Q1 2024 AGNC Investment Corp Earnings Call
Good morning, and welcome to the H E N C investment corporate.
First quarter 2024 shareholder call.
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I'd now like to turn the conference over to Katie Turlington and Investor Relations. Please go ahead.
Thank you all for joining agency investment Corp, first quarter 'twenty 'twenty four earnings call before we begin I'd like to review the Safe Harbor statement.
This conference call and corresponding slide presentation contains statements that to the extent they are not recitations of historical fact constitute forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995.
All such forward looking statements are intended to be subject to the safe Harbor protection provided by the Reform Act actual outcomes and results could differ materially from those forecast it to be.
Impact of many factors beyond the control of agency <unk>.
All forward looking statements included in this presentation.
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&T is periodic reports filed with the Securities and Exchange Commission.
Copies are available on the Sec's website.
C C dot Gov weed.
We disclaim any obligation to update our forward looking statements unless required by law.
Participants on this call include Pete.
Peter Federico.
Speaker Change: 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 Vice President Non agency portfolio management, and John 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 earnings call.
GNC generated a strong economic return of five 7% in the first quarter driven by a combination of a compelling dividend and book value appreciation.
On our earnings call last quarter, we talked about our growing confidence that the difficult transition period for agency MBS was nearing its conclusion.
A durable and favorable investment environment for AT&T was slowly emerging.
We highlighted our belief that short term rates had peaked for this tightening cycle that.
Net interest rate volatility would decline and that agency MBS would remain in this new more attractive trading range.
These positive dynamics were all present to some degree in the first quarter and will ultimately drive a gnc's performance over the remainder of the year.
With respect to monetary policy, there were both positive and negative developments in the quarter.
On the positive side, there was a growing consensus amongst fed members regarding the level and direction of short term interest rates.
Speaker Change: As reflected in the March minutes.
Participants judge the policy rate was likely at its peak for this tightening cycle and almost all participants noted that it would be appropriate to move to a less restrictive monetary policy stance. This year, if the economy evolved as expected.
And his testimony before Congress chairman Powell characterized the fed's position as waiting for a bit more data and that rate cuts may not be far away.
Importantly, the study also indicated that it would reduce the pace of run off on our treasury portfolio at an upcoming meeting.
This initial balance sheet action is a positive development for fixed income investors.
The negative development was stronger than expected economic data.
Inflation indicators did not show the continued decline that the fed was hoping for.
And growth in labor readings remained surprisingly robust.
As a result, the timing and magnitude of future rate cuts became considerably more uncertain.
The interest rate environment during the quarter was generally positive as interest rates increase gradually across the yield curve.
Interest rate volatility also declined meaningfully during the quarter.
Against this backdrop agency MBS performance across the coupon stack was mixed with spreads on lower coupon securities widening in spreads on higher coupon securities tightening.
Also noteworthy agency MBS spreads remain in the same well defined trading range.
Red volatility declined meaningfully.
Speaker Change: In fact in the first quarter spread volatility was 20% to 30% lower than what we experienced last year.
The supply and demand technicals for agency MBS were also favorable in the first quarter.
Seasonal factors and affordability issues significantly curtailed origination activity.
At the same time bank demand proved to be greater than expected.
This uptick in bank demand was in part due to a view that Basel three would be substantially revised.
Collectively these factors drove our favorable first quarter results.
That said periods of market turbulence are to be expected given the evolving nature of monetary policy.
April is a good example of such an episode.
After a period of relative stability in the first quarter benchmark interest rates and volatility increased sharply due to less optimistic inflation expectations and escalating geopolitical risks.
Against this backdrop agency MBS spreads widened meaningfully but remained below the midpoint of the recent trading range.
Absent further adverse inflation developments, which caused the fed to change the direction of monetary policy. We believe this period of fixed income market turbulence will be relatively short lived.
Looking beyond the recent downturn.
Long term fundamentals for agency MBS continue to be favorable and give us reason for optimism.
With absolute yields above 6% and backed by the explicit support of the U S government.
Agency MBS are appealing to an expanding universe of investors.
Moreover, its monetary policy evolves largely as expected interest rate volatility will decline the yield curve will steepen and quantitative tightening will come to an end.
The specific timing of fed rate cuts is not critical to the long run performance of agency MBS.
Is it highly liquid pure play Levered agency MBS investment vehicle.
We believe a GNC is well positioned to benefit from these favorable investment dynamics as they evolve over time.
