AGNC Investment Corp (AGNCL) 2019 Q3 法說會逐字稿

Good morning, and welcome to the AGNC Investment Corp.

Third Quarter 2019 Shareholder Call.

(Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Katie Wisecarver, Investor Relations.

Please go ahead.

Thank you, Pete, and thank you all for joining AGNC Investment Corp.'s Third Quarter 2019 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 14, by dialing (877) 344-7529 or (412) 317-0088, and the conference ID number is 10135532.

To view the slide presentation, turn to our website, agnc.com and click on the Q3 2019 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 today's call include Gary Kain, Chief Executive Officer; Bernie Bell, Senior Vice President and Chief Financial Officer; Chris Kuehl, Executive Vice President; Aaron Pas, Senior Vice President; and Peter Federico, President and Chief Operating Officer.

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

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

During the third quarter, global growth continued to decelerate with weakness evident in almost all major regions of the globe.

Economic activity in the U.S. was also impacted by trade tensions, causing business activity to slow during the quarter.

Against this backdrop, equity prices declined intraquarter, financial market volatility increased and interest rates fell.

In response to the deteriorating financial conditions, central banks around the globe supplied further accommodation via interest rate cuts, and in the case of the ECB, renewed quantitative easing.

The Fed did its part as well, cutting the funds rate twice during the third quarter and then again yesterday.

The move down in interest rates was significant intraquarter with the yield on the 10-year treasury falling almost 60 basis points to 1.45% through early September, before giving up about a third of that move to close the quarter at 1.66%.

Despite the rate cuts by the Fed, the yield curve continued to flatten with 2-10s actually inverting a couple of times during Q3.

The S&P 500, on the other hand, was able to erase all of the August weakness and closed the quarter slightly higher with a large part of the recovery attributable to easier monetary policy.

Credit spreads were generally weaker during the quarter though subsectors, including GSE credit risk transfers, did improve.

Agency MBS spreads, on the other hand, continued their widening trend as the interest rate volatility, fast TBA speeds and an inverted curve pushed risk premiums materially higher.

Specified pools, while still wider on the quarter, outperformed higher coupon TBAs.

Finally, the underperformance of treasury and Agency MBS repo remained a significant headwind given the well-publicized spike in repo rates late in the quarter.

Given the backdrop I just described, AGNC's Q3 performance was quite remarkable as we were able to generate a 2.7% positive economic return with book value largely unchanged.

At a high level, AGNC's strong financial results can be attributed to both the optimization of our specific MBS holdings and the significant repositioning of our hedge portfolio discussed on our last earnings call.

While many factors can materially impact our prospective financial results, we currently believe that the majority of the improvement in our net spread and dollar roll income in Q3 should be sustainable over the near term.

Before turning the call over to Bernie, I want to close my prepared remarks with a high-level look at the prospects for our business over the intermediate term.

First of all, regardless of your choice of measure, option adjusted or static spreads, mortgage evaluations are currently sitting near multiyear wides.

At the same time, some fixed income credit spreads are near multiyear tights.

This dichotomy can be explained by the long-running equity bull market boosting the credit sector, while outsized Agency MBS supply, interest rate volatility and inverted yield curve, funding pressures and fast TBA prepayments have all combined to put material pressure on Agency MBS.

That said, these headwinds should be fully priced in at this point and some of the fundamental factors like repo funding and the inverted curve are beginning to abate given the significant actions announced by the Fed.

Additionally, the impact of the fast TBA speeds is largely a nonevent for AGNC, given the composition of our portfolio.

From a technical perspective, the significant increase in gross and net MBS supply, which was probably the largest driver of the MBS underperformance over the past several months should also improve given the combination of the backup in mortgage rates with somewhat larger Fed purchases and as a function of the slower winter mortgage origination period.

On the interest rate front, the current backdrop should be more favorable for Agency MBS.

The Fed's 3 insurance cuts and the potential for a trade truce has somewhat reduced the downside risk to the economy and interest rates.

On the other hand, despite the recent risk on moving equities and credit, inflation pressures are nonexistent and the global economy should continue to underwhelm, likely keeping interest rates relatively range bound over the near term.

