Q4 2023 AGNC Investment Corp Earnings Call
[music].
Good morning, everyone and welcome to the Aegean Sea investigate Corp, fourth quarter, two 2023 shareholder call.
All participants will be in a listen only mode should you need assistance. Please signal a conference specialist by pressing the star key followed by zero.
After todays presentation, there will be an opportunity to ask questions.
Ask a question you May press Star then one on your Touchtone telephone to withdraw your question you May Press Star then two.
Please also note today's event is being recorded.
At this time I'd like to turn the floor over to Katie Turner Investor Relations.
Yep.
Katie R. Wisecarver: Please go ahead.
Katie R. Wisecarver: Thank you all for joining agency investment Corp's fourth quarter 2023 earnings call before we begin I'd like to review the Safe Harbor statement.
Katie R. Wisecarver: This conference call and corresponding slide presentation contains statements that to the extent, they're not recitations of historical fact constitute forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995.
Katie R. Wisecarver: All such forward looking statements are intended to be subject to the safe Harbor protection provided by the Reform Act.
Katie R. Wisecarver: Actual outcomes and results could differ materially from those forecasts due to the impact of many factors beyond the control of the agency.
Katie R. Wisecarver: 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.
Katie R. Wisecarver: Certain factors that could cause actual results to differ materially from those contained in the forward. Looking statements are included in agencies periodic reports filed with the Securities and Exchange Commission copies are available on the Sec's website I see it I got.
Katie R. Wisecarver: We disclaim any obligation to update our forward looking statements unless required by law.
Katie R. Wisecarver: Participants on this call include.
Katie R. Wisecarver: Peter Federico Director, President and Chief Executive Officer, Bernie Bell Executive Vice President and Chief Financial Officer, Chris Shaw Executive Vice President and Chief Investment Officer, Aaron Pas senior.
Katie R. Wisecarver: Senior Vice President non agency portfolio management, and Sean Reid Executive Vice President strategy, and corporate development with that I'll turn the call over to Peter Federico.
Peter J. Federico: Good morning, and thank you all for joining our call.
Peter J. Federico: The fourth quarter of 2023 illustrated the importance of our active portfolio management strategy as a GNC generated a very favorable 12% economic return despite significant intra quarter volatility.
Over the last two years the federal reserve has engineered one of the most aggressive tightening campaigns ever experienced raising the federal funds rate by 525 basis points, while simultaneously, reducing its balance sheet by 1.3 trillion dollars.
Peter J. Federico: Despite this challenging and volatile fixed income environment Aegean Sea generated a positive economic return of 3% and 20 twenty-three produced a positive total stock return of 10% and importantly provided shareholders with a stable and compelling monthly dividend.
Peter J. Federico: Early in the quarter Treasury supply concerns and persistent monetary policy uncertainty weighed heavily on the fixed income market driving the yield on the 10 year Treasury and the current coupon agency MBS 215 year highs.
Peter J. Federico: Five and 7% respectively.
Later in the quarter better than expected economic data and the Fed's monetary policy pivot triggered a dramatic rally across the fixed income and equity markets as investors sought to lock in attractive return opportunities.
Peter J. Federico: To put the fixed income rally in perspective from the peak in yields on October 19 through the end of the year treasury rates rallied by more than 100 basis points across the yield curve.
Peter J. Federico: And the Bloomberg aggregate Bond index posted a total return of close to 10% over that time period.
The performance of agency MBS closely track Treasury yields underperforming early in the quarter as interest rates increased and outperforming later in the quarter as interest rates fell.
Peter J. Federico: Agency MBS spreads hit their widest level at the same time Treasury yields peaked in mid October.
Peter J. Federico: In November and December as Treasury rates fell agency MBS spreads tightened meaningfully across the coupon stack.
Peter J. Federico: As we began 2024, we believe the investment outlook for agency MBS is decidedly more favorable than the previous two years.
Peter J. Federico: This positive outlook is supported by a historically attractive valuation levels on both an absolute and relative basis.
Peter J. Federico: Low mortgage origination volumes declining interest rate volatility a less inverted yield curve and most importantly, a more investor friendly monetary policy stance by the federal reserve.
Peter J. Federico: Our favorable outlook for agency MBS is further supported by several important developments.
Peter J. Federico: First in the fourth quarter, the fed adopted a more neutral monetary policy stance as inflation measures continued to show progress toward the fed's long run target.
Peter J. Federico: More significantly at the December meeting the fed also indicated that multiple rate cuts where possible in 'twenty 'twenty four assuming inflation measures continue to improve as expected.
Peter J. Federico: Second interest rate volatility is poised to decline.
Peter J. Federico: Over the last two years the distribution of potential interest rate path has been exceedingly wide due to the many uncertainties associated with inflation the economy regional banks fiscal policy Geo political events and of course, the fed's unprecedented dual track approach.
Two monetary policy tightening.
Peter J. Federico: Not surprisingly these major uncertainties led to a meaningful increase in interest rate volatility.
Peter J. Federico: The move index, which is a broad measure of interest rate volatility continues to trade more than 50% above its 10 year historical average.
Although some uncertainty still remain we expect interest rate volatility to gradually decline as many of these factors are now largely behind us.
Peter J. Federico: Such a decline would be beneficial to agency MBS and unbalance would incrementally reduced the need for and cost of our interest rate risk management activities.
Peter J. Federico: The third and final development relates to agency MBS spreads over the last five quarters agency MBS spreads to benchmark rates have experienced five distinct widening episodes. The most recent one being this past fall.
And each of these episodes to spread range was relatively consistent.
Peter J. Federico: As measured by the current coupon agency MBS spread to a blend of five and 10 year treasuries.
Peter J. Federico: The range has been between 140 and 190 basis points.
Peter J. Federico: The important takeaway from this experience is that strong incremental demand for agency MBS emerges when spreads are near the upper end of the range.
Peter J. Federico: In the fourth quarter, we hit the upper end of the range and again the range held.
Peter J. Federico: Spreads in this range are materially above the average of the last 10 years.
Peter J. Federico: Agency MBS very compelling on both an absolute and relative basis.
And we believe are sufficient to attract a greater amount of private capital to the agency MBS market over time.
These are positive developments and we are excited about the outlook for our business.
Peter J. Federico: As a levered investor and agency MBS. The two primary drivers of our performance our changes in spreads and interest rate volatility.
Peter J. Federico: Over the last two years as the fed aggressively tightened monetary policy.
Peter J. Federico: C N P S spreads widened by more than 100 basis points.
Peter J. Federico: And interest rates and interest rate volatility move sharply higher.
Peter J. Federico: Today, we believe many of the factors that drove these adverse conditions are largely behind us here.
Peter J. Federico: Historically attractive and stable agency MBS spreads combined with declining interest rate volatility create a compelling investment environment for Aegean Sea and forms the basis of our positive investment outlook.
Speaker Change: With that I'll now turn the call over to Bernie Bell to discuss our financial results in greater detail.
Bernice E. Bell: Thank you Peter.
Bernice E. Bell: For the fourth quarter, a GNC had comprehensive income of one dollar per share as the mortgage market rebounded following October selloff and a difficult third quarter.
Bernice E. Bell: Economic return on tangible common equity was 12, 1% for the quarter comprised of 36 cents of dividends declared per common share and a 62 cent increase in our tangible net book value per share.
Bernice E. Bell: As Peter mentioned, despite the very challenging fixed income environment for the year, we achieved a positive economic return of 3%, including $1.44 of dividends per common share and $1 14 decline in tangible net book value per share.
Bernice E. Bell: With common stockholders experiencing a total stock return of 10% for the year.
Bernice E. Bell: As of late last week tangible net book value per share was up 1% to 2% for January.
Bernice E. Bell: While average leverage was largely unchanged for the quarter at 7.4 times tangible equity our end of period leverage declined to seven times tangible equity as of Q4 from seven nine times as of Q3.
Bernice E. Bell: Our liquidity remained exceptionally strong during the quarter ending the year with unencumbered cash and agency MBS totaling $5 1 billion or 66% of our tangible equity and an additional $90 million of unencumbered credit securities.
Bernice E. Bell: Net spread and dollar roll income also remained strong at 60 per share for the quarter.
Bernice E. Bell: Down from 65 for the prior quarter due to a somewhat smaller asset base and a larger share count for the fourth quarter at the same time, our net interest rate spread improved five basis points to 308 basis points as higher asset yields more than offset moderately higher funding cost.
Bernice E. Bell: The average projected life CPR for our portfolio increased to 11, 4% at quarter end from eight 3% the prior quarter, reflecting the higher average coupon of our holdings and the decline in mortgage rates.
Unnamed Host: Good morning, everyone, and welcome to the AGNC Investment Corp. fourth quarter 2023 shareholder call. All participants will be in a listen-only mode.
