AGNC Investment Corp. (AGNCL) Q2 2019 Earnings Report, Transcript and Summary

Good morning, and welcome to the AGNC Investment Corp. Second Quarter 2019 Shareholder Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Katie Wisecarver in Investor Relations. Please go ahead.

Thank you, Allison, and thank you all for joining AGNC Investment Corp.'s second quarter 2019 earnings call. Before we begin, I'd like to review the Safe Harbor statement. This conference call and corresponding slide presentation contain statements that to the extent they are not recitations of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act. Actual outcomes and results could differ materially from those forecast due to the impact of many factors beyond the control of AGNC. All forward-looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice. Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in the Risk Factors section of AGNC's periodic reports filed with the Securities and Exchange Commission. Copies are available on the SEC's Web site at www.sec.gov. We disclaim any obligation to update our forward-looking statements unless required by law. An archive of this presentation will be available on our Web site, and the telephone recording can be accessed through August 8th by dialing 877-344-7529 or 412-317-0088, and the conference ID number is 10132872. To view the slide presentation, turn to our Web site, agnc.com, and click on the Q2 2019 Earnings Presentation link in the lower right corner. Select the webcast option for both slides and audio or click on the link in the conference call section to view the streaming slide presentation during the call. Participants on the call today include Gary Kain, Chief Executive Officer; Bernie Bell, Senior Vice President and Chief Financial Officer; Chris Kuehl, Executive Vice President; Aaron Pas, Senior Vice President; and Peter Federico, President and Chief Operating Officer. With that, I'll turn the call over to Gary Kain.

Thanks, Katie, and thanks to all of you for your interest in AGNC. The rapidly changing interest rate environment was the key theme that dominated financial markets during the second quarter. In response to continued global economic weakness, ongoing trade uncertainty, and declining inflation expectations, almost all major central banks signaled a willingness to lower short-term interest rates, and in some cases potentially add further monetary policy accommodation through quantitative easing or other measures. In response, the entire interest rate complex rallied significantly with the one to three-year part of the swap curve leading the way. Two-year swap rates dropped 57 basis points during the quarter, while 10-year swaps declined 45 basis points. The treasury curve underperformed the move in swaps, but the yield on the two-year treasury still rallied 51 basis points, while the 10-year feel 40 to just over 2%. Risk assets performed reasonably well as expectations for central bank accommodation outweighed the weakness on the global growth front. During the second quarter, credit spreads tightened modestly, and equities added to the gains achieved in Q1. Agency MBS spreads on the other hand widened as growing prepayment concerns and the inversion in the front end of the yield curve pushed risk premiums higher. The wider agency MBS spreads drove the decline in our book value during the quarter, and the negative 0.9% economic return. Additionally our net spread and dollar roll income continued to face headwinds from elevated government repo rates relative to LIBOR. As we look ahead, however, there is reason for optimism on a number of fronts. First and foremost, as Chris will discuss shortly, our portfolio is very well positioned to navigate today's elevated prepayment environment. Secondly, by significantly increasing our short-term swap hedges late in Q2, we were essentially able to lock in most of the economic benefit we would have achieved from a hundred or more basis points in future fed rates cuts. Peter will expand on this shortly, but this action should minimize the earnings impact of the inverted curve over the next several quarters. Lastly, while the underperformance of government and agency repo has been a significant headwind for us over the last three quarters, our funding relative to LIBOR has begun to improve from late Q2 levels, and we are hopeful this momentum can be sustained during the second-half of the year as the fed lowers rates and ends its balance sheet runoff. Furthermore, if we take a step back and look at the big picture there is another reason to be optimistic. While a lower interest rate higher prepayment environment presents some risks, it also provides us with a substantial opportunity to generate excess returns. This is especially true for an investor like AGNC with a proven track record managing the intricacies of asset selection in falling rate environments. To this point, although future performance is uncertain, it is worth noting that our best returns have historically occurred in low-rate faster prepayment environments. Lastly, before I turn the call over to Bernie, I do want to quickly mention that our Board of Directors approved up to $1 billion in share repurchases. Our prior repurchase authority expired in December of 2017. Given the recent volatility in the stock, we decided to put the program back in place as a precautionary measure so we are in a position to react if share repurchases are accretive to stockholders. At this point I will ask Bernie to review our financial results for the second quarter.

