AGNC Investment Corp (AGNCL) 2018 Q3 法說會逐字稿

Good morning, and welcome to the AGNC Investment Corp.

Third Quarter 2018 Shareholder Call.

(Operator Instructions) Please also note, today's event is being recorded.

And at this time, I'd like to turn the conference call over to Katie Wisecarver, in Investor Relations.

Please go ahead.

Thank you, Jamie, and thank you all for joining AGNC Investment Corp.'s Third Quarter 2018 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 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 the Risk Factors section of 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.

An archive of this presentation will be available on our website, and the telephone recording can be accessed through November 8, by dialing (877) 344-7529 or (412) 317-0088, and the conference ID number is 10124456.

To view this slide presentation, turn to our website, agnc.com, and click on the Q3 2018 earnings presentation link in the lower-right corner.

Select the Webcast option for both slides and audio or click on the link in the conference call section to view the streaming slide presentation during the call.

Participants on the call today include Gary Kain, Chief Executive Officer; Bernie Bell, Senior Vice President and Chief Financial Officer; Chris Kuehl, Executive Vice President; Peter Federico, President and Chief Operating Officer; and Aaron Pas, Senior Vice President.

With that, I'll turn the call over to Gary Kain.

Thanks, Katie, and thanks to all of you for your interest in AGNC.

10-year treasury rates closed the quarter north of 3% for the first time since 2013, rising around 20 basis points in Q3.

Investor confidence in the strength of the U.S. economy, coupled with somewhat more hawkish Fed commentary, finally took its toll on the bond market.

U.S. equities continued their march higher during the quarter, while fixed income credit spreads tightened further.

On the negative side, international growth was unable to regain any positive momentum, and emerging markets were hard hit.

Against the backdrop of higher rates and mixed Agency MBS spreads, AGNC's economic return was slightly positive at 0.7% for the quarter, as book value declined around 2%.

Since quarter-end, we have seen a spike in both equity and fixed income volatility, while rates continued to head higher with 10-year rates peaking around 3.25% earlier in the month before declining with the recent risk-off move.

Equities, both in the U.S. and globally, have struggled throughout October, while credit spreads have given back most of the tightening experienced in Q3.

We continue to believe that the deteriorating international picture, coupled with higher interest rates, greater political uncertainty and a growing fiscal deficit, will eventually take its toll on growth in the U.S. That said, it is difficult to ascertain the timing in light of the positive momentum currently enjoyed by the U.S. economy.

We also believe that longer-term inflation expectations will remain well anchored.

As such, further increases in intermediate and longer-term rates should be relatively muted with 10-year rates unlikely to exceed 3.5% for any extended period of time.

On the Agency MBS front, the bias remains toward further widening, as the bulk of the demand has come from money managers and other relative value players, while banks have added fewer MBS than previously anticipated.

This is unlikely to change as we head into the end of the year.

Additionally, volatility probably will not return to recent lows in the near term, which will also keep some pressure on Agency MBS.

With this in mind, we have maintained our conservative leverage position, but would be very comfortable opportunistically increasing our MBS exposure if spreads were to widen materially.

At this point, I'd like to turn the call over to Bernie to review the highlights for the quarter.

Thank you, Gary.

Turning to Slide 4, comprehensive income was $0.03 per share for the quarter.

Net spread and dollar roll income, excluding catch-up am was $0.61 per share.

As Chris and Peter will discuss shortly, weaker TBA funding levels and a decline in the favorable spread differential between our repo funding and 3-month LIBOR received on our interest rate swaps contributed to the $0.02 decline in our net spread income from the second to third quarter.

As Gary mentioned, tangible net book value declined a little over 2% to $18.00 per share as of the end of the quarter, while our economic return, which include $0.54 of dividends paid for the quarter, was slightly positive at 0.7%.

Moving to Slide 5. Our investment portfolio increased to $82 billion as a function of our capital raised during the quarter.

Our at-risk leverage averaged approximately 8.5x tangible equity for the quarter.

We ended the quarter slightly lower at 8.2x, as we proactively sold some MBS late in the quarter in anticipation of an increase in volatility going into year-end.

