Q4 2021 AGNC Investment Corp Earnings Call
This abrupt shift by the fed led to an uptick in interest rate volatility amid greater monetary policy uncertainty.
The risk of materially higher short term rates caused the yield curve flattened significantly.
With short term rates, increasing meaningfully and longer term rates remaining relatively unchanged.
Against this backdrop agency MBS underperformed in the fourth quarter as spreads to benchmark rates widened.
Most of that spread widening occurred in November and led to our negative economic return for the quarter.
Our economic return for the year, However was positive 2.9% and.
And represents the combination of our 9.6% annual dividend yield and a decline in book value due to wider agency MBS spreads.
We will likely continue to face some challenging market conditions as deferred pivots from near zero short term rates and quantitative easing to.
To higher rates and quantitative tightening in 2022.
The fed also communicated the possibility of starting.
The balance sheet reduction sooner and more rapidly than previously anticipated.
The amount and timing of this balance sheet reduction will be an important driver of agency MBS spreads going forward.
Accordingly, we will continue to operate with a more defensive position characterized by lower leverage and significant hedge protection.
We will also continue to be patient and opportunistic in our investment decisions.
In 2021 wider spreads led to a decline in our book value.
This trend continued in January with current coupon MBS spreads widening and additional 20 basis points.
As a result, our book value was down about 6% in January through last Friday.
Importantly, despite the significant move in January our leverage today is at seven and a half times in our duration gap is it a half a year.
This positioning gives us the capacity and flexibility to take advantage of attractive investment opportunities as they arise.
Today, the expected return on the production coupon 30 year MBS is in the 10% to 12% range before including the incremental benefit associated with favorable TBA dollar roll funding.
Wider mortgage spreads adversely impact our book value in the short run, but benefit our business over the longer run.
The net present value of our business can be thought of as the expected return on our existing portfolio combined with the expected return on the new investments that we had over time.
If an agency MBS investor is well positioned and enters a period of spread widening with lower leverage as we have our business benefits in two ways.
First with respect to our existing portfolio wider mortgage spreads can improve the cash flows on higher coupons specified pools.
Through slower prepayment speeds and reduced premium amortization expense.
Second with respect to our future portfolio wider spreads obviously improve the return on new investments for example.
25 basis point widening in spreads Levered eight times improves the are we on new investments by 2.25%.
So to summarize we are well positioned for the current environment.
And while challenging in the short run wider spreads are good for our business over the long run as they lead to stronger earnings and greater franchise value.
Looking at a gnc's performance over a multiyear period illustrates the value of being a long term investor and the durability of our business model across a wide range of market conditions.
Over the last three years, a GNC generated a total economic return of 25%.
During that period, we had to navigate unprecedented volatility and broad financial market dislocation is due to the pandemic.
The growth of the fed's balance sheet to close to nine trillion dollars and now uncertainty as the fed tightens monetary policy yet.
Yet despite these challenges over that time period, a GNC paid shareholders and average annual dividend of over 10% per year, while experiencing a relatively small decline in book value.
With that I'll now turn the call over to Bernie to discuss our financial results.
Thank you Peter AT&T had a comprehensive loss of 31 per share for the fourth quarter economic return on tangible common equity was negative one 8% for the quarter, reducing our total economic return for the year to positive two 9% comprised of a $1 44 in dividends per common share.
And a 96% decline in tangible net book value per share.
Our at risk leverage increased modestly during the quarter to seven seven times, our tangible equity as of year end as the reduction in our asset base was offset by the decline in our tangible net book value importantly.
Importantly, our leverage is still meaningfully below our normal operating levels.
Our unencumbered.
<unk> cash and agency MBS at quarter end totaled $4 9 billion, which excludes unencumbered credit assets and assets held at our captive broker dealer subsidiary at 50% of our tangible equity. We believe this positions us well to increase leverage to take advantage of attractive investment opportunities once market conditions stabilize.
