Q1 2023 AGNC Investment Corp. Earnings Call
Speaker 2: Good morning and welcome to the AGNC Investment Corporation first quarter 2023 Shareholder of this organization suggested a model 170 bothering somebody was 218 and 300 members were
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Speaker 2: I would now like to turn the conference over to Katie Wisecarver and investor relations. Please go ahead.
Speaker 3: Thank you all for joining AGNC Investment Corps' first quarter 2023 earnings call. Before we begin, I'd like to review the Safe Harbor Statement.
Speaker 3: This conference calling corresponding slide presentation contains statements that to the extent they are not receptations of historical fact constitute forward-looking statements.
Speaker 3: within the meaning of the Private Security's litigation reform act of 1995.
Speaker 3: All set for the few statements.
Speaker 3: Our intended V subject to the Safe Harbor Protection provided by the Reform Act.
Speaker 3: Actual outcomes and results could differ materially from those forecasts due to the impact of many factors beyond the control of AGMC.
Speaker 3: All four looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice.
Speaker 3: Certain factors that could cause actual results to differ materially from those contained in the forward looking statements.
Speaker 3: are included in agency's periodic reports filed with the Securities and Exchange Commission.
Speaker 3: copies are available on the SEC's website at SEC.gov.
Speaker 3: We disclaim any obligation to update our forward-looking statements in less required by law.
Speaker 3: Participants on the call include Peter Federico, Director, President, and Chief Executive Officer.
Speaker 3: Bernie Bell, Executive Vice President and Chief Financial Officer.
Speaker 3: Chris Cuell, Executive Vice President, and Chief Investment Officer.
Speaker 3: Aaron Paz, Senior Vice President, Non-Agency Portfolio Management, and Sean Reed, Executive Vice President, Strategy and Corporate Development.
Speaker 3: Aaron Paz, Senior Vice President, Non-Agency Portfolio Management, and Sean Reed, Executive Vice President, Strategy and Corporate Development. With that, I'll turn the call over to Peter Federico.
Speaker 4: Thank you, Katie. The performance of agency mortgage-backed securities in the first half of the quarter was very strong, continuing the positive momentum that began last November . This led to a notable increase in our net asset value through mid-February.
Speaker 4: These favorable conditions, however, gave way to a more challenging investment environment in the second half of the quarter as regional bank instability dramatically altered the macroeconomic and monetary policy outlook and led to a material increase in interest rate volatility.
Speaker 4: and rapid repositioning of fixed income portfolios.
Speaker 4: As a result, the strong improvement in our net asset value early in the quarter turned into a modest decline by quarter end.
Speaker 4: Following stronger than expected economic data in January , the Fed raised the federal funds rate by 25 basis points at the February 1st meeting and indicated more hikes were likely and that short-term rates would remain higher for longer.
Speaker 4: By early March, the terminal Fed funds rate implied by the futures market approached 6%, indicating that another 100 basis points of tightening was likely.
Speaker 4: Against this backdrop, the yield curve became meaningfully inverted with the two year-to-ten year treasury yield differential reaching negative 108 basis points in early March.
Speaker 4: This sharply inverted yield curve and more aggressive monetary policy outlook raise serious questions about bank earnings and unrealize losses on their asset portfolios.
Speaker 4: These concerns ultimately led to the abrupt failure of Silicon Valley Bank and drove a dramatic repricing in monetary policy expectations.
Speaker 4: At the peak of the banking uncertainty, meaningful rate cuts were expected over the remainder of the year, rather than rate increases as previously indicated by the Fed.
Speaker 4: In this highly uncertain environment, interest rate volatility increased to crisis levels.
Speaker 4: As an example, the Move Index, which measures Treasury market volatility, reached a 15-year high.
Speaker 4: Short-term interest rates experience the greatest volatility with the yield on the two-year treasury dropping 61 basis points in a single day unmatched by any day during the great financial crisis. Long-term treasury rates were also volatile with the yield on the ten-year treasury
Speaker 4: which became a reality with Silicon Valley Bank also weighed an agency MBS performance late in the quarter.
Speaker 4: Given these banking issues, the supply and demand outlook for agency MBS is now more uncertain.
Speaker 4: Over the near term, it is likely that banks will not be meaningful buyers of MBS and in some cases could be sellers. Over the last two years, the fixed income markets experienced a significant repricing as the Fed tightened monetary policy at a historic pace.
