AGNC Investment Corp (AGNCN) 2017 Q3 法說會逐字稿

Good morning and welcome to the AGNC Investment Corp.

third-quarter 2017 shareholder call.

(Operator Instructions).

Please note this event is being recorded.

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

Thank you, Alison, and thank you all for joining AGNC Investment Corp.'s third-quarter 2017 earnings call.

Before we begin I'd like to review the Safe Harbor statement.

This conference calling 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 9 by dialing 877-344-7529 or 412-317-0088 and the conference ID number is 10112675.

To view the slide presentation turn to our website, AGNC.com, and click on the Q3 2017 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; Peter Federico, Executive Vice President and Chief Financial Officer; Chris Kuehl, Executive Vice President; Aaron Pas, Senior Vice President; and Bernie Bell, Senior Vice President and Chief Accounting 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.

We are very pleased with AGNC's performance during the quarter as we were able to generate an economic return of 5.6%.

As importantly, we continue to be excited about how AGNC is positioned going forward against the backdrop of the Fed beginning the process of gradually tapering its reinvestment activity.

During the third quarter, the key themes from prior quarters remained in place with continued strength in equity and credit centric fixed income markets and very limited interest rate volatility.

Interestingly, agency MBS spreads tightened meaningfully in September despite the Fed's announcement of its plan to taper reinvestments.

This performance drove the increase in our net asset value over the quarter and clearly corroborated the position we noted on our last several earnings calls that the MBS market had already priced in the reduced support from the Fed.

Despite the spread tightening, levered risk-adjusted returns on agency MBS positions continue to look reasonable in absolute terms and attractive relative to both equities and other fixed income products.

With that as the introduction let me turn to slide 4 and quickly review our results for the quarter.

Comprehensive income totaled $0.99 per share.

Net spread income, which includes dollar roll income, was $0.62 per share net of catch-up am.

Our net spread income remained solidly above our dividend and the decline from the prior quarter was largely a function of timing differences between the reaction of three-month LIBOR and of our agency repo and dollar roll book to the June rate hike.

Incremental hedging activity at slightly lower leverage were also factors.

For comparison net spread income was only down slightly from the $0.64 we reported for three straight quarters from Q3 2016 through Q1 of this year, despite multiple Fed rate increases.

Tangible book value per share increased 2.8% to $19.78 during the quarter.

As I mentioned earlier, economic return was positive 5.6% in Q3 or almost 10% year to date through September 30.

Turning to slide 5, our at risk leverage declined slightly to 8 times tangible book.

Our portfolio grew to almost $73 billion as we raised approximately $735 million in new common equity and another $142 million in net preferred stock.

The common equity was accretive to tangible book, enhanced our scale and common stock liquidity and further improved our already industry-leading operating cost structure.

Inclusive of the fee income for managing MTGE and taking into account the equity raised, AGNC's all-in operating expenses were less than 65 basis points of quarter-end equity, or around 8 basis points of gross assets on an annualized basis.

This larger scale increases AGNC's annual operating cost advantage over our peer group average to around 110 basis points.

Even assuming no further capital raises or changes in operating costs, this represents a recurring 110 basis points annual economic return benefit.

If you compare two identical hypothetical REITs with a difference of 110 basis points in annual operating expenses, you would expect the lower cost REIT to trade at a substantial premium on that basis alone.

If we were to assume a duration or a multiplier of 10 for the 110 basis points of cost savings, this would translate to a theoretical price-to-book premium of 11%.

We believe that this cost structure advantage should translate into a meaningful valuation premium for AGNC, and that is before any consideration of AGNC's best-in-class returns since inception, greater size and liquidity relative to most of the space and overall transparency.

At this point I'd like to turn the call over to Chris to discuss the market and our agency portfolio.

Thanks, Gary.

Turning to slide 6, you can see that shorter-term rates were slightly higher quarter over quarter while longer-term rates were essentially unchanged as the yield curve continued to flatten.

If you recall, last quarter we highlighted the underperformance of agency MBS versus other fixed income sectors against the backdrop of strong fundamentals such as attractive funding markets for levered investors, low prepayment risk and low levels of interest rate volatility, each of which we expected to be supportive of agency MBS spreads.

