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Article by DailyStocks_admin    (11-14-12 01:55 AM)

Description

American Capital Mortgage Investment Corp. 10% Owner Kain Gary D Warburg Pincus bought 67521 shares on 5-19-2012 at $ 14.4

BUSINESS OVERVIEW

Our Company
American Capital Mortgage Investment Corp. ("MTGE", the "Company", "we", "us", and "our") was incorporated in Maryland on March 15, 2011 and commenced operations on August 9, 2011 following the completion of our initial public offering (“IPO”) of 8.0 million shares of common stock. Concurrent with our IPO, American Capital, Ltd. ("American Capital") purchased 2.0 million shares of our common stock in a private placement. We are externally managed by American Capital MTGE Management, LLC (our “Manager”), an affiliate of American Capital. We do not have any employees. Our common stock is traded on the NASDAQ Global Select Market under the symbol “MTGE.”
We invest in, finance and manage a leveraged portfolio of mortgage-related investments, which we define to include agency mortgage investments, non-agency mortgage investments and other mortgage-related investments. Agency mortgage investments include residential mortgage pass-through certificates and collateralized mortgage obligations (“CMOs”) structured from residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by a government-sponsored entity (“GSE”), such as the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), or by a U.S. Government agency, such as the Government National Mortgage Association ("Ginnie Mae”). Non-agency mortgage investments include residential mortgage-backed securities (“RMBS”) backed by residential mortgages that are not guaranteed by a GSE or U.S. Government agency. Non-agency mortgage investments may also include prime and non-prime residential mortgage loans. Other mortgage-related investments may include commercial mortgage-backed securities (“CMBS”), commercial mortgage loans, mortgage-related derivatives and other mortgage-related investments.
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, we are required to distribute annually at least 90% of our taxable net income. As long as we qualify as a REIT, we will generally not be subject to U.S. federal 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.
Our Investment Strategy
Our objective is to provide attractive risk-adjusted returns to our stockholders over the long-term through a combination of dividends and net book value appreciation. In pursuing this objective, we rely on our Manager's expertise to construct and manage a diversified mortgage investment portfolio by identifying asset classes that, when properly financed and hedged, are designed to produce attractive returns across a variety of market conditions and economic cycles, considering the risks associated with owning such investments.
We consider the following areas of focus to be critical to our success in meeting our investment objectives:

1.

Careful asset selection

2.

Active portfolio management

3.

Prudent risk management
Through research, investment underwriting analysis and disciplined asset selection, our Manager seeks to build a portfolio of mortgage investments with attractive risk-adjusted yields. Our Manager evaluates investment opportunities by reviewing: cash flow characteristics of underlying mortgages and properties; borrower credit quality; regional economic factors, including the potential for growth or contraction, future demand for residential and commercial properties and the potential for home price appreciation or deprecation; and potential drivers of defaults and loss characteristics of underlying collateral.
We seek to profit not only from current earnings generated by our investment portfolio, but also from the identification of investment opportunities whose relative value, arising from current or expected market trends and dislocations, has diverged from other investment opportunities. Specifically, we evaluate the risk/return characteristics of individual investment opportunities against other mortgage investment opportunities as well as opportunities in other investment sectors. We focus our asset selection on investments that are expected to generate attractive returns relative to other investments with similar levels of risk and are anticipated to benefit from expected trends within the mortgage market.
The factors our Manager considers in selecting non-agency mortgage investments include, but are not limited to, items such as interest rates, property prices, other economic indicators and loan level and borrower characteristics. These factors drive our Manager's projections of prepayments, loan modifications, defaults and loss severities. In addition, these loan cash flow projections, which may be adjusted to reflect servicer specific behavior, in combination with the deal structure, allow our Manager to project security returns under a variety of scenarios and to select securities that provide attractive returns given the specific level of risk.
We believe that the residential mortgage market will undergo dramatic change in the coming years and we expect our target asset allocation to evolve as opportunities emerge and the government, through the GSEs and the Federal Housing Administration ("FHA"), modifies its involvement in the U.S. housing finance market. Currently, the GSEs (along with the FHA) guarantee approximately 90% of all new mortgage production within the United States and, consequently, the early allocation of our capital has been significantly directed toward agency mortgage investments. Depending on the pace of regulatory reform, the wind down and run-off of the GSE portfolios, the GSEs' level of participation in new securitizations and other factors affecting the housing market, we expect our allocation of capital to agency mortgage investments to eventually range from approximately 75% to 25%, with an allocation of approximately 25% to 75% to non-agency mortgage investments and other mortgage-related investments (other mortgage-related investments account for 0% to 25% of the latter range).
Our active management strategy involves buying and selling assets in all sectors of the mortgage market. Therefore, the composition of our investment portfolio will vary as our Manager believes changes to market conditions, risks and valuations warrant. Consequently, we may experience investment gains or losses when we sell instruments that our Manager no longer believes provide attractive risk-adjusted returns relative to other sectors of the mortgage market.

