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 contain 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, thank you for your question. You're correct that we've seen a positive movement in spreads recently. As I mentioned earlier, over the past four years, the range between current coupons and the blended swap curve has been approximately 160 to 200 basis points, and we are currently closer to the lower end of that range at about 170 basis points. When considering the relationship between mortgages, swaps, and treasuries, I still believe that the expected return on equity for current coupons falls between 16% and 18%, which aligns well with our overall cost of capital. Therefore, when assessing dividend sustainability, it's important to refer to this metric since it represents the coverage of all our common and preferred stock dividends as well as our operating costs relative to our equity base. This measure has decreased by about 1% quarter-over-quarter due to the increase in our equity base and now stands at approximately 17%. This is consistent with the current trading environment for mortgages. There were some fluctuations in our net spread and dollar roll income, which dropped to $0.35, influenced by temporary factors including the expiration of some short swaps, a lower hedge ratio this quarter, and day count effects. While various elements contributed to the decline, indications suggest we are at or near a low point for this measure, and improvements in earnings are likely ahead. Overall, while spreads have indeed tightened significantly, both dividend sustainability and return perspectives appear to be well-matched at this time. I'll pause for any further questions.
All very useful. You mentioned in your prepared remarks that you significantly reduced the hedge ratio this quarter. Can you elaborate on that? What was the reason behind this decision? Are you adopting a more short-term outlook regarding rates, particularly with reduced rate declines? Additionally, what do you see as the main risks associated with the lower ratio, and how do the receiver swaptions factor into these risks?
There are several important developments concerning the hedge ratio. I previously mentioned receiver swaptions, which I will discuss further shortly. Bernie also addressed our overall hedge ratio. With the addition of receiver swaptions, we provided two hedge ratios this time. Our overall hedge portfolio decreased to approximately 68%. However, I believe the more relevant number, particularly when considering our net spread and dollar roll income, is our hedge ratio associated with our swap-based and treasury-based hedges. This ratio was 77% at the end of the quarter, indicating that 23% of our funding mix consists of short-term debt. It's essential to consider the costs of short-term debt compared to other funding costs. Last quarter, the average repo cost for short-term debt was 4.43%, which is the highest in our funding mix. As the Federal Reserve reduces rates, this cost is expected to decrease over time. When comparing our short-term debt funded at 4.43% to swap rates in the 3 to 5-year sector, there is roughly a 100 basis point additional cost, potentially translating into a $0.05 improvement as short-term rates decline. We have positioned our portfolio with this hedge ratio to capitalize on the Fed's shift toward a more accommodative monetary policy, and it appears that the likelihood of rate cuts is increasing. I expect to see the benefits from this in the coming quarters. We’ve also made adjustments to our portfolio composition based on the current rate environment and the administration’s focus on long-term rates. We are more cautious about the risks associated with lower long-term rates and increased prepayment risks in mortgages. Due to reduced volatility and our desire for more protection against falling rates, we have enhanced our position through asset selection and options. In the last quarter, we added $7 billion of receiver swaptions to provide additional down rate protection, but this receiver position complicates the hedge ratio calculation. Thus, there are two crucial aspects to our hedge composition that are significant—first, understanding the current pressures on our net spread and dollar roll income, which we believe will improve over time, and second, the 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 truly interesting and anticipated; the change in monetary policy is significant, especially for the fixed income market, which has been waiting for the Fed to adjust its stance amidst the uncertainty regarding tariffs. Now that the pivot has occurred, it appears to be gaining traction. In terms of bond fund flows, we saw $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, and then a considerable increase to $180 billion in the third quarter. Currently, we are witnessing over $8.5 billion in daily inflows, and we are on track for bond fund inflows to reach around $450 billion this year, with no signs of this slowing down. I anticipate these inflows to remain strong, especially with the Fed expected to ease rates at the upcoming meetings. Additionally, the equity market seems less optimistic in the current climate, leading to more cash sitting in money market funds. As such, I foresee continued strong bond fund flows supporting lower and middle coupons as we approach the end of the year. Another key factor influencing demand, although still somewhat uncertain, is banks' activity. They have added approximately $50 billion in mortgages this year and an interesting $200 billion in treasuries. As bank reforms are implemented, which I believe will happen in the first quarter, this should positively affect bank capital in relation to mortgage credit. This could potentially lead to increased bank demand for mortgages and a shift from treasuries to mortgages once regulations are clearer. Overall, I believe the demand outlook is stable or potentially 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 earnings to dip by about $0.01 or $0.02 more