AGNC Investment Corp

NASDAQ:AGNC

Earnings Call Analysis

Company Navigates Market Stability Amidst Risks

The company conveyed a modest 1-2% increase in book value and manageable convexity risk despite a 100 basis point rally last quarter. Positions in 5% and 5.5% coupons remain robust against the current 6.5-7% mortgage rates, indicating room for rate rally before refinancing impacts. The portfolio's convexity is being addressed through asset selection and delta hedging, with more rate options possible if implied volatility drops. The bond market's liquidity challenges, recognized from recent years' experiences, influence the firm's comfortable liquidity levels and leverage strategy. Incrementally higher leverage is achievable with the current unencumbered capacity, allowing resilience against market fluctuations and confidence in the future.

Strong Performance Amidst Market Volatility

AGNC Investment Corp navigated the tumultuous financial waters of 2023 with adroit portfolio management, achieving a 12% economic return in Q4 despite significant volatility. The Federal Reserve's hefty interest rate hikes, totaling 525 basis points over two years, and balance sheet reduction put fixed income markets under stress. Even so, AGNC managed a positive 3% economic return for the year, a 10% total stock return, and maintained a stable monthly dividend for shareholders.

Financials and Liquidity Position

The fourth quarter saw AGNC posting comprehensive income of $1 per share, with an economic return on tangible common equity standing at 12.1%. Even though overall leverage remained stable at 7.4x tangible equity, the end-of-period leverage decreased to 7x, compared to 7.9x from the previous quarter. The company held substantial liquidity, ending the year with $5.1 billion in unencumbered cash and Agency MBS, equivalent to 66% of tangible equity.

Shift in Monetary Policy and Market Sentiment

The financial landscape shifted with changing Fed policy expectations and fixed income market sentiment. Improved inflation data and a Federal Reserve pivot in December influenced the market to anticipate rate cuts in 2024. The change from a hawkish to a more neutral tone improved market sentiment, laying the foundation for a positive investment outlook.

Future Outlook for Agency MBS

Looking ahead, Agency MBS investments seem enticing due to historically beneficial valuations, low mortgage origination volumes, and an anticipated decline in interest rate volatility. These favorables are fortified by a more accommodating Federal Reserve policy and a less inverted yield curve, potentially drawing in more private capital and fostering a buoyant investment climate for AGNC.

Strategic Asset and Hedge Positioning

Throughout the quarter, AGNC optimized its portfolio by altering coupon positioning and shifting the duration of hedge positions. This strategic maneuvering was warranted by a 111 basis point rally in PAR coupon yields, which led to a shortened duration of portfolio assets. AGNC accordingly reduced treasury-based hedges, particularly within the 5- to 7-year curve segment.

Investor Demand and Agency MBS Spreads

Agency MBS spreads widened during volatility spikes, prompting investor demand when reaching higher range levels, reinforcing the investment's attractiveness. As market conditions solidified, the spread narrowed, and they stabilized towards the lower end of the historical range. AGNC anticipates that this pattern will persist, with demand emerging when spreads peak, creating a palatable environment for both short- and long-term investment.

Dynamics Shaping Long-term Spread Ranges

Long-term spread ranges for Agency MBS will likely be molded by the Fed's balance sheet decisions, regulatory changes in banking, and shifting investment flows between treasury securities and Agency MBS. A regulatory environment conducive to mortgage investments can prompt banks to favor Agency MBS over treasuries, leading to narrower spreads over time.

Portfolio Management and Risk Positioning

AGNC's careful asset selection and hedge management underscore a fortified position to manage prepayment and call risk efficiently. The company's portfolio structure, which emphasizes favorable convexity characteristics and manageable call risk, strategically mitigates potential adverse effects from shifts in refinancing patterns and interest rate changes.

Dividend Outlook Amidst Expected Rate Cuts

Factors influencing dividend decisions include operational environment projections, leverage expectations, interest rate volatility, and evaluations of AGNC's breakeven return on equity. Current mid-teens portfolio returns suggest alignment between economic performance and dividend levels, with the anticipation of rate cuts and decreasing volatility potentially reinforcing this posture throughout 2024.

Earnings Call Transcript 2023-Q4

[Operator]

Good morning, everyone, and welcome to the AGNC Investment Corp Fourth Quarter 2023 Shareholder Call. All participants will be in a listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please also note today's event is being recorded.

At this time, I'd like to turn the floor over to Katie Turlington in Investor Relations. Ma'am please go ahead.

