Q3 2020 AGNC Investment Corp Earnings Call

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 a GMC. Reports filed with the Securities and Exchange Commission copies are available on the ftc's website. We disclaim any obligation to update our forward-looking statements unless required by law.

Participants on the call includes Gary teen chief executive officer Brittany Bell senior vice president and Chief Financial Officer Chris Executive Vice President Bush senior vice president and Peter Federico president and Chief Operating Officer with that. I'll turn the call over to Gary Payne.

Thanks, Katie and thanks to all of you for your interest in a GMC. We were extremely pleased with the performance of our portfolio in the third quarter with economic return totaling almost 39% 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 income for the quarter. We remain optimistic about the earnings power of our portfolio during the third quarter Equity markets continue to strengthen an interest rate volatility remain muted despite the upcoming election and the inability of lawmakers to agree on a new stimulus package.

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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 George 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 3 days, which comprise a very small percentage of our portfolio em, just continue to benefit from ongoing fed support negligible interest rate volatility favorable funding conditions and the plateauing of prepayment speeds on many cohorts May well be it at elevated levels in aggregate specified pool performance was somewhat stronger during the quarter with performance dependent on coupon and other attributes lower coupon TBA s which benefited from both solid price performance and very strong dollar roll funding levels were the best-performing component of our Palm foleo 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 $2 rolls. We expect the implied funding Advantage relative to repo to contract somewhat from the very strong level 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 purchases at this point. I will turn the call over to Bernie to review our financial results for the quarter.

Thank you. Very turning to slide for we had total comprehensive income of a dollar and $0.28 per share for the third quarter net spread and we'll income excluding ketchup and mayonnaise was $0.81 per share for the quarter which is our highest level and every five years, we'll 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 that spread and dollar one come as a significant funding advantage of our TV a position likely decline somewhat and portfolio turnover continues to be reinvested at prevailing asset yields.

That said we do expect the majority of the Improvement and our net spread and dollar will income experienced in Q3 to be maintained over the coming several quarters.

Tangible that book value increased 6.4% for the quarter as our Foley of largely lower coupon assets and higher coupon specified pool Holdings significantly outperformed Dar interest rate Hedges, including dividends of 36 cents per share. Our economic return on tangible. Common Equity was 8.8% for the third quarter.

As of last Friday, we estimate that are tangible net Book value is up about 2%

turning to slide five our Investment Portfolio at quarter-end total 97.6 billion largely unchanged from the second quarter are ending leverage was 8.8 time 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 24.3% for the quarter but importantly this does not include the lower coupon component of our Holdings which is held in four months.

Are forecasted life CPR decrease to 15.9% as of the end of the quarter from 16.6% at the end of Q2 largely due to change in a set composition.

Lastly during the third quarter. We repurchased $154 of our common stock at a meaningful discount to our tangible and 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 old curve continued to modestly steep in with two year treasury yield sending the quarter to basis points lower at 13 basis points while 10-year treasury yields ended the quarter or three basis points higher at 69 basis points agency. MBS spreads generally tightened with lower coupon name is 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 TV a performance package and support from the FED purchasing forty billion and agency MBS per month in addition to reinvesting pay Downs on its portfolio into production coupon MBS drove the outperformance in life coupons.

As you can see in the lower left table on page 6:30 or two's increased in price by more than a point despite 10-year treasury prices selling off a little more than a quarter of a point off your coupon TBA performance was mixed with Thirty or three s clearly the worst performer during the third quarter. However, given rich valuations in prepayment concerns. We materially reduced or generic holding down 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 continue to shift the composition to lower coupons in both thirty years during the third quarter. We reduced Holdings in two and half percent coupons and above by approximately 18 billion vs adding 30-year and 15-year or 2001 and half's 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 dog rolls.

Given this favorable backdrop. We increase the

Size of our TV a role 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 be a role finance office on Lower coupons averaged around -60 basis points during the third quarter since quarter n Roll specialness is moderated somewhat, especially in more coupons like 30 or two and half months but 30 or two's continue to trade exceptionally. Well currently at around -65 basis points were about 80 basis points through repo 15 year production coupon roll financing is currently trading around ten to twenty basis points through repo as we mentioned last quarter rolls specialness can contribute materially to Total returns. So the degree of specialness overtime will likely track or modest levels while mortgage spreads have tightened. We remain optimistic about the investment environment give an attractive role carry and low interest rate volatility. And while the prepayment backdrop is Chad.

Or Diversified portfolio of higher coupon specified pools in production coupon TBA has offsetting risk characteristics that position as well for the environment on the I'll turn the call Aaron to discuss the non-agency market.

