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.

Rick Shane: Got it. Yes. And that really does get to the punchline, which is that as you’re looking forward to all of those factors, that’s really what’s dictating the dividend policy and…

Peter Federico: I appreciate that clarification. That’s exactly right. It’s setting the dividend policy based on the level of return from an economic perspective that we’re seeing as opposed to the current period earnings – that gets reflected in our net interest margin.

Rick Shane: Okay, thank you very much.

Peter Federico: Sure. Appreciate the question.

Operator: Our next question comes from the line of Terry Ma with Barclays. Please go ahead.

Peter Federico: Good morning, Terry.

Terry Ma: Hey, good morning. Thank you. So you mentioned that you thought the recent volatility would be short-lived. Can you maybe just give a little bit more color on what gives you confidence that it will be short-lived – and then maybe just your expectations on where near-term spreads are set once the volatility this year?

Peter Federico: Sure. Both Chris and I tried to address this to some extent in our in our prepared remarks. And I think Chris referenced the fact that this quarter looked a lot different than previous quarters when we had similar moves. And that’s really a critical point from our perspective. What occurred in the first quarter was generally a very stable market conditions, but there was a very significant repricing of the timing and magnitude of short-term rate moves from the Fed. Importantly, it was not a shift and has not yet become a shift in paradigm with respect to monetary policy. Said another way, the Fed was really clear in a number of communications that the policy rate was likely at its peak and the next move was likely going to be an ease.

What we had in the first quarter was simply a plateauing of CPI data – it came in at 3.9% and then 3.8% and 3.8% again. It just didn’t show the improvement that the Fed was looking for. And in the 2 or 3 days following each of those CPI reports the 10-year treasury moved up 20 to 25 basis points and at stance taking out one. So when we started the year, the market probably incorrectly so, may be too optimistic, expected the Fed to ease 5 or 6x. Now as we sit here today, the market has repriced to only 1.5 moves this year and importantly, in aggregate, the Fed funds futures in 2027 tell us there’s only six moves in total, meaning that the Fed funds rate now according to the market’s projections is going to settle out at around 4%. That’s materially higher than what the Fed’s own long-run target is, which is still 2.5%.

So what we had occur is a very significant repricing of the path of short-term interest rates. We did not have a paradigm shift. If inflation continues to not evolve or reaccelerate, there could be a shift in monetary policy. We don’t believe that’s going to happen. We get important inflation data at the end of this week in the PCE report. But we believe, and I think the Fed still believes that inflation will show signs of improvement. We will move more toward the Fed’s long-run target, which, by the way, the Fed’s own estimate of PC at the end of this year, is 2.6%. That’s not going to be materially off where the number comes out at the end of this week. And with that projection, the Fed expected to remove. So we think that where the 10-year is at, call it, 4.5 to 4.75.

That seems like a pretty healthy place for the 10-year in the context of a Fed funds target that’s ultimately going to move to 3%. We think the inflation report ultimately come in favor of the direction the Fed ones. And I think this repricing has simply been just a healthy movement of where short-term rate cuts are going to occur and the magnitude of those, not a paradigm shift. And so spreads moved. We had a lot of geopolitical risk. We had volatility following inflation reports. If we get two or three inflation reports that are at or better than expected, we’ll have the same sort of significant repricing in the opposite direction. I think the Fed is looking for 2 or 3 months in a row of better data to have sufficient confidence. And once they get that data, then everybody will be pricing in the eases again and the direction of monetary policy will be clear again.

Right now, it’s a little uncertain, but we think the repricing is largely over. With respect to spreads, you asked that. Again, when you look at current coupon spreads near the middle of the range, that seems like a good place from our perspective. Current coupons of the 5-and 10-year treasury at 150 to 160 basis points seems like a healthy place against swaps, 180 to 190, seems like a healthy place. We do have some negative seasonals right now between this next April and May should be kind of the worst seasonal months for mortgages in terms of origination. So the market sort of, I think, is in a good place right now with the repricing that has taken place.

Terry Ma: Got it. Thank you. Very helpful color. And then just on your hedge ratio and your duration gap, you guys took the hedge ratio down and you’re now running a slightly positive duration gap. So maybe just a little bit more color on that move and then talk about where you’re comfortable running the book in this environment.

