consolidated VIEs. Securities transferred to our consolidated VIEs can only be used to settle the obligations of each respective VIE. However, we may pledge our retained interests in our consolidated VIEs as collateral under our repurchase agreements and derivative contracts. Please refer to Notes 3 and 4 for additional information regarding our consolidated VIEs.
Assets Pledged from Counterparties
As of December 31, 20162017 and 2015,2016, we had assets pledged to us from counterparties as collateral under our reverse repurchase, repurchase and derivative agreements summarized in the tables below (in millions).
| | | | | December 31, 2016 | | December 31, 2015 | | December 31, 2017 | | December 31, 2016 |
| Assets Pledged to AGNC | | Reverse Repurchase Agreements | | Derivative Agreements | | Repurchase Agreements | | Total | | Reverse Repurchase Agreements | | Derivative Agreements | | Repurchase Agreements | | Total | | Reverse Repurchase Agreements 1 | | Derivative Agreements | | Repurchase Agreements | | Total | | Reverse Repurchase Agreements | | Derivative Agreements | | Repurchase Agreements | | Total |
| Agency MBS - fair value | | $ | — |
| | $ | — |
| | $ | 14 |
| | $ | 14 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| |
| Agency RMBS - fair value | | | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 14 |
| | $ | 14 |
|
| U.S. Treasury securities - fair value | | 7,636 |
| | — |
| | — |
| | 7,636 |
| | 1,702 |
| | — |
| | — |
| | 1,702 |
| | 10,853 |
| | — |
| | — |
| | 10,853 |
| | 7,636 |
| | — |
| | — |
| | 7,636 |
|
| Cash | | — |
| | 107 |
| | — |
| | 107 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 82 |
| | — |
| | 82 |
| | — |
| | 107 |
| | — |
| | 107 |
|
| Total | | $ | 7,636 |
| | $ | 107 |
| | $ | 14 |
| | $ | 7,757 |
| | $ | 1,702 |
| | $ | — |
| | $ | — |
| | $ | 1,702 |
| | $ | 10,853 |
| | $ | 82 |
| | $ | — |
| | $ | 10,935 |
| | $ | 7,636 |
| | $ | 107 |
| | $ | 14 |
| | $ | 7,757 |
|
U.S Treasury securities received as collateral under our reverse repurchase agreements that we use to cover short sales of U.S. Treasury securities are accounted for as securities borrowing transactions. We recognize a corresponding obligation to return the borrowed securities at fair value on the accompanying consolidated balance sheets based on the value of the underlying borrowed securities as of the reporting date.
Cash collateral received is recognized in cash and cash equivalents with a corresponding amount recognized in accounts payable and other accrued liabilities on the accompanying consolidated balance sheets.
Offsetting Assets and Liabilities
Certain of our repurchase agreements and derivative transactions are governed by underlying agreements that generally provide for a right of setoff under master netting arrangements (or similar agreements), including in the event of default or in the event of bankruptcy of either party to the transactions. We present our assets and liabilities subject to such arrangements on a gross basis in our consolidated balance sheets. The following tables present information about our assets and liabilities that are
subject to master netting arrangements and can potentially be offset on our consolidated balance sheets as of December 31, 20162017 and 20152016 (in millions):
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Offsetting of Financial and Derivative Assets |
| | | Gross Amounts of Recognized Assets | | Gross Amounts Offset in the Consolidated Balance Sheets | | Net Amounts of Assets Presented in the Consolidated Balance Sheets | | Gross Amounts Not Offset in the Consolidated Balance Sheets | | Net Amount |
| | | | | | Financial Instruments | | Collateral Received 2 | |
| December 31, 2017 | | | | | | | | | | | | |
Interest rate swap and swaption agreements, at fair value 1 | | $ | 156 |
| | $ | — |
| | $ | 156 |
| | $ | (1 | ) | | $ | (82 | ) | | $ | 73 |
|
| TBA securities, at fair value | | 30 |
| | — |
| | 30 |
| | (22 | ) | | — |
| | 8 |
|
| Receivable under reverse repurchase agreements | | 10,961 |
| | — |
| | 10,961 |
| | (9,682 | ) | | (1,279 | ) | | — |
|
| Total | | $ | 11,147 |
| | $ | — |
| | $ | 11,147 |
| | $ | (9,705 | ) | | $ | (1,361 | ) | | $ | 81 |
|
| | | | | | | | | | | | | |
| December 31, 2016 | | | | | | | | | | | | |
Interest rate swap and swaption agreements, at fair value 1 | | $ | 342 |
| | $ | — |
| | $ | 342 |
| | $ | (80 | ) | | $ | (49 | ) | | $ | 213 |
|
| TBA securities, at fair value | | 4 |
| | — |
| | 4 |
| | (4 | ) | | — |
| | — |
|
| Receivable under reverse repurchase agreements | | 7,716 |
| | — |
| | 7,716 |
| | (6,963 | ) | | (753 | ) | | — |
|
| Total | | $ | 8,062 |
| | $ | — |
| | $ | 8,062 |
| | $ | (7,047 | ) | | $ | (802 | ) | | $ | 213 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Offsetting of Financial and Derivative Assets |
| | | Gross Amounts of Recognized Assets | | Gross Amounts Offset in the Consolidated Balance Sheets | | Net Amounts of Assets Presented in the Consolidated Balance Sheets | | Gross Amounts Not Offset in the Consolidated Balance Sheets | | Net Amount |
| | | | | | Financial Instruments | | Collateral Received 2 | |
| December 31, 2016 | | | | | | | | | | | | |
Interest rate swap and swaption agreements, at fair value 1 | | $ | 342 |
| | $ | — |
| | $ | 342 |
| | $ | (80 | ) | | $ | (49 | ) | | $ | 213 |
|
| TBA | | 4 |
| | — |
| | 4 |
| | (4 | ) | | — |
| | — |
|
| Receivable under reverse repurchase agreements | | 7,716 |
| | — |
| | 7,716 |
| | (6,963 | ) | | (753 | ) | | — |
|
| Total | | $ | 8,062 |
| | $ | — |
| | $ | 8,062 |
| | $ | (7,047 | ) | | $ | (802 | ) | | $ | 213 |
|
| | | | | | | | | | | | | |
| December 31, 2015 | | | | | | | | | | | | |
Interest rate swap and swaption agreements, at fair value 1 | | $ | 48 |
| | $ | — |
| | $ | 48 |
| | $ | (31 | ) | | $ | — |
| | $ | 17 |
|
| TBA | | 29 |
| | — |
| | 29 |
| | (15 | ) | | — |
| | 14 |
|
| Receivable under reverse repurchase agreements | | 1,713 |
| | — |
| | 1,713 |
| | (1,356 | ) | | (357 | ) | | — |
|
| Total | | $ | 1,790 |
| | $ | — |
| | $ | 1,790 |
| | $ | (1,402 | ) | | $ | (357 | ) | | $ | 31 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Offsetting of Financial and Derivative Liabilities |
| | | Gross Amounts of Recognized Liabilities | | Gross Amounts Offset in the Consolidated Balance Sheets | | Net Amounts of Liabilities Presented in the Consolidated Balance Sheets | | Gross Amounts Not Offset in the Consolidated Balance Sheets | | Net Amount |
| | | | | | Financial Instruments | | Collateral Pledged 2 | |
| December 31, 2017 | | | | | | | | | | | | |
Interest rate swap agreements, at fair value 1 | | $ | 1 |
| | $ | — |
| | $ | 1 |
| | $ | (1 | ) | | $ | — |
| | $ | — |
|
| TBA securities, at fair value | | 27 |
| | — |
| | 27 |
| | (22 | ) | | (5 | ) | | — |
|
| Repurchase agreements | | 50,296 |
| | — |
| | 50,296 |
| | (9,682 | ) | | (40,614 | ) | | — |
|
| Total | | $ | 50,324 |
| | $ | — |
| | $ | 50,324 |
| | $ | (9,705 | ) | | $ | (40,619 | ) | | $ | — |
|
| | | | | | | | | | | | | |
| December 31, 2016 | | | | | | | | | | | | |
Interest rate swap agreements, at fair value 1 | | $ | 105 |
| | $ | — |
| | $ | 105 |
| | $ | (80 | ) | | $ | (25 | ) | | $ | — |
|
| TBA securities, at fair value | | 151 |
| | — |
| | 151 |
| | (4 | ) | | (147 | ) | | — |
|
| Repurchase agreements and FHLB advances | | 40,895 |
| | — |
| | 40,895 |
| | (6,963 | ) | | (33,932 | ) | | — |
|
| Total | | $ | 41,151 |
| | $ | — |
| | $ | 41,151 |
| | $ | (7,047 | ) | | $ | (34,104 | ) | | $ | — |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Offsetting of Financial and Derivative Liabilities |
| | | Gross Amounts of Recognized Liabilities | | Gross Amounts Offset in the Consolidated Balance Sheets | | Net Amounts of Liabilities Presented in the Consolidated Balance Sheets | | Gross Amounts Not Offset in the Consolidated Balance Sheets | | Net Amount |
| | | | | | Financial Instruments | | Collateral Pledged 2 | |
| December 31, 2016 | | | | | | | | | | | | |
Interest rate swap agreements, at fair value 1 | | $ | 105 |
| | $ | — |
| | $ | 105 |
| | $ | (80 | ) | | $ | (25 | ) | | $ | — |
|
| TBA | | 151 |
| | — |
| | 151 |
| | (4 | ) | | (147 | ) | | — |
|
| Repurchase agreements and FHLB advances | | 40,895 |
