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AGNC Reports Strong Economic Returns Amid Stable Market Conditions

AGNC Investment Corp. has demonstrated resilience in a fluctuating market, posting a net asset value increase and notable economic returns in the first three quarters of the year. The company’s net asset value per common share rose 1.4%, while economic returns reached an impressive 13.8% when accounting for dividends.

As we look at the overall stock performance, including reinvested dividends, AGNC achieved a total stock return of 17.5% during the same period. This highlights AGNC’s strength in maintaining attractive returns in a stable market with wide spreads. Going forward, the company’s outlook suggests that Agency MBS spreads will likely remain within the current trading range, based on solid supply and demand dynamics.

With current mortgage rates experiencing a slight decline, there is potential for an increase in the issuance of agency MBS in the intermediate term. However, with a steady demand bolstered by accommodating monetary policy and less stringent bank regulations, the demand for high-quality fixed-income assets appears poised to increase, especially as the Federal Reserve considers lowering short-term interest rates.

Now, I will hand over the call to Bernice E. Bell, Executive Vice President, Chief Financial Officer, to provide further insights into our financial results.

Bernice E. Bell — Executive Vice President, Chief Financial Officer

Thank you, Peter. In terms of our third-quarter performance, AGNC reported a total comprehensive income of $0.63 per share. The economic return on tangible common equity stood at 9.3%, reflecting $0.36 in declared dividends per common share and a rise in tangible net book value to $0.42 per share, equating to 5%. By the end of October, our tangible net book value per common share had declined by approximately 3% to account for our monthly dividend accrual.

Throughout the quarter, leverage decreased slightly to 7.2 times tangible equity, down from 7.4 times in the previous quarter. At quarter’s end, our balance sheet included $6.2 billion in unencumbered cash and agency MBS, representing 68% of our tangible equity, an increase from $5.3 billion or 65% as of June 30. As of September 30, our portfolio’s average projected life CPR rose by 4% to 13.2%, consistent with the drop in interest rates, while the average coupon remained steady at just over 5%. The actual CPR for the quarter averaged 7.3%, a slight increase from 7.1% in Q2.

For the quarter, net spread and dollar roll income decreased by $0.10, coming in at $0.43 per common share due to a contraction in our net interest rate spread, which narrowed by about 50 basis points to just above 220 basis points. This decline partly resulted from $6.5 billion in low-cost pay-fixed swaps reaching maturity, with no additional swaps maturing until the second quarter of next year. The remainder of the reduction related to our strategy to cut back on swap-based hedges and enhance our treasury-based hedging approach.

Moreover, during the third quarter, we issued $781 million of common equity via our at-the-market offering program. This step, taken against a backdrop of favorable price-to-book premiums, significantly bolstered our book value, benefitting our common stockholders by positioning us for further investment opportunities.

I’ll now turn the call over to Christopher Jon Kuehl, Executive Vice President, Agency Portfolio Investments, for additional commentary on the agency mortgage market.

Christopher Jon Kuehl — Executive Vice President, Agency Portfolio Investments

Thank you, Bernie. During the third quarter, weaker economic data alongside a more dovish stance from the Fed contributed positively to the environment for risk assets and duration. The yield curve experienced substantial steepening, with the two-year and 10-year Treasury yields decreasing by 112 and 62 basis points, respectively. Remarkably, MBS and corporate credit indices exceeded Treasury benchmarks in performance.

However, it’s important to note that returns within MBS were significantly affected by attributes such as coupon rates and hedge types. Lower coupon MBS, which dominate the Bloomberg MBS index, outperformed higher coupons, with 4.5% and lower coupons tightening by 10 to 15 basis points, while 5% and higher coupons varied from slightly tighter to slightly wider. The strength of lower coupon MBS was supported by favorable technical conditions, driven by an average weekly inflow of $8.5 billion into fixed income bond funds, nearly double last year’s average.

In contrast, the drop in primary mortgage rates, coupled with the tail end of seasonal housing activity, resulted in increased supply and underperformance from production coupon MBS. Notably, agency MBS spread volatility has decreased significantly in 2024, with par coupon spreads trading within a range of 40 basis points—an improvement from the wider ranges seen in 2022 and 2023. This quarter, we expanded our agency MBS holdings by roughly $5 billion, pushing our investment portfolio to $72.1 billion as of September 30.