During the quarter, we raised a little over $800 million in new equity capital to a follow-on offering.

This new equity was both accretive to book value and further enhances our operating efficiency.

As the largest internally managed mortgage REIT, our cost structure as a percent of total equity is less than half that of our agency peer group average.

Lastly, during the third quarter, we received $42 million of termination fee income in connection with the sale of MTGE and corresponding termination of the MTGE management agreement.

The $42 million cash termination fee received more than exceeded the write-off of our remaining intangible asset associated with the management agreement of $23 million during the quarter.

And with that, I'll turn the call over to Chris to discuss the market.

Thanks, Bernie.

Let's turn to Slide 6. Rates across the curve continue to move higher during the third quarter with 5-year and 10-year swap rates increasing 19 basis points.

Swap spreads were a few basis points tighter with yields on 10-year treasuries increasing 21 basis point.

30-year Agency MBS spreads were more or less unchanged to slightly wider during the third quarter, while credit spreads were notably tighter with AAA CMBS and investment grade corporate debt approximately 13 basis points tighter and residential credit spreads approximately 20 basis points tighter quarter-over-quarter.

Thus far into the fourth quarter, rates have continued to sell off, and spreads on both Agency MBS and credit are noticeably wider.

Turning to Slide 7. You can see in the top-left chart, that the investment portfolio increased to $81.8 billion in market value as of September 30.

Consistent with our equity raise, on a net basis, we added approximately $4.7 billion in MBS.

In the charts on the lower half of the Slide 7, you'll notice that our TBA position declined to $9.4 billion, driven by weaker roll implied financing rates and relatively attractive specified pool valuations.

Low loan balance and other specified pool valuations languished for much of this year, given a combination of higher rate levels, a benign prepayment environments and the marginal bid for mortgages coming from money managers and investor base predominantly focused on TBA.

These factors, combined with the reduced Fed presence in the Agency MBS market, also pressured role-implied financing rates lower, while at the same time, allowed for specified pools to trade at attractive levels relative to both nominal carry metrics and option-adjusted valuations.

Over the last 2 quarters, we've net added approximately $14 billion in 30-year specified pools backed by loans with either lower loan balances or other favorable convexity characteristics.

Given the increase in specified pool holdings, I want to highlight a couple of points: first is that the absolute pay-up risk on our portfolio versus TBA is just over 0.5 of 1 point.

Additionally, given the average seasoning of our holdings, the aggregate downside to pay ups on the portfolio into higher-rate environments is low.

Going forward, we will continue to be opportunistic and weigh TBA roll financing against alternative funding options, specified pool valuations and the overall prepayment environment.

Importantly, we do expect that over the longer term, we will continue to have favorable opportunities to finance TBA positions at levels consistent with long-run historical averages of around 10 to 15 basis points below repo.

But it's important to recognize that there will be times when supply-and-demand technicals are less favorable.

We just happen to be in one of those periods.

I'll now turn the call over to Peter to discuss funding and risk management.

Thanks, Chris.

I'll start with a brief review of our financing activity.

Consistent with the Fed's decision to raise short-term rates another 25 basis points in September, our average funding cost, which includes the cost of our repo funding and the implied financing rate on our TBA assets, increased by a similar amount in the third quarter to 2.18%.

Our total cost of funds, which includes the benefit we receive from our pay-fixed swaps, increased 21 basis point to 1.88% in the third quarter.

Our aggregate cost of funds was negatively impacted in the third quarter by some deterioration in the spread between repo funding and 3-month LIBOR as well as the weakening in TBA funding levels that Chris mentions.

Both of these funding variables have been relatively stable thus far in the fourth quarter.

Turning to Slide 10, I'll quickly review our hedging activity.

Consistent with the increase in our capital base and corresponding growth in our asset portfolio, we increased our hedge portfolio to $71.7 billion.

At that level, our hedge portfolio covered 95% of our funding liabilities.

Finally, on Slide 11, we provide a summary of our interest rate risk position.

Despite the increase in interest rates during the quarter, our duration gap remained relatively stable at 0.9 years.

Lastly, extension risk in our portfolio continues to be limited with our estimated duration gap in the up 100 basis point scenario, being less than 2 years.