Peter Federico: Sure. I’ve talked about this for a while. It does make sense for us to gradually move our hedge ratio down as the Fed’s monetary policy outlook changes. We obviously wanted to run with a very high hedge ratio. More than 100% of our short-term debt essentially termed out in order to protect our funding cost in a rising short-term rate environment. We’re now at the inflection point – and so over time, I would expect that to come down. And as we get more confidence when and the magnitude of the Fed cuts, then we’ll ultimately probably operate with even a lower hedge ratio such that at some point in the monetary policy easing process we would want to operate with, in a sense, some percent of our short-term debt unhedged, have that – a bigger part of our funding mix.

So over time, we’ll do that. Chris mentioned, and I’ll let him speak to this. He mentioned our gradual movement to more towards swaps in our hedge mix. And I think we have a sort of a positive outlook. Chris, do you want to talk a little bit about that?

Chris Kuehl: Yes, so our funding is obviously SOFR-based. And so logically, we want to have generally a more significant portion of our hedges and SOFR-based swaps, which also have better carry. But over the last couple of years, the bid for mortgages was highly correlated with treasuries, given the dominant investor base were index funds as opposed to banks. And so, it made sense to have a more sizable component of our hedge book in treasury based hedges. U.S. Treasury issuance was also extraordinarily high at a time when banks were not in a position to grow the securities holdings. And so that had the effect of cheapening treasuries versus swaps. And now with bank deposits stabilizing and QT likely drawing to an end, we’re gradually moving our hedge book to have a higher concentration in swap-based hedges. But this will be a gradual shift, and we want to maintain diversification within our hedge portfolio composition just as we do on the asset side.

Terry Ma: Okay, great. Thank you.

Peter Federico: Sure. Thanks for the question.

Operator: Our next question comes from the line of Crispin Love with Piper Sandler. Please go ahead.

Crispin Love: Thanks. Good morning. I appreciate for taking the question, thanks. Good morning, Peter. Just looking at fund flows, bond flows have been very positive. Government fund flows have been positive as well, which have positive implications agency, but only tells part of the story. So can you just speak to what you’re seeing on the flow side? Who are the major buyers right now of Agency MBS? I think you mentioned a little bit about banks coming back in the first quarter, but do you think some of the recent rate moves could keep some of them on the sidelines for a bit?

Peter Federico: Yes. Well, we certainly did see that. You’re right. If you look at the – and this is part of the reason why didn’t feel like a paradigm shift in why the first quarter was not nearly as disruptive despite the amount of repricing that took place because bond fund flows generally stayed positive throughout the quarter, there was probably a week or 2 where they actually got to zero, maybe negative, but there was never really any big movement out of bond flows like we saw at different times last year. So the bond fund flows continue to be neutral to positive. I think we’re also starting to see outside the bond fund complex inflows into mortgage-backed securities. Those flows are obviously hard to quantify, I think they are evident in particular, if you look at the way the mortgages performed across the coupon stack were lower in the first quarter where lower coupons underperformed in higher coupons.

The current coupon are really above the 6 and 6.5 in particular – actually tightened on the quarter. I think that shows you that there’s new demand for those sort of high-yielding securities. With the backup that we have, the current coupon now at around 6.5% that, again, looks really, really attractive to treasuries. It also looks really attractive to investment-grade corporates. That spread has again widened out to around 30 basis points. So mortgages look cheap to investment grade. Corporates – current coupon in particular or the highest yielding ones. They look cheap to treasuries. I think the credit quality, obviously backed by the support of the U.S. government, helps in an environment where the economy is ultimately slowing. So I think those are going to continue to drive demand for agency mortgage-backed securities not so much on a levered basis, but actually on an unlevered basis, and that has a really positive long run fundamental.

So I think that – I think that trend is going to stay in place for a while. They just – those reallocations tend to take time for slow-moving reallocations.

Crispin Love: Great. Thanks, Peter. Appreciate taking my questions.

Operator: Our next question comes from the line of Doug Harter with UBS. Please go ahead.

Peter Federico: Good morning, Doug.

Doug Harter: Good morning. The way you’ve kind of described the market, how are you thinking about continued capital raises and the attractiveness of that opportunity?

