Q2 2024 AGNC Investment Corp Earnings Call
Good morning, and welcome to the a G N C investment Corp, second quarter 2024 shareholder call all participants will be in listen.
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Please note. This event is being recorded I would now like to turn the conference over to Katy.
Turlington and Investor Relations. Please go ahead.
Thank you all for joining H M. C investment Corp, second quarter 2024 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.
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 AT&T.
All forward looking statements included in this presentation I made only as of the date of this presentation and are subject to change without notice.
Certain factors 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.
Copies are available on the Sec's website at SEC Gov.
We disclaim any obligation to update our forward looking statements unless required by law.
Participants on this call include Peter Federico President and Chief Executive Officer.
Speaker Change: Bernie Bell Executive Vice President and Chief Financial Officer, Chris Shaw, Executive Vice President and Chief Investment Officer.
Speaker Change: And Paas Senior Vice President non agency portfolio management, and John Reed Executive Vice President strategy and corporate development.
I'll turn the call over to Peter Federico.
Good morning, and thank you for joining our second quarter earnings call the.
The strong fixed income momentum that began in the fourth quarter of 2023.
In the second quarter.
Speaker Change: Reserve and market participants looked for indications that the economy was slowing and inflation moderating.
On balance the data showed that consumer spending and confidence were weakening the labor market was moving into better balance.
And most importantly inflation measures, we're trending towards the fed's long run target.
From a monetary policy perspective, this was a welcome development.
Nevertheless, the federal reserve was unwilling to adopt a more accommodative monetary policy stance.
Against this backdrop of diverging economic and monetary policy outlooks.
Income markets became more cautious.
Speaker Change: In nature quarter volatility increased.
In aggregate interest rate edged higher.
Speaker Change: The agency mortgage backed security spreads widened driving a G N CS negative economic return of just under 1%.
In the current environment, each economic relief curious elevated importance as deferred seeks greater confidence before easing monetary policy conditions.
This was clearly the case in the second quarter with interest rates and spreads reacting sharply so each labor and inflation report.
The 10 year Treasury for example ended the quarter, just 20 basis points higher but experienced several sharp selloff and rally episodes during the quarter that drove accumulative daily yield change of more than 300 basis points.
For agency MBS, the second quarter was a push and pull between evolving supply and demand dynamics.
On the demand side banking foreign demand moderated in the second quarter.
Demand from bond funds remained steady, but limited given an already overweight position.
The modest weakening of MBS demand and associated widening of mortgage spreads was also somewhat expected.
Spreads ended the first quarter at the tighter end of the recent trading range.
On the supply side favorable seasonal dynamics, often lead to a notable uptick in mortgage supply in the second quarter of the year.
This was indeed the case this year with $52 billion of supply in the second quarter double the pace of the first quarter.
Speaker Change: Supply was especially heavily.
During the last week of the quarter.
As a result agency MBS spreads to treasuries widened five to 10 basis points across the coupon stack with a good portion of that spread widening occurring over the last several days of the quarter.
Production coupons, namely five and a half and sixes experienced the greatest spread widening given the uptick in supply.
Importantly, however agency MBS continued to trade in the same relatively narrow spread range that has emerged over the last nine months.
The current coupon that trading range has been 140 to 160 basis points to a blend of five and 10 year Treasury hedges.
Using a similar combination of swap hedges that range has been 170 to 190 basis points.
Spreads at quarter end to treasuries and swaps were 115 180 basis points, respectively right in the middle of the recent range.
We continue to view this range bound trading behavior as a very positive development for agency MBS.
Since quarter end economic data has continued to be supportive of the fed moving toward a more accommodative monetary policy stance.
That shift will likely occur over the next several months and should be viewed as the beginning of a new more favorable monetary policy cycle.
To this point and its most recent summary of economic projections deferred short term rate forecast showed a total of nine rate cuts over the next two years.
Speaker Change: As at least some of these rate cuts become a reality the risk of meaningfully higher rates will decline.
Interest rate volatility will decline.
And the yield curve will steepen. These.
Speaker Change: These will all be positive developments for the agency MBS market specifically.
For fixed income more broadly.
