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spk12: Good morning, and welcome to the AGNC Investment Corp. Second Quarter 2024 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 your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Katie Turlington in Investor Relations. Please go ahead.
spk01: Thank you all for joining AGMC Investment Corps' second quarter 2024 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 facts, 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 AGMC. 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 could cause actual results to differ materially from those contained in the forward-looking statements are included in agencies' 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 this call include Peter Federico, Director, President, and Chief Executive Officer. Bernie Bell, Executive Vice President and Chief Financial Officer. Chris Kuhl, Executive Vice President and Chief Investment Officer. Aaron Tass, Senior Vice President, Non-Agency Portfolio Management. And Sean Reed, Executive Vice President, Strategy and Corporate Development. With that, I'll turn the call over to Peter Federico.
spk07: Good morning, and thank you for joining our second quarter earnings call. The strong fixed income momentum that began in the fourth quarter of 2023 abated in the second quarter as the Federal Reserve and market participants looked for indications that the economy was slowing and inflation moderating. On balance, the data showed that consumer spending and confidence were weakening, the labor market was moving into better balance, and most importantly, inflation measures were trending toward the Fed's long run target. From a monetary policy perspective, this was a welcome development. Nevertheless, the Federal Reserve was unwilling to adopt a more accommodative monetary policy stance. Against this backdrop of diverging economic and monetary policy outlooks, fixed income markets became more cautious and inter-quarter volatility increased. In aggregate, interest rates edged higher and agency mortgage-backed security spreads widened, driving AGNC's negative economic return of just under 1%. In the current environment, each economic release carries elevated importance as the Fed seeks greater confidence before easing monetary policy conditions. This was clearly the case in the second quarter, with interest rates and spreads reacting sharply to each labor and inflation report. The 10-year Treasury, for example, ended the quarter just 20 basis points higher, but experienced several sharp sell-off and rally episodes during the quarter that drove a cumulative daily yield change of more than 300 basis points. For agency MBS, the second quarter was a push and pull between evolving supply and demand dynamics. On the demand side, bank and foreign demand moderated in the second quarter, while demand from bond funds remained steady but limited given an already overweight position. The modest weakening of MBS demand and associated widening of mortgage spreads was also somewhat expected as spreads ended the first quarter at the tighter end of the recent trading range. On the supply side, favorable seasonal dynamics often lead to a notable uptick in mortgage supply in the second quarter of the year. This was indeed the case this year, with $52 billion in supply in the second quarter, double the pace of the first quarter. Supply was especially heavy during the last week of the quarter. As a result, agency MBS spreads to treasuries widened five to ten basis points across the coupon stack with a good portion of that spread widening occurring over the last several days of the quarter. Production coupons, namely five and a half and sixes, experienced the greatest spread widening given the uptick in supply. Importantly, however, agency MBS continued to trade in the same relatively narrow spread range that has emerged over the last nine months. For the current coupon, that trading range has been 140 to 160 basis points to a blend of five and 10-year treasury hedges. Using a similar combination of swap hedges, that range has been 170 to 190 basis points. Spreads at quarter end to treasuries and swaps were 150 and 180 basis points respectively, right in the middle of the recent range. We continue to view this range bound trading behavior as a very positive development for agency MBS. Since quarter end, economic data has continued to be supportive of the Fed moving toward a more accommodative monetary policy stance. That shift will likely occur over the next several months and should be viewed as the beginning of a new, more favorable monetary policy cycle. To this point, in its most recent summary of economic projections, the Fed's short-term rate forecast showed a total of nine rate cuts over the next two years. As at least some of these rate cuts become a reality, the risk of meaningfully higher rates will decline. interest rate volatility will decline, and the yield curve will steepen. These will all be positive developments for the agency MBS market specifically and for fixed income more broadly. Lastly, the long-term fundamentals for agency MBS remain very favorable and continue to give us reason for optimism. In light of persistent affordability challenges and historically slow prepayment speeds, the net supply of agency MBS over the intermediate term will likely remain below previous expectations. At the same time, from a demand perspective, agency MBS provide investors with a meaningful amount of incremental yield relative to both U.S. Treasuries and investment grade corporate debt at current valuation levels. For these reasons, we continue to be very optimistic about both the current returns and the future prospects for our business. With that, I'll now turn the call over to Bernie Bell to discuss our financial results in greater detail.