Thank you, Gary. Turning to slide four, we had a total comprehensive loss of $0.15 per share for the quarter. Net spread and dollar roll income excluding catch-up am was $0.49 per share or $0.03 lower than the first quarter as continuing elevated repo funding cost and faster prepayment expectations adversely impacted our earnings. As I mentioned on our last call, our accounting yields are based on lifetime prepayment assumptions which take into account forward interest rate expectations rather than actual CPRs for the quarter. Given the decline in rates, our forward-looking CPRs increased to 12.4% as of the end of the second quarter from 10.5% last quarter, and drove a $0.02 decline in our net spread and dollar roll income from the resulting increase in premium amortization expense. As Chris will discuss shortly, although our actual CPR for the quarter was up, it remained well-contained, at 10%, materially lower than prepayment speeds observed on generic higher coupon MBS due to the favorable prepayment characteristics of the majority of our holdings. On the funding side, our repo cost was largely unchanged from the prior quarter. The higher than expected funding cost was somewhat offset by better carry on our swap position, but still resulted in a $0.01 decline in net interest spread and dollar roll income. Tangible net book value decreased 3.8% to $16.58 per share at the end of the quarter due to wider mortgage spreads, partly offset by the continued out-performance of our specified pool holdings. Including $0.50 of dividends declared for common share, we had a negative economic return of 0.9% for the second quarter. Thus far in July, our current estimate is that our tangible net book value has improved 2% to 3%. Moving to slide five, we operated with an average at risk leverage ratio of 10 times our tangible net equity for the second quarter, up from 9.3 times for the prior quarter. And we ended the second quarter at 9.8 times leverage. With that, I'll turn the call over to Chris to discuss the agency market.

Thanks, Bernie. Let's turn to slide six. The second quarter was a volatile period for the rates markets. 10-year treasury yields initially traded higher, hitting 2.6% in the second week of April and later than rally 60 basis points to end the quarter at 2%. Given the sharp move of lower run rates and growing prepayment concerns, agency MBS underperformed both swap and treasury hedges during the quarter. Specified pools underperformed to a lesser degree with the weighted average pay up on our portfolio increasing just over 5/8 of a point during the second quarter. In contrast, as Gary mentioned residential credit, high yield, and investment grade corporate debt performed well benefiting from the abrupt shift in fed tone and market expectations for easier monetary policy. Turning to slide seven, you can see that the investment portfolio increased to a $104 billion as of June 20. During the quarter, we continued to reposition the portfolio to optimize performance in today's faster prepayment environment. We sold approximately $8 billion relatively generic 30-year 4 and 4.5% pools in TBA versus adding predominantly lower coupon 30-year MBS. In the current rate environment holding positions in TBA 30-year 4 and 4.5% MBS generates negligible income as evidenced by dollar roll price drops trading close to zero given the combination of fast repayment expectations and the inversion in the front-end of the yield curve. Turning to slide eight, we have a table highlighting the importance of asset selection in the current environment. Here we provide a more detailed breakdown of our specified pool holding by coupon with our most recent CPR compared with where lesser quality TBA deliverable pools are currently prepaying. In today's environment, 30-year 4s and 4.5 are clearly the biggest area of concern. And as you see from the table, the vast majority of our higher coupon holdings are in pools with characteristics that significantly mitigate prepayment risk. In the case of 30-years and 4.5s, 79 and 91% of our holdings respectively are in high quality specified pools. Our goal with specified collateral is to protect the portfolio in areas that are most exposed to prepayment risk. With respect to lower coupons, the benefits of high quality specs are less compelling as prepayment differences assuming overweigh the absolute worst calls are relatively small. Role financing is also more attractive in lower production coupons. In the months ahead, asset selection will be critical to strong performance, and we view the current environment as an opportunity to take advantage of the substantial prepayment risk premiums that are priced into the market with the goal of translating them into excess returns as we have been able to do in past low rate environments. I will now turn the call over to Aaron to discuss the non-agency sector.