Our net spread and dollar roll income continued to benefit from a favorable funding environment stable hedge cost and advantageous dollar all opportunities. That's despite our smaller asset base net spread and dollar roll income remained very strong at 75 per share for the fourth quarter.
Our net interest spread for the quarter declined modestly to $2, one 5% from $2 one 9% for the third quarter, but remained above our average for the year of two 1%.
Our average forecasted life CPR was largely unchanged at 10, 9% as of quarter end, while our actual CPR continued to trend lower averaging 18, 6% for the quarter compared to 22, 5% for the prior quarter.
And this trend appears poised to continue into the new year as evidenced by our most recent CPR published in January .
Assets held as of December 31, which declined to 22 months low to 16, 8%.
Lastly, demonstrating our commitment to shareholder friendly capital markets activities. During the fourth quarter, we completed $42 million of accretive common stock repurchases, increasing total accretive repurchases for the year to $257 million or 3% of common shares outstanding.
I'll now turn the call over to Chris to discuss the agency mortgage market.
Thanks, Bernie as Peter described the markets have repriced considerably over the last two months following the shift in fed policy guidance during the fourth quarter of the yield curve flattened dramatically with two year treasury rates, increasing 45 basis points, while 10 year rates were little changed as of 12 31.
Given the heightened uncertainty surrounding fed policy agency MBS underperformed interest rate hedges in Q4, However performance was heavily influenced by hedge positioning on the curve with longer term hedges, providing little benefit.
Your current coupon MBS spreads ended the year of approximately 20 basis points wider than the tightest levels observed midway through the second quarter of last year. In contrast investment grade CTX and other highly rated structured product spreads ended the year near the tightest valuations observed during 2021.
But at the end of QE approaching an increased uncertainty surrounding the pace and structure of balance sheet normalization. It is logical for agency MBS spreads to have underperformed.
Under performance intensified in January as the market reprice to the possibility of a more aggressive start to balance sheet normalization.
Given the widening that has occurred to date spreads are within 10 basis points of average levels observed in 2018, when the fed was reducing its balance sheet. Following the end of Q3 as a result current valuations are attractive both on an absolute basis and relative to other asset classes.
Fundamentals for the agency MBS markets are also strong funding markets remains deep and liquid prepayment risk is lower given the move higher in interest rates and cross sector relative value was supportive of agency MBS.
However, as Peter described given the likely headwinds on the supply and demand front, we've remained defensively positioned and we'll be patient and taking leverage higher.
The technical challenges for MBS stemmed from the combination of the uncertainty around the fed's path towards balance sheet normalization and expectations for relatively heavy organic supply and new originations of GSE eligible mortgages in 2022.
However, I want to stress that these dynamics should create an excellent investment environment for a GNC once the market fully reflects these factors.
As of quarter end, our investment portfolio totaled 82 billion down $2 billion from the prior quarter TBA dollar roll financing remains strong during the quarter and continues to provide a substantial benefit with 30 year production coupon rolls trading approximately 35 basis points through repo.
TBA Specialness, however will likely trend lower over the course of the year as the fed begins to reduce its MBS holdings.
Our hedge portfolio totaled $75 4 billion at quarter end up $2 5 billion from the previous quarter, our hedge ratio or the notional balance of our hedges relative to our funding liabilities increased to 101%.
Given the volatility and uncertainty associated with the current environment, we continue to favor a hedge portfolio that is well diversified by hedge type and by maturity. We will also continue to operate with a high hedge ratio is doing so minimize the short term debt repricing risk.
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 I'll describe in just a minute we were able to find some opportunities on the non agency front due to increased volatility in spreads in the fourth quarter.
Having said that as Chris mentioned, the credit complex generally performed quite well overall in the quarter, considering the rapidly changing landscape with respect to the fed and future policy changes.
Turning to our holdings the non agency portfolio increased modestly in the fourth quarter to $2 3 billion from $2 1 billion as of September 32021.
This increase was primarily driven by additions of highly rated private label arm B S and shorter spread duration commercial credit assets.