Unnamed Host: Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press the star key and then one on your touchtone telephone.
Bernice E. Bell: Actual CPR for the quarter averaged six 2% compared to seven 1% for the prior quarter.
Bernice E. Bell: Lastly, in the fourth quarter, we raised approximately $380 million of common equity through our at the market offering program at a meaningful price to book premium.
Unnamed Host: To withdraw your questions, you may press star and two. Please also note today's event is being recorded. At this point, I'd like to turn the floor over to Katie Turlington in investor relations. Ma'am, please go ahead.
I'll now turn the call over to Chris cure to discuss the agency mortgage market.
Thanks, Bernie the fourth quarter marked a decided shift and fed policy expectations and fixed income market sentiment. The shift in sentiment was led by favorable inflation data and was ultimately reinforced at the December fed meeting with a reset of market expectations for a series of rate cuts in 2024.
Thank you all for joining AGNC Investment Corp.'s fourth quarter 2023 earnings call. Before we begin, I'd like to review the Safe Harbor Statement. This conference call and corresponding slide presentation contain statements that, to the extent they are not recitations of historical 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 their format. Actual outcomes and results could differ materially from those forecast due to the impact of many factors beyond the control of the agency.
Bernice E. Bell: The path to the Feds December pivot was anything but a straight line October was a continuation of extraordinary interest rate volatility persistent higher for longer rhetoric from the fed and weak performance across most all fixed income asset classes as the 10 year Treasury note yield broke through 5% Mark.
Bernice E. Bell: Market sentiment, however, improved materially in November following downside inflation data surprises and generally more balanced messaging from the fed regarding the outlook for monetary policy and inflation.
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 AT&C's periodic reports filed with the Securities and Exchange Commission. Copies are available on the SEC's website at sec.gov.
Bernice E. Bell: In response to this improving outlook and with the equity markets near all time highs fixed income investor sentiment turned in favor of adding duration, which in turn caused interest rates to rally and spread products to outperform.
Bernice E. Bell: Agency MBS across the coupon stack outperformed treasury and swap based hedges with lower and middle coupons performing somewhat better than higher coupons hedge composition was also a significant driver of performance during the quarter as swap spreads tightened 10 basis points across the curve twos through turns as a result.
We disclaim any obligation to update our forward-looking statements unless required by law. Participants on this call include Peter Federico, Director, President, and Chief Executive Officer; Bernie Bell, Executive Vice President and Chief Financial Officer; Chris Kuehl, Executive Vice President and Chief Investment Officer; and Aaron Pas.
Bernice E. Bell: MBS position with Treasury based hedges performed meaningfully better than our swap based hedge position.
Bernice E. Bell: Our portfolio increased slightly from $59 3 billion to 60.2 billion as of December 31st within our agency holdings, our coupon positioning was modestly higher as we continue to move up in coupon at attractive yields and spreads our TBA position was also modestly higher at $5 3 billion.
Peter J. Federico: 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. Good morning, and thank you all for joining our call. The fourth quarter of 2023 illustrated the importance of our active portfolio management strategy as AGNC generated a very favorable 12% economic return despite significant intracorporate volatility. Over the last two years, the Federal Reserve has engineered one of the most aggressive tightening campaigns ever experienced, raising the federal funds rate by 525 basis points while simultaneously reducing its balance sheet by $1.3 trillion. Despite this challenging and volatile fixed income environment, AGNC generated a positive economic return of 3% in 2023, produced a positive total stock return of 10%, and importantly, provided shareholders with a stable and compelling monthly dividend.
Bernice E. Bell: And remains largely comprised of Ginnie Mae TBA, given attractive valuations and better roll implied financing relative to U M. B S.
With the 111 basis point rally in par coupon yields the duration of our assets shortened during the quarter and as a result, we reduced the duration of our hedge portfolio, primarily by reducing our treasury based hedges and the five to seven year part of the curve.
As of 12 31, our hedge portfolio totaled 60.5 billion down about 3 billion from the previous quarter.
Bernice E. Bell: As I mentioned on the call last quarter more than 50% of the duration of our hedge portfolio came from Treasury based hedges. This was a significant benefit in Q4.
Bernice E. Bell: Over time as the supply and demand technicals improved for treasuries, we will likely gradually move back towards a heavier allocation of swap based hedges.
Bernice E. Bell: Looking forward our outlook for agency MBS continues to be very favorable with limited organic agency supply low levels of prepayment risk and deep and liquid financing markets and while spreads have tightened interest rate volatility has also declined and agency MBS spreads remain attractive relative to historical norms.
Peter J. Federico: Early in the quarter, Treasury supply concerns and persistent monetary policy uncertainty weighed heavily on the fixed income market, driving the yield on the 10-year Treasury and the current coupon agency, MBS, to 15-year highs of 5% and 7%, respectively. Later in the quarter, better-than-expected economic data and the Fed's monetary policy pivot triggered a dramatic rally across the fixed income and equity markets as investors sought to lock in attractive return opportunities. To put the fixed income rally in perspective, from the peak in yields on October 19th through the end of the year, Treasury rates rallied by more than 100 basis points across the yield curve. And the Bloomberg Aggregate Bond Index posted a total return of close to 10% over that time period. The performance of Agency MBS closely tracked Treasury yields, underperforming early in the quarter as interest rates increased and outperforming later in the quarter as interest rates fell. Agency MBS spreads hit their widest level at the same time as Treasury yields peaked in mid-October.
Speaker Change: I'll now turn the call over to Aaron to discuss the non agency markets.
Aaron Joshua Pas: Thanks, Chris the reversal in rates, improving inflation readings and increase the odds of a soft landing scenario contributed to a risk on environment.
Aaron Joshua Pas: For spread product in the latter part of the fourth quarter.
Aaron Joshua Pas: Market expectations for both an increased number and accelerated timing of fed rate cuts were particularly beneficial for interest rate sensitive credit sectors.
In light of this we saw tightening across the majority of the fixed income credit complex.
Aaron Joshua Pas: As a proxy for credit spread moves in Q4, the synthetic investment grade see Dx and ex tightened 18 basis points, while the Bloomberg I G index, which represents spreads on cash bonds tightened by 22 basis points.
Aaron Joshua Pas: Deeper in the corporate credit spectrum spreads tightened even more with high yield C. D X ending the quarter of 132 basis points tighter.
Aaron Joshua Pas: More relevant to a G N C. We saw meaningful spread tightening in CRT R. M. B S and large segments of CRE back debt.
Peter J. Federico: In November and December, as treasury rates fell, agency MBS spreads tightened meaningfully across the coupon stack. As we begin 2024, we believe the investment outlook for agency MBS is decidedly more favorable than the previous two years. This positive outlook is supported by historically attractive valuation levels on both an absolute and relative basis, low mortgage origination volumes, declining interest rate volatility, a less inverted yield curve, and, most importantly, a more investor-friendly monetary policy stance by the Federal Reserve. Our favorable outlook for agency MBS is further supported by several important developments. First, in the fourth quarter, the Fed adopted a more neutral monetary policy stance as inflation measures continue to show progress toward the Fed's long-run target. Furthermore, at the December meeting, the Fed also indicated that multiple rate cuts were possible in 2024, assuming inflation measures continue to improve as expected.
Aaron Joshua Pas: This spread tightening in Q4 is logical as a result of the positive shift in the macroeconomic outlook relative to several months ago.
Aaron Joshua Pas: That said valuations are now full on both an absolute and relative basis and yields on the assets have correspondingly declined along with falling benchmark rates and tighter asset spreads.
Aaron Joshua Pas: As a result meaningful further tightening from these levels appears less likely.
Aaron Joshua Pas: Turning to credit fundamentals, we continue to watch consumer level dynamics, considering low housing affordability levels impacting new owner households, as well as renters.
Aaron Joshua Pas: We expect mortgage credit performance. They continue to hold up as a result of relatively stringent underwriting standards, but predominantly significant homeowners' equity.
Aaron Joshua Pas: Renters in your homeowners, however have been significantly stretched on a relative basis.
Aaron Joshua Pas: Given the need for and prioritization of shelter, we expect the ultimate result will be a weakening of consumer discretionary demand from these households.
Aaron Joshua Pas: With respect to our portfolio of non agency securities ended the quarter at just over 1 billion in market value.
Peter J. Federico: Second, interest rate volatility is poised to decline. Over the last two years, the distribution of potential interest rate paths has been exceedingly wide due to the many uncertainties associated with inflation, the economy, regional banks, fiscal policy, geopolitical events, and, of course, the Fed's unprecedented dual-track approach to monetary policy tightening. Not surprisingly, these major uncertainties led to a meaningful increase in interest rate volatility. The MOVE Index, which is a broad measure of interest rate volatility, continues to trade more than 50% above its 10-year historical average.