Peter Federico: Yes, I appreciate the question. Well, obviously, we always look at it through the lens of our existing shareholders, first and foremost. And as Bernie mentioned, we were able to raise capital through our at the money program, at the market program very accretively in the first quarter. And we’ll continue to look at those opportunities. The first quarter is a really good example of one, the cost-effective nature of that capital issuance, the book value accretion that can be generated by it, but also the flexibility that affords us. As Chris mentioned, we added about little over $3 billion worth of mortgages in the quarter. If you think about that, given the amount of capital we raised, we were able to deploy those proceeds immediately into the mortgage market.

About half of those purchases if you will, went towards levering that new capital immediately. So there’s no drag from a dividend perspective. It’s accretive to book value. That translates to value for our existing shareholders. We will continue to look for opportunities to do that. I like mortgages better. Obviously, at this level, mortgages did spend a lot of time in the first quarter near the tighter end of the range, which gave us a little bit of pause. But we will continue to be opportunistic with it if we can generate existing value – we can generate value for our existing shareholders through our capital markets activities, we will certainly look to do that.

Doug Harter: And then Peter, just contrast…

Peter Federico: I am sorry, Doug, go ahead.

Doug Harter: Yes. No, sorry. And if you could just contrast that with kind of how you see leverage today and kind of how leverage might move around given kind of book value weakness but also ability to add – protect and/or add new assets?

Peter Federico: Yes. Well, we certainly have a lot of capacity the way I would describe it today, a lot of flexibility. And I think that’s appropriate because we are moving, it sort of made this, I mean in our – in my initial remarks that we are moving in a positive direction, but we are still moving essentially in that direction slowly, and there is going to be volatility along the way. And we want to be disciplined with our capital deployment and our leverage because monetary policy is still evolving. There is lots of variables that are going to drive the Fed. Over time, we are going to get more clarity. And there may be a time where we have even more confidence in the outlook. But our confidence is growing. We have a lot of – as Bernie mentioned, we have a very strong liquidity position of $5.4 billion.

As a percent of equity, I think it maybe was one of our highest points just last quarter at 67%. If you think about that on our assets, it’s over 8%. So, we have a lot of capacity, but we also want to be disciplined. And what’s important about the outlook from our perspective is that we think we are entering a period that’s going to be from a long-term durable, attractive investment opportunities, so we don’t feel any rush to deploy capital. We feel like we can be disciplined. We feel like we can continue to be opportunistic like we were in the first quarter. And so the environment is going to evolve over time. Our confidence will grow. Mortgage spread behavior within the trading range is important. And I think what we are starting to see is some consolidation in that spread, which I think is a healthy development for the market.

Said another way, for mortgages to move to the high end of the range, I think it’s becoming more challenging for that to occur. And there is growing reasons why mortgages can trade at the lower end of the range. We just haven’t seen them all evolve fully yet, but we will see that over time, and we will see how the economy unfolds over the next three months to six months and how the Fed’s behavior and the Fed outlook changes. That’s really going to be a key driver for the fixed income market is what happens to monetary policy because once the Fed starts to ease, I think ultimately, the market will price the Fed moving the Fed funds rate all the way back to 3%. But they have to start that move from a place of confidence and the market doesn’t have that confidence, yet the Fed doesn’t have that confidence.

Doug Harter: Great. Thank you, Peter.

Peter Federico: Sure. Appreciate that.

Operator: Our next question comes from the line of Jason Weaver with Jones Trading. Please go ahead.

Jason Weaver: Hi. Good morning. I was hoping you could expand a little bit more on Doug’s first question there. The 25 million shares you issued during the quarter, can you talk a little bit about the timing and coupon deployment of that capital in the quarter and subsequently.

Peter Federico: I am sorry, could you repeat the first part? I didn’t have a little to here in your question.

Jason Weaver: Sorry, Peter. I was just trying to expand on the answer to Doug’s first question about the timing and deployment of the ATM issuance you raised in the first quarter.

Peter Federico: Well, yes, like I have said, the ATM gives us a lot of flexibility. So, we were able to raise money through our – through the ATM program and deploy it immediately. As Chris mentioned, you could talk about where we would like a coupon staff. But that gets deployed really simultaneously almost.

Chris Kuehl: Peter mentioned the $3 billion increase. That was a fair value increase. We added roughly $4 billion in Agency MBS during the quarter in current phase terms. Majority of which was in higher coupon 30-year TBA. We also added about $400 million in hybrid ARMs.

Jason Weaver: Was that sort of weighted throughout the quarter or weighted towards the beginning or end? Can you speak to that?