Speaker 4: Agency MBS have been uniquely impacted with the spread between the current coupon MBS and the 10-year treasury widening 135 basis points since April 2021.
Speaker 4: Importantly, we believe this repricing is in the late stages and that a new trading range is emerging.
Speaker 4: More specifically, we think spreads could remain at these compelling levels until this tightening cycle is well behind us.
Speaker 4: Such bread levels provide investors with meaningful incremental return and are about double the average of the last 10 years.
Speaker 4: We also believe agency MBS are attractively priced and adequately compensate investors for the volatility and uncertainty that characterize the U.S. Treasury and agency MBS markets today.
Speaker 4: In addition, for investors seeking the highest credit quality and incremental return, agency MBS provide a compelling alternative to U.S. Treasuries.
Speaker 4: In addition for investors seeking the highest credit quality and incremental return, agency MBS provide a compelling alternative to U.S. Treasuries. As we mentioned last quarter, U.S. Treasuries is a
Speaker 4: The path to stability is not a straight line and the first quarter is a good reminder of that.
Speaker 4: But despite the headwinds that we encountered in March, our outlook continues to be very positive.
Speaker 4: A key driver of this optimism is our belief that our portfolio can generate mid-teen returns at current valuation levels and without spread tightening.
Speaker 4: For much of the last 15 years, we have competed with the world's largest and most price-insensitive buyer of agency MBS.
Speaker 4: As the Fed and now banks reposition their balance sheets, we find ourselves in the favorable position of being one of the few permanent capital vehicles dedicated to agency MBS at a time when valuations are historically attractive and appear poised to remain that way for some time.
Speaker 4: Also important, unlike banks, our interest rate exposure is conservatively hedged and our portfolio is fully marked to market.
Speaker 4: As such, when you invest in AGMC today, you are buying into a levered and hedge portfolio priced at today's historically attractive valuation levels.
Speaker 4: Making this opportunity very similar to 2009, which was one of Agencies's most favorable periods.
Speaker 4: With that, I will now turn the call over to Bernie Bell to discuss our financial results in greater detail.
Speaker 3: Thank you, Peter. For the first quarter, AGMC had a comprehensive loss of $0.7 per share. Economic return on tangible common equity was negative 0.7% for the quarter.
Speaker 3: comprised of a decrease in our tangible net book value of 43 cents per share and 36 cents of dividends declared per common share
Speaker 3: As of last Friday, tangible net book value was down about 1% for April .
Speaker 3: Leverage at the end of the quarter was 7.2 times tangible equity, down from 7.4 times as of the fourth quarter, driven by a reduction in our asset balance and the addition of $171 million of common equity raised through our ATHLE market offering program.
Speaker 3: This issuance occurred opportunistically during the quarter at levels that were meaningfully accretive to book value.
Speaker 3: Our average leverage for the quarter was 7.7 times tangible equity compared to 7.8 times for the fourth quarter.
Speaker 3: As a quarter end, we had cash and unencumbered agency MBS totaling 4.1 billion or 57% of our tangible equity and 70 million of unencumbered credit securities. Net spread and dollar roll income excluding catch up amortization was 70 cents per share for the quarter.
Speaker 3: a decline of $0.04 per share from the fourth quarter due primarily to somewhat higher funding cost and the addition of new longer term pay fix swap hedges.
Speaker 3: Lastly, the average projected life CPR in our portfolio at the end of the quarter increased to 10%.
Speaker 3: From 7.4% as of the prior quarter end, consistent with moderately lower forward mortgage rates and a higher average coupon on our portfolio.
Speaker 3: Actual CPRs for the quarter declined to 5.2%. I'll now turn the call over to Chris Kuhl to discuss the agency mortgage market.
Speaker 2: Thanks, Bernie. The first quarter was marked by extreme rate volatility. The tailwind of a growing consensus around the outlook for Fed policy and expectations for lower rate volatility carried over from year-end through the month of January leading to one of the strongest months on record for agency MBS performance.
Speaker 2: But that tail went abruptly ended in February with a release of much stronger than anticipated economic data, and in turn material repricing of expectations for further fed policy tightening.
Speaker 2: Against this more challenging backdrop, agency MBS materially underperformed hedges in the second half of the quarter.
Speaker 2: Performance across the coupons stack varied considerably with 3.5-4.5 out-performing production coupons early in the quarter and lower coupons materially underperforming in March as the market priced the impending supply shock following the failures of Silicon Valley Bank and signature bank.
