Earnings Call Transcript
AGNC Investment Corp. (AGNC)
Earnings Call Transcript - AGNC Q2 2024
Operator, Operator
Good morning, and welcome to the AGNC Investment Corp Second Quarter 2024 Shareholder Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Katie Turlington in Investor Relations. Please go ahead.
Katie Turlington, Investor Relations
Thank you all for joining AGNC Investment Corp.’s second quarter 2024 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 facts, 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 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 this call include Peter Federico, Director, President and Chief Executive Officer; Bernie Bell, Executive Vice President and Chief Financial Officer; Chris Kuehl, Executive Vice President and Chief Investment Officer; Aaron Pas, Senior Vice President, Non-Agency Portfolio Management; and Sean Reid, Executive Vice President, Strategy and Corporate Development. With that, I will turn the call over to Peter Federico.
Peter Federico, CEO
Good morning, and thank you for joining our second quarter earnings call. The strong fixed income momentum that began in the fourth quarter of 2023 abated in the second quarter as the Federal Reserve and market participants looked for indications that the economy was slowing and inflation moderating. On balance, the data showed that consumer spending and confidence were weakening, the labor market was moving into better balance, and most importantly, inflation measures were trending toward the Fed's long run target. From a monetary policy perspective, this was a welcome development. Nevertheless, the Federal Reserve was unwilling to adopt a more accommodative monetary policy stance. Against this backdrop of diverging economic and monetary policy outlooks, fixed income markets became more cautious and intra-quarter volatility increased. In aggregate, interest rates edged higher and agency mortgage-backed securities spreads widened, driving AGNC's negative economic return of just under 1%. In the current environment, each economic release carries elevated importance as the Fed seeks greater confidence before easing monetary policy conditions. This was clearly the case in the second quarter with interest rates and spreads reacting sharply to each labor and inflation report. The 10-year treasury, for example, ended the quarter just 20 basis points higher but experienced several sharp sell-offs and rally episodes during the quarter that drove a cumulative daily yield change of more than 300 basis points. For agency MBS, the second quarter was a push and pull between evolving supply and demand dynamics. On the demand side, bank and foreign demand moderated in the second quarter, while demand from bond funds remained steady but limited given an already overweight position. The modest weakening of MBS demand and associated widening of mortgage spreads was also somewhat expected as spreads ended the first quarter at the tighter end of the recent trading range. On the supply side, favorable seasonal dynamics often lead to a notable uptick in mortgage supply in the second quarter of the year. This was indeed the case this year with $52 billion in supply in the second quarter, double the pace of the first quarter. Supply was especially heavy during the last week of the quarter. As a result, agency MBS spreads to treasuries widened 5 basis points to 10 basis points across the coupon stack, with a good portion of that spread widening occurring over the last several days of the quarter. Production coupons namely 5.5 and 6s experienced the greatest spread widening given the uptick in supply. Importantly, however, agency MBS continue to trade in the same relatively narrow spread range that has emerged over the last nine months. For the current coupon, that trading range has been 140 basis points to 160 basis points to a blend of five and 10-year treasury hedges. Using a similar combination of swap hedges, that range has been 170 basis points to 190 basis points. Spreads at quarter end to treasuries and swaps were 115 basis points and 180 basis points respectively, right in the middle of the recent range. We continue to view this range-bound trading behavior as a very positive development for agency MBS. Since quarter end, economic data has continued to be supportive of the Fed moving toward a more accommodative monetary policy stance. That shift will likely occur over the next several months and should be viewed as the beginning of a new more favorable monetary policy cycle. To this point, in its most recent summary of economic projections, the Fed's short-term rate forecast showed a total of 9 rate cuts over the next two years. As at least some of these rate cuts become a reality, the risk of meaningfully higher rates will decline, interest rate volatility will decline and the yield curve will steepen. These will all be positive developments for the agency MBS market specifically and for fixed income more broadly. Lastly, the long-term fundamentals for agency MBS remain very favorable and continue to give us reason for optimism. In light of persistent affordability challenges and historically slow prepayment speeds, the net supply of agency MBS over the intermediate term will likely remain below previous expectations. At the same time, from a demand perspective, agency MBS provide investors with a meaningful amount of incremental yield relative to both U.S. treasuries and investment-grade corporate debt at current valuation levels. For these reasons, we continue to be very optimistic about both the current returns and the future prospects for our business. With that, I'll now turn the call over to Bernie Bell to discuss our financial results in greater detail.