| | — |
| | 40,895 |
| | (6,963 | ) | | (33,932 | ) | | — |
|
| Total | | $ | 41,151 |
| | $ | — |
| | $ | 41,151 |
| | $ | (7,047 | ) | | $ | (34,104 | ) | | $ | — |
|
| | | | | | | | | | | | | |
| December 31, 2015 | | | | | | | | | | | | |
Interest rate swap agreements, at fair value 1 | | $ | 920 |
| | $ | — |
| | $ | 920 |
| | $ | (31 | ) | | $ | (889 | ) | | $ | — |
|
| TBA | | 15 |
| | | | 15 |
| | (15 | ) | | — |
| | — |
|
| Repurchase agreements and FHLB advances | | 45,507 |
| | — |
| | 45,507 |
| | (1,356 | ) | | (44,151 | ) | | — |
|
| Total | | $ | 46,442 |
| | $ | — |
| | $ | 46,442 |
| | $ | (1,402 | ) | | $ | (45,040 | ) | | $ | — |
|
_______________________
| |
| 1. | Reported under derivative assets/assets / liabilities, at fair value in the accompanying consolidated balance sheets. Refer to Note 5 for a reconciliation of derivative assets/assets / liabilities, at fair value to their sub-components. |
| |
| 2. | Includes cash and securities pledged/pledged / received as collateral, at fair value. Amounts presented are limited to collateral pledged sufficient to reduce the net amount to zero for individual counterparties, as applicable. |
Note 7. Fair Value Measurements
We determine the fair value of our investment securities and debt of consolidated VIEs based upon fair value estimates obtained from multiple third partythird-party pricing services and dealers. In determining fair value, third partythird-party pricing sources use various valuation approaches, including market and income approaches. Factors used by third partythird-party sources in estimating the fair value of an instrument may include observable inputs such as coupons, primary and secondary mortgage rates, pricing information, credit data, volatility statistics, and other market data that are current as of the measurement date. The availability of observable inputs can vary by instrument and is affected by a wide variety of factors, including the type of instrument, whether the instrument is new and not yet established in the marketplace and other characteristics particular to the instrument. Third partyThird-party pricing sources may also use certain unobservable inputs, such as assumptions of future levels of prepayment, defaults and foreclosures, especially when estimating fair values for securities with lower levels of recent trading activity. We make inquiries of third partythird-party pricing
sources to understand the significant inputs and assumptions they used to determine their prices. For further information regarding valuation of our derivative instruments, please refer to the discussion of derivative and other hedging instruments in Note 2.
We review the various third partythird-party fair value estimates and perform procedures to validate their reasonableness, including an analysis of the range of third party estimates for each position, comparison to recent trade activity for similar securities, and management review for consistency with market conditions observed as of the measurement date. While we do not adjust prices we obtain from third partythird-party pricing sources, we will exclude third partythird-party prices for securities from our determinationestimation of fair value if we determine (based on our validation procedures and our market knowledge and expertise) that the price is significantly different from what observable market data would indicate and we cannot obtain an understanding from the third partythird-party source as to the significant inputs used to determine the price.
The validation procedures described above also influence our determination of the appropriate fair value measurement classification. We utilize a three-level valuation hierarchy for disclosure of fair value measurement. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument's categorization within the hierarchy is based upon the lowest level of input that is significant to the fair value measurement. There were no transfers between valuation hierarchy levels during fiscal years December 31,2017 and 2016. The three levels of valuation hierarchy are defined as follows:
Level 1 Inputs —Quoted prices (unadjusted) for identical unrestricted assets and liabilities in active markets that are accessible at the measurement date.
Level 2 Inputs —Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 Inputs —Instruments with primarily unobservable market data that cannot be corroborated.
The following table provides a summary of our assets and liabilities that are measured at fair value on a recurring basis as of December 31, 20162017 and 20152016 (in millions):
| | | | | December 31, 2016 | | December 31, 2015 | | December 31, 2017 | | December 31, 2016 |
| | | Level 1 | | Level 2 | | Level 3 | | Level 1 | | Level 2 | | Level 3 | | Level 1 | | Level 2 | | Level 3 | | Level 1 | | Level 2 | | Level 3 |
| Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Agency securities | | $ | — |
| | $ | 45,393 |
| | $ | — |
| | $ | — |
| | $ | 51,331 |
| | $ | — |
| | $ | — |
| | $ | 55,506 |
| | $ | — |
| | $ | — |
| | $ | 45,393 |
| | $ | — |
|
| Agency securities transferred to consolidated VIEs | | — |
| | 818 |
| | — |
| | — |
| | 1,029 |
| | — |
| | — |
| | 662 |
| | — |
| | — |
| | 818 |
| | — |
|
| Credit risk transfer securities | | | — |
| | 876 |
| | — |
| | — |
| | 164 |
| | — |
|
| Non-Agency securities | | — |
| | 124 |
| | — |
| | — |
| | 113 |
| | — |
| | — |
| | 36 |
| | — |
| | — |
| | 124 |
| | — |
|
| Credit risk transfer securities | | — |
| | 164 |
| | — |
| | — |
| | — |
| | — |
| |
| U.S. Treasury securities | | 182 |
| | — |
| | — |
| | 25 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 182 |
| | — |
| | — |
|
| REIT equity securities | | | 29 |
| | — |
| | — |
| | — |
| | — |
| | — |
|
| Interest rate swaps | | — |
| | 321 |
| | — |
| | — |
| | 31 |
| | — |
| | — |
| | 81 |
| | — |
| | — |
| | 321 |
| | — |
|
| Swaptions | | — |
| | 22 |
| | — |
| | — |
| | 17 |
| | — |
| | — |
| | 75 |
| | — |
| | — |
| | 22 |
| | — |
|
| TBA securities | | — |
| | 4 |
| | — |
| | — |
| | 29 |
| | — |
| | — |
| | 30 |
| | — |
| | — |
| | 4 |
| | — |
|
| U.S. Treasury futures | | 8 |
| | — |
| | — |
| | 4 |
| | — |
| | — |
| | 19 |
| | — |
| | — |
| | 8 |
| | — |
| | — |
|
| REIT equity securities | | — |
| | — |
| | — |
| | 33 |
| | — |
| | — |
| |
| Total | | $ | 190 |
| | $ | 46,846 |
| | $ | — |
| | $ | 62 |
| | $ | 52,550 |
| | $ | — |
| | $ | 48 |
| | $ | 57,266 |
| | $ | — |
| | $ | 190 |
| | $ | 46,846 |
| | $ | — |
|
| Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Debt of consolidated VIEs | | $ | — |
| | $ | 460 |
| | $ | — |
| | $ | — |
| | $ | 595 |
| | $ | — |
| | $ | — |
| | $ | 357 |
| | $ | — |
| | $ | — |
| | $ | 460 |
| | $ | — |
|
| Obligation to return U.S. Treasury securities borrowed under reverse repurchase agreements | | 7,636 |
| | — |
| | — |
| | 1,696 |
| | — |
| | — |
| | 10,467 |
| | — |
| | — |
| | 7,636 |
| | — |
| | — |
|
| Interest rate swaps | | — |
| | 105 |
| | — |
| | — |
| | 920 |
| | — |
| | — |
| | 1 |
| | — |
| | — |
| | 105 |
| | — |
|
| TBA securities | | — |
| | 151 |
| | — |
| | — |
| | 15 |
| | — |
| | — |
| | 27 |
| | — |
| | — |
| | 151 |
| | — |
|
| Total | | $ | 7,636 |
|
| $ | 716 |
|
| $ | — |
| | $ | 1,696 |
| | $ | 1,530 |
| | $ | — |
| | $ | 10,467 |
|
| $ | 385 |
|
| $ | — |
| | $ | 7,636 |
| | $ | 716 |
| | $ | — |
|
We elected the option to account for debt of consolidated VIEs at fair value with changes in fair value reflected in earnings during the period in which they occur, because we believe this election more appropriately reflects our financial position as both
the consolidated Agency securities and consolidated debt are presented in a consistent manner, at fair value, on our consolidated balance sheets. We estimate the fair value of the consolidated debt based on the difference between (i) the fair value of the RMBS transferred to consolidated VIEs and (ii) the fair value of our retained interests, each of which is based on valuations obtained
from third-party pricing services and non-binding dealer quotes derived from common market pricing methods using "Level 2" inputs, andwhich are more observable than using inputs to estimate the fair value of the consolidated debt on a stand-alone basis.
