AGNC Investment Corp. (NASDAQ:AGNC) Q4 2023 Earnings Call Transcript

AGNC Investment Corp. (NASDAQ:AGNC) Q4 2023 Earnings Call Transcript January 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, everyone, and welcome to the AGNC Investment Corp. Fourth Quarter 2023 Shareholder Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today’s presentation, there will be an opportunity to ask questions. To ask a question, you may press star and then one on your touchtone telephone. To withdraw your question, you may press star then two. Please also note today’s event is being recorded. At this time, I’d like to turn the floor over to Katie Turlington in Investor Relations. Ma’am, please go ahead.

Katie Turlington: Thank you all for joining AGNC Investment Corp’s fourth quarter 2023 earnings call. Before we begin, I’d like to review the Safe Harbor statement. This conference call and corresponding slide presentation contains statements that, to the extent they are not recitations of historical fact, 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 protections 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’ll turn the call over to Peter Federico.

Peter Federico: Good morning and thank you all for joining our call. The fourth quarter of 2023 illustrated the importance of our active portfolio management strategy as AGNC generated a very favorable 12% economic return despite significant intra-quarter volatility. Over the last two years, the Federal Reserve has engineered one of the most aggressive tightening campaigns ever experienced, raising the federal funds rate by 525 basis points while simultaneously reducing its balance sheet by $1.3 trillion. Despite this challenging and volatile fixed income environment, AGNC generated a positive economic return of 3% in 2023, produced a positive total stock return of 10%, and importantly provided shareholders with a stable and compelling monthly dividend.

Early in the quarter, treasury supply concerns and persistent monetary policy uncertainty weighed heavily on the fixed income market, driving the yield on the 10-year treasury and the current coupon agency MBS to 15-year highs of 5% and 7%, respectively. Later in the quarter, better-than-expected economic data and the Fed’s monetary policy pivot triggered a dramatic rally across the fixed income and equity markets as investors sought to lock in attractive return opportunities. To put the fixed income rally in perspective, from the peak in yields on October 19 through the end of the year, treasury rates rallied by more than 100 basis points across the yield curve and the Bloomberg Aggregate Bond Index posted a total return of close to 10% over that time period.

The performance of agency MBS closely tracked treasury yields, underperforming early in the quarter as interest rates increased and outperforming later in the quarter as interest rates fell. Agency MBS spreads hit their widest level at the same time treasury yields peaked in mid-October. In November and December as treasury rates fell, agency MBS spreads tightened meaningfully across the coupon stack. As we begin 2024, we believe the investment outlook for agency MBS is decidedly more favorable than the previous two years. This positive outlook is supported by historically attractive valuation levels on both an absolute and relative basis, loan mortgage origination volumes, declining interest rate volatility, a less inverted yield curve and, most importantly, a more investor-friendly monetary policy stance by the Federal Reserve.

Our favorable outlook for agency MBS is further supported by several important developments. First, in the fourth quarter, the Fed adopted a more neutral monetary policy stance as inflation measures continued to show progress toward the Fed’s long run target. More significantly, at the December meeting, the Fed also indicated that multiple rate cuts were possible in 2024, assuming inflation measures continue to improve as expected. Second, interest rate volatility is poised to decline. Over the last two years, the distribution of potential interest rate paths has been exceedingly wide due to the many uncertainties associated with inflation, the economy, regional banks, fiscal policy, geopolitical events, and of course the Fed’s unprecedented dual track approach to monetary policy tightening.

Not surprisingly, these major uncertainties led to a meaningful increase in interest rate volatility. The MOVE Index, which is a broad measure of interest rate volatility, continues to trade more than 50% above its 10-year historical average. Although some uncertainties still remain, we expect interest rate volatility to gradually decline as many of these factors are now largely behind us. Such a decline would be beneficial to agency MBS and on balance would incrementally reduce the need for and cost of our interest rate risk management activities. The third and final development relates to agency MBS spreads. Over the last five quarters, agency MBS spreads to benchmark rates have experienced five distinct widening episodes, the most recent only being this past fall.