spk00: Thank you, Peter. For the second quarter, AG&C had a comprehensive loss of 13 cents per share given the moderate spread widening that occurred for the quarter. Economic return on tangible common equity was negative 0.9% for the quarter, comprised of $0.36 of dividends declared for common share and a decline in our tangible netbook value of $0.44 per share. As of late last week, our tangible netbook value per share was up about 2% for July, or 1% after deducting our monthly dividend accrual. Leverage increased modestly for the quarter to 7.4 times tangible equity as of the end of Q2, from 7.1 times as of Q1. At the same time, our liquidity remained very strong, with unencumbered cash and agency MBS of $5.3 billion, or 65% of our tangible equity as of quarter end. Consistent with the increase in interest rates, the average projected life CPR for our portfolio at quarter end decreased 120 basis points, to 9.2 percent. Seasonal factors drove an increase in our actual CPRs for the quarter to an average of 7.1 percent, up from 5.7 percent for the prior quarter. Net spread and dollar roll income for the quarter remained well above our dividend at 53 cents per share. The 5 cents per share decline for the quarter was due to a decrease in our net interest rate spread of approximately 30 basis points to just under 270 basis points for the quarter, as higher swap costs more than offset the increase in the average yield on our asset portfolio. Lastly, in the second quarter, we issued $434 million of common equity through our at-the-market offering program. Our capital management framework provides us the ability to opportunistically create incremental value for existing stockholders through book value and earnings accretions. In the second quarter, we issued stock at a substantial price-to-book premium and invested those proceeds in attractively priced assets. And with that, I'll now turn the call over to Chris Kuehl to discuss the agency mortgage market.
spk04: Thank you, Bernie. From a macro perspective, the second quarter was similar to the first quarter in many ways, with economic data repricing Fed expectations and heavily influencing fixed-income market sentiments. Strong economic data at the start of the quarter caused the market to lower its expectations for Fed easing in 2024. Fed rhetoric also turned hawkish in April, with Chair Powell expressing disappointment in the recent progress against the Fed's inflation objective. As a result, rate volatility increased as 10-year yields moved through the upper end of the year-to-date range, ultimately reaching just over 4.7% in late April. These macro and market dynamics, coupled with higher seasonal supply, negatively impacted agency MBS performance early in the quarter. Market sentiment shifted, however, in May and June following weaker labor and inflation data. Notably, headline unemployment increased from 3.8% in the April nonfarm payroll release to 4% in June. Softer labor data and favorable CPI reports in both May and June allowed for a more balanced market focus on the Fed's dual mandate of maximum employment and stable prices. As a result, Treasury yields and agency MBS spreads partially retraced the negative performance by the end of the quarter. Despite elevated rate volatility, agency MBS traded in a much tighter range than they did during periods of stress seen last year. This is encouraging and is a result of many factors, including much stronger high-grade fixed income inflows year-to-date, the Fed's decision to start tapering QT, stability in bank deposits, and most importantly, a growing consensus firmly rooted in economic data that the Fed may begin normalizing rates over the next couple of months. During the second quarter, we added approximately $3 billion in agency MBS, and as a result, the investment portfolio increased to $66 billion as of June 30th. Our TBA position declined by $3 billion, As conventional roles traded somewhat weaker, we opportunistically added approximately $6 billion in specified pools, most of which in lower pay-up categories. Our Ginnie Mae TBA holdings in aggregate were largely unchanged as of June 30th, as valuations remained attractive and role-implied financing rates continued to offer a significant advantage versus repo funding. Our hedge portfolio increased to $58.8 billion as of June 30th, largely due to the increase in our asset portfolio. During the second quarter, we continued to gradually shift the hedge composition to a heavier allocation of swap-based hedges. As a result, swap-based hedges currently represent approximately 65% of our hedge portfolio on a duration dollars basis. Our swap-based hedges were a drag on our book value performance in the second quarter as swap spreads tightened five to eight basis points across the yield curve. Lastly, as Peter discussed, The data-dependent nature of Fed policy will likely continue to create volatility in markets, but the earnings environment for agency MBS remains very favorable with historically widespread low levels of prepayment risk in liquid financing markets. I'll now turn the call over to Aaron to discuss the non-agency markets.