Within the residential private label market.
Spreads widened meaningfully on AAA securities backed by agency eligible investor loans in the quarter.
Price spread levels in November were at significant concessions to where the agency equivalent security traded.
We view this as an attractive entry point and we increased our AAA position further.
Additionally, on the MBS front certain short spread duration assets widened as investors made room for heavy new issue supply.
We took advantage of this widening and made incremental investments.
With the end of Q with the end of QE on the horizon. These shorter spread duration profiles were a good fit.
Finally with increased clarity around the CRT supply outlook, we decreased the size of our portfolio in Q4 by roughly 10%.
As we look forward, we see a solid fundamentals supporting the credit risk back in both our residential and commercial credit holdings housing continues to perform well.
Commercial real estate assets posted strong price gains in 2021 and certain segments of the commercial sector are poised to continue to benefit from inflationary tailwind.
That said potential impacts of fed policy will leave his position in a bit more cautiously in the near term.
With that I'll turn the call back over to Peter.
Thank you Erin and with that we'll now open the call up to your questions.
We will now begin the question and answer session.
To ask a question you May Press Star then one on your Touchtone phone.
If youre using a speakerphone please pick up your handset before pressing the keys.
If at any time your question has been okay, and you would like to withdraw your question. Please.
Dr <unk>.
At this time, we will pause momentarily to assemble our roster.
On the first question comes from Rick Shane with J P. Morgan. Please go ahead.
Good morning, guys and thanks for taking my questions.
Peter.
Wood provided an update on.
Book value through January Ingalls.
<unk> also put that in the context of 20 basis points of spread widening that you've seen if.
If we look at the rate sensitivity or the basis sensitivity chart.
Your book value versus the Blue.
<unk> performed expectations, what's driving that divergence and is that something that we should continue to expect that theres something doesn't mitigate the basis risk in the short term.
Thank you for the question, we're going to it's a good question. If you look at our sensitivity table.
My memory serves me correctly, the 10 basis points is worth about five 5%.
10 basis points of widening were five 5%.
And what I mentioned in a.
In January is that the current coupon head widened about 20 basis points.
All the lower coupons generally underperformed in higher coupons outperformed a little bit on a relative basis. They were still wider by five to 10 basis points, but on average if you looked at our portfolio spreads widened.
We're in the neighborhood of 11 or 12 basis points, probably on average, which still would point to a little bit of outperformance relative to that and really one of the key.
Drivers of performance in this environment is not only the composition of your portfolio, but it's also the spread duration of your portfolio one of the reasons why we like having higher coupon.
In our portfolio as it gives us a lower spread duration, a little bit less sensitivity.
So those are two drivers and the other is hedge composition and hedge position, that's really really important.
In this last in the last quarter, we had two year rates increased by about 50 basis points and 10 year rates remained relatively unchanged as Chris pointed out in his prepared remarks.
If you had us over overweight in the longer end of the curve from a hedge perspective, you really would have gotten no benefit from those hedges. So it's a combination of the assets.
Part of our portfolio, having a mix, having the higher coupons that give us less spread duration and then it's the overall hedge composition, it's going to have.
And impact on our overall performance, but youre right on average given just looking at spreads I would say our book value outperformed what that spread table would tell you.
Hope that helps great very helpful.
And then one other question you talked about the buyback and you mentioned several times that the repurchases during the fourth quarter were accretive when we think about accretion we can think about it in the context of GAAP book value.
GAAP book value tangible book value or earnings.
And I'm curious when you reference accretion which of those metrics are you referencing specifically right now and when you think about your repurchase policy one the one that drives the behavior.
Well at the end of the day, we think that our capital management activities can be a real source of value for our shareholders. So we're always looking at the market conditions, whether it's to issue stock that we believe is accretive or to buy back stock that is accretive and we look at it from an accretion perspective on a daily basis and I'll give you. An example in the fourth quarter.