With that, I'll turn the call back over to Gary.

Thanks, Peter.

And at this point, I'd like to open up the call to questions.

(Operator Instructions) Our first question today comes from Bose George from KBW.

Just given your commentary on spreads, et cetera, can you give us an update on just quarter-to-date book value?

Sure.

I mean, obviously, the things have been relatively volatile on both the rate front and on the spread front.

But let's say, down 4% or so is a good ballpark number.

Okay, great.

And then the -- just given that as well, can you just talk about where incremental returns are?

What's that done to the opportunity for you guys?

I mean, spread widening is noticeable in the quarter, but we'll call it, maybe, just over 5 basis points.

So I mean, there is a little bit of a benefit there in terms of ROEs.

But at this stage of the game, I wouldn't say that spread widening has created, kind of, a massive change in the outlook.

I mean, it's for that reason that we kind of proactively kind of kept our leverage unchanged.

We've talked for a while about increasing leverage, and we still fully intend to do that at some point.

But as I mentioned earlier, we're -- we still remain somewhat bearish on mortgage spreads in the near term.

But again, if spreads were to move more materially, then we view that as a very good opportunity.

Okay.

And then actually one small one just on your repo maturities.

It came down to 67 days from 101.

Just curious, what drove that?

Bose, this is Peter.

Yes.

That's one of the benefits we get from having our own broker-dealer.

And we're able to, through that broker-dealer, I think, access shorter-term funds, which we think, in the current environment, is a benefit, given the fact that when you move out to 3 months, 4 months and 6 months out in that range, you start to price in materially more Fed activity.

So keeping our book a little shorter has given us the benefit in our overall funding.

But I don't expect it to change much from where it is today.

Our next question comes from Rick Shane from JPMorgan.

Gary, when you sort of laid out your macro or your outlook, you pointed to higher volatility, greater risk of spread widening and potentially, sort of, limited near-term risk on higher rates.

The -- that suggests a couple of things, primarily that hedge cost will probably go up a little bit, but at the same time, you have less interest potentially in swapping out that book.

Should we expect, that duration in the portfolio is going to go up modestly?

And should that lead to marginally better returns?

I guess, what I would say, let me characterize it a little differently.

What I would say is, in this short run, I think we still remain a little bearish on interest rates, but we, again, don't think that rates are likely to move that much higher.

Against that backdrop, our duration gap, as Peter mentioned, that today is not very different from what it was at the end of the quarter.

I think if we were to get to that higher end of the range, what I mentioned, if we would get up near, let's say, 3.5% on rates, let's say, this current risk-off bout that we're dealing with ends and rates pick up a little bit.

I think it is logical to assume that we would increase our duration gap since -- in that environment that would still be a positive slope to the yield curve that would help earnings a little bit, as we would reduce our, kind of, overall hedging activity as a percentage of the book.

So I think there is upside, assuming we get that kind of scenario.

With respect to, kind of, current positioning, yes, hedges are cheaper now, given the shape of the yield curve.

But on the other hand, we have to be cognizant that with mortgage negative convexity, we have 2-sided interest rate risk.

And that's kind of dictated the interest rate position that we have now.

I think I got most of your question, but let me know if there's something you want me to follow up on.

Our next question comes from Doug Harter from Crédit Suisse.

Gary, have you seen any change in credit pricing, kind of, given this risk-off move we've seen here?

And just in general, what's your appetite on credit today?

So yes, I mean, credit spreads have clearly widened noticeably on the quarter.

They're pretty close to -- basically having given back the performance in Q3, the tightening in Q3.

That said, I mean ROE's are still, even for us, with a really low expense ratio, net ROEs are still mid-single digits, maybe a little better than that.

So big picture, we haven't seen enough of a change to get us more interested in increasing our credit positions.

But I do think, it's important to stress that -- look, we're, obviously, kind of going through this -- we'll call it at this point, a mini credit event where volatility has picked up.

We've seen a few of these over the last 3 or 4 years.

At some point, one of these is going to propagate into something bigger than that.

And we are very focused on being well positioned for that type of scenario.