Thanks, Chris. Please turn to slide nine. And I will provide a quick update on our credit investments. Our credit portfolio totaled $1.7 billion, roughly 4% of equity at the end of the second quarter, down marginally from the first quarter. The composition of the portfolio is largely constant that we did sell our remaining Jumbo 2.0 and re-performing loan backed AAA securities. Spreads for those two AAA sectors tightened meaningfully in Q2 despite increased capacity concerns related to the underlying cash flows. Despite a move wider in credit spreads and risk assets in May, fed rate cut expectations lifted risk assets throughout the remainder of the quarter and generally closed the quarter at or near their tights. Mortgage rates fell further in Q2. And while we don't expect a continued decline to drive year-over-year home price appreciation back into the upper single digits, the decline will serve to some affordability issues and ultimately lead to a better backdrop for the housing market. As it relates to mortgage credit, the tightening in corporate credit and structured product spreads coupled with much lower mortgage rates resulted in a relatively favorable backdrop. Faster prepayment expectations on certain securities has materially reduced the amount of credit risk embedded in these cash flows through reduction and expected defaults providing a further tailwind to the improved macro environment. While CRT and other mortgage credit spreads are relatively tight at this point, they are understandably so. Lastly, the tables at the bottom of the slide help illustrate the bias we have in residential mortgage credit towards that of lower price tones over Jumbo that I mentioned on last quarter's call. As you can see our CRT exposure is almost all below investment grade. While we have made some investments in new issues securitizations backed by Jumbo and confirming loans, we generally have an open credit bias. With that, I will turn the call over to Peter to discuss funding and risk management.

Thanks, Aaron. I will start with the review of our financing activity on slide 10. Our average repo funding cost in the second quarter was 2.62%, down just two basis points from the prior quarter. This minimal decline is in sharp contrast to other short-term money market rates like three-month LIBOR, which experienced a much more significant decline. The elevated repo rates are a continuation of the pressure that showed up late last year and that has persisted now through the first two quarters of this year. On slide 11, we provide two graphs that highlight the divergence between our repo cost and other key interest rates. Unlike our repo funding, these other rates did reprice during the quarter to reflect the increased probability that the fed will soon begin to lower the federal funds rate. First, the graph on the left shows our average repo cost each day as compared to the rolling average three-month LIBOR rate. As we discussed last quarter, this relationship which turned negative earlier this year is an important driver of our aggregate cost of funds. This negative trend continued in the second quarter as evidenced by the divergence between these two lines with three-month LIBOR being about 15 basis points below our average repo rate at the end of the quarter. Also noteworthy on this graph is the repo line itself which clearly shows the unusual tightness in the repo market and the corresponding rate spikes that have occurred over each month end. Looking ahead, I expect our repo funding levels to improve further as the fed cuts rates and eventually ends its balance sheet run off. The graph on the right side of the slide shows the dramatic re-pricing that took place in the swap market over the quarter relative to our repo cost. The bar show our average repo cost followed by quarter-end swap rates across the curve. The two lines across the top show the swap curve at year-end and again at the end of the first quarter. As you can see, swap rates in the one to five year range experienced the most dramatic re-pricing with a big piece of that move occurring in June as the market aggressively reset to the new short-term rate outlook. As we show in the table at the bottom by quarter-end two and three year swap rates reflected at least three rate cuts. With the pay fixed rate on shorter term swaps well below 2%, the carry profile on these swaps turn meaningfully positive in the second quarter and provided us the opportunity to lock in more attractive funding levels. To take advantage of this opportunity, we significantly increased our position in one to three year swaps during the quarter. Because many of these swaps were added in June when the rates were at or near their lowest point, the benefit of these new swaps will not be fully reflected in our cost of funds until the third quarter. This benefit coupled with the improvement we expect in repo levels should put downward pressure on our cost of funds in the third quarter. Slide 12 highlights these changes to our swap portfolio in greater detail. In aggregate, we increased our hedge portfolio to $88 billion and our hedge ratio to 91% of funding liabilities. The biggest change as I mentioned came in our swap book which we increased to $75 billion and now covers 78% of our funding liabilities. The quarter-over-quarter increase was driven by the addition of about $30 billion of one to three year swaps. Additionally, given the 5 to 10 basis point tightening in swaps spreads across the curve, we opportunistically shifted a greater share of our hedges from short Treasury positions to pay fixed swaps. On slide 13, we show our duration gap and duration gap sensitivity. Despite this significant rally in interest rates and the large increase in the notional value of our swap portfolio, our duration gap only shortened by about a quarter of a year as essentially all of the incremental negative duration of the new swaps was offset by reductions in our intermediate and longer term Treasury and swap hedges. Today, our duration gap is again slightly positive as we continue to believe that mortgage spreads are biased to widen in a rally as prepayment concerns continue to rise. Against this backdrop, we believe a small long duration position is desirable from a risk management perspective. That said, with the aggregate duration of our asset portfolio now less than three years, we also added some incremental optional protection as we need to be mindful of the growing extension risk in our portfolio and in the mortgage market as a whole. With that, I'll turn the call back over to Gary.