Lastly, the long term fundamentals for agency MBS remain very favorable and continue to give us reason for optimism.
In light of persistent affordability challenges and historically slow prepayment speeds.
Speaker Change: The net supply of agency MBS over the intermediate term will likely remain below previous expectations.
At the same time from a demand perspective agency MBS provide investors with a meaningful amount of incremental yield relative to both U S treasuries.
And investment grade corporate debt at current valuation levels.
For these reasons, we continue to be very optimistic about both the current returns and the future prospects for our business.
With that I'll now turn the call over to Bernie Bell to discuss our financial results in greater detail.
Thank you Peter for.
Bernice E. Bell: For the second quarter, a GNC had a comprehensive loss of 13 cents per share given the moderate spread widening that occurred for the quarter.
Bernice E. Bell: Economic return on tangible common equity was negative <unk>, 9% for the quarter comprised of 36 cents of dividends declared per common share and a decline in our tangible net book value of 44 cents per share.
As of late last week, our tangible net book value per share was up about 2% for July are 1% after deducting our monthly dividend accrual.
Leverage increased modestly for the quarter to 7.4 times tangible equity as of the end of Q2 from seven one times as of Q1 at the same time, our liquidity remained very strong with unencumbered cash and agency MBS of $5 3 billion or 65% of our tangible equity.
As of quarter end.
Consistent with the increase in interest rates the average projected life CPR for our portfolio at quarter end decreased to 120 basis points to nine 2%.
Seasonal factors drove an increase in our actual CPR for the quarter to an average of seven 1% up from five 7% for the prior quarter.
Net spread and dollar roll income for the quarter remained well above our dividend at <unk> 53 per share.
The <unk> per share decline for the quarter was due to a decrease in our net interest rate spread of approximately 30 basis points to just under 270 basis points for the quarter as higher swap costs more than offset the increase in the average yield on our asset portfolio.
Bernice E. Bell: Lastly, in the second quarter, we issued $434 million of common equity through our aftermarket offering program.
Our capital management framework provides us the ability to opportunistically create incremental value for existing stockholders through book value and earnings accretion.
In the second quarter, we issued stock at a substantial price to book premium and invested those proceeds and attractively priced assets.
Christopher J. Kuehl: And with that I'll now turn the call over to Chris <unk> to discuss the agency mortgage market.
Thank you Bernie from a macro perspective, the second quarter was similar to the first quarter in many ways with economic data repricing fed expectations and heavily influence in fixed income market sentiment strong economic data at the start of the quarter caused the market to lower its expectations for fed easing in 2024 fed rate.
<unk> also turned hawkish in April with chair Powell expressing disappointment and the recent progress against the Fed's inflation objective.
As a result rate volatility increased his tenure yields moved through the upper end of the year to date range ultimately, reaching just over four 7% in late April.
These macro and market dynamics, coupled with higher seasonal supply negatively impacted agency MBS performance early in the quarter market sentiment shifted however in May and June following weaker labor and installation data, notably headline unemployment increased from three 8% in the April nonfarm payroll.
<unk> to 4% in June.
Softer labor data and favorable CPI reports in both May and June allowed for a more balanced market focus on the fed's dual mandate of maximum employments and stable prices as a result treasury yields in agency MBS spreads partially retraced the negative performance by the end of the quarter.
Christopher J. Kuehl: Despite elevated rate volatility agency MBS traded in a much tighter range than they did during periods of stress seen last year. This was encouraging and as a result of many factors, including much stronger high grade fixed income inflows year to date, the fed's decision to start tapering Qt stability and bank deposits.
And most importantly, a growing consensus firmly rooted in economic data that the fed may begin normalizing rates over the next couple of months.
During the second quarter, we added approximately $3 billion in agency MBS and as a result, the investment portfolio increased to 66 billion as of June 30.
Our TBA position declined by $3 billion.
As conventional rolls traded somewhat weaker and we opportunistically added approximately $6 billion in specified pools, most of which in lower pay up categories.
Our Ginnie Mae TBA holdings in aggregate were largely unchanged as of June 30th evaluations remained attractive and roll implied financing rates continued to offer a significant advantage versus repo funding.