Bernie Bell, CFO
Thank you, Peter. For the second quarter, AGNC had a comprehensive loss of $0.13 per share, given the moderate spread widening that occurred for the quarter. Economic return on tangible common equity was negative 0.9% for the quarter, comprised of $0.36 of dividends declared for common share and a decline in our tangible net book value of $0.44 per share. As of late last week, our tangible net book value per share was up about 2% for July, or 1% after deducting our monthly dividend accrual. Leverage increased modestly for the quarter to 7.4 times tangible equity as of the end of Q2 from 7.1 times as of Q1. At the same time, our liquidity remained very strong with unencumbered cash and agency MBS of $5.3 billion or 65% of our tangible equity as of quarter end. Consistent with the increase in interest rates, the average projected life CPR for our portfolio at quarter end decreased 120 basis points to 9.2%. Seasonal factors drove an increase in our actual CPRs for the quarter to an average of 7.1%, up from 5.7% for the prior quarter. Net spread and dollar roll income for the quarter remained well above our dividend at $0.53 per share. The $0.05 per share decline for the quarter was due to a decrease in our net interest rate spread of approximately 30 basis points to just under 270 basis points for the quarter, as higher swap costs more than offset the increase in the average yield on our asset portfolio. Lastly, in the second quarter, we issued $434 million of common equity through our aftermarket offering program. Our capital management framework provides us the ability to opportunistically create incremental value for existing stockholders through book value and earnings accretion. In the second quarter, we issued stock at a substantial price-to-book premium and invested those proceeds in attractively priced assets. And with that, I'll now turn the call over to Chris Kuehl to discuss the agency mortgage market.
Chris Kuehl, CIO
Thank you, Bernie. From a macro perspective, the second quarter was similar to the first quarter in many ways, with economic data repricing Fed expectations and heavily influencing fixed income market sentiment. Strong economic data at the start of the quarter caused the market to lower its expectations for Fed easing in 2024. Fed rhetoric also turned hawkish in April with Chair Powell expressing disappointment in the recent progress against the Fed's inflation objective. As a result, rate volatility increased as 10-year yields moved through the upper end of the year-to-date range, ultimately reaching just over 4.7% in late April. These macro and market dynamics, coupled with higher seasonal supply negatively impacted agency MBS performance early in the quarter. Market sentiment shifted, however, in May and June following weaker labor and inflation data. Notably, headline unemployment increased from 3.8% in the April non-farm payroll release to 4% in June. Softer labor data and favorable CPI reports in both May and June allowed for a more balanced market focus on the Fed’s dual mandate of maximum employment and stable prices. As a result, treasury yields and agency MBS spreads partially retraced the negative performance by the end of the quarter. Despite elevated rate volatility, agency MBS traded in a much tighter range than they did during periods of stress seen last year. This is encouraging and is a result of many factors, including much stronger high-grade fixed income inflows year-to-date, the Fed's decision to start tapering QT, stability in bank deposits, and most importantly, a growing consensus firmly rooted in economic data that the Fed may begin normalizing rates over the next couple of months. During the second quarter, we added approximately $3 billion in agency MBS. And as a result, the investment portfolio increased to $66 billion as of June 30. Our TBA position declined by $3 billion as conventional rolls traded somewhat weaker, and we opportunistically added approximately $6 billion in specified pools, most of which in lower pay-up categories. Our Ginnie Mae TBA holdings in aggregate were largely unchanged as of June 30 as valuations remained attractive and roll implied financing rates continued to offer a significant advantage versus repo funding. Our hedge portfolio increased to $58.8 billion as of June 30, largely due to the increase in our asset portfolio. During the second quarter, we continued to gradually shift the hedge composition to a heavier allocation of swap-based hedges. As a result, swap-based hedges currently represent approximately 65% of our hedge portfolio on a duration dollars basis. Our swap-based hedges were a drag on our book value performance in the second quarter as swap spreads tightened 5 basis points to 8 basis points across the yield curve. Lastly, as Peter discussed, the data-dependent nature of Fed policy will likely continue to create volatility in markets, but the earnings environment for agency MBS remains very favorable with historically wide spreads and low levels of prepayment risk in liquid financing markets. I'll now turn the call over to Aaron to discuss the non-agency markets.
