AGNC Investment Corp (AGNCN) 2017 Q4 法說會逐字稿

Good morning, and welcome to the AGNC Investment Corp. Fourth 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. Please, go ahead.

Thank you, Phil, and thank you all for joining AGNC Investment Corp.'s Fourth Quarter 2017 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 a telephone recording can be accessed through February 15, by dialing (877) 344-7529 or (412) 317-0088, and the conference ID number is 10115477. To view the slide presentation, turn to our website, AGNC.com and click on the Q4 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 the call today 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 fourth quarter and for 2017 in its entirety. Economic return for the quarter was 2.3%, which brought the full year economic return to 12.1%.

The key themes from prior quarters remained in place in Q4. Equity markets continued to set new records, while valuations of credit-sensitive, fixed-income products improved yet again. The yield curve continued to flatten and interest rate volatility remained muted. As an illustration of how stable longer-term interest rates were in 2017, consider that the 10-year treasury began the year at 2.43% and closed at 2.41%. Even more unprecedented is that the yield on the 10-year closed every quarter of 2017 between 2.3% and 2.41%. This is an incredibly tight range, especially considering materially stronger global growth and 3 interest rate hikes from the Fed in 2017. While the 10-year has increased about 30 basis points so far in 2018, we continue to believe rates are biased somewhat higher, but there is little reason to anticipate a significant spike in rates similar to the Taper Tantrum back in 2013 where the move we experienced in late 2016 following the election. To this point, we believe the widespread optimism surrounding the global economy is already largely priced into financial markets.

Turning to Agency MBS. We anticipate that spreads could widen somewhat during 2018, as the technical landscape becomes more challenging against the backdrop of the steady decline in Fed purchases. Accordingly, we expect levered returns in Agency MBS to remain attractive and even improve relative to other competing products. This incremental relative value, especially for levered investors, should help the market absorb the increase in net MBS supply and in turn mitigate the impact on spreads.

As an aside, the higher relative ROE on agency investments is not the only benefit investor should consider when evaluating the agency mortgage REIT space in the current environment. Agency MBS have the ability to outperform if the economy were to weaken or if the tremendous run we have seen in evaluations of risk assets comes to an end. This countercyclicality provides a very important diversification benefit to a typical portfolio given that the vast majority of most equity investors' portfolios are heavily biased toward a continuation of the current risk-on mindset.

An investment in AGNC is one of the few alternatives investors have at their disposal to achieve equity returns that can hold up even if the current bull market runs out of steam. That said, AGNC performed extremely well in 2017 with a total stock return of almost 24%. So a weaker economy is, by no need -- means, a necessary condition for AGNC to generate attractive returns.

With that as the introduction, let me turn to Slide 4 and quickly review our results for the quarter. Comprehensive income totaled $0.44 per share. Net spread and dollar roll income, excluding catch-up [AM] , increased in Q4 to $0.63 per share from $0.62 the prior quarter. More importantly, as you can see on the bottom of Slide 22, our net spread and dollar roll income declined only $0.01 per share over the past 6 quarters despite 4 interest rate hikes and a dramatic flattening of the yield curve. Our very high hedge ratio is a significant driver of this favorable result.

Additionally, we reported that $0.20 of our net spread income came from our TBA dollar roll position. As Chris will discuss, the funding advantage on TBAs is currently in line with our longer-term expectations. As a result, our net spread income today is less sensitive to the size and specialness of our dollar roll position. To be more specific, we estimate that if we had replaced our entire TBA position with on-balance-sheet assets and funded them with repo prior to the fourth quarter, our net spread income would likely have been only $0.02 per share lower than the $0.63 we just reported. I do want to be clear that we have no intention of doing this, because the incremental $0.02 is worthwhile given the limited incremental prepayment risk. The TBA position also enhances our liquidity and can reduce our aggregate margin requirements.

Tangible book value per share declined 0.5% to $19.69 during the quarter with economic return coming in at 2.3%.

Additionally, despite the selloff in rates in January, our current estimate of tangible book value indicates a year-to-date decline of only about 1% to 2%. Changes to our leverage and aggregate portfolio size were minimal during the quarter.

