AGNC Investment Corp
NASDAQ:AGNC
Earnings Call Analysis
Q3-2023 Analysis
AGNC Investment Corp
AGNC Investment Corp's third quarter of 2023 faced significant headwinds as intensifying bond market sell-offs rattled investor confidence. The historically steep rise in treasury yields resulted in a mass exodus from less stable securities, sending ripples across the financial landscape. Agency Mortgage-Backed Securities (MBS) took a notable hit, with underperformance compared to treasuries and widening spreads reaching levels last seen during the early pandemic.
The tumultuous quarter culminated in a comprehensive loss of $1.02 per share for AGNC, a stark contrast to the previous period's financial stability. This loss encompassed a disappointing economic return on tangible common equity of negative 10.1%, primarily driven by a sharp decline in the company's tangible net book value. Despite the increase in average leverage levels from 7.2 to 7.5 times tangible equity, AGNC upheld robust liquidity, revealing a glimmer of resilience amidst the chaos.
In a practical response to the quarter's challenges, AGNC raised $432 million in common equity at a premium, bolstering its net book value against the tide of market adversity. Adjustments to the portfolio were made with an aim to recalibrate the investment strategy to the current high-volatility, high-spread environment, shifting towards higher coupon securities and maintaining strong hedge positions.
While the quarter was predominantly turbulent, AGNC's leadership is optimistic. They've recognized the Agency MBS market beginning to establish a new, albeit wider, spread range against treasuries, a potentially stabilizing development. Moreover, favorable characteristics of Agency MBS, like minimal organic supply, out-of-the-money prepayment risks, and deep liquidity, cement a bullish outlook for this sector moving forward.
AGNC remains committed to its long-term strategic investments despite the near-term uncertainties. They continue to be on the lookout for rebalancing opportunities within their MBS stack without being swayed by tax implications or market volatility. As they navigate these turbulent waters, the management remains unfazed by the turmoil and has not engaged in any forced sales, maintaining a disciplined stance on their long-established strategies.
Peter Federico of AGNC discusses dividend sustainability, noting the significant spread widening over the past years, emphasizing the higher dividend yields on stock. Despite not providing forward guidance, Federico mentions that the total return needed on their total tangible equity capital base is around 16%, providing insight into how the company thinks about their returns and dividend payouts in relation to the evolving market conditions.
Steering through a period of instability, AGNC managed their leverage conservatively, targeting an optimal balance to capitalize on the attractive valuations of mortgages. The company reported a slight increase in leverage to 8.2 times as of mid-October from 7.9 times at quarter end, before pulling back to approximately 7.8 times, showcasing their nimble approach to leverage management. Furthermore, the company's firm stance on maintaining a robust unencumbered position, which stood at $4 billion by the end of September, adds to its financial resilience.
After the market's response to the high interest rates and unforeseen challenges in the treasury market, AGNC closes the quarter with an air of cautious optimism. With their eyes on potential economic recuperation, the company remains vigilant, ready to adapt their strategies in line with market movements to ensure they are best positioned for the long term. The company leaves investors with the promise of discipline and a bullish stance on the future of Agency MBS.
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Good morning, and welcome to the AGNC Investment Corp. Third Quarter 2023 Shareholder Call. [Operator Instructions] I would now like to turn the call over to Kate Wisecarver Investor Relations. Please go ahead.
Thank you all for joining AGNC Investment Corp.'s Third 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 forecasts 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.
Thank you, Katie, and good morning. Despite signs of improvement early in the quarter, the sell-off in the bond market intensified in the third quarter as treasury supply concerns and the threat of overly restrictive monetary policy weighed heavily on investor sentiment and drove benchmark interest rates and interest rate volatility materially higher. The treasury market continues to be in the midst of a historic multiyear repricing event.