Aaron Joshua Pas: Going ahead. The GSE is may aggressively look to extinguish the credit protection provided by CRT Securities Unseasoned and de Levered loans through tender offers.
Aaron Joshua Pas: To the extent the secure occurs we will likely reduce the notional balance of our CRT position over time.
Speaker Change: With that I'll turn the call back over to Peter.
Peter J. Federico: Thank you Aaron we'll now open the call up for your questions.
Peter J. Federico: Ladies and gentlemen, we will now begin the question and answer session.
Peter J. Federico: To ask a question you May press Star and then one using a touch tone telephone.
Peter J. Federico: You are using a speakerphone please.
Peter J. Federico: Please pick up the handset before pressing the keys.
Peter J. Federico: So it's all your questions you May press star two.
Peter J. Federico: Once again that is star and then one to join the question queue.
Peter J. Federico: Although some uncertainty still remains, we expect interest rate volatility to gradually decline, as many of these factors are now largely behind us. Such a decline would be beneficial to agency MBS and, on balance, would incrementally reduce the need for and cost of our interest rate risk management activities. The third and final development relates to agency MBS spreads. Over the last five quarters, agency MBS spreads to benchmark rates experienced five distinct widening episodes, the most recent one being this past fall. In each of these episodes, the spread range was relatively consistent, as measured by the current coupon agency MBS spread to a blend of five and ten-year treasuries. The range has been between 140 and 190 basis points. The important takeaway from this experience is that strong incremental demand for agency MBS emerges when spreads are near the upper end of the range. In the fourth quarter, we hit the upper end of the range, and again, the range held.
Peter J. Federico: Pause momentarily to assemble the roster.
Peter J. Federico: And our first question today comes from.
Christian Love: Christian Love from Piper Sandler. Please go ahead with your question.
Speaker Change: Thanks. Good morning, everyone. Appreciate you taking my questions.
Speaker Change: First just update us on your outlook for spreads just given the favorable outlook you laid out as you said significant tightening since late October. So curious on your view here with with rate cuts likely coming in 2024 and in the past Peter you talked about different spread ranges so interested on kind of what.
Speaker Change: Range is do you think we could be in today.
And just when you think we're more inclined to tighten our widened from from current level.
Speaker Change: Sure. Good morning Christmas. Thank you for the question Yeah as I mentioned in my prepared remarks, I still think that the the range that we've been in for the last five quarters is the right range for the current environment.
Speaker Change: Again, you can look at it off a lot of different measures I was using the one in my prepared remarks of the current coupon to the five and 10 year treasuries I still think in the 140 to 190 basis at the very wise of those range and I think that that range will hold for the foreseeable future what was important.
Speaker Change: And that I mentioned, specifically is that when we get to the upper end of the range and I think this is a really important development for the agency MBS market is significant resistance emerges mean is significant demand for mortgages comes into play when rate when spreads get to the high end of that range and that's a very healthy development for the market gives us greater confidence.
Peter J. Federico: The spreads in this range are materially above the average of the last 10 years, making Agency MBS very compelling on both an absolute and relative basis, and, we believe, are sufficient to attract a greater amount of private capital to the Agency MBS market over time. These are positive developments, and we are excited about the outlook for our business as a levered investor in agency MBS. The two primary drivers of our performance are changes in spreads and interest rate volatility.
Speaker Change: <unk> and the upper end of the range.
Speaker Change: And you're right. We've moved we moved significantly down to those more toward the lower end of that range, but I think this range is the right range for the foreseeable future because we still have a lot of uncertainty with respect to the fed and the fed's balance sheet and a lot of mortgages need to be consumed by the private sector. Just like a lot of a lot of treasuries are going.
Bernice E. Bell: Over the last two years, as the Fed aggressively tightened monetary policy, agency MBS spreads widened by more than 100 basis points, and interest rates and interest rate volatility moved sharply higher. Today, we believe many of the factors that drove these adverse conditions are largely behind us; historically attractive and stable agency MBS spreads, combined with declining interest rate volatility, create a compelling investment environment for AGNC and form the basis of our positive investment outlook. With that, I'll now turn the call over to Bernie Bell to discuss our financial results in greater detail. Thank you, Peter.
Speaker Change: You have to be consumed by the private sector. So at a spread of call. It 140 to 160 basis points just to narrow that range, a little but I think that there is a lot of a lot of compensation for investors for the current environment I think it makes agency MBS look attractive on an absolute basis and on a.
Speaker Change: <unk> basis, which is really important so I could see us staying there for the foreseeable future over the near term and then there there will be some more information come and what's really important obviously you point out when the fed again shifts which to a to an easing environment, which will likely happen in the second half of this year that will be a positive.
Speaker Change: For the market it'll likely be a positive for the shape of the yield curve, which could draw more investors and that's going to be a really important development to watch it could have an impact on on the spread range and the other one that's that's not talked enough about yet, but it's going to be a significant development in the first quarter is what is the fed.
Bernice E. Bell: For the fourth quarter, A, G, and C had comprehensive income of $1 per share as the mortgage market rebounded following October's sell-off and a difficult third quarter. Economic return on Tangible Common Equity was 12.1% for the quarter, comprised of $0.36 of dividends declared per common share and a $0.62 increase in our tangible net book value per share. As Peter mentioned, despite the very challenging fixed income environment, for the year, we achieved a positive economic return of 3%, including $1.44 of dividends per common share and $1.14 decline in tangible net book value per share, with common stockholders experiencing a total stock return of 10% for the year. As of late last week, tangible net book value per share was up 1 to 2% for January. Average leverage was largely unchanged for the quarter at 7.4 times tangible equity.
Speaker Change: You're going to do with respect to quantitative tightening how is it going to stop how is it going to taper that's going to that's going to also be important new information that may.
Speaker Change: Help determine what the right ranges, but but for now I think where mortgages are trading.
Speaker Change: Is is ample compensation for investors and that's one of the reasons why we're optimistic and feel much better about the outlook for agency MBS at the beginning of this year versus the last two years is that if mortgage is just simply stabilize in this area, which we believe is a greater probability then you can really generate attractive re.
Speaker Change: <unk> for shareholders over the long run, particularly if interest rate volatility comes down. So I think that's the outlook over the short term more information will be coming over the next three to six months, which will help determine the longer run outlook.
Bernice E. Bell: Our end-of-period leverage declined to 7x tangible equity as of Q4 from 7.9x as of Q3. However, our liquidity remained exceptionally strong during the quarter, ending the year with unencumbered cash and agency MBS totaling $5.1 billion, or 66% of our tangible equity, and an additional $90 million of unencumbered credit security. Net spread and dollar roll income also remained strong at $0.60 per share for the quarter, down from $0.65 for the prior quarter due to a somewhat smaller asset base and a larger share count for the fourth quarter. At the same time, our net interest rate spread improved five basis points to 308 basis points, as higher asset yields more than offset moderately higher funding. The average projected life CPR for our portfolio increased to 11.4% at quarter end from 8.3% the prior quarter, reflecting the higher average coupon of our holdings and the decline in mortgage rates. However, actual CPRs for the quarter averaged 6.2% compared to 7.1% for the prior quarter.
Speaker Change: Thanks Peter.
Speaker Change: All very helpful. There and then just on the incremental buyers of agency MBS today are you seeing money managers being the key buyer here and based on your point as well as our current spread deterring money managers at all or are they waiting for them to get wider or could the rate environments. They just help me again sure I'll let.
Speaker Change: I'll, let Chris talk about the diversity of the bid today for mortgages versus over the last several months, particularly money managers and some recent information from banks.
Chris Shaw: I think the I mean, the money manager bad has been clearly the the the the dominant bad for the last year and change.
Chris Shaw: You know the.
Chris Shaw: The negative associated with it has just been the correlation with with fed policy and and just overall fixed income inflows outflows money managers, even given the tightening you know are still generally overweight the indices.
Chris Shaw: Around high single digits, So I think it's around 10% or so.
Lastly, in the fourth quarter, we raised approximately $380 million of common equity through our at-the-market offering program at a meaningful price-to-book premium. I'll now turn the call over to Chris Kuehl to discuss the agency mortgage market. Thanks, Bernie.
Chris Shaw: But we are seeing evidence with you know deposits.
Chris Shaw: Deposit stabilizing on the in the banking sector in the fourth quarter earnings releases showed some evidence that banks are starting to grow their securities Holdings again.
Chris Shaw: The ones that actually disclose or break out MBS versus versus treasuries.
The fourth quarter marked a decided shift in Fed policy expectations and fixed income markets. The shift in sentiment was led by favorable inflation data and was ultimately reinforced at the December Fed meeting with a reset of market expectations for a series of rate cuts in 2024. However, the path to the Fed's December pivot was anything but a straight line.
Chris Shaw: Showed some some additions in mortgages for the first time.