Thanks, Peter. And at this point we'll open up the call to questions.

Thank you. We will now being the question-and-answer session. [Operator Instructions] Our first question today will come from Bose George of KBW. Please go ahead.

Hey guys, good morning. Actually first just wanted to check on the spread on new investments now and I guess towards the end of the quarter as you were sort of capturing the benefit of the lower swap rates.

Given obviously the shape of the curve and the fact that short rates are somewhat in flux, and obviously given the fact that prepayment variability is greater, I think there is more uncertainty realistically around the investment spreads. It's hard to quite a specific number so to speak. That said, I think there 90 basis points is still a reasonable kind of starting point for that. And obviously there's also the variability in LIBOR versus repo that plays into that.

Okay. And then, I mean to the extent that the fed cuts one or -- whatever, two or three times, but I guess given the positioning of your portfolio now does that change things in terms of your return or -- given how much you've swapped you've kind of, I guess, locked in a lot of your returns.

Yes. To your point we have locked in a lot of that. Now importantly, we didn't get any -- or we got very, very little of that benefit in Q2 because we increased the swap portfolio very late in the quarter. And the compelling kind of driver there was the significant decline in shorter swap rates. So at this point, given our high swap hedge ratio, only like a quarter of that benefit in theory will factor in, in terms of what the fed actually does in a sense to your -- again, we were able to in a sense monetize the expectations for rate hikes. And so there is less variability and for us in terms of what the fed actually does, and importantly exactly when they pull the trigger on the eases. So we feel good about that, and felt like that was an opportunity that we were supposed to take advantage of.

Okay, thanks. And then actually just one on leverage, your leverage ticked up a little bit, mostly I guess on the mark-to-market. Can you just give us updated thoughts on leverage, where we could see that in the back-half of the year and into next year?

Yes, I think at this point we've talked a lot about leverage over the last couple of years. I think our leverage at this point is kind of within the range that we would likely expect it to be over -- let's say over the next year. I mean certain it could tick up from here. I mean I think we'd be very comfortable with leverage being in the 9.5 to 10.5 kind of region on an ongoing basis, and we'd be comfortable with it outside of that range for a short period of time. But I think at this point most of the adjustment to leverage has been implemented, so to speak.

Okay, great. Thanks.

Thank you.

The next question will come from Douglas Harter of Credit Suisse. Please go ahead.

Hi. Gary, on the last call you talked about being in a lower volatility environment and kind of a greater expectation of being able to achieve kind of your dividend yield as kind of an economic return. Obviously the world has gone through a bit of a change or the environment has gone through a bit of the change in the last quarter, just wondering if you could update kind of on your thoughts around that comment and kind of the achievability of economic returns.

So very good question, and clearly, as I said in my opening remarks, the mortgage market has priced in greater prepayment risk premiums. We have sort of a non-standard yield curve at this point. But the yield curve is also a temporary situation in that the curve is pricing in the expectation of relatively near-term fed rate cuts. So I think that will -- I think the yield curve component of uncertainty hopefully will be -- a lot of that will be kind of rectified over the remainder of this year. And so the earlier question, I think we've been able to largely insulate our portfolio going forward from a fair amount of the uncertainty there. So that leaves the other kind of piece being the prepayment piece in terms of variability to our kind of true economic returns, and that's an area that we feel really good about. So what I had said last quarter was I thought we were looking at a world where potential returns were lower but the probability of kind of being able to achieve that was higher. Where -- I mean if you look at our history we seem to be entering a world where a lower rate faster prepayment environment, where if you look at our economic returns over our over 10-year history those have been the periods of our best realized returns. And so honestly I do feel that the prepayment risk quotient clearly has gone up. I think that we're not quite sure how this -- how quickly the fed will cut rates and to what extent. But I think what's really important and most important to not getting a negative surprise on the rates front is the inflation outlook. And I think what I really think has solidified over the course of this year more so than a few rate cuts, is that the global appreciation for the fact that inflation is not going to be a problem on the high side I think has so solidified that a significant up-rate shock is highly unlikely, and that makes managing the portfolio much easier. Not to say that we have to put on some option hedges and we do need to be cognizant that rates can always go up, but I think practically speaking the inflation picture is very benign. So that leaves a question about lower rates and prepayments, and that's just something we feel very comfortable dealing with. So big picture, yes, more volatility, but also we may be heading to an environment that historically has been very favorable for us.

