Prepared remarks
Thank you all for joining AGNC Investment Corp.'s Third Quarter 2025 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 facts, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements are intended to be subject to the safe harbor protection provided by the Reform Act. Actual outcomes and results could differ materially from those forecast due to the impact of many factors beyond the control of AGNC. All forward-looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice. Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in AGNC's periodic reports filed with the Securities and Exchange Commission. Copies are available on the SEC's website at sec.gov. We disclaim any obligation to update our forward-looking statements unless required by law. Participants on the call include Peter Federico, President, Chief Executive Officer and Chief Investment Officer; Bernie Bell, Executive Vice President and Chief Financial Officer; and Sean Reid, Executive Vice President, Strategy and Corporate Development. With that, I'll turn the call over to Peter Federico.
Good morning, and thank you all for joining our conference call. In the third quarter, the Federal Reserve's pivot to a less restrictive monetary policy stance and the easing of fiscal policy concerns drove robust financial market performance and a significant improvement in investor sentiment. Agency mortgage-backed securities were one of the best-performing fixed income asset classes during the quarter and have now outperformed U.S. treasuries for 5 consecutive months, a sequence of outperformance that has not happened since 2013. In this favorable investment environment, AGNC generated a very strong economic return of 10.6%, comprised of our attractive monthly dividend and book value appreciation. At its September meeting, the Fed lowered the federal funds rate as expected and signaled further monetary policy accommodation with the possibility of rate cuts at the October and December meetings. On the fiscal policy side, the passage of the tax bill early in the quarter and several positive tariff developments eased some of the concerns that dampened the investment outlook in the second quarter. These investor-friendly developments led to a material decline in interest rate volatility and contributed to the outperformance of Agency MBS. As we have discussed, a number of emerging factors support our constructive outlook for agency mortgage-backed securities. The first relates to the improved spread environment for Agency MBS. Over the last 4 years, the spread range between agency securities and benchmark rates has become increasingly well-defined with incremental investor demand consistently emerging when spreads trade near the upper end of the range. In addition, the administration has begun to focus on mortgage spreads as a means of improving housing affordability. In an interview in late September, the Treasury Secretary reinforced this view when he said, 'The really important thing is that we either maintain mortgage spreads or narrow them further to help the American people.' This focus on spreads by the administration is good for Agency MBS and good for our business. Second, the supply and demand dynamic for agency mortgage-backed securities continues to be well balanced. With the primary mortgage rate persistently above 6%, the net new supply of Agency MBS this year will be about $200 billion, the lower end of initial expectations. At the same time, the demand outlook has improved. Bank demand for Agency MBS has been relatively muted this year, but should increase as regulatory reforms get implemented. The money manager community is another important source of demand for Agency MBS. Demand from this sector increased meaningfully in the third quarter, as the favorable shift in monetary policy led to $180 billion of bond fund inflows, which are now running slightly ahead of last year's pace. Third, the financing market for Agency MBS remains strong. With bank reserves just under $3 trillion, the Fed will likely end balance sheet runoff within the next few months. Importantly, the Fed is also considering joining the FICC for purposes of the standing repo facility and using a repo-based measure as its primary target rate. If adopted, these changes would be highly beneficial to the repo market for U.S. treasuries and Agency MBS, particularly during times of stress. Fourth and finally, the potential path of GSE reform continues to move in a favorable direction. The Treasury Department has taken a leadership role in the reform process, holding a series of roundtable discussions with a wide range of housing and mortgage market participants to gain insight into potential reform actions. This careful approach demonstrates the treasury's commitment to maintaining mortgage market stability. To that end, the treasury has emphasized 3 important guiding principles for GSE reform: maximize taxpayer value, lower the mortgage rate through stable or tighter mortgage spreads, and do no harm to the housing finance system. The mortgage market has responded well to this approach. Collectively, the 4 factors that I mentioned are currently pointing in a favorable direction for Agency MBS. Moreover, given the treasury's thoughtful approach, it is possible the agency market emerges from this reform process with a stronger and more durable structure. In this evolving investment environment, we believe AGNC as the largest pure-play levered agency investment vehicle is well positioned to generate attractive risk-adjusted returns for our shareholders. With that, I'll now turn the call over to Bernie Bell, our Chief Financial Officer, to discuss our financial results in greater detail.
