AGNC Investment Corp (AGNCO) 2016 Q1 法說會逐字稿

Good morning, and welcome to the American Capital Agency first quarter 2016 shareholder call.

(Operator Instructions)

Please note this event is being recorded.

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

Please go ahead.

Thank you, Laura, and the thank you all for joining American Capital Agency's first quarter 2016 earnings call.

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

This conference call and corresponding slide presentation contain 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 May 10 by dialing 877-344-7529 or 412-317-0088 and the conference ID number is 10083761.

To view be the slide presentation, turn to our website AGNC.com, and click on the Q1 2016 earnings presentation link in the upper 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; Chris Kuehl, Senior Vice President, Mortgage investments; Peter Federico, Senior Vice President and Chief Risk Officer; 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.

Consistent with the theme of recent quarters, we again experienced significant volatility across a wide range of markets.

The S&P 500 was down around 10% in the middle of February.

Treasury rates dropped to near historical lows, and credit sensitive fixed income markets experienced very significant intra-quarter spread widening.

When all was said and done; however, most of these markets ended the quarter largely unchanged.

There was one notable exception, and that was the rates market, with both Treasury and swap rates ending the quarter materially lower.

For example, the 10 year swap rate rallied 55 basis points, and closed the quarter at 1.64%.

This was the second lowest monthly close on the 10 year swap rate ever, with only July of 2012 being five basis points lower at 1.59%.

It's pretty amazing to think that this dramatic move lower in interest rates occurred in the two months immediately following the Fed's first increase in short-term rates in almost 10 years.

I believe the driver of this counterintuitive result was the market's recognition of the reality of the seriousness of the global economic headwinds, and that the US economy will have trouble maintaining its modest growth trajectory against this backdrop.

As we said on our last earnings call, we expected that the Fed would be unable to normalize monetary policy any time soon, and that interest rates would be lower for longer.

That said, the size of the rate move in the first quarter was surprising to us, as it was to most market participants.

While the Fed still may raise rates a couple of more times this year, we believe that they will likely abandon their tightening bias by the first half of 2017.

The FOMC is already moving in this direction, as they passed on a rate increase in March, and reduced their own projections for rate hikes, which now call for only two rate moves in 2016, versus the four they predicted in December.

In short, the Fed adopted a decidedly more dovish tone in the first quarter than many expected.

When you combine a more dovish stance from the Fed with aggressive easing on the part of other large central banks, it is logical that interest rates across the globe are at or near their all-time lows.

Collectively, the central bank actions support the low for longer theme we stressed on our prior call.

This benign interest rate landscape is very supportive of our business, and so we are not surprised by the recent improvement we've seen in mortgage REIT equity evaluations.

As we said on our last call, mortgage REIT price to book ratios were unsustainably low in our opinion, and completely inconsistent with the improving fundamentals of the business.

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

Comprehensive income totaled $0.01 per share.

Net spread income, which includes dollar roll income, but excludes catch-up AM, was $0.52 per share.

Economic return was slightly positive at 0.4% for the quarter, or 1.8% on an annualized basis, as our $0.60 dividend exceeded the $0.50 per share drop in our book value.

During the quarter, we repurchased $116 million, or just shy of 2% of our common stock.

We'd actually anticipated larger repurchases, but as our price to book ratio improved over the quarter, we reduced our share repurchase activity accordingly.

On Slide 5, I just want to highlight that our leverage increased to 7.3 times.

We have taken a disciplined approach to raising our leverage over the last several quarters, given the volatility in the financial markets.

That said, given wider mortgage spreads and the more favorable rate environment, leverage closer to our long-run average is warranted.

At this point let me turn the call over to Chris to discuss the market and our portfolio.

Thanks, Gary.

Turning to Slide 6, I'll start with a review of what happened in the markets during the first quarter.

Interest rates ended the quarter much lower, with 5 and 10 year swap rates rallying 55 basis points as of March 31.

