Q3 2024 AGNC Investment Corp Earnings Call
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Speaker Change: Good morning everyone and welcome to the IGNC Investment Corps, 3rd quarter 2024 shareholder call.
Speaker Change: All participants will be in a listen only mode, should you need assistance? Please stay in our conference specialist by pressing the star key followed by zero.
Speaker Change: After today's presentation, I will be an opportunity to ask questions. Ask a question you may press star and then one using a touching or telephone. So with draw your questions you may press star and two.
Speaker Change: Please note today's event is being recorded.
Speaker Change: At this time, I'd like to turn the comments all over to Katie Turlington of Investor Relations.
Speaker Change: Please go ahead.
Katie Turlington: Thank you all for joining ATNC Investment Corps, third quarter 2024 earnings call. Before we begin, I'd like to review the safe harbor statement.
Katie Turlington: This conference call and correspondent slide presentation contains statements that, to the extent they are not recitations of a historical fact, constitute forward-looking statements within the meeting of the private security litigation reform act of 1995.
Katie Turlington: All such forward-looking statements are intended to be subject to the face harbor protection provided by their format.
Katie Turlington: Actual outcomes and results could differ materially from this forecast due to the impact of many factors beyond the control of agency.
Katie Turlington: All four of looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice.
Katie Turlington: Certain factors that could cause actual results to differ materially from those contained in the four looking statements are included in agency's periodic reports filed with the security's and exchange commission.
Katie Turlington: copies are available on the SETs website at SCC.gov. We just claim any obligation to update our forward looking statements unless required by law.
Katie Turlington: Preccessive hints on the call included.
Speaker Change: Peter Federico, director, president, and chief executive officer.
Speaker Change: Bernie Bell, Executive Vice President and Chief Financial Officer, Chris Kuehl, Executive Vice President and Chief Investment Officer, Aaron Pas, Senior Vice President, Non-Agency Portfolio Management, and Sean Reed, Executive Vice President, Strategy and Corporate Development. With that, I will turn the call over to Peter Federico.
Peter Federico: Good morning and thank you for joining us third quarter, Bernice Call.
Peter Federico: For the last several quarters, we have spoken about a promising and durable investment environment that we believe was unfolding for AGNC.
Peter Federico: An environment characterized by mortgage spreads that were materially wider than historical norms.
Peter Federico: declining interest rate volatility and the emerging accommodative monetary policy stands by the Federal Reserve.
Peter Federico: In the third quarter, these positive trends became increasingly apparent, and as a result, investor optimism grew.
Peter Federico: Against this favorable, fixed income investment backdrop, AGNC generated a very strong economic return of 9.3% in the third quarter, driven by solid book value growth and our compelling monthly dividend, which has now remained stable at 12 cents per common share for 55 consecutive months.
Peter Federico: and its September meeting to fed began the process of recalibrating monetary policy with an initial rate cut that was larger than many expected.
Peter Federico: More important than the magnitude of the rate caught itself, the move marked the end of a very challenging three-year period of unprecedented monetary policy restraint.
Peter Federico: In addition, the Fed also communicated its intention to lower short term rates to a neutral level over time.
Peter Federico: Consistent with this view, the September summary of economic projections showed the median federal funds rate declining by 250 basis points by the end of 2026.
Peter Federico: While the past to this neutral policy stance will undoubtedly depend on economic data, as Chairman Powell explicitly stated, the direction of travel is now clear.
Peter Federico: This significant transition in monetary policy marked a positive development for AGNC and for fixed income markets broadly speaking.
Peter Federico: In response to this improved monetary policy outlook, Treasury rates rallied across the yield curve, with short-term rates declining significantly more than long-term rates.
Peter Federico: To put the right moves in perspective, the Yokev ended the quarter with a positive slope for the first time in two years.
Peter Federico: Agency MBS Performance Theory to Third Court are very considerably by coupon and hedge composition.
Peter Federico: Our performance benefited from having a diversified mix of assets, as well as a meaningful share of longer-term Treasury-based hedges.
Peter Federico: From a macro perspective, there were a couple of important takeaways from the third quarter.
Peter Federico: First, the long awaited Fed Pivot occurred and consistent with historical experience. The Fed is expected to return the federal funds rate to a neutral level over the next 12 to 24 months.
Peter Federico: Typically, in such periods of monetary policy accommodation, the yield curve steepens and the demand for high quality fixed income instruments like agency and BS grows.