Freddie Mac Certificates
Freddie Mac is a stockholder-owned, federally-chartered corporation created pursuant to an act of the U.S. Congress on July 24, 1970. During September 2008, the Federal Housing and Finance Agency ("FHFA") placed Freddie Mac into conservatorship. As the conservator of Freddie Mac, FHFA controls and directs the operations of Freddie Mac. The principal activity of Freddie Mac currently consists of purchasing residential mortgage loans and mortgage-related securities in the secondary mortgage market and securitizing them into mortgage-backed securities (“MBS”) sold to investors. Freddie Mac guarantees to each holder of Freddie Mac certificates the timely payment of interest at the applicable pass-through rate and principal on the holder's pro rata share of the unpaid principal balance of the related mortgage loans. The U.S. Treasury has committed agency capital to Freddie Mac to support its positive net worth through 2012.
Freddie Mac certificates are backed by pools of single-family mortgage loans or multi-family mortgage loans. These underlying mortgage loans may have original terms to maturity of up to 40 years. Freddie Mac certificates may be issued under cash programs (composed of mortgage loans purchased from a number of sellers) or guarantor programs (composed of mortgage loans acquired from one seller in exchange for certificates representing interests in the mortgage loans purchased). Freddie Mac certificates may pay interest at a fixed rate or an adjustable rate. The interest rate paid on adjustable-rate Freddie Mac certificates (“Freddie Mac ARMs”) adjusts periodically within 60 days prior to the month in which the interest rates on the underlying mortgage loans adjust. The interest rates paid on certificates issued under Freddie Mac's standard ARM programs adjust in relation to the Treasury index.
Other specified indices used in Freddie Mac ARM programs include the 11th District Cost of Funds Index published by the Federal Home Loan Bank of San Francisco, LIBOR and other indices. Interest rates paid on fully- indexed Freddie Mac ARM certificates equal the applicable index rate plus a specified number of basis points. The majority of series of Freddie Mac ARM certificates issued to date have pools of mortgage loans with monthly, semi-annual or annual interest adjustments. Adjustments in the interest rates paid are generally limited to an annual increase or decrease of either 100 or 200 basis points and to a lifetime cap of 500 or 600 basis points over the initial interest rate. Certain Freddie Mac programs include mortgage loans which allow the borrower to convert the adjustable mortgage interest rate to a fixed rate. Adjustable-rate mortgages which are converted into fixed-rate mortgage loans are repurchased by Freddie Mac or by the seller of the loan to Freddie Mac at the unpaid principal balance of the loan plus accrued interest to the due date of the last adjustable rate interest payment.
Fannie Mae Certificates
Fannie Mae is a stockholder owned, federally-chartered corporation organized and existing under the Federal National Mortgage Association Charter Act, created in 1938 and rechartered in 1968 by Congress as a stockholder owned company. During September 2008, FHFA placed Fannie Mae into conservatorship. As the conservator of Fannie Mae, FHFA controls and directs the operations of Fannie Mae. Fannie Mae provides funds to the mortgage market primarily by purchasing home mortgage loans from local lenders, thereby replenishing their funds for additional lending. Fannie Mae guarantees to each MBS trust that issues Fannie Mae certificates that it will supplement the amounts received by the MBS trust from the underlying mortgage loans as required to make the timely payment of monthly principal and interest on the certificates it has issued. The U.S. Treasury has committed agency capital to Fannie Mae to support its positive net worth through 2012.
Fannie Mae certificates may be backed by pools of single-family or multi-family mortgage loans. The original term to maturity of any such mortgage loan generally does not exceed 40 years. Fannie Mae certificates may pay interest at a fixed rate or an adjustable rate. Each series of Fannie Mae ARM certificates bears an initial interest rate and margin tied to an index based on all loans in the related pool, less a fixed percentage representing servicing compensation and Fannie Mae's guarantee fee. The specified index used in different series has included the Treasury Index, the 11th District Cost of Funds Index published by the Federal Home Loan Bank of San Francisco, LIBOR and other indices. Interest rates paid on fully-indexed Fannie Mae ARM certificates equal the applicable index rate plus a specified number of percentage points. The majority of series of Fannie Mae ARM certificates issued to date have pools of mortgage loans with monthly, semi-annual or annual interest rate adjustments. Adjustments in the interest rates paid are generally limited to an annual increase or decrease of either 100 or 200 basis points and to a lifetime cap of 500 or 600 basis points over the initial interest rate.
Ginnie Mae Certificates
Ginnie Mae is a wholly-owned corporate instrumentality of the United States within the Department of Housing and Urban Development, or HUD. The National Housing Act of 1934 authorizes Ginnie Mae to guarantee the timely payment of the principal of and interest on certificates that represent an interest in a pool of mortgages insured by FHA, or partially guaranteed by the Department of Veterans Affairs and other loans eligible for inclusion in mortgage pools underlying Ginnie Mae certificates. Section 306(g) of the Housing Act provides that the full faith and credit of the United States is pledged to the payment of all amounts which may be required to be paid under any guaranty by Ginnie Mae.
At present, most Ginnie Mae certificates are backed by single-family mortgage loans. The interest rate paid on Ginnie Mae certificates may be a fixed rate or an adjustable rate. The interest rate on Ginnie Mae certificates issued under Ginnie Mae's standard ARM program adjusts annually in relation to the Treasury index. Adjustments in the interest rate are generally limited to an annual increase or decrease of 100 basis points and to a lifetime cap of 500 basis points over the initial coupon rate.

Investment Methods
We purchase mortgage-backed securities either in initial offerings or on the secondary market through broker/dealers or similar entities. We may also enter into arrangements with originators and intermediaries to source collateral for mortgage-backed securities.
We utilize to-be-announced forward contracts (“TBAs”) in order to invest in agency securities or to hedge our investments. Pursuant to these TBAs, we agree to purchase, for future delivery, agency securities with certain principal and interest terms and certain types of collateral, but the particular agency securities to be delivered would not be identified until shortly before the TBA settlement date. Our ability to purchase agency securities through TBAs may be limited by applicable REIT requirements.
We may invest directly in non-agency residential mortgage loans (prime mortgage loans and non-prime mortgage loans) through direct purchases of loans from mortgage originators and through purchases of loans on the secondary market.


We may also enter into purchase agreements with a number of loan originators and intermediaries, including mortgage bankers, commercial banks, savings and loan associates, home builders, credit unions and other mortgage conduits. We intend to invest primarily in mortgage loans secured by properties within the United States.
Our Manager is responsible for making portfolio allocation decisions which are guided by our intent to provide attractive risk-adjusted returns over the long term through the distribution of quarterly dividends and net book value appreciation, while continuing to qualify as a REIT, and remain exempt from the registration requirements of the Investment Company Act. Our Manager's decisions depend on prevailing market conditions and may change over time in response to its view of opportunities available in different interest rate, economic and credit environments. As a result, we cannot predict the percentage of our assets that will be invested in any of our target asset classes at any given time. We may change our strategy and policies without a vote of our stockholders. We believe that the diversification of our investment portfolio, our Manager's expertise investing in our target assets and the flexibility of our strategy, will enable us to achieve attractive risk-adjusted returns under a variety of market conditions and economic cycles.

Our Financing Strategy
As part of our investment strategy, we prudently leverage our investment portfolio to increase potential returns to our stockholders. We may finance our investments, subject to market conditions, through a combination of other financing arrangements, including, but not limited to, repurchase agreements, warehouse facilities, securitizations, term financing facilities and dollar roll transactions. We primarily finance our investments by entering into short-term master repurchase agreements. A repurchase transaction acts as a financing arrangement under which we effectively pledge our investment assets as collateral to secure a short-term loan. Our borrowings pursuant to these repurchase transactions generally have maturities that range from 30 to 90 days, but may have maturities of fewer than 30 days or more than one year.
We have entered into master repurchase agreements with 22 financial institutions as of December 31, 2011. The terms of the repurchase transaction borrowings under 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 we have initially sold under the repurchase transaction. In addition, each lender typically requires that we include supplemental terms and conditions to the standard master repurchase agreement. Typical supplemental terms and conditions include changes to the margin maintenance requirements, required haircuts, purchase price maintenance requirements, requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction and cross default provisions. These provisions differ for each of our lenders and certain of these terms are not determined until we engage in a specific repurchase transaction.

Our leverage may vary periodically depending on market conditions, our portfolio composition and our Manager's assessment of risks and returns. We finance different asset classes through the most efficient means available for a particular asset class at any given time. Therefore, our overall leverage is highly dependent on our investment portfolio composition. Our Manager's selection of funding alternatives are restricted in that we may not enter into funding transactions that would cause us to fail to qualify as a REIT for federal income tax purposes.
Based on the current financing market for mortgage-backed securities, which is predominantly short-term repurchase financing, we operate our agency mortgage investment portfolio within a leverage range of 6x to 12x and our non-agency mortgage investment portfolio within a leverage range of 1x to 6x. Within each of these asset classes, the level and availability of financing are influenced by the specific security or loan being financed. Our other mortgage-related investments may include certain derivative products, which in many instances may be implicitly leveraged by their structure and, as such, the appropriate financing for such investments will be evaluated on a case-by-case basis. As the financing market evolves, we expect our leverage ranges to change, and they may well increase. Such changes will be discussed with the investment committee and our Board of Directors but do not require stockholder approval.