Thanks, Chris. I'll quickly recap the quarter a car and positioning and then update you with our outlook on credit. Please turn this light eight significant rally in Q2 across Structured Products continue with the third quarter with for selling. Well behind us down and credit blood away as the credit Curve will flatten across most asset classes with with respect to our Holdings. We reduce exposure to higher-rated cmbs, rmbs and RPL bonds by close to a hundred 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 by a sales and pay Downs. 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 is tight and somewhat affordability levels are back at the most attractive level in years coupled with historically low housing Supply.

Additionally conventional forbearance rates continue to take lower declining about 30% during the quarter.

In light of this we've tilted the CRT portfolio a bit further down and credit and in dollar price and 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 a guy across Structured Products is not what it was pre COVID-19.

As we set on last quarter's call with the fed's actions as a Tailwind. We expect Structured Products spreads for good credits to remain well supported over the coming years. However, the economic recovery clear liquid still presents risk with significant challenges in certain areas as such any longer run tightening and spreads will likely face bouts of widening along the way in some sectors such as retail and hospitality and 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 financial summary on slide 9 as expected our average repo funding costs dropped to 40 basis points in the third quarter from 76 basis points the prior quarter.

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Reflects the feds very accommodative monetary policy stance and short-term forward rate guidance. I expect this favorable funding environment to continue with following a cost from overnight to 1-year staying in the 15 to 30 basis-point range as such I expect a repo cost to Trend marginally lower over the next several years.

Our aggregate cost of funds which includes the funding cost associated with our T be a position as well as the cost of our swap hedge has declined more sharply in the third quarter of 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 am very attractive dollar roll funding levels on tva's 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 in our net interest margin which for the quarter increased to 215 basis points from 168 basis points to the prior quarter looking ahead. I expect our net interest margin to be biased somewhat lower as asset pay downs and portfolio repositioning will likely push the yield on our asset portfolio gradually lower.

On slide ten. We provide a summary of our hedge portfolio, which total $59 billion in covered 71% of our funding liabilities while our aggregate hedge position wage Lee unchanged we did continue to alter the composition and 10 of our swap portfolio. Most notably we continue to shift to Soffer index swaps long 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 secure overnight financing rate, and we had no libor-based swaps.

This transition to so for swaps drove the decline in our swap cost during the quarter the average maturity of our swap portfolio also increased again this quarter to five point three years as we added slightly longer-term swaps.

Lastly on slide 11:00 we show our duration Gap and duration Gap sensitivity adoration 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 at 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 * then 1 on your touchtone phone. If you are using a speaker phone, please pick up your handset before pressing the keys to withdraw from the question you please press star then to 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 and clearly you guys are are you know, very significantly covering it from kind of a spreading come basis and not mentioned economic return has kind of recovered the one key decline. So, you know, how are you thinking about at the dividend?

Sure, and thanks Doug for for the question. Look first of all, our priority 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 wrong business sort of like other companies, but look that said as we talked about, you know in the prepared remarks, we are really confident about the outlook for net spread and I'll rolling come home 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 see 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 pod

For investors and against this backdrop management and the board will will look at the market landscape and the earnings picture over the next several months and we'll 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, how much we you know, if we do is really just kind of a function of assessing the optimal or appropriate cushion really between expected burnings and the dividend, you know in a way that though facilitates some growth in Book value over time because we 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, you know to have as we're currently paying and comfortably as you mentioned a dividend in excess of 10% which is Thursday.

Extremely attractive in today's environment while we're building Book value, and we're buying back our stock. So that's that's a great combination, you know where we sit right now, So thanks again for the question.

Great. Thank you, very.

The next question comes from the line of those George with KBW, please go ahead real. Good morning.

You know go ahead Chris.

Okay. No, I was just going to say it's a spreads are you know certainly tighter now than they were last quarter given the outperformance of mortgages versus Hedges, you know with respect to higher wage tax given, you know, the strong performance and the prepayment environment gross are always are generally in the very high single-digits, you know, but I'd say, you know, the majority of our incremental practices have been concentrated in production coupons where you know, the gross are we for example in 30 or two's is around 11% without rules specialness butt off, you know, and then if you assume 25 basis points of role advantage that adds a little over 2% our way which you know puts the gross are always around 13% before convexity off.