Peter Federico: The other important takeaway from the quarter is that agency MBS spreads remain in the same relatively narrow trading range that has now been in place for close to a year.
Peter Federico: Distraiding range compares very favorably to the highly volatile spread environment that existed while the Fed was aggressively tightening monetary policy.
Peter Federico: as a Leverden Hedge investor in agency on BS.
Peter Federico: AGNC's return opportunities are most favorable when agency and BS spreads to swap and treasury rates are wide and stable and when interest rates and monetary policy are less volatile.
Peter Federico: We anticipated that this type of environment would eventually emerge once the fetch transition to an accommodative monetary policy stance, which it did at the September meeting.
Peter Federico: With agency on behalf of Spreads Trading in a relatively narrow range this year.
Peter Federico: It follows that our common stock net asset value would also be relatively stable.
Peter Federico: That has been the case with our net asset value per comment share increasing a modest 1.4% over the first 9 months of the year.
Peter Federico: Much more significantly, however, our economic return per common share, which includes the dividends we paid, as well as the change in our net asset value, was 13.8% through the first nine months of the year.
Peter Federico: Similarly, our total stock return with dividends reinvested was 17.5% over the same period.
Peter Federico: This performance exemplifies AGNC's ability to generate very attractive returns and environments where spreads are wide and stable.
Peter Federico: Looking ahead, we believe the most likely scenario for agency MBS spreads is that they remain in the current trading range.
Peter Federico: This viewers predicated in part on our belief that the supply and demand dynamics for agency MBS remain in reasonable balance.
Peter Federico: Given the recent modest decline in mortgage rates, it is possible that the supply of agency NBS will increase somewhat over the intermediate term.
Peter Federico: On the Devanside, however, accommodative monetary policy, a steeper yield curve, historically large money market mutual fund balances.
Peter Federico: and less owner-spank regulation indicate to us that the demand for high-quality fixed income assets is biased to increase as the Fed reduces short-term interest rates.
Peter Federico: While the passive financial markets is never perfectly smooth, and periods of volatility are inevitable.
Peter Federico: The Outlook for agency on BS is decidedly better today than it was in 2022 and 2023, given the current economic outlook.
Peter Federico: The stance of the Fed and our expectation that long-term interest rates and agency MBS spreads will remain relatively stable.
Speaker Change: With that, I'll now turn the call over to Bernie Bell to discuss a financial results in greater detail.
Bernie Bell: Thank you, Peter.
Bernie Bell: For the third quarter, agency had total comprehensive income of 63 cents per share. Economic return on tangible common equity was 9.3% for the quarter, comprised of 36 cents of dividends to cleared per common share, and an increase in our tangible netbook value of 42 cents per share or 5%.
Bernie Bell: As of late last week, our tangible netbook value for common share was down about 3% for October, or about 3.5% after deducting our monthly dividend of roll.
Bernie Bell: Reverage decrease modestly for the quarter to 7.2 times tangible equity as of quarter end from 7.4 times as of Q2. Additionally, we concluded the quarter with unencumbered cash and agency MBS of 6.2 billion or 68% of our tangible equity, which was up from 5.3 billion or 65% of tangible equity as of June Darius.
Bernie Bell: The average projected life CPR for our portfolio at quarter-ends increased 4% to 13.2% consistent with the decline in interest rates. While the average coupon on our portfolio was largely unchanged at just over 5% as of 1930.
Bernie Bell: Actual CPRs for the quarter average 7.3% up slightly from 7.1% for Q2.
Bernie Bell: Net spread in dollar oil income declined by 10 cents to 43 cents per common share for the quarter. Driven by a reduction in our net interest rate spread, which narrowed by approximately 50 basis points, to just above 220 basis points for the quarter.
Bernie Bell: About half of the decline in our net interest bread.
Bernie Bell: was a result of six and a half billion very low-cost pay-six swaps that matured during the quarter.
Bernie Bell: We have now additional swap scheduled to mature until the second quarter of next year.
Bernie Bell: The other half of the decline was due to our decision to further reduce our swap-based hedges and increase our use of treasury-based hedges, which are not captured in our reported net interest spread.
Bernie Bell: Lastly, in the third quarter, we issued $781 million of common equity to our At the Market Offering Program.
Bernie Bell: The significant increase in ATM issuance was consistent with the substantial price to book premium on our common stock throughout the quarter, and drove material book value accretion for the benefit of our common stock orders.
Bernie Bell: In addition, the positive investment environment provided a favorable backdrop for the deployment of this new capital.
