AGNC Investment Corp (AGNCO) 2016 Q3 法說會逐字稿

Good morning and welcome to the AGNC Investment Corp. third-quarter 2016 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, Terry, and thank you all for joining AGNC Investment Corp.'s third-quarter 2016 earnings call.

Before we begin, I would like to review the Safe Harbor statement. This conference call and corresponding slide presentation contains statements that, to the extent they are not recitations of historical fact, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act. Actual outcomes and results could differ materially from those forecast due to the impact of many factors beyond the control of AGNC. All forward-looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice. Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in the Risk Factors section of AGNC's periodic reports filed with the Securities and Exchange Commission. Copies are available on the SEC's website at sec.gov. We disclaim any obligation to update our forward-looking statements unless required by law.

An archive of this presentation will be available on our website, and the telephone recording can be accessed through November 8 by dialing 877-344-7529 or 412-317-0088, and the conference ID number is 10093704. To view the slide presentation, turn to our website, agnc.com, and click on the Q3 2016 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, Senior Vice President, Mortgage Investments; Aaron Pas, Senior Vice President; and Bernie Bell, Senior Vice President and Chief Accounting Officer.

With that, I will 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 third quarter as economic returns were extremely strong at 5.6% or just over 22% on an annualized basis. This was our fourth straight quarter of positive economic returns, and economic return through the first three quarters of 2016 is already slightly above 9%.

During the third quarter, the treasury yield curve bear flattened slightly. The flattening was much more pronounced in the swap curve as shorter-term swap rates increase significantly more than treasuries, while longer-term swaps spreads hit new tights. The widening in shorter-term swap spreads had a small positive impact on our book value, but could be indicative of a much more positive development: the underperformance of LIBOR versus short-term governments. This dynamic has already driven a significant improvement in repo rates on agency MBS in relation to three-month LIBOR.

It is interesting that the reverse of this, the underperformance of MBS repo versus LIBOR, which occurred late last year, was one of the largest concerns we heard from investors as we began 2016.

While we expressed our confidence on our Q4 2015 earnings call that this weakness would be short lived, we certainly did not expect the massive repricing of this spread witnessed over the past six months. Peter will discuss the importance of this relationship in some detail in a few minutes, but it has the potential to be a significant tailwind for our portfolio.

The completion of AGNC's internalization was another positive development during the quarter. We are extremely pleased with the progress on the transition and are already seeing the benefits of our lower operating cost structure.

Importantly, this is an ongoing and sustainable benefit, and we continue to expect our total operating costs to remain at or below 90 basis points on a run rate basis. If we include the benefit of the current management fee we receive for managing MTGE, AGNC's effective net operating costs is anticipated to be below 75 basis points.

Lastly, AGNC made its first investments in GSE credit risk transfer securities in the third quarter, consistent with our announcement last month that we revised our investment guidelines to permit purchases of credit-sensitive assets.

We view the GSE's dispositions of credit risk associated with their ongoing guarantee activities to be a game changer in that it allows access to a large sector of the market that was previously the exclusive domain of the GSEs.

Said another way, a significant portion of the credit risk underlying about $3 trillion in conforming mortgages will likely transition from the GSEs or government sector to the private sector over the next five to seven years. When you combine this favorable technical backdrop with our expertise in the space and the somewhat offsetting nature of agency prepayment and credit exposures, we believe AGNC is well-suited to benefit from this opportunity over time.

With that introduction, let me turn to slide 4 and quickly review our results for the quarter. Comprehensive income totaled $1.25 per share. Net spread income, which includes dollar roll income, but excludes catch-up [BAM], increased to $0.64 per share from $0.56 per share the prior quarter. The majority of this improvement was a result of the reduction in our operating cost related to the internalization, and our net spread income also benefited from the improved funding equation I mentioned earlier.

Total book value per share increased $0.69 or 3.1% to $22.91 as of September 30. Tangible book value, which excludes the goodwill and other intangible assets associated with the internalization, was $21.23 at the end of Q3.

Turning to slide 5, at risk leverage was essentially unchanged at 7.7 times tangible book, and our portfolio totaled $63 billion at the end of Q3.

The biggest change in our portfolio composition this quarter was the doubling of our TBA position, which Chris will discuss next.

With that, I will turn the call over to Chris to discuss the market and our portfolio.