To put the move in context, the increase in the 10-year treasury yield over the last 3 years, is the second largest ever recorded over such a short time period. In percentage terms, the treasury market has never experienced anything like this. The Bloomberg long Treasury Bond Index which tracks maturities of 10 years or more, has experienced a total return loss of close to 50% over the last 2.5 years, a loss equal to what the S&P 500 experienced following the dot-com bust in 2000. The move higher in Treasury rates began relatively early in the quarter as supply expectations were revised materially higher due to the growing fiscal deficit. The bare sentiment accelerated late in the quarter following a hawkish message from the Fed that short-term rates would likely remain higher for longer.
In environments like this when treasury prices fall abruptly and the market struggles to find its new equilibrium, Agency MBS typically underperformed. That was indeed the case in the third quarter, as Agency MBS performance relative to benchmark rates lagged meaningfully. In aggregate, Agency MBS spreads to comparable duration treasuries widened 20 to 25 basis points across most of the coupon stack. Since quarter end, Agency MBS have remained under pressure with spreads widening by a similar amount in October.
At this point, Agency MBS spreads are close to the widest levels reached during the height of the pandemic in March of 2020. The sharp steepening of the yield curve also caused Agency MBS performance to vary significantly across the yield curve. Agency MBS hedged with short and intermediate term instruments perform materially worse than Agency MBS hedged with longer-term instruments.
The volatile market conditions that we are now experiencing are a result of a complex set of domestic and global factors. In addition, the Fed is nearing a critical inflection point in monetary policy. During these types of transitions, economic data is highly scrutinized by the market and can have an outsized impact on the trajectory of monetary policy.
Once the downward trend in labor and inflation data becomes certain, a more favorable monetary policy stance will undoubtedly emerge. As challenging as this period has been for all bond market participants, the current investment opportunity in agency MBS on both an unlevered and levered basis is without question.
On an unlevered basis, new production par-priced agency MBS provide investors with the opportunity to earn a yield of close to 7% on a security that benefits from the explicit support of the U.S. government. Importantly, this yield is now at least 150 basis points higher than every point on the treasury yield curve and materially above highly rated corporate debt instruments.
For levered investors in addition to the very compelling base yield of close to 7%, it is becoming increasingly apparent that a new trading range is developing for Agency MBS which materially improves returns. Over the last 6 months, the spread between current coupon Agency MBS and a blend of 5- and 10-year treasuries has ranged between 150 and 195 basis points. The average has been 170 basis points, and currently, the spread is near the upper end of the trading range. Like all bond market participants, our financial results have been negatively impacted by the unprecedented speed and magnitude of this Fed tightening cycle.
The rapid rise in long-term interest rates the increase in interest rate and financial market volatility, heightened geopolitical risk and growing U.S. government dysfunction. As the Fed recently stated, however, this tightening cycle may be nearing its conclusion, and the economic balance of risks is now 2 sided. Although this process has taken longer and has been considerably more difficult than anticipated, we continue to believe that a durable and very attractive investment environment is still ahead of us once the uncertainties associated with the current environment subside. With that, I'll now turn the call over to Bernie Bell to discuss our financial results.
Thank you, Peter. For the third quarter, AGNC had a comprehensive loss of $1.02 per share, resulting from the significant rate volatility and spread widening that occurred during the quarter. Economic return on tangible common equity was negative 10.1% for the quarter. comprised of $0.36 of dividends declared per common share and a decline in our tangible net book value of $1.31 per share.
As of late last week, our tangible net book value was down about 11% for October. Despite the decline in our tangible net book value, leverage at the end of the quarter remained well contained at 7.9x tangible equity or only moderately higher than 7.2x as of the end of the second quarter.
With our average leverage for the quarter being 7.5x compared to 7.2x for the prior quarter. Our liquidity also remained strong throughout the quarter and in line with our typical operating parameters. As of quarter end, we had unencumbered cash and Agency MBS totaling $3.6 billion or 52% of our tangible equity and $80 million of unencumbered credit securities. During the quarter, we also issued $432 million of common equity through our at-the-market offering program, which at a significant price-to-book premium was accretive to our net book value.
Net spread and Dollar Roll Income, excluding catch-up amortization, was $0.65 per share for the quarter, a quarterly decline of $0.02 per share. The decline was largely due to a 23 basis point decrease in our net interest spread to 303 basis points for the quarter, driven by higher funding costs, which more than offset an increase in our average asset yield.