Excluded from the table above are financial instruments, including cash and cash equivalents, restricted cash and cash equivalents, receivables, payables and borrowings under repurchase agreements and FHLB advances, which are presented in our consolidated financial statements at cost. The cost basis of these instruments is determined to approximate fair value due to their short duration or, in the case of longer-term repo, and FHLB advances, due to floating rates of interest based on an index plus or minus a fixed spread which is consistent with fixed spreads demanded in the market. We estimate the fair value of these instruments using "Level 1" or "Level 2" inputs.
Note 8. Net Income Per Common Share
Basic net income per common share includes no dilution and is computed by dividing net income applicable to common stock by the weighted-average number of common shares outstanding for the respective period. Diluted earnings per common share includes the impact of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares outstanding include unvested restricted stock units and performance share units granted under our long-term incentive program to employees and non-employee Board of Directors. The following table presents the computations of basic and diluted net income per common share for the periods indicated (shares and dollars in millions):
|
| | | | | | | | | | | | |
| | | Fiscal Year |
| | | 2017 | | 2016 | | 2015 |
| Weighted average number of common shares outstanding - basic | | 358.6 |
| | 331.9 |
| | 348.6 |
|
| Unvested restricted stock units and performance share units | | 0.1 |
| | — |
| | — |
|
| Weighted average number of common shares outstanding - diluted | | 358.7 |
| | 331.9 | | 348.6 |
| Net income available to common stockholders | | $ | 733 |
| | $ | 595 |
| | $ | 187 |
|
| Net income per common share - basic and diluted | | $ | 2.04 |
| | $ | 1.79 |
| | $ | 0.54 |
|
Note 8.9. Stockholders' Equity
Preferred Stock
Pursuant to our amended and restated certificate of incorporation, we are authorized to designate and issue up to 10.0 million shares of preferred stock in one or more classes or series. Our BoardAs of Directors has designated December 31, 2016, 6.9 million shares were designated as 8.000% Series A Cumulative Redeemable Preferred Stock ("Series A Preferred Stock") and 8,050 shares were designated as 7.750% Series B Cumulative Redeemable Preferred Stock ("Series B Preferred Stock"). The Series B Preferred Stock is represented by Series B depositary shares of 1/1000 interest in a share of Series B Preferred Stock. As of December 31, 2016,, we had 3.16.9 million shares of Series A Preferred Stock and 7,000 shares of Series B Preferred Stock (representing 7.0 million depositary shares) outstanding. During fiscal year 2017, we designated 13,800 shares as 7.00% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock ("Series C Preferred Stock"), represented by Series C depositary shares of 1/1000 interest in each share of Series C Preferred Stock. In August 2017, we issued 13,000 shares of Series C Preferred Stock in a public offering of 13.0 million Series C depositary shares at a price of $25 per depositary share for net proceeds of $315 million, after deducting underwriting discounts and estimated offering expenses. In September 2017, we redeemed all of our issued and outstanding shares of Series A Preferred Stock for $173 million (or $25 per share liquidation preference), plus accrued and unpaid dividends, and, in October of 2017, we filed a Certificate of Elimination of our Series A Preferred Stock with the Secretary of State of the State of Delaware, which eliminated the designation of Series A Preferred Stock from our amended and restated certificate of incorporation. As of December 31, 2017, we had 7,000 shares of Series B Preferred Stock (represented by 7.0 million Series B depositary shares) and 13,000 shares of Series C Preferred Stock (represented by 13.0 million Series C depositary shares) outstanding and 9,980,000 of authorized but unissued shares of preferred stock. Our Board of Directors may designate additional series of authorized preferred stock ranking junior to or in parity with the Series A or Series B Preferred Stock or designate additional shares of the Series A or Series B Preferred Stock and authorize the issuance of such shares.
In April 2012, we completed a public offering in which 6.9 million sharesPrior to the September 2017 redemption, holders of our Series A Preferred Stock were soldentitled to the underwritersreceive cumulative cash dividends at a pricerate of $24.21258.000% per annum of their $25.00 per share for proceeds, net of offering expenses, of $167 million. In May 2014, we completed a public offering in which 7.0 million depositary shares were sold to the underwriters at a price of $24.2125 per depositary share for proceeds, net of offering expenses, of $169 million. Each depositary share represents a 1/1,000th interest in a share of our Series B Preferred Stock.
Our Series A and Series B Preferred Stock have no stated maturity, are not subject to any sinking fund or mandatory redemption and rank on parity with each other. Under certain circumstances upon a change of control, our Series A and Series B Preferred Stock are convertible to shares of our common stock.liquidation preference. Holders of our Series A Preferred Stock and depository shares underlying our Series B Preferred Stock have no voting rights, except under limited conditions, and are entitled to receive cumulative cash dividends at a rate of 8.000% and 7.750% per annum respectively, of their $25.00 per share and $25.00 per depositary share liquidation preference, respectively, before holderspreference. Holders of depositary shares underlying our common stockSeries C Preferred Stock are entitled to receive any dividends. Sharescumulative cash dividends at a rate of our Series A Preferred Stock7.00% per annum up to, and depository shares underlying our Series B Preferred Stock are each redeemableincluding, October 14, 2022 and thereafter at a floating rate equal to three-month LIBOR plus a spread of 5.111% per annum of their $25.00 per depositary share plus accumulated and unpaid dividends (whether or not declared) exclusively at our option commencing on April 5, 2017 and May 8, 2019, respectively, or earlier under certain circumstances intended to preserve our qualification as a REIT for federal income tax purposes.liquidation preference. Dividends are payable quarterly in arrears on the 15th day of each January, April, July and October. As of December 31, 2016,2017, we had declared all required quarterly dividends on our preferred stock.
Our preferred stock ranks senior to our common stock with respect to the payment of dividends and the distribution of assets upon a voluntary or involuntary liquidation, dissolution or winding up of the Company. Our preferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and ranks on parity with each other. Under certain circumstances upon a change of control, our preferred stock is convertible to shares of our common stock. Holders of our preferred stock and depository shares underlying our preferred stock have no voting rights, except under limited conditions. Beginning on May 8, 2019 and October 15, 2022, depository shares underlying our Series AB and Series BC Preferred Stock.Stock, respectively, will be redeemable at $25.00 per depositary share, plus accumulated and unpaid dividends (whether or not declared) exclusively at our option. We may redeem shares of our preferred stock prior to our optional redemption date under certain circumstances intended to preserve our qualification as a REIT for Federal income tax purposes.
Common Stock Offerings
In May 2017, we completed a public offering in which 24.5 million shares of our common stock were sold to the underwriters for proceeds of $503 million, or $20.51 per common share, net of offering costs. In September 2017, we completed a public offering in which 28.2 million shares of our common stock were sold to the underwriters for proceeds of $577 million, or $20.47 per common share, net of estimated offering costs.
At-the-Market Offering Program
In February 2017, we entered into agreements with sales agents to publicly offer and sell shares of our common stock in privately negotiated and/or at-the-market transactions from time-to-time up to an aggregate amount of $750 million of shares of our common stock. During fiscal year 2017, we sold 7.6 million shares of our common stock under the sales agreements for proceeds of $159 million, or $20.96 per common share, net of estimated offering costs. As of December 31, 2017, $589 million of shares of our common stock remain available for issuance under this program.
Common Stock Repurchase Program
In October 2012, our Board of Directors adopted a program that provided for stock repurchases, which, as amended, authorized repurchases of our common stock up to $2 billion through December 31, 2016. In October 2016, our Board of Directors terminated theour existing stock repurchase program which had a total of $0.6 billion remaining for authorized repurchases of our common stock, and replaced it with a new stock repurchase authorization. Under the new stock repurchase program we arewere authorized to repurchase up to $1 billion of our outstanding shares of common stock through December 31, 2017.
Shares of our common stock may be purchased in the open market, including through block purchases, or through privately negotiated transactions, or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The timing, manner, price and amount of any repurchases will be determined at our discretion and the program may be suspended, terminated or modified at any time for any reason. Among other factors, we intend to only consider repurchasing shares of our common stock when the purchase price is less than our estimate of our current tangible net asset value per common share. Generally, when we repurchase our common stock at a discount to our tangible net asset value, the tangible net asset value of our remaining shares of common stock outstanding increases. In addition, we do not intend to repurchase any shares from directors, officers or other affiliates. The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.
During the fiscal years 2016 2015 and 2014,2015, we repurchased 6.5 million and 15.3 million and 3.4 million shares, respectively, of our common stock at an average repurchase price of $17.89 $18.58 and $22.10$18.58 per share, respectively, including expenses, totaling $116 million and $285 million, and $74 million. As of December 31, 2016, the total remaining amount authorized for repurchasesrespectively. We did not repurchase shares of our common stock was $1 billion.during fiscal year 2017.