CEO BACKGROUND

Malon Wilkus (2011)
60 Mr. Wilkus is our Chair and Chief Executive Officer and the Chief Executive Officer of American Capital MTGE Management, LLC, our Manager. Mr. Wilkus founded American Capital, Ltd. (“American Capital”), the indirect majority owner of our Manager, in 1986 and has served as its Chief Executive Officer and Chairman of the Board of Directors since that time, except for the period from 1997 to 1998 during which he served as Chief Executive Officer and Vice Chairman of the Board of Directors. He also served as President of American Capital from 2001 to 2008 and from 1986 to 1999. Mr. Wilkus has also been the Chairman of European Capital Limited, a European private equity and mezzanine fund, since its formation in 2005. In addition, Mr. Wilkus is the Chief Executive Officer and President of American Capital, LLC, the asset fund management portfolio company of American Capital and the majority owner of the parent company of our Manager. Mr. Wilkus has also served as the Chair and Chief Executive Officer of American Capital Agency Corp. since January 2008 and as the Chief Executive Officer of its manager, American Capital AGNC Management, LLC, since April 2011. He previously served as President of American Capital Agency Corp. from January 2008 to April 2011. He has also served on the board of directors of over a dozen middle-market companies in various industries.

Mr. Wilkus’ extensive board and senior executive experience investing in and managing private and public investment vehicles, and his financial expertise and deep knowledge of our business as our Chief Executive Officer strengthen our Board’s collective qualifications, skills, experience and viewpoints.


John R. Erickson (2011)
52

Mr. Erickson is our Executive Vice President and Chief Financial Officer and Executive Vice President and Treasurer of our Manager. Mr. Erickson is also the Executive Vice President and Chief Financial Officer of American Capital Agency Corp. and the Executive Vice President and Treasurer of its manager, American Capital AGNC Management, LLC. In addition, he is Executive Vice President and Treasurer of American Capital, LLC, the asset fund management portfolio company of American Capital. Mr. Erickson has also served as President, Structured Finance of American Capital since 2008 and as its Chief Financial Officer since 1998. From 1991 to 1998, Mr. Erickson was the Chief Financial Officer of Storage USA, Inc., a REIT formerly traded on the New York Stock Exchange (NYSE: SUS).



Mr. Erickson’s extensive senior executive experience, his financial expertise and his deep knowledge of our business as our Executive Vice President and Chief Financial Officer strengthen our Board’s collective qualifications, skills, experience and viewpoints.


Alvin N. Puryear (2011)
74

Dr. Puryear is Professor Emeritus of Management and Entrepreneurship at Baruch College of the City University of New York where he was the initial recipient of the Lawrence N. Field Professorship in Entrepreneurship. Dr. Puryear is also a management consultant, who advises existing and new businesses with high-growth potential. Prior to his appointment at Baruch College, Dr. Puryear was on the faculty of the graduate school of business administration at Rutgers University. During leaves-of-absence from Baruch, he served as a Vice President at the Ford Foundation and First Deputy Comptroller for the City of New York. Before joining the academic community, he held executive positions in finance and information technology with the Mobil Corporation and Allied Chemical Corporation, respectively. He is also a member of the Boards of Directors of American Capital and American Capital Agency Corp. In the past five years, Dr. Puryear also served as a director of North Fork Bancorporation, North Fork Bank and the Bank of Tokyo-Mitsubishi UFG Trust Company.



Dr. Puryear’s extensive academic and board service and his experiences in finance, corporate governance and executive compensation matters strengthen our Board’s collective qualifications, skills, experience and viewpoints.

Robert M. Couch* (2011)
54

Mr. Couch is Counsel to Bradley Arant Boult Cummings LLP, a law firm based in Birmingham, Alabama. Mr. Couch is also Chairman of ARK Real Estate Strategies, LLC. ARK helps banks and financial institutions evaluate, manage and market foreclosed residential real estate. ARK is also the manager of the ARK Real Estate Opportunity Fund I, LLC, an investment fund focused on distressed residential real estate. Mr. Couch is a member of the Board of Directors of Prospect Holding Company, LLC, the parent company of Prospect Mortgage of Sherman Oaks, California. In December 2011, Mr. Couch was also appointed to the Bipartisan Policy Center Housing Commission. From June 2007 to November 2008, Mr. Couch served as General Counsel of the United States Department of Housing and Urban Development, or HUD. From December 2006 until June 2007, Mr. Couch served as Acting General Counsel of HUD. Mr. Couch began his service at HUD as President of Ginnie Mae from June 2006 until June 2007. Prior to his government service, Mr. Couch served as President and Chief Executive Officer of New South Federal Savings Bank. He holds a Juris Doctor degree from Washington and Lee University. Mr. Couch also serves on the board of directors of American Capital Agency Corp.



Mr. Couch’s extensive senior executive and board experience, including in real estate and government, strengthen our Board’s collective qualifications, skills, experience and viewpoints.


Morris A. Davis* (2011)
40

Dr. Davis is an Associate Professor in the Department of Real Estate and Urban Land Economics at the University of Wisconsin-Madison, School of Business. He has worked in the department since September 2006. He is currently on the Academic Advisory Council of the Federal Reserve Bank of Chicago and served in 2007 as a Research Associate at the Federal Reserve Bank of Cleveland. From July 2002 to August 2006, Dr. Davis was an economist at the Federal Reserve Board working in the Flow of Funds Section. From October 2001 to July 2002, he was Director of Yield Optimization at Return Buy, Inc. and from August 1998 to October 2001, Dr. Davis was an economist at the Macroeconomics and Quantitative Studies Section of the Federal Reserve Board. Dr. Davis is widely published on issues related to the U.S. housing markets and a frequent lecturer. He holds a Ph.D. in Economics from the University of Pennsylvania. Dr. Davis also serves on the board of directors of American Capital Agency Corp.



Dr. Davis’s expertise in economics and finance matters strengthens our Board’s collective qualifications, skills, experience and viewpoints.

Randy E. Dobbs* (2011)
61

Mr. Dobbs has been a self-employed business consultant and business speaker since the end of 2010. Prior to that, he was a Senior Operating Executive at Welsh, Carson, Anderson & Stowe (“Welsh Carson”), a private equity firm. At Welsh Carson, Mr. Dobbs was responsible for portfolio company operational oversight, business acquisitions and equity opportunity development. From February 2005 to October 2008, he was the Chief Executive Officer of US Investigations Services, Inc. and its subsidiaries (“USIS”). USIS provides business intelligence and risk management solutions, security and related services and expert staffing solutions for businesses and federal agencies. From April 2003 to February 2005, Mr. Dobbs was President and Chief Executive Officer of Philips Medical Systems, North America, a manufacturer of systems for imaging, radiation oncology and patient monitoring, as well as information management and resuscitation products. Prior to April 2003, Mr. Dobbs spent 27 years with General Electric Company where he held various senior level positions, including President and Chief Executive Officer of GE Capital, IT Solutions. Mr. Dobbs also serves on the board of directors of American Capital Agency Corp. and the board of directors of various private equity companies and previously served on the board of directors of Savvis, Inc. (NASDAQ: SVVS) from November 2010 to August 2011.



Mr. Dobbs’s extensive senior executive experience managing a wide variety of businesses strengthens our Board’s collective qualifications, skills, experience and viewpoints.