Turning to Slide 6, I want to quickly recap some highlights for the full year. Net comprehensive income totaled $2.19 per share. Net spread and dollar roll income was $2.56 per share, significantly exceeding the $2.16 in dividends declared during 2017. As I mentioned earlier, economic return totaled 12.1% and total stock return was materially stronger at 23.7%.

In aggregate, 2017 was a very good year for AGNC and its shareholders. At this point, I'd like to turn the call over to Chris, to discuss the market and our agency portfolio.

Thanks, Gary. Let's turn to Slide 7. As you can see the yield curve continued to flatten during the fourth quarter, as the market priced in additional rate increases from the Fed, 2-year treasury notes increased 41 basis points while 10-year notes increased only 8 basis points in yield. Agency MBS performed reasonably well during the quarter with LIBOR option-adjusted spreads on 30-year MBS plus or minus a few basis points from unchanged versus the prior quarter.

Let's turn to Slide 8. Consistent with at-risk leverage little changed quarter-over-quarter, the investment portfolio balance was $72.8 billion as of December 31. On the top right of Slide 8, you can see that prepayment speeds remained well contained given the combination of our asset selection, overall interest rate levels and slower seasonal factors. Our average CPR for the fourth quarter was 10.1%, down 2 CPR from 12.1% last quarter.

The average balance of our TBA position was relatively unchanged in Q4 at $18.4 billion. However, the period-ending balance was lower as of December 31 at $15.7 billion. TBA roll-implied financing specialness moderated somewhat late in the fourth quarter. Over the longer run, we expect implied financing rates to average around 10 to 20 basis points through mortgage repo funding and against the backdrop of a low-risk prepayment environment, we expect to maintain a relatively large TBA roll position. 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. Our funding cost increased during the quarter due to the combination of the Fed's rate hike in mid-December and year-end funding pressure. These factors led to higher repo cost for our on-balance-sheet assets and similarly higher funding rates for our dollar-roll-funded TBA assets. Specifically, our average repo funding cost for the fourth quarter was 143 basis points, up 9 basis points from 134 basis points the previous quarter. We experienced a very similar increase in the implied financing rate on our TBA assets, which for the quarter we estimated to be 123 basis points, up 11 basis points from the prior quarter. Taking these 2 funding sources together, our average funding cost was 139 basis points for the quarter, up from 128 basis points the prior quarter.

Our aggregate cost of funds, which includes the cost of our pay-fixed swaps also increased during the quarter, but to a lesser extent, as our swap expense declined quarter-over-quarter. This decline was driven by an increase in the received floating leg of our pay-fixed swaps, which improved as 3-month LIBOR rose consistent with the Fed's rate hike.

Our swap cost improved 5 basis points during the quarter and thus offset about half of the increase in our repo and TBA funding. As a result, our aggregate average cost of funds increased just 6 basis points during the quarter to 152 basis points. For your reference, we provide these funding numbers on Slide 16 of the presentation.

Turning to Slide 10, I'll quickly review our hedging activity. Given the market dynamics that Gary discussed, we chose to operate with less interest rate risk during the quarter. As such, we increased the size of our hedge portfolio to a little over $64 billion and increased our hedge ratio to 97% of funding liabilities. We also increased the number of option-based hedges bringing our swaption balance to $6.7 billion at quarter-end. These hedges give us greater protection against larger rate moves and higher volatility. The effects of these actions can be seen on Slide 11.

As we show in the table, our duration gap at year-end was just 0.1 years, down from 0.4 years the prior quarter. In addition due in part to our swaption position, our estimated duration gap in the up 100 basis point scenario is just 1.2 years.

Lastly, the interest rate risk table on Slide 26 shows a similar reduction in our sensitivity to higher rates. As shown on the table, in the scenario where interest rates increase 100 basis points and assuming no rebalancing actions are taken, our estimated decline in net asset value is relatively small at 6.6%. This sensitivity to higher rates is the lowest projected decline that we have reported over the last 4.5 years.

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

Thanks, and at this point, I'd like to ask the operator to open up the lines to questions.

(Operator Instructions) The first question comes from Bose George with KBW.

Thanks for the update on book value since quarter-end. Just a follow-up, the -- with the move in rates, et cetera, can you give us some color on returns -- incremental returns now versus year-end?

