AGNC Investment Corp. (AGNCO) Q3 2021 Earnings Report, Transcript and Summary

Good morning everyone, and welcome to the AGNC Investment Corp. Third Quarter 2021 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 would like to turn the conference call over to Katie Wisecarver in Investor Relations. Ma'am, please go ahead.

Thank you all for joining AGNC Investment Corp Third Quarter 2021 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're 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 website at sec.gov. We disclaim any obligation to update our Forward-looking statements unless required by law. Participants on the call include Peter Federico, Director, President and Chief Executive Officer. Bernie Bell, Senior Vice President and Chief Financial Officer. Chris Kuehl, Executive Vice President and Chief Investment Officer. Aaron Pas, Senior Vice President of Non-Agency Portfolio Management, and Gary Kain, Executive Chair. With that, I'll turn the call over to Peter Federico.

Thanks Katie, and thank you to everyone on the call today. We are very pleased with our third quarter financial results. Economic return for the quarter totaled 2.3%, while net spread and dollar roll income came in at $0.75 per share in line with the previous three quarters. Our economic return for the year is now 4.7%, which I believe speaks to the strength of our business model given considerable interest rate volatility, elevated prepayment speeds, spread widening, and the Fed's progression toward asset tapering. The message that we communicated last quarter was one of cautious optimism and a desire to maintain portfolio flexibility. We identified several risks that shaped the agency investment landscape, including uncertainty with respect to the timing and duration of Fed tapering, two-way interest rate risk, and elevated prepayment speeds. In the third quarter, there were positive developments regarding each of these risks. With respect to asset tapering, the Fed's anticipated timeline is now known, and market expectations are well aligned. The most likely scenario is that the Fed will announce tapering at the November meeting, commence tapering in December, and reduce MBS purchases by 5 billion per month over an 8 month period. Under this approach, the Fed will purchase close to $200 billion of agency MBS between now and July of next year. Once tapering is complete, and this is a very important point, the Fed will continue to buy billions of dollars of agency MBS on a monthly basis as they reinvest the paydowns on their existing portfolio. The Fed's reinvestment program will likely continue for a significant period of time, and should be a positive technical for agency MBS. The interest rate in prepayment environment also improved in the third quarter, with intermediate and longer-term rates increasing late in the quarter. Primary mortgage rates are now about 40 basis points above the February low of 2.8%. This increase in rates should lead to a more benign prepayment environment and lower supply. Taken together, greater clarity from the firm, higher interest rates and slowing prepayment speeds create a more favorable backdrop for agency MBS, particularly given the spread widening that has already occurred. And while some spread volatility is possible during the tapering cycle, we do not expect significant widening as agency MBS already look attractive relative to other financial assets which still trade at or near historically tight levels. Projected returns on new investments were relatively unchanged during the quarter. Lower coupon TABs continue to offer the most attractive return at around 12%, including the additional benefit from favorable dollar roll funding. Returns on higher coupon MBS, meanwhile, remain in the high single-digit range. Spreads on most non-agency securities remain historically tight, keeping expected returns on these investments in the mid-single-digit range. As such, levered positions and agency MBS continued to look compelling on both an absolute and relative basis. While the outlook for agency MBS has improved relative to last quarter, there is still considerable uncertainty with respect to the broader economic and interest rate environment. Most notably inflation measures are elevated, and supply chain shortages and disruptions appear to be intensifying and more widespread. At the same time, the employment outlook appears to be poised for strong growth in the coming months as job vacancies outpace job seekers, unemployment benefits return to normal levels, and wages increase. As a result, the Fed's transitory inflation narrative could become increasingly difficult to defend. If inflation pressures persist or intensify further, there is a risk that the market and the Fed lose confidence in this view. In this scenario, expectations with respect to Fed actions could become increasingly difficult to predict. Given this macroeconomic uncertainty, we continue to favor operating with a more conservative risk profile. Looking ahead, we believe we are very well-positioned for the current environment with a well-balanced asset portfolio, significant hedge protection, and leverage at around 7.5 times. Together, this position gives us considerable flexibility to take advantage of attractive investment opportunities as they arise. With that, I'll now turn the call over to Bernie to discuss our financial results in greater detail.