We were looking at our book value everyday relative to the current stock price, that's our tangible book value as we see it in real time relative to the current stock price and when we see that at a meaningful discount that's accretive to our shareholders from a book value perspective, and clearly when we're buying back our shares that is also.
So can be accretive from an earnings perspective, but our primary measure is looking at it and making sure that those capital market activities are accretive to our tangible book value.
And worth mentioning again youre doing that on a real time basis of your royalty update what the NAV or what the book value is based on your on your marks and making that decision on a real time basis that is correct.
Okay, great very helpful. I will drop back into the queue and thank you guys alright. Thank you.
The next question comes from Douglas Harter with Credit Suisse. Please go ahead.
Hey, good morning, guys good morning.
You talked about you know continuing to kind of keep a more defensive positioning right now what are the conditions that you would be looking for to start to kind of go on a little bit of more often.
At the time as a spread level, yeah, just kind of what are what are your thought processes sure. Thank you for the question.
You're right, we continue to be really positioned fairly defensively I mentioned in my prepared remarks, even though that our leverage was seven 7% at the end of last quarter was still currently around seven five so were operating really pretty significantly below where we have operated in the past from a lead.
Average perspective, which gives us a lot of flexibility.
But the outlook, obviously, given the uncertainty certainty that we faced with the fed and in the supply outlook in the mortgage market. Our bias is that spreads are going to continue.
Bias to go to go wider maybe not meaningfully wider but we still believe they can go wider from here just to put a number on it might be you know.
Somewhere in the five to 15 basis point range is probably possible. So we want to see some clarity from the fed we want to see some stability in the overall market.
And if you just step back and you look at the agency market what are the messages that we're trying to communicate is that the agency MBS market actually it's not really good footing from a fundamental perspective right now if you look at it from just the fundamentals to fundings really good the liquidity is good absolute returns as I.
<unk> have improved quite a bit from where they were for example may of last year. So your roe's have improved 2% or 3% from from that point the relative value of agency MBS continues to look really strong the stock effect of what fed in bank's own is really significant day, one about 70%.
Of the overall market. So the tradable supply is not that great in and.
Generally speaking investors are underway those are all really positive forces and prepayments are starting to improve the headwind is a technical one that we have to sort of endure over the short run as we want to get through this as 2022 supply overhang that we're likely going to see we want.
Clarity from the fed we want to sort of understand where rates settle out in this macroeconomic environment, but when we get that clarity and I think it's not that far away.
We have a real opportunity to add mortgages at very attractive levels. So we're looking at it from that perspective is we need to get through the next several meetings were going to get a lot of clarity from the fed.
Our guess is that mortgage spreads widen some there'll be even more attractive on probably both in absolute and relative basis and once we get that sort of clarity, we will look to take our leverage up but we need a little more time I think to get to that point, so I'll pause there and let you all of them.
That's incredibly helpful. Peter So I appreciate the insights there.
Sure. Thank you.
The next question comes from Bose, George with K VW. Please go ahead.
Hey, everyone. Good morning, good morning.
Peter can you just elaborate a little more you mentioned, we could see a little more spread widening.
You guys noted earlier spreads or I think 10 basis points from where we saw in 2018. So just yet what are your expectations could be see 18 levels could we see worse.
Sure, let me start with that and then I'll pass it off to Chris who will talk a little bit about some sort of a more historical perspective, like I mentioned spreads because could certainly widen.
You know five to 15 basis points from here.
It's also important to look at how much spreads have widened over the last 13 months. If you look at just sort of collectively on average let's.
I'd say somewhere in the neighborhood of 25 basis points of widening and importantly.
As I mentioned already from where they were at the beginning of May of last year, they're probably close to 40 basis points 35, or 40 basis points. So we've seen material widening.
But if mortgages were to widen to say you know 510, 15 20 basis points for I think it would put it back in some historical ranges, Chris can talk about that.
Yes.