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: The first quarter, a GNC had comprehensive income of 48 cents per share and generated an economic return on tangible common equity of five 7%, which included 36 cents of dividends declared per common share and a 14th increase in tangible net book value per share.
As Peter mentioned the investment environment has been more challenging in April.
With longer term interest rates moving sharply higher in agency MBS spreads widening 10 to 15 basis points across the coupon stack.
At the worst point late last week, our tangible net book value was lower by about 8% after deducting our monthly dividend accrual.
Leverage as of the end of the first quarter increased modestly to seven one times tangible equity compared to seven times as of Q4, while average leverage for the quarter decreased to seven times from seven four times in Q4.
Net spread and dollar roll income for the quarter remained strong at 58 cents per share the modest decline of two cents per share for the quarter was due to a decrease in our net interest spread of 10 basis points to a little under 300 basis points for the quarter as higher slot swap costs more than offset the.
And the average asset yield on our portfolio.
Consistent with higher interest rates the average projected life CPR for our portfolio at quarter end decreased to 100 basis points to 10, 4%.
Actual CPR for the quarter averaged five 7% down from six 2% for the prior quarter.
In the first quarter. We also successfully raised approximately $240 million of common equity through our aftermarket offering program at a significant price to book premium.
Lastly, what's unencumbered cash and agency MBS of $5 $4 billion for 67% of our tangible equity as of quarter end, our liquidity continues to be very strong.
We believe the substantial liquidity not only enables us to withstand episodes of volatility, but also to take advantage of attractive investment opportunities as they arise.
Bernice E. Bell: And with that I'll now turn the call over to Chris <unk> to discuss the agency mortgage market.
Thank you Bernie stronger than expected economic data during the first quarter led to a material repricing of market expectations for fed rate cuts in 2024, accordingly yields on five and 10 year U S. Treasuries were higher by 36 32 basis points respectively.
In general risk assets handled this repricing well considering the magnitude of the adjustment with the S&P, gaining more than 10% and the Bloomberg investment grade corporate bond index generating an excess return of approximately 90 basis points.
In aggregate the Bloomberg Agency MBS index lag the performance of other fixed income sectors with spreads slightly wider versus U S. Treasuries.
Given the large move in rates the relatively benign magnitude of aggregate underperformance was encouraging as compared to the way that MBS performed last year during similar moves.
The performance of agency MBS by individual coupons varied considerably with spreads on the lowest index coupons widening approximately 10 basis points as the potential for bank supply weighed heavily on these coupons in contrast, higher coupon MBS performed very well during the quarter tightening five to 10 basis points.
<unk> is relatively slow prepayment speeds limited supply and steady fixed income inflows provided a favorable backdrop for these coupons.
Our portfolio increased $3 1 billion from the start of the year to end the quarter at $63 3 billion as of March 31.
During the first quarter, we continued to gradually move up in coupon and optimize our holdings in specified pools versus TBA.
Our TBA position ended the quarter higher at $8 4 billion with Ginnie Mae TBA, representing approximately $5 2 billion as of quarter end.
Our hedge portfolio totaled $56 3 billion as of March 31, and as I mentioned on the call last quarter, we began to gradually shift the composition in favor of a heavier allocation to swap based hedges.
This move benefited our performance during the first quarter as swap spreads widened nine basis points and five basis points at the five and 10 year points on the curb respectively.
As Peter discussed the data dependent nature of current fed policy will likely create some volatility in markets. However, the longer run earnings environment for agency MBS is very favorable with historically widespread low levels of prepayment risk and deep and liquid financing markets I'll now turn the call over to Aaron to discuss.
The non agency markets.
Thank you, Chris well higher rate environments, typically have negative implications for both consumer and corporate credit fundamentals.
Current robust employment landscape continues to bolster our credit performance.
Consequently, fixed income credit generally performed well in the quarter, resulting in positive excess returns across most sectors.
Bernice E. Bell: As an indicator for credit spreads in Q1, the synthetic investment grade and high yield indices.
Adjusting for the role tightened by approximately 10 and 45 basis points respectively.
On the credit fundamentals side, we continue to expect an increasing divergence of consumer performance metrics.
Bernice E. Bell: As we have previously noted U S households have experienced varying degrees of inflationary pressures, but primarily bifurcated between households, with low note rate mortgage debt, who are relatively immune to the higher rate environment and housing and inflationary impacts and renter households, who are not.
As a result, we expect the divergence of credit performance between the two groups to widen with renters at a relatively higher risk of falling behind on obligations, such as rent auto loan payments and credit card debt.