Thank you, Peter. AGNC had total comprehensive income of $0.37 per share for the quarter. Economic return on tangible common equity was 2.3%, comprised of the $0.02 increase in our tangible net book value, and 9% annualized dividend yield for the quarter. So far for October, we estimate our tangible net book value is up marginally. Consistent with our decision to operate with lower risk in the current environment, our at-risk leverage declined to 7.5 times our tangible equity as of September 30th. Notably, despite our smaller asset base, net spread and dollar roll income remain very strong at $0.75 per share. We attribute this positive performance to a very strong funding environment, stable hedge cost, and favorable TBA dollar roll opportunities, which drove a 10 basis point increase in our net interest spread to 2.19% for the quarter. Our forecasted life CPRs decreased to 10.7% as of quarter-end, due to changes in portfolio composition and higher interest rates. Our actual prepayment rate for the quarter also trended lower at 22.5%, compared to 25.7% for the prior quarter. Our most recent prepayment rate published this month for assets held as of September 30th, decreased to a post-pandemic ROE of 19.8 CPR. Lastly, our unencumbered cash and agency MBS at quarter-end increased to $5.2 billion, which excludes unencumbered credit assets and assets held at our captive broker-dealer subsidiary. Importantly, as Peter noted, our strong liquidity position at 51% of tangible equity gives us considerable flexibility to opportunistically increase leverage. With that, I'll now turn the call over to Chris to discuss the agency mortgage market..

Thanks, Bernie. During the third quarter, the economy continued to make progress and the Fed did a good job setting the stage for an official announcement at the upcoming November meeting that it will soon begin to slow the pace of balance sheet growth. Importantly, the solidification of the timeline for tapering was achieved without market disruption, in sharp contrast to what happened in 2013. Interest rates were modestly higher with 5-year and 10-year swap rates increasing 8 and 7 basis points respectively. However, there was significant intra -quarter volatility with the Delta variant concerns driving 10-year yields down to 117 basis points in early August before selling off to end the quarter at nearly 1.5%. Fixed income spreads were relatively stable quarter-over-quarter with credit remaining near historical highs. Within the agency MBS sector, higher coupons outperformed as interest rates drifted higher, and actual speeds continued to show signs of prepayment burnout. Over the near term, the prepayment backdrop will likely continue to benefit from slowing seasonal factors and the move higher in rates since quarter-end. Lower coupon MBS modestly underperformed hedges as the Fed prepared the markets for tapering. It's anticipated that the Fed will deliver the official tapering announcement next week, and to reiterate, we do not expect a repeat of the taper tantrum or spreads widened materially. The funding markets for agency MBS remain incredibly deep and liquid, prepayment risk is trending lower, and cross-sector relative valuations continue to be supportive of agency MBS. And so while we do anticipate an increase in volatility with an active Fed, spread widening events will likely be shallow and provide us with an opportunity to increase leverage. As of quarter end, our investment portfolio totaled just over 84 billion down 3 billion from the prior quarter, and our asset composition was largely unchanged. With interest rates modestly higher quarter-over-quarter, our hedge portfolio was also relatively unchanged at 73 billion in covered 98% of our funding liabilities. [Indiscernible] portfolio now totals 13 billion and provides significant protection in the event that longer-term interest rates move meaningfully above 2%. Our duration gap at quarter-end was 0.4 years, little change from the prior quarter. In the current environment, we continue to favor a slightly positive duration gap given that we expect agency MBS to trade to relatively short durations, likely under performing on a rally scenario and outperforming in most higher rates scenarios. I'll now turn the call over to Aaron to discuss the non-agency markets.

