AGNC Investment Corp. Q2 FY2025 Earnings Call

Thank you all for joining AGNC Investment Corp. Second Quarter 2025 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 forecasts 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 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. Participants on the call include Peter Federico, President, Chief Executive Officer and Chief Investment Officer; Bernie Bell, Executive Vice President and Chief Financial Officer; and Sean Reid, Executive Vice President, Strategy and Corporate Development. With that, I'll turn the call over to Peter Federico.

Good morning, and thank you all for joining our second quarter earnings call. Following the administration's tariff announcement in early April, elevated governmental policy risk caused investor sentiment to turn sharply negative and financial markets to reassess the macroeconomic and monetary policy outlook. After a sharp repricing in April, most markets retraced their early period losses and ended the quarter at better valuation levels. The performance of Agency mortgage-backed securities relative to benchmark interest rates, however, was notably weaker quarter-over-quarter. As a result of this underperformance, AGNC's economic return for the second quarter was negative 1%. During the first three weeks of April, when the financial market stress was most pronounced, the yield on the 10-year treasury fluctuated by more than 100 basis points and the S&P 500 Stock Index declined by 12%. This volatility and macroeconomic uncertainty adversely impacted Agency mortgage-backed securities with spreads to treasury and swap rates widening meaningfully. A primary focus of AGNC's risk management framework is maintaining sufficient liquidity to withstand episodes of significant financial market stress. One important measure of this capacity is the percentage of equity that we hold in unencumbered cash and Agency mortgage-backed securities, which are available to meet margin calls in the normal course of business. This focus enabled us to begin the second quarter with a strong liquidity position and to navigate the financial market volatility without issue and importantly, without selling assets. Moreover, we were able to take advantage of the wider MBS spread environment by raising accretive capital during the quarter and opportunistically deploying a portion of that capital in attractively priced assets. Over the last two months of the quarter, most financial markets retraced the April losses, and in some cases, set new record highs. For example, the S&P 500 Index rallied 25% from the April low and ended the quarter about 10% higher. Investment-grade and high-yield debt also performed well with spreads tightening 10 and 50 basis points, respectively. The one notable performance exception was Agency mortgage-backed securities as the current coupon spread to a blend of treasury and swap benchmarks ended the quarter 7 and 14 basis points wider, respectively. Although the Fed and treasury have indicated that beneficial regulatory reforms are forthcoming, bank demand for MBS still appears to be constrained. Similarly, foreign investor demand may be hindered by U.S. dollar weakness and geopolitical risk. Looking ahead, we expect banks and foreign demand for Agency MBS to grow. In addition, as we enter the third quarter, the seasonal supply pattern for MBS issuance should improve. We expect the net supply of new MBS will be about $200 billion this year, the low end of most forecasts. Since quarter end, MBS spreads have tightened slightly and are showing signs of stabilization. As a leveraged and hedged investor in Agency mortgage-backed securities, AGNC's return profile is most favorable in environments in which mortgage spreads are wide and stable. Our favorable outlook for Agency MBS was further improved in the second quarter by the very positive message from key decision-makers related to the potential recapitalization and release from conservatorship of the GSEs. The White House, the Treasury Department, and FHFA affirmed the government's commitment to maintaining the implicit guarantee for Agency MBS and also indicated that they are taking a do-no-harm approach to GSE reform. Specifically, President Trump made an unprecedented statement in late May regarding the GSEs and the ongoing role of the government in the housing finance system. He said, our great mortgage agencies, Fannie Mae and Freddie Mac, provide a vital service to our nation helping hard-working Americans reach the American dream of homeownership. I am working on taking these amazing companies public, but I want to be clear, the U.S. government will keep its implicit guarantees. Treasury Secretary Bessent also made several important statements regarding the GSEs during the quarter. The one that stood out the most to us was when he said, the one requirement of this privatization is that they are privatized in such a way that mortgage spreads do not widen. And in fact, is there a way that we can make the spread between the risk-free rate and mortgages tighten as Freddie Mac and Fannie Mae are privatized. Finally, Director Pulte weighed in with similar positive statements saying, our number one thing is to do no harm and keep the implicit guarantees intact. We cannot have any disruption to the mortgage market. There cannot be any upward pressure on the mortgage rate, and I am very confident that the mortgage market will be safer and sounder as a result of any option that the President takes. These statements individually and collectively clarify the administration's approach and more importantly, should provide investors greater confidence that the credit quality of the $8 trillion of outstanding Agency mortgage-backed securities as it is understood to be today will not be impaired by actions associated with privatization. In fact, given the explicit statement of credit support made by the President of the United States, that the implicit guarantee of Agency MBS will be preserved, investors could reasonably conclude that the credit quality of the outstanding stock of Agency mortgage-backed securities has never been stronger. These statements also make it clear that maintaining stability in the mortgage market and lowering mortgage costs are two important guiding principles of GSE reform. This is a very positive development that should lead to tighter mortgage spreads over time.