Speaker 2: Higher coupons widened as well, in sympathy with lower coupons, although two or lesser degree. In total, interest rates rallied approximately 40 basis points in twos through tens. From this perspective, the quarter appears much more benign than what actually occurred.
Speaker 2: Given the extreme intra-quarter rate volatility and stress in the regional banking system, it is not surprising that mortgages underperformed. Since quarter-end, rate volatility has declined materially as contagion concerns in the banking system have subsided somewhat, and economic data appear supportive of Fed policy nearing the terminal level for rates.
Speaker 2: Despite relatively calmer markets, the overhang of supply from the FDIC and related bank failures has driven agency paracoupons breads 10 basis points wider since quarter end to approximately 163 basis points to a blend of 5 and 10 year treasuries.
Speaker 2: Our agency MBS portfolio declined to 56.8 billion as of March 31st, down from 59.5 billion at the start of the year as we adjusted leverage lower to enhance flexibility to add agency MBS as a result of the highly volatile market environment. Despite relatively weak role implied financing levels during the quarter, specified
Speaker 2: coupon with the weighted average coupon of the portfolio increasing approximately 10 basis points during the quarter.
Speaker 2: As of March 31st, the Hedgeport Folio totaled 59.7 billion, and our duration gap was 0.2 years.
Speaker 2: Our hedge ratio had declined to 114%, consistent with the expectation that we are nearing the terminal stage of the Fed tightening cycle. And as we have discussed, we expected to gradually shift the composition of our hedge portfolio towards a greater share of longer-dated hedges to address the risk of a yield curve steepening.
Speaker 2: This effort continued in the first quarter and was most pronounced in our Treasury holdings where we added intermediate-term Treasuries while maintaining a short position in longer-term Treasury-based hedges. Looking ahead, the combination of widespreads, low-prepayment risk, and robust funding markets for agency MBS creates what we believe to be an extraordinary—
Speaker 4: credit spreads were on the whole fairly well behaved.
Speaker 4: These local wides were significantly tighter than what occurred during the UK liability-driven investment crisis late in the third quarter. In addition, both were tighter at 3.31 as compared to year-end. Post-SVB falling rates or rising bond prices for benchmark bonds provided support for the spread product complex.
Speaker 5: and bolstering credit spread performance.
Speaker 5: Consistent with these themes, residential credit spreads performed well in the first quarter. On the run CRT closed largely unchanged to slightly tighter over the prior quarter, while pockets of seasoned CRT tightened more meaningfully.
Speaker 5: The residential credit space likely will be a favored asset class in the near term, as credit concerns play out in other asset classes. The residential space as a whole is still supported by low mark to market LTVs and conservative underwriting. This results in reduced sensitivity to even moderate housing shocks or a small increase in unemployment.
Turning to our holdings are 9-E's and C-portfolio ended at 1.3 billion, a decline of approximately 100 billion from your end. The majority of the decline was driven by sales of AAA CNPS.
With wide agency MBS valuations and a stronger relative funding outlook, surrogate investments for agency MBS such as high grade residential and commercial backcast loads have become less attractive for us to hold.
Our CRT portfolio was little changed in the first quarter and performed well due to the composition of our holdings.
We continue to maintain a high allocation of bonds that provide little to no capital relief to the GSEs.
At such, our expectation is for the GSEs to attempt to extinguish this protection over time, by tendering the securities at above prevailing market levels.
In fact, just yesterday Fannie Mae announced a tender for season CRT.
We expect these tenders to drive favorable total returns for this portion of our holdings.
With that, I'll turn the call back over to Peter. Thank you, Aaron. 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 1 on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys.
into withdraw your question, please press star then two.
At this time we will pause this momentarily to assemble our roster.
And our first question here will come from Rick Shane with JP Morgan. Please go ahead with your question. Good morning everybody and thanks for taking my question. Look, we're obviously at a really confusing crossroads right now in terms of rates.
and what the signals you will look for to weigh in more aggressively once you see the the market taking a direction.