[Katherine Turlington, executive]

Thank you all for joining AGNC Investment Corp.'s Fourth Quarter 2023 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 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'll turn the call over to Peter Federico.

[Peter Federico, executive]

Good morning, and thank you all for joining our call. The fourth quarter of 2023 illustrated the importance of our active portfolio management strategy as AGNC generated a very favorable 12% economic return despite significant intra-quarter volatility. Over the last 2 years, the Federal Reserve has engineered one of the most aggressive tightening campaigns ever experienced, raising the federal funds rate by 525 basis points, while simultaneously reducing its balance sheet by $1.3 trillion.

Despite this challenging and volatile fixed income environment, AGNC generated a positive economic return of 3% in 2023, produced a positive total stock return of 10% and importantly, provided shareholders with a stable and compelling monthly dividend. Early in the quarter, treasury supply concerns and persistent monetary policy uncertainty weighed heavily on the fixed income market, driving the yield on the 10-year treasury and the current coupon Agency MBS to 15-year highs of 5% and 7%, respectively.

Later in the quarter, better-than-expected economic data and the Fed's monetary policy pivot triggered a dramatic rally across the fixed income and equity markets as investors sought to lock in attractive return opportunities. To put the fixed income rally in perspective, from the peak in yields on October 19 through the end of the year, Treasury rates rallied by more than 100 basis points across the yield curve. And the Bloomberg Aggregate Bond Index posted a total return of close to 10% over that time period.

The performance of Agency MBS closely tracked Treasury yields underperforming early in the quarter as interest rates increased and outperforming later in the quarter as interest rates fell. Agency MBS spreads hit their widest level at the same time, treasury yields peaked in mid-October. In November and December, as treasury rates fell, Agency MBS spreads tightened meaningfully across the coupon stack.

As we begin 2024, we believe the investment outlook for Agency MBS is decidedly more favorable than the previous 2 years. This positive outlook is supported by historically attractive valuation levels on both an absolute and relative basis. Low mortgage origination volumes, declining interest rate volatility, a less inverted yield curve and most importantly, a more investor-friendly monetary policy stance by the Federal Reserve.

Our favorable outlook for Agency MBS is further supported by several important developments. First, in the fourth quarter, the Fed adopted a more neutral monetary policy stance as inflation measures continue to show progress toward the Fed's long-run target. More significantly, at the December meeting, the Fed also indicated that multiple rate cuts were possible in 2024, assuming inflation measures continue to improve as expected.

Second, interest rate volatility is poised to decline. Over the last 2 years, the distribution of potential interest rate path has been exceedingly wide, due to the many uncertainties associated with inflation, the economy, regional banks, fiscal policy, geopolitical events and of course, the Fed's unprecedented dual-track approach to monetary policy tightening. Not surprisingly, these major uncertainties led to a meaningful increase in interest rate volatility.

The MOVE Index, which is a broad measure of interest rate volatility continues to trade more than 50% above its 10-year historical average. Although some uncertainties still remain, we expect interest rate volatility to gradually decline as many of these factors are now largely behind us. Such a decline would be beneficial to Agency MBS and on balance would incrementally reduce the need for and cost of our interest rate risk management activities.

The third and final development relates to agency MBS spreads. Over the last 5 quarters, Agency MBS spreads to benchmark rates have experienced 5 distinct widening episodes, the most recent one being this past fall. In each of these episodes, the spread range was relatively consistent. As measured by the current coupon Agency MBS spread to a blend of 5- and 10-year treasuries, the range has been between 140 and 190 basis points.

The important takeaway from this experience is that strong incremental demand for Agency MBS emerges, when spreads are near the upper end of the range. In the fourth quarter, we hit the upper end of the range and again, the range held. Spreads in this range are materially above the average of the last 10 years, make Agency MBS very compelling on both an absolute and relative basis, and we believe are sufficient to attract a greater amount of private capital to the Agency MBS market over time.

These are positive developments, and we are excited about the outlook for our business. As a levered investor in Agency MBS, the 2 primary drivers of our performance our changes in spreads and interest rate volatility. Over the last 2 years, as the Fed aggressively tightened monetary policy, Agency MBS spreads widened by more than 100 basis points and interest rates -- and interest rate volatility moved sharply higher.

Today, we believe many of the factors that drove these adverse conditions are largely behind us. Historically attractive and stable Agency MBS spreads, combined with declining interest rate volatility create a compelling investment environment for AGNC and form the basis of our positive investment outlook. With that, I'll now turn the call over to Bernie Bell to discuss our financial results in greater detail.