spk06: Thank you, Chris. Credit spread performance in the second quarter was mixed with some areas widening marginally while others were a bit firmer. Early in the quarter, spreads across credit products generally weakened as rates tested local highs. Subsequently, the backdrop of improving inflation readings and a softer employment outlook, combined with relatively high issuance in the structured product market, led to the divergent performance of credit products during the quarter. As an indicator of credit spreads in Q2, the synthetic investment grade and high yield indices widened by approximately 3%, and 14 basis points respectively. This widening retraced just over half of the tightening we saw in the first quarter. Credit fundamentals remain consistent with past trends we have noted, showing a bifurcated consumer base. Lower-income households are currently stretched, as reflected by increasing auto loan and credit card delinquency rates. Conversely, higher-income or wealthier households appear to be in reasonably good shape. Turning to our portfolio, our portfolio of non-agency securities ended the quarter at $940 million, down roughly 10% from the prior quarter end. This decline was largely anticipated and driven primarily by our participation in the GFC tender offers for its outstanding credit risk transfer securities. Additionally, a significant portion of our CMBS holdings paid off or paid down in Q2. In both segments of the non-agency portfolio, we were able to opportunistically redeploy a portion of the freed up capital. Lastly, the funding landscape for non-agency securities remains stable and relatively attractive by historical standards. With that, I'll hand the call back to Peter.
spk07: Thank you, Aaron. With that, we'll now open the call up to your questions.
spk12: We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from Kristen Love with Piper Sandler. Please go ahead.
spk03: Thanks, Scott. Good morning, everyone. Peter, just with the presidential election news cycle ramping up, the potential for a Trump versus Harris election, can you just discuss how you might expect the election to impact you from both a pre- and post-election standpoint, what you've experienced in past elections, how it might impact investment positioning, volatility? And then what you might expect post election, just depending on who's in the White House in January and how that could impact agency MBS regulation and what could be kind of favorable or unfavorable from your seat.
spk07: Sure. There's a lot there. Thank you for the question. Obviously that's on a lot of people's mind. If you're right, if you go back and you look at previous elections, like to take, for example, 2016, we did have a very significant rate move following that election. This one probably is a little bit more difficult to read. Obviously, it's a very evolving situation now in terms of the political landscape. Still a little unclear, I think, from a monetary policy perspective and from a fiscal policy what the implications may be. So we're going to have to watch this develop over the next several quarters. But generally speaking, we approach it as going into episodes like that with sort of a lower risk profile you'll see us really not take a lot of interest rate risk in that environment. We'll wait and see what the outcome is and position the portfolio a little bit more cautiously heading into a high volatility environment. From a GSE perspective, you're right. There's obviously some talk. Going back to that fiscal point, it's not clear from either party which is better or worse for U.S. Treasuries. Obviously, when we look at what happened with the Treasury market, and in particular, what happened with the swap spreads in the end of the second quarter, one of the reasons why swap spreads widened like they did sort of late in the quarter was the concern as the Republican Party started to gain momentum and the risk that both sides of the Congress were going to shift toward Republican, that that may lead to more Treasury issuance. That puts some downward pressure on on swap spreads. So those are the kinds of things that we'll have to watch more closely. On the GSE side, I would say it's definitely too early to tell which way that may go. I know that from the Republican Party side, there is a view that will go back more toward the movement to try to move the GSEs out of conservatorship should Trump win. But what I would say is, look, when you look at the housing market overall, and you look at where homeownership rates are, it's clear that our housing finance system is really the envy of the world, and it's clear that the housing finance system is functioning very well post-Great Financial Crisis with the involvement of government in it. I know both parties are talking about trying to reduce the cost of homeownership in the current environment, so it seems like an agenda for both parties. And I can't see a scenario where disrupting the highly liquid, highly desirable market that we have would be a good thing for making homeownership more affordable and lowering the cost of housing. We have an $8.5 trillion market that's functioning very well. And by the way, I would also add, when you look at the job that FHFA does, and Director Thompson in particular, she's a very highly regarded regulator. I think she's done a great job disrupting the... The liquidity that we have doesn't seem to make a whole lot of sense if you're trying to make homeownership more affordable. So it's something that's going to bounce around. We're going to hear about it. We're going to talk about it. But at the end of the day, things are working really well. So it seems to me it's more like a solution looking for a problem, and less is more when it comes to that front. So I don't expect a lot of change there, certainly not over the near term.