Christopher J. Kuehl: Our hedge portfolio increased to $58 8 billion as of June 30th largely due to the increase in our asset portfolio. During the second quarter. We continued to gradually shift the hedge composition to a heavier allocation of swap based hedges as a result swap based hedges currently represent approximately 65% of our edge ports.
Folio one of duration dollars basis, our swap based hedges were a drag on our book value performance in the second quarter as swap spreads tightened five to eight basis points across the yield curve.
Lastly, as Peter discussed the data dependent nature of fed policy will likely continue to create volatility in markets, but the earnings environment for agency MBS remains very favorable with historically widespread low levels of prepayment risk and liquid financing markets I will now turn the call over to Aaron to discuss.
The non agency markets.
Thank you Chris credit spread performance in the second quarter was mixed with some areas widening marginally while others were a bit firmer.
Early in the quarter spreads across credit products generally weakened as rates tested local highs.
Subsequently, the backdrop of improving inflation readings and a softer employment outlook.
Combined with relatively high issuance in the structured product market led to the divergent performance of credit products during the quarter.
As an indicator of credit spreads in Q2, the synthetic investment grade and high yield indices widened by approximately three and 14 basis points respectively.
This widening retrace just over half of the tightening we saw in the first quarter.
Christopher J. Kuehl: Credit fundamentals remain consistent with past trends, we have noted showing a bifurcated consumer base.
Lower income households are currently stretched as reflected by increasing auto loan and credit card delinquency rates.
Conversely, higher income are wealthier households appear to be in reasonably good shape.
Turning to our portfolio our portfolio of non agency securities ended the quarter at $940 million down roughly 10% from the prior quarter end.
This decline was largely anticipated and driven primarily by our participation in the GSE tender offers for its outstanding credit risk transfer securities.
Additionally, a significant portion of our C. MBS holdings paid off or paid down in Q2.
In both segments in the non agency portfolio, we were able to opportunistically redeploy a portion of the freed up capital.
Lastly, the funding landscape for non agency securities remained stable and relatively attractive by historical standards with that I'll hand, the call back to Peter.
Peter: Thank you Erin with that we'll now open the call up to your questions.
We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone if youre using a speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then two at this time, we will pause momentarily to assemble.
Our roster.
Peter: Our first question comes from Crispin Love with Piper Sandler. Please go ahead.
Thanks, Scott good morning, everyone.
Peter just with that one has a bunch of election news cycle ramping up the potential for a Trump first Harris election can you just discuss how you might expect the election to impact you from both a pre and post election election standpoint, what you've experienced in past elections, how it might impact investment positioning volatility and then what you.
Might expect post the election, just depending on who's in the White House in January and how that could impact on agency MBS regulation, and what could be kind of favorable or unfavorable from your seat.
Sure. There's a lot there. Thank you for the question obviously, that's on a lot of People's mind.
Speaker Change: You're right. If you go back and you look at previous elections like take for example, 2016, we did have a very significant rate move following that election.
This one probably is a little bit more difficult to read obviously, it's a very evolving situation now in terms of the political landscape.
Still a little unclear I think from a monetary policy perspective, and from a fiscal policy what the implications may be so we're gonna have to.
Watch this develop over the next several quarters, but generally speaking we approach it is.
Going into episodes like that with sort of a lower risk profile. If you will.
See us really not taken a lot of interest rate risk in that environment, we'll wait and see what the outcome is in and positioned the portfolio a little bit more cautiously heading into a high volatility environment.
From the GSE perspective, Youre right Theres Theres, obviously, some talking going back to that physical point, it's not clear.
From either party, which is better or worse for U S. Treasuries obviously.
When we when we look at what happened with the Treasury market and in particular, what happened with the swap spreads in the end of the second quarter. One of the reasons why swap spreads widened like they did sort of late in the quarter was the concern as the Republican party started to gain momentum and the risks that both the.
Both both sides of the Congress, we're going to shift toward Republicans that may lead to more treasury issuance that put some downward pressure on on swap spreads. So those are the kinds of things that we'll have to watch more closely on.