[Bernice Bell, executive]

Thank you, Peter. For the fourth quarter, AGNC had comprehensive income of $1 per share as the mortgage market rebounded following October sell-off and a difficult third quarter. Economic return on tangible common equity was 12.1% for the quarter, comprised of $0.36 of dividends declared per common share and a $0.62 increase in our tangible net book value per share.

As Peter mentioned, despite the very challenging fixed income environment for the year, we achieved a positive economic return of 3%, including $1.44 of dividends per common share and $1.14 decline in tangible net book value per share, with common stockholders experiencing a total stock return of 10% for the year. As of late last week, tangible net book value per share was up 1% to 2% for January.

While average leverage was largely unchanged for the quarter at 7.4x tangible equity, our end-of-period leverage declined to 7x tangible equity as of Q4 from 7.9x as of Q3. Our liquidity remained exceptionally strong during the quarter, ending the year with unencumbered cash and Agency MBS totaling $5.1 billion or 66% of our tangible equity and an additional $90 million of unencumbered credit securities.

Net spread and dollar roll income also remained strong at $0.60 per share for the quarter, down from $0.65 for the prior quarter due to a somewhat smaller asset base and a larger share count for the fourth quarter. At the same time, our net interest rate spread improved 5 basis points to 308 basis points, as higher asset yields more than offset moderately higher funding cost.

The average projected life CPR for our portfolio increased to 11.4% at quarter end from 8.3% the prior quarter, reflecting the higher average coupon of our holdings and the decline in mortgage rates. Actual CPRs for the quarter averaged 6.2% compared to 7.1% for the prior quarter.

Lastly, in the fourth quarter, we raised approximately $380 million of common equity through our at-the-market offering program at a meaningful price to book premium. I'll now turn the call over to Chris Kuehl to discuss the agency mortgage market.

[Christopher Kuehl, executive]

Thanks, Bernie. The fourth quarter market decided shift in Fed policy expectations in fixed income market sentiment. The shift in sentiment was led by favorable inflation data and was ultimately reinforced at the December Fed meeting with a reset of market expectations for a series of rate cuts in 2024. The path to the Fed's December pivot was anything, but a straight line.

October was a continuation of extraordinary interest rate volatility, persistent higher for longer rhetoric from the Fed and weak performance across most all fixed income asset classes as the 10-year Treasury note yield broke through 5%. Market sentiment, however, improved materially in November, following downside inflation data surprises and generally more balanced messaging from the Fed regarding the outlook for monetary policy and inflation.

In response to this improving outlook and with equity markets near all-time highs, fixed income investor sentiment turned in favor of adding duration, which in turn cause the interest rates to rally and spread products to outperform. Agency MBS across the coupon stack outperformed treasury and swap based hedges with lower and middle coupons performing somewhat better than higher coupons.

Hedge composition was also a significant driver of performance during the quarter as swap spreads tightened 10 basis points across the curve, chose to return. As a result, an MBS position with treasury-based hedges performed meaningfully better than a swap-based hedge position.

Our portfolio increased slightly from $59.3 billion to $60.2 billion as of December 31st. Within our agency holdings, our coupon positioning was modestly higher as we continue to move up in coupon at attractive yields and spreads. Our TBA position was also modestly higher at $5.3 billion and remains largely comprised of Ginnie Mae TBA, given attractive valuations and better roll implied financing relative to UMBS.

With the 111 basis point rally in PAR coupon yields, the duration of our assets shortened during the quarter. And as a result, we reduced the duration of our hedge portfolio primarily by reducing our treasury-based hedges in the 5- to 7-year part of the curve. As of 12/31, our hedge portfolio totaled $60.5 billion, down about $3 billion from the previous quarter.

As I mentioned on the call last quarter, more than 50% of the duration dollars of our hedge portfolio came from Treasury-based hedges. This was a significant benefit in Q4. Over time, as the supply and demand technicals improve for treasuries, we will likely gradually move back towards a heavier allocation of swap-based hedges.

Looking forward, our outlook for agency MBS continues to be very favorable. With limited organic agency supply, low levels of prepayment risk and deep and liquid financing markets. And while spreads have tightened, interest rate volatility has also declined and Agency MBS spreads remain attractive relative to historical norms. I'll now turn the call over to Aaron to discuss the non-agency markets.