Putting this all together, especially against the backdrop of our strong quarterly results, we are increasingly optimistic about the prospects for our business as we look ahead over the next year or so.

And at this point, I'll ask Bernie to review our financial results.

Thank you, Gary.

Turning to Slide 4. We had total comprehensive income of $0.42 per share for the quarter.

Net spread and dollar roll income, excluding catch-up am was $0.59 per share, up $0.10 from the second quarter, largely due to hedge repositioning actions taken in recent quarters.

As we mentioned during our last earnings call, we did not expect to see the benefit of these actions until the third quarter.

Led by lower rates, projected CPRs increased to 13.4% as of the end of the third quarter, up from 12.4% as of last quarter.

As Chris will discuss shortly, our actual CPR for the quarter also increased, but at 13.5%, remained materially lower than prepayment speeds observed on other generic higher coupon MBS.

As Gary mentioned, despite significant interest rate fluctuations and wider mortgage spreads, tangible net book value was largely unchanged for the quarter, down $0.03 per share to $16.55 per share at the end of the quarter.

Including $0.48 of dividends paid for the quarter, we had a positive economic return of 2.7% for the third quarter, bringing our year-to-date economic return to 9.1%.

We will announce our October 31 net book value in a couple of weeks, but our current estimate is largely unchanged from September.

Moving to Slide 5, our average at-risk leverage ratio was unchanged at 10x our tangible net equity.

As of the end of the third quarter, our average leverage was slightly lower at 9.8x.

On the capital front, we opportunistically repurchased just over $100 million or slightly over 1% of our outstanding common stock at an average repurchase price of $14.90 per share during the third quarter.

These repurchases at an average price discount of approximately 8% were accretive to net book value.

Importantly, this action demonstrates management's commitment to aggressively repurchase stock when the economics are compelling.

And as of the end of the third quarter, we had approximately $900 million remaining available for future stock repurchases under our current stock repurchase program.

In late September, we priced a public offering of $403 million of our Series E 6.5% fixed-to-floating rate preferred stock.

This transaction was both our largest preferred stock issuance and our lowest fixed-rate coupon to date.

Because the transaction settled in early October, this capital was not reflected in our quarter-end leverage calculation.

Lastly, we recently announced that we will redeem our 7.75% Series B preferred stock on November 26, meaningfully reducing our total cost to preferred capital.

With that, I will turn the call over to Chris to discuss the agency market.

Thanks, Bernie.

Let's turn to Slide 6. The third quarter got off to a good start with relatively stable rates and risk assets performing well in the month of July.

However, as Gary mentioned earlier, volatility picked up materially in August with 10-year treasury notes rallying 57 basis points to 1.45% in early September, only to then sell off and end the quarter at 1.66%.

With heightened volatility and lower rates, MBS spreads widened, but performance varied depending on coupon, specified pool category and hedge position on the yield curve.

More specifically, with the yield curve flattening 22 basis points 2-10s, the hedge position like ours biased towards shorter-term hedges resulted in materially better performance during the third quarter than would be implied by OAS or static spread measures.

Turning to Slide 7. You can see that the investment portfolio declined slightly to $102.6 billion as of September 30.

During the quarter, we added approximately $13 billion 30-year 3% in lower coupon MBS at attractive spreads, while continuing to reduce more generic higher coupon holdings.

Spreads on lower coupon MBS have been pressured by heavy supply, driven by the spike in origination volumes and the continued reduction in the Fed's MBS portfolio.

This supply has led to compelling valuations, especially considering the limited prepayment risk inherent in lower coupons.

Additionally, the outstanding floats in production coupon MBS should benefit over time from the Fed's reinvestment bid now that runoff is in excess of the $20 billion per month cap.

Turning to Slide 8. We provide an updated version of a slide that we included last quarter.

As you can see on the right side of the table, pools that represent the TBA deliverable in 3.5s through 4.5s are paying between 40% and 55% CPR.

In contrast, prepayment speeds on AGNC's portfolio remain very well behaved.