Lastly, the average projected life CPR on our portfolio at the end of the quarter decreased to 8.3% from 9.8% as of the second quarter. Actual CPRs for the quarter averaged 7.1% compared to 6.6% for the prior quarter. I'll now turn the call over to Chris Kuehl to discuss the agency mortgage market.
Thanks, Bernie. The start of the third quarter was relatively favorable for both U.S. treasuries and Agency MBS as inflation data continued to show a downward trajectory and regional bank sector stress faded into the background. In fact, treasury yields rallied and Agency MBS tightened over the first few weeks of July. This favorable sentiment shifted, however, when the treasury released its borrowing estimate, which was larger than anticipated.
Following the September FOMC meeting, the sell-off in treasuries accelerated with 5- and 10-year treasury yields ultimately increasing 45 and 73 basis points, respectively, as of 9/30 with 2-year yields moving only modestly higher, the yield curve steepened significantly during the quarter. Against this challenging backdrop, Agency MBS underperformed both treasury and swap based hedges with performance varying considerably depending on hedge positioning on the curve.
Coupon positioning was also a significant driver of performance as lower and middle coupons materially underperformed production coupons. Our portfolio increased modestly from $58 billion to $59 billion as of September 30. Within our agency holdings, we continue to move up in coupon at more attractive yields and wider spreads.
During the quarter, we added approximately $10 billion in 5.5% through 6.5% versus lower coupons. We also converted a material portion of our TBA position to a mix of both high quality and low pay-up specified pools. Our remaining TBA position was largely comprised of Ginnie Mae TBA given attractive valuations and better roll implied financing relative to UMBS. As of 9/30, our hedge portfolio totaled $63.2 billion, given the duration extension in our assets, we increased the duration of our hedge portfolio primarily by adding treasury-based hedges at the 10-year point of the curve.
As a result, our duration gap remained low throughout the quarter and was 0.2 years at quarter end. As of 9/30, approximately 70% of our hedge portfolio duration dollars are at the 7-year or longer points on the yield curve with approximately 50% of our duration in Treasury-based hedges.
Looking forward, our outlook for Agency MBS is very favorable. Spreads have decoupled from treasuries and corporates due to supply and demand technical factors that we expect will ease over time. And as Aaron will describe in more detail, spreads and other fixed income sectors are close to post-GFC long-term averages, while spreads on Agency MBS are in the 95-plus percentile area. This is especially remarkable given that the fundamentals for Agency MBS have rarely looked as compelling as they do today.
Organic agency supply is minimal prepayment risk is deeply out of the money and repo markets for Agency MBS are deep and liquid. With spreads as wide as they are today, we believe investors in Agency MBS are well compensated for elevated rate volatility over the near term. That being said, geopolitical tensions have increased the near-term risk quotion. And while we believe we are in one of the most favorable earnings environments of our history, we will remain disciplined with respect to managing rate risk and leverage. I'll now turn the call over to Aaron to discuss the non-agency markets.
Thanks, Chris. The significant interest rate volatility and the sharp move higher in yields by the end of the quarter had a more material impact on interest rate sensitive products than credit spreads. Credit spreads were mixed in the third quarter and many sectors of the market generated slightly positive excess returns. As a proxy for credit spread moves in Q3, the synthetic IG index was 8 basis points wider, while the Bloomberg IG Index representing spreads on cash bonds was actually 2 basis points tighter over the quarter, both outperformed mortgage spreads.
The majority of fixed income credit spreads are currently at valuations far from extreme levels, unlike Agency MBS. Taking a step back, while MBS are near their widest spread since the GFC by almost any measure, CDX IG spreads are roughly at their average over the past 15 years. A brief overview of several consumer fundamentals suggest that weakening is developing, albeit slowly. Auto loans, credit cards and marketplace lending delinquencies have ticked higher.