Chris Shaw: In a long time, and so you know the diversity and the Investor base is improving and that is helping liquidity.
Chris Shaw: We do think that there's there's still a lot of.
Chris Shaw: Sort of questions that need to be answered with respect to bank regulation that won't be answered for quite some time. So we're not overly optimistic on banks, adding in a material way over the near term, but I do think that.
October was a continuation of extraordinary interest rate volatility, persistent hire for longer rhetoric from the Fed, and weak performance across most fixed income asset classes. For example, the 10 year Treasury note yield broke through five percent. Market sentiment, however, improved materially in November following downside inflation data surprises and generally more balanced messaging from the Fed regarding the outlook for monetary policy and inflation. In response to this improving outlook and with the equity markets near all-time highs, fixed income investor sentiment turned in favor of adding duration, which in turn caused interest rates to rally and spread products to outperform. Agency MBS across the coupon stack outperformed Treasury and swap-based hedges, with lower and middle coupons performing somewhat better than higher coupons. Hedge composition was also a significant driver of performance during the quarter, as swap spreads tightened 10 basis points across the curve, 2s through 10s. As a result, an MBS position with treasury-based hedges performed meaningfully better than a swap-based hedge. Our portfolio increased slightly from $59.3 billion to $60.2 billion as of December 31st.
Chris Shaw: You know whats the depart with deposit stabilizing.
Chris Shaw: You know, possibly at a rate cuts on the horizon, possibly slower C&I loan growth later this year banks could be a more material investor base for the space.
Chris Shaw: And just to add to that Christmas you. When you think about the outlook of supply for the year.
Chris Shaw: J P. Morgan put out some numbers the other day, which I thought were Wichita reasonable it depends on the mortgage rates somewhere between a six and a half and 7% mortgage rate. The net supply of mortgages is a very manageable number when you think about 'twenty 'twenty four it somewhere in the neighborhood of $400 billion to $450 billion is probably the best estimate right now, but when you.
Chris Shaw: Take out from that number so to the no-one demands of mortgages, whether it be some assumptions about banks and foreign holdings and even even reach what it tells you is that the residual amount of mortgages that have to be consumed by money managers and other is a pretty reasonable number at maybe somewhere between two and 300 billion for the whole year.
Speaker Change: Yeah. So I think it gives you some perspective that the outlook of supplies right now appears to be very manageable.
Within our agency holdings, our coupon positioning was modestly higher as we continued to move up in coupon at attractive yields and spreads. Our TBA position was also modestly higher at $5.3 billion and remains largely comprised of Ginnie Mae TBA given attractive valuations and a better role in applied financing relative to UMBS. With the 111 basis point rally in par coupon yields, the duration of our assets shortened during the quarter, and as a result, we reduced the duration of our hedge portfolio, primarily by reducing our treasury-based hedges in the five to seven-year part of the curve. As of 12-31, our hedge portfolio totaled $60.5 billion, down about $3 billion from the previous quarter.
Speaker Change: Thanks, I appreciate you taking my questions. This morning.
Speaker Change: Sure. Thank you.
Speaker Change: Our next question comes from Doug Harter from UBS. Please go ahead with your question.
Got it thanks.
Doug Harter: Good morning, I'm wondering if you could talk about your outlook for the dividend I'm kind of given the volatility just manage through and kind of how you're thinking about a dividend levels throughout 2024.
Doug Harter: Sure.
You know, there's obviously a lot goes into the dividend decision is always does in terms of the environment. The operating environment, our expectations about leverage on a go forward basis and put.
Aaron Joshua Pas: As I mentioned on the call last quarter, more than 50% of the duration dollars of our hedge portfolio came from Treasury-based hedges. This was a significant benefit in Q4. Over time, as the supply and demand technicals improve for treasuries, we will likely gradually move back towards the heavier allocation of swap-based hedges. Looking forward, our outlook for agency MBS continues to be very favorable, with limited organic agency supply, low levels of prepayment risk, and deep and liquid financing markets. And while spreads have tightened, interest rate volatility has also declined, and agency MBS spreads remain attractive relative to historical norms. I'll now turn the call over to Aaron to discuss the non-agency... Thanks, Chris.
Doug Harter: And importantly interest rate volatility and sort of the cost of rebalancing.
But again like I mentioned last time, another key input into that equation is what is our breakeven are we on our business. When you take into account the dividends on both our common and preferred our operating costs.
Doug Harter: What is that number on a percentage basis of our total capital that number for example at the end of the.
Doug Harter: End of the fourth quarter, if you analyze annualize those numbers is somewhere in a breakeven or we have around 15, 5%. So I think it's important to understand that number and think about that number in the context of what we think the portfolio can earn on a go forward basis based on the economics of where of where price.
Aaron Joshua Pas: The reversal in rates, improving inflation readings, and increased odds of a soft landing scenario contributed to a risk-on environment for spread product in the latter part of the fourth quarter. Market expectations for both an increased number and accelerated timing of Fed rate cuts were particularly beneficial for interest rate sensitive credit sectors. In light of this, we saw tightening across the majority of the fixed income credit comp. As a proxy for credit spread moves in Q4, the Synthetic Investment Grade CDX index tightened 18 basis points, while the Bloomberg IG index, which represents spreads on cash bonds, tightened by 22 basis points. Deeper in the corporate credit spectrum, spreads tightened even more with the high-yield CDX ending the quarter 132 basis points tighter.
Doug Harter: <unk> are today not from an accounting perspective, not on current carry but the economics of our portfolio today on a mark to market basis and that number at with spreads to call. It just roundly in the 150 basis point range. I think you can conclude that mortgages are generating mid teens roe's given the way we're managing it.
Portfolio. So I think the important takeaway is those two things still remain well it relatively well aligned and again.
Doug Harter: As the environment unfolds, and we talked about some favorable drivers decline in interest rate volatility is beneficial.
Speaker Change: There's no doubt about that and so you know we'll have to make those determinations over time, but generally speaking.
Speaker Change: I think it's fair to say that those those two things are still well aligned.
Speaker Change: Great.
Aaron Joshua Pas: More relevant to AGNC, we saw meaningful spread tightening in CRT, RMBS, and large segments of CRE-backed debt. This spread tightening in Q4 is logical as a result of the positive shift in the macroeconomic outlook relative to several months ago. That said, valuations are now full on both an absolute and relative basis, and yields on the assets have correspondingly declined along with falling benchmark rates and tighter asset spreads. As a result, meaningful further tightening from these levels appears less likely. Turning to credit fundamentals, we continue to watch consumer level dynamics considering low housing affordability levels impacting new owner households as well as renters. We expect mortgage credit performance to continue to hold up as a result of relatively stringent underwriting standards but predominantly significant homeowner equity. Renters and newer homeowners, however, have been significantly stretched on a relative basis.
Speaker Change: And then you know you talked about and we've experienced kind of at that range. You know the 140 to 190.
Speaker Change: As you've gotten more you know kind of.
Speaker Change: Evidence that you know kind of that range does that change kind of how you would manage.
Speaker Change: The portfolio and the risk off as spreads are widening and does that give you more comfort to kind of let leverage move higher and kind of whole hold onto assets, you know kind of as you're going towards the higher end of that range or just kind of lessons learned from this volatility.
Speaker Change: That's a really great clarification.
Speaker Change: Triggered my memory, because thinking about that last part of the question and it was important point to bring up the the leverage outlook, because where we are from a leverage perspective, ending the quarter at only seven times leverage and putting that in the context of our unencumbered liquidity position, which is at the highest percent it's ever been at either way it's at 66%.
Speaker Change: That tells you that we have significant amount of capacity to take greater risk as the environment unfolds for us and we will be able to do that we just don't feel like we're being pressured to do that because like we said we'd talk about rent spreads.
Peter J. Federico: Given the need for and prioritization of shelter, we expect the ultimate result will be a weakening of consumer discretionary demand from these houses. With respect to our portfolio, our non-agency securities ended the quarter at just over $1 billion in market value. Looking ahead, the GSEs may aggressively look to extinguish the credit protection provided by CRT securities on seasoned and delevered loans through tender options. To the extent this occurs, we will likely reduce the notional balance of our CRT position over time. With that, I'll turn the call back over to Peter. Thank you, Aaron.
Speaker Change: Spreads staying relatively stable in this area. So we can be patient and disciplined as we deploy capital, but you're 100% right. The key point of my prepared remarks was the fact that more times that you hit the upper end of the range and the more times that holds it gives you greater confidence that you are starting to understand the flow of demand for.
Speaker Change: Mortgages at different rate levels, and so it does give you greater confidence to to it which will ultimately feed into your risk position and our ability to manage our levered portfolio. When when the market was very deep destabilize win when there was a lot of uncertainty about the fed yeah.