Thanks, Chris. I'll quickly recap the quarter and provide a brief update on our current positioning. As Chris mentioned, credit spreads were mixed during the quarter and remain near post great financial crisis tights. At current spread levels, we would expect that future returns will be generated primarily from Kerry as opposed to further spread tightening. Turning to our holdings, the non-agency portfolio increased modestly in the third quarter to 2.1 billion from 2 billion as of June 30, 2021. The themes I mentioned in Q2 with respect to our portfolio activity generally continued. We continue to rotate a portion of our CRT holdings in the lower credit tranches, which we believe will enhance the return profile of our CRT portfolio based upon the underlying strength in the residential conforming mortgage market. And then on the CMBS front, we were able to find some attractive investment opportunities in single asset, single borrower deals. Lastly, on the RMBS side, we increased our position in AAA private label securities. Looking forward, the [Indiscernible] supply backdrop has shifted favorably as Fannie Mae has returned to the market. Just last week, Fannie Mae priced their first deal since Q1 2020. While issuance plans for 2022 to remain unclear, there will undoubtedly be more supply, which over time should lead to more attractive investment opportunities. That said recent transactions have included a five-year call option that allows the GSC's to extinguish their credit protection at that time. This option will somewhat limit total return potential for bondholders. Finally, I'll quickly touch on the non-agency repo market. There continues to be meaningful competition to lend against non-agency securities which has reduced both repo costs and haircuts. At quarter-end, our average borrowing costs had declined to 72 basis points over [Indiscernible]. Although the tightening and repo spreads has lagged the compression and asset spreads, it certainly has been a favorable tailwind. With that I will turn the call back over to Peter.

Thank you, Aaron. With that, we will now open the call up to your questions.

Ladies and gentlemen, at this time, we'll begin the question-and-answer session. [Operator Instructions]. If you are using a speaker phone, we do ask you please pick up your handset before pressing the keys to ensure the best sound quality. [Operator Instructions]. We will pause momentarily to assemble the roster. Our first question today comes from Kevin Barker from Piper Sandler. Please go ahead with your question.

Good morning. Thanks for taking my questions. It seems like the tone is shifting where you seem a much more proactive in an increasing leverage here in the near future, especially with some of the Fed's actions. I mean, are you seeing significant opportunity start to develop especially in the near-term or do you expect that leverage to really increase I guess over the coming months or coming quarters? Thank you.

Sure. Good morning, Kevin. Thank you for the question. What I would say is first let me sort of give you some perspective of where we were and where we think we are now. If you think back to Last Quarter when we talked about our Leverage Position, I sort of described it as being in the sweet spot at 7.5 times, meaning we could take it lower if we expected mortgage spreads to widen further in there, to be volatility around the tapering or take it up opportunistically. And as it turned down in the third quarter, things stabilized quite a bit, and the way I would describe our position today, we're still at around 7.5, but we see much less downside risk in the agency MBS market. There could be certainly spread volatility in the tapering cycle, but in spreads could in fact widened further. But any meaningful widening, we think will be met with strong investor demand, particularly because agency MBS look so attractive relative to other asset classes. Any cheapening, I think will be really quickly bought. So the way I would describe our position today is that we are more optimistic and more favorable with respect to the agency landscape and all other things equal, I do expect our leverage to increase over time. If you think back to where we operated on a historical basis, it was really be more something like 8.5 times to 9.5 close to 10 times would be our more normal operating range. In an environment where we are optimistic about agency MBS as well as the interest rate environment, and that's the one piece that we're still trying to communicate in our prepared remarks. We're still a little cautious about the macroeconomic environment because there are a lot of moving pieces right now, The Fed has a lot to do with respect to its inflation and its employment. And there could be potentially more interest rate volatility. So we're being cautious in our leverage position, But all that said, we do expect it to improve and increase over time, but we're going to do so really deliberately, really measured, and really try to be opportunistic with our investment choices. And we think we have the ability to do that. We're in a strong earnings position right now. So we have a lot of upside, but we want to be patient with our investment decision.

Okay. And then just a follow-up on some of your prepared comments, and correct me if I'm wrong, but --

Sure.

-- it appeared that you are expect more of the incremental economic return for shareholders to be driven more by dividends or earnings versus book value. Am I interpreting that correctly, or how should I -- your prepared comments?