Aaron Pas, SVP of Non-Agency Portfolio Management
Thank you, Chris. Credit spread performance in the second quarter was mixed with some areas widening marginally, while others were a bit firmer. Early in the quarter, spreads across credit products generally weakened as rates tested local highs. Subsequently, the backdrop of improving inflation ratings and a softer employment outlook, combined with relatively high issuance in the structured product market, led to the divergent performance of credit products during the quarter. As an indicator of credit spreads in Q2, the synthetic investment grade and high yield indices widened by approximately 3 basis points and 14 basis points, respectively. This widening retraced just over half of the tightening we saw in the first quarter. Credit fundamentals remain consistent with past trends we have noted showing a bifurcated consumer base. Lower-income households are currently stretched, as reflected by increasing auto loan and credit card delinquency rates. Conversely, higher-income or wealthier households appear to be in reasonably good shape. Turning to our portfolio, our portfolio of non-agency securities ended the quarter at $940 million, down roughly 10% from the prior quarter-end. This decline was largely anticipated and driven primarily by our participation in the GSE tender offers for its outstanding credit risk transfer securities. Additionally, a significant portion of our CMBS holdings paid off or paid down in Q2. In both segments of the non-Agency portfolio, we were able to opportunistically redeploy a portion of the freed-up capital. Lastly, the funding landscape for non-agency securities remains stable and relatively attractive by historical standards. With that, I'll hand the call back to Peter.
Peter Federico, CEO
Thank you, Aaron. With that, we'll now open the call up to your questions.
Operator, Operator
We will now begin the question-and-answer session. The first question comes from Crispin Love with Piper Sandler. Please go ahead.
Crispin Love, Analyst
Thanks. Good morning, everyone. Peter, just with the presidential election news cycle ramping up, the potential for a Trump versus Harris election. Can you just discuss how you might expect the election to impact you from both the pre and post-election standpoint? What you've experienced in past elections? How it might impact investment positioning, volatility, and then what you might expect post-election just depending on who's in the White House in January and how that could impact agency MBS regulation and what could be kind of favorable or unfavorable from your seat?