I guess just on that, can you just talk about kind of how the portfolio's position from a risk perspective from either kind of a further decline in rates or kind of a surprise increase in rates and kind of the relative risk positioning of those two scenarios?

Sure. I mean if you look at slide 13, it shows our duration gap sensitivity at the end of the quarter. As Peter mentioned, our duration gap is a little longer at this point, even though rates really haven't changed that much. But realistically there is variability in the duration gap. The other thing that we evaluate is what is likely to happen to spreads if we were to get a 50 basis point rally or if we were to get a 50 basis point sell-off. I think clearly the rally scenario, a further decline would be pressure on mortgage spreads relative to a 50 basis point increase which would alleviate basically all of the prepayment uncertainty and get back to very comfortable rate levels. So with that in mind, I think our mindset is to run with a small positive duration gap as some protection against a rally, which is clearly still a material possibility. So, big picture, our bias is to protect a little more against the downside. Also keep in mind that it also matters where your hedges are, and not just the duration gap, and I think it's important, as we just talked about, both on the -- in our prepared remarks and answers to the prior questions, most of our negative duration now is coming in the very front-end of the curve, where -- what we've done is we've locked in kind of expectations for the fed funds rate over the next couple years. So, if it turns out that the fed cuts rates a little faster than that, we're likely going to end up with a steeper yield curve, and that's also a favorable situation for us. So it's not just the duration gap. It's also a function of where are your hedges and I think with our hedges being in the front-end of the curve, then that reduces kind of risk in terms of in a big rally.

Thanks, Gary.

Thank you.

Our next question will come from Trevor Cranston of JMP Securities. Please go ahead.

Hey, thanks. I have a follow-up related to the comments you just made Gary about, the risk of rates going either down or up. I guess first, that you made the comment that if rates were to say increase 50 basis points, it would alleviate a lot of the prepaid concerns and presumably be a positive for spreads. I was wondering if you can comment on how you think your spec pools specifically would perform in that type of environment given how far payoffs have increased. And then second, part of the question would be, if we did get an incremental move down in rates if you guys could maybe provide some color on, how much incrementally of the mortgage market would be re-financeable if sale rates rallied another 50 bips. And if you think the magnitude of widening in that scenario would be similar to what we got this quarter or maybe a little bit less, given how far rates have already come down? Thanks.

Sure. Good questions. So first off, if we did get the -- if 10 -- if the 10-year backed up to the 2.5% area, yes, specified pay-ups will drop. Of course, we build in incremental duration for specified pools, but would they underperform TBAs in that scenario? Yes, they probably would, but it would be sort of, it would be probably a little less of a reversal to what we have seen. In other words, I think they'd still be valued better than they were -- the last time we were at 250, because of both the scarcity of them and the kind of recent realization of how valuable they are in certain coupons. So I think that's the best way to think about that. I'll let Chris talk to you about the second part of your question.

Hey, Trevor. So, the only thing I'd add to what Gary said about spec pools is that, I think they would be more risk in the up 50 scenario, to the extent that they were really overvalued while they've done well, here today, I'd say they're appropriately valued for the current environment. So the other thing I'd say is that, a lot of our specified pool positions are lower loan balance pools, which get a lot of their convexity benefit from call protection, but they also generally have faster turnover as well. And so, in the upgrade scenarios that can help as well, but back to your question on, and just the percentage of the universe that's refinanced today. With a 4%, primary mortgage rate, it's about 30%, down 25, that number goes to about 40, call it mid-40s, and then down 50, it's probably mid-60s, percent of the universe that would be exposed to a 50 basis, point incentive to refinance. And then, in terms of I think the last part of your question was around, what kind of widening could we expect in mortgages? And I think it's going to be very coupon dependent, but I think it's logical to assume something on the order of, 10 to 15 basis points in, something like 50 basis point move, but it's going to depend on a lot of other factors curve and other things. But again, it's going to be coupon specific, and so it's hard just to throw a number out there.