Larry K. Harvey* (2011)
47

Mr. Harvey has been Executive Vice President and Chief Financial Officer of Host Hotels & Resorts, Inc. (“Host”) since November 2007. He also served as Treasurer of Host from September 2007 to February 2010. Host is a lodging REIT (NYSE: HST). From February 2006 to November 2007, he served as Senior Vice President, Chief Accounting Officer of Host and from February 2003 to February 2006, he served as Host’s Senior Vice President and Corporate Controller. Prior to rejoining Host in February 2003, he served as Chief Financial Officer of Barceló Crestline Corporation, formerly Crestline Capital Corporation. Prior to that, Mr. Harvey was Host’s Vice President of Corporate Accounting, before the spin-off of Crestline in 1998. Mr. Harvey also serves on the board of directors of American Capital Agency Corp. Mr. Harvey is an “audit committee financial expert” (as defined in Item 407 of Regulation S-K under the Securities Act of 1933, as amended (the “Securities Act”)).



Mr. Harvey’s public company accounting, finance and risk management expertise, including his extensive experience as a senior executive of a REIT responsible for the preparation of financial statements, strengthens our Board’s collective qualifications, skills, experience and viewpoints.

MANAGEMENT DISCUSSION FROM LATEST 10K

EXECUTIVE OVERVIEW
We were incorporated on March 15, 2011 and commenced operations on August 9, 2011 following the completion of our IPO.
We invest in, finance and manage a leveraged portfolio of mortgage-related investments, which we define to include agency mortgage investments, non-agency mortgage investments and other mortgage-related investments. Agency mortgage investments include residential mortgage pass-through certificates and CMOs structured from residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by a GSE, such as Fannie Mae and Freddie Mac, or by a U.S. Government agency, such as Ginnie Mae. Non-agency mortgage investments include RMBS backed by residential mortgages that are not guaranteed by a GSE or U.S. Government agency. Non-agency mortgage investments may also include prime and non-prime residential mortgage loans. Other mortgage-related investments may include CMBS, commercial mortgage loans, mortgage-related derivatives and other mortgage-related investments.
We intend to qualify to be taxed as a REIT under the Internal Revenue Code. As such, we will be required to distribute annually 90% of our taxable net income. As long as we qualify as a REIT, we will generally not be subject to U.S. federal 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.
We are externally managed by our Manager, an affiliate of American Capital. We do not have any employees.

Trends and Recent Market Impacts
From our commencement of operations on August 9, 2011 and throughout the remainder of 2011, we have encountered extreme volatility in the U.S. markets fueled by an array of significant global economic and political events, including slow U.S. economic growth, the European debt crisis, and S&P's downgrade of its U.S. sovereign debt ratings. In addition, the Federal Reserve has continued its efforts to try to help stimulate the U.S. economy with its September 2011 announcement of “Operation Twist” and its plan to reinvest principal and interest received from its holdings of agency securities into new purchases of agency securities, each designed to reduce interest rates. These events led to historically low 10-year U.S. Treasury and fixed-rate mortgage rates for much of the third and fourth quarters of 2011. Low mortgage rates, coupled with changes to the GSE's underwriting practices also drove escalating prepayment fears during this period.
The size and composition of our investment portfolio depends on investment strategies implemented by our Manager, 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. Market conditions are influenced by, among other things, current levels of and expectations for future levels of, interest rates, mortgage prepayments, market liquidity, housing prices, unemployment rates, general economic conditions, government participation in the mortgage market, evolving regulations or legal settlements that impact servicing practices or other mortgage related activities.
Summary of Critical Accounting Estimates
Our critical accounting estimates relate to the fair value of our investments, recognition of interest income, and derivatives. Certain of these items involve estimates that require management to make judgments that are subjective in nature. We rely on our Manager's 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 using these critical accounting policies. 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.
We have elected the option to account for all of our financial assets, including all mortgage-related investments, at fair value, with changes in fair value reflected in income during the period in which they occur. In management's view, this election more appropriately reflects the results of our operations for a particular reporting period, as financial asset fair value changes are presented in a manner consistent with the presentation and timing of the fair value changes of economic hedging instruments.
Investments in Mortgage-Backed Securities
We estimate the fair value of our mortgage-backed securities based on a market approach using inputs from multiple third-party pricing services and dealer quotes. The third-party pricing services use pricing models which incorporate such factors as coupons, primary and secondary mortgage rates, prepayment speeds, spread to the Treasury and interest rate swap curves, convexity, duration, periodic and life caps, default and severity rates and credit enhancements. The dealer quotes incorporate common market pricing methods, including a spread measurement to the Treasury or interest rate swap curve as well as 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. Our Manager observes market information relevant to our specific investment portfolio by trading in the market for mortgage related investments. Our Manager uses this observable market information in reviewing the inputs to and the estimates derived from the valuation process for reasonableness. 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 than the valuations currently estimated. See Note 7 to the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K.
Interest Income
Interest income is accrued based on the outstanding principal amount of the securities and their contractual terms. Premiums and discounts associated with the purchase of agency securities and non-agency securities of high credit quality are amortized or accreted into interest income over the projected lives of the securities, including contractual payments and estimated prepayments, using the effective interest method. We estimate long-term prepayment speeds using a third-party service and market data.
The third-party service estimates prepayment speeds using models that incorporate the forward yield curve, current mortgage rates, current mortgage rates of the outstanding loans, loan age, 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 service, and based on our Manager’s judgment, we may make adjustments to their estimates. Actual and anticipated prepayment experience is reviewed at least quarterly and effective yields are recalculated when differences arise between the previously estimated future prepayments and the amounts actually received plus current anticipated future prepayments. If the actual and anticipated 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 non-agency securities and loans 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 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 Manager's 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.
Derivatives
We maintain a risk management strategy, under which we may use a variety of derivative instruments to economically hedge some of our exposure to market risks, including interest rate risk, prepayment risk and credit risk. Our risk management objective is to reduce fluctuations in net book value over a range of market conditions. The principal instruments that we currently use are interest rate swaps, to-be-announced forward contracts (“TBAs”), U.S. Treasury securities, and options to enter into interest rate swaps (“interest rate swaptions”). In the future, we may also use forward contracts for specified agency securities, U.S. Treasury futures contracts and put or call options on TBA securities. We may also invest in other types of mortgage derivatives, such as interest-only securities, credit default swaps and synthetic total return swaps.
We recognize all derivatives as either assets or liabilities on the balance sheet, measured at fair value. As we have not designated any derivatives as hedging instruments, all changes in fair value are reported in earnings in our consolidated statement of operations in unrealized gain (loss) on other derivatives and securities, net during the period in which they occur. Derivatives in a gain position are reported as derivative assets at fair value and derivatives in a loss position are reported as derivative liabilities at fair value in our consolidated balance sheet. In our consolidated statement of cash flows, cash receipts and payments related to derivative instruments are reported in the investing section.
The use of derivatives creates exposure to credit risk relating to potential losses that could be recognized in the event that 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. See Notes 2 and 6 to the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K.