Sure, thank you for the question Rick, it's a good question to start with. There's a lot to it and I might leave some things out so if I missed some of it, ask more. But first let me talk about leverage in sort of the issue that you raised is it is a really challenging...
environment and that sort of to be expected when you think about it we're right at sort of the the end of the Fed tightening cycle and I think the Fed tightening cycle is going to end at the next meeting whether they raised 25 basis points or pause or just simply pause here I think it's likely the last move
So it's not surprising that the market is so if you will sensitive right now And really when you go back and you think about the concerns that the market confronted last September
really the issue that destabilized the market was the concern that the Fed would go too far and ultimately cause something in the financial system to break and that in fact happened in March. And now as we look forward, I think the Fed now understands that and they've made it clear that
the instability that occurred in the banking system is going to have material impact on credit availability and ultimately slow the economy down and ultimately act as a tightening of monetary policy. So I think we're near the end of that process. I also think that, as Chris mentioned in his prepared remarks, we are starting to see some stabilization in the bank.
net during the quarter. As Bernie mentioned, we used our ATM accretively to help manage our desired leverage position. So I think that worked out beneficial to our shareholders. And we put ourselves importantly, and this gets to the sort of the dial. Look.
We put ourselves in a position now where we have, I think, a lot of flexibility. And I think that there's going to be opportunities that arise in the mortgage market and given our liquidity position, give us our leverage position, I think we're really well positioned to take advantage of those. Thank you.
Now another key point though, and this is what I think makes this environment so unique and so favorable, and I tried to touch on this in my prepared remarks.
is that we really don't feel any sense of urgency with respect to meaningfully changing our leverage profile because we think spreads are gonna remain fairly stable in this area and I think it's likely going to...
Spreads will likely remain at these levels, which I think are cheap by anybody's measure, regardless of how you look at them across the curve. They're going to remain generally speaking in this area for the foreseeable near term future. And that really gives us an opportunity to be patient and to adjust our portfolio over time. But in the meantime, as I said, our portfolio can generate really attractive returns. So we're...
as can be seen in some of our numbers and as Chris mentioned, consistent with the Fed coming to the end of the tightening cycle.
seen in some of our numbers and asked Chris mentioned, consistent with the Fed coming to the end of the tightening cycle. As the Fed...
shifted from an easy cycle to a tightening cycle. We talked about this. We wanted to have a greater portion of our hedges in the front part of the curve because we expected the yield curve to invert, which it clearly did. And as the Fed comes to the end of the cycle, we would expect the opposite to happen. And that has started to happen. We expect the yield curve to steepen.
and ultimately the front end of the market to rally more. And so in that environment, we'll likely operate with a lower hedge ratio. Chris mentioned it went down to 114. As we sit today, it's actually under 100%. And we'll likely operate with a greater share of longer term hedges so that we have a little bit more exposure to the yield curve steepening and that would benefit our hedge portfolio. So I'll pause there and let you.
ask a follow up if there is any. No, great answer, very helpful and I will pass with it on. All right, appreciate it, Rick. Our next question will come from Trevor Cranston with JMP Securities. Please go ahead and have your question. Hey, thanks, good morning. Good morning, Trevor. Thank you.
But follow up on the comments you guys have made already about the sales of the failed bank fully. Can you talk about how much of that you think is priced in versus how much additional widening we might see as those?
Sales actually come to markets and you know how much like who do you see as the marginal buyer and how much Cassidy they have to absorb that right now. Thanks. Yeah, let me just start and then I'll pass it over to Chris I think the market has had enough time to digest that information It's now pretty well understood What exactly they're selling and it was a little bit different than the expectations initially and Chris can talk about
so it's going to take them a long time. I suspect this is going to take the better part of a year.
and they'll adjust according to market conditions and as liquidity and demand shows up. But I think there could be some opportunities in that portfolio. Chris can talk a little bit about that.
The only thing I'd add, I mean what we learned last week was the composition and the likely pace for liquidation by asset class. And as Peter said, the pace of sales is a bit longer than maybe what the market feared or at least some had feared. There's 60 billion in pass-throughs that are expected to be sold or that are pace of around 6 to 7 billion per month and so.
roughly eight to nine months, 22 billion in CMOs that are expected to be sold at a pace around a billion six per month. So that's a little over a year and then there's 14 billion of CNBS and 7 billion in munis. You know, lower coupons, widens materially up to this event. And so I would say, you know, I would expect the, you know,
the generic sort of 30-year pass-throughs, the trade pretty well. I think there are a few categories within the pass-through position that trade with payups that could trade at very wide spreads. There are a few categories within the CMO holdings that could also trade at very wide levels.
We'll have to see, we'll certainly be engaged on the list if they come out. The first round of list last week traded well. We'll have to see how things go. But with the disclosures, Peter said, they also had some market friendly language that suggested that the FDIC does want to...
You asked about the marginal buyer activity.
marginal buyer activity.