Speaker Change: and with that I'll now turn the call over to Chris Kuehl to discuss the agency mortgage market.
Chris Kuehl: Thanks Bernie, weaker economic data and increasingly dovish Fed rhetoric provided the constructive backdrop for risk assets and duration throughout the third quarter. The yield curve steepened dramatically with two year and ten year treasury yields declining 112 basis points and 62 basis points respectively.
Chris Kuehl: Both MBS and Corporate Credit indices outperformed Treasury benchmarks during the quarter. However, within MBS, performance was heavily influenced by coupon, hedge type, and tether. Lower coupon MBS, which comprise the vast majority of the Bloomberg MBS index outperformed higher coupons in the third quarter, with 4.5% and lower coupons tightening 10-15 basis points, while 5% and higher coupons range from slightly tighter to modestly wider.
Chris Kuehl: The outperformance of lower poop on MBS was driven by favorable technicals as fixed income bond fund it inflows continued to increase. At an average weekly pace, year to date of 8.5 billion, roughly double the pace of last year.
Chris Kuehl: These funds are largely index-based and has such drove demand for lower coupon MBS. In contrast, the decline in primary mortgage rates combined with the tail end of elevated seasonal housing activity led to an increase in supply and relative under performance of production coupon MBS.
Chris Kuehl: Notably, Agency MBS spread volatility has been considerably lower in 2024, with park who ponds spreads to a blend of five and ten year treasury yields, trading in a range of 40 basis points.
Chris Kuehl: This compares favorably to 2023 in 2022 when Park Hoopon's spreads traded in a range of 75 and 108 basis points respectively.
Chris Kuehl: During the third quarter, we added about 5 billion in agency MBS, and as a result, our investment portfolio increased to 72.1 billion as of September 30th. In terms of portfolio composition, we added approximately 6 billion in pools during the quarter, most of which were in low pay-up categories, while our TBA position declined consistent with conventional roles trading at relatively weak and plied funding levels.
Chris Kuehl: Our Ginny May TBA position in aggregate was largely unchanged as of September 30th, as valuations remained attractive and role-inplied financing continued to offer an advantage versus repo funding.
Chris Kuehl: Page Positioning was also a material driver of performance during the third quarter, given the combination of yield curve steepening and swapspred tightening. As a result, MBS hedged with longer-tener U.S. Treasury-based instruments generated significantly better total returns.
Chris Kuehl: During the third quarter, we decreased our swap-based hedges and increased our allocation to treasury-based hedges. Importantly, we also continue to increase our use of longer-term hedges, given the shift in monetary policy, their expectations for further yield curve steepening.
Chris Kuehl: Consistent with this shift towards longer-term hedges, are overall head ratio decline to 72%.
Chris Kuehl: We believe longer-term treasury hedges give us additional protection against the challenges posed by the growing US government debt and ongoing budget deficits. I'll now turn the call over to Aaron to discuss the non-agency markets.
Aaron Pa: Thank you, Chris. In early August, as Market Expectations shifted toward Pas to Ray Cuts, Curtis Brothers initially widened.
Aaron Pa: by the end of the quarter, however, broad-based, wrist-on sentiment, push-back-remarket's higher. As a result, credit spreads generally end of the quarter unchanged to somewhat tighter.
Aaron Pa: In Q3, the synthetic investment grade index was close to unchanged, while the high yield index tightened by about 15 basis points.
Aaron Pa: On the cast-bond side, the Bloomberg IG Index narrowed by five basis points, and subsequent to a quarter-end has tightened about eight basis points.
Aaron Pa: Last week, this index closed through the tightest level seemed during the COVID-19 period and reaching the tightest valuations in the post-grade financial crisis era.
Aaron Pa: As we've mentioned before, Credit Fundamentals continue to show a divided consumer base. Lower income households continue to face pressure, but we've yet to see significant signs of distress.
Aaron Pa: Our non-agency securities portfolio and the quarter at 890 million, down roughly 5% from the previous quarter, but the composition of our holdings mostly unchanged. The reduction in the portfolio was due to our participation in GSE tender offers for credit risk transfer securities.
Aaron Pa: Lastly, the funding environment for non-agency securities remains stable and historically attractive.
Speaker Change: With that, I'll hand it call back of the Peter.
Peter Federico: Thank you, Aaron. With that, we'll now open the call up to your questions.
Speaker Change: Ladies and gentlemen, at this time we'll begin the question and answer session. To ask a question, you may press star and then one on your touch to and telephones.