Additionally, the resumption of student loan payments this month will stretch a relatively broad segment of households even further. While excess savings numbers have been revised higher recently, lower income and renter households have likely drawn down a material amount of savings as a result of increased exposure to inflationary pressures.
Taken together, the outlook for the consumer has declined and will contribute to further economic slowdown. That said, we expect a much more muted impact on the mortgage side due to the significant amounts of homeowners' equity resulting from several years of strong HPA growth. Turning to our holdings. Our non-Agency portfolio is roughly unchanged in size, ending the quarter at just over $1 billion in market value. Within CRT, we turned over roughly 15% of the portfolio and continue to skew holdings to reposition into likely tender candidates or migrating further down the credit stack in seasoned and delevered profiles.
The favorable technicals in the CRT market that we discussed on last quarter's call remain in place, low issuance volumes, coupled with the GSE desire to extinguish older credit protection via tender offers.
This drove further spread tightening on our CRT portfolio during the quarter. The meaningful valuation improvement throughout this year has correspondingly led to lower expected go-forward return expectations. Nevertheless, the risk side of the equation has declined as we expect lower spread and price volatility for many of our CRT securities as certain segments of the market have become anchored to some degree. With that, I'll turn the call back over to Peter.
Thank you, Aaron. Before opening the call up to your questions, I want to briefly discuss our current common stock dividend. We do not provide forward guidance for our dividends, but I do want to share some thoughts on the dividend in the current environment. As I have mentioned many times, one of the primary factors that we evaluate in setting our dividend is the economic return that we expect to earn on our portfolio at current MBS valuation levels.
You can think of this return as the mark-to-market return on our portfolio. Given the significant spread widening that has occurred over the last 2 years in Agency MBS and the subsequent decline in tangible net book value per share and stock price, the dividend yield on our common stock has increased notably. At the end of the third quarter, the dividend yield on our tangible net book value of our common equity was close to 18%. While this number is informative, it does not include the benefit of our lower cost preferred equity, which is also permanent capital.
Including this preferred component, our dividend yield on total equity including both our contractual preferred stock dividends and our current common stock dividend was approximately 15% at the end of the third quarter, including our operating expenses, the required yield on our total capital was just over 16%.
Said another way, as of the end of the third quarter, we needed to earn a 16% return on our total tangible equity capital base of $6.9 billion in order to satisfy all of our operating costs and dividend obligations. At current valuation levels, the expected levered return on Agency MBS depending on coupon is in the mid-teen to low 20% range before convexity and rebalancing costs.
The important takeaway from this analysis is that our common stock dividend remains well aligned with the return that we expect to earn on our portfolio at current valuation levels and operating parameters. That said, we continuously evaluate our dividend as market conditions, expected returns and risk management considerations are always changing.
With that, we will now open the call up to your questions.
We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Crispin Love with Piper Sandler.
First off, can you just give us your updated thoughts on leverage just based on the preannouncement last week, you were at, I think, about 8.2x as of October 20. But what are the ranges that you're comfortable operating at? And what is the max level that you would operate at before needing to bring it lower?
Thank you for the question. You're right. We reported that our updated leverage was as of about a week ago, 8.2%, up from 7.9% at the end of the quarter. As we sit today, our leverage actually is more in line with where it was at the end of the quarter, right around 7.8%. And we're comfortable -- very comfortable operating in the current leverage range. Obviously, mortgages are extraordinarily cheap. We would love to operate with higher leverage, given how cheap mortgages are, but we also have to be very cognizant of the volatile market conditions that are broadly affecting all fixed income markets, particularly the treasury market.
The other thing that I would also point out is, as we disclosed and as Bernie mentioned, from a leverage perspective, and this gets to sort of your maximum leverage question, which is that we continue to operate with a very significant unencumbered cash and security position as Bernie mentioned, it was 52% at the end of last quarter. It's still in the mid-50s, actually as we sit today.
So we have a lot of capacity and we are waiting for the right opportunity. And I think that opportunity ultimately will come as the market, all the uncertainties that the market had to contend with in the third quarter subsided. So I can't give you an answer specifically on the maximum leverage because that's sort of an environmental question. It will have to -- it has to be consistent with the environment that we're in, the volatility of interest rates, the expectation about spreads, where you are at spread levels.