Thanks, Gary. Turning to slide 6, I will start with a brief review of the markets. Interest rates edged higher during the quarter, and the yield curve flattened with three-year swap rates increasing 26 basis points, while 10-year swap rates moved higher by just 8 basis points. Agency MBS, along with other risk assets, performed very well during the quarter with LIBOR option adjusted spreads tightening between a couple basis points to as much as 10 basis points depending on the term and coupon. Higher quality call protected specified pools also performed very well during the quarter, generally outperforming more generic TBA MBS.

Let's turn to slide 7 and I will review the investment portfolio. At risk leverage was unchanged as of September 30 at 7.7 times tangible equity. The investment portfolio increased slightly to $62.9 billion. On our call last quarter, we characterized the prepayment environment as no longer benign. Prepayment speeds did, in fact, increase significantly on certain coupons and vintages. For example, the 2014 Fannie Mae 30-year 3.5% cohort paid at 32% and 31% CPR during the months of August and September, respectively.

On a comparison, speeds on our portfolio were well behaved, averaging 14% CPR for the quarter. Looking ahead, we expect prepayment speeds on the portfolio to decline into the fourth quarter, given seasonal impacts on housing turnover, as well as somewhat higher primary mortgage rate levels. The most notable change in the composition of the investment portfolio during the third quarter was the increase in the TBA role position. Role implied financing rates for production coupons have consistently been favorable relative to repo with dollar roll levels on our largest TBA position, 30-year 3s, averaging approximately 25 basis points through repo during the quarter. This coupled with our expectations of faster prepayment speeds on certain securities during the quarter made it advantageous to convert additional pool positions to TBA. The size of our roll position will likely continue to fluctuate as both supply/demand technicals and the prepayment environments evolve. This proactive approach to managing prepayment risk is critical to generating strong returns, and it will continue to be a differentiating factor in performance.

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

Thanks, Chris. I will begin with our financing summary on slide 8. The cost of our repo funding increased slightly during the quarter to 83 basis points, up from 78 basis points the prior quarter. This increase was driven primarily by higher LIBOR rates observed during the quarter.

As I mentioned on our last call, we expected to begin financing activity through our broker-dealer, Bethesda Securities, in the third quarter following the completion of our buildout and receipt of final membership approval from the fixed income clearing corporation. We achieved these milestones and at quarter end had financed $1.2 billion of our agency MBS through Bethesda Securities. We will continue to expand our financing activity through Bethesda Securities over the next several quarters.

Turning to the next couple of pages, I would like to spend a few minutes discussing the favorable funding dynamic that Gary mentioned. If you recall, throughout 2015, the narrative around agency MBS funding was rather negative due to capital-related balance sheet constraints at large banks, the significant selling of US treasuries by foreign central banks, and the uncertainty associated with money market reform.

On our fourth-quarter 2015 earnings call, we said the agency MBS funding paradigm was beginning to shift in a positive way as balance sheet repositioning by larger banks had been substantially completed and treasury-related funding pressures was expected to be temporary.

In retrospect, these proved to be the case, and as a result, our funding capacity has remained strong throughout 2016.

We also discussed our view that money market reform could be a significant positive for agency MBS. Specifically, we mentioned that the floating NAV requirement by prime funds could lead to a shift in money out of prime funds and into government funds. This requirement became effective just a couple of weeks ago, and it did, in fact, drive a dramatic reallocation of money within the money fund complex.

We show this dynamic on the chart on the bottom left of slide 9. As you can see, nearly $1 trillion has been withdrawn from prime funds and redeployed into government funds over the last several quarters. This shift to government funds has led to a pickup in demand for high quality, short-term assets like repo backed by agency MBS.

In turn, the increase in demand has favorably impacted agency repo levels. This improvement can be seen on the graph on the bottom right of slide 9. Here, we show the spread between generic, three-month agency repo and three-month LIBOR. As you can see, there has been a significant improvement in recent months. At the beginning of the year, three-month repo rates were about 25 basis points above LIBOR. At quarter end, they were 7 basis points through LIBOR, a dramatic improvement in funding levels. We show this spread relationship because our repo funding spread to three-month LIBOR is a key variable in our overall cost of funds equation as a significant portion of our funding is hedged with pay fix swaps.

Turning to slide 10, we provide some additional data that will help quantify the improvement in our overall cost of funds based on this dynamic. To review, in a pay fix swap kind contract, we pay a fixed rate and receive a floating rate that is typically three-month LIBOR. When our debt is hedged with a swap, the critical variable is the difference between the cost of our repo funding and the rate we receive on the floating leg of our swap. If the spread between our repo funding and the receipt floating rate on our swap gets larger or widens, we incur a higher all-in cost of funds. Conversely, if the spread between the two tightens, we realize a lower all-in cost of funds on the portion of our debt that is hedged with pay fix swaps.