spk03: Thanks, Peter. That's all really helpful. And then also, I think you mentioned some comments on demand for agency MBS in your prepared comments, bank demand moderating. I think you said asset matters for staying consistent. Can you just dig a little deeper there in your views on the incremental buyer here for agency MBS today?
spk07: Yeah. And when you look at the second quarter, it was really an interesting quarter because there was some really significant positive fundamental development for the fixed income market And when you look at our performance, it sort of got masked by the fact that spreads moved a little bit wider and our economic return was sort of unchanged. But the fundamental outlook for fixed income improved dramatically in the second quarter. And the reason why it doesn't feel that way is because most of the fixed income markets started the second quarter and really went through the entire second quarter sort of taking a wait-and-see approach. What happened in the first quarter is we had surprisingly strong economic data that put the Fed on guard and put all market participants on guard, and everybody approached the second quarter saying, everybody, meaning fixed income market participants generally, just take a wait-and-see approach. We needed to see the economic data, the underlying fundamentals change, whether they were going to deteriorate further, meaning that the economy was going to reaccelerate, inflation was going to become a problem, Fed was going to have to be more restrictive, or the converse, which is actually what materializes. Now it looks like there's broad... slowing in the economy, inflation is trending back, and the Fed now is clearly, I think, shifting to a more accommodative monetary policy. But that didn't manifest itself really in the way spreads behaved and the way interest rates behaved. That will, I think, occur over time. The third quarter and summer tends to be a little thin and a little volatile from a fixed income market participants. And as you point out, we have the election coming. But over time, the demand, I think, for mortgage-backed securities will become much clearer. And there's a couple sources of it. One is that it's now, I think, clear, even though we don't know the final rules, that bank regulation is likely going to be a positive or certainly less negative from a bank demand perspective. That's going to materialize over the end of the year and ultimately implemented early next year. And then just the fundamental shift from a monetary policy perspective, that is a much better environment for fixed income broadly. The yield curve steepening, for example, would be a very positive development for the demand of mortgage-backed securities. As the yield curve becomes steep, short-term rates come down, there's a lot of money in money market funds that will ultimately move out of money market funds. So I expect the demand for mortgages to improve as monetary policy outlook improves as we get through this summer period, as we get through the election. I think bank regulation will ultimately prove to be less onerous than we had feared, and that actually may lead to demand for mortgages, particularly if that regulation comes out such that banks have to hedge more interest rate risk then I think that may push banks actually to mortgage-backed securities and away from U.S. treasuries. So those are things that will evolve over time, but I think those are the reasons why the demand for agency MBS should improve.
spk12: Thanks, Barrett. Appreciate you taking my question. The next question comes from Doug Carter with UBS. Please go ahead. Good morning, Doug.
spk09: Good morning, Peter. Can you remind us, Peter, how you think about setting the dividend? What are kind of the most important factors and kind of how you see the current dividend level in light of those factors?