Obviously the key marginal buyer in this environment is going to continue to be money managers. The Silicon Valley bank portfolios low coupons and more than 50% of the mortgage indexes made up of these low coupons. So the money managers are going to be the key buyers of mortgages going forward at the margin.
I think large banks could at some point come back into the market. But more importantly, I think there's going to continue to be a rotation out of treasuries into agency mortgage backed securities. I think we're starting to see some of that over the last several months. I think there's a lot of things that we're going to see in the market.
demand on an absolute, unlevard basis for agency MBS that is growing. I think you see that in the formation of the ETS that have occurred. BlackRock's ETF has gained a lot of asset value over the last six months, double line, initiated an agency ETF. So I think there's going to be demand. And...
that will continue to, fixed income demand, that will continue to make its way into the agency on the S market. But it's just going to take time, but I think that's that stuff for a positive dynamic. Yeah, that makes sense. Okay, thank you, you guys. Thank you, Joe.
prepared remarks you mentioned kind of favorable funding markets. Can you just talk about how you're thinking about, you know, the debt ceiling and, you know, kind of how you're seeing funding markets kind of around around that time?
mentioned favorable funding markets. Can you just talk about how you're thinking about the debt ceiling and how you're seeing funding markets around that time? Sure. Thanks for the question, Doug.
We really haven't seen any disruptions in the agency funding market. And that's one of the things that obviously makes agency MBS so compelling on a relative value basis. Chris mentioned that in his prepared remarks.
disruption in the agency mortgage market. There's still a lot of liquidity. I don't expect the debt ceiling to have any impact on the repo market for.
agency, MBS, or for U.S. Treasuries for that matter. The amount of money in the money markets system, the amount of money at the reverse repo facility at the Fed.
Sort of signals to me that there's plenty of liquidity in the funding markets. I don't expect that the debt ceiling to be an issue in the repo markets. It may be an issue in interest rate volatility with respect to treasuries, but that's one of the reasons why we're operating with a relatively small duration gap will continue to keep our interest rate exposure low. And ultimately this.
That ceiling issue will get resolved. I think the market is mature enough and has gone through this enough times to know that a solution will be found hopefully, it can be found quick. But if it's not, I think the market ultimately will price in the fact that it will be resolved. maggot
Great. Thank you. Sure. Thanks for the question, John . And our next question will come from Bose George with KBW. Please go ahead of your question.
Hey guys, good morning. Peter, in your comments you noted a new trading range, you know, in agency MBS. Can you talk a little more about that sort of just in terms of nominal spreads where you think things could end up? Sure. Well, you know, what's interesting, Bo, is when you, at this point when you look at agency MBS spreads, a lot of times it's...
It really is dependent on where you look, you know, sort of out of point on the curve because you can have meaningful differences whether you use treasuries or swap hedges or whether you use ten-year hedges or three-year hedges. But when you look at mortgages today, agency MBS, they're cheap by all measures. You know, for example, if you look at ten years to three years in the treasurary market, the spreads are somewhere between 125 and 175 basis points.
If you look at it, mortgages against the so-for-market, three years to ten years, they're 150 to 200 basis points. So that's why I think everybody looks at the mortgage market and said they're probably in the 160 to 175 basis point range. Ultimately, I think spreads will tighten from here. Here.
I think they can trade in this 150th range for some period of time. And the reason why I sort of come to that number is that I think that's a number that is obviously about double, if you think about that versus the tenure. That's about double the spreads that we've experienced for the last 10 years. So that's meaningfully wider.
But that's a lot of additional compensation for the same credit quality as the U.S. Treasury. So think about it, if you're looking at the 10-year Treasury at 3.5% and you can earn 5.25% for the same credit quality, for a duration that's actually shorter than a 10-year, I think that's really compelling.
I think investors in this environment requires a higher return. It's not surprising that we are here given the amount of monetary policy on certainty and economic policy on certainty. I think the market is going to be highly sensitive to economic data for the next several months until it's clear.
how the Fed is going to progress through this pause period. So I think it keeps spreads in this range, but if you ask me 12 months from now where are spreads, I would say they're tighter than they are today, but they're still meaningfully wider than historical averages.
Okay, great, thanks, that makes sense. Sure. And I think I'm close, I mean, I think that's just, yeah, I just think that's really the key point. And the message is that that really does set up for a very good earnings environment. So I'm sorry, go ahead. Yep, yep, yep, no, absolutely, that makes sense. Thanks. And if you have any other question ahead, anything you guys referred to this briefly, but.