And as Peter mentioned, I mean were within about 10 basis points of average levels from 2018, when the fed was last running off its balance sheet I think the thing to keep in mind as you know we had a 20 basis point widening in spreads in January .
It is logical given how abrupt this shift in policy guidance was that the initial adjustment is going to be centered in the agency mortgage market. It is a deep liquid very short a bull market were hedges can easily be set against other sectors that have also benefited from QE, but.
Given the sharp under performance.
They should enjoy a fair amount of support on a relative basis versus other sectors, you know the balance sheet.
The impact from Q T will will take time I mean, its impact is cumulative it shouldnt be a 100% on day, one or even five months in advance for that matter.
And so you don't want a relative basis, we think mortgage is probably will be reasonably well supported that's not to say that they couldnt widen another five to 15 basis points, but it really depends on the.
The ultimate structure of balance sheet normalization, we're in a period of high uncertainty with respect to fed policy, the economic outlook and so we do expect elevated spread volatility and for valuations to <unk>.
Possibly overshoot fair value at times and that will provide us a good opportunity to increase leverage given our starting position, especially if if rates are settling in a bit higher against the backdrop of low prepayment risk it'll be a very attractive earnings environment.
Okay, great. Thanks, Yeah. It makes a lot of sense. Thanks, and then I guess I just wanted to ask about Gibson.
I just wanted to ask about the Specialness as well how do you expect that to trend in the back half of the year.
Ted.
Yeah go ahead, Chris.
So.
Roll Specialness should gradually week in this year.
But given the amount of float as Peter mentioned, that's tied up with the fed and banks.
Certainly persist a good deal longer than the last time, the fed was reducing its balance sheet. The speed with which you know specialness comes off will depend on a lot of a lot of factors.
That are unknown, where the caps are set relative to the level of rates on the long end will determine how quickly the quality of the float deteriorates if rates are near current levels.
And trending higher.
And the caps are set at reasonable levels. The float is going to stay clean for for a long time if on the other hand.
Long end rates rally back to sub $1 50 on tons and the caps are set at very high levels. The float is going to deteriorate a lot faster I would say your base case roll specialness trends towards 15 basis points through repo this year, which will which would be fine.
You know longer term average levels of roll Specialness is around 10 basis points in <unk>.
Even 10 basis points as compelling a prepayment risk is low and so.
It's difficult to project, but it depends on a lot of different factors, but hopefully that gives you some some guidance.
Yes, that's very helpful. Thanks, a lot.
Thank you.
Your next question comes from Kevin Barker with Piper Sandler. Please go ahead.
Thank you I appreciate all the comments around spread widening and the potential opportunity out there.
Obviously was.
It was a little more aggressive than I think the market expected I mean do you feel like the.
Maybe from a just of your own personal perspective do you feel like the fed is it's getting a little too aggressive.
Given.
What we've seen out there from an inflationary perspective, and do you feel like there's probably an opportunity that's going to emerge as we move through this year.
Where the fed is.
<unk> catch up okay great.
A much bigger opportunity to redeploy capital.
Well. Thank you for the question, Kevin and it's obviously.
A challenging question in the current environment.
I can't say, whether or not the fed is behind or not behind I think the fed believes that they are behind right now which was why they made such an abrupt shift in its monetary policy stance.
I think though you sort of have to separate what the fed's actions are into two paths and I think what the fed did it just last meeting was make it very clear that their primary tool for tightening monetary policy conditions is through the fed funds rate.
So on that front I think theyre going to began raising rates in March and I think theyre going to do that.
Very steadily in fact, there were some comments from fed members just yesterday about sort of steady increases show, having four or five rate increases in 2022 does not seem sort of out of expectations. It disappointed I think defense is going to be fairly aggressive on that front I don't believe that the terminal rate.
Has changed much from what the fed themselves have said it would be in the two to two and a half range, but I think theyre going to be more aggressive on the short term Ray front, which is one of the reasons why having a high hedge ratio is so important in the current environment.