The combination of these factors, in addition to attractive relative valuations, led to reasonably strong performance during the third quarter despite the Fed tapering announcement.

And as Gary mentioned, while absolute spread levels are tighter, we think that agency MBS will continue to perform well given the aforementioned strong fundamentals and attractive relative valuations that remain intact versus competing fixed income products.

Let's turn to slide 7. The investment portfolio increased to $72.5 billion as of September 30 as we fully deployed the capital raise during the third quarter.

The composition of our asset mix was relatively unchanged quarter over quarter as we continue to carry a sizable TBA roll position given the backdrop of low prepayment risk and favorable dollar roll financing.

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

Thanks, Chris.

I'll begin with our financing summary on slide 8. Our repo funding cost at quarter end was 136 basis points, up from 127 basis points the prior quarter, as repo rates during the quarter fully reflected the Fed's June 14 rate increase.

Similarly, our aggregate cost of funds, which includes the cost of our repo funding, the implied funding cost on our TBA position, and the cost of our pay fixed swaps also increase during the quarter to 146 basis points from 131 basis points the prior quarter.

This increase was driven by three factors.

First, as I mentioned, repo costs were higher throughout the quarter in response to the Fed's rate hike.

Second, there is only a small decrease in costs associated with our pay fixed swaps during the quarter as three month LIBOR, which drives the rates we receive on our swaps, increased by just 3 basis points.

And lastly, consistent with the growth in our asset portfolio, we shifted the composition of our hedge portfolio to include a greater share of longer-term swaps.

Looking ahead I would expect our cost of funds to be more stable in the fourth quarter as repo rates relative to LIBOR have improved somewhat.

Turning to slide 9, I will briefly review our hedge portfolio.

Given the increase in our assets our hedge portfolio increased by $4.1 billion over the quarter with the increase being split relatively evenly between longer-term pay fixed swaps and treasury hedges.

As a result, our overall hedge ratio remained very high at 92% of our funding liabilities at quarter end.

On slide 10 we provide a summary of our interest rate risk position.

As shown on the table, the hedges that we added during the quarter allowed us to keep our duration gap unchanged to 0.4 years.

Additionally, as we show, our duration gap remains well contained across a wide range of interest rate scenarios.

Should interest rates increase by 100 basis points, for example, our duration gap would widen to only about 1.5 years.

Given that our asset portfolio would be close to fully extended in that scenario with 10-year rates at or above 3.25%, we would likely be comfortable operating with a larger duration gap all other things equal.

With that I will turn the call back over to Gary.

Thanks, Peter.

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

(Operator Instructions).

Doug Harter, Credit Suisse.

Gary, I believe you mentioned something about this, but it looked like the relative profitability of the TBAs came down in the quarter.

Can you just talk about what was behind that and how you see the relative attractiveness of TBAs versus specified pools today?

Yes, just quickly at a very high level on the TBA front, remember that the TBA dollar roll income number doesn't include any hedges.

So, it really is the asset yield net of implied funding costs.

And so, the bulk of that decline in TBA income related to just the rate increase in June being fully reflected in the third quarter.

So that's the majority of that.

There are other implications.

There are composition variables, there are -- there's also implied prepayment speed variables.

There are other variables, but the bulk of it really was the reflection of the rate hike from June that's reflected in this quarter's number and really didn't affect last quarter's.

So, is that something that continues and, as we go into a possible rate hike in December, that that number could come down further in the first quarter as that's fully reflected, all else being equal?

That number will continue to come down based on that, all things being equal.

But remember that we do hedge the TBA portfolio, but the hedge effect -- the hedge numbers flow through to the other -- through to the on balance sheet portfolio.

So again, when we quote -- like when Peter quotes the 92% hedge ratio, that includes hedges for the TBAs.

So it's more of a geographic issue.

And again, I think you should put this in perspective with the timing issues that we talked about and when the hedges -- the hedges which react to three-month LIBOR are going to tend to reflect a rate hike a little sooner and the reset on either dollar rolls which are basically monthly and a lot of our repo which is monthly as well.