Thank you, Peter. For the third quarter, AGNC reported comprehensive income of $0.78 per common share. Our economic return on tangible common equity was 10.6%, consisting of $0.36 of dividends declared per common share and a $0.47 increase in tangible net book value per common share, driven by a significant decline in interest rate volatility and tighter mortgage spreads to benchmark rates. As of late last week, our tangible net book value per common share was unchanged to slightly up for October. We ended the third quarter with leverage of 7.6x tangible equity and average leverage of 7.5x, both unchanged from the prior quarter. Our liquidity position remained very strong with $7.2 billion in cash and unencumbered Agency MBS at the end of the quarter, representing 66% of tangible equity. Net spread and dollar roll income declined $0.03 to $0.35 per common share for the quarter, driven by lower swap income due to the maturity of $4 billion of legacy swaps and a timing mismatch between the issuance and deployment of new preferred and common equity capital. Another important driver of our net spread and dollar roll income is the amount of unhedged short-term debt in our funding mix as measured by our hedge ratio. As of the end of the third quarter, our hedge ratio was 77%, representing the amount of swap and treasury-based hedges, excluding option-based hedges relative to our total funding liabilities. This hedge portfolio positioning reflects our expectations for an accommodative monetary policy environment and positions our net spread and dollar roll income to benefit from rate cuts as they occur. Looking ahead, we expect that lower funding costs from the September rate cut and widely anticipated future rate cuts, along with the full deployment of recently raised capital and a shift in our hedge mix toward a greater share of swap-based hedges will collectively provide a moderate tailwind to net spread and dollar roll income. The average projected life CPR of our portfolio increased 80 basis points to 8.6% at quarter end from 7.8% the prior quarter on lower mortgage rates. Actual CPRs averaged 8.3% for the quarter compared to 8.7% in the prior quarter. Lastly, during the third quarter, we issued $345 million of Fixed-Rate preferred equity, the largest mortgage REIT preferred stock offering since 2021 and $309 million of common equity through our At-the-Market Offering program at a significant premium to our tangible net book value per share. Notably, the preferred issuance carries a cost significantly below the levered returns available on deployed capital, which is expected to further enhance future earnings available to common shareholders. And with that, I will now turn the call back over to Peter for his concluding remarks.
Thank you, Bernie. Before opening the call up to your questions, I want to provide a brief review of our portfolio activity. Agency spreads to both treasury and swap rates tightened meaningfully across the coupon stack in the third quarter as interest rate volatility declined sharply. Intermediate coupons performed the best driven by strong index-based buying from money managers. Higher coupons also generated positive excess returns, but to a lesser extent, as the sizable inter-quarter rally in long-term interest rates increased prepayment concerns associated with these coupons. Hedge composition was also a driver of performance in the third quarter as swap spreads widened 2 to 5 basis points across the curve. Our asset portfolio totaled $91 billion at quarter end, up meaningfully from the prior quarter as we fully deployed the capital that we raised in the second and third quarters. As is often the case when we deploy new capital, the mortgages that we added were largely newly originated production coupon MBS. Over time, however, we optimized our asset composition by rotating into pools with favorable prepayment characteristics as opportunities arise. Consistent with the growth in our asset portfolio, our TBA position increased to $14 billion at quarter end. As a result, the percentage of our assets with favorable prepayment attributes declined to 76% in the third quarter. The weighted average coupon of our portfolio increased slightly to 5.14%. The notional balance of our swap and treasury-based hedges remained relatively stable during the quarter, but the composition of our portfolio shifted to a greater share of longer-dated swap-based hedges. In duration dollar terms, our swap-based hedges increased to 59% of our overall portfolio. Lastly, given the convexity profile of our assets and the large decline in interest rate volatility, we opportunistically added $7 billion of receiver swaptions during the quarter as an additional source of downgrade protection. With that, I'll now open the call up to your questions.
