Q3 2021 AGNC Investment Corp Earnings Call
Good morning, everyone and welcome to the Aegean Sea investment Corp, third quarter, 2021 shareholder call.
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At this time I'd like to turn the conference call over to Katie Wisecarver in Investor Relations Ma'am. Please go ahead.
Thank you all for joining a GNC investment Corp's third quarter 2021 earnings call before we begin I'd like to review the Safe Harbor statement.
This conference call and corresponding slide presentation contains 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 a GNC.
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 AGN see its periodic reports filed with the Securities and Exchange Commission.
Copies are available on the SEC's website.
C C dot Gov, we disclaim any obligation to update our forward looking statements unless required by law.
Participants on the call include Peter Federico Director, President and Chief Executive Officer.
Bernie Bell Senior Vice President and Chief Financial Officer.
Chris Kuehl Executive Vice President and Chief Investment Officer.
Aaron Paas senior Vice President of non agency portfolio management.
And Gary Kain Executive chair with that I'll turn the call over to Peter Federico.
Thanks, Katie and thank you to everyone on the call today, we are very pleased with our third quarter financial results.
Economic return for the quarter totaled 2.3%, while net spread and dollar roll income came in at 75 cents per share in line with the previous three quarters.
Our economic return for the year is now, 4.7%, which I believe speaks to the strength of our business model given considerable interest rate volatility elevated prepayments speeds spread widening and the fed's progression toward asset tapering.
The message that we communicated last quarter was one of cautious optimism and a desire to maintain portfolio flexibility.
We identified several risks that shape, the agency investment landscape, including uncertainty with respect to the timing and duration of fed tapering.
Two way interest rate risk and elevated prepayments fees.
In the third quarter, there were positive developments regarding each of these risks with respect to asset tapering.
As anticipated timeline is now known and market expectations are well aligned.
Under this approach the fed will purchase close to $200 billion of agency MBS between now and July of next year.
Once tapering is complete and this is a very important point the fed will continue to buy billions of dollars of agency MBS on a monthly basis as they reinvest the paydowns on their existing portfolio.
The Fed's reinvestment program will likely continue for a significant period of time and should be a positive technical for agency MBS.
The interest rate and prepayment environment also improved in the third quarter with intermediate and longer term rates increasing late in the quarter.
Primary mortgage rates are now about 40 basis points above the February low of two 8%.
This increase in rates should lead to a more benign prepayment environment and lower supply.
Taken together greater clarity from the fed higher interest rates and slowing prepayment speeds create a more favorable backdrop for agency MBS, particularly given the spread widening that has already occurred.
And while some spread volatility as possible during the tapering cycle, we do not expect significant widening as agency MBS already look attractive relative to other financial assets, which still trade at or near historically tight levels.
Projected returns on new investments were relatively unchanged during the quarter.
Lower coupon TBA is continue to offer the most attractive return at around 12%, including the additional benefit from favorable dollar roll funding.
Returns on higher coupon MBS. Meanwhile, remain in the high single digit range.
Spreads on most non agency securities remain historically tight keeping expected returns on these investments in the mid single digit range as such Levered positions in agency MBS continued to look compelling on both an absolute and relative basis.
Well the outlook for agency MBS has improved relative to last quarter. There is still considerable uncertainty with respect to the broader economic and interest rate environment.
Most notably inflation measures are elevated and supply chain shortages and disruptions appeared to be intensifying and more widespread.
At the same time, the employment outlook appears to be poised for strong growth in the coming months as job vacancies outpaced job seekers unemployment benefits returned to normal levels and wages increase.
As a result, the feds transitory inflation narrative could become increasingly difficult to defend.
If inflation pressures persist or intensified further there is a risk that the market and the fed lose confidence in this view.
In this scenario expectations with respect to fed actions could become increasingly difficult to predict.
Given this macroeconomic uncertainty we continue to favor operating with a more conservative risk profile.
Looking ahead, we believe we are very well positioned for the current environment with a well balanced asset portfolio significant hedge protection and leverage at around seven and a half times.