Given our current portfolio construction deteriorating performance for this cohort would be expected to have a negligible impact on our holdings.
Accumulated inflation pressures and prolonged exposure to increase rate levels could however, become a more material issue for a broader group of consumers to the extent they persist for a significant period of time.
Turning to our portfolio the market value of our non agency securities ended the quarter at $1 billion in line with the prior quarter.
Composition of our holdings was largely unchanged, though we did continue to rotate some of our credit risk transfer securities down the capital structure, where we saw relative value opportunity is to improve risk adjusted returns.
Lastly, although asset spreads have continued to tighten presenting a challenge for projected future returns the funding landscape for non agency Securities is currently stable and remains relatively attractive.
With that I'll turn the call back over to Peter.
Thank you Aaron we will now open the call up to your questions.
Okay.
Speaker Change: We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.
You are using a speaker phone please pick up your handset before pressing the keys to withdraw your question. Please press Star then two.
Speaker Change: At this time, we will pause momentarily to assemble our roster.
The first question comes from the line of Bose, George with K B W. Please go ahead.
Everyone. Good morning.
Can you tell me what the level of current spreads and what that implies in terms of incremental rovs.
Sure.
I appreciate the question Bose, yes, as we talked about and Bernie mentioned, you know, we see mortgage spreads across the coupon stack widening somewhere between 10 and 15 basis points really in the month of April.
The middle coupons, you know the five and a half kind of area has been actually the worst performing coupons quarter to date, but when you look at where mortgage spreads are now and they are approaching the middle of the range, but they're still below the middle range roughly you look at the current coupon to the five and 10 year Treasury.
Speaker Change: At the low $1 50 range. If you look at it and importantly to wear five and 10 year swaps are that's more like 185 basis points.
So it depends on what your hedge mix will obviously drive our net interest margin.
The current coupon part of the stack right now, but that would translate to given the way, we hedge mix of swaps and treasuries and leaning more towards swaps and treasuries and just environment.
Could put that initial margin up into 170 to 175 basis point range and operating with the leverage that we typically operate.
Speaker Change: Mid sevens low to mid Sevens currently in this environment, that's still translates to.
Expected are a way of somewhere between call. It 16, and 18% given our cost structure. So mortgages are obviously more attractive than they were at the end of last quarter. The more attractive right now and that that seems to be a pretty compelling level from our perspective.
Speaker Change: Okay, great. Thanks, and then just a related question can you just talk about the comfort level on the dividend.
Yeah.
As you've pointed out in the past it depends on how you look at that calculation and I think you're referring to the dividend yield on our common and that would translate to 17. So you'd have to think about leverage on common. If you wanted to think about it that way and I think if you did that same calculation. We just went through but did it on the common leverage you would end up with the.
And are we are at or above the 17 level I'd like to look at it and we've talked about this it's important given our capital structure and the amount of preferred it's still generating a lot of incremental value for our common shareholders. The average cost of our preferred stock I think in the end of the end of last quarter was around seven in a quarter.
A little higher now given the reset of one of our preferreds, but theres a lot of incremental value. There. So if you think about it from a total cost of capital the amount of common dividends, we pay preferred dividends and our operating costs and you think about that as a percentage of equity at the end of last quarter, I think that came to around 15.7% or thereabouts. So.
I look at the portfolio today at current valuation levels and I think you can see that our dividend level and that total cost of capital remains well aligned.
Okay, great. Thank you.
Appreciate the good questions ship both.
Speaker Change: The next question comes from the line of Rick Shane with J P. Morgan. Please go ahead.
Hey, guys. Thanks for taking my questions. This morning.
Look so one of the interesting facets of the portfolio is the contribution from swaps.
Over the next 12 months, you have eight and a half billion dollars notional.
Speaker Change: Hum.
Rolling off.
Those swaps essentially contribute about 20% to 25% of your spread income.
As you look forward given the opportunity how do you replace that run off.
Yeah appreciate the question rich.
Yeah, I think I didn't hear the actually the first part of your question, but I think you were talking about swap spreads and swap spread performance to some extent and that was an important driver.
Of of performance because swap spreads tightened a lot, but when you think about our net interest margin. We've talked a lot about this our net interest margin has remained really really robust less last quarter was 200, and 298 basis points and that is not consistent with the economics that we just went to if you think about that net interest margin at <unk>.