[Aaron Pas, executive]

Thanks, Chris. The reversal in rates, improving inflation readings and increased odds of a soft landing scenario contributed to a risk-on environment for spread product in the latter part of the fourth quarter. Market expectations for both an increased number and accelerated timing of Fed rate cuts were particularly beneficial for interest rate-sensitive credit sectors.

In light of this, we saw tightening across the majority of the fixed income credit complex. As a proxy for credit spread moves in Q4, the synthetic investment-grade CDX index tightened 18 basis points, while the Bloomberg IG Index, which represents spreads on cash bonds tightened by 22 basis points. Deeper in the corporate credit spectrum, spreads tightened even more with high-yield CDX ending the quarter 132 basis points tighter.

More relevant to AGNC, we saw meaningful spread tightening in CRT, RMBS and large segments of CRE backed debt. This spread tightening in Q4 is logical as a result of the positive shift in the macroeconomic outlook relative to several months ago. That said, valuations are now full on both an absolute and relative basis, and yields on the assets have correspondingly declined along with falling benchmark rates and tighter asset spreads. As a result, meaningful further tightening from these levels appears less likely.

Turning to credit fundamentals. We continue to watch consumer level dynamics considering low housing affordability levels impacting new owner households as well as renters. We expect mortgage credit performance to continue to hold up as a result of relatively stringent underwriting standards, but predominantly significant homeowners equity. Renters and newer homeowners, however, have been significantly stretched on a relative basis. Given the need for and prioritization of shelter, we expect the ultimate result will be a weakening of consumer discretionary demand from these households.

With respect to our portfolio, our non-agency securities ended the quarter at just over $1 billion in market value. Looking ahead, the GSEs may aggressively look to extinguish the credit protection provided by CRT securities on seasoned and delevered loans through tender offers. To the extent that occurs, we will likely reduce the notional balance of our CRT position over time.

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

[Peter Federico, executive]

Thank you, Aaron. We'll now open the call up for your questions.

[Operator]

[Operator Instructions]. And our first question today comes from Crispin Love from Piper Sandler.

[Crispin Love, analyst]

Can you just first just update us on your outlook for spreads, just given the favorable outlook you laid out. As you said, significant tightening since late October. So curious on your view here with rate cuts likely coming in 2024. And in the past, Peter, you've talked about different spread ranges. So interested on kind of what ranges you think we could be in today? And just what do you think we're more inclined to tighten or widen from current levels?

[Peter Federico, executive]

Crispin, thank you for the question. Yes, as I mentioned in my prepared remarks, I still think that the range that we've been in for the last 5 quarters is the right range for the current environment. And again, you can look at it of to a lot of different measures. I was using the one in my prepared remarks of the current coupon to the 5- and 10-year treasuries. I still think in the 140 to 190 at the very wides of those range. That I think that range will hold for the foreseeable future.

What was important -- and that I mentioned specifically is that when we get to the upper end of the range, and I think this is a really important development for the Agency MBS market is significant resistance emerges meaning significant demand for mortgages comes into play, when spreads get to the high end of that range, and that's a very healthy development for the market. Gives us greater confidence in the upper end of the range. And you're right, we've moved significantly down to those -- more toward the lower end of that range.

But I think this range is the right range for the foreseeable future because we still have a lot of uncertainty with respect to the Fed and the Fed's balance sheet. And a lot of mortgages need to be consumed by the private sector, just like a lot of treasuries are going to have to be consumed by the private sector. So at a spread of, call it, 140 to 160 basis points just to narrow that range a little bit, I think that there is a lot of compensation for investors for the current environment. I think -- it makes Agency MBS look attractive on an absolute basis and on a relative basis, which is really important. So I could see us staying there for the foreseeable future over the near term.

And then there will be some more information coming. What's really important, obviously, you point out, when the Fed again shifts, which to an easing environment, which will likely happen in the second half of this year, that will be a positive for the market. It will likely be a positive for the shape of the yield curve, which could draw more investors in. That's going to be a really important development to watch. It could have an impact on the spread range.

And the other one that's not talked enough about yet, but it's going to be a significant development in the first quarter is what is the Fed going to do with respect to quantitative tightening. How is it going to stop? How is it going to taper? That's going to also be important new information that may help determine what the right range is. But for now, I think where mortgages are trading is ample compensation for investors.

And that's one of the reasons why we're optimistic and feel much better about the outlook for Agency MBS at the beginning of this year versus the last 2 years is that if mortgage is just simply stabilize in this area, which we believe is a greater probability, then you can really generate attractive returns for shareholders over the long run, particularly if interest rate volatility comes down.