Together this position gives us considerable flexibility to take advantage of attractive investment opportunities as they arise with that I'll now turn the call over to Bernie to discuss our financial results in greater detail.
Thank you Peter a GNC had total comprehensive income of 37 cents per share for the quarter.
Economic return on tangible common equity was 2.3% comprised of the Tucson increase in our tangible net book value of 9% annualized dividend yield for the quarter.
So far for October we estimate our tangible net book value is up marginally.
Consistent with our decision to operate with lower risk in the current environment, our at risk leverage declined to 7.5 times, our tangible equity as of September 30th.
We attribute this positive performance to a very strong funding environment stable hedge cost and favorable TBA dollar roll opportunities, which drove a 10 basis point increase in our net interest spread to 2.19% for the quarter.
Our forecasted life CPR decreased to 10, 7% as of quarter end due to changes in portfolio composition and higher interest rates, our actual prepayment rate for the quarter also trended lower at 22, 5% compared to 25, 7% for the prior quarter.
Our most recent prepayment rate published this month for assets held as of September 30th decrease to a post pandemic low of 19.8 C. P. R.
Lastly, our unencumbered cash and agency MBS at quarter end increased to $5.2 billion.
Which excludes unencumbered credit assets and assets held at our captive broker dealer subsidiary importantly, as Peter noted our strong liquidity position at 51% of tangible equity gives us considerable flexibility to opportunistically increase leverage.
With that I'll now turn the call over to Chris to discuss the agency mortgage market.
Thanks, Bernie during the third quarter the economy continued to make progress in the fed did a good job setting the stage for an official announcement at the upcoming November meeting that it will soon begin to slow the pace of balance sheet growth importantly, the solidification of the timeline for tapering was achieved without market disruption in sharp con.
<unk> what happened in 2013.
Interest rates were modestly higher with five year, and 10 year swap rates, increasing to eight and seven basis points, respectively. However, there was significant intra quarter volatility with the Delta variant concerns driving 10 year yields down to 117 basis points in early August before selling off to end the quarter at nearly 1.5.
5%.
Fixed income spreads were relatively stable quarter over quarter with credit remaining near historical types within the agency MBS sector higher coupons outperformed as interest rates drifted higher and actual speeds continued to show signs of prepayment burnout.
Over the near term the prepayment backdrop will likely continue to benefit from slowing seasonal factors and the move higher in rates since quarter end.
Lower coupon MBS modestly underperformed hedges as the fed prepared the markets for tapering.
It is anticipated that the fed will deliver the official tapering announcement next week and to reiterate we do not expect a repeat of the taper tantrum where spreads widen materially.
The funding markets for agency MBS remain incredibly deep and liquid prepayment risk is trending lower and cross sector relative valuations continue to be supportive of agency MBS.
And so while we do anticipate an increase in volatility with an active fed spread widening events will likely be shallow and provide us with an opportunity to increase leverage.
As of quarter end, our investment portfolio totaled just over 84 billion down 3 billion from the prior quarter and our asset composition was largely unchanged with interest rates modestly higher quarter over quarter. Our hedge portfolio was also relatively unchanged at 73 billion in covered 98% of our funding.
It is our swaption portfolio now totals 13 billion and provides significant protection in the event that longer term interest rates move meaningfully above 2%.
Our duration gap at quarter end with 0.4 years little changed from the prior quarter.
In the current environment, we continue to favor a slightly positive duration gap given that we expect agency MBS to trade to relatively short durations likely underperforming in a rally scenario and outperforming and most higher rate scenarios I'll now turn the call over to Aaron to discuss the non agency markets.
Thanks, Chris I'll quickly recap the quarter and provide a brief update on our current positioning.
As Chris mentioned credit spreads were mixed during the quarter and remained near post great financial crisis tights at <unk>.
Current spread levels, we would expect that future returns will be generated primarily from carry as opposed to further spread tightening.
Turning to our holdings the non agency portfolio increased modestly in the third quarter to $2 1 billion from 2 billion as of June 30, 2021.
The themes I mentioned in Q2 with respect to our portfolio activity generally continued.