Unnamed Host: We'll now open the call up for your questions. Ladies and gentlemen, we'll now begin the question and answer session. To ask a question, you may press star and then one on a touchtone telephone.
Unnamed Host: If you are using a speakerphone, we ask that you please pick up the handset before pressing the key. To withdraw your questions, you may press star and. Once again, that is star and then one to join the question queue. And our first question today comes from Crispin Love from Piper Sandler. Please go ahead with your question. Thanks. Good morning, everyone.
Speaker Change: Have to think about your leverage on a volatility adjusted basis and all the other things equal that will tell you that you know per unit of risk. He got to operate with a lower lower amount of risk or lower leverage what you're describing is an environment where that will start to go the opposite way per unit of risk you can actually take it a little bit more risk.
Speaker Change: As you get more and more confident that the spread range is is going to be stable. So it's an important point and that will develop more over the course of 'twenty 'twenty four.
Peter J. Federico: Appreciate you taking my questions. Can you first just update us on your outlook for spreads, given the favorable outlook you laid out? As you said, significant tightening since late October. So curious on your view here with rate cuts likely coming in 2024. And in the past, Peter, you've talked about different spread ranges. So interested in what kind of what ranges you think we could be in today? And just and just if you think we're more inclined to tighten or widen from current levels. Thanks. Sure. Good morning, Christopher.
Speaker Change: Great. Thank you Peter.
Peter J. Federico: Sure. Thank you for the question good question.
Speaker Change: Our next question comes from Bose George from <unk>. Please go ahead with your question.
Bose George: Everyone. Good morning.
Bose George: I'm going to answer your question on spreads.
Speaker Change: Peter you gave kind of the long the near term range of expectations. There can you just talk a little bit about the longer term range ones and a volatility comes down you know where where do you think can kind of settle eventually.
Speaker Change: That's a great question Bose and I think there's two things that really.
Peter J. Federico: Thank you for the question. Yeah, as I mentioned in my prepared remarks, I still think that the range that we've been in for the last five quarters is the right range for the current environment. And again, you can look at it from a lot of different measures. I was using the one in my prepared remarks on the current coupon to the five and 10-year treasuries.
Speaker Change: Could drive that and Theres. The one is that we don't exactly know what the feds ultimate balance sheet is going to look like with respect to its composition.
Of mortgages treasuries now we what we know from the fed right now is that they're likely going to stop a run off of their portfolio depends there's a lot of different estimates right now but.
Peter J. Federico: I still think in the 140 to 190 base, at the very wides of those ranges, I think that range will hold for the foreseeable future. What was important, and what I mentioned specifically, is that when we get to the upper end of the range, and I think this is a really important development for the agency MBS market, significant resistance emerges, meaning significant demand for mortgages comes into play when spreads get to the high end of that range. And that's a very healthy development for the market. This gives us greater confidence in the upper end of the range. And you're right; we've moved significantly down toward the lower end of that range.
Speaker Change: But I think one of the big changes that has occurred in the fourth quarter, particularly in December is that the fed is now made it clear that they will have to stop tapering.
Speaker Change: Probably sooner than any of us had anticipated no sooner than I had anticipated I anticipated to run off to stop in 2025, and now pretty confident it's going to stop in 'twenty 'twenty four but.
Speaker Change: We don't ultimately know what the composition of the portfolio might be with respect to mortgages and treasuries.
Speaker Change: It would be in the best interest of the market. If the fed ended up because they are permanently going to hold mortgages.
Peter J. Federico: But I think this range is the right range for the foreseeable future because we still have a lot of uncertainty with respect to the Fed and the Fed's balance sheet. And a lot of mortgages need to be consumed by the private sector, just like a lot of treasuries are going to have to be consumed by the private sector. So at a spread of, call it 140 to 160 basis points, just to narrow that range a little bit, I think that there's a lot of compensation for investors in the current environment. I think it makes agency MBS look attractive on an absolute basis and on a relative basis, which is really important.
Speaker Change: Or.
Speaker Change: Permanently have a balance sheet, that's going to be significant in size I think it would make sense from a monetary policy perspective for them to own both mortgages and treasuries because mortgages in the housing market are so fundamental to housing policy, we've seen that when they've tried to accelerate the economy by keeping mortgage rates low and we've seen them try to slow.
Speaker Change: Our economy down by keeping mortgage rates high so they're in extra can be linked together and I think it makes sense for the fed over the long run so that's going to be an important development will change spreads the other though.
Speaker Change: Bose away from that is the more longer term fundamental that the both the agency MBS market in the U S. Treasury market face, which is that there is this transition to a greater share of private capital that has to come into both of these markets over say the next five years because if the fed does in fact continue to reduce.
Peter J. Federico: So I could see us staying there for the foreseeable future in the near term. And then there will be some more information coming. What's really important, obviously, you point out.
Peter J. Federico: When the Fed again shifts to an easing environment, which will likely happen in the second half of this year, that will be a positive for the market. It will likely be positive for the shape of the yield curve, which could draw more investors in. That's going to be a really important development to watch.
Speaker Change: <unk> balance sheet.
Speaker Change: Organic supply of mortgages plus fed run off will be a couple of trillion dollars of supply of mortgages say over the next five years at the same time, we know now that the treasury is going to have to issue, perhaps a couple of trillion dollars of of new more new treasuries a year. So we're talking about multiple trillions of dollars.
Peter J. Federico: It could have an impact on the spread range. And the other one that's not talked about enough yet but is going to be a significant development in the first quarter is what is the Fed going to do with respect to quantitative tightening? And when is it going to stop?
Speaker Change: Does that have to be consumed not by levered buyers, but by Unlevered buyers real money flowing into the U S. Fixed income market for these two high quality assets, both agency MBS and treasuries and I think spreads where do you think about an agency MBS, which has the.
Peter J. Federico: How is it going to taper? That's going to also be important new information that may help determine what the right range is. But for now, I think where mortgages are trading is ample compensation for investors. And that's one of the reasons why we're optimistic and feel much better about the outlook for agency MBS at the beginning of this year compared to the last two years. If mortgages just simply stabilize in this area, which we believe is a greater probability, then you can really generate attractive returns for shareholders over the long run, particularly if interest rate volatility comes down. So I think that's the outlook over the short term. More information will be coming over the next three to six months, which will help determine the longer-run outlook. Thanks, Peter.
Speaker Change: Blissett government support behind it at 150 basis points for argument's sake over a treasury, which is government guaranteed but in a sense. They're both government guaranteed securities of 150 basis points of incremental spread is really a significant amount of spread particularly if the 10 year is at say three or four.
Speaker Change: Percent, you're talking about 25 or more percent improvement in your yield. So I think it's going to bring investors into the agency MBS market I think it's gonna be a reallocation out of treasuries.
Speaker Change: Agency MBS out of corporates in the agency MBS and the final important point, which will drive spreads ultimate which we could be a factor that makes spreads ultimately lower but we don't know yet is what happens with bank regulation and if banks have to for example, manage their interest rate position on their securities portfolio.
Peter J. Federico: All very helpful there. And then, just on the incremental buyers of agency MVF today, are you seeing money managers being the key buyer here? And, based on your point as well, are current spreads deterring money managers at all? Are they waiting for them to get wider?
Or could the rate environment change that? And then just how could banks get involved in 2024? Sure.
I'll let Chris talk about the diversity of the bid today for mortgages versus the last several months, particularly money managers and some recent information from banks. But I think the money manager bid has been clearly the dominant bid for the last year and change. The negative associated with it has just been the correlation with Fed policy and just overall fixed income inflows to outflows. However, money managers, even given the tightening, are still generally overweight the indices around high single digits. I think it's around 10% or so.
Speaker Change: Julio it's much more likely that they're going to want to own.
Speaker Change: Mortgages are agency MBS in that environment, because there you can actually buy a longer term security hedged interest rate risk and still generate a positive return it won't make sense for for banks to own treasuries, and then hedged interest rate risk there'll be no return there. So those are all longer terms.
Speaker Change: Factors that will have to develop over time, which will drive where spreads ultimately are but that's one of the reasons why I think they're gonna stay highest because there is this need for a lot of capital to flow into the Treasury and agency MBS markets.
Speaker Change: Okay, great very helpful. Thanks, Peter actually just wanted to follow up also on the book value update quarter to date.
But we are seeing evidence with deposit stabilization in the banking sector; fourth quarter earnings releases showed some evidence that banks are starting to grow their securities holdings again. The ones that actually disclosed a breakout, MBS versus Treasuries, showed some additions in mortgages for the first time in a long time. And so the diversity in the investor base is improving, and that's helping liquidity. We do think that there are still a lot of questions that need to be answered with respect to bank regulation that won't be answered for quite some time.
Peter J. Federico: We'll be tracking it looks like spreads had at least versus swaps it widened a little bit across the curve. So.