But right now, given how cheap mortgages are Obviously, it is a good investment time. Ultimately, we need some more stability overall in the financial markets, particularly from the Fed and stability in the treasury market. So I'll pause there.
All very helpful there. And then just kind of on your point on how cheap mortgages are. Can you just give an update on your outlook for spreads, they remain very cheap. But curious on your outlook and if it's changed at all over the last kind of several weeks and months on spreads being range bound in your expectations there?
Yes. There's a lot to like about the mortgage market. And in our prepared remarks, I talked about the fact that the current coupon is close to 7%. So what I think is interesting about the mortgage market right now from a return perspective is that it's highly appealing to a very broad cross-section of investors.
From an unlevered perspective, Agency MBS offer extraordinarily value, almost 200 basis points over the treasury curve for security that is -- has the guaranteed support of the U.S. government. So -- and if you look at Agency MBS relative to corporates, high-grade corporates in particular, it's a significant yield pickup. So I think it's very attractive on an unlevered basis.
And as I mentioned in my prepared remarks, I do think that the Agency MBS market from a spread perspective is starting to establish a new range, which I believe is somewhere -- if you think about it versus the 5- and 10-year treasury current coupon as our starting point, I think that range is now in the 150 to 200 basis point range. And what's important about what we just experienced in the third quarter is that -- for now, over the course of the last, call it, 12 months, we've hit the upper end of that range on a number of occasions, 3 or 4 occasions.
We hit the upper end of that range about a week ago and mortgages have sort of bumped off the top of the range and has started to come back down over the course of the last week, finding their footing. And that, I think, is a really positive signal. But I do think mortgages in over the near term will remain sort of in the upper half of that range, maybe 160 to 180 basis points seems to be a comfortable level right now given the amount of uncertainty in the sort of broader fixed income market with respect to the Fed and with respect to the treasury supply and given the elevated level of interest rate volatility.
But over time, as those uncertainties subside and as interest rate volatility comes down, I think mortgages can move back sort of more comfortably in that range.
But over the near term, I think there's still a lot of uncertainty, but I do take it as a positive sign that mortgages have bumped off the top of the range now on a number of occasions and have started to stabilize.
Our next question will come from Rick Shane with JP Morgan.
Thanks, everybody, and nice to talk to you this morning. I'd like to talk a little bit about the decisions, the tactical decisions to sell securities during the quarter and repositioning yourself within the stack. Obviously, the market saw the substantial realized losses. And I guess, to some extent, just by rotating within the stack, you're realizing losses, but as long as you're reinvesting further up the stack, you will benefit from spreads tightening ultimately. Can you talk about that decision? And can you also talk a little bit about the tax implications of that trade?
Yes. I appreciate that. From a -- we don't really think about it from a realized or unrealized loss perspective, right? At the end of the day, our securities are all mark-to-market, one way or the other through our income statement, whether they're mark-to-market above the line or through our comprehensive income because we still have some securities that are available for sale. But that's a relatively small component. So we don't think about those decisions as whether or not to realize or unrealized.
What we're trying to do throughout the quarter and we do this every day is what is the right mix of securities that we believe is going to give us the best risk return trade-off right? And moving up in coupon has given us a lot of benefit, not the least of which is that the highest expected returns are in the higher coupons.
So we continue to do that during the quarter. we will likely continue to do that from a sales perspective. We're always looking to put ourselves in a position from a risk management perspective that gives us the best position for the current environment. So we don't really think about and make decisions based on the tax implications or on the financial statement appearance, if you will, of our decisions to buy or sell securities.
Great. Peter, it's helpful context. And again, look, we've had the experience of following you guys for a very, very long time. And when you were externally managed, there were different potential incentives associated with selling instruments at losses. And even then, you guys were very, very thoughtful about where you want to -- what you wanted to own in the stack.
