AGNC Investment Corp.

Good morning and welcome to the AGNC Investment Corp. Third Quarter 2020 Shareholder Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw from the question queue, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Katie Wisecarver, Investor Relations. Please go ahead.

Thank you all for joining AGNC Investment Corp's third quarter 2020 earnings call. Before we begin, I'd like to review the Safe Harbor Statement. This conference call and corresponding slide presentation 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 could differ materially from those forecast due to the impact of many factors beyond the control of AGNC. All forward-looking statements included in this presentation are made only as of the date of this 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 the risk factors section of AGMC's periodic reports filed with the Securities and Exchange Commission. Copies are available on the SEC's website at sec.gov. We disclaim any obligation to update our forward-looking statements unless required by law. Participants on the call include Gary Kain, Chief Executive Officer, Bernie Bell, Senior Vice President and Chief Financial Officer, Chris Kuehl, Executive Vice President, Aaron Pas, Senior Vice President, and Peter Federico, President and Chief Operating Officer. With that, I'll turn the call over to Gary Kain.

Thanks, Katie, and thanks to all of you for your interest in AGNC. We were extremely pleased with the performance of our portfolio in the third quarter, with economic return totaling almost 9%. We have now recovered the vast majority of our Q1 economic loss over the past two quarters. Importantly, as demonstrated by our strong net spread in dollar roll income for the quarter, We remain optimistic about the earnings power of our portfolio. During the third quarter, equity markets continued to strengthen and interest rate volatility remained muted despite the upcoming election and the inability of lawmakers to agree on a new stimulus package. The continued resilience in financial markets is a testament to the tremendous liquidity provided by global central banks and the market's confidence that future monetary and fiscal support will be able to bridge the remaining economic gap before a vaccine becomes widely available. Agency MBS performance was generally strong during the quarter, with the exception of 30 or threes, which comprise a very small percentage of our portfolio. MBS continued to benefit from ongoing Fed support, negligible interest rate volatility and many others. In aggregate, specified pool performance was somewhat stronger during the quarter, with performance dependent on coupon and other attributes. Lower coupon TBAs, which benefited from both solid price performance and very strong dollar roll funding levels, were the best performing component of our portfolio, both in terms of earnings and economic return. Looking ahead, the investment environment for agency MBS should remain attractive given the favorable funding backdrop, ongoing Fed support, and lack of exposure to credit risk. With respect to dollar rolls, we expect the implied funding advantage relative to repo to contract somewhat from the very strong levels experienced in Q3, but to remain a significant positive contributor to our financial results in light of the combination of heavy origination volumes and ongoing Fed purchases. At this point, I will turn the call over to Bernie to review our financial results for the quarter.

Thank you, Gary. Turning to slide four, we had total comprehensive income of $1.28 per share for the third quarter. Net spread and dollar roll income, excluding catch-up amortization, was $0.81 per share for the quarter, which is our highest level in over five years. PBA dollar roll specialness and very low funding costs, which are now fully reflected in our aggregate cost of funds, were the primary drivers of our net spread and dollar roll income for the quarter. Looking ahead, over the next several quarters, we expect some downward pressure on net spread and dollar roll income as a significant funding advantage of our TBA position likely declines somewhat and portfolio turnover continues to be reinvested at prevailing asset yields. That said, we do expect the majority of the improvement in our net spread and dollar roll income experienced in Q3 to be maintained over the coming several quarters. Tangible net book value increased 6.4% for the quarter as our portfolio of largely lower coupon assets and higher coupon-specified pool holdings significantly outperformed our interest rate hedges. Including dividends of 36 cents per share, our economic return on tangible common equity was 8.8% for the third quarter. So far, fourth quarter to date, as of last Friday, we estimate that our tangible net book value is up about 2%. Turning to slide five, our investment portfolio at quarter end totaled $97.6 billion, largely unchanged from the second quarter. Our ending leverage was 8.8 times tangible equity, down from 9.2 times as of last quarter end, largely due to book value appreciation. Our liquidity position remained very strong in the third quarter, with cash and unencumbered agency assets totaling $5.2 billion at quarter end, which excludes both unencumbered CRT and non-agency securities. as well as assets held at our broker-dealer subsidiary, Bethesda Securities. Actual prepayment speeds on our portfolio increased to 24.3% for the quarter, but importantly, this does not include the lower coupon component of our holdings, which is held in TBA form. Our forecasted life CPRs decreased to 15.9% as of the end of the quarter, from 16.6% at the end of Q2. largely due to changes in asset composition. Lastly, during the third quarter, we repurchased $154 million of our common stock at a meaningful discount to our tangible net book value for an average repurchase price of $13.95 per share. With that, I'll turn the call over to Chris to discuss the agency market.