Speaker Change: The GSE side I would say, it's definitely too early to tell which way that may go I know that from the Republican Party side. There is a view that we'll go back more toward the movement to try to move to <unk> out of Conservatorship should Trump win.
But what I would say is look when you look at the housing market overall.
Looking where homeownership rates are it's clear that our housing finance system is really the envy of the world and it is clear that the it that the housing finance system is functioning very well post great financial crisis with the involvement of government in it.
Speaker Change: I know both parties are talking about trying to reduce the cost of homeownership in the current environment. So it seems like an agenda for both parties and I can't see a scenario where disrupting the highly liquid highly desirable market that we have would be a good thing for making homeownership more affordable and lowering the <unk>.
Cost of housing, we have an eight and a half trillion dollar market, that's functioning very well and by the way I would also add when you look at the the job that FHFA does and director of Thompson in particular, she's a very highly regarded regulator I think she's done a great job disrupting the the liquidity that we have.
Doesn't seem to make a whole lot of sense, if you're trying to make homeownership more affordable so.
It's something that's going to bounce around and we're going to hear about it we're going to talk about it but at the end of the day things are working really well. So it seems to me it's more like a a solution looking for a problem and and less is more when it comes to that front. So I don't expect a lot of change there certainly not over the near term.
Thanks, Peter that's all really helpful. And then also I think you mentioned some comments on demand for agency MBS in your prepared comments bank demand moderating I think he's got a asset stack.
Staying consistent can you just dig a little deeper there and your views on the incremental buyer here for agency MBS today.
Speaker Change: Yeah, and when you look at the second quarter. It was really an interesting quarter because there was some really significant positive fundamental development for the fixed income market and when you look at our performance of sort of got masked by the fact that spreads moved a little bit wider than our economic return was sort of unchanged, but the fundamental outlook for fixed.
Speaker Change: Income improved dramatically in the second quarter.
And the reason why it doesn't feel that way is because most of the fixed income market started the second quarter and really went through the entire second quarter and sort of taken a wait and see approach alright, but what happened in the first quarter as we had surprisingly strong economic data that put the fed on garden put all market participants on guard and everybody approach to <unk>.
Quarter, saying, everybody, meaning fixed income market participants generally.
Speaker Change: Just take a wait and see approach we needed to see the economic data the underlying fundamentals change whether they were going to deteriorate further meaning that the economy was going to reaccelerate inflation was going to become a problem I thought it was gonna have to be more restrictive or the converse, which is actually what materialized as now that it looks like theres broad slowing.
And the economy inflation is trending back in the fed now is is clearly I think shifting to a more accommodative monetary policy, but that didn't manifest itself really in the way spreads behaved in a way interest rates behaved that will I think occur over time.
The third quarter and summer tends to be a little thing I'm, a little volatile from a fixed income market participants and as you pointed out we have the election coming but over time the demand I think for mortgage backed securities will become much clearer.
And there's a couple of sources of it one is that it's now I think clear even though we don't know the final rules.
The bank regulation is likely going to be.
Our positive or certainly less negative from a bank demand perspective, that's going to materialize over the end of the year and ultimately implemented early next year and then just the fundamental shift from a monetary policy perspective that is a much better environment for fixed income.
Speaker Change: <unk>.
Broadly the yield curve Steepening for example would be a very positive development for the demand of mortgage backed securities as the yield curve become steep short term rates come down there's a lot of money in money market funds that will ultimately.
Move out of money market funds. So I expect the demand for mortgages to improve as monetary policy outlook improves as we get through the summer period as we get through the election.
Bank regulation will ultimately prove to be less onerous than we had feared and that actually may lead to demand for mortgages, particularly if that regulation comes out such that banks have to hedge more interest rate risk than I think that may push banks actually to mortgage backed securities and away from U S. Treasuries. So those are things that will evolve.
Over time, but I think those are the reasons why the.
The demand for agency MBS should should improve.
Thanks, Barry I appreciate you taking my questions.
The next question comes from Doug Harter with UBS. Please go ahead.
Morning, Doug.
Good morning, Peter can.
Doug: Can you remind us Peter how you think about setting that.