We continued to rotate a portion of our CRT holdings into lower credit tranches, which we believe will enhance the return profile of our CRT portfolio based upon the underlying strength in the residential conforming mortgage market.
And then on the C N B S front, we were able to find some attractive investment opportunities in single asset single borrower deals.
Lastly on the RMB S side, we increased our position in AAA private label Securities.
Looking forward the CRT supply backdrop has shifted favorably as Fannie Mae has returned to the market.
Just last week Fannie may price their first deal since Q1 2020.
While issuance plans for 2020 to remain unclear there will undoubtedly be more supply.
Over time should lead to more attractive investment opportunities.
That said recent transactions have included a five year call option that allows the GSE used to extinguish their credit protection at that time.
This option will somewhat limit total return potential for bondholders.
Lee I'll quickly touch on the non agency repo market.
There continues to be meaningful competition to lend against non agency securities, which is reduce reduce both repo costs and haircuts at quarter end, our average borrowing costs have declined to 72 basis points over LIBOR.
Although the tightening and repo spreads has lagged the compressing that asset spreads. It certainly has been a favorable tailwind with that I'll turn the call back over to Peter.
Thank you Aaron with that we will now open the call up to your questions.
Yeah.
Ladies and gentlemen at this time, we'll begin the question and answer session.
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Our first question today comes from Kevin Barker from Piper Sandler. Please go ahead with your question.
Good morning, Thanks for taking my questions.
It seems like the tone has shifted where you're at.
<unk> seen a much more proactive in an increasing leverage here in the near future, especially.
Some of the fed's actions.
Are you seeing significant opportunity to start to develop especially in the near term or do you expect that leverage to really increase I guess, everyone you know.
Coming months or coming quarters. Thank you.
Sure Good morning, Kevin and thank you for the question what I would say is first let me sort of give you some perspective of where we were and where we think we are now if you think back to last quarter. When we talked about our leverage position I sort of described it as being in the sweet spot at seven and a half times, meaning we could take it lower if we expected.
Mortgage spreads to widen further in there to be volatility around the tapering or take it up opportunistically and as it turned out in the third quarter things stabilized quite a bit and the way I would describe our position today, we're still at around seven and a half, but like we've seen much less downside risk in the agency MBS market there.
Could be certainly spread volatility in the taper in cycle, but and spreads could in fact widened further but any meaningful widening we think will be met with strong investor demand, particularly because of that.
C N B S look so attractive relative to other asset classes and the cheapening I think will be really quickly bought so the way I would describe our position today is that we are more optimistic and more favorable with respect to the agency landscape and all other things equal I do expect our leverage to increase.
Over time.
If you think back to where we operate it's sort of on a historical basis. It was really be more something like eight and a half times 10, nine and a half close to 10 times would be a more normal operating range in an environment, where we are optimistic about agency MBS as well as the interest rate environment and that's the one piece that were.
Still tried.
<unk> tried to communicate in our prepared remarks, we're still a little cautious about the macroeconomic environment. Because there are a lot of moving pieces right now the fed has.
A lot to do with respect to its inflation in it and its employment and there could be potentially.
Potentially more interest rate volatility, so we're being cautious in our and our leverage position, but all that said we.
We do expect it to improve and increase over time, but we're gonna do so really deliberately really measured.
And really try to be opportunistic with our with our investment choices and we think we have the ability to do that we're in a strong earnings position right now.
So we have a lot of upside, but we want to be patient with our investment decision.
Okay, and then just a follow up on some of your prepared comments and correct me if I'm wrong, but.
It appeared that you were.
We expect more of the incremental economic return for shareholders to be driven more by dividends or earnings versus book value am I interpreting that correctly or how should your prepared comments yeah. It's an interesting observation what I would say is if you look back at last quarter, which is a great example of I think what you just described in an environment where.
Our book value was really stable just a slight positive essentially all of our economic return was driven by a 9% annualized dividend. So that's very positive and generally speaking we we are seeing more stability in book value from agency spreads right now that continues to be the case.
Into October here.