The graph on the bottom left of the page shows our actual repo costs relative to three-month LIBOR. As you can see, our cost has improved by about 15 basis points over the last four quarters. The graph on the bottom right of the page shows how this trend has positively impacted our overall cost of funds.

Here, we show our actual repo rate compared to the rate we received on the floating leg of our swaps. Again, because we are paying the repo rate and receiving the floating rate, it is the differential between these two lines that matters for our cost of funds on the swap portion of our portfolio.

As you can see, the differential between these two lines has narrowed considerably over the course of the year from 20 basis points at the beginning of the year to 5 basis points at the end of the third quarter.

Said another way, the all-in cost of our debt that is hedged with pay fix swaps has improved by 15 basis points this year.

It is also important to note that this spread was improving throughout the third quarter. So the full benefit will not be realized until the fourth quarter.

Lastly, on slide 12, we provide a summary of our interest rate risk position. Given the increase in rates during the quarter, our duration gap at quarter end was 3/10 of a year, up from a zero duration gap last quarter.

And, with that, I will turn the call back over to Gary.

Thanks, Peter. And, since this is our first quarter post-internalization, I think it is helpful to close our prepared remarks with slide 13, which summarizes AGNC's enhanced value proposition. AGNC now offers investors the unique opportunity to invest in a vehicle that has the lowest cost structure in the space, a proven track record of significant outperformance versus its peer group, substantial liquidity and scale as the largest internally managed residential mortgage REIT, disciplined risk management, and a structural alignment between management and shareholder interest. When you combine the straightforward and comprehensive value proposition with the improved funding picture Peter discussed and a low for longer global interest rate landscape, it is easy to be excited about the future of the new AGNC Investment Corp. Hopefully, investors also like our new website and the new logo as well.

With that, let me ask the operator to open up the call to questions.

(Operator Instructions) Bose George, KBW.

It is actually [Eric] on for Bose. It looks like the run rate compensation expense is slightly below the pro forma figure that you modeled after internalizing. Should we take this quarter at about $9 million as the true burn rate going forward?

No, the run rate will actually be a little different and actually a little higher. We are not accruing for like stock-based compensation expense at this point, and so that is one difference kind of versus the run rate. So we include that in the run rate.

We also have -- we are including in the expense in the $9 million the amortization of someone -- some retention bonuses that won't necessarily be there over the long run. So there are some differences between the currently reported number and our expected run rate.

Got it. Thanks, Gary. And do you expect the repo -- I want to be clear from your comments earlier that you expect the repo LIBOR basis tightening to continue, and that if nothing changes, the third quarter swap run rate is a good reflection of what it will be going forward.

Let me start with our view on the repo versus LIBOR situation. I think we expect it to be favorable going forward. We feel that what was creating the issues last year, the balance sheet reduction kind of treasuries floating around the system, we feel those things have been addressed and they are kind of things of the past.

We also do think that, over the longer run, there are some positives. As an example, new entrants that don't have the same capital requirements such as our -- Bethesda Securities.

So, over the long run, we feel like the funding picture is likely to get better. What I would say is there is some temporary noise in LIBOR and in that relationship that could bounce around.

So what I would say is, we are bullish on our funding picture versus its long-run average going forward. But we do expect some noise over the near term in that relationship, and I think it could go either way in the short run.

Got it. One more, if you don't mind, from me. How do you think about the structure of your hedges going into next year, and how would you possibly hedge differently if it actually looks as though the Fed could get more aggressive than what you currently expect?

What I would say is, first off, the structure of our hedges, we have tended to relatively fully hedge the portfolio as we have discussed, really, over the last year or so. And also, our hedges have been biased toward the front end of the curve as we've expected the curve to generally flatten.

And so we have had sort of that bias with respect to our hedges.

I think you have to be careful just reacting to the short-term views on the Fed. As we have seen, really, over the course of this year and last year, we have seen rates generally fall over this period where the Fed has been actively talking about raising rates. And, yes, we do expect them to tighten in December, but, again, a lot of that is priced in.

I think, actually, we feel a lot of the flattening of the yield curve may have run its course at this point and are likely to really take a little bit more balanced approach to hedging at this point.