In each of these episodes, the spread range was relatively consistent. As measured by the current coupon agency MBS spread to a blend of five and 10-year treasuries, the range has been between 140 basis points and 190 basis points. The important takeaway from this experience is that strong incremental demand for agency MBS emerges when spreads are near the upper end of the range. In the fourth quarter, we hit the upper end of the range and again the range held. Spreads in this range are materially above the average of the last 10 years, make agency MBS very compelling on both an absolute and relative basis, and we believe are sufficient to attract a greater amount of private capital to the agency MBS market over time. These are positive developments, and we are excited about the outlook for our business.

As a levered investor in agency MBS, the two primary drivers of our performance are changes in spreads and interest rate volatility. Over the last two years, as the Fed aggressively tightened monetary policy, agency MBS spreads widened by more than 100 basis points and interest rate volatility moved sharply higher. Today, we believe many of the factors that drove these adverse conditions are largely behind us. Historically, attractive and stable agency MBS spreads, combined with declining interest rate volatility, create a compelling investment environment for AGNC and form the basis of our positive investment outlook. With that, I’ll now turn the call over to Bernie Bell to discuss our financial results in greater detail.

Bernie Bell: Thank you, Peter. For the fourth quarter, AGNC had comprehensive income of $1 per share as the mortgage market rebounded following an October sell-off and a difficult third quarter. Economic return on tangible common equity was 12.1% for the quarter, comprised of $0.36 of dividends declared per common share and a $0.62 increase in our tangible net book value per share. As Peter mentioned, despite the very challenging fixed income environment, for the year, we achieved a positive economic return of 3%, including $1.44 of dividends per common share and $1.14 decline in tangible net book value per share, with common stockholders experiencing a total stock return of 10% for the year As of late last week, tangible net book value per share was up 1% to 2% for January.

While average leverage was largely unchanged for the quarter at 7.4 times tangible equity, our end-of-period leverage declined to 7 times tangible equity as of Q4, from 7.9 times as of Q3. Our liquidity remained exceptionally strong during the quarter, ending the year with unencumbered cash and agency MBS totaling $5.1 billion or 66% of our tangible equity, and an additional $90 million of unencumbered credit securities. Net spread and dollar roll income also remained strong at $0.60 per share for the quarter, down from $0.65 for the prior quarter due to a somewhat smaller asset base and a larger share count for the fourth quarter. At the same time, our net interest rate spread improved 5 basis points to 308 basis points as higher asset yields more than offset moderate higher funding costs.

The average projected life CPR for our portfolio increased to 11.4% at quarter end from 8.3% the prior quarter, reflecting the higher average coupon of our holdings and the decline in mortgage rates. Actual CPRs for the quarter averaged 6.2% compared to 7.1% for the prior quarter. Lastly, in the fourth quarter we raised approximately $380 million of common equity through our at-the-market offering program at a meaningful price-to-book premium. I’ll now turn the call over to Chris Kuehl to discuss the agency mortgage market.

Chris Kuehl: Thanks Bernie. The fourth quarter marked a decided shift in Fed policy expectations and fixed income market sentiment. The shift in sentiment was led by favorable inflation data and was ultimately reinforced at the December Fed meeting with a reset of market expectations for a series of rate cuts in 2024. The path to the Fed’s December pivot was anything but a straight line. October was a continuation of extraordinary interest rate volatility, persistent higher for longer rhetoric from the Fed, and weak performance across most all fixed income asset classes as the 10-year treasury note yield broke through 5%. Market sentiment, however, improved materially in November following downside inflation data surprises and generally more balanced messaging from the Fed regarding the outlook for monetary policy and inflation.

In response to this improving outlook and with equity markets near all-time highs, fixed income investor sentiment turned in favor of adding duration, which in turn caused interest rates to rally and spread products to outperform. Agency MBS across the coupon stack outperformed treasury and swap-based hedges with lower and middle coupons performing somewhat better than higher coupons. Hedge composition was also a significant driver of performance during the quarter as swap spreads tightened 10 basis points across the curve, 2s through 10s. As a result, an MBS position with treasury-based hedges performed meaningfully better than a swap-based hedge position. Our portfolio increased slightly from $59.3 billion to $60.2 billion as of December 31.