You know as Bernie mentioned in her prepared remarks, our book value was slightly positive as we sit today, it's it's probably up around a half a percent maybe a little more than a half a percent in October because mortgage spreads again have been stable higher coupons have outperformed slightly so again.
If that were the case and your conclusion would be right that the majority of our economic return will be driven by the return of our dividend.
Okay. Thank you for taking my questions sure. Thank you.
Yeah.
Our next question comes from Bose George from <unk>. Please go ahead with your question.
Yeah. Good morning, just wanted to follow up on your comments about TBA.
Sorry, just your comments on spread widening and the taper starting that is likely to be modest and then could you quantify that a bit I mean is it like 10 to 15 basis points do you think is where it could be met with strong demand or just curious where you think you know how do you think that plays that yeah, Hi, Bose good morning.
Interesting question and the answer is we don't know.
But if you look back historically mortgage is still do look tight on a historic basis, you could make the case that if you look back to previous cycles, maybe they could be 25 basis points wider but we don't think that 25 basis points would be the right number in the current environment given where.
Other returns are given the interest rate environment, given asset valuations generally speaking we think that.
You know the right level for mortgages is here or maybe slightly wider but but again, it's too soon to tell and we don't know how it's all going to play out.
But at the end of the day the key for the mortgage market is not only the fed being really patient and deliberate in the way. Its tapering. It also will be driven a lot by what the fed does once the tapering is done in their reinvestment policy and.
You've made some comments on that but generally speaking we think the fed is going to be reinvesting pay downs for a considerable period of time.
And that's going to be a really positive technical for the mortgage market. In addition, if you think about it if we're right in the economy recovers and rates are higher that means there's going to be less supply of mortgages.
At the same time, the fed will continuing to buy a lot of mortgages to replace its run off so the environment could shape up shape up pretty well for the mortgage market, but that's going to have to unfold over time.
And then of course, we think just generally speaking mortgages from other investors perspectives are relatively underweight. So I think theres going to be a lot of demand for agency MBS. So there could be some spread widening but we don't expect it to be anything like we saw in previous cycles.
Okay, Great. That's helpful. Thanks, and then just switching over to TBA.
Level of Specialness, how does that look so far in the fourth quarter and just looking out into next year, especially given what you mentioned with the fed how do you think TBA Specialness will look next year sure I'll have I'll have Chris give you some more details on that but just generally speaking we expect that to remain.
Really fairly attractive through 2020 to Krishna.
Sure. So you know rolls traded very very well during the third quarter. They're currently trading around negative 30 basis points in the case of twos, and two and a half which represent the vast majority of production in 30 days or so.
30 basis points. So it's roughly 40 to 45 basis points of Specialness versus repo and as Peter said despite tapering.
The technicals are likely to remain strong.
Well implied financing rates will likely.
Trend a bit weaker I think they'll continue to trade well through.
Long term historical averages for quite some time and given that it's you know I'd say, it's likely our roll position will stay.
Elevated in the $20 billion to $30 billion range, probably towards the upper end of that range. The backdrop for the rural markets incredibly supportive even with tapering.
You mentioned earlier, the fed is likely to add 180 billion in mortgages on a net basis between now and the middle of next year.
And if if QE three can serve as a guide the fed will likely continue to reinvest runoff well into the next rate hiking cycle.
Which following QE III took nearly three years before the fed started tapering reinvestments and so even after the fed stops growing its balance sheet by the middle of next year, it's likely they're going to continue to take out probably $40 billion to $50 billion of the worst to deliver from the Florida each month.
Just through reinvesting paydowns, but obviously depends on the level of rates and prepayments.
But theyre probably going to continue doing this well into the next rate hiking cycle and that's an incredibly important dynamic.
For the market I mean prior to QE the market's never enjoyed a consistent take out of the worst to deliver bad worst to deliver flowed month after month with this sort of consistency and magnitude and so we think Roes are going to continue to trade through historical averages for quite some time.
Okay, great. Thanks, that's helpful.
Our next question comes from Doug Harter from Credit Suisse. Please go ahead with your question.