Peter Federico: No, we usually don’t give those sorts of detail. I appreciate the question, but…

Jason Weaver: Fair enough.

Peter Federico: Yes.

Jason Weaver: No, that’s fine. And here is – what were you thinking about the implications for the Fed’s reduction in Q2 and how that might change your portfolio strategy, hedging strategy?

Peter Federico: Well, as Chris mentioned, just real quickly, I will make a couple of comments. As Chris mentioned, obviously, the Fed is going to move first and significantly with respect to its treasury portfolio. So, I expect the Fed to announce next week at the meeting that they will cut the treasury cap by half. It does not appear based on the minutes that they are going to make a change at this point to the mortgage cap because the mortgages are running off so far below. They are actually running off at about half of the cap right now. So, I don’t expect the Fed to make a change on that. But I do expect treasuries to come down and over the remainder of the year, I expect treasury run-off cap to actually come to zero. And that has a positive development generally speaking, for treasuries versus swaps.

When you think about bank regulation and the fact that bank regulation is going to be less onerous, I think that’s going to also push us to, as Chris mentioned, to swap. So, I think that’s where it has an implication from a hedging perspective. Longer term, I think it’s still unclear exactly how the Fed is going to handle its mortgage portfolio with respect to its changes to its balance sheet. And this is going to be an important development. Last week, for example, there was a paper that came out from the open markets desk at the New York Fed, where they show two examples of how the Fed may approach tapering its portfolio runoff. And in both of those scenarios, they had the mortgage cap getting cut in half. Now, that won’t have any practical impact on the speed of runoff because mortgages for the Fed’s portfolio are running off between $17 billion and $20 billion.

But it would have a long-term stabilizing effect on the mortgage market if they did choose a cap structure like that, they could still achieve their stated purpose of allowing mortgages to run off and be redeployed into treasuries. And ultimately, over a very long time horizon, they would be able to achieve their objective of having primarily treasuries. But this is – that would be a sort of transfer of mortgages to treasuries that would occur over multiple years. If they use a lower cap to allow that to happen, that could be a positive development for mortgages. We will have to wait and see how the Fed handles that. I don’t think we are going to get that level of detail right now, at this first initial move, but I think we will get that over time.

Jason Weaver: Alright. Thank you for that.

Peter Federico: Sure.

Operator: Our next question comes from the line of Merrill Ross with Compass Point. Please go ahead.

Merrill Ross: Good morning and thank you. You might not answer this, given what you have just said. But did you add to the portfolio into April’s volatility, particularly in the 5.5 and what is the current leverage given the decline – the 8% decline that Bernie referred to in book value?

Peter Federico: I am sorry, I didn’t hear this last part. We have a little bit of a bad connection. I think the first part was, did we add to the portfolio in April? What was the second?

Merrill Ross: The current leverage.

Peter Federico: Current leverage, yes, Chris could talk a little bit about mortgages in the current environment and where he is adding and seeing value. With respect to current leverage, it’s a little higher today. It’s actually around 7.4 given the backup in net asset value and portfolio activity to-date. Anything that’s particular about today’s market?

Chris Kuehl: Yes. With respect to – we haven’t had any material changes in the size of the portfolio quarter-to-date. With respect to relative value within the agency space, as I mentioned earlier, higher coupons significantly outperformed lower coupons during the quarter, in part, given concerns around bank sales and lower coupons related to some M&A balance sheet restructuring announcements that were made. But also in response to very favorable prepayment reports that showed considerably flatter refi responses in higher coupons compared with what we saw during the last refi wave during COVID with similar incentives to refinance. And so up in coupon benefited from that as well. And despite the higher coupons outperforming, I would say relative value is still generally upward sloping across the coupon stack.

Merrill Ross: Okay. I have one other unrelated question, if you don’t mind.

Peter Federico: Sure.

Merrill Ross: The Series C that’s callable. Wouldn’t you use some of your liquidity? I mean maybe on the margin, it’s not really material to you? I am just curious.

Peter Federico: Appreciate that question. We are constantly evaluating our capital structure. And you are right, that series is callable. But as I mentioned, even though it has reset higher and the coupon on that one is a little, 10.7%. It is certainly materially higher than our other fixed rate preferreds. Even at 10.7%, given where the returns are on our portfolio, that is still a lot of value that is accruing to the benefit of our common shareholders. So, we will look for always as we do, look for opportunities to optimize that cost of our capital. The preferred market has been relatively quiet right now. So, there is not a lot of activity going on in part because of the rate uncertainty. But I expect that to change over the remainder of the year, and there might be opportunities in the preferred market as we move forward. So, we will continue to evaluate that. But it does generate incremental value right now for our common shareholders.