Management Fees and General and Administrative Expenses
We pay our Manager a base management fee payable monthly in arrears in an amount equal to one twelfth of 1.50% of our Equity. Our Equity is defined as our month-end GAAP stockholders’ equity, adjusted to exclude the effect of any unrealized gains or losses included in retained earnings as computed in accordance with GAAP. There is no incentive compensation payable to our Manager pursuant to the management agreement. We incurred management fees of $1.2 million for the period from August 9, 2011 through December 31, 2011 .
General and administrative expenses were $1.6 million for the period from August 9, 2011 through December 31, 2011 . Our general and administrative expenses primarily consist of prime brokerage fees, information technology costs, research and data service fees, audit fees, Board of Director fees and insurance expenses.
Our total management fee and general and administrative expenses as a percentage of our average stockholders’ equity on an annualized basis was 3.42% for the period from August 9, 2011 through December 31, 2011 .

Income Taxes

For fiscal year 2011 we declared dividends of $1.00 per share. As a REIT, we are required to distribute annually 90% of our taxable income to maintain our status as a REIT and all of our taxable income to avoid Federal and state corporate income taxes. We can treat dividends declared by September 15 and paid by December 31 as having been a distribution of our taxable income for our prior tax year. 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 associated with interest rate swaps and other derivatives and securities marked-to-market in current income for GAAP purposes, but excluded from taxable income until realized or settled, (ii) temporary differences related to the amortization of premiums or accretion of discounts on investments, including original issue discount, (iii) timing differences in the recognition of certain realized gains and losses, and (iv) permanent differences for excise tax expense.
As a REIT, we are subject to a nondeductible Federal excise tax of 4% to the extent that the sum of (i) 85% of our ordinary taxable income, (ii) 95% of our capital gains and (iii) any undistributed taxable income from the prior year exceeds our distributions paid in such year. For the period from August 9, 2011 (date operations commenced) through December 31, 2011, we accrued a Federal excise tax of less than $0.1 million because our calendar year distributions were less than the total of these amounts.
Dividends
For the fiscal year ended December 31, 2011 , we declared dividends of $1.00 per share. As a REIT, we are required to distribute annually 90% of our taxable income to maintain our status as a REIT and all of our taxable income to avoid Federal, state and local corporate income taxes. For the REIT distribution requirement, we can treat dividends declared by September 15 and paid by December 31 of the subsequent year as having been a distribution of our taxable income for our prior tax year. For excise tax purposes, dividends declared by December 31 and paid by January 31 are treated as having been a distribution of our taxable income for the prior tax year. As of December 31, 2011 , we have an estimated $2.4 million of undistributed taxable income related to our 2011 tax year, net of the December 31, 2011 dividend payable of $ 8.0 million . 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. Examples include temporary differences related to unrealized gains and losses on derivative instruments and investment securities that are recognized in income for GAAP but are excluded from taxable income until realized or settled and temporary differences in the CPR used to amortize premiums or accrete discounts.
Net Spread Income
GAAP interest income does not include interest earned on non-agency securities underlying our Linked Transactions, and GAAP interest expense does not include either interest related to repurchase agreements underlying our Linked Transactions, or periodic settlements associated with undesignated interest rate swaps. Interest income and expense related to Linked Transactions is reported within unrealized loss and net interest income on linked transactions, net and periodic interest settlements associated with undesignated interest rate swaps are reported in realized loss on periodic settlements of interest rate swaps, net on our consolidated statement of operations. As we believe that these items are beneficial to the understanding of our investment performance, we provide a non-GAAP measure called adjusted net interest income, which is comprised of net interest income plus the net interest income related to Linked Transactions, less net periodic settlements of interest rate swaps. Additionally, we present net spread income as a measure of our operating performance. Net spread income is comprised of adjusted net interest income, less total operating expenses. Net spread income excludes all unrealized gains or losses due to changes in fair value, realized gains or losses on sales of securities, realized losses associated with derivative instruments and income taxes.

LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of funds are borrowings under master repurchase agreements, equity offerings, asset sales and monthly principal and interest payments on our investment portfolio. Because the level of our borrowings can be adjusted on a daily basis, the level of cash and cash equivalents carried on the balance sheet is significantly less important than the potential liquidity available under our borrowing arrangements. 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. To qualify as a REIT, we must distribute annually at least 90% of our taxable income. To the extent that we annually distribute all of our taxable income in a timely manner, we will generally not be subject to federal and state income taxes. We currently expect to distribute all of our taxable income in a timely manner so that we are not subject to Federal and state income taxes. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital from operations.
Equity Capital
On August 9, 2011, we completed our IPO by selling 8.0 million shares of our common stock at $20.00 per share for proceeds, net of offering costs, of $159.1 million. Concurrent with the IPO, American Capital purchased 2.0 million shares of our common stock in a private placement at $20.00 per share, for aggregate proceeds of $40.0 million. As part of the IPO, our Manager paid the underwriters' fee of $6.2 million.
American Capital has agreed that, for a period of 365 days after August 3, 2011, it will not, without the prior written consent of the representatives of the underwriters of our IPO, dispose of or hedge any of the shares of our common stock that it purchased in the concurrent private placement, subject to certain exceptions.
Debt Capital
As part of our investment strategy, we borrow against our investment portfolio pursuant to master repurchase agreements. We expect that our borrowings pursuant to repurchase transactions under such master repurchase agreements generally will have maturities of less than one year. When adjusted for net payables and receivables for unsettled securities and repurchase agreement financing recorded as Linked Transactions, our leverage ratio was 8.0x the amount of our stockholders’ equity as of December 31, 2011 . Our cost of borrowings under master repurchase agreements generally corresponds to LIBOR plus or minus a margin. We have master repurchase agreements with 22 financial institutions, which are described below. As of December 31, 2011 , borrowings under repurchase arrangements secured by agency and non-agency securities (including those underlying Linked Transactions) totaled $ 1.7 billion and $ 44.9 million , respectively, with weighted average days to maturity of 45 and 22, respectively. As of December 31, 2011, we did not have an amount at risk with any counterparty greater than 6% of our equity at risk, with the top five counterparties representing less than 21% of our equity at risk.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

EXECUTIVE OVERVIEW
We were incorporated in Maryland on March 15, 2011 and commenced operations on August 9, 2011 following the completion of our IPO. We invest in, finance and manage a leveraged portfolio of mortgage-related investments, which we define to include agency mortgage investments, non-agency mortgage investments and other mortgage-related investments. Agency mortgage investments include residential mortgage pass-through certificates and collateralized mortgage obligations (“CMOs”) structured from residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by a government-sponsored entity (“GSE”), such as the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), or by a U.S. Government agency, such as the Government National Mortgage Association ("Ginnie Mae”). Non-agency mortgage investments include residential mortgage-backed securities (“RMBS”) backed by residential mortgages that are not guaranteed by a GSE or U.S. Government agency. Non-agency mortgage investments may also include prime and non-prime residential mortgage loans. Other mortgage-related investments may include commercial mortgage-backed securities (“CMBS”), commercial mortgage loans, mortgage-related derivatives and other mortgage-related investments.
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, we are required to, among other things, distribute annually at least 90% of our taxable net income. As long as we qualify as a REIT, we will generally not be subject to U.S. federal corporate taxes on our taxable net income to the extent that we distribute all of our annual taxable net income to our stockholders.
We are externally managed by American Capital MTGE Management, LLC (our “Manager”), an affiliate of American Capital, Ltd. ("American Capital"). We do not have any employees.