So I think that's the outlook over the short term. More information will be coming over the next 3 to 6 months, which will help determine the longer run outlook.

[Crispin Love, analyst]

Thanks, Peter. All very helpful there. And then just on the incremental buyers of Agency MBS today. Are you seeing money managers being the key buyer here? And based on your point as well, that is our current spreads deterring money managers at all? Are they waiting for them to get wider? Or could the rate environment change that? And then just how things could get involved in '24?

[Peter Federico, executive]

Sure. I'll let Chris talk about the diversity of the bid today for mortgages versus over the last several months, particularly money managers and some recent information from banks.

[Christopher Kuehl, executive]

Yes. I think the -- I mean, the money manager bid has been clearly the dominant bid for the last year and change. The negative associated with it has just been the correlation with Fed policy and just overall fixed income inflows, outflows. Money managers even, given the tightening are still generally overweight the indices around high single digits. I think it's around 10% or so.

But we are seeing evidence with deposits stabilizing on the -- in the banking sector. The fourth quarter earnings releases showed some evidence that banks are starting to grow their securities holdings again. The ones that actually disclose or breakout MBS versus treasuries showed some additions in mortgages for the first time in a long time. And so the diversity in the investor base is improving, that's helping liquidity.

We do think that there's still a lot of sort of questions that need to be answered with respect to bank regulation. That won't be answered for quite some time. So we're not overly optimistic on banks adding in a material way over the near term. But I do think that with deposits stabilizing, possibly rate cuts on the horizon, possibly slower C&I loan growth later this year. Banks could be a more material investor base for the space.

[Peter Federico, executive]

And just to add to that, Crispin. When you think about the outlook of supply for the year, and JPMorgan put out some numbers the other day, which I thought we -- which we thought were reasonable. It depends on the mortgage rate somewhere between a 6.5% and 7% mortgage rate.

The net supply of mortgages is a very manageable number, when you think about 2024, it's somewhere in the neighborhood of $400 billion to $450 billion is the probably the best estimate right now. But when you take out from that number, sort of the known demanders of mortgages, whether it would be some assumptions about banks and foreign holdings and even REITs. What it tells you is that the residual amount of mortgages that have to be consumed by money managers and other is a pretty reasonable number at maybe somewhere between $200 billion and $300 billion for the whole year. So I think it gives you some perspective that the outlook of supply right now appears to be very manageable.

[Operator]

Our next question comes from Doug Harter from UBS.

[Douglas Harter, analyst]

Wondering if you could talk about your outlook for the dividend kind of given the volatility you just manage through and kind of how you're thinking about dividend levels throughout 2024?

[Peter Federico, executive]

Sure. There's -- obviously, a lot goes into the dividend decision. It always does in terms of the environment, the operating environment, our expectations about leverage on a go-forward basis and importantly, interest rate volatility and sort of the cost of rebalancing.

But again, like I mentioned last time, another key input into that equation is what is our breakeven ROE on our business. When you take into account the dividends on both our common and preferred, our operating costs, what is that number on a percentage basis of our total capital. That number, for example, at the end of the fourth quarter, if you annualize those numbers is somewhere in as a breakeven ROE of around 15.5%.

So I think it's important to understand that number and think about that number in the context of what we think the portfolio can earn on a go-forward basis based on the economics of where prices are today. Not from an accounting perspective, not on current carry, but the economics of our portfolio today on a mark-to-market basis. And that number with spreads, call it, just roundly in the 150 basis point range, I think you can conclude that mortgages are generating mid-teens ROEs given the way we're managing our portfolio.

So I think the important takeaway is those 2 things still remain relatively well aligned. And again, as the environment unfolds and we talked about some favorable drivers, decline in interest rate volatility is beneficial. There's no doubt about that. And so we'll have to make those determinations over time. But generally speaking, I think it's fair to say that those 2 things are still well aligned.

[Douglas Harter, analyst]

Great. And then you talked about -- and we've experienced kind of that range, the 140 to 190. Kind of -- as you've gotten more kind of evidence that kind of that range, does that change kind of how you would manage the portfolio and the risk off as spreads are widening? And does that give you more comfort to kind of let leverage move higher and kind of hold on to assets kind of as you're going towards the higher end of that range or just kind of lessons learned from this volatility?