Thanks, Peter hoping you could talk a little bit about how you're approaching hedging the portfolio given given the comments about the potential inflationary concerns and risks to rates.
Sure.
Well first of all I think this is an environment from an interest rate perspective, where you're going to see us continue to be really active on the hedging side. Both in terms of the amount of hedges, we have and as you. All know were operating close with 100% hedge ratio and a relatively small duration gap, we're going to continue to keep our interest rate risk profile.
Well managed and in low by historical standards.
Because of the potential interest rate volatility in the interest rate environment that we may be in.
But the other important point is to think about our overall hedge portfolio relative to the composition of our asset portfolio. We're going to continue to have a well balanced asset portfolio between lower coupon TBA and generic MBS and higher coupons those two instruments sort of have different hedging needs and you.
You can see how our overall hedge portfolio sort of has has developed along those lines. If you look at our hedge portfolio now, it's really well sort of balanced across the curve from a duration.
Perspective about a third of our hedges are in the I call. It the three to five year sector, a third in the five to seven year in AR and a third in the seven to 10 year sector. So we're well balanced across the curve, which I think is important you've.
<unk> seen us increase the optionality in our hedge portfolio and that really gets to if we're going to be in an environment, where interest rates volatility increases we want to have more option based hedges and our mix as Chris mentioned, we added.
Quite a bit of optionality to our portfolio replace some some swaption and added some other swaption, it's close to around 20% of our hedge mix. So overall, that's the kind of thing that you'll see US do is continue to likely to add options maintain a high hedge ratio and if I had to pick a point of the curve if there.
There is a lot of interest rate volatility and if there if we're right that there is some some question around the fed in its rate moves they'll likely part of the curve that will be most negatively impacted by the middle of the curve right around the five year part of the curve and so.
Year part of the curve for example has underperformed this quarter to date.
So you'll see us likely use that part of the curve from a hedging perspective, a little bit more in an environment like we may be and what the fed so those would be the high level comments with respect to our hedging approach.
Great and then just following up as you were talking about portfolio construction.
Yes almost.
You.
You know whenever it may be.
TBA Specialness kind of normalizes and I guess, how do you think about portfolio construction the mix between kind of TBA.
<unk>, you know kind of in that environment.
You know kind of whenever whenever that might be.
Yeah, well first off I think that that's.
A ways away.
As Chris mentioned I expect us to have a sizable TBA position given the outlook that Christian gave with respect to especially in this well into 2022 and maybe into 2023. So I think we're a long ways away from that and I think that the the movement down in specialists will be gradual.
It does start to happen, but as you recall there is typically always some level of specialness.
Between the T V. A N a non balance sheet pool, and you know historically, it's probably 10 to 20 basis points not the 50 that Chris just described so there is always some benefit but then of course, there's the trade off between the incremental returns that we pick up from the TBA and the underlying characteristics that we might be getting to.
<unk>.
That's just described that as being very favorable over the long run that's really the question that we have to make from a portfolio perspective, when we have to sort of make that on a real time basis.
So I can't really sit here today and say how the portfolio composition will change that far forward, but at the end of the day, we're always looking at those variables. We're trying to give ourselves the best diversified portfolio will give us the greatest book value stability over the greatest range of rates and give us the ability to generate the best carry we can.
Can for our shareholders. So that we can generate the best economic return we can.
Makes sense. Thanks, Peter sure. Thank you Doug.
Our next question comes from Eric Hagen from <unk>. Please go ahead with your question.
Hey, Thanks, good morning, so if mortgage rates just.
Good morning, with mortgage rates, just over 3% right now premiums for higher coupon spec pools appear to have held up pretty well I guess the question is what kind of sensitivity you envision there.
We're looking at mortgage rates pushing higher.
And then can you also share the kind of mark to market sensitivity of those bonds might carry at the short end of the curve.
Yeah, sure Eric Crystal, Chris I'll take that and I'll chime in yeah, so with respect to higher coupon <unk>.
Seasons back say you know the the important thing is that prepayment burn out has been a pretty consistent theme now for the last several months and given that we think.