On the balance sheet I think it's much more difficult to predict at this point what the fed is going to do in fact that chairman himself said at the last meeting that the fed still needs a couple of meetings to discuss.
But what he did communicate which I take some comfort in is how he described how he wants to run off to work and the words that are used several times, we're predictable orderly and run in the background.
And if the fed does that then I think they will set the caps at sort of reasonably can.
Comfortable levels.
And if they do that then I think ultimately they will allow their balance sheet runoff to happen sort of durably over the next couple of years, which would get give them the opportunity to get the nine trillion down to something like six trillion without destabilizing the market.
Financial markets and I think the fed is very focused on making sure that this program operate like he said in the background maintain orderly markets keep prices relatively stable. So I think they're going to lean that way a little bit more cautious on on the balance sheet tool they themselves say they don't.
Really know exactly how the balance sheet sort of works with monetary policy, whereas they know exactly what the impact from monetary policy perspective will be a short term rate. So I think they're going to focus on that and try to get the balance sheet running off in a predictable and durable way, which would be fine for us.
And ultimately I think that could lead as you say to an environment at the back end of that.
Period of you know, maybe six months, where we actually have a pretty attractive opportunity in agency MBS. So I'll pause there.
Okay and those comments are very helpful.
In your view, where do you see.
The greatest tell risk given the current.
The economic environment and the uncertainty that we see out there today is it inflation is at the fed.
I don't want to say mistake, but.
Overly aggressive fed.
What does it.
Main thing that you're paying attention to a significant tail risk.
What I would say is that.
Certainly the inflation.
Outlook and current situation with CPI at 7%.
Is becoming really problematic for the fed and obviously they are going to adjust short term rates quickly if it were to persist.
Even in the face of that there could be incremental pressure on the fed to adjust its balance sheet more aggressively. The fed has there are members within the fed who believe that balance sheet adjustment could be a more significant monetary policy tool. It could have an impact on the shape of.
The yield curve, if you were to sell assets more quickly or run off your balance sheet more quickly. So that that's the area that I think there'll be a lot of debate even within the fed as to how quickly they can run off their balance sheet. The fed themselves looks at the reverse repo facility. For example in the fact that there is a true.
Billion and a half plus dollars and that is an indication that they can reduce their balance sheet relatively quickly without disrupting the market. So.
That's the area that I think there is the greatest the greatest uncertainty because we don't exactly know how the fed is going to use that tool.
With respect to its balance sheet for monetary policy adjustment.
Okay. Thank you for taking my question.
The next question comes from Kenneth Lee with RBC capital markets. Please go ahead.
Hi, Good morning, Thanks for taking my question Hi, Ken.
I'm wondering if you could just talk a little bit more about how you think expected returns on new money investments could change, especially as the fed starts tightening and the dollar roll specialness starts to dissipate. Thanks.
Sure Yes.
I'll start and then I'll have Chris talk a little bit of it but as I mentioned, we've seen quite a bit of improvement just in sort of the base Roe.
And at the low.
Double digit ROE range. So we've seen some meaningful improvement and obviously if spreads widen further there could be some opportunities there for us and as Chris mentioned Specialness is going to remain positive.
Yes.
As Peter said.
<unk> gross returns on production coupons are in the 10% to 12% area. Currently spreads widening will will obviously help that to some degree but roll specialness will offset.
And those returns by the way.
Our without roll Specialness, but.
Within the the production coupons, we've threes are towards the higher end of that range, two and a half towards the lower end of that range.
<unk>.
But.
And hiring.
Production coupon specs are currently in the high single digits.
Great very helpful.
Just one follow up if I.
I may just on prepayment speeds I'm wondering if you could give any updated thoughts around how fast they could continue to decline as rates potentially price. Thanks.
Sure so.
Over the next couple of months.
Speeds should drop off pretty materially.
Mary rates or almost 50 basis points higher since year end.
We're also entering a seasonal low period for housing turnover speeds that'll be released in a couple of days should be down around 15% or so for.