Questions and answers
And the first question will come from Crispin Love with Piper Sandler.
Spreads have tightened materially over the last few months and just looking at your results, core earnings were $0.01 below the dividend. Can you just discuss expected ROEs? Have they shifted at all just given the spread tightening and then just touching on the sustainability of the current EBITDA?
Sure, I appreciate your question. You're right, we have seen a significant movement in spreads. As I mentioned earlier, over the past four years, the spread has typically ranged from 160 to 200 basis points, and we're currently trading closer to the lower end of that range at about 170 basis points. In terms of mortgages relative to swaps and treasuries, I would say that the expected return on equity for current coupon mortgages is between 16% and 18%, which aligns well with our total cost of capital. When considering dividend sustainability, it's important to look at that measure as it reflects the payment of all common and preferred stock dividends along with our operating costs against our equity base. This measure has decreased by about 1% quarter-over-quarter due to an increase in our equity base, and it's now at around 17%, which is consistent with current mortgage trading conditions. Additionally, there has been some fluctuation in our net spread and dollar roll income, which has dropped to $0.35 for several reasons, including the expiration of some short swaps and changes in our hedge ratio. Although these factors have contributed to the current situation, I believe we are near a low point for this measure, with expectations for improvement moving forward. Overall, while spreads have tightened significantly and various factors could impact this, from the perspectives of dividend sustainability and returns, I think we are still well-positioned. I'll pause here for any follow-up questions.
All really helpful. You mentioned in your prepared remarks that you decreased the hedge ratio significantly during the quarter. Can you elaborate on that? What were the driving factors behind this decision? Are you taking a more short-term outlook on interest rates, particularly with regard to decreased rate fall? What do you see as the main risk associated with the lower hedge ratio, especially concerning the receiver swaptions you previously mentioned?
There are a few key developments regarding the hedge ratio. I previously mentioned receiver swaptions, which I will address later, and Bernie also discussed our overall hedge ratio. With the addition of receiver swaptions, we presented two hedge ratios this time. Our overall hedge portfolio decreased to around 68%. However, an important number to consider in relation to our net spread and dollar roll income is our hedge ratio for swap-based and treasury-based hedges, which we use to convert our short-term debt to synthetic long-term debt. At the end of the quarter, that hedge ratio was 77%. This indicates that 23% of our funding is derived from short-term debt. It's crucial to compare short-term debt costs with other costs; last quarter's average repo cost for short-term debt was 4.43%, the highest in our funding mix. This cost is expected to decline over time as the Fed eases monetary policy. We anticipate a decrease after the first easing and expect further reductions, allowing us to benefit from that change. To quantify, our short-term debt funded at 4.43% compared to swap rates in the 3- to 5-year range results in an additional cost of about 100 basis points, translating to around a $0.05 improvement as short-term rates decrease. We positioned our portfolio from a hedge ratio perspective to capitalize on the Fed's shift towards more accommodative policies, and momentum for rate cuts seems to be growing, suggesting we will see benefits in the coming quarters. Regarding the composition of our portfolio, given the current rate environment and the administration’s focus on long-term rates, we must be more aware of the risk of decreasing long-term rates and increased prepayments. With declining volatility and the desire for more down-rate protection, we approached this through asset selection and options. Last quarter, we added $7 billion of receiver swaptions for extra down-rate protection. However, since this is a receiver position, it affects the hedge ratio calculation, which is why I wanted to clarify that aspect. Thus, there are two significant factors affecting our hedge composition: one relates to net spread and dollar roll income's current pressure, which should improve over time, and the other concerns our need for additional down-rate protection.