Setting the dividend what what are kind of the most important factors and and kind of how you see the current dividend level in light of those factors.
Doug: Sure.
Obviously, a lot goes into it in terms of the environment and the outlook the outlook for our business in terms of where we can operate from a leverage perspective, and where we think interest rate volatility is in mortgage spread volatility. Those are obviously very very important in terms of.
US setting a risk parameters for our portfolio, but sort of foundational to the decision is always starts with what is our total cost of capital what is the required breakeven if you will.
And how does that compare to the economics of our business today. If you look at our portfolio on current valuation levels. What do we think the economics of our business is going to generate from a return on equity perspective going forward.
From a total cost of capital for example, when you take the.
The cost of our common dividend for example in the second quarter.
Doug: The cost of our preferred dividend and our operating costs annualize those.
Doug: As I did in divided by our total capital position, you'll get a number something around 16.3 years you know.
Call. It 16, 5%. So that's the amount of return that we need to earn to cover all of those costs in our business you compare that to what are the economics of our business at current valuation levels.
And I would say when you think about where spreads are as I talked about 150 on average 280, <unk>, let's say if spreads are in the current spreads for mortgage backed securities are in the 165 basis point range. When you use a blend of hedges leverage.
At about where we operate right now given our cost of capital given where the current coupon yield as that would translate into a expected return on an economic basis of call it somewhere between.
16% to 19% so very much aligned with that total cost of capital now.
Speaker Change: Now what.
Isn't it is important to point out what that doesn't include when I do that calculation is it doesn't include the cost of on balance ongoing rebalancing, which would be a drag on that.
So that's something you have to consider over time, but at the same time what it also does not include is the positive benefit we get.
Which is about 2% for example on our preferred stock position. So it's.
It's not the most complete measure, but it's certainly a good indication.
And I think those two things remain really reasonably well aligned and that's really important from a dividend sustainability perspective. So that's the way we think about it and in this current environment.
We also have to take into account the positive benefit that we get from issuing common stock at an accretive level. So that's an incremental source of return that has been available to us now for some period of time. So that's the way we think about the Devon I think there I think our dividend and our total <unk>.
Cost of capital.
A reasonably well aligned with the economics of where mortgage backed securities are leveraged and hedged away, we look at them and leverage them today.
Great I appreciate that answer Peter Thank you.
I appreciate the question.
The next question comes from Bose, George with K B W. Please go ahead.
Hey, guys good morning.
Goodbye.
Spreads when I look at it.
It looked like it widened in April then it sort of came back pretty fully in but nominal spreads widened and didn't come back as much as that I guess is that right and just can you talk about some of the drivers.
Yeah.
Yeah, Let me have Chris talk a little bit about that but it's really the driver of the difference between nominal spreads in and Oh.
<unk>, Yeah, I mean, it was largely just the increase in implied volatility early that started early in the quarter the difference between those two.
Speaker Change: Okay, meaning when volatility goes up Oas's will go down and that will lead to a little bit of confusion there.
Okay, Okay that makes sense and then actually switching over to the funding markets it looks like.
Sofa was pretty elevated at the end of the quarter was.
A little more pronounced than in the first quarter anything you're keeping an eye on there just could you just talk about some of what's happening.
Yeah.
Speaker Change: There is something to keep an eye on there and I think this is exactly what the fed is keeping an eye on which is the fed is clearly continuing to drain reserves from the system through its balance sheet runoff, it's running off at about $45 billion to $50 billion.
A month and what the fed is doing is obviously draining reserves from the system.
And the gap I think now starting to see the impact of the reduction, which I don't I can't remember what the numbers I think they think they've taken out about one and a half a trillion dollars out of the system ready, but theyre getting to the point, where they're moving from the abundant Bank reserve.
Two the ample target.
And when you listen to the way the chairman is talking about it they're gonna watch disease indicators, and ultimately that will inform them as to when.
Reserves are abundant and that will ultimately lead them to stop their balance sheet runoff, which I expect them to do stop their balance sheet run off perhaps somewhere in the neighborhood of the next five or six months because that would put bank reserves at this pace, which are now three three trillion down to around three trillion and I think at that number.