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

Well, I would just add, if you look at the composition of our hedge portfolio, like Gary mentioned, we are running at about a 75% hedge ratio. So, in terms of themes things to look for going forward, that hedge ratio may creep up a little bit in the coming quarters.

We also have a significant position in treasury hedges, which, over time, we may choose to move back more and have a higher percent of our hedges in swaps versus treasuries, as market conditions evolve.

And then, thirdly, as Gary mentioned, a significant portion of our hedges are in the front and intermediate curve, and we may shift some of those out to the longer part of the curve, depending on our view on the (inaudible). So those would be the three themes to look for over the next couple of quarters.

Got it. Thanks, guys, and well done on a solid quarter.

Steve Delaney, JMP Securities.

Congratulations on a great first quarter under your new internal structure, and I think I just saw the stock hit a new 52-week high. So (inaudible).

So I was struck, obviously, by the increase in PBA dollar rolls. It looks like about 25% of the total portfolio now. I'm just curious with the 40 Act limitation on whole pools -- and, of course, these are derivatives anyway, but I mean what is your flexibility, Gary, if the TBAs continue to look more attractive than repo? Can you go higher in that allocation?

Yes, the 40 Act wouldn't be a limitation for us. We could go higher, but, big picture, as we have talked about in the past, we do feel very strongly about the core specified position that we own. We will call that somewhere around 60% of the total portfolio, which are seasoned specified for pools, which we feel are going to be very strong performers in both directions.

And so what I would say is that, while we have flexibility to have a somewhat larger TBA position, we probably wouldn't grow it that much just given the fact that we would start to have to, then, value TPAs versus pools that we feel have long run value that we might not be able to get back. So it is much easier when you're moving around kind of within some of our, we will call them, shorter term holdings in a pool of securities than when you start to -- if you start to grow it too much, then you are looking at -- then you have the long run implications of positions that we like and that we might not be able to get back.

Got it. So it is really a question more of how much generic risk I guess you want to have embedded in the portfolio.

Right.

The special -- the level of specialness that you saw in the third quarter, are you seeing that continue into the fourth quarter?

It is a little weaker at this point. It was actually very strong in the third quarter, but some of the positions are still very, compelling, Chris, I don't know if you want to add anything to that.

Yes. No, that is right. The lower production coupons like 30-year 3s during the quarter averaged around 25 basis points through repo. 15-year 2.5s were also very special. They averaged around 35 to 40 basis points through repo during the quarter.

As Gary mentioned, since quarter end, they have weakened a little bit, and I wouldn't be surprised to see them continue to weaken a little bit into quarter end -- or into year-end, but maybe they have weakened 10 basis points or so versus repo. But we expect that, at least within the production coupons of the specialness, we will be in place for some time assuming we stay in these rate levels on.

One thing to keep in mind, just around the dollar rolls, is that, while our position closed the quarter at a relatively high level, the difference in terms of the average position over the quarter was much smaller. I think it was -- last quarter, it was somewhere in the low 8s versus like a little over 10 this quarter. So just keep that in mind as well.

Will do. And my last question has to do with premium amortization. There was an actual decline in dollar terms, I believe, by $24 million to $110 million, despite CPR. Could you explain what is in that trend, given CPR or higher amortization lower, and I assume it has something to do with the mix of coupons that you had. But I would like some clarity there.

Hi, Steve. This is Peter. You are actually right. When you are looking at the projected CPRs, there was just a slight change, and there was a pretty significant shift in composition during the portfolio, and that led to the difference in our forward CPR projections. If you look in our press release, we actually give you the breakdown of the premium amortization expense, and when you take out the catch-up immunization amortization, it was actually unchanged quarter over quarter at $102 million. So it was just really a catch-up amortization issue this quarter.

Got it. Thanks. Okay, guys. Thanks for the comments. Appreciate it.

Doug Harter, Credit Suisse.

I was hoping you could talk a little bit about the decision to expand into credit risk transfers, especially with the fact that you manage MTGE and how you think about which vehicle -- I know it is a bigger market, but the thought of having a similar investment strategy of CRTs across both vehicles?

Sure. So I will start with the question related to the vehicle -- the two vehicles. First and foremost -- and I think we have been generally clear about this over time -- we have to manage the vehicle separately. And if we believe that expanding the investment guidelines for AGNC makes sense for AGNC, then that is a decision that management and the board have to make, again, if we think it makes sense for AGNC. And that is really -- and that is what happened in this case. And to kind of reiterate the reason why we feel CRT makes sense for AGNC at this point, really relates to the fact that, yes, you can argue maybe we should have done it a year ago or something like that. But, forgetting kind of the exact timing of the decision, it really is important to keep in mind that the GOC is selling the credit risk underlying their guarantee activity is a really big picture issue. I mean, in a sense, you can say our agency business was built around the GOCs selling the interest rate risk and prepayment risk off of their guarantees, which began in the 1980s, and so businesses like ours were built around that.