than anticipated. Bernie mentioned timing mismatches concerning our capital raising. We previously discussed this at the end of the second quarter, noting that we were slow to use those funds, which we did on purpose. Consequently, we ended the quarter with some surplus capital that we eventually allocated. This delay had an impact on our earnings, which we observed. However, as I mentioned and as Bernie pointed out, all those funds are now fully deployed, removing that headwind, which is significant. Additionally, regarding short-term debt, it's crucial to consider where short-term swap rates are positioned in relation to the neutral federal funds rate. Over the past couple of months, as the Fed has made its transitions, we saw the first rate cut, which is important. For instance, 2- and 3-year swap rates now essentially mirror the neutral federal funds rate of approximately 3.25%. We can approach this in one of two ways: we can wait for the actual rate cuts to influence our repo balance, or we can extend that into the swap market at a comparable long-run neutral rate. I anticipate this will offer a benefit in the next three to four quarters.
Next question will come from Rick Shane with JPMorgan.
In my office, I have a note that states things are never truly different this time. However, when we examine the refinancing environment, the distribution of outstanding mortgages appears unique. It's not a normal distribution; instead, it's a barbell shape. Over the past three years, many borrowers have likely been sold mortgages with the expectation of refinancing. We may finally be on the verge of seeing technology transform the mortgage origination process, something we have anticipated for two decades. Are you noticing different behaviors in terms of speeds? Is this a risk we should consider at this point?
Yes to all of the above. That's one of the reasons I mentioned earlier about wanting more protection against rate declines, especially given the administration's focus on mortgage rates and housing affordability, which are very important factors. To provide some perspective on the refinance outlook from a mortgage perspective, we consider the refinanceability of the market when mortgages are around 50 basis points in the money. Currently, with mortgage rates at approximately 6%, only 20% of the market meets this 50 basis point incentive. This rate has been stable above 6%, and it's unlikely to fall significantly below 4% for the 10-year, keeping that percentage at about 20% for now. A one hundred basis point decrease to a 5% mortgage rate would increase that percentage to 30%. Additionally, it would require a full 200 basis point drop to 4% for 40% of the market to become refinanceable. In summary, a significant move in mortgage rates is necessary for a notable increase in prepayment activity. However, we consistently observe strong capacity for refinance activity in the system. Technology is playing a crucial role in this, as seen in recent quarters. For instance, in September, when mortgage rates briefly fell below 6.15%, we noticed a rapid increase in refinance activity. This indicates pent-up demand and the ability to process these loans more quickly than usual. Therefore, we need to be aware of these dynamics, which is why we seek more protection against rate declines, and we'll likely maintain a positive duration gap. We continuously strive to optimize our portfolio's asset composition for better prepayment protection, with our prepayment protection percentage around 75% to 76%. However, we have been operating at over 80%, especially for higher coupon rates where we aim for even higher percentages. Lastly, regarding our prepayment outlook, our portfolio's coupon composition has shifted, focusing more on the production coupon range of 5% to 5.5%, with current concentrations between 4.5% and 5.5%, providing further 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 answer that in two ways because it is really fascinating. First, there's a lot of capacity in the origination business right now from a mortgage originator perspective regarding refinancing and technology. There seems to be anecdotal evidence that some mortgage borrowers are refinancing with an incentive of less than 50 basis points. It's possible that people could be refinancing for as little as 25 basis points if the technology is easy to use and costs are low. A lot depends on geography, as the state you live in, locality, title, taxes, and recording costs can vary greatly from one place to another. That's certainly a consideration. There are ways to streamline the process further. For instance, the GSEs have, at times, taken actions like waiving appraisals or other forms of insurance. There's a discussion about an insurance waiver for refinances, which is interesting. I'm not sure if that will be implemented due to associated risks. This is a clear example of the GSEs and regulators trying to find ways to improve refinanceability, and they could also adjust their g-fees. From an administrative perspective, the current administration's focus on mortgage spreads is unprecedented. I've never heard the administration and the Treasury Secretary so clearly identify the spread between mortgage rates and the risk-free rate. It's a clear sign they believe actions through potential reforms to stabilize or lower that spread will impact mortgage rates and refinanceability. They can also influence treasury issuance, with a clear focus on the 10-year. We need to watch whether they change the composition of their interest issuance, leaning more towards short-term versus long-term. Additionally, regarding the GSE reform process, I believe there's much that can be done in how they treat MBS from a capital perspective under new bank regulations. This could lead to greater refinance activity and possibly adjustments to the capital requirements for Agency MBS depending on the reform path. There's a lot that can be done, and a lot is happening, making it a very 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?