As Gary mentioned, the first quarter was also volatile, with rates, equities, oil, and credit spreads all under significant pressure in early February.

For perspective, investment-grade corporate CDX started the year at a spread of around 88 basis points, and got as wide as the high 120s, only to then recover all of this widening and then some, to end the quarter a few basis points tighter.

Agency mortgage spreads also experienced some volatility; however the spread movements were much more contained, given the relative safe haven status and superior liquidity.

At the bottom of Slide 6 we have a time series of average daily option adjusted spreads for both 15 year 3.0%s and 30 year 3.5% MBS, which on average were wider versus Treasury and swap hedges throughout most of the first quarter.

Let's turn to Slide 7 to review our investment portfolio composition.

As Gary mentioned, we took leverage -- we took advantage of wider spread levels during the first quarter, adding approximately $2.2 billion in MBS.

This, coupled with our share repurchases, increased at-risk leverage to 7.3 times as of March 31.

Our improved outlook for the mortgage basis was not only a function of wider spreads.

Other indicators of risk also declined in the second half of the quarter, as commodity and credit markets stabilized, and messaging from Federal Reserve policymakers converged somewhat with market expectations and economic data.

Going forward, we will continue to look for opportunities to move to a more normal risk position, if our outlook for risk-adjusted returns continues to improve.

At a high level, our portfolio composition was largely unchanged quarter over quarter, as the combination of both season pools and prepayment protected securities positioned the portfolio to perform well in the current environment.

And lastly, with respect to prepayments, you can see in the table on the top right, that prepayment speeds on our portfolio remained well behaved, despite the significant move lower in driving rates.

I'll 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 weighted average on balance sheet funding costs increased 74 basis points at the end of the first quarter, up from 60 basis points the prior quarter.

As our repo position turned over during the quarter, the new repos that we entered into fully reflected the Fed's December rate hike, and as such was the primary driver of the increase in our overall funding costs.

The liquidity in the repo markets for agency MBS continues to be very good, and we are optimistic that these positive conditions will continue into the future.

Given this outlook, we expect our funding spread to LIBOR over the longer term to remain relatively stable at current levels.

The balance of our Federal Home Loan Bank advances fell slightly to $3 billion at quarter end, as a portion of our advances matured during the quarter.

We expect the outstanding balance of our advances to remain at this level for the remainder of the year.

Turning to Slide 9, I'll review briefly a few changes to our hedge portfolio.

The outstanding balance of our hedges declined slightly to $45.5 billion.

In total, our hedge portfolio covers 83% of our funding liabilities.

In addition, the composition of our hedges shifted slightly toward a greater portion of Treasury hedges in our overall hedge mix.

In the current environment we favor using a greater share of Treasury based hedges, given the unique risks associated with swap spreads.

Lastly, on Slide 10, we show our duration gap and duration gap sensitivity.

Consistent with the significant drop in interest rates during the quarter, our duration gap naturally decreased from 0.8 years at year-end, to a zero duration gap at the end of the first quarter.

At the current low level of rates, we are comfortable operating with a very small or even negative duration gap.

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

Thanks, Peter, and at this point I'll open up the call to questions.

(Operator Instructions)

Steve DeLaney, JMP Securities.

Good morning, everyone, and thank you for taking the question.

Gary, based on the Fed -- I'm sorry, I'm getting feedback.

Can you hear me okay?

Okay, great.

So given the rate hike in December, the first hike, obviously we expected to see an increase in the cost of funds.

But you've got such good coverage with swaps, that it's really hard to determine whether the six basis points in the cost of funds, excluding TBA swaps, to [151], it's hard to tell whether that is, how much of that is a direct result of the Fed hike, how much is a function of extending repo terms?

And one specific question I had was your swap receive rate jumped to 62 basis points, equal to three month LIBOR at March 31, from 40 basis points, so 22 basis points of benefit.

And Peter, what I was trying to understand is, was the full benefit of the 22 basis point increase in the receive rate, was the full benefit realized throughout the first quarter, or did that kick in as the quarter went along?