300 basis points, and you divide that and think about that from an ROE perspective, you're going to get in our way of 'twenty, five 'twenty, 6% or take our net and net spread and dollar roll income and divide that by our common equity, which would be consistent with that 300 ish basis points of net interest margin you're going to get in our way of 25, 26%.
The economics of our business as we just talked about are in the mid to high teens.
What's going to happen over time is as those swaps run off and Youre right. We have about eight and a half billion still maturing we had about 5 billion mature by the way in the second in the first quarter and that contributed to somewhat that that slight decline in our net interest margin.
Those will roll off over time, and our net spread and dollar roll or our net interest margin because of those swaps rolling off will come down.
Those are there are other factors, though that you got to consider so it's not it's not it's not.
As easy as just those swaps rolling off we will put other swaps on that have positive carry on them. If you put on a longer term swap today, it's still positive carry by take for example, the 10 year by 150 or so basis points.
And also our asset yield is still below.
Market yields our asset yield is still 25 to 30 basis points below market deal. So as Christian team roll the portfolio over and we continue to move our assets around and we'll end up seeing some uptick in our asset yield like you saw last quarter.
But over time that net interest margin over a longer time will come down more in line with the economics of our business. So that's what that's what that's what you'll see over the next several quarters to years as old swaps roll off new swaps come on assets get replaced net interest margins should come back down.
In alignment with the economics of our business, which is really the mark to market yield that we just talked about in the previous question.
Got it yeah and that that really does get to the punchline, which is that as you're looking forward to all of those factors, that's really what's dictating the dividend policy and.
Yeah, Yeah yeah.
I appreciate that clarification, that's exactly right is setting the dividend policy based on the level of return from an economic perspective, they were seen as opposed to the current period earnings.
That gets reflected in our net interest margin.
Okay. Thank you very much.
Sure I appreciate the question.
Our next question comes from the line of Terry MA with Barclays. Please go ahead.
Monetary, saying hey, good morning, Thank you.
So you mentioned that you thought the recent volatility would be short lives can you, maybe just give a little bit more color on what gives you confidence that it will be short lived and then maybe just your expectations on where near term spreads will settle once the volatility.
This near shore.
Sure both Christian and I tried to address this to some extent in our <unk>.
Our prepared remarks.
And I think Chris referenced the fact that this quarter.
Looked a lot different than previous quarters. When we had similar moves in that that's really a critical point from our perspective.
What occurred in the first quarter was generally a very stable market conditions, but there was a very significant repricing of the timing and magnitude of short term rate moves from the fed.
Importantly, it was not a shift and has not yet become a shift in paradigm with respect to monetary policy said another way. The study was really clear and a number of communications that the policy rate was likely at its peak and the next move was likely going to be in as what we had in the first quarter.
It was simply a plateauing.
C. P. I data it came in at three nine and then three eight and three eight again it just didn't show the improvement that the fed was looking for and then in the two or three days following each of those C. P. C. P. I reports the 10 year Treasury moved up 20 to 25 basis points and it sense taking out one E.
When we started the year the market probably incorrectly so maybe too optimistic expected deferred to age five or six times.
Speaker Change: Now as we sit here today.
The market has re priced to only one and a half moves this year.
And importantly in aggregate the fed funds futures in 2027 tell us there's only six moves in total.
Meaning that the fed funds rate now according to the market projections is going to settle out at around 4% that's materially higher than what the feds own long run target is which is still two and a half so.
What we had occur it's a very significant repricing of the path of short term interest rates, we did not have a paradigm shift.
If inflation continues to not involve or reuse reaccelerate there could be a shift in monetary policy. We don't believe that's going to happen, we get important inflation data at.
At the end of this week and the P. C E report.
But we believe and I think the fed still believes that inflation will show signs of improvement, we will move more toward defense long run target, which by the way the feds own estimate of P. C. At the end of this year, it's 2.6% that's not gonna be materially off where the number comes out at the end of this week.
<unk>.
And with that projection to fed expected three minutes. So we think that where the 10 year is at call. It four and a half to four and three quarters that seems like a pretty healthy place for the 10 year in the context of <unk>.
Fed funds target, that's ultimately going to move to 3%. We think the inflation report will will ultimately come in favor direction deferred once and I think this repricing has simply been just a healthy movement of where short term rate cut.
Cuts are going to occur in the magnitude of those not a paradigm shift and so.
Spreads moved we had a lot of geopolitical risk we had volatility following inflation reports, if we get two or three inflation reports that are at or better than expected. We will have the same sort of significant repricing in the opposite direction I think the fed is looking for two or three months in a row.