Distributions to Stockholders
The following table summarizes cash dividends declared for fiscal years 2017, 2016 2015 and 20142015 (in millions, except per share amounts):
| | | | | Dividends Declared | | Dividends Declared Per Share | | Dividends Declared | | Dividends Declared Per Share |
| 8.000 % Series A Cumulative Redeemable Preferred Stock | | | | | | | | |
| Fiscal year 2017 | | | $ | 9 |
| | $ | 1.333000 |
|
| Fiscal year 2016 | | $ | 14 |
| | $ | 2.000000 |
| | $ | 14 |
| | $ | 2.000000 |
|
| Fiscal year 2015 | | $ | 14 |
| | $ | 2.000000 |
| | $ | 14 |
| | $ | 2.000000 |
|
| Fiscal year 2014 | | $ | 14 |
| | $ | 2.000000 |
| |
| 7.750% Series B Cumulative Redeemable Preferred Stock (Per Depositary Share) | | | | | | | | |
| Fiscal year 2017 | | | $ | 14 |
| | $ | 1.937500 |
|
| Fiscal year 2016 | | $ | 14 |
| | $ | 1.937500 |
| | $ | 14 |
| | $ | 1.937500 |
|
| Fiscal year 2015 | | $ | 14 |
| | $ | 1.937500 |
| | $ | 14 |
| | $ | 1.937500 |
|
| Fiscal year 2014 | | $ | 6 |
| | $ | 0.844965 |
| |
| 7.00% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (Per Depositary Share) | | | | | |
| Fiscal year 2017 | | | $ | 9 |
| | $ | 0.695140 |
|
| Common Stock | | | | | | | | |
| Fiscal year 2017 | | | $ | 777 |
| | $ | 2.160000 |
|
| Fiscal year 2016 | | $ | 763 |
| | $ | 2.300000 |
| | $ | 763 |
| | $ | 2.300000 |
|
| Fiscal year 2015 | | $ | 863 |
| | $ | 2.480000 |
| | $ | 863 |
| | $ | 2.480000 |
|
| Fiscal year 2014 | | $ | 921 |
| | $ | 2.610000 |
| |
Accumulated Other Comprehensive Income (Loss)
The following table summarizes changes to accumulated OCI for fiscal years 2017, 2016 2015 and 20142015 (in millions):
| | | Accumulated Other Comprehensive Income (Loss) | | Net Unrealized Gain (Loss) on Available-for-Sale MBS | | Net Unrealized Gain (Loss) on Swaps | | Total Accumulated OCI Balance | | Net Unrealized Gain (Loss) on Available-for-Sale MBS | | Net Unrealized Gain (Loss) on Swaps | | Total Accumulated OCI Balance |
| Balance as of December 31, 2013 | | $ | (1,087 | ) | | $ | (296 | ) | | $ | (1,383 | ) | |
| OCI before reclassifications | | 1,708 |
| | — |
| | 1,708 |
| |
| Amounts reclassified from accumulated OCI | | (51 | ) | | 156 |
| | 105 |
| |
| Balance as of December 31, 2014 | | 570 |
| | (140 | ) | | 430 |
| | $ | 570 |
| | $ | (140 | ) | | $ | 430 |
|
| OCI before reclassifications | | (620 | ) | | — |
| | (620 | ) | | (620 | ) | | — |
| | (620 | ) |
| Amounts reclassified from accumulated OCI | | 23 |
| | 101 |
| | 124 |
| | 23 |
| | 101 |
| | 124 |
|
| Balance as of December 31, 2015 | | (27 | ) | | (39 | ) | | (66 | ) | | $ | (27 | ) | | $ | (39 | ) | | $ | (66 | ) |
| OCI before reclassifications | | (261 | ) | | — |
| | (261 | ) | | (261 | ) | | — |
| | (261 | ) |
| Amounts reclassified from accumulated OCI | | (109 | ) | | 39 |
| | (70 | ) | | (109 | ) | | 39 |
| | (70 | ) |
| Balance as of December 31, 2016 | | $ | (397 | ) | | $ | — |
| | $ | (397 | ) | | $ | (397 | ) | | $ | — |
| | $ | (397 | ) |
| OCI before reclassifications | | | (31 | ) | | — |
| | (31 | ) |
| Amounts reclassified from accumulated OCI | | | 83 |
| | — |
| | 83 |
|
| Balance as of December 31, 2017 | | | $ | (345 | ) | | $ | — |
| | $ | (345 | ) |
The following table summarizes reclassifications out of accumulated OCI for fiscal years 2017, 2016 and 2015 (in millions):
|
| | | | | | | | | | | | | | |
| | | Fiscal Year | | Line Item in the Consolidated Statements of Comprehensive Income Where Net Income is Presented |
| Amounts Reclassified from Accumulated OCI | | 2016 | | 2015 | | 2014 | |
| (Gain) loss amounts reclassified from accumulated OCI for available-for-sale MBS upon realization | | $ | (109 | ) | | $ | 23 |
| | $ | (51 | ) | | Gain (loss) on sale of mortgage-backed securities, net |
| Periodic interest costs of interest rate swaps previously designated as hedges under GAAP, net | | 39 |
| | 101 |
| | 156 |
| | Interest expense |
| Total reclassifications | | $ | (70 | ) | | $ | 124 |
| | $ | 105 |
| | |
|
| | | | | | | | | | | | | | |
| | | Fiscal Year | | Line Item in the Consolidated Statements of Comprehensive Income Where Net Income is Presented |
| Amounts Reclassified from Accumulated OCI | | 2017 | | 2016 | | 2015 | |
| (Gain) loss amounts reclassified from accumulated OCI for available-for-sale MBS upon realization | | $ | 83 |
| | $ | (109 | ) | | $ | 23 |
| | Realized gain (loss) on sale of investment securities, net |
| Periodic interest costs of interest rate swaps previously designated as hedges under GAAP, net | | — |
| | 39 |
| | 101 |
| | Interest expense |
| Total reclassifications | | $ | 83 |
| | $ | (70 | ) | | $ | 124 |
| | |
Note 9. Equity10. Long-Term Incentive Compensation
Stock-Based Incentive Plans
We sponsor an equity incentive plan to provide for the issuance of equity-based awards, including stock options, restricted stock, restricted stock units and unrestricted stock awards to our independent directors (the "Director Plan"). During fiscal years 2016, 2015 and 2014, we granted restricted stock unit ("RSU") awards under the plan totaling $625,000, $625,000 and $375,000, respectively. The awards represent the right to receive an equivalent number of shares of common stock as measured by the closing price of our common stock on the grant date, plus any equivalent shares for dividends declared on our common stock, and vest over a 13 month period, subject toIn accordance with the terms and conditions of the plan. Prior to fiscal year 2013, we granted restricted stock awards under the Plan. The restricted stock awards had a grant date fair value equal to the closing price of our common stock on such date and vested annually over three years. The Director Plan was terminated and succeeded in its entirety by the 2016 Equity and Incentive Compensation Plan (the "2016 Equity Plan"), which was approvedadopted by our stockholders on December 9, 2016. Outstanding awards under the Director Plan, however, will continue in effect in accordance with their terms. The following table summarizes restricted stock and RSU transactions under the Director Plan for fiscal years 2016, 2015 and 2014:
|
| | | | | | | | | | | | | | |
| Director Plan | | Shares of Restricted Stock | | Restricted Stock Units | | Weighted Average Grant Date Fair Value 1 | | Weighted Average Vest Date Fair Value 2 |
| Unvested balance as of December 31, 2013 | | 27,000 | | — |
| | $ | 30.37 |
| | $ | — |
|
| Granted | | — |
| | 16,770 |
| | $ | 22.36 |
| | $ | — |
|
| Accrued RSU dividend equivalents | | — |
| | 1,469 |
| | $ | — |
| | $ | — |
|
| Vested | | (13,000 | ) | | — |
| | $ | 30.01 |
| | $ | 22.01 |
|
| Unvested balance as of December 31, 2014 | | 14,000 | | 18,239 |
| | $ | 25.11 |
| | $ | — |
|
| Granted | | — |
| | 28,880 |
| | $ | 21.64 |
| | $ | — |
|
| Accrued RSU dividend equivalents | | — |
| | 3,319 |
| | $ | — |
| | $ | — |
|
| Vested | | (9,000 | ) | | (19,007 | ) | | $ | 23.17 |
| | $ | 21.03 |
|
| Unvested balance as of December 31, 2015 | | 5,000 | | 31,431 |
| | $ | 21.44 |
| | $ | — |
|
| Granted | | — |
| | 33,015 |
| | $ | 18.93 |
| | $ | — |
|
| Accrued RSU dividend equivalents | | — |
| | 3,527 |
| | $ | — |
| | $ | — |
|
| Vested | | (5,000 | ) | | (46,538 | ) | | $ | 20.00 |
| | $ | 18.99 |
|
| Unvested balance as of December 31, 2016 | | — |
| | 21,435 | | $ | 17.49 |
| | $ | — |
|
_______________________
| |
1. | Accrued RSU dividend equivalents have a weighted averagewe may grant date fair value of $0. |
| |
2. | Weighted average vest date fair value is based on the closing price of our common stock on the vest date. |
The 2016 Equity Plan provides for grants of equity-based compensation in the form of stock options, stock appreciation rights, ("SARs"), restricted shares, RSUs,restricted stock units, performance shares, performance units, dividend equivalents and certain other awards denominated or payable in, or otherwise based on, shares of our common stock, plus cash incentive awards, for the purpose of providing our non-employee directors, officers and other employees and those of our subsidiaries, incentives and rewards for service or performance. The 2016 Equity Plan authorizes a total of 10 million shares our common stock that may be used to satisfy awards under the plan, subject to the share counting rules set forth within the plan. The Compensation Committee of our Board of Directors determines awards to be granted under theour 2016 Equity Plan and the terms of such awards, including vesting schedules. Prior to establishing our 2016 Equity Plan, we granted equity-based awards to independent directors per the terms of our AGNC Equity Incentive Plan for Independent Directors (the "Director Plan"). The Director Plan was terminated in December of 2016 and replaced by our 2016 Equity Plan. Outstanding awards under the Director Plan continued in effect in accordance with their terms.
