That number with spreads, call it just roundly in the 150 basis point range, I think you can conclude that mortgages are generating mid-teens ROEs, given the way we’re managing our portfolio, so I think the important takeaway is those two things still remain relatively well aligned. Again, as the environment unfolds, and we talk about some favorable drivers – decline in interest rate volatility is beneficial, there’s no doubt about that, and so we’ll have to make those determinations over time. But generally speaking, I think it’s fair to say that those two things are still well aligned.
Doug Harter: Great, and then you talked about, and we’ve experienced kind of that range – you know, the 140 to 190, as you’ve gotten more evidence of that range, does that change how you would manage the portfolio in the risk-off as spreads are widening, and does that give you more comfort to kind of let leverage move higher and hold onto assets as you’re going towards the higher end of that range, or just kind of lessons learned from this volatility?
Peter Federico: That’s a really great clarification – it triggered my memory because, thinking about that last part of the question, it was an important point to bring up the leverage outlook because where we are from a leverage perspective, ending the quarter at only seven times leverage, and putting that in the context of our unencumbered liquidity position, which is at the highest percent it’s ever been at, by the way, it’s at 66%, tells you that we have significant amount of capacity to take greater risk as the environment unfold for us, and we’ll be able to do that. We just don’t feel like we’re being pressured to do that because, like we said, we talk about spreads staying relatively stable in this area, so we can be patient and disciplined as we deploy capital.
But you’re 100% right – the key point of my prepared remarks was the fact the more times that you hit the upper end of the range and the more times that holds, gives you greater confidence that you’re starting to understand the flow of demand for mortgages at different rate levels, and so it does give you greater confidence which will ultimately feed into your risk position and our ability to manage our levered portfolio. When the market was very destabilized, when there was a lot of uncertainty about the Fed, you have to think about your leverage on a volatility-adjusted basis, and all other things equal, that will tell you that per unit of risk, you’ve got to operate with a lower amount of risk or lower leverage. What you’re describing is an environment where that will start to go the opposite way – per unit of risk, you can actually take a little bit more risk as you get more and more confident that the spread range is going to be stable, so it’s an important point.
That will develop more over the course of 2024.
Doug Harter: Great, thank you, Peter.
Peter Federico: Sure. Thank you for the question. Good question.
Operator: Our next question comes from Bose George from KBW. Please go ahead with your question
Bose George: Hey everyone, good morning. On an earlier question on spreads, Peter, you gave the near term range of expectations. Can you just talk a little bit about the longer term range once volatility comes down, where you think things can kind of settle eventually?
Peter Federico: Yes, it’s a great question, Bose, and I think there’s two things that really could drive that. The one is that we don’t exactly know what the Fed’s ultimate balance sheet is going to look like with respect to its composition of mortgages and treasuries. Now, what we know from the Fed right now is that they’re likely going to stop run-off of their portfolio. It depends – there’s a lot of different estimates right now, but I think one of the big changes that has occurred in the fourth quarter, particularly in December, is that the Fed has now made it clear that they will have to stop tapering probably sooner than any of us had anticipated, I know sooner than I had anticipated. I had anticipated the run-off to stop in 2025, and now I’m pretty confident it’s going to stop in 2024.
But we don’t ultimately know what the composition of the portfolio might be with respect to mortgages and treasuries. I think it would be in the best interest of the market if the Fed ended up–because they are permanently going to hold mortgages or permanently have a balance sheet that’s going to be significant in size, I think it would make sense from a monetary policy perspective for them to own both mortgages and treasuries, because mortgages and the housing market are so fundamental to housing policy. We’ve seen that when they’ve tried to accelerate the economy by keeping mortgage rates low, and we’ve seen them try to slow that economy down by keeping mortgage rates high, so they’re inextricably linked together and I think it makes sense for the Fed over the long run, so that’s going to be an important development that will change spreads.
The other though, Bose, away from that, is the more longer term fundamental that both the agency MBS market and the U.S. treasury market face, which is that there this is transition to a greater share of private capital that has to come into both of these markets over, say, the next five years, because if the Fed does in fact continue to reduce its balance sheet, organic supply of mortgages plus Fed run-off will be a couple trillion dollars of supply of mortgages, say, over the next five years at the same time we know now that the treasury is going to have to issue perhaps a couple trillion of new treasuries a year, so we’re talking about multiple trillions of dollars that have to be consumed, not by levered buyers but by unlevered buyers, real money flowing into the U.S. fixed income market for these two high quality assets, both agency MBS and treasures.
I think spreads–when you think about an agency MBS, which has the explicit government support behind it at 150 basis points, for argument’s sake, over a treasury which is government guaranteed, but in a sense they’re both government guaranteed securities, 150 basis points of incremental spread is really a significant amount of spread, particularly if the 10-year is at, say, 3% or 4% – you’re talking about a 25% or more improvement in your yield, so I think it’s going to bring investors into the agency MBS market. I think it’s going to be a reallocation out of treasuries into agency MBS, out of corporates into agency MBS, and the final important point which will drive spreads ultimately–which could be a factor that makes spreads ultimately lower, but we won’t know yet, is what happens with bank regulation.
If banks have to, for example, manage their interest rate position on their securities portfolio, it’s much more likely that they’re going to want to own mortgages or agency MBS in that environment because there, you can’t actually buy a longer term security, hedge the interest rate risk and still generate a positive return. It won’t make sense for banks to own treasuries and then hedge the interest rate risk – there will be no return there. Those are all longer term factors that will have to develop over time, which will drive spreads ultimately are, but that’s one of the reasons why I think they’re going to stay high, is because there is this need for a lot of capital to flow into the treasury and agency MBS markets.
Bose George: Okay, great. Very helpful, thanks Peter. Just wanted to follow up also on the book value update quarter to date. The way we track it, it looks like spreads, at least versus swaps, have widened a little bit across the curve, so just curious with your book value up, whether there was other factors. Should we look more at treasury swaps, or just any color there would be great.
Peter Federico: Yes, what I would say is obviously we have a little bit of a different duration position now. Our duration position is really neutral in the current environment. Our book value was up, as Bernie mentioned, 1% to 2%. The coupon distribution of our portfolio helped us, and obviously the combination of swaps versus treasuries in our portfolio helped us. The yield curve also benefited us a little bit this quarter, so not much of a change in book value but generally positive.
Bose George: Okay, great. Thanks.
Operator: Our next question comes from Trevor Cranston from JMP Securities. Please go ahead with your question.
Peter Federico: Good morning Trevor.