Speaker Change: If you are using a speaker phone, we do ask that you please pick up your handset before pressing the keys.
Speaker Change: Withdraw your questions you may press star in 2.
Speaker Change: What's again that is starring then one to join the question to you.
Speaker Change: Our first question today comes from those George from KBW. Please go ahead with your question.
Speaker Change: Hey everyone, good morning. Just wanted to follow up first on the comments you made on the changes to your hedges. So this position you better for curb steepening is that the sort of the driver.
Speaker Change: Yeah, both, that's exactly right, it's a great question. You know, Chris mentioned this in his prepare remarks and we've talked about this now for several quarters and...
Speaker Change: but you really see the impact of a discord with our head ratio coming down to 72% from 98% to last quarter.
Speaker Change: and as Chris mentioned, we systematically shifted our hedges more toward the longer part of the yield curve. In fact, if you think about it from a...
Speaker Change: A duration perspective.
Speaker Change: Almost 80% of our hedges come from hedges that are seven years and longer, so we're concentrating our hedges.
Speaker Change: Our hedge book to have longer dated instruments with the expectation that the yield curve will steep it over time and that's consistent with the monetary policy environment that we earn and also from our perspective make sense for us now to operate with a hedge ratio less than 100% so that we over time will gain some benefit of having some of our debt repressing to the new Fed funds rate.
Speaker Change: Okay, great. Thanks. And then actually on the core earnings, you know, obviously makes sense with the slot for a lot, you know, the direction of that. You know, just over time, I mean, it's the way to think about it as your core earnings should sort of essentially converge with your economic return. So, you know, if we think you can generate a 17 ROE that's kind of where core earnings end up.
Speaker Change: That's exactly right. There's a lot of factors that went into the decline in our net spread and dollar roll income this last quarter. Bernie mentioned, you know, we had $6.5 billion worth of swaps mature this quarter. We actually don't have any swaps maturing over the next two quarters. But more than that, we took some actions to actually reduce our swap book further, because we did favor treasury based hedges. They actually were a better performing hedge. Really, for the last several quarters, given the tightening and swap spreads. So we wanted to have more treasury based hedges, and that has a direct impact on our net spread and dollar roll income because it doesn't include those hedges.
Speaker Change: It only includes our treasury-based hedges. In fact, for example, if you included the carry on our treasury position, it would probably be somewhere in the neighborhood of about eight cents of carry on our treasury position right now that is not captured in that Netsport and Dollar Roll income. So from that perspective, it's not a significant driver. In fact, it's not a driver at all of our dividend policy. If you think about our Netsport and Dollar Roll income has been well over our dividend now for a couple years, and it has an impact at our dividend policy. It's a reflection of the current period earnings.
Speaker Change: When you take that, this friend, Dollar will even express that on our equity, it translates to a return on equity of somewhere between 19 and 20 percent, that's still above the long run economics as you point out.
Speaker Change: Today, the economics of new mortgages are in the 16 to really 18% range right now. I would expect our net spread and dollar roll income on our margin to compress consistent with that. In the speed and pace of growth of our portfolio also has an impact on that compression. For example, we have raised a lot of capital in the last two quarters and as Chris has mentioned, we've purchased over the last two quarters.
Speaker Change: $8 billion worth of mortgage. So we've grown our mortgage portfolio at a pace of around 12 and a half percent and we're bringing those on at those current spreads called it between 150 and 200 basis points. So that in and of itself is driving some of that compression. So it's not a number that net net net interest margin nor our net spread and dollar only come. Those are current period numbers. They're not they're not numbers that affect our dividend policy. We're looking at the long run economics of our portfolio. We think it still remains very well aligned. That's helpful. Thanks.
Speaker Change: Sure, thank you both.
Speaker Change: Our next question comes from Crispin Love from Paper Samar. Please go ahead with your question.
Crispin Love: Thanks. Good morning, everyone. Peter, just following up on that last question, just based on your comments and expectations of AGNC spreads remaining in the current trading range. Can you discuss the return expectations in AGNC MBS and then how that compares to your book value yields right now, which is around the mid teens, about 17% or so? I think you mentioned a normalized level of 16, 18%. So do you feel good about the current dividend level here? That you do have some near term benefits with the head just before getting to that 16, 18% level?