[Peter Federico, executive]

That's a really great clarification. It triggered my memory because thinking about that last part of the question, and it was an important point to bring up the leverage outlook. Because where we are from a leverage perspective and in the quarter, at only 7x leverage and putting that into context of our unencumbered liquidity position, which is at the highest percent it's ever been, by the way, it's at 66%.

It tells you that we have significant amount of capacity to take greater risk as the environment unfolds for us and we'll be able to do that. We just don't feel like we're being pressured to do that because like we said, we talked about spreads staying relatively stable in this area. So we can be patient and disciplined as we deploy capital. But you're 100% right.

The key point of my prepared remarks was the fact that more times that you hit the upper end of the range and the more times that holds, gives you greater confidence that you're starting to understand the flow of demand for mortgages at different rate levels. And so it does give you greater confidence to -- which will ultimately feed into your risk position and our ability to manage our levered portfolio.

When the market was very destabilized, when there was a lot of uncertainty about the Fed, you have to think about your leverage on a volatility-adjusted basis and all other things equal, that will tell you that per unit of risk, you got to operate with a lower amount of risk or lower leverage. What you're describing is an environment, where that will start to go the opposite way. And per unit of risk, you can actually take a little bit more risk as you get more and more confident that the spread range is going to be stable. So it's an important point. That will develop more over the course of 2024.

[Operator]

Our next question comes from Bose George from KBW.

[Bose George, analyst]

Actually, on the earlier question on spreads, Peter, you gave kind of the long -- the near-term range of expectations. Can you just talk a little bit about the longer-term range once volatility comes down? Where do you think things could kind of settle eventually?

[Peter Federico, executive]

It's a great question, Bose. And I think there's 2 things that really could drive that. And there's -- the one is that we don't exactly know what the Fed's ultimate balance sheet is going to look like with respect to its composition of mortgages and treasuries. Now what we know from the Fed right now is that they're likely going to stop runoff of their portfolio. It depends. There's a lot of different estimates right now.

But I think one of the big changes that has occurred in the fourth quarter, particularly in December, is that the Fed has now made it clear that they will have to stop tapering probably sooner than any of us had anticipated. I know sooner than I had anticipated. I anticipated the run off to stop in 2025. And now pretty confident it's going to stop in 2024. But we don't ultimately know what the composition of the portfolio might be with respect to mortgages and treasuries.

I think it would be in the best interest of the market, if the Fed ended up -- because they are permanently going to hold mortgages or permanently have a balance sheet that's going to be significant in size. I think it would make sense from a monetary policy perspective for them to own both mortgages and treasuries because mortgages in the housing market are so fundamental to housing policy. We've seen that when they've tried to accelerate the economy by keeping mortgage rates low, and we've seen them try to slow the economy down by keeping mortgage rates high.

So their [ annexure ] can be linked together and I think it makes sense for the Fed over the long run. So that's going to be an important development will change spreads. The other, though, goes away from that is the more longer-term fundamental that both the Agency MBS market and the U.S. Treasury marketplace, which is that there is this transition to a greater share of private capital that has to come into both of these markets over, say, the next 5 years, right?

Because if the Fed does, in fact, continue to reduce its balance sheet, organic supply of mortgages plus Fed runoff will be a couple of trillion dollars of supply of mortgages, say, over the next 5 years. At the same time, we know now that the treasury is going to have to issue perhaps a couple trillion of new treasuries a year. So we're talking about multiple trillions of dollars that have to be consumed not by levered buyers, but by unlevered buyers, real money flowing into the U.S. fixed income market, for these 2 high-quality assets, both Agency MBS and treasuries.

And I think spreads, when you think about Agency MBS, which has the explicit government support behind it, at 150 basis points for argument's sake over a treasury, which is government guaranteed. But in a sense, they're both government-guaranteed securities, 150 basis points of incremental spread is really a significant amount of spread, particularly if the 10-year is at, say, 3% or 4%, you're talking about 25% or more percent improvement in your yield.

So I think it's going to bring investors into the Agency MBS market. I think it's going to be a reallocation out of treasuries into Agency MBS out of corporates into Agency MBS. And the final important point which will drive spreads ultimate, which could be a factor that makes spreads ultimately lower, but we don't know yet is what happens with bank regulation.

And if banks have to, for example, manage their interest rate position on their securities portfolio, it's much more likely that they're going to want to own mortgages or Agency MBS in that environment because there you can actually buy a longer-term security, hedge the interest rate risk and still generate a positive return. It won't make sense for banks to own treasuries and then hedge the interest rate risk. There will be no return there.