It's important to note that we have elected to keep some lower pay-up 30-year 3.5s and 4s, that are prepaying well above our average speed for the coupon because they're still profitable to retain relative to our TBA short positions.

For example, if you subtracted our fastest $3 billion 4s, an amount equal to our TBA short, our average speed on the coupon would drop from 20 CPR to 16 CPR.

In part for this reason and because we will likely continue to migrate our more generic pool holdings to lower coupons, we believe our portfolio CPR is likely biased lower over the near term, even if aggregate speeds pick up marginally.

On this -- lastly on this slide, we've included the average dollar roll trading levels or price drops for the most recent October/November roll cycle.

As you can see, there's a dramatic difference in carry on lower coupons versus higher coupon TBA.

As a reminder, the price drop represents 1 month's worth of income, inclusive of implied funding cost but excluding hedges.

The prices are in 30 seconds of 1%.

As you can clearly see, 30-year 3s have positive carry while higher coupons do not.

Importantly, the inclusion of hedges actually improves the relative carry advantage for lower coupons given their longer durations and the inverted yield curve.

The reason higher coupon rolls are trading so poorly is due to very fast prepayment assumptions that are warranted given the recent speeds we have seen within the TBA float.

Over time, prepayment speeds on higher coupon should slow or burn out as the most responsive borrowers will have refinanced.

And this should lead to improved valuations and better dollar roll levels on higher coupon TBAs.

However, given current rate levels and the adverse characteristics of many of the pools currently in the float, we expect higher coupon rolls to remain under pressure over the near term.

I'll now turn the call over to Aaron to discuss the non-agency sector.

Thanks, Chris.

Please turn to Slide 9, and I'll provide a quick update on our credit investments.

Our non-agency portfolio remained constant at $1.7 billion or roughly 4% of equity in the third quarter.

The majority of the changes in the portfolio were driven by changes in the prepayment landscape.

We reduced exposure to investment grade new issue RMBS subordinate bonds as these outperformed our hedges into the rally and no longer looked attractive in light of faster prepayments as well as some rotation within the CRT space.

Over the quarter, credit spreads were somewhat mixed with high-yield CDX spreads leaking marginally wider while investment-grade spreads remained largely unchanged.

Within CRT, CMBS and CMBX, [Downing] credit generally performed well as the Fed's more accommodative stance was supportive for risk assets and lower mortgage rates particularly beneficial for CRT at the lowest parts of the capital structure.

Since quarter end, spreads have remained largely -- relatively firm, while equity stood at all-time highs.

However, there are some signs of investor concern on the corporate side, particularly for higher-leveraged and weaker-credit companies.

This can be seen in CCC credit spreads drifting wider and a decline in prices for leverage loans over the last few weeks.

On the credit risk transfer front we see somewhat limited opportunity for tightening and price appreciation in more recently issued M2s, and we would likely sell into a further tightening.

With that, I will turn the call over to Peter to discuss funding and risk management.

Thanks, Aaron.

I'll start with our financing summary on Slide 10.

Our average repo funding cost in the second quarter was 2.48%, down 14 basis points from the prior quarter.

Despite the decline, repo rates remained elevated in the third quarter.

In mid-September, a confluence of factors, including corporate tax payments, treasury settlements, cash withdrawals related to the oil price shock and the market carrying unusually high overnight repo balances due to uncertainty related to the September Fed meeting, resulted in a significant spike in repo rates for both treasury and mortgage collateral.

The repo shock in September negatively impacted our cost of funds, but the impact was relatively small given it only affected incremental funding over the last 2 weeks of the quarter.

On Slide 11, we provide additional color on the funding environment.

The 2 graphs highlight the divergence between repo funding levels and other benchmark rates.

The graph on the top shows the difference between 3-month repo and 3-month LIBOR.

As the line shows, although funding cost by this measure improved somewhat during the quarter, they were still unusually volatile.

The bottom graph shows the rate difference between 1-month repo and the 1-month overnight index swap rate, which is a good proxy for the expected average overnight Fed funds rate over the same period.

The large spike in mid-September clearly shows the dislocation that occurred in the repo market relative to the Fed's primary benchmark rate.