Trends and Recent Market Impacts
On September 13, 2012, the Federal Reserve announced their third quantitative easing program, commonly known as QE3, and extended their guidance to keep the federal funds rate at "exceptional low levels" through at least mid-2015. QE3 entails large-scale purchases of agency mortgage-backed securities ("MBS") at the pace of $40 billion per month in addition to the Federal Reserve's existing policy of reinvesting principal payments from its holdings of agency MBS into new agency MBS purchases. The program is open-ended in nature, and is intended to put downward pressure on longer-term interest rates, support mortgage markets, and help make the broader financial conditions more accommodative. The Federal Reserve plans to continue their purchases of agency MBS and employ other policy tools, as appropriate, until they foresee substantial improvement in the outlook for the U.S. labor market.

Leverage
Our leverage was 6.7x and 8.2x our stockholders’ equity as of September 30, 2012 and December 31, 2011 , respectively. When adjusted for the net payables and receivables for unsettled securities and repurchase agreements underlying Linked Transactions, our leverage ratio was 6.6x and 8.0x our stockholders’ equity as of September 30, 2012 and December 31, 2011 , respectively. Our actual leverage will vary from time to time based on various factors, including our Manager’s opinion of the level of risk of our assets and liabilities, composition of our investment portfolio, our liquidity position, our level of unused borrowing capacity, over-collateralization levels required by lenders when we pledge securities to secure our borrowings and the current market value of our investment portfolio. In addition, certain of our master repurchase agreements and master swap agreements contain a restriction that prohibits our leverage from exceeding certain levels ranging from 10 to 12 times the amount of our stockholders' equity.

LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of funds are borrowings under master repurchase agreements, equity offerings, asset sales and monthly principal and interest payments on our investment portfolio. Because the level of our borrowings can be adjusted on a daily basis, the level of cash and cash equivalents carried on the balance sheet is significantly less important than the potential liquidity available under our borrowing arrangements. 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. To qualify as a REIT, we must distribute annually at least 90% of our taxable income. To the extent that we annually distribute all of our taxable income in a timely manner, we will generally not be subject to federal and state income taxes. We currently expect to distribute all of our taxable income in a timely manner so that we are not subject to Federal and state income taxes. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital from operations.
Equity Capital

To the extent we raise additional equity capital through follow-on equity offerings, we currently anticipate using cash proceeds from such transactions to purchase additional investment securities, to make scheduled payments of principal and interest on our repurchase agreements and 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.

Off-Balance Sheet Arrangements
As of September 30, 2012 , 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 facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, as of September 30, 2012 , we had not guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities.

CONF CALL

Hannah Rutman - Investor Relations

Thank you, Emily, and thank you all for joining American Capital Mortgage Investment Corp. third quarter 2012 earnings call.

Before we begin, I’d like to review the Safe Harbor statement. This conference call and corresponding slide presentations contain statements that to the extent they are not recitations of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act.

Actual outcomes and results may differ materially from those forecast due to the impact of many factors beyond the control of MTGE. Our forward-looking statements included in this presentation are made only as of the date of the presentation and are subject to change without notice.

Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in our periodic reports filed with SEC. Copies of these reports are available on the SEC’s website. We disclaim any obligation to update our forward-looking statements unless required by law.

To view a webcast of this presentation, access our website, mtge.com and click on the Earnings Presentation link in the upper right corner. An archive of this presentation will be available on our website and a telephone recording of this call can be accessed through November 16th by dialing 877-344-7529 using the conference ID 10019155.

Participating on today’s call are Malon Wilkus, Chairman and Chief Executive Officer; Sam Flax, Executive Vice President and Secretary; Gary Kain, President and Chief Investment Officer; Jeff Winkler, Senior Vice President and Co-Chief Investment Officer; Peter Federico, Senior Vice President and Chief Risk Officer; Chris Kuehl, Senior Vice President, Agency Mortgage Investments; Jason Campbell, Senior Vice President and Head of Asset and Liability Management; Don Holley, Vice President and Controller.

With that, I’ll call the -- turn the call over to Gary Kain.
Gary Kain - President and CIO

Thanks, Hannah, and thanks to all of you for your interest in MTGE. We feel really good about MTGE’s performance this quarter and as importantly since our IPO last August.

During the third quarter, MTGE was able to continue to pay an attractive dividend, significantly build its undistributed tax income and grow book value around 14%. Economic returns, which include both the $0.90 dividend and the $3.13 of book value growth equated to 72% annualized return for the quarter.

In our first full quarter since our IPO, MTGE has paid $3.50 per share in dividends and increased book value by $5.25 per share. This $8.75 per share of total shareholder value creation equates to a 44% annualized return over the past 12 months.

Importantly, we’ve been able to accomplish this with the conservative approach to managing credit, interest rate and liquidity risk.

Looking ahead, investors are clearly focused on QE3 means to our business. The bottom line is that we feel very good about how MTGE is positioned against the dual challenges of tighter spreads across both the agency and non-agency spectrums, and a more difficult prepayment landscape on the agency side.

Slow speeds are critical to minimizing the impact of the tighter spread environment. If our prepayments obtained we have minimal reinvestment needs, which in turn means that tighter spread environment should have a very limited impact on our total returns.

We may and probably will choose to sell a fair amount of agency MBS at some point during the duration of QE3. That would be a proactive decision, where we are confident the net of those sales and subsequent reinvestment into non-agency and agency securities will add incremental value to shareholders.

So the key to this environment is in a combination of having being correctly positioned prior to QE3 and then trusting management to position the portfolio going forward as relative value opportunities present themselves across the entire spectrum of mortgage assets.

With that, let’s review the highlights for the quarter on slide two. Net income which incorporates both realized and unrealized gains and losses on both assets and hedges was $4.03 per share.

Net spread income which excludes $3.32 of investment related gains came in at $0.71 per share. The decline in net spread income during the quarter was largely a function of faster prepayment projections.

Estimated taxable net income totaled $1.33, which significantly exceeded our $0.90 per share dividend. As a result, our estimated undistributed taxable income grew materially to $0.54 per share.

Book value increased $3.13 or just over 14% to $25.21 per share during the quarter, as the performance of both agency and non-agency MBS were very strong.

Our portfolio, turning to slide three, our portfolio increased to $6.9 billion as we grew the agency and non-agency components of the portfolio. Leverage declined slightly during the quarter to 6.6 times from 6.8 times as of June 30th.

Now MTGE’s average CPR remained very slow at just below 7% and that’s both last month and for the third quarter as a whole. In response to QE3 and lower mortgage rates, we did increase our projected CPR to 13%, which is now around 90% higher than our actual QE3 CPR.

This significant increase in our CPR projection was the primary driver of the contraction in our quarter end net interest margin from a 194 basis points to a 188 basis points, had we used our projection equal to our actual CPR, our quarter end margin would have actually increased.

Lastly, we announced that the Board authorized up to $50 million in share repurchases. Management and the Board are committed to using all tools at our disposal to generate long-term value to our shareholders, including stock buybacks when our shares are trading at a material discount to our book value. It is important to understand that they are costs associated with both issuing and repurchasing shares. So repurchases are not likely with very small price to book discounts.

Now let’s turn to slide four and look at what happened in the markets during the third quarter.