And I think 1 question that sort of emerges and it's pretty clear, I think, in looking at the balance sheet. These were not for sales. Can you talk a little bit about what you saw during the quarter, were there are moments of distress where you felt like you needed to do things that you didn't want to do?
No, that's a great question. And the first answer to that is absolutely not. There wasn't a moment where we felt like there was any forced action. And what I would say is that if you think about our position over the course of the quarter, we actually started taking steps because the market actually sort of had a sort of a pronounced shift in sentiment that occurred late in July.
And as Chris mentioned in his prepared remarks, the footing for the bond market was actually really positive for the first 3 weeks of July, both in the treasury market where treasury rates, the lower 10-year treasury rate, was July '19, and I think it was around 380 at that time.
So -- and as Chris mentioned, mortgage spreads actually tightened for the first 3 weeks. So the market was on a really good footing until the discussions from the Fed started coming out about the term premium and then ultimately, what really set the whole thing in motion was to move in treasury supply and expectations about that. So in August, things were sort of illiquid and we were taking actions throughout that time to maintain the leverage that we were comfortable with.
Our leverage really never got anything above what we just reported at 8.2%. Our cash position throughout that time. was in the high 50s at each month end just like it had been. So we were never in a position where we were forced to do anything that we didn't want to on a day that we didn't want to.
But what I think you are getting at is the challenge that is starting to reveal itself in both the treasury market and the Agency MBS market and in Agency MBS market, in particular, and this is why I think Agency MBS tend to underperform in the down trade like we just experienced, is that the market is generally speaking, very illiquid at times because the flows in the -- particularly in the Agency MBS market and to an extent in the treasury market, tend to be one-way flows right now with the Fed backing away in running off its balance sheet. And given the constraints that are being potentially put on banks, it really leaves the money manager community as the key buyer or seller of securities.
And when you get in an environment like we got in, in August and in September, the fixed income sentiment turned negative and bond fund flows turned to be outflows. And when bond funds get outflow and redemptions, they just simply sell the most liquid securities that they can sell, which are treasuries and Agency MBS. And that's why, as Aaron pointed out, corporates didn't move very much at all. In fact, corporate spreads are relatively unchanged. It looks like a great environment for corporates, yet the selling pressure from money managers was coming in sort of a one-way flow.
That seems to have subsided. That will stop and the market can move very quickly to the other direction. So for our portfolio, we try to do is we try to take actions early on these and sort of take smaller actions on time sort of delta hedge as we go and never be put in a position where we're forced to delever and that certainly was not the case in the third quarter. We were operating with a position that we were comfortable operating with throughout the quarter.
I guess the challenge of having permanent capital is that there are decisions that you have to make that someone who just has experienced outflows doesn't have to.
Well, that's exactly right. And that's the challenge. And sometimes you have to make decisions. For example, we made decisions to sell some securities, which unfortunately, you don't like to do because they are cheap, but there will also come a time when we're comfortable adding more securities and the outlook from a spread perspective will be a lot better than it was at times during the third quarter. And maybe some of that improvement is starting to reveal itself right now.
I apologize, I've taken too much time.
I appreciate the question, Richard.
Our next question will come from Trevor Cranston with JMP Securities.
You've talked about the sort of new trading range you're seeing for spreads. Can you maybe talk about sort of how much conviction you have in the upper range of spreads given the sort of weak demand picture, in particular for MBS at the moment. And if we were to see, for example, like another significant move higher in the 10-year, who do you think the buyer could be a [indiscernible] to sort of contain additional widening.
Yes, I appreciate the question. And you're right, I do have growing conviction that the upper end of the range can hold, but that doesn't mean that it's not going to be breached. What we're seeing as you point out, is that when -- particularly -- the events of the third quarter were not a mortgage-related event. It was it was a follow-on effect coming from all of the challenges that the treasury market was facing when it came to supply, when it came to runoff, when it came to bank constraints, government -- potential government shutdown.
There was a lot of challenges that the treasury market had to contend with. And those can come back, and we can have more of those challenges and that could lead to further weakness in Agency MBS. So there's certainly the possibility that mortgage spreads could widen from here.