The disruptions in the repo market, being so pronounced and so public, turned out to be a catalyst for the Fed to act, which over time, should be a positive for our business.

First, the Fed reinstituted daily open market repurchase operations.

These overnight and term operations added significant liquidity to the repo market and quickly pushed funding rates back down.

Second, and more importantly, in mid-October, the Fed announced its plan to purchase approximately $60 billion of treasury bills per month for at least 6 months as well as upsized their overnight and term open market operations to a $120 billion and $45 billion, respectively.

Together, these actions could add more than $500 billion of liquidity to the system over the next 6 months.

As such, we are optimistic that the repo headwinds that we face throughout 2019 will soon abate.

That said, given balance sheet constraints at large banks and the fact that the Fed's purchases will take time to accumulate, we expect funding to remain a headwind in the fourth quarter before improving materially next year.

Turning to Slide 12, we provide a summary of our hedged portfolio, which in aggregate increased to $97 billion and covered just over 100% of our funding liabilities.

The increase was driven by additions to both our swap and swaptions portfolios.

The increase in our swap position was predominantly through the addition of shorter-term swaps that allowed us to lock in attractive all-in funding levels.

We also transitioned a material percentage of our swap portfolio away from LIBOR-based swaps to swaps indexed off OIS and SOFR.

These swaps not only eliminated our exposure to LIBOR but also carried substantially lower pay rates and we believe will better track our actual funding over time.

All of these swaps were executed at prevailing market rates.

As Gary mentioned in his opening remarks, our swap portfolio has already provided us substantial benefits.

As a reminder, while we materially increased the size of our swap book in the second quarter, we also terminated a significant amount of longer-term pay-fixed swaps and short treasury positions.

In aggregate, these actions concentrated our hedge book on the front end of the yield curve, which turned out to be a significant positive for our book value and economic return in the third quarter.

Additionally, the carry on of our swap portfolio benefited our aggregate cost of funds measure, which dropped 39 basis points in the third quarter to 1.85%.

On slide 13, we show our duration gap and duration gap sensitivity.

Despite the significant rally in interest rates, our duration gap remained flat over the quarter as we continued to rebalance our hedge portfolio.

In addition, as we show on the table, extension risk for our portfolio and for the market as a whole has increased and there is an important consideration in how we determine our duration gap and hedge portfolio composition.

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

Thanks, Peter, and at this point, we'd like to open up the lines to questions.

(Operator Instructions) And the first question comes from Douglas Harter with Crédit Suisse.

Gary, I think you mentioned that you view kind of the improvement as in this quarter's earnings as fairly sustainable.

Could you talk about how you're thinking about the dividend in that context given, kind of, the significant upside of core earnings versus the dividend this quarter?

Sure.

So just to repeat what I said in my prepared remarks, we do feel -- I mean, obviously, there was a large difference between net spread and dollar roll income in Q3 versus Q2.

And so what we believe is that the majority of that increase looks to be sustainable over the long term -- I'm sorry, over the shorter term.

That said, there are always factors outside of our control or knowledge that can affect things.

But more importantly, getting to the question around dividends, what we've always said, I mean, we know the market cares a lot about net spread and dollar roll income and it's an important measure, but it's never been the sole driver of our dividend choices.

And realistically, we think about the economic or true earnings potential of the portfolio, and we look at that kind of assuming current market conditions and then embedded in that is almost the assumption if we bought our portfolio today, what do we think the returns are.

And they are still quite attractive than we believe.

They certainly exceed the dividend, but I want to stress that if you look at AGNC's performance over the -- in the past, we recognize the plus and minuses of net spread and dollar roll income.

And that's never been the kind of the predominant driver of our dividend decisions.

All right.

And then Peter, you mentioned that you moved more of your new hedges kind of away from LIBOR based.

Could you just talk about kind of what the mix is between LIBOR based and non-LIBOR based is as of today?

Sure, Doug.

We're about -- close to about 85%, either OIS -- predominantly OIS and some SOFR.

The last 15% or 20% of our portfolio is LIBOR based.