In terms of composition, we added around $6 billion in pools, predominantly in low pay-up categories, while our TBA position decreased in line with weaker implied funding levels. Our Ginnie Mae TBA position remained largely unchanged as of September 30, given the attractiveness of valuations and advantageous roll implied financing. Performance this quarter was also influenced by our adjustment in hedge positioning in response to the yield curve steepening and swap spread tightening.

Our strategy to favor longer tenor U.S. Treasury-based instruments over swap-based hedging yielded enhanced total returns during the quarter. Consequently, we reduced swap-based hedge utilization and increased our Treasury allocation. We believe these longer-term hedges will help us navigate the challenges from the rising U.S. government debt and budget deficits. Now, I will pass the call to Aaron Joshua Pas, Senior Vice President, Non-Agency Portfolio Management, for insights into the non-agency markets.

Aaron Joshua Pas — Senior Vice President, Non-Agency Portfolio Management

Thank you, Chris. In August, as market expectations shifted towards expedited rate cuts, we initially observed credit spreads widening. However, as the quarter progressed, a broader risk-on sentiment prevailed, leading to a recovery.

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Credit Markets Display Stability Amid Economic Variability

Q3 Overview: Investment Grade and High-Yield Trends

In the third quarter, the synthetic investment grade index remained largely unchanged, while the high-yield index saw a tightening of approximately 15 basis points. On the cash bond front, the Bloomberg IG index narrowed by 5 basis points and later tightened by an additional 8 basis points post-quarter end. Notably, this index has reached levels tighter than those seen during the COVID-19 quantitative easing period and is now at its lowest valuation since the aftermath of the Great Financial Crisis. These trends indicate a notable division in consumer credit health.

Lower-income households are still experiencing economic strain; however, current indicators reveal no significant distress signals. At the end of the quarter, our non-agency securities portfolio stood at $890 million, reflecting a decrease of roughly 5% from the previous quarter, while the makeup of our holdings remained stable. This decline is attributed to our participation in government-sponsored enterprise (GSE) tender offers for credit risk transfer securities. The funding climate for non-agency securities has continued to be stable and historically favorable.

Strategic Shifts in Hedging Approach

Peter J. Federico — President and Chief Operating Officer

Thank you, Aaron. We will now open the floor for questions.

Questions & Answers:

Operator

At this time, we begin the Q&A session. Please follow operator instructions. Our first question is from Bose George of KBW. Please go ahead.

Bose George — Analyst

Good morning. I want to revisit your hedging changes. Do these adjustments better position you for curve steepening?

Peter J. Federico — President and Chief Operating Officer

Yes, that’s correct. Chris highlighted this in his comments, and we have seen the effects this quarter with our hedge ratio decreasing from 98% to 72%. Additionally, we’ve gravitated towards longer-dated hedges. About 80% of our hedges are now seven years and longer, as we anticipate a steepening yield curve alongside current monetary policies. Operating with a hedge ratio below 100% allows us to benefit from the repricing of some of our debt to match the new Federal Funds rate.

Bose George — Analyst

Great, thanks. Focusing on core earnings, should we expect them to align closely with your economic returns? For instance, if you anticipate generating a 17% return on equity (ROE), should we consider that as a target for core earnings?

Peter J. Federico — President and Chief Operating Officer

Exactly. Several elements influenced the decline in our net spread and dollar roll income this quarter. Notably, $6.5 billion in swaps matured, and none will mature in the upcoming two quarters. We’ve intentionally reduced our swap position in favor of Treasury-based hedges, which have outperformed swaps recently due to tightening spreads. The carry on our Treasury position is currently about $0.08, not reflected in our reported net spread and dollar roll income. This situation doesn’t significantly affect our dividend policy as our net spread and dollar roll income have consistently surpassed our dividend. Overall, our quarterly earnings still show a return on equity between 19% and 20%, above the long-term economics, which is presently in the 16% to 18% range.

Bose George — Analyst

Helpful insights, thanks.

Peter J. Federico — President and Chief Operating Officer

Thank you, Bose.

Operator

Our next question is from Crispin Love of Piper Sandler. Please proceed with your question.

Crispin Love — Piper Sandler — Analyst

Thanks, good morning. Based on your input and your expectations for agency spreads, could you elaborate on the return expectations for agency MBS? How does that compare with your current book value yield, around 17%? You mentioned a normalized level of 16% to 18%. Are you comfortable with your current dividend given the benefits you have in your hedges?