Now, in the last couple of years essentially, they are selling the credit risk underlying the conforming market, and we think of that as a very big picture issue and something that we have been essentially paying attention to. We believe the program is going to be ongoing. And then, what I would also say is that, as I mentioned in the prepared remarks, we feel like we do sort of have a competitive advantage here because, A), we know the product very, very well, and, two, there is a natural offset between the interest rate risk and prepayment risk associated with an agency mortgage and some of the credit exposures in that they are inversely correlated.

So for those reasons, we feel AGNC -- and, in addition, it has got a very strong liquidity position -- is not having other credit investments make it a very good candidate for this space over the long run.

I do want to be clear that this was a very much long run decision. It is not related to the timing of -- that we think this is a great time this quarter to be jumping into CRT or credit in general. Credit in general is relatively tight. Within credit, we think CRT looks reasonable. But, again, this isn't -- this is not a short-term trading decision or timing decision. It is really a long run issue about the risk underlying $3 trillion in mortgages transitioning from the government to the private sector, and I was thinking that that is going to create an opportunity over the next decade.

Now, just back to the issue of AGNC and MTGE, what I would say is that I think it is very important to keep in mind that the two portfolios are very different at this point. Okay? MTGE has less than half -- a little less than half of its equity dedicated to agencies, whereas AGNC has about 99% of its equity there.

So the two companies are currently very different. In addition, MTGE is looking at investments and is making investments in healthcare-oriented real estate. And so, from our perspective, we think the portfolios are likely to be very different for an extended period of time.

So even -- again, just to reiterate, we like this opportunity for AGNC. We feel like it makes a ton of sense for it. We have to think about the two companies separately, but even when you look at that, we think the companies are still and will be for the foreseeable future -- will have very different portfolios.

And, I guess, when you look at the two options of agency versus CRT today, which do you think offers the more attractive return?

I will give you a little bit of a complicated answer. In the very short run, for incremental CRT purchases where we can kind of fund them with agencies, CRT, even with the tightening, is very attractive on a pure ROE basis. But that is not really a good long run perspective on it.

I mean, right now, we actually think the ROEs on the agency business are a little better, but we expect that to vary over time. And then, just to reiterate, in the short run, we do get the benefit of being able to fund a noticeable amount of purchases, kind of with the kind of unpledged portion of the agency portfolio.

Got it. Thank you.

Joel Houck, Wells Fargo.

Again, congrats on a strong quarter, the first quarter of the internalization. My question has to do with the swap book. So, in the Q, if you look at the seven- to 10-year, generally the longer swaps have been coming down rather systemically the past year and being replaced by shorter swaps. I know there is a lot going on there, but how much of that is just a view of lower for longer versus the swap spreads normalizing in the shorter part of the curve? And if there is anything else that is going on that we are missing, if you could point that out, that would be helpful as well.

Hi, Joel. We are having a little trouble hearing your question, but I think I got it, which you were talking about the composition of the swap portfolio shortening somewhat over the course of the last year or so.

And the short answer is, if you recall, back three, four, five quarters ago, we talked a lot about changing the composition of our hedge portfolio such that we wanted to think about the hedge portfolio as a way to protect our all-in franchise value, if you will, against the flattening of the yield curve. So, along those lines, we did intentionally change the composition of our hedge portfolio, got rid of a lot of our longer-term swaps and moved the concentration of our swap portfolio from the end of the three to, call it, three- to seven-year part of the curve.

And essentially, what we mentioned earlier, I think, is the case that, given the flattening that has already occurred, that obviously proved to be a valuable thing for us. We don't, at this point, really expect the curve to flatten much more. In fact, I think the risk is starting to shift more toward a steeper curve. So we may start moving some of the composition of our hedged portfolio to the longer to intermediate part of the curve.

Okay. Good. That's helpful. That is what I was looking for. And, just to kind of stick on the funding topic on, I think the chart on slide 10 is a great one. Can you hear me okay?

Yes. We can hear you better now. Thank you.