Peter J. Federico: Curious with your book value up whether there was other factors, who we look more at treasury swaps or just any color there would be great.
Speaker Change: Yeah, what I would say is obviously, we have a little bit of a different duration position now our duration position.
Speaker Change: Is really neutral in the current environment, our book value was up as Bernie mentioned, 1% to 2%, but the coupon distribution of our portfolio helped us.
Speaker Change: And obviously the combination of swaps versus treasuries and our portfolio helped us in the yield curve.
So we're not overly optimistic on banks adding a material layer over the near term. But I do think that with deposit stabilization, possibly rate cuts on the horizon, possibly slower C&I loan growth later this year, banks could be a more material investor base for the space. And just to add to that, Chris, when you think about the outlook for the year, and JP Morgan put out some numbers the other day, which I thought were reasonable, it depends on the mortgage rate, somewhere between a six and a half and 7% mortgage rate. The net supply of mortgages is a very manageable number when you think about 2024; it's somewhere in the neighborhood of 400 to $450 billion is probably the best estimate right now.
Speaker Change: Also self benefited us a little bit this quarter, so not much of a change in book value, but generally positive.
Speaker Change: Okay, great. Thanks.
Speaker Change: Our next question comes from Trevor Cranston from JMP Securities. Please go ahead with your question.
Trevor Cranston: Good morning Charles.
Okay.
Trevor Cranston: Can you talk a little bit more about the movement in the duration gap positioning during the quarter and the decision to shift to slightly negative position.
Speaker Change: Yeah and as it gets.
Speaker Change: The second part of that if you can maybe comment on if you think going forward agent.
Speaker Change: Agency spreads are likely to remain correlated with the directionality of birds.
Speaker Change: That's a really good place, let's let's start with that because that's really a significant factor in that's going to ultimately dictate.
Peter J. Federico: But when you take out from that number, sort of the known demanders of mortgages, whether it be some assumptions about banks and foreign holdings and even REITs, what it tells you is that the residual amount of mortgages that have to be consumed by money managers and others is a pretty reasonable number at maybe somewhere between $200 and $300 billion for the whole year. So I think it gives you some perspective that the outlook for supply right now appears to be, Thanks. I appreciate you taking my questions this morning. Sure, thank you. Our next question comes from Doug Harter from UBS. Please go ahead with your question. Thanks. Good morning.
Speaker Change: To a large extent, where we operate from a duration gap perspective is what do we think mortgages are going to do with respect to interest rates and that correlation Chris can talk a little bit about how that correlation has been in what we expect it to be going forward and what that means from a hedging perspective.
Chris Shaw: So as Peter mentioned, our duration gap you know as of today is slightly positive right around zero given the move higher in rates since year end.
Chris Shaw: But given the shift in sentiment with rate cuts now on the horizon mortgages are trading shorter than they did last.
Chris Shaw: Last year much of the last year and a half relative to model durations, which makes sense as some of the higher rate tail scenarios have been sort of coapt or have become less probable and so given that you know mortgages can trade to shorter durations and with our portfolio, having somewhat more call risk then extension risk or likely.
Peter J. Federico: I'm wondering if you could talk about your outlook for the dividend, kind of given the volatility we just managed through and kind of how you're thinking about dividend levels throughout 2020. Sure. You know, obviously, a lot goes into the dividend decision; it always does in terms of the environment, the operating environment, our expectations about leverage on a go forward basis, and importantly, interest rate volatility and sort of the cost of rebalancing. But again, like I mentioned last time, another key input into that equation is what is our breakeven ROE on our business when you take into account the dividends on both our common and preferred, as well as our What is that number on a percentage basis of our total capital?
Chris Shaw: To try to maintain a near zero to slightly positive duration gap in the current environment I'd say fast forward. Another six to 12 months and if we find ourselves at rate levels with <unk>.
Significantly lower rate levels with significantly more refinancing activity and the fed still running off its portfolio. Then I think a case could be made for running a significantly longer duration gap as you know mortgage supply both organic and fed runoff would be much more sensitive or spreads would be much more sensitive to rate levels with spread.
Chris Shaw: It is likely widen in a rally tightening into a sell off.
You know, but for moderate moves in rates from here over the near term.
Peter J. Federico: That number, for example, at the end of the fourth quarter, if you analyze those numbers, is somewhere in as a breakeven are we have around 15.5%. So I think it's important to understand that number. And think about that number in the context of what we think the portfolio can earn on a go forward basis based on the economics of where prices are today, not from an accounting perspective, not on current carry, but the economics of our portfolio today on a market to market basis. And that number, with spreads, call it just roundly in the 150 basis point range; I think you can conclude that mortgages are generating mid-teens ROEs, given the way we're managing our portfolio. So I think the important takeaway is that those two things still remain relatively well aligned. And again, as the environment unfolds, and we talked about some favorable drivers, declining interest rate volatility is beneficial. There's no doubt about that.
Chris Shaw: You know I think spreads are less correlated with rates than they have been for the last year or so and so we're likely to try to maintain close to a zero duration gap to a slightly positive duration gap over the over the near term in the current environment.
Speaker Change: Got it okay. That's very helpful. Thank you.
Speaker Change: And our next question comes from Rick Shane from J P. Morgan. Please go ahead with your question.
Richard B. Shane: Hi, Thanks, guys for taking for taking my questions. This morning.
Richard B. Shane: You talked a little bit about the.
Richard B. Shane: Taylor.
The about call risk within.
Richard B. Shane: Within the portfolio when we look at slide 23, there are probably twice as many coupons on there as there were three years ago.
Richard B. Shane: When the issue is that is that <unk>.
Peter J. Federico: And so, you know, we'll have to make those determinations over time. But, generally speaking, I think it's fair to say that those two things are still well aligned. Great.
Richard B. Shane: Staff gets bigger and bigger and we're in this incredibly strange environment.
Richard B. Shane: There is much much more.
Concentration of call risk at the at the higher coupons, you guys were pretty deliberate about moving up the stack and being willing to realized losses.
Peter J. Federico: And then, you know, you talked about, and we've experienced kind of that, that range, you know, the 140 to 190, you know, kind of, as you've gotten more, you know, kind of evidence that, you know, that range, does that change how you would manage, you know, the portfolio and the risk off as spreads are widening? And does that give you more comfort to kind of let leverage move higher and kind of hold on to assets? That's, you know, kind of as you're going towards the higher end of that range, or just kind of lessons learned from this volatility? That's a really great clarification that triggered my memory, because I was thinking about that last part of the question, and it was an important point to bring up the leverage outlook, because where we are from a leverage perspective, ending the quarter at only seven times leverage, and putting that in the context of our unencumbered liquidity position, which is at the highest percent it's ever been at, by the way, it's at 66%, tell And we'll be able to do that.
Richard B. Shane: We're moving should we expect that you will start to realize some gains and again I realize it's sort of indifferent economically, but when you start to move back down the stack in order to mitigate some of that call risk.
Speaker Change: Yeah sure I'll, let Chris talk about that I mean, our our weighted average coupon is still quite low relative to the production coupons I think its just over 480.
Chris Shaw: The bottom line is the convexity risk on our portfolio.
Chris Shaw: Has it.
Chris Shaw: Gotten worse, given the 100 basis point rally over the last quarter, but it's still very low and very manageable you know generally speaking sourcing convexity through pool selection.
Chris Shaw: You know, it's still very attractive.
Chris Shaw: We did add a small receiver option during the quarter as vol traded lower but implied vol. Is still you know is still relatively you know, it's still very high relative to historical norms and so.
Peter J. Federico: We just don't feel like we're being pressured to do that, because, like we said, we talk about the spread staying relatively stable in this area, so we can be patient and disciplined as we deploy capital. But you're 100% right. The key point of my prepared remarks was the fact that the more times that you hit the upper end of the range, and the more times that holds true, it gives you greater confidence that you're starting to understand the flow of demand for mortgages at different rate levels. And so it does give you greater confidence, which will ultimately feed into your risk position and our ability to manage our levered portfolio. When the market was very destabilized, when there was a lot of uncertainty about the Fed, you have to think about your leverage on a volatility adjusted basis, and all the other things equal that will tell you that, you know, per unit of risk, you have to operate with a lower, lower amount of risk or lower leverage. What you're describing is an environment where things will start to go the opposite way.
Chris Shaw: We're likely to manage the negative convexity on the portfolio you know simply through Delta hedging in this environment and through asset selection on the pool side, which almost always is cheaper than buying explicit protection on rates through the options market.
If implied volatility declines materially.
Chris Shaw: You could see us do a little more on the on the right option side, but over the you know for this environment, you know convexity risk very manageable.
Speaker Change: Largely through Delta hedging and asset selection and just just to add to that Rick you know when you. When you look at that page 23, you can see we provide our positions in those coupons and you could see that.