Peter J. Federico — President and Chief Operating Officer

Yes, we are confident in our alignment with our dividend policy and the portfolio’s economic viability. Mortgage stability has shown to be a positive factor for earnings in the first three quarters. Furthermore, the reduction in spread volatility has helped; the spread on mortgages has fluctuated within a 40 basis point range this year, compared to a 100 basis point range two years ago. This stability positively influences our risk management and portfolio positioning.

Mortgage Market Overview: Trends and Predictions Amid Rising Rates

Mortgage rates have shown stability recently, moving back towards the middle of their historical range. Currently, the current coupon spread to the five- and ten-year Treasury notes sits close to 150 basis points, right within the expected 140 to 160 basis point range. Notably, the current mortgage coupon, aligned with a blend of swap hedges, is around 185 basis points. The company’s strategy effectively balances approximately 40% of its hedges utilizing treasuries, alongside a mix of swaps.

The expectation for returns on equity remains strong, with average spreads translating into attractive revenue, and the forecast suggests these rates are likely to hold steady.

Crispin Love — Piper Sandler — Analyst

Thank you, Peter. Looking ahead, how do you see the 30-year mortgage rates? They increased during the third quarter and have continued to rise recently.

Peter J. Federico — President and Chief Operating Officer

Absolutely, the current outlook for the mortgage market is crucial. If we had this discussion at the end of the last quarter, the 10-year Treasury yield was around 3.60%. Since then, it has climbed to approximately 4.25%, resulting in primary mortgage rates now exceeding 6.50% and approaching 6.75%. This shift signifies a substantial change in the market’s landscape.

The increase in mortgage rates will likely reduce the supply of new mortgages, which—given a more accommodating Federal Reserve—could enhance market conditions. As we see the 10-year treasury settle in the 4% to 4.25% range, the expectation is that mortgage rates will remain above 6.5% for some time. This is partly why we are optimistic about the mortgage market’s future.

Crispin Love — Piper Sandler — Analyst

Appreciate the insights, Peter. That’s very helpful.

Operator

Our next question comes from Rick Shane of J.P. Morgan. Please proceed with your question.

Rick Shane — Analyst

Thank you for taking my question. It’s been a volatile few weeks, especially with the 10-year treasury yield climbing 40 basis points and the spread widening 20 basis points within the quarter. How do these changes impact book value? What risks and opportunities should we consider in the short term?

Peter J. Federico — President and Chief Operating Officer

Thanks for the question, Rick. As previously mentioned, our book value saw a decline of about 3.5% as of last week due to rising treasury rates. At the end of last quarter, we maintained a slight positive duration gap of approximately 0.2 years.

Though the rise in rates had a negative impact on book value, the return of mortgage spreads toward the mid-range serves as a counterbalance. Right now, we are experiencing heightened volatility, largely driven by the approaching election. This volatility is reflected in our cautious approach, maintaining low leverage at 7.2% to manage risks and opportunities—our unencumbered cash position was $6.2 billion, or about 68% of our equity. Historically, this is one of our highest positions. While the interest rates are volatile now, we believe the fundamentals of the mortgage market will prevail post-election.

Rick Shane — Analyst

Understood. I appreciate the clarification.

Operator

Next, we have Doug Harter from UBS. Please go ahead with your question.

Douglas Harter — Analyst

Thanks, Peter. In light of the current market, how do you plan to manage delta hedging and leverage in the lead-up to the election?

Peter J. Federico — President and Chief Operating Officer

We feel well-positioned regarding our leverage; no significant changes are anticipated there. Instead, we will focus on delta hedging the rate fluctuations. As it stands, our duration gap is around 0.4 to 0.5 years. We plan to remain active in managing this aspect, while not expecting it to increase significantly in the near term. This volatility seems temporary.

Rick Shane — Analyst

Thank you, Peter. Regarding the treasury hedges, swap spreads have widened recently. How do you see that spread evolving, and when might it make sense to transition to more SOFR-based hedges?

Peter J. Federico — President and Chief Operating Officer

That’s a good question. Transitioning to more SOFR-based hedges is definitely something to consider, especially as we’ve discussed increasing swap-based hedges in prior quarters. However, last quarter saw a strategic shift in prioritizing other market conditions.

Anticipating Changes in Hedge Strategies and Market Dynamics

Assessing the Shift in Hedge Portfolios

Long-term expectations indicate a potential return to swap-based hedges. Recently, market conditions, particularly following the election and its impact on treasury supply, have led to a delay in this transition. Historically, the firm has maintained 70% to 80% of hedges in swaps. Currently, this figure stands at 60%. A stabilization in the rate market may eventually allow for a shift of 10% to 20% back toward typical hedge strategies.