Valuations look fair.
Plus or minus 25 basis points durations. These bonds should continue to trade to pretty short durations theres still price too.
To fast prepayment speeds, which means that they have a fair amount of upside.
You know into into higher rates and so for that reason.
Peter mentioned these positions really complement our lower coupon holdings, well given that they'll benefit in some of the scenarios that are more difficult for lower coupons steeper curve higher vol.
Wider par coupon spreads in the positions effectively help flatten the convexity profile of the mortgage portfolio.
Eric what I would add to that is you know.
What we're seeing in the current environment as Christa described gradual improvement in the prepayment outlook and were seeing burn out start to reveal itself and we expect that to continue.
But we're also seeing the price changes of higher coupons reflect.
Just sort of progression through the prepayment environment.
Positions him as you well know have been prepaying exceedingly fast for now five quarters, but each each month and each quarter that we sort of move past another high prepayment speed.
The price of those securities are improving we saw that last quarter as far as any higher coupon prices went up as we sort of put another.
A fast prepayment speeds behind us those positions are not carrying if you will.
The current yield on those positions at a 30 CPR is not very attractive.
So each quarter that those prepayment speeds past the prices are improving we expect that to continue and then just to sort of round. This out to your point about the hedging.
That was why I made the comment with respect to the composition of our portfolio and having a significant significant amount of our hedges on the shorter end of the curve sort of the three four year five year part of the curve those hedges give us a lot of protection against this position as well as operating with a positive duration gap to give us some protection against mortgages underperform.
And a downrate scenario, so I hope that answers your question yes.
Yes that was really helpful. Maybe a quick follow up on the on the conversation around burnout and speeds more generally can you can you guys share how you incorporate expectations for home price appreciation and modeling prepayment speeds.
Yeah, I think the I mean with mortgage rates.
Having increased well off the lows I think we're going to start to see focus on cash out refis and.
From some of it just given some of the excess capacity in the market and from the house price. The accumulated house price appreciation is a great thing from a mortgage investors perspective in that housing turnover.
Materially improves the convexity of our mortgage position into higher rate levels and so.
It could be a positive.
From a risk management perspective.
Rates continue to move higher.
In that we should still continue to expect reasonably fast turnover.
Good stuff. Thank you very much.
Take care.
Our next question comes from Trevor Cranston from JMP Securities. Please go ahead with your question.
Alright. Thanks.
One one more question around the taper.
You guys talked about some of the macro uncertainties that are out there.
Do you think there's any risk at this point that the fed could change.
Taper timeline from from what the baseline expectation is now.
Increasing concern about the level of inflation.
And if there were to be a change in the timeline I'm curious how you think the market would be able to digest that.
Yeah, It's a good question Trevor.
And the answer is obviously, we don't know I think the fed has.
Ben So clear in its communication with what its preferred approach would be if you think back to where we were in in the second quarter. There was a lot of fed discussion within the fed.
Some in the fed wanted a faster taper and timeline for months or for meeting some wanted to do what they did last time and they seem to have settled the compromised position seems to be an eight month approach, but I think the way to end.
And they sort of indicated at this point, they're ready to lift off and initiate so I would be surprised if they didn't do that.
Of course with an eight month approach they do have the flexibility in that time period to either slow it down or to accelerate it I I'm sure, they're not going to commit.
But maybe just give us the indication that that's the direction. They want to go if they commit that would be great. I think first it's the stability of the market, but I don't think they would do that I think they would retain that optionality and so youre right. There is always a risk of <unk>.
Of that and ultimately that could create some volatility that's why we are still a little bit cautious and we think that it could present some.
Attractive opportunities to add investments at that at that period of time, but then the flip side of that is even if they do accelerate it going back to the point that Christa just described they are going to reinvest cash flows at that point so.
In the end, they're going to buy a lot of mortgages next year, they're going to grow their balance sheet.
And they're just gonna net add a lot of mortgages and maintain that balance for some period of time, that's really I think going to be where the interesting dialogue starts to develop next year is how long does that reinvestment period last and we're just gonna have to wait and see but we think it will be substantial.