As you can see in the middle section of the table, treasury rates were largely unchanged during the quarter with the five-year treasury rallying 9 basis points and the 10-year drooping only 2 basis points.

Swap rates rallied on average of about 10 basis points more, as the risk on backdrop during the quarter led to tighter swap spreads.

As shown on the top left, the prices of lower coupon mortgage-backed securities increased substantially during the quarter, despite the relatively small changes in rates, 30-year 3% coupons increased over 3 points during the quarter.

The prices of higher coupons were also up but to a lesser extent with 4.5% coupons up less than 1 point. Clearly, QE3 was a key driver here and we will look at an updated picture of the relative performance of agency MBS since QE3 in a few minutes.

Now with respect to risk assets, Q3 was a very strong quarter across the Board. The S&P 500 was up around 6% and spreads on almost all risk products were noticeably tighter.

Home prices also showed improvement and the housing market feels like it has some positive momentum. Against this backdrop, as Jeff will discuss shortly, non-agency RMBS prices were up strongly during the quarter.

But before I turn the call over to Jeff, I want to directly address QE3 on slide five, because I know it is a big issue for investors right now and it has led to some significant volatility in mortgage REIT stock prices.

Prepared now our third round of quantitative easing and extended its low rate guidance to mid-2015 after September 13th meeting. The new program involves large scale agency mortgage loan purchases and it is open ended in nature.

The Fed is buying around $70 billion a month in agency MBS and that is comprised of $40 billion a month for QE3 itself and close to $30 billion related to reinvesting their paidouts on the existing portfolio.

The Fed is purchasing the lowest coupon fixed rate MBS because these securities have the greatest impact on the rates offered to borrowers. As such, in the absence of a material change in interest rates, the Fed’s future purchases are likely to be focused on mainly 30-year 2.5%s and 3s and 15-year 2% and 2.5% coupons.

Therefore, QE3 is likely to impact agency investors in several ways. First, QE3 has already impacted the prices of lower coupon mortgage securities, which has reduced the yields and ROEs on new purchases in this sector.

Secondly, prepayments on existing mortgages will be faster than they otherwise would have been in response to lower mortgage rates.

And third, we do believe that the risk of significant book value declines is lower today, as the Fed’s large purchases should reduce the risk that agency MBS significantly underperform our swap, swaption and treasury hedges.

Liquidity and funding risk should also be less of an issue right now as the Fed’s purchases not only directly improve market liquidity, but they also remove substantial amounts of securities from the hands of private holders that would otherwise have financed them in the repo market.

Now, the performance of non-agency MBS have and should continue to be impacted by QE3 as well. First of all, demand for the product has increased as investors seek out higher yielding assets, the spreads on agencies and other competing products tighten.

Secondly, the lower mortgage rates should help support the housing market and actually drive some prepayments on non-agencies both of which are net positives for this space.

So with this as the background, let’s turn to the next slide where we can see the direct impact of Fed has had on various types of agencies securities from the day before QE3 through last Tuesday, October 23rd.

The price performance of lower and higher coupon MBS have diverged significantly now that the market has had a chance to more fully price in the implications of QE3. For example, 30-year 3% coupons have rallied 1.36 points, while 30-year 4.5%s are essentially unchanged.

The contrast is even greater in 15 years with the 2.5% coupon up two-thirds of a point while the next level coupon 30-year 3s are unchanged and 15-year 3.5% and above are actually down in price.

Interestingly and contrary to conventional wisdom as of last week, the price of the majority of the outstanding MBS were relatively unchanged and some were actually lower.

However, 30-year MBS backed by lower loan balance in HARP securities have appreciated meaningfully relative to generic mortgages in most coupons, as prepayment fears have increased post QE3.

Let’s look at the table on the bottom left. Pools backed by $85 to $110,000 loan balance 4% coupon mortgages have appreciated almost a full point versus their generic counterparts, which were up less than $0.20 since the start of QE3. And as the performance of lower coupon and prepayment protected assets demonstrates, asset selection is more important now than ever.

With that said, let’s turn to slide seven. We can see how MTGE’s capital was deployed at the end of September. And the table at the top shows, our portfolio remained biased toward agencies at the end of the quarter but to a lesser extent than in prior quarters. We had about 23% of our equity dedicated to non-agencies at the end of Q3. Our non-agency portfolio continues to grow at a measured pace and we remain focused on the all day sector.

Additionally given our expectation that the Fed’s purchases will continue to drive lower coupon MBS spreads tighter from these level, we would expect the percentage of our capital dedicated to non-agencies to increase over the course of the next three to 12 months.

However, as we know all too well, things can change quickly and a key advantage of MTGE’s business model is its flexibility. As such, we will continue to actively manage our portfolio and will not hesitate to reposition the portfolio in any direction, as economic or market conditions evolve.

At this point, let me turn the call over to Jeff to discuss the non-agency landscape.
Jeff Winkler - Senior Vice President and Co-CIO

Thank you, Gary. So turning to slide nine, some of the key themes over the year in the non-agency market -- in the non-agency market remained firmly in place, contributing to a very strong quarter for this sector as a whole.

First, we had a continuation of the low interest rate environment, further reinforced by the recent Federal Reserve Actions that Gary just highlighted. This period of low rates has helped stabilized housing, both due to attractive rental yields and as an inflation hedge. Housing data has responded favorably with broad price indices up in the low single-digit year-over-year.

Further, investors in the capital markets are moving further out the risk spectrum in search of higher yielding assets. When you combine this with the decreasing universe of non-agencies, the result with strong performance across the board with the sectors that have more leverage to housing outperforming.

In terms of spread moves, the cleaner sectors like prime starting at about 100 basis points while the more credit sensitive sectors like subprime tightened about 200 to 250 basis points. As the table shows, at current market prices and with conservative leverage levels we see the return on equity in this space to be about 8% to 11%.

Now I wanted to spend a few minutes on the next slide, slide 10, discussing our thought process related to how we assess relative value within the non-agency space. Obviously, return on equity is a major driver both within non-agencies and relative to our agency investments.

In addition, exposure to a housing recovery, stability and cash flows, and market liquidity are also key factors when assessing the quality of returns in the non-agency sector. The following example demonstrates some of the differences among these sectors.

The table on the left has some static information including how many borrowers have never missed the payment, how may are re-performers and how many are still delinquent for the bonds we used to represent each sector. We also provide our estimate for the average current loan to value of the underlying home, the FICO at origination and the leverage we use for these bonds.

The graph on the right shows the estimated return on equity across a few simplified housing scenarios. The housing scenarios only differ in terms of what happens over the next two years. The base are flat scenario assumes a cumulative change in home prices over the next two years of up 3%. The lower corresponds to down 5% and the higher up 12%.

Based on the graph, Alt-A and subprime have the highest return on equity in a flat housing scenario. Equally important, both sectors outperform in a housing recovery as they will benefit the most from lower default and severities. This makes sense given the delinquency profile of these sectors.

As far as cash flow stability goes, we feel that Alt-A securities are more attractive, given the higher percentage of borrowers who have never missed payments, while it is true that borrowers who are re-performing have been exhibiting better payment behavior recently. The re-default rate is still around 40% and there can be a fair amount of choppiness in those cash flows, particularly due to service or behavior.