Within our agency holdings, our coupon positioning was modestly higher as we continued to move up in coupon at attractive yields and spreads. Our TBA position was also modestly higher at $5.3 billion and remains largely comprised of Ginnie Mae TBA, given attractive valuations and better roll implied financing relative to UMBS. With the 111-basis point rally in par coupon yields, the duration of our assets shortened during the quarter and as a result, we reduced the duration of our hedge portfolio primarily by reducing our treasury-based hedges in the five to seven-year part of the curve. As of 12/31, our hedge portfolio totaled $60.5 billion, down about $3 billion from the previous quarter. As I mentioned on the call last quarter, more than 50% of the duration dollars of our hedge portfolio came from treasury-based hedges.

This was a significant benefit in Q4. Over time as the supply and demand technicals improve for treasuries, we will likely gradually move back towards a heavier allocation of swap-based hedges. Looking forward, our outlook for agency MBS continues to be very favorable with limited organic agency supply, low levels of prepayment risk, and deep and liquid financing markets; and while spreads have tightened, interest rate volatility has also declined and agency MBS spreads remain attractive relative to historical norms. I’ll now turn the call over to Aaron to discuss the non-agency markets.

Aaron Pas: Thanks Chris. The reversal on rates, improving inflation readings, and increased odds of a soft landing scenario contributed to a risk-on environment for spread product in the latter part of the fourth quarter. Market expectations for both an increased number and accelerated timing of Fed rate cuts were particularly beneficial for interest rate sensitive credit sectors. In light of this, we saw tightening across the majority of the fixed income credit complex. As a proxy for credit spread moves in Q4, the synthetic investment-grade CDX Index tightened 18 basis points while the Bloomberg IG Index, which represents spreads on cash bonds, tightened by 22 basis points. Deeper in the corporate credit spectrum, spreads, tightened even more with high yield CDX ending the quarter 132 basis points tighter.

More relevant to AGNC, we saw meaningful spread tightening in CRT, RMBS and large segments of CRE-backed debt. This spread tightening in Q4 is logical as a result of the positive shift in the macroeconomic outlook relative to several months ago. That said, valuations are now full on both an absolute and relative basis, and yields on the assets have correspondingly declined along with falling benchmark rates and tighter asset spreads. As a result, meaningful further tightening from these levels appears less likely. Turning to credit fundamentals, we continue to watch consumer-level dynamics considering low housing affordability levels impacting new owner households, as well as renters. We expect mortgage credit performance to continue to hold up as a result of relatively stringent underwriting standards, but predominantly significant homeowners equity.

Renters and newer homeowners, however, have been significantly stretched on a relative basis. Given the need for and prioritization of shelter, we expect the ultimate result will be a weakening of consumer discretionary demand from these households. With respect to our portfolio, our non-agency securities ended the quarter at just over $1 billion in market value. Looking ahead, the GSCs may aggressively look to extinguish the credit protection provided by CRT securities on seasoned and de-levered loans through tender offers. To the extent this occurs, we will likely reduce the notional balance of our CRT position over time. With that, I’ll turn the call back over to Peter.

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

Operator: Ladies and gentlemen, we’ll now begin the question-and-answer session. [Operator instructions] And our first question today comes from Crispin Love from Piper Sandler. Please go ahead with your question.

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Q&A Session

Crispin Love: Thanks. Good morning, everyone. Appreciate you taking my questions. Can you first just update us on your outlook for spreads, just given the favorable outlook you laid out? As you said, significant tightening since late October, so curious on your view here with rate cuts likely coming in 2024. In the past, Peter, you’ve talked about different spread ranges, so interested on kind of what ranges you think we could be in today, and just if you think we’re more inclined to tightened or widen from current levels. Thanks.

Peter Federico: Sure. Good morning, Crispin. Thank you for the question. Yes, as I mentioned in my prepared remarks, I still think that the range that we’ve been in for the last five quarters is the right range for the current environment, and again you can look at it off a lot of different measures, I was using the one in my prepared remarks of the current coupon to the five and 10-year treasures. I still think in the 140 to 190 basis points, at the very wides of those ranges, and I think that range will hold for the foreseeable future. What was important and that I mentioned specifically is that when we get to the upper end of the range, and I think this is a really important development for the agency MBS market, is significant resistance emerges, meaning significant demand for mortgages comes into play when spreads get to the high end of that range, and that’s a very healthy development for the market.