Of better data to have sufficient confidence and once they get that data then everybody will be pricing in the east is again and the direction of monetary policy will be clear again right now it's a little uncertain, but we think we think the repricing is largely over with respect to spreads you asked that.
Again, when you look at current coupon spreads.
Near the middle of the range that seems like it seems like a good place from our perspective you know.
Current coupon to the five and 10 year Treasury at 115 to 160 basis points seems like a healthy place against swaps 180 to 190 seems like a healthy place we do have some.
Some negative seasonal right now between the next April and May should be you know kind of the worst seasonal months for mortgages in terms of origination so all of them.
Speaker Change: Market sort of I think is in a good place right now with the repricing that has taken taken taking place.
Got it thank you very helpful color.
Then just on your hedge ratio and your duration gap you guys took the hedge ratio down and you're now running a slightly positive duration gap. So maybe just a little bit more color on that move and then talk about where you're comfortable running the book and in this environment.
Sure.
Well I've talked about this for a while.
It does makes sense for us to gradually move our hedge ratio down as the fed's monetary policy outlook changes, we obviously wanted to run with a very high hedge ratio more than 100% of our short term debt essentially termed out in order to protect our funding costs and a rising short term rate environment were now at.
The inflection point and so over time, I would expect that to come down and as we get more confidence.
When and the magnitude of the fed cuts then will ultimately probably operate with even a lower hedge ratio such that at some point in the monetary policy easing process, we would want to operate with and have sent some percent of our short term debt unhedged.
Have that a bigger part of our funding mix. So over time, we'll do that Chris mentioned all.
And I'll, let him speak to this he he mentioned are our gradual movement to more towards swaps in our hedge mix and I think we have a sort of a crowd positive outlook, Chris you want to talk a little bit about that yes.
So.
Our funding is obviously sulfur based and so logically you know we want to have generally a more significant portion of our hedges and software based swaps, which you also have better carry but over the last couple of years. The bid for mortgages was was highly correlated with treasuries given the dominant investor base, where index funds as opposed.
The banks and so it made sense to have a more sizable component of our hedge book and Treasury based.
Hedges.
U S. Treasury issuance was also extraordinarily high at a time when banks were not in a position to grow their securities holdings, and so that had the effect of a cheapening treasuries versus swaps and now with bank deposit stabilizing in Q T wakely, drawing to it and we're gradually moving our hedge book to have a higher concentration.
<unk> swap based hedges, but this will be a gradual shift and want to maintain diversification within our hedge portfolio composition, just as we do on the asset side.
Okay, great. Thank you.
Sure. Thanks for the question.
Our next question comes from the line of Crispin Love with Piper Sandler. Please go ahead.
Good morning. Thanks. Good morning, I. Appreciate you taking my question and thanks. Good morning, Peter I'm just looking at fund flows bond flows have been very positive government fund flows have been positive as well, which have positive implications for for agency, but it only tells part of the story. So can you speak to what you're seeing on the flow side, who are the major buyers right now of agency MBS.
I think you mentioned a little bit about banks coming back in the first quarter, but do you think some recent rate moves could keep some of them on the sidelines for a bit.
Speaker Change: Yeah, well, we certainly did see that you're right. If you look at the and this is part of the reason why.
Didn't feel like a paradigm shift and why the first quarter was not nearly as disruptive. Despite the amount of repricing that took place because bond fund flows generally stayed positive throughout the quarter. There was probably a week or two where they actually got to zero, maybe negative, but there was never really any big movement out of bond flows like we saw.
At different times last year. So the bond fund flows continue to be neutral to positive I think we're also starting to see outside the bond fund complex inflows into mortgage backed securities. Those flows are obviously hard to.
Quantify I think they I think they they they are evident and particularly if you look at the way the mortgages performed across the coupon stack were lower in the first quarter were lower coupons underperformed and higher coupons to current coupon on it.
Really above the $6 six and a half in particular actually tightened down in the quarter I think that shows you that there's new demand for those sort of high yielding securities with the backup that we have the current coupon now at around 6.25% that again looks really really attractive to treasuries.
It also looks really attractive to investment grade corporates that spread is again widened out to around 30 basis points of mortgages look cheap to investment grade.
Speaker Change: Corporates current coupon in particular or the highest yielding ones. They look cheap to treasuries I think the credit quality, obviously backed by the support of the U S. Government helps in an environment, where the economy's ultimately slowing so I think those are going to continue to drive.