spk07: Sure. Obviously, a lot goes into it in terms of the environment and the outlook, the outlook for our business in terms of where we can operate from a leverage perspective and where we think interest rate volatility is and mortgage spread volatility. Those are obviously very, very important in terms of us setting our risk parameters for our portfolio. But sort of foundational to the decision is always starts with what is our total cost of capital? What is our required break even, if you will? And how does that compare to the economics of our business today? If you look at our portfolio, On current valuation levels, what do we think the economics of our business is going to generate from a return on equity perspective going forward? From a total cost of capital, for example, when you take the cost of our common dividend, for example, in the second quarter, the cost of our preferred dividend and our operating costs, annualize those as I did and divide it by our total cost. capital position, you'll get a number something around 16.3 or call it 16.5%. So that's the amount of return that we need to earn to cover all of those costs in our business. You compare that to what are the economics of our business at current valuation levels, and I would say when you think about where spreads are, as I talked about, 150 on average to 180. Let's say If spreads are in the current spreads for mortgage-backed securities are in the 165 basis point range when you use a blend of hedges, leverage at about where we operate right now, given our cost of capital, given where the current coupon yield is, that would translate into an expected return on an economic basis of call it somewhere between 16% to 19%. So very much aligned with that. total cost of capital. Now, what is important to point out, what that doesn't include when I do that calculation is it doesn't include the cost of ongoing rebalancing, which would be a drag on that. So that's something you have to consider over time. But at the same time, what it also does not include is the positive benefit we get, which is about 2%, for example, on our preferred stock position. So It's not the most complete measure, but it's certainly a good indication. And I think those two things remain really reasonably well aligned. And that's really important from a dividend sustainability perspective. So that's the way we think about it. And in this current environment, we also have to take into account the positive benefit that we get from issuing common stock at an accretive level. So that's an incremental source of return that has been available to us now for some period of time. So that's the way we think about the dividend. I think our dividend and our total cost of capital are reasonably well aligned with the economics of where mortgage-backed securities are leveraged and hedged the way we hedge them and leverage them today.
spk09: Great. I appreciate that answer, Peter. Thank you. Sure. Appreciate the question.
spk12: The next question comes from Bose George with KBW. Please go ahead.
spk08: Hey, guys. Good morning. So I wanted to ask about spreads. When I look at OAS, it looked like it widened in April. Then it sort of came back pretty fully. But nominal spreads widened and didn't come back as much. I guess, is that right? And just can you talk about some of the drivers?
spk07: Yeah. Let me have Chris talk a little bit about that. It's really the driver of the difference between nominal spreads and OASs volatility.
spk04: Yeah, it is largely just the increase in implied volatility that started early in the quarter, the difference between those two.
spk07: Okay. Meaning when implied volatility goes up, OASs will go down, and that will lead to a little bit of confusion there.
spk08: Okay, yes, that makes sense. And then actually switching over to the funding markets, it looks like SOFR was pretty elevated at the end of the quarter. Was it a little more pronounced in the first quarter? Anything you're keeping an eye on there? Could you talk about some of what's happening?
spk07: Yeah, there is something to keep an eye on there, and I think this is exactly what the Fed is keeping an eye on, which is the Fed is clearly continuing to drain funds reserves from the system through its balance sheet runoff. It's running off at about $45, $50 billion a month. And what the Fed is doing is obviously draining reserves from the system. And they're, I think, now starting to see the impact of the reduction, which I can't remember what the number is. I think they've taken out about $1.5 trillion out of the system already. But they're getting to the point where they're moving from the abundant bank reserve to the ample target. And when you listen to the way the chairman is talking about it, they're going to watch these indicators, and ultimately that will inform them as to when reserves are abundant, and that will ultimately lead them to stop their balance sheet runoff, which I expect them to do, stop their balance sheet runoff, perhaps somewhere in the neighborhood of the next five or six months, because that would put bank reserves at this pace which are now 3.3 trillion down to around 3 trillion. And I think at that number, that's probably a number that perhaps aligns on a percentage basis of GDP with their target. But obviously, we don't know any of those numbers with specificity. But what we saw at the end of last quarter was a little bit of pressure at sort of quarter end, which is normal in a market. It was not normal when... reserves were as ample and as abundant as they were. But as we get a little closer to that target, we'll see that period end pressure show up again. That's nothing particularly troubling. It's just a normal market, and the Fed certainly has lots of tools to maintain liquidity in the repo market for U.S. Treasuries and agency MBS. So I don't view that as a concern. In fact, I view it as an indication that the Fed will be stopping its balance sheet runoff fairly soon.