It gives us greater confidence in the upper end of the range. And you’re right, we’ve moved significantly down more toward the lower end of that range, but I think this range is the right range for the foreseeable future because we still have a lot of uncertainty with respect to the Fed and the Fed’s balance sheet, and a lot of mortgages need to be consumed by the private sector, just like a lot of treasures are going to have to be consumed by the private sector. So at a spread of, call it, 140 basis points to 160 basis points, just to narrow that range a little, but I think that there is a lot of compensation for investors for the current environment. I think it makes agency MBS look attractive on an absolute basis and on a relative basis, which is really important.

So I could see us staying there for the foreseeable future over the near term, and then there will be some information coming. What’s really important, obviously, you point out when the Fed again shifts to an easing environment, which will likely happen in the second half of this year, that will be a positive for the market. It will likely be a positive for the shape of the yield curve, which could draw more investors in. That’s going to be a really important development to watch. It could have an impact on the spread range. And the other one that’s not talked enough about yet but is going to be a significant development in the first quarter is what is the Fed going to do with respect to quantitative tightening, how is it going to stop, how is it going to taper?

That’s going to also be important new information that may help determine what the right range is. But for now, I think where mortgages are trading is ample compensation for investors, and that’s one of the reasons why we’re optimistic and feel much better about the outlook for agency MBS at the beginning of this year versus the last two years, is that if mortgages just simply stabilize in this area, which we believe is a greater probability, then you can really generate attractive returns for shareholders over the long run, particularly if interest rate volatility comes down. So I think that’s the outlook over the short-term. More information will be coming over the next three to six months, which will help determine the longer run outlook.

Crispin Love: Thanks, Peter, all very helpful there. And then just on the incremental buyers of agency MBS today, are you seeing money managers being the key buyers here, and based on your point as well, are current spreads deterring money managers at all? Are they waiting for them to get wider, or could the rate environment change, and then just how banks could get involved in ’24?

Peter Federico: Sure. I’ll let Chris talk about the diversity of the bid today for mortgages versus over the last several months, particularly money managers and some recent information from banks.

Chris Kuehl: Yes, I think the–I mean, the money manager bid has been clearly the dominant bid for the last year and change. The negative associated with it has just been the correlation with Fed policy and just overall fixed income inflows/outflows. Money managers, even given the tightening, are still generally overweight at the indices, around high single digits, I think it’s around 10% or so. But we are seeing evidence with deposits stabilizing in the banking sector, fourth quarter earnings releases showed some evidence that banks are starting to grow their securities holdings again. The ones that actually disclose or break out MBS versus treasuries showed some additions in mortgages for the first time in a long time, and so the diversity in the investor base is improving, that’s helping liquidity.

We do think that there’s still a lot of sort of questions that need to be answered with respect to bank regulation, that won’t be answered for quite some time. So we’re not overly optimistic on banks adding a material layer for the near term, but I do think that with deposits stabilizing, possibly rate cuts on the horizon, possibly slower C&I loan growth later this year, banks could be a more material investor base for the space.

Peter Federico: Yeah. And just to add to that, Crispin, when you think about the outlook of supply for the year, JP Morgan put out some numbers the other day which I thought were reasonable, it depends on the mortgage rate somewhere between 6.5% and 7% mortgage rate. The net supply of mortgages is a very manageable number when you think about 2024, it’s somewhere in the neighborhood of $400 billion to $450 billion, is probably the best estimate right now. But when you take out from that number sort of the known demanders of mortgages, whether it be some assumptions about banks and foreign holdings, and even REITs, what it tells you is that the residual amount of mortgages that have to be consumed by money managers and other is a pretty reasonable number at maybe somewhere between $200 billion and $300 billion for the whole year. So I think that gives you some perspective that the outlook of supply right now appears to be very manageable.

Crispin Love: Thanks, appreciate you taking my questions this morning.

Peter Federico: Sure. Thank you.

Operator: Our next question comes from Doug Harter from UBS. Please go ahead with your question.

Peter Federico: Good morning Doug.

Doug Harter: Thanks. Good morning. Wondering if you could talk about your outlook for the dividend, kind of given the volatility you just managed through, and kind of how you’re thinking about dividend levels throughout 2024.