So there are going to be some timing issues but, again, we feel that in aggregate our portfolio is relatively well hedged for rate increases.

Doug, just to add to that, for example, to the extent that 100% of our TBA position was hedged with pay fixed swaps, the carry on our pay fixed swaps would go down commensurate with the decrease in the dollar roll income.

And that would show up in our other income line item of our income statement.

So, it's just a little bit of the income statement geography to the extent it was hedged 100% with pay fixed swaps.

The other thing is -- this is Chris -- the only other thing I'd add is, since the last time we spoke rolls have continued to trade well with respect to specialness versus other short-term funding markets.

So currently implied financing rates or specialness of rolls on 30-year TBA coupons are the most liquid coupons; 3s through 4s are in the area of around 10 to 25 basis points through repo.

And so, as long as we stay in this low prepayment risk environment with attractive roll specialness we're going to continue to like carrying a relatively large TBA position.

I think your other question was around TBAs versus specified pools.

Generally speaking specified pool valuations are fair.

There is some opportunity to add incremental value there.

But again, as long as we are in this low risk prepayment environment it's not likely we are going to convert much of our TBA position to spec pools, at least not in the current environment.

Great, thank you.

Bose George, KBW.

Just following up on the dollar rolls, when you think about the spread differential now between dollar rolls and on balance sheet investments, the 10 to 25 basis point number, Chris, you mentioned is that the way to think about it?

Yes, yes, that's really the key differential.

Okay, great.

Thanks.

And then actually just in terms of incremental returns now after the spread tightening we saw in September versus prior to that, how much has it changed?

Like what are current incremental ROEs that you're seeing?

They are still low-double-digits, but they are probably down close to 2% from I think 6 months ago when we last put out the statement.

But I think, again, this is interesting.

For us we still feel like net ROEs pre-convexity costs for on agency, more on a levered position of agency mortgages for us net, net ROEs are still in the double-digits just given our low operating costs.

Okay, thanks.

And then actually one more on book value.

Just with the move in rate since quarter end can you just give us an idea of book value trends since the end of the quarter?

Yes, I mean book value is maybe off a percent-ish as of Tuesday or whatever.

So give or take, but -- so it's not a big move.

Okay, great.

Thanks.

(Operator Instructions).

[Jim Delisle], Wasatch Advisors.

Have you had any conversations along the way with any other people who manage indexes about the possibility of companies like yourselves reaching a certain equity level and all that being included in the broader market indexes?

We haven't had recent conversations along those lines, but I think that is something that could happen going forward.

But we are obviously included in some indices and not in others and we will certainly look at that over time.

And a second question relating to TBAs.

Presumably, if in fact the taper goes according to plan, one would assume that the speciality of TBAs going forward would diminish a little bit.

Have you given any thought for the glide path of TBAs going back more toward general market funding levels?

What I would just say quickly on that is maybe specialness weakens a little bit, but remember even well before the Fed's purchase program there was specialness in TBAs.

And it is their -- again, the main cause of the specialness is the fact that mortgages are originated a couple months out, originated and hedged a couple months out before they settle.

And it's this built in hedging, forward hedging on the part of originators that's the initial impetus for the bulk of the specialness.

And then, yes, demand factors and float factors are also -- can also impact specialness.

But what I would say is from where we are now we don't expect a dramatic change in specialness over the course of the year.

I think again where you might -- where you would see that difference is when the Fed's done and they're not cleaning up the float, so to speak, if then we were to have a major rally, I think that's where you're going to see a major difference in the specialness we saw last time during a high prepayment environment let's say versus this time if the Fed is no longer adding mortgages.

Great.

Two questions and a comment.

And the comment is great job keeping returns high and the expenses low.

Thank you.

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

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

Well, I'd like to thank everyone for your interest in AGNC and we look forward to talking to you next quarter.

The conference has now concluded.

An archive of this presentation will be available on AGNC's website and a telephone recording of this call can be accessed through November 9 by dialing 877-344-7529 or 412-317-0088 and the conference ID number is 10112675.

Thank you for joining today's call.

You may now disconnect.