Thanks, Bernie. Let's turn to slide six. Much like the second quarter, interest rate volatility was muted. The yield curve continued to modestly steepen, with 2-year Treasury yields ending the quarter 2 basis points lower at 13 basis points, while 10-year Treasury yields ended the quarter 3 basis points higher at 69 basis points. Agency MBS spreads generally tightened, with lower coupon TBAs outperforming higher coupons. Specified pools generally held onto their gains from the second quarter, but pay-up changes were mixed depending on coupon and underlying TBA performance. The continued support from the Fed purchasing $40 billion in agency MBS per month in addition to reinvesting paydowns on its portfolio into production coupon MBS drove the outperformance in lower coupons. As you can see in the lower left table on page 6, 30-year twos increased in price by more than a point despite 10-year treasury prices selling off a little more than a quarter of a point. Higher coupon TBA performance was mixed, with 30-year threes clearly the worst performer during the third quarter. However, given rich valuations and prepayment concerns, we maturely reduced our generic holdings in the coupon during the second quarter. Let's turn to slide seven. You can see in the top left chart that the size of the investment portfolio at $98 billion was little changed as of September 30th. However, we continued to shift the composition to lower coupons in both 30-year and 15-year MBS. During the third quarter, we reduced holdings in 2.5% coupons and above by approximately $18 billion versus adding 30-year and 15-year 2s and 1.5s. As I mentioned on the call last quarter, we expected dollar roll financing to trade well as the combination of heavy origination and Fed purchases creates an ideal backdrop for dollar rolls. Given this favorable backdrop, we increased the size of our TBA roll position and carried an average balance of $28 billion during the third quarter, which was up from an average balance of $16 billion during the second quarter. TBA roll financing on lower coupons averaged around negative 60 basis points during the third quarter. Since quarter end, roll specialness has moderated somewhat, especially in more cuspy coupons like 30 or 2.5s, But 30-year twos continue to trade exceptionally well, currently at around negative 65 basis points or about 80 basis points through repo. 15-year production coupon role financing is currently trading around 10 to 20 basis points through repo. As we mentioned last quarter, role specialness can contribute materially to total returns, though the degree of specialness over time will likely trend to more modest levels. While mortgage spreads have tightened, we remain optimistic about the investment environment. given attractive role carry and low interest rate volatility. And while the prepayment backdrop is challenging, our diversified portfolio of higher coupon-specified pools and production coupon TBA has offsetting risk characteristics that position us well for the environment. I'll now turn the call over to Aaron to discuss the non-agency market.