Yes, Steve, this is Peter and it's a great question.

And really I think you touched on all of the components of the answer to your question.

And really what you have is, as I mentioned 83% of our portfolio is, of our liabilities is synthetically covered with swaps, so a significant offset to any increase in our funding cost will show up in our swap cost.

But we do have timing differences, and I think that's what you often see.

Our swap portfolio rolls over at slightly different time than our funding cost, and so as we roll through the first quarter, our portfolio is all resetting at sort of different times.

Ultimately though, you're right, largely the cost will be offset, and over time I think you'll see that relationship stabilize.

Okay, that's great.

I guess the real key for us to watch going forward is to make sure that actual, the practical repo rates in the market for the 30, 60 days did not widen against three month LIBOR.

Right.

And the other key point I actually referred to in my prepared remarks about, really, at the end of the day the question is if you have a portfolio as hedged as ours, is what is the relationship in our funding cost relative to LIBOR, because our swaps are going to reset off three month LIBOR.

The question is what is our basis on our funding cost and how does that change?

And that's why I said once we got through year-end, we're starting to see our cost, our funding cost relative to LIBOR actually come down in the repo market.

We expect that to continue to improve and stabilize at these levels.

Great.

And that's a great segue to my second and last question, could you guys give us an update on Bethesda Securities?

Your 10-K suggested that you were hoping to be operational by mid-2016.

Yes, unfortunately I don't have an lot new to report there.

I can tell you though that from a timing perspective everything continues to be on time.

We're still in the final stages of the application process.

We're essentially staffed, up and running, but we're just going through the normal process, and I do still believe that by the end of the year we'll be up and running, and you'll see more activity there.

Okay, Peter, and just to clarify, the endgame, assuming that things go well with all the regulatory authorities and with the FICC, is the real objective here to be able to tap into repo funding that is not dependent on a bank balance sheet capacity?

Yes, that exactly right, there's two significant benefits that we would garner from having the in-house broker-dealer, and that's the first key one which is that it would allow us to do repo directly with the FICC, and therefore avoid having to rely on the balance sheets of large financial institutions which are obviously increasingly constrained.

So it will give us access to a source of funding that will be, from our perspective, more cost effective, more effective from a haircut perspective, and importantly a new source of liquidity for us.

So it'll be very significant on the funding side.

It will also allow us to clear our own TBA trades, which would be another sort of new form of liquidity for us that we don't currently have today.

Great.

Thank you for the comments.

Douglas Harter, Credit Suisse.

Thanks.

Can you talk about what maybe average leverage was for the quarter, just to get a sense of when you added to the portfolio?

Sure.

The average leverage was 7 for the quarter, versus 7.3, obviously at the end, and 6.8 at the beginning.

But keep in mind as well that the average leverage is affected, as you said, we did add MBS during the quarter, that tended to be pushed back or later in the quarter.

The other things that affected leverage were share repurchases, which were predominantly let's say in the middle of the quarter.

But then also keep in mind that the movement in book value which was lower in January, a little bit, well was lowest towards the end of February, also affects the timing and the average calculation of leverage.

But I think the important conclusion is that not much of the benefit of higher leverage really accrued intra-quarter.

I think that's probably the key conclusion that you could draw from that.

And sort of along those lines, you've been talking about sort of over time normalizing, both the leverage and the interest rate risk position.

Can you just give us an update as to where you think you stand on each of those measures, and whether there's more room to go in the current environment you would see sort of taking, increasing the risks on each of those two components?

Sure.

I mean look, I think our bias is still higher on leverage at this point.

Again, we view something in the high 7s to 8 as being normal leverage, and we view mortgage spreads relative to other instruments as well relatively attractive at this point.

And we view the interest rate environment as improving, as we've talked about.

I think, so from that perspective, the bias is still higher in terms of leverage, but we don't expect, at this point we wouldn't expect to get to 8 very quickly.

But what I would say is that I think where the story is a little different is on the interest rate risk piece.