The flip side of that, though, is that I don't think even a widening would be sustainable, meaning that when you think about the fact that the agency MBS security today post great financial crisis, has the full support of the U.S. government. It just doesn't make sense to me why that credit quality security is trading 200 basis points over the U.S. Treasury.
And I think over time, investors will rotate into that security, particularly on an unlevered basis, and I think this gets to your question, the marginal demand for Agency MBS over the foreseeable future and particularly now with the 10-year being close to 5% and Agency MBS being close to 7%, the rotation in fixed income is going to come from unlevered money coming out of other fixed income products like investment-grade corporate debt that gives you a lower yield and more risk.
The rotation will come from corporates and the rotation will come from equities as we enter a period where the economy is slowing. And ultimately, that's going to be the marginal demand for U.S. treasuries and Agency MBS securities and agency MBS securities, in particular, will benefit that.
The challenge is that does take time to happen. People have to physically move money from one security to another the agency MBS market is a little more difficult for investors to access. But ultimately, that's why I think the upper end of the spread range will hold. And ultimately, I think at 200 basis points, that's excessive incremental return for Agency MBS.
Our next question will come from Bose George with KBW.
Thanks for the comments on the dividend. In terms of the ROE that you noted there, I mean, is it another way to kind of think about it is by look for us to look at the leverage on the common. So if you do the math of the 180 basis points or whatever the spread is, we should be thinking really about not the 7.9% advise leverage, but sort of adding the leverage as given by our preferred and that kind of gets us to more like a higher high-teens ROE on your invested capital.
Right. That would be an apples-to-apples comparison. I'm doing it from that perspective. Yes. And what I was trying to point out with that with my prepared remarks on the dividend, is that it's important to look if you're going to look at what can you earn? It's -- what are you -- what's the right comparison to that. And for us, you got to look at it what can we earn on our portfolio versus our entire cost of capital. And that's why it's important because our preferred stock does give us a meaningful benefit given the fixed dividend of around 7% on that capital.
And obviously, over time, that relationship will continue to change. Right now, we're operating with about 23%, 24% of our capital in preferred stock. So -- but if you did that calculation, like you just suggested, you would get ROEs in the low 20% range, which would align, again, very well with the 18% that I referenced at the end of the third quarter.
Yes, perfect. That makes a lot of sense. And then just to confirm, the 11% decline in book value that's after accruing for the dividend, right? So it's like a 7.25 mark-to-market.
I'll site with the 11% as opposed to giving you a point estimate. But yes, that does. And the estimate that, obviously, what you can tell is that when we gave our numbers out a week ago. By the way, we released them because that's typically when we would have released them. This call happens to be about a week later than it normally is for schedule of reasons. But the market was, in fact, weaker, a week ago than it was just last week, as I mentioned, mortgages have found some footing and have begun to improve and 11% is a reasonable number for right now.
Our final question will come from Eric Hagen with BTIG.
Maybe just a follow-up actually on the structural leverage and the mix between preferred and common and really just how -- just kind of how you think about that leverage and what you're comfortable with over maybe shorter and longer periods of time. And even how you think that leverage kind of retraces and affects the valuation of the common stock and what you guys might be willing to tolerate right now and over, again, kind of longer periods from that respect?
Yes, thank you. Over the longer run, we've operated with our preferred mix right now in low 20 range for the last several quarters. It's been 22%, 23% at the end of last quarter. It's ticked up as the book value has declined, has been absorbed by the common that percent has gone up to around 24%, and we're comfortable operating in that range. I don't expect it to change much. It does give us the benefit that you're talking about with respect to our overall cost of capital.
But also importantly, and I think this sort of gets to part of your question, when you think about our sensitivities and from a risk management perspective, the sensitivities that we disclose, for example, our interest rate sensitivity and our spread sensitivity is based on the common component of that. So from a risk management perspective, we are looking at that sensitivity, obviously, as a driver of how we're making decisions about our overall leverage position, our overall interest rate position and our overall liquidity position.