Peter Federico, CEO
Sure. There's a lot there. Thank you for the question. Obviously, that's on a lot of people's minds. You're right; if you go back and you look at previous elections, like, take for example, 2016, we did have a very significant rate move following that election. This one probably is a little bit more difficult to read. Obviously, it's a very evolving situation now in terms of the political landscape, still a little unclear, I think, from a monetary policy perspective and from a fiscal policy, what the implications may be. So we're going to have to watch this develop over the next several quarters. But generally speaking, we approach it as going into episodes like that with sort of a lower risk profile; you'll see us really not take a lot of interest rate risk in that environment. We'll wait and see what the outcome is and position the portfolio a little bit more cautiously heading into a high volatility environment. From a GSE perspective, you're right, there's obviously some talk. And going back to that fiscal point, it's not clear from either party which is better or worse for U.S. treasuries. Obviously, when we look at what happened with the treasury market and in particular, what happened with the swap spreads in the end of the second quarter. One of the reasons why swap spreads widened like they did sort of late in the quarter was the concern as the Republican party started to gain momentum and the risk that both sides of the Congress were going to shift towards Republican to that may lead to more treasury issuance that puts some downward pressure on swap spreads. So those are the kinds of things that we'll have to watch more closely. On the GSE side, I would say it's definitely too early to tell which way that may go. I know that from the Republican party side, there is a view that will go back more toward the movement to try to move the GSEs out of conservatorship, should Trump win. But what I would say is, look, when you look at the housing market overall and you look at where homeownership rates are, it's clear that our housing finance system is really the envy of the world. And it's clear that the housing finance system is functioning very well post Great Financial Crisis with the involvement of government in it. I know both parties are talking about trying to reduce the cost of homeownership in the current environment. So it seems like an agenda for both parties. And I can't see a scenario where disrupting the highly liquid, highly desirable market that we have would be a good thing for making homeownership more affordable and lowering the cost of housing. We have an $8.5 trillion market that's functioning very well. And by the way, I would also add, when you look at the job that FHFA does and Director Thompson, in particular, she's a very highly regarded regulator. I think she's done a great job disrupting the liquidity that we have. It doesn’t seem to make a whole lot of sense if you're trying to make homeownership more affordable. So it's something that's going to bounce around. We're going to hear about it. We're going to talk about it. But at the end of the day, things are working really well. So it seems to me it's more like a solution looking for a problem and less is more when it comes to that front. So I don't expect a lot of change there, certainly not over the near term.
Crispin Love, Analyst
Thanks, Peter. That's all really helpful. And then also, I think you mentioned some comments on demand for agency MBS in your prepared comments, bank demand moderating. I think you said asset managers were staying consistent. Can you just dig a little deeper there on your views on the incremental buyer here for agency MBS today?
Peter Federico, CEO
Yeah. When you look at the second quarter, it was really an interesting quarter because there were some really significant positive fundamental developments for the fixed income market. And when you look at our performance, it sort of got masked by the fact that spreads moved a little bit wider and our economic return was sort of unchanged. But the fundamental outlook for fixed income improved dramatically in the second quarter. And the reason why it doesn't feel that way is because most of the fixed income markets started the second quarter and really went through the entire second quarter sort of taken a wait-and-see approach, right? What happened in the first quarter is we had surprisingly strong economic data that put the Fed on guard and put all market participants on guard and everybody approached the second quarter saying everybody meaning fixed income market participants generally just take a wait-and-see approach. We needed to see the economic data, the underlying fundamentals change, whether they were going to deteriorate further, meaning that the economy was going to reaccelerate inflation was going to become a problem, the Fed was going to have to be more restrictive or the converse, which is actually what materializes. Now there looks like there’s broad slowing in the economy. Inflation is trending back in the Fed now is clearly, I think, shifting to a more accommodative monetary policy, but that didn't manifest itself really in the way spreads behave and the way interest rates behave. That will, I think, occur over time. The third quarter and summer tends to be a little thin and a little volatile from a fixed income market perspective. And as you point out, we have the election coming. But over time, the demand, I think, for mortgage-backed securities will become much clearer. And there are a couple of sources of it. One is that it's now, I think, clear, even though we don't know the final rules, that bank regulation is likely going to be a positive or certainly less negative from a bank demand perspective, that's going to materialize over the end of the year and ultimately implement it early next year. And then just the fundamental shift from a monetary policy perspective that is a much better environment for fixed income. Broadly, the yield curve steepening, for example, would be a very positive development for the demand of mortgage-backed securities as the yield curve becomes steep, short-term rates come down, and there is a lot of money in money market funds that will ultimately move out of money market funds. So I expect the demand for mortgages to improve as the monetary policy outlook improves as we get through this summer period as we get to the election. I think bank regulation will ultimately prove to be less onerous than we had feared, and that actually may lead to demand for mortgages, particularly if that regulation comes out such that banks have to hedge more interest rate risk then I think that may push banks actually to mortgage-backed securities and away from U.S. treasury. So those are things that will evolve over time. But I think those are the reasons why the demand for agency MBS should improve.
Crispin Love, Analyst
Thanks, Peter. Appreciate you taking my questions.