As Peter mentioned, we closed the quarter with basically no duration gap.

Running at no duration gap costs money obviously versus running, let's say, if we had to say give a base duration number it would be a year or slightly higher than that.

I think right there on that front, the level of rates is such that while we're constructive on the rates market over time, we don't view this as a short term opportunity to increase the duration of the position.

But what I would say is, again, given our -- the fact that we're long run constructive on rates, we certainly would view a backup in rates as more of an opportunity, and that could at any point get us more comfortable on that front.

Makes sense.

Thanks, Gary.

Rick Shane, JPMorgan.

Thanks, guys, for taking my question this morning.

I'd like to talk about couple things, and Gary, you talked about spreads and you've shown them to be wider.

And you alluded to the fact that they're attractive, but you didn't, I don't think you used the word cheap at this point, and I think a little bit of what's going on here is that we're seeing OAS adjust to reflect changes in the repo market.

And so when we look at the charts on Page 6, perhaps with the changes in the market, those averages are no longer necessarily appropriate.

Can you talk about what you think is going to happen long-term?

But the other issue here is, and I think this is all related, this is the third quarter where the core income didn't cover the dividend.

I'm curious if you think that there is the opportunity through leverage and through the widening of spreads to get back to a point where the dividend's fully covered?

Sure.

So there were a couple different points there.

So with respect to your first comment, which I think is just a very, very important observation and it's consistent with Peter's answer to an earlier question, if mortgage spreads widen but repo rates widen relative to LIBOR by the same amount, and the expectation is they're going to stay there indefinitely, then we will not achieve the benefits of the cheapening of mortgages in terms of ROE.

So I think that's an important point, I'm really glad you asked it.

I think what is, the way we think about it, however, is that we really do believe, and it goes to what Peter has said, which is, we don't believe that the long run for government funding, repo funding is challenged.

There is a huge amount of demand to lend against government securities, and what we've seen is a change in obviously balance sheet kind of capital charges, balance sheet requirements on the part of the largest banks, and so there's an adjustment process going on in the markets with respect to how to line up buyers and sellers, so to speak, in the repo market.

And as that process evolves, we're pretty confident actually that we're not going to see this, the basis between repo and funding deteriorate, and actually I think from its wides of a few months ago, we actually think there'll be improvement.

So I think that's a core piece of it.

So we view option adjusted spreads, or we view spreads in the market right now as being attractive, but to your point, you have to make some adjustments and that's why we don't view them as, we'll call it back up the truck attractive.

Now let me go on to your second question, which relates to the dividend, dividend and net spread income, and what I would start with there is, what I've said in the past which is, we've don't give dividend guidance.

But in addition, we also don't and have not viewed net spread income as an all-encompassing figure that really perfectly expresses the true earnings power of the portfolio.

And in prior calls over the years I've discussed some of the shortcomings of that measure.

So in the end, what is going to determine our go forward earnings and our expectation of earnings over the intermediate period are the other things we talked about earlier with the second question, which related to what's going to happen with our leverage and what's going to happen in a sense with our duration gap.

And to the extent that we are comfortable, we will be taking more, increasing those risk positions, our earnings are going to improve, and then that will obviously provide a tailwind earnings, improving to the overall dividend equation.

So I think that's really the key thing to keep in mind, so again we do not focus, we've never focused on net spread income as the guiding light, so to speak, to the dividend.

But I think the driver is our expectation of our earnings power over time, and again that's a function of the market environments, and it's a function of our expectation on how much risk we're willing to take.

Okay.

So you say not focused on net spread income, I understand that, and you talked about the broader earnings power.

Is the incremental factor your ability to consistently realize gains?

What is the difference in your mind between those two metrics?

No, it is not only that.

It's a function of -- the net spread income captures some hedges, it doesn't capture other hedges.

It works off of the cost basis of our assets and the cost basis of our swaps.