Peter Federico: Yeah, we do feel good about our alignment with the dividend policy and the economics of our portfolio. And there's a couple really important takeaways. I mentioned this in my prepare remarks, but the fact that mortgages continue to stay in this same narrower range is a really positive development just overall. That's from our perspective, mortgages being at wide levels and stable levels, allow us to generate the really attractive earnings like we've experienced so far for the first three quarters. And importantly, the spread volatility has come down. Chris mentioned this. You think about that spread range this year, for example, mortgages have only traded in a 40 basis point range.
Peter Federico: Compare that to two years ago. It was over a hundred basis point range. So that obviously has a lot of impact on our risk management position and how we position to portfolio. It does appear to us that mortgages are comfortable in this range and if you look back to the end of the quarter to now mortgages have actually moved back toward the middle of the range. I often refer to the current coupon spread to the five and ten years as just a benchmark. That now is back around close to 150 basis points, which is sort of right in the middle of the 140 to 160 basis point range. And importantly mortgages, current coupon, anyhow, to a blend of swap.
Peter Federico: Hedges is somewhere in the 185 basis point range now. So if we're going to use, like we always do, even though we have about 40% of our hedges and treasuries now, we're always going to use a mix of swaps and treasuries as hedges. You can think about that spread is being somewhere average, you know, about 170, 175 basis points that translates to really attractive are ways. That's our base case expectation is they stay in this range. So we're going to do that. We're going to do that. We're going to do that.
Speaker Change: Great, thanks Peter, and then just on your expectations.
Speaker Change: for the level of 30-year mortgage rates over the year to intermediate-term mortgage rates rallied in the third quarter, backed up a bit in recent weeks. So curious on your thoughts here, I know you said publicly that you didn't expect them to break below 6%, but just curious on what your expectations are right now. Yeah, no, I think it's a really important point about the outlook for the mortgage market. If we had this call, for example, right at the end of the quarter when the 10-year was at [inaudible]
Speaker Change: 360 or so, and the risk was that it was going lower. We would have had a lot of conversation about prepayment risk in the mortgage market because it was clearly starting to pick up. Certainly with some of the more recent ventages, but now the mortgage rate, we've given the backup of treasury rates 10 years treasury close to 425 as of yesterday. Today,
Speaker Change: Primary mortgage rates are now above $6.50, approaching $6.75, depending on where you look. That's a really significant shift. Again, it's going to slow the supply of mortgages down, which really improves the technicals. Against the backdrop of a more accommodative, growing demand for fixed income in general, and now giving the backup and mortgage rates, and it appears that the tenure really is sort of well positioned at this four to four and a quarter range. It seems to be the loss that the likely scenario is that the primary mortgage rate stays above $6.50 for an extended period of time, so it's part of why we're so optimistic about the outlook for the mortgage market.
Speaker Change: Thanks for watching, I'll see you in the next video, it's all super helpful.
Chris: Sir, thank you, Chris.
Speaker Change: Our next question comes from Rick Shane from Jason Morgan. Please go ahead with your question.
Speaker Change: Thank everybody for taking my question. Good morning. Look, you've laid out sort of strategically what the opportunity is, but you know, we're basically 22 days into the quarter, 10 years backed up, 40 basis points, spreads on the 5, 10 spread is wide and 20 basis points. The move index has gone from 95 to like 128. It's
Speaker Change: A pretty challenging or a pretty volatile three weeks.
Speaker Change: How does that impact the value on an updated basis? What opportunities and what risks should we be thinking about in the short term, given pretty dramatic moves? And again, I realize within the sort of norms, but it's a 20-day move that drives that.
Speaker Change: Yeah, Bernie mentioned it to prepare to mark. Thanks for the question. Bernie mentioned it to prepare remarks that our book value as of the end of last week was down about three and a half percent given the back up in Treasury rates. We ended last quarter with a slightly positive duration gap point two years. So the back up and rates had a little bit of a negative impact on our book value. But as I mentioned, mortgage spreads moving back toward the middle of the range has been the other driver.
Speaker Change: of that. What I think it shows is that we're in a higher volatility environment right now over the near term and it's simply because of the election. One of the reasons why we ended the quarter, last quarter with our leverage still very low at 7.2 was essentially retaining some capacity.
Speaker Change: for this environment, from a risk management perspective, and from an opportunity perspective, our unencumbered position, cash position at the end of last quarter was 6.2 billion or 68% of our equity as one of the highest prints we've had. But we did anticipate that as we went into the election, the interest rate environment would become much more volatile, and that clearly has been the case given the outlook of how close the election is, this back up in interest rates.