Great. Okay. I appreciate the comments. Thank you.

The next question will come from Rick Shane of JP Morgan. Please go ahead.

Hey, guys. Thanks for taking my questions and looking at Peter slides on repo and LIBOR, it's clear and we've gone back and looked at this, it's clear that there is some sort of data or lag in those new or low beta or some sort of lag in this movement. But when we look at the current trend, it does look like something structurally has shifted on, do you think that will just be a longer lag, or do you think that there's behavior that's going on? That's going to cause that thread to be more persistent?

Yes, that's a great question, and I think you're right to an extent. And I think that's really the fundamental thing that's going on is why the fed ultimately has changed his balance sheet run up, which it's understanding now better today, that the essentially the entire system needs more reserves in it. And so, it's ending its balance sheet run off to in the sense limit the drain of supply out of the system, and it's making the system I think, just tighter than it should otherwise be. So that's one of the sort of macro factors that I think the fed now understands. And it's one of the reasons why I think it is likely that the fed will introduce some sort of repo facility between now and the end of the year to help address this sort of structural issue. The other is that we have a lot of variability in treasury bill supply. Now the debt ceiling is another example of that where between now and the end of the year, we are likely going to have about $200 billion worth of treasury bill supply, which is going to put some incremental pressure on all of the money market rates and on repo level. So those are sort of the macro factors. That said, I do believe that this trend is not going to deteriorate further and I do believe over the longer term it is going to improve again, I will give you an example. During the quarter, you just looked at our three months, where you could fund three months repo each day versus the prevailing three month LIBOR rate, that relationship deteriorated by about 15 basis points, we started the quarter funding about five or six basis points through repo and ended the quarter at about 10 or so above repo. So there was about a 16 or 17 basis, point deterioration. And that shows up in that graph that I put on that page as well. But since quarter end, we've seen about a 10-basis point improvement. And today, for example, if we were to go out and borrow a three months repo, we will be doing so at around the three-month LIBOR level. So there's a lot of variability. There's a lot of big forces going on right now, but I do think we're trending in the right direction. But a lot can happen, and it's going to be variable between now and the end of the year.

Got it. That's very helpful. Thank you.

Sure. Good question.

And the next question will come from Jim Young with West Family Investments. Please go ahead.

Yes, hi Gary, just a little bit more of a macro question, but when you look at that about the liquidity as being add into the overall system, you get the fed, which is likely to cut rates next week, and you got the ECB with dragging on the tape this morning saying. They are going to continue lower rates with them? My question overall, is when you think about over the next couple of years, what implications and ramifications does it have for the global economies for investments overall, and not just I'm not just alluding to referring to mortgage investment? Thank you.

Sure, and a good question. I think we sometimes like, just take each week or months new incremental news and just build it into kind of the overall picture, but I think it is important sometimes to take a step back and say, "Well, what's going on?" I think there are two things. One is that inflation expectations obviously have disappointed central bankers. And honestly, despite the actions that are likely to be taken this year, I don't see that changing. I think we're in a different environment, and it has globalization technology. There's a lot of factors that are going to make inflation really hard to come by. And if we couldn't generate inflation, with very low unemployment and very accommodative monetary policy over the last five years. It's hard to see that happening over the next five. So I think what -- I think what you're going to see is that we're in this very low rate environment for a while and central bankers are going to continue to be fighting what I think is a losing battle against inflation. And so what is that mean, I think first what it means is that when you look at the asset prices in the U.S., they're going to continue to be supported. They're going to be supported because there's nothing to buy outside of the U.S. especially it's obvious and obviously on the fixed income side is the most striking example of that, but when you think about some of the things like increased debt issuance in the United States that's nothing compared to the lack of any positive returning safe instrument outside of the U.S. So I think again financial instruments are going to have a sort of continued support like what they've seen this quarter where the assumption is where central banks are supporting risk taking, so to speak or almost forcing it. That said we're in a long run. This expansion has gone on a long time. And if you look outside of the U.S., it appears to be ending and I don't think the central bank actions are going to change that, and I don't -- and I also don't think it's just China trade deal if it were to happen changes that. So I do think we are looking at a weaker economic environment at some point. I mean we've seen some weakness but I think it gets much more noticeable maybe a year to two years from now. And unfortunately I think central banks are sort of out of ammunition. So when that occurs, I think what you'll notice is maybe not the severity of it early on but maybe it's longevity. I think that might be the difference going forward but hopefully that answers your question. I know it's a topic we could talk about for a long time.