Your next question will come from Terry Ma with Barclays.
Maybe just touch on your comments around incremental demand for MBS from money managers in the quarter. Was that kind of episodic or do you think that appetite will be sustained going forward?
It's really fascinating to see the shift in monetary policy, which is significant and has greatly impacted the fixed income market. We've all been anticipating the Fed's pivot, and now that it has occurred, it seems to be gaining momentum. Looking at bond fund flows, there were $100 billion in inflows during the first quarter, followed by $50 billion in the second quarter, totaling $150 billion in the first half of the year. We then saw a substantial increase to $180 billion in the third quarter, with daily inflows exceeding $8.5 billion. We're on track for bond fund inflows to reach around $450 billion this year, with recent data suggesting that this pace will continue. I expect these inflows to remain strong, especially in light of the Fed's actions, as the market anticipates easing in the next two meetings. Moreover, the equity outlook appears less optimistic, leading to a lot of money remaining in money market funds, possibly shifting away from equities given their current high levels. Therefore, I expect bond fund inflows to be robust, supporting lower and middle coupons through the end of the year. Additionally, an important factor in demand, which is still uncertain but looks promising, is the activity from banks. This year, banks have added about $50 billion in mortgages and notably $200 billion in treasuries. As bank reforms are implemented, likely in the first quarter, this could positively affect bank capital, especially regarding mortgage credit. Therefore, I anticipate an increase in bank demand for mortgages and potential shifts from treasuries to mortgages once the new regulations are clearer. Thus, the demand outlook appears stable, if not improving.
Got it. That's helpful. And then just a follow-up. I appreciate all the color on net spread and the dynamics around that. But I guess, to the extent that Fed easing gets delayed or pushed out or maybe doesn't even materialize. Do you still expect a near-term tailwind to the net spread when you kind of factor in just, I guess, capital deployment and then also just swaps rolling off?
Yes, I do. There are a few factors that have caused a slight decline, maybe $0.01 or $0.02 more than anticipated. Bernie mentioned some timing mismatches with our capital raising. We discussed this at the end of the second quarter when we raised, I believe, a certain amount in the second quarter but were slow to deploy those proceeds intentionally. This left us with some excess capital that we eventually deployed. This delay can impact our earnings, and we observed that effect. However, as both I and Bernie mentioned, all those proceeds are now fully deployed, which removes that headwind, and that's significant. Regarding short-term debt, what's crucial now is the positioning of short-term swap rates relative to the Fed funds neutral rate or target rate. In recent months, as the Fed has made changes, we saw the first easing, which is important. For instance, the 2- and 3-year swap rates now essentially reflect the neutral Fed funds rate around 3.25%. You can either wait for the actual eases to be reflected in our repo balance or term it out into the swap market at a similar long-term neutral rate. I expect this to provide a benefit over the next three or four quarters.
Next question will come from Rick Shane with JPMorgan.
In my office, I keep a note that says it's never different this time. However, when we examine the refinancing environment, the distribution of outstanding mortgages is unlike anything we've seen before. It's not a bell curve; it's a barbell. Over the last three years, borrowers have been sold mortgages with the expectation that they would be able to refinance. I believe we might finally be on the verge of a transformation in the mortgage origination process due to technology. Are you observing different behaviors in terms of speeds? Is this a risk we should be considering at this moment?