spk08: Okay, great. Thanks.
spk12: The next question comes from Terry Ma with Barclay. Please go ahead.
spk10: Hi, thanks. Good morning. So your net interest margin was down about 30 basis points quarter to quarter. It looks like that was just a function of putting on longer dated swaps rather than shorter dated ones rolled off. And I think you kind of highlighted this dynamic on the NEM last quarter. So I guess looking forward, do you guys have another $10.5 billion of swaps potentially rolling off soon? So should we kind of expect the same magnitude of NEM decline each quarter, or how should we think about that?
spk07: No, Terry, that's a really good question, and I'm glad you asked it because the runoff of our shorter-term swaps, which was about $2 billion, did have an impact directionally, obviously, on our NEM. But that was obviously not the biggest impact because we did add $6.5 billion, as you point out, of longer-term swaps. About half of those swaps, and the average pay rate on that $6.5 billion was 4.2%, so obviously a much more significant cost. About half of those swaps that we added were used to hedge new mortgages because of the stock that we issued and the mortgages that we bought with that stock. We, in a sense, accelerated some of that NIM decline. At the same time, we also added about $3 billion, the other half of that $6 billion of swaps. As Chris has mentioned this in his prepared remarks, we have rotated out of treasury hedges into swap-based hedges. So that, again, because those swap-based hedges show up in our net interest margin, led to perhaps a more significant decline in our net interest margin than people would have expected if you just anticipated the reduction and our swap portfolio due to the maturity of our short-term swap. So to the extent that we grow our portfolio and are able to do so at really attractive investment returns, that will change the timing, if you will, of NIM. But you're right, over time, the shorter-term swaps that we have, and we have about $6 billion of them maturing in the second half of the year, then that'll have some impact on our net interest margin. But again, it's moving our net interest margin back into alignment. If you think about our net interest margin at around 270 basis points, giving us the net spread income we have, that return on capital for the second quarter was 24%. That is not the economics of our business, and that's why they're going to come back into alignment, as we just talked about in the question from Doug. The economics of our business are more in the 18% range, not 24% range. Great.
spk10: That's helpful.
spk07: Thank you. Sure. Appreciate the question.
spk12: Next question comes from Rick Shane with JP Morgan. Please go ahead.
spk11: Good morning, everybody. Thanks for taking my question. Sure. Look, during the quarter, it looks like you issued about 45 million shares, and that makes sense. stock was trading at a premium to tangible book consistently spreads widen, which creates an attractive investment opportunity. I am curious when you think about issuing shares off the ATM, how dynamic is that? Is it something that you set out at the beginning of the quarter and say, hey, we want to issue 40 million shares, plus or minus 5 million, or do you on a daily basis, look at this and say, wait a second, you know, we've got an attractive, we're trading an attractive premium, spreads have widened, it's a good time, and really lean into it. I'm trying to understand the dynamic throughout the quarter.
spk07: Yeah, no, that's a really great question. I appreciate it. What I would say, just to start with, is we never start out with a set expectation. So there is no at the beginning of the year we need to or want to or we're going to raise this amount of capital. It's based on what's happening with our portfolio and based on what's happening with the market. And you're right. One of the real values of using the ATM or at-the-market program is that it allows you a lot of flexibility. So it allows you flexibility to issue stock, for example, on days when there's high volume in your stock or when there's unique demand in your stock. And we often see reverse inquiry, if you will, from institutional or large investors looking for transactions. So that's something that we could consider as they come in. At the same time, it allows you to issue stock in increments, if you will, that make it efficient to deploy, as opposed to raising a lot of capital and having to deploy that over time in assets without driving asset prices, this gives us the ability to issue stock in a way that doesn't disrupt, if you will, the assets that we're acquiring. For example, in the second quarter, we did raise a little over $400 million, and we bought over $3 billion worth of mortgages, buying them over the quarter as the coincidence with the stock issuance allows us to do that in a way that is gives us better economics. So it's something that we approach from a dynamic perspective and from a flexibility perspective.