Yeah. It's interesting observation what I would say is if you look back at Last Quarter, which is great example of I think what you just described in an environment where book value was really stable, just a slight positive. Essentially, all of our economic return was driven by our 9% annualized dividend. So that's very positive, and generally speaking, we are seeing more stability in book value from agency spreads right now. That continues to be the case into the -- into October here, we -- as Bernie mentioned in her prepared remarks, our book value was slightly positive. As we sit today, it's probably up around a 0.5%, maybe a little more than a 0.5% in October because mortgage spreads, again have been stable, higher coupons have outperformed slightly. Again, if that were the case, then your conclusion would be right that the majority of our economic return will be driven by the return of our dividend.

Okay. Thank you for taking my questions.

Sure. Thank you.

Our next question comes from Bose George from KBW. Please go ahead with your question.

Good morning. Just wanted to follow up on your comments about TBA, sorry just your comments on spread widening. And with the tapers starting that is likely to be modest. Now, could you quantify that a bit? I mean, is it like 10-15 basis points you think is where it could be met with strong demand or just your curious where you think -- how you think that plays out.

Yeah. Hi Bose. Good morning. Interesting question and the answer is we don't know. But I mean, if you look back historically, mortgages still do look tight on a historic basis. You can make the case that if you look back to previous cycles, maybe they could be 25 basis points wider. But we don't think that 25 basis points would be the right number in the current environment given where other returns are, given the interest rate environment, given asset valuations, generally speaking. We think that the right level for mortgages is here, or maybe slightly wider. But again, it's too soon to tell and we don't know how it's all going to play out. But at the end of the day, the key for the mortgage market is not only the Fed being really patient and deliberate in the way it's tapering. It also will be driven a lot by what the Fed does once the tapering is done and the reinvestment policy, and they've made some comments on that. But generally speaking, we think the Fed is going to be reinvesting paydowns for a considerable period of time, and that's going to be a really positive technical for the mortgage market. In addition, if you think about it, if we're right and the economy recovers and rates are higher, that means there's going to be less supply of mortgages, at the same time, the Fed will continuing to buy a lot of mortgages to replace its -- its runoff. So the environment could shape up pretty well for the mortgage market, but that's going to have to unfold over time. And then of course, we think just generally speaking, mortgages from other investors perspectives are relatively underweight. I think there's going to be a lot of demand for agency MBS. So there could be some spread widening but we don't expect it to be anything like we saw in previous cycles.

Okay, great. That's helpful. Thanks. And then, just switching over to TBA, this level of specialness. How does that look so far? In the fourth quarter and just looking out into next year, especially given what you mentioned with the Fed, how do you think TBA 's specialness will look next year?

Sure. I'll have Chris give you some more details on that. But just generally speaking, we expect that to remain really fairly attractive through 2022. Chris, go on.

Sure. So ROE traded very, very well during the third quarter or they're currently trading around negative 30 basis points in the case of 2s and 2.5, which represent the vast majority of production in 30s. And so negative 30 basis points, that's roughly 40% to 45% basis points of specialness versus repo. And as Peter said, despite tapering, the technicals are likely to remain strong. Well, implied financing rates will likely trend a bit weaker. I think they will continue to trade well through long-term historical averages for quite some time. And given that it's -- I'd say it's likely our ROE position will stay elevated in the $20 to $30 billion range, probably towards the upper end of that range. The backdrop for the ROE market is incredibly supportive, even with tapering, as Peter mentioned earlier, the Fed is likely to add a 180 billion in mortgages on a net basis between now and the middle of next year. and if QE3 can serve as a guide, the Fed will likely continue to reinvest runoff well into the next rate hiking cycle, which following QE3 took nearly three years before the Fed started tapering reinvestments. And so even after the Fed stops growing its balance sheet by the middle of next year, it's likely they are going to continue to take out probably 40-50 billion of the worst to deliver from the float each month just to reinvest in paydowns, but obviously depends on the level of rates and prepayments. But they're probably going to continue doing this well into the next rate hiking cycle. And that's an incredibly important dynamic for the market. I mean, prior to QE, the markets never enjoyed a consistent takeout of the worst to deliver float month after month with this consistency in magnitude. And so we think ROEs are going to continue to trade through historical averages for quite some time.