That's probably a number that.
Perhaps our lines on a percentage basis of GDP with their target, but obviously, we don't know any of those numbers with specificity, but what we saw at the end of last quarter.
Speaker Change: Well, it's a little bit of pressure at sort of quarter end, which is normal and in a in a market. It was not normal when reserves were as ample and as abundant as they were but as we get a little closer to that target. We will see that period end pressure show up again.
That's nothing particularly troubling, it's just a normal market and the fed certainly has lots of tools to maintain liquidity in the repo market for U S Treasuries and agency MBS. So I don't view that as a concern in fact I view it as an indication that the fed will be stopping its balance sheet runoff fairly soon.
Okay, great. Thanks.
The next question comes from Terry MA with Barclays. Please go ahead.
Hi, Thanks, good morning.
Your net interest margin was down about 30 basis points quarter over quarter. It looks like that was just a function of putting on longer dated swaps water shorter dated ones wrote off and I think you've kind of highlighted this dynamic on our NIM last quarter. So.
So I guess looking forward do you guys have another turn and a half billion of swaps potentially rolling off soon so.
So should we kind of expect the same magnitude of NIM decline each quarter or how should we think about that.
I'll tell you that's a really good question and I'm glad you asked it because the run off of our shorter term swaps, which was about $2 billion did have an impact directionally, obviously on our NIM, but that was obviously not the biggest impact because we did add six 5 billion as you point out of <unk>.
Our term swaps about half of those swaps and the average pay rate on that $6 5 billion was four 2%. So obviously a much more significant cost.
Speaker Change: About half of those swaps that we added.
We're used to hedge new mortgages because of the stock that we issued in the mortgages that we bought with that stock we in a sense accelerated some of that NIM decline.
At the same time, we also added about $3 billion. The other half of that 6 billion of swaps.
Speaker Change: As Christian has mentioned this in his prepared remarks, we have rotated out of treasury hedges into swap based hedges.
So that again, because those swap based hedges show up in our net interest margin led to perhaps a more significant decline in our net interest margin than people would have expected. If you just anticipated the reduction in our swap portfolio due to the maturity of our short term swaps so to the extent.
Speaker Change: We grow our portfolio.
And our ability to do so at really attractive investment returns that will change the timing. If you will of NIM, but youre right over time to have shorter term swaps that we have.
And we have about $6 billion of maturing in the second half of the year, then that'll have some impact on our net interest margin, but again, it's moving our net interest margin back into alignment. If you think about our net interest margin.
At around 270 basis points, giving us the net spread income we have that return on capital for for for the second quarter was 24% that is not the economics of our of our business and that's why they're going to come back into alignment is as we just talked about and the question from Doug The economics of our <unk>.
I'm more in the 18% range not 24% range.
Great. That's helpful. Thank you sure I appreciate the question.
Next question comes from Rick Shane with J P. Morgan. Please go ahead.
Richard Barry Shane: Good morning, everyone and thanks for taking my question.
Sure.
Look.
During the quarter you it looks like you issued about 45 million shares.
That makes sense stock was trading at a premium to tangible book consistently spreads widen which creates an attractive.
Investment opportunity.
I am curious when you think about issuing shares off the ATM how.
Dynamic is that is it something that you set out at the beginning of the quarter and say hey.
We're we want to issue 40 million shares plus or minus $5 million or do you on a daily basis look at this and say wait a second.
You know, we've got an attractive we're trading an attractive premium spreads have widened its a good time and really lean into it I'm trying to understand the dynamic throughout the quarter.
Yeah, No that's a really great question I appreciate it.
But I would say just to start with is we never start out with a set expectation.
So there is no.
Decision at the beginning of year, we need to or want to or we're going to raise this amount of capital is based on what's happening with our portfolio and based on what's happening with the market and you're right one of the real values of of using the ATM.
Our aftermarket program is that it allows you a lot of flexibility. So it allows you flexibility to issue stock for example on days when there is high volume in your stock or when there's unique demand in your stock and we often see.
Reverse inquiry, if you will put them in from an institutional or large investors looking for transactions. So it's something that we could consider as they come in at the same time. It allows you to issue stock in increments, if you will that make it.