Okay, great. Thanks. And then you know in terms of your the size of your TV along position, you know, I guess this quarter, you know, understandably increase what is the thoughts just in terms of you know, where that could go is this kind of the the level or things are attractive enough to just go up further. Just how do you think of that in terms of you know, the size of the Fisher project? I'd say given the environment. It's likely that a role positions going to stay in the the 25 to you know, call it Thirty billion average balance area, you know, but it is early in the corner. So that's just a a best guess based on current conditions. You know, I'd say generally speaking. It's tough to project the size of the TV a position because you know, there are going to be technical situations were roll Spike or temporarily get hit will move the the TV a position versus our pool position when there's an economic reason to do so, but you know again I'd say, um, you know based on current conditions

Which are you favorable for roll financing, you know will likely continue to carry a significant TV a position in lower coupons. The backdrop is you know is very supportive with heavy Supply wage, um from origination and you know, 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 you know production controls will trade, you know, better than long-term historical averages for for some time to come. Okay. Thanks. Let me speak and one more just on average wage and just with the book value going up, you know, just curious what your thoughts are on Leverage.

Sure. It's probably ticked down a little more, you know intro quarter or quarter to date to probably the mid AIDS but we view that as somewhat. 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 we're obviously seeing some volatility and kind of Kovac cases around the world at this point. So, you know given the the strong kind of earnings power of the portfolio. Anyway at this point it it seems so logical for us, you know to tone down leverage temporarily, you know, just in light of the potential volatility over the next month or so wage. Um, but you know, then I think we would likely, you know looked for opportunities to kind of bring it back up to let's say low to mid nines which you know, why would

Is our kind of current expected run.

right

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, you know, volatility in in rates and and markets around the election and other things.

Can you comment more specifically on you know the duration profile of the portfolio more specifically around the long end of the of the curve as opposed to sort of parallel shift. So I mean what's important is first, you know in a sense. It's not quite fifty fifty. I mean, we still have more higher coupon season specify pools that we do lower coupons, but it's getting closer. But those two kind of those two pieces of the portfolio will react very differently to Life Changes in interest rates. And and that's something that we're that we really liked about the composition of our portfolio. So we have our new local coupons which point your point or clearly going to track the seven to ten year kind of part of the curve. Whereas the higher coupons but while dead

You know in a model they they show a fair amount of duration or exposure to kind of you know, the back end of the curve for the first fifty basis points of a move. We really don't expect them to be very reactive because basically if if the back end of the curve were to sell off they benefit on the prepaid front in terms of you know, slower expectations over time and that's going to help them more than they're going to get hurt on the discounting front. So we think I am a small upward moves. Let's say sub fifty 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, you know, obviously lower coupons have to radiation and that's why we have Hedges, you know, and which we pretty well detail, but we feel like we're we're proud.

Well hedged for kind of an initial move if we were to get it in the back end of the curve. I'm focusing this discussion on the back end of the curve because I think for obvious reasons, we're unlikely to see it movement really, you know inside of five years given kind of you know, what everything we've heard from the fed and the obvious economic backdrop. So, you know big picture like as we have sold off this quarter, you know, as we mentioned earlier Book value package looks to you know to be up a couple percent as of last Friday and you know, we've seen the benefit from our Hedges. We've actually seen the higher coupon for a portion of our portfolio do very well and lower coupons tools have actually done well relative to or done. OK relative to Hedges. We've continued to see weakness in the middle. Yep.

The coupon stack like 2 and 1/2 sand 3s.

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 with the the weighted average price you bought pictures was in three q and then more generally can you come in and how you thinking about, you know, the share repurchase opportunity versus new investments into the portfolio about today.

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 not in terms of the discount to book, you know ballpark over that was in the will say upper 80s percent of book give or take so long, you know that that was noticeably higher than where we bought back stock in Q2, which was lower 80s, you know, a 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 nineties book. So that gives you a range of three different, you know time periods with you have three different kind of price-to-book spots so to speak but yep.

I mean big picture we look at you know, the overall environment. We we look at what we think in terms of what the opportunities are to reinvest, you know, kind of wage deploy capital in investments in the mortgage Market versus the discount vs the liquidity environment, but I can't stress enough that I you know for a GMC the we have so much liquidity in our mortgage portfolio in particular given the large TV a position that often when we think about buying back shares, we're not forced to to think of are we willing to increase our leverage by buying back shares? I mean, we we essentially can do that on a completely leverage neutral basis where if we buy back a hundred, you know million in chairs, we sell a billion and mortgages and and dead.

You know, everything else is neutral and we're really isolating the discount to book. So I think what investors should you know, take confidence both in what we say, but more so in a actions, which is that we're we're going to look at this logically. We're going to look at the you know, the the conditions in the market, but we're very willing to to buy back shares when they make sense and the liquidity of our portfolio affords us the ability to do that and almost any environment.

I appreciate the comments. Thank you.