I'm not predicting that this -- what we've seen over the last month is going to translate into that opportunity, but there is going to be a credit event probably in the not-too-distant future.

And the liquidity of our agency portfolio, coupled with the capabilities that we've developed over the years, partially in managing MTGE, but also in just making direct investments for AGNC, are such that, if that scenario unfolds, we intend to be very active in looking at a range of credit products.

So again, at this stage, the move is not -- has not been anywhere near material enough to change the relative value landscape, but that would be a very good scenario for us, if that were to -- if this were to continue down that path.

Our next question comes from Trevor Cranston from JMP Securities.

Question on prepay speeds.

Looking at the projected lifetime speed for the book and I guess, the speed you guys saw for October, the numbers are pretty low.

So I was wondering if you guys could comment on, where you see sort of the baseline turnover speeds for your portfolio?

And incrementally, if we did see the 10-year, sort of, move up to the 3.50% level, how much more room there is for speeds to continue to climb.

Yes, sure.

So over the very near term, speeds are likely to decline.

Next month, speeds will actually be up slightly, just given increase in day count.

But seasonals into the winter months, speeds will likely decline a bit from here.

But with respect to turnover, I'd say it's pretty close to this area, call it, 6, 7 CPR on the 30-year book.

It's kind of a reasonable long-term projection.

I think over the near term, turnover -- baseline turnover has been coming in quite a bit faster than that due to just general relatively fast housing turnover and cash-out refis.

I think that's likely to start to slow, just given the move in rates, the cost of doing the cash-out refinance is going up materially.

So I think it's reasonable to expect that the long-term, sort of, forecasted CPRs will start to become more in line with, sort of, actual turnover going forward.

Got it.

Okay, that's helpful.

And then a question on the financing side.

The repo coming through Bethesda is up to about $26 billion now.

Can you remind us how to think about, sort of, how you guys view the optimal size of that, and what the capacity for borrowing through Bethesda as a percentage of their total borrowings?

This is Peter.

Yes, it's up to that level.

On a percentage basis, it was actually down a little bit quarter-over-quarter.

But I would expect it to be in, let's say, for a longer-run target, somewhere in the 40% to 50% of our funding level.

And obviously, it's really attractive funding.

It's hugely beneficial from a margin perspective.

It makes us much more efficient from a capital perspective.

It, obviously, gives us access to a lower-cost funding.

But at the same time, we're also cognizant that we want to maintain maximum liquidity with all of our counterparties.

We have 46 counterparties in addition to Bethesda Securities that we want to be active with, so that we have ample liquidity with everybody.

And so I think in that 40% to 50% range would be a comfortable target for the foreseeable future.

Our next question comes from Mark DeVries from Barclays.

Gary, you mentioned the expectation that spreads widen here on agencies in the intermediate term, and when you see that happen, maybe there will be a more attractive opportunity to lever up.

But how do you think about the idea of delevering some, in advance of that widening to kind of dampen some of the book value volatility and protect a little bit more equity that you have to relever when the spreads get more attractive?

Look, that's a good question.

And I mean, I guess, in theory, we did a little of that in September.

Our average leverage was higher.

We felt spreads had gone too far.

We thought, there would be some year-end volatility.

So we took our leverage back down, let's say, in mid-September.

But I think one of the things that we're very cognizant of in terms of the AGNC's value proposition, is to be a little more transparent and somewhat a little more consistent.

And trying to move leverage around and make big timing trades has a cost in terms of obviously, earnings and kind of start -- and we are harder to predict and obviously, less transparent.

In big picture, I think we take very seriously, the transparency for shareholders, consistency of returns and so forth.

And so we intend to actively manage the portfolio, be proactive, but we have to balance that against a backdrop of being consistent and not -- and transparent.

And so that's kind of the mindset that we take in that process.

And ladies and gentlemen, at this time, I'm showing no additional questions.

We'll complete today's question-and-answer session.

I'd like to turn the conference call back over to Gary Kain for any concluding remarks.

Well, I'd like to thank everyone for their participation on the call, and we look forward to talking to you next quarter.

And ladies and gentlemen, that does conclude today's conference call.

We do thank you for joining today's presentation.

You may now disconnect your lines.