Yes, it's an important question. As previously mentioned, we're currently observing spreads at the lower end of their historical range. The essential question now is whether we will see a rebound into the range. Is there a potential for spreads to recover from these lows and return to the middle of the range, as has often been the case? Additionally, what are the evolving factors that might influence spreads in either direction? My perspective on spreads, from a macro viewpoint, is that there have been numerous uncertainties surrounding what the upper limit of the range could be over the past few years, including monetary policy, fiscal policy, and geopolitical risks, all exacerbated by the Fed's unprecedented monetary tightening and balance sheet reduction, which raised questions about the upper end of the spread range. However, I now feel quite confident about the upper limit. In contrast, I have growing concerns regarding the lower end, as several factors suggest that spreads might break below that level. The administration is currently focused on spreads, and the improving demand outlook, coupled with relatively stable supply, is noteworthy. The funding market is particularly interesting, with the Fed nearing a decision point regarding its balance sheet. Given current funding rates, I anticipate the Fed will conclude its balance sheet adjustments soon, perhaps by this meeting with an announcement for November or December, definitely by year-end, considering the behavior of funding markets. Furthermore, as I mentioned, they are also contemplating other changes that could positively impact the repo market. In terms of volatility, we are witnessing a beneficial shift in monetary policy, which should bode well for volatility levels. If clarity emerges regarding tariffs over the next month or two, we could have an environment conducive to maintaining relatively low volatility in interest rates. When you combine all these factors, they suggest that there is a likelihood for mortgages to break through the lower end of the range. Overall, there are fewer reasons to worry about mortgages widening, and an increasing number of factors indicating that they might slide through the lower end of the range.
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?
We created the index not for economic reasons, but because we believed it would be beneficial for the market. The mortgage market is often misunderstood and lacks transparency. While there's a large fixed income market, it's challenging for retail investors to access and gather information about it. Without a Bloomberg terminal, it's tough to track mortgage behavior. The main benchmark for mortgage performance is the Bloomberg Mortgage Index, which encompasses the entire $9 trillion market. The average coupon in the Bloomberg Aggregate Index is about 3.5%. Investors in a bond fund gain exposure to the mortgage market through this index, receiving an average coupon around 3.5%. However, there wasn't any index reflecting the characteristics of newly originated mortgage coupons each month. We developed an index that rebalances monthly to create the right mix around the par coupon, which currently has a yield of about 5%. This index provides investors with more information, and the performance history is available on our website, eliminating the need for a Bloomberg terminal. Our aim is to enhance transparency and offer investors more insights, which could potentially attract more investment to this 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?
Yes. I would say the key risks are primarily macroeconomic. For instance, if there were a significant shift in fiscal policy that impacted the inflation outlook, it wouldn't be reflected in the market right away. Additionally, if factors caused inflation and volatility to increase, leading the Fed to pause their actions, that could exert pressure on fixed income in general and specifically on Agency MBS. Currently, these are the main macroeconomic influences. If there is a significant change in tariff expectations or if the Fed perceives a drastic shift in the inflation outlook, they may need to adjust their approach. However, any change in inflation would likely need to be very significant and probably not related to tariffs, as the Fed seems to consider tariffs now as a fixed price change rather than an ongoing inflationary concern. Ultimately, the inflation pressures would have to be substantial enough to surpass the evident weakening in the labor market, which the Fed will need 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 prefer to operate with a slightly larger duration gap than we currently have, which is around 0.2. It's not very significant. Additionally, the 10-year rate is near 4%, and I believe the near-term risk is that this rate might increase rather than decrease. Therefore, there may come a time when we want to have a higher duration gap, but given that the rate is just below 4%, that may not be the right moment to make that change.