And we really felt like it was a good opportunity to move away from the LIBOR-based swaps.

I mean, there's a number of reasons, obviously, one, LIBOR is going to go away over time, so everybody is going to have to face this issue; but it was also we think a good time in terms of our desire to receive OIS versus LIBOR.

In the current environment, those 2 indexes actually were the same rate.

In the third quarter, they both were -- the overnight -- average overnight rate and average LIBOR rate actually came out at the same level at 220%.

And then as I mentioned, you also get a materially lower pay rate, which was about 25 basis point difference.

But the final consideration is that we really think that LIBOR -- or repo funding will actually better track OIS over time versus LIBOR.

A LIBOR obviously can have a lot of factors that influence it.

It is limited to a small number of banks -- relatively small number of banks, so we think over time, our repo fund is going to track OIS better.

It gave us a big economic advantage in the current environment.

We like receiving the Fed funds rate versus 3-month LIBOR in an environment when the Fed is either easing or holding rates constant.

So we think that spread differential between those 2 indexes will be relatively small.

And what I would just add is really the perfect answer for us, it would be having to receive like the SOFR, which would essentially be tied to really a repo, the overnight repo rate.

But right now, those swaps, to be perfectly frank, aren't very liquid.

There are times when you can enter into them at market -- at good levels, but that is something what you should look for us to increase over time as the swaps really start to trade more.

But honestly, when you take a step back and you look at -- and I want to be clear, this was not an overreaction -- or these trades were done before funding issues in September.

It wasn't a reaction to that.

But what I would say is that when you take a step back and you just think about our business and how we should be, the best way to hedge our business, we buy mortgages, we fund those mortgages via mortgage repo or GC repo, government repo, and we have the interest rate risk.

So to pay fixed on a swap and receive a repo rate back is the perfect -- is really a much, much, much cleaner trade than introducing LIBOR into that equation.

So I think the long run, we're pretty confident we'll get there.

We just have to be practical about the market liquidity.

And it's starting to improve, but OIS is a step that's hopefully 75% of the way there.

Got it.

Just to make sure I understand.

So these moves, all else being equal, should reduce the volatility of your -- of the cost of funds, swings quarter-to-quarter?

Yes.

And importantly, I think this is important to stress, and Peter mentioned it a couple times, but it is a risk management benefit and should reduce the volatility in our cost of funds.

But we were able -- you're able to enter into these at 20, 25 basis point lower pay rates.

So it's not something we have to pay a lot of money to reduce risk.

You -- these were attractive as well.

So it's a combination of being in a better risk position, and I think it's because of the unique attributes of our business, which is our funding is tied to government securities, it gives us the ability to use these swaps and to be at a benefit from the lower rate.

And the next question comes from Bose George with KBW.

In terms of incremental spreads, you noted that they're fairly stable.

Can you just walk through the returns, especially on the spec pools versus TBAs.

And then, actually on Slide 8, I was just trying to understand that a little better as well.

I guess, it looks like the negative drop on some of that stuff -- and actually, also just tie that into what you guys did at the end of the quarter or the positioning where your net TBAs contracted pretty meaningfully.

Bose, this is Chris.

Thanks for the question.

So just contextually, yields are around 270, with our spread to swaps around 105 to 110 basis points.

So just use round numbers with 10x leverage that generates a gross spot ROE just above 13% before our convexity cost.

Specs are -- there is a wide range of pool types and pay-ups but contextually in the same area.

With respect to the TBA position, it did come down a fair amount during the third quarter as we added newer production, lower coupon pools versus selling higher coupon TBAs.

And since quarter end, we've continued to do more of that, the direction of that trade, but it's been, we sold higher coupon pools versus adding lower coupon TBAs and so currently, the TBA position's back up to just shy of, I believe, $8 billion as of today.

But it's difficult to project the size of the TBA position.

It's a function of implied financing rates, the prepayment environments, how pool pay-ups are trading.

But we often carry a pretty sizable generic pool position, particularly when rolls are trading weaker because it gives us a lot of flexibility with respect how we manage the TBA position.

So for example, for rolls trading really special versus repo, we can quickly monetize that by selling or delivering pools out versus the roll.