Speaker Change: is related to that. I expect that it's going to remain volatile for the next several weeks or maybe even a month or so. But in the end, once you get through the election, I think the fundamental outlook for the mortgage market takes over and for fixed income in general. And that's why we're so optimistic, but you're right, we have to be a little defensive here for the next couple weeks until we get through the election. Thank you.
Speaker Change: Got it. No, sorry for missing the comments. I was clearly making another cup of coffee, I apologize. No problem. Towards repeat. That's it for me. Thanks, guys.
Speaker Change: Our next question comes from Doug Harder from UBS. Please go ahead with your question.
Doug Harder: Hi, Doug. Thanks. Hi, Peter. Just on the last comment about, you know, kind of being defensive, you know, I guess, how are you thinking about, you know, kind of, kind of, of deltahedging, you know, kind of reducing portfolio size or leverage, you know, kind of in, in the run up to the election or in this kind of current volatility versus, you know, kind of having the flexibility of of kind of letting leverage rise.
Speaker Change: Yeah, I think we were well positioned from a leverage perspective, so I don't anticipate us having to do anything on the leverage side, but I do anticipate, and we typically would do this in such an environment is, you know, Delta Head, some of the rate move, our duration gap, for example, today is probably about 0.4 years or something in that neighborhood, about a half year. I don't expect it to be much larger than that and may even come down over time. So we'll be a little bit more active on the delta hedging side. I don't anticipate us having to do anything on the on the leverage side. I expect this again to be a fairly short lived.
Speaker Change: Buried of volatility.
Speaker Change: Great. And then on the treasury hedges, clearly Swap Spreads have moved and widened and being in treasuries was the better place to be. How do you think about where that spread can go and at some point it makes sense to try to capture that difference and move into more sofa-based hedges?
Speaker Change: I'll start with the latter part. It definitely does. And if you recall over the last several quarters, we've actually talked more about increasing our swap base hedges. But we did the opposite last quarter because of the way the market was trading. But you're right over the long run or longer run. I do expect us to shift back more toward swap based hedges.
Speaker Change: But as Chris mentioned, right now given the focus on the deficit, given the sort of response and the treasury market to the election and how that may play out and what that may mean under either administration for the supply of treasuries.
Speaker Change: We've sort of delayed that transition to back toward more of our swap based hedges. If you think, like historically, we probably have on average operate with somewhere between 70 to 80% of our hedges and swap based hedges. Today, it's 60%. So there could be 10 or 20% shift in our hedge portfolio over time. Once we get stability in the rate market and stability in the swap spreads, but swap spreads as you pointed out, they're very technical. Very difficult to read. A lot goes into them.
Speaker Change: But over the long run, we will ship back one towards flop-based hedges at some point.
Speaker Change: Great, appreciate it, Peter.
Speaker Change: Our next question comes from Trevor Cranston from JMP Securities, because you have with your question.
Trevor Cranston: Hey, thanks. I want to, I want to, I want to. I think you mentioned in the prepared comments that, you know, as the yield curve starts to steep in with the Fed easing.
Trevor Cranston: You know, you'd expect to see some increased demand for MBS. You can elaborate on that a little bit in terms of, you know, like how much curb steepness you typically need to see for some lead demand to come in and kind of who the investor base that comes in as the curb becomes stupid. Thanks.
Speaker Change: Yeah, it's an unknown, but I do expect it to increase and I expect it to demand to really come from unlovered investors, not levered investors that while there are some levered investors
Speaker Change: They're not the significant share of the market, as we see it going forward. Chris mentioned
Speaker Change: the bond fund inflows and that's really one of them.
Speaker Change: One of the key drivers of that will be the shape of the yield curve. There's returns of over 5%, those are obviously going away and over time.
Speaker Change: Fixed income like a high quality agency current coupon with a yield today of five and a half or so percent will look really attractive and I think that ultimately money will flow out of those funds and out of equity into fixed income given the attractive yield opportunity. So it's something that's just going to occur over time. But the shape of the yield curve obviously will be important from a bank perspective in terms of the carry on on mortgages. It is foreign demand, perhaps we do expect and we thought we were going to get some resolution on the basil end game. Certainly the Fed indicated that they were moving toward resolution on that.
Speaker Change: A late in the third quarter, that seems to have been delayed, but that was heading in a very positive direction, so there will be some clarity over that over the next.
Speaker Change: Quarter or so. And so I think that'll be a positive for the bond market as well. So those are the sources that we see occurring over time.
Speaker Change: Okay, I appreciate it. Thank you.
Speaker Change: Sure. Our next question comes from Eric Caging from BTIG. Please go ahead with your question.