Thank you, Peter. For the second quarter, AGNC reported a comprehensive loss of $0.13 per common share. Our economic return on tangible common equity was negative 1%, consisting of $0.36 of dividends declared per common share and a $0.44 decline in tangible net book value per share as mortgage spreads ended the quarter moderately wider. As of late last week, our tangible net book value per common share was up about 1% for July after deducting our monthly dividend accrual. Quarter end leverage increased slightly to 7.6x tangible equity compared to 7.5x at the end of Q1. Average leverage for the quarter rose to 7.5x from 7.3x in the prior quarter. As of quarter end, our liquidity position totaled $6.4 billion in cash and unencumbered Agency MBS, representing 65% of tangible equity, up from 63% as of the prior quarter. As Peter noted, we were able to navigate the substantial financial market volatility in April with our portfolio intact as a result of our risk management positioning and ample liquidity entering that period. Additionally, during the quarter, we opportunistically raised just under $800 million of common equity through our at-the-market offering program at a significant premium to tangible net book value. As of quarter end, we had deployed slightly less than half of the proceeds, and we have continued to deploy the remaining capital post quarter end. In utilizing the ATM, we attempt to maximize both the accretion benefit associated with the stock issuance premium and the investment returns on acquired assets. However, the optimal timing for stock issuances and capital deployment may not fully align. As a result, our investment of the new capital may lag the issuance as it did this quarter as we evaluate market conditions and wait for favorable entry points. Net spread and dollar roll income declined $0.06 to $0.38 per common share for the quarter, primarily due to the timing of deployment of the new capital raised over the quarter with moderately higher swap costs also contributing to the decline. Our net interest rate spread decreased 11 basis points to 201 basis points for the quarter, largely due to higher swap costs. Our treasury-based hedges contributed additional net spread income of approximately $0.01 per share for the quarter, which is not reflected in our reported net spread and dollar roll income. Lastly, the average projected life CPR of our portfolio declined to 7.8% at quarter end from 8.3% as of Q1, consistent with higher mortgage rates. Actual CPRs averaged 8.7% for the quarter, up from 7% in the prior quarter.

Thank you, Bernie. I'll provide a brief review of our portfolio before taking your questions. Trade, fiscal and monetary policy uncertainty caused Agency MBS spreads to widen across the coupon stack with higher coupon MBS performing slightly better than lower coupon MBS. MBS performance also varied considerably by hedge type and maturity as the yield curve steepened significantly during the quarter and swap spreads tightened 5 to 10 basis points. As a result, MBS hedged with longer-dated treasury-based hedges performed materially better than MBS hedged with short- and intermediate-term swap-based hedges. Our asset portfolio totaled $82 billion at quarter end, up about $3.5 billion from the prior quarter. The mortgages that we added were largely higher coupon specified pools with favorable prepayment characteristics. As a result, the percentage of our assets with some form of positive prepayment attribute increased to 81%. Our aggregate TBA position remained relatively stable at about $8 billion, consistent with our preference for specified pools in the current environment. With both our pool and TBA activity concentrated in higher coupons, the weighted average coupon of our asset portfolio increased to 5.13% during the quarter. The notional balance of our hedge portfolio increased to $65.5 billion at quarter end. In duration dollar terms, our hedge portfolio consisted of 46% treasury-based hedges and 54% swap-based hedges. In summary, despite the second quarter volatility and elevated geopolitical and government policy risk that still remains, we continue to have a very positive outlook for Agency mortgage-backed securities. In fact, we believe the outlook actually improved in the second quarter due to four factors. First, MBS supply appears to be manageable as seasonality factors turn more favorable and the mortgage rate remains high. Second, the demand for MBS appears poised to grow as a result of anticipated regulatory changes and relative value attractiveness. Third, agency spreads appear to be stabilizing at historically cheap levels. And lastly, key policymakers appear to be taking a cautious do-no-harm approach to GSE reform while reaffirming the government's ongoing role in the housing finance system. Collectively, we believe these positive developments create a very favorable investment outlook for Agency mortgage-backed securities as a fixed income asset class. With that, we'll now open the call up to your questions.

The first question comes from Doug Harter with UBS.