During fiscal years 2017 and 2016, we granted time-based RSU awards to employees with a grant date fair value of $5 million and $2 million, respectively, which vest annually over a three-year period. We granted time-based RSU awards to independent directors during fiscal year 2017 of $500,000 under our 2016 Equity Plan and during fiscal years 2016 and 2015 of $625,000 and $625,000, respectively, under our prior Director Plan, which vest at the end of a 13-month period.
The following table summarizes time-based RSU transactions under our 2016 Equity Plan for fiscal years 2017 and 2016.
|
| | | | | | | | | | | |
| 2016 Equity Incentive Plan | | Time-Based RSUs | | Weighted Average Grant Date Fair Value 1 | | Weighted Average Vest Date Fair Value |
| Unvested balance as of December 31, 2015 | | — |
| | $ | — |
| | $ | — |
|
| Granted | | 101,407 |
| | $ | 17.89 |
| | $ | — |
|
| Accrued RSU dividend equivalents | | 968 |
| | $ | — |
| | $ | — |
|
| Unvested balance as of December 31, 2016 | | 102,375 |
| | $ | 17.72 |
| | $ | — |
|
| Granted | | 238,203 |
| | $ | 19.52 |
| | $ | — |
|
| Accrued RSU dividend equivalents | | 32,498 |
| | $ | — |
| | $ | — |
|
| Vested | | (37,602 | ) | | $ | 16.08 |
| | $ | 20.42 |
|
| Forfeitures | | (246 | ) | | $ | 18.29 |
| | $ | — |
|
| Unvested balance as of December 31, 2017 | | 335,228 |
| | $ | 17.46 |
| | $ | — |
|
| |
| 1. | Accrued RSU dividend equivalents have a weighted average grant date fair value of $0. |
The following table summarizes restricted stock and RSU transactions under the Director Plan for fiscal years 2017, 2016 and 2015:
|
| | | | | | | | | | | | | | |
| Director Plan | | Shares of Restricted Stock | | Time-Based RSUs | | Weighted Average Grant Date Fair Value 1 | | Weighted Average Vest Date Fair Value |
Unvested balance as of December 31, 2014 2 | | 14,000 | | 18,239 |
| | $ | 25.11 |
| | $ | — |
|
| Granted | | — |
| | 28,880 |
| | $ | 21.64 |
| | $ | — |
|
| Accrued RSU dividend equivalents | | — |
| | 3,319 |
| | $ | — |
| | $ | — |
|
| Vested | | (9,000 | ) | | (19,007 | ) | | $ | 23.17 |
| | $ | 21.03 |
|
| Unvested balance as of December 31, 2015 | | 5,000 | | 31,431 |
| | $ | 21.44 |
| | $ | — |
|
| Granted | | — |
| | 33,015 |
| | $ | 18.93 |
| | $ | — |
|
| Accrued RSU dividend equivalents | | — |
| | 3,527 |
| | $ | — |
| | $ | — |
|
| Vested | | (5,000 | ) | | (46,538 | ) | | $ | 20.00 |
| | $ | 18.99 |
|
| Unvested balance as of December 31, 2016 | | — |
| | 21,435 |
| | $ | 17.49 |
| | $ | — |
|
| Accrued RSU dividend equivalents | | — |
| | 1,032 |
| | $ | — |
| | $ | — |
|
| Vested | | — |
| | (22,467 | ) | | $ | 16.69 |
| | $ | 20.15 |
|
| Unvested balance as of December 31, 2017 | | — |
| | — |
| | $ | — |
| | $ | — |
|
| |
| 1. | Accrued RSU dividend equivalents have a weighted average grant date fair value of $0. |
| |
| 2. | Consist of restricted stock awards granted to independent directors prior to fiscal year 2015, which had a grant date fair value equal to the closing price of our common stock on the grant date and vested annually over three years. |
During fiscal year 2016,2017, we granted performance-based RSU awards to employees under our 2016 Equity Plan, which vest at the end of a three-year period provided that specified performance criteria are met. The performance criteria are based on a formula tied to our achievement of long-term economic returns consisting of the change in tangible net book value and dividends paid per common share on an absolute basis and relative to a select group of our peers. The fair value of the performance-based RSU awards as of the grant date was $5 million assuming the target levels of performance is achieved, but the actual value will vary within a range of 0% to 200% of target based on actual performance achieved relative to the targets. The following table summarizes performance-based RSU awards under the plan totaling $2 million. Theour 2016 Equity Plan for fiscal year 2017. No performance-based awards represent the right to receive an equivalent number of shares of common stock as measured by the closing price of our common stock on the grant date, or 101,407 shares, plus any equivalent shares for dividends declared on our common stock, and vest over a threewere issued during fiscal year period, subject to the terms and conditions of the plan. 2016.
|
| | | | | | | |
| 2016 Equity Incentive Plan | | Performance-Based RSUs at Target Performance Level | | Weighted Average Grant Date Fair Value 1 |
| Unvested balance as of December 31, 2016 | | — |
| | $ | — |
|
| Granted | | 250,609 |
| | $ | 19.39 |
|
| Accrued RSU dividend equivalents | | 22,767 |
| | $ | — |
|
| Vested | | — |
| | $ | — |
|
| Unvested balance as of December 31, 2017 | | 273,376 |
| | $ | 17.78 |
|
_______________________
| |
| 1. | Accrued RSU dividend equivalents have a weighted average grant date fair value of $0. |
As of December 31, 2016, 9.92017, 9.1 million shares remained available for awards under the 2016 Equity Plan. For purposes of determining the total number of shares available for awards under the 2016 Equity Plan, excluding securities to beavailable shares are reduced by (i) shares issued for priorvested RSU awards, grantednet of units withheld to cover minimum statutory tax withholding requirements paid by us in cash on behalf of the employee and (ii) outstanding unvested awards, (iii) outstanding previously vested awards, if distribution of such awards has been deferred beyond the vesting date, and (iv) accrued dividend equivalent units on outstanding awards through December 31, 2017. Unvested performance-based awards assume the maximum payout under the plan.terms of the award. As of December 31, 2017, there were no outstanding previously vested awards.
We recognize the cost of equity-based compensation awards based on the grant-date fair value of those awards, or the fair value of liabilities incurred, over the requisite service period. We recognize the impact of forfeitures as they occur. During fiscal years 2017 and 2016, 2015we recognized compensation expense of $3.1 million and 2014,$28 thousand, respectively, for stock-based awards to employees. During fiscal years 2017, 2016 and 2015, we recognized other operating expense of $455,000, $731,000 and $704,000, and $540,000, respectively, under the Director Plan and during fiscal year 2016 we recognized compensation expense of $28,000 under the 2016 Equity Plan.for stock-based awards to independent directors. As of December 31, 2016,2017, we had unrecognized expense related to stock-based awards granted under the plans of approximately $2$8 million, which is expected to be recognized over a weighted average period of 2.81.9 years.
Other Long-Term Incentive Compensation
During fiscal year 2017, we granted long-term incentive compensation awards under our MTGE Incentive Plan of $2 million, which was used to purchase shares of MTGE common stock on the open market. The awards vests annually over a three-year period. During fiscal year 2017, we recognized accrued compensation expense of $1 million associated with MTGE Incentive Plan awards. As of December 31, 2017, we had unrecognized compensation expense of $2 million associated with such awards, measured at fair value based on the closing stock price of MTGE common stock.
Note 10.11. Income Taxes
As of December 31, 2016,2017, we have distributed all of our estimated taxable income for fiscal year 2016.2017. Accordingly, we do not expect to incur an income tax liability on our 20162017 taxable income. For fiscal years 20152016 and 2014,2015, we distributed all of
our taxable income within the time limits prescribed by the Internal Revenue Code. Accordingly, we did not incur an income tax liability on our taxable income for such periods.
Based on our analysis of any potential uncertain income tax positions, we concluded that we do not have any uncertain tax positions that meet the recognition or measurement criteria of ASC 740 as of December 31, 2017, 2016 2015 and 2014.2015. Our tax returns for tax years 20132014 and forward are open to examination by the IRS. In the event thatIf we incur income tax related interest and penalties, our policy is to classify them as a component of provision for income taxes.