All of this contains though as the function of market pricing. If the differential return on equity across sectors change dramatically we would reevaluate and reposition the portfolio.

There is also a lot of sensitivity around this estimate especially at the individual security level. Against this backdrop, we’ve constructed a portfolio comprised 50% in Alt-A, 25% in subprime Option ARM and the remaining 25% in prime assets.

Now, I’ll turn the call over to Chris to discuss the agency portion of our portfolio.
Chris Kuehl - SVP, Agency Mortgage Investments

Thanks, Jeff. On slide 12 we have a graph comparing the prepayment performance of 34% passthroughs with different loan characteristics. As you can clearly see in the graph, repayment performance continues to vary significantly across different types of mortgages, even of the same vintage and coupon.

Just look at the two extremes, on the slower side, we see that lower loan balances, in this case loans between 85 and 110,000, as well as higher LTV HARP securities continue to perform well prepaying around 10 CPR.

On the other hand, if you contrast that with the ARMs lines which represent pulls back by Jumbo confirming loans, which generally have loan balances averaging over 500,000 are still prepaying right around 50 CPR. The generic or TBA securities shown in blue on the graph are also quite fast with speeds in the mid-30s.

Now, something to keep in mind as you look at this graph is that these speeds are a result of the environment prior to QE3. The 30-year mortgage rate today is approximately 25 basis points lower than rates driving the October speeds in this graph.

We expect that today’s loan rates coupled with the media attention given to QE3 will continue to drive prepayments bit higher on more generic securities in the coming months.

On the other hand, we expect prepayments speeds on lower loan balance and higher LTV HARP securities to remain well behaved. And as we’ll see on the next slide, thoughtful asset selection is even more critical in today’s high prepayment risk, high dollar price environments than it has been in the past.

So turning to slide 13, we have two hypothetical yields tables. In the table on the top half of the page, we have yields on generic 30-year 3.5s but the TBA price as of October 23rd. To put this table into perspective, the 2011 Fannie Mae 30-year 3.5% universe, which is now on average only 12-month seasoned paid at 31.6 CPR last month.

So even at 25 CPR these passthroughs yield approximately 1.43%. If assume a funding cost of 75 basis points, that leaves just 68 basis points of net spread or a hypothetical gross ROE of 6.19% with 7 times leverage.

Now if we look at 30 CPR, which is more likely over the next year or so, the net margin falls to only 28 basis points and the ROE drops to just 3%. The picture clearly gets much worse on generic mortgages with speeds above 30 CPR.

Now on the table in the lower half of the page, we again have 30-year 3.5s. However, here we’re calculating yields at a price 1.5 points above the TBA price, which is approximately were MLB or 110K max loan balance pools were trading as of last week.

And as the table shows, despite the strong out-performance of lower loan balance and HARP securities during the last quarter, the returns are still very compiling even at today’s higher payups versus holding more generic TBA passthroughs.

And if speeds remain contained on these types of securities, as we expect they will, low double-digit returns are still achievable even with lower leverage than where we’re currently running.

Let’s turn to slide 14 now to review the composition of the agency investment portfolio. As we’ve discussed it once since the launch of our IPO, managing prepayment and interest rate risk is critical to performance.

During the quarter, we continued to maintain a large percentage of our holdings and positions with favorable prepayment characteristics. The majority of our more generic positions were in new production, lower coupons in the case of 15-year mostly 2.5s and in the case of 30-year pulls on our balance sheet mostly 3.5s as of quarter-end.

However given the yield table, that we just went over on the prior page, generic 30-year 3.5s now comprise a small percentage of our position as this exposure has largely shifted to 3s.

I’d also like to highlight the fact that the portfolio’s prepayment speeds, as Gary mentioned, remain well-contained coming in at approximately 7 CPR for the most recent October factor release, which was down from approximately 8 CPR in the prior month.

Again these speeds should be evaluated against the backdrop or the average of the Fannie Mae 30-year universe has been prepaying around 30 CPR over the past few months.

With that, I’d like to turn the call over to Peter to discuss our funding and hedging activities.
Peter Federico - Senior Vice President and CRO

Thanks, Chris. Today, I’ll briefly review our finance and hedging activities for the quarter. I’ll begin with our financing summary on slide 15. As of the end of the third quarter, our overall repo funding costs was 51 basis points, up slightly from 47 basis points the previous quarter. The increase in funding costs was due to generally higher rates throughout the repo market, as well as the slightly longer term of our repo funding.

Turning to slide 16 and 17, I’ll review our hedging activities during the quarter. At quarter end the notional balance of our pay fixed swap portfolio was $2.9 billion, down slightly from the previous quarter.

Our swap portfolio has an average maturity of 5.6 years and covers 48% of our repo funding.

Our swaptions and treasury hedges totaled $500 million and $350 million respectively at quarter end. Taken together, our swap, swaption and treasury hedges covered 62% of our repo balance and will provide substantial market value protection in rising rate environment.

Turing to slide 18, I’ll review our duration gap information. As you can see from the table, given the drop in mortgage rates and the increase in mortgage security prices experienced during the quarter, the effective duration of our assets fell to 2.3 years from 2.9 years last quarter. In response to this move, we shortened the net duration of our liabilities and hedges to 2.8 years from 3.4 years the previous quarter.

As a result, at quarter-end our net duration gap was negative 0.5 years, unchanged from the previous quarter. At current rate levels, mortgage assets carry a significant amount of extension risk.

Additionally, we believe that our models somewhat understate asset durations in this unique market environment. For these reasons, we believe it is prudent from a risk management perspective to position the portfolio with the negative duration gap.

With that, I will turn the call back over to Gary.
Gary Kain - President and CIO

Thanks, Peter. Let’s quickly turn to slide 19, so we can review the business economics as of September 30th. The asset yield on the agency side declined 25 basis points to 2.43%. During the quarter, we increased our projected pre-payment speed from 9.5 CPR to 13%. And this was the key driver of the decline in asset yield.

Again, our 13% CPR projection is now around 90% higher than our actual quarterly speed of 6.7 CPR. Our net funding cost declined by 9 basis points, largely as a function of the reduction in the percentage of our repo balance covered with interest rates swaps.

The combination of these changes led to a net interest rate spread of a 156 basis points and when you apply leverage of 8.2 times and add back the asset yield, you get a gross ROE snapshot of around 15%. Of course, this table is based on our cost basis for assets and the original cost of the swap portfolio. Footnote one, gives you the same figures on a mark-to-market basis.

On the non-agency side, our funding yield -- our asset yield decreased around 43 basis points from 7.39% to 6.96%. Funding cost also declined by around 24 basis points, as we continued to leverage the agency portfolio for greater percentage of our non-agency funding.

After applying leverage and adding back the asset yield, the gross ROE falls out just under 16% for the non-agency portfolio, in aggregate, the combination of the two sides of the business weigh to a gross ROE of near 15% and a net ROE of 13.3%.

In conclusion, we believe our portfolio is very well-positioned for the current environment. Given this, we continue to believe that we can produce attractive risk-adjusted returns across a range of economic and interest rate environments despite today’s tighter spreads.

We also view the current market as more of a total return environment, where asset selection and active management are really going to be critical to performance. And we’re going continue to manage our portfolio accordingly.

So, with that, let me open up the call to questions.

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