The Demand for Mortgage-Backed Securities

As interest rates change, increased demand for mortgage-backed securities (MBS) is anticipated, especially when the yield curve steepens due to Federal Reserve easing. Demand is expected to stem primarily from unlevered investors rather than those using leverage. Currently, over $6 trillion in money market mutual funds are yielding over 5%, but as these rates diminish, fixed-income options may become more appealing.

Peter Federico, President and COO, noted that high-quality agency current coupons yielding around 5.5% might attract substantial investment, potentially pulling cash from both these funds and equity markets. The yield curve’s shape will also play a critical role in bank operations regarding mortgage carrying costs and foreign demand.

Amid discussions of regulatory updates like the Basel endgame, clarity is expected to emerge in the coming quarter, which should benefit the bond market.

Understanding Leverage in an Uncertain Market

The current leverage rate remains below eight times, but evaluation of how much further leverage could be applied depends on market conditions, specifically interest rate and spread volatility. The firm has indicated that as mortgage spreads stabilize, there will be more confidence to increase leverage. Decisions on leveraging will be informed by the mortgage spread’s position; if they are high, leverage can be increased, but caution is necessary when spreads fall. Having 68% of capital unencumbered positions the firm well to operate with additional leverage as confidence in spread stability grows.

Opportunities in Different Coupon Rates

As additional capital is raised, the focus shifts to production coupons, which traditionally yield better risk-adjusted returns despite posing higher prepayment risks. Insights from Christopher Kuehl, Executive VP of Agency Portfolio Investments, indicate that higher coupon spreads are currently wider due to unfavorable market conditions. If banks increase their acquisitions of securities, the upward slope of the spread curve might lessen, indicating a potential shift in investment dynamics going forward.

Market Update: Adjustments in Bond Fund Strategies Amid Shifting Rates

As the sentiment in fixed income improves, bond fund inflows are mostly targeting index coupons, which remain scarce. In contrast, there is a notable availability of organic supplies and higher coupons. Over time, banks are expected to transition from lower-yielding securities towards higher coupons, which may eventually shift relative value relationships, albeit gradually. This shift might depend on clarifications around Basel III regulations and perhaps a couple more rate cuts from the Federal Reserve.

Currently, our strategy will focus on maintaining and adding higher coupon bonds compared to the index, as these are likely to yield the best long-term returns. However, it’s worth noting that certain sectors within the lower coupon category could present appealing total returns, alongside offering diversification and liquidity benefits in specific market conditions. Nevertheless, our primary focus remains on producing higher coupons.

Eric Hagen — Analyst

Thank you, that’s very insightful.

Christopher Jon Kuehl — Executive Vice President, Agency Portfolio Investments

Thank you.

Operator

Our next question is from Jason Stewart at Janney Montgomery. Please proceed with your question.

Jason Stewart — Janney Montgomery Scott — Analyst

Good morning. Peter, could you elaborate on your outlook regarding the current prepayment environment, particularly concerning the capacity within the servicing industry and its effects on prepayments related to current coupons?

Peter J. Federico — President and Chief Operating Officer

Sure. I’ll defer to Chris for that.

Christopher Jon Kuehl — Executive Vice President, Agency Portfolio Investments

Of course. The prepayment reports from the last two periods have been notably intriguing since COVID restrictions were eased. A significant portion of higher coupon securities was exposed to a refinancing incentive exceeding 50 basis points. However, this accounted for a small fraction, around 10%, of the overall float. Notably, when mortgage rates dipped to approximately 6% last September, over 30% of new loans originated since 2022 took advantage of this incentive.

Recently, rates have increased by more than 40 basis points in October, leading to a quick end to the refinancing wave. In comparison to earlier waves, the current response to refinancing incentives has been sharper than the previous mini-wave at the start of the year but remains slower than during the peak of the COVID crisis. These observations suggest a less aggressive response than in past periods; however, it’s essential to note that the sample sizes are not large enough to draw any concrete conclusions. Capacity in the servicing industry does not seem to be a concern, though the dynamics today may contribute to a weaker response.

For instance, the lack of media influence is notable, and with the current flat yield curve, refinancing products like ARMs might be less attractive to borrowers. These factors help explain the current response dynamics.

