AGNC Investment Corp. (NASDAQ:AGNC) Q1 2024 Earnings Call Transcript

AGNC Investment Corp. (NASDAQ:AGNC) Q1 2024 Earnings Call Transcript April 23, 2024

AGNC Investment Corp.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning and welcome to the AGNC Investment Corp First Quarter 2024 Shareholder Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Katie Turlington in Investor Relations. Please go ahead.

Katie Turlington: Thank you all for joining AGNC Investment Corp.’s first 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 facts, 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 due to the impact of many factors beyond the control of AGNC. All forward-looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice.

Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in AGNC’s periodic reports filed with the Securities and Exchange Commission. 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, Director, President and Chief Executive Officer; 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 Reid, 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 all for joining our earnings call. AGNC generated a strong economic return of 5.7% in the first quarter, driven by a combination of our 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 and that a durable and favorable investment environment for AGNC was slowly emerging. We highlighted our belief that short-term rates had peaked for this tightening cycle that 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 AGNC’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 among Fed members regarding the level and direction of short-term interest rates. As reflected in the March Minutes, participants judge that 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. In 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 Fed also indicated that it would reduce the pace of runoff on its 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 remain 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 increased 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 and spreads on higher coupon securities tightening.

Also noteworthy, Agency MBS spreads remained in the same well-defined trading range and spread volatility declined meaningfully. 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 as 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 III 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 cause 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, the 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, if 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. As a highly liquid pure-play levered Agency MBS investment vehicle, we believe AGNC is well positioned to benefit from these favorable investment dynamics as they evolve over time. With that, I will now turn the call over to Bernie Bell to discuss our financial results in greater detail.

Bernie Bell: Thank you, Peter. For the first quarter, AGNC had comprehensive income of $0.48 per share and generated an economic return on tangible common equity of 5.7%, which included $0.36 of dividends declared per common share and a $0.14 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 and 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 7.1x tangible equity compared to 7x as of Q4, while average leverage for the quarter decreased to 7x from 7.4x in Q4.

Net spread and dollar roll income for the quarter remained strong at $0.58 per share. The modest decline of $0.02 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 swap costs more than offset the increase in the average asset yield in our portfolio. Consistent with higher interest rates, the average projected life CPR for our portfolio at quarter end decreased 100 basis points to 10.4%. Actual CPRs for the quarter averaged 5.7%, down from 6.2% 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, with Unencumbered Cash and Agency MBS of $5.4 billion or 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. And with that, I’ll now turn the call over to Chris Kuehl to discuss the agency mortgage market.

Chris Kuehl: 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 5 and 10-year U.S. treasuries were higher by 36 and 32 basis points, respectively. In general, risk assets handled the repricing well considering the magnitude of the adjustment with the S&P gaining more than 10% and in the Bloomberg investment-grade corporate bond index generating an excess return of approximately 90 basis points. In aggregate, the Bloomberg Agency MBS index lagged the performance of other fixed income sectors with spreads slightly wider versus U.S. treasuries. However, 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 weight heavily on these coupons. In contrast, higher coupon MBS performed very well during the quarter, tightening 5 to 10 basis points as 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 9 basis points and 5 basis points at the 5 and 10-year points on the curve, 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 wide spreads low levels of pre-payment risk in deep and liquid financing markets. I’ll now turn the call over to Aaron to discuss the non-agency markets.

Aaron Pas: Thank you, Chris. While higher rate environments typically have negative implications for both consumer and corporate credit fundamentals, the current robust employment landscape continues to bolster credit performance. Consequently, fixed income credit generally performed well in the quarter, resulting in positive excess returns across most sectors. As an indicator for credit spreads in Q1, the synthetic investment grade in high-yield indices adjusting for the role tightened by approximately 10 and 45 basis points, respectively. On the credit fundamental side, we continue to expect an increasing divergence of consumer performance metrics. As we have previously noted, U.S. households have experienced varying degrees of inflationary pressures primarily bifurcated between households with low note rate mortgage debt, who are relatively immune to the higher rate environment and housing inflationary impacts and renter households who are not.

As a result, we expect the divergence of credit performance between the 2 groups to widen with renters at a relatively high 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 increased 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. The 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 opportunities 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.

Peter Federico: Thank you, Aaron. We’ll now open the call up to your questions.

Operator: [Operator Instructions] The first question comes from the line of Bose George with KBW. Please go ahead.

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Q&A Session

Bose George: Everyone, good morning.

Peter Federico: Good morning, Bose.

Bose George: Can you decline the level of current spreads and what that implies is in terms of incremental ROEs?

Peter Federico: Sure, I appreciate the question, Bose. Yes, as we talked about and Bernie mentioned, 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, the 5.5% 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 of the range, roughly, you look at the current coupon to the 5 and 10-year treasury at the low 150 range. If you look at it importantly to where 5 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 than treasuries in this environment could put that initial margin up in the 170 to 175 basis point range, an operating with the leverage that we typically operate in the mid-7s, low to mid-7s currently in this environment. That still translates to expected ROE 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, they are more attractive right now, and that seems to be a pretty compelling level from our perspective.

Bose George: Okay, great. Thanks. And then just a related question, can you just talk about the comfort level on the dividend, the breakeven ROE now, I guess, high 17s, but I guess that’s within the range you just mentioned?

Peter Federico: Yes. And as you pointed out in the past, it depends on how you look at that calculation. 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 want 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 an ROE above that 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 that’s still generating a lot of incremental value for our common shareholders. The average cost of our preferred stock, I think at the end of last quarter was around 7.25%.

It’s a little higher now given the reset of one of our preferreds. But there’s 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.

Bose George: Okay, great. Thank you.

Peter Federico: Sure. Appreciate the good questions, Bose.

Operator: The next question comes from the line of Rick Shane with JPMorgan. Please go ahead.

Rick Shane: Hey, guys. Thanks for taking my questions this morning. Look, so one of the interesting facets of the portfolio as the contribution from swaps over the next several months, you have $8.5 billion notional 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 runoff?

Peter Federico: Yes, I appreciate the question, Rick. Yes, I think I didn’t hear the – actually the first part of your question, but I think you’re talking about swap spreads and swap spread performance to some extent. And that was an important driver of performance because swap spreads tightened a lot. But when you think about our net interest margin, we talked a lot about this. Our net interest margin has remained really, really robust. Last quarter, it was 298 basis points and that is not consistent with the economics that we just went through. If you think about that net interest margin at around 300 basis points, and you divide that and think about that from an ROE perspective, you’re going to get an ROE of 25%, 26% or take our net spread and dollar roll income and divide that by our common equity, which would be consistent with that 300 basis points of net interest margin, you’re going to get an ROE of 25%, 26%.

The economics of our business, as we just talked about, are in the mid to high teens. And what’s going to happen over time is as those swaps run off and you are right, we have about $8.5 billion still maturing and we had about $5 billion mature, by the way, in the first quarter and that contributed to somewhat that slight decline in our net interest margin. Those will roll off over time and our net spread in dollar – or our net interest margin because of those swaps rolling off will come down. There are other factors, though, that you got to consider. So 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 longer-term swap today, it’s still a positive carry by, for example, a 10-year by 150 or so basis points.

And also, our asset yield is still below market yields. Our asset yield is still 25, 30 basis points below market yields. So, as Chris and team roll the portfolio over, and we continue to move our assets around, 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 you’ll see over the next several quarters to years as old swaps roll off, new swaps come on, assets get replaced, net interest margin 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.