Merrill Ross: I believe MSA refinanced a series at 9%, I am just curious, not that, that seems like a really huge relative value trade from 10% to 9%, but…

Peter Federico: And the other important part – the other important point about the floating rate preferred obviously is your – we are likely at the peak of that coupon. And obviously, coupon can change very, very rapidly. So, there is lot of option value in those series right now. The Fed obviously, a couple of quarters or a couple of months of positive inflation data, and the forward curve will be materially downward sloping and those coupons could look very attractive in a year or so.

Merrill Ross: Great. Thank you.

Peter Federico: Sure. I appreciate your question.

Operator: And our last question comes from the line of Eric Hagen with BTIG. Please go ahead.

Jake Katsikas: Good morning. This is actually Jake Katsikas on for Eric. Appreciate you guys taking my questions. First one, could you flesh out a little bit the outlook you have for prepayment speeds including how much room you might see for your forecast to change with mortgage rates kind of coming up recently. Do you think faster speeds would be a benefit or maybe a headwind on earnings or possible economic return? Thanks.

Peter Federico: Sure. Chris, do you want to talk about prepayment?

Chris Kuehl: Given our coupon composition, slower speeds, the prepay reports over the last two months have been some of the more interesting reports than we have had – that we have had over the last couple of years after spending December, sort of through the December mid-February timeframe. It’s sort of local lows and mortgage rates with rates around 6.5% to 6.75% after spending the second quarter and third quarter last year, originating pools with 7.5% to 8% note rates. And so we got a lot of insight into what the refi response was going to look like on a sizable population of loans with, call it, 75 basis points to 100 basis points of incentive to refinance. And what we learned was that speeds were quite a bit slower than what many had feared and slower than what we observed during COVID on loans with similar incentives to refinance.

And so this, as I mentioned, has provided a tailwind to higher coupons. It’s interesting. I think there are a number of factors that likely contributed to the slower response than what we saw during the last refi wave. So, slower speeds are favorable for our position. With respect to the lowest coupons, which are a very small percentage of our holdings, even there, I would say, turnover speeds have been over the last year, a little better or a little faster than what many had feared. So, hopefully, that gives you some insight into our outlook on speeds.

Jake Katsikas: Yes, it does. Appreciate that. And then finally, just going back to leverage, what is your historical range for leverage been? And do you think that range might change at all if mortgage spreads remain historically wide?

Peter Federico: Yes. I mean look, if you look back over a very long history and we have put these numbers out, our leverage has ranged probably at the low point, maybe around 6% or thereabouts and at the highest print was probably in the 9%, 9.5%. So, it sort of give you some bookends. But really, what you have to think about is when you think about leverage is it’s dependent on the environment. It depends on where mortgage spreads are, if mortgage spreads being tight versus mortgage spreads being historically wide that’s a really critical driver of the interest rate environment to volatility. As I talked about a lot over the last couple of years, all other things equal, in an environment that we have just gone through, where there has been a significant negative fixed income market re-pricing as the Fed went from quantitative easing to quantitative tightening, bad for all fixed income securities volatility was really high.

Liquidity was challenging at times. You sort of have to volatility adjust down the leverage. Said another way, each unit of leverage has a higher risk element to it. So, all other things equal, we had to bring our leverage down to account for the increased volatility. As the environment changes, as we get more and more confident that mortgage spreads will not break out of this new range that the high end, importantly, of the range will hold like it has held now for better part of seven quarters. Those will be important drivers for leverage going forward. But it’s going to depend on monetary policy. It’s going to depend on the volatility of interest rates, the cost to rebalance, liquidity in the market and obviously our view on where mortgage spreads may go.

Jake Katsikas: Thank you so much.

Peter Federico: Sure. Appreciate all the questions.

Operator: We have now completed the question-and-answer session. I would like to turn the call back over to Peter Federico, for closing remarks.

Peter Federico: Again, we appreciate everybody’s time this morning, and we look forward to speaking to you again at the end of the second quarter.

Operator: Thank you for joining the call. You may now disconnect.