Yes to all of the above. That’s one of the reasons I mentioned before about wanting more down-rate protection, especially since the administration is focused on mortgage rates and housing affordability, which are very important factors. To provide some context on the refinance outlook, from a mortgage perspective, we consider refinancing when mortgages are about 50 basis points in the money. Currently, with mortgage rates around 6%, only 20% of the market has this 50 basis point incentive. This mortgage rate has remained consistently at 6% or above and is likely to stay high, making it difficult for the 10-year yield to drop below 4%. A full drop of 100 basis points to 5% would increase the refinanceable percentage to 30% of the universe. It would take a 200 basis point decline in the mortgage rate to 4% for 40% of the universe to be refinanceable. Therefore, a significant move in mortgage rates is necessary for a large prepayment event. That said, we are consistently seeing a lot of capacity in the system for refinance activity. Technology is making a difference; for instance, in the last quarter when the mortgage rate briefly fell below 6.15%, we observed a rapid increase in refinance activity. This suggests a pent-up demand and the capacity to process those loans more quickly than usual. These factors are why we are seeking more down rate protection and will likely maintain a positive duration gap. We continuously optimize our portfolio's asset composition to ensure we have the best possible characteristics for prepayment protection. While that percentage has been around 75% to 76%, we have been operating at 80% or above. For our higher coupons, we aim for that percentage to be quite high. Lastly, regarding prepayment outlook, we have focused our purchases in the production coupon range of 5% to 5.5%, leading to a concentration of our portfolio now between 4.5% and 5.5%, providing us with additional prepayment protection.
Got it, Peter, this is why I love this job. That's such an interesting answer. I do appreciate it. If I can ask one follow-up, which is that as policymakers are looking for ways to improve affordability, do you see levers out there that are available to reduce the incentive that borrowers need to narrow that 50 basis points in a way that could increase speeds as well?
I'll address that in two parts because it's quite intriguing. Firstly, there is significant capacity in the mortgage origination sector right now. Anecdotal evidence suggests that some mortgage borrowers are refinancing with incentives as low as 25 basis points, rather than the typical 50 basis points. This trend could be attributed to advancements in technology and lower associated costs. The location plays a crucial role in refinancing expenses, as factors such as state regulations, local conditions, title fees, taxes, and recording costs can vary significantly. There are potential actions that could further streamline the process. For example, government-sponsored enterprises (GSEs) have, at times, waived appraisals and considered insurance waivers for refinancing scenarios. This is an interesting development, although I’m unsure if it will be implemented, as it carries certain risks. This reflects the GSEs and regulators' efforts to enhance refinancing options, including adjustments to guarantee fees. Moreover, I want to highlight the administration's current focus on mortgage spreads, which I believe is unprecedented. The Treasury Secretary has specifically pointed out the difference between mortgage rates and risk-free rates, signaling that they may take steps to further stabilize or reduce this spread, which could, in turn, affect mortgage rates and refinancing options. The Treasury's focus on the 10-year bond is also noteworthy. We should monitor any changes they may make regarding the blend of short-term and long-term issuance. Regarding GSE reform, there are still potential improvements, particularly concerning how mortgage-backed securities (MBS) are treated from a capital standpoint under new banking regulations. This could influence refinancing activity and might prompt adjustments to capital requirements for Agency MBS, depending on how the reform progresses. There are many possibilities and ongoing developments, making this an exceptionally interesting time.
Next question will come from Trevor Cranston with Citizens JMP.
Peter, you painted a pretty positive picture in terms of the supply-demand outlook for MBS. I guess the other thing that could have a major impact on spreads would be implied volatility and how that's being priced. So can you maybe share your outlook on volatility if you think there's room for that to continue coming down or if there are things you guys are thinking about that could cause that to move back to a higher level?