Thanks, Chris. I'll quickly recap the quarter, our current positioning, and then update you with our outlook on credit. Please turn to slide eight. The significant rally in Q2 across structured products continued in the third quarter. With forced selling well behind us, down in credit led the way as the credit curve both flattened across most asset classes. With respect to our holdings, we reduced exposure to higher-rated CMBS, RMBS, and RPL bonds by close to 100 million. Demand has been strong for these securities, and in many cases, they have retraced a majority of the widening that occurred in the first quarter. Additionally, our CRT portfolio contracted marginally over the quarter via sales and paydowns. I'll touch on the composition shift in a moment. Our outlook for house prices and, in turn, residential credit performance remains relatively favorable. While the mortgage credit box has tightened somewhat, affordability levels are back at the most attractive level in years, coupled with historically low housing supply. Additionally, conventional forbearance rates continue to tick lower, declining about 30% during the quarter. In light of this, we've tilted the CRT portfolio a bit further down in credit and in dollar price in deals where we think risk of loss remains fairly remote. I'll quickly touch on repo as it relates to our non-agency holdings. We continue to see favorable trends on the repo side, both in improving rates and haircuts. While the depth and availability of repo across structured products is not what it was pre-COVID, this is a welcome improvement. As we said on last quarter's call, with the Fed's actions as a tailwind, we expect structured product spreads for good credits to remain well-supported over the coming years. However, the economic recovery clearly still presents risk with significant challenges in certain areas. As such, any longer-run tightening in spreads will likely face bouts of widening along the way and some sectors such as retail and hospitality in the commercial space are clearly not out of the woods. With that, I'll turn the call over to Peter to discuss funding and risk management.

Thanks, Aaron. I'll start with our financing summary on slide nine. As expected, our average repo funding costs dropped to 40 basis points in the third quarter from 76 basis points the prior quarter. This improvement reflects the Fed's very accommodative monetary policy stance and short-term forward rate guidance. I expect this favorable funding environment to continue with borrowing costs from overnight to one year staying in the 15 to 30 basis point range. As such, I expect our repo costs to trend marginally lower over the next several quarters. Our aggregate cost of funds, which includes the funding costs associated with our TBA position, as well as the cost of our swap hedges declined more sharply in the third quarter. Our average cost of funds for the quarter was 15 basis points down meaningfully from 88 basis points the prior quarter. This improvement was due to the combination of lower repo costs, very attractive dollar roll funding levels on TBAs, and materially lower swap hedging costs. The improvement in our cost of funds more than offset the decline in our asset yield and as such drove the significant improvement and our net interest margin, which for the quarter increased to 215 basis points from 168 basis points the prior quarter. Looking ahead, I expect our net interest margin to be by a somewhat lower as asset paydowns and portfolio repositioning will likely push the yield on our asset portfolio gradually lower. On slide 10, we provide a summary of our hedge portfolio which totaled $59 billion and covered 71% of our funding liabilities. While our aggregate hedge position was largely unchanged, we did continue to alter the composition and tenor of our swap portfolio. Most notably, we continued to shift to SOFR index swaps as we believe these swaps will be correlated well with our repo funding. At quarter end, about 70% of our swap portfolio was indexed to the secured overnight financing rate, and we had no LIBOR-based swaps. This transition to SOFR swaps drove the decline in our swap costs during the quarter. The average maturity of our swap portfolio also increased again this quarter to 5.3 years as we added slightly longer-term swaps. Lastly, on slide 11, we show our duration gap and duration gap sensitivity. Our duration gap at quarter end was flat, relatively unchanged from the prior quarter. Given the current asymmetry in our risk profile and the potential for some incremental volatility in longer-term rates associated with the election and prospects for fiscal stimulus, we will continue to actively manage this extension risk. With that, I'll turn the call back over to Gary.

Thanks, Peter. And at this point, we'll open up the call to questions.

We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the question queue, please press star, then 2. The first question comes from the line of Doug Harder with Credit Suisse. Please go ahead.

Thanks, Gary. Can you talk about how you're thinking about the dividend? Clearly, you guys are very significantly covering it from kind of a spread income basis. And as you mentioned, economic return has kind of recovered the 1Q decline. So how are you thinking about the dividend?