And so it is not a marked to market number, so to speak, and over time there can be quite a bit of drift between your actual earnings capacity, and this accounting number that I know gets a ton of focus.

So I would separate those two, again, for a number of reasons, but there are other things such as things like if we expect to be buying back shares at a discount, then that's going to increase our earnings power as well.

If we think that mortgage spreads are biased tighter over time and funding costs are biased to improve, then that's going to improve the earnings picture.

It is a complicated picture, and honestly it's not like we have some perfect in-house model for it, but I think that it is important for people to understand, as we've talked we talked about over the years, that the net spread income has a lot of shortfalls.

Got it, okay, thank you very much, Gary.

Joel Houck, Wells Fargo.

Thanks and good morning.

So to I guess follow up little bit on Rick's point or question and your explanation, earlier you said, Gary, you're constructive on the rates market.

Can you kind of articulate what that, what does that mean practically in terms of where you think rates are headed, and the shape of yield curve?

Because, as you said, the Fed raised rates, who would've thought that we would have seen the reaction in the long end.

So I guess that's a starting point, because that then, from that falls out how you're willing to take the hedge ratio down to take more duration risk.

Does that make sense?

Sure, look, no, very good question and very reasonable.

I want to, what I want to stress is in our comments around the rates picture, and again, I think our comments today are almost identical to what they were three months ago, and we've seen some changes obviously in the market since then.

But I want to recognize, again, what we're stressing in our comments around being constructive on interest rates is the theme of low for longer.

We think that, actually do think that it's likely that if we don't see another, kind of, we'll call it shock either, a surprise in the economic numbers, or a deterioration of financial conditions, or some other shock to the system, I actually think it's very likely that the Fed goes again.

I think that might create or, over the course of the remainder of the year, we're likely to see some of those shocks come into play, and that might be the last time they go.

But I think we just also in terms of we have to be practical with respect to when you increase your duration position, and if you look at where rates have been over the last two or three months, they've obviously been at historical lows, and we think the bottom line is my current gut is that in the short run, we're likely to see rates a little higher.

But again, so again I would define that as constructive over the long run, but a little less convicted that the next move is lower with respect to the short run.

I don't know, Peter, if you want to add anything?

No, that's exactly why I added at the end of my prepared remarks, Joel, the point about, at the current level, we're comfortable operating with little or no duration gap.

We just feel like with rates being historically low, that's the prudent position to be in, and it does appear that the Fed still wants to increase rates one or two more times, in our opinion.

But to Gary's point, once they do that, we think that there's a period where they're going to get essentially stopped out of that trade, and at that point it'll be think a much more constructive time to take an interest rate position.

Okay.

That make sense.

And the second question I had, and this is more near-term obviously, is how are you thinking about the potential exit of the UK from the EU in June?

I think most people would agree that it's probably not priced in, people are thinking they're going to stay in, but if the unexpected happens -- give us kind of your views of what that looks like in terms of rates, volatility, and how do you potentially hedge into that, not unknown event, but unlikely?

Yes, well I'll start and Gary can add to it his thoughts.

But I think you're exactly right.

It's a complete unknown to the market.

It would obviously be a significant event, and to be honest I don't know how the market would react, I don't know if it would cause rates to go up or rates to go down, and that's part of why we're operating where we're operating from a hedge position.

At the end of the day, the market is coming to the conclusion that the Fed's not going to raise rates on its normal path because of these global headwinds, that the recovery in United States is not going to be quite as robust.

That gives us confidence that the lower to longer theme will be in place.

But in the short run, we are at historically low levels, we do have a lot of uncertainty in the marketplace, whether it be with respect foreign reserve selling, or that potential that you described.

So we like operating right now with the hedge ratio north of 80%, 83% to 85%, and a low duration gap, until we get through some of these periods where we actually feel like we have some transparency into how the market will react.

Because like you said those can be very significant event.

I would just add, I mean look, I think it's one event and it is significant, but there's a lot of other things going on globally, and the jury's still out on what happens with China, obviously.