It's a great question. I think it's really important because we discussed earlier where spreads are today, which are closer to the lower end of the range. The key question now is whether we will see a rebound back into the range or if there are reasons for spreads to rise from these lows and move back toward the middle of the range, as has historically happened. There are factors evolving that will influence spreads in various directions. My outlook on spreads from a macro perspective is that over the last few years, there were many uncertainties regarding where the upper end of the range lies due to monetary policy, fiscal policy, geopolitical risks, the Fed tightening its monetary policy, and balance sheet runoff. Today, I feel confident in the upper end of the spread range, but I have reservations about the lower end, as there are several factors that could potentially push spreads below this point. The administration is paying attention to spreads, and we see an improving demand outlook while supply remains relatively stable. The funding market is also noteworthy because the Fed is nearing a pivotal moment regarding its balance sheet. Given the current funding rates, I expect the Fed to wrap up its balance sheet soon, possibly announcing it this meeting for November or December. By the end of the year, I anticipate they will have achieved this, considering how the funding markets are acting. Additionally, they are contemplating other changes that may benefit the repo market, which is a positive development. Furthermore, the treasury's focus on GSE reform suggests they are actively seeking measures to enhance the spread outlook. From a volatility standpoint, we are witnessing a favorable evolution in monetary policy, which bodes well for volatility. If we see clarity on tariffs in the coming month or two, we could maintain a relatively stable volatility environment for interest rates. All of these factors indicate that there is potential for mortgages to move below the lower end of the range, and overall, there are fewer reasons to worry about mortgages widening, especially in surpassing the upper end of the range, while more factors suggest they could dip below the lower end.
Yes. Okay. That makes sense. And then you guys recently announced the creation of these current coupon indices. Can you maybe just briefly talk about kind of what the economics are for AGNC and if there's kind of any other things you guys are sort of exploring on the like third-party asset management side of things?
Yes, we did that not for economic reasons. We invested considerable time in creating that index because we believed it would be advantageous to the market. The mortgage market is often misunderstood and lacks transparency. Even though there's a significant fixed income market, retail investors find it challenging to access and gather information about it. Without a Bloomberg terminal, it's tough to understand mortgage behavior. Currently, there is only one main benchmark for mortgage performance, the Bloomberg Mortgage Index, which covers the entire $9 trillion market and has characteristics different from other market segments. The average coupon on the Bloomberg Aggregate Index is around 3.5%. When investors buy into a bond fund, they gain exposure to this index and receive an average coupon of about 3.5%. However, there's no index indicating the characteristics of a newly originated mortgage coupon. Therefore, we developed an index that rebalances monthly, providing the optimal mix of the two coupons around the par coupon, which is currently at 5%. This gives investors more insights. We’ve made the entire performance history available on our website, eliminating the need for a Bloomberg terminal. Our aim is to enhance transparency, giving investors more information and understanding, which could also support other measures. There is one ETF focused on the current coupon, offering a way for investors to access this par price production coupon. We believe that providing more information can help attract more investors to the fixed income asset class.
Next question will come from Doug Harter with UBS.
It's actually Marissa Lobo on for Doug today. If you could talk to us about your view of optimal leverage in the current spread and ball environment?
Yes. Yes. Well, I would say right now, you look at our leverage, we're sort of operating right where we have normally been. It was a little higher at times when mortgages were cheaper, we're back to around 7.5x leverage, as Bernie mentioned, I think that's a good place to be. We think we're at that unencumbered cash, which is 66% of our equity. So we have a lot of flexibility. And what I would just say is that given all that flexibility and given all the considerations and the factors that we are looking at, as they evolve, over the next couple of months. Those factors will inform whether or not we want to continue to operate with this leverage or higher leverage or lower leverage. But certainly at this level, we have a lot of capacity, a lot of flexibility, and we're able to generate really attractive returns.
And I know you touched on this with Trevor's question. But what do you see as the biggest near-term risk to your constructive view on spreads?
I think the main issues are macroeconomic in nature. If there were a significant change in fiscal policy that affected the inflation outlook, it might not be reflected in the market yet. Additionally, if inflation and volatility rise, and the Fed needs to pause, that would create pressure on fixed income in general and specifically on Agency MBS. Right now, those are the key macroeconomic factors. Should there be a major shift in tariff policy or if the Fed perceives a dramatic change in the inflation outlook, they would need to adjust their approach. However, any change in the inflation outlook would likely need to be substantial, and it seems that tariffs are currently seen by the Fed as a one-time price adjustment rather than an ongoing inflationary issue. It would require something significant, and this inflation pressure would need to be strong enough to counter the visible weakening in the labor market, which the Fed will have to address.
The next question will come from Kenneth Lee with RBC Capital Markets.