Note 11.12. Management Agreement and Related Party Transactions
Prior to our acquisition of AMM on July 1, 2016, we were externally managed by AGNC Management, LLC (our "Manager").managed. We paid our Manager a management fee payable monthly in arrears in an amount equal to one-twelfth of 1.25% of our month-end stockholders' equity, adjusted to exclude the effect of any unrealized gains or losses included in either retained earnings or accumulated OCI, each as computed in accordance with GAAP. There was no incentive compensation payable to our Manager pursuant to the management agreement. WeFor fiscal years 2016 and 2015, we incurred management fees of $52 million and $116 million, and $119 million for the first half of fiscal year 2016 and for fiscal years 2015 and 2014, respectively. Following our management internalization, we no longer incur a management fee,fees, but we incur expenses associated with an internally managed organization, including compensation expense previously borne by our Manager. For fiscal year 2016, we had compensation and benefits expense of $19 million, consisting of base salary, bonus accruals and benefits expense.
Our management agreement provided for automatic annual one-year renewal terms and could only be terminated by us or our Manager without cause, as defined in the management agreement, after the completion of the then current renewal term, provided that either party provided 180-days prior written notice of non-renewal of the management agreement. If we were to not renew the management agreement without cause, we would have been required to pay a termination fee on the last day of the applicable term, equal to three times the average annual management fee earned by our Manager during the prior 24-month period immediately preceding the most recently completed month prior to the effective date of termination. We could only not renew the management agreement with or without cause with the consent of the majority of our independent directors.
Pursuant to our management agreement, we were also obligated to reimburse our Manager for its expenses incurred directly related to our operations, excluding employment-related expenses of our Manager's officers and employees and any American Capital employees who provided services to us pursuant to the management agreement.operations. For fiscal years 2016 2015 and 2014,2015, we recorded expense reimbursements to our Manager of $3 million $8 million and $8 million, respectively, primarily consisting of costs related to information technology systems.respectively.
During fiscal year 2017 and 2016, following our acquisition of AMM, we earned management fees of $13 million and $8 million from our management of MTGE.
Note 12. Business Combination - Acquisition of AGNC Mortgage Management, LLC
On July 1, 2016, we completed our acquisition of all of the outstanding membership interests of AMM from ACAM, a wholly owned portfolio company of ACAS, for a purchase price of $562 million in cash. Following the closing of the acquisition, we became internally managed and are no longer affiliated with ACAS. The results of AMM's operations have been included in our consolidated financial statements since that date. We believe internalizing our management function will result in lower operating costs as well as provide management fee income from MTGE.
Our acquisition of AMM is accounted for as a business combination using the acquisition method of accounting, whereby the total purchase price has been allocated to identifiable assets acquired and liabilities assumed based on their respective fair values as of the acquisition date. Goodwill is calculated as the excess of the consideration transferred over the net assets acquired that meet the criteria for separate recognition and represents the estimated future economic benefits arising from these and other assets acquired that could not be individually identified or do not qualify for recognition as a separate asset. A large majority of the acquisition price has been recognized as goodwill, which is attributable to our pre-existing management agreement with AMM that does not qualify for separate recognition. Goodwill is expected to be deductible for income tax purposes over a 15 year amortization period. We did not recognize a gain or loss associated with the effective settlement of our management agreement with AMM on the acquisition date based on comparable agreements available in the market.
The fair values of intangible assets acquired were determined using a market-based measurement under the income approach based on primarily unobservable market data that cannot be corroborated and, thus, represent a level 3 measurement (see Note 7). The primary market-based inputs include forecasted revenues and expenses, discount rate and corporate income tax rate.
The following table summarizes the fair values of assets acquired and liabilities assumed at the acquisition date (in millions).
|
| | | | |
| | | July 1, 2016(Acquisition Date)
|
| Cash | | $ | 7 |
|
| MTGE management agreement | | 29 |
|
| Other intangible asset | | 1 |
|
| Total identifiable assets | | 37 |
|
| Accounts payable and other liabilities | | (1 | ) |
| Identifiable net assets acquired | | 36 |
|
| Goodwill | | 526 |
|
| Net assets acquired | | $ | 562 |
|
The MTGE management agreement is being amortized over a 10 year amortization period. We recognized $9 million of transaction related costs that were expensed during fiscal year 2016. These costs are included in other operating expenses in our consolidated statements of comprehensive income.
AMM's revenue and net loss included in our consolidated statements of comprehensive income from the acquisition date to December 31, 2016 are $8 million and $(11) million, respectively, after elimination of AGNC's management fee and other intercompany transactions. The following table represents our pro forma consolidated revenue and net income as if AMM had been included in our consolidated results for fiscal year 2015 and for all of fiscal year 2016 (in millions). Revenue includes interest income from our investment portfolio and management fee income from managing MTGE. Amounts have been calculated after applying our accounting policies and adjusting AMM's results to reflect amortization expense that would have been charged assuming the fair value adjustments to intangible assets had been applied on January 1, 2015. All AGNC management fees and all other actual and pro forma intercompany transactions have been eliminated. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what operating results would have been had the AMM acquisition occurred on January 1, 2015 and may not be indicative of future operating results.
|
| | | | | | | | |
| | | Pro Forma Consolidated Revenue and Net Income |
| | | Fiscal Year |
| | | 2016 | | 2015 |
| Revenue | | $ | 1,337 |
| | $ | 1,483 |
|
| Net Income | | $ | 661 |
| | $ | 303 |
|
Note 13. Quarterly Results (Unaudited)
The following is a presentation of the quarterly results of operations and comprehensive income for fiscal years 20162017 and 20152016 (in millions, except per share data).
|
| | | | | | | | | | | | | | | |
| | Quarter Ended |
| | March 31, 2017 | | June 30, 2017 | | September 30, 2017 | | December 31, 2017 |
| Interest income: | | | | | | | |
| Interest income | $ | 296 |
| | $ | 293 |
| | $ | 318 |
| | $ | 386 |
|
| Interest expense | 98 |
| | 112 |
| | 140 |
| | 174 |
|
| Net interest income | 198 |
| | 181 |
| | 178 |
| | 212 |
|
| Other gain (loss): | | | | | | | |
| Gain (loss) on sale of investment securities, net | (84 | ) | | 15 |
| | 22 |
| | (16 | ) |
| Unrealized gain (loss) on investment securities measured at fair value through net income, net | 16 |
| | 9 |
| | (31 | ) | | (65 | ) |
| Gain (loss) on derivative instruments and other securities, net | (40 | ) | | (169 | ) | | 131 |
| | 271 |
|
| Management fee income | 3 |
| | 4 |
| | 3 |
| | 3 |
|
| Total other gain (loss), net | (105 | ) | | (141 | ) | | 125 |
| | 193 |
|
| Expenses: | | | | | | | |
| Compensation and benefits | 10 |
| | 10 |
| | 10 |
| | 12 |
|
| Other operating expenses | 7 |
| | 6 |
| | 7 |
| | 8 |
|
| Total expenses | 17 |
| | 16 |
| | 17 |
| | 20 |
|
| Net income | 76 |
| | 24 |
| | 286 |
| | 385 |
|
| Dividend on preferred stock | 7 |
| | 7 |
| | 9 |
| | 9 |
|
| Issuance costs of redeemed preferred stock | — |
| | — |
| | 6 |
| | — |
|
| Net income available to common shareholders | $ | 69 |
| | $ | 17 |
| | $ | 271 |
| | $ | 376 |
|
| | | | | | | | |
| Net income | $ | 76 |
| | $ | 24 |
| | $ | 286 |
| | $ | 385 |
|
| Unrealized gain (loss) on investment securities measured at fair value through other comprehensive income (loss), net | 46 |
| | 121 |
| | 90 |
| | (205 | ) |
| Comprehensive Income | 122 |
| | 145 |
| | 376 |
| | 180 |
|
| Dividend on preferred stock | 7 |
| | 7 |
| | 9 |
| | 9 |
|
| Issuance costs of redeemed preferred stock | — |
| | — |
| | 6 |