spk11: Got it. And Peter, that's helpful. And when we think about you making those investments, it's raising the capital, it's acquiring the assets, it's levering the assets, levering that capital, acquiring the assets and hedging them. Is the most cumbersome part of that the hedging part is your deploying capital? I'm just curious where the friction is from a timing perspective, given the ATM is super efficient, the repo markets are super efficient, your markets trade incredibly liquid. I'm curious if there's any, on the hedging side, if there's any sort of friction there.
spk07: No, there's no issue there. I mean, there's plenty of liquidity. But really, it's the comparison of, for example, doing a bought deal. So let's just take the... Second quarter is an example. If we did a bought transaction for that amount, $450 million, you'd get that all in one day, and then you would have to go out and buy. That would support the purchase of a little over $3 billion worth of mortgages. It would be clear that if you did that transaction, that AGNC would either have had to buy those mortgages in advance or buy them thereafter, and that would likely potentially lead to a change in valuation of mortgages, as opposed to just simply doing it at a very measured, disciplined pace, trying to connect the liquidity in our stock with the richness or cheapness of mortgages. And that's why we do that throughout the quarter. It's not consistent. When those sort of align and the liquidity is in our stock and mortgages we think are cheap, then we'll buy mortgages. For example, at the beginning of the quarter, mortgages were at the tight side of the range and they were not as attractive to us as they became later in the quarter when mortgages moved back into the middle of the range. And in fact, our book value accretion was better at the end of the quarter. And so the ATM program actually worked better for us at the end of the quarter rather than at the beginning of the quarter.
spk11: Got it.
spk07: Okay, very helpful. Thank you.
spk12: Sure. The next question comes from Eric Hagen with BTIG. Please go ahead.
spk05: Hey, thanks. Good morning. Hey, good morning. Good morning. So if the range for mortgage spreads is tighter because the narrative is really focused on Fed cuts, do you feel like that maybe drives more flexibility to take your leverage higher? And what do you feel like that range for your leverage is? And do you feel like we could maybe think about seven and a half times being more of a minimum leverage over call it the near or medium term?
spk07: Well, I think those are, all points and considerations when we think about our leverage. We certainly have the capacity, as you point out, when you look at our cash and unencumbered position that Bernie mentioned at 65% of our equity, that would indicate that we have a lot of capacity to take leverage higher if we so chose. And obviously our outlook for mortgage spread volatility is really important in that equation. And both Chris and I mentioned that in our prepared remarks as an important development. It's an important development for our business because of just that point that you're making, which is when you go back and you look at how mortgage spreads have behaved, we went through a very difficult repricing period from 2022 to 2023 to find this new range. And the challenge in 2023 was that we didn't know where the top of the range was. and obviously we hit it on a number of occasions at close to 200 basis points, and then ultimately that top held. What we've seen subsequently, and this is a really healthy signal, I think, is that there's a new range within the range. And the narrower the spread range, the more capacity we have essentially to take greater risk. Obviously, as we talked about already on this call, we're going into a period where volatility tends to increase a little bit. We obviously have some big macro issues coming that we'll have to contend with. But over time, those will certainly inform our position about the appropriate amount of leverage.
spk05: That was really helpful, Colorado. Thank you. Okay, so we're looking at the forecasted prepayment speed over the next 12 months. I think it's 7 CPR. That's the same as the paydown that we saw last quarter. Is there a way to drill down there? I mean, does that assume that mortgage rates are flat How do you think mortgage rates kind of trend here? And if we saw a pickup in speeds, do you feel like that would be positive for total return, or is it maybe dependent on other variables?
spk07: I'll let Chris answer that.