Okay, thank you very much.

Our last question today will come from Matthew Howlett of Nomura. Please go ahead.

Thanks for taking my question. And there's a lot of sort of moving parts with the NIM and looking just to 3Q, I mean you're going to get some benefit clearly in the funding side. It mean I know you sort of model, you come for the prepayments a little bit differently than some of the others. Is there sort of any color you can give us in terms of the trend in margin in 3Q with everything all the moving parts?

It's a very good question. We don't like generally to give forecasts but we've touched on some of the drivers obviously prepayment speeds, we project prepayment speeds, so short-term prepayment outcomes aren't likely to be a big driver. On the other hand, interest rate movements can change our projected prepayments speed. So that's kind of that variable. On the funding side, we expect we're hopeful that we're turning the corner. I think we've talked about that. But most importantly it really comes from the other driver of cost of funds which is the swap portfolio and the ability in a sense to lock in significant positive carry there. And so that should be a tailwind in going forward that in the absence of something else kind of negatively impacting things that tailwind should help us.

Got it, and let me -- and you sort of mentioned that, you don't want to get pinned down to the 90 basis points but let me ask you this, what scenario could that that spread go lower to the new investments. In other words, you think existing mortgages will widen as if rates go down. I guess what's the scenario where the spread even goes below 90 or goes a lot lower given unless the Fed's going to increase rates, it does the tenure goes to 150, that could jeopardize that investment spread, do you think we've sort of bottomed out here at 90 bps?

I think further rally in rates won't hurt that spread as we've said, I think mortgage spreads widen to the extent that the Fed is lowering interest rates, we will probably get rid of this inversion. So I don't think it occurs there, I think it's mortgage spreads tightening with long rates sort of backing off a bit and prepayment fears sort of getting priced out of the market. I mean again just one of the things that one of the reasons why we have historically done well in lower rate faster prepayment environments is because as an agency mortgage investor, we get paid to take prepayment risk. That's our biggest source of income in a sense. And so, in an environment like today and an environment where rates are continuing to fall, the amount that we're going to get paid to take prepayment risk is going to continue to go up and as long as we make good decisions around what -- where we take that risk then our spread opportunities are probably larger. Again I think going back to kind of the 250 everything flat world that we were looking at is three to six months ago that was an environment where we were in a very -- we were in a low spread environment. And that's kind of if we went back there and we did and we didn't seen improvement in the funding front than you could see the sub-90 type spreads.

So, just last thing, just any quick comments on the single security to going live, I mean you've talked a lot about prepayments just any overall comments on that and the impact if any AGNC?

I would say the single security really was largely a non-event. Now it's interesting when you talk to people you sometimes don't hear that because TBA quality has worsened over the course of the end of last year and the beginning of this year, but those things had happened already, the other kind of material issue that has impacted kind of the way dollar rolls have traded and TBA performance, price performance is a fact that the Fed hasn't been buying mortgages, so that the tradable supply of kind of weak pools has been much greater than it was in prior rallies. So, some people will -- logically given the fact that this just happened a few months ago, will attribute some of those dynamics to the single security, big picture, Freddie prepayments have been a little faster than Fannie's or are a couple little things to keep track of, but the bulk of what we've seen in the market was going to occur either way and it was a function of these other factors, not the single securities. So from our perspective, single security, our UMBS has not been a big picture factor and isn't likely to be going forward.

Really appreciate comments. Thank you.

Thank you.

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

I'd like to thank everyone for their participation in our Q2 earnings call and we look forward to speaking to you next quarter.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.