So, as you pointed out, Peter, you didn't get the full benefit in the quarter, but if we were to look at where the 5 basis point spread at the end of the quarter and assume that is similar in Q4, how -- I guess the overall question is, you get a 12% ROE on core EPS annualized this quarter, one would think that is going to move higher in the fourth quarter and potentially next year unless something dramatic changes between the repo cost spread to the swap receive rate.

Yes. Let me talk a little bit about what we think will happen in the fourth quarter. And, as you point out, that graph on the bottom right of slide 10 shows that 5 basis point spread, and the receive leg on that was 78 basis points at the end of the quarter. When you think about where three-month LIBOR is today, three-month LIBOR has widened further and is now at 88 basis points. So, all other things equal, the receive leg, or that green line, is going to continue to move off toward 88 basis points as we go through the quarter and as our swaps reset.

The other question, then, obviously is what is going to happen to the repo rate or the line on the top. And, right now, just to give you a sense on the marginal cost of three-month funding, today, it costs us about 85 basis points to borrow on three months relative to LIBOR. So that is a 3 basis points through LIBOR, so 88 versus 83. So we are still funding at the margin and about a negative 3 basis points to three-month LIBOR. So I would expect those two lines to compress further and be close to zero over the course of the fourth quarter.

But, Joel, just keep in mind that there are obviously lots of other moving parts in the equation there. So, obviously, not the whole portfolio is hedged with swaps, and so higher repo rates will -- just everything else being equal, higher is still increased the funding -- overall funding costs. And, obviously, asset yields and so forth can vary.

So just keep in mind that, while we feel good about this relationship, there are other factors that vary quarter over quarter.

Okay. No, I'm glad you pointed that out. That is an important consideration. I think sometimes we get -- at least analysts get too myopic on one subject.

But a broader question and I will hop off, you guys, I think, correctly subscribe to the lower for longer thesis. There has been -- we talked at length, I guess, about the notion of what can the Fed really do in terms of rising rates. Has your view of the Fed and what they could potentially do past the election changed at all, Gary, or are you still fairly, I guess sanguine is the word, in terms of their ability to go on a sustainable rate hike trail or whatever you want to call it?

Yes. My view is still the same, that we are in a global lower for longer environment. I do think, again, that they will likely raise rates in December, and they might get another rate hike in. But I think that it is unlikely that they have any ability to normalize interest rates. I mean, the global interest rate picture still remains very low, and I think what people have to keep in mind is that it is one thing to look at the spot picture of the global economy or -- which may look a little better right now, but there is still a number of areas -- I mean, Europe -- the UK, China, other parts of Asia, Latin America, that -- where the risks are so weighted to the downside that I think we certainly could get into a period in the short run where post-election where people feel better about the steady state. But I think the reality is that we are just going to be bouncing between -- I mean, we are just going to be waiting for, let's say, another downside risk to show up. So I think against that backdrop, we are still in a lower for longer environment.

All right. Great. Thanks for the color, guys and, again, solid quarter, first quarter as an internally managed company. Thanks for the answers.

Rick Shane, JPMorgan.

And, Gary, you alluded in your answers to Joel's questions about other factors, and I would love to explore one of those other factors, which is in looking at slide 6, the other impact of the relationship between LIBOR and repo is that, asset spreads have tightened pretty considerably as well. And I would love to have you explore two things here.

One is, obviously, that is helpful on the, call it, $65 billion portfolio that is 75% hedged. But if you could talk about the spreads on incremental investments, given the asset pricing, that would be great. And then, also, in the past when you have talked about buying back stock, one of the considerations you have had is whether or not you think assets are cheaper or expensive. Do you think that this is a permanent shift in OAS, and how does that sort of influence your decision about whether or not you are buying back stock at this point?

Sure. Look, both are really good questions, and what I would -- what I first want to stress is that the spread tightening that you saw, was really just a getting back some of the widening that occurred in 2015. And, remember that that widening occurred against the backdrop of funding for governments getting worse, and that was certainly a major factor that people were contributing to the widening of spreads.

So what I would say is, if you actually look at how much our funding has improved relative to how much the assets have tightened, actually, there isn't much of a move in the ROE expectation in terms of new purchases. So I wanted to make sure to answer that question kind of because they are very related.

And, as I mentioned earlier, I don't want to repeat the answer, but we feel good about the go forward funding picture, obviously, against the backdrop of some noise, but we feel good about that. So we remain comfortable, and I think this is very important to keep in mind.