Operator, Operator
The next question comes from Doug Harter with UBS. Please go ahead.
Douglas Harter, Analyst
Good morning, Peter. Can you remind us, Peter, how you think about setting the dividend? What are kind of the most important factors, and kind of how you see the current dividend level in light of those factors?
Peter Federico, CEO
Sure. Obviously, a lot goes into it in terms of the environment and the outlook for our business in terms of where we can operate from a leverage perspective. And where we think interest rate volatility is in mortgage spread volatility, those are obviously very important in terms of us setting our risk parameters for our portfolio. But sort of foundational to the decision always starts with what is our total cost of capital? What is that required breakeven, if you will? And how does that compare to the economics of our business today? If you look at our portfolio on current valuation levels, what do we think the economics of our business are going to generate from a return on equity perspective going forward? From a total cost of capital, for example, when you take the cost of our common dividend, for example, in the second quarter, the cost of our preferred dividend and our operating costs annualized those, as I did and divide it by our total capital position, you'll get a number something around 16.3% or, call it, 16.5%. So that's the amount of return that we need to earn to cover all of those costs in our business. If you compare that to what are the economics of our business at current valuation levels. And I would say, when you think about where spreads are, as I talked about 150 on average 180, let's say, if spreads are in the current spreads for mortgage-backed securities are 165 basis point range when you use a blend of hedges, leverage at about where we operate right now given our cost of capital, given where the current coupon yield is that would translate into an expected return on an economic basis of, call it, somewhere between 16% to 19%. So very much aligned with that total cost of capital. Now what is important to point out, what that doesn't include when I do that calculation, it doesn't include the cost of ongoing rebalancing, which would be a drag on that. So that's something you have to consider over time. But at the same time, what it also does not include is the positive benefit we get, which is about 2%, for example, on our preferred stock position. So it's not the most complete measure, but it's certainly a good indication. And I think those two things remain really reasonably well aligned, and that's really important from a dividend sustainability perspective. So that's the way we think about it; in this current environment, we also have to take into account the positive benefit that we get from issuing common stock at an accretive level. So that's an incremental source of return that has been available to us now for some period of time. So that's the way we think about the dividend. I think our dividend and our total cost of capital are reasonably well aligned with the economics of where mortgage-backed securities are leveraged and hedged the way we had them and leverage them today.
Douglas Harter, Analyst
Great. I appreciate that answer, Peter. Thank you.
Operator, Operator
The next question comes from Bose George with KBW. Please go ahead.
Bose George, Analyst
Hey, guys. Good morning. So I wanted to ask about spreads.
Peter Federico, CEO
Good morning.
Bose George, Analyst
When I look at OAS, it seemed to widen in April, but then it returned to nearly its previous level, while nominal spreads widened and didn't recover as much. Is that accurate? Can you discuss some of the factors behind this?
Peter Federico, CEO
Yeah. Let me have Chris talk a little bit about that. But it's really the driver of the difference between nominal spreads and OAS’s volatility.
Chris Kuehl, CIO
Yeah. It's largely just the increase in implied volatility earlier that started early in the quarter, the difference between those two.
Bose George, Analyst
Okay.
Peter Federico, CEO
Meaning, when implied volatility goes up, OAS’s will go down, and that will lead to a little bit of confusion there.
Bose George, Analyst
Okay. Yeah. That makes sense. And then actually switching over to the funding markets. It looks like SOFR was pretty elevated at the end of the quarter. It was a little more pronounced in the first quarter. Is there anything you're keeping an eye on there? And just could you just talk about some of what's happening?