Just kind of digging into the last comments you made about the attractive environment. As you look at that environment and you look to continue to take advantage of that, do you think that, that comes in the form of looking to raise additional capital? Or is increasing leverage from kind of this area where you've been for the past couple of quarters a consideration as well?

Sure, I appreciate your question. Our outlook is quite positive as we enter the second half of the year, especially following some developments in the second quarter related to the GSEs. This creates a solid environment for Agency mortgage-backed securities. Currently, we are seeing some stabilization, and I anticipate that spreads will gradually tighten, although I don't expect them to decrease sharply in the short term. This is significant because, as Bernie indicated, we've taken a patient and measured approach to deploying the capital we raised in the second quarter, having deployed just under half of it. From this standpoint, we still have room to invest those funds at what remain attractive levels. The current coupon on Agency mortgage-backed securities compared to swap rates is about 200 basis points, which is at the upper end of the last four years' range. If we have the chance to raise additional capital during the quarter, we would look to do that to create more value for our shareholders. We're positioned well to allocate capital at a measured pace, and I believe there will be opportunities available for some time. We also have the ability to operate with somewhat higher leverage. Bernie's note about our unencumbered cash position at the end of the quarter being $6.4 billion or 65%, which is 2% higher than at the end of the first quarter, suggests we are managing our volatility well. Despite growing our portfolio by $3.5 billion, our unencumbered cash as a percentage of equity has actually increased at the end of the second quarter. So, we are well-equipped to proceed with the plans you mentioned. We'll allow the market to guide our actions while monitoring mortgage spreads and the ongoing political uncertainties. We hope for some resolutions regarding government policy and tariffs in the next few weeks, and we also anticipate clarity on monetary policy within the next month or two. Overall, we have considerable capacity and flexibility to be opportunistic in this environment.

The next question comes from Crispin Love with Piper Sandler.

Peter, can you speak to your views on the core earnings trajectory and what that means for the dividend level? Core returns are high, spreads are pretty wide, swaps continue to roll off. But curious what you view to be the run rate for earnings and core returns over the near to intermediate term?

Yes. We've discussed our net spread and dollar roll income for several quarters now, focusing on how it aligns more closely with our portfolio's economics. There are many factors to consider when evaluating net spread and dollar roll income, considering the accounting for asset yields and hedge costs. This measure does not necessarily reflect the long-term economic earnings potential of our portfolio; it is more of a snapshot of current earnings. However, it has become more in line with our portfolio's current economic situation. Regarding the $0.38 return on equity, it appears to be around the 19.5% range. I mention this because mortgage valuations today – the current coupon versus treasury rates and swap rates – show current coupon to be about 160 basis points compared to a mix of rates from 3 to 10 years and 200 basis points to swaps. This results in an estimated return spread of roughly 180 basis points in the current environment. Given our leverage, this equates to about a 19% return on equity for marginal investments. In this current environment, with spreads, I would estimate returns to be in the high teens, between 18% to 20%, which is consistent with our net spread and dollar roll income. However, there will be fluctuations in that figure from period to period. Bernie mentioned that it declined last quarter due to the slower deployment of capital we raised, and as we deploy that capital, the drag we observed in the second quarter will diminish. Additionally, there will continue to be a drag as our swap hedges roll off. We rolled off about $5 billion in the second quarter and replaced $2.3 billion of that, so our swap costs will increase over time. I anticipate that our repo costs will decrease as the Fed moves towards easing, and our asset yields should gradually improve since they remain below market levels. Overall, our net spread and dollar roll income should stay in the range we're currently seeing, likely in the mid to high $0.30s to low to mid-$0.40s. I provided a lot of information, and I hope that clarifies your question.

Absolutely. No, that was very helpful, Peter. And then just following up on Doug's issuance question and comments you've made about deployment. You raised accretive capital, deployed about 50% of that in the second quarter. I believe that was a comment or it might be 50% to date. But can you just share where you stand today? How much more have you deployed since quarter end? And then just where are the best opportunities, coupons, investments, et cetera? And then just given the outsized issuance in the second quarter, would you expect issuance in the third to come down versus historical levels?

I'll address that question first, then we'll circle back. You provided a lot of information there. Our approach will be opportunistic, and I believe we are positioned well to be patient regarding our capital raising efforts. We appreciate the circumstances in the second quarter, especially given the significant volatility, which allowed us to raise capital in a way that was beneficial for us. This enhanced our liquidity, providing us with the capability to manage any further disruptions if they arose, and also enabled us to utilize those funds. However, I wouldn't consider the second quarter as a predictor of future quarters; we will evaluate each quarter individually. Please repeat the first part of your question for me.