Richard B. Shane: The biggest positions are really into five and five and a half.
Richard B. Shane: Coupons. So you think about those positions relative to the current mortgage rate, which is still between six and a half of 7% to Chris's point.
Peter J. Federico: Per unit of risk, you can actually take a little bit more risk as you get more and more confident that the spread range is going to be stable. So it's an important point, and that will develop more over the course of 2024. Great, thank you. Sure, thank you for the question. Our next question comes from Bose George from KBW. Please go ahead with your question. Everyone, good morning.
Richard B. Shane: You know we've moved in a sense, where we're more exposed to the middle coupons as opposed to the highest coupons. So we still have a lot of room to rally in the mortgage rate before those refinance.
Speaker Change: The other the other thing I would also just real quick would add as you know when you look at the percentage of specified pools in some of those higher coupons look at the you know the end notes on the composition.
Speaker Change: 47% on average specified pools, but the next 'twenty actually close to 30% of the portfolio is also in pools with favorable convexity characteristics Theyre just not the low loan the lowest slow unbalanced cuts. There say you know specified pool characteristics like low FICO certain.
Peter J. Federico: Actually, on your earlier question on spreads, you know, Peter, you gave kind of the longer near-term range of expectations. Now, can you just talk a little bit about, you know, the longer-term range once, you know, volatility comes down, you know, where you think things could kind of settle eventually? That's a great question, Bose.
Peter J. Federico: And I think there are two things that really could drive the markets. And one is that we don't exactly know what the Fed's ultimate balance sheet is going to look like with respect to its composition of mortgages and treasuries. Now, what we know from the Fed right now is that they're likely going to stop the runoff of their portfolio. It depends.
Geographies investor or a second homes modified pools. So you know there we do have a you know the again the call risk on the portfolio.
Speaker Change: In the current environment is very manageable given the composition of our holdings.
Speaker Change: Got it yeah, and it's interesting when you look at the portfolio in aggregate.
Peter J. Federico: There are a lot of different estimates right now, but I think one of the big changes that have occurred in the fourth quarter, particularly in December, is that the Fed has now made it clear that they will have to stop tapering, probably sooner than any of us had anticipated. I know it was sooner than I anticipated.
Speaker Change: Agree with you, 100% and definitely note the concentration in the fives in the fives and has a very slight amortized cost premium there I was just more curious on.
Speaker Change: Sort of a tale of a six and the six or has there is more premium and perhaps a little bit more risk in this particular environment.
Peter J. Federico: I anticipated the runoff to stop in 2025, and now I'm pretty confident it's gonna stop in 2024. But we don't ultimately know what the composition of the portfolio might be with respect to mortgages and treasures. I think it would be in the best interest of the market if the Fed ended up, because they are permanently going to hold mortgages or permanently have a balance sheet that's going to be significant in size. I think it would make sense from a monetary policy perspective for them to own both mortgages and treasuries because mortgages in the housing market are so fundamental to housing policy. We've seen that when they tried to accelerate the economy by keeping mortgage rates low, and we've seen them try to slow the economy down by keeping mortgage rates high.
Speaker Change: But yeah I mean, the last thing I'd say on you know just sort of a prepayment environment I mean, when you step back you know obviously the vast majority of the universe has almost no incentive to refinance you know 98% of the universe, but the origination over the last four or five months, there's going to be very.
Speaker Change: Interesting.
Just to observe speeds given the that on average you know that that cohort will have a 50 ish basis point.
Speaker Change: Incentive to refinance and lenders certainly have capacity, they're probably likely going to be willing to work then to capture what little volume there is.
Speaker Change: You know and so that would argue for pretty fast speeds on the highest coupons that were originated you know call. It through the August through November time frame.
Peter J. Federico: So they're inextricably linked together, and I think it makes sense for the Fed over the long run. So that's going to be an important development; we'll change spreads. The other, Bose, away from that, is the more longer-term fundamental that both the agency MBS market and the US treasury market face, which is that there's this transition to a greater share of private capital that has to come into both of these markets over, say, the next five years. Because if the Fed does, in fact, continue to reduce its balance, the organic supply of mortgages plus Fed runoff will be a At the same time, we know now that the Treasury is going to have to issue perhaps a couple trillion new Treasuries a year.
Speaker Change: But there are other arguments as to why you know the S curves could be could be quite a bit flatter as well.
Speaker Change: You know relative to what we saw in 2020 and 21.
Speaker Change: Yeah.
Speaker Change: Yeah, I'm guessing this three and a half some floors are going to be on the books for a really long time. Thank you for taking my questions guys.
Speaker Change: Thank you.
Speaker Change: And ladies and gentlemen, our last question today comes from Eric Hagen from <unk>. Please go ahead with your question.
Eric Hagen: Hey, Thanks, good morning.
Eric Hagen: Just a follow up on maybe the liquidity you know how are you guys thinking about the amount of liquidity you're comfortable holding at these spread levels versus.
Peter J. Federico: So we're talking about multiple trillions of dollars that have to be consumed, not by levered buyers but by unlevered buyers, real money flowing into the US fixed income market for these two high-quality assets, both agency MBS and Treasuries. And I think spreads when you think about an agency MBS, which has explicit government support behind it, at 150 basis points, for argument's sake, over a Treasury, which is government guaranteed, but in a sense, they're both government guaranteed securities, 150 basis points of incremental spread is really a significant amount of spread, particularly if the 10-year is at, say, 3% or 4%. You're talking about a 25 or more percent improvement in your yield.
Eric Hagen: You know when spreads were wider and maybe how does that amount of liquidity kind of play into the amount of leverage you are comfortable with a different spread levels on shape of the curve and all that.
Speaker Change: Yeah, well it certainly does I mean look what we've learned over the last couple of years is that just generally speaking the liquidity in the bond market both for U S. Treasuries and agency MBS is not what it used to be.
Speaker Change: With the fed.
Speaker Change: Changing its balance sheet with the amount of regulation post great financial crisis, we now know that.
Speaker Change: The major support.
Speaker Change: Source of demand for both treasuries and.
Speaker Change: In mortgages can be money manager bids, which tend to be very volatile and directional with interest rates. So we know that the market is less liquid than that that obviously matters from a liquidity perspective, and we're always trying to do is put ourselves in a position where we've never been obviously forced to delever. We've always wanted to manage our <unk>.
Peter J. Federico: So I think it's going to bring investors into the agency MBS market. I think it's going to be a reallocation out of Treasuries into agency MBS, and out of corporates into agency MBS. And the final important point, which will drive spreads, which could be a factor that makes spreads ultimately lower, but we won't know yet, is what happens with bank regulation. And if banks have to, for example, manage their interest rate position on their securities portfolio, it's much more likely that they're going to want to own mortgages or agency MBS in that environment, because there you can actually buy a longer-term security, hedge the It won't make sense for banks to own treasuries and then hedge the interest rate risk. There'll be no return on that.
Speaker Change: Quiddity position such that when you get to extremes in interest rates and spreads you're still comfortable holding positions that doesn't mean that we're not going to make decisions because at those times where.
Speaker Change: Where we think Theres still you know the environment is changing but.
Speaker Change: From where we sit right now we're in a really efficient positioned from a capital position and you can see that in the percent of unencumbered that we have that gives us a lot of flexibility to operate with higher leverage and still be and still have have a liquidity position that's consistent with where we've operated historically so we're always trying to refer.
Speaker Change: Fine and improve the efficiency with respect to our capital position and our undercover so we're able to operate with incrementally higher leverage with in a sense. The same amount of unencumbered capacity to withstand these episodes that the market does go through where you have sort of gaps in bids and volatility spikes and you have to.
Peter J. Federico: So those are all longer-term factors that will have to develop over time, which will drive where spreads ultimately are. But one of the reasons why I think they're going to stay high is because there is this need for a lot of capital to flow into the treasury and agency MBS. Okay, great. Very helpful.
Peter J. Federico: Thanks, Peter. Actually, I just wanted to follow up on the book value update quarter to date. You know, just the way we track it, it looked like spreads, you know, at least versus swaps, they widened a little bit across the curve. So, you know, just curious with your book value up whether there were other factors. Should we look more at Treasury swaps or, you know, just any color that would be? Yeah, what I would say is, obviously, we have a little bit of a different duration position now. Our duration position is really neutral in the current environment.
Speaker Change: To be able to endure those environments and now what we're learning is they happen they're going to continue to happen, but also if you're well positioned for them you can wait it out and ultimately the market will return back to normal levels and that's what we're seeing now so it gives us greater confidence going forward and we'll be able to adjust our our leverage position accordingly for.
Speaker Change: That.
Speaker Change: Yep. Thank you guys so much.
Speaker Change: Alright, Thank you okay.
Speaker Change: And ladies and gentlemen, with that we'll conclude today's question and answer session I'd like to turn the floor back over to Peter Federico for any closing comments.