spk04: That forecast just assumes that the forwards are realized. It's a base case single path forecast along the forward rate curve. With respect to convexity risk on the portfolio or managing prepayment risk, Given our coupon and pool composition, peak negative convexity on our portfolio is about 150 basis points lower than today's rate level. So significant move in rates to get to that sort of level. You know, specified pools, you know, higher quality specs represent about 45% of our holdings. The next category of specified pools also have favorable cash flow characteristics. That represents about 30% of our holdings. And, you know, importantly in the higher coupons where we, you know, have the most prepayment risk, those two categories combined represent about, you know, in sixes and six and a half is about 85% of our holdings. convexity risk, prepayment risk in this environment is still very manageable.
spk07: Eric, just to go back and round out the discussion on spreads, sort of the way I would characterize the outlook right now is I expect mortgages to sort of stay range bound over the nearer term. But longer term, I think what we now are seeing is there are where there's more reasons for mortgages to tighten than they are to widen. There's certainly the catalyst for mortgages to move to the high end of the spread range, the very high end of the spread range, are harder to see, and there's starting to be more reasons to believe that mortgages could tighten over time.
spk05: Right. Good perspective. We appreciate you. Thank you.
spk07: Sure. Thank you.
spk12: And the final question comes from Jason Stewart with Jannie. Please go ahead.
spk02: Hi, Jason. Hey, Peter. Thanks for taking the question. Just to follow up on Eric's question there, going back to that high and call it mid-quality spec pools up in coupon, what's the average pay up on that 85% if you could give us an idea of what that looks like? Okay.
spk04: We don't have that broken out in our disclosures, but the average pay-up on our aggregate portfolio, including the TBA position, which is relatively small, is just under a point. It's around 30 ticks. Excluding the TBA position, it's slightly over a point, so around 33 ticks. Okay.
spk02: All right. Thanks for that. Yeah, I guess I wanted to ask just a little bit more perspective on coupon selection. I mean, you have a wide range of coupons to pick from in this environment. And really, you know, the push and pull between total return and carry and up in coupon, you know, giving your outlook for the refi, you know, some new programs out there for the refi outlook. Maybe you could just drill down into what sort of drives your coupon selection over the next two or three quarters. That'd be helpful. Thanks.
spk04: Sure. So, you know, Within, you know, across the coupon stack, production coupons, you know, still, you know, by far offer the most attractive spreads. And so that's where we've been investing marginal capital. Assuming, you know, current relationships across the stack remain, that'll be where we continue to invest marginal capital. Higher coupons have very different technicals than lower coupons. It's where all the organic supply is against relatively anemic bid from banks and overseas. And so naturally, or if you compare that to the lowest coupons, which are 300, 400 basis points away from being produced, and most of the float is tied up at the Fed, and so when you have passive index fund inflows, that need to buy assets that aren't being produced, you can get pretty dislocated relative valuations across the stack. It's logical why this relative value relationship has been persistent. Higher coupons, as we discussed earlier, certainly have more prepayment risk, worse convexity, but you know, I would say that's, you know, more than in the price. You're collecting a lot of spread that can be used to manage that risk in a number of different ways. You can buy options on rates. You can, you know, spend it on pay-ups and source that convexity through asset selection and buying specified pools. And then you can delta hedge. And in the current environment, the latter two are more attractive and fly volatilities is still extremely elevated. And so options are expensive. And so generally speaking, you know, it's much cheaper to source convexity through pool selection and coupon selection. So, you know, roughly about two-thirds of the position is in fives and higher. You know, the positions in three-and-a-halves through four-and-a-halves, the so-called belly coupons, have, you know, still attractive spreads and extremely stable cash flow profiles. And so, you know, we like the diversity of that and that keeps the convexity risk in the aggregate portfolio very manageable. Great. That's good feedback.
spk02: Thank you for that.
spk10: Sure.
spk12: We have now completed the question and answer session. I'd like to turn the call back over to Peter Federico for concluding remarks.
spk07: We appreciate everybody participating in our call this morning, and we look forward to speaking to you again at the end of the third quarter.
spk12: The conference is now concluded. You may now disconnect.
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