Yes. So you talked about deploying 50% of the capital. Just the timing of that, was that in the second quarter or to date? And I'm just curious where you are right now.

Yes, according to Bernie, it was in the second quarter, but she mentioned that we have continued to deploy. We purchased about $1 billion worth of mortgages earlier this month. So we still like the market and are deploying capital at a disciplined pace. In terms of our preferences, as I mentioned, we continue to favor upper coupons, particularly in specified pools with higher coupons in the 5% to 6% range, and pools with favorable prepayment characteristics. We appreciate the yield profile there and the prepayment protection offered by certain characteristics.

The next question comes from Trevor Cranston with Citizens JMP.

Another question on the capital raising. Peter, obviously, for the last several quarters, you guys have been able to do a decent amount at pretty accretive levels. And obviously, there's a lot of benefits to being able to issue so accretively. I guess big picture, can you kind of give us an update on your thoughts as to how you think about kind of the optimal size of the company and particularly if you continue to be able to issue accretively for the foreseeable future?

Yes, that's a great question. We have discussed this periodically. I want to start by noting that our growth isn't just for the sake of growing; it's aimed at raising capital in a way that benefits our current shareholders and supports our dividends. If we can keep doing this, we will certainly look to seize that opportunity. Additionally, operating at our scale brings significant advantages. For instance, our operating costs this last quarter were 111 basis points, making us one of the lowest in the industry, which is quite compelling. Furthermore, our stock has impressive liquidity, which is valuable for shareholders. We have concentrated our portfolio in agency or agency-like securities, allowing investors who seek this exposure to easily purchase our stock. Our common equity exceeds $8 billion, providing substantial liquidity. This ease of access to fixed-income exposure is beneficial for investors. On the positive side, as our company grows in size and our market cap increases, we become more appealing to indices, enhancing our accessibility as we expand. However, on the downside, we are aware of market capacity constraints regarding our size. The liquidity in the fixed-income market isn't as favorable today as it was 10 or 15 years ago, prior to the financial crisis. We remain mindful of our asset portfolio's size and our ability to transact in both the hedge and asset markets. We strive to find the right balance among these various factors, recognizing that while there are many benefits linked to size, there are also limits to how large we will grow.

The next question comes from Bose George with KBW.

First, just given the level of swap spreads, how do you see the appropriate balance between swap hedges and treasury futures? And then when you gave the ROE number at 19% plus is that kind of reflect the mix that you guys currently have in the portfolio?

When I calculated the ROE, I arrived at 180 basis points using a 50-50 blend, which we believe is a suitable long-term balance due to the diversification advantages of combining treasuries and swaps. However, we currently hold a higher proportion of swaps overall. In the second quarter, approximately two-thirds of our hedges were based on swaps, indicating our preference for them. Moving forward, we may favor a slightly greater percentage of swaps compared to the long-term average of 50-50, as I anticipate stability will develop within swap spreads over time, along with upward pressure that could widen those spreads. This change will benefit us as we expect reforms to the supplemental leverage ratio to take effect, likely in the fourth quarter, or possibly even in the third quarter. Notably, the dynamics in the swap market during the second quarter highlighted key movements in mortgage performance, particularly as longer-term swap spreads tightened nearly 10 basis points, showcasing existing balance sheet constraints between swaps and treasuries. We expect these constraints to ease with the implementation of bank regulations and adjustments to the supplemental leverage ratio. Consequently, I believe we will gain from our current overweight in swaps, although a 50-50 mix remains ideal in the long term.

Okay. Great. And then in terms of your CPR, so it looks like the lifetime CPR declined. Does that just reflect the market expectation on rates?

Exactly right. In the second quarter, the yield curve steepened, particularly with the 10-year yield remaining almost unchanged, only rising by 2 or 3 basis points. However, we saw a significant increase of 17 basis points in the 2-year yield. The more important development was at the back end of the yield curve, which negatively impacted our mortgage portfolio. I highlighted this in my prepared remarks because the 20- and 30-year parts of the curve saw increases, with the 30-year rising by 21 basis points. This movement influences mortgage rate propagation—essentially, the upward shift in the 20- and 30-year yields pushed forward mortgage rates higher in the second quarter, which contributed to the changes in lifetime CPR. It's important to note that most portfolios, including ours, typically do not hedge long-term cash flows in mortgages, primarily focusing on the intermediate part of the curve, usually up to about 15 years. The back end is quite unique and challenging to hedge from a mortgage perspective, leading us to concentrate our hedging efforts in the 10-year part of the curve to manage long durations. Therefore, significant movements in the 10s and 30s curve could drive mortgage performance.