| | — |
|
| Comprehensive income available to common shareholders | $ | 115 |
| | $ | 138 |
| | $ | 361 |
| | $ | 171 |
|
| | | | | | | | |
| Weighted average number of common shares outstanding - basic | 331.0 |
| | 346.4 |
| | 364.7 |
| | 391.3 |
|
| Weighted average number of common shares outstanding - diluted | 331.1 |
| | 346.5 |
| | 364.9 |
| | 391.5 |
|
| Net income per common share - basic and diluted | $ | 0.21 |
| | $ | 0.05 |
| | $ | 0.74 |
| | $ | 0.96 |
|
| Comprehensive income per common share - basic and diluted | $ | 0.35 |
| | $ | 0.40 |
| | $ | 0.99 |
| | $ | 0.44 |
|
| Dividends declared per common share | $ | 0.54 |
| | $ | 0.54 |
| | $ | 0.54 |
| | $ | 0.54 |
|
|
| | | | | | | | | | | | | | | |
| | Quarter Ended |
| | March 31, 2016 | | June 30, 2016 | | September 30, 2016 | | December 31, 2016 |
| Interest income: | | | | | | | |
| Interest income | $ | 295 |
| | $ | 318 |
| | $ | 315 |
| | $ | 393 |
|
| Interest expense | 99 |
| | 101 |
| | 96 |
| | 98 |
|
| Net interest income | 196 |
| | 217 |
| | 219 |
| | 295 |
|
| Other gain (loss): | | | | | | | |
| Gain (loss) on sale of investment securities, net | (2 | ) | | 55 |
| | 61 |
| | (5 | ) |
| Unrealized gain (loss) on investment securities measured at fair value through net income, net | 11 |
| | — |
| | (6 | ) | | (11 | ) |
| Gain (loss) on derivative instruments and other securities, net | (944 | ) | | (367 | ) | | 248 |
| | 753 |
|
| Management fee income | — |
| | — |
| | 4 |
| | 4 |
|
| Total other gain (loss), net | (935 | ) | | (312 | ) | | 307 |
| | 741 |
|
| Expenses: | | | | | | | |
| Management fee expense | 27 |
| | 25 |
| | — |
| | — |
|
| Compensation and benefits | — |
| | — |
| | 9 |
| | 10 |
|
| Other operating expenses | 6 |
| | 15 |
| | 6 |
| | 7 |
|
| Total expenses | 33 |
| | 40 |
| | 15 |
| | 17 |
|
| Net income (loss) | (772 | ) | | (135 | ) | | 511 |
| | 1,019 |
|
| Dividend on preferred stock | 7 |
| | 7 |
| | 7 |
| | 7 |
|
| Net income (loss) available (attributable) to common shareholders | $ | (779 | ) | | $ | (142 | ) | | $ | 504 |
| | $ | 1,012 |
|
| | | | | | | | |
| Net income (loss) | $ | (772 | ) | | $ | (135 | ) | | $ | 511 |
| | $ | 1,019 |
|
| Other comprehensive income (loss): | | | | | | | |
| Unrealized gain (loss) on available-for-sale securities, net | 765 |
| | 370 |
| | (97 | ) | | (1,408 | ) |
| Unrealized gain on derivative instruments, net | 19 |
| | 12 |
| | 7 |
| | 1 |
|
| Other comprehensive income (loss) | 784 |
| | 382 |
| | (90 | ) | | (1,407 | ) |
| Comprehensive income (loss) | 12 |
| | 247 |
| | 421 |
| | (388 | ) |
| Dividend on preferred stock | 7 |
| | 7 |
| | 7 |
| | 7 |
|
| Comprehensive income (loss) available (attributable) to common shareholders | $ | 5 |
| | $ | 240 |
| | $ | 414 |
| | $ | (395 | ) |
| | | | | | | | |
| Weighted average number of common shares outstanding - basic and diluted | 334.4 |
| | 331.0 |
| | 331.0 |
| | 331.0 |
|
| Net income (loss) per common share - basic and diluted | $ | (2.33 | ) | | $ | (0.43 | ) | | $ | 1.52 |
| | $ | 3.06 |
|
| Comprehensive income (loss) per common share - basic and diluted | $ | 0.01 |
| | $ | 0.73 |
| | $ | 1.25 |
| | $ | (1.19 | ) |
| Dividends declared per common share | $ | 0.60 |
| | $ | 0.60 |
| | $ | 0.56 |
| | $ | 0.54 |
|
|
| | | | | | | | | | | | | | | |
| | Quarter Ended |
| | March 31,
2015 | | June 30, 2015 | | September 30,
2015 | | December 31, 2015 |
| Interest income: | | | | | | | |
| Interest income | $ | 383 |
| | $ | 414 |
| | $ | 295 |
| | $ | 374 |
|
| Interest expense | 86 |
| | 81 |
| | 77 |
| | 86 |
|
| Net interest income | 297 |
| | 333 |
| | 218 |
| | 288 |
|
| Other gain (loss): | | | | | | | |
| Gain (loss) on sale of investment securities, net | 36 |
| | (22 | ) | | (39 | ) | | 2 |
|
| Unrealized gain (loss) on investment securities measured at fair value through net income, net | 11 |
| | (7 | ) | | 10 |
| | (9 | ) |
| Gain (loss) on derivative instruments and other securities, net | (560 | ) | | 244 |
| | (788 | ) | | 340 |
|
| Total other gain (loss), net | (513 | ) | | 215 |
| | (817 | ) | | 333 |
|
| Expenses: | | | | | | | |
| Management fees | 30 |
| | 29 |
| | 29 |
| | 28 |
|
| General and administrative expenses | 6 |
| | 7 |
| | 5 |
| | 5 |
|
| Total expenses | 36 |
| | 36 |
| | 34 |
| | 33 |
|
| Net income (loss) | (252 | ) | | 512 |
| | (633 | ) | | 588 |
|
| Dividend on preferred stock | 7 |
| | 7 |
| | 7 |
| | 7 |
|
| Net income (loss) available (attributable) to common shareholders | $ | (259 | ) | | $ | 505 |
| | $ | (640 | ) | | $ | 581 |
|
| | | | | | | | |
| Net income (loss) | $ | (252 | ) | | $ | 512 |
| | $ | (633 | ) | | $ | 588 |
|
| Other comprehensive income (loss): | | | | | | | |
| Unrealized gain (loss) on available-for-sale securities, net | 391 |
| | (872 | ) | | 467 |
| | (583 | ) |
| Unrealized gain on derivative instruments, net | 29 |
| | 26 |
| | 24 |
| | 22 |
|
| Other comprehensive income (loss) | 420 |
| | (846 | ) | | 491 |
| | (561 | ) |
| Comprehensive income (loss) | 168 |
| | (334 | ) | | (142 | ) | | 27 |
|
| Dividend on preferred stock | 7 |
| | 7 |
| | 7 |
| | 7 |
|
| Comprehensive income (loss) available (attributable) to common shareholders | $ | 161 |
| | $ | (341 | ) | | $ | (149 | ) | | $ | 20 |
|
| | | | | | | | |
| Weighted average number of common shares outstanding-basic and diluted | 352.8 |
| | 352.1 |
| | 347.8 |
| | 341.6 |
|
| Net income (loss) per common share - basic and diluted | $ | (0.73 | ) | | $ | 1.43 |
| | $ | (1.84 | ) | | $ | 1.70 |
|
| Comprehensive income (loss) per common share - basic and diluted | $ | 0.46 |
| | $ | (0.97 | ) | | $ | (0.43 | ) | | $ | 0.06 |
|
| Dividends declared per common share | $ | 0.66 |
| | $ | 0.62 |
| | $ | 0.60 |
| | $ | 0.60 |
|
Note 14. Subsequent Events
On each of January 12, 201711, 2018 and February 14, 2017,13, 2018, our Board of Directors declared a monthly dividend of $0.18 per common share, payable on February 8, 20172018 and March 8, 2017,2018, respectively, to common stockholders of record as of January 31, 20172018 and February 28, 2017,2018, respectively.
On February 1, 2017, we entered into sales agreements with underwriters to publicly offer and sell shares of our common stock, from time-to-time, through publicly negotiated and/or at-the-market transactions, up to an aggregate offering amount of $750 million.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act of 1934, as amended (the "Exchange Act") reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of "disclosure controls and procedures" as promulgated under the Exchange Act and the rules and regulations thereunder. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
We, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2016.2017. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.
Management's Report on Internal Control over Financial Reporting
Management Report on Internal Control over Financial Reporting is included in "Item 8. Financial Statements and Supplementary Data."
Attestation Report of Registered Public Accounting Firm
The attestation report of our registered public accounting firm is included in "Item 8. Financial Statements and Supplementary Data."
Changes in Internal Control over Financial Reporting
There have been no changes in our "internal control over financial reporting" (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. As previously disclosed, we completed the acquisition of AMM on July 1, 2016. Where appropriate, we are reviewing related internal controls and making changes to align and integrate AMM into our financial control environment. This initiative is being done as a part of our integration plan and is not in response to any identified deficiency or weakness in the Company’s or AMM’s internal control over financial reporting.
Item 9B. Other Information
Additional U.S. Federal Income Tax Considerations
None.The following summary of certain U.S. Federal income tax considerations supplements the discussion set forth under the heading "U.S. Federal Income Tax Considerations" in our prospectus dated June 26, 2015, filed as part of our registration statement on Form S-3ASR (No. 333-205307), and any supplements thereto, and is subject to the qualifications set forth therein. Capitalized terms used but not defined herein have the meanings set forth in such prospectus. The following summary is for general information only and is not tax advice. This discussion does not purport to deal with all aspects of taxation that may be relevant to particular holders of our common stock in light of their personal investment or tax circumstances.
EACH PROSPECTIVE HOLDER IS ADVISED TO CONSULT HIS, HER OR ITS TAX ADVISOR REGARDING THE SPECIFIC U.S. FEDERAL, STATE, LOCAL, AND FOREIGN INCOME AND OTHER TAX CONSEQUENCES TO HIM, HER OR IT OF ACQUIRING, HOLDING, EXCHANGING, OR OTHERWISE DISPOSING OF OUR COMMON SHARES AND OF OUR ELECTION TO BE TAXED AS A REIT, AND OF POTENTIAL CHANGES IN APPLICABLE TAX LAWS.