Our last question comes from the line of Rick Schoen from JPMorgan, 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 terms of having to balance potential direction of rates and timing of movements. And I think realistically rep risk is is asymmetric as it's ever been during 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 dead, you know generate excess returns or what's the long-term implication and then if if that sort of framework is correct.

I think the biggest challenge for you guys is managing the timing of sort of giving up some of those access returns. How do you think about that and manage that timing risk?

Well, I think you bring up to really good points, which one is that? The cost of Hedges right now is historically very low just given birth 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 a negative then the downside of a short position, you know or app a fixed position is is much lower than it's been in the past month. We we absolutely have talked about that on prior calls, we feel that way but you you know, but you also don't want to lose track of and one thing that we are very focused on is that we are we are more concerned that mortgage spreads would widen into a rally from here and they would actual dead.

Perform reasonably. Well, like what we see in quarter-to-date in particular higher coupons if we sell off so one of the other factors that you're a quote model doesn't capture is this the the performance of of mortgages and mortgage spreads in you know, different rate moves. And so the one thing that get, you know gives us pause from let's say hedging even more than what we're doing today is the the fact that we we do believe at least for smaller upward moves wage rates mortgages, you know would perform would perform pretty well. Whereas if we were to retest sub fifty basis points on 10,000 notes for instance that environment would likely be an environment that's going to put pressure on on mortgage spreads. So we overlay that in as well into the wage.

to the overall hedging equation, but

In the end what what you see from us is a portfolio. That's that's pretty well hedged. And as you can see on our swap portfolio we put on a lot of swaps when you know near the Lowe's in in rags. I don't know Peter if you want to add any just you know, if you look at the composition of our swap portfolio, it is gradually increasing over the last couple of quarters and I would expect that to continue. We obviously only had a 71% hedge ratio now until the extent we add swaps may I mentioned this quarter we're adding longer-term swaps. I would expect are marginal swaps that we add to our portfolio maybe over time will will look to add options to our portfolio. Once we get better Clarity on the interest rate environment, but they're going to be more on the five seven and 10-year part of the curve to give us that protection against the back end of the yield curve moving cuz obviously as Gary mentioned earlier the front end of the curve is really dead.

Is really very little volatility to given the what the FED is going to do. So, you know, I think over the next couple of 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 in very helpful, and thank you guys very much. Thank you. Thanks Rick.

And our last question comes from the line of Mark of Reeves of Barclays, please go ahead.

Yeah, thanks. Could you talk a little bit more about your your prepayment expectations? And you know, what kind of risk you see from from speed accelerating if you were to see more of a compression in the primary secondary spread as Originators at capacity, which a lot of them have really been doing in recent months. Yeah. Sure. So

Chris why don't I go first and then you can you can chime in look first off while the speed the average speed on our portfolio increased down quarter-over-quarter. Um, if you look at sort of that increase on the increase in speeds in the market has really been in these cuspy coupons to and half's and threes if you actually look at our portfolio and you know, we we added, you know, we have the one-month speeds on 3 and 1/2 offs for as in 4 and 1/2 offs. You see there was like a 1 c p r increase in fours and four and half so in our portfolio from like in the case of Ford from 29 to 30, so we're not seeing a big increase in wage in those in speeds on the kind of seasoned higher coupon portion of the portfolio. So even if mortgage rates were to you know to continue to come down.

Then we do think those are sort of plateaued so to speak where you're going to see the kind of more volatility and speed. So it's going to be very much a function of the mortgage rate is in the 2 and 1/2 3 S and to some degree three and half percent coupon and you know, those are not insignificant to a certainly but they're a very very manageable component of the of the portfolio. So I think what's what's in first and foremost to keep in mind is we really do like a split between kind of a mostly twos in thirty years in lower coupons. And then the higher coupon seasoned specified pools are you know, again, we're already seeing this, you know, the the plateauing of speeds now that said, you know, I don't think there's as much room for a primer.

secondary spreads

To compresses kind of maybe a lot many or if you just look at history or look at the time period prior to you know, the pandemic wage just in that there are changes to the market servicing multiples or lower and they're going to stay lower for good reason and there, you know, 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 life. We're seeing here so big picture, I think we we expect to see prepayments pick up on on 2 and 1/2 sand threes and and in particular pick up onto and off but that's a you know, that's a coupon that we've been shrinking our exposure to so when we look at it as a whole for the portfolio, you know, yes, you have to manage speeds and yep.

There is risk of faster prepayments, but it's something like we feel that we can manage.

I hope that answered it and Chris. I don't know if you want to add anything. 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 Kane 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. Thanks again.

The conference has now concluded thank you for attending today's presentation. You may now disconnect.