For the fab factors down another 10% to 15% for the fed March period.
Prepayment risk is has dropped considerably current mortgage rates around $3 65 to $3 70 average note rate on the float somewhere around $3 40 to $3 50.
With only around 15% of the universe exposed to a 50 basis point incentive to refinance.
And so you know lender focus is going to shift more towards purchase related transactions and cash out refis.
Early indications.
<unk> suggests that this could also be.
A pretty big uptick in burn outs or signs of burn out for higher coupons.
Yes, so we expect to see speeds come down considerably.
Great very helpful. Thanks again.
Sure.
The next question comes from Eric Hagen with <unk>. Please go ahead.
Hey, Thanks. Good morning, a couple for me just wanted to follow up on funding funding costs and Specialness would you say there is a difference in how you hedge lower coupon TBA versus the pools.
Or does the decision to move between those purely boil down to Specialness in funding costs.
The second one as you know lots of focus.
This administration on affordable housing access to credit and such a lot of your specified pools are mostly backed by loans to lower income borrowers would probably fit into the cohort of folks that the administration is trying to help I'm curious if that plays any impact into the value you see in our spec pool portfolio going forward.
Yeah, I guess I mean on Specialness on repo funded positions versus TBA positions.
Really it comes down to just funding arbitrage between the two and what the overall backdrop is for the prepayment environment.
And.
Theres really no difference in how we think about hedging those two assets necessarily apart from our convexity differences between say a high quality specified pool.
And in a TBA.
With respect to the direction from you know that FHFA.
Is heading heading towards there's clearly a focus on affordable lending.
We weren't surprised to see the increase in pricing on.
On second homes, and a high balance loans.
We expect that they're going to continue to look for ways to subsidize.
You know more affordable lending.
Type products or borrowers.
And but I do expect that the changes will be on the margin.
I don't expect that there'll be any any dramatic shifts.
The areas that are that are most likely to be affected or are some of the lower pay up less call protected areas like <unk>.
Weaker credits.
Low FICO higher LTV.
But the call protection on those products was marginal to begin with and pay ups were already very very low.
With respect to the higher quality.
<unk> holdings in our portfolio.
I would describe them not not as much I mean, there is certainly a correlation between loan balance and income.
But our holdings are heavily concentrated in other sectors as well like certain geographies like New York.
And certain other geographies that tend to have better a better convexity profile and so again I think the I think the impacts are going to be marginal.
I don't the direction is clear towards affordable lending and weaker credits but.
I don't expect them to I don't expect there to be dramatic changes there that have materially changed the.
The prepayment profile on higher quality specs.
That's helpful. Thank you.
The next question comes from Trevor Cranston, with Jay and Keith Securities. Please go ahead.
Alright, Thanks Trevor.
Trevor.
Good morning, a question on the hedge side could.
Could you talk a little bit about how you are.
Thinking about the shape of the yield curve evolving.
As the fed begins tightening this year.
And also maybe provide some commentary on how occur.
The curve flattened or would impact the portfolio as opposed to the parallel shift that's shown in the standard duration tables. Thanks sure.
Yeah. Thank you for the question and I think it's an important one as I mentioned in the current environment I've talked about this on the last call and I think this is going to continue to be the case I think we're going to continue to see a lot of yield curve volatility as the market.
Sort of re prices along and against what the fed is doing in terms of tightening monetary policy and obviously, we don't know to the extent that they pull forward and move more aggressively that would sort of indicate that there would be a bias toward a flattening, but we also have to see what happens with respect to the macroeconomic environment and what.
<unk> is doing and whether or not the market believes that the fed is in front of it and going to control it or actually behind it in which case to curve could move into Bakken rates could go higher so from a hedge perspective that creates a lot of challenge for us. What we've done is we've continued to sort of concentrate our hedges.
In the intermediate part of the curve, which I think is really important in this environment what tends to happen is from two years to say seven years that part of the curve will tend to lead the rate increase.