And vice versa, when rolls are trading weaker, we can carry the pools versus repo.

So there's a lot of flexibility in carrying a position, a lower pay-up pool position.

So in other words, there's a fair amount of option value in carrying lower pay-up pools.

Hopefully, that helps to answer your question.

It does.

I guess, I was just, so trying to understand is there -- the difference in holding in rolling versus holding pools, just given the differences in return from the different coupons.

Well, just -- this is Gary.

What I'd just add, so if you want to just get specific and say, like, let's look at our 4% coupon position where we have a short TBA position of $3.3 billion, right, and then we have these other pool positions, let's separate out the kind of the higher-quality specified pools.

These other pool positions, essentially, many of these have very low pay-ups at where maybe they have a tick pay-up or something like that.

There are some that have bigger pay-ups.

But if essentially, if the roll is pricing a 50 CPR and you have a pool that you think is going to pay at 45 CPR, you don't want to deliver that into TBAs.

Yes, it's going to raise our average CPR for the quarter, okay, because it's going to pay at 45, but it's actually going to be more advantageous to keep that pool versus where the dollar roll is trading.

And so that's the trade-off that you make.

Sometimes, if you can get a decent pay-up for it, then you, obviously, can sell it.

But to Chris' point, there's a lot of optionality, but generally speaking, if there's no pay-up, if a pool is going to prepay 5 or 10 CPR below kind of what's implied in the roll pricing, you're better off keeping it for a short period of time.

And so it's interesting that's sort of why we said that if you took out our worse $3.3 billion in that coupon, our CPR in aggregate for our coupon would have dropped to 16 CPR from 20.

So that's probably the best way to think about it.

As long as the speed on an incremental pool with negligible pay-up is below what's implied in the roll, then there is at least some economics to keeping it.

One the thing I'd add is just -- to Gary's point, if at some point carry on the pools converge with what's implied in carry on the roll, due to either the rolls improving or speeds on these pools increasing, we may flatten out the position.

But just to reiterate the point, it's a very low-risk, positive carry position to have on.

And the next question comes from Rick Shane with JPMorgan.

I think that there are 3 factors that we've sort of heard from you guys: one is that you think that asset pricing is attractive with wider spreads; two, you expect funding to normalize as we move into 2020; and then three, when we look at the hedge ratio, it's as high as it's -- at the high end of what we've seen historically.

All of that suggests that there is an opportunity for you guys to grow the balance sheet as you move into 2020.

I'm curious, given where leverage is, do you see that driving that through additional leverage?

Look, that's a good question.

And essentially, I think what I said on the last call around leverage is that we see the current operating kind of environment there being a range of leverage in the 9.5 to 10.5x is where we would expect to operate.

Now look, we may be outside of that range at some periods, and we're totally comfortable with that.

And to your point, I mean, when we look at the return kind of prospects going forward, we feel like they look good.

Mortgages, as I kind of said earlier, mortgages are definitely on the wide end of the valuation range, both in absolute space and probably even more so in relative space that's a positive.

And the interest rate environment feels very manageable, I mean, really the risk of a big uprate shock seems extremely low.

And even when you listened to Powell yesterday, he was absolutely discounting rate hikes.

And the question is: Can inflation stay where they -- or inch up a little bit at a state -- get where they want it to get?

It's not -- I don't think anyone is thinking it can get too hot in the foreseeable future, realistically.

So I think you have a one-way risk to rates.

So that's an easier situation to manage, generally.

So from those perspectives, you could argue for being at the higher end of the leverage range.

I would say, kind of given year-end, the volatility we've seen, we feel like in the very short run, there might be better entry points, and we'll kind of watch for it.

But big picture, we're operating largely in the range that we've set up, but we do feel like the environment is becoming more favorable.

Okay.

That's helpful.

And actually, I think it's consistent with what we're seeing in terms of the hedge portfolio, too, when we look at what you guys did during the quarter, you kind of barbell things.

You took shorter swaps but added significantly to the swaption position.

And is that sort of consistent with the expectation of low volatility but basically buying cheap insurance in a low rate low [vol] environment?