So those are all longer terms factors that will have to develop over time, which will drive where our spreads ultimately are. But that's one of the reasons why I think they're going to stay high is because there is this need for a lot of capital to flow into the treasury and Agency MBS markets.

[Bose George, analyst]

Okay. Great. Very helpful. Actually, I just wanted to follow-up also on the book value update quarter-to-date. Just the way we track it, it looks like spreads at least versus swaps had widened a little bit across the curve. So just curious with your book value up, whether there was other factors should we look more at treasury swaps? Or just any color there would be great.

[Peter Federico, executive]

Yes. What I would say is, obviously, we have a little bit of a different duration position now. Our duration position is really neutral in the current environment. Our book value was up as Bernie mentioned, 1% to 2%. The coupon distribution of our portfolio helped us and obviously, the combination of swaps versus treasuries in our portfolio helped us. And the yield curve also has helped benefited us a little bit this quarter. So not much of a change in book value, but generally positive.

[Operator]

Our next question comes from Trevor Cranston from JMP Securities.

[Trevor Cranston, analyst]

Can you talk a little bit more about the movement in the duration gap positioning during the quarter and the decision to shift to a slightly negative position? As a second part of that, if you can maybe comment on if you think going forward, agency spreads are likely to remain correlated with the directionality of rates?

[Peter Federico, executive]

Yes, that's a really good question. Let's start with that because that's really a significant factor, and that's going to ultimately dictate to a large extent, where we operate from a duration gap perspective is what do we think mortgages are going to do with respect to interest rates and that correlation. Chris can talk a little bit about how that correlation has been and what we expect it to be going forward and what that means from a hedging perspective.

[Christopher Kuehl, executive]

Yes. So as Peter mentioned, our duration gap as of today is slightly positive, right around 0 given the move higher in rates, since year-end. But given the shift in sentiment with rate cuts now on the horizon, mortgages are trading shorter than they did last year, much of the last 1.5 years, relative to model durations, which makes sense as some of the higher rate tail scenarios have been sort of clipped or have become less probable.

And so given that mortgages can trade to shorter durations and with our portfolio having somewhat more call risk than extension risk, we're likely to try to maintain a near 0 to slightly positive duration gap in the current environment. I'd say, fast forward another 6 to 12 months, and if we find ourselves at rate levels with significantly lower rate levels with significantly more refinancing activity and the Fed is still running off its portfolio.

Then I think a case could be made for running a significantly longer duration gap as mortgage supply, both organic and Fed runoff would be much more sensitive or spreads would be much more sensitive to rate levels with spreads likely widening in a rally, tightening into a selloff.

But for moderate moves in rates from here over the near term, I think spreads are less correlated with rates than they have been for the last year or so. And so we're likely to try to maintain close to a 0 duration gap to a slightly positive duration gap over the near term in the current environment.

[Operator]

And our next question comes from Rick Shane from JPMorgan.

[Richard Shane, analyst]

Look, you talked a little bit about the -- about call risk within the portfolio. When we look at Slide 23, there are probably twice as many coupons on there as there were 3 years ago. When -- the issue is that stack gets bigger and bigger and we're in this incredibly strange environment, there's much, much more concentration of call risk at the higher coupons. You guys were pretty deliberate about moving up the stack and being willing to realize losses, when coupons were moving.

Should we expect that you will start to realize some gains? And again, I realize it's sort of indifferent economically, but will you start to move back down the stack in order to mitigate some of that call risk.

[Peter Federico, executive]

Yes. Sure, I'll let Chris talk about that.

[Christopher Kuehl, executive]

Yes. I mean, our weighted average coupon is still quite low relative to the production coupons. I think it's just over 480. The bottom line is the convexity risk on our portfolio has gotten worse given the 100 basis point rally over the last quarter, but it's still very low and very manageable.

Generally speaking, sourcing convexity through pool selection, still very attractive. We did add a small receiver option during the quarter as well traded lower. But implied vol is still relatively -- it's still very high relative to historical norms. And so again, we're likely to manage the negative convexity on the portfolio simply through delta hedging in this environment and through asset selection on the pool side, which almost always is cheaper than buying explicit protection on rates through the options market.

If implied volatility declines materially, you could see us do a little more on the rate option side. But over the for this environment, convexity risk, very manageable, largely through delta hedging and asset selection.