Peter Federico: Sure. Obviously a lot goes into the dividend decision, always does, in terms of the environment, the operating environment, our expectations about leverage on a go-forward basis, and importantly interest rate volatility and sort of the cost of rebalancing. But again, like I mentioned last time, another key input into that equation is what is our breakeven ROE on our business when you take into account the dividends on both our common and preferred, our operating cost, what is that number on a percentage basis of our total capital. That number, for example at the end of the fourth quarter, if you annualize those numbers, is somewhere as a breakeven ROE of around 15.5%. So I think it’s important to understand that number and think about that number in the context of what we think the portfolio can earn on a go-forward basis, based on the economics of where prices are today, not from an accounting perspective, not on current carry, but the economics of our portfolio today on a mark-to-market basis.

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.

Trevor Cranston: Hey, thanks. Good morning. Can you talk a little bit more about the movement in the duration gap positioning during the quarter and the decision to shift to a slightly negative position? As a second part of that, if you can maybe comment on if you think going forward, agency spreads are likely to remain correlated with the directionality of rates. Thanks.

Peter Federico: Oh yes, that’s a really good question. Let’s start with that, because that’s really a significant factor, and that’s going to ultimately dictate to a large extent where we operate from a duration gap perspective, is what do we think mortgages are going to do with respect to interest rates and that correlation. Chris can talk a little bit about how that correlation has been and what we expect it to be going forward, and what that means from a hedging perspective.

Chris Kuehl: Yes, so as Peter mentioned, our duration gap as of today is slightly positive, right around zero given the move higher in rates since year end. But given the shift in sentiment with rate cuts now on the horizon, mortgages are trading shorter than they did last year, much of the last year and a half relative to model durations, which makes sense as some of the higher rate tail scenarios have been sort of clipped or had become less probable, and so given that mortgages can trade to shorter durations and with our portfolio having somewhat more call risk than extension risk, we’re likely to try to maintain a near zero to slightly positive duration gap in the current environment. I’d say fast forward another six to 12 months, and if we find ourselves at rate levels with significantly–you know, lower rate levels with significantly lower refinancing activity and the Fed still running off its portfolio, then I think a case could be made for running a significantly longer duration gap as mortgage supply, both organic and Fed run-off, would be much more sensitive, or spreads would be much more sensitive to rate levels with spreads likely widening in a rally, tightening into a sell-off.

But for moderate moves in rates from here over the near term, I think spreads are less correlated with rates than they have been for the last year or so, and so we’re likely to try to maintain close to a zero duration gap to a slightly positive duration gap over the near term in the current environment.

Trevor Cranston: Got it, okay. That’s very helpful, thank you.

Operator: Our next question comes from Rick Shane from JP Morgan. Please go ahead with your questions.

Rick Shane: Thanks, guys, for taking my questions this morning. Look – you talked a little bit about the call risk within the portfolio. When we look at Slide 23, there are probably twice as many coupons on there as there were three years ago. The issue is that stack gets bigger and we’re in this incredibly strange environment, there’s much, much more concentration of call risk at the higher coupon. You guys were pretty deliberate about moving up the stack and being willing to realize losses when coupons were moving. Should we expect that you will start to realize some gains, and again I realize it’s sort of indifferent economically, but will you start to move back down the stack in order to mitigate some of that call risk?

Peter Federico: Yes, sure. I’ll let Chris talk about that.

Chris Kuehl: Yes, our weighted average coupon is still quite low relative to the production coupons – I think it’s just over 480. The bottom line is the convexity risk on our portfolio has gotten worse, given the 100 basis point rally over the last quarter, but it’s still very low and very manageable. Generally speaking, sourcing convexity through pool selection is still very attractive. We did add a small receiver option during the quarter as vol traded lower, but implied vol is still relatively–you know, it’s still very high relative to historical norms, and so again we’re likely to manage the negative convexity on the portfolio simply through delta hedging in this environment and through asset selection on the pool side, which almost always is cheaper than buying explicit protection on rates through the options market.

If implied volatility declines materially, you could see us do a little more on the rate option side, but over the–you know, for this environment, convexity risk, very manageable largely through delta hedging and asset selection.

Peter Federico: And just to add to that, Rick, when you look at that Page 23, you can see we provide our positions in those coupons, and you can see that the biggest positions are really in the 5% and 5.5% coupon, so you think about those positions relative to the current mortgage rate, which is still between 6.5% and 7%, to Chris’ point, in a sense we’re more exposed to the middle coupons as opposed to the highest coupon, so we still have a lot of room to rally in the mortgage rate before those refinance.