The recently enacted TCJA significantly changed the U.S. Federal income tax laws applicable to businesses and their owners, including REITs and their stockholders. Among other amendments, the TCJA effected the following changes (generally effective for taxable years beginning after December 31, 2017, unless otherwise indicated):
For taxable years that begin after December 31, 2017, and before January 1, 2026: (i) the U.S. Federal income tax brackets generally applicable to ordinary income of individuals, trusts and estates have been modified (with the rates generally reduced), and (ii) stockholders that are individuals, trusts or estates are generally entitled to a deduction equal to 20% of the aggregate amount of ordinary income dividends received from a REIT (not including dividends that are eligible for the reduced rates applicable to "qualified dividend income" or treated as capital gain dividends), subject to certain limitations.
The U.S. Federal income tax rate applicable to corporations has been reduced to 21% (from the previous maximum rate of 35%), and the alternative minimum tax has been repealed for corporations. These changes would generally reduce the amount of income taxes payable by our TRS, as well as by us to the extent we would otherwise be subject to regular corporate-level U.S. Federal income tax (for example, if we were to become subject to tax as a result of distributing less than 100% of our taxable income or recognizing built-in gains in assets acquired from C corporations). In addition, the maximum withholding rate on distributions by us to non-U.S. stockholders that are attributable to gain from the disposition of a U.S. real property interest is reduced from 35% to 21%.
There are new limitations on the deductibility of interest expense and net operating losses, which may affect the deductibility of interest paid or accrued by, or net operating losses generated by, us or our TRS or other subsidiaries.
A U.S. tax-exempt stockholder that is subject to tax on its unrelated business taxable income (‘‘UBTI’’) will be required to segregate its taxable income and loss for each unrelated trade or business activity for purposes of determining its UBTI.
New rules have been enacted that in some circumstances may accelerate the recognition of certain income items.
Significant changes have been enacted to the international tax rules, which, among other consequences, could affect the amount, timing, or character of income we recognize with respect to any foreign entity in or through which we may invest.
Technical corrections or other amendments to the TCJA or administrative guidance interpreting the TCJA may be forthcoming at any time. We cannot predict the long-term effect of the TCJA or any future law changes on REITs or their stockholders. You are urged to consult your tax advisor regarding the effects of the TCJA on your investment in our common shares.
PART III.III
Item 10. Directors, Executive Officers and Corporate Governance
Information in response to this Item is incorporated herein by reference to the information provided in our Proxy Statement for our 20172018 Annual Meeting of Stockholders (the "2017"2018 Proxy Statement") under the headings "PROPOSAL 1: ELECTION OF DIRECTORS", "EXECUTIVE OFFICERS", "BOARD AND GOVERNANCE MATTERS", and "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE."
Item 11. Executive Compensation
Information in response to this Item is incorporated herein by reference to the information provided in the 20172018 Proxy Statement under the headings "PROPOSAL 1: ELECTION OF DIRECTORS", "EXECUTIVE COMPENSATION", "COMPENSATION DISCUSSION AND ANALYSIS", "REPORT OF THE COMPENSATION AND CORPORATE GOVERNANCE COMMITTEE", and "COMPENSATION AND CORPORATE GOVERNANCE COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION."
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information in response to this Item is incorporated herein by reference to the information provided in the 20172018 Proxy Statement under the heading "SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS."
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information in response to this Item is incorporated herein by reference to the information provided in the 20172018 Proxy Statement under the headings "CERTAIN TRANSACTIONS WITH RELATED PERSONS" and "PROPOSAL 1: ELECTION OF DIRECTORS."
Item 14. Principal Accounting Fees and Services
Information in response to this Item is incorporated herein by reference to the information provided in the 20172018 Proxy Statement under the heading "PROPOSAL 4: RATIFICATION OF APPOINTMENT OF INDEPENDENT PUBLIC ACCOUNTANT."
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) List of documents filed as part of this report:
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| (1) | The following financial statements are filed herewith: |
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| Consolidated Balance Sheets as of December 31, 20162017 and 20152016 |
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| Consolidated Statements of Comprehensive Income for fiscal years 2017, 2016 2015 and 2014 2015 |
Consolidated Statements of Stockholders' Equity for fiscal years 2017, 2016 2015 and 20142015
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| Consolidated Statements of Cash Flows for fiscal years 2017, 2016 2015 and 20142015 |
(2) The following exhibits are filed herewith or incorporated herein by reference
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| Exhibit No. | Description |
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| Purchase and Sale Agreement, dated as of May 23, 2016, by and among American Capital Asset Management, LLC, American Capital Mortgage Management, LLC, American Capital, Ltd. and American Capital Agency Corp., incorporated by reference to Exhibit 2.1 of Form 8-K (File No. 001-34057), filed May 25, 2016. |
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*3.1 |
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| Certificate of Designations of 7.750% Series B Cumulative Redeemable Preferred Stock, incorporated herein by reference to Exhibit 3.3 of Form 8-A (File No. 001-34057), filed May 7, 2014. |
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| Specimen 8.000% Series A Cumulative Redeemable Preferred Stock Certificate, incorporated herein by reference to Exhibit 4.1 of Form 8-K (File No. 001-34057), filed April 3, 2012. |
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| Letter Agreement, dated as of December 1, 2015, as amended on July 1, 2016 and December 18, 2017, by and between American CapitalAGNC Mortgage Management, LLC and Bernice E. Bell, incorporated herein by reference to Exhibit 10.410.1 of Form 8-K (File No. 001-34057), filed July 8, 2016.December 18, 2017. |
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| Transition Services Agreement,Retention Bonus Grant Letter, dated July 1, 2016, by and amongbetween American Capital Agency Corp., American Capital, Ltd., American Capital AssetMortgage Management, LLC and American CapitalAaron Pas, incorporated herein by reference to Exhibit 10.1 of Form 10-Q (File No. 001-34057), filed May 8, 2017. |
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12.1 |
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| Underwriting Agreement, dated September 12, 2017, among AGNC Investment Corp., Credit Suisse Securities (USA) LLC, J.P. Morgan Securities LLC, Morgan Stanley & Co. LLC, UBS Securities LLC and Wells Fargo Securities, LLC as representatives of the several underwriters listed on Schedule I attached thereto, incorporated herein by reference to Exhibit 1.1 of Form 8-K (File No. 001-34057), filed September 15, 2017. |
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| Subsidiaries of the Company and jurisdiction of incorporation: |
| | 1) AGNC TRS, LLC, a Delaware limited liability company |
| | 2) Old Georgetown Insurance Co. LLC, a Missouri limited liability company |
| | 3) Bethesda Securities, LLC, a Delaware limited liability company |
| | 4) AGNC Mortgage Management, LLC, a Delaware limited liability company |
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| 101.INS** |
| XBRL Instance Document |
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| 101.SCH** |
| XBRL Taxonomy Extension Schema Document |
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| 101.CAL** |
| XBRL Taxonomy Extension Calculation Linkbase Document |
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| 101.LAB** |
| XBRL Taxonomy Extension Labels Linkbase Document |
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| 101.PRE** |
| XBRL Taxonomy Extension Presentation Linkbase Document |
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| 101.DEF** |
| XBRL Taxonomy Extension Definition Linkbase Document |
______________________
* Previously filed
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| ** | This exhibit is being furnished rather than filed, and shall not be deemed incorporated by reference into any filing, in accordance with Item 601 of Regulation S-K |
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| † | Management contract or compensatory plan or arrangement |
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| | See the exhibits filed herewith. |
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| (c) | Additional financial statement schedules |
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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| | | | AGNC INVESTMENT CORP. |
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| | | | By: | /s/ GARY KAINGARY KAIN |
| | | | | Gary Kain
Chief Executive Officer, President and
Chief Investment Officer (Principal Executive Officer) |
| Date: | February 27, 201726, 2018 | | | |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
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| | Name | Title | Date |
| | /s/ GARY KAIN | Chief Executive Officer, President and Chief Investment Officer (Principal Executive Officer)
| February 27, 201726, 2018 |
| | Gary Kain | | |
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| | /s/ PETER FEDERICO | Chief Financial Officer and
Executive Vice President (Principal Financial Officer) | February 27, 201726, 2018 |
| | Peter Federico | | |
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| | /s/ BERNICE E. BELL | Senior Vice President and Chief Accounting Officer (Principal Accounting Officer) | February 27, 201726, 2018 |
| | Bernice E. Bell | | |
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| | * | Director | February 27, 201726, 2018 |
| | Morris A. Davis | | |
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| | * | Director | February 27, 201726, 2018 |
| | Larry K. Harvey | | |
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| | * | Director | February 27, 201726, 2018 |
| | Prue B. Larocca | | |
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| | * | Director | February 27, 201726, 2018 |
| | Paul E. Mullings | | |
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| *By: | /s/ KENNETH L. POLLACK | | |
| | Kenneth L. Pollack | | |
| | Attorney-in-fact | | |