They really haven't moved much. I mean, mortgages are a little wider, but not -- I mean, I wouldn't call it significant. They tightened really early and the -- at the beginning of the year and they sort of gave that back. So it's not a big move in spreads. And then -- I mean, the yield increase helps a little. But I would say, there isn't a big change year to date.

Okay. So -- and just in terms of quantifying the return now, is it kind of a low double-digit return?

Yes. I mean, I would -- double-digit barrel, it's right around, let's say, 10% in that ZIP Code.

Okay, Great. And then just on the CRT side, just given your comments on spreads there, et cetera, is it kind of safe to say you're on the sidelines there for a little while?

Yes, I think that's a safe comment. Realistically, while we have tremendous confidence in the fundamentals of the housing market, and in particular, the conforming housing market, we assume we have no credit concerns there. The reality is that the levered investor right now is being squeezed out of that product by long-only funds. And so I think it's not practical. As a matter of fact, I mean, look, we've -- we would probably be more likely if the current trends continue to shrink that position rather than grow it.

Okay. Great. And just one more on leverage. Can you just give us an updated thoughts on leverage? It was pretty stable, and you've talked before about that going up over time. Just curious about the kinds of scenarios that could take that number up.

I'm glad you asked the question. It's a really good one and I want to be clear, nothing has changed with respect to the comments that I've made over the last year that we see the trend higher in leverage and we're very comfortable with that. But if you go back to the comments I made at the beginning, we do feel the technical landscape for mortgages is going to be a little more challenging this year. And so I think, we plan to be opportunistic with respect to leverage. So if anything, we're -- in the short run -- very short run, I wouldn't expect it to pick up, but that's certainly something that we're focused on and nothing's changed our view that 2 years from now we'd be operating at materially higher leverage.

The next question comes from the line of Douglas Harter with Crédit Suisse.

Can you talk about your outlook for what you might do with risk metrics kind of given your commentary that you don't see rates moving substantially higher, but also -- but you just said that technically, it's a challenging landscape? Do you think you sort of maintain current low levels -- lower levels of interest rate risk or is that something you might tighten up further?

Doug, it's Peter. Yes, as I said, we obviously reduced our interest rate exposure in the fourth quarter. We're happy about that given the rate move. But we do -- even though we entered the quarter with a fairly defensive position, it is our practice to delta hedge as we get into rate moves. So far this year, we have actually added to our hedge position a little further. As I mentioned, our hedge ratio was about 97% at the end of the fourth quarter. At the end of January, it was actually about 100%. I mean, we added a few more options to our mix. We like having a little more optionality in the current environment. Those hedges have been relatively cheap, and they do give us some protection against outsized moves. But as Gary mentioned, at the beginning, in his prepared remarks, we have sort of a bias for rates to go higher, but not too meaningfully so. But we'll continue to operate with a defensive position.

Just one thing to add, which is sort of unique for us and if you think about the up-rate scenario, Peter discussed in his prepared remarks how our exposure to an up -- a 100 scenario, the modeled exposure is lower than it's been in a very long time. And -- but in addition, if you look at Slide 11, where we show our exposure to an up, what happens to our duration gap in an up a 100 scenario. The 1.2 years is actually lower than we may want to run in that scenario. So while we have done some incremental delta hedging to further reduce the exposure to a rising rate environment, at some point if this were to continue, we actually might start to go the other way, and we'd be in a position to do so given kind of our starting point on rates, because if we were above 3%, we might be very comfortable with the 1.5 year duration gap. So we feel like we're in a very good position from the perspective of our interest rate risk.

And then, I guess, just staying on interest rate risk if -- Peter, you just said you kind of about 100% hedge ratio, can you just talk about what you think your sensitivity to the 3-or-so Fed increases that we're going to see this year from a spread perspective?