Jason Stewart — Janney Montgomery Scott — Analyst

Thank you for the clarification. Moving to a broader question: In reference to Slide 24 regarding MBS spread sensitivity, could you remind me how that’s measured? Perhaps you could clarify the delta between the realized figure and the snapshot we reviewed. I believe we noted around 12.6% appreciation for a 25 basis point move at 6.30%.

Peter J. Federico — President and Chief Operating Officer

Absolutely. This quarter posed challenges in understanding these metrics. It’s critical to avoid relying solely on simple benchmark spreads. We analyze the entire portfolio and assess the impact across various coupons to determine sensitivity. The real challenge for investors is how to replicate this in assessing our book value performance.

For instance, while the current coupon appeared to tighten significantly this past quarter, we actually shifted down by nearly a full coupon, moving from 6% to 5%. This drop in yield does not typically correspond to economics associated with spread tightening. To achieve an accurate analysis, it’s essential to consider each coupon’s performance against a hedged benchmark, whether using swaps or treasuries.

For context, during this last quarter, the 6% coupon actually widened by about 8 basis points, while the 5% coupon tightened slightly. Thus, understanding performance requires examining the detailed dynamics within our portfolio.

Jason Stewart — Janney Montgomery Scott — Analyst

Thank you for clarifying that. It’s insightful to understand the nuances behind those figures.

Peter J. Federico — President and Chief Operating Officer

Glad to hear that.

Operator

Our final question comes from Harsh Hemnani of Green Street. Please proceed with your question.

Harsh Hemnani — Green Street Advisors — Analyst

Thank you. I’d like to follow up on the prepayment speeds. The expected lifetime CPR has risen significantly. Could you explain this increase, especially given expectations for mortgage rates hovering around 6.5%? Is the main driver the increased sensitivity to refinancing incentives?

Peter J. Federico — President and Chief Operating Officer

Yes, the rise in our expected lifetime CPR is attributed to the lower interest rates observed towards the end of the quarter. As interest rates dropped during Q3, our forecasts for prepayment speeds over the portfolio’s lifetime also adjusted accordingly. This trend aligns with the current projections for forward mortgage rates, which will naturally fluctuate each quarter based on market conditions.

Harsh Hemnani — Green Street Advisors — Analyst

Thank you, that explains it well. Additionally, the average group on our MBS portfolio experienced a slight decline during the quarter, consistent with

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Future Trends in Mortgage Coupons: Insights from AGNC’s Leadership

The current coupon has noticeably increased, raising questions about the future of mortgage rates. Will this trend of increasing coupons persist over the next few quarters?

Peter J. Federico Discusses Coupon Strategies

Peter J. Federico — President and Chief Operating Officer

Yes, indeed. As Chris pointed out during the call, there was a slight dip in our coupon last quarter. This occurred while we increased our holdings, specifically a notable rise in our 4.5% coupon holdings. This shift was a key factor in the reduction of our average coupon. However, as Chris noted, we are now inclined to raise our average coupon in response to the current rate environment. Thus, I anticipate upward pressure on our average coupon due to our portfolio reallocation.

Analyst Response

Harsh Hemnani — Green Street Advisors — Analyst

Got it, thank you.

Closing Remarks: A Positive Outlook

Operator

We will now conclude today’s Q&A session and return to Peter Federico for his closing thoughts.

Peter J. Federico — President and Chief Operating Officer

I appreciate everyone joining our call today. We are pleased with our third-quarter results and feel optimistic about the mortgage market’s future. We look forward to our next discussion at the end of the year.

Operator

With that, we conclude today’s conference call. Thank you for participating, and you may now disconnect your lines.

Duration: 0 minutes

Call Participants:

Katie Turlington — Investor Relations

Peter J. Federico — President and Chief Operating Officer

Bernice E. Bell — Executive Vice President, Chief Financial Officer

Christopher Jon Kuehl — Executive Vice President, Agency Portfolio Investments

Aaron Joshua Pas — Senior Vice President, Non-Agency Portfolio Management

Bose George — Analyst

Crispin Love — Piper Sandler — Analyst

Rick Shane — Analyst

Douglas Harter — Analyst

Trevor Cranston — Analyst

Eric Hagen — Analyst

Chris Kuehl — Executive Vice President, Agency Portfolio Investments

Jason Stewart — Janney Montgomery Scott — Analyst

Harsh Hemnani — Green Street Advisors — Analyst

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