[Peter Federico, executive]

And just to add to that, Rick, when you look at that Page 23, you could see we provide our positions in those coupons. And you could see that the biggest positions are really in the 5% and 5.5% coupon. So you think about those positions relative to the current mortgage rate, which is still between 6.5% and 7% to Chris' point, we've moved -- in a sense, we're more exposed to the middle coupons as opposed to the highest coupon. So we still have a lot of room to rally in the mortgage rate before those refinance.

[Christopher Kuehl, executive]

The other thing I would just -- real quick, I would add is when you look at the percentage of specified pools in some of those higher coupons, look at the end notes on the composition. So 47% on average specified pools. But the next 20 -- actually close to 30% of the portfolio is also in pools with favorable convexity characteristics. They're just not on the lowest loan balance cuts. They're specified pool characteristics like low FICO certain geographies, investors, second homes, modified pools. So there -- we do have a -- again, the call risk on the portfolio at -- in the current environment is very manageable, given the composition of our holdings.

[Richard Shane, analyst]

Got it. Yes, it's interesting. When you look at the portfolio in aggregate, I agree with you 100% and definitely note the concentration in the 5% and the 5.5%, very slight amortized cost premium there. I was just more curious on sort of the tail of the 6% and the 6.5%, there is more premium and perhaps a little bit more risk in this particular environment.

[Christopher Kuehl, executive]

Yes. I mean the last thing I'd say on just sort of the prepayment environment. I mean, when you step back obviously, the vast majority of the universe has almost no incentive to refinance 98% of the universe. But the origination over the last 4 or 5 months is going to be very interesting just to observe speeds, given that, on average, that cohort will have a 50-ish basis point incentive to refinance. And lenders certainly have capacity. They're probably likely going to be willing to work then to capture what little volume there is.

And so that would argue for pretty fast speeds on the highest coupons that were originated, call it, through the August through November time frame. But there are other arguments as to why the S curves could be quite a bit flatter as well relative to what we saw in 2020 and '21?

[Richard Shane, analyst]

Yes. I'm guessing those 3.5% and 4% are going to be on the books for a really long time.

[Operator]

And ladies and gentlemen, our last question today comes from Eric Hagen from BTIG.

[Eric Hagen, analyst]

Just a follow-up on maybe the liquidity. How are you guys thinking about the amount of liquidity you're comfortable holding at these spread levels versus when spreads were wider. And maybe how does that amount of liquidity kind of play into the amount of leverage you're comfortable with at different spread levels? In shape of the curve and all that.

[Peter Federico, executive]

Yes. Well, I think', it certainly does. I mean, look, what we've learned over the last couple of years is that just generally speaking, the liquidity in the bond market, both for U.S. treasuries and Agency MBS is not what it used to be. And with the Fed changing its balance sheet with the amount of regulation post great financial crisis. We now know that the major source of demand for both treasuries and mortgages can be money manager bids, which tend to be very volatile and directional with interest rates.

So we know that the market is less liquid, and that obviously matters from a liquidity perspective. And what we're always trying to do is put ourselves in a position, where we're never being obviously forced to delever. We always want to manage our liquidity position such that when we get to extremes and interest rates and spreads, you're still comfortable holding positions. That doesn't mean that we're not going to make decisions because at those times where we think there's still -- the environment is changing.

But from where we sit right now, we're in a really efficient position from a capital position, and you can see that in the percent of unencumbered that we have. That gives us a lot of flexibility to operate with higher leverage and still be -- still have a liquidity position that's consistent with where we've operated historically. So we're always trying to refine and improve the efficiency with respect to our capital position and are unencumbered.

So we're able to operate with incrementally higher leverage with in a sense, the same amount of unencumbered capacity to withstand these episodes that the market does go through, where you have sort of gaps in bids and volatility spikes, and you have to be able to endure those environments. And now what we're learning is they happen, they're going to continue to happen. But also if you're well positioned for them, you can wait it out and ultimately, the market will return back to normal levels, and that's what we're seeing now. So it gives us greater confidence going forward, and we'll be able to adjust our leverage position accordingly for that.

[Operator]

And ladies and gentlemen, with that, we'll conclude today's question-and-answer session. I'd like to turn the floor back over to Peter Federico for any closing comments.

[Peter Federico, executive]

Again, thank you all for participating on our call today, and we look forward to speaking to you all again at the end of the first quarter.

[Operator]

And with that, ladies and gentlemen, we'll conclude today's conference call. We thank you for attending today's presentation. You may now disconnect your lines.