I think it's appropriate to think about tangible at-risk leverage as being based on your total capital base because our preferred is permanent capital that we can use. But I think from a risk perspective, you want to look to the sensitivity on your common only, and that's why we break it out that way.
Yes, that makes sense. Just a question on the hedging here and how high you envision the hedge ratio getting just given the shape of the yield curve and maybe even anything you're looking for this week in the Fed meeting that can maybe change your posture towards taking a duration gap going forward.
Yes. Let me start with hedging question. What we're trying to do with our hedge portfolio, if you think about it at a high level, we're trying to achieve 2 purposes. And the 2 purposes are, one is that you want the right mix of hedges that you think gives you the best opportunity to offset the value changes, the market value of your asset portfolio. I think that's the way most people think about it. But there's also another objective of the hedge portfolio, and that is to give you the most stable cost of funds.
In order to have a very stable cost of funds, you have to have essentially a 100% hedge ratio, meaning all of your short-term debt is hedged with the same notional amount of hedges. So we're trying to find a mix this sort of achieves both those purposes because both of those objectives are really important. When we think about the hedging the portfolio in the third quarter is a good example because as both Chris and I mentioned in our prepared remarks, there was a lot of variation in mortgage performance across the yield curve because the 10-year moved up so much in the 5-year didn't move as much in the 2-year hardly moved.
If you think about the market value exposure of a mortgage, -- you can think about that duration being broken down across the key rates, if you will, 2-year part of the curve, the 5-year part of the curve and the 10-year part of the curve.
For our portfolio, for example, if you took our mortgage portfolio duration and you broke it down across the curve, it would be something like 20% of the sensitivity of the mortgage would be to the 2-year and less about 30% around the 5-year and around 50% to the back end of the curve. If you look at our hedge portfolio, often I think people look at the notional -- and they say, well, AGNC has a lot of short-term hedges. We do from a notional perspective, 44% of our hedges, for example, are 3 years and in.
But when you think about the market value sensitivity of our hedge portfolio, only about 18% of the duration of our portfolio is coming from the 2-year part of our curve. So we don't have a lot of interest rate sensitivity from our short-term hedges.
In fact, we have from a model perspective, if you will, just the right amount of 2-year hedges. So we have 44% notional hedges, but only 18% of our hedge sensitivity comes from our 2-year part of the curve. So I point that out because as we think -- as you ask about the hedge ratio, we've operated with a really high hedge ratio and a mix of hedges across the curve to try to achieve both those purposes.
We've talked about for several quarters now that we've moved more and more of our hedges to the longer end of the curve. In fact, Chris mentioned in his prepared remarks, that 70% of the duration exposure of our hedge portfolio is 7 years or more. And we will continue to likely move more of our of our duration to the longer and intermediate part of the curve as we expect the yield curve to steepen as we expect the Fed to pause.
And I think at this next meeting, the Fed will, in fact, stay constant. Again, I think they'll talk about the fact that the economy and the outlook is continuing to move in their direction. So I don't expect the Fed to make any move. At this meaning, in fact, I don't expect the Fed to tighten at all anymore. I expect the next move from the Fed to be in the east ultimately down the road.
But as the Fed does get, in fact, closer to the pause point and reflect that in the market, then ultimately, I think you would expect us to operate with a lower hedge ratio over time as we want to benefit the portfolio from a decline in short-term rates. But that, I think, is further out. Obviously, that will be something in 2024, where the Fed actually starts to ease. So for now, we like having more of our hedges in the longer part of the curve.
We'll likely do more of that shift. And over time, I think you'll see our hedge ratio come down. But I wanted to give you that sort of explanation on the key rates because I think it's important for people to understand what the notional of our portfolio means and what the duration dollar means.
We have now concluded the question-and-answer session. I'd like to turn the call back over to Peter Federico for closing remarks.
Well, appreciate everybody's time on the call today, and we look forward to speaking to you again at the end of the fourth quarter. Thank you for participating.
The conference has now concluded. Thank you for joining the call. You may now disconnect.