Great, thanks. That's helpful.

Thanks, Bose.

Our next question comes from Doug Harter from Credit Suisse. Please go ahead with your question.

Thanks. Peter, hoping you could talk a little bit about how you're approaching -- hedging the portfolio given the comments about the potential inflationary concerns and risk to rates.

Sure. Well, first off, I think this is an environment from an interest rate perspective where you're going to see us continue to be really active on the hedging side both in terms of the amount of hedges we have, and as you well know we're operating close with 100% hedge ratio and a relatively small duration gap. We're going to continue to keep our interest rate risk profile well-managed and low by historical standards because of the potential interest rate volatility and the interest rate environment that we may be in. But the other important point is to think about our overall hedge portfolio relative to the composition of our asset portfolio. We're going to continue to have a well-balanced asset portfolio between lower coupon TBAs and generic MBS and higher coupons. Those 2 instruments have different hedging needs, and you can see how our overall hedge portfolio sort of has developed along those lines. If you look at our hedge portfolio now, it's really well balanced across the curve from a duration perspective, about a third of our hedges are in the -- call it the 3 to 5 year sector, a third in the 5 to 7 year, and a third in the 7 to 10 year sector. So we're well balanced across the curve, which I think is important. You've seen us increase the optionality in our hedge portfolio and that really gets to, if we're going to be in an environment where interest rate volatility increases, we want to have more option-based hedges in our mix. As Chris mentioned, we added quite a bit of optionality to our portfolio; replaced some swaptions and added some other swaptions. It's close to around 20% of our hedge mix, so overall that's the kind of thing that you'll see us do is continue likely to add options, maintain a high hedge ratio, and if I had a pickup point of the curve if there is a lot of interest rate volatility and if there -- if we're right that there is some question around the Fed and its rate moves, they're likely part of the curve that will be most negatively impacted will be the middle of the curve right around the five-year part of the curve. And so five-year part of the curve, for example, has under performed this Quarter to date. And so you'll see us likely use that part of the curve from a hedging perspective a little bit more in an environment like we may be in with the Fed. So those would be the high-level comments with respect to our hedge approach.

Great. And then just following up as you were talking about portfolio construction, this covers whenever it may be the TBA specialness normalizes. I guess, how do you think about portfolio construction? The mix between TBA and [Indiscernible] in that environment whenever that may be.

Yeah. Well, first off, I think that that's ways away. As Chris mentioned, I expect us to have a sizable TBA position given the outlook that Chris just gave with respect to specialness, well into 2022 and maybe into 2023. So I think we're a long ways away from that, and I think that the movement down in specialness will be gradual when it does start to happen. But as you recall, there is typically always some level of specialness between the TBA in an on-balance sheet pool and historically it's probably 10-20 basis points, not to 50 that Chris just described. So there is always some benefit but then of course there's the trade-off and between the incremental return that we pick up from the TBAs and the underlying characteristics that we might be getting delivered, Chris just described that as being very favorable over the long run. That's really the question that we have to make from a portfolio perspective and we have to make that on a real-time basis. So I can't really sit here in today and say how the portfolio composition will change that far forward. But at the end of the day, we are always looking at those variables and trying to give ourselves the best diversified portfolio that gives us the greatest book value stability over the greatest range of rates, and give us the ability to generate the best carry we can for our shareholders so that we can generate the best economic return we can.

Thanks, Peter.

Sure. Thank you, Doug.

Our next question comes from Eric Hagen from BTIG. Please go ahead with your question.

Hey, thanks. Good morning. With mortgage rates just -- good morning. With mortgage rates just over 3% right now, premiums for higher coupons, spec-pools [inaudible 00:29:50] have held up pretty well. I guess the question is, what kind of sensitivity you envision there, if we're looking at mortgage rates pushing higher. And then can you also share the kind of mark-to-market sensitivity those bonds might carry at the short end of the curve.