Demand for agency mortgage backed securities not so much on a levered basis, but actually on an unlevered basis and that is a really positive long run fundamental so.
I think that's I think that trend is going to stay in place for a while they just do those those reallocations tend to take time for slow moving reallocations.
Speaker Change: Great. Thanks, Peter I appreciate you taking my question.
Our next question comes from the line of Doug Harter with UBS. Please go ahead.
Good morning, Doug.
Good morning.
The way you've kind of described the market you know how are you thinking about continued capital raises and the attractiveness of that opportunity.
Yeah. Appreciate the question well, obviously, we always look at it through the lens of our existing shareholders first and foremost and as Bernie mentioned, we were able to raise capital through our at the money program at the market program.
Very accretively in the in the first quarter and we'll continue to look at those opportunities. The first quarters is a really good example of one.
One the cost effective nature of that.
Capital issuance to book value accretion that that can be generated by it but also the flexibility that affords us as Chris mentioned, we added about three little over $3 billion worth of mortgages in the quarter and if you think about that given the amount of capital raised were able to deploy those proceeds immediately into the mortgage market.
About half of those purchases if you will went toward leveraging that new capital immediately so.
Theres no drag from a dividend perspective, it's accretive to book value.
That translates to value for our existing shareholders will continue to look for opportunities to do that like.
Speaker Change: I like mortgages better obviously it at this level mortgages did spend a lot of time in the first quarter near the tighter end of the range, which gave us a little bit of pause, but it will continue to be opportunistic with and if we can generate a existing value. If we can generate value for our existing shareholders through our capital markets activities, we will certainly.
Look to do that.
And then what you're getting.
Speaker Change: Interesting contrasts blended measure given that I'm sorry, Doug go ahead.
Yeah, No sorry, and if you could just contrast that with you know kind of how you see leverage today.
And you know kind of how you know how how to leverage might move around given.
What kind of book value weakness, but also the ability to add it.
Speaker Change: Protecting and or add new assets.
Yeah, well, we certainly have a lot of capacity the way I would describe it today a lot of flexibility and I think that's appropriate because we're moving in that sort of made this in.
In my initial remarks that we're moving in a positive direction, but we're still moving essentially in that direction slowly and theres going to be volatility along the way and we want to we want to be disciplined with our capital deployment and our leverage because monetary policy is still evolving there is lots of variables that are going on.
Drive deferred.
Over time, we're going to get more clarity and there may be a time, where we have even more confidence in the outlook, but our confidence is growing we have a lot of as Bernie mentioned, we have a very strong liquidity position of $5 4 billion as a percent of equity I think maybe it was one of our highest points this last quarter.
We're at 67% do you think about that on assets is over 8%. So we have a lot of capacity, but we also want to be disciplined and what's important about the outlook from our perspective is that we think we're entering a period that's going to be from a long term durable attractive investment opportunity. So we don't feel any rush.
<unk> to deploy.
Deploy capital we feel like we can be disciplined and we feel like we can continue to be opportunistic like we were in the first quarter and so the environment is going to evolve over time, our confidence will grow.
Mortgage spread behavior within the trading range is important and I think what we're starting to see some consolidation in that spread which I think is a healthy development for the market said another way.
Yeah.
For mortgages to move to the high end of the range I think it's becoming more challenging for that to occur.
And there's growing reasons why mortgages can trade at the lower end of the range. We just haven't seen them all evolved fully yet, but we'll see that over time and we'll see how the economy unfolds over the next three to six months and how the fed's behavior and the fed outlook changes, that's really going to be the key driver for the fixed income market.
What happens to monetary policy because once the fed starts to ease I think ultimately the mark.
Well priced the fed move in the fed funds rate all the way back to 3%, but they have to start that move pull up a place of confidence and the market doesn't have that confidence yet the fed doesn't have that confidence.
Great. Thank you Peter.
Sure I appreciate it.
Our next question comes from the line of Jason Weaver with Jones trading. Please go ahead.
Jason Weaver: Hi, Good morning, I was hoping you could expand a little bit more on Doug's first question. There. The 25 million shares issued during the quarter can you talk a little bit about the timing and coupon deployment of that capital.
In the quarter and subsequently.
I'm, sorry could you repeat the first part of that had a little trouble hearing the question.
So sorry, Peter I was just trying to expand on the answer to Doug's first question.
About the timing of deployment of the ATM issuance you raised in the first quarter.
Well, yeah like I said, the a T M gives us a lot of flexibility.