Aaron Pas, SVP of Non-Agency Portfolio Management
There is something to monitor regarding the Fed's actions. The Fed is continuing to reduce reserves from the system through its balance sheet runoff at a rate of approximately $45 billion to $50 billion each month. This process is clearly draining reserves, and they have reportedly removed about $1.5 trillion from the system so far. They are transitioning from a phase of abundant bank reserves to an ample target. The Chairman has indicated they will observe certain indicators to determine when reserves are considered abundant, which will influence their decision to cease the balance sheet runoff. I anticipate they may stop this process in the next five to six months, which would reduce bank reserves from the current $3.3 trillion to around $3 trillion. At this level, it likely aligns with their GDP percentage target, although we don't have precise numbers. At the end of last quarter, there was typical pressure at quarter-end, which is normal in the market, especially now that reserves aren't as ample. As we near that target, we can expect similar quarter-end pressures, but this is not a cause for concern. The Fed has numerous tools to maintain liquidity in the repo market for U.S. treasuries and agency MBS. Thus, I do not see this as an issue, but rather a sign that the Fed may soon halt its balance sheet runoff.
Bose George, Analyst
Okay. Great. Thanks.
Operator, Operator
The next question comes from Terry Ma with Barclays. Please go ahead.
Terry Ma, Analyst
Hi. Thanks. Good morning. So your net interest margin was down about 30 basis points quarter-over-quarter. It looks like that was just a function of putting on longer dated swaps or the shorter dated ones rolled off. And I think you kind of highlighted this dynamic on the NIM last quarter. So I guess, looking forward, you guys have another $10.5 billion of swaps potentially rolling off soon. Should we kind of expect the same magnitude of NIM decline each quarter or how should we think about that?
Peter Federico, CEO
No, Terry. That's a really good question, and I'm glad you asked it because the run-off of our shorter-term swaps, which was about $2 billion, did have an impact directionally, obviously, on our NIM, but that was obviously not the biggest impact because we did add $6.5 billion, as you point out, of longer-term swaps. About half of those swaps and the average pay rate on that $6.5 billion was 4.2%. So obviously, a much more significant cost. About half of those swaps that we added were used to hedge new mortgages because of the stock that we issued and the mortgages that we bought with that stock we, in a sense, accelerated some of that NIM decline. At the same time, we also added about $3 billion. The other half of that $6 billion of swaps, as Chris has mentioned this in his prepared remarks, we have rotated out of treasury hedges into swap-based hedges. So that again, because those spot-based hedges show up in our net interest margin led to perhaps a more significant decline in our net interest margin that people would have expected. If you just anticipated the reduction in our swap portfolio due to the maturity of our short-term swaps. So to the extent that we grow our portfolio and able to do so at really attractive investment returns that will change the timing, if you will, of NIM. But you're right; over time, the shorter-term swaps that we have and we have about $6 billion maturing in the second half of the year then that will have some impact on our net interest margin. But again, it's moving our net interest margin back into alignment. If you think about our net interest margin at around 270 basis points, giving us the net spread income we have, that return on capital for the second quarter was 24%; that is not the economics of our business, and that's why they're going to come back into alignment. As we just talked about in the question from Doug, the economics of our business are more in the 18% range, not 24% range.
Terry Ma, Analyst
Great. That’s helpful. Thank you.
Peter Federico, CEO
Sure. Appreciate your question.
Operator, Operator
Next question comes from Rick Shane with JPMorgan. Please go ahead.
Rich Shane, Analyst
Good morning, everybody, and thanks for taking my question.
Peter Federico, CEO
Good morning. Sure.
Rich Shane, Analyst
During the quarter, it appears that you issued approximately 45 million shares, which is understandable. The stock was consistently trading at a premium to tangible book value, and as spreads widened, it created an appealing investment opportunity. I am interested in your approach to issuing shares through the ATM. Is it predetermined at the start of the quarter, where you decide to issue around 40 million shares, give or take 5 million? Or do you evaluate this on a daily basis and determine if trading at an attractive premium and widened spreads make it a good time to proceed? I'm trying to grasp how this dynamic unfolded throughout the quarter.