Bernice E. Bell: Our book value was up, as Bernie mentioned, 1% to 2%. The coupon distribution of our portfolio helped us. And obviously, the combination of swaps versus treasuries in our portfolio helped us, and the yield curve also helped us a little bit this quarter. So not much of a change in book value, but generally possible. Okay, great.
Peter J. Federico: Again, thank you all for participating on our call today, and we look forward to speaking to you all again at the end of the first quarter.
Speaker Change: And with that ladies and gentlemen, we will conclude today's conference call. We thank you for attending today's presentation. You may now disconnect your lines.
Thanks. Our next question comes from Trevor Cranston from JMP Securities. Please go ahead with your question. Eric Hagen.
Speaker Change: Okay.
Morning. Can you talk a little bit more about the movement in the duration gap positioning during the quarter and the decision to, you know, shift to a slightly negative position? Yeah, I think as a second part of that, if you can maybe comment on whether you think, going forward, agency spreads are likely to remain correlated with the directionality of rates. Oh yeah, that's a really good question.
Let's start with that because that's really a significant factor and that's going to ultimately dictate... To a large extent, where we operate from a duration gap perspective, is what do we think mortgages are going to do with respect to interest rates and that correlation? Chris can talk a little bit about how that correlation has been and what we expect it to be going forward and what that means from a hedging perspective. Yeah, so as Peter mentioned, our duration gap, you know, as of today, is slightly positive, right around zero, given the move higher in rates since year end.
You know, but given the shift in sentiment with rate cuts now on the horizon, mortgages are trading shorter than they did, you know, last year, much of the last year and a half, relative to model durations, which makes sense as some of the higher rate tail scenarios have been sort of clipped or have become less probable. And so given that, you know, mortgages can trade to shorter durations, and with our portfolio having, you know, somewhat more call risk than extension risk, we're likely to try to maintain, you know, a near zero to slightly positive duration gap in the in the current environment. You know, I'd say, you know, fast forward in other six to 12 months, and if we find ourselves at rate levels with, you know, significantly, you know, lower rate levels with significantly more refinancing activity and the Fed still running off its portfolio, then I think a case could be made for running, you know, a significantly longer duration gap is, you know, mortgage supply, both organic and Fed runoff would be, you know, much more sensitive or spreads would be much more sensitive to rate levels with spreads likely widening in a rally tightening into a sell off, you know, but for moderate moves in rates from here over the near term, you know, I think spreads are less correlated with rates than they have been for the last year or so. And so we're likely to try to maintain, you know, close to a zero duration gap to a slightly positive duration gap over the over the near term. Kronenberg.
Got it. Okay, that's very helpful. Thank you. And our next question comes from Rick Shane from J.P. Morgan. Please go ahead with your question.
Thanks, guys, for taking for taking my questions this morning. Look, you talked a little bit about call risk within the portfolio. When we look at slide 23, there are probably twice as many coupons on there as there were three years ago. The issue is that Stack gets bigger and bigger, and we're in this incredibly strange environment.
There's much, much more concentration of call risk at the higher coupons. You guys were pretty deliberate about moving up the stack and being willing to realize losses when prices were moving. Should we expect that you will start to realize some gains?
And again, I realize it's sort of indifferent economically, but will you start to move back down the stack in order to mitigate some of that call risk? Yeah, sure. I'll let Chris talk about that. Yeah, I mean, our weighted average coupon is still quite low relative to the production coupons. I think it's just over 480.
You know, the bottom line is the convexity risk on our portfolio has, you know, gotten worse given the hundred basis point rally over the last quarter, but it's still, you know, very low and very manageable. You know, generally speaking, sourcing convexity through pool selection is still very attractive. You know, we did add a small receiver option during the quarter as vol traded lower, but implied vol is still, you know, is still relatively, it's still very high relative to historical norms.
And so, you know, again, we're likely to manage the negative convexity on the portfolio simply through Delta hedging in this environment and through, you know, asset selection on the pool side, which, you know, almost always is cheaper than buying explicit protection on rates through the options market. You know, if implied volatility declines maturely, you could see us do a little more on the, you know, rate option side, but over the, you know, for this environment, convexity risk is very manageable, you know, largely through Delta hedging and asset selection. And just to add to that, Rick, you know, when you look at page 23, you can see, you know, we provide our positions in those coupons, and you can see that, you know, the biggest positions are really in the five and five and a half coupons.
So you think about those positions relative to the current mortgage rate, which is still between six and a half and 7%, to Chris's point. You know, we've moved in a sense where we're more exposed to the middle coupons as opposed to the highest coupon. So we still have a lot of room to rally in the mortgage rate before that. The other thing I would just real quick add is, you know, when you look at the percentage of specified pools in some of those higher coupons, look at the, you know, the end notes on the composition, you know, so 47% on average, specified pools, but the next 20, actually close to 30% of the portfolio is also in pools with favorable convexity characteristics. They're just not the lowest loan, the lowest loan balance cuts; they're, you know, specified pool characteristics like low FICO, certain geographies, investors, second homes, modified pools.
So, you know, there, we do have a, you know, the, again, the call risk on the portfolio, you know, at, in the current environment is, is very manageable given the composition of our whole. Got it. Yeah, it's interesting. When you look at the portfolio in aggregate, I agree with you 100% and definitely note the concentration in the fives and the fives and a half, very slight amortized cost premium there. I was just more curious on, you know, sort of the tail, the fix in the six and a half, there is more premium and perhaps a little bit more risk in this particular environment. Yeah, I mean, the last thing I'd say on, you know, just sort of the prepayment environment, I mean, when you step back, you know, obviously, the vast majority of the universe, you know, has almost no incentive to refinance, you know, 98% of the universe, but the origination over the last, you know, four or five months is going to be very interesting, you know, just to observe speeds given that on average, you know, that that cohort will have, you know, a 50 ish basis point incentive to refinance and, you know, lenders certainly have capacity, they're probably likely going to be willing to work thin to capture what little volume there is, you know, and so that would argue for pretty fast speeds on on the highest coupons that were originated, you know, call it through the August, you know, through November timeframe. But there are other, you know, arguments as to why, you know, the s curves could be could be quite a bit flatter as well, you know, relative to what we saw in 2020. Yeah, I'm guessing those three-and-a-halfs and fours are going to be on the books for a really long time.
Peter J. Federico: Thank you for taking my questions. Thank you. And ladies and gentlemen, our last question today comes from Eric Hagen from BTIG. Please go ahead with your question. Hey, thanks. Good morning. Just to follow up on maybe the liquidity, you know, how are you guys thinking about the amount of liquidity you're comfortable holding at these spread levels versus, you know, when the spreads were wider, and maybe how does that amount of liquidity kind of play into the amount of leverage you're comfortable with at different spread levels and the shape of the curve and all that. Yeah, well, it certainly does.
Peter J. Federico: I mean, look, what we've learned over the last couple of years is that, just generally speaking, the liquidity in the bond market, both for US Treasuries and agency MBS, is not what it used to be. With the Fed changing its balance sheet and the amount of regulation post-great financial crisis, we now know that the major source of demand for both treasuries and mortgages can be money manager bids, which tend to be very volatile and directional with interest rates. So we know that the market is less liquid, and that obviously matters from a liquidity perspective. And what we're always trying to do is put ourselves in a position where we're never clearly forced to delever. We always want to manage our liquidity positions such that when we get to extremes in interest rates and spreads, you're still comfortable holding positions.
Peter J. Federico: That doesn't mean that we're not going to make decisions because, at those times when we think they're still, you know, the environment is changing, but from where we sit right now, we're in a really efficient position from a capital point of view, and you can see that in that percent of unencumbered that we have. That gives us a lot of flexibility to operate with higher leverage and still have a liquidity position that's consistent with where we've operated historically. So we're always trying to refine and improve efficiency with respect to our capital position and our undercumbered, so we're able to operate with incrementally higher leverage with, in a sense, the same amount of unencumbered capacity to withstand these episodes that the market does go through where you have sort of gaps in bids and volatility spikes, and you have to be able to endure those environments.
Peter J. Federico: And now, what we're learning is that they happen, they're going to continue to happen, but also, if you're well positioned for them, you can wait it out, and ultimately, the market will return to normal levels, and that's what we're seeing now. So it gives us greater confidence going forward, and we'll be able to adjust our leverage position accordingly for that.
Peter J. Federico: Thank you guys so much. All right. Thank you. Take care. And ladies and gentlemen, with that, we'll conclude today's question and answer session. I'd like to turn the floor back over to Peter Federico for any closing remarks. Again, thank you all for participating in our call today, and we look forward to speaking to you all again at the end of the first quarter. And with that, ladies and gentlemen, we'll conclude today's conference call. We thank you for attending today's presentation. You may now disconnect your line.