So we're able to raise money through the through the ATM program and deploy it immediately as Chris mentioned.
You could talk about where we'd like the coupon stack, but that gets deployed really simultaneously almost Peter mentioned the $3 billion increase that was a fair value increase we added roughly 4 billion in agency MBS during the quarter and current face terms.
Majority of which was in the higher coupon 30 year TBA. We also added about 400 million in hybrid arms.
With that sort of weighted.
Throughout the quarter or weighted towards the beginning or in can you can you speak to that.
No.
So we don't give those sorts of details I appreciate the question, but fair enough.
Yeah.
No that's fine.
And.
Here's what were you thinking about the implications for the fed's reduction in Q T and how that might change your yeah folio strategy hedging strategy.
Yeah.
Well as Chris mentioned, just real quickly a couple.
A couple of comments as Chris mentioned, obviously.
The fed is going to move first and significantly with respect to what's your treasury portfolio. So I expect the fed to announce next week at the meeting that they will cut the treasury cap by half.
Jason Weaver: It does not appear based on the minutes that theyre going to make a change at this point to the mortgage capped because the mortgages are running off so far below the actually running off at about that.
Jason Weaver: Half of the cap right now so I don't expect the fed to make a change.
On that but I do expect treasuries to come down and but over the remainder of the year I expect treasury run off caps actually come to come to zero and that is a positive development.
Generally speaking for treasuries versus swaps.
When you think about bank regulation and the fact that bank regulation is going to be less onerous I think that's gonna also pushes too that as Chris mentioned to swap. So I think that's where it has an implication from a from a hedging perspective.
Longer term I think it's still unclear exactly how the fed is going to handle its mortgage portfolio with respect to.
It's changes.
Was it.
Two its balance sheet and this is going to be an important development.
Last week for example.
There was a paper that came out from the open markets desk at the New York Fed where they show two examples of how the fed may approach tapering its portfolio run off and in both those scenarios. They had the mortgage cap getting cut in half now.
Now that won't have any practical impact on the speed of runoff because mortgages for the feds portfolio running off between 17 and $20 billion, but it would have a long term stabilizing effect on the mortgage market. If they did choose a cap structure like that they could still achieve their stated purpose.
Of allowing mortgages to run off and be redeployed into treasuries.
And ultimately over a very long time horizon.
They would be able to achieve the objective of having primarily treasuries, but this is that would be a a sort of.
Jason Weaver: Transfer of mortgages to treasuries that would occur over multiple years.
If they use a lower cap to allow that to happen that could be a positive development for for mortgages will have to wait and see how the fed handles that I don't think we're gonna get that that level of detail right. Now at this first initial move but I think we will get that over time.
Alright, thank you for that.
Jason Weaver: Sure.
Our next question comes from the line of Merrill Ross with Compass point. Please go ahead.
Good morning, and thank you he might not answer this given what you just said.
But did you add to the portfolio into April volatility, particularly in there so you're going to have.
And.
What is the current leverage given the decline 8% declined at Ernie referred to in book value.
Yeah.
I'm, sorry, I didn't hear the last part we have a little bit of a bad connection I think the first part was did we add to the portfolio in April.
What was the second.
The current leverage.
Current leverage yes.
Can you talk a little bit about about mortgages in the current environment, and where he's adding and seeing value with respect to current leverage at a little higher today.
It's actually around 7.7 0.4, given the backup in that.
Asset value and portfolio activity to date.
Anything in particular about.
Jason Weaver: Today's market Yeah with respect to you know we haven't had any material changes in the size of the portfolio quarter to date with respect to relative value within the agency space as I mentioned earlier higher coupons significantly outperformed lower coupons during the quarter in part given concern.
And around bank sales and lower coupons related to some M&A balance sheet restructuring announcements.
Jason Weaver: That were made but also in response to very favorable prepayment reports, but showed considerably flatter.
Refi responses in higher coupons compared with what we saw during the last refi wave during COVID-19 with similar incentives to refinance and so up in coupon benefited from that as well and despite the higher coupons outperforming and I'd say relative value is still generally upward sloping across.
Jason Weaver: The coupon stack.
Mhm.
I have one other unrelated question if you don't mind I'm sure. The series C. That's callable wouldn't you use some of your liquidity I mean, maybe on the margin, it's not really material to you.
Just curious.
Yeah.
That question, we're constantly evaluating our capital structure and you're right. That's that series is callable, but as I mentioned, even though it has reset higher in the coupon on that one is little bit 10, 10 710, 7%.