Yes, I think it is.

And it's interesting, I mean, look, we have to be practical.

As I just said, I think the risk of a big uprate shock is very low.

But look, there is -- we have to be practical about the steps that we've highlighted when Chris has described the portfolio.

We feel like the portfolio was extremely well positioned for a carry to make money in this environment, to be able to handle a down rate shock.

But we do have longer-duration mortgages, we have lower coupons, and we have specs.

We have to be practical about the fact that there is extension risk in those holdings.

And so to your point, the optional protection is the best way to sort of buy some insurance if that shock, a temporary shock, comes along.

But we're being practical about the composition of the portfolio.

It's -- for all the reasons we've talked about, it's critical that we have this composition of the portfolio.

But you can't ignore the other attributes.

And I think that lends itself to having protection -- optional protection.

And the next question comes from Trevor Cranston with JMP securities.

Bit of a follow-up to Rick's questioning.

At the end of Peter's remarks, he commented that the extension risk in the MBS market, it increased.

And then listening to Gary's comments, he sort of indicated that he viewed rate risk as kind of one-sided to the downside.

So I was wondering if you could elaborate a little bit on how you guys are thinking about extension risk within the portfolio and how you're constructing the asset composition.

Just elaborate on that a little bit, if you could.

Sure.

I'll start.

In response to the last question, what I was -- I think what's really important, again, I think you're absolutely right.

You characterized our perspective on interest rates, which is, again -- and I think it's consistent with what Jerome Powell said yesterday.

Inflation -- the Fed raises rates, and rates go up because of inflation and inflation expectations, I mean, depending on what part of the curve you're looking at.

We see that as a very low probability, and I think that view is shared by a lot of people, I don't think that's an outlier, which means that the risk of an uprate shock -- and rates have backed up, obviously, from their lows noticeably.

We think the risk of that uprate shock is relatively low.

But again, we have to weigh that against the composition of our portfolio, and to Peter's earlier comment, the composition of the market, which means that we have to be practical that if there was an uprate shock, even if it didn't last, that will -- it could catch market participants a little unprepared, given the fact that it seems unlikely.

So that's really the driver -- we have to factor that in.

I mean, we can have an opinion on rates, but what you'll notice, the size of our hedge portfolio, the increase in options, and we are just being cognizant of the fact that our portfolio composition has changed, and it requires some actions on our part to protect against some of that extension risk.

Got it.

Okay.

And then a couple of questions on the repo book.

First question would be if you guys could comment on kind of where you're seeing repo pricing today after the Fed cut.

And then the second question would be, as you guys move towards year-end, if you could comment on, sort of, how you're approaching that.

And how much of the book you're sort of expecting to get funded across year-end, sort of, well in advance of December, given the potential for more rate volatility?

Sure, Trevor.

This is Peter.

I'm happy to that, and a good question.

It's really difficult to answer the first part of that question right now, and that's one of the reasons why we sort of said in the couple places in our prepared remarks that we thought the fourth quarter still may be a funding headwind.

It's hard to gauge exactly where the repo market is in terms of relative rate right now because there's so much happening that the repricing, if you will, related to the Fed cut just yesterday hasn't been fully reflected in the market.

All of the Fed liquidity hasn't been fully reflected in the market.

So said another way, it's taking term repo rates, it's taking time for those rates to come down as much as we would like them to come down.

Directionally, they are improving.

As one of the reasons why we had the issue the market as a whole in September is because the term market wasn't properly pricing all of the market's expectations around the Fed.

Now that the Fed has eased, again, yesterday and sort of changed its language and given the indication that it may be on hold for a while, I think term rates will come down over the next couple of weeks.

The Fed is adding more liquidity.

So in general, just to give you a sort of a benchmark, if you will, I think that our -- using 3-month repo as sort of your guide, I think that, that's going to settle out over the next quarter or 2 at LIBOR flat to minus 10 basis points.

So I think that there'll be some real improvement there.

I think over the longer run, LIBOR flat to less 10 is a reasonable place.