Efficient to deploy as opposed to raising a lot of capital and having to deploy that over time and assets without driving asset prices. This gives us the ability to issue stock.
Richard Barry Shane: In a way that.
It doesn't just rough if you will the assets that we're acquiring for example in the second quarter, we did raise a little over $400 million and we bought over $3 billion worth of mortgages buying them over the quarter.
As the coincident with the stock issuance and allows us to do that in a way that is it gives us better economics. So it's something that we we approached from a dynamic perspective and from a flexibility perspective.
Got it Peter that's helpful and when we think about making.
Making those investments it's raising the capital.
Acquiring the assets levering the at levering that capital acquire any assets and hedging them.
The.
Most cumbersome part of that the hedging.
Is your deploying capital I'm, just curious where the friction is from a timing perspective, given the ATM superefficient. The repo markets are superefficient your markets trade incredibly liquid.
Curious if there's any on the hedging side, if there's any sort of friction there.
No. There's no there's no issue there I mean, there's plenty of liquidity, but really it's the comparison of for example, doing a <unk>.
<unk> deal so, let's just take the second quarter as an example, if we did a bond transaction for that amount of $450 million.
You'd get that all in one day and then you would have to go out and buy that would support the purchase of a little over $3 billion worth of mortgages.
That would be clear that if you did that transaction that agency would either have had to buy those mortgages in advance or buys them thereafter.
That would likely potentially lead to a change in valuation of mortgages as opposed to just simply doing it at a very measured disciplined place trying to connect.
The liquidity in our stock.
With the richness or cheapest of mortgages and that's why we do that throughout the quarter, it's not consistent it's when those when those sort of.
Align and the liquidity in our stock and mortgages. We think are cheap then we'll buy mortgages for example at the beginning of the quarter mortgages, whereas the tight side of the range and they were not as attractive to US is they became later in the quarter when mortgages moved back into the middle of the range and in fact.
Our book value accretion was better at the end of the quarter and so the ATM program actually worked better for us at the end of the quarter rather than at the beginning of the quarter.
Got it okay very helpful. Thank you.
Sure.
The next question comes from Eric Hagen with <unk>. Please go ahead.
Hey, Thanks, Good morning, Hey, good morning, good morning.
So if the range for mortgage spreads as tighter because the narrative has really focused on fed cuts do you feel like that maybe drives more flexibility to take your leverage higher and what do you feel like that range for your leverage is and do you feel like we can maybe think about seven five times being more of a minimum leverage.
Over call it the near or medium term.
Well I think those are all points and considerations when we think about our leverage we certainly have the capacity as you point out.
When you look at our cash and unencumbered position that Bernie mentioned at 65% of our equity that would indicate that we have a lot of capacity to take leverage higher if we show chose and obviously our outlook for mortgage spread volatility is really important in that equation.
And both Chris and I mentioned that in our prepared remarks is an important development is an important development for our business.
Cause of just that point that you're making which is when you go back and you look at how mortgage spreads have behaved. We went through a very difficult repricing period from 2020, twos and 2023 to find this new range and the challenge in 2023 was that we didn't know where the top of the range was.
And obviously, we hit it on a number of vacations that close to 200 basis points and then ultimately that top health what we've seen subsequently and this is a really healthy signal I think is that theres, a new range within the range and the narrower the spread range.
The more capacity, we have essentially to take greater risk obviously as we talked about already on this call we're going into a period where.
Volatility tends to increase a little bit we obviously have some big macro issues.
Coming that will have to contend with but over time those will certainly inform our position about.
The appropriate amount of leverage.
That's really helpful color. Thank you.
Okay. So we're looking at the forecasted prepayment speed over the next 12 months I think its seven CPR. That's the same as to pay down that we saw last quarter is there a way to drill down there I mean does that assume that mortgage rates are flat.
But how do you think mortgage rates kind of kind of a trend here and.
And if we saw a pickup in speeds do you feel like that would be positive for total return or is it maybe dependent on other variables.
I'll, let I'll, let Chris.