Chris Kuehl: Just real quick, what I’d add is when you look at the percentage of specified pools in some of those higher coupons, look at the end notes on the composition, so 47% on average specified pools, but the next 20, actually close to 30% of the portfolio is also in pools with favorable convexity characteristics. They’re just not the lowest loan balance cuts. They’re specified pool characteristics like low FICO, certain geographies, investor or second homes, modified pools. We do have a–you know, again, the call risk on the portfolio in the current environment is very manageable, given the composition of our holdings.

Rick Shane: Got it. Yes, it’s interesting – when you look at the portfolio in aggregate, I agree with you 100%, and definitely note the concentration in the 5s and the 5.5s, very slight amortized cost premium there. I was just more curious on the tail, the 6 and the 6.5s, there is more premium and perhaps a little bit more risk in this particular environment.

Chris Kuehl: Yes, I mean, the last thing I’d say on the prepayment environment – I mean, when you step back, obviously the vast majority of the universe has almost no incentive to refinance, 98% of the universe. But the origination over the last four or five months is going to be very interesting just to observe speeds, given that on average that cohort will have a 50-ish basis point incentive to refinance, and lenders certainly have capacity, they’re probably going to be willing to work thin to capture what little volume there is, and so that would argue for pretty fast speeds on the highest coupons that were originated, call it though the August through November time frame, but there are other arguments as to why the S-curves could be quite a bit flatter as well relative to what we saw in 2020 and ’21.

Rick Shane: Great. Yes, I’m guessing the 3.5s and 4s are going to be on the books for a really long time. Thank you for taking my questions, guys.

Peter Federico: Sure, thank you.

Operator: Ladies and gentlemen, our last question today comes from Eric Hagen from BTIG. Please go ahead with your question.

Eric Hagen: Hey, thanks. Good morning. Just a follow-up on maybe the liquidity. How are you guys thinking about the amount of liquidity you’re comfortable holding at these spread levels versus when the spreads were wider, and maybe how does that amount of liquidity play into the amount of leverage you’re comfortable with at different spread levels, the shape of the curve and all that?

Peter Federico: It certainly does. I mean, what we’ve learned over the last couple of years is that just generally speaking, the liquidity in the bond market, both for U.S. treasuries and agency MBS, is not what it used to be. With the Fed changing its balance sheet, with the amount of regulation post-Great Financial Crisis, we now know that the major source of demand for both treasuries and mortgages can be money manager bids, which tend to be very volatile and directional with interest rates. We know that the market is less liquid, and that obviously matters from a liquidity perspective. What we’re always trying to do is put ourselves in a position where we’re never being obviously forced to de-lever. We always want to manage our liquidity position such that when we get to extremes in interest rates and spread, you’re still comfortable holding positions.

That doesn’t mean that we’re not going to make decisions because, at those times where we think there’s still–you know, the environment is changing, but from where we sit right now, we’re in a really efficient position from a capital position, and you can see that in the percent of unencumbered that we have. That gives us a lot of flexibility to operate with higher leverage and still be–still have a liquidity position that’s consistent with where we’ve operated historically. We’re always trying to refine and improve the efficiency with respect to our capital position and our unencumbered, so we’re able to operate with incrementally higher leverage with, in a sense, the same amount of unencumbered capacity to withstand these episodes that the market does go through, where you have sort of gaps in bids and volatility spikes, and you have to be able to endure those environments.

Now what we’re learning is they happen, they’re going to continue to happen, but also if you’re well positioned for them, you can wait it out and ultimately the market will return back to normal levels, and that’s what we’re seeing now. It gives us greater confidence going forward, and we’ll be able to adjust our leverage position accordingly for that.

Eric Hagen: Yes, thank you guys so much.

Peter Federico: All right, thank you. Take care.

Operator: Ladies and gentlemen, we’ll conclude today’s question and answer session. I’d like to turn the floor back over to Peter Federico for any closing comments.

Peter Federico: Again, thank you all for participating on our call today, and we look forward to speaking to you all again at the end of the first quarter.

Operator: With that, ladies and gentlemen, we’ll conclude today’s conference call. We thank you for attending today’s presentation. You may now disconnect your lines.