Speaker Change: Thank you, thank you very much for following up on the leverage questions, hope I'm going to say.
Eric Caging: You guys are running less than eight times leverage, but like you said, mortgage spreads are still relatively wide. How much room do you feel like you have to raise leverage and what's the right way to benchmark your leverage? And maybe the upper bound that you could target versus periods historically, where their shape of the curve has.
Speaker Change: You know, maybe we've been a little different in your valuation, also supports the ability to raise a creative capital right now.
Speaker Change: Yeah, there's a lot there and it's difficult to give you any sort of hard quantification of the upper bound or lower bound because it's really driven by the specific environment that you're in. So the variables that matter a lot when you're thinking about setting your leverage really comes down to volatility, comes down to volatility of interest rates and volatility of spreads.
Speaker Change: and when you're in a highly volatile spread and we are a spread business, that is the biggest driver of our book, value.
Speaker Change: So, the food environment, like we were, this is why we specifically brought this up on this call.
Speaker Change: Back a year or two ago when mortgage spread range was really wide, you had to really be defensive in terms of your leverage position to give yourself sufficient capacity to absorb these very wide spread moves.
Speaker Change: As that range narrow segment, obviously gives you more confidence.
Speaker Change: to operate with higher leverage.
Speaker Change: That, as I've been trying to communicate, has been materializing over the last several quarters. The more we stay in the range, the more confidence you get in the range gives you greater ability to operate with higher leverage.
Speaker Change: to the extent that mortgages are on the upper end of that range.
Speaker Change: and your confident at range holds. That's a more of an ideal time to employ more leverage when you get to the lower end of the range we obviously are a little more hesitant to deploy capital at those levels. For example, in the third quarter when we raised capital.
Speaker Change: At times, mortgages were in that range in the middle of the range and they were really attractive when they got to the lower end of the range. We actually paused and didn't deploy capital as quickly. So it's an opportunistic sort of decision, but...
Speaker Change: The point is today, as we ended the quarter with 68% of our capital unencumbered, it does give us capacity to operate with higher leverage, once we get confidence, and the mortgage spread range, which is become, we're becoming increasingly confident in. And then once we get through this interest rate environment, obviously we've had experiences with elections where interest rates have become very volatile, that's something that we're going to have to be disciplined with over the short run.
Speaker Change: That's really helpful. Hey, do you guys see a material difference in yield or carry within the coupon stack? And as you guys raised additional capital, where do you expect to essentially deploy that within the stack? Thank you. Yeah, I'll have Chris talk a little bit about where we see the opportunities. Yeah, so generally speaking, production coupons.
Chris Kuehl: All for the best long run, risk adjusted returns, of course they have more pre-payment risk, but we think that's more than in the price. You know, higher coupon spreads are wide because they have to contend with much worse tacticals, right? If banks were more involved in growing their securities holdings, the spread curve would likely be less upward sloping. Instead, you have a market dynamic that's been in place for over a year now, as fixed income, you know, sentiment has improved, you know, bond fund inflows are generally directed to index coupons, which aren't being produced, whereas, you know, all the organic supplies and higher coupons. I think, you know, over time as banks rotate out of lower yielding securities and into higher coupons and ultimately,
Chris Kuehl: Absolutely, you know, start growing their securities holdings relative value relationships, you know, will likely shift, but it will take time, but likely require a basil three clarity as Peter mentioned, maybe a couple more Fed rate cuts. In the meantime, you know, we're likely to, you know, maintain and add, you know, higher coupons relative to the index, which, you know, we think offer the best, the best longer on returns. You know, that said, you know, there are sectors within lower coupons that can be compelling from, you know, a total return perspective and also provide diversification and liquidity benefits in certain environments.
Chris Kuehl: and the channel is speaking, you know, we see the best opportunities and production coupons.
Speaker Change: Let's roll a helpful. Thank you guys.
Speaker Change: Thank you.
Speaker Change: Our next question comes from Jason Stewart from Jenny Montgomery. Please go ahead with your question.
Jason Stewart: Thanks, good morning.
Jason Stewart: Peter, maybe you could elaborate on your view of the current pre-payment environment and maybe specific to the servicing industry capacity and how that affects your current pre-payment outlooks on current coupons.
Speaker Change: Sure, I'll let Chris address that.
Chris: And sure, so, you know, the last two pre-pay reports, you know, we're certainly the most interesting that we've had really, you know, in the post-COVID period.