Yes. Sure. Eric, Chris will take that and then I'll chime in.

Yes. So with respect to higher-coupon season SPAC, the important thing is that prepayment burnout has been a pretty consistent theme now for the last several months and given that we think valuations look fair, plus or minus 25 basis points durations. These bonds should continue to trade to pretty short durations. There's still price to fast prepayment speeds, which means that they have a fair amount of upside into higher rates. And so for that reason, as Peter mentioned, these positions really compliment our lower coupon holdings well, given that they'll benefit in some of the scenarios that are more difficult for lower coupons. Steeper curve, higher vol, wider park coupon spreads, and the positions effectively help flatten that convexity profile of the mortgage portfolio.

And Eric, what I would add to that is what we're seeing in the current environment is, as Chris described, gradual improvement in the prepayment outlook. And we're seeing burnout start to reveal itself and we expect that to continue. But we're also seeing the price changes of higher coupons reflect the progressions through the prepayment environment. Those positions have, as you well know, have been prepaying exceedingly fast for now 5 Quarters, but each month and each quarter that we move past another high prepayment speed, the price of those securities are improving. We saw that Last Quarter is why the higher-coupon prices went up, as we put another quarter of fast prepayment speeds behind us. Those positions are not carrying if you will, that their current yield on those positions at a 30 cpr is not very attractive. So each quarter that those prepayments speeds passed, the prices are improving. We expect that to continue. And then just to round this out to your point about the hedging, that was why I made the comment with respect to the composition of our portfolio and having a significant amount of our hedges on the shorter end of the curve, the 3, 4-year, 5-year part of the curve. Those hedges give us a lot of protection against this position as well as operating with a positive duration gap to give us some protection against mortgages under performing in a down-rate scenario. So I hope that answers your question.

Yeah. That was really helpful, maybe a quick follow-up on the conversation around burnout and speeds more generally. Can you guys share how you incorporate expectations for home price appreciation and modeling prepayment speeds?

Yeah. I mean, with mortgage rates having increased well off the lows, I think we're going to start to see focus on cash out, refis and just given some of the excess capacity in the market. And from the house price of -- the accumulated house price appreciation is a great thing from a mortgage investor's perspective. In that housing turnover as it materially improves the convexity of a mortgage position into higher rate levels, and so that could be a positive from a risk management perspective if rates continue to move higher. In that we should still continue to expect reasonably fast turnover.

Good stuff. Thank you very much.

Thank you.

Our next question comes from Trevor Cranston from JMP Securities. Please go ahead with your question.

All right. Thanks.

Good morning.

One more question around the taper, you guys talked about some of the macro uncertainties that are out there. Do you think there's any risk at this point that the Fed could change the taper timeline from what the baseline expectation now -- is now, if there's increasing concern about the level of inflation, and if there were to be a change in the timeline, I'm curious how you think the market would be able to digest that?

It's a good question, Trevor. The answer is obviously we don't know. I think the Fed has been so clear in its communication with what its preferred approach would be if you think back to where we were in the Second Quarter, there was lot of Fed discussion within the Fed. some in the Fed wanted a faster tapering timeline, 4 months [Indiscernible] meeting someone to do what they did last time. And they seem to have settled, the compromise position seems to be an 8 month approach. But I think the way that -- and they've indicated at this point they're ready to lift off and initiate, so I would be surprised if they didn't do that. Of course, with an 8 month approach, they do have the flexibility in that time period to either slow it down or to accelerate it. I'm sure they are not going to commit, but maybe just give us the indication that that's the direction they want to go. If they commit, that would be great, I think, for the stability of the market, but I don't think they would do that. I think they would retain that optionality. And so you're right, there is always a risk of that. And ultimately that could create some volatility that's why we are still a little bit cautious and we think it could present some attractive opportunities to add investments at debt in that period of time. But then the flip side of that is, even if they do accelerate it, going back to the point that Chris described, they are going to reinvest cash flows at that point. So in the end, they're going to buy a lot of mortgages next year, they're going to grow their balance sheet, and they are just going to net add a lot of mortgages and maintain that balance for some period of time. That's really, I think, going to be where the interesting dialogue starts to develop next year is how long does that reinvestment period last? And we're just going to have to wait and see, but we think it will be substantial.