It is certainly materially higher than our other fixed rate preferreds.
Even at 10.7, given where the returns are on our portfolio that is still in a lot of value there.
Crewing to the benefit of our common shareholders. So we will look for always as we do look for opportunities to optimize that cost of our capital.
The preferred market has been relatively quiet.
Right now so there's not a lot of activity going on and in part because of the rate uncertainty, but I expect that to change over the remainder of the year and there might be opportunities in the preferred market.
Jason Weaver: As we move forward. So we'll continue to evaluate that.
But it but it does generate incremental value right now for our common shareholders.
I believe MSA refinanced a series at nine.
And just yeah just curious.
Speaker Change: Not really.
A really huge relative values okay.
Tend to wait until that kind of thing but.
And they are there and the other important part the other important point about the.
The floating rate preferred obviously is Europe, we're likely at the peak of that of that coupon.
Obviously Dupont can change very very rapidly. So there is a lot of option value in those series right now the fed obviously couple of a couple of quarters or a couple of months of positive inflation data and the forward curve will be materially downward sloping and those coupons could look very attractive and a.
Year or so.
Great.
<unk>.
Sure I appreciate the question.
And our last question comes from the line of Eric Hagen with Pete P. P. I G. Please go ahead.
Good morning. This is actually Jake <unk> on for Eric I. Appreciate you guys, taking my questions Sean.
First one could you flesh out a little bit the outlook you have for prepayment speeds, including how much room, you might see for your forecast a change with mortgage rates kind of coming up recently.
Do you think faster speeds would be a benefit or maybe a headwind on earnings or thoughtful economic return. Thanks.
Sure Chris you want to talk about three things given our coupon composition.
You know slower speeds the prepay reports over the last two months have been some of the more interesting reports than we've had that we've had over the last couple of years.
After spending in December or sort of through the December mid February time frame, it's sort of local lows in mortgage rates with rates.
The rates around six and a half two six and three quarters percent after spending.
The second and third quarter last year originating pools with 7.5% to 8% note rates and so we've got a lot of insight into what the refi response was going to look like on a sizeable population of loans with you know call. It 75 to 100 basis points of incentive to refinance and what we learned was that speeds were quite.
A bit slower than what many had feared and slower than what we observed during COVID-19.
On loans with similar incentives to refinance and so you know this you know as I mentioned has provided a tailwind to higher coupons. It's interesting and I think there are a number of factors that likely contributed.
To the slower response than what we saw during the last refi wave.
So you know slower speeds are favorable for our position.
With respect to the lowest coupons, which are a very small percentage of our holdings.
Even there I'd say turnover speeds have been you know over the last year, a little better or a little faster than what many had feared.
So hopefully that gives you some insight into.
Outlook on stage.
Yeah. It does I appreciate that and then finally, just going back to leverage what is your historical range for leverage fan and do you think that range might change at all if mortgage spreads remain historically wide.
Yeah, I mean look if you look back over a very long history.
Speaker Change: Put these numbers out.
It may be around six or thereabouts and at the highest sprint was probably in the nines.
Nine and a half so I think you sort of give you some bookends but.
Really what you have to think about is when you think about leverage is it's it's dependent on the environment. It depends on where mortgage spreads are if mortgage spreads being tight versus mortgage spreads being historically wide that's.
That's a really critical driver of the interest rate environment, the volatility as I talked about a lot over the last couple of years all other things equal in an environment that we've just gone through where that's been a significant negative fixed income market repricing as deferred went from quantitative easing to quantitative tightening.
Bad for all fixed income securities volatility was really high liquidity was challenging at times, you sort of have the volatility adjust down the leverage said another way each unit of leverage has a higher risk element to it. So all other things equal we had to bring our leverage down.
To account for the increased volatility.
As the environment changes as we get more and more confident that mortgage spreads will not break out of this new range that the high end importantly of the range will hold like it has held now for better part of seven quarters. Those will be important drivers of for leverage going forward, but it's going to depend on monetary policy.
It's going up and down the volatility of interest rates the cost to rebalance liquidity in the market and obviously our view on where mortgage spreads may go.
Okay, great. Thank you so much.
I appreciate all the questions.
We have now completed the question and answer session I'd like to turn the call back over to Peter Federico for closing remarks.
Peter J. Federico: Again, we appreciate everybody's time this morning, and we look forward to speaking to you again at the end of the second quarter.
Thank you for joining the call you may now disconnect.