Chris: Since we had a pretty sizable portion of the float in higher coupons, at least exposed to 50 plus basis point in the Senate to refinance, on fairness, as a percentage of the outstanding float, it was still very small around 10%, but as a percent of the float originated since 2022, it was a little over 30% when mortgage rates got down to around 6% back in September . We've since obviously sold off 40 plus basis points in October . So the refiwave was again very short-lived. But what we observed is that the response for a given incentive to refinance was definitely sharper than what we observed during the last many...
Chris: ReFi Wave, you know, around the start of the year, but still quite a bit slower than what we experienced during COVID. So in other words, for the same incentive, for similar loans.
Chris: Peakspeeds were still quite a bit lower than what we experienced during COVID. So, you know, in fairness, you know, these sample sizes, you know, are too short-lived to draw any, you know, significant conclusions from, but, you know, what we've observed so far is a less aggressive.
Chris: response than a couple of years ago. You know, the only other thing I'd say, you know, capacity clearly is not an issue in the system. We're not, certainly not betting against efficiency in the refi process longer run, but they're, you know, there possibly, you know, some differences today that explain the weaker response, a lack of immediate effect is one for sure, you know, and given the relatively flat curve refi products like arms or less compelling to borrowers. And so there are exploit explanations, you know, to the, to the tamer response, but, you know, again, it's hard to draw, you know, long run conclusions from such a short
Speaker Change: Okay, that's really helpful. Thank you for that. And then a high level question. You know, as we look at slide 24, we just look at the MBS spread sensitivity to a shock. Can you remind us, you know, first how that's measured in terms of the MBS spread and maybe what the Delta is between realizing that and that snapshot, I believe we're something like 12.6% appreciation for 25. Basically, this point at 630. So maybe if you could just help, you know, put a point in the primary drivers between actual and and and that snapshot, that'd be helpful. Thanks.
Speaker Change: Yeah, it's one of the issues that I think maybe maybe made this quarter a little bit confusing because you really can't look at just a simple benchmark spread. Really when we're doing that, we're running our entire portfolio and shock in each of our coupons.
Speaker Change: and coming up with that sensitivity, the challenge for investors is to, how do I replicate that in terms of estimating our bookvalley performance? If you look for example, at the current coupon spread as a benchmark, which I often refer to in terms of...
Speaker Change: given indications of richness or cheapness, it can lead to misleading results, like, for example, this last court, a current coupon, looked like a tightened a lot.
Speaker Change: and that's because we shifted down in coupon by almost a full coupon. So we went from a six at the beginning and a quarter to a five and so there's a big drop in yield.
Speaker Change: Not consistent with the economics of spread tightening.
Speaker Change: What you really have to do is you have to look at...
Speaker Change: You have to look at the performance of each coupon to sort of hedge benchmark.
Speaker Change: and come up with a weighted average approach that will lead you to a more correct conclusion. If you look at, for example, the performance of a six in the performance of a five last quarter.
Speaker Change: Sixes actually were wider on the court by close to eight basis points and fives were actually tighter on the court by a couple basis points. So that was really the way you have to look at the performance. That's what we're doing when we do that sensitivity. You would have to look at our portfolio, look at it by coupon, look at the performance of each coupon to a benchmark. Thank you Mark.
Speaker Change: Hedge portfolio, whether it be swaps or treasures and draw conclusions from there.
Speaker Change: Thanks. No, no, no. It makes perfect sense to me. You beat us by 15 cents, so that's the way we do it, but I do get the question a lot, so I thought it was helpful to draw a high level take away.
Speaker Change: Perfect.
Speaker Change: and our final question comes from Harsh Amnani from Green Street. Please go ahead with your question.
Speaker Change: Thank you.
Speaker Change: Maybe following up on that pre-pain and pre-squestions, the expected light CPR increased quite a bit. Can you help explain that increase against the backdrop of, you know, where you're expecting, call it mortgage rates to trade in the six and a half percent range? Is it just the sensitivity to the same refund center increasing or any color that would be helpful?
Speaker Change: Yeah, the increase in our projected lifetime CPR was based on where inter-perreliant interest rates were at the end of the quarter. So interest rates in the third quarter declined.
Speaker Change: Full wood interest rates were also lower that led to an acceleration in our expectation of repayment speeds on our portfolio over the lifetime based on each particular coup on.
Speaker Change: So it's consistent with where four wood rates are and four wood mortgage rates.
Speaker Change: Or...
Speaker Change: I don't know if that chord answers you.