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 calculation reflects the potential drag if short-term rates were to shift from 4.43 to a neutral rate with a 100 basis point difference. If this change were to occur over the next six months, we could see that $0.05 impact within that time frame. It ultimately depends on how quickly the Fed decides to lower short-term rates or how we manage converting that short-term debt into swaps at comparable rates.
Okay, that makes sense. In terms of potential further tightening of spreads, is that a positive or negative development? It certainly impacts your book value, but does it complicate covering the dividend? Or does the calculation still hold since you're obtaining a lower return on equity on a larger 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 if quantitative tightening is likely to be concluded soon. But if the Fed continues to sell off Agency MBS and reinvests in treasuries, does that introduce a potential risk for spreads widening compared to treasuries?
Yes. Chairman Powell recently mentioned in his meeting that they are at a turning point for the balance sheet and plan to end the runoff. It is now clear they intend to do so. He continues to refer to the current guidance, which indicates they will mainly hold treasury securities. However, they have not specified what "primarily" means, which is significant for the mortgage outlook. "Primarily" could imply 95% or 60%, and that is an important distinction. He stated they will review and clarify this. Importantly, they are expected to manage the runoff in a way that avoids market instability, which he highlighted. Therefore, I do not anticipate any actions regarding the mortgage portfolio that would destabilize the market. Currently, the Fed's balance sheet runoff is about $200 billion a year, a manageable amount of mortgages that the private sector can handle, which will be redeployed into treasuries. There is ongoing discussion that may affect the balance sheet's composition. Ultimately, as we discussed, this could be a significant factor that the government believes would enhance mortgage affordability by altering the composition to include mortgages. If that occurs, it would likely put downward pressure on 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?
Sure. It was great to be able to access that market again, especially since we had shut off from it for about five years. This market has been inactive for roughly four years, so reopening it was significant. We were the second transaction to complete in that market, and from our perspective, the coupon rate was higher than what we had issued before. However, it aligned well with our floating rate breakevens, coming in at an 8.75% coupon, which performed very well in the aftermarket. We're pleased with this outcome. For our common shareholders, the important takeaway is that we expect to generate a return by utilizing the proceeds from this preferred issuance. Simplifying it, we anticipate a return around 16%, which means an additional 9% in carry to benefit our common shareholders. We aimed to increase our issuance of preferred stock, and after this transaction, it now represents about 18% of our overall capital mix, which we feel is a good balance in our capital structure. There is potential for that percentage to increase; it has been as high as 22% to 25% in the past. We wanted to leverage the reopening of this market because we believe it will lead to additional earnings for our common shareholders as a result of the preferred stock.
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, that's a crucial point. One of the reasons we provide a table highlighting what we refer to as high-quality prepayment characteristics is to address this. There are additional characteristics we consider beyond just low loan balance that also offer prepayment protection. I mentioned earlier that 76% of our portfolio includes these other characteristics. Regarding the higher coupons, on Page 8, we indicate that 39% have high-quality prepayment characteristics and 37% include other important characteristics. These additional features significantly impact performance and may include loan age, credit, FICO scores, and geographic factors, as well as specifics related to certain MSAs. Nearly all of the higher coupons, particularly in the high 90s percentage, incorporate some form of embedded prepayment characteristics that we favor. Although these higher coupons do face prepayment risk, especially in the current environment, we remain aware of the characteristics of those pools and seek to source pools that we believe will provide greater stability in cash flows. We have adjusted our portfolio to reduce exposure to higher coupons, but those we retain possess attributes that we find favorable.
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 quarter end.
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 our third-quarter results, which may be among our fourth best quarters in the last decade. We're happy to provide this for our shareholders. As I mentioned, we remain optimistic about the agency market and our business outlook. We look forward to speaking with you again after the fourth quarter, sometime in January.
Thank you for joining the call. You may now disconnect.