Okay. That makes sense. I think all the rest of my questions have been asked and answered. Thank you.

Thank you.

And our next question comes from Rick Shane from JP Morgan. Please go ahead with your question.

Hey, guys, thanks for taking my question. Most of them really have been asked and answered, but I just want to delve in a little bit on what we should take from the hedging, actually the tactical moves in terms of hedging during the quarter. You increase the swap position as you mentioned, you reduce the treasury short modestly, you kept the swap position flat. I think that what that suggests is that your view is that rates are going to be lower for a bit longer, but still ultimately strategizing for a more hawkish Fed and higher rates.

Yeah. If you go back -- if you look at, we've made some fairly substantial changes to our hedge composition. If you think about where we were at the beginning of the year, at the very beginning of the year, we added a lot of longer dated hedges that gave us a lot of benefit in the First Quarter because we were worried about the yield curve steepening, and then of course we had the opposite effect in the Second Quarter with the yield curve flat, and I still think that there is a reasonable amount of volatility with respect to the shape of the yield curve. Obviously as the Fed and the market pulls forward or moves back short-term rate increases, that's going to have an impact on the shape of the curve. So you've seen us balance out our curve position. And if anything, our hedge portfolio today is biased to generate a little incremental value in a flattening type scenario which gives us a more of a macro business hedge. And to your point, while we do think rates are going to be reasonably stable, there is a bias, from our perspective now, that rates will be higher, not lower. They certainly seem to be comfortable in the 1.5 to say, for example, 2% range on the 10-year. That's a really healthy place for -- if they do stabilize in that range, that'll be a really healthy place for the agency MBS market for them to level out at. We'd be very pleased with that. I think mortgages performed very well in that scenario. But compared to Last Quarter when we talked about two way risks, we see a lot more up risk exposure now, but again, gradually. And finally, the reason that options give us so much protection, options are always good for outsized moves. Our option portfolio today at $13 billion has a strike of less than 2% at around 1.87%. So there could be a significant amount of value generation from those options if over time the economy really does take hold, which we believe it will, and the Fed does have to become active. Interest rates will be higher and those options will give us a lot of protection against outsized moves. So you'll see us continue, likely, to increase that position as well over time.

Got it. And from your perspective, is the environment we're in now from a hedging perspective a little bit easier. You've got -- you have less concern about spreads widening at this point, you have more to your point, a skew towards higher rates as opposed to a binary or a two-way market. It's early, I apologize. But you understand my point is you just feel a tad easier to manage the risk at this point.

Well, I would like to say yes, but there's one caveat to that which I think is a challenge, which is there could be more volatility in the shape of the curve. So hedge location is a little bit more challenging if you think about what could happen as the market prices the Fed 's reaction function, it'll have a lot of impact on the shape of the curve. If the market thinks that the Fed is behind on its inflation objective and slow to react, the yield curve will steep insignificantly. And so you'd want to have your hedges in that part of the curve. Conversely, if the market thinks that the Fed 's behind on its inflation and that they're going to take actions quickly and pull forward rate moves, it's going to have a flattening effect on the curve. We've seen that just unfold in the last 30 and 60 days with curve movements like that. So I think that's the one part that makes it challenging. So that's where you have to be a little bit more active in your hedging in terms of moving hedges from one part of the curve to the other in order to generate some incremental value. That's the challenging part, is the market pulling forward or moving back rate moves, and that could be the dominant question in 2022.

That's really helpful. Thank you so much.

Sure. All right. Thank you so much for it.

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

Thank you. That concludes our third quarter call. We appreciate everyone's participation on the call today and we look forward to speaking to you again next quarter. Thank you very much.

And ladies and gentlemen, with that, we'll end today's question-and-answer session and today's conference call. We do thank you for attending. You may now disconnect your lines.