The next question comes from Jason Weaver with Jones Trading.

Peter, considering the value implications we've discussed, we've been examining MBS spreads for some time due to their wideness. Would it be accurate to say that spreads have begun a larger long-term trend, especially since volatility levels have diminished, yet we're still observing 200 over on swaps?

Yes, I believe we have established a new trading range. When I look back at mortgage spreads over the last four years, excluding the COVID event, we are currently at the high end of that range. We slightly broke out in the recent episode, reaching 220 basis points as a closing mark versus swaps. However, that range remains intact. For mortgages compared to swaps, I would say the range is likely between 160 to 200 basis points, and in relation to treasuries, it falls between 160 to approximately 120 basis points. This seems to be the new norm. Given the current environment, I expect to remain in the upper half of that range due to geopolitical, fiscal, and monetary policy uncertainties. I don't anticipate significant catalysts to break out of that range, which I consider an important development over the second quarter. We have navigated significant tariff-related market stress, which is noteworthy. Another potential catalyst that could have redefined the trading range was GSE reform, given the uncertainty surrounding it. Key policymakers effectively explained their approach and the importance of maintaining the unique characteristics of the market today, which I believe alleviates some upward spread pressure. So, while we are in a new range, we are currently at the top of it, and I expect it to stabilize and potentially move lower. Yes. I mentioned in my prepared remarks that about 81% of our portfolio has some form of positive prepayment attribute. In one of our tables at the beginning of our presentation on the asset portfolio, we noted that about 41% of it consists of high-quality specified pools. We believe there are numerous attributes beyond just typical high-quality ones, such as low loan balance, that can lead to strong mortgage performance and more stable cash flows. These include factors like FICO scores, loan-to-value ratios, and characteristics related to location, house prices, and loan types, whether they are primary residences, second homes, or investment properties. Therefore, we are keen on adding specified pools, especially those with higher coupons, as they offer significant yield advantages, although they do come with increased convexity risk. In the current environment, where house prices are stabilizing or declining in some areas, we see great value in acquiring those specified pools. Additionally, in light of what we observed in the second quarter, there is a unique benefit to TBA positions, particularly regarding the implied financing levels for specific coupons in Ginnie Mae securities, which constitute a large part of our long positions. However, there is not much advantage to conventional TBA positions at this moment, as they do not present significant funding benefits. Therefore, we prefer to focus on higher coupon specified pools rather than TBA positions under the current conditions.

The next question comes from Jason Stewart with Janney.

It seems that the curve steepener trade is quite crowded. We have discussed hedges, but could you elaborate more on the asset side? You began to address this in response to Jason's question. In a post steepener trade, how do you position the asset side of the balance sheet regarding coupons, etc., to optimize returns going forward?

There is certainly a lot of flexibility. You can see us significantly adjusting our coupon position from quarter to quarter. We have ample liquidity and the capacity to make these shifts between TBAs and specified pools. The characteristics we've discussed alter our profile. There are many ways for us to adjust on the asset side, especially if we hold a TBA position; we can transition from TBAs to pools and different coupons. As the yield curve fluctuates, we can certainly alter the asset side of our portfolio. As you mentioned, this will primarily be dictated by our hedge location, which is crucial, and we have considerable capacity for adjustments. Most of our hedges are focused in the 7- to 12-year range, with approximately 83% of our hedge duration exceeding seven years. This concentration indicates that when analyzing our asset key rate duration profile alongside our hedge profile, one can infer that we've positioned our overall portfolio to benefit from a steepening yield curve between 2 years and 10 years. Consequently, we have advantages and will continue to do so. If 2-year rates decline while 10-year rates remain steady or rise, our overall portfolio, given our asset and hedge composition, would benefit from that situation. We anticipate this steepening to persist, especially considering the pressure we are experiencing with the Fed. Currently, the 2-year to 10-year segment of the curve stands at approximately 52 basis points, which is around 50 to 60 basis points flatter than the 25-year average. Therefore, I expect the 2-year to 10-year portion of the curve to steepen over time, and I believe our portfolio will gain from this trend. Yes. Bernie mentioned at the end of last week, it was up about 1%.

We have now completed the question-and-answer session. I'd like to turn the call back over to Peter Federico for concluding remarks.

Again, we appreciate everybody's time and participation on our call today, and we look forward to speaking to you all again at the end of the third quarter.

Thank you for joining the call. You may now disconnect.