While a lot of fixed income products have tightened -- basically spreads on all products within fixed income have tightened materially over the past six months, in the agency space, at least you get back a lot of that, so to speak, with the improved funding picture. Whereas, in other products, you are dealing with tighter spreads. And, again, even in those products, at least the first part of that move was just kind of getting back some of the widening, which was excessive earlier.

But, again, more importantly, just that in the case of agency MBS, the tightening of spreads is -- there is a major compensating factor, which is the improved funding picture. So I don't know if I missed -- did I get everything -- all your questions there?

Yes, I think you did. It is interesting, because you are right, I think when I am looking at this, I am really looking at it on an LTM basis. But I think the implication in, fine, what is basically your comment about ROEs sort of being consistent currently, is right. Are you suggesting, however, given the historical relationship between LIBOR repo and OAS that you actually think that MBS is still a little bit cheap?

Yes, I think that on a relative basis, we are very comfortable with agency MBS versus the rest of the spread product universe. And, look, we are in a lower returned environment, obviously, across the board no matter what product, whether you are talking about equities or fixed income or, really, anything. So -- but, within that environment, we don't have any specific concerns around agency MBS having gone too far or something.

Got it. And where do you see the fully expensed ROE on incremental investment at this point?

So just these 30-year 3s as an example, yield is currently around 2.45%-ish, depending on the type of poo,l and assuming, let's say, 7.5 times leverage, gross spot ROEs are in the low double digits.

Okay. Great. Thank you very much.

Merrill Ross, Wunderlich.

Thank you for taking my questions. My first question is, just bluntly, why did the board cut the dividend given the strength in the earnings this quarter, recognizing that potentially some of the tailwinds are somewhat temporary?

No, that is a good question. I think one thing you have to think about is that, as I just mentioned, globally, this is a lower return environment. And when you think about a 10%, 11% dividend, we feel that that is a substantial dividend in this environment, and we are very comfortable paying a dividend in that range.

Remember that our taxable income, because of the dollar roll activity and so forth, is below that. And so we have no obligations to pay higher dividends. And I think that realistically, we are very comfortable if incremental earnings, assuming they accrue, are retained and show up essentially for investors and book value. So that is the logic.

Yes. Makes sense. And the second question is, if you are seriously trading at a premium to tangible book, could you raise capital and invest it accretively at this point?

We are currently not at a premium to tangible book, and look, accretive equity raises often, or usually, do make sense.

On the other hand, as you mentioned, you have to be able to -- you want to feel good about the investments and the ability to deploy capital. The agency space is deep enough that you could certainly deploy capital, but, again, I think that there are a lot of factors that go into that analysis, and we are not in that environment yet.

Thank you.

Brock Vandervliet, Nomura Securities.

So the Bethesda Securities is operational. I guess there is $1.2 billion in funding tied to that. Could you just take a moment and talk about how that will be employed? What kind of collateral is tied to that?

Sure, Brock. We had just generic agency MBS that we are financing through Bethesda Securities with respect to that $1.2 billion that I mentioned, and that will continue to be the case. We will continue to just move agency securities and finance them through that vehicle.

Right now, we are approaching $2 billion, and over the next several quarters, we will expect that percent of our funding to increase to the range that I talked about before, which is probably in the 20% to 25% range of our funding over the next, call it, three to four quarters.

And just to give you a sense, as a follow-on to, I believe, next question, in terms of the benefit, when we finance through Bethesda Securities, right now we are seeing about a 10-basis-point lower funding differential when we financed through the FICC versus our generic two-party DDP repo.

Okay. And has the FHLB balance has come off early next year, I believe, would that flow through Bethesda?

Yes, that would be a logical place for us to replace that funding. As you mentioned, it will come off in February, barring some change which we don't expect, and ultimately Bethesda Securities can easily absorb that and then some.

Okay. Thank you.

Ken Bruce, Bank of America Merrill Lynch.

My first question relates to CRT. I guess, you pointed out that CRT bonds today have a better return profile than a lot of other credit, and I assumed that part of that has to do with the liquidity around it and so you are getting paid a premium to hold that particular asset. I don't know if you can kind of comment on that, but that is what it certainly feels like, and I guess I am interested in how you think that develops over time, just given that I would assume with that much product you could put into the market that there will be additional investors that begin to focus on that.

So, first off, our reason for, I'd say, preferring CRT to other credit products isn't as much liquidity related. Our reason for AGNC paying attention and having interest in the space over the long run certainly relates to the size of this opportunity and, as I mentioned, the $3 trillion for the credit -- a large percentage of the credit exposure underlying $3 trillion of mortgages that will move from the government balance sheet essentially to the private sector is a major reason to pay attention to this market because it can be very material for an investor the size of AGNC.