Sure. And thanks, Doug, for the question. Look, first of all, our priority is really continues to be on generating risk-adjusted returns and enhancing the earnings power of the portfolio, and rather than on how we allocate these returns between dividends and the reinvestment in the business, sort of like other companies. But look, that said, as we talked about in the prepared remarks, We are really confident about the outlook for net spread and dollar roll income. And yeah, we expect that measure to be well above the current dividend for the foreseeable future. And not only that, we expect our true economic earnings to exceed the dividend as well. And importantly, though, as I said on the last call, we do believe that having a tailwind to book value really is a positive thing for investors. And against this backdrop, management and the board will look at the market landscape and the earnings picture over the next several months and will evaluate what dividend level we think is optimal for shareholders kind of as we enter next year. You know, the decision whether to raise the dividend, you know, by how much we, you know, or if we do is really just kind of a function of assessing the optimal or appropriate cushion really between expected earnings and the dividend, you know, in a way that though facilitates some growth in book value over time because we really do think that's important. So look, big picture though, I mean, the most important thing here is This is a great problem to have as we're currently paying and comfortably, as you mentioned, a dividend in excess of 10%, which is extremely attractive in today's environment while we're building book value and we're buying back our stock. So that's a great combination where we sit right now. So thanks again for the question.

Great. Thank you, Gary.

The next question comes from the line of Boze George with KBW. Please go ahead.

Boze George Well, good morning.

Can you just give us an update on where returns are now just under a unspecified pool?

Chris Baird Go ahead, Chris.

Chris Baird Okay. No, I was just going to say, so spreads are certainly tighter now than they were last quarter given the outperformance of mortgages versus hedges. With respect to higher coupon specs, given the strong performance and the prepayment environment, gross ROEs are generally in the very high single digits. But I'd say the majority of our incremental purchases have been concentrated in production coupons where the gross ROE, for example, in 30 or 2s is around 11% without real specialness. But and then if you assume 25 basis points of role advantage that adds a little over 2% ROE which puts the gross ROEs around 13% before convex fee cost.

Okay, great. Thanks. And then in terms of the size of your TBA long position, I guess this quarter understandably it increased. What are the thoughts just in terms of where that could go? Is this kind of the and many more.

There are going to be technical situations where roles spike or temporarily get hit. We'll move the TBA position versus our pool position when there's an economic reason to do so. But again, I'd say based on current conditions, which are favorable for role financing, we'll likely continue to carry a significant TBA position and lower coupons. The backdrop is very supportive with heavy supply from origination and The Fed absorbing $115 billion of the worst to deliver each month. And so the technicals are extraordinarily supportive. And so I think it's reasonable to assume that production coupon rolls will trade better than long-term historical averages for some time to come.

Okay. Great. Thanks, Alex. Let me speak in one more. Just on leverage, it's obviously ticked down just with your book value going up. Just curious what your thoughts are on leverage.

Sure. It's probably ticked down a little more, you know, intra quarter or quarter to date to probably the mid AIDS. But we view that as somewhat temporary. I mean, look, let's be clear, you know, we have the election. We're going to get results from, you know, the vaccine trials. You know, we're obviously seeing some volatility and kind of COVID cases around the world at this point. So given the strong kind of earnings power of the portfolio anyway at this point, it seems logical for us to tone down leverage temporarily just in light of the potential volatility over the next month or so. But then I think we would likely look for opportunities to kind of bring it back up Let's say low to mid-nines, which I would say is our kind of current expected run rate.

Okay, great. Thanks a lot.

The next question comes from the line of Trevor Cranston with JMP Securities. Please go ahead.

Hey, thanks. Good morning. You mentioned a couple times the potential for some volatility in and many more.