Just one from me. And I think you've touched upon this briefly. In terms of the hedges, net duration gap didn't change that much. Is the thinking here that it could potentially be more positive over the near term as you look to get more down rate protection, but I just wanted to get your thoughts around that?
Yes, we would like to operate with a possibly larger duration gap than we currently have. Right now, it's around 0.2, which isn't very substantial. However, with the 10-year rate at about 4% or slightly below, there is a near-term risk that this rate could rise rather than fall. Therefore, there may be a time in the future when we aim for a higher duration gap, but given the current rate, that may not be the right moment.
Your next question will come from Harsh Hemnani with Green Street.
You touched on this in the prepared remarks a little bit, but there's two ways to manage that down rate risk. The first is asset selection, as you mentioned, and the second would be the path you took this quarter was maybe expanding TBAs and getting outright convexity hedges. Given that you've deployed all the capital you raised in, call it, the second quarter and third quarter, was this sort of a decision driven by sizing at all in the sense that it might be harder for you to source those specified pools in the market at this time or at the speed you would like to? Anything on that front in terms of sizing?
Yes. No, it's a really good question, Harsh. Thank you. You're right. So quite often, as I mentioned, when we raise capital, we want to deploy it sort of immediately. And so we do that by buying generic kind of mortgages, TBAs or production coupons that have the most negative convexity, if you will. But what's important is that over time, we continue to refine and upgrade, if you will, our asset composition. And there's lots of opportunities and capacity to do that. In the third quarter, for example, what you don't see in our overall numbers is that we actively rotate out of certain specified pools into new specified pools as those opportunities arise as the GSEs, for example, sell new specified pools. Just to put a number on that in the third quarter, about $8 billion of our specified pools rotated and changed into different specified pools that had slightly different characteristics that we preferred more than our existing holdings. So that optimization happens all the time in our portfolio, and that is an important source of alpha generation for us. And I think that there's lots of capacity to do that. It does take some time months and quarters, but you can do that in significant size on a regular basis. And so what you'll likely see us because we are always trying to give ourselves greater down-rate protection, particularly in the current environment. You'll see us rotate out of those generic pools as opportunities arise into specified pools with certain characteristics that we think are beneficial in the current environment. It could relate to credit, it could relate to LTV, it could relate to HPA in certain areas, lots of little factors can have a big impact on the refinanceability of a mortgage.
Next question will come from Bose George with KBW.
Actually, a couple of little things for me. Peter, you mentioned the $0.05 tailwind. What's the time frame for that? Is that sort of looking at the forward curve and by the time the Fed is done? Or just any color on that?
The $0.05 reflects the impact if short-term rates, instead of being at 4.43, were approximately 100 basis points lower, aligning with the neutral rate. If this were to happen over, say, the next six months, that $0.05 would manifest during that period. It ultimately depends on how quickly the Fed reduces short-term rates or how swiftly we convert that short-term debt into swaps at the corresponding rate.
Okay. That makes sense. In terms of whether tightening spreads is positive or negative, it clearly increases your book value, but does it complicate dividend coverage? Or does the situation still balance out since you're achieving a lower return on equity with a higher dollar amount of equity?
Well, you're right in that if the entire change of our book value is due to spreads, then from an investor perspective, they get the benefit, the same economics of the benefit. So if spreads stay where they are, for example, then there's no change in our book value and the future earnings stay strong. Conversely, if the only thing that changes is that spreads tighten, then our book value goes up by the present value of those earnings that you give up. So from an investor perspective, you're sort of indifferent from a return perspective, you're going to get the same economics of the return whether it's in the form of future earnings or in book value appreciation. From that point forward, then the dividend yield on our book value would be lower. The return on our portfolio would be lower, but they would still be aligned. And from an investor perspective, they would have gotten the same economic benefit all in.