That certainly was the case, so far with now 10 year rates going up but then it sort of stabilizing it at 180.
Our portfolio has about 45% of our hedges our hedge portfolio about 45% of our hedges on the intermediate part of the curve only about 20% in the two to three year range and about 30% in the in the backend. So we're going to continue to move our hedges around as we see this playing.
But it's going to be a challenge and it's going to be also a driver of overall overall performance, but what we're trying to do with our hedge portfolio is stay really well diversified across the curve have a concentration in the intermediate part of the curve have our hedge ratio be close to 100% and now keep our duration gap.
GAAP fairly contained our bias is that rates are going to go higher but the curve movements could be significant and thats just something that we're going to have to work through over the next few few quarters.
Got it okay. That's helpful. Thank you sure.
And our last question comes from Mark Brown with Barclays. Please go ahead.
Yes. Thanks, just one question for me could you talk about.
Where you could see leverage going once you get to this.
A more stable environment, where spreads have widened out and you've got less less rate volatility.
Sure.
We have a lot of capacity.
We've talked about this in the past if you just look at our current leverage versus historical leverage we could certainly comfortably operate eight and a half 995 times leverage.
One of the real benefits that we have from a capital perspective is our Bethesda securities subsidiary that gives us tremendous amount of capital flexibility.
And has freed up a lot of excess capital Bernie mentioned in her prepared remarks today, we are still operating with <unk>.
Five ish billion of unencumbered equity. So we have a lot of a lot of capacity and a lot of room to be able to operate easily in the eight five to nine five times range, which would really be significant from an earnings perspective from from the jump off point here at seven and a half you think about where.
We're operating in we know we have been operating here.
For multiple quarters, we're still able to generate really attractive earnings our existing portfolio is really strong our hedge position.
<unk> is really strong so we're able to have great earnings in the current environment and still be operating with a relatively low leverage point. So we have the opportunity and I think we will over the next couple of quarters to be able to take advantage of this environment once the market sort of finishes at three.
Pricing to the current fed environment, so, but we have I think we have significant capacity to move move up in leverage.
Okay.
And then one more question if I may have missed this maybe a tough one to answer but how do you think about what normalized ROE is or for the agency business.
It's hard to answer because the fed obviously for most of the last decade has been artificially depressing returns.
Because it feels like we've been in QE for as long as I can remember.
But how do you think once they removed themselves from the market, where we eventually settle out in terms of what Levered returns can be.
Yes, it's a great. It's a great question.
If you look back over the last three.
13 years to fed has basically been involved in the market and about nine of the 13 years.
So we've really come to.
Have a market that the fed is basically and a lot of ways taken ownership of whether it's on the funding side they've done some dramatic things there that are beneficial to our business and the fed has clearly demonstrated a willingness to step in and stabilize both the treasury and agency MBS market in times of distress as a levered.
Or that is a very significant positive for us, but because the fed has participated so long youre right that all other things equal that sort of would put downward pressure on spreads, but I still believe that the agency MBS market from a levered investor perspective can consistently generate.
Low double digit Roe.
Even taking into account the feds participation and if you look back at spreads over the last 13 or 14 years and returns over that time period at the tightest. They have been in the high single digit range, maybe 789% <unk> and at the wide as they've been in the mid to <unk>.
High teens, so I think they settle out in the in the low teens, which is very supportive of our business model, meaning if you can operate with eight or nine times leverage.
Taking into into account the cost of your business that should translate into supporting a dividend.
Obviously is lower than that but still very very attractive and if you look at our dividend today.
Based on the current stock price at around nine 5% I think that the agency MBS market can be very supportive of a dividend in that level.
Okay, great. Thank you.
Alright.
This concludes our question and answer session I would like to turn the conference back over to Peter Federico for any closing remarks.
Thank you operator, and thank you for everybody for your participation on the call today, we look forward to talking to you again at the end of the first quarter.
Okay.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.
[music].
[music].
[music].