I think if you look at it relative to the overnight rate, I think our average repo book will average something like 10 to 20 basis points above that.

But again, a lot has to happen between now and year-end.

With respect to your question about year-end, I expect a lot of the term market to open up this -- in November and December.

We'll carry a sort of typical position into year-end.

Right now, year-end still seems to be trading in the high 2s or low 3%, which is too high, but ultimately, I think it's going to come down.

We have month end today.

I expect that to be one of our best month ends at around 2%.

So there's reason to be optimistic, but we are cautious.

I think year-end will show another little spike because there are those balance sheet constraints from large banks.

And that's the issue that the Fed is facing is it's difficult for the liquidity that the Fed is providing to make its way all the way through the system because of balance sheet constraints.

So that's I think one of the reasons the Fed wants to add so much liquidity over the next 6 months so that we're back to around $2 trillion of excess reserves, and there's ample money in the system.

So that's where we're going.

It's just going to take us a little while to get there, but I hope that's responsive.

And the last question comes from Matthew Howlett with Nomura.

Most of my questions have been answered.

But Gary, just wanted to ask you your thoughts as one of the largest holders of agency mortgage-backed securities in the GSEs.

Look like they're moving quickly to exit the conservatorship.

You weren't supporting one of them.

What are your thoughts?

How does it impact your business?

We see higher GCs, low additions.

Just maybe could you comment on what you see happening with those 2 entities?

Sure.

GSE reform is definitely a topic that's gotten a lot more discussion of late.

What I would say, I mean, big picture, while there is definitely -- we've seen -- we got the planned finally released from the administration.

And I think the bottom line was that the intent is, yes, for the GSEs to build capital, and yes, they are starting to talk about that.

FHFA is talking about it.

And it is, I would say, beginning to get in motion.

But there is a long runway for this.

Importantly, the government has acknowledged, the administration has acknowledged the need for them to maintain a government guarantee.

That's going to require a legislative solution.

When you put all that together, I really don't think anything fundamental is going to change with the GSEs for a number of years.

And I put that as something like 5 years.

It is -- there's nothing short term that's going to change in terms of them exiting conservatorship from our perspective.

There will be talk, but that's a ways off.

Now your other question, and the one that's maybe a little more relevant, is the incremental changes that could occur or likely will occur that FHFA can sort of administrate on their own.

And yes, I think it's logical to see the GSE footprint shrink a little bit, and I think from the perspective -- or how does that impact us?

I think one thing is it will -- it should over the next, let's say, few years, it should help Agency MBS trade a little tighter than where they otherwise would, and it will, in essence, kind of be constraints of net supply a little bit.

And alternatively, if we were to get into an environment where credit risk was more attractively priced, I think from AGNC's perspective, we'd be very happy to increase our credit book in response.

Currently, as we've talked about on so many calls, we view the mortgage credit space as relatively fully valued or tight.

And the levered ROEs are insufficient, but in a world over time, a more normal credit environment, we'd love to see product move from the GSEs to the private markets.

And as a levered investor, we're very well positioned to take advantage of that.

So in the short run, I think there is a lot more bark than there is bite to the GSE kind of discussion.

But I don't see it being a significant driver of our business or business decisions.

Great.

And then just to be clear, you don't -- I mean, there's been some talk that the agency spreads are widening on the fact government could move the PSPA out and try to (inaudible).

You don't think there's any risk or any spread widening due to possibly them moving, trying to get out of conservatorship?

So there was concern like 4 or 5 months ago, and I sit on a couple committees, a SIFMA committee, which is the bond market association.

And we -- there was concern initially with (inaudible), but if you look at what they've put out recently and kind of reiterating the need for the government guarantee or for the securities to trade with a implied at the -- or really to continue to trade as if they're fully backed by the government, I think those fears have receded.

So you're absolutely right to point out the fact that there was some concern probably at the beginning of the summer along those lines.

But at this point, I think those concerns have been assuaged.

Thank you.

We have now completed the question-and-answer session.

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

Well, thanks.

I would like to thank everyone for their participation on our Q3 call, and we look forward to talking to you next quarter.

Thank you.

Thank you.