Yes, well, thanks for that question, because one of the things I think that is -- people look at is our net interest margin, as Gary mentioned, we've had 5 rate moves already. If you look at our cost of funds and our net interest margin, that doesn't give us the whole picture because in that cost of funds measure, it only includes our swap hedge, it doesn't include all of our hedges. But when you look at our net spread income, it has been remarkably stable in low 60s for several quarters now despite the Fed continuing to raise rates. So over time, what I think you're going to continue to see is, the cost of funds measure to come down a little bit and our net interest margin to come down a little bit, because, again, it doesn't include all of our hedges. But I think you'll see that our earnings will be fairly stable and that's really important for us to maintain that high hedge ratio to have essentially the same amount of notional hedges of our Treasuries and our swap position, as our funding liabilities including both our on-balance-sheet repo and our off-balance-sheet TBA funding. And you have to look at that picture holistically and that's one of the reasons why we gave you that extra information on Page 16 of the presentation. So it gives you a breakdown and you can see exactly the drivers of the net interest margin. But over time, we're going to continue to operate with a high hedge ratio. That should give us a lot of protection for our earnings going forward.

(Operator Instructions) Our last question currently in the queue comes from the line of Rick Shane with JPMorgan.

My peers have asked great questions and most of them have been -- most of my questions have been answered. But I'd love to walk through sort of the scenario that I think I'm hearing from you guys, which is an expectation of higher rates, an expectation of wider spreads. And let's just say, rates are up 100 basis points, spreads widen at a 100 basis points, I think what I'm hearing you guys say is that as that evolves, you will lever up the balance sheet modestly, affectively lowering the hedge ratio extending the duration. In that scenario, where do you think ROEs go in the context of where we are today? Do you think that you can actually enhance ROEs in that scenario, maintain them or would you expect some sort of compression?

It's a good question. So I would think ROEs will actually expand noticeably in that scenario. Let me just say, on the projections, yes, we are a little bearish on interest rates, but I would say that we don't see a 100 basis point move. I think if -- 50 would be on -- from where we are today, would probably be on the higher side of what we likely -- what we could see over the course of the year or maybe even into early next year. So -- and on the spread side, what I would say is, we think the technical -- the technicals are definitely more challenging. We wouldn't be surprised to see some spread widening, but we absolutely think it will be contained. Mortgages, the agency mortgages are just -- are more attractive than most competing instruments already at this point. And so what we saw with QE was when the Fed was buying Treasuries and mortgages, you saw very favorable impacts on other products as people, basically bought less of those and more of other things. And so practically speaking, one has to assume the same thing is going to happen going in the other direction. So you're not going to see a complete -- you're not going to see mortgages completely kind of disassociate from everything else. So I think spread widening more in the 10 to 15 basis points is more of a practical kind of mindset. But against that backdrop, higher yields and wider spreads alone will help ROEs, but then a larger duration gap and higher leverage will even more materially help ROEs. So you could see a pretty significant increase in ROE on kind of go-forward purchases if that scenario unfolds sort of as I described.

Got it, makes sense. And again, I agree with you. 100 basis points seems pretty aggressive. 10, 15 basis points spread widening seems very realistic. Let me ask the question in a slightly different way, which is when you think about the next 12 months, what would you -- what would the scenario be that you would love to see? What's -- what are you licking your chops for? And what's the -- when you think about it, it puts that bad warm feeling in your stomach, like, "Oh, that's going to be bad for us."

So honestly, I think, we would like to see spreads overreact in the short run or at some point this year to the technical factors, which is not out of the question. I think, that's a reasonable -- it's definitely possible. And that would give us an opportunity to kind of to reset leverage, so to speak. So that would be a big -- that would be a positive. I think on the rate side, we would like to see the scenario more turn out the way we described, an extreme move up in rates, while I think would create an opportunity at some point. It's not usually favorable for -- to have extreme volatility for a levered mortgage portfolio. In terms of scenario, I don't really want to see -- I would say, again, any extreme move in either direction would be -- as always challenging when managing a mortgage portfolio and I think our increased purchases of option certainly help in that regard. But a bull flattener probably would not be the best scenario in the short run, but I think that's -- again, that's not something we envision in the near term.

We have now completed the question-and-answer session. I would like to turn the call back over to Gary Kain, for any concluding remarks.

Thank you for joining us on our Q4 2017 call, and we look forward to speaking with you next quarter.

The conference has now concluded. An archive of this presentation will be available on AGNC's website, and the telephone recording of this call can be accessed through February 15, by dialing (877) 344-7529 or (412) 317-0088, and the conference ID number is 10115477. Thank you for joining today's call. You may now disconnect.