Peter Federico, CEO
That's a really great question. I appreciate it. To begin with, we don't set a specific expectation at the start of the year for how much capital we want or need to raise. It really depends on what's happening with our portfolio and the market. You're correct that one of the key benefits of using the ATM program is the flexibility it provides. It allows us to issue stock on days of high volume or when there is unique demand. We often receive inquiries from institutional or large investors seeking transactions, which we can consider as they arise. At the same time, this approach enables us to issue stock in increments, making it efficient to deploy rather than raising a large amount of capital that we would have to invest over time without influencing asset prices. This method allows us to issue stock in a way that doesn't disrupt the assets we are acquiring. For instance, in the second quarter, we raised just over $400 million and purchased more than $3 billion worth of mortgages, coordinating the stock issuance with our acquisitions to achieve better economic outcomes. We view this from a dynamic and flexible perspective.
Rich Shane, Analyst
Got it, Peter, that's helpful. When we consider your investments, it involves raising capital, acquiring assets, leveraging that capital, acquiring more assets, and hedging them. Is the hedging process the most challenging aspect as you deploy capital? I'm interested in where the timing issues may arise, especially since the ATM and repo markets are very efficient and your markets are highly liquid. Is there any friction on the hedging side?
Peter Federico, CEO
No. There's no issue there. I mean there's plenty of liquidity. But really, it's the comparison of, for example, doing a bought deal. So let's just take the second quarter as an example, if we did a bought transaction for that amount of $450 million, you would get that all in one day, and then you would have to go out and buy that would support the purchase of a little over $3 billion worth of mortgages. That would be clear that if you did that transaction that AGNC would either have had to buy those mortgages in advance or buy them thereafter. And that would likely potentially lead to a change in valuation of mortgages, as opposed to just simply doing it at a very measured disciplined place, trying to connect the liquidity in our stock with the richness or cheapest of mortgages. And that's why we do that throughout the quarter; it's not consistent. When those sort of align and the liquidities in our stock and mortgages we think are cheap, then we'll buy mortgages. For example, at the beginning of the quarter, mortgages were at the tight side of the range, and they were not as attractive to us. Is they became later in the quarter when mortgages moved back into the middle of the range. And in fact, our book value accretion was better at the end of the quarter. And so the ATM program actually worked better for us at the end of the quarter rather than the beginning of the quarter.
Rich Shane, Analyst
Got it. Okay. Very helpful. Thank you.
Operator, Operator
The next question comes from Eric Hagen with BTIG. Please go ahead.
Eric Hagen, Analyst
Hey, thanks. Good morning.
Peter Federico, CEO
Good morning, Eric.
Eric Hagen, Analyst
So if the range for mortgage spreads is tighter because the narrative is really focused on Fed cuts, do you feel like that maybe drives more flexibility to take your leverage higher and what do you feel like that range for your leverage is? And do you feel like we can maybe think about 7.5 times being more of a minimum leverage over, call it, the near or medium term?
Peter Federico, CEO
I think all these factors are important when we consider our leverage. As you noted, our cash and unencumbered position, which represents 65% of our equity, shows that we have significant capacity to increase our leverage if we choose to do so. The outlook for mortgage spread volatility is crucial in this context, as both Chris and I pointed out in our prepared remarks. It’s significant for our business, particularly regarding how mortgage spreads have functioned. We experienced a challenging repricing period from 2022 to 2023 to establish a new range, and in 2023, the difficulty lay in not knowing the peak of that range. We encountered levels close to 200 basis points. A positive development we have observed since then is the emergence of a new range within the existing one. A narrower spread range allows us to take on more risk. As we mentioned earlier in this call, we are entering a time when volatility may increase, and there are major macro issues we will need to address. However, these factors will inform our perspective on the appropriate level of leverage over time.
Eric Hagen, Analyst
That was really helpful color. Thank you. Okay. So we're looking at the forecasted prepayment speed over the next 12 months, I think it’s 7 CPR, as the same as the pay down that we saw last quarter. Is there a way to drill down there? I mean, does that assume that mortgage rates are flat? How do you think mortgage rates kind of trend here? And if we saw a pickup in speeds, do you feel like that would be positive for total return or is it maybe dependent on other variables?
Peter Federico, CEO
I'll let Chris fill in.