Okay. That makes sense. I have one more question about spreads. You mentioned that quantitative tightening is likely to conclude soon. However, if the Federal Reserve continues to reduce its Agency MBS holdings and reinvests in treasuries, could that lead to potential risks of spreads widening compared to treasuries?
Yes. Chairman Powell recently discussed the balance sheet situation, indicating that they are at a turning point and will stop the runoff. It has become clear that they intend to hold mostly treasury securities. However, they still need to clarify what "primarily" encompasses, which is crucial for the mortgage outlook. It could mean anything from 95% to 60%. He mentioned they will study this further and provide clarification. They have a clear mandate to manage the runoff without causing market instability, and I don’t expect them to take any actions regarding the mortgage portfolio that would disturb the market. Currently, the Fed's balance sheet runoff is about $200 billion a year, a manageable amount for the private sector, which will see those mortgages redeployed into treasuries. There are still discussions about the balance sheet and its composition that could change. As we mentioned, adjusting the composition to include more mortgages could improve mortgage affordability and potentially lower mortgage spreads and rates.
Your next question will come from Eric Hagen with BTIG.
Can you walk through the approach behind raising the preferred stock and how much leverage in the capital structure you feel like you're comfortable taking both maybe in the near and longer term. And just generally, I mean, what are the variables that you consider to raise preferred stock is like a substitute for common stock?
The transaction we completed allowed us to re-enter a market that had been inactive for about four years. We were the second transaction to succeed in that market, which featured a higher coupon than our previous issuances, aligning well with our floating rate breakevens. The 8.75% coupon performed strongly in the aftermarket, and we are pleased with the outcome. From a common shareholder perspective, if we reinvest the proceeds from the preferred stock issuance effectively, we could generate an approximate return of 16%, which translates to an additional 9% in carry benefits for our common shareholders. Following this transaction, preferred shares make up about 18% of our overall capital structure, which we believe reflects a solid balance. This percentage could be adjusted, as we have previously reached levels between 22% and 25%. We aimed to capitalize on reopening this market, as it presents opportunities for additional earnings for our common shareholders due to the preferred stock issuance.
Our last question for today will come from Jason Weaver with JonesTrading.
Peter, can you talk a little bit about how you see the prepay risk in those higher coupon 30s in the 6% and 6.5% range? I think a bit under half are spec, but what specific type of collateral protection are you focusing on there?
Yes, it's an important point. One of the reasons we provide a table showing what we call high-quality prepayment characteristics is relevant here. However, there are additional factors we consider beyond just low loan balances that are also categorized under prepayment protection. As noted in our presentation, 76% of our portfolio possesses these other characteristics. Regarding the higher coupons, on Page 8, we break down that 39% have high-quality prepayment characteristics while 37% have other significant characteristics. These additional factors, such as loan age, credit scores, geography, and specific metropolitan statistical areas, all play a crucial role. Almost all of our higher coupon loans, in the high 90s percentage, possess some form of embedded prepayment characteristics that we find favorable. Even though we hold some higher coupons that face prepayment risk in this environment, we are very aware of the characteristics of those pools and strive to source pools with traits that we believe will provide greater stability in cash flows. Thus, we have adjusted down in coupon exposure, and the higher coupons we still maintain in our portfolio have qualities that we prefer.
That's helpful. And then maybe one more for Bernie. I know you gave an unchanged book value estimate to date, but can you give me any sense of the level of liquidity into October and whether it's substantially different from your cash on hand at quarter end?
Sure. Yes, our liquidity is largely unchanged since the end of the quarter.
We have now completed the question-and-answer session. I would like to turn the conference back over to Peter Federico for concluding remarks. Please go ahead.
I want to thank everyone for joining our call today. We are pleased to report the results we achieved in the third quarter, which may be our fourth best quarter in the last decade. We are happy to provide this for our shareholders. Additionally, we remain optimistic about the outlook for the agency market and our business. We look forward to connecting with you again at the end of the fourth quarter, sometime in January.
Thank you for joining the call. You may now disconnect.