In a sense, it's not quite 50-50. I mean, we still have more higher coupon season specified pools than we do lower coupons, but it's getting closer. But those two pieces of the portfolio will react very differently to changes in interest rates. And that's something that we really like about the composition of our portfolio. So we have our new low coupons, which, to your point, are clearly going to track the 7 to 10 year kind of part of the curve. Whereas the higher coupons, while in a model, they show a fair amount of duration or exposure to kind of the back end of the curve, for the first 50 basis points of a move, we really don't expect them to be very reactive because basically if the back end of the curve were to sell off, they benefit on the prepayment front in terms of slower expectations over time. And that's gonna help them more than they're gonna get hurt on the discounting front. So we think for relatively small upward moves, let's say sub 50 basis points, the spec portfolio, the higher coupon portfolio isn't going to show a lot of sensitivity to the back end of the curve, whereas obviously lower coupons have duration and that's why we have hedges, which we pretty well detail. But we feel like we're pretty well hedged for kind of an initial move if we were to get it in the back end of the curve. Focusing This discussion on the back end of the curve, because I think for obvious reasons, we're unlikely to see a movement really inside of five years, given everything we've heard from the Fed and the obvious economic backdrop. So big picture, as we have sold off this quarter, as we mentioned earlier, book value looks to be up a couple percent as of last Friday. We've seen the benefit from our hedges. We've actually seen the higher coupon portion of our portfolio do very well. Lower coupons, twos have actually done well relative to or done okay relative to hedges. We've continued to see weakness in the middle of the coupon stack, like two and a halfs and threes. But again, that's a smaller component of the portfolio at this point.

Okay, that's helpful. Then in terms of the share buybacks, I mean, first, can you say what the weighted average price you bought back shares was in 3Q? And then More generally, can you comment on how you're thinking about, you know, the share repurchase opportunity versus doing new investments into the portfolio today?

Thanks. Yeah, let me start on the big picture question. I think it was $13.95, I think, was our weighted average purchase price. But, you know, and in terms of... The discount to book, you know, ballpark over that was in the, we'll say, upper 80s percent of book, give or take. So, you know, that was noticeably higher than where we bought back stock in Q2, which was lower 80s, you know, very low 80s on average. But if you went back to August of 2019, we repurchased shares. And what we said at the time was that those repurchases were low 90s a book. So that gives you a range of three different time periods with three different kind of price to book spots, so to speak. But I mean, big picture, we look at The overall environment, we look at what we think in terms of what the opportunities are to reinvest, to deploy capital in investments in the mortgage market versus the discount, versus the liquidity environment. But I can't stress enough that for AGNC, we have so much liquidity in our mortgage portfolio, in particular, given the large TBA position, that when we think about buying back shares, we're not forced to think of, are we willing to increase our leverage by buying back shares? I mean, we essentially can do that on a completely leverage neutral basis, where if we buy back $100,000, and many more. which is that we're going to look at this logically. We're going to look at the conditions in the market. But we're very willing to buy back shares when they make sense. And the liquidity of our portfolio affords us the ability to do that in almost any environment.

I appreciate the comments. Thank you.

And our last question comes from the line of Rick Shane from JP Morgan. Please go ahead.

Hey, guys. Thanks for taking my questions this morning. Look, I think we're in a unique environment. Your portfolio construction and hedging is always sort of multivariate in terms of having to balance potential direction of rates and timing of movements. and I think realistically rate risk is asymmetric as it's ever been during the existence of the company. I'm curious how you guys think about this. Does it mean from your perspective that risk is lower than it would normally be? And then how do you use this opportunity to either generate I think you bring up two really good points which one is that the cost of hedges

right now is historically very low just given how low swap rates are. And on the risk management front or the asymmetry, you're right, as long as you believe rates can't go substantially negative, then the downside of a short position or a pay fixed position is much lower than it's been in the past. We absolutely have talked about that on prior calls. We feel that way. But you also don't want to lose track of – and one thing that we are very focused on is that we are more concerned that mortgage spreads would widen into a rally from here. and they would actually perform reasonably well like what we've seen quarter to date in particular higher coupons if we sell off. So one of the other factors that your quote model doesn't capture is the performance of mortgages and mortgage spreads in different rate moves. And so the one thing that gives us pause from let's say Hedging even more than what we're doing today is the fact that we do believe, at least for smaller upward moves in rates, mortgages would perform pretty well. Whereas if we were to retest sub-50 basis points on tenure notes, for instance, that environment would likely be an environment that's going to put pressure on mortgage spreads. So we overlay that in as well into the overall hedging equation. But in the end, what you see from us is a portfolio that's pretty well hedged. And as you can see in our swap portfolio, we put on a lot of swaps near the lows in rates. I don't know, Peter, if you want to add anything.