Chris Kuehl, CIO
That forecast just assumes that the forwards are realized. It's a base case single path forecast along the forward rate curve. With respect to convexity risk on the portfolio or managing prepayment risk given our coupon and pool composition, peak negative convexity on our portfolio is about 150 basis points lower than today's rate levels. So a significant move in rates to get to that sort of level. Specified pools, higher quality specs represent about 45% of our holdings; the next category of specified pools also have favorable cash flow characteristics, that represents about 30% of our holdings. And importantly, in the higher coupons where we have the most prepayment risk. Those two categories combined represent about 85% of our holdings. And so convexity risk prepayment risk in this environment is still very manageable.
Eric Hagen, Analyst
Yeah. That’s helpful.
Peter Federico, CEO
And Eric, just to go back and round up the discussion on spreads, sort of the way I would characterize the outlook right now is expect mortgages to sort of stay range-bound over the nearer term. But longer term, I think what we now are seeing is a scenario where there's more reasons for mortgages to tighten than they are to widen. There are certainly the catalysts for mortgages to move to the high end of the spread range; the very high end of the spread range are harder to see, and they're starting to be more reasons to believe that mortgages could tighten over time.
Eric Hagen, Analyst
Right. Good perspective. We appreciate you. Thank you.
Operator, Operator
And the final question comes from Jason Stewart with Janney. Please go ahead.
Jason Stewart, Analyst
Hey, Peter. Thanks for taking the questions. Just a follow-up on Eric's question there. Going back to the high, call it, mid-quality spec pools up in coupon, what's the average pay up on that, say, 85%, if you could give us an idea of what that looks like?
Chris Kuehl, CIO
Sure. We don't have that detailed in our disclosures, but the average pay up on our overall portfolio, including the TBA position, which is relatively small, is just under a point, around 30 ticks. If we exclude the TBA position, it is slightly above a point, so approximately 33 ticks.
Jason Stewart, Analyst
Okay. All right. Thanks for that. Yeah. I guess I wanted to ask just a little bit more perspective on coupon selection. I mean you have a wide range of coupons to pick from in this environment and really the push and pull between total return and carry and coupon given your outlook for the refi, some new programs out there for the refi outlook. Maybe you could just drill down into what sort of drives your coupon selection over the next two or three quarters, that would be helpful. Thanks.
Chris Kuehl, CIO
Certainly. Within the coupon stack, production coupons are currently the most appealing due to their attractive spreads. That’s where we’ve been directing additional capital, and as long as the current relationships across the stack hold, we will continue to invest there. Higher coupons present different tactical considerations compared to lower coupons. The organic supply is primarily found in the higher coupons while banks and overseas investors have a relatively weak bid. In contrast, the lowest coupons are significantly away from being produced and much of the float is tied up at the Fed. With passive index fund inflows requiring the purchase of assets that aren't being produced, there can be notable mispricings across the stack. This explains the persistence of the relative value relationship. As we mentioned earlier, while higher coupons do carry greater prepayment risk and have worse convexity, this is more than reflected in their pricing. The spread we collect provides various means to manage that risk, such as buying options on rates, engaging in pay-ups, and carefully selecting assets and specified pools. Delta hedging is also an option, but in the current market, the latter two methods are more appealing since volatility remains high, making options relatively expensive. Overall, it’s much more cost-effective to manage convexity through careful selection of full and coupon types. Approximately two-thirds of our position is in 5s and above, while positions in the 3.5 to 4.5 range, known as belly coupons, continue to offer attractive spreads and highly stable cash flows. We appreciate this diversity, as it keeps the overall convexity risk in our portfolio quite manageable.
Jason Stewart, Analyst
Great. That's good feedback. Thank you for that.
Operator, Operator
We have now completed the question-and-answer session. I'd like to turn the call back over to Peter Federico for concluding remarks.
Peter Federico, CEO
Again, we appreciate everybody participating on our call this morning, and we look forward to speaking to you again at the end of the third quarter.
Operator, Operator
The conference has now concluded. You may now disconnect.