Things have calmed down and they have been -- they have executed lots of stimulatory actions over in China, so what I would just say is, you're right point that out, it's a very near-term risk, but there are plenty of others out there as well.

All right, thanks guys for your comments.

Bose George, KBW.

Hi, guys, first Chris, this is related to some of the previous ones, but what's the ROE on the incremental investments you're making and how does that compare to what you were doing a few months ago?

Thanks for the question.

So yields on 30 year 3.5%s right now, for example, are in the 260, 270-ish range, depending on the type of pool, and just assuming seven times leverage and a one-year duration gap on marginal purchases.

Return on equity on a spot basis is well into the double digits at this point.

It's not materially different to where it was a couple months ago.

Okay, great, thanks.

And then actually on the repo funding side, did you guys mention what your current repo funding costs are?

You mean with respect to -- what's that, I'm sorry, Bose?

Yes, just what you guys are seeing in the market currently?

Right now I would say, it's easier to think about it relative to LIBOR, but like in the three-month range, we're probably about 5 to 10 basis points over LIBOR.

It's marginal, so I would say between 65 and 75 basis points would be our marginal cost right now.

Okay, thanks.

And just wanted to clarify something in the press release when you guys give the yield at 2.76, I think it was, does that touch on, use the dollar roll number or is that just the gap yield and then you adjust for that catch up?

The 2.76 on the asset yield?

Yes, yes.

You said the asset yield, I guess it was --

That would be excluding, I think you're referring to, that would be excluding the catch-up amortization.

(Multiple speakers)

Yes, the dollar rolls won't be in there.

Okay, great, thanks.

Brock Vandervliet, Nomura Securities.

Thanks for sneaking me in here.

I guess just trying to put together some of your responses from some of the prior questions all tied to earnings power.

You mentioned earlier you didn't have the full benefit this quarter of the higher leverage.

Is there anything you can say to quantify if you'd had that benefit, and a couple of the other things for the entire quarter, how much different things would have looked?

Well again, given when we were going through the leverage discussion of the average versus the ending, there's a couple of moving parts in there, such as book value bounces around, that affects your leverage calculation.

You're changing leverage via a couple different actions, stock buybacks and purchases, so it's hard to directly quantify it.

Remember the other two moving parts are prepayment speeds affect your results as well, and obviously funding costs, and the timing mismatch.

So I don't want to just try to put a number on it, but what I would say is that we certainly, you can do straight math as what the difference of a half a turn means, but I think that again you have to stress that there are a number of factors that go into the calculation, but I think it is a definitive statement or accurate statement to say that the full benefit of the larger portfolio is not priced in, again, it is hard to just put a number on that.

Okay.

And just as a quick follow-up, you touched on prepaid speeds, could you talk about how they've trended over the quarter?

It seems like that, the concern of that pressure point may be abating here with the 10 year around [190]?

No, that is a good point.

So this is an important, and I'm glad you followed up with that.

It's important for people to realize that we project prepayment speeds.

And so when interest rates close the quarter year near their lows, we were projecting a meaningful increase in speeds on the portfolio, from the low 8s to the low 10s, and if interest rates back up, our prepayment rejections will likely come back down, which will help yields and NIM and so forth.

What's interesting is our actual CPR for the quarter actually declined.

And so had we been actually just working off of actual CPRs, we would have had a very -- the quote results would have looked very different.

So it's really important that people understand the distinction there and the way we project prepayments.

And so to your point, even if the actual speeds pick up, because of the fact that there were lower rates driving the prepayments, if interest rates are going up then we're going to be projecting slower speeds, and that's what's going to flow through to the financials.

So yes, obviously we can't tell you where rates are going to close the second quarter, but at this point rates are higher and at this point we would be projecting lower speeds.

Great.

Okay, thanks, Gary.

And 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.

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

The conference is 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 May 10 by dialling 877-344-7529 or 412-317-0088, and the conference ID number is 10083761.

Thank you for joining today's call.

You may now disconnect.