Well, yeah, and I'll just add, Rick, you know, if you look at the composition of our swap portfolio, it is gradually increasing over the last couple quarters. And I would expect that to continue. We obviously only had a 71% hedge ratio now. And to the extent we add swaps, As I mentioned this quarter, we're adding longer-term swaps. I would expect our marginal swaps that we add to our portfolio, maybe over time we'll look to add options to our portfolio once we get better clarity on the interest rate environment. But they're going to be more in the 5, 7, and 10-year part of the curve to give us that protection against the back end of the yield curve moving, because obviously, as Gary mentioned earlier, the front end of the curve is really is really very little volatility given what the Fed is going to do. So I think over the next couple quarters as we get better clarity on the interest rate environment post-election, the composition of our portfolio, it wouldn't be unreasonable to expect our hedge portfolio to increase a little further.

Great. That's kind of what I expected and a very helpful answer. Thank you guys very much.

Okay. Thank you, Rick. Thanks, Rick.

And our last question comes from the line of Mark DeVries of Barclays. Please go ahead.

Yeah, thanks. Could you talk a little bit more about your prepayment expectations and what kind of risk you see from speeds accelerating if you were to see more of a compression in the primary-secondary spread as originators add capacity, which a lot of them have really been doing in recent months? Yeah, sure. Sure.

Chris, why don't I go first and then you can chime in. Look, first off, while the speed, the average speed in our portfolio increased a lot quarter over quarter, if you look at sort of that increase and the increase in speeds in the market has really been in these cuspy coupons, two and a halves and threes. If you actually look at our We have the one-month speeds on 3.5s, 4s, and 4.5s. You see there was like a one CPR increase in 4s and 4.5s on our portfolio, like in the case of 4s from 29 to 30. So we're not seeing a big increase in speeds on the kind of seasoned higher coupon portion of the portfolio. So even if mortgage rates were to continue to come down, then we do think those have sort of plateaued, so to speak. Where you're going to see kind of more volatility in speed, so it's going to be very much a function of the mortgage rate, is in the two and a half threes and to some degree three and a half percent coupon. Those are not insignificant to us, certainly, but they're a very, very manageable component of the portfolio. So I think what's first and foremost to keep in mind is we really do like the split between kind of mostly twos in 30 years in lower coupons and then the higher coupon-seasoned specified pools. where, you know, again, we're already seeing this, you know, the plateauing of speeds. Now, that said, you know, I don't think there's as much room for primary, secondary spreads to compress as kind of maybe a lot, many people, or if you just look at history or look at the time period prior to, you know, the pandemic, just in that there are changes to the market. Servicing multiples are lower and they're going to stay lower for good reason. And there are other kind of hindrances to primary, secondary spreads kind of getting back to historical norms. And they don't normally get there in the midst of a big refi boom like what we're seeing here. So big picture, I think we We expect to see prepayments pick up on two-and-a-halves and threes, and in particular, pick up on two-and-a-halves. But that's a coupon that we've been shrinking our exposure to. So when we look at it as a whole for the portfolio, yes, you have to manage speeds, and yes, there is risk of faster prepayments, but it's something like we feel that we can manage. I hope that answered it. Chris, I don't know if you want to add anything.

No, I think you covered it well.

Okay, great. Thank you.

Thanks, Mark.

We have now completed the question and answer session. I'd like to turn the call back over to Gary Kain for concluding remarks.

I'd like to thank everyone for their participation in our Q3 earnings call, and we look forward to talking to you again next quarter.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.