So that that forecast is just assumes that the forwards are realized it's a it's a <unk>.
This case single path forecast along the forward rate curve.
You know with respect to it'll convexity risk on the portfolio are managing prepayment risk given our coupon in pool composition peak.
Peak negative convexity on our portfolio was about 150 basis point basis points lower than today's rate levels. So significant move in rates to get to that sort of level.
Specified pools higher quality specs represent about 45% of our holdings.
The next category of specified pools also have favorable cash flow characteristics that represents about 30% of our holdings.
And importantly in the higher coupons, where we have the the most prepayment risk those two categories combined represent about and fixes in six and a half so about 85% of our holdings and so you know convexity risk prepayment risk in this environment is still very manageable.
Richard Barry Shane: Yeah.
Speaker Change: But some are just to just to go back and round up the discussion on on spreads.
The way I would characterize the outlook right now is.
We expect mortgages to sort of stay range bound over the nearer term, but longer term I think what we now are seeing is a scenario, where there's more reasons for mortgages to tighten than they are to widen or certainly the catalyst for mortgages to move to the high end of the spread range for very high end of the spring race.
Speaker Change: Are harder to see and there's starting to be more reasons to believe that mortgages could tighten over time.
Alright, good perspective, we'd appreciate you. Thank you sure. Thank.
Speaker Change: Yeah.
Okay.
And the final question comes from Jason Stewart with Janney. Please go ahead.
Hi, Jason.
Hey, Peter Thanks for taking the question.
Just a follow up on Eric's question there.
Going back to that high end call. It in mid quality spec pools up in coupon.
What's the average pay up on that say, 85%, if you could give us an idea of what that looks like.
Sure.
We don't have that broken out in our disclosures, but the average pay up on our aggregate portfolio, including TV, the TBA position, which is relatively small it's just over.
It's just under a point that's it's around 30 tax excluding the TBA position, it's slightly over slightly over a point so around 33 tax.
Okay, alright, thanks for that Yeah, I guess I wanted to ask just a little bit more perspective on coupon selection. I mean, you have a wide range of coupons to take from in this environment and really the push and pull between total return and carry in the up in coupon you know given your outlook for the refi you know some new programs out there just for the.
<unk> outlook, maybe you could just drill down into what sort of drives your coupons collection over the next two or three quarters that'd be helpful. Thanks.
Sure. So you know what.
Within E you know across the coupon stack production coupons.
Still by far offer the most attractive spreads.
And so that's where we've been investing marginal capital assuming.
You know current relationships across the stack remain that'll be where we are we continue to invest marginal capital higher coupons have you know very different tactical some lower coupons, it's where all the organic supply as against relatively anemic bid from banks and overseas and so naturally or if you compare that.
Speaker Change: So the lowest coupons, which are you know for three or 400 basis points away from being produced.
And most of the Florida is tied up at the fed and so when you have passive index fund inflows that need to buy assets that arent being produced you can get pretty dislocated relative valuations across the sac and so it's.
It's logical why this relative value relationship has been persistent.
Coupons, you know as we discussed earlier I mean, certainly have more prepayment risk scores convexity, but you know I would say that's more than in the price are collecting a lot of spread that can be used to manage that risk in a number of different ways. You can buy options on rates you can spend it on pay ups and sourced back convexity through asset selection.
And buying specified pools, and then you can delta hedge in the current environment. The latter two are more attractive implied volatilities is still extremely elevated and so options are expensive and so generally speaking.
It's much cheaper to source convexity through full selection and coupon selection.
So roughly about two thirds of the position is in is in fives and higher.
You know the the positions in three and a half three or four and a half the so-called belly coupons have still attractive spreads in an extremely.
Stable cash flow profiles, and so you know we like the diversity of that and that keeps the convexity risk in the aggregate portfolio very manageable.
Great. That's good feedback thank you for that.
Sure.
Yeah.
Yeah.
We have now completed the question and answer session I would like to turn the call back over to Peter.
Federico for concluding remarks.
Again, we appreciate everybody participating on our call.
This morning, and we look forward to speaking to you again at the end of the third quarter.
Okay.
The conference has now concluded you may now disconnect.