But, in terms of relative value, the relative value equation for CRT versus other credit products, it is actually much more of a view related to the combination of the structure of the product versus other products out there and the conforming -- the conforming housing market versus, let's say, the jumbo market. I mean, we feel better about lower-priced and midpriced homes versus the higher-end markets, which have more exposure to actually changing demographics and to foreign money, which has certainly kind of driven house prices in some areas.

So when we look at the conforming space versus the jumbo space, we prefer it. When we look at the conforming space versus things like the commercial space, we feel a lot better about the amortizing nature of single-family mortgages versus kind of

the need to continuously refinance commercial properties and the risks associated with, if we had another event like that we saw in January and February, where credit products were widening very quickly and markets were starting to seize up, in a situation like that, the conforming space continues to have the GSEs to provide credit on a continuous basis, and again, existing borrowers don't actually have to refinance. In some of these other markets, you don't have those circuit breakers. So those are really the key reasons for us liking this space on a relative basis, and we think many of those benefits are going to be in place over time.

Yes. I guess I understand some of the aspects as to why you are going into those and fully support that, but I am trying to understand if you think that return backdrop changes just as more -- as the volume of those bonds increases or the stock amount of those bonds increases in the market and it draws in additional investors, if you think the dynamic around effectively the value changes because of that, and it becomes more efficient, I suppose?

Well, I think it will be more efficient, and I think the liquidity of the product will improve. But -- and so that is -- should be a benefit over time.

CRT, the outstanding amount has increased. The liquidity has improved a little bit, but I don't think it is at this stage correct to kind of view it as an extreme -- as a liquid space. But I think that statement is very true across almost every credit product at this point. But, again, it is a sizable opportunity and should be over time, and that is the attraction.

Got it. And then, staying on that theme, and this is obviously not a near-term discussion because I think the housing market is in a pretty good spot. So the credit behind that should be pretty good, all things being equal. But, as you think about how does an investor in that CRT market -- GSE CRT market distinguish itself in non-agency bonds, you can kind of choose what you buy and price it accordingly. Do you have flexibility to designate what kind of bonds you are either buying or how -- what goes into those, or is it purely a pricing function that allows you to distinguish yourself?

So that is a very good question, and I think that -- so, in a sense, you are asking about the relative value opportunities and the ability to generate alpha. And there are some relative value opportunities. There is definitely the -- you can choose or you will be able over time to choose between different vintages.

But I think that bigger picture, we -- the attractiveness of the space actually relates to the fact that the product is somewhat homogeneous. It is what the GSEs are putting out is a cross-section of what they are buying, and we feel that that is a very good fit for our portfolio over time because we do get the benefit. We are buying kind of -- we tailor our purchases on the agency side based on loan attributes as you guys are very aware of. But we feel that there is the natural offsetting nature of -- between some of the underlying credit exposures on mortgages and the prepayment exposures.

Obviously, some of our best trades over the past seven or so years have related to understanding the dynamics about a borrower's ability to refinance, and credit has been a key driver of that. So the natural offset in the universe is a benefit to our portfolio as well.

But, just to summarize the issue on relative value, there will be some opportunities over time, but our view is the aggregate market itself will be a good place to invest.

Okay. And, maybe just two clarifying follow-up questions. Just on the drivers improved rebuild funding year to date, do you believe that those issues are kind of resolves at this point from the standpoint of bank balance sheets? Obviously, you have seen a big improvement in the money funds and the like. But do you feel like those issues that were kind of concerns for the market at the end of last year are resolved, or are they just kind of temporarily gone away or maybe there is a split vote on that?

What I would say with respect to our counterparties, we feel like it has been largely resolved. We feel like we have a lot of stability with our counterparties now with regard to their balance sheet.

Certainly, the central bank selling pressure of treasuries subsided greatly so we don't expect that, although that can come and go. But that does not appear to be an issue at all right now.

And then, thirdly, with respect to the money market reform, I think the shift from -- to government funds from private funds is going to prove to be a much more long-term shift than maybe we in the market had anticipated. So I don't expect that to change anytime soon.

Great. That is all I have got. Thank you very much.

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

Thank you for your interest in AGNC, and we will talk to you again 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 November 8 by dialing 877-344-7529 or 412-317-0088. And the conference ID number is 10093704.

Thank you for joining today's call. You may now disconnect.