Okay that makes sense.
I think all the the rest of my questions have been asked and answered. Thank you. Thank you.
Okay.
And our next question comes from Rick Shane from Jpmorgan. Please go ahead with your question.
Hey, guys. Thanks for taking my question.
Most of them really have been asked and answered but I.
Just wanted to delve in a little bit on what we.
We should take from the hedging.
Actually the tactical moves in terms of hedging.
During the quarter.
You increased the swaption position as you mentioned as you reduce the treasury short modestly kept the swap position flat.
I think that what that suggests is that your view is that rates are going to be lower for a bit longer.
But still ultimately strategizing for.
A more hawkish fed and higher rates.
Yeah, you know if you go back and you look at we've made some fairly substantial changes to our hedge composition. If you think about where we were at the beginning of the year at the very beginning of the year, we added a lot of longer dated hedges.
They gave us a lot of benefit in the first quarter, because we were worried about the yield curve Steepening and then of course, we had the opposite effect in the second quarter with the yield curve flattened I still think that there is.
A reasonable amount of volatility with respect to the shape of the yield curve, obviously as the fed and the market pulls forward or moves back short term rate increases that's going to have an impact on the shape of the curve. So you've seen us sort of balance out our curve position and if anything.
Our hedge portfolio today is biased to generate a little incremental value in a flattening type scenario, which gives us sort of a more of a macro business hedge.
And and to your point.
While we do think rates are going to be reasonably stable. There is a bias. It from our perspective now that rates will be higher not lower they certainly seem to be comfortable in the one and a half to say for example, 2% range on the 10 year, that's a really healthy place for if they do stabilize in that.
Range that'll be a really healthy place for the agency MBS market for them to sort of level out at we'd be very pleased with that cause I think mortgages performed very well in that scenario, but.
Compared to last quarter, when we talked about two way risk, we see a lot more up risk exposure now, but again gradually and finally, the reason that options give us so much protection.
Options are always good for outsized moves.
Our option portfolio today at 13 $13 billion.
Has a strike of less than 2% at around 1.87%. So there could be a significant amount of value generation from those options. If over time the economy really does take hold which we believe it will and the fed does have to become active interest rates will be higher in those options.
We will give us a lot of a lot of protection against outsized moves so you'll see us continue likely to increase that position us well over time.
Got it.
From your perspective is the environment. We're in now from a hedging perspective, a little bit easier you've got you have less concerned about spreads widening at this point.
You have more to your point.
M a.
You know.
A skew towards higher rates.
As opposed to sort of a binary or a two way market ghansham. It's early I apologize.
But you understand my point is just feel a tad easier to manage the risk at this point.
Well I would like to say, yes, but there's one caveat to that which I think is a challenge which is there could be more volatility in the shape of the curve. So hedged location is a little bit more challenging if you think about what could happen.
As the market prices the fed's reaction function it'll have a lot of impact on the shape of the curve if the market thinks that the fed.
Is behind on its inflation objective and slow to react to yield curve steepened significantly.
And so you'd want to have your hedges in that part of the curve. Conversely, if the market thinks that the feds behind on its inflation and that theyre going to take actions quickly and pull forward rate moves. It's gonna have a flattening effect on the curve. We've seen that just unfold in the last 30 to 60 days with curve movements like that so.
That's the one part that makes it challenging so that's where you have to be a little bit more active in your hedging in terms of moving hedges from one part of the curve to the other in order to generate some incremental value. That's the that's the challenging part is the market pulling forward or moving back rate moves and that could be that could be the dominant question.
In 2022.
That's really helpful. Thank you so much sure alright. Thank you so much for it.
And ladies and gentlemen, with that we'll be ending today's question and answer session I would like to turn the floor back over to Peter Federico for Federico for any closing remarks.
Thank you that concludes our third quarter call. We appreciate everyone's participation on the call today and we look forward to speaking to you again next quarter. Thank you very much.
And ladies and gentlemen, with that we'll end today's question and answer session and today's conference call. We do thank you for attending you may now disconnect your lines.
Okay.
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